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Management's Discussion and Analysis of Financial Condition and Results of Operations   The Registrant (the "company" or "TI") announced third-quarter financial results that show the company's third-quarter revenue was $1849 million, down 9 percent from the second quarter and slightly better than the company's outlook issued in July for a decline of 10 to 15 percent. Orders, which had fallen 10 percent sequentially in the second quarter, declined 4 percent sequentially in the third quarter to $1638 million. Semiconductor orders were about even with the second-quarter level.   TI's overall book-to-bill for semiconductors continued to rise sequentially, and TI's DSP book-to-bill exceeded one for the second consecutive quarter. DSP revenue was up 10 percent sequentially and orders were up 11 percent sequentially. Orders for high-performance Analog turned the corner and increased 10 percent sequentially.   Inventory was reduced by $182 million from the end of the second quarter. Despite the decline in revenue, days of inventory were reduced to 58 from 72 at the end of the second quarter. Cash flow from operations was $334 million, and free cash flow was $22 million. The company also repurchased $152 million of company stock.   SUMMARY  OF  FINANCIAL  RESULTS  For the third quarter of 2001, TI reported the following:   - Total revenue for TI was $1849 million, down 41 percent from $3149 million in the year-ago quarter and down 9 percent sequentially due to weakness in Semiconductor.   - Cost of revenues in the third quarter was $1424 million, compared with $1637 million in the year-ago quarter. Cost of revenues decreased primarily due to decreased Semiconductor revenue.   - Research and development (R&D) totaled $358 million, down from $533 million in the third quarter of 2000 primarily due to acquisition- related charges for in-process R?in the third quarter of 2000.   - Selling, general and administrative expense in the quarter was $312 million, down from $453 million in the year-ago quarter due to savings resulting from restructuring activities and tight spending controls.   - Other income (expense) net decreased from $565 million in the third quarter of 2000 to $37 million in the third quarter of 2001, primarily due to a gain on the sale of Micron stock in the third quarter of 2000.   - The income tax rate for the quarter was 47 percent.   - TI orders in the third quarter were $1638 million, compared with $3250 million in the year-ago quarter and $1704 million in the second quarter.   Results for the third quarter of 2001 include net special charges of $37 million, of which $19 million is severance cost for a worldwide cost- reduction program and $16 million relates to the restructuring charges for the closing of three Semiconductor facilities (Santa Cruz, California; Merrimack, New Hampshire; and Tustin, California). Of the $16 million, $15 million is for the acceleration of depreciation over the remaining service life of the facilities. Also included is amortization of goodwill and other acquisition-related intangibles of $56 million.   For the second quarter of 2001, results include net special charges of $252 million, of which $214 million is severance cost for a worldwide cost-reduction program and $35 million relates to the restructuring charges for the closing of three Semiconductor facilities (Merrimack, New Hampshire; Tustin, California; and Santa Cruz, California). In addition, TI recorded a $68 million increase to the income tax provision to adjust to the expected tax rate for the year. Also included is amortization of goodwill and other acquisition-related intangibles of $58 million.   For the first quarter of 2001, results include net special charges of $50 million, of which $11 million is severance cost for first-quarter employee acceptances under the U.S. voluntary retirement program, $16 million is severance cost for restructuring actions in international Semiconductor locations, and $25 million relates to the closing of a Semiconductor manufacturing facility in Santa Cruz, California. Also included is amortization of goodwill and other acquisition-related intangibles of $59 million.   For the third quarter of 2000, results include investment gains of $425 million, included in other income, from the sale of 5.6 million shares of Micron Technology, Inc. (Micron) common stock, and net special charges of $163 million, of which $112 million is for purchased in-process R?costs from the Dot Wireless, Inc. and Alantro Communications, Inc. acquisitions, $41 million is for pooling of interests transaction costs from the Burr- Brown Corporation acquisition, and $10 million, net, is for several Semiconductor and Sensors & Controls restructuring and other actions in the U.S., Japan and Europe. Also included is amortization of goodwill and other acquisition-related intangibles of $41 million.   For the second quarter of 2000, results include an investment gain of $1211 million, included in other income, from the sale of 20 million shares of Micron common stock. Also included is amortization of goodwill and other acquisition-related intangibles of $25 million.   For the first quarter of 2000, results included net special charges of $29 million for actions including the closing of a Sensors & Controls manufacturing facility in Versailles, Kentucky, and TI's acquisition of Toccata Technology ApS. Also included is amortization of goodwill and other acquisition-related intangibles of $25 million.   Additional information relating to these items appears below under the heading "Special Charges and Gains."   OUTLOOK  It appears that third quarter of 2001 will mark the bottom for semiconductor orders, and the floor for revenue should be set in the fourth quarter. Fourth-quarter TI revenue is expected to decline about 10 percent sequentially, mostly due to normal seasonal declines in Educational & Productivity Solutions (E&PS) as well as continued weakness in Semiconductor.   Specifically, TI expects the following for the fourth quarter compared to the third quarter:   - In Semiconductor, revenue will decline about 5 percent as continued growth in DSP is more than offset by declines in other products.   - Sensors & Controls revenue will be about even.   - E&PS revenue will decline by about $110 million, or 60 percent, as the back-to-school season for educational products ends.   - Operating margin will decline about 9 percentage points before the effect of special charges and amortization of goodwill and other acquisition-related intangibles, reflecting the lower revenue level and further reductions in inventory.   - Non-operating income will decline about $10 million reflecting lower interest rates.   - Loss per share will be about 6 cents more in the fourth quarter, compared with the third quarter, before the effect of special charges and amortization of goodwill and other acquisition-related intangibles.   For 2001, TI expects the following:   - R?of $1.5 billion, excluding acquisition-related amortization and purchased in-process R&D, compared with the company's prior estimate of $1.6 billion and last year's $1.6 billion.   - Capital expenditures of $1.8 billion, unchanged from the prior estimate and down about 35 percent from last year.   - Depreciation of $1.6 billion, compared with the prior estimate of $1.5 billion and up about 30 percent from last year.   SEMICONDUCTOR  Semiconductor revenue in the third quarter was $1453 million, down from $2692 million in the year-ago period. Revenue was down from $1657 million in the second quarter due to continued weakness across most Semiconductor products, excluding DSP.   As a result of lower revenue, Semiconductor had a $219 million operating loss, compared with an operating profit of $681 million in the year-ago period and an operating loss of $37 million in the second quarter.   Analog revenue was down 45 percent from the year-ago period and 16 percent sequentially due to broad based weakness in demand. In the first nine months of the year, about 40 percent of total Semiconductor revenue came from Analog.   DSP revenue decreased 37 percent from the year-ago quarter due to broad based weakness in demand but increased 10 percent sequentially due to strength in wireless. In the first nine months of the year, about 25 percent of total Semiconductor revenue came from DSP.   TI's remaining Semiconductor revenue decreased from the year-ago quarter and sequentially.   TI's Semiconductor revenue in key markets was as follows:   - Wireless revenue was down 42 percent from the year-ago period but increased 16 percent sequentially. In the first nine months of the year, about 20 percent of total Semiconductor revenue came from wireless.   - Revenue from TI's catalog products, comprised of high-performance Analog and DSP, declined 52 percent from the year-ago quarter and 16 percent sequentially. In the first nine months of the year, about 15 percent of total Semiconductor revenue came from catalog products.   - Broadband communications revenue, which includes digital subscriber line (DSL) and cable modems, was up 8 percent from the year-ago quarter but declined 53 percent sequentially. In the first nine months of the year, about 5 percent of total Semiconductor revenue came from broadband communications.   - Semiconductor orders were $1308 million, compared with $2884 in the year-ago period and $1321 million in the second quarter.   SENSORS  &  CONTROLS  Revenue was $222 million, compared with $245 million in the year-ago period due to overall market weakness, and down from $257 million in the second quarter due to seasonal patterns in the heating and air conditioning industry and market weakness.   Operating profit was $45 million, or 20.2 percent of revenue. Operating profit in the year-ago period was $43 million, or 17.5 percent of revenue. Operating profit in the second quarter was $52 million, or 20.2 percent of revenue.   EDUCATIONAL  &  PRODUCTIVITY  SOLUTIONS  (E&PS)  E&PS revenue was $179 million, compared with $175 million in the year-ago quarter. Sequentially, revenue increased by $50 million due to back-to- school sales of educational products.   Operating profit was $67 million, or 37.3 percent of revenue, compared with $64 million, or 36.3 percent of revenue in the year-ago quarter. Operating profit increased 76 percent from the second quarter's $38 million due to seasonality.   FIRST  NINE  MONTHS  OF  2001  For the first nine months of 2001, TI reported the following:   - TI revenue was $6414 million, down from $8843 million in the first nine months of 2000, due to Semiconductor. The decrease in Semiconductor revenue for the first nine months of 2001 was primarily due to weakness across most Semiconductor products. The decrease in Sensors & Controls was primarily due to overall market weakness. E&PS was up slightly due to strength of educational products.   - Cost of revenues was $4452 million compared with $4544 million in the year-ago period. Cost of revenues decreased primarily due to decreased Semiconductor revenue.   - R?totaled $1216 million, compared with $1306 million in the first nine months of 2000. The decrease was primarily due to acquisition-related charges for purchased in-process R?in the first nine months of 2000.   - Selling, general and administrative expense was $1060 million, down from $1268 million in the year-ago period primarily due to cost reduction actions and reduced profit sharing.   - Other income (expense) net decreased from $2039 million in the first nine months of 2000 to $201 million for the first nine months of 2001, primarily due to the sale of Micron stock in 2000.   - The income tax rate was 46 percent.   - Orders were $5239 million, down from $9601 million for the same period a year ago, primarily due to weakness in Semiconductor. Semiconductor orders for the first nine months were down, primarily due to a combination of weak electronic end-equipment markets and excess customer inventories. Sensors & Controls orders were down due to overall market weakness. E&PS orders were up slightly due to strength of educational products.   FINANCIAL  CONDITION  In the first nine months of 2001, cash and cash equivalents plus short-term investments decreased by $1011 million to $2992 million, primarily due to capital expenditures. During the third quarter of 2001, cash and cash equivalents plus short-term investments decreased by $22 million due to the repurchase of the company's common stock.   Cash flow from operating activities was $1039 million in the first three quarters of 2001.   Capital expenditures totaled $1554 million in the first nine months of 2001, compared with $1789 million in the first nine months of 2000. Capital expenditures totaled $312 million in the third quarter of 2001 versus $585 million in the year-ago quarter.   Depreciation for the first three quarters of 2001 was $1145 million, compared with $869 million in the same period a year ago. Depreciation for the third quarter of 2001 was $414 million, versus $319 million in the year-ago quarter.   Debt-to-total-capital ratio was 0.10 at the end of the third quarter, the same as at the end of 2000.   In June 2001, the Financial Accounting Standards Board issued Statements of Financial Accounting Standards No. 141, Business Combinations, and No. 142, Goodwill and Other Intangibles, effective for fiscal years beginning after December 15, 2001. Under the new rules, goodwill and intangible assets deemed to have indefinite lives will no longer be amortized but will be subject to annual impairment tests in accordance with the Statements. Other intangible assets will continue to be amortized over their useful lives. The company will apply the new rules on accounting for goodwill and other intangible assets beginning in the first quarter of 2002. Application of the non- amortization provisions of the Statement is expected to result in an increase in net income of $100 million ($0.06 per share). During 2002, the company will perform the first of the required impairment tests of goodwill and indefinite lived intangible assets as of January 1, 2002 and has not yet determined what effect, if any, these tests will have on the earnings and financial position of the company.   SPECIAL  CHARGES  AND  GAINS  Third Quarter of 2001   As of September 30, 2001, $184 million of the $290 million aggregate severance cost obligations for the first, second and third quarter 2001 worldwide cost reduction and restructuring actions affecting a total of 5724 employees had been paid. In total, these first, second and third quarter 2001 actions are expected to result in annualized savings of approximately $400 million. In the third quarter of 2001, pretax charges of $37 million net were taken, of which $19 million was severance cost for a worldwide cost- reduction program affecting 285 employees and $16 million relates to the restructuring charges for the closing of three Semiconductor facilities (Santa Cruz, California; Merrimack, New Hampshire; and Tustin, California). Of the $16 million, $15 million was for the acceleration of depreciation over the remaining service life of the facilities. Of the $37 million, $27 million is included in cost of revenues, $8 million is in selling, general and administrative expense and $2 million is in research and development expense.   Second Quarter of 2001   In the second quarter of 2001, pretax charges of $252 million net were taken, of which $214 million was severance cost for a worldwide cost-reduction program affecting 3778 employees and $35 million relates to the restructuring charges for the closing of three Semiconductor facilities (Merrimack, New Hampshire; Tustin, California; and Santa Cruz, California) affecting an additional 559 employees. Of the $35 million charge, $14 million was for severance cost and $16 million was for the acceleration of depreciation over the remaining service life of the facilities. Of the $252 million, $162 million was included in cost of revenues, $84 million is in selling, general and administrative expense and $6 million is in research and development expense. Also included was a $68 million increase to the income tax provision to adjust to the expected tax rate for the year.   First Quarter of 2001   In the first quarter of 2001, pretax charges of $50 million net were taken, of which $11 million was for severance cost for 241 first-quarter employee acceptances under the U.S. voluntary retirement program, $16 million was for severance cost for restructuring actions affecting 261 employees in international Semiconductor locations, and $25 million relates to the closing of a Semiconductor manufacturing facility in Santa Cruz, California. Of the $25 million charge, $16 million was for severance cost for 600 employees and $5 million was for acceleration of depreciation over the remaining service life of the facility. Of the $50 million, $44 million was included in cost of revenues, $7 million is in selling, general and administrative expense, $2 million is in research and development expense, and $3 million is in other income.   Third Quarter of 2000   In the third quarter of 2000, TI recorded investment gains of $425 million from the sale of 5.6 million shares of Micron Technology, Inc. (Micron) common stock, offset by special charges of $163 million net, of which $112 million was for purchased in-process R? costs from the Dot Wireless, Inc. and Alantro Communications, Inc. acquisitions, $41 million was for acquisition costs from the pooling of interests with Burr-Brown Corporation, and $10 million, net, was for several Semiconductor and Sensors & Controls restructuring and other actions in the U.S., Japan and Europe affecting 432 employees. Of the $163 million, $112 million was included in research and development expense, $46 million is in selling, general and administrative expense, $31 million is in cost of revenues, $15 million is in net revenues and $11 million is in other income. The primary benefit from the above actions is reduced personnel costs, which are estimated to reach $31 million annually. The benefit began in the fourth quarter of 2000. As of September 30, 2001, $13 million of the $19 million severance cost obligation had been paid.   Second Quarter of 2000   In the second quarter of 2000, an investment gain of $1211 million, included in other income, was realized from the sale of 20 million shares of Micron common stock.   First Quarter of 2000   In the first quarter of 2000, pretax charges of $29 million net were taken, associated with actions including the closing of the Sensors & Controls manufacturing facility in Versailles, Kentucky, and TI's acquisition of Toccata Technology ApS. Of the $29 million charge, $12 million was for severance for the elimination of 480 jobs in Kentucky. Of the $29 million, $20 million was included in cost of revenues, $6 million is in selling, general and administrative expense and $3 million is in research and development expense. The primary benefit from the Kentucky action is reduced personnel costs, which are estimated to reach $10 million annually. The benefit began in the fourth quarter of 2000. As of September 30, 2001, $9 million of the severance cost obligation had been paid.   Purchased In-Process R?Charges   Year-to-date acquisition-related purchased in-process research and development (R&D) charges were zero in 2001 and $112 million in 2000. These charges are for R?from business purchase acquisitions. Values for acquired in-process R?(purchased R&D) were determined at the acquisition date based upon the appraised value of the related developmental projects. Purchased R?projects were assessed, analyzed and valued within the context and framework articulated by the Securities and Exchange Commission herein described as the Exclusion Approach.   Major assumptions, detailed in the following table, used in determining the value of significant purchased R?included the discount rate, the estimated beginning date of projected operating cash flows, and the remaining cost and time, in engineer-months, to complete the R?projects. The term "engineer month" refers to the average amount of research work expected to be performed by an engineer in a month.   The relative stage of completion and projected operating cash flows of the underlying in-process projects acquired were the most significant and uncertain assumptions utilized in the valuation analysis of the purchased R&D. Such uncertainties could give rise to unforeseen budget overruns and/or revenue shortfalls in the event that TI is unable to successfully complete and commercialize the projects. TI management is primarily responsible for estimating the value of the purchased R?in all acquisitions accounted for under the purchase method. TI expects to essentially meet its original return expectations for the projects.   Millions of Dollars -   Cost/time to                                                            Purchased                                     complete R&D       Year                                                            in-process                                       projects     cash flows  Entity   Acquisition  Consid-            Other   Deferred    R&D     Appraisal   R&D       Discount -------------------- projected acquired     date      eration  Goodwill  intan-  compen-    charge    method     focus       rate   At acquisi-    At    to begin                                           gibles  sation                                                tion    Sept. 2001 --------- ----------- --------- --------  ------  --------  --------  ---------  ---------  -------- ---------- ---------  -------- Alantro     Third      $277      $148     $ 81    $ 32       $ 52     Exclusion  Wireless     24%     $4.1/      $1.7/66    2002 Commun-     quarter                                                   approach   networking           256        engineer ications,   2000                                                                 technology           engineer   months Inc.                                                                             for home             months                                                                                  and office  (c) 1995-2001 Cybernet Data Systems, Inc. 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