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[February 15, 2013]
ALTERA CORP - 10-K - MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS.
(Edgar Glimpses Via Acquire Media NewsEdge) The following discussion and analysis should be read in conjunction with our consolidated financial statements and related notes thereto included in Item 8 and the Risk Factors included in Item 1A of this Annual Report on Form 10-K.
Executive Overview Company and Market Overview We are a global semiconductor company, serving over 12,500 customers within the Telecom and Wireless, Industrial Automation, Military and Automotive, Networking, Computer and Storage, and Other vertical markets. The Other vertical market includes sub-markets of broadcast, consumer, medical and test. We design, manufacture, and market a variety of products: • Programmable logic devices ("PLDs"), which consist of field-programmable gate arrays ("FPGAs"), including those that incorporate embedded processors, and complex programmable logic devices ("CPLDs"), are standard semiconductor integrated circuits, or chips, that our customers program to perform desired logic functions in their electronic systems.
• HardCopy® application-specific integrated circuits ("ASICs") transition customer designs from high-density FPGAs to low-cost non-programmable implementations for volume production. HardCopy ASICs deliver performance that can be an alternative to traditional ASICs, but with reduced development costs and shorter production lead times.
• Pre-defined design building blocks, known as intellectual property ("IP") cores, can be licensed by customers to add standard functions to their PLD designs.
• Proprietary development software, which operates on personal computers and engineering workstations, is used by customers to develop, compile, and verify their designs, and then program their designs into our PLDs.
In 2012, sales of PLDs generated 93% of our net sales, with FPGA and CPLD sales comprising approximately 84% and 9% of our net sales, respectively. The remainder of our net sales is comprised of our HardCopy devices and configuration devices used in conjunction with our FPGAs, as well as licensing of IP cores and proprietary development tools.
Market Opportunity Based on publicly available data and information derived from Gartner Dataquest, an independent research firm, we estimate that the PLD market was approximately $4.5 billion in 2012. We also estimate that the combined ASIC and ASSP market in 2012 was approximately $101 billion, comprised of the ASIC market at approximately $21 billion and the ASSP market at approximately $80 billion. Due to the low priced nature of some very high volume ASIC and ASSP applications, including mobile phones and certain consumer applications such as PC-related equipment, video games and portable media applications, we do not believe that the entire ASIC and ASSP market is available for displacement by PLDs. As such, we estimate that the PLD accessible ASIC and ASSP market was approximately $50 billion in 2012 ($13 billion in accessible ASICs and $37 billion in accessible ASSPs) and that this represents significant PLD growth potential.
In addition to the accessible portion of the ASIC and ASSP market of $50 billion in 2012, we believe our recent and future embedded processor solutions, including recently introduced FPGAs which integrate ARM®-based hard processor systems, offers an additional available market of approximately $9 billion, and that this additional market opportunity offers significant overlap with the end equipment markets we currently serve. We believe our ongoing investments in software programmer solutions, hard and soft processor-related IP, and licensed cores for microprocessors and memory, as well as application-targeted FPGAs, will allow us to capture a higher percentage of the semiconductor bill of materials in an embedded system.
With the increasing tendency towards silicon convergence, the impact of "tipping point" economics, and the ever-increasing need for programmability within an electronic system, we believe that customers will increasingly turn to PLD suppliers for not only logic functionality, but also system integration in both prototyping and production quantities. With a combined $59 billion ASIC, ASSP and embedded market replacement opportunity, our goal is that, over time, the average growth rate of our revenue can double that of the total semiconductor industry.
While we have had success winning customer designs against ASICs, ASSPs, embedded processors and microcontrollers, the rate at which customers will adopt the use of PLDs is unclear. Technological issues, including those related to power consumption, performance specifications and design methodology, may limit certain customers' broader adoption of PLDs. Despite having success in winning new designs and a higher growth rate of PLDs relative to ASICs, ASSPs, embedded processors and 30 -------------------------------------------------------------------------------- microcontrollers in recent years, our share gains relative to these alternatives may take many years to become significant. This is due to the small size of the PLD market when compared to the combined accessible revenue of ASICs, ASSPs, embedded processors and microcontrollers. This is compounded by the fact that it may take a long period of time for revenue from new designs to become meaningful when compared with the existing legacy revenue stream.
Driving Operational Excellence Since the PLD market emerged in the 1980s, the financial business models of the leading PLD suppliers have generally been favorable when compared to most other semiconductor companies. Fabless strategies, high barriers to entry, and proprietary architectures have contributed to strong financial results for PLD suppliers.
We regularly engage in a strategic review of our business to improve operations and financial returns. We are focused on maximizing return on invested capital by pursuing greater efficiencies in all aspects of our operations while seeking balance with our commitment to continued investment in advanced technology for the development of new products. In recent years, we have increased our focus on enhancing our business model through process efficiency gains while also growing PLD market share.
Our ability to maintain investment in the research and development of future products has been aided by our early and ongoing cost savings initiatives, which is a vital factor for our future sales and earnings growth. In addition, our prior work in analyzing business processes has not only allowed us to effectively identify and implement simplification and cost reduction initiatives, but the concept of "workflow efficiency" has become a valued aspect of our business culture.
Leveraging Our Global Structure We believe that we have opportunities to further expand our position outside of the U.S. Our organization and management structure integrates our U.S. and non-U.S. operations and provides our management team with a global perspective on our markets. We believe that this infrastructure provides opportunities to develop and commercialize new products that meet global needs and can be rapidly launched in multiple markets.
Competing for Design Wins We compete with other PLD vendors to displace other semiconductor alternatives and for market share within the PLD market. Competition between PLD vendors is most intense in the "design-win" phase of the customer's design, when customers select products for use in the customer's electronic system. Customers often prefer to use the same PLD vendor in successive product generations. This "incumbency advantage" is driven by a customer's investment in building expertise with the PLD vendor's software and the re-use of portions of a design from prior generations. In addition, because each PLD vendor's products are proprietary, the cost to switch PLDs after a system has been designed and prototyped is very high. Therefore, a design win can provide the PLD vendor with a profitable revenue stream through the life of the customer's program.
From the time a design win is secured, it can be two or more years before a customer starts volume production of its system. Typically, the customer selects the PLD vendor relatively early in a customer's design process, but it may take several years to complete system design, build prototypes, sample the marketplace for customer acceptance, make modifications and manufacture in volume. Thus, there is a delay between developing a competitive advantage and experiencing a shift in the PLD market, meaning that market share is a lagging indicator of relative competitive strength. Because it is extremely difficult to forecast the success and timing of customer programs, and because the end markets are highly fragmented (we have over 12,500 PLD customers), it is difficult even for PLD vendors to gauge their own competitive strength in winning designs at a particular point in time.
Developing Competitive Products A PLD vendor's ability to secure design wins and to maintain or increase market share is highly dependent on the cost and quality of its products, its ability to provide tailored architectures, and the effectiveness and reliability of its proprietary development software. Development software, working in tandem with device logic architecture and features, creates the functionality desired by the customer. We develop our software in parallel with our devices, and there are schedule and integration risks between the two processes. If we fail to create adequate software to support our new devices as they are introduced, we weaken our competitive position, which can have long-lasting effects if customers switch to competing solutions and become less familiar and less skilled with our software.
Increasing our FPGA market share and the further success of our tailored architectural approach in our new FPGA product families is important to our long-term growth and profitability. Due to the higher integration density and lower cost per function, the FPGA market has outgrown the CPLD market in recent years, and industry participants and observers believe this trend will continue.
31 -------------------------------------------------------------------------------- Since the initial introduction of our Stratix and Cyclone FPGA families in 2002, we have introduced several more FPGA families in the Stratix, Cyclone and Arria series of products, including devices that incorporate hard embedded processors.
As a result of these product introductions, we estimate, based on publicly available data and with information derived from Gartner Dataquest, that our market share has increased as follows: Market Share 2007 2012 PLD(1) 35 % 40 % FPGA 33 % 39 % CPLD 37 % 39 % (1) Includes revenue from FPGA and CPLD sub-segments as well other products including development software, intellectual property and HardCopy devices Complementing our Stratix FPGAs is our HardCopy family of ASICs. The availability of a HardCopy conversion path for high-density FPGA designs is a competitive advantage. We first shipped HardCopy devices in 2001, offering customers low-cost, non-programmable production devices that use our highest density FPGAs as an integrated development vehicle. HardCopy devices are targeted specifically at those applications and customers that have used PLDs for prototyping and development and traditional cell-based ASICs from other vendors for their volume production needs.
We have improved our CPLD offering with the MAX II and the MAX V families. MAX V CPLDs offer pricing and features that we believe are competitively attractive, with cost, performance, power consumption, and density that are superior to our previous offerings.
An FPGA family typically reaches peak sales approximately five years after initial product shipment. As a result, the Stratix IV and Arria II families, introduced in the fourth quarter of 2008 and the second quarter of 2009, respectively, comprised approximately 25% of our net sales in 2012, and may be at or near peak sales. To improve or even sustain our growth rate, we must successfully introduce successor generations of devices. The degree to which other PLD vendors improve the competitiveness and execution of their products, including the ability to support silicon convergence, may impair our ability to improve our growth rate.
Within the next several quarters, we plan to ship newer FPGA families using more advanced production techniques that will further improve product performance and lower cost. Our foundry partner, Taiwan Semiconductor Manufacturing Company ("TSMC"), will manufacture these die using production processes that are new to the industry. Given the extreme complexity of semiconductor fabrication, TSMC may encounter difficulties that could delay our product launch or limit supply so that we would be unable to meet customer commitments. We may discover manufacturing errors after we begin shipping, which could harm customer relations and cause us to incur additional unforeseen costs. Simultaneous introduction of new PLD architectures and ramp of new technology processes are inherently risky. Diagnosing failures, identifying root causes, and implementing corrective actions in a production wafer fabrication facility are expensive and time-consuming. We may not successfully commercialize our new products, or our new products may not enable us to maintain or increase market share. Some of our competitive offerings may be offered later than the competition, and it is possible that our competitive offerings will be less effective, thus weakening our market share.
It is also possible that our primary competitor may have secured design wins that, when they enter production, will reverse some of our recent market share gains. Our main competitor is larger in size with more sales and research and development resources, and we may not enjoy the same success that we saw with previous FPGA generations.
Critical Accounting Estimates The preparation of our consolidated financial statements and related disclosures in conformity with accounting principles generally accepted in the United States of America ("U.S. GAAP") requires our management to make certain judgments and estimates that affect the amounts reported in our consolidated financial statements. Our management believes that we consistently apply these judgments and estimates and the consolidated financial statements 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 condition. Critical accounting estimates, as defined by the Securities and Exchange Commission ("SEC"), are those that are most important to the portrayal of our 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.
32--------------------------------------------------------------------------------Revenue Recognition We sell the majority of our products to distributors for subsequent resale to OEMs or their subcontract manufacturers. In most cases, sales to distributors are made under agreements allowing for subsequent price adjustments and returns.
We defer recognition of revenue and costs until the products are resold by the distributor. Our revenue reporting is highly dependent on receiving pertinent and accurate data from our distributors in a timely fashion. Distributors provide us with periodic data regarding the product, price, quantity and end customer when products are resold as well as the quantities of our products they still have in stock. We maintain system controls to validate distributor data and to verify that reported data is accurate. At times, we must use estimates and apply judgments to reconcile distributors' reported inventories to their activities. This reconciliation process requires us to estimate the amount of in-transit shipments (net of in-transit returns) to our distributors. In-transit days can significantly vary among geographies and individual distributors. We also apply judgment when estimating the total value of price concessions earned by our distributors but not claimed by the end of the reporting period. This is because there is a time lag between the price concessions earned and claimed by the distributors for any underlying resale of products. Any error in our judgment could lead to inaccurate reporting of our net sales, deferred income and allowances on sales to distributors, and net income.
Valuation of Inventories Inventories are recorded at the lower of cost determined on a first-in-first-out basis (approximated by standard cost) or market. We routinely compare our inventory against projected demand and record provisions for excess and obsolete inventories as necessary. We establish provisions for inventory for technological obsolescence or if inventory levels on hand are in excess of projected customer demand. Such provisions result in a write-down of inventory to net realizable value and a charge to cost of sales. Historically, it has been difficult to forecast customer demand. Actual demand may materially differ from our projected demand, and this difference could have a material impact on our gross margin and inventory balances based on additional provisions for excess or obsolete inventory or a benefit from inventory previously written down. Many of the orders we receive from our customers and distributors request delivery of product on relatively short notice and with lead times less than our manufacturing cycle time. In order to provide competitive delivery times to our customers, we build and stock a certain amount of inventory in anticipation of customer demand that may not materialize. Moreover, as is common in the semiconductor industry, we generally allow customers to cancel orders with minimal advance notice. Thus, even product built to satisfy specific customer orders may not ultimately be required to fulfill customer demand.
Income Taxes We establish a tax provision for the anticipated tax consequences of the reported results of operations. Deferred tax assets and liabilities are recognized for the expected future tax consequences of temporary differences between the financial reporting and tax basis of assets and liabilities, and for operating losses and tax carryforwards. We record valuation allowances, when necessary, to reduce our deferred tax assets to the amount that management estimates is more likely than not to be realized. If, in the future, we determine that we are not likely to realize all or part of our net deferred tax assets, an adjustment to the deferred tax asset valuation allowance would be recorded as a charge to earnings in the period such determination is made.
We measure and recognize uncertain tax positions in accordance with U.S. GAAP, whereby we only recognize the tax benefit from an uncertain tax position if it is more likely than not that the tax position will be sustained on examination by the taxing authorities, based on the merits of the position.
The calculation of our tax liabilities involves the inherent uncertainty associated with the application of U.S. GAAP and complex tax laws. We are subject to examination by various taxing authorities. We believe we have adequately provided in our financial statements for additional taxes that we estimate may be required to be paid as a result of such examinations. If the payment ultimately proves to be unnecessary, the reversal of the tax liabilities would result in tax benefits being recognized in the period we determine the liabilities are no longer necessary. If an ultimate tax assessment exceeds our estimate of tax liabilities, an additional charge to expense will result.
33 --------------------------------------------------------------------------------Results of Operations Results of operations expressed as a percentage of net sales were as follows: 2012 2011 2010 Net sales 100.0 % 100.0 % 100.0 % Cost of sales 30.4 % 29.6 % 29.0 % Gross margin 69.6 % 70.4 % 71.0 % Research and development expense 20.2 % 15.8 % 13.5 % Selling, general, and administrative expense 16.3 % 13.5 % 13.0 % Compensation expense (benefit) - deferred compensation plan 0.4 % (0.1 )% 0.3 % (Gain) loss on deferred compensation plan securities (0.4 )% 0.1 % (0.3 )% Interest income and other (0.5 )% (0.2 )% (0.2 )% Interest expense 0.4 % 0.2 % 0.2 % Income tax expense 2.0 % 3.8 % 4.3 % Net income 31.2 % 37.3 % 40.1 % Sales Overview Net sales were $1.78 billion in 2012, $2.06 billion in 2011 and $1.95 billion in 2010. Net sales decreased by 14% in 2012 from 2011. The Net sales decrease in 2012 was due to a decrease in customer demand across all vertical markets and in all geographies. We saw strong growth in sales of our New Products while there was a decrease in our Mainstream and Mature Product categories.
Net sales increased by 6% in 2011 from 2010, out-pacing the general semiconductor, ASIC, ASSP and PLD markets by a wide margin. The significant increase in net sales was primarily driven by strong growth in sales of our New and Mainstream Products. In 2011, with design incumbency from our 40-nanometer product success, our momentum continued in 28-nanometer, and our FPGA market share improved.
Huawei Technologies Co., Ltd. ("Huawei"), an OEM, individually accounted for 16% of net sales in 2012 and 13% in each of 2011 and 2010. No other individual OEM accounted for more than 10% of net sales in 2012, 2011 or 2010. See Note 5 - Accounts Receivable, Net and Significant Customers to our consolidated financial statements.
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 Stratix® V, Stratix IV, Arria® V, Arria II , Cyclone® IV , MAX® V, and HardCopy® IV devices.
• 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.
The product categories above approximate the relative life cycle stages of our products. 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.
34 --------------------------------------------------------------------------------Net Sales by product category were as follows: Annual Growth Rate 2012 2011 2010 2012 2011 New 32 % 22 % 11 % 22 % 107 % Mainstream 30 % 34 % 32 % (22 )% 11 % Mature and Other 38 % 44 % 57 % (26 )% (18 )% Net Sales 100 % 100 % 100 % (14 )% 6 % 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.
Net Sales by vertical market were as follows: Annual Growth Rate 2012 2011 2010 2012 2011 Telecom & Wireless 44 % 43 % 44 % (12 )% 4 % Industrial Automation, Military & Automotive 21 % 23 % 21 % (22 )% 12 % Networking, Computer & Storage 17 % 17 % 14 % (11 )% 29 % Other 18 % 17 % 21 % (10 )% (13 )% Net Sales 100 % 100 % 100 % (14 )% 6 % Sales of FPGAs and CPLDs Our PLDs consist of field-programmable gate arrays, or FPGAs, and complex programmable logic devices, or CPLDs. FPGAs consist of our Stratix, Cyclone, Arria, APEX, FLEX and ACEX series, as well as our Excalibur and Mercury families. CPLDs consist of our MAX, MAX II, and Classic families. Our other products consist of HardCopy, HardCopy II and other masked programmed logic devices, configuration devices, software and other tools and IP cores (collectively, "Other Products").
Net sales of FPGAs, CPLDs and Other Products were as follows: Annual Growth Rate 2012 2011 2010 2012 2011 FPGA 84 % 81 % 82 % (11 )% 5 % CPLD 9 % 10 % 12 % (22 )% (11 )% Other Products 7 % 9 % 6 % (27 )% 41 % Net Sales 100 % 100 % 100 % (14 )% 6 % 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.
35--------------------------------------------------------------------------------Net Sales by geography were as follows: Annual Growth Rate 2012 2011 2010 2012 2011 Americas 18 % 19 % 19 % (18 )% 7 % Asia Pacific 43 % 41 % 42 % (9 )% 2 % EMEA 25 % 25 % 23 % (15 )% 17 % Japan 14 % 15 % 16 % (18 )% (1 )% Net Sales 100 % 100 % 100 % (14 )% 6 % Price Concessions and Product Returns from Distributors We sell the majority of our products to distributors worldwide at a list price.
Our 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. Total price concessions earned by distributors were $4.3 billion and $4.0 billion for 2012 and 2011, respectively. See Note 8: Deferred Income and Allowances on Sales to Distributors to our consolidated financial statements. Average aggregate price concessions typically range from 65% to 80% 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 price concessions.
Our distributors have certain rights under our contracts to return defective, overstocked, obsolete and 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 $82.6 million and $127.6 million for 2012 and 2011, respectively. See Note 8: Deferred Income and Allowances on Sales to Distributors to our consolidated financial statements.
Gross Margin 2012 2011 2010 Gross Margin Percentage 69.6 % 70.4 % 71.0 % Our gross margin rates are heavily influenced by both vertical market mix and the timing of material cost improvements. While these variables will continue to fluctuate on a cyclical basis, our gross margin target over the long term is 67%. We believe that the 67% gross margin target will enable us to achieve our desired balance between growth and profitability. Our gross margin percentage decreased in 2012 by 0.8 points when compared with 2011. The decrease was primarily attributable to an unfavorable vertical market mix when compared with 2011.
Gross margin percentage decreased in 2011 by 0.6 points compared to 2010. The decrease was primarily due to the change in the mix of revenue by vertical market.
Research and Development Expense Research and development expense includes costs for compensation and benefits, development masks, prototype wafers, and depreciation and amortization. These expenditures are for the design of new PLD and ASIC families, the development of process technologies, new package technology, software to support new products and design environments, and IP cores.
36 -------------------------------------------------------------------------------- We will continue to make significant investments in the development of new products and focus our efforts on the development of new programmable logic devices that use advanced semiconductor wafer fabrication processes, as well as related development software. We are currently investing in the development of future silicon products, as well as our Quartus II software, our library of IP cores and other future products.
2012 vs. 2011 2011 vs. 2010 ($ in millions) 2012 2011 2010 Change Change Research and Development Expense $ 360.4 $ 325.7 $ 264.6 11 % 23 % Percentage of Net Sales 20.2 % 15.8 % 13.5 % Research and development expense for 2012 increased by $34.7 million, or 11%, compared with 2011. The increase was primarily attributable to a $27.4 million increase in personnel-related costs due to an increase in the number of employees, a $12.4 million increase in product development activities, a $6.8 million increase in rental and telephone expense, a $5.2 million increase in stock-based compensation driven by an increase in the number of employees and a $4.8 million increase in depreciation and maintenance and repair expenses. These increases were partially offset by a $24.4 million decrease in variable compensation expenses based on lower operating results in 2012.
Research and development expense for 2011 increased by $61.1 million, or 23%, when compared with 2010. The increase was primarily attributable to a $23.8 million increase in personnel-related costs due to an increase in the number of employees, a $9.1 million increase in stock-based compensation driven by an increase in the number of employees, and a $25.0 million increase in product development activities.
Selling, General, and Administrative Expense Selling, general, and administrative expense primarily includes compensation and benefits related to sales, marketing and administrative employees, commissions and incentives, depreciation, legal, advertising, facilities and travel expenses.
2012 vs. 2011 2011 vs. 2010 ($ in millions) 2012 2011 2010 Change Change Selling, General and Administrative Expense $ 289.9 $ 279.2 $ 254.5 4 % 10 % Percentage of Net Sales 16.3 % 13.5 % 13.0 % Selling, general, and administrative expense for 2012 increased by $10.7 million, or 4%, when compared with 2011. The increase was primarily attributable to a $9.8 million increase in personnel-related costs due to an increase in the number of employees, a $5.4 million increase in stock-based compensation driven by an increase in the number of employees, an $8.4 million increase in professional services and consulting fees. These increases were partially offset by a $13.4 million decrease in variable compensation expenses based on lower operating results in 2012.
Selling, general, and administrative expense for 2011 increased by $24.7 million, or 10%, when compared with 2010. The increase was primarily attributable to an $8.3 million increase in personnel-related costs due to an increase in the number of employees, an $11.1 million increase in stock-based compensation driven by an increase in the number of employees, and a $6.3 million increase in professional services and consulting fees.
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 (Gain)/loss on deferred compensation plan securities in our consolidated statements of comprehensive income. We reported (gain)/loss on NQDC Plan assets of $(7.1) million, $2.0 million and $(6.8) million in 2012, 2011 and 2010, respectively. These 37 -------------------------------------------------------------------------------- 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 expense (benefit) - deferred compensation plan in our consolidated statements of comprehensive income. The compensation expense (benefit) associated with our deferred compensation plan obligations is offset by (gain)/loss from 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 16 - Employee Benefits Plans to our consolidated financial statements for a detailed discussion of our NQDC Plan.
Interest Income and Other Interest income and other consists mainly of interest income generated from investments in bonds, money market funds and high-quality fixed income securities. The increase in Interest income and other in 2012 compared with 2011 was primarily due to higher cash and investments and changes in our investment portfolio elections during 2012 that generated higher investment income.
Interest income and other remained relatively flat in 2011 compared with 2010 as neither returns nor invested balances changed significantly.
Interest Expense The increase in Interest expense in 2012 compared with 2011 was mainly due to the new long-term debt, which has a higher effective interest rate than the former credit facility. See Note 17: Credit Facility and Long-Term Debt for further discussion. In 2011, the year-over-year decrease in Interest expense when compared with 2010 was due primarily to the slight decrease of the LIBOR rate.
Income Tax Expense Our effective tax rate reflects the impact of significant amounts of our earnings being taxed in foreign jurisdictions at rates substantially below the U.S. statutory rate. Our effective tax rates were 5.9% for 2012, 9.2% for 2011 and 9.8% for 2010.
The significant net decrease in our effective tax rate in 2012 when compared with 2011 was primarily due to higher one-time tax benefits in 2012 compared to 2011, partially offset by the absence of a U.S. federal research and development tax credit in 2012, due to its expiration in 2011. During 2012, the effective tax rate includes the following net tax benefits associated with the release of liabilities for uncertain tax positions: 1) a $24.4 million net tax benefit primarily associated with the expiration of the federal statutes of limitation, the reassessment and recognition of previously unrecognized federal tax benefits, and the reversal of the related interest accruals; 2) a $6.9 million net tax benefit as a result of a Statutory Notice of Deficiency received from the IRS for 2005 to 2007; and 3) a $9.1 million net tax benefit as a result of the expiration of the statutes of limitations for certain foreign jurisdictions.
In 2011, we reversed $4.3 million of liabilities for uncertain tax positions as a result of a Statutory Notice of Deficiency received from the Internal Revenue Service for 2002 through 2004. In addition, in 2011 we reversed $8.2 million of liabilities for uncertain tax positions upon expiration of the statutes of limitations and settlement with certain foreign jurisdictions.
Our 2011 effective tax rate was favorably affected by the higher benefit of the 2011 adjustments as compared to 2010. During 2011, we reversed $4.3 million of liabilities for uncertain tax positions as a result of a Statutory Notice of Deficiency received from the Internal Revenue Service for 2002 through 2004. In addition, we reversed $8.2 million of liabilities for uncertain tax positions upon expiration of the statutes of limitations and settlement with certain foreign jurisdictions. In 2010, we reversed $19.4 million of liabilities for uncertain tax positions, partially offset by an $8.2 million charge related to the revaluation of our state deferred tax assets.
38--------------------------------------------------------------------------------Financial Condition, Liquidity, Credit Facility and Capital Resources Overview We derive our liquidity and capital resources primarily from our cash flows from operations. We continue to generate strong positive operating cash flows. In May 2012, we issued 1.75% senior notes that will mature on May 15, 2017 (the "Notes") in the aggregate principal amount of $500 million. We used the net proceeds to repay our former credit facility. In June 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 December 31, 2012, we had no borrowings under the Facility. As such, the $250 million available under the Facility represents a source of liquidity. See Note 17: Credit Facility and Long-Term Debt to our consolidated financial statements for further discussion.
We currently use cash to fund dividends, capital expenditures and repurchases of our common stock. Based on past performance and current expectations, we believe that our current available sources of funds (including cash, cash equivalents, short-term investments and the Facility, plus anticipated cash generated from operations) will be adequate to finance our operations, cash dividends, capital expenditures and stock repurchases for at least the next year.
Our cash and cash equivalents balance decreased by $495.3 million during the year ended December 31, 2012. The change in cash and cash equivalents for 2012, 2011 and 2010 was as follows: (In millions) 2012 2011 2010 Net cash provided by operating activities $ 587.2 $ 959.6 $ 856.7 Net cash used in investing activities (767.2 ) (170.9 ) (23 ) Net cash (used in) provided by financing activities (315.3 ) (181.9 ) 384.8 Net (decrease) increase in cash and cash equivalents $ (495.3 ) $ 606.8 $ 1,218.5 Total cash and cash equivalents accounted for 62% and 79% of total assets at December 31, 2012 and 2011, respectively.
Operating Activities In 2012, our operating activities provided $587.2 million in cash, primarily attributable to net income of $556.8 million, adjusted for non-cash stock-based compensation expense of $87.1 million (net of related tax effects), depreciation and amortization of $36.9 million, deferred income tax expense of $8.8 million and changes in working capital accounts. Significant changes in working capital accounts (excluding cash and cash equivalents) included a $91.4 million increase in Accounts receivable, net, a $30.4 million increase in Inventories, a $3.1 million increase in Other assets, a $50.6 million decrease in Accounts payable and other liabilities, a $66.1 million increase in Deferred income and allowances on sales to distributors and an $8.6 million increase in Income tax payable.
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 condensed consolidated balance sheets. Decreases in Accounts receivable, net associated with lower billings are generally offset by corresponding decreases in Deferred income and allowances on sales to distributors. However, timing differences between gross billings, advances to distributors, 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 $91.4 million increase in Accounts receivable, net, and the $66.1 million increase in Deferred income and allowances on sales to distributors principally relates to increased gross billings to distributors and OEMs, associated with an upward trend in demand for certain products in the fourth quarter of 2012 compared with the same period in 2011.
The $30.4 million increase in Inventories was attributable to increased production of new products in the fourth quarter of 2012 compared with the same period in 2011.
The $3.1 million increase in Other assets primarily resulted from the increase in deferred financing costs as a result of the issuance of long-term debt, offset by returns of advances from distributors and a decrease in prepaid income taxes and other prepaids due to timing.
39 --------------------------------------------------------------------------------The $50.6 million decrease in Accounts payable and other liabilities was primarily attributable to a decrease in the accrual for product development activities due to timing and the accrual for sales incentives and variable compensation as a result of lower operating results, partially offset by an increase in other accrued liabilities.
The $8.6 million increase in Income tax payable was primarily attributable to higher tax liabilities along with timing related to the payment of taxes.
In 2011, our operating activities provided $959.6 million in cash, primarily attributable to net income of $770.7 million, adjusted for non-cash stock-based compensation expense of $81.6 million (net of related tax effects), depreciation and amortization of $31.9 million, deferred income tax expense of $15.7 million and changes in working capital accounts. Significant changes in working capital accounts (excluding cash and cash equivalents) included a $131.3 million decrease in Accounts receivable, net, a $24.2 million decrease in Inventories, a $54.7 million decrease in Other assets, a $32.5 million decrease in Accounts payable and other liabilities, a $148.8 million decrease in Deferred income and allowances on sales to distributors and a $31.1 million increase in Income tax payable.
Investing Activities During 2012, our investing activities resulted in a use of cash primarily for the purchase of available for sale securities of $921.4 million. This included $501.1 million used to purchase U.S. Treasury securities which provide an approximate economic hedge of the interest rate exposure of our Notes. In addition, we made purchases of property and equipment of $60.9 million and purchase of intangible assets and other investment of $7.2 million, partially offset by cash proceeds from the maturities and sales of available-for-sale investments of $220.8 million.
During 2011, our investing activities resulted in a use of cash primarily for the purchase of available for sale securities of $164.4 million and purchases of property and equipment of $31.8 million, partially offset by cash proceeds from the maturities and sales of available-for-sale investments of $25.0 million.
Financing Activities During 2012, our financing included repayment of our former credit facility in the aggregate principal amount of $500.0 million, a use of cash for the repurchase of common stock of $229.1 million, dividend payments of $115.5 million, and minimum statutory withholding for vested restricted stock units of $31.5 million, partially offset by cash proceeds of $500.0 million from the issuance of long-term debt and cash proceeds of $49.7 million from the issuance of common stock to employees through our employee stock plans.
During 2011, our financing activities resulted in a use of cash for the repurchase of common stock of $197.0 million, dividend payments of $90.1 million, and minimum statutory withholding for vested restricted stock units of $32.2 million, partially offset by cash proceeds of $120.0 million from the issuance of common stock to employees through our employee stock plans.
Our dividend policy could be impacted in the future by, among other items, future changes in our cash flows from operations and our capital spending needs such as those relating to research and development, investments and acquisitions, common stock repurchases and other strategic investments.
Contractual Obligations The following table summarizes our significant contractual cash obligations as of December 31, 2012, and the effect that such obligations are expected to have on liquidity and cash flows in future periods: 40 -------------------------------------------------------------------------------- Payments Due by Period Less than 1 More than 5 (In millions) Total Year 1-3 Years 3-5 Years Years Operating lease obligations (1) $ 33.4 $ 9.1 $ 9.2 $ 5.8 $ 9.3 Wafer purchase obligations (2) 138.4 138.4 - - - Long term debt 500.0 - - 500.0 - Interest on long term debt (3) 39.4 8.8 17.5 13.1 - Obligations under service award program (4) 9.1 2.3 1.2 2.0 3.6 Electronic design automation software licenses (5) 5.8 2.9 2.9 - - Total contractual cash obligations $ 726.1 $ 161.5 $ 30.8 $ 520.9 $ 12.9 (1) We lease facilities under non-cancelable lease agreements expiring at various times through 2017. Rental expense under all operating leases was $10.6 million in 2012, and $8.1 million in each of 2011 and 2010.
(2) Due to lengthy subcontractor lead times, we must order materials and services from these subcontractors well in advance, and we are obligated to pay for the materials once they are completed. We expect to receive and pay for these materials in 2013.
(3) Interest is based on our $500 million aggregate principal amount of 1.75% senior notes that will mature on May 15, 2017 (the "Notes") with an effective interest rate of 1.91%. Interest on the Notes is payable semiannually in arrears on May 15 and November 15 of each year, beginning on November 15, 2012. The Notes are governed by a base and supplemental indenture between Altera and U.S. Bank National Association, as trustee.
(4) We offer to the majority of our U.S and non-U.S. employees participation in the Service Award Program ("SAP"). The SAP provides employees with one to four weeks of additional paid vacation upon their attainment of five, ten, fifteen, twenty, twenty-five and thirty-year service anniversaries.
See Note 16: Employee Benefits Plans to our consolidated financial statements.
(5) As of December 31, 2012, we had $5.8 million of non-cancelable license obligations to providers of electronic design automation software and maintenance expiring at various dates throughout December 2014.
Due to the uncertainty with respect to the timing of future cash flows associated with our unrecognized tax benefits as of December 31, 2012, we are unable to make reasonably reliable estimates of the period of cash settlement with the respective taxing authority. Therefore, $272.0 million of unrecognized tax benefits classified as Income tax payable- non-current in the accompanying consolidated balance sheet as of December 31, 2012, have been excluded from the contractual obligations table above. See Note 14: Income Taxes to our consolidated financial statements for a discussion of income taxes.
In addition to the above obligations we enter into a variety of agreements and financial commitments in the normal course of business. It is not possible to predict the maximum potential amount of future payments under these or similar 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 condition or operating results.
Impact of Foreign Currency and Inflation We have international operations and incur expenditures in currencies other than U.S. dollars. For non-U.S. subsidiaries and branches, foreign currency transaction gains and losses and the impact of the remeasurement of local currency assets and liabilities into U.S. dollars in 2012, 2011 and 2010 were not significant. We do not enter into foreign exchange transactions for trading or speculative purposes.
Common Stock Repurchases We repurchase shares under our stock purchase program 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. Since the inception of our stock repurchase program through December 31, 2012, our board of directors has authorized 203.0 million shares for repurchase and we have repurchased a total of 190 million shares of our common stock for an aggregate cost of $4.1 billion. As of December 31, 2012, 13 million shares remained authorized for repurchase under our stock repurchase program.
41 -------------------------------------------------------------------------------- Common stock repurchase activity was as follows: (In millions, except per share amounts) 2012 2011 Shares repurchased 6.9 4.8 Cost of shares repurchased $ 229.1 $ 197.0 Average price per share $ 33.10 $ 41.05 No shares were repurchased in 2010.
Off-balance Sheet Arrangements As of December 31, 2012, we did not have any off-balance sheet arrangements, as defined in Item 303(a)(4)(ii) of SEC Regulation S-K.
Subsequent Events On January 21, 2013, our board of directors declared a cash dividend of $0.10 per common share payable on March 1, 2013 to stockholders of record on February 11, 2013.
The American Taxpayer Relief Act of 2012, which was enacted on January 2, 2013, extends the federal research tax credit retroactively for two years from January 1, 2012 through December 31, 2013. The tax benefit from the extension of the federal research tax credit of $10.6 million will be reflected in the income tax provision in the quarter ending March 29, 2013.
On January 31, 2013, the IRS conceded an adjustment for certain inter-company transactions in our litigation over the 2004 through 2007 tax years. The concession only impacted our 2007 tax year. Our other inter-company transactions continue to be subject to litigation for 2004 through 2007. As a result of this concession, we expect to recognize a tax and interest benefit of $7.5 million during the three months ending March 29, 2013 due to the release of certain tax reserves.
New Accounting Pronouncements The information contained in Note 2: Significant Accounting Policies to our consolidated financial statements in Part II, Item 8 under the heading "Recent Accounting Pronouncements" is incorporated by reference into this Part II, Item 7.
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