| MICREL INC Item 1A Risk Factors 13 ITEM 1A RISK FACTORS Factors That May Affect Operating Results If a companyapstas operating results are below the expectations of public market analysts or investors, then the market price of its Common Stock could decline |
| Many factors that can affect a companyapstas quarterly and annual results are difficult to control or predict |
| Some of the factors which can affect a multinational semiconductor business such as the Company are described below |
| Geopolitical and Macroeconomic Risks That May Affect Multinational Enterprises - ------------------------------------------------------------------------------ Demand for semiconductor components is increasingly dependent upon the rate of growth of the global economy |
| If the rate of global economic growth slows, or contracts, customer demand for products could be adversely affected, which in turn could negatively affect revenues, results of operations and financial condition |
| Many factors could adversely affect regional or global economic growth |
| Some of the factors that could slow global economic growth include: increased price inflation for goods, services or materials, rising interest rates in the United States, a slowdown in the rate of growth of the Chinese economy, a significant act of terrorism which disrupts global trade or consumer confidence, and geopolitical tensions including war and civil unrest |
| Reduced levels of economic activity, or disruptions of international transportation, could adversely affect sales on either a global basis or in specific geographic regions |
| 13 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 |
| In 2005, 75prca of the Companyapstas revenues were derived from export shipments |
| In addition, 65prca of the Companyapstas revenues were derived from export shipments to customers in Asia |
| International markets are subject to a variety of risks, including changes in policy by the US or foreign governments, acts of terrorism, foreign government instability, social conditions 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 |
| Changes in exchange rates that strengthen the US dollar could increase the price of the Companyapstas products in the local currencies of the foreign markets it serves |
| This would result in making the Companyapstas products relatively more expensive than its competitors &apos 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 |
| 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 elsewhere in the world |
| Such factors could adversely affect the Companyapstas 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 US The Companyapstas supply could be interrupted as a result of any of the previously mentioned risk factors relating to international markets |
| Market conditions may lead the Company to initiate additional cost reduction plans, which may negatively affect near term operating results |
| Weak customer demand, competitive pricing pressures, excess capacity, weak economic conditions or other factors, may cause the Company to initiate additional actions to reduce the Companyapstas cost structure and improve the Companyapstas future operating results |
| The cost reduction actions may require incremental costs to implement, which could negatively affect the Companyapstas operating results in periods when the incremental costs or liabilities are incurred |
| Semiconductor Industry Specific Risks - ------------------------------------- The volatility of customer demand in the semiconductor industry limits a companyapstas ability to predict future levels of sales and profitability |
| Semiconductor suppliers can rapidly increase production output, leading 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 products can result in excess quantities of certain products relative to demand |
| Should this occur the Companyapstas operating results may be adversely affected as a result of charges to reduce the carrying value of the Companyapstas inventory to the estimated demand level or market price |
| The Companyapstas quarterly revenues are highly dependent upon turns fill orders (orders booked and shipped in the same quarter) |
| The short-term and volatile nature of customer demand makes it extremely difficult to accurately predict near term revenues and profits |
| 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 and price; timing of product introductions; emergence of new computer and communications standards; quality and customer support |
| Many semiconductor companies face risks associated with a dependence upon third parties that manufacture, assemble or package certain of its products |
| These risks include reduced control over delivery schedules and quality; inadequate manufacturing yields and excessive costs; the potential lack of adequate capacity during periods of excess demand; difficulties selecting and integrating new subcontractors; potential increases in prices; disruption in 14 supply due to civil unrest, terrorism or other events which may occur in the countries in which the subcontractors operate; and potential misappropriation of the Companyapstas intellectual property |
| The occurrence of any of these events may lead to increased costs or delay delivery of the Companyapstas products, which would harm its profitability and customer relationships |
| Additionally, the Companyapstas 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 |
| Customers are requiring that the Company offer its products in lead-free packages |
| Governmental regulations in certain countries and customers &apos intention to produce products that are less harmful to the environment has resulted in a requirement from many of the Companyapstas customers to purchase integrated circuits that do not contain lead |
| The Company has responded by offering its products in lead-free versions |
| While the lead-free versions of the Companyapstas products are expected to be more friendly to the environment, the ultimate impact is uncertain |
| The transition to lead-free products may produce sudden changes in demand depending on the packaging method used, which may result in excess inventory of products packaged using traditional methods |
| This may have an adverse affect on the Companyapstas results of operations |
| In addition, the quality, cost and manufacturing yields of the lead free products may be less favorable compared to the products packaged using more traditional materials which may result in higher costs to the Company |
| During a period when economic growth and customer demand have been less certain, both the semiconductor industry and the Company have experienced significant price erosion since the beginning of 2001 |
| If price erosion continues, it will have the effect of reducing revenue levels and gross margins in future periods |
| Furthermore, the trend for the Companyapstas customers to move their electronics manufacturing to Asian countries has brought increased pricing pressure for Micrel and the semiconductor industry |
| Asian based manufacturers are typically more concerned about cost and less concerned about the capability of the integrated circuits they purchase |
| The increased concentration of electronics procurement and manufacturing in the Asia Pacific region may lead to continued price pressure and additional product advertising costs for the Companyapstas products in the future |
| An important part of the Companyapstas strategy is to continue to focus on the market for high-speed communications ICs |
| If the growth in the telecommunications infrastructure and wire line networking markets is not sustainable, resulting in reduced demand for the Companyapstas high bandwidth products, the Companyapstas future revenue growth and profitability could be adversely affected |
| The short lead time environment in the semiconductor industry has allowed many end consumers to rely on stocking representatives and distributors to carry inventory to meet short term requirements and minimize their investment in on-hand inventory |
| The Company maintains a network of stocking representatives and distributors, that carry inventory to service the volatile short-term demand of the end customer |
| Should the relationship with a distributor or stocking representative be terminated, the future level of product returns could be higher than the returns allowance established, which could negatively affect the Companyapstas revenues and results of operations |
| 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 Companyapstas 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 |
| 15 Because the standard products market for ICs 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 |
| 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 Companyapstas financial condition, results of operations, or cash flows |
| The significant investment in semiconductor manufacturing capacity and the rapid growth of circuit design centers in China may present a competitive threat to established semiconductor companies due to the current low cost of labor and capital in China |
| The emergence of low cost competitors in China could reduce the revenues and profitability of established semiconductor manufacturers |
| There is intense competition for qualified personnel in the semiconductor industry, in particular design engineers |
| 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 Companyapstas product and process development programs |
| The success of companies in the semiconductor industry depends in part upon 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 Companyapstas 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 Companyapstas business, financial condition, results of operations, or cash flows |
| The Statement of Accounting Standards ( "e SFAS "e ) Nodtta 123R, "e Share-Based Payment "e will require the Company to recognize the cost of employee services received in exchange for awards of equity instruments, based on the grant date fair value of those awards, in the financial statements |
| As discussed in Note 1 of Notes to Consolidated Financial Statements, the effect of the adoption of this accounting standard in 2006 is expected to significantly increase stock based compensation expense in future periods after adoption |
| The pro forma effect to net income and earnings per share had the Company applied the fair value method to stock-based awards has been disclosed in the Companyapstas previous Form 10-K filings and is contained in Note 1 of the Notes to Consolidated Financial Statements of this Form 10-K However, the requirement to recognize the cost of stock option awards as an expense in the financial statements will reduce net income and earnings per share from the expensing of stock option awards in the Companyapstas future results of operation and may have an adverse affect on the value of the Companyapstas common stock |
| If the Company reduces the number of stock option grants to employees to minimize the cost associated with share based incentive awards, it will most likely make it more difficult for the Company to hire and retain employees |
| 16 Companies in the semiconductor industry are 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 its manufacturing process |
| Any failure to comply with present or future regulations could result in the imposition of fines, the suspension of production, alteration of manufacturing processes or a cessation of operations |
| In addition, these regulations could restrict the Companyapstas ability to expand its facilities at their present locations or construct or operate a new wafer fabrication facility or could require the Company to acquire costly equipment or incur other significant expenses to comply with environmental regulations or clean up prior discharges |
| The Companyapstas failure to appropriately 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 |
| Company-Specific Risks - ---------------------- In addition to the risks that affect multinational semiconductor companies listed above, there are additional risks which are more specific to the Company such as: The Companyapstas gross margin, operating margin and net income are highly dependent on the level of revenue and capacity utilization that the Company experiences |
| 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 profit margins |
| The cellular telephone (wireless handset) market comprises a significant portion of the Companyapstas standard product revenues |
| The proportion of the Companyapstas annual revenues from customers serving the cellular telephone market has been increasing over the last four years, growing from less than 20prca of worldwide sales in 2001 to approximately 25prca in 2004 and 26prca in 2005 |
| Due to the highly competitive and fast changing environment in which the Companyapstas cellular telephone customers operate, demand for the product the Company sells into this end market can change rapidly and unexpectedly |
| If the Companyapstas cellular telephone customers lose market share, or accumulate too much inventory of completed handsets, the demand for the Companyapstas products can decline sharply which could adversely affect the Companyapstas revenues and results of operations |
| The Company is currently involved in a number of lawsuits |
| The Company currently has four significant pending litigations |
| Litigation is by its nature unpredictable and costly |
| One case was tried in the fourth quarter of 2005, and the parties are awaiting the Courtapstas ruling |
| Two cases have not yet been set for trial, but it is likely that one case will be tried in the second half of 2006 and another will be tried in 2007 |
| In the fourth case, the Company has filed a notice of its intent to appeal an adverse jury verdict |
| The Company currently expects that outside legal expenses will continue to be significant in 2006 |
| If the level of effort required to prosecute or defend the Companyapstas position in any of the lawsuits increases significantly, or if a judgment is entered against the Company, the resulting expense could adversely affect the Companyapstas financial condition, results of operations and cash flows |
| The Company derives a significant portion of its revenues from customers located in certain geographic regions or countries |
| A significant portion of the Companyapstas revenues come from customers located in South Korea |
| In the event that political tensions surrounding North Korea evolve into military or social conflict, or other factors disrupt the Korean economy, the Companyapstas revenues, results of operations, cash flow and financial condition could be adversely affected |
| A significant portion of the Companyapstas revenues come from customers located in Taiwan and China |
| In the event that economic activity in these two countries declines, or is disrupted by geopolitical events, the Companyapstas revenues and results of operations could be adversely affected |
| 17 The Company manufactures most of its semiconductors at its San Jose, California fabrication facilities |
| The Companyapstas existing wafer fabrication facility, located in Northern California, 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 Companyapstas business, financial condition and operating results |
| Furthermore, manufacturing semiconductors requires manufacturing tools that are unique to each product being produced |
| If one of these unique manufacturing tools was damaged or destroyed, the Companyapstas 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 ICs 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 |
| The Company maintains approximately two to three months of inventory that has completed the wafer fabrication manufacturing process |
| This inventory is generally located offshore at third party subcontractors and can act to buffer some of the adverse impact from a disruption to the Companyapstas San Jose wafer fabrication activity arising from a natural disaster such as an earthquake |