德州儀器 (TXN) 2013 Q3 法說會逐字稿

Good day, and welcome to the Texas Instruments third quarter 2013 earnings conference call.

At this time, I'd like to turn the conference over to Mr. Ron Slaymaker.

Please go ahead, sir.

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

As usual, Kevin March, TI's CFO, is with me today.

For any of you who missed the release, you can find it and relevant non-GAAP reconciliations on our website at www.TI.com/IR.

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

A replay will be available through the web.

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

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

Our mid-quarter update for our outlook is scheduled this quarter for December 9. At that time, we expect to adjust the revenue and earnings guidance ranges as appropriate.

This was a good quarter for TI.

Revenue came in just above the midpoint of our guidance range, growing 6% sequentially and growing 10% if you exclude legacy wireless revenue, which declined to less than 2% of TI revenue in the quarter.

Analog and embedded processing increased to 80% of TI revenue.

The improved quality of our revenue is reflected in record gross margin in the quarter.

Kevin will discuss this more in a few minutes.

Revenue growth in the quarter was supported by some of the vertical markets that were especially weak in the second quarter, including computing, game consoles, and handset revenue outside of our legacy wireless revenue.

Revenue from the communications infrastructure market continued to grow in the quarter.

These areas were complemented by continued strength in our automotive and industrial revenue.

From a year ago, revenue declined 4% due to the decrease in legacy wireless revenue.

Excluding this revenue, we grew 3% from the year-ago quarter.

On this basis, this was the first quarter of year-on-year growth since the third quarter of 2012.

Again, excluding legacy wireless, we expect growth to accelerate to 8% in the fourth quarter, at the middle of our guidance range.

The strength of our business model not only provides strong profitability; it also gives us confidence that we can sustainably generate $0.20 to $0.25 of free cash flow for every dollar of revenue.

This metric is especially important to our shareholders as our capital management strategy is to return all of our free cash flow to them, except what is needed to repay debt.

When measured over the trailing 12 months, free cash flow was 24% of revenue.

Over the same period, we returned 133% of free cash flow to shareholders.

In the third quarter alone, we returned $1 billion to shareholders through a combination of dividends and stock repurchases.

Earnings in the third quarter were above our expected range, a result of better than expected revenue and gross profit, tight operating expense control, and some help from discrete tax items.

Let me walk through a few details of revenue.

Analog revenue grew 11% sequentially.

All four analog product lines contributed to this growth, although power management was up the most followed by high-volume analog and logic.

These areas benefited from sequential growth across many markets, including those vertical markets that were impacted by inventory reductions in the second quarter.

Embedded processing revenue grew 8% sequentially, with processors up the most, followed by growth in microcontrollers and connectivity.

Processors were driven by application processors sales into consumer and automotive applications, and DSP sales into industrial applications.

Microcontrollers were lifted mostly by sales of MSP430 products into industrial applications as well as sales of microcontrollers into automotive safety applications.

In our other segment, sequential growth in most product areas was offset by decline in legacy wireless.

Legacy wireless revenue fell by $91 million to $57 million as we had expected.

This decline was partially offset by growth in calculators and in custom ASIC revenue, which grew as a result of communications infrastructure.

Royalties also grew, and DLP product revenue was about even.

Turning to distribution, resales grew 9% sequentially.

Distributors' inventory levels declined by about a day to just over five weeks.

Now Kevin will review profitability and our outlook.

Thanks, Ron, and good afternoon everyone.

This quarter, gross profit was $1.78 billion, up 13% sequentially.

Gross margin was a record 54.8% of revenue and expanded 330 basis points sequentially.

I think is useful to compare this quarter's gross margin to that of the third quarter of 2010, when our last high-watermark gross margin was set at 54.5%.

In that earlier quarter, revenue was $3.74 billion, up -- 15% higher than our revenue this past quarter.

Factory utilization in that earlier quarter was 8 points higher, and our manufacturing capacity was lower since we had not yet brought online our cost-efficient 300 millimeter analog wafer fab in Richardson, Texas or our yet-to-be-acquired wafer fab in Chengdu, China.

We were also still in the early stages of ramping our recently acquired Aizu, Japan wafer fab.

In addition, analog and embedded processing were also much smaller then, contributing 60% of our revenue at that time.

The conclusion one can draw from this is that due to the structural changes that we have made at TI over the past few years, the quality of our revenue is much higher today.

It is more diverse, more profitable and less capital intensive, and we remain better positioned to support future growth from a manufacturing capacity standpoint.

Continuing to operating expense, combined R&D and SG&A expense of $833 million was reduced by $27 million sequentially.

Acquisition charges were $86 million, unchanged from last quarter.

Almost all of this amount is the ongoing amortization of intangibles, which is a non-cash expense.

The restructuring charges and other lines of our income statement transitioned from a $282 million gain last quarter to a $16 million charge this quarter.

As a reminder, last quarter's gain was due to the transfer of wireless connectivity technology to a customer.

This quarter's charge is associated with the shutdown cost from the previously announced factory closings in Houston and Hiji, Japan.

Operating profit was $844 million or 26% of revenue.

Our tax rate in the quarter was 23%, 1 point below our 24% annual effective tax due to discrete items that were included in the third quarter.

Our annual effective tax rate is unchanged, and 24% is the rate you should use in your models for the fourth quarter.

Net income in the third quarter was $629 million or $0.56 per share, which includes a penny of discrete tax benefits.

Let me now comment on our capital management strategy starting with cash generation.

Cash flow from operations was $1.15 billion in the quarter.

We increased our inventory by $6 million compared with the prior quarter.

Inventory days increased by one day to 106 days consistent with our model of 105 to 115 days.

Capital expenditures were $124 million in the quarter, and free cash flow was $1.03 billion.

On a trailing 12 month basis, cash flow from operations was $3.27 billion, about the same as a year ago.

Trailing 12 month capital expenditures were $402 million, down 27% from a year ago.

As a result, free cash flow was $2.87 billion, up 4% from the year ago.

Free cash flow was 24% of revenue for the trailing 12 month period, within our expected range of 20% to 25% of revenue.

In the year-ago trailing 12 month period, free cash flow was 21% of revenue.

Capital expenditures for the past 12 months were 3% of revenue.

Our continued low capital spending level is a direct result of the strong capacity position that we have built with our strategic investments in the past few years.

The cash flow that will result as we continue to fill up this capacity should be strong in the years ahead.

I'll note that depreciation expense for the past 12 months exceeded our capital expenditures by $496 million.

As a percent of revenue, depreciation was more than 400 basis points higher than our capital expenditures.

This is one of the reasons why our free cash flow has been trending higher than our net income.

Of course, as depreciation declines to the rate of capital spending over the next few years, gross margin will benefit.

Another reason why free cash flow has trended higher than net income is the non-cash amortization expense of $80 million to $85 million per quarter that will remain on our income statement for another six years.

For the past 12 months, amortization expense was $339 million or about 3% of revenue.

As we've said, strong cash flow, particularly cash flow -- free cash flow means that we can continue to provide significant cash returns to our shareholders.

In the third quarter, TI paid $308 million in dividends and repurchased $734 million of our stock.

Our capital management strategy is to return all of our free cash flow to shareholders except for what we need to repay debt.

In the last year, we reduced our debt level by $500 million.

Free cash flow was $2.87 billion, and we returned a total of $3.82 billion to shareholders or 133% of free cash flow.

We have been able to return more than our free cash flow because proceeds from exercises of employee stock options totaling $1.28 billion over the past 12 months have also been additional source of cash for the company.

To break out the cash return, in the past 12 months we repurchased $2.7 billion of our stock, or 95% of free cash flow.

Similarly, we paid $1.08 billion in dividends or 38% of our free cash flow.

Fundamental to our cash return strategy and our cash management are tax practices.

We ended the third quarter with $3.59 billion of cash and short term investments, with 82% of that amount owned by TI's US entities.

Because our cash is largely onshore, it is readily available for a variety of uses, including paying dividends and repurchasing our stock.

TI orders were about even sequentially, and our book-to-bill ratio was 0.97, consistent with seasonal declines in the fourth quarter.

We expect TI revenue in the range of $2.86 billion to $3.10 billion in the fourth quarter.

At the middle of this range, revenue would decline 8% sequentially, with about half of that decline coming from the seasonal drop in calculators.

The remainder of the decline is consistent with the semiconductor industry's pattern over the past three years, 2010, 2011 and 2012, as well as our own history over the same period when legacy wireless revenue is excluded.

In the fourth quarter, legacy wireless products should decline to about $50 million.

We continue to expect that revenue from these products will essentially be gone as we enter next year.

We expect earnings per share to be in the range of $0.42 to $0.50.

In summary, we believe the third quarter provides a preview of what TI is capable of producing as a company focused on analog and embedded processors.

The improved quality of our revenue is evident from the higher gross margin of free cash flow generation compared with our past.

We also believe our top line performance and potential will become more evident without the steady headwind of declining wireless revenue in the past few years.

Our manufacturing capacity position remains strong, and we have a good opportunity for continued growth while maintaining our capital expenditures at low levels in the years ahead.

With that, let me turn it back to Ron.

Thanks Kevin.

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

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

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

Operator?

(Operator Instructions)

John Pitzer, Credit Suisse.

Ron, my first question, relative to that consumer bucket of computing, gaming and handsets, could you give us a sense of how much that represented of the overall business in the September quarter and how much that was up versus the rest of the businesses sequentially?

John, probably the best I could do is help you understand the weight of each of those segments.

I don't have the growth broken out quite to those areas for you.

Let me go through real quickly the weighting of our in-market exposure, which I can let you then play with to make some assumptions on.

Comps in total were 27%, and this is first half 2013 data.

Computing 23%, industrial 23%, consumer 11%, automotive 13%, and education 3%.

Again, the reason we called out the three areas was because I think in second quarter, we called them out as especially weak.

And in fact we also said that in our outlook for third quarter, we expected that they would recover.

Keep in mind the reason they were weak in the second quarter was because customers in those areas were depleting inventories ahead of the anticipated new product launches in second half, which we are now well into.

Those new product launches were what was -- were a factor in those areas that was driving growth.

Again, comps infrastructure was already strong and growing in second quarter.

It continued in third quarter, as was automotive and industrial.

Strong second quarter continued as well into the third quarter.

Did you have a follow-up, John?

I do, this is for Kevin.

Just on the incremental gross margin, Kevin.

If you look at both the June and September quarter, your incremental gross margin both quarters were over 100%.

I'm just curious, to what extent was that just the wireless business declining into I think about a 30% type gross margin there?

And then more importantly, when the wireless business is down to zero, how should I think about incremental gross margin from there?

John, on the -- I'll answer the last part first.

The incremental gross margin from our analysis in the past over the course of a cycle averages about 75% up and down.

In any one quarter it rarely actually works out to that number.

It tends to be pretty noisy in any one quarter, but over time, about 75%.

And that is what we do for internal planning purposes.

As it relates to the most recent quarter, you are right.

The fall-through was about 106%, so certainly a pretty rich fall-through.

And part of that was mix, but part of that also was improved factory utilization.

We had higher revenues this quarter than the prior, and so consequently we had a slight utilization benefit as well.

Blayne Curtis, Barclays.

Maybe from a high level if you could just talking about, now that we have -- you definitely showed an increase in year-over-year growth.

September was up and then December accelerating although off of a pretty easy compare.

For the full year analog growth, seems more like a few percent.

So if you could talk about now that we have a full picture for the year, do you think there's anything going on in the analog bucket, or do you think this is representative of what the overall market is growing?

Blayne, I think the year is not done.

And right now there is a lot of point spreads being made for fourth quarter, but we really to wait until we get into January to understand with the final score is.

I think we feel pretty confident that 2013, when the final scores are in, will show market share gain once again for TI.

Again we have to push through the fourth quarter, but we believe just as you have seen over the past few years, once again we will be gaining share in 2013 for analog overall.

Did you have a follow-on?

Could you provide some color as -- within the segments in analog, which one you're seeing, if there's any material difference between the sub segments?

It looked like power was up a bunch if I have my numbers right in September.

If you could talk about the growth driver there and then where you see the biggest declines into December?

I think in the case of power, power had a strong quarter, but also -- you used the term earlier, easy compare.

It was one of probably more impacted by weakness or the inventory reductions in some of those vertical areas in the second quarter.

In the third quarter, its growth was very broad base, but it also benefited from recovery in some of those vertical markets.

And then I would say the same for HVAL.

If you look at third-quarter, probably because those vertical markets layered on growth to what was already reasonable base of industrial and automotive, power and HVAL both grew faster than the catalog spaces of HPA and SVA.

But I think if you go back to first half of the year and especially second quarter, you probably saw more relative strength in SVA and HPA.

I think to put it all together, they're all pulling well in terms of growth in 2013 thus far.

We will see -- again, when we go through fourth quarter, but some quarters you have had more strength out of SVA or HPA and other quarters as in third quarter, more coming out of power and HVAL

Doug Freedman, RBC Capital Markets.

Kevin, can you give us an idea of what we should be thinking for the other operating expenses?

I know it seems to be moving around.

I do know you had the asset sale last quarter, but ex the asset sale, still a reasonable bit of spending there.

Can you give us some idea of what we should be budgeting for next year in terms of that line on the income statement?

Doug, I'm going to try to make sure I got what you're asking for.

OpEx overall for the company, our model is to run between 20% and 25% of revenue depending upon where we're at in overall revenue demand.

Most of that spending is actually inside the analog and the embedded processing segments.

It was relatively small levels of ongoing support spending inside the other segment, little bit of R&D inside the other segment for DLP technology, but other than that, pretty small.

The larger numbers you see passing through the other as we go forward will be the continued amortization of intangibles, which will run about $85 million a quarter as we go through 2014.

And that will eventually declined to about $80 million a quarter.

And keep in mind that will stay there for six years until that finally winds down.

In addition, that's also where we tend to record any restructuring charges.

So the restructuring charges that we just had this past quarter, there were $16 million, and those also were recorded n the other segment.

As we look into the fourth quarter, I'd expect you will see acquisition charges to continue at about the $85 million, $86 million level, and you will see probably final restructuring charges associated with the closure of our Hiji and Houston factors of about $20 million in the fourth quarter.

Doug, I think if you look at the income statement for the company, for the entire period of comparison here over the last four quarters, all of the acquisition charges and restructuring other line are directly from that other segment.

With that, you can then if you want to extract that out to see what R&D in SG&A trends have been in that other segment, you will see both -- you won't see them independently, but the combination of R&D and SG&A have calmed down whether you look at it year-over-year or whether you look at it sequentially.

Again, that is largely driven by the reductions in legacy wireless as Kevin noted.

Doug, do you have a follow-on question?

As my follow-on, if we look at the embedded processing business, that business is growing nicely, but not necessarily delivering the operating margins of the corporate average.

Can you talk about what you're doing as far as the operating margin leverage for the business?

Doug as you may recall, we spent a couple of years significantly increasing our investments in that segment, particularly as it relates to microcontroller portion of that particular segment.

We have taken that spending up to a level now that doesn't need to increase anymore.

Really what that business unit is focused on is the top line growth.

They get rather attractive gross margins off the parts when they shipped them.

It is really about diversifying the revenue base and getting more overall top line growth to fall through to bottom line.

That is what you saw quarter over quarter was the top line growth came rather nicely through to the bottom line.

Stephen Chin, UBS.

First one is on the operating expenses, in the quarter it looks like you guys saw OpEx decline about [3%] versus the original guidance for down 2%.

Wondering there was any timing or how you guys were able to do better than your original guidance and what the expectation for OpEx Q4 is?

The OpEx, we did guide to about 2%, but we were able to keep a pretty tight handle on spending in the quarter, so it came in a little bit lower than we had originally planned, which frankly just dropped right through to the bottom line and produced extra earnings per share for our shareholders.

As we look into the fourth quarter, we typically have some seasonality in the fourth quarter with the holidays, Thanksgiving and the Christmas break.

We expect to see OpEx probably decline somewhere in the 3% to 5% range as we move into the fourth quarter.

One question on the embedded processing division, particularly the microprocessors, with the MSP430 that you mentioned, is the consumer or wireless segment an area where you're looking to be more aggressive on expanding the sales of your MCU product?

I think probably the way to think about it, Stephen, is probably the biggest driver of growth for microcontrollers will be industrial.

These are catalog devices that go into lots and lots of different applications.

That being said, we are not -- if there is growth in other end markets or growth opportunities in other end markets, we will certainly pursue them, but our expectation is that industrial will likely be the largest driver going forward.

That is for the microcontrollers.

For the processor side of the business, I would say we would expect -- com infrastructure certainly is part of that revenue and important end market for us, but similarly, we sell DSP products into lots of different applications.

And those broader applications are going to be just as important, maybe even more important than communications infrastructure going forward.

That is not anything negative about communications infrastructure.

It is just that we have great market share, very high market share already in communications infrastructure where there is still a lot of opportunity in some of these other areas for us to experience not only the rapid growth of that end market, but also rapid market share gains as well.

One of the things I should further delineate is when I am talking about industrial likely being the fastest grower for microcontrollers, let me also more broadly include automotive in that as well because that is a great opportunity that we are very well positioned with those products there.

Let's move to the next caller.

Tristan Gerra, Baird.

Your R&D spending as a percent of revenue is fairly low relative to some of your high value peers.

So what leads you to believe that you can maintain the growth, gain market share in the mix, or do you think that there is a possibility of raising your R&D over time?

Let me just remind everybody of the R&D that you're seeing for TI.

The R&D spend that we had in the analog segment has been a pretty consistent level versus the revenues of that business for quite a few years now.

The fact of the matter is, the reality is that the R&D spend is being compared fairly efficiently into revenue growth to the point where that business continues to outgrow its competitors and gain market share each year.

I would offer to you that that is actually a very efficient organization when it comes to its R&D spend.

I cannot explain why some of their competitors have to spend as much as they do.

Similarly in embedded processing, we've increased the spending over there as I mentioned to the last question, over the last couple of years, largely to expand the opportunities that we can pursue in the microcontrollers space.

After bringing up the level of spending for a couple of years now, I would say it is high enough at this point, and we now need to see it start converting into real revenue growth, which we are starting to see early signs of.

When you look at total TI R&D, it is coming down quite sharply, and that is purely a function of us winding down the legacy wireless products including the announcement that we had that we're closing some of our operations and sites as it relates to that.

And that will take our total R&D spend down as we go forward.

On the core products of embedded processing and analog, I have no hesitation of being comfortable with the level of R&D spend that we have in those areas today.

Tristan, let me also just offer, in the analog space, I would argue we are probably spend more than any of our competitors.

You are looking at a percent of revenue, but if you look at the absolute dollars, yes we are bigger in terms of revenue.

But we are spending more than any competitor that I am aware of in that space.

It is not like we are not investing in that business; we are investing quite heavily.

Do have a follow-on Tristan?

Certainly, that's very useful.

The part of your business that is not consigned business, so distribution, is your Q4 guidance embedding shipments about in line with on demand, or any variance that you can mention relative to on demand and fill in?

Tristan, I do not know that we have a real breakout in terms of the outlook between consigned versus non-consigned.

We're really looking at it just in terms of what we shipped in -- or what we're shipping into that channel.

I do not specifically know the answer to that.

I will point, if you back to the third quarter anyway as a reference plan, think we said TI total revenue excluding the legacy wireless grew 10% and our resales or sales out of the distribution channel grew 9%, so you saw very close alignment in third quarter.

I don't not have any specific data to share with respect to fourth quarter.

The other thing I will say even with third-quarter, we had a decline of a day of distribution inventory level.

Stacy Rasgon, Sanford Bernstein.

I had one quick one on OpEx.

Your R&D guide for the year still puts you about $1.5 billion, which would not -- which you said OpEx would be down like 4%, then the midpoint would imply R&D down like [12%].

Are you just rounding down to $1.5 billion, and could you give us a little more color on your expectations for the R&D and the assumptions around the OpEx?

Stacy, we do round to the nearest $100 million, on all of the guidance numbers we give you, be it R&D or CapEx or any others.

There will be some rounding inside there.

Keep in mind also the OpEx guidance I gave includes SG&A as well, and we will see that decline in the fourth quarter really on the seasonal patterns I mentioned a moment ago with the holiday periods coming on.

Around gross margins, sounds like you got a bit more restructuring left over from the 6-inch fab closures in Q4.

Have the benefits from those closures fully impacted gross margins?

I think in total it was supposed to be about 75 basis points.

And if they haven't fully impacted yet, can you give us some feeling for the trajectory of that impact on the margins?

Stacy, what we talked about when we announced that we were closing those two older 6-inch factories is that once each one of them was closed, we should see about [$50] million per factory of cost savings on an annualized basis.

One of those factories did close at the end of second quarter, and the other one should close here in the fourth quarter -- excuse me, third quarter.

So we're beginning to see in the third quarter already partial benefit from that, and we should begin to see the benefit from the second factory closure, which we realize in the fourth quarter.

Going into next year, we will begin to see that $100 million of annualized cost savings as a result of closing those two older factories.

Vivek Arya, Bank of America Merrill Lynch.

First one on the Q4 outlook, just wanted to make sure if there has been any downshift or conservatism regarding the Q4 outlook.

Because I think heading into the quarter there was an expectation that macro trends are improving, industrial businesses are doing better, the coms infrastructure build that the broader analog industrial players would be able to give above seasonal guidance.

Maybe it was optimism, but since then, we have seen seasonal or slightly below seasonal outlook from linear, from Cyprus.

And now you're also guiding somewhat below street expectation.

So my first question is, has there been any conservatism regarding Q4 outlook, and specifically what segment do you think would be at seasonal patterns versus below seasonal patterns for Q4?

I will go head and make some comments on that and let Ron add some additional color.

If you take a look at our guidance, midpoint of our guidance is down about 8% third quarter going into fourth.

About half of that is the seasonal decline that we normally get with the role off of the calculator business.

The other half is pretty much attributable to our underlying semiconductor business.

If you take a look at -- we actually believe that is probably quite seasonal and in fact quite consistent.

If you take a look as I mentioned in my prepared remarks, 2010, 2011, 2012, the semi industry as a whole, excluding memory, in fact has seen fourth quarter declines from third quarter in each of those past three years.

And based upon the guidance that we are hearing from some of the other competitors, ourselves included, t looks like we're setting up for a fourth quarter of -- a fourth year of Q4 declines.

In fact if you take a look at TI and extract out the wireless revenue, you will see that our revenues have gone down in the fourth quarter of each of those three years similar to the industry.

When you do the simple math during the last three years for the industry, it's down about 4%.

So in fact, I don't think that we are suggesting there is some changed outlook or changed future.

I would offer to you that fourth quarter appears to be shaping up quite normally to us.

We take a look at our third-quarter orders, they were actually up about 1% sequentially.

Our distribution inventory as Ron mentioned went down about a day, and they remain quite lean with our distributors as well as our other customers.

Our cancellations remain very low, and we have had no unusual requests for backlog push outs.

When we put all of that together, that suggests to us that fourth quarter is shaping up to be a normal demand environment similar to what we have seen for the last three years.

I think the thing I would add is even when we talked at the mid-quarter update, somebody asked questions about order trends.

And I remember saying at that point that orders quarter-to-date have been strong.

Book-to-bill was above 1, but that we expected that to slow as we approached to the end of the quarter, basically as we -- for a couple of factors.

One, seasonality in general, both calculators as well as semiconductors.

Don't -- was there slowing through the end of the quarter?

Yes.

But also we expected that slowing would occur, and it pretty much happens almost every year and certainly has happened as Kevin just pointed out each of the last three years.

You have a follow-on?

Very helpful clarification.

As my follow up, I just wanted to make sure, Kevin, did you say that tax rate for Q4 will be 24% or for the full year would be 24%?

And then the real question is on dividends and buybacks, think you mentioned that they have been 133% of free cash flow over the last year.

How long can they stay at those levels, and should we expect them to turn back to whatever -- closer to the 100% target that you have outlined as a longer term target?

The 24% effective tax rate is what you should use for the fourth quarter.

With the various things occurring during the year, the entire year will be a little bit different than that, but for planning purposes, use 24% for the fourth quarter.

I would remind you that that tax rate includes the R&D tax credit, which is set to expire at the end of this year, and it is unclear whether or not that will be renewed by Congress in a timely fashion as we get in 2014.

For us, that provides about a 2% benefit to our taxes.

So absent that R&D tax credit, we would be closer to a 26% tax rate as opposed to the 24% that we are suggesting you use for fourth quarter.

As it relates to buybacks, I would just mention that again, the reason it's been as strong as it has been, the buybacks and dividend at 133% of our free cash flow is a function of not only improving free cash flow which we certainly have seen, but also the benefit the company receives when employees exercise their non-qual stock options.

And given the increases in the stock prices this past year for our company, we've seen an increase in employee stock option exercises.

Just to give you a few numbers to summarize that, to recharacterize what I mentioned in my prepared remarks, our free cash flow for the last 12 months was $2.87 billion.

Proceeds from employee stock options was $1.28 billion, so that means we have sources of cash over the last 12 months of $4.15 billion.

We used a return to shareholders in the form of dividends and buybacks, $3.82 billion, then we paid off debt earlier this year of $500 million.

So we've used a total of $4.32 billion.

We have virtually used all we have generated this past year.

We do that because one of the things we mentioned at our capital management strategy is we have a model for how much cash that we carry.

To the extent that we generate cash beyond that model level, we are quite comfortable with returning that to shareholders as we have been doing.

As to the ability of that to continue to run at those high levels, that is a really hard call.

I would say that stock options do expire over time, and these are generally 10 year stock option grants of that are granted to employees.

So quite a few these options are quite old, and they get used up.

I would expect that as we move into the future, we are apt to see less extra cash coming in from stock option exercise.

I think it is almost impossible to try to forecast the magnitude of that change.

Steve Smigie, Raymond James.

I was hoping you could comment a little bit on Silicon Valley Analog here in terms of where we are on your three year plan.

And if you do not have it available this quarter, would it be possible on the mid-quarter update to talk about where the revenue is there just so we can see where it was relative to where you guys acquired it?

Steve, I would say with Silicon Valley Analog, first off on the side of revenue, we disclose revenues at the segment level, and we don't disclose revenue below that.

So we won't be offering the actual revenue figures for SVA.

But if I were to talk about where are we at with respect to our expectation for SVA versus when we acquired National Semiconductor, I would say that the overall revenues are probably a little bit lower than we initially expected at this point in time given the overall market environment that we have been faced with these past few years.

However, the rate of progress on share gain has been quite a bit faster.

As we mentioned during the last call, those product lines are actually gaining share about a year faster than we had expected.

In addition, we have had more cost synergies than we modeled into the acquisition.

We had lower interest expense on very low-cost debt we have been able to issue, and we have substantial benefits from taxes as a result of the acquisition.

When you put it all together, the profit that we are achieving on the National Semiconductor portfolio today is very close to what we have modeled at this point in time, so I would say we are reasonably satisfied with the bottom line impact.

Steve, even though we did not break out revenue quarterly, I can give you a rough breakout for the subsegment for the analog for 2013 year to date.

HVAL 35%, power 25%, and then HPA and SVA are each about 20% of total analog revenue, and again that is year to date.

Did you have a follow-on?

Thanks a lot for that clarity there.

Just if we could follow on in terms of acquisition strategy in general, if you look at the microcontroller business overall, it is still fairly fragmented out there.

And also in the analog side, you guys talked a lot about gaining share and perhaps accelerating that through an acquisition.

Is there anything substantial you might do on either side there to change your position or any sort of substantial weight at this point or is it more organic growth from here?

Steve, I think most of our growth for the foreseeable future is going to be organic.

To the extent that we do continued looking at acquisitions, given the valuations that we presently see with many companies that might be an attractive addition to our portfolio, it is difficult for us to look at what we might have to pay for some of those acquisitions and actually get a reasonable return on the investment for our shareholders.

That suggests to me that to the extent that we are doing acquisitions, they're probably going to be smaller tuck-in ones, though probably come with reasonably good product lines to fill in holes we have or talented engineers to help with our R&D efforts.

It's probably going to be biased towards analog.

One of the problems when you go into the microcontroller side s you start getting different architectures into your family of products, and that can add complexity that may not be easy to leverage.

That is not to say that we wouldn't look there, but these are just the odds that the microcontroller would be a tuck-in acquisition.

David Wong, Wells Fargo.

Your guidance for EPS and revenue next quarter, does it assume that gross margin will be flat to slightly down with lower revenues, or does gross margin keep rising?

I think inherently with the revenue decline that we are expecting the fourth quarter will be reducing the loadings in our factories a little bit.

So you would expect underutilization charges would probably increase a bit and have a corresponding impact on gross margins declining a bit in the quarter.

Great, and a minor thing.

You noted that your cash is slightly on shore, so you have no problem returning to shareholders.

How do you get your tax rate down to 24%, so far below US tax rate and still generate primarily US cash?

I would first just comment that I do not really think our tax rate is all that low.

24% is an awful lot of money for having to send to the tax collectors.

But that aside, tax is inherently pretty complex.

And there's a lot of things that can affect the tax rate, and especially a company's somewhat unique global footprint.

Our footprint on a global basis including the benefits that we got with the National acquisition is allowing us to have a relatively effective current tax rate and further enable us a pretty high repatriation of cash.

And as you noted, we took most of our cash home, and we just ended this past quarter with 82% of our cash onshore.

For planning purposes as we look into the future, we assume the US tax rate stays about the same incrementally at 35%.

We just model that on a go forward basis from a repat standpoint.

Our objective again is to maintain 80% or more of our cash onshore so we have it available to use for our shareholders for dividends and stock buybacks.

Tore Svanberg, Stifel.

First one for Kevin, you have about [$4.2] billon in long-term debt, and I think you have about $1 billion in non-payable.

Can you just remind us what your plans are right now as far as paying back that debt, especially timing?

Tore, we do have in short-term debt $1 billion that comes due on May 15, 2014.

We had postured in our capital management strategy discussion back in February that debt clearly is going to be a portion -- part of our capital structure for quite a long time, especially given we've got debt that goes as far as 10 years out.

We will continue including debt in our capital structure, rolling over portions of our debt if economics made sense.

To us, the definition of the economics making sense is if we can issue new debt at rates that are even below our impression of what the inflation rate would be or below our dividend yields.

With that in mind, I cannot forecast exactly what we will wind up doing when May comes around, but clearly we'll be prepared to pay off that $1 billion if we need to.

But if the economics make sense, we may very well decide to go ahead and replace that with new debt.

Follow-on for you, Ron, I don't know if you'll answer or not, but any comments on which end markets will do in a relative basis in the December quarter?

No, but I will give you a consolation and talk about what they did in the third quarter.

In the third quarter, this is not a fourth quarter comment, industrial as we pointed out grew and continue to be strong.

Automotive grew, for us being driven mainly by infotainment and advanced driver systems such as blind spot detection, parking assist, lots of those cool things you see on car commercials these days and aspire one day to have a car that actually does that.

Computing, note books were weak, and tablets a grew.

I heard some competitor talking about weakness in tablets.

Don't know where that came from, they were strong for us.

Coms infrastructure, the big word was China and third-quarter operators in fact started deployment, released contracts.

Two thirds of those contracts went to China OEMs, one third to European.

I'll note that we sell to both, and maybe different products to different players, but we expect to continue to enjoy participation in that China business.

Small cell trials are continuing.

What I would say is first deployments we expect to happen probably call it mid to second half of next year.

Handsets, probably the good news there is now it's up [2%] of our revenue as legacy wireless keeps going down.

Consumer, good recovery in the revenue there after some of the inventory reduction in second quarter.

It is probably a game console comment mostly, digital television continues weak.

Again, sorry I didn't answer the question, but hopefully there was some value there.

Patrick Wang, Evercore.

One question for me, can you help us understand the underutilization charge in Q3?

What you see for utilization in the fourth quarter I guess in terms of that charge.

And then also what you plan to exit the year with in terms of inventory both on the balance sheet and in the channel?

Patrick the underutilization charge in third quarter was about $70 million.

That is it down from about $100 million in the prior quarter.

As I mentioned with reductions in our factory loadings expected during the fourth quarter, I'd expect that charge to go up.

I won't give you a forecast of exact number just yet, that will be a function of exactly what our footing is at the end of the quarter.

As it relates to inventory, our model for inventory is to carry between 105 and 115 days of inventory.

We just closed the current quarter with 106 days, so we have got room that we probably want to take those days up a little bit more.

And with the slowdown in [van] in fourth quarter, that seems like an opportunity for us to bring those inventory days up a little bit as we get ready to enter 2014.

Patrick, I think I understood you to say basically you have got all of your questions in there.

To get more callers, we will move on.

Ambrish Srivastava, Bank of Montreal.

I apologize, don't want to put you on the spot, but I'm getting a lot of e-mails, and I am confused, investors are confused.

Going back to the mid-quarter update, I think you did say that long-term seasonality is [eight], but then you also said the variability's a lot.

So the right way to think about it is the decline of 4% over the last two years, or the last four-year average.

Is it that we misinterpreted that and walked away thinking -- not that I was modeling down 4%, but this tree was clearly higher than me and hence the [decalsoft] question.

Did we misinterpreted your comments or did something change in the quarter?

I think the key to looking at that -- and all of that is exactly true.

If you look at five year average, it is down 8%.

If you look at the last four years and take I think it was fourth quarter 2008 out, it is down 4% I think which you hear us talking about here if you look over the last three years, I think in the case of the industry and CI were both something like down 9%.

The difference is just that -- the only real difference in terms of how we are discussing our own data is I think a meaningful change to say if you take legacy wireless out.

And that was obviously three years ago, four years ago, a very significant part of our revenue mix.

Today it is an insignificant part of the mix.

Any impact that has on seasonality going forward, frankly is -- what it did in the past is relevant to our future.

That is really the distinction that we are making at this point.

Do you have a follow-on?

Just to look forward now, now that the legacy business will be gone when we go into next year, what should we be thinking about the normal seasonal patterns?

And I'm sure you'll answer it, and we will come back and ask you again for the four quarters.

The math I have done is I think if you look at first quarter and you take legacy wireless and you look at the last three years, it is flattish.

But what I will encourage you to do n-- I think we have all of the data out on our website, and that would be a great project for you to work on tonight and publish in your note tomorrow.

That will be a lot of value added in that.

Again, I will refer you to the data and let you do the math.

Jim Covello, Goldman Sachs.

I will stick with the theme of a couple callers ago and stick to one question.

There has been a lot of activity in the analog segment lately relative to sensors.

There's been some M&A activity in some of the analog peers this year that have grown in excess of the markets -- have grown because they have gained some share or had some opportunity in the sensor market.

How do you feel about the position in that market?

Where do you see you guys going there?

I do not know that -- probably the one thing I would say, Jim, in that sensing space -- and obviously there are lots of different types of sensors and they are different.

But I think at some time in the last month anyway, a few weeks, we did an announcement really of a breakthrough product category in inductive sensing, which is basically in entirely new class of data converters.

That truly is innovative, that truly is breakthrough.

That being said, when you look at the size of TI in our portfolio of 100,000 products, it can be a breakaway success and it's not going to have a big impact on TI in terms of moving the needle.

I think it is a great example of the kind of innovation that has been taking place at TI over the last decade and why you see just consistent share gain from our company.

A lot of people talk about innovation, and a lot of times, that is spun up in technical terms.

We've really simplify it and measure it by our reproducing and innovating and developing products that customers want, and we really let our market share tell the story back, provide feedback of whether we are providing innovation that is valued by our customers.

That is one example, a little broader than your sensing question, but absolutely a great space, and we are right in the middle of it.

Glen Yeung, Citi Group.

Ron, when you look at the activity that your cancellations are pulling, things you might not normally expect to see in the context of a set of orders, are you seeing anything there that is unusual either one way or the other from your customers?

No.

Cancellations remain at what we would call very low-level by historical standards, and that is part of the reason why we really feel this is a -- we're coming up on a pretty seasonal fourth quarter.

Were not seeing anything in the cancellation front for example that would indicate it is anything weaker than normal.

I know a lot of people maybe were worried about what is the effect of the government shutdown, is that showing up in customer demand or anything like that.

I am not sure we have perfect visibility there, but we sure didn't see backlog being pushed out by customers.]

We did not see a higher rate of cancellations, which we think are both meaningful indicators.

Did you have a follow-up, Glen?

As a follow-up, as I'm looking at the reported gross margin, there are almost around 150 basis points more than what consensus is modeling for next year's gross margin.

And I recognize there's some movements in revenue, hence utilization will affect that.

As we think about the puts and takes, assuming that next year is even a modest growth year for semiconductors.

If we think about the puts and takes on gross margins, what could the consensus do you right, i.e.

gross margin down 150 basis points from current levels or is consensus seeing things wrong?

I guess I would just remind people as you put your models together, couple of things.

We look at what is going to drive our gross margins going forward.

keep in mind that as we fill these very cost effective factories that we acquired over the last couple of years and especially as we fill them with a higher mix of industrial and automotive end market type products, we are going to see margins continue to be pretty healthy.

Another important point to keep in mind is that depreciation today is running about 400 basis points ahead of capital expenditures.

So by definition, that means depreciation will start to work itself down over the next couple years, and that by itself will be a boost for gross margins.

Those are probably the three things I would point to.

And that is, again as we grow and fill up those factories, as we improve our portfolio mix especially industrial automotive, and as depreciation declines over the next few years on these lower levels of CapEx, those together should provide nice tailwinds to our gross margins as we go forward.

To the scenario that Glenn talked about, if 2014 has any kind of reasonable growth or any growth at all, given those tailwinds it doesn't sound like the street that they are modeling down 150 basis points on gross margin, that does not sound consistent with what you just described, is that right?

It sounds inconsistent, but it would also suggest that you are missing how much free cash flow we're going to generate next year.

I think, operator, we're going to try to squeeze in one final caller and then we will wrap it up.

Ross Seymore, Deutsche Bank.

Kevin, you just talked about some of the puts and takes for gross margin for next year.

From the $800 million roughly level your core OpEx in the fourth quarter of this year, ex charges, restructuring, et cetera, what sort of OpEx puts and takes should we think of heading into 2014?

The simplest thing I would suggest is that clearly the people who are in R&D and SG&A, the OpEx bucket as we call them, are correctly anticipating the pay increases in 2014.

So we will certainly see the effect of that.

I would probably also remind you that in first quarter, our OpEx typically is seasonably up from the fourth quarter, and that is a function of two things.

One is the absence of the holiday of the holiday periods we see in the fourth quarter.

And the second is the annual pay and benefit increases that begin to take effect in the first quarter and take full effect in the second quarter.

Again, I would expect the spend rate as we go into next year begin to increase coming off of a low fourth quarter.

Year-over-year, given the wind down of legacy wireless, probably still year over year attractive within our OpEx model in the 20% to 25% range, probably -- 20% to 30% range of revenue, excuse me, being at the lower edge of that range.

Ross, maybe shorter term, fourth to first OpEx typically goes up because of the pay and benefit increase that Kevin described that kicks in in February, but also just fewer holiday and vacation days taken in first quarter compared with fourth.

Fourth we see the benefit from those holidays and vacation days, but sequentially then it tends to work against us in the first quarter.

In general we're going to stop there.

Thank you for joining us.

A replay of this call s available on our website.

Good evening.

That does conclude today's call.

Thank you all for your participation.