Texas Instruments Inc (TXN) — Q1 2018 Earnings Call Transcript

Good afternoon and thank you for joining our first quarter 2018 earnings conference call. Rafael Lizardi, 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/ir. This call is being broadcast live over the web and can be accessed through our website. A replay will also be available through the website. 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. I'll start with a quick summary of our financial results. Revenue for the first quarter increased 11% from a year ago as demand for our products remained strong in the industrial and automotive markets. In our core businesses, Analog revenue grew 14% and Embedded Processing revenue grew 15% compared with the same quarter a year ago. Operating margin increased in both businesses. Earnings per share were $1.35, including $0.14 in tax-related benefits not in our original guidance. These were primarily due to the recent tax reform law. With that backdrop, I'll provide details on our performance, which we believe continues to be representative of the ongoing strength of our business model. In the first quarter, our cash flow from operations was $1.1 billion. We believe that free cash flow growth, especially on a per-share basis, is most important to maximizing shareholder value in the long term. Free cash flow for the trailing 12-month period was $4.9 billion, up 17% from a year ago. Free cash flow margin for the same period was 32.1% of revenue, up from 30.7% 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 be valued if it is productively invested in the business or returned to owners. For the trailing 12-month period, we returned $5.1 billion of cash to owners through a combination of dividends and stock repurchases. I'll now provide some details by segment. From a year-ago quarter, Analog revenue grew 14% due to Power and Signal Chain. High Volume was about even. Embedded Processing revenue increased by 15% from a year-ago quarter due to growth in both Processors and Connected Microcontrollers. In our Other segment, revenue declined 13% from a year ago primarily due to Custom ASIC products. Now, I'll provide some insight into this quarter's revenue performance by end market versus a year ago. Industrial demand remained strong with broad-based growth. Automotive demand remained strong, with all sectors contributing to growth. Personal electronics grew, with increases across several sectors and customers. Communications equipment declined, but was about even compared with the fourth quarter. And lastly, enterprise systems grew. As we get more insight into and guidelines on the tax reform law, we have updated our tax estimates. First, we now expect a 16% ongoing annual operating tax rate starting in 2019, down from our prior expectation of 18%. Second, for 2018, investors should now assume a 20% annual operating tax rate, down from our prior expectation of 23%. The 2018 rate is higher than the 2019 rate due to a transitional non-cash expense in 2018. As a reminder, our operating tax rate does not include any discrete tax items. To get you to an effective tax rate by quarter, for the balance of the year, we continue to expect the benefit from stock-based compensation to be about $10 million in the second and third quarters, and about $5 million in the fourth quarter. Therefore, the effective tax rate will be about 20% in each of the remaining quarters of 2018. You will find this information summarized on our IR website under financial summary data as we have done in the past. And then lastly, in the first quarter of 2018, we had about $140 million of tax benefits that were not in our original guidance. These include $50 million due to stock-based compensation, $50 million due to the updated estimates related to the tax reform law, and $40 million primarily due to the previously described decrease in the tax rate for 2018. In summary, we continue to focus our strategy on the industrial and automotive markets, where we have 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. These markets 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.

Thanks, Dave, and good afternoon everyone. Gross profit in the quarter was $2.45 billion, or 64.6% of revenue. From a year ago, gross profit increased due to higher revenue and lower manufacturing costs. Gross profit margin increased 160 basis points. Operating expenses in the quarter were $818 million, a 1% increase from a year ago and about as expected. R&D grew 4% and SG&A was about even. On a trailing 12-month basis, operating expenses were 20.9% of revenue, within our range of expectations. Over the last 12 months, we have invested $1.52 billion in R&D. We are pleased with our disciplined process of allocating capital to R&D that allows us to continue to grow our top line and gain market share. Acquisition charges, a non-cash expense, were $80 million. Acquisition charges will be about $80 million per quarter through the third quarter of 2019, then decline to about $50 million per quarter for the remaining two years. Operating profit was $1.55 billion, or 40.9% of revenue. Operating profit was up 24% from the year-ago quarter. Operating margin for Analog was 45.4%, up from 41.4% a year ago, and for Embedded Processing was 35.4%, up from 29.9% a year ago. Our focused investments on the best sustainable growth opportunities with differentiated positions enable both businesses to continue to contribute nicely to free cash flow growth. Net income in the first quarter was $1.37 billion, or $1.35 per share. Let me now comment on our capital management results, starting with our cash generation. Cash flow from operations was $1.11 billion in the quarter. Capital expenditures were $189 million in the quarter. Free cash flow was $4.92 billion on a trailing 12-month basis, up 17% from a year ago. In the first quarter, we paid $611 million in dividends and repurchased $873 million of our own stock for a total return of $1.48 billion in the first quarter. We have returned $5.1 billion to owners in the past 12 months, consistent with our strategy to return to owners all of our free cash flow. Over the same period, our dividends represented 45% of free cash flow, underscoring their sustainability. Our balance sheet remains strong with $4.1 billion of cash and short-term investments at the end of the first quarter. Total debt is also $4.1 billion with a weighted average coupon rate of 2.05%. Inventory days were 136, up 4 days from a year ago and within our expected range. Turning to our outlook for the second quarter, we expect TI revenue in the range of $3.78 billion to $4.10 billion, and earnings per share to be in the range of $1.19 to $1.39, which includes an estimated $10 million discrete tax benefit. In closing, I'll note that the strength of our business model was demonstrated throughout our financial performance over the last few years, from top-line growth and margin expansion to free cash flow generation. We continue to invest in our competitive advantages, which are manufacturing and technology, portfolio breadth, market reach, and diverse 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 flow per share growth for a long time to come. With that, let me turn it back to Dave.

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

Thanks for taking my question and congratulations on the strong results and consistent execution. For my first question, since you have such a wide perspective on the global economy, I was wondering if you could give us a sense of what you are seeing versus what you might have thought at the start of the year. Are you noticing any areas of slowdown or pause or anything because your Q1 results are very strong, Q2 is above consensus expectations, perhaps sequentially it's not what it has been in the past. So just broadly what you're seeing in the economy versus what you thought three months ago?

I will start by saying that from a global standpoint, we are observing that the macro economy remains positive, although there are clear uncertainties introduced by geopolitical factors. With everything happening around us, it is still too early to determine the overall impact on the macro level. However, on a year-over-year basis, we continue to see strength in the industrial and automotive sectors, as Dave mentioned in his earlier comments. Personal electronics have seen growth across several sectors, and while communications equipment has seen a decline, it has remained relatively stable sequentially. Dave.

I think Vivek when you look at the quarter with revenue increasing 11%, the demand continuing to remain strong in both industrial and automotive and I just described that demand is continuing to be very broad-based. So I think that speaks to one of our competitive advantages which is diversity and longevity of products, so we're certainly benefiting from that today. Do you have a follow on, Vivek?

CapEx is up 42% on a trailing 12-month basis running ahead of revenue growth that's closer to 5% or 6% up there versus the 4% target. I'm curious why is CapEx growing so much faster when you're only 50% utilized in your 300-millimeter factory? I mean should we look at growing CapEx as a sign of confidence in demand or at what point should we be worried that maybe you are going to buy too much inventory?

I will give you a few things on that. First, most importantly let's step back and think about what is the purpose of CapEx. We talked about this during our capital management strategy a couple of months ago. In CapEx, our objective is to support technology development and revenue growth. We want to expand our low-cost manufacturing advantage, especially to the 300-millimeter where we are the only analog company with its own 300-millimeter factory and what that does at the end of the day is allow us to maximize long-term free cash flow per share growth. So that's what the ultimate objective is. The CapEx percent of revenue is just a general guide that we gave. And on that, our sense is that 4% could vary depending on what's going on in the marketplace, because of very strong demand, when we are expanding capacity, that could run off. And right now on a trailing 12-month basis 4.9%. But of course the reason that would run off is that we see opportunities to continue expanding our technology development and our low-cost manufacturing advantage so that ultimately we drive long-term growth of our free cash flow per share.

Thank you for that and we can go to the next caller please.

First, I wanted to ask about operating expenses; in Q1 they grew but probably at a rate slightly below what is typically expected sequentially. Were there any specific factors that may have delayed spending into Q2? Additionally, usually Q2 operating expenses are a bit higher. Should we anticipate any changes from what is typically expected there?

On OpEx, in the first quarter, it came in about as expected and we continue to be pleased with how we are allocating capital to OpEx in general, specifically to our R&D as it continues to drive growth in the top line and we continue to gain market share. On the subsequent quarter, as you know, we gave a range on revenue and EPS; we don't provide guidance on OpEx specifically, but if there was something unusual going on, we would point that out, and we are not pointing out anything unusual.

You have a follow-on, Stacy?

I wanted to ask about the growth in personal electronics. I was also surprised just given what we've heard from other players in that space right now. Could you give us a little more color about what's actually going on under the covers in personal electronics? And I guess, whether or not you see the current trends actually extending into next quarter given what is going on in the supply chain?

Let me talk about this quarter that we are reporting and wait for second quarter results to go through the details there. We described that we saw growth across several sectors and several customers, so you know that we tried to point out there, it is not just the insets that are growing, there are other things growing inside of that. And I will describe the growth as somewhere in the mid to single-digit. So good growth, especially for a sector like personal electronics. Long-term of course, we think that we will see auto and industrial drive our business where we've been allocating increasingly our capital. And that's just the belief that those will be the two areas that will drive growth not just for us but certainly in our industry overall.

On inventory, Dave, I think Q1 inventory grew about 4% sequentially. I think days inventory grew a little bit as well. Can you describe how you guys see internal inventory today? And if you can comment on the channel, where you guys are seeing the channel that will be helpful as well?

I'll talk about internal inventory and then Dave will talk about channel inventory. But on inventory, let me step back again and refer you to our long-term objective that we talked about at the capital management call. What do we want inventory for? The objective of our inventory is to maintain high levels of customer service, minimize obsolescence, improve our manufacturing asset utilization and we also see value in controlling that inventory, having more of it in our own product distribution centers, more in consignment, and more in low-volume buffers. I talked about this at the capital management call as well as 90 days ago when we closed the last quarter and this topic came up. So we're very pleased with where our inventory ended up. From a day standpoint, it was 136 days, from a year ago that's up 4 days, sequentially is up 2 days and is well within our 115 to 145 day inventory baseline.

From a channel perspective, inventory is approximately at 4 weeks. As Rafael mentioned, we believe there is value in owning and controlling our own inventory, and the actual results are reflected in our consignment program. Around 65% of our distribution revenue is generated through this program, meaning that the 4 weeks we are seeing is actually equivalent to about half to a third of what many of our competitors experience in the channel. We consider this to be a healthy level when combined with the inventory positions we have recorded. Do you have a follow-up question, Toshiya?

I do thank you. So on communications equipment specifically, I think three months ago, you guys talked about the business being a little bit choppy and today I guess you told us that revenues were down year-over-year and flattish sequentially. At what point would you expect this business to revert to growth? Is that sort of in the second half of '18 given lower comps or do we need to wait longer for this business to start growing again?

Yeah, so I won't try to predict what the back half of the growth for communications equipment will look like. As you mentioned, and you have been following the industry long enough, you know that factors are just choppy the way that operators place orders and the OEMs have to build inventories to respond to that. That doesn't make it a bad business; it is just the nature of it and there will be more communications equipment shifts in the coming years. So we have got a great position today in 4G products. We will have a great position in 5G products and really any time trying to figure out when that mix will begin to shift and we will just enjoy the demand as it comes in.

Why don't you just talk about what you're seeing? You mentioned channel inventory. If you can speak to your customer's inventory a little bit and I guess we've seen shortages of things outside of your space like passives and embedded memory and things like that. Is that causing any change to your customer's inventory behavior in your business either because they have inventory waiting for those things that are in shortage or are they holding more of a buffer, or is it sort of business as usual?

I would say that we haven't seen any signs of increasing inventories or double orders, which historically have been indicators. It's important to note that these changes are not typically visible in advance. With that in mind, it's crucial to assess what we can actually observe. We have good visibility into the distribution inventories I mentioned earlier, a significant portion of which remains on consignment, meaning we will retain the inventory on our records. Our insight into customer inventories varies depending on whether it's consignment. For consignment OEMs, we are carrying that inventory ourselves. We're not noticing anything unusual, such as expedited orders, which could imply a larger issue. Our visibility into inventory beyond our customers' manufacturing operations is quite limited, leading to stable lead times. While we occasionally encounter hot spots, we actively collaborate with customers to address them, and metrics like cancellations and reschedules remain low. These are the aspects that we can track and evaluate. Moving forward, we'll continue our focus on maintaining stable lead times and high delivery metrics, as this is what ultimately assures customers of our support when they need it. Do you have any follow-up questions, Joe?

First question just a quick one. So sequentially revenue increased; the gross margins were down a bit. Can you comment on why that happened?

Yes, when you look at gross margin fall-through which kind of was embedding your question there, in any one sequential transition particularly when revenue was about flat is up 1% is difficult to make anything meaningful out of that analysis. You probably want to look at it on a year-on-year basis and on that basis our gross margin, gross profit margin increased 160 basis points; the fall-through was about 78%. And that's along the lines of what we have guided all of you before, that on a long-term basis that falls through you should expect from our revenue gross to be between 70% to 75%.

Yes, so my follow-up. You never said but the tax rate continues to go down. Can you just talk about your plans for this extra cash? Is it possible? I know you usually raise the dividend sometime around August or September; is it possible or feasible you could raise the dividend twice this year? Why not crank up the buyback a little bit more? I think you took your share count down by just a couple of million around that.

Yes, let me step back and talk about cash return and how we think about that and then how we think about dividends and repurchases. From a cash return standpoint our objective is to return all free cash flow to the owners of the company. And we have been doing that for a number of years. In fact on a trailing 12-month basis, we generated $4.9 billion of free cash flow and we have returned $5.1 billion of free cash flow. So we are doing that. Now obviously we do that in two ways, dividends or repurchases. From a dividend standpoint we want to provide sustainable and growing dividend. As of the end of last year we have been growing that dividend 24% on a compounded basis for the previous five years, and at the end of last year also on a trailing 12-month basis that's 45% of free cash flow. So that underscores the sustainability. On the repurchases, we just got done repurchasing $873 million of our own stock and our objective there is accretive capture of the future free cash for the long-term owners of the company. So we just resell our assumptions to extrapolate estimate what we think our free cash flow growth is going to be and then based on that we come up with different scenarios and valuation as well as the market prices below those scenarios, we buy back the stock and that's what you have seen us do for a number of years now and we will continue doing that.

Okay thank you, Chris; we will go to our next caller, please.

Actually maybe I could just follow up on the last question on gross margin, made on guide specifically in for June, but just kind of similar question. Sequential growth in June; what's the way to think about gross margin? Is there any segment to think about mix-wise or such as to why the gross margin will be up?

I will just tell you of course for whenever you in fact hear a specific projection on that we give the revenue range and an EPS range. But the bigger picture on that is that; a, we continue to drive revenue growth and that's the biggest contributor to free cash flow growth. And then in addition to that, we continue increasing our loadings on 300-millimeter which has a 40% cost advantage. That's one of our competitive advantages. We're the only Analog company with own 300-millimeter factory. So every time we build an incremental wafer on 300-millimeter, we have better fall-through on that. We have better free cash flow per share growth. So we will continue to do that for the foreseeable future and even beyond the current capacity of those taxes.

Just in the March quarter, you saw good strength in embedded and particularly processors. Wondering if you can just speak about that strength in terms of end market or particular product discussed will be helpful?

If you look at embedded overall and processors specifically, they have a very high exposure to industrial and automotive. So that growth is really coming from very diverse places. Connected microcontrollers also grew very nicely as well, and again that includes our connectivity products there and they are doing quite well and we are encouraged because that growth is coming from diverse places which I think gives us confidence in the long-term ability of that portion of our business to continue to grow. Okay. Thank you. Blayne, we will go to the next caller please.

Thank you very much Dave, Rafael. I apologize if I had missed it. What were the orders for the quarter?

Our orders for the quarter increased by about 11% compared to last year, resulting in a book-to-bill ratio of approximately 1.03. I want to remind everyone that around 60% of our revenues come from consignment, so we do not maintain a backlog. We receive orders leading up to the quarter, and there's a demand for new revenue caps. Therefore, it's important to be cautious with these figures. Do you have a follow-up, Ambrish?

Yes, I did and thanks for the color. Geo wise, was there any geographies that stood out as stronger or weaker as you went through the quarter? Thank you.

So from a geo standpoint, we had revenue up in three of the four regions from a year ago. So Asia was up followed by the U.S. and Europe; Japan was down. And a couple of comments, so first, I'll make the comments that that is measured by where we ship the product and not where it's consumed. So usually our regional shipments don't often reflect the broader macro in a particular region. And the second thing then I'll add is from a Japan standpoint, we are seeing that companies in Japan are building products in other regions of the world. So as products get designed in Japan, they actually may be produced in other regions, so I wouldn't look too much on that as well. Okay. Thank you Ambrish, and we will go to the next caller, please.

Just a question on what you saw as perhaps better and worse in the quarter and it looks like the revenues came in a little better than you had expected? Can you talk about what was the driver of that?

Yes, Chris, so revenues came in within our expectations for the quarter. Certainly they are in the upper half of our expectations. And I'd just say that of course that was driven by industrial and automotive. And I just say that strength we saw very, very broadly. So there wasn't one specific thing that we could point to. And I think again that highlights one of those competitive advantages of diversity in line with positions. That we can see that kind of strength and it shows up even on the top line. You have a follow-up?

I do, thank you. And I guess that we've been in a situation where business conditions have been stable if not pretty good for a while. I know you guys have been doing this a while, whenever things are good in semis we wonder how long it's going to last. Can you talk about perhaps what we're seeing now? What perhaps is different than what we have seen in past cycles? Are there things that TI is doing differently? Is there things within the industry that are different as compared to last cycles such that things would be more stable now?

What I want to emphasize in response to this question is that we have significantly expanded our presence in the industrial and automotive sectors. As of the end of last year, our revenue from these sectors was 54%, an increase from below 40% just a few years prior. This growth has brought greater stability to our revenue, as we now serve a wide range of customers and industries within the industrial sector and equipment market. However, this doesn’t mean we would be unaffected by a market correction, which could impact all sectors in the short to medium term. The key takeaway is that in the long run, we are committed to these markets because they are where we see growth for the company. Even if we experience a downturn, our long-term trajectory, looking 10, 15, or 20 years ahead, remains focused on increasing our presence and content in these key markets.

Okay. Thank you, Chris, and we've got time for one more caller operator.

Great. Thanks for taking my question. Hey guys. So just following up on the last question, Rafael, if I look at the five- and ten-year averages for revenue growth, Q1 has been down low to mid single digits, Q2 and Q3 have been up high singles and then Q4 has been down the most. Given your enhanced exposure to industrial and automotive, do you still think those averages are good guideposts for us as we forecast your business or do you think it's different now?

Romit, I will take a shot at that. I think that when we look at seasonality, I would remind you that we still have a very nice calculator business that has a strong seasonal pattern with the back-to-school. So that along with the balance of the semiconductor business in the past has been stronger in the second and third quarters. So as you know for seasonality in general, that makes second and third quarters stronger than the first and fourth quarters. If you look at those sequential changes you will see that you can take an average of them but the lot of the last five or 10 years is a very, very wide range of numbers that are in there. So when we look at it, we just talk about seasonality in those two quarters. Do you have a follow on?

Yes, thanks for that. Just on R&D in the last several years in Q1, R&D has gone up by about $20 million to $25 million; this Q1 R&D was down $1 million. I know that in 2016, R&D grew faster than revenues and then it grew about in line with revenues in 2017. Just given what we've seen so far year-to-date is it reasonable to assume that we might see more R&D leverage this year versus the last couple of years?

We are pleased that we're allocating capital to R&D, even SG&A and CapEx and ultimately to drive a top line growth in market share. We do that based on long-term expectations on growth, particularly industrial and automotive as I talked about earlier given how well our portfolio matches those markets. So we will continue to do that. And if we have opportunities to increase R&D because we have even better opportunities, we will do that; if not, we will keep it about where it is, but we don't have any said percent increase or number to give you.

Okay. Thank you, Romit, and with that we will wrap up the call. Thank you all for joining us. A replay of this call is available on our website. Good evening.