EX-13 5 txn-12312012xexhibit13.htm TXN-12312012EXHIBIT13 TXN - 12.31.2012 - Exhibit 13

Exhibit 13

 
 
For Years Ended
December 31,
Consolidated statements of income
 
2012
 
2011
 
2010
[Millions of dollars, except share and per-share amounts]
 
 
 
 
 
 
Revenue
 
$
12,825

 
$
13,735

 
$
13,966

Cost of revenue (COR)
 
6,457

 
6,963

 
6,474

Gross profit
 
6,368

 
6,772

 
7,492

Research and development (R&D)
 
1,877

 
1,715

 
1,570

Selling, general and administrative (SG&A)
 
1,804

 
1,638

 
1,519

Acquisition charges
 
450

 
315

 

Restructuring charges/other
 
264

 
112

 
(111
)
Operating profit
 
1,973

 
2,992

 
4,514

Other income (expense) net (OI&E)
 
47

 
5

 
37

Interest and debt expense
 
85

 
42

 

Income before income taxes
 
1,935

 
2,955

 
4,551

Provision for income taxes
 
176

 
719

 
1,323

Net income
 
$
1,759

 
$
2,236

 
$
3,228

 
 
 
 
 
 
 
Earnings per common share:
 
 

 
 

 
 

Basic
 
$
1.53

 
$
1.91

 
$
2.66

Diluted
 
$
1.51

 
$
1.88

 
$
2.62

 
 
 
 
 
 
 
Average shares outstanding (millions):
 
 

 
 

 
 

Basic
 
1,132

 
1,151

 
1,199

Diluted
 
1,146

 
1,171

 
1,213

 
 
 
 
 
 
 
Cash dividends declared per share of common stock
 
$
0.72

 
$
0.56

 
$
0.49


See accompanying notes.

1


 
 
For Years Ended
December 31,
Consolidated statements of comprehensive income
 
2012
 
2011
 
2010
[Millions of dollars]
 
 
 
 
 
 
Net income
 
$
1,759

 
$
2,236

 
$
3,228

Other comprehensive income (loss):
 
 

 
 

 
 

Available-for-sale investments:
 
 

 
 

 
 

Unrealized gains (losses), net of tax benefit (expense) of ($1), $1 and ($3)
 
3

 
(2
)
 
7

Reclassification of recognized transactions, net of tax benefit (expense) of $0, ($7) and $0
 

 
12

 

Net actuarial gains (losses) of defined benefit plans:
 
 
 
 

 
 

Adjustment, net of tax benefit (expense) of $29, $65 and $61
 
(81
)
 
(124
)
 
(154
)
Reclassification of recognized transactions, net of tax benefit (expense) of ($104), ($28) and ($36)
 
160

 
48

 
65

Prior service cost of defined benefit plans:
 
 

 
 

 
 

Adjustment, net of tax benefit (expense) of $1, $5 and ($1)
 
(2
)
 
(9
)
 
2

Reclassification of recognized transactions, net of tax benefit (expense) of $0, ($1) and $0
 

 
2

 

Change in fair value of derivative instrument, net of tax benefit (expense) of $1, $1 and $0
 
(3
)
 
(2
)
 

Other comprehensive income (loss), net of taxes
 
77

 
(75
)
 
(80
)
Total comprehensive income
 
$
1,836

 
$
2,161

 
$
3,148


See accompanying notes.

2


 
 
December 31,
Consolidated balance sheets
 
2012
 
2011
[Millions of dollars, except share amounts]
 
 
 
 
Assets
 
 
 
 
Current assets:
 
 
 
 
Cash and cash equivalents
 
$
1,416

 
$
992

Short-term investments
 
2,549

 
1,943

Accounts receivable, net of allowances of ($31) and ($19)
 
1,230

 
1,545

Raw materials
 
116

 
115

Work in process
 
935

 
1,004

Finished goods
 
706

 
669

Inventories
 
1,757

 
1,788

Deferred income taxes
 
1,044

 
1,174

Prepaid expenses and other current assets
 
234

 
386

Total current assets
 
8,230

 
7,828

Property, plant and equipment at cost
 
6,891

 
7,133

Less accumulated depreciation
 
(2,979
)
 
(2,705
)
Property, plant and equipment, net
 
3,912

 
4,428

Long-term investments
 
215

 
265

Goodwill
 
4,362

 
4,452

Acquisition-related intangibles, net
 
2,558

 
2,900

Deferred income taxes
 
280

 
321

Capitalized software licenses, net
 
142

 
206

Overfunded retirement plans
 
68

 
40

Other assets
 
254

 
57

Total assets
 
$
20,021

 
$
20,497

 
 
 
 
 
Liabilities and stockholders’ equity
 
 

 
 

Current liabilities:
 
 

 
 

Commercial paper borrowings
 
$

 
$
999

Current portion of long-term debt
 
1,500

 
382

Accounts payable
 
444

 
625

Accrued compensation
 
524

 
597

Income taxes payable
 
79

 
101

Deferred income taxes
 
2

 

Accrued expenses and other liabilities
 
881

 
795

Total current liabilities
 
3,430

 
3,499

Long-term debt
 
4,186

 
4,211

Underfunded retirement plans
 
269

 
701

Deferred income taxes
 
572

 
607

Deferred credits and other liabilities
 
603

 
527

Total liabilities
 
9,060

 
9,545

Stockholders’ equity:
 
 

 
 

Preferred stock, $25 par value. Authorized – 10,000,000 shares.
       Participating cumulative preferred. None issued.
 

 

Common stock, $1 par value. Authorized – 2,400,000,000 shares.
       Shares issued: 2012 – 1,740,815,939; 2011 – 1,740,630,391
 
1,741

 
1,741

Paid-in capital
 
1,176

 
1,194

Retained earnings
 
27,205

 
26,278

Less treasury common stock at cost.
       Shares: 2012 – 632,636,970; 2011 – 601,131,631
 
(18,462
)
 
(17,485
)
Accumulated other comprehensive income (loss), net of taxes
 
(699
)
 
(776
)
Total stockholders’ equity
 
10,961

 
10,952

Total liabilities and stockholders’ equity
 
$
20,021

 
$
20,497

See accompanying notes.

3


 
 
For Years Ended
December 31,
Consolidated statements of cash flows
 
2012
 
2011
 
2010
[Millions of dollars]
 
 
 
 
 
 
Cash flows from operating activities:
 
 
 
 
 
 
Net income
 
$
1,759

 
$
2,236

 
$
3,228

Adjustments to net income:
 
 

 
 

 
 

Depreciation
 
957

 
904

 
865

Amortization of acquisition-related intangibles
 
342

 
111

 
48

Stock-based compensation
 
263

 
269

 
190

Gain on sales of assets and divestiture
 

 
(5
)
 
(144
)
Deferred income taxes
 
65

 
(119
)
 
(188
)
Gain on transfer of Japan substitutional pension
 
(144
)
 

 

Increase (decrease) from changes in:
 
 

 
 

 
 

Accounts receivable
 
311

 
112

 
(231
)
Inventories
 
5

 
(17
)
 
(304
)
Prepaid expenses and other current assets
 
227

 
(29
)
 
(8
)
Accounts payable and accrued expenses
 
99

 
2

 
57

Accrued compensation
 
(82
)
 
(77
)
 
246

Income taxes payable
 
(229
)
 
(85
)
 
(19
)
Changes in funded status of retirement plans
 
(198
)
 
(7
)
 
26

Other
 
39

 
(39
)
 
54

Cash flows from operating activities
 
3,414

 
3,256

 
3,820

 
 
 
 
 
 
 
Cash flows from investing activities:
 
 

 
 

 
 

Additions to property, plant and equipment
 
(495
)
 
(816
)
 
(1,199
)
Proceeds from insurance recovery, asset sales and divestiture
 

 
16

 
148

Purchases of short-term investments
 
(2,802
)
 
(3,653
)
 
(2,510
)
Proceeds from short-term investments
 
2,198

 
3,555

 
2,564

Purchases of long-term investments
 
(1
)
 
(6
)
 
(8
)
Proceeds from long-term investments
 
61

 
157

 
147

Business acquisitions, net of cash acquired
 

 
(5,425
)
 
(199
)
Cash flows from investing activities
 
(1,039
)
 
(6,172
)
 
(1,057
)
 
 
 
 
 
 
 
Cash flows from financing activities:
 
 

 
 

 
 

Proceeds from issuance of long-term debt and commercial paper borrowings
 
1,492

 
4,697

 

Repayment of debt and commercial paper borrowings
 
(1,375
)
 
(200
)
 

Dividends paid
 
(819
)
 
(644
)
 
(592
)
Stock repurchases
 
(1,800
)
 
(1,973
)
 
(2,454
)
Proceeds from common stock transactions
 
523

 
690

 
407

Excess tax benefit from share-based payments
 
38

 
31

 
13

Other
 
(10
)
 
(12
)
 

Cash flows from financing activities
 
(1,951
)
 
2,589

 
(2,626
)
 
 
 
 
 
 
 
Net change in cash and cash equivalents
 
424

 
(327
)
 
137

Cash and cash equivalents at beginning of year
 
992

 
1,319

 
1,182

Cash and cash equivalents at end of year
 
$
1,416

 
$
992

 
$
1,319

 
 
 
 
 
 
 

See accompanying notes.

4


Consolidated statements of stockholders’ equity
 
Common
Stock
 
Paid-in
Capital
 
Retained
Earnings
 
Treasury
Common
Stock
 
Accumulated Other
Comprehensive
Income (Loss)
[Millions of dollars, except per-share amounts]
 
 
 
 
 
 
 
 
 
 
Balance, December 31, 2009
 
$
1,740

 
$
1,086

 
$
22,066

 
$
(14,549
)
 
$
(621
)
 
 
 
 
 
 
 
 
 
 
 
2010
 
 

 
 

 
 

 
 

 
 

Net income
 

 

 
3,228

 

 

Dividends declared and paid ($.49 per share)
 

 

 
(592
)
 

 

Common stock issued for stock-based awards
 

 
(182
)
 

 
588

 

Stock repurchases
 

 

 

 
(2,450
)
 

Stock-based compensation
 

 
190

 

 

 

Tax impact from exercise of options
 

 
21

 

 

 

Other comprehensive income (loss), net of taxes
 

 

 

 

 
(80
)
Other
 

 
(1
)
 
(7
)
 

 

Balance, December 31, 2010
 
1,740

 
1,114

 
24,695

 
(16,411
)
 
(701
)
 
 
 
 
 
 
 
 
 
 
 
2011
 
 

 
 

 
 

 
 

 
 

Net income
 

 

 
2,236

 

 

Dividends declared and paid ($.56 per share)
 

 

 
(644
)
 

 

Common stock issued for stock-based awards
 
1

 
(252
)
 

 
898

 

Stock repurchases
 

 

 

 
(1,973
)
 

Stock-based compensation
 

 
269

 

 

 

Tax impact from exercise of options
 

 
45

 

 

 

Other comprehensive income (loss), net of taxes
 

 

 

 

 
(75
)
Other
 

 
18

 
(9
)
 
1

 

Balance, December 31, 2011
 
1,741

 
1,194

 
26,278

 
(17,485
)
 
(776
)
 
 
 
 
 
 
 
 
 
 
 
2012
 
 

 
 

 
 

 
 

 
 

Net income
 

 

 
1,759

 

 

  Dividends declared and paid ($.72 per share)
 

 

 
(819
)
 

 

Common stock issued for stock-based awards
 

 
(337
)
 

 
823

 

Stock repurchases
 

 

 

 
(1,800
)
 

Stock-based compensation
 

 
263

 

 

 

Tax impact from exercise of options
 

 
56

 

 

 

Other comprehensive income (loss), net of taxes
 

 

 

 

 
77

Other
 

 

 
(13
)
 

 

Balance, December 31, 2012
 
$
1,741

 
$
1,176

 
$
27,205

 
$
(18,462
)
 
$
(699
)

See accompanying notes.


5


Notes to financial statements

1. Description of business and significant accounting policies and practices
Business
At Texas Instruments (TI), we design and make semiconductors that we sell to electronics designers and manufacturers all over the world. As of December 31, 2012, we have three reportable segments, which are established along major categories of products as follows:

Analog – consists of the following major product lines: High Volume Analog & Logic (HVAL), Power Management (Power), High Performance Analog (HPA) and Silicon Valley Analog (SVA). SVA consists of products that we acquired through our purchase of National Semiconductor Corporation (National) in 2011.
Embedded Processing – consists of digital signal processors (DSPs) and microcontrollers used in catalog, communications infrastructure and automotive applications; and
Wireless – consists of OMAP™ applications processors, connectivity products and baseband products.

We report the results of our remaining business activities in Other. As previously announced, the Wireless segment will be eliminated due to the decision to wind down certain of its product lines. As a result, we will restructure our reportable segments beginning January 1, 2013, and we will report our first quarter of 2013 financial results accordingly. See Note 16 for additional information on our business segments.

Basis of presentation
The consolidated financial statements have been prepared in accordance with accounting principles generally accepted in the United States (U.S. GAAP). The basis of these financial statements is comparable for all periods presented herein.

The consolidated financial statements include the accounts of all subsidiaries. All intercompany balances and transactions have been eliminated in consolidation. All dollar amounts in the financial statements and tables in these notes, except per-share amounts, are stated in millions of U.S. dollars unless otherwise indicated. We have reclassified certain amounts in the prior periods’ financial statements to conform to the 2012 presentation. The preparation of financial statements requires the use of estimates from which final results may vary.

On September 23, 2011, we completed the acquisition of National. We accounted for this transaction under Accounting Standards Codification (ASC) 805 - Business Combinations, and the consolidated financial statements include the balances and results of operations of National from the date of acquisition. See Note 2 for more detailed information.

Revenue recognition
We recognize revenue from direct sales of our products to our customers, including shipping fees, when title and risk of loss pass to the customer, which usually occurs upon shipment or delivery, depending upon the terms of the sales order; when persuasive evidence of an arrangement exists; when sales amounts are fixed or determinable; and when collectability is reasonably assured. Revenue from sales of our products that are subject to inventory consignment agreements is recognized consistent with the principles discussed above, but delivery occurs when the customer pulls product from consignment inventory that we store at designated locations. Estimates of product returns for quality reasons and of price allowances (based on historical experience, product shipment analysis and customer contractual arrangements) are recorded when revenue is recognized. Allowances include volume-based incentives and special pricing arrangements. In addition, we record allowances for accounts receivable that we estimate may not be collected.

We recognize revenue from direct sales of our products to our distributors, net of allowances, consistent with the principles discussed above. Title transfers to the distributors at delivery or when the products are pulled from consignment inventory, and payment is due on our standard commercial terms; payment terms are not contingent upon resale of the products. We calculate credit allowances based on historical data, current economic conditions and contractual terms. For instance, we sell to distributors at standard published prices, but we may grant them price adjustment credits in response to individual competitive opportunities they may have. To estimate allowances, we use statistical percentages of revenue, determined quarterly, based upon recent historical adjustment trends. We also provide allowances for certain growth-based incentives.

We provide distributors an allowance to scrap certain slow-selling or obsolete products in their inventory, estimated as a negotiated fixed percentage of each distributor’s purchases from us. In addition, if we publish a new price for a product that is lower than that paid by distributors for the same product still remaining in each distributor’s on-hand inventory, we may credit them for the difference between those prices. The allowance for this type of credit is based on the identified product price difference applied to our estimate of each distributor’s on-hand inventory of that product. We believe we can reasonably and reliably estimate allowances for credits to distributors in a timely manner.

6



We determine the amount and timing of royalty revenue based on our contractual agreements with intellectual property licensees. We recognize royalty revenue when earned under the terms of the agreements and when we consider realization of payment to be probable. Where royalties are based on a percentage of licensee sales of royalty-bearing products, we recognize royalty revenue by applying this percentage to our estimate of applicable licensee sales. We base this estimate on historical experience and an analysis of each licensee’s sales results. Where royalties are based on fixed payment amounts, we recognize royalty revenue ratably over the term of the royalty agreement. Where warranted, revenue from licensees may be recognized on a cash basis.

We include shipping and handling costs in COR.

Advertising costs
We expense advertising and other promotional costs as incurred. This expense was $46 million in 2012, $43 million in 2011 and $44 million in 2010.

Income taxes
We account for income taxes using an asset and liability approach. We record the amount of taxes payable or refundable for the current year and the deferred tax assets and liabilities for future tax consequences of events that have been recognized in the financial statements or tax returns. We record a valuation allowance when it is more likely than not that some or all of the deferred tax assets will not be realized.

Other assessed taxes
Some transactions require us to collect taxes such as sales, value-added and excise taxes from our customers. These transactions are presented in our statements of income on a net (excluded from revenue) basis.

Earnings per share (EPS)
Unvested awards of share-based payments with rights to receive dividends or dividend equivalents, such as our restricted stock units (RSUs), are considered to be participating securities and the two-class method is used for purposes of calculating EPS. Under the two-class method, a portion of net income is allocated to these participating securities and, therefore, is excluded from the calculation of EPS allocated to common stock, as shown in the table below. 

Computation and reconciliation of earnings per common share are as follows (shares in millions):
 
 
2012
 
2011
 
2010
 
 
Net Income
 
Shares
 
EPS
 
Net Income
 
Shares
 
EPS
 
Net Income
 
Shares
 
EPS
Basic EPS:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Net income
 
$
1,759

 
 
 
 
 
$
2,236

 
 
 
 
 
$
3,228

 
 
 
 
Less income allocated to RSUs
 
(31
)
 
 
 
 
 
(35
)
 
 
 
 
 
(44
)
 
 
 
 
Income allocated to common stock for basic EPS calculation
 
$
1,728

 
1,132

 
$
1.53

 
$
2,201

 
1,151

 
$
1.91

 
$
3,184

 
1,199

 
$
2.66

 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Adjustment for dilutive shares:
 
 

 
 

 
 

 
 

 
 

 
 

 
 

 
 

 
 

Stock-based compensation plans
 
 

 
14

 
 

 
 

 
20

 
 

 
 

 
14

 
 

 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Diluted EPS:
 
 

 
 

 
 

 
 

 
 

 
 

 
 

 
 

 
 

Net income
 
$
1,759

 
 

 
 

 
$
2,236

 
 

 
 

 
$
3,228

 
 

 
 

Less income allocated to RSUs
 
(31
)
 
 

 
 

 
(34
)
 
 

 
 

 
(44
)
 
 

 
 

Income allocated to common stock for diluted EPS calculation
 
$
1,728

 
1,146

 
$
1.51

 
$
2,202

 
1,171

 
$
1.88

 
$
3,184

 
1,213

 
$
2.62

 
Potentially dilutive securities representing 52 million, 24 million and 66 million shares of common stock that were outstanding during 2012, 2011 and 2010, respectively, were excluded from the computation of diluted earnings per common share for these periods because their effect would have been anti-dilutive.


7


Investments
We present investments on our balance sheets as cash equivalents, short-term investments or long-term investments. Specific details are as follows:

Cash equivalents and short-term investments: We consider investments in debt securities with maturities of 90 days or less from the date of our investment to be cash equivalents. We consider investments in debt securities with maturities beyond 90 days from the date of our investment as being available for use in current operations and include these investments in short-term investments. The primary objectives of our cash equivalent and short-term investment activities are to preserve capital and maintain liquidity while generating appropriate returns.
Long-term investments: Long-term investments consist of mutual funds, venture capital funds and non-marketable equity securities. Prior to the fourth quarter of 2012, this also included auction-rate securities.
Classification of investments: Depending on our reasons for holding the investment and our ownership percentage, we classify investments in securities as available for sale, trading, or equity- or cost-method investments, which are more fully described in Note 9. We determine cost or amortized cost, as appropriate, on a specific identification basis.

Inventories
Inventories are stated at the lower of cost or estimated net realizable value. Cost is generally computed on a currently adjusted standard cost basis, which approximates cost on a first-in first-out basis. Standard cost is based on the normal utilization of installed factory capacity. Cost associated with underutilization of capacity is expensed as incurred. Inventory held at consignment locations is included in our finished goods inventory. Consigned inventory was $169 million and $129 million as of December 31, 2012 and 2011, respectively.

We review inventory quarterly for salability and obsolescence. A specific allowance is provided for inventory considered unlikely to be sold. Remaining inventory includes a salability and obsolescence allowance based on an analysis of historical disposal activity. We write off inventory in the period in which disposal occurs.

Property, plant and equipment; acquisition-related intangibles and other capitalized costs
Property, plant and equipment are stated at cost and depreciated over their estimated useful lives using the straight-line method. Our cost basis includes certain assets acquired in business combinations that were initially recorded at fair value as of the date of acquisition. Leasehold improvements are amortized using the straight-line method over the shorter of the remaining lease term or the estimated useful lives of the improvements. We amortize acquisition-related intangibles on a straight-line basis over the estimated economic life of the assets. Capitalized software licenses generally are amortized on a straight-line basis over the term of the license. Fully depreciated or amortized assets are written off against accumulated depreciation or amortization.

Impairments of long-lived assets
We regularly review whether facts or circumstances exist that indicate the carrying values of property, plant and equipment or other long-lived assets, including intangible assets, are impaired. We assess the recoverability of assets by comparing the projected undiscounted net cash flows associated with those assets to their respective carrying amounts. Any impairment charge is based on the excess of the carrying amount over the fair value of those assets. Fair value is determined by available market valuations, if applicable, or by discounted cash flows.

Goodwill and indefinite-lived intangibles
Goodwill is not amortized but is reviewed for impairment annually or more frequently if certain impairment indicators arise. We perform our annual goodwill impairment tests as of October 1 for our reporting units. The test compares the fair value for each reporting unit to its associated carrying value including goodwill. See Note 10 for additional information.

Foreign currency
The functional currency for our non-U.S. subsidiaries is the U.S. dollar. Accounts recorded in currencies other than the U.S. dollar are remeasured into the functional currency. Current assets (except inventories), deferred income taxes, other assets, current liabilities and long-term liabilities are remeasured at exchange rates in effect at the end of each reporting period. Property, plant and equipment with associated depreciation and inventories are remeasured at historic exchange rates. Revenue and expense accounts other than depreciation for each month are remeasured at the appropriate daily rate of exchange. Currency exchange gains and losses from remeasurement are credited or charged to OI&E.

Derivatives and hedging
In connection with the issuance of variable-rate long-term debt in May 2011, as more fully described in Note 12, we entered into an interest rate swap designated as a hedge of the variability of cash flows related to interest payments. Gains and losses from changes in the fair value of the interest rate swap are credited or charged to Accumulated other comprehensive income (loss), net of taxes (AOCI).

8



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

We do not use derivatives for speculative or trading purposes.

Changes in accounting standards
As of December 31, 2012, the Financial Accounting Standards Board had issued several accounting standards that we have not yet been required to adopt. None of these standards would have a material effect on our financial condition, results of operations or financial disclosures.

2. Acquisition-related charges
National acquisition
On September 23, 2011, we completed the acquisition of National by acquiring all issued and outstanding common shares in exchange for total consideration of $6.56 billion. We recognized $3.528 billion of goodwill, which was applied to the Analog segment. None of the goodwill related to the National acquisition was deductible for tax purposes.

We incurred various costs as a result of the acquisition of National that are included in Other consistent with how management measures the performance of its segments. These total acquisition-related charges are as follows:
 
 
For Years Ended
December 31,
 
 
2012
 
2011
Distributor contract termination
 
$
21

 
$

Inventory related
 

 
96

Property, plant and equipment related
 

 
15

As recorded in COR
 
21

 
111

Amortization of intangible assets
 
325

 
87

Retention bonuses
 
57

 
46

Stock-based compensation
 
17

 
50

Severance and other benefits:
 
 
 
 
Employment reductions announced at closing
 
16

 
29

Change of control
 

 
41

Transaction and other costs
 
35

 
62

As recorded in Acquisition charges
 
450

 
315

Total acquisition-related charges
 
$
471

 
$
426


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

At acquisition, we recognized costs associated with the adjustments to write up the value of acquired inventory and property, plant and equipment to fair value. These costs are in addition to the normal expensing of the acquired assets based on their carrying or book value prior to the acquisition. The total fair-value write-up of $96 million for the acquired inventory was expensed as that inventory was sold. The total fair-value write-up for the acquired property, plant and equipment was $436 million. In the fourth quarter of 2011, depreciation was $15 million. It continues at a declining rate and is no longer separately disclosed as an acquisition-related charge.

The amount of recognized amortization of acquired intangible assets resulting from the National acquisition is based on estimated useful lives varying between two and ten years. See Note 10 for additional information.

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

9



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

Severance and other benefits costs were for former National employees who were terminated after the closing date. These costs totaled $70 million for the year ended December 31, 2011, with $41 million in charges related to change of control provisions under existing employment agreements and $29 million in charges for announced employment reductions affecting about 350 jobs. All of these jobs were eliminated by the end of 2012 as a result of redundancies and cost efficiency measures, with approximately $16 million of additional expense recognized in 2012. Of the $86 million in cumulative charges recognized through December 31, 2012, $65 million was paid in 2012 and $14 million was paid in 2011.

Transaction and other costs include various expenses incurred in connection with the National acquisition. In 2011, we also incurred bridge financing costs.

In conformance with Accounting Standards Codification (ASC) 805 – Business Combinations, the following unaudited summaries of pro forma combined results of operation for the years ended December 31, 2011 and 2010, give effect to the acquisition as if it had been completed on January 1, 2010. These pro forma summaries do not reflect any operating efficiencies, cost savings or revenue enhancements that may be achieved by the combined companies. In addition, certain non-recurring expenses, such as restructuring charges and retention bonuses, are not reflected in the pro forma summaries. These pro forma summaries are presented for informational purposes only and are not indicative of what the actual results of operations would have been had the acquisition taken place as of that date, nor are they indicative of future consolidated results of operations.
 
 
For Years Ended
December 31,
 
 
2011
 
2010
 
 
(Unaudited)
Revenue
 
$
14,805

 
$
15,529

Net income
 
2,438

 
3,218

Earnings per common share – diluted
 
$
2.05

 
$
2.61


Other acquisitions
In October 2010, we acquired our first semiconductor manufacturing site in China, located in the Chengdu High-tech Zone. This acquisition, which was recorded as a business combination, used net cash of $140 million. As contractually agreed, we made an additional payment of $35 million to the seller in October 2011.

In August 2010, we completed the acquisition of two wafer fabs and equipment in Aizu-Wakamatsu, Japan, for net cash of $130 million. The acquisition of the fabs and related 200-millimeter equipment was recorded as a business combination for net cash of $59 million. We also settled a contractual arrangement with a third party for our benefit for net cash of $12 million, which was recorded as a charge in COR in Other. Additionally, we incurred acquisition-related costs of $1 million, which were recorded in SG&A. This acquisition also included 300-millimeter production tools, which we recorded as a capital purchase for net cash of $58 million.
  
The results of operations for these acquisitions have been included in our financial statements from their respective acquisition dates. Operating results for transitional supply agreements are included in Other. Pro forma financial information for these acquisitions would not be materially different from amounts reported.


10


3. Restructuring charges/other
Restructuring charges/other is comprised of the following components:
 
For Years Ended
December 31,
 
2012
 
2011
 
2010
Restructuring charges by action:
 
 
 
 
 
Restructuring charges
$
261

 
$

 
$

Goodwill impairment
90

 

 

2012 Wireless action
351

 

 

2011 action
49

 
112

 

2008/2009 actions

 

 
33

 
 
 
 
 
 
Other:
 
 
 
 
 
Gain on transfer of Japan substitutional pension
(144
)
 

 

Gain on divested product line

 

 
(144
)
Other
8

 

 

Restructuring charges/other
$
264

 
$
112

 
$
(111
)

Restructuring charges/other recognized by segment are as follows:
 
 
For Years Ended
December 31,
 
 
2012
 
2011
 
2010
Analog
 
$

 
$

 
$
13

Embedded Processing
 

 

 
6

Wireless
 
351

 

 
10

Other
 
(87
)
 
112

 
(140
)
Total
 
$
264

 
$
112

 
$
(111
)

Restructuring charges
Restructuring charges may consist of voluntary or involuntary severance-related charges, asset-related charges and other costs to exit activities. We recognize voluntary termination benefits when the employee accepts the offered benefit arrangement. We recognize involuntary severance-related charges depending on whether the termination benefits are provided under an ongoing benefit arrangement or under a one-time benefit arrangement. If the former, we recognize the charges once they are probable and the amounts are estimable. If the latter, we recognize the charges once the benefits have been communicated to employees.

Restructuring activities associated with assets are recorded as an adjustment to the basis of the asset, not as a liability. When we commit to a plan to abandon a long-lived asset before the end of its previously estimated useful life, we accelerate the recognition of depreciation to reflect the use of the asset over its shortened useful life. When an asset is held to be sold, we write down the carrying value to its net realizable value and cease depreciation. Restructuring actions may be viewed as an impairment indicator requiring testing of the recoverability of intangible assets, including goodwill.

2012 Wireless action
In November 2012, we announced an action concerning our Wireless business that, when complete, is expected to reduce annualized expenses by about $450 million and will focus our investments on embedded markets with greater potential for sustainable growth. About 1,700 jobs worldwide are expected to be eliminated. The total restructuring charges related to this action will be about $360 million, of which about $245 million will be for severance and related benefits. We recognized $351 million of these costs in the fourth quarter of 2012 consisting of: $245 million for severance and benefit costs and other non-cash items of $3 million of accelerated depreciation of the affected facilities' assets, $13 million for other exit costs and $90 million for the non-tax deductible impairment of goodwill. See Note 10 for additional information on the goodwill impairment charge. We estimate that this action will be substantially complete by the end of 2013. As of December 31, 2012, $4 million has been paid to terminated employees for severance and benefits related to this action.


11


2011 action
Beginning in the fourth quarter of 2011, we recognized restructuring charges associated with the announced plans to close two older semiconductor manufacturing facilities in Hiji, Japan, and Houston, Texas, in 2013. Each facility employed about 500 people. The total charge for these closures is estimated at $215 million, of which $161 million has been recognized through December 31, 2012, consisting of: $113 million for severance and benefit costs, $23 million of accelerated depreciation of the facilities’ assets and $25 million for other exit costs. Of the estimated $215 million total cost, about $135 million will be for severance and related benefits, about $30 million will be for accelerated depreciation of facility assets and about $50 million will be for other exit costs. In 2012, $11 million was paid to terminated employees for severance and benefits related to this action.

The restructuring action related to the acquisition of National is discussed in Note 2 and is reflected in Acquisition charges in our Consolidated statements of income.

2008/2009 actions
In October 2008, we announced actions to reduce expenses in our Wireless segment, especially our baseband operation. In January 2009, we announced actions that included broad-based employment reductions to align our spending with weakened demand. Combined, these actions eliminated about 3,900 jobs; they were completed in 2009.

The table below reflects the changes in accrued restructuring balances associated with these actions:
 
 
2012 Action
 
2011 Action
 
2008/2009 Actions
 
 
 
 
Severance
and Benefits
 
Other
Charges
 
Severance
and Benefits
 
Other
Charges
 
Severance
and Benefits
 
Other
Charges
 
Total
Accrual at December 31, 2009
 
$

 
$

 
$

 
$

 
$
84

 
$
10

 
$
94

Restructuring charges
 

 

 

 

 
33

 

 
33

Non-cash items (a)
 

 

 

 

 
(33
)
 

 
(33
)
Payments
 

 

 

 

 
(62
)
 
(2
)
 
(64
)
Remaining accrual at December 31, 2010
 

 

 

 

 
22

 
8

 
30

 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Restructuring charges
 

 

 
107

 
5

 

 

 
112

Non-cash items (a)
 

 

 
(11
)
 
(5
)
 

 

 
(16
)
Payments
 

 

 

 

 
(9
)
 
(1
)
 
(10
)
Remaining accrual at December 31, 2011
 

 

 
96

 

 
13

 
7

 
116

 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Restructuring charges
 
245

 
106

 
6

 
43

 

 

 
400

Non-cash items (a)
 

 
(106
)
 
3

 
(18
)
 

 

 
(121
)
Payments
 
(4
)
 

 
(11
)
 
(22
)
 
(8
)
 
(1
)
 
(46
)
Remaining accrual at December 31, 2012
 
$
241

 
$

 
$
94

 
$
3

 
$
5

 
$
6

 
$
349

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

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

Other
Gain on transfer of Japan substitutional pension
During the third quarter of 2012, we transferred the obligations and assets of the substitutional portion of our Japan pension program from the pension trust to the government of Japan, resulting in a net gain of $144 million. See Note 11 for additional details.


12


Gain on divested product line
In November 2010, we divested a product line previously included in Other for $148 million and recognized a gain in operating profit of $144 million.

4. Losses associated with the 2011 earthquake in Japan
On March 11, 2011, a magnitude 9.0 earthquake struck near two of our three semiconductor manufacturing facilities in Japan. Our manufacturing site in Miho suffered substantial damage during the earthquake, our facility in Aizu experienced significantly less damage and our site in Hiji was undamaged. We maintain earthquake insurance policies in Japan for limited coverage for property damage and business interruption losses.

In 2011, we incurred cumulative gross operating losses of $101 million related to the earthquake and associated events in Japan. These losses related to property damage, the underutilization expense we incurred from having our manufacturing assets only partially loaded and costs associated with recovery teams assembled from across the world. Gross operating losses do not comprehend any lost revenue.

These losses have been offset by $36 million in cumulative insurance proceeds related to property damage claims ($23 million received in 2011 and $13 million for 2012). Almost all of these costs and proceeds are included in COR in our Consolidated statements of income and are recorded in Other.

In addition, we recognized $172 million in cumulative insurance proceeds through December 31, 2012, ($135 million received in 2012 and $37 million received in 2011) related to business interruption claims. These proceeds are recorded as revenue in our Consolidated statements of income and in Other.

In the third quarter of 2012, we completed discussions with our insurers and their advisors, settling all associated claims against our policies. All claims related to these events have been settled and the proceeds received.

5. Stock-based compensation
We have stock options outstanding to participants under various long-term incentive plans. We also have assumed stock options that were granted by companies that we later acquired. Unless the options are acquisition-related replacement options, the option price per share may not be less than 100 percent of the fair market value of our common stock on the date of the grant. Substantially all the options have a ten-year term and vest ratably over four years. Our options generally continue to vest after the option recipient retires.

We also have RSUs outstanding under the long-term incentive plans. Each RSU represents the right to receive one share of TI common stock on the vesting date, which is generally four years after the date of grant. Upon vesting, the shares are issued without payment by the grantee. RSUs generally do not continue to vest after the recipient’s retirement date. Holders of most RSUs receive an annual cash payment equal to the dividends paid on our common stock.

We have options and RSUs outstanding to non-employee directors under various director compensation plans. The plans generally provide for annual grants of stock options and RSUs, a one-time grant of RSUs to each new non-employee director and the issuance of TI common stock upon the distribution of stock units credited to deferred compensation accounts established for such directors.

We also have an employee stock purchase plan under which options are offered to all eligible employees in amounts based on a percentage of the employee’s compensation, subject to a cap. Under the plan, the option price per share is 85 percent of the fair market value on the exercise date, and options have a three-month term.


13


Total stock-based compensation expense recognized was as follows:
 
 
For Years Ended
 December 31,
 
 
2012
 
2011
 
2010
Stock-based compensation expense recognized in:
 
 
 
 
 
 
Cost of revenue (COR)
 
$
48

 
$
40

 
$
36

Research and development (R&D)
 
71

 
58

 
53

Selling, general and administrative (SG&A)
 
127

 
121

 
101

Acquisition charges
 
17

 
50

 

Total
 
$
263

 
$
269

 
$
190


These amounts include expense related to non-qualified stock options, RSUs and stock options offered under our employee stock purchase plan and are net of expected forfeitures.

We issue awards of non-qualified stock options generally with graded vesting provisions (e.g., 25 percent per year for four years). We recognize the related compensation cost on a straight-line basis over the minimum service period required for vesting of the award. For awards to employees who are retirement eligible or nearing retirement eligibility, we recognize compensation cost on a straight-line basis over the longer of the service period required to be performed by the employee in order to earn the award, or a six-month period.

Our RSUs generally vest four years after the date of grant. We recognize the related compensation costs on a straight-line basis over the vesting period.

Fair-value methods and assumptions
We account for all awards granted under our various stock-based compensation plans at fair value. We estimate the fair values for non-qualified stock options under long-term incentive and director compensation plans using the Black-Scholes option-pricing model with the following weighted average assumptions.
 
 
2012
 
2011
 
2010
Weighted average grant date fair value, per share
 
$
8.31

 
$
10.37

 
$
6.61

Weighted average assumptions used:
 
 
 
 

 
 

Expected volatility
 
30
%
 
30
%
 
32
%
Expected lives (in years)
 
7.1

 
6.9

 
6.4

Risk-free interest rates
 
1.40
%
 
2.61
%
 
2.83
%
Expected dividend yields
 
2.10
%
 
1.51
%
 
2.08
%

We determine expected volatility on all options granted after July 1, 2005, using available implied volatility rates. We believe that market-based measures of implied volatility are currently the best available indicators of the expected volatility used in these estimates.

We determine expected lives of options based on the historical option exercise experience of our optionees using a rolling ten-year average. We believe the historical experience method is the best estimate of future exercise patterns currently available.

Risk-free interest rates are determined using the implied yield currently available for zero-coupon U.S. government issues with a remaining term equal to the expected life of the options.

Expected dividend yields are based on the approved annual dividend rate in effect and the current market price of our common stock at the time of grant. No assumption for a future dividend rate change is included unless there is an approved plan to change the dividend in the near term.

The fair value per share of RSUs that we grant is determined based on the closing price of our common stock on the date of grant.


14


Our employee stock purchase plan is a discount-purchase plan and consequently the Black-Scholes option-pricing model is not used to determine the fair value per share of these awards. The fair value per share under this plan equals the amount of the discount.

Long-term incentive and director compensation plans
Stock option and RSU transactions under our long-term incentive and director compensation plans during 2012 were as follows:
 
 
Stock Options
 
RSUs
 
 
Shares
 
Weighted Average
Exercise Price
per Share
 
Shares
 
Weighted Average
Grant Date Fair
Value per Share
Outstanding grants, December 31, 2011
 
113,273,394

 
$
25.79

 
23,358,846

 
$
25.09

Granted
 
13,508,034

 
32.35

 
5,617,150

 
31.60

Vested RSUs
 

 

 
(4,182,928
)
 
28.66

Expired and forfeited
 
(4,732,514
)
 
29.78

 
(1,417,834
)
 
26.76

Exercised
 
(22,409,816
)
 
20.32

 

 

Outstanding grants, December 31, 2012
 
99,639,098

 
$
27.73

 
23,375,234

 
$
25.91


The weighted average grant date fair value of RSUs granted during the years 2012, 2011 and 2010 was $31.60, $33.20 and $23.47 per share, respectively. For the years ended December 31, 2012, 2011 and 2010, the total fair value of shares vested from RSU grants was $120 million, $155 million and $51 million, respectively.

Summarized information about stock options outstanding at December 31, 2012, is as follows:
 
 
 
Stock Options Outstanding
 
Options Exercisable
Range of
Exercise
Price
 
Number
Outstanding
(Shares)
 
Weighted Average
Remaining Contractual
Life (Years)
 
Weighted Average
Exercise Price per
Share
 
Number
Exercisable
(Shares)
 
Weighted Average
Exercise Price per
Share
$
9.56 to 10.00
 
4,882

 
0.8
 
$
9.56

 
4,882

 
$
9.56

 
10.01 to 20.00
 
13,179,570

 
4.5
 
15.32

 
9,619,657

 
15.43

 
20.01 to 30.00
 
34,637,310

 
4.8
 
24.86

 
27,154,258

 
25.33

 
30.01 to 38.40
 
51,817,336

 
4.9
 
32.81

 
31,755,628

 
32.59

$
9.56 to 38.40
 
99,639,098

 
4.8
 
$
27.73

 
68,534,425

 
$
27.30


During the years ended December 31, 2012, 2011 and 2010, the aggregate intrinsic value (i.e., the difference in the closing market price and the exercise price paid by the optionee) of options exercised was $244 million, $231 million and $140 million, respectively.

Summarized information as of December 31, 2012, about outstanding stock options that are vested and expected to vest, as well as stock options that are currently exercisable, is as follows:
 
 
Outstanding Stock Options (Fully
Vested and Expected to Vest) (a)
 
Options
Exercisable
Number of outstanding (shares)
 
96,121,395

 
68,534,425

Weighted average remaining contractual life (in years)
 
4.7

 
3.3

Weighted average exercise price per share
 
$
28.75

 
$
27.30

Intrinsic value (millions of dollars)
 
$
398

 
$
300

(a) Includes effects of expected forfeitures of approximately 4 million shares. Excluding the effects of expected forfeitures, the aggregate intrinsic value of stock options outstanding was $414 million.

As of December 31, 2012, the total future compensation cost related to equity awards not yet recognized in the Consolidated statements of income was $460 million, consisting of $143 million related to unvested stock options and $317 million related to RSUs. The $460 million will be recognized as follows: $205 million in 2013, $153 million in 2014, $94 million in 2015 and $8 million in 2016.


15


Employee stock purchase plan
Options outstanding under the employee stock purchase plan at December 31, 2012, had an exercise price of $27.47 per share (85 percent of the fair market value of TI common stock on the date of automatic exercise). Of the total outstanding options, none were exercisable at year-end 2012.

Employee stock purchase plan transactions during 2012 were as follows:
 
 
Employee Stock
Purchase Plan
(Shares)
 
Exercise Price
Outstanding grants, December 31, 2011
 
580,095

 
$
25.29

Granted
 
2,931,354

 
25.64

Exercised
 
(2,829,498
)
 
25.12

Outstanding grants, December 31, 2012
 
681,951

 
$
27.47


The weighted average grant date fair value of options granted under the employee stock purchase plans during the years 2012, 2011 and 2010 was $4.52, $4.59 and $3.97 per share, respectively. During the years ended December 31, 2012, 2011 and 2010, the total intrinsic value of options exercised under these plans was $13 million, $10 million and $9 million, respectively.

Effect on shares outstanding and treasury shares
Our practice is to issue shares of common stock upon exercise of stock options generally from treasury shares and, on a limited basis, from previously unissued shares. We settled stock option plan exercises using treasury shares of 25,064,951 in 2012; 27,308,311 in 2011 and 19,077,274 in 2010; and previously unissued common shares of 180,955 in 2012; 390,438 in 2011 and 342,380 in 2010.

Upon vesting of RSUs, we issued treasury shares of 3,187,490 in 2012; 3,748,623 in 2011 and 1,392,790 in 2010, and previously unissued common shares of 4,593 in 2012; 73,852 in 2011, with none in 2010.

Shares available for future grant and reserved for issuance are summarized below:
 
 
As of December 31, 2012
Shares
 
Long-term Incentive
and Director
Compensation Plans
 
Employee Stock
Purchase Plan
 
Total
Reserved for issuance (a)
 
197,554,600

 
25,137,819

 
222,692,419

Shares to be issued upon exercise of outstanding options and RSUs
 
(123,143,365
)
 
(681,951
)
 
(123,825,316
)
Available for future grants
 
74,411,235

 
24,455,868

 
98,867,103

(a) Includes 129,033 shares credited to directors’ deferred compensation accounts that settle in shares of TI common stock. These shares are not included as grants outstanding at December 31, 2012.

Effect on cash flows
Cash received from the exercise of options was $523 million in 2012, $690 million in 2011 and $407 million in 2010. The related net tax impact realized was $56 million, $45 million and $21 million (which includes excess tax benefits realized of $38 million, $31 million and $13 million) in 2012, 2011 and 2010, respectively.
 
6. Profit sharing plans
Profit sharing benefits are generally formulaic and determined by one or more subsidiary or company-wide financial metrics. We pay profit sharing benefits primarily under the company-wide TI Employee Profit Sharing Plan. This plan provides for profit sharing to be paid based solely on TI’s operating margin for the full calendar year. Under this plan, TI must achieve a minimum threshold of 10 percent operating margin before any profit sharing is paid. At 10 percent operating margin, profit sharing will be 2 percent of eligible payroll. The maximum amount of profit sharing available under the plan is 20 percent of eligible payroll, which is paid only if TI’s operating margin is at or above 35 percent for a full calendar year.

We recognized $96 million, $143 million and $279 million of profit sharing expense under the TI Employee Profit Sharing Plan in 2012, 2011 and 2010, respectively.


16


7. Income taxes
Income before income taxes
 
 
U.S.
 
Non-U.S.
 
Total
2012
 
$
319

 
$
1,616

 
$
1,935

2011
 
1,791

 
1,164

 
2,955

2010
 
3,769

 
782

 
4,551

 
Provision (benefit) for income taxes
 
 
U.S. Federal
 
Non-U.S.
 
U.S. State
 
Total
2012:
 
 
 
 
 
 
 
 
Current
 
$
(43
)
 
$
156

 
$
(2
)
 
$
111

Deferred
 

 
65

 

 
65

Total
 
$
(43
)
 
$
221

 
$
(2
)
 
$
176

 
 
 
 
 
 
 
 
 
2011:
 
 

 
 

 
 

 
 

Current
 
$
692

 
$
138

 
$
8

 
$
838

Deferred
 
(154
)
 
24

 
11

 
(119
)
Total
 
$
538

 
$
162

 
$
19

 
$
719

 
 
 
 
 
 
 
 
 
2010:
 
 

 
 

 
 

 
 

Current
 
$
1,401

 
$
92

 
$
18

 
$
1,511

Deferred
 
(188
)
 
(2
)
 
2

 
(188
)
Total
 
$
1,213

 
$
90

 
$
20

 
$
1,323


Principal reconciling items from income tax computed at the statutory federal rate follow:
 
 
2012
 
2011
 
2010
Computed tax at statutory rate
 
$
677

 
$
1,034

 
$
1,593

Non-U.S. effective tax rates
 
(345
)
 
(245
)
 
(184
)
U.S. tax benefit for manufacturing
 
(158
)
 
(31
)
 
(63
)
Impact of changes to uncertain tax positions
 
(88
)
 

 

Non-deductible expenses
 
42

 
27

 
10

U.S. R&D tax credit
 

 
(58
)
 
(54
)
Other
 
48

 
(8
)
 
21

Total provision for income taxes
 
$
176

 
$
719

 
$
1,323


The total provision for 2012 in the reconciliation above includes $252 million of discrete tax benefits primarily for additional U.S. tax benefits for manufacturing related to the years 2000 through 2011.


17


The primary components of deferred income tax assets and liabilities were as follows:
 
 
December 31,
 
 
2012
 
2011
Deferred income tax assets:
 
 
 
 
Inventories and related reserves
 
$
734

 
$
913

Deferred loss and tax credit carryforwards
 
382

 
400

Stock-based compensation
 
366

 
357

Postretirement benefit costs recognized in AOCI
 
357

 
431

Accrued expenses
 
331

 
322

Other
 
209

 
122

 
 
2,379

 
2,545

Less valuation allowance
 
(221
)
 
(178
)
 
 
2,158

 
2,367

Deferred income tax liabilities:
 
 
 
 

Acquisition-related intangibles and fair-value adjustments
 
(921
)
 
(1,030
)
Accrued retirement costs (defined benefit and retiree health care)
 
(243
)
 
(180
)
Property, plant and equipment
 
(131
)
 
(141
)
International earnings
 
(102
)
 
(92
)
Other
 
(11
)
 
(36
)
 
 
(1,408
)
 
(1,479
)
Net deferred income tax asset
 
$
750

 
$
888


The deferred income tax assets and liabilities based on tax jurisdictions are presented on the Consolidated balance sheets as follows:
 
 
December 31,
 
 
2012
 
2011
Current deferred income tax assets
 
$
1,044

 
$
1,174

Noncurrent deferred income tax assets
 
280

 
321

Current deferred income tax liabilities
 
(2
)
 

Noncurrent deferred income tax liabilities
 
(572
)
 
(607
)
Net deferred income tax asset
 
$
750

 
$
888


We make an ongoing assessment regarding the realization of U.S. and non-U.S. deferred tax assets. In 2012, we recognized a net increase of $43 million in our valuation allowance. This increase was due to valuation allowances on unutilized tax credits. While the net deferred tax assets of $2.16 billion at December 31, 2012, are not assured of realization, our assessment is that a valuation allowance is not required on this balance. This assessment is based on our evaluation of relevant criteria including the existence of deferred tax liabilities that can be used to absorb deferred tax assets, taxable income in prior carryback years and expectations for future taxable income.

We have U.S. and non-U.S. tax loss carryforwards of approximately $175 million, none of which will expire before the year 2023.

A provision has been made for deferred taxes on undistributed earnings of non-U.S. subsidiaries to the extent that dividend
payments from these subsidiaries are expected to result in additional tax liability. The remaining undistributed earnings (approximately $5.54 billion at December 31, 2012) have been indefinitely reinvested; therefore, no provision has been made for taxes due upon remittance of these earnings. The indefinitely reinvested earnings of our non-U.S. subsidiaries are primarily invested in tangible assets such as inventory and property, plant and equipment. Determination of the amount of unrecognized deferred income tax liability is not practical because of the complexities associated with its hypothetical calculation.

Cash payments made for income taxes, net of refunds, were $171 million, $902 million and $1.47 billion for the years ended December 31, 2012, 2011 and 2010, respectively.


18


Uncertain tax positions
We operate in a number of tax jurisdictions, and our income tax returns are subject to examination by tax authorities in those jurisdictions who may challenge any item on these tax returns. Because the matters challenged by authorities are typically complex, their ultimate outcome is uncertain. Before any benefit can be recorded in the financial statements, we must determine that it is “more likely than not” that a tax position will be sustained by the appropriate tax authorities. We recognize accrued interest related to uncertain tax positions and penalties as components of OI&E.

The changes in the total amounts of uncertain tax positions are summarized as follows:
 
 
2012
 
2011
 
2010
Balance, January 1
 
$
210

 
$
103

 
$
56

Additions based on tax positions related to the current year
 
12

 
15

 
12

Additions from the acquisition of National
 

 
132

 

Additions for tax positions of prior years
 
45

 
3

 
50

Reductions for tax positions of prior years
 
(92
)
 
(39
)
 
(12
)
Settlements with tax authorities
 
39

 
(4
)
 
(3
)
Expiration of the statute of limitations for assessing taxes
 
(30
)
 

 

Balance, December 31
 
$
184

 
$
210

 
$
103

 
 
 
 
 
 
 
Interest income (expense) recognized in the year ended December 31
 
$
32

 
$
1

 
$
(2
)
 
 
 
 
 
 
 
Interest receivable (payable) as of December 31
 
$
8

 
$
(3
)
 
$
5


The liability for uncertain tax positions is a component of Deferred credits and other liabilities on our December 31, 2012, balance sheet. The interest receivable is a component of Other assets on our December 31, 2012, balance sheet.

Within the $184 million liability for uncertain tax positions as of December 31, 2012, are positions totaling $159 million that, if recognized, would impact the tax rate. If these tax liabilities are ultimately realized, $78 million of existing deferred tax assets would also be realized, primarily related to refunds from counterparty jurisdictions resulting from procedures for relief from double taxation. Regarding the $184 million liability:

About $60 million of the liability represents uncertain tax positions for tax years in jurisdictions in which audit assessments have not been made. The liability is primarily related to transfer pricing issues for which procedures for relief from double taxation will mitigate the tax rate impact of any difference between the actual tax assessments and our estimates. The increase in the liability for transfer pricing issues for the next 12 months is expected to be about $10 million.

About $30 million of the liability represents audit assessments subject to ongoing procedures for relief from double taxation. Settlement of the $30 million is subject to timely completion of the tax treaty processes and may be settled within the next 12 months. Settlement would not have a significant tax rate impact, as the tax rates of the counterparty jurisdictions are similar.

The balance of the liability represents tax adjustments that are known and currently before the tax authorities or otherwise identified by the company as adjustments to filed returns. Settlement of these matters at the known amounts will not have any additional tax rate impact. Based on the expected settlement dates of various income tax examinations, the anticipated reduction in these uncertain tax positions during the next 12 months could range between about $30 million and $60 million.

Within the $210 million liability for uncertain tax positions as of December 31, 2011, are uncertain tax positions totaling $233 million that, if recognized, would impact the tax rate. If these tax liabilities are ultimately realized, $83 million of deferred tax assets would also be realized, primarily related to refunds from counterparty jurisdictions resulting from procedures for relief from double taxation.

As of December 31, 2012, the statute of limitations remains open for U.S. federal tax returns for 2000 and following years. Audit activities related to our U.S. federal tax returns through 2008 have been completed except for certain pending tax treaty procedures for relief from double taxation. These procedures pertain to U.S. federal tax returns for the years 2003 through 2008. U.S. federal tax returns for National are currently under audit for tax years through fiscal year 2012.

19



In non-U.S. jurisdictions, the years open to audit represent the years still open under the statute of limitations. With respect to major jurisdictions outside the U.S., our subsidiaries are no longer subject to income tax audits for years before 2005.

8. Financial instruments and risk concentration
Financial instruments
We hold derivative financial instruments such as forward foreign currency exchange contracts and interest rate swaps, the fair value of which was not material as of December 31, 2012. Our forward foreign currency exchange contracts outstanding as of December 31, 2012, had a notional value of $305 million to hedge our non-U.S. dollar net balance sheet exposures, including $140 million to sell Japanese yen, $26 million to sell Chinese yuan and $26 million to sell British pound sterling.

Our investments in cash equivalents, short-term investments and certain long-term investments, as well as our postretirement plan assets and deferred compensation liabilities are carried at fair value, which is described in Note 9. The carrying values for other current financial assets and liabilities, such as accounts receivable and accounts payable, approximate fair value due to the short maturity of such instruments. The carrying value of our long-term debt approximates the fair value as measured using broker-dealer quotes, which are Level 2 inputs. See Note 9 for the definition of Level 2 inputs.

Risk concentration
Financial instruments that could subject us to concentrations of credit risk are primarily cash, cash equivalents, short-term investments and accounts receivable. To manage our credit risk exposure, we place cash investments in investment-grade debt securities and limit the amount of credit exposure to any one issuer. We also limit counterparties on financial derivative contracts to financial institutions with investment-grade ratings.

Concentrations of credit risk with respect to accounts receivable are limited due to our large number of customers and their dispersion across different industries and geographic areas. We maintain allowances for expected returns, disputes, adjustments, incentives and collectability. These allowances are deducted from accounts receivable on our Consolidated balance sheets.

Details of these Accounts receivable allowances are as follows: