10-Q 1 form10q_063003.txt MICREL FORM 10-Q PERIOD ENDED 6-30-03, TEXT VERSION UNITED STATES SECURITIES AND EXCHANGE COMMISSION WASHINGTON, D.C. 20549 FORM 10-Q (Mark One) [X] QUARTERLY REPORT PURSUANT TO SECTION 13 or 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the quarterly period ended June 30, 2003. or [ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the transition period from to . Commission File Number 0-25236 M I C R E L, I N C O R P O R A T E D (Exact name of Registrant as specified in its charter) California 94-2526744 (State or other jurisdiction of (I.R.S. Employer incorporation or organization) Identification No.) 2180 Fortune Drive, San Jose, CA 95131 (Address of principal executive offices) (Zip Code) Registrant's telephone number, including area code: (408) 944-0800 Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes [X] No [ ] Indicate by check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Act. Yes [X] No [ ] As of July 31, 2003 there were 92,351,486 shares of common stock, no par value, outstanding. MICREL, INCORPORATED INDEX TO REPORT ON FORM 10-Q FOR THE THREE AND SIX MONTHS ENDED JUNE 30, 2003 Page ---- PART I. FINANCIAL INFORMATION Item 1. Financial Statements: Condensed Consolidated Balance Sheets - June 30, 2003 and December 31, 2002 3 Condensed Consolidated Statements of Operations - Three and Six Months Ended June 30, 2003 and 2002 4 Condensed Consolidated Statements of Cash Flows - Three and Six Months Ended June 30, 2003 and 2002 5 Notes to Condensed Consolidated Financial Statements 6 Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations 13 Item 3. Quantitative and Qualitative Disclosures about Market Risk 26 Item 4. Controls and Procedures 26 PART II. OTHER INFORMATION Item 1. Legal Proceedings 27 Item 4. Submission of Matters to a Vote of Security Holders 27 Item 6. Exhibits and Reports on Form 8-K 28 Signature 28 2 ITEM 1. FINANCIAL STATEMENTS
MICREL, INCORPORATED CONDENSED CONSOLIDATED BALANCE SHEETS (Unaudited) (In thousands, except share amounts) June 30, December 31, 2003 2002 (1) ------------ ------------ ASSETS CURRENT ASSETS: ---------- ---------- Cash and cash equivalents $ 123,466 $ 117,363 Accounts receivable, net 28,656 29,577 Inventories 37,584 39,531 Other current assets 2,595 2,675 Deferred income taxes 30,748 30,828 ---------- ---------- Total current assets 223,049 219,974 PROPERTY, PLANT AND EQUIPMENT, NET 90,223 92,318 DEFERRED INCOME TAXES 8,775 9,606 INTANGIBLE ASSETS, NET 6,942 8,387 OTHER ASSETS 439 390 ---------- ---------- TOTAL $ 329,428 $ 330,675 ========== ========== LIABILITIES AND SHAREHOLDERS' EQUITY CURRENT LIABILITIES: Accounts payable $ 10,329 $ 13,026 Taxes payable 2,510 3,405 Deferred income on shipments to distributors 10,965 9,832 Other current liabilities 11,763 10,645 Current portion of long-term debt 856 911 ---------- ---------- Total current liabilities 36,423 37,819 LONG-TERM DEBT 10,478 10,983 OTHER LONG-TERM OBLIGATIONS 5,725 8,254 SHAREHOLDERS' EQUITY: Preferred stock, no par value - authorized: 5,000,000 shares; issued and outstanding: none -- -- Common stock, no par value - authorized: 250,000,000 shares; issued and outstanding: 2003 - 92,089,079 shares; 2002 - 92,006,571 shares 161,221 160,889 Deferred stock compensation (6,380) (9,971) Accumulated other comprehensive loss (26) (25) Retained earnings 121,987 122,726 ---------- ---------- Total shareholders' equity 276,802 273,619 ---------- ---------- TOTAL $ 329,428 $ 330,675 ========== ========== (1) Derived from the audited balance sheet included in the Annual Report on Form 10-K of Micrel, Incorporated for the year ended December 31, 2002. See Notes to Condensed Consolidated Financial Statements.
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MICREL, INCORPORATED CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS (Unaudited) (In thousands, except per share amounts) Three Months Ended Six Months Ended June 30, June 30, -------------------- -------------------- 2003 2002 2003 2002 --------- --------- --------- --------- NET REVENUES $ 49,109 $ 55,363 $ 100,064 $ 103,688 COST OF REVENUES* 30,880 34,139 61,291 64,816 --------- --------- --------- --------- GROSS PROFIT 18,229 21,224 38,773 38,872 OPERATING EXPENSES: Research and development 12,136 13,009 24,825 26,371 Selling, general and administrative 6,582 8,874 13,574 16,869 Amortization of deferred stock compensation* 915 2,459 1,681 5,052 --------- --------- --------- --------- Total operating expenses 19,633 24,342 40,080 48,292 --------- --------- --------- --------- LOSS FROM OPERATIONS (1,404) (3,118) (1,307) (9,420) OTHER INCOME (EXPENSE), NET 181 (476) 347 588 --------- --------- --------- --------- LOSS BEFORE INCOME TAXES (1,223) (3,594) (960) (8,832) BENEFIT FOR INCOME TAXES (310) (3,864) (221) (5,121) --------- --------- --------- --------- NET INCOME (LOSS) $ (913) $ 270 $ (739) $ (3,711) ========= ========= ========= ========= NET INCOME (LOSS) PER SHARE: Basic $ (0.01) $ 0.00 $ (0.01) $ (0.04) ========= ========= ========= ========= Diluted $ (0.01) $ 0.00 $ (0.01) $ (0.04) ========= ========= ========= ========= SHARES USED IN COMPUTING PER SHARE AMOUNTS: Basic 92,171 92,984 92,105 93,045 ========= ========= ========= ========= Diluted 92,171 96,287 92,105 93,045 ========= ========= ========= ========= * Amortization of deferred stock compensation related to: Cost of revenues $ 290 $ 784 $ 591 $ 1,552 ========= ========= ========= ========= Operating expenses: Research and development $ 500 $ 1,367 $ 1,009 $ 2,727 Selling, general and administrative 415 1,092 672 2,325 --------- --------- --------- --------- Total operating expenses $ 915 $ 2,459 $ 1,681 $ 5,052 ========= ========= ========= ========= See Notes to Condensed Consolidated Financial Statements.
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MICREL, INCORPORATED CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS (Unaudited) (In thousands) Six Months Ended June 30, --------------------- 2003 2002 --------- --------- NET CASH FLOWS PROVIDED BY OPERATING ACTIVITIES: Net loss $ (739) $ (3,711) Adjustments to reconcile net income (loss) to net cash provided by operating activities: Depreciation and amortization 15,087 17,225 Stock based compensation 2,272 6,604 Loss on disposal of assets -- 73 Deferred rent 15 29 Deferred income taxes 911 (3,186) Changes in operating assets and liabilities: Accounts receivable 921 (1,551) Inventories 1,947 (8,699) Prepaid expenses and other assets 31 2,975 Accounts payable (2,697) 2,438 Income taxes (1,671) -- Other accrued liabilities (1,426) (2,259) Deferred income on shipments to distributors 1,133 (1,986) --------- --------- Net cash provided by operating activities 15,784 7,952 --------- --------- CASH FLOWS FROM INVESTING ACTIVITIES: Purchases of property, plant and equipment (11,547) (5,698) Purchase of intangible asset -- (2,054) Proceeds from sales and maturities of short-term investments -- 3,015 --------- --------- Net cash used by investing activities (11,547) (4,737) --------- --------- CASH FLOWS FROM FINANCING ACTIVITIES: Repayments of long-term debt (560) (2,190) Proceeds from the issuance of common stock, net 2,426 5,594 Repurchase of common stock -- (18,286) --------- --------- Net cash provided (used) by financing activities 1,866 (14,882) --------- --------- NET INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS 6,103 (11,667) CASH AND CASH EQUIVALENTS - Beginning of period 117,363 130,406 --------- --------- CASH AND CASH EQUIVALENTS - End of period $ 123,466 $ 118,739 ========= ========= SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION: Cash paid during the period for: Interest $ 365 $ 153 ========= ========= Income taxes $ 549 $ 86 ========= ========= Non-cash transactions: Deferred stock compensation (reversal) $ (2,094) $ (1,739) ========= ========= Acquisition of intangible asset under patent cross license and settlement agreement $ -- $ 5,154 ========= ========= See Notes to Condensed Consolidated Financial Statements.
5 MICREL, INCORPORATED NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Unaudited) 1. SIGNIFICANT ACCOUNTING POLICIES Interim Financial Information - The accompanying condensed consolidated financial statements of Micrel, Incorporated and its wholly-owned subsidiaries ("Micrel" or the "Company") as of June 30, 2003 and for the three and six months ended June 30, 2003 and 2002 are unaudited. In the opinion of management, the condensed consolidated financial statements include all adjustments (consisting only of normal recurring accruals) that management considers necessary for a fair presentation of its financial position, operating results and cash flows for the interim periods presented. Operating results and cash flows for interim periods are not necessarily indicative of results for the entire year. This financial data should be read in conjunction with the audited consolidated financial statements and notes thereto included in the Company's Annual Report on Form 10-K for the year ended December 31, 2002. This financial data should also be read in conjunction with the Company's critical accounting policies included in Management's Discussion and Analysis of Financial Condition and Results of Operations in the Company's Annual Report on Form 10-K for the year ended December 31, 2002. Net Income (Loss) Per Common and Equivalent Share - Basic net income (loss) per share is computed by dividing net income (loss) by the number of weighted average common shares outstanding. Diluted net income (loss) per share reflects potential dilution from outstanding stock options using the treasury stock method. The computation of diluted net loss per share, for the three months ended June 30, 2003 and the six months ended June 30, 2003 and 2002, exclude common equivalent shares since they are anti-dilutive in a loss period. Reconciliation of weighted average shares used in computing earnings per share is as follows (in thousands): Three Months Ended Six Months Ended June 30, June 30, -------------------- -------------------- 2003 2002 2003 2002 --------- --------- --------- --------- Weighted average common shares outstanding 92,171 92,984 92,105 93,045 Dilutive effect of stock options outstanding using the treasury stock method -- 3,303 -- -- --------- --------- --------- --------- Shares used in computing diluted net income per share 92,171 96,287 92,105 93,045 ========= ========= ========= =========
For the three months ended June 30, 2003, and the six months ended June 30, 2003 and 2002, 1.3 million, 1.1 million and 3.9 million common stock equivalent shares, respectively, have been excluded from the weighted- average number of common shares outstanding for the diluted net income (loss) per share computations as they were anti-dilutive. Stock Based Awards - The Company accounts for stock-based awards to employees using the intrinsic value method in accordance with Accounting Principles Board Opinion ("APB") No. 25, "Accounting for Stock Issued to Employees". Deferred stock compensation balances are recorded as a contra- equity amount and amortized as a charge to operating results over the applicable vesting periods. As of June 30, 2003 total unamortized stock compensation was $6.4 million. SFAS No. 123, "Accounting for Stock-Based Compensation," requires the disclosure of pro forma net income and earnings per share had the Company applied the fair value method. Under SFAS 123, the fair value of stock- based awards to employees is calculated through the use of option pricing models, even though such models were developed to estimate the fair value of freely tradable, fully transferable options without vesting restrictions, which significantly differ from the Company's stock option awards. These models also require subjective assumptions, including future stock volatility and expected time to exercise, which greatly affect the 6 MICREL, INCORPORATED NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Unaudited) calculated values. The Company's calculations for the fair value of stock options were made using the Black-Scholes option pricing model with the following weighted average assumptions for 2003 and 2003, respectively: expected life, 60 months; stock volatility, 85.8% and 86.1%; risk free interest rates, 2.6% and 2.9%; and no dividends during the expected terms. The Company's calculations are based on a multiple option valuation approach and forfeitures are recognized as they occur. The Company's calculations for the fair value of stock issued under the employee stock purchase plan were made using the Black-Scholes option pricing model with the following weighted average assumptions for 2003 and 2002, respectively: expected life, 6 months; stock volatility, 85.8% and 86.1; 2.6% and 2.9%; and no dividends during the term. SFAS No. 148 amends SFAS No. 123 in December 2002 to require that disclosures of the pro forma effect of using the fair value method of accounting for stock-based employee compensation be displayed more prominently and in a tabular format. The following table illustrates the effect on the Company's net income (loss) and net income (loss) per share if it had recorded compensation costs based on the estimated grant date fair value as defined by SFAS No. 123 for all granted stock-based awards (in thousands, except per share amounts): Three Months Ended Six Months Ended June 30, June 30, -------------------- -------------------- 2003 2002 2003 2002 --------- --------- --------- --------- Net income (loss) as reported $ (913) $ 270 $ (739) $ (3,711) Add: stock-based employee compensation expense included in reported net income (loss), net of tax effects 733 1,972 1,381 4,015 Deduct: stock-based employee compensation expense determined under fair value based method, net of tax effects (3,571) (6,361) (6,866) (12,383) --------- --------- --------- --------- Pro forma net income (loss) $ (3,751) $ (4,119) $ (6,224) $ (12,079) ========= ========= ========= ========= Net income (loss) per share as reported: Basic $ (0.01) $ 0.00 $ (0.01) $ (0.04) ========= ========= ========= ========= Diluted $ (0.01) $ 0.00 $ (0.01) $ (0.04) ========= ========= ========= ========= Pro forma net income (loss) per share: Basic $ (0.04) $ (0.04) $ (0.07) $ (0.13) ========= ========= ========= ========= Diluted $ (0.04) $ (0.04) $ (0.07) $ (0.13) ========= ========= ========= =========
2. RECENTLY ISSUED ACCOUNTING STANDARDS In January 2003, the Financial Accounting Standards Board ("FASB" or the "Board") issued Interpretation No. 46 ("FIN 46") "Consolidation of Variable Interest Entities." Until this interpretation, a company generally included another entity in its consolidated financial statements only if it controlled the entity through voting interests. FIN 46 requires a variable interest entity to be consolidated by a company if that company is subject to a majority of the risk of loss from the variable interest entity's activities or entitled to receive a majority of the entity's residual returns. Management is currently evaluating the effect of this statement on the Company's results of operations and financial position. FIN 46 is effective for public entities for the first interim period beginning after June 15, 2003 except for variable interest entities created after January 31, 2003 where it is effective immediately. The Company does not currently anticipate this statement to have any effect on its financial statements. 7 MICREL, INCORPORATED NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Unaudited) In November 2002, the Emerging Issues Task Force reached a consensus on Issue No. 00-21 ("EITF 00-21"), "Revenue Arrangements with Multiple Deliverables." EITF 00-21 provides guidance on how to account for arrangements that involve the delivery or performance of multiple products, services and/or rights to use assets. The provisions of EITF 00-21 will apply to revenue arrangements entered into in fiscal periods beginning after June 15, 2003. The Company does not believe the adoption of EITF 00- 21 will have a material impact on its financial position or results of operations. In May 2003, the FASB issued Statement of Accounting Standards No. 150 ("SFAS 150"), "Accounting for Certain Financial Instruments with Characteristics of both Liabilities and Equity." The Statement establishes standards for how an issuer classifies and measures certain financial instruments with characteristics of both liabilities and equity and further requires that an issuer classify as a liability (or an asset in some circumstances) financial instruments that fall within its scope because that financial instrument embodies an obligation of the issuer. Many of such instruments were previously classified as equity. The statement is effective for financial instruments entered into or modified after May 31, 2003, and otherwise is effective at the beginning of the first interim period beginning after June 15, 2003, except for mandatory redeemable financial instruments of non-public entities. The Statement is to be implemented by reporting the cumulative effect of a change in accounting principle for financial instruments created before the issuance of the date of the Statement and still existing at the beginning of the interim period of adoption. Restatement is not permitted. The Company does not believe that the adoption of this Statement will have a material impact on its financial position or results of operations. 3. INVENTORIES Inventories consist of the following (in thousands): June 30, December 31, 2003 2002 ------------ ------------ Finished goods $ 12,539 $ 15,597 Work in process 23,510 22,523 Raw materials 1,535 1,411 ---------- ---------- $ 37,584 $ 39,531 ========== ==========
4. BORROWING ARRANGEMENTS Borrowing agreements consisted of $5.0 million revolving line of credit from a commercial bank. There were no borrowings under the revolving line of credit agreement at June 30, 2003. The revolving line of credit agreement, which has been renewed, expires on June 30, 2005. Borrowings under the revolving line of credit bear interest rates of, at the Company's election, the prime rate (4.0% at June 30, 2003), or the bank's revolving offshore rate, which approximates LIBOR (1.12% at June 30, 2003) plus 2.0%. The agreement contains certain restrictive covenants that include a restriction on the declaration and payment of dividends without the lender's consent. The Company was in compliance with all such covenants at June 30, 2003. As of June 30, 2003, the Company had $11.3 million under term notes outstanding. 5. SIGNIFICANT CUSTOMERS During the six months ended June 30, 2003, two customers, a world wide distributor and an Asian based stocking representative, accounted for $12.9 million (13%) and $10.6 million (11%) of net revenues, respectively. No direct O.E.M. customer accounted for more than 10% of net revenues. During the six months ended June 30, 2002, one customer, an Asian based stocking representative, accounted for $14.4 million (13.9%) of net revenues. 8 MICREL, INCORPORATED NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Unaudited) 6. COMPREHENSIVE INCOME (LOSS) Comprehensive income or loss, which was comprised of the Company's net income or loss for the periods and changes in unrealized gains or losses on investments, was a net loss of $913,000 and a net loss of $740,000 for the three and six months ended June 30, 2003, respectively, and a net income of $269,000 and a net loss of $3.7 million for the three and six months ended June 30, 2002, respectively. 7. SEGMENT REPORTING The Company follows the provisions of SFAS No. 131, Disclosures about Segments of an Enterprise and Related Information. SFAS No. 131 establishes standards for reporting information regarding operating segments in annual financial statements and requires selected information for those segments to be presented in interim financial reports issued to stockholders. SFAS No. 131 also establishes standards for related disclosures about products and services and geographic areas. Operating segments are identified as components of an enterprise about which separate discrete financial information is available for evaluation by the chief operating decision maker. The Company operates in two reportable segments: standard products and custom and foundry products. The chief operating decision maker evaluates segment performance based on revenue. Accordingly, all expenses are considered corporate level activities and are not allocated to segments. Therefore, it is not practical to show profit or loss by operating segments. Also, the chief operating decision maker does not assign assets to these segments. Consequently, it is not practical to show assets by operating segments.
Net Revenues by Segment (Dollars in thousands) Three Months Ended Six Months Ended June 30, June 30, -------------------- -------------------- 2003 2002 2003 2002 --------- --------- --------- --------- Net Revenues: Standard Products $ 43,580 $ 49,376 $ 88,834 $ 92,408 Custom and Foundry Products 5,529 5,987 11,230 11,280 --------- --------- --------- --------- Total net revenues $ 49,109 $ 55,363 $ 100,064 $ 103,688 ========= ========= ========= ========= As a Percentage of Total Net Revenues: Standard Products 89% 89% 89% 89% Custom and Foundry Products 11% 11% 11% 11% --------- --------- --------- --------- Total net revenues 100% 100% 100% 100% ========= ========= ========= =========
8. LITIGATION AND OTHER CONTINGENCIES On February 26, 1999, the Lemelson Medical, Education & Research Foundation (the "Lemelson Partnership") filed a complaint which was served on the Company on June 15, 1999, entitled Lemelson Medical, Education & Research Foundation, Limited Partnership v. Lucent Technologies Inc., et al. in the United States District Court in Phoenix, Arizona, against eighty-eight defendants, including the Company, alleging infringement of Lemelson Foundation patents. The complaint in the lawsuit seeks unspecified compensatory damages, treble damages and attorneys' fees, as well as injunctive relief against further infringement of the Lemelson patents at issue. The case is currently in the motion and hearing phase. The Company intends to continue to defend itself against these claims. 9 MICREL, INCORPORATED NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Unaudited) On May 9, 1994, Linear Technology Corporation ("Linear" or "LTC"), a competitor of the Company, filed a complaint against the Company, entitled Linear Technology Corporation v. Micrel, Incorporated, in the United States District Court in San Jose, California, alleging patent and copyright infringement and unfair competition. All claims, except the patent infringement claim, have been settled or dismissed. The complaint in the lawsuit seeks unspecified compensatory damages, treble damages and attorneys' fees as well as preliminary and permanent injunctive relief against infringement of the Linear patent at issue. On August 20, 1999, the United States District Court in San Jose adjudicated in favor of the Company on a motion, finding the patent to be invalid under the "on sale bar" defense as the plaintiff had placed integrated circuits containing the alleged invention on sale more than a year before filing its patent application. The United States District Court in San Jose dismissed the plaintiff's complaint on the merits of the case and awarded the Company its legal costs. Linear appealed the trial Court's decision to the United States Court of Appeal for the Federal Circuit ("CAFC") on September 17, 1999. On December 28, 2001 the CAFC reversed the District Court's judgment of invalidity and remanded the case to the District Court. After the Company's Petition for Rehearing En Banc by the Court of Appeal was denied, the Company filed a Petition for Writ of Certiorari with the Supreme Court of the United States, which Linear opposed. On May 19, 2003, the Supreme Court denied the Petition for Writ of Certiorari. The parties subsequently attended a case management conference with the District Court, at which time a schedule was determined for further discovery and hearing matters before the Court. The Company intends to continue to defend itself against the claims alleged in this litigation. On December 27, 2002, the Company filed a complaint against TRW, Inc. ("TRW") entitled Micrel, Incorporated v. TRW, Inc., dba TRW Automotive Electronics Group, in the United States District Court, Northern District of Ohio, Eastern Division, alleging various causes of action relating to breach of a relationship surrounding the development of certain custom products by Micrel for TRW. In this lawsuit, Micrel is alleging that TRW breached various agreements to assist in Micrel's development of, and to purchase, certain Application Specific Integrated Circuits. The complaint seeks compensatory damages, attorneys' fees and costs of suit. On February 24, 2003, TRW filed an answer to the Company's complaint and a counterclaim alleging various causes of action relating to breach of the above-mentioned relationship concerning ASIC development. A Court-ordered attempt on July 1, 2003 to mediate the claims in this case was unsuccessful. The case is currently in the motion and discovery phase. On April 21, 2003, the Company filed a complaint against its former principal accountants Deloitte & Touche LLP ("Deloitte") entitled Micrel, Incorporated v. Deloitte & Touche LLP in the Superior Court of the State of California, County of Santa Clara, alleging various causes of action relating to certain professional advice received by Micrel from Deloitte. In this lawsuit, Micrel is alleging that Deloitte negligently rendered services as accountants to Micrel, breached certain agreements with Micrel by failing to perform services using ordinary skill and competence and in conformance with generally accepted principles for such work and made certain false representations upon which Micrel justifiably relied. As a direct result of Deloitte's actions, Micrel alleges damages including: expenses incurred in the form of payments to various professionals to address the impact on Micrel's financial statements and other effects of the wrongful conduct; loss of cash as well as equity from stock options; additional charges to earnings that Micrel would not incur but for the wrongful advice; additional potential liability for taxes; potential liability for tax penalties; and the harm to Micrel in both financial and semiconductor markets resulting in loss of overall value of the company as a whole. The complaint seeks compensatory damages, costs of suit and such other relief that the court may deem just and proper. The case is currently in the discovery phase. The Company believes that the ultimate outcome of the legal actions discussed above will not result in a material adverse effect on the Company's financial condition, results of operation or cash flows. However, litigation is subject to inherent uncertainties, and no assurance can be given that the Company will prevail in these lawsuits. Accordingly, the pending lawsuits, as well as potential future litigation with other companies, could result in substantial costs and diversion of resources and could have a material adverse effect on the Company's financial condition, results of operations or cash flows. 10 MICREL, INCORPORATED NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Unaudited) The semiconductor industry is characterized by frequent litigation regarding patent and other intellectual property rights. To the extent that the Company becomes involved in such intellectual property litigation, it could result in substantial costs and diversion of resources to the Company and could have a material adverse effect on the Company's financial condition, results of operation or cash flows. In the event of an adverse ruling in any intellectual property litigation that now exists or might arise in the future, the Company might be required to discontinue the use of certain processes, cease the manufacture, use and sale of infringing products, expend significant resources to develop non-infringing technology or obtain licenses to the infringing technology. There can be no assurance, however, that under such circumstances, a license would be available under reasonable terms or at all. In the event of a successful claim against the Company and the Company's failure to develop or license substitute technology on commercially reasonable terms, the Company's financial condition, results of operations, or cash flows could be adversely affected. Certain additional claims and lawsuits have arisen against the Company in its normal course of business. The Company believes that these claims and lawsuits will not have a material adverse effect on the Company's financial condition, results of operation or cash flows. 9. STOCK REPURCHASE PROGRAM In February 2002, the Company's Board of Directors announced a stock repurchase program under which the Company may purchase up to $20.0 million of its common stock. In July 2002, the Board of Directors approved an additional $20.0 million stock repurchase program by increasing the total authorized stock repurchase to $40.0 million of common stock in 2002. In February 2003, the Board of Directors extended the authorization to repurchase shares of common stock through December 31, 2003, up to a maximum purchase amount of $40 million for the years 2002 and 2003, of which $10.9 million remains authorized for repurchases through December 31, 2003. Shares of common stock purchased pursuant to the repurchase program are cancelled upon repurchase, and are intended to offset dilution from the Company's stock option plans, employee stock purchase plans and 401(k). The Company did not repurchase any shares of its common stock during the six months ended June 30, 2003. 10. STOCK OPTION EXCHANGE PROGRAM On November 8, 2002 the Company filed a Schedule TO with the Securities and Exchange Commission in order to initiate an offer to its employees to exchange certain of their outstanding options for new options to be granted six months and two days after expiration of the exchange offer. The Company's Directors, CEO and CFO were not eligible to participate in the stock option exchange program. This offer to exchange contemplated a grant of new options to eligible employees in a ratio equivalent to one new option granted for every two options elected for exchange and cancelled with respect to employees who held at the time of the offer the position of vice president or higher, and two new options granted for every three options elected for exchange and cancelled with respect to all other employees. The only options eligible to be exchanged were those outstanding employee stock options with an exercise price of $13 or higher. On December 11, 2002, options to purchase 3,330,401 shares of the Company's common stock were surrendered, and were replaced on June 13, 2003 with options to purchase 1,901,769 shares at an exercise price of $10.72 equal to the closing sales price of the Company's common stock as quoted on the Nasdaq National Market on the date preceding the replacement grant date. 11 MICREL, INCORPORATED NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Unaudited) 11. CLOSURE OF WAFER FABRICATION FACILITY In September 2002, the Company approved a plan to close its Santa Clara, CA wafer fabrication facility to reduce costs and improve operating efficiencies. Management believes that these actions are prudent given the current excess capacity levels within its wafer fabrication facilities combined with the uncertain demand in the high-speed communications market. Associated with the facility closure, the Company accrued $5.5 million in restructuring expenses which consisted of $1.0 million for equipment disposal costs and $4.5 million in net contractual building lease costs, excluding estimated sublease income, that will provide no future benefit. These restructuring costs are expected to be paid in cash over the remaining facility lease term, which expires in October 2006. Of the $5.5 million in accrued restructuring costs, $2.2 million has been classified as other current liabilities and the remaining $3.3 million has been classified as other long-term obligations as of June 30, 2003. The Company expects to complete the facility closure during the quarter ending September 30, 2003. 12 ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS Overview Micrel designs, develops, manufactures and markets a range of high performance standard analog integrated circuits and high-speed mixed-signal and digital integrated circuits. These circuits are used in a wide variety of electronics products, including those in the computer, telecommunications, industrial and networking markets. In addition to standard products, the Company manufactures custom analog and mixed-signal circuits and provides wafer foundry services. The Company derives a substantial portion of its net revenues from standard products. Standard products sales remained constant at 89% of net revenues for the three and six months ended June 30, 2003 and 2002. The Company believes that a substantial portion of its net revenues in the future will depend upon standard products sales, although such sales as a proportion of net revenues may vary as the Company adjusts product output levels to correspond with varying economic conditions and demand levels in the markets which it serves. The standard products business is characterized by short-term orders and shipment schedules, and customer orders typically can be canceled or rescheduled without significant penalty to the customer. Since most standard products backlog is cancelable without significant penalty, the Company typically plans its production and inventory levels based on internal forecasts of customer demand, which is highly unpredictable and can fluctuate substantially. In addition, the Company is limited in its ability to reduce costs quickly in response to any revenue shortfalls. The Company may experience significant fluctuations in its results of operations. Factors that affect the Company's results of operations include the volume and timing of orders received, changes in the mix of products sold, the utilization level of manufacturing capacity, competitive pricing pressures and the successful development of new products. These and other factors are described in further detail later in this discussion. As a result of the foregoing or other factors, there can be no assurance that the Company will not experience material fluctuations in future operating results on a quarterly or annual basis, which could materially and adversely affect the Company's business, financial condition, results of operations or cash flows. Critical Accounting Policies The financial statements included in this Form 10-Q and discussed within this Management's Discussion and Analysis of Financial Condition and Results of Operations have been prepared in accordance with accounting principles generally accepted in the United States. Preparation of these financial statements requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. On an on-going basis, management evaluates its estimates and judgements. Management bases its estimates and judgements on historical experience and on various other assumptions that are believed to be reasonable under the circumstances, the results of which form the basis for making judgments about the carrying values of assets and liabilities that are not readily apparent from other sources. Actual results may differ from these estimates under different assumptions or conditions. For a detailed discussion of the Company's significant accounting policies, see Note 1 of Notes to Consolidated Financial Statements in Item 14 of the Company's Annual Report on Form 10-K for the year ended December 31, 2002. Revenue Recognition. Micrel generates revenue by selling products to original equipment manufacturers ("OEM"s), distributors and stocking representatives. Stocking representative firms may buy and stock the Company's products for resale or may act as the Company's sales representative in arranging for direct sales from the Company to an OEM customer. The Company's policy is to recognize revenue from sales to customers when the rights and risks of ownership have passed to the customer, when persuasive evidence of an arrangement exists, the product has been delivered, the price is fixed and determinable and collection of the resulting receivable is reasonably assured. 13 MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (CONTINUED) Micrel allows certain distributors, primarily located in North America and Europe, significant return rights and pricing adjustments subsequent to the initial product shipment. Micrel defers recognition of revenue and related cost of sales (in the balance sheet line item "deferred income on shipments to distributors") derived from sales to these distributors until they have resold the Company's products to their customers. Sales to OEM customers and stocking representatives, primarily located in Asia, which have limited return rights and pricing adjustments, are recognized upon shipment and a related returns allowance is established based upon historical return rates. Actual future returns could be different than the returns allowance established. The Company also maintains an allowance for doubtful accounts for estimated uncollectible accounts receivables. This estimate is based on an analysis of specific customer creditworthiness and historical bad debts experience. Actual future uncollectible amounts could exceed the doubtful accounts allowance established. Inventory Valuation. Inventories are stated at the lower of cost (first-in, first-out method) or market. The Company has taken adjustments to write-down the cost of obsolete and excess inventory to the estimated market value based on historical and forecasted demand for its products. If actual future demand for the Company's products is less than currently forecasted, additional inventory adjustments may be required. Once a reserve is established, it is maintained until the product to which it relates is sold or otherwise disposed of. This treatment is in accordance with Accounting Research Bulletin 43 and Staff Accounting Bulletin 100 "Restructuring and Impairment Charges." Income Taxes. As of June 30, 2003, the Company had net deferred tax assets of $39.5 million, resulting from temporary timing differences between book and tax valuation of assets and liabilities. The Company believes that future taxable income levels will be sufficient to realize the tax benefits of these deferred tax assets and has not established a valuation allowance. Litigation. The semiconductor industry is characterized by frequent litigation regarding patent and other intellectual property rights. The Company is currently involved in such intellectual property litigation (see Note 8 of Notes to Condensed Consolidated Financial Statements) and has not accrued any liability for such litigation. The Company regularly evaluates current information available to determine whether such accruals should be made. An estimated liability would be accrued when it is determined to be probable that a liability has been incurred and the amount of loss can be reasonably estimated. If the Company were to determine that such a liability was probable and could be reasonably estimated, the adjustment would be charged to income in the period such determination was made. Results of Operations The following table sets forth certain operating data as a percentage of total net revenues for the periods indicated: Three Months Ended Six Months Ended June 30, June 30, -------------------- -------------------- 2003 2002 2003 2002 --------- --------- --------- --------- ------- ------- ------- ------- Net revenues 100.0% 100.0% 100.0% 100.0% Cost of revenues 62.9 61.7 61.3 62.5 ------- ------- ------- ------- Gross profit 37.1 38.3 38.7 37.5 ------- ------- ------- ------- Operating expenses: Research and development 24.7 23.5 24.8 25.4 Selling, general and administrative 13.4 16.0 13.6 16.3 Amortization of deferred stock compensation 1.9 4.4 1.7 4.9 ------- ------- ------- ------- Total operating expenses 40.0 43.9 40.0 46.6 ------- ------- ------- ------- Loss from operations (2.9) (5.6) (1.3) (9.1) Other income (loss), net 0.4 (0.9) 0.4 0.6 ------- ------- ------- ------- Loss before income taxes (2.5) (6.5) (0.9) (8.5) Benefit for income taxes (0.6) (7.0) (0.2) (4.9) ------- ------- ------- ------- Net income(loss) (1.9)% 0.5% (0.7)% (3.6)% ======= ======= ======= =======
14 MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (CONTINUED) Net Revenues. For the three months ended June 30, 2003, net revenues decreased 11% to $49.1 million from $55.4 million for the same period in the prior year. For the six months ended June 30, 2003, net revenues decreased 3% to $100.1 million from $103.7 million for the same period in the prior year. These decreases were due to decreased standard products revenues. The Company derives a substantial portion of its net revenues from standard products. Standard products sales remained constant at 89% of net revenues for the three and six months ended June 30, 2003 and 2002. For the three months ended June 30, 2003, standard products revenues decreased 12% to $43.6 million from $49.4 million for the same period in the prior year. Such decreases resulted primarily from decreased unit shipments of computer products combined with decreased average selling prices across all significant product lines, which were partially offset by increased unit shipments of industrial, high bandwidth communications and Ethernet communications products. Sales of standard products by the Company during the three months ended June 30, 2003 were led by low dropout regulators, Ethernet communications products and computer peripheral products. Such products were sold primarily to manufacturers within the industrial, telecommunications, network communications and computer markets. Standard product sales declined on a sequential and year-over-year basis due to a significant decline in demand from customers serving the wireless telecommunications end market. Weaker demand for mobile phones, primarily in Asian countries, caused customers to reduce their level of component purchases substantially more than the decline in their end unit production in order to control inventories. For the six months ended June 30, 2003, standard products revenues decreased 4% to $88.8 million from $92.4 million for the same period in the prior year. Such decreases resulted primarily from decreased average selling prices across all significant product lines, which were partially offset by increased unit shipments of industrial, telecommunications, computer, high bandwidth communications and Ethernet communications products. Sales of standard products by the Company during the six months ended June 30, 2003 were led by low dropout regulators, Ethernet communications products and computer peripheral products. Such products were sold primarily to manufacturers within the industrial, telecommunications, computer and network communications markets. For the three months ended June 30, 2003, custom and foundry products revenues decreased 8% to $5.5 million representing 11% of net revenues from $6.0 million also representing 11% of net revenues for the same period in the prior year. Such decreases were primarily due to decreased unit shipments of foundry products. For the six months ended June 30, 2003, custom and foundry products revenues were $11.2 million representing 11% of net revenues compared to $11.3 million also representing 11% of net revenues for the same period in the prior year. Customer demand for semiconductors can change quickly and unexpectedly. As a result of the slowing global economy, a rapid build-up of semiconductor inventories in global sales channels occurred during 2001, causing lead times for components to fall precipitously. Although it is generally believed that industry wide channel inventories have decreased substantially since 2001, the short lead time environment has continued from the middle of 2001 through the end of the second quarter of 2003 as a result of underutilization of manufacturing capacity and relatively high levels of work-in-process inventories within the semiconductor industry. Customers perceive that semiconductor components are readily available and continue to order only for their short-term needs, resulting in order backlog levels which are not sufficient for the Company to predict future revenue levels with certainty. The Company's revenue levels are highly dependent on the amount of new orders that are received for which product is requested to be delivered to the customer within the same period. Within the semiconductor industry these orders that are booked and shipped within the period are called "turns fill" orders. During the three months ended June 30, 2003, 53% of the Company's shipments resulted from turns-fill orders as compared to 60% for the same period in the prior year. The Company believes the current high turns-fill requirements and continuing pricing pressure will continue until the semiconductor industry recovers from the current downturn. The Company believes the key metrics that will evidence such an industry recovery are: a cumulative annual growth rate in worldwide semiconductor shipments of 14% or greater; backlog levels at or above 70% of the following quarters shipments; manufacturing capacity utilization levels at or above 80% of equipped capacity; a growth in aggregate channel inventories for a least two consecutive quarters; and an increase in average selling prices of at least 20% from the downturn low point. Currently, the uncertainty of customer demand, the high turns fill requirement, and associated uncertainty of product mix and pricing, make it difficult to predict future levels of sales and profitability. 15 MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (CONTINUED) International sales represented 68% and 70% of net revenues for the quarters ended June 30, 2003 and 2002, respectively. On a dollar basis, international sales decreased 13% to $33.3 million for the quarter ended June 30, 2003 from $38.5 million for the comparable period in 2002. Such decreases resulted primarily from decreased unit shipments of computer products, primarily in Asia, combined with decreased average selling prices across all significant product lines and geographic regions, which were partially offset by increased unit shipments of Ethernet communications products. For the six months ended June 30, 2003 and 2002, international sales represented 68% and 70% of net revenues, respectively. On a dollar basis, international sales decreased 6% to $68.2 million for the six months ended June 30, 2002 from $72.4 million for the comparable period in 2002. Such decreases resulted primarily from decreased average selling prices across all significant product lines and geographic regions, which were partially offset by increased unit shipments of telecommunications and network communications products. The Company's international sales are denominated in U.S. currency. Consequently, changes in exchange rates that strengthen the U.S. dollar could increase the price in local currencies of the Company's products in foreign markets and make the Company's products relatively more expensive than competitors' products that are denominated in local currencies, leading to a reduction in sales or profitability in those foreign markets. The Company has not taken any protective measures against exchange rate fluctuations, such as purchasing hedging instruments with respect to such fluctuations. Gross Profit. Gross profit is affected by a variety of factors including the volume of product sales, product mix, manufacturing utilization, product yields and average selling prices. For the three months ended June 30, 2003 the Company's gross margin decreased to 37% from 38% for the comparable period in 2002. This decrease in gross margin resulted primarily from a reduction in average selling prices which was partially offset by decreased wafer fabrication costs resulting from the Company's wafer fabrication consolidation project (see Note 11 of Notes to Condensed Consolidated Financial Statements) and lower costs for external assembly and test manufacturing services as compared to the same period in 2002. For the six months ended June 30, 2003 the Company's gross margin increased to 39% from 38% for the comparable period in 2002. This increase in gross margin resulted primarily from decreased wafer fabrication costs resulting from the Company's wafer fabrication consolidation project and lower costs for external assembly and test manufacturing services, which were partially offset by decreased average selling prices as compared to the same period in 2002. The Company believes pricing pressure will continue to affect gross profit until industry manufacturing capacity utilization levels increase and order lead times extend significantly beyond current levels. Research and Development Expenses. Research and development expenses include costs associated with the development of new processes and the definition, design and development of new products. The Company also expenses prototype wafers and new production mask sets related to new products as research and development costs until products based on new designs are fully characterized by the Company and are demonstrated to support published data sheets and satisfy reliability tests. As a percentage of net revenues, research and development expenses represented 25% and 24% for the three months ended June 30, 2003 and 2002, respectively. On a dollar basis, research and development expenses decreased $870,000 or 7% to $12.1 million for the three months ended June 30, 2003 from $13.0 million for the comparable period in 2002. For the six months ended June 30, 2003 and 2002, research and development expenses represented 25% of net revenues, respectively. On a dollar basis, research and development expenses decreased $1.5 million or 6% to $24.8 million for the six months ended June 30, 2003 from $26.4 million for the comparable period in 2002. The dollar decreases were primarily due to decreased prototype fabrication costs combined with reduced staffing costs. The Company believes that the development and introduction of new products is critical to its future success and expects to continue its investment in research and development activities in the future. Selling, General and Administrative Expenses. As a percentage of net revenues, selling, general and administrative expenses represented 13% and 16% for the three months ended June 30, 2003 and 2002, respectively. On a dollar basis, selling, general and administrative expenses decreased $2.3 million or 26% to $6.6 million for the three months ended June 30, 2003 from $8.9 million for the comparable period in 2002. For the six months ended June 30, 2003 and 2002, selling, general and administrative expenses represented 14% and 16% of net revenues, respectively. On a dollar basis, selling, general and administrative expenses decreased $3.3 million or 20% to $13.6 million for the 16 MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (CONTINUED) six months ended June 30, 2003 from $16.9 million for the comparable period in 2002. The dollar decreases were principally attributable to decreased outside legal costs combined with decreased advertising expenses. Amortization of deferred stock compensation. The Company accounts for stock- based awards to employees using the intrinsic value method in accordance with Accounting Principles Board Opinion No. 25 ("APB 25"), "Accounting for Stock Issued to Employees". Certain Company practices in effect prior to January 2002 related to employee stock option pricing resulted in stock compensation expense under APB 25. For the three months ended June 30, 2003 total amortization of deferred stock compensation was $1.2 million of which $290,000 was included in cost of revenues and $915,000 was included in amortization of deferred stock compensation. For the three months ended June 30, 2002 total amortization of deferred stock compensation was $3.2 million of which $784,000 was included in cost of revenues and $2.5 million was included in amortization of deferred stock compensation. For the six months ended June 30, 2003 total amortization of deferred stock compensation was $2.3 million of which $591,000 was included in cost of revenues and $1.7 million was included in amortization of deferred stock compensation. For the six months ended June 30, 2002 total amortization of deferred stock compensation was $6.6 million of which $1.6 million was included in cost of revenues and $5.0 million was included in amortization of deferred stock compensation. The decreases in 2003 resulted primarily from accelerated recognition of stock compensation during the fourth quarter of 2002 associated with an employee stock option exchange program (see Note 10 of Notes to Condensed Consolidated Financial Statements). As of June 30, 2003 total unamortized stock compensation was $6.4 million. Other Income (Expense), Net. Other income, net reflects interest income from investments in short-term, investment-grade, securities and money market funds offset by interest expense incurred on term notes, combined with other non-operating income or expenses. For the three months ended June 30, 2003, other income, net was $181,000 compared to a net expense of $476,000 for the comparable period in 2002. The increase was primarily due to the inclusion of $947,000 expense for the settlement of a patent dispute in the prior year which was partially offset by decreased rates of return on cash, cash equivalents and short-term investments as compared to the prior year. For the six months ended June 30, 2003, other income, net was $347,000 compared to $588,000 for the comparable period in 2002. The decrease was primarily due to decreased rates of return on cash, cash equivalents and short-term investments as compared to the prior year and the inclusion of $490,000 in non-recurring other income in the prior year which were partially offset by a $947,000 expense for the settlement of a patent dispute in the prior year. Provision (Benefit) for Income Taxes. For the three and six months ended June 30, 2003, the provision (benefit) for income taxes was 25% and 23% of pretax income (loss), respectively. During the three months ended June 30, 2003 the Company revised its 2003 estimated annual effective tax rate to 23% from 34% of income (loss) before tax, primarily due to the impact of state research and development credits in relation to revised estimated annual income before tax. The income tax provision (benefit) for such interim periods reflects the Company's estimated annual income tax rate. The estimated provision (benefit) for income taxes differs from taxes computed at the federal statutory rate primarily due to the effect of state income taxes, state research and development credits, and state manufacturing credits. Liquidity and Capital Resources Since inception, the Company's principal sources of funding have been its cash from operations, bank borrowings and sales of common stock. Principal sources of liquidity at June 30, 2003 consisted of cash and cash equivalents of $123.5 million and bank borrowing arrangements. Borrowing agreements consisted of $5.0 million under a revolving line of credit. There were no borrowings under this agreement as of June 30, 2003 (for a discussion of borrowing arrangements, see Note 4 of Notes to Condensed Consolidated Financial Statements). The Company's working capital increased by $4.5 million to $186.6 million as of June 30, 2003 from $182.2 million as of December 31, 2002. The increase was primarily attributable to a $6.1 million increase in cash and cash equivalents combined with a $1.4 million decrease in current liabilities which was partially offset by a $1.9 million decrease in inventories and a $921,000 decrease in accounts receivable. The Company's cash flows from operating activities were $15.8 million for the six months ended June 30, 2003 as compared to $8.0 million for the same period in the prior year. This $7.8 million cash flow increase over the same period 17 MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (CONTINUED) in the prior year resulted primarily from a $1.9 million decrease in inventory during the six months ended June 30, 2003 as compared to a $8.7 million increase in inventory during the comparable prior year period. The $15.8 million in cash flows from operating activities generated by the Company in the six months ended June 30, 2003 were primarily attributable to additions for non-cash activities of $18.3 million combined with a $1.9 million decrease in inventory and a $921,000 decrease in accounts receivable, which was partially offset by a net loss of $739,000 plus a $2.1 million decrease in current liabilities and a $2.5 million decrease in other non- current obligations. For the six months ended June 30, 2002, the Company's cash flows from operating activities were $8.0 million and were primarily attributable to additions for non-cash activities of $20.7 million which were partially offset by a net loss of $3.7 million plus a $8.7 million increase in inventory. The Company's investing activities during the six months ended June 30, 2003 used cash of $11.5 million as compared to $4.7 million during the comparable period in the prior year. The $6.8 million increase in cash used over the same period in the prior year resulted primarily from a $5.9 million increase in net purchases of property, plant and equipment combined with a $3.0 million decrease in net sales of short-term investments, which were partially offset by $2.1 million for the purchase in intangible assets included in the prior year. Cash used by investing activities during the six months ended June 30, 2003 resulted from the purchase of $11.5 in net purchases of property, plant and equipment. For the six months ended June 30, 2002, the Company's investing activities used cash of $4.7 million which resulted from $5.7 million in net purchases of property, plant and equipment and $2.1 million for the purchase of intangible assets, which was partially offset by $3.0 million in net sales of short-term investments. The Company's financing activities during the six months ended June 30, 2003 provided cash of $1.9 million as compared to cash used of $14.9 million during the comparable period in the prior year. This $16.8 million increase in cash provided over the same period in the prior year resulted primarily from a $18.3 million decrease in the repurchase of common stock, which was partially offset by decreased proceeds from the issuance of common stock. Cash provided by financing activities during the six months ended June 30, 2003 was the result of $2.4 million in proceeds from the issuance of common stock through employee stock transactions, which was partially offset by $560,000 in repayments of long-term debt. For the six months ended June 30, 2002, the Company's financing activities used cash of $14.9 million as a result of $18.3 million in repurchases of common stock and $2.2 million in repayments of long-term debt which was partially offset by proceeds from the issuance of common stock through employee stock transactions of $5.6 million. The Company currently intends to purchase approximately $15 million to $25 million in capital equipment and improvements during 2003. The majority of the anticipated 2003 capital spending is related to equipment and building improvements associated with the consolidation of wafer fabrication operations in its San Jose facility and new production mask sets. The Company also expects to purchase additional research and development related software and equipment, and manufacturing equipment for product testing of new products. The Company is currently authorized by its Board of Directors to repurchase an additional $10.9 million of its common stock in 2003. The Company expects that its cash requirements for the next 12 months will be met by its cash from operations, existing cash balances and short-term investments, and its credit facility. 18 MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (CONTINUED) Recently Issued Accounting Standards In January 2003, the Financial Accounting Standards Board ("FASB" or the "Board") issued Interpretation No. 46 ("FIN 46") "Consolidation of Variable Interest Entities." Until this interpretation, a company generally included another entity in its consolidated financial statements only if it controlled the entity through voting interests. FIN 46 requires a variable interest entity to be consolidated by a company if that company is subject to a majority of the risk of loss from the variable interest entity's activities or entitled to receive a majority of the entity's residual returns. Management is currently evaluating the effect of this statement on the Company's results of operations and financial position. FIN 46 is effective for public entities for the first interim period beginning after June 15, 2003 except for variable interest entities created after January 31, 2003 where it is effective immediately. The Company does not currently anticipate this statement to have any effect on its financial statements. In November 2002, the Emerging Issues Task Force reached a consensus on Issue No. 00-21 ("EITF 00-21"), "Revenue Arrangements with Multiple Deliverables." EITF 00-21 provides guidance on how to account for arrangements that involve the delivery or performance of multiple products, services and/or rights to use assets. The provisions of EITF 00-21 will apply to revenue arrangements entered into in fiscal periods beginning after June 15, 2003. The Company does not believe the adoption of EITF 00-21 will have a material impact on its financial position or results of operations. In May 2003, the FASB issued Statement of Accounting Standards No. 150 ("SFAS 150"), "Accounting for Certain Financial Instruments with Characteristics of both Liabilities and Equity." The Statement establishes standards for how an issuer classifies and measures certain financial instruments with characteristics of both liabilities and equity and further requires that an issuer classify as a liability (or an asset in some circumstances) financial instruments that fall within its scope because that financial instrument embodies an obligation of the issuer. Many of such instruments were previously classified as equity. The statement is effective for financial instruments entered into or modified after May 31, 2003, and otherwise is effective at the beginning of the first interim period beginning after June 15, 2003, except for mandatory redeemable financial instruments of non-public entities. The Statement is to be implemented by reporting the cumulative effect of a change in accounting principle for financial instruments created before the issuance of the date of the Statement and still existing at the beginning of the interim period of adoption. Restatement is not permitted. The Company does not believe that the adoption of this Statement will have a material impact on its financial position or results of operations. Contractual Obligations and Commitments The Company's contractual obligations disclosure in its Annual Report on Form 10-K for the year ended December 31, 2002 has not materially changed since that report was filed. During the six months ended June 30, 2003 payments of $1.5 million were made under previously existing operating leases, payments of $560,000 were made under previously existing long-term debt agreements and payments of $2.0 million were made under previously existing other long-term liabilities. Factors That May Affect Operating Results The statements contained in this Report on Form 10-Q that are not purely historical are forward-looking statements within the meaning of Section 27A of the Securities Act of 1933 and Section 21E of the Securities Exchange Act of 1934, including statements regarding the Company's expectations, hopes, intentions or strategies regarding the future. Forward-looking statements include statements regarding: future products or product development; future research and development spending and the Company's product development strategy; the success of future cost reduction programs, the levels of domestic and international sales; future expansion or utilization of manufacturing capacity; future expenditures; and current or future acquisitions. All forward-looking statements included in this document are based on information available to the Company on the date hereof, and the Company assumes no obligation to update any such forward-looking statements. It is important to note that the Company's actual results could differ materially from those in such forward-looking statements. Some of the factors that could cause actual results to differ materially are set forth below. Additional factors that may affect operating results are contained within the Company's Form 10-K for the year ended December 31, 2002. 19 MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (CONTINUED) The Company is exposed to risks because of the uncertain rate of growth in the global economy. Reduced corporate profits and weak capital spending, especially for technology related end markets that the Company serves such as the high-speed communications, enterprise computing and telecommunications markets, continue to dampen demand for the Company's products. In addition, the Company is unable to determine the future impact of various geo-political issues, as well as the after effects of severe acute respiratory syndrome ("SARS"), on global and regional economies. If economic conditions in the global or regional economies worsen, or if a wider global economic recession materializes, the Company's business, financial condition and results of operations may be materially and adversely affected. The Company's operating results may fluctuate because of a number of factors, many of which are beyond its control. If the Company's operating results are below the expectations of public market analysts or investors, then the market price of its Common Stock could decline. Some of the factors that affect or may affect the Company's quarterly and annual results, but which are difficult for the Company to control or predict are: - disruption of customer demand, transportation or supplier operations due to war or terrorism - disruption of customer demand, transportation or supplier operations due to SARS - the volume and timing of orders received - changes in the mix of products sold - market acceptance of the Company's products and its customers' products - competitive pricing pressures - cyclical semiconductor industry conditions - dependence on third party suppliers - the ability to introduce new products on a timely basis - the timing of new product announcements and introductions by the Company or its competitors - the timing and extent of research and development expenses - fluctuations in manufacturing yields - the ability to hire and retain key technical and management personnel - access to advanced process technologies - the timing and extent of process development costs Customer demand for the Company's products is volatile and difficult to predict. The Company's customers continuously adjust their inventories in response to changes in end market demand for their products and the availability of semiconductor components. This results in frequent changes in demand for the Company's products. The volatility of customer demand limits the Company's ability to predict future levels of sales and profitability. The supply of semiconductors can quickly and unexpectedly match or exceed demand because end customer demand can change very quickly. Also, semiconductor suppliers can rapidly increase production output. This can lead to a sudden oversupply situation and a subsequent reduction in order rates and revenues as customers adjust their inventories to true demand rates. A rapid and sudden decline in customer demand for the Company's products can result in excess quantities of certain of the Company's products relative to demand. Should this occur the Company's operating results may be adversely affected as a result of charges to reduce the carrying value of the Company's inventory to the estimated demand level or market price. The weakness in the global economy in 2001, 2002, and 2003 has caused the end markets that the Company's customers serve to grow less rapidly, or in some cases, contract. The resulting uncertainty of demand has caused most of the Company's customers to err on the side of caution until they see signs of order strength for their end products. Many customers are continuing to deplete inventories in response to short supplier lead times. Semiconductors are perceived to be readily available and supplier lead times are at or near historic lows. In this environment, customers are not making large purchase commitments, only ordering small quantities to fill known short-term requirements, greatly reducing the Company's visibility into customer demand. As a result, the Company's revenues are highly dependent upon turns fill orders (orders booked and shipped in the same quarter). The reduced level of 20 MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (CONTINUED) order backlog coupled with the short-term nature of customer demand makes it extremely difficult to predict near term revenues and profits. The short lead time environment has allowed many end consumers of the Company's products to rely on stocking representatives and distributors to carry inventory to meet short term requirements and minimize their investment in on-hand inventory. As a result the Company may carry a higher level of inventory at some of its stocking representatives and distributors to service the volatile short term demand of the end customer. Should the relationship with a distributor or stocking representative be terminated, future level of product returns could be higher than the returns allowance established, which could negatively affect the Company's revenues and results of operations. The semiconductor industry is highly competitive. The semiconductor industry is highly competitive and subject to rapid technological change, price-erosion and increased international competition. Significant competitive factors include: - product features - performance - price - timing of product introductions - emergence of new computer and communications standards - quality and customer support In times when economic growth and customer demand is less certain, such as the semiconductor industry is now experiencing, price competition becomes more prevalent. Both the semiconductor industry and the Company have experienced significant price erosion since the beginning of 2001. If this price erosion continues it will have the effect of reducing revenue levels and gross margins in future periods. Because the standard products market for integrated circuits is diverse and highly fragmented, the Company encounters different competitors in various market areas. Most of these competitors have substantially greater technical, financial and marketing resources and greater name recognition than the Company has. Increased competition could adversely affect the Company's financial condition or results of operations. There can be no assurance that the Company will be able to compete successfully in either the standard products or custom and foundry products business in the future or that competitive pressures will not adversely affect the Company's financial condition, results of operations, or cash flows. The cost reduction actions the Company has initiated may not materialize as expected, or be sustained as business improves. The Company has implemented or initiated a variety of cost reduction actions. The expected future cost savings from these programs may not materialize as anticipated resulting in a smaller benefit to the Company's financial results of operations. Furthermore, when customer demand improves and revenues increase, it is unclear whether Micrel will continue to benefit from all of the cost reduction actions that have been implemented. The consolidation of wafer fabrication operations into the Company's San Jose facility may negatively impact the results of operations or fail to result in expected cost savings. In September 2002, the Company approved a plan to close its Santa Clara, CA wafer fabrication facility and transfer the production and research and development processes and certain equipment into its San Jose, CA facility. If the transfer of the equipment and manufacturing processes is not successful or is delayed, this could result in the Company's inability to manufacture certain products and delay certain new product development. In addition, expected cost savings related to this consolidation may be delayed or unachieved. Either of these factors could have an adverse effect on the Company's results of operations and financial condition. 21 MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (CONTINUED) Market conditions may lead the Company to initiate additional cost reduction plans, which may negatively affect near term operating results. As a result of weak customer demand, competitive pricing pressures, excess capacity, weak economic conditions or other factors, the Company may decide to initiate additional actions to reduce the Company's cost structure and improve the Company's future operating results. The cost reduction actions may require incremental costs to implement, which could negatively affect the Company's operating results in periods when the incremental costs or liabilities are incurred. The Company's product offering, while diversified, is highly dependent on certain select end markets. The Company currently sells a significant portion of its products in the high-speed communications, computer, networking and wireless handset markets. These markets are characterized by short product life cycles, rapidly changing customer demand, evolving and competing industry standards and seasonal demand trends. Additionally, there can be no assurance that these markets will continue to grow. If the markets for high speed communications, computers, networking or wireless handsets that the Company serves fail to grow, or grow more slowly than it currently anticipates, or if there is increased competition in these markets, the Company's business, results of operations and financial condition could be adversely affected. An important part of the Company's strategy is to continue to focus on the market for high-speed communications integrated circuits. If the severe downturn in the telecommunications infrastructure industry continues resulting in lack of demand for the Company's high bandwidth products, the Company's future revenue growth and profitability could be adversely affected. The Company's Ethernet products have become an important portion of the Company's revenues. If the Company fails to develop new products to serve this market in a timely manner, or if the market acceptance of the Company's new Ethernet products is poor, if a competitor's products unfavorably affect pricing or demand for the Company's products, the Company's revenues and results of operations could be adversely affected. The Company currently derives the majority of its product revenues from sales of standard analog and mixed-signal integrated circuits and expects these products to continue to account for the majority of its revenues for the foreseeable future. As a result, factors adversely affecting the pricing of or demand for standard analog integrated and mixed-signal circuits, such as competition, product performance or technological change, could have a material adverse effect on the Company's business and consolidated results of operations and financial condition. The markets that the Company serves frequently undergo transitions in which products rapidly incorporate new features and performance standards on an industry-wide basis. If the Company's products are unable to support the new features or performance levels required by OEMs in these markets, it would likely lose business from existing or potential customers and would not have the opportunity to compete for new design wins until the next product transition. If the Company fails to develop products with required features or performance standards, or experiences even a short delay in bringing a new product to market, or if its customers fail to achieve market acceptance of their products, its revenues could be significantly reduced for a substantial period of time. The Company encounters risks associated with its international operations, including geopolitical risks. Reduced levels of economic activity, or disruptions of international transportation, could adversely affect the Company's sales on either a global basis or in specific geographic regions. Three of the Company's top ten direct customers are located in South Korea. In the event that current political tensions surrounding North Korea evolve into military or social conflict, the Company's revenues, results of operations, cash flow and financial condition could be adversely affected. The Company has generated a substantial portion of its net revenues from export sales. The Company believes that a substantial portion of its future net revenues will depend on export sales to customers in international markets, including Asia. International markets are subject to a variety of risks, including changes in policy by foreign governments, social conditions 22 MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (CONTINUED) such as civil unrest, economic conditions including high levels of inflation, fluctuation in the value of foreign currencies and currency exchange rates and trade restrictions or prohibitions. In addition, the Company sells to domestic customers that do business worldwide and cannot predict how the businesses of these customers may be affected by economic or political conditions in Asia or elsewhere in the world. Such factors could adversely affect the Company's future revenues, financial condition, results of operations or cash flows. The Company is reliant on certain key suppliers for wafer fabrication, circuit assembly and testing services. Most of these suppliers are based outside of the U.S. The Company's supply could be interrupted as a result of any of the previously mentioned risk factors relating to international markets. The Company's international sales are denominated in U.S. currency. Consequently, changes in exchange rates that strengthen the U.S. dollar could increase the price of the Company's products in the local currencies of the foreign markets it serves. This would result in making the Company's products relatively more expensive than its competitors' products that are denominated in local currencies, leading to a reduction in sales or profitability in those foreign markets. The Company has not taken any protective measures against exchange rate fluctuations, such as purchasing hedging instruments. The Company's gross margin is dependent upon a number of factors, including the level of capacity utilization. Semiconductor manufacturing is a capital-intensive business resulting in high fixed costs. If the Company is unable to utilize its installed wafer fabrication or test capacity at a high level, the costs associated with these facilities and equipment would not be fully absorbed, resulting in higher average unit costs and lower sales margins. The decline in new customer order rates has resulted in reduced capacity utilization of the Company's factories as it has attempted to match production with anticipated customer demand. The Company's gross margins have declined as a result of this reduced utilization of production capacity. Gross margins may deteriorate further should production activity be curtailed in response to lower customer demand in the future. Dependence on third-party manufacturing and supply relationships increases the risk that the Company will not have an adequate supply of products to meet demand or that its cost of materials will be higher than expected. The Company faces many risks associated with its dependence upon third parties that manufacture, assemble or package certain of its products. These risks include: - reduced control over delivery schedules and quality - risks of inadequate manufacturing yields and excessive costs - the potential lack of adequate capacity during periods of excess demand - difficulties selecting and integrating new subcontractors - limited warranties on wafers or products supplied to the Company - potential increases in prices - potential misappropriation of the Company's intellectual property Any of these risks may lead to increased costs or delay delivery of the Company's products, which would harm its profitability and customer relationships. Additionally, the Company's wafer and product requirements typically represent a relatively small portion of the total production of the third- party foundries and outside assembly, testing and packaging contractors. As a result, Micrel is subject to the risk that a foundry will provide delivery or capacity priority to other larger customers at the expense of Micrel, resulting in an inadequate supply to meet customer demand or higher costs to obtain the necessary product supply. Also, there is a risk that a third party manufacturer will cease production on an older or lower volume process that it uses to produce the Company's products. The Company cannot be certain that its outside manufacturers will continue to devote resources to the production of its products or continue to advance the process design technologies on which the manufacturing of its products are based. Each of these events could increase the Company's costs and harm its ability to deliver it's products on time. 23 MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (CONTINUED) The Company is subject to the risk of litigation and regulatory action in connection with the restatement of its financial statements, and the potential liability from any such litigation or regulatory action could harm its business. On January 28, 2002, the Company announced that it would restate its consolidated financial statements for the fiscal years ended December 31, 1998, 1999, and 2000, and the fiscal quarters ended March 31, 2001, June 30, 2001, and September 30, 2001. As a result of this restatement, the Company could become subject to litigation or regulatory proceedings, or both. As of the date hereof, the Company is not aware of any litigation having been commenced against it related to this restatement. However, such litigation could be commenced against the Company in the future and, if so, the Company cannot predict the outcome of any such action at this time. However, if an unfavorable result occurred in any such action, the Company's business and financial condition could be harmed. In addition, regulatory agencies, such as the Securities and Exchange Commission, could commence a formal investigation of the Company's restatement. At this time management cannot predict whether or not any regulatory investigation related to the restatement will be commenced or, if it is, the outcome of any such investigation. However, if any such investigation were to result in a regulatory proceeding or action against the Company, its business and financial condition could be harmed. The restatement also involves certain tax issues that need to be resolved with the appropriate taxing authorities. The Company has recorded a liability in its financial statements with respect to these tax issues. The Company cannot predict the results of its discussions with the appropriate tax authorities regarding the tax implications of its restatement and accordingly, the amount of actual financial impact may differ from the amount recorded in the Company's financial statements. The Company may not be able to protect its intellectual property adequately, or could be harmed by litigation involving its patents and proprietary rights. The Company's future success depends in part upon its intellectual property, including patents, trade secrets, know-how and continuing technology innovation. There can be no assurance that the steps taken by the Company to protect its intellectual property will be adequate to prevent misappropriation or that others will not develop competitive technologies or products. There can be no assurance that any patent owned by the Company will not be invalidated, circumvented or challenged, that the rights granted thereunder will provide competitive advantages or that any of its pending or future patent applications will be issued with the scope of the claims sought, if at all. Furthermore, there can be no assurance that others will not develop technologies that are similar or superior to the Company's technology, duplicate technology or design around the patents owned by the Company. Additionally, the semiconductor industry is characterized by frequent litigation regarding patent and other intellectual property rights. There can be no assurance that existing claims or any other assertions or claims for indemnity resulting from infringement claims will not adversely affect the Company's business, financial condition, results of operations, or cash flows. The Company's operating results substantially depend on manufacturing output and yields, which may not meet expectations. The Company manufactures most of its semiconductors at its San Jose, California fabrication facilities. Manufacturing semiconductors requires manufacturing tools that are unique to each product being produced. If one of these unique manufacturing tools was damaged or destroyed, then the Company's ability to manufacture the related product would be impaired and its business would suffer until the tool was repaired or replaced. Additionally, the fabrication of integrated circuits is a highly complex and precise process. Small impurities, contaminants in the manufacturing environment, difficulties in the fabrication process, defects in the masks used to print circuits on a wafer, manufacturing equipment failures, wafer breakage or other factors can cause a substantial percentage of wafers to be rejected or numerous die on each wafer to be nonfunctional. 24 MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (CONTINUED) The Company's future success depends in part on the continued service of its key design engineering, sales, marketing and executive personnel and its ability to identify, hire and retain additional personnel. There is intense competition for qualified personnel in the semiconductor industry, in particular design engineers, and the Company may not be able to continue to attract and train engineers or other qualified personnel necessary for the development of its business or to replace engineers or other qualified personnel who may leave its employ in the future. Loss of the services of, or failure to recruit, key design engineers or other technical and management personnel could be significantly detrimental to the Company's product and process development programs. The Company faces risks associated with acquisitions it has completed and will face risks associated with any future acquisitions. The Company has made acquisitions in the past and may make acquisitions in the future. The risks involved with acquisitions include: - diversion of management's attention - failure to retain key personnel - amortization of acquired intangible assets - customer dissatisfaction or performance problems with the acquired company - the cost associated with acquisitions and the integration of acquired operations - assumption of unknown liabilities Any of these risks could materially harm the Company's business, financial condition and results of operations. Additionally, any acquisition involves a significant amount of integration of two companies that have previously operated independently. No assurance can be given that difficulties will not be encountered in integrating certain products, technologies or operations of the acquired companies or that the benefits expected from such integration will be realized. There can be no assurance that any of the acquired companies will retain its key personnel, that the engineering teams of Micrel and the acquired companies will successfully cooperate and realize any technological benefits or that Micrel or the acquired companies will realize any of the other anticipated benefits of the acquisitions. In addition, the consummation of an acquisition could result in the cancellation, termination or non-renewal of arrangements with the acquired company by suppliers, distributors or customers, or the termination of negotiations or delays in ordering by prospective customers as a result of uncertainties that may be perceived as a result of the acquisition. Any significant amount of cancellations, terminations, delays or non-renewals of arrangements with the acquired company or loss of key employees or termination of negotiations or delays in ordering could have a material adverse effect on the business, operating results or financial condition of the acquired company and Micrel after the acquisition. In addition, some of the past acquisitions have been accounted for using the pooling-of-interests method of accounting which means the acquisitions are subject to rules established by the Financial Accounting Standards Board and the Securities and Exchange Commission. These rules are complex and the interpretation of them is subject to change. Additionally, the availability of pooling of interests accounting treatment for a business combination depends in part upon circumstances and events occurring after the acquisition. The failure of a past business combination that has been accounted for under the pooling of interests accounting method to qualify for this accounting treatment would materially harm the Company's reported and future earnings and likely, the price of its Common Stock. The Company's ability to manufacture sufficient wafers to meet demand could be severely hampered by natural disasters. The Company's existing wafer fabrication facilities are located in Northern California and these facilities may be subject to natural disasters such as earthquakes. A significant natural disaster, such as an earthquake or prolonged drought, could have a material adverse impact on the Company's business, financial condition and operating results. 25 MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (CONTINUED) The Company's business could be adversely affected by electrical power or natural gas supply interruptions. The majority of the Company's administrative, technical and manufacturing facilities are located in Northern California and these facilities may be subject to electrical power or natural gas supply interruptions. In recent months, electrical power suppliers have experienced shortages in electrical power which has resulted in brief electrical power interruptions. The weak financial condition of California's Public Utilities may aggravate the situation and shortages may develop for natural gas. Semiconductor manufacturing depends upon a controlled environment that requires high usage of electrical power and natural gas. Frequent or extended electrical power interruptions could have a negative impact on production output, manufacturing yields, and manufacturing efficiencies and could have a material adverse impact on the Company's business, financial condition and operating results. The Company could incur substantial fines or litigation costs associated with its storage, use and disposal of hazardous materials. The Company is subject to a variety of federal, state and local governmental regulations related to the use, storage, discharge and disposal of toxic, volatile or otherwise hazardous chemicals used in it's manufacturing process. Any failure to comply with present or future regulations could result in the imposition of fines, the suspension of production, alteration of the Company's manufacturing processes or a cessation of operations. In addition, these regulations could restrict the Company's ability to expand it's facilities at their present locations or construct or operate a new wafer fabrication facility or could require us to acquire costly equipment or incur other significant expenses to comply with environmental regulations or clean up prior discharges. The Company's failure to control the use of, disposal or storage of, or adequately restrict the discharge of, hazardous substances could subject it to future liabilities and could have a material adverse effect on its business. ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK The Company's market risk disclosures set forth in the Company's 2002 Form 10- K for the year ended December 31, 2002 have not changed significantly during the six months ended June 30, 2003. ITEM 4: CONTROLS AND PROCEDURES The Company maintains disclosure controls and procedures that are designed to ensure that information required to be disclosed in the Company's reports under the Securities Exchange Act of 1934 is recorded, processed, summarized and reported within the time periods specified in the rules and forms of the Securities and Exchange Commission, and that such information is accumulated and communicated to the Company's management, including its chief executive officer and chief financial officer, as appropriate, to allow timely decisions regarding required disclosure. In designing and evaluating the disclosure controls and procedures, management recognized that any controls and procedures, no matter how well designed and operated, can provide only reasonable assurance of achieving the desired control objectives, and management necessarily was required to apply its judgment in evaluating the cost-benefit relationship of possible controls and procedures. As required by Securities and Exchange Commission Rule 13a-15(b), the Company carried out an evaluation, under the supervision and with the participation of the Company's management, including the Company's chief executive officer and chief financial officer, of the effectiveness of the design and operation of the Company's disclosure controls and procedures as of the end of the quarter covered by this report. Based on the foregoing, the Company's chief executive officer and chief financial officer concluded that the Company's disclosure controls and procedures appear to be effective at the reasonable assurance level. There has been no change in the Company's internal controls over financial reporting during the Company's most recent fiscal quarter that has materially affected, or is reasonably likely to materially affect, the Company's internal controls over financial reporting. 26 PART II. OTHER INFORMATION ITEM 1. LEGAL PROCEEDINGS The information included in Note 8 of Notes to Condensed Consolidated Financial Statements under the caption "Litigation and Other Contingencies" in Item 1 of Part I is incorporated herein by reference. ITEM 2. CHANGES IN SECURITIES AND USE OF PROCEEDS (a) None. (b) Dividend Payment Restrictions The Company has entered into borrowing agreements that contain restrictions on the declaration and payment of dividends without the lender's consent. In addition, the Company currently intends to retain future earnings to fund operations, and does not anticipate paying dividends on its common stock in the foreseeable future. (c) None. (d) Not applicable. ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS The Company's Annual Meeting of Shareholders (the "Annual Meeting") was held on May 22, 2003 at 12:00 p.m. local time, at its corporate offices located at 2180 Fortune Drive, San Jose, California. The Annual Meeting was held for the purpose of (a) electing five members of the Board of Directors, (b) ratifying the selection of PricewaterhouseCoopers LLP as the independent auditor of the Company for its fiscal year ending December 31, 2003, (c) approving the adoption of the Company's 2003 Incentive Award Plan and the issuance of up to 6,568,800 shares of common stock under such Plan, and (d) transacting such other business as may properly come before the Annual Meeting. The following proposals were voted upon and approved: Proposal No. 1 - Election of four members of the Board of Directors: The following persons were duly elected to the Board by the shareholders for a one year term and until their successors are elected and qualified: NOMINATION FOR ABSTAINED ---------- --- --------- Raymond D. Zinn 86,907,962 357,737 Warren H. Muller 62,413,584 24,852,115 Donald H. Livingstone 86,787,709 477,990 Larry L. Hansen 85,875,203 1,390,496 George Kelly 85,713,100 1,552,599
Proposal No. 2 - Ratification of the appointment PricewaterhouseCoopers LLP as the independent auditor of the Company for its fiscal year ending December 31, 2003: NOMINATION FOR AGAINST ABSTAINED ---------- --- ------- --------- PricewaterhouseCoopers LLP 86,162,932 1,079,181 23,586
27 Proposal No. 3 Approve the adoption of the Company's 2003 Incentive Award Plan and the issuance of up to 6,568,800 shares of common stock under such: FOR AGAINST ABSTAINED --- ------- --------- 73,299,695 6,363,942 485,511
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K (a) Exhibits. Exhibit No. Description ----------- ----------- 10.1 Credit Agreement between the Registrant and Bank of The West dated June 30, 2003. 31 Certifications of the Company's Chief Executive Officer and Chief Financial Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002 32 Certifications of the Company's Chief Executive Officer and Chief Financial Officer pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 (b) Reports on Form 8-K. During the quarter ended June 30, 2003, the Company filed a Current Report on Form 8-K, on April 22, 2003, disclosing that the Company had filed a complaint against its former principal accountants Deloitte & Touche LLP ("Deloitte") entitled Micrel, Incorporated v. Deloitte & Touche LLP in the Superior Court of the State of California, County of Santa Clara, alleging various causes of action relating to certain professional advice received by Micrel from Deloitte. In addition, the Company filed a Current Report on Form 8-K, on April 22, 2003, announcing its results of operations for the quarter ended March 31, 2003 SIGNATURE Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized. MICREL, INCORPORATED -------------------- (Registrant) Date: August 13, 2003 By /s/ Richard D. Crowley, Jr. ---------------------------- Richard D. Crowley, Jr. Vice President, Finance and Chief Financial Officer (Authorized Officer and Principal Financial Officer)