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spk10: and welcome to the Texas Instruments Capital Management Conference Call. Today's conference is being recorded. At this time, I'd like to turn the conference over to Mr. David Paul. Please go ahead, sir.
spk09: Good morning, and thank you for joining our 2021 Capital Management Call. This call is being broadcast live over the web and can be accessed through our website at ti.com slash ir. 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 our most recent earnings release as well as our most recent SDC filings for a more complete description. During today's presentation, we'll begin with a recap of our objective, strategy, and business model that is built on our sustainable competitive advantages. Next, we'll review our scorecard for 2020 and updates for 2021. Then we'll provide a historical summary of our capital allocation and take a deeper look into specific areas of investment, including 300 millimeter analog, R&D allocation priorities, and our progress on building closer, direct relationships with our customers. We'll also discuss our free cash flow per share performance. And finally, we'll wrap up with a review of our cash returns. We've recently updated our investor overview, which you can find on TI.com on our investor relations website. We believe it will be a helpful overview of our business model and competitive advantages. The following guiding principles from that overview will help frame our discussions today. At TI, we run the company with the mindset of being a long-term owner. We believe that free cash flow per share is the primary driver of long-term value. Our ambitions and values are integral to how we build TI stronger. And when we're successful in achieving these ambitions, our employees, our customers, communities, and shareholders all win. Our strategy is comprised of a great business model, a disciplined approach to capital allocation, and a focus on efficiency. Our business model is built around four sustainable competitive advantages, manufacturing and technology, broad product portfolio, reach of our market channels, and diverse and long-lived positions. And after creative investments in the business to grow free cash flow for the long term, The remaining cash will be returned over time via dividends and share repurchases. With that as a framework, our objective is to maximize long-term growth of free cash flow per share, which we believe is the best metric to judge our performance and that generates long-term value for the owners of the company. Our strategy to achieve this objective has three elements. First, a great business model that is focused on analog and embedded products and built around four sustainable competitive advantages, advantages that we continue to invest in and make even stronger. Second, discipline in allocating capital to the best opportunities. This spans how we select R&D projects, develop new capabilities like TI.com, invest in new manufacturing capacity, or how we think about acquisitions and returning cash to owners. And third, striving to constantly increase our efficiency, which is about achieving more output for every dollar of input. Our strategy is designed around four sustainable competitive advantages that in combination provide tangible benefits and are difficult to replicate. First, at the bottom of the slide, we start with a foundation of manufacturing and technology. This provides us with lower costs and greater control of our supply chain. Second is a broad portfolio of analog and embedded products. These products provide us more opportunity per customer and more value for our investments. Third, the reach of our market channels include our field Salesforce and TI.com. This provides access to more customers, projects, sockets per project, and insight into their needs. And lastly, we have diverse and long-lived positions, resulting in less single-point dependency and longer returns on our investments. With that, I'll turn it over to Rafael, and he'll review our approach to capital management and the scorecard. Rafael?
spk05: Good morning. We have shared our capital management scorecard we've used since 2013. In 2020, we again met our multiple objectives. We are pleased with the consistency of these results that have been enabled by our business model and strategic decisions, particularly in a year that was impacted by COVID-19. You can see that the scorecard continues to include descriptions of our long-term objectives for each metric as well as the target range. The long-term objective provides insight into how we make decisions and run the business, as opposed to only a number that reflects a single data point. For 2021, we will be making several changes to our scorecard targets. First, we're updating the range of our days of inventory to 130 to 190 days. This change reflects our continuous efforts to maintain high levels of product availability with short lead times as we build closer direct relationships with our customers. Second, we are updating the range of our dividend as a percent of free cash flow to 40% to 80%. The growth and sustainability of our free cash flow makes us comfortable even with the higher end of the new range. Now, I would like to provide additional insight into how we allocate our capital. And I'll give you updates on several key investment areas. Over the last 10 years, we have allocated about $83 billion of capital. Given that magnitude, you can quickly appreciate why capital allocation is a job we take quite seriously and one that has a significant impact on our owners' returns. Our largest category of capital allocation is investment in critical areas that drive organic growth, such as R&D, sales and marketing, capital expenditures, and inventory. We're pleased with the results of our investments in R&D that strengthens both our manufacturing process technology as well as our product portfolios. Our isolation products, gallium nitride power products, or innovation in small footprint packaging are just a few recent examples of investments that will provide growth in the years ahead. The second largest category is share repurchases. Here, our objective is the accretive capture of future free cash flow for long-term owners. We focus on consistent repurchases when the present stock price is below the intrinsic value, using reasonable growth assumptions. Next is dividends, where our objective is to appeal to a broader set of investors, and we focus on their sustainability and growth for obvious reasons. And finally, potential acquisitions are evaluated through two primary factors that have remained unchanged. It must be a strategic match, meaning catalog-analog focus, with high exposure to industrial and automotive. Additionally, it must meet certain financial metrics, such as generating a return greater than a weighted average cost of capital within about four years. For simplicity, we have not included changes in net debt, which over this period increased $1.4 billion. With that framework set, let me ask Dick to comment on our investments in several specific areas.
spk09: Thanks, Rafael. I'd like to update you on our progress in strengthening our competitive advantages. First, I'll be updating you on our manufacturing advantage and investments in 300-millimeter analog capacity, which, as I mentioned earlier, helped to extend our cost advantage and give us greater control of our supply chain. As a reminder, for those not as familiar with the semiconductor industry, a chip, meaning an unpackaged product, made on a 300 millimeter wafer costs about 40% less than a chip built on a 200 millimeter wafer, the size used by many of our competitors. This translates into a great competitive advantage. The source of this advantage is the area of the wafer. A 300 millimeter wafer has 2.25 times more area, which in turn means we get about 2.3 times more chips. but it doesn't cost us 2.3 times more to process that larger wafer. This translates into a structural cost advantage. To understand how a 40% less expensive chip impacts gross margin, it's easiest to use an example, and one we've used for some time now, and it's shown on this slide, of a part built on a 200 millimeter wafer compared to one built on a 300 millimeter wafer. This example shows a theoretical part that sells for a dollar with a gross margin of 60%. The chip itself would cost about 20 cents if it was built on a 200 millimeter wafer, and it would be reduced to about 12 cents if built on a 300 millimeter wafer. In this example, the remaining costs of assembly and test are about the same, regardless of the wafer size. The net result is that gross margin improves by eight percentage points. As the simple example illustrates, our 300-millimeter manufacturing capability and the resulting cost structure provides a unique competitive advantage for TI. As we've discussed before, we currently have two 300-millimeter factories, our Richardson FAB, or RFAB, and DMOS VI, both located in the Dallas area. In 2020, we began construction of RFAB II, our third 300-millimeter wafer fab. RFAB 2 will be co-located on the site with RFAB 1, thus gaining operational efficiencies. FAB construction is well underway, and we expect the facility to be ready to support production in the second half of 2022. Next, I'll focus on our R&D investments that we allocate to higher value growth opportunities in order to strengthen our technology and product portfolio while improving diversity and longevity. On this slide, we summarize the current direction of our R&D investments and our revenue breakdown by end market. For the revenue breakdown, we've provided data for the years 2013, 2019, and 2020 so you can get a sense of how the portfolio has changed over the long term as well as compared to last year, summarizing the direction of our R&D investments shown in the second column. Industrial and automotive investments continue to be up broadly, reflecting our belief that these end markets will be the fastest growing markets due to their growing semiconductor content. Personal electronics investments are up slightly, but we will continue to be selective. Communications equipment investments are steady and analog only. Enterprise system investments are up slightly in support of the growing cloud server infrastructure. And other, which is shown for completeness, is primarily the calculator business where investment is flat but at low levels. On slide 16, you can see the strategic progress we've made in the important markets of industrial and automotive. In 2020, those markets combined for 57% of TI's revenue compared to just 42% back in 2013. As a reminder, the industrial and automotive markets have high diversity, meaning many customers, many sectors, and many end equipment types. These markets also have high longevity, where they tend to have life cycles ranging from several years to several decades. Success in the industrial and automotive therefore requires a long-term commitment and a willingness to invest broadly across sectors and product categories both of which we've done and will continue to do. I'd also like to share an update on progress in building closer, direct relationships with our customers, which serves to strengthen and extend the reach of our market channels. We believe that customers will increasingly desire the convenience and productivity of online relationships along with the skilled customer and commercial support. This is a broad secular trend, and we see it all around us in our daily lives. Our multi-year investments in our sales and applications teams, TI.com, business processes, logistics, and distribution channel changes uniquely positions TI to lead this transition in the semiconductor industry. In 2020, we took a critical step to accelerate direct relationships with our customers. Our percentage of direct business increased from 35% in 2019 to 47% in 2020. But more importantly, as you can see on the accompanying graph, we left the year with 63% of our business transacting directly. CI's reach of our market channel advantage results in higher growth through access to more customers, projects, sockets per customer, and better insight of our customer needs. With that, I'll turn it back to Rafael to talk about our free cash flow growth and cash returns.
spk05: Thanks, Dave. As we described at the beginning, our overall objective is to maximize long-term free cash flow per share. We believe this is not only the best metric to judge our performance, but it is also the one that we as owners ultimately care about. In 2020, even with the disruptions from COVID-19, free cash flow was $5.96 per share. This was down about 4% from 2019, and free cash flow margin was 38% for the year. Since 2004, free cash flow per share has grown 12% compounded annually. As mentioned before, our long-term objective is to provide a sustainable and growing dividend to appeal to a broader set of owners. For 17 consecutive years, we have steadily increased our dividend, including a 13% increase in the fourth quarter of 2020. These increases represent 22% for both the five-year and the 10-year compounded annual growth rates. In 2020, dividend payments represented 62% of free cash flow. supporting their continued sustainability and growth. As of January 31st, 2021, the dividend yield is 2.5%. Our objective in repurchasing shares is the accretive capture of free cash flow for long-term owners. We focus on consistently repurchasing shares when the intrinsic value of the company exceeds its market value. By using realistic discount factors and reasonable growth assumptions to calculate intrinsic stock value, we're aiming for confidence that investments made in stock repurchases are, in fact, earning rates of return greater than our cost of capital. While the ultimate assessment of return on investment depends on the future cash flow stream, the track record of this approach is encouraging. We have reduced shares outstanding 46% since 2004, including the 1.4% reduction in 2020. We ended 2020 with $10.6 billion in open authorizations, having bought back $2.6 billion worth of stock in the year. In total, as our free cash flow per share has continued to grow, so too has our cash return per share. In 2020, we returned $6.49 per share, which represents a 1.9% growth versus 2019. In total, in 2020, we returned 109% of free cash flow. And since 2004, we have grown returns at a 17% compounded annual growth rate. It may be helpful to frame our performance versus others in the S&P 500. Our free cash flow generation puts TI in the 89th percentile, cash returns in the 97th percentile, and return on invested capital in the 95th percentile when compared to the S&P 500. We believe our strong relative performance versus the S&P 500 is a reflection of our focus on growing free cash flow per share over the long term and the three elements of our strategy. First, a great business model that is built on our four competitive advantages, advantages in which we're continuing to invest and make even stronger. Second, discipline how we allocate our resources, focusing on the best product opportunities as well as areas that strengthen and leverage our competitive advantages. And third, striving to constantly increase our efficiency, which is about achieving more output for every dollar of input. We believe if we can continue to do these three things well, we should be able to grow free cash flow per share for a long time into the future. Let me wrap up my prepared remarks with a few summary comments. As engineers, it is a privilege to get to pursue our passion of creating a better world by making electronics more affordable through semiconductors. We're fortunate that our founders had the foresight to know that passion alone was not enough. Building a great company requires a special culture to thrive for the long term, and we continue to build this culture stronger every day. The desires of ESG and sustainable investors are aligned with our long-term ambitions and have been part of our formula for success for decades. We will remain focused on the belief that long-term growth of free cash flow per share is the ultimate measure to generate value. We will invest to strengthen our competitive advantages, be disciplined in capital allocation, and stay diligent in our pursuit of efficiencies. You can count on us to stay true to our ambitions, to think like owners for the long term, adapt and succeed in a world that's ever-changing, and behave in a way that makes us and our stakeholders proud. When we're successful, our employees, customers, communities, and shareholders all win. Thank you.
spk09: With that, I'll turn it back to Dave. Thanks, Rafael. Operator, you can now open the lines for questions. In order to provide as many of you the opportunity to ask a question, please limit yourself to a single question, and after your response, we'll provide you an opportunity for a follow-up. Operator?
spk10: Thank you. If you would like to ask a question, please signal by pressing star 1 on your telephone keypad. If you're using a speakerphone, please make sure your mute function is turned off to allow your signal to reach our equipment. Again, press star 1 to ask a question. We'll pause for just a moment to allow everyone the opportunity to signal for questions. And our first question is from Ambresh Srivastava with BMO. Please go ahead.
spk11: Hi. Thank you very much, guys. Very, very helpful. My first one, Rafael and Dave, what's the map of the thinking behind the increase in the DOI? And then how do we translate that into understanding on the impact on the business?
spk05: Yeah, so first let me step back and remind everyone on our long-term objectives for inventory. So DOI days of inventory that you were asking about. We believe the new range it's just more appropriate to maintain those high levels of customer service, minimize obsolescence, and improve manufacturing as a utilization. That's how we think about inventory. Essentially, it's... it's an asset and more than just on the balance sheet, but it's just a way to help us leverage that asset to ultimately gain more share with our customers. You know, a great example of that was what happened in 2020, where we continue building when people were concerned about the demand environment. And we built through that period in March, April, and May. And you can see the results over the last several quarters that we were able to Now, part of the reason we can do that is because our business model is different than our peers, right? And think of our competitive advantages, our broad portfolio, the diverse and long-lived positions, the products sell to many, many customers and last a long, long time. So that enables us to have that strategy in the first place. And now that we're expanding our engagement customers directly, it makes even more sense to have that inventory in our books versus in the distribution channel. As far as the financial impact that you asked, that depends how things play out. Our focus right now is not on building inventory for the balance sheet, but it's on supporting customers in this period of strong demand. And we'll continue to do that to keep leak time short. But at some point, as things progress, we should be able to build more inventory and then take those days of inventory higher, ideally somewhere in that range that we just updated.
spk08: I did, Dave. Thank you.
spk11: Actually, you're right, Rafael, though we haven't heard you guys say boo about not being able to meet demand where many of your peers have talked about tightness. From a follow-up, again, something you touched on just now, Rafael, is the high direct percentage. It's very unusual to see a company such as yours, which has such a diversified customer base. Just help us understand how to think about that in terms of large versus small customers and your reaches, and I forget the number, it's tens and thousands of customers that you have. So how have you managed to get to that point? Is it the TI.com has been the biggest driver or a combination of that plus the inventory that you have, your change in your inventory management that has been going on for a while? Thank you.
spk09: Yeah, it's a great question. Thanks for allowing me to just add some color to it. And I'd say, you know, that shift to, you know, to having more customers direct was substantial this year and wouldn't understate it. And we've been working towards that for, you know, many years now, as you know, and we're just thrilled, you know, with our increased direct relationships. And that's for you know, both large and small customers, and really just the early results that that's showing. So, and most importantly, you know, as we presented, this transition is about strengthening that competitive advantage or the reach of channels. And, you know, as we've talked about it, you know, it's that multi-year investments in its investments in our sales and applications team, it's in TI.com, it's in business processes, It's in logistics. And here more recently, it's those distribution changes. So it's not just one thing. But the tangible benefit that we'll get is higher growth. And that's the reason why that we're making it. And we'll just get more access to those customers, their projects, the sockets per project, and really just more insight. So We're already seeing that, and we really believe that that advantage will be difficult for our competitors to replicate.
spk05: If I may, let me just touch and reach back on your first question. Another angle is our manufacturing technology advantage, which I didn't touch on. And for many people on the call, I imagine there are some new people. So we have our own manufacturing technology. and technology that's a differentiator versus all of our peers, really. On the front end, the fab side, that is over about 80% of our internal capacity, our capacity is internal. But even on the back end, it's significantly higher than what any of our peers have. That allows us to control our own destiny, to keep costs at the lowest possible point. And then on your question on inventory, that's another reason why it makes sense for us to to have higher days of inventory. And then when you compare us to our peers, it's also a bit apples and oranges when we have our own factories and the vast majority of them don't or not nearly to the degree that we do.
spk09: That's great. Okay. Thank you. I will go to the next caller. Thank you. I appreciate it.
spk10: Okay. And if you find that your question has been answered, you may remove yourself from the queue by pressing star 2. Our next question is John Pitzer with Credit Suisse. Please go ahead.
spk07: Yeah, good morning, guys. Thanks for letting me ask the question. Dave, just going back to your slide 12 on the cost between $200 and $300, I'm kind of curious, is that a cash cost or is that a fully depreciated? And I sort of asked the question because, you know, the first time you guys built a 300-millimeter fab, you had the advantage of buying really cheap equipment. That's not available to you today, so I'm just kind of curious how that dynamic might change either capital intensity or kind of the manufacturing benefit.
spk05: Yeah, at the highest level, the difference between, you know, buying the equipment used at, you know, 20, 30 cents on the dollar versus buying it new is not that significant over the long term, John. Think of it, you know, depreciation for equipment we follow, we use five years for this equipment, and we've done that for a long time. But the reality is that that equipment lasts much, much longer than that, as you know. That's why we're able to buy used equipment. But, you know, when we buy new equipment, there's some advantages there, too. Many times it's more automated, more advanced. We get better yields. So there's an offset. The way I like to think about it, think of this new factory that we're building. When it's fully built out, it will have cost us probably in the neighborhood of $5 billion to you know, building, equipment, et cetera. And that is, you know, probably 70, 80% new equipment assumptions, somewhere in that neighborhood. So it's significantly more than the regional RFAB. So $5 billion of investment, but we're going to be able to generate revenue of about $5 billion per year For how long? Who knows? But I would say at least 20, 30 years, maybe more. We have factories right now that are about 50 years old, right? So it could even be 40 or 50 years. And from a cash basis, now to address your question, at that point, essentially the cost is just variable, right? Because you already spend equipment. So the cash flow through is very high on that annual $5 billion of revenue. Do an IIR.
spk09: You won't be disappointed in that return.
spk05: Yeah, you don't. And just to add to that, you know, if you do it, let's say it was 100% use. So instead of a $5 billion investment, maybe $3 billion, $3.5 billion. Of course, generally, I would prefer that. You know, I'd rather save the $1.5 billion or $2 billion. But, you know, annual revenue of $5 billion over 50 years, you know, more than makes up for that difference in investment up front. It's really, at the end of the day, not that significant.
spk07: Yeah, that's helpful. And then as you think about your goal of growing free cash flow, mathematically, you can do that by either accelerating top-line growth, getting more margin, or a combination of both. I'm just kind of curious, relative to the updates you gave today, where would you fall out on that spectrum? Does the customer engagement allow you to grow share at a margin targets, but you talk about incremental pass-through often. Did anything change on that today with this update?
spk09: Let me start, and then I'll turn it over to Rafael to add some comments. If you look, one of the things that make both analog and embedded high-quality markets is they're diverse. They've got lots of customers, lots of products. You see share doesn't move quickly. We often talk about that, that you need to look at share over time. All those things are true. Even looking specifically at fourth quarter, is there share gains in fourth quarter results? Absolutely, there's share gains in fourth quarter results. But always caution, don't look at any one given quarter. So, you know, and if you look in analog three or five or 10 or 15 years, you know, using a thumbnail, we're probably gaining 30, 40 basis points of share per year. And if we have competitive advantages and we continue to strengthen them, we believe that we'll continue to be able to outgrow our competitors over the long time. over a long period and, in fact, we'll be able to grow free cash flow, you know, faster than our best peers. So, in the things that we're doing, like strengthening our channel reach, continuing to invest in manufacturing and technology, broadening the product portfolio, just gives us more confidence that we can continue to gain that 30, 40 basis points a share in the future. I don't think we're predicting that we're going to have an inflection point, but certainly have high confidence that that 30 to 40 basis points will be able to continue.
spk05: Yeah, I would just add, it's mainly a share gain and top line growth story from here on. The margin, of course, two components, price and cost. The price will be what it will be. We need to be competitive out there. And obviously, we're not afraid of that. If anything, we embrace that because on the cost side, We have the best position in the industry, right? We have 300 millimeter factories that we own, we control, and we operate them very efficiently. So, you know, the margin will be what it will be based on those dynamics. Certainly the cost side, we should be able to continue to improve that going forward. We'll see, you know, on the price side, but it's mainly a top line share gain story.
spk09: That is certainly the longer term, but we still have structural cost advantages. Right. in the model. So, okay. Thank you, John. And we'll go to the next caller, please.
spk10: Okay. Our next caller is Tim McCurry with UBS.
spk02: Please go ahead. Hi. I guess I had two. So, first of all, if I look at the share, Dave, you were just talking about the baseline of 30 to 40 percent BIPs per year. But you gained 70 BIPs. If you look at the SIA data, you gained 70 BIPs in 2020, and you gained 60 BIPs the year before. And that's kind of the best two-year stretch you've had since like 2013. So I guess maybe my first question is like, can you deconstruct why that was? If you look at auto and industrial, it was pretty flat last year, but you still gained a lot of share. Was this in some way due to you holding this much inventory now? And maybe if, you know, on that point, can you sort of tell us what portion of sockets are sort of transactional where you can replace socket for socket because you have the part on the shelf? And then I had to follow up. Thanks.
spk09: Yeah, sure. So, yeah, so the vast majority of our products, of course, you know, aren't going to just be dropped in, you know, like if it were a commodity like a DRAM or something like that where you just drop in one part next to the other or like an IGBT or a FET, those types of products that are true commodities. And as I've talked to investors this last, after our earnings call, and certainly in the press, the fact that there are supply constraints in our industry is very apparent. But those supply constraints didn't just start in the fourth quarter. They really started a year ago in first quarter. So customers have had time to redesign systems and, you know, just take advantage of the high availability that we've had this year. So, again, that, you know, as I made comments, is there share gains in our numbers? Yes, there is. But, again, that's not – it doesn't move quickly. I wouldn't overstate that by any means. I'd look at our share over time. you know, three, five-year period, and it's much more easy for me to explain, you know, 70 basis points and, you know, five basis point, you know, if we were underneath that 30 to 40 basis point range. So, again, I just caution to look at it over a longer period of time.
spk05: Yeah, I just add, you know, at the highest level, it's all about the competitive advantages, right? So, just to touch on a few, the broad portfolio, the broadest portfolio in the industry is that's a big driver of our ability to continue to gain share. The reach of our market channels, right? And we've been strengthening that. That's to the point of the closer direct relationships with customers, and that has helped us over the last few years, certainly in 2020, and more importantly, puts us in a strong position going forward. and then owning our own manufacturing, having that control that, you know, other peers, they don't, right? And then all of that has enabled us to follow, you know, you asked about, you mentioned inventory, that those competitive advantages have enabled us to follow an inventory strategy that augmented that and supplemented that and put us in a really good position in 2020 to take advantage of the situation. Great. Do you have a follow-up on Tim?
spk02: I did. I did. Thanks. So just on the new expanded high end of the dividend component, it used to be 40 to 60 percent of free cash flow. Now you raise the high end up to 80 percent. And, you know, you've not bought back much stock the past couple of quarters. So I guess why was the high end expanded? Did you change your intrinsic value model for the stock or you're just sort of like looking at the valuation of the stock and, you know, and basically, you know, pivoting more the cash flow over to dividend versus repo. Thanks.
spk05: Yeah, no, let me explain that. So as we described in the summary, the way we think about this is after we make a creative investments to grow free cash flow for the long term. So the first thing is investments. The remaining cash, we will return over time. through dividends and buybacks. And let me stress it, it's over time. It's not any one quarter, even any one year. But over time, we will return it. Now, if you look at our track record, it's impressive, frankly, over the last 16 plus years. You look at how much free cash flow we have generated and we have returned all of that and then some to the owners of the company. Now, if you look at At that time, share repurchases have varied from year to year, but dividends have steadily grown. And they have grown to be a more significant part of our cash return. And we're increasing the dividend range today because we're comfortable that our dividend can continue to grow and be sustainable anywhere in that range, okay, whether it's 40% of free cash flow or even 80% of free cash flow would be comfortable anywhere in that range. So that's the main reason why we're increasing that range today.
spk09: That's great. Thank you for those questions, Tim.
spk08: And we'll go to the next caller, please.
spk10: And our next question is Torres Swansburg with Stifel. Please go ahead.
spk12: Yes, and thank you again for setting such a great standard for the semiconductor industry. First question, you talked about investing in inventory to perhaps gain some share. But what about CapEx? It seems like the industry is in a pretty precarious situation right now when it comes to capacity. So any thoughts about perhaps ramping CapEx a bit faster over the next two years?
spk05: Yeah, no, good question. So first, let me step back, remind everyone the way we think about CapEx, just as you said, it's an investment. It's an investment in our manufacturing and technology. We own our factories to a very high degree, both front-end and back-end. and CapEx is the fuel that drives it and ultimately drives top-line growth and free cash flow growth. The guidance that we have given you is 6% CapEx being 6% of revenue. That's a model. Last year, we ran lower than that. I would expect the next few years probably running a little higher than 6%, but over the long term, 6% is probably the model you want to look at. And, you know, maybe specific to your question, we're not slowing down CapEx for any particular short-term metric, right? We're driving CapEx to the numbers that we think are appropriate to sustain production levels in accordance to what we expect for demand over the next five or six years because these are all long-term bets. both for the factory we're building now, as well as other investments in CapEx, AT, and so forth that we expect in the future. Do you have a follow-on?
spk12: Sorry. Yes. Thank you, Dave. My follow-up is on M&A. I really appreciate and respect your discipline, especially on the weighted average cost of capital in the four-year period. But just given that interest rates are just chronically low now, Is there any flexibility on that metric whatsoever, you know, maybe like instead of four years, perhaps five years, or is there no thinking in that direction?
spk05: Yeah, no. So let me remind everybody, I mentioned it during the prepared remarks, but M&A, the way we think about it is first it's got to be a strategic fit. Generally that means analog companies with really great products to expand our broad portfolio, focus on auto and industrial ideally. And then the numbers need to make sense. And on your specific questions, the numbers need to make sense. That is a fairly flexible statement, frankly, to your point. Weighted average cost of capital, you ask a banker for an answer, and each banker will give you five different answers. You ask 10 bankers, you have 50 answers, and there's a big spectrum of possibilities there. And obviously, in all seriousness, interest rates does play a factor here. on that. You know, the four, five years, three years, that's also flexible, right? You know, at the end of the day, you have to do what makes sense for a business. Sometimes an investment is pretty obvious. So, you know, you take that into account where you're assessing that. Other times it's more risky. So you have to think about it a little differently. But the framework that I described, that is the big picture of how we think about it.
spk09: Great. Thank you, Tori. And we'll go to the next caller, please.
spk10: And our next question is William Stein with Therese. Please go ahead.
spk04: Great. Thanks for letting me ask a question. I'm going to pick up on that discussion of cost of capital. You have highlighted this focus on efficiency. But one of the things that sort of stands out on your balance sheet is your gross leverage is about one turn. Your net leverage is roughly zero. Interest coverage is something like 45 times. I'm wondering if the company has considered elevating its leverage to achieve efficiency with regard to its cost of capital.
spk05: Yeah, no, let me address that. So if you look at, I think it was page seven, we talk about how we think about debt from an objective standpoint. And the way we, because that's essentially what you're alluding to, um we um our objective is to increase rates of return with some leverage on the balance sheet when economics makes sense and avoid concentrated maturities and ensure strategic flexibility so you look at you know what we've done over the the years especially the last you know three or four years or so we have added uh debt to the balance sheet because it made sense given that uh that criteria right the uh the rates of return uh we're able to uh To optimize those, the cost of debt was low. Maybe not as low as it is now, but it was low. And you see how we deployed that capital over the last few years. And we'll continue to think in those terms.
spk04: Yeah, Paolo? Okay, sure. As a follow-up, I really appreciate the disclosure about the percent of businesses direct now so we can get an idea for how that's changed as you've consolidated down to one distributor. It's my recollection that most of your revenue through distribution historically has been on a consignment basis. And now that you're doing that internally, that is the, you know, you've brought in a significant amount that was previously in distribution, now direct. I'm wondering if you can update us on the percentage of business that sits in consignment at your customers, at your direct customers, for example, and how that's changed in the last year as well. Thank you.
spk09: Yeah, so, you know, the amount of consignment revenue that we have in distribution will remain very high, you know, with our distributor in the U.S. and that worldwide distributor. As we go direct, you know, many of those customers aren't as large nor have the infrastructure to have consignment. would love to be able to do that, should they choose to do it. So that number actually will come down in time. And so I'll just say that last year was the year of transition. So I actually don't have that number here in front of me. But it is moving. And then I'll also just say that we are transacting revenue across TI.com. And that is a very small number today. And that number is growing very quickly. And we just think the customers will increasingly want that convenience of having product that's highly available. They don't need to provide us a forecast with that. And they can go to the website and get that product directly from there. To some degree, those channels probably will shift somewhat, and we want to provide that flexibility. But the most important thing is having that direct relationship to the customers overall.
spk05: Yeah, I would only add, Dave is absolutely right in his statement on the shift. Many of those direct customers will not have consignment or do not have consignment, just the nature of their business is but at the highest level are intended to provide them with great support, obviously. And in order to do that, we plan to have that inventory on our books to the largest degree. So you, in fact, that's part of the reason why the inventory days range is going up, right? Even if we may move slightly below in the consignment metric, maybe think of it as a virtual consignment, essentially, where we will hold more of that inventory on our books, on our facilities, so that we can very easily, effectively support customers with the broad portfolio that we have of mainly catalog parts that, again, is very low risk of obsolescence. That's why we can hold so much of that in our facilities and then ship it to where it's needed for the customers. That's great.
spk08: Great color. Okay. Thank you, Will. And we'll go to the next caller, please.
spk10: And our next question is from Harlan Sir, JP Morgan. Please go ahead.
spk13: Morning, and thank you for the update. In 2019, about $4.8 billion of your analog revenues were at 300 millimeter. You grew that business by about $650 million in 2020. So is it fair to assume that 200 millimeter revenues last year were about $5.5 billion? So you were about 68% utilized on your 300 millimeter footprint?
spk05: Yeah, that is pretty good. So it's about 70%. So, yeah, you're getting to that ballpark. For the year 2020, and we don't disclose that in a ton of detail, but to keep it high level, for the year 2020, we ran at about 70% utilized on 300 millimeter. That existing footprint has a potential revenue capacity of about $8 billion between RFAB 1 and DEMO 6. And we've talked about that before. As I mentioned earlier, RFAB 2, once it's fully built out and equipped, will have another $5 billion of potential annual revenue capacity.
spk13: I appreciate that. Yeah, absolutely. So with that incremental sort of roughly 2.2, 2.5 billion of 300 millimeter revenue capability in just your two factories alone, and if I assume... the analog business grows mid-high single digits over the next few years, that should take you out through the 2020, maybe second half 2023, 2024 timeframe in terms of fully maximizing the two existing 300 millimeter fabs. So why bring on our fab two in 2022? I also know that you are closing two six-inch fabs. is this six-inch revenue moving into 300-millimeter? And so maybe you're accelerating the 300-millimeter analog revenue capacity still faster than just the growth of the business? Is that what's driving the earlier ramp of RFAB 2?
spk05: Yeah, I tell you, the highest level is an asymmetric bed, meaning the difference in cost between building it now versus... Waiting a few years, it's just the carrying cost of that cash that we were putting a little earlier. But the potential offset is huge if demand runs stronger than the assumptions you listed there. So I'd rather have that factory ready the sooner the better. So right now we're planning on middle of 2022, middle of next year by the time we start getting some output. from that factory. You know, if things work out that we don't need it, then we don't need to run it, right? Then you also added, you know, the couple factories that we talked about shutting down over the next few years. You know, that is also in the play and some of that will move to 300 millimeter. We don't have to, right? We can always delay that if demand continues to be strong. We wouldn't, you know, shoot ourselves in the foot on that front. So, So we have flexibility on what to do there.
spk09: Yeah. And when we started it, that was always the question of, geez, why in the world are you starting this? You know, we started it, you know, when the industry was in a cyclical low. Our plan is to ensure that we've got capacity for the long term. We're making those decisions on five and ten year horizons, not to try to time perfectly running out of capacity and potentially putting our customers in jeopardy of not being able to get product, but ensuring that we've got long-term capacity for their deeds and to be able to grow.
spk05: You know, the other angle is, remember, they call it $5 billion of investment on the new factory. About a billion of that is the build-in. Four billion is equipment. And equipment, you don't have to buy it all at once, obviously. So on equipment, we can be more incremental and measure. You know, you can't have half a build-in, right? You've got to have the full build-in. and all the pipes and things needed. So that's the other thing that goes into our thinking.
spk08: Okay, great. Okay, have a good day. We'll go to our next caller, please.
spk10: And our next question is Stacy Raxcomb with Bernstein Research.
spk03: Please go ahead. Hi, guys. Thanks for taking my questions. I thought it was interesting. You left your free cash flow margin targets remaining at 25% to 35% of sales. You've been running above the high end of that quite respectably for the last three years. Like, what's stopping you from raising that target? It seems like we've got enough track record now to maybe justify it.
spk05: Yeah, you know, nothing's stopping us. It's just, you know, at the end of the day, the focus is not on the margin. It's on the dollars of free cash flow per share dollars and the growth. And, you know, that's a little offside in in messing with that target and trying to indicate something that's not a priority for us, right? Our priority is the dollars. And if those dollars come in at 25% of revenue, the growth of those dollars, then that's great. If they come in at 40% of revenue, that's great too, right?
spk03: But is there any reason to expect that they should come in at lower rates than we've seen in the past, especially if you think you're going to grow and take share or It sounds like the margin structure is still pretty strong. Why should we expect that free cash flow percentage to be lower than it has been the last several years?
spk05: There's nothing structural driving that down.
spk03: Okay. Okay. Thank you. For my follow-up, I just want to ask you about the 300-millimeter. Again, in 2022, it's ready for output. I think you said you'll probably have some output coming out in the second half. How much revenue capacity do you think you will actually have installed and outputting by the second half of 2022 in 300 millimeter under the current plan?
spk05: Oh, you know, well, we'll have the $8 billion from the existing factors, of course. And so you're asking incremental on the extra $5 billion for RFAP2? I don't have a number for you, but it'd be very little.
spk09: What's unique about RFAP2 is that... Because it's at the same physical address, you know, we can put one tool in that facility. And let's say, you know, Litho is the tool that limits the capacity for the whole facility, and we can bring up capacity, you know, at that facility on both sides. So that's unique with RFAB 2 because it's located with RFAB 1. The second thing is the way qualification standards are written in our industry. We don't need ECNs and customer notifications of that change, where if it was Greenfield, you'd have to put in a whole pilot line and bring up the whole pilot line on one side. You'd have to have an ECN. and notify a customer of a change, they'd have to go through a qualification cycle. So there's some tactical benefits to RFAB 2 that we'll enjoy. You know, we don't have any room at any of our other sites, so the next facility we build, you know, we'll have to do that as we've had to do in the past. So it's not that big a deal, but we'll have that tactical advantage. That's helpful.
spk08: Thank you, guys. Go to the next caller, please.
spk10: And our next caller, question is from Vivek Oras, Bank of America Securities. Please go ahead.
spk01: Thanks for taking my question. And I wanted to echo what Tori said about TI setting such a strong, impressive quality standard for the rest of the industry. My first question is, you know, if I look at your business over the last decade, analog has grown at a 6% CAGR, but embedded has kind of been flattish. And I know you made some changes last year, but at what point does M&A become important in that sector? Can you really grow your overall sales without really growing in the embedded business where, you know, when I look at all your microcontroller or processor or connectivity competitors, it's a very fragmented and a lot more competitive industry than analog. So just you know, thoughts on your embedded business and how it relates to your growth targets.
spk09: Yeah, maybe I'll start, and if, Rafael, you want to add, I would say that, you know, as you've heard us talk about M&A, you know, our thoughts there haven't changed over time. And we talk about a strategic match, and the first thing we'll talk about is, you know, catalog, analog, high exposure to industrial and automotive. And you don't hear embedded in that. And it's not that we don't like embedded or don't consider it important. It just really comes down to how those businesses make money. They make money very differently. And in analog, diversity of product, uniqueness of product is highly valued. That's the way it makes money. In embedded, the way that you make money is you get as many customers and as much revenue over as few of instruction set architectures as you can. We essentially have, if I simply state it, three instruction set architectures in our embedded business today. And so our objective there is to invest and to grow those over time. Those are giving us full exposure to the markets in which we want to participate. So acquiring someone else's instruction set architectures and fragmenting that, you just can't get any leverage off of that. And I think that's, for companies that have done that, I think that that's why you see them struggle to some degree.
spk05: Yeah, so absolutely right. I would just add, you know, we're pleased with the progress that we're making. We've embedded, you know, as we have said before, our first goal was to stabilize the business and then to grow it sustainably and leveraging our competitive advantages. And those... The four competitive advantages apply to embedded just like they apply to analog. And we think embedded can be and will be a long-term contributor to our sustainable growth, top line, and free cash flow.
spk09: That's right. Yeah. And we wouldn't be making those investments if we didn't believe it. I'll just add that we're not looking for shortcuts. It will take time for that business to – prove that it can grow sustainably. And so, you know, we're making those investments today, but it will take time before that is demonstrated. So you have a follow-up, Vivek?
spk01: Yes, thank you. So you gave a range for, you know, very specific range for how you plan to have higher inventory. And then I think you mentioned the goal ultimately is to grow faster and I imagine that there is some help at some point in gross margins as well. Could you help us quantify what that benefit is? So how much faster can you grow with this new strategy and how much better flow through can you have in gross margins? So I understand why you're doing this change, but how do I quantify the benefit, whether it is in a faster top line growth or versus the industry as an example, or through the gross margin fall through, which I know historically your target has been 75% or so. Thank you.
spk09: Yeah, Vivek, maybe I'll start off and just answer. And I think John asked a question earlier on somewhat related to that. And I'll just say that going back to the characteristics of the analog market, in embedded markets, they just happen to be very high-quality markets, especially the portions that we choose to invest and participate in, and share just doesn't move quickly. So, and, you know, back to the comments that you've got to measure it over time, and, you know, we've been delivering kind of 30 or 40 basis points when you put your thumb up in the air and look at the numbers. So, the investments that we're making, strengthening our competitive advantages gives us confidence that we'll continue to be able to continue to do that. We're not talking about trying to accelerate that or we'd love to, you know, certainly we'd love to have it grow, you know, significantly faster than that and would aspire for that to happen. But I think that would be still a good expectation to have. And then, you know, the structural cost benefits that we get from 300 millimeter, you know, as we grow revenue, you know, we've talked about, as you know, that 70 to 75 points fall through. We still think that that's a good number. And, you know, I think you've done it before. If you plotted change in revenue and change in gross profit, you know, you look at that on a year-on-year basis or quarter-on-quarter basis, you can see that over time that that's a reasonable number. To Rafael's point, you're not going to get gross margins passing through 100% of revenue, so long-term growth is probably the most important thing for us to focus on.
spk05: Yeah, let me just add a few things just to complement what Dave said. The inventory strategy, this is not a big change. We did tweak the range up, but in some ways, we've been doing this for years. We've talked about building inventory buffers. We've talked about building low-volume inventory for a number of years. So this is just a little bit more of the same. It's working well. We're going to do a little more on that, and that's why we're moving the range up. And again, it's an enablement, ultimately, and it works in complement with our competitive advantages. The other one, you talked about fall-through several times. Let me just stress, the fall-through that you should expect is the same, 70% to 75%. That's not changing. Inventory is not going to make that difference. Over the short term, you know, any one quarter or two, everything else being equal, yeah, you know, your fall through is a little higher if you build inventory than if you don't. But, of course, that's non-cash. If anything, we're spending cash when that happens. So, you know, that's an investment. But over the long term, it's not going to change the fall through, you know, once we get to that desired inventory point at some point. So don't, you know, don't think of it that way, right? The fall through over the long term is still 70 to 75%.
spk08: Great. Thank you, Vivek. And we'll go to the next caller, please.
spk10: Okay. And our next caller is Chris Kingland with Citi. Please go ahead.
spk14: Hi, guys. I think that's me. Thanks for letting me ask a question. Hey, now that we're, you know, well past the DISD consolidation, can you talk about the impact it's had on your business? Has it enhanced revenue growth, held back revenue growth, done anything for margins-free cash flow? None of the above, no impact, maybe just a post-mortem on it?
spk09: Yeah, no, I think we're thrilled with the progress. Again, I would just say that shift was substantial. You think of where we started or ended 2019, we basically had two-thirds of our revenue going through distribution. We ended last year with essentially two-thirds of our revenue going direct, so substantial change. really reflective of a number of years of investment to get ourselves into a position to be able to do that. And just the insight of having closer direct relationships is very helpful. And as I talked about earlier, the supply constraints didn't show up in fourth quarter. They started earlier in the year. One of the things that customers do when they have shortages is they hand out lists of the parts they're looking for that are short. And we get those lists directly now as an example. They provide those to all their suppliers as they're scrambling to find parts. And our sales and apps people are working with their engineering teams and where we can find – Those designs that are working through, you know, we'll tell the procurement people and, hey, if we switch out these parts and change designs as they're coming through, you can take advantage of our high availability. So, one simple example of how that works, again, you know, share doesn't shift quickly over time. But that's one way where you can intersect things earlier on where you've got information where other people don't have it. So you have a follow-on, Chris?
spk14: Yep. I guess a philosophical question. So you guys talked about it on the call and prominently featured in the press release that you're trying to maximize free cash flow growth. And, you know, even though the results have improved somewhat on the embedded side and I guess a little bit on the other side, For the last several years, they've clearly been hampering free cash flow growth. In the past, you guys got rid of sensor and control business because of that same reason. It was not quite up to snuff. What's the reason for keeping these businesses around if they're clearly dragging your free cash flow growth and your stated goals to maximize it?
spk05: Yeah, sure. So ultimately, we evaluate everything based on a free cash flow per share growth over the long term, right? And, you know, think of it as free cash flow per share out into the future. What we think that's going to be, you know, there's a net present value of that in a simplistic way. You know, you can think about it that way. And if there was a different way to maximize that number, we would consider it. So, you know, we're not close to any ideas, but we are confident that the way we're running the business today, and that is analog and embedded, maximizes that free cash proposal share growth for the long-term owners of the company.
spk09: Okay, great. I think we've got time for one more caller, please.
spk10: Okay, and our last question is from Craig Hittenbaum with Morgan Stanley. Please go ahead.
spk00: Yes, thank you. A question on R&D, which you guys highlighted, is the main priority in terms of looking at capital. How do you think about it as the industry is consolidated? And, you know, one of the benefits TI has had is scale, for sure. And just as you see some consolidation and some other companies kind of close that gap, does that change the way you think about R&D at all in terms of either absolute or as a percentage of revenue?
spk05: I'll take the first crack at it. If I understand your question correctly, at the end of the day, to us, R&D, and really OPEX in some way, at least parts of SG&A, it's all about investments to drive the top-line growth. So R&D obviously adds more great products to that portfolio. They brought us in the industry. On the SG&A front, investments in TI.com, in a reach of market channels, That puts us in a strengthened competitive advantage to put us in a better position. So we look at that independent of percent of revenue, independent, frankly, of whatever our competitors are doing, and what can we do to maximize long-term growth of free cash flow. And if, you know, if doubling R&D would do it, we would double R&D, okay? If cutting in half would do it, we would do that too. And, you know, it's not an exact science, but, you know, we're confident in the way we do it. I think we've been getting good results on that consistently over many years. So, but every year, every, you know, our leaders look at that and we evaluate projects on different bases and then decide where it makes sense to make changes to a portfolio, add a little bit in one place, take in another place to maximize ultimately that long-term growth of free cash flow per share.
spk09: Yeah, and I'd also just add that one way to judge the efficiency of that R&D is just market share. And so, you know, if you stacked up our growth over, again, I go back to the long-term growth You have to look at it over a long term and our dollar spent in R&D and the growth that that's providing versus the dollar spent by others and the growth that that provides. You know, we're very pleased with that, not only the dollar amount, but the efficiency of it and what that's driving. You have a follow-on, Craig?
spk00: I do, and I appreciate all that color. Just a longer term question. I mean, you've been driving the mix for a number of years now towards autos and industrial, and that's been getting bigger. How do you think about longer term, you know, the whole topic of China insourcing? Is that something that naturally the markets where you see the most differentiated in terms of autos and industrial would continue? Does it mean you accelerate some of that and more consumer type markets? Or how do you think about the longer term, you know, where your mix is going and how any potential effects of China insourcing could influence that?
spk09: Let me start, and Rafael wants to add. China is and will continue to be an important market to us. I think that any place with the trade tensions that we have there, Certainly, you know, those trade tensions, if you've been a student of world history, those aren't things that, you know, will be solved in a short term. They'll be with us probably for decades to come. And, you know, given today if there were teams at our customers in China, if there's an alternative to select a local company, they're going to choose it. So our job is to ensure that there aren't any ties and, uh, in that selection process. So we've got to have, you know, uh, better products, better service, better costs, uh, better availability and not allow there to be ties. And you think about that, that's what we had to do before. Uh, we've got to do that not only in China, we've got to do that in other regions. So to some degree, that's not, uh, really anything different, but, uh, But that is very, very important. So we continue to do and make good progress there. It will be an important market for us, and we will continue to do that.
spk05: Yeah, just to add one comment to that, we have great respect for the competitors we have in China. There are many local players there that are good semiconductor companies. They tend to be smaller in size. The portfolio is nowhere near our portfolio. And so that goes back to our competitive advantages, and specifically that broad portfolio. You know, we have, what, 80,000, 100,000 different parts, and you need that kind of portfolio to compete in the analog space, especially in industrial and automotive. So as Dave said, our job is to stay ahead of that competition, release more great products that we augment, that portfolio drive our competitive advantage on manufacturing technology. So we have the absolute lowest cost in the industry, so we can compete effectively. The reach of market channels to continue to strengthen that, to make it really easy for our customers to choose us versus anybody, whether it's in China or anywhere else. So we're going to wrap up with that. So before I turn it over today, To finish the call, I want to thank all of you for taking time today to go through our capital management update. Let me emphasize a few points. First, we remain focused on consistent execution of how we manage capital. Second, our discipline allocation of R&D is delivering growth from the best products, analog and embedded, in the best markets, industrial and automotive. We have great diversity across all the sectors within this market. Our 300-millimeter analog manufacturing strategy is a unique advantage and will continue to benefit TI for a long time to come. We remain committed to returning all free cash flow to our owners.
spk09: Safe. Okay. Thank you all for joining. A replay of this call will be available on our website, as well as all the slides that we used today in the call. Good day.
spk10: And this concludes today's call. Thank you for your participation. You may now disconnect.
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