Texas Instruments Incorporated (TXN) Earnings Call Transcript & Summary

Good morning, everyone. I'm Stacy Rasgon. I'm Bernstein's Senior Analyst covering U.S. semiconductors and semiconductor capital equipment. And I can't express what an honor it is to have our guests here today, Rich Templeton, the Chairman, President and CEO of Texas Instruments. Before we begin, I want to mention that, you have questions you would like to ask during the presentation, which will last about 50 minutes today, you can submit them through our Pigeonhole forum. There should be a link on screen there. We will have time for audience Q&A at the end. So Rich comes here every year. And every year, I go on and on about TI's sort of what's been a remarkable multiyear transition story and how it's benefited from them. They've kind of made it look easy over the years. But in fact, Rich often says that he likes to see - he likes people to see them as boring. In reality, it was almost certainly not easy. And when you dig in, in my opinion, it's anything but boring. TI was one of the first companies who recognize the futility of competing in wireless. Some of those exits, painful at the time, freed up significant investments to grow and the much more attractive businesses that made it the bulk of the portfolio today. Their 300-millimeter manufacturing strategy, it seems old hat now, but it was -- looked at as crazy when they started it, but it's resulted in significantly lower CapEx levels, substantially higher free cash flow generation and margins and they're doubling down on that 300-millimeter strategy today. Gross margins have been an upward trajectory for years as the benefits of these strategies have rolled through. And more recently, they've been leveraging inventory and capacity strategically in ways their competitors just simply can't. And of course, TI was one of the first, if not the first of their peers through, both words and actions to commit to return 100% of free cash flow, which is at a higher level today, which of course, has become a very attractive story for many investors. To give us some color on these and many other topics, it's my great pleasure to welcome, Rich. Rich, thank you so much for being with us today.

Stacy, thanks for having me today. It's always a pleasure.

Likewise, likewise. Rich, I generally like to try to stay away from near-term questions in this format. Given the situation in the industry around shortages and everything else, I think I am going to have to start out with some of those. And certainly, I've been doing this job more than a dozen years. I've never seen anything quite like this. You've been doing this job a lot longer than I have. I'd be curious, just number one, have you ever seen anything similar to this? Maybe the financial crisis might be the thing that comes close. But I mean are we in sort of an unprecedented kind of shortage and constraint environment? Have you seen anything like this before?

Yes. Stacy, I think the analogy to the financial crisis is at least the most recent significant transition that we've looked at. But for those of us that were also managing through the Y2K ramp, where you had a strong PC world, that then got overheated with Y2K builds, it does have a little of that trough in it as well, just in terms of some of the energy that's around. So I've seen these, and we've gone through them. The comments that I make internally and it's going to go up. And then after it goes up, it's going to go down. And after it goes down, it will go up again. And I don't try to dismiss it, but we really just try to look through it at what the long-term growth trends are and that's tended to serve us pretty well.

Got it. It seems to me that you're one of the few players that sort of took a lesson from the financial crisis. So on the financial crisis, I was there as well. You kind of got caught along with everybody else in that scenario. I remember you'd kind of pulled back, your lead times stretched out to very lengthy time frames. And it seems like this time, you've decided that that wasn't going to happen again. I think even you said it, like the lost opportunity from not being able to serve demand. Obviously, it dwarves the impact of holding too much inventory. And at this point, like you've actually decided to build inventory through this whole cycle. I think you even said it like last year, you want to be prepared for demand in case of that snapback, which has certainly happened. Can you maybe talk a little bit about that decision, keep the fabs running mostly full, continuing to build channel inventory? And maybe just sort of like take us back to the financial crisis, there maybe some compare and contrast of the current situation versus what we saw today? Versus [ what we thought of ].

Yes, I think your summary is a pretty good one in terms of what we experienced back 10-odd years ago and how we've approached it. But we're also a very different profiled company versus 10 years to go. When you're running with a big wireless business and most of those devices, they may not be custom, but they're pretty close to custom. And you've got to be very careful about what you build inventory-wise. So move ahead to what we're living through today, by design, the portfolio looks and feels very different. We talk as one of the competitive advantages of diversity and longevity and that just lets us make very, to me, logical decisions like the one we announced on the earnings call in April a year ago when we said we were going to keep the factories running because it just made sense. You also watched us to your, I think, point made that when Rafael and Dave gave the capital management update, I think it's late January, early February, we've raised the high end of our inventory range because when you just think about the products that we build and the longevity that they are, it's just -- it's at a great advantage that we have. And so I think that we've handled this cycle much better than the one 10 years ago and better than our competitors. And we've got some really interesting things that we intend to be better even the next cycle because there will be another one. We don't know when it is. But these are just -- it's a great way to always be getting better.

Got it. Got it. And I guess I don't know I want to ask. Let's talk about, I guess, the demand profile. You talked about taking the inventory target up. You actually haven't really been able to take your days of inventory on your balance sheet up. I guess it's a function of how strong the demand actually is. Are you parsing, I guess, those order levels on that demand at all? Are you kind of trying to judge what your customers ordering versus what they need? Are you just -- or is it the case where you can fulfill the order that you're fulfilling it this way? And I don't know if you'd be able to tell the difference one way or the other in terms of what your customers are doing. Are you shipping the demand right now, just as the orders come in?

Stacy, we've talked many times, Dave has made this comment many times on the earnings call. Everybody says they have great channel visibility, until all of a sudden, they declare they don't. And so you do your best job keeping up with customers. And you said it very accurately, we would love to have our inventory levels higher, but demand is just so strong right now, and we're now a year plus into that. And we will get -- the window will open up. We'll get an opportunity to get that inventory rebuilt and we'll get that done at that time. But it's also why -- and I think Rafael or Dave talked on the earnings call, I'm not interested in going out and booking multiple years of inventory of backlog because customers don't know what they need. And so you can tell them it's noncancelable, but them ordering stuff they don't need is not that helpful. So we really just try to keep a steady hand on this, ship as best we can, keeping up with things. We've got a couple of hotspots we're still working. And as soon as things let up, we'll hopefully get some inventory build up.

Got it. Do you think like this trend of noncancelable orders -- do you think that eventually drives the eventual oscillation worse? If to your point, they're ordering stuff that they don't need, I mean, does that make the eventual like the cycle worse?

I have no -- my guess is no because that stuff will get processed through. And to me, that's probably more noise on the edge than it is overall volume because it's certainly not how we're operating. I don't think it's going to make a big difference, is my guess, but it's certainly not our approach.

Got it. Got it. Maybe on the good side of this, do you think you're taking share to your inventory and capacity strategy? So I know in general, share tends to be sticky. It's not that easy to swap one part out for other. But to your point, this has been going on for, what a year, longer. Is that enough time for customers to actually start designing? And are you actually seeing any of that kind of activity?

Well, the fact is I think that you really started seeing the shortages when things kind of snapped in March of 2020, particularly if you were staying very close to what was happening in China because they really went through that cycle beginning in January. And so customers have had more than enough time to redesign portions of boards based on lack of supply. And I think if you look at our general revenue trends over the past year, they've held up, I think, pretty well compared to most of the competitors that you would probably monitor us against or judged against even a WSTS number. We still always believe that you better judge share gains over the long term. I think they get talked about way too technically. But my guess, those moves have served us pretty well for the past year.

Got it. Got it. Let's talk a little bit about the -- I guess, the distribution strategy because that's the other kind of like side of this. And I guess, this is to the extent that I get people asking about a bear case on TI. This is one of the -- you guys have disintermediated your channel, and that's going to come back to bite you in some sense. At the same time, though, like it's not anything new. You guys have been sort of moving along a very kind of a concrete distribution strategy for going on 10 years, and it's been evolving over the time. Can you maybe talk a little bit about what you've done in your channel over that 10-year period, maybe from where we were in '08 or '09, the financial crisis to where we are today? What's changed and how is it benefiting you?

Yes. Stacy, we've talked again on this for quite a long time, and it's just been as we've looked at our competitive advantages, manufacturing and technology, breadth of our product line for each of our channel and then diversity and longevity. Reach of our channel is just extraordinarily unique thing that we have, and we can do it because of the breadth of the product portfolio. So we built up our own sales and applications team. It's larger than everybody, so we can get to everyone. We moved most of the design creation or design win work, boy, it's probably 5-plus years ago over. Everybody said, they're not going to -- they're going to lose share, and you've watched us now just continue to march higher. And then during, really 2020, we completed the last phase of that to where we moved significant amount of the revenue direct and narrowed down our distribution base just because we weren't going to be moving as much revenue through that channel. And again, this one goes back to as we talk internally, luck is what happens when preparation meets opportunity. And that turned out to be a pretty lucky move for 2020. When things are tight, customers want very close relationships and having distribution or people buffering between you and them only puts noise in it. And we've really been rewarded with those moves during the past year, I think. And I just think they're going to continue to serve us well. At the higher level, just go outside of our industry, nothing good happens when you've got buffers between you and your eventual customers. So we intend to have close relationships. We're going to get better insight, better knowledge. It's going to let us service the tactical production demand better. But it's also going to give us insight into what the business is, where aren't we, where do we have to win more and how do we grow our business even faster. So I am really thrilled that at the timing that we were able to get that last phase done in 2020 and right in the middle of the pandemic and it's really paid off for us.

Got it. How much of the business is direct today versus going through the channel?

We gave the update, I think, closing the year that I think we averaged, I forget, Stacy, was in the mid-40s, 45, 46, 47, but we left the year, I think, month of December, just approaching 60. And we'll get an update to everybody as we wrap up 2021 in January.

Got it. And you talked a lot about ti.com as a competitive differentiator to go direct. How much of the business -- how much of the revenue today goes through ti.com?

Yes. It's just -- it's one of these great, rapidly growing portions of the business. And one, we continue to add more capability. And those are investments that we've been making now really for 5 years, and we continue to get better and better in terms of how we can reach locally, be the importer of record, just make it easy to transact business. And it certainly helps, over the past year when you have product availability, that tends to make you a popular supplier as well. And so that's been really a great combination over time. So that's why I go back to a lot of investments, a lot of work that's been underway. And we've really been fortunate to see it come together at a very lucky time in terms of what the pandemic has done, how it's stressed the system, but how we've been able to perform.

Got it. But how much is actually going through that ti.com channel? I mean, if you -- like, close to 60% of the revenue exiting the year was direct, how much of that is actually going through the website?

Yes. We've not released the number on that. We'll figure out when we want to put some numbers on it, but it is rapidly growing. Very pleased with what it looks like.

Got it. Got it. Growth, in general, I've had this theory on analog space, in general that the growth just has to be a more important part of the recipe going forward. I mean you guys have -- the transformation, again, over the last 10 years plus has been phenomenal. I remember when I first started this job, you had aspirational targets to get to 55% gross margins and 30% operating margin. Obviously, you've blown through all of those. If I look forward from where we are today, just given like the improvement that we've seen in the model, I mean there's some and we can talk about how much headroom might be left, but I mean, you're probably not going to get another 1,500 basis points of margin expansion going forward, probably. So to me, that means growth needs to be a more important piece of the recipe going forward. Would you agree with that sentiment?

Yes. I think the sentiment is accurate. The only reason that you'll hear me give a careful answer, you'll hear Rafael give a careful answer...

You guys never sign up for a growth target, which I think would -- probably...

Well, and the reason -- Stacy, the reason behind that is just look at all the other companies where revenue growth becomes a singular objective. And if -- and we just have a very strong belief that you've got to get stronger and aim at the right markets and revenue growth is a result, not something you chase by itself. But your -- to the math, your math is, I think, very accurate to grow free cash flow per share over the next 10 years. It has to be predominantly driven by top line growth. And that's about the Analog business, and it's about the Embedded business, both contributing.

Got it. So let's talk about those 2 businesses then. And they've had different profiles recently, which we'll get into. But let's talk about Analog. Obviously, auto and industrial, analog and embedded, these are the areas that you guys have. But where is TI's competitive differentiation in Analog? Obviously, you are the biggest player, although we've got some folks, both, I guess, organically and inorganically, are trying to build up on the scale front. Where is TI's competitive advantage in Analog? And does it go beyond the things that you've talked about? I know you've talked about manufacturing capacity, you've talked about the inventory. Is there anything like special or specific to analog that TI does better than everybody else?

Yes. So I know it goes back probably to the boring comment when I just study this thing, and I know people say, yes, it's got to be more exciting. Well, take the 4 advantages, manufacturing and technology. If all you get out of manufacturing and technology is lower cost and better control of your supply chain, okay? That's a pretty good advantage, okay, for you to carry. And even with other companies that are trying to get bigger, you don't have anybody doing what we're doing in terms of 300-millimeter and in terms of what we do internally on assembly, for example. Then you move up to the channel discussions that I just had. And you think about an industrial and an automotive base, you've got to get literally to tens of thousands of customers. You've got to get to them efficiently. You've got to do a great technical job and a great production job. And you've got to make the investments to be able to do that better than anybody. So when you start looking at what really is a sustainable competitive advantage, meaning you get tangible benefits, plus it's difficult to copy, okay? I think those are going to things that really separate us in the long term. Do you have to have great designers and do great parts and have low power or high speed or low noise, all the technical attributes, depending on the product category, the answer is yes. You've got to have those. But the things that you really want is what can really set you apart from your competitors that it's just very difficult for them to copy. And I think we've got those well understood and we invest with those in mind.

Got it. Why is the Embedded business been so much different than Analog in terms of the growth profile over the last bit of time? Like why haven't...

Go ahead.

I just -- why haven't we seen the same level of performance in that business as we've seen in Analog?

Yes. I look at that one, Stacy, and we're very clear. When we have something that isn't performing well, we accept it, and we get to work on it. And you watched Embedded really top out back in, it's probably late 2018. And I think we've been very direct that we were extraordinarily focused portfolio-wise on that. We had a new leader that we brought in. And we said, hey, look, our goal is to turn that into a long-term grower that can grow just like Analog. We're not looking for short-term sockets that will kick up a quarter and make somebody feel better. And I think during 2020 and really even into first quarter of '21, you've started to see kind of Phase 1, which is get stability and get that business starting to improve. And now we've just got to go prove over the next couple of years that we can grow it the same way. I've got great confidence. The portfolio, the products, the management, the -- I've got the advantage of, I hear the salespeople firsthand and the customer is excited about what's going on. And that's always the right leading indicator of having confidence of where it's going to go.

Got it. What are some of the changes that you're making? Is it investing in new types of products? Or is it changing like how you're reaching out to the customers? Or like what was the issue there that's being changed? I know there was some exit there as well, I know some of it was the comm infrastructure exit, so that was some of it.

You have heard us be very careful. There's no doubt that comm infrastructure is part of that decline, but that is not the dominant part of it. And so you haven't heard us use that as an excuse. It's really about picking the areas of the products that we were in and really focusing on the ones to take you to the broader markets, the broader applications and the better growth opportunities. And that's really what I think that team has done and get it reoriented. The general product categories are identical. And we just had some areas that we thought we needed to heavy up, some that we thought we could invest less and then really move the emphasis and get people more aggressive. So we'll continue to -- we've just got to keep showing that we can drive results on that.

Got it. Got it. A lot of times, people also they look at the margins of that business and they compare with the Analog and obviously lower. Is that just a matter of the revenue scale? Like if Embedded was as big as Analog, would it have similar margins?

No, it's not going to be identical, but I laugh a little at that where how many of the top semiconductor companies, let alone the S&P 500, would love to have Embedded's profitability. And so I find that an academic discussion as opposed to it's a great business that can grow. And I don't need it to have identical margins to Analog. I just needed to grow nicely and be a great contributor to the company long term, which I think it can be.

Got it. But I mean it is true that as revenues grow, the margin should go up, correct?

Yes. You will get some scale just in terms of R&D leverage on that. But there's also no doubt that Analog is a pretty unique capability in terms of the margins that it operates at as well.

Got it. Let's talk a little bit about your R&D strategy. So like this is another thing, like one of the few companies that I've heard people say they should spend more money, not less. And it is true as a percentage of revenue, like on R&D, you guys tend to spend less than your competitors, although on an absolute basis, just given your scale, you spend a lot more. Could you talk a little bit about just your overall R&D strategy? How do you actually look at how do you make investments and sizing those investments? And how do you give investors confidence that you're spending the right amount of money on R&D?

Yes. To me, the best -- working that question backwards, the best way to talk to investors about confidence is what's the track record been in terms of investments and translating that into growth. Could we go justify spending a higher percentage of revenue and defend it that other companies are doing that? Sure. Data is there, as you said. But if we're growing faster then, that's kind of a silly comparison to go make. So our orientation really goes back to the comment I made on the revenue side a few minutes back, which is we want to get stronger, aim at the right markets, and that results in bigger. And so that's how you see us guiding where dollars go, what gets heavied up, what gets invested in. And we've continued to grow the absolute dollar value of R&D, and we'll continue to do that going forward. And the markets could go up and down, and you'll see us with a pretty steady hand because those R&D decisions are 5- and 10-year decisions that you've got to make. So I've been pleased with that discipline, and I think the results reflect that discipline.

Got it. And I guess to those share gains, I mean, you have still continued to gain share in Analog. I mean it's been -- I don't know what it is 0.5 point a year, 1 point a year or whatever it is, but it's...

We have probably run 30 to 40 basis points over the past 8, 9 years. And I usually try to benchmark post the national integration in 2012 just to have clean numbers going forward. The past couple of years have probably been a little higher than that. And now we just have to keep working, try to keep pushing that number up.