Highlights From TXN's Q3 Conference Call: Acquisition of National Was an Important Step

Texas Instruments, Inc. (NYSE: TXN) reported Q3 EPS of $0.60, $0.02 better than the analyst estimate of $0.58. Revenue for the quarter came in at $3.47 billion versus the consensus estimate of $3.33 billion. Shares are down 2.3% going into the close.

Texas Instruments, Inc. sees Q4 2011 EPS of $0.28-$0.36, versus the consensus of $0.54. Texas Instruments, Inc. sees Q4 2011 revenue of $3.26-$3.54 billion, versus the consensus of $3.43 billion.

Highlights From TXN's Q3 Conference Call:

• (Ron Slaymaker) Our acquisition of National was an important step in our strategy to further strengthen our position in the Analog semiconductor market. National's 12,000 products enhance our product portfolio.
  
• TI had 30,000 Analog products before the acquisition, and we'll introduce about 500 new products in 2011. These additions to our portfolio meaningfully accelerate our product strategy.
  
• Similarly, the addition of 5,000-plus employees - many of whom have deep and hard-to-find expertise in Analog design, Analog process technology, packaging, and manufacturing - will enhance our capabilities.
  
• Finally, National's three factories have lots of room for growth, which means we on focus our energies on customers and on driving growth from this portfolio instead of the unproductive task of moving products between factories that creates a lot of overhead expense and customer disruption.
  
• The revenue contribution over this seven-day period was $18 million, and there was $2 million of associated operating profit consolidated into our Analog segment under the organizational name Silicon Valley Analog. Silicon Valley Analog, or SVA as we abbreviate it, is now a fourth component of our Analog segment, along with High-Performance Analog, Power Management, and High-Volume Analog & Logic.
  
• So let's shift to the details of our third quarter results. Revenue declined 7% from a year ago and was flat sequentially. Revenue from our core product lines declined 3% from a year ago and declined 4% sequentially. The reason core products underperformed TI revenue overall in the sequential comparison was due to a rebound in DLP revenue, which is in the Other segment, as shipments from our Miho factory resumed in the third quarter following the shutdown after the Japan earthquake. Also, baseband revenue grew following our customers' inventory reductions in the first half of the year.
  
• Analog revenue declined 2% from a year ago and 2% sequentially. The decline from year-ago was mostly driven by lower High-Performance Analog, revenue while High-Volume Analog & Logic and Power Management were each about even. Sequentially, both HPA and Power Management were lower, while HVAL grew a few percent.
  
• In Embedded Processing, revenue declined 7% from a year ago and 10% sequentially. Catalog products were the reason for the decline from year-ago while communications infrastructure products were about even, and automotive products grew double-digits.
  
• In our Wireless segment, revenue grew 24% from a year ago and grew 4% sequentially. Baseband products were the biggest factor in both comparisons.
  
• Baseband revenue of $263 million in the third quarter fell 40% from a year ago and grew 16% from the prior quarter. Outside of baseband products, revenue from OMAP applications processors grew, and revenue from connectivity products declined in both comparisons.
  
• Recently announced programs that are based on our OMAP 4 platform include Samsung's Nexus smartphone, which will be our first OMAP production program based on Google's Ice Cream Sandwich (Nasdaq: GOOG) reference platform. Also, Samsung's Galaxy S II smartphone, Motorola's Droid Bionic and Droid Razr smartphones, LG's Thrill smartphone - which is the first to feature 3-D playback and capture - and the recently announced Amazon Fire tablet (Nasdaq: AMZN). A great lineup of customer products with more to come.
  
• (Kevin P. March) Let me start by walking through some of the acquisition-related costs. We will continue to report our results on a GAAP basis. However, we will make clear for you our costs associated with the acquisition, both in the near term as well as on an ongoing basis. We have broken out a line on our income statement called acquisition cost, where most of these charges have been consolidated. This includes items such as restructuring costs, transaction costs, retention bonuses, and amortization of intangibles.
  
• In the third quarter, we had $147 million of acquisition costs. An important Cosideration for the next quarter is how inventory is recognized under the acquisition method of accounting for business combinations.
  
• Although we are unable to consolidate this into the acquisition cost line, we will identify for you how much this cost impacts cost of revenue. In the third quarter, it was $7 million due to the limited amount of time that Silicon Valley Analog was part of TI. It will be much more significant in the fourth quarter, when we'll have a full quarter of shipments.
  
• Inventory that we initially received from National must be valued at fair value. Fair value generally means selling prices. Therefore, including cost of revenue is the expensing of the write-up of this inventory to fair value. Although we are unable to consolidate this into the acquisition cost line, we will identify for you how much this cost impacts cost of revenue.
  
• In the third quarter, it was $7 million due to the limited amount of time that Silicon Valley Analog was part of TI. It will be much more significant in the fourth quarter, when we'll have a full quarter of shipments.
  
• Let me provide a summary of the $154 million in acquisition-related costs for the third quarter. They include $147 million of acquisition costs as identified on the income statement, plus $7 million of inventory write-up to fair value that is included in cost of revenue.
  
• Additionally, there was a negative $10 million discrete tax impact. All of this sums to $0.09 per share of costs associated with the acquisition.
  
• Gross profit was essentially unchanged compared with the second quarter.
  
• Factory underutilization expense was higher as we lowered our production in response to weaker demand. To a lesser extent, and not atypical for a downturn, we scrapped some inventory of custom products in response to certain customer program cancellations. This was partially offset by a positive net contribution associated with the earthquake.
  
• Operating expenses of $783 million included $13 million associated with Silicon Valley Analog. Even so, operating expenses were reduced 6% sequentially or $52 million, primarily due to reductions in the variable components of our compensation plans in response to the weaker environment.
  
• As we discussed at our midquarter update, we have adjusted down our estimate for TI's annual effective tax rate for 2011 to 25% due to lower expected taxable income. The third quarter included catch-up adjustments for taxes since we had accrued at a higher rate in the first half of the year, partially offset by the $10 million tax-discrete acquisition-related charge I mentioned earlier.
  
• Net income in the third quarter was $601 million or $0.51 per share. Again, in the EPS calculation, please note that accounting rules require that we allocate a portion of net income to any unvested restricted stock units on which we pay dividend equivalents.
  
• I'll leave most of the cash flow and balance sheet items for you to review in the release. However, let me make just a few comments. The company ended the quarter with $2.62 billion in cash. During the quarter, we issued $1.2 billion in commercial paper, which remains outstanding.
  
• Cash flow from operations was $1.14 billion. This was up $511 million from last quarter, mostly reflecting the payment of income taxes in the prior quarter. Capital expenditures were $193 million in the quarter, down from $276 million the prior quarter. We used $450 million in the quarter to repurchase 14.1 million shares of TI common stock and pay dividends of $148 million.
  
• Receivables and days sales outstanding should similarly be adjusted for the acquisition, with the net effect being that DSOs of 46 days would be 43 days after the adjustment. Orders of $3.07 billion in the quarter were down 15% sequentially. TI's book-to-bill ratio was 0.89 in the quarter, compared with 1.04 in the second quarter.
  
• Turning to our outlook, we expect TI revenues in the range of $3.26 billion to $3.54 billion in the fourth quarter, or down 6% to up 2% sequentially. As a reminder, this includes a full quarter of SVA revenue compared with the third quarter that included only seven days. Also, please remember that the fourth quarter is when we typically see about a $100 million sequential decline in calculator revenue following the back-to-school period. We expect earnings per share to be in the range of $0.28 to $0.36.
  
• Our estimate for 2011 R&D, capital expenditures, and depreciation are unchanged.
  
• It might be useful for me to provide some insight into our expectations for acquisition-related charges as we go forward. As a first estimate, after $260million in the fourth quarter, we will be complete with the impact from the inventory write-up adjustment. As a result, we expect first quarter 2012 acquisition-related costs to decline to about $150 million, dropping to about $110 million in the second quarter. After that, these charges should decline about $10 million per quarter until we reach $80 million, which is the amortization of intangibles amount. This will continue for eight to 10 years. We will update you on our expectations as we move forward, and we will continue to make these charges visible for you as we report.

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