德州儀器 (TXN) 2005 Q3 法說會逐字稿

Good afternoon, everyone and welcome to the Texas Instruments third quarter 2005 earnings conference call.

At this time all lines have been placed on listen-only mode and the floor will be open for questions following the presentation.

At that time if you have a question or a comment, you will be asked to press star one on your telephone keypad.

And now, I would like to turn the floor over to your host, Mr. Ron Slaymaker.

Sir, you may begin.

Good afternoon and thank you for joining our third quarter earnings conference call.

Kevin March, TI's Chief Financial Officer, is with me today.

This call will last one hour.

For any of you who missed the release, you can find it on our Web site at TI.com/IR.

This call is being broadcast live over the Web and can be accessed through TI's Web site.

A replay will be available through the Web.

This call will include forward-looking statements that involve risk factors that could cause TI's results to differ materially from management's current expectations.

We encourage you to review the Safe Harbor statement contained in the earnings release published today as well as TI's most recent SEC filings for a complete description.

Our mid-quarter update to our outlook is scheduled this quarter for December 7th.

We expect to narrow or adjust the revenue and earnings guidance ranges as appropriate with this update.

We will observe a quiet period beginning on December 1st until the update.

In today's call I'll review our revenue performance and then Kevin will discuss profit performance and the fourth quarter outlook.

After this review we'll open the lines for your questions.

Third quarter TI revenue of $3.59 billion set a new record for the Company.

It exceeded our initial guidance range provided in July, and was near the top of our updated guidance range that we provided in September.

Semiconductor growth of 13%, both sequentially and year-on-year, accelerated in both comparisons and was at the top end of our expectations.

Sensors and Controls revenue seasonally declined 5% on a sequential basis and E&PS revenue declined slightly.

Especially encouraging was that we set new records for gross and operating margins despite the added pressure of stock option expensing which began in the quarter.

Our prior high margin level was set in the second quarter of 2000, so moving to this level was a significant milestone.

It's especially important to note that we simultaneously set records in revenue and margins and therefore operating profit dollars.

In fact, operating profit in the third quarter was 26% higher than in the second quarter of 2000 on revenue that was 22% higher.

We achieved this over time through a combination of pruning less profitable non-strategic product line while expanding our core areas.

In addition, our third quarter margin expansion occurred while inventory declined.

Inventory declined overall at TI, in our Semiconductor business and through our semiconductor distribution channel.

We believe all of this is indicative of the increasing importance of our product portfolio to key electronics products driving industry growth today and the strength of TI's customer relationships.

For example, TI's wireless revenue grew 16% sequentially and was up 20% from a year ago.

Once again we are seeing a broad base of growth with strength especially prominent in both 3G UMTS cell phones and in the low price segment.

We believe this is an early harbinger of future market trends as more segmentation occurs in the wireless market with some segments focused on the latest features and functions and others focused on basic voice functionality at very low cost.

TI has both the systems know-how and the leading positions in DSP and analog to accelerate new, cost effective features and functions, as well as the semiconductor integration and manufacturing skills to excel at the low-end of the market.

We are also benefiting from our strong relationships with the world's most important cell phone manufacturers that differentiate their own products based on our most advanced technologies.

As our customer base has continued to expand, and as our customers overall have gained share we have benefited.

A good example of this is our success in 3G UMTS cell phones.

We expect our 3G modem and application processor revenue to exceed a billion dollars in 2005.

To put in this context, we believe this is more than four times that of our closest competitor in UMTS chips.

Our 3G revenue in the third quarter more than doubled from a year ago.

In fact, our year-on-year 3G revenue growth has accelerated every quarter so far this year.

The overall UMTS handset market is expected to double this year and again next year.

Our 3G revenue is well balanced between the modem function and OMAP application processors.

In wireless application processors, IDC's most recent study released over the weekend credits TI as holding 77% share of this market and each of our competitors with10% share or less last year.

This was a 10 point increase for TI compared with the prior year.

Turning to analog.

TI's analog revenue increased 13% sequentially and 11% from the year-ago.

As a reminder, the year-ago quarter included $50 million of revenue from an LCD driver product line that was divested in the first quarter of this year.

This reduced analog growth by five percentage points and overall semiconductor growth by two percentage points in the year-ago comparison.

Again, high-performance analog was a big factor in our analog results and grew 10% sequentially and 16% from the year-ago quarter.

Similar to last quarter, high performance analog sales into the distribution channel were a little below our distributor's resale for these products with a slight decline in inventory resulting.

DSP revenue grew 16% sequentially and was up 20% from a year ago.

Wireless was the biggest factor in this growth.

DSP sequential growth also benefited from strength in catalog products, as well as automotive radio and navigation applications and gateway products.

TI's remaining semiconductor revenue grew 11% sequentially and grew 4% from the year-ago period.

DLP revenue grew over 40% sequentially.

Much of this growth reflects that we were shipping below consumption in the second quarter as our customers worked down inventory and that we are now shipping closer to true demand as our customers have inventory at desired levels again.

Compared with the year-ago quarter DLP revenue was about the same.

In other areas we had double-digit percent sequential growth in standard logic commodity products and revenue in microcontrollers and risk microprocessors were about the same as the second quarter.

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

Thanks, Ron, and good afternoon, everyone.

As Ron indicated, we are pleased with the progress that we made on profitability in the quarter.

Excluding the stock-based compensation expense, we basically achieved the 50% gross margin and 25% operating margin goals that we established some time back.

Recall that we set those objectives before stock option expensing was comprehended.

That being said, we fully realize that these stock-based compensation expenses are now part of our financial measures.

In the third quarter, the total stock-based compensation expense was $82 million, or 2.3% of revenue.

The distribution of this expense was 40 million to SG&A, 26 million to R&D, and 16 million to cost of revenue.

The earnings per share impact from this expense was $0.03 in the third quarter.

In comparison to prior periods please remember that stock option expense is not included in the periods prior to the third quarter.

I will try to move fairly quickly through our financial highlights so that we can allow more time for your questions.

TI's third quarter gross profit was 1.77 billion, or 49.3% of revenue.

Gross profit expanded primarily due to higher semiconductor revenue as well as manufacturing cost reductions and higher utilization of our semiconductor manufacturing assets.

Gross profit expanded significantly faster than revenue in the quarter and underscores the significant incremental margins that we drove in the quarter, 83% for TI overall and 88% for our Semiconductor business on a year-over-year basis.

Semiconductor gross margin was 50.9% in the third quarter.

Operating expenses of 956 million, or 26.6% of revenue increased 104 million from the second quarter.

Stock-based compensation expense was the biggest part of this increase.

TI's operating profit for the quarter was $815 million, or 22.7% of revenue.

As Ron said earlier in the call, this was the highest operating profit and operating margin ever produced at TI.

Our prior peak operating margin was 22% of revenue in the second quarter of 2000 and that period did not include stock option expenses.

By segment, Semiconductor operating margin was 26.6% in the third quarter, Sensors and Controls operating margin was 21.4% and Educational and Productivity Solutions operating margin was 44.7%.

These segments do not reflect stock-based compensation expense as we carry that expense at the corporate level.

The 27% effective tax rate for the third quarter was higher than the previously expected 24% due to a revision in the estimated annual effective tax rate and the associated cumulative increase in tax expense.

A big factor in the increase in the annual rate was an upward revision in our profit expectations for the year.

Net income was 631 million, or $0.38 per share.

It might help if I summarized the earnings per share transition from the $0.38 that we reported in the second quarter.

On the plus side, about $0.07 of higher EPS resulted from revenue growth and about $0.04 came from higher factory utilization and manufacturing cost reductions.

Other income and expense, excluding the tax interest benefit in the second quarter, contributed an additional penny to EPS.

On the minus side, EPS was reduced by about $0.03 for stock option expenses, $0.02 from higher operating expenses, and about $0.01 due to the higher tax rate in the third quarter.

Finally, a $0.06 non-recurring tax-related benefit in the second quarter did not repeat itself in the third quarter.

Cash flow from operations was a record $1.51 billion in the quarter, up $687 million sequentially.

This contributed to a $773 million sequential increase in total cash to $5.25 billion at the end of the quarter.

TI used 496 million of cash during the quarter to repurchase 15 million shares of TI common stock.

Since stepping up our stock repurchase programs we have repurchased a total of 140 million shares over the last four quarters.

Average diluted shares outstanding were 1.663 billion shares in the third quarter.

Capital expenditures of $450 million in the quarter increased by 193 million sequentially as we increased spending on assembly and test capacity, as well as advanced wafer fab equipment and building our new 300 millimeter manufacturing facility in Richardson, Texas.

Depreciation of 339 million decreased 6 million sequentially and is down 39 million from a year ago.

Inventory of 1.16 billion at the end of the quarter declined 44 million sequentially and 198 million from the year-ago quarter due to strong shipments.

Days of inventory at the end of the third quarter were 57, down from 63 at the end of the second quarter and 69 a year ago.

TI's orders in the third quarter were 3.74 billion, up 10% sequentially and 24% from a year ago.

Semiconductor orders were 3.32 billion, up 12% sequentially.

Semiconductor's book-to-bill ratio was 1.06 down slightly from 1.07 in the second quarter.

Turning to our expectations for the fourth quarter, we currently expect TI revenue to be in the range of 3.425 billion to 3.715 billion.

Semiconductor revenue should be in the range of 3.075 billion to 3.325 billion.

You may note that this represents a year-on-year growth range of 10 to 19% for Semiconductor.

Sensors and Controls should be in the range of 290 to 310 million, and E&PS should be in the range of 60 to 80 million.

Earnings per share in the range are expected to be in the range of 36 to $0.40 in the fourth quarter.

This estimate includes about $0.03 for stock-based compensation expense.

Our expectations for 2005 R&D, capital expenditures and depreciation are unchanged from the beginning of the year.

R&D is expected to be about 2.1 billion, capital expenditures to be about 1.3 billion and depreciation to be about 1.4 billion.

The ongoing effective tax rate for the remainder of the year is expected to be about 25%.

Despite being in an environment of some economic pressures in the form of rising interest rates and energy costs, third quarter's 13% sequential semiconductor growth represented TI's strongest third quarter semiconductor growth in more than 15 years.

Leaving the quarter our shipments continued to exceed our initial expectations, in turn taking our inventory below our desired levels.

Considering that fourth quarter demand tends to be more weighted towards the first two months of the quarter when compared with other quarters, we may be somewhat limited in our ability to support unforeseen end quarter demand surges.

These factors have been reflected in our outlook and the approach we're taking for the quarter.

In summary, we are very satisfied with our third quarter results.

Breaking through our prior financial records for revenue and profitability indicates the significant change that has occurred at TI over the past few years.

Our product portfolio is stronger, our manufacturing strategy is more robust, we're more efficient with our capital and we're generating high overall returns.

With that let me turn it back to Ron.

Thanks, Kevin.

At this time I'll ask the Operator to open the lines up for your questions.

In order to provide as many of you as possible an opportunity to ask your question, please limit yourself to a single question.

After our response we will provide you an opportunity for an additional follow-up.

Operator.

Thank you.

The floor is now open for questions.

[OPERATOR INSTRUCTIONS] The first question comes from Michael Masdea from CSFB.

Thanks a lot.

I guess the question, pretty simple.

Orders up 10%, semis up 12%, you're guiding what seems to be couple points below seasonal, you mentioned the manufacturing limitations but is there anything else going on here because it seems like a little bit conservative guidance given those order trends.

Michael, it's pretty much as I just stated up there, the demand coming out of third quarter just continued strong throughout the quarter and actually caused to us take inventories down below what we had planned.

We actually had, coming into third quarter, expected to have a slight build in inventory in order to support what we were anticipating then the fourth quarter demand might be, but as demand continued to remain strong throughout third quarter, we actually depleted our inventories by more than $40 million.

In fact, almost all of that drawdown was in finished goods with a majority of that out of semiconductor, so consequently our ability to respond to in-quarter surges could be somewhat limited solely because of the right mix of inventory on hand.

So it's not a demand issue it's more of your ability to respond to what's going on out there?

That's correct.

With a book-to-bill of 1.06 we think demand was quite strong coming out of the quarter.

Great.

And the second question just on the wireless side, there's a continued concern just about the shift to low-end handsets and also the OEM profitability out there especially as you head into the time of year when a lot of contracts are negotiated.

Just walk us through those two dynamics and what gives you comfort that we're not going to see either decent revenue or ASP risk in your wireless business relative to normal seasonality?

Okay, Michael, if we take a look at what we saw and what we've been seeing so far this year, I think Ron has characterized it in the past as something as barbell effect that we're seeing in our wireless markets.

We're seeing very strong growth on the 3G side, in fact almost all of our revenue growth year-to-date has been in the 3G space.

And we're seeing very high volume growth on the low-end side, the low-ends being your basic voice phones that would be selling into India, China, South America, other emerging markets.

So the result of that is when you put it together combined revenues are up for our wireless unit 16% quarter-over-quarter or 20% year-over-year with total contribution to profitability being what we would expect it to be given that TI's overall profitability is up on the quarter.

So we're not anticipating any issue from that standpoint that you just described.

Michael, the low-end part of the market adds unit growth, adds revenue growth and adds profit growth.

It's really as simple as that for TI.

Do you have higher ASPs down there or is it just because of the way it's architected your profitability's strong?

When you say do we higher ASPs down there you mean relative to what?

I mean like if you took a base band and I guess the question really is, do you have more content down there than you have in the higher end on average?

No, I would say on average the content in a low priced handset will be lower than it would be in a more feature-laden handset but that doesn't mean that we have lower margins necessarily.

It just means that we have to have lower costs to be able to support a comparable level of profitability.

And the one thing I would say as we start moving into, for example, '06, as we integrate more features and functions from that low priced handset into our single chip solution, we actually could see our content and would expect our content to increase just because we're sweeping up functionality that is currently provided by other semiconductor manufacturers.

But when you compare that low price handset to other more featured handsets the average content would be lower certainly.

That makes sense.

Thanks a lot.

Next caller, please.

The next question comes from Cody Acree from Legg Mason.

Thanks.

Guys, just following up on that question I just want to be clear.

So you've got a spike in demand that draws down the inventories.

How are you sure that that inventory is not now sitting out in the channel and that that's going to cannibalize some of your fourth quarter demand?

Cody, all indication that we have is that, not only is our inventory down but we look at our major OEMs, indications are that they're inventories are in good shape based upon the orders they're putting on us, and in the distribution channels we're actually seeing that our sell-in and their sell-out both increased although our sell-in was a little bit less than their sell-outs so their inventories also decreased.

So the indicators we're seeing so far is at least at the semiconductor component level the inventories seem to be in pretty good shape throughout the channel.

Cody, in distribution our turns level are now a little over seven.

So we would actually characterize distribution inventories as low and believe if anything the distributors would prefer to add some inventory from where they currently are.

And then just a point there, Ron, on the mid-quarter update you specifically, or just maybe offhandedly mentioned that the OEMs you thought maybe were building a little bit of inventory, would you retract that statement now?

No, I think you would, we would expect that OEMs at this time of the year will seasonally build inventory in preparation for their holiday selling season.

I mean, that's a normal course, but I think what Kevin is characterizing is that we believe they're currently within normal ranges but, you know, if you look at where they are at the end of the third quarter versus where they were at second quarter, there's a natural seasonal inventory build that takes place at the OEM customers.

It will vary by customer but certainly those that, for example, handset manufacturers that would be selling into holiday-related markets would be building inventory at this point.

And then lastly, was there any changes in lead times during the quarter?

I would say lead times are generally stable in some of the commodity products like standard logic, they've moved out a little bit and are now in the 12 to 16-week range but that really is an exception.

If you look across most of the standard products and the custom products lead times have been stable over the course of the last quarter.

Thanks, guys.

Thank you, Cody.

Next caller, please.

The next question comes from Ambrish Srivastava from Harris Nesbitt.

Hi, guys.

Excuse me.

Question on inventory.

What is the expectation now for Q4, and within that what's the current supply demand or inventory demand cycle in the DLP?

And I have a follow-up, then, Ron.

The inventory planning at this stage is actually getting to the point where we've got just another couple of weeks worth of starts for deliveries in this quarter, and then after that the wafer starts will be starting to put inventory in place for first quarter.

As we see first quarter is typically seasonally down a bit from fourth quarter, we will position the inventory according to our expectation in the first quarter, so we'll be working to try to make sure we can fill some of the gaps during the balance of this quarter to meet fourth quarter demand but we'll also be here in another couple of weeks really adjusting our starts to make sure that we're positioning inventory for first quarter demand.

So Kevin, Q4 should be relatively flat then?

I'm not going to say an exact amount there other than to say that we hope to be back at a point by the time we get to the end of the quarter we can report to you this desired inventory level again and not being tight on inventory like we are now.

But again, it will reflect our first quarter outlook which we'll tell you more about in January.

How's that Ambrish?

It sounds good, Ron.

Did you have a follow-up?

Yes.

My follow-up was on the inventory which was on the DLP side.

How comfortable do you feel strong Q-over-Q growth but where are we in the inventory demand cycle?

Are you seeing any signs of any buildup or are you feeling comfortable with where the inventory is in the channel?

Ambrish, our belief is that our various customers are at desired levels again.

Now I'll have to say we don't have perfect visibility all through those channels, but in general we believe that they're back at desired levels, and again, when you look at sequential growth it's very strong sequential growth but that really represents the level of undershipment that was taking place in second quarter as opposed to an inventory build that would be taking place in third quarter.

So it's our belief they're in line with their targeted level.

That's fair.

Thanks a lot.

Thank you, Ambrish.

Next caller, please.

Thank you.

The next question comes from Glen Yeung from Citigroup Investment.

Thank you very much.

You know if I'm running my model accurately and you can all question that, am I modeling correctly that gross margins in the fourth quarter are expected to be up?

Actually, Glen, I think that because we'll have the seasonal down from our E&PS, the calculator business, is seasonally down in fourth quarter I think you're going to see those gross margins, if you're trying to do that model, would have to reflect the fact that E&PS is going to be down sequentially.

So you may be a little bit off on that.

Okay.

And then, you know, just going back to your comments, Kevin, about wafer starts, it sounds like what you're seeing is that as we move beyond the next couple of wakes and start to reflect the first quarter your wafer starts will likely start to slow a little bit.

If that's the case, where should we expect that slowing to be?

Would it be mostly at your foundry partners at this stage of the game?

Well, actually, Glen, it's going to be across the board but given the seasonality of, say, some of our wireless markets for example, that tends to, we see a down tick in first quarter which says that we wouldn't need to have as much inventory in place by the end of the fourth quarter to support expected seasonal declines there.

That tends to be in our [inaudible] and we source those both internally and externally so you can expect there to be some kind of adjustments to reflect that, but any other adjustments could also occur across the rest of our portfolio and products, too.

Thank you.

Thank you, Glen.

Next caller, please.

Thank you.

The next question comes from Adam Parker from Sanford Bernstein.

Hi.

Just one housekeeping thing and then one other question.

Kevin, what was the impact that stock option expensing had on your inventory during Q3?

With a 57 day kind of turn cycle it doesn't really go through inventory it makes it straight through the P&L.

Okay.

So it was virtually negligible.

That's correct.

In terms of the margins, I'm not sure I totally understood your answer to the previous question, or maybe you could just give me a little bit more color.

Because I would have thought that your revenue guidance here in semis would have offset this calculator revenue shortfall in terms of the margin perspective.

Are there any other kind of margin headwinds in Q4 versus Q3 in terms of royalties or mix issues or factory loadings or can you just give me a little more color on what would be the major margin factor sequentially?

Adam, if we take a look, we're looking at semis having a range in it that includes some growth, but as we mentioned, I believe we're a little over 50% gross margin, 50.9% gross margin if I recall for semis in third quarter and about 26.5 or 26 [fix on] on operating margin.

E&P operates at higher margins than that and so as they come down that weights it down a bit as semiconductor comes up.

So the total blended rate is not necessarily correct to assume the blended rate goes up in fourth quarter just because of the weight of E&P coming off of that.

All right.

The other question was just more long-term on this wireless theme.

I know, sorry to beat this down, but it seems like for your release here the expectations from the street next year were for about 12 to 13% revenue growth for TI.

I guess that might mean more like 15% or so for the semi portion of TI.

And so I'm just, maybe you guys can help me out with how you view the wireless sector relative to that 15% bogey next year in terms of units or pricing or you referenced this single chip solution and the extra content there.

I'm just trying to figure it out if you guys think wireless units will grow above that rate or wireless ASPs will rise next year year-over-year, or there's things that are not wireless that will grow above that 15% rate.

Adam, I don't know that I can be as precise as you'd probably prefer.

I'm sure you won't be.

I think if you look even at this year how many of the analysts and customers, everybody came into wireless expecting kind of single-digit growth, now the estimates are more in the 15 to 20% growth.

So frankly, us sitting here and even stating what our expectations are for 2006, the only thing we can guarantee is they're going to be wrong, we just don't know which direction.

So what we believe is that our position in 3G is strong, and we will maintain that strength in '06 in a market that's doubling.

That's going to do good things for TI's overall growth.

And then when you look at the blending of things like the low-end or low priced segment that we're describing that's just starting and, you know, hopefully you've consistently picked up from TI that we believe that emergence of that entire segment is a positive for us, and is one where we hold very strong position and, frankly, as we ramp up our single chip solution in 2006, we believe the relative position we hold in that segment versus the breadth of our competitors gets only more differentiated.

So all I can say is that we believe wireless is going to continue to be a positive growth driver for TI, you know, is it relatively more or relatively less than areas like high performance analog and DLP and the overall semiconductor group, I don't know.

I can say each of those business managers is trying to make sure they're each performing at the top, but we'll see who wins in the end.

Okay.

Just versus the last two quarters where you're, you know, that theme that your wireless revenue has actually grown less rapidly than the handset market, and if the expectations from the street are 15% semi growth, I'm just trying to figure out if you need a 950 million unit handset market next year or if it's going to be content increases or what the drivers are going to be but, I'll leave it to the rest of the guys.

Thanks.

I'll comment on that.

The point you made where in second quarter we grew less than industry units was because of the mix change toward the low priced segment.

And as we've talked about already, if we have a lower content in that low price segment and that represents faster than average growth, the blended ASPs will reflect that as well.

I would advise against getting confused between a blended ASP showing a slight decline and that having a negative impact on the Company's revenue or profitability.

Certainly we don't know, you know, as you're pointing out what kind of unit growth we need to support a certain revenue growth will depend upon the mix of 3G versus low price next year.

Thanks, guys.

Thank you, Adam.

Next caller, please.

Thank you.

The next question comes from Jim Covello from Goldman Sachs.

Good evening.

Thanks so much.

A couple of quick questions.

First, relative to the comment from Mike Masdea about sort of strong demand constraining you revenue growth, should I take that to mean that either your own factories are running full out or so your capacity constrained there or you have no incremental ability to source some capacity from your foundry customers or is it more complicated than that?

It's maybe not quite as complicated as that, Jim, actually.

If you go back and take a look we're obviously outsourcing on our advanced lithography and assume that our advance capacity continues to be very highly utilized.

Our analog capacity still has availability in it.

What it really comes down to is when we started the third quarter we anticipated a certain level revenue.

In fact, a certain range of revenue, and we did our factory starts based upon that expectation.

Given a typical manufacturing cycle of six to eight weeks, you can begin to see where if you under call or under expect what actually happens, and you haven't started enough wafers you're not going to have enough inventory by the time you get to the end of the period, and that's exactly what happened to us.

We wound up with semiconductor revenue actually coming in above, well above, the original guidance that we had given for the original range.

But didn't it come in within the range for the mid-quarter update?

Yes, but there wasn't enough time inside the quarter to be able to start the wafers soon enough to bring the inventories up.

Sure, But wouldn't that give you time to start the wafers for next quarter for next [inaudible] because I thought the comment was relative to next quarter's revenue growth.

It was, but our anticipation coming into third quarter was that we would end the quarter with slightly increased inventories to support what we expected in fourth quarter.

As it is, we're ending the quarter with about $44 million less in inventories to support that next quarter.

Sure, no, I can appreciate that and I hate to belabor the point, but then couldn't you have just increased the starts over the last few weeks since the mid-quarter update when you knew that you were going to have higher revenues and lower inventories such that you could meet higher demand next quarter?

Which is done, it takes six to eight weeks on average for your manufacturing cycle time to go through your wafer fabs.

In the fourth quarter your demand tends to be front end loaded versus back end loaded so those wafers may or may not arrive in a timely enough fashion to hit that demand.

Okay.

Follow-up question then and that will be it for me is, how do you think about, forget the seasonality, how do you think about cyclically the incremental leverage in the model from here?

And thanks very much.

Well, we still have open capacity particularly on the analog side, so we will still have, as we see that capacity get, orders to start against it, we'll see some fairly high fall-throughs on that.

In addition to that, our capital expenditure has run below our depreciation for, I think, four years running now, expect it to again this year, and consequentially depreciation has come down each year and that gives us some leverage on a period over period basis so we would expect depreciation to decline again in 2006.

So to the extent that we've got loads in the factories and we've got declining depreciation, that should give us some nice year-over-year fall-through.

And Jim, I would just also point out that if you look at, and I'm not going to try to forecast what may happen in the fourth quarter or beyond, but if you look at our incremental gross margins in third quarter compared to second quarter they accelerated.

So we're not to the point, at least we weren't in third quarter, where we were starting to see a deceleration in those incremental gross margins, in fact, they were still accelerating.

Next caller, please.

Thank you.

The next question comes from John Barton from Wachovia Securities.

Thank you very much.

You've made comments that DLP grew 41% sequentially even year-over-year you talk about obviously, you know, we're coming off an undershipment period.

Via information coming from your customers is there any way to normalize that number out and get a feel for what you think DLP growth will be year-over-year if you could ex-out those inventory builds and [purchase]?

Boy, John, I don't know how to do it because we know the comparisons we're against in 2004 include inventory to build, which we then spent the first half of this year working off, so certainly when you look at the third quarter number of this year where we think customers are at desired levels versus third quarter number last year where we knew in hindsight we know they were building inventory, says we're already to a point where probably called end demand for DLP is growing year-over-year, but how much of last year's shipment and revenue went into excess inventory versus how much of this year's was inventory depletion, that gets more complex than what we've done at this point.

Okay.

Can you talk about acceptance, design wins, ramps, market share, whatever you want to call it for the new 1080 chip or how foresee that through this selling season and [inaudible]?

I don't know that I have sales results yet to be able to talk about, but certainly 1080p is something that we have pretty high expectations for.

In fact, if you look at the customers that have introduced product to date, or actually have them out in the retail channels, that includes Samsung, HP, Mitsubishi and Toshiba as well.

And if fact, we believe this year we're probably the only, DLP will be the only, what I will call readily available 1080p product that will be available at what I'll call reasonable price points.

That's not to say there aren't some competitors that have what I would call more demonstration-type product that's usually not at a price point that most consumers are willing to step up for.

And that's in the standard projection television market.

In the front projector side we have 1080p versions of both single chip front projectors as well as [three] chip projectors.

So that 1080p face we think is going to be well differentiated TI and DLP and we'll have to wait a few months probably before we know exactly what the financial contribution was this year.

Last question, if I could.

Tax rate changed a little this quarter for the year et cetera.

What are your thoughts now as you look out to '06 from a tax rate perspective please?

John, we haven't start forecasting '06 yet.

We'll give you guidance on that when we come out with our January results.

Okay, John, thank you.

Operator, let's move to the next caller, please.

Thank you.

The next question comes from Nimal Vallipuram from the Benchmark Company.

I have a couple of questions here.

Going back to that inventory issue on the third, basically saying, you know, a lack of inventory.

Is it possible to say that when you go back to 2000 and 2002 that you changed your business model essentially offering part of your advanced lithography products to outsourcing foundries, what happens here?

Is this downside of outsourcing your advanced product lithography, and if that is so as a result would you be rethinking your manufacturing strategy?

No, Nimal, it really doesn't have anything to do with available capacity.

It has to do with, did we plan to start the right number of wafers, [inaudible] irrespective of the source.

The source is not a problem at all.

So, in other words, if you had started in time or if you had the information to start the incremental capacity in time you have enough capacity available to you?

That's correct.

Okay.

My second question is, on your, just on your catalog products, DSP and analog, if you look at the end markets, though their markets tend to be somewhat sensitive to economic activity compared to the other end markets, when you look out in the fourth quarter, does your semiconductor guidance include any sort of, lack of better words, I mean weakening of demand in those end markets?

Nimal, the way that we've got the range for the third quarter actually reflects the fact that we have relatively low inventories in those areas.

Again, those catalog products, for the most part, sell through our distribution channel.

And our distribution inventory is down a bit again fourth quarter in a row now, and as Ron mentioned with turns a little over seven, that would suggest that the inventories are pretty lean through that channel.

From the standpoint of looking at the sell-out activity we did see again that [inaudible] sell-out was up over prior quarters.

That would indicate to us demand is pretty good so I don't think we're seeing signs that suggest the question you're asking about.

We're certainly paying attention for them but we've yet to see any signs that suggest that that's at an area any weight on overall demand for our semiconductor [inaudible].

Just finally, just on the product side, you had introduced a new video processor called Da Vinci-based platform.

And it looks like in the latest video product-based market, the iPod video product, it looks like Broadcom has got the design win.

When you look out in 2006 with your UMTS chip set for the 3G market and your single chip for the low-end of the handset market, would the Da Vinci chip set be in incremental sales into, potentially some sort of a video application [inaudible] handset market or is it hard to call?

Nimal, Da Vinci really isn't directly targeting the handset market.

The handset product that we have for multi-media based handsets is our OMAP offering.

Da Vinci is, I'd say, architecturally similar to what we're doing in handsets but is really targeting a different base of customers and products and applications than what we're addressing with OMAP for handset.

Thank you, Nimal.

We'll move to the next caller please, Operator.

Thank you.

The next question comes from Chris Danely from JP Morgan.

Thank a lot, guys.

By the way, congratulations on hitting the targets.

Would you guys care to throw out any new targets in terms of gross margin and operating margin?

Kevin?

Thanks, Ron.

Chris, just to remind most of the listeners who may not be aware or not remember, the targets that we put out there probably a year and a half or more ago for 50% in gross and 25% operating margins were based upon the belief, I think it's proven out this quarter that we are, we have put together a portfolio of products that are servicing growth markets that should allow to us deliver 50 and 25 type of results in good semiconductor markets.

It's neither a floor nor a ceiling, but in good markets.

If we try to take a look in front of us and see what can that mean for us in the future, there's a few things that we've talked about for a while.

One, high performance analog as an example continues to be a growing portion of our total revenue as it continues to win market share and that comes through at very attractive margins, so that's available to help average up our overall performance.

We continue to have open capacity especially on the analog side of our manufacturing factories, so that gives us more room there from a margin standpoint, plus, with Cap Ex for some four years in a row now being below depreciation, we can expect that depreciation will decline again next year, so that gives us a little bit more room once again.

So I think when you put those together providing that the market gives us the revenue opportunity that we need to continue to ship product, we're not indicating there's any new ceiling or anything on our margins right now.

It's really a question of making sure that the market remains healthy as we begin to ship product.

Can you identify which would be the biggest driver out of those three or four?

Boy, Chris, that's a really tough one there.

If the high performance analog guys keep doing as well as we want them to do, I'd like the say that that would be it.

But by the same token depreciation is not to be overlooked as being a fairly sizable year-over-year potential change for us given our cap ex continues to run below depreciation.

So it's probably somewhere between those two and to a lesser extent just open capacity overall.

Great.

And then last question.

I guess I'm a little confused.

So you guys said that your capacity constrained and obviously your inventory is low, and inventory in the end markets are low, so I guess I'm just trying to understand why wouldn't lead times be going up?

Again, Chris, it's not capacity constrained.

We've got the capacity.

We just, if we had to go back three months we probably would start up more wafers than we started so we're inventory constrained.

We have already extended lead times a bit in the commodity logic area that Ron was talking about.

We have little areas here and there elsewhere in the portfolio where we're seeing some adjustment in lead time but nothing on a broad scale like what we saw in the commodity logic areas.

But that's not to say that we have to work hard in order to meet those kinds of lead time requirements.

If we get a surge in demand in some of those other areas that's inconsistent with our present finished goods position, it may be difficult for to us continue to hold those lead times.

Got it.

Okay.

Thanks.

Thank you, Chris.

Next caller, please.

Thank you.

The next question comes from John Lau from Jeffries & Company.

Great.

Thanks.

A lot of questions answered.

On housekeeping focusing on the stock option expenses can we assume around an $82 million per quarter steady run rate?

And I have a follow-up on the DLP market, Ron.

John, on the stock option expensing we will advise you as we go through each quarter.

It won't be exactly flat each quarter.

We don't believe it will adjust a little bit.

For example, it turned out to be $82 million in the third quarter.

We think it will be somewhere around 75 or so in the fourth quarter, but without any more information than that I would counsel you that it's going to be at least around that range for awhile, and we'll give you more guidance as we get more insight into it.

It's really a function of how we grant stock options and so on during the year.

Hey, John, one thing that might be useful for you is on our Web site we have, I forget how far it goes back, but some history on our stock-based compensation expenses, if we would have had stock option expensing in earlier periods, at least you'll get a feel for what that run rate has looked like.

And you add DLP question?

Yes.

On specifically going back to the DLP market I was wondering if you can comment how fast is that migration to the 1080p and what is that percentage of the total DLP today?

The reason why is I want to know how much also what kind of a price delta are you getting as you move from 480 to the 1080p?

Okay.

It will be a premium product but what I will say is a reasonably priced premium product.

So our customers are offering 1080p as premium option at multiple screen sizes.

So again, it's not at just the very, very high-end of the segment.

It will be offered across screen sizes at a premium price relative to 720p but we think a lot of consumers will elect to step up just given, call it the future proofing that that technology brings.

I don't know that I have a mix for you at this point.

We'll probably have more starting with our January call but at this point it's still premature to make any call on consumer demand for the 1080p versus 720p.

Thank you, Ron.

Thank you, John.

Next caller, please.

Thank you.

The next caller is Chris Caso from Friedman Billings.

Hi, Chris.

Thank you.

Just a big picture question, I guess.

In your opening comments you referred to some of the macro uncertainty that's out there and of course we're reading it in all the papers.

You guys touch a lot of different end markets.

If you could give us a sense of kind of what your customers are telling you at this point and if you've seen, you know, any change in any of the end markets in terms of, you know, how much inventory your customers wanted to have or how they're reacting [inaudible] orders.

It sounds like it wasn't a big impact from what I heard so far.

Chris, I think you summarized it well.

It hasn't been a big impact yet.

Of course, we're paying attention to it and it's sort of natural to assume that it's weighing on people's minds.

I mean, clearly, that's something we pay attention to internally for no other reason because like everybody else we're not immune to such things as rising energy costs.

So we're paying attention to that, also.

But from a demand standpoint the only sort of feedback I can even think of that we've gotten anywhere has been a shift on some of the larger platform automobiles possibly moving to some of the more efficient cars.

That hasn't really had a material impact on what we see in demand for product [inaudible].

Do you have a follow-up, Chris?

Yeah, sure.

I guess with regard to the 3G market you guys are in a joint project with DoKoMo [over] some additional content next year.

If you could just give us a bit of an update on that and I'm not sure if you've provided any date so far on that, but when that might start being material to you.

Okay.

Chris, that is, the part you're referring to is a integrated part that will include our, what I'll call next generation application process, our product called OMAP 2, and the UMTS digital base stand function.

And that part has not been announced but we expect that it will be sampling before the end of this year and then will ramp into production in 2006.

So everything is still go and that product remains on schedule.

And that part will be the part that we have rights to sell to other handset vendors and including outside of the DoKoMo as a service provider.

So we have rights to sell that part on a worldwide basis as a standard or merchant solution from TI.

So again, everything's on schedule and you should hear about us sampling that product by the end of the year.

That's great.

Thank you.

Thank you, Chris.

Next caller, please.

Thank you.

The next question comes from Tim Luke from Lehman Brothers.

Thanks.

Just to clarify, Kevin, did you say that all of, if I got that right you said all of the revenue growth came from, on a year-over-year basis from 3G?

I'd imagine not but I wasn't sure if I got that right.

No, I think you misunderstood.

Certainly 3G was the primary driver of our wireless growth on a year-on-year basis but as we also spent time talking about the low priced segment was the driver of year-on-year revenue growth for wireless as well.

And did, you said, Ron, that there was a fairly even balance in your billion dollars of revenue from 3G between the modems and the applications processors.

Is that something that you would expect to continue next year, that it would be fairly similar and how should we think about the time line for your own merchant solution in 3G developing and beginning to contribute to revenue fall-off?

As I said to the prior caller, that merchant solution will ramp in 2006.

So it will become a contributor to revenue, we would expect, in 2006.

On, I'm sorry, could you repeat quickly your --

Just the balance between applications and modems.

Right, the mix.

Okay.

That mix again is well balanced.

If you look at comparison '05 to '04, more of our '04 revenue is more of a 60/40 mix, more of the revenue coming from OMAP than the base band.

This year it's closer to 50/50 so the base band revenue has been faster growing.

I don't want to try to forecast what the mix will be in '06.

And in fact, it's going to become more difficult to categorize as we ramp up this new merchant solution which is OMAP and the base band on the same chip.

But suffice to say both are contributing to our revenue growth in 3G.

Just one follow-up, Ron, on the analog side.

You are significantly outpacing the overall market in terms of HPA.

I was wondering if you could talk about the elements that are contributing to that?

You have a wireless analog business, which I imagine must be pretty strong, and then you have the HPA arena.

Can you give us some color on the dynamics there?

And you're right that when we talk about our wireless revenue we do not include high performance analog.

Most of the high performance analog revenue would be standard products going into a broad range of customers, it's not including what we're shipping into, you know, our volume handset customers really.

The only characterization I would give a couple of things.

One, I think our product portfolio has improved markedly over the last two years and the revenue growth you're seeing from TI really reflects customer enthusiasm for the products that we're putting into the market.

And then secondly, as we've talked before, I think the fact that TI has the size of sales force and the sales force increasing comfort and skill set at selling high performance analog is making a big difference.

If you compare TI sales force to that of our typical high performance analog competitor, in any one market, we probably have five to six times the number of sales people as those competitors do which means we can cover a broader range of customers and we can cover the big customers a lot deeper.

And I think our results are reflecting that.

If you look at distribution, what I can say is if you look, for example, if you look at our year-on-year growth in high performance analog as being up 16%, that actually includes inventory reduction taking place in distribution.

Resale growth for high performance analog was up 19% versus year-ago period.

So this is real in demand, real customer enthusiasm driving the success that we're having in high performance analog, and frankly, we love it, it's great for bottom line profitability.

Thank you, Tim.

Next caller, please.

Thank you.

The next question comes from Ben Lynch from Deutsche Bank.

Yes, hi, guys.

I should probably just dial into these calls towards the end.

That's usually when I get my question.

I'm going to predict again Joe Osha's after me.

So I want to come back, Ron, to this barbell pattern that you talk about in the wireless market.

So there are obviously competing forces, low-end certainly at the moment maybe having some downward pressure on ASP and 3G positive, what would you say your blended ASP for wireless will end up having been in 2005?

And when you look into 2006, you said the emerging markets trend is really only starting, so from that perspective it would be more powerful next year, 3G will continue to grow in '06 and in both segments you sort of single chip initiatives.

So do you think the, for year-on-year blended ASP effect will be more or less strong in 2006?

And then I have a follow-up, please.

Okay.

On your first comment about where you land in the queue, I think you're making comments about the lateness of your call, Ben.

I'm not sure if that's specific to our conference call or if that's a general statement.

But, anyway, just kidding.

On blended ASP, I don't have that data.

I don't, and frankly, if you look across our wireless product it is so complex across OMAP and different digital-based bands and analog product it would be difficult to say, but I think just looking at the top line revenue growth versus industry units, we know the low-end, or low priced is reflected in that.

And I don't know how to forecast do we expect or what will actually happen in '06 in terms of relative growth and importance between things like 3G, where we've stated we expect, and analysts I think in general expect that market to double again next year, and we will be the primary beneficiary of that.

And then secondly, you know, low price will be attractive again next year in terms of its growth rate.

How those balance out, we'll tell you in January '07.

How's that?

Okay.

I guess your wireless, or I don't know what's implicit in your Q4 guidance, but let's say it looks like it's sort of going to be around 15% or so you refer to the market, the projections out there are 15, 20%.

I think you'd also say in that in 3G your share has grown year-on-year where it's clearly the share of your key OEM customers up as well.

So your addressed units will be up more than the 15 to 20% and your revs may be up as much as the low-end of that so that would sort of, and that feels to me like your blended ASPs are going to be down a bit year-on-year.

Okay.

You're the analyst.

All right, Ben, thank you.

Let's move to the next caller, please.

Thank you.

The next question comes from Tom Thornhill from UBS.

Kevin, am I correct in that your book-to-bill is bookings that go beyond 13 weeks?

Tom, it's a bit of a mix but some do go beyond 13 weeks but not really that much.

Most of it's inside the, most of it's in the quarter.

Most of it's in the quarter?

Yes, and some of it's in the quarter itself, okay, so a lot of our quarters that we get, for example, if you get end of the quarter with half your quarter's outlook on backlog then clearly half of your orders you get are going to be for that quarter's deliveries.

Tom, let me be very clear.

The increase we're seeing in backlog is not, you call it greater than 90 day backlog increase.

Most of the increase really is if you compare where we left third quarter versus say where we left second quarter, most of that increase is shippable within next 90 days or Q4 is what the demand is for.

Given that we're running the food chain fairly tight as you talked about, given your inventory, customer inventory, does, what does this suggest for the transition into Q1 barring some significant macro impact into the growth rates in Q1?

Tom, it's not real clear to me when you're asking for whose perspective on the growth?

Yours.

Given that bookings have been pretty good, you're running fairly tight relative to inventory, and the manufacturing cycle time to be able to deliver during this quarter, and your comments that the customers' inventories seem to be running fairly lean as well, shouldn't that allow us to transition through Q4 to Q1 with perhaps a little better than seasonal pattern, and I'm saying barring some macro impact, negative macro impact.

You're thinking from our start plan.

Yeah, from your start plan through your inventory, through your customer inventory.

Clearly all things being equal that you are correct, we would have to probably have starts a little higher than we would typically have had we entered the quarter with as much inventory as we wanted to have for this quarter.

And then we'd have our normal first quarter seasonal adjustments going on.

So you're correct in your conclusions there, Tom.

All right.

Ron, looking at your barbell scenario for the wireless business, will the DRP product be additive or dilutive to wireless gross margins?

I don't think it makes a difference to wireless gross margins.

I think it is additive to wireless revenue and to wireless profit dollars because we're talking about functionality that we currently are not capturing but from a, and, so therefore, it contributes to operating margin expansion but from a gross margin standpoint, I don't think DRP makes much difference one way or the other.

Okay.

One final on gross margins.

Kevin, you've talked about the components, HPA capacity, Cap Ex and depreciation.

How much of this do you really think is sustainable structurally in terms of the change in the product portfolio that would allow the Company to really having reached this plateau, sustain this plateau as long as we've got some reasonable revenue run rates?

Well, with that final presumption that you put in there with reasonable revenue run rates, if you take a look at how we've been spending our capital over the last few years, a larger portion of that capital has moved into the assembly test operations and away from the wafer fab side of the house as our volumes have increased and as analog and high performance analog in particular, becomes a bigger component of our overall revenue, because the actual die size is smaller, as you get a lot more die per wafer than you do on digital.

From a sustainability standpoint this is why we have broken ground on the Richardson fab and have put that in place to make sure that we've got our next big shell ready for equipment move-in to make sure that we can continue to migrate the older digital fabs to support the mixed signal and later the analog.

You may recall that technology road map we have for migration on the fabs.

So the fact that we've broken ground, the shell's going to be ready for equipment move-in sometime in second quarter next year, we still have clean room space open in [DMOS] 6 until we get there, I think that we've got in place a capital plan that's structurally consistent with the kind of results you've been seeing.

Okay.

Thank you.

Tom, let's move to the next caller, please.

Thank you.

The next question comes from Mark Edelstone from Morgan Stanley.

Good afternoon, guys.

First question is related to the areas where you might be constrained here in the fourth quarter, so a lot of discussion obviously on the inventory levels and capacity constraints.

Kevin, I guess if you looked at the business overall I know it's going to be mix related but where would you think the biggest constraints would be for you either on a product or an end market perspective?

I think if we just take a look at where we saw sizable sales growth, as Ron indicated we saw significant resale growth inside the distribution channel, which, and also strong growth just inside TI from our analog side of the house, it's that scenario there where there's some pretty good growth going on, and, therefore, it's getting harder to meet short lead times from customers.

Not impossible yet but harder.

The large platforms, or the big custom verticals is not as much of an issue.

It's more on the catalog side of the house.

Do you have a follow-on, Mark?

Yes, I do.

I guess given that point, it would seem like your visibility here for Q4 in what normally would be a front end loaded quarter anyways, you know, reigned in by some of these constraints would be very high, and yet you guidance for both total revs and for semi revs have your typical wide range associated with it.

Can you comment on why you wouldn't have more visibility on where you would be within that range at this point?

Well, we talk about the fourth quarter is usually more front end loaded than the other quarters.

That's a relative comment.

It's not a huge absolute difference when you look at it, unlike some other quarters where you might see 38, 39, 40% of your revenue in the third month of the quarter, you might see a point or two less on that in the fourth quarter with that delta being distributed into the first and second month of the quarter.

So that's what we talk about on our front end loaded side of things.

So our visibility, while a little bit better to your point, Mark, it's not crystal clear because there is still a full 31 days in December for to us deal with.

Mark, I would just say don't try to read too much in terms of level of visibility or certainty or uncertainty based upon the width of our range.

We maintain a pretty consistent range in the guidance quarter-to-quarter so that just typically doesn't change.

Could I just ask one other quick one, Ron?

Yes.

The calculator business was clearly weak here below normal expectations.

That's your one market where you get a true read on end demand.

Can you just talk about that and what the implications might be like there for the broader economy if there is any?

Mark, one of the ways that we've learned to look at that market over the last few years is you've really got to add together second quarter and third quarter.

And the reason is, a lot of the selling activity for that particular product line happens in very late June, early July.

So just a one or two-day slip can make your quarters look odd so you've got to kind of add them together.

When you do that, there's really not a tremendous amount of change on a year-over-year basis.

It's more a little bit of second quarter, third quarter timing going n there.

That being said, these are fairly expensive pieces of school equipment, and from that standpoint we do pay attention there to see what the resale take away is, and we think that maybe the resale take away is a little bit more moderated, hence you can see our range that we gave for the calculator piece for fourth quarter being in the 60 to $80 million range, perhaps a little bit to the left of what we might like to see on a normal fourth quarter.

So overall, I think that there might be some small signs for us to be paying attention to there.

And this is to the point we've talked about earlier on what's going on in the economy as a whole, but nothing of a real loud message to us that we can read back into the rest of the business.

Thank you, Mark.

Let's move to the next caller, please.

Thank you.

The next question comes from Hans Mosesmann from Moors & Cabot.

Just a quick one here to end it, or close to end it.

Can comment on your foundry relationships, how things are looking for Q1in terms of availability of wafer starts and such?

Thanks.

I think in general even as Kevin would say, if you look at third quarter when demand was, call it very strong, we did not have an issue in terms of availability of wafer starts that were available to us at foundry.

We simply didn't start what we could have.

So we're looking forward into first quarter we do not anticipate any issue in terms of availability of supply from our foundries.

Do you have a follow-up, Ron?

No, that's it.

Thanks.

Okay.

Thank you.

Next caller, please.

Thank you.

Our next question comes from Joseph Osha from Merrill Lynch.

Hi, guys.

Just back to the financial model for a second as we look at that 25% that you've talked about.

It seems to me like you're already pretty close to where you've talked about getting it, the gross margin level.

You made some comments about HPA which obviously is helpful there.

But would I be fair in saying that getting to 25% at this point is largely going to be about growing into your operating cost structure or is there something else going on there?

Joe, we would characterize that we're already there at the 25%, because recall when we set that goal, the 50 and 25, and that was about a year and a half two years ago, before the mechanics of stock option expenses were known, so had about 22.7% of operating profit in the quarter we just closed and about 2.3 points of costs associated with the stock option expensing, so you add that back in and you can compute that it looks like with that 25 that we were talking about on a pre-expensing level.

Beyond that, just enriching the mix going forward as we continue to see the acceleration of some of these more attractive products would be the sort of thing that we'll see sustaining those kind of margins for us into the future, especially as you mentioned on the HPA.

Can I get you then perhaps to articulate what a new including FAS 123 target model might be there?

No.

I'm not trying to hold you off but really if you just characterize it like it is today, the numbers today are similar to what a FAS 123 50/25 model--

No, I understand that but you're saying on one hand you think you can continue to improve the margin structure and I'm asking you, okay, you know, where do you think it can go?

Or are you telling me that it can't improve anymore?

No, Joe, it can improve.

The reason I really don't want to characterize where it can go is, it is revenue dependent.

Providing that revenue continues on a fairly consistent basis we've got, as I mentioned before, a few things in our favor, HPA mix becomes a richer portion of our revenue.

We've got the open capacity on analog [inaudible].

Fine.

So that circles back then to my initial question.

I wasn't trying to zing you.

It sounds to me then like you're saying you think there is some additional gross margin leverage as well as the ability to absorb operating costs.

As long as the revenue continues to support that, yes, I do.

Okay.

Perfect.

Thanks.

Thank you, Joe.

Next, we're going to have, Operator, time for one final caller here.

Thank you.

Our final question comes from Jack Romaine from SG Cowen.

Hi, guys.

Anything we need to be thinking about in terms of the profit sharing program looking forward now that you've hit these profitability targets?

Jack, that's no problem with those.

Remember that we changed our formula effective with the beginning of this year so that it derives solely off of operating margin.

And incidentally, that includes the effective stock option expensing so we don't exclude that for purposes of the profit sharing calculation.

Based upon what we saw last year, was similar profitability levels lasts year, you could have expected that we'd have about $100 million in total profit sharing this year versus about 254, I think it was, last year if I recall.

So it will continue to be a lighter level than we've seen in the past and won't move around quite as much as we've seen in the past.

Jack, if you're really asking is profit sharing going to go away because we hit the goal, profit sharing doesn't max out until we hit 35% operating margin.

So we still have a long way to go before we get to claim that that's maxed out.

Do you have a follow-up quickly, Jack?

Well I guess, what I was just trying to get at is, is this a tiered structure or is it a linear structure?

Are we going to hit a break point where a large level profit sharing expense kicks in?

Jack, it's relatively linear between 10% operating margin and 35% operating margin.

So it kicks in at 10, it stops kicking in at 35.

Okay.

And then a quick clarification.

You've been talking about R&D guidance for the year of 2.1 billion.

Does that include two quarters of option expensing?

Yes, does it.

Okay.

Thank you.

Okay.

Great.

Thank you, Jack, and at this point we'll wrap up.

Before we end the call, let me remind you that the replay is available on our Web site.

Thank you and good evening.

Thank you, everyone.

This does conclude today's teleconference.

You may disconnect your lines at this time and have a wonderful day.