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Texas Instrument Incorporated (NASDAQ:TXN)

Q1 2008 Earnings Call

April 21, 2008 5:30 am pm ET

Executives

Ron Slaymaker – VP and Manager Investor Relations

Kevin March – Senior VP & CFO

Analysts

John Pitzer - Credit Suisse

Glen Yeung – Citigroup

Cody Acree - Stifel Nicholaus

Chris Danely - JP Morgan

David Wu - Global Crown Capital

Tristan Gerra - Robert W. Baird & Co.

Ross Seymore - Deutsche Bank Securities

David Wong - Wachovia Capital Markets

Sumit Dhanda - Banc of America Securities

Amit Kapur - Piper Jaffray

John Dryden - Charter Equity

Joanne Feeney - FTN Midwest Securities

Jim Covello - Goldman Sachs

John Lau - Jefferies & Co.

Steven Smigie - Raymond James

Tim Luke - Lehman Brothers

Mark Lipacis - Morgan Stanley

Operator

Good afternoon and welcome to the first quarter 2008 earnings conference call. (Operator Instructions) Mr. Slaymaker you may begin your conference.

Ron Slaymaker

Good afternoon and thank you for joining our first quarter 2008 earnings conference call. Kevin March, TI’s Chief Financial Officer is with me today. For any of you who missed the release you can find it on our website at www.ti/com/ir. This call is being broadcast liver 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 9th. We expect to narrow or adjust the revenue in earnings guidance ranges as appropriate with this update. All of our financial results will be described for continuing operations including historical comparisons unless otherwise indicated. In today’s call we’ll try to address the key questions that are on your minds. I suspect at the top of the list is whether an uncertain and slowing economy is beginning to affect demand for semiconductors. We’ll provide our perspective and we’ll also breakdown demand into specific markets that we address and product lines that we sell. Next many of you have undoubtedly noted an increase in our inventory in the first quarter. We’ll discuss the causes for this build and our plans to reduce inventory in upcoming quarters.

Finally we’ll address questions about the impact that slowing demand might have on TI’s profitability and margins.

At the top level we believe the first quarter’s results again demonstrate the progress that we are making in analog and the benefits that a stronger mix of analog products provide to TI’s profitability. Notably TI revenue was up 3% from the year-ago quarter while operating profit was up 19%. At the same time unseasonably lower sales into the cell phone market, especially for high end cell phones weighed on our revenue in the quarter. As a result semiconductor revenue was down 8% sequentially.

So let’s break it down. As a reminder the sale of our DSL CP product line in July of last year caused the decline in revenue of about $55 million compared with the first quarter of 2007 or a negative impact of almost two percentage points of growth. Since most of these products were mixed signal technologies they mostly affected our application-specific analog revenue over this period although there was also some DSP impact.

Analog revenue of $1.32 billion in the quarter increased 6% from a year ago. The increase was driven by another solid quarter of growth in high performance analog which was up 20%. High performance analog or HPA revenue grew strongly in all of the major product categories; amplifiers, power management, data converters and interface. Outside of high performance analog the remaining analog revenue which is comprised mainly of application-specific analog products declined 4% from a year ago. The decline was due to the sale of the DSL product line as well as lower revenue from cell phone applications. There more than offset gains in other areas including hard disk drive, automotive as well as battery management products used in a wide range of portable applications.

Sequentially our analog revenue was down 4%. HPA was about even with the fourth quarter consistent with the seasonal average over the past five years. Beyond HPA the remaining analog revenue declined 7% sequentially mostly due to lower sales of application-specific products into hard disk drive and cell phone applications. Both of these areas are typically down in the first quarter although this decline was more than usual. Even with the below seasonal first quarter our hard disk drive revenue was up over 20% compared with a year ago.

As we’ve said before we believe analog will be our most important growth driver in the years ahead. To achieve this we need to sustain our out performance in HPA that we’ve achieved over the past five years. Just as important we also have actions underway that if successfully executed, should accelerate out revenue growth in application-specific analog. The potential for market share gains combined with the higher margins and lower capital investments that characterize the well-run analog business support our belief that we are pursuing what is likely the best opportunity in the entire semiconductor industry.

DSP revenue of $1.12 billion declined 3% from a year ago and 18% from the fourth quarter. The declines were due to lower sales into cell phone applications. Outside of handsets our focus in DSP is to address opportunities across a broad range of customers where those customers layer their innovations on top of our DSP platform in the form of software that they have developed. The amount of innovation ongoing with DSPs is tremendous. Although these results often are masked by changes in the much larger handset DSP revenue.

For example, in the first quarter non-handset DSP revenue was up almost 10% from a year ago even with the negative impact that the DSL product line sale had on this comparison. Inside of this revenue wireless infrastructure DSP revenue grew about 16% from a year ago. An example of an opportunity that is small in size today but we believe big in potential is security and surveillance where our DSP revenue was up 63% from a year ago.

Total wireless revenue of $1.09 billion in the quarter was down 4% from a year ago and was down 18% from the fourth quarter, well below the average sequential decline of about 5%. You will recall that March we lowered our first quarter guidance because some of our customers had become more cautious about demand for high end or 3G cell phones. Most of the sequential weakness was associated with lower than expected customer build plans where our position is solid. A small part of the weakness was due to the supplier transition underway at Ericsson Mobile platforms that we have discussed before with you and that proceeded according to our expectations in the quarter.

As our customers became more cautious our wireless revenue was impacted especially since our semiconductor content is much higher in a 3G handset than in an entry level handset. The 4% decline in wireless revenue from a year ago also reflects a similar mix story. Although we had double-digit growth in unit shipments of digital base bands from a year ago, our total wireless revenue declined as low end units represented a higher proportion of the shipments. Pricing over this period trended normally.

The takeaway is that total unit trends are not particularly relevant today as a predictor of results in the wireless market given the wide range of handset technologies and our varying content within those different technologies. The remainder of our semiconductor revenue grew 6% from a year ago and 2% from the prior quarter. In both comparisons microcontrollers were the biggest factors in the increase.

At this point I’ll ask Kevin to review profitability and our outlook.

Kevin March

Thanks Ron and good afternoon everyone. Gross profit was $1.76 billion in the quarter or 53.7% of revenue. This was up $119 million from the year ago as we continued to benefit from higher sales of more profitable analog products and to a lesser extent from higher microcontroller sales. Gross profit declined $170 million sequentially primarily due to the lower revenue level.

Operating expenses were slightly lower from the year ago quarter and up $19 million sequentially as we invested in field sales and customer support especially in emerging regions of the world. As a result operating profit for the quarter of $807 million increased $127 million or 19% from a year ago. Operating profit declined $189 million sequentially. Operating margin was 24.7% of revenue in the quarter up 340 basis points from the year ago quarter and down 330 basis points from the prior quarter.

Income from continuing operations was $662 million or $0.49 per share. Earnings per share included a $0.06 benefit associated with discreet tax items in the quarter. 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 $641 million in the quarter and we ended the quarter with $1.88 billion in total cash. In the quarter we reduced our holdings of auction rate securities which are based on pools of student loans that are guaranteed by the US Department of Education by $473 million. As of the end of the quarter we reclassified the remaining auction rate securities which have a fair value of $551 million from short-term investments to long-term investments due to reduced liquidity for these securities.

In this process we recognized a $20 million temporary impairment in the value of these securities on the balance sheet that is included under stockholders’ equity. No write-down has been taken through the income statement as we viewed the impairment as temporary with the underlying credit quality of these securities remaining sound.

In the quarter we also continued our share repurchases buying back 28.6 million shares of TI common stock. Inventory of $1.58 billion at the end of the quarter increased $169 million from a year ago and $160 million from the prior quarter. Inventory days increased to 94. About one-third of the increase in inventory was the result of the unexpected build to plan changes that we received from our wireless customers in the quarter. As we explained in our mid-quarter update that product was already being manufactured when we received the changes so we carried more inventory of this product than we had initially expected at the end of the quarter.

Another third of the increase is tied to our changing perspective for demand in the second quarter. When we started manufacturing that product we had higher expectations for second quarter demand than our more conservative view today. As a result we need less inventory to support this expected demand. We began to lower production levels in early March to reduce our inventory at a measured pace over the next few quarters.

Although we could make the adjustments more rapidly we believe it is appropriate in this uncertain environment to move more deliberately to maintain our flexibility to support potential upsize in customer demand should they arise. The final third of the increased inventory was the result of a planned build especially in high performance analog. It was our objective to move this inventory up to enable us to better service our customers and we plan to maintain that at this higher level. TI orders in the quarter were $3.32 billion, an increase of $111 million from a year ago and a decrease of $164 million sequentially.

Turning to our outlook for the second quarter in this economic environment we are approaching the quarter cautiously relative to our guidance and our internal operating plans. This approach is driving our factory loadings and has been used to set our operating expense levels. We chose this approach because it allows us to run prudent operating plans but still have the ability to react quickly to any strength in customer demand.

As a result we expect total TI revenue in the range of $3.24 billion to $3.50 billion. Semiconductor revenue should be in the range of $3.08 billion to $3.32 billion. This range represents a sequential decline of 3% to a growth of 4% compared with the seasonal average of about 4% growth for our semiconductor segment in the second quarter. Education technology revenue should be in the range of $160 million to $180 million with revenue likely to more than double as retailers begin stocking for the back-to-school season. Earnings per share are expected to be in the range of $0.42 to $0.48 in the second quarter.

To summarize we are encouraged with our continued progress in analog. This product line promises the opportunity for sustained market share expansion and revenue growth with higher levels of profitability and lower levels of capital investment than most of our other semiconductor product lines. At the same time we are becoming more conservative about the economic environment and near-term demand. We believe the flexibility that we have built into our manufacturing operations will allow us to adapt much more readily to changes in demand than was historically the case without big swings in our profitability.

We also believe a weaker environment may present opportunities for us to bolster our strategic position in the analog market that simply are not available to us when demand is strong. These can range from improved availability of analog engineering resources to purchasing used manufacturing equipment at attractive prices to additional opportunities for targeted acquisitions. Our financial goals remain unchanged and are as follows: grow revenue faster than our markets; grow earnings per share faster than revenue; and continue our efficient usage of capital. In addition we believe that with our improving portfolio of analog and DSP products, TI is capable of achieving gross margin of 55% and operating margin of 30%.

With that let me turn it back to Ron.

Ron Slaymaker

Thanks Kevin. 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.

Question-and-Answer Session

Operator

Your first question comes from John Pitzer - Credit Suisse

John Pitzer – Credit Suisse

Just briefly on the calculator guidance going forward how much macro economic headwind have you factored into that? What’s normal seasonal going into the June quarter and how might have you discounted that?

Kevin March

John the normal seasonality is actually to approximately double revenues quarter-over-quarter and the indications that we’ve gotten from our customers in that product line has been to expect the kind of guidance that we just gave you. So we don’t really have that much in the way of macro events factored into that guidance.

Ron Slaymaker

John I would just say very quickly that tends not to be a discretionary consumer purchase though. Generally if a middle school or a high school student is taking a particular math course they’re required to have a particular TI calculator as part of that curriculum. So again consider it in that vain.

John Pitzer – Credit Suisse

And then as my follow-up question just as you look at gross margins for the June quarter and the different mixes of the businesses that make up the June quarter revenue guidance what’s the expectation on the gross margin line? Could we actually see modest improvement as you move more towards HPA or given the overall volumes is that going to be difficult to achieve?

Kevin March

John, we don’t get into actually characterizing gross margins in our guidance. We just stick with revenue and earnings per share. I would just remind – I think the point that you were probably driving at is that analog does continue and has been continuing to be an increasing portion of our mix. In fact if you look at TI over the last five or six years you can see our gross margins have consistently increased during that period as we’ve had an improved product portfolio and improved overall execution from a manufacturing strategy as well as our foundry strategy. And that’s really the more important directional indicators that we think are happening but within the actual quarter itself, we won’t be providing any more detail than what we already have.

Operator

Your next question comes from Glen Yeung – Citigroup

Glen Yeung – Citigroup

Kevin a question for you on your comments about OpEx as it pertains to revenue, I think you made the point that your OpEx, you’re trying to adjust that based on your expectation for lower revenues. You reiterated your R&D number so should we therefore expect to see your SG&A number for Q2 actually come time?

Kevin March

Glen I think the – what we’re trying to do is make sure that the overall spending does not get ahead of the change in revenue and from the overall guidance standpoint I believe our R&D for the year is guided at $2 billion and we expect that to be achievable within the year. So beyond that I won’t get into more details as to the mix between R&D and SG&A but we have put together plans that actually try to keep the OpEx consistent with what we see as a different revenue environment than we thought three months ago.

Ron Slaymaker

Glen one other thing I’d just point out is with that $2 billion guidance for the year if you look at our first quarter run rate anyway for R&D we were 514 and so with the range that we’ve given for second quarter I think certainly one of the things that we’re trying to tell you is that we don’t expect R&D to be trending up; if anything maybe slimming down a little bit as we move through the year.

Glen Yeung – Citigroup

On your inventories, can you give us a sense as to what in your inventory are chips that are [fabed] internally by TI versus externally?

Kevin March

Yes Glen about a third of that inventory growth I mentioned was attributable to the change in demand that we experienced in March in the wireless business and you can pretty much assume that all of those wafers – almost all of those wafers are sourced from foundries. Most of the balance is sourced internally with about half of that balance of course being in the planned build we were doing for high performance analog and then the other half having to do with the fact that our outlook for 2Q is less than we thought at the time we started building that inventory.

Ron Slaymaker

And Glen maybe just another consideration is that with the wireless inventory, a lot of that would be probably be considered custom product and you can assume being custom product we don’t want to be carrying a lot of excess inventory so you’ll see a work to adjust that pretty quickly. Much of the internally manufactured product tends to be more standard product where the shelf life is long and the risk of obsolescence is low and therefore will be moving more deliberately on reductions of the TI sourced inventory.

Operator

Your next question comes from Cody Acree - Stifel Nicholaus

Cody Acree - Stifel Nicholaus

Kevin in your second element of reductions of visibility you said the change in demand since maybe last time we talked on the mid-quarter update, can you maybe give a little more detail as to what visibly has changed? Because then you were talking very specifically about this one wireless customer maybe by in applications or just what is it that’s kind of led to this outside of just kind of macro caution?

Kevin March

Cody I’d say its probably a bit more on the macro side of things in the context that we’re seeing our customers be quite conservative in how they’re choosing to manage their inventories and keeping their inventory levels quite well managed. They’re also not giving us a great deal of visibility and so overall when we assess what the environment looks like, we’re approaching it in conservative fashion. So there’s no one area that we would point to; its more broadly speaking. I would just remind you that coming out of first quarter the high end handsets in the wireless space did come in below what was previously expected so obviously any movement forward from there is from a lower base than what would have previously been expected.

Cody Acree - Stifel Nicholaus

And then maybe just in that same vain then the change in orders quarter-to-quarter can you quantify or give some qualification as to how much of that had to do with what we’ve just seen come out of the wireless space versus maybe what you’ve seen change in order linearity here just over the last few weeks?

Ron Slaymaker

Cody I would say, there’s not a big – there hasn’t been a big change in order linearity. So don’t view this as deterioration in the last few weeks. In fact if you look at I think for both revenue and orders, basically February was the low point in the quarter and then March actually was the strongest month in the quarter. I think if you go back to the mid-quarter we were just describing at that point what we expected in the first quarter and now is when we’re rolling that out into the second quarter. I think its safe to assume that even if you just listen to what various customers have described in recent weeks a lot of the same pressures that we saw in first quarter would generally be expected to carry over into second quarter as well.

Operator

Your next question comes from Chris Danely - JP Morgan

Chris Danely - JP Morgan

Sorry to harp on the inventory so much but it sounds like you’re going to take utilization rates down somewhat in Q2 and you’re leaving the door open for the second half of the year. Can we infer that if business doesn’t get that much better than you will take them down again in Q3 and can you give us a sense of how much you’re going to take down inventory in terms of dollars?

Kevin March

Yes Chris we’re going to use the next couple of quarters to adjust the inventory levels that we’re carrying and its really just a function of learning from lessons of the past and that is taking inventory down too hard and then under calling actually demand has tended to hurt our customers in the past and we’ve done that so we’re taking a much more measured approach over the next couple of quarters to take down that one-third of the inventory that I was talking about that we had built in anticipation of a stronger 2Q demand. From a utilization standpoint obviously that means we’ll be loading the factories a little bit differently but more than anything, the loads that we put into the factories will be more a function of what our customers begin to indicate to us demand like look like in third quarter and so therefore it’s a little bit – I wouldn’t be being honest with you if I tried to tell you what our utilization rates actually work out to be.

Chris Danely - JP Morgan

Yes as my follow-up just to I guess pinpoint you a little bit, you know your average inventory days in ’06 were sort of high 70s. Is that what you’re shooting for or will you be a little bit higher than that or a little bit lower than that and can you give us a dollar amount of inventory you’re shooting for?

Kevin March

Chris, I can’t give you either. I can just note that as you’ve mentioned in 2007 we were in the high 70s I think this time a year ago we were about 82 days. As we see analog and especially high performance analog being a bigger portion of our inventory carrying value, that’s what we’ve been talking about for a few years and they’ll be higher than what you might have seen in the year past. But clearly 94 days is not what we were targeting this quarter and we are trying to drive that inventory down.

Ron Slaymaker

Chris maybe a different way to describe it and just let me reinforce what Kevin said, of the inventory that we built about a third of it was a very targeted build in areas like high performance analog. We’re comfortable with that higher level. In hindsight about two-thirds of that build we would characterize today as being higher than what we desire. So that may – you’d probably come back down into some targeted – targeted is a bad word because it’ll vary from quarter to quarter depending upon what our demand outlook is. But at least where we would have liked to have finished the second quarter or the first quarter at, that’ll give you some means to get to that.

Operator

Your next question comes from David Wu - Global Crown Capital

David Wu - Global Crown Capital

Kevin can you give a little color on the high volume analog business and the non I guess cell phone business in a miscellaneous bucket. It appears that the only thing that in that products group that was good was microcontroller. What’s happened to the outlook in the second quarter for that bunch of products in your portfolio?

Kevin March

David in the high volume business we actually saw everything come in pretty much as we expected in the first quarter. The only additional color I’d give about how the first quarter shaped up was that while we normally see storage products, the hard disk drive products, decline in the quarter. We saw that decline more sharply in the first quarter than we typically see in the quarter. That’s off of a year of very strong growth in that space so that may not be a real indicator that we can use to judge the future with. Looking into the second quarter we’re really just given guidance that I indicted a few moments ago that’s just designed based upon customer input of a pretty conservative outlook based upon an uncertain economy and that’s pretty broad across all of our customers and all of our markets. So I don’t really have any more color than that to give to you on that space David.

David Wu - Global Crown Capital

That includes your better performing high performance analog and microcontrollers?

Kevin March

Microcontrollers is separate from the high performance analog but yes I think inside each of those pieces we’re going to see some areas probably up and some areas not up as much. But other than that we’re not going to give a whole lot of color into the specific parts of our forecast just the total sum economic forecast.

Operator

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

Tristan Gerra - Robert W. Baird & Co.

Are you where you need in terms of your fab outsourcing mix and was there any meaningful change in terms of how you – the mix of outsourcing and insourcing in the quarter sequentially?

Kevin March

Well the outsource and actually in hindsight with the change in demand that we had from our wireless customers were probably more than we needed, that’s the third of the inventory growth that we talked about. So as we adjust for that in second quarter there may be a different, lower mix on that as we bring that inventory back in line. But broadly speaking over a longer term period we’re very comfortable and actually quite pleased with the mixed internal versus external from a foundry versus internal capacity standpoint.

Tristan Gerra - Robert W. Baird & Co.

Are you seeing any change in raw material costs which could impact your gross margin over the next few quarters based on current trends?

Kevin March

Well yes in fact we are seeing changes. I think most people are aware for example that gold prices have moved up quite a bit in the past few quarters and that’s an important component in the manufacture of semiconductors. So that’s clearly something that is an increasing cost element for us but its one that we’re managing with the best efforts that we can. We’re probably also seeing transportation costs increase given that many of our products ship around the world what with higher fuel costs and so on. But once again we are working to manage those costs in an effective fashion.

Operator

Your next question comes from Ross Seymore - Deutsche Bank Securities

Ross Seymore - Deutsche Bank Securities

The range you had down three to up four in your semi business, can you just walk us through some of the puts and takes that gets you from one end to the other, if there’s anything specific beyond just the macro conservatism?

Ron Slaymaker

Ross I don’t think, again in the spirit of not trying to break down our outlook into individual products or above and beyond the assumptions, clearly if the macro economy does better that’s probably one part of the range. If it does worse, that’s another part of the range. If you look at what have historically been swing elements for TI. Certainly wireless would come into that category but specific assumptions we probably don’t want to go into.

Ross Seymore - Deutsche Bank Securities

Completely different topic, Kevin on the interest income line, given what’s going on with rates, can you give us any color on how we should think about that as that can be a reasonable percentage of your net income?

Kevin March

Yes Ross you’ll probably notice that was actually down in first quarter versus prior quarters given the Fed significant cuts in interest rates. And short of them increasing those any time soon, I would expect that that trend will continue until we begin to see a change in the Fed’s posture on interest rates. You add that to the fact that our cash balances were a bit lower than we’ve had in the past few quarters and those two elements will come together to drive that interest income down some.

Operator

Your next question comes from David Wong - Wachovia Capital Markets

David Wong - Wachovia Capital Markets

OMAP, can you tell us what that did in terms of year-over-year growth?

Ron Slaymaker

David in terms of year-over-year growth let me start with sequential just to make some general comments. As you might expect OMAP is also – basically we sell two core functions into a 3G handset, the digital base band, as well as the application processor. In some cases we also very well may sell other what we call connectivity products such as Bluetooth or GPS, so all of those would have been affected by the mix that we saw when we went from fourth quarter into the first quarter given just the comments we already made about cuts on the 3G side. That generally is the same trend that we saw from a year ago in that OMAP revenue is down from a year ago and again a lot of the unit growth that we saw from a year ago goes back to the strength in low end units as opposed to 3G.

David Wong - Wachovia Capital Markets

What percentage of your current analog revenues are application-specific analog please?

Ron Slaymaker

The revenue mix and this is probably a 2000 number as opposed to a first quarter number is 45% high performance analog, and that would leave 55% for the remainder and not all, but almost all of that remainder would be considered application-specific analog.

Operator

Your next question comes from Sumit Dhanda - Banc of America Securities

Sumit Dhanda - Banc of America Securities

A couple of questions, the first one Ron or Kevin could you give us a sense of exactly what percentage of your overall DSPs is now non-handsets. Is it about a third? Is that number too high, too low? And in the context of growth per se other than modest infrastructure and surveillance security, what are the growth drivers for that particular business and the growth rates we should be thinking of?

Ron Slaymaker

Okay Sumit about 75% of our DSP revenue is handset. Was that your question?

Sumit Dhanda - Banc of America Securities

Right.

Ron Slaymaker

Okay and then what was your follow-up?

Sumit Dhanda - Banc of America Securities

Well as part of the same question, how do we think about growth within general purpose DSPs, I mean you highlighted a couple of areas which have grown well for you but not general purpose but non-handset DSPs, but what else can we latch onto given that the wireless DSP business has been performing at less than optimal [inaudible].

Ron Slaymaker

In general I don’t know how to project growth other than you probably if you look at the market analysts generally probably call total DSP growth which includes the handset business is probably somewhere in the low teens to mid teens type of outlook. I think if you look at – again sort of a forecast only just kind of go back to the data of the current quarter, I said 10% was the year-on-year growth for non-handset DSP. And again that was negatively impacted probably I believe it was about five points by DSL revenue that was DSP that we had in the year ago quarter that was impacted by the sale. So that would say somewhere in the 10% to 15% range is if you look at without DSL over that year-on-year period.

Sumit Dhanda - Banc of America Securities

One of the things that you had talked about, call it a year or year and a half ago, was asked us not to focus on the base band business per se but your increasing share of wallet as it relates to the wireless opportunity, can you update that on how that’s progressed and in particular in which particular segment or category those share gains are really showing up because it doesn’t seem that obvious to me on the surface?

Ron Slaymaker

Sumit I’m not following your question. You’re saying share of wallet meaning share of a wireless handset and your view that that is going up, is that correct?

Sumit Dhanda - Banc of America Securities

I think one of the things you talked about was despite some share in losses in base band there were other avenues where you’d gain share from a silicon content perspective – Bluetooth or wireless plan or what have you or analog content within handsets. I’m trying to understand where it at all that’s really starting to show up in your financials.

Ron Slaymaker

Okay and maybe you misunderstood me, I wasn’t necessarily trying to say we had gained share I was trying to underscore that there’s a very significant content difference for TI in a high end or a 3G handset versus a low end handset and I’ll be happy to illustrate that. But whether that translates to overall share increase or decrease when you look at share on a dollar basis of overall handsets, will depend largely on is growth more pronounced at the low end of the market or at the high end of the market? But if you consider for example at the low end of the market, probably a typical content for TI which would be an integrated base band type of product probably is in $4.00 type of range on average. On the other hand if you go to a 3G handset, a typical content for TI where we would have the digital base band and an OMAP application processor would be in the $15.00 to $20.00 range and then depending upon our level of participation with functions like Bluetooth or GPS or Wi-Fi, our content can be well above the $20.00 level. But again that will vary handset by handset. So again the point I was really trying to just make was our content in high end or 3G handsets is much, much richer than at the low end and so in a quarter such as we just saw where there was weakened demand on the high end side, that disproportionately affected TI’s revenue versus what say the handset units maybe would have indicated otherwise.

Operator

Your next question comes from Amit Kapur - Piper Jaffray

Amit Kapur - Piper Jaffray

Just in terms of your macro caution, what’s your view of channel inventory at analog distributors?

Ron Slaymaker

I think in general to our understanding distribution inventory is in pretty good shape. I don’t have it broken down by individual product line but in general if you look at our trends resale’s grew a little bit sequentially, our shipments into the distributors grew a little bit and inventory may have been up a little bit but with those trends obviously the change was pretty minimal so in general and again this is overall not specific to analog, inventory levels at distributor are in the eight to nine weeks. Generally they’ve been in that range probably over the course of the last year or so and we think the distributors are comfortable running at those levels. So again we don’t see that as an issue right now.

Amit Kapur - Piper Jaffray

In terms of the commentary that you use further weakness as the opportunity to buy some used equipment, would that be more reallocation of your current CapEx budget or would we see maybe a little bit of an uptick there?

Kevin March

Amit it could be either quite frankly. It just depends on what equipment might come available. Right now we don’t have plans to increase our CapEx budget but if an attractive opportunity presents itself, we will not let that budget get in the way of pursuing a good opportunity.

Operator

Your next question comes from John Dryden - Charter Equity

John Dryden - Charter Equity

Question on wireless for customers on demand [hub] are price cuts annual by long-term contract or highly variable and is there a difference based on the product that you deliver or the phone tier?

Ron Slaymaker

Probably yes to everything you said. They vary with a lot of different variables. I think time would be one variable. Volume would be a variable. Technology meaning the relative maturity of that technology and that product would be a variable. Generally the price curves are understood by TI and the customer when we engage on a new program and the end result of that is we know the path that we need to follow in terms of cost reduction to be able to support the price changes that we’ve built into those programs and we just need to invest and execute accordingly to be able to make sure that the margins on those business stay where we believe they would be.

John Dryden – Charter Equity

Switching to analog FAEs can you provide percent end count increase for 2007, last quarter you gave us the 2006 increase.

Ron Slaymaker

I’m looking at Kevin and he has as blank of a look as I do so I guess the answer is we don’t have that data here with us John. So I apologize.

Operator

Your next question comes from Joanne Feeney - FTN Midwest Securities

Joanne Feeney - FTN Midwest Securities

A couple questions; one I’m hoping you can give us a little more on capacity utilization in particular do you have room at this point to reduce your use of foundries or are you at your contract minimums if revenue and shipments and wafer [subs] do fall off it really is going to start to hit your gross margin more severely?

Kevin March

Joanne we have a lot of flexibility with our foundries and we’re well with inside of all the boundary conditions that we are in agreement with them on what we can take from [ins] and access.

Joanne Feeney - FTN Midwest Securities

And then on the analog side which hasn’t gotten as much attention here today do you still see analog growing this year as a share of your total revenues and what are your – what are you pointing to as the main sources of progress? Is it the high performance analog and within that is it power management and do you need to take share in order to make that kind of progress?

Kevin March

We won’t necessarily predict the year but just to show you what we’ve done so far this year, its I believe if you do the math on what we reported there, about 41% of our semiconductor revenue is analog. Last year I think we averaged somewhere around 40% or so so it continues to increase. And clearly with high performance analog growing as strongly as it has we mentioned earlier up 20% year-over-year and even quarter-over-quarter we would expect that to be an important contributor. The area that we’re targeting to accelerate the growth even faster is within the high volume analog and we’ve talked in the past year or so about some adjustments we’ve done over there from reorganizing some of the efforts underneath that particular area, putting a new management team in place and then pursing new markets with a lot of aggressiveness. So we would hope to begin to see that contributing to the growth as we move forward in time. But over the long haul we would expect analog to be an increasing proportion of our revenue quarter-by-quarter, year-by-year on average over time.

Operator

Your next question comes from Jim Covello - Goldman Sachs

Jim Covello - Goldman Sachs

First question, relative to handset demand as you think about how you want to manage the inventories down in a very sort of cautious sense, how do you determine if the issues we’re seeing on the demand side are cyclical or secular and when I say that what I really mean is the replacement rates that we need to have in the emerging markets now to kind of keep us on the same kind of demand trend line need to start to get close to the replacement rates that we’ve historically seen in the established markets. So is there a risk that we’re sort of trending down on handset demand because that replacement rate in the emerging markets isn’t going to be as good.

Ron Slaymaker

Jim, I don’t know that I mean what you’re describing is something that would be considered on a longer term basis but certainly what we’re seeing here now is continued good demand from the emerging market. The issues that we saw and that we’re facing in the near-term probably are more at the high end handset which is you can argue whether that’s a question of our replacement rates – not in the emerging markets but in the developed markets starting to slow or is it just that consumers maybe not spending as much on a – just from an economic consideration on high end handsets. Or you probably can come up with other theories as well. All we know is that first quarter we saw 3G demand well below our expectations and our customers’ expectations but Jim I’ll also remind you that we also saw a good solid 3G growth in fourth quarter so nothings new in the wireless base. You’ll have some quarters that are outside our expectations and other quarters that lag them.

Jim Covello - Goldman Sachs

Relative to the customer diversification in share, obviously you referenced the EMP and the impact that had on the numbers this quarter, to the extent that your largest customer is choosing the second source kind of across the board when might that start to show up in your numbers so we’re not surprised from a modeling perspective?

Ron Slaymaker

Jim I think you have – you probably best ask that customer for in order to get a real feed on it. I think generally the – I think it’s acknowledged by even the competitors that we face here, the programs at the low end and the mid range that had been expected to be in production this year have both slipped – I believe both of them are now into 2009. In the 3G which is kind of where we saw the softness in first quarter I believe the plan of record is 2010 at the earliest. So again what we’re seeing here now today has nothing to do with their moves toward supplier diversification. It really has to do with just probably demand changes and responses to that change in demand.

Operator

Your next question comes from John Lau - Jefferies & Co.

John Lau – Jefferies & Co.

Ron you know you’ve answered a lot of questions but I think one of the biggest questions that the many investors are worried about is the weakness that you’re seeing out there and you’ve commented a couple of things about order linearity. I was wondering has there been any change in terms of any recent upticks or any characterization of the wireless side and in terms of the analog side, where would be the biggest area of weakness. Just a little bit more color on what’s happening up to date.

Ron Slaymaker

Was that question was a change in the last hour since we provided you that guidance John or just – I don’t know what to say other than and again we didn’t break our guidance down into individual product lines but I would just say that it is what it is and I’ll not try to break it out beyond that. Just overall I would say what we’ve seen thus far in the quarters in the current quarter in terms of orders and revenue trends, are consistent with the guidance that we’ve provided but let me not make any wireless-specific comments if I can do that.

John Lau – Jefferies & Co.

And touching on, I know the wireless is a sensitive topic, but in the analog area what was the area of greatest weakness or is it pretty broad based right now?

Ron Slaymaker

What was the area of greatest weakness in analog you’re asking?

John Lau - Jefferies & Co.

Yes.

Ron Slaymaker

Okay well probably the greatest weakness is the revenue that was lost associated with the sale of our DSL business from year-on-year basis. Wireless also was down year-on-year. Sequentially and I think we said these in our opening remarks the two areas would be both cell phones and storage products which both were down I think we commented that its typical for them to be down the first quarter but I would also describe both as being down more than what you would normally expect in a first quarter. So and then also to offset the weakness comments –- or to balance those weakness comments let me remind you high performance analog again up 20% from a year ago, even sequentially and even is about the seasonal norm for high performance analogs.

Operator

Your next question comes from Steven Smigie - Raymond James

Steven Smigie - Raymond James

I was wondering if you could talk a little bit about market share and analog now that 2007 is concluded where you think you wound up in sort of the major analog categories there?

Ron Slaymaker

Well I believe we think we gained, or we know we gained share according to the WSTS report. As you might suspect the standard category is high performance analog is where it would be most pronounced. I don’t have for you the breakout by product category such as power or amplifiers or whatever. I’m sure you’ll plan to be our Analyst Meeting in a few weeks and I suspect we’ll have that level of granularity there. But I don’t have it with me here today. On the application-specific side of analog, I don’t know relative to the market what our growth – how our growth compared. I will say we’re not satisfied with our growth in application-specific. As Kevin indicated before that’s an area where we are absolutely convinced we can do better in terms of growth rate and we’re working hard to make that happen.

Steven Smigie - Raymond James

Along the lines of the ASSP stuff there, you’ve been talking for a little while about taking actions to increase the growth there. You talked about it a little bit more today. Can you talk a little bit about the actions that you’ve been taking most recently and do you think the lack of growth here is just again the macro environment weakening or is there just – you haven’t had the guys in the right places and when you might expect that to start taking off?

Ron Slaymaker

No I think there are some TI specific opportunities for us to accelerate that growth. We’re not just going to play victim to the market or to the economy. A few examples; one hard disk drive, printer markets we have a very strong presence and market share but there are other areas where we believe we’re significantly under penetrated. Some examples would be wireless, believe it or not on the analog side we are under penetrated. Automotive and consumer. So one of the actions that we’ve taken just organizationally, instead of having kind of a large application-specific analog functional team as in one big R&D center, we’ve basically broken it down into smaller teams. More focus accountability and focus specific to those markets that I’ve mentioned, there’s a lot of activity underway also just to improve R&D efficiency from the perspective of reusing intellectual property for those application-specific projects either that might have been originally developed in high performance analog or elsewhere inside TI. So and I don’t want to try to be overly anxious from the perspective that we know that those kinds of changes are going to take time to translate into revenue and revenue growth but nonetheless we believe the opportunity is really significant for TI and we think we’re doing the right things there so stay tuned Steve.

Operator

Your next question comes from Tim Luke - Lehman Brothers

Tim Luke - Lehman Brothers

In your guidance you’re inferring a flat semi quarter in a quarter that’s usually up and the wireless industry is guided for the second quarter by your biggest customer to be up mid single-digits in a quarter where they would expect – they’re expecting to take market share so one would have inferred that you would have had a sequential improvement in the wireless business which you’re essentially saying is not happening because you’ve got to work through this inventory. I guess the question is, is it better to suggest that the wireless business and the analog business would be expected to be below seasonal or where the weakness is somewhat evenly balanced or is it essentially more over wireless this year?

Ron Slaymaker

I guess I’ll have to just reiterate that we don’t break our guidance down by individual product areas Tim. I think you’re right that the assumptions that you listed off, generally I would agree with. The middle of our semiconductor range would indicate it would be a [inaudible] even from the fourth quarter. The only thing when you talk about a customer reflecting an outlook of up mid single-digit sequential growth in second quarter I believe you’re talking about units again. And for all the reasons we just spend a lot of time talking about you have to be really careful trying to translate units to revenue because mix will matter an awful lot in terms of how that affects TI revenue. So again I think what we’ve tried to reflect is that we’re taking a more conservative view on the second quarter and demand and I’ll probably just leave it at that.

Tim Luke - Lehman Brothers

Just as a clarification is there any impact of the more subdued customer’s commentary on the lead times that they’re expecting from you and as part of that also you had an unusually strong other semiconductor segment first quarter. It’s usually down, it was up. Could you just give a little bit more color on why it was up and is there anything there that we should expect going forward to continue?

Ron Slaymaker

I’m sorry the part you just said about – I’m not sure, what were you saying was up in the first quarter?

Tim Luke - Lehman Brothers

The revenue bucket that is other semis –

Ron Slaymaker

Okay, so as you might guess with the inventory that we inadvertently build in first quarter associated with wireless lead times for those specific products are short but I don’t know that that affected our revenue expectations in terms of demand but certainly if we get surprised to the upside whether it’s wireless or whether its any area within semiconductor given the inventory build that we just accomplished in the first quarter you can assume we’re probably going to be pretty well positioned to support those upsides. On the other product category that you noted where we saw a lot of growth, you’re right it was mainly driven as we noted by microcontrollers. We’ve got really a pretty sweet little business inside of there. There’s a product line called the MSP 430. It is an ultra low power microcontroller that is – it’s a catalogue [product] and it’s just finding its way into lots and lots of new applications. And we’re optimistic this isn’t a comment about second quarter but we’re just optimistic in general, about where that product line can go. You probably haven’t heard us talk a lot about it in the past, but it has a great opportunity ahead of it and we’re going to ride it for all its worth so stay tuned on that one as well.

Operator

Your final question comes from Mark Lipacis - Morgan Stanley

Mark Lipacis - Morgan Stanley

If you look at the press release the first paragraph talks about how great the analog business was and the second paragraph talks about wireless not being so good and I’m trying to understand how strategic is the handset based band DSP business. Could you review the framework that you’ve been using over the last several years to make decisions about divesting businesses like the sensors and controls business and whether or not that same framework could be applied to other large businesses and whether or not the handset based band DSP was considered to be strategic or exempt from that kind of a framework?

Kevin March

We really don’t discuss any topics about acquisitions or divestitures of a specific nature but you’re talking about in the past and portfolio tuning and stuff that we’ve done, there’s a couple of things that have impacted and will continue to impact our margins; analog becoming a bigger portion of our total mix of revenue. The fact that our CapEx has been down and continues to be down so we’ve got moderating depreciation so therefore as revenue grows fixed costs get spread over more products. And then of course one of the things that we look at is portfolio tuning from time to time such as you referred to. From a tuning standpoint as you mentioned we sold the sensors and controls business about two years ago now. We’ve also within semiconductor divested our DSL business last year; our LCD business a couple of years ago. We keep looking at opportunities like that but it’s really a question of not only how they’ve been doing in the past but our perspective on their prospect for the future. And you’ve been hearing us talk a lot about analog and DSP being important to our future and I think that can kind of take you to how important we see DSP in that total portfolio to the business that we see today and going to the future.

Ron Slaymaker

Mark, let me make just a couple of comments. I think Kevin certainly addressed the acquisition consideration but just the importance of base band. It is important. It’s a big part of our revenue today and we have customers that place significant value on what we can bring to them in terms of developing specifically custom products and engagements whether it be Nokia, whether it be Motorola that we’ve discussed where we have a major 3G custom program or even in the case of Ericsson Mobile platforms where we have new design wins in place that in those cases will ramp revenue for TI in 2009. That being said as you see customers probably shift more over time toward standard products in the form of their modem function or the digital base band, actually the best opportunity that we see and in fact our strategy more and more in wireless will be led by is the OMAP application processor. And I don’t think I need to convince you the fastest growth category inside of cell phones is Smartphone and more and more you hear customers talk about the importance of applications and services and how more of their own R&D investment is getting focused on those functions as opposed to connectivity to the network and that’s all about the application processor in terms of what will lie underneath or what will provide that capability to the customers. And I think there’s no other way to describe TI’s position in that market other than we have an elite position with our OMAP application processor and that’s where we are here now today. We’re on the third generation of the technology. We have engagements I believe it’s with all five of the top five handset OEMs. There are even customers we have in that space that might be using for whatever reason a modem or a base band from another supplier but they realize that where they’re truly trying to differentiate their handsets with the multimedia and application functionality, they’re engaged with TI on OMAP. So we think that’s a great opportunity and more and more you’re to see that move front and center over time as that opportunity just gets bigger and bigger over time.

Before we close up, let me remind you that on May 8th and 9th we are holding our financial analyst meeting. I realize that many of you are already registered and I thank you for that. If you have not yet registered and plan to attend, please do that as soon as possible. Thank you for joining us tonight. A replay of this call is available on our website. Good evening.

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Source: Texas Instruments Incorporated F1Q08 (Qtr End 03/31/08) Earnings Call Transcript
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