Texas Instruments 2005 Annual Report Download - page 48

not decline with reductions in customer demand or our utilization of our manufacturing capacity, and can adversely affect
profit margins as a result. Conversely, as product demand rises and factory utilization increases, the fixed costs are
spread over increased output, which should improve profit margins.
As part of our manufacturing strategy, we outsource a portion of our product manufacturing to outside suppliers (foundries and
assembly/test subcontractors), which reduces both the amount of capital expenditures and subsequent depreciation required
to meet customer demands, and fluctuations in profit margins. Outside foundries provided about 20 percent of our total wafers
produced in 2005. (A wafer is a thin slice of silicon on which an array of semiconductor devices has been fabricated.)
The semiconductor market is characterized by constant and typically incremental innovation in product design
and manufacturing technologies. We make significant investments in research and development (R&D). Typically, products
resulting from our R&D investments in the current period do not contribute materially to revenue in that period, but
should benefit us in future years. In general, new semiconductor products are shipped in limited quantities initially and
will then ramp into high volumes over time. Prices and manufacturing costs tend to decline over time.
In our Sensors & Controls segment, products include sensors, electrical and electronic controls, and radio frequency
identification (RFID) systems. Our primary markets are automotive and industrial. Other targeted markets include heating,
ventilation, air conditioning, refrigeration and industrial control systems. This business segment represented 9 percent of
our revenue in 2005. Prices of Sensors & Controls products tend to decline over time.
In early 2006, we entered into an agreement to sell to an affiliate of Bain Capital, LLC, for $3 billion, substantially all of
our Sensors & Controls segment. We expect to complete this sale in the first half of 2006. The financial results of this
business will be accounted for as a discontinued operation beginning with the first quarter of 2006. The RFID operations,
which are not included in the sale, will become part of our Semiconductor segment.
Our Educational & Productivity Solutions (E&PS) segment is a leading supplier of graphing handheld calculators. It also
provides our customers with business and scientific calculators and a wide range of advanced classroom tools and
professional development that enables students and teachers to interactively explore math and science. Our products are
marketed primarily through retailers and to schools through instructional dealers. This business segment represented
4 percent of our revenue in 2005. Prices of E&PS products tend to be stable.
Profit sharing expense in 2005 was $115 million compared with $243 million in 2004. Beginning in 2005, expenses under
the TI employee profit sharing plan are determined using a different formula than was used in 2004. The plan now
provides for profit sharing to be calculated based solely upon our operating margin for the calendar year, whereas in
2004 profit sharing was calculated based upon operating margin and revenue growth. Under the current plan, a minimum
threshold of 10 percent operating margin must be achieved before any profit sharing is paid. Profit sharing at 10 percent
operating margin is 2 percent of eligible payroll. The maximum amount of profit sharing available under the plan is 20
percent of eligible payroll, and is paid only when our operating margin meets or exceeds 35 percent for a full calendar
year. We accrue profit sharing based on how we expect to perform for the year in total. The accrual in a given quarter is
based on our expectations at that time as to annual performance. The profit sharing accrual is included in cost of
revenue, R&D expense, and selling, general and administrative (SG&A) expense. As a result of the change in our profit
sharing formula we expect profit sharing expenses to be more stable over time.
In the third quarter of 2005, we implemented the Financial Accounting Standards Board’s Statement of Financial Accounting
Standard (SFAS) No. 123(R), “Share-Based Payments.” The financial results of 2005 include the effects of adopting this new
accounting rule for stock options effective July 1, 2005. Before July 1, 2005, our financial results include the expense of
restricted stock units, but not stock options. As a result our 2005 financial results are not fully comparable to our prior financial
results. For the year, the total stock-based compensation expense was $178 million, or 1.3 percent of revenue. The distribution
of this expense was $92 million to SG&A expense, $53 million to R&D expense and $33 million to cost of revenue. See Changes
in Accounting Standards below and Note 1 to the Financial Statements for additional information.
As a result of a study of the pattern of usage of long-lived depreciable assets, effective January 1, 2006, we will adopt
the straight-line method of depreciation for all property, plant and equipment on a prospective basis as allowed for under
new SFAS No. 154, “Accounting Changes and Error Corrections, a replacement of APB Opinion No. 20 and FASB
Statement No. 3.” See Financial Condition below and Note 1 to the Financial Statements for additional information.
46
TEXAS INSTRUMENTS 2005 ANNUAL REPORT