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Executives

Kevin March – SVP & CFO

Ron Slaymaker – VP, IR

Analysts

Uche Orji - UBS

Tim Luke - Barclays Capital

Ross Seymore - Deutsche Bank

Christopher Danely - JPMorgan

Tristan Gerra - Robert W. Baird

Glen Yeung - Citi

Srini Pajjuri - Calyon Securities

Ed Snyder - Charter Equity Research

Adam Benjamin – Jeffries & Co.

Daniel Berenbaum - Auriga USA

Sumit Dhanda - Banc of America Securities/Merrill Lynch

John Pitzer - Credit Suisse

Doug Freedman - Broadpoint.AmTech

Craig Berger - FBR Capital Markets

David Wu - Global Crown Capital

Texas Instruments Incorporated (TXN) Q3 2009 Earnings Call October 19, 2009 5:30 PM ET

Operator

Welcome to the Texas Instruments third quarter 2009 earnings conference call. At this time, I would like to turn the conference over to Ron Slaymaker. Please go ahead, sir.

Ron Slaymaker

Good afternoon and thank you for joining our third quarter earnings conference call. As usual, Kevin March, TI's CFO, is with me today.

For any of you who missed the release, you can find it on our website at www.ti.com/ir. This call is being 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 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 earnings release published today, as well as TI's most recent SEC filings for a complete description.

Our mid-quarter update to our outlook is scheduled this quarter for December 8th. We expect to narrow or adjust the revenue and earnings guidance ranges as appropriate with this update. In today’s call, we’ll address the drivers behind our continued revenue growth and margin expansion, and discuss what we see ahead on those fronts.

We’ll also discuss the investments the we’re making that will allow us to accelerate our strategy in analog and embedded processing. I’ll start by noting that revenue and earnings for the third quarter exceeded the high end of our range of expectations for the quarter, even after we raised those expectations at the mid-quarter update.

The sharp declines we saw late last year and in the first quarter of this year, have almost been matched by sharp increases in the second and the third quarters. Initially this rebound was driven by normalization of demand as our customers slowed their inventory reduction and our shipments began to increase to their level of production.

This quarter that normalization process has been complimented by production increases at our customers. Overall TI revenue grew 17% sequentially and was down 15% from a year ago. We were especially pleased with the growth in our core areas of analog and embedded processing.

At 20% sequential growth analog was the biggest driver of TI’s growth once again this quarter with all three of its major businesses contributing strongly; high volume analog and logic, or HVAL, power, and high performance analog.

HVAL was again the biggest contributor within analog to this sequential growth with broad based increases. Analog revenue was down 8% from a year ago, a performance that we believe will compare very favorably to most of our analog competitors. Notably, revenue from power management products has now moved above the year ago level.

Driving the growth in power management are share gains and overall strong demand in battery management, gauges and chargers for notebooks and handheld devices. TI’s investments over the past decade in power are paying off as we continue to gain share in what will likely prove to be one of the best secular market stories of the upcoming decade as portability and energy efficiency continue to drive innovation and growth.

Embedded processing grew 12% sequentially due mostly to strength in catalog products. Growth here came from a number of product areas including microcontrollers for consumer applications, as well as industrial applications such as air conditioning systems in Asia.

On the DSC side, we saw growth in video security systems, and high performance audio video receivers. Revenue from embedded processing products for automotive applications also grew including strength in high-end automotive entertainment and information systems.

Embedded processing revenue declined 8% from a year ago. Wireless revenue increased 12% sequentially and declined 26% from a year ago. Baseband revenue of $450 million in the quarter declined to 16% of total TI revenue. Baseband revenue increased 10% sequentially and declined 33% from a year ago.

Excluding baseband, our wireless segment which is focused on Smart Phones grew 18% sequentially and declined 7% from a year ago. Connectivity products paced this growth. In our other segment sequential growth of 20% was driven mostly by a combination of seasonal growth in calculators and strength in DLP [front] projector products.

From a geographical perspective, growth continued to be mostly driven by the Asia Pacific and Japan regions. Although growth in the US and European regions was slower, we are encouraged with the turnaround in those regions. Each grew revenue about 10% sequentially following a four-quarter slide in Europe and a three quarter slide in the US.

We’re careful not to read too much into the geographical data because it mostly represents where our customers are manufacturing products, not in consumption. Now let me make a few comments with respect to our distribution channels.

Resale or sales out of our distribution channel, grew in excess of 20% sequentially and distributors’ inventory of TI products declined again. Resales grew in every region in excess of 10%. Now Kevin will review profitability and our outlook.

Kevin March

Thanks Ron and good afternoon everyone. Higher revenue as well as higher factory utilization contributed to our gross profit increasing by 32% sequentially. Gross margin increased 570 basis points sequentially to 51.4% of revenue. Compared to the year ago quarter, gross margin increased 290 basis points on $507 million lower revenue and slightly higher utilization.

We are pleased with the gross margin performance as it reflects an improving product portfolio of analog and embedded processing along with efficient manufacturing operations. Operating expenses were up slightly from the second quarter but declined $189 million from the year ago level.

Operating expenses were below 25% of revenue in the quarter. Although we will remain disciplined on these expenses in this uncertain environment, we generally have had them at a level that we believe is appropriate for our business model.

Restructuring charges in the third quarter were $10 million, down $75 million sequentially. The distribution of these charges across our segments is included in our earnings release. Operating profit for the quarter was $763 million, more than double the prior quarter’s amount as revenue grew strongly as utilization of our factory assets increased, and as restructuring charges fell.

From the year ago quarter operating profit was up $17 million. While on the surface this was a relatively small improvement, it was much more significant when you consider that revenue was down by over $500 million across that period.

The gain is attributable to our lower operating expenses as well as improvements in gross margin. Operating margin in the quarter was 26.5% of revenue, a 12.5 percentage point gain from the last quarter.

As a result of higher profitability in the second half of 2009, we have increased our annual effective tax rate estimate to 28%, higher then the 27% rate we had previously estimated. The third quarter rate was about 30% as we had to catch up our cumulative tax accruals for the higher annual effective tax rate and also had some discrete tax items in the quarter that had a negative impact.

Net income was $538 million or $0.42 per share. I’ll leave most of the cash flow and balance sheet items for you to review in the release, however let me make just a few comments. Almost all of the higher net income compared with the last quarter fell through to higher cash flow from operations, which exceeded $800 million in the quarter.

This strong cash flow has allowed us to increase our investments in manufacturing capacity, raise our dividend, and repurchase more stock, while still increasing our cash and short-term investment balances.

Capital expenditures increased to $226 million in the quarter. Most of this was spent in assembly and tests to help remove operational bottlenecks that are associated with the significant increases in demand that we are seeing.

We used $251 million in the quarter to repurchase 10.5 million shares of TI common stock, and paid dividends of $138 million in the quarter. We increased cash and short-term investments to $2.83 billion in the quarter.

Our balance sheet continues to be strong and remains a competitive advantage for TI in this environment. Inventory increased $53 million in the quarter while inventory days held even with the prior quarter’s level of 72 days. Inventory days were 81 a year ago.

TI orders in the quarter were $3.11 billion, up 11% sequentially. TI’s book to bill ratio was 1.08 in the quarter.

Turning to our outlook, we expect TI revenue in the range of $2.78 billion to $3.02 billion in the third quarter or negative 3% to positive 5% sequential growth. As a reminder this estimate assumes a seasonal decline in our calculator revenue of about $115 million.

This means that the range of sequential for our semiconductor product revenue would be positive one percent to 10% better then the seasonal average. From a year on year perspective this would be our first positive growth comparison for TI since the first quarter of 2008, with year on year growth expected in a range to 12% to 21%.

We expect earnings per share to be in the range of $0.42 to $0.50 per share. This EPS estimate includes $0.01 per share negative impact resulting from expected restructuring charges. In 2009 we have increased our estimate for capital expenditures to about $800 million.

As we have discussed previously we have purchased equipment from Comonda’s bankruptcy proceedings that we will use to equip our [fav] as the world’s first 300mm [fav]. Although we will need to supplement this purchase with some additional equipment, we believe that a applying advanced manufacturing technology to analog at an attractive cost, will provide TI and opportunity to accelerate our strategy and to extend our leadership position in the analog market.

We are also purchasing additional assembly and test equipment to alleviate the stress that current high demand levels for certain packaged types are placing on our operations and our product lead times.

As is typical when equipment in new fab, there will be a short-term increase in our spending levels after which we expect to return to lower levels again. Our estimates for 2009 R&D and depreciation are unchanged.

In summary, we are encouraged that analog and embedded processing are driving today’s growth and that the strategic investments we are making in R&D, acquisitions, our sales network, and our manufacturing capacity, will continue this momentum for the long-term.

Profit margins, both gross and operating, have recovered quickly at substantially lower levels of revenue giving confidence to our strategic direction and the financial returns that they can generate.

With that we are now ready for your questions.

Question-and-Answer Session

Operator

(Operator Instructions) Your first question comes from the line of Uche Orji - UBS

Uche Orji - UBS

Let me ask you a question about the [inaudible] your bookings, I just wanted to understand the [mid control] base, just the momentum in bookings and essentially what drove that, and within that if you can also comment on connectivity which continues to grow strongly. If you can also explain what’s driving that growth.

Ron Slaymaker

I don’t unfortunately have data for you on kind of month-to-month or week by week booking linearity other then the data we provided you where bookings were strong in the quarter. We had a 1.08 book to bill and certainly as we indicated we have an above seasonal outlook for our business overall.

But beyond that I don’t really have any input. On connectivity I would say it’s a combination of factors. Certainly the fact that Smart Phones and other advanced handsets are having a lot more connection options or features beyond just the cellular connection, these include of course Bluetooth which is highly penetrated in handsets but especially WiFi and GPS functionality where TI has an especially good position as well.

So it’s a combination of the feature set pervading more handsets and TI gaining share within those features. So a combination.

Uche Orji - UBS

My follow-on will be flatly a different question in the sense that I’m asking about your acquired [inaudible] fab, your operating margins for analog are still not where we saw them in 2007 and when your acquired this fab I don’t know [inaudible] rates are, but what do you need to do, how will this help you drive the operating margin for the analog business. Should we expect that to structurally take operating margins higher then the levels we saw them in 2007 and when should we expect this fab to become really operational for you and so kind of walk me through the thinking behind the acquisition of that fab and how you will drive margins.

Kevin March

I’ll go ahead and offer some comments on that, as we’ve announced the equipment that we’re putting into our fab will be 300mm equipment. Up until this point in time our analog products have all been on 200mm wafers. Generally speaking we can expect that probably 30% or better kind of cost efficiencies on that size of wafer.

In addition we were able to acquire the equipment from Comondo out of its bankruptcy proceedings so we got particularly attractive pricing on that equipment which will certainly lower the depreciation burden on each dollar of revenue that generates versus buying new equipment. So one would expect that that will allow us to continue to generate improving profitability over time on our analog revenue.

Of course not to be forgotten is that as analog and embedded processing become increasing portions of our total revenue, that also will contribute to expansion of our overall margins. As to when that factory becomes operational we are in process this quarter of relocating that equipment from the Commode fab into our fab here in the Richardson area, and will begin to bring up a mini line later this year and expect to have that mini line operational by the end of the year, by the end of 2010.

Ron Slaymaker

Let me just also add, your point was our analog operating margins are not maybe at some historical peak but also keep in mind we just increased our analog operating margin by 16.1 percentage points from second quarter. So clearly that was a good step up and good improvement toward those historical margins as well.

Operator

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

Tim Luke - Barclays Capital

Nice job on your quarter, I wanted to ask with respect to your guidance outlook, as you look at the semi business being seasonally somewhat stronger then the normal, up [1% to 10%] should we think about the continuation of that analog and embedded business leading that or might it be some other segment there and as you look at your inventory, its obviously sort of flat in terms of days, should we think about you trying to build a little inventory through the fourth quarter or how should we think about that.

Ron Slaymaker

We don’t as you’re aware, we don’t break our outlook down into individual segments, whether it be analog, imbedded, wireless or other, but clearly where our investments are focused up, where our operating expenses are heavied up you might say in terms of investments, are in analog and imbedded processing.

And I think the best I can tell you over the long-term, you have to assume analog and imbedded processing become a bigger and bigger factor both in terms of our revenue as well as our earnings growth.

Tim Luke - Barclays Capital

On inventory, maybe if you could broaden that into sort of how does that thought on inventory impact, just some of the elements that may contribute to the gross margin outlook. Those are sort of the two elements I was trying to get at.

Kevin March

On the inventory, as you’re familiar with, we don’t typically give a forecast on that. I would just note if you look at what happened this past quarter, we actually did increase our inventory by a little over $50 million or about 5% and yet it remains very lean at 72 days. And so consequently we have found ourselves in a need to go ahead and adjust some of the lead times on a few of our products because of the demand that we’ve had.

That’s driven us to go ahead and acquire some additional assembly test equipment to expand our capability to help us get inventory back to levels that help us meet our customer service indices. We did increase our wafer starts through the quarter and we would expect the loads that we had coming out of the quarter to be continuing through the quarter so that should help us get our inventory better staged to get back to customer service metrics that our customers are coming to expect from us.

Beyond that, we’ll report on what that actual inventory turns out to be when we get to the end of the quarter, that will be a function of course of our outlook for first quarter as well as where our revenue actually lands in fourth quarter.

Ron Slaymaker

And just in terms of impact on gross margin, of course as you would know, if we build inventory certainly it supports higher levels of utilization then if we don’t build that inventory and would be beneficial and then of course the reverse holds, when we’re reducing inventory.

Operator

Your next question comes from the line of Ross Seymore - Deutsche Bank

Ross Seymore - Deutsche Bank

Congrats on a strong quarter, brining the channel inventory down again, you kind of just talked about what you’re trying to do to stage that etc., do you believe that its sustainable at the dollar amount that we are seeing now or is the next step beyond the staging process that you just mentioned actually starting to increase the channel inventory going forward.

Kevin March

Recall that one of the things that’s driving down the channel inventory is the implementation of our consignment programs with our distribution customers. Roughly 25% of that inventory is now in consignment and so we’re keeping that on our books. So of course that just mathematically drives down the overall level of inventory that our customers hold.

But in addition to that they’ve also had very strong growth in their shipments out last quarter as we had strong shipments in but our shipments in obviously were below their shipments out as their inventory continued to decline.

And their inventory decline was probably about half attributable to the fact that we put more of their material on this consignment and about half because they shipped more out then we could ship in. So far, we’re keeping up with their demands and I think we’ll just have to respond to what their needs are and desires are as to how much inventory they want to carry.

We can only ship as much as they want.

Ron Slaymaker

So with the consignment program being called a structural change, it absolutely, that piece of it anyway would be a sustainable change and we would expect distributors to run now and in the future with lower levels of inventory then what they historically did.

Ross Seymore - Deutsche Bank

Just switching gears to the OpEx side of things, I know what you said for the full year for R&D but if I recall right with the restructuring actions you took earlier this year, you talked about total OpEx being down about if I recall around $130 million from 4Q08 to 4Q09, is that still the right bogey as the benefit from your restructuring and if not, what’s changed.

Kevin March

We haven’t changed that. That’s still the right way to think about that.

Operator

Your next question comes from the line of Christopher Danely - JPMorgan

Christopher Danely - JPMorgan

Just a follow-up on the consignment with the, is this almost like you are going to more of a sell through model then a sell in model with your [inaudible] revenue or can you just talk about the differences between the consignment model and the sell through.

Kevin March

Actually that’s a good analogy you’re offering there, to the extent that, traditionally in the past we were on a sell in model, that is when we shipped product to our [inaudible] customers, we recognized the revenue and at some later date they would typically ship that product to their end customers. \

As we move to a consignment model, we are effectively moving that inventory that they’re shipping to those customers to a sell through method, that is they’re going to pull it only when they’ve got a sale at the time they pull it, they’ll recognize the revenue and they’ll ship it to their customer.

And again as I mentioned about 25% conversion has already been completed, that is about 25% of our revenue and inventory that goes to the distribution channel is now on this consignment program. Over the next year or so we expect to continue that conversion and we’ll probably reach about half of that total shipment through that channel somewhere about the end of this year, early next year.

Christopher Danely - JPMorgan

On the lead time extensions and all the back end capacity constraints, do you feel very confident that you will get all of these issues fixed this quarter. Are these basically only on the HVAL product line or is it anything else.

Kevin March

The lead time extensions that we’re seeing are effecting multiple areas of our portfolio, not just the HVAL. So its in various areas across our segments. Its difficult to predict that we’ll necessarily get it all reconciled this quarter. We certainly, part of our step up in capital spending in the third quarter was the acquisition of assembly and test equipment to relieve some bottlenecks on certain package types to help get our through put up.

We will continue to do that this quarter and into the early first half of next year, to extend that capacity particularly in the assembly test sites that we have in the Philippines, new assembly test site we opened the beginning of this year.

I suspect it may take us a couple of quarters to get this fully back in balance but that’s difficult to say based upon what we’re trying to do today and what our customers’ actual outlook is as we get into first and second quarter next year.

Ron Slaymaker

And keep in mind bringing all that into balance is not just, doesn’t just consider our capacity additions, it also considers what happens with demand and what we’ve seen over the last couple of quarters is demand continuing to build faster then we and our customers had forecasted. So we generally understand the capacity side and our ability to bring new capacity on board, but again, as long as we see continued unforecasted increases in demand, that’s a different factor in the equation.

Operator

Your next question comes from the line of Tristan Gerra - Robert W. Baird

Tristan Gerra - Robert W. Baird

Does the trends that you’re showing and the back to school spending suggest consumers are getting back to normal spending patterns or just was it merely stronger then your initial expectation. Any color you could provide on this.

Kevin March

The only area where we could give you color on back to school would be in our calculator business and actually we did see a seasonal up tick in the third quarter in our calculator business. It was probably about flat for total revenues where it booked a year ago and up about $44 million sequentially.

So it kind of reflected a normal back to school pattern if you will. As to the rest of our products, I don’t think we really have enough insight to give you any commentary or color as to whether or not back to school is effecting that demand.

Tristan Gerra - Robert W. Baird

Just in terms of any potential revenue impact over the next few quarters with this migration to consignment, which I would assume could have a slightly negative impact on the revenue trends.

Kevin March

You’re talking the consignment into the distribution channel, yes, clearly as we make that conversion rather then having if you will a snap back due to [disti] demand from shipping into them, because we hold the inventory until they actually ship it to their customers, there’s probably going to be, probably no more then a quarter delay on that proportion of inventory that we wind up holding in consignment versus shipping directly to them.

We’ve already been experiencing that in the past few quarters. We began this process back early to mid last year, but frankly we think it’s the best arrangement to get to given the interest that we have in gaining share at our distribution customers and the interest that the distribution customers have for the metrics they want to measures themselves by.

Ron Slaymaker

And again, that’s a question of timing. It won’t actually impact our revenue with those distribution partners and customers.

Operator

Your next question comes from the line of Glen Yeung - Citi

Glen Yeung - Citi

You mentioned that you’re seeing these lead time extensions, to what extent do you think you’re getting double orders because of that and then how are you able to discount that when you give us a revenue and an order forecast.

Ron Slaymaker

I guess how I would describe it is that we don’t have any evidence of double ordering, but as we all know we wouldn’t really expect to see any evidence either. I guess the way I would characterize is that our management team has been through many cycles in the past. We generally know what to expect and the way we’re working through that is basically to work very closely with our customers, understand what they need when they need it, and then do our best to support it.

So I guess I probably don’t have too much more to say beyond that. In terms of a discounting factor on our outlook, our outlook is our most realistic assessment of what we believe we will be shipping in the next quarter. I would note that if you look in terms of backlog expansion in the third quarter, you’ll see our book to bill as we mentioned already is 1.08.

Our revenue range of expectations probably has shifted down somewhat below that just based on if you look at where the middle of that range would be, but again, we’re just generally working with our customers trying to understand their specific needs and then doing our best to be able to support those needs.

Glen Yeung - Citi

Next question is on gross margin and if you could walk us through specifically the elements of the sequential in the quarter and then maybe help us to understand if, its so strong, if there is some expectation that you need to reset your target gross margins in the long-term.

Kevin March

I’d say that if you look on a sequential basis a sizable portion of that was due to just revenue growth and falling through to the bottom line. We had a little bit of improvement on utilization as well as demand continually increased throughout the quarter. And we also had the benefit of mix going on in there.

If you take a look at analog growing as fast as it has, its becoming a bigger and bigger portion of our total revenue and it does enjoy higher gross margins. So it’s a couple of things driving that. To as far as any adjustments to our goals, again, you’re referring to back in May of 2007, we had established profitability goals for the company, 55% gross margin and 30% operating margin that we expected to achieve sometime in the next few years after that announcement date.

I would say to you we’re not there yet and until we get there, it really isn’t appropriate for us I don’t think to discuss any further thoughts on what those goals should be and we’ll keep aiming for those goals as announced.

Operator

Your next question comes from the line of Srini Pajjuri - Calyon Securities

Srini Pajjuri - Calyon Securities

A follow-up to the previous question on the 300mm ramp here, I’m just curious as you bring that capacity on line, do you have to redo some of your mask sets and if so, what are the implications for R&D side of things and then, and also on an apples to apples basis what kind of cost savings are we talking about once you move to 300mm.

Kevin March

You’re correct on the assumption on mask sets, obviously we’re dealing with a larger wafer here and so we’ll have to make some adjustments. And also these are analog processes that we’re bringing up which take a little bit of tuning to get right. And so we expect that tuning process and that bring up process to occur during calendar year 2010.

We will be as I mentioned earlier in the call, bringing up what we call a mini line initially, by the end of the year. So we don’t expect to be, to have all of that capacity available for full production. That will probably flow over into 2011 unless demand arrives sooner.

As far as R&D is concerned, we intend to migrate existing products, high volume products, as well as new products that are released during that time frame onto those products. So it shouldn’t be much in the way of incremental R&D for that purpose. Its really just going to be some operating costs to bring up the new line as it relates to cutting new masks and so on.

Srini Pajjuri - Calyon Securities

The other segment that has picked up nicely in the last couple of quarters, as we look out to the next few quarters and there are a lot of puts and takes in it, I’m just trying to understand how we should think about the growth process there. Obviously you said DLP is growing, calculators are growing but it also looks like the [risk] business is declining here so I’m trying to understand how we should think about the growth there.

Ron Slaymaker

I think the observations you made are certainly valid. I don’t know that I have a whole lot more to provide in terms of projecting how those various pieces will move going forward. I think in general we believe that the main thing that’s predictable there in terms of, at least that I should call out, is the seasonal pattern in our calculator business.

Beyond that we think DLP now that we’ve, for the most part, shaken out the DLP TV revenue, and what we have there today is DLP front projectors and digital cinema, it probably is stable to growing and then the other pieces will just kind of, will happen as they do.

But for the most part, I think overall if you look at the other segment, we tend to think of that over the longer term as kind of a low single-digit type of growth outlook and again that’s a longer term type of projection not a specific forecast over the next few quarters.

Operator

Your next question comes from the line of Ed Snyder - Charter Equity Research

Ed Snyder - Charter Equity Research

With regard to the wireless if you look at your baseband business, it looks down substantially year over year, leaving most of the other wireless flat which is an improvement, is this mostly due do you think to the economic issues, or do you finally think we’re playing out and getting out of a lot of the handset models that you were supplying some of your biggest customers and then the corollary to that is OMAP, which is in most of the hotter new Smart Phones out and coming out this quarter, should we expect that we see a rebound in wireless based on OMAP. I’m not looking for guidance for next quarter but in general if we’re modeling for TI’s wireless business out into next year, since Smart Phones are becoming a higher part of the mix and OMAP is a big part of those devices, shouldn’t we expect that to start picking up some of your shares, percentage of wireless for a total.

Ron Slaymaker

And the first part of that question, was that specific to basebands.

Ed Snyder - Charter Equity Research

Yes, the baseband issue, your baseband is down, everything else is about flat year over year, is that economic or are you finally seeing yourself kind of fading out of a lot of the handset models that you were supplying over the last—

Ron Slaymaker

I think in terms of baseband, the biggest factor year on year would be a combination of just the overall wireless market, still seeing weakness when compared with a year ago. And then the other factor would be for the most part our baseband 3G position transition out of the Sony Ericson handsets and recall we had a program with previously, with Ericson mobile platforms that we were moving out of but especially with their joint venture with ST, that program is now out of our revenue.

The other factor, I wouldn’t say we were out of most of the models, again we still have $450 million of baseband revenue in the quarter, most of that, not all but most of that is centered up on a single customer and again, our outlook there is unchanged that generally we would expect that by the end of 2012 that revenue will have wound down as that customer brings on additional suppliers and as we’ve now for the most part, stopped investing in that baseband business.

So no change to that. The remainder of our wireless business is as you pointed out focused on Smart Phones both the connectivity side of that business and especially the OMAP side. OMAP did see declines, sequentially, not this quarter but earlier such that we believe that business has bottomed out in first half of this year and really is poised for growth for some period going forward here.

And that really is based on a very strong design in position that we have with a lot of different handset makers for our OMAP 3 product line which will be, at some customers we’re in production, at other customers that production ramp is still to come. But again, OMAP 3 we expect to be a good driver of revenue for our wireless business.

Ed Snyder - Charter Equity Research

The philosophy now and its shared by a number of different and former suppliers of baseband, [inaudible] is another one, that ask processors alone will maybe to hold sockets and actually pull through connectivity. It seems to be playing out but the recession has kind of eclipsed that whole trend. What’s your feeling now. You were seeing your connectivity business pick up, is that tied to a large degree to the success in wins in OMAP or are you seeing connectivity wins without any other socket and handsets and do you think that’s going to grow on its own merits.

Ron Slaymaker

We believe today its growing on its own merits. You asked an interesting version of the question which is the I’ll call it the [task] between connectivity and ap processors. Of course the other question we get is the connection between or the attachment between aps processors and baseband. But we really see all three of those as pretty independent.

Our connectivity revenue as we said previously is really leading growth currently. We expect aps processors to ramp pretty nicely as I said with OMAP 3 and both of those are really independent of baseband just based upon the significant design in positions we have both in connectivity as well as with OMAP 3.

Operator

Your next question comes from the line of Adam Benjamin – Jeffries & Co.

Adam Benjamin – Jeffries & Co.

Just had a question in terms of going into it deeper on the 300mm ramp. Obviously you have those Comondo assets, I’m just curious, in addition to that what CapEx requirements will be needed and then as we think about how you ramp up that fab the time it takes to qualify new products on the 300mm process, with also DMOS 6 dropping off late next year, and in that capacity how we should be thinking about utilization coming down to the 200mm, coming up on the 300mm and how that could impact both the utilization rates and gross margin and is likely the real tailwind is really 2011, maybe even 2012. If you could frame that, that would be helpful.

Kevin March

If I can remember all that, I’ll try to frame it for you. The step up that we have in capital spending for the next couple of quarters especially for this quarter, not only includes the Comondo equipment but also some supplemental equipment that we’ll need to balance that line as we get ready to bring it into the Richardson fab.

So roughly speaking probably half of what we spend this quarter we expect will be for fab related equipment for our fab and then the balance of it will be for the assembly and test sites. As relates to time to qualify, as I had mentioned earlier, we plan to bring up a mini line in 2010 and we expect that to qualify late next year.

Because it’s a mini line I don’t expect it to have a significant impact on utilization of our available capacity any time soon for purposes of utilization. This is a strategic acquisition, not a tactical one and so this is for the longer term growth of the company. And as it relates to gross profit margins we would expect that it will continue to help us with our goals of driving our margins up given the fact that on 300mm wafers, just quite simply the cost per chip will be less to manufacture on those process nodes and so we should be able to enjoy continuing healthy and growing gross margins.

And I think you had a question on DMOS 6, but I’m not sure what it was.

Adam Benjamin – Jeffries & Co.

Well maybe just as a follow-up not to pin you on this but so really we should be thinking about a gross margin tailwind on the 300mm really in 2011, 2012, that would be helpful.

Kevin March

Yes I think as we think about it today given the fact that we’re bringing up a mini line its not going to be enough to really move the needle for us in 2010. So you’re correct to think its more like an 2011, 2012 additional tailwind for us.

I say that notwithstanding if we have a very strong analog growth in 2010, that may cause us to pull those plans forward. But based upon how our plans are right now I think your statement is accurate.

Ron Slaymaker

But I think we also have the potential, I think one of the things you mentioned about DMOS 6 and I’m not sure exactly what was behind it, you were talking about a drop off in DMOS 6 capacity or load, I’m not sure, but the reality is we can load and have begun to load some analog into DMOS 6 as well, so as for example, if wireless has lower demands of DMOS 6, that will be another source of capacity and very cost effective capacity for us to source analog products as well.

Operator

Your next question comes from the line of Daniel Berenbaum - Auriga USA

Daniel Berenbaum - Auriga USA

Maybe just to wrap all these questions on the 300mm fab, break it down simply for me, if we fast forward to a year from now taking into account the 300mm fab, and your revenue is the same, call it $2.9 billion with sort of a similar mix, what would, what effect would the 300mm fab have on gross margin and OpEx and maybe if you could answer that question if we fast forward one year, and then if we fast forward two years.

Kevin March

Are you asking that in the context, it sounds like that if we installed it but we’re not using it, is that the context you’re getting at.

Daniel Berenbaum - Auriga USA

No, if you installed it, I guess the assumption is that you would use it because your mix is shifting more to analog and so you’re effectively doing more production in house, is that a correct assumption.

Kevin March

Yes, and it kind of goes back to what Ron was saying a moment ago, if we saw a scenario like you described on flat revenues but analog is becoming a bigger portion, we of course would use the convertible equipment that we’ve got available in DMOS 6 first to support that because again our plan is just a mini line for qualifying the process in our fab next year.

So I wouldn’t look to it having a, our fab alone having an impact on gross margins in 2010 so much as I would continuing mix change of analog and imbedded processing becoming a bigger portion of our revenue in 2010. That’s going to have a bigger bearing as to how our gross margins will go up.

Ron Slaymaker

But let me also comment versus those scenarios. As Kevin just said we’ll modulate the pace at which we ramp our fab based upon what we see for demand but we’re not rolling out our fab as a means to just lower our analog cost basis.

We’re rolling out our fab to support analog growth and so it is mainly a strategy to allow us to meet our aspirations and goals for the size of our business and the growth rate of our analog business as opposed to just being a cost driver to bring down analog costs.

Now it does have that nice side benefit that goes hand in hand but it is been done for us to grow our analog business.

Daniel Berenbaum - Auriga USA

Maybe to follow-up on that, how much additional revenue generating capacity in analog would be 300mm equipment that you’ve already bought from Comondo, or that you already have available to you from them or from where ever else, what’s the incremental revenue generating capacity.

Ron Slaymaker

Think about it this way, again we’ll talk about this first phase of our fab which will be by the way about 30% of our fab floor space and it will also be about just to give another metric, about 13,000 300mm wafers of production capacity per month. We believe that first phase will support more than $1 billion of additional analog revenue per year for TI. And again that’s the reason we’re making the investment.

Operator

Your next question comes from the line of Sumit Dhanda - Banc of America Securities/Merrill Lynch

Sumit Dhanda - Banc of America Securities/Merrill Lynch

Couple of questions, first on capital spending, its going up a little bit this quarter and you said it might stay elevated for a couple of quarters, following that should we anticipate a significant drop in the number and the reason I ask this is because you’ve talked about CapEx being below depreciation as a tailwind, but this year, they’re reasonably comparable, not quite there. So how should we think about that line item in the context of depreciation going forward.

Kevin March

We as you mentioned there, we will see elevated spending not only in the fourth quarter this year, but during the first half of next year, it drops back down to what we’ll call it a more normal level. If you take a look at the last three years of capital spending for us, it has fluctuated between 5% and 8% of revenue in the last three years.

And I would suggest for purposes of developing a model that you’re trying to do for TI, that that’s a good range to think about over the long-term going forward and we would expect to come back down into that kind of range as we move into second half of next year based upon our current planning and assumptions for 2010 growth.

Also just to put it into perspective the comment on tailwind from depreciation, if you look over the last 12 months, our depreciation has been about 9.5% of our revenue over the last 12 months. At the same time during that last 12 months our CapEx has been about 4% of our revenue during that period.

So we continue to spend CapEx at lower then the depreciation rate and even with this up tick I think that the longer term trend is we’re going to see CapEx again in the 5% to 8% kind of range which means that depreciation rather then running around 9.5% of revenues will begin to run a little bit less then that over time.

Sumit Dhanda - Banc of America Securities/Merrill Lynch

Correct me if I’m wrong, but you have some profit sharing plans that tend to kick in when your full year Op margins hit 20% and from the way you’re guiding it seems like you’ll be around that number, does the fourth quarter outlook incorporate that catch up bump that you might end up seeing if that’s indeed the case.

Kevin March

Yes, in fact it kicks in a bit lower then that and it incrementally goes up. That’s actually, it accrues at profitability ranges between 10% PFO at the low end and 35% PFO at the high end. So its quite a wide range but clearly with our increasing outlook for the year versus how we started the year, we have already in the third quarter increased accruals for compensation purposes related to profit sharing and that higher run rate is now also built into the fourth quarter.

I would just mention that the third quarter means that not only did we increase it, we had a bit of a catch up for the year given our improved outlook and in fourth quarter we’ll continue at that higher rate.

Ron Slaymaker

So its already in the estimate for fourth quarter.

Operator

Your next question comes from the line of John Pitzer - Credit Suisse

John Pitzer - Credit Suisse

Just really quickly when you look at the midpoint of revenue guidance for the December quarter its essentially flat up 1%, I’m just curious when you take into effect sort of mix, pricing, utilization, and what you want to do with your inventories, could we expect to see gross margins continue to grow sequentially on sort of flattish revenue.

Kevin March

Let me just remind you that that flattish sort of revenue has our calculator business going seasonally down in the quarter, that’s about $120 million or so sequentially down in the quarter and so that, the rest of its being offset by continued expectation of some growth in the semiconductor products.

And because of that growth in semiconductor products, that means that we will continue to run wafers through the factories and so our utilization levels will probably be a little bit higher then what we saw in the fourth quarter which of course had a favorable impact on our margins.

Beyond that I won’t give a specific forecast to margin, but you can certainly see the cross currents going on there and the margin should be reasonably healthy in fourth quarter.

John Pitzer - Credit Suisse

Just in your prepared comments you talked about your analog business being down 8% year on year and you thought that would compare favorably, by our estimation its going to be 3 to 500 basis points better then the industry, can you hazard a guess as to how much market share you think you’re poised to gain here and I guess more importantly in what parts of the analog business do you think you’re best positioned, are we starting to see some of the work you’ve done on HVAL come through or is this kind of across the board.

Ron Slaymaker

I will leave to you the math of what did you say, 300 to 500 basis points better and what does that translate into markets there because if I try to do it in my head here today, I’ll embarrass myself, but I can try to address where.

I think a couple of areas that are notable, HVAL as you pointed out we noted that HVAL once again led the sequential growth trends for analog. That’s the second quarter in a row where HVAL has led the overall growth and that’s not to take away what [HPA] and power contributed because both of those areas did very well as well.

But I think most analysts would say that more application specific side of the analog market tends to grow a little bit slower then the overall analog market. So the fact that we’re, our growth has been led by that area probably says that we’re significantly gaining share in the more application specific side of the analog market.

The other area that I would just note is the power side. I think power has just, and this is not a two quarter trend, this is a multi year trend for TI where it actually culminated in us breaking that power product line out and making it a separate business inside of analog.

We have been growing exceptionally well in power and I think we have the nice double impact of the power market itself is growing faster then analog as well. And I think we’re gaining share inside of power. So a good combination.

So again there are probably other areas as well but those would be the two that I would note; power and then also what we’re seeing in high volume analog.

Operator

Your next question comes from the line of Doug Freedman - Broadpoint.AmTech

Doug Freedman - Broadpoint.AmTech

If you could comment on now that you’re seeing such strong growth out of the analog business and imbedded processing are you’re expectations and should ours change for seasonal impact. Then if you could help us understand sort of the overall mix that that product is seeing by more of an end market could be helpful.

Ron Slaymaker

I don’t know that analog and imbedded processing itself would throw on a new seasonal trend for TI but what could impact is that wireless is becoming a smaller part of our mix and I think wireless historically had a pretty specific seasonal pattern especially for growth in the third quarter. So its probably less analog and imbedded having its own seasonal pattern and just more a factor of less exposure to wireless and baseband specifically and the impact that that would have.

Kevin March

I think you said it well, the only nuance that might be inside there and I doubt that it would really move the needle at the top is that the high volume analog and logic does tend to concentrate in certain end [inaudible] and so you might see some seasonal variance in there for example in storage products as PC cycle adjusts or in printers or even in the automotive side, but I’m not sure that it would move the needle at the top that much.

Doug Freedman - Broadpoint.AmTech

If I could move on and retouch on the target model question that was asked earlier how should we think about you trying to balance say market share gains with, versus the possibility when you get there of needing to move the target model. Is it something that you’ve given any thought to yet.

Kevin March

Its something that we have certainly discussed but its not anything that we’re willing or prepared to discuss in a public manner just yet because clearly there is a trade off there. I would say though that we view it as being very important that we step up our top line growth and so certainly that has to be balanced with any objectives that we might also set for overall profitability and make the proper trade off.

But certainly top line growth is becoming increasingly important as we are getting much closer to reaching our model GPM and operating profit levels.

Ron Slaymaker

And nor do we believe top line growth is mutually exclusive with expanding margins. I think if you just look at our performance over the last couple of quarters whereas we’ve layered on a lot of revenue growth you’ve seen a very significant margin expansion. That matters a lot to us and so again, those aren’t mutually exclusive.

Then the other thing I would just lay on is we’re growing in the right areas. Analog and imbedded processing are both well above the corporate average margins anyway so as we grow in those areas we probably have to worry less about the refinement of where we’re seeing growth inside of those spaces and more just focus on broadening the growth in analog and imbedded processing and realizing that if we grow in the right areas, that growth will do good things for TI’s gross margin.

It will do good things for our operating margin as well.

Operator

Your next question comes from the line of Craig Berger - FBR Capital Markets

Craig Berger - FBR Capital Markets

Great job on the results, do you have any concerns that inventories building downstream not at your distributors but beyond that at ODM’s or OEM’s and can you talk about maybe the timing of peak builds this year versus prior years.

Kevin March

I would say, we talked earlier about certainly our distribution channel being down about 5% quarter over quarter and I would remind you that we ship about 30% of our revenue through distribution so certainly that appears to be quite lean.

We have a significant portion of our revenue that sells via consignment to large OEM’s and based upon what we can see at their pull rates and so on, I would characterize their inventories as also being well managed. In other words, it doesn’t appear to be accumulated in their warehouses.

As it relates non-consignment OEM’s or contract manufacturers, we really have to wait until the public data by those companies gets reported before we can comment on them. But certainly the channels were more than half of our revenue pass through, the inventories appear to be well managed and if not, in some cases, relatively lean.

Ron Slaymaker

And again, this is as I said before, this is a time especially when lead times are extended somewhat where we really have to work closely with those customers and understand their requirements. And I think they understand that the stress, the entire supply chain, is going through. I really believe we’re getting pretty clear insight into kind of what their bottom line needs are so to the best we can tell, we’re not seeing where there’s bubbles of inventory building.

Again they’re ramping production, and there’s likely some finished goods being built in anticipation of the upcoming holiday season but that’s very normal for this time of the year as well.

Craig Berger - FBR Capital Markets

Any initial thoughts on Q1, should we think typically season and what’s typical for Q1 seasonality.

Ron Slaymaker

I can answer the second part of that in terms of what’s typical for Q1 seasonality, for TI it would be that this is again an average number, our last five years, we would be down 3% and that’s pretty consistent both the calculator business is generally flattish Q4 to Q1 as well as the semiconductor would follow that overall trend.

So in terms of this Q1 specifically, I don’t have anything to provide you in terms of outlook or guidance at this point.

Operator

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

David Wu - Global Crown Capital

Can you quantify the lead times now for your analog business and the power management and the high performance analog. And then I have a follow-up, really the wireless baseband, I’m amazed that this is supposed to decline all year and actually you had a sequential increase in Q3, does it ever go down, the baseband business.

Ron Slaymaker

Let me try to address both those, I don’t have a breakout for you on lead times by product area. What I can say is that given the rapid and unforecasted increase in our customer demand for analog and frankly a lot of other product lines, our supply is constrained in some areas. I think as I said before our factories have done an absolute outstanding job in terms of the rate at which they have responded and ramped our production, again compared to those initial plans that we had coming into third quarter or even when we came into second quarter.

That being said, our customer service metrics aren’t where we want them including lead times and we’re working very hard to address that. But I don’t have anything more specific for you.

On the baseband trends and you noted that basebands grew sequentially, we’ve given kind of the best overall just call it general planning number that we can provide which is that the baseband revenue generally will decline and decline call it linearly between now and the end of 2012.

It will be lumpy. There will be quarters where we are below that trend. There will be other quarters where we’re above that trend so I don’t want to try to pretend there’s too much precision in that. Some of the factors that are behind the rate of that decline will include things like the mix of 2G and Smart Phones or, the general high end or low end handsets.

It will include how the overall market does. It will include how our customers specifically do in the marketplace and then finally it will include our competitors’ execution in bringing on those alternative baseband products for our customers to move into production.

And so you can go, try to have various reads on each of those factors but it is what it is and the fact that we saw that sequential growth this quarter that has good cash flow contributions associated with it and we appreciate it.

Again I don’t have any revised guidance other then what we had previously told you.

Thank all of you for joining us. A replay of this call is available on our website. Good evening.

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Source: Texas Instruments Incorporated Q3 2009 Earnings Call Transcript
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