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ALTERA CORP - 10-Q - : Management's Discussion and Analysis of Financial Condition and Results of Operations
[October 24, 2014]

ALTERA 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 financial statements and notes to assist readers in understanding our results of operations, financial condition, and cash flows. 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 31, 2013.



The following MD&A, as well as information contained in the risk factors described in Part II Item 1A of this report and elsewhere in this report, contains forward-looking statements, which are provided under the "safe harbor" protection of the Private Securities Litigation Reform Act of 1995.

Forward-looking statements are generally written in the future tense and/or are preceded by words such as "will," "may," "should," "could," "expect," "suggest," "believe," "anticipate," "intend," "plan," "seek," "estimate," "continue," or other similar words. In addition, any statements that refer to projections of our future financial performance, our anticipated growth and trends in our business, uncertain events or assumptions, and other characteristics of future events or circumstances are forward-looking statements. Examples of forward-looking statements include statements regarding (1) our gross margins and factors that affect gross margins; (2) trends in our future sales; (3) our research and development expenditures and efforts; (4) our capital expenditures; (5) our provision for tax liabilities and other critical accounting estimates; and (6) our exposure to market risks related to changes in interest rates, equity prices and foreign currency exchange rates.


Forward-looking statements are not guarantees of future performance and involve risks and uncertainties. The forward-looking statements contained in this report are based on information that is currently available to us and expectations and assumptions that we deemed reasonable at the time the statements were made. We do not undertake any obligation to update any forward-looking statements in this report or in any of our other communications, except as required by law. All such forward-looking statements should be read as of the time the statements were made and with the recognition that these forward-looking statements may not be complete or accurate at a later date.

Many factors may cause actual results to differ materially from those expressed or implied by the forward-looking statements contained in this report. These factors include, but are not limited to, those risks described in Part II Item 1A of this report and those risks described under "Management's Discussion and Analysis of Financial Condition and Results of Operations" and "Risk Factors" in our Annual Report on Form 10-K for the year ended December 31, 2013.

CRITICAL ACCOUNTING ESTIMATES The preparation of our consolidated financial statements and related disclosures in conformity with accounting principles generally accepted in the United States requires our management to make judgments and estimates that affect the amounts reported in our consolidated financial statements and accompanying notes. Our management believes that we consistently apply these judgments and estimates and the consolidated financial statements and accompanying notes fairly represent all periods presented. However, any differences between these judgments and estimates and actual results could have a material impact on our consolidated statements of comprehensive income and financial position. Critical accounting estimates, as defined by the Securities and Exchange Commission ("SEC"), are those that are most important to the portrayal of our consolidated financial condition and results of operations and require our management's most difficult and subjective judgments and estimates of matters that are inherently uncertain.

Our critical accounting estimates include those regarding (1) revenue recognition, (2) valuation of inventories, and (3) income taxes. For a discussion of our critical accounting estimates, see "Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations - Critical Accounting Estimates" in our Annual Report on Form 10-K for the year ended December 31, 2013.

RESULTS OF OPERATIONS Overview Three Months Ended Nine Months Ended (In thousands, except share and per share data) September 26, 2014 June 27, 2014 Change September 26, 2014 September 27, 2013 Change Net sales $ 499,606 $ 491,517 $ 8,089 $ 1,452,216 $ 1,278,205 $ 174,011 Gross margin $ 333,587 $ 329,126 $ 4,461 $ 971,937 $ 875,493 $ 96,444 Operating margin (1) $ 141,320 $ 146,567 $ (5,247 ) $ 422,482 $ 358,601 $ 63,881 Operating cash flows $ 214,049 $ 170,958 $ 43,091 $ 515,437 $ 459,449 $ 55,988 Total cash, cash equivalents and investments $ 4,558,974 4,563,243 $ (4,269 ) $ 4,558,974 $ 3,820,895 $ 738,079 Diluted shares 310,184 313,513 (3,329 ) 314,130 323,355 (9,225 ) Diluted net income per share $ 0.38 $ 0.41 $ (0.03 ) $ 1.15 $ 1.05 $ 0.10 Dividends per common share $ 0.18 $ 0.15 $ 0.03 $ 0.48 $ 0.35 $ 0.13 (1) We define operating margin as gross margin less research and development expense, selling, general and administrative expense and amortization of acquisition-related intangible assets. This presentation differs from income from operations as defined by United States ("U.S.") Generally Accepted Accounting Principles ("GAAP"), as it excludes the effect of compensation associated with the deferred compensation plan obligations.

Our third quarter 2014 net sales of $499.6 million increased 2% from the second quarter of 2014 and represented the sixth consecutive quarter of sequential net sales growth. Net sales of New Products grew 9% sequentially in the third quarter of 2014, mostly due to an increase in net sales of our 28 nm products, which grew 30% sequentially. The increase was offset by a decline in net sales of our Mainstream and Mature and Other Products. Net sales increased in our Network, Computer & Storage vertical market with the remaining vertical markets essentially flat sequentially. Our gross margin percentage decreased from 67.0% in the second quarter of 2014 to 66.8% for the third quarter of 2014, driven by an unfavorable mix within vertical markets.

For the fourth quarter of 2014, we are forecasting a 2% to 6% decrease in net sales compared with the third quarter of 2014. The Telecom & Wireless, Networking, Computer & Storage and Other vertical markets are expected to decline in the fourth quarter of 2014, while the Industrial Automation, Military& Automotive vertical market is expected to remain flat. The forecast reflects anticipated continued strength in our 28 nm products.

We continue to generate strong operating cash flows, with $214.0 million in cash flows from operations for the third quarter of 2014. We ended the quarter with $4.6 billion in cash, cash equivalents and investments. During the third quarter of 2014, we returned cash to shareholders by both paying $55.7 million in dividends and repurchasing $144.2 million of common stock through our stock repurchase program. On October 20, 2014, our board of directors declared a cash dividend of $0.18 per share for the fourth quarter of 2014.

23-------------------------------------------------------------------------------- Table of Contents Results of operations expressed as a percentage of net sales were as follows: Three Months Ended Nine Months Ended September 27, September 27, September 26, 2014 2013 September 26, 2014 2013 Net sales 100.0 % 100.0 % 100.0 % 100.0 % Cost of sales 33.2 % 31.7 % 33.1 % 31.5 % Gross margin 66.8 % 68.3 % 66.9 % 68.5 % Research and development expense 22.4 % 21.4 % 21.4 % 21.8 % Selling, general, and administrative expense 15.6 % 17.7 % 15.9 % 18.4 % Amortization of acquisition-related intangible assets 0.5 % 0.4 % 0.5 % 0.2 % Compensation (benefit)/expense - deferred compensation plan (0.1 )% 0.8 % 0.3 % 0.5 % Loss/(gain) on deferred compensation plan securities 0.1 % (0.8 )% (0.3 )% (0.5 )% Interest income and other (0.9 )% (0.5 )% (1.3 )% (0.5 )% Interest expense 2.2 % 0.6 % 2.2 % 0.7 % Income tax expense 3.4 % 1.9 % 3.3 % 1.2 % Net income 23.6 % 26.8 % 24.9 % 26.7 % Our net sales for the third quarter of 2014 increased by 12% from the third quarter of 2013. The increase was mainly due to significant growth in demand for our New Products, especially in our 28 nm products. Net sales of our 28 nm products increased nearly 200% in the third quarter of 2014 compared with the third quarter of 2013. The increase in net sales for our New Products was offset by a decrease in net sales in our Mainstream and Mature and Other Products as our new technologies are being adopted.

We experienced growth in most of our vertical markets with Telecom & Wireless and Other both exhibiting double-digit year-over-year growth in the third quarter of 2014, which was slightly offset by decreases in our Networking, Computer & Storage vertical market. Net sales increased in all geographies except Japan, which experienced a modest decrease in the third quarter of 2014 compared with the third quarter of 2013.

Our net sales for the nine months ended September 26, 2014 increased by 14% from the nine months ended September 27, 2013. The increase was primarily due to significant growth in demand for our New Products, specifically in our 28 nm products. Net sales of our 28 nm products increased nearly 200% while net sales of our 40 nm products also grew in the nine months ended September 26, 2014 compared with the same period in 2013. We experienced growth in a majority of our vertical markets, particularly in the Telecom & Wireless vertical market where net sales grew 25% in the nine months ended September 26, 2014 compared to the same period in 2013. Growth in the period was slightly offset by a decrease in our Networking, Computer & Storage vertical market. Net sales increased in all geographies except the Americas, which experienced a modest decrease for the nine months ended September 26, 2014 compared with the nine months ended September 27, 2013.

Sales by Product Category We classify our products into three categories: New, Mainstream, and Mature and Other Products. The composition of each product category is as follows: • New Products include the Arria® 10, Stratix® V, Stratix IV, Arria V, Arria II, Cyclone® V, Cyclone IV, MAX® 10, MAX V, HardCopy® IV devices and Enpirion PowerSoCs.

• Mainstream Products include the Stratix III, Cyclone III, MAX II and HardCopy III devices.

• Mature and Other Products include the Stratix II, Stratix, Arria GX, Cyclone II, Cyclone, Classic™, MAX 3000A, MAX 7000, MAX 7000A, MAX 7000B, MAX 7000S, MAX 9000, HardCopy II, HardCopy, FLEX® series, APEX™ series, Mercury™, and Excalibur™ devices, configuration and other devices, intellectual property cores and software and other tools.

24-------------------------------------------------------------------------------- Table of Contents New Products are primarily comprised of our most advanced products. Customers typically select these products for their latest generation of electronic systems. Demand is generally driven by prototyping and production needs.

Mainstream Products are somewhat older products that are generally no longer design-win vehicles. Demand is driven by customers' later stage production-based needs. Mature Products are yet older products with demand generated by the oldest customer systems still in production. This category also includes sales of software, intellectual property and other miscellaneous devices.

Net sales by product category were as follows: Year- Year- Three Months Ended Over- Nine Months Ended Over- September 26, September 27, June 27, Year Year 2014 2013 2014 Change Sequential Change September 26, 2014 September 27, 2013 Change New 56 % 44 % 53 % 45 % 9 % 53 % 41 % 45 % Mainstream 21 % 26 % 21 % (13 )% (3 )% 22 % 28 % (12 )% Mature and Other 23 % 30 % 26 % (14 )% (10 )% 25 % 31 % (6 )% Net Sales 100 % 100 % 100 % 12 % 2 % 100 % 100 % 14 % Sales by Vertical Market The following vertical market data is derived from data that is provided to us by our distributors and end customers. With a broad base of customers, who in some cases manufacture end products spanning multiple market segments, the assignment of net sales to a vertical market requires the use of estimates, judgment and extrapolation. As such, actual results may differ from those reported.

Year- Year- Three Months Ended Over- Nine Months Ended Over- September 26, September 27, June 27, Year September 27, Year 2014 2013 2014 Change Sequential Change September 26, 2014 2013 Change Telecom & Wireless 45 % 41 % 46 % 23 % (1 )% 46 % 41 % 25 % Industrial Automation, Military & Automotive 21 % 23 % 21 % 3 % 0 % 21 % 22 % 10 % Networking, Computer & Storage 16 % 19 % 15 % (5 )% 14 % 15 % 19 % (6 )% Other 18 % 17 % 18 % 18 % 1 % 18 % 18 % 14 % Net Sales 100 % 100 % 100 % 12 % 2 % 100 % 100 % 14 % Sales of FPGAs and CPLDs Our PLDs consist of field-programmable gate arrays, or FPGAs, including those referred to as system-on-chip FPGAs ("SoC FPGAs") that incorporate hard embedded processor cores, and complex programmable logic devices, or CPLDs. FPGAs consist of our Stratix, Cyclone, Arria, APEX, FLEX, MAX 10, and ACEX 1K, as well as our Excalibur and Mercury families. CPLDs consist of our MAX family except for MAX 10. Other Products consist of our Enpirion PowerSoCs, HardCopy ASIC devices, configuration devices, software and other tools, and IP cores.

25-------------------------------------------------------------------------------- Table of Contents Our net sales of FPGAs, CPLDs, and Other Products were as follows: Year- Year- Three Months Ended Over- Nine Months Ended Over- September 26, September 27, June 27, Year September 27, Year 2014 2013 2014 Change Sequential Change September 26, 2014 2013 Change FPGA 85 % 82 % 84 % 17 % 3 % 84 % 83 % 15 % CPLD 8 % 9 % 8 % (10 )% (6 )% 8 % 9 % 4 % Other Products 7 % 9 % 8 % (7 )% (6 )% 8 % 8 % 10 % Net Sales 100 % 100 % 100 % 12 % 2 % 100 % 100 % 14 % Sales by Geography The following table is based on the geographic location of the original equipment manufacturers or the distributors who purchased our products. The geographic location of distributors may be different from the geographic location of the ultimate end users.

Net sales by geography were as follows: Year- Year- Three Months Ended Over- Nine Months Ended Over- September 26, September 27, June 27, Year September 26, September 27, Year 2014 2013 2014 Change Sequential Change 2014 2013 Change Americas 16 % 18 % 16 % 1 % 7 % 16 % 18 % (2 )% Asia Pacific 42 % 39 % 43 % 20 % 0 % 43 % 39 % 24 % EMEA 29 % 28 % 27 % 15 % 6 % 27 % 28 % 13 % Japan 13 % 15 % 14 % (1 )% (7 )% 14 % 15 % 7 % Net Sales 100 % 100 % 100 % 12 % 2 % 100 % 100 % 14 % Price Concessions and Product Returns from Distributors We sell the majority of our products to distributors worldwide at a list price.

However, distributors resell our products to end customers at a very broad range of individually negotiated prices based on a variety of factors, including customer, product, quantity, geography and competitive differentiation. Under these circumstances, we remit back to the distributor a portion of its original purchase price after the resale transaction is completed and we validate the distributor's resale information, including end customer, device, quantity and price, against the distributor price concession that we have approved in advance. To receive price concessions, distributors must submit the price concession claims to us for approval within 60 days of the resale of the product to an end customer. Primarily because of the uncertainty related to the final price, we defer revenue recognition on sales to distributors until our products are sold from the distributor to the end customer, which is when our price is fixed or determinable. Accordingly, these pricing uncertainties impact our results of operations, liquidity and capital resources. Average aggregate price concessions typically range from 70% to 85% of our list price on an annual basis, depending upon the composition of our sales, volume and factors associated with timing of shipments to distributors or payment of the price concession. Total price concessions earned by distributors were $3.6 billion and $3.4 billion for the nine months ended September 26, 2014 and September 27, 2013, respectively.

Our distributors have certain rights under our contracts to return defective, overstocked, obsolete or discontinued products. Our stock rotation program generally allows distributors to return unsold product to Altera, subject to certain contract limits, based on a percentage of sales occurring over various periods prior to the stock rotation. Products resold by the distributor to end customers are no longer eligible for return, unless specifically authorized by us. In addition, we generally warrant our products against defects in material, workmanship and non-conformance to our specifications. Returns from distributors totaled $50.6 million and $57.5 million for the nine months ended September 26, 2014 and September 27, 2013, respectively.

26-------------------------------------------------------------------------------- Table of Contents Gross Margin Three Months Ended Nine Months Ended September 26, September 27, June 27, September 26, September 27, 2014 2013 2014 2014 2013 Gross Margin Percentage 66.8 % 68.3 % 67.0 % 66.9 % 68.5 % Gross margin rates are heavily influenced by both vertical market mix, customer pricing, and material cost improvements. While these variables will continue to fluctuate on a cyclical basis, our gross margin target over the next two to three years is between 67% and 70%. We believe that this gross margin target will enable us to achieve our desired balance between growth and profitability.

Our gross margin percentage for the three months ended September 26, 2014 decreased by 1.5 points compared with the same period of 2013. Our gross margin percentage for the nine months ended September 26, 2014 decreased by 1.6 points compared with the same period of 2013. The decrease in both the three and nine-month periods is primarily attributable to an unfavorable net sales mix across and within vertical markets and customers when compared with the same periods of 2013.

Research and Development Expense Research and development expense includes costs for compensation and benefits, development masks, prototype wafers, and depreciation and amortization. These expenditures are for the design of new products, the development of process technologies, new package technology, software to support new products and design environments, and IP cores.

We will continue to make significant investments in the development of new products and focus our efforts on the development of new programmable logic devices that use advanced semiconductor wafer fabrication processes, as well as related development software. We are currently investing in the development of future silicon products, as well as our Quartus II software, PowerSoCs, our expanding library of IP cores and other future products.

Year- Year- Three Months Ended Over- Nine Months Ended Over- September 26, September 27, June 27, Year September 26, September 27, Year (In millions) 2014 2013 2014 Change Sequential Change 2014 2013 Change Research and Development Expense $ 112.1 $ 95.3 $ 101.1 18 % 11 % $ 310.9 $ 278.5 12 % Percentage of Net Sales 22.4 % 21.4 % 20.6 % 21.4 % 21.8 % Research and development expense for the three months ended September 26, 2014 increased by $16.7 million, or 18%, compared with the three months ended September 27, 2013. The increase was primarily attributable to a $10.6 million increase related to timing of external costs for product development activities, a $5.8 million increase in variable compensation expense based upon improved operating results for the three months ended September 26, 2014, and a $2.0 million increase in depreciation and amortization expense. These increases were partially offset by a $2.2 million decrease in stock-based compensation expense.

Research and development expense for the nine months ended September 26, 2014 increased by $32.3 million, or 12%, compared with the nine months ended September 27, 2013. The increase was primarily attributable to a $15.4 million increase in variable compensation expense based upon improved operating results for the nine months ended September 26, 2014, an $11.7 million increase related to timing of external costs for product development activities, a $7.4 million increase in depreciation and amortization expense, and a $1.2 million increase in license costs in connection with our product development activities. These increases were partially offset by a $2.1 million decrease in professional services in connection with our product development activities, and a $1.8 million decrease in stock-based compensation expense.

27-------------------------------------------------------------------------------- Table of Contents Selling, General, and Administrative Expense Selling, general, and administrative expense includes costs for compensation and benefits related to sales, marketing, and administrative employees, commissions and incentives, depreciation, legal, advertising, facilities and travel expenses.

Year- Year- Three Months Ended Over- Nine Months Ended Over- September 26, September 27, June 27, Year Year (In millions) 2014 2013 2014 Change Sequential Change September 26, 2014 September 27, 2013 Change Selling, General and Administrative Expense $ 77.7 $ 78.9 $ 79.0 (1 )% (2 )% $ 231.2 $ 235.4 (2 )% Percentage of Net Sales 15.6 % 17.7 % 16.1 % 15.9 % 18.4 % Selling, general, and administrative expense for the three months ended September 26, 2014 decreased by $1.2 million, or 1%, compared with the three months ended September 27, 2013. The decrease was primarily attributable to a $2.6 million decrease in external professional services, a $1.1 million decrease in stock-based compensation expense, and a $0.9 million decrease in personnel-related costs. These decreases were offset by a $2.8 million increase in variable compensation expense based upon improved operating results for the three months ended September 26, 2014.

Selling, general, and administrative expense for the nine months ended September 26, 2014 decreased by $4.2 million, or 2%, compared with the nine months ended September 27, 2013. The decrease was attributable to a $5.6 million decrease in external professional services, a non-recurring $3.0 million 2013 expense for local non-income taxes, a $2.9 million decrease in personnel-related costs and a $0.6 million decrease in stock-based compensation expense. These decreases were offset by a $7.7 million increase in variable compensation expense based upon improved operating results for the nine months ended September 26, 2014.

Amortization of Acquisition-Related Intangible Assets Amortization of acquisition-related intangible assets increased by $0.6 million for the three months ended September 26, 2014, when compared with the same period in 2013, primarily due to additional in-process research & development ("IPR&D"), which was reclassified to the developed technology intangible asset upon finalization of the projects post-acquisition.

Amortization of acquisition-related intangible assets increased by $4.4 million for the nine months ended September 26, 2014, when compared with the same period in 2013, primarily due to acquisitions in the second quarter of 2013.

Deferred Compensation Plan We allow our U.S.-based officers and director-level employees to defer a portion of their compensation under the Altera Corporation Non-Qualified Deferred Compensation Plan (the "NQDC Plan"). Since the inception of the NQDC Plan, we have not made any contributions to the NQDC Plan and we have no commitments to do so in the future. There are no NQDC Plan provisions that provide for any guarantees or minimum return on investments. Investment income or loss earned by the NQDC Plan is recorded as Loss/(gain) on deferred compensation plan securities in our consolidated statements of comprehensive income. We reported a net investment loss of $0.5 million and a gain of $4.1 million on NQDC Plan assets for the three and nine months ended September 26, 2014. We reported a net investment gain of $3.5 million and $6.7 million on NQDC Plan assets for the three and nine months ended September 27, 2013, respectively. These amounts resulted from the overall market performance of the underlying securities. The investment (gain) / loss also represents an (increase) / decrease in the future payout to employees and is recorded as Compensation (benefit)/expense - deferred compensation plan in our consolidated statements of comprehensive income. The compensation (benefit)/expense associated with our NQDC Plan obligations is offset by loss/(gains) from the related securities. The net effect of the investment income or loss and related compensation expense or benefit has no impact on our income before income taxes, net income or cash balances. See Note 18 - Non-Qualified Deferred Compensation Plan to our consolidated financial statements for a detailed discussion of the NQDC Plan.

Interest Income and Other Interest income and other, consisting mainly of interest income generated from money market funds and high quality fixed income securities, increased by $2.3 million and $11.7 million for the three and nine months ended September 26, 2014, respectively, when compared with the same periods in 2013, primarily due to the purchase of higher yielding securities to facilitate an economic hedge relative to our issuance of public debt.

28-------------------------------------------------------------------------------- Table of Contents Interest Expense Interest expense increased by $8.3 million and $23.8 million for the three and nine months ended September 26, 2014, respectively, when compared with the same periods in the prior year, primarily due to the long-term debt issued in the fourth quarter of 2013.

Income Tax Expense Our effective tax rate reflects the impact of a significant amount of our earnings being taxed in foreign jurisdictions at rates below the U.S. statutory tax rate. Our effective tax rate for the three months ended September 26, 2014 was 12.7% compared with 6.7% for the three months ended September 27, 2013. The increase in our effective tax rate was primarily due to lower one-time tax benefits in 2014 compared with the same period in 2013, and the expiration of the U.S. federal research and development tax credit for 2014. The U.S. federal research and development tax credit has not been extended beyond 2013. During the three months ended September 26, 2014, we reversed $2.9 million of liabilities and related interest for uncertain tax positions upon the expiration of foreign and domestic statutes of limitation, which was substantially offset by the change in proportionately lower earnings in foreign jurisdictions taxed at rates below the U.S. statutory tax rate. During the three months ended September 27, 2013, the U.S. federal research and development tax credit was reinstated, which had expired in 2011, and we reversed $30.3 million of liabilities and the related interest for uncertain tax positions upon the expiration of foreign and domestic statutes of limitation, which was substantially offset by $27.7 million of tax accrued on foreign dividends.

Our effective tax rate for the nine months ended September 26, 2014 was 11.6%, compared with 4.4% for the nine months ended September 27, 2013. The net change in our effective tax rate was primarily due to lower one-time tax benefits in 2014 compared with the same period in 2013, and the expiration of the U.S.

federal research and development tax credit for 2014. During the nine months ended September 26, 2014, we reversed $6.9 million of liabilities and the related interest for uncertain tax positions upon the expiration of a domestic and foreign statute of limitations, which was substantially offset by the change in proportionately lower earnings in foreign jurisdictions taxed at rates below the U.S. statutory tax rate. During the nine months ended September 27, 2013, we recognized a benefit of $10.6 million resulting from the enactment of the American Taxpayer Relief Act in January 2013, which extended the U.S. federal research and development tax credit through December 31, 2013. In addition, we reversed $6.8 million of liabilities for uncertain tax liabilities due to the IRS conceding an adjustment for certain 2007 inter-company transactions in our litigation regarding the 2004 through 2007 tax years, and $2.3 million of liabilities for uncertain tax positions relating to changes in estimate for certain foreign tax jurisdictions, and $30.3 million of liabilities for uncertain tax positions upon the expiration of foreign and domestic statutes of limitation and the related interest, which was substantially offset by $27.7 million of tax accrued on foreign dividends.

As of September 26, 2014, we had total gross unrecognized tax benefits of $330.5 million which, if recognized, would potentially impact our effective tax rate.

On December 31, 2013, we had total gross unrecognized tax benefits of $301.3 million. We are unable to make a reasonable estimate as to if and when cash settlements with the relevant taxing authorities may occur.

We recognize interest and penalties related to uncertain tax positions in our income tax provision. We have accrued approximately $51.7 million and $48.8 million for the payment of interest and penalties related to uncertain tax positions as of September 26, 2014 and December 31, 2013, respectively.

During the fourth quarter of fiscal 2013,we recorded a deferred charge for the deferral of income tax expense on intercompany profits that resulted from the sale of our newly acquired intellectual property rights from one of our U.S.

subsidiaries to one of our foreign subsidiaries. The deferred charge is included in Other current assets and Other assets, net on our consolidated balance sheets. As of September 26, 2014, the deferred charge balance in Other current assets was $2.2 million, and $17.2 million in Other assets, net. The deferred charge will be amortized on a straight-line basis as a component of income tax expense over ten years, based on the economic life of the intellectual property and is not expected to have a material impact on our effective tax rate.

In connection with one of our acquisitions in 2013, we are indemnified by the selling company for certain potential tax obligations arising prior to the acquisition. We have recognized a tax indemnification receivable of $6.5 million in Other assets, net in our consolidated balance sheets. We do not expect any significant effect on earnings or cash flows related to these potential tax obligations.

29-------------------------------------------------------------------------------- Table of Contents FINANCIAL CONDITION, LIQUIDITY AND CAPITAL RESOURCES We derive our liquidity and capital resources primarily from our cash flows from operations. We continue to generate strong positive operating cash flows. In 2013, we issued $600 million aggregate principal amount of 2.5% senior notes (the "2.50% Notes") and $400 million aggregate principal amount of 4.10% senior notes (the "4.10% Notes") that will mature on November 15, 2018, and November 15, 2023, respectively, for stock repurchases and general corporate purposes (collectively the "2013 Notes"). In 2012, we issued $500 million aggregate principal amount of 1.75% senior notes (the "1.75% Notes") that will mature on May 15, 2017 to repay our former credit facility (the "2012 Notes").

In 2012, we entered into a credit agreement that provides for a $250 million unsecured revolving line of credit (the "Facility"), which is scheduled to mature in June 2017. As of September 26, 2014, we had no borrowings under the Facility. As such, the $250 million available under the Facility represents a source of liquidity.

We purchased $1.6 billion in U.S. Treasury securities over the past two years, of which $1.5 billion provides an economic hedge of the interest rate exposure on our 2013 and 2012 Notes. Overall, our investment portfolio is invested in mid to high investment grade securities and our investment policy generally limits the amount of credit exposure to any one issuer. The policy requires investments to be investment grade with the objective of minimizing the potential risk of principal loss.

We currently use cash to fund our operations, dividends, capital expenditures and for repurchases of our common stock. Based on past performance and current expectations, we believe that our existing cash, cash equivalents, investments, together with cash expected to be generated from operations, the Facility and our access to capital markets will be sufficient to satisfy our operations, cash dividends, capital expenditures and stock repurchases over the next 12 months.

We earn a significant amount of our operating income outside of the U.S., which is deemed to be indefinitely reinvested in foreign jurisdictions. For at least the next 12 months, we have sufficient cash in the U.S. and we expect domestic cash flow to sustain our operating activities and our expected use of cash for quarterly dividends and share buy-backs. Most of the amounts held outside of the U.S. could be repatriated to the U.S. but, under the current law, would be subject to U.S. federal income taxes, less applicable foreign tax credits. As of September 26, 2014, we had approximately $2.0 billion of cash and cash equivalents and short-term investments held by our non-U.S. subsidiaries. We believe our U.S. sources of cash and liquidity, including external sources of financing, are sufficient to meet our business needs in the U.S. without repatriating aggregate unremitted earnings of our foreign subsidiaries.

Share Repurchases and Dividends We repurchase shares under our stock repurchase program that was announced on July 15, 1996, which has no specified expiration. No existing repurchase plans or programs have expired, nor have we decided to terminate any repurchase plans or programs prior to expiration. In 2013, we announced that our board of directors increased the share repurchase program authorization by an additional 30.0 million shares. Combined with the board's previous authorizations, there is a total of 233.0 million shares authorized for repurchase with approximately 22.0 million shares remaining for further repurchases under our stock repurchase program as of September 26, 2014. Since the inception of the stock repurchase program through September 26, 2014, we have repurchased a total of 211.0 million shares of our common stock for an aggregate cost of $4.8 billion. Management believes that this authorization is sufficient to support our share repurchase objectives through mid-2015.

During the nine months ended September 26, 2014, we paid $149.8 million in cash dividends to stockholders, representing $0.48 per common share. On October 20, 2014, our board of directors declared a cash dividend of $0.18 per share for the third quarter of 2014.

Shelf Registration Statement We have an effective shelf registration statement on file with the Securities and Exchange Commission that allows us to issue senior debt securities from time to time in one or more offerings. Each issuance under the shelf registration will require the filing of a prospectus supplement identifying the amount and terms of the securities to be issued. The registration statement does not limit the amount of debt securities that may be issued thereunder. Our ability to issue debt securities is subject to market conditions and other factors impacting our borrowing capacity, including our credit ratings and compliance with the covenants in our credit agreement.

30-------------------------------------------------------------------------------- Table of Contents Cash Flows Our cash and cash equivalents balance during the nine months ended September 26, 2014 decreased by $189.1 million. The change in cash and cash equivalents was as follows: Nine Months Ended September 26, September 27, (In thousands) 2014 2013 Net cash provided by operating activities $ 515,437 $ 459,449 Net cash used in investing activities (60,744 ) (203,666 ) Net cash used in financing activities (643,766 ) (176,325 ) Net (decrease)/increase in cash and cash equivalents $ (189,073 ) $ 79,458 Total cash and cash equivalents accounted for 46% and 48% of total assets at September 26, 2014 and December 31, 2013, respectively.

Operating Activities For the nine months ended September 26, 2014, our operating activities provided $515.4 million in cash, primarily attributable to net income of $361.5 million, adjusted for non-cash stock-based compensation expense of $73.2 million (net of related tax effects), depreciation and amortization (including amortization of acquisition-related intangible assets) of $49.8 million, deferred income tax expense of $11.5 million, amortization of debt discount and debt issuance costs of $2.3 million, and net amortization of investment discount/premium of $1.9 million. The net change in working capital accounts (excluding cash and cash equivalents and effects of acquisitions) was primarily due to a $76.3 million decrease in Accounts receivable, net, a $22.5 million increase in Inventories, a $3.9 million decrease in Other assets, a $90.7 million decrease in Deferred income and allowances on sales to distributors, a $32.6 million increase in Accounts payable and other liabilities, a $21.5 million increase in Income taxes payable, and a $5.9 million decrease in Deferred compensation plan obligations.

Our sales to distributors are primarily made under agreements allowing for subsequent price adjustments and returns, and we defer recognition of revenue until the products are resold by the distributor. At the time of shipment to distributors, we (1) record a trade receivable at the list selling price since there is a legally enforceable obligation from the distributor to pay us currently for product delivered, (2) relieve inventory for the carrying value of goods shipped since legal title has passed to the distributor and (3) record deferred revenue and deferred cost of sales in Deferred income and allowances on sales to distributors in the liability section of our consolidated balance sheets. Accordingly, increases in Accounts receivable, net associated with higher billings are generally offset by corresponding increases in Deferred income and allowances on sales to distributors. However, timing differences between gross billings, discounts earned, collections, revenue recognition and changes in the mix of sales to OEMs and distributors may result in a temporary interruption to the normal relationship between these two accounts.

The $76.3 million decrease in Accounts receivable, net was primarily due to the timing of cash collection by and subsequent price concessions to certain distributors. The $90.7 million decrease in Deferred income and allowances on sales to distributors was due to net sales out-pacing gross billings to distributors near the end of the period.

The $22.5 million increase in Inventories was mainly due to timing of material receipts and shifts in customer demand and product mix.

The $3.9 million decrease in Other assets was primarily attributable to a net decrease in income tax receivable due to the receipt of a federal income tax refund in the second quarter of 2014, offset by an additional income tax receivable recorded in the third quarter of 2014 relating to our 2014 federal income tax return filing. This decrease was slightly offset by an increase in other prepaid items for business operations due to timing.

31-------------------------------------------------------------------------------- Table of Contents The $32.6 million increase in Accounts payable and other liabilities was primarily attributable to an increase in inventory purchases during the third quarter of 2014 compared with the same period in 2013 associated with an increase in demand for our products. The increase was also attributable to an increase in accrued variable compensation expense based upon higher operating results for the nine months ended September 26, 2014, an increase in accrued payroll due to the difference in timing between expense recognition and cash remittance, and an increase in accrued interest payable for our senior notes in the third quarter of 2014. The increase was partially offset by a decrease in other accrued liabilities due to a holdback payment for one of our 2013 acquisitions and various other accrued items as a result of timing.

The $21.5 million increase in Income taxes payable was primarily related to higher tax liabilities in the U.S. and certain foreign jurisdictions for tax exposures related to cost sharing and transfer pricing. The increase was partially offset by a decrease in unrecognized tax benefits resulting from a new accounting pronouncement adopted in the first quarter of 2014 and the reversal of uncertain tax positions for the expiration of foreign and domestic statutes of limitations in the first and third quarters of 2014.

Investing Activities Cash used in investing activities in the nine months ended September 26, 2014 primarily consisted of purchases of available for sale securities of $276.9 million, purchases of property and equipment of $34.9 million, purchases of other investments of $8.2 million, and purchases of intangible assets of $1.3 million. These items were partially offset by the proceeds from the maturity of available-for-sale securities of $175.3 million, proceeds from sales of available-for-sale securities of $79.4 million, and sales of deferred compensation plan securities, net of $5.9 million.

Financing Activities Cash used in financing activities in the nine months ended September 26, 2014 primarily consisted of repurchases of common stock of $503.0 million, cash dividend payments of $149.8 million, minimum statutory withholding for vested restricted stock units of $20.9 million, a holdback payment for a 2013 acquisition of 3.4 million, and long-term debt and credit facility issuance costs of $1.3 million. These items were partially offset by proceeds of $29.9 million from the issuance of common stock to employees through our employee stock plans and an excess tax benefit from stock-based compensation of $4.7 million.

CONTRACTUAL OBLIGATIONS We depend entirely upon subcontractors to manufacture our silicon wafers and provide assembly and test services. Due to lengthy subcontractor lead times, we must order these materials and services from these subcontractors well in advance, and we are obligated to pay for the materials and services once they are completed. As of September 26, 2014, we had approximately $143.0 million of outstanding purchase commitments to such subcontractors. We expect to receive and pay for these materials and services over the next six months.

As of September 26, 2014, we had $0.6 million of non-cancelable license obligations to providers of electronic design automation software and maintenance obligations expiring at various dates through December 2014.

We lease facilities under non-cancelable lease agreements expiring at various times through 2024. There have been no significant changes to our operating lease obligations since December 31, 2013.

In addition to these lease and purchase obligations, in the normal course of business we enter into a variety of agreements and financial commitments. It is not possible to predict the maximum potential amount of future payments under these agreements due to the conditional nature of our obligations and the unique facts and circumstances involved in each particular agreement. Historically, payments pursuant to such agreements have not been material. We believe that any future payments required pursuant to such agreements would not be significant to our consolidated financial position or operating results.

As of September 26, 2014, we had total gross unrecognized tax benefits of $330.5 million. Due to the uncertainty with respect to the timing of future cash flows associated with our unrecognized tax benefits, as of September 26, 2014, we are unable to make a reasonably reliable estimate as to if and when cash settlements with the relevant taxing authorities will occur.

OFF-BALANCE SHEET ARRANGEMENTS As of September 26, 2014, we did not have any off-balance sheet arrangements, as defined in Item 303(a)(4)(ii) of SEC Regulation S-K.

SUBSEQUENT EVENT On October 20, 2014, our board of directors declared a quarterly cash dividend of $0.18 per common share, payable on December 1, 2014 to stockholders of record on November 10, 2014.

32-------------------------------------------------------------------------------- Table of Contents RECENT ACCOUNTING PRONOUNCEMENTS The information contained in Note 2 - Recent Accounting Pronouncements to our consolidated financial statements in Part I, Item 1 is incorporated by reference into this Part I, Item 2.

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