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MANAGEMENT DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS | |||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||
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1997 RESULTS OF OPERATIONS COMPARED WITH 1996 | |||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||
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UNLESS STATED OTHERWISE, THE FINANCIAL RESULTS THAT FOLLOW ARE FROM CONTINUING OPERATIONS AND EXCLUDE SPECIAL ITEMS. TI’s orders were $9796 million, compared with $9268 million in 1996. Net revenues in 1997 were $9750 million, compared with $9940 million in 1996. Financial results in 1996 included revenues from TI businesses that have since been sold, primarily software, mobile computing and printers. Excluding the sold businesses, TI orders were up 19 percent for the year and revenues were up 10 percent, primarily due to growth in semiconductor. Profit from operations in 1997 was $1213 million, up from $374 million in 1996. The increase was primarily from higher semiconductor profits in the non-memory portion of the business. The absence of losses in the sold businesses, primarily mobile computing. In 1996, these businesses lost $193 million more than in 1997. Results for the fourth quarter include a charge of $461 million for in-process R&D associated with the acquisition of Amati Communications Corporation, along with a pretax charge of $42 million for cost reduction actions, primarily in the materials & controls business. In addition to the fourth quarter charges, the 1997 earnings include previously announced special pretax charges of $56 million, primarily related to the sale of TI’s mobile computing business, and $44 million for the termination of joint-venture agreements in Thailand. Results for 1997 also include a $66 million gain for the sale of three businesses, the largest of which was software. The total of the 1997 special items is equivalent to $1.27 per share. In 1996, special charges were $400 million before taxes, with $208 million being in the fourth quarter. These charges were equivalent to $0.86 per share for the year. Income for the year was $809 million, compared with $281 million in 1996. TI’s diluted earnings per share (EPS) in 1997 were $2.03, compared with $0.74 in 1996. Including the effect of the special items, income for the year was $302 million compared to a loss of $46 million in 1996, and earnings per share were $0.76 compared with a loss per share of $0.12 in 1996. Results for 1997 also included an accrual for profit sharing of $122 million, which was 7.82 percent of eligible payroll. There was no profit sharing in 1996. Including the effect of special items, net income for 1997 was $1805 million, which consisted of income from continuing operations of $302 million, income from the discontinued defense business of $52 million, gain on sale of the discontinued defense business of $1473 million, and an extraordinary charge of $22 million associated with debt retirement. On a similar basis, net income for 1996 was $63 million, which consisted of a loss from continuing operations of $46 million and income from the discontinued defense business of $109 million. Royalty revenues in 1997 were essentially steady with 1996. Negotiations continue with potential licensees. TI continues to expect a significant ongoing stream of royalty revenue into the next century. In September, the Tokyo High Court upheld a ruling that Fujitsu Limited’s production of certain memory products does not infringe TI’s Kilby patent. The company has appealed the ruling to the Japan Supreme Court. In November, the Japan Patent Office invalidated the Kilby patent. TI plans to appeal this decision to the Tokyo High Court. Since the Kilby patent expires in 2001, the company does not expect the outcome of either appeal to be material. Interest income for 1997 was up $84 million from 1996, primarily as a result of investment of net proceeds from the sale of the defense business to Raytheon. The income tax rate for 1997 was 35 percent. TI’s backlog of unfilled orders as of December 31, 1997, was $1623 million, unchanged from year-end 1996. R&D for 1997 was $1075 million, excluding the $461 million charge for in-process R&D associated with the Amati acquisition, compared with $989 million in 1996, excluding the $192 million charge for in-process R&D associated with the SSi acquisition. Capital expenditures were $1238 million in 1997, compared with $2063 million in 1996. Depreciation for 1997 was $1109 million compared with $904 million in 1996. Depreciation for 1998 is expected to be $1.3 billion. TI management will recommend to the Board of Directors that the timing of dividend declarations be moved to the first month of the quarter, with paydates shifting accordingly to the second month of the quarter. The change is planned to begin in March 1998. Semiconductor: Orders in semiconductor for 1997 were $8109 million, up 21 percent from $6723 million in 1996. The increase resulted from strong demand for digital signal processing solutions, as DSPS orders increased over 40 percent. Semiconductor revenues were $8087 million, up 10 percent from $7357 million in 1996. The increase in semiconductor resulted from an increase of more than 35 percent in DSPS revenues due to increased shipments, which more than offset a $400 million decrease in memory, as DRAM prices continued to decline sharply. For the fourth quarter, semiconductor revenues, which include royalties from semiconductor patent licenses, represented about 85 percent of TI’s revenues. Digital signal processors plus mixed-signal/analog represented about 45 percent of semiconductor. Memory, made up primarily of DRAMs, accounted for less than 20 percent of semiconductor. The remainder of semiconductor consists primarily of a broad range of advanced products, including application-specific integrated circuits, reduced instruction-set microprocessors, microcontrollers and standard logic. Revenues reached record levels for digital signal processing for both the year and the fourth quarter. Mixed-signal/analog also had a strong year, with record revenues for the year and fourth quarter, growing more than twice as fast as the market in 1997. Memory continued to be significantly affected by DRAM price pressures, with revenues down by 10 percent in the fourth quarter from the year-ago fourth quarter. TI continues to emphasize aggressive shrinks of DRAM devices and the transition to new synchronous DRAMs. TI believes these improvements will help offset some of the financial pressures faced by joint venture manufacturing operations in this environment. TI and other joint venture shareholders continue to explore further measures with respect to the joint venture structures. In this regard, TI and Hitachi, Ltd., major shareholders of one joint venture, announced on February 9, 1998, plans to discontinue their joint venture arrangement, with TI to purchase the assets of the venture. In connection with this action, TI expects to take a special charge in the first quarter of 1998. TI’s other semiconductor products, such as microcontrollers and application-specific integrated circuits, made good progress in growth and profitability in 1997 Semiconductor profit from operations increased from $783 million in 1996 to $1354 million in 1997 and operating margins improved from 10.6 percent to 16.7 percent. The improvement was primarily from higher margins in the non-memory portion of the business, particularly benefiting from higher DSPS shipments. The outlook remains positive for longer-term growth of the semiconductor market, although TI remains cautious in the near-term as continuing volatility in DRAMs and slowing in Asian economies are expected to put pressure on first quarter 1998 revenues and margins. TI now believes the 1998 worldwide semiconductor market will grow at about 10 percent, up from 4 percent in 1997. In the non-memory area of the market, TI expects to see faster growth than the total market, led by about 30 percent growth for DSPs and mixed-signal devices. The U.S. market outlook remains healthy and Europe shows ongoing strengthening, although turmoil in Asia could impact these markets as well. In addition, new markets are emerging, such as low cost personal computers, higher speed internet access and digital consumer products, important to the future growth of the industry. TI continues to see strength in wireless communications and networking markets, with semiconductor content rising about 60 percent over the past four years. Materials & Controls: Orders in materials & controls of $972 million were up from $896 million in 1996, primarily due to TIRIS. Revenues of $954 million were up $64 million from 1996 due primarily to the growing acceptance of TIRIS in automotive applications. PFO increased from $90 million in 1996 to $123 million in 1997, with margins improving from 10.1 percent to 12.9 percent. The increase was due primarily to manufacturing cost reduction. Education Technology: Orders in Education Technology were $448 million, up $22 million from 1996 as a result of continued growth in instructional calculators. Revenues were $447 million, an increase of $24 million from 1996 also as a result of growth in instructional calculators. PFO increased from $56 million in 1996 to $59 million in 1997 and operating margins remained flat at 13.2 percent. Digital Imaging: TI’s digital imaging business continued to make progress throughout 1997, further focusing its strategy on key market opportunities. Financial Condition: During 1997, cash and cash equivalents plus short-term investments increased by $2042 million to $3020 million. The sale of TI’s defense operations to Raytheon Company on July 11 provided $2950 million of cash. In addition, the sale of three other TI businesses generated $177 million of cash in the second quarter. In the fourth quarter, TI used $306 million of cash to acquire about 78 percent of the issued and outstanding shares of Amati Communications Corporation’s common stock at a price of $20 per share. TI intends to acquire the remaining shares of Amati’s common stock in the first quarter of 1998. Additionally, TI used $740 million of cash in the fourth quarter to pay 1997 federal income taxes which included taxes of $676 million on the gain on the sale of TI’s defense operations. This sale and the related accrued income tax liability were recognized in the third quarter of 1997. For 1997, cash flow from operating activities net of additions to property, plant, and equipment was $605 million, and 1997 capital expenditures totaled $1238 million. During the third quarter TI began a stock repurchase program with the goal of neutralizing the potential dilutive effect of shares to be issued upon the exercise of stock options under the 1997 employee stock purchase plan and stock option/incentive plans. Through December, TI used $86 million of cash to repurchase shares of its common stock. The outstanding balance of commercial paper was reduced from $300 million to zero during the second quarter of 1997. The company’s outstanding 2.75% convertible subordinated debentures due 2002 in the principal amount of $103 million were called for redemption and converted to TI common stock in the third quarter of 1997. In the fourth quarter, TI retired a face amount of $248 million of its previously outstanding long-term debt. At year-end 1997 the debt-to-total-capital ratio was .19, down from the year-end 1996 value of .33. Authorizations for future capital expenditures were $1105 million at December 31, 1997. TI’s capital expenditures for 1998 are being constrained to $1.4 billion, up from $1.2 billion in 1997. R&D will be increased to $1.3 billion, up from $1.1 billion in 1997, primarily to support digital signal processing solutions and other advanced semiconductor technologies. The company maintains lines of credit to support commercial paper borrowings and to provide additional liquidity. These lines of credit totaled $651 million at December 31, 1997. Of this amount, $600 million exists to support outstanding and future commercial paper borrowings or short-term bank loans. TI’s financial strength puts the company in an excellent position to continue to take strategic actions even in a cautious global economy. Year 2000: The company is actively engaged in resolving the issues involved with the Year 2000 challenge. These issues result from the use of two-digit year dates rather than four-digits year dates in computer code, which could cause potential failures in date-sensitive software that does not recognize "00" as 2000. In 1995, TI formed teams to address the company’s Year 2000 challenge. The company is on schedule to complete assessment, testing, and modifications to strategic business systems in 1998. TI is also assessing the scope of Year 2000 issues in its physical plant and infrastructure and will soon begin corrective actions. TI is communicating with its major customers and suppliers to resolve Year 2000 interface issues. While TI expects success in this cooperative effort, it cannot guarantee the performance of third parties. The company is developing contingency plans to minimize potential disruptions. Based on assessments to date, the company believes its current products are ready for Year 2000. Obsolete and discontinued products, as well as divested product lines, are not included in this assessment. The estimate of overall costs for TI’s Year 2000 project is not expected to be material. The completion dates and costs are based on management’s current best estimates. Market Risk Sensitive Instruments: The U.S. dollar is the functional currency for financial reporting. In this regard, the company uses forward currency exchange contracts, including Italian lira note currency swaps, to minimize the adverse earnings impact from the effect of exchange rate fluctuations on the company’s non-U.S. dollar net balance sheet exposures. For example, at year-end 1997, the company had forward currency exchange contracts outstanding of $275 million (including $101 million to buy lira, $73 million to buy deutsche marks, and $24 million to buy Singapore dollars). Because most of the aggregate non-U.S. dollar balance sheet exposure is hedged by these exchange contracts and swaps, a hypothetical 10% plus or minus fluctuation in non-U.S. currency exchange rates would not be expected to have a material earnings impact, e.g., based on year-end 1997 balances and rates, a pretax currency exchange gain or loss of $10 million. The company has interest rate swaps which change the characteristics of the interest payments on its $300 million of 6.125% notes due 2006 from fixed-rate payments to short-term LIBOR-based variable rate payments in order to achieve a mix of interest rates on the company’s long-term debt which, over time, is expected to moderate financing costs. The effect of these interest rate swaps was to reduce interest expense by $2 million in 1997. The year-end 1997 effective interest rate for the $300 million of notes due 2006, including the effect of the swaps, was approximately 5.1%. These swaps are sensitive to interest rate changes. For example, if short-term interest rates increase (decrease) by one percentage point from year-end 1997 rates, annual pretax interest expense would increase (decrease) by $3 million. The company’s long-term debt has a fair value, based on current interest rates, of approximately $1390 million at year-end 1997. Fair value will vary as interest rates change. The following table presents the aggregate maturities and carrying amounts of the debt principal and related weighted average interest rates by maturity dates (millions of dollars):
Total long-term debt carrying amount at year-end 1997 was $1353 million. The company’s cash equivalents and short-term investments are debt securities with remaining maturities within three months (cash equivalents) and beyond three months and within 13 months (short-term investments). Their aggregate fair value and carrying amount was $2566 million at year-end 1997. Fair value will vary as interest rates change. The following table presents the aggregate maturities of cash equivalents and short-term investments and related weighted average interest rates by maturity dates (millions of dollars):
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