UNITED STATES SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
(Mark One)
þ | QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 | |
For the quarterly period ended September 27, 2014. | ||
Or
¨ | 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 000-06217
INTEL CORPORATION
(Exact name of registrant as specified in its charter)
Delaware | 94-1672743 | |
(State or other jurisdiction of incorporation or organization) | (I.R.S. Employer Identification No.) | |
2200 Mission College Boulevard, Santa Clara, California | 95054-1549 | |
(Address of principal executive offices) | (Zip Code) | |
(408) 765-8080
(Registrant’s telephone number, including area code)
N/A
(Former name, former address and former fiscal year, if changed since last report)
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 þ 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 þ 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 þ | Accelerated filer ¨ | Non-accelerated filer ¨ | Smaller reporting company ¨ | |||
(Do not check if a 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 þ
Shares outstanding of the Registrant’s common stock:
Class | Outstanding as of October 17, 2014 | |
Common stock, $0.001 par value | 4,835 million | |
PART I – FINANCIAL INFORMATION
ITEM 1. | FINANCIAL STATEMENTS |
INTEL CORPORATION
CONSOLIDATED CONDENSED STATEMENTS OF INCOME (Unaudited)
Three Months Ended | Nine Months Ended | |||||||||||||||
(In Millions, Except Per Share Amounts) | Sep 27, 2014 | Sep 28, 2013 | Sep 27, 2014 | Sep 28, 2013 | ||||||||||||
Net revenue | $ | 14,554 | $ | 13,483 | $ | 41,149 | $ | 38,874 | ||||||||
Cost of sales | 5,096 | 5,069 | 15,161 | 15,924 | ||||||||||||
Gross margin | 9,458 | 8,414 | 25,988 | 22,950 | ||||||||||||
Research and development | 2,842 | 2,742 | 8,547 | 7,785 | ||||||||||||
Marketing, general and administrative | 1,979 | 1,970 | 6,087 | 6,082 | ||||||||||||
Restructuring and asset impairment charges | 20 | 124 | 238 | 124 | ||||||||||||
Amortization of acquisition-related intangibles | 77 | 74 | 222 | 217 | ||||||||||||
Operating expenses | 4,918 | 4,910 | 15,094 | 14,208 | ||||||||||||
Operating income | 4,540 | 3,504 | 10,894 | 8,742 | ||||||||||||
Gains (losses) on equity investments, net | 35 | 452 | 178 | 437 | ||||||||||||
Interest and other, net | (25 | ) | (32 | ) | 70 | (119 | ) | |||||||||
Income before taxes | 4,550 | 3,924 | 11,142 | 9,060 | ||||||||||||
Provision for taxes | 1,233 | 974 | 3,099 | 2,065 | ||||||||||||
Net income | $ | 3,317 | $ | 2,950 | $ | 8,043 | $ | 6,995 | ||||||||
Basic earnings per common share | $ | 0.68 | $ | 0.59 | $ | 1.63 | $ | 1.41 | ||||||||
Diluted earnings per common share | $ | 0.66 | $ | 0.58 | $ | 1.58 | $ | 1.37 | ||||||||
Cash dividends declared per common share | $ | 0.45 | $ | 0.45 | $ | 0.90 | $ | 0.90 | ||||||||
Weighted average common shares outstanding: | ||||||||||||||||
Basic | 4,880 | 4,981 | 4,945 | 4,969 | ||||||||||||
Diluted | 5,045 | 5,100 | 5,095 | 5,095 | ||||||||||||
See accompanying notes.
2
INTEL CORPORATION
CONSOLIDATED CONDENSED STATEMENTS OF COMPREHENSIVE INCOME (Unaudited)
Three Months Ended | Nine Months Ended | |||||||||||||||
(In Millions) | Sep 27, 2014 | Sep 28, 2013 | Sep 27, 2014 | Sep 28, 2013 | ||||||||||||
Net income | $ | 3,317 | $ | 2,950 | $ | 8,043 | $ | 6,995 | ||||||||
Other comprehensive income, net of tax: | ||||||||||||||||
Change in net unrealized holding gains (losses) on available-for-sale investments | 303 | 769 | 217 | 1,376 | ||||||||||||
Change in deferred tax asset valuation allowance | (26 | ) | (20 | ) | (30 | ) | (20 | ) | ||||||||
Change in net unrealized holding gains (losses) on derivatives | (184 | ) | 70 | (173 | ) | (37 | ) | |||||||||
Change in net prior service costs (credits) | 2 | 2 | (41 | ) | 4 | |||||||||||
Change in actuarial valuation | (148 | ) | 31 | (143 | ) | 101 | ||||||||||
Change in net foreign currency translation adjustment | (121 | ) | 51 | (127 | ) | 23 | ||||||||||
Other comprehensive income (loss) | (174 | ) | 903 | (297 | ) | 1,447 | ||||||||||
Total comprehensive income | $ | 3,143 | $ | 3,853 | $ | 7,746 | $ | 8,442 | ||||||||
See accompanying notes.
3
INTEL CORPORATION
CONSOLIDATED CONDENSED BALANCE SHEETS (Unaudited)
(In Millions) | Sep 27, 2014 | Dec 28, 2013 | ||||||
Assets | ||||||||
Current assets: | ||||||||
Cash and cash equivalents | $ | 3,143 | $ | 5,674 | ||||
Short-term investments | 3,451 | 5,972 | ||||||
Trading assets | 9,000 | 8,441 | ||||||
Accounts receivable, net | 3,647 | 3,582 | ||||||
Inventories | 4,115 | 4,172 | ||||||
Deferred tax assets | 1,674 | 2,594 | ||||||
Other current assets | 2,479 | 1,649 | ||||||
Total current assets | 27,509 | 32,084 | ||||||
Property, plant and equipment, net of accumulated depreciation of $45,368 ($41,988 as of December 28, 2013) | 33,135 | 31,428 | ||||||
Marketable equity securities | 6,514 | 6,221 | ||||||
Other long-term investments | 2,153 | 1,473 | ||||||
Goodwill | 10,556 | 10,513 | ||||||
Identified intangible assets, net | 4,379 | 5,150 | ||||||
Other long-term assets | 6,370 | 5,489 | ||||||
Total assets | $ | 90,616 | $ | 92,358 | ||||
Liabilities, temporary equity, and stockholders’ equity | ||||||||
Current liabilities: | ||||||||
Short-term debt | $ | 1,164 | $ | 281 | ||||
Accounts payable | 2,597 | 2,969 | ||||||
Accrued compensation and benefits | 2,931 | 3,123 | ||||||
Accrued advertising | 1,100 | 1,021 | ||||||
Deferred income | 2,189 | 2,096 | ||||||
Other accrued liabilities | 4,923 | 4,078 | ||||||
Total current liabilities | 14,904 | 13,568 | ||||||
Long-term debt | 12,103 | 13,165 | ||||||
Long-term deferred tax liabilities | 3,551 | 4,397 | ||||||
Other long-term liabilities | 3,070 | 2,972 | ||||||
Contingencies (Note 22) | ||||||||
Temporary equity | 915 | — | ||||||
Stockholders’ equity: | ||||||||
Preferred stock | — | — | ||||||
Common stock and capital in excess of par value, 4,867 shares issued and 4,857 shares outstanding (4,967 issued and outstanding as of December 28, 2013) | 21,894 | 21,536 | ||||||
Accumulated other comprehensive income (loss) | 946 | 1,243 | ||||||
Retained earnings | 33,233 | 35,477 | ||||||
Total stockholders’ equity | 56,073 | 58,256 | ||||||
Total liabilities, temporary equity, and stockholders’ equity | $ | 90,616 | $ | 92,358 | ||||
See accompanying notes.
4
INTEL CORPORATION
CONSOLIDATED CONDENSED STATEMENTS OF CASH FLOWS (Unaudited)
Nine Months Ended | ||||||||
(In Millions) | Sep 27, 2014 | Sep 28, 2013 | ||||||
Cash and cash equivalents, beginning of period | $ | 5,674 | $ | 8,478 | ||||
Cash flows provided by (used for) operating activities: | ||||||||
Net income | 8,043 | 6,995 | ||||||
Adjustments to reconcile net income to net cash provided by operating activities: | ||||||||
Depreciation | 5,491 | 5,123 | ||||||
Share-based compensation | 867 | 855 | ||||||
Restructuring and asset impairment charges | 238 | 124 | ||||||
Excess tax benefit from share-based payment arrangements | (109 | ) | (42 | ) | ||||
Amortization of intangibles | 884 | 953 | ||||||
(Gains) losses on equity investments, net | (124 | ) | (391 | ) | ||||
Deferred taxes | (347 | ) | (513 | ) | ||||
Changes in assets and liabilities: | ||||||||
Accounts receivable | (76 | ) | 131 | |||||
Inventories | 59 | 205 | ||||||
Accounts payable | (292 | ) | 312 | |||||
Accrued compensation and benefits | (408 | ) | (222 | ) | ||||
Income taxes payable and receivable | (190 | ) | 873 | |||||
Other assets and liabilities | 611 | 335 | ||||||
Total adjustments | 6,604 | 7,743 | ||||||
Net cash provided by operating activities | 14,647 | 14,738 | ||||||
Cash flows provided by (used for) investing activities: | ||||||||
Additions to property, plant and equipment | (7,962 | ) | (7,763 | ) | ||||
Acquisitions, net of cash acquired | (193 | ) | (882 | ) | ||||
Purchases of available-for-sale investments | (6,077 | ) | (10,107 | ) | ||||
Sales of available-for-sale investments | 786 | 864 | ||||||
Maturities of available-for-sale investments | 7,396 | 5,586 | ||||||
Purchases of trading assets | (10,347 | ) | (13,034 | ) | ||||
Maturities and sales of trading assets | 9,541 | 10,890 | ||||||
Collection of loans receivable | 17 | 124 | ||||||
Origination of loans receivable | — | (100 | ) | |||||
Investments in non-marketable equity investments | (1,330 | ) | (258 | ) | ||||
Other investing | 168 | 528 | ||||||
Net cash used for investing activities | (8,001 | ) | (14,152 | ) | ||||
Cash flows provided by (used for) financing activities: | ||||||||
Increase (decrease) in short-term debt, net | (202 | ) | 38 | |||||
Excess tax benefit from share-based payment arrangements | 109 | 42 | ||||||
Proceeds from sales of shares through employee equity incentive plans | 1,566 | 1,308 | ||||||
Repurchase of common stock | (7,106 | ) | (1,899 | ) | ||||
Payment of dividends to stockholders | (3,340 | ) | (3,358 | ) | ||||
Other financing | (199 | ) | (307 | ) | ||||
Net cash used for financing activities | (9,172 | ) | (4,176 | ) | ||||
Effect of exchange rate fluctuations on cash and cash equivalents | (5 | ) | (7 | ) | ||||
Net increase (decrease) in cash and cash equivalents | (2,531 | ) | (3,597 | ) | ||||
Cash and cash equivalents, end of period | $ | 3,143 | $ | 4,881 | ||||
Supplemental disclosures of cash flow information: | ||||||||
Cash paid during the period for: | ||||||||
Interest, net of capitalized interest | $ | 59 | $ | 91 | ||||
Income taxes, net of refunds | $ | 3,579 | $ | 1,669 | ||||
5
INTEL CORPORATION
NOTES TO CONSOLIDATED CONDENSED FINANCIAL STATEMENTS — Unaudited
Note 1: Basis of Presentation
We prepared our interim consolidated condensed financial statements that accompany these notes in conformity with U.S. generally accepted accounting principles, consistent in all material respects with those applied in our Annual Report on Form 10-K for the year ended December 28, 2013. We have reclassified certain prior period amounts to conform to current period presentation.
We have made estimates and judgments affecting the amounts reported in our consolidated condensed financial statements and the accompanying notes. The actual results that we experience may differ materially from our estimates. The interim financial information is unaudited, but reflects all normal adjustments that are, in our opinion, necessary to provide a fair statement of results for the interim periods presented. This interim information should be read in conjunction with the consolidated financial statements in our Annual Report on Form 10-K for the year ended December 28, 2013.
Note 2: Recent Accounting Standards
In May 2014, the Financial Accounting Standards Board issued a new standard to achieve a consistent application of revenue recognition within the U.S., resulting in a single revenue model to be applied by reporting companies under U.S. generally accepted accounting principles. Under the new model, recognition of revenue occurs when a customer obtains control of promised goods or services in an amount that reflects the consideration to which the entity expects to be entitled in exchange for those goods or services. In addition, the new standard requires that reporting companies disclose the nature, amount, timing, and uncertainty of revenue and cash flows arising from contracts with customers. The new standard is effective for us beginning in the first quarter of 2017; early adoption is prohibited. The new standard is required to be applied retrospectively to each prior reporting period presented or retrospectively with the cumulative effect of initially applying it recognized at the date of initial application. We have not yet selected a transition method nor have we determined the impact of the new standard on our consolidated condensed financial statements.
Note 3: Fair Value
Fair value is the price that would be received from selling an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date. When determining fair value, we consider the principal or most advantageous market in which we would transact, and we consider assumptions that market participants would use when pricing the asset or liability. Our financial assets are measured and recorded at fair value, except for equity method investments, cost method investments, cost method loans receivable, and reverse repurchase agreements with original maturities greater than approximately three months. Most of our liabilities are not measured and recorded at fair value.
Fair Value Hierarchy
The three levels of inputs that may be used to measure fair value are as follows:
Level 1. Quoted prices in active markets for identical assets or liabilities.
Level 2. Observable inputs other than Level 1 prices, such as quoted prices for similar assets or liabilities, quoted prices in less active markets, or model-derived valuations in which all significant inputs are observable or can be derived principally from or corroborated with observable market data for substantially the full term of the assets or liabilities. Level 2 inputs also include non-binding market consensus prices that can be corroborated with observable market data, as well as quoted prices that were adjusted for security-specific restrictions.
Level 3. Unobservable inputs to the valuation methodology that are significant to the measurement of the fair value of assets or liabilities. Level 3 inputs also include non-binding market consensus prices or non-binding broker quotes that we were unable to corroborate with observable market data.
6
INTEL CORPORATION
NOTES TO CONSOLIDATED CONDENSED FINANCIAL STATEMENTS — Unaudited (Continued)
Assets and Liabilities Measured and Recorded at Fair Value on a Recurring Basis
Assets and liabilities measured and recorded at fair value on a recurring basis at the end of each period were as follows:
September 27, 2014 | December 28, 2013 | |||||||||||||||||||||||||||||||
Fair Value Measured and Recorded at Reporting Date Using | Fair Value Measured and Recorded at Reporting Date Using | |||||||||||||||||||||||||||||||
(In Millions) | Level 1 | Level 2 | Level 3 | Total | Level 1 | Level 2 | Level 3 | Total | ||||||||||||||||||||||||
Assets | ||||||||||||||||||||||||||||||||
Cash equivalents: | ||||||||||||||||||||||||||||||||
Corporate debt | $ | — | $ | 967 | $ | — | $ | 967 | $ | 154 | $ | 1,920 | $ | — | $ | 2,074 | ||||||||||||||||
Financial institution instruments | 230 | 1,079 | — | 1,309 | 887 | 1,190 | — | 2,077 | ||||||||||||||||||||||||
Government debt | — | 23 | — | 23 | — | 269 | — | 269 | ||||||||||||||||||||||||
Reverse repurchase agreements | — | 268 | — | 268 | — | 400 | — | 400 | ||||||||||||||||||||||||
Short-term investments: | ||||||||||||||||||||||||||||||||
Corporate debt | 194 | 489 | 29 | 712 | 274 | 1,374 | 19 | 1,667 | ||||||||||||||||||||||||
Financial institution instruments | 84 | 1,910 | — | 1,994 | 194 | 2,895 | — | 3,089 | ||||||||||||||||||||||||
Government debt | 323 | 422 | — | 745 | 183 | 1,033 | — | 1,216 | ||||||||||||||||||||||||
Trading assets: | ||||||||||||||||||||||||||||||||
Asset-backed securities | — | 831 | 66 | 897 | — | 684 | 4 | 688 | ||||||||||||||||||||||||
Corporate debt | 2,580 | 442 | — | 3,022 | 2,161 | 628 | — | 2,789 | ||||||||||||||||||||||||
Financial institution instruments | 1,113 | 593 | — | 1,706 | 1,188 | 418 | — | 1,606 | ||||||||||||||||||||||||
Government debt | 1,338 | 2,037 | — | 3,375 | 1,625 | 1,733 | — | 3,358 | ||||||||||||||||||||||||
Other current assets: | ||||||||||||||||||||||||||||||||
Derivative assets | — | 306 | — | 306 | 48 | 309 | — | 357 | ||||||||||||||||||||||||
Loans receivable | — | 596 | — | 596 | — | 103 | — | 103 | ||||||||||||||||||||||||
Marketable equity securities | 6,437 | 77 | — | 6,514 | 6,221 | — | — | 6,221 | ||||||||||||||||||||||||
Other long-term investments: | ||||||||||||||||||||||||||||||||
Asset-backed securities | — | — | 7 | 7 | — | — | 9 | 9 | ||||||||||||||||||||||||
Corporate debt | 588 | 578 | 18 | 1,184 | 228 | 270 | 27 | 525 | ||||||||||||||||||||||||
Financial institution instruments | 254 | 425 | — | 679 | 90 | 402 | — | 492 | ||||||||||||||||||||||||
Government debt | 63 | 220 | — | 283 | 259 | 188 | — | 447 | ||||||||||||||||||||||||
Other long-term assets: | ||||||||||||||||||||||||||||||||
Derivative assets | — | 23 | 27 | 50 | — | 7 | 29 | 36 | ||||||||||||||||||||||||
Loans receivable | — | 162 | — | 162 | — | 702 | — | 702 | ||||||||||||||||||||||||
Total assets measured and recorded at fair value | $ | 13,204 | $ | 11,448 | $ | 147 | $ | 24,799 | $ | 13,512 | $ | 14,525 | $ | 88 | $ | 28,125 | ||||||||||||||||
Liabilities | ||||||||||||||||||||||||||||||||
Other accrued liabilities: | ||||||||||||||||||||||||||||||||
Derivative liabilities | $ | — | $ | 323 | $ | — | $ | 323 | $ | — | $ | 372 | $ | — | $ | 372 | ||||||||||||||||
Other long-term liabilities: | ||||||||||||||||||||||||||||||||
Derivative liabilities | — | 22 | — | 22 | — | 50 | — | 50 | ||||||||||||||||||||||||
Total liabilities measured and recorded at fair value | $ | — | $ | 345 | $ | — | $ | 345 | $ | — | $ | 422 | $ | — | $ | 422 | ||||||||||||||||
Government debt includes instruments such as non-U.S. government bonds, U.S. agency securities, and U.S. Treasury securities. Financial institution instruments include instruments issued or managed by financial institutions in various forms such as commercial paper, fixed and floating rate bonds, money market fund deposits, and time deposits.
7
INTEL CORPORATION
NOTES TO CONSOLIDATED CONDENSED FINANCIAL STATEMENTS — Unaudited (Continued)
For assets held as of September 27, 2014, we transferred corporate debt, financial institution instruments, and government debt of approximately $230 million from Level 1 to Level 2 of the fair value hierarchy and approximately $400 million from Level 2 to Level 1 during the first nine months of 2014. These transfers were primarily based on changes in market activity for the underlying securities. Our policy is to reflect transfers between the fair value hierarchy levels at the beginning of the quarter in which a change in circumstances resulted in the transfer.
Investments in Debt Instruments
Debt instruments reflected in the preceding table include investments such as asset-backed securities, corporate debt, financial institution instruments, government debt, and reverse repurchase agreements classified as cash equivalents. We classify our debt instruments as Level 2 when we use observable market prices for identical securities that are traded in less active markets. When observable market prices for identical securities are not available, we price the debt instruments using our own models, such as a discounted cash flow model, or non-binding market consensus prices based on the proprietary valuation models of pricing providers or brokers. We corroborate non-binding market consensus prices with observable market data using statistical models when observable market data exists, quoted market prices for similar instruments, or pricing models such as a discounted cash flow model. These valuation models incorporate a number of inputs, including non-binding and binding broker quotes; observable market prices for identical or similar instruments; and the internal assumptions of pricing providers or brokers that use observable market inputs and unobservable market inputs that we consider to be not significant. The discounted cash flow model uses observable market inputs, such as LIBOR-based yield curves, currency spot and forward rates, and credit ratings. All significant inputs are derived from or corroborated with observable market data.
The fair values of debt instruments classified as Level 3 are generally derived from discounted cash flow models, performed either by us or our pricing providers, using inputs that we are unable to corroborate with observable market data. We monitor and review the inputs and results of these valuation models to ensure the fair value measurements are reasonable and consistent with market experience in similar asset classes.
Fair Value Option for Loans Receivable
We elected the fair value option for loans receivable when the interest rate or currency exchange rate risk was hedged at inception with a related derivative instrument. As of September 27, 2014, the fair value of our loans receivable for which we elected the fair value option did not significantly differ from the contractual principal balance based on the contractual currency. Loans receivable are classified within other current assets and other long-term assets. Fair value is determined using a discounted cash flow model, with all significant inputs derived from or corroborated with observable market data. Gains and losses from changes in fair value on the loans receivable and related derivative instruments, as well as interest income, are recorded in interest and other, net. During all periods presented, changes in the fair value of our loans receivable were largely offset by changes in the related derivative instruments, resulting in an insignificant net impact on our consolidated condensed statements of income. Gains and losses attributable to changes in credit risk are determined using observable credit default spreads for the issuer or comparable companies; these gains and losses were insignificant during all periods presented. We did not elect the fair value option for loans receivable when the interest rate or currency exchange rate risk was not hedged at inception with a related derivative instrument. Loans receivable not measured and recorded at fair value are included in the following "Financial Instruments Not Recorded at Fair Value on a Recurring Basis" section.
Assets Measured and Recorded at Fair Value on a Non-Recurring Basis
Our non-marketable equity investments, marketable equity method investments, and non-financial assets, such as intangible assets and property, plant and equipment, are recorded at fair value only if an impairment charge is recognized.
Some of our non-marketable equity investments have been measured and recorded at fair value due to events or circumstances that significantly impacted the fair value of those investments, resulting in other-than-temporary impairment charges. We classified these investments as Level 3 because the valuations used unobservable inputs that were significant to the fair value measurements and required management judgment due to the absence of quoted market prices. Impairment charges recognized on non-marketable equity investments held as of September 27, 2014, were $28 million during the third quarter of 2014 and $93 million during the first nine months of 2014 ($23 million during the third quarter of 2013 and $93 million during the first nine months of 2013 on non-marketable equity investments held as of September 28, 2013).
8
INTEL CORPORATION
NOTES TO CONSOLIDATED CONDENSED FINANCIAL STATEMENTS — Unaudited (Continued)
Financial Instruments Not Recorded at Fair Value on a Recurring Basis
On a quarterly basis, we measure the fair value of our grants receivable, cost method loans receivable, non-marketable cost method investments, reverse repurchase agreements with original maturities greater than approximately three months, and indebtedness carried at amortized cost; however, the assets are recorded at fair value only when an impairment charge is recognized. The carrying amounts and fair values of financial instruments not recorded at fair value on a recurring basis at the end of each period were as follows:
September 27, 2014 | ||||||||||||||||||||
(In Millions) | Carrying Amount | Fair Value Measured Using | Fair Value | |||||||||||||||||
Level 1 | Level 2 | Level 3 | ||||||||||||||||||
Grants receivable | $ | 777 | $ | — | $ | 784 | $ | — | $ | 784 | ||||||||||
Loans receivable | $ | 250 | $ | — | $ | 250 | $ | — | $ | 250 | ||||||||||
Non-marketable cost method investments | $ | 1,871 | $ | — | $ | — | $ | 2,801 | $ | 2,801 | ||||||||||
Reverse repurchase agreements | $ | 450 | $ | — | $ | 450 | $ | — | $ | 450 | ||||||||||
Short-term debt | $ | 1,085 | $ | — | $ | 1,550 | $ | — | $ | 1,550 | ||||||||||
Long-term debt | $ | 12,103 | $ | 11,319 | $ | 1,220 | $ | — | $ | 12,539 | ||||||||||
NVIDIA Corporation cross-license agreement liability | $ | 393 | $ | — | $ | 399 | $ | — | $ | 399 | ||||||||||
December 28, 2013 | ||||||||||||||||||||
(In Millions) | Carrying Amount | Fair Value Measured Using | Fair Value | |||||||||||||||||
Level 1 | Level 2 | Level 3 | ||||||||||||||||||
Grants receivable | $ | 416 | $ | — | $ | 481 | $ | — | $ | 481 | ||||||||||
Loans receivable | $ | 267 | $ | — | $ | 250 | $ | 17 | $ | 267 | ||||||||||
Non-marketable cost method investments | $ | 1,270 | $ | — | $ | — | $ | 2,105 | $ | 2,105 | ||||||||||
Reverse repurchase agreements | $ | 400 | $ | — | $ | 400 | $ | — | $ | 400 | ||||||||||
Short-term debt | $ | 24 | $ | — | $ | 24 | $ | — | $ | 24 | ||||||||||
Long-term debt | $ | 13,165 | $ | 10,937 | $ | 2,601 | $ | — | $ | 13,538 | ||||||||||
NVIDIA Corporation cross-license agreement liability | $ | 587 | $ | — | $ | 597 | $ | — | $ | 597 | ||||||||||
The fair value of our grants receivable is determined using a discounted cash flow model, which discounts future cash flows using an appropriate yield curve. As of September 27, 2014 and December 28, 2013, the carrying amount of our grants receivable was classified within other current assets and other long-term assets, as applicable.
The carrying amount and fair value of loans receivable exclude loans measured and recorded at a fair value of $758 million as of September 27, 2014 ($805 million as of December 28, 2013). The fair value of our loans receivable and reverse repurchase agreements, including those held at fair value, is determined using a discounted cash flow model. All significant inputs in the models are derived from or corroborated with observable market data, such as LIBOR-based yield curves, currency spot and forward rates, and credit ratings. The credit quality of these assets remains high, with credit ratings of A+/A1 or better for the substantial majority of our loans receivable and the majority of our reverse repurchase agreements as of September 27, 2014.
As of September 27, 2014 and December 28, 2013, the unrealized loss position of our non-marketable cost method investments was insignificant. Our non-marketable cost method investments are valued using the market and income approaches. The market approach includes the use of financial metrics and ratios of comparable public companies. The selection of comparable companies requires management judgment and is based on a number of factors, including comparable companies’ sizes, growth rates, industries, and development stages. The income approach includes the use of a discounted cash flow model, which requires significant estimates regarding investees’ revenue, costs, and discount rates based on the risk profile of comparable companies. Estimates of revenue and costs are developed using available market, historical, and forecast data. The valuation of these non-marketable cost method investments also takes into account variables such as conditions reflected in the capital markets, recent financing activities by the investees, the investees’ capital structure, the terms of the investees’ issued interests, and the level of marketability of the investments.
9
INTEL CORPORATION
NOTES TO CONSOLIDATED CONDENSED FINANCIAL STATEMENTS — Unaudited (Continued)
The carrying amount and fair value of short-term debt exclude drafts payable. Our short-term debt recognized at amortized cost includes our 2009 junior subordinated convertible debentures (2009 debentures). During the third quarter of 2014, the 2009 debentures were reclassified from long-term debt to short-term debt on the consolidated condensed balance sheets. Beginning September 28, 2014, holders may, at their option, surrender the 2009 debentures for conversion during the fourth quarter of 2014. For further information, see “Note 12: Borrowings." Our long-term debt recognized at amortized cost is comprised of our senior notes and our 2005 junior subordinated convertible debentures (2005 debentures). The fair value of our senior notes is determined using active market prices, and is therefore classified as Level 1. The fair value of our 2009 and 2005 convertible debentures is determined using discounted cash flow models with observable market inputs, and takes into consideration variables such as interest rate changes, comparable instruments, subordination discount, and credit-rating changes, and is therefore classified as Level 2.
The NVIDIA Corporation (NVIDIA) cross-license agreement liability in the preceding table was incurred as a result of entering into a long-term patent cross-license agreement with NVIDIA in January 2011. We agreed to make payments to NVIDIA over six years. As of September 27, 2014 and December 28, 2013, the carrying amount of the liability arising from the agreement was classified within other accrued liabilities and other long-term liabilities, as applicable. The fair value is determined using a discounted cash flow model, which discounts future cash flows using our incremental borrowing rates.
Note 4: Cash and Investments
Cash and investments at the end of each period were as follows:
(In Millions) | Sep 27, 2014 | Dec 28, 2013 | ||||||
Available-for-sale investments | $ | 14,417 | $ | 18,086 | ||||
Cash | 576 | 854 | ||||||
Equity method investments | 1,491 | 1,038 | ||||||
Loans receivable | 1,008 | 1,072 | ||||||
Non-marketable cost method investments | 1,871 | 1,270 | ||||||
Reverse repurchase agreements | 718 | 800 | ||||||
Trading assets | 9,000 | 8,441 | ||||||
Total cash and investments | $ | 29,081 | $ | 31,561 | ||||
Available-for-Sale Investments
Available-for-sale investments at the end of each period were as follows:
September 27, 2014 | December 28, 2013 | |||||||||||||||||||||||||||||||
(In Millions) | Adjusted Cost | Gross Unrealized Gains | Gross Unrealized Losses | Fair Value | Adjusted Cost | Gross Unrealized Gains | Gross Unrealized Losses | Fair Value | ||||||||||||||||||||||||
Asset-backed securities | $ | 8 | $ | — | $ | (1 | ) | $ | 7 | $ | 11 | $ | — | $ | (2 | ) | $ | 9 | ||||||||||||||
Corporate debt | 2,848 | 18 | (3 | ) | 2,863 | 4,254 | 15 | (3 | ) | 4,266 | ||||||||||||||||||||||
Financial institution instruments | 3,976 | 6 | — | 3,982 | 5,654 | 5 | (1 | ) | 5,658 | |||||||||||||||||||||||
Government debt | 1,052 | — | (1 | ) | 1,051 | 1,932 | 1 | (1 | ) | 1,932 | ||||||||||||||||||||||
Marketable equity securities | 3,305 | 3,209 | — | 6,514 | 3,340 | 2,881 | — | 6,221 | ||||||||||||||||||||||||
Total available-for-sale investments | $ | 11,189 | $ | 3,233 | $ | (5 | ) | $ | 14,417 | $ | 15,191 | $ | 2,902 | $ | (7 | ) | $ | 18,086 | ||||||||||||||
Government debt includes instruments such as non-U.S. government bonds, U.S. agency securities, and U.S. Treasury securities. Financial institution instruments include instruments issued or managed by financial institutions in various forms such as commercial paper, fixed and floating rate bonds, money market fund deposits, and time deposits. Time deposits were primarily issued by institutions outside the U.S. as of September 27, 2014 and December 28, 2013.
10
INTEL CORPORATION
NOTES TO CONSOLIDATED CONDENSED FINANCIAL STATEMENTS — Unaudited (Continued)
For information on the unrealized holding gains (losses) on available-for-sale investments reclassified out of accumulated other comprehensive income (loss) into the consolidated condensed statements of income, see "Note 21: Other Comprehensive Income (Loss)."
During the third quarter of 2014, we sold available-for-sale investments for proceeds of $373 million, of which $82 million related to sales of cash and cash equivalents ($359 million in the third quarter of 2013, of which $93 million related to sales of cash and cash equivalents). During the first nine months of 2014, we sold available-for-sale investments for proceeds of $1.2 billion, of which $459 million related to sales of cash and cash equivalents ($1.2 billion in the first nine months of 2013 of which $339 million related to sales of cash and cash equivalents). Proceeds received in the third quarter of 2013 included $142 million from the sale of our shares in Clearwire Corporation, previously included as marketable equity securities in the preceding table. There were no gross realized gains on sales of available-for-sale investments recognized in the third quarter of 2014 and $136 million in the first nine months of 2014 ($134 million in the third quarter of 2013 and $143 million in the first nine months of 2013). Gross realized gains recognized in the third quarter of 2013 included $111 million on the sale of our shares in Clearwire Corporation. For further information, see "Note 18: Gains (Losses) on Equity Investments, Net."
The amortized cost and fair value of available-for-sale debt investments, by contractual maturity, as of September 27, 2014, were as follows:
(In Millions) | Cost | Fair Value | ||||||
Due in 1 year or less | $ | 5,331 | $ | 5,350 | ||||
Due in 1–2 years | 1,197 | 1,198 | ||||||
Due in 2–5 years | 922 | 923 | ||||||
Instruments not due at a single maturity date | 434 | 432 | ||||||
Total | $ | 7,884 | $ | 7,903 | ||||
Equity Method Investments
IM Flash Technologies, LLC
Micron Technology, Inc. (Micron) and Intel formed IM Flash Technologies, LLC (IMFT) in 2007 to manufacture NAND flash memory products for Micron and Intel. During 2012, we amended the operating agreement for IMFT and entered into agreements with Micron that modified our joint venture relationship. The amended operating agreement extended the term of IMFT to 2024, unless earlier terminated under certain terms and conditions, and provides that IMFT may manufacture certain emerging memory technologies in addition to NAND flash memory. Additionally, the amended agreement provides for certain rights that, beginning in 2015, will enable us to sell to Micron, or enable Micron to purchase from us, our interest in IMFT. If Intel exercises this right, Micron would set the closing date of the transaction within two years following such election and could elect to receive financing from Intel for one to two years. The agreements with Micron include a supply agreement for Micron to supply us with NAND flash memory products. The agreements also extend and expand our NAND joint development program with Micron to include emerging memory technologies.
As of September 27, 2014, we own a 49% interest in IMFT. The carrying value of our investment was $713 million as of September 27, 2014 ($646 million as of December 28, 2013) and is classified within other long-term assets.
IMFT is a variable interest entity. All costs of the IMFT joint venture will be passed on to Micron and Intel pursuant to our purchase agreements. Intel's portion of IMFT costs, primarily related to product purchases and production-related services, was approximately $100 million in the third quarter of 2014 and approximately $305 million in the first nine months of 2014 (approximately $80 million in the third quarter of 2013 and approximately $280 million in the first nine months of 2013). The amount due to IMFT for product purchases and services provided was approximately $85 million as of September 27, 2014 (approximately $75 million as of December 28, 2013).
11
INTEL CORPORATION
NOTES TO CONSOLIDATED CONDENSED FINANCIAL STATEMENTS — Unaudited (Continued)
IMFT depends on Micron and Intel for any additional cash needs. Our known maximum exposure to loss approximated the carrying value of our investment balance in IMFT, which was $713 million as of September 27, 2014. Except for the amount due to IMFT for product purchases and services, we did not have any additional liabilities recognized on our consolidated condensed balance sheets in connection with our interests in this joint venture as of September 27, 2014. Our potential future losses could be higher than the carrying amount of our investment, as Intel and Micron are liable for other future operating costs or obligations of IMFT. Future cash calls could also increase our investment balance and the related exposure to loss. In addition, because we are currently committed to purchasing 49% of IMFT’s production output and production-related services, we may be required to purchase products at a cost in excess of realizable value.
We have determined that we do not have the characteristics of a consolidating investor in the variable interest entity and, therefore, we account for our interest in IMFT using the equity method of accounting.
Cloudera, Inc.
During the second quarter of 2014, we invested in Cloudera, Inc. (Cloudera). Our fully-diluted ownership interest in Cloudera is 18% as of September 27, 2014. Our investment is accounted for under the equity and cost methods of accounting and is classified within other long-term assets. As of September 27, 2014, the carrying value of our equity method investment was $280 million and of our cost method investment was $454 million.
Trading Assets
As of September 27, 2014 and December 28, 2013, all of our trading assets were marketable debt instruments. Net losses related to trading assets still held at the reporting date were $283 million in the third quarter of 2014 and net losses were $254 million in the first nine months of 2014 (net gains of $96 million in the third quarter of 2013 and $43 million in the first nine months of 2013). Net gains on the related derivatives were $278 million in the third quarter of 2014 and net gains of $252 million in the first nine months of 2014 (net losses of $97 million in the third quarter of 2013 and $40 million in the first nine months of 2013).
Note 5: Inventories
We compute inventory cost on a first-in, first-out basis. Costs incurred to manufacture our products are included in the valuation of inventory beginning in the quarter in which a product meets the technical criteria to qualify for sale to customers. Prior to qualification for sale, costs that do not meet the criteria for research and development are included in cost of sales in the period incurred. Inventories at the end of each period were as follows:
(In Millions) | Sep 27, 2014 | Dec 28, 2013 | ||||||
Raw materials | $ | 496 | $ | 458 | ||||
Work in process | 2,292 | 1,998 | ||||||
Finished goods | 1,327 | 1,716 | ||||||
Total inventories | $ | 4,115 | $ | 4,172 | ||||
12
INTEL CORPORATION
NOTES TO CONSOLIDATED CONDENSED FINANCIAL STATEMENTS — Unaudited (Continued)
Note 6: Derivative Financial Instruments
Our primary objective for holding derivative financial instruments is to manage currency exchange rate risk and interest rate risk, and, to a lesser extent, equity market risk, commodity price risk, and credit risk. We also enter into master netting arrangements with counterparties when possible to mitigate credit risk in derivative transactions. A master netting arrangement may allow counterparties to net settle amounts owed to each other as a result of multiple, separate derivative transactions. Generally our master netting agreements allow for net settlement in case of certain triggering events such as bankruptcy or default of one of the counterparties to the transaction. We may also elect to exchange cash collateral with certain of our counterparties on a regular basis. For presentation on our consolidated condensed balance sheets, we do not offset fair value amounts recognized for derivative instruments under master netting arrangements.
Currency Exchange Rate Risk
We are exposed to currency exchange rate risk and generally hedge our exposures with currency forward contracts, currency interest rate swaps, or currency options. Substantially all of our revenue is transacted in U.S. dollars. However, a significant amount of our operating expenditures and capital purchases is incurred in or exposed to other currencies, primarily the euro, the Japanese yen, the Israeli shekel, and the Chinese yuan. We have established balance sheet and forecasted transaction currency risk management programs to protect against fluctuations in fair value and the volatility of the functional currency equivalent of future cash flows caused by changes in exchange rates. Our non-U.S.-dollar-denominated investments in debt instruments and loans receivable are generally hedged with offsetting currency forward contracts or currency interest rate swaps. We may also hedge currency risk arising from funding foreign currency denominated forecasted investments. These programs reduce, but do not eliminate, the impact of currency exchange movements.
Our currency risk management programs include:
• | Currency derivatives with cash flow hedge accounting designation that utilize currency forward contracts and currency options to hedge exposures to the variability in the U.S.-dollar equivalent of anticipated non-U.S.-dollar-denominated cash flows. These instruments generally mature within 12 months. For these derivatives, we report the after-tax gain or loss from the effective portion of the hedge as a component of accumulated other comprehensive income (loss), and we reclassify it into earnings in the same period or periods in which the hedged transaction affects earnings, and in the same line item on the consolidated condensed statements of income as the impact of the hedged transaction. |
• | Currency derivatives without hedge accounting designation that utilize currency forward contracts or currency interest rate swaps to economically hedge the functional currency equivalent cash flows of recognized monetary assets and liabilities, non-U.S.-dollar-denominated debt instruments classified as trading assets, and hedges of non-U.S.-dollar-denominated loans receivable recognized at fair value. The majority of these instruments mature within 12 months. Changes in the functional currency equivalent cash flows of the underlying assets and liabilities are approximately offset by the changes in fair value of the related derivatives. We record net gains or losses in the line item on the consolidated condensed statements of income most closely associated with the related exposures, primarily in interest and other, net, except for equity-related gains or losses, which we primarily record in gains (losses) on equity investments, net. |
Interest Rate Risk
Our primary objective for holding investments in debt instruments is to preserve principal while maximizing yields. We generally swap the returns on our investments in fixed-rate debt instruments with remaining maturities longer than six months into U.S. dollar three-month LIBOR-based returns, unless management specifically approves otherwise. These swaps are settled at various interest payment times involving cash payments at each interest and principal payment date, with the majority of the contracts having quarterly payments.
13
INTEL CORPORATION
NOTES TO CONSOLIDATED CONDENSED FINANCIAL STATEMENTS — Unaudited (Continued)
Our interest rate risk management programs include:
• | Interest rate derivatives with cash flow hedge accounting designation that utilize interest rate swap agreements to modify the interest characteristics of debt instruments. For these derivatives, we report the after-tax gain or loss from the effective portion of the hedge as a component of accumulated other comprehensive income (loss), and we reclassify it into earnings in the same period or periods in which the hedged transaction affects earnings, and in the same line item on the consolidated condensed statements of income as the impact of the hedged transaction. |
• | Interest rate derivatives without hedge accounting designation that utilize interest rate swaps and currency interest rate swaps in economic hedging transactions, including hedges of non-U.S.-dollar-denominated debt instruments classified as trading assets and hedges of non-U.S.-dollar-denominated loans receivable recognized at fair value. Floating interest rates on the swaps generally reset on a quarterly basis. Changes in fair value of the debt instruments classified as trading assets and loans receivable recognized at fair value are generally offset by changes in fair value of the related derivatives, both of which are recorded in interest and other, net. |
Equity Market Risk
Our investments include marketable equity securities and equity derivative instruments. We typically do not attempt to reduce or eliminate our equity market exposure through hedging activities at the inception of our investments. Before we enter into hedge arrangements, we evaluate legal, market, and economic factors, as well as the expected timing of disposal to determine whether hedging is appropriate. Our equity market risk management program may include equity derivatives with or without hedge accounting designation that utilize warrants, equity options, or other equity derivatives. We recognize changes in the fair value of such derivatives in gains (losses) on equity investments, net. We also utilize total return swaps to offset changes in liabilities related to the equity market risks of certain deferred compensation arrangements. Gains and losses from changes in fair value of these total return swaps are generally offset by the losses and gains on the related liabilities, both of which are recorded in cost of sales and operating expenses.
Commodity Price Risk
We operate facilities that consume commodities, and have established forecasted transaction risk management programs to protect against fluctuations in fair value and the volatility of future cash flows caused by changes in commodity prices, such as those for natural gas. These programs reduce, but do not always eliminate, the impact of commodity price movements.
Our commodity price risk management program includes commodity derivatives with cash flow hedge accounting designation that utilize commodity swap contracts to hedge future cash flow exposures to the variability in commodity prices. These instruments generally mature within 12 months. For these derivatives, we report the after-tax gain (loss) from the effective portion of the hedge as a component of accumulated other comprehensive income (loss) and reclassify it into earnings in the same period or periods in which the hedged transaction affects earnings, and in the same line item on the consolidated condensed statements of income as the impact of the hedged transaction.
14
INTEL CORPORATION
NOTES TO CONSOLIDATED CONDENSED FINANCIAL STATEMENTS — Unaudited (Continued)
Volume of Derivative Activity
Total gross notional amounts for outstanding derivatives (recorded at fair value) at the end of each period were as follows:
(In Millions) | Sep 27, 2014 | Dec 28, 2013 | Sep 28, 2013 | |||||||||
Currency forwards | $ | 13,896 | $ | 13,404 | $ | 12,458 | ||||||
Currency interest rate swaps | 5,015 | 4,377 | 3,665 | |||||||||
Embedded debt derivatives | 3,600 | 3,600 | 3,600 | |||||||||
Interest rate swaps | 1,259 | 1,377 | 1,269 | |||||||||
Total return swaps | 1,032 | 914 | 873 | |||||||||
Other | 53 | 67 | 72 | |||||||||
Total | $ | 24,855 | $ | 23,739 | $ | 21,937 | ||||||
The gross notional amounts for currency forwards and currency interest rate swaps (presented by currency) at the end of each period were as follows:
(In Millions) | Sep 27, 2014 | Dec 28, 2013 | Sep 28, 2013 | |||||||||
British pound sterling | $ | 420 | $ | 549 | $ | 403 | ||||||
Chinese yuan | 1,420 | 1,116 | 648 | |||||||||
Euro | 6,973 | 6,874 | 5,952 | |||||||||
Israeli shekel | 2,170 | 2,244 | 2,006 | |||||||||
Japanese yen | 4,223 | 4,116 | 3,864 | |||||||||
Malaysian ringgit | 771 | 506 | 444 | |||||||||
Swiss franc | 1,361 | 1,189 | 1,416 | |||||||||
Other | 1,573 | 1,187 | 1,390 | |||||||||
Total | $ | 18,911 | $ | 17,781 | $ | 16,123 | ||||||
Fair Value of Derivative Instruments in the Consolidated Condensed Balance Sheets
The fair value of our derivative instruments at the end of each period were as follows:
September 27, 2014 | December 28, 2013 | |||||||||||||||||||||||||||||||
(In Millions) | Other Current Assets | Other Long-Term Assets | Other Accrued Liabilities | Other Long-Term Liabilities | Other Current Assets | Other Long-Term Assets | Other Accrued Liabilities | Other Long-Term Liabilities | ||||||||||||||||||||||||
Derivatives designated as hedging instruments: | ||||||||||||||||||||||||||||||||
Currency forwards | $ | 17 | $ | — | $ | 224 | $ | 14 | $ | 114 | $ | 1 | $ | 118 | $ | 2 | ||||||||||||||||
Total derivatives designated as hedging instruments | $ | 17 | $ | — | $ | 224 | $ | 14 | $ | 114 | $ | 1 | $ | 118 | $ | 2 | ||||||||||||||||
Derivatives not designated as hedging instruments: | ||||||||||||||||||||||||||||||||
Currency forwards | $ | 121 | $ | — | $ | 39 | $ | — | $ | 66 | $ | — | $ | 63 | $ | — | ||||||||||||||||
Currency interest rate swaps | 164 | 22 | 43 | — | 124 | 6 | 163 | 29 | ||||||||||||||||||||||||
Interest rate swaps | 4 | — | 17 | — | 5 | — | 28 | — | ||||||||||||||||||||||||
Total return swaps | — | — | — | — | 48 | — | — | — | ||||||||||||||||||||||||
Other | — | 28 | — | 8 | — | 29 | — | 19 | ||||||||||||||||||||||||
Total derivatives not designated as hedging instruments | $ | 289 | $ | 50 | $ | 99 | $ | 8 | $ | 243 | $ | 35 | $ | 254 | $ | 48 | ||||||||||||||||
Total derivatives | $ | 306 | $ | 50 | $ | 323 | $ | 22 | $ | 357 | $ | 36 | $ | 372 | $ | 50 | ||||||||||||||||
15
INTEL CORPORATION
NOTES TO CONSOLIDATED CONDENSED FINANCIAL STATEMENTS — Unaudited (Continued)
Amounts Offset in the Consolidated Condensed Balance Sheets
The gross amounts of our derivative instruments and reverse repurchase agreements subject to master netting arrangements with various counterparties and cash and non-cash collateral posted under such agreements at the end of each period were as follows:
September 27, 2014 | ||||||||||||||||||||||||
Gross Amounts Not Offset in the Balance Sheet | ||||||||||||||||||||||||
(In Millions) | Gross Amounts Recognized | Gross Amounts Offset in the Balance Sheet | Net Amounts Presented in the Balance Sheet | Financial Instruments | Cash and Non-Cash Collateral Received or Pledged | Net Amount | ||||||||||||||||||
Assets: | ||||||||||||||||||||||||
Derivative assets subject to master netting arrangements | $ | 312 | $ | — | $ | 312 | $ | (220 | ) | $ | (54 | ) | $ | 38 | ||||||||||
Reverse repurchase agreements | 718 | — | 718 | — | (715 | ) | 3 | |||||||||||||||||
Total assets | $ | 1,030 | $ | — | $ | 1,030 | $ | (220 | ) | $ | (769 | ) | $ | 41 | ||||||||||
Liabilities: | ||||||||||||||||||||||||
Derivative liabilities subject to master netting arrangements | $ | 328 | $ | — | $ | 328 | $ | (220 | ) | $ | (88 | ) | $ | 20 | ||||||||||
Total liabilities | $ | 328 | $ | — | $ | 328 | $ | (220 | ) | $ | (88 | ) | $ | 20 | ||||||||||
December 28, 2013 | ||||||||||||||||||||||||
Gross Amounts Not Offset in the Balance Sheet | ||||||||||||||||||||||||
(In Millions) | Gross Amounts Recognized | Gross Amounts Offset in the Balance Sheet | Net Amounts Presented in the Balance Sheet | Financial Instruments | Cash and Non-Cash Collateral Received or Pledged | Net Amount | ||||||||||||||||||
Assets: | ||||||||||||||||||||||||
Derivative assets subject to master netting arrangements | $ | 325 | $ | — | $ | 325 | $ | (158 | ) | $ | (3 | ) | $ | 164 | ||||||||||
Reverse repurchase agreements | 800 | — | 800 | — | (800 | ) | — | |||||||||||||||||
Total assets | $ | 1,125 | $ | — | $ | 1,125 | $ | (158 | ) | $ | (803 | ) | $ | 164 | ||||||||||
Liabilities: | ||||||||||||||||||||||||
Derivative liabilities subject to master netting arrangements | $ | 401 | $ | — | $ | 401 | $ | (158 | ) | $ | (32 | ) | $ | 211 | ||||||||||
Total liabilities | $ | 401 | $ | — | $ | 401 | $ | (158 | ) | $ | (32 | ) | $ | 211 | ||||||||||
16
INTEL CORPORATION
NOTES TO CONSOLIDATED CONDENSED FINANCIAL STATEMENTS — Unaudited (Continued)
Derivatives in Cash Flow Hedging Relationships
The before-tax gains (losses), attributed to the effective portion of cash flow hedges, recognized in other comprehensive income (loss) for each period were as follows:
Three Months Ended | Nine Months Ended | |||||||||||||||
(In Millions) | Sep 27, 2014 | Sep 28, 2013 | Sep 27, 2014 | Sep 28, 2013 | ||||||||||||
Currency forwards | $ | (241 | ) | $ | 84 | $ | (201 | ) | $ | (105 | ) | |||||
Other | — | (1 | ) | (3 | ) | — | ||||||||||
Total | $ | (241 | ) | $ | 83 | $ | (204 | ) | $ | (105 | ) | |||||
Gains and losses on derivative instruments in cash flow hedging relationships related to hedge ineffectiveness and amounts excluded from effectiveness testing, were insignificant during all periods presented in the preceding tables. Additionally, for all periods presented, there was an insignificant impact on results of operations from discontinued cash flow hedges, which arises when forecasted transactions are probable of not occurring.
For information on the unrealized holding gains (losses) on derivatives reclassified out of accumulated other comprehensive income into the consolidated condensed statements of income, see "Note 21: Other Comprehensive Income (Loss)."
Derivatives Not Designated as Hedging Instruments
The effects of derivative instruments not designated as hedging instruments on the consolidated condensed statements of income for each period were as follows:
Three Months Ended | Nine Months Ended | |||||||||||||||||
(In Millions) | Location of Gains (Losses) Recognized in Income on Derivatives | Sep 27, 2014 | Sep 28, 2013 | Sep 27, 2014 | Sep 28, 2013 | |||||||||||||
Currency forwards | Interest and other, net | $ | 62 | $ | (27 | ) | $ | 40 | $ | 23 | ||||||||
Currency interest rate swaps | Interest and other, net | 221 | (56 | ) | 193 | — | ||||||||||||
Interest rate swaps | Interest and other, net | 1 | (5 | ) | (3 | ) | (2 | ) | ||||||||||
Total return swaps | Various | (7 | ) | 70 | 51 | 99 | ||||||||||||
Other | Gains (losses) on equity investments, net | (3 | ) | (6 | ) | (1 | ) | 1 | ||||||||||
Total | $ | 274 | $ | (24 | ) | $ | 280 | $ | 121 | |||||||||
Note 7: Acquisitions
During the first nine months of 2014, we completed five acquisitions qualifying as business combinations in exchange for aggregate net cash consideration of $193 million, the substantial majority of which was allocated to goodwill. For information on the assignment of goodwill to our operating segments, see “Note 9: Goodwill.” The completed acquisitions in the first nine months of 2014, both individually and in the aggregate, were not significant to our results of operations.
Note 8: Divestitures
During the first quarter of 2014, we completed the divestiture of our Intel Media assets, a business division dedicated to the development of cloud TV products and services, to Verizon Communications Inc. As a result of the transaction, we received aggregate net cash consideration of $150 million, presented within investing activities on the consolidated condensed statements of cash flows, and recognized a gain within interest and other, net on the consolidated condensed statements of income.
17
INTEL CORPORATION
NOTES TO CONSOLIDATED CONDENSED FINANCIAL STATEMENTS — Unaudited (Continued)
Note 9: Goodwill
Goodwill activity for the first nine months of 2014 was as follows:
(In Millions) | Dec 28, 2013 | Additions Due to Acquisitions | Transfers | Effect of Exchange Rate Fluctuations and Other | Sep 27, 2014 | |||||||||||||||
PC Client Group | $ | 3,058 | $ | — | $ | — | $ | — | $ | 3,058 | ||||||||||
Data Center Group | 1,831 | 8 | 138 | — | 1,977 | |||||||||||||||
Internet of Things Group | — | — | 428 | — | 428 | |||||||||||||||
Mobile and Communications Group | — | 19 | 631 | — | 650 | |||||||||||||||
Other Intel architecture operating segments | 1,075 | — | (1,075 | ) | — | — | ||||||||||||||
Software and services operating segments | 4,549 | 41 | (140 | ) | (108 | ) | 4,342 | |||||||||||||
All other | — | 101 | 18 | (18 | ) | 101 | ||||||||||||||
Total | $ | 10,513 | $ | 169 | $ | — | $ | (126 | ) | $ | 10,556 | |||||||||
In the first quarter of 2014, we formed the Internet of Things Group and we changed our organizational structure to align with our critical objectives, which included the addition of Mobile and Communication Group as a reportable operating segment. For further information, see "Note 23: Operating Segments Information." Due to this reorganization, goodwill was allocated from our prior reporting units to our new reporting units, as shown in the preceding table within "transfers." The allocation was based on the fair value of each business group within its original reporting unit relative to the fair value of that reporting unit.
18
INTEL CORPORATION
NOTES TO CONSOLIDATED CONDENSED FINANCIAL STATEMENTS — Unaudited (Continued)
Note 10: Identified Intangible Assets
Identified intangible assets at the end of each period were as follows:
September 27, 2014 | ||||||||||||
(In Millions) | Gross Assets | Accumulated Amortization | Net | |||||||||
Acquisition-related developed technology | $ | 2,873 | $ | (2,094 | ) | $ | 779 | |||||
Acquisition-related customer relationships | 1,670 | (967 | ) | 703 | ||||||||
Acquisition-related trade names | 60 | (47 | ) | 13 | ||||||||
Licensed technology and patents | 3,109 | (1,157 | ) | 1,952 | ||||||||
Identified intangible assets subject to amortization | 7,712 | (4,265 | ) | 3,447 | ||||||||
Acquisition-related trade names | 802 | — | 802 | |||||||||
Other intangible assets | 130 | — | 130 | |||||||||
Identified intangible assets not subject to amortization | 932 | — | 932 | |||||||||
Total identified intangible assets | $ | 8,644 | $ | (4,265 | ) | $ | 4,379 | |||||
December 28, 2013 | ||||||||||||
(In Millions) | Gross Assets | Accumulated Amortization | Net | |||||||||
Acquisition-related developed technology | $ | 2,922 | $ | (1,691 | ) | $ | 1,231 | |||||
Acquisition-related customer relationships | 1,760 | (828 | ) | 932 | ||||||||
Acquisition-related trade names | 65 | (44 | ) | 21 | ||||||||
Licensed technology and patents | 3,093 | (974 | ) | 2,119 | ||||||||
Identified intangible assets subject to amortization | 7,840 | (3,537 | ) | 4,303 | ||||||||
Acquisition-related trade names | 818 | — | 818 | |||||||||
Other intangible assets | 29 | — | 29 | |||||||||
Identified intangible assets not subject to amortization | 847 | — | 847 | |||||||||
Total identified intangible assets | $ | 8,687 | $ | (3,537 | ) | $ | 5,150 | |||||
For identified intangible assets that are subject to amortization, we recorded amortization expense on the consolidated condensed statements of income as follows: amortization of acquisition-related developed technology and licensed technology and patents is included in cost of sales, amortization of acquisition-related customer relationships and trade names is included in amortization of acquisition-related intangibles, and amortization of other intangible assets is recorded as a reduction of revenue.
Amortization expenses for each period were as follows:
Three Months Ended | Nine Months Ended | |||||||||||||||
(In Millions) | Sep 27, 2014 | Sep 28, 2013 | Sep 27, 2014 | Sep 28, 2013 | ||||||||||||
Acquisition-related developed technology | $ | 161 | $ | 150 | $ | 454 | $ | 430 | ||||||||
Acquisition-related customer relationships | 75 | 70 | 214 | 208 | ||||||||||||
Acquisition-related trade names | 2 | 3 | 8 | 8 | ||||||||||||
Licensed technology and patents | 69 | 69 | 208 | 204 | ||||||||||||
Other intangible assets | — | — | — | 103 | ||||||||||||
Total amortization expenses | $ | 307 | $ | 292 | $ | 884 | $ | 953 | ||||||||
19
INTEL CORPORATION
NOTES TO CONSOLIDATED CONDENSED FINANCIAL STATEMENTS — Unaudited (Continued)
Based on identified intangible assets that are subject to amortization as of September 27, 2014, we expect future amortization expenses for each period to be as follows:
(In Millions) | Remainder of 2014 | 2015 | 2016 | 2017 | 2018 | |||||||||||||||
Acquisition-related developed technology | $ | 141 | $ | 300 | $ | 209 | $ | 59 | $ | 37 | ||||||||||
Acquisition-related customer relationships | 63 | 245 | 227 | 137 | 28 | |||||||||||||||
Acquisition-related trade names | 2 | 8 | 3 | — | — | |||||||||||||||
Licensed technology and patents | 67 | 255 | 239 | 202 | 161 | |||||||||||||||
Total future amortization expenses | $ | 273 | $ | 808 | $ | 678 | $ | 398 | $ | 226 | ||||||||||
Note 11: Other Long-Term Assets
Other long-term assets at the end of each period were as follows:
(In Millions) | Sep 27, 2014 | Dec 28, 2013 | ||||||
Equity method investments | $ | 1,491 | $ | 1,038 | ||||
Non-marketable cost method investments | 1,871 | 1,270 | ||||||
Non-current deferred tax assets | 545 | 434 | ||||||
Loans receivable | 362 | 952 | ||||||
Prepayments for property, plant and equipment | 519 | 521 | ||||||
Other | 1,582 | 1,274 | ||||||
Total other long-term assets | $ | 6,370 | $ | 5,489 | ||||
During the first nine months of 2014, we received equipment that was prepaid in 2010 and 2011. Upon receipt of the equipment, we transferred $135 million from other long-term assets to property, plant and equipment. We recognized the prepayments within operating activities in the consolidated condensed statement of cash flows when we paid for the equipment in 2010 and 2011, and the receipt of the equipment is reflected as a non-cash transaction in the current period.
20
INTEL CORPORATION
NOTES TO CONSOLIDATED CONDENSED FINANCIAL STATEMENTS — Unaudited (Continued)
Note 12: Borrowings
Short-Term Debt
Our short-term debt at the end of each period was as follows:
(In Millions) | Sep 27, 2014 | Dec 28, 2013 | ||||||
Drafts payable | $ | 79 | $ | 257 | ||||
Notes payable | — | 24 | ||||||
Current portion of long-term debt | 1,085 | — | ||||||
Short-term debt | $ | 1,164 | $ | 281 | ||||
We have an ongoing authorization from our Board of Directors to borrow up to $3.0 billion, which was fully available for use as of September 27, 2014. This ongoing authorization includes borrowings under our commercial paper program. Maximum borrowings under our commercial paper program were $2.1 billion during the first nine months of 2014 ($300 million during the first nine months of 2013). Our commercial paper was rated A-1+ by Standard & Poor’s and P-1 by Moody’s as of September 27, 2014.
Long-Term Debt
Our long-term debt at the end of each period was as follows:
(In Millions) | Sep 27, 2014 | Dec 28, 2013 | ||||||
2012 Senior notes due 2017 at 1.35% | $ | 2,998 | $ | 2,997 | ||||
2012 Senior notes due 2022 at 2.70% | 1,495 | 1,494 | ||||||
2012 Senior notes due 2032 at 4.00% | 744 | 744 | ||||||
2012 Senior notes due 2042 at 4.25% | 924 | 924 | ||||||
2011 Senior notes due 2016 at 1.95% | 1,499 | 1,499 | ||||||
2011 Senior notes due 2021 at 3.30% | 1,997 | 1,996 | ||||||
2011 Senior notes due 2041 at 4.80% | 1,490 | 1,490 | ||||||
2009 Junior subordinated convertible debentures due 2039 at 3.25% | 1,085 | 1,075 | ||||||
2005 Junior subordinated convertible debentures due 2035 at 2.95% | 956 | 946 | ||||||
Total debt | $ | 13,188 | $ | 13,165 | ||||
Less: current portion of long-term debt | (1,085 | ) | — | |||||
Long-term debt | $ | 12,103 | $ | 13,165 | ||||
Senior Notes
In the fourth quarter of 2012, we issued $6.2 billion aggregate principal amount of senior unsecured notes for general corporate purposes and to repurchase shares of our common stock pursuant to our authorized common stock repurchase program. In the third quarter of 2011, we issued $5.0 billion aggregate principal amount of senior unsecured notes, primarily to repurchase shares of our common stock pursuant to our authorized common stock repurchase program, and for general corporate purposes.
Our senior notes pay a fixed rate of interest semiannually. We may redeem our senior notes, in whole or in part, at any time at our option at specified redemption prices. The senior notes rank equally in right of payment with all of our other existing and future senior unsecured indebtedness and will effectively rank junior to all liabilities of our subsidiaries.
21
INTEL CORPORATION
NOTES TO CONSOLIDATED CONDENSED FINANCIAL STATEMENTS — Unaudited (Continued)
Convertible Debentures
In 2009, we issued $2.0 billion of 2009 debentures. In 2005, we issued $1.6 billion of 2005 debentures. Both the 2009 and 2005 debentures pay a fixed rate of interest semiannually.
2009 Debentures | 2005 Debentures | |||||
Annual coupon interest rate | 3.25 | % | 2.95 | % | ||
Annual effective interest rate | 7.20 | % | 6.45 | % | ||
Maximum amount of contingent interest that will accrue per year | 0.50 | % | 0.40 | % | ||
The effective interest rate is based on the rate for a similar instrument that does not have a conversion feature.
Both the 2009 and 2005 debentures have a contingent interest component that requires us to pay interest based on certain thresholds or for certain events, commencing on August 1, 2019 for the 2009 debentures. As of September 27, 2014 and December 28, 2013, we had not met any of the thresholds or events related to the 2005 debentures. The fair values of the related contingent interest embedded derivatives were $8 million and zero as of September 27, 2014, for the 2009 and 2005 debentures, respectively ($10 million and $9 million as of December 28, 2013 for the 2009 and 2005 debentures, respectively).
Both the 2009 and 2005 debentures are convertible, subject to certain conditions, into shares of our common stock. Holders can surrender the 2009 debentures for conversion if the closing price of Intel common stock has been at least 130% of the conversion price then in effect for at least 20 trading days during the 30 consecutive trading-day period ending on the last trading day of the preceding fiscal quarter. Holders can surrender the 2005 debentures for conversion at any time. We will settle any conversion or repurchase of the 2009 debentures in cash up to the face value, and any amount in excess of face value will be settled in cash or stock at our option. However, we can settle any conversion or repurchase of the 2005 debentures in cash or stock at our option. On or after August 5, 2019, we can redeem, for cash, all or part of the 2009 debentures for the principal amount, plus any accrued and unpaid interest, if the closing price of Intel common stock has been at least 150% of the conversion price then in effect for at least 20 trading days during any 30 consecutive trading-day period prior to the date on which we provide notice of redemption. We can redeem, for cash, all or part of the 2005 debentures for the principal amount, plus any accrued and unpaid interest, if the closing price of Intel common stock has been at least 130% of the conversion price then in effect for at least 20 trading days during any 30 consecutive trading-day period prior to the date on which we provide notice of redemption. If certain events occur in the future, the indentures governing the 2009 and 2005 debentures provide that each holder of the debentures can, for a pre-defined period of time, require us to repurchase the holder’s debentures for the principal amount plus any accrued and unpaid interest. Both the 2009 and 2005 debentures are subordinated in right of payment to any existing and future senior debt and to the other liabilities of our subsidiaries. We have concluded that both the 2009 and 2005 debentures are not conventional convertible debt instruments and that the embedded stock conversion options qualify as derivatives. In addition, we have concluded that the embedded conversion options would be classified in stockholders’ equity if they were freestanding derivative instruments. As such, the embedded conversion options are not accounted for separately as derivatives.
2009 Debentures | 2005 Debentures | |||||||||||||||
(In Millions, Except Per Share Amounts) | Sep 27, 2014 | Dec 28, 2013 | Sep 27, 2014 | Dec 28, 2013 | ||||||||||||
Outstanding principal | $ | 2,000 | $ | 2,000 | $ | 1,600 | $ | 1,600 | ||||||||
Equity component (including temporary equity) carrying amount | $ | 613 | $ | 613 | $ | 466 | $ | 466 | ||||||||
Unamortized discount | $ | 915 | $ | 925 | $ | 644 | $ | 654 | ||||||||
Net debt carrying amount | $ | 1,085 | $ | 1,075 | $ | 956 | $ | 946 | ||||||||
Conversion rate (shares of common stock per $1,000 principal amount of debentures) | 46.06 | 45.57 | 34.95 | 34.60 | ||||||||||||
Effective conversion price (per share of common stock) | $ | 21.71 | $ | 21.94 | $ | 28.61 | $ | 28.90 | ||||||||
In the preceding table, the remaining amortization periods for the unamortized discounts for the 2009 and 2005 debentures are approximately 25 and 21 years, respectively, as of September 27, 2014.
22
INTEL CORPORATION
NOTES TO CONSOLIDATED CONDENSED FINANCIAL STATEMENTS — Unaudited (Continued)
The conversion rate adjusts for certain events outlined in the indentures governing the 2009 and 2005 debentures, such as quarterly dividend distributions in excess of $0.14 and $0.10 per share for the 2009 and 2005 debentures, respectively, but it does not adjust for accrued interest. In addition, the conversion rate will increase for a holder of either the 2009 or 2005 debentures who elects to convert the debentures in connection with certain share exchanges, mergers, or consolidations involving Intel.
During the third quarter of 2014, the closing stock price conversion right condition of the 2009 debentures was met and the debentures will be convertible at the option of the holders during the fourth quarter of 2014. As a result of the conversion period during the fourth quarter of 2014, the $1.1 billion carrying amount of the 2009 debentures was reclassified from long-term debt to short-term debt on our consolidated condensed balance sheets as of September 27, 2014. The excess of the amount of cash payable if converted over the carrying amount of the 2009 debentures of $915 million was reclassified from stockholders’ equity to temporary equity on our consolidated condensed balance sheets as of September 27, 2014. In future periods, if the closing stock price conversion right condition is no longer met, all outstanding 2009 debentures would be reclassified to long-term debt and the temporary equity would be reclassified to stockholders’ equity on our consolidated condensed balance sheets. The 2009 debentures were not convertible for the fourth quarter of 2013, therefore the liability and equity components of the 2009 debentures were classified as long-term debt and stockholders’ equity, respectively, as of December 28, 2013.
Note 13: Restructuring and Asset Impairment Charges
Beginning in the third quarter of 2013, management has approved several restructuring actions including targeted workforce reductions and the exit of certain businesses and facilities. These actions include the wind down of our 200 millimeter wafer fabrication facility in Massachusetts and the closure of our assembly and test facility in Costa Rica, which we expect to cease production in the first quarter of 2015 and the end of 2014, respectively. These targeted reductions will enable the company to better align our resources in areas providing the greatest benefit in the current business environment.
Restructuring and asset impairment charges for each period were as follows:
Three Months Ended | Nine Months Ended | |||||||||||||||
(In Millions) | Sep 27, 2014 | Sep 28, 2013 | Sep 27, 2014 | Sep 28, 2013 | ||||||||||||
Employee severance and benefit arrangements | $ | 9 | $ | 85 | $ | 218 | $ | 85 | ||||||||
Asset impairments and other restructuring charges | 11 | 39 | 20 | 39 | ||||||||||||
Total restructuring and asset impairment charges | $ | 20 | $ | 124 | $ | 238 | $ | 124 | ||||||||
The restructuring and asset impairment activity for first nine months of 2014 was as follows:
(In Millions) | Employee Severance and Benefits | Asset Impairments and Other | Total | |||||||||
Accrued restructuring balance as of December 28, 2013 | $ | 183 | $ | — | $ | 183 | ||||||
Additional accruals | 203 | 19 | 222 | |||||||||
Adjustments | 15 | 1 | 16 | |||||||||
Cash payments | (283 | ) | (3 | ) | (286 | ) | ||||||
Non-cash settlements | — | (9 | ) | (9 | ) | |||||||
Accrued restructuring balance as of September 27, 2014 | $ | 118 | $ | 8 | $ | 126 | ||||||
We recorded the additional accruals and adjustments as restructuring and asset impairment charges in the consolidated condensed statements of income and within the “all other” operating segments category. The charges incurred during the first nine months of 2014 included $218 million related to employee severance and benefit arrangements, which impacted approximately 2,800 employees. In the second quarter of 2014, we had estimated that 3,500 employees would be impacted by restructuring actions, but such number has decreased to 2,800 employees, mainly driven by the internal placement of previously impacted employees and the cancellation of prior quarter actions. Most of the accrued restructuring balance as of September 27, 2014 relates to employee severance and benefits, which are expected to be paid within the next 12 months, and was recorded as a current liability within accrued compensation and benefits in the consolidated condensed balance sheets.
23
INTEL CORPORATION
NOTES TO CONSOLIDATED CONDENSED FINANCIAL STATEMENTS — Unaudited (Continued)
Since the third quarter of 2013, we have incurred a total of $478 million in restructuring and asset impairment charges. These charges included a total of $419 million related to employee severance and benefit arrangements for approximately 6,700 employees, and $59 million in asset impairment and other restructuring charges.
Note 14: Deferred Income
Deferred income at the end of each period was as follows:
(In Millions) | Sep 27, 2014 | Dec 28, 2013 | ||||||
Deferred income on shipments of components to distributors | $ | 992 | $ | 852 | ||||
Deferred income from software and services | 1,197 | 1,244 | ||||||
Current deferred income | 2,189 | 2,096 | ||||||
Non-current deferred income from software and services | 452 | 506 | ||||||
Total deferred income | $ | 2,641 | $ | 2,602 | ||||
We classify non-current deferred income from the software and services in other long-term liabilities.
Note 15: Retirement Benefit Plans
During the second quarter of 2014, we communicated to employees our intent, beginning on January 1, 2015, to freeze future benefit accruals in the U.S. Intel Minimum Pension Plan to all employees at or above a specific grade level, and generally covering all highly compensated employees in the plan. This change was contingent on receiving a favorable private letter ruling (PLR) from the Internal Revenue Service (IRS), which we filed for in January 2014. The third quarter 2014 consolidated condensed financial statements do not include any adjustments for this transaction due to the uncertainties regarding the ruling request with the IRS. A favorable PLR was received in October 2014 and we do not expect that the anticipated change will have a significant impact on our fourth quarter 2014 consolidated financial statements.
Note 16: Employee Equity Incentive Plans
Our equity incentive plans are broad-based, long-term programs intended to attract and retain talented employees and align stockholder and employee interests.
Under the 2006 Equity Incentive Plan (the 2006 Plan), 719 million shares of common stock are available for issuance as equity awards to employees and non-employee directors through June 2016. A maximum of 517 million of these shares of common stock can be granted as restricted stock or restricted stock units. As of September 27, 2014, 260 million shares of common stock remained available for future grant under the 2006 Plan.
The 2006 Stock Purchase Plan allows eligible employees to purchase shares of our common stock at 85% of the value of our common stock on specific dates. Rights to purchase shares of common stock are granted during the first and third quarters of each year. Under the 2006 Stock Purchase Plan, stockholders made 373 million shares of common stock available for issuance through August 2016. As of September 27, 2014, 197 million shares of common stock were available for issuance under the 2006 Stock Purchase Plan.
Share-Based Compensation
We recognized $281 million of share-based compensation in the third quarter of 2014 and $867 million for the first nine months of 2014 ($268 million in the third quarter of 2013 and $855 million for the first nine months of 2013).
24
INTEL CORPORATION
NOTES TO CONSOLIDATED CONDENSED FINANCIAL STATEMENTS — Unaudited (Continued)
We estimate the fair value of restricted stock unit awards with time-based vesting using the value of our common stock on the date of grant, reduced by the present value of dividends expected to be paid on our common stock prior to vesting. We estimate the fair value of market-based restricted stock units using a Monte Carlo simulation model on the date of grant. We based the weighted average estimated value of restricted stock unit grants, as well as the weighted average assumptions that we used in calculating the fair value, on estimates at the date of grant, for each period as follows:
Three Months Ended | Nine Months Ended | |||||||||||||||
Sep 27, 2014 | Sep 28, 2013 | Sep 27, 2014 | Sep 28, 2013 | |||||||||||||
Estimated values | $ | 32.93 | $ | 21.20 | $ | 25.12 | $ | 21.43 | ||||||||
Risk-free interest rate | 0.5 | % | 0.3 | % | 0.5 | % | 0.2 | % | ||||||||
Dividend yield | 2.6 | % | 3.9 | % | 3.4 | % | 3.8 | % | ||||||||
Volatility | 23 | % | 24 | % | 23 | % | 25 | % | ||||||||
We use the Black-Scholes option pricing model to estimate the fair value of options granted under our equity incentive plans and rights to acquire stock granted under our stock purchase plan. We based the weighted average estimated value of employee stock option grants and rights granted under the stock purchase plan, as well as the weighted average assumptions used in calculating the fair value, on estimates at the date of grant, for each period as follows (no options were granted during the third of quarter of 2014):
Stock Options | Stock Purchase Plan | |||||||||||||||||||||||||||||
Three Months Ended | Nine Months Ended | Three Months Ended | Nine Months Ended | |||||||||||||||||||||||||||
Sep 27, 2014 | Sep 28, 2013 | Sep 27, 2014 | Sep 28, 2013 | Sep 27, 2014 | Sep 28, 2013 | Sep 27, 2014 | Sep 28, 2013 | |||||||||||||||||||||||
Estimated values | n/a | $ | 3.25 | $ | 3.61 | $ | 3.11 | $ | 6.99 | $ | 4.74 | $ | 5.87 | $ | 4.52 | |||||||||||||||
Expected life (in years) | n/a | 5.2 | 5.1 | 5.2 | 0.5 | 0.5 | 0.5 | 0.5 | ||||||||||||||||||||||
Risk-free interest rate | n/a | 1.5 | % | 1.7 | % | 0.8 | % | 0.1 | % | 0.1 | % | 0.1 | % | 0.1 | % | |||||||||||||||
Dividend yield | n/a | 3.9 | % | 3.6 | % | 3.9 | % | 2.6 | % | 3.9 | % | 3.2 | % | 4.0 | % | |||||||||||||||
Volatility | n/a | 24 | % | 23 | % | 25 | % | 22 | % | 22 | % | 22 | % | 22 | % | |||||||||||||||
Restricted Stock Unit Awards
Information with respect to outstanding restricted stock unit (RSU) activity in the first nine months of 2014 was as follows:
Number of RSUs (In Millions) | Weighted Average Grant-Date Fair Value | ||||||
December 28, 2013 | 113.3 | $ | 22.47 | ||||
Granted | 54.0 | $ | 25.12 | ||||
Vested | (40.8 | ) | $ | 22.34 | |||
Forfeited | (7.1 | ) | $ | 22.79 | |||
September 27, 2014 | 119.4 | $ | 23.69 | ||||
The aggregate fair value of awards that vested in the first nine months of 2014 was $1.1 billion, which represents the market value of our common stock on the date that the restricted stock units vested. The grant-date fair value of awards that vested in first nine months of 2014 was $911 million. The number of restricted stock units vested includes shares of common stock that we withheld on behalf of employees to satisfy the minimum statutory tax withholding requirements. Restricted stock units that are expected to vest are net of estimated future forfeitures.
As of September 27, 2014, 3.8 million of the outstanding restricted stock units were market-based restricted stock units.
25
INTEL CORPORATION
NOTES TO CONSOLIDATED CONDENSED FINANCIAL STATEMENTS — Unaudited (Continued)
Stock Option Awards
Information with respect to outstanding stock option activity in the first nine months of 2014 was as follows:
Number of Options (In Millions) | Weighted Average Exercise Price | ||||||
December 28, 2013 | 153.0 | $ | 21.10 | ||||
Granted | 0.6 | $ | 25.34 | ||||
Exercised | (59.1 | ) | $ | 19.87 | |||
Cancelled and forfeited | (2.6 | ) | $ | 23.70 | |||
Expired | (9.8 | ) | $ | 27.03 | |||
September 27, 2014 | 82.1 | $ | 21.23 | ||||
Options exercisable as of: | |||||||
December 28, 2013 | 111.5 | $ | 20.25 | ||||
September 27, 2014 | 58.8 | $ | 20.24 | ||||
During the first nine months of 2014, the aggregate intrinsic value of stock option exercises was $541 million, which represents the difference between the exercise price and the value of our common stock at the time of exercise.
Stock Purchase Plan
Employees purchased 19.4 million shares of common stock in the first nine months of 2014 for $393 million (20.5 million shares of common stock in the first nine months of 2013 for $369 million) under the 2006 Stock Purchase Plan.
Note 17: Common Stock Repurchases
Common Stock Repurchase Program
We have an ongoing authorization, originally approved by our Board of Directors in 2005, and subsequently amended, to repurchase up to $65 billion in shares of our common stock in open market or negotiated transactions. This amount includes an increase of $20 billion in the authorization limit approved by our Board of Directors in July 2014. As of September 27, 2014, $16.4 billion remained available for repurchase under the existing repurchase authorization limit.
During the third quarter of 2014, we repurchased 119.5 million shares of common stock at a cost of $4.1 billion (23.6 million shares of common stock at a cost of $536 million during the third quarter of 2013). During the first nine months of 2014, we repurchased 217.4 million shares of common stock at a cost of $6.8 billion (72.1 million shares of common stock at a cost of $1.6 billion in the first nine months of 2013). We have repurchased 4.6 billion shares of common stock at a cost of $98 billion since the program began in 1990.
Restricted Stock Unit Withholdings
We issue restricted stock units as part of our equity incentive plans. For the majority of restricted stock units granted, the number of shares of common stock issued on the date the restricted stock units vest is net of the minimum statutory withholding requirements that we pay in cash to the appropriate taxing authorities on behalf of our employees. In our consolidated condensed financial statements, we also treat shares of common stock withheld for tax purposes on behalf of our employees in connection with the vesting of restricted stock units as common stock repurchases because they reduce the number of shares that would have been issued upon vesting. These withheld shares of common stock are not considered common stock repurchases under our authorized common stock repurchase plan. During the first nine months of 2014, we withheld 11.7 million shares of common stock to satisfy $314 million (12.6 million shares of common stock to satisfy $280 million during the first nine months of 2013) of employees’ tax obligations.
26
INTEL CORPORATION
NOTES TO CONSOLIDATED CONDENSED FINANCIAL STATEMENTS — Unaudited (Continued)
Note 18: Gains (Losses) on Equity Investments, Net
The components of gains (losses) on equity investments, net for each period were as follows:
Three Months Ended | Nine Months Ended | |||||||||||||||
(In Millions) | Sep 27, 2014 | Sep 28, 2013 | Sep 27, 2014 | Sep 28, 2013 | ||||||||||||
Share of equity method investee losses, net | $ | (17 | ) | $ | (14 | ) | $ | (42 | ) | $ | (56 | ) | ||||
Impairment charges | (33 | ) | (33 | ) | (108 | ) | (110 | ) | ||||||||
Gains on sales, net | — | 472 | 147 | 486 | ||||||||||||
Dividends | 1 | 1 | 54 | 46 | ||||||||||||
Other, net | 84 | 26 | 127 | 71 | ||||||||||||
Total gains (losses) on equity investments, net | $ | 35 | $ | 452 | $ | 178 | $ | 437 | ||||||||
During the third quarter of 2013, we sold our shares in Clearwire Corporation, which had been accounted for as available-for-sale marketable equity securities, and our interest in Clearwire Communications, LLC (Clearwire LLC), which had been accounted for as an equity method investment. We received proceeds of $142 million on the sale of our shares in Clearwire Corporation and $328 million on the sale of our interest in Clearwire LLC. The proceeds received on the sale of our shares in Clearwire Corporation and our interest in Clearwire LLC are included in "sales of available-for-sale investments" and "other investing", respectively, within investing activities on the consolidated condensed statements of cash flows. During the third quarter of 2013, we recognized gains of $111 million on the sale of our shares in Clearwire Corporation and $328 million on the sale of our interest in Clearwire LLC. The total gain of $439 million on these transactions is included in "gains (losses) on equity investments, net" on the consolidated condensed statements of income.
Note 19: Interest and Other, Net
The components of interest and other, net for each period were as follows:
Three Months Ended | Nine Months Ended | |||||||||||||||
(In Millions) | Sep 27, 2014 | Sep 28, 2013 | Sep 27, 2014 | Sep 28, 2013 | ||||||||||||
Interest income | $ | 35 | $ | 24 | $ | 108 | $ | 73 | ||||||||
Interest expense | (53 | ) | (56 | ) | (139 | ) | (189 | ) | ||||||||
Other, net | (7 | ) | — | 101 | (3 | ) | ||||||||||
Total interest and other, net | $ | (25 | ) | $ | (32 | ) | $ | 70 | $ | (119 | ) | |||||
Interest expense in the preceding table is net of $63 million of interest capitalized in the third quarter of 2014 and $203 million of interest capitalized in the first nine months of 2014 ($55 million in the third quarter of 2013 and $176 million in the first nine months of 2013).
During the first quarter of 2014, we completed the divestiture of our Intel Media assets. As a result of the transaction, we recognized a gain within "other, net" in the preceding table. For further information, see "Note 8: Divestitures."
27
INTEL CORPORATION
NOTES TO CONSOLIDATED CONDENSED FINANCIAL STATEMENTS — Unaudited (Continued)
Note 20: Earnings Per Share
We computed our basic and diluted earnings per common share for each period as follows:
Three Months Ended | Nine Months Ended | |||||||||||||||
(In Millions, Except Per Share Amounts) | Sep 27, 2014 | Sep 28, 2013 | Sep 27, 2014 | Sep 28, 2013 | ||||||||||||
Net income available to common stockholders | $ | 3,317 | $ | 2,950 | $ | 8,043 | $ | 6,995 | ||||||||
Weighted average common shares outstanding—basic | 4,880 | 4,981 | 4,945 | 4,969 | ||||||||||||
Dilutive effect of employee equity incentive plans | 76 | 60 | 73 | 68 | ||||||||||||
Dilutive effect of convertible debt | 89 | 59 | 77 | 58 | ||||||||||||
Weighted average common shares outstanding—diluted | 5,045 | 5,100 | 5,095 | 5,095 | ||||||||||||
Basic earnings per common share | $ | 0.68 | $ | 0.59 | $ | 1.63 | $ | 1.41 | ||||||||
Diluted earnings per common share | $ | 0.66 | $ | 0.58 | $ | 1.58 | $ | 1.37 | ||||||||
We computed basic earnings per common share using net income available to common stockholders and the weighted average number of common shares outstanding during the period. We computed diluted earnings per common share using net income available to common stockholders and the weighted average number of common shares outstanding plus potentially dilutive common shares outstanding during the period. Net income available to participating securities was insignificant for all periods presented.
Potentially dilutive common shares from employee incentive plans are determined by applying the treasury stock method to the assumed exercise of outstanding stock options, the assumed vesting of outstanding restricted stock units, and the assumed issuance of common stock under the stock purchase plan. Potentially dilutive common shares are determined by applying the if-converted method for our 2005 debentures. However, as our 2009 debentures require settlement of the principal amount of the debt in cash upon conversion, with the conversion premium paid in cash or stock at our option, potentially dilutive common shares are determined by applying the treasury stock method.
During the third quarter of 2014, no outstanding stock options and restricted stock units were excluded from the computation of diluted earnings per common share (56 million were excluded for the third quarter of 2013 because these shares would have been antidilutive). During the first nine months of 2014, we excluded on average 14 million outstanding stock options and restricted stock units from the computation of diluted earnings per common share because these would have been antidilutive (56 million for the first nine months of 2013). These options could potentially be included in the diluted earnings per common share calculation in the future if the average market value of the common shares increases and is greater than the exercise price of these options.
In the third quarter of 2014 and 2013, we included our 2009 debentures in the calculation of diluted earnings per common share because the average market price was above the conversion price. We could potentially exclude the 2009 debentures in the future if the average market price is below the conversion price.
28
INTEL CORPORATION
NOTES TO CONSOLIDATED CONDENSED FINANCIAL STATEMENTS — Unaudited (Continued)
Note 21: Other Comprehensive Income (Loss)
The changes in accumulated other comprehensive income (loss) by component and related tax effects in the first nine months of 2014 were as follows:
(In Millions) | Unrealized Holding Gains (Losses) on Available-for-Sale Investments | Deferred Tax Asset Valuation Allowance | Unrealized Holding Gains (Losses) on Derivatives | Prior Service Credits (Costs) | Actuarial Gains (Losses) | Foreign Currency Translation Adjustment | Total | |||||||||||||||||||||
December 28, 2013 | $ | 1,882 | $ | 67 | $ | 4 | $ | (14 | ) | $ | (602 | ) | $ | (94 | ) | $ | 1,243 | |||||||||||
Other comprehensive income before reclassifications | 469 | — | (204 | ) | (49 | ) | (248 | ) | (140 | ) | (172 | ) | ||||||||||||||||
Amounts reclassified out of accumulated other comprehensive income (loss) | (139 | ) | — | (21 | ) | 4 | 29 | — | (127 | ) | ||||||||||||||||||
Tax effects | (113 | ) | (30 | ) | 52 | 4 | 76 | 13 | 2 | |||||||||||||||||||
Other comprehensive income (loss) | 217 | (30 | ) | (173 | ) | (41 | ) | (143 | ) | (127 | ) | (297 | ) | |||||||||||||||
September 27, 2014 | $ | 2,099 | $ | 37 | $ | (169 | ) | $ | (55 | ) | $ | (745 | ) | $ | (221 | ) | $ | 946 | ||||||||||
The amounts reclassified out of accumulated other comprehensive income (loss) into the consolidated condensed statements of income, with presentation location, for each period were as follows:
Income Before Taxes Impact (In Millions) | ||||||||||||||||||
Three Months Ended | Nine Months Ended | |||||||||||||||||
Comprehensive Income Components | Sep 27, 2014 | Sep 28, 2013 | Sep 27, 2014 | Sep 28, 2013 | Location | |||||||||||||
Unrealized holding gains (losses) on available-for-sale investments: | ||||||||||||||||||
$ | 9 | $ | — | $ | 7 | $ | 3 | Interest and other, net | ||||||||||
9 | 130 | 132 | 139 | Gains (losses) on equity investments, net | ||||||||||||||
18 | 130 | 139 | 142 | |||||||||||||||
Unrealized holding gains (losses) on derivatives: | ||||||||||||||||||
Currency forwards | (5 | ) | (19 | ) | (10 | ) | (47 | ) | Cost of sales | |||||||||
8 | 7 | 26 | 15 | Research and development | ||||||||||||||
2 | (2 | ) | 7 | (6 | ) | Marketing, general and administrative | ||||||||||||
Other instruments | (2 | ) | — | (2 | ) | 1 | Cost of sales | |||||||||||
3 | (14 | ) | 21 | (37 | ) | |||||||||||||
Amortization of pension and postretirement benefit components: | ||||||||||||||||||
Prior service credits (costs) | (2 | ) | (2 | ) | (4 | ) | (4 | ) | ||||||||||
Actuarial gains (losses) | (10 | ) | (26 | ) | (29 | ) | (77 | ) | ||||||||||
(12 | ) | (28 | ) | (33 | ) | (81 | ) | |||||||||||
Total amounts reclassified out of accumulated other comprehensive income (loss) | $ | 9 | $ | 88 | $ | 127 | $ | 24 | ||||||||||
The amortization of pension and postretirement benefit components are included in the computation of net periodic benefit cost. For further information, see the "Retirement Benefit Plans" note in Part II, Item 8 of our Annual Report on Form 10-K for the year ended December 28, 2013.
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INTEL CORPORATION
NOTES TO CONSOLIDATED CONDENSED FINANCIAL STATEMENTS — Unaudited (Continued)
We estimate that we will reclassify approximately $154 million (before taxes) of net derivative losses included in accumulated other comprehensive income (loss) into earnings within the next 12 months.
Note 22: Contingencies
Legal Proceedings
We are a party to various legal proceedings, including those noted in this section. Although management at present believes that the ultimate outcome of these proceedings, individually and in the aggregate, will not materially harm our financial position, results of operations, cash flows, or overall trends, legal proceedings and related government investigations are subject to inherent uncertainties, and unfavorable rulings or other events could occur. Unfavorable resolutions could include substantial monetary damages. In addition, in matters for which injunctive relief or other conduct remedies are sought, unfavorable resolutions could include an injunction or other order prohibiting us from selling one or more products at all or in particular ways, precluding particular business practices, or requiring other remedies. An unfavorable outcome may result in a material adverse impact on our business, results of operations, financial position, and overall trends. We might also conclude that settling one or more such matters is in the best interests of our stockholders, employees, and customers, and any such settlement could include substantial payments. Except as specifically described below, we have not concluded that settlement of any of the legal proceedings noted in this section is appropriate at this time.
A number of proceedings generally have challenged and continue to challenge certain of our competitive practices. The allegations in these proceedings vary and are described in more detail in the following paragraphs. In general, they contend that we improperly conditioned price rebates and other discounts on our microprocessors on exclusive or near-exclusive dealing by some of our customers; and they allege that our software compiler business unfairly preferred Intel® microprocessors over competing microprocessors and that, through the use of our compilers and other means, we have caused the dissemination of inaccurate and misleading benchmark results concerning our microprocessors. Based on the procedural posture of the various remaining competition matters, which we describe in subsequent paragraphs, our investment of resources to explain and defend our position has declined as compared to the period 2005-2011. Nonetheless, certain of the matters remain active, and these challenges could continue for a number of years, potentially requiring us to invest additional resources. We believe that we compete lawfully and that our marketing, business, intellectual property, and other challenged practices benefit our customers and our stockholders, and we will continue to conduct a vigorous defense in the remaining proceedings.
Government Competition Matters and Related Consumer Class Actions
In 2001, the European Commission (EC) commenced an investigation regarding claims by Advanced Micro Devices, Inc. (AMD) that we used unfair business practices to persuade customers to buy our microprocessors. We received numerous requests for information and documents from the EC and we responded to each of those requests. The EC issued a Statement of Objections in July 2007 and held a hearing on that Statement in March 2008. The EC issued a Supplemental Statement of Objections in July 2008.
In May 2009, the EC issued a decision finding that we had violated Article 82 of the EC Treaty and Article 54 of the European Economic Area Agreement. In general, the EC found that we violated Article 82 (later renumbered as Article 102 by a new treaty) by offering alleged “conditional rebates and payments” that required our customers to purchase all or most of their x86 microprocessors from us. The EC also found that we violated Article 82 by making alleged “payments to prevent sales of specific rival products.” The EC imposed a fine in the amount of €1.06 billion ($1.447 billion as of May 2009), which we subsequently paid during the third quarter of 2009, and ordered us to “immediately bring to an end the infringement referred to in” the EC decision. The EC decision contained no specific direction on whether or how we should modify our business practices. Instead, the decision stated that we should “cease and desist” from further conduct that, in the EC's opinion, would violate applicable law. We took steps, which are subject to the EC's ongoing review, to comply with that decision pending appeal. We had discussions with the EC to better understand the decision and to explain changes to our business practices.
We appealed the EC decision to the Court of First Instance (which has been renamed the General Court) in July 2009. The hearing of our appeal took place in July 2012. In June 2014, the General Court rejected our appeal in its entirety. In August 2014, we filed an appeal with the European Court of Justice.
30
INTEL CORPORATION
NOTES TO CONSOLIDATED CONDENSED FINANCIAL STATEMENTS — Unaudited (Continued)
At least 82 separate class-action lawsuits have been filed in the U.S. District Courts for the Northern District of California, Southern District of California, District of Idaho, District of Nebraska, District of New Mexico, District of Maine, and District of Delaware, as well as in various California, Kansas, and Tennessee state courts. These actions generally repeat the allegations made in a now-settled lawsuit filed against us by AMD in June 2005 in the U.S. District Court for the District of Delaware (AMD litigation). Like the AMD litigation, these class-action lawsuits allege that we engaged in various actions in violation of the Sherman Act and other laws by, among other things: providing discounts and rebates to our manufacturer and distributor customers conditioned on exclusive or near-exclusive dealing that allegedly unfairly interfered with AMD's ability to sell its microprocessors; interfering with certain AMD product launches; and interfering with AMD's participation in certain industry standards-setting groups. The class actions allege various consumer injuries, including that consumers in various states have been injured by paying higher prices for computers containing our microprocessors. We dispute these class-action claims and intend to defend the lawsuits vigorously.
All of the federal and state class actions other than the California class actions were transferred by the Multidistrict Litigation Panel to the U.S. District Court in Delaware for all pre-trial proceedings and discovery (MDL proceedings). The Delaware district court appointed a Special Master to address issues in the MDL proceedings, as assigned by the court. In January 2010, the plaintiffs in the Delaware action filed a motion for sanctions for our alleged failure to preserve evidence. This motion largely copies a motion previously filed by AMD in the AMD litigation, which has settled. The plaintiffs in the MDL proceedings also moved for certification of a class of members who purchased certain personal computers containing products sold by us. In July 2010, the Special Master issued a Report and Recommendation (Report) denying the motion to certify a class. The MDL plaintiffs filed objections to the Special Master's Report, and a hearing on those objections was held before the district court in July 2013. In July 2014, the district court affirmed the Special Master's ruling and issued an order denying the MDL plaintiffs' motion for class certification. In August 2014, plaintiffs filed a request for interlocutory appeal of the district court's decision with the U.S. Court of Appeals for the Third Circuit.
All California class actions have been consolidated in the Superior Court of California in Santa Clara County. The plaintiffs in the California actions have moved for class certification, which we are in the process of opposing. At our request, the court in the California actions agreed to delay ruling on this motion until after the Delaware district court ruled on the similar motion in the MDL proceedings. Given the procedural posture and the nature of these cases, including the fact that the Delaware district court's decision has been appealed, we are unable to make a reasonable estimate of the potential loss or range of losses, if any, arising from these matters.
In re High Tech Employee Antitrust Litigation
Between May and July 2011, former employees of Intel, Adobe Systems Incorporated, Apple Inc., Google Inc., Intuit Inc., Lucasfilm Ltd., and Pixar filed antitrust class action lawsuits in the California Superior Courts alleging that these companies had entered into a conspiracy to suppress the compensation of their employees. The lawsuits were removed to the United States District Court for the Northern District of California, and in September 2011 the plaintiffs filed a consolidated amended complaint, captioned In re High Tech Employee Antitrust Litigation. The plaintiffs’ allegations reference the 2009 and 2010 investigation by the Department of Justice (DOJ) into employment practices in the technology industry, as well as the DOJ’s complaints and subsequent stipulated final judgments with the seven companies named as defendants in the lawsuits. The plaintiffs allege that the defendants entered into certain unlawful agreements not to cold call employees of particular other defendants and that there was an overarching conspiracy among the defendants. Plaintiffs assert one such agreement specific to Intel, namely that Intel and Google entered into an agreement starting in 2005, not to cold call each other's employees. Plaintiffs assert claims under Section 1 of the Sherman Antitrust Act and Section 4 of the Clayton Antitrust Act and seek a declaration that the defendants’ alleged actions violated the antitrust laws, damages trebled as provided for by law under the Sherman Act or Clayton Act, restitution and disgorgement, and attorneys’ fees and costs.
In October 2013, the district court certified a class consisting of approximately 65,000 current or former employees of the seven defendants and set the matter for trial in late May 2014. The so-called “technical class” consists of a group of current and former technical, creative, and research and development employees at each of the defendants. In January 2014, Intel filed a motion for summary judgment, which the court denied in March 2014.
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INTEL CORPORATION
NOTES TO CONSOLIDATED CONDENSED FINANCIAL STATEMENTS — Unaudited (Continued)
In April 2014, Intel, Adobe, Apple, and Google reached an agreement with plaintiffs to settle this lawsuit, which is subject to court approval. In August 2014, the district court denied preliminary approval of the settlement. In September 2014, defendants filed a petition for writ of mandamus asking the U.S. Court of Appeals for the Ninth Circuit to reverse the district court’s decision. The Ninth Circuit has ordered briefing and will schedule a hearing date on the writ petition. We continue to dispute the plaintiffs’ claims, but agreed to settle this lawsuit to avoid the uncertainties, expenses, and diversion of resources from continued litigation. Our operating expenses for the first quarter of 2014 reflect an accrual for this proceeding and we believe reasonably possible losses in excess of the accrual amount are not material to our financial statements.
In re Intel Corporation Shareholder Derivative Litigation
In March 2014, the Police Retirement System of St. Louis filed a stockholder derivative action in the Superior Court of California in Santa Clara County against the members of our Board of Directors, certain former Board members, and a current officer. The complaint alleges that the defendants breached their duties to the company by participating in, or allowing, alleged antitrust violations, as described in the In re High Tech Employee Antitrust Litigation. In March 2014, a second plaintiff, Barbara Templeton, filed a substantially similar derivative suit in the same court. In May 2014, a third shareholder, Robert Achermann, filed a substantially similar derivative action in the same court. The court consolidated the three actions into one, which is captioned In re Intel Corporation Shareholder Derivative Litigation. Plaintiffs filed a consolidated complaint in July 2014. In August 2014, we moved to dismiss the consolidated complaint. The court granted our motion in September 2014, but granted plaintiffs leave to amend their complaint.
Lehman Brothers Holdings Inc. and Lehman Brothers OTC Derivatives Inc. v. Intel
In May 2013, Lehman Brothers OTC Derivatives Inc. (LOTC) and Lehman Brothers Holdings Inc. (LBHI) filed an adversary complaint in the United States Bankruptcy Court in the Southern District of New York asserting claims against us arising from a 2008 contract between Intel and LOTC. Under the terms of the 2008 contract, we prepaid $1.0 billion to LOTC, in exchange for which LOTC was required to deliver to us on or before September 29, 2008, quantities of Intel common stock and cash determined by a formula set forth in the contract. LOTC's performance under the contract was secured by $1.0 billion of cash collateral. Under the terms of the contract, LOTC was obligated to deliver approximately 50 million shares of our common stock to us on September 29, 2008. LOTC failed to deliver any Intel common stock or cash, and we exercised our right of set-off against the $1.0 billion collateral. LOTC and LBHI acknowledge in their complaint that we were entitled to set off our losses against the collateral, but they assert that we withheld collateral in excess of our losses that should have been returned to LOTC. The complaint asserts a claim for breach of contract, a claim for “turnover” under section 542(a) of the Bankruptcy Code, and a claim for violation of the automatic stay under section 362(a)(3) of the Bankruptcy Code. The complaint does not expressly quantify the amount of damages claimed but does assert multiple theories of damages that impliedly seek up to $312 million of alleged excess collateral, plus interest based on LOTC's claimed cost of borrowing. In June 2013, we filed a motion to dismiss plaintiffs' bankruptcy claims and for a determination that the breach of contract claim is “non-core” under the Bankruptcy Code. The bankruptcy court granted our motion in its entirety in December 2013. In May 2014, the United States District Court for the Southern District of New York denied our request that it withdraw its reference of plaintiff's adversary complaint to the bankruptcy court. Given the procedural posture and the nature of this case, including that discovery is still in process, we are unable to make a reasonable estimate of the potential loss or range of losses, if any, that might arise from this matter. We believe that we acted in a manner consistent with our contractual rights, and we intend to defend against any claim to the contrary.
McAfee, Inc. Shareholder Litigation
On August 19, 2010, we announced that we had agreed to acquire all of the common stock of McAfee, Inc. (McAfee) for $48.00 per share. Four McAfee shareholders filed putative class-action lawsuits in Santa Clara County, California Superior Court challenging the proposed transaction. The cases were ordered consolidated in September 2010. Plaintiffs filed an amended complaint that named former McAfee board members, McAfee and Intel as defendants, and alleged that the McAfee board members breached their fiduciary duties and that McAfee and Intel aided and abetted those breaches of duty. The complaint requested rescission of the merger agreement, such other equitable relief as the court may deem proper, and an award of damages in an unspecified amount. In June 2012, the plaintiffs’ damages expert asserted that the value of a McAfee share for the purposes of assessing damages should be $62.08.
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INTEL CORPORATION
NOTES TO CONSOLIDATED CONDENSED FINANCIAL STATEMENTS — Unaudited (Continued)
In January 2012, the court certified the action as a class action, appointed the Central Pension Laborers’ Fund to act as the class representative, and scheduled trial to begin in January 2013. In March 2012, defendants filed a petition with the California Court of Appeal for a writ of mandate to reverse the class certification order; the petition was denied in June 2012. In March 2012, at defendants’ request, the court held that plaintiffs were not entitled to a jury trial, and ordered a bench trial. In April 2012, plaintiffs filed a petition with the California Court of Appeal for a writ of mandate to reverse that order, which the court of appeal denied in July 2012. In August 2012, defendants filed a motion for summary judgment. The trial court granted that motion in November 2012, and entered final judgment in the case in February 2013. In April 2013, plaintiffs filed a notice of appeal. Because the resolution of the appeal may materially impact the scope and nature of the proceeding, we are unable to make a reasonable estimate of the potential loss or range of losses, if any, arising from this matter. We dispute the class-action claims and intend to continue to defend the lawsuit vigorously.
X2Y Attenuators, LLC v. Intel et al
In May 2011, X2Y Attenuators, LLC (X2Y) filed a patent infringement lawsuit in the U.S. District Court for the Western District of Pennsylvania and a complaint with the U.S. International Trade Commission (ITC) pursuant to Section 337 of the Tariff Act of 1930 against us and two of our customers, Apple and Hewlett-Packard Company, alleging infringement of five patents. X2Y subsequently added a sixth patent to both actions. The district court action was stayed pending resolution of the ITC proceeding. X2Y alleged that at least Intel® Core™ and Intel® Xeon® processor families infringe the asserted patents. X2Y also requested that the ITC issue permanent exclusion and cease-and-desist orders to, among other things, prohibit us from importing these microprocessors and Apple and Hewlett-Packard Company products that incorporate these microprocessors into the United States. In the stayed district court action, X2Y seeks unspecified damages, including enhanced damages for alleged willful infringement, and injunctive relief.
In June 2012, the Administrative Law Judge issued an initial determination granting X2Y’s motion to partially terminate the ITC investigation with respect to three of the asserted patents. The Administrative Law Judge held a hearing on the remaining three patents in August 2012 and issued an initial determination in December 2012. In the initial determination, the Administrative Law Judge found that Intel, Apple, and Hewlett-Packard Company have not violated Section 337 of the Tariff Act of 1930 because they have not infringed any of the asserted claims of the three patents, and ruled that the asserted claims of two of the patents were invalid. In December 2012, the parties filed petitions for review of the initial determination by the ITC. In February 2013, the ITC determined to review in part the initial determination. On review, the ITC determined to terminate the investigation with a finding of no violation. In April 2013, X2Y filed a notice of appeal with the U.S. Court of Appeals for the Federal Circuit. In July 2014, the Federal Circuit affirmed the ITC's finding that Intel's microprocessors did not infringe the X2Y patents. In September 2014, X2Y filed a petition for en banc review, which was denied by the Federal Circuit. Given the procedural posture and nature of the cases, including the fact that discovery regarding X2Y’s claimed damages has not commenced in the stayed district court action, we are unable to make a reasonable estimate of the potential loss or range of losses, if any, arising from these matters. We dispute the claims and intend to defend against X2Y's claims vigorously.
Note 23: Operating Segments Information
Our operating segments in effect as of September 27, 2014 include:
• PC Client Group | • All other | |
• Data Center Group | • Non-Volatile Memory Solutions Group | |
• Internet of Things Group | • Netbook Group | |
• Mobile and Communications Group | • New Devices Group | |
• Software and services operating segments | ||
• McAfee | ||
• Software and Services Group | ||
In the first three months of 2014, we formed the Internet of Things Group, which includes platforms and software-optimized for the Internet of Things market segment. Additionally, we changed our organizational structure to align with our critical objectives, which changed information that our Chief Operating Decision Maker (CODM) reviews for purposes of allocating resources and assessing performance. After the reorganization, we have nine operating segments: PC Client Group (PCCG), Data Center Group (DCG), Internet of Things Group (IOTG), Mobile and Communication Group (MCG), McAfee, Software and Services Group, Non-Volatile Memory Solutions Group,
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INTEL CORPORATION
NOTES TO CONSOLIDATED CONDENSED FINANCIAL STATEMENTS — Unaudited (Continued)
Netbook Group, and New Devices Group. All prior-period amounts have been adjusted retrospectively to reflect these operating segment changes, as well as other minor reorganizations.
The CODM is our CEO. The CODM allocates resources to and assesses the performance of each operating segment using information about its revenue and operating income (loss).
PCCG, DCG, and MCG are our reportable operating segments. IOTG and the aggregated “software and services operating segments” as shown in the preceding operating segment list, do not meet the quantitative thresholds to qualify as reportable operating segments; however, we have elected to disclose the results of these non-reportable operating segments. Our Non-Volatile Memory Solutions Group, Netbook Group, and New Devices Group operating segments do not meet the quantitative thresholds to qualify as reportable segments and their combined results are included within the “all other” category.
Revenue for our reportable and aggregated non-reportable operating segments is primarily related to the following product lines:
• | PC Client Group. Includes platforms designed for the notebook (including Ultrabook™ devices and 2 in 1 systems) and the desktop (including all-in-ones and high-end enthusiast PCs); wireless and wired connectivity products; as well as home gateway and set-top box components. |
• | Data Center Group. Includes platforms designed for the server, workstation, networking, and storage computing market segments. |
• | Internet of Things Group. Includes platforms designed for embedded market segments including retail, transportation, industrial, and buildings and home, along with a broad range of other market segments. |
• | Mobile and Communications Group. Includes platforms designed for the tablet and smartphone market segments; and mobile communications components such as baseband processors, radio frequency transceivers, Wi-Fi, Bluetooth®, global navigation satellite systems, and power management chips. |
• | Software and services operating segments. Includes software products for endpoint security, network and content security, risk and compliance, and consumer and mobile security from our McAfee business, and software products and services that promote Intel architecture as the platform of choice for software development. |
We have sales and marketing, manufacturing, finance, and administration groups. Expenses for these groups are generally allocated to the operating segments, and the expenses are included in the following operating results.
The “all other” category includes revenue, expenses, and charges such as:
• | results of operations from our Non-Volatile Memory Solutions Group, Netbook Group, and New Devices Group; |
• | amounts included within restructuring and asset impairment charges; |
• | a portion of profit-dependent compensation and other expenses not allocated to the operating segments; |
• | divested businesses for which discrete operating results are not regularly reviewed by our CODM; |
• | results of operations of startup businesses that support our initiatives, including our foundry business; and |
• | acquisition-related costs, including amortization and any impairment of acquisition-related intangibles and goodwill. |
The CODM does not evaluate operating segments using discrete asset information. Operating segments do not record inter-segment revenue. We do not allocate gains and losses from equity investments, interest and other income, or taxes to operating segments. Although the CODM uses operating income to evaluate the segments, operating costs included in one segment may benefit other segments. Except for these differences, the accounting policies for segment reporting are the same as for Intel as a whole.
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INTEL CORPORATION
NOTES TO CONSOLIDATED CONDENSED FINANCIAL STATEMENTS — Unaudited (Continued)
Net revenue and operating income (loss) for each period were as follows:
Three Months Ended | Nine Months Ended | |||||||||||||||
(In Millions) | Sep 27, 2014 | Sep 28, 2013 | Sep 27, 2014 | Sep 28, 2013 | ||||||||||||
Net revenue: | ||||||||||||||||
PC Client Group | $ | 9,190 | $ | 8,440 | $ | 25,798 | $ | 24,654 | ||||||||
Data Center Group | 3,700 | 3,178 | 10,296 | 8,899 | ||||||||||||
Internet of Things Group | 530 | 464 | 1,551 | 1,263 | ||||||||||||
Mobile and Communications Group | 1 | 353 | 208 | 1,049 | ||||||||||||
Software and services operating segments | 558 | 545 | 1,659 | 1,599 | ||||||||||||
All other | 575 | 503 | 1,637 | 1,410 | ||||||||||||
Total net revenue | $ | 14,554 | $ | 13,483 | $ | 41,149 | $ | 38,874 | ||||||||
Operating income (loss): | ||||||||||||||||
PC Client Group | $ | 4,120 | $ | 3,243 | $ | 10,656 | $ | 8,377 | ||||||||
Data Center Group | 1,915 | 1,520 | 5,049 | 3,966 | ||||||||||||
Internet of Things Group | 153 | 152 | 431 | 342 | ||||||||||||
Mobile and Communications Group | (1,043 | ) | (810 | ) | (3,096 | ) | (2,274 | ) | ||||||||
Software and services operating segments | 29 | 1 | 30 | (6 | ) | |||||||||||
All other | (634 | ) | (602 | ) | (2,176 | ) | (1,663 | ) | ||||||||
Total operating income | $ | 4,540 | $ | 3,504 | $ | 10,894 | $ | 8,742 | ||||||||
35
ITEM 2. | MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS |
Our Management’s Discussion and Analysis of Financial Condition and Results of Operations (MD&A) is provided in addition to the accompanying consolidated condensed financial statements and notes to assist readers in understanding our results of operations, financial condition, and cash flows. MD&A is organized as follows:
• | Overview. Discussion of our business and overall analysis of financial and other highlights affecting the company in order to provide context for the remainder of MD&A. |
• | Results of Operations. An analysis of our financial results comparing the three and nine months ended September 27, 2014 to the three and nine months ended September 28, 2013. |
• | Liquidity and Capital Resources. An analysis of changes in our balance sheets and cash flows, and discussion of our financial condition and potential sources of liquidity. |
• | Fair Value of Financial Instruments. Discussion of the methodologies used in the valuation of our financial instruments. |
This interim MD&A should be read in conjunction with the MD&A in our Annual Report on Form 10-K for the year ended December 28, 2013. The various sections of this MD&A contain a number of forward-looking statements that involve a number of risks and uncertainties. Words such as “anticipates,” “expects,” “intends,” “goals,” “plans,” “believes,” “seeks,” “estimates,” “continues,” “may,” “will,” “should,” and variations of such words and similar expressions are intended to identify such forward-looking statements. In addition, any statements that refer to projections of our future financial performance, our anticipated growth and trends in our businesses, uncertain events or assumptions, and other characterizations of future events or circumstances are forward-looking statements. Such statements are based on our current expectations and could be affected by the uncertainties and risk factors described in “Risk Factors” in Part I, Item 1A of our Annual Report on Form 10-K, and as may be updated in our subsequent Quarterly Reports on Form 10-Q. Our actual results may differ materially, and these forward-looking statements do not reflect the potential impact of any divestitures, mergers, acquisitions, or other business combinations that had not been completed as of October 29, 2014.
Overview
Our results of operations for each period were as follows:
(Dollars in Millions, Except Per Share Amounts) | Q3 2014 | Q2 2014 | Change | Q3 2014 | Q3 2013 | Change | ||||||||||||||||||
Net revenue | $ | 14,554 | $ | 13,831 | $ | 723 | $ | 14,554 | $ | 13,483 | $ | 1,071 | ||||||||||||
Gross margin | $ | 9,458 | $ | 8,917 | $ | 541 | $ | 9,458 | $ | 8,414 | $ | 1,044 | ||||||||||||
Gross margin percentage | 65.0 | % | 64.5 | % | 0.5 | % | 65.0 | % | 62.4 | % | 2.6 | % | ||||||||||||
Operating income | $ | 4,540 | $ | 3,844 | $ | 696 | $ | 4,540 | $ | 3,504 | $ | 1,036 | ||||||||||||
Net income | $ | 3,317 | $ | 2,796 | $ | 521 | $ | 3,317 | $ | 2,950 | $ | 367 | ||||||||||||
Diluted earnings per common share | $ | 0.66 | $ | 0.55 | $ | 0.11 | $ | 0.66 | $ | 0.58 | $ | 0.08 | ||||||||||||
In Q3 2014, we had record net revenue and earnings per share. Net revenue in Q3 2014 of $14.6 billion was up 5% compared to Q2 2014 and up 8% compared to Q3 2013, and up 1% from the midpoint of the Business Outlook we provided in July 2014 of $14.4 billion. The increase from Q2 2014 was largely due to increased PC Client Group (PCCG) and Data Center Group (DCG) platform unit sales driven by stability in mature markets and strength in enterprise, as well as growth in all segments of our data center business. The worldwide PC supply chain appears to be healthy, with inventory levels appropriate in anticipation of the fourth quarter retail cycles. Net revenue for the PCCG operating segment was up 6% compared to Q2 2014 and up 9% compared to Q3 2013. Our notebook platform units increased as we are enabling innovative 2 in 1 devices and growing our market segment share by offering compelling platforms at lower price points. We had record net revenues in our DCG operating segment of $3.7 billion, up 5% compared to Q2 2014 and up 16% compared to Q3 2013. For Q4 2014, we are forecasting a revenue midpoint of $14.7 billion, up 1% from Q3 2014 and in line with the average seasonal increase.
Gross margin improved by half a percentage point from Q2 2014 and down one percentage point from the Business Outlook we provided in July 2014. The increase from Q2 2014 was primarily due to lower PCCG and DCG platform (Platform) unit costs on our 22-nanometer (nm) products and higher Platform unit sales. These increases were mostly offset by higher production costs on our 14nm products treated as period charges. We are forecasting Q4 2014 gross margin to be 64%, down one percentage point from Q3 2014, due to higher Platform unit costs and higher factory start-up costs, partially offset by lower production costs on 14nm.
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INTEL CORPORATION
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (Continued)
In Q3 2014, we continued to ramp sales of our 5th generation Intel® Core™ processor family on 14nm process technology. We launched Intel® Core™ M processor, a new family of products, with full core performance in both compute and graphics in a fanless design, enabling new designs and form factors. We expect the first of these systems to be available for retail purchase in early Q4 2014. In the data center market segment, we launched our next generation Intel Xeon processor E5 family platform, formally code-named Grantley, on our 22nm process technology. We are customizing our Intel Xeon processor products for specific customers and workloads. In the wireless business, we qualified our second generation LTE solution, featuring CAT6 and carrier aggregation, in early Q3 2014. Our Cat6 LTE modem with carrier aggregation is now commercially available in the Samsung Galaxy Alpha*. Additionally, we expect to have our first integrated SoC application processor and baseband 3G solution, code-named "SoFIA," available in Q4 2014. We also remain on track to achieve our 40 million unit sales goal for tablets in fiscal year 2014. Finally, we entered into a series of agreements with Tsinghua Unigroup Ltd., an operating subsidiary of Tsinghua Holdings Co. Ltd., to, among other things, jointly develop Intel® architecture and communications-based solutions for mobile phones. For further information, see "Contractual Obligations".
Our business continues to produce significant cash from operations, generating $5.7 billion in Q3 2014. We ended Q3 2014 with $15.6 billion of cash and cash equivalents, short-term investments, and trading assets. During Q3 2014, we purchased $2.4 billion in capital assets and returned cash to stockholders by repurchasing $4.2 billion of common stock through our common stock repurchase program and paying $1.1 billion in dividends. With the cash generated from operations, we intend to continue our repurchases of common stock, and as a result reduce our cash balances. Additionally, the cash generated from operations is expected to enable sufficient liquidity for operations, provide the strategic flexibility to invest in our business and continue to return cash to our stockholders. In July 2014, the Board of Directors authorized an increase of $20 billion to the common stock repurchase program. As of September 27, 2014, $16.4 billion remained available for repurchase under the existing repurchase authorization limit. Additionally, the Board of Directors declared a cash dividend in September 2014 of $0.225 per share of common stock to be paid in December 2014.
Our Business Outlook for Q4 2014 and full-year 2014 includes, where applicable, our current expectations for revenue, gross margin percentage, spending (research and development (R&D) plus marketing, general and administrative (MG&A)), and capital expenditures. We publish our Business Outlook in our quarterly earnings release. Our Business Outlook and any updates thereto are publicly available on our Investor Relations web site www.intc.com. This Business Outlook is not incorporated by reference in this Form 10-Q. We expect that our corporate representatives will, from time to time, meet publicly or privately with investors and others, and may reiterate the forward-looking statements contained in the Business Outlook or in this Form 10-Q.
The statements in the Business Outlook and forward-looking statements in this Form 10-Q are subject to revision during the course of the year in our quarterly earnings releases and filings with the Securities and Exchange Commission (SEC) and at other times. The forward-looking statements in the Business Outlook and reiterated or updated in this Form 10-Q will be effective through the close of business on December 12, 2014 unless updated earlier or except as specifically noted otherwise in the Business Outlook. From the close of business on December 12, 2014 until our quarterly earnings release is published, currently scheduled for January 15, 2015, we will observe a “quiet period.”
During the quiet period, the Business Outlook and other forward-looking statements first published in our Form 8-K filed on October 14, 2014, and other forward-looking statements disclosed in the company's news releases and filings with the SEC, as reiterated or updated as applicable in this Form 10-Q, should be considered historical, speaking prior to the quiet period only and not subject to update. During the quiet period, our representatives will not comment on our Business Outlook or our financial results or expectations. The exact timing and duration of the routine quiet period, and any others that we utilize from time to time, may vary at our discretion.
37
INTEL CORPORATION
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (Continued)
Results of Operations – Third Quarter of 2014 Compared to Third Quarter of 2013
The following table sets forth certain consolidated condensed statements of income data as a percentage of net revenue for each period as follows:
Q3 2014 | Q3 2013 | |||||||||||||
(Dollars in Millions, Except Per Share Amounts) | Dollars | % of Net Revenue | Dollars | % of Net Revenue | ||||||||||
Net revenue | $ | 14,554 | 100.0 | % | $ | 13,483 | 100.0 | % | ||||||
Cost of sales | 5,096 | 35.0 | % | 5,069 | 37.6 | % | ||||||||
Gross margin | 9,458 | 65.0 | % | 8,414 | 62.4 | % | ||||||||
Research and development | 2,842 | 19.5 | % | 2,742 | 20.3 | % | ||||||||
Marketing, general and administrative | 1,979 | 13.6 | % | 1,970 | 14.7 | % | ||||||||
Restructuring and asset impairment charges | 20 | 0.1 | % | 124 | 0.9 | % | ||||||||
Amortization of acquisition-related intangibles | 77 | 0.5 | % | 74 | 0.5 | % | ||||||||
Operating income | 4,540 | 31.3 | % | 3,504 | 26.0 | % | ||||||||
Gains (losses) on equity investments, net | 35 | 0.2 | % | 452 | 3.4 | % | ||||||||
Interest and other, net | (25 | ) | (0.2 | )% | (32 | ) | (0.3 | )% | ||||||
Income before taxes | 4,550 | 31.3 | % | 3,924 | 29.1 | % | ||||||||
Provision for taxes | 1,233 | 8.5 | % | 974 | 7.2 | % | ||||||||
Net income | $ | 3,317 | 22.8 | % | $ | 2,950 | 21.9 | % | ||||||
Diluted earnings per common share | $ | 0.66 | $ | 0.58 | ||||||||||
Our net revenue for Q3 2014 increased by $1.1 billion, or 8%, compared to Q3 2013. PCCG and DCG platform unit sales increased by 14% driven by strength in the traditional PC business. These increases were reduced by lower PCCG and DCG platform average selling prices, which were down 3%, and higher cash consideration to our customers to meet competition by offsetting a higher bill of materials and system level costs associated with integrating our tablet platform.
Our overall gross margin dollars for Q3 2014 increased by $1.0 billion, or 12%, compared to Q3 2013. This increase was due to higher PCCG and DCG platform revenue, approximately $580 million of lower PCCG and DCG platform unit costs, and approximately $320 million of lower factory start-up costs primarily driven by our next generation 14nm process technology. These increases were partially offset by approximately $340 million of higher production costs on our 14nm products treated as period charges and approximately $190 million of combined higher cash consideration provided to customers associated with integrating our tablet platform and higher cost of sales associated with higher tablet platform unit sales.
Our overall gross margin percentage increased to 65.0% in Q3 2014 from 62.4% in Q3 2013. The increase in gross margin percentage was primarily due to the gross margin increase in PCCG. We derived most of our overall gross margin dollars in Q3 2014 and Q3 2013 from the sale of platforms in the PCCG and DCG operating segments.
PC Client Group
The revenue and operating income for the PCCG operating segment for each period were as follows:
(In Millions) | Q3 2014 | Q3 2013 | ||||||
Net revenue | $ | 9,190 | $ | 8,440 | ||||
Operating income | $ | 4,120 | $ | 3,243 | ||||
Net revenue for the PCCG operating segment increased by $750 million, or 9%, in Q3 2014 compared to Q3 2013. PCCG platform unit sales were up 15% while PCCG platform average selling prices were down 5%. The increase in revenue was driven primarily by higher notebook platform unit sales of 21%. To a lesser extent, higher desktop platform unit sales of 6% and higher desktop platform average selling prices of 2% also contributed to the increase. These increases were partially offset by lower notebook platform average selling prices of 10%.
38
INTEL CORPORATION
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (Continued)
Operating income increased by $877 million, or 27%, in Q3 2014 compared to Q3 2013, which was driven by $832 million of higher gross margin and $45 million of lower operating expenses. The increase in gross margin was driven by approximately $525 million of lower PCCG platform unit costs, higher PCCG platform revenue, and approximately $315 million of lower factory start-up costs primarily for our next generation 14nm process technology. These increases were partially offset by approximately $340 million of higher production costs on our 14nm products treated as period charges.
Data Center Group
The revenue and operating income for the DCG operating segment for each period were as follows:
(In Millions) | Q3 2014 | Q3 2013 | ||||||
Net revenue | $ | 3,700 | $ | 3,178 | ||||
Operating income | $ | 1,915 | $ | 1,520 | ||||
Net revenue for the DCG operating segment increased by $522 million, or 16%, in Q3 2014 compared to Q3 2013. DCG platform average selling prices and unit sales were up 9% and 6%, respectively. Our server platform revenue continued to benefit from growth in the Internet cloud computing and high-performance computing market segments with continued strengthening of the enterprise market segment.
Operating income increased by $395 million, or 26%, in Q3 2014 compared to Q3 2013 with $578 million of higher gross margin partially offset by $183 million of higher operating expenses. The increase in gross margin was driven primarily by higher DCG platform revenue.
Internet of Things Group
The revenue and operating income for the Internet of Things Group (IOTG) operating segment for each period were as follows:
(In Millions) | Q3 2014 | Q3 2013 | ||||||
Net revenue | $ | 530 | $ | 464 | ||||
Operating income | $ | 153 | $ | 152 | ||||
Net revenue for the IOTG operating segment increased by $66 million, or 14%, in Q3 2014 compared to Q3 2013. The increase was primarily due to higher IOTG platform unit sales based on strength in the retail market segment.
Operating income for the IOTG operating segment increased by $1 million, or 1%, in Q3 2014 compared to Q3 2013. The increase was primarily due to higher IOTG platform revenue offset by higher operating expenses.
Mobile and Communications Group
The revenue and operating loss for the Mobile and Communications Group (MCG) operating segment for each period were as follows:
(In Millions) | Q3 2014 | Q3 2013 | ||||||
Net revenue | $ | 1 | $ | 353 | ||||
Operating loss | $ | (1,043 | ) | $ | (810 | ) | ||
Net revenue for MCG operating segment decreased by $352 million, or 100%, in Q3 2014 compared to Q3 2013. This decrease was primarily due to higher cash consideration to our customers associated with integrating our tablet and phone platforms. Additionally, lower MCG phone components unit sales contributed to the decrease. These decreases were partially offset by higher tablet platform unit sales.
Operating loss for the MCG operating segment increased by $233 million, or 29%, in Q3 2014 compared to Q3 2013 with $339 million in lower gross margin partially offset by $106 million of lower operating expenses. The operating loss increased primarily due to higher cash consideration provided to customers and lower phone components revenue.
39
INTEL CORPORATION
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (Continued)
Software and Services Operating Segments
The revenue and operating income (loss) for the software and services (SSG) operating segments, including McAfee and the Software and Services Group, for each period were as follows:
(In Millions) | Q3 2014 | Q3 2013 | ||||||
Net revenue | $ | 558 | $ | 545 | ||||
Operating income (loss) | $ | 29 | $ | 1 | ||||
Net revenue for the SSG operating segments increased by $13 million in Q3 2014 compared to Q3 2013.
The operating results for the SSG operating segments increased by $28 million in Q3 2014 compared to Q3 2013.
Operating Expenses
Operating expenses for each period were as follows:
(Dollar in Millions) | Q3 2014 | Q3 2013 | ||||||
Research and development | $ | 2,842 | $ | 2,742 | ||||
Marketing, general and administrative | $ | 1,979 | $ | 1,970 | ||||
R&D and MG&A as percentage of net revenue | 33 | % | 35 | % | ||||
Restructuring and asset impairment charges | $ | 20 | $ | 124 | ||||
Amortization of acquisition-related intangibles | $ | 77 | $ | 74 | ||||
Research and Development. R&D spending increased by $100 million, or 4%, in Q3 2014 compared to Q3 2013. This increase was driven by higher compensation expenses mainly due to higher profit-dependent compensation and annual salary increases.
Marketing, General and Administrative. MG&A increased by $9 million, in Q3 2014 compared to Q3 2013.
Restructuring and Asset Impairment Charges. Restructuring and asset impairment charges for each period were as follows:
(In Millions) | Q3 2014 | Q3 2013 | ||||||
Employee severance and benefit arrangements | $ | 9 | $ | 85 | ||||
Asset impairments and other restructuring charges | 11 | 39 | ||||||
Total restructuring and asset impairment charges | $ | 20 | $ | 124 | ||||
For further discussion, see "Results of Operations – First Nine Months of 2014 Compared to First Nine Months of 2013."
Gains (Losses) on Equity Investments and Interest and Other
Gains (losses) on equity investments, net and interest and other, net for each period were as follows:
(In Millions) | Q3 2014 | Q3 2013 | ||||||
Gains (losses) on equity investments, net | $ | 35 | $ | 452 | ||||
Interest and other, net | $ | (25 | ) | $ | (32 | ) | ||
We recognized lower net gains on equity investments in Q3 2014 compared to Q3 2013 primarily due to lower gains on sales of equity investments. In Q3 2013, we sold our interest in Clearwire Communications, LLC (Clearwire LLC), which had been accounted for as an equity method investment, and our shares in Clearwire Corporation, which had been accounted for as available-for-sale marketable equity securities. We received proceeds of $470 million on the sale of these investments and recognized a gain of $439 million in Q3 2013.
40
INTEL CORPORATION
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (Continued)
Provision for Taxes
Our provision for taxes and effective tax rate for each period were as follows:
(Dollars in Millions) | Q3 2014 | Q3 2013 | ||||||
Income before taxes | $ | 4,550 | $ | 3,924 | ||||
Provision for taxes | $ | 1,233 | $ | 974 | ||||
Effective tax rate | 27.1 | % | 24.8 | % | ||||
The U.S. R&D tax credit was reenacted in Q1 2013 retroactive to the beginning of 2012. The U.S. R&D tax credit expired at the end of 2013 and has not been reenacted for 2014. A substantial majority of the increase in our effective tax rate between Q3 2014 and Q3 2013 was driven by the expiration of the U.S. R&D tax credit.
Results of Operations – First Nine Months of 2014 Compared to First Nine Months of 2013
Certain consolidated condensed statements of income data as a percentage of net revenue for each period were as follows:
YTD 2014 | YTD 2013 | |||||||||||||
(Dollars in Millions, Except Per Share Amounts) | Dollars | % of Net Revenue | Dollars | % of Net Revenue | ||||||||||
Net revenue | $ | 41,149 | 100.0 | % | $ | 38,874 | 100.0 | % | ||||||
Cost of sales | 15,161 | 36.8 | % | 15,924 | 41.0 | % | ||||||||
Gross margin | 25,988 | 63.2 | % | 22,950 | 59.0 | % | ||||||||
Research and development | 8,547 | 20.8 | % | 7,785 | 20.0 | % | ||||||||
Marketing, general and administrative | 6,087 | 14.8 | % | 6,082 | 15.6 | % | ||||||||
Restructuring and asset impairment charges | 238 | 0.6 | % | 124 | 0.3 | % | ||||||||
Amortization of acquisition-related intangibles | 222 | 0.5 | % | 217 | 0.6 | % | ||||||||
Operating income | 10,894 | 26.5 | % | 8,742 | 22.5 | % | ||||||||
Gains (losses) on equity investments, net | 178 | 0.4 | % | 437 | 1.1 | % | ||||||||
Interest and other, net | 70 | 0.2 | % | (119 | ) | (0.3 | )% | |||||||
Income before taxes | 11,142 | 27.1 | % | 9,060 | 23.3 | % | ||||||||
Provision for taxes | 3,099 | 7.6 | % | 2,065 | 5.3 | % | ||||||||
Net income | $ | 8,043 | 19.5 | % | $ | 6,995 | 18.0 | % | ||||||
Diluted earnings per common share | $ | 1.58 | $ | 1.37 | ||||||||||
Our net revenue for the first nine months of 2014 increased by $2.3 billion, or 6%, compared to the first nine months of 2013. PCCG and DCG platform unit sales increased by 8% driven by strength in the traditional PC business. To a lesser extent, higher IOTG platform unit sales contributed to the increase. These increases were partially offset by higher cash consideration to our customers associated with integrating our tablet platform and lower MCG phone component unit sales.
Our overall gross margin dollars for the first nine months of 2014 increased by $3.0 billion, or 13%, compared to the first nine months of 2013. This increase was due primarily to higher PCCG and DCG platform revenue and approximately $1.3 billion of lower PCCG and DCG platform unit costs. To a lesser extent, approximately $540 million of lower factory start-up costs was primarily driven by our next generation 14nm process technology and approximately $315 million of lower excess capacity charges also contributed to the increase. These increases were partially offset by approximately $475 million of higher cash consideration provided to customers associated with integrating our tablet platform and higher cost of sales associated with higher tablet platform unit sales.
Our overall gross margin percentage increased to 63.2% in the first nine months of 2014 from 59.0% in the first nine months of 2013. The increase in gross margin percentage was primarily due to the gross margin increase in PCCG. We derived most of our overall gross margin dollars for the first nine months of 2014 and the first nine months of 2013 from the sale of platforms in the PCCG and DCG operating segments.
41
PC Client Group
The revenue and operating income for the PCCG operating segment for each period were as follows:
(In Millions) | YTD 2014 | YTD 2013 | ||||||
Net revenue | $ | 25,798 | $ | 24,654 | ||||
Operating income | $ | 10,656 | $ | 8,377 | ||||
Net revenue for the PCCG operating segment increased by $1.1 billion, or 5%, in the first nine months of 2014 compared to the first nine months of 2013. PCCG platform unit sales were up 8% while PCCG platform average selling prices were down 4%. The increase in revenue was driven by higher notebook platform unit sales of 11%. To a lesser extent, higher desktop platform unit sales of 5% and higher desktop platform average selling prices of 2% also contributed to the increase. These increases were partially offset by lower notebook platform average selling prices of 9%.
Operating income increased by $2.3 billion, or 27%, in the first nine months of 2014 compared to the first nine months of 2013, which was driven by $2.2 billion of higher gross margin and $74 million of lower operating expenses. The increase in gross margin was driven by approximately $1.2 billion of lower PCCG platform unit costs, approximately $610 million of lower factory start-up costs primarily driven by our next generation 14nm process technology, and higher PCCG platform revenue. Additionally, approximately $220 million of lower excess capacity charges also contributed to the increase. These increases were partially offset by approximately $340 million of higher production costs on our 14nm products treated as period charges.
Data Center Group
The revenue and operating income for the DCG operating segment for each period were as follows:
(In Millions) | YTD 2014 | YTD 2013 | ||||||
Net revenue | $ | 10,296 | $ | 8,899 | ||||
Operating income | $ | 5,049 | $ | 3,966 | ||||
Net revenue for the DCG operating segment increased by $1.4 billion, or 16%, in the first nine months of 2014 compared to the first nine months of 2013. DCG platform average selling prices and unit sales were up 10% and 6%, respectively. Our server platform revenue continued to benefit from growth in the Internet cloud computing and high-performance computing market segments with continued strengthening of the enterprise market segment.
Operating income increased by $1.1 billion, or 27%, in the first nine months of 2014 compared to the first nine months of 2013 with $1.6 billion of higher gross margin partially offset by $519 million of higher operating expenses. The increase in gross margin was driven primarily by higher DCG platform revenue. Lower DCG platform unit costs of approximately $135 million also contributed to the increase.
Internet of Things Group
The revenue and operating income for the IOTG operating segment for each period were as follows:
(In Millions) | YTD 2014 | YTD 2013 | ||||||
Net revenue | $ | 1,551 | $ | 1,263 | ||||
Operating income | $ | 431 | $ | 342 | ||||
Net revenue for the IOTG operating segment increased by $288 million, or 23%, in the first nine months of 2014 compared to the first nine months of 2013. The increase was primarily due to higher IOTG platform unit sales based on strength in the retail and industrial market segments.
Operating income for the IOTG operating segment increased by $89 million, or 26%, in the first nine months of 2014 compared to the first nine months of 2013. The increase was primarily due to higher IOTG platform revenue partially offset by higher IOTG platform operating expenses.
42
Mobile and Communications Group
The revenue and operating loss for the MCG operating segment for each period were as follows:
(In Millions) | YTD 2014 | YTD 2013 | ||||||
Net revenue | $ | 208 | $ | 1,049 | ||||
Operating loss | $ | (3,096 | ) | $ | (2,274 | ) | ||
Net revenue for the MCG operating segment decreased by $841 million, or 80%, in the first nine months of 2014 compared to the first nine months of 2013. This decrease was primarily due to higher cash consideration to our customers associated with integrating our tablet platform and lower phone component unit sales. These decreases were partially offset by higher tablet platform unit sales.
Operating loss for the MCG operating segment increased by $822 million, or 36%, in the first nine months of 2014 compared to the first nine months of 2013 with $873 million in lower gross margin and $51 million of lower operating expenses. The operating loss increased primarily due to higher cash consideration provided to customers, higher cost of sales associated with higher tablet platform unit sales, and lower phone components revenue. These decreases were partially offset by lower tablet unit costs.
Software and Services Operating Segments
The revenue and operating income (loss) for the SSG operating segments, including McAfee and the Software and Services Group, for each period were as follows:
(In Millions) | YTD 2014 | YTD 2013 | ||||||
Net revenue | $ | 1,659 | $ | 1,599 | ||||
Operating income (loss) | $ | 30 | $ | (6 | ) | |||
Net revenue for the SSG operating segments increased by $60 million in the first nine months of 2014 compared to the first nine months of 2013.
The operating results for the SSG operating segments increased by $36 million in the first nine months of 2014 compared to the first nine months of 2013.
Operating Expenses
Operating expenses for each period were as follows:
(Dollars in Millions) | YTD 2014 | YTD 2013 | ||||||
Research and development | $ | 8,547 | $ | 7,785 | ||||
Marketing, general and administrative | $ | 6,087 | $ | 6,082 | ||||
R&D and MG&A as percentage of net revenue | 36 | % | 36 | % | ||||
Restructuring and asset impairment charges | $ | 238 | $ | 124 | ||||
Amortization of acquisition-related intangibles | $ | 222 | $ | 217 | ||||
Research and Development. R&D spending increased by $762 million, or 10%, in the first nine months of 2014 compared to the first nine months of 2013. This increase was primarily driven by higher 10nm process technology development costs, higher compensation expenses due to higher profit-dependent compensation and annual salary increases, and increased investments in our products.
Marketing, General and Administrative. MG&A expenses increased by $5 million in the first nine months of 2014 compared to the first nine months of 2013. This increase was primarily due to a Q1 2014 charge related to ongoing litigation, the majority of which was offset by lower marketing expenses in 2014.
43
Restructuring and Asset Impairment Charges. Beginning in Q3 2013, management has approved several restructuring actions including targeted workforce reductions and the exit of certain businesses and facilities. These actions include the wind down of our 200 millimeter wafer fabrication facility in Massachusetts and the closure of our assembly and test facility in Costa Rica, which we expect to cease production in the first quarter of 2015 and the end of 2014, respectively. These targeted reductions will enable the company to better align our resources in areas providing the greatest benefit in the current business environment.
Restructuring and asset impairment charges for each period were as follows:
(In Millions) | YTD 2014 | YTD 2013 | ||||||
Employee severance and benefit arrangements | $ | 218 | $ | 85 | ||||
Asset impairments and other restructuring charges | 20 | 39 | ||||||
Total restructuring and asset impairment charges | $ | 238 | $ | 124 | ||||
The restructuring and asset impairment activity for the first nine months of 2014 was as follows:
(In Millions) | Employee Severance and Benefits | Asset Impairments and Other | Total | |||||||||
Accrued restructuring balance as of December 28, 2013 | $ | 183 | $ | — | $ | 183 | ||||||
Additional accruals | 203 | 19 | 222 | |||||||||
Adjustments | 15 | 1 | 16 | |||||||||
Cash payments | (283 | ) | (3 | ) | (286 | ) | ||||||
Non-cash settlements | — | (9 | ) | (9 | ) | |||||||
Accrued restructuring balance as of September 27, 2014 | $ | 118 | $ | 8 | $ | 126 | ||||||
We recorded the additional accruals and adjustments as restructuring and asset impairment charges in the consolidated condensed statements of income and within the “all other” operating segments category. The charges incurred during the first nine months of 2014 included $218 million related to employee severance and benefit arrangements, which impacted approximately 2,800 employees. In Q2 2014, we had estimated that 3,500 employees would be impacted by restructuring actions, but such number has decreased to 2,800 employees, mainly driven by the internal placement of previously impacted employees and the cancellation of prior quarter actions. Most of the accrued restructuring balance as of September 27, 2014 relates to employee severance and benefits, which are expected to be paid within the next 12 months, and was recorded as a current liability within accrued compensation and benefits in the consolidated condensed balance sheets.
Since Q3 2013, we have incurred a total of $478 million in restructuring and asset impairment charges. These charges included a total of $419 million related to employee severance and benefit arrangements for approximately 6,700 employees, and $59 million in asset impairment and other restructuring charges.
We estimate that employee severance and benefit charges to date will result in gross annual savings of approximately$500 million, which will be realized within R&D, cost of sales, and MG&A. We began to realize these savings in Q4 2013 and expect to fully realize these savings beginning in Q2 2015.
44
Gains (Losses) on Equity Investments, Net and Interest and Other, Net
Gains (losses) on equity investments, net and interest and other, net for each period were as follows:
(In Millions) | YTD 2014 | YTD 2013 | ||||||
Gains (losses) on equity investments, net | $ | 178 | $ | 437 | ||||
Interest and other, net | $ | 70 | $ | (119 | ) | |||
We recognized lower net gains on equity investments in the first nine months of 2014 compared to the first nine months of 2013 primarily due to lower gains on sales of equity investments. Net gains on equity investments in the first nine months of 2013 included a gain of $439 million on the sale of our interest in Clearwire LLC, which had been accounted for as an equity method investment, and our shares in Clearwire Corporation, which had been accounted for as available-for-sale marketable equity securities.
We recognized an interest and other net gain in the first nine months of 2014 compared to a net loss in the first nine months of 2013 due to a gain recognized on the divestiture of our Intel Media assets in 2014. For further information, see "Note 8: Divestitures" in the Notes to Consolidated Condensed Financial Statements of this Form 10-Q.
Provision for Taxes
Our provision for taxes and effective tax rate for each period were as follows:
(Dollars in Millions) | YTD 2014 | YTD 2013 | ||||||
Income before taxes | $ | 11,142 | $ | 9,060 | ||||
Provision for taxes | $ | 3,099 | $ | 2,065 | ||||
Effective tax rate | 27.8 | % | 22.8 | % | ||||
The U.S. R&D tax credit was reenacted in Q1 2013 retroactive to the beginning of 2012. The U.S. R&D tax credit expired at the end of 2013 and has not been reenacted for 2014. A substantial majority of the increase in our effective tax rate between the first nine months of 2014 and the first nine months of 2013 was driven by the recognition of the full year of 2012 and first nine months of 2013 portion of the U.S. R&D tax credit.
Liquidity and Capital Resources
(Dollars in Millions) | Sep 27, 2014 | Dec 28, 2013 | ||||||
Cash and cash equivalents, short-term investments, and trading assets | $ | 15,594 | $ | 20,087 | ||||
Other long-term investments | $ | 2,153 | $ | 1,473 | ||||
Loans receivable and other | $ | 1,355 | $ | 1,226 | ||||
Reverse repurchase agreements with original maturities greater than approximately three months | $ | 450 | $ | 400 | ||||
Short-term and long-term debt | $ | 13,267 | $ | 13,446 | ||||
Debt as percentage of stockholders’ equity | 23.7 | % | 23.1 | % | ||||
In summary, our cash flows for each period were as follows:
(In Millions) | YTD 2014 | YTD 2013 | ||||||
Net cash provided by operating activities | $ | 14,647 | $ | 14,738 | ||||
Net cash used for investing activities | (8,001 | ) | (14,152 | ) | ||||
Net cash used for financing activities | (9,172 | ) | (4,176 | ) | ||||
Effect of exchange rate fluctuations on cash and cash equivalents | (5 | ) | (7 | ) | ||||
Net increase (decrease) in cash and cash equivalents | $ | (2,531 | ) | $ | (3,597 | ) | ||
45
INTEL CORPORATION
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (Continued)
Operating Activities
Cash provided by operating activities is net income adjusted for certain non-cash items and changes in assets and liabilities.
For the first nine months of 2014 compared to the first nine months of 2013, the $91 million decrease in cash provided by operations was due to changes in assets and liabilities, offset by higher net income and adjustments for non-cash items. The adjustments for non-cash items were higher in the first nine months of 2014 compared to the first nine months of 2013, primarily due to higher depreciation and lower gains on equity investments. Income taxes paid, net of refunds, in the first nine months of 2014 compared to the first nine months of 2013 were $1.9 billion higher mostly due to 2012 income tax overpayments reducing income taxes paid in 2013 and higher income before taxes in 2014.
Changes in assets and liabilities as of September 27, 2014, compared to December 28, 2013, included a decrease in accrued compensation and benefits due to the payout of 2013 profit-dependent compensation and a decrease in accounts payable due to the timing of payments.
For the first nine months of 2014, our three largest customers accounted for 46% of net revenue (44% for the first nine months of 2013) with Hewlett-Packard Company accounting for 18% of our net revenue (17% for the first nine months of 2013), Dell Inc. accounting for 16% of our net revenue (15% for the first nine months of 2013), and Lenovo Group Limited accounting for 12% of our net revenue (12% for the first nine months of 2013). These three customers accounted for 46% of net accounts receivable as of September 27, 2014 (34% as of December 28, 2013).
Investing Activities
Investing cash flows consist primarily of capital expenditures; investment purchases, sales, maturities, and disposals; as well as proceeds from divestitures and cash used for acquisitions.
Cash used for investing activities was lower for the first nine months of 2014 compared to the first nine months of 2013. Cash used for investing activities decreased primarily due to lower purchases of available-for-sale investments and trading assets, higher maturities of available-for-sale investments, and lower cash paid for acquisitions. This decrease was partially offset by lower maturities and sales of trading assets and higher investments in non-marketable equity investments.
Financing Activities
Financing cash flows consist primarily of repurchases of common stock, payment of dividends to stockholders, issuance and repayment of long-term debt, and proceeds from the sale of shares of common stock through employee equity incentive plans.
The increase in cash used for financing activities for the first nine months of 2014 compared to the first nine months of 2013 was primarily due to higher repurchases of common stock.
Liquidity
Cash generated by operations is our primary source of liquidity. We maintain a diverse investment portfolio that we continually analyze based on issuer, industry, and country. As of September 27, 2014, cash and cash equivalents, short-term investments, and trading assets totaled $15.6 billion ($20.1 billion as of December 28, 2013). In addition to the $15.6 billion, we have $2.2 billion of other long-term investments, $1.4 billion of loans receivable and other, and $450 million of reverse repurchase agreements with original maturities greater than approximately three months, that we include when assessing our sources of liquidity. Most of our investments in debt instruments are in A/A2 or better rated issuances, and the majority of the issuances are rated AA-/Aa3 or better.
Another potential source of liquidity is an ongoing authorization from our Board of Directors to borrow up to $3.0 billion, which was fully available for use as of September 27, 2014. This ongoing authorization includes borrowings under our commercial paper program. Maximum borrowings under our commercial paper program were $2.1 billion during the first nine months of 2014. Our commercial paper was rated A-1+ by Standard & Poor’s and P-1 by Moody’s as of September 27, 2014. We also have an automatic shelf registration statement on file with the SEC, pursuant to which we may offer an unspecified amount of debt, equity, and other securities.
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INTEL CORPORATION
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (Continued)
As of September 27, 2014, $11.6 billion of our $15.6 billion of cash and cash equivalents, short-term investments, and trading assets was held by our non-U.S. subsidiaries. Of the $11.6 billion held by our non-U.S. subsidiaries, approximately $2.0 billion was available for use in the U.S. without incurring additional U.S. income taxes in excess of the amounts already accrued in our financial statements as of September 27, 2014. The remaining amount of non-U.S. cash and cash equivalents, short-term investments, and trading assets has been indefinitely reinvested and, therefore, no U.S. current or deferred taxes have been accrued and this amount is earmarked for near-term investment in our operations outside the U.S. and future acquisitions of non-U.S. entities. We believe our U.S. sources of cash and liquidity are sufficient to meet our business needs in the U.S. and do not expect that we will need to repatriate the funds we have designated as indefinitely reinvested outside the U.S. Under current tax laws, should our plans change and we were to choose to repatriate some or all of the funds we have designated as indefinitely reinvested outside the U.S., such amounts would be subject to U.S. income taxes and applicable non-U.S. income and withholding taxes.
We believe we have sufficient financial resources to meet our business requirements in the next 12 months, including capital expenditures for worldwide manufacturing and assembly and test, working capital requirements, dividends, common stock repurchases, acquisitions, and strategic investments.
Fair Value of Financial Instruments
When determining fair value, we consider the principal or most advantageous market in which we would transact, and we consider assumptions, such as an obligor’s credit risk, that market participants would use when pricing the asset or liability. For further information, see “Note 3: Fair Value” in the Notes to Consolidated Condensed Financial Statements in this Form 10-Q.
Marketable Debt Instruments
As of September 27, 2014, our assets measured and recorded at fair value on a recurring basis included $16.9 billion of marketable debt instruments. Of these instruments, $6.8 billion was classified as Level 1, $10.0 billion as Level 2, and $120 million as Level 3.
Our marketable debt instruments that are measured and recorded at fair value on a recurring basis and classified as Level 1 were classified as such due to the use of observable market prices for identical securities that are traded in active markets. We evaluate security-specific market data when determining whether the market for a debt security is active.
Of the $10.0 billion of marketable debt instruments measured and recorded at fair value on a recurring basis and classified as Level 2, approximately 50% was classified as Level 2 due to the use of a discounted cash flow model, and approximately 50% was classified as such due to the use of non-binding market consensus prices that were corroborated with observable market data.
Our marketable debt instruments that are measured and recorded at fair value on a recurring basis and classified as Level 3, are classified as such because the fair values are generally derived from discounted cash flow models, performed either by us or our pricing providers, using inputs that we are unable to corroborate with observable market data. We monitor and review the inputs and results of these valuation models to ensure the fair value measurements are reasonable and consistent with market experience in similar asset classes.
Loans Receivable and Reverse Repurchase Agreements
As of September 27, 2014, our assets measured and recorded at fair value on a recurring basis included $758 million of loans receivable and $268 million of reverse repurchase agreements. All of these investments were classified as Level 2, as the fair value is determined using a discounted cash flow model with all significant inputs derived from or corroborated with observable market data.
Marketable Equity Securities
As of September 27, 2014, our assets measured and recorded at fair value on a recurring basis included $6.5 billion of marketable equity securities. Substantially all of these securities were classified as Level 1 because the valuations were based on quoted prices for identical securities in active markets. Our assessment of an active market for our marketable equity securities generally takes into consideration the number of days that each individual equity security trades over a specified period.
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INTEL CORPORATION
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (Continued)
Contractual Obligations
During Q3 2014, we entered into a series of agreements with Tsinghua Unigroup Ltd., an operating subsidiary of Tsinghua Holdings Co. Ltd., to among other things, jointly develop Intel architecture and communications-based solutions for mobile phones. Subject to regulatory approvals and other closing conditions, we have also agreed to invest up to RMB 9.0 billion (approximately $1.5 billion as of the date of the agreement) for a minority stake of approximately 20% of the holding company under Tsinghua Unigroup which will own Spreadtrum Communications and RDA Microelectronics. As of Q3 2014, these amounts have not been recognized in our consolidated condensed balance sheet.
ITEM 3. | QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK |
We are affected by changes in currency exchange rates, interest rates, and equity prices. The information in this section should be read in conjunction with the discussion about market risk and sensitivity analysis related to changes in currency exchange rates and changes in interest rates in Part II, Item 7A, Quantitative and Qualitative Disclosures About Market Risk, in our Annual Report on Form 10-K for the year ended December 28, 2013. All of the following potential changes are based on sensitivity analyses performed on our financial positions as of September 27, 2014 and December 28, 2013. Actual results may differ materially.
Equity Prices
Our investments include marketable equity securities and equity derivative instruments. We typically do not attempt to reduce or eliminate our equity market exposure through hedging activities at the inception of our investments. Before we enter into hedge arrangements, we evaluate legal, market, and economic factors, as well as the expected timing of disposal to determine whether hedging is appropriate. Our equity market risk management program may include equity derivatives with or without hedge accounting designation that utilize warrants, equity options, or other equity derivatives. We also utilize total return swaps to offset changes in liabilities related to the equity market risks of certain deferred compensation arrangements. Gains and losses from changes in fair value of these total return swaps are generally offset by the losses and gains on the related liabilities.
As of September 27, 2014, the fair value of our marketable equity investments and our equity derivative instruments, including hedging positions, was $6.5 billion ($6.3 billion as of December 28, 2013). Substantially all of our marketable equity investments portfolio as of September 27, 2014, was concentrated in our investment in ASML Holding N.V. of $6.3 billion ($5.9 billion as of December 28, 2013). Our marketable equity method investments are excluded from our analysis, as the carrying value does not fluctuate based on market price changes unless an other-than-temporary impairment is deemed necessary. To determine reasonably possible decreases in the market value of our marketable equity investments, we have analyzed the historical market price sensitivity of our marketable equity investment portfolio. Assuming a loss of 30% in market prices, and after reflecting the impact of hedges and offsetting positions, the aggregate value of our marketable equity investments could decrease by approximately $2.0 billion, based on the value as of September 27, 2014 (a decrease in value of approximately $1.6 billion, based on the value as of December 28, 2013 using an assumed loss of 25%).
Many of the same factors that could result in an adverse movement of equity market prices affect our non-marketable equity investments, although we cannot always quantify the impact directly. Financial markets are volatile, which could negatively affect the prospects of the companies we invest in, their ability to raise additional capital, and the likelihood of our ability to realize value in our investments through liquidity events such as initial public offerings, mergers, and private sales. These types of investments involve a great deal of risk, and there can be no assurance that any specific company will grow or become successful; consequently, we could lose all or part of our investment. Our non-marketable equity investments, excluding investments accounted for under the equity method, had a carrying amount of $1.9 billion as of September 27, 2014 ($1.3 billion as of December 28, 2013). The carrying amount of our non-marketable equity method investments was $1.5 billion as of September 27, 2014 ($1.0 billion as of December 28, 2013). The majority of our non-marketable equity method investments balance as of September 27, 2014 was concentrated in our IM Flash Technologies, LLC (IMFT) and Cloudera, Inc. investments of $713 million and $280 million, respectively ($646 million for IMFT as of December 28, 2013).
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ITEM 4. | CONTROLS AND PROCEDURES |
Evaluation of Disclosure Controls and Procedures
Based on management’s evaluation, with the participation of our Chief Executive Officer (CEO) and Chief Financial Officer (CFO), as of the end of the period covered by this report, our CEO and CFO have concluded that our disclosure controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934, as amended (the Exchange Act)), are effective to provide reasonable assurance that information required to be disclosed by us in reports that we file or submit under the Exchange Act is recorded, processed, summarized, and reported within the time periods specified in SEC rules and forms, and is accumulated and communicated to management, including our principal executive officer and principal financial officer, as appropriate, to allow timely decisions regarding required disclosure.
Changes in Internal Control over Financial Reporting
There were no changes to our internal control over financial reporting (as defined in Rules 13a-15(f) and 15d-15(f) under the Exchange Act) that occurred during the quarter ended September 27, 2014 that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.
Inherent Limitations on Effectiveness of Controls
Our management, including our CEO and CFO, does not expect that our disclosure controls or our internal control over financial reporting will prevent or detect all error and all fraud. A control system, no matter how well designed and operated, can provide only reasonable, not absolute, assurance that the control system’s objectives will be met. The design of a control system must reflect the fact that there are resource constraints, and the benefits of controls must be considered relative to their costs. Further, because of the inherent limitations in all control systems, no evaluation of controls can provide absolute assurance that misstatements due to error or fraud will not occur or that all control issues and instances of fraud, if any, have been detected. The design of any system of controls is based in part on certain assumptions about the likelihood of future events, and there can be no assurance that any design will succeed in achieving its stated goals under all potential future conditions. Projections of any evaluation of the effectiveness of controls to future periods are subject to risks. Over time, controls may become inadequate because of changes in conditions or deterioration in the degree of compliance with policies or procedures.
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PART II – OTHER INFORMATION
ITEM 1. | LEGAL PROCEEDINGS |
For a discussion of legal proceedings, see “Note 22: Contingencies” in the Notes to Consolidated Condensed Financial Statements in this Form 10-Q.
ITEM 1A. | RISK FACTORS |
The risks described in Part I, Item 1A, "Risk Factors," in our Annual Report on Form 10-K for the year ended December 28, 2013, could materially and adversely affect our business, financial condition and results of operations, and the trading price of our common stock could decline. These risk factors do not identify all risks that we face - our operations could also be affected by factors that are not presently known to us or that we currently consider to be immaterial to our operations. Due to risks and uncertainties, known and unknown, our past financial results may not be a reliable indicator of future performance and historical trends should not be used to anticipate results or trends in future periods. The Risk Factors section of our 2013 Annual Report on Form 10-K remains current in all material respects.
ITEM 2. | UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS |
Issuer Purchases of Equity Securities
We have an ongoing authorization, originally approved by our Board of Directors in 2005, and subsequently amended, to repurchase up to $65 billion in shares of our common stock in open market or negotiated transactions. This amount includes an increase of $20 billion in the authorization limit approved by our Board of Directors in July 2014. As of September 27, 2014, $16.4 billion remained available for repurchase under the existing repurchase authorization limit.
Common stock repurchase activity under our publicly announced stock repurchase plan during the third quarter of 2014 was as follows:
Period | Total Number of Shares Purchased (In Millions) | Average Price Paid Per Share | Dollar Value of Shares That May Yet Be Purchased (In Millions) | ||||||||
June 29, 2014 – July 26, 2014 | 101.1 | $ | 34.27 | $ | 17,025 | ||||||
July 27, 2014 – August 23, 2014 | 8.6 | $ | 34.36 | $ | 16,730 | ||||||
August 24, 2014 – September 27, 2014 | 9.8 | $ | 34.36 | $ | 16,393 | ||||||
Total | 119.5 | $ | 34.28 | ||||||||
In our consolidated condensed financial statements, we also treat shares of common stock withheld for tax purposes on behalf of our employees in connection with the vesting of restricted stock units as common stock repurchases because they reduce the number of shares that would have been issued upon vesting. These withheld shares of common stock are not considered common stock repurchases under our authorized common stock repurchase plan and accordingly are not included in the common stock repurchase totals in the preceding table.
For further discussion, see "Note 17: Common Stock Repurchases" in the Notes to Consolidated Condensed Financial Statements in this Form 10-Q.
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ITEM 6. | EXHIBITS |
Incorporated by Reference | ||||||||||||
Exhibit Number | Exhibit Description | Form | File Number | Exhibit | Filing Date | Filed or Furnished Herewith | ||||||
3.1 | Intel Corporation Third Restated Certificate of Incorporation of Intel Corporation dated May 17, 2006 | 8-K | 000-06217 | 3.1 | 5/22/2006 | |||||||
3.2 | Intel Corporation Bylaws, as amended and restated on July 26, 2011 | 8-K | 000-06217 | 3.1 | 7/27/2011 | |||||||
10.1** | Intel Corporation 2006 Equity Incentive Plan Standard Terms and Conditions Relating to Restricted Stock Units Granted on and after January 23, 2014 under the 2006 Equity Incentive Plan (standard OSU program) | X | ||||||||||
10.2** | Intel Corporation Non-Employee Director Restricted Stock Unit Agreement under the 2006 Equity Incentive Plan (for RSUs granted on or after July 1, 2014 under the OSU program) | X | ||||||||||
12.1 | Statement Setting Forth the Computation of Ratios of Earnings to Fixed Charges | X | ||||||||||
31.1 | Certification of Chief Executive Officer pursuant to Rule 13a-14(a) of the Securities Exchange Act of 1934, as amended (the Exchange Act) | X | ||||||||||
31.2 | Certification of Chief Financial Officer and Principal Accounting Officer pursuant to Rule 13a-14(a) of the Exchange Act | X | ||||||||||
32.1 | Certification of the Chief Executive Officer and the Chief Financial Officer and Principal Accounting Officer pursuant to Rule 13a-14(b) of the Exchange Act and 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 | X | ||||||||||
101.INS | XBRL Instance Document | X | ||||||||||
101.SCH | XBRL Taxonomy Extension Schema Document | X | ||||||||||
101.CAL | XBRL Taxonomy Extension Calculation Linkbase Document | X | ||||||||||
101.DEF | XBRL Taxonomy Extension Definition Linkbase Document | X | ||||||||||
101.LAB | XBRL Taxonomy Extension Label Linkbase Document | X | ||||||||||
101.PRE | XBRL Taxonomy Extension Presentation Linkbase Document | X | ||||||||||
Intel, Intel logo, Intel Core, Xeon, and Ultrabook are trademarks of Intel Corporation in the U.S. and/or other countries.
* Other names and brands may be claimed as the property of others.
** Management contracts or compensation plans or arrangements in which directors or executive officers are eligible to participate.
The Bluetooth® word mark is a registered trademark owned by Bluetooth SIG, Inc. and any use of such marks by Intel Corporation is under license.
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SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.
INTEL CORPORATION (Registrant) | |||||
Date: | October 29, 2014 | By: | /s/ STACY J. SMITH | ||
Stacy J. Smith | |||||
Executive Vice President, Chief Financial Officer, and Principal Accounting Officer | |||||
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