Summary of TEXAS INSTRUMENTS INC

ITEM 2. Management's Discussion and Analysis of Financial Condition and Results of Operations.

The following should be read in conjunction with the Financial Statements and the related Notes that appear elsewhere in this document. All dollar amounts in the tables in this discussion are stated in millions of U.S. dollars, except per-share amounts. All amounts in this discussion reference continuing operations unless otherwise noted.

Overview

At Texas Instruments, we design and make high-technology components that we sell to customers all over the world. We have two business segments: Semiconductor and Education Technology. Semiconductor is by far the larger of these segments, accounting for 96 percent of our revenue in 2007. This segment sells integrated circuits, or semiconductors, to electronics designers and manufacturers. Our Education Technology segment accounts for the remaining 4 percent of our revenue and sells calculators and related technologies to consumers and educators.

With our quarterly report on Form 10-Q for the quarter ended June 30, 2008, we began describing Semiconductor revenue in four product categories: Analog, Embedded Processing, Wireless and remaining semiconductor. We expect that for our 2008 10-K, we will have transitioned to four segments: Analog, Embedded Processing, Wireless and Other. Our Other segment will consist of what is presently remaining semiconductor and Education Technology. For a complete description of these changes, please reference the Enhanced Financial Reporting Structure materials from our conference call and webcast, held on July 1, 2008, available at www.ti.com/ir.

The details relevant to each segment are discussed below.

Semiconductor

Background

Our Semiconductor segment invents and produces a variety of semiconductors, commonly called "chips." These semiconductors are used to accomplish many different things, such as converting and amplifying signals, interfacing with input and output devices and other semiconductors, managing and distributing power, processing data, canceling noise and improving signal resolution. Our portfolio includes products that are central to almost all electronic equipment.

Our Semiconductor segment can be affected by cyclical upturns and downturns characteristic of the markets for our products, which sometimes cause wide swings in growth rates from quarter to quarter or year to year. Prices and manufacturing costs of Semiconductor products tend to decline over time.

Although we regularly introduce new products, they are typically shipped in limited quantities initially and ramp into higher volume over time. Consequently, new products tend not to have a significant impact on Semiconductor revenue in the quarter in which they are introduced. In the discussion below, changes in our Semiconductor shipments are attributable to changing demand for our products, unless otherwise noted.

Products

We have three major semiconductor product categories: Analog, Embedded Processing and Wireless. We expect Analog and Embedded Processing to be our primary growth engines in the years ahead, and therefore we focus our resources on these product categories.

Within our semiconductor product categories, there are two general types of products, custom and standard - terms that refer to how and to whom the products are sold. A custom product is designed for a specific customer for a specific application, is sold only to that customer and is typically sold directly to the customer. A standard product is designed for use by many customers and/or many applications and is generally sold through both distribution and direct channels. Standard products include both commodity and proprietary products.

Analog

Analog semiconductors change real-world signals - such as sound, temperature, pressure or images - by conditioning them, amplifying them and often converting them to a stream of digital data so the signals can be processed by digital signal processors (DSPs). Analog semiconductors are also used to manage power distribution and consumption. Sales from our Analog product category accounted for about 35 percent of our revenue in 2007. The worldwide market for analog semiconductors was about $36 billion in 2007. Our share in this very fragmented market is about 13 percent, and we believe that we are well positioned to increase it over time. We have two categories of analog products: high-performance analog and high-volume analog & logic.

High-performance analog products: These include standard analog semiconductors (our portfolio is about 17,000 products) that we market to many different customers (nearly 80,000) who will use them in many different products. These products generally have long life cycles, often 10 to 20 years.

High-volume analog & logic products: These include two product types. The first, high-volume analog, includes custom products marketed for specific applications. The life cycles of our high-volume analog products are generally shorter than our high-performance analog products. End markets for high-volume analog products include communications equipment, automobiles, computing equipment and many consumer electronics products. The second type of products in this line, standard logic, includes commodity products marketed to many different customers for many different applications.

Embedded Processing

Our embedded processing products are DSPs and microcontrollers. DSPs perform mathematical computations almost instantaneously to process and improve digital data. Microcontrollers are microprocessors that are designed to control a very specific task for electronic equipment. Sales of embedded processing products accounted for about 12 percent of our revenue in 2007. The worldwide market for embedded processors was about $17 billion in 2007 and we have about 10 percent market share. A unique characteristic of embedded processing products is that our customers often invest their own research and development (R&D) to write software that operates only with our products. We make and sell standard products used in many different applications and custom products used in applications that include communications infrastructure equipment and automobiles.

Wireless

Cell phones require a radio or "baseband" to connect to the wireless carrier's network. Today's advanced cell phones also require an applications processor to run the phone's software and services, and semiconductors to enable connectivity to Bluetooth® devices, WiFi networks or GPS location services. We design, make and sell products to satisfy each of these requirements. Wireless products are typically sold in high volumes and our wireless portfolio includes both standard (or merchant) products and custom products. Sales of wireless products accounted for about 30 percent of our revenue in 2007.

As wireless communications have proliferated, consumers are demanding capabilities beyond voice. Smartphones (phones that contain email, media, games and computing capability) represent one of the fastest growing wireless markets. These phones tend to include many semiconductor products. Major handset manufacturers are actively pursuing the smartphone market and increasingly focusing their R&D on applications and services. As a result, we believe customer demand for applications processors will continue to increase as handset manufacturers seek to differentiate their products by providing software and a unique user experience. Our OMAPTM product line has a leading position in the applications processor market and is used by most of the top handset manufacturers.

Our Wireless product category has been shifting focus from baseband chips, a market with shrinking competitive barriers, to applications processors. Consistent with this shift in focus, we are actively pursuing the sale of our merchant baseband chipset product lines and will concentrate our remaining investments on our application processors and connectivity products. For additional detail, see the discussion under the heading "Third-Quarter 2008 Results."

In addition to our three major semiconductor product categories, we offer the following (referred to as remaining semiconductor): DLP® products (which are used to create high-definition images for data projectors, televisions and movie projectors), reduced-instruction set computing (RISC) microprocessors (which are designed to provide very fast computing and are often implemented in servers), application-specific integrated circuits (ASICs) (which are custom chips), and radio-frequency identification (RFID) semiconductors (which provide the technology used in, among other things, automatic transportation payments and product tracking). An additional source of semiconductor revenue is royalties received for our patented technology that we license to other electronics companies.

Inventory

Our inventory practices vary by product type. For standard products, where the risk of obsolescence is low, we generally carry higher levels of inventory. These products usually have many customers and long life cycles, and are often ordered in small quantities. Standard product inventory is sometimes held in unfinished form, giving us greater flexibility to meet final package and test configurations.

For custom products, where the risk of obsolescence is higher, we carry lower levels of inventory when possible. These products usually have a single customer, are sold in high volumes and have shorter life cycles. Life cycles of these products are often determined by end-equipment upgrade cycles and can be as short as 12 to 24 months.

As we've become a stronger competitor in the market for high-performance analog products, we've increased the inventory levels we carry for these products so that our tens of thousands of customers have access to what they need when they need it. Additionally, consignment programs with our largest customers and the fact that distributors now carry less inventory contribute to the need for us to carry higher levels of inventory.

Manufacturing

We own and operate semiconductor manufacturing sites in North America, Asia and Europe. These facilities include high-volume wafer fabrication plants and assembly/test sites. Our facilities require substantial investment to construct and are largely fixed-cost assets once in operation. Because we own much of our manufacturing capacity, a significant portion of our operating costs is fixed. In general, these costs do not decline with reductions in customer demand or utilization of capacity, potentially reducing our profit margins. Conversely, as product demand rises and factory utilization increases, the fixed costs are spread over increased output, potentially benefiting our profit margins.

Our analog semiconductors typically require a lower level of investment in manufacturing processes and equipment than our other semiconductor products, which are based on advanced logic manufacturing processes. While analog chips benefit from unique, proprietary manufacturing processes, these processes can be applied using older, less expensive equipment. In addition, these processes and equipment remain usable for much longer than the manufacturing processes and equipment required for advanced logic manufacturing. Consequently, the level of capital spending needed to support analog semiconductor manufacturing is considerably less than is needed for an equivalent level of advanced logic semiconductor manufacturing.

To supplement our internal advanced logic wafer fabrication capacity, maximize our responsiveness to customer demand and minimize our overall capital expenditures, our manufacturing strategy utilizes the capacity of outside suppliers, commonly known as foundries. External foundries provide about 50 percent of the fabricated wafers for our advanced logic products. We expect the proportion of our advanced logic wafers provided by foundries will increase over time. We expect to maintain sufficient internal wafer fabrication capacity to meet substantially all our analog production needs.

As our internal manufacturing efforts shift to a higher percentage of analog products, an increasing proportion of our capital expenditures is devoted to assembly/test facilities and equipment. This is primarily due to the lower capital needs of analog wafer manufacturing equipment. We also use subcontractors to provide a small portion of our assembly and test needs, either where a product requires unique assembly packaging but we do not sell sufficient volume to justify purchasing the necessary equipment or where we have acquired companies whose products are already assembled and tested by subcontractors.

Another element of our manufacturing strategy for advanced logic semiconductors involves working collaboratively with our foundry suppliers to develop future generations of wafer fabrication manufacturing processes, a model we transitioned to in 2007. Historically, we had developed these manufacturing processes in-house. This strategic shift allows us to better serve customers with cost-effective manufacturing processes from our foundry suppliers, while also increasing the efficiency of our own R&D and capital. As we have decreased our R&D spending on advanced logic manufacturing process development, we have increased R&D spending, albeit at lesser amounts, on our analog manufacturing process development, where we remain able to differentiate our products through process technologies.

Education Technology

Our Education Technology segment is the world's leading supplier of handheld graphing calculators. It also designs business and scientific calculators, as well as a wide range of advanced classroom hardware and software that help students and teachers explore math and science interactively. Our products are sold primarily through retailers and instructional dealers. Our Education Technology segment has an annual pattern of revenue that is tied to the U.S. back-to-school season. As a result, revenue is at its highest in the second and third quarters. This segment represented 4 percent of our revenue in 2007. Prices of Education Technology products tend to be stable.

Tax Considerations

We operate in a number of tax jurisdictions and are subject to several types of taxes including those based on income, capital, property and payroll, and sales and other transactional taxes. The timing of the final determination of our tax liabilities varies among the various jurisdictions and their taxing authorities. As a result, during any particular reporting period, we might reflect in our financial statements one or more tax refunds or assessments, or changes to tax liabilities, involving one or more taxing authorities.

Third-Quarter 2008 Results

Our third-quarter revenue was $3.39 billion, net income was $563 million and earnings per share were $0.43. Income included a $34 million discrete tax benefit primarily due to adjustments identified through the completion of tax returns for prior years. This benefit was largely offset by $44 million of pre-tax charges associated with impairments of long-lived assets and with site consolidations, $17 million of which is in cost of revenue, $23 million in R&D and $4 million in selling, general & administrative (SG&A).

We entered the third quarter with a cautious view of the economy and its impact on our markets. Revenue was weak, as expected, because consumers and corporations reduced their spending in this uncertain economy. Even so, the soundness of our strategic direction was underscored by results from our core product categories. Revenue for our Analog product category was steady and revenue for our Embedded Processing product category grew 9 percent compared with a year ago. Although not immune to near-term economic pressures, these are two of the best long-term opportunities in our industry. We are a leader in each and expect to strengthen our position even in this period of economic weakness.

Our outlook for the fourth quarter is for revenue to decline substantially based on weak order trends over the past few months, and our operating plan assumes a further decline in the first quarter of 2009. In anticipation of declining demand, we reduced our own inventory aggressively in the third quarter, which brought factory utilization down and put additional pressure on our profitability. We also worked closely with our distributors to reduce their inventory. We will accelerate our inventory reduction in the fourth quarter. We also will continue to reduce expenses and capital spending. At the same time, we will continue to invest in opportunities to strengthen our positions in Analog and Embedded Processing.

Subsequent to the end of the third quarter, we announced we are taking actions that, when complete, are expected to reduce expenses more than $200 million annualized in our Wireless operations, especially in our cellular baseband operation. About 85 percent of these savings will be in R&D, 10 percent in cost of revenue and 5 percent in SG&A. We are also actively pursuing the sale of the merchant portion of this operation and are in discussions with potential buyers. Revenue from this merchant operation is expected to be about $350-400 million in 2008. If a sale of this product line cannot be arranged, we will take action to eliminate the majority of the operating expenses required to support this product line. Reductions in the remaining cellular baseband operations will begin immediately and are expected to be complete by June 2009. We expect to take restructuring charges of approximately $110 million across the next three quarters.

We will continue to support select programs in the custom portion of our baseband operation, which is expected to have revenue of about $2.3 billion this year. We expect revenue from our custom baseband operation to decline over time as programs with Ericsson Mobile Platforms continue to wind down and as our largest customer implements its multi-supplier strategy.

We will focus our remaining Wireless investments in OMAP applications processors, which are at the heart of many smartphone products.

The market for smartphones is growing rapidly and our handset customers are differentiating their product lines through applications and user interfaces. We anticipated this opportunity and have been investing in it for more than a decade. As a result, our OMAP applications processors lead the market, and we will concentrate on extending this lead.