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Texas Instruments Incorporated (NASDAQ:TXN)

Q4 2008 Financial Update Call

December 8, 2008 5:30 pm ET

Executives

Ronald Slaymaker – VP, Manager IR

Analysts

Srini Pajjuri – Merrill Lynch

Chris Danely – JPMorgan

Glen Yeung – Citigroup

Steve Smigie – Raymond James

Jim Covello - Goldman Sachs

Tim Luke – Barclays Capital

Doug Freedman – American Technology Research

Uche Orji – UBS

David Wu - Global Crown Capital

Cody Acree – Stifel Nicolaus

Operator

Good afternoon and welcome everyone to the Texas Instruments’ fourth quarter 2008 mid-quarter update conference call. (Operator Instructions) Mr. Slaymaker, you may begin your conference.

Ronald Slaymaker

Good afternoon and thank you for joining Texas Instruments’ fourth quarter mid-quarter financial update. In a moment I will provide a short summary of TI’s current expectations for the quarter, updating the revenue and EPS estimate ranges for the company.

In general I will not provide detailed information on revenue trends by products 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.

After today’s call we will not be available for further discussion 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 www.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 include risk factors 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 complete description.

We have lowered our expected ranges for TI’s revenue and EPS reflecting a significant broad based deterioration in demand from our customers as the quarter has progressed. We now expect TI revenue between $2.30 billion and $2.50 billion.

We expect earnings per share between $0.10 and $0.16. You will note that we have not narrowed these ranges as we usually do at this point in the quarter. This is the result of a high amount of uncertainty that continues to exist in the environment.

We are not standing idly by as conditions worsen. We continue to aggressively reduce inventory even in the face of weaker then expected demand. We are reducing our own inventory and working with our distributors to reduce channel inventory.

This means factory utilization levels will also be lower then we had previously expected and therefore profitability will be lower then we had expected. But we will be well served by keeping a tight rein on inventory levels in this environment.

Average factory utilization this quarter is now expected to be in the mid-40s, compared with the mid-60s in the third quarter. The last time utilization was at this level, was in the second half of 2001. Gross margins were about 22% during that period; 15 to 20 points below where we expect them to be this quarter.

The difference illustrates the progress we’ve made in reducing the company’s capital intensity and improving the quality of our product portfolio. We are driving cost actions on multiple fronts under the assumption that this is a significant downturn that will last for a while.

We described in October that we believe this downturn would be serious and fortunately we’ve been able to get ahead of it with actions to reduce costs. For example, in addition to the specific wireless actions we announced in October that should reduce annualized expenses by more then $200 million by the middle of next year, today we announced a voluntary retirement program for TI employees.

Since participation in this program is voluntary I cannot provide you an estimate of the associated costs savings, although we should have these numbers for you in January. Similarly we expect that there will be costs associated with the program this quarter that are not included in our EPS guidance.

In addition we are temporarily idling many of our factories in late December and early in the first quarter to minimize the impact of under-loadings. We have suspended essentially all hiring. We have also very tight restraints on capital spending, travel, and discretionary expenses, and we will continue to evaluate other cost actions as we believe appropriate.

These actions should begin to result in reductions in cost of revenue and operating expenses in the current quarter although we expect more significant impact as we move through 2009.

We are taking these actions in the context of our priorities and our understanding that analog and imbedded processing will be the most important growth drivers for TI in the years ahead.

One final comment before we move to Q&A, given our current estimates for revenue and associated profits, we should have a negative tax accrual this quarter. This includes a benefit of approximately $65 million associated with the reinstatement of the Federal Research tax credit that was signed into law this quarter and made retroactive to the beginning of the year as we discussed in October.

Our estimate for the full year 2008 effective tax rate remains about 28%.

We are now ready for questions.

Question-and-Answer Session

Operator

(Operator Instructions) Your first question comes from the line of Srini Pajjuri – Merrill Lynch

Srini Pajjuri – Merrill Lynch

You said that utilization will go to about 40% levels, do you expect that to bottom this quarter, or is it going to be in the next couple of quarters?

Ronald Slaymaker

What I said was we expect it to average in the mid-40s this quarter and based upon on current operating plan, the mid-40s is an average number. It has come down as we progress through the quarter. Based on our current level of loadings and our current operating plan for the first quarter, we would expect that our utilization level, or our current production levels would remain about consistent through first quarter but again that doesn’t comprehend that late this quarter as well as into early first quarter we will be doing idlings of our factories as well.

Based upon the operating plan of record that we have in place today, we would expect loadings or utilization level to remain about where it is currently. And again the mid-40s is an average level if progressed downward through the quarter so that would say first quarter average would be a little bit below where we were on average in fourth quarter.

Operator

Your next question comes from the line of Chris Danely – JPMorgan

Chris Danely – JPMorgan

So it sounds like you are cranking up the cost cutting a little bit so in other words can we expect your OpEx to trend down in Q1 and Q2 next year, or is that too far to look out?

Ronald Slaymaker

What we’ve said is we would expect OpEx to be down Q4 versus Q3 and then those cost reductions to continue to gain in magnitude through 2009. I don’t know that that would exactly be every quarter a sequential decrease but in general we would expect the cost actions to continue to gain momentum through next year.

Chris Danely – JPMorgan

So given the current environment is fairly challenging to say the least, are you looking at getting a little bit more aggressive on pricing and picking up a little market share here at the bottom so it helps you more whenever things recover?

Ronald Slaymaker

For most of the product lines that we sell, price action would have practically no near-term impact on our demand. Pricing usually is a factor at the point of design end for our product lines and by the time those products literally move into production and begin shipments its probably 18 months maybe even two years in many cases.

So a price move now generally would translate to revenue impact two years out and who knows what that environment is like. So again, we do not use pricing and the 95% of our product areas that would be considered proprietary as a means to drive demand.

Now certainly in the less then 5% of our revenue that would be considered commodity what you’re describing is in fact the case where not necessarily we move pricing to gain share to try to drive volume, but in fact pricing does move with that near-term environment in that small part of our revenue.

Operator

Your next question comes from the line of Glen Yeung – Citigroup

Glen Yeung – Citigroup

Just to clarify based on your comments are you suggesting that fourth quarter gross margins will be between 37% and 42%?

Ronald Slaymaker

I think that’s a reasonable assessment. Yes, I think what you’re deriving that from is when I said back in—yes we talked 22% and that would be 15 to 20 beyond, below where we are this quarter, so yes, somewhere in that range is about correct.

Glen Yeung – Citigroup

Do you think that you’re running below assumptions levels today and if the answer is yes, do you have any sense as to when you think customer inventories may be down to a level where you can balance those two things out.

Ronald Slaymaker

We do believe that we are shipping below in-demand or in-consumption levels today. However I can’t—the issue is that in-consumption is continuing to fall as well so if you’re trying to get into when does the inventory depletion complete and potentially get into a snap back in terms of our own shipments or revenues, the issue is what will happen within demand and where will that land or where will it settle out once the inventory depletion is completed.

So all I can really say is that even though at this point our visibility in the first quarter is very limited, we don’t see that type of snap back on the near-term horizon anyway so again we don’t have clear visibility to when customers finish inventory.

I would say though that when it comes to first quarter and kind of the way that outlook would be, I would say that we’re not anticipating an overall recovery in that time period and in fact, conditions likely get worse before they get better. So at least for what its worth our current operating plan is assuming that first quarter revenue won’t decline as much as it will this quarter as kind of what you’re describing takes place.

Basically some of the inventory effect will be lesser in first quarter then it is in fourth quarter but nonetheless we do expect a significant sequential decline again in the first quarter.

Operator

Your next question comes from the line of Steve Smigie – Raymond James

Steve Smigie – Raymond James

In terms of the change in EPS guidance I was wondering if you could talk about how much of that is driven by drop in operations versus say one-time charges you might be taking in the quarter for restructuring activities, etc.

Ronald Slaymaker

It is driven by the change in operations so it does comprehend—I think last quarter we talked about a penny of impact associated with wireless restructuring that we announced in October, but there is no new restructuring activity that is in that EPS estimate. This is driven by the lower revenue level as well as the lower margins associated with lower factory utilization.

Steve Smigie – Raymond James

On lead times, what that looks like now, and in a snap back when that comes, how is that going to progress, is it obviously distributors take inventory down now and a drop in demand but at some point if you’re under shipping demand now obviously there will be some quick turn up but how would that pattern orders and stuff come or start to look like to you when that starts recovering?

Ronald Slaymaker

I would say lead times certainly are short pretty much in most product areas so in general product availability is not an issue. We welcome that snap back in demand but again we don’t see it in the near-term horizon. But based upon where the operations are today, again I would just say product availability is not an issue pretty much across the board.

Operator

Your next question comes from the line of Jim Covello - Goldman Sachs

Jim Covello - Goldman Sachs

Just on the wireless handset front, any update on the divestiture of the merchant wireless business?

Ronald Slaymaker

I don’t really have a progress update for you on the sale of that at all. So just kind of stay tuned but nothing different in terms of where I have to say now versus what we said in October.

Jim Covello - Goldman Sachs

On the competitive environment not so much pricing, but just general competitive environment in the high performance analog and micro controller space, anything different that you sense out there in this downturn versus prior downturns or how you feel about TI’s positioning in both those markets?

Ronald Slaymaker

I think we feel good about our positioning. The issue is just one of in-demand is rapidly drying up and I think what you hear us describe is a situation where in-demand is going down but its also being amplified in terms of its effect on our revenue because there’s also a significant inventory reduction that’s underway as well.

So for example, we’re working with our distributors to ship significantly less product into their channel versus what they’re shipping out of their channel to their customers. So our strategy even as you saw last quarter is to stay ahead of this falling demand to minimize inventory excesses in our channels.

You’ll recall last quarter we reduced our inventory at distributors by about $35 million, this quarter we expect our reduction in the distributor channels to be more then twice that amount. So re-sales for example we would expect to be down about 20% this quarter but we expect our shipments into the distributors to be down significantly more then that as we reduce inventories.

That’s just the distribution channel. OEM customers are also reducing inventory with the end results being that the impact on our revenue of weaker in-demand again will be amplified for some period of time due to the accompanying inventory reductions.

But that I would describe as we are doing some things very proactively to make sure we stay well positioned, we stay lean with our distributors, at the same time ship probably a higher percentage of the amount of supply chain inventory at TI where we think there’s more flexibility in that inventory. So we want to be able to respond quickly when demand returns but at the same time we want to be insightful as to where this inventory is, how much is there, and also how we manage it.

But again we think our position in both of those product lines both analog as well as in better processing is probably as strong as its ever been, its just a matter of we’re facing some pretty high level macro issues right now.

Operator

Your next question comes from the line of Tim Luke – Barclays Capital

Tim Luke – Barclays Capital

With respect to the calendar first quarter it sounds like you’re implying that you would expect a somewhat below seasonal first quarter off this lower fourth quarter base, and separately in outlining the weakness its obviously broad based but is it fair to say that you’re seeing it more in the high volume segment of analog or the imbedded versus high performance analog. Any color there would be helpful.

Ronald Slaymaker

No, I would not say that. I think what I would say is that overall wireless as I think I said before, wireless is leading the decline both compared against normal seasonality as well as against what our initial expectations were back in October. But I would also say that all major product areas are weaker then we had expected back in October and I think just from the numbers I gave where again distributor re-sales are expected to be down about 20% and our sales into that channel down significantly more then that, that says it also is impacting the catalogue product areas in addition to the high volume areas, so again across the board.

Tim Luke – Barclays Capital

With respect to expectations on first quarter seasonality and maybe as part of that how you would expect gross margin to be impacted by the seasonally lower first quarter potentially.

Ronald Slaymaker

If you just look at last five-year average just to define seasonality, our semiconductor revenue typically dips about 4% from the fourth quarter, but again that’s just a seasonal number. I think I’ll just repeat what I said before, we expect revenue to decline significantly in the first quarter although probably not as sharply as what we are seeing in the fourth quarter.

So that puts some boundary conditions on it but I really don’t have more to offer then that at this point.

Operator

Your next question is a follow-up from the line of Srini Pajjuri – Merrill Lynch

Srini Pajjuri – Merrill Lynch

If I look at your inventory days, I guess last quarter it was about 90 days and I went back and looked at your 2001, [inaudible] at 50 days. I’m just wondering why you need to keep, I understand its going to come down this quarter but is it going to come down all the way to 50 or 60 days or is it going to be at 70, 80 days?

Ronald Slaymaker

I think if you—let me just ask that we’re careful on the day comparison because we are going to reduce inventory significantly this quarter and I think even what we had talked about and if you go back to our comments in the fourth quarter was we expected at that time something on the order of $150 million reduction.

Let me just say with demand down significantly more so then what we had expected, that inventory reduction becomes more challenging but as you’ve also seen with the utilization numbers is demand has fallen below our expectations. We’ve responded with significant cuts in our production loading.

What I would say is even as we cut production loadings, there’s also delay between when the loadings are reduced and when this impacts inventory. So again we will have a significant reduction in inventory dollars this quarter.

The one point I wanted to make though is that even with that reduction in dollars you’ll probably see inventory days for TI move up somewhat this quarter just because the revenue with the kind of numbers we’ve just provided you, the revenue decline expectations are more then what we expect as a percent of decline on the inventory numbers.

So we’re going to bring down inventory dollars significantly but in the near-term inventory days could move up somewhat.

Operator

Your next question comes from the line of Doug Freedman – American Technology Research

Doug Freedman – American Technology Research

Can you talk a little bit about what you’re seeing in this adjustment period versus what we saw in the dot com period and whether TI is holding customers to the typical sales terms or are we trying to get this sort of correction behind us a little faster, the inventory adjustment period meaning are you holding—you have a lot of customers that are on just in time delivery so I believe your revenue number probably corrects to the demand level a bit quicker then maybe some of your competitors.

Ronald Slaymaker

Yes, in fact I think the other consideration I would say just in general, there’s been a long-term trend toward inventory moving probably upstream in the supply chain meaning we’re holding more of the supply chain inventory and as you pointed out the just in time customers are good example.

Further down in the supply chain there’s less inventory as a percentage of the total. The good thing about that is it does allow us better visibility into how much inventory is out there and therefore better management of that inventory. But at the same time this is a much different downturn in many ways then what we saw back in 2001. That was pretty much an inventory driven downturn, so its just a question of once we and our customers worked all through the inventory excesses that defined the bottom.

In this case it is a demand driven downturn and as demand goes down yes, everybody is reducing inventory to appropriate levels to support that demand but this downturn was not initiated at least as applied to TI by excess amounts of inventory at our customers or in the channel. It is a demand driven downturn.

So in some ways similar and in some ways very different.

Doug Freedman – American Technology Research

If you could just offer a little bit more color maybe on the mix impact to the margins and how you expect that to play out on a longer-term basis possibly.

Ronald Slaymaker

I don’t really have mix type of data to provide you at this time, but I’ll just go back to my comments I made earlier, this is a very broad based decline and so in terms of the expectations we have as well as just the absolute numbers, all major product lines are down, all major product lines are down more then we had expected in October and so therefore I wouldn’t say—mix is a very small piece of this.

It is much more driven by demand being below expectations and then what we need to do in terms of utilization to be able to adjust for that lower demand.

Operator

Your next question comes from the line of Uche Orji – UBS

Uche Orji – UBS

Regarding your outsourcing, how much of your products now you are outsourcing to your partners and how much are you pulling back into your own process, just for me to understand the [inaudible] guidance.

Ronald Slaymaker

I don’t have especially kind of a mid quarter update on that for you. Historically almost all of our analog products are sourced inside TI. The advanced logic products which include products like wireless we’ve historically run probably over the last six quarters or so, kind of a 50/50 mix between what was done inside TI and what was down outside at foundries.

Currently a much higher percentage of that production is done inside TI as that the entire strategy of usage of foundries, basically as demand goes down we will ship more of that production inside TI, maintain higher levels of utilization of our factories.

So again, historically its run 50/50 on advance logic, its higher then that currently.

Uche Orji – UBS

What is your approach to your use of cash right now, are you still buying back stock, or has the company decided to move more into cash conservation mode and slowdown the rates of buyback?

Ronald Slaymaker

We have a strong cash position, you seen that cash position move up somewhat over the last couple of quarters even. At the same time we have in fact repurchased shares this quarter and I would just say as usual, we’ll report the specifics of those share repurchases in January.

Operator

Your next question comes from the line of David Wu - Global Crown Capital

David Wu - Global Crown Capital

In terms of the utilization rate of roughly 45% for fourth quarter how would you characterize your high volume digital fabs versus your eight-inch analog fabs?

Ronald Slaymaker

I don’t have a breakout between the two, I would say the advanced logic fabs run a higher utilization level because we have the foundries there as buffer, but other then that as a general statement I don’t have specific utilizations to share between the different product types.

David Wu - Global Crown Capital

If we have a recovery some time in a magical 2009 calendar year and its broad, I was just wondering where would you get the most leverage on the gross margin front, from recovering analog fab utilization rate or the uping of the digital fab utilization rate?

Ronald Slaymaker

Well as we fill up the digital fabs because there’s a bigger capital expense or depreciation level associated with those on a unit per unit basis will get more bang for filling up the digital fabs the rest of the way.

But that being said, as I commented before, the analog fabs are more under utilized then the digital fabs so there’s more to go there. The net or total benefit and how it compares between the two I don’t know.

The other consideration is assembly test. Assembly test is another part of our production operating environment that has depreciation associated with it and therefore fixed costs and its another consideration that as we get more units flowing through the assembly test and that also helps with gross profit and again that doesn’t really matter whether its digital or analog, any kind of product there helps.

Operator

Your final question comes from the line of Cody Acree – Stifel Nicolaus

Cody Acree – Stifel Nicolaus

Assuming your days of inventory in the channel is relatively low and that may be an assumption given some of the order trends I guess, what level and how much visibility are you, what’s driving your visibility that Q1 is going to be down significantly if that days of inventory level is so low?

Ronald Slaymaker

Let me just say the same thing there that I said with respect to our own days of inventory, we expect a significant inventory reduction at distributors but when you look at it from a days perspective, we could actually see an increase in days of inventory because their own re-sales are dropping by 20%.

So all things being equal with re-sales going down 20% we would need to achieve on the order of a 20% reduction in inventory levels in the channel just to be able to maintain consistent days with where we were at the end of the last quarter.

We actually could, even with a significant decrease in inventory levels whether its at TI or at our channels we could actually see days of inventory drift up somewhat. So we don’t expect that this inventory reduction is all wrapped up and complete here by the end of the year.

Cody Acree – Stifel Nicolaus

On those distributors, what’s your view of the health of those distributors and is there much of an impact on what you’re seeing today as maybe some of those distributors struggle?

Ronald Slaymaker

I will say that in general we believe our distributor network is strong. We generally are dealing with large distributors but that being said, at the same time, we watch whether it’s the distributors or whether its our customers, we watch them closely. We watch the payment of their receivables closely and our approach is very simple, if we don’t get paid or if we’re not getting paid on time, from those players, we don’t ship more product.

So we are not going to start letting our liabilities there creep out in terms of payment and the financial status of those various players. We keep it tight, we keep a tight watch on it and at the same time let me go back and say we believe our distributor network is probably as strong as they come just by nature of the players that we’re dealing with.

Before we end the call, let me remind you that the replay is available on our website. Thank you and good evening.

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