德州儀器 (TXN) 2014 Q2 法說會逐字稿

Good day, and welcome to the Texas Instruments second-quarter 2014 earnings conference call.

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

Please go ahead, sir.

Good afternoon, and thank you for joining our second-quarter 2014 earnings conference call.

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

In addition, Dave Pahl has joined us.

As many of you know, I will retire in August, and Dave will replace me as Head of Investor Relations.

Dave has worked at TI for 25 years and has worked directly with me in Investor Relations for 10 years.

With that consideration, you probably should allow him some time to come up to speed.

Dave has also been recently elected by TI's Board to the position of Company Vice President.

Dave will moderate today's call.

With that, let me turn it over to Dave.

Thank you, Ron.

It's good to join you today for the call.

And now down to business.

For any of you who missed the release, you can find it and any relevant non-GAAP reconciliation on our website at ti.com/ir.

This call is being broadcast live over the web and can be accessed it 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.

The second quarter was another solid quarter.

Our core businesses of Analog and Embedded processing grew strongly, with combined revenue up 14% from a year ago.

We continue to benefit from our investments in industrial and automotive, as these important markets continue to grow as a percentage of our revenue.

Revenue of $3.29 billion came in slightly higher than the middle of the expected range we communicated to you in April.

Earnings per share of $0.62 were near the top of our expected range, as profitability was stronger in the quarter.

Free cash flow of $3.2 billion, or 25% of revenue, for the trailing 12-month period, was right in line with the 20% to 30% range in which we expect to operate over time.

Also over the past 12 months, we returned $4.2 billion of cash to investors through a combination of dividends and stock repurchases.

As a reminder, our model for cash returns to shareholders is to return all of our free cash flow, less the net debt amount that is retired, plus any proceeds we receive from exercises of equity compensation.

This model demonstrates our confidence in TI's business and our commitment to return excess cash to our shareholders.

In the second quarter, TI revenue grew 8% from a year ago, with double-digit growth in both Analog and Embedded Processing.

Analog revenue grew 14% from a year ago, primarily driven by power management.

High-Performance Analog, High Volume Analog & Logic, and Silicon Valley Analog also grew.

Embedded Processing revenue grew 14% from a year ago, primarily due to processors and microcontrollers, both of which grew about the same amount.

Connectivity grew at a faster rate, although it was coming from a much smaller base.

Embedded Processing delivered its 7th quarter in a row of year-over-year growth, as our investments over the past few years in strategic areas are yielding favorable results.

In our other segment, revenue declined $90 million, or 13%, from a year ago due to legacy wireless, which is essentially gone.

Turning to distribution, re-sales increased 15% from a year ago, while distributors' inventories were about even.

Weeks of inventories fell by several days to just over 4.5 weeks.

This reduction was driven by a higher percentage of re-sales being supported by TI's consignment inventory programs.

From an end-market perspective, most growth from the year ago came in communications equipment, followed by automotive and industrial.

Enterprise systems was also up, while revenue and personal electronics declined, due to mobile phones and tablets, areas that use legacy wireless products from TI.

Now, Kevin will review profitability, capital management, and our outlook.

Thanks Dave, and good afternoon, everyone.

Gross profit in the quarter was $1.88 billion, or 57.1% of revenue.

Gross profit increased 20% from the year-ago quarter, and gross margin hit another new record.

When compared with the previous record in the third quarter of 2013, revenue was $48 million higher and gross profit was $102 million higher.

This reflects an improved product portfolio focus on Analog and Embedded Processing, as well as increased efficiency in our manufacturing operations.

Moving to operating expenses, combined R&D and SG&A expense of $821 million was down $39 million from a year ago.

The decline primarily reflects the reductions in legacy wireless, as well as continued cost discipline across TI.

Acquisition charges were $82 million, almost all of which were the ongoing amortization of intangibles and non-cash expense.

Restructuring and other charges were a $4 million benefit.

As a reminder, the year-ago quarter included the gain of $315 million associated with the transfer of wireless connectivity technology to a customer.

Operating profit was $982 million, or 29.8% of revenue.

Operating profit was up 8% from the year-ago quarter.

Net income in the second quarter was $683 million, or $0.62 per share.

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

Cash flow from operations was $775 million in the quarter.

Inventory days were 111, consistent with our model of 105 days to 115 days.

Capital expenditures were $80 million in the quarter.

On a trailing 12-month basis, cash flow from operations was $3.59 billion, up 8% from the same period a year ago.

Trailing 12-month capital expenditures were $388 million, or 3% of revenue, even lower than our long-term expectation of 4%.

Although we've been able to keep capital expenditures at this low level, we continue to invest to expand both our capabilities and our capacity.

As examples, capital expenditures in second quarter included the cost to prepare the site and install the first tools into our new assembly and test facility in Chengdu, China.

We completed manufacturing our first units there for qualification purposes.

In addition, we brought on additional tools to expand capacity in our 300-millimeter facility in Richardson, Texas.

We are able to make these investments and keep our capital spending at low levels because of our strategy to invest in capacity opportunistically and ahead of demand.

Free cash flow for the past 12 months was $3.20 billion, or 25% of revenue, in the middle of our expected 20% to 30% range.

Free cash flow was 10% higher than a year ago.

Depreciation expense for the past 12 months was $856 million.

Depreciation exceeded our capital expenditures by $468 million, or 3.7% of revenue.

We continue to expect to hold capital spending at low levels, or at about 4% of revenue.

As a result, the depreciation will decline to the rate of capital spending and our gross margins will directly benefit.

As we've said, we believe strong cash flow growth, particularly free cash flow growth, is most important to maximizing shareholder value in the long term, and will be valued only if it's return to shareholders or productively reinvested in the business.

To that end, in the second quarter TI paid $323 million in dividends and repurchased $743 million of our stock, for a total return of $1.07 billion.

The shareholder return part of our capital management strategy is to return all of our free cash flow, minus that retirement, plus any proceeds that we receive from exercises of equity compensation.

Total cash return in the past 12 months was $4.2 billion, which was 18% higher than a year ago.

Dividends were up 32% and stock repurchases were up 13%.

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

We ended the second quarter with $2.80 billion of cash and short-term investments, down from $4.03 billion at the beginning of the quarter.

The decline mostly reflects the use of $1 billion to retire debt in the quarter.

TI's US entities own 82% of our cash.

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

TI orders in the quarter were $3.33 billion, up 7% from a year ago, and our book-to-bill ratio was 1.01, which would have been higher, but was impacted by the conversion of consignment of some products that are sold through distribution.

Turning to our outlook, we expect TI revenue in the range of $3.31 billion to $3.59 billion in the third quarter.

At the middle of this range, revenue would increase 6% from a year ago.

If you exclude the $57 million in legacy wireless revenue from the year-ago quarter, revenue would increase 8%.

We expected third-quarter earnings per share to be in the range of $0.66 to $0.76.

Restructuring charges will continue to be essentially nil.

Acquisition charges, which are non-cash amortization charges, will remain about even, and hold at this level for the next five years.

Our expectation for our effective tax rate in 2014 remains about 28%.

This is the tax rate you should use for the third quarter.

In summary, the second quarter demonstrates the strength of TI's business model, focused on Analog and Embedded Processing, which we believe are the best opportunities inside of the semiconductor market.

We continue to invest in areas that offer sustainable growth, solid profitability, and good cash flow from operations.

The percentage of our business from industrial and automotive markets continues to grow, as customers increasingly embrace technology that makes end products smarter and more connected.

At the same time, we continue to invest in our manufacturing capabilities, and our strategy to opportunistically acquire manufacturing assets means that we can deliver strong free cash flows.

We continue to demonstrate, as we did again in the second quarter, our commitment to provide strong returns to our shareholders in the form of dividends and share repurchases.

With that, let me turn it back to Dave.

Thanks, Kevin.

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

(Caller Instructions)

Go ahead, Renee.

(Operator Instructions)

John Pitzer, Credit Suisse.

Yes.

Good afternoon guys.

Congratulations on the strong results.

Kevin, I guess my first question is on OpEx.

For the June quarter, going into June you guided that OpEx would be flattish Q-on-Q, and you did better than that.

I'm curious, is that a pull-in of the $130 million of annualized savings you expected from the restructuring?

Or is that just a bigger number than $130 million, and how do we think about OpEx trending in September in the back half of the year?

Yes, John.

You're right.

The OpEx we had expected to be roughly even from first quarter to second quarter, and in fact, came in a bit lower than we'd expected.

Part of that was some pull-in with the restructuring actions that we announced in the first quarter for both Embedded Processing and the resizing of operation in Japan.

Part of it was just continued discipline on the part of all the business units in TI when it came to spending.

As you look into 3Q, we continue to expect the second half to be the primary benefit of the cost savings that we talked about for those restructuring actions.

Recall that we expect about $130 million of annualized savings, with about 85% of that in OpEx and the balance in cost of revenue.

So, as we go into third quarter, we'll see probably about half of that come out -- come into our results in OpEx, with the balance in fourth quarter.

So by the time we leave the year, we should be at an annualized $130 million cost savings from that action.

Do you have a follow-up, John?

Yes, that's helpful Kevin.

As a follow-up, I know this is somewhat of an unfair question, but if you look at the proceeds from equity compensation, last year it was almost about a third of the cash returns to investors.

I know that's been a volatile number and probably a number that's impossible to predict, but I'm curious, how should you think we should think about that number going forward from here?

How do we try to model that number in the future?

John, we talked in during the update to our capital management strategy that going forward, we would expect the proceeds from stock option exercises to reduce considerably.

We saw -- gosh -- I guess it was probably two to three times our normal rate of stock option exercises and cash proceeds in 2013 than we'd seen in prior years.

We had talked about that going forward, that would probably come back to a more normalized level.

I would suspect that what we saw last quarter, what we saw this quarter, probably is more reflective of what you should model going forward.

Figure about -- I think we saw about 4% or 5% of stock options exercised last year, and that will probably drop back down to 1.5%, 2% level.

Okay.

Thank you, John.

Next caller, please.

Jim Covello, Goldman Sachs.

Great work guys.

Thanks so much for taking the question.

I appreciate it.

Could you just give us some perspective on the broader cyclical environment?

Would you say there's anything at all going on other than normal, and maybe break that down by subcategory a little bit?

And I'll leave that as both questions and pass from there.

Thanks.

Okay, Jim.

I think that we don't have any unique insight into what's going on from a cyclical standpoint.

I think that the quarter that we just delivered, we feel good about.

If you look at the middle of our range into third quarter, 8% if you're excluding legacy wireless is another good quarter on a year-on-year basis.

If you look at a lot of the signals that one would pay attention to, such as inventory inside of the channel, we took several days out of inventory in the quarter, as we had a higher percentage of revenues afforded by our consignment programs inside of distribution.

And if you look at cancellations, they continue to remain at very, very low levels.

We think inventory at customers remains in check, as well.

And then if you look at our lead times, they continue to remain stable.

We'll always have some pockets where they may move out temporarily, but with our capacity and the position of our inventory, we feel really good to be able to continue to support that.

So, you have a following question?

Dave, the shoved the verticals -- any differences by vertical?

No.

I think that from a year-on-year standpoint, we had -- if you look at industrial, we had growth in nearly all the sectors.

So, very broad-based from that standpoint, led by areas like factory automation.

Automotive, we had double-digit growth in all of our sectors, led by ADAS, or Advanced Driver Assist Systems.

Personal electronics was down, but it would've been up, had it not been for legacy wireless.

Our enterprise systems, we saw growth, driven by projectors and servers.

And coms equipment was up, due to wireless infrastructure.

So, really, broad-based growth on that stand.

Okay.

Thanks.

We'll go to the next caller.

Stacy Rasgon, Sanford Bernstein.

Hi guys.

Thanks for taking my questions.

First, I want to dig into your margin trajectory.

Your incremental operating margins for Analog and Embedded Processing both exceeded 100% sequentially in the quarter.

Your Analog business also has about 100% incremental operating margins year over year.

I guess the strong performance, particularly in Analog, surprises me a little bit.

I had thought most of the cuts you did were in Embedded Processing.

So, I was wondering if you could give us some sort of view on what's driving that strong incremental on margins.

How much of that is gross margin expansion within the businesses versus OpEx?

And what do you see as sustainable levels of incremental operating margin going forward as the revenues in the businesses continue to grow?

Stacy, the fall-through is very good, both on a quarter-over-quarter and a year-over-year basis, certainly at the Company level and at the segment levels.

I'd mentioned on the first call from John that from an OpEx standpoint, funding remained discipline across the Company.

While the restructuring action that you refer to will disproportionately benefit Embedded Processing versus other areas of the Company, some of that will also -- some of that restructuring will benefit other areas of the Company as well.

For example, we mentioned resizing our sales team in Japan, and that's not just the sales team in support of the Embedded Processing, but also those in support of some of the other business units.

So you get a little bit of benefit there, but then you really got just disciplined spending across the Company, as frankly, people are spending only what they need to support the growth of the business.

On a go-forward basis, again we expect OpEx to be down a little bit sequentially, primarily for the benefit of Embedded Processing.

That'll be true for both the third and fourth quarter.

Beyond that, I don't know that I'd give you any more specific forecast on OpEx, other than by the time we've reached the end of the year, we will enter next year with OpEx total cost savings from the restructuring about $130 million, about 85% of that coming of OpEx.

Got it.

That's helpful.

For my follow-on, I want to dig into gross margins just a little bit.

If I take that half of the $130 million hitting you -- or 85% hitting you by next quarter, sounds to me like you're guiding OpEx down about 2%, which would give me an implied gross margin guidance at the corporate level -- call it into the upper 57%.

So up maybe 500 basis points, maybe even a little more from Q2.

If you could give us just some view of what's driving that gross margin expansion?

Is this just further efficiencies -- manufacturing efficiencies?

Is this just depreciation coming down?

Is this something else to do with mix or pricing, or just overall revenue leverages are up as revenues grow?

I think it's a little bit of all of that, to be quite frank, Stacy.

If you take a look at -- as we go forward on gross margin, there's multiple drivers inside the portfolio, not the least of which is being able to load or fill up our very cost-effective factories.

We also get improved product mix, especially as we see industrial and automotive becoming a larger portion of our total revenue mix.

And finally, we get the benefit from depreciation as it begins to roll off, being that the CapEx is running substantially below depreciation now for quite some time.

Again, just as a reminder, depreciation was about 7% of revenue over the last 12 months, and CapEx is expected to be around 4%, so we've got some closure that'll start happening over the next couple years.

Depreciation this year is expected to be down a bit versus last year, but it will start to climb more rapidly next year.

You've got a number of different things going on, not just next quarter, that will move gross margins up again, as you indicated.

But should also continue to benefit us as we look out into the balance of the year and going into 2015.

Great.

Thank you, Stacy.

Operator, we can go to the next caller, please.

(Operator Instructions)

Blayne Curtis, Barclays.

Hey, good afternoon.

Thanks for taking my question.

I was wondering what utilization was in the quarter and where you expect that to go?

The second part of my question, as you look into December, typically seasonally a softer period, things seem fairly normal.

I was wondering your thoughts on just seasonality into December.

I'll mention -- I'll talk to utilization and Dave will talk to seasonality there.

Blayne, we look at utilization 2Q to 3Q.

We don't expect that to really change all that much.

As we have -- our wafer starts not too far off from what we saw in the first quarter -- excuse me, the second quarter.

And what we started the second quarter will come out of the factory in the third quarter.

So overall utilization, unlikely to change all that much as we look into the near term.

From a seasonality standpoint, Blayne, essentially, we're going to let you determine what you believe seasonality is.

Just a few things to consider as you go through that.

Obviously, calculator revenue is usually strongest in second quarter and third quarter with the back-to-school buying period.

And you saw that in our results this quarter.

Our semiconductor growth is typically relatively stronger in the second and third quarters compared with the first and fourth.

Outside of that, we don't put much credence on a specific sequential growth number, just because the numbers around that have been so unpredictable.

We're just going to step back from trying to provide any appearance of doing math on it, because it will appear that we're endorsing one number over another.

Do you have a follow-on, Blayne?

Just wondering maybe in the September quarter, a similar question, whether outside of calculators there's any areas of particular strength or weakness?

You had mentioned com had been a strong point.

Is that sustaining?

And then it seems like autos, as well, have held in there better.

Usually a seasonally weaker second half, but seems strong.

Any comments there?

Yes.

Sure.

Other than the top-level guidance, we don't really get into strength or weakness by sector.

If there's something very unusual going, on like with our legacy wireless, of course, we've given visibility into those types of things in the past.

So with that, we'll move to the next caller.

Doug Freedman, RBC Capital Markets.

Hi, guys.

Thanks for taking my question.

And before I begin my question, Ron, it's been great working with you, and best of luck in retirement, before I forget to say that.

Going into the numbers, if you could talk a little bit about your strategy to increase free cash flow.

When we look at what's going on with your balance sheet, you're getting pretty close to getting a debt level that might be good to carry that debt and stop retiring it, or maybe just start rolling it forward.

Can you maybe talk a little bit, Kevin, about your strategy there?

Well, the strategy is less about debt and more about the actual product portfolio and the markets that we're going after, Doug.

It's really about being sure that we're thoughtful in how we spend our research and development dollars, and that we spend them on products that we expect to have very long revenue life streams off of them.

In correlation with that is to continue to be opportunistic and to expand our manufacturing capacity at times when you may least expect us to do that, because we can get it for costs that are very low.

That's are our two biggest levers for expanding cash flow.

As it relates to that, going forward, as you observed, we just paid off a net of $500 million this year.

We raised $500 million in the first quarter and repaid $1 billion in the second quarter, so a net reduction of $500 million.

We still have on the balance sheet total debt of about $4.625 billion, and those actually have lives that extend all the way out to 2023.

So I don't see a balance vanishing -- or debt vanishing from our balance sheet anytime soon.

On a go-forward basis, of course, our buyback -- I think that was one of the things you were asking about on a free cash flow -- is really a function of what our calculation of net present value of the Company is.

And so long as we see that the intrinsic value of the Company exceeds the market value, we'll continue to be buyers of the stock.

Okay.

Doug do have a follow-up?

Yes.

What role will M&A possibly play?

And when do you think -- is there an opportunity to reenter the M&A market?

You guys really have not been active since the National Semi deal has closed.

When it comes to M&A, and again it's about product strategy, our bias is likely to be, should we find an opportunity that would be attractive to us, our bias would probably be in the Analog space as opposed to Embedded Processing.

And frankly, aside from the technology that we acquire or the product opportunity that we acquire being attractive, meaning along revenue streams, it would also have to work for us mathematically.

Meaning that the price at which we could acquire it would have to be such that we could get a return on our invested capital inside a three- to four-year period, and we're pretty disciplined about that.

Some of the opportunities that some have speculated on here in recent months are such, if you do the math, it's very difficult to overcome that hurdle of making sure it's ROIC-accretive.

And we think that's very important if we're going to actually generate excess cash flow and free cash flow off of any acquisition in the future.

Okay.

Thank you, Doug.

Operator, next caller, please.

Joe Moore, Morgan Stanley.

Great, thank you.

Wondering if you could touch on the strengths that you had alluded to in communications equipment in Q2.

Is that macro base stations, or is there some other element of that?

Yes.

The majority of that is -- would be macro base stations.

If you look at investments that we're making longer-term, that will include small cell, but we really don't have measurable revenue on products like that at this point.

Okay.

Thanks.

And as part of the Embedded restructuring that you had done, it sounded like you were pulling back on some of the investing in that category.

Does that change your trajectory at all, or does that mean you participate less in base stations over time?

No.

I think if you look at those investments and those product cycles, they tend to have -- they tend to be very long in nature.

The areas that we pull back tend to be areas that we now believe are either mature, or in the process of maturing.

And yet we continue to invest in areas that will drive growth in the future, such as small cells, as I indicated before.

Thank you, Joe.

We'll go to the next caller, please.

Ambrish Srivastava, BMO.

Hi.

Thank you.

A question on CapEx, Kevin.

Capital intensity has been fairly below the 4% that you had said you would be.

What should we be modeling for the remainder of the year, and more importantly, what would cause it to deflect to move inflect upwards?

Yes, Ambrish.

Again, I think for purposes of your models, I would just assume about a 4% of revenue planning.

It's going to get you pretty close to probably the right answer over time.

In any one quarter, I'm sure it's going to be off, but it'll be okay on a rough annual period.

Anything that may cause us to go above that could possibly be, if we had a sudden opportunity present itself, if we could add capacity at a significant cost savings.

We wouldn't let that 4% artificially restrain us from taking advantage of very inexpensive manufacturing capacity, which would benefit our future free cash flow.

But right now, I don't see that on the horizon.

Again, for your model, I'd probably just use 4%.

Okay.

And my quick follow-up, Dave, you mentioned that consignment as a percent of sales has changed.

What hasn't gone back up, and I remember it used to be in the mid-40s before?

Yes.

If you look overall, our consignment as a percent of revenues has moved up a little bit from about 45% to about 50%.

If you look inside of our distribution channel, so about 55% of our revenues are go-through distribution.

And about 55% of those revenues are supported by consignment.

So that's really the part that's beginning to drive that higher, and our inventories that's owned by distributors lower.

Thanks, Ambrish.

And we go to the next caller, please.

Christopher Rolland, FBR Capital Markets.

Hey, guys.

So your extra capacity at the bottom of the cycle may have been a bit of a burden, but can be very valuable as the cycle heats up here.

Do you think we're at the point in the cycle when you guys are benefiting from that extra capacity, either front end or back end?

Do you think that some of your competitors might have a lack of capacity there and might be switching to your products?

Christopher, clearly we had the strategy in place now for a number of years, where we're requiring, as inexpensively as we can manage to in advance of our needs.

The most recent example was the acquisition of an assembly test operation in Chengdu China that I commented on earlier in the call that we're now bringing online.

That has certainly been a benefit to us to allow us to have very stable lead times on behalf of our customers and to be able to meet any short-term spikes or inside lead-time requests that customers have had.

Broadly speaking across the industry, it does strike us that many people perhaps have chosen not to invest in as much capacity as they might have in the past.

It's unclear to us just what that may mean going forward.

But at least from our standpoint for our customers, they can have confidence to know we have ample capacity to meet their need.

Yes.

Chris, I'll add also, we've taken other actions that utilize that capacity -- different points of demand.

One thing that we've done, and you can see it on the balance sheet, is that in periods of weaker demand, we'll actually build finished good inventory, as well as staging wafers to support future demand on low volume products.

It may take 20 minutes, 30 minutes to set up a piece of assembly test equipment.

And you may run only 10,000 units on that part, and that might take you a half hour or an hour.

But it doesn't take much longer to build either six months of demand or a full year of demand, or a year-and-a-half of demand and put that on the shelf.

When demand actually get stronger, we've got the capacity open and available to support that stronger demand.

We feel good to be able to support really any demand environment that we see in the future.

Do you have a follow-on, Chris?

Sure.

The other segment, it was above the Street, also above seasonality.

Is that just calculators, or is there something else there?

Yes.

That's really just calculators.

It's seasonally strong in the second and the third quarter for back-to-school selling season.

And then it's typically weaker in the fourth and first quarter, as kids are already in school and have their calculators.

Thank you, Chris.

Now we'll go to the next caller, please.

Vivek Arya, Bank of America

Thanks for taking my question, and good luck to both Dave and to Ron.

For my first question, I'm curious, what are underutilization charges running at right now?

And at what level of utilization can they go to zero?

Vivek, they were about $56 million last quarter.

That's down from the prior quarter, which was about $105 million.

That's a bit of a theoretical question as to what revenue it would take to get to zero, because clearly, the mix of products flowing across the various manufacturing flows are going to have a direct bearing on that.

So if we had much higher demand, but it was on a flow where we didn't have a lot of excess capacity, it wouldn't help much on the end utilization.

Our job on that is to make sure that all of our flows maintain open capacity.

I'll remind everybody again that the underutilization, we don't let that distract us.

That's an accounting adjustment -- it affects -- nothing happened to it free cash flow.

We are completely focused on free cash flow as the way to return value to our shareholders.

And Vivek, I'll also mention that that charge is -- less than half of it is actual cash, or about half of it is non-cash.

It really doesn't impact our free cash flow by having that open capacity.

Do you have a follow-up?

Yes.

That means the open capacity you have is more a source of keeping CapEx low and free cash flow rather than being a big source of expanding gross margins, per se.

But onto my second question.

On the demand environment, can you give us a sense -- I think you mentioned end markets, but what about the geographies?

Are there certain geos that are better or worse than what you thought three months ago?

Thank you.

Okay.

Let me follow up on the last one, just to make a clarifying point.

As Kevin talked about, there's certain factories that -- and you've seen some competitors -- some of the manufacturers in Taiwan run above 100% capacity.

When we've got factories or flows that run above 100%, or above the theoretical level that we've got from a utilization standpoint, we'll continue to get a benefit.

And we still may have a under utilization charge.

So don't think that all you have left as revenue grows, that small number, that's an underutilization charge.

Just wanted to make that clear.

From a regional standpoint, year over year, Vivek, we saw Asia, Europe, and Japan were up.

The US, we saw it was roughly even from a year-ago standpoint.

So, with that, we'll go to the next caller.

CJ Muse, ISI Group.

Yes.

Good afternoon.

Thank you for taking my question.

First question, once OpEx normalizes exiting calendar 2014, how should we think about growth in OpEx relative to top line into 2015 and beyond?

Well, CJ, that's some long-range planning you're doing there for a semiconductor analyst.

From an OpEx standpoint, I think that it will probably grow at least with the change in pay and benefits that you'd expect on a year-over-year basis.

You certainly start there.

And then, to the extent that we see additional opportunities that we may want to invest in from an R&D standpoint, or additional sales opportunities we may want to expand that may grow a bit beyond that.

But typically, you're going to see -- I think this last year, pay and benefits increased average around 3%, maybe 4%, depending upon the average from around the world.

That's what I'd probably use for planning.

Okay, helpful.

As a follow-up, question on the cycle.

It looks like your guide for Q3 year over year is slowing a bit.

Would love to hear your thoughts on where we are here -- were we rebuilding inventory downstream and now we're normalizing and now tracking more with GDP?

And/or are there any signs of re-acceleration in GDP, or in demand, in any parts geographically or product-wise, et cetera?

Yes.

CJ, I think on that front, we really don't spend a lot of time looking at the cycle.

Our strongest indicator demand, of course, is the view that we get from orders and the forecast that we get from our consignment customers as they'll give us forecasts.

Those forecasts, of course, can change.

We just turned in good growth year on year.

If you look at the year-on-year growth at 6%, 8% without legacy wireless, continues to be strong.

At the midpoint.

At the midpoint of the guidance range.

Yes.

That's what we believe all those indicators are showing us.

As I talked about before, things like, you said that where we build in demand in the channel, or downstream, we actually took inventory out of the channel as more of our distributors moved to consignment, and as the products that were on consignment actually grew faster than the other products.

We really -- at 4, a little over 4 1/2 weeks of inventory that's in the channel.

We consider that to be lean, but probably we'll be running in what is more of a new normal range.

Those changes in inventory downstream, because of the consignment that we've got, going to have less of an impact on our revenues as what they've had in the past.

With that, we can go to the next caller, please.

David Wong, Wells Fargo.

Thank you very much.

Could you give us an idea of how your policy of returning the bulk of your cash to shareholders offset future acquisition policy?

Do you have an expectation your acquisition activity will be relatively low, or that you'll be working primarily in stock purchases?

Yes.

David, I think the way to think about it, and it relates -- it goes back a bit to a question that was asked earlier about, I believe by Doug, on debt on the balance sheet.

From an acquisition standpoint, again, we'll look at first, the strategic fit, make sure it makes sense.

And then second, to make sure the numbers actually work from return on invested capital that we put into it.

Beyond that, the way we'd pay for it is probably very similar to what we did this last time.

When we bought National Semiconductor, we used some cash on hand.

But we actually released the strength of the balance sheet and went out to the bond market and issued quite a bit of debt, which supported that acquisition.

As we slowly retire debt, as we have been, and continue to over the next foreseeable future, that just opens the balance sheet back up and makes it available again to take on debt if there's an attractive ROIC-accretive acquisition out there.

That's where I would -- that's how I would think about the strategy going forward.

I don't see any of our cash management strategy having any interference whatsoever with our ability to continue to acquire when it makes sense.

Great.

Thanks.

William Stein, Ventura.

Great.

Thanks for taking my questions, and congratulations on the good quarter and guide.

I'm hoping you might comment on the margin progression, the Embedded segment.

It seems to have progressed a bit better.

It looks to us as though perhaps the restructuring benefits that you're targeting are coming in a bit earlier than you previously expected?

Yes, William.

You're exactly right on that.

They have started to come in a bit earlier than we planned, but we still have a long way to go.

We will see additional benefit as you move into second and third quarter, as we talked about earlier -- excuse me, third and fourth quarter, as we'd talked about earlier, as we see more of the costs beginning to come out of there.

But frankly, while that is certainly helpful in moving the profit performance of that segment forward, it is not going to be done when that's over with.

There's a lot more work to be done there, and the work is really on the revenue growth side.

The operating profit, clearly, is below what we think the potential for that segment is.

And that management team is very focused on driving results to get that profit up to where it should be.

Really, after the restructuring actions that are complete by the end of this year, it's really going to be all about revenue growth.

It actually has been a lot about revenue growth, as evidenced by the fact that that business has successfully grown for seven quarters in a row on a year-over-year basis.

We expect to see more of that as we go forward, so that business can grow its way into the cost structure I'll have remaining.

Kevin, that's helpful.

If I can follow up just a bit in that.

There's one area of that business where you're under-hitting relative to your weight in the industry, and that's microcontrollers.

I know that you've invested in this area in the last year or two.

I'm wondering if you can talk about the strategy in terms of products, end markets, features, that might lead to accelerating share gain in that category.

Yes.

I'll make a comment, and if you'd like add in, Kevin.

Well, as you know, that's an area that we decided to step up investments going back several years ago now, back 2010, 2011, in that period.

The expansion of investments included both development teams to produce more products and begin to broaden the portfolio, and second, as in application support, basically supporting customers and design in.

We feel really good about the progress that we've got.

We've had several years that we have gained share inside of microcontrollers.

We still -- I think we're -- some industry analysts will have us at a number six position inside of the market.

So we've got plenty of room to grow, and those are the types of markets that take a while to begin to get traction.

It's somewhat like a fly wheel, that you keep investing, keep making progress, and that progress begins to snowball.

From a product standpoint, we're really building out a broad portfolio.

We're focused on catalog products, primarily going into industrial applications.

You'll note, inside of Embedded Processing, we also have connectivity products.

There, we support about a dozen different wireless standards.

We're getting very good traction.

You can go to our website today and be able to find reference designs with microcontrollers ranging from $0.25 up to a couple of dollars, using all of those different combinations of the connectivity products.

We feel really good about the progress.

As I said in the opening remarks, Embedded Processing has had seven quarters of year-on-year growth, and a big part of that is driven from microcontrollers.

Okay.

Thank you very much, Will.

We can go to the next caller, please.

Ross Seymore, Deutsche Bank.

Hi, guys.

Before my questions, I also wanted to just pass on the congrats to Ron and to Dave on the promotion.

Best of luck to both of you.

Kevin, one clarification for -- that I wanted to get from you, if I could.

What was the starting point off of which that $130 million in savings exiting this year was going to be achieved?

Ross, we announced that action with our first-quarter results, when we took the -- excuse me -- with the fourth quarter and first quarter results, as I recall.

Fourth quarter, we took a charge for Embedded Processing, so that's the start there.

And the second quarter, we took the charge for the Japan restructuring.

It's a bit of a mixed start, if you will, so it'll be a little hard for you to do a direct correlation.

But again, the math you should be using is $130 million annualized savings by the time we end the year, with 85% of it coming out of OpEx.

Great.

As my follow-up, in the past, and I don't know if you guys are going to do this anymore now that you've started to split out the revenues in a different way.

But in the past, in the middle of the year you would say what the revenues by end market did mid-year.

Is that something that you can give us now?

Yes, Ross.

We're really just planning on giving those numbers on an annualized basis.

As I answered Jim's question earlier, we'll provide revenue on a quarterly basis, just color on what's happened in each of the markets.

And that's what we've decided to move to.

With that, we can move to our next caller, please.

Tore Svanberg, Stifel.

Yes.

Thank you, Ron, and best wishes in your retirement.

First question, you talk a lot about strength being broad-based, but are there any segments or markets in Q3 that are relatively weak, whether that's seasonal or even cyclical?

From a end market standpoint, Tore, the only market that we saw decline was in personal electronics, and that was -- I'm sorry -- was it third quarter or second quarter?

For Q3 guidance.

I'm sorry.

Yes.

Again, I somewhat addressed that, but we're really not trying to get into the color by end market or product segments, or that we're really just focused on the top line number overall.

Did you have a follow-on, Tore?

Yes.

That's fair.

My follow-up is, did you have a change in your distribution strategy at all in the quarter, or are you planning it?

I'm thinking, are you going to go to certain customers, more of a direct business, or --?

No.

We haven't had any change in the quarter.

I can say that we've had changes to our business arrangements with distributors on a periodic basis over the years.

For example, if we just go back a few years ago, as an example, we implemented the consignment program with distribution.

Now we've got more than half of our overall revenues supported by distribution.

They're going to continue to be a very important part of our business.

We are focused on growing our revenues overall, which will mean growing our revenues with them.

As we invest in catalog products and in industrial markets, we want to work with the distributors to be able to broaden our reach with customers.

We will do things that will optimize both our resources and theirs, but any specifics of details that we've got going on with changes, we just won't get into.

Okay.

With that, we'll go to the next caller, please.

Srini Pajjuri, CLSA Research.

Thank you.

Dave, just looking at the end market breakdown one more time.

I apologize.

I know that this question has been asked several times.

You gave us the year-on-year trends.

Can you also talk about sequential trends from Q1 to Q2?

Sure.

Yes.

I think, aside from the increase in calculators, communication and personal electronics actually grew the most.

We did see a benefit in personal electronics, led by a strong quarter in PC and notebooks.

We did see industrial enterprise systems and automotive all contribute to the growth sequentially.

If you look underneath that, and industrial is an example, we had -- we've got over a dozen sectors inside of industrial.

With that, we saw areas like factory automation and control, Smart Grid motor drives drive that.

In automotive, on a sequential basis, we had growth in all sectors overall, and that was led by ADAS.

Those are the things that drove the revenue in the quarter sequentially.

Great.

Thank you.

Then on the connectivity front, Dave, I think you mentioned you participate in a number of different standards.

If I recall correctly, you sold the smartphone business a while back.

My question is, is there anything preventing you from participating in the wearables market, if you think about the watches, et cetera?

No.

And in fact, you'll -- I actually wear some of those products to track my steps, and it has quite a bit of TI contact, both from a power management standpoint and other Analog products, as well as connectivity.

The beauty of having a catalog portfolio is that the incremental cost to engage a customer, the tools and the support, are all in place.

We can very readily and very easily support markets like that overall.

Thanks, Srini.

We'll go to the next caller, please.

Evening -- MKM Partners.

Yes.

Thanks.

Just a clarification on being opportunistic in acquisition of manufacturing assets.

Are you -- is it for taking a long view on increasing capacity, or are you removing bottlenecks in the manufacturing flow?

It looks like Richardson Analog is still a lot of headroom here.

Yes, Ian, it can be a little bit of both.

If we see bottlenecks popping up someplace and we're able to go ahead and pick up equipment inexpensively, or if we anticipate that a flow is going to become a bigger, more important revenue source in the future, we can go ahead and pick up for that.

Or just outright new factories, for example, and that's what we did when we bought the assembly test site in Chengdu, China.

It was an entire factory that we bought in that case.

We'll play -- we'll take advantage whenever opportunity presents itself, especially if the finances are compelling.

Great.

This commentary on connectivity growing faster within Embedded, I'm assuming we're talking about internet of things and wearables, do these sockets have good attach with microcontrollers and power management?

And do you have a sense of IOT mix, how much of it is more industrial, military, first responder type of applications with long cycles?

Yes.

If you look at our -- the product portfolio, we actually support a dozen or so different wireless technologies, so whether you need Bluetooth, low energy, or Wi-Fi, we've got GPS.

We have multiple sub-gigahertz standards, including things like ZigBee.

Whether -- whatever label that you want to put onto that, essentially, if things are getting smarter and more connected, we've got a broad range of catalog products in which to show to customers.

We can be fairly agnostic on how to solve their problem and bring, really, the best fit of the technology to whatever market they're trying to enter.

And oftentimes, we'll find manufacturers that have never had any wireless experience, so they'll want to go to the web.

They'll want to contact our local apps people and get support for that product, and they really don't have to become RF experts, so they can focus their time on other things.

And that's a combination that's working real well.

Okay.

With that, we can go to the next caller, please.

Chris Caso, Susquehanna Financial Group.

Yes.

Thank you.

Wonder if I could go back to some of your earlier comments with regard to the consignment revenue.

Just to clarify that, what you're saying is the higher percentage of fulfillment through a consignment that you are expecting for third quarter is what's pulling down the book-to-bill.

I think in the past you've talked about your book-to-bill for the non-consignment portion of your business.

Could you tell us what that is, and perhaps that's a better indicator of the end market booking trends?

Yes.

On -- what I talked about, Chris, was that we've had a conversion of more products into consignment going to distribution.

That suppressed the book-to-bill a little bit that we just came out of the quarter with.

If you keep in mind that -- gosh -- how much of our revenue's going through consignment now?

Probably --

50%.

50% for the total Company's going through consignment.

So what that really means is that book-to-bill for that consignment revenue is, by definition, 1. The book-to-bill that reported to Company now really just applies to the other half of the revenue.

So, that 1.01 that we just reported, in very simple terms would be 1.02, because it really applies to the non-consignment portion of the business.

Again, that was suppressed somewhat as a result of a conversion from the previously direct sale to a consignment arrangement.

Yes.

Chris, I'll just add, in second quarter, we delivered a 10% sequential growth, and our book-to-bill was 1.03.

If you look at orders, they were up 9% sequentially.

So that book-to-bill number is just one number, and as Kevin said, it's got some noise in it.

It's one consideration that we look at as we put together the demand forecast.

Do you have a follow-on, Chris?

Yes.

Sure.

For my follow-on, I guess I asked a little bit of a bigger picture question.

TI over the years has always been a cyclical company, just the function of the industry.

As you guys are operating the business a little bit differently now, your focus is on different end markets, just interested in your view of, going forward, what does that do to the cyclicality of TI as we go over the next couple of years?

Yes.

I think you're spot on, Chris.

As you look at the mix of what's going on inside our portfolio, in years past, as you observed, we had some big verticals, certain end markets you might be able to take a look at, and our business would cycle with that end market, in addition to a so-called semiconductor cycle itself.

Now, as we have industrial and automotive becoming a larger and larger percentage of our total revenue, and the markets to which our products are being shipped into, arguably, we would see -- likely see less impact as a result of big vertical fluctuations and begin to see a little bit more correlation between TI's growth going forward and the global GDP as a whole.

That will probably track more to the economy as opposed to a particular single end market.

That's not to say that we escape the semi cycle, if there still is one.

It's simply to say that our fortunes are more tied much more broadly than they have -- than ever in the past, and therefore will be much more reflective of how does the overall global GDP tend to expand over time?

Okay.

And with that, operator, we have time for one last caller.

Timothy Arcuri, Cowen and Company.

Thanks so much.

Guys, based on your current schedule of depreciation, and if you assume that CapEx remains at roughly 4% of sales, when is depreciation going to hit the level of CapEx?

Is this a 2016 event, or is this sometime beyond that?

Thanks.

Yes, Tim.

It's unlikely that we would see CapEx and depreciation converge prior to 2016.

So, that's probably a good starting point for you to build your models with.

Do have a follow-on, Tim?

Okay, great.

And then a question about gross margin drop-through.

The number has been a little bit above 75% the last couple of quarters, but is that still the right number to think about going forward for the gross margin drop-through?

I know people were talking about operating margin drop-through, but I'm wondering about gross margin.

Thanks.

Certainly, we're operating at a higher level now, Tim, than we have in years past.

And we talked a number of years ago about over a long-term -- a long window of time, that that fall-through during the course of the business cycle historically has been a pretty good indicator to follow, but in any one time period, it's always been a number that doesn't really apply very well.

More importantly, going forward, we're operating at a much higher level of gross profit than we have ever in our past, and I would expect that to continue to drive through quite richly, and importantly, drop through in free cash flow, that we continue to return to our shareholders in the form of the dividends and stock buybacks.

Okay, great.

And with that, I will turn it over to Ron to make some final remarks.

Okay.

As we wrap this up, let me just close by saying the past 32 years working at TI really has been a good -- actually, a great ride.

For Dave and Kevin, let me simply pass on the request and words of advice that have been passed down through generations of TI managers, and that's, please don't screw it up.

Thank you all for joining us.

A replay of the call is available on our website.

Good evening.

That does conclude today's presentation.

We thank you for your participation.