d870401_14-a.htm

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

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MICREL, INCORPORATED

(Name of Registrant as Specified in Its Charter)

Obrem Capital Offshore Master, L.P.

Obrem Capital (QP), L.P.

Obrem Capital Management, LLC

Obrem Capital (GP), LLC

Andrew Rechtschaffen

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Letter sent to Micrel, Incorporated dated March 12, 2008

March 12, 2008

Micrel, Inc.

2180 Fortune Drive

San Jose, CA 95131

USA

Micrel Board of Directors c/o: Mr. Raymond D. Zinn, Chairman of the Board

Dear Sirs:

As of the date of this letter Obrem Capital Management (“Obrem”) owns approximately 6.9 million shares of Micrel (“Micrel” or “the Company”), representing approximately 9.62% of the outstanding shares. We are writing to request a meeting with the Board of Directors (“the Board”) of Micrel as soon as practical. We believe that shares of Micrel are substantially undervalued by the market and seek to engage the Board to proactively enhance shareholder value.

Obrem believes that Micrel’s management has failed to create shareholder value1 over the past decade despite the Company’s multiple competitive strengths, which include: 1) a strong technology platform, 2) valuable manufacturing know-how, 3) an attractive customer base, 4) a cash-rich, debt-free balance sheet, and 5) a solid reputation within the semiconductor industry.

Despite these strengths, Micrel has underperformed its high-performance analog “Peer Group”2 on numerous financial metrics, including:

Revenue growth (see Table 1)

EPS growth (see Tables 2-3)

Operating margin (see Tables 4-6)

Share price performance (see Chart 1 and Tables 7-8)

We believe there are several reasons for Micrel’s significant underperformance, including:

Insufficient manufacturing scale

A poorly developed outsourcing strategy and cost reduction roadmap

A bloated cost structure

After significant analysis and discussion with industry experts, we have concluded that the Board would maximize value for Micrel’s shareholders by selling the Company to a strategic buyer. We believe a diligent review by the Board will result in a similar view. We hope that, at a minimum, the Board will fulfill its fiduciary responsibility and create an independent special committee to examine strategies to maximize shareholder value.

1 Shares of Micrel were $9.125, adjusted for splits, on Friday, March 13, 1998.

2 The “Peer Group” is defined as Analog Devices, Intersil, Linear Technology, Maxim Integrated Products, Microsemi, Monolithic Power Systems, O2 Micro International, Semtech, and Texas Instruments.

I.	Micrel’s Historical Performance

Despite Micrel’s numerous strengths, the Company has underperformed its peer group, the broader analog sector, and the entire semiconductor industry since 1999. This is demonstrable using a wide variety of short-term and long-term metrics.

Revenue growth. Between 1999 and 2007, Micrel’s revenue increased from $200.0mn to $258.0mn, a 3.2% CAGR, well below the 6.5% CAGR of the analog industry as a whole, and below that of relevant industry comparables. From 2002 (the industry bottom) through 2007, Micrel’s revenue CAGR has been just 4.7%, significantly below the overall analog industry CAGR (8.8%) and the semiconductor industry CAGR (12.6%). Excluding the revenue generated by the Kendin acquisition (purchased in 2001), which accounted for approximately 14% of 4Q 2007 revenue,3 top-line growth has been even weaker. In fact, according to data from the WSTS, in six of the last seven years Micrel’s revenue growth has trailed that of the analog sector as a whole (see Table 1).

Table 1: Revenue of Analog Sector, Semiconductor Industry and Micrel 1999-2007

	1999	2000	2001	2002	2003	2004	2005	2006	2007	CAGR 99-07	CAGR 02-07
Analog Sector ($bn)	22	31	23	24	27	31	32	37	37	6.5%	8.8%
y/y growth		38.0%	-23.9%	3.0%	12.1%	17.2%	1.6%	15.7%	-1.1%
Semiconductor Industry ($bn)	149	204	139	141	167	213	228	248	254	6.9%	12.6%
y/y growth		36.8%	-32.0%	1.2%	18.3%	27.9%	6.8%	8.9%	2.7%
Micrel (Smn)	200	346	218	205	212	258	250	273	258	3.2%	4.7%
y/y growth		73.2%	-37.1%	-6.0%	3.4%	21.7%	-2.8%	9.2%	-5.6%

Source: Company reports, WSTS

EPS growth. Micrel’s EPS growth compares unfavorably with its Peer Group, with 2007 EPS of $0.50 just 30% higher than its 1999 EPS of $0.394, and below 2000 (“Tech Bubble”) levels. Micrel’s EPS CAGR from 1999 through 2007 is just 3.3% (see Table 2).

Table 2: Micrel Non-GAAP EPS 1999-2007

	1999	2000	2001	2002	2003	2004	2005	2006	2007	EPS CAGR 1999-2007
Micrel	$0.39	$0.81	$0.17	($0.06)	$0.05	$0.27	$0.36	$0.54	$0.50	3.3%

Source: Micrel filings

The EPS growth of Micrel’s high-performance analog Peer Group is significantly above Micrel’s (see Table 3).

3 Using Ethernet revenue as a proxy for Kendin, with figures provided by Micrel CFO Rick Crowley on the 4Q07 conference call, January 31, 2008.

4 Adjusted for stock splits.

Table 3: Non-GAAP EPS Micrel and comparable group 1999 and 2007

		1999		2007	EPS CAGR1 1999-2007
Analog Devices	$	0.73	$	1.53	9.7%
Linear Technology	$	0.70	$	1.69	11.6%
Maxim2	$	0.79	$	1.17	5.0%
Microsemi	$	0.05	$	0.85	42.5%
Semtech	$	0.42	$	0.68	6.2%
Texas Instruments	$	0.90	$	1.96	10.2%
Micrel	$	0.39	$	0.50	3.3%

1 EPS has been calendarized to provide consistency.

2 2007 is based on consensus analyst estimates as company is delinquent in filings.

Source: Company filings, Bloomberg

We have excluded Intersil, Monolithic Power and O2 Micro from this comparison since they all went public at later dates; however, each of them has achieved significantly more rapid EPS growth than Micrel.

Operating margin. Micrel’s operating margin of 18.4% in 2007 was at the lower end of its high-performance analog industry Peer Group. In 2007, companies in the Peer Group had operating margins ranging from a low of 13.7% to a high of 54.0%, with Micrel ranking among the bottom three (see Table 4).

Table 4: Operating margin1 of Micrel and Peer Group

	2007 Revenues ($mn)	2007 Operating Margin
Analog Devices	2,662	21.2%
Intersil	757	27.9%
Linear Technology	1,093	54.0%
Maxim2	2,070	36.0%
Microsemi	463	24.4%
Monolithic Power	134	22.5%
O2 Micro	166	15.7%
Semtech	285	13.7%
Texas Instruments	13,834	25.3%
Micrel	258	18.4%

1 EPS has been calendarized to provide consistency.

2 2007 is based on consensus analyst estimates as company is delinquent in filings.

Source: Company filings, Bloomberg

Perhaps more importantly, Micrel’s current operating margins compare poorly to its own historical levels. Micrel achieved “tech bubble” peak operating margins of 32.8% in 2000 and had 26.4% operating margins in 1999, but in 2007 had operating margins of just 18.4% (see Table 5).

Table 5: Micrel Margins 1999, 2000, 2007

	1999	2000	2007
Gross margin	55.7%	57.6%	57.1%
Operating Margin	26.4%	32.8%	18.4%

Source: Company filings, Bloomberg

Over the last 5 years, Micrel has returned its gross margins to historically high levels but appears to be doing so with a bloated operating expense structure. It is noteworthy that Micrel’s operating income in 2007 was roughly flat with 1999 despite almost 30% higher revenue. All of Micrel’s Peer Group companies, except for Maxim and Semtech, exceeded their own 1999 operating margins in 2007 (see Table 6).

Table 6: Peer Group Operating Margins

	1999	2000	2007
Analog Devices	20.0%	31.6%	21.2%
Intersil	10.5%	16.3%	27.9%
Linear Technology	51.5%	55.6%	54.0%
Maxim2	40.1%	37.9%	36.0%
Microsemi	3.6%	9.6%	24.4%
02 Micro	2.9%	14.4%	15.7%
Semtech	25.0%	29.9%	13.7%
Texas Instruments	20.4%	22.8%	25.3%
Micrel	26.4%	32.8%	18.4%

1 EPS has been calendarized to provide consistency.

2 2007 is based on consensus analyst estimates as company is delinquent in filings.

Source: Company filings, Bloomberg

Share price performance. Shares of Micrel have underperformed their Peer Group over the last decade (see Chart 1 and Table 7).

Chart 1: Peer Group Share Price Performance

March 13, 1998-March 12, 2008

Table 7: Peer Group price performance March 13, 1998 to March 12, 2008

Company	Price on 13-Mar-98		Price on 12-Mar-08		Percent Change
Analog Devices	$	16.88	$	27.84	65.0%
Linear Technology	$	17.72	$	29.72	67.7%
Maxim	$	18.97	$	17.95	(5.4%)
Microsemi	$	4.63	$	21.18	357.9%
Semtech	$	6.53	$	13.64	108.8%
Texas Instruments	$	13.55	$	28.38	109.5%
Semiconductor Industry (SOX)		294.99		345.13	17.0%
Micrel	$	9.13	$	8.27	(9.4%)

Source: Bloomberg

In addition, Table 8 illustrates that Micrel underperformed relevant peers from the time of their IPOs through today.

Table 8: Micrel stock price performance versus recently IPOd Peer Group

Company	IPO Date	Price on IPO date		Price on 12-Mar-08		Percent Change
Intersil	10-Sep-99	$	31.12	$	25.38	(18.4%)
Micrel		$	24.22	$	8.27	(65.9%)

02 Micro	23-Aug-00	$	20.77	$	8.01	(61.4%)
Micrel		$	60.44	$	8.27	(86.3%)

Monolithic Power	18-Nov-04	$	8.50	$	16.91	98.9%
Micrel		$	11.89	$	8.27	(30.4%)

Source: Bloomberg

II.	Obrem has analyzed Micrel’s strengths and weaknesses and believes there are several issues that continue to weigh on Micrel’s performance.

Insufficient manufacturing scale. Micrel owns a 6” fab, with a 28,000 square foot clean room facility based in San Jose, California. Despite consolidating its two fabs into a single facility, Micrel’s fab remains significantly underutilized at 57% utilization in 4Q07 (down from 60% in 3Q07), with management guiding for further declines in 1 Q08.5 Obrem believes that Micrel lacks the scale to fully benefit from ownership of its fab. Micrel has indicated that it could achieve gross margins in the 60%- 70% range if it could increase revenue to over $80mn per quarter.6 However, management has not indicated that it expects to achieve such growth in the foreseeable future.7 Our analysis suggests that Micrel’s underutilized fab could prove a valuable asset to a company with production levels that could more adequately utilize the fab.

Poorly developed outsourcing strategy and cost reduction roadmap. Micrel produced 95% of its parts in-house (with Ethernet representing the outsourced portion) in 2007. While in-house manufacturing enhances capacity utilization, we believe that Micrel is at a competitive disadvantage in terms of its manufacturing strategy. Though analog development is not driven by Moore’s law to the same extent as digital ICs, Micrel’s high-performance analog competitors have taken advantage of 8” wafers, smaller feature sizes (extending as low as .18 micron), and standard manufacturing processes.8 There are times where utilizing a foundry can help reduce costs and use of 8” capacity can be beneficial.9 However, Micrel is in a challenging position as incremental outsourcing would further reduce already depressed utilization. Furthermore, Micrel does not have adequate revenue to justify the costs to upgrade to an 8” facility. Micrel has competed more successfully in certain high-end markets (i.e. handsets), but less so in mid-range and low-end markets, which Obrem believes could reflect a somewhat limited cost reduction roadmap. Several upstarts, such as Monolithic Power (founded in 1997 by former Micrel employees Michael Hsing and Jim Moyer), have been able to garner healthy market share and generate gross margins in the 60-65% range. By having a well defined outsourcing and cost reduction roadmap, they have benefited by being fabless and have grown significantly despite having far less industry experience and customer rapport than Micrel. To our knowledge, Micrel does not possess a clear cost reduction roadmap via the use of outsourcing to foundries.10

5 According to Micrel 4Q07 conference call transcript, held 1/31/08.

6 Micrel 2006 and 2007 Analyst Days. Multiple analyst reports citing Micrel management.

7 According to Micrel 4Q07 conference call transcript, 1/31/08, the Company expects revenue growth in excess of the market in 2008, which is unlikely to result in revenue growth of this magnitude. Notably, in Micrel’s 1Q07 call (transcript 4/25/07) management guided growth in excess of the Company’s forecast semiconductor industry market growth of 5-10%. Micrel’s revenue declined 5.6% in 2007.

8 See p117 of Intersil’s 2008 Analyst Day presentation, commentary from others in Peer Group, and fact that several in Peer Group have modified/upgraded 6 “ facilities to 8”.

9 See note 8.

10 Micrel management has indicated that its capital spending for 2008, projected at $16-22mn, will in part fund technology for smaller process technologies, but management has not articulated a cost reducing outsourcing strategy.

Bloated cost structure. Micrel currently enjoys gross margins that are toward the higher-end of the analog segment. Despite these solid gross margins, and the steady improvement it has enjoyed from a low of 28% in 3Q02, Micrel has surprisingly low operating margins. Although Micrel’s revenue has grown 30% since 1999, operating margins have declined 800bps. This compares unfavorably with almost all of its competitors, with only Maxim and Semtech below 1999 operating margin levels. Obrem believes that while Micrel has effectively focused on pursuing higher gross margin business, the Company has been unable to adequately manage overall expense growth.

III.	Conclusion

While Obrem acknowledges the significant ongoing share repurchases by the Company, management has failed to create permanent value for shareholders. We believe that the market continues to significantly undervalue Micrel’s shares and we call upon the Board to take action to rectify this situation.

Unfortunately, Obrem believes that management will be challenged to overcome the issues that we have outlined. Management on numerous occasions has discussed design wins, excitement regarding new customers and products, and strong order growth.11 Despite this enthusiasm, however, Micrel has consistently grown below market rates. There is no evidence to suggest that Micrel can accelerate sales growth to better leverage operating expenses or significantly improve utilization. In addition, management has not articulated an outsourcing strategy or a cost reduction roadmap. We doubt that management can surmount the Company’s challenges and feel it is incumbent upon the Board to explore options to create permanent shareholder value.

Obrem believes there is a simple solution. All of these issues could be resolved by a sale to a larger semiconductor company. Numerous competitors could benefit from Micrel’s manufacturing expertise and would ensure high utilization, increasing the gross margin profile of the fab. An acquirer could quickly migrate some of Micrel’s parts to foundries, lower costs, and fill Micrel’s fab with appropriate 6” parts. In addition, Micrel’s product roadmap could be enhanced with die shrinks and new processes to lower costs and open additional markets. Alternatively, an acquirer could close the fab, move some production in-house and some to foundry partners, and immediately reduce significant overhead. When factoring in the significant potential operational synergies as well as potential top-line benefits from cross-selling products and opening new channels, an acquirer could pay a substantial premium to acquire Micrel shares in an accretive transaction.

We appreciate the Board’s attention to this matter. As interested and committed shareholders we look forward to a response within one week of receipt of this letter and would appreciate a meeting with the Board as soon as possible to discuss the issues that we have raised.

Sincerely,

Andrew Rechtschaffen

Managing Member, Obrem Capital Management

Eric Gomberg

Senior Analyst, Obrem Capital Management



cc:	Michael J. Callahan

	David W. Conrath

	Neil J. Miotto

	Frank W. Schneider

11 See multiple earnings call transcripts, analyst days, etc.

Letter sent to Micrel, Incorporated dated March 25, 2008

OBREM CAPITAL MANAGEMENT, L.L.C.

VIA FACSIMILE AND REGISTERED MAIL

Attention	Mr. Raymond D. Zinn, Chief Executive Officer and Chairman of the Board of Directors
	Mr. Richard D. Crowley, Jr., Vice President, Finance and Chief Financial Officer
	Mr. Vince Tortolano, Vice President, General Counsel and Secretary