Good day, and
welcome to the Texas Instruments Third Quarter 2013 Earnings Conference Call. At this time, I'd like to turn the conference over to Mr. Ron Fleimaker. Please go ahead, sir.
Good afternoon and thank you for joining our Q3 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 and relevant non GAAP reconciliations 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 9. At that time, we expect to adjust the revenue and earnings guidance ranges as appropriate. This was a good quarter for TI.
Revenue came in just above the midpoint of our guidance range growing 6% sequentially and growing 10% if you exclude legacy wireless revenue, which declined to less than 2% of TI revenue in the quarter. Analog and embedded processing increased to 80% of TI revenue. The improved quality of our revenue is reflected in record gross margin in the quarter. Kevin will discuss this more in a few minutes. Revenue growth in the quarter was supported by some of the vertical markets that were especially weak in the Q2 including computing, game consoles and handset revenue outside of our legacy wireless revenue.
Revenue from the communications infrastructure market continued to grow in the quarter. These areas were complemented by continued strength in our automotive and industrial revenue. From a year ago, revenue declined 4% due to the decrease in legacy wireless revenue. Excluding this revenue, we grew 3% from the year ago quarter. On this basis, this was the Q1 of year on year growth since the Q3 of 2012.
Again, excluding legacy wireless, we expect growth to accelerate to 8% in the 4th quarter at the middle of our guidance range. The strength of our business model not only provides strong profitability, it also gives us confidence that we can sustainably generate $0.20 to $0.25 of free cash flow for every dollar of revenue. This metric is especially important to our shareholders as our capital management strategy is to return all of our free cash flows to them except what is needed to repay debt. When measured over the trailing 12 months, free cash flow was 24% of revenue. Over that same period, we returned 133% of free cash flow to shareholders.
In the 3rd quarter alone, we returned $1,000,000,000 to shareholders through a combination of dividends and stock repurchases. Earnings in the 3rd quarter were above our expected range, a result of better than expected revenue and gross profit, tight operating expense control and some help from discrete tax items. Let me walk through a few details of revenue. Analog revenue grew 11% sequentially. All 4 analog product lines contributed to this growth, although power management was up the most followed by high volume analog and logic.
These areas benefited from sequential growth across many markets, including those vertical markets that were impacted by inventory reductions in the Q2. Embedded processing revenue grew 8% sequentially with processors up the most followed by growth in microcontrollers and connectivity. Processors were driven by applications processor sales into consumer and automotive applications and DSP sales into industrial applications. Microcontrollers were lifted mostly by sales of MSP430 products into industrial applications as well as sales of microcontrollers into automotive safety applications. In our other segment, sequential growth in most product areas was offset by decline in legacy wireless.
Legacy wireless revenue fell by $91,000,000 to $57,000,000 as we had expected. This decline was partially offset by growth in calculators and in custom ASIC revenue, which grew as a result of communications infrastructure. Royalties also grew and DLP product revenue was about even. Turning to distribution. Free sales grew 9% sequentially.
Distributors inventory levels declined by about a day to just over 5 weeks. Now Kevin will review profitability and our outlook. Thanks Ron and good afternoon everyone.
This quarter gross profit was 1 point Gross margin was a record 54.8 percent of revenue and expanded 330 basis points sequentially. I think it is useful to compare this quarter's gross margin to that of the Q3 of 2010 when our last high watermark gross margin was set at 54.5%. In that earlier quarter, revenue was $3,740,000,000 up 15% higher than our revenue this past quarter. Factory utilization in that earlier quarter was 8 points higher and our manufacturing capacity was lower since we had not yet brought online our cost efficient 300 millimeter analog wafer fab in Richardson, Texas or our yet to be acquired wafer fab in Chengdu, China. We were also still in the early stages of ramping our recently acquired Aizu Japan wafer fab.
In addition, analog and embedded processing were also much smaller then contributing 60% of our revenue at that time. The conclusion one can draw from this is that due to the structural changes that we've made at TI over the past few years, the quality of our revenue is much higher today. It is more diverse, more profitable and less capital intensive and we remain better positioned to support future growth from a manufacturing capacity standpoint. Continuing to operating expense, combined R and D and SG and A expense of $833,000,000 was reduced by $27,000,000 sequentially. Acquisition charges were $86,000,000 unchanged from last quarter.
Almost all of this amount is the ongoing amortization of intangibles, which is a non cash expense. The restructuring charges and other line of our income statement transitioned from a $282,000,000 gain last quarter to a $16,000,000 charge this quarter. As a reminder, last quarter's gain was due to the transfer of wireless connectivity technology to a customer. This quarter's charge is associated with the shutdown costs from the previously announced factory closings in Houston and Hiju, Japan. Operating profit was $844,000,000 or 26 percent of revenue.
Our tax rate in the quarter was 23%, a point below our 24% annual effective tax due to discrete items that were included in the 3rd quarter. Our annual effective tax rate is unchanged and 24% is the rate you should use in your models for the 4th quarter. Net income in the Q3 was $629,000,000 or $0.56 per share, which includes a penny of discrete tax benefits. Let me now comment on our capital management strategy, starting with cash generation. Cash flow from operations was $1,150,000,000 in the quarter.
We increased our inventory by $6,000,000 compared with the prior quarter. Inventory days increased by one day to 106 days consistent with our model of 105 to 115 days. Capital expenditures were $124,000,000 in the quarter and free cash flow was $1,030,000,000 On a trailing 12 month basis, cash flow from operations was $3,270,000,000 about the same as a year ago. Trailing 12 months capital expenditures were $402,000,000 down 27% from a year ago. As a result, free cash flow was $2,870,000,000 up 4% from a year ago.
Free cash flow was 24% of revenue for the trailing 12 month period within our expected range of 20% to 25% of revenue. In the year ago trailing 12 months period, free cash flow was 21% of revenue. Capital expenditures for the past 12 months were 3% of revenue. Our continued low capital spending level
is a
direct result of the strong capacity position that we have built with our strategic investments over the past few years. The cash flow that will result as we continue to fill up this capacity should be strong in the years ahead. I'll note that depreciation expense for the past 12 months exceeded our capital expenditures by $496,000,000 As a percent of revenue, depreciation was more than 400 basis points higher than our capital expenditures. This is one of the reasons why our free cash flow has been trending higher than our net income. Of course, as depreciation declines to the rate of capital spending over the next few years, gross margin will benefit.
Another reason why free cash flow has trended higher than net income is the non cash amortization expense of $80,000,000 to $85,000,000 per quarter that will remain on our income statement for another 6 years. For the past 12 months, amortization expense was $339,000,000 or about 3% of revenue. And as we've said, strong cash flow, particularly cash flow free cash flow means that we can continue to provide significant cash returns to our shareholders. In the Q3, TI paid $308,000,000 in dividends and repurchased $734,000,000 of our stock. Our capital management strategy is to return all of our free cash flow to shareholders except for what we need to repay debt.
In the last year, we reduced our debt level by $500,000,000 Free cash flow was $2,870,000,000 and we returned the total of 3 point to shareholders or 133 percent of free cash flow. We've been able to return more than our free cash flow because proceeds from exercises of employee stock options totaling $1,280,000,000 over the past 12 months have also been an additional source of cash for the company. To break out the cash return, in the past 12 months we repurchased $2,700,000,000 of our stock or 95% of free cash flow. Similarly, we paid $1,080,000,000 in dividends or 38% of our free cash flow. Fundamental to our cash return strategy and our cash management and our tax practices, we ended the 3rd quarter with $3,590,000,000 of cash and short term investments with 82% of that amount owned by TI's U.
S. Entities. Because our cash is largely onshore, it's readily available for a variety of uses including paying dividends and repurchasing our stock. TI orders were about even sequentially and our book to bill ratio was 0.97 consistent with seasonal declines in the 4th quarter. We expect TI revenue in the range of $2,860,000,000 to 3 point $10,000,000,000 in the 4th quarter.
At the middle of this range, revenue would decline 8% sequentially with about half of that decline coming from the seasonal drop in calculators. The remainder of the decline is consistent with the semiconductor industry's pattern over the past 3 years, 2010, 2011, 2012, as well as our own history over that same period when legacy wireless revenue is excluded. In the Q4, legacy wireless products should decline to above $50,000,000 We continue to expect that revenue from these products will essentially be gone as we enter next year. We expect earnings per share to be in the range of $0.42 to $0.50 In summary, we believe the 3rd quarter provides a preview of what TI is capable of producing as a company focused on analog and embedded processing. The improved quality of our revenue is evident from the higher gross margin and free cash flow generation compared with our past.
We also believe our top line performance and potential will become more evident without the steady headwind of declining wireless revenue in the past few years. Our manufacturing capacity position remains strong and we have a good opportunity for continued growth, while maintaining our capital expenditures at low levels in the years ahead. With that, let me turn it back to Russ.
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'll provide you an opportunity for an additional follow-up. Operator?
Thank you. And we'll go first to Jon Pitzer with Credit Suisse.
Good morning, guys. Thanks for letting me ask the question. Ron, I guess my first question, just relative to that consumer bucket of computing, gaming and handsets,
can you just give us a
sense of how much that represented of the overall business in the September quarter? And how much that was up versus the rest of the businesses sequentially?
John, probably the best I could do is help you understand the weight of each of those segments. I don't have the growth broken out by each of those areas for you. But let me just kind of go through real quickly the weighting of our end market total were 27% and this is first half twenty thirteen data. Computing 23%, industrial 23% percent Consumer 11 percent Automotive 13% and Education 3%. So again, the reason we called out those three areas was because I think in Q2 we called them out as especially weak.
And in fact, we also said that in our outlook for Q3, we expected that they would recover. And keep in mind, the reason they were weak in Q2 was because customers in those areas were depleting inventories ahead of anticipated new product launches in second half, which we are now well into. So those new product launches were what was drive were a factor in those areas that was driving growth. Again, comms infrastructure was already strong and growing in Q2. It continued in Q3 as was automotive and industrial strong second quarter continued as well into the Q3.
Joe, follow on Sean?
I do. This is for Kevin. Just on the incremental gross margin Kevin, if you look at both the June September quarter, your incremental gross margin both quarters were over 100%. I guess I'm just kind of curious to what extent was that just the wireless business declining? Do I think about a 30% type gross margin there?
And then more importantly, when the wireless business is down to 0, how should I think about incremental gross margin from there?
Yes. John on the I'll answer the last part first. The incremental gross margin from our analysis in the past over the course of a cycle averages about 75% up and down. In any one quarter, it really actually works out to that number. It tends to be pretty noisy in any one quarter, but over time about 75% and that's what we do for internal planning purposes.
As it relates to the most recent quarter, you're right, the fall through was about 106%. So it was certainly a pretty rich fall through. And part of that was mix, but part of that also was improved factory utilization as we had higher revenues this quarter than the prior quarter. And so consequently we had a slight utilization benefit as well.
Okay. Thanks, John. Let's move to next caller please.
Next we'll go to Blayne Curtis with Barclays.
Thanks. Maybe from a high level if you could just talk about now that we have you definitely showed increasing year over year growth. September was up and then December accelerating, although off of a pretty easy compare. For the full year, analog growth seems more like a few percent. So if you could just talk about now that we have a full picture for the year, do you think there's anything going on in the analog bucket?
Or do you think that this is kind of representative of what the overall market is growing? Blaine, I think the year is not done. And right now there's kind of a lot of point spreads being made for Q4, but we really need to wait until we get into January to understand what the final score is. But I think we feel pretty confident that 2013 when the final scores are in will show market share gains once again for TI. So again, we have to push through the Q4, but we believe just as you've seen over the past few years, once again we'll be gaining share in 2013 for analog overall.
Do you
have a follow on? Thanks. And then just if you could provide some color as within the segments in analog, which one you're seeing the if there's any material difference between the sub segments, it looked like Power was up a bunch if I had my numbers right in September, if you could talk about the growth driver there and then where you see the biggest declines into December? Thanks. Okay.
I think in the case of Power, Power had a strong quarter, but also you used the term earlier easy compare. It was one that's probably more impacted by weakness or the inventory reductions in some of those vertical areas in the Q2. So in the Q3, its growth was very broad based, but it also benefited from recovery in some of those vertical markets. And then I would say the same for HVAL. So if you look at Q3, probably because those vertical markets layered on growth to what was already a reasonable base of industrial and automotive.
Power and HVAL both grew faster than the catalog spaces of HPA and SVA. Yet I think if you go back to first half of the year and especially Q2, you probably saw more relative strength in SVA and HPA. So I guess to put it all together, they're all pulling well in terms of growth in 2013 thus far. We'll see where it takes again where we go through 4th quarter, But some quarters you've had more strength out of SBA or HBA in other quarters that's in Q3 more coming out of Power and HVAC. Okay, Blayne.
Thanks for your questions and we'll move to the next caller.
Next we'll go to Doug Friedman with RBC Capital Markets. Great. Thanks for taking my question guys. Kevin, can you give us an idea of what sort of we should be thinking for the other operating expenses that NOI seems to be moving around? I do know you had the asset sale last quarter, but ex the asset sale still a reasonable bit of spending there.
Can you give us some idea of what we should be budgeting for next year in terms of that line on the income statement?
Doug, I'm going to try to make sure I got what you're asking for. OpEx overall for the company, our model is to run between 20% 25% of revenue dependent upon where we're at in overall revenue demand. And most of that spending is actually inside the analog and the embedded processing segments. There's relatively small levels of ongoing support spending inside the other segment, a little bit of R and D inside the other segment for DLP Technologies, but other than that pretty small. The larger numbers you'll see passing through the others as we go forward will be the continued amortization of intangibles, which will run about $85,000,000 a quarter as we go through 2014.
And that will eventually decline to about $80,000,000 a quarter. And keep in mind, that will stay there for 6 years until that finally winds down. In addition, that's also where we tend to record any restructuring charges. So the restructuring charges that we just had this past quarter were $16,000,000 and those also are recorded in the other segment. As we look into the 4th quarter, I'd expect that you'll see acquisition charges continue at about the $85,000,000 $86,000,000 level and you'll see probably final restructuring charges associated with the closure of our HEE and Houston factories of about $20,000,000 in the 4th quarter.
And Doug, I think if you look at the income statement for the company, all of the for the entire period of comparison here over the last 4 quarters, all of the acquisition charges and restructuring other line are directly from that other segment. So with that, you can then if you want to extract that out to see what R and D and SG and A trends have been in that other segment, You'll see both you won't see them independently, but the combination of R and D and SG and A has gone down whether you look at it year over year or whether you look at it sequentially. And again that's largely driven by the reductions in legacy wireless as Kevin noted. All right, Doug, do you have a follow on question?
Yes. For my follow on, if we look at the embedded processing business, that business growing nicely, but not necessarily delivering the operating margins of the corporate average. Can you talk about what you're doing as far as the operating margin leverage to that business?
Yes. Doug, as you may recall, we spent a couple of years significantly increasing our investments in that segment, particularly as it relates to microcontroller portion of that particular segment. We've taken that spending up to a level now that doesn't need to increase anymore. And really what that business unit is focused on is the top line growth. They get rather attractive gross margins off their parts when they ship them.
It's really about diversifying the revenue base and getting more overall top line growth to fall through to the bottom line. That's really what you just saw quarter over quarter is that top line growth came through rather nicely to the bottom line.
Okay, Doug. Thanks for your questions. We'll move to next caller please.
Next we'll go to Stephen Chen with UBS. Hi. Thanks for taking my question. First one is on operating expenses. In the quarter, it looks like you guys saw OpEx decline by 3% versus the original guidance were down 2%.
Wondering if there's any timing or any or how you guys are able to do better than the original guidance? And what's the expectation for OpEx for us?
Yes. So it seems that OpEx we did guide to them about 2 percent, but we were able to keep a pretty tight handle on spending in the quarter. And so it came in a little bit lower than we had originally planned, which frankly just dropped right through the bottom line and produced extra earnings per share for our shareholders. As we look into the Q4, we typically have some seasonality in the Q4, what with the holidays for Thanksgiving and during the Christmas break. And so we'd expect to see OpEx probably decline somewhere in the 3% to 5% range as we move into the Q4.
Okay, Jeff. On, Steven?
Yes. One question on the embedded processing division, particularly microprocessors. So with the MSP430 that you mentioned, I was wondering, is the consumer or wireless segment an area where you're looking to be more aggressive on expanding the sales of your MCU products? Thanks.
I think probably the way to think about it Stephen is probably the biggest driver of growth for microcontrollers will be industrial. These are catalog devices that go into lots and lots and lots of different applications. That being said, we're not if there's growth in other end markets or growth opportunities in other end markets, we'll certainly pursue them. But our expectation is that industrial will likely be the largest driver going forward. And that's for the microcontrollers.
For the processor side of the business, I would say we would expect comms infrastructure certainly is part of that revenue and an important end market for us. But similarly, we sell DSP products into lots of different applications and those broader applications are going to be just as important, maybe even more important than communications infrastructure going forward. And that's not anything negative about communications infrastructure. It's just we have great market share, very high market share already in communications infrastructure where there's still a lot of opportunity in some of these other areas for us to experience not only the rapid growth of that end market, but also rapid market share gains as well. Okay, Stephen, thank you for your question.
And one of the things I should further delineate is when I'm talking about industrial likely being the fastest grower for microcontrollers, let me also more broadly include automotive in that as well because that is a great opportunity that we're very well positioned with those products there. Okay, Stephen. Thank you. And let's move to next caller.
Next we'll go to Tristan Gerra with Baird.
Hi, good afternoon. Your R and D spending as a percent of revenue is fairly low relative to the some of your high value peers. So what leads you to believe that you can maintain the growth, gain market share and the mix? Or do you think that there is a possibility of raising R and D over time?
Yes. Tristan, let me just again remind everybody of the R and D that you're seeing for TI. The R and D spend that we've had in the analog segment has been at a pretty consistent level versus the revenues of that business for quite a few years now. And the fact of the matter is, the reality is that that R and D spend is being converted fairly efficiently into revenue growth to the point where that business continues to outgrow its competitors and gain market share each year. So I would offer to you that that's actually a very efficient organization when it comes to this R and D spend.
I can't explain why some of their competitors have to spend as much as they do. Similarly, in embedded processing, we've increased the spending over there as I mentioned on the last question over the last couple of years largely to expand the opportunities that we can pursue in the microcontroller space. And so after bringing up that level of spending for a couple of years now, I'd say it's high enough at this point and we now need to see it start converting into real revenue growth, which we're starting to see early signs of. When you look at total TI R and D, it is coming down quite sharply and that's purely a function of us winding down the legacy wireless products, including the announcement that we had that we're closing some of our operations and sites as it relates to that and that will take our total R and D spend down as we go forward. But on the core products of embedded processing and analog, I have no hesitation of being comfortable with the level of R and D spend that we have in those areas today.
And Tristan,
let me also just offer, in the analog space, I would argue we're probably spending more than any of our competitors. You're looking at it as a percent of revenue, but if you look at absolute dollars, yes, we're bigger in terms of revenue, but we're spending more than any competitor that I'm aware of out in that space. So it's not like we're not investing in that business. We're investing quite heavily. Do you have a follow on Tristan?
Sure, Ian. It's very useful. The part of your business that's non consigned business, so distribution, is your Q4 revenue guidance embedding shipments about in line with end demand or any variance that you can mention relative to end demand and sell in?
Tristan, I don't know that we have a real breakout in terms of the outlook between consigned versus non consigned. We're really looking at it just in terms of what we shipped in or what we're shipping into that channel. So I don't specifically know the answer to that. I will point if you just back to Q3 anyway as a reference point. I think we said TI's total revenue excluding the legacy wireless grew 10% and our resales or sales out of the distribution channel grew 9%.
So you saw a very close alignment in Q3. I just don't have any specific data to share with respect to 4th quarter. The other thing I'll say even with Q3, we had a decline of a day of distribution inventory level. All right, Tristan, thank you. And we'll move to the next caller.
And next we'll hear from Stacy Rasgon with Sanford Bernstein. Hi, guys. Thanks for taking my questions. Had one quick one on OpEx. Your R and D guide for the year still puts you about $1,500,000,000 which would not which you said OpEx should be down 4%.
So the midpoint of that would imply R and D down like 12%. Are you just rounding down to that $1,500,000,000 And maybe could you give us a little more color on your expectations for the R and D and the assumptions around the OpEx?
Yes Stacy, we do round to the nearest $100,000,000 on all of these guidance numbers we give you be it R and D or CapEx or any of the others. So in fact, there will be some rounding inside there. But keep in mind also the OpEx guidance I gave includes SG and A as well. And we will see that decline in the 4th quarter really on the seasonal patterns I mentioned a moment ago with the holiday periods going on.
Do you have a follow on Stacy? I do. Just around again gross margins, sounds like you got a bit more restructuring left over from the 6 inches fab closures in Q4. Have the benefits from those closures fully impacted gross margins? I think
in total it was supposed to
be about 75 basis points. And if they haven't fully impacted yet, can you give us some feeling for the trajectory of that impact on the margins?
Yes. Stacy, what we talked about when we announced that we were closing those 2 older 6 inches factories is that once each one of them was closed, we should see about $50,000,000 per factory of cost savings on an annualized basis. 1 of those factories did close at the end of 2nd quarter and the other one should close here in the Q4. So we're beginning to see excuse me, Q3. So we're beginning to see in the Q3 already partial benefit from that and we should begin to see the benefit from that second factory closure materialize in the 4th quarter.
So going into next year, we'll begin to see that $100,000,000 of annualized cost savings as a result of closing those 2 older factories.
Okay, Stacy. Thank you. Let's move to next caller.
Next we'll go to Vivek Arya with Bank of America Merrill Lynch. Thanks for taking my question. First one just on the Q4 outlook. I just wanted to make sure if there's been any downshift or conservatism regarding Q4 outlook, Because I think heading into the quarter there was an expectation that look macro trends are improving, industrial businesses are doing better, there is this comms infrastructure build that the broader analog industrial players would be able to give above seasonal guidance. Maybe it was optimism.
But since then, we have just seen sort of seasonal or slightly below seasonal outlook from linear from Cypress and now you're also guiding somewhat below Street expectations. So my first question is, has there been any conservatism regarding Q4 outlook? And specifically, what segments do you think will be at seasonal patterns versus below seasonal patterns for Q4?
Yes. Vivek, I'll go ahead and make some comments on that, let Ron add some additional color. But the if you take a look at our guidance, the midpoint of our guidance is down about 8% Q3 going into 4th. About half of that is just the seasonal decline that we normally get with the roll off of the calculator business. So the other half is pretty much attributable to our underlying semiconductor business.
If you take a look at we actually believe that that's probably quite seasonal and in fact quite consistent. If you take a look, as I mentioned in my prepared remarks, 2010, 2011, 2012, the semi industry as a whole, excluding memory, in fact, has seen 4th quarter declines from 3rd quarter in each of those past 3 years. And based upon the guidance that we're hearing from some of the other competitors, ourselves included, it looks like we're setting up for a 4th quarter of a 4th year of 4Q declines. In fact, if you take a look at TI and extract out the wireless revenue, you'll see that our revenues have gone down in the Q4 of each of those same years similar to the industry. And in fact, when you just do the simple math during those last 3 years for the industry, it's down about 4%.
So in fact, I don't think that we're suggesting that there's some changed outlook or changed future. In fact, I would offer to you that Q4 appears to be shaping up quite normal to us. When we take a look at our 3rd quarter orders, they were actually up about 1% sequentially. Our distribution inventories, as Ron mentioned, were down about a day and they remain quite lean with our distributors as well as our other customers. Our cancellations remain very low and we've had no unusual requests for backlog push outs.
So when we put all that together that suggests to us that the Q4 is shaping up to be a normal demand environment similar to what we've seen for certainly the last 3 years.
Vivek, I think the other thing I would just add is even when we talked to you at the mid quarter update, somebody asked a question about order trends. And I remember saying at that point that orders quarter to date today had been strong, book to bill was above 1, but that we expected that to slow as we approach the end of the quarter basically as we for a couple of factors. 1, just seasonality in general both calculators as well as semiconductors. So don't was there a slowing through the end of the quarter? Yes.
But also we expected that slowing would occur and it pretty much happens almost every year and certainly has happened as Kevin just pointed out each of the last 3 years. Do you have a follow on to that?
Yes. Thanks, John. Very helpful clarification. So as my follow-up, I just wanted to make sure, Kevin, did you say that tax rate for Q4 will be 24% or for the full year would be 24%? And then the real question is on dividends and buybacks.
I think you mentioned that they have been at 133% of free cash flow over the last year. How long can they stay at those level? And should we just expect them to trend back to whatever closer to the
24% effective tax rate is what you should use for the 4th quarter. With the various things occurring during the year, the entire year will be a little bit different than that. But for planning purposes, use 24% for the 4th quarter. I would remind you that that tax rate includes the R and D tax credit, which is set to expire at the end of this year. And it's unclear whether or not that will be renewed by Congress in a timely fashion as we get into 2014.
For us, that provides about a 2% benefit to our taxes. So absent that R and D tax credit, we'd be closer to a 26 percent tax rate as opposed to the 24% that we're suggesting that you use for Q4. As it relates to buybacks, I would just mention that again the reason it's been as strong as it has been, the buybacks and dividends at 133 percent of our free cash flow is a function of not only improving free cash flow, which we've certainly seen, but also the benefit the company receives when employees exercise their non qual stock options. And given the increase in stock prices this past year for our company, we've seen an increase in employee stock option exercises. Just to give you a few numbers to summarize that, to recharacterize what I've mentioned in my prepared remarks, our free cash flow for the last 12 months was $2,870,000,000 Proceeds from employee stock options was $1,280,000,000 so that means we had sources of cash over the last 12 months of $4,150,000,000 We used or returned to shareholders in the form of dividends and buybacks $3,820,000,000 and we paid off debt earlier this year of $500,000,000 So we've used a total of 4,320,000,000 dollars So we virtually used all that we have generated this past year.
And we do that because one of the things we mentioned in our capital management strategy
is
that we have a model for how much cash that we carry. And to the extent that we generate cash beyond that model level, we're quite comfortable with returning that to shareholders as we have been doing. As to the ability of that to continue to run at those high levels, that's a really hard call. I would say that stock options do expire over time and these are generally 10 year stock option grants that are granted to employees. So quite a few of these options are quite old, and they get used up.
So I would expect that as we move into the future, we're apt to see less extra cash coming in from stock option exercises, but I think it's almost impossible to try to forecast the magnitude of that change.
Okay, Vivek. Thank you. Let's move to the next caller.
Next we'll go to Steve Smiggy with Raymond James. Great. Thanks a lot. I was hoping you could comment a little bit on Silicon Valley analog here in terms of where we are in your 3 year plan. And if you don't have it available this quarter, would it be possible maybe on mid quarter update to talk about where the revenue is there just so we can see where it was relative to where you guys acquired it?
Yes. Steve, I would say with the Silicon Valley analog, first off, on the point of revenues, we disclose revenues at the segment level. We don't disclose revenues below that. So we won't be offering the actual revenue figures for SBA. But if I were to talk about where are we at with respect to our expectation for SBA versus when we acquired National Semiconductor, I would say that the overall revenues are probably a little bit lower than we'd initially expected at this point in time given the overall market environment that we've been faced with these past few years.
However, the rate of progress on share gain has been quite a bit faster. As we mentioned during the last call, those product lines are actually gaining share about a year faster than we expected. In addition, we've had more cost synergies than we modeled into the acquisition. We've had lower interest expense on very low cost debt we've been able to issue and we've had substantially benefits from taxes as a result of the acquisition. So when you put it all together, the profit that we're achieving on the National Semiconductor portfolio today is very close to what we've modeled at this point in time.
And so I'd say we're reasonably satisfied with that bottom line effect. Hey, Steve. Even though we don't break out revenue quarterly, I can give you kind of a rough breakout for the sub segments of analog for 2013 year to date. So HVAL 35%, Power 25% and then HPA and SBA are each about 20% of total analog revenue. And again that's year to date.
You have a follow on Steve?
Yes. Great. Thanks a lot for that clarity there. And just if we could follow on in terms of overall acquisition strategy in general. If you look at the microcontroller business, overall still fairly fragmented out there.
And also on the analog side, you guys have talked a lot about gaining share and perhaps accelerating that through acquisition. Is there anything substantial you guys might do on either side there to change your position in any sort of substantial way at this point? Or is it more organic growth from here?
Yes. Steve, I think that most of our growth for the foreseeable future is going to be organic. To the extent that we do continue looking at acquisitions, given the valuations that we presently see with many companies out there that might be an attractive to our portfolio, it's difficult for us to look at what we might have to pay for some of those acquisitions and actually get a reasonable return on the investment for our shareholders. So that suggests to me that to the extent that we are doing acquisitions, they're probably going to be smaller tuck in ones They'll probably come with reasonably good product lines to fill in holes that we have or talented engineers to help with our R and D efforts. They're probably going to be biased towards analog.
One of the problems when you go into the microcontroller side, if you start getting different architectures into your family of products and that can add complexity that may not be easy leverageable. That's not to say that we wouldn't look there, but that reduces the odds you'd see a microcontroller tuck in kind of acquisition. Okay, Steve. Thanks for your questions. Let's go to the next caller.
Next we'll go to David Wong with Wells Fargo. Thanks very much. Your guidance for EPS and revenue next quarter, does it assume the gross margin will be flat to slightly down with the lower revenues or does gross margin keep rising?
Yes, David, I think inherently with the revenue decline that we're expecting in the Q4, we'll be reducing the loadings in our factories a little bit. So you'd expect underutilization charges will probably increase a bit and have a corresponding impact on gross margins decline in the picture of the quarter.
Okay, great. And a minor administrative thing. You noted that your cash is largely onshore, so you have no problem returning to shareholders. How do you get your tax rate down to 24% so far below U. S.
Tax rate and still generate primarily U. S. Cash?
Yes. Well, I would first just comment that I don't really think our tax rate is all that low. 24% is an awful lot of money that we're having to send to the tax collectors. But that aside, taxes inherently are pretty complex and there's a lot of things that can affect the tax rates and especially a company's somewhat unique global footprint. Our footprint on a global basis including the benefit that we got with the National acquisition is allowing us to have a relatively effective current tax rate and further enabling us a pretty high repatriation of cash.
As you noted, we've made most of our cash home and we just ended this past quarter with 82% of our cash onshore. For planning purposes, as we look into the future, we assume that the U. S. Tax rate stays about the same incrementally at 35%. And we just model that on a go forward basis from a repat standpoint.
Our objective again is to maintain 80% or more of our cash onshore so that we have it available to use for our shareholders for dividends and stock buybacks. Okay, David. Thank you for your question. Let's go to the next caller.
Next we'll go to Tore Svanberg with Stifel.
Yes. Thank you. First one for Kevin. So you have about $4,200,000,000 in long term debt and I you have about $1,000,000,000 in the note payable. Can you just remind us what your plans are right now as far as paying back that debt especially timing?
Yes, Tore. We do have in short term debt $1,000,000,000 that comes due on May 15, 2014. We had talked during our capital management strategy discussion back in February that debt clearly is going to be a portion or part of our capital structure for quite a long time, especially given that we've got debt goes up as far as 10 years up. And that in fact we would continue including debt in our capital structure or rolling over portions of our debt if the economics made sense. And to us the definition of the economics making sense is if we can issue new debt at rates that are either below our impression of what the inflation rate will be or below our dividend yield.
So with that in mind, I can't forecast exactly what we'll wind up doing when May comes around, but clearly we'll be prepared to pay off that $1,000,000,000 if we need to. But if the economics make sense, we may very well decide to go ahead and just replace that with new debt. Follow on, Tore? Yes. A follow on for you, Ron.
I don't know if you'll answer it or not, but can you maybe comment on which end markets we'll do on a relative basis in the December quarter?
No. But I will give you a consolation and talk about what they did in the 3rd quarter. So in the Q3, this is not a Q4 comment, industrial as we pointed out grew and continued to be strong. Automotive grew for us being driven mainly by infotainment and advanced driver assist systems such as blind spot detection, parking assist, a lot of those cool things you see on car commercials these days and aspire one day to have a car that actually does that. Computing notebooks were weak and tablets grew.
I heard some competitors talking about weakness in tablets. Don't know where that came from. They were strong for us. Comms infrastructure, the big word was China and 3rd quarter operators in fact started deployment, released contracts. 2 thirds of those contracts went to China OEMs, 1 third to European.
I'll note we sell to both and maybe different products to different players, but we expect to continue to enjoy participation in that China business. Small cell trials are continuing. What I would say is first deployments we expect to happen probably call it mid to second half of next year. Handsets probably the good news there is now sub-two percent of our revenue is legacy wireless keeps going down. Consumer, good recovery in revenue there after some of the inventory reductions in Q2.
It's probably a game console comment mostly. Digital television continues weak. So again, sorry, I didn't answer the question, but hopefully there was some value there. Tory, thank you for your question and we'll move to the next caller.
Next we'll hear from Patrick Wong with Evercore.
Yes. Thanks a lot. Just one question for me. Can you help us understand the underutilization charge in Q3? What you see for utilizations in the Q4, I guess, in terms of that charge?
And then also what you plan to exit the year with in terms of inventory, both on the balance sheet and in the
channel? Thanks.
Yes. Patrick, the underutilization charge in the Q3 was about $70,000,000 That's down from about $100,000,000 in the prior quarter. And as I mentioned with reductions in our factory loadings expected during the Q4, I'd expect that charge to go up. But I won't give you a forecast with an exact number just yet. That will be a function of exactly what our books will turn out to be by the end of the quarter.
As it relates to inventory, our model for inventory is to carry between 105115 days of inventory. We just closed the current quarter to 106 days. So we've got room that we probably want to take those days up a little bit more and with the slowdown in demand in Q4 that seems like a slight opportunity for us to go ahead and bring those inventory days up a little bit as we get ready to enter 2014.
Patrick, I think I understood you to say basically you got
all your questions in there.
And to get to more colors, we'll move on to the next caller please.
Next we'll go to Ambrish Srivastava from Bank of Montreal. Hi. Thank you, Ron. And I apologize I don't want to put you on the spot, but I'm getting a lot of e mails and I'm confused investors are confused. Going back to the mid quarter update, I think you did say that the long term seasonality is 8%, but then you also said the variability is a lot.
So the right way to think about it is the decline of the 4% for the last 4 years of the last 4 year average. And so is it that we miss misinterpreted that and walked away thinking not that I was modeling for down 4%, but the Street was clearly higher than me so and hence Vivek also asked that question. Did we misinterpret your comments? Or did something change in the quarter?
I think the key to looking at that, Ambrish, and all of that is exactly true. If you look at 5 year average, it's down 8%. If you look at the last 4 years and take I think it was Q4 2018 out, it's down 4%. I think what you hear us talking about here are if you look over the last 3 years, I think in case of the industry and TI both were excuse me, it's something like down 9%. And so I guess the difference is just that the only real difference in terms of how we're discussing our own data is I think a meaningful change to say if you take legacy wireless out.
And that was obviously 3 years ago, 4 years ago a very significant part of our revenue mix. Today, it's an insignificant part of the mix. So any impact that has on seasonality going forward, frankly is what it did in the past is irrelevant to our future. So that's really the distinction that we're making at this point. Do you have a follow on on, Ambrish?
Hi, Brett. So just to look forward now, what should now that the legacy business will be gone when we go into next year, what should be thinking about the normal seasonal patterns? And I'm sure you'll answer it and we come back and ask you again for the 4 quarters.
What the math I've done is I think if you look at Q1 and you take legacy wireless out and you look at the last 3 years, it's flattish. But what I will encourage you to do, I think we have all of that data out on our website and that would be a great project for you to work on tonight and publish in your note tomorrow. There'd probably be a lot of value added in that. So again, I'll just I'll refer you to that data and let you do the math.
I'll play with the data, Ron.
Thank you. You'll enjoy that. Ambrish, thank you. And we'll move to next caller please.
Next we'll go to Jim Covello with Goldman Sachs. Great. Thanks so much for taking the question. I'll stick with the theme of
a couple of callers ago and just stick
to one question. There's been a lot of activity in the analog segment lately relative to sensors. There's been some M and A activity and some of the analog peers this year that have grown in excess of the market have grown because they've gained some share or had some opportunities in the sensor market. How do you feel about TI's position in that market? Where do you see you guys go in there?
Thanks a lot.
I don't know that probably the one thing I would say Jim that in that sensing space and obviously there are lots of different types of sensors and they're different. But I think it's sometime in the last month anyway a few weeks, we did an announcement really of a breakthrough product category in inductive sensing, which is basically an entirely new class of data converters. And that truly is innovative. That truly is breakthrough. That being said, when you look at the size of TI and our portfolio of 100,000 products, it can be a breakaway success and it's not going to have a big impact on TI in terms of moving the needle.
But I think it's a great example of the kind of innovation that's been taking place at TI over the last decade and why you see just consistent share gains from our company. A lot of people talk about innovation and a lot of times that spun up in technical terms. We really simplify it and measure it by our reproducing and innovating and developing products that customers want and we really let our market share tell the story back, provide the feedback of whether we're providing innovation that is valued by our customers. So that's one example. I went a little broader than your sensing question, but absolutely a great space and we're right in the middle of it.
Thanks Jim and we'll move to the next caller.
We'll go to Glenn Young with Citigroup. Thanks. Hey, Ron, when you look at the activities that either cancellations or pull in things you might not normally expect to see in the context of a set of orders. Are you seeing anything there that's unusual either one way or the other from your customers?
No. Cancellations remain at what we would call very low levels by historical standards. And that's part of the reason why we really feel this is a we were coming up on a pretty seasonal Q4. We're not seeing anything in the kind of the cancellation front for example that would indicate it's anything weaker than normal. I know a lot of people maybe were worried about well what's the effect of the government shutdown and is that showing up in customer demand or anything like that.
I'm not sure. We have perfect visibility there, but we sure didn't see backlog being pushed out by customers. We didn't see a higher rate of cancellations, which we think are both meaningful indicators. Do you have a follow-up, Glenn? Yes.
Thanks for that Ron.
As a follow-up, as I look at the reported gross margins, they're almost around 150 basis points more than what consensus is modeling for next year's gross margins. And I recognize that movements in revenue and enhanced utilization will affect that. As we think about the puts and takes, assuming that next year is even a modest growth year for semiconductors, if we think about the puts and takes on gross margins, What could the consensus see you right I. E. Gross margin is down 158 basis points from current levels or is perhaps consensus seeing things wrong?
Yes, Glenn. I guess I would just remind people as they're putting their models together of a couple of things. As we look at what's going to drive our gross margins going forward, keep in mind as we fill these very cost effective factories that we acquired over the last couple of years and especially as we fill them with a higher mix of industrial and automotive end market type products, we're going to see margins continue to be pretty healthy. Another important point to keep in mind is that depreciation today is running about 400 basis points ahead of capital expenditures. So by definition that means depreciation will start to work itself down over the next couple of years and that by itself will be a boost to gross margins.
Those are probably the three things I would really point to and that is again as we grow and fill up those factories, as we improve our portfolio mix especially industrial automotive and as depreciation declines over the next few years on these lower levels of CapEx, Those together should provide nice tailwinds to our gross margins as
we go forward. So to the scenario that Glenn talked about, if 2014 has any kind of reasonable growth or any growth at all given those tailwinds, it doesn't sound like The Street if they're modeling down 150 basis points on gross margin that does not sound consistent with what you just described. Is that right?
It sounds inconsistent and it would also suggest that you're missing just exactly how much free cash flow we'll generate next year.
All right. Thank you, Kevin. Okay. And I think operator we're going to try to squeeze in one final caller and then we'll wrap it up.
Okay. Our final question will come from Ross Seymore with Deutsche Bank.
Hey, Ron. Thanks for squeezing me in. I'll with the one question theme. Kevin, you just talked about some of the puts and takes for gross margin for next year. From the $800,000,000 roughly level you are for core OpEx in the Q4 of this year ex charges restructuring etcetera, what sort of OpEx puts and takes should we think of heading into 2014?
Ross, I think the simplest thing I'd suggest to you is that clearly the people who are in R and D and SG and A, the OpEx buckets as we call them are correctly anticipating that they'll see pay and benefit increases in 2014. So we would certainly see the effect of that. I would probably also remind you that in Q1, our OpEx typically is seasonally up from Q4 and that's a function of 2 things. 1, it's the absence of the holiday periods that we see in the Q4 And the second is the annual paying benefit increases that begin to take effect in the Q1 and take full effect in the Q2. So again, I would expect the spend rate as we go into next year begin to increase coming off of a low 4th quarter.
Year over year though given the wind down of legacy wireless probably still year over year attractive within our OpEx model in the 20% to 25% range probably 20% to 30% range of revenue excuse me being at the lower end
of that range. And Rod just maybe even shorter term, 4th to 1st OpEx typically goes up because of the pay and benefit increase that Kevin described that kicks in February, but also just fewer holiday and vacation days taken in the Q1 compared with 4th. 4th, we see the benefit from those holidays and vacation days, but sequentially then it tends to work against us in the Q1. Okay, Ross. Thanks for your questions.
And in general, we're going to stop here. Thank you for joining us. A replay of this call is available on our website. Good evening.
And that does conclude today's call. Thank you all for your participation.