Good day,
and welcome to the Texas Instruments Third Quarter 2010 Earnings Conference Call. Today's conference is being recorded. At this time, I would like to turn the conference over to Mr. Ron Slemmaker. Please go ahead, sir.
Good afternoon, and thank you for joining our Q3 2010 earnings conference call. As usual, Kevin March, TI's CFO 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 risks and uncertainties that could cause TI's results to differ materially from management's current expectations. We encourage you to review the Safe Harbor statement contained in the earnings release published today as well as TI's most recent SEC filings for a more complete description. Our mid quarter update to our outlook is scheduled this quarter for December 7. We expect to narrow or adjust the revenue and earnings guidance ranges as appropriate with this update. In today's call, we'll describe how TI's strategic position in our core businesses of analog, embedded processing and smartphone chips continues to strengthen.
We'll discuss our manufacturing strategy and recent additions that we have made to our analog capacity. Will also provide our perspective of the near term demand environment. Revenue in the 3rd quarter generally tracked closely with our initial expectations in the quarter. In July, the middle of our guidance range projected about 6% sequential revenue growth. We held that level with our September update and in the end we delivered 7% growth.
Although our results are good, demand is a bit of a mixed bag. The industrial market was strong for us in the Q3 as it continued a cyclical recovery. We believe this market has now recovered and therefore we expect industrial growth will be somewhat less robust in the 4th quarter. In communications, wireless infrastructure was strong as operators continue to expand capacity to support increased data traffic. Accordingly, demand for chips that we sell into smartphones was also strong in the quarter.
As we said at our September update, we saw a notable slowing in demand for products that we ship into the PC market during the Q3. We expect demand from our PC customers to remain subdued in the 4th quarter. Similarly, some of the consumer related markets such as televisions also slowed in the Q3 and we expect these trends to continue through the current quarter. The increase in TI revenue was driven by growth across all of our segments. Analog revenue grew 5% sequentially and 35% from a year ago.
Sequentially, analog revenue was up most in high performance analog where we have higher industrial exposure. High volume analog and logic and power management products both grew although to a lesser extent with their exposure to the computing and consumer markets. From a year ago, all three product areas contributed to growth about the same and all contributed to TI's market share expansion in analog. Embedded Processing grew rapidly again this quarter. This partly reflects its exposure to markets that performed well, including industrial and communications infrastructure.
It also reflects continued market share gains for TI and the strategic importance of embedded processing to our company. Sequentially, embedded processing grew 12% with both communications infrastructure and catalog products contributing about equally to this growth. Catalog products include both digital signal processors and microcontrollers. From a year ago, embedded processing grew 47% with catalog products being the biggest factor in the growth. Wireless revenue grew 6% sequentially and 11% from a year ago.
Collectively, product targeting the smartphone market, those being connectivity products and OMAP applications processors, grew 6% sequentially and 37% from a year ago. These are the wireless products that we're investing in for growth. We've had tremendous design and success, especially with our latest generations of OMAP applications processors across a range of smartphones and tablets and we look forward to solid growth as our customers' new products transition into volume production. Baseband product revenue was $438,000,000 in the quarter and grew 5% sequentially and declined 3% from a year ago. Our other segment revenue grew 10% sequentially driven by custom ASIC products, DLP products and calculators.
From a year ago, this revenue was up 29% with growth from DLP products and custom ASIC products being the biggest factors. Distribution resales were up 8% sequentially in the quarter, about the same as TI revenue overall. We were able to help distributors build a few days of inventory in the 3rd quarter. We're comfortable that their inventory is appropriate relative to current levels of demand and to historical metrics. Now Kevin will review profitability and our outlook.
Thanks, Ron, and good afternoon, everyone. Our financial performance this quarter underscores the benefit of our transformation to a company focused on analog and embedded processing. Gross profit increased 8% sequentially and our gross margin moved up another 30 basis points to 54.5 percent of revenue. The combination of R and D and SG and A increased $38,000,000 in the second quarter with most of the increase in R and D, especially for our core businesses. Operating profit for the quarter was $1,230,000,000 an increase of 11% from last quarter as we once again pushed the bar higher from last quarter's record high.
Operating margin in the 3rd quarter was 32.8 percent of revenue. Net income in the 3rd quarter was $859,000,000 or $0.71 per share. In the EPS calculation, please note that accounting rules require that we allocate a portion of net income to any unvested restricted stock units that receive dividends. In the Q3, the amount of net income excluded from the EPS calculation was $13,000,000 If you don't make this adjustment, you'll likely calculate EPS to be $0.01 higher than we have reported. 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 $1,320,000,000 This was up $756,000,000 from the last quarter and up $484,000,000 from a year ago. Capital expenditures increased to $396,000,000 in the quarter and include additions to our assembly and test capacity as well as our analog wafer fab capacity. In July, we announced that we had purchased additional 200 millimeter equipment and an operational 200 millimeter fab and 300 millimeter equipment as part expansion Japan's bankruptcy proceeding. This purchase closed on schedule at the end of August and we are now porting TI's analog process technology into that fab.
Earlier this month, we announced that we also acquired our 1st wafer fab in China. This 200 millimeter operational fab was also purchased at a substantial discount and will support our growth strategy for analog in the years ahead. With these acquisitions, we believe we are very well positioned with wafer fab capacity to support our intermediate term growth plans. Return on invested capital in the quarter moved up to 34%. Our strategy is to drive significant growth while also generating high returns on our investments.
Having purchased manufacturing assets that have long productive lives and purchasing those assets opportunistically at low prices is an important part of the strategy. We used $600,000,000 in the quarter to repurchase 24,000,000 shares of TI common stock and pay dividends of $143,000,000 in the quarter. We increased our inventory by $75,000,000 in the quarter, while lowering inventory days by one day to 75. Our lead times have continued to decline as we bring additional manufacturing capacity online and get better positioned with inventory. Orders in the quarter declined to $3,430,000,000 TI's book to bill ratio was 0.92 in the quarter.
Turning to our outlook, we expect TI revenue in the range of $3,360,000,000 to $3,640,000,000 in the Q4 or down 10% to down 3% sequentially. Part of the decline will be associated with the normal seasonal decline in calculators following back to school as well as seasonality in semiconductors. Depending on where we land in this range, revenue could come in a little below normal seasonality due to the impact of continued subdued demand from our computing and consumer customers. We expect earnings per share to be in the range of $0.59 to $0.67 Our estimate for 20.10 R and D now rounds up to $1,600,000,000 Our estimates for 20 10 depreciation, capital expenditures and the annual tax rate are unchanged. In summary, we continue to execute a strategy that is focused on significant expansion of our market position in the analog and embedded processing markets, as well as the strong growth resulting from increasing demand for smartphone chips.
These are all large diverse markets that provide us an excellent opportunity for long term growth. Combining the financial returns of these markets with growth that is significantly above market rates will deliver an earnings model that we believe will be attractive to long term shareholders. We are also maintaining a strong discipline on capital and spending levels. If we find great opportunities for investments, we have a strong balance sheet and a resolve to move aggressively to pursue them, such as you've seen us do with the manufacturing assets that we've purchased over the past year. If we're generating cash beyond the needs of the business, we're proud to return it to our shareholders through share buybacks and increased dividends.
For example, since the end of 2004, we've lowered our shares outstanding by 32%. This means that all else being equal, our shareholders are now getting 47% more earnings per share than they would have had we not done these repurchases. And in September, we announced that our Board authorized an additional $7,500,000,000 in repurchases or about 25% of our recent market capitalization and another dividend increase. We're confident that continuing to tune our business to generate higher growth and earnings while also maintaining a capital model that lowers our shares outstanding will be a good combination in the years ahead. With that, let me turn it back to Ron.
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?
Thank you. Our first question comes from Chris Danely of JPMorgan.
Hey, thanks
guys. Just to clarify, you continue to expect the lead times to normalize by the end of this quarter?
Chris, lead times did come in, in the Q3 and we expect them to continue to come in the Q4. And if all goes well, then as we enter next year, we should have lead times back to normal.
Great. And then as my follow-up, it seems like the PC and the consumer end markets are below normal. Is everything else roughly normal or is anything above normal?
Chris, I would say probably is this a 4th quarter question? Okay. With I guess what I would say is you're right, those are the areas that would be below kind of normal run rate. Probably the one area I would say that continues to be strong is comms infrastructure. Handsets, since we only have one customer there really, I don't want to provide any specific commentary.
Industrial, I would say probably the best description there is that it is normalizing. It's going from it's transitioning from 3rd quarter, which is really an extension of the 1st three quarters of this year where it has been growing pretty rapidly due to that cyclical recovery. But I would say Q4 would represent more normalizing to probably a more typical seasonal pattern from industrial. So you did identify really the two areas that we would call out as being weaker, those being computing and parts of the consumer market. All right, Chris.
Thank you for your questions and we'll move to the next caller.
Our next question comes from Glenn Young of Citi.
Thanks. Ron or Kevin, it just doesn't feel like the cycle is as dramatic as we've seen other cycles in the past, at least that's my perception. I wonder, 1, if you agree with that? 2, when do you think this inventory issue might be over? And what are the clues that you have that suggest that to you if that's in fact what you see?
Glenn, I think that your perception probably is shared by us that is that the adjustment that we're seeing underway or starting now is probably more focused and not broad based and is probably generally pretty mild. If you look in the past, when you look at book to bills, typically if we get 4, 5, 6 quarters of positive book to bills and followed by a couple of quarters of negative or near one book to bills, which typically suggest you'll have maybe a couple of quarters from an adjustment phase before you have a resumption of demand. In the PC and consumer space, as we've discussed here, we saw demand soften up in that quarter. So we're probably halfway through our Q1 on that. And so if we take a look out, it would be from our view reasonable to assume that we get through this adjustment process over the next quarter or 2 and then we see a resumption of overall end market demand.
Yes. Pavan, Glenn?
Yes. There's a press release just a little while ago about ZTE spending a bit of money. You guys were named as one of the people with whom they'd be spending. I wonder if you can just shed any light on that particular announcement and help us to understand whether or not this is something that's new with these guys with ZTE and if there are any material elements of the contract we should know about?
Glenn, I guess I probably don't have a lot to say. I would refer you to ZTE in terms of anything they may want to offer. But we've had a strong presence in China overall and we've had a relationship specifically with ZTE for many years. So I think this is just an extension of a lot of good things that have been happening for TI for some time and are growing momentum in that market, which is one that we see is going to be especially important for TI in the years to come. But beyond that, I really don't have anything specific to say about that one specifically.
Okay, Glenn. Thank you for your questions. And we'll move to the next caller.
Our next question comes from Tristan Gerra of Robert Baird.
Hi, good afternoon. The ramping capacity you're putting in place implies a lot of market share gains over the next couple of years. What's your pricing outlook for analog with regards to that strategy? And also in view of the current weakness that we're seeing in some end markets notably at the low end?
Tristan, I don't think that the capacity that we're adding necessarily has any bearing on the pricing outlook per se. That capacity, you may recall that we began over a year ago with the acquisition of equipment from Camunda who was in bankruptcy at the time to begin to put 300 millimeter equipment into our R fab, our Richardson fab. We went through a second phase on that with another location they had in Dresden where we purchased equipment to complete Phase 2 in RFAB. In addition, last quarter, we announced acquiring expansion of Japan out of bankruptcy. And this past month, we announced our first manufacturing acquisition or manufacturing plant in China.
The to put in perspective where we're at in those acquisitions right now, the RFAB qualified its first product this quarter and we do expect to ship our 1st revenue generating wafers out of that factory this quarter. It will ramp up consistent with demand. As expansion is concerned, the one we acquired in Japan, we expect to have our first wafers out of that factory by the end of this quarter as we've ported one of our processes into that factory. And with the Chengdu factory in China, in fact, we had already been using that factory as a foundry for some of our H valve products and we will be porting additional products into that factory over the next couple of quarters. So we would expect those factories to ramp up fairly slowly on our products consistent with whatever we see in demand.
In the meantime, those 2 factories, the 1 in Japan and the 1 in China, in both cases, we have transitional service agreements with the sellers, whereby we are selling them some product out of those factories that to a large extent will offset our operating costs as we bring up our own process technologies in those factories.
So, Truce, I guess the only thing I would add is if you think about what Kevin said, I mean even with RFAB where we're moving into production this quarter, as of now, we have one product qualified and moving into production. So really, if you think about the timing of that as well as the other two factories and you compare that to what Kevin said previously about this period of market weakness, our view is going to be relatively short lived and mild. Those factories ramping really are probably coming on more online on the other side of this period of weakness as opposed to while the market weakness is underway. Do you
have a follow on Tristan?
Thanks for that one. How do you expect resales to disti to track in Q4 versus sell in? You mentioned that your inventory levels in the channel were at normal levels. So is it fair to assume that you don't expect any type of adjustments for this coming quarter?
Tristan, I probably I guess I'll stick with our normal practice, which is we don't try to forecast resales in the out quarter. I mean, probably the best I can do is point out that if you look in the prior quarter, the Q3, resales generally tracked very closely with TI zone revenue trends, but I don't have a specific projection for you on resales in Q4. Okay, let's move to the next caller. Thank you, Tristan.
Our next question comes from Edward Schneider of Charter Equity Research.
Thank you very much. Ron, thinking about 300 millimeter here and where we are in this kind of in the whole cycle, you've got things moderating a bit. Industrial seems like it's peaked out. Am I taking you correctly and saying that it's not necessarily slowing down, it's just not going to grow as fast as we've seen over the last several quarters or so?
I think you have it right. It is slowing down, but it's the comparison is to a cyclical recovery. So it's moving more to seasonal patterns. It's not expected to go through a at this point, we don't see a correction per se. We just see it moving to a more normalized seasonal pattern.
Okay. So if we've got things returning to normal, you're bringing up 300 millimeter. Sounds like price remains firm. You've had a nice ramp of margin improvement here. Why shouldn't we expect say through next year that margins will continue to improve as your cost basis drives down.
It doesn't sound like we're in a downward cycle with demand and yet your costs have got to be starting to drop, especially if you're bringing up these new fabs close to operating cost in terms of the agreements that you're doing with the people you're buying them from?
Yes, Edward, clearly bringing on these factories, these kind of cost profiles certainly is a favorable outlook for our overall margins. Importantly, as analog and embedded processing become a bigger portion of our overall portfolio, that also will have give us more tailwind on our margins. But the fact of the matter is we're not really focusing on trying to improve our margins so much as we are focusing a lot more on trying to improve our top line growth. You've heard us talking for a number of quarters now about having a growth objective whereby we are considerably outgrowing our markets and gaining market share from our customers. And that's really where all our energy and focus is at.
That doesn't mean that we will not let margins fall through as they produce themselves, but that's not what we're aiming at and that's not the purpose of the acquisition of those factories. The purpose of the acquisition of those factories is really to support that top line growth and happily those factories came to us at very inexpensive cost.
Okay. Do you have a follow on it?
Yes. Just as a clarification then, if it comes down between you're not getting a top line growth that you're after and your margins are at record levels, we would be reasonable to assume that the margins will be capped in maybe little bit more of aggressive pricing profile so that you can grow the top line?
No, I don't think I'd make any assumptions, Edward. I think that we don't set the prices, the market sets the prices and we can't anticipate how competitors will respond to customer demands. What we're really focused on is making sure we have adequate capacity to grow as rapidly as we can as our customers will accept our products, But to infer that, that would lead us to a pricing decision would be an incorrect conclusion because frankly, prices are set competitively not unilaterally in our space.
Yes. And as you've heard us say for some period but for the broader audience, especially in analog, pricing is determined more based on the quality of the product, the specifications of the product, the performance levels of the product and you have to be competitive on pricing, but that's not how you win business. You win business based upon the quality and performance levels of the product. And so even in a weaker market environment or if growth is not producing the levels that we expect, you don't change that fundamental dynamic by changing your prices. Changing prices or lowering prices below market just leaves money on the table.
It does not result in incremental revenue for the vast majority of our product lines. There's a small part of our product line that represents less than 5% of our revenue that would be considered commodity type products that is price elastic. But again, that's a net relative to, I think the broader product portfolio. Okay, Ed. Thanks for your questions and we'll move to the next caller.
And our next question comes from Ramesh Misra of Regentine Advisors.
Good afternoon, guys. My first question is in regards to your capital spending. So you've been very opportunistic over the last 12 to 18 months, but it sounds like you're still looking for opportunities here and if you found an inexpensive fab and you'd still be expanding capacity. So at what point would that stop?
Ramesh, what I have indicated to in my opening remarks was that we believe that we have acquired enough capacity to meet our intermediate term growth objectives. So we're pretty satisfied with what we've got so far. Now that's not to say that if we continue to find some of these factories at price points that frankly are unheard of in our time in this industry, that we may not consider them for acquisition. But our focus now is on bringing these factories up that we have and bringing products up into production, getting ready for what we believe will be a resumption of growth in the industry in the next couple of quarters.
And I think Kevin was just saying in general, we look for investment opportunities not that makes sense for our business that could be smaller acquisitions or that could be the capital equipment that you've seen us, but probably the former would be the priority. Okay. Do you have a follow-up Ramesh?
Okay. Just a very quick one. In your other segment, did you see weakness in the consumer oriented parts of it as well, such as calculators? In other words, was your strength in the other segment driven predominantly by your customer ASICs?
It wasn't. I don't know I'd say predominantly. We actually saw calculators increased sequentially from 2nd to 3rd quarter, but that's just seasonal. Back to school usually peaks in the Q3 for us and Q3 typically increases somewhat beyond Q2. The biggest area of sequential strength in that other segment was in custom ASIC.
I would probably note a couple of areas inside of that. One is we do have a significant part of our custom ASIC business that goes into communications infrastructure, both wireless base stations as well as the enterprise side and both increased sequentially in the quarter. And then we also sell custom ASIC products. This is kind of more one off, but for touch screen controllers going into smartphones that also did nicely for us in the quarter. So that's a little bit of insight into the custom ASIC.
The other area that we mentioned was DLP. DLP is still being dominated in terms of that revenue base by front projector business and continues to be a nice business and has even shown some recent growth for us. So no real change on that front though. Okay, Ramesh. Thanks for your questions and we'll move to the next caller.
And our next question comes from Udi Orji of UBS.
Thank you very much. Ron, can I just ask you within the Edge File business, you talked about weakness in computing in the consumer products? How is that stabilizing now in terms of booking strength? And within that also, can you talk about whether you have any position in the tablet market and what that will mean for TI?
Okay. I think if you look at HVAL, you are right. There's probably there the computing tie is more through products that go into hard disk drives. Our power product line in analog also sells into PCs via some of the power management products, but HVAL is probably more through hard disk drives and storage products. It and I think your description of that well, I'll just say we expect that it will continue to be what I said before, demand will continue kind of the current trends that we saw in the 3rd quarter slowing going into Q4 as well.
HVAL also sells into a range of other products such as smartphones, some of the power management areas in smartphones, they sell into some video gaming on the consumer side. And even though we said consumer televisions were weak, there were other areas such as video gaming on the consumer side that actually did reasonably well for us in the Q3. And I'm trying to think if there are other areas of notable to mention. Those are probably the ones I would tie. Yes, maybe a final one would just be infrastructure.
It sells into some of that communications and wireless infrastructure as well. And of course, that almost anything that's touching infrastructure for us, that would be, I guess, on the both the HbAO side, but then also some of the HBA products tie into comps infrastructure as well. And as I said, anything that we have selling into infrastructure, whether it was ASIC products I mentioned, the embedded processing products or some of these analog products have done well and we would expect to continue doing well into the Q4. Okay. Ustad, do you have a follow on?
Yes. Just we've talked about tablets as we've seen some strength in tablets markets. And my question here is, how does that impact TI across the board? One will obviously expect gains for the OMAP business, but I'd quite like to get a sense of your focus there and your positioning in some of the upcoming tablets. And then how that cuts across all that segments of your business through you talked about HDD.
Obviously, tablets are going to cannibalize the PC, what will be the impact of that on TI? Or do you have a commensurate gain also on tablets offset any weakness there? So any comments you can make as to what this means for TI across Boucher OMAP business? Yes, I think.
Okay. So I would say we sell a lot of I guess I would describe as principally various analog products, for example, power products that go into tablets. We saw strength in those areas as you might guess in the Q3. That strength was not even though it's nice growing business and offset some of the weakness that we saw on the PC front or the notebook front, it wasn't the PC exposure these days just because of the relative size of that market, of course, is higher for us. We'll see how that changes over time.
But those tend to be some of the more those type of products tend to be a little less visible, I guess you might say. I know I see all the various tear downs and they try to describe who has this processor or that processor. Products like power tend to run under the radar. A couple of other areas I would mention, the audio amplifiers, some of the connectivity products, certainly there's opportunity in tablets. And then as I previously mentioned, clearly, OMAP as the main processor to handle some of the both the applications, the graphics, etcetera, certainly is a great opportunity.
But the opportunity goes well beyond OMAP. And we're already benefiting even in Q3 from the growth of tablets, and we expect that to just broaden as products like OMAP transition into production over in that space. Okay, Uche, thank you for your questions. And we'll move to next caller.
Our next question comes from Sean Webster of Macquarie Capital.
Yes, thank you. On the factories, is what you're spending for the factories in China and Japan part of your capital expenditure budget? And then can you add some color on you said you're getting some revenues from your some of these factory agreements. Can you quantify that how much that's contributing going into Q4?
Yes. Sean, the factories, some portion of those acquisitions are in capital and some portion of those acquisitions are being accounted for as the acquisition of the business. In fact, you can see that on the cash flow statement with our earnings release. For example, on the Japan acquisition, we used net of about $130,000,000 acquiring all of those assets and about $59,000,000 of that is for an acquisition of a business and the balance of it is in adjusted CapEx. With the acquisition of Chengdu, we will initially use about $140,000,000 in acquiring that asset and most of that will probably go through acquisition of the business.
The remaining $35,000,000 or so will be earned out on that acquisition over the course of next year. So it's a bit of a mix. Some of it's going through cataracts and some of it is acquisition of our business. Just far as the revenue that we expect, we anticipate that the revenue that we'll get to those transition service agreements will be less than 1% of TI's revenue. And by and large, what that will wind up doing is absorbing the cost of those factories during the period that we are bringing up our own process technologies inside those factories.
So transitionally, I guess the other way that we tend to look at this, yes, there will be a little bit of benefit as we have some of that revenue in Q4 that we did not have in Q3. But at the same time, I'll remind you that we also are selling our cable modem business and we expect that transaction to close in Q4. And for the most part, what we lose in Q4 transitionally on cable modem will be about the same amount that we'll gain through some of these transitional supply agreements. Okay, Sean, do you have a follow-up question?
Yes. Maybe just on gross margins and utilization rates. Can you give us, I guess, your view on the puts and takes for gross margins going into Q4 and maybe into the first half? And also can you share with us what your utilization rate trends were in terms of are they higher in Q3, lower in your expectations for Q4? Thanks.
Yes, Sean. We haven't publicized our utilization rates in a while, but I would just leave it to say that they were relatively flat the last couple of quarters. And with the increase in capacity coming online and our expectation of decline in revenues going into Q4, we expect our utilization probably to drop a little bit, but I don't think there's going to be any material impact there, especially given the cost of the capacity we brought online. We don't give a GPM forecast. We just give a revenue and earnings per share forecast.
And I think I'll just leave it at that for now.
Okay, Sean. Thank you for your questions. And we'll move to the next caller.
Our next question comes from Srini Pajjuri of CLSA.
Thank you. Ron, on the distri distributors growing inventory a little bit, I'm just wondering, given that demand is weakening on the margin and also you're heading into a seasonally weaker period. Why would the distillers be building inventory? Is it because there were some pockets of strength or is it because some regions needed more inventory, if
you could just clarify that?
I think it's because they needed more inventory in certain product lines in certain areas. I mean, keep in mind, lead times have been extended and supply has been constrained for some period. And even though we've made progress, lead times are still, as Kevin pointed out earlier, extended beyond where we really want them as of right now. And so I think as things have loosened up a little bit, we and the distributors took advantage of that in the Q3 to put in place some inventory that they really had been trying to get in place for some time. Jeff, on stream?
Yes. For Kevin. Kevin, on the gross margin, just wondering about as we head into the first half, which is seasonally somewhat softer, should we expect besides the utilization coming down maybe a bit, should we expect any incremental depreciation from some of the new acquisitions? Thank you.
Srini, there will be some incremental depreciation. In fact, with the qualification of RFAT this quarter, we expect to see depreciation going up a little bit in the Q4. But I would remind you also that there's a natural roll off goes on. So while depreciation may be up for a couple of quarters, I expect it will come back down as you move into next year. In fact, if you just kind of step back and take a look at the broader picture, you may recall that we depreciate on a 5 year straight line basis.
If you go back to 2,005 and look at our capital expenditures back then, it was about $1,330,000,000 if I recall, and that's beginning to roll off and will roll off over the next couple of quarters. Our CapEx forecast for this year is $1,200,000,000 and I mentioned earlier that some of those acquisitions are going through acquisition of the business. So you add it all together and we're probably talking about $1,400,000,000 or so of assets that we're acquiring this year that will be depreciated. So to a large extent, what's rolling off will be replaced with the acquisitions that we've made in 2000 or plan to make here in 20 10. And so year over year, we don't expect our depreciation to change all that much.
We'll be able to give a more precise outlook on that after we close the Q4. But for some early planning and for trying to figure out what depreciation might do for GPM, that may help frame that for you a little bit.
So Kevin, I guess I would just add on the as a question. So fixed costs are relatively stable, but what about some of the variable costs then associated with the new factories we're bringing on?
Yes. The variable cost of RFAB will scale with revenue. So clearly staffing and material costs so on are highly variable and will be brought on only as revenue pulls demand through that factory. And then the variable cost associated again with the acquisitions in Japan and China, by and large have been offset by the transition services agreement, as we bring up our new processes there. So we expect a fairly smooth transition as those transition services agreement begin to shift downward and that cost is left behind.
That should happen about the same time that we're bringing up our own production inside those factories and we can absorb that into revenue generating wafers.
Okay. All right. Thank you, Kevin. And Srini, thank you for your questions. We'll move to next caller.
Our next question comes from Stacy Rasgon of Sanford Bernstein. Hi, guys. Thanks for taking my question. Very quickly in the wireless business, so you had all pieces up, but we had OMAP application processes that were up, but then a little less in connectivity. And I actually done that a little bit surprising.
I was wondering if you could talk a little bit about what you think is driving, I guess, the larger upside that you're seeing, particularly in connectivity in terms of end market or products? And if you could comment a little bit on how you see market share in application processors, particularly as that market is growing very strongly when you have competitors like Qualcomm and some of the other guys that are also making their pushes in there as well?
Sure. Stacy, I guess I would just say that what's driving growth in connectivity are just a series of design wins that we've accomplished over the last several years. I believe we have the most integrated connectivity solution that's out there centered up on our Wi Fi solution. And even if you look at where connectivity has been over the last few years and where it's going, clearly there's a trend toward integration and a lot of the players that kind of were single technology players just don't have the capability to integrate and do it as quickly as TI has where we've played across historically Wi Fi, Bluetooth, GPS, FM radio. And so we it's quite natural for us to have the capability to roll that all together into an integrated solution.
So the trend toward integration in the connectivity market has positioned that just favorably worked to TI's benefit. We've won a lot of designs as a result and you're seeing that in terms of revenue growth. Now before you take that and extrapolate it too far, as I said in the prepared remarks, we've also had tremendous success in designing in OMAP-three and OMAP-four product generations as well. And so I think you'll see the even though for the last few quarters connectivity is probably then the growing. That could rapidly change and go through a period of time where OMAP is growing fast.
So I think you'll see both of those areas grow, but kind of happen in fits and starts based on as new generations of product rollout and as design wins move into production. Jeff, on Stacy?
Yes. I think part of my first question was also on application processes, if you could address that. But my follow-up would be one more on gross margins just really briefly. I'd like to see if you could give me any color on for next quarter, Do you anticipate any sort of impact either the positive or the negative from the 300 millimeters you start to ramp that to volume? And is there any sort of measurable impact on the gross margin front from the foundry arrangement some from expansion and from Chengdu?
Okay. Stacy, I think we hit the app processors in the first discussion.
So we'll just go ahead and
move on to let Kevin answer the gross margin question.
Yes. Stacy, I think that the short answer is no on the impact from GPM. I did mention earlier that we will see depreciation go up a bit in 4th quarter because we have now qualified most of the equipment in RFAP. So clearly that will be there. But I don't think it will actually move the needle that much from an overall GPM standpoint.
Okay, Stacy. Thanks for your questions. We'll move
to the
next caller.
Our next question comes from Ambrish Srivastava of BMO Capital Markets.
Hello, Ambrish. Hi, thank you. Kevin, question on VoIP. Excuse me, my voice is really hoarse from rooting on the Giants.
What was that? Yes, I
know I was going
to say on the PI call. My question on the
ROIC, Kevin, you do give out
the number every quarter. I'm just going back looking historically. I don't think you guys have been this high and now you're bumping up against that other analog company that's only slightly more profitable than you. Is there a target that you're managing the business to Kevin? And then I had a quick follow-up as well.
No. On the return on invested capital, you're right, it's pretty high this quarter. We're about 34.2 percent by my math there. I wouldn't say that there is a model per se other than that we're mindful of the fact that profitable enterprises have to return on their capital in excess of what their cost of capital is. So clearly as long as we're above that, we believe we're adding value to our shareholders and clearly we are well above that right now.
One of the things that high ROIC does do for us is it allows us to generate healthy levels of cash And as we've seen here, certainly for an extended period of time, cash in excess of what we need to actually grow and operate our business on a day to day and quarter to quarter basis, which allows us to be pretty aggressive on buying back shares and also over time returning cash to shareholders in the form of dividends as well.
Okay. And a quick follow-up, Kevin. Sure. And actually maybe Ron could answer that as well. What is the normal seasonality for the OMAP and the connectivity business for Q4?
Or given the design win momentum you have, is that not relevant in the coming quarter?
Ambrish, I would probably agree with the latter. I think in general, what we're seeing there are secular trends that go well beyond any kind of normal seasonality that might apply in the wireless market. So I guess I would agree with your conclusion there that that doesn't matter. Okay. And so with that, we'll move on to the next caller.
Ambrish, thank you for your questions. And I know you mentioned you were cheering on the Giants and not the Yankees, but that would be a distraction. So we'll move to the next caller please.
Our next question comes from Chris Caso of Susquehanna Financial Group.
Thank you. Yes, I'm not sure, Ron, if you directed that at me, but you'll notice I'm a Yankee fan and my voice sounds just fine.
You didn't have anything to cheer for. Go ahead, Chris.
There you go. Well, I wonder if you could talk a bit about the strategy going forward on adding the new capacity. And there's obviously been a lot of talk from some of the analyst side, some of your competitors about what the where the low hanging fruit is for you guys. What do we see as we go through the next year in terms of where you guys would expect sort of the most growth as a result from this new capacity?
Chris, the capacity we're putting in place is aimed directly at our analog portfolio. If you take a look in the from a 300 millimeter standpoint, clearly the higher volume parts, such as those parts by that are developed in our HVAL business as well as some of our higher volume power parts and certain other parts would be prime candidates to go through that factory. I also mentioned earlier that the factory in Chengdu, China was already manufacturing some parts for us for our HVAC business and it will continue to do that. And as we put our processes in there, we expect to put our power MOSFET business into that factory as we go into 2011. And then as it relates to our factory in Japan, the process report in there will be initially ideal to suit the high performance analog business portfolio.
So each of those factories will be able to support all three elements of our analog, but again they're really aimed at the analog portfolio. As we look into 2011 with the fab capacity brought online, we'll be continuing to pay attention to our assembly and test capacity to make sure that we keep that ahead of the output from those wafer fabs.
So Chris, the only thing else I would add is and I'll even just respond to this from reading various sell side notes from visits to various competitors. It seems like the common denominator is that each competitor feels 300 millimeter is directed at somebody besides them. And what I would say is 300 millimeter is going to go across the board in analog. And that means HVAL, it means power and it means high performance analog. And we won't delve off too deeply here, but 300 millimeter, we have a lot more flexibility given the automation systems in that factory to take a 300 millimeter lot of wafers and subdivide it down into 2 wafers product A and 4 wafers of product B.
That lot does not have to all be the same product. So therefore, the argument that somehow 300 millimeter scale doesn't apply to certain areas such as high performance analog makes no sense to us. And I think you'll see us move forward accordingly. Jeff, hold on, Chris.
I do. Thanks. And I guess you guys have stopped breaking out baseband within the wireless. If you could give us just a bit color, however, on sort of where we are in the transition away from the baseband business relative to kind of what you told us in the past?
Chris, actually we do break it out. I gave it in my prepared remarks and if I can find my data real quick, I'll give it to you. It was $438,000,000 in the quarter. So that grew looks like about 5% sequentially and it was down 3% from a year ago. I'm sorry, then was that the question or was there?
Profile.
The profile? Okay. So again, we probably nothing really has changed. I think what we've described before is that if you basically just straight line it from here to 0 by the end of 2012, you'll have quarters as you've seen, some quarters that are above that line, some quarters that are below that line. And so really probably no difference in terms of guidance from us.
It will be a bit noisy, but that's probably about the best that we could recommend. No change in terms of when we expect that revenue basically to be essentially the 0 by the time we go into the year 2013. Okay, Chris. Thank you for your questions and we'll move to the next caller.
Our next question comes from Adam Benjamin of Jefferies.
Thanks guys. You commented the fact that you thought this was going to be sort of a shallow problem here in terms of demand. And I'm just curious what gives you confidence that that's going to be the case and why based on the orders you're seeing or just some customer feedback? That would be helpful. Thanks.
Yes. Adam, I think that a lot of times in the past when we've seen, what are typically described as inventory corrections in the semiconductor market, it's brought on by usually an excess of inventory in the channel or more often an excess of capacity driving that excess of material. And in fact, we've seen we appear to see just the opposite. The channel inventories remain fairly lean, at least from indications from our products that we can get from information from our customers for our products. And broadly speaking, you look across the whole industry, I've seen numerous reports that indicate the total installed capacity for wafer fabs from the start standpoint globally is still down significantly from the tie point in Q3 of 2018.
Most recent stats I've seen suggest that it's still running around 15% 14%, 15% below where it was back then. So we don't have excess capacity driving excess production. Generally speaking, we do not see much evidence of any excess components of ours out in the channel. What we do seem to be seeing is after the cyclical snapback last year and a half in many of these channels, we're seeing growth rates now that we begin to mirror much more to what's happening in the global economy from overall demand. So from that standpoint and just from the history of these kinds of adjustments, we'd expect a couple of quarters of relatively mild adjustment and a resumption in growth.
We're not making a prediction as to what that growth looks like when it resumes, but we expect it will be a resumption of growth after a few quarters of the past.
And I guess just to add to that, Adam, if we you talked about order trends. I mean our orders and of course in Q3 were a step down from what we saw in Q2, but we also didn't see orders spiral down as we move through the quarter month by month. They actually stepped down in July and held at that level relatively stable through August September. So that's just another data point, I guess, you might say as to what's driving those comments from us. Do you have a follow on, Adam?
I do. Just on the connectivity business, I was curious, how committed you are to that business going forward? Obviously, you have some significant customer concentration and you've done pretty in terms of the portfolio and ahead of many of your peers. But I'm just looking out longer term. I know you're not going to tell us you're going to shut it down or sell it tomorrow, but I'm just curious how committed you are in terms of R and D investment, going forward given that you're not in the baseband market going forward?
Adam, I'll go ahead and answer that for you. I think that the R and D investments probably a good intro to an answer on that. Over the last year, we have pretty much removed all of our investment in the baseband as we've talked about for multiple quarters now and directed that over to the non baseband portion of our wireless portfolio, which is both connectivity as well as the apps processor. Including the apps processor is getting a large share of that R and D investment. I would add that connectivity is also as we're finding different markets for those products to be sold into.
But clearly, the lion's share of the R and D is going into the apps processor space. That is a space that is ripe for growth not only in cell phones, but in tablets and other applications as well such as personal navigation devices, infotainment systems on board cars, a number of different spaces where those products can be used.
And Adam, I guess the only other thing I would say is, I know there's all this ongoing relentless debate about integrated solutions with baseband and connectivity products or baseband and applications processors. But if you just look at it, our connectivity and OMAP revenue is up over 50% year to date. And so it's a great growth business and that's up 50% while
I mean it's clear we're getting
out of the we're pulling back on baseband and exiting that marketplace. So again, I think the data and evidence increasingly proves that can be a very good growth business for TI even without being in the baseband business. So, we'll keep riding that one hard. We like it. Okay, Adam, that was your follow on.
Let's go to the next caller, please. Thank you for your questions.
Our next question comes from Tore Svanberg of Stifel Nicolaus.
Yes, thank you. First of all, it looks like your embedded processor business saw a pretty nice increase in its operating margin. And I was just wondering what that came from. I know it grew sequentially, but it was a pretty steep increase in operating margin. Just wondering where that came from?
Yes. Tore, that was that's really just getting leverage from the revenue growth that you saw there. The overall operating expenditures are we increased those. You might recall back in Q1, we moved quite a few resources from our other segment into the EP segment, into the Embedded Processing segment, which temporarily depressed operating margins there. And now as we're seeing the revenue growing very strongly there, we're just simply getting a great deal of leverage off that.
Jeff, I'm sorry?
Yes. The follow-up is on CapEx. I think CapEx hit more than 10% of revenue. That's the first time in a long while. I mean, let's take Q4 'nine out of the equation here.
But it's above 10%. I'm just wondering, are we getting to peak there? Are we going to start to see it trend back down sort of to the 5% to 7% level again?
Yes. Troy, our goal remains to be in the 5% to 8% level. And as we've indicated that that should be what you see us doing over time. We won't let that artificially prevent us from going after very attractive opportunities such as you've seen us move on here recently. But in fact, for purposes of modeling, we should continue to expect us to operate in 5% to 8% and consider what has occurred here recently as an opportunistic aberration.
And clearly, I think you've heard us quantify how much revenue we can generate off the capacity that we purchase. Clearly, that's multiple years of capacity needs. So probably, if anything, you could even see us moving to the lower end of that range in the near term. Okay, Tore, thank you for your questions. And operator, I believe we have time for one additional questioner.
All right. And we'll take our next question from Jim Covello of Goldman Sachs.
Thanks, guys. I could see the strategy is here to stop all the Yankee fans on at the end of the call to add further insult to injury. But thanks for fitting me in.
I think
it wouldn't have fit you in had I known you were a Yankee fan, but go ahead.
I understand your comments about the 4th quarter disti inventory. You didn't want to
make a comment on that, but
how about Texan zone inventory for the Q4? Would you expect it to flat up or down?
Yes. Jim, I'll comment on that. We grew inventory in dollar terms in 3rd quarter and yet our days dropped by another day on us. And in fact, we would like to continue to try to grow some especially in those areas where we have lead times that are beyond what our And given the fact that we would expect, And given the fact that we would expect revenue in the Q4 below the Q3, that should have some impact on our days of inventory as well as we go in the Q4.
Okay. Do you have
a follow on, Joe?
Yes, please. The buyback you guys announced is terrific. As you guys talked about a quarter of the market cap is the authorization. There's not your cash flow generation is terrific, but even you guys don't have that much cash on the balance sheet. Would you ever be willing to think about taking on some leverage in order to fulfill that buyback?
Or should we just think about the buyback coming in as the cash flow growth continues?
I think it's the latter, Jim. You should look at us using our free operating cash flow for purposes of that buyback. We have no intention of doing an accelerated buyback. Okay Jim. Thanks for your questions.
And let
me before we leave apologize if I offended or embarrassed any Yankees fans. I realize your team had already done that for you and to you. And San Francisco guys, you're next. In general, thank you for joining us. A replay of this call is available on our website.
Good evening.
And this does conclude today's conference call. We thank you for your participation and have a wonderful day.