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Texas Instruments Inc. (NASDAQ:TXN)

Q4 2012 Mid-Quarter Financial Update Conference

December 10, 2012 5:00 pm ET

Executives

Ron Slaymaker

Analysts

Patrick Walsh - Crédit Suisse AG, Research Division

Joseph Moore - Morgan Stanley, Research Division

Ross Seymore - Deutsche Bank AG, Research Division

Stacy A. Rasgon - Sanford C. Bernstein & Co., LLC., Research Division

James Covello - Goldman Sachs Group Inc., Research Division

Tore Svanberg - Stifel, Nicolaus & Co., Inc., Research Division

Shawn R. Webster - Macquarie Research

Christopher Caso - Susquehanna Financial Group, LLLP, Research Division

Romit J. Shah - Nomura Securities Co. Ltd., Research Division

David M. Wong - Wells Fargo Securities, LLC, Research Division

Operator

Good day, everyone, and welcome to the Texas Instruments' Fourth Quarter 2012 Mid-Quarter Update Call. At this time, I would like to turn the conference over to Ron Slaymaker. Please go ahead, sir.

Ron Slaymaker

Good afternoon. Thank you for joining TI's mid-quarter financial update for the fourth quarter of 2012. In a moment, I will provide a short summary of TI's current expectations for the quarter, updating the revenue and EPS ranges for the company. In general, I will not provide detailed information on revenue trends by segment or end markets, and I will not address details of profit margins. In our earnings release at the end of the quarter, we will provide this information. As usual with our mid-quarter update, we will not be taking follow-up calls this evening. Considering the limited information available at this point in the quarter and in consideration of everyone's time, we will limit this call to 30 minutes. For any of you who missed the release, you can find it on our website at ti.com/ir. This call is broadcast live over the web and can be accessed through TI's website. A replay will be available through the web.

This call will include forward-looking statements that involve risks and uncertainties that could cause TI's results to differ materially from management's current expectations. We encourage you to review the Safe Harbor statement contained in the news release published today, as well as TI's most recent SEC filings for a more complete description.

We have narrowed our expected ranges for TI's revenue and earnings from our previous ranges. We now expect TI revenue between $2.89 billion and $3.01 billion, a range that has been narrowed to the middle of our prior range. We expect earnings per share between $0.05 and $0.09 on a GAAP basis. In addition to the $0.06 of acquisition and restructuring charges included in our original guidance for the quarter, EPS also now includes $0.21 of charges associated with the previously announced restructuring in our wireless segment.

As a reminder, we said the wireless restructuring charges would be about $325 million in total, of which about $220 million is for severance and related benefits, and most of the remainder is for noncash impairments related to the Wireless business. Most of these charges will be recognized in the current quarter, although some are subject to the outcome of required negotiations in countries outside the U.S.

If you're having trouble translating the charge amount to the EPS impact in the quarter, please note that goodwill impairment is not tax-deductible. The $0.21 impact that I identified comprehends the tax treatment.

Operator, you can now open the lines for questions. In order to provide as many of you as possible the opportunity to ask a question, please limit yourself to a single question. I will provide you the opportunity to ask a follow-up question. Operator?

Question-and-Answer Session

Operator

[Operator Instructions] And we'll hear first from John Pitzer with Crédit Suisse.

Patrick Walsh - Crédit Suisse AG, Research Division

This is Patrick Walsh calling in for John Pitzer. Just have a quick question on the profitability. On a non-GAAP basis, it looks a little better. Curious, is that all driven by wireless?

Ron Slaymaker

No. Actually, the cost reductions that we're -- the restructuring that we're doing in wireless really won't have any significant impact this quarter as most of the employment reductions are happening late in the quarter. What you're seeing probably translates to about $0.01 better on a, as you call, a non-GAAP basis or however you would get there. And what I would say is that's really just we're continuing to generally tighten down on expenses where possible and that really is just considering the weak environment that we're operating in. So again, just holding a tight rein on expenses. You have a follow-on, Patrick?

Patrick Walsh - Crédit Suisse AG, Research Division

Yes. As a follow-up, do you think that the Wireless business can get to breakeven in the calendar first quarter? And if so, do you expect to be able to stay breakeven as revenue declines going forward?

Ron Slaymaker

Okay. Let me -- the answer to that whole situation is complex. Let me just start with the fourth quarter. I would say that wireless, clearly in the fourth quarter will have an operating loss because it will include the restructuring charge. Going forward, I really don't have a date for you on when that loss will go away as it depends on how fast the revenue declines relative to the cost. I think we said back on our October call that we expect that our baseband revenue in first quarter will be about half of the level that it was in the fourth quarter. So again, considering the baseband revenues declining and then on top of that how fast the OMAP and connectivity declines occur from a revenue standpoint will really drive what will happens from our profitability or loss perspective. Okay, Patrick, thank you for your call.

Operator

Next, we'll hear from Joe Moore with Morgan Stanley.

Joseph Moore - Morgan Stanley, Research Division

Let me just a follow up on the last question. What do you see is the tail for the OMAP and connectivity business? It seems like your customer base in the next couple of quarters probably doesn't change all that much. I mean, is there going to be a fairly healthy tail in that business the next couple quarters?

Ron Slaymaker

Joe, that's a good question. I should have clarified that on the prior call. We -- the revenue that's there, which this year for OMAP and connectivity products that are sold into smartphones and tablet applications, probably will be about $800 million total. In the fourth quarter, it will be right around $200 million. And again, that's not the entire segment revenue for OMAP and connectivity because some of that is sold into embedded applications, probably a couple hundred million dollars in 2012. But the $800 million overall for 2012 that's sold into smartphones and tablets or the $200 million in fourth quarter for smartphones and tablets we would expect to decline through the course of 2013 such that it's gone by the time we enter 2014. And then probably a similar trajectory in terms of the cost savings. The cost will decline through the course of 2013, and as we enter 2014, we will have about $450 million of annualized cost savings, again, as we enter 2014 or by the end of 2013. Do you have a follow-on, Joe?

Joseph Moore - Morgan Stanley, Research Division

Yes. Just on that note, the $450 million, how does that split between operating expense and cost of sales savings?

Ron Slaymaker

Okay, the estimate we have is about 75% of that will be R&D, about 15% SG&A and then about 10% cost of revenue. Okay, Joe, thank you.

Operator

And our next question comes from Ross Seymore of Deutsche Bank.

Ross Seymore - Deutsche Bank AG, Research Division

First one, following up on the OMAP side of things with connectivity. Do you expect any impact on your Analog side of your business as some of those connectivity products and OMAP brought Analog along for the ride?

Ron Slaymaker

Ross, I mean clearly, we have -- not sure I would agree that they're along for the ride. But we do have good Analog content typically in a system where we're selling OMAP yet. And clearly if we have an applications processor in the system, that gives our sales folks good visibility into that overall system. That being said, those Analog products kind of have to earn their way; each product. Customers aren't going to accept an interior Analog product just because they're using our application processors. So our view is that our Analog products will continue to do fine in the tablet and smartphone applications. And in fact, what I can -- I can also envision the scenario that they could even benefit because I mean think about -- we work with other application processor suppliers on their reference designs to include our Analog products to the extent they don't view us as an application processor competitor, we might find some of those other application processors suppliers more amenable and cooperative on the Analog side. So we'll see that conjecture, but I think we'll do just fine on the Analog side of those systems. Do you have a follow-on, Ross?

Ross Seymore - Deutsche Bank AG, Research Division

Yes, I do. Getting away from OMAP maybe for a second, just talk about the quarter. The mid-quarter, you guys tightened to the midpoint of range on revenues. Any either product line or end market color you can give us about positives and negatives quarter-to-date, please?

Ron Slaymaker

Okay, sure. And let me just make a couple of reminders. As you would probably guess, the fact that we tightened to the middle of the range is generally most areas are tracking consistent with our expectations that we had in October. But just as a reminder, there are a few special considerations in this sequential trend this quarter that a reminder is probably worth a few minutes. First of all, our calculated revenue typically declined by about $100 million in the fourth quarter following the peak third quarter back-to-school season. Second consideration is that we had $60 million in the third quarter of business interruption insurance proceeds that was the final settlement from last year's earthquake in Japan. So that amount will not recur again this quarter. And I think the final point I would make is that in our October call, I explained that our SVA Analog product line would begin to convert over to a consignment inventory program at distribution this quarter, and that really is the result of us getting that SVA business, which again was the former national semiconductor operation converted over to TI's IT system. So with that, we'll be able to move them to the same type of consignment inventory program we have with distributors. That conversion will impact our revenue this quarter. But certainly, distributors are anxious to move over to the program. So with those 3 considerations, I would say the remainder of our semiconductor revenue is generally clustered around a 7% to 8% sequential revenue decline.

From an end markets standpoint, let me just quickly go through those. Computing continues to be weak this quarter. In communications, I would characterize it also as weak. If you look at handsets and tablets, our baseband revenue, we would expect to be seasonally flat, maybe even up a little this quarter, although that will be more than offset by revenue declines in OMAP and connectivity, again, for smartphones and tablets. I guess I don't normally provide a longer-term outlook in this update but given our recent announcement to discontinue our investments for OMAP and connectivity products in the smartphones and tablet areas, let me go ahead and note that we expect this revenue again to decline from about $200 million to be gone by the end of 2013. So just a reminder on that.

In communications infrastructure, particularly wireless base stations, that revenue continues to be weak with spending levels by operators constrained pretty much across the world. So specifically the U.S., Europe and China where there has a historically been -- those regions have historically been drivers there. Consumer, as a result they're somewhat mixed TV sales remain weak as they were last quarter reflecting the overall economy. And we believe actually the emergence of tablets as an alternative viewing device for video is probably having some impact there as well.

Game consoles are doing well and e-books also are doing well for TI. And then finally in industrial I would say overall, demand generally remains weak. Inside of our automotive sales are mixed regionally with the U.S. strong, but both China and Europe weak. Okay, that was a long answer to a quick question, Ross. So thank you for that.

Operator

Next, we'll hear from Stacy Rasgon with Sanford Bernstein.

Stacy A. Rasgon - Sanford C. Bernstein & Co., LLC., Research Division

I was just wondering if you could give us a little bit of color, Ron, on order linearity. I think last -- the earnings call, you said September orders were the low point in Q3. October's kind of flattish. Can you give us some view for how November and December tracking relative both to those points in September, October relative to your expectations?

Ron Slaymaker

Stacy, I don't have feedback for you on linearity but what I will say is just in general, we expect that orders will decline this quarter and they're largely tracking the revenue result trends. So what I mean by that is they're weakest for our other segments due to the seasonal calculated declines and again, that nonrecurrence of the business interruption insurance. They're also weakest for our SVA product line due to the conversion to the distribution consignment program and the impact that it has both on revenue, as well as orders. But I don't have the month-by-month linearity feedback for you. Do you have a follow-on, Stacy?

Stacy A. Rasgon - Sanford C. Bernstein & Co., LLC., Research Division

Yes, I do. That's helpful. I think around -- if I go back to wireless just a second, the chunk that's remaining the embedded OMAP connectivity, it's got $200 million in annual revenue right now. What are your targets for the economics of that business following the completion of your restructuring? Is that going to be making money? Is it going to be breakeven or will be losing money at that level? Do we assume growth in order to make money?

Ron Slaymaker

No. Our expectation is that the loss that you've seen our wireless segment incur over the last few quarters will largely be eliminated by the restructuring action that we have underway. And so that's not assuming growth or anything like that. It's just taking the loss and taking the cost actions and recognizing we're going to lose about $800 million of revenue and therefore, gross profit is associated with that. But the cost savings that we're implementing should largely offset or essentially offset that loss. And so we'll just leave it at that. Okay, Stacy, thank you.

Operator

Moving on, we'll hear from Jim Covello with Goldman Sachs.

James Covello - Goldman Sachs Group Inc., Research Division

Great. Thanks especially for the market commentary by area. In consideration of that, is there an area where you feel more most confident that your under shipping demand and inventories getting drawn down in the channel? And then conversely, are there are still areas where you think you might be over shipping demand?

Ron Slaymaker

Jim, I don't know of any area that we're over shipping demand. I mean there could be some out there, but they're not visible to us. So I would say in general, we're shipping consistent with demand and inventory levels are very low or there still could be some areas that inventories continuing to be reduced. I know one area that -- I don't that I would draw -- underscore anything in terms of what we're seeing this quarter but I know for example in the third quarter, communications infrastructure was an area that we highlighted was experiencing some inventory reduction. Probably another one that I would highlight is distribution this quarter. And I guess I would note that resales from distribution we expected to decline this quarter but at this point, it looks like distributors could also reduce some inventory. And we'll see how the rest of the year plays out. But at this point, we would expect they're going to reduce some inventory. Do you have a follow-on, James?

James Covello - Goldman Sachs Group Inc., Research Division

I do. That was helpful. And then kind of going back to Ross' question about the attach rates of the pull through, as we look at the wind down of the OMAP and connectivity segments in certain areas, when you look back on the history or lessons learned from the baseband wind down, do you did you see any reduction in pull through or attach rates on Analog in those segments? Or did you see pretty steady share in with the customers or the SKUs that you wound down with baseband?

Ron Slaymaker

Jim, I'm not aware that there was any notable shift in our penetration in those customer systems where we have baseband that then, when we got out of the baseband, we saw declines in other product lines. So I would say in the case of baseband, practically no, if any, impact. And we would expect similar with the Analog products and the OMAP connectivity. In fact again, we have -- we do have good Analog content in many of the OMAP systems, but we can also find customer systems that don't use our OMAP product at all where our Analog content was just as high. So again I think for the most part, we would have to say those Analog sockets are won individually and they tie very little directly to the OMAP processor. Okay, Jim, thank you.

Operator

And our next caller is Tore Svanberg of Stifel, Nicolaus.

Tore Svanberg - Stifel, Nicolaus & Co., Inc., Research Division

Could you just give us an update this quarter about any shutdowns that you're planning or just any color at all on your manufacturing?

Ron Slaymaker

Well, I don't -- the shutdowns and idling that occur through the course of the holiday period will vary from factory to factory as it does every year. And that will just depend upon demand, et cetera, for particular products that are manufactured in those factories. So some we certainly will be idling through the course of the holidays as we typically do. And by the way, that's just a means by which we can most cost effectively manage when we have open capacity such as we do. So that's just a means by which we handle lower levels of utilization cost effectively. So we will be doing that through the course of these holidays, but it will vary factory by factory. Okay, Tore, do you have a follow-on?

Tore Svanberg - Stifel, Nicolaus & Co., Inc., Research Division

Yes. Could you also talk a little bit about lead times? If I recall correctly, lead times were fairly short at the beginning of the quarter. Just wondering, have they remained short or any movements at all there?

Ron Slaymaker

Really no movements of significance at all. So I would say lead times overall remain very short with the strong majority continuing to be below 6 weeks for TI. Okay, Tore, thank you.

Operator

And our next caller is Shawn Webster of Macquarie.

Shawn R. Webster - Macquarie Research

Kind of on that thread, do you guys expect utilization rates to come up in either Q1 or Q2? And then for your own -- my follow-up question would be for your own inventories, what's your expectation for them in terms of dollars and days in Q4 and maybe in Q1 if you have a view on that?

Ron Slaymaker

Okay. So maybe you missed, Shawn, this is the fourth quarter mid-quarter update. So I can talk about utilization trends this quarter, which really are consistent with what we expected in October. Utilization will be lower in the fourth quarter compared with third as we reduced new production starts in response to weaker demand. What happens with utilization in first quarter and beyond, I really don't have a lot to comment on at this -- I really have nothing to comment on at this point.

And then in terms of TI's own inventory, I guess I would say in light of our actions to reduce the production levels in our factories that I just described, we would expect that our inventory will decline this quarter. From a day standpoint, it's a little more complex. I would say inventory days, even with the absolute reduction in inventory, you could see days still drift up a little and that's just in consideration that revenue will also decline in the quarter. Shawn, I believe that was your first question -- first 2 questions. Do you have a follow-on?

Shawn R. Webster - Macquarie Research

Yes. In terms of your -- it sounds like your expenses are doing a little bit better. Can you remind us in terms of the OpEx linearity, it normally comes up in Q1 and then partially in Q2, is that the normal linearity? And I'm talking normal, I know you have restructuring going on, which is kind of bringing it down.

Ron Slaymaker

So good point, Shawn. OpEx typically is down in Q4 seasonally, and that really just reflects that more vacation time and holiday time is taken in the fourth quarter compared with the third quarter and then that will reverse itself in the first quarter typically as less holiday and vacation time occurs. And then the other consideration in the first quarter is that the annual pay and benefit increases are implemented in the month of February. So usually from a seasonal standpoint, we see some increase in OpEx in the first quarter as well. Okay, Shawn, and I didn't mean to give you 3 questions there, but I'm glad you appreciate that.

Operator

Our next caller is Chris Caso of Susquehanna Financial Group.

Christopher Caso - Susquehanna Financial Group, LLLP, Research Division

I wonder if you can expand a little bit on some of the comments you made about inventory in the channel. And we also heard from one of your competitors who recently thought that there was some destocking going on. Do you have any metrics that you could share with us in terms of where we are relative to normal levels? And just looking forward, just comment on perhaps the sustainability of the channel inventory at these levels, even taking into account where the levels of demand are right now.

Ron Slaymaker

Okay. So what I would say is if you'd listen to us those past few quarters, we've been running 6.5 weeks or so over the last few quarters. That is a lean inventory level. We've characterize that, that way. That's lean by historic standards and that's lean even comprehending that we are carrying some of what historically was distributor inventory on TI's books as consignment inventory. Okay. So again, a couple things have happened. Inventories are lean, but we've also implemented the consignment program. But even adjusting for that, they were lean. I really don't want to give you any kind of specific projection on the fourth quarter other than we could see a few more days come out of that inventory level. And it's at this point, the data usually is not very predictive of the full quarter. But I would say we, at this point, probably would be expecting to see a few more days of inventory come out of distribution. Is that sustainable? I don't believe so. I think in general, the channel inventories and to the insight we have at customers, I would say we believe inventory levels are lean and therefore, from a risk standpoint, it's probably somewhat asymmetric. They are lean relative in consideration of the weak environment. But if there's any growth that starts to occur again, we would fully expect replenishment to occur both in distribution, as well as at customers that carry their own inventory. So again, the lean inventories that are there reflect economic uncertainty and relatively weak demand currently. But clearly, there will be replenishment if growth is to occur again. Okay, Chris, thank you.

Operator

Our next caller is Romit Shah of Nomura.

Romit J. Shah - Nomura Securities Co. Ltd., Research Division

Just to clarify, did you say your lead times are 4 to 5 weeks right now?

Ron Slaymaker

I said the strong majority of our leads times are 6 weeks or less.

Romit J. Shah - Nomura Securities Co. Ltd., Research Division

So if the channel is carrying about 6 weeks, then I understand that it's lean from a historical perspective, but isn't that sufficient given where your lead times are? What would be the incentive for them to restock?

Ron Slaymaker

Well, it's -- that's a kind of false impression that pulls everybody in. So it's fine if lead times and everything are totally stable. And, Romit, we are from the standpoint of positioning our own inventory and all that and certainly our capacity, we try to keep it positioned such that we will be able to maintain lead times short. But more generally in our industry, short lead times occur in the trough of the cycle or during relatively weak periods. And then when customer demand starts to come back, lead times tend to extend and that causes customer demand to get even more heated as customers then try to replenish inventory. So do I believe more broadly in the industry that current inventory levels and current lead times are sustainable? No way. And we'll see. That's only just based on 30 years of semiconductor industry history that I have. Maybe this time will be different, but I wouldn't bet on it. Okay, Romit, do you have a follow-on?

Romit J. Shah - Nomura Securities Co. Ltd., Research Division

Yes. That's helpful. I was hoping you could just talk specifically about common infrastructure to the big business for you guys. And on one hand, we're hearing about AT&T spending more capital but at the same time, you guys are talking about a reduction in inventory. So maybe just some specifics on what you're seeing from the comm infrastructure space and if you could segment it by geography, that will be helpful.

Ron Slaymaker

I probably don't have a lot to say there other than U.S., Europe, China all being weak, as I said previously. We believe that when I just look at TI's revenue trends this quarter, they're very consistent with what we believe the card shipments are from the equipment providers overall. So I don't -- there could be, as I said, some component inventory reduction but there's not a big distinct difference between what we're seeing with our shipments and what we believe is happening in terms of shipments to the operators currently. So I realize there are operators that have forecast more capital spending, et cetera, but I think that's still likely ahead of us as opposed to anything that's impacting our business this quarter. Okay, Romit, thank you for your questions and, Operator, we have time for one final caller.

Operator

Certainly, and that will come from David Wong of Wells Fargo.

David M. Wong - Wells Fargo Securities, LLC, Research Division

So, Ron, the cost savings that you get from your exit of the Wireless business, as 2013 progresses, do you actually manage to reduce in absolute terms your operating expenses? Or do they keep rising because you have other things you're investing in?

Ron Slaymaker

Oh, you mean for TI?

David M. Wong - Wells Fargo Securities, LLC, Research Division

Yes, for TI as a whole.

Ron Slaymaker

Boy, that -- David, I don't want to try to project that. I mean, they're -- I think you're seeing TI manage our expenses overall pretty tightly and I think you will continue to see that going forward. The $450 million, what I can assure you is that $450 million is not just moving out of our Wireless segment into other parts of TI. These are costs that are leading Texas Instruments. So I think you would -- if you consider how much we're spending in operating expense currently, we probably -- that probably would clearly translate to a net reduction. But again, the only thing we're really forecasting here is what we're doing inside of our Wireless segment and I'll provide you the assurance as those costs are truly leading TI as opposed to just shifting somewhere else inside of TI. Do you have a follow-on, David?

David M. Wong - Wells Fargo Securities, LLC, Research Division

Yes. The connectivity products you're exiting, are they manufactured in-house? And if so, what percentage of manufacturing do these currently represent?

Ron Slaymaker

What I would say is in both of these areas, connectivity and OMAP, most of the production is done through third party foundries. So as we exit these, this will really -- this will not have an impact on capacity utilization. We will not have traded capacity as a result of this action.

Okay. And with that, we will go ahead and wrap up. What I will say is before we end the call, let me remind you there's a replay available on our website. Thank you, and good evening.

Operator

Ladies and gentlemen, that does conclude today's conference. We thank you again for your participation.

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