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Texas Instruments Incorporated (NASDAQ:TXN)

Q4 2009 Earnings Call

January 25, 2010 5:30 pm ET

Executives

Ron Slaymaker – Vice President Investor Relations

Kevin P. March – Chief Financial Officer & Senior Vice President

Analysts

Uchi Orji – UBS

John Pitzer – Credit Suisse

Tristan Gerra – Robert W. Baird & Co.

David Wu – GC Research, LTD.

Edward Snyder – Charter Equity Research

[John Harbor] – Calyon Securities

David Wong – Wells Fargo

Ross Seymore – Deutsche Bank Securities

James Covello – Goldman Sachs

Stacey Rasgon – Sanford Bernstein

Srini Pajjuri – Calyon Securities (NYSE:USA), Inc.

Craig Berger – FBR Capital Markets

Doug Freedman – Broadpoint AmTech

Leonard Young – Citi

Christopher Danley – JP Morgan

Operator

Welcome to Texas Instruments fourth quarter and 2009 earnings call. Just a reminder, this call is being recorded. At this time I’d like to turn the call over to Mr. Ron Slaymaker.

Ron Slaymaker

Thank you for joining our fourth quarter and year 2009 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 March 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 growth, what’s driving it and is it sustainable. We’ll also address inventory and provide our perspective on where they stand today in the supply chain. Finally, we’ll discuss actions that we’re taking today to support continued growth in the future. Revenue in the fourth quarter was near the high end of our range of expectations. Earnings exceeded the top end of our range of expectations.

Sequential growth began in the second quarter of 2009 as our shipments normalized to customers’ production levels following a sharp inventory correction. We believe growth is not being fueled by standing production at our customers. Inventories through TI’s and our customers’ supply chains are lean and growing end demand is stressing the entire supply chain.

Let’s start with breaking down the fourth quarter revenue trends. Overall revenue was up 4% sequentially or 21% from a year ago. Sequentially our calculator revenue seasonally declined by $116 million. Our semiconductor revenue therefore grew about 9% sequentially. Our analog, embedded processing and wireless segments all contributed to sequential growth while the other segments declined due to the lower calculator revenue.

Analog revenue grew 9% sequentially and was up 27% from the year ago quarter. Again this quarter we had good contributions by all three of our major analog product areas to this growth. I described last quarter our high expectations for the long term opportunity that we have in the power management area of analog. Power was the fastest growing part of analog for TI this quarter as we penetrated new opportunities and gained share. Specifically, growth was strong in power supplies for computing applications, an area where our shares is rapidly expanding in a strong market.

We also had strength in displays specifically LCD TVs as higher frame rates, LED backlighting and power efficiency become more important. As we saw strength in notebooks and Smartphones and for TI these are products such as white LED drivers and battery gagers. In HVAL, automotive was the fastest growing area sequentially and in HPA low power wireless products were the fastest growing.

Embedded processing revenue grew 5% sequentially and was up 21% from a year ago. Catalog products were the bigger driver of this growth followed by automotive. Embedded processing should continue to benefit as the industrial markets strengthen. Wireless revenue grew 8% sequentially and 13% from a year ago. [Inaudible] revenue of $465 million grew 3% sequentially and was even with a year ago. Most of the wireless growth was driven by application processors and conductivity products. These products collectively grew 19% sequentially and grew 46% from a year ago.

Other revenue declined by 9% sequentially due to the seasonal decline in calculator revenue and grew by 17% compared with a year ago. [DLP] was the biggest factor in this growth and more than offset a significant decline in risk micro processors from a year ago. From a geographically perspective, while sequential growth was fastest in the US and European markets, all regions grew. Compared with a year ago all regions were up except for the US market.

Turning to distribution resales or sales out of our distribution channel increased sequentially in the quarter as well as from a year ago. Distributor inventory was about even in the quarter and remains lean compared with historical metrics. Now, Kevin will review profitability and our outlook.

Kevin P. March

Our gross profit continued to expand this quarter as revenue grew and utilization increased. Gross margin increased 150 basis points sequentially to 52.9% of revenue compared with the year ago quarter gross margin increased 890 basis points. Operating expenses were down slightly from the third quarter and declined $90 million from the year ago level. Operating expenses were 23% of revenue in the quarter, well within our planned operating model.

Restructuring charges in the fourth quarter were $12 million, about the same as the third quarter and down $242 million from a year ago. The distribution of these charges across our segments is included in our earnings release. Operating profit for the quarter was $875 million, 15% higher than the third quarter mostly due to higher gross profit. From the year ago quarter operating profit was up $824 million primarily due to higher gross profit as well as lower restructuring charges.

Operating margin in the quarter was 29.1% of revenue. The last time we approached this level of profitability was the fourth quarter of 2007 when TI’s operating margin was 28% of revenue. It is noteworthy that revenue is 18% higher in that quarter. Today’s improved performance reflects the potential of our business model that is now focused on analog and embedded processes. We expect the benefits of this strategy to continue to accrue to TI and our shareholders in the years ahead.

Net income in the fourth quarter was $665 million or $0.52 per share. Net income includes $16 million of benefits from discreet tax items. 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. All of the higher net income compared with last quarter fell through to higher cash flow from operations which was $1 billion in the quarter. This strong cash flow allowed us to increase our investments in manufacturing capacity, pay a higher dividend and repurchase more stock all while increasing our cash and short term investment balances.

Capital expenditures increased to $436 million in the quarter. This included our purchase of the Qimonda fab equipment as well as continued elevated expenditures to expand our assembly and test capacity. As we’ve discussed before the Qimonda equipment is going in to our 300 millimeter analog factory called RFAB. We have the initial pilot line in place today and have begun to process initial wafers. We’re on track to achieve full production qualification before the end of the year.

We use $351 million in the quarter to repurchase 14.8 million shares of TI common stock and paid dividends of $149 million in the quarter. We increased cash and short term investments to $2.92 billion in the quarter. Our balance sheet continues to be strong and remains a competitive advantage to TI in this environment.

We were able to increase inventory by $86 million in the quarter, almost all in finished goods resulting in inventory days increasing to 76. This will allow us to continue to improve our customer service performance levels. Our delivery performance has been improving since mid November. Even so, our inventory remains lean in this strong demand environment.

TI orders in the quarter were $3.26 billion, up 5% sequentially. TI’s book-to-bill ratio was 1.08 in the quarter, the same as last quarter. Turning to our outlook, we expect TI revenue in the range of $2.95 billion to $3.19 billion in the first quarter or -2% to 6% sequential growth. This compares favorably with our more typically seasonal decline of about 5% in the first quarter. We expect earnings per share to be in a range of $0.44 to $0.52. This EPS estimate includes the negative impact of a higher annual effective tax rate which we estimate will be about 31% in 2010. The increase in the tax rate includes our estimate for higher profits as well as the impact of the expiration of the federal R&D tax credit at the end of 2009.

For 2010, our estimate for capital expenditures is about $900 million. We expect these expenditures to be weighted towards the first half of the year as we continue to expand our assembly and test capacity and install equipment in our 300 millimeter analog fab. Our estimate for 2010 R&D is $1.5 billion but even with our 2009 level. We estimate depreciation will be about $900 million this year, about the same level as 2009.

In summary, as the recovery continues to develop, we are seeing the results that we expected from our focus on analog and embedded processing. We are investing to position TI for growth in these strategic areas as evidenced by our investments in the industry’s first 300 millimeter analog fab and our assembly and test capacity expansion as well as our continued investment in employing field sales and application resources in to the regions and markets that we expect to growth the fastest and we’re well positioned in the electronic markets that we expect to drive growth.

For example, our position in bay stations is strong and continued data traffic increases should drive accelerated deployments of wireless infrastructure. Also, our products are well positioned in the industrial markets that are still in the early stages of recovery and there’s a lot of pent up demand for PC upgrades especially in emerging markets for which we’ll benefit from well positioned products such as our analog power management as well as products sold in to hard disk drives and other peripherals.

All of which gives us confidence that there is plenty of opportunities for TI and our shareholders ahead. With that, let me turn it back to Ron.

Ron Slaymaker

Operator, you can now open the line for questions. In order to provide as many of you as possible an opportunity to ask your questions, please limit yourself to a single question. After our response, we will provide you an opportunity for an additional follow up.

Question-and-Answer Session

Operator

(Operator Instructions) Your first question comes from Uchi Orji – UBS.

Uchi Orji – UBS

The first question is on lead times, there’s been some talk in the industry about lead times coming down, can you just give us some color as to what’s happening to lead times across the various products that you have? Are there still some areas of shortages and tightness? Any color there will be helpful?

Ron Slaymaker

I can’t break it out product-by-product but what I would describe is that our operations have responded aggressively to meet what’s been some pretty strong increased demand across the last few quarters. But, with that increased demand our lead times have generally moved down as that demand has outpaced our supply. I’d say it moved out fourth quarter overall relative to third quarter and that’s very similar to how I described it back at the December update.

We’re certainly investing in manufacturing equipment to relieve these operational bottlenecks especially in our assembly and test areas and to get the lead times pulled back again but to this point I would describe fourth quarter lead times generally moved out relative to third quarter. I will note what Kevin said in his prepared remarks that our delivery performance has improved since the mid November time period but we’re focused on getting delivery performance improved before we start pulling lead times back in.

Uchi Orji – UBS

Kevin, you made a point about gross margins and the fact that revenues are lower than some levels that you saw [inaudible] gross margin in 2007. If I look through the rest of the year can you just kind of walk me through what will be the key drivers of gross margin? Will it be utilization, demand, mix, any color you can give us to how to think about gross margins maybe for next quarter and also for the rest of the year if possible?

Kevin P. March

What I mentioned was operating margins had reached a new high versus where we were at in late 2007. On the gross margins we did turn in a solid growth quarter of about 52.9%. As we look forward as we’ve discussed in prior calls, we would expect that trend to continue to work its way up really as we move forward on a higher mix of analog and embedded processing as a portion of our total revenue.

From a utilization standpoint we’re getting back closer to more normalized utilization levels and so there is probably a little bit less to be expected on that front as we go forward and really it’s going to be much more driven by a higher mix of analog and embedded processing. I would add to that that we’d expect to see some benefit also as we put in place low cost manufacturing and a good example is 300 millimeter analog fab that we just opened in Richardson.

Operator

Your next question comes from John Pitzer – Credit Suisse.

John Pitzer – Credit Suisse

A couple of questions, first Ron when you look Q4 above seasonal your guidance for Q1 above seasonal to what extent do you think this is true demand pull versus the supply chain trying to refresh some inventory in the March quarter? And, how comfortable are you that you can tell the difference?

Ron Slaymaker

I don’t know that we have great visibility in to our customers and their supply chains. I think we commented that our view was if you go back to fourth quarter and this is more anecdotal versus direct measurement, our view is that the supply chain truly all the way to end demand are lean on inventory. I think customers would have liked to have built inventory but to this point they are pretty much hand to mouth ramping their production to be able to support higher levels of end demand.

Where we can measure is our own distribution channels and I’ll just repeat what we said in the prepared remarks, inventory there was pretty much unchanged from the third quarter on resales that were higher. So again, our distribution channel inventories are clearly lean by any historical metric.

John Pitzer – Credit Suisse

Ron, we’re all hyper focused on lead times and when they might come in and what that might signal. When we look at the data you guys did a great job gaining market share despite pretty tight backend capacity, how would we think about your ability to gain share if you were able to grow backend capacity going in to Q2 or do you think you’re leaving business on the table right now?

Ron Slaymaker

I think John if you look at most of our products, they’re proprietary or they’re differentiated products that customer don’t have a lot of [inaudible] across different suppliers. I know there are some suppliers, especially in the analog marketplace that have been vocal and crowing about their short lead times but I’ll also note those are the same analog suppliers that for the most part aren’t growing. I think although some of the analog competitors and suppliers are starting to show some sequential growth again I don’t think any of our major competitors in analog has posted anywhere close to the 27% growth that our analog business just did from a year ago.

That is not a statement that says we are satisfied with all aspects of delivery and customer service levels. You’ve heard us say we’re doing a lot of investment to try to fix that. But, I’ll also note that to a large part we were, especially when it comes to the analog space, I am not aware of too many suppliers that added capacity both fab capacity as well as assembly test capacity all the way through the downturn the way TI did.

I think what you’re seeing in terms of lead times from TI simply reflects the demand that customers have for our products and to the extent that there’s anything left on the table it really comes about because our customers may not be able to fully get everything they want in the near term that they would maybe desire from TI. But again, I think if you look at the investments we are making and generally the relationships we have with our customer base it’s pretty clear to us that they like where we’re headed, they like where we’re headed long term with the capacity investments we’re making and they believe CI is the analog supplier they want to bet on for the long term.

Operator

Your next question comes from Tristan Gerra – Robert W. Baird & Co.

Tristan Gerra – Robert W. Baird & Co.

Do you see the potential for higher wafer pricing at foundries this first half? And, what is your strategy this year for in sourcing versus outsourcing?

Kevin P. March

Tristan our foundry agreements tend to be long term so we don’t see anything in the way of short term price fluctuations on that front. As far as our foundry usage going forward we’ll really do more of the same of what we’ve done in the past and that is increasing portion of our advanced digital capacity will come from foundries and we’ll source pretty much the majority if not almost all of our capacity internally with a little bit of supplemental external.

Tristan Gerra – Robert W. Baird & Co.

How would you characterize US OEM’s ordering patterns post Christmas? Do you think we’re back to normalized ordering patterns or do you still get a sense that people are still pretty cautious in the way they are ordering?

Kevin P. March

I would just offer up that our book-to-bill came in at 1.08 again, that’s the second quarter in a row that it was 1.08. It has been positive almost all year so what we’re seeing I think from OEMs in general is that they’re giving us visibility in to their orders a little bit further out in time. That backlog is extending and so it could suggest an increasing level of confidence. It has given us the better ability to actually plan for their needs as well.

Ron Slaymaker

One other thing that I would add is there are orders, which basically about 60% of our revenue is supported by and then separately we have consignment programs where those customers provide us visibility in to their needs based on rolling forecasts from their MRP system. So again, 40% of our revenue on consignment and for that revenue basically order entry occurs at the same time as the revenue is recognized. So from an investor standpoint or externally you see that as all kind of what looks like turns business because the order comes in inside the same quarter that we’re shipping but from a visibility perspective their forecast provide us a more detailed visibility.

Operator

Your next question comes from David Wu – GC Research, LTD.

David Wu – GC Research, LTD.

In terms of the very unusual first quarter can you talk about what will have sequential revenue increase in Q1? Are they the same kinds of things that we saw in Q4 or are they other drivers for Q1 of 2010?

Ron Slaymaker

I think in Kevin’s prepared remarks he talked about some areas that we expect to be longer term drivers but what I would say is that inside of Q1, we don’t specifically try and break our forecast out but we have some areas that typically are seasonally down that we expect to be seasonally down in first quarter. Then, we have other areas for example industrial, I think you’ve heard from a lot of suppliers that industrial usually tends to be seasonally strong in first quarter. Industrial was an end market that came on later in terms of its recovery and a lot of that strength is still ahead of us.

So I would say inside of that first quarter outlook you have a range of some areas seasonally down and other areas that are still kind of ramping driven by recovery and there’s going to be a range inside of there.

David Wu – GC Research, LTD.

Can you talk a little bit about the wireless business? The baseband business I guess has been perplexingly robust or stable throughout calendar ’09 and I was wondering what’s your visibility in to 2010 and can connectivity and application processor increase in a seasonally tough first quarter?

Ron Slaymaker

You’re right that seasonally wireless is an area that is typically down in first quarter so again, I’m not going to try to forecast specifics about that segment or product lines inside of that segment. In terms of baseband, you’re right I think if you look at the trends there you’ve seen sequential growth now three quarters in a row. The reality is I think we have some competitors that are late relatively to their original plans in bringing up their baseband product lines and until they do we are more than happy to continue to supply our customer with baseband products.

That being said, we have as we’ve described before stopped our investments in the baseband area but again, we will continue to supply that product as long as the customer needs us to provide it. That being said, even though the profile maybe has been a little bit surprising in terms of the sequential trends of late, we do expect or continue to expect that revenue basically to have ramped down by the end of 2012 such that we really have no remaining revenue in 2013.

So now real change in expectations on the end point although the last two quarters have certainly held up stronger than maybe we would have expected. I’m not going to try to forecast 2010 other than to say or suggest look at various baseband alternative suppliers and make your own assessment as to when you think they are going to be positioned to ramp and especially I would say ramp on 3G products as that’s where the strong majority of our sales continue to be.

Operator

Your next question comes from Edward Snyder – Charter Equity Research.

Edward Snyder – Charter Equity Research

Everybody is trying to get their arms around the difference between inventory replenishment, a recovery in the economy and then market share gains. I know it is kind of difficult for you too given how widely diversified your analog business is but, since that’s the big grower here maybe we can touch on that quickly. How do you determine whether or not, and we all talk about inventory, whether or not the channel is filing we understand that but how much of this is market share gain versus how much you say is economic recovery or do you just see as the quarter unveils that you’re posting better sales than you would have expected and just go with it for as long as it will last? Can you give us some kind of feeling of where all the strength is coming from?

Kevin P. March

Ed, I don’t know that we can give a high accurate answer but I can give you some anecdotal observations. Back to what Ron indicated earlier, if we look at the majority of our analog competitors, our analog business has continually outgrown them sequentially and year-over-year for several quarters in a row now. So it would certainly suggest that one side of the answer to your question is that we’re gaining some market share. But, as to how much of additional growth may be attributable to an inventory replenishment or economic recovery that’s pretty much an impossible answer for us to give to you.

Ron Slaymaker

One thing I would say is I know a lot of time the term inventory replenishment gets thrown around but I’ll just remind you that early in 2009 as the economy had turned down and there was a very serious inventory correction underway I’ll just describe the channel overall, specifically our customers and their supply chain, our shipments in to that channel were well below what our customers were producing and what they were shipping out. So certainly not necessarily still today, but as I said before for certainly second quarter and third quarter sequential growth a lot of that was just our shipments normalizing back to their production levels. So again, that’s not inventory replenishment but there was that normalization process taking place whereas now we believe it is being driven by their increasing production levels.

Edward Snyder – Charter Equity Research

I would like to do the same thing for the wireless side which is a little bit easier to get your arms around because I know you’ve got fewer larger customers there, OMAP or the apps processors there and your connectivity seem to be doing particularly well. Do you see this as a few big programs, I think everybody knows the Smartphones which you’re on now some of which are launching some of which have launched and are still selling well, are you seeing share gains? Is the strength you’re seeing in wireless due to a lot of other folks signing up and starting to ship products or to a handful of very successful products that are still ramping?

Ron Slaymaker

It’s share gain in the form of more customers that we’re engaged with and then it also ties to penetration of technology. For example, the various connectivity technologies in to a broader range of handsets. So again, share gain on both OMAP and connectivity and then certainly the number of Smartphones and the size of that market which is growing is a big factor on both ends but then connectivity, the penetration rate for or pervasion rate for technologies such as GPS and Wi-Fi in to a much richer set of handsets.

Operator

Your next question comes from [John Harbor] – Calyon Securities.

[John Harbor] – Calyon Securities

In your prepared comments you talked about the expansion of field sales and field apps, can you just touch on what that might mean to the SG&A line and kind of how you are approaching that just as guys become available you are picking them up or would you expect something more aggressive, regulating it based upon revenue expansion, etc.?

Kevin P. March

John we’re focusing the growth in that area and we have been actually throughout 2009 and we’ll continue to in 2010 in to markets that we think will give us additional proportionate growth. Right now that’s really talking about China, India and certain parts of Eastern Europe. Of course, that will as you point out come through the SG&A line but I don’t think you’ll see it like a pop what you’ll see is just a gradual change in that over time.

I would just take a moment to point out though going in to first quarter embedded in our discussion about what our earnings range is, is that we do expect pay and benefit increases to occur in the first quarter which often happens in the first quarter of the year. It did not occur last year of course because the restructuring was underway. But, we are resuming giving increases this year. We also expect 2010 to be a more profitable year than 2009 and so other incentive type of compensations such as profit sharing will accrue at a higher rate going in to next year starting at the first quarter.

So you will see some increases probably in the G&A line and perhaps even in the R&D line as well as we transition in to those higher accrual rates. But, you’ll also just see a steady increases in the sales and apps line as we go throughout 2010 and probably in to 2011 as well.

[John Harbor] – Calyon Securities

Specific to the March quarter on the SG&A line could you further quantify exactly what you might expect to see sequentially from that event?

Kevin P. March

I think at the highest level on the op ex, the total op ex for R&D and SG&A I wouldn’t be surprised to see it increase at the $40 to $50 million range.

Operator

Your next question comes from David Wong – Wells Fargo.

David Wong – Wells Fargo

Can you give us any feel of who your biggest customers in application processors are please?

Ron Slaymaker

David I think if you look we are across a lot of the traditional handset players so I’m trying to think what’s been publically announced but I think clearly it’s known that Nokia is a customer, Sony Ericsson has done announcements, Samsung had done announcements, Motorola and a lot of their new products, their android based Droid handset are OMAP based. Obviously there are a couple of players that are more positioned in the Smartphone space those being Apple and RIM where we are not engaged with OMAP.

Apple using their own proprietary architecture and then RIM using for the most part legacy architecture that they’ve been engaged with for some time. Then there is one other player PALM that is focused primarily in the Smartphone space that is OMAP based as well. Hopefully that gives you a feel for where we are positioned. What I would say also is OMAP 3 has done very well for us. We have something like 40 different program engagements that will be ramping in to production over the next 12 to 18 months that will be good for us in that space.

David Wong – Wells Fargo

You sort of touched on it but can you give us a feel for which of your end markets are showing the strongest amount of recovery at the moment and are there any that appear to be not yet recovering?

Ron Slaymaker

I don’t know that I would say that there are any that are not yet recovering. They have moved at different paces. I think if you kind of go back through 2009 late in the first quarter and in to the second quarter you heard us talking more about high volume spaces, products line computing, some of the handset areas, some of the consumer areas that seem to recovery fastest and then probably the last market that has been more recent in its recovery would be industrial. I am sure inside of those different markets you can find particular products that are maybe still lagging but for the most part I would say with industrial now picking it up it looks like all the major markets are now in recovery mode.

Operator

Your next question comes from Ross Seymore – Deutsche Bank Securities.

Ross Seymore – Deutsche Bank Securities

Just a question on the margin side of things, the gross margin is a couple of points off your long term target while the operating margin is actually pretty close to it. Can you hit the long term gross margin of 55 if wireless basebands are still 15% of sales?

Kevin P. March

We’ve talked about that, that’s really a function of increasing mix of the higher profitability of products which is analog and embedded processing. So inherently that is going to suggest that baseband will become less than 15% that it currently has reduced to overtime. And, as Ron mentioned earlier we expect that to go to zero by the end of 2012. So really just the growth along of the analog and embedded processing even with baseband in there at 15% you are seeing margins come up pretty strong. So I don’t think you have to depend on baseband to be gone in order for the margins to continue to improve but that certainly would accelerate the arrival of higher margins.

Ron Slaymaker

I would just add even with baseband in the mix we’re certainly not in any kind of hurry to push that out to enhance gross margins because with very little operating expense it falls through nicely to operating profit and cash flow as well so we will welcome that baseband business as long as our customer wants to purchase that product and as long as we’re continuing of course not to be making investment which is our plan.

Ross Seymore – Deutsche Bank Securities

Just kind of exactly on what you were talking about, you almost hit about a 25% operating margin in that wireless business, how should we think about what sort of op ex is necessary to keep the OMAP and connectivity side going because you’re clearing doing a great job of milking the baseband side?

Kevin P. March

We won’t go in to specifics in to how the P&L shapes up inside those segments other than to just talk about the segment as a whole but the overall economics of that business unit will be such that we should continue to see it delivering margins not too far off from where it’s at, these kind of revenue levels and the mix of product will continue to change over time as connectivity and OMAP become a bigger portion of the total revenue inside that.

Ron Slaymaker

It’s safe to say Ross we’re investing ahead in OMAP and connectivity. Both areas have gross margins above for example what baseband has but we certainly expect revenue growth in OMAP and connectivity to exceed any additional operating expense growth in those areas.

Operator

Your next question comes from James Covello – Goldman Sachs.

James Covello – Goldman Sachs

Q2 inventories, do you have a goal for internal Q1 inventories?

Ron Slaymaker

Q2? We haven’t even shared a goal of Q1.

James Covello – Goldman Sachs

I’m sorry Q1.

Ron Slaymaker

I like that you think ahead Jim but the answer is we don’t have a specific goal that we want to publically share anyway on Q1 or Q2. As you’ve seen even in the last few quarters, a lot of what we achieve or what we don’t achieve in repositioning of inventory will depend upon what happens with end demand as well as what actions we might be taking to support quarter out demand expectations as well as what we’re doing from a customer service metric positioning. But, we don’t publically disclose those expectations.

James Covello – Goldman Sachs

Could you let me know what would cap ex have been in the fourth quarter without the money spent towards the Qimonda assets?

Kevin P. March

Jim I think it was in the press release that we spent about $172 million on those assets.

James Covello – Goldman Sachs

So all that $172 million was recognized in the fourth quarter cap ex?

Kevin P. March

Yes.

Operator

Your next question comes from Stacey Rasgon – Sanford Bernstein.

Stacey Rasgon – Sanford Bernstein

I just wanted to verify something, in terms of the upside a little bit that you saw in Q4 it seems from your commentary and from the release that you don’t feel like you saw restocking this quarter it really was all due to just continued normalization. Upside in Q1, you actually expect to see that upside from some restocking activity? Then, I was wondering whether you could give me any color on whether or not you expect that restocking activity to continue past Q1 and maybe in to the first half or in to the rest of the year?

Ron Slaymaker

I agree with your characterization of Q4 that I think for the most part the supply chain was stretched and even if there had been a desire to get some inventory positioned for the most part the supply chain was unable to do that. Now, whether they are able to take advantage of does in demand seasonally slow in Q1 and are they able to take advantage of that in order to get some inventory position I think a lot of customers and distributors down through their supply chain would like to do that but again, the question is just going to be are they able to do that in Q1. I really don’t have a forecast or perspective to be able to provide on that.

Stacey Rasgon – Sanford Bernstein

Around the cap ex budget for 2010, the $900 million can you give me some feeling for how that is going to split up from assembly and test from maybe additional 300 millimeter investments to round out the process set versus additional 200 millimeter buys? Can you give me some feeling on how that might split?

Kevin P. March

Right now Stacey I would suggest that the majority of that will be going towards the assembly and test operations as our volumes continue to increase. We will put more in to the 300 millimeter as we bring up incremental parts of that line and we’ll put more in to 200 millimeter in to other factories as we did this last quarter. But certainly the 2010 budget, the majority of that is appointed towards the assembly test sites.

Operator

Your next question comes from Srini Pajjuri – Calyon Securities (USA), Inc.

Srini Pajjuri – Calyon Securities (USA), Inc.

Just a couple of clarifications on the gross margin side, Kevin just if I take the midpoint of your revenue guidance and plug in the assumptions I’m getting gross margin to be about flattish and based on what you’re saying about Q1 and the history I would expect the mix to improve and the revenues are growing so my question is why wouldn’t the gross margins go higher? Are there any offsetting factors here?

Kevin P. March

Srini, I’m not sure how you’re building your assumptions in but let me just be sure to share a couple of points that might help understand how we’re looking at the first quarter. If you look on our balance sheet you actually saw that we grew inventory in the fourth quarter and principally on the finished goods line which is one of the things that will allow us to be able to continue to improve on our delivery commitments to customers in first quarter and help our revenue in the first quarter.

That also goes to say that we probably have enough wafers in flow to begin to deal with demand and so therefore we don’t expect utilization of our factories, our front end wafer fabs could change that much in the first quarter. I mentioned a few minutes ago that the outlook for the year is for higher profitability than what we had in 2009 and I also mentioned that we’re resuming increases in base pay for people. Those two combined will increase not only our op ex fourth quarter to first quarter but will also have an increase on the cost of goods line which will affect GPM a little bit. So those may be two things affecting the analysis that you’re trying to put together right now.

Srini Pajjuri – Calyon Securities (USA), Inc.

Then if I look at the analog business Kevin, some of the product share gains that you mentioned it looks like the majority of them are coming from the consumer side, like the PCS and the LCD TVs. My question is how does that impact the gross margin for that particular segment, the analog business going forward? Do you see any impact at all or do you expect to maintain that 65% to 70% gross margin that that business typically has?

Kevin P. March

Srini that higher gross margin that you’re talking about is typically on the higher performance analog products and we actually don’t see that being impacted by the demand that we’re seeing for that part. Some of the other spaces that you were referring to was actually in the power products where we’re seeing a lot of success for new products going in there. While the gross margins there might not be quite as high as one might expect from high performance analog the operating margins are very similar. So while there may be mix over time that causes bit and pieces to move it up, down a little bit as we pass through quarter-to-quarter we think overall the mix will continue to go up because the total analog portfolio and embedded processing portfolio combines exceeds what we get from the rest of the portfolio. In addition, they’re growing faster than the rest of the portfolio so they’re becoming a bigger portion of the overall revenue mix.

Ron Slaymaker

Pretty much the same comments apply to HVAL where the growth margins are a little lighter than when compared to high performance analog, the SG&A and R&D requirements are lower and operating margin is very similar. So whether it’s HVAL, whether it’s HPA or whether it’s power our objective and our expectation long term is to get all of them growing at about the same pace but even if there are variations at the operating margin it won’t make much difference.

Operator

Your next question comes from Craig Berger – FBR Capital Markets.

Craig Berger – FBR Capital Markets

Just in talking to some of the investors, the main concern is as lead times come down you may see order volatility or you may see a little air pocket of demand. Do you think there’s enough inventory out there in the channel for that situation to arise? And, can you also talk about where fab lead times are and backend lead times are?

Ron Slaymaker

Let me take part of it and then I’ll let Kevin add to it. I think if lead times decline might there be order volatility? Could be but I would also say that we’re not overly concerned with that. Like I said there are a lot of means by which we have visibility in to what demands is and orders are just part of that. The second part of your question I think is totally pertinent though which is there enough inventory out there such that true demand from our customers would go volatile and that is where given how lean the supply chains are I don’t think it would make any difference.

So again, if lead times pulled in today customers may not feel the need to give us much long term visibility in to their demand but their take rate in terms of demand per shipment likely wouldn’t wiggle at all. But, we’ll see how that develops over time. The second part of your saying manufacturing cycle times?

Craig Berger – FBR Capital Markets

The question was utilizations front end and backend kind of where are they and where do you see them going?

Kevin P. March

On utilization, we don’t actually call it that, I’d say we’re back more to a normal kind of utilization environment unlike where we were a year ago of course when our utilization in the first quarter dropped in to the mid 30% kind of a range. We’re back in to a more normal kind of utilization rate today. I mentioned a few minutes ago that we would expect our utilization going in the first quarter to be very flat to what it was in fourth quarter. That’s a reference to our front end or the wafer fabs.

On the backend we have been investing for a couple of quarters now on expanding our capacity especially on certain package types of [inaudible] our utilization is very, very high on certain of those lines but equipment is getting in to place now and we’re beginning to see our throughput increase. Again, you can see that if you look at our balance sheet where our finished goods are, we actually had to increase for the first time since the second quarter of 2008.

Operator

Your next question comes from Doug Freedman – Broadpoint AmTech.

Doug Freedman – Broadpoint AmTech

If you could talk a little bit about where we are with the distributor conversions that are going on and how much that might have impacted revenues either this quarter or next?

Kevin P. March

Doug right now we are probably about a quarter – let me just go to the highest level. There is probably about 30% of our revenue goes to the distribution channel and of that about ¼ of it is on consignment. We are slowly increasing that each quarter, the portion that is on consignment with the idea that sometime probably late next year, next year being 2011, we’ll arrive somewhere on the order of half of our total distribution inventory being on a consignment basis.

Doug Freedman – Broadpoint AmTech

Were you able to calculate what impact that had to revenue recognition in this quarter?

Kevin P. March

Not precisely. Doug, I don’t have that number with me so I just don’t have the answer for you.

Ron Slaymaker

But again, probably the way to think about it Doug is if you go back we started that consignment program with distributors in June of 2008 so over the last six quarters we’ve gotten 25% of that revenue converted over to consignment. You probably based on that, can go make some average call it headwind calculation from that consignment program. But, the fact that we’re doing a relatively slow deployment on that would say probably in any one quarter, it’s kind of a slow headwind on the timing of revenue but again, it doesn’t impact resale at all, it doesn’t impact the end demand it just has the effect of moving it out a quarter as distributors rely more and more on that consignment program.

Doug Freedman – Broadpoint AmTech

The guys have already commented on your operating margin coming in sort of above target this quarter, can you give us an idea how many quarters you would run with your operating margins above your target before you think it might be appropriate to adjust some of the targets? If I look at the R&D and SG&A as a percentage of sales, I guess it might be a really good quarter to be at TI next quarter because you’re going to have to increase spending a lot more than what you just guided to get it up to the 25% number.

Kevin P. March

Doug, I think we still have not achieved the target that we set for ourselves a couple of years ago which was 55% growth and 30% operating. We didn’t set those as a ceiling we set those as an objective that the company should be able to operate at and ideally on a sustained basis. We think it is pretty important for us to be focusing on top line growth right now and demonstrate that we can sustainably deliver those kinds of margins over a period of time.

Ron Slaymaker

Let’s not celebrate yet. We’re close to the margin goals but we’re not there yet.

Operator

Your next question comes from Leonard Young – Citi.

Leonard Young – Citi

Can you guys talk about the pricing environment that you’re seeing sort of generally across your products but specifically in some of the commodity products?

Ron Slaymaker

I’ll start with commodity but let me do the normal caveat of you have to remember it’s only a few percent of our revenue but pricing and commodities is doing what you would expect in a situation where suppliers pretty much across the board are short relative to what the demand environment is. So, pricing is moving up on commodities as you might expect. Outside of commodities I would say, which again is almost all of our revenue, pricing is pretty much following normal trends so nothing really environmentally unusual there, even in commodities it is not unusual but it has moved up in this constrained environment.

Leonard Young – Citi

If you look back at the 2003/2004 timeframe, really 2004 was the last time we had a material inventory problem and I’m wondering if you can compare and contrast what you see today versus what you saw back then?

Kevin P. March

Len, are you talking about coming out of the tech bubble?

Leonard Young – Citi

No, I’m really thinking about ’04 when we had what I would characterize more as an inventory issue, shorter term obviously. You could look at the tech bubble too where it was obviously a much bigger inventory issue but I think in both periods we had some problems.

Ron Slaymaker

Len, I have a couple of things I would observe and I would suspect you’ve noted it also. Typically when you get in to the cycle rolling over again you are coming from periods where inventory has been inflated, usually as that inventory build is taking place customers, suppliers, distributors convince themselves it’s being done because the demand environment outlook is going to be strong. Then it results in some form of correction of that excess inventory level. We all recognize when that inventory is being built but again, we convince ourselves and I am talking the entire supply chain here, that it is appropriate relative to the demand outlook.

I think what’s different in this environment is pretty much if you look at TI, you look at our distributors, you look at our customers, you seen inventory levels that are historically lean and that’s a big difference between pretty much every other cycle that peaks out and rolls over versus where we are today. We have demand today that is being driven call it more macro level in demand increases and you have inventories that to date have remained very lean and well behaved. I think Stacy asked the question earlier about replenishment and whether that is an expectation.

I think typically at some point as demand continues to build and as suppliers get capacity online you would expect at some point replenishment of inventory levels. But, I would describe that as ahead of us as opposed to anything that we’ve seen to date.

Operator

Your final question comes from Christopher Danley – JP Morgan.

Christopher Danley – JP Morgan

On the analog, I know you talked about trying to get the HPA HVAL and power to grow equally, can you just give us the relative growth rates between those three products in 2009?

Ron Slaymaker

Let me say first of all I don’t know I intended to say it’s our objective to get them to grow equally. Clearly, historically we’ve had really good growth in HPA and we’ve had outstanding growth in power but HVAL has been a lager. Frankly, it wasn’t just a lager relative to those other two product areas, it was a lager relative to what our perception of the market was. So our view is there is no reason that all three of those areas shouldn’t have growth that is relatively similar across them but to some degree you’re going to have variations that develop.

I think if you look at historically like I said – I would almost have to leave it at that, HPA and power clearly have been the primary areas of growth in analog over the last few years. HVAL lagged, HVAL lagged even through the first part of 2009, I would say midyear we bottomed out some of the fruit of our effort over the last few years basically starting with management changes and then organizational changes below that end markets on which we are focused, all the things that we have talked to you about in the past started to come to fruition. And, over the last couple of quarters certainly HVAL has pulled its weight as well.

But that’s really what we’re intending to say and I think we’re reasonably satisfied that we have good growth opportunities in all three and we’re positioned to realize those growth opportunities but any quarter-by-quarter and even year-by-year you may have differences and that will be okay.

Christopher Danley – JP Morgan

Just on the whole lead time thing, so lead times have been going out for a couple of quarters now and I think you guys have said that it’s mostly related to backend issues so my question is when you guys first saw the lead times going out why didn’t you just ramp up your backend aggressively and squelch them? Are you trying to sort of keep the lead times a little bit longer? I’m just wondering about the imaginations of that process.

Kevin P. March

When you think back to when we began to see some of the challenges, it was still on the way down. How quickly we forget sort of thing but it wasn’t that long ago that the bottom was falling out of demand across the board and then when demand did start coming back the second quarter, it was all of us scratched our head trying to decide whether or not that was real. Certainly in retrospect it was real and once we acknowledged that we began to step up capital spend. You saw it move up in the third quarter and you saw it move up again in the fourth quarter and most of that money is going towards backend capacity trying to [inaudible].

So again, kind of remembering the history we came through is how we kind of got to where we’re at. It certainly was not an intended outcome. The last thing we want to do is displease our customers in the manner in which we have on certain of these product lines. It is our objective to get this fixed as quickly as possible but experience also tells us that when we get behind like this it usually takes us quite a few quarters to get caught back up.

Ron Slaymaker

Chris, just as a reminder don’t forget second and third quarter growth rates across that six month period was higher than what we’ve ever seen before at least in any of the history that Kevin or I could find. So, you do your planning, you do the best you can and sometimes it’s not good enough but nonetheless we’d rather be in the situation where we have revenues rapidly growing than the alternative. Thank you for joining us. A replay of this call is available on our website. Good evening.

Operator

That does conclude today’s conference. Thank you for your participation today.

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