Texas Instruments Incorporated

Good day, and welcome to the Texas Instruments 2Q19 earnings release conference call. Today's conference is being recorded. At this time, I'd like to turn the conference over to Mr. Dave Paul. Please go ahead, sir.

Good afternoon, and thank you for joining our second quarter 2019 earnings conference call. Rafael Lazzardi, TI's Chief Financial Officer, is with me today. For any of you who missed the release, you can find it on our website at ti.com slash IR. This call is being broadcast live over the web and can be accessed through our 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 notice regarding forward-looking statements contained in the earnings release published today, as well as TI's most recent SEC filings for a more complete description. For today's call, let me start by summarizing what Rafael and I will be reviewing. I'll be covering the following topics. First, a high-level summary of the financial results for the second quarter, and second, some details by segment and end market. Rafael will then review profitability, capital management results, and then the outlook. After that, we'll open the call for Q&A. Starting with high-level summary of our second quarter financial results, the quarter progressed about as we expected, with revenue decreasing 9% from a year ago due to broad-based weakness. In our core businesses, analog revenue declined 6% and embedded processing revenue declined 16% compared with the same quarter a year ago. Both businesses -on-year growth decelerated. Earnings per share were $1.36, including a 7-cent benefit for items not in our original guidance. The benefit includes 4 cents due to the previously announced sale of our Greenix Scotland fab, with the balance primarily due to discrete tax benefits. With that backdrop, I'll now provide details on our performance, which we believe continues to be representative of the ongoing strength of our business model. In the second quarter, our cash flow from operations was $1.8 billion. As we know each quarter, we believe that free cash flow growth, especially on a per share basis, is most important to maximizing shareholder value in the long term. We remain committed to returning all of our free cash flow to owners. Free cash flow for the trailing 12-month period was $5.9 billion, up 3% from a year ago. Free cash flow margin for the same period was .9% of revenue, up from .6% a year ago. We continue to benefit from the quality of our product portfolio that is long-lived and diverse and the efficiency of our manufacturing strategy, the latter of which includes our growing 300-millimeter analog output. We believe that free cash flow will only be valued if it's productively invested in the business or returned to owners. For the trailing 12-month period, we returned $8 billion of cash to our owners through a combination of dividends and stock repurchases, demonstrating our confidence in our business model and our commitment to return all of our free cash flow to owners. Moving on, I'll now provide some details on the second quarter by segment and end market. For the year-ago quarter, analog revenue declined 6% due to declines in high volume, power, and signal chain. Embedded processing revenue declined by 16% from a year-ago quarter due to declines in both product lines, processors, and connected microcontrollers. Next, I'll provide some insight into this quarter's performance by end market versus a year ago. Industrial and automotive together declined upper single digits due to broad-based weakness. Personal electronics declined low double digits also due to broad-based weakness. In communications equipment, revenue declined sequentially but was about even from a year ago versus a very weak compare. And lastly, enterprise systems declined. In summary, we continue to focus our strategy on the industrial and automotive markets where we've been allocating our capital and driving initiatives to strengthen our position. This is based on a belief that industrial and automotive will be the fastest growing semiconductor markets. They have increasing semiconductor content and also provide diversity and longevity. All of this translates to a high terminal value of our portfolio. Rafael will now review profitability, capital management, and our outlook.

Rafael? Thanks, Dave, and good afternoon, everyone. Gross profit in the quarter was $2.36 billion or .3% of revenue. From a year ago, gross profit decreased due to lower revenue. Gross profit margin decreased 90 basis points. Operating expenses in the quarter were $810 million, down about 2% from a year ago and about as expected. On a trailing 12-month basis, operating expenses were .1% of revenue, within our expectations. Over the last 12 months, we have invested $1.57 billion in R&D, an important element of our capital allocation. We are pleased with our disciplined processes of allocating capital to R&D, which we believe will allow us to continue to grow our top line over the long term. Acquisition charges and non-cash expense were $80 million. Acquisition charges will be about $80 million per quarter through the third quarter of this year, then decline to about $50 million per quarter for two remaining years. Restructuring charges slash other was a credit of $36 million due to the sale of our Greenock, Scotland facility. Operating profit was $1.51 billion or .1% of revenue. Operating profit was down 12% from a year ago quarter. Operating margin for analog was 43.7%, down from 47% a year ago. And for embedded processing was 33.5%, down from .4% a year ago. Our focused investments on the best sustainable growth opportunities with differentiated positions will enable both businesses to continue to contribute nicely to free cash flow growth over time. Other income and expense was $52 million benefit, up $28 million primarily due to investment gains and tax-related items. Net income in the second quarter was $1.31 billion or $1.36 per share, which included a 7-cent benefit for items that were not in our prior outlook, as we have discussed. Let me now comment on our capital management results, starting with our cash generation. Cash flow for operations was $1.8 billion in the quarter. Capital expenditures were $284 million in the quarter. Free cash flow on a trailing 12-month basis was $5.93 billion. In the second quarter, we paid $722 million in dividends and repurchased $863 million of our stock for a total return to owners of $1.59 billion. In total, we have returned $8.01 billion in the past 12 months, consistent with our strategy to return all of our free cash flow. Over the same period, our dividends represented 47% of free cash flow, underscoring their sustainability. Our balance sheet remains strong, with $4.22 billion of cash and short-term investments at the end of the second quarter. Total debt is $5.8 billion, with a weighted average coupon of 2.91%. Inventory days were 143, up eight days from a year ago and down one day sequentially. We are pleased with the progress we have made replenishing inventory of low-volume devices and implementing the next phase of our consignment programs with our distributors. Work in both of these areas will continue in the third quarter. We believe there is strategic value in owning and controlling our inventory, and will manage it with our long-term objectives in mind. Turning to our outlook for the third quarter, we expect TI revenue in the range of $3.65 billion, and earnings per share to be in the range of $1.31 to $1.53, which includes an estimated $10 million discrete tax benefit. We continue to expect our annual operating tax rate to be about 16% for 2019. In closing, we have just completed our third quarter of -on-year declines for TI. As we stated last quarter, if you look at the last 30 years of history in our industry, cycles are always different, but typically you could see four to five quarters of -on-year declines before -on-year growth resumes. Again, we are not trying to forecast a cycle, but simply offer some historical perspective. Given our experience, we will stay focused on making TI stronger for the long term. We continue to invest in our competitive advantages, which are technology and manufacturing, portfolio and long-lived products. We will continue to strengthen these advantages through disciplined capital allocation and by focusing on the best products, analog and embedded processing, and the best markets, industrial and automotive, which I believe will enable us to continue to improve and deliver free cash for per share growth for a long time to come. With that, let me turn it back to Dave.

Thanks, Rafael. Operator, you can now open up the lines for questions. In order to provide as many of you as possible an opportunity to ask your questions, please limit yourself to a single question. After our response, we'll provide you an opportunity for an additional follow-up. Operator?

Thank you. If you'd like to ask a question, please signal by pressing star one on your telephone keypad. If you are using a speakerphone, please make sure your mute function is turned off to allow your signal to reach our equipment. Once again, that is star one if you'd like to ask a question. We'll take our first question from the Vick area with Bank of America. Please go ahead.

Thanks for taking my question. For my first one, when you reported three months ago, I think things were looking somewhat more downbeat. I was curious, Rafael or Dave, how would you characterize the current environment? Is it similar? Is it better? Is it worse? I'm just trying to put your Q3 outlook, which is for 3% to 4% sequential growth. It's below seasonal trend, but it's still up sequentially. I'm just trying to get a better sense of how you are seeing the broader environment versus three months ago.

Yeah, I'll start. And if Rafael wants to add anything, he's welcome to. I think as we stated, the quarter came in about as we expected. And that was really across the board. Really all the end markets performed about as we had expected. We've just completed our third quarter of -on-year declines for TI. I think that if you look at history, things are always different when you look at cyclicality. But I think things are performing as we would expect.

The only thing I would add is we're ready for any scenario. The economy strengthens, we're ready. If it runs sideways or if it weakens, we're ready. And that's both a strategic comment, how we position the company, focus on auto and industrial and catalog products inside of that, but also operationally with our inventory strategy and other things that we're doing to continue to strengthen the company. You have a follow on to that?

Yeah, thanks Dave. So for my follow on, I'm curious, the sales to China, how's the environment there? I assume that you don't have a lot of direct specific exposure to Huawei. But what's the demand environment, I guess, in China and outside of China that are conditions better outside of China and then within China, how's the demand environment outside of Huawei?

Yeah, so I think we've said before that Huawei is about 3 to 4% of our revenue overall. It's a mix of comms equipment and some handset in there and some other products. And if you look at comms equipment overall, it's 11% of our revenue. We had seen some nice growth in our 5G products as we've talked about before. And if you look from a regional standpoint, I'd say there's nothing unusual going on. We've talked about that in the past when there was. And certainly if you look at where we ship product, that's not always indicative of actual demand and look through to those economies, meaning we may ship into one region and that may get packaged up and shipped to another region before it's actually consumed. So overall, by the regions, they came in as we expected and nothing unusual. We didn't see anything unusual this quarter. So thank you, Vivek, and we'll go to the next caller, please. Thank you. We'll hear now from

Tushiya Hari with Commons X.

Great. Thanks very much for taking the question. Guys, based on the comments that you just made, it appears as though your view on the cycle hasn't really changed over the past couple of months. That said, I think you guys decided to delay the new FAB. So just curious what kind of thought process went into the decision to push the FAB.

Yeah. So, you know, just to clarify, you know, we said back in our February capital management call and really have been saying since then that we plan to begin building that next factory in the next few years, and that hasn't changed. There was a filing and it was a proposed amendment to a local tax abatement schedule that has caused some confusion on that topic. But just to say again, you know, as we said back in February, you know, those plans hadn't changed. You have a follow on?

I do. Thanks, Dave. And then just going back to the US China situation, I realize your business tends to be very sticky. But has the backdrop impacted your ability to conduct business in China at all? Or have you sensed any shifts to market share in your business? Thank you.

No, not at all.

Yeah. And I just say that our markets, because they're diverse and you see market share doesn't move around quickly, you know, they're just good quality markets. And you know, one of our competitive advantages being diversity and longevity, I think, helps like this and situations like that in particular. So, okay. Thank you, Toshia. We'll go to the next caller, please.

Thank you. We'll take our next question from Ambrish Servat Saval with BMO. Hi. Thank you very

much. I had a question on gross margin, flow through, fall through, and especially as it relates to utilization and inventory. So, free cash flow, 12-month trailing, which you always point us to correctly, which was kind of in the same ballpark that you had last quarter. But then inventory was down and the fall through to margins is much higher incrementally. And I know it's not the same every quarter, but I was just curious if there's something going on there. What are the puts and takes that cause the incremental fall through to be higher?

Yeah, I'll take that. You know, from the way you want to think about it is our fall through, as we have said before, is about 70 to 75 percent. And you want to look at that on a -on-year basis. And even then, you know, this is sometimes a little less, a little more. But that's the right way to look at it. And this quarter is actually right between that 70 and 75 percent. The other thing I would mention is over the long, over a longer time period, over the last many years, and we expect this to continue, you're seeing the benefit of 300-millimeter manufacturing. That is part of our competitive advantage, manufacturing technology. And as we have talked about before, it's just a structural cost advantage because of the geometry of the wafer and the relatively small incremental cost that goes into producing a 300-millimeter wafer versus a 200-millimeter wafer. So we expect that benefit to continue to accrue to gross margins and ultimately free cash flow margin, which is the one that drives value for the owners of the company. Yeah, following on,

Ambrish? Yes, I did. And this is more blocking and taxing. And I know you guys have correctly refrained from calling a cycle because everybody's track record, including my own, is absolutely wrong on that front. But bookings, cancellations, and lead times, where are we on these metrics? Thank you.

Yeah, I think if you look at those metrics overall, I'd say that inventory and the channel, and more broadly, I think you're looking at kind of the cyclical metrics that you looked at. Inventory and channel was down about a day, still about four and a half weeks, and has been steady at that for a couple of quarters now. Order rates, when we look at those, those looked normal as they came through. Cancellations were down a little bit from last quarter, but really didn't change much. And then our lead times overall have remained stable. Certainly they were stable as things got more heated in the industry. But of course, there's always areas that we would still be tight on today, but in general, the lead times have remained very stable. So thank you, Ambrish. And we'll go to the next caller, please.

Thank you. We'll take our next question from Stacey Raskin with Bernstein Research.

Hi, guys. Thanks for taking my questions. First, just on Huawei, you answered sort of generally, but specifically, what do you have embedded in your guidance regarding Huawei? Are you still contemplating selling product to them, or are you not? What's in the guidance regarding that customer?

Yeah. So, you know, I'd say, Stacey, just over this past quarter, you know, we obviously had halted shipments when the order was given. Since then, we've resumed shipments of the products that we've determined we could ship, you know, that are in compliance with the U.S. regulations. So, you know, overall in this quarter, you know, things came in as we expected. As I stated before, that would be inclusive of communications equipment where Huawei would sit. So, you know, in our guidance, you know, we obviously, you know, have that in for the quarter. And if there was something unusual that we were keeping out, you know, our practice has been to call that out, and there's nothing unusual that we're planning on. Do you have a follow-on?

Yes, I do. Thank you. The stockpiling and consignment 2.0 strategy that you've been doing, it's been going on for a while. How much do you think that has increased utilization over the last few quarters as you've been rolling that out, and how much longer do you anticipate driving that strategy before it reaches completion?

Let me start, and then, Dave, if you want to comment. But, you know, we've had an inventory strategy for many years. We just continue to tweak it over time, make it better, stronger. And as the cycle started in third quarter, so then we deployed some specific tools during that time to then take advantage of that situation and use what we caught our way for stars. We devoted an increasing share of that to the low-volume inventory strategy. We have built a lot of that, but it's not complete, but incrementally it's going to be less going forward than what it was in the last few quarters, because you get to obviously diminishing returns at some point in that. Yeah, and I'll

point out that obviously you saw our inventory dollars are down sequentially. They're actually down year on year. Inventory days were down sequentially, even with those planned builds of those low-volume parts. And we feel really good about being able to do that in our operations. The second part of your question there was what is the impact of consignment have on utilization? It really has no impact at all. Basically, it optically and by definition just puts more inventory on our books. But even if the inventory didn't change in the channel, it just would put pressure and optically put pressure on our inventory, and that's going on as well.

Yeah, I want to make one more comment on this topic. Remember what inventory is about, right? What is the objective of inventory? It's not about maximizing utilization or gross margins or anything like that. It's about maintaining high levels of customer service. So what we have done is deployed our cash to inventory. And as they said, inventory actually decreased. But within that decrease, we built some inventory of low-volume parts that now puts us in a great position as we move into the third quarter and beyond to have that inventory of low volume that is generally difficult to build. We have it ready. So then we'll be able to serve our customers on the other side of this very well. Okay. Thank you, Stacey. And we'll go to the next caller,

please. Thank you. We'll hear now from Ross Seymour with Deutsche Bank.

Hi, guys. Thanks for asking the question. I wanted to stick on that consignment topic with just a slightly different spin. I think you've said in the last few calls that it's upward. The two-thirds of your revenues go through consignment. That's increased substantially over the last three, five, ten years. Why do you think your -over-year revenue performance is so similar to your broader peer group if you're controlling that inventory? I would think all of being equal, you wouldn't have to deal with the distribution channel burning inventory and weighing on your revenues during a period like this.

I'll give you one comment. And, Dave, you want to chime in? What I would tell you is maybe take into account in the last, what, four quarters or so, five quarters, we have gone into that next phase of consignment. And we have added, I want to say, 30 to 40 million of revenue to that program per quarter during that time for a total of close to 200 million. We probably still have one more quarter to go where that's going to happen, and maybe through the end of the year, but it's getting to a diminishing point. But that is revenue that, from the P&L, it has sort of disappeared, right? But obviously the demand hasn't changed. The end demand truly hasn't changed. It's just that now it goes into our inventory and the revenue is delayed, but it just puts it in a much better position to then own that inventory, distribute it better where it's needed, work with our manufacturing facilities better to determine what's needed to be built to replenish that inventory. So it's just a

better way to operate. Yeah, and I'll just add that when you think of one of our competitive advantage, which is the reach of our market channels, this is just one component of what we're doing to have a closer, more direct relationship with our customers. And we think that ultimately servicing them better with product will benefit them and therefore benefit us. You have a follow on, Ross?

Yeah, one, it's a little bit more housekeeping. I was wondering, Dave, from an end market point of view, you went through and gave the year over years. So could you give the quarter over quarters beyond the comm side? And was there any reason you put industrial and automotive together, saying they were down upper single digits year over year? Usually you split those up.

No, yeah, sure. So the first is they performed similarly. Industrial was a little weaker. Auto was a little less weak, but in the same zip code. And that was the same for the sequential. Together they grew low single digits and that same profile was the same. Personal electronics grew high single digits with broad based seasonal growth. Comm's equipment, as I mentioned earlier, had declined and then enterprise systems actually grew sequentially. So, okay, thank you, Ross. And we'll go to the next caller, please. Thank

you. We'll hear now from Harlan Sur with JP Morgan.

Good afternoon. Thanks for taking my question. Looking at the most recent SIA data, April, May sales were down about 10% year over year for the global analog segment. While you guys were only down 6%, you clearly outperformed the analog segment last year as well. So outside of the end market mix, i.e. better comm equipment sector, can you guys just help us understand any product areas where you're either capturing market share or seeing strong dollar content growth?

Well, yeah. So first, Harlan, I'd always be careful to read too much into any of those numbers in the short term. I think when you look at share gains, they just really need to be measured even over several year period. And I think that even in that case, I think we come out very well. And I think especially we continue to do well in industrial and automotive. As I mentioned earlier, that is we believe that those will be the most important markets to semiconductors and industrial in particular. And we've got a lot of programs and a lot of thought going into how to get better and get stronger to be able to service those markets. You have a follow on?

Yeah, thanks for the insights there. I know we have to be careful on how we interpret this number, but can you guys just tell us what the book to bill ratio was for the June quarter?

Yes. So you set me up perfect there because I always have the preamble that I'll give it. I've debated, honestly, whether I should continue to give it, but I will just because we do. But, you know, there is a lot of noise that's in it. So it was point nine four and it was one point six a year ago and point nine nine last quarter. So and I'll just remind everyone that we have the majority of the revenue on consignment, so we don't get orders in advance for that. We've got backlog and the consignment, the orders in the backlog are all consistent with the guidance that we gave. So thank you, Harland. And I believe we'll go to the next caller, please. Thank you. We'll hear now

from Chris Stanley with Citigroup.

Hey, thanks, guys. Can you just talk about the linearity of orders during the quarter? And I guess more specifically, have you seen any change in customer or channel behavior since the Huawei reinstatement and the I guess the threat of 300 billion in additional tariffs was taken away a few weeks ago?

Yeah, Chris, really no changes on that front. I think when we look at the linearity, it came in fairly normal, you know, minus the the stock shipment to Huawei. But once we determined that we could continue to resume most of those products, it really got back to normal pretty quickly. You have a follow on?

Yeah, you know, given we're in this, I guess, you know, mildly depressed or sluggish or flaccid or whatever you want to call it kind of environment. Have you guys changed your thoughts on, you know, kind of long term capex?

The short answer is no. We are, as we said in our capital management strategy, our guide on capex is six percent and will continue to be six percent. That's without buildings. So, of course, as we talked about, we we announced the new factory that will the new 300 million factory that will we build in Richardson, Texas in the next few years. So outside of that, we'll be running about six percent.

OK, thank you, Chris. And operator, I think we've got time for one more call. Thank you. We'll take our next question from

Mark with Jeffries.

Hi, thanks for taking my question. Can you hear me OK? We can mark. OK, the your inventory is declined in dollars and days. What do you think happens to your inventories on your balance sheet in the September quarter and Dave on the inventory? Commentary, I believe you said you characterize channel inventories kind of in a stable range. Would you would you call them stable in a normal and healthy level or would you characterize them somewhat differently?

Let me start and maybe if you want to jump in, but let me first step back to the objective for inventory to remind everybody. And as I said earlier in the call is to maintain high levels of customer service. We also want to minimize obsolescence of that inventory and improve asset utilization. But the main thing is to to maintain high levels of customer service. And our target is 115 to 145. So last last quarter, two quarters ago, we made we went above that target 152. But then last quarter 144 in one first quarter and then second quarter, we just finished at 143. So both of those inside of our target.

Yeah. And I'll just add again that even inside of those numbers, we've made really good progress of executing to building those low volume parts. And we believe that that's important so we can continue to service customers well. And the second part of your question, Mark, was, yeah, I was down a little bit sequentially on a day's basis in in distribution still at about four and a half weeks. You know, that's that is a healthy level. And I would say that that number will structurally kind of work its way down as we're implementing more of this revenue on consignment. And that's a great thing for our distributors. It's a great thing for our customers. And it does require that we will be carrying some more inventory on our balance sheet. But we think that that's a good investment in working capital. You have a follow on Mark?

Yes, please. Thank you. The follow up is, have you have you been noticing since the since the US and China trade debate? Have you been noticing any shift in the supply chain from the standpoint of where things are being manufactured? Not your not your own Texas Instruments supply chain, but where you're shipping to? Are you shipping more outside of China or is or is everything fairly stable? Thank you.

Yeah, yeah, I'll take that. You know, it's too early to tell. We've read some of the same media reports and anecdotal comments that people make on that front. But but it's too early to tell. So we'll watch how things evolve on that front over the next few years. So I'm going to finish with a few comments on key items for everybody to remember. We will remain focused on analog and embedded, the best products and industrial and automotive, the best markets. We will continue to be disciplined in executing our capital management strategy and remain committed to returning free cash flow to the owners of the company. And finally, we continue to believe growing free cash flow per share dollars over the long term is what will maximize value for the owners of the company.

Thank you for listening. Replay will be available on the Web and have a good night. Thank you. That does conclude today's conference. Thank you all for your participation. You may not disconnect.