SIGNIFICANT ACCOUNTING POLICIES

Nature of Business — Micrel, Incorporated and its wholly-owned subsidiaries (the "Company") develops, manufactures and markets analog, mixed-signal and digital semiconductor devices. The Company also provides custom and foundry services which include silicon wafer fabrication, integrated circuit ("IC") assembly and testing. The Company’s standard ICs are sold principally in North America, Asia, and Europe for use in a variety of products, including those in the computing, communications, and industrial markets. The Company’s custom circuits and wafer foundry services are provided to a wide range of customers that produce electronic systems for communications, consumer, automotive and military applications. The Company produces the majority of its wafers at the Company’s wafer fabrication facilities located in San Jose, California. After wafer fabrication, the completed wafers are then separated into individual circuits and packaged at independent assembly and final test contract facilities primarily located in Malaysia, Taiwan and China.

Basis of Presentation — The accompanying consolidated financial data has been prepared by the Company pursuant to the rules and regulations of the U.S. Securities and Exchange Commission ("SEC") and is in conformity with U.S. generally accepted accounting principles ("US GAAP").

Principles of Consolidation — The accompanying consolidated financial statements include the accounts of Micrel, Incorporated and its wholly-owned subsidiaries. All significant intercompany accounts and transactions have been eliminated.

Revision of Prior Period Financial Statements — In preparing the consolidated financial statements for the year ended December 31, 2012, the Company's management identified several income tax provision and income tax balance sheet classification errors that impacted the Company's previously issued consolidated financial statements for the years ended December 31, 2011 and 2010. The Company has revised these periods to correct for the errors. In addition, there existed a $1.6 million error that was determined to relate to periods prior to December 31, 2010, which has been presented as a correction to opening retained earnings in the Consolidated Statements' of Shareholders' Equity.

Errors that impacted the year ended December 31, 2011 consisted of liquidating dividends ($198,000) from two closed foreign subsidiaries, and recognition of deemed dividends ($55,000) from certain foreign subsidiaries, offset by the reversal of interest accrued ($97,000) for the state apportionment reserve.

Errors that impacted the year ended December 31, 2010 consisted of the write-off of a deferred tax asset ($180,000) associated with net operating losses, and recognition of deemed dividends ($55,000) from certain foreign subsidiaries, offset by the reversal of interest accrued ($62,000) for the state apportionment reserve.

In addition, there were two balance sheet classification errors in which income tax receivable was understated by $1.5 million (long-term deferred tax assets were overstated by the same amount) related to R&D credits, and short-term deferred tax assets were understated by $260,000 (long-term deferred assets were overstated by the same amount) related to share-based compensation.

The Company evaluated the materiality of these errors on prior periods' financial statements in accordance with ASC 250 (SEC's Staff Accounting Bulletin No. 99, Materiality), and concluded that they did not, individually or in the aggregate, result in a material misstatement of the Company's previously issued consolidated financial statements. However, the Company also concluded that the effect of recording all corrections in the fourth quarter and year ended December 31, 2012 would have been material and misleading to the users of the financial statements. In accordance with ASC 250 (SEC Staff Accounting Bulletin No. 108, “Considering the Effects of Prior Year Misstatements when Quantifying Misstatements in Current Year Financial Statements,”), the financial statements of prior periods have been revised to correct the errors. The revision had no impact on the Company's total cash flows from operating, investing or financing activities for all the prior periods affected.

Following are the line items within the consolidated financial statements for and as of the years ended December 31, 2011 and 2010 that have been impacted by the revisions.



	As of December 31, 2011							As of December 31, 2010
(in thousands)	As Reported		Adjustment			As Revised		As Reported		Adjustment			As Revised

Consolidated Balance Sheets
Income taxes receivable	$	6,881	$	(44	)	$	6,837	$	6,547	$	154		$	6,701
Short-term deferred income taxes	22,854		348			23,202		25,022		88			25,110
Total current assets	232,164		304			232,468		214,362		242			214,604
Long-term deferred income taxes	8,657		(2,261		)	6,396		9,740		(2,001		)	7,739
Total assets	309,975		(1,957		)	308,018		302,453		(1,759		)	300,694
Long-term income taxes payable	6,450		(46		)	6,404		5,664		(4		)	5,660
Total liabilities	63,546		(46		)	63,500		78,812		(4		)	78,808
Retained earnings	247,110		(1,911		)	245,199		222,452		(1,755		)	220,697
Total shareholders’ equity	246,429		(1,911		)	244,518		223,641		(1,755		)	221,886
Total liabilities and shareholders’ equity	309,975		(1,957		)	308,018		302,453		(1,759		)	300,694



	For the Year Ended December 31, 2011							For the Year Ended December 31, 2010
(in thousands except per share amounts)	As Reported		Adjustment			As Revised		As Reported		Adjustment			As Revised

Consolidated Statements of Operations
Provision for income taxes	$	13,586	$	156		$	13,742	$	24,754	$	173		$	24,927
Net income	34,016		(156		)	33,860		50,708		(173		)	50,535
Net income per share:
Basic	0.55		—			0.55		0.82		(0.01		)	0.81
Diluted	0.55		(0.01		)	0.54		0.81		—			0.81



	For the Year Ended December 31, 2011							For the Year Ended December 31, 2010
(in thousands)	As Reported		Adjustment			As Revised		As Reported		Adjustment			As Revised

Consolidated Statements of Other Comprehensive Income
Net income	$	34,016	$	(156	)	$	33,860	$	50,708	$	(173	)	$	50,535
Comprehensive income	34,341		(156		)	34,185		51,255		(173		)	51,082



	As of and for the Year Ended December 31, 2011							As of and for the Year Ended December 31, 2010
(in thousands)	As Reported		Adjustment			As Revised		As Reported		Adjustment			As Revised

Consolidated Statements of Shareholders' Equity
Net income	$	34,016	$	(156	)	$	33,860	$	50,708	$	(173	)	$	50,535
Retained earnings	247,110		(1,911		)	245,199		222,452		(1,755		)	220,697
Total shareholders’ equity	246,429		(1,911		)	244,518		223,641		(1,755		)	221,886

Use of Estimates — In accordance with accounting principles generally accepted in the United States of America, management utilizes certain 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. The primary estimates underlying the Company's financial statements include allowances for doubtful accounts receivable, allowances for product returns and price adjustments, provisions for obsolete and slow moving inventory, share-based compensation, income taxes, litigation, valuation of auction rate securities and accruals for other liabilities. Actual results could differ from those estimates.

Cash Equivalents — The Company considers all highly liquid debt instruments purchased with remaining maturities of three months or less to be cash equivalents.

Investments — 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 regard to those securities (expectations of sales and redemptions). Short-term investments as of December 31, 2012, consisted primarily of liquid municipal and corporate debt instruments and were classified as available-for-sale securities. Long-term investments as of December 31, 2012, consisted of auction rate notes secured by student loans and were classified as available-for-sale securities. Available-for sale securities are stated at market value with unrealized gains and losses included in accumulated other comprehensive income, a component of shareholders' equity. As of December 31, 2012, accumulated other comprehensive loss of $532,000 consisted of unrealized gains and losses on investments. 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.

A summary of the Company’s short-term investments at December 31, 2012 and 2011 was as follows (in thousands):



	As of December 31, 2012									As of December 31, 2011
	Cost		Gross Gains		Gross Losses			Fair Value		Cost		Gross Gains		Gross Losses			Fair Value
Municipal Securities	$	12,520	$	—	$	(116	)	$	12,404	$	11,413	$	—	$	(115	)	$	11,298
Corporate Debt Securities	26,575		—		(139		)	26,436		33,723		—		(327		)	33,396
Commercial Paper	18,464		—		(2		)	18,462		4,991		—		(2		)	4,989
U.S. Agencies	—		—		—			—		4,528		—		(17		)	4,511
Certificates of Deposits	19,047		—		—			19,047		23,071		—		—			23,071
Total	$	76,606	$	—	$	(257	)	$	76,349	$	77,726	$	—	$	(461	)	$	77,265

As of December 31, 2012, $8.2 million of the Company’s short-term investments have been in a continuous unrealized loss position for more than twelve months. The Company recorded a charge of $163,000 net of tax ($257,000 pre-tax) for temporary impairment of its short-term securities as of December 31, 2012 to accumulated other comprehensive income, a component of shareholders’ equity.

To determine the fair value of financial instruments, the Company uses a fair value hierarchy that prioritizes the inputs to valuation techniques used to measure fair value. The hierarchy gives the highest priority to unadjusted quoted prices in active markets for identical assets or liabilities (level 1 measurements) and the lowest priority to unobservable inputs (level 3 measurements). The three levels of the fair value hierarchy are described below:


•	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.

A financial instrument’s level within the fair value hierarchy is based on the lowest level of any input that is significant to the fair value measurement. Most of the Company’s financial instruments are classified within Level 1 or Level 2 of the fair value hierarchy because they are valued using quoted market prices, broker or dealer quotations, or alternative pricing sources with reasonable levels of price transparency.

The types of instruments valued based on quoted market prices in active markets include money market funds and time deposits. Such instruments are generally classified within Level 1 of the fair value hierarchy. The types of instruments valued based on other observable inputs include commercial paper, corporate bonds, municipal securities and U.S. agency securities. Such instruments are generally classified within Level 2 of the fair value hierarchy. The types of instruments valued based on unobservable inputs consist of the auction rate securities held by the Company. Such instruments are generally classified within Level 3 of the fair value hierarchy. The Company estimated the fair value of these auction rate securities using a discounted cash flow model incorporating assumptions that market participants would use in their estimates of fair value. Some of these assumptions include estimates for interest rates, timing and amount of cash flows and expected holding periods of the auction rate securities.

Financial assets and liabilities measured at fair value on a recurring basis were as follows (in thousands):



	Fair Value Measurements as of December 31, 2012
	Quoted Prices in Active Markets for Identical Assets Level 1		Significant Other Observable Inputs Level 2		Significant Unobservable Inputs Level 3		Total
Money Market Funds (1)	$	13,845	$	—	$	—	$	13,845
Certificates of Deposits (2)	19,046		—		—		19,046
Corporate Debt Securities (2)	—		26,437		—		26,437
Commercial Paper (2)	—		18,462		—		18,462
Municipal Securities (2)	—		12,404		—		12,404
U.S. Agencies (2)	—		—		—		—
Auction rate notes (3)	—		—		4,159		4,159
Total	$	32,891	$	57,303	$	4,159	$	94,353



	Fair Value Measurements as of December 31, 2011
	Quoted Prices in Active Markets for Identical Assets Level 1		Significant Other Observable Inputs Level 2		Significant Unobservable Inputs Level 3		Total
Money Market Funds (1)	$	55,912	$	—	$	—	$	55,912
Certificates of Deposits (2)	23,071		—		—		23,071
Corporate Debt Securities (2)	—		33,396		—		33,396
Commercial Paper (2)	—		4,989		—		4,989
Municipal Securities (2)	—		11,298		—		11,298
U.S. Agencies (2)	—		4,511		—		4,511
Auction rate notes (3)	—		—		6,857		6,857
Total	$	78,983	$	54,194	$	6,857	$	140,034

__________

(1) Included in cash and cash equivalents

(2) Included in short-term investments

(3) Included in long-term investments

As of December 31, 2012, the Company had $4.7 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 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. As a result of sell orders exceeding buy orders, auctions for the student loan-backed notes held by the Company have failed as of December 31, 2012. To date the Company has collected all interest receivable on all of its auction-rate securities when due and expects 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, the issuers repay principal over time from cash flows prior to final maturity or final payments come due according to contractual maturities ranging from 19 to 35 years. As a result, the Company has classified all auction rate notes as long-term investments as of December 31, 2012 and December 31, 2011. 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 December 31, 2012 and December 31, 2011, the maximum interest rate is generally one month LIBOR plus 1.5% and 2.5% based on the notes’ rating as of that date.

The Company has used a combination of discounted cash flow models and observable transactions for similar securities to determine the estimated fair value of its investment in auction rate notes as of December 31, 2012 and December 31, 2011. 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 December 31, 2012, the Company determined there was a cumulative decline in the fair value of its auction rate notes and recorded a $346,000 net of tax ($543,000 pre-tax) temporary impairment of these securities to accumulated other comprehensive income, a component of shareholders’ equity.

For the year ended December 31, 2012, the changes in the Company’s Level 3 securities (consisting of auction rate notes) were as follows (in thousands):



	Fair Value Measurements Using Significant Unobservable Inputs (Level 3)
Beginning balance, December 31, 2011	$	6,857
Transfers in and/or out of Level 3	—
Total gains, before tax, included in other comprehensive income	402
Settlements	(3,100		)
Ending balance, December 31, 2012	$	4,159

Certain Significant Risks and Uncertainties — Financial instruments that potentially subject the Company to concentrations of credit risk consist of cash and cash equivalents, investments and accounts receivable. Risks associated with cash are mitigated by banking with creditworthy institutions. Cash equivalents and investments consist primarily of commercial paper, bank certificates of deposit, money market funds and auction rate notes and are regularly monitored by management. Credit risk with respect to the trade receivables is spread over geographically diverse customers. The Company performs ongoing credit evaluations of its customers and maintains an allowance for potential credit losses. At December 31, 2012, one worldwide distributor and an Asia-based distributor accounted for 28% and 14%, respectively, of total accounts receivable. At December 31, 2011, two worldwide distributors and an Asia-based distributor accounted for 23%, 10% and 11%, respectively, of total accounts receivable.

Micrel currently purchases certain components from a limited group of vendors. The packaging of the Company's products is performed by, and certain of the raw materials included in such products are obtained from, a limited group of suppliers. The wafer supply for the Company’s LAN products is currently dependent upon two large third-party wafer foundry suppliers. Although the Company seeks to reduce its dependence on limited source suppliers, disruption or termination of any of these sources could occur and such disruptions could have an adverse effect on the Company's financial condition, results of operations, or cash flows.

The Company participates in a dynamic high technology industry and believes that changes in any of the following areas could have a material adverse effect on the Company’s future financial position, results of operations, or cash flows: changes in the overall demand for products offered by the Company; competitive pressures in the form of new products or price reductions on current products; advances and trends in new technologies and industry standards; changes in product mix; changes in third-party manufacturers; changes in key suppliers; changes in certain strategic relationships or customer relationships; litigation or claims against the Company based on intellectual property, patents, product, regulatory or other factors; risks associated with the ability to obtain necessary components; risks associated with the Company’s ability to attract and retain employees necessary to support its growth.

Inventories — 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. Once an inventory write-down provision is established, it is maintained until the product to which it relates is sold or otherwise disposed of.

Property, Plant and Equipment — Equipment, building and leasehold improvements are stated at cost and depreciated using the straight-line method. Equipment is depreciated over estimated useful lives of three to five years. Buildings are depreciated over an estimated useful life of twenty to thirty years. Building improvements are depreciated over estimated useful lives of fifteen to thirty years.

Goodwill and Intangible Assets — Goodwill is tested for impairment on an annual basis at the reporting unit level by first performing a qualitative assessment to determine whether it is more likely than not that the fair value of the reporting unit is less than its carrying value. If the reporting unit does not pass the qualitative assessment, then the reporting unit's carrying value is compared to its fair value. The fair value of the reporting unit is estimated using a discounted cash flow approach. Goodwill is considered impaired if the carrying value of the reporting unit exceeds its fair value. The discounted cash flow approach is based on expected future operating results. Failure to achieve these expected results may cause a future impairment of goodwill at the reporting unit. The Company's goodwill was assigned to its timing and communication reporting unit.

Intangible assets consist of developed technology, customer relationships, trademarks, non-competition agreements and in-process research and development. Intangible assets are amortized over the period of estimated benefit using the straight-line method and estimated useful lives ranging from two to ten years.

Impairment of Long-Lived Assets — The Company evaluates long-lived assets (including intangible assets) for impairment whenever events or changes in circumstances indicate that the carrying amount of a long-lived asset may not be recoverable. An asset is considered impaired if its carrying amount exceeds the undiscounted future net cash flow that the asset is expected to generate. The process of evaluating the potential impairment of long-lived intangible assets is highly subjective and requires significant judgment. In estimating the fair value of these assets, the Company makes estimates and judgments about future revenues and cash flows. The Company’s forecasts will be based on assumptions that are consistent with the plans and estimates the Company is using to manage the business. Changes in these estimates could change the Company’s conclusion regarding impairment of the long-lived assets. The Company recorded an impairment of $1.0 million as a component of research and development expense for a technology which was replaced by more advanced technologies. In 2011 and 2010, no impairment was noted.

Revenue Recognition and Receivables — Micrel generates revenue by selling products to OEMs, sell-through distributors and sell-in distributors. Sell-in distributors 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 sell-through distributors located in North America and Europe, and to a lesser extent 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 and related cost of sales are not recognized, 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 sell-through distributor upon shipment. In addition, the Company may offer to its sell-through distributors, where revenue is deferred upon shipment and recognized on a sell-through basis, price adjustments to allow the sell-through distributor to price the Company's products competitively for specific resale opportunities. The Company estimates and records an allowance for sell-through distributor price adjustments for which the specific resale transaction has been completed, but the price adjustment claim has not yet been received by the Company.

Sales to OEM customers and Asia-based sell-in distributors 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 sell-in distributors. In addition, the Company is not contractually obligated to offer, but may infrequently grant, price adjustments or price protection to certain sell-in distributors on an exception basis. At the time of shipment to OEMs and sell-in distributors, 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.

The Company's accounts receivable balances represent trade accounts receivables which have been recorded at invoiced amount and do not bear interest. The Company 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 debt experience.

Shipping and handling costs — Shipping and handling costs are included in cost of revenues and are recognized as period expense as incurred.

Litigation — 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.

Warranty Costs — The Company warrants products against defects for a period of up to 30 days. The majority of Micrel's product warranty claims are settled through the return of defective product and the reshipment of replacement product. As of December 31, 2012 and 2011, respectively, accrued warranty expenses were immaterial amounts.

Research and Development Expenses — Research and development costs are expensed as incurred and consist primarily of payroll and other headcount related costs and cost of materials associated with the development of new wafer fabrication processes and the definition, design and development of standard products. The Company also expenses prototype wafers and new production mask sets related to new products as research and development costs until products based on new designs are released to production by the Company and are demonstrated to support published data sheets and satisfy reliability tests.

Self Insurance — The Company utilizes third-party insurance subject to varying retention levels or self insurance. The Company is self insured for a portion of the losses and liabilities primarily associated with earthquake damage, workers’ compensation claims and health benefit claims. Losses are accrued based upon the Company’s estimates of the aggregate liability for claims incurred using historical experience and certain actuarial assumptions followed in the insurance industry.

Advertising Expenses — The Company expenses advertising costs to selling, general and administrative expense as incurred. Advertising expenses for 2012, 2011 and 2010 were $1.0 million, $948,000 and $1.0 million, respectively.

Income Taxes — Deferred tax assets and liabilities are recognized for the expected future tax consequences of events that have been reflected in the financial statements. Deferred tax assets and liabilities are determined based on the differences between the book and tax bases of assets and liabilities and operating loss carryforwards, using tax rates expected to be in effect for the years in which the differences are expected to reverse. A valuation allowance is provided to reduce net deferred tax assets if, based upon the available evidence, it is more likely than not that some or all of the deferred tax assets will not be realized. The Company determines whether it is more likely than not that a tax position will be sustained upon examination. The tax benefit of any tax position that meets the more-likely-than-not recognition threshold is calculated at the largest amount that is more than 50% likely of being realized upon resolution of the uncertainty. To the extent a full benefit is not expected to be realized on the uncertain tax position, a reduction to a deferred asset is recorded or an income tax liability is established. Interest and penalties on income tax obligations, including uncertain tax provisions, are included in the income tax provision.

Share-based Compensation — 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.

Net Income Per Common and Diluted Share — Basic net income per share is computed by dividing net income attributable to Micrel, Incorporated shareholders 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 and restricted stock units. Reconciliation of weighted-average shares used in computing net income per share attributable to Micrel, Incorporated shareholders is as follows (in thousands):



	Year Ended December 31,
	2012	2011	2010
Weighted average common shares outstanding	59,623	61,609	62,030
Dilutive effect of stock options and restricted stock units	665	762	527
Shares used in computing diluted net income per share	60,288	62,371	62,557

For the years ended December 31, 2012, 2011 and 2010, 5.2 million , 4.1 million and 4.0 million shares underlying 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 would have been anti-dilutive.

Fair Value of Financial Instruments — Financial instruments included in the Company’s consolidated balance sheets at December 31, 2012 and 2011, consist of cash, cash equivalents, accounts receivable, accounts payable and investments. For cash, the carrying amount is the fair value. The carrying amount for cash equivalents, accounts receivable and accounts payable approximates fair value because of the short maturity of those instruments. The fair values of investments are based on quoted market prices or valuation models for investments for which quoted market prices are unavailable.