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Texas Instruments Inc. (NASDAQ:TXN)

December 08, 2011 5:00 pm ET

Executives

Ron Slaymaker -

Richard K. Templeton - Chairman, Chief Executive Officer, President and Member of Special Committee

Analysts

John Pitzer - Crédit Suisse AG, Research Division

James Covello - Goldman Sachs Group Inc., Research Division

Craig A. Ellis - Caris & Company, Inc., Research Division

Uche X. Orji - UBS Investment Bank, Research Division

Mark Lipacis - Jefferies & Company, Inc., Research Division

Christopher B. Danely - JP Morgan Chase & Co, Research Division

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

Vivek Arya - BofA Merrill Lynch, Research Division

Shawn R. Webster - Macquarie Research

Operator

Good day, and welcome to the Texas Instruments Fourth Quarter 2011 Mid-Quarter Update Conference Call. At this time, I would like to turn the conference over to Mr. Ron Slaymaker. Please go ahead, sir.

Ron Slaymaker

Good afternoon, and thank you for joining TI's mid-quarter financial update for the fourth 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 $3.19 billion and $3.33 billion. We expect earnings per share between $0.21 and $0.25. The reductions are due to broadly lower demand across a wide range of markets, customers and products, except for wireless applications processors.

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 go first to Uche Orji with UBS.

Uche X. Orji - UBS Investment Bank, Research Division

Ron, can I just ask you if there are any one-time items that may have impacted the EPS the way it did related to the revenue downgrade?

Ron Slaymaker

Uche, are you asking specifically about why it seems like EPS moved...

Uche X. Orji - UBS Investment Bank, Research Division

That is correct.

Richard K. Templeton

Down disproportionate to the revenue? I don't know that I would say -- actually, there are some one-time items. Let me kind of walk through that transition, in general, if I can. First of all, I would say mix is unfavorable. And if you think about it, we actually haven't talked yet about product areas per se, but what I would say is we're seeing downsize versus our expectations in some of the more profitable areas, such as communications infrastructure and some of the catalog analog and Embedded Processing product areas, while at the same time, we're seeing upside in Wireless. So that mix shift is unfavorable to profit margins, and therefore, EPS. I think also impacting us this quarter is utilization, with revenue down more than we had initially expected. We've also further reduced production loadings to avoid building excess inventory. And so as a result, the underutilization expense will be higher this quarter, therefore further pressuring profit margins compared to last quarter. And then finally, maybe to the point you had initially asked. We will have higher acquisition-related expenses by about $20 million, which is about $0.01 per share higher than what we had previously expected.

Uche X. Orji - UBS Investment Bank, Research Division

Now in terms of the -- what changed between the last earnings call and now? Obviously, we know the macro has continued to weaken. But in terms of the expectation that we will have seen a bottoming process forming, are you still willing to stand by that comment even though you've had to lower now? I mean, you've had to recalibrate how you view things from here onwards. In respect to the earlier comments from your last earnings call, how should I think about it?

Ron Slaymaker

Okay. So let's start with what changed. And again, as I said in my opening remarks, the weakness really is pretty broad-based with the exception of Wireless. So revenue in our Analog, Embedded Processing and other segments is weaker than we had originally expected. If you look at it by end market, communications infrastructure is exceptionally weak. Really, that's being driven by UMTS-based systems in North America as those couple of carriers await the outcome of their proposed merger. Industrial markets also remain weak, and I would say in that space, we have both customers and distributors seemingly pushing component inventory levels to very low levels. In the computing space, computing overall is down with declines at storage or hard disk drive customers, especially exacerbated by the flooding in Thailand. And then consumer product areas, such as televisions and video games are also weak this quarter. I mentioned the one bright spot is Wireless, and there our OMAP revenue is doing very well this quarter. Just as a reminder, we're now seeing the benefit of customer programs that have ramped into production using our latest OMAP 4 processor. Those customer programs include Samsung's Nexus smartphone, which is our first production program based on Google's Ice Cream Sandwich reference design; Samsung's GALAXY S II smartphone, Motorola's DROID BIONIC and RAZR smartphones, LG's Thrill smartphone with its 3D playback and capture feature. And then most recently, the Amazon Fire tablet and the Barnes & Noble NOOK Tablet are both based upon OMAP 4. And then probably the final end market area that I would mention is automotive. And there, I would describe that sales into our automotive applications, we would expect this quarter to be about flat sequentially, which was really about as we had expected. So that's really what changed, Uche.

Operator

We'll go next to Shawn Webster with Macquarie.

Shawn R. Webster - Macquarie Research

I was wondering if you could add some color, if you could, on the order linearity. When did -- did you see cancellations and pushouts? Or is it just turns didn't come in as expected? And how did orders progress month by month for the quarter so far?

Ron Slaymaker

Okay. Shawn, I would say orders -- total orders likely declined some from the third quarter level. This decline -- excuse me, this decline includes the seasonal impact from calculators, as well as what I would just characterize as lumpiness in baseband. If we just look at our semiconductor products and pull out baseband because of that lumpiness, I would say orders there have generally been moving sideways since the significant drop that we saw in the month of July and that we talked about in our October call. They've been kind of noisy from a month-to-month basis, but the overall trend has been flattish since that period.

Shawn R. Webster - Macquarie Research

Just on inventories, I was wondering if you could hazard a guess if you think your OEM and your distribution customers are burning inventory now or what your visibility there is?

Ron Slaymaker

All right. Clearly, reducing inventories, and I would say really in both fronts. The distribution, we, obviously, see that data most clearly because we just know what distributors are carrying. And they are continuing to take inventories down, and I would say they have inventories down to very low levels. And our belief is that at the OEM customers, inventory is being reduced and that, in fact, we're undershipping those customers' production levels.

Operator

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

Vivek Arya - BofA Merrill Lynch, Research Division

I have actually a longer term question. So in the past year, you have added a significant amount of capacity and I understand these are not shotgun decisions. But structurally, are there actions that you can take to in the downside if macro remains somewhat weak for the next 1 or 2 quarters also?

Ron Slaymaker

You mean specifically in terms of shutting down some of that capacity.

Vivek Arya - BofA Merrill Lynch, Research Division

Yes, because gross margin have taken a big hit over the last several quarters and I'm trying to understand how you can sort of limit downside from here given that the visibility is still somewhat weak out there.

Ron Slaymaker

Yes. In fact, I would just say that's not in our plans. And obviously, there are a lot of options we could do, but especially given our view that we're undershipping demand; therefore, when customers are through with their inventory correction, we will be seeing growth even if there is no growth in end demand or inventory replenishment just as we move back to the customers' production levels. So in that environment and especially considering the low carrying cost of the capacity that we have on board, we have no intention to take any of that, especially the new capacity that we've been bringing on and doing anything other than fill it up over the course of time.

Vivek Arya - BofA Merrill Lynch, Research Division

So one more. You mentioned that you are undershipping demand. So if you looked at historical trends, how long can that situation persist, i.e. is Q4 a bottom? Is Q1 a bottom? How do we get a sense for that based on what you have seen in similar situations before?.

Ron Slaymaker

Okay. Sure. And I think this ties somewhat back to the question Uche asked maybe, that I hadn't gotten to specifically, which is do we still believe that we're in this bottoming process in the downturn, and the answer is we do. So what we look at, first of all, is that inventory levels of TI just as customers and distributors are now very low, and as I said before, we believe we're undershipping demand. So just to reiterate, at some point, customers will have to stop reducing inventory. And when that happens, our revenue will grow as our shipments increase to match the customers' production level even if there's no growth in end demand or replenishment of inventory. And for anybody that's watched this industry cycle over the course of time, you fully understand that once you start to get in that process and customers regain confidence in their own outlook, the next phase is they will typically then layer in addition inventory as well. The customers historically have not forecast these snapbacks in their demand, and instead, they rely on short product lead times to support their increased demand. We think we are very well positioned both with our inventory, as well as our short lead times to support that inevitable increase in demand. And the other thing that I would point to, which I had mentioned earlier, is just the stability you might say in terms of the orders took a step down in the month of July, but they've generally been flattish since that time, which is to us indicative of a bottoming process as well. I don't have an exact time period. Is it this quarter or is it next quarter as to where that snapback could occur? Historically, if you look at semiconductor inventory corrections, the response time generally results in a couple of quarters of inventory burn. And that's just looking at history. But we'll have to see what this one holds. But I guess I would say we continue to be encouraged that we're in the bottoming process even though demand was a little weaker than what we had initially expected this quarter.

Operator

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

James Covello - Goldman Sachs Group Inc., Research Division

I guess first question is kind of strategically with all the strategic fab capacity that you guys have, how do you think about using that in this kind of environment? Or maybe even more specifically, as things start to bounce back a little bit, do you try to be a little bit more aggressive on pricing to pick up a little bit of that incremental bump in business that you'll see as customers start to normalize the order patterns? Or is it more important you keep pricing pretty steady and try and get the margins back to a more healthy level?

Ron Slaymaker

Well, margins will return to more normalized levels just as we fill that capacity up. So my view is that probably doesn't tie so much to pricing and just a matter of as we ship more units, and therefore, amortize that what currently is an underutilization expense, that will do good things for margins. You've heard us say many times in the past that for the most part, the proprietary product lines that we sell tend to be more spec-elastic versus price-elastic. So even -- we're aggressive in pursuing new opportunities. We tend to do it based on the product specifications that we're offering, the support package, the applications engineering as opposed to thinking that somehow if we drop a couple cents off the price, that somehow that would make a difference in the demand that we actually see. So again, we tend not to view price. Although I will also say, we recognize we have to be competitive on price. And I think we have a cost structure that allows us to be competitive with any of our -- any competitor in the world. So again, I think that's why for our salespeople, price is not an excuse for them to lose a piece of business, but nor is it the reason they should win a piece of business. We want to be competitive on price, but we win the business based on other considerations.

James Covello - Goldman Sachs Group Inc., Research Division

This question is specifically about Analog. So I understand there's a lot of program ramps and design wins and share gains and apps processors. But relative to the Analog piece of the business, when is it fair for us to measure your share gain story again? In other words, it's always difficult in the downturn to say, well, they're not gaining any share in the downturn. But when is it going to be fair for us to say, look at your revenue share of the industry versus your revenue share in a previous period or cycle and to determine whether the share gain story is kind of playing out?

Ron Slaymaker

Jim, I don't know that it's not fair to look at it in a downturn. I mean we look at it every quarter. Now we don't overreact to any particular data point. But I think the right way to do it is to sample it quarterly and we ask ourselves the question, if there's a quarter where we believe we underperform, we ask ourselves why, and frankly, you guys should be asking us why as well. So sample it quarterly and the best way to make the story work over the long term is to make sure it works every quarter. But at the same time, maybe in a downturn like this, you may see more strategic long-term use in terms of share from the standpoint of gaining position at customers on new design programs and things like that, more so than the different show up in revenue that particular quarter. But again, every quarter absolutely counts.

Operator

We'll go to Mark Lipacis with Jefferies.

Mark Lipacis - Jefferies & Company, Inc., Research Division

Ron, you said on your October quarter call, I believe that you said that the distributor inventory is worth 6 weeks and that was at normal levels. It sounds like they're lower now. Given that you have a pretty clear visibility there, can you quantify where they are now? Or at least talk qualitatively about how close they are relative to where they were at the depths of the financial crisis?

Ron Slaymaker

I don't want to try to quantify where distributors are right now until the end of the quarter, Mark, but I think your interpretation of what we're saying is correct, that distributor inventory is going down this quarter. In fact, and maybe if I can just comment on distribution overall, but make some specific inventory comments. If you just look at resales, we would expect resales from distribution to the client compared to the third quarter, although at this point, it looks like they'll decline a little less than TI's revenue would overall if we take the national or the SBA revenue out just because we only had it for, what, a week last quarter. Inventory distributors, we expect to be down by a double-digit percentage at this point. And again, that's compared with the third quarter. Although I'll also say that, that includes inventory returns from a discontinued national distributor. And so that, the returns from that distributor probably will contribute maybe a couple few points of the decline in and of itself. Even without that, you can see there's a pretty sharp decline in distributor inventory levels. Just one data point that I saw that I'll pass on almost anecdotally: if you look at inventory for the products that we would characterize as specific to the industrial market, just in the last couple of quarters, inventory of those products at distributors has been cut in half. So again, the distributors are moving pretty aggressively in terms of reducing inventory. And we all have to watch it because demand can come back pretty quickly. But again, call it the buffer. What we feel comfortable with that is that inside TI, our own inventory, we think we're pretty well positioned. So distributors are tightening up somewhat, but we feel that we have enough buffer inside TI to be able to respond as business comes back again.

Mark Lipacis - Jefferies & Company, Inc., Research Division

Thanks for that detail. In kind of modeling the cash flow for next year, I guess I have to believe that front-end CapEx will be at maintenance levels, and you've been -- you may or may not have to get back into equipment. One, is that a fair way to think about it? And two, could you give us a sense of what is like a maintenance level of CapEx?

Ron Slaymaker

Maybe one way to look at it overall, Mark, is I think historically, we've guided that we would expect our CapEx to range somewhere between 5% to 8% of revenue. As you pointed out, with the capacity additions we've made and over the past couple of years, I think it's fair. We clearly have pulled in capital spending from future years. We don't need to spend a lot on front-end capacity. And therefore, we would expect to be at the lower end of that range kind of what you said, both capital maintenance on the front end and then additions to assembly test. What I would say is, even assembly test, depending upon growth, as we have more years produced, obviously, we'll need to expand our capacity on assembly test after we refill the existing capacity. And so with utilization both on front end and back end coming back somewhat as we've gone through this downturn, clearly, we have room to grow from current levels before we really even need to spend on back end capacity to any significance.

Operator

We'll go to Tore Svanberg with Stifel, Nicolaus.

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

Ron, you've qualitatively talked about some of your end markets, but could you also do the same for your regions space?

Ron Slaymaker

Sure. I guess, and again, this is just based on the first 2 months of the quarter and extrapolating that through the end of the quarter. But probably no surprise, Europe is currently our weakest region, followed by Asia, and then the U.S. All 3 of those regions, we would expect to be down based upon that 2 months worth of data. Japan, therefore, is the only region that is tracking to be up sequentially, and that's really as it just continues its post-earthquake recovery.

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

You talked about the Wireless infrastructure being intentionally weak, and I think you mentioned maybe that's due to some pushouts. Do you have a sense on how those pushouts look like, meaning is it a quarter or is this going to be a multi-quarter pushout?

Ron Slaymaker

I don't know. And I think as I said, it really goes beyond our customers to their customers what the carriers, and I think you're all aware they're trying to merge and how they spend and where they spend will be different based on whether that merger happens or if for some reason it doesn't happen. And so in the interim, while they're sorting that out, they've pretty much stopped spending. So I have no idea how to assess how long that may last, but that's what's currently impacting us there in terms of the decline. Other carriers are flattish. Some of the programs in India or China that we've all talked about and hoped was maybe going to be ramping are still on hold at this point, but actually what's impacting us in terms of the decline would be those North American carriers that I talked about.

Operator

We'll go to Christopher Danely with JP Morgan.

Christopher B. Danely - JP Morgan Chase & Co, Research Division

So one thing you said today that you guys also said on the conference call about a 1.5 month ago is that bookings have essentially bottomed for the last couple of months, but clearly the revenue outlook is worse. I'm just wondering what is the difference there? Or is this just, in your opinion, a massive inventory drawdown by the distis? Are your customers telling you where demand is risky [ph]? Can you sort of parse that out?

Ron Slaymaker

Chris, I can -- and I don't know that I can talk too specifically about customer demand. But our assessment is that this is mostly them taking inventory levels down more than what we had expected, as opposed to their demand is significantly weaker than what we had expected.

Christopher B. Danely - JP Morgan Chase & Co, Research Division

And have you noticed any, I guess, worse performance from the national versus the legacy TI business? Is there any more downside from national? Do you think any of this is a result of the merger?

Ron Slaymaker

No. In fact, I would say national is declining this quarter, but declining about the same as our HPA revenues. And as you know, both of those areas are catalog products sold through distribution. And I would say they both have relatively strong ties to the industrial market, which is weak right now. But I wouldn't say national is disproportionately a factor one way or the other here.

Operator

We'll go next to John Pitzer with Credit Suisse.

John Pitzer - Crédit Suisse AG, Research Division

I guess I'm trying to figure out a little bit better what's going on with gross margins in the December quarter. So I guess can you help me understand if OpEx dollars are kind of flattish with the old model, it implies sort of a 200-basis point drop. If that's the case, what's utilization versus mix? And were you able to do anything on the OpEx line? Or with the national integration, is OpEx kind of a fixed cost this quarter?

Ron Slaymaker

Okay. And, John, let me make sure I understand or maybe let me just kind of reiterate what we said last quarter. OpEx I think we said in our October call, our view is that OpEx would go up somewhere in the $160 million to $170 million range. And that was a combination of basically having a full quarter of national OpEx in fourth quarter versus only a week of it in the third quarter. And then also, I think we talked about some of the -- as we had adjusted in light of the environment and forecast some of the variable element of compensation in the third quarter, there were catch-up accruals basically to adjust the cumulative effect for first half. And that catch-up piece of those lower accruals would not, therefore, recur in the fourth quarter. So we said OpEx would be up about $150 million to $170 million. Suffice it to say in this environment, we're going to try to keep a tight control and do better than that. But that's certainly part of it, which is we're not going to be able to do anything about. So OpEx will go up by about that amount. Gross margin, I think, as you pointed out, will be down, but it's also down for the 2 reasons I talked about, mix and then specialty utilization. And then the only other consideration that I should just remind you about is, remember, on cost of revenue, there's about $100 million of additional expense in the fourth quarter that I would describe as acquisition-related. And that's tied to the fair value markup of the inventory that we received from National as part of that acquisition. But that's probably -- those are probably the moving pieces that I can think off to point out at this point. Did that answer your question, John?

John Pitzer - Crédit Suisse AG, Research Division

I guess as a follow-up, midpoint of revenue coming down by about $140 million. I guess I just want to understand, did Wireless quarter-to-date on the OMAP coming in better than you originally expected at the beginning of the quarter? And can you help us kind of give the magnitudes, if I x out OMAP, what's the rest of the business doing versus expectations at the beginning of the quarter?

Ron Slaymaker

Well, yes. OMAP is doing better than expected. I can't quantify it at this point in the quarter, but I would just say OMAP is growing very nicely, and we'll have more details for you in January. But we expected good growth out of it and it's delivering even better growth. And so other areas are making up -- more than offsetting that growth, and obviously, we've taken the overall guidance down. So they're all doing quite a bit worse than what we had anticipated when we came in. And again, probably for reasons of both macro as well as inventory reduction.

Operator

We'll go next to Craig Ellis of Caris & Company.

Craig A. Ellis - Caris & Company, Inc., Research Division

Just an inquiry on the PC related businesses. You mentioned some Thai flooding impact. Is that proving to be a little bit worse than the what the company expected into the quarter or pretty much in line?

Ron Slaymaker

Well, and again, if you go back to what we said in October, we looked our own supply chain's risk both in terms of, I think a lead frame that we bought from a supplier there that we knew would be disrupted, and from assembly test that we had there, and I think we quantified that impact as about 1%. But again, that was just TI supply chain. What we tried to communicate was the first order effect, which was the customer, the direct customer impact of hard disk drive that were manufactured in Thailand. And then maybe even a second order effect of PC manufacturers that couldn't get hard disk drives that might be weaker than otherwise expected. And again, we had some estimates there, but clearly that is having impact, certainly the first order effect. I don't know how much -- we're not the best source to be able to comment on the PC manufacturers. Clearly, they're going to be impacted by the same macro considerations that every other market segment is. So they likely would have been weak anyway. Was that weakness exacerbated by lack of storage? I don't know.

Craig A. Ellis - Caris & Company, Inc., Research Division

With one of the design-ins you have with OMAP 4, the Kindle Fire, you've done a good job getting other content in there, like Wi-Fi. As you look at your design-in funnel with Ice Cream Sandwich systems, do you see a greater propensity of those design wins bundling more TI content? Or how do you think about your ability to attach other components when you get that OMAP 4 design win?

Ron Slaymaker

I would describe that as pretty strong, no guarantees, but usually almost always when we win OMAP, we'll have some power management Analog type products attached to it. And then sometimes connectivity. We don't bundle the 2. So there will be places we fill connectivity without OMAP, there will be places we fill OMAP without connectivity and then there will be customers we fill both into. But almost always, when we fill OMAP, customers just find it more convenient to work with TI on a lot of the Analog products, such as power management, as well as our sales force is trained to work their way through those customer systems and pick up as much of that companion Analog content as they possibly can. So I would say when we sell OMAP, we usually do very well selling other products outside of OMAP as well.

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

Operator

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

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