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Texas Instruments 10-Q 2013

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
TXN-2013.9.30 - 10Q

 
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
 _______________________________________________________________________________________________________________
FORM 10-Q 
 _______________________________________________________________________________________________________________
x
QUARTERLY REPORT PURSUANT TO SECTION 13 or 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
 
For the quarterly period ended September 30, 2013

¨
TRANSITION REPORT UNDER 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 214-479-3773
 _______________________________________________________________________________________________________________
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 x   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 x   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
x
 
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 x

1,094,563,114
Number of shares of Registrant's common stock outstanding as of
September 30, 2013
 



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
September 30,
 
For Nine Months Ended
September 30,
 
2013
 
2012
 
2013
 
2012
Revenue
$
3,244

 
$
3,390

 
$
9,177

 
$
9,846

Cost of revenue (COR)
1,465

 
1,650

 
4,453

 
4,924

Gross profit
1,779

 
1,740

 
4,724

 
4,922

Research and development (R&D)
368

 
463

 
1,176

 
1,452

Selling, general and administrative (SG&A)
465

 
453

 
1,397

 
1,372

Acquisition charges
86

 
106

 
257

 
363

Restructuring charges/other
16

 
(122
)
 
(251
)
 
(99
)
Operating profit
844

 
840

 
2,145

 
1,834

Other income (expense), net (OI&E)
(4
)
 
24

 
(2
)
 
8

Interest and debt expense
24

 
21

 
71

 
62

Income before income taxes
816

 
843

 
2,072

 
1,780

Provision for income taxes
187

 
59

 
421

 
285

Net income
$
629

 
$
784

 
$
1,651

 
$
1,495

 
 
 
 
 
 
 
 
Earnings per common share:
 

 
 

 
 
 
 
Basic
$
.56

 
$
.68

 
$
1.47

 
$
1.29

Diluted
$
.56

 
$
.67

 
$
1.45

 
$
1.27

 
 
 
 
 
 
 
 
Average shares outstanding (millions):
 

 
 

 
 
 
 
Basic
1,096

 
1,130

 
1,102

 
1,138

Diluted
1,111

 
1,141

 
1,117

 
1,153

 
 
 
 
 
 
 
 
Cash dividends declared per share of common stock
$
.28

 
$
.17

 
$
.77

 
$
.51


See accompanying notes.

2


TEXAS INSTRUMENTS INCORPORATED AND SUBSIDIARIES
Consolidated statements of comprehensive income
[Millions of dollars]

 
For Three Months Ended
September 30,
 
For Nine Months Ended
September 30,
 
2013
 
2012
 
2013
 
2012
Net income
$
629

 
$
784

 
$
1,651

 
$
1,495

Other comprehensive income (loss):
 
 
 
 
 
 
 
Available-for-sale investments:
 
 
 
 
 
 
 
Unrealized gains (losses), net of taxes

 
1

 

 
3

Net actuarial gains (losses) of defined benefit plans:
 
 
 
 
 
 
 
Adjustment, net of taxes
6

 
(3
)
 
86

 
8

Reclassification of recognized transactions, net of taxes
13

 
128

 
46

 
151

Prior service cost of defined benefit plans:
 
 
 
 
 
 
 
Adjustment, net of taxes

 

 
(2
)
 

Reclassification of recognized transactions, net of taxes
(1
)
 

 
(3
)
 

Derivative instrument:
 
 
 
 
 
 
 
Change in fair value, net of taxes

 
(3
)
 
(1
)
 
(3
)
Reclassification of recognized transactions, net of taxes

 

 
1

 

Other comprehensive income (loss), net of taxes
18

 
123

 
127

 
159

Total comprehensive income
$
647

 
$
907

 
$
1,778

 
$
1,654


See accompanying notes.

3


TEXAS INSTRUMENTS INCORPORATED AND SUBSIDIARIES
Consolidated balance sheets
[Millions of dollars, except share amounts]

 
September 30,
2013
 
December 31,
2012
Assets
 
 
 
Current assets:
 
 
 
Cash and cash equivalents
$
1,435

 
$
1,416

Short-term investments
2,158

 
2,549

Accounts receivable, net of allowances of ($29) and ($31)
1,524

 
1,230

Raw materials
107

 
116

Work in process
954

 
935

Finished goods
665

 
706

Inventories
1,726

 
1,757

Deferred income taxes
1,039

 
1,044

Prepaid expenses and other current assets
219

 
234

Total current assets
8,101

 
8,230

Property, plant and equipment at cost
6,539

 
6,891

Less accumulated depreciation
(3,030
)
 
(2,979
)
Property, plant and equipment, net
3,509

 
3,912

Long-term investments
210

 
215

Goodwill, net
4,362

 
4,362

Acquisition-related intangibles, net
2,305

 
2,558

Deferred income taxes
227

 
280

Capitalized software licenses, net
139

 
142

Overfunded retirement plans
119

 
68

Other assets
272

 
254

Total assets
$
19,244

 
$
20,021

 
 
 
 
Liabilities and stockholders’ equity
 

 
 

Current liabilities:
 

 
 

Current portion of long-term debt
$
1,000

 
$
1,500

Accounts payable
426

 
444

Accrued compensation
567

 
524

Income taxes payable
37

 
79

Deferred income taxes
2

 
2

Accrued expenses and other liabilities
691

 
881

Total current liabilities
2,723

 
3,430

Long-term debt
4,161

 
4,186

Underfunded retirement plans
253

 
269

Deferred income taxes
564

 
572

Deferred credits and other liabilities
492

 
603

Total liabilities
8,193

 
9,060

 
 
 
 
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 – 1,740,815,939
1,741

 
1,741

Paid-in capital
1,125

 
1,176

Retained earnings
27,993

 
27,205

Less treasury common stock at cost.  Shares:  September 30, 2013 – 646,252,825; December 31, 2012 – 632,636,970
(19,236
)
 
(18,462
)
Accumulated other comprehensive income (loss), net of taxes
(572
)
 
(699
)
Total stockholders’ equity
11,051

 
10,961

Total liabilities and stockholders’ equity
$
19,244

 
$
20,021


See accompanying notes.

4


TEXAS INSTRUMENTS INCORPORATED AND SUBSIDIARIES
Consolidated statements of cash flows
[Millions of dollars]
 
 
For Nine Months Ended
September 30,
 
2013
 
2012
Cash flows from operating activities:
 
 
 
Net income
$
1,651

 
$
1,495

Adjustments to net income:


 


Depreciation
666

 
725

Amortization of acquisition-related intangibles
253

 
257

Stock-based compensation
221

 
199

Gains on sales of assets
(6
)
 

Deferred income taxes
(9
)
 
136

Gain on transfer of Japan substitutional pension

 
(144
)
Increase (decrease) from changes in:


 


Accounts receivable
(302
)
 
(70
)
Inventories
31

 
(86
)
Prepaid expenses and other current assets
(54
)
 
80

Accounts payable and accrued expenses
(297
)
 
(123
)
Accrued compensation
37

 
(41
)
Income taxes payable
(29
)
 
(177
)
Changes in funded status of retirement plans
82

 
59

Other
(59
)
 
19

Cash flows from operating activities
2,185

 
2,329

 
 
 
 
Cash flows from investing activities:
 

 
 

Capital expenditures
(305
)
 
(399
)
Proceeds from asset sales
21

 

Purchases of short-term investments
(3,177
)
 
(2,141
)
Proceeds from short-term investments
3,564

 
1,639

Purchases of long-term investments
(1
)
 
(1
)
Proceeds from long-term investments
18

 
52

Cash flows from investing activities
120

 
(850
)
 
 
 
 
Cash flows from financing activities:
 

 
 

Proceeds from issuance of debt
986

 
1,492

Repayment of debt and commercial paper borrowings
(1,500
)
 
(1,375
)
Dividends paid
(849
)
 
(584
)
Stock repurchases
(2,134
)
 
(1,200
)
Proceeds from common stock transactions
1,146

 
390

Excess tax benefit from share-based payments
72

 
26

Other
(7
)
 
(10
)
Cash flows from financing activities
(2,286
)
 
(1,261
)
 
 
 
 
Net change in cash and cash equivalents
19

 
218

Cash and cash equivalents, beginning of period
1,416

 
992

Cash and cash equivalents, end of period
$
1,435

 
$
1,210


See accompanying notes.

5


TEXAS INSTRUMENTS INCORPORATED AND SUBSIDIARIES
Notes to financial statements
1.
Description of business and significant accounting policies and practices
At Texas Instruments (TI), we design and make semiconductors that we sell to electronics designers and manufacturers all over the world. Effective January 1, 2013, we have two reportable segments, which are established along major categories of products as follows:

Ÿ Analog - consists of the following major product lines: High Volume Analog & Logic (HVAL), Power Management (Power), High Performance Analog (HPA) and Silicon Valley Analog (SVA); and
Ÿ Embedded Processing - consists of the following major product lines: Processors, Microcontrollers and Connectivity.

We report the results of our remaining business activities in Other. As previously announced, we restructured our Wireless business to focus our OMAP™ applications processors and connectivity products (formerly Wireless products) on embedded applications with long life cycles. Consistent with this restructuring, effective January 1, 2013, the Wireless segment was eliminated. Financial results for embedded OMAP applications processors and embedded connectivity products, both of which have many of the same characteristics as the products in our Embedded Processing segment, are now reported in that segment. Financial results for baseband products and Wireless products for the smartphone and consumer tablet markets, both of which are product lines that we have announced we are exiting, are included in Other and are collectively referred to as “legacy wireless products.” We also reclassified certain product lines, primarily radio frequency identification (RFID) products, from Other to Embedded Processing.

See Note 11 for the results of our business segments. On May 3, 2013, we filed a Form 8-K to update our Form 10-K for the year ended December 31, 2012, to reflect these changes. Prior period segment presentations have been recast to conform to this new reporting structure.

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, 2012, and as updated by the Form 8-K. The consolidated statements of income, statements of comprehensive income and statements of cash flows for the periods ended September 30, 2013 and 2012, and the balance sheet as of September 30, 2013, 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. 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, 2012, as updated by the Form 8-K. 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 these notes, except per-share amounts, are stated in millions of U.S. dollars unless otherwise indicated.

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.


6


Computation and reconciliation of earnings per common share are as follows (shares in millions):

 
For Three Months Ended
September 30, 2013
 
For Three Months Ended
September 30, 2012
 
Net Income
 
Shares
 
EPS
 
Net Income
 
Shares
 
EPS
Basic EPS:
 
 
 
 
 
 
 
 
 
 
 
Net income
$
629

 
 
 
 
 
$
784

 
 
 
 
Less income allocated to RSUs
(11
)
 
 
 
 
 
(15
)
 
 
 
 
Income allocated to common stock for basic EPS calculation
$
618

 
1,096

 
$
.56

 
$
769

 
1,130

 
$
.68

 
 
 
 
 
 
 
 
 
 
 
 
Adjustment for dilutive shares:
 

 
 

 
 

 
 

 
 

 
 
Stock-based compensation plans
 

 
15

 
 

 
 

 
11

 
 
 
 
 
 
 
 
 
 
 
 
 
 
Diluted EPS:
 

 
 

 
 

 
 

 
 

 
 
Net income
$
629

 
 

 
 

 
$
784

 
 

 
 
Less income allocated to RSUs
(11
)
 
 

 
 

 
(14
)
 
 

 
 
Income allocated to common stock for diluted EPS calculation
$
618

 
1,111

 
$
.56

 
$
770

 
1,141

 
$
.67

 
For Nine Months Ended
September 30, 2013
 
For Nine Months Ended
September 30, 2012
 
Net
Income
 
Shares
 
EPS
 
Net
Income
 
Shares
 
EPS
Basic EPS:
 
 
 
 
 
 
 
 
 
 
 
Net income
$
1,651

 
 
 
 
 
$
1,495

 
 
 
 
Less income allocated to RSUs
(29
)
 
 
 
 
 
(27
)
 
 
 
 
Income allocated to common stock for basic EPS calculation
$
1,622

 
1,102

 
$
1.47

 
$
1,468

 
1,138

 
$
1.29

 
 
 
 
 
 
 
 
 
 
 
 
Adjustment for dilutive shares:
 

 
 

 
 

 
 

 
 

 
 
Stock-based compensation plans
 

 
15

 
 

 
 

 
15

 
 
 
 
 
 
 
 
 
 
 
 
 
 
Diluted EPS:
 

 
 

 
 

 
 

 
 

 
 
Net income
$
1,651

 
 

 
 

 
$
1,495

 
 

 
 
Less income allocated to RSUs
(28
)
 
 

 
 

 
(27
)
 
 

 
 
Income allocated to common stock for diluted EPS calculation
$
1,623

 
1,117

 
$
1.45

 
$
1,468

 
1,153

 
$
1.27


There were no potentially dilutive securities excluded from the computation of diluted earnings per common share during the third quarter and the first nine months of 2013. Potentially dilutive securities representing 65 million shares of common stock that were outstanding during both the third quarter and the first nine months of 2012 were excluded from the computation of diluted earnings per common share for these periods because their effect would have been anti-dilutive.

Derivatives and hedging
In connection with the issuance of variable-rate long-term debt in May 2011, we entered into an interest rate swap designated as a hedge of the variability of cash flows related to interest payments. Gains and losses from changes in the fair value of the interest rate swap were credited or charged to Accumulated other comprehensive income (loss), net of taxes (AOCI). In connection with the repayment of this long-term debt in the second quarter of 2013, this interest rate swap was settled for no gain or loss. In association with the issuance of long-term debt, we use financial derivatives such as treasury rate lock agreements, the results of which have not been material.

We also use derivative financial instruments to manage exposure to foreign exchange risk. These instruments are primarily forward foreign currency exchange contracts that are used as economic hedges to reduce the earnings impact exchange rate fluctuations may have on our non-U.S. dollar net balance sheet exposures. Gains and losses from changes in the fair value of these forward foreign currency exchange contracts are credited or charged to OI&E. We do not apply hedge accounting to our foreign currency derivative instruments.

7



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, 2013. Our investments in cash equivalents, short-term investments and certain long-term investments, as well as our deferred compensation liabilities, are carried at fair value and are discussed in Note 5. The carrying values for other current financial assets and liabilities, such as accounts receivable and accounts payable, approximate fair value due to the short maturity of such instruments. The carrying value of our long-term debt approximates the fair value as measured using broker-dealer quotes, which are based on Level 2 inputs. See Note 5 for the definition of Level 2 inputs.

Changes in Accounting Standards
In January 2013, the FASB issued Accounting Standards Update (ASU) No. 2013-01, Balance Sheet (Topic 210): Clarifying the Scope of Disclosures about Offsetting Assets and Liabilities. This standard clarifies that a previously issued standard on disclosure requirements of offsetting (or netting) financial instruments applies only to derivatives, repurchase agreements and certain securities lending transactions. The required disclosures are both gross and net information about instruments and transactions eligible for offset in the statement of financial position and instruments and transactions subject to an agreement similar to a master netting arrangement. This standard is effective as of the first quarter of 2013 and did not have a material impact on our financial disclosures because the derivatives to which it applies are not significant.
In February 2013, the FASB issued ASU No. 2013-02, Comprehensive Income (Topic 220): Reporting of Amounts Reclassified Out of Accumulated Other Comprehensive Income. This standard requires an entity to disclose information about amounts reclassified out of AOCI by component and by statement of income line item. This standard is effective as of the first quarter of 2013 and is applied prospectively. See Note 10 for the required disclosure.

2.
Acquisition-related charges
We completed the acquisition of National Semiconductor Corporation (National) in September 2011. Various costs incurred as a result of that acquisition are included in Other, consistent with how management measures the performance of its segments. These total acquisition-related charges are as follows:

 
For Three Months Ended
September 30,
 
For Nine Months Ended
September 30,
 
2013
 
2012
 
2013
 
2012
Acquisition charges:
 
 
 
 
 
 
 
Amortization of intangible assets
$
81

 
$
81

 
$
244

 
$
244

Retention bonuses
2

 
5

 
5

 
53

Severance and other benefits

 
3

 

 
17

Stock-based compensation
3

 
4

 
8

 
14

Transaction and other costs

 
13

 

 
35

As recorded in Acquisition charges
86

 
106

 
257

 
363

Distributor contract termination recorded in COR

 

 

 
21

Total acquisition-related costs
$
86

 
$
106

 
$
257

 
$
384

  
The amount of recognized amortization of acquired intangible assets resulting from the National acquisition is based on estimated useful lives varying between two and ten years. See Note 6 for additional information.

Retention bonuses reflect amounts already or expected to be paid to former National employees who fulfill agreed-upon service period obligations and are recognized ratably over the required service period.

Severance and other benefits costs were for former National employees who were terminated after the closing date. About 350 jobs were eliminated by the end of 2012 as a result of redundancies and cost efficiency measures. As of September 30, 2013, a total of $86 million in cumulative charges have been recognized, of which $82 million has been paid.

Stock-based compensation was recognized for the accelerated vesting of equity awards upon the termination of employees, with additional compensation being recognized over the applicable vesting period for the remaining grantees.

8



Transaction and other costs include various expenses incurred in connection with the National acquisition.

In 2011, we discontinued using one of National’s distributors. We acquired the distributor’s inventory at fair value, resulting in an incremental charge of $21 million to COR upon sale of the inventory in 2012.

3.
Restructuring charges/other
Restructuring charges/other is included in Other and is comprised of the following components:

 
For Three Months Ended
September 30,
 
For Nine Months Ended
September 30,
 
Cumulative
Since Actions
Initiated
 
2013
 
2012
 
2013
 
2012
 
Restructuring charges:
 
 
 
 
 
 
 
 
 
2012 Wireless action
 
 
 
 
 
 
 
 
 
Severance and benefits cost
$

 
$

 
$
30

 
$

 
$
275

Accelerated depreciation

 

 
6

 

 
9

Other exit costs

 

 
2

 

 
105

 

 

 
38

 

 
389

2011 actions
 
 
 
 
 
 
 
 
 
Severance and benefits cost
2

 
1

 
3

 
3

 
116

Accelerated depreciation

 
4

 
5

 
13

 
28

Other exit costs
14

 
9

 
18

 
21

 
43

 
16

 
14

 
26

 
37

 
187

Total restructuring charges
16

 
14

 
64

 
37

 
$
576

 
 
 
 
 
 
 
 
 
 
Other:
 
 
 
 
 
 
 
 
 
Gain on technology transfer

 

 
(315
)
 

 
 
Gain on transfer of Japan substitutional pension

 
(144
)
 

 
(144
)
 
 
Other

 
8

 

 
8

 
 
Total Restructuring charges/other
$
16

 
$
(122
)
 
$
(251
)
 
$
(99
)
 
 

Restructuring actions related to the acquisition of National are discussed in Note 2 and are reflected on the Acquisition charges line of our Consolidated statements of income.

2012 Wireless action
In November 2012, we announced an action concerning our former Wireless segment that, when complete, is expected to reduce annualized expenses by about $450 million and will focus our investments on embedded markets with greater potential for sustainable growth. This action will be substantially complete by the end of 2013, eliminating about 1,700 jobs worldwide. As of September 30, 2013, $124 million has been paid to terminated employees for severance and benefits related to this action.

2011 actions
Beginning in the fourth quarter of 2011, we recognized restructuring charges associated with the closure of two older semiconductor manufacturing facilities in Houston, Texas, and Hiji, Japan, in 2013. This action will be substantially complete by the end of 2013. As of September 30, 2013, about $90 million has been paid to terminated employees for severance and benefits related to this action.


9



The table below reflects the changes in accrued restructuring balances associated with these actions:

 
2012 Wireless Action
 
2011 Actions
 
Prior Actions
 
 
 
Severance and Benefits
 
Other Charges
 
Severance and Benefits
 
Other Charges
 
Severance and Benefits
 
Other Charges
 
Total
Remaining accrual at December 31, 2012
$
241

 
$

 
$
94

 
$
3

 
$
5

 
$
6

 
$
349

Restructuring charges
30

 
8

 
3

 
23

 

 

 
64

Non-cash items (a)

 
(6
)
 
(1
)
 
(11
)
 

 

 
(18
)
Payments
(119
)
 
(2
)
 
(79
)
 
(13
)
 
(4
)
 

 
(217
)
Remaining accrual at September 30, 2013
$
152

 
$

 
$
17

 
$
2

 
$
1

 
$
6

 
$
178

(a) Reflects charges for stock-based compensation, impacts of postretirement benefit plans and accelerated depreciation.

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

Other
Gain on technology transfer
During the second quarter of 2013, we entered into an agreement to transfer wireless connectivity technology to a customer. This technology was associated with the former Wireless business that we have previously announced we are exiting. As a result, we recognized a gain of $315 million.

Gain on transfer of Japan substitutional pension
During the third quarter of 2012, we transferred the obligations and assets of the substitutional portion of our Japan pension plan to the government of Japan, resulting in a net gain of $144 million. See Note 7 for additional details.

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. As of September 30, 2013, the estimated annual effective tax rate for 2013 is about 24 percent, which differs from the 35 percent statutory corporate tax rate due to lower statutory tax rates applicable to our operations in many of the jurisdictions in which we operate and from U.S. tax benefits. These lower tax rates are generally statutory in nature, without expiration and available to companies that operate in those taxing jurisdictions. The tax provision for the nine months ended September 30, 2013 includes a $65 million discrete tax benefit from the reinstatement in the first quarter of 2013 of the federal research tax credit retroactive to the beginning of 2012.

5.
Valuation of debt and equity investments and certain liabilities
Debt and equity investments
We classify our investments as available for sale, trading, equity method or cost method. Most of our investments are classified as available for sale.

Available-for-sale and trading securities are stated at fair value, which is generally based on market prices, broker quotes or, when necessary, financial models (see fair-value discussion below). Unrealized gains and losses on available-for-sale securities are recorded as an increase or decrease, net of taxes, in AOCI on our Consolidated balance sheets. We record other-than-temporary impairments on available-for-sale securities in OI&E in our Consolidated statements of income.

We classify certain mutual funds as trading securities. These mutual funds hold a variety of debt and equity investments intended to generate returns that offset changes in certain deferred compensation liabilities. We record changes in the fair value of these mutual funds and the related deferred compensation liabilities in SG&A.

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.


10


Details of our investments are as follows:
 
 
September 30, 2013
 
December 31, 2012
 
Cash and Cash
Equivalents
 
Short-term Investments
 
Long-term Investments
 
Cash and Cash
Equivalents
 
Short-term Investments
 
Long-term Investments
Measured at fair value:
 
 
 
 
 
 
 
 
 
 
 
Available-for-sale securities
 
 
 
 
 
 
 
 
 
 
 
Money market funds
$
582

 
$

 
$

 
$
211

 
$

 
$

Corporate obligations
75

 
317

 

 
188

 
325

 

U.S. Government agency and Treasury securities
680

 
1,841

 

 
795

 
2,224

 

Trading securities
 

 
 

 
 

 
 

 
 

 
 

Mutual funds

 

 
168

 

 

 
159

Total
$
1,337

 
$
2,158

 
$
168

 
$
1,194

 
$
2,549

 
$
159

 
 
 
 
 
 
 
 
 
 
 
 
Other measurement basis:
 

 
 

 
 

 
 

 
 

 
 

Equity-method investments
$

 
$

 
$
24

 
$

 
$

 
$
34

Cost-method investments

 

 
18

 

 

 
22

Cash on hand
98

 

 

 
222

 

 

Total
$
1,435

 
$
2,158

 
$
210

 
$
1,416

 
$
2,549

 
$
215

 

As of September 30, 2013, and December 31, 2012, we had no significant unrealized gains or losses associated with our available-for-sale investments. For the three months and nine months ended September 30, 2013 and 2012, we did not recognize in earnings any credit losses related to these investments.

For the nine months ended September 30, 2013 and 2012, the proceeds from sales, redemptions and maturities of short-term available-for-sale investments were $3.56 billion and $1.64 billion, respectively. Gross realized gains and losses from these sales were not significant.

The following table presents the aggregate maturities of investments in debt securities classified as available for sale at September 30, 2013:

Due
 
Fair Value
One year or less
 
$
3,230

One to three years
 
265

 
Fair-value considerations
We measure and report certain financial assets and liabilities at fair value on a recurring basis. Fair value is defined as the price that would be received to sell an asset or paid to transfer a liability (an exit price) in the principal or most advantageous market for the asset or liability in an orderly transaction between market participants on the measurement date.

The three-level hierarchy discussed below indicates the extent and level of judgment used to estimate fair-value measurements.

Level 1 — Uses unadjusted quoted prices that are available in active markets for identical assets or liabilities as of the reporting date.

Level 2 — Uses inputs other than Level 1 that are either directly or indirectly observable as of the reporting date through correlation with market data, including quoted prices for similar assets and liabilities in active markets and quoted prices in markets that are not active. Level 2 also includes assets and liabilities that are valued using models or other pricing methodologies that do not require significant judgment since the input assumptions used in the models, such as interest rates and volatility factors, are corroborated by readily observable data. Our Level 2 assets consist of corporate obligations and some U.S. government agency and Treasury securities. We utilize a third-party data service to provide Level 2

11


valuations, verifying these valuations for reasonableness relative to unadjusted quotes obtained from brokers or dealers based on observable prices for similar assets in active markets.

Level 3 — Uses inputs that are unobservable, supported by little or no market activity and reflect the use of significant management judgment. These values are generally determined using pricing models that utilize management estimates of market participant assumptions.

The following are our assets and liabilities that were accounted for at fair value on a recurring basis as of September 30, 2013, and December 31, 2012. For these periods, we had no Level 3 assets or liabilities. 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,
2013
 
Level 1
 
Level 2
Assets:
 
 
 

 
 

Money market funds
$
582

 
$
582

 
$

Corporate obligations
392

 

 
392

U.S. Government agency and Treasury securities
2,521

 
1,667

 
854

Mutual funds
168

 
168

 

Total assets
$
3,663

 
$
2,417

 
$
1,246

 
 
 
 
 
 
Liabilities:
 

 
 

 
 

Deferred compensation
$
186

 
$
186

 
$

Total liabilities
$
186

 
$
186

 
$


 
Fair Value
 
 
 
 
 
December 31,
2012
 
Level 1
 
Level 2
Assets:
 
 
 

 
 

Money market funds
$
211

 
$
211

 
$

Corporate obligations
513

 

 
513

U.S. Government agency and Treasury securities
3,019

 
1,145

 
1,874

Mutual funds
159

 
159

 

Total assets
$
3,902

 
$
1,515

 
$
2,387

 
 
 
 
 
 
Liabilities:
 

 
 

 
 

Deferred compensation
$
174

 
$
174

 
$

Total liabilities
$
174

 
$
174

 
$

 

The following table summarizes the change in the fair values for Level 3 assets:

 
Level 3
Changes in fair value during the period (pre-tax):
Auction-rate Securities
Balance, December 31, 2011
$
134

Change in unrealized loss – included in AOCI
13

Redemptions
(84
)
Sales
(63
)
Balance, September 30, 2012
$


We had no Level 3 assets as of either September 30, 2013, or December 31, 2012.


12



6.
Goodwill and acquisition-related intangibles
Goodwill was $4.362 billion net of accumulated impairment of $90 million as of September 30, 2013, and December 31, 2012. There was no impairment of goodwill during the three months and nine months ended September 30, 2013. The following table shows the components of acquisition-related intangible assets as of September 30, 2013, and December 31, 2012:

 
 
 
 
September 30, 2013
 
December 31, 2012
Acquisition-related Intangibles
 
Amortization Period (Years)
 
Gross Carrying Amount
 
Accumulated Amortization
 
Net
 
Gross Carrying Amount
 
Accumulated Amortization
 
Net
Developed technology
 
5 - 10
 
$
2,153

 
$
469

 
$
1,684

 
$
2,145

 
$
312

 
$
1,833

Customer relationships
 
5 - 8
 
820

 
213

 
607

 
821

 
137

 
684

Other intangibles
 
5
 
5

 
3

 
2

 
46

 
36

 
10

In-process R&D
 
(a)
 
12

 
n/a

 
12

 
31

 
n/a

 
31

Total
 
 
 
$
2,990

 
$
685

 
$
2,305

 
$
3,043

 
$
485

 
$
2,558

(a) In-process R&D is not amortized until the associated project has been successfully completed, at which point it would be reclassified to developed technology. Alternatively, if the associated project is determined not to be viable, it will be expensed.

Amortization of acquisition-related intangibles was $83 million and $86 million for the three months ($253 million and $257 million for the nine months) ended September 30, 2013 and 2012.

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
2013
 
2012
 
2013
 
2012
 
2013
 
2012
Service cost
$
6

 
$
6

 
$
1

 
$
1

 
$
9

 
$
10

Interest cost
12

 
11

 
5

 
6

 
15

 
19

Expected return on plan assets
(11
)
 
(12
)
 
(6
)
 
(6
)
 
(17
)
 
(20
)
Amortization of prior service cost (credit)

 

 
1

 
1

 
(1
)
 
(1
)
Recognized net actuarial loss
5

 
4

 
3

 
4

 
7

 
10

Net periodic benefit cost
12

 
9

 
4

 
6

 
13

 
18

 
 
 
 
 
 
 
 
 
 
 
 
Settlement loss
5

 

 

 

 
4

 
193

Curtailment gain

 

 

 

 
(2
)
 

Special termination benefit gain

 

 

 

 

 
(337
)
Total, including other postretirement losses (gains)
$
17

 
$
9

 
$
4

 
$
6

 
$
15

 
$
(126
)
 
U.S.
Defined Benefit
 
U.S.
Retiree Health Care
 
Non-U.S.
Defined Benefit
For Nine Months Ended September 30
2013
 
2012
 
2013
 
2012
 
2013
 
2012
Service cost
$
20

 
$
18

 
$
4

 
$
4

 
$
29

 
$
29

Interest cost
33

 
33

 
15

 
18

 
46

 
58

Expected return on plan assets
(36
)
 
(37
)
 
(18
)
 
(18
)
 
(50
)
 
(59
)
Amortization of prior service cost (credit)

 
1

 
3

 
3

 
(3
)
 
(3
)
Recognized net actuarial loss
16

 
12

 
9

 
10

 
24

 
34

Net periodic benefit cost
33

 
27

 
13

 
17

 
46

 
59

 
 
 
 
 
 
 
 
 
 
 
 
Settlement loss
18

 

 

 

 
4

 
193

Curtailment gain

 

 

 
(1
)
 
(5
)
 

Special termination benefit gain

 
(2
)
 

 

 

 
(337
)
Total, including other postretirement losses (gains)
$
51

 
$
25