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Article by DailyStocks_admin    (04-29-08 07:06 AM)

Filed with the SEC from Apr 17 to Apr 24:

Micrel (MCRL)
Obrem Capital Management plans to nominate six directors for election to Micrel's board at the company's 2008 annual meeting. Obrem identified its nominees as Keith R. Gollust, Keith M. Kolerus, Bill R. Bradford, Andrew V. Rechtschaffen, Eric W. Gomberg and Benjamin J. Goren. Obrem may communicate with members of Micrel's management, board, other current or prospective shareholders, industry analysts, or existing or potential strategic partners. Obrem currently holds 10,735,690 shares (15% of the total outstanding).

BUSINESS OVERVIEW

General

The Company was incorporated in California in July 1978. References to the ''Company'' and ''Micrel'' refer to Micrel, Incorporated and subsidiaries, which also does business as Micrel Semiconductor. The Company's principal executive offices are located at 2180 Fortune Drive, San Jose, California 95131. The Company's telephone number is (408) 944-0800. The Company maintains a corporate website located at www.micrel.com. The Company's annual reports on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K, and amendments to those reports are made available, free of charge, on the website noted above as soon as reasonably practicable after filing with or being furnished to the Securities and Exchange Commission.

Micrel designs, develops, manufactures and markets a range of high-performance analog power integrated circuits ("ICs"), mixed-signal and digital ICs. The Company currently ships over 2,000 standard products and has derived the majority of its product revenue for the year ended December 31, 2007 from sales of standard analog and high speed communications ICs. These products address a wide range of end markets including cellular handsets, portable computing, enterprise and home networking, wide area and metropolitan area networks, digital televisions and industrial equipment. For the years ended December 31, 2007, 2006, and 2005, the Company's standard products accounted for 92%, 93%, and 96%, respectively, of the Company's net revenues. The Company also manufactures custom analog and mixed-signal circuits and provides wafer foundry services for customers who produce electronic systems for communications, consumer and military applications.

Micrel develops and manufactures high performance power management analog products which are characterized by high speed, low noise and maximum efficiency in the smallest package. Continuing trends to lower voltages and higher currents in the communications, networking and computing markets have created demand for high performance analog products to accurately control, regulate, convert and route voltage and current in electronic systems. The demand for high performance power management circuits has been further fueled by the growth of portable communications and computing devices (e.g. cellular handsets, portable media players and notebook computers). The Company also has an extensive power management offering for the networking and communications infrastructure markets including single-board and enterprise servers, network switches and routers, storage area networks and wireless base stations. In addition, the Company offers standard analog products that address other markets, including industrial, defense and automotive electronics.

In addition to power and thermal management products, Micrel also offers two families of highly integrated radio frequency ("RF") products. Micrel's QwikRadio® devices enable customers to develop wireless control systems significantly improving the consumer experience of their products. Applications for the QwikRadio® products include remote keyless entry for automobiles, garage door openers and remote controls. Micrel's RadioWire® transceivers provide a higher level of performance for more demanding applications such as remote metering, security systems and factory automation.

The Company's high bandwidth communications circuits are used primarily for enterprise networks, storage area networks, access networks, and metropolitan area networks. With form factor, size reductions, and ease of use critical for system designs, Micrel utilizes innovative packaging and proprietary process technology to address these challenges.

The Company's family of Ethernet products target the digital home and industrial/embedded networking markets. This product portfolio consists of transceivers, Media Access Controllers ("MAC"), switches, and System-On-Chip ("SoC") devices that support various Ethernet protocols supporting communication transmission speeds from 10 Megabits per second to 100 Megabits per second.

In addition to standard analog and mixed signal products, Micrel offers customers various combinations of design, process and foundry services.

Industry Background

Analog Circuit, Mixed-Signal and Digital ICs Markets

ICs may be divided into three general categories — digital, analog (also known as ''linear'') and mixed-signal. Digital circuits, such as memories and microprocessors, process information in the form of on-off electronic signals and are capable of implementing only two values, "1" or "0." Analog circuits, such as regulators, converters and amplifiers, process information in the form of continuously varying voltages and currents that have an infinite number of values or states. Analog circuits condition, process, and measure or control real world variables such as current, sound, temperature, pressure or speed. Mixed-signal ICs combine analog and digital functions on one chip.

Analog circuits are used in virtually every electronic system, and the largest markets for such circuits are computers, telecommunications and data communications, industrial equipment, military, consumer and automotive electronics. Because of their numerous applications, analog circuits have a wide range of operating specifications and functions. For each application, different users may have unique requirements for circuits with specific resolution, linearity, speed, power and signal amplitude capability.

Mixed-signal and digital ICs may be divided into six general categories, LSI/MSI logic, data processing, signal processing, memory, FPGA and application specific.

Mixed-signal and digital ICs are used in computer and communication systems and in industrial products. The primary markets for such circuits are consumer, communications, personal and enterprise computer systems, networking and industrial.

As compared with the digital integrated circuit industry, the analog integrated circuit industry has the following important characteristics:

•

Dependence on Individual Design Teams . The design of analog circuits involves the complex and critical placement of various circuits. Analog circuit design has traditionally been highly dependent on the skills and experience of individual design engineers.

•

Interdependence of Design and Process . Analog designers, especially at companies having their own wafer fabrication facility, are able to select from several wafer fabrication processes in order to achieve higher performance and greater functionality from their designs.

•

Longer Product Cycles and More Stable Pricing . Analog circuits generally have longer product cycles and greater price stability as compared to digital circuits.

Analog, mixed-signal and digital ICs are sold to customers as either standard products or custom products.

Recent Trends in Analog Power Management, Mixed-Signal and Digital ICs

Most electronic systems utilize analog circuits to perform power management functions (''power analog circuits'') such as the control, regulation, conversion and routing of voltages and current. The computer and communications markets have emerged as two of the largest markets for power analog circuits. In particular, the recent growth and proliferation of portable, battery-powered devices, such as cellular telephones, digital cameras, portable media players and notebook computers, continue to increase demand and create new technological challenges for power analog circuits.

Cellular telephones, which are composed of components and subsystems that utilize several different voltage levels, require multiple power analog circuits to precisely regulate and control voltage. Manufacturers continue to pack more processing power and functionality into smaller form factors placing severe demands on the battery. To maintain or extend talk times, high performance power management products are required.

The rapid adoption of the Internet for information exchange, in business and consumer markets, has led to a significant increase in the need for broadband communications technology. In recent years, there has been a significant expansion in the number of broadband subscribers for both DSL, cable modem and fiber to the home technologies. The increased bandwidth demand of these users will continue to consume the installed capacity in metropolitan and wide area networks. The additional demand of new wireless services utilizing the transmission of video will further consume this installed capacity.

In the networking market, Ethernet has been widely adopted as a communication standard. Ethernet ports are now being provided on equipment ranging from PCs and PC peripherals to other consumer products such as printers, Internet Protocol Set-Top Boxes ("IP-STB"), Internet Protocol Phones ("IP-phone"), game consoles, media converters and industrial equipment. This is driving rapid growth in both the digital home market to connect multiple PCs and peripherals and the industrial market to connect machinery to central control and monitoring equipment.


Micrel’s Strategy

Micrel seeks to capitalize on the growth opportunities within the high-performance analog, mixed-signal and digital semiconductor markets. The Company's core competencies are its analog design and process technology, its large, in-house wafer fabrication capability and manufacturing expertise. The Company also seeks to capitalize on growth opportunities within the communications and networking markets and has successfully acquired companies serving these market segments. The Company intends to build a leadership position in its targeted markets by pursuing the following strategies:

•

Focus on Standard Products for High Growth Markets . Currently, Micrel ships over 2,000 standard products, with net revenues from standard products generating 92% of the Company's total net revenues for the year ended December 31, 2007. The Company, however, will pursue additional custom and foundry business as opportunities arise.

•

Target Power Analog, High-Speed Mixed-signal and Digital Markets . Micrel has leveraged its expertise in power analog circuits by addressing market opportunities in cellular telephones and other portable electronics, set-top boxes, enterprise computing, desktop and notebook computers as well as telecom and networking.

•

Maintain Technological Leadership . The Company seeks to utilize its design strengths and its process expertise to enhance what the Company believes are its competitive advantages in linear and switching regulators, MOSFET drivers, USB power switches, hot-swap-power controllers, high-speed interface, and communications devices.

•

Develop/Acquire New Complementary Businesses. The Company seeks to identify complementary business opportunities building on its core strengths in the analog and mixed signal area.

•

Capitalize on In-house Wafer Fabrication Facility . The Company believes that its in-house six-inch wafer fabrication facility provides a significant competitive advantage because it facilitates close collaboration between design and process engineers in the development of the Company's products.

•

Maintain a Strategic Level of Custom and Foundry Products Revenue . Micrel believes that its custom and foundry products business complements its standard products business by generating a broader revenue base and lowering overall per unit manufacturing costs through greater utilization of its manufacturing facilities.

•

Protect Proprietary Technology . The Company seeks to identify and protect its proprietary technology through the acquisition of patents, trademarks and copyrights.


Products and Markets

Overview

Standard Products

In recent years, the Company has directed a majority of its development, sales and marketing efforts towards standard products in an effort to address the larger markets for these products and to expand its customer base. The Company offers a broad range of high performance analog, mixed signal, and digital ICs that address high growth markets including cellular telephones, portable electronics, set-top boxes, desktop and notebook computers, networking and communications. The majority of the Company's revenue is derived from power management standard products that, in addition to the above markets, are also used in the industrial, consumer, defense, and automotive electronics markets.

Portable Battery-Powered Computer Market . The Company makes power analog circuits for notebook computers, tablet PCs, and PDAs. Products in this growing market are differentiated on the basis of power efficiency, weight, small size and battery life.

Cellular Telephone Market . Micrel offers a range of power control and regulating analog circuits to address the demand for cellular telephones with longer battery lives. Micrel supplies high performance low dropout (“LDO”) regulators, high efficiency switching regulators and integrated power management ICs ("PMIC"s) that convert, regulate, switch and control the DC voltages used in cellular telephones. In addition, Micrel offers LED and EL drivers to illuminate displays and keypads and to power camera flashes, as well as tiny load switches to disconnect power rails and regulators to charge batteries.

Universal Serial Bus Market . USB has become the standard way of connecting computers with computer peripherals. In addition to implementing data communications between the connected devices, USB also provides a power source capable of powering the peripheral. Micrel supplies USB transceivers for data communication and for USB power; voltage regulators and current limiting power switches.

PCMCIA Card and Socket Markets . Micrel has been a leader in the design and manufacture of ICs for power control in PCMCIA and CardBus sockets and is involved in the creation of next generation PC card standards, including Express Card. The Company also has developed IC’s for the new Cable Card standard for digital televisions and set top boxes.

Power Supply Market . Most electronic equipment includes a power supply that converts and regulates the electrical power source into usable current for the equipment. Micrel has several families of high voltage switching controllers for the networking, telecommunications and computing markets. These devices offer high efficiency to minimize power loss through heat, and high switching frequencies to provide a minimal solution size. In addition to SMPS controllers and single chip SMPS regulators, Micrel offers a full line of MOSFET drivers, smart switches, voltage supervisors and LDOs.

General Purpose Analog. Micrel sells a variety of general purpose analog products including high-speed operational amplifiers, low-power operational amplifiers, comparators and intelligent protected power switches. Most of these general purpose devices focus on low-voltage and low-current applications.

Thermal Management. Micrel's thermal management products address the need to accurately measure temperature in several system locations and control cooling fans. Applications for these products include notebook computers, servers, enterprise storage, printers, copiers and set-top boxes.

Hot Swap Power Controllers. Micrel's hot swap power controllers support the requirement for 24/7 operation in high-performance enterprise servers, enterprise storage, and telecommunication infrastructure equipment. These products allow customers to upgrade or replace system boards without having to power down the system. This portfolio offers the industry’s most integrated, dual-slot hot swap solutions for CompactPCI™, PCI-X, and PCI Express applications. The Company also offers other low-voltage and high-voltage (+/- 48V) controllers for the telecommunications and networking equipment markets.

Radio Frequency Data Communications. Micrel's QwikRadio® family of RF receivers and transmitters are designed for use in any system requiring a cost-effective, low-data-rate wireless link. Typical examples include garage door openers, lighting and fan controls, automotive keyless entry and remote controls. Micrel's RadioWire® transceivers provide a higher level of performance for more demanding applications such as remote metering, security systems and factory automation.

Networking and High-Speed Communications Market. The Company's High Bandwidth division develops and produces high speed integrated circuits for communications products targeted at fiber optic modules as well as clock recovery, clock distribution and level translation applications.

Micrel's Ethernet division offers a broad range of physical layer ("PHY"), media access controller ("MAC"), switch and system-on-chip ("SoC") products for the 10/100 Megabit Ethernet standard. The primary applications for the products are Digital Home Networks, such as Internet Protocol Set-Top Boxes ("IP-STB"), Personal Video Recorder (PVR), Multimedia Server, Voice Over Internet Protocol ("VOIP") Phones, Analog Telephone Adaptor ("ATA"), Network Printer and Media Converters, used to convert signals transmitted optically over fiber to standard cable (copper) and vice versa, and other Industrial/Embedded Ethernet systems.

The Company's future success will depend in part upon the timely completion, introduction, and market acceptance of new standard products. The standard products business is characterized by generally shorter product lifecycles, greater pricing pressure, larger competitors and more rapid technological change as compared to the Company's custom and foundry products business.


Custom and Foundry Products

Micrel offers various combinations of design, process and foundry services in order to provide customers with the following alternatives:

Full Service Custom. Based on a customer's specification, Micrel designs and then manufactures ICs.

Custom and Semicustom. Based on a customer's high level or partial circuit design, Micrel uses varying combinations of its design and process technologies to complete the design and then manufactures ICs for the customer.

R&D Foundry. Micrel modifies a process or develops a new process for a customer. Using that process and mask sets provided by the customer, Micrel manufactures fabricated wafers for the customer.

Foundry . Micrel duplicates a customer's process to manufacture fabricated wafers designed by the customer.

Micrel's full service custom, custom and semicustom products primarily address solar cell, high bandwidth communications, consumer, automotive and military applications and use both analog and digital technologies. Military applications include communications and transport aircraft.


Sales, Distribution and Marketing

The Company sells its products through a worldwide network of independent sales representative, independent distributor and stocking representative firms and through a direct sales staff.

The Company sells its products in Europe through a direct sales staff in England, France, Germany, Finland and Sweden as well as independent sales representative firms, independent distributors and independent stocking representative firms. Asian sales are handled through Micrel sales offices in Korea, Japan, Taiwan, China and Singapore, independent distributors and independent stocking representative firms. The stocking representative firms may buy and stock the Company's products for resale or may act as the Company's sales representative in arranging for direct sales from the Company to an OEM customer.

In 2007, sales to customers in North America, Asia and Europe accounted for 33%, 55% and 12% respectively, of the Company's net revenues. 2007 sales in North America, Asia and Europe, as a percentage of net revenues, was about the same as 2006 which was 30%, 59% and 11%, respectively. As compared to 2005, 2007 sales to North America as a percentage of net revenues was up 8%, Asia was down 10% and Europe was up 2%. 2005 sales to customers in North America, Asia and Europe accounted for 25%, 65% and 10%, respectively, of net revenues. The Company's standard products are sold throughout the world, while its custom and foundry products are primarily sold to North American customers. The Company's net revenues by country, including the United States, are included in Note 11 of Notes to Consolidated Financial Statements.

The Company's international sales are primarily denominated in U.S. dollars. Consequently, changes in exchange rates that strengthen the U.S. dollar could increase the price in local currencies of the Company's products in foreign markets and make the Company's products relatively more expensive than competitors' products that are denominated in local currencies, leading to a reduction in sales or profitability in those foreign markets. The Company has not taken any protective measures against exchange rate fluctuations, such as purchasing hedging instruments with respect to such fluctuations.


Customers

For the year ended December 31, 2007 two worldwide distributors accounted for 15% and 13%, respectively, of the Company's net revenues. For the year ended December 31, 2006 three customers, two worldwide distributors and an Asian based stocking representative accounted for 13%, 12% and 10%, respectively, of the Company's net revenues. For the year ended December 31, 2005 three customers, an Asian based original equipment manufacturer, an Asian based stocking representative and a worldwide distributor, accounted for 14%, 12% and 12%, respectively, of the Company's net revenues.


Design and Process Technology

Micrel's analog proprietary design technology depends on the skills of its analog design team. The Company has experienced analog design engineers who utilize an extensive macro library of analog and mixed-signal circuits and computer simulation models.

Micrel can produce ICs using a variety of manufacturing processes, some of which are proprietary and provide enhanced product features. Designers at companies that do not have in-house fabs or have a limited selection of available processes often have to compromise design methodology in order to match process parameters.

The Company utilizes the following process technologies:


•

Bipolar


•

High Speed Bipolar


•

Super β eta PNP™


•

CMOS


•

BiCMOS — Bipolar/CMOS (''BiCMOS'')


•

BCD — Bipolar/CMOS/DMOS (''BCD'')


•

ASSET — All Spacer Separated Element Transistor ("ASSET")


•

S ilicon Germanium – Silicon Germanium (“SiGe”)

The Company continues to develop process technologies to improve both the performance and cost of its new products. Micrel is also developing new process technologies to support its own product development and the needs of its foundry customers.

The Company utilizes third-party wafer fabrication foundries for advanced CMOS fabrication processes and other advanced processes that are not available in-house. For the year ended December 31, 2007, approximately 5% of Micrel's wafer requirements were fabricated at third-party foundry suppliers, including all of Micrel's Ethernet networking products.


Research and Development

The ability of the Company to compete will substantially depend on its ability to define, design, develop and introduce on a timely basis new products offering design or technology innovations. Research and development in the analog and mixed-signal integrated circuit industry is characterized primarily by circuit design and product engineering that enables new functionality or improved performance. The Company's research and development efforts are also directed at its process technologies and focus on cost reductions to existing manufacturing processes and the development of new process capabilities to manufacture new products and add new features to existing products. With respect to more established products, the Company's research and development efforts also include product redesign, shrinkage of device size and the reduction of mask steps in order to improve die yields per wafer and reduce per device costs.

The Company's analog design engineers principally focus on developing next generation standard products. The Company's new product development strategy emphasizes a broad line of standard products that are based on customer input and requests.

The Company's mixed-signal design engineers principally focus on high-speed, low-noise media driving and clock/data recovery devices used in communication and advanced computer systems.

In 2007, 2006, and 2005 the Company spent $54.5 million $52.1 million, and $45.2 million, respectively, on research and development. The Company expects that it will continue to spend substantial funds on research and development activities.

Patents and Intellectual Property Protection

The Company seeks patent protection for those inventions and technologies for which such protection is suitable and is likely to provide a competitive advantage to the Company. The Company currently holds 225 United States patents on semiconductor devices and methods, with various expiration dates through 2026. The Company has applications for 102 United States patents pending. The Company holds 46 issued foreign patents and has applications for 69 foreign patents pending.


Supply of Materials and Purchased Components

Micrel currently purchases certain components from a limited group of vendors. The packaging of the Company's products is performed by, and certain of the raw materials included in such products are obtained from, a limited group of suppliers. The wafer supply for the Company’s Ethernet products is primarily dependent upon two large third-party wafer foundry suppliers.


Manufacturing

The Company produces the majority of its wafers at the Company’s wafer fabrication facility located in San Jose, California while a small percentage of wafer fabrication is subcontracted to outside foundries, including 100% of Micrel's Ethernet product wafer requirements. The San Jose facility includes a 57,000 square foot office and manufacturing facility containing a 28,000 square foot clean room facility, which provides production processes. Approximately 70% of the San Jose facility's clean room space is classified as a Class 1 facility, which means that the facility achieves a clean room level of fewer than 1 foreign particle larger than 0.3 microns in size in each cubic foot of space. The remainder of the facility's clean room space is classified as Class 10, achieving fewer than 10 foreign particles larger than 0.3 microns in size in each cubic foot of space. The facility uses six-inch wafer technology. The Company also owns approximately 63,000 square feet of additional adjacent space in San Jose that is used as a testing facility and administrative offices.

Generally, each die on the Company's wafers is electrically tested for performance, and most of the wafers are subsequently sent to independent assembly and final test contract facilities in Malaysia and certain other Asian countries. At such facilities, the wafers are separated into individual circuits and packaged. The Company's reliance on independent assemblers may subject the Company to longer manufacturing cycle times. The Company from time to time has experienced competition with respect to these contractors from other manufacturers seeking assembly of circuits by independent contractors.


Competition

The semiconductor industry is highly competitive and subject to rapid technological change. Significant competitive factors in the market for standard products include product features, performance, price, the timing of product introductions, the emergence of new technological standards, quality and customer support. The Company believes that it competes favorably in all of these areas.

MANAGEMENT DISCUSSION FROM LATEST 10K

Overview

Micrel designs, develops, manufactures and markets a range of high-performance analog power ICs, mixed-signal and digital ICs. These products address a wide range of end markets including cellular handsets, enterprise and portable computing, enterprise and home networking, wide area and metropolitan area networks and industrial equipment. The Company also manufactures custom analog and mixed-signal circuits and provides wafer foundry services for customers who produce electronic systems for communications, consumer and military applications.

To enhance the readers' understanding of the Company's performance, the following chronological overview of the Company's results for the years 2005 through 2007 have been provided.

In the first quarter of 2005, demand as measured by order rates, improved substantially over fourth quarter of 2004 levels. First quarter bookings increased by 40% over fourth quarter 2004 levels. The improvement in order rates was driven by customers serving the industrial, computing and communications end markets. Bookings from Micrel’s major distributors increased in the first quarter after falling sharply in the second half of 2004 as distributors adjusted to shorter industry lead times and reduced their inventory levels. Despite increased bookings during the first quarter and lean supply chain inventory levels, order lead times from Micrel's customers continued to average two to three weeks.

In the second quarter of 2005, the ongoing short lead time environment continued to cause customers to order only what was required for their short term needs. Second quarter order rates declined from first quarter levels primarily due to lower order amounts from the Company’s distributors and certain customers serving the wireless handset end market. Bookings from the Company’s major sell-through distributors declined from strong first quarter levels and were less than overall resales for the second quarter as distributors attempted to increase their inventory turns to improve their return on working capital. In the wireless handset market, customers reduced both orders and production levels in coordination with efforts to reduce channel inventories of handsets. Second quarter 2005 net revenues of $62.1 million increased sequentially by 2%, but were 10% less than the net revenues of the year ago period. The Company continued to exercise pricing discipline for most of its products in an attempt to improve gross profit. Consequently, sales of certain products, such as those serving the SOHO Ethernet market and the low end personal computer market, declined resulting in a lower rate of revenue growth for the Company.

Third quarter 2005 order rates increased substantially from second quarter levels, increasing sequentially in all geographic regions. Throughout the third quarter, customers continued to place orders with short delivery requirements, even as the aggregate order level increased. Order levels from the Company's distributors increased in the third quarter, returning to a level consistent with sales of Micrel’s products to their end customers. Third quarter net revenues increased sequentially by 1% to $62.5 million, but were 8% below the revenue level of the year ago period.

Continued broad based demand, combined with lean channel inventories and short lead times, resulted in higher order rates for the Company in the fourth quarter of 2005. Order strength in the quarter from customers serving the industrial and communications end markets, and from the Company’s major distributors, resulted in the second highest quarterly booking level since calendar year 2000. Net revenues increased 4% on a sequential basis in the fourth quarter to $65.1 million and were 10% above the net revenues in the year ago period. Although order rates increased in the fourth quarter, customer lead times remained short, averaging three to four weeks.

In 2005, the Company’s gross margin improved continuously throughout the year, returning to levels recorded in the year 2000 despite significantly lower levels of revenue and capacity utilization. The increase in gross margin was in part, due to better pricing discipline, improved sales mix of higher margin products, ongoing manufacturing cost reductions and lower depreciation expense as a result of disciplined capital spending.

In the first quarter of 2006, broad based strength in customer demand, combined with continued lean channel inventories resulted in the highest quarterly booking level for Micrel since calendar year 2000. Orders from Micrel’s major sell-through distributors and from customers serving the communications and industrial end markets strengthened in the first quarter. Net revenues increased 5% on a sequential basis to $68.2 million and were 12% above the net revenues of the year-ago period. The sequential growth in net revenues was primarily the result of increased demand from customers serving the wireline communications end market and higher resales of the Company’s products through its distributors, partially offset by seasonal declines in sales to the wireless handset (primarily in Korea) and computing end markets. First quarter of 2006 gross margin of 58.5% was the highest quarterly gross margin as of that time in the Company’s history. The sequential improvement in gross margin was primarily the result of a richer sales mix driven by increased sales of higher margin wireline communications products. The Company’s inventory increased on a sequential basis in response to higher demand and in order to provide competitive lead times to our customers. The sequential increase in inventory added approximately one percentage point to first quarter gross margin, about the same as that experienced in the fourth quarter of 2005.

In the second quarter of 2006, overall order rates moderated from the levels experienced in the first quarter. Second quarter 2006 net revenues of $70.2 million increased by 3% sequentially and were 13% above the prior year period. The growth in net revenues continued to be led by demand from customers serving the wireline communications end market. This growth was partially offset by continued weakness in demand from Korean-based customers serving the wireless handset end market as they experienced a sequential decline in handset shipments during the second quarter. Second quarter 2006 gross margin of 57.3% declined by 1.2 percentage points as compared to the first quarter of 2006 but was up 5.5 percentage points from the 51.8% reported for the comparable period in 2005. The sequential decline in gross margin was primarily the result of normal fluctuations in sales mix and changes in inventory combined with a greater unfavorable impact from stock compensation expense. The Company’s on-hand inventories increased by $1.5 million on a sequential basis. The majority of the second quarter inventory growth was for purchased Ethernet product materials driven by increased customer demand coupled with long 3 rd party foundry cycle times.

In the third quarter of 2006, overall order rates declined on a sequential basis, primarily because the Company’s sell-through distributors reduced orders and consumed backlog in an attempt to control inventory levels. Orders from direct OEM customers increased slightly on a sequential basis in the third quarter primarily due to higher bookings from customers serving the wireless handset and computing end markets, and increased foundry orders. Third quarter 2006 net revenues of $73.5 million increased by 5% sequentially and were 18% above the prior year period. Continued strength from the industrial end market, combined with a rebound in the Company’s wireless handset business, led the product revenue growth in the third quarter. Third quarter resales of the Company’s products through the distribution channel increased slightly in what is traditionally a seasonally slow period for North American and European distributors. Sales to the wireline communications markets slowed in the quarter after rapid growth in the first half of 2006. Third quarter 2006 net revenues included $2.9 million associated with a patent license that was previously under litigation.

Third quarter 2006 gross margin of 58.6% matched the highest level in the Company’s history. The settlement of intellectual property matters, and related licensing revenues and expenses, resulted in $2.2 million of net pre-tax operating income in the third quarter, increasing third quarter 2006 net income by $0.02 per diluted share. The Company’s September ending on-hand inventory increased $2.6 million from the second quarter. The majority of the inventory growth was for purchased material for Ethernet products, as manufacturing cycle times at the foundries that manufacture Ethernet products declined during the third quarter while end demand for certain Ethernet products decreased.

Fourth quarter 2006 order rates were slightly lower than the third quarter, and remained below the level of fourth quarter revenues as customers attempted to reduce inventory levels. Fourth quarter net revenues were $64.5 million, a decrease of 12% from third quarter revenues of $73.5 million and 1% lower than revenues of $65.1 million recorded in the year-ago period. The sequential decline in sales resulted primarily from reduced demand from wireless handset manufacturers combined with lower distribution revenues and the absence of patent license revenue. Gross margin of 57.2% declined from the previous quarter primarily due to lower revenues and the impact of reduced manufacturing volumes leading to less absorption of fixed cost. The Company’s inventory was flat on a sequential basis as the Company reduced manufacturing activity in response to reduced demand.

Micrel’s overall financial performance in 2006 was one of the best on an annual basis in the Company’s history. Revenues of $276.3 million were the second highest annual amount ever recorded. Total sales increased by 10.4% over the $250.4 million posted in 2005. Gross margin of 57.9% improved for the fourth consecutive year and reached the highest level in the Company’s history, exceeding previous peak levels recorded in the year 2000 when revenues were 25% higher than 2006. Income from operations of $57.8 million increased by 74% from the $33.1 million recorded in 2005. Operating margin improved to 20.9% from 13.3% in 2005. Year 2006 net income was $38.3 million, or $0.46 per diluted share, an increase of 50% from $25.4 million, or $0.29 per diluted share in 2005. Year 2006 net income and earnings per share were the second highest ever recorded by Micrel on an annual basis. Operating cash flow for the year of 2006 was $59 million.

During the first quarter of 2007, customers continued to control their inventories closely. However, the order rates the Company experienced during the quarter suggested that customer and channel inventories had fallen to levels consistent with end demand. Micrel’s first quarter bookings increased in all major geographic regions resulting in an 18% growth in orders compared with fourth quarter 2006 levels. The total overall amount of new orders booked in the first quarter exceeded revenues. The sequential improvement in bookings was driven by higher order levels from customers serving the high speed communications, wireless handset and industrial end markets. Order rates increased for both OEM customers and sell-through distributors, while bookings from Micrel’s Asian-based sell-in distributors were flat from fourth quarter levels. First quarter revenues were $63.1 million, 2% less than the $64.5 million recorded in the fourth quarter 2006 and 7% lower than the $68.2 million posted in the first quarter of 2006. Seasonal declines in sales to customers serving the computing, wireless handset and consumer end markets were partially offset by higher resales through the Company’s sell-through distributors. Gross margin increased sequentially to 58.1% despite lower revenues and inventory reduction due to a combination of lower manufacturing costs and a higher gross margin sales mix. First quarter operating profit was $11.3 million, or 18% of sales. The Company’s on-hand inventory declined on a sequential basis. Overall channel inventories remained relatively flat from the end of 2006, with increases at the Company’s sell-through distributors offset by lower inventory levels at Micrel’s sell-in distributors.

In the second quarter of 2007, order lead times remained in the four to six week range. Although customers continued to closely monitor their inventories, the dollar amount of second quarter bookings exceeded the Company’s revenue level. Second quarter revenues were $65.1 million, a sequential increase of 3% over the $63.1 million recorded in the first quarter, and 7% lower than the $70.2 million posted in the year-ago period. The sequential growth in second quarter revenues was led by increased sales to customers serving the communications and computing end markets, offsetting lower sales of the Company’s products to major Korean wireless handset customers. Gross margin of 57.0% was flat to the prior year period and decreased by approximately 1% from the first quarter. During the second quarter, the Company operated at a lower level of factory utilization, which had the combined effect of reducing both inventory levels and gross margin. Channel inventories also declined on a sequential basis as the Company’s major global sell-through distributors attempted to take advantage of readily available semiconductor component supplies to increase their working capital turns.

Demand for the Company's products in the third quarter of 2007 was generally seasonal in nature. Bookings from industrial and wireline communication customers softened, while holiday and back-to-school related markets such as wireless handsets, computing and consumer were more robust. Faced with concerns about the growth of the U.S. economy, the Company’s sell-through distributors were cautious throughout the third quarter as they saw their orders slow and inventories build. The overall amount of orders booked by the Company in the third quarter was approximately the same as the revenue level for the quarter. Customers continued to control their inventories very closely during the third quarter in the face of short lead times, due in part to their belief that the semiconductor industry had sufficient inventory and/or the ability to deliver sufficient quantities to meet customer demand in this shorter lead time environment. Micrel’s order lead times decreased throughout the quarter, starting out at about five weeks in July and declining to three to four weeks in September. Third quarter revenues were $65.2 million, up slightly compared to the second quarter, and 11% lower than the $73.5 million posted in the year-ago period. An increase in third quarter sales to customers in the wireless handset and consumer end market was offset by lower revenues from customers in the wireline communications end market, arising from lower shipments to major Chinese communications customers as they trimmed inventory levels. Gross margin increased from 57.0% in the second quarter to 57.5% in the third quarter of 2007, and decreased from 58.6% in the year ago period. During the third quarter, the Company reduced on-hand inventory levels despite a higher level of factory utilization. Channel inventories increased by approximately one week over the second quarter due to seasonally slower distribution sales of the Company’s products. Third quarter operating profit was $12.9 million, or 19.8% of revenues.

In the fourth quarter of 2007, the increasingly uncertain macroeconomic environment appeared to heighten our customer’s focus on maintaining lean inventories. Global distributors and certain OEM customers informed the Company that they attempted to minimize inventory at year-end. As a consequence, customer orders and purchases declined more quickly than usual in the month of December, resulting in a quarterly book-to-bill ratio of less than one, and impacting fourth quarter revenues. Revenues for the fourth quarter of 2007 decreased 1% from the third quarter to $64.6 million and were essentially flat to the revenues in the year-ago period. Sales to customers serving the consumer, computing and the wire line communications end markets declined on a sequential basis, partially offset by increased sales of the Company’s Ethernet products during the quarter. Gross margin decreased to 55.8% in the fourth quarter from 57.5% in the third quarter primarily as a result of a less favorable sales mix. Fourth quarter operating profit was $11.7 million, or 18% of revenues. On-hand inventories increased during the fourth quarter, while channel inventories decreased by approximately one week from the end of the third quarter.

Micrel’s financial performance in 2007 remained solid. Total year gross margin of 57% was the second highest in the Company history. Net income for fiscal 2007 increased 15.8% to $44.4 million, or $0.57 per diluted share, compared with net income of $38.3 million, or $0.46 per diluted share in 2006. Included in 2007 pre-tax income was a $15.5 million gain associated with a first quarter legal settlement, which after income taxes, was equivalent to $9.9 million or $0.13 per diluted share. Cash flows from operations of $67.8 million during the year enabled the repurchase of 5.5 million shares of common stock for $55.1 million, representing approximately 7% of the shares outstanding at the beginning of the year. In addition, the Company commenced a $0.03 per common share cash dividend payment to shareholders in the second quarter of 2007.

The Company derives a substantial portion of its net revenues from standard products. For 2007, 2006 and 2005 the Company's standard products sales accounted for 92%, 93%, and 96%, respectively, of the Company's net revenues. The Company believes that a substantial portion of its net revenues in the future will depend upon standard products sales, although such sales as a proportion of net revenues may vary as the Company adjusts product output levels to correspond with varying economic conditions and demand levels in the markets which it serves. The standard products business is characterized by short-term orders and shipment schedules, and customer orders typically can be canceled or rescheduled without significant penalty to the customer. Since most standard products backlog is cancelable without significant penalty, the Company typically plans its production and inventory levels based on internal forecasts of customer demand, which is highly unpredictable and can fluctuate substantially. In addition, the Company is limited in its ability to reduce costs quickly in response to any revenue shortfalls.

The Company may experience significant fluctuations in its results of operations. Factors that affect the Company's results of operations include the volume and timing of orders received, changes in the mix of products sold, the utilization level of manufacturing capacity, competitive pricing pressures and the successful development of new products. These and other factors are described in further detail later in this discussion and in Item 1A. As a result of the foregoing or other factors, there can be no assurance that the Company will not experience material fluctuations in future operating results on a quarterly or annual basis, which could materially and adversely affect the Company's business, financial condition, results of operations or cash flows.

Results of Operations


Net Revenues . Net revenues decreased 7% to $258.0 million for the year ended December 31, 2007 from $276.3 million in 2006 due to decreased standard product revenues which were partially offset by increased other products revenues.

Standard product revenues decreased 8% to $237.4 million, which represented 92% of net revenues for the year ended December 31, 2007, compared to $258.2 million and 93% of net revenues for 2006. These decreases resulted primarily from decreased shipments of standard products to the wireless handset, computer products, telecommunications, networking and high speed communications end markets, which were partially offset by increase unit shipments to the industrial end market.

Other products revenues which consist primarily of custom and foundry products revenues and revenues from the license of patents, increased 14% to $20.6 million, which represented 8% of net revenues for the year ended December 31, 2007, compared to $18.1 million and 7% of net revenues for 2006. These increases resulted primarily from increased foundry product shipments, which were partially offset by a $2.9 million patent license included in 2006.

For the year ended December 31, 2006, net revenues increased 10% to $276.3 million from $250.4 million in 2005 due to increased standard product revenues and increased other products revenues. Standard product revenues increased 8% to $258.2 million, which represented 93% of net revenues for 2006, compared to $239.2 million and 96% of net revenues for 2005. These increases resulted primarily from increased shipments of standard products to the industrial, networking and high-speed communications end markets. Other products revenues which consist primarily of custom and foundry products revenues and revenues from the license of patents, increased 62% to $18.1 million, which represented 7% of net revenues for 2006, compared to $11.2 million and 4% of net revenues for 2005. These increases partially resulted from a $2.9 million patent license included in 2006 combined with increased shipments of foundry and custom products.

Customer demand for semiconductors can change quickly and unexpectedly. The Company’s revenue levels have been highly dependent on the amount of new orders that are received for which product is requested to be delivered to the customer within the same quarter. Within the semiconductor industry these orders that are booked and shipped within the quarter are called “turns fill” orders. When the turns fill level exceeds approximately 35% of quarterly revenue, it makes it very difficult to predict near term revenues and income. Because of the long cycle time to build its products, the Company’s lack of visibility into demand when turns fill is high makes it difficult to predict what product to build to match future demand. During 2007, the Company averaged approximately 50% to 60% OEM turns fill per quarter compared to approximately 50% to 55% turns fill per quarter during 2006.

As noted in Item 1A “Risk Factors” and in the overview section of this Item 7 “Management's Discussion and Analysis of Financial Condition and Results of Operations”, a trend has developed over the last several years whereby customers in the semiconductor supply chain have worked to minimize the amount of inventory of semiconductors they hold. As a consequence, customers are generally providing less order backlog to the Company and other semiconductor suppliers, and relying on short lead times to buffer their build schedules. Shorter lead times reduce visibility into end demand and increase the reliance on turns fill orders. To deal with these market forces while maintaining reliable service levels, the Company and other semiconductor suppliers are carrying higher relative levels of inventory compared with historical averages prior to 2001. The reluctance of customers to provide order backlog together with short lead times and the uncertain growth rate of the world economy, make it difficult to precisely predict future levels of sales and profitability.

International sales represented 67%, 70%, and 75% of net revenues for the years ended December 31, 2007, 2006 and 2005, respectively. On a dollar basis, international sales decreased 10% to $173.6 million for the year ended December 31, 2007 from $193.5 million for the comparable period in 2006. These decreases resulted primarily from decreased shipments of standard products to the networking communications, wireless handsets and computer products end markets, primarily in Asia.

The trend for the Company’s customers to move their electronics manufacturing to Asian countries has brought increased pricing pressure for Micrel and other semiconductor manufacturers. Asian based manufacturers are typically more concerned about cost and less concerned about the capability of the integrated circuits they purchase. This can make it more difficult for United States based companies to differentiate themselves except by price. The increased concentration of electronics procurement and manufacturing in the Asia Pacific region has led, and may continue to lead, to continued price pressure for the Company’s products in the future.

Share-Based Compensation . Effective January 1, 2006, the Company adopted the fair value recognition provisions of SFAS No. 123R using the modified prospective transition method and therefore has not restated results for prior periods. The Company's results of operations for the years ended December 31, 2007 and 2006 were impacted by the recognition of non-cash expense related to the fair value of share-based compensation awards. During 2007, Micrel recorded $5.5 million in pre-tax share-based compensation expense, of which $1.2 million is included in cost of revenues, $2.1 million is included in research and development expense and $2.2 million is included in sales, general and administrative expense. During 2006, Micrel recorded $8.4 million in pre-tax share-based compensation expense, of which $1.5 million is included in cost of revenues, $3.4 million is included in research and development expense and $3.5 million is included in sales, general and administrative expense.

Prior to January 1, 2006, the Company accounted for share-based awards to employees using the intrinsic value method in accordance with Accounting Principles Board Opinion ("APB") No. 25, "Accounting for Stock Issued to Employees". During the years 1996 through December 2001, certain of the Company's option pricing practices resulted in stock compensation expense under APB No. 25. In addition, the Company assumed certain stock options granted to employees of Kendin Communications in connection with the acquisition of Kendin Communications in 2001 which were compensatory under APB No. 25. For the year ended December 31, 2005, total amortization of deferred stock compensation was $770,000.

Gross Profit. Gross profit is affected by a variety of factors including the volume of product sales, product mix, manufacturing capacity utilization, product yields and average selling prices. The Company's gross margin decreased to 57% for the year ended December 31, 2007 from 58% for 2006. The decrease in gross margin resulted primarily from reduced revenue levels to cover fixed manufacturing costs. Depreciation and amortization as a percent of sales increased to 7.0% for 2007 as compared to 6.3% for 2006 due to additional depreciation on new equipment purchases combined with a decrease in annual revenues. The 2007 gross margin was also affected by a greater sales mix of lower margin products and lower revenues from the license of patents.

For the year ended December 31, 2006, the Company's gross margin increased to 58% from 53% for 2005. The increases in gross margin resulted primarily from a greater sales mix of higher margin products combined with decreased depreciation, decreased wafer fabrication costs and decreased external assembly and test costs, which were partially offset by increased share-based compensation costs due to the adoption of SFAS No. 123R. Depreciation and amortization as a percent of sales declined to 6.3% for 2006 as compared to 8.0% for 2005. This reduction in depreciation was primarily due to existing equipment becoming fully depreciated, which was partially offset by additional depreciation on new equipment purchases. In addition, included in gross profit for 2006 is $2.9 million in net revenues for a patent license (see Note 10 of Notes to Consolidated Financial Statements), which is partially offset by a $714,000 charge to cost of revenues related to the settlement of a patent dispute (see Note 10 of Notes to Consolidated Financial Statements).

Research and Development Expenses. Research and development expenses as a percentage of net revenues represented 21% and 19% for the years ended December 31, 2007 and 2006, respectively. On a dollar basis, research and development expenses increased $2.4 million or 5% to $54.5 million for 2007 from $52.1 million in 2006. These increases were primarily due to increased staffing costs. The Company believes that the development and introduction of new products is critical to its future success and expects to continue its investment in research and development activities in the future.

For the year ended December 31, 2006, research and development expenses increased $6.8 million to $52.1 million from $45.2 million in 2005. This increase was primarily due to increased share-based compensation costs due to the adoption of SFAS No. 123R combined with increased prototype fabrication costs.

Selling, General and Administrative Expenses. As a percentage of net revenues, selling, general and administrative expenses represented 18% for both of the years ended December 31, 2007 and 2006. On a dollar basis, selling, general and administrative expenses decreased $4.0 million or 8% to $45.0 million for 2007 from $49.0 million for 2006. This decrease was primarily due to decreased outside legal costs.

For the year ended December 31, 2006 selling, general and administrative expenses increased $2.9 million to $49.0 million from $46.2 million for 2005. These increases were primarily due to increased share-based compensation costs due to the adoption of SFAS No. 123R and increased staffing costs, including salaries and sales commissions, which were partially offset by decreased outside legal costs.

Restructuring Expense. In September 2002, the Company approved a plan to close its Santa Clara, California wafer fabrication facility to reduce costs and improve operating efficiencies. During 2003, the Company ceased all manufacturing processes within the Santa Clara facility and completed the relocation of all employees to its San Jose, CA facilities. As of December 31, 2007, the remaining restructuring accrual related to this facility closure was $1.8 million (see Note 12 of Notes to Consolidated Financial Statements) and is classified as other current liabilities. Actual future costs may be different than these estimates and would require an adjustment to restructuring expense in the period such determination is made.

Other Operating Expense. Other operating expenses in 2006 consist primarily of accrued costs related to the settlement of patent infringement lawsuits (see Note 10 of Notes to Consolidated Financial Statements). In 2005, the Company recorded $9.3 million in other operating expense related to a jury verdict against Micrel in its suit against TRW Automotive and for TRW Automotive in its countersuit against Micrel. (see Note 10 of Notes to Consolidated Financial Statements).

Other Income, Net . Other income, net reflects interest income from investments in short-term and long-term investment securities and money market funds and other non-operating income, offset by interest expense incurred on term notes and accrued interest related to accrued litigation liabilities. During 2007 the Company recorded $15.5 million in non-operating income resulting from the settlement of litigation (see Note 10 of Notes to Consolidated Financial Statements).

Provision for Income Taxes . For the year ended December 31, 2007, the provision for income taxes was $24.9 million or 36% of income before taxes as compared to 39% of income before taxes for 2006. The tax rate decrease is due primarily to the reduction in nondeductible share-based compensation expense combined with an increased effect of federal and state research and development credits. The 2007 provision for income taxes differs from taxes computed at the federal statutory rate primarily due to the effects of non-deductible share-based compensation expense, state income taxes, federal and state research and development credits and federal qualified production activity deductions.

For the year ended December 31, 2006, the provision for income taxes was $24.9 million or 39% of income before taxes as compared to 32% of income before taxes for the comparable period in 2005. The tax rate increase is due primarily to the effects of nondeductible share-based compensation expense combined with a reduced impact of federal qualified production activity deductions and federal and state research and development credits as a result of significantly increased income before tax in 2006. The provision for income taxes differs from taxes computed at the federal statutory rate primarily due to the effect of nondeductible share-based compensation expense, state income taxes, state research and development credits, and federal qualified production activity deductions.

MANAGEMENT DISCUSSION FOR LATEST QUARTER

Results of Operations

Net Revenues. For the three months ended September 30, 2007, net revenues decreased 11% to $65.2 million from $73.5 million for the same period in the prior year. For the nine months ended September 30, 2007, net revenues decreased 9% to $193.4 million from $211.8 million for the same period in the prior year. These decreases were due to decreases in standard products revenues and other products revenues.

Standard products revenues for the three months ended September 30, 2007 decreased 10% to $59.5 million from $66.5 million for the same period in the prior year. For the nine months ended September 30, 2007, standard products revenues decreased 10% to $177.7 million from $198.4 million for the same period in the prior year. These decreases resulted primarily from decreased unit shipments of standard products to the computer products, telecommunications, networking and high speed communications end markets, which were partially offset by increase unit shipments to the industrial end market.

Other products, which consist primarily of custom and foundry products revenues and revenues from the license of patents, for the three months ended September 30, 2007 decreased 19% to $5.7 million from $7.0 million for the same period in the prior year. This decrease resulted primarily from a $2.9 million sale of intellectual property included in 2006 , which was partially offset by increased foundry product shipments. For the nine months ended September 30, 2007, other products revenues increased 17% to $15.7 million from $13.4 million for the same period in the prior year. This increase resulted primarily from increased unit shipments of foundry products, which was partially offset by a $2.9 million sale of intellectual property included in 2006.

Customer demand for semiconductors can change quickly and unexpectedly. The Company’s revenue levels have been highly dependent on the amount of new orders that are received for which product is requested to be delivered to the customer within the same quarter. Within the semiconductor industry these orders that are booked and shipped within the quarter are called “turns fill” orders. When the turns fill level exceeds approximately 35% of quarterly revenue, it makes it very difficult to predict near term revenues and income. Because of the long cycle time to build its products, the Company’s lack of visibility into demand when turns fill is high makes it difficult to predict what product to build to match future demand. During 2006, the Company averaged approximately 50% to 55% turns fill per quarter. During the first nine months of 2007, turns fill rate for OEM and stocking representatives remained in the 55% to 60% range.

As noted in Item 1A “Risk Factors” and above in the overview section of this “Management's Discussion and Analysis of Financial Condition and Results of Operations”, a trend has developed over the last five years whereby customers in the semiconductor supply chain have worked to minimize the amount of inventory of semiconductors they hold. As a consequence, customers are generally providing less order backlog to the Company and other semiconductor suppliers, and relying on short lead times to buffer their build schedules. Shorter lead times reduce visibility into end demand and increase the reliance on turns fill orders. To deal with these market forces while maintaining reliable service levels, the Company and other semiconductor suppliers are carrying higher relative levels of inventory compared with historical averages prior to 2001. The reluctance of customers to provide order backlog, combined with short lead times and the uncertain growth rate of the world economy, make it difficult to precisely predict future levels of sales and profitability.

International sales represented 66% and 68% of net revenues for the three months ended September 30, 2007 and 2006, respectively. On a dollar basis, international sales decreased 14% to $43.1 million for the three months ended September 30, 2007 from $50.3 million for the comparable period in 2006. For the nine months ended September 30, 2007 and 2006, international sales represented 68% and 71% of net revenues, respectively. For the nine months ended September 30, 2007 international sales decreased 13% to $130.5 million from $149.8 million for the comparable period in 2006. These decreases resulted primarily from decreased shipments of standard products to the networking communications and computer products end markets, primarily in Asia.

The trend for the Company’s customers to move their electronics manufacturing to Asian countries has brought increased pricing pressure for Micrel and other semiconductor manufacturers. Asian based manufacturers are typically more concerned about cost and less concerned about the capability of the integrated circuits they purchase. This can make it more difficult for United States based companies to differentiate themselves except by price. The increased concentration of electronics procurement and manufacturing in the Asia Pacific region has led, and may continue to lead, to continued price pressure for the Company’s products in the future.

Share-Based Compensation . Effective January 1, 2006, the Company adopted the fair value recognition provisions of SFAS No. 123R using the modified prospective transition method. The Company's results of operations for the three month periods ended September 30, 2007 and 2006 include $1.4 million and $2.0 million, respectively, of non-cash expense related to the fair value of share-based compensation awards. For the nine month periods ended September 30, 2007 and 2006, the Company's results of operations include $4.3 million and $7.0 million, respectively, of non-cash expense related to the fair value of share-based compensation awards (see Note 3 of Notes to Condensed Consolidated Financial Statements.)

Gross Profit . Gross profit is affected by a variety of factors including the volume of product sales, product mix, manufacturing capacity utilization, product yields and average selling prices. The Company's gross margin decreased to 57.5% for the three months ended September 30, 2007 from 58.6% for the comparable period in 2006. For the nine months ended September 30, 2007, the Company's gross margin decreased to 57.5% from 58.2% for the comparable period in 2006. These decreases in gross margin resulted primarily from decreased manufacturing capacity utilization and the inclusion of, in 2006, $2.9 million in net revenues for sale of intellectual property, which is partially offset by a $714,000 charge to cost of revenues related to the settlement of a patent dispute.

Research and Development Expenses. Research and development expenses as a percentage of net revenues represented 21.0% and 17.8%, for the three months ended September 30, 2007 and 2006, respectively. On a dollar basis, research and development expenses increased $609,000 or 5% to $13.7 million for the three months ended September 30, 2007 from $13.1 million for the comparable period in 2006. For the nine months ended September 30, 2007 and 2006, research and development expenses as a percentage of net revenues represented 21.3% and 18.6%, respectively. On a dollar basis, research and development expenses increased $1.9 million or 5% to $41.1 million for the nine months ended September 30, 2007 from $39.3 million for the comparable period in 2006. These increases were primarily due to increased staffing costs combined with increased prototype fabrication costs. The Company believes that the development and introduction of new products is critical to its future success and expects to continue its investment in research and development activities in the future.

Selling, General and Administrative Expenses. As a percentage of net revenues, selling, general and administrative expenses represented 16.7% and 16.2% for the three months ended September 30, 2007 and 2006, respectively. On a dollar basis, selling, general and administrative expenses decreased $1.0 million or 8% to $10.9 million for the three months ended September 30, 2007 from $11.9 million for the comparable period in 2006. For the nine months ended September 30, 2007 and 2006, as a percentage of net revenues, selling, general and administrative expenses represented 17.7% and 17.8%, respectively. On a dollar basis, selling, general and administrative expenses decreased $3.4 million or 9% to $34.1 million for the nine months ended September 30, 2007 from $37.5 million for the comparable period in 2006. These decreases were primarily due to decreased outside legal expenses.

Other Income (Expense) . Other income (expense) reflects interest income from investments in short-term investment grade securities and money market funds and other non-operating income, offset by interest expense incurred on term notes and accrued interest related to the settlement of certain previously provided for litigation liabilities. For the nine months ended September 30, 2007, other income includes $15.5 million in non-operating income resulting from the settlement of litigation (see Note 12 of Notes to Condensed Consolidated Financial Statements).

Provision for Income Taxes. The income tax provision for the three and nine months ended September 30, 2007, as a percentage of income before taxes, was 35.1% and 35.9%, respectively, decreasing from 39.9% and 40.4% for the comparable periods in the prior year. These decreases resulted from decreased non-deductible share-based compensation expense combined with increased tax benefits from the federal research and development credit and federal qualified production activity deductions. The income tax provision for such interim periods differs from taxes computed at the federal statutory rate primarily due to the effect of non-deductible share-based compensation expense, state income taxes, federal and state research and development credits and federal qualified production activity deductions.


Liquidity and Capital Resources

Since inception, the Company's principal sources of funding have been its cash from operations, bank borrowings and sales of common stock. Principal sources of liquidity at September 30, 2007, consisted of cash and short-term investments of $115.6 million and a $6 million revolving line of credit from a commercial bank (see Note 8 of Notes to Condensed Consolidated Financial Statements).

The Company generated $47.6 million in cash flows from operating activities for the nine months ended September 30, 2007, primarily attributable to net income of $35.9 million plus additions for non-cash activities of $20.9 million (consisting primarily of $13.5 million in depreciation and amortization, $4.3 million in share-based compensation expense and a $2.1 million decrease in deferred tax assets) combined with a $5.2 million increase in income taxes payable and a $3.7 million decrease in inventories, which was partially offset by a $10.9 million decrease in other current liabilities, resulting primarily from the payment of a legal judgment, $1.9 million decrease in accounts payable combined with a $3.4 million increase in accounts receivable and a $2.4 million increase in income taxes receivable.

For the nine months ended September 30, 2006, the Company generated $39.7 million in cash flows from operating activities, primarily attributable to net income of $29.5 million plus additions for non-cash activities of $19.4 million (consisting primarily of $12.8 million in depreciation and amortization, $7.0 million in share-based compensation expense) combined with a $7.3 million increase in deferred income on shipments to distributors, which was partially offset by a $6.5 million increase in inventories combined with a $4.9 million decrease in income taxes payable and a $2.6 million decrease in accounts payable.


The Company used $18.3 million of cash in investing activities during the nine months ended September 30, 2007, comprised of $13.9 million in purchases of property, plant and equipment and $7.0 million in net purchases of short-term investments which was partially offset by a $2.6 million decease in restricted cash.

For the nine months ended September 30, 2006, the Company generated $20.9 million of cash from investing activities, comprised of $36.4 million in proceeds from net sales of short-term investments which was partially offset by $11.3 million in purchases of property, plant and equipment, $1.6 million in purchases of intangible assets and $2.6 million increase in restricted cash.

The Company used $28.1 million of cash in financing activities during the nine months ended September 30, 2007 primarily for the repurchase of $34.4 million of the Company's common stock and $4.7 million for the payment of cash dividends, which was partially offset by $10.9 million in proceeds from the exercise of employee stock awards.

For the nine months ended September 30, 2006, the Company used $55.2 million of cash in financing activities during the nine months ended September 30, 2006 primarily for the repurchase of $58.0 million of the Company's common stock, which was partially offset by $2.7 million in proceeds from employee stock transactions.

The Company currently intends to spend approximately $18 million to $23 million to purchase capital equipment and make facility improvements during the next 12 months primarily for wafer fabrication and product testing and additional research and development related software and equipment. The Company is currently authorized by its Board of Directors to repurchase an additional $65.6 million of its common stock through December 31, 2008. In addition, on October 22, 2007, the Company's Board of Directors declared a $0.03 per common share cash dividend, payable November 20, 2007 to shareholders of record on November 5, 2007. The cash dividend payout by the Company on November 20 2007 is expected to be approximately $2.3 million. Since inception, the Company's principal sources of funding have been its cash from operations, bank borrowings and sales of common stock. The Company believes that its cash flows from operations, existing cash balances and short-term investments, and its credit facility will be sufficient to meet its cash requirements for the next 12 months. In the longer term, the Company believes future cash requirements will continue to be met by its cash from operations, credit arrangements and future debt or equity financings as required.

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