Texas Instruments Inc Q1 FY2021 Earnings Call

Thank you for standing by. Good day and welcome to the Texas Instruments Q1 2021 Earnings Release Conference Call. Today's conference is being recorded. At this time, I would like to turn the conference over to Mr. Dave Pahl. Please go ahead, sir.

Good afternoon and thank you for joining our first quarter 2021 earnings conference call. 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 be available through the web. This call will include forward-looking statements that involve risks and uncertainties and 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. Our Chief Financial Officer, Rafael Lizardi, is with me today, and will provide the following updates. First, I'll start with a quick overview of the quarter; next, I'll provide insight into the first quarter revenue results with more details than usual by end market, including some sequential performance since it's more informative at this time; and then lastly, Rafael will cover the financial results, some insights into one-time items, and our guidance for the second quarter of 2021. Starting with a quick overview of the first quarter. The company’s revenue increased 5% sequentially and 29% year-over-year driven by strong demand in industrial, automotive and personal electronics. On a sequential basis, Analog grew 5% and Embedded Processing grew 7%. On a year-over-year basis, Analog grew 33% and Embedded Processing grew 17%. Our other segment grew 12% from a year ago quarter. Moving on, given the current environment, again this quarter, I’ll provide some insights into our first quarter revenue by end market and then some comments on our lead times. First, the industrial market was up about 20% sequentially and up almost 30% from a year ago. The strength was seen across most sectors. The automotive market was about even compared to a very strong fourth quarter 2020 and up about 25% from a year ago. Compared to the pre-COVID-19 levels of the fourth quarter of 2019 our shipments to automotives in both the fourth quarter of 2020 and the first quarter of 2021 were up about 25% as we work to help our automotive customers recover from their supply chain disruptions. Personal electronics was down about 10% sequentially and up about 50% compared to a year ago. The strength was broad based across sectors and customers within personal electronics. Next communications equipment grew in the high teens sequentially, and was about even from the year ago. Enterprise systems grew upper single digit sequentially, and was down about 10% from the year ago. Regarding lead times, over 80% of our products have steady lead times, and more than 50,000 parts have off-the-shelf availability via ti.com. However, the growing demand in the first quarter of 2021 did expand our list of hotspots, which required extending some lead times. We will continue to add incremental capacity in 2021 and the first half of 2022 with additional support from the start-up of our third 300 millimeter wafer fab, RFAB II that will come online in the second half of 2022. As discussed during our Capital Management Review in February, our competitive advantage of internal manufacturing and technology delivers the benefits of lower costs and greater control of our supply chain, which really shows through a market environment like this. Rafael will now look and review profitability, capital management, and our outlook.

Thanks, Dave. And good afternoon everyone. First quarter revenue was $4.3 billion, up 29% from a year ago. Gross profit in the quarter was $2.8 billion, or 65% of revenue. From a year ago, gross profit margin increased 250 basis points. Operating expenses in the quarter were $811 million, up 2% from a year ago. And, about as expected, on a trailing 12-month basis, operating expenses were 21% of revenue. Over the last 12 months, we have invested $1.5 billion in R&D. Acquisition charges and non-cash expense were $47 million in the first quarter. Acquisition charges will remain at about this level through the third quarter of 2021 and then go to zero. Operating profit was $1.9 billion in the quarter or 45% of revenue. Operating profit was up 56% from a year ago quarter. Net income in the first quarter was $1.8 billion, or $1.87 per share, which included a $0.02 net benefit that was not in our prior outlook, primarily due to discrete tax benefit, which was partially offset by about $50 million of utility costs related to the February winter storm in Texas. Most of this expense is in our cost of revenue and reported in our other segment results. Let me now comment on our capital management results starting with our cash generation. Cash flow from operations was $1.9 billion in the quarter. Capital expenditures were $308 million in the quarter. Free cash flow on a trailing 12-month basis was $6.3 billion. In the quarter we paid $940 million in dividends and repurchased $100 million of our stock. In total, we have returned $4.5 billion in the past 12 months. Over the same period, our dividend represented 56% of free cash flow underscoring its sustainability. Our balance sheet remains strong with $6.7 billion of cash and short term investments at the end of the first quarter. We retired $550 million of debt in the quarter leaving $6.3 billion of total debt with a weighted average coupon of 2.77%. Regarding inventory, TI inventory dollars were down $65 million from the prior quarter, and days were 114. For the second quarter, we expect TI revenue in the range of $4.13 to $4.47 billion and earnings per share to be in the range of $1.68 to $1.92. We continue to expect our annual operating tax rate to be about 14%. In closing, we continue to invest to strengthen our competitive advantages and in making our business stronger. With that, let me turn it back to Dave.

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

And first, we'll go to Chris Danley with Citi.

Hey, thanks, guys. So Q1 clearly was very strong, well above seasonality and above guidance, however, your sequential guidance is flat and well below seasonality. So my question is, are you guys seeing cancellations and push-outs or why is that guidance so weak after a strong Q1? Thanks.

Yes, Chris. Thanks for that question. We aren’t seeing cancellations or push-outs. If you look at Q1, it was very strong both sequentially and year-over-year. At the midpoint, second quarter will be a strong quarter from a year-on-year standpoint.

Yes, I mean, I guess would just be a follow on to the first question, this would be the lowest sequential guidance you guys have given in some time. So I guess why not? Why not guide for a seasonal or even close to seasonal sequential guide?

Yes, Chris, it really is the best estimate that we have for our revenue for the quarter. And, again, I would describe it as following a very strong first quarter. It will be a strong quarter again.

And next we'll go to Stacy Rasgon with Bernstein Research.

Hi, guys, thanks for taking my question. I want to talk about your inventory strategy. I know you have a strategy to build out inventory for customer service. I guess how do I reconcile that with the fact that your inventory dollars are down, and you're still getting some pockets of lead time extensions? Is that just a function of demand being just so strong you can't keep up? And I guess in that light, how do you parse the quality of those orders that you're getting? How do you know? Are you just having to ship whatever is being asked for at this point? And I guess, like what are the plans for loadings and inventories as we go into Q2, are you going to try to replenish the inventory that's been drained?

Thanks for your question, Stacy. First, let me step back and remind everyone inventory objective is to maintain high levels of customer service while we minimize obsolescence and improve manufacturing realization. And as you alluded in the question, we would prefer to have higher levels of inventory. In fact, about 60 days ago at our capital management strategy meeting, we increased the target for inventory to 130 to 190 days, up from 115 to 145 previously. So yes, we'd like to have more inventory. But in the current environment, we're focusing our capacity on fulfilling demand, not on building inventory. Whenever things slow down, which at some point they will, or as we increase capacity — which we are increasing incrementally — we will continue to rebalance through the rest of this year into the first half of next year. In the second half of next year, we will have first output from our RFAB II. As those things come together, then we will be able to build more inventory. If I missed part of your question, please use your follow up.

Okay, I'll use the follow up. So how are you parsing the quality of the orders that you're getting? Are you just shipping whatever is being ordered at this point?

Yes, and I'm glad you chose that as a follow up. As you know, we have moved away from distributors over the last couple years; really, it's been more of a 10-year process. In the last few years we pulled the trigger and no longer ship to many distributors we used to. Now we're going direct with a lot of our customers. We exited last year with almost two thirds of our revenue shipping direct. That has put us in a great position, particularly in the current environment, because we now have more direct access to customers who have a better understanding of what they really need. We don't have that intermediary that can cloud the picture. We use that information to better allocate our resources — inventory, manufacturing, etc. — in order to fulfill demand from our customers.

That's great. Thank you, Stacy. Now we’ll go to the next caller, please.

And our next question will come from John Pitzer with Credit Suisse.

Yes, good afternoon, guys. I think somebody asked the question, not original but a follow up to the June revenue guide. I'm just curious Rafael; you said you would be growing supply sequentially from March to June. So the implication is, you might be able to build some inventory on your own balance sheet. I'm just curious, given how lean inventories are across the channel, why would you not expect incremental supply that you bring on to be used by your customers and actually show sequential revenue growth?

I think you're mixing a couple points from my earlier comments. We drained inventory from the fourth quarter to the first quarter. So even if we're increasing output, that doesn't necessarily mean that we'll be able to build inventory immediately. You shouldn't take the statement that we're increasing output as a guarantee that we'll build inventory going into the second quarter. We are adding incremental capacity through the balance of this year and through the first half of next year, until RFAB II comes on in the second half of 2022. So there are multiple moving pieces.

Yes. It was nice to see in the March quarter embedded at least sequentially growing faster than analog. And we've talked about this in the past, Dave, about kind of the growth there is kind of a lag that of analog. Do you feel like within the embedded market, you're turning the corner on it? Can you help us kind of understand how you guys see the design funnel there? And what the growth rate in that market might be beyond kind of the cyclical recovery?

I'll give you a few comments on that. High level, we're pleased with the trajectory of embedded. However, we're still in very early phases. As we have said before, our goal with embedded was first to stabilize embedded, make some changes that we have made and then leverage our competitive advantages to have embedded headed in a better direction. We're in the early phases, but we're pleased with those early results.

Great. Thank you.

Thank you, John. And we'll go to the next caller, please.

Moving on, we'll go to Craig Hettenbach with Morgan Stanley.

Dave, thanks for the color on lead times. In the hotspots, maybe 20% or so that's been impacted? Can you just give a sense of what you're seeing there? And maybe your sense of when you would expect that the lead times in certain areas to normalize? And then, personal electronics was up 50% year-over-year. I know there's been some nice tailwinds from work from home. Any more color in terms of some of the segments that you're seeing growth? And how you feel about that business for Q2?

There's a lot of moving pieces on that. I think it's premature to give a precise timing for normalization. Our teams are working very hard with customers to close those demand and fulfill those needs. It really depends on technologies and packages and what customer requirements are. We describe it as hotspots; it's a combination of technologies, end markets, and package types when demand is outstripping short-term supply. On personal electronics, at a high level, when we look into a quarter, there's nothing unusual that we feel the need to call out. Looking back at the first quarter and in the past few quarters, demand in personal electronics has been very broad based, both by customer and by sector. As a reminder, personal electronics includes handsets, tablets, personal computers including laptops, televisions, smart speakers, printers — it's a broad category with roughly nine or ten sectors — and we've seen very strong demand across many of those.

I'd add on lead times that as long as demand is ahead of supply, lead times will be extended. The key point is we own our own manufacturing and technology. That is a key differentiator versus competitors. It is one of our competitive advantages. We are in a unique strategic position to have that control of inventory and to be able to add capacity incrementally over the next year and a half or so. And more significantly after that when RFAB II is built and starts to be equipped. That puts us in a much better position to fulfill customer demand both short term and over the long haul, as we continue to focus on industrial and automotive customers.

Good color. Yes. Thank you. Okay. We'll go to the next caller. Please.

And that will come from Harlan Sur with JPMorgan.

Good afternoon, Thanks for answering my question. On the extended lead times, maybe a different way to ask the question. You also noted about 20% of your wafer requirements are outsourced and most of it is for embedded, and you outsource 40% of test and assembly. I'm just wondering if this is where you're seeing more of the extended lead times given capacity at your outsourced partners? Or is it across both internal and outsourced manufacturing?

It's not specifically tied to outsourced partners. It's more end-market or technology driven and package-type driven. We've described it as hotspots: a combination of demand, technologies, and packages when demand outstrips short-term supply. We do the majority of assembly and test in-house, which most peers do not. Most of our peers outsource assembly and test, while we control a large portion in-house. Also, because we do 80% of our wafers in-house, we can expand capacity incrementally and control cost to a much higher degree. Those are important advantages in times like these. Additionally, 300-millimeter capacity we're adding comes in at structurally lower cost.

Thanks for the insights there. Good again to see the year-over-year momentum in the embedded business. I know somebody tried to ask about this previously, but wondering if you could give us a profile of embedded relative to the overall corporate profile? Does it have the same end-market exposure as the overall business? Or is it skewed toward particular end markets? And on a go-forward basis which end markets within embedded are you spending more R&D dollars on?

We have directed investments in embedded at the best growth opportunities. As we took a step back, we focused those investments toward industrial and automotive markets. The largest portion of embedded revenue is in those two markets. We do have some revenue in communications, enterprise and personal electronics inside embedded, but the majority is industrial and automotive. As Rafael said, we're in the early stages. Our first objective was to stabilize revenue. We feel very good about progress so far and are making investments because we believe embedded will be a great contributor to free cash flow growth over the long term. Several years from now we'll look back and be pleased with these investments and with embedded's contribution to free cash flow.

And that will come from Ambrish Srivastava with Bank of Montreal.

Hi. Thank you very much. Just a question on the order patterns that you're seeing. Many of your peers have talked about no cancellation policies, facets of the business we haven't seen in many cases. Are customers looking for commitments to capacity, and as a result are you having to change clauses with customers in terms of cancellation policy or similar? Are there any changes on that front?

We don't think it's a good idea to force customers to commit a year out. They simply don't know what they will need a year from now. We want to be in a position to supply what they need and be a supplier they can count on. Our competitive advantage of owning manufacturing and technology also gives us control of costs. We haven't been in a position where we've had to raise prices as many of our peers have. Those two things combined are translating into share gains. We believe part of the revenue growth this quarter reflects share gains, although you should measure that over time rather than over one quarter. We believe this will benefit us over the long term.

Just quickly on capacity and CapEx intensity, we shouldn't be modeling a different intensity over the next few quarters, correct? We should be within the guidance range that you've given as you build the third fab? And then, is that second half 2022 timing a pull-in versus what you were expecting?

No, it's not a pull-in. That's about where we've always expected. Regarding CapEx intensity, we've guided long term to around 6% of revenue as a way to think about CapEx. In the short term for two to three years, we're going to run higher in absolute terms and as a percent of revenue as we invest to address the current situation and more importantly to strengthen our manufacturing technology, especially 300-millimeter, which provides structural cost advantages. So in the near term expect higher than the long-term 6% guidance, but use 6% as a long-term model.

Okay, Thank you, Ambrish. And we'll go to the next caller, please.

And that question will come from Timothy Arcuri with UBS.

Thanks a lot. Dave, I wanted to ask about the guidance. There's some school of thought that because you control your supply chain and inventory, your model could drive some share gains and upside given what's going on. I know you're typically conservative and you have a very tough comp on Q1. But I wonder if customers are not pulling your product because of shortages elsewhere — maybe it's sitting there in consignment waiting for them — and if you're hearing that from any customers that they're not pulling due to shortages elsewhere, and whether that might be contributing to your June guidance?

Tim, we think that that probably happens occasionally, but we don't believe it's occurring at any significant level. So no, we don't believe that's a significant factor in second quarter.

I also asked last quarter about share repurchases. I know you always say that free cash flow only matters if it's returned. But you didn't buy back much again this quarter — it's like $100 million — and it's been a pattern of three quarters in a row. You have a pretty strong intrinsic value model for your stock. Can you just talk about buybacks?

Thanks. Stepping back, our objective is to return all free cash flow to owners over the long term. If you look at our 15- to 16-year history, we've returned all free cash flow and then some to owners, and we'll continue doing that over time. That doesn't necessarily mean every quarter or every year. Over the long term, we will return free cash flow via both dividends and buybacks. There are different criteria we look at for each, and we've discussed those in prior meetings.

Okay. We've got time for one more caller.

And that question will come from Tore Svanberg with Stifel.

Yes. Thank you, and congratulations on the record revenues and earnings. First question, Dave or Rafael, could you step back and looking at the last 90 days, what exactly changed this last quarter? Did orders continue to accelerate? Did capacity situation ease? Maybe just walk through exactly what changed?

I'll give you a few comments. Demand continues to be strong and we're still in an environment where demand exceeds supply capacity. Our revenue has continued growing in that environment both year-on-year and sequentially, and we are incrementally adding capacity while doing that. During the early phase of the pandemic when many pulled back, we built through that cycle — a tactical decision enabled by our strategic position and our focus on industrial, automotive, and catalog parts with low obsolescence risk. That prepared us for the demand recovery. We've also gained strategic ground focusing on auto and industrial. While doing that we have invested for the long term in our competitive advantages: manufacturing technology, product portfolio via R&D, and our direct channels. A concrete example is availability of many parts directly on ti.com for immediate purchase, which supports customers.

Thank you. Your operating margin was just shy of a record 45.2%. Rafael, in the past you've talked about OpEx running between 20% and 25% of revenue. Given the sustained demand, is it safe to say OpEx ratio might change and maybe stay at 20% to 25%?

In the short term, we run OpEx on a trailing 12-month basis at about $3.2 billion and that's not going to change much in the near term because those are long-term investments, particularly in R&D and certain SG&A areas that we view as investments. Over the long term, the guidance we have given you of OpEx being in the 20% to 25% range still applies. So you should think of it in those terms. Okay, so I think that was the last one. Let me go ahead and wrap up by reiterating what we have said previously: our engineering and technology are the foundation of our company. Ultimately, our objective and 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 that objective, we will 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.

Thank you. That does conclude today's conference. We'd like to thank everyone for their participation. You may now disconnect.