UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 8-K
CURRENT REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
DATE OF REPORT (DATE OF EARLIEST EVENT REPORTED): May 3, 2013
TEXAS INSTRUMENTS INCORPORATED
(Exact name of Registrant as specified in its charter)
DELAWARE | 001-03761 | 75-0289970 | ||
(State or other jurisdiction of incorporation) | (Commission file number) | (I.R.S. employer identification no.) | ||
12500 TI BOULEVARD
P.O. BOX 660199
DALLAS, TEXAS 75266-0199
(Address of principal executive offices)
Registrant's telephone number, including area code: (214) 479-3773
Check the appropriate box below if the Form 8-K is intended to simultaneously satisfy the filing obligation of the registrant under any of the following provisions:
o | Written communications pursuant to Rule 425 under the Securities Act (17 CFR 230.425) |
o | Soliciting material pursuant to Rule 14a-12 under the Exchange Act (17 CFR 240.14a-12) |
o | Pre-commencement communications pursuant to Rule 14d-2(b) under the Exchange Act (17 CFR 240.14d-2(b)) |
o | Pre-commencement communications pursuant to Rule 13e-4(c) under the Exchange Act (17 CFR 240.13e-4(c)) |
ITEM 8.01. Other Events
As previously announced, Texas Instruments Incorporated (“TI,” “we” or “our”) has restructured its Wireless business to focus investments on embedded markets with greater potential for sustainable growth instead of the smartphone and consumer tablet markets. Consistent with this restructuring, effective January 1, 2013, the Wireless segment was eliminated and our embedded wireless products are now included in our Embedded Processing segment. The remaining Wireless products are now included in Other. We also reclassified certain products, primarily radio frequency identification (RFID) products, from Other to Embedded Processing. Our Quarterly Report on Form 10-Q for the quarter ended March 31, 2013, reflects these changes.
We are filing this Current Report on Form 8-K to recast the description of business, certain notes to the financial statements and management's discussion and analysis for the periods presented in our Annual Report on Form 10-K for the year ended December 31, 2012 (the “2012 Form 10-K”), to reflect the change in reportable segments. Only the following notes to the financial statements have been recast from their previous presentation:
Note 1 - Description of business and significant accounting policies and practices
Note 3 - Restructuring charges/other
Note 10 - Goodwill and acquisition-related intangibles
Note 16 - Segment and geographic area data
Exhibits 99.1 and 99.2 to this Report contain the recast information. The information presented in Exhibits 99.1 and 99.2 does not reflect events occurring after the filing of the 2012 Form 10-K. For information concerning significant developments and other changes to our business since the filing of the 2012 Form 10-K, please review our subsequent SEC filings.
ITEM 9.01. Exhibits
Designation of Exhibit in this Report | Description of Exhibit | |
23 | Consent of Ernst & Young LLP, Independent Registered Public Accounting Firm | |
99.1 | Description of business from the Registrant's Annual Report on Form 10-K for the year ended December 31, 2012, recast to reflect changes in segment reporting | |
99.2 | Financial Statements and Supplementary Data and Management's Discussion and Analysis of Financial Condition and Results of Operations from the Registrant's Annual Report on Form 10-K for the year ended December 31, 2012, recast to reflect changes in segment reporting | |
101.ins | Instance Document | |
101.sch | XBRL Taxonomy Schema | |
101.cal | XBRL Taxonomy Calculation Linkbase | |
101.lab | XBRL Taxonomy Labels Linkbase | |
101.pre | XBRL Taxonomy Presentation Linkbase | |
101.Def | XBRL Taxonomy Definitions Documents | |
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 hereunto duly authorized.
TEXAS INSTRUMENTS INCORPORATED | |
By: | /s/ Kevin P. March |
Kevin P. March Senior Vice President and Chief Financial Officer | |
Date: May 3, 2013
Exhibit 23
CONSENT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
We consent to the incorporation by reference in the following registration statements, and in the related prospectuses thereto, of our report dated February 22, 2013 (except for Notes 1, 3, 10 and 16, as to which the date is May 3, 2013), with respect to the consolidated financial statements of Texas Instruments Incorporated, included in this Current Report (Form 8-K) dated May 3, 2013: Registration Statements (Forms S-8) No. 333-158933, No. 333-158934, No. 33-42172, No. 33-54615, No. 33-61154, No. 333-07127 (as amended), No. 333-41913, No. 333-41919, No. 333-31321 (as amended), No. 333-31323, No. 333-48389, No. 333-44662, No. 333-107759, No. 333-107760, No. 333-107761, No. 333-127021, and No. 333-177235; Registration Statements (Form S-3) No. 333-165045 and No. 333-186803; and Registration Statements (Forms S-4) No. 333-89433 (as amended), No. 333-87199, No. 333-80157 (as amended), and No. 333-41030 (as amended).
/S/ ERNST & YOUNG LLP |
ERNST & YOUNG LLP |
Dallas, Texas
May 3, 2013
Exhibit 99.1
ITEM 1. Business.
Company Overview
At TI, we design and make semiconductors that we sell to electronics designers and manufacturers all over the world. We began operations in 1930. We are incorporated in Delaware, headquartered in Dallas, Texas, and have design, manufacturing or sales operations in more than 35 countries. We have three segments: Analog, Embedded Processing and Other. We expect Analog and Embedded Processing to be our primary growth engines in the years ahead, and we therefore focus our resources on these segments.
We were the world's fourth largest semiconductor company in 2012 as measured by revenue, according to preliminary estimates from an external source.
Financial information with respect to our segments and our operations outside the United States is contained in the note to the financial statements captioned “Segment and geographic area data” and is incorporated herein by reference.
Product Information
Semiconductors are electronic components that serve as the building blocks inside modern electronic systems and equipment. Semiconductors come in two basic forms: individual transistors and integrated circuits (generally known as “chips”) that combine multiple transistors on a single piece of material to form a complete electronic circuit. Our products, more than 100,000 orderable parts, are integrated circuits that are used to accomplish many different things, such as converting and amplifying signals, interfacing with other devices, managing and distributing power, processing data, canceling noise and improving signal resolution. This broad portfolio includes products that are integral to almost all electronic equipment.
We sell catalog and, to a lesser extent, custom semiconductor products. Catalog products are designed for use by many customers and/or many applications and are sold through both distribution and direct channels. The majority of our catalog products are proprietary, but some are commodity products. The life cycles of catalog products generally span multiple years, with some products continuing to sell for decades after their initial release. Custom products are designed for a specific customer for a specific application, are sold only to that customer and are typically sold directly to the customer. The life cycles of custom products are generally determined by end-equipment upgrade cycles and can be as short as 12 to 24 months.
Our segments represent groups of similar products that are combined on the basis of similar design and development requirements, product characteristics, manufacturing processes and distribution channels, and how management allocates resources and measures results. Additional information regarding each segment's products follows.
Analog
Analog semiconductors change real-world signals - such as sound, temperature, pressure or images - by conditioning them, amplifying them and often converting them to a stream of digital data that can be processed by other semiconductors, such as digital signal processors (DSPs). Analog semiconductors are also used to manage power in every electronic device, whether plugged into a wall or running off a battery. We estimate that we sell our Analog products to more than 100,000 customers. These sales generated about 55 percent of our revenue in 2012. According to external sources, the worldwide market for analog semiconductors was about $39 billion in 2012. Our Analog segment's revenue in 2012 was about $7.0 billion, or about 18 percent of this fragmented market, the leading position. We believe that we are well positioned to increase our market share over time.
Our Analog segment includes the following major product lines: High Volume Analog & Logic (HVAL), Power Management (Power), High Performance Analog (HPA) and Silicon Valley Analog (SVA).
HVAL products: These include both high-volume analog and logic products. High-volume analog includes integrated analog products for specific applications, including custom products. End markets for high-volume analog products include communications, automotive, computing and many consumer electronics products. Logic includes some commodity products marketed to many different customers for many different applications.
Power products: These include both catalog and application-specific products that help customers manage power in any type of electronic system. We design and manufacture power management semiconductors for both portable devices
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(battery-powered devices, such as handheld consumer electronics, laptop computers and cordless power tools) and line-powered systems (products that require an external electrical source, such as computers, digital TVs, wireless basestations and high-voltage industrial equipment).
HPA products: These include catalog analog products, such as amplifiers, data converters and interface semiconductors, that we market to many different customers who use them in manufacturing a wide range of products sold in many end markets, including the industrial, communications, computing and consumer electronics markets. HPA products generally have long life cycles, often more than 10 years.
SVA products: These consist of products that we acquired through our purchase of National Semiconductor Corporation (National) in 2011. These include power management, data converter, interface and operational amplifier catalog analog products, nearly all of which are complementary to our other Analog products. This portfolio of thousands of products is marketed to many different customers who use them in manufacturing a wide range of products sold in many end markets. SVA products generally have long life cycles, often more than 10 years.
Embedded Processing
Embedded Processing products are the “brains” of many electronic devices. Compared with general purpose microprocessors that perform many different tasks, embedded processors are designed to handle specific tasks and can be optimized for various combinations of performance, power and cost, depending on the application. The devices vary from simple, low-cost products used in electric toothbrushes to highly specialized, complex devices used in wireless basestation communications infrastructure equipment. Our Embedded Processing products are used in many end markets, particularly industrial, automotive and communications infrastructure.
An important characteristic of our Embedded Processing products is that our customers often invest their own research and development (R&D) to write software that operates on our products. This investment tends to increase the length of our customer relationships because many customers prefer to re-use software from one product generation to the next.
Sales of Embedded Processing products generated about 18 percent of our revenue in 2012. According to external sources, the worldwide market for embedded processors was about $17 billion in 2012. Our Embedded Processing segment's revenue in 2012 was about $2.3 billion. This was the number two position and represented about 13 percent of this fragmented market. We believe we are well positioned to increase our market share over time.
Our Embedded Processing segment includes the following major product lines: Processors, Microcontrollers and Connectivity.
Processor products: These include DSPs and applications processors. DSPs perform mathematical computations almost instantaneously to process or improve digital data. Applications processors like our embedded OMAPTM and SitaraTM products run an industry-standard operating system and perform multiple complex tasks, often communicating with other systems.
Microcontroller products: Microcontrollers are self-contained systems with a processor core, memory and peripherals that are designed to control a set of specific tasks for electronic equipment. Microcontrollers tend to have minimal requirements for memory and program length, with no operating system and low software complexity. Analog components that control or interface with sensors and other systems are often integrated into microcontrollers. Microcontroller products also include radio frequency identification (RFID) products, which are frequently used in automotive applications and sold along with our microcontroller products.
Connectivity products: Connectivity products enable electronic devices to seamlessly connect and transfer data, and the requirements for speed, data capability, distance and power vary depending on the application. Our Connectivity products support many wireless technologies to meet these requirements, including low-power wireless network standards like Zigbee® and other technologies like Bluetooth®, WiFi, GPS and Near Field Communications. Our Connectivity products are usually designed into customer devices alongside our processor and microcontroller products, enabling data to be collected, transmitted and acted upon.
Other
Other includes revenue from our smaller product lines, such as DLP® (primarily used in projectors to create high-definition images), custom semiconductors known as application-specific integrated circuits (ASICs) and calculators. It includes
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royalties received for our patented technology that we license to other electronics companies and revenue from transitional supply agreements related to acquisitions and divestitures. We also include revenue, about $1.2 billion in 2012, from our baseband products and from our OMAP applications processors and connectivity products sold into smartphone and consumer tablet applications, all of which are product lines that we have previously announced we are exiting. We expect this revenue to substantially cease by the end of 2013. Other generated about $3.6 billion in 2012.
We also include in Other restructuring charges and certain acquisition-related charges that are not used in evaluating results of and allocating resources to our Analog and Embedded Processing segments. These acquisition-related charges include certain fair-value adjustments, restructuring charges, transaction expenses, acquisition-related retention bonuses and amortization of intangible assets. Other also includes certain corporate-level items, such as litigation and environmental costs, insurance proceeds, and assets and liabilities associated with our centralized operations, such as our worldwide manufacturing, facilities and procurement operations.
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Applications for Our Products
The table below lists the major end markets that used our products in 2012 and the approximate percentage of our 2012 product revenue that the market represented. The chart also lists the most frequent applications and our products used within these key markets.
End Market | Applications | TI Products |
Communications (31% of product revenue) | Phones and infrastructure equipment Mobile connectivity solutions (including wireless LAN, global positioning systems, Bluetooth®, NFC) Video conferencing | Analog, Embedded Processing, Other |
Computing (25% of product revenue) | Printers Hard disk drives Monitors and projectors Notebooks, netbooks, desktop computers and servers Tablets | Analog, Embedded Processing, Other |
Industrial (17% of product revenue) | Digital power controls: Switch mode power supplies Uninterruptible power supplies Motor controls: Heating/ventilation/air conditioning Industrial control motor drives Power tools Copiers Security: Biometrics (fingerprint identification and authentication) Intelligent sensing (smoke and glass-breakage detection) Video analytics (surveillance) Smart metering Test and measurement Point of service/portable data terminals Medical diagnostic and monitoring equipment LED lighting Factory automation | Analog, Embedded Processing, Other |
Consumer Electronics (13% of product revenue) | Digital cameras Gaming Home and portable audio/visual equipment Home appliances Personal navigation devices eBook readers Pico projectors | Analog, Embedded Processing, Other |
Automotive (11% of product revenue) | Safety systems Driver information/entertainment Power train Body systems | Analog, Embedded Processing, Other |
Education (3% of product revenue) | Handheld graphing and scientific calculators and peripheral hardware Educational software | Other |
Market Characteristics
Product cycle
The global semiconductor market is characterized by constant, though generally incremental, advances in product designs and manufacturing processes. Semiconductor prices and manufacturing costs tend to decline over time as manufacturing processes and product life cycles mature.
Market cycle
The “semiconductor cycle” is an important concept that refers to the ebb and flow of supply and demand. The semiconductor market historically has been characterized by periods of tight supply caused by strengthening demand and/or insufficient
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manufacturing capacity, followed by periods of surplus inventory caused by weakening demand and/or excess manufacturing capacity. These are typically referred to as upturns and downturns in the semiconductor cycle. The semiconductor cycle is affected by the significant time and money required to build and maintain semiconductor manufacturing facilities.
Seasonality
Our revenue and operating results are subject to some seasonal variation. Our semiconductor sales generally are seasonally weaker in the first and fourth quarters and stronger in the second and third quarters, as manufacturers prepare for the major holiday selling seasons. Calculator revenue is tied to the U.S. back-to-school season and is therefore at its highest in the second and third quarters.
Competitive landscape
We face significant global competition from numerous large and small companies, including both broad-based suppliers and niche suppliers. Our competitors also include emerging companies, particularly in Asia, that sell products into the same markets in which we operate. We believe that competitive performance in the semiconductor market generally depends on several factors, including the breadth of a company's product line, the strength and depth of the sales network, technological innovation, technical support, customer service, quality, reliability, price and scale.
The primary competitive factors for our Analog products include design proficiency, a diverse product portfolio to meet wide-ranging customer needs, manufacturing process technologies that provide differentiated levels of performance, applications and sales support, and manufacturing expertise and capacity. Our primary Analog competitors include Analog Devices, Inc.; Fairchild Semiconductor Corporation; Freescale Semiconductor, Inc.; Infineon Technologies AG; Intersil Corporation; Linear Technology Corporation; Maxim Integrated Products, Inc.; NXP Semiconductors N.V.; QUALCOMM Incorporated; Richtek Technology Corporation; and STMicroelectronics NV.
The primary competitive factors for our Embedded Processing products are the ability to design and cost-effectively manufacture products, system-level knowledge about targeted end markets, installed base of software, software expertise, applications and sales support, and a product's performance and power characteristics. Primary competitors of our Embedded Processing segment include Atmel Corporation; Broadcom Corp.; Freescale Semiconductor, Inc.; Infineon Technologies AG; Microchip Technology, Inc.; NVIDIA Corporation; NXP Semiconductors N.V.; QUALCOMM Incorporated; Renesas Electronics Corporation; and STMicroelectronics NV.
Manufacturing
Semiconductor manufacturing begins with a sequence of photo-lithographic and chemical processing steps that fabricate a number of semiconductor devices on a thin silicon wafer. Each device on the wafer is tested, the wafer is cut into individual units and each unit is assembled into a package that then is usually retested. The entire process takes place in highly specialized facilities and requires an average of 12 weeks, with most products completing within 8 to 16 weeks.
The cost and lifespan of the equipment and processes we use to manufacture semiconductors vary by technology. Our Analog products and most of our Embedded Processing products can be manufactured using mature and stable, and therefore less expensive, equipment than is needed for manufacturing advanced CMOS logic products, such as our OMAP products.
We own and operate semiconductor manufacturing facilities in North America, Asia, Japan and Europe. These include both wafer fabrication and assembly/test facilities. Our facilities require substantial investment to construct and are largely fixed-cost assets once in operation. Because we own much of our manufacturing capacity, a significant portion of our operating cost is fixed. In general, these fixed costs do not decline with reductions in customer demand or utilization of capacity, potentially hurting our profit margins. Conversely, as product demand rises and factory utilization increases, the fixed costs are spread over increased output, potentially benefiting our profit margins.
We expect to maintain sufficient internal wafer fabrication capacity to meet the vast majority of our production needs. To supplement our internal wafer fabrication capacity and maximize our responsiveness to customer demand and return on capital, our wafer manufacturing strategy utilizes the capacity of outside suppliers, commonly known as foundries, and subcontractors. In 2012, we sourced about 20 percent of our total wafers and about 75 percent of our advanced CMOS logic needs from external foundries.
In 2011, we initiated closure of an older wafer fabrication facility in Hiji, Japan, and another in Houston, Texas. We expect to complete these plant closures in 2013.
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Inventory
Our inventory practices differ by product, but we generally maintain inventory levels that are consistent with our expectations of customer demand. Because of the longer product life cycles of catalog products and their inherently lower risk of obsolescence, we generally carry more inventory of those products than custom products. Additionally, we sometimes maintain catalog-product inventory in unfinished wafer form, as well as higher finished-goods inventory of low-volume products, allowing greater flexibility in periods of high demand. We also have consignment inventory programs in place for our largest customers and some distributors.
Design Centers
Our design centers provide design, engineering and product application support as well as after-sales customer service. The design centers are strategically located around the world to take advantage of key technical and engineering talent and proximity to key customers.
Customers
Our products are sold to original equipment manufacturers (OEMs), original design manufacturers (ODMs), contract manufacturers and distributors. (An OEM designs and sells products under its own brand that it manufactures in-house or has manufactured by others. An ODM designs and manufactures products for other companies, which then sell those products under their own brand.) In 2012, no single customer accounted for 10 percent or more of our revenue.
Sales and Distribution
We market and sell our semiconductor products through a direct sales force, distributors and authorized third-party sales representatives. We have sales or marketing offices in 34 countries worldwide and have expanded our sales networks in the emerging markets of China, India and Eastern Europe over the last few years. Distributors located around the world account for about 50 percent of our revenue. Our distributors maintain an inventory of our products and sell directly to a wide range of customers. They also sell products from our competitors. Our distribution network holds a mix of distributor-owned and TI-consigned inventory. Over time, we expect this mix will shift more toward consignment. We sell our calculator products primarily through retailers and instructional dealers.
Acquisitions, Divestitures and Investments
From time to time we consider acquisitions and divestitures that may strengthen or better focus our business portfolio. We also make investments directly or indirectly in private companies. Investments are focused primarily on next-generation technologies and markets strategic to us. In September 2011, we acquired National Semiconductor Corporation.
Backlog
We define backlog as of a particular date as firm purchase orders with a customer-requested delivery date within a specified length of time. As customer requirements and industry conditions change, orders may be, under certain circumstances, subject to cancellation or modification of terms such as pricing, quantity or delivery date. Customer order placement practices continually evolve based on customers' individual business needs and capabilities, as well as industry supply and capacity considerations. Accordingly, our backlog at any particular date may not be indicative of revenue for any future period. Our backlog of orders was $1.17 billion at December 31, 2012, and $1.39 billion at December 31, 2011.
Raw Materials
We purchase materials, parts and supplies from a number of suppliers. In some cases we purchase such items from sole source suppliers. The materials, parts and supplies essential to our business are generally available at present, and we believe that such materials, parts and supplies will be available in the foreseeable future.
Intellectual Property
We own many patents, and have many patent applications pending, in the United States and other countries in fields relating to our business. We have developed a strong, broad-based patent portfolio and continually add patents to that portfolio. We also
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have agreements with numerous companies involving license rights and anticipate that other license agreements may be negotiated in the future. In general, our license agreements have multi-year terms and may be renewed after renegotiation.
Our semiconductor patent portfolio is an ongoing contributor to our revenue. We do not consider our business materially dependent upon any one patent or patent license, although taken as a whole, our rights and the products made and sold under patents and patent licenses are important to our business.
We often participate in industry initiatives to set technical standards. Our competitors may also participate in the same initiatives. Participation in these initiatives may require us to license our patents to other companies.
We own trademarks that are used in the conduct of our business. These trademarks are valuable assets, the most important of which are “Texas Instruments” and our corporate monogram. Other valuable trademarks include OMAPTM and DLP®.
Research and Development
Our R&D expense was $1.88 billion in 2012, compared with $1.72 billion in 2011 and $1.57 billion in 2010. Our primary areas of R&D investment are Analog and Embedded Processing products.
We conduct most of our R&D internally. However, we also closely engage with a wide range of third parties, including software suppliers, universities and select external industry consortia, and we collaborate with our foundry suppliers on semiconductor manufacturing technology.
From time to time we may terminate R&D projects before completion or decide not to manufacture and sell a developed product. We do not expect that all of our R&D projects will result in products that are ultimately released for sale, or that our projects will contribute significant revenue until at least a few years following completion.
Executive Officers of the Registrant
The following is an alphabetical list of the names and ages of the executive officers of the company and the positions or offices with the company presently held by each person named:
Name | Age | Position |
Niels Anderskouv | 43 | Senior Vice President |
Stephen A. Anderson | 51 | Senior Vice President |
Brian T. Crutcher | 40 | Senior Vice President |
R. Gregory Delagi | 50 | Senior Vice President |
David K. Heacock | 52 | Senior Vice President |
Joseph F. Hubach | 55 | Senior Vice President, Secretary and General Counsel |
Sami Kiriaki | 52 | Senior Vice President |
Melendy E. Lovett | 54 | Senior Vice President (President, Education Technology) |
Kevin P. March | 55 | Senior Vice President and Chief Financial Officer |
Robert K. Novak | 47 | Senior Vice President |
Kevin J. Ritchie | 56 | Senior Vice President |
John J. Szczsponik, Jr. | 52 | Senior Vice President |
Richard K. Templeton | 54 | Director; Chairman of the Board; President and Chief Executive Officer |
Teresa L. West | 52 | Senior Vice President |
Darla H. Whitaker | 47 | Senior Vice President |
The term of office of the above-listed officers is from the date of their election until their successor shall have been elected and qualified. All executive officers of the company have been employees of the company for more than five years. Mses. Lovett, West and Whitaker and Messrs. Delagi, Heacock, Hubach, March, Ritchie and Templeton have served as executive officers of the company for more than five years. Messrs. Anderson and Novak became executive officers of the company in 2008. Mr. Szczsponik became an executive officer of the company in 2009. Messrs. Crutcher and Kiriaki became executive officers of the company in 2010. Mr. Anderskouv became an executive officer of the company in 2012.
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Employees
At December 31, 2012, we had 34,151 employees.
Available Information
Our Internet address is www.ti.com. Information on our web site is not a part of this report. We make available, free of charge, through our investor relations web site our reports on Forms 10-K, 10-Q and 8-K, and amendments to those reports, as soon as reasonably practicable after they are filed with the SEC. Also available through the TI investor relations web site are reports filed by our directors and executive officers on Forms 3, 4 and 5, and amendments to those reports.
Available on our web site at www.ti.com/corporategovernance are: (i) our Corporate Governance Guidelines; (ii) charters for the Audit, Compensation, and Governance and Stockholder Relations Committees of our board of directors; (iii) our Code of Business Conduct; and (iv) our Code of Ethics for TI Chief Executive Officer and Senior Financial Officers. Stockholders may request copies of these documents free of charge by writing to Texas Instruments Incorporated, P.O. Box 660199, MS 8657, Dallas, Texas, 75266-0199, Attention: Investor Relations.
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Exhibit 99.2
TEXAS INSTRUMENTS INCORPORATED AND SUBSIDIARIES
INDEX TO EXHIBIT
Page Reference | |
Index | 1 |
Consolidated financial statements | |
Income for each of the three years in the period ended December 31, 2012 | 2 |
Comprehensive income for each of the three years in the period ended December 31, 2012 | 3 |
Balance sheets at December 31, 2012 and 2011 | 4 |
Cash flows for each of the three years in the period ended December 31, 2012 | 5 |
Stockholders' equity for each of the three years in the period ended December 31, 2012 | 6 |
Notes to financial statements | 7 |
Report of independent registered public accounting firm | 38 |
Management's discussion and analysis of financial condition and results of operations | 39 |
Schedules have been omitted because the required information is not present or not present in amounts sufficient to require submission of the schedule, or because the information required is included in the consolidated financial statements or the notes thereto.
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For Years Ended December 31, | ||||||||||||
Consolidated statements of income | 2012 | 2011 | 2010 | |||||||||
[Millions of dollars, except share and per-share amounts] | ||||||||||||
Revenue | $ | 12,825 | $ | 13,735 | $ | 13,966 | ||||||
Cost of revenue (COR) | 6,457 | 6,963 | 6,474 | |||||||||
Gross profit | 6,368 | 6,772 | 7,492 | |||||||||
Research and development (R&D) | 1,877 | 1,715 | 1,570 | |||||||||
Selling, general and administrative (SG&A) | 1,804 | 1,638 | 1,519 | |||||||||
Acquisition charges | 450 | 315 | — | |||||||||
Restructuring charges/other | 264 | 112 | (111 | ) | ||||||||
Operating profit | 1,973 | 2,992 | 4,514 | |||||||||
Other income (expense) net (OI&E) | 47 | 5 | 37 | |||||||||
Interest and debt expense | 85 | 42 | — | |||||||||
Income before income taxes | 1,935 | 2,955 | 4,551 | |||||||||
Provision for income taxes | 176 | 719 | 1,323 | |||||||||
Net income | $ | 1,759 | $ | 2,236 | $ | 3,228 | ||||||
Earnings per common share: | ||||||||||||
Basic | $ | 1.53 | $ | 1.91 | $ | 2.66 | ||||||
Diluted | $ | 1.51 | $ | 1.88 | $ | 2.62 | ||||||
Average shares outstanding (millions): | ||||||||||||
Basic | 1,132 | 1,151 | 1,199 | |||||||||
Diluted | 1,146 | 1,171 | 1,213 | |||||||||
Cash dividends declared per share of common stock | $ | 0.72 | $ | 0.56 | $ | 0.49 | ||||||
See accompanying notes.
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For Years Ended December 31, | ||||||||||||
Consolidated statements of comprehensive income | 2012 | 2011 | 2010 | |||||||||
[Millions of dollars] | ||||||||||||
Net income | $ | 1,759 | $ | 2,236 | $ | 3,228 | ||||||
Other comprehensive income (loss): | ||||||||||||
Available-for-sale investments: | ||||||||||||
Unrealized gains (losses), net of tax benefit (expense) of ($1), $1 and ($3) | 3 | (2 | ) | 7 | ||||||||
Reclassification of recognized transactions, net of tax benefit (expense) of $0, ($7) and $0 | — | 12 | — | |||||||||
Net actuarial gains (losses) of defined benefit plans: | ||||||||||||
Adjustment, net of tax benefit (expense) of $29, $65 and $61 | (81 | ) | (124 | ) | (154 | ) | ||||||
Reclassification of recognized transactions, net of tax benefit (expense) of ($104), ($28) and ($36) | 160 | 48 | 65 | |||||||||
Prior service cost of defined benefit plans: | ||||||||||||
Adjustment, net of tax benefit (expense) of $1, $5 and ($1) | (2 | ) | (9 | ) | 2 | |||||||
Reclassification of recognized transactions, net of tax benefit (expense) of $0, ($1) and $0 | — | 2 | — | |||||||||
Change in fair value of derivative instrument, net of tax benefit (expense) of $1, $1 and $0 | (3 | ) | (2 | ) | — | |||||||
Other comprehensive income (loss), net of taxes | 77 | (75 | ) | (80 | ) | |||||||
Total comprehensive income | $ | 1,836 | $ | 2,161 | $ | 3,148 | ||||||
See accompanying notes.
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December 31, | ||||||||
Consolidated balance sheets | 2012 | 2011 | ||||||
[Millions of dollars, except share amounts] | ||||||||
Assets | ||||||||
Current assets: | ||||||||
Cash and cash equivalents | $ | 1,416 | $ | 992 | ||||
Short-term investments | 2,549 | 1,943 | ||||||
Accounts receivable, net of allowances of ($31) and ($19) | 1,230 | 1,545 | ||||||
Raw materials | 116 | 115 | ||||||
Work in process | 935 | 1,004 | ||||||
Finished goods | 706 | 669 | ||||||
Inventories | 1,757 | 1,788 | ||||||
Deferred income taxes | 1,044 | 1,174 | ||||||
Prepaid expenses and other current assets | 234 | 386 | ||||||
Total current assets | 8,230 | 7,828 | ||||||
Property, plant and equipment at cost | 6,891 | 7,133 | ||||||
Less accumulated depreciation | (2,979 | ) | (2,705 | ) | ||||
Property, plant and equipment, net | 3,912 | 4,428 | ||||||
Long-term investments | 215 | 265 | ||||||
Goodwill | 4,362 | 4,452 | ||||||
Acquisition-related intangibles, net | 2,558 | 2,900 | ||||||
Deferred income taxes | 280 | 321 | ||||||
Capitalized software licenses, net | 142 | 206 | ||||||
Overfunded retirement plans | 68 | 40 | ||||||
Other assets | 254 | 57 | ||||||
Total assets | $ | 20,021 | $ | 20,497 | ||||
Liabilities and stockholders’ equity | ||||||||
Current liabilities: | ||||||||
Commercial paper borrowings | $ | — | $ | 999 | ||||
Current portion of long-term debt | 1,500 | 382 | ||||||
Accounts payable | 444 | 625 | ||||||
Accrued compensation | 524 | 597 | ||||||
Income taxes payable | 79 | 101 | ||||||
Deferred income taxes | 2 | — | ||||||
Accrued expenses and other liabilities | 881 | 795 | ||||||
Total current liabilities | 3,430 | 3,499 | ||||||
Long-term debt | 4,186 | 4,211 | ||||||
Underfunded retirement plans | 269 | 701 | ||||||
Deferred income taxes | 572 | 607 | ||||||
Deferred credits and other liabilities | 603 | 527 | ||||||
Total liabilities | 9,060 | 9,545 | ||||||
Stockholders’ equity: | ||||||||
Preferred stock, $25 par value. Authorized – 10,000,000 shares. Participating cumulative preferred. None issued. | — | — | ||||||
Common stock, $1 par value. Authorized – 2,400,000,000 shares. Shares issued: 2012 – 1,740,815,939; 2011 – 1,740,630,391 | 1,741 | 1,741 | ||||||
Paid-in capital | 1,176 | 1,194 | ||||||
Retained earnings | 27,205 | 26,278 | ||||||
Less treasury common stock at cost. Shares: 2012 – 632,636,970; 2011 – 601,131,631 | (18,462 | ) | (17,485 | ) | ||||
Accumulated other comprehensive income (loss), net of taxes | (699 | ) | (776 | ) | ||||
Total stockholders’ equity | 10,961 | 10,952 | ||||||
Total liabilities and stockholders’ equity | $ | 20,021 | $ | 20,497 | ||||
See accompanying notes.
4
For Years Ended December 31, | ||||||||||||
Consolidated statements of cash flows | 2012 | 2011 | 2010 | |||||||||
[Millions of dollars] | ||||||||||||
Cash flows from operating activities: | ||||||||||||
Net income | $ | 1,759 | $ | 2,236 | $ | 3,228 | ||||||
Adjustments to net income: | ||||||||||||
Depreciation | 957 | 904 | 865 | |||||||||
Amortization of acquisition-related intangibles | 342 | 111 | 48 | |||||||||
Stock-based compensation | 263 | 269 | 190 | |||||||||
Gain on sales of assets and divestiture | — | (5 | ) | (144 | ) | |||||||
Deferred income taxes | 65 | (119 | ) | (188 | ) | |||||||
Gain on transfer of Japan substitutional pension | (144 | ) | — | — | ||||||||
Increase (decrease) from changes in: | ||||||||||||
Accounts receivable | 311 | 112 | (231 | ) | ||||||||
Inventories | 5 | (17 | ) | (304 | ) | |||||||
Prepaid expenses and other current assets | 227 | (29 | ) | (8 | ) | |||||||
Accounts payable and accrued expenses | 99 | 2 | 57 | |||||||||
Accrued compensation | (82 | ) | (77 | ) | 246 | |||||||
Income taxes payable | (229 | ) | (85 | ) | (19 | ) | ||||||
Changes in funded status of retirement plans | (198 | ) | (7 | ) | 26 | |||||||
Other | 39 | (39 | ) | 54 | ||||||||
Cash flows from operating activities | 3,414 | 3,256 | 3,820 | |||||||||
Cash flows from investing activities: | ||||||||||||
Additions to property, plant and equipment | (495 | ) | (816 | ) | (1,199 | ) | ||||||
Proceeds from insurance recovery, asset sales and divestiture | — | 16 | 148 | |||||||||
Purchases of short-term investments | (2,802 | ) | (3,653 | ) | (2,510 | ) | ||||||
Proceeds from short-term investments | 2,198 | 3,555 | 2,564 | |||||||||
Purchases of long-term investments | (1 | ) | (6 | ) | (8 | ) | ||||||
Proceeds from long-term investments | 61 | 157 | 147 | |||||||||
Business acquisitions, net of cash acquired | — | (5,425 | ) | (199 | ) | |||||||
Cash flows from investing activities | (1,039 | ) | (6,172 | ) | (1,057 | ) | ||||||
Cash flows from financing activities: | ||||||||||||
Proceeds from issuance of long-term debt and commercial paper borrowings | 1,492 | 4,697 | — | |||||||||
Repayment of debt and commercial paper borrowings | (1,375 | ) | (200 | ) | — | |||||||
Dividends paid | (819 | ) | (644 | ) | (592 | ) | ||||||
Stock repurchases | (1,800 | ) | (1,973 | ) | (2,454 | ) | ||||||
Proceeds from common stock transactions | 523 | 690 | 407 | |||||||||
Excess tax benefit from share-based payments | 38 | 31 | 13 | |||||||||
Other | (10 | ) | (12 | ) | — | |||||||
Cash flows from financing activities | (1,951 | ) | 2,589 | (2,626 | ) | |||||||
Net change in cash and cash equivalents | 424 | (327 | ) | 137 | ||||||||
Cash and cash equivalents at beginning of year | 992 | 1,319 | 1,182 | |||||||||
Cash and cash equivalents at end of year | $ | 1,416 | $ | 992 | $ | 1,319 | ||||||
See accompanying notes.
5
Consolidated statements of stockholders’ equity | Common Stock | Paid-in Capital | Retained Earnings | Treasury Common Stock | Accumulated Other Comprehensive Income (Loss) | |||||||||||||||
[Millions of dollars, except per-share amounts] | ||||||||||||||||||||
Balance, December 31, 2009 | $ | 1,740 | $ | 1,086 | $ | 22,066 | $ | (14,549 | ) | $ | (621 | ) | ||||||||
2010 | ||||||||||||||||||||
Net income | — | — | 3,228 | — | — | |||||||||||||||
Dividends declared and paid ($.49 per share) | — | — | (592 | ) | — | — | ||||||||||||||
Common stock issued for stock-based awards | — | (182 | ) | — | 588 | — | ||||||||||||||
Stock repurchases | — | — | — | (2,450 | ) | — | ||||||||||||||
Stock-based compensation | — | 190 | — | — | — | |||||||||||||||
Tax impact from exercise of options | — | 21 | — | — | — | |||||||||||||||
Other comprehensive income (loss), net of taxes | — | — | — | — | (80 | ) | ||||||||||||||
Other | — | (1 | ) | (7 | ) | — | — | |||||||||||||
Balance, December 31, 2010 | 1,740 | 1,114 | 24,695 | (16,411 | ) | (701 | ) | |||||||||||||
2011 | ||||||||||||||||||||
Net income | — | — | 2,236 | — | — | |||||||||||||||
Dividends declared and paid ($.56 per share) | — | — | (644 | ) | — | — | ||||||||||||||
Common stock issued for stock-based awards | 1 | (252 | ) | — | 898 | — | ||||||||||||||
Stock repurchases | — | — | — | (1,973 | ) | — | ||||||||||||||
Stock-based compensation | — | 269 | — | — | — | |||||||||||||||
Tax impact from exercise of options | — | 45 | — | — | — | |||||||||||||||
Other comprehensive income (loss), net of taxes | — | — | — | — | (75 | ) | ||||||||||||||
Other | — | 18 | (9 | ) | 1 | — | ||||||||||||||
Balance, December 31, 2011 | 1,741 | 1,194 | 26,278 | (17,485 | ) | (776 | ) | |||||||||||||
2012 | ||||||||||||||||||||
Net income | — | — | 1,759 | — | — | |||||||||||||||
Dividends declared and paid ($.72 per share) | — | — | (819 | ) | — | — | ||||||||||||||
Common stock issued for stock-based awards | — | (337 | ) | — | 823 | — | ||||||||||||||
Stock repurchases | — | — | — | (1,800 | ) | — | ||||||||||||||
Stock-based compensation | — | 263 | — | — | — | |||||||||||||||
Tax impact from exercise of options | — | 56 | — | — | — | |||||||||||||||
Other comprehensive income (loss), net of taxes | — | — | — | — | 77 | |||||||||||||||
Other | — | — | (13 | ) | — | — | ||||||||||||||
Balance, December 31, 2012 | $ | 1,741 | $ | 1,176 | $ | 27,205 | $ | (18,462 | ) | $ | (699 | ) | ||||||||
See accompanying notes.
6
Notes to financial statements
1. Description of business and significant accounting policies and practices
Business
At Texas Instruments (TI), we design and make semiconductors that we sell to electronics designers and manufacturers all over the world. We have two reportable segments, which are established along major categories of products as follows:
• | Analog – consists of the following major product lines: High Volume Analog & Logic (HVAL), Power Management (Power), High Performance Analog (HPA) and Silicon Valley Analog (SVA). SVA consists of products that we acquired through our purchase of National Semiconductor Corporation (National) in 2011. |
• | Embedded Processing – consists of the following major product lines: Processors, Microcontrollers and Connectivity. |
We report the results of our remaining business activities in Other. As previously announced, we restructured our Wireless business to focus our OMAP™ applications processors and connectivity products (formerly Wireless products) on embedded applications with long life cycles. Consistent with this restructuring, effective January 1, 2013, the Wireless segment was eliminated. Financial results for embedded OMAP applications processors and embedded connectivity products, both of which have many of the same characteristics as the products in our Embedded Processing segment, are now reported in that segment. Financial results for baseband products and Wireless products for the smartphone and consumer tablet markets, both of which are product lines that we have announced we are exiting, are included in Other. We also reclassified certain product lines, primarily radio frequency identification (RFID) products, from Other to Embedded Processing. See Note 16 for additional information on our business segments.
Basis of presentation
The consolidated financial statements have been prepared in accordance with accounting principles generally accepted in the United States (U.S. GAAP). The basis of these financial statements is comparable for all periods presented herein.
The consolidated financial statements include the accounts of all subsidiaries. All intercompany balances and transactions have been eliminated in consolidation. All dollar amounts in the financial statements and tables in these notes, except per-share amounts, are stated in millions of U.S. dollars unless otherwise indicated. We have reclassified certain amounts in the prior periods’ financial statements to conform to the 2012 presentation. The preparation of financial statements requires the use of estimates from which final results may vary.
On September 23, 2011, we completed the acquisition of National. We accounted for this transaction under Accounting Standards Codification (ASC) 805 - Business Combinations, and the consolidated financial statements include the balances and results of operations of National from the date of acquisition. See Note 2 for more detailed information.
Revenue recognition
We recognize revenue from direct sales of our products to our customers, including shipping fees, when title and risk of loss pass to the customer, which usually occurs upon shipment or delivery, depending upon the terms of the sales order; when persuasive evidence of an arrangement exists; when sales amounts are fixed or determinable; and when collectability is reasonably assured. Revenue from sales of our products that are subject to inventory consignment agreements is recognized consistent with the principles discussed above, but delivery occurs when the customer pulls product from consignment inventory that we store at designated locations. Estimates of product returns for quality reasons and of price allowances (based on historical experience, product shipment analysis and customer contractual arrangements) are recorded when revenue is recognized. Allowances include volume-based incentives and special pricing arrangements. In addition, we record allowances for accounts receivable that we estimate may not be collected.
We recognize revenue from direct sales of our products to our distributors, net of allowances, consistent with the principles discussed above. Title transfers to the distributors at delivery or when the products are pulled from consignment inventory, and payment is due on our standard commercial terms; payment terms are not contingent upon resale of the products. We calculate credit allowances based on historical data, current economic conditions and contractual terms. For instance, we sell to distributors at standard published prices, but we may grant them price adjustment credits in response to individual competitive opportunities they may have. To estimate allowances, we use statistical percentages of revenue, determined quarterly, based upon recent historical adjustment trends. We also provide allowances for certain growth-based incentives.
We provide distributors an allowance to scrap certain slow-selling or obsolete products in their inventory, estimated as a negotiated fixed percentage of each distributor’s purchases from us. In addition, if we publish a new price for a product that is lower than that paid by distributors for the same product still remaining in each distributor’s on-hand inventory, we may credit them for the difference between those prices. The allowance for this type of credit is based on the identified product price
7
difference applied to our estimate of each distributor’s on-hand inventory of that product. We believe we can reasonably and reliably estimate allowances for credits to distributors in a timely manner.
We determine the amount and timing of royalty revenue based on our contractual agreements with intellectual property licensees. We recognize royalty revenue when earned under the terms of the agreements and when we consider realization of payment to be probable. Where royalties are based on a percentage of licensee sales of royalty-bearing products, we recognize royalty revenue by applying this percentage to our estimate of applicable licensee sales. We base this estimate on historical experience and an analysis of each licensee’s sales results. Where royalties are based on fixed payment amounts, we recognize royalty revenue ratably over the term of the royalty agreement. Where warranted, revenue from licensees may be recognized on a cash basis.
We include shipping and handling costs in COR.
Advertising costs
We expense advertising and other promotional costs as incurred. This expense was $46 million in 2012, $43 million in 2011 and $44 million in 2010.
Income taxes
We account for income taxes using an asset and liability approach. We record the amount of taxes payable or refundable for the current year and the deferred tax assets and liabilities for future tax consequences of events that have been recognized in the financial statements or tax returns. We record a valuation allowance when it is more likely than not that some or all of the deferred tax assets will not be realized.
Other assessed taxes
Some transactions require us to collect taxes such as sales, value-added and excise taxes from our customers. These transactions are presented in our statements of income on a net (excluded from revenue) basis.
Earnings per share (EPS)
Unvested awards of share-based payments with rights to receive dividends or dividend equivalents, such as our restricted stock units (RSUs), are considered to be participating securities and the two-class method is used for purposes of calculating EPS. Under the two-class method, a portion of net income is allocated to these participating securities and, therefore, is excluded from the calculation of EPS allocated to common stock, as shown in the table below.
Computation and reconciliation of earnings per common share are as follows (shares in millions):
2012 | 2011 | 2010 | |||||||||||||||||||||||||||||||
Net Income | Shares | EPS | Net Income | Shares | EPS | Net Income | Shares | EPS | |||||||||||||||||||||||||
Basic EPS: | |||||||||||||||||||||||||||||||||
Net income | $ | 1,759 | $ | 2,236 | $ | 3,228 | |||||||||||||||||||||||||||
Less income allocated to RSUs | (31 | ) | (35 | ) | (44 | ) | |||||||||||||||||||||||||||
Income allocated to common stock for basic EPS calculation | $ | 1,728 | 1,132 | $ | 1.53 | $ | 2,201 | 1,151 | $ | 1.91 | $ | 3,184 | 1,199 | $ | 2.66 | ||||||||||||||||||
Adjustment for dilutive shares: | |||||||||||||||||||||||||||||||||
Stock-based compensation plans | 14 | 20 | 14 | ||||||||||||||||||||||||||||||
Diluted EPS: | |||||||||||||||||||||||||||||||||
Net income | $ | 1,759 | $ | 2,236 | $ | 3,228 | |||||||||||||||||||||||||||
Less income allocated to RSUs | (31 | ) | (34 | ) | (44 | ) | |||||||||||||||||||||||||||
Income allocated to common stock for diluted EPS calculation | $ | 1,728 | 1,146 | $ | 1.51 | $ | 2,202 | 1,171 | $ | 1.88 | $ | 3,184 | 1,213 | $ | 2.62 | ||||||||||||||||||
8
Potentially dilutive securities representing 52 million, 24 million and 66 million shares of common stock that were outstanding during 2012, 2011 and 2010, respectively, were excluded from the computation of diluted earnings per common share for these periods because their effect would have been anti-dilutive.
Investments
We present investments on our balance sheets as cash equivalents, short-term investments or long-term investments. Specific details are as follows:
• | Cash equivalents and short-term investments: We consider investments in debt securities with maturities of 90 days or less from the date of our investment to be cash equivalents. We consider investments in debt securities with maturities beyond 90 days from the date of our investment as being available for use in current operations and include these investments in short-term investments. The primary objectives of our cash equivalent and short-term investment activities are to preserve capital and maintain liquidity while generating appropriate returns. |
• | Long-term investments: Long-term investments consist of mutual funds, venture capital funds and non-marketable equity securities. Prior to the fourth quarter of 2012, this also included auction-rate securities. |
• | Classification of investments: Depending on our reasons for holding the investment and our ownership percentage, we classify investments in securities as available for sale, trading, or equity- or cost-method investments, which are more fully described in Note 9. We determine cost or amortized cost, as appropriate, on a specific identification basis. |
Inventories
Inventories are stated at the lower of cost or estimated net realizable value. Cost is generally computed on a currently adjusted standard cost basis, which approximates cost on a first-in first-out basis. Standard cost is based on the normal utilization of installed factory capacity. Cost associated with underutilization of capacity is expensed as incurred. Inventory held at consignment locations is included in our finished goods inventory. Consigned inventory was $169 million and $129 million as of December 31, 2012 and 2011, respectively.
We review inventory quarterly for salability and obsolescence. A specific allowance is provided for inventory considered unlikely to be sold. Remaining inventory includes a salability and obsolescence allowance based on an analysis of historical disposal activity. We write off inventory in the period in which disposal occurs.
Property, plant and equipment; acquisition-related intangibles and other capitalized costs
Property, plant and equipment are stated at cost and depreciated over their estimated useful lives using the straight-line method. Our cost basis includes certain assets acquired in business combinations that were initially recorded at fair value as of the date of acquisition. Leasehold improvements are amortized using the straight-line method over the shorter of the remaining lease term or the estimated useful lives of the improvements. We amortize acquisition-related intangibles on a straight-line basis over the estimated economic life of the assets. Capitalized software licenses generally are amortized on a straight-line basis over the term of the license. Fully depreciated or amortized assets are written off against accumulated depreciation or amortization.
Impairments of long-lived assets
We regularly review whether facts or circumstances exist that indicate the carrying values of property, plant and equipment or other long-lived assets, including intangible assets, are impaired. We assess the recoverability of assets by comparing the projected undiscounted net cash flows associated with those assets to their respective carrying amounts. Any impairment charge is based on the excess of the carrying amount over the fair value of those assets. Fair value is determined by available market valuations, if applicable, or by discounted cash flows.
Goodwill and indefinite-lived intangibles
Goodwill is not amortized but is reviewed for impairment annually or more frequently if certain impairment indicators arise. We perform our annual goodwill impairment tests as of October 1 for our reporting units. The test compares the fair value for each reporting unit to its associated carrying value including goodwill. See Note 10 for additional information.
Foreign currency
The functional currency for our non-U.S. subsidiaries is the U.S. dollar. Accounts recorded in currencies other than the U.S. dollar are remeasured into the functional currency. Current assets (except inventories), deferred income taxes, other assets, current liabilities and long-term liabilities are remeasured at exchange rates in effect at the end of each reporting period. Property, plant and equipment with associated depreciation and inventories are remeasured at historic exchange rates. Revenue and expense accounts other than depreciation for each month are remeasured at the appropriate daily rate of exchange. Currency exchange gains and losses from remeasurement are credited or charged to OI&E.
9
Derivatives and hedging
In connection with the issuance of variable-rate long-term debt in May 2011, as more fully described in Note 12, we entered into an interest rate swap designated as a hedge of the variability of cash flows related to interest payments. Gains and losses from changes in the fair value of the interest rate swap are credited or charged to Accumulated other comprehensive income (loss), net of taxes (AOCI).
We also use derivative financial instruments to manage exposure to foreign exchange risk. These instruments are primarily forward foreign currency exchange contracts that are used as economic hedges to reduce the earnings impact exchange rate fluctuations may have on our non-U.S. dollar net balance sheet exposures. Gains and losses from changes in the fair value of these forward foreign currency exchange contracts are credited or charged to OI&E. We do not apply hedge accounting to our foreign currency derivative instruments.
We do not use derivatives for speculative or trading purposes.
Changes in accounting standards
As of December 31, 2012, the Financial Accounting Standards Board had issued several accounting standards that we have not yet been required to adopt. None of these standards would have a material effect on our financial condition, results of operations or financial disclosures.
2. Acquisition-related charges
National acquisition
On September 23, 2011, we completed the acquisition of National by acquiring all issued and outstanding common shares in exchange for total consideration of $6.56 billion. We recognized $3.528 billion of goodwill, which was applied to the Analog segment. None of the goodwill related to the National acquisition was deductible for tax purposes.
We incurred various costs as a result of the acquisition of National that are included in Other consistent with how management measures the performance of its segments. These total acquisition-related charges are as follows:
For Years Ended December 31, | ||||||||
2012 | 2011 | |||||||
Distributor contract termination | $ | 21 | $ | — | ||||
Inventory related | — | 96 | ||||||
Property, plant and equipment related | — | 15 | ||||||
As recorded in COR | 21 | 111 | ||||||
Amortization of intangible assets | 325 | 87 | ||||||
Retention bonuses | 57 | 46 | ||||||
Stock-based compensation | 17 | 50 | ||||||
Severance and other benefits: | ||||||||
Employment reductions announced at closing | 16 | 29 | ||||||
Change of control | — | 41 | ||||||
Transaction and other costs | 35 | 62 | ||||||
As recorded in Acquisition charges | 450 | 315 | ||||||
Total acquisition-related charges | $ | 471 | $ | 426 | ||||
In 2011, we discontinued using one of National’s distributors. We acquired the distributor’s inventory at fair value, resulting in an incremental charge of $21 million to COR upon sale of the inventory in 2012.
At acquisition, we recognized costs associated with the adjustments to write up the value of acquired inventory and property, plant and equipment to fair value. These costs are in addition to the normal expensing of the acquired assets based on their carrying or book value prior to the acquisition. The total fair-value write-up of $96 million for the acquired inventory was expensed as that inventory was sold. The total fair-value write-up for the acquired property, plant and equipment was $436 million. In the fourth quarter of 2011, depreciation was $15 million. It continues at a declining rate and is no longer separately disclosed as an acquisition-related charge.
10
The amount of recognized amortization of acquired intangible assets resulting from the National acquisition is based on estimated useful lives varying between two and ten years. See Note 10 for additional information.
Retention bonuses reflect amounts already or expected to be paid to former National employees who fulfill agreed-upon service period obligations and are recognized ratably over the required service period.
Stock-based compensation was recognized for the accelerated vesting of equity awards upon the termination of employees, with additional compensation being recognized over the applicable vesting period for the remaining grantees.
Severance and other benefits costs were for former National employees who were terminated after the closing date. These costs totaled $70 million for the year ended December 31, 2011, with $41 million in charges related to change of control provisions under existing employment agreements and $29 million in charges for announced employment reductions affecting about 350 jobs. All of these jobs were eliminated by the end of 2012 as a result of redundancies and cost efficiency measures, with approximately $16 million of additional expense recognized in 2012. Of the $86 million in cumulative charges recognized through December 31, 2012, $65 million was paid in 2012 and $14 million was paid in 2011.
Transaction and other costs include various expenses incurred in connection with the National acquisition. In 2011, we also incurred bridge financing costs.
In conformance with Accounting Standards Codification (ASC) 805 – Business Combinations, the following unaudited summaries of pro forma combined results of operation for the years ended December 31, 2011 and 2010, give effect to the acquisition as if it had been completed on January 1, 2010. These pro forma summaries do not reflect any operating efficiencies, cost savings or revenue enhancements that may be achieved by the combined companies. In addition, certain non-recurring expenses, such as restructuring charges and retention bonuses, are not reflected in the pro forma summaries. These pro forma summaries are presented for informational purposes only and are not indicative of what the actual results of operations would have been had the acquisition taken place as of that date, nor are they indicative of future consolidated results of operations.
For Years Ended December 31, | ||||||||
2011 | 2010 | |||||||
(Unaudited) | ||||||||
Revenue | $ | 14,805 | $ | 15,529 | ||||
Net income | 2,438 | 3,218 | ||||||
Earnings per common share – diluted | $ | 2.05 | $ | 2.61 | ||||
Other acquisitions
In October 2010, we acquired our first semiconductor manufacturing site in China, located in the Chengdu High-tech Zone. This acquisition, which was recorded as a business combination, used net cash of $140 million. As contractually agreed, we made an additional payment of $35 million to the seller in October 2011.
In August 2010, we completed the acquisition of two wafer fabs and equipment in Aizu-Wakamatsu, Japan, for net cash of $130 million. The acquisition of the fabs and related 200-millimeter equipment was recorded as a business combination for net cash of $59 million. We also settled a contractual arrangement with a third party for our benefit for net cash of $12 million, which was recorded as a charge in COR in Other. Additionally, we incurred acquisition-related costs of $1 million, which were recorded in SG&A. This acquisition also included 300-millimeter production tools, which we recorded as a capital purchase for net cash of $58 million.
The results of operations for these acquisitions have been included in our financial statements from their respective acquisition dates. Operating results for transitional supply agreements are included in Other. Pro forma financial information for these acquisitions would not be materially different from amounts reported.
11
3. Restructuring charges/other
Restructuring charges/other is comprised of the following components:
For Years Ended December 31, | |||||||||||
2012 | 2011 | 2010 | |||||||||
Restructuring charges by action: | |||||||||||
Restructuring charges | $ | 261 | $ | — | $ | — | |||||
Goodwill impairment | 90 | — | — | ||||||||
2012 Wireless action | 351 | — | — | ||||||||
2011 action | 49 | 112 | — | ||||||||
2008/2009 actions | — | — | 33 | ||||||||
Other: | |||||||||||
Gain on transfer of Japan substitutional pension | (144 | ) | — | — | |||||||
Gain on divested product line | — | — | (144 | ) | |||||||
Other | 8 | — | — | ||||||||
Restructuring charges/other | $ | 264 | $ | 112 | $ | (111 | ) | ||||
Restructuring charges/other recognized by segment are as follows:
For Years Ended December 31, | ||||||||||||
2012 | 2011 | 2010 | ||||||||||
Analog | $ | — | $ | — | $ | 13 | ||||||
Embedded Processing | — | — | 8 | |||||||||
Other | 264 | 112 | (132 | ) | ||||||||
Total | $ | 264 | $ | 112 | $ | (111 | ) | |||||
Restructuring charges
Restructuring charges may consist of voluntary or involuntary severance-related charges, asset-related charges and other costs to exit activities. We recognize voluntary termination benefits when the employee accepts the offered benefit arrangement. We recognize involuntary severance-related charges depending on whether the termination benefits are provided under an ongoing benefit arrangement or under a one-time benefit arrangement. If the former, we recognize the charges once they are probable and the amounts are estimable. If the latter, we recognize the charges once the benefits have been communicated to employees.
Restructuring activities associated with assets are recorded as an adjustment to the basis of the asset, not as a liability. When we commit to a plan to abandon a long-lived asset before the end of its previously estimated useful life, we accelerate the recognition of depreciation to reflect the use of the asset over its shortened useful life. When an asset is held to be sold, we write down the carrying value to its net realizable value and cease depreciation. Restructuring actions may be viewed as an impairment indicator requiring testing of the recoverability of intangible assets, including goodwill.
2012 Wireless action
In November 2012, we announced an action concerning our Wireless business that, when complete, is expected to reduce annualized expenses by about $450 million and will focus our investments on embedded markets with greater potential for sustainable growth. About 1,700 jobs worldwide are expected to be eliminated. The total restructuring charges related to this action will be about $360 million, of which about $245 million will be for severance and related benefits. We recognized $351 million of these costs in the fourth quarter of 2012 in Other consisting of: $245 million for severance and benefit costs and other non-cash items of $3 million of accelerated depreciation of the affected facilities' assets, $13 million for other exit costs and $90 million for the non-tax deductible impairment of goodwill. See Note 10 for additional information on the goodwill impairment charge. We estimate that this action will be substantially complete by the end of 2013. As of December 31, 2012, $4 million has been paid to terminated employees for severance and benefits related to this action.
2011 action
Beginning in the fourth quarter of 2011, we recognized restructuring charges associated with the announced plans to close two older semiconductor manufacturing facilities in Hiji, Japan, and Houston, Texas, in 2013. Each facility employed about 500
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people. The total charge for these closures is estimated at $215 million, of which $161 million has been recognized through December 31, 2012, consisting of: $113 million for severance and benefit costs, $23 million of accelerated depreciation of the facilities’ assets and $25 million for other exit costs. Of the estimated $215 million total cost, about $135 million will be for severance and related benefits, about $30 million will be for accelerated depreciation of facility assets and about $50 million will be for other exit costs. In 2012, $11 million was paid to terminated employees for severance and benefits related to this action.
The restructuring action related to the acquisition of National is discussed in Note 2 and is reflected in Acquisition charges in our Consolidated statements of income.
2008/2009 actions
In October 2008, we announced actions to reduce expenses in our Wireless business, especially our baseband operation. In January 2009, we announced actions that included broad-based employment reductions to align our spending with weakened demand. Combined, these actions eliminated about 3,900 jobs; they were completed in 2009.
The table below reflects the changes in accrued restructuring balances associated with these actions:
2012 Action | 2011 Action | 2008/2009 Actions | ||||||||||||||||||||||||||
Severance and Benefits | Other Charges | Severance and Benefits | Other Charges | Severance and Benefits | Other Charges | Total | ||||||||||||||||||||||
Accrual at December 31, 2009 | $ | — | $ | — | $ | — | $ | — | $ | 84 | $ | 10 | $ | 94 | ||||||||||||||
Restructuring charges | — | — | — | — | 33 | — | 33 | |||||||||||||||||||||
Non-cash items (a) | — | — | — | — | (33 | ) | — | (33 | ) | |||||||||||||||||||
Payments | — | — | — | — | (62 | ) | (2 | ) | (64 | ) | ||||||||||||||||||
Remaining accrual at December 31, 2010 | — | — | — | — | 22 | 8 | 30 | |||||||||||||||||||||
Restructuring charges | — | — | 107 | 5 | — | — | 112 | |||||||||||||||||||||
Non-cash items (a) | — | — | (11 | ) | (5 | ) | — | — | (16 | ) | ||||||||||||||||||
Payments | — | — | — | — | (9 | ) | (1 | ) | (10 | ) | ||||||||||||||||||
Remaining accrual at December 31, 2011 | — | — | 96 | — | 13 | 7 | 116 | |||||||||||||||||||||
Restructuring charges | 245 | 106 | 6 | 43 | — | — | 400 | |||||||||||||||||||||
Non-cash items (a) | — | (106 | ) | 3 | (18 | ) | — | — | (121 | ) | ||||||||||||||||||
Payments | (4 | ) | — | (11 | ) | (22 | ) | (8 | ) | (1 | ) | (46 | ) | |||||||||||||||
Remaining accrual at December 31, 2012 | $ | 241 | $ | — | $ | 94 | $ | 3 | $ | 5 | $ | 6 | $ | 349 | ||||||||||||||
(a) Reflects charges for goodwill impairment, stock-based compensation, impacts of postretirement benefit plans and accelerated depreciation.
The accrual balances above are a component of Accrued expenses and other liabilities or Deferred credits and other liabilities on our Consolidated balance sheets, depending on the expected timing of payment.
Other
Gain on transfer of Japan substitutional pension
During the third quarter of 2012, we transferred the obligations and assets of the substitutional portion of our Japan pension program from the pension trust to the government of Japan, resulting in a net gain of $144 million. See Note 11 for additional details.
Gain on divested product line
In November 2010, we divested a product line previously included in Other for $148 million and recognized a gain in operating profit of $144 million.
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4. Losses associated with the 2011 earthquake in Japan
On March 11, 2011, a magnitude 9.0 earthquake struck near two of our three semiconductor manufacturing facilities in Japan. Our manufacturing site in Miho suffered substantial damage during the earthquake, our facility in Aizu experienced significantly less damage and our site in Hiji was undamaged. We maintain earthquake insurance policies in Japan for limited coverage for property damage and business interruption losses.
In 2011, we incurred cumulative gross operating losses of $101 million related to the earthquake and associated events in Japan. These losses related to property damage, the underutilization expense we incurred from having our manufacturing assets only partially loaded and costs associated with recovery teams assembled from across the world. Gross operating losses do not comprehend any lost revenue.
These losses have been offset by $36 million in cumulative insurance proceeds related to property damage claims ($23 million received in 2011 and $13 million for 2012). Almost all of these costs and proceeds are included in COR in our Consolidated statements of income and are recorded in Other.
In addition, we recognized $172 million in cumulative insurance proceeds through December 31, 2012, ($135 million received in 2012 and $37 million received in 2011) related to business interruption claims. These proceeds are recorded as revenue in our Consolidated statements of income and in Other.
In the third quarter of 2012, we completed discussions with our insurers and their advisors, settling all associated claims against our policies. All claims related to these events have been settled and the proceeds received.
5. Stock-based compensation
We have stock options outstanding to participants under various long-term incentive plans. We also have assumed stock options that were granted by companies that we later acquired. Unless the options are acquisition-related replacement options, the option price per share may not be less than 100 percent of the fair market value of our common stock on the date of the grant. Substantially all the options have a ten-year term and vest ratably over four years. Our options generally continue to vest after the option recipient retires.
We also have RSUs outstanding under the long-term incentive plans. Each RSU represents the right to receive one share of TI common stock on the vesting date, which is generally four years after the date of grant. Upon vesting, the shares are issued without payment by the grantee. RSUs generally do not continue to vest after the recipient’s retirement date. Holders of most RSUs receive an annual cash payment equal to the dividends paid on our common stock.
We have options and RSUs outstanding to non-employee directors under various director compensation plans. The plans generally provide for annual grants of stock options and RSUs, a one-time grant of RSUs to each new non-employee director and the issuance of TI common stock upon the distribution of stock units credited to deferred compensation accounts established for such directors.
We also have an employee stock purchase plan under which options are offered to all eligible employees in amounts based on a percentage of the employee’s compensation, subject to a cap. Under the plan, the option price per share is 85 percent of the fair market value on the exercise date, and options have a three-month term.
Total stock-based compensation expense recognized was as follows:
For Years Ended December 31, | ||||||||||||
2012 | 2011 | 2010 | ||||||||||
Stock-based compensation expense recognized in: | ||||||||||||
Cost of revenue (COR) | $ | 48 | $ | 40 | $ | 36 | ||||||
Research and development (R&D) | 71 | 58 | 53 | |||||||||
Selling, general and administrative (SG&A) | 127 | 121 | 101 | |||||||||
Acquisition charges | 17 | 50 | — | |||||||||
Total | $ | 263 | $ | 269 | $ | 190 | ||||||
These amounts include expense related to non-qualified stock options, RSUs and stock options offered under our employee stock purchase plan and are net of expected forfeitures.
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We issue awards of non-qualified stock options generally with graded vesting provisions (e.g., 25 percent per year for four years). We recognize the related compensation cost on a straight-line basis over the minimum service period required for vesting of the award. For awards to employees who are retirement eligible or nearing retirement eligibility, we recognize compensation cost on a straight-line basis over the longer of the service period required to be performed by the employee in order to earn the award, or a six-month period.
Our RSUs generally vest four years after the date of grant. We recognize the related compensation costs on a straight-line basis over the vesting period.
Fair-value methods and assumptions
We account for all awards granted under our various stock-based compensation plans at fair value. We estimate the fair values for non-qualified stock options under long-term incentive and director compensation plans using the Black-Scholes option-pricing model with the following weighted average assumptions.
2012 | 2011 | 2010 | ||||||||||
Weighted average grant date fair value, per share | $ | 8.31 | $ | 10.37 | $ | 6.61 | ||||||
Weighted average assumptions used: | ||||||||||||
Expected volatility | 30 | % | 30 | % | 32 | % | ||||||
Expected lives (in years) | 7.1 | 6.9 | 6.4 | |||||||||
Risk-free interest rates | 1.40 | % | 2.61 | % | 2.83 | % | ||||||
Expected dividend yields | 2.10 | % | 1.51 | % | 2.08 | % | ||||||
We determine expected volatility on all options granted after July 1, 2005, using available implied volatility rates. We believe that market-based measures of implied volatility are currently the best available indicators of the expected volatility used in these estimates.
We determine expected lives of options based on the historical option exercise experience of our optionees using a rolling ten-year average. We believe the historical experience method is the best estimate of future exercise patterns currently available.
Risk-free interest rates are determined using the implied yield currently available for zero-coupon U.S. government issues with a remaining term equal to the expected life of the options.
Expected dividend yields are based on the approved annual dividend rate in effect and the current market price of our common stock at the time of grant. No assumption for a future dividend rate change is included unless there is an approved plan to change the dividend in the near term.
The fair value per share of RSUs that we grant is determined based on the closing price of our common stock on the date of grant.
Our employee stock purchase plan is a discount-purchase plan and consequently the Black-Scholes option-pricing model is not used to determine the fair value per share of these awards. The fair value per share under this plan equals the amount of the discount.
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Long-term incentive and director compensation plans
Stock option and RSU transactions under our long-term incentive and director compensation plans during 2012 were as follows:
Stock Options | RSUs | |||||||||||||
Shares | Weighted Average Exercise Price per Share | Shares | Weighted Average Grant Date Fair Value per Share | |||||||||||
Outstanding grants, December 31, 2011 | 113,273,394 | $ | 25.79 | 23,358,846 | $ | 25.09 | ||||||||
Granted | 13,508,034 | 32.35 | 5,617,150 | 31.60 | ||||||||||
Vested RSUs | — | — | (4,182,928 | ) | 28.66 | |||||||||
Expired and forfeited | (4,732,514 | ) | 29.78 | (1,417,834 | ) | 26.76 | ||||||||
Exercised | (22,409,816 | ) | 20.32 | — | — | |||||||||
Outstanding grants, December 31, 2012 | 99,639,098 | $ | 27.73 | 23,375,234 | $ | 25.91 | ||||||||
The weighted average grant date fair value of RSUs granted during the years 2012, 2011 and 2010 was $31.60, $33.20 and $23.47 per share, respectively. For the years ended December 31, 2012, 2011 and 2010, the total fair value of shares vested from RSU grants was $120 million, $155 million and $51 million, respectively.
Summarized information about stock options outstanding at December 31, 2012, is as follows:
Stock Options Outstanding | Options Exercisable | ||||||||||||||||
Range of Exercise Price | Number Outstanding (Shares) | Weighted Average Remaining Contractual Life (Years) | Weighted Average Exercise Price per Share | Number Exercisable (Shares) | Weighted Average Exercise Price per Share | ||||||||||||
$ | 9.56 to 10.00 | 4,882 | 0.8 | $ | 9.56 | 4,882 | $ | 9.56 | |||||||||
10.01 to 20.00 | 13,179,570 | 4.5 | 15.32 | 9,619,657 | 15.43 | ||||||||||||
20.01 to 30.00 | 34,637,310 | 4.8 | 24.86 | 27,154,258 | 25.33 | ||||||||||||
30.01 to 38.40 | 51,817,336 | 4.9 | 32.81 | 31,755,628 | 32.59 | ||||||||||||
$ | 9.56 to 38.40 | 99,639,098 | 4.8 | $ | 27.73 | 68,534,425 | $ | 27.30 | |||||||||
During the years ended December 31, 2012, 2011 and 2010, the aggregate intrinsic value (i.e., the difference in the closing market price and the exercise price paid by the optionee) of options exercised was $244 million, $231 million and $140 million, respectively.
Summarized information as of December 31, 2012, about outstanding stock options that are vested and expected to vest, as well as stock options that are currently exercisable, is as follows:
Outstanding Stock Options (Fully Vested and Expected to Vest) (a) | Options Exercisable | |||||||
Number of outstanding (shares) | 96,121,395 | 68,534,425 | ||||||
Weighted average remaining contractual life (in years) | 4.7 | 3.3 | ||||||
Weighted average exercise price per share | $ | 28.75 | $ | 27.30 | ||||
Intrinsic value (millions of dollars) | $ | 398 | $ | 300 | ||||
(a) Includes effects of expected forfeitures of approximately 4 million shares. Excluding the effects of expected forfeitures, the aggregate intrinsic value of stock options outstanding was $414 million.
As of December 31, 2012, the total future compensation cost related to equity awards not yet recognized in the Consolidated statements of income was $460 million, consisting of $143 million related to unvested stock options and $317 million related to RSUs. The $460 million will be recognized as follows: $205 million in 2013, $153 million in 2014, $94 million in 2015 and $8 million in 2016.
Employee stock purchase plan
Options outstanding under the employee stock purchase plan at December 31, 2012, had an exercise price of $27.47 per share (85 percent of the fair market value of TI common stock on the date of automatic exercise). Of the total outstanding options, none were exercisable at year-end 2012.
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Employee stock purchase plan transactions during 2012 were as follows:
Employee Stock Purchase Plan (Shares) | Exercise Price | ||||||
Outstanding grants, December 31, 2011 | 580,095 | $ | 25.29 | ||||
Granted | 2,931,354 | 25.64 | |||||
Exercised | (2,829,498 | ) | 25.12 | ||||
Outstanding grants, December 31, 2012 | 681,951 | $ | 27.47 | ||||
The weighted average grant date fair value of options granted under the employee stock purchase plans during the years 2012, 2011 and 2010 was $4.52, $4.59 and $3.97 per share, respectively. During the years ended December 31, 2012, 2011 and 2010, the total intrinsic value of options exercised under these plans was $13 million, $10 million and $9 million, respectively.
Effect on shares outstanding and treasury shares
Our practice is to issue shares of common stock upon exercise of stock options generally from treasury shares and, on a limited basis, from previously unissued shares. We settled stock option plan exercises using treasury shares of 25,064,951 in 2012; 27,308,311 in 2011 and 19,077,274 in 2010; and previously unissued common shares of 180,955 in 2012; 390,438 in 2011 and 342,380 in 2010.
Upon vesting of RSUs, we issued treasury shares of 3,187,490 in 2012; 3,748,623 in 2011 and 1,392,790 in 2010, and previously unissued common shares of 4,593 in 2012; 73,852 in 2011, with none in 2010.
Shares available for future grant and reserved for issuance are summarized below:
As of December 31, 2012 | |||||||||
Shares | Long-term Incentive and Director Compensation Plans | Employee Stock Purchase Plan | Total | ||||||
Reserved for issuance (a) | 197,554,600 | 25,137,819 | 222,692,419 | ||||||
Shares to be issued upon exercise of outstanding options and RSUs | (123,143,365 | ) | (681,951 | ) | (123,825,316 | ) | |||
Available for future grants | 74,411,235 | 24,455,868 | 98,867,103 | ||||||
(a) Includes 129,033 shares credited to directors’ deferred compensation accounts that settle in shares of TI common stock. These shares are not included as grants outstanding at December 31, 2012.
Effect on cash flows
Cash received from the exercise of options was $523 million in 2012, $690 million in 2011 and $407 million in 2010. The related net tax impact realized was $56 million, $45 million and $21 million (which includes excess tax benefits realized of $38 million, $31 million and $13 million) in 2012, 2011 and 2010, respectively.
6. Profit sharing plans
Profit sharing benefits are generally formulaic and determined by one or more subsidiary or company-wide financial metrics. We pay profit sharing benefits primarily under the company-wide TI Employee Profit Sharing Plan. This plan provides for profit sharing to be paid based solely on TI’s operating margin for the full calendar year. Under this plan, TI must achieve a minimum threshold of 10 percent operating margin before any profit sharing is paid. At 10 percent operating margin, profit sharing will be 2 percent of eligible payroll. The maximum amount of profit sharing available under the plan is 20 percent of eligible payroll, which is paid only if TI’s operating margin is at or above 35 percent for a full calendar year.
We recognized $96 million, $143 million and $279 million of profit sharing expense under the TI Employee Profit Sharing Plan in 2012, 2011 and 2010, respectively.
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7. Income taxes
Income before income taxes
U.S. | Non-U.S. | Total | ||||||||||
2012 | $ | 319 | $ | 1,616 | $ | 1,935 | ||||||
2011 | 1,791 | 1,164 | 2,955 | |||||||||
2010 | 3,769 | 782 | 4,551 | |||||||||
Provision (benefit) for income taxes
U.S. Federal | Non-U.S. | U.S. State | Total | |||||||||||||
2012: | ||||||||||||||||
Current | $ | (43 | ) | $ | 156 | $ | (2 | ) | $ | 111 | ||||||
Deferred | — | 65 | — | 65 | ||||||||||||
Total | $ | (43 | ) | $ | 221 | $ | (2 | ) | $ | 176 | ||||||
2011: | ||||||||||||||||
Current | $ | 692 | $ | 138 | $ | 8 | $ | 838 | ||||||||
Deferred | (154 | ) | 24 | 11 | (119 | ) | ||||||||||
Total | $ | 538 | $ | 162 | $ | 19 | $ | 719 | ||||||||
2010: | ||||||||||||||||
Current | $ | 1,401 | $ | 92 | $ | 18 | $ | 1,511 | ||||||||
Deferred | (188 | ) | (2 | ) | 2 | (188 | ) | |||||||||
Total | $ | 1,213 | $ | 90 | $ | 20 | $ | 1,323 | ||||||||
Principal reconciling items from income tax computed at the statutory federal rate follow:
2012 | 2011 | 2010 | ||||||||||
Computed tax at statutory rate | $ | 677 | $ | 1,034 | $ | 1,593 | ||||||
Non-U.S. effective tax rates | (345 | ) | (245 | ) | (184 | ) | ||||||
U.S. tax benefit for manufacturing | (158 | ) | (31 | ) | (63 | ) | ||||||
Impact of changes to uncertain tax positions | (88 | ) | — | — | ||||||||
Non-deductible expenses | 42 | 27 | 10 | |||||||||
U.S. R&D tax credit | — | (58 | ) | (54 | ) | |||||||
Other | 48 | (8 | ) | 21 | ||||||||
Total provision for income taxes | $ | 176 | $ | 719 | $ | 1,323 | ||||||
The total provision for 2012 in the reconciliation above includes $252 million of discrete tax benefits primarily for additional U.S. tax benefits for manufacturing related to the years 2000 through 2011.
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The primary components of deferred income tax assets and liabilities were as follows:
December 31, | ||||||||
2012 | 2011 | |||||||
Deferred income tax assets: | ||||||||
Inventories and related reserves | $ | 734 | $ | 913 | ||||
Deferred loss and tax credit carryforwards | 382 | 400 | ||||||
Stock-based compensation | 366 | 357 | ||||||
Postretirement benefit costs recognized in AOCI | 357 | 431 | ||||||
Accrued expenses | 331 | 322 | ||||||
Other | 209 | 122 | ||||||
2,379 | 2,545 | |||||||
Less valuation allowance | (221 | ) | (178 | ) | ||||
2,158 | 2,367 | |||||||
Deferred income tax liabilities: | ||||||||
Acquisition-related intangibles and fair-value adjustments | (921 | ) | (1,030 | ) | ||||
Accrued retirement costs (defined benefit and retiree health care) | (243 | ) | (180 | ) | ||||
Property, plant and equipment | (131 | ) | (141 | ) | ||||
International earnings | (102 | ) | (92 | ) | ||||
Other | (11 | ) | (36 | ) | ||||
(1,408 | ) | (1,479 | ) | |||||
Net deferred income tax asset | $ | 750 | $ | 888 | ||||
The deferred income tax assets and liabilities based on tax jurisdictions are presented on the Consolidated balance sheets as follows:
December 31, | ||||||||
2012 | 2011 | |||||||
Current deferred income tax assets | $ | 1,044 | $ | 1,174 | ||||
Noncurrent deferred income tax assets | 280 | 321 | ||||||
Current deferred income tax liabilities | (2 | ) | — | |||||
Noncurrent deferred income tax liabilities | (572 | ) | (607 | ) | ||||
Net deferred income tax asset | $ | 750 | $ | 888 | ||||
We make an ongoing assessment regarding the realization of U.S. and non-U.S. deferred tax assets. In 2012, we recognized a net increase of $43 million in our valuation allowance. This increase was due to valuation allowances on unutilized tax credits. While the net deferred tax assets of $2.16 billion at December 31, 2012, are not assured of realization, our assessment is that a valuation allowance is not required on this balance. This assessment is based on our evaluation of relevant criteria including the existence of deferred tax liabilities that can be used to absorb deferred tax assets, taxable income in prior carryback years and expectations for future taxable income.
We have U.S. and non-U.S. tax loss carryforwards of approximately $175 million, none of which will expire before the year 2023.
A provision has been made for deferred taxes on undistributed earnings of non-U.S. subsidiaries to the extent that dividend
payments from these subsidiaries are expected to result in additional tax liability. The remaining undistributed earnings (approximately $5.54 billion at December 31, 2012) have been indefinitely reinvested; therefore, no provision has been made for taxes due upon remittance of these earnings. The indefinitely reinvested earnings of our non-U.S. subsidiaries are primarily invested in tangible assets such as inventory and property, plant and equipment. Determination of the amount of unrecognized deferred income tax liability is not practical because of the complexities associated with its hypothetical calculation.
Cash payments made for income taxes, net of refunds, were $171 million, $902 million and $1.47 billion for the years ended December 31, 2012, 2011 and 2010, respectively.
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Uncertain tax positions
We operate in a number of tax jurisdictions, and our income tax returns are subject to examination by tax authorities in those jurisdictions who may challenge any item on these tax returns. Because the matters challenged by authorities are typically complex, their ultimate outcome is uncertain. Before any benefit can be recorded in the financial statements, we must determine that it is “more likely than not” that a tax position will be sustained by the appropriate tax authorities. We recognize accrued interest related to uncertain tax positions and penalties as components of OI&E.
The changes in the total amounts of uncertain tax positions are summarized as follows:
2012 | 2011 | 2010 | ||||||||||
Balance, January 1 | $ | 210 | $ | 103 | $ | 56 | ||||||
Additions based on tax positions related to the current year | 12 | 15 | 12 | |||||||||
Additions from the acquisition of National | — | 132 | — | |||||||||
Additions for tax positions of prior years | 45 | 3 | 50 | |||||||||
Reductions for tax positions of prior years | (92 | ) | (39 | ) | (12 | ) | ||||||
Settlements with tax authorities | 39 | (4 | ) | (3 | ) | |||||||
Expiration of the statute of limitations for assessing taxes | (30 | ) | — | — | ||||||||
Balance, December 31 | $ | 184 | $ | 210 | $ | 103 | ||||||
Interest income (expense) recognized in the year ended December 31 | $ | 32 | $ | 1 | $ | (2 | ) | |||||
Interest receivable (payable) as of December 31 | $ | 8 | $ | (3 | ) | $ | 5 | |||||
The liability for uncertain tax positions is a component of Deferred credits and other liabilities on our December 31, 2012, balance sheet. The interest receivable is a component of Other assets on our December 31, 2012, balance sheet.
Within the $184 million liability for uncertain tax positions as of December 31, 2012, are positions totaling $159 million that, if recognized, would impact the tax rate. If these tax liabilities are ultimately realized, $78 million of existing deferred tax assets would also be realized, primarily related to refunds from counterparty jurisdictions resulting from procedures for relief from double taxation. Regarding the $184 million liability:
• | About $60 million of the liability represents uncertain tax positions for tax years in jurisdictions in which audit assessments have not been made. The liability is primarily related to transfer pricing issues for which procedures for relief from double taxation will mitigate the tax rate impact of any difference between the actual tax assessments and our estimates. The increase in the liability for transfer pricing issues for the next 12 months is expected to be about $10 million. |
• | About $30 million of the liability represents audit assessments subject to ongoing procedures for relief from double taxation. Settlement of the $30 million is subject to timely completion of the tax treaty processes and may be settled within the next 12 months. Settlement would not have a significant tax rate impact, as the tax rates of the counterparty jurisdictions are similar. |
• | The balance of the liability represents tax adjustments that are known and currently before the tax authorities or otherwise identified by the company as adjustments to filed returns. Settlement of these matters at the known amounts will not have any additional tax rate impact. Based on the expected settlement dates of various income tax examinations, the anticipated reduction in these uncertain tax positions during the next 12 months could range between about $30 million and $60 million. |
Within the $210 million liability for uncertain tax positions as of December 31, 2011, are uncertain tax positions totaling $233 million that, if recognized, would impact the tax rate. If these tax liabilities are ultimately realized, $83 million of deferred tax assets would also be realized, primarily related to refunds from counterparty jurisdictions resulting from procedures for relief from double taxation.
As of December 31, 2012, the statute of limitations remains open for U.S. federal tax returns for 2000 and following years. Audit activities related to our U.S. federal tax returns through 2008 have been completed except for certain pending tax treaty procedures for relief from double taxation. These procedures pertain to U.S. federal tax returns for the years 2003 through 2008. U.S. federal tax returns for National are currently under audit for tax years through fiscal year 2012.
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In non-U.S. jurisdictions, the years open to audit represent the years still open under the statute of limitations. With respect to major jurisdictions outside the U.S., our subsidiaries are no longer subject to income tax audits for years before 2005.
8. Financial instruments and risk concentration
Financial instruments
We hold derivative financial instruments such as forward foreign currency exchange contracts and interest rate swaps, the fair value of which was not material as of December 31, 2012. Our forward foreign currency exchange contracts outstanding as of December 31, 2012, had a notional value of $305 million to hedge our non-U.S. dollar net balance sheet exposures, including $140 million to sell Japanese yen, $26 million to sell Chinese yuan and $26 million to sell British pound sterling.
Our investments in cash equivalents, short-term investments and certain long-term investments, as well as our postretirement plan assets and deferred compensation liabilities, are carried at fair value, which is described in Note 9. The carrying values for other current financial assets and liabilities, such as accounts receivable and accounts payable, approximate fair value due to the short maturity of such instruments. The carrying value of our long-term debt approximates the fair value as measured using broker-dealer quotes, which are Level 2 inputs. See Note 9 for the definition of Level 2 inputs.
Risk concentration
Financial instruments that could subject us to concentrations of credit risk are primarily cash, cash equivalents, short-term investments and accounts receivable. To manage our credit risk exposure, we place cash investments in investment-grade debt securities and limit the amount of credit exposure to any one issuer. We also limit counterparties on financial derivative contracts to financial institutions with investment-grade ratings.
Concentrations of credit risk with respect to accounts receivable are limited due to our large number of customers and their dispersion across different industries and geographic areas. We maintain allowances for expected returns, disputes, adjustments, incentives and collectability. These allowances are deducted from accounts receivable on our Consolidated balance sheets.
Details of these Accounts receivable allowances are as follows:
Accounts receivable allowances | Balance at Beginning of Year | Additions Charged (Credited) to Operating Results | Recoveries and Write-offs, Net | Balance at End of Year | ||||||||||||
2012 | $ | 19 | $ | 12 | $ | — | $ | 31 | ||||||||
2011 | 18 | 1 | — | 19 | ||||||||||||
2010 | 23 | (4 | ) | (1 | ) | 18 | ||||||||||
9. Valuation of debt and equity investments and certain liabilities
Debt and equity investments
We classify our investments as available for sale, trading, equity method or cost method. Most of our investments are classified as available for sale.
Available-for-sale and trading securities are stated at fair value, which is generally based on market prices, broker quotes or, when necessary, financial models (see fair-value discussion below). Unrealized gains and losses on available-for-sale securities are recorded as an increase or decrease, net of taxes, in AOCI on our Consolidated balance sheets. We record other-than-temporary impairments on available-for-sale securities in OI&E in our Consolidated statements of income.
We classify certain mutual funds as trading securities. These mutual funds hold a variety of debt and equity investments intended to generate returns that offset changes in certain deferred compensation liabilities. We record changes in the fair value of these mutual funds and the related deferred compensation liabilities in SG&A. Changes in the fair value of debt securities classified as trading securities are recorded in OI&E.
Our other investments are not measured at fair value but are accounted for using either the equity method or cost method. These investments consist of interests in venture capital funds and other non-marketable equity securities. Gains and losses from equity-method investments are reflected in OI&E based on our ownership share of the investee’s financial results. Gains and losses on cost-method investments are recorded in OI&E when realized or when an impairment of the investment’s value is warranted based on our assessment of the recoverability of each investment.
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Details of our investments and related unrealized gains and losses included in AOCI are as follows:
December 31, 2012 | December 31, 2011 | |||||||||||||||||||||||
Cash and Cash Equivalents | Short-term Investments | Long-term Investments | Cash and Cash Equivalents | Short-term Investments | Long-term Investments | |||||||||||||||||||
Measured at fair value: | ||||||||||||||||||||||||
Available-for-sale securities | ||||||||||||||||||||||||
Money market funds | $ | 211 | $ | — | $ | — | $ | 55 | $ | — | $ | — | ||||||||||||
Corporate obligations | 188 | 325 | — | 135 | 159 | — | ||||||||||||||||||
U.S. Government agency and Treasury securities | 795 | 2,224 | — | 430 | 1,691 | — | ||||||||||||||||||
Auction-rate securities | — | — | — | — | — | 41 | ||||||||||||||||||
Trading securities | ||||||||||||||||||||||||
Auction-rate securities | — | — | — | — | 93 | — | ||||||||||||||||||
Mutual funds | — | — | 159 | — | — | 169 | ||||||||||||||||||
Total | 1,194 | 2,549 | 159 | 620 | 1,943 | 210 | ||||||||||||||||||
Other measurement basis: | ||||||||||||||||||||||||
Equity-method investments | — | — | 34 | — | — | 32 | ||||||||||||||||||
Cost-method investments | — | — | 22 | — | — | 23 | ||||||||||||||||||
Cash on hand | 222 | — | — | 372 | — | — | ||||||||||||||||||
Total | $ | 1,416 | $ | 2,549 | $ | 215 | $ | 992 | $ | 1,943 | $ | 265 | ||||||||||||
Amounts included in AOCI from available-for-sale securities: | ||||||||||||||||||||||||
Unrealized gains (pre-tax) | $ | — | $ | — | $ | — | $ | — | $ | — | $ | — | ||||||||||||
Unrealized losses (pre-tax) | $ | — | $ | — | $ | — | $ | — | $ | — | $ | 5 | ||||||||||||
At December 31, 2012, we had no significant unrealized losses associated with our available-for-sale investments. We have determined that our remaining available-for-sale investments with unrealized losses are not other-than-temporarily impaired as we expect to recover the entire cost basis of these securities. We do not intend to sell these investments, nor do we expect to be required to sell these investments, before a recovery of the cost basis. We did not recognize any credit losses related to available-for-sale investments for the years ended December 31, 2012 and 2011. During the third quarter of 2012, we sold all of our remaining investments in auction-rate securities.
For the years ended December 31, 2012, 2011 and 2010, the proceeds from sales, redemptions and maturities of short-term available-for-sale investments were $2.20 billion, $3.55 billion and $2.56 billion, respectively. Gross realized gains and losses from these sales were not significant.
The following table presents the aggregate maturities of investments in debt securities classified as available for sale at
December 31, 2012:
Due | Fair Value | |||
One year or less | $ | 3,343 | ||
One to three years | 400 | |||
Gross realized gains and losses from sales of long-term investments were not significant for 2012, 2011 or 2010. Other-than-temporary declines and impairments in the values of these investments recognized in OI&E were $7 million, $2 million and $1 million in 2012, 2011 and 2010, respectively.
22
Fair-value considerations
We measure and report certain financial assets and liabilities at fair value on a recurring basis. Fair value is defined as the price that would be received to sell an asset or paid to transfer a liability (an exit price) in the principal or most advantageous market for the asset or liability in an orderly transaction between market participants on the measurement date.
The three-level hierarchy discussed below indicates the extent and level of judgment used to estimate fair-value measurements.
Level 1 – | Uses unadjusted quoted prices that are available in active markets for identical assets or liabilities as of the reporting date. |
Level 2 – | Uses inputs other than Level 1 that are either directly or indirectly observable as of the reporting date through correlation with market data, including quoted prices for similar assets and liabilities in active markets and quoted prices in markets that are not active. Level 2 also includes assets and liabilities that are valued using models or other pricing methodologies that do not require significant judgment since the input assumptions used in the models, such as interest rates and volatility factors, are corroborated by readily observable data. Our Level 2 assets consist of corporate obligations and some U.S. government agency and Treasury securities. We utilize a third-party data service to provide Level 2 valuations, verifying these valuations for reasonableness relative to unadjusted quotes obtained from brokers or dealers based on observable prices for similar assets in active markets. |
Level 3 – | Uses inputs that are unobservable, supported by little or no market activity and reflect the use of significant management judgment. These values are generally determined using pricing models that utilize management estimates of market participant assumptions. |
The following are our assets and liabilities that were accounted for at fair value on a recurring basis as of December 31, 2012 and 2011. These tables do not include cash on hand, assets held by our postretirement plans, or assets and liabilities that are measured at historical cost or any basis other than fair value.
Fair Value December 31, 2012 | Level 1 | Level 2 | Level 3 | |||||||||||||
Assets | ||||||||||||||||
Money market funds | $ | 211 | $ | 211 | $ | — | $ | — | ||||||||
Corporate obligations | 513 | — | 513 | — | ||||||||||||
U.S. Government agency and Treasury securities | 3,019 | 1,145 | 1,874 | — | ||||||||||||
Mutual funds | 159 | 159 | — | — | ||||||||||||
Total assets | $ | 3,902 | $ | 1,515 | $ | 2,387 | $ | — | ||||||||
Liabilities | ||||||||||||||||
Deferred compensation | $ | 174 | $ | 174 | $ | — | $ | — | ||||||||
Total liabilities | $ | 174 | $ | 174 | $ | — | $ | — | ||||||||
Fair Value December 31, 2011 | Level 1 | Level 2 | Level 3 | |||||||||||||
Assets | ||||||||||||||||
Money market funds | $ | 55 | $ | 55 | $ | — | $ | — | ||||||||
Corporate obligations | 294 | — | 294 | — | ||||||||||||
U.S. Government agency and Treasury securities | 2,121 | 606 | 1,515 | — | ||||||||||||
Auction-rate securities | 134 | — | — | 134 | ||||||||||||
Mutual funds | 169 | 169 | — | — | ||||||||||||
Total assets | $ | 2,773 | $ | 830 | $ | 1,809 | $ | 134 | ||||||||
Liabilities | ||||||||||||||||
Deferred compensation | $ | 191 | $ | 191 | $ | — | $ | — | ||||||||
Total liabilities | $ | 191 | $ | 191 | $ | — | $ | — | ||||||||
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The following table summarizes the change in the fair values for Level 3 assets and liabilities for the years ended December 31, 2012 and 2011.
Level 3 | ||||||||
Auction-rate Securities | Contingent Consideration | |||||||
Balance, December 31, 2010 | $ | 257 | $ | 8 | ||||
Change in fair value of contingent consideration – included in operating profit | — | (8 | ) | |||||
Change in unrealized loss – included in AOCI | (1 | ) | — | |||||
Redemptions and sales | (122 | ) | — | |||||
Balance, December 31, 2011 | 134 | — | ||||||
Change in unrealized loss – included in AOCI | 13 | — | ||||||
Redemptions | (84 | ) | — | |||||
Sales | (63 | ) | — | |||||
Balance, December 31, 2012 | $ | — | $ | — | ||||
10. Goodwill and acquisition-related intangibles
The following table summarizes the changes in goodwill by segment for the years ended December 31, 2012 and 2011.
Analog | Embedded Processing | Other | Total | |||||||||||||
Goodwill, December 31, 2010 | $ | 630 | $ | 172 | $ | 122 | $ | 924 | ||||||||
Additions from acquisitions | 3,528 | — | — | 3,528 | ||||||||||||
Goodwill, December 31, 2011 | 4,158 | 172 | 122 | 4,452 | ||||||||||||
Impairment | — | — | (90 | ) | (90 | ) | ||||||||||
Goodwill, December 31, 2012 | $ | 4,158 | $ | 172 | $ | 32 | $ | 4,362 | ||||||||
We performed our annual goodwill impairment test as of October 1, 2012, and determined the fair value of each of our reporting units was in excess of its carrying value. Determination of fair value was based upon management estimates and judgment, using unobservable inputs in discounted cash flow models to calculate the fair value of each reporting unit. These unobservable inputs are considered Level 3 measurements.
In November 2012, as a result of unsuccessful efforts to divest certain Wireless product lines and the subsequent decision to restructure and wind down those product lines, we reassessed the recoverability of the goodwill associated with the former Wireless segment. We determined its fair value, using a discounted cash flow analysis, was less than the carrying amount and, therefore, performed the required second step of the impairment analysis to determine the amount of the impairment charge. We deducted the fair value of the former Wireless segment from the total of the estimated fair values of the segment's identifiable assets and liabilities, including intangible assets with no carrying value. This calculation resulted in an implied negative fair value of goodwill. As a result, we recognized a non-cash, non-tax deductible impairment charge of $90 million for all the associated goodwill of the former Wireless segment. We recognized this impairment in Restructuring charges/other in the Consolidated statements of income, as discussed in Note 3. There was no impairment of goodwill during 2011 or 2010.
24
The addition to Analog goodwill in 2011 was from the National acquisition. We also recognized other intangible assets associated with this acquisition of $2.96 billion, primarily for developed technology and customer relationships. In 2012, we had no additional intangible assets from an acquisition. The components of acquisition-related intangible assets as of December 31, 2012 and 2011, are as follows:
December 31, 2012 | December 31, 2011 | |||||||||||||||||||||||||
Amortization Period (Years) | Gross Carrying Amount | Accumulated Amortization | Net | Gross Carrying Amount | Accumulated Amortization | Net | ||||||||||||||||||||
Acquisition-related intangibles: | ||||||||||||||||||||||||||
Developed technology | 4 - 10 | $ | 2,145 | $ | 312 | $ | 1,833 | $ | 2,089 | $ | 91 | $ | 1,998 | |||||||||||||
Customer relationships | 5 - 8 | 821 | 137 | 684 | 822 | 34 | 788 | |||||||||||||||||||
Other intangibles | 2 - 7 | 46 | 36 | 10 | 50 | 29 | 21 | |||||||||||||||||||
In-process R&D | (a) | 31 | n/a | 31 | 93 | n/a | 93 | |||||||||||||||||||
Total | $ | 3,043 | $ | 485 | $ | 2,558 | $ | 3,054 | $ | 154 | $ | 2,900 | ||||||||||||||
(a) In-process R&D is not amortized until the associated project has been completed. Alternatively, if the associated project is determined not to be viable, it will be expensed.
Amortization of acquisition-related intangibles was $342 million, $111 million and $48 million for 2012, 2011 and 2010, respectively, primarily related to developed technology. Amortization expenses related to the National acquisition were $325 million and $87 million for 2012 and 2011, respectively. Future estimated amortization of acquisition-related intangibles for the years ended December 31 is as follows:
2013 | $ | 335 | |
2014 | 321 | ||
2015 | 319 | ||
2016 | 319 | ||
2017 | 318 | ||
Thereafter | 946 | ||
11. Postretirement benefit plans
Plan descriptions
We have various employee retirement plans including defined benefit, defined contribution and retiree health care benefit plans. For qualifying employees, we offer deferred compensation arrangements. As a part of the National acquisition, we assumed the assets and liabilities of its defined benefit plans, primarily those associated with the United Kingdom and Germany.
U.S. retirement plans:
Our principal retirement plans in the U.S. are qualified and non-qualified defined benefit pension plans (all of which were closed to new participants after November 1997), a defined contribution plan and an enhanced defined contribution plan. The defined benefit pension plans include employees still accruing benefits as well as employees and participants who no longer accrue service-related benefits, but instead, may participate in the enhanced defined contribution plan.
Both defined contribution plans offer an employer-matching savings option that allows employees to make pre-tax contributions to various investment choices, including a TI common stock fund. Employees who elected to continue accruing a benefit in the qualified defined benefit pension plans may also participate in the defined contribution plan, where employer-matching contributions are provided for up to 2 percent of the employee’s annual eligible earnings. Employees who elected not to continue accruing a benefit in the defined benefit pension plans, and employees hired after November 1997 and through December 31, 2003, may participate in the enhanced defined contribution plan. This plan provides for a fixed employer contribution of 2 percent of the employee’s annual eligible earnings, plus an employer-matching contribution of up to 4 percent of the employee’s annual eligible earnings. Employees hired after December 31, 2003, do not receive the fixed employer contribution of 2 percent of the employee’s annual eligible earnings.
At December 31, 2012 and 2011, as a result of employees’ elections, TI’s U.S. defined contribution plans held shares of TI common stock totaling 20 million shares and 22 million shares valued at $610 million and $639 million, respectively. Dividends paid on these shares for 2012 and 2011 were $16 million and $13 million, respectively.
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Our aggregate expense for the U.S. defined contribution plans was $70 million in 2012, $55 million in 2011 and $50 million in 2010.
Benefits under the qualified defined benefit pension plan are determined using a formula based upon years of service and the highest five consecutive years of compensation. We intend to contribute amounts to this plan to meet the minimum funding requirements of applicable local laws and regulations, plus such additional amounts as we deem appropriate. The non-qualified defined benefit plans are unfunded and closed to new participants.
U.S. retiree health care benefit plan:
U.S. employees who meet eligibility requirements are offered medical coverage during retirement. We make a contribution toward the cost of those retiree medical benefits for certain retirees and their dependents. The contribution rates are based upon various factors, the most important of which are an employee’s date of hire, date of retirement, years of service and eligibility for Medicare benefits. The balance of the cost is borne by the plan’s participants. Employees hired after January 1, 2001, are responsible for the full cost of their medical benefits during retirement.
Non-U.S. retirement plans:
We provide retirement coverage for non-U.S. employees, as required by local laws or to the extent we deem appropriate, through a number of defined benefit and defined contribution plans. Retirement benefits are generally based on an employee’s years of service and compensation. Funding requirements are determined on an individual country and plan basis and are subject to local country practices and market circumstances.
As of December 31, 2012 and 2011, as a result of employees’ elections, TI’s non-U.S. defined contribution plans held TI common stock valued at $13 million and $12 million, respectively. Dividends paid on these shares of TI common stock for 2012 and 2011 were not material.
Effect on the statements of income and balance sheets
Expense related to defined benefit and retiree health care benefit plans was as follows:
U.S. Defined Benefit | U.S. Retiree Health Care | Non-U.S. Defined Benefit | ||||||||||||||||||||||||||||||||||
2012 | 2011 | 2010 | 2012 | 2011 | 2010 | 2012 | 2011 | 2010 | ||||||||||||||||||||||||||||
Service cost | $ | 24 | $ | 22 | $ | 20 | $ | 5 | $ | 4 | $ | 4 | $ | 45 | $ | 41 | $ | 37 | ||||||||||||||||||
Interest cost | 44 | 46 | 45 | 25 | 25 | 26 | 75 | 69 | 62 | |||||||||||||||||||||||||||
Expected return on plan assets | (50 | ) | (45 | ) | (49 | ) | (23 | ) | (21 | ) | (23 | ) | (78 | ) | (83 | ) | (73 | ) | ||||||||||||||||||
Amortization of prior service cost (credit) | 1 | 1 | 1 | 3 | 2 | 2 | (4 | ) | (4 | ) | (3 | ) | ||||||||||||||||||||||||
Recognized net actuarial loss | 16 | 23 | 22 | 13 | 13 | 12 | 41 | 40 | 30 | |||||||||||||||||||||||||||
Net periodic benefit costs | 35 | 47 | 39 | 23 | 23 | 21 | 79 | 63 | 53 | |||||||||||||||||||||||||||
Settlement charges (a) (b) | — | — | 37 | — | — | — | 193 | — | — | |||||||||||||||||||||||||||
Curtailment charges (credits) | — | — | — | (1 | ) | 5 | — | — | 2 | — | ||||||||||||||||||||||||||
Special termination benefit charges (credits) (b) | (1 | ) | 4 | — | — | — | — | (337 | ) | — | — | |||||||||||||||||||||||||
Total, including charges | $ | 34 | $ | 51 | $ | 76 | $ | 22 | $ | 28 | $ | 21 | $ | (65 | ) | $ | 65 | $ | 53 | |||||||||||||||||
(a) Includes restructuring and non-restructuring-related settlement charges.
(b) In Japan, we maintain employee pension fund plans (EPFs) pursuant to the Japanese Welfare Pension Insurance Law(JWPIL). An EPF consists of two portions: a substitutional portion based on JWPIL-determined minimum old-age pension benefits similar to Social Security benefits in the United States; and a corporate portion established at the discretion of each employer. Employers and employees are exempt from contributing to the Japanese Pension Insurance (JPI) if the substitutional portion is funded by an EPF.
The JWPIL was amended to permit each EPF to separate the substitutional portion and transfer those obligations and related assets to the government of Japan. After such a transfer, the employer is required to contribute periodically to JPI, and the government of Japan is responsible for future benefit payments relating to the substitutional portion.
During the third quarter of 2012, our EPF received final approval for such a separation and transferred the obligations and assets of its substitutional portion to the government of Japan. On a pre-tax basis, this resulted in a net gain of
26
$144 million recorded in Restructuring charges/other on our Consolidated statements of income and included in Other. This net gain of $144 million consisted of two parts - a gain of $337 million, representing the difference between the fair values of the obligations settled ($533 million) and the assets transferred from the pension trust to the government of Japan ($196 million), offset by a settlement loss of $193 million related to the recognition of previously unrecognized actuarial losses included in AOCI.
For the U.S. qualified pension and retiree health care plans, the expected return on the plan assets component of net periodic benefit cost is based upon a market-related value of assets. In accordance with U.S. GAAP, the market-related value of assets is adjusted by a smoothing technique whereby certain gains and losses are phased in over a period of three years.
Changes in the benefit obligations and plan assets for the defined benefit and retiree health care benefit plans were as follows:
U.S. Defined Benefit | U.S. Retiree Health Care | Non-U.S. Defined Benefit | ||||||||||||||||||||||
2012 | 2011 | 2012 | 2011 | 2012 | 2011 | |||||||||||||||||||
Change in plan benefit obligation: | ||||||||||||||||||||||||
Benefit obligation at beginning of year | $ | 959 | $ | 880 | $ | 521 | $ | 473 | $ | 2,748 | $ | 2,217 | ||||||||||||
Service cost | 24 | 22 | 5 | 4 | 45 | 41 | ||||||||||||||||||
Interest cost | 44 | 46 | 25 | 25 | 75 | 69 | ||||||||||||||||||
Participant contributions | — | — | 17 | 18 | 1 | 1 | ||||||||||||||||||
Benefits paid | (45 | ) | (52 | ) | (47 | ) | (43 | ) | (83 | ) | (72 | ) | ||||||||||||
Medicare subsidy | — | — | 5 | 4 | — | — | ||||||||||||||||||
Actuarial (gain) loss | 116 | 61 | (17 | ) | 19 | 222 | 91 | |||||||||||||||||
Settlements | — | — | — | — | (533 | ) | (1 | ) | ||||||||||||||||
Curtailments | 1 | (2 | ) | (1 | ) | 4 | — | (3 | ) | |||||||||||||||
Assumed with National acquisition | — | — | — | — | — | 301 | ||||||||||||||||||
Special termination benefit charges (credits) | (1 | ) | 4 | — | — | — | — | |||||||||||||||||
Plan amendments | — | — | 1 | 17 | — | — | ||||||||||||||||||
Effects of exchange rate changes | — | — | — | — | (61 | ) | 104 | |||||||||||||||||
Benefit obligation at end of year (BO) | $ | 1,098 | $ | 959 | $ | 509 | $ | 521 | $ | 2,414 | $ | 2,748 | ||||||||||||
Change in plan assets: | ||||||||||||||||||||||||
Fair value of plan assets at beginning of year | $ | 914 | $ | 833 | $ | 431 | $ | 404 | $ | 2,211 | $ | 1,835 | ||||||||||||
Actual return on plan assets | 95 | 106 | 37 | 6 | 207 | 53 | ||||||||||||||||||
Employer contributions (funding of qualified plans) | 104 | 25 | 78 | 46 | 134 | 72 | ||||||||||||||||||
Employer contributions (payments for non-qualified plans) | 3 | 2 | — | — | — | — | ||||||||||||||||||
Participant contributions | — | — | 17 | 18 | 1 | 1 | ||||||||||||||||||
Assumed with National acquisition | — | — | — | — | — | 235 | ||||||||||||||||||
Benefits paid | (45 | ) | (52 | ) | (46 | ) | (43 | ) | (83 | ) | (72 | ) | ||||||||||||
Settlements | — | — | — | — | (196 | ) | (1 | ) | ||||||||||||||||
Effects of exchange rate changes | — | — | — | — | (56 | ) | 88 | |||||||||||||||||
Fair value of plan assets at end of year (FVPA) | $ | 1,071 | $ | 914 | $ | 517 | $ | 431 | $ | 2,218 | $ | 2,211 | ||||||||||||
Funded status (FVPA – BO) at end of year | $ | (27 | ) | $ | (45 | ) | $ | 8 | $ | (90 | ) | $ | (196 | ) | $ | (537 | ) | |||||||
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Amounts recognized on the balance sheet as of December 31, 2012, were as follows:
U.S. Defined Benefit | U.S. Retiree Health Care | Non-U.S. Defined Benefit | Total | |||||||||||||
Overfunded retirement plans | $ | 34 | $ | 12 | $ | 22 | $ | 68 | ||||||||
Accrued expenses and other liabilities | (8 | ) | — | (6 | ) | (14 | ) | |||||||||
Underfunded retirement plans | (53 | ) | (4 | ) | (212 | ) | (269 | ) | ||||||||
Funded status (FVPA – BO) at end of year | $ | (27 | ) | $ | 8 | $ | (196 | ) | $ | (215 | ) | |||||
Amounts recognized on the balance sheet as of December 31, 2011, were as follows:
U.S. Defined Benefit | U.S. Retiree Health Care | Non-U.S. Defined Benefit | Total | |||||||||||||
Overfunded retirement plans | $ | 11 | $ | — | $ | 29 | $ | 40 | ||||||||
Accrued expenses and other liabilities | (2 | ) | — | (9 | ) | (11 | ) | |||||||||
Underfunded retirement plans | (54 | ) | (90 | ) | (557 | ) | (701 | ) | ||||||||
Funded status (FVPA – BO) at end of year | $ | (45 | ) | $ | (90 | ) | $ | (537 | ) | $ | (672 | ) | ||||
Contributions to the plans meet or exceed all minimum funding requirements. We expect to contribute about $100 million to our retirement benefit plans in 2013. The amounts shown for underfunded U.S. defined benefit plans were for non-qualified pension plans. Because contributions to those non-qualified plans are not tax deductible until the benefit is actually paid to the employee, we do not fund them. As of December 31, 2012 and 2011, the unfunded benefit obligations of those non-qualified plans were $61 million and $56 million, respectively.
Accumulated benefit obligations, which represent the benefit obligations excluding the impact of future salary increases, were $1.01 billion and $875 million at year-end 2012 and 2011, respectively, for the U.S. defined benefit plans, and $2.23 billion and $2.54 billion at year-end 2012 and 2011, respectively, for the non-U.S. defined benefit plans.
The amounts recorded in AOCI for the years ended December 31, 2012 and 2011, are detailed below by plan type:
U.S. Defined Benefit | U.S. Retiree Health Care | Non-U.S. Defined Benefit | Total | |||||||||||||||||||||||||||||
Net Actuarial Loss | Prior Service Cost | Net Actuarial Loss | Prior Service Cost | Net Actuarial Loss | Prior Service Cost | Net Actuarial Loss | Prior Service Cost | |||||||||||||||||||||||||
AOCI balance, December 31, 2011, net of taxes | $ | 140 | $ | — | $ | 140 | $ | 14 | $ | 500 | $ | (23 | ) | $ | 780 | $ | (9 | ) | ||||||||||||||
Changes in AOCI by category in 2012: | ||||||||||||||||||||||||||||||||
Annual adjustments | 72 | — | (31 | ) | 1 | 68 | 2 | 109 | 3 | |||||||||||||||||||||||
Reclassification of recognized transactions | (16 | ) | (1 | ) | (13 | ) | (3 | ) | (234 | ) | 4 | (263 | ) | — | ||||||||||||||||||
Less tax expense (benefit) | (20 | ) | — | 16 | 1 | 79 | (2 | ) | 75 | (1 | ) | |||||||||||||||||||||
Total change to AOCI in 2012 | 36 | (1 | ) | (28 | ) | (1 | ) | (87 | ) | 4 | (79 | ) | 2 | |||||||||||||||||||
AOCI balance, December 31, 2012, net of taxes | $ | 176 | $ | (1 | ) | $ | 112 | $ | 13 | $ | 413 | $ | (19 | ) | $ | 701 | $ | (7 | ) | |||||||||||||
The estimated amounts of net actuarial loss and unrecognized prior service cost (credit) included in AOCI as of December 31, 2012, that are expected to be amortized into net periodic benefit cost over the next fiscal year are: $23 million and $1 million for the U.S. defined benefit plans; $11 million and $4 million for the U.S. retiree health care plan; and $39 million and ($4) million for the non-U.S. defined benefit plans.
28
Information on plan assets
We report and measure the plan assets of our defined benefit pension and other postretirement plans at fair value. The tables below set forth the fair value of our plan assets as of December 31, 2012 and 2011, using the same three-level hierarchy of fair-value inputs described in Note 9.
Fair Value December 31, 2012 | Level 1 | Level 2 | Level 3 | |||||||||||||
Assets of U.S. defined benefit plan | ||||||||||||||||
Money market collective trusts | $ | 119 | $ | — | $ | 119 | $ | — | ||||||||
U.S. Government agency and Treasury securities | 247 | — | 247 | — | ||||||||||||
U.S. bond funds | 368 | — | 368 | — | ||||||||||||
U.S. equity funds and option collars | 219 | — | 219 | — | ||||||||||||
International equity funds | 81 | — | 81 | — | ||||||||||||
Limited partnerships | 37 | — | — | 37 | ||||||||||||
Total | $ | 1,071 | $ | — | $ | 1,034 | $ | 37 | ||||||||
Assets of U.S. retiree health care plan | ||||||||||||||||
Money market collective trusts | $ | 49 | $ | — | $ | 49 | $ | — | ||||||||
U.S. bond funds | 205 | 205 | — | — | ||||||||||||
U.S. equity funds and option collars | 197 | 46 | 151 | — | ||||||||||||
International equity funds | 66 | — | 66 | — | ||||||||||||
Total | $ | 517 | $ | 251 | $ | 266 | $ | — | ||||||||
Assets of non-U.S. defined benefit plans | ||||||||||||||||
Cash and money market collective trusts | $ | 133 | $ | 88 | $ | 45 | $ | — | ||||||||
Local market bond funds | 942 | 183 | 759 | — | ||||||||||||
International/global bond funds | 343 | 19 | 324 | — | ||||||||||||
Local market equity funds | 204 | 20 | 184 | — | ||||||||||||
International/global equity funds | 564 | — | 564 | — | ||||||||||||
Other investments | 32 | — | 13 | 19 | ||||||||||||
Total | $ | 2,218 | $ | 310 | $ | 1,889 | $ | 19 | ||||||||
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Fair Value December 31, 2011 | Level 1 | Level 2 | Level 3 | |||||||||||||
Assets of U.S. defined benefit plan | ||||||||||||||||
Money market collective trusts | $ | 23 | $ | — | $ | 23 | $ | — | ||||||||
U.S. Government agency and Treasury securities | 266 | 244 | 22 | — | ||||||||||||
U.S. bond funds | 309 | — | 309 | — | ||||||||||||
U.S. equity funds and option collars | 229 | — | 229 | — | ||||||||||||
International equity funds | 52 | — | 52 | — | ||||||||||||
Limited partnerships | 35 | — | — | 35 | ||||||||||||
Total | $ | 914 | $ | 244 | $ | 635 | $ | 35 | ||||||||
Assets of U.S. retiree health care plan | ||||||||||||||||
Money market collective trusts | $ | 50 | $ | — | $ | 50 | $ | — | ||||||||
U.S. bond funds | 175 | 175 | — | — | ||||||||||||
U.S. equity funds and option collars | 159 | 40 | 119 | — | ||||||||||||
International equity funds | 47 | — | 47 | — | ||||||||||||
Total | $ | 431 | $ | 215 | $ | 216 | $ | — | ||||||||
Assets of non-U.S. defined benefit plans | ||||||||||||||||
Cash and money market collective trusts | $ | 50 | $ | 41 | $ | 9 | $ | — | ||||||||
Local market bond funds | 1,129 | 209 | 920 | — | ||||||||||||
International/global bond funds | 335 | 3 | 332 | — | ||||||||||||
Local market equity funds | 133 | 13 | 120 | — | ||||||||||||
International/global equity funds | 521 | 136 | 385 | — | ||||||||||||
Other investments | 43 | — | 25 | 18 | ||||||||||||
Total | $ | 2,211 | $ | 402 | $ | 1,791 | $ | 18 | ||||||||
The investments in our major benefit plans largely consist of low-cost, broad-market index funds to mitigate risks of concentration within market sectors. In recent years, our investment policy has shifted toward a closer matching of the interest rate sensitivity of the plan assets and liabilities. The appropriate mix of equity and bond investments is determined primarily through the use of detailed asset-liability modeling studies that look to balance the impact of changes in the discount rate against the need to provide asset growth to cover future service cost. Most of our plans around the world have added a greater proportion of fixed income securities with return characteristics that are more closely aligned with changes in the liabilities caused by discount rate volatility. For the U.S. plans, we utilize an option collar strategy to reduce the volatility of returns on investments in U.S. equity funds.
The only Level 3 assets in our worldwide benefit plans are certain private equity limited partnerships in our U.S. pension plan and diversified hedge and property funds in a non-U.S. pension plan. These investments are valued using inputs from the fund managers and internal models. The following table summarizes the change in the fair values for Level 3 plan assets for the years ending December 31, 2012 and 2011:
Level 3 Plan Assets | ||||||||
U.S. Defined Benefit | Non-U.S. Defined Benefit | |||||||
Balance, December 31, 2010 | $ | 34 | $ | 51 | ||||
Redemptions | — | (51 | ) | |||||
Unrealized gain | 1 | — | ||||||
Assumed with National acquisition | — | 18 | ||||||
Balance, December 31, 2011 | 35 | 18 | ||||||
Redemptions | (2 | ) | — | |||||
Unrealized gain | 4 | 1 | ||||||
Balance, December 31, 2012 | $ | 37 | $ | 19 | ||||
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Assumptions and investment policies
Defined Benefit | U.S. Retiree Health Care | |||||||
2012 | 2011 | 2012 | 2011 | |||||
Weighted average assumptions used to determine benefit obligations: | ||||||||
U.S. discount rate | 4.16% | 4.92% | 3.97% | 4.89% | ||||
Non-U.S. discount rate | 2.80% | 2.89% | ||||||
U.S. average long-term pay progression | 3.50% | 3.50% | ||||||
Non-U.S. average long-term pay progression | 3.10% | 3.18% | ||||||
Weighted average assumptions used to determine net periodic benefit cost: | ||||||||
U.S. discount rate | 4.92% | 5.58% | 4.86% | 5.48% | ||||
Non-U.S. discount rate | 2.88% | 2.79% | ||||||
U.S. long-term rate of return on plan assets | 6.00% | 6.25% | 5.50% | 5.50% | ||||
Non-U.S. long-term rate of return on plan assets | 3.83% | 4.17% | ||||||
U.S. average long-term pay progression | 3.50% | 3.40% | ||||||
Non-U.S. average long-term pay progression | 3.17% | 3.24% | ||||||
We utilize a variety of methods to select an appropriate discount rate depending on the depth of the corporate bond market in the country in which the benefit plan operates. In the U.S., we use a settlement approach whereby a portfolio of bonds is selected from the universe of actively traded high-quality U.S. corporate bonds. The selected portfolio is designed to provide cash flows sufficient to pay the plan’s expected benefit payments when due. The resulting discount rate reflects the rate of return of the selected portfolio of bonds. For our non-U.S. locations with a sufficient number of actively traded high-quality bonds, an analysis is performed in which the projected cash flows from the defined benefit plans are discounted against a yield curve constructed with an appropriate universe of high-quality corporate bonds available in each country. In this manner, a present value is developed. The discount rate selected is the single equivalent rate that produces the same present value. Both the settlement approach and the yield curve approach produce a discount rate that recognizes each plan’s distinct liability characteristics. For countries that lack a sufficient corporate bond market, a government bond index adjusted for an appropriate risk premium is used to establish the discount rate.
Assumptions for the expected long-term rate of return on plan assets are based on future expectations for returns for each asset class and the effect of periodic target asset allocation rebalancing. We adjust the results for the payment of reasonable expenses of the plan from plan assets. We believe our assumptions are appropriate based on the investment mix and long-term nature of the plans’ investments. Assumptions used for the non-U.S. defined benefit plans reflect the different economic environments within the various countries.
The table below shows target allocation ranges for the plans that hold a substantial majority of the defined benefit assets.
Asset category | U.S. Defined Benefit | U.S. Retiree Health Care | Non-U.S. Defined Benefit | |||
Equity securities | 35% | 50% | 25% - 60% | |||
Fixed income securities and cash equivalents | 65% | 50% | 40% - 75% | |||
We intend to rebalance the plans’ investments when they are not within the target allocation ranges. Additional contributions are invested consistent with the target ranges and may be used to rebalance the portfolio. The investment allocations and individual investments are chosen with regard to the duration of the obligations of each plan.
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Weighted average asset allocations as of December 31, are as follows:
U.S. Defined Benefit | U.S. Retiree Health Care | Non-U.S. Defined Benefit | ||||||||||
Asset category | 2012 | 2011 | 2012 | 2011 | 2012 | 2011 | ||||||
Equity securities | 31% | 35% | 51% | 48% | 36% | 32% | ||||||
Fixed income securities | 58% | 63% | 40% | 41% | 58% | 66% | ||||||
Cash equivalents | 11% | 2% | 9% | 11% | 6% | 2% | ||||||
The plans are slightly outside their target allocation ranges due to cash funding late in the year. None of the plan assets related to the defined benefit pension plans and retiree health care benefit plan are directly invested in TI common stock. As of December 31, 2012, we do not expect to return any of the plans’ assets to TI in the next 12 months.
The following table shows the benefits we expect to pay to participants from the plans in the next ten years. Almost all of the payments will be made from plan assets and not from company assets.
U.S. Defined Benefit | U.S. Retiree Health Care | Medicare Subsidy | Non-U.S. Defined Benefit | |||||||||||||
2013 | $ | 197 | $ | 34 | $ | (4 | ) | $ | 80 | |||||||
2014 | 102 | 35 | (4 | ) | 81 | |||||||||||
2015 | 111 | 37 | (4 | ) | 87 | |||||||||||
2016 | 113 | 38 | (5 | ) | 91 | |||||||||||
2017 | 111 | 39 | (5 | ) | 94 | |||||||||||
2018-2022 | 495 | 193 | (16 | ) | 535 | |||||||||||
Assumed health care cost trend rates for the U.S. retiree health care plan at December 31 are as follows:
2012 | 2011 | |||
Assumed health care cost trend rate for next year | 7.0% | 9.0% | ||
Ultimate trend rate | 5.0% | 5.0% | ||
Year in which ultimate trend rate is reached | 2018 | 2017 | ||
A one percentage point increase or decrease in health care cost trend rates over all future periods would have increased or decreased the accumulated postretirement benefit obligation for the U.S. retiree health care plan at December 31, 2012, by $26 million or $22 million, respectively. The service cost and interest cost components of 2012 plan expense would have increased or decreased by $2 million.
Deferred compensation arrangements
We have a deferred compensation plan that allows U.S. employees whose base salary and management responsibility exceed a certain level to defer receipt of a portion of their cash compensation. Payments under this plan are made based on the participant’s distribution election and plan balance. Participants can earn a return on their deferred compensation based on notional investments in the same investment funds that are offered in our defined contribution plans.
As of December 31, 2012, our liability to participants of the deferred compensation plan was $139 million and is recorded in Deferred credits and other liabilities on our Consolidated balance sheets. This amount reflects the accumulated participant deferrals and earnings thereon as of that date. Except as described in the next paragraph, no assets are held in trust for the deferred compensation plan and so we remain liable to the participants. To serve as an economic hedge against changes in fair values of this liability, we invest in similar mutual funds that are recorded in Long-term investments. We record changes in the fair value of the liability and the related investment in SG&A as discussed in Note 9.
In connection with the National acquisition, we assumed its deferred compensation plan. As of December 31, 2012, this consisted of $35 million of obligations and matching assets held in a Rabbi trust. No further contributions will be made to this plan.
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12. Debt and lines of credit
Short-term borrowings
We maintain a line of credit to support commercial paper borrowings, if any, and to provide additional liquidity through bank loans. As of December 31, 2012, we have a five-year variable-rate revolving credit facility from a consortium of investment-grade banks that allows us to borrow up to $2 billion through March 2017. The interest rate on borrowings under this credit facility, if drawn, is indexed to the applicable London Interbank Offered Rate (LIBOR). As of December 31, 2012, we have no commercial paper outstanding, having repaid $1 billion on a cumulative basis in 2012.
Long-term debt
In August 2012, we issued an aggregate principal amount of $1.5 billion of fixed-rate long-term debt, with $750 million due in 2015 and $750 million due in 2019. The proceeds of the offering were $1.492 billion, net of the original issuance discount. We also incurred $7 million of issuance costs that are included in Other assets and are being amortized to Interest and debt expense over the term of the debt.
In May 2011, we issued fixed- and floating-rate long-term debt to help fund the National acquisition. The proceeds of the offering were $3.497 billion, net of the original issuance discount. We also incurred $12 million of issuance costs that are included in Other assets and are being amortized to Interest and debt expense over the term of the debt.
We also have an interest rate swap agreement related to the $1 billion floating-rate debt due 2013. Under this agreement, we will receive variable payments based on three-month LIBOR rates and pay a fixed rate through May 15, 2013. Changes in the cash flows of the interest rate swap are expected to exactly offset the changes in cash flows attributable to fluctuations in the three-month LIBOR-based interest payments. We have designated this interest rate swap as a cash flow hedge and record changes in its fair value in AOCI. As of December 31, 2012, the fair value of the swap agreement is a $2 million liability. The net effect of this swap is to convert the $1 billion floating-rate debt to a fixed-rate obligation bearing a rate of 0.922 percent.
At the acquisition date, we assumed $1 billion of outstanding National debt with a fair value of $1.105 billion. The excess of the fair value over the stated value is amortized as a reduction of Interest and debt expense over the term of the related debt. In 2012 and 2011, we amortized $26 million and $9 million, respectively. During 2012, we repaid $375 million of this debt.
Total long-term debt outstanding as of December 31, 2012 and 2011 is as follows:
December 31, | |||||||
2012 | 2011 | ||||||
Notes due 2012 at 6.15% (assumed with National acquisition) | $ | — | $ | 375 | |||
Floating-rate notes due 2013 (swapped to a 0.922% fixed rate) | 1,000 | 1,000 | |||||
Notes due 2013 at 0.875% | 500 | 500 | |||||
Notes due 2014 at 1.375% | 1,000 | 1,000 | |||||
Notes due 2015 at 3.95% (assumed with National acquisition) | 250 | 250 | |||||
Notes due 2015 at 0.45% | 750 | — | |||||
Notes due 2016 at 2.375% | 1,000 | 1,000 | |||||
Notes due 2017 at 6.60% (assumed with National acquisition) | 375 | 375 | |||||
Notes due 2019 at 1.65% | 750 | — | |||||
5,625 | 4,500 | ||||||
Add net unamortized premium | 61 | 93 | |||||
Less current portion of long-term debt | (1,500 | ) | (382 | ) | |||
Total long-term debt | $ | 4,186 | $ | 4,211 | |||
Interest and debt expense was $85 million in 2012 and $42 million in 2011. This was net of the amortization of the debt premium and other debt issuance costs. Cash payments for interest on long-term debt were $97 million in 2012 and $54 million in 2011. Capitalized interest was not material.
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13. Commitments and contingencies
Operating leases
We conduct certain operations in leased facilities and also lease a portion of our data processing and other equipment. In addition, certain long-term supply agreements to purchase industrial gases are accounted for as operating leases. Lease agreements frequently include purchase and renewal provisions and require us to pay taxes, insurance and maintenance costs. Rental and lease expense incurred was $124 million, $109 million and $100 million in 2012, 2011 and 2010, respectively.
Capitalized software licenses
We have licenses for certain internal-use electronic design automation software that we account for as capital leases. The related liabilities are apportioned between Accounts payable and Deferred credits and other liabilities on our Consolidated balance sheets, depending on the contractual timing of payments.
Purchase commitments
Some of our purchase commitments entered in the ordinary course of business provide for minimum payments. At December 31, 2012, we had committed to make the following minimum payments under our non-cancellable operating leases, capitalized software licenses and purchase commitments:
Operating Leases | Capitalized Software Licenses | Purchase Commitments | ||||||||||
2013 | $ | 102 | $ | 46 | $ | 77 | ||||||
2014 | 77 | 33 | 54 | |||||||||
2015 | 66 | 14 | 25 | |||||||||
2016 | 49 | — | 18 | |||||||||
2017 | 32 | — | 10 | |||||||||
Thereafter | 80 | — | 22 | |||||||||
Indemnification guarantees
We routinely sell products with an intellectual property indemnification included in the terms of sale. Historically, we have had only minimal, infrequent losses associated with these indemnities. Consequently, we cannot reasonably estimate or accrue for any future liabilities that may result.
Warranty costs/product liabilities
We accrue for known product-related claims if a loss is probable and can be reasonably estimated. During the periods presented, there have been no material accruals or payments regarding product warranty or product liability. Historically, we have experienced a low rate of payments on product claims. Although we cannot predict the likelihood or amount of any future claims, we do not believe they will have a material adverse effect on our financial condition, results of operations or liquidity. Consistent with general industry practice, we enter into formal contracts with certain customers that include negotiated warranty remedies. Typically, under these agreements our warranty for semiconductor products includes three years of coverage; an obligation to repair, replace or refund; and a maximum payment obligation tied to the price paid for our products. In some cases, product claims may exceed the price of our products.
General
We are subject to various legal and administrative proceedings. Although it is not possible to predict the outcome of these matters, we believe that the results of these proceedings will not have a material adverse effect on our financial condition, results of operations or liquidity. From time to time, we also negotiate contingent consideration payment arrangements associated with certain acquisitions, which are recorded at fair value.
Discontinued operations indemnity
In connection with the 2006 sale of the former Sensors & Controls (S&C) business, we have agreed to indemnify Sensata Technologies, Inc., for specified litigation matters and certain liabilities, including environmental liabilities. In a settlement with a third party, we have agreed to indemnify that party for certain events relating to S&C products, which events we consider remote. We believe our total remaining potential exposure from both of these indemnities will not exceed $200 million. As of December 31, 2012, we believe future payments related to these indemnity obligations will not have a material effect on our financial condition, results of operations or liquidity.
14. Stockholders’ equity
We are authorized to issue 10,000,000 shares of preferred stock. No preferred stock is currently outstanding.
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Treasury shares acquired in connection with the board-authorized stock repurchase program in 2012, 2011 and 2010 were 59,757,780 shares, 59,466,168 shares and 93,522,896 shares, respectively. As of December 31, 2012, $3.9 billion of stock repurchase authorizations remain, and no expiration date has been specified.
15. Supplemental financial information
Other income (expense) net
2012 | 2011 | 2010 | ||||||||||
Interest income | $ | 8 | $ | 11 | $ | 13 | ||||||
Net gains on investments | 18 | 6 | 11 | |||||||||
Tax interest (expense) | 32 | 1 | (2 | ) | ||||||||
Other (a) | (11 | ) | (13 | ) | 15 | |||||||
Total | $ | 47 | $ | 5 | $ | 37 | ||||||
(a) Includes lease income of approximately $15 million per year, primarily from the purchaser of a former business. As of December 31, 2012, the aggregate amount of non-cancellable future lease payments to be received from these leases is $66 million. These leases contain renewal options. Other also includes miscellaneous non-operational items such as realized gains and losses associated with former equity investments; gains and losses related to former businesses, including settlements in 2012 and 2011; gains and losses from currency exchange rate changes; and gains and losses from our derivative financial instruments, primarily forward foreign currency exchange contracts.
Property, plant and equipment at cost
Depreciable Lives (Years) | December 31, | |||||||||
2012 | 2011 | |||||||||
Land | — | $ | 189 | $ | 188 | |||||
Buildings and improvements | 5-40 | 3,006 | 2,998 | |||||||
Machinery and equipment | 3-10 | 3,696 | 3,947 | |||||||
Total | $ | 6,891 | $ | 7,133 | ||||||
Authorizations for property, plant and equipment expenditures in future years were $234 million at December 31, 2012.
Accrued expenses and other liabilities
December 31, | ||||||||
2012 | 2011 | |||||||
Customer incentive programs and allowances | $ | 213 | $ | 190 | ||||
Severance and related expenses | 217 | 140 | ||||||
Property and other non-income taxes | 127 | 98 | ||||||
Other | 324 | 367 | ||||||
Total | $ | 881 | $ | 795 | ||||
Accumulated other comprehensive income (loss), net of taxes
December 31, | ||||||||
2012 | 2011 | |||||||
Unrealized losses on available-for-sale investments | $ | — | $ | (3 | ) | |||
Postretirement benefit plans: | ||||||||
Net actuarial loss | (701 | ) | (780 | ) | ||||
Net prior service credit | 7 | 9 | ||||||
Cash flow hedge derivative | (5 | ) | (2 | ) | ||||
Total | $ | (699 | ) | $ | (776 | ) | ||
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16. Segment and geographic area data
Reportable segments
Our financial reporting structure is comprised of two reportable segments: Analog and Embedded Processing. These reportable segments represent groups of similar products that are combined on the basis of similar design and development requirements, product characteristics, manufacturing processes and distribution channels. A summary of each reportable segment follows:
• | Analog – Analog semiconductors change real-world signals – such as sound, temperature, pressure or images - by conditioning them, amplifying them and often converting them to a stream of digital data that can be processed by other semiconductors, such as digital signal processors (DSPs). Analog semiconductors are also used to manage power in every electronic device, whether plugged into a wall or running off a battery. Analog includes the following major product lines: HVAL, Power, HPA and SVA. |
• | Embedded Processing – Embedded Processing products are the “brains” of many electronic devices. Compared with general purpose microprocessors that perform many different tasks, embedded processors are designed to handle specific tasks and can be optimized for various combinations of performance, power and cost, depending on the application. The devices vary from simple, low-cost products used in electric toothbrushes to highly specialized, complex devices used in wireless basestation communications infrastructure equipment. Our Embedded Processing products are used in many end markets, particularly industrial, automotive and communications infrastructure. Embedded Processing includes the following major product lines: Processors, Microcontrollers and Connectivity. |
The information presented in our Notes to financial statements has been recast to reflect our elimination of the Wireless segment, which was effective January 1, 2013. Financial results for embedded OMAP applications processors and embedded connectivity products (formerly Wireless products), both of which have many of the same characteristics as the products in our Embedded Processing segment, are reported in that segment. Financial results for baseband products and Wireless products for the smartphone and consumer tablet markets, both of which are product lines that we have announced we are exiting, are included in Other. We refer to those exited product lines collectively as “legacy wireless products.” We also reclassified certain product lines, primarily radio frequency identification (RFID) products, from Other to Embedded Processing.
Other
Other includes other operating segments that neither meet the quantitative thresholds for individually reportable segments nor are they aggregated with other operating segments. These operating segments primarily include our smaller product lines such as DLP® products (primarily used in projectors to create high-definition images), custom semiconductors known as application-specific integrated circuits (ASICs) and calculators.
In addition to revenue from our legacy wireless products, Other also includes royalties received for our patented technology that we license to other electronics companies and revenue from transitional supply agreements related to acquisitions and divestitures. Other may also include certain unallocated income and expenses such as gains and losses on sales of assets; sales tax refunds; and certain litigation costs, settlements or reserves. Except for these few unallocated items, we allocate all of our expenses associated with corporate activities to our operating segments based on specific methodologies, such as percentage of operating expenses or headcount.
Acquisition-related charges related to National are also recorded in Other in 2012 and 2011, as detailed in Note 2.
Restructuring charges related to the 2012 Wireless action and the 2011 announced action in Hiji, Japan, and Houston, Texas; losses and insurance proceeds associated with the 2011 earthquake in Japan; and the 2012 gain on the transfer of the Japan substitutional pension are also included in Other. In 2010, the gain related to a divestiture of a product line is included in Other. See Notes 3 and 4 for additional information.
We use centralized manufacturing and facilities organizations to provide products and support to our operating segments. Costs incurred by these organizations, including depreciation, are charged to the segments on a per-unit basis. Consequently, depreciation expense is not an independently identifiable component within the segments' results and therefore is not provided.
With the exception of goodwill, we do not identify or allocate assets by operating segment, nor does the chief operating decision maker evaluate operating segments using discrete asset information. There was no significant intersegment revenue. The accounting policies of the segments are the same as those described in the summary of significant accounting policies.
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Segment information
Analog | Embedded Processing | Other | Total | |||||||||||||
Revenue | ||||||||||||||||
2012 | $ | 6,998 | $ | 2,257 | $ | 3,570 | $ | 12,825 | ||||||||
2011 | 6,375 | 2,381 | 4,979 | 13,735 | ||||||||||||
2010 | 5,979 | 2,359 | 5,628 | 13,966 | ||||||||||||
Operating profit | ||||||||||||||||
2012 | $ | 1,650 | $ | 158 | $ | 165 | $ | 1,973 | ||||||||
2011 | 1,693 | 387 | 912 | 2,992 | ||||||||||||
2010 | 1,876 | 534 | 2,104 | 4,514 | ||||||||||||
Geographic area information
The following geographic area data include revenue, based on product shipment destination and royalty payor location, and property, plant and equipment, based on physical location:
U.S. | Asia (a) | Europe | Japan | Rest of World | Total | |||||||||||||||||||
Revenue | ||||||||||||||||||||||||
2012 | $ | 1,596 | $ | 7,808 | $ | 1,861 | $ | 1,357 | $ | 203 | $ | 12,825 | ||||||||||||
2011 | 1,468 | 8,619 | 1,822 | 1,462 | 364 | 13,735 | ||||||||||||||||||
2010 | 1,539 | 8,903 | 1,760 | 1,366 | 398 | 13,966 | ||||||||||||||||||
Property, plant and equipment, net | ||||||||||||||||||||||||
2012 | $ | 1,931 | $ | 1,547 | $ | 241 | $ | 174 | $ | 19 | $ | 3,912 | ||||||||||||
2011 | 2,159 | 1,739 | 276 | 228 | 26 | 4,428 | ||||||||||||||||||
2010 | 1,694 | 1,575 | 139 | 249 | 23 | 3,680 | ||||||||||||||||||
(a) | Revenue from products shipped into China (including Hong Kong) was $5.38 billion in 2012, $5.83 billion in 2011 and $5.69 billion in 2010. |
Major customer
No customer accounts for 10 percent or more of 2012 revenue. Sales to the Nokia group of companies, including sales to indirect contract manufacturers, accounted for 13 percent and 19 percent of our 2011 and 2010 revenue, respectively. Revenue from sales to Nokia is reflected primarily in Other.
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Report of independent registered public accounting firm
The Board of Directors and Stockholders
Texas Instruments Incorporated
We have audited the accompanying consolidated balance sheets of Texas Instruments Incorporated and subsidiaries (the Company) as of December 31, 2012 and 2011, and the related consolidated statements of income, comprehensive income, stockholders’ equity, and cash flows for each of the three years in the period ended December 31, 2012. These financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on these financial statements based on our audits.
We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the financial statements referred to above present fairly, in all material respects, the consolidated financial position of Texas Instruments Incorporated and subsidiaries at December 31, 2012 and 2011, and the consolidated results of their operations and their cash flows for each of the three years in the period ended December 31, 2012, in conformity with U.S. generally accepted accounting principles.
We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the Company’s internal control over financial reporting as of December 31, 2012, based on criteria established in Internal Control-Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission and our report dated February 22, 2013, expressed an unqualified opinion thereon.
Dallas, Texas
February 22, 2013, except for Notes 1, 3, 10
and 16, as to which the date is May 3, 2013
38
Management’s discussion and analysis of financial condition and results of operations
The following should be read in conjunction with the financial statements and the related notes that appear elsewhere in this document. All dollar amounts in the tables in this discussion are stated in millions of U.S. dollars, except per-share amounts.
Overview
At TI, we design and make semiconductors that we sell to electronics designers and manufacturers all over the world. We began operations in 1930. We are incorporated in Delaware, headquartered in Dallas, Texas, and have design, manufacturing or sales operations in more than 35 countries. We have three segments: Analog, Embedded Processing and Other. We expect Analog and Embedded Processing to be our primary growth engines in the years ahead, and we therefore focus our resources on these segments.
We were the world's fourth largest semiconductor company in 2012 as measured by revenue, according to preliminary estimates from an external source.
Financial information with respect to our segments and our operations outside the United States is contained in the note to the financial statements captioned “Segment and geographic area data” and is incorporated herein by reference.
Product information
Semiconductors are electronic components that serve as the building blocks inside modern electronic systems and equipment. Semiconductors come in two basic forms: individual transistors and integrated circuits (generally known as “chips”) that combine multiple transistors on a single piece of material to form a complete electronic circuit. Our products, more than 100,000 orderable parts, are integrated circuits that are used to accomplish many different things, such as converting and amplifying signals, interfacing with other devices, managing and distributing power, processing data, canceling noise and improving signal resolution. This broad portfolio includes products that are integral to almost all electronic equipment.
We sell catalog and, to a lesser extent, custom semiconductor products. Catalog products are designed for use by many customers and/or many applications and are sold through both distribution and direct channels. The majority of our catalog products are proprietary, but some are commodity products. The life cycles of catalog products generally span multiple years, with some products continuing to sell for decades after their initial release. Custom products are designed for a specific customer for a specific application, are sold only to that customer and are typically sold directly to the customer. The life cycles of custom products are generally determined by end-equipment upgrade cycles and can be as short as 12 to 24 months.
Our segments represent groups of similar products that are combined on the basis of similar design and development requirements, product characteristics, manufacturing processes and distribution channels, and how management allocates resources and measures results. Additional information regarding each segment's products follows.
Analog
Analog semiconductors change real-world signals - such as sound, temperature, pressure or images - by conditioning them, amplifying them and often converting them to a stream of digital data that can be processed by other semiconductors, such as digital signal processors (DSPs). Analog semiconductors are also used to manage power in every electronic device, whether plugged into a wall or running off a battery. We estimate that we sell our Analog products to more than 100,000 customers. These sales generated about 55 percent of our revenue in 2012. According to external sources, the worldwide market for analog semiconductors was about $39 billion in 2012. Our Analog segment's revenue in 2012 was about $7.0 billion, or about 18 percent of this fragmented market, the leading position. We believe that we are well positioned to increase our market share over time.
Our Analog segment includes the following major product lines: High Volume Analog & Logic (HVAL), Power Management (Power), High Performance Analog (HPA) and Silicon Valley Analog (SVA).
HVAL products: These include both high-volume analog and logic products. High-volume analog includes integrated analog products for specific applications, including custom products. End markets for high-volume analog products include communications, automotive, computing and many consumer electronics products. Logic includes some commodity products marketed to many different customers for many different applications.
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Power products: These include both catalog and application-specific products that help customers manage power in any type of electronic system. We design and manufacture power management semiconductors for both portable devices (battery-powered devices, such as handheld consumer electronics, laptop computers and cordless power tools) and line-powered systems (products that require an external electrical source, such as computers, digital TVs, wireless basestations and high-voltage industrial equipment).
HPA products: These include catalog analog products, such as amplifiers, data converters and interface semiconductors, that we market to many different customers who use them in manufacturing a wide range of products sold in many end markets, including the industrial, communications, computing and consumer electronics markets. HPA products generally have long life cycles, often more than 10 years.
SVA products: These consist of products that we acquired through our purchase of National Semiconductor Corporation (National) in 2011. These include power management, data converter, interface and operational amplifier catalog analog products, nearly all of which are complementary to our other Analog products. This portfolio of thousands of products is marketed to many different customers who use them in manufacturing a wide range of products sold in many end markets. SVA products generally have long life cycles, often more than 10 years.
Embedded Processing
Embedded Processing products are the “brains” of many electronic devices. Compared with general purpose microprocessors that perform many different tasks, embedded processors are designed to handle specific tasks and can be optimized for various combinations of performance, power and cost, depending on the application. The devices vary from simple, low-cost products used in electric toothbrushes to highly specialized, complex devices used in wireless basestation communications infrastructure equipment. Our Embedded Processing products are used in many end markets, particularly industrial, automotive and communications infrastructure.
An important characteristic of our Embedded Processing products is that our customers often invest their own research and development (R&D) to write software that operates on our products. This investment tends to increase the length of our customer relationships because many customers prefer to re-use software from one product generation to the next.
Sales of Embedded Processing products generated about 18 percent of our revenue in 2012. According to external sources, the worldwide market for embedded processors was about $17 billion in 2012. Our Embedded Processing segment's revenue in 2012 was about $2.3 billion. This was the number two position and represented about 13 percent of this fragmented market. We believe we are well positioned to increase our market share over time.
Our Embedded Processing segment includes the following major product lines: Processors, Microcontrollers and Connectivity.
Processor products: These include DSPs and applications processors. DSPs perform mathematical computations almost instantaneously to process or improve digital data. Applications processors like our embedded OMAPTM and SitaraTM products run an industry-standard operating system and perform multiple complex tasks, often communicating with other systems.
Microcontroller products: Microcontrollers are self-contained systems with a processor core, memory and peripherals that are designed to control a set of specific tasks for electronic equipment. Microcontrollers tend to have minimal requirements for memory and program length, with no operating system and low software complexity. Analog components that control or interface with sensors and other systems are often integrated into microcontrollers. Microcontroller products also include radio frequency identification (RFID) products, which are frequently used in automotive applications and sold along with our microcontroller products.
Connectivity products: Connectivity products enable electronic devices to seamlessly connect and transfer data, and the requirements for speed, data capability, distance and power vary depending on the application. Our Connectivity products support many wireless technologies to meet these requirements, including low-power wireless network standards like Zigbee® and other technologies like Bluetooth®, WiFi, GPS and Near Field Communications. Our Connectivity products are usually designed into customer devices alongside our processor and microcontroller products, enabling data to be collected, transmitted and acted upon.
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Other
Other includes revenue from our smaller product lines, such as DLP® (primarily used in projectors to create high-definition images), custom semiconductors known as application-specific integrated circuits (ASICs) and calculators. It includes royalties received for our patented technology that we license to other electronics companies and revenue from transitional supply agreements related to acquisitions and divestitures. We also include revenue, about $1.2 billion in 2012, from our baseband products and from our OMAP applications processors and connectivity products sold into smartphone and consumer tablet applications, all of which are product lines that we have previously announced we are exiting. We expect this revenue to substantially cease by the end of 2013. Other generated about $3.6 billion in 2012.
We also include in Other restructuring charges and certain acquisition-related charges that are not used in evaluating results of and allocating resources to our Analog and Embedded Processing segments. These acquisition-related charges include certain fair-value adjustments, restructuring charges, transaction expenses, acquisition-related retention bonuses and amortization of intangible assets. Other also includes certain corporate-level items, such as litigation and environmental costs, insurance proceeds, and assets and liabilities associated with our centralized operations, such as our worldwide manufacturing, facilities and procurement operations.
Inventory
Our inventory practices differ by product, but we generally maintain inventory levels that are consistent with our expectations of customer demand. Because of the longer product life cycles of catalog products and their inherently lower risk of obsolescence, we generally carry more inventory of those products than custom products. Additionally, we sometimes maintain catalog-product inventory in unfinished wafer form, as well as higher finished-goods inventory of low-volume products, allowing greater flexibility in periods of high demand. We also have consignment inventory programs in place for our largest customers and some distributors.
Manufacturing
Semiconductor manufacturing begins with a sequence of photo-lithographic and chemical processing steps that fabricate a number of semiconductor devices on a thin silicon wafer. Each device on the wafer is tested, the wafer is cut into individual units and each unit is assembled into a package that then is usually retested. The entire process takes place in highly specialized facilities and requires an average of 12 weeks, with most products completing within 8 to 16 weeks.
The cost and lifespan of the equipment and processes we use to manufacture semiconductors vary by technology. Our Analog products and most of our Embedded Processing products can be manufactured using mature and stable, and therefore less expensive, equipment than is needed for manufacturing advanced CMOS logic products, such as our OMAP products.
We own and operate semiconductor manufacturing facilities in North America, Asia, Japan and Europe. These include both wafer fabrication and assembly/test facilities. Our facilities require substantial investment to construct and are largely fixed-cost assets once in operation. Because we own much of our manufacturing capacity, a significant portion of our operating cost is fixed. In general, these fixed costs do not decline with reductions in customer demand or utilization of capacity, potentially hurting our profit margins. Conversely, as product demand rises and factory utilization increases, the fixed costs are spread over increased output, potentially benefiting our profit margins.
We expect to maintain sufficient internal wafer fabrication capacity to meet the vast majority of our production needs. To supplement our internal wafer fabrication capacity and maximize our responsiveness to customer demand and return on capital, our wafer manufacturing strategy utilizes the capacity of outside suppliers, commonly known as foundries, and subcontractors. In 2012, we sourced about 20 percent of our total wafers and about 75 percent of our advanced CMOS logic needs from external foundries.
In 2011, we initiated closure of an older wafer fabrication facility in Hiji, Japan, and another in Houston, Texas. We expect to complete these plant closures in 2013.
Product cycle
The global semiconductor market is characterized by constant, though generally incremental, advances in product designs and manufacturing processes. Semiconductor prices and manufacturing costs tend to decline over time as manufacturing processes and product life cycles mature.
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Market cycle
The “semiconductor cycle” is an important concept that refers to the ebb and flow of supply and demand. The semiconductor market historically has been characterized by periods of tight supply caused by strengthening demand and/or insufficient manufacturing capacity, followed by periods of surplus inventory caused by weakening demand and/or excess manufacturing capacity. These are typically referred to as upturns and downturns in the semiconductor cycle. The semiconductor cycle is affected by the significant time and money required to build and maintain semiconductor manufacturing facilities.
Seasonality
Our revenue and operating results are subject to some seasonal variation. Our semiconductor sales generally are seasonally weaker in the first and fourth quarters and stronger in the second and third quarters, as manufacturers prepare for the major holiday selling seasons. Calculator revenue is tied to the U.S. back-to-school season and is therefore at its highest in the second and third quarters.
Tax considerations
We operate in a number of tax jurisdictions and are subject to several types of taxes including those that are based on income, capital, property and payroll, as well as sales and other transactional taxes. The timing of the final determination of our tax liabilities varies by jurisdiction and taxing authority. As a result, during any particular reporting period we may reflect in our financial statements one or more tax refunds or assessments, or changes to tax liabilities, involving one or more taxing authorities.
Results of operations
The information presented in this Management's discussion and analysis of financial condition and results of operations (MD&A) has been recast to reflect our elimination, effective January 1, 2013, of the Wireless segment. As previously announced, we now focus our OMAP applications processors and connectivity products (formerly Wireless products) on embedded applications with long life cycles. Financial results for embedded OMAP applications processors and embedded connectivity products, both of which have many of the same characteristics as the products in our Embedded Processing segment, are now reported in that segment. Financial results for baseband products and Wireless products for the smartphone and consumer tablet markets, both of which are product lines that we have announced we are exiting, are included in Other and are referred to collectively as “legacy wireless products.” We also reclassified certain product lines, primarily radio frequency identification (RFID) products, from Other to Embedded Processing. Revenue from those reclassified product lines was about $130 million in 2012.
Throughout the following discussion of our results of operations, unless otherwise noted, changes in our revenue are attributable to changes in customer demand, which are evidenced by fluctuations in shipment volumes. New products tend not to have a significant impact because our revenue is derived from such a large number of products. From time to time, our revenue and gross profit are affected by changes in demand for higher-priced or lower-priced products, which we refer to as changes in the “mix” of products shipped.
2012 compared with 2011
During 2012, we faced a weak demand environment, but our operations performed well and we strengthened our strategic position. We reached a milestone in 2012, with 72 percent of our revenue coming from our core businesses of Analog and Embedded Processing. Also during the year, we successfully integrated National into our operations and increased the diversity of our customer base, especially in the industrial sector. Despite lower revenue that resulted primarily from our exit from baseband products, we grew our free cash flow to almost $3 billion, or 23 percent of revenue. Our free cash flow was the result of more of our revenue coming from Analog and Embedded Processing, which offer solid growth and high margins and have low capital needs. We returned 90 percent of this free cash flow to stockholders through our continued share repurchases and higher dividend payments. Free cash flow will continue to benefit from our strategic purchases of manufacturing capacity during the past few years. (Free cash flow is a non-GAAP financial measure. For a reconciliation to GAAP and an explanation of the purpose for providing this non-GAAP measure, see the Non-GAAP financial information section after the Liquidity and capital resources section.)
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For Years Ended December 31, | ||||||||||||
2012 | 2011 | 2010 | ||||||||||
Revenue by segment: | ||||||||||||
Analog | $ | 6,998 | $ | 6,375 | $ | 5,979 | ||||||
Embedded Processing | 2,257 | 2,381 | 2,359 | |||||||||
Other | 3,570 | 4,979 | 5,628 | |||||||||
Revenue | 12,825 | 13,735 | 13,966 | |||||||||
Cost of revenue (COR) | 6,457 | 6,963 | 6,474 | |||||||||
Gross profit | 6,368 | 6,772 | 7,492 | |||||||||
Research and development (R&D) | 1,877 | 1,715 | 1,570 | |||||||||
Selling, general and administrative (SG&A) | 1,804 | 1,638 | 1,519 | |||||||||
Acquisition charges | 450 | 315 | — | |||||||||
Restructuring charges/other | 264 | 112 | (111 | ) | ||||||||
Operating profit | 1,973 | 2,992 | 4,514 | |||||||||
Other income (expense) net (OI&E) | 47 | 5 | 37 | |||||||||
Interest and debt expense | 85 | 42 | — | |||||||||
Income before income taxes | 1,935 | 2,955 | 4,551 | |||||||||
Provision for income taxes | 176 | 719 | 1,323 | |||||||||
Net income | $ | 1,759 | $ | 2,236 | $ | 3,228 | ||||||
Diluted earnings per common share | $ | 1.51 | $ | 1.88 | $ | 2.62 | ||||||
Percentage of revenue: | ||||||||||||
Gross profit | 49.6 | % | 49.3 | % | 53.6 | % | ||||||
R&D | 14.6 | % | 12.5 | % | 11.2 | % | ||||||
SG&A | 14.1 | % | 11.9 | % | 10.9 | % | ||||||
Operating profit | 15.4 | % | 21.8 | % | 32.3 | % | ||||||
Details of 2012 financial results
Revenue in 2012 was $12.82 billion, down $910 million, or 7 percent, from 2011 primarily due to a weak demand environment. Revenue from a full year's inclusion of SVA slightly more than offset lower revenue from wireless baseband products.
Gross profit in 2012 was $6.37 billion, a decrease of $404 million, or 6 percent, from 2011. The decrease was primarily due to lower revenue. Gross profit margin in 2012 was 49.6 percent of revenue compared with 49.3 percent in 2011.
Operating expenses were $1.88 billion for R&D and $1.80 billion for SG&A. R&D expense increased $162 million, or 9 percent, from 2011 primarily due to the inclusion of a full year of SVA. R&D expense as a percent of revenue was 14.6 percent compared with 12.5 percent in 2011. SG&A expense increased $166 million, or 10 percent, from 2011 due to the inclusion of a full year of SVA. SG&A expense as a percent of revenue was 14.1 percent compared with 11.9 percent in 2011.
Acquisition charges related to the National acquisition were $450 million in 2012 and $315 million in 2011. The increase was due to a full year of amortization of acquired intangible assets. See Notes 2 and 10 to the financial statements for details.
Restructuring charges/other were $264 million in 2012 and $112 million in 2011. The increase was primarily due to the restructuring of our former Wireless segment, partially offset by a $144 million gain we recognized from the transfer of the obligations and assets of a portion of our Japan pension program from the pension trust to the government of Japan. See Note 3 to the financial statements for details.
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Operating profit was $1.97 billion, or 15.4 percent of revenue, compared with $2.99 billion, or 21.8 percent of revenue, in 2011. The decrease was due to, in decreasing order, lower gross profit, higher operating expenses, higher restructuring charges and higher acquisition charges.
OI&E for 2012 was income of $47 million compared with $5 million for 2011. The increase was primarily due to tax-related interest income.
Interest and debt expense was $85 million compared with $42 million in the year-ago period. The increase over 2011 was primarily due to having debt outstanding for a full year in 2012 compared with about eight months in 2011. We issued debt in May 2011 and assumed debt in September 2011, both in connection with our acquisition of National. See Note 12 to the financial statements for details.
The annual effective tax rate for 2012 was 22 percent. Taxes at this rate were reduced by discrete tax benefits of $252 million, resulting in a total tax provision for 2012 of $176 million compared with a total tax provision of $719 million for the prior year. The decrease in the total tax provision was due to the combination of lower income before income taxes and the impact of the discrete tax benefits. The decrease was partially offset by the impact of the expiration of the federal research tax credit at the end of 2011. The discrete tax benefits in 2012 were primarily due to additional U.S. tax benefits for manufacturing related to the years 2000 through 2011. The tax provision for 2012 did not include the January 2013 reinstatement of the federal research tax credit. The effect of the reinstatement of about $65 million for 2012 will be recorded as a discrete tax benefit in the first quarter of 2013.
See Note 7 to the financial statements for a reconciliation of effective tax rates to the statutory federal tax rate.
Net income was $1.76 billion, a decrease of $477 million, or 21 percent, from 2011. EPS for 2012 was $1.51 compared with $1.88 for 2011. The decline in EPS was due to lower net income. EPS benefitted $0.03 from 2011 due to a lower number of average shares outstanding as a result of our stock repurchase program.
Segment results
A detailed discussion of our segment results appears below.
Analog
2012 | 2011 | Change | |||||||||
Revenue | $ | 6,998 | $ | 6,375 | 10 | % | |||||
Operating profit | 1,650 | 1,693 | -3 | % | |||||||
Operating profit % of revenue | 23.6 | % | 26.6 | % | |||||||
Analog revenue increased $623 million, or 10 percent, from 2011 primarily due to the inclusion of a full year of SVA, and to a lesser extent, growth in Power Management. Partially offsetting the increase was lower revenue from High Performance Analog. Revenue from High Volume Analog & Logic products was about even.
Operating profit was $1.65 billion, or 23.6 percent of revenue. This was a decrease of $43 million, or 3 percent, compared with 2011 primarily due to higher operating expenses from the inclusion of a full year of SVA, partially offset by higher gross profit.
Embedded Processing
2012 | 2011 | Change | |||||||||
Revenue | $ | 2,257 | $ | 2,381 | -5 | % | |||||
Operating profit | 158 | 387 | -59 | % | |||||||
Operating profit % of revenue | 7.0 | % | 16.3 | % | |||||||
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Embedded Processing revenue decreased $124 million, or 5 percent, compared with 2011 due to lower revenue from Processor products and, to a lesser extent, a less favorable mix of Microcontroller products. The decrease was partially offset by higher revenue from Connectivity products.
Operating profit was $158 million, or 7.0 percent of revenue. This was a decrease of $229 million, or 59 percent, compared with 2011 primarily due to lower gross profit, and to a lesser extent, higher operating expenses.
Other
2012 | 2011 | Change | |||||||||
Revenue | $ | 3,570 | $ | 4,979 | -28 | % | |||||
Operating profit | 165 | 912 | -82 | % | |||||||
Operating profit % of revenue | 4.6 | % | 18.3 | % | |||||||
Restructuring charges/other* | $ | 264 | $ | 112 | |||||||
Acquisition charges* | 450 | 315 | |||||||||
* Included in Operating profit
Revenue from Other was $3.57 billion in 2012. This was a decrease of $1.41 billion, or 28 percent, from 2011 primarily due to lower revenue from legacy wireless products. Also contributing to the decline were the expiration of transitional supply agreements, a less favorable mix of DLP products and lower revenue from calculators and royalties. The decrease was partially offset by business interruption insurance proceeds resulting from the 2011 Japan earthquake and increased revenue from custom ASIC products.
Operating profit for 2012 from Other was $165 million, or 4.6 percent of revenue. This was a decrease of $747 million, or 82 percent, compared with 2011 due to lower revenue and associated gross profit and higher restructuring and acquisition charges. Included in Restructuring charges/other for 2012 was a $144 million gain from the Japan pension program change. The increase in acquisition charges was due to a full year of increased amortization expense for acquired intangible assets.
Prior results of operations - 2011 compared with 2010
Our 2011 revenue was $13.73 billion, net income was $2.24 billion and EPS was $1.88.
Although 2011 started strong, global economic uncertainty and the March 2011 earthquake in Japan impacted TI, our customers and our suppliers. Despite these challenges, we successfully completed the acquisition of National, we gained share in the Analog and Embedded Processing markets, and we continued to wind down our baseband operations.
Revenue in 2011 was $13.73 billion, down $231 million, or 2 percent, from 2010 due to lower revenue from wireless baseband products.
Gross profit in 2011 was $6.77 billion, a decrease of $720 million, or 10 percent, from 2010. The decrease was primarily due to a combination of, in decreasing order, lower revenue, lower average levels of factory utilization as we reduced production in response to weaker demand, acquisition-related charges reflected in COR and inventory charges. Lower factory utilization decreased our gross profit by $175 million from 2010. Gross profit margin was 49.3 percent of revenue compared with 53.6 percent in 2010.
Operating expenses were $1.72 billion for R&D and $1.64 billion for SG&A. R&D expense increased $145 million, or 9 percent, from 2010 primarily due to the addition of a partial year of SVA and higher product development costs in Embedded Processing and our other major Analog product lines. R&D expense as a percent of revenue was 12.5 percent compared with 11.2 percent in 2010.
SG&A expense increased $119 million, or 8 percent, from 2010 primarily due to the addition of a partial year of SVA, and to a lesser extent, higher investments in sales and marketing in support of our other major Analog product lines and Embedded Processing. SG&A expense as a percent of revenue was 11.9 percent compared with 10.9 percent in 2010.
Acquisition charges were $315 million in 2011. There were no acquisition charges in 2010.
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Restructuring charges/other of $112 million for 2011 were associated with the action initiated to close certain manufacturing facilities in Texas and Japan. Restructuring charges/other for 2010 included $33 million of restructuring charges associated with pension benefit settlements related to actions taken in 2009, offset by a gain of $144 million from the divestiture of a product line included in Other.
Operating profit was $2.99 billion, or 21.8 percent of revenue, compared with $4.51 billion, or 32.3 percent of revenue, in 2010. The decrease was due to, in decreasing order, lower gross profit, higher total acquisition-related charges, higher operating expenses and a gain on the divestiture of a product line in 2010.
OI&E for 2011 was income of $5 million. This was $32 million lower than in 2010 due to an expense in 2011 associated with a settlement related to a divested business.
Interest and debt expense was $42 million. This included interest and amortization of debt expense associated with our issuance of new debt in 2011 and the assumption of debt as a result of our acquisition of National.
The tax provision for 2011 was $719 million compared with $1.32 billion for the prior year. The decrease was primarily due to lower income before income taxes.
Net income was $2.24 billion, a decrease of $992 million from 2010. EPS for 2011 was $1.88 compared with $2.62 for 2010. EPS benefited $0.07 from 2010 due to a lower number of average shares outstanding as a result of our stock repurchase program.
Segment results
A detailed discussion of our segment results appears below.
Analog
2011 | 2010 | Change | |||||||||
Revenue | $ | 6,375 | $ | 5,979 | 7 | % | |||||
Operating profit | 1,693 | 1,876 | -10 | % | |||||||
Operating profit % of revenue | 26.6 | % | 31.4 | % | |||||||
Restructuring charges/other* | $ | — | $ | 13 | |||||||
* Included in Operating profit
Analog revenue increased $396 million, or 7 percent, from 2010 primarily due to the inclusion of a partial year of SVA, and to a lesser extent, increased shipments of Power Management and High Volume Analog & Logic products. Partially offsetting these increases was lower revenue from High Performance Analog due to normal price declines.
Operating profit was $1.69 billion, or 26.6 percent of revenue. This was a decrease of $183 million, or 10 percent, compared with 2010 due to higher operating expenses from the inclusion of a partial year of SVA and, to a lesser extent, lower gross profit resulting from lower factory utilization.
Embedded Processing
2011 | 2010 | Change | |||||||||
Revenue | $ | 2,381 | $ | 2,359 | 1 | % | |||||
Operating profit | 387 | 534 | -28 | % | |||||||
Operating profit % of revenue | 16.3 | % | 22.6 | % | |||||||
Restructuring charges/other* | $ | — | $ | 8 | |||||||
* Included in Operating profit
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Embedded Processing revenue was about even compared with 2010. Increased revenue from Microcontroller, and to a lesser extent, Connectivity, products were offset by lower revenue from Processor products.
Operating profit was $387 million, or 16.3 percent of revenue. This was a decrease of $147 million, or 28 percent, compared with 2010 primarily due to lower gross profit, and to a lesser extent, higher operating expenses. Lower gross profit was primarily due to the effect of the mix of products, and to a lesser extent, lower factory utilization.
Other
2011 | 2010 | Change | |||||||||
Revenue | $ | 4,979 | $ | 5,628 | -12 | % | |||||
Operating profit | 912 | 2,104 | -57 | % | |||||||
Operating profit % of revenue | 18.3 | % | 37.4 | % | |||||||
Restructuring charges/other* | $ | 112 | $ | (132 | ) | ||||||
Acquisition charges* | 315 | — | |||||||||
* Included in Operating profit
Revenue from Other was $4.98 billion in 2011. This was a decrease of $649 million, or 12 percent, from 2010 due to decreased shipments across most areas.
Operating profit for 2011 from Other was $912 million, or 18.3 percent of revenue. This was a decrease of $1.19 billion, or 57 percent, compared with 2010 due to lower revenue and associated gross profit; charges associated with the National acquisition; the absence of a gain on divestiture; restructuring charges related to the action initiated in 2011 to close certain manufacturing facilities in Texas and Japan; and the net losses associated with the Japan earthquake.
Restructuring Action
In November 2012, we announced that we would restructure our Wireless business to focus investments on embedded markets with greater potential for sustainable growth. Specifically, we now focus our OMAP applications processors and connectivity products on embedded applications with long life cycles instead of on the smartphone and consumer tablet markets, where large customers are increasingly developing their own custom chips. These changes will result in lower resource and investment demands. As a result of the restructuring, we recorded a $351 million charge in the fourth quarter of 2012, of which $245 million was for severance and benefit costs and $106 million was for non-cash items, which includes a non-tax deductible goodwill impairment of $90 million. We expect about 1,700 jobs to be eliminated and about $450 million in annualized cost savings to be realized by the time this action is completed in 2013.
For more information on the restructuring action, see Note 3 to the financial statements.
Financial condition
At the end of 2012, total cash (Cash and cash equivalents plus Short-term investments) was $3.96 billion, an increase of $1.03 billion from the end of 2011.
Accounts receivable were $1.23 billion at the end of 2012. This was a decrease of $315 million compared with the end of 2011. The decrease in accounts receivable was due to lower revenue in December 2012 than in December 2011. Days sales outstanding were 37 at the end of 2012 compared with 41 at the end of 2011.
Inventory was $1.76 billion at the end of 2012. This was a decrease of $31 million from the end of 2011. Days of inventory at the end of 2012 were 103 compared with 86 at the end of 2011. Our days of inventory increased in order to support higher customer service levels.
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Liquidity and capital resources
Our primary source of liquidity is cash flow from operations. Additional sources of liquidity are Cash and cash equivalents, Short-term investments and revolving credit facilities. Cash flow from operations for 2012 was $3.41 billion, an increase of $158 million from the prior year due to an increase in cash provided by working capital.
We had $1.416 billion of Cash and cash equivalents and $2.549 billion of Short-term investments as of December 31, 2012.
We have a variable-rate revolving credit facility with a consortium of investment-grade banks that allows us to borrow up to $2 billion until March 2017. This credit facility also serves as support for the issuance of commercial paper. As of December 31, 2012, we had no commercial paper outstanding.
In 2012, investing activities used $1.04 billion. This compares with $6.17 billion used in 2011 primarily for the National acquisition, net of cash acquired. See Note 2 to the financial statements for details. For 2012, capital expenditures (Additions to property, plant and equipment) were $495 million compared with $816 million in 2011. Capital expenditures in 2012 were primarily for semiconductor manufacturing equipment. We used cash of $604 million to make net purchases of short-term investments in 2012 compared with $98 million in 2011.
In 2012, financing activities used net cash of $1.95 billion and provided $2.59 billion in 2011. In 2012, we received proceeds of $1.49 billion from the issuance of fixed-rate long-term debt (net of original issuance discount). This compares with proceeds in 2011 of $3.50 billion we received from the issuance of fixed- and variable-rate long-term debt (net of the original issuance discount) and $1.20 billion from the issuance of commercial paper. The 2011 issuance of long-term debt was used in the National acquisition. The commercial paper was issued for general corporate purposes and to maintain cash balances at desired levels. See Note 12 to the financial statements for additional details. We used $1.38 billion to repay debt and commercial paper in 2012 compared with $200 million used to repay commercial paper in 2011. Dividends paid in 2012 of $819 million compared with $644 million in 2011, reflecting increases in the dividend rate in each year. In September 2012, we announced a 24 percent increase in our quarterly cash dividend. The quarterly dividend increased from $0.17 to $0.21 per share, resulting in an annualized dividend payment of $0.84 per share. We used $1.80 billion to repurchase 59.8 million shares of our common stock in 2012 compared with $1.97 billion used to repurchase 59.5 million shares in 2011. Employee exercises of stock options are also reflected in cash from financing activities. In 2012, these exercises provided cash proceeds of $523 million compared with $690 million in 2011.
We believe we have the necessary financial resources and operating plans to fund our working capital needs, capital expenditures, dividend and debt-related payments, and other business requirements for at least the next 12 months.
Non-GAAP financial information
This MD&A includes a discussion of free cash flow, a measure that was not prepared in accordance with generally accepted accounting principles in the United States (non-GAAP measure). We provide this measure to give investors insight into the company's liquidity and cash-generating capability and the amount of its cash available to return to investors. It is supplemental to the comparable GAAP measure.
Free cash flow was calculated by subtracting capital expenditures (Additions to property, plant and equipment) from Cash flows from operating activities. The components of this calculation are included in the table below.
For Years Ended | ||||||||
December 31, | ||||||||
2012 | 2011 | |||||||
Cash flows from operating activities (GAAP) | $ | 3,414 | $ | 3,256 | ||||
Less capital expenditures (Additions to property, plant and equipment) | 495 | 816 | ||||||
Free cash flow (non-GAAP) | $ | 2,919 | $ | 2,440 | ||||
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Long-term contractual obligations
Payments Due by Period | ||||||||||||||||||||
Contractual obligations | 2013 | 2014/2015 | 2016/2017 | Thereafter | Total | |||||||||||||||
Long-term debt obligations (a) | $ | 1,500 | $ | 2,000 | $ | 1,375 | $ | 750 | $ | 5,625 | ||||||||||
Operating lease obligations (b) | 102 | 143 | 81 | 80 | 406 | |||||||||||||||
Software license obligations (c) | 46 | 47 | — | — | 93 | |||||||||||||||
Purchase obligations (d) | 77 | 79 | 28 | 22 | 206 | |||||||||||||||
Deferred compensation plan (e) | 12 | 31 | 30 | 66 | 139 | |||||||||||||||
Total (f) | $ | 1,737 | $ | 2,300 | $ | 1,514 | $ | 918 | $ | 6,469 | ||||||||||
(a) Long-term debt obligations include amounts classified as the current portion of long-term debt, i.e., obligations that will be retired within 12 months. The related interest payments are not included.
(b) | Includes minimum payments for leased facilities and equipment, as well as purchases of industrial gases under contracts accounted for as an operating lease. |
(c) | Includes payments under license agreements for electronic design automation software. |
(d) | Includes contractual arrangements with suppliers where there is a fixed non-cancellable payment schedule or minimum payments due with a reduced delivery schedule. Excluded from the table are cancellable arrangements. However, depending on when certain purchase arrangements may be cancelled, an additional $10 million of cancellation penalties may be required to be paid, which are not reflected in the table. |
(e) | Includes an estimate of payments under this plan for the liability that existed at December 31, 2012. |
(f) Excluded from the table are $184 million of uncertain tax liabilities under ASC 740, as well as any planned, future funding contributions to retirement benefit plans. Amounts associated with uncertain tax liabilities have been excluded because of the difficulty in making reasonably reliable estimates of the timing of cash settlements with the respective taxing authorities. Regarding future funding of retirement benefit plans, we plan to contribute about $100 million in 2013, but funding projections beyond 2013 are not practical to estimate due to the rules affecting tax-deductible contributions and the impact from the plans' asset performance, interest rates and potential U.S. and non-U.S. legislation.
Critical accounting policies
In preparing our consolidated financial statements in conformity with accounting principles generally accepted in the United States, we use statistical analyses, estimates and projections that affect the reported amounts and related disclosures and may vary from actual results. We consider the following accounting policies to be both those that are most important to the portrayal of our financial condition and that require the most subjective judgment. If actual results differ significantly from management's estimates and projections, there could be a significant effect on our financial statements.
Revenue recognition
Revenue from sales of our products, including sales to our distributors, is recognized upon shipment or delivery, depending upon the terms of the sales order, provided that persuasive evidence of a sales arrangement exists, title and risk of loss have transferred to the customer, the sales amounts are fixed or determinable, and collection of the revenue is reasonably assured. Revenue from sales of our products that are subject to inventory consignment agreements is recognized when the customer or distributor pulls product from consignment inventory that we store at designated locations.
We reduce revenue based on estimates of future credits to be granted to customers. Credits include volume-based incentives, other special pricing arrangements and product returns due to quality issues. Our estimates of future credits are based on historical experience, analysis of product shipments and contractual arrangements with customers and distributors.
In 2012, about 50 percent of our revenue was generated from sales of our products to distributors. We recognize distributor revenue net of allowances, which are management's estimates based on analysis of historical data, current economic conditions and contractual terms. These allowances recognize the impact of credits granted to distributors under certain programs
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common in the semiconductor industry whereby distributors receive certain price adjustments to meet individual competitive opportunities, or are allowed to return or scrap a limited amount of product in accordance with contractual terms agreed upon with the distributor, or receive price protection credits when our standard published prices are lowered from the price the distributor paid for product still in its inventory, or other incentives designed to maximize growth opportunities. Historical claims data are maintained for each of the programs, with differences among geographic regions taken into consideration. We continually monitor the actual claimed allowances against our estimates, and we adjust our estimates as appropriate to reflect trends in distributor revenue and inventory levels. Allowances are also adjusted when recent historical data do not represent anticipated future activity. About 40 percent of our distributor revenue is generated from sales of consigned inventory, and we expect this proportion to grow over time. The allowances we record against this revenue are not material.
In addition, we monitor collectability of accounts receivable primarily through review of the accounts receivable aging. When collection is at risk, we assess the impact on amounts recorded for bad debts and, if necessary, will record a charge in the period such determination is made.
Income taxes
In determining net income for financial statement purposes, we must make certain estimates and judgments in the calculation of tax provisions and the resultant tax liabilities, and in the recoverability of deferred tax assets that arise from temporary differences between the tax and financial statement recognition of revenue and expense.
In the ordinary course of global business, there may be many transactions and calculations where the ultimate tax outcome is uncertain. The calculation of tax liabilities involves dealing with uncertainties in the application of complex tax laws. We recognize potential liabilities for anticipated tax audit issues in the U.S. and other tax jurisdictions based on an estimate of the ultimate resolution of whether, and the extent to which, additional taxes will be due. Although we believe the estimates are reasonable, no assurance can be given that the final outcome of these matters will not be different than what is reflected in the historical income tax provisions and accruals.
As part of our financial process, we must assess the likelihood that our deferred tax assets can be recovered. If recovery is not likely, the provision for taxes must be increased by recording a reserve in the form of a valuation allowance for the deferred tax assets that are estimated not to be ultimately recoverable. In this process, certain relevant criteria are evaluated including the existence of deferred tax liabilities that can be used to absorb deferred tax assets, the taxable income in prior years that can be used to absorb net operating losses and credit carrybacks, and taxable income in future years. Our judgment regarding future recoverability of our deferred tax assets based on these criteria may change due to various factors, including changes in U.S. or international tax laws and changes in market conditions and their impact on our assessment of taxable income in future periods. These changes, if any, may require material adjustments to the deferred tax assets and an accompanying reduction or increase in net income in the period when such determinations are made.
In addition to the factors described above, the effective tax rate reflected in forward-looking statements is based on then-current tax law. Significant changes in tax law enacted during the year could affect these estimates. Retroactive changes in tax law enacted subsequent to the end of a reporting period are reflected in the period of enactment as a discrete tax item.
Inventory valuation allowances
Inventory is valued net of allowances for unsalable or obsolete raw materials, work-in-process and finished goods. Allowances are determined quarterly by comparing inventory levels of individual materials and parts to historical usage rates, current backlog and estimated future sales and by analyzing the age of inventory, in order to identify specific components of inventory that are judged unlikely to be sold. Allowances are also calculated quarterly for instances where inventoried costs for individual products are in excess of market prices for those products. In addition to this specific identification process, statistical allowances are calculated for remaining inventory based on historical write-offs of inventory for salability and obsolescence reasons. Actual future write-offs of inventory for salability and obsolescence reasons may differ from estimates and calculations used to determine valuation allowances due to changes in customer demand, customer negotiations, technology shifts and other factors.
Impairment of acquisition-related intangibles and goodwill
We review acquisition-related intangible assets for impairment when certain indicators suggest the carrying amount may not be recoverable. Factors considered include the underperformance of an asset compared with expectations and shortened useful lives due to planned changes in the use of the assets. Recoverability is determined by comparing the carrying amount of the assets to estimated future undiscounted cash flows. If future undiscounted cash flows are less than the carrying amount, an impairment charge would be recognized for the excess of the carrying amount over fair value, determined by utilizing a discounted cash flow technique. Additionally, in the case of intangible assets that will continue to be used in future periods, a
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shortened useful life may be utilized if appropriate, resulting in accelerated amortization based upon the expected net realizable value of the asset at the date the asset will no longer be utilized.
We review goodwill for impairment annually, or more frequently if certain impairment indicators arise, such as significant changes in business climate, operating performance or competition, or upon the disposition of a significant portion of a reporting unit. A significant amount of judgment is involved in determining if an indicator of impairment has occurred between annual test dates. This impairment review compares the fair value for each reporting unit containing goodwill to its carrying value. Determining the fair value of a reporting unit involves the use of significant estimates and assumptions, including projected future cash flows, discount rates based on weighted average cost of capital and future economic and market conditions. We base our fair-value estimates on assumptions we believe to be reasonable.
Actual cash flow amounts for future periods may differ from estimates used in impairment testing.
Business combinations
The acquisition method of accounting requires that we recognize the assets acquired and liabilities assumed at their acquisition date fair values. Goodwill is measured as the excess of consideration transferred over the acquisition date net fair values of the assets acquired and the liabilities assumed.
The measurement of the fair values of assets acquired and liabilities assumed requires considerable judgment. Although independent appraisals may be used to assist in the determination of the fair values of certain assets and liabilities, those determinations are usually based on significant estimates provided by management, such as forecasted revenue or profit. In determining the fair value of intangible assets, an income approach is generally used and may incorporate the use of a discounted cash flow method. In applying the discounted cash flow method, the estimated future cash flows and residual values for each intangible asset are discounted to a present value using a discount rate based on an estimated weighted average cost of capital for the semiconductor industry. These cash flow projections are based on management's estimates of economic and market conditions including revenue growth rates, operating margins, capital expenditures and working capital requirements.
While we use our best estimates and assumptions as part of the process to value assets acquired and liabilities assumed at the acquisition date, our estimates are inherently uncertain and subject to refinement. During the measurement period, which occurs before finalization of the purchase price allocation, changes in assumptions and estimates that result in adjustments to the fair values of assets acquired and liabilities assumed are recorded on a retrospective basis as of the acquisition date, with the corresponding offset to goodwill. Upon the conclusion of the measurement period, any subsequent adjustments will be recorded to our Consolidated statements of income. The measurement period for the National acquisition concluded on December 31, 2011.
Changes in accounting standards
As of December 31, 2012, the Financial Accounting Standards Board had issued several accounting standards that we have not yet been required to adopt. None of these standards would have a material effect on our financial condition, results of operations or financial disclosures.
Off-balance sheet arrangements
As of December 31, 2012, we had no significant off-balance sheet arrangements as defined in Item 303(a)(4)(ii) of SEC Regulation S-K.
Commitments and contingencies
See Note 13 to the financial statements for a discussion of our commitments and contingencies.
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