Higher volumes of chipset products also contributed toward the increase in revenues from 1995 to 1997 and helped enable the Pentium and Pentium Pro microprocessor ramps and the ongoing ramp of the Pentium II microprocessor. Revenues from embedded control products and networking and communications products also grew over this period. Revenues from flash memory products grew from 1995 to 1996 but declined from 1996 to 1997.

The gross margin percentage was 60% in 1997, compared to 56% in 1996 and 52% in 1995 as a result of the cost and revenue factors discussed above. However, for the second half of 1997, the gross margin percentage was 58%, compared to 60% in the second half of 1996, primarily due to the impact of the SEC cartridge and a weaker flash memory market segment in 1997. See "Outlook" for a discussion of gross margin expectations.

Sales of Pentium family microprocessors and related board-level products comprised a majority of the Company's revenues and gross margin during 1997. During 1996 and 1995, a majority of the Company's revenues and a substantial majority of its gross margin were derived from these products. Sales of Pentium Pro and Pentium II microprocessors became an increasing portion of the Company's revenues and gross margin in 1996 and a significant portion in 1997. The Intel486(TM) microprocessor family contributed significant but declining revenues and gross margin in 1995 and negligible revenues and gross margin in 1996.

Research and development spending grew by 30% from 1996 to 1997 and 40% from 1995 to 1996, as the Company substantially increased its investments over this time period in strategic programs, particularly for the internal development of microprocessor products and related manufacturing technology. Increased spending for marketing programs (including media merchandising and the Company's Intel Inside(R) cooperative advertising program), other revenue-dependent expenses and expenses related to headcount in 1997 drove the 25% and 26% increases in marketing, general and administrative expenses from 1996 to 1997 and from 1995 to 1996, respectively.

Interest and other income increased by $393 million from 1996 to 1997, primarily due to higher average investment balances and higher gains on sales of equity investments. Although the Company had higher average investment balances in 1996 than in 1995, interest and other income decreased by $9 million from 1995 to 1996, primarily due to the offsetting effect of $118 million in unusual gains in 1995.

The Company's financial condition remains very strong. As of December 27, 1997, total cash, trading assets and short- and long-term investments totaled $11.8 billion, up from $9.3 billion at December 28, 1996. Cash generated from operating activities rose to $10.0 billion in 1997, compared to $8.7 billion and $4.0 billion in 1996 and 1995, respectively.

Inventory levels, particularly work in process and finished goods, increased significantly in 1997. This increase was primarily attributable to the ramp of the Pentium II processor and the related higher level of purchased components on the SEC cartridge. The decrease in accounts receivable in 1997 was mainly due to improved receivable collections and higher revenues in geographic regions with faster payment patterns. The Company's five largest customers accounted for approximately 39% of net revenues for 1997, and one customer accounted for 12% of revenues. No customers accounted for more than 10% of revenues in 1996 and 1995. At December 27, 1997, the five largest customers accounted for approximately 34% of net accounts receivable.

The Company used $3.2 billion for financing activities in 1997, compared to $773 million and $1.1 billion in 1996 and 1995, respectively. The major financing applications of cash in 1997 were for repurchase of 43.6 million shares of Common Stock for $3.4 billion and a $300 million repayment under a private reverse repurchase arrangement. The major financing applications of cash in 1996 and 1995 were for stock repurchases totaling $1.3 billion (including $108 million for exercised put warrants) and $1.0 billion, respectively. Financing sources of cash during 1997 included $357 million in proceeds from the sale of shares primarily pursuant to employee stock plans ($261 million in 1996 and $192 million in 1995). Financing sources in 1996 also included $300 million under the private reverse repurchase arrangement.

As part of its authorized stock repurchase program, the Company had outstanding put warrants at the end of 1997, with the potential obligation to buy back 26.3 million shares of its Common Stock at an aggregate price of $2.0 billion. The exercise price of these warrants ranged from $68 to $95 per share, with an average exercise price of $78 per share as of December 27, 1997.

Other sources of liquidity include authorized commercial paper borrowings of $700 million. The Company also maintains the ability to issue an aggregate of approximately $1.4 billion in debt, equity and other securities under Securities and Exchange Commission shelf registration statements.

In January 1998, the Company acquired the outstanding shares of Chips and Technologies, Inc. of San Jose, California, for approximately $430 million.

On October 27, 1997, the Company and Digital Equipment Corporation ("Digital") announced that they have agreed to establish a broad-based business relationship. Under the agreement, Intel will purchase Digital's semiconductor operations, including facilities in Hudson, Massachusetts as well as development operations in Jerusalem, Israel and Austin, Texas for approximately $700 million. The agreement is subject to U.S. government review.

The Company believes that it has the financial resources needed to meet business requirements in the foreseeable future, including capital expenditures for the expansion of worldwide manufacturing capacity, working capital requirements, the potential put warrant obligation and the dividend program.

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The Company is exposed to financial market risks, including changes in interest rates, foreign currency exchange rates and marketable equity security prices. To mitigate these risks, the Company utilizes derivative financial instruments. The Company does not use derivative financial instruments for speculative or trading purposes.

The primary objective of the Company's investment activities is to preserve principal while at the same time maximizing yields without significantly increasing risk. To achieve this objective, the returns on a majority of the Company's marketable investments in long-term fixed rate debt and equity securities are swapped to U.S. dollar LIBOR-based returns. A hypothetical 60 basis point increase in interest rates would result in an approximate $18 million decrease (less than 0.2%) in the fair value of the Company's available-for-sale securities.

The Company hedges currency risks of investments denominated in foreign currencies with foreign currency borrowings, currency forward contracts and currency interest rate swaps. Gains and losses on these foreign currency investments would generally be offset by corresponding losses and gains on the related hedging instruments, resulting in negligible net exposure to the Company.

A substantial majority of the Company's revenue, expense and capital purchasing activities are transacted in U.S. dollars. However, the Company does enter into these transactions in other currencies, primarily Japanese yen and certain other Asian and European currencies. To protect against reductions in value and the volatility of future cash flows caused by changes in foreign exchange rates, the Company has established revenue, expense and balance sheet hedging programs. Currency forward contracts and currency options are utilized in these hedging programs. The Company's hedging programs reduce, but do not always entirely eliminate, the impact of foreign currency exchange rate movements. An adverse change (defined as 20% in certain Asian currencies and 10% in all other currencies) in exchange rates would result in a decline in income before taxes of less than $20 million.

The Company is exposed to equity price risks on the marketable portion of equity securities included in its portfolio of investments entered into for the promotion of business and strategic objectives. These investments are generally in small capitalization stocks in the high-technology industry sector. The Company typically does not attempt to reduce or eliminate its market exposure on these securities. A 20% adverse change in equity prices would result in an approximate $75 million decrease in the fair value of the Company's available-for-sale securities.

All of the potential changes noted above are based on sensitivity analyses performed on the Company's financial positions at December 27, 1997. Actual results may differ materially.

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This outlook section contains a number of forward-looking statements, all of which are based on current expectations. Actual results may differ materially. These statements do not reflect the potential impact of any future mergers or acquisitions, except as noted below.

Intel expects that the total number of computers using Intel's Pentium family processors, sixth-generation processors (including Pentium II and Pentium Pro processors) and other semiconductor components sold worldwide will continue to grow in 1998. The Company's financial results are substantially dependent on sales of these microprocessors and other semiconductor components. Revenue is also a function of the mix of microprocessor types and speeds sold, as well as the mix of microprocessors and related purchased components, all of which are difficult to forecast. Because of the large price difference between types of microprocessors, this mix affects the average price Intel will realize and has a large impact on Intel's revenues. The Company's expectations regarding growth in the computing industry worldwide are subject to the impact of economic conditions in various geographic regions, including the Asia-Pacific region, which has recently been undergoing a currency and economic crisis.

Intel's strategy is to introduce ever higher performance microprocessors tailored for the different segments of the worldwide computing market. To implement this strategy, the Company plans to cultivate new businesses and continue to work with the software industry to develop compelling applications that can take advantage of this higher performance, thus driving demand toward the newer products in each computing market segment. In line with this strategy, the Company is seeking to develop higher performance microprocessors for each market segment, including servers, workstations, high-end business PCs, the basic PC and other product lines. The Company may continue to reduce microprocessor prices at such times as it deems appropriate in order to bring its technology to market within each relevant market segment.

The Company's gross margin varies depending on the mix of types and speeds of processors sold and the mix of microprocessors and related purchased components within a product family. The Company's most advanced product, the Pentium II processor, is packaged with purchased components in the SEC cartridge, and the inclusion of purchased components tends to increase absolute dollar margins but to lower the gross margin percentage. This increased volume of purchased components on the SEC cartridge is expected to reduce the gross margin percentage over the next several quarters from 59% in the fourth quarter of 1997. Various other factors (including unit volumes and costs, yield issues associated with production at factories, ramp of new technologies, excess or obsolete inventory, and mix of shipments of other semiconductors) will also continue to affect the amount of cost of sales and the variability of gross margin percentages. The Company currently expects that revenue and the gross margin percentage in the first quarter of 1998 will be adversely affected by weaker demand from original equipment manufacturers. Intel's primary goal is to get its advanced technology to the marketplace, and the Company sometimes implements strategies that increase dollar margins but lower margin percentages. These strategies include the SEC cartridge, as discussed above, and the Company's plans to grow in non-microprocessor areas that have the potential to expand computing and telecommunications capabilities, an example of which is the acquisition of Chips and Technologies, Inc.

The Company believes that over the long term the gross margin percentage will be 50% plus or minus a few points. In addition, from time to time, the Company may forecast a range of gross margin percentages for the coming quarter. Actual results may differ from these estimates.

The Company has expanded manufacturing capacity over the last few years and continues to expand capacity based on the assumed continued success of its strategy and the acceptance of its products in specific market segments. If the market demand does not continue to grow and move rapidly toward higher performance products in the various market segments, revenues and gross margin may be affected, the manufacturing capacity installed may be under-utilized, and capital spending may be slowed. Revenues and gross margin may also be affected if the Company does not add capacity fast enough to meet market demand. The Company expects that capital spending will increase to approximately $5.3 billion in 1998 to support significant expansion of worldwide manufacturing capacity. The Company's capital spending plan includes the acquisition of Digital's semiconductor facilities. This plan is dependent upon expectations regarding manufacturing efficiencies, delivery times of various machines and construction schedules for new facilities. Depreciation for 1998 is expected to be approximately $2.7 billion. Most of the increased depreciation would be included in cost of sales and research and development spending.

The industry in which Intel operates is characterized by very short product life cycles, and the Company's continued success is dependent on technological advances, including the development and implementation of new processes and new strategic products for specific market segments. As Intel considers it imperative to maintain a strong research and development program, spending for research and development in 1998 is expected to increase to approximately $2.8 billion. In addition, the Company expects the acquisition of Chips and Technologies, Inc. in 1998 to result in a one-time charge for in-process research and development of approximately $165 million in the first quarter. The Company will also continue spending to promote its products and to increase the value of its product brands. Based on current forecasts, spending for marketing, general and administrative expenses is also expected to increase in 1998.

The Company currently expects its tax rate to decrease to 34% for 1998 due to the settlement of federal tax audits and favorable resolution of significant state tax issues and tax matters in other countries. This estimate, based on current tax law and current estimate of earnings, excludes the effect of the one-time charge related to Chips and Technologies, Inc. and is subject to change.

In September 1997, the Federal Trade Commission ("FTC") staff notified Intel that the FTC has begun an investigation of the Company's business practices. To date, no allegations have been made, nor have any charges been filed. The Company has an aggressive program in place to make sure its business practices are in full compliance with federal laws in this area. Although neither the extent nor the outcome of this investigation can be determined at this time, management, including internal counsel, does not believe that the outcome will have a material adverse effect on the Company's financial position or overall trend in results of operations.

Like many other companies, the year 2000 computer issue creates risk for Intel. If internal systems do not correctly recognize date information when the year changes to 2000, there could be an adverse impact on the Company's operations. The Company has initiated a comprehensive project to prepare its computer systems for the year 2000 and plans to have changes to critical systems completed by the first quarter of 1999 to allow time for testing. The Company is also assessing the capability of its products sold to customers over a period of years to handle the year 2000 and has a plan in place to address product issues during 1998. Management believes that the likelihood of a material adverse impact due to problems with internal systems or products sold to customers is remote and expects that the cost of these projects over the next two years will not have a material effect on the Company's financial position or overall trends in results of operations. Intel is also contacting critical suppliers of products and services to determine that the suppliers' operations and the products and services they provide are year 2000 capable or to monitor their progress toward year 2000 capability. There can be no assurance that another company's failure to ensure year 2000 capability would not have an adverse effect on the Company.

The Company's future results of operations and the other forward-looking statements contained in this outlook - in particular the statements regarding growth in the computing industry, gross margin, capital spending, depreciation, research and development, marketing and general and administrative expenses, the FTC investigation and the year 2000 issue - involve a number of risks and uncertainties. In addition to the factors discussed above, among the other factors that could cause actual results to differ materially are the following: changes in customer order patterns, including changes in customer and channel inventory levels; competitive factors, such as rival chip architectures and manufacturing technologies, competing software-compatible microprocessors and availability of other computing alternatives; timing of software industry product introductions; execution of the manufacturing ramp; the ability to successfully integrate and operate any acquired businesses; costs or other adverse effects associated with processors and other products containing errata (deviations from published specifications); risks associated with foreign operations; and litigation involving intellectual property, consumer and other issues.