We design, develop, manufacture and market a wide range of semiconductor products, most of which are analog and mixed-signal integrated circuits. Our goal is to be the premier provider of high-performance energy-efficient analog and mixed-signal solutions. These solutions are marketed under our PowerWise® brand. Energy-efficiency is our overarching theme, and our PowerWise® products enable systems that consume less power, extend battery life and generate less heat. Our leading-edge products include power management circuits and sub-systems, audio and operational amplifiers, communication interface products and data conversion solutions.

On April 4, 2011, we entered into the Merger Agreement with TI and Merger Sub, under which Merger Sub will, subject to the satisfaction or waiver of the conditions in the Merger Agreement, merge with and into National, and National will be the surviving corporation in the merger and a wholly owned subsidiary of TI. Pursuant to the terms and subject to the conditions of the Merger Agreement, at the Effective Time, each share of National common stock issued and outstanding immediately prior to the Effective Time (other than shares (i) held in treasury of National, (ii) owned by TI or Merger Sub or (iii) owned by shareholders who have perfected and not withdrawn a demand for appraisal rights under Delaware law) will be converted into the right to receive $25.00 in cash, without interest. Our Board of Directors unanimously approved the Merger Agreement and the merger on April 4, 2011, and on June 21, 2011, the Merger Agreement was adopted by our shareholders at a special meeting. The completion of the merger is subject to various closing conditions, including receiving certain foreign antitrust approvals. The transaction is expected to close before the end of the calendar year.

The consolidated financial statements include National Semiconductor Corporation and our majority-owned subsidiaries. All significant intercompany transactions are eliminated in consolidation. These financial statements have been prepared on the basis that our operations continue as planned prior to entering into the Merger Agreement with TI and therefore, do not include any effect of the expected consummation of the merger with TI, except for costs incurred to date in connection with the merger.

Our fiscal year ends on the last Sunday of May. For each of our fiscal years ended May 29, 2011, and May 30, 2010, we had a 52-week year. For our fiscal year ended May 31, 2009, we had a 53-week year. Operating results for the additional week in fiscal 2009 were considered immaterial to our consolidated results of operations for fiscal 2009.

We recognize revenue from the sale of semiconductor products upon shipment, provided we have persuasive evidence of an arrangement typically in the form of a purchase order, title and risk of loss have passed to the customer, the amount is fixed or determinable and collection of the revenue is reasonably assured. We record a provision for estimated future returns at the time of shipment. Approximately 71 percent of our semiconductor product sales were made to distributors in fiscal 2011, which includes approximately 9 percent of sales made through dairitens in Japan under local business practices. This compares to approximately 64 percent in fiscal 2010 and approximately 53 percent in fiscal 2009, which includes sales made through dairitens in Japan of approximately 9 percent in fiscal 2010 and approximately 8 percent in fiscal 2009. We have agreements with our distributors that cover various programs, including pricing adjustments based on resale pricing and volume, price protection for inventory and scrap allowances.

In line with industry practices, we generally credit distributors for the effect of price reductions on their inventory of our products and, under specific conditions, we repurchase products that we have discontinued. In general, distributors do not have the right to return product, except under customary warranty provisions. The programs we offer to our distributors could include one or both of the following:

Under the contract sales debit program, products are sold to distributors at standard published prices that are contained in price books that are broadly provided to our various distributors. Distributors are required to pay for this product within our standard commercial terms. After the initial purchase of the product, the distributor has the opportunity to request a price allowance for a particular part number depending on the current market conditions for that specific part as well as volume considerations. This request is made prior to the distributor reselling the part. Once we have approved an allowance to the distributor, the distributor proceeds with the resale of the product and credits are issued to the distributor in accordance with the specific allowance that we approved. Periodically, we issue new distributor price books. For those parts for which the standard prices have been reduced, we provide an immediate credit to distributors for inventory quantities they have on hand.

Under the scrap allowance program, certain distributors are given a contractually defined allowance to cover the cost of any scrap they might incur. The amount of the allowance is specifically agreed upon with each distributor.

The revenue we record for these distribution sales is net of estimated provisions for these programs. Our estimates are based upon historical experience rates by geography and product family, inventory levels in the distribution channel, current economic trends and other related factors. We regularly monitor the claimed allowances against the rates assumed in our estimates of the allowances. Actual distributor claims activity has been materially consistent with the provisions we have made based on our estimates.

Service revenues are recognized as the services are provided or as milestones are achieved, depending on the terms of the arrangement. These revenues are included in net sales and totaled $18.4 million in fiscal 2011, $19.6 million in fiscal 2010 and $17.4 million in fiscal 2009.

Certain intellectual property income is classified as revenue if it meets specified criteria established by company policy that defines whether it is considered a source of income from our primary operations. These revenues are included in net sales and totaled $0.3 million in fiscal 2011, $1.3 million in fiscal 2010 and $2.6 million in fiscal 2009. All other intellectual property income that does not meet the specified criteria is not considered a source of income from primary operations and is therefore classified as a component of other operating income, net, in the consolidated statement of income. Intellectual property income is recognized when the license is delivered, the fee is fixed or determinable, collection of the fee is reasonably assured and remaining obligations are perfunctory or inconsequential to the other party.

Inventories are stated at the lower of standard cost, which approximates actual cost on a first-in, first-out basis, or market. The total carrying value of our inventory is reduced for any difference between cost and estimated market value of inventory that is determined to be obsolete or unmarketable, based upon assumptions about future demand and market conditions.

Property, plant and equipment are recorded at cost. We use the straight-line method to depreciate machinery and equipment over their estimated useful life (3-9 years). Buildings and improvements are depreciated using both straight-line and declining-balance methods over the assets' remaining estimated useful life (3-50 years), or, in the case of leasehold improvements, over the lesser of the estimated useful life or lease term.

We capitalize eligible costs to acquire software used internally. We use the straight-line method to amortize software used internally over its estimated useful life (generally 3-5 years). Internal-use software is included in the property, plant and equipment balance.

Goodwill represents the excess of the purchase price over the fair value of identifiable net tangible and intangible assets acquired in a business combination. Goodwill is assigned to reporting units and as of May 29, 2011, we have five reporting units that contain goodwill.

We evaluate goodwill for impairment on an annual basis and whenever events or changes in circumstance indicate that it is more likely than not that an impairment loss has been incurred. We assess the impairment of goodwill annually in our fourth fiscal quarter, which has been selected as the period for our recurring evaluation for all reporting units. Our impairment evaluation of goodwill is based on comparing the fair value to the carrying value of our reporting units containing goodwill. The fair value of a reporting unit is measured at the business unit level using a discounted cash flow approach that incorporates our estimates of future revenues and costs for those business units.

We assess the impairment of long-lived assets whenever events or changes in circumstances indicate that their carrying value may not be recoverable from the estimated future cash flows expected to result from their use and eventual disposition. Our long-lived assets subject to this evaluation include property, plant and equipment and amortizable intangible assets. Amortizable intangible assets subject to this evaluation include developed technology we have acquired, patents and technology licenses. Our impairment evaluation of long-lived assets includes an analysis of estimated future undiscounted net cash flows expected to be generated by the assets over their remaining estimated useful lives. If our estimate of future undiscounted net cash flows is insufficient to recover the carrying value of the assets over the remaining estimated useful lives, we record an impairment loss in the amount by which the carrying value of the assets exceeds the fair value. If assets are determined to be recoverable, but the useful lives are shorter than we originally estimated, we depreciate or amortize the net book value of the asset over the newly determined remaining useful lives.

We classify long-lived assets as assets held for sale when the criteria have been met, in accordance with ASC Topic 360, "Property, Plant, and Equipment." Upon classification of an asset as held for sale, we cease depreciation of the asset and classify the asset as a current asset at the lower of its carrying value or fair value (less cost to sell). If an asset is held for sale as a result of a restructuring of operations, any write down to fair value (less cost to sell) is included as a restructuring expense in the consolidated statement of income. When we commit to a plan to abandon a long-lived asset before the end of its previously estimated useful life, we revise depreciation estimates to reflect the use of the asset over its shortened useful life. We review depreciation estimates periodically, including both estimated useful lives and estimated salvage values. These reviews may result in changes to historical depreciation rates, which are considered to be changes in accounting estimates and are accounted for on a prospective basis.

We determine deferred tax assets and liabilities based on the future tax consequences that can be attributed to net operating loss and credit carryovers and differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases, using the enacted tax rates expected to be applied when the taxes are actually paid or recovered. The recognition of deferred tax assets is reduced by a valuation allowance if it is more likely than not that the tax benefits will not be realized. The ultimate realization of deferred tax assets depends upon the generation of future taxable income during the periods in which the net operating loss and credit carryovers and differences between financial statement carrying amounts and their respective tax bases become deductible.

We compute basic earnings per share using the weighted-average number of common shares outstanding. Diluted earnings per share are computed using the weighted-average common shares outstanding after giving effect to potential common shares from share-based awards using the treasury stock method.

For all years presented, the reported net income was used as the numerator in our computation of basic and diluted earnings per share. A reconciliation of the shares used in the computation follows:

(In Millions, Except Exercise Prices)			2011		2010		2009


Weighted-average common shares outstanding used for basic earnings per share				241.8		236.4		229.1
Effect of dilutive securities:
	Share-based awards			6.4		4.9		6.0

Weighted-average common and potential common shares outstanding used for diluted earnings per share				248.2		241.3		235.1

Anti-dilutive potential common shares:
	Stock options:
		Number of shares		11.7		34.1		41.9

		Weighted-average exercise price	$	19.97	$	21.68	$	23.25

Anti-dilutive potential common shares are not included in the calculation of diluted earnings per share. For fiscal 2011, 2010 and 2009, the effect of these shares was anti-dilutive because the exercise price of the related stock options exceeded the average market price during each of those years. Shares related to outstanding stock options at May 29, 2011 that were anti-dilutive could potentially dilute basic earnings per share in the future.

The functional currency for all operations worldwide is the U.S. dollar. We include gains and losses arising from remeasurement of foreign currency financial statement balances into U.S. dollars and gains and losses resulting from foreign currency transactions in selling, general and administrative expenses. Included in net income were net foreign currency losses of $2.6 million in fiscal 2011, $3.9 million in fiscal 2010 and $3.4 million in fiscal 2009.

Cash and Cash Equivalents. Cash equivalents are highly liquid instruments with an original maturity of three months or less. We maintain cash equivalents in various currencies and in a variety of financial instruments.

Deferred Compensation Plan Assets. Employee contributions under the deferred compensation plan (See Note 12 to the Consolidated Financial Statements) are maintained in a rabbi trust and are not readily available to us. Participants can direct the investment of their deferred compensation plan accounts in the same investments funds offered by the 401(k) plan. Although participants direct the investment of these funds, they are classified as trading securities and are included in other assets because they remain assets of the company until they are actually paid out to the participants. We had deferred compensation plan assets of $41.8 million at May 29, 2011 and $40.3 million at May 30, 2010, which are included in other assets. In connection with these trading securities, we recorded net gains of $6.4 million in fiscal 2011 and $5.3 million in fiscal 2010 and a net loss of $7.7 million in fiscal 2009. There is an offset for the same amounts included in SG&A expenses in fiscal 2011, 2010 and 2009, respectively, that represents the corresponding change in the liability associated with the employee deferred compensation plan due to the change in market value of these trading securities.

Derivative Financial Instruments. As part of our risk management strategy we use derivative financial instruments, including forwards, swaps and purchased options, to hedge certain foreign currency and interest rate exposures. Our intent is to offset gains and losses that occur from our underlying exposure with gains and losses on the derivative contracts used to hedge them. As a matter of company policy, we do not enter into speculative positions with derivative instruments. The criteria we use for designating an instrument as a hedge include the instrument's effectiveness in risk reduction and direct matching of the financial instrument to the underlying transaction.

We record all derivative instruments on the balance sheet at fair value. Gains or losses resulting from changes in the values of these derivatives are accounted for based on the use of the derivative and whether it qualifies for hedge accounting. See Note 3 to the Consolidated Financial Statements for a full description of our hedging activities and related accounting policies.

We measure and record compensation expense for all share-based payment awards based on estimated fair values in accordance with ASC Topic 718, "Compensation-Stock Compensation." We provide share-based awards to our employees, executive officers and directors through various equity compensation plans including our employee equity, stock option, stock purchase and restricted stock plans.

The fair value of stock option and stock purchase equity awards is measured at the date of grant using a Black-Scholes option pricing model and the fair value of restricted stock awards is based on the market price of our common stock on the date of grant. The fair value of these awards is recognized on a straight-line basis over the vesting period. The cash awards that were paid on November 29, 2010 in connection with retention arrangements with each of our executive officers (approved by the Compensation Committee of our Board of Directors in November 2008) were considered a share-based payment award and measured at fair value since the award was indexed to the price of our common stock (See Note 14 to the Consolidated Financial Statements). The fair value of these cash awards was measured each reporting period and was calculated using the Monte Carlo valuation method.

The compensation expense for share-based awards is based on awards that are expected to vest and is reduced for estimated forfeitures. We apply an annual forfeiture rate that is determined based on historical forfeiture activity. Our estimated forfeiture rate is evaluated each reporting period and, taking into consideration all available evidence both before and after the reporting date, we make appropriate adjustments. This forfeiture rate represents the awards expected to be forfeited each year and results in the recognition of share-based compensation expense over the vesting period for those awards that vest. For fiscal 2011, 2010 and 2009, forfeiture rates of 7.3 percent, 6.5 percent and 7.7 percent, respectively, were applied for share-based compensation expense related to employee stock options (excluding officers).

Share-based compensation expense included in operating results for fiscal 2011, 2010 and 2009 is presented in the following table:

(In Millions, Except Per Share Amounts)		2011			2010			2009


Cost of sales:
	Gross compensation	$	7.3		$	9.8		$	15.5
	Capitalized in inventory during the period		(6.5	)		(7.8	)		(13.0	)
	Realized from inventory during the period		6.8			8.3			13.5

			7.6			10.3			16.0
Research and development			15.8			17.8			24.3
Selling, general and administrative			31.6			45.7			30.6

Total share-based compensation included in income before taxes			55.0			73.8			70.9
Income tax benefit			(18.4	)		(23.5	)		(21.0	)

Total share-based compensation, net of tax, included in net income		$	36.6		$	50.3		$	49.9

Share-based compensation effects on earnings per share:
	Basic	$	0.15		$	0.21		$	0.22
	Diluted	$	0.15		$	0.21		$	0.21
Share-based compensation capitalized in inventory		$	0.7		$	1.0		$	1.5

Total gross share-based compensation		$	54.7		$	73.3		$	70.4

The fair value of share-based awards to employees in connection with equity compensation plans was estimated using a Black-Scholes option pricing model that used the following weighted-average assumptions:




Stock Option Plan:
Expected life (in years)	3.8		3.8		3.7
Expected volatility	41	%	45	%	45	%
Risk-free interest rate	1.4	%	1.9	%	2.4	%
Dividend yield	2.2	%	2.3	%	1.4	%
Stock Purchase Plan:
Expected life (in years)	0.8		0.8		0.7
Expected volatility	35	%	42	%	39	%
Risk-free interest rate	0.2	%	0.3	%	1.8	%
Dividend yield	2.3	%	2.3	%	1.4	%

The weighted-average fair value of stock options granted during both fiscal 2011 and 2010 was $4.01 per share, and during fiscal 2009 was $5.83 per share. The weighted-average fair value of rights granted under the stock purchase plan was $3.41, $4.06 and $5.05 per share for fiscal 2011, 2010 and 2009 respectively.

The fair value of cash awards that were paid on November 29, 2010 in connection with the executive officer retention arrangements was estimated using the Monte Carlo valuation method. At May 30, 2010 the following closing stock price and weighted-average assumptions used were:

	2010


Executive Officer Retention Awards:
Closing stock price	$	14.05
Remaining term (in years)		0.5
Expected volatility		32	%
Risk-free interest rate		0.2	%
Dividend yield		2.3	%

For all options granted after December 31, 2007, we determine expected life based on historical stock option exercise experience for the last four years, adjusted for our expectation of future exercise activity. For options granted prior to January 1, 2008, we use the simplified method specified by SEC's Staff Accounting Bulletin (SAB) No. 107 to determine the expected life of stock options. The expected volatility is based on implied volatility, as management has determined that implied volatility better reflects the market's expectation of future volatility than historical volatility, and is determined based on our traded options, which are actively traded on several exchanges. We derive the implied volatility using the closing prices of traded options during a period that closely matches the timing of the option grant for the stock option and stock purchase plans, and on the last day of the quarter for the cash awards under the executive officer retention arrangements. The traded options selected for our measurement for the stock option and stock purchase plans are near-the-money and close to the exercise price of the option grants and have terms ranging from one to two years. The traded options selected for our measurement of the cash awards under the executive officer retention arrangements were near-the-money and at the closing price of our common stock on the last day of the quarter and had similar remaining terms (in years). The risk-free interest rate is based upon interest rates that match the expected life of the outstanding options under our employee stock option plans, the expected life of the purchase rights under our employee stock purchase plan and the retention period under the executive officer retention arrangements, as applicable. The dividend yield is based on recent history and our expectation of dividend payouts.

Under our equity compensation plans, employees who retire from the company and meet certain conditions set forth in the plans and related stock option grant agreements continue to vest in their stock options after retirement. During that post-retirement period of continued vesting, no service is required of the employee. Prior to fiscal 2007, we historically recognized compensation costs of these options using the nominal vesting period approach for pro forma reporting purposes. The FASB guidance specifies that a stock option award is considered to be vested when the employee's retention of the option is no longer contingent on the obligation to provide continuous service (the "non-substantive vesting period approach"). Under the non-substantive vesting period approach, the compensation cost should be recognized immediately for options granted to employees who are eligible for retirement at the time the option is granted. If an employee is not currently eligible for retirement, but is expected to become eligible during the nominal vesting period, then the compensation expense for the option should be recognized over the period from the grant date to the date retirement eligibility occurs. Beginning in fiscal 2007, we changed the method for recognizing the compensation cost for these options to the non-substantive vesting period approach for those options that were granted beginning in fiscal 2007. If we had used the non-substantive vesting period approach in calculating the amounts for unvested option grants prior to fiscal 2007, the pre-tax share-based compensation expense would have been lower by $1.3 million in fiscal 2010 and $6.8 million in fiscal 2009. Pre-tax share-based compensation expense in fiscal 2011 was not affected.

The preparation of financial statements in conformity with accounting principles generally accepted in the United States of America requires us to make estimates and assumptions that affect the reported amounts of assets and liabilities and the disclosure of contingent liabilities at the date of the financial statements and the reported amounts of net sales and expenses during the reporting period. Actual results could differ from those estimates.

In October 2009, the Financial Accounting Standards Board (FASB) issued FASB Accounting Standards Update (ASU) No. 2009-13, "Revenue Recognition (Topic 605) – Multiple-Deliverable Revenue Arrangements – a consensus of the FASB Emerging Issues Task Force." In the absence of vendor-specific objective evidence (VSOE) or other third party evidence (TPE) of the selling price for the deliverables in a multiple-element arrangement, this ASU requires companies to use an estimated selling price (ESP) for the individual deliverables. Companies are to apply the relative-selling price model for allocating an arrangement's total consideration to its individual elements. Under this model, the ESP is used for both the delivered and undelivered elements that do not have VSOE or TPE of the selling price. The FASB also issued ASU No. 2009-14, "Software (Topic 985) – Certain Revenue Arrangements That Include Software Elements," which excludes the software from the scope of software revenue guidance if the software contained in the tangible product is essential to the tangible product's functionality. Both ASUs are effective for us beginning in our fiscal 2012, with earlier application permitted. We elected to early adopt the accounting requirements in these ASUs during the second quarter of fiscal 2011. Their adoption did not have a material effect on our consolidated financial statements.

Certain amounts in the consolidated financial statements and notes to consolidated financial statements for prior years have been reclassified to conform to the fiscal 2011 presentation. Net operating results have not been affected by these reclassifications.