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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 nine months ended September 27, 2014 to the three and nine months ended September 28, 2013. • Liquidity and Capital Resources. An analysis of changes in our balance sheets and cash flows, and discussion of our financial condition and potential sources of liquidity. • Fair Value of Financial Instruments. Discussion of the methodologies used in the valuation of our financial instruments. This interim MD&A should be read in conjunction with the MD&A in our Annual Report on Form 10-K for the year ended December 28, 2013. The various sections of this MD&A contain a number of forward-looking statements that involve a number of risks and uncertainties. Words such as "anticipates," "expects," "intends," "goals," "plans," "believes," "seeks," "estimates," "continues," "may," "will," "should," and variations of such words and similar expressions are intended to identify such forward-looking statements. In addition, any statements that refer to projections of our future financial performance, our anticipated growth and trends in our businesses, uncertain events or assumptions, and other characterizations of future events or circumstances are forward-looking statements. Such statements are based on our current expectations and could be affected by the uncertainties and risk factors described in "Risk Factors" in Part I, Item 1A of our Annual Report on Form 10-K, and as may be updated in our subsequent Quarterly Reports on Form 10-Q. Our actual results may differ materially, and these forward-looking statements do not reflect the potential impact of any divestitures, mergers, acquisitions, or other business combinations that had not been completed as of October 29, 2014. Overview Our results of operations for each period were as follows: (Dollars in Millions, Except Per Share Amounts) Q3 2014 Q2 2014 Change Q3 2014 Q3 2013 Change Net revenue $ 14,554 $ 13,831 $ 723 $ 14,554 $ 13,483 $ 1,071 Gross margin $ 9,458 $ 8,917 $ 541 $ 9,458 $ 8,414 $ 1,044 Gross margin percentage 65.0 % 64.5 % 0.5 % 65.0 % 62.4 % 2.6 % Operating income $ 4,540 $ 3,844 $ 696 $ 4,540 $ 3,504 $ 1,036 Net income $ 3,317 $ 2,796 $ 521 $ 3,317 $ 2,950 $ 367 Diluted earnings per common share $ 0.66 $ 0.55 $ 0.11 $ 0.66 $ 0.58 $ 0.08 In Q3 2014, we had record net revenue and earnings per share. Net revenue in Q3 2014 of $14.6 billion was up 5% compared to Q2 2014 and up 8% compared to Q3 2013, and up 1% from the midpoint of the Business Outlook we provided in July 2014 of $14.4 billion. The increase from Q2 2014 was largely due to increased PC Client Group (PCCG) and Data Center Group (DCG) platform unit sales driven by stability in mature markets and strength in enterprise, as well as growth in all segments of our data center business. The worldwide PC supply chain appears to be healthy, with inventory levels appropriate in anticipation of the fourth quarter retail cycles. Net revenue for the PCCG operating segment was up 6% compared to Q2 2014 and up 9% compared to Q3 2013. Our notebook platform units increased as we are enabling innovative 2 in 1 devices and growing our market segment share by offering compelling platforms at lower price points. We had record net revenues in our DCG operating segment of $3.7 billion, up 5% compared to Q2 2014 and up 16% compared to Q3 2013. For Q4 2014, we are forecasting a revenue midpoint of $14.7 billion, up 1% from Q3 2014 and in line with the average seasonal increase. Gross margin improved by half a percentage point from Q2 2014 and down one percentage point from the Business Outlook we provided in July 2014. The increase from Q2 2014 was primarily due to lower PCCG and DCG platform (Platform) unit costs on our 22-nanometer (nm) products and higher Platform unit sales. These increases were mostly offset by higher production costs on our 14nm products treated as period charges. We are forecasting Q4 2014 gross margin to be 64%, down one percentage point from Q3 2014, due to higher Platform unit costs and higher factory start-up costs, partially offset by lower production costs on 14nm. 36 -------------------------------------------------------------------------------- INTEL CORPORATION MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (Continued) In Q3 2014, we continued to ramp sales of our 5th generation Intel® Core™ processor family on 14nm process technology. We launched Intel® Core™ M processor, a new family of products, with full core performance in both compute and graphics in a fanless design, enabling new designs and form factors. We expect the first of these systems to be available for retail purchase in early Q4 2014. In the data center market segment, we launched our next generation Intel Xeon processor E5 family platform, formally code-named Grantley, on our 22nm process technology. We are customizing our Intel Xeon processor products for specific customers and workloads. In the wireless business, we qualified our second generation LTE solution, featuring CAT6 and carrier aggregation, in early Q3 2014. Our Cat6 LTE modem with carrier aggregation is now commercially available in the Samsung Galaxy Alpha*. Additionally, we expect to have our first integrated SoC application processor and baseband 3G solution, code-named "SoFIA," available in Q4 2014. We also remain on track to achieve our 40 million unit sales goal for tablets in fiscal year 2014. Finally, we entered into a series of agreements with Tsinghua Unigroup Ltd., an operating subsidiary of Tsinghua Holdings Co. Ltd., to, among other things, jointly develop Intel® architecture and communications-based solutions for mobile phones. For further information, see "Contractual Obligations". Our business continues to produce significant cash from operations, generating $5.7 billion in Q3 2014. We ended Q3 2014 with $15.6 billion of cash and cash equivalents, short-term investments, and trading assets. During Q3 2014, we purchased $2.4 billion in capital assets and returned cash to stockholders by repurchasing $4.2 billion of common stock through our common stock repurchase program and paying $1.1 billion in dividends. With the cash generated from operations, we intend to continue our repurchases of common stock, and as a result reduce our cash balances. Additionally, the cash generated from operations is expected to enable sufficient liquidity for operations, provide the strategic flexibility to invest in our business and continue to return cash to our stockholders. In July 2014, the Board of Directors authorized an increase of $20 billion to the common stock repurchase program. As of September 27, 2014, $16.4 billion remained available for repurchase under the existing repurchase authorization limit. Additionally, the Board of Directors declared a cash dividend in September 2014 of $0.225 per share of common stock to be paid in December 2014. Our Business Outlook for Q4 2014 and full-year 2014 includes, where applicable, our current expectations for revenue, gross margin percentage, spending (research and development (R&D) plus marketing, general and administrative (MG&A)), and capital expenditures. We publish our Business Outlook in our quarterly earnings release. Our Business Outlook and any updates thereto are publicly available on our Investor Relations web site www.intc.com. This Business Outlook is not incorporated by reference in this Form 10-Q. We expect that our corporate representatives will, from time to time, meet publicly or privately with investors and others, and may reiterate the forward-looking statements contained in the Business Outlook or in this Form 10-Q. The statements in the Business Outlook and forward-looking statements in this Form 10-Q are subject to revision during the course of the year in our quarterly earnings releases and filings with the Securities and Exchange Commission (SEC) and at other times. The forward-looking statements in the Business Outlook and reiterated or updated in this Form 10-Q will be effective through the close of business on December 12, 2014 unless updated earlier or except as specifically noted otherwise in the Business Outlook. From the close of business on December 12, 2014 until our quarterly earnings release is published, currently scheduled for January 15, 2015, we will observe a "quiet period." During the quiet period, the Business Outlook and other forward-looking statements first published in our Form 8-K filed on October 14, 2014, and other forward-looking statements disclosed in the company's news releases and filings with the SEC, as reiterated or updated as applicable in this Form 10-Q, should be considered historical, speaking prior to the quiet period only and not subject to update. During the quiet period, our representatives will not comment on our Business Outlook or our financial results or expectations. The exact timing and duration of the routine quiet period, and any others that we utilize from time to time, may vary at our discretion. 37 -------------------------------------------------------------------------------- INTEL CORPORATION MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (Continued)Results of Operations - Third Quarter of 2014 Compared to Third Quarter of 2013 The following table sets forth certain consolidated condensed statements of income data as a percentage of net revenue for each period as follows: Q3 2014 Q3 2013 (Dollars in Millions, Except Per Share % of Net % of Net Amounts) Dollars Revenue Dollars Revenue Net revenue $ 14,554 100.0 % $ 13,483 100.0 % Cost of sales 5,096 35.0 % 5,069 37.6 % Gross margin 9,458 65.0 % 8,414 62.4 % Research and development 2,842 19.5 % 2,742 20.3 % Marketing, general and administrative 1,979 13.6 % 1,970 14.7 % Restructuring and asset impairment charges 20 0.1 % 124 0.9 % Amortization of acquisition-related intangibles 77 0.5 % 74 0.5 % Operating income 4,540 31.3 % 3,504 26.0 % Gains (losses) on equity investments, net 35 0.2 % 452 3.4 % Interest and other, net (25 ) (0.2 )% (32 ) (0.3 )% Income before taxes 4,550 31.3 % 3,924 29.1 % Provision for taxes 1,233 8.5 % 974 7.2 % Net income $ 3,317 22.8 % $ 2,950 21.9 % Diluted earnings per common share $ 0.66 $ 0.58 Our net revenue for Q3 2014 increased by $1.1 billion, or 8%, compared to Q3 2013. PCCG and DCG platform unit sales increased by 14% driven by strength in the traditional PC business. These increases were reduced by lower PCCG and DCG platform average selling prices, which were down 3%, and higher cash consideration to our customers to meet competition by offsetting a higher bill of materials and system level costs associated with integrating our tablet platform. Our overall gross margin dollars for Q3 2014 increased by $1.0 billion, or 12%, compared to Q3 2013. This increase was due to higher PCCG and DCG platform revenue, approximately $580 million of lower PCCG and DCG platform unit costs, and approximately $320 million of lower factory start-up costs primarily driven by our next generation 14nm process technology. These increases were partially offset by approximately $340 million of higher production costs on our 14nm products treated as period charges and approximately $190 million of combined higher cash consideration provided to customers associated with integrating our tablet platform and higher cost of sales associated with higher tablet platform unit sales. Our overall gross margin percentage increased to 65.0% in Q3 2014 from 62.4% in Q3 2013. The increase in gross margin percentage was primarily due to the gross margin increase in PCCG. We derived most of our overall gross margin dollars in Q3 2014 and Q3 2013 from the sale of platforms in the PCCG and DCG operating segments. PC Client Group The revenue and operating income for the PCCG operating segment for each period were as follows: (In Millions) Q3 2014 Q3 2013 Net revenue $ 9,190 $ 8,440 Operating income $ 4,120 $ 3,243 Net revenue for the PCCG operating segment increased by $750 million, or 9%, in Q3 2014 compared to Q3 2013. PCCG platform unit sales were up 15% while PCCG platform average selling prices were down 5%. The increase in revenue was driven primarily by higher notebook platform unit sales of 21%. To a lesser extent, higher desktop platform unit sales of 6% and higher desktop platform average selling prices of 2% also contributed to the increase. These increases were partially offset by lower notebook platform average selling prices of 10%. 38 -------------------------------------------------------------------------------- INTEL CORPORATION MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (Continued) Operating income increased by $877 million, or 27%, in Q3 2014 compared to Q3 2013, which was driven by $832 million of higher gross margin and $45 million of lower operating expenses. The increase in gross margin was driven by approximately $525 million of lower PCCG platform unit costs, higher PCCG platform revenue, and approximately $315 million of lower factory start-up costs primarily for our next generation 14nm process technology. These increases were partially offset by approximately $340 million of higher production costs on our 14nm products treated as period charges. Data Center Group The revenue and operating income for the DCG operating segment for each period were as follows: (In Millions) Q3 2014 Q3 2013 Net revenue $ 3,700 $ 3,178 Operating income $ 1,915 $ 1,520 Net revenue for the DCG operating segment increased by $522 million, or 16%, in Q3 2014 compared to Q3 2013. DCG platform average selling prices and unit sales were up 9% and 6%, respectively. Our server platform revenue continued to benefit from growth in the Internet cloud computing and high-performance computing market segments with continued strengthening of the enterprise market segment. Operating income increased by $395 million, or 26%, in Q3 2014 compared to Q3 2013 with $578 million of higher gross margin partially offset by $183 million of higher operating expenses. The increase in gross margin was driven primarily by higher DCG platform revenue. Internet of Things Group The revenue and operating income for the Internet of Things Group (IOTG) operating segment for each period were as follows: (In Millions) Q3 2014 Q3 2013 Net revenue $ 530 $ 464 Operating income $ 153 $ 152 Net revenue for the IOTG operating segment increased by $66 million, or 14%, in Q3 2014 compared to Q3 2013. The increase was primarily due to higher IOTG platform unit sales based on strength in the retail market segment. Operating income for the IOTG operating segment increased by $1 million, or 1%, in Q3 2014 compared to Q3 2013. The increase was primarily due to higher IOTG platform revenue offset by higher operating expenses. Mobile and Communications Group The revenue and operating loss for the Mobile and Communications Group (MCG) operating segment for each period were as follows: (In Millions) Q3 2014 Q3 2013 Net revenue $ 1 $ 353 Operating loss $ (1,043 ) $ (810 ) Net revenue for MCG operating segment decreased by $352 million, or 100%, in Q3 2014 compared to Q3 2013. This decrease was primarily due to higher cash consideration to our customers associated with integrating our tablet and phone platforms. Additionally, lower MCG phone components unit sales contributed to the decrease. These decreases were partially offset by higher tablet platform unit sales. Operating loss for the MCG operating segment increased by $233 million, or 29%, in Q3 2014 compared to Q3 2013 with $339 million in lower gross margin partially offset by $106 million of lower operating expenses. The operating loss increased primarily due to higher cash consideration provided to customers and lower phone components revenue. 39 -------------------------------------------------------------------------------- INTEL CORPORATION MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (Continued) Software and Services Operating Segments The revenue and operating income (loss) for the software and services (SSG) operating segments, including McAfee and the Software and Services Group, for each period were as follows: (In Millions) Q3 2014 Q3 2013 Net revenue $ 558 $ 545 Operating income (loss) $ 29 $ 1 Net revenue for the SSG operating segments increased by $13 million in Q3 2014 compared to Q3 2013. The operating results for the SSG operating segments increased by $28 million in Q3 2014 compared to Q3 2013. Operating Expenses Operating expenses for each period were as follows: (Dollar in Millions) Q3 2014 Q3 2013 Research and development $ 2,842 $ 2,742 Marketing, general and administrative $ 1,979 $ 1,970 R&D and MG&A as percentage of net revenue 33 % 35 % Restructuring and asset impairment charges $ 20 $ 124 Amortization of acquisition-related intangibles $ 77 $ 74 Research and Development. R&D spending increased by $100 million, or 4%, in Q3 2014 compared to Q3 2013. This increase was driven by higher compensation expenses mainly due to higher profit-dependent compensation and annual salary increases. Marketing, General and Administrative. MG&A increased by $9 million, in Q3 2014 compared to Q3 2013. Restructuring and Asset Impairment Charges. Restructuring and asset impairment charges for each period were as follows: (In Millions) Q3 2014 Q3 2013 Employee severance and benefit arrangements $ 9 $ 85 Asset impairments and other restructuring charges 11 39 Total restructuring and asset impairment charges $ 20 $ 124 For further discussion, see "Results of Operations - First Nine Months of 2014 Compared to First Nine Months of 2013." Gains (Losses) on Equity Investments and Interest and Other Gains (losses) on equity investments, net and interest and other, net for each period were as follows: (In Millions) Q3 2014 Q3 2013 Gains (losses) on equity investments, net $ 35 $ 452 Interest and other, net $ (25 ) $ (32 ) We recognized lower net gains on equity investments in Q3 2014 compared to Q3 2013 primarily due to lower gains on sales of equity investments. In Q3 2013, we sold our interest in Clearwire Communications, LLC (Clearwire LLC), which had been accounted for as an equity method investment, and our shares in Clearwire Corporation, which had been accounted for as available-for-sale marketable equity securities. We received proceeds of $470 million on the sale of these investments and recognized a gain of $439 million in Q3 2013. 40 -------------------------------------------------------------------------------- INTEL CORPORATION MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (Continued) Provision for Taxes Our provision for taxes and effective tax rate for each period were as follows: (Dollars in Millions) Q3 2014 Q3 2013 Income before taxes $ 4,550 $ 3,924 Provision for taxes $ 1,233 $ 974 Effective tax rate 27.1 % 24.8 % The U.S. R&D tax credit was reenacted in Q1 2013 retroactive to the beginning of 2012. The U.S. R&D tax credit expired at the end of 2013 and has not been reenacted for 2014. A substantial majority of the increase in our effective tax rate between Q3 2014 and Q3 2013 was driven by the expiration of the U.S. R&D tax credit. Results of Operations - First Nine Months of 2014 Compared to First Nine Months of 2013 Certain consolidated condensed statements of income data as a percentage of net revenue for each period were as follows: YTD 2014 YTD 2013 (Dollars in Millions, Except Per Share % of Net % of Net Amounts) Dollars Revenue Dollars Revenue Net revenue $ 41,149 100.0 % $ 38,874 100.0 % Cost of sales 15,161 36.8 % 15,924 41.0 % Gross margin 25,988 63.2 % 22,950 59.0 % Research and development 8,547 20.8 % 7,785 20.0 % Marketing, general and administrative 6,087 14.8 % 6,082 15.6 % Restructuring and asset impairment charges 238 0.6 % 124 0.3 % Amortization of acquisition-related intangibles 222 0.5 % 217 0.6 % Operating income 10,894 26.5 % 8,742 22.5 % Gains (losses) on equity investments, net 178 0.4 % 437 1.1 % Interest and other, net 70 0.2 % (119 ) (0.3 )% Income before taxes 11,142 27.1 % 9,060 23.3 % Provision for taxes 3,099 7.6 % 2,065 5.3 % Net income $ 8,043 19.5 % $ 6,995 18.0 % Diluted earnings per common share $ 1.58 $ 1.37 Our net revenue for the first nine months of 2014 increased by $2.3 billion, or 6%, compared to the first nine months of 2013. PCCG and DCG platform unit sales increased by 8% driven by strength in the traditional PC business. To a lesser extent, higher IOTG platform unit sales contributed to the increase. These increases were partially offset by higher cash consideration to our customers associated with integrating our tablet platform and lower MCG phone component unit sales. Our overall gross margin dollars for the first nine months of 2014 increased by $3.0 billion, or 13%, compared to the first nine months of 2013. This increase was due primarily to higher PCCG and DCG platform revenue and approximately $1.3 billion of lower PCCG and DCG platform unit costs. To a lesser extent, approximately $540 million of lower factory start-up costs was primarily driven by our next generation 14nm process technology and approximately $315 million of lower excess capacity charges also contributed to the increase. These increases were partially offset by approximately $475 million of higher cash consideration provided to customers associated with integrating our tablet platform and higher cost of sales associated with higher tablet platform unit sales. Our overall gross margin percentage increased to 63.2% in the first nine months of 2014 from 59.0% in the first nine months of 2013. The increase in gross margin percentage was primarily due to the gross margin increase in PCCG. We derived most of our overall gross margin dollars for the first nine months of 2014 and the first nine months of 2013 from the sale of platforms in the PCCG and DCG operating segments. 41 -------------------------------------------------------------------------------- PC Client Group The revenue and operating income for the PCCG operating segment for each period were as follows: (In Millions) YTD 2014 YTD 2013 Net revenue $ 25,798 $ 24,654 Operating income $ 10,656 $ 8,377 Net revenue for the PCCG operating segment increased by $1.1 billion, or 5%, in the first nine months of 2014 compared to the first nine months of 2013. PCCG platform unit sales were up 8% while PCCG platform average selling prices were down 4%. The increase in revenue was driven by higher notebook platform unit sales of 11%. To a lesser extent, higher desktop platform unit sales of 5% and higher desktop platform average selling prices of 2% also contributed to the increase. These increases were partially offset by lower notebook platform average selling prices of 9%. Operating income increased by $2.3 billion, or 27%, in the first nine months of 2014 compared to the first nine months of 2013, which was driven by $2.2 billion of higher gross margin and $74 million of lower operating expenses. The increase in gross margin was driven by approximately $1.2 billion of lower PCCG platform unit costs, approximately $610 million of lower factory start-up costs primarily driven by our next generation 14nm process technology, and higher PCCG platform revenue. Additionally, approximately $220 million of lower excess capacity charges also contributed to the increase. These increases were partially offset by approximately $340 million of higher production costs on our 14nm products treated as period charges. Data Center Group The revenue and operating income for the DCG operating segment for each period were as follows: (In Millions) YTD 2014 YTD 2013 Net revenue $ 10,296 $ 8,899 Operating income $ 5,049 $ 3,966 Net revenue for the DCG operating segment increased by $1.4 billion, or 16%, in the first nine months of 2014 compared to the first nine months of 2013. DCG platform average selling prices and unit sales were up 10% and 6%, respectively. Our server platform revenue continued to benefit from growth in the Internet cloud computing and high-performance computing market segments with continued strengthening of the enterprise market segment. Operating income increased by $1.1 billion, or 27%, in the first nine months of 2014 compared to the first nine months of 2013 with $1.6 billion of higher gross margin partially offset by $519 million of higher operating expenses. The increase in gross margin was driven primarily by higher DCG platform revenue. Lower DCG platform unit costs of approximately $135 million also contributed to the increase. Internet of Things Group The revenue and operating income for the IOTG operating segment for each period were as follows: (In Millions) YTD 2014 YTD 2013 Net revenue $ 1,551 $ 1,263 Operating income $ 431 $ 342 Net revenue for the IOTG operating segment increased by $288 million, or 23%, in the first nine months of 2014 compared to the first nine months of 2013. The increase was primarily due to higher IOTG platform unit sales based on strength in the retail and industrial market segments. Operating income for the IOTG operating segment increased by $89 million, or 26%, in the first nine months of 2014 compared to the first nine months of 2013. The increase was primarily due to higher IOTG platform revenue partially offset by higher IOTG platform operating expenses. 42 -------------------------------------------------------------------------------- Mobile and Communications Group The revenue and operating loss for the MCG operating segment for each period were as follows: (In Millions) YTD 2014 YTD 2013 Net revenue $ 208 $ 1,049 Operating loss $ (3,096 ) $ (2,274 ) Net revenue for the MCG operating segment decreased by $841 million, or 80%, in the first nine months of 2014 compared to the first nine months of 2013. This decrease was primarily due to higher cash consideration to our customers associated with integrating our tablet platform and lower phone component unit sales. These decreases were partially offset by higher tablet platform unit sales. Operating loss for the MCG operating segment increased by $822 million, or 36%, in the first nine months of 2014 compared to the first nine months of 2013 with $873 million in lower gross margin and $51 million of lower operating expenses. The operating loss increased primarily due to higher cash consideration provided to customers, higher cost of sales associated with higher tablet platform unit sales, and lower phone components revenue. These decreases were partially offset by lower tablet unit costs. Software and Services Operating Segments The revenue and operating income (loss) for the SSG operating segments, including McAfee and the Software and Services Group, for each period were as follows: (In Millions) YTD 2014 YTD 2013 Net revenue $ 1,659 $ 1,599 Operating income (loss) $ 30 $ (6 ) Net revenue for the SSG operating segments increased by $60 million in the first nine months of 2014 compared to the first nine months of 2013. The operating results for the SSG operating segments increased by $36 million in the first nine months of 2014 compared to the first nine months of 2013. Operating Expenses Operating expenses for each period were as follows: (Dollars in Millions) YTD 2014 YTD 2013 Research and development $ 8,547 $ 7,785 Marketing, general and administrative $ 6,087 $ 6,082 R&D and MG&A as percentage of net revenue 36 % 36 % Restructuring and asset impairment charges $ 238 $ 124 Amortization of acquisition-related intangibles $ 222 $ 217 Research and Development. R&D spending increased by $762 million, or 10%, in the first nine months of 2014 compared to the first nine months of 2013. This increase was primarily driven by higher 10nm process technology development costs, higher compensation expenses due to higher profit-dependent compensation and annual salary increases, and increased investments in our products. Marketing, General and Administrative. MG&A expenses increased by $5 million in the first nine months of 2014 compared to the first nine months of 2013. This increase was primarily due to a Q1 2014 charge related to ongoing litigation, the majority of which was offset by lower marketing expenses in 2014. 43 -------------------------------------------------------------------------------- Restructuring and Asset Impairment Charges. Beginning in Q3 2013, management has approved several restructuring actions including targeted workforce reductions and the exit of certain businesses and facilities. These actions include the wind down of our 200 millimeter wafer fabrication facility in Massachusetts and the closure of our assembly and test facility in Costa Rica, which we expect to cease production in the first quarter of 2015 and the end of 2014, respectively. These targeted reductions will enable the company to better align our resources in areas providing the greatest benefit in the current business environment. Restructuring and asset impairment charges for each period were as follows: (In Millions) YTD 2014 YTD 2013 Employee severance and benefit arrangements $ 218 $ 85 Asset impairments and other restructuring charges 20 39 Total restructuring and asset impairment charges $ 238 $ 124 The restructuring and asset impairment activity for the first nine months of 2014 was as follows: Employee Severance (In Millions) and Benefits Asset Impairments and Other Total Accrued restructuring balance as of December 28, 2013 $ 183 $ - $ 183 Additional accruals 203 19 222 Adjustments 15 1 16 Cash payments (283 ) (3 ) (286 ) Non-cash settlements - (9 ) (9 ) Accrued restructuring balance as of September 27, 2014 $ 118 $ 8 $ 126 We recorded the additional accruals and adjustments as restructuring and asset impairment charges in the consolidated condensed statements of income and within the "all other" operating segments category. The charges incurred during the first nine months of 2014 included $218 million related to employee severance and benefit arrangements, which impacted approximately 2,800 employees. In Q2 2014, we had estimated that 3,500 employees would be impacted by restructuring actions, but such number has decreased to 2,800 employees, mainly driven by the internal placement of previously impacted employees and the cancellation of prior quarter actions. Most of the accrued restructuring balance as of September 27, 2014 relates to employee severance and benefits, which are expected to be paid within the next 12 months, and was recorded as a current liability within accrued compensation and benefits in the consolidated condensed balance sheets. Since Q3 2013, we have incurred a total of $478 million in restructuring and asset impairment charges. These charges included a total of $419 million related to employee severance and benefit arrangements for approximately 6,700 employees, and $59 million in asset impairment and other restructuring charges. We estimate that employee severance and benefit charges to date will result in gross annual savings of approximately$500 million, which will be realized within R&D, cost of sales, and MG&A. We began to realize these savings in Q4 2013 and expect to fully realize these savings beginning in Q2 2015. 44 -------------------------------------------------------------------------------- Gains (Losses) on Equity Investments, Net and Interest and Other, Net Gains (losses) on equity investments, net and interest and other, net for each period were as follows: (In Millions) YTD 2014 YTD 2013 Gains (losses) on equity investments, net $ 178 $ 437 Interest and other, net $ 70 $ (119 ) We recognized lower net gains on equity investments in the first nine months of 2014 compared to the first nine months of 2013 primarily due to lower gains on sales of equity investments. Net gains on equity investments in the first nine months of 2013 included a gain of $439 million on the sale of our interest in Clearwire LLC, which had been accounted for as an equity method investment, and our shares in Clearwire Corporation, which had been accounted for as available-for-sale marketable equity securities. We recognized an interest and other net gain in the first nine months of 2014 compared to a net loss in the first nine months of 2013 due to a gain recognized on the divestiture of our Intel Media assets in 2014. For further information, see "Note 8: Divestitures" in the Notes to Consolidated Condensed Financial Statements of this Form 10-Q. Provision for Taxes Our provision for taxes and effective tax rate for each period were as follows: (Dollars in Millions) YTD 2014 YTD 2013 Income before taxes $ 11,142 $ 9,060 Provision for taxes $ 3,099 $ 2,065 Effective tax rate 27.8 % 22.8 % The U.S. R&D tax credit was reenacted in Q1 2013 retroactive to the beginning of 2012. The U.S. R&D tax credit expired at the end of 2013 and has not been reenacted for 2014. A substantial majority of the increase in our effective tax rate between the first nine months of 2014 and the first nine months of 2013 was driven by the recognition of the full year of 2012 and first nine months of 2013 portion of the U.S. R&D tax credit. Liquidity and Capital Resources Sep 27, Dec 28, (Dollars in Millions) 2014 2013 Cash and cash equivalents, short-term investments, and trading assets $ 15,594 $ 20,087 Other long-term investments $ 2,153 $ 1,473 Loans receivable and other $ 1,355 $ 1,226 Reverse repurchase agreements with original maturities greater than approximately three months $ 450 $ 400 Short-term and long-term debt $ 13,267 $ 13,446 Debt as percentage of stockholders' equity 23.7 % 23.1 % In summary, our cash flows for each period were as follows: (In Millions) YTD 2014 YTD 2013 Net cash provided by operating activities $ 14,647 $ 14,738 Net cash used for investing activities (8,001 ) (14,152 ) Net cash used for financing activities (9,172 ) (4,176 ) Effect of exchange rate fluctuations on cash and cash equivalents (5 ) (7 ) Net increase (decrease) in cash and cash equivalents $ (2,531 ) $ (3,597 ) 45 -------------------------------------------------------------------------------- INTEL CORPORATION MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (Continued) Operating Activities Cash provided by operating activities is net income adjusted for certain non-cash items and changes in assets and liabilities. For the first nine months of 2014 compared to the first nine months of 2013, the $91 million decrease in cash provided by operations was due to changes in assets and liabilities, offset by higher net income and adjustments for non-cash items. The adjustments for non-cash items were higher in the first nine months of 2014 compared to the first nine months of 2013, primarily due to higher depreciation and lower gains on equity investments. Income taxes paid, net of refunds, in the first nine months of 2014 compared to the first nine months of 2013 were $1.9 billion higher mostly due to 2012 income tax overpayments reducing income taxes paid in 2013 and higher income before taxes in 2014. Changes in assets and liabilities as of September 27, 2014, compared to December 28, 2013, included a decrease in accrued compensation and benefits due to the payout of 2013 profit-dependent compensation and a decrease in accounts payable due to the timing of payments. For the first nine months of 2014, our three largest customers accounted for 46% of net revenue (44% for the first nine months of 2013) with Hewlett-Packard Company accounting for 18% of our net revenue (17% for the first nine months of 2013), Dell Inc. accounting for 16% of our net revenue (15% for the first nine months of 2013), and Lenovo Group Limited accounting for 12% of our net revenue (12% for the first nine months of 2013). These three customers accounted for 46% of net accounts receivable as of September 27, 2014 (34% as of December 28, 2013). Investing Activities Investing cash flows consist primarily of capital expenditures; investment purchases, sales, maturities, and disposals; as well as proceeds from divestitures and cash used for acquisitions. Cash used for investing activities was lower for the first nine months of 2014 compared to the first nine months of 2013. Cash used for investing activities decreased primarily due to lower purchases of available-for-sale investments and trading assets, higher maturities of available-for-sale investments, and lower cash paid for acquisitions. This decrease was partially offset by lower maturities and sales of trading assets and higher investments in non-marketable equity investments. Financing Activities Financing cash flows consist primarily of repurchases of common stock, payment of dividends to stockholders, issuance and repayment of long-term debt, and proceeds from the sale of shares of common stock through employee equity incentive plans. The increase in cash used for financing activities for the first nine months of 2014 compared to the first nine months of 2013 was primarily due to higher repurchases of common stock. Liquidity Cash generated by operations is our primary source of liquidity. We maintain a diverse investment portfolio that we continually analyze based on issuer, industry, and country. As of September 27, 2014, cash and cash equivalents, short-term investments, and trading assets totaled $15.6 billion ($20.1 billion as of December 28, 2013). In addition to the $15.6 billion, we have $2.2 billion of other long-term investments, $1.4 billion of loans receivable and other, and $450 million of reverse repurchase agreements with original maturities greater than approximately three months, that we include when assessing our sources of liquidity. Most of our investments in debt instruments are in A/A2 or better rated issuances, and the majority of the issuances are rated AA-/Aa3 or better. Another potential source of liquidity is an ongoing authorization from our Board of Directors to borrow up to $3.0 billion, which was fully available for use as of September 27, 2014. This ongoing authorization includes borrowings under our commercial paper program. Maximum borrowings under our commercial paper program were $2.1 billion during the first nine months of 2014. Our commercial paper was rated A-1+ by Standard & Poor's and P-1 by Moody's as of September 27, 2014. We also have an automatic shelf registration statement on file with the SEC, pursuant to which we may offer an unspecified amount of debt, equity, and other securities. 46 -------------------------------------------------------------------------------- INTEL CORPORATION MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (Continued) As of September 27, 2014, $11.6 billion of our $15.6 billion of cash and cash equivalents, short-term investments, and trading assets was held by our non-U.S. subsidiaries. Of the $11.6 billion held by our non-U.S. subsidiaries, approximately $2.0 billion was available for use in the U.S. without incurring additional U.S. income taxes in excess of the amounts already accrued in our financial statements as of September 27, 2014. The remaining amount of non-U.S. cash and cash equivalents, short-term investments, and trading assets has been indefinitely reinvested and, therefore, no U.S. current or deferred taxes have been accrued and this amount is earmarked for near-term investment in our operations outside the U.S. and future acquisitions of non-U.S. entities. We believe our U.S. sources of cash and liquidity are sufficient to meet our business needs in the U.S. and do not expect that we will need to repatriate the funds we have designated as indefinitely reinvested outside the U.S. Under current tax laws, should our plans change and we were to choose to repatriate some or all of the funds we have designated as indefinitely reinvested outside the U.S., such amounts would be subject to U.S. income taxes and applicable non-U.S. income and withholding taxes. We believe we have sufficient financial resources to meet our business requirements in the next 12 months, including capital expenditures for worldwide manufacturing and assembly and test, working capital requirements, dividends, common stock repurchases, acquisitions, and strategic investments. Fair Value of Financial Instruments When determining fair value, we consider the principal or most advantageous market in which we would transact, and we consider assumptions, such as an obligor's credit risk, that market participants would use when pricing the asset or liability. For further information, see "Note 3: Fair Value" in the Notes to Consolidated Condensed Financial Statements in this Form 10-Q. Marketable Debt Instruments As of September 27, 2014, our assets measured and recorded at fair value on a recurring basis included $16.9 billion of marketable debt instruments. Of these instruments, $6.8 billion was classified as Level 1, $10.0 billion as Level 2, and $120 million as Level 3. Our marketable debt instruments that are measured and recorded at fair value on a recurring basis and classified as Level 1 were classified as such due to the use of observable market prices for identical securities that are traded in active markets. We evaluate security-specific market data when determining whether the market for a debt security is active. Of the $10.0 billion of marketable debt instruments measured and recorded at fair value on a recurring basis and classified as Level 2, approximately 50% was classified as Level 2 due to the use of a discounted cash flow model, and approximately 50% was classified as such due to the use of non-binding market consensus prices that were corroborated with observable market data. Our marketable debt instruments that are measured and recorded at fair value on a recurring basis and classified as Level 3, are classified as such because the fair values are generally derived from discounted cash flow models, performed either by us or our pricing providers, using inputs that we are unable to corroborate with observable market data. We monitor and review the inputs and results of these valuation models to ensure the fair value measurements are reasonable and consistent with market experience in similar asset classes. Loans Receivable and Reverse Repurchase Agreements As of September 27, 2014, our assets measured and recorded at fair value on a recurring basis included $758 million of loans receivable and $268 million of reverse repurchase agreements. All of these investments were classified as Level 2, as the fair value is determined using a discounted cash flow model with all significant inputs derived from or corroborated with observable market data. Marketable Equity Securities As of September 27, 2014, our assets measured and recorded at fair value on a recurring basis included $6.5 billion of marketable equity securities. Substantially all of these securities were classified as Level 1 because the valuations were based on quoted prices for identical securities in active markets. Our assessment of an active market for our marketable equity securities generally takes into consideration the number of days that each individual equity security trades over a specified period. 47 -------------------------------------------------------------------------------- INTEL CORPORATION MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (Continued) Contractual Obligations During Q3 2014, we entered into a series of agreements with Tsinghua Unigroup Ltd., an operating subsidiary of Tsinghua Holdings Co. Ltd., to among other things, jointly develop Intel architecture and communications-based solutions for mobile phones. Subject to regulatory approvals and other closing conditions, we have also agreed to invest up to RMB 9.0 billion (approximately $1.5 billion as of the date of the agreement) for a minority stake of approximately 20% of the holding company under Tsinghua Unigroup which will own Spreadtrum Communications and RDA Microelectronics. As of Q3 2014, these amounts have not been recognized in our consolidated condensed balance sheet. |