德州儀器 (TXN) 2008 Q3 法說會逐字稿

Good afternoon.

I'll be your conference operator today.

At this time, I would like to welcome everyone to the third quarter '08 earnings conference call.

All lines have been placed on mute to prevent any background noise.

After the speakers remarks, there will be a question and answer session.

(OPERATOR INSTRUCTIONS) Mr.

Slaymaker, you may begin your conference.

Good afternoon, and thank you for joining our third quarter 2008 earnings conference call.

As usual, Kevin March, TI's CFO is with me and we also have a special guest, TI's CEO, Rich Templeton to share his perspective given the economic environment.

For any of you who missed the release you can find it on our website at ti.Com/ir.

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

A replay will be available through the web.

This call will include forward-looking statements that involve risk factors that could cause TI's results to differ materially from managements 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 8.

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

In this call, all of our financial results will be described for continuing operations, including historical comparisons unless otherwise indicated.

In today's call we'll address key questions such as what are the factors behind the drop in TI's profit margins, specifically what impact has our inventory reductions had on profitability, and what actions can TI take to reduce operating expenses further if we enter a period of prolonged weakness.

We'll also discuss details of the actions we announced today regarding our wireless business.

In July, we described that we had a cautious perspective of the overall economic environment and therefore, we were also being cautious with our own forecast and operating plans.

That approach served us well as our markets and our revenue for the quarter were in fact weak and revenue came in at the middle of our range of expectations.

Yet even so, we were able to get ahead of the curve with operating expense reductions as well as to achieve a significant reduction in inventory.

Considering today's increased economic uncertainty and our weakening order trends in the third quarter, we expect revenue to decline in the fourth quarter and have taken additional actions to reduce our expenses.

Also, we will pull back further on capital expenditures as additional capacity is not required in this period of softer demand.

Finally, we will accelerate our inventory reduction in the fourth quarter.

Let me start by describing the actions that we are taking to reduce expenses in our wireless business.

The total savings will be about one-third of our current wireless investment or about $200 million on an annualized basis once the actions are complete.

We will stop investing in merchant cellular based band chipsets and are actively pursuing the sale of our merchant chipset product line.

Even so, we will continue to support select custom base band programs.

We will focus our wireless investments on our OMAP applications processors.

You have heard us talk for some time about the good opportunity that we believe is ahead of us in smart phones with our OMAP applications processors.

The smart phone market is fast growing and TI is well positioned.

Handset makers are focusing their own R&D activities on user interfaces and applications in order to maximize the product differentiation.

From a semiconductor perspective this points to the applications processor as the best opportunity in the handset.

Looking ahead we will concentrate our wireless resources on OMAP and our intent on extending our lead in this market.

Let me now walk through the impact on our financials.

The sale of our merchant base band operations including the LoCosto and eCosto product lines would have the biggest near term impact.

This business is expected to produce revenue in the range of 350 million to $400 million in 2008.

The specific timing of the potential sale is undetermined although we should know this outcome within the next few months.

If a sale does not occur, we will continue to support existing customer engagements and will take additional action to remove almost all of the operating expense associated with this revenue.

In this scenario, we would expect this revenue to decline over several years.

Either approach should provide us a reasonable return on the business.

For the remaining base band revenue which is about $2.3 billion this year from sales of custom products, we will continue to support our largest customers.

We expect this revenue to decline in the years ahead as the previously discussed program with Ericsson Mobile platforms continue to wind down through the end of this year and as our largest customer implements its multi-supplier strategy.

As a result, we are adjusting our operating expenses to align with this reduced expectation.

In total the reductions we are implementing over the next three quarters will result in annualized savings of more than $200 million with about 85% of that in R&D, 10% in cost of revenue, and 5% in SG&A.

We expect to take restructuring charges of about $110 million as the actions are implemented.

Let's now shift to our quarterly results.

Revenue was $3.39 billion, a decline of 8% from a year ago and an increase of 1% from the second quarter.

There was some impact to revenue from actions we took with our distributors late in the quarter to reduce inventory in the channel in consideration of the weakening environment.

As a result, distributor inventory was reduced by about $35 million or about 5% and is now below eight weeks.

While this negatively impacted our quarter, it was the right decision and we will benefit by keeping inventory in our channel lean in this environment.

Our revenue results by product category are described in our release and I won't repeat them here.

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

Thanks, Ron, and good afternoon, everyone.

Gross profit was $1.64 billion in the quarter or 48.5% of revenue.

Gross profit was down $341 million from a year ago with most of this due to lower revenue, although our inventory reduction also impacted factory utilization resulting in unutilized manufacturing costs, impacting the current quarters cost of revenue.

As a reminder, the year ago quarter also included a $39 million gain from the sale of the DSL product line all of which was included in gross profit.

Gross profit declined $106 million from the second quarter.

Most of this decrease was attributable to the lower factory utilization due to our stepped up efforts to reduce inventory in the third quarter.

The cost of this underutilized capacity was expensed in the third quarter in turn increasing cost of revenue versus the second quarter.

In total, utilization dropped by about 10 percentage points in the quarter from the mid 70's to the mid 60s.

It's helpful to put this into historical perspective.

If we look back to the fourth quarter of 2002 when we were at similar utilization levels our gross margin was about 13 points lower in that quarter.

The progress that we've made in improving our portfolio and our manufacturing operations is quite evident.

Operating expenses in the quarter were down $74 million or 8% from a year ago with reductions in both SG&A and R&D expenses.

Sequentially, expenses were down $19 million or 2% due to lower SG&A expense.

As a result, operating profit for the quarter was $746 million or 22% of revenue.

Other income and expense declined to $10 million mostly due to lower interest income.

Income from continuing operations was $563 million or $0.43 per share.

Income includes a $34 million discrete tax benefit that was primarily due to adjustments that we identified as we completed from prior years tax returns.

This tax benefit was largely offset by $44 million of charges that were incurred in the quarter and were associated with impairments of long lived assets and site consolidations.

For example, we did some site consolidation in Japan and also had some asset impairments associated with converting our former Kilby wafer fab into the recently announced Kilby Labs.

The break up of these charges is as follows.

$17 million in cost of revenue, $23 million in R&D, and $4 million in SG&A.

I'll leave most of the cash flow and balance sheet items for you to review in the release; however let me make just a few comments.

Cash flow from operations was $1.05 billion in the quarter and we ended the quarter with $1.99 billion in total cash.

We used $429 million to repurchase 17.1 million shares of TI common stock and paid dividends of $131 million in the quarter.

As a reminder, in September we announced an increase in our dividend by 10% which will be effective with the next dividend payment in November.

This was the fifth consecutive year for TI to raise our dividend.

At recent stock prices our dividend yield is now about 2.5%.

Inventory of $1.58 billion at the end of the quarter was reduced to $76 million from the end of the prior quarter.

We have sharply reduced wafer starts in the quarter and as a result expect inventory to decline even faster in the fourth quarter or by more than $150 million.

Inventory days declined to 81 from 93 last quarter.

TI orders in the quarter were $3.23 billion, down 9% from the year ago quarter and down 7% from the prior quarter.

Product orders trended sequentially lower each month in the quarter.

As a result of these order trends and the increased uncertainty in the economic environment we expect revenue to continue to decline in the fourth quarter.

We expect total TI revenue in the range of 2.83 billion to $3.07 billion.

Our assumption is that semiconductor revenue will decline in a range of about 10% sequentially and that our calculator revenue will have its normal seasonal decline in the quarter.

We expect earnings per share to be in the range of $0.30 to $0.36.

The EPS estimate includes a $0.05 benefit from the reinstatement of a federal research tax credit which was signed into law in October and was retroactive to the beginning of the year.

This reinstatement along with the lower profit estimate for the year should result in an annual effective tax rate of about 28% for the year.

Included in the cumulative adjustment for the first three quarters we expect the tax rate in the fourth quarter will be about 18%.

The quarter will also include about $0.01 of charges associated with our wireless actions.

With that, let me turn it over to Rich for his perspective.

Kevin, thanks.

Many of you have heard the term, it's an uncertain economy, but the fact is we're pretty certain that it's serious.

Customers and I've spent quite a bit of time in the last month, a couple weeks ago in Europe, particularly in Germany, a couple weeks before that in Taiwan, we see customers that are observing slowing demand from their marketplaces and I think we have a number of customers that fear more reductions as they look at the overall economic environment and I believe we have a number of people starting to guard against getting caught with inventory so I think we see people reacting and starting to react pretty quickly.

We see general across all regions, across all end markets even though certainly the logical end markets have been more impacted.

Automotive for example, more impacted and at the other end of the spectrum things like the base station infrastructure marketplace doing better.

We've seen that through the balance of the last three weeks of September where ordinarily, you'd be seeing a building demand for the holiday season.

We in fact had a slowing demand and that has been held through the first 20 days of October accordingly.

As Ron and Kevin both commented we entered the third quarter cautious.

We continued to take actions as we saw things being softened and as a result, we very simply believe it's not a time to be waiting for perfect data.

It's a time to be acting and continuing to be diligent on this.

Second point to make is that actions are under way.

They will continue and the fact is we believe we will also have to adjust these actions as we learn more about where the economy really wants to go.

Kevin and Ron both described well that we have an operating plan that is assuming that fourth quarter will be down about 10% from a revenue perspective in semiconductor and we are assuming a further drop in the first quarter.

I will emphasize even though it will probably be not heard very well, these are assumptions that we've made, not a forecast.

Assumptions allow us to drive operating plan changes and take action to get a different result in the future.

The wafer fabs are now operating at a level that are consistent with these assumptions that if the rate will hold we'll be able to run utilization pretty steady through the fourth quarter and into the first quarter.

Kevin pointed out that these actions have had a major impact to margins in the third quarter but having been in the business a long time, history shows that taking these actions earlier are always merited and I think we've gotten ahead on this one and we've taken pretty tough actions accordingly.

We also work closely with distribution during the quarter as Ron pointed out, and despite the fact that we actually had resale increase slightly in the third quarter, we work closely with our distributors to reduce inventory, and again on that front, history shows that taking proactive steps to get ahead of an inventory situation in a softening economy are also merited.

Capital spending or capital expenditures have also brought down.

You should see in the release that the annual spend rate has been reduced from 900 to 800.

At this point that's obviously just an adjustment to the fourth quarter and the simple reason is because we don't need them from a capacity and a manufacturing perspective and yes, we will be able to continue to keep those at low levels if we continue to see soft demand.

Expenses are being reduced using a lot of the classic techniques that you will do in this type of time and we will also be very very targeted on our hiring.

In fact being focused primarily on new college hiring only as we move forward right now.

We are also prepared to adjust further as things change, because I believe we're in a marketplace in an economy that the assumptions that we've made will not be precise but we make them anyhow so we can act.

Last point before we open it up to questions is as I've been through a lot of these in my time in the semiconductor industry and the greatest news to me is that these are absolutely opportunities for companies to get stronger and it's exactly what we're doing and we will be doing as this moves on.

As we've talked to investors for about a year and a half now, we are very focused on analog and embedded processing.

We think they are literally the two best opportunities in the semiconductor market in terms of both size and therefore growth opportunity, margins and also cash flow just looking at the manufacturing assets and manufacturing basis they use.

The changes that we announced today on wireless are consistent with the strategic direction that we've been describing for about the past year and a half as well on the wireless market and they too will lead to TI becoming a stronger Company with those actions taken.

The great news is that many of the actions and many of the decisions over the past three and four years that we've made have all driven us to a position of having both strong cash flow but also a very strong balance sheet and that really is a great asset in these times.

We will continue to be active in our search of additional small acquisitions to strengthen our position in both analog and embedded processing and maybe most importantly to be paying very very close attention to customers as we increase the chips per board and the great growth opportunity we have around the world.

That is where the great strategic progress can be made in these times and we intend to stay very focused accordingly on that front.

With that let me turn it back to Ron.

Thanks Rich.

Operator, you can now open the lines up for questions.

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

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

Operator?

(OPERATOR INSTRUCTIONS) Your first question comes from the line of John Dryden with Charter Equity.

Thanks for taking my questions.

Ron can you discuss application specific analog both near term and long term, the impacts of the weakening demand and more importantly, long term on consolidation in the overall wireless industry and your merchant base band exit?

John, I think as we've discussed, you probably really, what we've seen in terms of longer term expectations for applications with specific analog are unchanged and specifically the opportunity that we see there.

Near term, I think you'll see even in third quarter we saw both high performance analog and application specific analog basically trend sequentially.

I think although application specific analog was down from a year ago but that's pretty consistent I think with what we've described as basically that revenue that has declined basically would bottom out and then the expectation being that we could see growth drive forward, maybe a couple few quarters out from there and again, we'll have to see what the economy holds but again, no change in our expectation for the opportunity for us to accelerate growth in our application specific analog business.

Do you have a follow-up, John?

Sure.

For Kevin, long term investments were down about $50 million.

Was any of that an increase in liquidity for your auction rate securities?

John, actually, a little bit of that was.

We had some of those auction rate securities redeemed in the quarter and we've also been notified to expect more redemptions in the fourth quarter and you're beginning to see the effect of that on a long term secure.

Thanks for your questions John.

Your next question comes from the line of Glen Yeung with Citi.

Thanks.

Maybe a question for Rich.

When you look into Q3, quarter reported, how much of the wireless business do you think was affected by a slowing end market versus share loss in that quarter?

Well, let me let Ron comment on the near term on that front.

I think environmentally, we feel pretty good about where we stand right now.

Ron can cover the specifics.

Glen, I think as we've said and described before, the E&P revenue continues to decline.

We don't break it out and report it quarter by quarter so I guess in that case, that single case you could refer to that as a, or characterize that as share loss but as we've seen actually over a number of quarters now, wireless results were mixed by customer.

If those customers report or have already reported you'll see they're performing at differing levels and in fact our shipments into those customers have varied accordingly as well, but I would say overall, we believe the market, the wireless market is weak, associated with the overall economic environment but again, it will be the specifics will be mixed somewhat by customer.

Did you have a follow on Glen?

Yes, the other question I have is thinking about the OMAP business as a standalone business.

As we think about the direction of chipset going to handsets over the coming quarters and years, to what risk is there in the OMAP business that the processor gets integrated and in fact having a base band is a necessity?

Glen, I think we've, again, we've played in the OMAP business now for pretty much as long as the applications processor has existed in the handset, and our experience has been and our conclusions today even with the actions that you're seeing is that we believe integration is very low risk.

It really comes down to customers want to maintain software flexibility.

The applications processor is a much different type of component in terms of their reliance upon that for differentiation of their handset through the user interfaces through the applications and services that you see them deploying and we believe that because that software flexibility, they will keep those as separate components as opposed to trying to drive them into an integrated solution.

Do either of you guys have a follow-on?

Okay, all right, Glen, thank you for your question and we'll move to the next caller please.

Your next question comes from the line of Cody Acree, with Stifel Nicolaus.

Thanks, guys.

Rich, while we've got you on the line, you mentioned specifically an appetite for smaller tuck-in acquisitions with the kind of decline in the market cap we've seen with some of these companies and the decline in health.

Have you increased an appetite for maybe slightly larger acquisition?

Cody, we've talked in the past with a lot of the investor base.

First on the smaller acquisitions, we think those are great leverage.

It really brings about the wonderful use of a sales team and an applications team that we have built around the globe that a lot of these smaller companies don't have, so it's a great amplifier for really good team, sort of really good sales outlet, so as we said we would press on with that.

When it comes to the larger acquisitions, I still go to a statement that again, you've heard something would have to just fundamentally make you stronger, not just bigger, and that's how we would always have to judge something or look at accordingly so valuation is not necessarily the driver but strategic ability to be able to do more things in front of our customers is what we would focus on.

Do you have a follow on, Cody?

I do.

With the sale of the LoCosto or eCosto product, what's any hindered participation in some of the emerging markets?

Obviously a lot of the growth in the wireless unit volume has been in those emerging markets and your OEMs, your partnered OEMs are still playing there, but does this hinder some of your participation in that group?

Yes, Cody, this is Rich.

In fact if you look at it, it is highly, highly independent and what I mean by that is we've built sales offices and sales channels throughout India, throughout China.

You're in working with a lot of the local companies throughout the industrial, consumer, medical different customer base and so whether or not you have a commercial chip set is somewhat irrelevant because that tends to be narrowed on really a handful in some ways of five OEMs and maybe at the most 10 when you start to get to some of the regional players.

Okay, thanks for your questions.

Next caller please?

Your next question comes from the line of Srini Pajjuri with Merrill Lynch.

Thank you.

Rich, a question for you.

If I look at your custom wireless business, it looks like you do anticipate losing some share and even taking a couple of years, it looks like that business is going to decline.

I'm just wondering what's you're thinking behind in exiting the merchant side of the business and staying in the custom business?

Srini, this is Rich.

I think Ron said it really quite well and that is that we've got a really well run custom business anchored with a great solid relationship and we're going to continue to operate it and continue to operate it very well with those couple of customers, so it's a business that runs well.

We could run it to make good money.

We provide a great cost, great quality, great operation support to our customers and we think simply we'll be able to continue to do that, yet at the same time, make sure we can size investments appropriately for what that revenue looks like.

Do you have a follow-up, Srini?

Yes, just a quick one, Ron.

Just looking at your 10% guidance can you talk about some of the trends you're seeing in different end markets?

Thank you.

Srini, we don't break our outlook down into individual end markets but I will comment.

This is not being driven by any particular end market.

It is a very broad based decline that we saw in orders as we moved through third quarter and therefore, outlook into fourth quarter, so think of it in terms of being broad based as opposed to a specific market and frankly, that's probably as you would suspect given that our statements that we believe it's economically driven.

Okay, Srini.

Next caller please.

Your next caller comes from the line of JoAnne Feeney with FTN.

Thanks, folks.

Yes, just a couple of questions.

One on wireless if you could talk about perhaps the main consequence there.

Is it mix primarily or units that you're seeing drop off?

JoAnne, you'll need to give me clarification.

Are you talking about in fourth quarter or talking about third quarter

Actually looking for the trend so emerging from the third quarter going into the fourth quarter we've been hearing about units holding up relatively well but mix shifting towards the lower end.

You guys have more exposure to the smart phone market.

I'm just wondering if you could clarify for us the mix issue versus the aggregate trend issue?

Okay and maybe what I can do, both accurately is describe the historical trend as opposed to the forecast, and in third quarter, you saw that our wireless revenue was up 1%.

First of all let's break that down in terms of mix.

We saw a growth probably think of it in terms of not double digit growth but single digit growth in 3G and so therefore, we saw some offset to that in the mid range or low end type of handsets, and so since 3G, our content tends to be much higher than what it would be in the mid range or low end handsets, clearly from a unit perspective, probably total units were down but again, we've benefited from the higher ASP and frankly higher unit specific to 3G.

So again, that was third quarter.

I don't want to try to project how that will carry forward in the fourth quarter but at least that's a bit of history.

Do you have a follow on question, JoAnne?

Yes, thanks.

On gross margin, so in order to drive inventories down by it sounds like twice the amount you did in the third quarter, how much room do you have to do that through your foundries or how much must you do that all with your in house manufacturing?

In other words, where should we expect capacity utilization and gross margin to go for the next couple of quarters?

JoAnne, I think Rich commented that we were taking down our starts through the quarter and we expect those starts in fourth quarter for the quarter to be less than what we had in first quarter so to say it another way utilization will be less in the fourth quarter than it was in the third quarter, by at least a few more points.

So that certainly has the potential to weigh on us gross margin wise, but we expect that utilization or that start level to hold pretty constant for the fourth quarter and the first quarter.

So on the top level you'd expect to have a little bit of utilization pressure continuing going into the fourth quarter and at the same time we're taking steps as well to try to reduce our expenses as we go into the fourth quarter to try to keep the overall bottom line impact minimal.

But again, Kevin, just to clarify, in fourth quarter, utilization will drop by a few points and in third quarter we actually saw roughly a 10 point drop; is that correct?

Right.

All right JoAnne, thanks for your question and let's move to the next caller.

Your next question comes from the line of David Wong with Wachovia.

Thank you very much.

Just a clarification.

When you said that you eventually, that you're going to continue to support your custom business, but it will drift down over the years, do you expect to eventually exit the business or do you expect it to go down to a fairly constant level and that you'll retain one or two customers at that level?

Yes, David, this is Rich.

We will focus on those couple of customers and really the one large customer, and we provide what guidance we can which is that business will probably get smaller over time just because of the said direction, if you listen to some of these customers about looking more towards a generic chipset in the merchant market over time, so we've made that assumption that it will trend down.

Obviously, if these large customers wanted to continue to work with us very closely the way we have, we'll continue to work very closely with them.

Do you have a follow-on David?

No that's it.

Okay, next caller, please?

Your next question comes from the line of Mark Lipacis with Morgan Stanley.

Thanks for taking my question.

First, a question for Kevin, I guess.

Kevin, going beyond the next couple quarters on the gross margin, can you give us a framework for thinking about what it will take to get the gross margins back up?

I'm trying to understand in the second half of last year your gross margins were 54%, assuming a static mix if you get to that revenue level is there any reason that we should assume that the margins don't get there or could go above that?

Yes, Mark there's several things actually I think that are important to keep in mind as you look out into the future for our margins.

We did mention about a year ago I guess May of '07 that we had set a goal for being able to put together a portfolio that would operate at about 55% gross margin and about 30% operating margin, and on our way there, what we're looking to is an increasing portion of the mix of our revenue to be coming from both analog and a better processing which both deliver those kinds of operating results, and at the same time, for our high performance analog, the subset of the analog piece, to continue to improve in its overall profitability as the quality of the products in that portfolio continue to improve.

Kind of tailing in behind that and squeeze back into a comment that Rich made about our capital spending, is that our CapEx has come down, in fact over the last, if you look at the last 12 months worth of revenue, our CapEx is running about 7% of that revenue, excuse me, about 6% of that revenue and our depreciation has been running about 7% so when your CapEx is running below your depreciation you're going to expect to see depreciation continue to decline as you go out over the next couple of years.

A final thing that you'll continue to see is just these portfolio adjustments that we continue to do.

You'll recall in 2005 we sold the LCD commodity driver business, that took on a low margin business.

Last year it was the DSL business.

This year, you've heard us talk about our merchant chipset business that we're going to go ahead and take action on.

In all three of those cases, those were elements of our portfolio that averaged down our overall gross and operating margins and so by removing those again that gives us some lift going forward so there's really three or four moving parts inside there.

We remain quite optimistic as to how this portfolio shifts over the next few years and works towards those kind of profit goals.

Mark, I think just more near term impact, there's two things that are affecting our gross margin.

One is declining revenue in fourth quarter and the other is just the impact especially as we saw in the third quarter of inventory reduction and the impact that had on lower levels of utilization, so in the near term, when we get the inventory depletion complete, or inventory reduction complete, that will tend to provide a lift on utilization and therefore margins and then the other consideration is whenever revenue would start to grow again, certainly that would be a benefit as well.

Do you have a follow-on Mark?

Yes.

Perhaps a question for Rich.

Sounds like your channel inventories around eight weeks are at the low end of historical range.

The assumptions that you've made on your revenues in Q4, do you think that that would be an accurate reflection of the real consumption of your components by the end market or do you think that the channels in the process of taking the inventories below even the current low levels that we see?

Thank you.

Mark, I think you've by asking that question, you're on the key thing about taking action, and that is that channel inventory metrics are usually trailing metrics, not leading, and that's why in all my experience and all my history, getting out ahead of this thing is usually merited, so that's why even with an increasing resale number in the third quarter, we just looked at the overall signs and said that this is the time to be getting back ahead of this thing.

So we feel good on a relative basis.

The real question that you're after is what's the absolute target you need to get to and it's going to take time to know.

Okay Mark thank you.

Let's move to next caller please?

Your next question comes from the line of Chris Danely with JPMorgan.

Probably a couple questions for Rich.

So, Rich, you guys are restructuring the wireless business but it looks like the part that is left is not going to grow and we all know it has lower profitability than your base business and in the past when this has happened whether it's DRAM or COM business or S&C, you've exited those businesses.

So I guess my question is why are you not exiting the entire wireless business?

Yes, Chris, let me, I think it's an interesting question but let me break into a couple of things.

First off is when you say the piece of wireless that's left, there's a few pieces in there.

One is you have a tremendous opportunity with application processors with what's happening in the smart phone world, and that is one where if you get with Greg and his whole team, you take a look at the customer, the customer adoption of these products, we really are pretty excited about where this thing wants to go.

Economies aside, and so that's why you invest aiming forward and in this case aiming forward is about aiming at the smart phone and the application processor business.

The flip side of that is what do you then do with the base band business or in this case the remaining element which is the custom base band business and that's where you have to sit down and you just have to run that in the smartest way you know how, and the smartest way that we know how is to be able to support customers, at minimized cost and investments on that front and as a result you can generate the best value for shareholders over the long term.

It's how we always tend to look at these and in this case, running that on the inside is the best choice.

Do you have a follow on Chris?

Yes.

Switching to the analog business, was any of the gross margin reduction due to analog pricing and I guess Rich looking out, you said you wanted to get a little more aggressive in your analog growth rates.

Are you willing to trade off margins for growth or how do you look at that?

Chris, nothing changed in terms of our strategy for pricing and analog, and that, you kind of have to look at the analog businesses separately.

The high performance analog price is very low on our customers list of priorities and considerations.

It's much more driven by technology, support, those types of considerations.

On the high volume analog side, it is more of a competitive market dynamic and pricing is more of a factor, but frankly, those are probably more considerations that are made when a customer is initially engaging with the supplier, because again, much of that business will tend to be custom type of products, so once you get into call it near term environmental changes such as we're seeing today, you tend not to see analog pricing move around with that near term environment and frankly, when things get better we don't go out and raise prices on our customers either.

Where we do see some price movement with the environment is in areas like our standard logic or our commodity logic product line, and keep in mind, Chris, that is a very small percentage, probably 5% if not less than our total revenue today, and, in that commodity area, yes you're seeing same kind of, you are seeing some pricing pressure as you would expect but again, it has very little impact on TI overall.

Okay Chris.

Thank you for your questions and we'll move to the next caller please?

Your next question comes from the line of David Wu with Global Crown Capital.

Yes.

Rich, while I have you on the phone can you help me with two things?

Number one is given the fact that you are exiting the merchant base band business and custom base band business are going to go South, are you maybe recalibrating your top line growth goal for the next five years?

The one that you set back in May of this year?

And the other one is it sounded like the merchant base band business you're talking to potential buyers, are we close to some kind of a deal or are we still in a preliminary stage of talking?

David, let me go ahead and answer that.

I think that the quick answer is no, it does not affect the overall top line growth that we talked about.

We talked about back in May putting together a portfolio that in a semiconductor market that's growing on average 8% compound annually, which has been the long term average here in the last dozen or so years, that in that kind of market we would expect our portfolio to be able to generate an average of around 10% annual growth rate, and along with that by the way, about a 15% compound annual growth rate in earnings.

We don't expect the changes in the merchant chipset that we just talked about or the custom business to affect that.

In fact we have been comprehending these kinds of market changes that all along when we actually gave that guidance.

Okay, David?

And let's see.

The merchant chip.

Yes, are you close to a deal?

Oh, yes, we haven't talked about that, usually companies are fairly close to a deal before it even mentions something like that, so I assume that that's the practice at TI as well?

I would just comment David we are in discussion with several interested parties and that's probably all I should say at this point in time.

David part of our announcement also is just driven by the need internally to make some disclosures and because we do have broader actions that are taking place inside of our wireless organization overall.

Yes.

$100 million of restructuring charges we should see it in the quarterly numbers right?

You take that quarter this year and the first two quarters of next year?

That's correct, David.

We're expecting right now over the next three quarters and in the fourth quarter estimate we're expecting approximately $0.01 of charge with the balance to occur in the first and second quarter of '09.

David I just, this is Rich.

I just wanted to follow-up on Kevin gave the exact right answer on the growth targets.

We look at the opportunity with analog, $36 billion odd market, embedded processing, $16 billion market while we've got great share, it can be just a lot greater.

So the growth opportunities that we see in front of us are the same ones we talked about really back in May.

Okay David.

Thank you for your questions and let's move to the next caller, Operator?

Your next question comes from the line of Steve Smigie with Raymond James.

Great, thank you.

So just make sure I'm connecting the dots right.

I think you indicated that revenue might be down again in Q1 but that you'd expect utilization to be about flat relative to Q4 so if that's the case does it mean then you're not reducing inventory at that point?

You're shipping back to demand?

Is that how I should sort of look at that?

Actually what we are expecting is what you said revenue would be down in fourth and first and that inventory will decline as we already mentioned by about $150 million in fourth quarter and there probably would be some incremental decline in first quarter.

That will be somewhat subject to what our expectation is on the 2Q revenue outlook which will moderate that a little bit when we get to that point in time.

Do you have a follow on, Steve?

Yes, if your inventory is coming down again and revenue is coming down, how does the utilization stay flat?

Keep in mind, Steve, it's a function of when you start your wafers and how long it takes it to run through the factory is your average cycle time will be call it two, two and a half months to run through so if you just kind of map out the cycle time of the wafers from when they start to when they come out, they don't come out fast enough to actually start growing inventory, if your revenue is in line with what we're expecting so you'd see your inventory decline further.

Steve this is Rich.

To me the simpler one is I think it emphasizes how hard we've gotten after this thing in the third quarter and that's how you do it is you end upbringing the utilizations down by the time we were leaving the quarter as Kevin and Ron talked about 10 percentage points, we left the quarter a couple 3, 4 points below that and we'll run that level theoretically through 4Q and 1Q, reducing a lot of inventory, some in Q3, a lot more in Q4 and then a little bit more in Q1.

So it's a magnitude statement about the aggressiveness of action.

Okay, Steve.

I'm not sure if you're still there.

Did you have a follow on question?

Okay, I guess that was it.

Okay, Operator?

We're ready for the next caller please?

Your next question comes from the line of Ross Seymore with Deutsche Bank.

Hi, guys, a question for Rich.

On the guidance that you gave, how much of that is a bottoms up versus kind of top down conservatism or caution given what you're seeing in the end market?

Ross, I think it's a great question and I want to be really careful with anybody hearing the word that our 10% down number is a cautious outlook, and I say that because I think we're just literally at a steep part of that curve and the ability to draw a line is very difficult, so we see customers currently making changes to their backlogs and their demands.

What we did was we got very aggressive actually during the third quarter to start putting some tough operating plans in front of us.

Our best estimate at this time is that down 10% but I think we'll have to see exactly where that comes out.

Do you have a follow on Ross?

Yes, when you talk about the first quarter revenues being down as well is that more of a statement on what you see in the end markets now, normal seasonality or something else?

Yes, Ross, I will follow-up.

That is about getting internal Operations to take action as opposed to waiting for perfect data in this world, so we've got an incremental reduction in first quarter revenue that we put into an operating plan that goes back to Steve's prior question on utilization.

That's slightly lower than seasonal down, and again, it's not for great wisdom of forecast.

It's for wisdom that says usually making choice to get ahead of these is better than waiting for perfect data to show up.

Okay, Ross, thanks for your questions and let's go to the next caller.

Your next question comes from the line of John Pitzer with Credit Suisse.

Yes, good afternoon guys.

Thanks for taking my call.

Ron quickly just a clarification on your Q4 revenue guidance.

Does that include the merchant wireless business or do we take $100 million out quarter on quarter?

How does that work?

It includes our merchant wireless business until we announce that sale has been achieved.

And then secondly for me, Kevin you talked a little bit about some of the positive offsets on the analog business margin profile.

I'm kind of curious when you look at the cost actions you're taking on the wireless business given the $200 million reduction in cost, $400 million reduction in revenue, going forward, structurally would that business be more or less profitable in the gross and operating margin?

Thanks.

John, the quick answer is it will be more profitable.

Taking out that much cost.

As we talked in the past the wireless business has generally averaged down the overall performance of the Company and by taking out this much cost, you can see where this will add a little bit more favorable bottom line results going forward.

Okay, John.

Thanks for your question.

Let's go to the next caller.

Your next question comes from the line of Doug Freedman with AmTech Research.

Hi, guys.

Thanks for taking my question.

If I could just clarify, did I hear correctly you're thinking that despite the fact that normal seasonality is sort of thrown out the window right now with what we're seeing macro wise, you're thinking that Q1 is going to be seasonal or worse than seasonal?

Did I hear that correctly?

I think what you heard Rich saying is that in this economic environment rather than waiting to find out what the signals tell us, we're preparing ourselves in the event that it's worse than seasonal and it's actually down quite a bit versus the fourth quarter.

The normal seasonal for us if you look back over the last 10 years was down about 1% versus fourth quarter.

We're preparing ourselves for the possibility that it would be down steeper than that.

Do you have a follow on Doug?

Yes, if you could.

Just focusing a little bit on some housekeeping a little bit.

How do you guys think about there is a lot of free cash flow that continues to come out of your business model.

How are you thinking about buyback versus dividend as far as returning equity to shareholders?

Well, Doug, actually that's a good question.

We just got Board approval to increase the dividend again this quarter, that's the fifth time in five years in a row now of increase in dividends to the point where now I believe the yield is around 2.5% based upon our recent stock price.

You've seen us use more dollars for buyback than for dividend, although that mix has changed somewhat, especially in the last year as we've taken a lot of the excess cash that we had generated from activity over the prior few years and used that for larger buybacks, and now what you're seeing is our use of cash for buybacks and dividends getting a little bit closer to our actual cash flow generation, and I think you'd see more of the same going forward.

Okay, Doug thanks for your questions.

Let's go to the next caller.

Your next question comes from the line of to is, Tore Svanberg Thomas Weisel Partners.

Yes, thank you.

Going back to gross margin, so the way I understand it here is that it was down 370 basis points this quarter and we should expect a lower drop than that in Q4 given the actions you've already taken?

Yes, Tore, you'll see it go down if for no other reason is because of the seasonality of the calculator business that we discussed.

It tends to operate at quite a high gross margin so that alone, that revenue alone will reduce quite a bit fourth quarter because of the normal seasonal activity.

Then beyond that there will be a smaller impact just by virtue of the fact that we don't expect our utilization to fall quite as sharply in fourth quarter as what it did in third quarter.

It will still go down some so that will pressure us a bit from the standpoint that we'll have some fixed costs that won't be absorbed but that we don't expect to fall quite as sharply as what we just saw this past quarter.

So with utilization roughly flattish although down a little bit, more of the growth margin trend will be driven by the changes in revenue and whatever fall through is associated with that as opposed to the under utilization costs that we just saw in the third quarter is that correct?

That's correct.

Proportionally more will be revenue driven as opposed to fixed cost driven.

Follow-up question, Tore?

Yes, I'm sure in times like this you take a strong revisit at your business and where you're going to go once we get out of it.

In analog and event processing you mentioned you expect to gain share.

Could you just talk about some of the end markets that you are perhaps penetrating a little bit more than others from a development perspective, please?

Yes.

Tore, I think that's, while I get to travel around a lot and you get the sense of what the economy and customers think, the thing that I remain excited about is all of the customers and the new applications and design in progress that's taking place.

Areas as broad as industrial to motor controls, improving the energy efficiency of white goods or industrial equipment to the impact of what's happening in medical to even continuing away in marketplaces like automotive, so that's why we remain so fascinated with both analog and embedded processing is that literally, you can sell chips to any Company in the world that builds on electronic base piece of equipment and so we feel pretty good about it.

Tore, thank you for your questions and let's move to the next caller.

Your next question comes from the line of Jim Covello with Goldman Sachs.

Good afternoon, guys.

Thanks so much.

A lot of good questions obviously already asked.

Maybe I'll just touch on the thoughts around the connectivity products.

Is there any change in your view on the connectivity products in wireless relative to the divestitures that you're having?

Jim, short version is no, and meaning that we still think that if you look at the smart phone world and the functionality going in the smart phones, this is going to be a rapidly growing space and Greg and his team have done some pretty interesting things in that area so while you hear a lot of the public attention on OMAP and the investments in OMAP, the connectivity business as you refer to it is a pretty impressive business as well.

And just for the broader audience, let's define what we mean by connectivity.

It's GPS, Bluetooth, and Wi-Fi, and in those areas, TI has especially strong positions in Wi-Fi for the handset as well as discrete GPS solutions.

Jim, do you have a follow on question?

I'll ask my follow-up on kind of the same topic but it can count as my follow-up.

Relative to those things being integrated, is it enough to integrate them with an OMAP processor or do you really need a base band processor as the connectivity market moves further toward integration?

Jim, I think what's going to happen on that it goes back to I forget who asked the question but Ron answered it, I think you're going to find application processors remain pretty discrete or standalone just because of the software, the programmable nature of those products, and as a result, there's not this major integration of devices like Bluetooth or GPS.

What we could see if you spend time with that team you'd hear about integration of the connectivity functions, and so you've seen some things so far in connectivity where Bluetooth and FM came together for example, so maybe you'll see some partitioning along those lines.

So I guess I don't think we're going to find all this stuff ends up on a single device, be it an application processor, nor the temptation to have it integrate on to the base band because base bands vary as you go throughout the world, and customers are going to want those platforms to be modular so they can adapt their product to different marketplaces.

Okay, Jim.

Thank you.

Let's move to the next caller, Operator?

Your next question comes from the line of Tim Luke with Barclays Capital.

Thanks so much.

Rich, just for you.

You clarified that you were clearly very focused on analog and embedded in the wireless area, you got the run rate business of around $3.6 billion and it seemed like you were disposing around 350 million to $400 million of it.

Would the balance of that business, could you just give us a sense of what some of the strategic options are there and maybe just remind us of how large just in terms of framework percentages your OMAP piece is that you seem focused on, of that $3.6 billion and remind us I think it's somewhat lower this year and maybe when do you expect that business to reaccelerate?

Thank you.

Tim, let me just kind of go through some of the numbers and I'll let Rich talk what regarding the strategic options.

Roughly, and I'm not sure this is a third quarter number as much as generally kind of what we've been running last year and maybe year-to-date this year, about three quarters of our wireless revenue has been base band.

Most of the remainder is OMAP application processors, although connectivity is part of that as well, so certainly, the majority of that or 75% or so of the total revenue though is base band.

So Tim, this is Rich.

Just following-up, and I guess it's not to try to sound too simplistic but our view on this is really one that when you look at the wireless business, you want to get your R&D lined up on things that are going to grow and things that are going to grow is a unit volume statement to where they're going to grow actually at unit volumes far greater than the total handset growth.

Handset market at $1.2 billion a year has only got certain growth capabilities given the size of the planet and the number of subscribers so we want the new capabilities that are going to be penetrating in.

That's where smart phone leads to OMAP leads to connectivity.

Those are great things that are going to grow.

We've been doing our best and continue to do today with today's announcement, get your investment focused on that, eliminate the things that aren't going to grow and make sure you're focused on delivering the most value for them.

So with that, just two quick clarifications.

First, do you remain committed to the non-merchant base band business, or are you evaluating different strategic options there, and given your comment that you wanted to sort of minimize investment there, how is the Motorola customized offering developing in terms of its time line?

Yes, Tim, simple answer is highly supportive because we've got great customers like Nokia and folks and you got to take good care of them including the custom base band business because it's got a lot of years left in it and the fact is the goal in life is not necessarily to just minimize, it's to align and what I mean by that is where we have customers that want to do more on a project, we get the right people lined up on it and make sure that we have that adjusted to the revenue opportunity that's there.

I think, Tim, the other thing that I just want to emphasize because I know a lot of times whether on this call or just investor questions in general it's a question of why don't you get out of the whole thing.

The reality is that base band business especially the custom side of the base band business has very good profitability, and is valuable to Texas Instruments, so that's not saying we can't take some expense out of it and make it even more profitable, but this is not something you shut down.

It carries a lot of value for TI in terms of its earnings contribution and we want to maximize that.

Okay, Tim, thanks for your questions.

Let's move to the next caller.

Your next question comes from the line of Uche Orji with UBS.

Uche, welcome and I think you just slipped in under the wire.

You're going to be our last caller tonight.

I'll take as many questions then as I can.

Thank you very much for that.

Just very quickly, Rich.

In terms of the timing of this announcement, I mean, this is a very tough market environment.

They are out there trying to sell your wireless business, and for the debt market is difficult so if you want to do the financial buyers or strategic buyers, it's just not a very easy environment to contemplate a deal of this size.

Why now?

And what gives you the confidence in terms of the time you laid out that this can get done?

Yes, Uche, if you look at the timing of why now, you've heard us talk for about a year and a half in terms of where the direction was we were going with the wireless business and we just think it's at a critical time to make sure we take the next step of focusing research and development in the right areas.

So as Ron commented earlier, that includes changing development road maps and also considering for sale or putting up for sale that business.

I think Ron or Kevin also pointed out that if that doesn't work or there is not an interested buyer in that merchant market chipset business, we're prepared to run it well, support customers and to also minimize the investment on that front.

So I think we can handle either outcome.

Just on that topic, just one last follow-up on that.

Obviously you've spoken to everybody involved.

What is the feedback from your OEM customers and is there any preference contractual or otherwise that will lean it toward the financial buyer or a strategic buyer?

Uche, I'll minimize any commentary except that obviously, when you consider anything like this, you talk to your customers because they're the important folks in this process.

We've let them know what our thinking was.

I think we've also established a lot of credibility over the years to support our customers, either directly or by making sure this sale would be completed successfully, and we'll continue to operate in that mode.

Okay, Uche, thank you for your questions and with that our hour is up.

Let me tell all of you thank you for joining us.

A replay of our call is available on our website and good evening.

That concludes today's conference call.

You may now disconnect.