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Texas Instruments 10-Q 2006

Documents found in this filing:

  1. 10-Q
  2. Ex-31.1
  3. Ex-31.2
  4. Ex-32.1
  5. Ex-32.2
  6. Ex-32.2
Form 10-Q for Second Quarter 2006


UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
 

 
FORM 10-Q
 

 
x QUARTERLY REPORT UNDER SECTION 13 or 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 
 
For the quarterly period ended June 30, 2006
 
¨ TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 
 
For the transition period from              to              
 
Commission File Number 001-03761
 

 
TEXAS INSTRUMENTS INCORPORATED
(Exact Name of Registrant as Specified in Its Charter)
 

 
   
Delaware
75-0289970
(State of Incorporation)
(I.R.S. Employer Identification No.)
 
   
12500 TI Boulevard, P.O. Box 660199, Dallas, Texas
75266-0199
(Address of principal executive offices)
(Zip Code)
 
Registrant’s telephone number, including area code 972-995-3773
 

 
Indicate by check mark whether the Registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the Registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.    Yes  S    No  ¨ 
 
Indicate by check mark whether the Registrant is a large accelerated filer, an accelerated filer or a non-accelerated filer. See definition of "accelerated filer and large accelerated filer" in Rule 12b-2 of the Exchange Act. (Check one):

 Large accelerated filer S   
 Accelerated filer ¨
 Non-accelerated filer ¨
 
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).
Yes ¨ No S
 
1,532,585,091
 
Number of shares of Registrant’s common stock outstanding as of
June 30, 2006
 




 

PART I - FINANCIAL INFORMATION
 
ITEM 1. Financial Statements.
 
TEXAS INSTRUMENTS INCORPORATED AND SUBSIDIARIES
Consolidated Statements of Income
(Millions of dollars, except per-share amounts)

 
 
For Three Months Ended June 30, 
For Six Months Ended June 30,
     
2006
   
2005
   
2006
   
2005
 
                           
Net revenue
 
$
3,697
 
$
2,971
 
$
7,031
 
$
5,673
 
                           
Operating costs and expenses:
                         
Cost of revenue
   
1,790
   
1,545
   
3,452
   
3,004
 
Research and development (R&D)
   
536
   
485
   
1,069
   
972
 
Selling, general and administrative (SG&A)
   
418
   
339
   
839
   
659
 
Total
   
2,744
   
2,369
   
5,360
   
4,635
 
Profit from operations
   
953
   
602
   
1,671
   
1,038
 
Other income (expense) net
   
88
   
56
   
140
   
105
 
Interest expense on loans
   
2
   
2
   
5
   
4
 
Income from continuing operations before income taxes
   
1,039
   
656
   
1,806
   
1,139
 
Provision for income taxes
   
300
   
72
   
524
   
184
 
Income from continuing operations
   
739
   
584
   
1,282
   
955
 
Income from discontinued operations, net of income taxes
   
1,648
   
44
   
1,690
   
83
 
Net income
 
$
2,387
 
$
628
 
$
2,972
 
$
1,038
 
 
                         
Basic earnings per common share:
                         
Income from continuing operations
 
$
.48
 
$
.36
 
$
.82
 
$
.57
 
Net income
 
$
1.54
 
$
.38
 
$
1.89
 
$
.62
 
                           
Diluted earnings per common share:
                         
Income from continuing operations
 
$
.47
 
$
.35
 
$
.80
 
$
.56
 
Net income
 
$
1.50
 
$
.38
 
$
1.85
 
$
.61
 
                           
Average shares outstanding (millions):
                         
Basic
   
1,553
   
1,633
   
1,569
   
1,667
 
Diluted
   
1,586
   
1,669
   
1,602
   
1,702
 
                           
Cash dividends declared per share of common stock
 
$
.030
 
$
.025
 
$
.060
 
$
.050
 
                           

See accompanying notes.


2



TEXAS INSTRUMENTS INCORPORATED AND SUBSIDIARIES
Consolidated Statements of Comprehensive Income
(Millions of dollars)


 
 
For Three Months Ended June 30, 
For Six Months Ended June 30,
     
2006
   
2005
   
2006
   
2005
 
                           
Income from continuing operations
 
$
739
 
$
584
 
$
1,282
 
$
955
 
 
                         
Accumulated other comprehensive income (loss):
                         
Minimum pension liability:
                         
Adjustment, net of tax benefit (expense) of:
2006 - $0 and $1; 2005 - ($3) and ($8)
   
(1
)
 
4
   
(1
)
 
5
 
                           
Changes in available-for-sale investments:
                         
Adjustment, net of tax benefit (expense) of:
2006 - $3 and $4; 2005 - ($7) and ($2)
   
(6
)
 
13
   
(7
)
 
4
 
                           
Total
   
(7
)
 
17
   
(8
)
 
9
 
                           
Total from continuing operations
   
732
   
601
   
1,274
   
964
 
                           
Income from discontinued operations
   
1,648
   
44
   
1,690
   
83
 
                           
Total comprehensive income
 
$
2,380
 
$
645
 
$
2,964
 
$
1,047
 

See accompanying notes.

3


TEXAS INSTRUMENTS INCORPORATED AND SUBSIDIARIES
Consolidated Balance Sheets
(Millions of dollars, except share amounts)  

 
   
June 30, 
   
December 31,
 
     
2006
   
2005
 
Assets
             
Current assets:
             
Cash and cash equivalents
 
$
1,678
 
$
1,214
 
Short-term investments
   
3,992
   
4,116
 
Accounts receivable, net of allowances of ($28) and ($34)
   
1,929
   
1,648
 
Raw materials
   
108
   
83
 
Work in process
   
818
   
813
 
Finished goods
   
409
   
289
 
Inventories
   
1,335
   
1,185
 
Deferred income taxes
   
632
   
619
 
Prepaid expenses and other current assets
   
215
   
135
 
Assets of discontinued operations
   
11
   
495
 
Total current assets
   
9,792
   
9,412
 
Property, plant and equipment at cost
   
8,406
   
8,374
 
Less accumulated depreciation
   
(4,422
)
 
(4,644
)
Property, plant and equipment, net
   
3,984
   
3,730
 
Equity and debt investments
   
253
   
236
 
Goodwill
   
792
   
677
 
Acquisition-related intangibles
   
117
   
60
 
Deferred income taxes
   
428
   
393
 
Capitalized software licenses, net
   
197
   
243
 
Prepaid retirement costs
   
219
   
199
 
Other assets
   
146
   
113
 
Total assets
 
$
15,928
 
$
15,063
 
               
Liabilities and Stockholders’ Equity
             
Current liabilities:
             
Loans payable and current portion of long-term debt
 
$
43
 
$
301
 
Accounts payable
   
788
   
702
 
Accrued expenses and other liabilities
   
994
   
948
 
Income taxes payable
   
870
   
154
 
Accrued profit sharing and retirement
   
77
   
121
 
Liabilities of discontinued operations
   
11
   
151
 
Total current liabilities
   
2,783
   
2,377
 
Long-term debt
   
--
   
329
 
Accrued retirement costs
   
103
   
136
 
Deferred income taxes
   
15
   
23
 
Deferred credits and other liabilities
   
239
   
261
 
Total liabilities
   
3,140
   
3,126
 
               
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: 2006 - 1,739,086,194; 2005 - 1,738,780,512
   
1,739
   
1,739
 
Paid-in capital
   
779
   
742
 
Retained earnings
   
16,271
   
13,394
 
Less treasury common stock at cost:
Shares: 2006 - 206,501,103; 2005 - 142,190,707
   
(5,911
)
 
(3,856
)
Accumulated other comprehensive income (loss), net of tax:
             
Minimum pension liability
   
(66
)
 
(65
)
Unrealized gains (losses) on available-for-sale investments
   
(23
)
 
(16
)
Unearned compensation
   
(1
)
 
(1
)
Total stockholders’ equity
   
12,788
   
11,937
 
Total liabilities and stockholders’ equity
 
$
15,928
 
$
15,063
 
 
See accompanying notes.

4


TEXAS INSTRUMENTS INCORPORATED AND SUBSIDIARIES
Consolidated Statements of Cash Flows
(Millions of dollars)  
 
 
For Six Months Ended June 30, 
     
2006
   
2005
 
Cash flows from operating activities:
             
Net income
 
$
2,972
 
$
1,038
 
Adjustments to reconcile net income to cash provided by operating activities of continuing operations:
             
Income from discontinued operations
   
(1,690
)
 
(83
)
Depreciation
   
537
   
678
 
Stock-based compensation
   
175
   
10
 
Amortization of capitalized software
   
59
   
60
 
Amortization of acquisition-related intangibles
   
31
   
30
 
Deferred income taxes
   
(77
)
 
(211
)
Increase/(decrease) from changes in:
             
Accounts receivable
   
(282
)
 
(213
)
Inventories
   
(146
)
 
46
 
Prepaid expenses and other current assets
   
(85
)
 
24
 
Accounts payable and accrued expenses
   
23
   
31
 
Income taxes payable
   
(183
)
 
84
 
Accrued profit sharing and retirement
   
(43
)
 
(184
)
Noncurrent accrued retirement costs
   
(51
)
 
12
 
Other
   
(51
)
 
(60
)
Net cash provided by operating activities of continuing operations
   
1,189
   
1,262
 
               
Cash flows from investing activities:
             
Additions to property, plant and equipment
   
(782
)
 
(514
)
Proceeds from sales of assets
   
2,986
   
42
 
Purchases of cash investments
   
(4,216
)
 
(1,066
)
Sales and maturities of cash investments
   
4,324
   
2,396
 
Purchases of equity investments
   
(22
)
 
(8
)
Sales of equity and debt investments
   
9
   
--
 
Acquisition of businesses, net of cash acquired
   
(205
)
 
--
 
Net cash provided by investing activities of continuing operations
   
2,094
   
850
 
               
Cash flows from financing activities:
             
Payments on loans and long-term debt
   
(586
)
 
(10
)
Dividends paid on common stock
   
(95
)
 
(84
)
Sales and other common stock transactions
   
279
   
173
 
Excess tax benefit from stock option exercises
   
64
   
--
 
Stock repurchases
   
(2,477
)
 
(2,785
)
Net cash used in financing activities of continuing operations
   
(2,815
)
 
(2,706
)
               
Cash flows from discontinued operations:
             
Operating activities
   
7
   
88
 
Investing activities
   
(16
)
 
(33
)
Net cash (used in)/provided by discontinued operations
   
(9
)
 
55
 
               
Effect of exchange rate changes on cash
   
5
   
4
 
Net increase/(decrease) in cash and cash equivalents
   
464
   
(535
)
Cash and cash equivalents, January 1
   
1,214
   
2,663
 
Cash and cash equivalents, June 30
 
$
1,678
 
$
2,128
 

See accompanying notes.
 

5


TEXAS INSTRUMENTS INCORPORATED AND SUBSIDIARIES
Notes to Financial Statements
 
1.  
Description of Business and Significant Accounting Policies and Practices. Texas Instruments (TI) makes, markets and sells high-technology components; more than 50,000 customers all over the world buy TI products.
 
Acquisitions - In January 2006, we acquired 100 percent of the equity of Chipcon Group ASA (Chipcon), a leading company in the design of short-range, low-power wireless radio frequency semiconductors, based in Oslo, Norway, for $183 million in cash. The acquisition will enhance our ability to offer customers complete short-range wireless solutions for consumer, home and building automation applications. The acquisition was accounted for as a purchase business combination, and the results of operations of this business have been included in the Semiconductor segment of our consolidated statements of income from the date of acquisition. Pro forma information has not been presented as it would not be materially different from amounts reported. As a result of the acquisition, we recorded a $5 million charge for in-process R&D in Corporate. We also recognized $115 million of goodwill and $86 million of other acquisition-related intangible assets, acquired $6 million of cash and assumed $29 million of other net liabilities. The following table contains a summary of the other intangible assets acquired:
 
Acquired Intangible Assets
 
Amount
 
Amortization Period
 
Developed technology
 
$
65
   
5 years
 
Non-compete agreements
   
6
   
2 years
 
Customer relationships
   
13
   
5 years
 
Trademark/trade name
   
2
   
3 years
 
 
In the second quarter of 2006, we also made an acquisition, which was not material, that was integrated into the Semiconductor business segment.

Dispositions - In January 2006, we entered into a definitive agreement to sell substantially all of our Sensors & Controls segment, excluding the radio frequency identification (RFID) systems operations that had been operated as a part of that segment, to an affiliate of Bain Capital, LLC, a leading global private equity investment firm, for $3 billion in cash. The sale was completed on April 27, 2006. The operations and cash flows of the former Sensors & Controls business have been eliminated from the ongoing operations of TI and we have no significant continuing involvement in the operations of the sold business.  Beginning in the first quarter of 2006, the former Sensors & Controls business is presented as a discontinued operation and the RFID operations retained are included within the Semiconductor business segment. Prior period financial statements, including segment information, have been reclassified to reflect these changes for all periods presented (see Note 2 for detailed information on discontinued operations and Note 6 for restated segment information).
 
Change in Capitalization - During the second quarter of 2006, TI’s Japan subsidiary prepaid $275 million of variable-rate bank notes. A portion of this debt had been due in 2008 and the remainder had been due in 2010.
 
Basis of Presentation - The consolidated financial statements have been prepared in accordance with accounting principles generally accepted in the U.S. (US GAAP) and, except for the adoption of a change in depreciation method in the first quarter of 2006 and the presentation of discontinued operations, on the same basis as the audited financial statements included in our annual report on Form 10-K for the year ended December 31, 2005. The consolidated statements of income, statements of comprehensive income and statements of cash flows for the periods ended June 30, 2006 and 2005, and the balance sheet as of June 30, 2006, are not audited but reflect all adjustments that are of a normal recurring nature and are necessary for a fair statement of the results of the periods shown. The consolidated balance sheet at December 31, 2005, was derived from the audited consolidated balance sheet at that date and restated to reflect discontinued operations. Certain amounts in the prior periods’ financial statements have been reclassified to conform to the current period presentation. Certain information and note disclosures normally included in annual consolidated financial statements have been omitted pursuant to the rules and regulations of the U.S. Securities and Exchange Commission. Because the consolidated interim financial statements do not include all of the information and notes required by US GAAP for a complete set of financial statements, they should be read in conjunction with the audited consolidated financial statements and notes included in our annual report on Form 10-K for the year ended December 31, 2005. The results for the six-month period are not necessarily indicative of a full year's results.
 
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 the notes, except share and per-share amounts, are stated in millions of U.S. dollars unless otherwise indicated.
 
6

Effective January 1, 2006, as a result of a study made of the pattern of usage of our long-lived depreciable assets, we adopted the straight-line method of depreciation for all property, plant and equipment. Under the provisions of Financial Accounting Standards Board (FASB) Statement of Financial Accounting Standards (SFAS) No. 154, “Accounting Changes and Error Corrections,” which became effective as of January 1, 2006, a change in depreciation method is treated on a prospective basis as a change in estimate. Prior period results will not be restated. The effect of the change in depreciation method for the three months and six months ended June 30, 2006, was to reduce depreciation expense by about $40 million and about $69 million, and increase both income from continuing operations and net income by about $21 million ($0.01 per share) and about $26 million ($0.02 per share), respectively.
 
Changes in Accounting Standards - Beginning as of January 1, 2006, we implemented SFAS No. 151, “Inventory Costs, an Amendment of ARB No. 43, Chapter 4.” The primary impact of this change to our inventory valuation methodology was to change how the fixed production overhead costs included in inventory are calculated. The effect of this change for the six months ended June 30, 2006, on inventory and net income was not material
 
In June 2006, the FASB ratified Emerging Issues Task Force (EITF) Issue No. 06-3, “How Taxes Collected from Customers and Remitted to Governmental Authorities Should Be Presented in the Income Statement (That Is, Gross Versus Net Presentation).This standard allows companies to present in their statements of income any taxes assessed by a governmental authority that are directly imposed on revenue-producing transactions between a seller and a customer, such as sales, use, value-added, and some excise taxes, on either a gross (included in revenue and costs) or a net (excluded from revenue) basis. This standard will be effective for us in interim and fiscal years beginning after December 15, 2006. We are currently evaluating the potential impact of this issue on our financial position and results of operations, but do not believe the impact of the adoption of this standard will be material.

2.  
Discontinued Operations. On January 9, 2006, we announced a definitive agreement to sell substantially all of the Sensors & Controls segment, excluding the RFID systems operations, to an affiliate of Bain Capital, LLC, for $3 billion in cash. The sale was completed on April 27, 2006. The former Sensors & Controls business acquired by Bain Capital, LLC was renamed Sensata Technologies (Sensata).
 
The results of operations of the former Sensors & Controls business are being presented as discontinued operations. The following summarizes results from the discontinued operations of the former Sensors & Controls business for the periods ended June 30, 2006 and 2005, included in the consolidated statements of income:
 
 
 
Three Months Ended
June 30,
Six Months Ended
June 30,
     
2006
   
2005
 
 
2006
   
2005
 
                           
Net revenue
 
$
81
 
$
268
 
$
375
 
$
538
 
Operating costs and expenses
   
84
   
201
   
313
   
410
 
Income (loss) from discontinued operations, before income taxes
   
(3
)
 
67
   
62
   
128
 
Provision for income taxes
   
--
   
23
   
23
   
45
 
Income (loss) from discontinued operations, net of tax
   
(3
)
 
44
   
39
   
83
 
                           
Gain on sale of discontinued operations
   
2,550
   
--
   
2,550
   
--
 
Provision for income taxes
   
899
   
--
   
899
   
--
 
Gain on sale of discontinued operations, net of tax
   
1,651
   
--
   
1,651
   
--
 
                           
Total income from discontinued operations
 
$
1,648
 
$
44
 
$
1,690
 
$
83
 
                           
Income from discontinued operations per common share:
                         
Basic 
 
$
1.06
 
$
.03
 
$
1.08
 
$
.05
 
Diluted 
 
$
1.04
 
$
.03
 
$
1.05
 
$
.05
 

 
Earnings per share amounts from continuing and discontinued operations may not add to net income per share due to rounding.
 
7

As of June 30, 2006, the remaining assets and liabilities of the former Sensors & Controls business, included in assets and liabilities of discontinued operations, are primarily attributable to obligations under pension and other postretirement benefit plans that are expected to be settled by the end of 2006 as well as other contingencies.
 
Continuing involvement - Upon closing of the sales transaction, we entered into a Transition Services Agreement (TSA) with Sensata to provide various temporary support services that are reasonably necessary to facilitate the continuation of the normal conduct of business of the former Sensors & Controls business such as finance and accounting, human resources, information technology, warehousing and logistics, and records retention and storage. Such services are expected to be provided for approximately six to twelve months, although certain information technology-related services may be provided for up to two years. The fees for these services will be generally equivalent to our cost. In addition, we entered into certain cross-license agreements to allow each party to continue to use the associated technology and intellectual property in the conduct of their respective business. However, these cross-license agreements generally do not involve the receipt or payment of any royalties and therefore are not considered to be a component of continuing involvement.

Although the services provided under the TSA generate continuing cash flows between us and Sensata, the amounts are not considered to be significant to the ongoing operations of either entity. In addition, we have no contractual ability through the TSA or any other agreement to significantly influence the operating or financial policies of Sensata. Under the provisions of EITF Issue No. 03-13, "Applying the Conditions of Paragraph 42 of FASB Statement No. 144 in Determining Whether to Report Discontinued Operations," we therefore have no significant continuing involvement in the operations of the former Sensors & Controls business and have classified the historical results of that business as discontinued operations.

Indemnification - In connection with the sale, we have agreed to indemnify Sensata for certain specified litigation matters, as well as other liabilities, including environmental liabilities. Our indemnification obligations with respect to breaches of representations and warranties and the specified litigation matters are, generally, subject to a total deductible of $30 million and our maximum potential exposure is limited to $300 million. As of June 30, 2006, there were no significant liabilities recorded under these indemnification obligations.

3.   Earnings per Share. Computation of earnings per common share (EPS) for income from continuing operations, and a reconciliation between the basic and diluted basis, for the periods ending June 30, are as follows:
  
 
 
 
2nd Quarter 2006 
 
2nd Quarter 2005 
 
 
 
 
Income 
 
Shares 
 
EPS 
 
Income 
 
Shares 
 
EPS 
 
                                         
 
Basic EPS
 
$
739
   
1,553
 
$
.48
 
$
584
   
1,633
 
$
.36
 
 
Dilutives:
                             
 
Stock-based compensation plans
    --     33           --     36        
 
Diluted EPS
 
$
739
   
1,586
 
$
.47
 
$
584
   
1,669
 
$
.35
 
 
 
 
 
Year To Date 2006 
 
Year To Date 2005 
 
 
 
 
Income 
 
Shares 
 
EPS 
 
Income 
 
Shares 
 
EPS 
 
                                         
 
Basic EPS
 
$
1,282
   
1,569
 
$
.82
 
$
955
   
1,667
 
$
.57
 
 
Dilutives:
                             
 
Stock-based compensation plans
    --     33           --     35        
 
Diluted EPS
 
$
1,282
   
1,602
 
$
.80
 
$
955
   
1,702
 
$
.56
 
 
4.   Stock-based Compensation. We have several stock-based employee compensation plans, which are more fully described in Note 13 in our 2005 annual report on Form 10-K. Prior to July 1, 2005, we accounted for awards granted under those plans following the recognition and measurement principles of Accounting Principles Board (APB) Opinion No. 25, “Accounting for Stock Issued to Employees,”and related interpretations. No compensation cost was reflected in net income for stock options, as all options granted under the plans have an exercise price equal to the market value of the underlying common stock on the date of the grant (except options granted under employee stock purchase plans and acquisition-related stock option awards). Compensation cost has previously been recognized for restricted stock units (RSUs).
 
8

Effective July 1, 2005, we adopted the fair value recognition provisions of SFAS No. 123(R), “Share-Based Payments, using the modified prospective application method. Under this transition method, compensation cost recognized for the periods ended June 30, 2006, includes the applicable amounts of: (a) compensation cost of all stock-based payments granted prior to, but not yet vested as of, July 1, 2005 (based on the grant-date fair value estimated in accordance with the original provisions of SFAS No. 123 and previously presented in pro forma footnote disclosures), and (b) compensation cost for all stock-based payments granted subsequent to July 1, 2005 (based on the grant-date fair value estimated in accordance with the new provisions of SFAS No. 123(R)). Results for periods prior to July 1, 2005, have not been restated.
 
The amounts of stock-based compensation expense recognized in the periods presented are as follows:
 
     
Three Months Ended June 30,
 
     
2006
 
2005
 
                 
 
Stock-based compensation expense recognized:
           
 
Cost of revenue
 
$
16
 
$
--
 
 
R&D
   
25
   
--
 
 
SG&A (only RSUs in 2005)
   
43
   
5
 
 
Total
 
$
84
 
$
5
 
 
     
Six Months Ended June 30,
 
     
2006
 
2005
 
                 
 
Stock-based compensation expense recognized:
           
 
Cost of revenue
 
$
34
 
$
--
 
 
R&D
   
53
   
--
 
 
SG&A (only RSUs in 2005)
   
88
   
10
 
 
Total
 
$
175
 
$
10
 
 
The amounts above include the impact of recognizing compensation expense related to nonqualified stock options, RSUs and stock options offered under the employee stock purchase plan. For 2005, before implementation of SFAS No. 123(R), only compensation expense related to RSUs was recognized and included in SG&A. Stock-based compensation expense has not been allocated to the various segments, but is reflected in Corporate.
 
Under the modified prospective application method, results for periods prior to July 1, 2005, have not been restated to reflect the effects of implementing SFAS No. 123(R). The following pro forma information, as required by SFAS No. 148, “Accounting for Stock-Based Compensation - Transition and Disclosure, an amendment of FASB Statement No. 123,” is presented for comparative purposes and illustrates the pro forma effect on income from continuing operations and related earnings per common share for the periods ended June 30, 2005, as if we had applied the fair value recognition provisions of SFAS No. 123 to stock-based compensation for that period:

 
   
For Three
Months Ended
June 30, 2005 
   
For Six
Months Ended
June 30, 2005
 
Income from continuing operations, as reported
 
$
584
 
$
955
 
               
Add: Stock-based compensation expense included in reported income, net of ($2) and ($4) tax expense
   
3
   
6
 
               
Deduct: Total stock-based compensation expense
determined under fair value-based method for all awards, net of $31 and $68 tax
   
(65
)
 
(140
)
Deduct: Adjustment for retirement-eligible employees, net of $49 tax
   
--
   
(93
)
               
Adjusted income from continuing operations
 
$
522
 
$
728
 
 
           
 
9

               
Earnings per common share:
             
Basic - as reported
 
$
.36
 
$
.57
 
 
           
Basic - as adjusted for stock-based compensation expense
 
$
.32
 
$
.44
 
 
             
Diluted - as reported
 
$
.35
 
$
.56
 
               
Diluted - as adjusted for stock-based compensation expense
 
$
.31
 
$
.43
 
 
In the first quarter of 2005, we reduced the attribution period used for certain grants of nonqualified stock options to recognize fair value-based compensation expense for pro forma disclosure purposes for those stock option recipients who are retirement eligible or become retirement eligible following the grant of the awards. Our nonqualified stock options have 10-year terms and generally vest over a four-year service period from the date of grant. Effective January 1, 2005, stock-based compensation expense for retirement-eligible employees is recognized over a six-month period, and for non-retirement-eligible employees, over the shorter of the period from grant date to the date they become retirement eligible (but not less than the six-month required service period) or the normal four-year vesting period. As a result, we included in our first quarter 2005 pro forma footnote disclosures a $93 million ($0.05 per share) inception-to-date adjustment of fair value-based compensation expense for both retirement-eligible employees and employees who became retirement eligible since the date of grants, to reflect the reduced attribution period.
 
5.  
Post-employment Benefit Plans. Components of net periodic employee benefit cost (in millions):
 
 
 
U.S. Defined Benefit 
U.S. Retiree Health Care
Non-U.S. Defined Benefit
For Three Months Ended June 30,
   
2006
   
2005
   
2006
   
2005
   
2006
   
2005
 
Service cost
 
$
6
 
$
6
 
$
1
 
$
1
 
$
11
 
$
11
 
Interest cost
   
12
   
10
   
6
   
6
   
11
   
13
 
Expected return on assets
   
(12
)
 
(11
)
 
(5
)
 
(5
)
 
(16
)
 
(13
)
Amortization of prior service cost
   
--
   
--
   
1
   
--
   
(1
)
 
(2
)
Recognized net actuarial loss
   
6
   
5
   
1
   
2
   
4
   
8
 
 
                         
Net periodic benefit cost
 
$
12
 
$
10
 
$
4
 
$
4
 
$
9
 
$
17
 

 
 
 
U.S. Defined Benefit 
U.S. Retiree Health Care
Non-U.S. Defined Benefit
For Six Months Ended June 30,
   
2006
   
2005
   
2006
   
2005
   
2006
   
2005
 
Service cost
 
$
13
 
$
12
 
$
2
 
$
2
 
$
21
 
$
25
 
Interest cost
   
22
   
20
   
12
   
12
   
23
   
27
 
Expected return on assets
   
(24
)
 
(22
)
 
(10
)
 
(10
)
 
(33
)
 
(29
)
Amortization of prior service cost
   
--
   
--
   
1
   
1
   
(2
)
 
(4
)
Recognized net actuarial loss
   
11
   
11
   
3
   
3
   
9
   
16
 
 
                         
Net periodic benefit cost
 
$
22
 
$
21
 
$
8
 
$
8
 
$
18
 
$
35
 

Settlement and curtailment (gains)/losses and special termination benefits for continuing operations were not material.
 
Discretionary contributions of $74 million were made to our U.S. and Japan post-employment benefit plans during the second quarter of 2006.
 
6.  
Business Segment Data. As a result of the agreement to sell the Sensors & Controls business, excluding the RFID operations, we now have two reportable operating business segments: Semiconductor and Educational & Productivity Solutions (E&PS). The former Sensors & Controls business has been reflected as discontinued operations (see Note 1 and Note 2). Segment results for prior periods presented have been restated to reflect the addition of the RFID operations retained within the Semiconductor business segment.
 
10

Business segment information for continuing operations follows:
 
 
 
For Three Months Ended June 30, 
For Six Months Ended June 30,
Business Segment Net Revenues
   
2006
   
2005
   
2006
   
2005
 
Semiconductor
 
$
3,505
 
$
2,791
 
$
6,767
 
$
5,412
 
Educational & Productivity Solutions
   
192
   
181
   
265
   
262
 
Intersegment eliminations
   
--
   
(1
)
 
(1
)
 
(1
)
Total net revenues
 
$
3,697
 
$
2,971
 
$
7,031
 
$
5,673
 

 
 
 
For Three Months Ended June 30, 
For Six Months Ended June 30,
Business Segment Profit (Loss)
   
2006
   
2005
   
2006
   
2005
 
Semiconductor*
 
$
1,032
 
$
597
 
$
1,915
 
$
1,059
 
Educational & Productivity Solutions
   
84
   
79
   
98
   
99
 
Corporate **
   
(163
)
 
(74
)
 
(342
)
 
(120
)
Profit from operations
 
$
953
 
$
602
 
$
1,671
 
$
1,038
 
 
* Semiconductor profit from operations in the second quarter of 2006 includes a benefit of $60 million from a royalty settlement (see Note 8). Also included is a benefit of $57 million from a $77 million net sales tax refund that was due to the settlement of an audit of Texas sales taxes paid on various purchases over a nine year period. The $57 million effect on profit from operations is reflected as $31 million in cost of revenue, $21 million in R&D and $5 million in SG&A. The remaining $20 million of the net sales tax refund is reflected in Other income (expense) net.
 
** Corporate profit from operations includes stock-based compensation expense of $84 million, $5 million, $175 million, and $10 million respectively. Also included in 2005 is a gain of $23 million in the first quarter on sales of assets related primarily to the disposition of a sales facility and the sale of our commodity liquid crystal driver product line.
 
7.  
Income Taxes. Federal income taxes for continuing operations for the interim periods presented have been included in the accompanying financial statements on the basis of an estimated annual rate. As of June 30, 2006, the estimated annual effective tax rate for 2006 is about 30 percent. The rate is based on current tax law and does not assume reinstatement of the federal research tax credit, which expired at the end of 2005. The primary reasons the effective annual tax rate for continuing operations for 2006 differs from the 35 percent statutory corporate tax rate are the effects of non-U.S. tax rates and the expected utilization of various tax benefits such as deductions for export sales and U.S. manufacturing.
 
8.  
Contingencies. Italian government auditors have substantially completed a review, conducted in the ordinary course, of approximately $250 million of grants from the Italian government to TI’s former memory operations in Italy for 13 separate projects. The auditors have raised a number of issues relating to compliance with grant requirements and the eligibility of specific expenses for the grants. As of June 30, 2006, the auditors have issued audit reports on all of the projects. The Ministry of Industry is responsible for reviewing the auditors’ findings. Depending on the Ministry’s decision, the review may result in a demand from the Italian government that we repay a portion of the grants. We believe that the grants were obtained and used in compliance with applicable law and contractual obligations. As of June 30, 2006, the Ministry has published final decrees on 12 of the projects representing approximately $175 million of grants. We do not expect the outcome to have a material adverse impact on our financial condition, results of operations or liquidity.
 
We routinely sell products with a limited intellectual property indemnification included in the terms of sale. Historically, we have had only minimal and infrequent losses associated with these indemnities. Consequently, any future liabilities brought about by the intellectual property indemnities cannot reasonably be estimated or accrued.
 
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, and historically we have experienced a low rate of payments on product claims. Consistent with general industry practice, we enter into formal contracts with certain customers in which the parties define warranty remedies. Typically, our warranty for semiconductor products covers three years, 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 be disproportionate to the price of our products.
 
11

On February 6, 2006, a jury in the U.S. District Court for the District of New Jersey determined that GlobespanVirata (Globespan), a subsidiary of Conexant Systems, Inc. (Conexant), had infringed two TI patents and one Stanford University (Stanford) patent relating to digital subscriber line (DSL) technology. The jury awarded $112 million in damages to TI. In June 2003, before Globespan's merger with Conexant, Globespan had sued TI and Stanford claiming that the TI and Stanford patents were invalid and not being infringed by Globespan, and alleging violations of the antitrust law. In response, TI and Stanford brought counterclaims of patent infringement against Globespan. On May 5, 2006, the companies announced a settlement resolving this litigation. Under the settlement, Conexant paid TI $70 million and TI granted Conexant a license to essential patents relating to DSL technology. Under an agreement with Stanford, TI will be required to make a payment of $10 million to Stanford related to the royalty amount received by TI from Conexant.
 
We are subject to various other 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 upon our financial condition, results of operations or liquidity.
 
 
12


ITEM 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations.
 
The following should be read in conjunction with the condensed consolidated financial statements and the related notes that appear elsewhere in this document. Except as noted, financial results are for continuing operations. Our former Sensors & Controls business is reported as discontinued operations. The divestiture of this business closed on April 27, 2006.
 
Overview
 
Texas Instruments makes, markets and sells high-technology components; more than 50,000 customers all over the world buy our products. We have two separate business segments: Semiconductor and Educational & Productivity Solutions. Semiconductor is by far the largest of these business segments. It accounted for 96 percent of our revenue from continuing operations in 2005, and historically it averages a higher growth rate than the other business segment, although the semiconductor market is characterized by wide swings in growth rates from year to year. We were the world’s third-largest semiconductor company in 2005 as measured by revenue, according to iSuppli Corporation, an industry analyst.
 
In our Semiconductor segment, we focus primarily on technologies that make it possible for a variety of consumer and industrial electronic equipment to process both analog and digital signals in real time. These technologies are known as analog semiconductors and digital signal processors, or DSPs, and together they account for about three-fourths of our Semiconductor revenue. Almost all of today’s digital electronic equipment requires some form of analog or digital signal processing.
 
Analog semiconductors process “real world” inputs, such as sound, temperature, pressure and visual images, conditioning them, amplifying them and converting them into digital signals. They also assist in the management of power distribution and consumption, aspects critical to today’s portable electronic devices. Generally, analog products require less capital-intensive factories to manufacture than digital products.
 
Our analog semiconductors consist of custom products and standard products. Custom products are designed for specific applications for specific customers. Standard products include application-specific standard products (designed for a specific application and usable by multiple customers) and high-performance standard catalog products (usable in multiple applications by multiple customers). These standard products are characterized by differentiated features and specifications, as well as relatively high margins. Standard analog products tend to have long life spans. Many custom and standard products are proprietary and difficult for competitors to imitate. Analog products also include commodity products, which are sold in high volume and into a broad range of applications, and generally are differentiated by price and availability. We are the world’s largest supplier of analog semiconductors.
 
DSPs use complex algorithms and compression techniques to alter and improve a data stream. These products are ideal for applications that require precise, real-time processing of real-world signals that have been converted into digital form. Their power efficiency is important for battery-powered devices.
 
Our DSP portfolio includes custom, application-specific and standard products. Custom products are designed for specific customers with very high volumes in established markets. Application-specific products are implementations crafted for specific applications like wireless infrastructure, VoIP (Voice over Internet Protocol) gateways, digital still cameras and residential gateways, to name a few. Our standard DSP products are sold into a broad range of applications and seed the next generation of signal-processing innovation. We are the world’s largest supplier of DSPs.
 
We own and operate semiconductor manufacturing sites in the Americas, Japan, Europe and Asia.  Our facilities require substantial investment to construct and are largely fixed-cost assets once in operation. Because we own most of our manufacturing capacity, a significant portion of our operating costs is fixed. In general, these costs do not decline with reductions in customer demand or our utilization of our manufacturing capacity, and can adversely affect profit margins as a result. Conversely, as product demand rises and factory utilization increases, the fixed costs are spread over increased output, which should improve profit margins.
 
As part of our manufacturing strategy, we outsource a portion of our product manufacturing to outside suppliers (foundries and assembly/test subcontractors), which reduces both the amount of capital expenditures and subsequent depreciation required to meet customer demands, and fluctuations in profit margins. Outside foundries provided about 20 percent of our total wafers produced in 2005. (A wafer is a thin slice of silicon on which an array of semiconductor devices has been fabricated.)
 
13

The semiconductor market is characterized by constant and typically incremental innovation in product design and manufacturing technologies. We make significant investments in research and development (R&D). Typically, products resulting from our R&D investments in the current period do not contribute materially to revenue in that period, but should benefit us in future years. In general, new semiconductor products are shipped in limited quantities initially and will then ramp into high volumes over time. Prices and manufacturing costs tend to decline over time.
 
Our Educational & Productivity Solutions (E&PS) segment is a leading supplier of graphing handheld calculators. It also provides our customers with business and scientific calculators and a wide range of advanced classroom tools and professional development that enables students and teachers to interactively explore math and science. Our products are marketed primarily through retailers and to schools through instructional dealers. This business segment represented 4 percent of our revenue from continuing operations in 2005. Prices of E&PS products tend to be stable.
 
In early 2006, we entered into an agreement to sell substantially all of our Sensors & Controls business, which had been a separate business segment before 2006, to an affiliate of Bain Capital, LLC, for $3 billion. This sale was completed on April 27, 2006. The financial results of this business are accounted for as discontinued operations and for the three- and six-month periods ended June 30, 2006, include operations during the periods prior to the date of sale, as well as the actual gain on sale. The amounts in comparison for the 2005 periods include operations of the sold business for the full three and six months (see Note 2 to the Financial Statements for additional information). Products manufactured and sold by this business included sensors, and electrical and electronic controls. The primary markets were automotive and industrial. Other targeted markets included heating, ventilation, air conditioning, refrigeration and industrial control systems.
 
In the third quarter of 2005, we implemented the Financial Accounting Standards Board’s Statement of Financial Accounting Standard (SFAS) No. 123(R), “Share-Based Payments.” The financial results of 2005 include the effects of adopting this new accounting rule for stock options effective July 1, 2005. Before July 1, 2005, our financial results include the expense of restricted stock units, but not stock options. Consequently, our financial results for periods after July 1, 2005, are not fully comparable to our prior financial results. For the second quarter of 2006, the total stock-based compensation expense was $84 million, or 2.3 percent of revenue. The distribution of this expense was $43 million to selling, general and administrative (SG&A) expense, $25 million to R&D expense and $16 million to cost of revenue. For the first half of 2006, the total stock-based compensation expense was $175 million, or 2.5 percent of revenue. The distribution of this expense was $88 million to SG&A expense, $53 million to R&D expense and $34 million to cost of revenue.
 
As a result of a study of the pattern of usage of long-lived depreciable assets, we adopted the straight-line method of depreciation for all property, plant and equipment on a prospective basis effective January 1, 2006, as allowed for under SFAS No. 154, “Accounting Changes and Error Corrections, a replacement of APB Opinion No. 20 and FASB Statement No. 3.” See Financial Condition below and Note 1 to the Financial Statements for additional information.
 
We operate in a number of tax jurisdictions and are subject to several types of taxes including taxes based on income, capital, property and payroll, and sales and other transactional taxes. The timing of the final determination of our tax liabilities varies among these jurisdictions and their taxing authorities. As a result, during any particular reporting period, we might reflect (in either income before income taxes, the provision for income taxes or both) one or more tax refunds or assessments, or changes to tax liabilities, involving one or more taxing authorities.
 
Second-Quarter 2006 Results 
 
Our revenue for the second quarter of 2006 was $3.70 billion, 11 percent higher sequentially and 24 percent higher than the same quarter a year ago due to higher shipments, as demand for our semiconductors continued to strengthen. Sequential growth also benefited from seasonal demand for graphing calculators, as retailers began to stock for the upcoming back-to-school season. Additionally, we received a $70 million royalty settlement in the quarter that was included in revenue.
 
Earnings per share (EPS) from continuing operations in the quarter were $0.47, up 42 percent sequentially and 34 percent from a year ago. EPS included an expense of $0.03 from stock-based compensation, a benefit of $0.03 from a state sales tax refund, and a benefit of $0.02 from the royalty settlement. We began expensing stock options in the third quarter of 2005 and, therefore, equivalent stock-based compensation expense was not reflected in the year-ago quarter, when we earned $0.35 per share from continuing operations.
 
This was another excellent quarter. All regions of the world showed strong revenue growth from a year ago. Revenue from our wireless semiconductors grew 27 percent, including more than 70 percent growth in 3G; revenue from high-performance analog semiconductors grew 32 percent; and revenue from our DLP® picture technology grew 34 percent.
 
14

Strategically, our focus on open wireless standards was reinforced by the actions of operators around the world, who are accelerating their infrastructure transitions to GSM (Global System for Mobile communication) because of its cost effectiveness and the wide range of choices it offers.
 
Going into the third quarter, our backlog of orders is up, and our outlook is for seasonal growth. As always, we will pay close attention to the world’s economies and to our inventory in the various market channels.
 
TEXAS INSTRUMENTS INCORPORATED AND SUBSIDIARIES
Statements of Income - Selected Items
(Millions of dollars, except per-share amounts)

 
 
For Three Months Ended 
 
   
June 30,
2006
   
Mar. 31,
2006
   
June 30,
2005
 
Net revenue
 
$
3,697
 
$
3,334
 
$
2,971
 
Cost of revenue (COR)
   
1,790
   
1,662
   
1,545
 
Gross profit
   
1,907
   
1,672
   
1,426
 
Gross profit % of revenue
   
51.6
%
 
50.1
%
 
48.0
%
Research and development (R&D)
   
536
   
533
   
485
 
R&D % of revenue
   
14.5
%
 
16.0
%
 
16.3
%
Selling, general and administrative (SG&A)
   
418
   
421
   
339
 
SG&A % of revenue
   
11.3
%
 
12.6
%
 
11.4
%
Profit from operations
   
953
   
718
   
602
 
Operating profit % of revenue
   
25.8
%
 
21.5
%
 
20.3
%
Other income (expense) net
   
88
   
52
   
56
 
Interest expense on loans
   
2
   
3
   
2
 
Income from continuing operations before income taxes
   
1,039
   
767
   
656
 
Provision for income taxes
   
300
   
225
   
72
 
Income from continuing operations
   
739
   
542
   
584
 
Income from discontinued operations, net of income taxes
   
1,648
   
43
   
44
 
Net income
 
$
2,387
 
$
585
 
$
628
 
                     
Diluted earnings per common share:
                   
Income from continuing operations  
 
$
.47
 
$
.33
 
$
.35
 
Net income
 
$
1.50
 
$
.36
 
$
.38
 
                     
Stock-based compensation expense included in continuing operations:
                   
                     
COR 
 
$
16
  $
18
  $
--
 
R&D 
   
25
   
28
   
--
 
SG&A 
   
43
   
45
   
5
 
Profit from operations 
  $
84
 
$
91
 
$
5
 
% of revenue 
   
2.3
%
 
2.7
%
 
0.2
%
 
Details of Financial Results
 
Our gross profit for the second quarter of 2006 was $1.91 billion, or 51.6 percent of revenue, an increase of $235 million from the prior quarter and an increase of $481 million from the year-ago quarter. The increases over both periods reflect higher revenue in our two segments, Semiconductor and E&PS.
 
15

In the second quarter of 2006 we received a royalty settlement of $70 million and a $77 million net sales tax refund. Similar to other royalties, the royalty settlement was included in Semiconductor revenue  (see Note 8 to Financial Statements). The net sales tax refund was due to the settlement of an audit of Texas sales taxes paid on various purchases over a nine-year period.
 
The royalty settlement and sales tax refund benefit included in our second-quarter 2006 results are detailed as follows (all items are in the Semiconductor segment results except the $20 million in other income (expense) net (OI&E), which is in Corporate):

 
 
Royalty Settlement
 
Sales Tax Refund
 
Orders
 
$
70
 
$
--
 
Net revenue
   
70
   
--
 
Cost of revenue
   
10
   
(31
)
Gross profit
   
60
   
31
 
R&D
   
--
   
(21
)
SG&A
   
--
   
(5
)
Profit from operations
   
60
   
57
 
OI&E
   
--
   
20
 
Income from continuing operations before income taxes
   
60
   
77
 
 
R&D expense for the second quarter of $536 million, or 14.5 percent of revenue, increased $3 million from the prior quarter due to higher spending for development of new semiconductor devices, particularly associated with wireless applications. The higher spending was largely offset by a $21 million reduction from the sales tax refund. R&D expense increased $51 million from the year-ago quarter primarily due to higher spending for development of new semiconductor devices, particularly associated with wireless applications, and, to a lesser extent, the inclusion of $25 million of stock-based compensation in the second quarter of 2006. The increase was partially offset by the refund of state sales tax.
 
SG&A expense for the second quarter was $418 million, or 11.3 percent of revenue. SG&A expense decreased $3 million from the prior quarter and was up $79 million from the year-ago quarter. The increase from a year ago was primarily due to the combination of increased stock-based compensation expense ($43 million in second-quarter 2006 for stock options and restricted stock units as compared to $5 million for only restricted stock units in second-quarter 2005) and, to a lesser extent, higher spending for consumer advertising of our DLP semiconductors used in high-definition televisions.
 
Operating profit for the second quarter was $953 million, or 25.8 percent of revenue. This increase of $235 million from the prior quarter was primarily due to higher gross profit in both of our segments. Operating profit increased $351 million from the year-ago quarter due to higher gross profit in the Semiconductor segment. As previously mentioned, operating profit in the second quarter of 2006 included both $57 million of the sales tax refund and $60 million from the royalty settlement, partially offset by total stock-based compensation expense of $84 million.
 
OI&E of $88 million in the second quarter of 2006 increased $36 million sequentially and $32 million from the year-ago quarter, primarily due to the combination of the sales tax refund and increased interest income on higher cash balances resulting from the receipt of the cash proceeds from the sale of our former Sensors & Controls business.
 
Quarterly income taxes are calculated using an estimate of the effective tax rate for the full year and are based on the tax laws in effect at the end of the quarter. The calculation of the effective tax rate, by definition, does not include discrete tax items. In the second quarter of 2005, we recognized net discrete items of $78 million associated with favorable developments on certain outstanding income tax matters that were partially offset by an accrual for taxes on dividends repatriated under the American Jobs Creation Act of 2004. The effective tax rate for continuing operations for the second quarter of 2006 was approximately 30 percent. This compares with 30 percent for the first quarter and 23 percent for the year-ago quarter. The increase in the effective rate for the second quarter of 2006 from the prior-year quarter was due to, in decreasing order, higher income before income taxes, the expiration of the federal research tax credit, and the effect of non-U.S. tax rates.
 
As of June 30, 2006, the estimated annual effective tax rate for continuing operations for 2006 is approximately 30 percent. This rate differs from the 35 percent statutory corporate tax rate primarily due to the effects of non-U.S. tax rates and, to a lesser extent, the expected utilization of various tax benefits such as deductions for export sales and U.S. manufacturing.
 
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Income from continuing operations for the second quarter was $739 million, or $0.47 per share, compared with $542 million in the first quarter and $584 million for the year-ago quarter. Net income, which includes continuing and discontinued operations, was $2.39 billion, or $1.50 per share, compared with $585 million in the first quarter and $628 million in the year-ago quarter. Income from discontinued operations was $1.65 billion due to the gain on the sale of our former Sensors & Controls business, compared with $43 million in the first quarter and $44 million in the year-ago quarter.
 
Our orders for continuing operations were $3.91 billion. This was an increase of $302 million from the prior quarter and an increase of $767 million from the year-ago quarter. Both increases were primarily due to higher demand for our semiconductor products.
 
Semiconductor
 
Semiconductor revenue in the second quarter was $3.51 billion. This was an increase of 7 percent from the prior quarter primarily due to increased shipments resulting from higher demand for our analog products and, to a lesser extent, the $70 million royalty settlement. Semiconductor revenue increased 26 percent from the year-ago quarter primarily due to increased shipments resulting from higher demand for our DSP and analog products.
 
Analog revenue was up 8 percent from the prior quarter and 23 percent from the year-ago quarter, primarily due to increased shipments resulting from higher demand for our high-performance analog products and analog products for broadband applications. Revenue from high-performance analog products grew 5 percent from the prior quarter and 32 percent from a year