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Texas Instruments (NASDAQ:TXN)

Q2 2008 Earnings Call

July 21, 2008 5:30 pm ET

Executives

Ron Slaymaker – Vice President and Manager, Investor Relations

Kevin March – Senior Vice President and Chief Financial Officer

Analysts

John Pitzer - Credit Suisse

James Covello - Goldman Sachs

Uche Orji - UBS

Christopher Danely - J.P. Morgan

Cody Acree - Stifel Nicolaus & Company, Inc.

Glen Yeung - Citigroup

Srini Pajjuri - Merrill Lynch

David Wong - Wachovia Capital Markets, LLC

Tristan Gerra - Robert W. Baird & Co., Inc.

Ross Seymore - Deutsche Bank Securities

David Wu - Global Crown Capital

John Lau - Jefferies & Co.

Sumit Dhanda - Banc of America Securities

Tim Luke - Lehman Brothers

Allan Mishan - Oppenheimer & Co.

Krishna Shankar - JMP Securities

Steven Smigie - Raymond James

Joanne Feeney - FTN Midwest Securities Corp.

Michael McConnell - Pacific Crest Securities

Tore Svanberg - Thomas Weisel Partners

Doug Freedman - American Technology Research

Ron Slaymaker

Good afternoon, and thank you for joining our second 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 TI.com/IR.

This call is being broadcast live over the web and can be accessed through TI's website. A replay will be available through the web.

This call will include forward-looking statements that involve risk factors that could cause TI's results to differ materially from management's current expectations. We encourage you to review the safe harbor statement contained in the earnings release published today as well as TI's most recent SEC filings for a complete description.

Our mid-quarter update to our outlook is scheduled this quarter for September 9. We expect to narrow or adjust the revenue and earnings guidance ranges as appropriate with this update.

In this call, all of our financial results will be described for continuing operations, including historical comparisons, unless otherwise indicated. In today's call, we'll address key questions such as what is driving the continued weak demand; why revenue and earnings were in the lower half of the ranges that we recently provided at our midquarter update. Also, we'll discuss why our inventory continued to increase this quarter despite our earlier projections that it would decline.

At the top level, we believe the second quarter's results illustrate the significance of the opportunities that we're addressing in Analog and Embedded Processing. Revenue in both of these areas grew sequentially and was up 10% from the year ago quarter.

At the same time, we had some disappointments, notably results landed in the lower half of our range of expectations. This was mostly the result of distributors not replenishing inventory to the level that we had expected.

You will recall at the mid-quarter update we said we expected that our sales into distributors and their resales of TI products would both be up a little, and that distributor inventory would remain about even. In fact, resales ended the quarter a little stronger than we had projected while our sales into the channel declined as distributors reduced inventory. The end result was that our revenue tracked below our expectations in June.

Let's look at it by product category.

Analog revenue was $1.29 billion in the quarter, up 10% from a year ago and up 2% from the first quarter. In both comparisons, high performance analog was the driver of growth.

Embedded Processing revenue of $436 million was up 10% from a year ago and was up 4% from the prior quarter. Catalog DSP and microcontroller products were the primary drivers of growth in both comparisons, although communications infrastructure also contributed solid growth.

Wireless revenue of $903 million declined 12% from a year ago and was down 2% sequentially. Baseband products were the reason for these declines.

Other revenue of $720 million declined 14% from a year ago. Most of these product lines were down over this period, although I should remind you the decline also included the impact of the sale of a DSL product line in July of last year. Sequentially, other revenue grew 8%, driven by the seasonality of graphing calculator sales, which more than offset weakness in RISC microprocessors.

On our website you can find some additional historical revenue data by the new categories. We've included revenue by quarter beginning with the first quarter of 2007.

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

Kevin March

Thanks, Ron, and good afternoon, everyone.

Gross profit was $1.75 billion in the quarter or 52.2% of revenue. Gross profit was down $35 million from a year ago due to lower revenue. Gross profit was about even with the first quarter although normally would have been expected to be up given the higher revenue level.

The shortfall was due to a number of factors that drove manufacturing costs higher, such as decreased absorption of fixed costs as a result of the lower factory utilization levels that resulted from our reductions in wafer starts in the quarter. Manufacturing costs were also impacted by expenses associated with converting capacity at our DMOS 5 wafer fab from digital to analog, higher costs on commodity raw materials such as gold, and the rate of exchange impact on expenses such as labor in regions where we compensate in currencies other than U.S. dollars. In addition, we continue to incur expenses associated with transferring equipment from our shuttered KFAB factory to increase capacity at analog wafer fabs around the world.

Although none of these items individually was particularly significant, the cumulative effect was noticeable.

Operating expenses were down 6% from a year ago and 3% from the prior quarter. Lower R&D expense was the biggest factor in both comparisons. As a result, operating profit for the quarter was $833 million, up $24 million from a year ago and up $26 million sequentially.

Other income and expense declined to $17 million due to a combination of lower interest income and lower earnings from investments.

Income from continuing operations was $588 million or $0.44 per share.

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 $520 million in the quarter, and we ended the quarter with $1.65 billion in total cash. We also continued our share repurchases using $433 million to buy back 14.1 million shares of TI common stock and pay dividends of $132 million in the quarter.

Inventory of $1.65 billion at the end of the quarter increased $227 million from a year ago and $73 million from the prior quarter. Inventory days declined to 93 from 94 last quarter. The increase in inventory was primarily due to higher manufacturing costs, as I previously discussed, and the lower than expected revenue in the quarter. Although we reduced wafer starts throughout the quarter, work in process continued to build as previously loaded wafers moved through the production lines and as other manufacturing costs increased.

In addition, about a third of the inventory increase was built to support the upcoming backtoschool season for our Education Technology business. TI orders in the quarter were $3.46 billion, about even with the year ago quarter and an increase of $143 million or 4% from the prior quarter.

Turning to our outlook for the third quarter, we continue to remain cautious relative to our guidance and our internal operating plans given the changing demand environment and the overall uncertain economic environment. We expect total TI revenue in the range of $3.26 billion to $3.54 billion. Earnings per share are expected to be in the range of $0.41 to $0.47.

To summarize, we're encouraged with our progress in Analog and Embedded Processes. We believe these areas will become the primary drivers of TI's financial performance in the years ahead and offer significant revenue and profit growth opportunities for TI.

At the same time, the broader economic environment and its impact on near-term demand have our attention. As a result, we will continue to be cautious in our operating plans and our forecasts until we have better clarity on demand.

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.

Operator?

Questions-and-Answer Session

Operator

(Operator Instructions) Your first question comes from John Pitzer - Credit Suisse

John Pitzer - Credit Suisse

When you look into the September quarter can you give us a sense of what kind of gross margins we should be expecting and how much of the margins in the quarter are going to be negatively impacted by sort of utilization rates coming down in order to control inventory?

Kevin March

John, we won't be forecasting gross margins specifically but I'll give you some other numbers to kind of work with. We've already given the range on revenue and earnings per share. I should mention that we still expect our R&D to be about $2 billion for the year and our depreciation to be about $1 billion for the year, with Capex continuing to be about $900 million for the year, so you can work into the math there what that may constitute on how you model our revenue expectations.

But with the continued efforts to reduce our overall inventory, we continue to expect the wafer fabs to be less than ideally loaded, and so that will put some pressure on our gross margin moving forward.

John Pitzer - Credit Suisse

Any targets for inventory exiting the September quarter?

Kevin March

No targets specifically. I would note that the inventory that we just left the second quarter with was higher than desired, roughly in the $100 to $150 million kind of range. We do build our inventory in expectation of what we expect our next quarter's revenues to be, and consequently, with our revenue expectation cautious right now, we have more inventory than we desire to support that revenue expectation at present.

Operator

Your next question comes from James Covello - Goldman Sachs.

James Covello - Goldman Sachs

Kind of a follow up to John's question or along similar lines, you commented the last couple of quarters that you didn't want to cut production too aggressively for fear that you could get caught with a shortage if demand snapped back. I didn't hear that on this call. Are we kind of beyond that point and to the point where you just have to be more aggressive in cutting utilization and managing the inventories down?

Kevin March

Yes, Jim, what we talked about last quarter when we came up with the first quarter earnings results was that we would spend the next two or three quarters working the inventory down in a measured manner.

Frankly speaking, we had anticipated having a quarter lower than what it just closed at. The fact of the matter is it was higher, and it was higher really for a couple of reasons. One was the increase in manufacturing costs as I mentioned earlier that we actually saw roll through the P&L in the quarter, and that's continuing to roll through into our inventory. And the other was that, as Ron mentioned during the call, distribution customers chose to reduce their inventories more than we expected late in the quarter, and consequently our revenue came in below where we thought it would be at, leaving us with more inventory than we expected.

So we will continue to work down the inventory over the next couple of quarters along the lines that we mentioned earlier.

James Covello - Goldman Sachs

I guess, you know, a lot of the questions that we're asking here are focused on your internal production. How about the external production in terms of wafer start requirements to the foundries for the wireless business?

Kevin March

As we mentioned during the last release, we had pulled back the loading in the foundries in that point in time to bring those inventories down, because you may recall that we had late demand reductions at the end of our first quarter in the wireless space.

We've progressed on that front and have loaded the foundries in order to support our expectation for revenue in the third quarter now.

Operator

Your next question comes from Uche Orji - UBS.

Uche Orji - UBS

Just very quickly, if I look at your Q3 guidance, how shall I expect that to break out between wireless and [inaudible] embedded? Is it fair to assume the wireless will be flatish to down in Q3?

Kevin March

Uche, we don't break our outlook down below the level that we've provided, which is TI. I think you can probably look at the quarter we just reported and note that wireless was certainly unseasonably weak in the second quarter. In fact, it was unseasonally weak in the first quarter as well. But we don't specifically break our outlook down into various product lines.

Uche Orji - UBS

If I look at this current quarter, can you just give me some more insight as to what happened to mix within wireless, specifically how much of the sales this quarter was 3G and how much was [inaudible] if possible, and any comments on ASB business units.

Kevin March

Okay, Uche, I can - and when you're saying this quarter I assume you're referring to the quarter we just reported, the second quarter - what color I can provide is that actually very similar in terms of mix as to what we even said we expected at the mid-quarter in that 3G rebounded somewhat from the very low level that we had in first quarter, and the only point I'll make on that was consider that first quarter was very weak specific to 3G.

And then the more legacy products, the GSN, GPRS, and probably EDGE, if you just take those in combination, were the areas that declined both sequentially as well as year-in-year. So again, mix improvement in terms of stronger 3G sales in both comparisons, but at the same time weaker legacy product sales in both comparisons as well.

Operator

Your next question comes from Christopher Danely - J.P. Morgan.

Christopher Danely - J.P. Morgan

Kevin, you said your outlook remains cautious, but I think on the last call you said you expect utilization rates in inventory to trend down throughout the end of the year. So can we assume that there's going to be a big slowdown in utilization rates in inventory in Q3 or should that spill into Q4 like you guys talked about last quarter?

Kevin March

Yes, Chris, we expect the utilization to continue to decline in a measured way, if you will, again, over the next quarter or so. Fourth quarter is a little bit too far out to call just yet. In fact, it did decline a fair amount in the second quarter as well, and it began to decline in the first quarter although it was fairly modest by the time that happened. And again recall that what drove our inventory increase this quarter, roughly a third of that was Education Technology, which is a seasonal build for the calculator sales, and about a third of that was due to cost growth that we're seeing, and then roughly the remaining third was due to the fact that the distribution customers chose to reduce their inventories unexpectedly in the quarter.

Christopher Danely - J.P. Morgan

And then as a follow up, in terms of the guidance, you know, your leading customers seemed to give fairly positive wireless trend guidance, and you guys seem a little more cautious than that, so can you just give us any hints as to what's going on out there? Is it pricing? Is it share loss? Is it, you know, you expected Motorola to come through in the second half, and they're going to sleep. Can you just give us a little insight there?

Ron Slaymaker

Chris, I probably can in terms of the second quarter performance, maybe more so than the outlook as I previously discussed. But I think if you look at the quarter we just reported and the decline in wireless revenue, which we'll note certainly was below seasonal, you know, you heard from our largest customer, Nokia, last week. I think our shipments and our revenue, our business levels with Nokia were fully consistent with what you heard from that customer. However, Nokia's not our only customer, and I would just say possibly or most likely the other customers did not fare as well as Nokia in terms of sales of their own products.

As far as share, probably the one caveat I would say is that we've discussed the loss of the 3G program Ericsson mobile platforms. That, as we've said before, we expect to decline until it bottoms out, oh, call it roughly the end of this year, stabilize for about a year before growth returns there on the next generation program that we've won. But that would probably be the one case in terms of a program where there's a share loss consideration for TI.

Outside of that one program, we believe that our share is stable at those various customers, and our results really are reflecting the varying performance levels of our customers in their marketplace.

Okay, and that's probably about all I can really add in terms of color there, Chris.

Operator

Your next question comes from Cody Acree - Stifel Nicolaus & Company, Inc.

Cody Acree - Stifel Nicolaus & Company, Inc.

Maybe, guys, you could talk about order trends in wireless. You said orders picked up, I think maybe [inaudible] versus wireless, order trends picking up, and if you can make any comments as to the makeup of those orders in the distribution channel. I'm assuming those aren't to your OEMs or to wireless.

Kevin March

Cody, I think you're right. There may be some distribution support of wireless, but for the most part the comments we're talking about distribution are much more broadly based than any particular end segment. I don't know that we made comments on distributor orders previously, but what I can say is distributor orders did increase in the quarter. Our backlog with distributors increased in the quarter. In fact, our book-to-bill with distributors is probably at the highest level it's been in a year. We saw, as we described already, resales increase at distributors even more than what we were expecting back in early June. So everything at distribution sounded good with the exception of, you know, our revenue went down as they reduced inventory.

And so, you know, I don't have a lot of insight as to exactly why they chose to reduce inventory other than the observation that in fact they did and that represents the gap in what we were expecting back in early June and what we actually closed out the quarter.

Cody Acree - Stifel Nicolaus & Company, Inc.

I guess the question then is what's in that distribution inventory that they're cutting back? Is it kind of catalog analog? Is it a high-performance analog? Where's the makeup?

Kevin March

Cody, best I can tell at this point is it was pretty broad based, so it wasn't specific to any particular product area in terms of focus on concentration. It was pretty broad based. And just as a reminder, distribution represents about 30% of our revenue. It would be predominantly products such as the catalog DSP and microcontroller products, the high-performance analog products, and the standard logic products. Those are the type of products that we moved.

I can't say it's totally uniform in terms of their inventory actions across those areas, but neither was it concentrated in any single product area.

Operator

Your next question comes from Glen Yeung - Citigroup.

Glen Yeung - Citigroup

Ron, you make the point that your June month saw slowdown. What's your sense as to how July has been, and are you getting any indications from your customers on direction?

Ron Slaymaker

You know, Glen, probably the best I can say is it's very consistent with the guidance that we're giving. And so, you know, the guidance has the range but generally if you look at the middle of the guidance that we're issuing, it would be flattish in terms of semiconductor, and what we've seen thus far in the month of July would be consistent with that type of outlook.

Nothing that we've seen in July is causing us to question whether that guidance should be moved one direction or the other.

Glen Yeung - Citigroup

Maybe this is for you, Kevin. To the extent that this is a downturn that lasts a long time here, is there room for you to cut costs, both on the OPEX side - particularly given that you haven't lowered that number for this year  and also on the gross margin side, is there still room here for you to tighten up the model a little bit?

Kevin March

Glen, there's always room for us to continue to improve. Let me start with the growth side.

The biggest benefits that we have still coming to us on the growth side is the increase of analog as a percentage of our total mix, especially high-performance analog which, as you know, delivers very generous gross profit margins. And so as we see that mix continue to change and become proportionally larger over time, that will give us a boost, as well as we expect to see depreciation continue to be modest, if not even going down a little bit. The last couple of years our Capex has been - last year and this year, our Capex running below our depreciation. And so it's only natural to assume that depreciation will continue to moderate.

In fact, if you look over the last four quarters or so, depreciation's been running - if you added the last four quarters' worth of revenue, depreciation's right about 7% of that and Capex has run about 6% of that, so that gives us a bit more headroom also on the gross line.

On the OPEX line, as we see certain markets changing we will clearly make the changes consistent with the timing of those market changes. And that'll be speaking to like a large program to large markets that may be shifting, where we'll shift resources accordingly or invest in those areas accordingly. So I would expect that the OPEX lines will reflect the changes that we see, and a fairly close timing to any outlook that we have for the respective businesses and the changes for their futures.

Operator

Your next question comes from Srini Pajjuri - Merrill Lynch.

Srini Pajjuri - Merrill Lynch

Kevin, the inventory, I'm just curious as to what's in that inventory? And as I look out to the next few quarters, I'm just trying to value the risk of any potential write-downs here.

Kevin March

Srini, the inventory on the custom side is pretty tightly managed. In fact, our biggest custom exposure is on the wireless that you may recall, and we in fact worked quite hard during the second quarter to bring that more in line with our customer demands there. So our view is there is very little risk to the value of the custom inventory.

The catalog inventory tends to have very long shelf life, so the only risk there is the timing at which that inventory will sell. It tends to not be too at risk from a price standpoint. It tends to be just a question of when it will actually sell. So we do not foresee inventory valuation risks at our current levels.

Srini Pajjuri - Merrill Lynch

And Kevin, for you again, just a follow up the previous question, I mean, obviously the business has been weak for the past few quarters, but it looks like you're sticking to your expense and depreciation forecast. I'm just wondering at what point would you say, okay, you know, we're going to take another look at R&D and [inaudible] expenses here, maybe resize the business a bit?

Kevin March

Srini, we talked about in the past what we would do if it turns out that we're dealing with a softer overall business climate than I think people are hoping for, and really what we would do is take advantage of the position that we have, both from a cash position as well as a market position.

In other words, from the cash standpoint if we did see continuing softening going on, we'd probably take the opportunity to go ahead and try to continue to acquisition used manufacturing equipment that we can get much cheaper in an environment like you're describing.

And from an overall market standpoint, we'll continue to deploy a sizeable sales force to sell to as many of competitor's customers as well as our own customers as possible.

So we'll continue to be fairly aggressive in our approach to the market.

Now that being said, of course, we won't have our head in the sand. We will be paying attention to cost, and where it makes sense for cost to be removed. Again consistent with changing fortunes for the businesses that we may be in, we'll go ahead and make those adjustments. But right now I don't have anything specific to predict for you.

Ron Slaymaker

But, Srini, let me also just remind you, our OPEX in the quarter we just reported is down 6% from the year ago quarter. So, in fact, those changes are ahead of revenue. Revenue is down 2% over that same period.

Operator

Your next question comes from David Wong - Wachovia Capital Markets, LLC.

David Wong - Wachovia Capital Markets, LLC

Just a clarification of your answer to Glen's question. So have you seen orders weakening since the end of the June quarter, and is your current run rate at book-to-bill of 1 or is it below 1?

Ron Slaymaker

Oh, David, I don't know that, you know, in terms of book-to-bill, looking at it on a weekly basis is meaningful. What I can is that orders in the month of June declined from what they had been running previously, and you might expect that just by nature of a lot of the distributor business that did not occur was in the form of turns business that we had expected to occur. So with that turns business turning down or those orders not coming in place just as the revenue turned down from our expectations, the orders turned down as well.

In response to Glen's question, I was not indicating a trend for the month of June other than saying the orders that  I'm sorry, for the month of July - other than saying what we are seeing thus far in the month of July is fully consistent with the guidance that we gave, and the guidance that we gave in the middle of that range would be flatish with what we saw in the June quarter.

But I'm not trying to provide at this point, you know, the first three weeks of July trended Direction X or Direction Y.

David Wong - Wachovia Capital Markets, LLC

Further on that sort of general idea, then, you're basically cautious on September. Are there any segments that seem to be weaker than others or is your caution broad brush across the board?

Kevin March

David, I guess would just say similar to what we've said before, that we're not breaking the guidance out by individual product lines. Probably the best we could say is look at the quarter's results that we just reported, what was weak, what was stronger, and make assessments that you might on the third quarter based on that. But we won't break our caution or our enthusiasm down into individual product areas.

Operator

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

Tristan Gerra - Robert W. Baird & Co., Inc.

You mentioned that your market share was stable outside of E&P and Wireless. Would you have the same comments for Analog, and specifically are you seeing anything abnormal in terms of pricing or competitive action, including in [PCs] into the second half?

Kevin March

And again, you're saying broader Analog, not analog in the handsets, is that correct, Tristan?

Tristan Gerra - Robert W. Baird & Co., Inc.

That's correct.

Kevin March

Yes, I don't know that, you know, to be honest, at this point we've seen none of our competitors report, so it's really difficult for us to make an assessment of did we hold share, did we gain share, in Analog overall. So I don't think we're aware of any significant moves that would indicate a share issue. And, again, if you look at our year-on-year grown in Analog, it was up 10%. You probably have an assessment, but I don't know that we believe the analog market is tracking up 10% this year.

So I would say the longer-term trends are what you've seen in the past in terms of share gains for Texas Instruments in Analog, but again, I don't have specific data from competitors at this point to provide much substance behind that speculation.

Tristan Gerra - Robert W. Baird & Co., Inc.

What's your inventory in weeks at distribution currently?

Kevin March

It's generally tracking between 8 and 9 weeks, as it has been over the last year. What I would say is it's moved toward the lower end of that range with the action that they took in the month of June, but generally it's been tracking 8 to 9 weeks and at the low end of that range currently.

Operator

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

Ross Seymore - Deutsche Bank Securities

Just a question again on the disti side of things. What are you expectations for your disti business heading into the third quarter, either on sell in, sell through or whatever metrics you can provide?

Kevin March

Ross, we don’t have that level of detail to provide on the outlook. What I would say is given they're running on the lean side of their historical trends in inventory, you know, if their resales pick up likely they will need to move inventory in the same direction. But we're not guiding specific to our disti expectations.

Ross Seymore - Deutsche Bank Securities

I guess the follow on would be kind of the inventory impact of all that. Even if I back [break in audio] .

Kevin March

Operator, it sounds like we lost Ross, so if - Ross, if you come back into the queue, we'll try to let you in. Otherwise, let's go ahead and move to the next caller, Operator.

Operator

Your next question comes from David Wu - Global Crown Capital.

David Wu - Global Crown Capital

Ron, can you help me on [this thing]? Because when I look at the products that were strong in the second quarter, they were all distributor related, and yet you had a revenue shortfall in the [inaudible] basis in the month of June. And I was trying to reconcile, you know, why was June so bad, and yet the stuff that were good would all through distribution in the quarter ended in June.

Ron Slaymaker

That's an interesting observation and, you know, all I can say David is that, you know, what that translates to is back in early June clearly we had expected those various areas to do even better than they had. And at least on a resale basis, in fact, they did. But, again, we got caught up in some distributor inventory actions even in those high-growth areas.

David Wu - Global Crown Capital

If we finished our inventory balancing act by the end of this calendar year, based on the trends we have seen thus far do you think that gross margin will be sequentially year-to-year higher as we go into '09 because both depreciation will be down and also your mix should be richer.

Kevin March

David, I agree with your assessment that, because we are in an inventory adjusting phase and therefore underloading the factories, presuming that in fact we do see some reasonable upward movement in revenue growth next year, then clearly we will have tailwinds on mix, depreciation and utilization.

Operator

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

John Lau - Jefferies & Co.

I may have missed it, but just to recap on the flex manufacturing model, you indicated that the inter utilization internally has gone down but the outsourcing was supposed to buffer that.

Is the internal loading downtick more of a mix issue? And, I guess, the bigger question is: How much flex can you manage with the mix constraints that you have?

Kevin March

John, the loadings with the foundries are primarily on the CMOS or digital wafers. And, in fact, that is where we have flexed our loadings up and down. Our internal loadings and those internal capacities actually remain quite well utilized throughout this period.

It's on the analog side; the analog loadings are the ones that we adjust a bit more to accommodate these changes in demand.

Ron Slaymaker

And John, just as a reminder, so where we use foundries is primarily in those advanced logic areas. Almost all of our analog production is done in-house at TI as opposed to a combination of TI and foundry partners.

John Lau - Jefferies & Co.

What is the overall utilization rate that you have internally now?

Kevin March

John, we don't publish our utilization rates. I'll just suffice to say that it has been down for a couple of quarters now as we have pulled back on our factory starts in order to begin to work our inventories back to a more desirable level.

Operator

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

Sumit Dhanda - Banc of America Securities

I'm having a little trouble reconciling your outlook for the September quarter, which is barely up on a semiconductoronly basis, and I guess my issue is given that your inventories are sensibly not at the low end of the range within the distribution channel, why guide so far below what would be your seasonal norm here, both in terms of your Wireless business and your core Analog?

Kevin March

Sumit, the reason that we're guiding is really it's a cautious approach to the market. As we described earlier, given the fact that was saw very late and unexpected demand changes late in June, we're using that as just a point of reference to be cautious in now we approach the third quarter.

The backlogs that we have, the order patterns that we've seen, support the range that we've got out there. The distribution, of course, is at the low end of the inventory weeks on hand that Ron talked about. I'm not sure if the distribution customers are going to continue to operate at that level or to increase it. We're not counting on that. Consequently, that all comes together to the forecast range that we've delivered to you.

Sumit Dhanda - Banc of America Securities

And then a separate question as a follow up, on the R&D line, you know, it came down fairly significantly sequentially, you know, down significantly on a year-over-year basis, your restructuring obviously helping. Can you highlight some areas which would allow you to sustain this level of R&D reduction going forward or are the businesses that you're not currently involved in going to require a fairly sustained level of R&D investment at [inaudible].

Kevin March

Yes, Sumit, the R&D is down, as you pointed out, year-over-year, and that's largely a reflection of the change to our advanced lithography development that we announced at the beginning of last year. Now we're working in conjunction with the foundries on that, so we're realizing the reduced expenses on a year-over-year basis there.

Quarterly, our OPEX was down, largely a function of compensation costs coming down.

We have given a guideline of $2 billion for the year, and we're actually right inside that, so we should be just fine at this spend rate or at about this spend rate on the balance of the year.

And again, to the extent that we continue to adjust program development costs based upon the outlook for programs that'll have an impact on those numbers going forward, but I don't anticipate at this point in time anything significant to talk about.

Operator

Your next question comes from Tim Luke - Lehman Brothers.

Tim Luke - Lehman Brothers

Kevin, you talked about shorter lead times. The ability to fulfill with shorter lead times being a factor, could you just frame for us what the shorter lead times are, and if you could also just remind us of how linearity has usually shaped in the third calendar quarter, I believe that would be helpful, too.

Kevin March

Tim, on the lead times, we generally had reasonable lead times for most of products. Some a still a little bit long, but by and large, they're coming in a little bit as we're positioned more inventory internally. And consequently, our customers don't have to carry as much as they may have, and we believe that's part of what we're seeing here. But they have more confidence in us and in us being able to deliver more quickly, as they're well aware that we have ample inventory to meet most of their near-term demand requirements.

Tim Luke - Lehman Brothers

What's the change there, Kevin? It's gone what to what?

Kevin March

I'm sorry, Tim, the change?

Tim Luke - Lehman Brothers

In lead times, so where are they now?

Ron Slaymaker

Tim, I think if you look at the broad base, you don't see a substantial difference in overall lead times. The cases where we've been able to pull lead times in where probably in areas where there were more, call it, outlier type of lead times. We've been able to get more - those lead times - more reduced consistent with, you know, probably the overall lead times that - I don't know. Probably - we have so many different product lines, probably lead times overall would range anywhere from 6 to 12 weeks, on average.

So, again, what we've managed to do is pull in the outliers into that range, and at the same time, we've also notably increased our delivery performance in terms of our delivery schedules and actually hitting the lead times that those customers were expecting.

Tim Luke - Lehman Brothers

For example, where? In saying that, what [inaudible] time, better delivery, where would we point to as being the biggest area of difference on that?

Ron Slaymaker

This is more of an example as opposed to a specific - where the mass of it would occur but, for example, in some of the Analog products, we had some products previously that lead times were out, oh, even greater than 20 weeks which, you know, clearly is not something that we want to sustain on a long-term basis, and we've been able to pull those back into 12-week range. So that would be just an example, Tim, not necessarily a high volume or representing a significant part of our revenue.

Kevin March

The follow-up question, Tim, that you asked was with respect to linearity in third quarter. What I would just say is from a revenue perspective, linearity tends to be - in every quarter, the last month of the quarter tends to be strongest. I guess if I think about it, there's different weightings. In some cases, there's more strength in that third month than there are in other quarters.

I would say it's reasonably pronounced for TI in the third quarter, meaning September's the strongest month. But even there, Tim, think of, you know, we don't have quarters that ship 50% of our revenue. When I'm talking about something being pronounced it would probably be more in the upper 30s as opposed to, you know, a straight 33% across each month of the quarter.

So again, September would be the strongest month but, you know, we're talking a few points off of a straight linearity.

Operator

Your next question comes from Krishna Shankar - JMP Securities.

Krishna Shankar - JMP Securities

Yes, can you - it looks, again, in terms of the cell phone market caution that you see more weakness in the low, midrange cell phones or just the high-end 3G phones. And with respect to Nokia, do you feel that you have stabilized your presence there in terms of market share?

Kevin March

Krishna, in terms of Nokia, we continue to ship into essentially all of their handsets, so I don't believe at Nokia there has been any noticeable impact on baseband products or application processors in terms of other competitors. And again, you know, what I tried to characterize was that our shipments into Nokia in the second quarter were very consistent with what you heard that customer describe in terms of their business last week with their own earnings release and conference call.

If you look outside of Nokia, that's where there's been probably customers that just have not been performing as well in the marketplace. And I think, you know, those customers that reported or will report their own results, and I'll probably just need to leave it at that.

Krishna Shankar - JMP Securities

I've been listening to high-performance analog, you know, it's just worked out of an extended downturn or a slowing in the global economy. How do you expect your high-performance analog business to respond under such macro conditions?

Ron Slaymaker

Krishna, I guess what I would just offer there is that we continue in that product line to introduce 400 to 500 new products each year. We continue to expand our sales force on the ground around the world, including our field applications engineers. And between those two things we have been discovering a lot more customers and gaining a lot more share over time.

So if the macro market slows down, it's difficult to predict what that might do to our growth rates, but I believe we would still be quite confident that we'd continue to take market share independent of what happens to the macroeconomic.

Kevin March

And, you know, certainly HPA as a marketplace is going to move up or down depending upon the macro environment. It is so well diversified and, you know, even our own revenue in there, the largest segment inside of high-performance analog is industrial. So it's clearly macro sensitive but, again, we would measure on a relative basis versus our peers, despite the overall environment.

Operator

Your next question comes from Steven Smigie - Raymond James.

Steven Smigie - Raymond James

I was hoping you could comment a little bit on the high-volume analog and how you are performing there relative to your hopes of getting that going and just sort of general coming attraction there.

Kevin March

Steve, I would say, you know, if you look at high-volume analog, you know, again, I think our characterization in the current quarter was that - or in the second quarter was that the analog results were driven predominantly by high-performance analog. I think we had, oh, let me just say some small growth in high-volume analog from a year ago, which says that, you know, it's doing okay, but certainly not consistent with where we expect that it has the potential to go going forward.

And, you know, I think as we've talked about, even at our analysts meeting in depth, probably the biggest single marketplace that we believe has the potential to drive that turnaround will be inside the wireless handset where we have been seeing that revenue decline over the last few years. I think you can expect that it is in the process of stabilizing, and then I think what we've described is that in second half '09 is when we expect that wireless handset revenue for analog or for HVAL to move back into growth mode again.

And again, that's not based on just wild hope. That's based upon design programs that we have in the pipeline and are well into the execution of.

So think of it again, stabilization for awhile and then second half '09 is when that specific thing will turn back into growth.

Steven Smigie - Raymond James

Actually, it's sort of looking for similar color on the 3G, [3.5G] design wins for baseband and apps processors. Is there anything going on there that might lead you to believe that you can have some potential to capture some share in that market or maybe not capture share? Is there any dynamic there that you could comment on a little bit?

Ron Slaymaker

Steve, I think probably the best that I could lead you to on that one is, again, set the Ericsson program aside. Outside of that, I think we're going to perform consistent with our customers. You know, the one new program is the custom 3G program at Motorola, and that'll be 2009 before it moves into production. The program at Ericsson where, again, it's kind of hurting us now but we said will move back into growth mode again, think of that as, you know, second half '09, late '09 before that translates into share gain.

So, again, for a period of time we'll move with the marketplace, and then once we get into 2009 some of those new programs at customers will have the opportunity to start translating to - I'll call it above-market growth or share gains for TI in 3G.

Operator

Your next question comes from Joanne Feeney - FTN Midwest Securities Corp.

Joanne Feeney - FTN Midwest Securities Corp.

A question one more time on the gross margin front, if we could. You remarked on a few one-time costs in manufacturing that contributed to its decline, and so I guess I'm wondering, with those going away presumably next quarter, how much greater headwind might there be from utilization rates falling? Secondly, are you seeing any increase in your cost of wafer processing with your foundry partners? And finally, how much is the decline in risk revenues contributing to that decline in gross margin and how much further could it fall because of that one factor?

Kevin March

Joanne, let me try to hit the manufacturing cost elements. In fact, we anticipate continuing to see some manufacturing cost increases as we go into the quarter, and really, we talked about a number of different things that are driving that. There's obviously the utilization rate that we talked about, and that will continue to be a headwind as we drive our inventories down some. We had also described the rate of exchange, the cost of certain raw materials such as gold and so on, and redeployment of some of our equipment as we expand our outlook past the internally.

Now we expect those costs to continue. They move through inventory and they make their way into the P&L, so there's about anywhere from an 8 to 12-week lag from when those costs are incurred to when they actually come through the P&L. So those have continued to be something of a headwind for us.

On the risk microprocessor, that really is one customer that we're seeing to there, and that is a fairly sizeable decline, partly a delay to a program ramp and also just that customer's outlook in the market which they serve, as they are quite dependent upon certain customers such as financial institutions and so on for their products and that will tend to have an impact on the kind of demand that we would expect that they would put into their products in the end.

Ron Slaymaker

And then, Joanne, on your question about foundry prices increases, an impact that would have, I would say zero. We're not seeing price increases from our foundries. Their prices are still too high, but we're certainly not seeing increases from them.

Joanne Feeney - FTN Midwest Securities Corp.

A quick question on the high-performance analog. Can you tell us how much just high-performance alone grew quarter-to-quarter and then specifically in power management, you've made some strong efforts there. I'm wondering if you could describe perhaps how successful those are looking these days?

Kevin March

Joanne, you're right. Power management has been a great story for TI over the last several years. We expect it will continue to be. If anything, we're intensifying our focus on the power market. In terms of specific growth numbers for HPA, again, with our new breakdown of revenue we're providing specific revenue growth numbers for analog, and we'll use, you know, the trends inside of that between HPA and HVAL to explain the overall analog, but we're not providing growth rates specific to HPA or HVAL on a go forward basis.

Operator

Your next question comes from Michael McConnell - Pacific Crest Securities.

Michael McConnell - Pacific Crest Securities

Ron, I'm just trying to understand this. So the book-to-bill was above 1 at disti. Your backlog's higher. Orders are up 4%. So it was just that in June the pools were not commensurate with the bookings and that's why we're getting more cautious with the guidance for Q3, is that it in a nutshell?

Ron Slaymaker

That's pretty close. The only thing I would say is the pools in the month of June, certainly they didn't place orders for what they didn't pull, either, so we saw - I don't know if we saw - I don't know what the disti-specific trend was in the month of June, but, you know, overall orders trended down with the revenue - call it the gap in revenue as associated with that. But basically what you've described is correct.

Michael McConnell - Pacific Crest Securities

So when you guys - at the mid-quarter, the orders were higher on a percentage basis, and now they've come in?

Ron Slaymaker

That's correct, yes.

Michael McConnell - Pacific Crest Securities

And then last one from me, just specific to, I guess, the industry versus TI, this dynamic we saw with the distributors working down inventories, was this more do you think an industrywide phenomenon or was it more being driven by the fact that you've, you know, maybe the distributors have more confidence that your lead times are going to be lower going forward or some dynamic with that? And the last one would just be any region in particular where you saw this occur?

Ron Slaymaker

Mike, I don't, you know, I don't know that we have the insight as to whether distributors pulled back across the board or whether it was more specific to TI. You know, I will say I know distributors are pleased with the delivery performance that they're seeing from TI and certainly we have enough inventory on our balance sheet to support their demand in third quarter on pretty short order, but whether they took just their inventories down more broadly than just TI, I think we probably need to wait until they report their own results for us to be able to say that specifically.

Kevin, do you know whether there was any waiting by region in terms of just, you know, did Asia pull back more so than North America or Europe? I don't recall that.

Kevin March

It was fairly broad. Asia being our largest region it was most noticeable, but it was broad across the regions. The only region where we didn't really see it was in Japan.

Operator

Your next question comes from Tore Svanberg - Thomas Weisel Partners.

Tore Svanberg - Thomas Weisel Partners

Just going back to you mentioned that you saw a late June decline in selling orders. Did you see that same element for sell through as well, late in June?

Ron Slaymaker

No, Tore, it was the opposite in terms of resale. So let me just kind of repeat what I said in the prepared remarks. When we gave our mid-quarter guidance, I think I even said on that call that we expected both sell in and sell out to be up a little on a sequential basis. And what ended up happening, the sell out increased more than we expected, and our sell into distributors actually declined in the quarter. So there was an acceleration in sell out, and a deceleration in sell in.

Tore Svanberg - Thomas Weisel Partners

And you talked about the 8 to 9 weeks of inventory at disti, and we're probably at the lower end of that now. How does that compare historically, let's say over the last, you know, 6 to 8 years?

Ron Slaymaker

Tore, I think over the last - if you look at it over that period, we probably, last I looked at it, the longer-term historical inventory level for TI distribution had been closer to 11 weeks, so they had been trending down over a number of years in terms of the level of inventory that they hold. And, in fact, as is evident from our own balance sheet trends over that time period, you've seen more of that inventory move upstream to TI. I think in general that's a trend that we appreciate just from the standpoint of it gives us better visibility. We don't have multiple buckets of inventory all through the supply chain that makes the marketplace more volatile in general.

But there has been a trend over the time period you're referring to for our own inventory to increase and our distributor inventory levels to go down.

Operator

Your last question comes from Doug Freedman - American Technology Research.

Doug Freedman - American Technology Research

Can we get a little bit of detail on your wireless infrastructure business? I know TI's got a fair share in that market; what you saw and what you expect to see in the back half of the year there.

Ron Slaymaker

Well, I can tell you what we saw, which was growth in both year-on-year as well as sequentially. I think, again, wireless infrastructure is now being described as part of our Embedded Processing revenue category or product category and was a nice contributor to that growth in both comparisons.

I think if you look at what we've said is certainly the bigger piece of that pie as well as the bigger part of the growth driver was the catalog products, both catalog DSP and microcontrollers, but we saw very nice growth out of coms infrastructure as well. As you're well aware, we have a very good position there, so it's most noticeably with our digital signal processors and probably most noticeably there or most pronounced in the advance infrastructure such as 3G.

So as 3G deploys, as TD-SCDMA deploys, as any of those advanced technologies deploy in the marketplace, TI will benefit with those deployments.

Doug Freedman - American Technology Research

If I could move over to Kevin for a second question, Kevin, looking at the dividend, in the past the company's been pretty quick to increase the dividend. You know, we're still at a low percentage of total earnings. I was wondering what the company's thought is about increasing the dividend and improving the yield here?

Kevin March

Yes, Doug, you're talking about the dividend. We've increased it five times in the past few years to the point now where it's almost five times what it was when we started the dividend increase back in late '04.

The Board, of course, has final say as to whether or not there's a change in our company's dividend. As we've talked about in the past, we do look for ways to return cash to our shareholders when we believe we have more cash than is necessary to run or invest in our business, and we do that primarily through stock repurchases and also through dividend.

So both of those continually get reassessed and reviewed with the Board on a periodic basis, and I expect we'll continue to review that. I can't predict any conclusions to what those reviews would be at this point in time.

Ron Slaymaker

Thank you for joining us. A replay of this call is available on our website. Good evening.

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