Today, and welcome to the Texas Instruments Fourth Quarter 2011 Mid-Quarter Update Conference Call. At this time, I would like to turn the conference over to Mr. Ron Slaymaker. Please go ahead, sir.
Good afternoon, and thank you for joining TI's Mid-Quarter Financial Update for the Fourth Quarter of 2011. In a moment, I will provide a short summary of TI's current expectations for the quarter, updating the revenue and EPS estimate ranges for the company. In general, I will not provide detailed information on revenue trends by segment or in market, and I will not address details of profit margins. In our earnings release at the end of the quarter, we will provide this information. As usual, with our Mid-Quarter Update, we will not be taking follow-up calls this evening. Considering the limited information available at this point in the quarter and in consideration of everyone's time, we will limit this call to 30 minutes. For your review of the Mid-Quarter release, you can find it on our website, ti.com/ir.
This call is broadcast live over the web and can be accessed through TI's website. A replay will be available through the web. This call will include forward-looking statements that involve risks and uncertainties that could cause TI's results to differ materially from management's current expectations. We encourage you to review the Pay ment Follow-Up statement contained in the news release published today, as well as TI's most recent SEC filings for a more complete description. We have narrowed and lowered our expected ranges for TI's revenue and earnings from our previous ranges. We now expect TI revenue between $3.19 billion and $3.33 billion. We expect earnings per share between $0.21 and $0.25. The reductions are due to broadly lower demand across a wide range of markets, customers, and products, except for wireless applications processors. Operators, you can now open the lines for questions.
In order to provide as many of you as possible the opportunity to ask a question, please limit yourself to a single question. I will provide you the opportunity to ask a follow-up question. Operators?
Thank you. If you would like to ask a question, please signal by pressing the star key followed by the digit one on your telephone keypad. If you're using a speakerphone, please make sure your mute function is turned off to allow your signal to reach our equipment. Once again, please press star one to ask a question. We'll go first to Uche Orji with UBS.
Thank you very much. Ron, can I just ask you if there are any one-time items that may have impacted the EPS the way it did relative to the revenue downgrade?
You said you're asking specifically about why things like EPS moved?
That is correct.
Down disproportionate to the revenue.
All that I would say, actually, there are some one-time items. Let me kind of walk through that transition in general if I can. First of all, I would say mix is unfavorable. If you think about it, we actually haven't talked yet about product areas per se. What I would say is we're seeing downsides versus our expectations in some of the more profitable areas, such as Communications Infrastructure and some of the Catalog, Analog, and Embedded Processing product areas, while at the same time we're seeing upsides in Wireless. That mix shift is unfavorable to profit margins and therefore EPS. I think also impacting us this quarter is utilization. With revenue down more than we had initially expected, we've also further reduced production loadings to avoid building excess inventory.
As a result, the underutilization expense will be higher this quarter, therefore further pressuring profit margins compared to last quarter. Finally, maybe to the point you had initially asked, we will have higher acquisition-related expenses by about $20 million, which is about $0.01 per share, higher than what we had previously expected.
Uche, on that note.
Yes, I do. Thank you very much for that. In terms of what changed between the last earnings call and now, obviously, we know the macro has continued to weaken. In terms of the expectation that we have seen is bottoming process forming, are you still willing to stand by that comment, even though you've had to lower now? If I had to recalibrate how you view things from here onwards, in respect to the early comments from the last earnings call, how should I think about it?
Okay. Let's start with what changed. As I said in my opening remarks, the weakness really is pretty broad-based with the exception of Wireless. Revenue in our Analog, Embedded Processing, and other segments is weaker than we had originally expected. If you look at it by in-market, Communications Infrastructure is exceptionally weak. That's being driven by UMTS-based systems in North America as those couple of carriers await the outcome of their proposed merger. Industrial markets also remain weak. In that space, we have both customers and distributors seemingly pushing component inventory levels to very low levels. In the computing space, computing is down with declines at storage or hard disk drive customers, especially exacerbated by the flooding in Thailand. Consumer product areas, such as televisions and video games, are also weak this quarter.
I mentioned the one bright spot is Wireless, and there, our OMAP revenue is doing very well this quarter. Just as a reminder, we're now seeing the benefit of customer programs that have ramped into production using our latest OMAP processor. Those customer programs include Samsung's Nexus smartphone, which is our first production program based on Google's Ice Cream Sandwich reference design, Samsung's Galaxy S2 smartphone, Motorola's Droid Bionic and Reva smartphones, LG's foldable smartphone with its 3D playback and capture feature. Most recently, the Amazon Fire Tablet and the Barnes & Noble Nook Tablet are both based upon OMAP 4. Probably the final in-market area that I would mention is automotive. There, I would describe that sales into automotive applications, we would expect this quarter to be about flat sequentially, which was about as we had expected. That's what changed, Uche. Thank you for your question.
We'll move to the next caller.
Thank you. We'll go next to Shawn Webster with Macquarie.
Thank you. I was wondering if you could add some color, if you could, on the order linearity. Did you see cancellations and push-outs, or is it just turns that didn't come in as expected? How did orders progress month by month for the quarter so far? Thank you.
Okay. Sean, I would say this is a relatively likely decline from the third quarter level. This decline includes the seasonal impact for calculators as well as what I would just characterize as lumpiness in baseband. If we look at our semiconductor products and pull out baseband because of that lumpiness, I would say orders have generally been moving sideways since the significant drop that we saw in the month of July and that we talked about in our October call. They've been kind of noisy from a month-to-month basis, but the overall trend has been flattish since that period. Do you have follow-up, Sean?
Just on inventories, I was wondering if you could hazard a guess if you think your OEM and your distribution customers are burning inventory now or what your visibility there is?
Clearly, reducing inventory. I would say really in both fronts. For distribution, we obviously see that data most clearly because we just know that distributors are carrying. They are continuing to take inventories down. I would say they have inventories down to very low levels. Our belief is that at the OEM customers, inventory is being reduced and that, in fact, we're undershipping those customers' production levels.
Hey, Sean, thanks for your questions. We'll move to the next caller.
Thank you. We'll go next to Vivek Arya with Bank of America Merrill Lynch.
Thanks for taking my question. I have actually a longer-term question. In the past, you allotted a significant amount of capacity. I understand these are not short-term decisions. Structurally, are there actions that you can take to limit downside if macro remains somewhat weak for the next one or two quarters also?
You mean specifically in terms of shutting down some of that capacity?
Yes, because gross margins have taken a big hit over the last several quarters. I'm trying to understand if you can sort of limit downside from there, given that the visibility is still somewhat weak out there.
Yeah. Vivek, I would just say that's not in our plans. Obviously, there are a lot of options we could do, especially given our view that we're undershipping demand. Therefore, when customers are through with their inventory correction, we will be seeing growth, even if there is no growth in in-demand or inventory replenishment, just as we move back to the customer's production levels. In that environment, and especially considering the low carrying cost of the capacity that we have on board, we have no intention to take any of that, especially the new capacity that we've been bringing on, and doing anything other than fill it up over the course of time. Do you have follow-up, Vivek?
You mentioned that you are undershipping demand. If you look at historical trends, how long can that situation persist? I.e., is Q4 a bottom? Is Q1 a bottom? How do we get a sense for that based on what you have seen in similar situations before?
Okay. Sure. I think it's tied somewhat back to the question Uche asked maybe that I hadn't gotten to specifically, which is, do we still believe that we're in this abominable process of downturn? The answer is, we do. What we look at, first of all, is the inventory levels of TI chips at customers and distributors are now very low. As I said before, we believe we're undershipping demand. Just to reiterate, at some point, customers will have to stop reducing inventory. When that happens, our revenue will grow as our shipments increase to match the customers' production levels, even if there's no growth in in-demand or replenishment of inventory.
For anybody that's watched this industry cycle over the course of time, you fully understand that once you start to get in that process and customers regain confidence in their own outlook, the next phases, they will typically then layer in additional inventory as well. The customers historically have not forecast these snapbacks in their demand. Instead, they rely on short product lead times to support their increased demand. We think we are very well positioned, both with our inventory as well as our short lead times to support that inevitable increase in demand. The other thing that I would point to, which I hadn't mentioned earlier, is just the stability, you might say, in terms of the orders took a step down in the month of July, but they've generally been flattish since that time, which is to us indicative of a bottoming process as well.
I don't have an exact time period, as of this quarter or the next quarter, as to when that snapback could occur. Historically, if you look at semiconductor inventory corrections, the response time generally results in a couple of quarters of inventory burn. That's just looking at history, but we'll have to see what this one holds. I would say we continue to be encouraged that we're in the bottoming process, even though demand was a little weaker than what we had initially expected this quarter.
Okay, Vivek, I believe that was your follow-up. We'll move to the next caller, please.
We'll go next to Jim Cavallo with Goldman Sachs.
Great. Thanks, Ron. Thanks so much for taking the question. Here's the first question. Kind of strategically, with all the strategic fat and capacity that you guys have, how do you think about using that in this kind of environment, at where maybe even more specifically, as things start to bounce back a little bit? Do you try to be a little bit more aggressive on pricing to pick up a little bit of that incremental bump in business that you'll see as customers start to normalize the order patterns? Is it more important you keep pricing pretty steady and try and get the margins back to a more healthy level?
The margins will return to normalized levels just as we fill that capacity up. My view is that probably doesn't tie so much to pricing and just a matter of, as we ship more units and therefore amortize that, what currently is an underutilization expense, that will do good things for margins. You've heard us say many times in the past that for the most part, the proprietary product lines that we sell tend to be more spec elastic versus price elastic. Even though we're aggressive in pursuing new opportunities, we tend to do it based on the product specifications that we're offering, the support package, the applications engineering, as opposed to thinking that somehow if we drop a couple of cents off the price, that would make a difference in the demand that we actually see.
We tend not to view price, although I will also say we recognize we have to be competitive on price. I think we have a cost structure that allows us to be competitive with any competitor in the world. That's why, for our salespeople, price is not an excuse for them to lose a piece of business, but nor is it the reason they should win a piece of business. We want to be competitive on price, but we win the business based on other considerations. Do you have follow-up, Jim?
Yeah. This question is specifically about Analog. I understand there's a lot of program ramps and design wins and share gains in apps processors, but to the Analog piece of the business, when is it fair for us to measure your share gain story again? In other words, it's always difficult in the downturn to say, you know, that they're not gaining any share in the downturn. When is it going to be fair for us to say, you know, look at your revenue share of the industry versus your revenue share, you know, in a previous period of the cycle and to determine what the share gain story is going to plan out?
Jim, I don't know that it's not fair to look at it in a downturn. We look at it every quarter. We don't overreact to any particular data point. I think the right way to do it is to sample it quarterly. We ask ourselves the question, if there's a quarter where we believe we underperformed, we ask ourselves why. Frankly, you guys should be asking us why as well. Sample it quarterly. The best way to make the story work over the long term is to make sure it works every quarter. At the same time, maybe in a downturn like this, you may see more strategic long-term moves in terms of share from the standpoint of gaining position at customers on new design programs and things like that, more so than the difference show up in revenue that particular quarter. Every quarter absolutely counts.
Okay, Jim, and we'll move to the next caller. Thank you.
Thank you. We'll go to Mark Lipacis with Jefferies.
Thanks for taking my question. Ron, you said on your October quarter call, I believe that you said that the distributor inventories were at six weeks, and that was at normal levels. It sounds that they're lower now. Given that you have pretty clear visibility, can you quantify where they are now or at least talk qualitatively about how close they are relative to the depths of the financial crisis?
I don't want to try to quantify where distributors are right now until the end of the quarter mark. I think your interpretation of what we're saying is correct, that distributor inventory is going down this quarter. In fact, maybe if I can just comment on distribution overall, but make some specific inventory comments. If you just look at resales, we would expect resales from distribution to decline compared to the third quarter. Although at this point, it looks like they'll decline a little less than TI's revenue would overall if we take the National or the SBA revenue out just because we only had it for, you know what, a week last quarter. Inventory distributors, we expect to be down by a double-digit percentage at this point. That's compared with the third quarter. I'll also say that includes inventory returns from a discontinued National distributor.
The returns from that distributor probably will contribute maybe a couple, few points of the decline in and of itself. Even without that, you can see there's a pretty sharp decline in distributor inventory levels. Just one data point that I saw that I'll pass on almost anecdotally. If you look at inventory for products that we would characterize as specific to the industrial market, just in the last couple of quarters, inventory of those products at distributors has been cut in half. The distributors are moving pretty aggressively in terms of reducing inventory. We all have to watch it because demand can come back pretty quickly. The buffer where we feel comfortable with that is that inside TI, our own inventory, we think we're pretty well positioned.
Distributors are tightening up somewhat, but we feel that we have enough buffer inside TI to be able to respond as business comes back again.
Do you have a follow-up, Mark?
Thank you, Ron. Thank you for that detail. I'm trying to model the cash flow for next year. I guess I have to believe that front-end CapEx should be at maintenance levels, and you may or may not have to get back into equipment. Is that a fair way to think about it? Could you give us a sense of what is like a maintenance level of CapEx?
Yeah. Maybe one way to look at it overall, Mark, is I think historically, we've guided that we would expect our CapEx to range somewhere between 5%- 8% of revenue. You know, as you pointed out, with the capacity additions we've made in the past couple of years, I think it's fair to say we clearly have pulled in capital spending from future years. We don't need to spend a lot on front-end capacity. Therefore, we would expect to be at the lower end of that range, kind of what you said, both maintenance on the front end and then additions to assembly test. What I would say is even assembly test, depending upon growth, as we have more units produced, obviously, we'll need to expand our capacity on assembly test after we've refilled the existing capacity.
With utilization both on front end and back end coming back somewhat as we've gone through this downturn, clearly, we have room to grow from current levels before we really need to spend on back-end capacity to any significance.
All right, Mark. Thank you. We'll move to the next caller.
Thank you. We'll go to Tore Svanberg with Stifel and Nicholas.
Thank you. I mean, you correctly reached out about the middle-end market. Could you also do the same for your regions, please?
Sure. I guess this is just based on the first two months of the quarter and extrapolating that through the end of the quarter. Probably no surprise, Europe is currently our weakest region, followed by Asia and then the U.S. All three of those regions, we would expect to be down based upon that two months' worth of data. Japan, therefore, is the only region that is tracking to be up sequentially. That's really as it just continues its post-earthquake recovery. Do you have follow-up, Rick?
Yes. You talked about why you've structured the session week, and I think you mentioned that we did some push-outs. Do you have a sense on how the push-outs look like, meaning, you know, is this a quarter or is this going to be a multi-quarter push-out?
I don't know. I think, as I've said, if they really go beyond our customers, it's to their customers, the carriers. I think you're all aware they're trying to merge, and how they spend and where they spend will be different based on whether that merger happens or if, for some reason, it doesn't happen. In the interim, while they're sorting that out, they pretty much stopped spending. I have no idea how to assess how long that may last, but that's what's currently impacting us there in terms of the decline. Other carriers are flattish. Some of the programs in India or China that we've all talked about, that were maybe going to be ramping, are still on hold at this point. Actually, what's impacting us in terms of the decline would be those North American carriers that I talked about. Do you have follow-up, Ted?
Yes, I appreciate it. Thank you, Ron.
Okay, thank you. Let's go to the next caller, please.
We'll go to Christopher Cesca with JP Morgan.
Thanks for having us. I believe you have a flat tire right now. Yeah. One thing you said today that you have also done on the conference call that I'm open afterwards was that the teams have essentially bottomed, you know, for the last couple of months. I was clearly, the revenue outlook is really soundness from you. What is the difference? Is this just, in your opinion, the massive inventory drawdown by the bookkeeper? Are your customers telling you where demand is worse? Can you sort of parse that out?
Chris, I don't know that I can talk too specifically about customer demand. Our assessment is that this is mostly them taking inventory levels down more than what we had expected, as opposed to their demand is significantly weaker than what we had expected. Do you have follow-up, Chris?
I'm a little nervous. Any, I guess, worse performance from the National versus the legacy TI business? Are you hearing more downside from National? Do you think any of this is a result of the merger?
No. In fact, I would say National Semiconductor is declining this quarter, but declining about the same as our HPA revenue. As you know, both of those areas are Analog products sold through distribution. I would say they both have relatively strong ties to the industrial market, which is weak right now. I wouldn't say National is disproportionately a factor one way or the other here.
Okay. Good. Thank you. We'll move to the next call.
Thank you. We'll go next to John Pitzer with Credit Suisse.
Yeah, Ron. I guess I'm trying to figure out a little bit better what's going on with gross margins in the December quarter. I guess, can you help me understand if OpEx dollars are kind of flattish with the old model? It implies sort of a 200 basis point drop. If that's the case, what's utilization versus mix? Were you able to do anything on the OpEx line or with the National Semiconductor integration? Is OpEx kind of a fixed cost this quarter?
Okay. And John, let me make sure I understand, or maybe let me just kind of reiterate what we said even last quarter. OpEx, I think we said it in our October call, our view was that OpEx would go up, oh, somewhere in the $160 million - $170 million range. That was a combination of basically having a third quarter of National OpEx and fourth quarter versus only a week of it in the third quarter. I think we talked about some of the, you know, as we adjusted in light of, you know, the environment and the forecast, some of the variable elements of compensation in the third quarter, if there were catch-up accruals basically to, you know, adjust the cumulative effect for first half, and that catch-up piece of those lower accruals would not therefore recur in the fourth quarter.
We said OpEx would be up about $160 million- $170 million. Suffice to say, in this environment, we're going to try to keep a tight control and do better than that. That's certainly part of it, which is the, you know, we're not going to be able to do anything about. OpEx will go up by about that amount. Gross margin, I think, as you pointed out, will be down, but it's also down for the two reasons I talked about, mix and then, you know, especially utilization. The only other consideration that I should just remind you about is, remember, on cost of revenue, there's about $100 million of additional expense in the fourth quarter that I would describe as acquisition-related. That tied to the fair value markup of the inventory that we received from National as part of that acquisition.
Those are probably the moving pieces that I can think of to point out at this point. Does that answer your question, John?
It did pretty much, Ron. I guess as a follow-up, midpoint of revenue coming down by about $140 million. I guess I just want to understand, did Wireless quarter-to-date on the OMAP coming in better than you originally expected at the beginning of the quarter? Can you help us kind of give the magnitude? If I exclude OMAP, what's the rest of the business doing versus expectations at the beginning of the quarter?
OMAP is doing better than expected. I can't quantify it at this point in the quarter, but I will just say OMAP is growing very nicely. We will have more details for you in January. We expected good growth out of it, and it's delivering even better growth. Other areas are making up more than offsetting that growth. Obviously, we've taken the overall guidance down. They're all doing quite a bit worse than what we had anticipated when we came in. Again, probably for reasons of both macro as well as inventory reduction.
Okay. Operator, I believe we'll take one additional caller, please.
We'll go next to Craig Ellis with Cars and Company.
Oh, hey, Ron. Thanks for speaking to the end. Just an inquiry on the PC related businesses. You mentioned some high flooding impact. Is that proving to be a little bit worse than what the company expected into the quarter, or pretty much in line?
If you go back to what we said in October, we looked at our own supply chain risk both in terms of a lead frame that we bought from a supplier there that we knew would be disrupted and some assembly tests that we had there. I think we quantified that impact as about 1%. That was just TI supply chain. What we tried to communicate was the first order effect, which would be the direct customer impact of hard disk drives that were manufactured in Thailand and then maybe even the second order effect of PC manufacturers that couldn't get hard disk drives that might be weaker than otherwise expected. We had some estimates there, but clearly, that is having an impact. Certainly, the first order effect, I don't know how much to, we're not the best source to be able to comment on the PC manufacturers.
Clearly, they're going to be impacted by the same macro considerations that every other market segment is. They likely would have been weak anyway, with that weakness exacerbated by lack of storage. Do you have follow-up, Chris?
Oh, Craig.
Yeah, thanks.
Yeah, no problem. Since with one of the designs you have with OMAP for the Fire Tablet, you've done a good job getting other content in there like Wi-Fi. As you look at your design and funnel with Ice Cream Sandwich systems, do you see a greater propensity of those design wins bundling more TI content? How do we think about your ability to attach other components when you get that OMAP 4 design win?
I would describe that as pretty strong. No guarantees, but usually, almost always when we win OMAP, we'll have some power management, analog type products attached to it. Sometimes connectivity. We don't bundle the two. There'll be places we sell connectivity without OMAP. There'll be places we sell OMAP without connectivity. There'll be customers we sell both into. Almost always when we sell OMAP, customers just find it more convenient to work with TI on a lot of the analog products such as power management, as well as our sales force is trained to work their way through those customer systems and pick up as much of that companion analog content as they possibly can.