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Texas Instruments Incorporated (NASDAQ:TXN)

Q1 2010 Earnings Call Transcript

April 26, 2010 5:30 pm ET

Executives

Ron Slaymaker – VP and Head of IR

Kevin March – SVP and CFO

Analysts

Christopher Danely – JP Morgan

Tristan Gerra – Robert Baird

Uche Orji – UBS

Shawn Webster – Macquarie

Tore Svanberg – Thomas Weisel Partners

Adam Benjamin – Jefferies

Jim Covello – Goldman Sachs

Srini Pajjuri – CLSA

Sumit Dhanda – Banc of America Securities/Merrill Lynch

Steve Smigie – Raymond James

Ross Seymore – Deutsche Bank

Glen Yeung – Citi

John Pitzer – Credit Suisse

Doug Freedman – Broadpoint

Stacy Rasgon – Sanford Bernstein

Tim Luke – Barclays

Operator

Good day and welcome to Texas Instruments first quarter 2010 earnings call. Today’s conference is being recorded. At this time, I would like to turn the conference over to Ron Slaymaker. Please go ahead, sir.

Ron Slaymaker

Thanks, Vivian. Good afternoon and thank you for joining our first quarter 2010 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 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 June 8th. We expect to narrow or adjust the revenue and earnings guidance ranges as appropriate with this update.

In today’s call, we will address TI’s plan for growth, we will talk about our progress to transform TI to a company-focused on Analog and Embedded Processing, how it’s driving our growth today, and our plans to support growth in the future. We’ll address near-term trends and inventories and lead-time, as well as our strategy for capacity to make sure we are positioned to grow in the years ahead.

Revenue in the first quarter slightly exceeded the high end of our range of expectations. Earnings landed at the top end of our expectations. Demand was strong and broad across end markets and regions, while supply chains across the electronics industry continue to be constrained, and inventories appear to remain lean.

Revenue in the quarter was up 7% sequentially and 54% compared with a year ago. Analog, Embedded Processing, and our core Wireless products, excluding baseband, were TI’s growth drivers in first quarter ’10 and we are investing to accelerate their growth from here. They received about 90% of our R&D investments in the first quarter. These businesses comprised 66% of our first quarter revenue, up from 61% a year ago and 58% in the first quarter of 2008.

Analog revenue grew 8% sequentially and was up 70% from the year-ago quarter. Once again, all three of our major analog product areas were strong contributors to this growth with each expanding about equally from its fourth quarter level. For HVAL, this was the fourth consecutive quarter of solid sequential growth further evidencing the turnaround in this business that we told you to expect and that is now being achieved.

A more important metric could be that our Analog revenue is up 8% compared with the third quarter of 2008, a quarter before the industry entered the downturn. While not all of our peers have reported, I believe this growth will compare favorably when results are in. The importance of this metric is that it captures performance a very longer period of time and indicates who is growing stronger out of the downturn.

We are working to extend our lead with investments we’ve made in product technology, sales support, and manufacturing capacity. Just last week, we bought another 100 tools for 300 millimeter analog production, taking off phase two of RFAB. Embedded Processing revenue grew 7% sequentially and was up 39% from a year ago. As a reminder, the year-ago quarter benefitted from growth in our communications infrastructure business, as China deployed 3G infrastructure.

The strongest areas of growth this quarter in both comparisons were in our catalog products that are used in a wide range of applications. Catalog microcontroller products were especially strong in the year-ago comparison. Similar to Analog, Embedded Processing revenue was up 3% from the third quarter of 2008, which should compare favorably to competitors.

Wireless revenue declined 5% sequentially and was up 27% from a year ago. Baseband revenue of $424 million fell 9% sequentially and was up 6% from a year ago, reflecting a stronger mix of 3G products. Basebands are now down to 13% of TI revenue compared with 15% in the fourth quarter and 19% in the year-ago quarter. Revenue of $293 million collectively from applications processors and connectivity products was even with the fourth quarter and was up 80% from a year ago. This was up 12% compared to the third quarter of 2008, another indication of our strong performance in the smartphone market.

I should note that we have moved our low-power wireless product from our Analog segment to our Wireless segment. We made this move because the wireless organization is better suited to support the significant growth opportunity. This low-power wireless product line is based on products that were included in or subsequently developed from our 2006 acquisition of Chipcon. Revenue from these products was $68 million in 2009. We have a chart on our website that shows our Analog and Wireless segments historically adjusted for this change.

Other revenue grew by 19% sequentially. Royalties increased, and we had a strong sequential growth in custom ASIC products as well as growth in DLP products and calculators. From a year ago, Other revenue grew 68%, mostly due to strong growth in DLP products where revenue more than doubled as well as strengthened loyalties, custom ASIC products and calculators.

From a geographical perspective, almost all of the sequential revenue growth came from the US, Asia-Pacific, and Japan regions.

Turning to distribution, re-sales or sales out of our distribution channel were up more than 10% sequentially. We believe this represents share gains across multiple distributors. Even with the strong resale growth, we were able to help distributors build some inventories to support future growth. Even so, distributors’ total weeks of inventory remain about five, similar to last quarter and low by historical standards.

Now Kevin will review profitability and our outlook.

Kevin March

Thanks, Ron. And good afternoon, everyone. Our gross profit expanded by 6% sequentially this quarter, as revenue grew. Gross margin declined slightly by 20 basis points to 52.7% of revenue. Operating expenses increased $27 million from the fourth quarter. As I explained in January, this was mostly the result of higher compensation expenses that resulted from our stronger financial outlook for 2010. For example, accruals for employee profit sharing and annual raises in February.

Operating expenses were 23% of revenue in the quarter within our planned operating models. Restructuring charges in the first quarter were $10 million. This was for US pension plan settlement accounting associated with actions that occurred in 2008 and 2009. The distribution of these charges across our segments is included in our earnings release.

Operating profit for the quarter was $950 million, 9% higher than the prior quarter due to higher gross profit. From the year-ago quarter, operating profit was up $940 million due to higher gross profit. Operating margin in the quarter was 29.7% of revenue.

Net income in the first quarter was $658 million or $0.52 per share. Included in net income was $7 million of discreet tax charges that were associated with the change in tax treatment of Medicare retiree growth subsidies. 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.

Cash flow from operations was $710 million. This was down from the last quarter’s $1 billion due to higher receivables. Cash flow from operations was up in the year-ago quarter due to higher net income. Capital expenditures declined sequentially to $219 million in the quarter. Expenditures included the purchase of additional assembly and test equipment as well as additional analog wafer fab equipment.

Our process qualification work at our 300 millimeter analog wafer fab, RFAB, is producing good results. The initial wafers that we began producing in January have completed processing with good early yields. We continue to track well to our goal in our full process production qualification before the end of this year. In the quarter, we used $504 million to repurchase 20.6 million shares of TI common stock and pay dividends of $149 million.

We were able to increase our inventory by $74 million in the quarter with most of the additional inventories stages as work in process to support our forecasted higher 2Q revenue. Inventory days held steady at 76. Consistent with what we described in our mid-quarter update, our delivery performance has continued to improve and our lead-times have continued to decline, as we bring additional manufacturing capacity online and get better positioned with inventory.

Even as we have begun an orderly process of reducing lead-times, demand from our customers has remained strong. Orders in the quarter were $3.64 billion, up 12% sequentially. TI’s book-to-bill ratio was 1.14 in the quarter, up from 1.08 in the fourth quarter and our strongest book-to-bill ratio since the second quarter of last year.

Turning to our outlook, we expect TI revenue in the range of $3.31 billion to $3.59 billion in the second quarter or 3% to 12% sequential growth. We expect earnings per share to be in the range of 56 –

Ron Slaymaker

Okay. We will continue with where Kevin left up there.

Kevin March

Actually what I’ll do is back up maybe a paragraph. I’m sure that’s caused a bit of distraction for everybody.

Turning to our outlook, we expect TI revenue in the range of $3.31 billion to $3.59 billion in the second quarter, or 3% to 12% sequential growth. We expect earnings per share to be in the range of $0.56 to $0.64. Our estimates for 2010 R&D, depreciation, and capital expenditures are unchanged from last quarter.

In summary, as the recovery continues to gain momentum, we are seeing the results from investments that we maintained even through the depths of the downturn. We have products well positioned, and field sales and applications team is second to none. Our production output is at an all-time high, and we have a multi-year ramp in capacity underway that will allow us to support our customers and therefore our shareholders with strong growth potential. And this capacity, both fab and assembly or test, is being procured at cost levels that will also advantage us competitively without burdening TI with a lot of fixed costs. We see this strategy as having lots of upside opportunity and manageable downside risk.

With that, let me turn it back to Ron.

Ron Slaymaker

Thanks, Kevin. While we are building the queue for Q&A, let me take a moment to remind you that we will be holding our 2009 Financial Analyst Meeting in New York next Thursday, May 6, starting at 2:00 PM Eastern Time. The meeting will be webcast. So if you are able to join us in person, pleased join the webcast.

Operator, you can now open the lines up 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. Operator?

Question-and-Answer Session

Operator

Thank you, Mr. Slaymaker. (Operator instructions) And we will take our first question from Christopher Danely with JP Morgan.

Ron Slaymaker

Chris, are you there? Operator, why don’t we move to the next caller and we will come back to Chris? Operator, are we still online?

Operator

Yes, sir. One moment please. And Mr. Danely, please go ahead, sir.

Christopher Danely – JP Morgan

Can you guys hear me?

Ron Slaymaker

We can hear you now, Chris.

Christopher Danely – JP Morgan

All right. Thanks. First question is on the gross margins, why were the gross margins down despite the increase in sales? And can you just maybe give us a sense of where gross margins can go for the rest of the year?

Kevin March

Yes, Chris, you may recall that in January when we had our fourth quarter earnings release and our first quarter call, I mentioned that we were reinstating compensation changes – compensation increases for everybody in 2010 and that we also based upon our higher outlook, we see related compensation such as profit sharing going up. And so really what you are seeing is the effect of that going through the gross margins line. In fact, if you adjust for that, the fall-through would be very closely better than expected it.

Ron Slaymaker

Do you have a follow-on, Chris?

Christopher Danely – JP Morgan

If you could just talk about where you can expect gross margins to trend for the rest of the year, i.e., can they go up much or will the compensation continue to impact?

Kevin March

Yes, we’ve established a gross margins target of 55% gross margin and 30% operating margin. And we remain very confident being able to achieve those. The main driver of that of course is going to be just the revenue mix, as we go forward. I think Ron mentioned already that Analog and Embedded Processing and the core Wireless Products are now about 66% of our total revenue that become a richer mix in most and a very nice gross margins. We would expect that mix to continue to richen up as we go through the year and the years follow, and the gross margins will move up accordingly. Beyond that, I won’t really give a specific time period as to when we think we will be achieving that 55% gross.

Ron Slaymaker

Kevin, could you speak just a minute on the compensation, how much of what we saw from fourth to first with kind of a one-time moving into the New Year versus what we just expected quarter-to-quarter going forward?

Kevin March

Yes, that’s a good point, Ron. The compensation changes that you saw in the first quarter, our annual raises are actually effective from February. So we saw two-thirds of the effect of that in the quarter. So we’ll see a bit more of that going into second quarter where the total rate will burden the quarter. And just on our outlook, our accruals that we take for other compensation for other compensation-related incentive type things such as profit sharing to be adjusted as well.

Ron Slaymaker

Okay. Thank you, Chris. And let’s move to the next caller, please.

Operator

And we will go next to Tristan Gerra with Robert Baird.

Tristan Gerra – Robert Baird

Hi, good afternoon. Sounds like your utilization rates went up in Q1, which I think maybe above the flattish expectation you had last quarter? And also if you could talk about your expectation in Q2 relative to your capacity ramps.

Kevin March

Yes. Tristan, our utilization rate really didn’t move that much. It was very consistent what we talk about. While we do expect utilization go up a little bit next quarter, it’s going to be that much again. We have – you may have noticed from our balance sheet, we are able to build some inventory in the first quarter even with our utilization not changing by that much. That helps position us well for growth going into the second quarter. And so we have just a small – relatively small additional wafer starts, we will be able to reach those types of revenue numbers that we gave in the guidance.

Ron Slaymaker

And Tristan, we don’t really have expectations that we are sharing on our second quarter utilization as that will really tie more to our third quarter expectations. Do have a follow-on, Tristan?

Tristan Gerra – Robert Baird

Also, given your expectation to face up the baseband business, are you changing your pricing strategy there or is it pretty much in line with what you’ve done in the past and perhaps also some pricing comments on the analog side of the business?

Ron Slaymaker

Tristan, I really don’t have comments on baseband pricing. Again, most of our pricing there tends to be driven more by longer-term contracts, but since most of our baseband revenue really goes to a single customer, it would be inappropriate for us to talk about pricing trend. With respect to analog, really no abnormal changes there. I think the analog pricing, in general, especially in the high performance area tends to be very stable.

And in areas like HVAL where it may tend to trend down over time, it tends to trend down based upon longer-term pricing agreements, and those are well understood trends that we engineer for. If I can broaden that, the only area where we have seen pricing that moves more with the near-term market environment would be on the commodity areas. And we’ve set pricing last quarter so that pricing has trended up. And in fact, we saw that as well in the first quarter. Okay, Tristan. Thank you. And let’s move to the next caller please.

Operator

We will go next to Adam Benjamin with Jefferies. Please check your mute function, Mr. Benjamin. Okay. We will go next to Uche Orji with UBS.

Uche Orji – UBS

Thank you very much. Can you hear me?

Ron Slaymaker

Yes, we can, Uche.

Uche Orji – UBS

Ron, just one quick question, Ron. I mean, when you look at your revenue growth in the last three or four quarters, which have been fairly strong, and we try to consolidate with the ultimate end market, be it industrial, be it wireless. Are you concerned at all that inventory might be (inaudible) down the line with the OEMs. I mean, it just seems to be – evidently, you kind of categorize this yourself and try to figure out why this is happening, because that seems to be little bit of a disconnect with the stress [ph] we have seen with the component growth as of the end market themselves?

Kevin March

Uche, I guess the advice I would have in doing that comparison is, you can’t have the starting point be in the last three or four quarters, because in the first half of last year, especially first quarter of last year and probably even starting at fourth quarter ’08 as the downturn really started to take force, we were significantly under-shipping our customers, as they were reducing inventory. So, to look at growth trends coming off of that bottom when we were under-shipping customers is probably not an appropriate metric. I do believe that – first of all, let’s talk about the customer inventory.

You heard us say first of all with respect to distribution, our channel inventory. We were able to get some inventory built there, but weeks of inventory maintained at about five, which is by any historical metric point to be lean. We have an additional significant percentage of our OEM customers where we are managing their component inventory because it’s business that’s done on a consignment basis. And we know that it’s lean, and it tends to be very productive fab-turning inventory. So if you put distribution and the OEM consignment programs together, that represents about two-thirds of TI’s revenue base. So that leaves about one-third of the customers that we have, frankly, less direct visibility into their inventory level. But Uche, all signs and indications that we pick up is that inventories remain lean.

As I said, this is a general supply chain type of consideration that inventories are lean. The customers are trying to build inventory and bring in products consistent with our end demand. But they are really not to a point where they have been able to significantly increase inventory from the days or weeks basis. So certainly we watch it, we watch relative growth, we talk to customers about their needs and all of that. But we haven’t seen anything to this point that is setting off any kind of alarm. In fact, if anything, we are still the other way around where we are trying to continue to pull up our supply to be able to fully meet the customer’s demand with the service levels that they are used to from TI. Okay. Uche, do you have a follow-on?

Uche Orji – UBS

Yes, I do actually. Thanks for the answer. My follow-on is, if I look at the other revenues, that seems to be a very meaningful contributor to margins. I mean, one of the key contributors there of course is the royalties. Can you give us any comments as to what’s driving royalties at the moment? What – if you don’t give us the actual size of that number, but just to get a sense of what’s driving royalties right now. I know you started to deal with DRAM companies, and what the acquisitions are. And also within DLP, if you can also talk about what the acquisitions are within that? That’s my last question. Thank you.

Kevin March

Uche, I think on the royalty front, naturally that’s a function of how well our licensees are doing. And in general, we’ve got a strong market going on. I will quantify any of the business units underneath the Other segment other than to say what’s up and what’s down. Royalties was up sequentially. DLP was also up quite a bit. That also happens to be a very attractive margin business. And that’s on the strength of projectors. In fact, not only quarter-over-quarter, but also year-over-year, if I recall, I believe it doubled on a year-over-year basis.

And going forward, we are seeing continued strong demand, especially for the DLP into the future. Again, not being specific on that area because we don’t really forecast – forecast below the company level. Overall, what we will see next quarter just so it’s not lost on folks, as we calculate our business, it’s inside the Other segment. And you may recall, that has a seasonally stronger second and third quarter that’s when the back-to-school selling season happens. And so we will typically see an uptick from 1Q to 2Q for that business, and we are expecting about $65 million to both 1Q and 2Q in terms of revenue there, typically go up a little bit in the third quarter and then drop off again in the fourth due to the seasonal nature of that business.

Ron Slaymaker

Uche –

Uche Orji – UBS

Thank you very much.

Ron Slaymaker

Yes. Let me make a couple comments also just on what’s driving that DLP strength, because certain part of it is the year-ago effect of markets being weak in inventory. But actually inside of DLP, education is a very big market driver for our front projector products. And we are seeing a lot of strength now, especially for example in Asia, as schools and classrooms over there start deploying DLP projectors and the classrooms similar to what may a difficult year had done. And DLP has a very significant reliability advantage that makes it attractive to educational systems.

The other thing that is more recently starting to play out is a differentiator for our DLP front projectors is they are 3D capable. And so you certainly know about 3D and the cinema, but actually educational systems are using a 3D capability to help students better visualize things that wouldn’t normally pop out in tech books or in 2D diagrams. And then certainly, you don’t have to look very far to realize how big 3D is with movie cinemas these days. And what I would just say is almost all of that is being done on TI-based DLP projectors. Okay Uche, thank you for your questions, and we’ll move to the next caller.

Operator

We’ll go next to Shawn Webster with Macquarie.

Shawn Webster – Macquarie

Yes, thank you. Can you hear me?

Ron Slaymaker

Yes, sir.

Shawn Webster – Macquarie

Okay, yes. I was wondering – you said that five weeks wasn’t – was still lean. What is that historically? And in terms of your lead-times, when do you think they will be going to a more normal level?

Ron Slaymaker

Okay. The historical distribution has one in the eight to nine weeks range, and that’s over the past few years, maybe excluding last year. But if we go back longer – if we go back further in history, they would have even carried more weeks of inventory. Certainly, part of the reason that inventory levels have come down are just structure things that we’ve done from a consignment program. And just as a refresher today, we actually started, I guess it was in June of 2008, pulling consignment programs to distribution. Today about 30% of our distribution revenue is supported by consignment. So structurally, that will tend to bring down inventory levels. But even accounting for that inventory levels, distributors remain lean. And Kevin, do you – would you like to answer the second?

Kevin March

On lead-times, Ron mentioned during the mid-quarter earnings conference call that we have already begun to pull in lead-times, as we’ve been bringing on capacity to deal with the high levels of demand that we’ve had. And we have further programs, as we came out of the quarter. We still have a number of products that have been kind of longer than we prefer at this point that we bring significant progress coming to the first quarter. And remind me that we are going to continue installing additional capacity for each of the quarters of 2010, and we expect that should greatly enable our ability to bring new accounts back to the normal level.

Ron Slaymaker

Do you have a follow-on, Shawn?

Shawn Webster – Macquarie

Yes, please. I was just wondering if you could provide us some color on how your order books looking going into Q2, what areas do you expect strength from, and what area do you expect the least growth?

Kevin March

Shawn, we don’t break our guidance down into particular markets. So I probably need to stay away from that. However, let me just say, thus far in the quarter, which is what, 26 days, orders are strong and fully consistent with the guidance that we just provided to you.

Ron Slaymaker

Okay, Shawn, thank you. And we’ll move to the next caller.

Operator

We’ll go next to Tore Svanberg with Thomas Weisel Partners.

Tore Svanberg – Thomas Weisel Partners

Yes. First of all, just going back to the lead-time topic, can you just put some parameters or numbers around where lead-times have been and where they are now?

Kevin March

We are talking about tens of thousands of part number series. There really is no one answer, but lead-times that were, say, in excess of 12 weeks, total back in to the eight to 10-week kind of range. Lead-times that were in excess of 16 and pulling back into the 12, 14 kind of range, it kind of seems across the board where unfortunately more and more of our products are moving back into a normal lead-time for that particular product, not all the saying that depends on the manufacturing process. Some process would take longer naturally than other processes. But the lead-times are all beginning to move back in consistent with those processes. But as I said, there is still some work to do on that that should be dealt with as new capacity continues to come online this year.

Ron Slaymaker

Hey, Tore. One way of thinking about it, I guess at mid-quarter, we were seeing data that allowed us to believe they had stabilized. And I think I described as we were making slight improvements in lead-times. Since then we’ve seen a lot of progress. And I would describe – compared to slight improvements at mid-quarter, I would describe the improvement as significant at this point. So they have turned. They have turned very clearly in the right direction, and we are making significant progress. Do you have a follow-on, Tore?

Tore Svanberg – Thomas Weisel Partners

Yes, one. You said the HVAL bases has grown four consecutive quarters and has fully recovered. Can you just talk a little bit about some of the bigger end markets that have been responsible for that recovery, please?

Kevin March

Yes. The only thing I would say is, I don’t know what I would say if fully recovered. I think we certainly believe we have it well on a path and we think the turnaround that we had talked about, I think, really for a couple of years now is well underway. But there are still – there is still work to do. There is still additional progress to be made in terms of further diversification of those products in the markets that we are working through. I think if you look at HVAL, really isn’t a single market, a variety markets. It’s even specific to first quarter, clearly computing and peripherals that we participate in with those products would include areas like printers, but maybe more significantly would be hard disk drive. Those were some examples. Probably automotive would be another one that I would mention as a notable area of improvement.

Ron Slaymaker

Okay, Tore. Thank you. And we’ll move to next caller please.

Operator

And we’ll go next to Adam Benjamin with Jefferies.

Ron Slaymaker

Hello, Adam. Welcome back.

Adam Benjamin – Jefferies

Thanks, guys. Sorry for the snap though. Just had a follow-up on the lead-times, with the lead-times coming in on the back end mostly, can you talk a little bit about cancellations that you’ve seen maybe on a relative basis in Q4 and then comparing that to Q1 and then what you’ve seen so far in this quarter?

Kevin March

Adam, I can answer that pretty quickly. We’ve seen no change in lead-times. There is no abnormal cancellation. Pardon me. No change in cancellations. We will have no more adjustments there at all. In fact, I would just observe it during the quarter, even though we were improving the lead-times on a considerable basis, but again we did see (inaudible) orders in the quarter. We talked about earlier that book-to-bill (inaudible) 1.14. So really showing that customers continue to have significant demand for our products.

Ron Slaymaker

I think – to be honest there, I know there has been a lot of investor and analyst concern and worry about what will happen when lead-times pour in and what – how that might affect orders. But beyond that, I think that kind of focus really is missing the force for the three. In this type of very strong demand environment. So was there any noise in the order line associated with our changing lead-times? There could have been, but it was more than plump by just rising in demand, rising production from our customers. So again, I just – I would caution against getting to micro-focused on that detail and focus more on just the recovering economy and what that’s driving in terms of demand for semiconductors. Adam, do you have a follow-on?

Adam Benjamin – Jefferies

Let me just follow up kind of on a longer term basis on gross margin, I know in this quarter you mentioned you’re layering on some comp and some CapEx. And I’m just curious if you move throughout this year and really into next year how you’re thinking about the gross margin and where we should be thinking about where that can trend to?

Kevin March

Adam, we’ve been talking for a couple years now about gross margins working their way as we rebuild the portfolio to a 55% kind of structure. And that’s not to say that the ceiling of our floors to say that our portfolio should be able to deliver that on a fairly reliable basis. Going forward, we continue to be even more confident that we will be in those kind of gross margins, especially as we see analog and embedded processing becoming a bigger mix of our revenue overall.

On the CapEx front, we’ve talked for a while about CapEx probably running in the 5% to 8% kind of range – percent of revenue. And in fact, we are consistent with that. I was just looking over some data this morning, and our capital spending for the last 12 months has been almost exactly 8% of revenue, which bodes well for depreciation as we move forward also. So we should see depreciation throughout – on the gross margin. In addition to that, we’ve been acquiring capital at extremely attractive prices. So we are getting more capacities than we would normally get dollar-for-dollar of capital spend, which bodes very well for being able to grow our top line, which is where we are highly focused inside the company is driving top line growth at this point as opposed to trying to adjust the gross margin models.

Ron Slaymaker

Okay. Thank you, Adam. And let’s move to the next caller please.

Operator

We will go next to Jim Covello with Goldman Sachs.

Jim Covello – Goldman Sachs

Great. Thanks guys so much for taking the question. I appreciate it. If we look forward the 300 millimeter fab getting ramped up, how quickly do you think realistically you could gain some kind of meaningful share coming out of that fab?

Kevin March

Jim, the schedule right now is for them to be shipping its first production worth product by the end of this year. We – as Ron mentioned, we just started Phase II expansion in that factory. The Phase I was to give us $1 billion of incremental revenue capacity. That’s what we announced a couple quarters ago. Phase two is a second $1 billion of revenue capacity, and we have just begun bringing equipment – just purchased equipment last week to support that, and we will be bringing that in very quickly. We would expect to probably have some fairly meaningful revenue begin to come out of there in 2011.

Ron Slaymaker

On that second phase offer?

Kevin March

Yes.

Ron Slaymaker

Okay. All right. Jim, do you have a follow-on?

Jim Covello – Goldman Sachs

I’ll stay on that. When do we think the first phase would be complete? I understand you will ship product in the fourth quarter, but when would that phase one be kind of fully ramped?

Ron Slaymaker

Jim, that’s going to be a functional demand I guess. Kevin would like to really forecast all the way out to the end of 2011 as to when each of those pieces of machines would be fully utilized, but they will certainly be ready to be fully utilized as we come out of this year and go into next year.

Jim Covello – Goldman Sachs

Okay, okay. So sometime early in 2011 then?

Kevin March

Generally available and we just wait for the orders.

Ron Slaymaker

Great, better. Thank you, Jim.

Jim Covello – Goldman Sachs

Thank you.

Ron Slaymaker

We’ll go to the next caller.

Operator

And we will go next to Srini Pajjuri with CLSA.

Srini Pajjuri – CLSA

Thank you. Kevin, a couple of questions. One, on accounts receivable, it went up a bit in the quarter. Given the tightness. I would have expected it to remain flat or actually come down a bit. If you can give us a bit more color to what’s going on there/

Kevin March

Yes. In the fourth quarter, what typically happens on our shipments in the fourth quarter are actually a drop off a fair amount in December, as customers put their factories on holiday and so on. And so our receivables will tend to decline and our days of receivables will tend to go down. Coming out of fourth quarter into first, we are back into a more normal manufacturing environment with our customers, more uniform factory loadings and full hour shipments are more uniform across the quarter, which in turn by contrast to fourth quarter range of receivables levels up when your revenue grows and you wind up your days going up as well. If you look on a year-over-year basis, actually very consistent on these bases.

Ron Slaymaker

Just relative linearity between fourth quarter and first quarter shipments.

Kevin March

Right.

Ron Slaymaker

Okay. Srini, do you have a follow-on?

Srini Pajjuri – CLSA

Yes, Ron. On the pricing front, Ron, you mentioned that you are seeing some beneficial pricing on the commodity side. Now that the leads times are coming in, do we expect any changes to pricing? I mean, do you expect the prices to kind of revert to the normal declines. And if so, what kind of impact should we have to expect on the gross margin? Thank you.

Kevin March

Srini, I really don’t want to try to forecast what commodity pricing might be. This is an area where first sometime I think since it’s really the beginning of the year, we have actually been on a what we call, controlled order entry process where customers just could not come in and place unlimited demand on us based upon a certain lead-time. We provide certain levels of support to customers that have been historic customers. And if competitors were having issues supplying product, we weren’t just going to be the benefactor for all of their customers to be able to gain support.

So commodity really has been kind of a different environment for the last few quarters, very difficult for this part with this kind of market environment in terms of how we and how our competitors move to a controlled order entry process. But the statements about lead-time reductions and such have not yet applied to those commodity products. That was more statements about general products in a better processing, high performance analog power, HVAL, those types of product areas.

Ron Slaymaker

Okay, Srini. Thanks for your questions. And we’ll move to the next caller.

Operator

We’ll go next to Sumit Dhanda with Banc of America/Merrill Lynch.

Sumit Dhanda – Banc of America Securities/Merrill Lynch

Yes, hi, guys. My first question, Kevin, you talked about OpEx going up and some impact to your cost line from higher compensation. A question on operating margins wise segment, it seems like that trend may have impacted all of your segments, but your Other segments. I was wondering what is special there. Was it just that royalty saw a bit uptick relative to everything else in the quarter?

Kevin March

Well, the Other segment actually doesn’t have none of the staffing level that you see in the three primary segments. And so there is not that much compensation to run through there compared to the other ones. And then again we have just very high margin kind of cash cow items, if you will, that are in that segment. And so dollar-for-dollar they tend to fall through quite rich, but really it’s going to come down to – you just don’t have as much compensation inside that segment that’s going to see the changes that we saw in the Other segment.

Ron Slaymaker

Do you have a follow-on to that?

Sumit Dhanda – Banc of America Securities/Merrill Lynch

Yes, I do have one. I know you refrained from commenting specifically on your baseband business into the second quarter. But just overall in terms of the year – do you expect the trends to be largely seasonal, better growth in 3G, offset by maybe some erosion in your hedge business? How should we think about it big picture basis?

Kevin March

Yes. Maybe if I can even move beyond this year, you’ve heard us say for some time and we’ll say it again today that we expect our baseband revenue to be essentially zero by the end of 2012. So if you take our first quarter baseband revenue of $424 million, $425 million and trade line that to zero at the end of 2012, I think what you are going to find is there will likely be quarters above this line and quarters below the line. The exact profile of the decline is going to depend upon our customers’ success in the market and the mix of their 3G versus older technologies, as well as our customers – I'm sorry, our competitors’ progress in delivering baseband product to meet the customers’ needs. So maybe some additional color that can help you to your own analysis on this is if you consider that today 3G baseband represent about 75% of our baseband revenue. And that’s up from about 50% a year ago as the market really has transitioned to these more advanced technologies.

I think it’s well known that our largest customer is intending to multi-source their baseband. And I think what you can expect in 2010 is that competitors should begin to support the older technologies that represented 25% of our baseband revenue in the first quarter. And for 3G, we don’t anticipate competitors to begin ramping new products there until sometime in 2011. So our revenue profile this year in 2010 is going to depend on how the competitive incursions compare against the ongoing market shift to 3G and also how our customer performs in that 3G market. So hopefully that provides you some level of insight. Okay. Thanks for your questions. And we will move to the next caller, please.

Operator

We will go next to Steve Smigie with Raymond James.

Steve Smigie – Raymond James

Great. Thanks, guys. I’m not sure if I missed it, but could you – if you’ve already discussed the mix of high performance in power versus HVAL within analog?

Kevin March

We didn’t specifically break that out, Steve, nor do we – the only – we kind of do more on an annual basis. Think about last year, it was a mix of 30% HPA, 30% power, and the remaining 40% within the HVAL. But we don’t provide quarter-by-quarter updates there. Do you have a follow-on, Steve?

Steve Smigie – Raymond James

Yes. Could you just at least give some color within HPA, what may be driving – I'm assuming that’s up since we are rolling on up 7%. What product types are just generally driving that? Is it amplifiers, is it converters, et cetera? Just on a percentage basis, give us just color on what’s wrong with that?

Kevin March

Yes, sure. From product standpoint, you named several of them there, operational amplifiers, data converters, and then also in the first quarter, industrial interface products or the areas that grew fast sequentially. And our high performance analog business, price similar to lot of the other HPA players that you’ve seen out there, really has a pretty strong exposure to the industrial market and is benefiting as the industrial market continues to have a pretty robust recovery here. So those product areas that I mentioned but didn’t offer maybe more aligned with industrial market overall.

Ron Slaymaker

Okay, Steve. Thanks for your questions. And we will move to the next caller.

Operator

We will go next to Ross Seymore with Deutsche Bank.

Ross Seymore – Deutsche Bank

Hi, guys. Ron, just first a little clarification. You said in your baseband business, 3G was 75% and 50% last year. Did you mean last year as in the first quarter of last year or the entirety of last year?

Ron Slaymaker

First quarter of 2009. So first quarter 2009, 50%, and first quarter 2010 has migrated to 75%.

Ross Seymore – Deutsche Bank

Do you have a kind of an average of what it was for the full year?

Ron Slaymaker

No, but I’ll get to somewhere between those two numbers. Sorry, I don’t have that data in front of me.

Ross Seymore – Deutsche Bank

That’s probably a pretty good guess. The follow-on question, shifting gears to the order book, I know guys – the duration of those orders can be three or six-month orders depending upon the type of customer. Has your lead-time being pulled in started to be visible in the duration of orders that people are placing, three-month versus six-month?

Kevin March

I would suggest that with a 1.14 book-to-bill and a growth rate that we are suggesting probably will consume all those orders next quarter. You can pretty assume, Ross, that we are still seeing some orders in the north of three months kind of window. Nothing north of six months. We just don’t recognize orders that far out. But probably a good portion of those in the three to six-month range. I don’t have the exact breakout, but that would be my expectation.

Ross Seymore – Deutsche Bank

Okay, thank you.

Ron Slaymaker

Okay, Ross, thank you. And we’ll move to the next caller.

Operator

We’ll go next to Glen Yeung with Citi.

Glen Yeung – Citi

Maybe just following up on that last question, when you guys are getting orders now, are you going through a process of scrubbing those for anything you think may be kind of questionable order, and if your process any different now than may it has been in the past?

Ron Slaymaker

Glen, probably this is real simple. The process is the same as it has been for the last few quarters now. And so we are looking very closely at each order coming in and making sure that we are meeting true demand, what the customer needs to keep their lines up.

Glen Yeung – Citi

Okay, thanks for that, Kevin. And then my follow-up is on capacity growth. Are you guys able to quantify how much capacity you are bringing on maybe in 8-inch equivalent, let’s say, by the end of this calendar year? And then can you compare that point to where you were at, say, the end of 2008, i.e., are you above your ‘08 amount of capacity or below?

Kevin March

Glen, I don’t have those numbers. Certainly we talked about on the 300 millimeter the incremental revenue that that will give us. And we have talked about purchasing and deploying 200 millimeter equipment last year and more this year, but frankly, I don’t have the numbers for you to give you any further answer on that.

Ron Slaymaker

We are clearly adding capacity. I think you saw, I believe it was in the release, every quarter of this year of – the starting point is production now for the first quarter is higher than it’s ever been and our capacity increases sequentially every quarter, as we move through 2010.

Glen Yeung – Citi

Maybe just to clarify that, was there some capacity decline from your peak capacity levels in ’08?

Kevin March

No, we did not take any factories offline. The other factory we’ve taken offline in the last couple of years has been KFAB. And we’ve redeployed that. That was back in early ’07. And then there was an older factory that we had acquired with the Burr-Brown acquisition in Tucson that we also ran down in the early ’08 time frame. But during the downturn we took no capacity offline. In fact, we’ve added in the capacity.

Glen Yeung – Citi

Okay. All right, thanks.

Ron Slaymaker

Thank you, Glen. Next caller please.

Operator

We’ll go to John Pitzer with Credit Suisse.

John Pitzer – Credit Suisse

Yes, good afternoon, guys. Thanks for taking my question. I guess, Kevin, if you guys hit the high end of your June guidance, you will start to see revenue that you saw make in sort of the December ’07 time period. But gross margins are actually going to be down a little bit from that December ’07 quarter. And I guess given that the mix has moved dramatically more towards analog, I’m just trying to figure out how we should think about that?

Kevin March

John, I don’t have the data in front of me from that time period back there. And I’m not quite sure how you are modeling the gross margin assumption. I would just remind you that the OpEx will be up a little bit though again next quarter, as I mentioned earlier, on our full quarter’s overall compensation change. So I don’t know how you are squeezing that through your model, but you should take note of that. But beyond that, I don’t have the data in front of me for that time frame in 2007. So I can’t respond to you well on that.

Ron Slaymaker

Do you have a follow-on, John?

John Pitzer – Credit Suisse

Yes. My follow-up, as we think about 300 millimeters coming online, how do we model that from a gross margin perspective? Is it just incremental depreciation or will you guys go through a couple quarters of kind of sub-optimal yields if we need to kind of work into the model?

Kevin March

Clearly, as we are ramping about, even as we speak, we are ramping up now. We are experiencing a cost there because everything that we are doing there is not inventory (inaudible) just being expensed. The way to think about the economics on that is, generally speaking, the die cost would be about 30% less than what the equivalent die would be on a 200 millimeter wafer. On LL parts, about 50% of your cost is in die and 50% is in the assembly or test. So you will get probably about 15% kind of manufacturing cost reduction in the apples-to-apples comparison to 8-inch. That’s really at the product level. And so as we look at turning that into analog revenue coming out of that factor, I think you can kind of model those numbers out and figure out the incremental gross margin, we will get out of that factory.

Ron Slaymaker

Okay, John. Thanks for your question.

John Pitzer – Credit Suisse

Thank you.

Ron Slaymaker

And we’ll move to the next caller, please.

Operator

We’ll go next to Doug Freedman with Broadpoint.

Doug Freedman – Broadpoint

Great. Thanks for taking my question, guys. Ron, you offered some great detail on the ramp-down on the Wireless business in the baseband side. Can you actually talk more about what’s happening on the business that you are keeping, that the apps processors and the connectivity and what you expectations are for that business throughout the year and into next year?

Ron Slaymaker

I don’t have a specific forecast for you, but let me just say, it’s tied to a smartphone market where we believe you probably have smartphones growing on the order of 40% unit growth this year compared to last year. So being in a rapidly growing market is always a good thing. And then secondly, a thoughtful expectation that over the course of time we want to continue taking market share there across all the applications, processors, as well as the connectivity products. So it’s a combination. The strategy, as you might guess, is very attractive market in terms of growth, which is why we’ve centered up our wireless investment in that space and then also playing from the strength of our position and our technology with the OMAP applications processor.

And then a lot of connectivity right now is a lot of integration of multiple connectivity technologies into pure chip, both for power consumption and cost. And we are absolutely leading that integration. I think near-term on OMAP, the growth driver will be just the deployment of OMAP 3, which is our latest production part, and soon to be followed up with OMAP 4, as you might guess. So we’ve got a good pipeline of technologies, and we have a great pipeline of design wins. OMAP 3 will be ramping more than 50 design wins over the course of the next – over the next year into production, and we think that points to a very attractive growth opportunity. Do you have a follow-on, Doug?

Doug Freedman – Broadpoint

Yes. That’s great color. Thank you, Ron. Kevin, for you, on the OpEx side, you keep mentioning your target model 55% and 30% for the operating margins. That would imply 25% OpEx spending. You are actually running under that. Are we going to get ourselves in trouble here thinking that it’s based at the present percentages, or should we be modeling that percentage to come back up? Then follow-on to that is, what is your present plan for use of cash and your fab ratios?

Kevin March

Doug, on the OpEx, we are mindful of computing that OpEx percent with baseband removed. We know it’s going to be going to zero at some point. And so when you do that, we’re actually at about 26%. So we will continue to be very disciplined in how we manage the OpEx for the foreseeable future. As to the use of cash, you’ve seen us over the last few years using cash flow (inaudible) and dividend increases. I can’t make any specific forecast on those – on dividend increase of course because they are subject to Board approval. But as we continue to generate cash, we first try to deploy it internally for growth and to the extent that we’ve deployed as much as we can effectively growth with, then we will continue to do buyback and also continue to pay dividends to our shareholders. I don’t have a specific payout ratio for you that tried to model in or (inaudible) communicate right now.

Ron Slaymaker

Okay. Thanks, Doug. And we’ll move to the next caller, please.

Operator

We’ll go next to Stacy Rasgon with Sanford Bernstein.

Stacy Rasgon – Sanford Bernstein

Hi, guys, thanks for taking my question. Just one question on the operating margins by business units. The core business is the non-Other stuff they all compressed. Embedded compressed quite a bit differently than the others. It was down about 500 basis points versus about 100 to 200 basis points for Analog and Wireless. Can you give me some feeling for – were the compensation increases and OpEx increases by business unit about the same? And what does that imply for the gross margins of those individual businesses and the change in those gross margins out of this quarter?

Kevin March

Really the biggest thing is we’ve got to kind of carefully look at us, Stacy, is we are still redeploying internally. I think Ron mentioned in his remarks that about 90% of our total R&D is now going towards three growth areas, the Analog, Embedded Processing, and the non-baseband portion of Wireless. That transition has been underway for really very aggressively during 2009, but even started earlier than that. So what you’re seeing on a quarter-over-quarter basis is a little bit more just to redeploy it. Again, some of that is coming out of the Other segment, going into Embedding Processing and so on. We’ve also stepped up our staffing level there quite a bit in the sales that you accelerate the opportunities we see, especially in the microcontroller space with the 32-bit opportunities that we see emerging on that side.

Ron Slaymaker

Kevin, I think you had a lot of TI employees listening very carefully to how you are going to answer that question. Stacy, do you have a follow-on?

Stacy Rasgon – Sanford Bernstein

Got it. Yes, I do. Around the phase two for the 300 millimeter, can you give me a feeling for – you bought 100 tools. Is that how complete is the purchase for phase two? Can you give me a feeling for I guess the degree of discount you are getting for this equipment versus what you paid for phase one? I think phase one was, what, $173 million for the full 13,000 wafers per month?

Kevin March

Yes. Phase one actually supports part of phase two also by the way. One of the things that phase two is really good is on line balancing for us. So we spend about $75 million on those 200 – on those 100 tools that we mentioned earlier. And we will be needing to acquire some more tools to complete phase two. Overall, spending will probably be below what we spent on phase one, but that’s really because of your line balancing. And what I mean by that is some of the phase one equipment can support more than just incremental $1 billion of revenue we’ve been talking about. It supports into the $2 billion number. But without some of the line balancing equipment that phase two starts bringing and you really can’t get that kind of fruit. So that’s what you are seeing happening here. And our cost for that equipment so far in phase two has been quite similar to what we saw in phase one.

Stacy Rasgon – Sanford Bernstein

Got it. Thank you, guys.

Ron Slaymaker

Okay. Thank you, Stacy. So, Kevin, what you just said was that the phase two – put it this way. The equipment purchase requirement for our second billion dollars of revenue at our fab should be less than what was required for phase one, which was the first billion dollars. Is that correct?

Kevin March

Right.

Ron Slaymaker

Okay. All right. And operator, we’re going to move to our final questioner here.

Operator

And we will go to Tim Luke with Barclays.

Tim Luke – Barclays

Hi (inaudible).

Ron Slaymaker

I didn’t know of you, Tim. (inaudible) go ahead.

Tim Luke – Barclays

Okay. Obviously you were successful in building a bit of inventory in the quarter. In the first quarter, are you thinking that you are likely or planning to build some more inventory in the coming quarter? And as you've now made some progress in reducing the lead-times, do you get the sense that your lead-times, Kevin, based on what you see now are likely with the plans that you have in place to be at the normalized levels by, say, the end of the third quarter? Or do you think that could happen somewhat earlier?

Kevin March

Tim, on the inventory build-out, if you look at into specific forecast on the inventory itself. I would just point out though, as I mentioned earlier to one of the other questions, at a 1.14 book-to-bill, really our orders are stronger than our outlook, which means we are getting orders that are probably out into the first quarter. And so in the second quarter, we will begin to build not only the second quarter deliveries but also third quarter deliveries. And to the extent that the revenue continues to grow, of course we have to build more inventory to support that. So you would see some growth if in fact we expect revenue to increase in the third quarter. But it’s too early for me to give you a forecast on that.

But as to the lead-times reach a normal level, I think our customers would love if I could say right now, but the truth of the matter is, we do plan on continuing to put equipment in place for each of the quarters of 2010. And it’s really going to be a function of just how strong demand continues to be. If it keeps on coming in at the upper end of our forecast ranges, it will take us longer to get that lead-time cleared up. If it comes in around the midpoint or lower, we’ll clean it up sooner. And clearly it is in our interest to try to get it cleaned up as quickly as possible, and I’d like to say the 2010 numbers.

Tim Luke – Barclays

A follow-up if I may is, given what you've seen, and you had a stronger than expected beginning of the year in the first quarter, then seasonal traditionally and maybe seasonal-ish in the second quarter, do you feel that you're now entering an environment that's likely to play out after the second half of the year largely according to seasonal norms given what you see? Or do you feel, given the strength of the beginning of the year, that you might expect it to be somewhat more moderate than the norm? And obviously Rich, in recent speeches, has been talking about how it's unusual to see a book-to-bill of more than one for five quarters. And this is the fifth quarter. But on the other hand, it seems you're saying that you've seen quite good order strength through the beginning of this. Do you have any further thoughts that you might be able to sort of share or frame with us in terms of expectation on how that book-to-bill might begin to trend? Thank you.

Kevin March

Look, I can give you a short answer and say I probably don’t know the answer to that question. But I would say that what we are seeing here is the results of economies are generally growing again and the consumers are beginning to spend again. We are seeing it in the automotive space. We are seeing the consumer space. We are seeing the industrial coming back. We know that inventories remain very lean, as we’ve been talking about. And it doesn’t appear to us that they are likely to become that cleared up, if you will, in the first half. So that would suggest that we will continue to see some interesting growth as to exactly what size – I don’t know how to forecast that for you right now.

Ron Slaymaker

So, Tim, one thing I would just add is, there has been a whole lot normal about this downturn and the subsequent recovery that we’ve gone through. I mean, I think the last 18 months has been highly unusual. So I wouldn’t try to force it into any kind of normal pattern matching. And then I think the other comment I would make is if you look at our second quarter outlook of – the middle of the outlook really is pretty seasonal for TI in terms of the second quarter. So we don’t have an outlook that we are issuing for second half, but at least the next quarter we can affirm our belief that it should be seasonal, at least in the middle of that range. Okay, Tim, thank you.

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

Operator

That concludes today’s conference. Thank you for your participation.

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Source: Texas Instruments Inc. Q1 2010 Earnings Call Transcript
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