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Micrel Inc. (NASDAQ:MCRL)

Q2 2008 Earnings Call Transcript

July 24, 2008 4:30 pm ET

Executives

Raymond Zinn – Chairman, President, CEO

Rick Crowley – VP, CFO

David Schie – VP, Analog Design & Process Development

Analysts

Tore Svanberg – Thomas Weisel Partners

Craig Hettenbach – Goldman Sachs

Doug Freedman – American Technology Research

Bob Gujavarty – Deutsche Bank

Krishna Shankar – JMP Securities

Gary Mobley – Piper Jaffray

Operator

Good afternoon, ladies and gentlemen and thank you for standing by. Welcome to the Micrel Incorporated second quarter 2008 financial results conference call.

During today's presentation all parties will be in a listen-only mode. Following the presentation, the conference will be open for questions. (Operator instructions) As a reminder, this conference is being recorded today, Thursday, July 24th 2008.

At this time, I'd like to turn the presentation over to the President and Chief Executive Officer of Micrel, Ray Zinn. Please go ahead, sir.

Raymond Zinn

Well, thank you and appreciate all of you joining with us today in our Q2 2008 Conference Call. With me today is Rick Crowley, our Vice President and Chief Financial Officer as well as David Schie, who is our Vice President of Analog Design and Process Development. So I'd like to begin right now, and Rick go ahead with the prepared remarks.

Rick Crowley

Thank you, Ray. In conjunction with this conference call, a number of supplemental charts will be made available on Micrel's Web site during the following prepared remarks. To access these charts go to www.micrel.com and click on the link to the Q2 2008 Conference Call slides.

Begin today's call with the legal disclaimers. All material contained in the webcast is the sole property and copyright of Micrel Incorporated with all rights reserved. Certain statements in this conference call which are not historical facts may be considered forward-looking statements that involve risks and uncertainties. Forward-looking statements include statements regarding 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 forth in such forward-looking statements.

Some of the factors that could affect the company's results have been set forth in our press release dated July 24, 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 March 31st 2008. Listeners who do not have a copy of our second quarter earnings press release may view the press release on the company's website at www.micrel.com.

Micrel posted very solid second quarter results despite uncertain economic conditions and the distractions of a proxy contest. Total bookings in the second quarter remain firm resulting in a book-to-bill ratio above one. Q2 bookings were paced by demand from customers serving the communications, industrial and wireless handset end markets.

In the current economic environment, customers remain very cautious which continues to keep order lead times in the four to five week range. In the second quarter, Micrel posted its highest sequential revenue growth rate in four years. Second quarter revenues of $70.6 million came in at the high end of our guidance increasing by $4.5 million or 7% from the first quarter and are up by $5.5 million or 8% from the prior year period.

The growth in revenues was led by stronger demand from customers serving the wireline communications, wireless handset and WiFi Voice-over-IP end markets combined with record sales through the company's global sell-through distributors. Turns fill percentage for the second quarter was a little over 50%. Standard product sales accounted for 95% of total Q2 revenues with foundry and custom product sales comprising 5%.

Revenues grew sequentially for all three major product groups in the second quarter with the high bandwidth and Ethernet product groups growing in excess of 10%. The first quarter sales mix by product area was Analog 65%; High Bandwidth 15.5%; Ethernet 16.5%; and Foundry 3%. Sales of Micrel's Ethernet product line reached their highest quarterly level in six years in the second quarter driven by the WiFi Voice-over-IP end market.

Micrel's second quarter revenue growth was led by a 27% quarter-to-quarter increase in sales to the wireless handset end market. The sequential growth was driven by design win ramps in both high end Smartphones and our new low cost portable power products that we first spoke about in the July 2007 conference call.

Sales to the wireless handset end market comprised 19% of company revenues in the second quarter compared with 16% in Q1. Shipments of Micrel's analog, high bandwidth and Ethernet products to the wireline communications market made up 28% of Q2 sales compared with 26.5% in Q1. 13% sequential increase in sales to the wireline communications end market was driven by continued growth in sales to WiFi Voice-over-IP customers and major network equipment manufacturers.

Sales to the industrial end market made up 36% of Q2 sales compared with 38.5% in Q1.

Although sales to the industrial end market were relatively flat on a dollar basis in Q2, Micrel continued to grow revenues in the global distribution channel during the second quarter.

In a memo to Micrel, the president of one of Micrel's larger distribution partners said, "The fact that Micrel continues to show strong growth in a market that is facing significant headwinds is a credit to both the strength of the Micrel line and a willingness of you and your team to work creatively with us to penetrate the market."

Completing the Q2 revenue mix, sales to customers in the computing end market made up 13% of second quarter revenues compared with 15% in the first quarter and sales to the consumer and military markets comprised 4% of total company sales, the same as in Q1.

Second quarter sales by geographic region were similar to Q1 with sales to Asian-based customers accounting for 55% of Q2 revenues, sales to North American customers 32%, and sales to European customers comprising 13%.

Now turning to the remainder of the income statement, second quarter gross margin was 56.4% about the same as the first quarter. R&D spending was $14.8 million or 21% of revenues in the second quarter. Sequential increase in R&D spending was due to higher process development costs incurred during the quarter as Micrel moves its capability to smaller geometry technology node.

During the quarter, Micrel released 20 new high performance products, included among the new products releases were four new low cost ultra small footprint LDOs, five new best-in-class buck switching regulators, two highly integrated RF products, and eight new communications products for our fiber optic modules, Voice-over-IP and networking infrastructure applications.

Q2 SG&A spending was $11.5 million or 16% of sales. This is down from $11.9 million on a comparable basis in the first quarter. Second quarter GAAP operating income was $10.8 million or 15% of sales. This compares to GAAP operating income of $11.8 million in the first quarter and $11.7 million in the year ago period.

Proxy contest expenses of $2.7 million reduced Micrel's GAAP operating income by approximately 20% in the second quarter or (inaudible) per diluted share. These proxy contest expenses also had the effect of reducing operating margin by roughly 4% in the second quarter. However, excluding non-recurring items, we did benefit from the leverage inherent in our operating model in the second quarter. If the effect from the proxy contest expenses and a first quarter restructuring credit are excluded, approximately 50% of the sequential revenue growth in Q2 fell to operating profit.

Reducing operating expenses is a key focus at Micrel. We have embarked on a companywide cost reduction effort in order to improve our operating profit margin independent of revenue level.

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 will be less of an impact in Q3 due to the severance costs associated with the workforce reduction.

Other income net was $700,000 in the second quarter, down $400,000 from the first quarter due to lower interest expense – interest income really. The effective tax rate for the second quarter was 37.2%. The combination of the lower interest income and a higher tax rate in Q2 resulted in nearly a $0.01 sequential reduction in earnings per share.

Second quarter GAAP net income was $7.2 million or $0.10 per diluted share. This compares with first quarter GAAP net income of $8.4 million or $0.12 per diluted share and GAAP net income of $8.6 million or $0.11 per diluted share in the year-ago period.

Our balance sheet remains strong. June ending cash and short-term investment balances of $79.1 million increased slightly compared to $78.5 million at the end of March. During the second quarter, $9.6 million was spent to repurchase 1 million shares of Micrel common stock. Accounts receivable balances increased by $1 million in the second quarter to $34.7 million.

Despite the growth in revenues in the quarter, days sales outstanding decreased to 45 days at the end of Q2 from 46 days at the end of Q1. Net inventory increased in dollar terms in Q2 slightly, but days of inventory decreased to 104 days at the end of the second quarter from 110 days at the end of Q1.

Inventories that our sell-through distributors increased modestly in the second quarter. However, due to the record resale level in Q2, weeks of inventory in the channel remained at approximately 10 weeks.

Capital expenditures totaled $3.4 million in the second quarter and Q2 depreciation and amortization, excluding the amortization of stock-based compensation was $4.9 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 flows to shareholders through the stock repurchase plan and quarterly dividend payment. Today, Micrel is announcing that its board of directors has authorized a quarterly dividend payment of (inaudible) per common share. The dividend is to be paid on August 21st 2008 to shareholders of record on August 5th.

Now, turning to the outlook for the semiconductor industry and Micrel, let's turn to Slide Number one of the webcast which is the Micrel semiconductor barometer. You will note that all of the metrics that we follow for the industry relative to Q2 are in line with our prediction. The issue that we see is related to the FUD or Fear, Uncertainty and Doubt.

The news reflecting a slowing global economy, particularly in North America and Europe has caused our customers to become more conservative in their outlook. While lead times have come in about half a week, they still remain in the four to five week range. The semiconductor distribution channel is the primary culprit in the shortened lead times. This indicates that they are less willing to carry the inventory and are relying on the semiconductor manufacturers to fill in the gaps. The FUD or uncertainty is making it extremely difficult for us to forecast our revenue growth for Q3 and beyond.

Now turn to Slide Number two which is our semiconductor industry cycle chart. We continue to expect semiconductor industry growth in 2008 of between 3% and 6%. This is premised on below average unit growth for the year combined with a more stable ASP trend.

However, the second half outlook remains cloudy due to concerns about the strength of this year's seasonal holiday build, the impact of the Olympics on the Chinese market and the U.S. presidential election.

Now turning to the third quarter outlook for Micrel. While Micrel is starting the third quarter with total backlog roughly equivalent to Q2, we're going to have to rely on a higher turns filled than we had in the second quarter if we're going to grow our revenue in Q3.

One of the factors impacting third quarter revenues is a push out of about $500,000 in orders from a foundry solar cell customer. In addition, we anticipate that the demand from our customers in the wireline communications and industrial end markets which helped pace our revenue growth in the first half will be seasonally weaker in the third quarter.

Our current forecast is that Q3 revenues will be relatively flat when compared to Q2 if we base our guidance on backlog and a similar turns fill. However, if Q3 turns out to be a more back-end loaded quarter, and historically it is, then Q3 could be up by as much as 3%. If however, business conditions weaken further because of the general fears of a slowdown, then we would actually see Q3 revenues slightly down.

Taking a snapshot as of July 23rd the company's third quarter revenue is currently tracking to the higher end of the guidance range. The swing factor for Micrel's third quarter revenues will be the turns fill level in September which is difficult to accurately predict today since lead times are approximately four to five weeks.

We believe the Asia-Pacific region will show some growth in Q3 primarily in wireless and communications while Europe will be down slightly due to seasonality and North America will be sluggish due to the present economic environment.

We forecast Micrel's third quarter 2008 gross margin will be down about 100 basis points from Q2 primarily due to a mix shift from higher margin wireline and industrial end market revenues to lower margin wireless and Ethernet product sales.

We anticipate total GAAP operating expenses will decrease on a sequential basis in the third quarter by well over $3 million to approximately $25.5 million. This should translate into a GAAP operating margin of approximately 20%.

Other income is projected to be about $500,000 and diluted shares outstanding are estimated to be 71 million shares for the third quarter. We estimate that FAS 123R will result in approximately $1.4 million of pre-tax stock compensation expense in the third quarter, and we anticipate the effective tax rate for the remainder of 2008 will continue to be approximately 37.2% on a GAAP basis due to the termination of the R&D tax credit. Based on these aforementioned projections, we believe third quarter 2008 GAAP diluted earnings per share will be approximately $0.11 to $0.13.

If our third quarter revenue is the same as Q2, we expect our EPS to be between $0.12 and $0.13 on a GAAP basis. The reason that our earnings could be up relative to Q2 on flat revenue is because of the cost reductions that Micrel has implemented that will take effect in Q3 combined with significantly lower expenses associated with the proxy challenge than we had in the second quarter.

In summary, we are extremely pleased with our second quarter financial results. In addition, we recently resolved the proxy issues that we had with Obrem Capital Management, and we are currently enjoying a cooperative relationship with our largest independent shareholder.

I would now like to turn the time over to David Schie, Vice President of Analog Design and Process Development who will spend a few minutes providing a report on his recent trip to a number of Micrel's major customers. David?

David Schie

Thank you, Rick. Yes. Ray asked me to report a little bit on a recent trip I took. I visited about 20 of Micrel's major customers in the mobile, data com, consumer and automotive segment. I’m very pleased to report that the doors are wide open. They had a lot of great things to say about our quality and delivery. And in fact, we're pleased to report that we actually got some high level awards there. We actually got Cisco's 100% rating in 2007 which was the highest score for any semiconductor manufacturer. We got a Best Supplier award from Yokogawa for 2007 and they're a Japanese customer with very rigorous quality requirements, and our biggest mobile customer actually rated our yearly rate at 22 parts per billion which is very, very small, very good achievement.

In terms of opportunities a lot's happening in the LED segment. The technologies in LEDs are changing, they're getting brighter, they're getting driven differently and that's opening up a lot of driver opportunities for which we're very well-positioned. This includes huge opportunities in mobile backlighting, in the Flash for the mobile phones, in LCD TVs, in the automotive segment, consumer and in signage, and a number of our patented driver architectures fit into those markets. And one of the most exciting things is several of these markets are new for Micrel. So, we're excited about opening up those new opportunities.

We've also been concentrating on proliferating a new DC/DC architecture that's being very well received. The architecture allows to us reduce component size and also eliminate up to half the capacitors in certain data com, set top box, LCD TV, cable, modem and mobile applications, and this is actually opening up large volume new power rails to us. And in fact, we collaborated with one of our largest data com customers, worked very closely with them, met their requirements and now we have a whole group of new opportunities. So, we're performing very well there and we see a lot of growth in that area.

Finally, our relationships to our key customers in the mobile space is producing a whole lot of new power management ICs, PMIC opportunities. We've been designing in our smaller PMICs and they're offering us new opportunities for higher integration and the benefit of these parts is their higher margin, higher ASP parts and so we're winning on those fronts. So overall the customers doors are wide open. They're asking for the new products and we're performing and we believe that's going to turn into significant growth over the coming months and years. Thank you.

Raymond Zinn

Thanks, David. We'd like now to turn to the Q&A portion of the conference call.

Question-and-Answer Session

Operator

Thank you, sir. Ladies and gentlemen, at this time we will begin the question-and-answer session. (Operator instructions) Our first question will come from the line of Tore Svanberg with Thomas Weisel Partners. Please go ahead.

Tore Svanberg – Thomas Weisel Partners

Yes. Thank you. And congratulations on the results. First of all, Ray, could you talk a little bit more about the distribution channel? Seems like they're being very conservative right now. Do you think that's because they know there's enough supply out there from the chip companies or do you think they're just seeing some heavy clouds here going forward in Q3 and Q4?

Raymond Zinn

Well, they're saying they're seeing heavy clouds, but the reality of it is I'm sure that there's – because of the lead times that they're giving us that certainly believe that the supply chain can meet their requirements. So, I mean, it depends upon if you look at their order patterns, you would say they believe there's enough supply. If you listen to what they're saying, what their body language is, they're saying because of the clouds.

Tore Svanberg – Thomas Weisel Partners

Great. And your handset business is really starting to shine quite significantly. As we move forward, how should we gauge that business? Should we just try and understand the Smartphone market, any specific customers you're ramping with? Just trying to understand how we should gauge that business going forward?

Raymond Zinn

With regard to the Smartphones and the higher end phones, it's the same customers we've had in the past. There's no one right now that we can announce that we have in the wings as you would. There are one or two in the wings that you will be – will be made known to you soon, but the current cast of characters are the same. The opportunities in the – what we call the platform phones with our lower cost power management products is also adding to our growth and so, it's a combination of both of those, just the acceptance of our power management products for the high end phones as well as these low cost power management products.

Tore Svanberg – Thomas Weisel Partners

Great. And a question for Rick. Rick, you mentioned OpEx down $3 million sequentially. Does that reflect the one-time expense last quarter or does it exclude it?

Rick Crowley

Yes. That was on a GAAP basis, Tore. (inaudible) over $3 million reduction from $29 million down to $25.5 million or so.

Tore Svanberg – Thomas Weisel Partners

Okay. And maybe a question for David. David, you mentioned the LED market and obviously, there's a lot of opportunities there, but from a timing perspective could you elaborate a little bit on when you expect Micrel to see some benefit there?

David Schie

We're actually already seeing benefit, number of our drivers have already been released and there's a lot of designing activity and with a number of them it looks like we hit the definition very well. So, we're already reaping the benefits.

Tore Svanberg – Thomas Weisel Partners

How about the revenue stream? When do you expect to see revenue?

David Schie

I would expect we'll probably start seeing revenue within six months, over six months of the next year.

Tore Svanberg – Thomas Weisel Partners

Great. And then the last question, either Ray or Rick, you talked about your guidance, up 3, down 3 and if things continue healthy, then you get to the higher end. Are you capped at 3% or do you think you could even be higher than that because it seems like this quarter you did quite a bit better than what you expected?

Raymond Zinn

Well, again we're trying to be realistic, Tore, and not to overshoot what we can do. There's certainly some concerns out there. We did really well in the second quarter and I just don't want to get over – get the exuberance of expectations up beyond what we believe is realistic. So, that's why went into, I think, great detail explaining how we arrived at our numbers. We thought that would be helpful so that you could at least see how we did it. As we mentioned, we're currently profiling to the high end, but September's our swing factor and given the unknowns, the uncertainties currently in the economy, again, we don't know what's going to be the result of the seasonality aspects. We don't know what's going to happen with the Chinese and the Olympics. There's just some – I know there's clouds every time we talk, but there are issues out there and I think part of them are brought on because of just the hype and the media just saying that things are going to get worse and so our customers are being cautious. And so that doesn't help us out because we rely on our customers' exuberance with regard to ordering and right now they're doing fine. I mean if we're up 3% for Q3, that's not bad, that's pretty, especially come off of a 7% Q2 and be up 3% for Q3, that's pretty doing good. So, to say I could be up 5% or 6%, it's possible, but I think that's getting a little bit carried away with given the conditions now. So, we profile it pretty accurately, we're trying not to do better than – or just and we're not trying to do better than what we say. We didn't end up higher than our high end, or we hit the high end of guidance and so we're hoping we can do it again in Q3, but right now, if I just factor in all the body language and other issues, that's why we're profiling it, or we're saying it's more flat, that's why get down 3, up 3, it's about September. September is a swing factor for us. Right now we're profiling to the high end, but I can't guarantee that's going to continue.

Tore Svanberg – Thomas Weisel Partners

That's very fair. We appreciate that. Thank you very much.

Raymond Zinn

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. Just to follow up in the handset market on the strong growth in Q2, outlook into Q3, can you give any feel for your customers in terms of how they're viewing their inventory builds and versus kind of maybe some of the design wins specific activity that you have powering results?

Raymond Zinn

Well, there is conservatism by our customers. We don't know what their real inventory levels are. Most of them haven't reported yet. So, we sense everything is kind of normal, I mean, we look at their order patterns and certainly from the looks of it, in Rick's prepared remarks, he did say that our growth is going to be in the wireless. So we are expecting wireless to be up over Q2. So that kind of speaks for itself, Craig, I don't know what I can say more than that inventory ask the questions regarding which markets are moving for us when we talked about both high end and the low end. So I don't know what other color I can throw at you on that specifically, Craig.

Craig Hettenbach – Goldman Sachs

Okay. No, that's helpful. And then Rick on the gross margin front, after Q3 can you talk about as you move forward what might have a bigger determinant factor whether it's mix or utilization? You mentioned some of the workforce reduction, just how things might play out kind of Q4 into maybe 2009?

Rick Crowley

We're hoping to get some reacceleration on gross margin there, Craig. I mean, workforce reduction should help us. Right now we're suffering a little bit because of the lower foundry volume. We anticipate that coming back as the Spanish subsidies got to get cleared up. Ultimately, it looks like they're going to be. But we're driving hard on our costs both at the cost of goods sold and the operating expense level, but we have to because with utility prices going up, and it seems like all the chemical suppliers want to raise prices, we're working hard to be able to hold to our gross margin model and actually accelerate our Op margin model level as we grow revenue.

Raymond Zinn

And further to that, Craig, I don't know Rick covered it in the prepared remarks, but we know we had it on the, I think on the press release that we're going to try to expand operating margin irrespective of revenue. So, we are taking positive action. One of the things was clear when we did the proxy challenge was that our OpEx expenses are too high and so we're going to school on that, and we are going to cut those expenses. We are going to get our Op margins up and I think you can see even on a Q3 profile for earnings that even if they're flat we expect earnings to be up nicely.

Craig Hettenbach – Goldman Sachs

Thank you.

Raymond 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, guys. Thanks for taking my question. Sorry, if I missed it there, Rick, if you gave it. The magnitude of the one-time severance charge, you said that we wouldn't see the full impact in the September quarter. Is there – can you give us an idea what the charge is and how you're going to treat it? Is it going to be rolled in the number or one-time doubt?

Rick Crowley

It's one-time doubt. It was just that we're not going to get the full benefit of the cost reduction of the severance because we had severance costs associated with it. So that will show up in Q4 and so that's why you don't see the full benefit of – in the gross margin line in Q3.

Doug Freedman – AmTech Research

Okay. Any guidance on sort of the magnitude of the impact that, that will have?

Raymond Zinn

Well, I think we covered that. You know what…

Rick Crowley

It could be…

Raymond Zinn

He said the dollar amount was $1 million to $1.5 million.

Rick Crowley

We should get about $1.1 million in payroll savings both and that's both in operating expense as well as cost of goods sold, probably about 60% of that's in cost of goods sold.

Doug Freedman – AmTech Research

Great. Sorry about that making you repeat it. If you wouldn't mind, can you talk a little bit about your efforts to going to some of the lower cost markets for the LDOs? How is that effort going and is it meeting your expectations? Any offerings you can do as far as that product family is going?

Raymond Zinn

Yes, we attributed the growth we saw in the handset market or the wireless side in Q2, to that not only the high end products that we do, but also these lower end power management products. So it's a combination of those two. I don't want to partition out what percentage was each, but certainly the low end power management products are meeting our expectations and what we at first had calculated back in July of 2007 when we talked to you guys about this on the conference call.

Doug Freedman – AmTech Research

All right. And then just lastly, you mentioned some concerns over the level of foundry, can you give us an update of what percentage of sales is coming from your foundry business because I know that, that business is…

Raymond Zinn

About 3%.

Doug Freedman – AmTech Research

About 3%. So there's very low risk there. Terrific. Nice job, guys, and thanks for taking my questions.

Raymond Zinn

Well, thank you, Doug.

Operator

Thank you. We'll move to the next question from the line of Ross Seymore from Deutsche Bank. Please go ahead.

Bob Gujavarty – Deutsche Bank

Hi. This is Bob Gujavarty for Ross, and thanks for taking my question. Just a quick housekeeping item, what were your turns in the quarter and what are the turns you're going to need to hit midpoint for next quarter?

Raymond Zinn

Little over 50% for Q2 and to be flat it's the same for Q3.

Bob Gujavarty – Deutsche Bank

Okay. Great. Thanks. And, Ray, I think you alluded to it a little bit in some of your earlier comments, but, has there been some kind of general agreements with Obrem about how you're going to run the company, what are some strategic moves you're making? You already alluded to kind of rationalizing your outbacks a little bit. Can you talk a little bit maybe about some other things you've come to agreement with them on?

Raymond Zinn

Well, I mean, they're just wanting to make sure that we're shareholder friendly and we're trying to convince them of that. And I think they see it so far because we are communicating regularly with them and we enjoy, I think, a very good relationship. We keep them apprised of what we're doing as far as strategically what the company's objectives are and I think at this point they're pleased with what they're hearing.

Bob Gujavarty – Deutsche Bank

Okay. Great. What do you think inventory will do in the next quarter? Are you going to try to keep it flat or grow it a little bit?

Raymond Zinn

Well, I'm trying to grow it a little bit just because I am hoping to grow in Q3. So we are going to try to grow the inventory, roughly $0.5 million is kind of the goal for Q3.

Bob Gujavarty – Deutsche Bank

Great. Thanks, guys.

Operator

Thank you. Our next question will come from line of Krishna Shankar with JMP Securities. Please go ahead.

Krishna Shankar – JMP Securities

Yes. As you look at Q3 and going potentially later on into Q4, do you – Ray, do you feel – how strongly do you feel about the recovery in some of the industrial and comps part of the business versus handsets and networking? Can you give us your relative assessment of the strength of these four markets going into Q3 and Q4?

Raymond Zinn

Well, historically, the second half is weaker for the industrial end comps market as you know, and it's more of a seasonal, holiday season type of build. So that's why we have the diversity that we do in our product line is to give us both the benefit from the com and industrial side as well as in the seasonal, holiday season area. So we expect, just generally speaking, the comms and industrials should slow a little bit in the second half relative to the first half. That's what it does historically. That's what we're expecting this year and we do expect that our holiday season products will, like HDTV, the wireless handsets, the set top boxes, other holiday related products will pick up the slack and then still allow us to grow in the second half. So, obviously, if you could get both of those going at the same time you'd really have a boomer, but the strategy of Micrel has been to have a balanced market strategy and so we benefit as you guys can see. We benefit from a growing comps and industrial market and we also benefit from a holiday market. So that's the best we can do. It's obviously a balancing act and obviously, consumer related market in the second half.

Krishna Shankar – JMP Securities

Okay. And then in terms of your cost reductions are you actually kicking out equipment and a part of the fab, can you talk about sort of the strategy in terms of cost reductions and moving manufacturing offshore and as you look out a year what might be your operating expense structure look like in terms of gross margins and OpEx?

Raymond Zinn

Regarding the fab equipment, we don't have a deep sub-micron fab, we don't do stuff in the 130 nanometer category. So we don't have expensive equipment, and so taking equipment offline or book value equipment, so it's not – I mean not book value but a zero value equipment. So the only thing we could do is maybe get a little bit of value by pulling it offline and we do that to get floor space, but our costs for our – for reducing our geometry going to a smaller geometry like 0.35, 0.25 actually add costs faster than we could pull it off by kicking the older equipment offline. So, there's not a lot of benefit that we're going to get from that. The main benefit, as you know, is really your variable cost, the direct cost. And so what we've done is we've reduced our variable cost (inaudible) part to help compensate and our depreciation is still relatively low in the 7%, pretty nominal compared to our peers. So that kind of tells you that there's not going to be – we're not going to be just shutting down a fab or part of a fab. The intent was just to get our fab size to get the gross margin up a little bit because we have seen some slowdown in foundry especially in the solar cell side, so we're just right sizing ourselves as you would and because we still want to grow our margins. And to answer that second part of your question which is what do we expect operating margins to go to, I'm targeting in the mid-20s for Micrel in the near future and no later than Q1, Q2 of next year to be 25 or above on Op margins.

Krishna Shankar – JMP Securities

Great. Thank you.

Operator

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

Gary Mobley – Piper Jaffray

Hi, guys.

Raymond Zinn

Hi, Gary.

Gary Mobley – Piper Jaffray

You mentioned in your prepared remarks some push out of the solar cell business, was that a $0.5 million in revenue or $5 million in revenue and was it the Spanish subsidies that's causing the push out? And then the last part of the question is when would you expect to fulfill that business?

Rick Crowley

Yes, the answer, Gary, is it's $0.5 million what we said in the prepared remarks, and I believe it's being impacted by the slowdown in Spain. But we do anticipate that's going to come back. We just don't know exactly when yet.

Gary Mobley – Piper Jaffray

Okay. And did you give how many shares were repurchased in the quarter and what is left on the authorized amount of shares to be repurchased?

Rick Crowley

Yes, we repurchased 1 million shares in Q2, we have about $15 million roughly left on the annual authorization.

Gary Mobley – Piper Jaffray

Okay. All right. Great. Thank you, guys.

Operator

Thank you. Management, at this time we have no additional questions. I'd like to turn the conference back to you for any closing remarks.

Raymond Zinn

Well, thank you for joining with us today. I appreciate, I know there's a lot of other companies that are reporting at the same time we are, and so thanks again for joining with us and we look forward to talking to you in October.

Operator

Thank you, management. Ladies and gentlemen, this will conclude today's teleconference. We do thank you for your participation in the Micrel conference call. If you would like to listen to a replay of today's presentation, please dial 1-800-405-2236 or 303-590-3000 with access code of 11117188 followed by the pound sign. Once again if you would like to listen to a replay of today's conference call, you may do so by dialing 1-800-405-2236 or 303-590-3000 with access code of 11117188 followed by the pound sign. Ladies and gentlemen, we will conclude. You may now disconnect, and thank you for participating on today's conference.

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Source: Micrel Inc. Q2 2008 Earnings Call Transcript
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