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 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 S 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
S
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 S
1,142,649,874
Number of shares of Registrant’s common stock outstanding as of
September 30, 2011
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,
2011
2010
2011
2010
Revenue
$
3,466
$
3,740
$
10,315
$
10,441
Cost of revenue
1,722
1,701
5,091
4,819
Gross profit
1,744
2,039
5,224
5,622
Research and development
395
417
1,241
1,178
Selling, general and administrative
388
391
1,194
1,129
Restructuring expense
—
4
—
31
Acquisition cost
147
—
162
—
Operating profit
814
1,227
2,627
3,284
Other income (expense) net
(19
)
8
1
19
Interest and debt expense
15
—
21
—
Income before income taxes
780
1,235
2,607
3,303
Provision for income taxes
179
376
669
1,017
Net income
$
601
$
859
$
1,938
$
2,286
Earnings per common share:
Basic
$
.52
$
.71
$
1.65
$
1.87
Diluted
$
.51
$
.71
$
1.62
$
1.85
Average shares outstanding (millions):
Basic
1,144
1,184
1,156
1,208
Diluted
1,157
1,196
1,177
1,221
Cash dividends declared per share of common stock
$
.13
$
.12
$
.39
$
.36
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,
2011
2010
2011
2010
Net income
$
601
$
859
$
1,938
$
2,286
Other comprehensive income (loss):
Available-for-sale investments:
Unrealized (losses) gains, net of taxes
(2
)
2
(1
)
4
Reclassification of recognized transactions, net of taxes
—
—
12
—
Net actuarial gains (losses) of defined benefit plans:
Adjustment, net of taxes
(15
)
(7
)
(34
)
(81
)
Reclassification of recognized transactions, net of taxes
12
14
35
52
Prior service cost of defined benefit plans:
Adjustment, net of taxes
1
1
3
2
Change in fair value of derivative instrument, net of taxes
(1
)
—
(4
)
—
Total
(5
)
10
11
(23
)
Total comprehensive income
$
596
$
869
$
1,949
$
2,263
See accompanying notes.
3
TEXAS INSTRUMENTS INCORPORATED AND SUBSIDIARIES
Consolidated Balance Sheets
(Millions of dollars, except share amounts)
Sept. 30, 2011
Dec. 31,
2010
Assets
Current assets:
Cash and cash equivalents
$
1,581
$
1,319
Short-term investments
1,037
1,753
Accounts receivable, net of allowances of ($26) and ($18)
Common stock, $1 par value. Authorized – 2,400,000,000 shares. Shares issued: September 30, 2011 – 1,740,552,451; December 31, 2010 – 1,740,166,101
1,741
1,740
Paid-in capital
1,172
1,114
Retained earnings
26,175
24,695
Less treasury common stock at cost. Shares: September 30, 2011 – 597,902,577; December 31, 2010 – 572,722,397
(17,372
)
(16,411
)
Accumulated other comprehensive income (loss), net of taxes
(690
)
(701
)
Total stockholders’ equity
11,026
10,437
Total liabilities and stockholders’ equity
$
20,907
$
13,401
See accompanying notes.
4
TEXAS INSTRUMENTS INCORPORATED AND SUBSIDIARIES
Consolidated Statements of Cash Flows
(Millions of dollars)
For Nine Months Ended Sept. 30,
2011
2010
Cash flows from operating activities:
Net income
$
1,938
$
2,286
Adjustments to net income:
Depreciation
657
639
Stock-based compensation
203
143
Amortization of acquisition-related intangibles
26
36
Gains on sales of assets
(5
)
—
Deferred income taxes
(9
)
(45
)
Increase (decrease) from changes in:
Accounts receivable
(124
)
(468
)
Inventories
(220
)
(213
)
Prepaid expenses and other current assets
(11
)
(30
)
Accounts payable and accrued expenses
70
97
Accrued compensation
(142
)
(97
)
Income taxes payable
(89
)
182
Other
(9
)
60
Net cash provided by operating activities
2,285
2,590
Cash flows from investing activities:
Additions to property, plant and equipment
(663
)
(898
)
Proceeds from asset sales and insurance recovery
16
—
Purchases of short-term investments
(2,463
)
(1,811
)
Sales, redemptions and maturities of short-term investments
3,254
2,175
Purchases of long-term investments
(4
)
(6
)
Sales and redemptions of long-term investments
75
90
Business acquisitions, net of cash acquired
(5,390
)
(59
)
Net cash used in investing activities
(5,175
)
(509
)
Cash flows from financing activities:
Proceeds from issuance of debt
4,697
—
Issuance costs for long-term debt
(12
)
—
Dividends paid
(451
)
(439
)
Sales and other common stock transactions
563
120
Excess tax benefit from share-based payments
28
3
Stock repurchases
(1,673
)
(1,854
)
Net cash provided by (used in) financing activities
3,152
(2,170
)
Net increase (decrease) in cash and cash equivalents
262
(89
)
Cash and cash equivalents, beginning of period
1,319
1,182
Cash and cash equivalents, end of period
$
1,581
$
1,093
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; more than 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, 2010. The consolidated statements of income, statements of comprehensive income and statements of cash flows for the periods ended September 30, 2011 and 2010, and the balance sheet as of September 30, 2011, 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, 2010, 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, 2010. The results for the three- 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.
On September 23, 2011, we completed the acquisition of National Semiconductor Corporation (National). The consolidated financial statements include the balances and results of operations of National from the date of acquisition. See Note 2 for more detailed information.
Use of Derivatives and Hedging — In connection with the issuance of long-term debt in May 2011, as more fully described in Note 5, we entered into an interest rate swap designated as a hedge of the variability of cash flows related to interest payments on the variable-rate portion of the debt. Gains and losses from changes in the fair value of the interest rate swap are credited or charged to accumulated other comprehensive income (AOCI).
We also use derivative financial instruments to manage exposure to foreign exchange risk. These instruments are primarily forward foreign currency exchange contracts that are used as economic hedges to reduce the earnings impact exchange rate fluctuations may have on our non-U.S. dollar net balance sheet exposures 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 apply hedge accounting to our foreign currency derivative instruments.
We do not use derivatives for speculative or trading purposes.
Fair Values of Financial Instruments — The fair values of our derivative financial instruments were not significant at September 30, 2011. Our investments in cash equivalents, short-term investments and certain long-term investments are carried at fair value and are discussed in Note 8. The carrying values for other current financial assets and liabilities, such as accounts receivable and accounts payable, approximate fair value due to the short maturity of such instruments. The fair value of our long-term debt approximates the carrying value.
Accounting Standards Adopted — In October 2009, the Financial Accounting Standards Board (FASB) concurrently issued the following Accounting Standards Updates (ASUs):
Ÿ ASU No. 2009 - 14 - Software (Topic 985): Certain Revenue Arrangements That Include Software Elements. This standard removes tangible products from the scope of software revenue recognition guidance and also provides guidance on determining whether software deliverables in an arrangement that includes a tangible product, such as embedded software, are within the scope of the software revenue guidance.
Ÿ ASU No. 2009 - 13 - Revenue Recognition (Topic 605): Multiple-Deliverable Revenue Arrangements. This standard modifies the revenue recognition guidance for arrangements that involve the delivery of multiple elements,
6
such as product, software, services and support, to a customer at different times as part of a single revenue generating transaction. This standard provides principles and application guidance to determine whether multiple deliverables exist, how the individual deliverables should be separated and how to allocate the revenue in the arrangement among those separate deliverables.
We adopted these standards in the first quarter of 2011 by applying them on a prospective basis to revenue arrangements entered into or materially modified beginning January 1, 2011. The adoption of these standards did not have a significant impact on our financial position or results of operations.
New Accounting Standard Not Yet Adopted — In May 2011, the FASB issued ASU No. 2011-04, Fair Value Measurement (Topic 820): Amendments to Achieve Common Fair Value Measurement and Disclosure Requirements in U.S. GAAP and IFRS. This standard results in a common requirement between the FASB and the International Accounting Standards Board (IASB) for measuring fair value and for disclosing information about fair value measurements. While this new standard will not affect how we measure or account for assets and liabilities at fair value, the disclosure requirements will be required for interim and annual periods beginning January 1, 2012. There will be no impact to our financial condition or results of operation from the adoption of this new standard.
2.
National Semiconductor acquisition. On September 23, 2011, we completed the acquisition of 100% of National’s issued and outstanding common stock. National designs, develops, manufactures and markets a wide range of semiconductor products, focusing on providing high-performance energy efficient analog and mixed-signal solutions. The purpose of the acquisition was to grow revenue by combining National’s products with TI’s larger sales force and customer base.
We accounted for this transaction under Accounting Standards Codification (ASC) 805 - Business Combinations, and National’s operating results are included in the Analog segment. The amount of National’s revenue included in our consolidated statement of income for the period from the closing date to September 30, 2011, was $18 million.
As of September 30, 2011, the allocation of the consideration transferred to the assets acquired and liabilities assumed from National is not yet complete. The preliminary estimates of fair value by major class of the assets acquired and liabilities assumed at the acquisition date are shown below. Because the acquisition closing was near our September 30 quarter-end date, these amounts are based on preliminary valuations. They include work performed by third-party valuation specialists retained to assist management in its valuation efforts, as well as our own estimates and assumptions. These preliminary fair value estimates are subject to change as valuations are finalized.
Cash and cash equivalents
$
1,145
Current assets
455
Inventory
225
Property, plant and equipment
904
Other assets
227
Acquired intangible assets (see detail below)
2,974
Goodwill
3,527
Assumed current liabilities
(195
)
Assumed long-term debt
(1,105
)
Deferred taxes and other assumed non-current liabilities
(1,600
)
Total consideration transferred
$
6,557
The acquisition date fair value of the consideration transferred is as follows:
Cash payments
$
6,535
Fair value of vested share-based awards assumed by TI
22
Total consideration transferred to National shareholders
$
6,557
7
The total cash flow impact of $5.390 billion results from the $6.535 billion cash payment offset by $1.145 billion cash balance of National at closing.
Identifiable intangible assets acquired and their estimated useful lives are as follows:
Asset amount
Weighted average useful life (in years)
Developed technology
$
2,025
10
Customer relationships
810
8
Other
34
5
Identified intangible assets subject to amortization
2,869
In-process research and development
105
*
Total identified intangible assets
$
2,974
* In-process research and development is not amortized until the associated project has been completed. Alternatively, if the associated project is not viable, it will be expensed.
We utilize the straight-line method of amortization for acquired intangible assets. Amortization of acquired intangible assets prior to the National acquisition was $19 million and $38 million for the nine months ended September 30, 2011 and 2010, respectively. Amortization of acquired intangible assets from the National acquisition is a component of acquisition cost, which is detailed later in this note. We recognized $6 million for the period from the acquisition date to September 30, 2011.
The remaining consideration, after adjusting for identified intangible assets and the net assets and liabilities recorded at fair value, was $3.527 billion and was applied to goodwill. This goodwill is attributed to National’s product portfolio and workforce expertise. None of the goodwill related to the National acquisition is deductible for tax purposes.
The following unaudited summaries of pro forma combined results of operation for the three months and nine months ended September 30, 2011 and 2010, give effect to the acquisition as if it had been completed on January 1, 2010. These pro forma summaries combine the historical results of TI for the three months and nine months ended September 30, 2011 and 2010, with the historical results of National (which had a year-end in May) for the three months and nine months ended August 28, 2011, and August 29, 2010, respectively. These pro forma summaries do not reflect any operating efficiencies, cost savings or revenue enhancements that may be achieved by the combined companies. In addition, certain non-recurring expenses, such as restructuring costs and retention bonuses, that are expected to be incurred within the first twelve months after the acquisition are not reflected in the pro forma summaries. These pro forma summaries are presented for informational purposes only and are not necessarily indicative of what the actual results of operations would have been had the acquisition taken place as of that date, nor are they indicative of future consolidated results of operations.
For Three Months Ended Sept. 30,
For Nine Months Ended Sept. 30,
2011
2010
2011
2010
Revenue
$
3,818
$
4,152
$
11,385
$
11,613
Net income
589
887
1,930
2,269
Earnings per common share - diluted
$
0.50
$
0.73
$
1.61
$
1.83
Acquisition cost
Included in the acquisition cost line of the Consolidated Statements of Income are the following:
8
For Three Months Ended Sept. 30,
For Nine Months Ended Sept. 30,
2011
2010
2011
2010
Transaction costs
$
30
$
—
$
45
$
—
Restructuring costs
53
—
53
—
Stock-based compensation
41
—
41
—
Accrual of retention bonuses
6
—
6
—
Amortization of intangible assets
6
—
6
—
Other costs
11
—
11
—
Total
$
147
$
—
$
162
$
—
Transaction costs include expenses incurred in connection with the National acquisition, such as investment advisory, legal, accounting and printing fees, as well as the costs associated with the bridge financing obtained in April 2011.
Restructuring costs associated with the National acquisition consist of severance and other benefit payments for former National employees who have been or will be terminated after the closing date. About 350 jobs will be eliminated by the end of 2012. Additional restructuring charges of about $30 million for this action will continue through the third quarter of 2012.
Stock-based compensation of $41 million was recognized for the accelerated vesting on employees being terminated. Additional stock-based compensation will be recognized over any remaining service periods.
The accrual of retention bonuses reflects amounts to be paid to former National employees who fulfill agreed upon service obligations. This expense will be recognized ratably over the service period. We accrued $6 million in the third quarter and the remaining expected charges of about $75 million will be recognized by the end of the first quarter of 2012.
Amortization of intangible assets is based on an estimated average useful life varying between 5 and 10 years. Annual amortization for the next 5 years is about $325 million per year. See Note 3 for additional details.
3.
Goodwill and other acquisition-related intangibles.
Changes in goodwill as of September 30, 2011, by segment are as follows:
Analog
Embedded Processing
Wireless
Other
Total
Goodwill, December 31, 2010
$
630
$
172
$
90
$
32
$
924
Additions from acquisitions
3,527
—
—
—
3,527
Goodwill, September 30, 2011
$
4,157
$
172
$
90
$
32
$
4,451
There was no impairment of goodwill during the nine months ended September 30, 2011. Goodwill in the Analog segment increased as a result of the National acquisition. The goodwill balances shown on our balance sheets are net of total accumulated amortization of $221 million.
The following table shows the components of acquisition-related intangible assets as of September 30, 2011 and December 31, 2010:
9
Sept. 30, 2011
Dec. 31, 2010
Amortization Period
Gross Carrying Amount
Accumulated Amortization
Net
Gross Carrying Amount
Accumulated Amortization
Net
Developed technology
4 - 10 years
$
2,180
$
117
$
2,063
$
155
$
100
$
55
Customer relationships
5 - 8 years
835
21
814
26
18
8
Other intangibles
3 - 10 years
68
26
42
34
21
13
In-process research and development
(a)
105
—
105
—
—
—
Total
$
3,188
$
164
$
3,024
$
215
$
139
$
76
(a) Not yet subject to amortization.
In the nine months ended September 30, 2011, we recognized intangible assets associated with acquisitions of $2.974 billion.
Amortization of acquisition-related intangibles was $25 million for the nine months ended September 30, 2011, primarily related to developed technology. This amount included $6 million of amortization expense related to the intangible assets acquired through the National acquisition.
4.
Losses associated with the earthquake in Japan. On March 11, 2011, a magnitude 9.0 earthquake struck near two of our three semiconductor wafer manufacturing facilities in Japan. Our manufacturing site in Miho suffered substantial damage during the earthquake, our facility in Aizu experienced significantly less damage, and our site in Hiji was undamaged. We maintain earthquake insurance policies in Japan for limited coverage for property damage and business interruption losses.
Assessment and recovery efforts began immediately at these facilities and officially ended in August. Our Aizu factory recovered first and has been in production since the second quarter, while our Miho factory opened a mini-line for products in mid-April and was back to full production this summer.
During the first nine months of 2011, we incurred gross operating losses recorded in Other of $98 million related to property damage, the underutilization expense we incurred from having our manufacturing assets only partially loaded and costs associated with recovery teams assembled from across the world. These losses have been offset by about $20 million in insurance proceeds related to property damage claims. Almost all of these costs and proceeds are included in cost of revenue in the Consolidated Statements of Income. In the third quarter of 2011, we benefited from a net reduction in cost of revenue of $1 million.
In addition to the costs associated with the earthquake, we also had an impact to revenue. In the third quarter of 2011 and for the first nine months of 2011, we recognized $22 million in insurance proceeds related to business interruption claims. These proceeds were recorded as revenue in Other.
We continue to be in discussions with our insurers and their advisors, but at this time, we cannot estimate the timing and amount of future proceeds we may ultimately receive from these policies.
5.
Debt. The balances include amounts assumed related to the National acquisition measured at fair value as of the acquisition date.
Short-term — On July 14, 2011, in anticipation of the acquisition, we issued an aggregate of $1.2 billion of commercial paper, which was supported by existing revolving credit facilities. As of September 30, 2011, the balance of commercial paper outstanding was $1.2 billion.
Long-term — On May 23, 2011, we issued an aggregate principal amount of $3.50 billion of fixed- and floating-rate long-term debt to help fund the acquisition. The proceeds of the offering were $3.497 billion, net of the original issuance discount. We also incurred $12 million of issuance costs that are included in other assets and will be amortized to interest and debt expense over the term of the debt.
In connection with this issuance, we also entered into an interest rate swap transaction related to the $1.0 billion notional
10
amount of our floating-rate debt due 2013. Under this swap agreement, we will receive variable payments based on three-month LIBOR rates and pay a fixed rate through May 15, 2013. Changes in the cash flows of the interest rate swap are expected to exactly offset the changes in cash flows attributable to fluctuations in the three-month LIBOR-based interest payments. We have designated this interest rate swap as a cash flow hedge and record changes in its fair value in AOCI. The net effect of this swap is to convert the variable interest rate to a fixed rate of 0.922 percent.
The following table summarizes the long-term debt outstanding as of September 30, 2011, including the $1.0 billion in face value of National’s long-term debt (fair value of $1.105 billion) assumed in connection with the acquisition:
Notes due 2012 at 6.15% (assumed with National acquisition)
$
375
Floating-rate notes due 2013 (swapped to a 0.922% fixed rate)
1,000
Notes due 2013 at 0.875%
500
Notes due 2014 at 1.375%
1,000
Notes due 2015 at 3.95% (assumed with National acquisition)
250
Notes due 2016 at 2.375%
1,000
Notes due 2017 at 6.60% (assumed with National acquisition)
375
4,500
Add net unamortized premium (assumed with National acquisition)
101
Less current portion of long-term debt
(386
)
Total long-term debt
$
4,215
6.
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. As of September 30, 2011, the estimated annual effective tax rate for 2011 is about 25 percent, which differs from the 35 percent statutory corporate tax rate primarily due to the effects of non-U.S. tax rates.
7.
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 Sept. 30, 2011
For Three Months Ended Sept. 30, 2010
Income
Shares
EPS
Income
Shares
EPS
Basic EPS:
Net income
$
601
$
859
Less income allocated to RSUs
(10
)
(13
)
Income allocated to common stock for basic EPS calculation
$
591
1,144
$
.52
$
846
1,184
$
.71
Adjustment for dilutive shares:
Stock-based compensation plans
13
12
Diluted EPS:
Net income
$
601
$
859
Less income allocated to RSUs
(10
)
(13
)
Income allocated to common stock for diluted EPS calculation
$
591
1,157
$
.51
$
846
1,196
$
.71
11
For Nine Months Ended Sept. 30, 2011
For Nine Months Ended Sept. 30, 2010
Income
Shares
EPS
Income
Shares
EPS
Basic EPS:
Net income
$
1,938
$
2,286
Less income allocated to RSUs
(30
)
(32
)
Income allocated to common stock for basic EPS calculation
$
1,908
1,156
$
1.65
$
2,254
1,208
$
1.87
Adjustment for dilutive shares:
Stock-based compensation plans
21
13
Diluted EPS:
Net income
$
1,938
$
2,286
Less income allocated to RSUs
(29
)
(31
)
Income allocated to common stock for diluted EPS calculation
$
1,909
1,177
$
1.62
$
2,255
1,221
$
1.85
Options to purchase 50 million and 96 million shares of common stock that were outstanding during the third quarters of 2011 and 2010, respectively, and 40 million and 96 million shares outstanding during the first nine months of 2011 and 2010, respectively, were not included in the computation of diluted EPS because their exercise price was greater than the average market price of the common shares and, therefore, the effect would be anti-dilutive.
8.
Valuation of debt and equity investments and certain liabilities.
Debt and equity investments
We classify our investments as available-for-sale, trading, equity method or cost method. Most of our investments are classified as available-for-sale.
Available-for-sale and trading securities are stated at fair value, which is generally based on market prices, broker quotes or, when necessary, financial models (see fair value discussion below).
Unrealized gains and losses on available-for-sale securities are recorded as an increase or decrease, net of taxes, in AOCI. We record other-than-temporary losses (impairments) on available-for-sale securities in OI&E.
Changes in the fair value of debt securities classified as trading securities are recorded in OI&E.
We classify certain mutual funds as trading securities. These mutual funds hold a variety of debt and equity investments intended to generate returns that offset changes in certain deferred compensation liabilities. We record changes in the fair value of these mutual funds and the related deferred compensation liabilities in 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 and losses from equity method investments are reflected in OI&E based on our ownership share of the investee’s financial results. Gains and losses on cost method investments are recorded in OI&E when realized or when an impairment of the investment’s value is warranted based on our assessment of the recoverability of each investment.
Details of our investments and related unrealized gains and losses included in AOCI are as follows:
12
Sept. 30, 2011
Dec. 31, 2010
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
$
506
$
—
$
—
$
167
$
—
$
—
Corporate obligations
300
166
—
44
649
—
U.S. government agency and Treasury securities
344
799
—
855
1,081
—
Auction-rate securities
—
—
42
—
23
257
Trading
Auction-rate securities
—
72
94
—
—
—
Mutual funds
—
—
158
—
—
139
Total
$
1,150
$
1,037
$
294
$
1,066
$
1,753
$
396
Other measurement basis:
Equity method investments
$
—
$
—
$
34
$
—
$
—
$
36
Cost method investments
—
—
22
—
—
21
Cash on hand
431
—
—
253
—
—
Total
$
1,581
$
1,037
$
350
$
1,319
$
1,753
$
453
Amounts included in AOCI from available-for-sale securities:
Unrealized gains (pre-tax)
$
—
$
—
$
—
$
—
$
1
$
—
Unrealized losses (pre-tax)
$
—
$
—
$
4
$
—
$
1
$
22
As of September 30, 2011, and December 31, 2010, the majority of unrealized losses included in AOCI were associated with auction-rate securities classified as securities that are available-for-sale. We have determined that our available-for-sale investments with unrealized losses are not other-than-temporarily impaired as we expect to recover the entire cost basis of these securities and 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. In the second quarter of 2011, we recategorized certain auction-rate securities from an available-for-sale classification to a trading classification as we intend to sell them.
For the nine months ended September 30, 2011 and 2010, the proceeds from sales, redemptions and maturities of short-term available-for-sale securities, excluding cash equivalents, were $3.25 billion and $2.18 billion, 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, 2011:
Due
Fair Value
One year or less
$
1,947
One to three years
168
Greater than three years
42
Fair value
We measure and report our financial assets and certain 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
13
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 utilize a third-party data service to provide Level 2 valuations, verifying these valuations for reasonableness relative to unadjusted quotes obtained from brokers or dealers based on observable prices for similar assets in active markets.
Level 3 — Uses inputs that are unobservable, supported by little or no market activity and reflect the use of significant management judgment. These values are generally determined using pricing models that utilize management estimates of market participant assumptions.
Our auction-rate securities 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. These auctions have not functioned since 2008. There is no active secondary market for these securities, although limited observable transactions do occasionally occur. As a result, 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 following are our assets and liabilities that are accounted for at fair value on a recurring basis as of September 30, 2011 and December 31, 2010. 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
Sept. 30,
2011
Level
1
Level
2
Level
3
Assets:
Money market funds
$
506
$
506
$
—
$
—
Corporate obligations
466
—
466
—
U.S. government agency and Treasury securities
1,143
380
763
—
Auction-rate securities
208
—
—
208
Mutual funds
158
158
—
—
Total assets
$
2,481
$
1,044
$
1,229
$
208
Liabilities (a):
Deferred compensation
180
180
—
—
Total liabilities
$
180
$
180
$
—
$
—
14
Fair Value
Dec. 31,
2010
Level
1
Level
2
Level
3
Assets:
Money market funds
$
167
$
167
$
—
$
—
Corporate obligations
693
—
693
—
U.S. government agency and Treasury securities
1,936
1,120
816
—
Auction-rate securities
280
—
23
257
Mutual funds
139
139
—
—
Total assets
$
3,215
$
1,426
$
1,532
$
257
Liabilities (a):
Contingent consideration
8
—
—
8
Deferred compensation
159
159
—
—
Total liabilities
$
167
$
159
$
—
$
8
(a)The liabilities 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.
The following table provides a reconciliation of changes in the fair values for Level 3 assets and liabilities.
Level 3
Changes in fair value during the period (pre-tax):
Auction-rate securities
Contingent consideration
Beginning 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
Change in fair value of contingent consideration - included in operating profit
—
(8
)
Reduction in unrealized loss - included in AOCI
5
—
Redemptions
(85
)
—
Transfers into Level 2
6
—
Ending Balance, December 31, 2010
257
8
Change in fair value of contingent consideration - included in operating profit
—
(8
)
Increase in unrealized loss - included in AOCI
(1
)
—
Redemptions and sales
(48
)
—
Ending Balance, September 30, 2011
$
208
$
—
9.
Postretirement benefit plans. Because the acquisition closed shortly before the end of the quarter, we have not included the effect of National’s postretirement benefit plans in the disclosures below. Components of net periodic employee benefit cost are as follows:
15
U.S.
Defined Benefit
U.S.
Retiree Health Care
Non-U.S.
Defined Benefit
For three months ended Sept. 30,
2011
2010
2011
2010
2011
2010
Service cost
$
6
$
5
$
1
$
1
$
9
$
8
Interest cost
11
11
6
6
16
16
Expected return on plan assets
(11
)
(12
)
(5
)
(6
)
(20
)
(19
)
Amortization of prior service cost
—
—
1
1
(1
)
(1
)
Recognized net actuarial loss
6
7
3
3
10
8
Net periodic benefit cost
$
12
$
11
$
6
$
5
$
14
$
12
Settlement charges *
—
5
—
—
—
—
Total, including charges
$
12
$
16
$
6
$
5
$
14
$
12
U.S.
Defined Benefit
U.S.
Retiree Health Care
Non-U.S.
Defined Benefit
For nine months ended Sept. 30,
2011
2010
2011
2010
2011
2010
Service cost
$
17
$
15
$
3
$
3
$
27
$
25
Interest cost
34
35
19
19
48
46
Expected return on plan assets
(34
)
(37
)
(16
)
(17
)
(59
)
(54
)
Amortization of prior service cost
1
1
2
2
(3
)
(3
)
Recognized net actuarial loss
17
16
9
9
29
22
Net periodic benefit cost
$
35
$
30
$
17
$
16
$
42
$
36
Settlement charges *
—
34
—
—
—
—
Total, including charges
$
35
$
64
$
17
$
16
$
42
$
36
* Includes restructuring and non-restructuring related settlement charges.
10.
Contingencies. We routinely sell products with an intellectual property indemnification included in the terms of sale. Historically, we have had only minimal, infrequent losses associated with these indemnities. Consequently, we cannot reasonably estimate or accrue for any future liabilities that may result.
We accrue for known product-related claims if a loss is probable and can be reasonably estimated. During the periods presented, there have been no material accruals or payments regarding product warranty or product liability. Historically, we have experienced a low rate of payments on product claims. Although we cannot predict the likelihood or amount of any future claims, we do not believe they will have a material adverse effect on our financial condition, results of operations or liquidity. Consistent with general industry practice, we enter into formal contracts with certain customers that include negotiated warranty remedies. Typically, under these agreements, our warranty for semiconductor products includes: three years coverage; an obligation to repair, replace or refund; and a maximum payment obligation tied to the price paid for our products. In some cases, product claims may exceed the price of our products. From time to time, we also negotiate contingent consideration payment arrangements associated with certain acquisitions, which are recorded at fair value.
We are subject to various legal and administrative proceedings. Although it is not possible to predict the outcome of these matters, we believe that the results of these proceedings will not have a material adverse effect on our financial condition, results of operations or liquidity.
Discontinued operations indemnities - In connection with the 2006 sale of the former Sensors & Controls business (S&C), we have agreed to indemnify Sensata Technologies, Inc., for specified litigation matters and certain liabilities, including environmental liabilities. In a settlement of litigation with a third party, we have agreed to indemnify that party for certain events relating to S&C products, which events we consider remote. We believe our remaining exposure from both of these indemnities is approximately $200 million. As of September 30, 2011, we believe future payments related to these indemnity obligations will not have a material effect on our financial condition, results of operations or liquidity.
11.
Segment data. Our Analog segment includes the following components that are based on product lines: High-Volume Analog & Logic (HVAL), High-Performance Analog (HPA) and Power Management (Power). Following the National acquisition which closed on September 23, 2011, our Analog segment also includes National’s ongoing operations under the name of Silicon Valley Analog (SVA).
16
Other includes our other operating segments that neither meet the quantitative thresholds for individually reportable segments, nor are they aggregated with other operating segments. These operating segments primarily include our smaller semiconductor product lines and our handheld graphing and scientific calculators.
Acquisition cost is recorded in Other. The expense associated with the incremental fair value write-up of both inventory and property, plant and equipment will be recorded in Other as well. This inventory-related expense will be classified as cost of revenue, and we expect it to cease after the fourth quarter of 2011. This property, plant and equipment-related expense will primarily be recognized as cost of revenue, tracking the depreciable lives of the underlying assets.
With the exception of goodwill, we do not identify or allocate assets by operating segment, nor does the chief operating decision maker evaluate operating segments using discrete asset information. There was no significant intersegment revenue. The accounting policies of the segments are the same as those described in the summary of significant accounting policies.
