Texas Instruments Inc (TXN) — Q4 2018 Earnings Call Transcript

Thanks, Dave, and good afternoon everyone. Gross profit in the quarter was $2.41 billion, or 64.8% of revenue. From a year ago, gross profit decreased primarily due to lower revenue and reduced factory loadings. Gross profit margin decreased 30 basis points. Operating expenses in the quarter were $814 million. Operating expenses for the year were up 1% and were 20.5% of revenue, within our range of expectations. For the year, we have invested $1.56 billion in R&D, an important element of our capital allocation. Acquisition charges, a non-cash expense, were $79 million. Acquisition charges will be about $80 million per quarter through the third quarter, and then decline to about $50 million per quarter for the next two remaining years. Operating profit was $1.52 billion, or 40.8% of revenue. Operating profit was down 3% from the year ago quarter. Operating margin for Analog was 46.7%, and for Embedded Processing was 29.6%. Our focused investments under the best sustainable growth opportunities with differentiated positions enable both businesses to continue to contribute nicely to free cash flow growth over time. Net income in the fourth quarter was $1.24 billion, or $1.27 per share, which included a $0.01 cent discrete tax benefit not in our prior outlook, as we have discussed. As a reminder, the year ago quarter included non-cash charges associated with the tax law changes. Let me now comment on our capital management results, starting with our cash generation. Cash flow from operations was $2.15 billion in the quarter, up 11% from a year ago. Capital expenditures were $323 million in the quarter. In the fourth quarter, we paid $736 million in dividends and repurchased $2.01 billion of our own stock for a total return to owners of $2.75 billion in the fourth quarter. Our balance sheet remains strong with $4.23 billion of cash and short-term investments at the end of the fourth quarter. Total debt was $5.1 billion with a weighted average coupon rate of 2.77%. Inventory days were 152, up 18 days from a year ago, and above our targeted range as mentioned on our last call. We continue to believe there is strategic value in owning and controlling our inventory. We have reduced our operating plan starting in the fourth quarter, but we are also working to replenish inventory of low volume devices; these actions have served us well in the past. In addition, we have made progress on our next phase of our consignment programs with our distributors. We expect inventory will continue to run above our targeted range for several more quarters. Now, let's look at some of these results for the year. In 2018, cash flow from operations was $7.19 billion. Capital expenditures were $1.13 billion, or 7.2% of revenue. Free cash flow for 2018 was $6.06 billion, or 38.4% of revenue. Our cash flow reflects the strength of our business model. As we have said, we believe free cash flow growth, especially on a per share basis, is most important to maximizing shareholder value in the long-term and will be valued only if it is productively invested in the business or returned to shareholders. We remain committed to return all our free cash flow to owners. Total cash returned to owners in 2018 was $7.66 billion. These combined returns of dividends and share repurchases demonstrate our confidence in our business model and our commitment to returning all free cash flow to our owners. In 2018, we paid $2.56 billion in dividends, or about 42% of free cash flow, evidence of their sustainability. Outstanding share count was reduced by 3.9% in 2018, and has been reduced by 45% since the end of 2004 when we initiated a program designed to reduce our share count. Turning to our outlook for the first quarter; we expect TI revenue in the range of $3.34 billion to $3.62 billion, and earnings per share to be in the range of $1.03 to $1.21, which includes an estimated $20 million discrete tax benefit. For 2019 our annual operating tax rate remains unchanged from our prior expectation of 16%. As usual, details of our expectations for taxes can be found on our IR website under Financial Summary Data. In closing, we believe that after 10 quarters of year-on-year growth, the weakness we are seeing is primarily due to the semiconductor cycle. In addition, the macro environment, including uncertainty caused by trade tensions, could impact the depth and duration of this cycle. Given our experience, we will stay focused on making TI stronger for the long-term, while remaining diligent in the short-term. We continue to invest in our competitive advantages, which are technology and manufacturing, portfolio breadth, market reach, and diverse and long-lived positions. 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 now open the lines up 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 an additional follow-up. Operator?

I'm curious, how are you managing your utilization in this downturn that you are seeing? I know Rafael, you mentioned that you have long-lived parts but how are you managing utilization? And are you making any distinction by the end-market that the specific part is going into? And as part of that, should we continue to assume the same 75% or so incremental gross margin fall-through?

Yes, let me address your last question first. As we mentioned on the call 90 days ago, we have lowered our wafer starts to better align our operating plan with our revenue expectations. We did this in the fourth quarter and are continuing in the first quarter. This reduction leads to lower factory loadings and impacts our financials, but from an ownership perspective, we view it as a cash issue. Managing inventory is important since it consumes cash, and by reducing inventory, we improve our cash flow. More importantly, this positions us to meet our revenue expectations for the upcoming year. If those revenue expectations change over time, we will adjust our factory loadings and utilization accordingly.

I'll just add to the second part of your question; we have tens of thousands of products across 100,000 customers, which creates a complex planning situation. The strongest signals we receive are the orders from customers and the demand signals we get from our consignment programs. As we plan wafer starts, we pay close attention to these signals. In times like this, we will be diligent in monitoring them and proactively adjust when necessary. Do you have a follow-up, Vivek?

I know you mentioned it's difficult to predict when we will emerge from this downturn. Are there any other indicators you consider, even if they are qualitative, that could provide insight into whether this will be a one, two, or three quarter issue? I understand that it’s very trade dependent, but have you observed any cancellations that differ from or resemble those in previous downturns? Any additional information you could share to help us better anticipate when we might recover would be greatly appreciated. Thank you.

Yes, Vivek, so maybe just a couple of things. I think when we look at different things that we can look at like cancellations, they were up in the quarter, but just up a little. Lead times, overall, they continue to be stable. We can always find pockets where we're working aggressively with customers to close but by and far, they tend to be very stable. So we'll look at all of those signals. I think on the broader view, I've been in the industry for over 30 years now, and we looked at data over that period of time, and I've been through 9 up cycles, and obviously, we're entering into the ninth down cycle. And if you stare at the data, and I've seen in your reports, Vivek, that you've done some analysis on that too, there is no typical or average to those numbers but if you had to pick a number it's probably around the 12 months that a cycle could last. And things like trade tensions could lengthen that, but it doesn't mean it has to be that long; as you know, it could be longer or shorter than that. So again, the best signal that we get is those orders from customers. Rafael, do you want to add to that?

Yes, just to add to that, we are proactively setting the operating plan so that we can manage whatever comes at us. So it's at a level that if we can run sideways for a while, we are prepared to support our potential snapback. Or if it's deeper and longer, then we have to make further adjustments, but we are in a good position to make those adjustments and protect the cash flow and have the company in a position going forward.

Just Rafael, regarding utilization and inventory; I know you mentioned in your prepared comments that you'll be above your inventory targets for the next several quarters. I'm curious about how you view the current situation and what actions you’ve already taken regarding utilization. Do you think the 152 days will mark the peak in inventory days, or do you expect it to increase before eventually decreasing? As you respond, could you also remind us of the new long-term targets for the consignment plan?

That's a good question. Let me share some thoughts on it. Our main goal is to maximize long-term growth of free cash flow, and that drives our decisions regarding various norms like loadings and inventory. We believe in the value of owning inventory, which is why we are building low-volume buffers and increasing consignment inventory. This does put upward pressure on inventory. Simultaneously, we have lowered our operating plan to manage the cash used for inventory, rather than focusing on any specific inventory days target. To address your specific question, it really depends. If the situation weakens, inventory days could potentially exceed 152. If it remains stable, we expect to return to the insider range over the next one, two, or three quarters.

Then Dave, as a follow-up, you mentioned there have been times when there is a discrepancy in growth between Analog and Embedded. Can you help us understand where this discrepancy is the largest from an end market perspective? For instance, I know that in the communication space, there is a strong content story on the Analog side that may not exist on the Embedded side. When comparing the growth rates, can you provide any insights regarding the different end markets?

Yes, both segments have different end market exposures. We've highlighted the advantages of Analog's presence in communications equipment. Most of our PE revenues come from Analog, which accounts for the difference, although we also have a portion within Embedded. If you examine the year-over-year growth rates since we introduced the segments, you'll find that they occasionally move in opposite directions. However, over time, their performances converge. Additionally, if you analyze industry data for the Analog market and compare it with the Embedded market, you'll see that they behave differently. That's simply how these two businesses operate. Thank you, we'll move on to the next caller.

What was the book-to-bill in the December quarter? And near-term, kind of looking at bookings and the rolling forecast on your direct and consignment base customers, have you guys seen any signs of stabilization or do the near-term trends still suggest kind of continued weakness along the same slope?

Yes. So our book-to-bill, and I always make this comment whenever it's asked, we've got now 65% of our revenues on some type of a consignment program, so you're seeing that number begin to move up as we implement further stages of our consignment programs with distributors; so book-to-bill is somewhat you just have to be cautious with the number. But this past quarter it was 0.98, it was 0.98 a year ago and 0.96 in the last quarter; so that's just what the facts are. I think if you look at things like order linearity, orders decreased each month of the quarter. To some degree, that's not completely unusual that in a fourth quarter that you'd see weakness as you got into the third month. But I'd just say that those orders and the demand feeds that we get from our customers has really driven us to give you the guidance that we have; so that's really where we are Harlan. You have a follow-on?

Yes. Given the growth this year, you guys drove another $1 billion of Analog revenues to your 300-millimeter fabs, you've got probably about $3 billion left to go. So, if I assume kind of high-single digits type of normalized revenue growth for Analog, your 300-millimeter fabs are going to be full in about 1.5 years. So it would seem that that the team would be having to make a decision soon about your new fab expansion initiatives. So you guys have any updates there?

Yes, let me share my perspective, and then Dave can add his thoughts. Capacity planning for the new 300-millimeter expansion is something we take very seriously, and it has a long-term outlook. This process isn't influenced by minor short-term fluctuations, so we are progressing with our planning and currently evaluating our options. As we mentioned around 90 days ago, if we choose to proceed with building a factory, it will likely cost between $600 million and $700 million for the shell, which we would invest over several years. However, that's not our only option for expanding capacity; acquiring an existing factory is also a possibility we are considering. Additionally, if we do decide to build a factory, we have multiple locations in mind.

And I'd just add Harlan; that last year we had about $4.8 billion of our Analog revenue on 300-millimeter footprint, that was up from about $4 billion, that's real close to what the Analog segment actually grew. So again, we plan to talk about as Analog would grow, that it would be 300-millimeter that would support the growth. And roughly, that's what we've seen again this quarter.

Dave, first of all, congratulations on surviving 8 downturns. Can you guys talk about the ability to manage CapEx and OpEx this year if this sluggish time period continues? Could you work OpEx down on a year-over-year basis? And then, I think you said CapEx was 7.2% of sales or something like that; what should we be thinking about CapEx as a percent of sales this year?

Let me provide some context. As I mentioned earlier, our primary goal is to optimize and maximize long-term growth of free cash flow per share, which aligns with our capital management strategy. Capital expenditures (CapEx) play a crucial role in this strategy, specifically aimed at investing in new technology development, driving revenue growth, and enhancing our low-cost manufacturing advantage. In 2018, we allocated $1.1 billion for CapEx, which represented 7.2% of our revenue. During the same period, we generated $6.1 billion in free cash flow, reflecting a 30% increase from previous years. This increase in free cash flow occurred despite the significant capital spending, and we believe that this CapEx positions us well for top-line and free cash flow growth in the future. However, considering the anticipated deceleration in the market, we may approach CapEx differently moving forward. I expect that if current conditions persist, we might see a reduction in CapEx, likely not in the first quarter or possibly even the second quarter, but throughout 2019. It's important to note that this will depend on our growth expectations not just for 2019 or 2020, but for the years ahead. We will adjust our CapEx plans as those expectations evolve.

I want to emphasize that looking ahead to 2019, we anticipate capital expenditures to approach 6% of revenue, which is an increase compared to previous years primarily due to the availability of 300-millimeter equipment in the market. Do you have a follow-up question, Chris?

Yes. Can you guys just talk about how the slowdown is impacting your two biggest end markets, industrial and automotive?

Yes, both markets experienced a slowdown in the quarter. Industrial had broad-based growth with double-digit growth year-on-year, but during the quarter, it grew in the upper single digits. Automotive also slowed down; it showed double-digit growth for the year, but for the quarter, it only grew in the low single digits year-on-year. Therefore, while both markets are still growing, the growth rates are not as high as we have seen in recent years. Thank you, Chris. Now, let's move on to the next caller.

Dave, can you give us an idea of OpEx for March? I know it's typically up like 5% seasonally, but it's also a little more fixed now than in the past. So is it going to be up a smidge, both year-over-year and on a quarterly basis? Thanks.

Sure, I'll take that one. First, to provide some context, operating expenses are a factor we need to manage for the long-term growth of free cash flow per share, which is ultimately our primary goal. Regarding operating expenses, this is an opportunity to invest in research and development, leading to more products for industrial and automotive markets, as well as initiatives geared towards increasing demand on the selling, general and administrative side, which will enhance our competitive edge. In 2018, our operating expenses grew by about 1% compared to the previous year and accounted for 20.5% of revenue. Looking ahead to 2019, I anticipate a modest increase in operating expenses, likely a couple of percentage points mainly due to pay and benefits increases, but overall, we expect it to remain at a similar level. Now, regarding the current quarter, we provide guidance on revenue and earnings per share but don’t delve into the specifics in between. However, I can confirm that we are not anticipating any unusual outcomes. You can analyze the expected impact of revenue on gross profit margins and develop your own estimates for the specifics in that range.

Do you have a follow-on?

I do, actually. So Rafael, the repurchase was the largest in terms of free cash flow over the past three years. I understand that you don't typically view it that way on a quarterly basis, but it has historically been more mechanical than opportunistic. Should we interpret that you were a bit more opportunistic due to the stock pullback? Thanks.

Thank you for the question. To clarify, our goal with repurchases is to return all free cash flow to our shareholders, and that has not changed. We achieve this through a mix of dividends and buybacks, and we have been and will continue to be opportunistic with our repurchases when it makes sense. For instance, in 2018, our free cash flow reached $6.1 billion, which was a 30% increase from the previous year. Throughout that year, we returned $7.7 billion via dividends and buybacks. The year-on-year growth in free cash flow was the main factor driving that increase in returns, rising from $4.7 billion the previous year.

Okay, great. We'll go to the next caller, please.

First question, I wondered if you can talk about geographic differences. And you mentioned China in your opening remarks, and I think that's obvious right now. Maybe what did you see there and contrast that with what you saw in the U.S. and Europe; was that weak also, just perhaps not as weak as China business?

Yes, that's exactly right, Chris. So when we looked at China, it was weaker than the other regions. And then when you drop down into the end markets within China, I just described it as really performing very similarly, directionally, meaning that comms equipment was up as it was in other areas, we saw the markets of auto and industrial, as well as enterprise get weaker from that standpoint; so we did see that difference this quarter. You have a follow-on?

Yes. You mentioned the impact of trade issues and tariffs, which is difficult to separate from current market conditions. Have you noticed any activity related to adjusting orders, such as moving them forward to avoid tariffs or delaying them because of the tariffs? Given that deadlines have changed and another one is approaching, how might this have influenced order patterns throughout the quarter?

Yes, I think it's difficult for us to pinpoint that exactly. However, we did observe that distributors became more cautious about their inventory towards the end of the quarter. As I noted earlier, coupled with the weakness we noticed in China, this has led us to believe that this reflects their caution regarding trade tensions. Thank you, Chris, and let's move on to the next caller, please.

This is Jerry on behalf of Ross. I just have a quick question about the consignment transition; could you quantify the impact on the first quarter of 2019 and for the entire year?

I would estimate that we experienced about a $50 million impact in the fourth quarter. In the third quarter, Rafael, can you remind me, it was around $20 million or $30 million?

Yes, in the third quarter.

In the third quarter of 2018. We'd expect as we go through next year that that impacted to be about in that range. And by the end of the year, we should have that next phase fully deployed. You have a follow-on?

Yes, there has been some questions about end markets; I just want to ask in a different way. Could you just talk about quarter-on-quarter what the end market did, specifically focusing on the fourth quarter?

Certainly. So industrial declined upper single digits, I'd just say those declines were broad-based. Automotive declined upper single digits with all sectors decreasing, personal electronics declined low double digits, comms equipment grew single digits, and enterprise systems declined. So with that, I think we have time for one more caller.

I guess two questions from me as well. I mean, first off, when I look at the March quarter guide and the implication is revenues will decline from 1% in December year-over-year to about 8% in March. What is driving that acceleration in revenue declines? Is there a couple of end markets you would specifically call out that's driving it where perhaps the challenge was adjusting aggressively or is it more or less broad-based?

Amit, we do not provide our guidance by specific end markets unless there is a significant event impacting how we operate. We will complete the quarter and then offer details by end markets. However, it is clear that the weakness we experienced in the third quarter has continued into the fourth, and we expect this trend to persist into the first quarter.

And just to add to that, as we've said in prepared remarks and during the call; we think this weakness is primarily due to the semiconductor cycle. We've grown for three quarters in a row, and that's the sort of thing that happens in the semiconductor industry. And in addition to that, the macro environment, including trade tensions could also be having an impact and could affect the depth and duration of this cycle.

You have a follow-on, Amit?

I do. Previously, you mentioned your ability to gain 30 to 40 basis points a share across your end markets. As you look at 2019, where revenue and broader industry trends are more challenging, do you find it easier for larger analog companies to gain market share, or is it more difficult for you? How would you assess that situation?

I think when you look at the quality of the opportunity in the Analog and Embedded space, if market share just doesn't move quickly across any of our peers in these marketplaces; and I think that just really speaks to the quality of that opportunity. So we continue to invest in our competitive advantages which are our manufacturing and technology we talked about earlier, the breadth of our product portfolio, the reach of our market channels which includes our sales force and the size of it but also our presence at TI.com, and then diversity and longevity. So we're not dependent on any particular customer or product or technology to drive that revenue. So we're working and investing to make those stronger, it's just hard to pick up market share; I can tell you that everyone here at TI will be focused on that even as we go through the downturn, and probably have even more diligence and intensity around that overall. But again, if you could make that number higher, we absolutely would, but it is a hard thing to move. So with that, let me turn it over to Rafael to add some final comments.

All right. So let me finish with a few comments on some key items for you to remember. First, during this period of weaker demand, we will stay focused on what will make us stronger long-term and diligent in the short-term. Second, we will remain focused on the Analog and Embedded, the best products, and Industrial and Automotive, the best markets. Third, we will continue to be disciplined in executing our capital management strategy and remain committed to returning all free cash flow to the owners of the company.

Okay, thank you for joining us. Again, please plan to join us for our Capital Management call on February 5 at 10 AM Central Time. A replay of this call is available on our website. Good evening.