TXN-2011.9.30- 10Q
 
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
 _______________________________________________________________________________________________________________
FORM 10-Q 
 _______________________________________________________________________________________________________________
S
QUARTERLY REPORT UNDER SECTION 13 or 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
 
For the quarterly period ended September 30, 2011

£
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the transition period from                to  
 Commission File Number 001-03761
 _______________________________________________________________________________________________________________
 TEXAS INSTRUMENTS INCORPORATED
(Exact Name of Registrant as Specified in Its Charter)
 _______________________________________________________________________________________________________________
 
Delaware
75-0289970
(State of Incorporation)
(I.R.S. Employer Identification No.)

12500 TI Boulevard, P.O. Box 660199, Dallas, Texas
75266-0199
(Address of principal executive offices)
(Zip Code)

Registrant’s telephone number, including area code 972-995-3773
 _______________________________________________________________________________________________________________
Indicate by check mark whether the Registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the Registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.
Yes  S   No £
Indicate by check mark whether the registrant 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)
1,784

 
1,518

Raw materials
148

 
122

Work in process
1,185

 
919

Finished goods
632

 
479

Inventories
1,965

 
1,520

Deferred income taxes
1,046

 
770

Prepaid expenses and other current assets
303

 
180

Total current assets
7,716

 
7,060

Property, plant and equipment at cost
7,239

 
6,907

Less accumulated depreciation
(2,667
)
 
(3,227
)
Property, plant and equipment, net
4,572

 
3,680

Long-term investments
350

 
453

Goodwill
4,451

 
924

Acquisition-related intangibles
3,024

 
76

Deferred income taxes
497

 
927

Capitalized software licenses, net
199

 
205

Overfunded retirement plans
28

 
31

Other assets
70

 
45

Total assets
$
20,907

 
$
13,401

 
 
 
 
Liabilities and Stockholders’ Equity
 

 
 

Current liabilities:
 

 
 

Short-term and current portion of long-term debt
$
1,586

 
$

Accounts payable
627

 
621

Accrued compensation
532

 
629

Income taxes payable
60

 
109

Accrued expenses and other liabilities
863

 
622

Total current liabilities
3,668

 
1,981

Long-term debt
4,215

 

Underfunded retirement plans
617

 
519

Deferred income taxes
822

 
86

Deferred credits and other liabilities
559

 
378

Total liabilities
9,881

 
2,964

 
 
 
 
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, 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.
 
 
For Three Months Ended
Sept. 30,
 
For Nine Months Ended
Sept. 30,
 
2011
 
2010
 
2011
 
2010
Segment Revenue
 
 
 
 
 
 
 
Analog
$
1,557

 
$
1,581

 
$
4,680

 
$
4,461

Embedded Processing
539

 
579

 
1,668

 
1,535

Wireless
580

 
767

 
1,797

 
2,211

Other
790

 
813

 
2,170

 
2,234

Total revenue
$
3,466

 
$
3,740

 
$
10,315

 
$
10,441


 
For Three Months Ended
Sept. 30,
 
For Nine Months Ended
Sept. 30,
 
2011
 
2010
 
2011
 
2010
Segment Operating Profit
 
 
 
 
 
 
 
Analog
$
414

 
$
520

 
$
1,278

 
$
1,391

Embedded Processing
113

 
160

 
356

 
348

Wireless
78

 
180

 
301

 
502

Other
209

 
367

 
692

 
1,043

Total operating profit
$
814

 
$
1,227

 
$
2,627

 
$
3,284



17



12.
Dividends. On September 15, 2011, we announced a 31 percent increase in our quarterly cash dividend rate. The new quarterly dividend will increase from $0.13 to $0.17 per share, resulting in annual dividend payments of $0.68 per share. The new quarterly cash dividend will be payable November 21, 2011, to stockholders of record on October 31, 2011.

18





ITEM 2.  Management’s discussion and analysis of financial condition and results of operations

The following should be read in conjunction with the Financial Statements and the related Notes that appear elsewhere in this document. All dollar amounts in the tables in this discussion are stated in millions of U.S. dollars, except per-share amounts.
Overview
We design and make semiconductors that we sell to electronics designers and manufacturers all over the world. We began operations in 1930. We are incorporated in Delaware, headquartered in Dallas, Texas, and have design, manufacturing or sales operations in more than 30 countries. We have four segments: Analog, Embedded Processing, Wireless and Other. We expect Analog and Embedded Processing to be our primary growth engines in the years ahead, and we therefore focus our resources on these segments.
We were the world’s fourth largest semiconductor company in 2010 as measured by revenue, according to an external source. Additionally, we sell calculators and related products.
On September 23, 2011, we completed the acquisition of National Semiconductor Corporation (National). The acquisition brings to TI a portfolio of 12,000 analog products and strong customer design tools, and is consistent with our strategy to grow our Analog business. National is now part of TI’s Analog segment under the name Silicon Valley Analog.

Product information

Semiconductors are electronic components that serve as the building blocks inside modern electronic systems and equipment. Semiconductors come in two basic forms: individual transistors and integrated circuits (generally known as “chips”) that combine multiple transistors on a single piece of material to form a complete electronic circuit. Our semiconductors are used to accomplish many different things, such as converting and amplifying signals, interfacing with other devices, managing and distributing power, processing data, canceling noise and improving signal resolution. Our portfolio includes products that are integral to almost all electronic equipment.
We sell custom and standard semiconductor products. Custom products are designed for a specific customer for a specific application, are sold only to that customer and are typically sold directly to the customer. The life cycles of custom products are generally determined by end-equipment upgrade cycles and can be as short as 12 to 24 months. Standard products are designed for use by many customers and/or many applications and are generally sold through both distribution and direct channels. They include both proprietary and commodity products. The life cycles of standard products are generally longer than for custom products.    
Additional information regarding each segment’s products follows.
Analog

Analog semiconductors change real-world signals — such as sound, temperature, pressure or images — by conditioning them, amplifying them and often converting them to a stream of digital data that can be processed by other semiconductors, such as digital signal processors (DSPs). Analog semiconductors are also used to manage power distribution and consumption. Sales to our Analog segment’s more than 80,000 customers generated 43 percent of our revenue in 2010. According to external sources, the worldwide market for analog semiconductors was about $42 billion in 2010. Our Analog segment’s revenue in 2010 was about $6 billion, or about 14 percent of this fragmented market, the leading position. We believe that we are well positioned to increase our market share over time.
Our Analog segment includes the following components that are based on product lines: High-Volume Analog & Logic (HVAL), High-Performance Analog (HPA), and Power Management (Power). Following the National acquisition, the Analog segment also includes Silicon Valley Analog (SVA).
HVAL products: These include both high-volume analog products and logic and standard linear products. High-volume analog includes products for specific applications, including custom products. The life cycles of our high-volume analog products are generally shorter than those of our HPA products. End markets for high-volume analog products include communications, automotive, computing and many consumer electronics products. Logic and standard linear includes commodity products marketed to many different customers for many different applications.

19

HPA products: These include standard analog semiconductors, such as amplifiers, data converters and interface semiconductors (our portfolio includes nearly 16,000 products), that we market to many different customers who use them in manufacturing a wide range of products sold in many end markets, including the industrial, communications, computing and consumer electronics markets. HPA products generally have long life cycles, often more than 10 years.
Power products: These include both standard and custom semiconductors that help customers manage power in any type of electronic system. We design and manufacture power management semiconductors for both portable devices (battery-powered devices, such as handheld consumer electronics, laptop computers and cordless power tools) and line-powered systems (products that require an external electrical source, such as computers, digital TVs, wireless base stations and high-voltage industrial equipment).
SVA products: Acquired through the National acquisition, these include standard analog products, particularly in the areas of power management, data converters, interface and operational amplifiers.  Similar to HPA, this portfolio of over 12,000 products is marketed to many different customers who use them in manufacturing a wide range of products sold in many end markets. Historically, the industrial market has accounted for almost half of the revenue from these products. 
Embedded Processing

Our Embedded Processing products include our DSPs and microcontrollers. DSPs perform mathematical computations almost instantaneously to process or improve digital data. Microcontrollers are designed to control a set of specific tasks for electronic equipment. Sales of Embedded Processing products generated 15 percent of our revenue in 2010. According to external sources, the worldwide market for embedded processors was about $18 billion in 2010. Our Embedded Processing segment’s revenue in 2010 was about $2 billion, or about 11 percent of this fragmented market. We believe we are well positioned to increase our market share over time.
An important characteristic of our Embedded Processing products is that our customers often invest their own research and development (R&D) to write software that operates on our products. This investment tends to increase the length of our customer relationships because customers prefer to re-use software from one product generation to the next. We make and sell standard, or catalog, Embedded Processing products used in many different applications and custom Embedded Processing products used in specific applications, such as communications infrastructure equipment and automotive.
Wireless

Growth in the wireless market is being driven by the demand for smartphones, tablet computers and other emerging portable devices. Many of today’s smartphones and tablets use an applications processor to run the device’s software operating system and to enable the expanding functionality that has made smartphones the fastest growing wireless segment. Smartphones and tablets also use other semiconductors to enable connectivity through means other than the cellular network (such as Bluetooth® devices, WiFi networks, GPS location services, and Near Field Communication (NFC)).

We design, make and sell products to satisfy each of these requirements. Wireless products are typically sold in high volumes, and our Wireless portfolio includes both standard products and custom products. Sales of Wireless products generated about $3 billion, or 21 percent of our revenue, in 2010, with a significant portion of those sales to a single customer.

Our Wireless investments are concentrated on our connectivity products and OMAP applications processors, areas we believe offer significant growth opportunities and which will enable us to take advantage of the increasing demand for more powerful and more functional mobile devices. We no longer invest in development of baseband products (products that allow a cell phone to connect to the cellular network), an area we believe offers far less promising growth prospects. Almost all of our baseband products are sold to a single customer. We expect substantially all of our baseband revenue, which was $1.7 billion in 2010, to cease by the end of 2012.

Other

Our Other segment includes revenue from our smaller semiconductor product lines and from sales of our handheld graphing and scientific calculators. It also includes royalties received for our patented technology that we license to other electronics companies and revenue from transitional supply agreements entered into in connection with acquisitions and divestitures. The semiconductor products in our Other segment include DLP® products (primarily used in projectors to create high-definition images) and custom semiconductors known as application-specific integrated circuits (ASICs). This segment generated about $3 billion, or 21 percent of our revenue, in 2010. We also include in Other certain acquisition-related costs that are not used in evaluating results and allocating resources to our segments. These costs include certain fair value adjustments, restructuring

20

expenses, transaction expenses, acquisition-related retention bonuses and the amortization of intangible assets.

Inventory

Our inventory practices differ by product, but we generally maintain inventory levels that are consistent with our expectations of customer demand. Because of the longer product life cycles of standard products and their inherently lower risk of obsolescence, we generally carry more of those products than custom products. Additionally, we sometimes maintain standard-product inventory in unfinished wafer form, as well as higher finished goods inventory of low-volume products, allowing greater flexibility in periods of high demand. We also have consignment inventory programs in place for our largest customers and some distributors.

Manufacturing

Semiconductor manufacturing begins with a sequence of photo-lithographic and chemical processing steps that fabricate a number of semiconductor devices on a thin silicon wafer. Each device on the wafer is tested and the wafer is cut into pieces called chips. Each chip is assembled into a package that then is usually retested. The entire process typically requires between 12 and 18 weeks and takes place in highly specialized facilities.
We own and operate semiconductor manufacturing facilities in North America, Asia and Europe. These include both high-volume wafer fabrication and assembly/test facilities. Our facilities require substantial investment to construct and are largely fixed-cost assets once in operation. Because we own much of our manufacturing capacity, a significant portion of our operating cost is fixed. In general, these fixed costs do not decline with reductions in customer demand or utilization of capacity, potentially hurting our profit margins. Conversely, as product demand rises and factory utilization increases, the fixed costs are spread over increased output, potentially benefiting our profit margins.
The cost and lifespan of the equipment and processes we use to manufacture semiconductors vary by product. Our Analog products and most of our Embedded Processing products can be manufactured using older, less expensive equipment than is needed for manufacturing advanced logic products, such as our Wireless products. Advanced logic wafer manufacturing continually requires new and expensive processes and equipment. In contrast, the processes and equipment required for manufacturing our Analog products and most of our Embedded Processing products do not have this requirement.
To supplement our internal wafer fabrication capacity and maximize our responsiveness to customer demand and return on capital, our wafer manufacturing strategy utilizes the capacity of outside suppliers, commonly known as foundries. We source about 25 percent of our wafers from external foundries, with the vast majority of this outsourcing being for advanced logic wafers. In 2010, external foundries provided 60 percent of the fabricated wafers for our advanced logic manufacturing needs. We expect the proportion of our advanced logic wafers provided by foundries will increase over time. We expect to maintain sufficient internal wafer fabrication capacity to meet the vast majority of our analog production needs.
In addition to using foundries to supplement our wafer fabrication capacity, we selectively use subcontractors to supplement our assembly/test capacity. We generally use subcontractors for assembly/test of products that would be less cost-efficient to complete in-house (e.g., relatively low-volume products that are unlikely to keep internal equipment fully utilized), or when demand temporarily exceeds our internal capacity. We believe we often have a cost advantage from maintaining internal assembly/test capacity.
Our internal/external manufacturing strategy reduces the level of our required capital expenditures, and thereby reduces our subsequent levels of depreciation below what it would be if we sourced all manufacturing internally. Consequently, we experience less fluctuation in our profit margins due to changing product demand, and lower cash requirements for expanding and updating our manufacturing capabilities.
Product cycle

The global semiconductor market is characterized by constant, though generally incremental, advances in product designs and manufacturing processes. Semiconductor prices and manufacturing costs tend to decline over time as manufacturing processes and product life cycles mature. Typically, new chips are produced in limited quantities at first and then ramp to high-volume production over time. Consequently, new products tend not to have a significant revenue impact for one or more quarters after their introduction. In the results discussions below, changes in our shipments are caused by changing demand for our products unless otherwise noted.


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Market cycle

The “semiconductor cycle” is an important concept that refers to the ebb and flow of supply. The semiconductor market historically has been characterized by periods of tight supply caused by strengthening demand and/or insufficient manufacturing capacity, followed by periods of surplus inventory caused by weakening demand and/or excess manufacturing capacity. This cycle is affected by the significant time and money required to build and maintain semiconductor manufacturing facilities.
Seasonality

Our revenue and operating results are subject to some seasonal variation. Our semiconductor sales generally are seasonally weaker in the first quarter than in other quarters, particularly for products sold into cell phones and other consumer electronics devices, which have stronger sales later in the year as manufacturers prepare for the major holiday selling seasons. Calculator revenue is tied to the U.S. back-to-school season and is therefore at its highest in the second and third quarters. Royalty revenue is not always uniform or predictable, in part due to the performance of our licensees and in part due to the timing of new license agreements or the expiration and renewal of existing agreements.
Tax considerations

We operate in a number of tax jurisdictions and are subject to several types of taxes including those that are based on income, capital, property and payroll, as well as sales and other transactional taxes. The timing of the final determination of our tax liabilities varies by jurisdiction and taxing authority. As a result, during any particular reporting period we might reflect in our financial statements one or more tax refunds or assessments, or changes to tax liabilities, involving one or more taxing authorities.

Third-Quarter 2011 results
Our third-quarter revenue was $3.47 billion, net income was $601 million and earnings per share (EPS) were 51 cents. EPS includes 9 cents in charges associated with the company’s acquisition of National.
The highlight of the third quarter was the completion of our purchase of National. Together we now have a combined portfolio of almost 45,000 Analog products that we are taking to customers all over the world.
Our revenue for the third quarter was higher than we expected though, overall, the quarter was below the seasonal average. We expect the same in the fourth quarter as economic uncertainty continues to weigh on demand in almost every major market segment in which we operate.  We are well prepared to continue to gain share in our core businesses, no matter the economic conditions.

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TEXAS INSTRUMENTS INCORPORATED AND SUBSIDIARIES
Consolidated Statements of Income
(Millions of dollars, except share and per-share amounts)
 
For Three Months Ended
 
Sept. 30, 2011
 
Sept. 30, 2010
 
June 30, 2011
Revenue
$
3,466

 
$
3,740

 
$
3,458

Cost of revenue
1,722

 
1,701

 
1,705

Gross profit
1,744

 
2,039

 
1,753

Research and development (R&D)
395

 
417

 
424

Selling, general and administrative (SG&A)
388

 
391

 
411

Restructuring expense

 
4

 

Acquisition cost
147

 

 
13

Operating profit
814

 
1,227

 
905

Other income (expense) net
(19
)
 
8

 
10

Interest and debt expense
15

 

 
6

Income before income taxes
780

 
1,235

 
909

Provision for income taxes
179

 
376

 
237

Net income
$
601

 
859

 
672

 
 
 
 
 
 
Earnings per common share:
 
 
 
 
 
  Basic
$
0.52

 
$
0.71

 
$
0.57

  Diluted
$
0.51

 
$
0.71

 
$
0.56

 
 
 
 
 
 
Average shares outstanding (millions):
 
 
 
 
 
Basic
1,144

 
1,184

 
1,156

Diluted
1,157

 
1,196

 
1,180

 
 
 
 
 
 
Cash dividends declared per share of common stock
$
0.13

 
0.12

 
0.13

 
 
 
 
 
 
Percentage of revenue:
 
 
 
 
 
Gross profit
50.3
%
 
54.5
%
 
50.7
%
R&D
11.4
%
 
11.1
%
 
12.3
%
SG&A
11.2
%
 
10.5
%
 
11.9
%
Operating profit
23.5
%
 
32.8
%
 
26.2
%

As required by accounting rule ASC 260, net income allocated to unvested restricted stock units (RSUs) on which we pay dividend equivalents is excluded from the calculation of EPS.  The amount excluded from earnings per common share was $10 million, $13 million and $10 million for the quarters ending September 30, 2011, September 30, 2010 and June 30, 2011.

Impact of National Acquisition

We completed our acquisition of National on September 23, 2011. We recorded the assets acquired and liabilities assumed measured at fair value as of that date. The total consideration transferred for the acquisition was $6.56 billion and the fair value of the net assets acquired and liabilities assumed was $3.03 billion, resulting in goodwill of $3.53 billion. The results of National’s operations from the acquisition date are included in the Analog segment. See Note 2 to the Financial Statements for more details regarding the acquisition.



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Special Items Included in Other

Other includes the financial impact of the March earthquake in Japan. See Note 4 to the Financial Statements for more details.

As a direct result of the National acquisition, we incurred various incremental costs that we recorded in Other. These include certain adjustments to write-up the value of acquired inventory and property, plant and equipment to fair value as of the acquisition date. These fair value adjustments have an impact on future operating results solely due to that write-up in value. These costs are incremental to the normal amortization and depreciation of the acquired assets based on their carrying or book value at the acquisition date. We believe these incremental costs are separately identifiable from the ongoing operating results of SVA included in the Analog segment and so we have classified them as a part of Other. We believe this presentation provides greater transparency of the operating results of our reporting business segments without the impact of mandatory accounting adjustments to fair value.

For the third quarter, the amount of incremental costs recognized was $7 million, attributable to the fair value write-up of acquired inventory that was sold after the date of acquisition. These costs are included in cost of revenue. The total fair value write-up of acquired inventory was $96 million. We expect to recognize the remainder of the write-up in cost of revenue in the fourth quarter.

The total fair value write-up for the acquired property, plant and equipment was $469 million, which will be depreciated at a rate of about $10 million quarterly and will be included primarily in cost of revenue.

Reflected on the face of the income statement is acquisition cost, which includes charges such as restructuring expense (primarily for severance and stock compensation expense), administrative fees, retention bonuses and amortization of intangible assets. This cost is included in Other.

In addition, the tax provision for the third quarter contained a $10 million discrete tax charge associated with the acquisition.

Details of financial results

This management’s discussion and analysis (MD&A) includes two measures that were not prepared in accordance with generally accepted accounting principles in the United States (non-GAAP measures): days sales outstanding and inventory days. For a reconciliation to GAAP and an explanation of the purpose for providing these non-GAAP measures, see the Non-GAAP Financial Information section at the end of the MD&A.

Revenue for the third quarter of 2011 was $3.47 billion, declining $274 million, or 7 percent, from the year-ago quarter across all segments. Revenue was about even with the prior quarter.

Gross profit for the third quarter of 2011 was $1.74 billion, or 50.3 percent of revenue, a decrease of $295 million, or 14 percent, from the year-ago quarter.  The decrease in gross profit from the year-ago quarter was due to a combination of, in decreasing order, lower revenue, costs associated with lower levels of factory utilization in the quarter as we lowered production in response to weaker demand, and scrap charges for inventory obsolescence on certain custom programs. The impact of lower utilization for the third quarter was about $90 million. Compared with the prior quarter, gross profit was about even. Negatively affecting gross profit were scrap charges for inventory obsolescence on certain custom programs and, to a lesser extent, lower levels of factory utilization. Partially offsetting these reductions were a $23 million of net benefit resulting from proceeds from ongoing insurance claims associated with the March earthquake in Japan (compared with net costs of $50 million in the second quarter of 2011) and lower compensation-related costs.

Operating expenses for the third quarter of 2011 were $395 million for R&D and $388 million for SG&A.  R&D expense decreased $22 million, or 5 percent, from the year-ago quarter primarily due about equally to lower product development costs and lower compensation-related costs.  Compared with the prior quarter, R&D expense decreased $29 million, or 7 percent, primarily due to lower compensation-related costs. SG&A expense was about even with the year-ago quarter.  Compared with the prior quarter, SG&A expense decreased $23 million, or 6 percent, due to lower compensation-related costs.

Acquisition cost for the third quarter was $147 million, compared with $13 million in the prior quarter. This cost is included in Other. See Note 2 to the Financial Statements for additional detail regarding these charges.

For the third quarter of 2011, our operating profit was $814 million, or 23.5 percent of revenue, compared with $1.23 billion, or 32.8 percent of revenue, for the year-ago quarter and $905 million, or 26.2 percent of revenue, for the prior quarter.  The

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decrease from the year-ago quarter was due to lower gross profit and, to a lesser extent, acquisition cost. Compared with the prior quarter, operating profit decreased $91 million, or 10 percent, due to acquisition cost, which was partially offset by lower operating expenses.

Interest and debt expense was $15 million compared with $6 million for the prior quarter. The increase was due to the accrual of a full quarter's worth of interest expense on our $3.5 billion of long-term debt issued in May 2011. See Note 5 to Financial Statements for details regarding debt outstanding.

Other income and expense (net) for the third quarter was a net expense of $19 million compared with income of $8 million for the year-ago quarter and $10 million for the prior quarter. The decrease in each comparison was due to an expense associated with a lawsuit related to a divested business.

As of September 30, 2011, our estimated annual effective tax rate for 2011 is about 25 percent. Quarterly income taxes are calculated using the estimated annual effective tax rate. See Note 6 to the Financial Statements for additional information.
 
For the third quarter of 2011, our tax provision was $179 million compared with $376 million in the year-ago quarter and $237 million in the prior quarter. The decrease in the tax provision in each comparison was primarily due to lower income before income taxes.

For the third quarter of 2011, our net income was $601 million compared with $859 million for the year-ago quarter and $672 million for the prior quarter. EPS was $0.51 compared with $0.71 for the year-ago quarter and $0.56 for the prior quarter.

Orders in the third quarter were $3.07 billion, a decrease of 10 percent from the year-ago quarter and 15 percent from the prior quarter.

Segment results


Analog

 
 
 
3Q11

 
 
 
3Q10

 
 
3Q11
vs. 3Q10
 
 
 
 
2Q11

 
 
3Q11
vs. 2Q11
 
 
Revenue
 
$
1,557

 
 
$
1,581

 
 
 
(2
)
%
 
$
1,588

 
 
 
(2
)
%
Operating profit
 
 
414

 
 
 
520

 
 
 
(20
)
%
 
 
446

 
 
 
(7
)
%
Operating profit % of revenue
 
 
26.6

%
 
 
32.9

%
 
 
 
 
 
 
28.1

%
 
 
 
 


Analog revenue decreased 2 percent from the year-ago quarter due to decreased shipments of HPA products. Revenue from National is reported in the Analog segment as SVA and contributed $18 million from the acquisition date through September 30, 2011. Analog revenue decreased 2 percent from the prior quarter primarily due to lower revenue from HPA and Power products resulting from a lower proportion of shipments of higher-priced products. Revenue from HVAL products was about even compared with the year-ago quarter but increased from the prior quarter due to an increased proportion of shipments of higher-priced products. Operating profit decreased from both the year-ago quarter and prior quarter due to lower gross profit.


Embedded Processing

 
 
 
3Q11

 
 
 
3Q10

 
 
3Q11
vs. 3Q10
 
 
 
 
2Q11

 
 
3Q11
vs. 2Q11
 
 
Revenue
 
$
539

 
 
$
579

 
 
 
(7
)
%
 
$
596

 
 
 
(10
)
%
Operating profit
 
 
113

 
 
 
160

 
 
 
(29
)
%
 
 
141

 
 
 
(20
)
%
Operating profit % of revenue
 
 
21.0

%
 
 
27.6

%
 
 
 
 
 
 
23.7

%
 
 
 
 


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Embedded Processing revenue decreased 7 percent from the year-ago quarter and 10 percent from the prior quarter, primarily due to decreased shipments of higher-priced catalog products. Lower shipments of products sold into communications infrastructure applications also contributed to the decline from the prior quarter. Operating profit decreased in both comparisons due to lower gross profit.

Wireless

 
 
 
3Q11

 
 
 
3Q10

 
 
3Q11
vs. 3Q10
 
 
 
 
2Q11

 
 
3Q11
vs. 2Q11
 
 
Revenue
 
$
580

 
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