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Micrel, Inc. (NASDAQ:MCRL)

Q3 2008 Earnings Call

October 27, 2008 5:00 pm ET

Executives

Ray Zinn - Chairman, President and CEO

Robert Barker - Interim CFO

David Schie - VP of Analog Design and Process Development

Analysts

Tore Svanberg - Thomas Weisel Partners

Craig Hettenbach - Goldman Sachs

Doug Freedman - AmTech Research

John Pitzer - Credit Suisse

Ross Seymore - Deutsche Bank

Gary Mobley - Piper Jaffray

David Wu - Global Capital

Operator

Welcome to the Micrel Incorporated third quarter results conference call. This Conference Call is being recorded today, Monday, October 27, 2008.

I would now like to turn the conference over to Mr. Ray Zinn, President and CEO.

Ray Zinn

Thank you, and welcome to our third quarter results conference call. With me today is Robert Barker, who is our interim CFO. Many of you know Robert from our prior times when Robert actually took the company public with me in 1994, and he is stepping back in for the time being. We welcome Robert back, and I'm sure he is going to be doing a great job while we look for a new CFO.

Also with me is David Schie who is our Vice President of Analog Design and Process Development, and he will be addressing some of our new products and talking a little bit about them.

And so with that, I'd like to turn the time over to Robert Barker to give you our prepared remarks. Robert?

Robert Barker

Thank you very much, Ray. For those of you that haven't followed the last nine years, I've been responsible for Micrel's Business Development, legal activities, and recently, Human Resources. And I'm actually really pleased to be able to help the company out during this transition period as the Interim CFO.

Let me move now to the prepared remarks. In conjunction with this conference call, several supplemental charts will be available on Micrel's website during the following prepared remarks. To access these charts, go to www.micrel.com and click on the link to the Q3 2008 conference call slides.

We'll begin today's call with some legal disclaimers. All material contained in the webcast is the sole property and copyright of Micrel Incorporated, with all rights reserved. Certain statements in the conference call which are not historical facts may be considered forward-looking statements, that involve risks and uncertainties.

Forward-looking statements include statements regarding world economic outlook, future business results, future levels of sales and profitability, including operating expenses, diluted shares outstanding, compensation expenses, effective tax rate, earnings per share, and future customer demand. Various factors could cause actual results to differ materially from what is set fourth in such forward-looking statements.

Some of the factors that could affect the company's results have been set fourth in our press release dated October 27th, 2008, and are also described in detail in the company's SEC filings, including but not limited to our Annual Report on Form 10-K for the year-ended December 31st, 2007, and our Quarterly Report on Form 10-Q for the quarter ended June 30, 2008. Listeners who do not have a copy of our third quarter earnings press release may view the press release on the company's website at www.micrel.com.

Micrel posted very solid third quarter results despite the economic slowdown that began to impact our demand at the end of the quarter. Going into the third quarter, we predicted that September turns-fill level would be key to achieving our revenue guidance. Unfortunately, customer demand dropped significantly in the last two weeks of the quarter, as the economic woes began to deepen.

Total bookings for the quarter were less than revenues, driven primarily because our distributors implemented actions to decrease inventory levels and conserve cash. Q3 bookings were paced by demand from customers serving the industrial, communications and wireless handset end markets. In the current turbulent economic environment, customers remain very cautious, which continues to keep order lead times in the four to five week range.

In the third quarter, Micrel posted $67.5 million in revenue, a decrease of 4% sequentially and an increase of 4% in the third quarter of 2007, although resales of the company's products from global sell-through distributors remained strong throughout the quarter and represented an all-time record for the company.

The sequential quarter decrease in sales was driven primarily by reduced demand from customers serving the wireline communication, Wi-Fi voice-over-IP and foundry sales to a major solar end customer. This was offset by slight increases in the computer and consumer markets. The OEM turns-fill percentage for the third quarter was approximately 50%. Standard product sales accounted for 96% of total Q3 revenues, with foundry and custom product sales comprising 4%.

Third quarter sales mix by product area was: analog, 68%; high bandwidth, 16%; Ethernet, 13%; and foundry, 3%.

Looking at sales by end market, the industrial end market grew one percentage point sequentially, to 37% of third quarter sales. Wireline communications market made up 26% of Q3 sales, down from 28% in Q2. Sales to the computer market increased sequentially by three percentage points to, 16% of sales. Sales to the wireless handset market decreased slightly from 19% in Q2 to 18% in Q3. Finally, consumer military sales increased 1 percentage point sequentially to 5% of third quarter sales. Our foundry sales decreased $0.5 million dollars to $2 million, but remained constant as a percent of overall sales at 3%.

Third quarter sales by geographical region was similar to Q2, with sales to Asian-based customers accounting for 56% of Q3 revenues; sales to North American customers, 32%; and sales to European customers comprising 12%. These Q3 percentages compare to Q2 results of Asia, 55%; North America, 32%; and Europe at 13%.

Now turning to the remainder of the income statement. Third quarter gross margin was 56%, about the same as Q2. R&D spending was 13.8 million, or 20% of revenues in the third quarter, compared to $14.8 million, or 21% of revenues, in the second quarter.

During the quarter, Micrel released the total of 24 new high performance products. David Schie, Micrel's Vice President of Analog Design, Development and R&D, will now take a moment to describe some of these products.

David Schie

Thank you, Robert. I am very encouraged with our progress as we introduce so many new products, and also as our product development capability is really accelerating. We've been focusing heavily on increasing the breadth of our product line, and filling in holes that exist in the portfolio, so that we can be a one-stop-shop source for our customers. This is being received well.

An example of this is in the DC-to-DC space, where we've been able to increase our sound by focusing on the 12-volt node where we already have a lot of products in at 5 volts. An example is the new 12-volt multi-phase converter that actually features our proprietary high performance differential tracking algorithm we've been working on for some time; what it allows customers to do is really reduce their capacitance, which saves them money and board space.

The additional trend that we're seeing is a shift towards these more complex switcher type and more integrated products, which bring us higher margins. In terms of switches, we continue to set the standard for size and current density.

We introduced a family of new 1.2-by-1.2 millimeter devices, which actually set the standard for the highest current density at 2.1 amps per square millimeter, and we also introduced new very small devices 0.85-by-0.85 for portable applications which utilize our proprietary MLF copper pillar technology. This lets you get the heat out so that you can obtain these kind of current densities.

We introduced two new USB interface switches for LCD TVs and consumer electronics, and we're also seeing a lot of improved design in traction as we introduce these new products. An example is our low-cost LDO family, which is already shipping at tens of millions of rate. It's been a big success, and we're proliferating that line.

We've introduced two of the smallest in the market dual one-by-one 150 milliamp LDOs, again using our copper pillar technology. We also introduced two new high current LDOs of 3 amp and 1.5 amp, which will enable the next generation of low input voltage applications and further these LDOs offer the best transient response of any similar LDOs, which again reduces the customers' capacitance which saves them money and board space.

In terms of enabling green technologies, we've introduced three new LED drivers for solid state lighting. We believe that high brightness LEDs represent a point source of very high efficiency, which is more palatable to customers than some compact fluorescent technologies. And these drivers will help enable general lighting, street lighting, and automotive applications. So we're excited about that.

In terms of high bandwidth and Ethernet applications, we introduced a new 2.5 gigabit per second laser diode driver, which integrates the limiting amplifiers with a burst mode laser driver. The result is a cost reduction for our customers in GPON applications. We also introduced an ARM9 processor-based multimedia chip, targeted at printer server, projector and other embedded applications.

So I'm very pleased with our performance and continue to believe that as we fill in the holes in our product line and become a one-stop-shop source for our customers, this is really going to lead to success in the future.

So, back to you, Robert.

Robert Barker

Okay. Thanks David. Returning to the income statement, Q3 SG&A spending was $11.3 million or 17% of sales. This is down from $11.6 million in the second quarter. Third quarter GAAP operating income was $12.7 million, or 19% of sales. This compares to GAAP operating income of $10.8 million in the second quarter and $12.9 million in the year-ago period.

Reducing operating expenses is a key focus at Micrel. We have implemented a companywide cost reduction effort in order to improve our operating profit margin independent of revenue growth. Recently, Micrel reduced its San Jose manufacturing workforce by approximately 10% as the company continues to move more of its manufacturing offshore. While this will help Micrel's gross margin in Q4 and beyond, there was less of an impact in Q3 due to the severance costs associated with the workforce reduction.

Other income net was unchanged during quarter-to-quarter at $700,000. The effective tax rate was 36.6% for the third quarter. A combination of a lower tax rate and lower diluted shares outstanding in Q3 resulted in nearly $.01 sequential gain in earnings per share. Shares used to calculate diluted earnings per share were $70.4 million in the third quarter versus $71.4 million in the second quarter and $78 million in the third quarter of 2007.

Third quarter GAAP net income was $8.5 million or $0.12 per diluted share. This compares with second quarter GAAP net income of $7.2 million, or $0.10 per diluted share, and GAAP net income of $9.4 million, or $0.12 per diluted share, in the year-ago period.

Our balance sheet remained strong. The company generated $16.3 million in cash from operations during the quarter. September ending cash and short-term investment balances of $82.3 million increased slightly compared to $79.1 million at the end of June. During the quarter, $10.5 million was spent to repurchase 1.1 million shares of Micrel common stock.

Accounts receivable balance decreased by $400,000 in the third quarter to $34.3 million. Days sales outstanding increased to 47 days at the end of Q3 from 45 days at the end of Q2. Net inventory increased slightly by $800,000 in Q3 to $36.5 million due to lower than projected revenues.

Inventories at our sell-through distributors increased by $2 million or 6% in the third quarter over Q2 levels. At the same time, distributor resales were increasing 2% over Q2 levels. The days of inventory at sell-through distributors remained roughly the same, at approximately 10.5 weeks.

Capital expenditures totaled $2.4 million in the third quarter, and Q3 depreciation and amortization excluding the amortization of stock-based compensation was $5 million, or 7% of sales.

Micrel's Board of Directors has been, and continues to be, focused on returning a portion of the company's cash flow to shareholders through the stock repurchase plan and a quarterly dividend payment. Today Micrel is announcing that its Board of Directors has authorized a quarterly dividend payment of $0.035 per common share. The dividend is to be paid on November 19th, 2008, to shareholders of record on November 5th.

Now turning to the outlook for the semiconductor industry and Micrel. Let's turn to slide number one on the webcast, which is the Micrel semiconductor barometer. The metrics that we follow for the industry relative to Q4 have deteriorated, and are predicted to stay that way through the first quarter of 2009.

The worldwide financial crisis has caused our customers to become more conservative in their outlook. Lead times remain in the four to five week range. Semiconductor distribution channel remains the primary culprit in the shortened lead times. This indicates they are less willing to carry the inventory and rely on the semiconductor manufacturers to fill in the gaps. This makes it difficult for us to forecast our revenue for Q4 and beyond.

Please turn to slide number 2, which is our semiconductor industry cycle chart. Because of the downturn, we now predict the overall semiconductor market will be down 1% to up 3% for 2008 compared to 2007.

Turning to 2009, with the economic uncertainty before us, our growth prediction is for the industry will be a little lighter than normal due to the unpredictability of the worldwide macroeconomy. Having said that, we believe the growth in 2009 will be no worse than flat if the financial crisis somehow gets resolved by the end of Q1 2009. If the channel inventories remain in control, which we believe they will, then we could see a growth of up to 5% in 2009.

Now for the third quarter outlook for Micrel. While we are starting the fourth quarter with a total backlog 8% lower than Q2, our Q3 beginning OEM backlog is roughly the same as the Q2 beginning backlog. To hit the mid point of our guidance range, we'll require 43% turns-fill for the quarter versus 50% turns-fill achieved in Q3. We are also forecasting a significant slowdown in the last two weeks in December.

One additional factor impacting fourth quarter revenues is a predicted decrease of $1.5 million in foundry demand to our solar cell customer. We are also factoring in a 7% decrease in distribution resales in the fourth quarter compared to the record resales achieved in Q3.

Our current forecast is that Q4 revenues will be down approximately 10% when compared to Q3. The swing factor for Micrel's fourth quarter revenues will be the distribution resales which occur on a week to week basis throughout the quarter and are difficult to accurately predict in today's chaotic financial climate.

We currently see slowness in the Asian-Pacific region and expect this region to rebound somewhat as the quarter progresses. We also expect both Europe and North America will also be down slightly.

Moving to our financial guidance for the fourth quarter, we project that revenue will decrease on a sequential quarter basis in the range of down 7% to down 13%. We also expect GAAP earnings to be in the range of $0.08 to $0.11 per diluted share.

Our guidance reflects the prevailing global economic uncertainty coupled with cautious purchasing patterns by our customers and their likely desire to hold little inventory at the end of 2008. We believe that we are beginning to take market share and grow faster than the overall analog market going forward.

Given the significant inventory reductions, we are seeing throughout the semiconductor supply chain, when growth resumes, it will likely be quite robust for both Micrel and many of our peers. We feel extremely good about the aspects of our business that we can control and are confident that Micrel would exit the current macro weakness with a significantly enhanced competitive position, higher margins and profitability.

There are several reasons for our confidence and optimism about Micrel's future. First, as we discussed at our Analyst Day, and throughout 2008, we have excellent new product momentum and design win activity. In 2008, we will have released a tremendous number of new products that has increased our analog SAM in 2009, roughly two times the size it was just a year ago.

For a company with Micrel's history and strong customer relationships, there is significant leverage to these product launches as we are well positioned to gain new sockets. It is important to recognize that just because the macroeconomic environment is weak does not mean that design activity is slowing. Activity is robust, and we are winning significant new designs with new products and new markets that will result in strong growth when the economic environment improves. Importantly, our product pipeline for 2009 is also very strong.

Second, we feel good about our efforts to improve our cost structure. Unlike some of our peers who are only now being reactive and taking action to reduce expenses, we have been proactive and thoughtful about reducing costs for the last several quarters. These cost reductions will now allow us to minimize the earnings impact and maintain margins in the face of the current economic downturn. When end markets improve, we will be positioned for greater operating margin expansion as we continue to reduce OpEx over the next few quarters.

Third, we have confidence in our management depth. We have previously discussed significant value add additions to both our Senior Management and our Board of Directors. Our efforts in this regard continue, and we are eager to further strengthen our talented Board. We are active in our search for a new CFO and have identified several candidates that we believe would be outstanding additions to the Micrel team.

Finally, we feel very good about our capital structure. We continue to maintain a cash-rich, debt-free balance sheet. We recently increased our authorized stock buyback from $50 million to $60 million and continue to actively repurchase shares, which reflect our confidence in our business momentum.

While the current macro environment could create interesting acquisition opportunities, we will only pursue them if they are strategically beneficial and meaningfully accretive. The bar is high as we believe few opportunities are likely to be more attractive than repurchasing our own shares, particularly at current prices.

As the stewards of your capital, we remain committed to using our significant free cash flow for the repurchase of our own shares and activity, which we have actively pursued since 2003, and has resulted in the reduction in share count of 30% without incurring any debt. We plan to continue this share repurchase activity, particularly given our confidence in Micrel's future. We believe that Micrel's strategy of being in the market, purchasing shares every day is a winning strategy for our shareholders.

We are cognizant of the uncertainties of the economic environment, but realize this too shall pass. We are confident that through the storm, we will enhance our position and create significant value for our shareholders. Thank you.

Now, we will go to the question-and-answer portion of the conference call.

Question-and-Answer Session

Operator

(Operator Instructions). Our first question comes from the line of Tore Svanberg with Thomas Weisel Partners. Please go ahead.

Tore Svanberg - Thomas Weisel Partners

Yes, thank you very much. Maybe I can start off with a question for Ray. Ray, you've been through these cycles several times. What's your current opinion on this one compared to others you've seen?

Ray Zinn

Well, this one is truly a macro problem. And it's not a micro, meaning that this is more of a financial global issue as opposed to being an inventory-initiated downturn.

In the past, when the semiconductor industry has undergone a significant downturn, it was because it was preceded by a large upswing in inventory which then we had to bleed off over time, and that usually took anywhere from a year to a year-and-a-half to absorb. And in this current environment, the inventories are, I think, well in control. We are not seeing any overbuilds. And therefore, given that the financial crisis resolves itself in some reasonable period of time, then we should see a quicker snapback of unit demand.

That's why if you go back to the cycle chart, that's what you see in our prediction. To the left is the actual. To the right of that line is the projected. So, if you go back and look at that, you'll see that that's following the bottom of the downturn, this is unit demand what I'm referring to, not the ESP, but the unit demand. You see that it begins to snap back some time in the June timeframe, and then goes up quite nicely, but is basically flat unit growth.

Yet, still we believe does indicate the fact that the industry is not undergoing a micro, but more of a macro downturn. So, we're still confident that the industry is still well in controlling utilizations are appropriate, and the cycle that we're currently saying being more macro financial in nature will abate itself, and we should see a resumption of industry growth.

Tore Svanberg - Thomas Weisel Partners

Good. Maybe as follow-up to Robert, Robert, I think you mentioned you expect gross margin to improve in Q4. Can you elaborate a little bit on that, especially in light of your sequential decline in sales, please?

Robert Barker

What I said was we stayed at the same revenue like rate, but what we're modeling is that for a decrease in revenues that the gross margin was dropped about 25 basis points for each $1 million of decrease in revenue.

Tore Svanberg - Thomas Weisel Partners

Great. And also and maybe finally, you gave us some turns requirements for hitting the mid point this quarter. Can you talk about how your current orders have been so far this quarter, and have you in reality actually seen sell-through bookings actually trail-off just yet?

Robert Barker

No. We've seen the sell-through bookings trail-off with respect to Q2. Again, it's pretty early, as you know, in this downturn. So, we haven't heartily established a trend yet, but we have seen some tail-off in POS shipments. And that's why we're giving this relatively wide range of guidance.

And the turns-fill is also factored into what we think is consistent with what might happen if we get a more of a fall-off towards the end of the year due to the lack of consumer support in the marketplace. So, we're being, I think, relatively conservative. Of course, no one knows for sure, but we model this thing best we can. We're in a box.

If I guidance too low, then of course this makes our earnings look bad. So, we're trying to keep it consistent with what we believe is going to happen, even though we don't know it for a fact.

Tore Svanberg - Thomas Weisel Partners

Sounds good. I'll follow-up with more questions later. Thank you.

Robert Barker

You're welcome.

Operator

Thank you. Our next question comes from the line of Craig Hettenbach with Goldman Sachs. Please go ahead.

Craig Hettenbach - Goldman Sachs

Yes, thank you. Ray, can you provide any color by end market for calendar Q4 in terms of expectations, some markets that might hold in a little better versus some that might lag into Q4?

Ray Zinn

Sure. So, anything that's related to the direct consumer market is the one we're concerned about. I even throw automotive in there, because automotive is a consumer related attribute. So the markets that I think are going to be relatively stable are going to be the industrial market, and we are seeing that.

Actually, many of our wireline customers are still doing relatively well. The handset market looks to be okay for us. I think it's because of the fact that we've won a lot of significant sockets. You might see from a wireless handset side, you might see a slight perturbation from total revenue for the industry or for that handset industry. I think we're going to do well, because it's just the design wins we have and the momentum we're seeing.

So, while we may not see as much reduction in the handset side, certainly from an industry point of view, there is some indication of softness in the wireless handset market. So, let's see on the computer market front, again, on the server more in the industrial side, we see that okay, not great.

Obviously, there are some push-outs on IT to conserve cash and to see what's going on in the overall financial market, but we see it. The server market still is okay. On the high-speed communication video side, it looks real good because of the conversion to HDTV. So, we're seeing a lot of design win and focus on that. So that will help us. And that's a strengthening market.

The HDTV market itself I think will be good, but not as good as maybe earlier predicted just because of the consumer issues associated with this financial crisis. We see things as a little tepid now that the consumer is being very cautious. Our customers are being cautious regarding their ordering. They don't want to be caught with any inventories.

Actually in a way it's a good thing, Craig, because if we keep these inventories in control, then the snapback will be more real and more significant than it would be if we were building inventories at a prodigious rate. And this is just not happening. So we've gone into this slump with minimal inventories. You heard that from our prepared remarks, and I believe the industry will also reflect that.

So, all in all, I believe that once we get through this debacle that we're currently facing in the macro sector and get the Presidential election out of the way and things begin to stabilize a little bit, this could be a pretty good snapback, probably beginning in May.

Craig Hettenbach - Goldman Sachs

Okay. And if I could just ask one follow-up. On the pricing environment, just given that this continues to take inventory down and end demand is slowing, have you seen much of an impact to pricing in the near term?

Ray Zinn

Haven't seen any yet, Craig. I think you've seen the gross margin still holding in there. There is not a lot of inventory for them to pressure. In other words, the only way you can really get pricing to fall is if you have an over-inventory situation. And that's just not the case.

And so, with lead times as short as they are, with inventories in check, they just don't have the pressure that you would have when you have more of a micro over inventory build cycle.

Craig Hettenbach - Goldman Sachs

Okay. Thank you.

Ray Zinn

You're welcome.

Operator

Thank you. Our next question comes from the line of Doug Freedman with AmTech Research. Please go ahead.

Doug Freedman - AmTech Research

Hi. Thanks for taking my question. Ray, can you talk about your plans or possibilities of shut downs over the next two quarters? It appears some of your peer group are already starting to implement such actions. Is that in your present guidance or are those additional steps that are possible?

Ray Zinn

Well, in the present guidance, we have flexibility. It depends upon how things look going into November. So, we still have some flexibility of days we can take off. We're right now taking off four days, which is normal for us. I mean we always take off those four days prior to Christmas. And so that's a normal thing.

So we don't have any abnormal hut downs baked in yet, but that doesn't mean we can't do that. I mean there are several things we can do, the several little levers we can pull, to reduce our costs, such as a complete shut down for more than four days and also just trimming some expenses in more of a discretionary area, bonuses and so forth. So we have few levers that we can still pull if we need to. But, Robert, are those baked in yet?

Robert Barker

No.

Ray Zinn

Okay. So we haven't gone to that extent. Again, we're still fishing around, trying to figure out what to do, but these things are all something that can still happen over the next couple of months.

Doug Freedman - AmTech Research

Alight, great. And can you talk about the lead times? You did talk about lead times declining. However, you're also forecasting a decline in the number of turns in the quarter. I would tend to reconcile that as lead times drop, turns percentages would increase. Can you help us understand when you think those factors will stabilize?

Ray Zinn

Yeah. Part of the turns issue is associated with POS, because we count POS as turns. And so, we see a reduction in POS and we're also seeing a reduction in turns. And as Robert talked about, we're seeing about a 7% drop-off in POS. And so if we were 50% last quarter, you drop 7%. That's 43%.

So, my turns I was referring to is OEM turns, but it's similar down about 7%, as you said, and distribution we're modeling, also down about 7%.

Doug Freedman - AmTech Research

Okay.

Ray Zinn

So, it's a combination of distribution and OEM, okay. But I'm comparing it, so you can just see that if POS is down 7%, that will also pull you, because that's only half of our business is POS anyway. So, I guess that models out. So I guess we're expecting half of it being OEM and half of it being distribution. And that's why we're reflecting a less of a POS, even with these lead times in this range. And believe me, all the customers are just ordering as they need it. They aren't placing any long-term demand.

Doug Freedman - AmTech Research

And if you could, my last question for you, are there any markets that you really feel strongly that you're taking share or any markets where you feel you may be giving up share just due to not having the right product for that market? If you could highlight those for us, that would be helpful.

Ray Zinn

That's a good question, Doug. What is it that we are that we are losing sockets. I don't know any of any off the top of my head where we're losing sockets. So, on the positive side, I think we're gaining in with our switchers. They're taking share. And a lot of our customers are switching from LDO to switches anyway, because of the Delta B issues.

We have a lot of good products right now that are taking hold in the wireless side. This is one of the all-time record for us is the number of products being designed in by our customers because of our switcher portfolio that we have. So, we see that is a pickup for us.

Also, in the high speed video side, we're seeing that growing for us. That's a new market, the HDTV side, of course. And we believe also that our Wi-Fi customer in Korea, I think they are going to come back some time in about the middle of Q1. So, that looks encouraging too.

So, we're quite encouraged. I mean given the amount of turmoil that's currently out there and the fact that our customers, especially our distributors, which are hanging back as you would, I feel quite encouraged about what we see and how we're kind of positioning ourselves relative to our peers.

So, no one likes this sort of thing happening. And of course, we are not the only ones that are seeing this, but it's very encouraging to see the amount of activity that's still there. I mean the phones are ringing, and we're still having lots of meetings with customers, and we're still doing a lot of price negotiation. And so there is a lot of activity going on. It's just orders are a little short right now, because I think everybody is sitting back, waiting for the next shoe to drop.

Doug Freedman - AmTech Research

Alright, great. Thank you so much.

Ray Zinn

You're welcome, Doug.

Operator

Thank you. Our next question comes from the line of John Pitzer with Credit Suisse. Please go ahead.

John Pitzer - Credit Suisse

Yes, good afternoon. Thanks for taking my question. Robert, first you talked about taking OpEx down. I apologize if I missed it, but could you give us sort of a range of where you could take OpEx right now?

Robert Barker

Going forward, we had a big substantial drop in Q3 compared to Q2. And just going forward, there will be just modest decreases, but I think we could drop maybe a $100,000 or a couple of hundred thousand if we stayed at the same revenue level. It will lower if there is less commission, but we still do expect to run a more and more efficient area. We took a pretty big reduction here during this quarter.

Ray Zinn

You see some improvements though, just as a mass cost reduction because the amortization of the mass set. So, we'll get some improvement there. And also, some of these severance costs are going to go away in Q4 also. So, we do get some improvement.

I don't know exactly what the numbers are John, because Robert has taken over for Rick in the last few weeks of the quarter here. Actually, he has been preparing for these financial remarks. So we're not as well prepared as we would normally be to be able to answer those questions. So, we'll know probably over the next week or so as we get into Q4 on how we're going to model our expenses.

So, just bear with us a little bit as Robert transitions into his new role as Interim CFO.

John Pitzer - Credit Suisse

Understood. I guess on that front, is it a little bit premature to talk about breakeven and where you might want to take that? I guess as you answer that question, then what are your thoughts on how you see March relative to normal seasonality would be helpful.

Ray Zinn

Okay, well, we don't like to forecast into the next quarter or two quarters out. We did say that if you look at the barometer that we show that we do see our Q1 still being a turbulent quarter for us, especially given we don't know how long this financial crisis is going to take to resolve itself.

But from a booking point of view, we're holding in there. We are probably a little lower. Booking levels are a little lower for Q1 than we had going into Q4. But a lot of that could be just the fact that we're not really seeing any distri orders at this juncture.

But from an OEM point of view in the POP side, that's still looking pretty similar to what we had going into December. So, Q1 doesn't look off the wall. I'm not going to forecast it already in the middle of October as you would try to forecast Q1 already, except looking at it from a macro point of view, which we've addressed from an industry point of view. But certainly, things are a little cloudy out there.

Breakeven-wise, we've already lost money one quarter out of the last one year or so. We lost money one year of the last 30, and that was in 2002, and that wasn't a big loss even there. So, our ability to breakeven, I think, is a record unparalleled in this industry. So we will do whatever it takes. We will not lose money. So, you can assure that we will do whatever it takes to get our cost structure in line with our revenue.

If you go back historically, $53 million was kind of the bottom number for us on revenue. That maybe is a little bit different cost structure, but anyway, certainly we could hold our own at least down to $53 million.

Robert Barker

At the range we've given, even at the lower end of the range, which is at the 13% decrease, we're still solidly profitable, and we project to be solidly profitable in that range.

Ray Zinn

Yeah, but he is wondering where the breakeven might occur. I'm saying it's at least no worse than $53.

Robert Barker

Right.

Ray Zinn

And as Robert pointed out, even down 13, we are still making good money.

John Pitzer - Credit Suisse

Two more questions from me. One, you talked about on your Analyst Day outgrowing the analog industry by about 1.5 times in '09. Is that still on track relative to the share gains you see out there?

Ray Zinn

Yeah, I do. We've doubled our SAM. And just with the activity we're seeing and the reception of our new products, yes, I still believe that that's very doable, albeit that right now we're a funk because of this macro problem.

John Pitzer - Credit Suisse

Last question: September gross margins held up well, even on worse revenue. Was that all mix related or was there other cost cutting that you did throughout the quarter that helped?

Ray Zinn

Well, it's a combination. Certainly, some of it is cost related. But again, we're not seeing a lot of price slashing. One of the questions was asked, do we see a lot of price pressure, and we haven't really seen any. Our newer products have decent margins on them, and a lot of this growth we're seeing is with our new products which have good margin. And so that's helping us.

So, the fact that we had less even in that business because of this Korean customer who had a financial problem, and the reason we were down in Q3 was because of this one Korean customer. And that's Ethernet. And Ethernet has one of our lower margins product lines. So, that obviously helped out margins too, the fact that the mix was less Ethernet.

Robert Barker

We also have some major cost reduction efforts going on in the back end of our operations, as we move more of our material offshore, and we're beginning to move some of our assembly and testing into China.

John Pitzer - Credit Suisse

Great. Thanks. I appreciate it.

Ray Zinn

You're welcome, John.

Operator

Thank you. Our next question comes from the line of Ross Seymore with Deutsche Bank. Please go ahead.

Ross Seymore - Deutsche Bank

Hi, guys. In your revenue guidance in the gross margin tied into that, what's the assumption on inventory for the fourth quarter?

Ray Zinn

We're going to hold. Again, depending on your estimate, the revenue is going to be first. We're trying not to let the inventory grow beyond, what, $34 million we're currently at now, Robert?

Robert Barker

We're at $36.5 million.

Ray Zinn

$36.5 million.

Robert Barker

Yes, we're trying to keep it at that level.

Ray Zinn

Right. It's more of a dollar basis rather than on a days basis, because we don't know what the revenue is going to be.

Ross Seymore - Deutsche Bank

What was your utilization in the third quarter? Are you going to keep it about the same in the fourth quarter or bring it down a little bit?

Ray Zinn

Utilization is going to remain roughly the same. I don't expect utilization to change much. Again, we are taking another look at how we define utilization in any case, because we're shifting more and more to the deep submicron lithographies, and we have just less capacity on that. And so, as a larger percentage of our product line moves to the lower lithography, that's just going to automatically moves up our utilization.

So, it's currently in the smaller geometries. We're actually approaching 80% utilization. That's mainly in the foundry business, which uses the larger geometries that are knocked out to deep submicron processes. That where we're seeing more capacity.

So, if our foundry business builds back up again, which we do expect in the second quarter of 2009, we expect more foundry sales to resume. Then, of course, that larger geometry capacity will start being taken up. So, we're actually moving into kind of a bimodal utilization mode where we have our deep submicron utilization, we have our larger geometry utilization.

Most of our new products, by the way, are going to the deep submicron. So, that's now changing with how you would look at our capacity. Does that make sense?

Ross Seymore - Deutsche Bank

Yes.

Ray Zinn

Okay.

Ross Seymore - Deutsche Bank

And then the last question for me, which is a bit of a housekeeping one, and I apologize if I'm just wrong on the math. But could you go over those end market splits in your third quarter revenues, those percentages, because as I added them up, I didn't get a 100%?

Ray Zinn

I think we had 18 for wireless. We had 36 for industrial.

Robert Barker

37 for industrial, 25 for wireline, 15 for computer, 5 for military and consumer.

Ray Zinn

Doesn't it add up to 100?

Robert Barker

I think it does.

Ross Seymore - Deutsche Bank

It could be just rounding.

Ray Zinn

Yes, don't forget Robert is the Interim CFO here.

Ross Seymore - Deutsche Bank

Thank you.

Ray Zinn

You're welcome.

Operator

Thank you. Next question comes from the line of Gary Mobley with Piper Jaffray. Please go ahead.

Gary Mobley - Piper Jaffray

Hi. I know you are dealing with a lot of variables such as those distributors that recognize where you recognize revenue based on selling and those where you don't. Taking the midpoint, say, minus 10%, I was estimating for the fourth quarter, what percent of that decline in revenue is expected from a drop in POS versus inventory rebalancing?

Ray Zinn

Well, it's not clear to us. Maybe I don't understand the question, Gary.

Gary Mobley - Piper Jaffray

Sure. You are expecting a 10% sequential revenue decline in the fourth quarter? I'm just curious, of that decline, what portion of it is attributable to weakening end demand versus inventory rebalancing for those customers where you recognize revenue based on selling.

Ray Zinn

Well, we don't have very many sell-in distributors. Most of our distributors are sell-through. So, we don't report that on the sell-ins. We just report those on the sell-through. So, deferred income is one of the numbers you use to understand their inventory build. As Robert said in the prepared remarks, their weeks of inventory remain the same as they did in the prior quarter.

Gary Mobley - Piper Jaffray

Okay. For Robert, a housekeeping question, also. With the passage of the R&D tax credit, what sort of tax rate are you looking at for the fourth quarter as well?

Robert Barker

For Q4, I'd model 25%. You know it's going to be less.

Gary Mobley - Piper Jaffray

All right. Thank you.

Operator

Thank you. Next question comes from the line of David Wu of Global Capital. Please go ahead.

David Wu - Global Capital

Yes. Good afternoon. I was wondering while we are on the subject of tax rate, should we be looking for calendar '09? And I've got some follow-ons.

Ray Zinn

About the same 25%. Robert?

Robert Barker

No, I think it will be higher. I am not --.

Ray Zinn

That's right.

Robert Barker

This is kind of a one-time catch up here. And I have to look at that. It will be in the 30s.

Ray Zinn

Yes, 33.

Robert Barker

Probably 33, 34. I don't know.

Ray Zinn

Yes.

David Wu - Global Capital

Okay. Moving on, I was wondering what the reduction in your San Jose facility's headcount, how much can you bring COGS down in Q4? A rough look at growth in your revenue, you're exiting this year at $240 million run rate. If the recovery in this 2009 isn't quite as robust as you hope it is at this point and we have a decline in year-to-year revenues, what kind of levers do you have actually in both the COGS as well as the OpEx to adjust to a possible decline in revenues in calendar '09?

Ray Zinn

Well, our depreciation as a percent of sales is 7%. So that's going to be fixed. So, the only other one we can do is reduce headcount. So, we can pull headcount down, and certainly we will do that if we don't have the volume to justify it.

Thus, the depreciation as a percent of sales is going to go up proportional to whatever revenue that we're going to be. So you might lose a couple percentage points because of just the depreciation expense being amortized over a smaller revenue amount. But the headcount, we can keep pulling down to whatever level we need to sustain our inventory requirements.

Robert Barker

Also, as we move more of our operations offshore, that makes them also more variable. And so, we're able to moderate more of that and with changes in fluctuations in demand.

David Wu - Global Capital

Robert, you just mentioned that for every $1 million drop-off in revenues, your gross margin will be off by about 1.25 point between Q3 and Q4. And obviously, this is mix dependent, difficult to model. But if you have declining revenues year-to-year next year for most of the year, how would that metric work?

Should I do the same metric as the one that we saw in Q3 to Q4 or should I use something different, because I think the numbers would suggest that unless we have a really swing sharp snapback, it's unlikely your revenue will be up year-to-year, Robert.

Robert Barker

Well, I told you over at least the range that we're looking here that you can use 25 basis points per $1 million swing.

Ray Zinn

That's on a quarterly basis.

Robert Barker

That's on a quarterly basis.

David Wu - Global Capital

Right.

Robert Barker

And you know what the fixed costs are. So, I haven't moved widely out of that range, because we're not --.

David Wu - Global Capital

We're all guessing about '09. None of us knows what that is. I thought I'd at least ask and say, on the COGS side, what can we look for?

Ray Zinn

We covered that already. We said that Q4, depending upon where you want to take the midpoint, we've already factored that in. What did you forecast of gross margin for Q4, Robert?

Robert Barker

Okay. I said --.

David Wu - Global Capital

Well, $7 million, that should be roughly midpoint, about, what, 1.75%, some thing like that.

Ray Zinn

Yes.

Robert Barker

Yes, right.

David Wu - Global Capital

Okay.

Ray Zinn

So, the thing that we have done, though, over the last few years, by moving more operations offshore, we have made the operating model more flexible to changing demand than it has been previously.

David Wu - Global Capital

I see. Okay, great. Thank you.

Ray Zinn

You're welcome.

Operator

Thank you. So, management, there are no further questions. I'll turn it back to you for closing comments.

Ray Zinn

Well, thank you for joining with us today. Hopefully, you can see that we're being proper stewards of your money and that we are working hard to make Micrel one of the premier analog semiconductor companies in the industry. And we look forward to buzzing with you in January.

Again, thanks for joining with us today, and let's all pray for a quick return to financial stability. Thank you.

Operator

Thank you. Ladies and gentlemen, that will conclude today's teleconference. If you would like to listen to a replay of today's conference, please dial into 303-590-3000 or 1-800-405-2236 and enter the access code of 11121027 followed by the "pound" sign.

We thank you again for your participation today. And at this time, you may disconnect. Have a nice day.

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Source: Micrel, Inc. Q3 2008 Earnings Call Transcript
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