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INTEL CORP - 10-Q - MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS(Edgar Glimpses Via Acquire Media NewsEdge) Our Management's Discussion and Analysis of Financial Condition and Results of Operations (MD&A) is provided in addition to the accompanying consolidated condensed financial statements and notes to assist readers in understanding our results of operations, financial condition, and cash flows. MD&A is organized as follows: • Overview. Discussion of our business and overall analysis of financial and other highlights affecting the company in order to provide context for the remainder of MD&A. • Results of Operations. An analysis of our financial results comparing the three and six months ended June 28, 2014 to the three and six months ended June 29, 2013. • Liquidity and Capital Resources. An analysis of changes in our balance sheets and cash flows, and discussion of our financial condition and potential sources of liquidity. • Fair Value of Financial Instruments. Discussion of the methodologies used in the valuation of our financial instruments. This interim MD&A should be read in conjunction with the MD&A in our Annual Report on Form 10-K for the year ended December 28, 2013. The various sections of this MD&A contain a number of forward-looking statements that involve a number of risks and uncertainties. Words such as "anticipates," "expects," "intends," "goals," "plans," "believes," "seeks," "estimates," "continues," "may," "will," "should," and variations of such words and similar expressions are intended to identify such forward-looking statements. In addition, any statements that refer to projections of our future financial performance, our anticipated growth and trends in our businesses, uncertain events or assumptions, and other characterizations of future events or circumstances are forward-looking statements. Such statements are based on our current expectations and could be affected by the uncertainties and risk factors described in "Risk Factors" in Part I, Item 1A of our Annual Report on Form 10-K, and as may be updated in our subsequent Quarterly Reports on Form 10-Q. Our actual results may differ materially, and these forward-looking statements do not reflect the potential impact of any divestitures, mergers, acquisitions, or other business combinations that had not been completed as of July 25, 2014. Overview Our results of operations for each period were as follows: (Dollars in Millions, Except Per Share Amounts) Q2 2014 Q1 2014 Change Q2 2014 Q2 2013 Change Net revenue $ 13,831 $ 12,764 $ 1,067 $ 13,831 $ 12,811 $ 1,020 Gross margin $ 8,917 $ 7,613 $ 1,304 $ 8,917 $ 7,470 $ 1,447 Gross margin percentage 64.5 % 59.6 % 4.9 % 64.5 % 58.3 % 6.2 % Operating income $ 3,844 $ 2,510 $ 1,334 $ 3,844 $ 2,719 $ 1,125 Net income $ 2,796 $ 1,930 $ 866 $ 2,796 $ 2,000 $ 796 Diluted earnings per common share $ 0.55 $ 0.38 $ 0.17 $ 0.55 $ 0.39 $ 0.16 Revenue in Q2 2014 of $13.8 billion was up 8% compared to both Q1 2014 and Q2 2013, and up 6% from the midpoint of the original Business Outlook we provided in April 2014 of $13.0 billion. The increase from Q1 2014 was largely due to increased PC Client Group (PCCG) and Data Center Group (DCG) platform unit sales, driven by strength in the enterprise and small and medium businesses. This strength was fueled by several factors including an improved economic environment, a PC refresh, Windows XP end of life, and the availability of new form factors. Net revenue for the PCCG operating segment was up 9% compared to Q1 2014 and 6% compared to Q2 2013, while net revenue for the DCG operating segment was up 14% and 19% over the same comparative periods. We had record net revenues in both our DCG operating segment of $3.5 billion and our Internet of Things Group (IOTG) operating segment of $539 million. For Q3 2014, we are forecasting a revenue midpoint of $14.4 billion, up 4% from Q2 2014. For full-year 2014, we are now expecting revenue growth of approximately 5%, which is higher than our original Business Outlook of approximately flat. 34 -------------------------------------------------------------------------------- INTEL CORPORATION MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (Continued) Gross margin improved by almost 5 percentage points sequentially and 6 percentage points year-over-year. The increase from Q1 2014 was largely due to lower factory start-up costs as we ramp our next generation 14-nanometer (nm) process technology and higher PCCG and DCG platform (Platform) unit sales in Q2 2014. Lower Platform unit costs and lower pre-qualification product costs on our 14nm products also contributed to increased gross margin. These increases were partially offset by higher cost of sales associated with higher tablet platform unit sales and cash consideration provided to our customers associated with integrating our tablet platform. We are forecasting Q3 2014 gross margin to be 66%, up 1.5 percentage points from Q2 2014, due to lower Platform unit costs, increased Platform unit sales, partially offset by lower Platform average selling prices. We are now forecasting full-year 2014 gross margin to be 63%, plus or minus a couple percentage points, up from our original Business Outlook of 61%. This increase is primarily driven by lower Platform unit costs, higher Platform unit sales, and partially offset by lower Platform average selling prices. In Q2 2014, our 5th generation Intel® Core™ processor family on 14nm process technology, code-named Broadwell, qualified for sale. We expect the first 14nm processor-based systems, including fanless 2 in 1's, to be on shelves for the holiday selling season. Our strong product portfolio continues to evolve as we expect to introduce several new products, across the market segments we serve, in the second half of 2014. In the data center market segment, we expect to launch our next generation Xeon® processor E5 family platform on our 22nm process technology, code-named Grantley, during Q3 2014. In the wireless business, we are working towards qualification of our second generation LTE solution, featuring CAT6 and carrier aggregation, in early Q3 2014. Additionally, we expect to have our first integrated SoC application processor and baseband 3G solution, code-named "SoFIA," available in Q4 2014. Finally, we are on track to achieve our 40 million unit sales goal for tablets in fiscal year 2014. Our business continues to produce significant cash from operations, generating $5.5 billion in Q2 2014. From a financial condition perspective, we ended Q2 2014 with $17.3 billion of cash and cash equivalents, short-term investments, and trading assets. During Q2 2014, we purchased $2.8 billion in capital assets and returned cash to stockholders by paying $1.1 billion in dividends and repurchasing $2.1 billion of common stock through our common stock repurchase program. With the cash generated from operations, we intend to increase our repurchases of common stock, and as a result reduce our cash balances. This is expected to enable sufficient liquidity for operations, while providing the strategic flexibility to invest in our business and continuing to return cash to our stockholders. In July 2014, the board of directors authorized an increase of $20 billion to the common stock repurchase program and we entered into a contract to repurchase $4 billion of our common stock in Q3 2014, and are expecting additional stock repurchases in Q4 2014. Additionally, the Board of Directors declared a cash dividend in July 2014 of $0.225 per share of common stock to be paid in September 2014. Our Business Outlook for Q3 2014 and full-year 2014 includes, where applicable, our current expectations for revenue, gross margin percentage, spending (research and development (R&D) plus marketing, general and administrative (MG&A)), and capital expenditures. We publish our Business Outlook in our quarterly earnings release. Our Business Outlook and any updates thereto are publicly available on our Investor Relations web site www.intc.com. This Business Outlook is not incorporated by reference in this Form 10-Q. We expect that our corporate representatives will, from time to time, meet publicly or privately with investors and others, and may reiterate the forward-looking statements contained in the Business Outlook or in this Form 10-Q. The statements in the Business Outlook and forward-looking statements in this Form 10-Q are subject to revision during the course of the year in our quarterly earnings releases and filings with the Securities and Exchange Commission (SEC) and at other times. The forward-looking statements in the Business Outlook and reiterated or updated in this Form 10-Q will be effective through the close of business on September 12, 2014 unless updated earlier or except as specifically noted otherwise in the Business Outlook. From the close of business on September 12, 2014 until our quarterly earnings release is published, currently scheduled for October 14, 2014, we will observe a "quiet period." During the quiet period, the Business Outlook and other forward-looking statements first published in our Form 8-K filed on July 15, 2014, and other forward-looking statements disclosed in the company's news releases and filings with the SEC, as reiterated or updated as applicable in this Form 10-Q, should be considered historical, speaking prior to the quiet period only and not subject to update. During the quiet period, our representatives will not comment on our Business Outlook or our financial results or expectations. The exact timing and duration of the routine quiet period, and any others that we utilize from time to time, may vary at our discretion. 35 -------------------------------------------------------------------------------- INTEL CORPORATION MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (Continued) Results of Operations - Second Quarter of 2014 Compared to Second Quarter of 2013 The following table sets forth certain consolidated condensed statements of income data as a percentage of net revenue for each period as follows: Q2 2014 Q2 2013 (Dollars in Millions, Except Per Share % of Net % of Net Amounts) Dollars Revenue Dollars Revenue Net revenue $ 13,831 100.0 % $ 12,811 100.0 % Cost of sales 4,914 35.5 % 5,341 41.7 % Gross margin 8,917 64.5 % 7,470 58.3 % Research and development 2,859 20.7 % 2,516 19.7 % Marketing, general and administrative 2,061 14.9 % 2,165 16.9 % Restructuring and asset impairment charges 81 0.6 % - - % Amortization of acquisition-related intangibles 72 0.5 % 70 0.5 % Operating income 3,844 27.8 % 2,719 21.2 % Gains (losses) on equity investments, net 95 0.7 % 11 0.1 % Interest and other, net (17 ) (0.1 )% (37 ) (0.3 )% Income before taxes 3,922 28.4 % 2,693 21.0 % Provision for taxes 1,126 8.2 % 693 5.4 % Net income $ 2,796 20.2 % $ 2,000 15.6 % Diluted earnings per common share $ 0.55 $ 0.39 Our net revenue for Q2 2014 increased by $1.0 billion, or 8%, compared to Q2 2013. PCCG and DCG platform unit sales increased by 9% driven by strength in the traditional PC business, while PCCG and DCG platform average selling prices were flat. To a lesser extent, higher tablet platform unit sales contributed to the increase. These increases were reduced by higher cash consideration to our customers to meet competition by offsetting a higher bill of materials and system level costs associated with integrating our tablet platform. Our overall gross margin dollars for Q2 2014 increased by $1.4 billion, or 19%, compared to Q2 2013. This increase was due to higher PCCG and DCG platform revenue, approximately $460 million of lower PCCG and DCG platform unit costs, and approximately $385 million of lower factory start-up costs for our next generation 14nm process technology. These increases were partially offset by higher cash consideration to our customers associated with integrating our tablet platform. Our overall gross margin percentage increased to 64.5% in Q2 2014 from 58.3% in Q2 2013. The increase in gross margin percentage was primarily due to the gross margin increase in PCCG. We derived most of our overall gross margin dollars in Q2 2014 and Q2 2013 from the sale of platforms in the PCCG and DCG operating segments. PC Client Group The revenue and operating income for the PCCG operating segment for each period were as follows: (In Millions) Q2 2014 Q2 2013 Net revenue $ 8,667 $ 8,160 Operating income $ 3,734 $ 2,646 Net revenue for the PCCG operating segment increased by $507 million, or 6%, in Q2 2014 compared to Q2 2013. PCCG platform unit sales were up 9% while PCCG platform average selling prices were down 4%. The increase in revenue was driven primarily by higher notebook platform unit sales and desktop platform unit sales, which were up 9% and 8%, respectively. To a lesser extent, higher desktop platform average selling prices of 2% also contributed to the increase. These increases were partially offset by lower notebook platform average selling prices of 7%. 36 -------------------------------------------------------------------------------- INTEL CORPORATION MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (Continued) Operating income increased by $1.1 billion, or 41%, in Q2 2014 compared to Q2 2013, which was driven by $1.1 billion of higher gross margin and $16 million of lower operating expenses. The increase in gross margin was driven by approximately $405 million of lower PCCG platform unit costs, approximately $365 million of lower factory start-up costs for our next generation 14nm process technology, and higher PCCG platform revenue. Data Center Group The revenue and operating income for the DCG operating segment for each period were as follows: (In Millions) Q2 2014 Q2 2013 Net revenue $ 3,509 $ 2,944 Operating income $ 1,817 $ 1,302 Net revenue for the DCG operating segment increased by $565 million, or 19%, in Q2 2014 compared to Q2 2013. DCG platform average selling prices and unit sales were up 11% and 9%, respectively. Our server platform revenue continued to benefit from growth in the high-performance computing with continued strengthening of the enterprise market segments. Operating income increased by $515 million, or 40%, in Q2 2014 compared to Q2 2013 with $672 million of higher gross margin partially offset by $157 million of higher operating expenses. The increase in gross margin was driven primarily by higher DCG platform revenue. Internet of Things Group The revenue and operating income for the IOTG operating segment for each period were as follows: (In Millions) Q2 2014 Q2 2013 Net revenue $ 539 $ 434 Operating income $ 155 $ 123 Net revenue for the IOTG operating segment increased by $105 million, or 24%, in Q2 2014 compared to Q2 2013. The increase was primarily due to higher IOTG platform unit sales and average selling prices based on strength in the industrial and retail market segments. Operating income for the IOTG operating segment increased by $32 million, or 26%, in Q2 2014 compared to Q2 2013. The increase was primarily due to higher IOTG platform revenue partially offset by higher operating expenses. Mobile and Communications Group The revenue and operating loss for the Mobile and Communications Group (MCG) operating segment for each period were as follows: (In Millions) Q2 2014 Q2 2013 Net revenue $ 51 $ 292 Operating loss $ (1,124 ) $ (761 ) Net revenue for MCG operating segment decreased by $241 million, or 83%, in Q2 2014 compared to Q2 2013. This decrease was primarily due to higher cash consideration to our customers associated with integrating our tablet platform. Additionally, lower MCG phone components unit sales contributed to the decrease. These decreases were partially offset by higher tablet platform unit sales. Operating results for the MCG operating segment decreased by $363 million, or 48%, in Q2 2014 compared to Q2 2013 with $370 million in lower gross margin partially offset by $7 million of lower operating expenses. The decline in operating results was primarily due to higher cash consideration provided to customers, higher cost of sales associated with higher tablet platform unit sales, and lower phone components revenue. These decreases were partially offset by lower tablet unit costs. 37 -------------------------------------------------------------------------------- INTEL CORPORATION MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (Continued) Software and Services Operating Segments The revenue and operating income (loss) for the software and services (SSG) operating segments, including McAfee and the Software and Services Group, for each period were as follows: (In Millions) Q2 2014 Q2 2013 Net revenue $ 548 $ 534 Operating income (loss) $ 8 $ (1 ) Net revenue for the SSG operating segments increased by $14 million in Q2 2014 compared to Q2 2013. The operating results for the SSG operating segments increased by $9 million in Q2 2014 compared to Q2 2013. Operating Expenses Operating expenses for each period were as follows: (Dollar in Millions) Q2 2014 Q2 2013 Research and development $ 2,859 $ 2,516 Marketing, general and administrative $ 2,061 $ 2,165 R&D and MG&A as percentage of net revenue 36 % 37 % Restructuring and asset impairment charges $ 81 $ - Amortization of acquisition-related intangibles $ 72 $ 70 Research and Development. R&D spending increased by $343 million, or 14%, in Q2 2014 compared to Q2 2013. This increase was driven by higher 10nm process technology development costs and higher compensation expenses mainly due to higher profit-dependent compensation as well as annual salary increases. Marketing, General and Administrative. MG&A decreased by $104 million, or 5%, in Q2 2014 compared to Q2 2013. This decrease was driven by lower marketing expenses. Restructuring and Asset Impairment Charges. Restructuring and asset impairment charges for each period were as follows: (In Millions) Q2 2014 Q2 2013 Employee severance and benefit arrangements $ 72 $ - Asset impairments and other restructuring charges 9 - Total restructuring and asset impairment charges $ 81 $ - For further discussion, see "Results of Operations - First Six Months of 2014 Compared to First Six Months of 2013." Gains (Losses) on Equity Investments and Interest and Other Gains (losses) on equity investments, net and interest and other, net for each period were as follows: (In Millions) Q2 2014 Q2 2013 Gains (losses) on equity investments, net $ 95 $ 11 Interest and other, net $ (17 ) $ (37 ) We recognized higher net gains on equity investments in Q2 2014 compared to Q2 2013 due to higher gains on sales of equity investments. 38 -------------------------------------------------------------------------------- INTEL CORPORATION MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (Continued) Provision for Taxes Our provision for taxes and effective tax rate for each period were as follows: (Dollars in Millions) Q2 2014 Q2 2013 Income before taxes $ 3,922 $ 2,693 Provision for taxes $ 1,126 $ 693 Effective tax rate 28.7 % 25.7 % The U.S. R&D tax credit was reenacted in Q1 2013 retroactive to the beginning of 2012. The U.S. R&D tax credit expired at the end of 2013 and has not been reenacted for 2014. The increase in our effective tax rate between Q2 2014 and Q2 2013 was primarily driven by the expiration of the U.S. R&D tax credit and a lower percentage of revenue generated in lower tax jurisdictions. Results of Operations - First Six Months of 2014 Compared to First Six Months of 2013 Certain consolidated condensed statements of income data as a percentage of net revenue for each period were as follows: YTD 2014 YTD 2013 (Dollars in Millions, Except Per Share % of Net % of Net Amounts) Dollars Revenue Dollars Revenue Net revenue $ 26,595 100.0 % $ 25,391 100.0 % Cost of sales 10,065 37.8 % 10,855 42.8 % Gross margin 16,530 62.2 % 14,536 57.2 % Research and development 5,705 21.6 % 5,043 19.8 % Marketing, general and administrative 4,108 15.4 % 4,112 16.2 % Restructuring and asset impairment charges 218 0.8 % - - % Amortization of acquisition-related intangibles 145 0.5 % 143 0.6 % Operating income 6,354 23.9 % 5,238 20.6 % Gains (losses) on equity investments, net 143 0.5 % (15 ) (0.1 )% Interest and other, net 95 0.4 % (87 ) (0.3 )% Income before taxes 6,592 24.8 % 5,136 20.2 % Provision for taxes 1,866 7.0 % 1,091 4.3 % Net income $ 4,726 17.8 % $ 4,045 15.9 % Diluted earnings per common share $ 0.92 $ 0.79 Our net revenue for the first six months of 2014 increased by $1.2 billion, or 5%, compared to the first six months of 2013. PCCG and DCG platform unit sales increased by 5% driven by strength in the traditional PC market while PCCG and DCG platform average selling prices were flat. To a lesser extent, higher IOTG platform unit sales and average selling prices contributed to the increase. These increases were partially offset by lower MCG phone component unit sales. Our overall gross margin dollars for the first six months of 2014 increased by $2.0 billion, or 13.7%, compared to the first six months of 2013. This increase was due primarily to higher PCCG and DCG platform revenue and approximately $795 million of lower PCCG and DCG platform unit costs. Additionally, approximately $295 million of lower excess capacity charges and approximately $220 million of lower factory start-up costs for our next generation 14nm process technology contributed to the increase. These increases were partially offset by higher cash consideration provided to customers associated with integrating our tablet platform and higher cost of sales associated with higher tablet platform unit sales. 39 -------------------------------------------------------------------------------- Our overall gross margin percentage increased to 62.2% in Q2 2014 from 57.2% in Q2 2013. The increase in gross margin percentage was primarily due to the gross margin increase in PCCG. We derived most of our overall gross margin dollars for the first six months of Q2 2014 and the first six months of Q2 2013 from the sale of platforms in the PCCG and DCG operating segments. PC Client Group The revenue and operating income for the PCCG operating segment for each period were as follows: (In Millions) YTD 2014 YTD 2013 Net revenue $ 16,608 $ 16,214 Operating income $ 6,536 $ 5,134 Net revenue for the PCCG operating segment increased by $394 million, or 2%, in the first six months of 2014 compared to the first six months of 2013. PCCG platform unit sales were up 5% while PCCG platform average selling prices were down 3%. The increase in revenue was driven by higher notebook platform unit sales and desktop platform unit sales, which were up 6% and 4%, respectively. To lesser extent, higher desktop platform average selling prices of 3% contributed to the increase. These increases were partially offset by lower notebook platform average selling prices of 8%. Operating income increased by $1.4 billion, or 27%, in the first six months of 2014 compared to the first six months of 2013, which was driven by $1.4 billion of higher gross margin and $31 million of lower operating expenses. The increase in gross margin was driven by approximately $675 million of lower PCCG platform unit costs, approximately $295 million of lower factory start-up costs for our next generation 14nm process technology, and approximately $215 million of lower excess capacity charges. Additionally, higher PCCG platform revenue also contributed to the increase. Data Center Group The revenue and operating income for the DCG operating segment for each period were as follows: (In Millions) YTD 2014 YTD 2013 Net revenue $ 6,596 $ 5,721 Operating income $ 3,134 $ 2,446 Net revenue for the DCG operating segment increased by $875 million, or 15%, in the first six months of 2014 compared to the first six months of 2013. DCG platform average selling prices and unit sales were up 10% and 6%, respectively. Our server platform revenue continued to benefit from growth in the Internet cloud computing and high-performance computing market segments with continued strengthening of the enterprise market segments. Operating income increased by $688 million, or 28%, in the first six months of 2014 compared to the first six months of 2013 with $1.0 billion of higher gross margin partially offset by $328 million of higher operating expenses. The increase in gross margin was driven primarily by higher DCG platform revenue. Lower DCG platform unit costs of approximately $120 million also contributed to the increase. These increases were partially offset by higher operating expenses. Internet of Things Group The revenue and operating income for the IOTG operating segment for each period were as follows: (In Millions) YTD 2014 YTD 2013 Net revenue $ 1,021 $ 799 Operating income $ 278 $ 190 Net revenue for the IOTG operating segment increased by $222 million, or 28%, in the first six months of 2014 compared to the first six months of 2013. The increase was primarily due to higher IOTG platform unit sales and average selling prices based on strength in the industrial and retail market segments. 40 -------------------------------------------------------------------------------- Operating income for the IOTG operating segment increased by $88 million, or 46%, in the first six months of 2014 compared to the first six months of 2013. The increase was primarily due to higher IOTG platform revenue partially offset by higher IOTG platform operating expenses. Mobile and Communications Group The revenue and operating loss for the MCG operating segment for each period were as follows: (In Millions) YTD 2014 YTD 2013 Net revenue $ 207 $ 696 Operating loss $ (2,053 ) $ (1,464 ) Net revenue for the MCG operating segment decreased by $489 million, or 70%, in the first six months of 2014 compared to the first six months of 2013. This decrease was primarily due to lower phone components unit sales and cash consideration to our customers associated with integrating our tablet platform. These decreases were partially offset by higher tablet platform unit sales. Operating results for the MCG operating segment decreased by $589 million, or 40%, in the first six months of 2014 compared to the first six months of 2013 with $535 million in lower gross margin and $54 million of higher operating expenses. The decline in operating results was primarily due to higher cash consideration provided to customers, lower phone components revenue, and the higher cost of sales associated with higher tablet platform unit sales. These decreases were partially offset by lower tablet unit costs. Software and Services Operating Segments The revenue and operating income (loss) for the SSG operating segments, including McAfee and the Software and Services Group, for each period were as follows: (In Millions) YTD 2014 YTD 2013 Net revenue $ 1,101 $ 1,054 Operating income (loss) $ 1 $ (7 ) Net revenue for the SSG operating segments increased by $47 million in the first six months of 2014 compared to the first six months of 2013. The operating results for the SSG operating segments increased by $8 million in the first six months of 2014 compared to the first six months of 2013. Operating Expenses Operating expenses for each period were as follows: (Dollars in Millions) YTD 2014 YTD 2013 Research and development $ 5,705 $ 5,043 Marketing, general and administrative $ 4,108 $ 4,112 R&D and MG&A as percentage of net revenue 37 % 36 % Restructuring and asset impairment charges $ 218 $ - Amortization of acquisition-related intangibles $ 145 $ 143 Research and Development. R&D spending increased by $662 million, or 13%, in the first six months of 2014 compared to the first six months of 2013. This increase was primarily driven by higher 10nm process technology development costs, higher compensation expenses due to annual salary increases, an increase in employees, and higher profit-dependent compensation, and increased investments in our products. Marketing, General and Administrative. MG&A expenses decreased by $4 million in the first six months of 2014 compared to the first six months of 2013. This decrease was primarily driven by lower marketing expenses in 2014, mostly offset by a Q1 2014 charge related to ongoing litigation. 41 -------------------------------------------------------------------------------- Restructuring and Asset Impairment Charges. In response to the current business environment, beginning in the third quarter of 2013, management has approved several restructuring actions including targeted workforce reductions and the exit of certain businesses and facilities. These actions include the wind down of our 200 millimeter wafer fabrication facility in Massachusetts and the closure of our assembly and test facility in Costa Rica, which we expect to cease production in the first quarter of 2015 and the end of 2014, respectively. These targeted reductions will enable the company to better align our resources in areas providing the greatest benefit in the changing market. Restructuring and asset impairment charges for each period were as follows: (In Millions) YTD 2014 YTD 2013 Employee severance and benefit arrangements $ 209 $ - Asset impairments and other restructuring charges 9 - Total restructuring and asset impairment charges $ 218 $ - The restructuring and asset impairment activity for the first six months of 2014 was as follows: Employee Severance (In Millions) and Benefits Asset Impairments and Other Total Accrued restructuring balance as of December 28, 2013 $ 183 $ - $ 183 Additional accruals 197 9 206 Adjustments 12 - 12 Cash payments (223 ) - (223 ) Non-cash settlements - (2 ) (2 ) Accrued restructuring balance as of June 28, 2014 $ 169 $ 7 $ 176 We recorded the additional accruals and adjustments as restructuring and asset impairment charges in the consolidated condensed statements of income and within the "all other" operating segments category. The charges incurred during the first six months of 2014 included $209 million related to employee severance and benefit arrangements, which impacted approximately 3,500 employees. Substantially all of the accrued restructuring balance as of June 28, 2014 relates to employee severance and benefits, which are expected to be paid within the next 12 months, and was recorded as a current liability within accrued compensation and benefits in the consolidated condensed balance sheets. Since Q3 2013, we have incurred a total of $458 million in restructuring and asset impairment charges. These charges included a total of $410 million related to employee severance and benefit arrangements for approximately 7,400 employees, and $48 million in asset impairment charges and other restructuring charges. We estimate that employee severance and benefit charges to date will result in gross annual savings of approximately$600 million, which will be realized within R&D, cost of sales, and MG&A. We began to realize these savings in Q4 2013 and expect to fully realize these savings beginning in Q2 2015. We may incur additional charges in the future for employee severance and benefit arrangements, as well as facility-related or other exit activities, as we continue to align our resources to meet the needs of the business. Gains (Losses) on Equity Investments, Net and Interest and Other, Net Gains (losses) on equity investments, net and interest and other, net for each period were as follows: (In Millions) YTD 2014 YTD 2013 Gains (losses) on equity investments, net $ 143 $ (15 ) Interest and other, net $ 95 $ (87 ) We recognized net gains on equity investments in the first six months of 2014 compared to net losses in the first six months of 2013 due to higher gains on sales of equity investments. We recognized an interest and other net gain in the first six months of 2014 compared to a net loss in the first six months of 2013 due to a gain recognized on the divestiture of our Intel Media assets. For further information, see "Note 8: Divestitures" in the Notes to Consolidated Condensed Financial Statements of this Form 10-Q. 42 -------------------------------------------------------------------------------- Provision for Taxes Our provision for taxes and effective tax rate for each period were as follows: (Dollars in Millions) YTD 2014 YTD 2013 Income before taxes $ 6,592 $ 5,136 Provision for taxes $ 1,866 $ 1,091 Effective tax rate 28.3 % 21.2 % The U.S. R&D tax credit was reenacted in Q1 2013 retroactive to the beginning of 2012. The U.S. R&D tax credit expired at the end of 2013 and has not been reenacted for 2014. Most of the increase in our effective tax rate between the first six months of 2014 and the first six months of 2013 was driven by the recognition of the full year of 2012 and first six months of 2013 portion of the U.S. R&D tax credit recognized in the first six months of 2013. Liquidity and Capital Resources Jun 28, Dec 28, (Dollars in Millions) 2014 2013 Cash and cash equivalents, short-term investments, and trading assets $ 17,311 $ 20,087 Other long-term investments $ 2,184 $ 1,473 Loans receivable and other $ 1,402 $ 1,226 Reverse repurchase agreements with original maturities greater than approximately three months $ 385 $ 400 Short-term and long-term debt $ 13,194 $ 13,446 Debt as percentage of stockholders' equity 22.3 % 23.1 % In summary, our cash flows for each period were as follows: (In Millions) YTD 2014 YTD 2013 Net cash provided by operating activities $ 8,954 $ 9,007 Net cash used for investing activities (7,015 ) (10,829 ) Net cash used for financing activities (4,565 ) (2,870 ) Effect of exchange rate fluctuations on cash and cash equivalents 1 (8 ) Net increase (decrease) in cash and cash equivalents $ (2,625 ) $ (4,700 ) Operating Activities Cash provided by operating activities is net income adjusted for certain non-cash items and changes in assets and liabilities. For the first six months of 2014 compared to the first six months of 2013, the $53 million decrease in cash provided by operations was due to changes in working capital, offset by higher net income and adjustments for non-cash items. The adjustments for non-cash items were higher in the first six months of 2014 compared to the first six months of 2013 due to higher depreciation and restructuring and asset impairment charges. Income taxes paid, net of refunds, in the first six months of 2014 compared to the first six months of 2013 were $801 million higher due to 2012 income tax overpayments reducing income taxes paid in 2013. Changes in assets and liabilities as of June 28, 2014, compared to December 28, 2013, included a decrease in accrued compensation and benefits due to the payout of 2013 profit-dependent compensation and a decrease in inventories due to the sell-through of older-generation products, partially offset by the ramp of 5th generation Intel Core Processor family products. For the first six months of 2014, our three largest customers accounted for 44% of net revenue (42% for the first six months of 2013) with Hewlett-Packard Company accounting for 17% of our net revenue (16% for the first six months of 2013), Dell Inc. accounting for 16% of our net revenue (15% for the first six months of 2013), and Lenovo Group Limited accounting for 11% of our net revenue (11% for the first six months of 2013). These three customers accounted for 44% of net accounts receivable as of June 28, 2014 (34% as of December 28, 2013). 43 -------------------------------------------------------------------------------- INTEL CORPORATION MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (Continued) Investing Activities Investing cash flows consist primarily of capital expenditures; investment purchases, sales, maturities, and disposals; as well as proceeds from divestitures and cash used for acquisitions. Cash used for investing activities was lower for the first six months of 2014 compared to the first six months of 2013. Cash used for investing activities decreased primarily due to a decrease in purchases of trading assets and available-for-sale investments and an increase in maturities and sales of available-for-sale investments. This decrease was partially offset by a decrease in maturities and sales of trading assets, higher investments in non-marketable equity investments, and higher capital expenditures. Financing Activities Financing cash flows consist primarily of repurchases of common stock, payment of dividends to stockholders, issuance and repayment of long-term debt, and proceeds from the sale of shares of common stock through employee equity incentive plans. The increase in cash used for financing activities for the first six months of 2014 compared to the first six months of 2013 was primarily due to higher repurchases of common stock under our authorized common stock repurchase program. Liquidity Cash generated by operations is our primary source of liquidity. We maintain a diverse investment portfolio that we continually analyze based on issuer, industry, and country. As of June 28, 2014, cash and cash equivalents, short-term investments, and trading assets totaled $17.3 billion ($20.1 billion as of December 28, 2013). In addition to the $17.3 billion, we have $2.2 billion of other long-term investments, $1.4 billion of loans receivable and other, and $385 million of reverse repurchase agreements with original maturities greater than approximately three months that we include when assessing our sources of liquidity. Most of our investments in debt instruments are in A/A2 or better rated issuances, and the majority of the issuances are rated AA-/Aa3 or better. Another potential source of liquidity is an ongoing authorization from our Board of Directors to borrow up to $3.0 billion, which was fully available for use as of June 28, 2014. This ongoing authorization includes borrowings under our commercial paper program. There were no borrowings under our commercial paper program during the first six months of 2014. Our commercial paper was rated A-1+ by Standard & Poor's and P-1 by Moody's as of June 28, 2014. We also have an automatic shelf registration statement on file with the SEC, pursuant to which we may offer an unspecified amount of debt, equity, and other securities. As of June 28, 2014, $11.2 billion of our cash and cash equivalents, short-term investments, and trading assets was held by our non-U.S. subsidiaries. Of the $11.2 billion held by our non-U.S. subsidiaries, approximately $2.0 billion was available for use in the U.S. without incurring additional U.S. income taxes in excess of the amounts already accrued in our financial statements as of June 28, 2014. The remaining amount of non-U.S. cash and cash equivalents, short-term investments, and trading assets has been indefinitely reinvested and, therefore, no U.S. current or deferred taxes have been accrued and this amount is earmarked for near-term investment in our operations outside the U.S. and future acquisitions of non-U.S. entities. We believe our U.S. sources of cash and liquidity are sufficient to meet our business needs in the U.S. and do not expect that we will need to repatriate the funds we have designated as indefinitely reinvested outside the U.S. Under current tax laws, should our plans change and we were to choose to repatriate some or all of the funds we have designated as indefinitely reinvested outside the U.S., such amounts would be subject to U.S. income taxes and applicable non-U.S. income and withholding taxes. We believe we have sufficient financial resources to meet our business requirements in the next 12 months, including capital expenditures for worldwide manufacturing and assembly and test, working capital requirements, dividends, common stock repurchases, acquisitions, and strategic investments. Fair Value of Financial Instruments When determining fair value, we consider the principal or most advantageous market in which we would transact, and we consider assumptions, such as an obligor's credit risk, that market participants would use when pricing the asset or liability. For further information, see "Note 3: Fair Value" in the Notes to Consolidated Condensed Financial Statements in this Form 10-Q. 44 -------------------------------------------------------------------------------- INTEL CORPORATION MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (Continued) Marketable Debt Instruments As of June 28, 2014, our assets measured and recorded at fair value on a recurring basis included $18.6 billion of marketable debt instruments. Of these instruments, $7.3 billion was classified as Level 1, $11.2 billion as Level 2, and $133 million as Level 3. Our marketable debt instruments that are measured and recorded at fair value on a recurring basis and classified as Level 1 were classified as such due to the use of observable market prices for identical securities that are traded in active markets. We evaluate security-specific market data when determining whether the market for a debt security is active. Of the $11.2 billion of marketable debt instruments measured and recorded at fair value on a recurring basis and classified as Level 2, approximately 55% was classified as Level 2 due to the use of a discounted cash flow model, and approximately 45% was classified as such due to the use of non-binding market consensus prices that were corroborated with observable market data. Our marketable debt instruments that are measured and recorded at fair value on a recurring basis and classified as Level 3, are classified as such because the fair values are generally derived from discounted cash flow models, performed either by us or our pricing providers, using inputs that we are unable to corroborate with observable market data. We monitor and review the inputs and results of these valuation models to ensure the fair value measurements are reasonable and consistent with market experience in similar asset classes. Loans Receivable and Reverse Repurchase Agreements As of June 28, 2014, our assets measured and recorded at fair value on a recurring basis included $802 million of loans receivable and $168 million of reverse repurchase agreements. All of these investments were classified as Level 2, as the fair value is determined using a discounted cash flow model with all significant inputs derived from or corroborated with observable market data. Marketable Equity Securities As of June 28, 2014, our assets measured and recorded at fair value on a recurring basis included $6.0 billion of marketable equity securities. Substantially all of these securities were classified as Level 1 because the valuations were based on quoted prices for identical securities in active markets. Our assessment of an active market for our marketable equity securities generally takes into consideration the number of days that each individual equity security trades over a specified period. 45-------------------------------------------------------------------------------- |