Texas Instruments Inc (TXN) — Q1 2022 Earnings Call Transcript

Thanks, Dave, and good afternoon, everyone. As Dave mentioned, first quarter revenue was $4.9 billion, up 14% from a year ago. Gross profit in the quarter was $3.4 billion or 70% of revenue. From a year ago, gross profit margin increased 500 basis points. As a reminder, we had about $50 million of additional utility expenses in cost of revenue related to the winter storm in the year-ago quarter. Operating expenses in the quarter were $830 million, about flat from a year ago and about as expected. On a trailing 12-month basis, operating expenses were $3.2 billion or 17% of revenue. Restructuring charges were $66 million in the first quarter and are associated with the LFAB purchase we closed in October of last year. Operating profit was $2.6 billion in the quarter or 52% of revenue. Operating profit was up 32% from the year-ago quarter. Net income in the first quarter was $2.2 billion or $2.35 per share, which included a $0.02 benefit that was not in our prior outlook. Let me now comment on our capital management results, starting with our cash generation. Cash flow from operations were $2.1 billion in the quarter. Capital expenditures were $443 million in the quarter and $2.6 billion over the last 12 months. Free cash flow on a trailing 12-month basis was $6.5 billion. In the quarter, we paid $1.1 billion in dividends and repurchased $589 million of our stock. In total, we have returned $5 billion in the past 12 months. Over the same period, our dividend represented 62% of free cash flow. Our balance sheet remains strong with $9.8 billion of cash and short-term investments at the end of the first quarter. Total debt outstanding was $7.8 billion with a weighted average coupon of 2.6%. Inventory dollars were up $150 million from the prior quarter to $2.1 billion and days were 127, up 11 days sequentially but still below the higher levels. For the second quarter, we expect TI revenue in the range of $4.2 billion to $4.8 billion and earnings per share to be in the range of $1.84 to $2.26. This outlook comprehends an impact due to reduced demand from COVID-19 restrictions in China, which are affecting our customers' manufacturing operations. We continue to expect our annual operating tax rate for 2022 to be about 14% and our effective tax rate to be about a point lower. In closing, we will stay focused in the areas that add value in the long term. We continue to invest in our competitive advantages, which are manufacturing and technology, a broad product portfolio, reach of our channels, and diverse and long-lived positions. We will continue to strengthen these advantages through disciplined capital allocation and by focusing on the best opportunities, which we believe will enable us to continue to deliver free cash flow per share growth over the long term. With that, let me turn it back to Dave.

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

Hi guys, thanks for taking my questions. First of all, I was wondering if you had any feeling for the size of the gap in revenue that's getting impacted by the COVID issues in China. Do you have any view for like what demand would be if you could ship? And like are the customers getting out of line at all? Is the overall demand and order environment kind of where it was, you just can't ship? But any color you can give on the size of that gap would be helpful.

Yes, Stacy, I'll comment on that. Our assessment in early April indicated that revenue would continue to incrementally grow again in the second quarter. However, it just became clear that we were experiencing lower demand, particularly due to COVID-19 restrictions in China. And just to be clear, customers' behavior wasn't changing as it related to backlog or cancellations. In fact, we continue to see expedites for deliveries. However, we did see that our customers' manufacturing operations were being impacted. So as a result, the approach that we took, we just took a top-down assessment and reduced the midpoint of second quarter by 10%, and so from roughly $5 billion at the midpoint to the $4.5 billion that you see. And the second thing we did was we slightly widened the range just to comprehend the higher uncertainty that we're seeing overall. Do you have a follow-up, Stacy?

I do. Thank you. And that's helpful. Just wondering if the fact that you have most internal manufacturing and you're trying to go most direct. Does that imply that you have to ship more direct to your customers in China? Do you think that these kinds of issues would impact you more than the broader industry, or do you think this is something that everybody is going to have to be dealing with to the same degree?

Stacy, our sense is this is primarily due to issues with our customers' factories, and it is not related to shipping direct or to distribution or anything of that sort.

Thank you, Stacy. And we’ll go to next caller please.

Thank you for taking my question. The first one also related to China. Do you think this is something you can recover? Is this demand destruction or is this something you can recover? And then along those lines, how would you characterize demand excluding your China customers where there were no other of these kinds of restrictions in place?

Yeah. Vivek, again, the approach that we took was really just a top-down 10% assessment of what the impact would be. So I wouldn't look at that as any precision in choosing that number. Part of the reason why we widened the guidance, I think trying to get into predictions of what could happen as the quarter unfolds. I think time will tell, and we'll see how that unfolds, and we'll report that when the quarter is over. So that's really the approach that we took at trying to assess what was going on. Do you have a follow-on?

Yes. Thanks Dave. So how are you managing your fab utilization and your inventory? It seems like you're implying gross margins down a few hundred basis points sequentially. So just curious how you're managing fab utilization? Because I thought I heard Rafael say that you are still below your target inventory level. So do you continue to plan and build more inventory during the quarter?

Yeah. So a couple of things in that question. Let me try to address most of them. Our factories are running at high levels of utilization as they have been over the last couple of years really. We've continued, in fact, we continue adding incremental capacity, as we have said we would. And the next step beyond incremental will be one RFAB2 starts production in the second half of the year, and then LFAB in the first quarter of next year of 2023. We are going to continue running our production high. We are going to build inventory; inventory did build about $150 million in this last quarter we just reported, but we're still below desired level. So our intent is to continue building that inventory, which is our objective inventory. As you know, our target is to maintain high levels of customer service, and roughly our target is 130 to 190 days, but we want to be at the high end of that, and we would not be uncomfortable even above the high end of that range.

Okay. Thank you, Vivek, and we'll go to the next caller.

Hi guys. Thanks for letting me ask the question. I guess the China side is weak and I guess 10% is as good a number as anyone could come up with. But to the extent there are shortages across the industry and demand elsewhere, it doesn't sound like it's changed from part of your preamble, Dave. Why wouldn't this allow a little bit of the fungibility of your standard product shipments to just increase to those customers and shortages to make up for the shortfall that you're otherwise going to see in China?

That's a valid question, and it's already incorporated into our process as much as possible. Our system supports the redirection of inventory. However, it's important to note that we are dealing with 100,000 different parts and 80,000 different customers, so it doesn't always align perfectly where inventory from one location can be effectively transferred to others. Additionally, as Dave has emphasized, this is a high-level estimate regarding those adjustments; it's not intended to suggest exactness.

And maybe I will just add to that too, Ross. The behavior that we've talked about now for a couple of quarters that we've been seeing as customers being more focused on match sets and that can be symptomatic of growing customer inventory that's out of mix. So even though we might have some parts that are available in one region, customers may not need them in the other. So, you've got multiple dynamics at work there. Do you have a follow-on?

I do. Since kind of we collectively have given you guys some grief over the last couple of years for not really buying back any stock, despite your 100% cash return goals. This quarter, you did, and it seems like you got pretty darn close back to that 100% return. What changed?

So Ross, you've known us for a long time and you know how we think about cash return, but just for everybody else, we talked about this in capital management every quarter, our objective when it comes to cash returns to return all free cash flow to the owners of the company. We do that through dividends and repurchases. And we've been really consistent in how we do that and we have a really good track record. So we have done that and are committed to continuing to do that.

Okay. Thank you, Ross. We’ll go to the next caller, please.

Hey, thanks guys. So given all these COVID issues in China and shutdowns, but then no change in the rest of the world. Do you expect the shortage situation at TI and in Semis to get better or worse from this, or do you think it will be no change?

Yes. I'll start, and Rafael, feel free to add. We're not attempting to predict the market cycle or even the upcoming quarters. Our focus remains on strengthening the company for the long term. This involves expanding our manufacturing capacity, investing in research and development, and enhancing our capabilities. These are the aspects we can control, and we will remain dedicated to them. Do you have a follow-up, Chris?

Yes. If we set aside the COVID issues in China, could you share any insights on the end market, whether things are looking better or worse than expected, either for the past quarter or looking ahead?

Yes. The quarter came in, I'd say about what we expected. We were just slightly above the top end of our range overall. The quarter was driven by the industrial and automotive markets. We did see strong growth in enterprise systems, as we had talked about. That was primarily from data center and enterprise computing. Now, that's a small part of our revenue, but you saw it grow strongly last quarter. And as you look over the coming years, that probably will continue to be a strong grower, but it's just not a very large portion of our revenue. So we continue to be pleased with the growth that we're seeing in industrial and automotive. That when you zoom out for a second, that is where the strategic focus has been for the company. And so, we're pleased to see that turn into grow longer term. So, thank you, Chris, and we'll go to the next caller, please.

Thank you. Could you first address the strong expedite activity you're seeing? Are the constraints coming from your internal fab capacity or the foundry back end? Can you provide some insight into where the bottlenecks are?

So I'll start. First, I want to maybe adjust what your premise a little bit. We are still seeing some experts. But as Dave mentioned a couple of times, customers continue to be selective in how they're expedited. So they're continuing to focus on the match set, okay? So it's not just expedite across the board. Second, specifically on what you said on the second part of your question, what we're seeing is primarily based on how our customers' manufacturing and operation is being affected in China.

And we're able to meet many of those expedite requests as well. So I think your question more, Joe, is where we do have constraints, what’s driving those? And that's not specific to any product or any particular area. It can move from one quarter to the other. It may be a process technology. It could be a packaging technology, other things that may drive it, that our teams work with customers on to meet those needs. Do you have a follow-on?

I was also interested in how your pricing has responded, especially since your competitors have implemented foundry price increases. Can you share how your pricing has changed on a comparable basis?

Yes. A couple of points to mention. First, regarding input costs, one of our competitive advantages lies in our manufacturing and technology. We own the majority of our manufacturing, with over 80% on the front end, and we aim to increase that to 90% in the coming years. This positions us well to manage input costs without being affected by the pricing strategies of foundries or subcontractors. On the topic of general pricing, we are working collaboratively with our customers. Our approach remains consistent; we price to market. As the prices have increased over the last two to three quarters, particularly in the first quarter, we have also adjusted our prices accordingly, which contributed to our growth in that quarter.

Okay. Thank you, Joe. We'll go to the next caller, please.

I wanted to follow up on the 10% reduction you mentioned for June. It seems like the lockdowns are starting to improve a bit. So my question is whether that 10% is based on the assumption that the current situation continues through June, or if conditions improve before then, could that 10% be too conservative? I also have a follow-up question.

Yes, I understand that the current situation might seem acceptable, but I want to reiterate that this is a high-level assessment. It doesn't imply precision; in fact, as mentioned earlier, we have even widened the range to account for increased uncertainty. Time will tell, and when we report in 90 days, we will see where we stand.

Got it. Thanks, Dave. My second question is related to something Ross asked earlier. If customers are under tight constraints and the lockdowns are expected to be temporary, I would assume they would take the product and increase their inventory. In the past three weeks, you chose to significantly lower your guidance. Is that due to customers delaying shipments, or is it because they are unable to accept shipments of your product? It seems more likely to be the latter, as everything is tight and the entire supply chain is trying to build inventory. Thanks.

Sure. Yes. And Tim, we've been discussing for a few quarters that we've noticed a change in customer behavior, with a strong shift toward focusing on specific match sets. This often indicates an increase in customer inventory that isn’t well balanced. We have tens of thousands of products readily available on our website, so customers can access more products if they are flexible about the types they need. However, they are increasingly focused on finding those match sets to finalize their orders. This can involve our products, but quite often it includes products from our competitors, and sometimes it may even involve items that are not semiconductors necessary for completing their systems. So, it's important to note that just because we have products available, customers are not universally taking them.

Let me add to that. Tim, if I understood your question correctly, regarding the bottleneck for customers in China running their operations, we are observing instances where factories are shut down and cannot accept deliveries. In other situations, freight forwarders are unwilling to transport our parts from our distribution centers to the factories in China, especially in the Shanghai area due to these shutdowns. That is the main reason our parts are not being delivered.

Or you run staff or other reasons that are going on that's reducing that demand. Okay. Thank you, Tim. We’ll go to the next caller please.

Thank you. The last question is quite similar to mine, so I’d like to ask it in a little more detail. Regarding the disruptions in China, can you provide more information? Are you not shipping to the entire region, or are you making decisions on a customer-by-customer basis about what you can ship? Additionally, we’ve heard about at least one major automotive OEM that recently reopened their facility and is ramping up production significantly. Do you observe this trend among your customers in general, or is it more of an exception? Thank you.

I think it varies from case to case. There are reports of dozens, if not hundreds, of factories that are closed, while many others are operating at different capacities. Some cities are more affected than others, with Shanghai being heavily impacted as reported in the news. However, the situation extends beyond just Shanghai. For some factories, operations are completely halted, while others are functioning at 20%, 50%, and so on. Do you have a follow-up question?

Perhaps you can talk about changes in delivery patterns by channel; in particular, I'd be curious if you saw any slowdown in orders at ti.com, which I think is somewhat of a different channel from your typical direct business? Thank you.

I would say that in this quarter, the environment is similar to what we've experienced in the previous quarters. Order rates are strong, and customer behavior regarding cancellations and reschedules remains consistent and low, just like in the past few quarters, across various channels and inputs.

Yeah. The other thing I would add is, as we have seen in other cases during the entire pandemic, but being able to ship direct and have the direct relationship with customers, it's just a huge advantage, especially when you face these types of challenges just not having an intermediary that, kind of, frankly, most of the time gets in the way, and it's not optimal for your relationship with the customer, but also there's the tactical operational delivery of products. So whether it's ti.com or non-ti.com legacy shipments going direct, it's a huge benefit, being able to do that, now close to 70% of our revenues directly.

Okay. Thank you, Will. We'll go to the next caller, please.

Hey. Thanks for filling me in. I want to ask you on the CapEx plans, you're pretty clear about your plans of the capital allocation today. I guess, the spend in March is a little bit kind of flat at that kind of base level, you are fairly high. I guess, you were talking about adding capacity in the second half. So maybe refresh us if you're still going to spend kind of $3.5 billion and if the capacity is still coming in line in the second half?

Yes. So regarding your question, there are no changes to our plans. These are long-term plans. Our $2.5 billion per year for the next four years remains unchanged, and we are very excited about that. RFAB2 will begin production in the second half of this year, and Lehi will qualify and start production in the first quarter of next year. We're going to break ground in Sherman shortly, which is exciting and remains on track. Concerning the CapEx, keep in mind that the fourth quarter CapEx included the Lehi expenses, leading to a higher number that you now see decreasing in the first quarter. There was approximately $800 million to nearly $900 million in CapEx. However, our plans for the $2.5 billion run rate per year through 2025 are still in place, and we are very enthusiastic about that.

Yes. That's just math. Blayne, do you have a follow-up?

Yes. Well, I guess, 400 times 4 is not 3.5%. That was, I guess, the question, but I guess you're still sticking to that forecast and as you go up.

Well, just remember that's an average. The $3.5 billion is an average. So it's not going to be $2.5 billion every year. We'll likely run below $2.5 billion in 2022, which means we'll run higher in the next three years. That's just the math on that, right?

Right. And then, I guess, just for the guide, I want to make sure I understand the mechanics. It sounds like utilization stays high. The mix has been kind of industrial and auto, that all favorable on gross margin, you did hit 70%. I think, a lot of companies have signaled that maybe gross margins would tail off through the rest of the year as kind of pricing comes down. I’m kind of curious of your perspective on, kind of, gross margins at this level being sustainable for the rest of the year.

Yes. Our focus is not on managing gross margins. Our focus has been and will continue to be on growing free cash flow per share for the long term. So gross margin will be what it will be, but we'll continue to make our investments on CapEx to support our revenue plans and generate long-term growth of free cash flow.

Okay. Thank you, Blayne. And we've got time for one more caller, please.

Hi. Thank you, Rafael and Dave. I had a question to clarify my understanding. From a top down perspective, I grasped that part. However, Dave, I thought I heard you say that cancellations have remained unchanged. Why shouldn't cancellations vary if you're reducing your numbers by 10%? Shouldn’t that result in changes to cancellations compared to the previous few quarters?

Customers whose operations are affected still want the product. They are not canceling their orders and want to remain in line to receive the product as soon as they can. This is why we are not seeing cancellations, although we do notice that demand is currently being impacted.

Got it. But that metric is usually for that one quarter, and I should know this answer, but I don't. Is that metric usually for the quarter you provide us, or is it for longer than a quarter?

The cancellations we observe are those that occur within a quarter, but they may stem from demand issues that extend beyond the current quarter or even for a longer duration. A customer might decide to cancel an order set for next week or one scheduled for six months later. Regardless of the time frame, we record the cancellation in the quarter in which we received the notification.

Got it.

Well, with that, we'll go ahead and wrap up, Rafael?

Okay. So let me wrap up by reiterating what we have said previously at our core, we're engineers and technology is the foundation of our company. But ultimately, our objective and the best metric to measure progress and generate long-term value for owners is the growth of free cash flow per share. While we strive to achieve our objective, we'll continue to pursue our three ambitions. We will act like owners who will own the company for decades. We will adapt and succeed in a world that's ever changing. And we will be a company that we're personally proud to be a part of and would want as our neighbor. When we're successful, our employees, customers, communities, and owners all benefit. Thank you, and have a good evening.