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  • 10-Q (Nov 2, 2017)
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Other

Texas Instruments 10-Q 2010

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
form10q.htm


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

FORM 10-Q
___________

T
QUARTERLY REPORT UNDER SECTION 13 or 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the quarterly period ended September 30, 2010

£
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  T   No £

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).       Yes  T   No £

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

Large accelerated filer 
T
 
Accelerated filer
£
         
Non-accelerated filer
£
(Do not check if a smaller reporting company)
Smaller reporting company 
£

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).       Yes £   No T
 
1,174,157,492
Number of shares of Registrant’s common stock outstanding as of
September 30, 2010
 


 
 

 

PART I - FINANCIAL INFORMATION

ITEM 1. Financial Statements.

TEXAS INSTRUMENTS INCORPORATED AND SUBSIDIARIES
Consolidated Statements of Income
(Millions of dollars, except share and per-share amounts)

   
For Three Months Ended Sept. 30,
   
For Nine Months Ended Sept. 30,
 
   
2010
   
2009
   
2010
   
2009
 
                         
Revenue
  $ 3,740     $ 2,880     $ 10,441     $ 7,422  
Cost of revenue
    1,701       1,399       4,819       4,012  
Gross profit
    2,039       1,481       5,622       3,410  
Research and development
    417       368       1,178       1,122  
Selling, general and administrative
    391       340       1,129       972  
Restructuring expense
    4       10       31       200  
Operating profit
    1,227       763       3,284       1,116  
Other income (expense) net
    8       2       19       20  
Income before income taxes
    1,235       765       3,303       1,136  
Provision for income taxes
    376       227       1,017       321  
Net income
  $ 859     $ 538     $ 2,286     $ 815  
                                 
Earnings per common share:
                               
Basic
  $ .71     $ .42     $ 1.87     $ .64  
Diluted
  $ .71     $ .42     $ 1.85     $ .63  
                                 
Average shares outstanding (millions):
                               
Basic
    1,184       1,255       1,208       1,266  
Diluted
    1,196       1,268       1,221       1,272  
                                 
Cash dividends declared per share of common stock
  $ .12     $ .11     $ .36     $ .33  

See accompanying notes.

 
2

 

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

   
For Three Months Ended Sept. 30,
   
For Nine Months Ended Sept. 30,
 
   
2010
   
2009
   
2010
   
2009
 
                         
Net income
  $ 859     $ 538     $ 2,286     $ 815  
Other comprehensive income (loss):
                               
Available-for-sale investments:
                               
Unrealized gains (losses), net of taxes
    2       (2 )     4       17  
Reclassification of recognized transactions, net of taxes
    --       5       --       6  
Net actuarial gains (losses) of defined benefit plans:
                               
Adjustment, net of taxes
    (7 )     (22 )     (81 )     58  
Reclassification of recognized transactions, net of taxes
    14       14       52       39  
Prior service cost of defined benefit plans:
                               
Adjustment, net of taxes
    1       1       2       (2 )
Reclassification of recognized transactions, net of taxes
    --       --       --       (6 )
Total
    10       (4 )     (23 )     112  
Total comprehensive income
  $ 869     $ 534     $ 2,263     $ 927  

See accompanying notes.

 
3

 

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

   
Sept. 30,
   
Dec. 31,
 
   
2010
   
2009
 
Assets
           
Current assets:
           
Cash and cash equivalents
  $ 1,093     $ 1,182  
Short-term investments
    1,417       1,743  
Accounts receivable, net of allowances of ($20) and ($23)
    1,754       1,277  
Raw materials
    114       93  
Work in process
    875       758  
Finished goods
    435       351  
Inventories
    1,424       1,202  
Deferred income taxes
    601       546  
Prepaid expenses and other current assets
    179       164  
Total current assets
    6,468       6,114  
Property, plant and equipment at cost
    6,897       6,705  
Less accumulated depreciation
    (3,441 )     (3,547 )
Property, plant and equipment, net
    3,456       3,158  
Long-term investments
    523       637  
Goodwill
    926       926  
Acquisition-related intangibles
    86       124  
Deferred income taxes
    907       926  
Capitalized software licenses, net
    213       119  
Overfunded retirement plans
    23       64  
Other assets
    47       51  
Total assets
  $ 12,649     $ 12,119  
                 
Liabilities and Stockholders’ Equity
               
Current liabilities:
               
Accounts payable
  $ 623     $ 503  
Accrued expenses and other liabilities
    965       841  
Income taxes payable
    31       128  
Accrued profit sharing and retirement
    219       115  
Total current liabilities
    1,838       1,587  
Underfunded retirement plans
    447       425  
Deferred income taxes
    82       67  
Deferred credits and other liabilities
    320       318  
Total liabilities
    2,687       2,397  

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:  September 30, 2010 -- 1,739,932,695; December 31, 2009 --  1,739,811,721
    1,740       1,740  
Paid-in capital
    1,128       1,086  
Retained earnings
    23,907       22,066  
Less treasury common stock at cost.
               
Shares:  September 30, 2010 -- 565,775,203; December 31, 2009 -- 499,693,704
    (16,169 )     (14,549 )
Accumulated other comprehensive income (loss), net of taxes
    (644 )     (621 )
Total stockholders’ equity
    9,962       9,722  
Total liabilities and stockholders’ equity
  $ 12,649     $ 12,119  

See accompanying notes.

 
4

 

TEXAS INSTRUMENTS INCORPORATED AND SUBSIDIARIES
Consolidated Statements of Cash Flows
(Millions of dollars)

   
For Nine Months Ended Sept. 30,
 
   
2010
   
2009
 
Cash flows from operating activities>:
           
Net income
  $ 2,286     $ 815  
Adjustments to net income:
               
Depreciation
    639       668  
Stock-based compensation
    143       143  
Amortization of acquisition-related intangibles
    36       34  
Deferred income taxes
    (45 )     80  
Increase (decrease) from changes in:
               
Accounts receivable
    (468 )     (520 )
Inventories
    (213 )     263  
Prepaid expenses and other current assets
    (11 )     24  
Accounts payable and accrued expenses
    173       36  
Income taxes payable
    (112 )     91  
Accrued profit sharing and retirement
    106       (43 )
Other
    56       51  
Net cash provided by operating activities
    2,590       1,642  
                 
Cash flows from investing activities:
               
Additions to property, plant and equipment
    (898 )     (317 )
Purchases of short-term investments
    (1,811 )     (1,442 )
Sales, redemptions and maturities of short-term investments
    2,175       1,412  
Purchases of long-term investments
    (6 )     (5 )
Redemptions and sales of long-term investments
    90       62  
Business acquisitions, net of cash acquired
    (59 )     (155 )
Net cash used in investing activities
    (509 )     (445 )
                 
Cash flows from financing activities>:
               
Dividends paid
    (439 )     (418 )
Sales and other common stock transactions
    120       71  
Excess tax benefits from share-based payments
    3       --  
Stock repurchases
    (1,854 )     (602 )
Net cash used in financing activities
    (2,170 )     (949 )
                 
Net (decrease) increase in cash and cash equivalents
    (89 )     248  
Cash and cash equivalents, beginning of period
    1,182       1,046  
Cash and cash equivalents, end of period
  $ 1,093     $ 1,294  

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) designs and makes semiconductors that we sell to electronics designers and manufacturers; about 80,000 customers all over the world buy our products.

Basis of Presentation – The consolidated financial statements have been prepared in accordance with accounting principles generally accepted in the U.S. (U.S. GAAP) and on the same basis as the audited financial statements included in our annual report on Form 10-K for the year ended December 31, 2009.  The consolidated statements of income, statements of comprehensive income and statements of cash flows for the periods ended September 30, 2010 and 2009, and the balance sheet as of September 30, 2010, 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 as of December 31, 2009, presented herein is derived from the audited consolidated balance sheet presented in our annual report on Form 10-K at that date.  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 U.S. 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, 2009.  The results for the three-month and nine-month periods 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.

Use of Derivatives and Hedging – We 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 or for specified non-U.S. dollar forecasted transactions.  Gains and losses from changes in the fair value of these forward foreign currency exchange contracts are credited or charged to other income (expense) net (OI&E).  We do not use derivatives for speculative or trading purposes. We do not apply hedge accounting to our foreign currency derivative instruments.

Fair Values of Financial Instruments – The fair values of our derivative financial instruments were not significant at September 30, 2010.  Our investments in cash equivalents, short-term investments and certain long-term investments are carried at fair value and are discussed in Note 6.  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.

Changes in Accounting Standards – In January 2010, the Financial Accounting Standards Board (FASB) issued Accounting Standards Update (ASU) No. 2010 - 06 – Fair Value Measurements and Disclosures (Topic 820): Improving Disclosures about Fair Value Measurements.  This standard amends the disclosure guidance with respect to fair value measurements for both interim and annual reporting periods. Specifically, this standard requires new disclosures for significant transfers of assets or liabilities between Level 1 and Level 2 in the fair value hierarchy; separate disclosures for purchases, sales, issuance and settlements of Level 3 fair value items on a gross, rather than net basis; and more robust disclosure of the valuation techniques and inputs used to measure Level 2 and Level 3 assets and liabilities. Except for the detailed disclosures of changes in Level 3 items, which will be effective for us as of January 1, 2011, the remaining new disclosure requirements were effective for us as of January 1, 2010. We have included these new disclosures, as applicable, in Note 6.

In April 2010, the FASB issued ASU No. 2010 - 17 – Revenue Recognition - Milestone Method (Topic 605): Milestone Method of Revenue Recognition. This standard provides guidance on defining a milestone and determining when it may be appropriate to apply the milestone method of revenue recognition for certain research and development transactions. Under this new standard, a company can recognize as revenue consideration that is contingent upon achievement of a milestone in the period in which it is achieved, only if the milestone meets all criteria to be considered substantive.  This standard will be effective for us on a prospective basis as of January 1, 2011.  We have evaluated the potential impact of this standard and expect it will have no significant impact on our financial position or results of operations.

 
6

 

2.
Acquisitions. On August 31, 2010, we completed the acquisition of two wafer fabrication facilities and equipment in Aizu-Wakamatsu, Japan for net cash of $130 million. These assets were previously operated by Spansion Japan Limited (SJL) and were acquired under a court-approved plan of reorganization.

The acquisition of the two wafer fabrication facilities and related 200-millimeter equipment was recorded as a business combination for net cash of $59 million. This agreement includes an operational 200-millimeter wafer fabrication facility as well as a non-operating wafer fabrication facility capable of either 200 or 300-millimeter production that will be preserved for future capacity expansion. Additionally, we offered employment to all of the SJL employees in Aizu. We will provide transitional supply services to Spansion LLC through June 2012, while also installing our analog production processes. We recorded $42 million of property, plant and equipment, $9 million of inventory and $8 million of expenses, which were charged to cost of revenue. Operating results for the transitional supply services provided to Spansion LLC will be included in our Other segment.

The acquisition also included 300-millimeter production tools which we recorded as a capital purchase for net cash of $58 million. Of this amount, $36 million was for tools to be used primarily in our 300-millimeter analog wafer factory in Richardson, Texas and the remaining $22 million will be held for sale.

In connection with this acquisition, 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 cost of revenue in our Other segment. Additionally, we incurred acquisition-related costs of $1 million which was recorded in selling, general and administrative expense.

In the second quarter of 2009, we acquired Luminary Micro for net cash of $51 million and other consideration of $7 million.  These operations were integrated into our Embedded Processing segment.

In the first quarter of 2009, we acquired CICLON Semiconductor Device Corporation for net cash of $104 million and other consideration of $7 million.  These operations were integrated into our Analog segment.

The results of operations of these business combinations have been included in our financial statements from their respective acquisition dates. Pro forma financial information for the comparable prior period of 2009 to reflect the latest acquisition would not be materially different from amounts reported.

3.
Restructuring activities.  In October 2008, we announced actions to reduce expenses in our Wireless segment, 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:

   
Severance and Benefits
   
Impairments and Other Charges
   
Total
 
                   
Remaining accrual at December 31, 2009
  $ 84     $ 10     $ 94  
                         
Restructuring expense
    31       --       31  
Non-cash charges
    (31 )*     --       (31 )
Payments
    (57 )     (2 )     (59 )
Remaining accrual at September 30, 2010
  $ 27     $ 8     $ 35  

* Reflects postretirement benefit plan settlement charges.

The accrual balances above are a component of Accrued expenses and other liabilities or Deferred credits and other liabilities on our balance sheets, depending on the expected timing of payment.

 
7

 

Restructuring expense recognized by segment from the actions above is as follows:

   
For Three Months Ended Sept. 30,
   
For Nine Months Ended Sept. 30,
 
   
2010
   
2009
   
2010
   
2009
 
                         
Analog
  $ 1     $ 4     $ 12     $ 78  
Embedded Processing
    1       2       6       40  
Wireless
    1       3       9       61  
Other
    1       1       4       21  
Total
  $ 4     $ 10     $ 31     $ 200  

4.
Income taxes.  Federal income taxes for the interim periods presented have been included in the accompanying financial statements on the basis of an estimated annual effective tax rate.  The rate is based on current tax law and for 2010 does not assume reinstatement of the federal research tax credit, which expired at the end of 2009.  As of September 30, 2010, the estimated annual effective tax rate for 2010 is about 31 percent, which differs from the 35 percent statutory corporate tax rate primarily due to the effects of non-U.S. tax rates.

5.
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:

   
For Three Months Ended
   
For Three Months Ended
 
   
September 30, 2010
   
September 30, 2009
 
   
Income
   
Shares
   
EPS
   
Income
   
Shares
   
EPS
 
                                     
Basic EPS:
                                   
Net Income
  $ 859                 $ 538              
Less income allocated to RSUs
    (13 )                 (6 )            
Income allocated to common stock for basic EPS calculation
  $ 846       1,184     $ .71     $ 532       1,255     $ .42  
                                                 
Adjustment for dilutive shares:
                                               
Stock-based compensation plans
            12                       13          
                                                 
Diluted EPS:
                                               
Net Income
  $ 859                     $ 538                  
Less income allocated to RSUs
    (13 )                     (6 )                
Income allocated to common stock for diluted EPS calculation
  $ 846       1,196     $ .71     $ 532       1,268     $ .42  


   
For Nine Months Ended
   
For Nine Months Ended
 
   
September 30, 2010
   
September 30, 2009
 
   
Income
   
Shares
   
EPS
   
Income
   
Shares
   
EPS
 
                                     
Basic EPS:
                                   
Net Income
  $ 2,286                 $ 815              
Less income allocated to RSUs
    (32 )                 (8 )            
Income allocated to common stock for basic EPS calculation
  $ 2,254       1,208     $ 1.87     $ 807       1,266     $ .64  
                                                 
Adjustment for dilutive shares:
                                               
Stock-based compensation plans
            13                       6          
                                                 
Diluted EPS:
                                               
Net Income
  $ 2,286                     $ 815                  
Less income allocated to RSUs
    (31 )                     (8 )                
Income allocated to common stock for diluted EPS calculation
  $ 2,255       1,221     $ 1.85     $ 807       1,272     $ .63  

 
8

 

Options to purchase 96 million and 121 million shares of common stock that were outstanding during the third quarters of 2010 and 2009, and 96 million and 137 million shares outstanding during the nine months of 2010 and 2009, respectively, were not included in the computation of diluted earnings per share because their exercise price was greater than the average market price of the common shares and, therefore, the effect would be anti-dilutive.

6.
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 securities consist primarily of money market funds and debt securities.  Available-for-sale 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).  We record other-than-temporary losses (impairments) on these securities in OI&E, and all other unrealized gains and losses as an increase or decrease, net of taxes, in accumulated other comprehensive income (AOCI).

Trading securities are stated at fair value based on market prices.  Our trading securities consist exclusively of mutual funds that 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 our trading securities and the related deferred compensation liabilities in selling, general and administrative expense.

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 or 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. We determine cost or amortized cost, as appropriate, on a specific identification basis.

In the quarter ending September 30, 2010, $35 million of auction-rate securities were redeemed and $29 million of auction-rate securities were called for redemption in October 2010. The auction-rate securities that have been called have been reclassified from long-term to short-term investments on the balance sheet.

 
9

 

Details of our investments by class and related unrealized gains and losses included in AOCI are as follows:

   
September 30, 2010
   
December 31, 2009
 
   
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
                                   
Money market funds
  $ 316     $ --     $ --     $ 563     $ --     $ --  
Corporate obligations
    100       649       --       100       438       --  
U.S. government agency and
                                               
Treasury securities
    461       739       --       360       1,305       --  
Auction-rate securities
    --       29       331       --       --       458  
                                                 
Trading
                                               
Mutual funds
    --       --       131       --       --       123  
Total
  $ 877     $ 1,417     $ 462     $ 1,023     $ 1,743     $ 581  
                                                 
                                                 
Other measurement basis:
                                               
Equity method investments
  $ --     $ --     $ 35     $ --     $ --     $ 33  
Cost method investments
    --       --       26       --       --       23  
Cash on hand
    216       --       --       159       --       --  
Total
  $ 1,093     $ 1,417     $ 523     $ 1,182     $ 1,743     $ 637  
                                                 
                                                 
Amounts included in AOCI from available-for-sale securities:
                                               
Unrealized gains (pre-tax)
  $ --     $ 2     $ --     $ --     $ 1     $ --  
Unrealized losses (pre-tax)
  $ --     $ --     $ 27     $ --     $ --     $ 32  

As of September 30, 2010, about 66 percent of our investments in the corporate obligations shown above are insured by either the Federal Deposit Insurance Corporation (FDIC) or the U.K. government.

As of September 30, 2010 and December 31, 2009, unrealized losses included in AOCI were associated with auction-rate securities.  We have determined that our available-for-sale investments with unrealized losses are not other-than-temporarily impaired.  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.  For the nine months ended September 30, 2010 and 2009, we did not recognize in earnings any credit losses related to these investments.

For the nine months ended September 30, 2010 and 2009, the proceeds from sales of available-for-sale securities prior to their scheduled maturities were $3.94 billion and $837 million, respectively.  Gross realized gains and losses from these sales were not significant.

The following table presents the aggregate maturities of investments in money market funds and other debt securities classified as available-for-sale at September 30, 2010:

Due
 
Fair Value
 
       
One year or less
  $ 1,839  
One to three years
    455  
Greater than three years (auction-rate securities)
    331  

 
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Fair value

We measure and report our financial assets and liabilities at fair value. 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, some U.S. government agency securities and auction-rate securities that have been called for redemption. We use a market approach to determine the fair value, primarily utilizing 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.

We own auction-rate securities that are primarily classified as Level 3 assets.  Auction-rate securities are debt instruments with variable interest rates that historically would periodically reset through an auction process.  There is currently no active market for auction-rate securities, so we use a discounted cash flow (DCF) model to determine the estimated fair value of these investments as of each quarter end.  The assumptions used in preparing the DCF model include estimates for the amount and timing of future interest and principal payments and the rate of return required by investors to own these securities in the current environment.  In making these assumptions we consider relevant factors including: the formula for each security that defines the interest rate paid to investors in the event of a failed auction; forward projections of the interest rate benchmarks specified in such formulas; the likely timing of principal repayments; the probability of full repayment considering the guarantees by the U.S. Department of Education of the underlying student loans and additional credit enhancements provided through other means; and, publicly available pricing data for student loan asset-backed securities that are not subject to auctions.  Our estimate of the rate of return required by investors to own these securities also considers the reduced liquidity for auction-rate securities.

To date, we have collected all interest on all of our auction-rate securities when due and expect to continue to do so in the future.  The principal associated with failed auctions will not be accessible until successful auctions resume, a buyer is found outside of the auction process, or issuers use a different form of financing to replace these securities.  Meanwhile, issuers continue to repay principal over time from cash flows prior to final maturity, or make final payments when they come due according to contractual maturities ranging from 12 to 37 years.  All of our auction-rate securities are backed by pools of student loans substantially guaranteed by the U.S. Department of Education and we continue to believe that the credit quality of these securities is high based on this guarantee.  As of September 30, 2010, all of these securities were rated AAA or Aaa by at least one of the major rating agencies.  Although most of these securities are dual rated AAA/Aaa, one ($25 million par value) is rated AAA/B3 and one ($12 million par value) is rated AAA/Baa1.   While our ability to liquidate auction-rate investments is likely to be limited for some period of time, we do not believe this will materially impact our ability to fund our working capital needs, capital expenditures, dividend payments or other business requirements.

 
11

 

The following are our assets and liabilities that were accounted for at fair value on a recurring basis as of September 30, 2010 and December 31, 2009.  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 September 30,
   
Level
   
Level
   
Level
 
   
2010
    1     2     3  
                               
Assets:
                             
Money market funds
  $ 316     $ 316     $ --     $ --  
Corporate obligations
    749       --       749       --  
U.S. government agency and Treasury securities
    1,200       741       459       --  
Auction–rate securities
    360       --       29       331  
Mutual funds
    131       131       --       --  
Total assets
  $ 2,756     $ 1,188     $ 1,237     $ 331  
                                 
Liabilities:
                               
Contingent consideration
  $ 16     $ --     $ --     $ 16  
Deferred compensation
    150       150       --       --  
Total liabilities
  $ 166     $ 150     $ --     $ 16  
                                 
                                 
   
Fair Value December 31,
   
Level
   
Level
   
Level
 
    2009     1     2     3  
                                 
Assets:
                               
Money market funds
  $ 563     $ 563     $ --     $ --  
Corporate obligations
    538       --       538       --  
U.S. government agency and Treasury securities
    1,665       911       754       --  
Auction–rate securities
    458       --       --       458  
Mutual funds
    123       123       --       --  
Total assets
  $ 3,347     $ 1,597     $ 1,292     $ 458  
                                 
Liabilities:
                               
Contingent consideration
  $ 18     $ --     $ --     $ 18  
Deferred compensation
    154       154       --       --  
Total liabilities
  $ 172     $ 154     $ --     $ 18  

The liabilities in the tables above are a component of Accrued expenses and other liabilities or Deferred credits and other liabilities on our balance sheets, depending on the expected timing of payment.

 
12

 

The following table provides a reconciliation of changes in the fair values for Level 3 assets and liabilities.  In the quarter ending September 30, 2010, we were notified that $29 million of our auction-rate securities were called for redemption in the fourth quarter of 2010.  As a result, we transferred these assets from Level 3 to Level 2 as of the end of the third quarter. These securities were redeemed in October 2010.

   
Level 3
 
Changes in fair value during the period (pre-tax):
 
Auction-rate securities
   
Contingent consideration
 
             
Beginning Balance, December 31, 2008
  $ 482     $ --  
New contingent consideration
    --       10  
Change in fair value of contingent consideration - included in operating profit
    --       8  
Reduction in unrealized loss - included in AOCI
    19       --  
Redemptions
    (44 )     --  
Ending Balance, September 30, 2009
    457       18  
                 
Reduction in unrealized loss - included in AOCI
    2       --  
Redemptions
    (1 )     --  
Ending Balance, December 31, 2009
    458       18  
                 
Change in fair value of contingent consideration - included in operating profit
    --       (2 )
Reduction in unrealized loss - included in AOCI
    5       --  
Redemptions
    (103 )     --  
Transfers into Level 2
    (29 )     --  
Ending Balance, September 30, 2010
  $ 331     $ 16  

 
13

 

7.
Postretirement benefit plans.  Components of net periodic employee benefit cost are as follows:

   
U.S. Defined Benefit
   
U.S. Retiree Health Care
   
Non-U.S. Defined Benefit
 
For Three Months Ended September 30,
 
2010
   
2009
   
2010
   
2009
   
2010
   
2009
 
                                     
Service cost
  $ 5     $ 5     $ 1     $ 1     $ 8     $ 9  
Interest cost
    11       12       6       7       16       16  
Expected return on plan assets
    (12 )     (11 )     (6 )     (7 )     (19 )     (18 )
Amortization of prior service cost
    --       --       1       --       (1 )     (1 )
Recognized net actuarial loss
    7       5       3       2       8       8  
Net periodic benefit cost
  $ 11     $ 11     $ 5     $ 3     $ 12     $ 14  
                                                 
Settlement charges *
    5       1       --       --       --       6  
Total, including charges
  $ 16     $ 12     $ 5     $ 3     $ 12     $ 20  


   
U.S. Defined Benefit
   
U.S. Retiree Health Care
   
Non-U.S. Defined Benefit
 
For Nine Months Ended September 30,
 
2010
   
2009
   
2010
   
2009
   
2010
   
2009
 
                                     
Service cost
  $ 15     $ 15     $ 3     $ 3     $ 25     $ 28  
Interest cost
    35       37       19       20       46       46  
Expected return on plan assets
    (37 )     (36 )     (17 )     (21 )     (54 )     (51 )
Amortization of prior service cost
    1       1       2       1       (3 )     (3 )
Recognized net actuarial loss
    16       13       9       6       22       27  
Net periodic benefit cost
  $ 30     $ 30     $ 16     $ 9     $ 36     $ 47  
                                                 
Settlement charges *
    34       8       --       --       --       6  
Curtailment charges (gains)
    --       --       --       2       --       (10 )
Special termination benefit charges
    --