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Texas Instruments Inc. (NASDAQ:TXN)

September 08, 2011 5:00 pm ET

Executives

Ron Slaymaker - IR

Analysts

James Covello - Goldman Sachs Group Inc.

Uche Orji - UBS Investment Bank

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

Christopher Muse - Barclays Capital

Christopher Danely - JP Morgan Chase & Co

Ross Seymore - Deutsche Bank AG

Srini Pajjuri - Credit Agricole Securities (NYSE:USA) Inc.

Vivek Arya - BofA Merrill Lynch

Romit Shah - Nomura Securities Co. Ltd.

Mark Lipacis - Jefferies & Company, Inc.

John Pitzer - Crédit Suisse AG

Operator

Good day, and welcome to the Texas Instruments Third Quarter 2011 Mid-Quarter Update Conference Call. Today's call is being recorded. At this time, I would like to turn the conference over to Ron Slaymaker. Please go ahead, sir.

Ron Slaymaker

Good afternoon. Thank you for joining TI's mid-quarter financial update for the third quarter of 2011. In a moment, I will provide a short summary of TI's current expectations for the quarter, updating the revenue and EPS estimate ranges for the company. In general, I will not provide detailed information on revenue trends by segment or end markets and I will not address details of profit margins. In our earnings release at the end of the quarter, we will provide this information.

As usual with our mid-quarter update, we will not be taking follow-up calls this evening. Considering the limited information available at this point in the quarter and in consideration of everyone's time, we will limit this call to 30 minutes. For any of you who missed the release, you can find it on our website at ti.com/ir. This call is broadcast live over the web and can be accessed through TI's website. A replay will be available through the web.

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

We have narrowed and lowered our expected ranges for TI's revenue and earnings from our previous ranges. We now expect TI revenue between $3.23 billion and $3.37 billion. We expect earnings per share between $0.56 and $0.60. The reductions are due to broadly lower demands across a wide range of products, markets and customers.

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

Question-and-Answer Session

Operator

[Operator Instructions] And we'll take our first question from John Pitzer with Credit Suisse.

John Pitzer - Crédit Suisse AG

I know you mentioned in the preamble you weren't going to talk about operating margins or profitably, but I'm just kind of curious, the EPS line is holding up much better than the revenue on the new guidance. I'm kind of curious if you could walk me kind of through the puts and takes of what's driving that. How quickly are you guys able to react on OpEx relative to the current environment versus what might be going on in the mix of revenue?

Ron Slaymaker

Okay, John, there's really 2 reasons behind why you didn't see a more, call it, proportionate drop between EPS and revenue. The first is that we are reducing variable expenses really on multiple fronts just in light of the weaker environment that we're currently in. So for example, our compensation includes variable components such as bonus and profit sharing that we've now revised downward. The second consideration is that with our lower profit outlook we've revised our annual effective tax rate estimate down to about 25% from our prior estimate of 27%. And as you're aware since we have been accruing both of those items at higher rates during the first half of the year, we will also then have a catch-up in the accounting, a catch-up benefit in the third quarter. So that really explains the difference between what you might have expected for EPS to go to versus what we're projecting here. Do you have a follow-on, John?

John Pitzer - Crédit Suisse AG

Yes. Ron, you talked a little about the variable cost that you can go after, just on the fixed cost side, anything happening to CapEx and/or headcount?

Ron Slaymaker

No. In terms of CapEx, no change to our guidance on that. And in terms of headcount, I would -- I'll actually change that somewhat to hiring. I mean we're actually still hiring for strategic programs. Hiring has become much more selective, you might say, in this environment. And we're certainly keeping our resources focused on what we believe are the best opportunities that we're addressing, but the hiring has become more selective. But outside of that, no real headcount swings other than what might come about from attrition. We'll move to the next caller, please?

Operator

And we'll go next to, Tore Svanberg with Stifel Nicolaus.

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

Ron, could you talk a little bit about the distribution channel, what you're seeing there, especially as far as inventory level and lead times. I'm just trying to understand how they are sort of reacting to this lower demand environment?

Ron Slaymaker

Okay. I guess what I would say is that we expect resales from our distribution channel to decline at about the same rate as our overall revenue. So therefore, kind of mid-single-digit declines on sales out of the channel. We expect really little change in distribution inventory levels on an absolute basis. Although with the declining resales, they could be up somewhat on a days basis. Do you have a follow-on, Tore?

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

Yes, should we assume that by product lines, things are tracking the same too? I'm just trying to understand if maybe your Wireless business is tracking seasonally better than, let's say, Analog and Embedded Processing?

Ron Slaymaker

Not really, Tore. I guess, just in general, we're seeing broadly lower demand across our product lines and then as I said previously, customers as well as markets. So if you kind of walk through the segment, we would expect both Analog and Embedded Processing, which are both very diverse businesses, to decline sequentially. Wireless will likely be about even with the second quarter but also note that the third quarter is traditionally our Wireless segment's seasonally strongest quarter, so flat is really pretty weak for that for our third quarter. Within Wireless, I would note that our OMAP applications processor revenue, we expect will be up strongly compared with the second quarter, while connectivity revenue will be down due to customer bit mix. Baseband revenue will likely also be up. Finally, our other segment, really, we would expect it to be up mostly due to DLP revenue that will benefit from increased output from our factory in Miho, Japan. And you might recall that product line, and certainly that factory, was impacted by the earthquake and the subsequent shutdown there. And let's move to the next caller.

Operator

And we'll go next to Chris Danely with JP Morgan.

Christopher Danely - JP Morgan Chase & Co

Ron, can you just maybe comment on TI's internal inventory and what the plans are for the utilization rate?

Ron Slaymaker

Okay. So from an inventory standpoint, I think, as you probably might assume, inventory and inventory days will both move up this quarter as we had planned operationally for a stronger demand environment than what is evidenced to us today. So that being said, we had already reduced production starts even coming out of second quarter, although there will be some lag time before that action would impact the inventory level. And I said even coming out of second quarter, you'll recall that in the second quarter, we said during the month of June is really when it started to become evident to us that we were seeing below seasonal forecast out of our computing and various consumer customers and that led to our guidance for our third quarter to be below seasonal. So again, during the month of June, we had already started to take action to lower utilization rate production starts. But again there's -- until that works through the system, there won't be an immediate impact on inventory. I'll also note the inventory that we had in place, for the most part are long-lived catalog products, where really there's practically no risk of obsolescence. Do you have a follow-on, Chris?

Christopher Danely - JP Morgan Chase & Co

Yes, just to follow up on your June commentary. Can you just talk about the linearity or trend of orders and bookings for this quarter and what it would mean for Q4?

Ron Slaymaker

Yes, I don't know that I want to talk linearity but I will say that orders are weak and we expect that in total, third quarter orders will be down from the second quarter level. And we'll move to the next caller.

Operator

And we'll go next to Mark Lipacis with Jefferies.

Mark Lipacis - Jefferies & Company, Inc.

Ron, in 2008, one of the things that we saw happen was the channel taking inventories below normal levels because of the panic associated with the financial crisis. And my question is to what extent do think what you're seeing now from your customers, the lower demand, is that driven by serious concerns about the market and people wanting to de-stock inventories and take them below normal? Or is this do you think a reflection of your customers just reacting right to the weaker demand environment?

Ron Slaymaker

I believe the latter. So we do not believe that what we're encountering would be a typical semiconductor inventory cycle. Macroeconomic weakness is resulting in broadly lower demand from both consumers and enterprises and as our customer's been or faced with lower demand for their product, of course, they rationalize their inventory levels. But the real root issue is demand, not too much inventory. And I think you'll recall, we described, in some detail, back in July, that we believe inventories were in pretty good shape both in our distribution channel as well as the high percentage of customers, OEM customers, where we have consignment programs. So again, we had reasonable visibility in inventory levels and they seemed fine. But of course, as people forecasted, customers forecasted, their demand goes down, then of course, they will rationalize inventory levels as well. Do you have a follow-on?

Mark Lipacis - Jefferies & Company, Inc.

Yes. Some analog companies are seeing higher commodity prices impact their gross margins, is this impacting you guys?

Ron Slaymaker

I would say to some degree. I mean items like gold certainly are a factor in our cost and they've -- commodities in general have gone up, but I don't know that we will, now or certainly in October, either be able to quantify that specifically. We'll move to the next caller, please?

Operator

We'll go next to Jim Covello of Goldman Sachs.

James Covello - Goldman Sachs Group Inc.

Ron, what do you get from the sense of your lead times versus your competitor lead times? The reason I ask, I'm trying to get sense of how much of the incremental revenue weakness you're talking about today is a function of the fact that if your lead times are a little longer than some others maybe this is just going to catch up from what others are seeing or if this is just an incremental let down for everybody?

Ron Slaymaker

Jim, I don't know that we can answer that. I think our lead times, we would characterize, are at normal levels. And I would say that also includes Miho-source products where, you might recall, we described in July, that lead times had been extended for those products that were manufactured there given the supply constraint. But we've pretty much resolved those and have lead times back to normal levels. So, I don't know are we leading or lagging in terms of time versus what you're seeing from others? But we'll let you make that assessment. Do you have a follow-on, Jim?

James Covello - Goldman Sachs Group Inc.

No that's good.

Ron Slaymaker

And next caller, please?

Operator

We'll go next to Ross Seymore with Deutsche Bank.

Ross Seymore - Deutsche Bank AG

Just wanted to think about the utilization you said you are bringing down is to try to control inventory. How does that flow through to the gross margin line? Do you period expense that or does it have to work its way through so the gross margin impact is actually delayed by a quarter or so?

Ron Slaymaker

No, the gross margin impact is felt immediately. So we expense -- essentially any cost impact associated with underutilization, we expense in the current period and all of our inventory is valued at standard cost. Do you have a follow-on, Ross?

Ross Seymore - Deutsche Bank AG

I do, a quick one, just for clarification. When you talked about the Wireless business performing roughly flat, did I hear right that both OMAP and Baseband would be up? And if so, does connectivity really have to go down a ton to offset those 2 rising?

Ron Slaymaker

You heard right that OMAP is up strongly, Baseband, we expect to be up and connectivity will offset growth in both of those areas, that's correct. And we'll move to the next caller.

Operator

We'll go next to Romit Shah with Nomura.

Romit Shah - Nomura Securities Co. Ltd.

Would you expect gross margins to be up given the reduction in variable expenses?

Ron Slaymaker

Romit, we don't specifically break out guidance on -- even with our end of the quarter guidance, we don't get it down to the gross margin levels. So, I won't specifically address that. I'll talk a little bit about maybe some of the puts and takes. We talked about even last quarter that, sequentially, we would have less impact from the cost associated with the shutdown and the various operational disruptions we had in Japan. That would be a positive factor also to last quarter. Certainly, utilization weighs on gross margin, although I would say, to a lesser degree today than if you go back a number of years ago just because Analog and Embedded Processing tend to be less capital intensive and relative to revenue, those fixed costs would tend to be lower as a percentage. And then some of the positive offsets, of course, tax won't have any impact on cost of goods although some of the variable compensation pieces would flow through cost of goods as well. Do you have a follow-on, Romit?

Romit Shah - Nomura Securities Co. Ltd.

Yes, Ron. I understand that the deal hasn't closed yet but previously, you talked about $100 million in synergies from the National acquisition. Is there any change there just given the overall environment?

Ron Slaymaker

No, not at all. Maybe I can provide a brief update in terms of where we are with National and closing and it really is unchanged from what we talked about previously though. I think we had previously said we have cleared all the antitrust reviews. There were something like 12 to 15 various reviews that we went through around the world. All of those are clear with the exception of China, which remains underway. We have -- National has their shareholder approval, of course. That occurred on, I believe it was June 21 and we have all of our funding in place. So again, the only thing we're waiting on is the clearance through China. We've encountered no specific obstacles. It's just taking longer there as we had initially expected. As soon as we get the China approval, you'll see us issue a public statement and then we would expect to close the transaction within a few days of that notice. With respect to synergies, this remains about accelerating revenue growth at National. You know as well as we do they have not grown consistent with the Analog market overall. We believe we know how to turn that around and get their growth in Analog very consistent with what you've seen from TI, which is a very significant outperformance relative to the market. So revenue synergy is the basis for the acquisition and for the return that we believe we can drive on that acquisition. From a cost standpoint, we continue to expect that we will be able to achieve about $100 million of cost synergy and have that run rate, annual run rate, achieved about 12 months after the close of the acquisition. Okay, hopefully that helps. We'll move to the next caller.

Operator

And we'll go next to Vivek Arya with Bank of America Merrill Lynch.

Vivek Arya - BofA Merrill Lynch

Ron, what is your sense of the industry broadly? Is this downturn looking like a one quarter issue or do you think it could persist in the fourth quarter? Also I understand visibility is sort of limited right now.

Ron Slaymaker

That's correct. So I guess what I would say is, since this downturn is macro driven. We really have no special insight into how long it will take. By contrast, in an inventory-driven correction, we can make some assumptions about how much excess inventory exists and the burn rate of that inventory to then estimate what might be the duration of the correction. In this case, all I can really say is we're confident we'll return to growth whenever consumer and enterprise spending starts to increase again and we'll let you make the estimates on when that might be. Do you have a follow-on?

Vivek Arya - BofA Merrill Lynch

Yes. Just one other one. I'm curious why connectivity would be down but OMAP and Baseband up in Q3. Do they generally track each other? Or is there some other competitive issue at play here?

Ron Slaymaker

Not a competitive issue. It's simply a question of customer mix. We sell connect -- there's some overlap in our OMAP and our connectivity customer basis but not complete. And I would just describe that some of our biggest connectivity customers have not been performing as well in their markets recently and you're seeing that in our connectivity revenue. But again, I would describe it as much more a customer mix consideration than any kind of a competitive consideration. Let's move to the next caller.

Operator

And we'll go next to C.J. Muse with Barclays Capital.

Christopher Muse - Barclays Capital

I guess first question. In terms of end market, I was hoping you could provide a little granularity there of the puts and takes that you're seeing, I guess in context of consumer and computing as being highlighted, the areas of weakness in July. Curious what you're seeing as of today?

Ron Slaymaker

Okay, so you're right. In July, we really identified consumer and computing as areas where we expected below seasonal results in the current quarter. What's different today is basically that today we see broad-based weakness. It's across more customers and markets. For example, in July, we described that the industrial market was still stable for us. Today, it's weakening. So in general, I would describe a market trend as all broadly weaker really without any major exceptions. Do you have a follow-on, C.J.?

Christopher Muse - Barclays Capital

I do. Given, I guess, the poor visibility you have today, uncertainty to the timing of recovery given how you stated it's macro driven, curious what your plans are today. You've got inventory growing Q-on-Q and would love to hear your thoughts on your plans for utilization and how we should think about the impact there to gross margins in the next quarter or 2.

Ron Slaymaker

Okay, C.J., we're not going to give you a completely satisfying answer other than saying what I said before, which is we have pulled back on production starts. We began that process in June. Utilization, we would expect to be lower this quarter than second quarter as a result of that. Utilization is one of many factors on gross margin. As I said previously, we also have some -- we have puts as well as takes such as lower Japan-related costs but I'll probably just leave it there. And we'll move to the next caller.

Operator

And we'll go next to Srini Pajjuri with CLSA Securities.

Srini Pajjuri - Credit Agricole Securities (USA) Inc.

Ron, on your balance sheet inventories, I guess, there were 93 days coming into the quarter and, historically, there were as low as 63 days. I'm just wondering what's the right way to think about that number going forward?

Ron Slaymaker

Okay, well, short term, as I said, 93 days will go higher. I think over the longer term, there has been, as you've noticed, a trend where our inventory levels have tended to move up. That's partly a nature of our product mix and as our revenue gets centered op more and more on Analog and Embedded Processing, and especially the catalog or standard product pieces of those product lines, as they become a bigger part of our revenue, those tend to be more off-the-shelf type of models certainly versus custom products, where we tend not to build until we have a customer commitment in hand. The good news is those catalog products, as I described before, in many cases will have a 10-plus year product life. So the risk of obsolescence, the risk of that inventory tends to be very low. There is some costs associated with that, but again the opportunity and the relative profit associated with those catalog products certainly justifies the cost of carrying it. The other thing I would mention, and you've heard us talk about this for sometime, is that inventory has tended to move upstream from distributors and from our OEMs to TI as we've implemented more customer-specific programs such as consignment. And frankly, yes, there is some costs to TI in terms of carrying that inventory but there's a huge benefit from the standpoint of that inventory is positioned where it's most flexible and it's also positioned where we have the greatest visibility. So the risk that you've seen in the past of various players hoarding inventory during times when the markets are hot and then having to deplete that inventory and what that amplifies in terms of the cycles on our business will be improved anyway by us carrying that inventory versus having it downstream from TI. So I'll just leave it with that. Srini, do you have a follow-on?

Srini Pajjuri - Credit Agricole Securities (USA) Inc.

Yes, Ron. On the end market discussion, you said most of the end markets are weak but PCN consumer, they have been weak for a while. I'm just wondering -- I mean are they continuing to weaken or at this point have they stabilized to a certain level?

Ron Slaymaker

I would say they're weaker than where we were expecting in July. And in July, what we were seeing was really not that we have seen those markets weaken or turn down versus we just weren't seeing customers' forecast seasonal growth in those markets. So I would say, they had -- again, it wasn't a turn down, it was just lack of growth. I would say, at this point, we would describe both of those have weakened. You might also be just interested in, from a geographical perspective, one thing that's happening there as we expected from a positive standpoint is we are seeing some lift out of Japan. So as those various customers get their factories online, we're seeing that post-earthquake recovery happen consistent with our expectation. We'll move to the next caller, please. This will need to be our last set of questions.

Operator

We'll go next to Uche Orji with UBS.

Uche Orji - UBS Investment Bank

Ron, real quickly, I just wanted to probe on the OMAP comments you made about it being up strongly, how much of that is seasonality and how much of that is new design wins and just for us to gauge how sustainable that strength is beyond just this season?

Ron Slaymaker

Okay. It is clearly new design wins. So it's not seasonality. It ties very specifically to programs that we've won, we've worked for some time, and we have customers now ramping or preparing -- ramping programs into production, preparing for their product launches, I guess is the best way of saying that. So in general, we're very confident in the strength of our design pipeline for OMAP products and that goes across a broad range of customers in both the tablet and smartphone markets. There's still a lot of work for us to do to turn those programs into revenue and we'll let our results there speak for themselves. I'm not going to try to give you a 2012 forecast for OMAP. But I will say that we have a solid ramp of programs, part of what we're experiencing today with a lot more of those yet to come. Do you have a follow-on, Uche?

Uche Orji - UBS Investment Bank

Yes, I do. The Baseband business, I mean, please correct me, did I heard you say it's going to be up?

Ron Slaymaker

Baseband, we do expect to be up. Was that a question or...

Uche Orji - UBS Investment Bank

I mean I just wanted to clarify that before I ask my question. So are we still -- is it planned still to ramp this down to 0 or technically wind this down by the end of 2013, which is what you've said in the past. And the reason I ask this is that business has been resilient for much longer than one would have expected and should we still be modeling this to technically be gone by the end of 2013?

Ron Slaymaker

That's a great question, Uche, and you're exactly right. We expect that by the end of 2012 that business will be ramped down, that revenue will ramp down, such that we really have no revenue to speak of there in 2013. I think what you've seen is, you'll recall, the last 2 quarters, we saw very sharp declines in our Baseband revenue. Our customer there obviously was adjusting both based on just their new run rates but also probably taking care of some inventory of their products. And so you'll see a little bit of maybe seasonality come back, maybe also a little bit of just call it, the small snapback from that inventory correction that we saw in the second quarter. But it'll probably be a bit lumpy but the Baseband revenue, we do expect to decline through the end of next year.

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

Operator

Thank you, everyone. That does conclude today's conference. We thank you for your participation.

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Source: Texas Instruments Inc. Q3 2011 Guidance/Update Call
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