UNITED
STATES


SECURITIES
AND EXCHANGE COMMISSION


WASHINGTON,
D.C.  20549








FORM
10-Q





(Mark
One)


x
            QUARTERLY
      REPORT PURSUANT TO SECTION 13 or 15(d) OF THE SECURITIES EXCHANGE ACT OF
      1934


For the quarterly period ended
September 30, 2008.





or





 ̈
            TRANSITION
      REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF
      1934


For the transition period from  to .





Commission File Number 1-34020








MICREL,
INCORPORATED


(Exact
name of Registrant as specified in its charter)








California
            94-2526744(State
      or other jurisdiction of
            (I.R.S.
      Employer Identification No.)incorporation
      or organization)








2180
Fortune Drive, San Jose,
CA       95131


(Address
of principal executive offices)   (Zip Code)








Registrant's
telephone number, including area code: (408) 944-0800








Indicate
by check mark whether the registrant (1) has filed all reports required to be
filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the
preceding 12 months (or for such shorter period that the registrant was required
to file such reports), and (2) has been subject to such filing requirements for
the past 90 days.  Yes x   No
 ̈





Indicate
by check mark whether the registrant is a large accelerated filer, an
accelerated filer, a non-accelerated filer, or a smaller reporting company. See
definition of “accelerated filer and large accelerated filer” in Rule 12b-2 of
the Exchange Act. Large accelerated filer  ̈  Accelerated
filer x  Non-accelerated
filer  ̈  Smaller
reporting company  ̈





Indicate
by check mark whether the registrant is a shell company (as defined in Rule
12b-2 of the Exchange Act.)  Yes  ̈ No
x











As of
November 3, 2008 there were 68,694,506 shares of common stock, no par value,
outstanding.











MICREL,
      INCORPORATED
              INDEX
      TO
              REPORT
      ON FORM 10-Q
              FOR
      THE THREE MONTHS ENDED SEPTEMBER 30, 2008PagePART
      I.  FINANCIAL INFORMATIONItem 1.
            Financial
      Statements (Unaudited):Condensed
      Consolidated Balance Sheets - at September 30, 2008 and at
      December 31, 2007
            
            
            3Condensed
      Consolidated Statements of Operations - Three and Nine Months Ended
      September 30, 2008 and 2007
            
            
            4Condensed
      Consolidated Statements of Cash Flows - Nine Months Ended September 30,
      2008 and 2007
            
            
            5Notes
      to Condensed Consolidated Financial Statements
            
            
            6Item
      2.
            Management’s
      Discussion and Analysis of Financial Condition and Results of
      Operations
            
            
            18Item
      3.
            Quantitative
      and Qualitative Disclosures about Market Risk
            
            
            30Item
      4.
            Controls
      and Procedures
            
            
            30PART
      II.  OTHER INFORMATIONItem
      1.
            Legal
      Proceedings
            
            
            31Item
      1A.
            Risk
      Factors
            
            
            31Item
      2.
            Unregistered
      Sales of Equity Securities and Use of Proceeds
            
            
            37Item
      6.
            Exhibits
            
            
            38Signature
            
            
            39











- 2
-





ITEM
      1. FINANCIAL STATEMENTSMICREL,
      INCORPORATEDCONDENSED
      CONSOLIDATED BALANCE SHEETS(Unaudited)(In
      thousands, except share amounts)September 30,
            
            
            December 31,2008
            
            
            2007ASSETSCURRENT
      ASSETS:Cash and cash
      equivalents
            
            $
            77,310
            
            
            $
            80,977Short term
    investments
            
            
            4,951
            
            
            
            10,150Accounts receivable,
      net
            
            
            34,271
            
            
            
            29,614Inventories
            
            
            36,483
            
            
            
            35,660Income
      taxes receivable
            
            
            824
            
            
            
            3,426Prepaid expenses and
      other
            
            
            1,431
            
            
            
            3,604Deferred income
    taxes
            
            
            19,561
            
            
            
            19,387Total current
      assets
            
            
            174,831
            
            
            
            182,818LONG-TERM
      INVESTMENTS
            
            
            13,453
            
            
            
            16,552PROPERTY,
      PLANT AND EQUIPMENT, NET
            
            
            78,475
            
            
            
            82,585DEFERRED
      INCOME TAXES
            
            
            10,364
            
            
            
            9,286INTANGIBLE
      ASSETS, NET
            
            
            1,760
            
            
            
            3,026OTHER
      ASSETS
            
            
            436
            
            
            
            478TOTAL
      ASSETS
            
            $
            279,319
            
            
            $
            294,745LIABILITIES
      AND SHAREHOLDERS’ EQUITYCURRENT
      LIABILITIES:Accounts payable
            
            $
            15,694
            
            
            $
            18,010Deferred income on shipments to
      distributors
            
            
            23,012
            
            
            
            20,238Other current
      liabilities
            
            
            10,645
            
            
            
            14,097Total current
      liabilities
            
            
            49,351
            
            
            
            52,345LONG-TERM
      INCOME TAXES PAYABLE
            
            
            3,612
            
            
            
            2,814OTHER
      LONG-TERM OBLIGATIONS
            
            
            290
            
            
            
            335TOTAL
      LIABILITIES
            
            
            53,253
            
            
            
            55,494SHAREHOLDERS’
      EQUITY:Preferred stock, no par value -
      authorized: 5,000,000 shares;issued and outstanding:
      none
            
            
            --
            
            
            
            --Common stock, no par value -
      authorized: 250,000,000 shares;issued and
      outstanding:  2008 – 69,768,113 shares; 2007 – 74, 001,360
      shares
            
            
            --
            
            
            
            --Accumulated other comprehensive
      loss
            
            
            (1,828
            )
            
            
            (32
            )Retained earnings
            
            
            227,894
            
            
            
            239,283Total shareholders’
      equity
            
            
            226,066
            
            
            
            239,251TOTAL
      LIABILITIES AND SHAREHOLDERS’ EQUITY
            
            $
            279,319
            
            
            $
            294,745The
      accompanying notes are an integral part of these unaudited condensed
      consolidated financial statements.


- 3
-





MICREL,
      INCORPORATEDCONDENSED
      CONSOLIDATED STATEMENTS OF OPERATIONS(Unaudited)(In
      thousands, except per share amounts)Three
      Months Ended
            
            
            Nine
      Months EndedSeptember 30,
            
            
            September 30,2008
            
            
            2007
            
            
            2008
            
            
            2007NET
      REVENUES
            
            $
            67,549
            
            
            $
            65,191
            
            
            $
            204,194
            
            
            $
            193,405COST
      OF REVENUES (1)
            
            
            29,678
            
            
            
            27,698
            
            
            
            89,218
            
            
            
            82,118GROSS
      PROFIT
            
            
            37,871
            
            
            
            37,493
            
            
            
            114,976
            
            
            
            111,287OPERATING
      EXPENSES:Research and development (1)
            
            
            13,832
            
            
            
            13,680
            
            
            
            42,716
            
            
            
            41,123Selling, general and
      administrative (1)
            
            
            11,307
            
            
            
            10,871
            
            
            
            34,789
            
            
            
            34,123Restructuring charges
      (credits)
            
            
            --
            
            
            
            28
            
            
            
            (842
            )
            
            
            100Proxy contest
    expense
            
            
            16
            
            
            
            --
            
            
            
            3,003
            
            
            
            --Other expense
            
            
            --
            
            
            
            --
            
            
            
            --
            
            
            
            86Total operating
      expenses
            
            
            25,155
            
            
            
            24,579
            
            
            
            79,666
            
            
            
            75,432INCOME
      FROM OPERATIONS
            
            
            12,716
            
            
            
            12,914
            
            
            
            35,310
            
            
            
            35,855OTHER
      INCOME (EXPENSE):Interest income
            
            
            652
            
            
            
            1,605
            
            
            
            2,382
            
            
            
            4,767Interest expense
            
            
            (1
            )
            
            
            (11
            )
            
            
            (2
            )
            
            
            (83
            )Litigation settlement and other
      income, net (Note
      12)
            
            
            10
            
            
            
            10
            
            
            
            57
            
            
            
            15,533Total other income,
      net
            
            
            661
            
            
            
            1,604
            
            
            
            2,437
            
            
            
            20,217INCOME
      BEFORE INCOME TAXES
            
            
            13,377
            
            
            
            14,518
            
            
            
            37,747
            
            
            
            56,072PROVISION
      FOR INCOME TAXES
            
            
            4,900
            
            
            
            5,095
            
            
            
            13,641
            
            
            
            20,140NET
      INCOME
            
            $
            8,477
            
            
            $
            9,423
            
            
            $
            24,106
            
            
            $
            35,932NET
      INCOME PER SHARE:Basic
            
            $
            0.12
            
            
            $
            0.12
            
            
            $
            0.34
            
            
            $
            0.46Diluted
            
            $
            0.12
            
            
            $
            0.12
            
            
            $
            0.34
            
            
            $
            0.46WEIGHTED
      AVERAGE SHARES USED INCOMPUTING
      PER SHARE AMOUNTS:Basic
            
            
            70,299
            
            
            
            76,964
            
            
            
            71,243
            
            
            
            77,466Diluted
            
            
            70,427
            
            
            
            77,971
            
            
            
            71,365
            
            
            
            78,625(1)
      Share-based compensation expense included in:Cost of
revenues
            
            $
            243
            
            
            $
            260
            
            
            $
            759
            
            
            $
            848Research and
      development
            
            
            544
            
            
            
            543
            
            
            
            1,716
            
            
            
            1,678Selling, general and
      administrative
            
            
            544
            
            
            
            564
            
            
            
            1,785
            
            
            
            1,791The
      accompanying notes are an integral part of these unaudited condensed
      consolidated financial statements.


- 4
-





MICREL,
      INCORPORATEDCONDENSED
      CONSOLIDATED STATEMENTS OF CASH FLOWS(Unaudited)(In
      thousands)
            
            Nine
      Months EndedSeptember 30,2008
            
            
            2007NET
      CASH FLOWS PROVIDED BY OPERATING ACTIVITIES:Net income
            
            $
            24,106
            
            
            $
            35,932Adjustments to reconcile net
      income to net cashprovided by operating activities:Depreciation and
      amortization
            
            
            14,541
            
            
            
            13,499Share-based compensation
      expense
            
            
            4,260
            
            
            
            4,317Tax benefit on the exercise of
      employee stock options
            
            
            230
            
            
            
            1,265Excess tax benefits associated
      with share-based compensation
            
            
            --
            
            
            
            (158
            )Gain on disposal of
      assets
            
            
            (113
            )
            
            
            --Accrued rent
            
            
            (45
            )
            
            
            (107
            )Deferred income taxes
      provision
            
            
            (141)
            
            
            
            2,115Changes in operating assets and
      liabilities:Accounts
    receivable
            
            
            (4,657
            )
            
            
            (3,442
            )Inventories
            
            
            (782
            )
            
            
            3,651Income taxes
      receivable
            
            
            2,602
            
            
            
            (2,428
            )Prepaid expenses and other
      assets
            
            
            2,215
            
            
            
            636Accounts
payable
            
            
            (2,316
            )
            
            
            (1,860
            )Income taxes
      payable
            
            
            814
            
            
            
            5,154Other current
      liabilities
            
            
            (3,531
            )
            
            
            (10,917
            )Deferred income on shipments to
      distributors
            
            
            2,774
            
            
            
            (14
            )Net cash provided by operating
      activities
            
            
            39,957
            
            
            
            47,643CASH
      FLOWS FROM INVESTING ACTIVITIES:Change in restricted
      cash
            
            
            --
            
            
            
            2,629Purchases of property, plant and
      equipment, net
            
            
            (9,175
            )
            
            
            (13,931
            )Proceeds
      from sale of equipment
            
            
            123
            
            
            
            --Purchases of
      investments
            
            
            (8,951
            )
            
            
            (13,056
            )Proceeds from the sale of
      investments
            
            
            14,323
            
            
            
            6,064Net cash used in investing
      activities
            
            
            (3,680
            )
            
            
            (18,294
            )CASH
      FLOWS FROM FINANCING ACTIVITIES:Repayments of long-term
      debt
            
            
            --
            
            
            
            (80
            )Proceeds from the issuance of
      common stock
            
            
            3,186
            
            
            
            10,914Repurchases of common
      stock
            
            
            (35,997
            )
            
            
            (34,402
            )Payment of cash
      dividends
            
            
            (7,133
            )
            
            
            (4,667
            )Excess tax benefits associated
      with share-based compensation
            
            
            --
            
            
            
            158Net cash used in financing
      activities
            
            
            (39,944
            )
            
            
            (28,077
            )NET
      INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS
            
            
            (3,667
            )
            
            
            1,272CASH
      AND CASH EQUIVALENTS - Beginning of period
            
            
            80,977
            
            
            
            92,259CASH
      AND CASH EQUIVALENTS - End of period
            
            $
            77,310
            
            
            $
            93,531SUPPLEMENTAL
      DISCLOSURE OF CASH FLOW INFORMATION:Cash
      paid during the period for:Interest
            
            $
            13
            
            
            $
            816Income taxes
            
            $
            9,940
            
            
            $
            13,987The
      accompanying notes are an integral part of these unaudited condensed
      consolidated financial statements.





- 5
-
 MICREL,
INCORPORATED
 NOTES
TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
 (Unaudited)


1.
            SIGNIFICANT
      ACCOUNTING POLICIES





Interim
      Financial Information -The accompanying
      condensed consolidated financial statements of Micrel, Incorporated and
      its wholly-owned subsidiaries (“Micrel” or the “Company”) as of September
      30, 2008 and for the three and nine months ended September 30, 2008 and
      2007 are unaudited.  In the opinion of management, the condensed
      consolidated financial statements include all adjustments (consisting only
      of normal recurring accruals) that management considers necessary for a
      fair statement of its financial position, operating results and cash flows
      for the interim periods presented.  Operating results and cash
      flows for interim periods are not necessarily indicative of results for
      the entire year. The Condensed Consolidated Balance Sheet as of
      December 31, 2007, was derived from audited financial statements, but
      does not include all disclosures required by accounting principles
      generally accepted ("GAAP") in the United States of America. These
      financial statements should be read in conjunction with the audited
      consolidated financial statements and notes thereto included in the
      Company’s Annual Report on Form 10-K for the year ended December 31,
      2007.  These financial statements should also be read in
      conjunction with the Company's critical accounting policies included in
      the Company’s Annual Report on Form 10-K for the year ended
      December 31, 2007.





Net Income Per
Common and Equivalent Share-Basic net income per share
is computed by dividing net income by the number of weighted-average common
shares outstanding.  Diluted net income per share reflects potential
dilution from outstanding stock options using the treasury stock
method.  Reconciliation of weighted-average shares used in computing
net income per share is as follows (in thousands):





Three
      Months Ended
            
            
            Nine
      Months EndedSeptember 30,
            
            
            September 30,2008
            
            
            2007
            
            
            2008
            
            
            2007Weighted average common shares
      outstanding
            
            
            70,299
            
            
            
            76,964
            
            
            
            71,243
            
            
            
            77,466Dilutive effect of stock
      options outstanding using the treasury stock method
            
            
            128
            
            
            
            1,007
            
            
            
            122
            
            
            
            1,159Shares used in computing
      diluted net income per share
            
            
            70,427
            
            
            
            77,971
            
            
            
            71,365
            
            
            
            78,625





For the
three and nine months ended September 30, 2008, 10.1 million stock options and
10.4 million stock options, respectively, have been excluded from the
weighted-average number of common shares outstanding for the diluted net income
per share computations as they were anti-dilutive. For the three and nine months
ended September 30, 2007, 6.1 million stock options and 5.7 million stock
options, respectively have been excluded from the weighted-average number of
common shares outstanding for the diluted net income per share computations as
they were anti-dilutive.





2.
            RECENTLY
      ISSUED ACCOUNTING STANDARDS





In
September 2006, the FASB issued Statement 157 (“SFAS 157”), “Fair Value
Measurements”. SFAS 157 establishes a common definition for fair value to be
applied to US GAAP requiring use of fair value, establishes a framework for
measuring fair value, and expands disclosure about such fair value measurements.
SFAS 157 is effective for fiscal years beginning after November 15,
2007.  In February 2008, the FASB issued FASB Staff Position 157-2
(“FSP 157-2”), “Partial Deferral of the Effective Date of Statement 157”.
FSP 157-2 delays the effective date of SFAS 157 to fiscal years
beginning after November 15, 2008 for all nonfinancial assets and
nonfinancial liabilities, except those that are recognized or disclosed at fair
value in the financial statements on a recurring basis (at least annually). On
October 10, 2008, the FASB staff has issued FSP 157-3 “Determining the Fair
Value of a “Financial Asset When the Market for That Asset Is Not Active.” The
Company has adopted SFAS 157 as of January 1, 2008 related to
financial assets and financial liabilities. Refer to Note 4 for additional
discussion on fair value measurements. The Company is currently evaluating the
impact of SFAS 157 related to nonfinancial assets and nonfinancial
liabilities on the Company’s financial position, results of operations and cash
flows.


- 6
-
 MICREL,
INCORPORATED
 NOTES
TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
 (Unaudited)


In
February 2007, the FASB issued Statement No. 159 (“SFAS 159”), “The
Fair Value Option for Financial Assets and Financial Liabilities -
including an amendment of FASB Statement No. 115”, which permits an entity
to measure certain financial assets and financial liabilities at fair value,
with unrealized gains and losses reported in earnings at each subsequent
measurement date. The fair value option may be elected on an
instrument-by-instrument basis, as long as it is applied to the instrument in
its entirety. The fair value option election is irrevocable, unless an event
specified in SFAS 159 occurs that results in a new election date. This
statement is effective for fiscal years beginning after November 15, 2007.
The Company adopted SFAS 159 as of January 1, 2008 and has elected not
to measure any additional financial instruments and other items at fair
value.





In
December 2007, the FASB issued Statement No. 141(R) (“SFAS 141(R)”), “Business
Combinations”, which replaces FASB Statement No. 141. SFAS 141(R) establishes
principles and requirements for how an acquirer in a business combination
recognizes and measures in its financial statements the identifiable assets
acquired, the liabilities assumed, and any controlling interest; recognizes and
measures the goodwill acquired in the business combination or a gain from a
bargain purchase; and determines what information to disclose to enable users of
the financial statements to evaluate the nature and financial effects of the
business combination. FAS 141(R) is to be applied prospectively to business
combinations for which the acquisition date is on or after an entity’s fiscal
year that begins after December 15, 2008. The Company will assess the
impact of SFAS 141(R) if and when a future acquisition occurs.





In April
2008, the FASB issued Staff Position No. FAS 142-3, Determination of the Useful
Life of Intangible Assets (“FSP FAS 142-3”). FSP FAS 142-3 amends the factors
that should be considered in developing renewal or extension assumptions used to
determine the useful life of a recognized intangible asset under SFAS
No. 142, Goodwill and Other Intangible Assets (“SFAS 142”). The intent of
FSP FAS 142-3 is to improve the consistency between the useful life of a
recognized intangible asset under SFAS 142 and the period of expected cash flows
used to measure the fair value of the asset under SFAS 141(R) and other
applicable accounting literature. FSP FAS 142-3 is effective for fiscal years
beginning after December 15, 2008. The Company is currently evaluating the
potential impact of FSP FAS 142-3 on its consolidated financial
statements.





In May
2008, the FASB issued Statement No. 162 ("SFAS 162"), "The Hierarchy of
Generally Accepted Accounting Principles". SFAS 162 identifies the sources
of accounting principles and the framework for selecting the principles used in
the preparation of financial statements. SFAS 162 is effective 60 days
following the SEC's approval of the Public Company Accounting Oversight Board
amendments to AU Section 411, "The Meaning of Present Fairly in Conformity
with Generally Accepted Accounting Principles". The Company does not expect that
this standard will have a material impact on its results of operations,
financial position or cash flows.








3.
            SHARE-BASED
      COMPENSATION





The
Company accounts for share-based compensation under the provisions of Statement
of Financial Accounting Standard No. 123 (revised 2004) ("SFAS 123R"),
“Share-Based Payment”. Share-based compensation is measured at the grant date,
based on the fair value of the award and is recognized over the employee's
requisite service period. For further details regarding the Company's
share-based compensation arrangements, refer to Note 6 of Notes to Consolidated
Financial Statements included in the Company’s Annual Report on Form 10-K for
the year ended December 31, 2007. The following table summarizes total
share-based compensation expense included in the Condensed Consolidated
Statement of Operations:


- 7
-
 MICREL,
INCORPORATED
 NOTES
TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
 (Unaudited)








Three
      Months Ended
            
            
            Nine
      Months EndedSeptember 30,
            
            
            September 30,2008
            
            
            2007
            
            
            2008
            
            
            2007Cost of
revenues
            
            $
            243
            
            
            $
            260
            
            
            $
            759
            
            
            $
            848Research and
      development
            
            
            544
            
            
            
            543
            
            
            
            1,716
            
            
            
            1,678Selling, general and
      administrative
            
            
            544
            
            
            
            564
            
            
            
            1,785
            
            
            
            1,791Pre-tax share-based compensation
      expense
            
            
            1,331
            
            
            
            1,367
            
            
            
            4,260
            
            
            
            4,317Less income tax
      effect
            
            
            (299
            )
            
            
            (276
            )
            
            
            (910
            )
            
            
            (730
            )Net share-based compensation
      expense
            
            $
            1,032
            
            
            $
            1,091
            
            
            $
            3,350
            
            
            $
            3,587





During
the three months ended September 30, 2008 and 2007, the Company granted 120,233
and 381,650 stock options, respectively, at weighted average fair values of
$4.26 and $5.35 per share, respectively. For the nine months ended September 30,
2008 and 2007, the Company granted 1,240,398 and 1,534,425 stock options,
respectively, at weighted average fair values of $3.49 and $6.11 per share,
respectively.





The fair
value of the Company’s stock options granted under the Option Plans was
estimated at the date of grant using the Black-Scholes option pricing model with
the following weighted-average assumptions:





Three
      Months Ended
            
            
            Nine
      Months EndedSeptember 30,
            
            
            September 30,2008
            
            
            2007
            
            
            2008
            
            
            2007Expected term
      (years)
            
            
            6.4
            
            
            
            5.8
            
            
            
            6.2
            
            
            
            5.9Stock
volatility
            
            
            47.5
            %
            
            
            51.0
            %
            
            
            48.3
            %
            
            
            51.7
            %Risk free interest
      rates
            
            
            3.3
            %
            
            
            4.3
            %
            
            
            3.2
            %
            
            
            4.6
            %Dividends during expected
      terms
            
            
            1.5
            %
            
            
            1.1
            %
            
            
            1.5
            %
            
            
            0.7
            %





As of
September 30, 2008, there was $15.4 million of total unrecognized share-based
compensation related to non-vested stock option awards which is expected to be
recognized over a weighted-average period of 3.6 years. Total share-based
compensation capitalized as part of inventory as of September 30, 2008 and
December 31, 2007 was $163,000 and $122,000, respectively.





4.
            INVESTMENTS





The
Company accounts for its investment instruments in accordance with Statement of
Financial Accounting Standards No. 115 (“SFAS 115”), “Accounting for
Certain Investments in Debt and Equity Securities.” Investments purchased with
remaining maturity dates of greater than three months and less than 12 months
are classified as short-term. Investments purchased with remaining maturity
dates of 12 months or greater are classified either as short-term or as
long-term based on maturities and the Company's intent with regards to those
securities (expectations of sales and redemptions). Short-term investments as of
September 30, 2008 consist primarily of liquid corporate debt instruments and
are classified as available-for-sale securities. Long-term investments as of
September 30, 2008, consist of senior auction rate notes secured by student
loans and are classified as available-for-sale securities.  Per SFAS
115 available-for sale securities are stated at market value with unrealized
gains and losses included in shareholders’ equity. Unrealized losses are charged
against income when a decline in the fair market value of an individual security
is determined to be other than temporary. Realized gains and losses on
investments are included in other income or expense.


- 8
-
 MICREL,
INCORPORATED
 NOTES
TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
 (Unaudited)





The
Company adopted SFAS 157, “Fair Value Measurements” as of January 1, 2008
to measure the fair value of certain of its financial assets required to be
measured on a recurring basis. Under SFAS 157, based on the observability
of the inputs used in the valuation techniques, the Company is required to
provide the following information according to the fair value hierarchy. The
fair value hierarchy ranks the quality and reliability of the information used
to determine fair values. Financial assets and liabilities carried at fair value
will be classified and disclosed in one of the following three
categories:


•
            Level
      1 - Quoted prices in active markets for identical assets or
      liabilities.


•
            Level
      2 - Inputs other than Level 1 that are observable, either directly or
      indirectly, such as quoted prices for similar assets or liabilities;
      quoted prices in markets that are not active; or other inputs that are
      observable or can be corroborated by observable market data for
      substantially the full term of the assets or
  liabilities.


•
            Level
      3 - Unobservable inputs that are supported by little or no market activity
      and that are significant to the fair value of the assets or
      liabilities.





The
following table represents the Company’s fair value hierarchy for its financial
assets (cash equivalents and investments) measured at fair value on a recurring
basis as of September 30, 2008 (in thousands):





Fair Value Measurements as of September 30,
      2008Description
            
            Quoted
      Prices in Active Markets for Identical Assets
              Level 1
            
            
            Significant
      Other Observable Inputs
              Level 2
            
            
            Significant
      Unobservable Inputs
              Level 3
            
            
            TotalMoney
      market funds
            
            $
            68,471
            
            
            $
            4,438
            
            
            $
            −
            
            
            $
            72,909Short-term
      available-for-sale securities
            
            
            4,951
            
            
            
            −
            
            
            
            −
            
            
            
            4,951Auction
      rate notes
            
            
            −
            
            
            
            −
            
            
            
            13,453
            
            
            
            13,453Total
            
            $
            73,422
            
            
            $
            4,438
            
            
            $
            13,453
            
            
            $
            91,313





As of
September 30, 2008, the Company had $13.5 million of auction rate notes, the
fair value of which has been measured using Level 3 inputs. Auction rate notes
are securities that are structured with short-term interest rate reset dates of
generally less than ninety days, but with contractual maturities that can be
well in excess of ten years. At the end of each reset period, which occurs every
seven or twenty eight days for the securities held by the Company, investors can
sell or continue to hold the securities at par. During the first quarter of 2008
and continuing into the third quarter of 2008, the auction rate securities
market experienced a significant increase in the number of failed auctions,
which occurs when sell orders exceed buy orders. Auctions for the student
loan-backed notes held by the Company have failed as of September 30, 2008. To
date we have collected all interest payable on all of our auction-rate
securities when due and expect to continue to do so in the future. The
principal associated with failed auctions will not be accessible until a
successful auction occurs, a buyer is found outside of the auction process, the
issuers redeem the securities, issuers repay principal over time from cash flows
prior to final maturity or final payments come due according to contractual
maturities ranging from 24 to 37 years.  As a result, the Company has
classified all auction rate notes as long-term investments as of September 30,
2008. In the event of a failed auction, the notes bear interest at a
predetermined maximum rate based on the credit rating of notes as determined by
one or more nationally recognized statistical rating
organizations.  For the auction rate notes held by the Company as of
September 30, 2008, the maximum interest rate is generally one month LIBOR plus
1.5% based on the notes’ AAA rating as of that date.  The auction rate
notes in the Company’s portfolio had successful auctions until February 2008 and
as such, their fair value would have been measured using level 1 inputs at
January 1, 2008.  However, since auctions have failed as of
September 30, 2008, for all auction rate notes held by the Company, the auction
rate notes have been transferred from Level 1 to Level 3 category as of
September 30, 2008.


- 9
-
 MICREL,
INCORPORATED
 NOTES
TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
 (Unaudited)





The
Company has used a combination of discounted cash flow and direct discounted
cash flow model to determine the estimated fair value of its investment in
auction rate notes as of September 30, 2008. The assumptions used in preparing
the discounted cash flow model include estimates for interest rates; estimates
for discount rates using yields of comparable traded instruments adjusted for
illiquidity and other risk factors, amount of cash flows and expected holding
periods of the auction rate notes.  Based on this assessment of fair
value, as of September 30, 2008, the Company determined there was a decline in
the fair value of its auction rate notes of approximately $2.9 million (recorded
net of tax as an unrealized loss in accumulated other comprehensive income),
which was deemed temporary as the Company currently has the ability and intent
to hold these investments until a recovery of the auction process occurs, the
issuers redeem the securities or principal is repaid by the issuers over time or
at the contractual maturity date.





Fair
      Value Measurements Using Significant Unobservable Inputs
              (Level 3)Beginning
      balance, December 31, 2007
            
            $
            −Transfers
      in and/or out of Level 3
            
            
            16,517Total
      gains or losses (realized/unrealized), before tax:Included in other comprehensive
      income
            
            
            (2,914
            )Purchases,
      issuances, and settlements
            
            
            (150
            )Ending
      balance, September 30, 2008
            
            $
            13,453




5.
            INVENTORIES





Inventories
consist of the following (in thousands):


September 30,
            
            
            December 31,2008
            
            
            2007Finished goods
            
            $
            13,029
            
            
            $
            14,261Work in process
            
            
            21,202
            
            
            
            19,439Raw materials
            
            
            2,252
            
            
            
            1,960$
            36,483
            
            
            $
            35,660




6.
            PROPERTY,
      PLANT AND EQUIPMENT





Property,
      plant and equipment at September 30, 2008 consist of the following (in
      thousands):


September 30,
            
            
            December 31,2008
            
            
            2007Manufacturing
      equipment
            
            $
            186,883
            
            
            $
            181,421Land
            
            
            6,636
            
            
            
            6,636Buildings and
      improvements
            
            
            47,269
            
            
            
            46,876Leasehold
      Improvements
            
            
            726
            
            
            
            638Office
      furniture and research
            
            
            14,542
            
            
            
            12,544256,056
            
            
            
            248,115Accumulated
      depreciation
            
            
            (177,581
            )
            
            
            (165,530
            )$
            78,475
            
            
            $
            82,585





Depreciation
      expense at September 30, 2008 and December 31, 2007 was $ 12.0 million and
      $16.3 million, respectively.


- 10
-
 MICREL,
INCORPORATED
 NOTES
TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
 (Unaudited)





7.
            INTANGIBLE
      ASSETS





Components
of intangible assets were as follows (in thousands):


As of September 30, 2008
            
            
            As of December 31,
2007Gross
              Carrying
              Amount
            
            
            Accumulated
              Amortization
            
            
            Net
              Carrying
              Amount
            
            
            Gross
              Carrying
              Amount
            
            
            Accumulated
              Amortization
            
            
            Net
              Carrying
              AmountDeveloped and core
      technology
            
            $
            8,718
            
            
            $
            8,551
            
            
            $
            167
            
            
            $
            8,718
            
            
            $
            8,349
            
            
            $
            369Patents and trade
      name
            
            
            10,318
            
            
            
            8,725
            
            
            
            1,593
            
            
            
            10,318
            
            
            
            7,661
            
            
            
            2,657Customer
      relationships
            
            
            1,455
            
            
            
            1,455
            
            
            
            --
            
            
            
            1,455
            
            
            
            1,455
            
            
            
            --$
            20,491
            
            
            $
            18,731
            
            
            $
            1,760
            
            
            $
            20,491
            
            
            $
            17,465
            
            
            $
            3,026





Acquired
technology, patents and other intangible assets continue to be amortized over
their estimated useful lives of 3 to 7 years using the straight-line method.
Total intangible amortization expense for the three and nine month periods ended
September 30, 2008 was $0.4 million and $1.3 million
respectively.  Total intangible amortization expense for the three and
nine month periods ended September 30, 2007 was $0.4 million and $1.3 million
respectively.





The
estimated future amortization expense of intangible assets as of September 30,
2008 was as follows (in thousands):





Year Ending
      December 31,2008 (three
    months)
            
            $
            4222009
            
            
            8282010
            
            
            2552011
            
            
            255Thereafter
            
            
            -$
            1,760





- 11
-
 MICREL,
INCORPORATED
 NOTES
TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
 (Unaudited)





8.
            OTHER
      CURRENT LIABILITIES





Other
current liabilities consist of the following (in thousands):





September
      30,
            
            
            December 31,2008
            
            
            2007Current portion of
      restructuring expenses (Note 17)
            
            $
            -
            
            
            $
            1,787Accrued workers compensation
      and health insurance
            
            
            959
            
            
            
            1,121Accrued
      compensation
            
            
            5,960
            
            
            
            8,579Accrued
    commissions
            
            
            3,099
            
            
            
            1,993All other current accrued
      liabilities
            
            
            627
            
            
            
            617Total other current
      liabilities
            
            $
            10,645
            
            
            $
            14,097








9.
            BORROWING
      ARRANGEMENTS





Borrowing
arrangements consist of a $6 million revolving line of credit from a commercial
bank.  The revolving line of credit agreement includes a provision for
the issuance of commercial or standby letters of credit by the bank on behalf of
the Company.  The value of all letters of credit outstanding reduces
the total line of credit available.  There were no borrowings under
the revolving line of credit at September 30, 2008, and there were $325,000 in
standby letters of credit outstanding.  The revolving line of credit
agreement has been extended to June 20, 2010.  Borrowings under
the revolving line of credit bear interest rates of, at the Company's election,
the prime rate (5.0% at September 30, 2008), or the bank's revolving offshore
rate, which approximates LIBOR plus 2% (4.0525% at September 30, 2008). The
agreement contains certain restrictive covenants. The Company was in compliance
with all such covenants at September 30, 2008.








10.
            SIGNIFICANT
      CUSTOMERS





During
the nine months ended September 30, 2008, no original equipment manufacturer
accounted for more than 10% of net revenues and two worldwide distributors
accounted for $30.3 million (15%) and $29.4 million (14%) of net revenues,
respectively. During the nine months ended September 30, 2007, the same two
worldwide distributors accounted for $31.7 million (16%) and $24.6 million (13%)
of net revenues, respectively.





As of
September 30, 2008, two worldwide distributors each accounted for 20% of net
total accounts receivable. At December 31, 2007, two worldwide distributors
and an Asian based stocking representative, accounted for 18%, 10% and 15%,
respectively, of total accounts receivable








11.
            COMPREHENSIVE
      INCOME





Comprehensive
income, which was comprised of the Company's net income for the periods and
changes in unrealized gains or losses on investments, net of tax, was $8.1
million and $22.3 million for the three and nine months ended September 30,
2008, respectively. Comprehensive income for the three and nine months ended
September 30, 2008 includes an unrecognized loss on available-for-sale auction
rate notes, net of tax, of $351,000 and $1.8 million, respectively (see
Note 4). Comprehensive income for the three and nine months ended September
30, 2007 was $9.4 million and $35.9 million, respectively





- 12
-
 MICREL,
INCORPORATED
 NOTES
TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
 (Unaudited)





12.
            SEGMENT
      REPORTING





The
Company follows the provisions of SFAS No. 131, Disclosures about Segments of an
Enterprise and Related Information. SFAS No. 131 establishes standards for
reporting information regarding operating segments in annual financial
statements and requires selected information for those segments to be presented
in interim financial reports issued to stockholders. SFAS No. 131 also
establishes standards for related disclosures about products and services and
geographic areas. Operating segments are identified as components of an
enterprise about which separate discrete financial information is available for
evaluation by the chief operating decision maker. The Company has two reportable
segments: standard products and other products, which consist primarily of
custom and foundry products and revenues from the license of patents. The chief
operating decision maker evaluates segment performance based on revenue.
Accordingly, all expenses are considered corporate level activities and are not
allocated to segments. Therefore, it is not practical to show profit or loss by
reportable segments. Also, the chief operating decision maker does not assign
assets to these segments. Consequently, it is not relevant to show assets by
reportable segments.





Net Revenues by
      Segment
            
            Three
      Months Ended
            
            
            Nine
      Months Ended(dollars in
      thousands)
            
            September 30,
            
            
            September 30,2008
            
            
            2007
            
            
            2008
            
            
            2007Net Revenues:Standard
    Products
            
            $
            64,575
            
            
            $
            59,522
            
            
            $
            192,886
            
            
            $
            177,719Other Products
            
            
            2,974
            
            
            
            5,669
            
            
            
            11,308
            
            
            
            15,686Total net
revenues
            
            $
            67,549
            
            
            $
            65,191
            
            
            $
            204,194
            
            
            $
            193,405As a Percentage of Total Net
      Revenues:Standard
    Products
            
            
            96
            %
            
            
            91
            %
            
            
            94
            %
            
            
            92
            %Other Products
            
            
            4
            %
            
            
            9
            %
            
            
            6
            %
            
            
            8
            %Total net
revenues
            
            
            100
            %
            
            
            100
            %
            
            
            100
            %
            
            
            100
            %








13.
            LITIGATION
      AND OTHER CONTINGENCIES





The
Company is currently not involved in any litigation. The following summarizes
resolved litigation that had an impact on prior financial results.





On
December 27, 2002, the Company filed a complaint against TRW, Inc. (“TRW”)
entitled Micrel, Incorporated v. TRW, Inc., dba TRW Automotive Electronics
Group, in the United States District Court, Northern District of Ohio, Eastern
Division, alleging various causes of action relating to breach of a relationship
surrounding the development of certain custom products by Micrel for
TRW.  The complaint sought compensatory damages, attorneys’ fees and
costs associated with the suit.  On February 24, 2003, TRW filed
an answer to the Company’s complaint and a counterclaim alleging various causes
of action relating to breach of the above-mentioned relationship concerning ASIC
development.  On July 22, 2005, a jury ruled against the Company
and in favor of TRW in its counterclaim against Micrel, resulting in a judgment
on July 26, 2005 awarding damages for the benefit of TRW in the amount of
$9.3 million.  The damages amount was accrued in other current
liabilities in the Company’s second quarter 2005 financial
statements.  On January 13, 2006, the Company filed a notice of
its intent to appeal the jury’s verdict and on October 24, 2006, filed an
appeal brief in the United States District Court, Northern District of
Ohio.  On May 4, 2007, the Court of Appeals issued its ruling
affirming the jury’s verdict.  During the quarter ended June 30,
2007, the Company paid TRW the legal judgment for total damages and interest in
the amount of $10.2 million.


- 13
-
 MICREL,
INCORPORATED
 NOTES
TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
 (Unaudited)





On
April 21, 2003, the Company filed a complaint against its former
independent public accountants Deloitte & Touche LLP (“Deloitte”) entitled
Micrel, Incorporated v. Deloitte & Touche LLP in the Superior Court of the
State of California, County of Santa Clara, alleging various causes of action
relating to certain professional advice received by Micrel from
Deloitte.  The complaint sought compensatory damages, costs associated
with the suit and such other relief that the court may deem just and
proper.  Deloitte denied all allegations in the
complaint.  On February 23, 2007, the parties entered into a
Settlement Agreement and Mutual Releases. Under the terms of the Agreement, the
parties agreed to dismiss with prejudice the pending litigation and Deloitte
paid to Micrel a settlement amount of $15.5 million. The Company recorded the
$15.5 million settlement amount, in the quarter ended March 31, 2007, as
other non-operating income as the settlement payment did not represent, either
directly or indirectly, income earned from the Company’s operations, nor did it
represent reimbursement of operating expenses incurred.





On
June 9, 2006, Deerfield 3250 Scott, LLC ("Deerfield"), the building owner
of Micrel's Santa Clara Wafer Fab facility which was closed in 2003, filed a
complaint against the Company entitled "Deerfield 3250 Scott, LLC vs. Micrel,
Inc. et al" in the Superior Court of the State of California, County of Santa
Clara.  In February 2006, Micrel terminated this building lease under the
terms of the lease agreement due to major vandalism rendering the building
unusable.  Deerfield disputes that Micrel had a right to terminate,
alleging that the vandalism took place because of the negligence of Micrel and
that Micrel should not be able to benefit from its own negligence.  The
complaint sought damages in an unspecified amount for rent through the remaining
term of the lease (from March 1 through October 31, 2006), alleged
damages to the premises, and for wrongful removal of equipment.   On
July 21, 2006, Micrel answered the complaint with a denial of any liability and
the filing of a cross-complaint against Deerfield seeking return of the security
deposit and rent paid from the date of the casualty, January 20, 2006
through February 28, 2006.  On February 13, 2008, the parties
participated in a mediation session.  Ultimately, on March 5,
2008, the Company and Deerfield entered into a Settlement Agreement, agreeing to
dismiss with prejudice all claims and counterclaims in the litigation. 
Under the terms of the Agreement, the Company paid Deerfield $875,000 in the
first quarter of 2008. The payment to Deerfield reduced previously accrued
restructuring expenses (see Note 17).





With the
exception of the previously recorded operating expenses, the Company believes it
is not reasonably possible that an unrecorded material loss has been
incurred.  Generally, litigation is subject to inherent uncertainties,
and no assurance can be given that the Company will prevail in any particular
lawsuit.  Accordingly, the pending lawsuits, as well as potential
future litigation with other companies, could result in substantial costs and
diversion of resources and could have a material adverse effect on the Company’s
financial condition, results of operations or cash flows.





Additional
claims have been filed by or have arisen against the Company in its normal
course of business.  The Company believes that the ultimate resolution
of these claims and lawsuits will not have a material adverse effect on the
Company's financial condition, results of operations or cash flows.








14.
            SHARE
      REPURCHASE PROGRAM





On
October 22, 2007, the Company's Board of Directors approved a $50 million
share repurchase program for calendar year 2008. On October 1, 2008, the Board
of Directors approved the addition of $10 million to the total amount that maybe
spent under the 2008 share repurchase program. Repurchases may occur from time
to time in the open market or in privately negotiated transactions through
December 31, 2008. During the nine months ended September 30, 2008, the
Company repurchased 4,660,647 shares of its common stock for $36.0
million.





Share
repurchases are recorded as a reduction of common stock to the extent available.
Any amounts in excess of common stock are recorded as a reduction of retained
earnings.





- 14
-
 MICREL,
INCORPORATED
 NOTES
TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
 (Unaudited)





15.
            SHAREHOLDER
      RIGHTS PLAN





The
Company has adopted a limited duration Shareholder Rights Plan (the “Rights
Plan”). The Rights Plan is designed to ensure that all of the Company’s
shareholders receive fair and equal treatment in the event of any unsolicited
takeover of the Company and to protect shareholders from partial tender offers,
open market accumulations and other abusive or coercive tactics to gain control
of the Company without offering an adequate price to all shareholders. The
Rights Plan is not intended to prevent a takeover, but rather to encourage
anyone seeking to acquire the Company to negotiate with the Board of Directors
prior to attempting a takeover. The Rights Plan is intended to enable all of the
Company’s shareholders to realize the long-term value of their investment in the
Company.





As a
result of the Board’s adoption of the Rights Plan, one preferred stock purchase
right was distributed as a dividend on each common share held of record as of
the close of business on April 15, 2008 (a “Right”). Each Right, if and
when it becomes exercisable, entitles the holder to buy one one-thousandth of a
share of a new series of participating preferred stock for $36.00.





Initially
the rights will be represented by the Company’s Common Stock certificates and
will not be exercisable. If any person or group becomes the beneficial owner of
15% or more of Micrel’s Common Stock (which includes for this purpose stock
referenced in derivative transactions and securities) at any time after the
March 24, 2008 date of adoption of the Rights Plan (with certain limited
exceptions including the result of an acquisition of Common Shares by the
Company which, by reducing the number of shares outstanding, increases the
proportionate number of shares beneficially owned by such person or group to 15%
or more of the Common Shares of the Company then outstanding) or if any
additional such securities are acquired in the case or a person or group that
owned 15% or more of such securities as of the date of adoption of the Rights
Plan (an “Acquiring Person”), then each Right not owned by such Acquiring Person
will entitle its holder to purchase, at the Right’s then-current exercise price,
shares of Common Stock having a market value of twice the Right’s then-current
exercise price. In addition, if, after any person has become an Acquiring
Person, the Company is involved in a merger or other business combination
transaction with another person, each Right will entitle its holder (other than
such Acquiring Person) to purchase, at the Right’s then-current exercise price,
common shares of the acquiring company having a value of twice the Right’s
then-current exercise price.





The
Company may redeem the Rights at a price of $.01 per Right at any time prior to
the date on which any person has become an Acquiring Person. The Rights Plan
will continue in effect until the close of business March 24, 2009, unless
earlier redeemed or terminated by Micrel, as provided in the Rights
Plan.








16.
            PROXY
      CONTEST EXPENSE





During
the first quarter of 2008, the Company became engaged in its first proxy contest
since going public in 1994, with a small activist hedge fund, Obrem Capital
Management LLC (“OCM”).  This issue resulted in Micrel incurring
incremental expenses on this matter of $330,000 during the first quarter, $2.7
million in the second quarter and additional $16,000 in the third quarter of
2008. These expenses consist primarily of outside consulting and legal
fees.  Subsequent to a special meeting of shareholders on May 20,
2008, at which the Company’s shareholders rejected all proposals set forth by
OCM. Micrel announced on July 9, 2008 that OCM had agreed to withdraw its slate
of nominees for the board of directors, and support Micrel’s board nominees at
the upcoming annual meeting of shareholders. Micrel’s slate of directors was
subsequently elected by shareholders at the Company’s annual meeting on October
1. 2008.


- 15
-
 MICREL,
INCORPORATED
 NOTES
TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
 (Unaudited)





17.
            INCOME
      TAXES





The
income tax provision for the three and nine months ended September 30, 2008, as
a percentage of income before taxes, was 36.6% and 36.1%, respectively, compared
to 35.1% and 35.9%, respectively, for the same periods in the prior year. 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.





As of
September 30, 2008, the gross liability for uncertain tax positions was $8.2
million, as compared to $8.0 million as of December 31, 2007. The net
liability as of September 30, 2008, reduced for the federal effects of potential
state tax exposures, was $5.8 million as compared to $5.4 million as of
December 31, 2007. If these uncertain tax positions are sustained upon tax
authority audit, or otherwise become certain, the net $5.8 million would
favorably affect the Company’s tax provision in such future
periods.  Included in the $5.8 million is $2.2 million which has not
yet reduced income tax payments, and, therefore, has been netted against
non-current deferred tax assets.  The remaining $3.6 million liability
is included in long-term income taxes payable. The Company does not anticipate a
significant change to the net liability for uncertain income tax positions
within the next 12 months.





The Company continues to recognize
interest and penalties related to income tax matters as part of the income tax
provision. As of September 30, 2008 and December 31, 2007, the Company had
$355,000 and $251,000, respectively, accrued for interest and $0 accrued for
penalties for both periods. These accruals are included as a component of
long-term income taxes payable.





The
Company is required to file U.S. federal income tax returns as well as income
tax returns in various states and foreign jurisdictions. The Company may be
subject to examination by the Internal Revenue Service (“IRS”) for calendar
years 2003 and forward. Significant state tax jurisdictions include California,
New York and Texas, and generally, the Company is subject to routine examination
for years 2002 and forward in these jurisdictions. In addition, any research and
development credit carryforwards that were generated in prior years and utilized
in these years may also be subject to examination by respective state taxing
authorities. Generally, the Company is subject to routine examination for years
2001 and forward in various immaterial foreign tax jurisdictions in which it
operates.





Deferred
tax assets and liabilities result primarily from temporary differences between
book and tax bases of assets and liabilities, state and federal research and
development credit carryforwards and state manufacturers credit
carryforwards.  The Company had net current deferred tax assets of
$19.6 million and net long-term deferred tax assets of $10.4 million as of
September 30, 2008.  The Company must regularly assess the likelihood
that future taxable income levels will be sufficient to ultimately realize the
tax benefits of these deferred tax assets.  The Company currently
believes that future taxable income levels will be sufficient to realize the tax
benefits of these deferred tax assets and has not established a valuation
allowance.  Should the Company determine that future realization of
these tax benefits is not likely, a valuation allowance would be established,
which would increase the Company's tax provision in the period of such
determination.





- 16
-
 MICREL,
INCORPORATED
 NOTES
TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
 (Unaudited)





18.
            RESTRUCTURING
      AND MANUFACTURING FACILITY
IMPAIRMENT





During
2003 the Company closed its Santa Clara wafer fabrication facility. In February
2006, the Company terminated the facility lease under the terms of the lease
agreement due to major vandalism rendering the building unusable.  The
facility Lessor disputed the termination of the lease.  In March 2008,
the Company entered into a Settlement and Mutual Release agreement with the
Lessor. Under the terms of the agreement, the Company paid $875,000 to the
Lessor and released a $70,000 security deposit for full settlement of all
obligations under the lease (see Note 12).  The remaining unused
restructuring expense accruals were credited to restructuring charges (credits)
in the statement of operations during the first quarter of 2008. A summary of
restructuring expense accruals associated with this facility closure is as
follows: ($000)





Contractual
      Facility Costs
            
            
            Other
              Disposal
              Costs
            
            
            TotalBalance December 31,
      2005
            
            $
            1,399
            
            
            $
            360
            
            
            $
            1,7592006Charges
            
            
            117
            
            
            
            152
            
            
            
            2692006Uses
            
            
            (259
            )
            
            
            (195
            )
            
            
            (454
            )Balance December 31,
      2006
            
            
            1,257
            
            
            
            317
            
            
            
            1,5742007Charges
            
            
            128
            
            
            
            --
            
            
            
            1282007Other
            
            
            85
            
            
            
            --
            
            
            
            85Balance December 31,
      2007
            
            
            1,470
            
            
            
            317
            
            
            
            1,7872008Uses
            
            
            (945
            )
            
            
            --
            
            
            
            (945
            )2008Other
      reductions
            
            
            (525
            )
            
            
            (317
            )
            
            
            (842
            )Balance September 30,
      2008
            
            $
            --
            
            
            $
            --
            
            
            $
            --








19.
            DIVIDENDS





On July
24, 2008 the Company’s Board of Directors declared a cash dividend of $0.035 per
outstanding share of common stock. The payment of $2.5 million was made on
August 21, 2008, to shareholders of record at the close of business on August 5,
2008. During the first and second quarters of 2008, the Company paid cash
dividends of $2.2 million ($0.03 per outstanding share) and $2.5 million ($0.035
per outstanding share), respectively.





20.
            SUBSEQUENT
      EVENT





Richard
D. Crowley resigned effective October 10, 2008 as Vice President of Finance
& Chief Financial Officer. Robert J Barker, Micrel’s Vice President,
Corporate Business Development & Human Resources has assumed the
responsibilities of Chief Financial Officer on an interim basis effective
October 11, 2008.  Mr. Barker previously held the position of Vice
President of Finance and Chief Financial Officer at Micrel from 1994 to
1999.




On
October 27, 2008 the Company's Board of Directors declared a quarterly cash
dividend of $0.035 per outstanding share of common stock payable on November 19,
2008, to shareholders of record at the close of business on November 5,
2008.





On
October 1, 2008, the Board of Directors of Micrel has authorized additional $10
million to repurchase the Company’s common stocks in the open market as part of
the Company’s 2008 share repurchase program previously authorized by the
Board.





- 17
-
 ITEM
      2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
      OF OPERATIONS





Overview





The statements contained in this
Report on Form 10-Q that are not purely historical are forward-looking
statements within the meaning of Section 27A of the Securities Act of 1933 and
Section 21E of the Securities Exchange Act of 1934, as amended,including statements regarding the
Company’s expectations, hopes, intentions or strategies regarding the
future.  Forward-looking statements include, but are not limited to
statements regarding: future revenues and dependence on standard products sales
and international sales; the levels of international sales; the effect of global
market conditions on revenue levels, profitability and results of operations:
future products or product development; statements regarding fluctuations in the
Company’s results of operations; future returns and price adjustments and
allowance; future uncollectible amounts and doubtful accounts allowance; future
products or product development; future research and development spending and
the Company’s product development strategy; the Company’s markets, product
features and performance; product demand and inventory to service such demand;
competitive threats and pricing pressure; the effect of dependence on third
parties; the Company’s future use and protection of its intellectual property;
future expansion or utilization of manufacturing capacity; future expenditures;
current or future acquisitions; the ability to meet anticipated short term and
long term cash requirements; effect of changes in market interest rates on
investments; the Company’s need and ability to attract and retain certain
personnel; the cost and outcome of litigation and its effect on the Company; the
future realization of tax benefits; and share based incentive awards and
expectations regarding future stock based compensation expense and estimates
made under SFAS No. 123R. In some cases, forward-looking statements can be
identified by the use of forward-looking terminology such as "believe,"
"estimate," "may," "can," "will," "could," "would," "intend," "objective,"
"plan," "expect," "likely," "potential," "possible" or "anticipate" or the
negative of these terms or other comparable terminology. All forward-looking
statements included in this document are based on information available to the
Company on the date of this report, and the Company assumes no obligation to
update any such forward-looking statements ,including those risks discussed
under” Risks Factors” and elsewhere in this document. These statements are
subject to risks and uncertainties that could cause actual results and events to
differ materially from those expressed or implied by such forward-looking
statements.  Additional factors that may affect operating results are
contained within the Company's Form 10-K for the year ended December 31,
2007.





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 quarterly periods from January 1, 2007 through
September 30, 2008 has been provided.





During the first quarter of 2007,
customers controlled 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 2007 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.  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.


- 18
-
 MANAGEMENT'S
DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
(CONTINUED)





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.





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 slowly 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.  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.





In 2007 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.


- 19
-
 MANAGEMENT'S
DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
(CONTINUED)


In the first quarter of 2008, bookings
levels rebounded from the fourth quarter of 2007, resulting in the highest
quarterly booking level since Q1 2006 and a book-to-bill ratio significantly
above one.  First quarter revenues of $66.1 million increased 2%
sequentially compared to fourth quarter 2007 revenues of $64.6 million and
increased 5% compared to revenues of $63.1 million recorded in the year-ago
period.  The increase in revenues was primarily due to stronger demand
from the wire line communications, digital TV, industrial and voice-over-IP end
markets, which offset seasonal declines in sales to the computing and wireless
handset end markets.  Revenues through Micrel’s sell-through
distributors increased in the first quarter and the number of weeks of
distribution channel inventory decreased slightly on a sequential
basis.  Gross margin improved to 56.5% in the first quarter of 2008
from 55.8% in the fourth quarter of 2007 while at the same time inventory levels
were reduced.  First quarter operating profit was $11.8 million, or
18% of revenues. Earnings per diluted share for the first quarter of 2008
increased to $0.12 per share from $0.11 per share reported in the fourth quarter
of 2007.





During
the first quarter of 2008, the Company became engaged in its first proxy contest
since going public in 1994, with a small activist hedge fund, Obrem Capital
Management LLC (“OCM”). This issue resulted in Micrel incurring incremental
operating expenses on this matter of $330,000 during the first quarter, $2.7
million in the second quarter, and $16,000 in the third quarter of 2008.See Proxy ContestExpense in
the Results of Operations section in Management Discussions and Analysis of
Financial Conditions and Results of Operations.





In the
second quarter of 2008, total bookings remained firm, resulting in a
book-to-bill ratio above one.  Second quarter bookings were paced by
demand from customers serving the communications, industrial, and wireless
handset end markets.  Customers remained very cautious, which
continued to keep order lead times in the 4 to 5 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 were 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 wi-fi voice-over-IP end markets,
combined with record sales through the Company’s global sell-through
distributors.  The turns fill percentage for the second quarter was a
little over 50%.  Gross margin was 56.4%, about the same as the first
quarter of 2008.  Second quarter operating profit was $10.8 million,
or 15% of sales.  A total of $2.7 million of proxy contest expenses
reduced Micrel’s operating income by approximately 20% in the second quarter,
and also had the effect of reducing operating margin by approximately 4% in the
second quarter.  Second quarter 2008 net income was $7.2 million, or
$0.10 per diluted share.  This compares with first quarter 2008 net
income of $8.4 million, or $0.12 per diluted share, and net income of $8.6
million or $0.11 per diluted share in the year ago period.  Expenses
related to the Company’s proxy contest reduced net income by $0.023 per share in
the second quarter.





During
the third quarter of 2008, total bookings were less than revenues, resulting in
book-to-bill ratio less than one. Third quarter bookings decreased abruptly in
the last two weeks of the quarter. Notwithstanding the order decrease, resales
of the Company’s products from global sell-through distributors remained strong
throughout the quarter and represented an all-time record for the Company. In
the third quarter, Micrel posted $67.5 million in revenue, a decrease of 4%
sequentially and an increase of 4% from third quarter of 2007.The sequential
quarter decrease in sales primarily resulted from reduced demand from customers
serving the wireline communications, Wi-FI voice-over IP and foundry sales to a
major solar end customer. This was offset by slight increases in the computer
and consumer markets. The OEM turns fill percentage for the third quarter was
approximately 50%. Standard product sales accounted for 96% of total Q3
revenues, with foundry and custom product sales comprising 4%. The wireline
communications market made up 26% of third quarter sales down from 28% in second
quarter. Sales to the computer market increased sequentially by 3 percentage
points to 16% of sales. Sales to the wireless handset end market decrease
slightly from 19% in Q2 to 18% in Q3. Consumer/military sales increased 1
percentage point sequentially to 5% of third quarter sales. Foundry sales
decreased $0.5million to $2.0 million but remained constant as a percent of
overall sales at 3%. Third quarter gross margin was 56%, about the same as Q2.
Research and development spending was $13.8 million, or 20% of revenues in the
third quarter compared to $14.8 million or 21% of revenues in the second
quarter. Selling, general and administrative expenses were $11.3 million, or 17%
of sales. This is down from $11.6 million in the second quarter. GAAP operating
income was $12.7 million, or 19% of sales. This compares to operating income of
$10.8 million in the second quarter and $12.9 million in the year ago period.
Other income, net was unchanged quarter to quarter at $700 thousand. The
effective tax rate was 36.6 % for the third quarter. Third quarter net income
was $8.5 million, or $0.12 per diluted share. This compares with second quarter
GAAP net income of $7.2 million, or $0.10 per diluted share, and GAAP net income
of $9.4 million or $0.12 per diluted share in the year ago.




- 20
-
 
 MANAGEMENT'S
DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
(CONTINUED)







The
Company derives a substantial portion of its net revenues from standard
products.  For the three and nine month periods ended September 30,
2008 the Company's standard products sales accounted for 96% and 94%, of the
Company's net revenues, respectively. For the three and nine month periods ended
September 30, 2007 the Company's standard products sales accounted for 91% and
92% of the Company's net revenue, respectively.  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 current macroeconomic turmoil (see
ITEM 1A. RISK FACTORS, below) has resulted in a slowing of orders from Micrel’s
distributors and direct OEM customers, which has caused the Company to lower its
revenue expectations. We are unable to predict the likely duration and severity
of the current disruption in financial markets and adverse economic conditions
in the U.S. and other countries and such conditions, if they persist, will
continue to adversely impact our revenues and profitability. In addition, the
semiconductor industry has traditionally been highly cyclical and has often
experienced significant downturns in connection with, or in anticipation of,
declines in general economic conditions.






The
Company is taking measures to reduce its overall cost structure, including
implementing a shutdown of nine working days during the fourth quarter
among other cost cutting efforts. Micrel believes that these current cost
cutting activities coupled with the significant cost reductions the Company
began implementing in the second quarter of 2008 will reduce the effects of the
economic slowdown on profitability. However, the Company expects demand in the
semiconductor industry in general and for its products to continue to remain
weak until global economic conditions improve, which may adversely impact
revenues and profitability.







The Company may experience significant
fluctuations in its results of operations.  In addition to the
macroeconomic conditions described above, other 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 “Risk
Factors”.  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, and results of
operations or cash flows.








- 21
-
 
 MANAGEMENT'S
DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
(CONTINUED)





Critical
Accounting Policies and Estimates





The financial statements included in
this Form 10-Q and discussed within this Management's Discussion and Analysis of
Financial Condition and Results of Operations have been prepared in accordance
with accounting principles generally accepted in the United States of America.
Preparation of these financial statements requires management to make estimates
and assumptions that affect the reported amounts of assets and liabilities at
the date of the financial statements and the reported amounts of revenues and
expenses during the reporting period. On an on-going basis, management evaluates
its estimates and judgments. Management bases its estimates and judgments on
historical experience and on various other assumptions that are believed to be
reasonable under the circumstances, the results of which form the basis for
making judgments about the carrying values of assets and liabilities that are
not readily apparent from other sources. Actual results may differ from these
estimates under different assumptions or conditions. The Company considers
certain accounting policies related to revenue recognition and valuation of
receivables, inventory valuation, share-based compensation, income taxes, and
litigation to be critical to the fair presentation of its financial statements.
For a detailed discussion of the Company's significant accounting policies, see
Note 1 of Notes to Consolidated Financial Statements in Item 8 of the Company's
Annual Report on Form 10-K for the year ended December 31,
2007.





Revenue Recognition and
Receivables. Micrel generates revenue by selling products to OEM's,
distributors and stocking representatives.  Stocking representative
firms may buy and stock the Company's products for resale or may act as the
Company's sales representative in arranging for direct sales from the Company to
an OEM customer.  The Company's policy is to recognize revenue from
sales to customers when the rights and risks of ownership have passed to the
customer, when persuasive evidence of an arrangement exists, the product has
been delivered, the price is fixed or determinable and collection of the
resulting receivable is reasonably assured.





Micrel allows certain distributors
located in North America and Europe, and in certain countries in Asia,
significant return rights, price protection and pricing adjustments subsequent
to the initial product shipment.  As these returns and price
concessions have historically been significant, and future returns and price
concessions are difficult to reliably estimate, the Company defers recognition
of revenue and related cost of sales (in the balance sheet line item “deferred
income on shipments to distributors”) derived from sales to these distributors
until they have resold the Company's products to their customers. Although
revenue recognition and related cost of sales are deferred, the Company records
an accounts receivable and relieves inventory at the time of initial product
shipment. As standard terms are FOB shipping point, payment terms are enforced
from shipment date and legal title and risk of inventory loss passes to the
distributor upon shipment. In addition, where revenue is deferred upon shipment
and recognized on a sell-through basis, the Company may offer price adjustments
to its distributors to allow the distributor to price the Company's products
competitively for specific resale opportunities. The Company estimates and
records an allowance for distributor price adjustments for which the specific
resale transaction has been completed, but the price adjustment claim has not
yet been received and recorded by the Company.





Sales to OEM customers and Asian based
stocking representatives are recognized based upon the shipment terms of the
sale transaction when all other revenue recognition criteria have been
met.  The Company does not grant return rights, price protection or
pricing adjustments to OEM customers.  The Company offers limited
contractual stock rotation rights to stocking representatives.  In
addition, the Company is not contractually obligated to offer, but may
infrequently grant, price adjustments or price protection to certain stocking
representatives on an exception basis. At the time of shipment to OEMs and
stocking representatives, an allowance for returns is established based upon
historical return rates, and an allowance for price adjustments is established
based on an estimate of price adjustments to be granted. Actual future returns
and price adjustments could be different than the allowance
established.





The Company also maintains an allowance
for doubtful accounts for estimated uncollectible accounts receivable. This
estimate is based on an analysis of specific customer creditworthiness and
historical bad debts experience. Actual future uncollectible amounts could
exceed the doubtful accounts allowance established.


-
22-
 MANAGEMENT'S
DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
(CONTINUED)





Inventory Valuation.
Inventories are stated at the lower of cost (first-in, first-out method) or
market. The Company records adjustments to write down the cost of obsolete and
excess inventory to the estimated market value based on historical and
forecasted demand for its products. If actual future demand for the Company's
products is less than currently forecasted, additional inventory adjustments may
be required. Once an inventory write-down provision is established, it is
maintained until the product to which it relates is sold or otherwise disposed
of. This treatment is in accordance with Accounting Research Bulletin 43 and SEC
Staff Accounting Bulletin 100 "Restructuring and Impairment
Charges."





Share-Based Compensation.
Under SFAS 123(R) share-based compensation is measured at the grant date based
on the fair value of the award and is recognized as expense in the statement of
operations. To determine fair value, the Company uses the Black-Scholes
valuation model which requires input factors such as expected term, stock price
volatility, dividend yield and risk free interest rate. In addition, SFAS 123(R)
requires an estimate of expected forfeiture rates of stock grants and
share-based compensation expense is to be only recognized for those shares
expected to vest. Determining the input factors, such as expected term, expected
volatility and estimated forfeiture rates, requires significant judgment based
on subjective future expectations.





Income Taxes.Deferred tax
assets and liabilities result primarily from temporary timing differences
between book and tax valuation of assets and liabilities, and state research and
development credit carryforwards. The Company must regularly assess the
likelihood that future taxable income levels will be sufficient to ultimately
realize the tax benefits of these deferred tax assets. As of September 30, 2008,
the Company believes that future taxable income levels will be sufficient to
realize the tax benefits of these deferred tax assets and has not established a
valuation allowance. Should the Company determine that future realization of
these tax benefits is not more likely than not, a valuation allowance would be
established, which would increase the Company's tax provision in the period of
such determination.





Effective January 1, 2007, the
Company adopted the provisions of FASB Interpretation No. 48 (“FIN 48”),
Accounting for Uncertainty in Income Taxes - an interpretation of FASB Statement
No. 109. FIN 48 contains a two-step approach to recognizing and measuring
uncertain tax positions accounted for in accordance with SFAS No. 109. The first
step is to evaluate the tax position for recognition by determining if the
weight of available evidence indicates it is more likely than not that the
position will be sustained on audit, including resolution of related appeals or
litigation processes, if any. The second step is to measure the tax benefit as
the largest amount which is more than 50% likely of being realized upon ultimate
settlement. The Company considers many factors when evaluating and estimating
its tax positions and tax benefits, which may require periodic adjustments and
which may not accurately anticipate actual outcomes.





Litigation.The
semiconductor industry is characterized by frequent litigation regarding patent
and other intellectual property rights.  An estimated liability is
accrued when it is determined to be probable that a liability has been incurred
and the amount of loss can be reasonably estimated. The liability accrual is
charged to income in the period such determination is made. The Company
regularly evaluates current information available to determine whether such
accruals should be made.





- 23
-
 MANAGEMENT'S
DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
(CONTINUED)





Results
of Operations





The following table sets forth certain
operating data as a percentage of total net revenues for the periods
indicated:





Three
      Months Ended
            
            
            Nine
      Months EndedSeptember 30,
            
            
            September 30,2008
            
            
            2007
            
            
            2008
            
            
            2007Net
      revenues
            
            
            100.0
            %
            
            
            100.0
            %
            
            
            100.0
            %
            
            
            100.0
            %Cost
      of revenues
            
            
            43.9
            
            
            
            42.5
            
            
            
            43.7
            
            
            
            42.4Gross profit
            
            
            56.1
            
            
            
            57.5
            
            
            
            56.3
            
            
            
            57.6Operating
      expenses:Research and
      development
            
            
            20.5
            
            
            
            21.0
            
            
            
            20.9
            
            
            
            21.3Selling, general and
      administrative
            
            
            16.8
            
            
            
            16.7
            
            
            
            17.0
            
            
            
            17.7Restructuring charges
      (credits)
            
            
            --
            
            
            
            --
            
            
            
            (0.4
            )
            
            
            0.1Proxy contest
    expense
            
            
            --
            
            
            
            --
            
            
            
            1.5
            
            
            
            --Total operating
      expenses
            
            
            37.3
            
            
            
            37.7
            
            
            
            39.0
            
            
            
            39.0Income
      from operations
            
            
            18.8
            
            
            
            19.8
            
            
            
            17.3
            
            
            
            18.6Other
      income (expense):Interest income
            
            
            1.0
            
            
            
            2.5
            
            
            
            1.2
            
            
            
            2.4Litigation settlement and other
      income, net
            
            
            --
            
            
            
            --
            
            
            
            --
            
            
            
            8.0Total other income,
      net
            
            
            1.0
            
            
            
            2.5
            
            
            
            1.2
            
            
            
            10.4Income
      before income taxes
            
            
            19.8
            
            
            
            22.3
            
            
            
            18.5
            
            
            
            29.0Provision
      for income taxes
            
            
            7.3
            
            
            
            7.8
            
            
            
            6.7
            
            
            
            10.4Net
      income
            
            
            12.5
            %
            
            
            14.5
            %
            
            
            11.8
            %
            
            
            18.6
            %





Net Revenues.  For
the three months ended September 30, 2008, net revenues increased 4% to $67.5
million from $65.2 million for the same period in the prior year. For the nine
months ended September 30, 2008, net revenues increased 6% to $204.2 million
from $193.4 million for the same period in the prior year. These increases were
due to increased standard products revenues.





Standard products revenues for the
three months ended September 30, 2008 increased 8% to $64.6 million from $59.5
million for the same period in the prior year. For the nine months ended
September 30, 2008, standard products revenues increased 9% to $192.9 million
from $177.7 million for the same period in the prior year. These increases
resulted primarily from increased sales of standard products to the networking,
high speed communications, consumer and telecommunications end
markets.





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, 2008, decreased 48% to $3.0
million from $5.6 million for the same period in the prior year.  For
the nine months ended September 30, 2008, other products revenues decreased 28%
to $11.3 million from $15.7 million for the same period in the prior year. These
decreases resulted primarily from decreased unit shipments of foundry products.
As discussed in the overview to Management’s Discussion and Analysis, the
current slowdown in the global markets, the unprecedented volatility and
severely diminished liquidity and credit availability has worsened the ongoing
weakness in the semiconductor industry. This has softened demand for the
Company’s products. The persistence of such conditions could have a significant
adverse effect on the Company’s revenues, profitability and results of
operations.





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.  During the first nine months of 2008,
turns fill rate for OEM and stocking representatives was approximately
55%.


- 24
-
 MANAGEMENT'S
DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
(CONTINUED)





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 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 68% and
66% of net revenues for the three months ended September 30, 2008 and 2007,
respectively. On a dollar basis, international sales increased 6% to
$45.8 million for the three months ended September 30, 2008 from $43.1
million for the comparable period in 2007. For the nine months ended September
30, 2008 international sales increased 6% to $138.6 million from $130.5
million for the comparable period in 2007.  This increase resulted
primarily from increased shipments of standard products to the networking and
high speed communications and the telecommunications end markets, primarily in
Asia and to a lesser extent Europe.





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. The
Company accounts for share-based compensation under the fair value recognition
provisions of SFAS 123(R). The Company's results of operations for the three
month periods ended September 30, 2008 and 2007 include $1.3 million and $1.4
million, respectively, of non-cash expense related to the fair value of
share-based compensation awards. For the nine month periods ended September 30,
2008 and 2007, the Company's results of operations include $4.3 million and $4.3
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 56.1% for the three months ended September 30, 2008
from 57.5% for the comparable period in 2007.  For the nine months
ended September 30, 2008, the Company's gross margin decreased to 56.3% from
57.5% for the comparable period in 2007. These decreases in gross margin
resulted primarily from an increase in sales mix of lower margin
telecommunications products in 2008 as compared to the same period in
2007.





Research and Development Expenses.Research and development expenses as a percentage of net revenues
represented 20.5% and 20.9%, for the three months ended September 30, 2008 and
2007, respectively.  On a dollar basis, research and development
expenses increased $152,000 or 1% to $13.8 million for the three months ended
September 30, 2008 from $13.7 million for the comparable period in 2007. For the
nine months ended September 30, 2008 and 2007, research and development expenses
as a percentage of net revenues represented 20.9% and 21.3%,
respectively.  On a dollar basis, research and development expenses
increased $1.6 million or 4% to $42.7 million for the nine months ended
September 30, 2008 from $41.1 million for the comparable period in 2007. 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.


- 25
-
 MANAGEMENT'S
DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
(CONTINUED)





Selling, General and Administrative
Expenses.As a percentage of net revenues, selling, general
and administrative expenses represented 16.8% and 16.7% for the three months
ended September 30, 2008 and 2007, respectively.  On a dollar basis,
selling, general and administrative expenses increased $0.4 million or 4% to
$11.3 million for the three months ended September 30, 2008 from $10.9 million
for the comparable period in 2007. For the three months ended September 30,
2008, increases were due to higher labor costs and commissions. For the nine
months ended September 30, 2008 and 2007, as a percentage of net revenues,
selling, general and administrative expenses represented 17.0% and 17.6%,
respectively.  On a dollar basis, selling, general and administrative
expenses increased $666,000 or 2% to $34.8 million for the nine months ended
September 30, 2008 from $34.1 million for the comparable period in 2007.
Increased expenses for the nine months ended September 30, 2008, consisting of a
combination of increases in labor costs, commissions and export costs, were
offset by lower legal fees, and profit sharing, respectively, for the comparable
period in 2007.





Proxy contest expense. During
the first quarter of 2008, the Company became engaged in its first proxy contest
since going public in 1994, with a small activist hedge fund, Obrem Capital
Management LLC (“OCM”).  This issue resulted in Micrel incurring
incremental operating expenses on this matter of $330,000 during the first
quarter, $2.7 million in the second quarter and $16,000 in the third quarter of
2008. The expenses consist primarily of outside consulting and legal fees.
Subsequent to a special meeting of shareholders on May 20, 2008, at which the
Company’s shareholders’ rejected all proposals set forth by OCM. Micrel
announced on July 9, 2008 that OCM had agreed to withdrew its slate of nominees
for the board of directors, and support Micrel’s board nominees at the upcoming
annual meeting of shareholders. Micrel’s slate of directors was subsequently
elected by shareholders at the Company’s annual meeting on October 1,
2008.





Restructuring charges
(credits). During 2003 the Company closed its Santa Clara wafer
fabrication facility. In February 2006, the Company terminated the facility
lease under the terms of the lease agreement due to major vandalism rendering
the building unusable.  The facility Lessor disputed the termination
of the lease.  In March 2008, the Company entered into a Settlement
and Mutual Release agreement with the Lessor. Under the terms of the agreement,
the Company paid $875,000 to the Lessor and released a $70,000 security deposit
for full settlement of all obligations under the lease (see Note
12).  The remaining $842,000 unused restructuring expense accruals
were credited to restructuring charges (credits) in the statement of operations
during the first quarter of 2008 (see Note 17 of Notes to Condensed Consolidated
Financial Statements).





Other Income
(Expense).  Other income (expense) reflects interest income
from investments in short-term and long-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 payroll tax liabilities.  For the three months
ended September 30, 2008, interest income decreased $1.0 million to $652,000
from $1.6 million for the comparable period in the prior year. This decrease
resulted from a decrease in average cash and investment balances combined with
reduced average interest rates earned. 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, 2008, as
a percentage of income before taxes, was 36.6% and 36.1%, respectively, compared
to 35.1% and 35.9%, respectively, for the same periods in the prior year. 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, and federal qualified production
activity deductions.





- 26
-
 MANAGEMENT'S
DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
(CONTINUED)





Liquidity and Capital
Resources





Since inception, the Company's
principal sources of funding have been its cash from operations, bank borrowings
and proceeds from sales of common stock. Principal sources of liquidity at
September 30, 2008, consisted of cash and short-term investments of $82.3
million and a $6 million revolving line of credit from a commercial bank under
which the Company could borrow $5.7 million. The revolving line of credit
agreement expires on June 30, 2010 (see Note 8 of Notes to Condensed
Consolidated Financial Statements).





The Company generated $40.0 million in
cash flows from operating activities for the nine months ended September 30,
2008, primarily attributable to net income of $24.1 million plus additions for
non-cash activities of $18.7 million (consisting primarily of $14.5 million in
depreciation and amortization, $4.3 million in share-based compensation expense)
combined with a $2.2 million decrease in prepaid expense and other assets and a
$2.8 million increase in deferred income on shipments to distributors, which
were partially offset by a $4.7 million increase in accounts receivable a $3.5
million decrease in other current liabilities and a $2.3 million decrease in
accounts payable.





At September 30, 2008, the Company held
$16.4 million in principal of senior auction rate notes secured by student
loans.  During the first quarter of 2008 and continuing into the
second and third quarter of 2008, the auction rate securities market experienced
a significant increase in the number of failed auctions, which occurs when sell
orders exceed buy orders. Auctions for the six student loan-backed notes held by
the Company have failed as of September 30, 2008.  The funds
associated with failed auctions will not be accessible until a successful
auction occurs, a buyer is found outside of the auction process, the issuers
redeem the securities or the underlying securities have matured. As a result the
Company’s ability to liquidate its investment and fully recover the carrying
value of our investment in the near term may be limited or not
exist.  During the first quarter of 2008, the Company recorded a $1.8
million pre-tax temporary impairment of these securities to other comprehensive
income, a component of shareholders’ equity.  In the second quarter of
2008, the company recorded an additional $0.5 million pre-tax temporary
impairment of these auction rate securities to other comprehensive income.
During third quarter, the Company recorded additional pre-tax temporary
impairment totaling $0.4 million. The Company currently has the ability and
intent to hold these investments until a recovery of the auction process occurs
or the issuers redeem the securities. For additional information regarding the
Company's investments, see Note 4 of Notes to Condensed Consolidated Financial
Statements.





For the nine months ended September 30,
2007, the Company generated $47.6 million in cash flows from operating
activities 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 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 income taxes
receivable.





The Company used $3.7 million of cash
from investing activities during the nine months ended September 30, 2008,
comprised of $9.2 million in purchases of property, plant and equipment combined
with net purchases of short-term investments of $9.0 million offset by net
proceeds of short and long-term investments of $14.3 million.





For the nine months ended September 30,
2007, the Company used $18.3 million of cash in investing activities, 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 decrease in restricted cash.





The Company used $39.9 million of cash
in financing activities during the nine months ended September 30, 2008
primarily for the repurchase of $36.0 million of the Company's common stock and
$7.1 million for the payment of cash dividends, which were partially offset by
$3.2 million in proceeds from the exercise of employee stock
awards.





During the nine months ended September
30, 2007, the Company used $28.1 million of cash in financing activities
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.


- 27
-
 MANAGEMENT'S
DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
(CONTINUED)





The Company currently intends to spend
approximately $18 million to $23 million to purchase capital equipment and make
facility improvements during the next 15 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 $24.0 million of its common stock through December 31,
2008. On October 27, 2008, the Board of Directors has authorized a quarterly
dividend payment of $0.035 per common share. The dividend is to be paid on
November 19, 2008 to shareholders of record on November 5, 2008.





Since
inception, the Company's principal sources of funding have been its cash from
operations, bank borrowings and sales of common stock. At September 30, 2008,
the Company had cash and cash equivalents of $77.3 million. Some of these
available cash and cash equivalents are held in accounts managed by third party
financial institutions and consist of invested cash and cash in the Company’s
operating accounts. The invested cash is invested in interest bearing funds
managed by third party financial institutions. To date, the Company has
experienced no loss or lack of access to our invested cash or cash equivalents;
however, the Company can provide no assurances that access to its invested cash
and cash equivalents will not be impacted by adverse conditions in the financial
markets. 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 at least 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.





At any point in time the Company also
has International accounts in its subsidiaries that are with third party
financial institutions. These balances exceed the countries bank guaranteed
limits. While the Company monitors daily cash balances from its operating
subsidiaries as appropriate, these cash balances as well as the availability of
the Company’s line of credit could be impacted if the underlying financial
institutions fail or be subject to other adverse conditions in the financial
markets. To date, the Company has experienced no loss or lack of access to cash
in its operating accounts or its revolving line of credit.





Recently
Issued Accounting Standards





Please refer to Note 2 of Notes to
Condensed Consolidated Financial Statements for a discussion of the expected
impact of recently issued accounting standards.








Contractual
      Obligations and Commitments





As of September 30, 2008, the Company
had the following contractual obligations and commitments:





(in thousands)
            
            Payments Due By PeriodTotal
            
            
            Less
      than
              1 Year
            
            
            1-3
              Years
            
            
            4-5
              Years
            
            
            After
      5
              YearsOperating
leases
            
            $
            5,350
            
            
            $
            2,168
            
            
            $
            3,050
            
            
            $
            132
            
            
            $
            —Open purchase
      orders
            
            
            13,653
            
            
            
            13,653
            
            
            
            —
            
            
            
            —
            
            
            
            —Total
            
            $
            19,003
            
            
            $
            15,821
            
            
            $
            3,050
            
            
            $
            132
            
            
            $
            —





Open purchase orders are defined as
agreements to purchase goods or services that are enforceable and legally
binding and that specify all significant terms, including: fixed or minimum
quantities to be purchased; fixed, minimum or variable pricing provisions; and
the approximate timing of the transactions.





Borrowing agreements consisted of a
$6.0 million revolving line of credit from a commercial bank. The revolving line
of credit agreement includes a provision for the issuance of commercial or
standby letters of credit by the bank on behalf of the Company. The value of all
letters of credit outstanding reduces the total line of credit available. There
were no borrowings under the revolving line of credit at September 30, 2008 and
there were $325,000 in standby letters of credit outstanding as of September 30,
2008. The letters of credit are issued to guarantee payments for the Company's
workers compensation program.


- 28
-


Effective January 1, 2007, the
Company adopted the provisions of FIN 48 (see Note 16 of Notes to Condensed
Consolidated Financial Statements.) As of September 30, 2008, the liability for
uncertain tax positions, net of federal impacts on state tax issues was $5.8
million, of which, none is expected to be paid within one
year.  Included in the $5.8 million is $2.2 million which has not yet
reduced income tax payments, and, therefore, has been netted against non-current
deferred tax assets.  The remaining $2.6 liability is included in
long-term income taxes payable. The Company does not anticipate a significant
change to the net liability for uncertain income tax positions within the next
12 months.





The Company has no other off-balance
sheet arrangements and has not entered into any transactions involving
unconsolidated, limited purpose entities or commodity contracts.


- 29
-




ITEM
3.  QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET
RISK





At September 30, 2008, the Company held
$5.0 million in short-term investments. Short-term investments consist primarily
of liquid debt instruments and are classified as available-for-sale securities.
The short-term investments held at September 30, 2008 are primarily fixed rate
securities. These available-for-sale securities are subject to interest rate
risk and will fall in value if market interest rates increase. If market
interest rates were to increase immediately and uniformly by 10 percent from
levels at September 30, 2008, the fair value of the short-term investments would
decline by an immaterial amount.





At
September 30, 2008, the Company held $16.4 million in principal of senior
auction rate notes secured by student loans. As of September 30, 2008, all of
these auction rate securities have failed to auction successfully due to sell
orders exceeding buy orders. During the first quarter of 2008, the company
recorded a $1.8 million pre-tax temporary impairment of these securities to
other comprehensive income, a component of shareholders’ equity.  In
the second quarter of 2008, the company recorded an additional $0.5 million
pre-tax temporary impairment of these auction rate securities to other
comprehensive income. During third quarter, the Company recorded additional
pre-tax temporary impairment totaling $360,000. If it is determined that the
fair value of these securities is other than temporarily impaired, the Company
would record a loss, which could be material, in its statement of operations in
the period such other than temporary decline in fair value is determined. For
additional information regarding the Company's investments, see Note 4 of Notes
to Condensed Consolidated Financial Statements.





At September 30, 2008, the Company had
no fixed-rate long-term debt subject to interest rate risk.








ITEM
4:  CONTROLS AND PROCEDURES





The Company maintains disclosure
controls and procedures, as such term is defined under Rule 13a-15(e)
promulgated under the Securities Exchange Act of 1934, as amended (the Exchange
Act).  In designing and evaluating the disclosure controls and
procedures, management recognizes that any disclosure controls and procedures,
no matter how well designed and operated, can provide only reasonable assurance
of achieving the desired control objectives, and management necessarily is
required to apply its judgment in evaluating the cost-benefit relationship of
possible controls and procedures.





Under the supervision and with the
participation of the Company's management, including its principal executive
officer and principal financial officer, the Company conducted an evaluation of
the effectiveness of its disclosure controls and procedures as of the end of the
period covered by this report. Based on this evaluation, the Company's principal
executive officer and principal financial officer have concluded that the
Company's disclosure controls and procedures were effective at the reasonable
assurance level as of September 30, 2008.





There has been no change in the
Company’s internal control over financial reporting during the Company’s most
recent fiscal quarter that has materially affected, or is reasonably likely to
materially affect, the Company’s internal control over financial
reporting.


- 30
-








PART
II.  OTHER INFORMATION





ITEM
1.  LEGAL PROCEEDINGS





The information included in Note 12 of
Notes to Condensed Consolidated Financial Statements under the caption
"Litigation and Other Contingencies" in Item 1 of Part I is incorporated herein
by reference.








ITEM
1A.  RISK FACTORS





Factors
That May Affect Operating Results





If a company's operating results are
below the expectations of public market analysts or investors, then the market
price of its Common Stock could decline. Many factors that can affect a
company's quarterly and annual results are difficult to control or
predict.  Some of the factors which can affect a multinational
semiconductor business such as the Company are described below.





Geopolitical and
Macroeconomic Risks That May Affect Multinational
Enterprises





There
is a slowdown in United States and global economy and unprecedented volatility
in global markets, which can negatively impact the demand for semiconductor
components, which is increasingly dependent upon the conditions in the global
economy.





The
current slowdown in the United States and global economy and unprecedented
volatility in global markets has worsened the ongoing weakness in the
semiconductor industry, and the future economic environment may continue to be
less favorable than that of the recent years. Further significant disruption has
worsened the economic slowdown. The economic slowdown and current tightening of
credit in the financial markets has resulted in a decrease in orders for the
Company’s products. In addition to reduction in sales, our profitability may
decrease during downturns because we may not be able to reduce costs at the same
rate as our sales decline. Many factors could adversely affect regional or
global economic growth. Some of the factors that could slow economic growth
include: continued volatility in the United States and global credit markets,
increased price inflation for goods, services or materials, slowdown in the rate
of growth of the Chinese economy, a significant act of terrorism which disrupts
global trade or consumer confidence, and geopolitical tensions including war and
civil wars. Reduced level of economic activity, or disruptions of international
transportation, could adversely affect sales on either a global basis or in
specific geographic regions.





Recent macroeconomic turmoil in the
world financial markets is affecting commercial and consumer
markets.  Financial markets in the United States, Europe and
Asia have been experiencing extreme disruption in recent months, causing
customers and consumers to cut back on spending in order to conserve
cash.  Our operating results in one or more segments may be affected
by such economic conditions, and if such conditions remain uncertain, persist,
or deteriorate further, we may experience material impacts on our business,
operating results, and financial condition.





Demand for semiconductor components
is increasingly dependent upon the rate of growth of the global
economy.   If the rate of global economic growth slows, or
contracts, customer demand for products could be adversely affected, which in
turn could negatively affect revenues, results of operations and financial
condition.  Many factors could adversely affect regional or global
economic growth.  Some of the factors that could slow global economic
growth include: continued volatility in the United States and global credit
markets, increased price inflation for goods, services or materials, a slowdown
in the rate of growth of the Chinese economy, a significant act of terrorism
which disrupts global trade or consumer confidence, and geopolitical tensions
including war and civil unrest.  Reduced levels of economic activity,
or disruptions of international transportation, could adversely affect sales on
either a global basis or in specific geographic regions.


- 31
-


Market conditions may lead the
Company to initiate additional cost reduction plans, which may negatively affect
near term operating results.  Weaker customer demand,
competitive pricing pressures, excess capacity, weak economic conditions or
other factors, may cause the Company to initiate additional actions to reduce
the Company’s cost structure and improve the Company’s future operating results.
The cost reduction actions may require incremental costs to implement, which
could negatively affect the Company’s operating results in periods when the
incremental costs or liabilities are incurred.





The current tightening of the credit
markets may adversely affect the Company’s business in a number of ways.The unprecedented contraction and extreme disruption in recent months in
the credit and financial markets in the United States, Europe, and Asia has led
to, among other things, extreme volatility in security prices, severely
diminished liquidity and credit availability, rating downgrades of certain
investments and declining valuation of others. While the Company does not
currently require access to credit markets to finance its operations, these
economic developments may adversely affect the Company’s business in a number of
ways. The current tightening of credit in financial markets may limit the
ability of the Company’s customers and suppliers to obtain financing for capital
purchases and operations. This could result in a decrease in or cancellation of
orders for the Company’s products or reduced ability to finance operations to
supply products to the Company.




The Company has generated a
substantial portion of its net revenues from export sales.The Company
believes that a substantial portion of its future net revenues will depend on
export sales to customers in international markets, including
Asia.  International markets are subject to a variety of risks,
including changes in policy by the U.S. or foreign governments, acts of
terrorism, foreign government instability, social conditions such as civil
unrest, economic conditions including high levels of inflation, fluctuation in
the value of foreign currencies and currency exchange rates and trade
restrictions or prohibitions. Changes in exchange rates that strengthen the U.S.
dollar could increase the price of the Company's products in the local
currencies of the foreign markets it serves. This would result in making the
Company's products relatively more expensive than its competitors' products that
are denominated in local currencies, leading to a reduction in sales or
profitability in those foreign markets. The Company has not taken any protective
measures against exchange rate fluctuations, such as purchasing hedging
instruments. In addition, the Company sells to domestic customers that do
business worldwide and cannot predict how the businesses of these customers may
be affected by economic or political conditions elsewhere in the world. Such
factors could adversely affect the Company's future revenues, financial
condition, results of operations or cash flows.





The Company is reliant on certain
key suppliers for wafer fabrication, circuit assembly and testing
services. Most of these suppliers are based outside of the U.S. The
Company's supply could be interrupted as a result of any of the previously
mentioned risk factors relating to international markets.


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Semiconductor Industry
Specific Risks





The volatility of customer demand in
the semiconductor industry limits a company's ability to predict future levels
of sales and profitability. Semiconductor suppliers can rapidly increase
production output, leading to a sudden oversupply situation and a subsequent
reduction in order rates and revenues as customers adjust their inventories to
true demand rates.  A rapid and sudden decline in customer demand for
products can result in excess quantities of certain products relative to
demand.  Should this occur the Company’s operating results may be
adversely affected as a result of charges to reduce the carrying value of the
Company’s inventory to the estimated demand level or market
price.  The Company's quarterly revenues are highly dependent upon
turns fill orders (orders booked and shipped in the same
quarter).  The short-term and volatile nature of customer demand makes
it extremely difficult to accurately predict near term revenues and
profits.





The semiconductor industry is highly
competitive and subject to rapid technological change, price-erosion and
increased international competition.  Significant competitive
factors include product features, performance and price; timing of product
introductions; emergence of new computer and communications standards; quality
and customer support. If the Company is unable to compete favorably in these
areas, revenues and profits could be negatively affected.





The short lead time environment in
the semiconductor industry has allowed many end consumers to rely on
semiconductor suppliers, stocking representatives and distributors to carry
inventory to meet short term requirements and minimize their investment in
on-hand inventory.Over the past several years, customers have
worked to minimize the amount of inventory of semiconductors they
hold.  Original equipment manufacturers, distributors and contract
manufacturers within the electronics industry have reduced their semiconductor
component days of inventory on hand by approximately 20% over the past six
years. Over the same six years, the industry average for semiconductor
manufacturer’s inventory days on hand has increased by approximately 25%. As a
consequence customers are generally providing less order backlog to the Company
and other semiconductor suppliers, resulting in short order lead times and
reduced visibility into customer demand.  As a consequence of the
short lead time environment and corresponding unpredictability of customer
demand, the Company has increased its inventories approximately 20% over the
past five to six years to maintain reliable service levels.  If actual
customer demand for the Company’s products is different from the Company’s
estimated demand, product inventory may have to be scrapped, or the carrying
value reduced, which could adversely affect the Company's business, financial
condition, results of operations, or cash flows. In addition, the Company
maintains a network of stocking representatives and distributors that carry
inventory to service the volatile short-term demand of the end
customer.  Should the relationship with a distributor or stocking
representative be terminated, the future level of product returns could be
higher than the returns allowance established, which could negatively affect the
Company’s revenues and results of operations.





During periods when economic growth
and customer demand have been less certain, both the semiconductor industry and
the Company have experienced significant price erosion.  If
price erosion occurs, it will have the effect of reducing revenue levels and
gross margins in future periods.  Furthermore, the trend for the
Company’s customers to move their electronics manufacturing to Asian countries
has brought increased pricing pressure for Micrel and the semiconductor
industry.  Asian based manufacturers are typically more concerned
about cost and less concerned about the capability of the integrated circuits
they purchase.  The increased concentration of electronics procurement
and manufacturing in the Asia Pacific region may lead to continued price
pressure and additional product advertising costs for the Company’s products in
the future.


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Many semiconductor companies face
risks associated with a dependence upon third parties that manufacture, assemble
or package certain of its products.  These risks include
reduced control over delivery schedules and quality;  inadequate
manufacturing yields and excessive costs; the potential lack of adequate
capacity during periods of excess demand; difficulties selecting and integrating
new subcontractors; potential increases in prices; disruption in supply due to
civil unrest, terrorism or other events which may occur in the countries in
which the subcontractors operate; and potential misappropriation of the
Company's intellectual property.  The occurrence of any of these
events may lead to increased costs or delay delivery of the Company's products,
which would harm its profitability and customer
relationships.  Additionally, the Company's wafer and product
requirements typically represent a relatively small portion of the total
production of the third-party foundries and outside assembly, testing and
packaging contractors.  As a result, Micrel is subject to the risk
that a foundry will provide delivery or capacity priority to other larger
customers at the expense of Micrel, resulting in an inadequate supply to meet
customer demand or higher costs to obtain the necessary product
supply.





The markets that the Company serves
frequently undergo transitions in which products rapidly incorporate new
features and performance standards on an industry-wide
basis.  If the Company's products are unable to support the new
features or performance levels required by OEMs in these markets, it would
likely lose business from existing or potential customers and would not have the
opportunity to compete for new design wins until the next product transition. If
the Company fails to develop products with required features or performance
standards, or experiences even a short delay in bringing a new product to
market, or if its customers fail to achieve market acceptance of their products,
its revenues could be significantly reduced for a substantial period of
time.





Because the standard products market
for ICs is diverse and highly fragmented, the Company encounters different
competitors in various market areas.  Many of these competitors
have substantially greater technical, financial and marketing resources and
greater name recognition than the Company.  The Company may not be
able to compete successfully in either the standard products or custom and
foundry products business in the future and competitive pressures may adversely
affect the Company's financial condition, results of operations, or cash
flows.





The success of companies in the
semiconductor industry depends in part upon intellectual property, including
patents, trade secrets, know-how and continuing technology innovation.
The success of companies like Micrel may depend on their ability to obtain
necessary intellectual property rights and protect such rights. There can be no
assurance that the steps taken by the Company to protect its intellectual
property will be adequate to prevent misappropriation or that others will not
develop competitive technologies or products. There can be no assurance that any
patent owned by the Company will not be invalidated, circumvented or challenged,
that the rights granted thereunder will provide competitive advantages or that
any of its pending or future patent applications will be issued with the scope
of the claims sought, if at all. Furthermore, others may develop technologies
that are similar or superior to the Company's technology, duplicate technology
or design around the patents owned by the Company. Additionally, the
semiconductor industry is characterized by frequent litigation regarding patent
and other intellectual property rights. Claims alleging infringement of
intellectual property rights have been asserted against the Company in the past
and could be asserted against the Company in the future. These claims could
result in the Company having to discontinue the use of certain processes; cease
the manufacture, use and sale of infringing products; incur significant
litigation costs and damages; attempt to obtain a license to the relevant
intellectual property and develop non-infringing technology. The Company may not
be able to obtain or renew such licenses on acceptable terms or to develop
non-infringing technology. Existing claims or other assertions or claims for
indemnity resulting from infringement claims, or the failure to obtain a key
license or renew or renegotiate existing licenses on favorable terms could
adversely affect the Company's business, financial condition, results of
operations, or cash flows.





The significant investment in
semiconductor manufacturing capacity and the rapid growth of circuit design
centers in China may present a competitive threat to established semiconductor
companies due to the current low cost of labor and capital in China.The
emergence of low cost competitors in China could reduce the revenues and
profitability of established semiconductor manufacturers.


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There is intense competition for
qualified personnel in the semiconductor industry, in particular design
engineers.  The Company may not be able to continue to attract
and train engineers or other qualified personnel necessary for the development
of its business or to replace engineers or other qualified personnel who may
leave its employ in the future. Loss of the services of, or failure to recruit,
key design engineers or other technical and management personnel could be
significantly detrimental to the Company's product and process development
programs.





Companies in the semiconductor
industry are subject to a variety of federal, state and local governmental
regulations related to the use, storage, discharge and disposal of toxic,
volatile or otherwise hazardous chemicals used in its manufacturing
process.  Any failure to comply with present or future
regulations could result in the imposition of fines, the suspension of
production, alteration of manufacturing processes or a cessation of
operations.  In addition, these regulations could restrict the
Company's ability to expand its facilities at their present locations or
construct or operate a new wafer fabrication facility or could require the
Company to acquire costly equipment or incur other significant expenses to
comply with environmental regulations or clean up prior discharges. The
Company's failure to appropriately control the use of, disposal or storage of,
or adequately restrict the discharge of, hazardous substances could subject it
to future liabilities and could have a material adverse effect on its
business.





The Statement of Financial
Accounting Standards No. 123R, "Share-Based Payment” requires the Company to
recognize the cost of employee services received in exchange for awards of
equity instruments, based on the grant date fair value of those awards, in the
financial statements.  As discussed in Note 3 of the Notes to
Consolidated Financial Statements, the effect of the adoption of this accounting
standard in 2006 has significantly increased stock based compensation expense in
2007 and 2008 and such expense is expected to continue in future
periods.  The requirement to recognize the cost of stock option awards
as an expense in the financial statements has and will continue to reduce net
income and earnings per share and may have an adverse affect on the value of the
Company’s common stock.  If the Company reduces the number of stock
option grants to employees to minimize the cost associated with share based
incentive awards, it will most likely be more difficult for the Company to hire
and retain employees.





Company-Specific
Risks





In addition to the risks that affect
multinational semiconductor companies listed above, there are additional risks
which are more specific to the Company such as:





The Company has invested in certain
auction rate securities that may not be accessible for in excess of 12 months
and these auction rate securities may experience an other than temporary decline
in value, which would adversely affect the Company’s income.At September
30, 2008, the Company held $16.5 million in principal of senior auction rate
notes secured by student loans. As of September 30, 2008, all of these auction
rate securities have failed to auction successfully due to sell orders exceeding
buy orders. During the first nine months of 2008, the company recorded a $2.9
million pre-tax temporary impairment of these securities to other comprehensive
income, a component of shareholders’ equity.  If it is determined that
the fair value of these securities is other than temporarily impaired, the
Company would record a loss, which could be material, in its statement of
operations in the period such other than temporary decline in fair value is
determined. For additional information regarding the Company's investments, see
Note 4 of Notes to Condensed Consolidated Financial Statements.





The Company’s gross margin,
operating margin and net income are highly dependent on the level of revenue and
capacity utilization that the Company
experiences.  Semiconductor manufacturing is a
capital-intensive business resulting in high fixed costs. If the Company is
unable to utilize its installed wafer fabrication or test capacity at a high
level, the costs associated with these facilities and equipment would not be
fully absorbed, resulting in higher average unit costs and lower profit
margins.





An important part of the Company's
strategy is to continue to focus on the market for high-speed communications
IC’s.  Should demand from the Company’s customers in this end
market decrease, or if lower customer demand for the Company’s high bandwidth
products materializes, the Company's future revenue growth and profitability
could be adversely affected.


- 35
-





The cellular telephone (wireless
handset) market comprises a significant portion of the Company’s standard
product revenues.  The Company derives a significant portion of
its net revenues from customers serving the cellular telephone market. Due to
the highly competitive and fast changing environment in which the Company’s
cellular telephone customers operate, demand for the product the Company sells
into this end market can change rapidly and unexpectedly.  If the
Company’s cellular telephone customers acceptance of Micrel’s products
decreases, or if these customers lose market share, or accumulate too much
inventory of completed handsets, the demand for the Company’s products can
decline sharply which could adversely affect the Company’s revenues and results
of operations.





The Company derives a significant
portion of its net revenues from customers located in certain geographic regions
or countries.  A significant portion of the Company’s net
revenues come from customers located in South Korea. In the event that political
tensions surrounding North Korea evolve into military or social conflict, or
other factors disrupt the Korean economy, the Company’s revenues, results of
operations, cash flow and financial condition could be adversely
affected.  A significant portion of the Company’s net revenues come
from customers located in Taiwan and China.  In the event that
economic activity in these two countries declines, or is disrupted by
geopolitical events, the Company’s revenues and results of operations could be
adversely affected.





The Company faces various risks
associated with the trend in increased shareholder
activism.  In the first half of 2008, the Company became
engaged in a proxy contest with a large shareholder. This dispute led to a
significant increase in operating expenses which appreciably reduced the
Company’s operating profit and net income.  The Company prevailed in
the contest and has subsequently engaged in discussions with the activist
shareholder. To-date, this has resolved the dispute and limited further
operating expenses.  See Item 4, Submission of Matters to a Vote of
Security Holders.  However, if the Company should become engaged in
another proxy battle with either this same shareholder, or another large
shareholder, a new proxy contest would require significant additional management
time and increased operating expenses which could adversely affect the Company’s
profitability and cash flows.





The semiconductor industry is
characterized by frequent litigation regarding patent and other intellectual
property rights.  To the extent that the Company becomes
involved in such intellectual property litigation, it could result in
substantial costs and diversion of resources to the Company and could have a
material adverse effect on the Company's financial condition, results of
operation or cash flows.





In the event of an adverse ruling in
any intellectual property litigation that might arise in the future, the Company
might be required to discontinue the use of certain processes, cease the
manufacture, use and sale of infringing products, expend significant resources
to develop non-infringing technology or obtain licenses to the infringing
technology.  There can be no assurance, however, that under such
circumstances, a license would be available under reasonable terms or at
all.  In the event of a successful claim against the Company and the
Company's failure to develop or license substitute technology on commercially
reasonable terms, the Company's financial condition, results of operations, or
cash flows could be adversely affected.  The Company does not believe
that any material and specific risk currently exists related to the loss of use
of patents, products or processes.





The Company manufactures most of its
semiconductors at its San Jose, California fabrication
facilities.  The Company's existing wafer fabrication facility,
located in Northern California, may be subject to natural disasters such as
earthquakes.  A significant natural disaster, such as an earthquake or
prolonged drought, could have a material adverse impact on the Company's
business, financial condition and operating results.  Furthermore,
manufacturing semiconductors requires manufacturing tools that are unique to
each product being produced.  If one of these unique manufacturing
tools was damaged or destroyed, the Company's ability to manufacture the related
product would be impaired and its business would suffer until the tool was
repaired or replaced.  Additionally, the fabrication of ICs is a
highly complex and precise process.  Small impurities, contaminants in
the manufacturing environment, difficulties in the fabrication process, defects
in the masks used to print circuits on a wafer, manufacturing equipment
failures, and wafer breakage or other factors can cause a substantial percentage
of wafers to be rejected or numerous die on each wafer to be
nonfunctional.  The Company maintains approximately two to three
months of inventory that has completed the wafer fabrication manufacturing
process.  This inventory is generally located offshore at third party
subcontractors and can act to buffer some of the adverse impact from a
disruption to the Company’s San Jose wafer fabrication activity arising from a
natural disaster such as an earthquake.


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ITEM
      2.  UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF
      PROCEEDS





Dividend
Policy





On January 31, 2008 Micrel’s Board
of Directors declared a cash dividend of $0.03 per outstanding share of common
stock. The payment of $2.2 million was made on February 26, 2008 to
shareholders of record as of February 11, 2008.





On April 24, 2008 the Company's
Board of Directors declared a cash dividend of $0.035 per outstanding share of
common stock.  The payment of $2.5 million was made on May 22,
2008 to shareholders of record as of May 6, 2008.





On
July 24, 2008 the Company's Board of Directors declared a cash dividend of
$0.035 per outstanding share of common stock. The payment of $2.5 million was
made on August 21, 2008, to shareholders of record as of business on
August 5, 2008.





On October 23, 2008 the Company’s Board
of Directors declared a cash dividend of $0.035 per outstanding share of common
stock and is payable on November 19, 2008 for shareholders of record on November
5, 2008.





Issuer
Repurchases of Equity Securities





On October 22, 2007, the Company's
Board of Directors approved a $50 million share repurchase program for calendar
year 2008.  On October 1, 2008, the Board of Directors approved an
additional $10 million for the 2008 share repurchase program, bringing the
amount that maybe spent to repurchase the Company’s common stock during 2008 to
$60 million. Shares of common stock purchased pursuant to the repurchase program
are cancelled from outstanding shares upon repurchase and credited to an
authorized and un-issued reserve account, and are intended to reduce the number
of outstanding shares of Common Stock to increase shareholder value and offset
dilution from the Company's stock option plans, employee stock purchase plan and
401(k) plan.  The timing and amount of any repurchase of shares will
be determined by the Company’s management, based on its evaluation of market
conditions and other factors.





Repurchases
of the Company's common stock during 2008 were as follows:


Period
            
            Total
      Number ofShares
      Purchased
            
            
            Average
      Price
              Paid Per Share
            
            
            Total
      Number of Shares Purchased as Part of Publicly Announced
              Plans or Programs
            
            
            Maximum
      Dollar Value of Shares that May Yet be Repurchased Under the
              Plans or Programs ($000)January 2008
            
            
            1,623,470
            
            
            $
            6.27
            
            
            
            1,623,470
            
            
            $
            39,814February 2008
            
            
            732,000
            
            
            $
            6.32
            
            
            
            732,000
            
            
            $
            35,191March 2008
            
            
            267,400
            
            
            $
            8.15
            
            
            
            267,400
            
            
            $
            33,012Total Q1 2008
            
            
            2,622,870
            
            
            $
            6.48
            
            
            
            2,622,870April 2008
            
            
            247,300
            
            
            $
            9.36
            
            
            
            247,300
            
            
            $
            30,696May 2008
            
            
            330,337
            
            
            $
            9.73
            
            
            
            330,337
            
            
            $
            27,483June 2008
            
            
            310,300
            
            
            $
            9.56
            
            
            
            310,300
            
            
            $
            24,518Total Q2 2008
            
            
            887,937
            
            
            $
            9.57
            
            
            
            887,937July 2008
            
            
            349,880
            
            
            $
            9.21
            
            
            
            349,880
            
            
            $
            21,295August
      2008
            
            
            312,300
            
            
            $
            9.44
            
            
            
            312,300
            
            
            $
            18,347September
      2008
            
            
            487,660
            
            
            $
            8.91
            
            
            
            487,660
            
            
            $
            14,004Total
      Q3 2008
            
            
            1,149,840
            
            
            $
            9.14
            
            
            
            1,149,840Total
      2008
            
            
            4,.660,647
            
            
            $
            7.72
            
            
            
            4,660,647








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ITEM
6.  EXHIBITS





Exhibit No.
            Description31
            Certifications
      of the Company’s Chief Executive Officer and Chief Financial Officer
      pursuant to Section 302 of the Sarbanes-Oxley Act of
  200232
            Certifications
      of the Company’s Chief Executive Officer and Chief Financial Officer
      pursuant to Section 906 of the Sarbanes-Oxley Act of
  2002








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-





SIGNATURE





Pursuant to the requirements of the
Securities Exchange Act of 1934, the registrant has duly caused this report to
be signed on its behalf by the undersigned thereunto duly
authorized.











MICREL, INCORPORATED(Registrant)Date:
      November 7, 2008
            By           /s/ Robert J. BarkerRobert J. BarkerInterim Vice President,
      Financeand Chief Financial
      Officer(Authorized Officer
      andPrincipal Financial
      Officer)