FORM 10-Q

 

 

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 October 1, 2011.

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

LOGO

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 28, 2011
Common stock, $0.001 par value   5,092 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)

   Oct. 1,
2011
    Sept. 25,
2010
    Oct. 1,
2011
    Sept. 25,
2010
 

Net revenue

   $  14,233     $  11,102     $  40,112     $  32,166  

Cost of sales

     5,215       3,781       15,307       11,081  
  

 

 

   

 

 

   

 

 

   

 

 

 

Gross margin

     9,018       7,321       24,805       21,085  
  

 

 

   

 

 

   

 

 

   

 

 

 

Research and development

     2,140       1,675       6,042       4,905  

Marketing, general and administrative

     2,017       1,506       5,697       4,604  

Amortization of acquisition-related intangibles

     76       4       188       11  
  

 

 

   

 

 

   

 

 

   

 

 

 

Operating expenses

     4,233       3,185       11,927       9,520  
  

 

 

   

 

 

   

 

 

   

 

 

 

Operating income

     4,785       4,136       12,878       11,565  

Gains (losses) on equity method investments, net

     (40     126       (148     163  

Gains (losses) on other equity investments, net

     132       (49     243       76  

Interest and other, net

     15       38       221       78  
  

 

 

   

 

 

   

 

 

   

 

 

 

Income before taxes

     4,892       4,251       13,194       11,882  

Provision for taxes

     1,424       1,296       3,612       3,598  
  

 

 

   

 

 

   

 

 

   

 

 

 

Net income

   $ 3,468     $ 2,955     $ 9,582     $ 8,284  
  

 

 

   

 

 

   

 

 

   

 

 

 

Basic earnings per common share

   $ 0.67     $ 0.53     $ 1.80     $ 1.49  
  

 

 

   

 

 

   

 

 

   

 

 

 

Diluted earnings per common share

   $ 0.65     $ 0.52     $ 1.75     $ 1.45  
  

 

 

   

 

 

   

 

 

   

 

 

 

Cash dividends declared per common share

   $ 0.4200      $ 0.3150     $ 0.7824      $ 0.6300  
  

 

 

   

 

 

   

 

 

   

 

 

 

Weighted average common shares outstanding:

        

Basic

     5,194       5,575       5,317       5,556  
  

 

 

   

 

 

   

 

 

   

 

 

 

Diluted

     5,340       5,694       5,466       5,695  
  

 

 

   

 

 

   

 

 

   

 

 

 

See accompanying notes.

 

2


INTEL CORPORATION

CONSOLIDATED CONDENSED BALANCE SHEETS (Unaudited)

 

0000000 0000000

(In Millions)

   Oct. 1,
2011
    Dec. 25,
2010
 

Assets

    

Current assets:

    

Cash and cash equivalents

   $ 7,057     $ 5,498  

Short-term investments

     3,876       11,294  

Trading assets

     4,265       5,093  

Accounts receivable, net

     3,821       2,867  

Inventories

     3,959       3,757  

Deferred tax assets

     2,011       1,488  

Other current assets

     1,709       1,614  
  

 

 

   

 

 

 

Total current assets

     26,698       31,611  
  

 

 

   

 

 

 

Property, plant and equipment, net of accumulated depreciation of $34,660 ($32,582 as of December 25, 2010)

     22,157       17,899  

Marketable equity securities

     516       1,008  

Other long-term investments

     858       3,026  

Goodwill

     9,138       4,531  

Identified intangible assets, net

     6,445       860  

Other long-term assets

     4,739       4,251  
  

 

 

   

 

 

 

Total assets

   $ 70,551     $ 63,186  
  

 

 

   

 

 

 

Liabilities and stockholders’ equity

    

Current liabilities:

    

Short-term debt

   $ 66     $ 38  

Accounts payable

     2,999       2,290  

Accrued compensation and benefits

     2,270       2,888  

Accrued advertising

     1,215       1,007  

Deferred income

     1,917       747  

Other accrued liabilities

     3,442       2,357  
  

 

 

   

 

 

 

Total current liabilities

     11,909       9,327  
  

 

 

   

 

 

 

Long-term income taxes payable

     192       190  

Long-term debt

     7,076       2,077  

Long-term deferred tax liabilities

     2,762       926  

Other long-term liabilities

     2,495       1,236  

Contingencies (Note 26)

    

Stockholders’ equity:

    

Preferred stock

              

Common stock and capital in excess of par value, 5,118 shares issued and outstanding (5,581 issued and 5,511 outstanding as of December 25, 2010)

     16,247       16,178  

Accumulated other comprehensive income (loss)

     (32     333  

Retained earnings

     29,902       32,919  
  

 

 

   

 

 

 

Total stockholders’ equity

     46,117       49,430  
  

 

 

   

 

 

 

Total liabilities and stockholders’ equity

   $ 70,551     $ 63,186  
  

 

 

   

 

 

 

See accompanying notes.

 

3


INTEL CORPORATION

CONSOLIDATED CONDENSED STATEMENTS OF CASH FLOWS (Unaudited)

 

     Nine Months Ended  

(In Millions)

   Oct. 1,
2011
    Sept. 25,
2010
 

Cash and cash equivalents, beginning of period

   $ 5,498     $ 3,987  
  

 

 

   

 

 

 

Cash flows provided by (used for) operating activities:

    

Net income

     9,582       8,284  

Adjustments to reconcile net income to net cash provided by operating activities:

    

Depreciation

     3,808       3,252  

Share-based compensation

     812       704  

Net loss on retirement of assets

     78       26  

Excess tax benefit from share-based payment arrangements

     (28     (63

Amortization of intangibles

     667       180  

(Gains) losses on equity method investments, net

     148       (163

(Gains) losses on other equity investments, net

     (243     (76

(Gains) losses on divestitures

     (164       

Deferred taxes

     589       (36

Changes in assets and liabilities:

    

Accounts receivable

     (856     (628

Inventories

     (110     (479

Accounts payable

     645       20  

Accrued compensation and benefits

     (651     (205

Income taxes payable and receivable

     194       179  

Other assets and liabilities

     (138     147  
  

 

 

   

 

 

 

Total adjustments

     4,751       2,858  
  

 

 

   

 

 

 

Net cash provided by operating activities

     14,333       11,142  
  

 

 

   

 

 

 

Cash flows provided by (used for) investing activities:

    

Additions to property, plant and equipment

     (7,920     (3,338

Acquisitions, net of cash acquired

     (8,477     (70

Purchases of available-for-sale investments

     (7,426     (11,835

Sales of available-for-sale investments

     9,052       430  

Maturities of available-for-sale investments

     8,645       8,363  

Purchases of trading assets

     (6,795     (6,761

Maturities and sales of trading assets

     7,688       5,949  

Origination of loans receivable

     (206     (421

Investments in non-marketable equity investments

     (569     (242

Return of equity method investments

     172       151  

Proceeds from divestitures

     50         

Other investing

     252       207  
  

 

 

   

 

 

 

Net cash used for investing activities

     (5,534     (7,567
  

 

 

   

 

 

 

Cash flows provided by (used for) financing activities:

    

Increase (decrease) in short-term debt, net

     28       87  

Proceeds from government grants

     56       79  

Excess tax benefit from share-based payment arrangements

     28       63  

Issuance of long-term debt

     4,962         

Proceeds from sales of shares through employee equity incentive plans

     925       535  

Repurchase of common stock

     (10,187     (222

Payment of dividends to stockholders

     (3,057     (2,624

Other financing

     (5     37  
  

 

 

   

 

 

 

Net cash used for financing activities

     (7,250     (2,045
  

 

 

   

 

 

 

Effect of exchange rate fluctuations on cash and cash equivalents

     10         
  

 

 

   

 

 

 

Net increase (decrease) in cash and cash equivalents

     1,559       1,530  
  

 

 

   

 

 

 

Cash and cash equivalents, end of period

   $ 7,057     $ 5,517  
  

 

 

   

 

 

 

Supplemental disclosures of cash flow information:

    

Cash paid during the period for:

    

Income taxes, net of refunds

   $ 2,770     $ 3,493  

See accompanying notes.

 

4


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 (GAAP), consistent in all material respects with those applied in our Annual Report on Form 10-K for the year ended December 25, 2010.

We have a 52- or 53-week fiscal year that ends on the last Saturday in December. Fiscal year 2011 is a 53-week fiscal year, and the first quarter of 2011 was a 14-week quarter. Fiscal year 2010 was a 52-week fiscal year, and the first quarter of 2010 was a 13-week quarter.

In the first quarter of 2011, we completed the acquisition of McAfee, Inc. For further information, see “Note 15: Acquisitions.” Certain of the operations acquired from McAfee have a functional currency other than the U.S. dollar. As a result, translation adjustments have been recorded through accumulated other comprehensive income (loss) beginning in 2011.

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 accounting estimates that require our most significant, difficult, and subjective judgments include:

   

the valuation of non-marketable equity investments and the determination of other-than-temporary impairments;

   

the assessment of recoverability of long-lived assets (property, plant and equipment; goodwill; and identified intangibles);

   

the recognition and measurement of current and deferred income taxes (including the measurement of uncertain tax positions);

   

the valuation of inventory; and

   

the recognition and measurement of loss contingencies.

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 25, 2010.

Note 2: Accounting Policies

We have adopted additional revenue recognition accounting policies as they apply to the acquired McAfee business. Revenue from license agreements with our McAfee business generally includes service and support agreements for which the related revenue is deferred and recognized ratably over the performance period. Revenue derived from online subscription products is deferred and recognized ratably over the performance period. Professional services revenue is recognized as services are performed or if required, upon customer acceptance. For arrangements with multiple elements, including software licenses, maintenance, and/or services, revenue is allocated across the separately identified deliverables and may be recognized or deferred. When vendor-specific objective evidence (VSOE) does not exist for undelivered elements such as maintenance and support, the entire arrangement fee is recognized ratably over the performance period. Direct costs, such as costs related to revenue-sharing and royalty arrangements associated with license arrangements, as well as component costs associated with product revenue, are deferred and amortized over the same period that the related revenue is recognized.

 

5


INTEL CORPORATION

NOTES TO CONSOLIDATED CONDENSED FINANCIAL STATEMENTS — Unaudited (Continued)

 

Note 3: Accounting Changes

In the first quarter of 2011, we adopted new standards for revenue recognition with multiple deliverables. These new standards change the determination of whether the individual deliverables included in a multiple-element arrangement may be treated as separate units for accounting purposes. Additionally, these new standards modify the method by which revenue is allocated to the separately identified deliverables. The adoption of these new standards did not have a significant impact on our consolidated condensed financial statements.

In the first quarter of 2011, we adopted new standards that remove certain tangible products and associated software from the scope of the software revenue recognition guidance. The adoption of these new standards did not have a significant impact on our consolidated condensed financial statements.

Note 4: Recent Accounting Standards

In May 2011, the Financial Accounting Standards Board (FASB) issued amended standards to achieve a consistent definition of fair value and common requirements for measurement of and disclosure about fair value between U.S. GAAP and International Financial Reporting Standards. For assets and liabilities categorized as Level 3 and recognized at fair value, these amended standards require disclosure of quantitative information about unobservable inputs, a description of the valuation processes used by the entity, and a qualitative discussion about the sensitivity of the measurements. In addition, these amended standards require that we disclose the level in the fair value hierarchy for financial instruments disclosed at fair value but not recorded at fair value. These new standards are effective for us beginning in the first quarter of 2012; early adoption of these standards is prohibited. We do not expect these new standards to significantly impact our consolidated condensed financial statements.

In June 2011, the FASB issued amended standards to increase the prominence of items reported in other comprehensive income. These amendments eliminate the option to present components of other comprehensive income as part of the statement of changes in stockholders’ equity and require that all changes in stockholders’ equity—except investments by, and distributions to, owners—be presented either in a single continuous statement of comprehensive income or in two separate but consecutive statements. In addition, these amendments require that we present on the face of the financial statements reclassification adjustments for items that are reclassified from other comprehensive income to net income in the statement(s) where the components of net income and the components of other comprehensive income are presented. These new standards are effective for us beginning in the first quarter of 2012 and are to be applied retrospectively. These amended standards will impact the presentation of other comprehensive income but will not impact our financial position or results of operations. We do not expect these new standards to significantly impact our consolidated condensed financial statements.

In September 2011, the FASB issued amended standards to simplify how entities test goodwill for impairment. These amended standards permit an assessment of qualitative factors to determine whether it is more likely than not that the fair value of a reporting unit in which goodwill resides is less than its carrying value. For reporting units in which this assessment concludes it is more likely than not that the fair value is more than its carrying value, these amended standards eliminate the requirement to perform further goodwill impairment testing as outlined in the previously issued standards. These amended standards are effective for us beginning in the first quarter of 2012; however, we plan to early adopt in the fourth quarter. We do not expect these new standards to significantly impact our consolidated condensed financial statements.

 

6


INTEL CORPORATION

NOTES TO CONSOLIDATED CONDENSED FINANCIAL STATEMENTS — Unaudited (Continued)

 

Note 5: 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 and liabilities are measured and recorded at fair value, except for equity method investments, cost method investments, cost method loans receivable, and most of our liabilities.

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 markets with insufficient volume or infrequent transactions (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.

Marketable Debt Instruments

Marketable debt instruments include instruments such as commercial paper, corporate bonds, government bonds, bank deposits, asset-backed securities, municipal bonds, and money market fund deposits. When we use observable market prices for identical securities that are traded in less active markets, we classify our marketable debt instruments as Level 2. When observable market prices for identical securities are not available, we price our marketable debt instruments using non-binding market consensus prices that are corroborated with observable market data; quoted market prices for similar instruments; or pricing models, such as a discounted cash flow model, with all significant inputs derived from or corroborated with observable market data. Non-binding market consensus prices are based on the proprietary valuation models of pricing providers or brokers. These valuation models incorporate a number of inputs, including non-binding and binding broker quotes; observable market prices for identical or similar securities; and the internal assumptions of pricing providers or brokers that use observable market inputs and, to a lesser degree, unobservable market inputs. We corroborate non-binding market consensus prices with observable market data using statistical models when observable market data exists. The discounted cash flow model uses observable market inputs, such as LIBOR-based yield curves, currency spot and forward rates, and credit ratings.

Our marketable debt instruments that are classified as Level 3 are classified as such due to the lack of observable market data to corroborate either the non-binding market consensus prices or the non-binding broker quotes. When observable market data is not available, we corroborate non-binding market consensus prices and non-binding broker quotes using available unobservable data.

 

7


INTEL CORPORATION

NOTES TO CONSOLIDATED CONDENSED FINANCIAL STATEMENTS — Unaudited (Continued)

 

Assets/Liabilities Measured and Recorded at Fair Value on a Recurring Basis

Assets and liabilities measured and recorded at fair value on a recurring basis consisted of the following types of instruments as of October 1, 2011 and December 25, 2010:

 

00000 00000 00000 00000 00000 00000 00000 00000
     October 1, 2011      December 25, 2010  
     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:

                       

Commercial paper

   $       $ 3,457      $       $ 3,457      $       $ 2,600      $       $ 2,600  

Government bonds

     1,650                        1,650        1,279        505                1,784  

Bank deposits

             499                499                560                560  

Money market fund deposits

     463                        463        34                        34  

Short-term investments:

                       

Commercial paper

             2,403                2,403                2,712                2,712  

Corporate bonds

     144        525        7        676        121        1,378        1        1,500  

Government bonds

     82        373                455        4,890        1,320                6,210  

Bank deposits

             342                342                858                858  

Asset-backed securities

                                                     14        14  

Trading assets:

                       

Government bonds

     883        1,683                2,566        311        2,115                2,426  

Corporate bonds

     201        540                741        199        916                1,115  

Commercial paper

             404                404                488                488  

Municipal bonds

             288                288                375                375  

Asset-backed securities

                     130        130                        190        190  

Bank deposits

             89                89                108                108  

Money market fund deposits

     41                        41        3                        3  

Marketable equity securities

     6                        6        388                        388  

Other current assets:

                       

Derivative assets

             224                224                330                330  

Loans receivable

             34                34                                  

Marketable equity securities

     448        68                516        785        223                1,008  

Other long-term investments:

                       

Corporate bonds

     34        340        59        433        104        601        50        755  

Government bonds

             300                300        83        2,002                2,085  

Bank deposits

             75                75                133                133  

Asset-backed securities

                     50        50                        53        53  

Other long-term assets:

                       

Loans receivable

             745                745                642                642  

Derivative assets

             20        30        50                19        31        50  
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Total assets measured and recorded at fair value

   $ 3,952      $ 12,409      $ 276      $ 16,637      $ 8,197      $ 17,885      $ 339      $ 26,421  
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Liabilities

                       

Other accrued liabilities:

                       

Derivative liabilities

   $       $ 279      $ 11      $ 290      $       $ 201      $ 7      $ 208  

Long-term debt

                     129        129                        128        128  

Other long-term liabilities:

                       

Derivative liabilities

             32                32                47                47  
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Total liabilities measured and recorded at fair value

   $       $ 311      $ 140      $ 451      $       $ 248      $ 135      $ 383  
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Government bonds include bonds issued or deemed to be guaranteed by government entities. Government bonds include instruments such as non-U.S. government bonds, U.S. Treasury securities, U.S. agency securities, and Federal Deposit Insurance Corporation (FDIC)-insured corporate bonds.

 

8


INTEL CORPORATION

NOTES TO CONSOLIDATED CONDENSED FINANCIAL STATEMENTS — Unaudited (Continued)

 

The tables below present reconciliations for all assets and liabilities measured and recorded at fair value on a recurring basis using significant unobservable inputs (Level 3) for the nine months ended October 1, 2011 and for the twelve months ended December 25, 2010:

 

     Fair Value Measured and Recorded Using Significant Unobservable  Inputs (Level 3)        

(In Millions)

  Corporate Bonds     Asset-Backed
Securities
    Derivative Assets     Derivative Liabilities     Long-term
Debt
    Total  Gains
(Losses)
 

Balance as of December 25, 2010

  $ 51     $ 257     $ 31     $ (7   $ (128  

Total gains or losses (realized and unrealized):

           

Included in earnings

    (2     (2     (1     (4     (1     (10

Included in other comprehensive income (loss)

    8       (3                          5  

Purchases

    13       12       3                  

Settlements and maturities

    (4     (84                       

Transfers out of Level 3

                  (3                
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

Balance as of October 1, 2011

  $ 66     $ 180     $ 30     $ (11   $ (129  
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

Changes in unrealized gains or losses included in earnings related to assets and liabilities still held as of October 1, 2011

  $ (2   $ (2   $ (1   $ (4   $ (1   $ (10
     Fair Value Measured and Recorded Using Significant Unobservable  Inputs (Level 3)        

(In Millions)

  Corporate Bonds     Asset-Backed
Securities
    Derivative Assets     Derivative Liabilities     Long-term
Debt
    Total Gains
(Losses)
 

Balance as of December 26, 2009

  $ 369     $ 754     $ 31     $ (65   $ (123  

Total gains or losses (realized and unrealized):

           

Included in earnings

    (2     6       (3     (2     (5     (6

Included in other comprehensive income (loss)

    4       9                            13  

Purchases

    6              7                  

Sales

    (44     (28     (4                

Settlements and maturities

    (75     (484                       

Transfers out of Level 3

    (207                   60           
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

Balance as of December 25, 2010

  $ 51     $ 257     $ 31     $ (7   $ (128  
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

Changes in unrealized gains or losses included in earnings related to assets and liabilities still held as of December 25, 2010

  $      $ 6     $ (4   $ (1   $ (5   $ (4

For all periods presented, gains and losses (realized and unrealized) included in earnings were primarily reported outside of operating income. During 2010, we transferred corporate bonds from Level 3 to Level 2 due to improved availability of observable market data and non-binding market consensus prices to value or corroborate the value of these instruments. Our policy is to reflect transfers in and transfers out at the beginning of the quarter in which a change in circumstances resulted in the transfer.

Fair Value Option for Financial Assets/Liabilities

We elected the fair value option for loans made to third parties when the interest rate or foreign exchange rate risk was hedged at inception with a related derivative instrument. As of October 1, 2011, 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. These loans receivable are classified within other long-term assets and other current 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 the three and nine months ended October 1, 2011, 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 and were insignificant during the three and nine months ended October 1, 2011. We did not elect the fair value option for loans when the interest rate or foreign exchange rate risk was not hedged at inception with a related derivative instrument.

 

9


INTEL CORPORATION

NOTES TO CONSOLIDATED CONDENSED FINANCIAL STATEMENTS — Unaudited (Continued)

 

We elected this fair value option for the bonds issued in 2007 by the Industrial Development Authority of the City of Chandler, Arizona (2007 Arizona bonds). In connection with the 2007 Arizona bonds, we entered into a total return swap agreement that effectively converts the fixed-rate obligation on the bonds to a floating U.S.-dollar LIBOR-based rate. As a result, changes in the fair value of this debt are largely offset by changes in the fair value of the total return swap agreement, without the need to apply hedge accounting provisions. The 2007 Arizona bonds are included in long-term debt. As of October 1, 2011 and December 25, 2010, no other instruments were similar to the 2007 Arizona bonds for which we elected fair value treatment.

As of October 1, 2011, the fair value of the 2007 Arizona bonds did not significantly differ from the contractual principal balance. The fair value of the 2007 Arizona bonds was determined using inputs that are observable in the market or that can be derived from or corroborated with observable market data, as well as unobservable inputs that were significant to the fair value. Gains and losses on the 2007 Arizona bonds and the related total return swap are recorded in interest and other, net. We capitalize interest associated with the 2007 Arizona bonds. We add capitalized interest to the cost of qualified assets and amortize it over the estimated useful lives of the assets.

Assets Measured and Recorded at Fair Value on a Non-Recurring Basis

Our non-marketable equity 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. The following table presents the financial instruments and non-financial assets that were measured and recorded at fair value on a non-recurring basis during the nine months ended October 1, 2011, and the gains (losses) recorded during the three and nine months ended October 1, 2011 on those assets:

 

(In Millions)

  Net Carrying
Value as of
    Fair Value Measured and Recorded Using    

Total Gains
(Losses) for
Three Months

Ended

    Total Gains
(Losses) for
Nine Months
Ended
 
  Oct. 1, 2011     Leve l     Level 2     Level 3     Oct. 1, 2011     Oct. 1, 2011  

Non-marketable equity investments

  $ 53     $      $      $ 53     $ (12   $ (33

Property, plant and equipment

  $      $      $      $      $      $ (10
         

 

 

   

 

 

 

Total gains (losses) for assets held as of October 1, 2011

          $ (12   $ (43
         

 

 

   

 

 

 

Gains (losses) for non-marketable equity investments no longer held

          $      $ (1

Gains (losses) for property, plant and equipment no longer held

          $ (23   $ (68
         

 

 

   

 

 

 

Total gains (losses) for recorded non-recurring measurement

          $ (35   $ (112
         

 

 

   

 

 

 

The following table presents the financial instruments and non-financial assets that were measured and recorded at fair value on a non-recurring basis during the nine months ended September 25, 2010, and the gains (losses) recorded during the three and nine months ended September 25, 2010 on those assets:

 

(In Millions)

  Net Carrying
Value as of
    Fair Value Measured and Recorded Using     Total Gains
(Losses) for
Three Months
Ended
    Total Gains
(Losses) for
Nine Months
Ended
 
  Sept. 25, 2010     Leve l     Level 2     Level 3     Sept. 25, 2010     Sept. 25, 2010  

Non-marketable equity investments

  $ 123     $      $      $ 125     $ (32   $ (94
         

 

 

   

 

 

 

Total gains (losses) for assets held
as of September 25, 2010

          $ (32   $ (94
         

 

 

   

 

 

 

Gains (losses) for non-marketable equity investments no longer held

          $      $ (1

Gains (losses) for property, plant and equipment no longer held

          $ (9   $ (49
         

 

 

   

 

 

 

Total gains (losses) for recorded
non-recurring measurement

          $ (41   $ (144
         

 

 

   

 

 

 

 

10


INTEL CORPORATION

NOTES TO CONSOLIDATED CONDENSED FINANCIAL STATEMENTS — Unaudited (Continued)

 

In the preceding tables, the carrying value of our impaired non-marketable equity investments at the end of the period may not equal our fair value measurement at the time of impairment due to the subsequent recognition of equity method adjustments. In addition, the carrying value of our impaired property, plant and equipment at the end of the period may not equal our fair value measurement at the time of impairment due to the subsequent recognition of depreciation expense.

A portion of our non-marketable equity investments were measured and recorded at fair value in the first nine months of 2011 and 2010 due to events or circumstances that significantly impacted the fair value of those investments, resulting in other-than-temporary impairment charges. We classified these measurements as Level 3, as we used unobservable inputs to the valuation methodologies that were significant to the fair value measurements, and the valuations required management judgment due to the absence of quoted market prices. We determine the fair value of our non-marketable equity investments 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, development stages, and other relevant factors. The income approach includes the use of a discounted cash flow model, which requires the following significant estimates for the investee: revenue, costs, and discount rates based on the risk profile of comparable companies. Estimates of revenues and costs are developed using historical data and available market data. The valuation of these non-marketable equity 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 lack of marketability of the investments.

Additionally, certain of our property, plant and equipment was measured and recorded at fair value during the first nine months of 2011 and 2010 due to events or circumstances we identified that indicated that the carrying value of the assets or the asset grouping was not recoverable, resulting in impairment charges. Most of these asset impairments related to manufacturing assets.

Financial Instruments Not Recorded at Fair Value on a Recurring Basis

We measure the fair value of our non-marketable equity investments, marketable equity method investment, debt carried at amortized cost, and cost method loans receivable quarterly for disclosure purposes; however, they 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 as of October 1, 2011 and December 25, 2010 were as follows:

 

0000000 0000000 0000000 0000000
     October 1, 2011      December 25, 2010  

(In Millions)

   Carrying
Amount
     Fair
Value
     Carrying
Amount
     Fair
Value
 

Non-marketable equity investments

   $ 2,795      $ 5,588      $ 2,633      $ 5,144  

Marketable equity method investment

   $ 37      $ 73      $ 31      $ 167  

Loans receivable

   $ 258      $ 258      $ 208      $ 208  

Long-term debt

   $ 6,947      $ 7,533      $ 1,949      $ 2,283  

As of October 1, 2011 and December 25, 2010, the unrealized loss position of our non-marketable equity investments was not significant.

Our marketable equity method investment is our ownership interest in SMART Technologies, Inc. The fair value of our ownership interest in SMART was based on the quoted closing stock price as of October 1, 2011 and December 25, 2010.

The carrying amount and fair value of loans receivable exclude loans measured and recorded at a fair value of $779 million as of October 1, 2011 ($642 million as of December 25, 2010). The carrying amount and fair value of long-term debt exclude long-term debt measured and recorded at a fair value of $129 million as of October 1, 2011 ($128 million as of December 25, 2010).

The fair value of our loans receivable is determined using a discounted cash flow model, with all significant inputs derived from or corroborated with observable market data. The credit quality of our loans receivable remains high, with credit ratings of BBB+/A2 or better as of October 1, 2011. The fair value of our long-term debt is determined using third party market prices and discounted cash flow models that take into consideration variables such as credit-rating changes and interest rate changes.

In addition to the financial instruments in the table above, we incurred a liability as result of entering into a long-term patent cross-license agreement with NVIDIA Corporation in January 2011. We agreed to make payments to NVIDIA over six years. For further information on the payment terms and recognition of licensed technology intangible assets, see “Note 18: Identified Intangible Assets.” As of October 1, 2011, the carrying amount of the liability arising from the agreement was $1.2 billion and is classified within other accrued liabilities and other long-term liabilities, as applicable. The fair value of the liability arising from the NVIDIA cross-license agreement approximates the carrying amount. The fair value is determined using a discounted cash flow model, with all significant inputs derived from or corroborated with observable market data.

 

11


INTEL CORPORATION

NOTES TO CONSOLIDATED CONDENSED FINANCIAL STATEMENTS — Unaudited (Continued)

 

Note 6: Trading Assets

Trading assets as of October 1, 2011 and December 25, 2010 were as follows:

 

(In Millions)

   Oct. 1,
2011
     Dec. 25
2010
 

Marketable debt instruments

   $  4,259      $  4,705  

Marketable equity securities

     6        388  
  

 

 

    

 

 

 

Total trading assets

   $  4,265      $  5,093  
  

 

 

    

 

 

 

Net losses on marketable debt instruments classified as trading assets still held at the reporting date were $89 million in the third quarter of 2011 and $37 million in the first nine months of 2011 (net gains of $154 million in the third quarter of 2010 and net losses of $11 million in the first nine months of 2010). Net gains on the related derivatives were $81 million in the third quarter of 2011 and $42 million in the first nine months of 2011 (net losses of $130 million in the third quarter of 2010 and net gains of $4 million in the first nine months of 2010).

Net losses on marketable equity securities classified as trading assets still held at the reporting date, excluding the impacts of the related derivatives, were insignificant in the third quarter of 2011 and in the first nine months of 2011 (net losses of $129 million in the third quarter of 2010 and $91 million in the first nine months of 2010).

In 2010, we sold our ownership interest in Numonyx B.V. to Micron Technology, Inc. The Micron common stock we received in the transaction was classified as marketable equity securities within trading assets. During the second quarter of 2011, we sold our remaining shares in Micron.

Note 7: Available-for-Sale Investments

Available-for-sale investments as of October 1, 2011 and December 25, 2010 were as follows:

 

     October 1, 2011      December 25, 2010  

(In Millions)

   Adjusted
Cost
     Gross
Unrealized
Gains
     Gross
Unrealized
Losses
    Fair
Value
     Adjusted
Cost
     Gross
Unrealized
Gains
     Gross
Unrealized
Losses
    Fair
Value
 

Commercial paper

   $ 5,864      $       $ (4   $ 5,860      $ 5,312      $       $      $ 5,312  

Government bonds

     2,407                (2     2,405        10,075        9        (5     10,079  

Corporate bonds

     1,100        14        (5     1,109        2,250        9        (4     2,255  

Bank deposits

     916                       916        1,550        1               1,551  

Marketable equity securities

     200        319        (3     516        380        629        (1     1,008  

Money market fund deposits

     463                       463        34                       34  

Asset-backed securities

     63                (13     50        76                (9     67  
  

 

 

    

 

 

    

 

 

   

 

 

    

 

 

    

 

 

    

 

 

   

 

 

 

Total available-for-sale

investments

   $  11,013      $  333      $ (27   $  11,319      $  19,677      $  648      $ (19   $  20,306  
  

 

 

    

 

 

    

 

 

   

 

 

    

 

 

    

 

 

    

 

 

   

 

 

 

In the preceding table, government bonds include bonds issued or deemed to be guaranteed by government entities. Government bonds include instruments such as U.S. Treasury securities, non-U.S. government bonds, U.S. agency securities, and Federal Deposit Insurance Corporation (FDIC)-insured corporate bonds as of October 1, 2011 and December 25, 2010.

The amortized cost and fair value of available-for-sale debt investments as of October 1, 2011, by contractual maturity, were as follows:

 

(In Millions)

   Cost      Fair Value  

Due in 1 year or less

   $ 9,487      $ 9,483  

Due in 1–2 years

     512        515  

Due in 2–5 years

     284        289  

Due after 5 years

     4        3  

Instruments not due at a single maturity date

     526        513  
  

 

 

    

 

 

 

Total

   $  10,813      $  10,803  
  

 

 

    

 

 

 

Instruments not due at a single maturity date in the table above includes asset-backed securities and money market fund deposits.

 

12


INTEL CORPORATION

NOTES TO CONSOLIDATED CONDENSED FINANCIAL STATEMENTS — Unaudited (Continued)

 

We sold available-for-sale investments for proceeds of $298 million in the third quarter of 2011 and $9.1 billion in the first nine months of 2011 ($93 million in the third quarter of 2010 and $399 million in the first nine months of 2010). Substantially all of the proceeds in the first nine months of 2011 were from debt investments that were primarily used to fund our acquisition of McAfee. The gross realized gains on sales of available-for-sale investments were $186 million in the third quarter of 2011 and $251 million in the first nine months of 2011 ($33 million in the third quarter of 2010 and $112 million in the first nine months of 2010) and were primarily related to our sales of marketable equity securities. We determine the cost of an investment sold on an average cost basis at the individual security level.

The before-tax net unrealized holding gains (losses) on available-for-sale investments that have been included in other comprehensive income (loss) and the before-tax net gains (losses) reclassified from accumulated other comprehensive income (loss) into earnings were as follows:

 

     Three Months Ended      Nine Months Ended  

(In Millions)

   Oct. 1,
2011
    Sept. 25,
2010
     Oct. 1,
2011
    Sept. 25,
2010
 

Net unrealized holding gains (losses) included in other
comprehensive income (loss)

   $ (47   $ 231      $ (23   $ 365  

Net gains (losses) reclassified from accumulated other comprehensive
income (loss) into  earnings

   $ 203     $ 16      $ 291     $ 90  

Note 8: Inventories

Inventories at the end of each period were as follows:

 

(In Millions)

   Oct. 1,
2011
     Dec. 25,
2010
 

Raw materials

   $ 614      $ 471  

Work in process

     1,494        1,887  

Finished goods

     1,851        1,399  
  

 

 

    

 

 

 

Total inventories

   $  3,959      $  3,757  
  

 

 

    

 

 

 

Note 9: 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 and commodity price risk. We currently do not hold derivative instruments for the purpose of managing credit risk since we limit the amount of credit exposure to any one counterparty and generally enter into derivative transactions with high-credit-quality counterparties. 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. 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 options, or currency interest rate swaps. Substantially all of our revenue is transacted in U.S. dollars. However, a significant amount of our operating expenditures and capital purchases are incurred in or exposed to other currencies, primarily the Japanese yen, the euro, and the Israeli shekel. We have established balance sheet and forecasted transaction currency risk management programs to protect against fluctuations in fair value and the volatility 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. These programs reduce, but do not entirely 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. All of our currency forward contracts are settled at maturity involving one cash-payment exchange. 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 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.

 

13


INTEL CORPORATION

NOTES TO CONSOLIDATED CONDENSED FINANCIAL STATEMENTS — Unaudited (Continued)

 

 

   

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. The currency interest rate 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. Changes in the U.S.-dollar-equivalent cash flows of the underlying assets and liabilities are approximately offset by the changes in fair values 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 other 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.

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 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 are reset on a monthly, quarterly, or semiannual basis. Changes in fair value of the debt instruments classified as trading assets and hedges of 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 marketable investments include marketable equity securities and equity derivative instruments. To the extent that our marketable equity securities have strategic value, we typically do not attempt to reduce or eliminate our equity market exposure through hedging activities. We may enter into transactions to reduce or eliminate the equity market risks for our investments in strategic equity derivative instruments. For securities that we no longer consider strategic, we evaluate legal, market, and economic factors in our decision on the timing of disposal and whether it is possible and appropriate to hedge the equity market risk. Our equity market risk management program includes equity derivatives 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 other 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 gains and losses on the related liabilities, which are both recorded in cost of sales and operating expenses.

In the second quarter of 2010, we sold our ownership interest in Numonyx to Micron for consideration consisting of shares of Micron. We also entered into equity option transactions that economically hedged a portion of the ownership interest in Micron that we acquired. In the second quarter of 2011, we sold our remaining ownership interest in Micron and the related equity options matured.

 

14


INTEL CORPORATION

NOTES TO CONSOLIDATED CONDENSED FINANCIAL STATEMENTS — Unaudited (Continued)

 

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 entirely 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 within the same line item on the consolidated condensed statements of income as the impact of the hedged transaction.

Volume of Derivative Activity

Total gross notional amounts for outstanding derivatives (recorded at fair value) were as follows:

 

(In Millions)

   Oct. 1,
2011
     Dec. 25,
2010
     Sept. 25,
2010
 

Currency forwards

   $ 9,902      $ 8,502      $ 7,272  

Interest rate swaps

     2,001        2,166        2,208  

Currency interest rate swaps

     1,870        2,259        2,189  

Embedded debt derivatives

     3,600        3,600        3,600  

Total return swaps

     731        627        550  

Equity options

     31        496        501  

Currency options

             94        94  

Other

     136        66        65  
  

 

 

    

 

 

    

 

 

 

Total

   $ 18,271      $ 17,810      $ 16,479  
  

 

 

    

 

 

    

 

 

 

The gross notional amounts for currency forwards, currency interest rate swaps, and currency options (presented by currency) were as follows:

 

(In Millions)

   Oct. 1,
2011
     Dec. 25,
2010
     Sept. 25,
2010
 

Euro

   $ 3,958      $ 4,445      $ 4,122  

Japanese yen

     3,464        3,440        2,954  

Israeli shekel

     1,987        1,191        845  

Chinese yuan

     606        347        289  

Malaysian ringgit

     549        382        278  

British pound sterling

     371        424        430  

Other

     837        626        637  
  

 

 

    

 

 

    

 

 

 

Total

   $ 11,772      $ 10,855      $ 9,555  
  

 

 

    

 

 

    

 

 

 

Credit-Risk-Related Contingent Features

As of October 1, 2011 and December 25, 2010, we did not have any derivative instruments that contain credit-risk-related contingent features, such as provisions that require our debt to maintain an investment grade credit rating from each of the major credit rating agencies.

 

15


INTEL CORPORATION

NOTES TO CONSOLIDATED CONDENSED FINANCIAL STATEMENTS — Unaudited (Continued)

 

Fair Values of Derivative Instruments in the Consolidated Condensed Balance Sheets

The fair values of our derivative instruments as of October 1, 2011 and December 25, 2010 were as follows:

 

Current Current Current Current Current Current Current Current
    Oct. 1, 2011     Dec. 25, 2010  

(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

  $ 124     $ 2     $ 124     $ 10     $ 120     $ 3     $ 43     $ 3  

Other

    1                            2                       
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total derivatives designated as hedging instruments

  $ 125     $ 2     $ 124     $ 10     $ 122     $ 3     $ 43     $ 3  
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Derivatives not designated as hedging instruments

               

Currency forwards

  $ 69     $      $ 46     $      $ 35     $      $ 14     $   

Interest rate swaps

    2              77              2              96         

Currency interest rate swaps

    28       18       33       17       64       17       47       13  

Embedded debt derivatives

                         5                            31  

Total return swaps

           6                     41       6                

Equity options

           1       10              65       5       7         

Other

           23                     1       19       1         
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total derivatives not designated as hedging instruments

  $ 99     $ 48     $ 166     $ 22     $ 208     $ 47     $ 165     $ 44  
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total derivatives

  $ 224     $ 50     $ 290     $ 32     $ 330     $ 50     $ 208     $ 47  
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Derivatives in Cash Flow Hedging Relationships

The before-tax effects of derivative instruments in cash flow hedging relationships for the three and nine months ended October 1, 2011 and September 25, 2010 were as follows:

 

YTD 2011 YTD 2011 YTD 2011 YTD 2011 YTD 2011
     Gains (Losses)
Recognized in
OCI on Derivatives
(Effective Portion)
    Gains (Losses) Reclassified from Accumulated
OCI Into Income by Derivative Instrument Type (Effective Portion)
 

(In Millions)

   Q3 2011     Q3 2010     Location      Q3 2011      Q3 2010  

Currency forwards

   $ (101   $ 184       Cost of sales       $ 38      $ 3  
         Research and development         8        4  
         Marketing, general and administrative         8        (4

Other

     —          (2     Cost of sales         —           1  
  

 

 

   

 

 

      

 

 

    

 

 

 

Total

   $ (101   $ 182        $ 54      $ 4  
  

 

 

   

 

 

      

 

 

    

 

 

 

 

YTD20111 YTD20111 YTD20111 YTD20111 YTD20111
     Gains (Losses)
Recognized in
OCI on Derivatives
(Effective Portion)
     Gains (Losses) Reclassified from Accumulated
OCI into Income by Derivative Instrument Type (Effective Portion)
 

(In Millions)

   YTD 2011      YTD 2010      Location      YTD 2011      YTD 2010  

Currency forwards

   $ 155      $ 6        Cost of sales       $ 114      $ 32  
           Research and development         31        21  
           Marketing, general and administrative         25        2  

Other

     2        1        Cost of sales         2        (2
  

 

 

    

 

 

       

 

 

    

 

 

 

Total

   $ 157      $ 7         $ 172      $ 53  
  

 

 

    

 

 

       

 

 

    

 

 

 

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. We estimate that we will reclassify approximately $27 million (before taxes) of net derivative gains included in other accumulated comprehensive income (loss) into earnings within the next 12 months. For all periods presented, there was an insignificant impact on results of operations from discontinued cash flow hedges as a result of forecasted transactions that did not occur.

 

16


INTEL CORPORATION

NOTES TO CONSOLIDATED CONDENSED FINANCIAL STATEMENTS — Unaudited (Continued)

 

Derivatives Not Designated as Hedging Instruments

The effects of derivative instruments not designated as hedging instruments on the consolidated condensed statements of income were as follows:

 

$(114) $(114) $(114) $(114) $(114)
         Three Months Ended     Nine Months Ended  

(In Millions)

   Location of Gains (Losses)
Recognized in Income on Derivatives
  Oct. 1,
2011
    Sept. 25,
2010
    Oct. 1,
2011
    Sept. 25,
2010
 

Currency forwards

   Interest and other, net   $ 34     $ (60   $ 50     $ 83  

Interest rate swaps

   Interest and other, net     (11     (20     (30     (66

Currency interest rate swaps

   Interest and other, net     85       (132     (43     94  

Total return swaps

   Various     (64     33       (44     31  

Equity options

   Gains (losses) on other equity investments, net     (4     63       (70     78  

Other

   Gains (losses) on other equity investments, net     1       2       3       (2
    

 

 

   

 

 

   

 

 

   

 

 

 

Total

     $ 41     $ (114   $ (134   $ 218  
    

 

 

   

 

 

   

 

 

   

 

 

 

Note 10: Other Long-Term Assets

Other long-term assets at the end of each period were as follows:

 

     Oct. 1,      Dec. 25,  

(In Millions)

   2011      2010  

Equity method investments

   $ 1,772      $ 1,791  

Non-marketable cost method investments

     1,060        872  

Non-current deferred tax assets

     333        289  

Loans receivable

     749        741  

Other

     825        558  
  

 

 

    

 

 

 

Total other long-term assets

   $  4,739      $  4,251  
  

 

 

    

 

 

 

Note 11: Equity Method Investments

IMFT/IMFS

Micron and Intel formed IM Flash Technologies, LLC (IMFT) in January 2006 and IM Flash Singapore, LLP (IMFS) in February 2007. We established these joint ventures to manufacture NAND flash memory products for Micron and Intel. As of October 1, 2011, we owned a 49% interest in IMFT and an 18% interest in IMFS. The carrying value of our investment in IMFT/IMFS was $1.4 billion as of October 1, 2011 ($1.5 billion as of December 25, 2010) and is classified within other long-term assets. In the third quarter of 2011, we made an additional investment of $131 million in IMFS, which increased our ownership interest compared to the second quarter of 2011. The IMFS fabrication facility began initial production in the second quarter of 2011. IMFT and IMFS are each governed by a Board of Managers, with Micron and Intel initially appointing an equal number of managers to each of the boards. The number of managers appointed by each party adjusts depending on the parties’ ownership interests. As a result of our overall net reduction of our ownership interest in IMFS, Micron now appoints the majority of the managers on the IMFS board. These ventures are expected to operate until 2016 but are subject to earlier termination under certain terms and conditions.

These joint ventures are variable interest entities. All costs of the joint ventures will be passed on to Micron and Intel through our purchase agreements. IMFT and IMFS are dependent upon Micron and Intel for any additional cash requirements. Our known maximum exposure to loss approximated the carrying value of our investment balance in IMFT/IMFS as of October 1, 2011. Except for the amount due to IMFT/IMFS 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 these joint ventures as of October 1, 2011. Future cash calls could increase our investment balance and the related exposure to loss. 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/IMFS. Finally, as we are currently committed to purchasing 49% of IMFT’s and 29% of IMFS’s production output and production-related services, we may be required to purchase products at a cost in excess of realizable value. Our contractual commitment to purchase product output and fund production-related services adjusts to changes in our ownership percentage on a lag.

 

17


INTEL CORPORATION

NOTES TO CONSOLIDATED CONDENSED FINANCIAL STATEMENTS — Unaudited (Continued)

 

Our portion of IMFT/IMFS costs, primarily related to product purchases and production-related services, was approximately $255 million during the third quarter of 2011 and approximately $725 million during the first nine months of 2011 (approximately $200 million during the third quarter of 2010 and approximately $580 million during the first nine months of 2010). The amount due to IMFT/IMFS for product purchases and services provided was approximately $155 million as of October 1, 2011 (approximately $105 million as of December 25, 2010). During the first nine months of 2011, $172 million was returned to Intel by IMFT/IMFS, which is reflected as a return of equity method investment within investing activities on the consolidated condensed statements of cash flows ($151 million during the first nine months of 2010).

Under the accounting standards for consolidating variable interest entities, the consolidating investor is the entity with the power to direct the activities of the venture that most significantly impact the venture’s economic performance and with the obligation to absorb losses or the right to receive benefits from the venture that could potentially be significant to the venture. We have determined that we do not have both of these characteristics and, therefore, we account for our interests using the equity method of accounting.

Intel-GE Care Innovations, LLC

In the first quarter of 2011, Intel and General Electric Company (GE) formed an equally owned joint venture, Intel-GE Care Innovations, LLC (Care Innovations), in the healthcare industry that focuses on independent living and delivery of health-related services via telecommunications. The company was formed by combining assets of GE Healthcare’s Home Health division and Intel’s Digital Health Group. As a result of the formation of Care Innovations, we recognized a gain of $164 million in the first quarter of 2011 that is recorded in interest and other, net. The carrying value of our investment in Care Innovations was $149 million as of October 1, 2011 and is classified in other long-term assets.

Care Innovations is dependent upon Intel and GE for any additional cash requirements and, therefore, is a variable interest entity. Our known maximum exposure to loss approximated the carrying value of our investment balance in Care Innovations as of October 1, 2011. In addition to the potential loss of our existing investment, our actual losses could be higher, as we are liable to contribute additional future funding up to $65 million if Care Innovations meets established milestones.

Intel and GE share the power to direct all of Care Innovations’ activities that most significantly impact its economic performance. As a result, we account for our interests in Care Innovations under the equity method of accounting.

Note 12: Gains (Losses) on Equity Method Investments, Net

Gains (losses) on equity method investments, net included:

 

$ 243 $ 243 $ 243 $ 243
     Three Months Ended     Nine Months Ended  

(In Millions)

   Oct. 1,
2011
    Sept. 25,
2010
    Oct. 1,
2011
    Sept. 25,
2010
 

Equity method losses, net

   $ (63   $ (28   $ (192   $ (72

Impairment charges

                          (10

Other, net

     23       154       44       245  
  

 

 

   

 

 

   

 

 

   

 

 

 

Total gains (losses) on equity method investments, net

   $ (40   $ 126     $ (148   $ 163  
  

 

 

   

 

 

   

 

 

   

 

 

 

Note 13: Gains (Losses) on Other Equity Investments, Net

Gains (losses) on other equity investments, net included:

 

$ 243 $ 243 $ 243 $ 243
     Three Months Ended     Nine Months Ended  

(In Millions)

   Oct. 1,
2011
    Sept. 25,
2010
    Oct. 1,
2011
    Sept. 25,
2010
 

Impairment charges

   $ (79   $ (32   $ (102   $ (85

Gains on sales, net

     189       22       276       125  

Other, net

     22       (39     69       36  
  

 

 

   

 

 

   

 

 

   

 

 

 

Total gains (losses) on other equity investments, net

   $  132     $ (49   $  243     $ 76  
  

 

 

   

 

 

   

 

 

   

 

 

 

 

18


INTEL CORPORATION

NOTES TO CONSOLIDATED CONDENSED FINANCIAL STATEMENTS — Unaudited (Continued)

 

Note 14: Interest and Other, Net

The components of interest and other, net were as follows:

 

     Three Months Ended      Nine Months Ended  

(In Millions)

   Oct. 1,
2011
    Sept. 25,
2010
     Oct. 1,
2011
    Sept. 25,
2010
 

Interest income

   $ 22     $ 35      $ 70     $ 90  

Interest expense

                    (6       

Other, net

     (7     3        157       (12
  

 

 

   

 

 

    

 

 

   

 

 

 

Total interest and other, net

   $ 15     $ 38      $  221     $ 78  
  

 

 

   

 

 

    

 

 

   

 

 

 

In the first quarter of 2011, we recognized a gain upon formation of the Intel and GE joint venture, Care Innovations, of $164 million, included within “other, net,” in the table above. See “Note 11: Equity Method Investments,” for further information.

Note 15: Acquisitions

McAfee, Inc.

On February 28, 2011, we completed the acquisition of McAfee by acquiring all issued and outstanding common shares in exchange for cash. The acquired company will continue to operate as McAfee and offer products for endpoint security, system security, consumer security, network security, and risk and compliance. In addition to managing the existing McAfee business, the objective of the acquisition is to accelerate and enhance the combination of hardware and software security solutions, improving the overall security of our platforms.

Total consideration to acquire McAfee was $6.7 billion (net of $943 million of cash and cash equivalents acquired) and comprised the following:

 

(In Millions)

      

Cash

   $  6,652  

Share-based awards assumed

     48  
  

 

 

 

Total

   $  6,700  
  

 

 

 

The allocation of purchase consideration to assets and liabilities is not yet finalized. The preliminary allocation of the purchase price was based upon a preliminary valuation and our estimates and assumptions are subject to change within the measurement period (up to one year from the acquisition date). The primary areas of the preliminary purchase price allocation that are not yet finalized are the determination of the tax basis of certain assets and liabilities, the determination of certain tax carry forwards, residual goodwill, and the allocation of goodwill to our reporting units. Reporting units are equivalent to our operating segments. The preliminary fair values of the assets acquired and liabilities assumed by major class in the acquisition of McAfee were recognized as follows:

 

(In Millions)

      

Marketable debt securities

   $ 329  

Goodwill

     4,299  

Identified intangible assets

     3,552  

Deferred tax assets

     738  

Other assets

     417  

Deferred income

     (1,049

Deferred tax liabilities

     (1,191

Other liabilities

     (395
  

 

 

 

Total

   $  6,700  
  

 

 

 

The preliminary goodwill of $4.3 billion arising from the acquisition is primarily attributed to the assembled workforce of McAfee and synergies to enable the combination of security and hardware from a single company to protect online devices. Substantially all of the goodwill recognized is not expected to be deductible for tax purposes. Goodwill for the McAfee acquisition has not yet been assigned to our operating segments. For further information, see “Note 17: Goodwill.”

 

19


INTEL CORPORATION

NOTES TO CONSOLIDATED CONDENSED FINANCIAL STATEMENTS — Unaudited (Continued)

 

The identified intangible assets assumed in the acquisition of McAfee were recognized as follows based upon their fair values as of February 28, 2011:

 

     Fair Value
(In Millions)
     Estimated
Useful Life
(In Years)
 

Developed technology

   $ 1,221        4  

Customer relationships

     1,418        2–7   
  

 

 

    

Total identified intangible assets subject to amortization

   $ 2,639     

In-process research and development

     92     

Trade names

     821     
  

 

 

    

Total identified intangible assets

   $ 3,552     
  

 

 

    

Acquired developed technology represents the fair values of McAfee products that have reached technological feasibility and are a part of McAfee’s product offerings. Customer relationships represent the fair values of the underlying relationships and agreements with McAfee’s customers. In-process research and development represents the fair values of incomplete McAfee research and development projects that had not reached technological feasibility as of the date of acquisition. In the future, the fair value of each project at the acquisition date will be either amortized or impaired depending on whether the project is completed or abandoned. Trade names are indefinite lived intangible assets and represent the fair values of brand and name recognition associated with the marketing of McAfee’s products and services.

Other 2011 Acquisitions

During the first nine months of 2011, in addition to the McAfee acquisition, we completed eleven acquisitions qualifying as business combinations in exchange for total consideration of $1.9 billion, substantially all cash consideration. Total net cash consideration to acquire the Wireless Solutions (WLS) business of Infineon Technologies AG, which operates as Intel Mobile Communications, was $1.4 billion. The WLS business offers mobile phone components such as baseband processors, radio frequency transceivers, and power management chips. In addition to managing the existing WLS business, the objective of the acquisition is to provide solutions that enable wireless connectivity for a broad range of computing applications.

The allocation of purchase consideration to assets and liabilities acquired in the acquisition of the WLS business is not yet finalized. The preliminary allocation of the purchase price was based upon a preliminary valuation and our estimates and assumptions are subject to change within the measurement period (up to one year from the acquisition date). The primary areas of the preliminary purchase price allocation that are not yet finalized are the valuation of net tangible assets acquired and residual goodwill. The preliminary fair values of the assets acquired and liabilities assumed by major class in the acquisitions completed during the first nine months of 2011, excluding McAfee, were allocated as follows:

 

(In Millions)

      

Fair value of net tangible assets acquired

   $ 202  

Goodwill

     353  

Identified intangible assets

     1,332  
  

 

 

 

Total

   $  1,887  
  

 

 

 

For the information on the assignment of preliminary goodwill for the acquisitions, see “Note 17: Goodwill.”

The identified intangible assets assumed in the acquisitions completed during the first nine months of 2011, excluding McAfee, were recognized as follows:

 

     Fair Value
(In Millions)
     Estimated
Useful Life
(In Years)
 

Developed technology

   $ 1,054        3–9   

Customer relationships

     116        5–8   

Other intangible assets

     43        2–5   
     

 

 

    

Total identified intangible assets subject to amortization

   $ 1,213     

In-process research and development

     119     
     

 

 

    

Total identified intangible assets

   $ 1,332     
     

 

 

    

 

20


INTEL CORPORATION

NOTES TO CONSOLIDATED COMDENSED FINANCIAL STATEMENTS — Unaudited (Continued)

 

Acquired developed technology represents the fair values of the acquirees’ products that have reached technological feasibility and are a part of the acquirees’ product lines. Customer relationships represent the fair values of the underlying relationships and agreements with the acquirees’ customers. In-process research and development represents the fair values of incomplete research and development projects that had not reached technological feasibility as of the date of acquisition.

Actual and Pro Forma Results of Acquirees

Net revenue and net income attributable to acquisitions completed during the first nine months of 2011 have been included in our consolidated condensed statements of income from their respective acquisition dates to the period ended October 1, 2011. The acquisitions completed during the first nine months of 2011 were not individually significant to our consolidated condensed results of operations, however, they were significant in the aggregate. For the three and nine months ended October 1, 2011, the results of the businesses acquired in 2011 contributed approximately $1.1 billion and $2.7 billion, respectively, to our net revenue and reduced our net income by approximately $35 million and $155 million, respectively; substantially all of these impacts were attributable to McAfee and Intel Mobile Communications and include the impacts of the amortization of acquired identified intangible assets.

McAfee is a non-reportable operating segment and is aggregated with similar non-reportable operating segments within the software and services operating segments category for segment reporting purposes. Intel Mobile Communications is a non-reportable operating segment and is aggregated with similar non-reportable operating segments within the other Intel architecture operating segments category for segment reporting purposes. For further information, see “Note 27: Operating Segment Information.”

The unaudited pro forma financial results for the three and nine months ended October 1, 2011 and September 25, 2010 combine the historical results of Intel for the three and nine months ended October 1, 2011 and September 25, 2010, respectively, along with the historical results of the businesses acquired during the first nine months of 2011 for the three and nine months ended September 30, 2011 and September 30, 2010, respectively (due to differences in reporting periods). The results include the effects of pro forma adjustments as if businesses acquired in the first nine months of 2011 were acquired on December 27, 2009. The three and nine months ended September 25, 2010 pro forma results include nonrecurring adjustments of $67 million and $268 million, respectively, which reduce net income due to the revaluation of McAfee’s historic deferred revenue to fair value.

The pro forma financial results presented below do not include any anticipated synergies or other expected benefits of the acquisitions. This is presented for informational purposes only and is not indicative of future operations or results that would have been achieved had the acquisitions been completed as of December 27, 2009.

 

     Three Months Ended      Nine Months Ended  

(In Millions, Except Per Share Amounts)

   Oct. 1,
2011
     Sept. 25,
2010
     Oct. 1,
2011
     Sept. 25,
2010
 

Net revenue

   $  14,272      $  12,134      $  40,803      $  34,728  

Net income

   $ 3,492      $ 2,939      $ 9,684      $ 8,017  

Diluted earnings per share

   $ 0.65      $ 0.52      $ 1.77      $ 1.41  

Note 16: Divestitures

In the first quarter of 2011, we completed the divestiture of our Digital Health Group by entering into an agreement with GE to form an equally owned joint venture to create a new healthcare company focused on independent living and delivery of health-related services via telecommunications. The new company, Care Innovations, was formed by combining assets of GE Healthcare’s Home Health division and Intel’s Digital Health Group. During the first quarter of 2011, as a result of the formation of Care Innovations, we recognized a gain of $164 million, within interest and other, net. For further information, see “Note 11: Equity Method Investments.”

 

21


INTEL CORPORATION

NOTES TO CONSOLIDATED COMDENSED FINANCIAL STATEMENTS — Unaudited (Continued)

 

Note 17: Goodwill

Goodwill activity for the first nine months of 2011 was as follows:

 

(In Millions)

   PC Client
Group
    Data Center
Group
     Other Intel
Architecture
Operating
Segments
     Software and
Services
Operating
Segments
     Unallocated     Total  

December 25, 2010

   $  2,234     $  1,459      $  582      $  256      $     $  4,531  

Additions due to McAfee acquisition

                                    4,299       4,299  

Additions due to other acquisitions

     14       94        177        28        40       353  

Transfers

     (86             86                         

Effect of exchange rate fluctuations

                                    (45     (45
  

 

 

   

 

 

    

 

 

    

 

 

    

 

 

   

 

 

 

October 1, 2011

   $  2,162     $  1,553      $  845      $  284      $  4,294     $  9,138  
  

 

 

   

 

 

    

 

 

    

 

 

    

 

 

   

 

 

 

During the first quarter of 2011, we formed the Netbook and Tablet Group, which includes microprocessors and related chipsets designed for the netbook and tablet market segments. Due to the formation of this new operating segment, goodwill was transferred from our PC Client Group to our Netbook and Tablet Group as shown in the preceding table. Our Netbook and Tablet Group is included in the other Intel architecture operating segments category in the preceding table.

During the first quarter of 2011, we completed the acquisition of McAfee. The goodwill recognized from this acquisition is unallocated to date. We will use information from our annual planning process, which will be completed later this year, to measure the synergistic value that the McAfee acquisition creates for operating segments other than McAfee. The substantial majority of goodwill recognized from other acquisitions was allocated to Intel Mobile Communications, the Data Center Group, the Ultra-Mobility Group, the Software and Services Group, and the PC Client Group. Intel Mobile Communications and the Ultra-Mobility Group are included in the other Intel architecture operating segments category in the preceding table, while our Software and Services Group is included in the software and services operating segments category. The remaining goodwill from other acquisitions is unallocated to date as we continue to measure the synergistic value that the acquisitions create for our individual operating segments. For further information about our acquisitions during the first nine months of 2011, see “Note 15: Acquisitions.”

No goodwill was impaired during the first nine months of 2011 and 2010, and the accumulated impairment losses as of October 1, 2011 were $713 million: $341 million associated with our PC Client Group, $279 million associated with our Data Center Group, and $93 million associated with other Intel architecture operating segments. The accumulated impairment losses as of December 25, 2010 were $713 million: $355 million associated with our PC Client Group, $279 million associated with our Data Center Group, and $79 million associated with other Intel architecture operating segments.

 

22


INTEL CORPORATION

NOTES TO CONSOLIDATED CONDENSED FINANCIAL STATEMENTS — Unaudited (Continued)

 

Note 18: Identified Intangible Assets

Identified intangible assets consisted of the following as of October 1, 2011 and December 25, 2010:

 

$(1,302) $(1,302) $(1,302)
     October 1, 2011  

(In Millions)

   Gross Assets      Accumulated
Amortization
    Net  

Acquisition-related developed technology

   $  2,526      $ (437   $  2,089  

Acquisition-related customer relationships

     1,706        (187     1,519  

Acquisition-related trade names

     65        (18     47  

Licensed technology

     2,349        (660     1,689  
  

 

 

    

 

 

   

 

 

 

Identified intangible assets subject to amortization

   $  6,646      $ (1,302   $  5,344  

Acquisition-related trade names

     812               812  

Other intangible assets

     289               289  
  

 

 

    

 

 

   

 

 

 

Identified intangible assets not subject to amortization

   $  1,101      $      $  1,101  
  

 

 

    

 

 

   

 

 

 

Total identified intangible assets

   $  7,747      $ (1,302   $  6,445  
  

 

 

    

 

 

   

 

 

 

 

$(1,302) $(1,302) $(1,302)
     December 25, 2010  

(In Millions)

   Gross Assets      Accumulated
Amortization
    Net  

Acquisition-related developed technology

   $ 235      $ (97   $  138  

Acquisition-related customer relationships

     152        (10     142  

Acquisition-related trade names

     46        (10     36  

Licensed technology

     1,204        (765     439  
  

 

 

    

 

 

   

 

 

 

Identified intangible assets subject to amortization

   $  1,637      $ (882   $  755  

Other intangible assets

     105               105  
  

 

 

    

 

 

   

 

 

 

Total identified intangible assets

   $  1,742      $ (882   $  860  
  

 

 

    

 

 

   

 

 

 

As a result of our acquisition of McAfee during the first quarter of 2011, we recorded $3.6 billion of identified intangible assets. In addition, as a result of our other acquisitions during the first nine months of 2011, we recorded $1.3 billion of identified intangible assets, most of which was from the acquisition of the WLS business of Infineon. For further information about identified intangible assets recorded as a result of acquisitions during the first nine months of 2011, see “Note 15: Acquisitions.”

In January 2011, we entered into a long-term patent cross-license agreement with NVIDIA. Under the agreement, we received a license to all of NVIDIA’s patents while NVIDIA products are licensed to our patents, subject to exclusions for x86 products, certain chipsets, and certain flash memory technology products. The agreement also included settlement of the existing litigation between the companies as well as broad mutual general releases. We agreed to make payments totaling $1.5 billion to NVIDIA over six years ($300 million in each of January 2011, 2012, and 2013; and $200 million in each of January 2014, 2015, and 2016), which resulted in a liability totaling approximately $1.4 billion, on a discounted basis. In the fourth quarter of 2010, we recognized an expense of $100 million related to the litigation settlement. In the first quarter of 2011, we recognized the remaining amount of $1.3 billion as licensed technology which will be amortized into cost of sales over its estimated useful life of 17 years. As of October 1, 2011, the remaining liability of $1.2 billion is classified within other accrued liabilities and other long-term liabilities, based on the expected timing of the underlying payments. The intangible asset and associated liability for future payments to NVIDIA are treated as a noncash transaction and, therefore, have no impact on our consolidated condensed statements of cash flows for the nine months ended October 1, 2011. These future payments will be treated as cash used for financing activities.

 

23


INTEL CORPORATION

NOTES TO CONSOLIDATED CONDENSED FINANCIAL STATEMENTS — Unaudited (Continued)

 

For identified intangible assets that are subject to amortization, we recorded amortization expense on the consolidated condensed statements of income as follows:

 

Remainder Remainder Remainder Remainder Remainder
       Three Months Ended      Nine Months Ended  

(In Millions)

     Oct. 1,
2011
     Sept. 25,
2010
     Oct. 1,
2011
     Sept. 25,
2010
 

Acquisition-related developed technology

  

   $  135      $  16      $  345      $ 48  

Licensed technology

  

     44        36        133        121  
  

 

 

    

 

 

    

 

 

    

 

 

 

Cost of sales

  

   $  179      $  52      $  478      $  169  

Research and development (licensed technology)

  

   $ 1      $       $ 1      $   

Acquisition-related customer relationships

  

   $ 73      $ 2      $  180      $ 5  

Acquisition-related trade names

  

     3        2        8        6  
  

 

 

    

 

 

    

 

 

    

 

 

 

Amortization of acquisition-related intangibles

  

   $ 76      $ 4      $  188      $ 11  

 

Based on the identified intangible assets that are subject to amortization as of October 1, 2011, we expect future amortization expense to be as follows:

 

   

     Remainder                              

(In Millions)

   of 2011      2012      2013      2014      2015  

Acquisition-related developed technology

   $  134      $  518      $  503      $  484      $  212  

Licensed technology

     44        169        152        141        123  
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Cost of sales

   $  178      $  687      $  655      $  625      $  335  

Research and development (licensed technology)

   $ 1      $ 6      $ 6      $ 6      $ 6  

Acquisition-related customer relationships

   $ 72      $  283      $  263      $  258      $  250  

Acquisition-related trade names

     2        10        10        10        9  
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Amortization of acquisition-related intangibles

   $ 74      $  293      $  273      $  268      $  259  

 

Note 19: Deferred Income

 

Deferred income at the end of each period was as follows:

 

  

  

(In Millions)

     Oct. 1,
2011
     Dec. 25,
2010
 

Deferred income on shipments of components to distributors

  

   $ 833      $  622  

Deferred income from software and services operating segments

  

     1,084        125  
  

 

 

    

 

 

 

Current deferred income

  

   $  1,917      $  747  

Non-current deferred income from software and services operating segments

  

     381        21  
  

 

 

    

 

 

 

Total deferred income

  

   $  2,298      $  768  
  

 

 

    

 

 

 

We classify non-current deferred income from the software and services operating segments in other long-term liabilities.

 

24


INTEL CORPORATION

NOTES TO CONSOLIDATED CONDENSED FINANCIAL STATEMENTS — Unaudited (Continued)

 

Note 20: Chipset Design Issue

In January 2011, as part of our ongoing quality assurance procedures, we identified a design issue with the Intel® 6 Series Express Chipset family (formerly code-named Cougar Point). The issue affected chipsets sold in the fourth quarter of 2010 and January 2011. We subsequently implemented a silicon fix, and began shipping the updated version of the affected chipset in February 2011. We estimate that the total cost to repair and replace affected materials and systems, located with customers and in the market, will be $733 million. We recorded a charge of $311 million in the fourth quarter of 2010, which comprised $67 million in product costs for the affected chipsets and $244 million to establish a product accrual for this issue. We recognized a charge of $343 million in the first quarter of 2011, primarily related to an additional product accrual for the estimated costs to repair and replace affected materials and systems associated with products sold subsequent to December 25, 2010. In the second quarter of 2011, we recognized an additional $79 million charge as we finalized agreements with customers for reimbursement to repair and replace affected materials and systems. Therefore, we do not expect to have any significant future adjustments to our estimate. The charges incurred in the first half of 2011 are reflected in the results of the PC Client Group operating segment. As of October 1, 2011, the remaining product accrual for the chipset design issue was $144 million and is classified within other accrued liabilities.

Note 21: Borrowings

Short-Term Debt

We have an ongoing authorization from our Board of Directors to borrow up to $3.0 billion, including through the issuance of commercial paper. Maximum borrowings under our commercial paper program during the first nine months of 2011 were $1.4 billion, although no commercial paper remained outstanding as of October 1, 2011.

Long-Term Debt

Senior Notes

In the third quarter of 2011, we issued $5.0 billion aggregate principal amount of senior unsecured notes (the notes). The outstanding balance for the notes included in long-term debt was as follows.

 

(In Millions)

   October 1, 2011  

1.95% Senior Notes due October 1, 2016

   $ 1,498  

3.30% Senior Notes due October 1, 2021

     1,995  

4.80% Senior Notes due October 1, 2041

     1,489  
  

 

 

 

Total

   $ 4,982  
  

 

 

 

The notes bear a fixed rate of interest payable semiannually on April 1 and October 1 of each year, beginning on April 1, 2012. We may redeem the notes, in whole or in part, at any time at our option at specified redemption prices. The 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.

The notes were issued primarily to repurchase shares of our common stock pursuant to our common stock repurchase program, and for general corporate purposes.

Convertible Debentures

In 2009, we issued $2.0 billion of junior subordinated convertible debentures (the 2009 debentures) due in 2039. In 2005, we issued $1.6 billion of junior subordinated convertible debentures (the 2005 debentures) due in 2035. The conversion rates for the 2009 and 2005 debentures adjust for certain events outlined in the indenture governing the debentures, such as quarterly dividend distributions in excess of $0.14 per share and $0.10 per share, for the 2009 and 2005 debentures, respectively. As of October 1, 2011, the conversion rate for the 2009 debentures was 44.55 shares of common stock per $1,000 principal amount of debentures, representing an effective conversion price of approximately $22.45 per share of common stock (as of December 25, 2010, the conversion rate was 44.09 shares of common stock per $1,000 principal amount of debentures, representing an effective conversion price of approximately $22.68 per share of common stock). As of October 1, 2011, the conversion rate for the 2005 debentures was 32.94 shares of common stock per $1,000 principal amount of debentures, representing an effective conversion price of approximately $30.36 per share of common stock (as of December 25, 2010, the conversion rate was 32.52 shares of common stock per $1,000 principal amount of debentures, representing an effective conversion price of approximately $30.75 per share of common stock).

 

25


INTEL CORPORATION

NOTES TO CONSOLIDATED CONDENSED FINANCIAL STATEMENTS — Unaudited (Continued)

 

Note 22: 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.

In connection with our completed acquisition of McAfee, we assumed their equity incentive plans and issued replacement awards in the first quarter of 2011. The stock options and restricted stock units issued generally retain the terms and conditions of the respective plans under which they were originally granted. We will not grant additional shares under these plans.

In May 2011, stockholders approved an extension of the 2006 Equity Incentive Plan (2006 Plan). Stockholders approved 168 million additional shares for issuance, increasing the total shares of common stock available for issuance as equity awards to employees and non-employee directors to 596 million shares. The approval also extended the expiration date of the 2006 Plan to June 2014. The maximum shares to be awarded as non-vested shares (restricted stock) or non-vested share units (restricted stock units) was increased to 394 million shares. As of October 1, 2011, 308 million shares 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 are granted during the first and third quarters of each year. In May 2011, stockholders approved an extension of the 2006 Stock Purchase Plan. Stockholders approved 133 million additional shares for issuance, increasing the total shares of common stock available for issuance to 373 million shares. The approval also extended the expiration date of the 2006 Stock Purchase Plan to August 2016. As of October 1, 2011, 254 million shares were available for issuance under the 2006 Stock Purchase Plan.

Share-Based Compensation

We recognized $250 million of share-based compensation in the third quarter of 2011 and $812 million for the first nine months of 2011 ($224 million in the third quarter of 2010 and $704 million for the first nine months of 2010).

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 values 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, as follows:

 

     Three Months Ended     Nine Months Ended  
     Oct. 1,
2011
    Sept. 25,
2010
    Oct. 1,
2011
    Sept. 25,
2010
 

Estimated values

   $ 21.37     $ 20.58     $ 19.80     $ 22.64  

Risk-free interest rate

     0.5     0.6     0.7     1.1

Dividend yield

     3.6     2.9     3.4     2.6

Volatility

     26     33     27     31

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 values of employee stock option grants and rights granted under the stock purchase plan, as well as the weighted average assumptions used in calculating these values, on estimates at the date of grant, as follows:

 

     Stock Options     Stock Purchase Plan  
     Three Months Ended     Nine Months Ended     Three Months Ended     Nine Months Ended  
     Oct. 1,
2011
    Sept. 25,
2010
    Oct. 1,
2011
    Sept. 25,
2010
    Oct. 1,
2011
    Sept. 25,
2010
    Oct. 1,
2011
    Sept. 25,
2010
 

Estimated values

   $ 3.82     $ 5.13     $ 3.88     $ 4.84     $ 4.90     $ 4.82     $ 4.69     $ 4.71  

Expected life (in years)

     5.4       4.8       5.3       4.9       0.5       0.5       0.5       0.5  

Risk-free interest rate

     1.7     2.5     2.2     2.6     0.2     0.3     0.2     0.2

Volatility

     26     33     26     28     28     32     26     32

Dividend yield

     3.6     2.9     3.4     2.7     3.7     3.0     3.6     3.1

Under the stock purchase plan, rights to purchase shares are only granted during the first and third quarters of each year.

 

26


INTEL CORPORATION

NOTES TO CONSOLIDATED CONDENSED FINANCIAL STATEMENTS — Unaudited (Continued)

 

Restricted Stock Unit Awards

Activity with respect to outstanding restricted stock units (RSUs) for the first nine months of 2011 was as follows:

 

Exercise Price Exercise Price

(In Millions, Except Per RSU Amounts)

   Number of
RSUs
    Weighted
Average
Grant-Date
Fair Value
 

December 25, 2010

     99.8     $ 18.56  

Granted

     41.8     $ 19.80  

Assumed in acquisition

     5.8     $ 20.80  

Vested

     (34.3   $ 18.51  

Forfeited

     (3.7   $ 19.03  
  

 

 

   

October 1, 2011

     109.4     $ 19.16  
  

 

 

   

The aggregate fair value of awards that vested during the first nine months of 2011 was $679 million, which represents the market value of Intel common stock on the date that the restricted stock units vested. The grant date fair value of awards that vested during the first nine months of 2011 was $635 million. The number of restricted stock units vested includes shares that we withheld on behalf of employees to satisfy the minimum statutory tax withholding requirements. As of October 1, 2011, 4 million of the outstanding restricted stock units were market-based restricted stock units.

Stock Option Awards

Activity with respect to outstanding stock options for the first nine months of 2011 was as follows:

 

Exercise Price Exercise Price

(In Millions, Except Per Option Amounts)

   Number of
Options
    Weighted
Average
Exercise Price
 

December 25, 2010

     386.4     $ 20.45  

Granted

     14.1     $ 21.39  

Assumed in acquisition

     11.8     $ 15.95  

Exercised

     (32.3   $ 18.85  

Cancelled and forfeited

     (7.8   $ 20.40  

Expired

     (17.9   $ 24.96  
  

 

 

   

October 1, 2011

     354.3     $ 20.25  
  

 

 

   

Options exercisable as of:

    

December 25, 2010

     263.0     $ 21.03  

October 1, 2011

     237.3     $ 20.70  

During the first nine months of 2011, the aggregate intrinsic value of stock option exercises was $120 million, which represents the difference between the exercise price and the value of Intel common stock at the time of exercise.

Stock Purchase Plan

Employees purchased 18.5 million shares in the first nine months of 2011 (17.2 million shares in the first nine months of 2010) for $318 million ($281 million in the first nine months of 2010) under the 2006 Stock Purchase Plan.

Note 23: Common Stock Repurchases

Common Stock Repurchase Program

We have an ongoing authorization, since October 2005, as amended, from our Board of Directors to repurchase up to $45 billion in shares of our common stock in open market or negotiated transactions. This amount includes the $10 billion increase in the authorization limit approved by our Board of Directors in September 2011. As of October 1, 2011, $14.2 billion remained available for repurchase under the existing repurchase authorization limit. During the third quarter of 2011, we repurchased 186.2 million shares of common stock at a cost of $4.0 billion. During the first nine months of 2011, we repurchased 468.6 million shares of common stock at a cost of $10.0 billion. We did not make any common stock repurchases under our authorized plan during the first nine months of 2010. We have repurchased 3.9 billion shares at a cost of $80 billion since the program began in 1990.

 

27


INTEL CORPORATION

NOTES TO CONSOLIDATED CONDENSED FINANCIAL STATEMENTS — Unaudited (Continued)

 

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 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. During the first nine months of 2011, we withheld 9.5 million shares (9.3 million shares during the first nine months of 2010) to satisfy $187 million ($222 million during the first nine months of 2010) of employees’ tax obligations. Although shares withheld are not issued, they are treated as common stock repurchases in our financial statements, as they reduce the number of shares that would have been issued upon vesting.

Note 24: Earnings Per Share

We computed our basic and diluted earnings per common share as follows:

 

     Three Months Ended      Nine Months Ended  

(In Millions, Except Per Share Amounts)

   Oct. 1,
2011
     Sept. 25,
2010
     Oct. 1,
2011
     Sept. 25,
2010
 

Net income available to common stockholders

   $ 3,468      $ 2,955      $ 9,582      $ 8,284  

Weighted average common shares outstanding — basic

     5,194        5,575        5,317        5,556  

Dilutive effect of employee equity incentive plans

     93        67        96        87  

Dilutive effect of convertible debt

     53        52        53        52  
  

 

 

    

 

 

    

 

 

    

 

 

 

Weighted average common shares outstanding — diluted

     5,340        5,694        5,466        5,695  
  

 

 

    

 

 

    

 

 

    

 

 

 

Basic earnings per common share

   $ 0.67      $ 0.53      $ 1.80      $ 1.49  
  

 

 

    

 

 

    

 

 

    

 

 

 

Diluted earnings per common share

   $ 0.65      $ 0.52      $ 1.75      $ 1.45  
  

 

 

    

 

 

    

 

 

    

 

 

 

We computed our 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.

For the third quarter of 2011, we excluded 104 million outstanding weighted average stock options (108 million for the first nine months of 2011) from the calculation of diluted earnings per common share because the exercise prices of these stock options were greater than or equal to the average market value of the common shares (200 million for the third quarter of 2010 and 168 million for the first nine months of 2010). These options could be included in the calculation in the future if the average market value of the common shares increases and is greater than the exercise price of these options. We also excluded our 2009 debentures from the calculation of diluted earnings per common share because the conversion option of the debentures was anti-dilutive. In the future, we could have potentially dilutive shares if the average market price is above the conversion price.

 

28


INTEL CORPORATION

NOTES TO CONSOLIDATED CONDENSED FINANCIAL STATEMENTS — Unaudited (Continued)

 

Note 25: Comprehensive Income

The components of total comprehensive income were as follows:

 

$9,5820 $9,5820 $9,5820 $9,5820
     Three Months Ended      Nine Months Ended  

(In Millions)

   Oct. 1,
2011
    Sept. 25,
2010
     Oct. 1,
2011
    Sept. 25,
2010
 

Net income

   $ 3,468     $ 2,955      $ 9,582     $ 8,284  

Change in net unrealized holding gain (loss) on available-for-sale investments

     (161     137        (202     175  

Change in deferred tax asset valuation allowance

     (54     34        (68     62  

Change in net unrealized holding gain (loss) on derivatives

     (134     129        (29     (45

Change in net prior service cost

     2               2       (40

Change in actuarial loss

     6               (7     (14

Change in net foreign currency translation adjustment

     (157             (61       
  

 

 

   

 

 

    

 

 

   

 

 

 

Total comprehensive income

   $ 2,970     $ 3,255      $ 9,217     $ 8,422  
  

 

 

   

 

 

    

 

 

   

 

 

 

The components of accumulated other comprehensive income, net of tax, at the end of each period were as follows:

 

$3,468 $3,468

(In Millions)

   Oct. 1,
2011
    Dec. 25,
2010
 

Accumulated net unrealized holding gain (loss) on available-for-sale investments

   $       199     $       401  

Accumulated net change in deferred tax asset valuation allowance

     135       203  

Accumulated net unrealized holding gain (loss) on derivatives

     98       127  

Accumulated net prior service cost

     (34     (36

Accumulated net actuarial loss

     (369     (362

Accumulated net foreign currency translation adjustment

     (61       
  

 

 

   

 

 

 

Total accumulated other comprehensive income (loss)

   $ (32   $ 333  
  

 

 

   

 

 

 

Note 26: Contingencies

Legal Proceedings

We are currently a party to various legal proceedings, including those noted in this section. While management presently believes that the ultimate outcome of these proceedings, individually and in the aggregate, will not materially harm the company’s financial position, cash flows, or overall trends in results of operations, 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, and in matters for which injunctive relief or other conduct remedies are sought, 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 such as compulsory licensing of intellectual property. Were unfavorable final outcomes to occur, there exists the possibility of a material adverse impact on our business, results of operations, financial position, and overall trends. It is also possible that we could conclude it is in the best interests of our stockholders, employees, and customers to settle one or more such matters, and any such settlement could include substantial payments; however, we have not reached this conclusion with respect to any particular matter 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, but in general contend that we improperly condition price rebates and other discounts on our microprocessors on exclusive or near-exclusive dealing by some of our customers; claim that our software compiler business unfairly prefers Intel microprocessors over competing microprocessors and that, through the use of our compiler and other means, we have caused inaccurate and misleading benchmark results concerning our microprocessors to be disseminated; allege that we unfairly controlled the content and timing of release of various standard computer interfaces developed by Intel in cooperation with other industry participants; and accuse us of engaging in various acts of improper competitive activity in competing against what is referred to as general-purpose graphics processing units, including certain licensing practices and our actions in connection with developing and disclosing potentially competitive technology.

 

29


INTEL CORPORATION

NOTES TO CONSOLIDATED CONDENSED FINANCIAL STATEMENTS — Unaudited (Continued)

 

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 these proceedings. While we have settled some of these matters, the distractions caused by challenges to our conduct from the remaining matters are undesirable, and the legal and other costs associated with defending and resolving our position have been and continue to be significant. We assume that these challenges could continue for a number of years and may require the investment of substantial additional management time and substantial financial resources to explain and defend our position.

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 have received numerous requests for information and documents from the EC and we have 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 also ordered us to “immediately bring to an end the infringement referred to in” the EC decision. In the second quarter of 2009, we recorded the related charge within marketing, general and administrative. We strongly disagree with the EC’s decision, and we appealed the decision to the Court of First Instance (which has been renamed the General Court) in July 2009. The EC filed an answer to our reply brief in November 2010. The court’s decision, after oral argument, is expected in late 2012 or early 2013.

The EC decision exceeds 500 pages and does not contain specific direction on whether or how we should modify our business practices. Instead, the decision states that we should “cease and desist” from further conduct that, in the EC’s opinion, would violate applicable law. We have taken steps, which are subject to the EC’s ongoing review, to comply with that decision pending appeal. We opened discussions with the EC to better understand the decision and to explain changes to our business practices. Based on our current understanding and expectations, we do not believe that any such changes will be material to our financial position, results, or cash flows.

In June 2005, we received an inquiry from the Korea Fair Trade Commission (KFTC) requesting documents from our Korean subsidiary related to marketing and rebate programs that we entered into with Korean PC manufacturers. In February 2006, the KFTC initiated an inspection of documents at our offices in Korea. In September 2007, the KFTC served on us an Examination Report alleging that sales to two customers during parts of 2002–2005 violated Korea’s Monopoly Regulation and Fair Trade Act. In December 2007, we submitted our written response to the KFTC. In February 2008, the KFTC’s examiner submitted a written reply to our response. In March 2008, we submitted a further response. In April 2008, we participated in a pre-hearing conference before the KFTC, and we participated in formal hearings in May and June 2008. In June 2008, the KFTC announced its intent to fine us approximately $25 million for providing discounts to Samsung Electronics Co., Ltd. and TriGem Computer Inc. In November 2008, the KFTC issued a final written decision concluding that our discounts had violated Korean antitrust law and imposing a fine on us of approximately $20 million, which we paid in January 2009. In December 2008, we appealed this decision by filing a lawsuit in the Seoul High Court seeking to overturn the KFTC’s decision. We expect a decision from the court in 2012.

In November 2009, the State of New York filed a lawsuit against us in the U.S. District Court for the District of Delaware. The lawsuit alleges that we violated federal antitrust laws; the New York Donnelly Act, which prohibits contracts or agreements to monopolize; and the New York Executive Law, which proscribes underlying violations of federal and state antitrust laws. The lawsuit alleges that we engaged in a systematic worldwide campaign of illegal, exclusionary conduct to maintain monopoly power and prices in the market for x86 microprocessors through the use of various alleged actions, including exclusive or near-exclusive agreements from large computer makers in exchange for “loyalty payments” and “bribes,” and other alleged threats and retaliation. New York claims that our alleged actions harmed New York consumers, competition, and innovation. The complaint seeks a declaration that our alleged actions have violated the federal and New York antitrust laws and the New York Executive Law; an injunction to prevent further alleged unlawful acts; damages in an amount to be proven at trial based on alleged overcharges on purchases of computers containing Intel microprocessors by New York state agencies and non-state entities, as well as by individual New York consumers, trebled as provided for by law under the Sherman Act or Donnelly Act, restitution, and disgorgement; $1 million in civil penalties for alleged violations of the Donnelly Act; and attorneys’ fees and costs. We disagree with the State of New York’s allegations and claims, and we intend to conduct a vigorous defense of the lawsuit. We filed our answer in January 2010, and the court has scheduled trial to begin in this matter in February 2012.

 

30


INTEL CORPORATION

NOTES TO CONSOLIDATED CONDENSED FINANCIAL STATEMENTS — Unaudited (Continued)

 

In December 2010, the State of New York requested the court’s permission to amend its complaint to expand the scope of parties covered by its Donnelly Act and Executive Law claims to include small and medium businesses operating within the state of New York. We opposed that request, and in May 2011, the court denied the State of New York permission to amend its complaint. In May 2011, we filed three motions, the first seeking partial summary judgment on any claims for damages under the Sherman Act based on purchases of computers containing Intel microprocessors not made within four years of the filing of the complaint, and any claims for damages under the Donnelly Act and Executive Law based on purchases not made within three years of the filing of the complaint; the second seeking dismissal of all claims brought on behalf of non-State of New York public entities on the ground that the State of New York did not obtain proper requests to represent them; and the third seeking judgment on the pleadings on the ground that the State of New York cannot recover damages on behalf of New York consumers for certain claims. In October 2011, we filed two additional motions for summary judgment and a motion seeking to exclude the opinions and testimony of New York’s economic expert. We seek summary judgment on the grounds that each of New York’s claims lacks legal merit because our discounted prices challenged in the lawsuit were lawful and that New York cannot establish antitrust injury because, among other things, it has no evidence of any harm to competition from our alleged actions. Because resolution of these motions may materially impact the scope and nature of New York’s claims, we are unable to make a reasonable estimate of the potential loss or range of losses, if any, arising from this litigation.

At least 82 separate class actions 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 Intel 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 suits allege that Intel 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 dealings 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 the class-action claims and intend to defend the lawsuits vigorously.

All of the federal class actions and the Kansas and Tennessee state court class actions have been transferred by the Multidistrict Litigation Panel to the U.S. District Court in Delaware for all pretrial proceedings and discovery (MDL proceedings). The Delaware district court has 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 Intel. In July 2010, the Special Master issued a Report and Recommendation (Class Report) denying the motion to certify a class. The MDL plaintiffs filed objections to the Special Master’s Class Report, and a hearing on these objections was held in March 2011. The Delaware district court has not yet ruled on those objections. 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 has agreed to delay ruling on this motion until after the Delaware district court rules on the similar motion in the MDL proceedings. Based on the procedural posture and the nature of the cases, including, but not limited to, the fact that the Special Master’s Class Report is on review in the Delaware district court, we are unable to make a reasonable estimate of the potential loss or range of losses, if any, arising from these matters.

Lehman Matter

In November 2009, representatives of the Lehman Brothers OTC Derivatives Inc. (LOTC) bankruptcy estate advised us informally that the estate was considering a claim against us arising from a 2008 contract between Intel and LOTC. Under the terms of the 2008 contract, Intel prepaid $1.0 billion to LOTC, in exchange for which LOTC was required to purchase and deliver to Intel the number of shares of Intel common stock that could be purchased for $1.0 billion at the discounted volume-weighted average price specified in the contract for the period September 2, 2008 to September 26, 2008. 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 shares of our common stock, and we exercised our right to setoff against the $1.0 billion collateral. LOTC has not initiated any action against us to date, but in February 2010, LOTC served a subpoena on us in connection with this transaction. In October 2010, LOTC demanded that Intel pay it at least $417 million. In September 2010, we entered into an agreement with LOTC that tolled any applicable statutes of limitations for 90 days and precluded the parties from commencing any formal proceedings to prosecute any claims against each other in any forum during that period. The tolling agreement with LOTC was extended several times, but lapsed in June 2011. We continue to believe that we acted appropriately under our agreement with LOTC, and we intend to defend any claim to the contrary. No complaint has been filed and we are in the early stages of evaluating this dispute, and accordingly are unable to make a reasonable estimate of the potential loss or range of losses, if any, arising from this matter.

 

31


INTEL CORPORATION

NOTES TO CONSOLIDATED CONDENSED FINANCIAL STATEMENTS — Unaudited (Continued)

 

Frank T. Shum v. Intel Corporation, Jean-Marc Verdiell, and LightLogic, Inc.

We acquired LightLogic, Inc. in May 2001. Frank Shum subsequently sued us, LightLogic, and LightLogic’s founder, Jean-Marc Verdiell, claiming that much of LightLogic’s intellectual property is based on alleged inventions that Shum conceived while he and Verdiell were partners at Radiance Design, Inc. Shum has alleged claims for fraud, breach of fiduciary duty, fraudulent concealment, and breach of contract. Shum also seeks alleged correction of inventorship of seven patents acquired by us as part of the LightLogic acquisition. In January 2005, the U.S. District Court for the Northern District of California denied Shum’s inventorship claim, and thereafter granted our motion for summary judgment on Shum’s remaining claims. In August 2007, the U.S. Court of Appeals for the Federal Circuit vacated the District Court’s rulings and remanded the case for further proceedings. In October 2008, the District Court granted our motion for summary judgment on Shum’s claims for breach of fiduciary duty and fraudulent concealment, but denied our motion on Shum’s remaining claims. A jury trial on Shum’s remaining claims took place in November and December 2008. In pretrial proceedings and at trial, Shum requested monetary damages against the defendants in amounts ranging from $31 million to $931 million, and his final request to the jury was for as much as $175 million. Following deliberations, the jury was unable to reach a verdict on most of the claims. With respect to Shum’s claim that he is the proper inventor on certain LightLogic patents now assigned to us, the jury agreed with Shum on some of those claims and was unable to reach a verdict regarding the remaining claims. In April 2009, the court granted defendants’ motions for judgment as a matter of law. Shum appealed that ruling to the U.S. Court of Appeals for the Federal Circuit, which heard oral arguments in August 2010 and affirmed the trial court’s orders in favor of Intel in December 2010. In January 2011, Shum petitioned the Federal Circuit for a re-hearing and re-hearing en banc. In February 2011, the Federal Circuit denied Shum’s request. Shum petitioned the U.S. Supreme Court for review in May 2011, and we filed our response in August 2011. The U.S. Supreme Court denied certiorari in October 2011, ending the matter.

Note 27: Operating Segment Information

Our operating segments in effect as of October 1, 2011 include:

•    PC Client Group

  

•    Ultra-Mobility Group

•    Data Center Group

  

•    McAfee

•    Intel Mobile Communications

  

•    Wind River Software Group

•    Intelligent Systems Group

  

•    Software and Services Group

•    Netbook and Tablet Group

  

•    Non-Volatile Memory Solutions Group

•    Digital Home Group

  

In the first quarter of 2011, we formed the Netbook and Tablet Group, which includes microprocessors and related chipsets designed for the netbook and tablet market segments, and we divested the Digital Health Group (for further information see “Note 16: Divestitures”). Prior-period amounts have been adjusted retrospectively to reflect these operating segment changes as well as other minor reorganizations. Additionally, in the first quarter of 2011, we formed the Intel Mobile Communications and McAfee operating segments as a result of acquisitions (for further information see “Note 15: Acquisitions”).

The Chief Operating Decision Maker (CODM) is our President and Chief Executive Officer. The CODM allocates resources to and assesses the performance of each operating segment using information about its revenue and operating income (loss).

Our PC Client Group and our Data Center Group are reportable operating segments. We aggregate and disclose the financial results of the following non-reportable operating segments within “other Intel architecture operating segments”: Intel Mobile Communications, Intelligent Systems Group (formerly known as the Embedded and Communications Group), Netbook and Tablet Group, Digital Home Group, and Ultra-Mobility Group. We also aggregate and disclose the financial results of the following non-reportable operating segments within “software and services operating segments”: McAfee, Wind River Software Group, and Software and Services Group. Each of these aggregated operating segments does not meet the quantitative thresholds to qualify as a reportable operating segment; however, we have elected to disclose the aggregation of these non-reportable operating segments. Revenue for our reportable and aggregated non-reportable operating segments is primarily related to the following product lines:

   

PC Client Group. Includes microprocessors and related chipsets and motherboards designed for the notebook and desktop (including high-end enthusiast PCs) market segments; and wireless connectivity products.

   

Data Center Group. Includes microprocessors and related chipsets and motherboards designed for the server, workstation, and storage computing market segments; and wired network connectivity products.

   

Other Intel architecture operating segments. Includes mobile phone components such as baseband processors, radio frequency transceivers, and power management chips; microprocessors and related chipsets designed for embedded applications; microprocessors and related chipsets designed for the netbook and tablet market segments; products designed for the consumer electronics market segment; and products designed for the handheld market segment.

   

Software and services operating segments. Includes software products for endpoint security, system security, consumer security, network security, and risk and compliance from our McAfee business; software optimized products for the embedded and handheld market segments; and software products and services that promote Intel® architecture as the platform of choice for software development.

 

32


INTEL CORPORATION

NOTES TO CONSOLIDATED CONDENSED FINANCIAL STATEMENTS — Unaudited (Continued)

 

We have sales and marketing, manufacturing, finance, and administration groups. Expenses for these groups are generally allocated to the operating segments, and the allocated expenses are included in the operating results reported below.

The “All other” category includes revenue, expenses, and charges such as:

   

results of operations from our Non-Volatile Memory Solutions Group that includes NAND flash memory products for use in a variety of devices;

   

a portion of profit-dependent compensation and other expenses not allocated to the operating segments;

   

divested businesses for which discrete operating results are not reviewed by our CODM;

   

results of operations of seed businesses that support our initiatives; 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. The accounting policies for segment reporting are the same as for Intel as a whole.

Segment information is summarized as follows:

 

     Three Months Ended     Nine Months Ended  

(In Millions)

   Oct. 1,
2011
    Sept. 25,
2010
    Oct. 1,
2011
    Sept. 25,
2010
 

Net revenue

        
PC Client Group                         

Microprocessor revenue

   $ 7,521     $ 6,072     $ 20,877     $ 17,666  

Chipsets, motherboard, and other revenue

     1,896       1,666       5,482       4,948  
  

 

 

   

 

 

   

 

 

   

 

 

 
     9,417       7,738       26,359       22,614  

Data Center Group

        

Microprocessor revenue

     2,118       1,847       6,233       5,196  

Chipsets, motherboard, and other revenue

     394       339       1,179       975  
  

 

 

   

 

 

   

 

 

   

 

 

 
     2,512       2,186       7,412       6,171  

Other Intel architecture operating segments

     1,368       812       3,906       2,241  

Software and services operating segments

     541       66       1,292       189  

All other

     395       300       1,143       951  
  

 

 

   

 

 

   

 

 

   

 

 

 

Total net revenue

   $ 14,233     $ 11,102     $ 40,112     $ 32,166  
  

 

 

   

 

 

   

 

 

   

 

 

 

Operating income (loss)

        

PC Client Group

   $ 4,014     $ 3,345     $ 10,841     $ 9,765  

Data Center Group

     1,221       1,068       3,647       2,962  

Other Intel architecture operating segments

     (140     92       (209     194  

Software and services operating segments

     18       (36     (48     (128

All other

     (328     (333     (1,353     (1,228
  

 

 

   

 

 

   

 

 

   

 

 

 

Total operating income (loss)

   $ 4,785     $ 4,136     $ 12,878     $ 11,565  
  

 

 

   

 

 

   

 

 

   

 

 

 

 

33


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.

   

Strategy. Our overall strategy.

   

Critical Accounting Estimates. Accounting estimates that we believe are most important to understanding the assumptions and judgments incorporated in our reported financial results and forecasts.

   

Results of Operations. An analysis of our financial results comparing the three and nine months ended October 1, 2011 to the three and nine months ended September 25, 2010. In the first quarter of 2011, we formed the Netbook and Tablet Group (NTG), which includes microprocessors and related chipsets designed for the netbook and tablet market segments. NTG results were previously included in the results of the PC Client Group and are now included in the other Intel architecture operating segments category. The analysis of our operating segment results of operations reflects this reorganization and prior-period amounts have been adjusted retrospectively.

   

Business Outlook. Our expectations for selected financial items for the fourth quarter of 2011 and the 2011 full year.

   

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.

The various sections of this MD&A contain a number of forward-looking statements. Words such as “expects,” “goals,” “plans,” “believes,” “continues,” “may,” “will,” 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, 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 throughout this filing and particularly in the “Business Outlook” section and in “Risk Factors” in Part II, Item 1A of this 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 November 4, 2011.

Overview

Our results of operations were as follows:

 

(Dollars in Millions)

   Q3 2011     Q2 2011     Q3 2010  

Net revenue

   $ 14,233     $ 13,032     $ 11,102  

Gross margin

   $ 9,018     $ 7,902     $ 7,321  

Gross margin percentage

     63.4     60.6     65.9

Operating income

   $ 4,785     $ 3,935     $ 4,136  

Net income

   $ 3,468     $ 2,954     $ 2,955  

The third quarter of 2011 was a record quarter for revenue, gross margin dollars, operating income, net income, and earnings per share, as increased demand from emerging markets and the enterprise market segment, partially offset by slower growth in the mature market consumer segment were similar to the trends exhibited in the first half of 2011. Our third quarter revenue of $14.2 billion increased 9% from the second quarter and 28% from the third quarter of 2010. Increased demand for our 2nd generation Intel® CoreTM processor products drove a significant increase in notebook microprocessor unit sales from the second quarter which contributed to record microprocessor unit sales in the third quarter. Platform (microprocessor and chipset) average selling prices were flat from the second quarter. We expect our revenue in the fourth quarter to be below seasonal trends based on macroeconomic concerns about mature market consumer growth, particularly in Europe, which historically has been strong during the fourth quarter. In addition, during the fourth quarter, we expect our customers to tightly manage the supply chain and we expect a reduction in Intel Mobile Communications revenue on customer transitions.

Our gross margin percentage for the third quarter of 2011 was up 2.8 percentage points from the second quarter on seasonally higher platform volume, lower platform unit costs as we continue to ramp our 32nm factories, lower start-up costs as we started volume production using our 22nm process technology, and lower charges related to the chipset design issue (see “Note 20: Chipset Design Issue” in the Notes to Consolidated Condensed Financial Statements of this Form 10-Q). We expect our gross margin percentage to increase in the fourth quarter on higher platform volume, lower platform unit costs, and lower start-up costs. This fourth quarter gross margin percentage expectation assumes a late quarter qualification for sale of our 22nm process technology microprocessors (code-named “Ivy Bridge”).

 

34


MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (Continued)

 

Our strong financial performance during the first nine months of 2011 has allowed us to make significant investments in our business as well as increase the return of cash to our stockholders through common stock repurchases and dividends. The cash generation of our business remained strong in the third quarter of 2011 with $6.3 billion of cash from operations, and we ended the quarter with an investment portfolio of $15.2 billion, consisting of cash and cash equivalents, short-term investments, and marketable debt instruments included in trading assets. During the third quarter, we issued $5.0 billion of notes primarily to repurchase shares of our common stock pursuant to our common stock repurchase program; repurchased $4.0 billion of common stock through our common stock repurchase program; purchased $2.7 billion in capital assets; and returned $1.1 billion to stockholders through dividends. In September, the Board of Directors declared a dividend of $0.21 per common share for the fourth quarter of 2011 and increased the repurchase authorization limit of our common stock repurchase program by $10 billion.

We continue to deliver improvements in our product offerings through our “tick-tock” technology development cadence as we began volume production of Ivy Bridge during the third quarter of 2011 in advance of our anticipated launch in early 2012. Ivy Bridge introduces the first three-dimensional transistor design called Tri-Gate, which is expected to improve performance and energy efficiency, as well as increase transistor density, compared to the existing two-dimensional transistor structure.

We believe that we are beginning to realize returns on the investments we have made to expand our capabilities and create long-term opportunities across the computing continuum. We have shipped certain versions of our 2nd generation Intel® CoreTM server processor-based platform (code-named “Romley”) and expect significant demand upon our launch of all versions of the platform in the spring of 2012 as customers look for cost savings and energy-efficient performance in the Internet data center and cloud computing environments. We announced our collaboration with Google Inc. to enable and optimize future releases of the Android platform for Intel ® AtomTM processors which we expect to accelerate the time-to-market of Intel Architecture-based mobile devices using the Android platform. In addition, as we begin to see the first generation of PCs using UltrabookTM system designs in the marketplace, we believe there is high industry and consumer interest in these thin and light form factors with instant-on capability, enhanced security, and excellent battery life.

Strategy

Our goal is to be the preeminent computing solutions company that powers the worldwide digital economy. We believe that the proliferation of the Internet and cloud computing has driven fundamental changes in the computing industry. We are transforming from a company with a primary focus on the design and manufacture of semiconductor chips for PCs and servers to a computing company that delivers complete solutions in the form of hardware and software platforms and supporting services. The number and variety of devices connected to the Internet is growing, and computing is becoming an increasingly engaging and personal experience. End users value consistency across devices that connect seamlessly and effortlessly to the Internet and to each other. We will help to enable this experience by innovating around three pillars of computing: energy-efficient performance, connectivity, and security.

   

Energy-Efficient Performance. We are focusing on improved energy-efficient performance for computing and communications systems and devices. Improved energy-efficient performance involves balancing higher performance with lower power consumption.

   

Connectivity. We are positioning our business to take advantage of the growth in devices that compute and connect to the Internet. In the first quarter of 2011, we acquired the Wireless Solutions (WLS) business of Infineon Technologies AG. This acquisition enables us to offer a portfolio of products that covers a broad range of wireless connectivity options by combining the Intel® WiFi technology with WLS’ 2G and 3G technologies, and creates a combined path to accelerate industry adoption of 4G LTE.

   

Security. Our goal is to enhance security features through a combination of hardware and software solutions. This may include identity protection and fraud deterrence; detection and prevention of malware; securing data and assets; as well as system recovery and enhanced security patching. In the first quarter of 2011, we acquired McAfee, Inc. We believe this acquisition accelerates and enhances our hardware and software security solutions, improving the overall security of our platforms.

To succeed in the changing computing environment, we have the following key objectives:

   

Strive to ensure that Intel technology remains the best choice for the PC as well as cloud computing and the data center. Our UltrabookTM system designs will enable a new user experience by accelerating a new class of mobile computers that use low power processors. These computers will combine the performance and capabilities of today’s laptops and tablets in a thin and light form factor that is highly responsive, secure, and seamlessly connects to the Internet and other enabled devices.

   

Expand platforms into adjacent market segments to bring compelling new solutions to the smartphone, the tablet, the car, and the embedded world.

   

Enable devices that connect to the Internet and to each other to create a continuum of personal computing. This continuum would give consumers a set of secure, consistent, engaging and personalized computing experiences.

   

Positively impact the world through our actions and the application of our energy-efficient technology.

 

35


MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (Continued)

 

We will use our core assets to meet these objectives. Our core assets include our silicon and process technology, our architecture and platforms, our global presence, our strong relationships across the industry, and our brand recognition. We believe that applying these core assets to our key focus areas provides us with the scale, capacity, and global reach to establish new technologies and respond to customers’ needs quickly. Some of our core assets and key focus areas are:

   

Silicon and Manufacturing Technology Leadership. We have long been a leader in silicon process technology and manufacturing, and we aim to continue our lead through investment and innovation in this critical area. We drive a regular two-year upgrade cycle—introducing a new microarchitecture approximately every two years and ramping the next generation of silicon process technology in the intervening years. We refer to this as our “tick-tock” technology development cadence. As we continue to drive Moore’s Law over the next several years, we believe that the value of this leadership will increase. We have accelerated the Intel® AtomTM processor-based system-on-chip roadmap for netbooks, smartphones, tablets, and other devices, from 32nm through 22nm to 14nm within three successive years. We expect that this acceleration will result in a significant reduction in transistor leakage, lower active power, and an increase of transistor density to enable more powerful smartphones, tablets, and netbooks with more features and longer battery life. Additionally, we aim to have the best process technology, and unlike most semiconductor companies, we primarily manufacture our products in our own facilities. This allows us to optimize performance, reduce our time to market, and scale new products more rapidly.

   

Architecture and Platforms. We are now developing a wide range of solutions for devices that span the computing continuum, from PCs, Ultrabook systems, tablets, and smartphones to in-vehicle infotainment systems and beyond. Users want computing experiences that are consistent and devices that are interoperable. Users and developers value consistency of architecture, which provides a common framework that allows for reduced time to market, with the ability to leverage technologies across multiple form factors. We believe that we can meet the needs of both users and developers by offering Intel® architecture-based computing solutions across the computing continuum. We continue to invest in improving Intel architecture so that we can deliver increased value to our customers in existing market segments and also expand the capabilities of the architecture to meet end-user and customer needs in adjacent market segments. Increasingly, we are delivering our architecture in the form of platforms. Platforms include not only the microprocessor, but other critical hardware and software ingredients that are necessary to create computing solutions. We are expanding our platform capabilities with connectivity solutions, new types of user interfaces, new features and capabilities, and complementary software.

   

Software. We enable and advance the computing ecosystem by providing development tools and support to help software developers create software applications and operating systems that take advantage of our platforms. We seek to expedite growth in various market segments, such as the embedded market segment, through our software offerings. Additionally, we have collaborated with other companies to develop software platforms optimized for our Intel® AtomTM processors and that support multiple hardware architectures as well as multiple operating systems. We also deliver proactive and proven solutions and services that help secure systems and networks around the world.

   

Customer Orientation. Our strategy focuses on developing our next generation of products based on the needs and expectations of our customers. In turn, our products help enable the design and development of new form factors and usage models for businesses and consumers. We offer platforms that incorporate various components designed and configured to work together to provide an optimized solution compared to components that are used separately. Additionally, we promote industry standards that we believe will yield innovation and improved technologies for users.

   

Strategic Investments. We make investments in companies around the world that we believe will generate financial returns, further our strategic objectives, and support our key business initiatives. Our investments, including those made through our Intel Capital program, generally focus on investing in companies and initiatives to stimulate growth in the digital economy, create new business opportunities for Intel, and expand global markets for our products.

   

Stewardship. We are committed to developing energy-efficient technology solutions that can be used to address major global problems while reducing our environmental impact. We are also committed to helping transform education globally through our technology, program, and policy leadership, as well as funding through the Intel Foundation. In addition, we strive to cultivate a work environment where engaged, energized employees can thrive in their jobs and in their communities.

Our continued investment in developing our assets and execution on key focus areas will strengthen our competitive position as we enter and expand into new market segments. We believe that these new market segments will result in demand that is incremental to that of microprocessors designed for notebook and desktop computers. We also believe that increased Internet traffic and use of cloud computing create a need for greater server infrastructure, including server products optimized for energy-efficient performance and virtualization.

 

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MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (Continued)

 

Critical Accounting Estimates

The methods, estimates, and judgments that we use in applying our accounting policies have a significant impact on the results that we report in our consolidated condensed financial statements. Some of our accounting policies require us to make difficult and subjective judgments, often as a result of the need to make estimates regarding matters that are inherently uncertain. Our most critical accounting estimates include:

 

   

the valuation of non-marketable equity investments and the determination of other-than-temporary impairments, which impact gains (losses) on equity method investments, net, or gains (losses) on other equity investments, net when we record impairments;

   

the assessment of recoverability of long-lived assets (property, plant and equipment; goodwill; and identified intangibles), which impacts gross margin or operating expenses when we record asset impairments or accelerate their depreciation or amortization;

   

the recognition and measurement of current and deferred income taxes (including the measurement of uncertain tax positions), which impact our provision for taxes;

   

the valuation of inventory, which impacts gross margin; and

   

the recognition and measurement of loss contingencies, which impact gross margin or operating expenses when we recognize a loss contingency, revise the estimate for a loss contingency, or record an asset impairment.

Below, we discuss these policies further, as well as the estimates and judgments involved.

Non-Marketable Equity Investments

We regularly invest in non-marketable equity instruments of private companies, which range from early-stage companies that are often still defining their strategic direction to more mature companies with established revenue streams and business models. The carrying value of our non-marketable equity investment portfolio, excluding equity derivatives, totaled $2.8 billion as of October 1, 2011 ($2.6 billion as of December 25, 2010). Approximately half of this balance as of October 1, 2011 was concentrated in companies in the flash memory market segment. Our flash memory market segment investments include our investment in IM Flash Technologies, LLC (IMFT) and IM Flash Singapore, LLP (IMFS) of $1.4 billion ($1.5 billion as of December 25, 2010). For further information, see “Note 11: Equity Method Investments” in the Notes to Consolidated Condensed Financial Statements of this Form 10-Q.

Our non-marketable equity investments are recorded using the cost method or the equity method of accounting, depending on the facts and circumstances of each investment. Our non-marketable equity investments are classified within other long-term assets on the consolidated condensed balance sheets.

Non-marketable equity investments are inherently risky, and their success is dependent on product development, market acceptance, operational efficiency, the ability of the investee companies to raise additional funds in financial markets that can be volatile, and other key business factors. The companies could fail or not be able to raise additional funds when needed, or they may receive lower valuations with less favorable investment terms than previous financings. These events could cause our investments to become impaired. In addition, financial market volatility could negatively affect our ability to realize value in our investments through liquidity events such as initial public offerings, mergers, and private sales. For further information about our investment portfolio risks, see “Risk Factors” in Part II, Item 1A of this Form 10-Q.

We determine the fair value of our non-marketable equity investments quarterly for disclosure purposes; however, the investments are recorded at fair value only if an impairment charge is recognized. We determine the fair value of our non-marketable equity investments using the market and income approaches. The market approach includes the use of financial metrics and ratios of comparable public companies, such as projected revenues, earnings, and comparable performance multiples. The selection of comparable companies requires management judgment and is based on a number of factors, including comparable companies’ sizes, growth rates, industries, development stages, and other relevant factors. The income approach includes the use of a discounted cash flow model, which may include one or multiple discounted cash flow scenarios and requires the following significant estimates for the investee: revenue; expenses, capital spending, and other costs; and discount rates based on the risk profile of comparable companies. Estimates of revenue, expenses, capital spending, and other costs are developed using historical data and available market data. The valuation of our non-marketable equity investments also takes into account variables such as conditions reflected in the capital markets, recent financing activities by the investees, the investees’ capital structures, the terms of the investees’ issued interests, and the lack of marketability of the investments.

 

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MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (Continued)

 

For non-marketable equity investments, the measurement of fair value requires significant judgment and includes quantitative and qualitative analysis of identified events or circumstances that impact the fair value of the investment, such as:

   

the investee’s revenue and earnings trends relative to pre-defined milestones and overall business prospects;

   

the technological feasibility of the investee’s products and technologies;

   

the general market conditions in the investee’s industry or geographic area, including adverse regulatory or economic changes;

   

factors related to the investee’s ability to remain in business, such as the investee’s liquidity, debt ratios, and the rate at which the investee is using its cash; and

   

the investee’s receipt of additional funding at a lower valuation.

If the fair value of an investment is below our carrying value, we determine if the investment is other than temporarily impaired based on our quantitative and qualitative analysis, which includes assessing the severity and duration of the impairment and the likelihood of recovery before disposal. If the investment is considered to be other than temporarily impaired, we write down the investment to its fair value. Impairments of non-marketable equity investments were $12 million in the third quarter of 2011 ($34 million in the first nine months of 2011). Over the past 12 quarters, including the third quarter of 2011, impairments of non-marketable equity investments ranged from $8 million to $896 million per quarter. This range included impairments of $896 million during the fourth quarter of 2008, primarily related to a $762 million impairment charge on our investment in Clearwire Communications, LLC.

IMFT/IMFS

IMFT and IMFS are variable interest entities that are designed to manufacture and sell NAND products to Intel and Micron Technology, Inc. at manufacturing cost. We determine the fair value of our investment in IMFT/IMFS using the income approach based on a weighted average of multiple discounted cash flow scenarios of our NAND Solutions Group business, which requires the use of unobservable inputs. Unobservable inputs that require us to make our most difficult and subjective judgments are the estimates for projected revenue and discount rate. Changes in management estimates for these unobservable inputs have the most significant effect on the fair value determination. We have not had an other-than-temporary impairment of our investment in IMFT/IMFS.

Long-Lived Assets

Property, Plant and Equipment

We assess property, plant and equipment for impairment when events or changes in circumstances indicate that the carrying value of the assets or the asset grouping may not be recoverable. Factors that we consider in deciding when to perform an impairment review include significant under-performance of a business or product line in relation to expectations, significant negative industry or economic trends, and significant changes or planned changes in our use of the assets. We measure the recoverability of assets that will continue to be used in our operations by comparing the carrying value of the asset grouping to our estimate of the related total future undiscounted net cash flows. If an asset grouping’s carrying value is not recoverable through the related undiscounted cash flows, the asset grouping is considered to be impaired. The impairment is measured by comparing the difference between the asset grouping’s carrying value and its fair value. Property, plant and equipment is considered a non-financial asset and is recorded at fair value only if an impairment charge is recognized.

Impairments are determined for groups of assets related to the lowest level of identifiable independent cash flows. Due to our asset usage model and the interchangeable nature of our semiconductor manufacturing capacity, we must make subjective judgments in determining the independent cash flows that can be related to specific asset groupings. In addition, as we make manufacturing process conversions and other factory planning decisions, we must make subjective judgments regarding the remaining useful lives of assets, primarily process-specific semiconductor manufacturing tools and building improvements. When we determine that the useful lives of assets are shorter than we had originally estimated, we accelerate the rate of depreciation over the assets’ new, shorter useful lives. Over the past 12 quarters, including the third quarter of 2011, impairments and accelerated depreciation of long-lived assets ranged from $10 million to $75 million per quarter.

Goodwill

Goodwill is recorded when the purchase price paid for an acquisition exceeds the estimated fair value of the net identified tangible and intangible assets acquired. Goodwill is allocated to our reporting units based on relative fair value of the future benefit of the purchased operations to our existing business units as well as the acquired business unit.

 

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MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (Continued)

 

We perform an annual review in the fourth quarter of each year, or more frequently if indicators of potential impairment exist, to determine if the carrying value of the recorded goodwill is impaired. Our impairment review process compares the fair value of the reporting unit in which goodwill resides to its carrying value. Reporting units may be operating segments as a whole or an operation one level below an operating segment, referred to as a component. Our reporting units are consistent with the operating segments identified in “Note 27: Operating Segment Information” in the Notes to Consolidated Condensed Financial Statements of this Form 10-Q.

If the fair value of the reporting unit exceeds the carrying value of the net assets assigned to that unit, goodwill is not considered impaired and we are not required to perform further testing. If the carrying value of the net assets assigned to the reporting unit exceeds the fair value of the reporting unit, then we must perform the second step of the impairment test in order to determine the implied fair value of the reporting unit’s goodwill. If the carrying value of a reporting unit’s goodwill exceeds its implied fair value, we would record an impairment loss equal to the difference.

Determining the fair value of a reporting unit involves the use of significant estimates and assumptions. Our impairment review process uses the income method to estimate the reporting unit’s fair value and is based on a discounted future cash flow approach that uses the following reporting unit estimates: revenue, based on assumed market segment growth rates and Intel’s assumed market segment share; estimated costs; and appropriate discount rates based on the reporting units’ weighted average cost of capital as determined by considering the observable weighted average cost of capital of comparable companies. Our estimates of market segment growth, our market segment share and costs are based on historical data, various internal estimates and a variety of external sources, and are developed as part of our routine long-range planning process. The same estimates are also used in planning for our long-term manufacturing and assembly and test capacity needs as part of our capital budgeting process and for both long-term and short-term business planning and forecasting. We test the reasonableness of the inputs and outcomes of our discounted cash flow analysis against available comparable market data. In determining the carrying value of the reporting unit, we must include an allocation of our manufacturing and assembly and test assets because of the interchangeable nature of our manufacturing and assembly and test capacity. This allocation is based on each reporting unit’s relative percentage utilization of our manufacturing and assembly and test assets.

During the fourth quarter of each of the prior two fiscal years, we completed our annual impairment reviews and concluded that goodwill was not impaired in either of these years.

Identified Intangibles

We make judgments about the recoverability of purchased finite lived intangible assets whenever events or changes in circumstances indicate that an impairment may exist. Recoverability of finite lived intangible assets is measured by comparison of the carrying amount of the asset to the future undiscounted cash flows the asset is expected to generate. We review indefinite lived intangible assets for impairment quarterly and whenever events or changes in circumstances indicate the carrying value may not be recoverable. Recoverability of indefinite lived intangible assets is measured by comparison of the carrying amount of the asset to the future discounted cash flows the asset is expected to generate. If it is determined that an individual asset is impaired, the amount of any impairment is measured as the difference between the carrying value and the fair value of the impaired asset.

The assumptions and estimates used to determine future values and remaining useful lives of our intangible and other long-lived assets are complex and subjective. They can be affected by various factors, including external factors such as industry and economic trends, and internal factors such as changes in our business strategy and our forecasts for specific product lines. Based on our impairment reviews of our intangible assets, we have not recognized any impairment charges in 2011 or 2010.

Income Taxes

We must make estimates and judgments in determining the provision for taxes for financial statement purposes. These estimates and judgments occur in the calculation of tax credits, benefits, and deductions, and in the calculation of certain tax assets and liabilities that arise from differences in the timing of recognition of revenue and expense for tax and financial statement purposes, as well as the interest and penalties related to uncertain tax positions. Significant changes in these estimates may result in an increase or decrease to our tax provision in a subsequent period.

We must assess the likelihood that we will be able to recover our deferred tax assets. If recovery is not likely, we must increase our provision for taxes by recording a valuation allowance against the deferred tax assets that we estimate will not ultimately be recoverable. We believe that we will ultimately recover the deferred tax assets recorded on our consolidated condensed balance sheets. However, should there be a change in our ability to recover our deferred tax assets, our tax provision would increase in the period in which we determined that the recovery was not likely. Recovery of a portion of our deferred tax assets is impacted by management’s plans with respect to holding or disposing of certain investments; therefore, changes in management’s plans with respect to holding or disposing of investments could affect our future provision for taxes.

 

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MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (Continued)

 

The calculation of our tax liabilities involves dealing with uncertainties in the application of complex tax regulations. We recognize liabilities for uncertain tax positions based on a two-step process. The first step is to evaluate the tax position for recognition by determining if the weight of available evidence indicates that it is more likely than not that the position will be sustained on audit, including resolution of related appeals or li