Texas Instruments Incorporated (TXN) Earnings Call Transcript & Summary

Welcome to the Texas Instruments Third Quarter 2022 Earnings Release Conference Call. I'm Dave Pahl, Head of Investor Relations, and I'm joined by our Chief Financial Officer, Rafael Lizardi. 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. In addition, today's call is being recorded, and you'll be able to get it via replay on our website. This call will include forward-looking statements that involve risks and uncertainties that could cause TI's results to differ materially from management's current expectations. We encourage you to review the notice regarding forward-looking statements contained in the earnings release published today as well as TI's most recent SEC filings for a more complete description. Today, we'll provide the following updates. First, I'll start with a quick overview of the quarter. Next, I'll provide insight into third quarter's revenue results with some details of what we're seeing with respect to our customers and markets. And lastly, Rafael will come to results and our guidance for the fourth quarter of 2022. Starting with a quick overview of the third quarter. Revenue in the quarter came in about as expected at $5.2 billion, an increase of 1% sequentially and 13% year-over-year. Analog revenue grew 13%. Embedded Processing grew 11%, and our Other segment grew 20% from the year ago quarter. Now I'll provide some insight into third quarter revenue by market. This quarter, I'll focus on our sequential performance as it's more informative at this time. First, personal electronics declined mid-teens as we continue to see the weakness we described in the second quarter. Industrial was about even sequentially as we saw weakness begin to broaden in the industrial market. The automotive market remains strong and was about 10%. Next, communications equipment was up high single digits. And finally, enterprise systems was up mid-single digits. Turning to our expectations for the fourth. We expect that most of our end markets will decline sequentially with the exception of the automotive market. Lastly, we and our customers remain pleased with the progress of our expansion of our manufacturing capacity, which was outlined in our February capital management call and will support the long-term secular trend of increased semiconductor content per system. Customers especially value the geopolitically dependable footprint of our manufacturing additions. We are now in production in RFAB2 and expect production in LFAB later this year. In addition, construction of SM-1 and SM-2 in Sherman, Texas continues as planned. Rafael will now review profitability, capital management and our outlook.

Thanks, Dave, and good afternoon, everyone. As Dave mentioned, third quarter revenue was $5.2 billion, up 13% from a year ago. Gross profit in the quarter was $3.6 billion or 69% of revenue. From a year ago, gross profit margin increased 110 basis points. Operating expenses in the quarter were $862 million, up 8% from a year ago and about as expected. On a trailing 12-month basis, operating expenses were $3.3 billion or 16% of revenue. Restructuring charges were $77 million in the third quarter and are associated with a LFAB factory that we purchased in October of last year. These charges will move to cost of revenue as we start production. The assets associated with the acquisition of the factory will begin to depreciate at the same time. Moving on, operating profit was $2.7 billion in the quarter or 51% of revenue. Operating profit was up 16% from the year ago quarter. [ Net income ] in the third quarter was $2.3 billion or $2.47 per share. Earnings per share included a $0.02 benefit for items that were not in our original guidance. Let me now comment on our capital management results, starting with our cash generation. Cash flow from operations was $2.8 billion in the quarter. Capital expenditures were $790 million in the quarter and $3.1 billion over the last 12 months. Free cash flow on a trailing 12-month basis was $5.9 billion. In the quarter, we paid $1.1 billion in dividends and repurchased $1 billion of our stock. In total, we have returned $7.1 billion in the past 12 months. In September, we announced we would increase our dividend by 8%, marking our 19th consecutive year of dividend increases. We also increased our share repurchase authorizations by $15 billion. These actions reflect our commitment to return of free cash flow to our owners. Our balance sheet remains strong with $9.1 billion of cash and short-term investments at the end of the third quarter. In the quarter, we issued $700 million in debt. Total debt outstanding was $8 billion with a weighted average coupon of 2.8%. Inventory dollars were up $205 million from the prior quarter to $2.4 billion, and days were 133, up 8 days sequentially and below the higher levels. For the fourth quarter, we expect TI revenue in the range of $4.4 billion to $4.8 billion and earnings per share to be in the range of $1.83 to $2. This outlook comprehends the market conditions that Dave previously mentioned. We continue to expect our 2022 effective tax rate to be about 14%. As you are looking at your models for 2023, without additional changes to tax law, we would expect our effective tax rate to remain above what it is in 2022 with a similar quarterly profile. Let me now make a few comments on the CHIPS Act that was recently signed-in to law. The combination of the investment tax credit, the grant as well as funding for research and development will help make the U.S. semiconductor industry more competitive. We accrued about $50 million on the balance sheet in third quarter due to the 25% investment tax credit for investments in our U.S. factories. This will eventually flow some statement as lower depreciation and we will receive the associated cash benefit in the future. 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 growth over the long-term. With that, let me turn it back to Dave.

Thanks, Rafael. Operator, you can now open the lines for questions. [Operator Instructions] Operator?

[Operator Instructions] We will take the first question from Timothy Arcuri from UBS.

Dave, I wonder if you can sort of go into any detail within distribution versus consignment? Maybe what I'm trying to get at is sort of any differences in demand pull as measured by bookings inside distribution or demand pull from the consignment segment, is one better than the other? And if also, is there any cancellations inside of -- into distribution?

Yes. So on the first part, Tim, we didn't see really anything different between the direct business back going through distribution. As you know, we have had an effort over the past few years to have direct -- close-to-direct relationships with our customers. So the amount of revenue going through distribution is much lower today. So probably only about 30% of our revenue actually goes through distribution. We did see cancellations increased in the quarters just as customers work to align the backlog to their needs. Do you have a follow-up?

[indiscernible] So we will take the next question from Vivek Arya, Bank of America Securities.

So the first one, it seems like consumer electronics is your biggest area of headwinds in Q3, I think you said down mid-teens. And I imagine about the same kind of double-digit down in Q4. Do you think are we past the worst of the consumer? Or should we be expecting the seasonal decline again for consumer in Q1? I know it's a little bit further out, but I just wanted to check what you're seeing in terms of consumer right now. And I guess the bigger picture question there is, is TI more exposed to the cyclical downturn versus your peers because you have the highest consumer exposure? And if that is the case, do you need to do something different, given that mix headwind?

Yes. Vivek, thanks for that question and the opportunity to clarify. So personal electronics last year was 24% of our revenue. If you look at the market overall, personal electronics, a little more than 50% of the semiconductor market without memory. So we have less than half of the exposure there. If you look at industrial and automotive, that makes up 62% of our revenues. And inside of the market, that's 26% of the market. So we're really highly exposed to both industrial and automotive, and that's not by accident, is probably more than a decade ago, we began allocating more of our resources to automotive and industrial and the emphasis there. So we're very pleased with our exposure. And we believe that, that will be there just will be more content added into those systems. Now that said, there's great opportunities inside of personal electronics, communications equipment and enterprise systems in the decades ahead. but we'll just have those secular tailwinds more than average inside of industrial and automotive. Do you have a follow-on, Vivek.

Yes. so kind of a similar question, but on automotive, which you suggested grew 10% sequential in Q3. And interestingly, you're suggesting it can grow again in Q4. What's your sense of kind of the supply-demand balance in automotive among your Tier 1 and then the auto OEM customers? Many investors are concerned that this kind of rolling correction that we are seeing in semi is going to eventually hit automotive, which has been a very strong area over the last 1 to 2 years. So what's your sense of what kind of the supply-demand balance is in this automotive end market?

Yes. I'd say first, I think when you look at the secular trends inside of automotive, I think all of us know that it will be a great grower for us, and we're investing very broadly. So we're just thrilled with the position. If you look at second quarter of 2020, our growth there has, off the bottom been very, very strong. Will that market eventually roll over? It will. I mean that's just what happens. And we're not trying to predict when that will happen, we'll continue to ship product to customers as they request it. And we're really focused on making sure we've got capacity in place for them over the long-term. So we're not really trying to worry about when that will happen. So thank you, Vivek, and we'll go to the next caller, please.

Next question from Joshua Buchalter from Cowen. .

I wanted to double-click on the industrial market. Did anything change materially through the quarter? Anything you can give us on linearity or by geography. As we think about what's baked into the guide, is it more, I guess, conservatism on the macro? Or was there really a material change in your customers' order patterns?

Yes, Josh, thanks for that question. I would say if you look at the third quarter results across the board and also inclusive of industrial, the quarter came in as we expected. If you look at -- and even sequential is not unusual inside of industrial. That's about what we were expecting. But as we described it, the weakness began to broaden into that. So there wasn't one place that we could put the finger on to say it was one thing or one group of customers, but we did see just different signals inside of there that is leading us to that conclusion that it is -- that weakness is broadening. And in fact, we expect that weakness to broaden into most of the other markets as well as we move into fourth quarter, of course, with the exception of auto. So that's really what we're seeing. It's order rates. If you look at order rates quarter-to-date, they are, of course, consistent with our outlook, but they are weak quarter-to-date. And so it's those types of signals that are leading to the outlook. And really, those are the types of signals that really best inform what our shipments in the quarter and in the short term are going to be. Do you have a follow-up, Joshua?

Yes. That's very helpful. I also wanted to clarify the comments on the CHIPS Act. You mentioned $50 million was accrued on the balance sheet. Was that from the investment tax credit only? Because I know there's a second bucket for manufacturing incentives. And if not, when should -- when would you expect to, I guess, get more clarity on how much you'll be able to accrue for the manufacturing incentive portion of the CHIPS Act?

Yes. So first, let me step back. Big picture, the combination of the investment actually the grant as well as the funding for research and development will help. U.S. semiconductor are more competitive. We accrued the $50 million that we talked about in the prepared remarks that you referred to, that was for the 25% investment tax credit that is for manufacturing assets that will go into service in 2023 and beyond. And that is -- that was for $200 million. So 1/4 of that is what we accrued that we will receive from the government at some point in the future as lower taxes. But in the P&L, it flows. It will flow through lower depreciation. I think maybe what you're referring to when you talk about manufacturing is the grant portion. Is that what you're referring to? Well, maybe we'll answer them both. But if you are talking about the grant that is part of the CHIPS Act, but it's separate from the investment tax credit that remains to be seen as more. We will apply for those, the application window doesn't open until February. So we will apply for those. And as we learn more, we'll let you know. And big picture, when we get to February, the next capital management call, we will talk about the CHIPS Act, the overall investment will try to quantify that and what benefit we'll get. At the same time, since the last capital management call, our confidence around the long-term growth prospects in our industry, the secular trends that Dave talked about earlier. That confidence has only grown, so we feel really good about that. So we'll tell you about the net impact between those 2, the benefits of the CHIPS Act and the growing confidence at the next capital management call and any changes to our numbers based on that. So I think you dropped off.

We'll go to the next caller please.

Will take the follow-up Christian from Timothy Arcuri, UBS.

So my follow-up was on China. And I'm wondering if you can talk about your business there. Are you seeing any signs of pull-ins or push-outs as a result of some of these bands. Are you seeing any changes sort of in the linearity around the bands getting announced? And I think also, you had talked about China being like high teens of consumption of your product. Is that still where you see it?

So -- and Rafael, maybe you want to add to it. But on the bands, that the recent changes in some of the bands, there were companies added to the entities list overall. We don't expect that there's really much, if any, impact due to those changes really to that or in any of the restrictions from overall from that. Anything to add on that?

Yes, correct. 99% of our parts fall on the very lowest category of restrictions, just given the nature of the types of parts that we sell. So we don't have restrictions on those. Of course, there are restrictions specific to entities. There's the entity lease that you hear about, the FDPR, that's another list. And we, of course, follow all the regulations when it comes to that. So when an entity goes listed in there, we take that into account and restrict shipments as according to the law. But given how that works, we don't expect any meaningful or significant impact to our revenue with those export loss.

Yes. And that was the first part of your question, Tim. The second part you had mentioned high teens, it's actually about 25% of our revenue comes from customers that are based in China. So that's the number. We'll go to the next caller, please.

Next one from Stacy Rasgon, Bernstein Research.

So my first one, I just wanted to verify, are there any changes to the trajectory of the near- to medium-term CapEx plan just given changes in the current environment? And I guess related to that, the Lehi headwinds that are coming, do you have any of those embedded in Q4? Because you said it's coming online starting in Q4. And I'm getting implied gross margins down a few hundred basis points sequentially.

Yes. So let me answer the first one -- the last one first. So you see on our P&L, about $77 million of restructuring charges in third quarter, that is all because of -- those are the Lehi costs that we chosen to put in there before it qualifies once it qualifies that cost will move to cost of revenue. So it will move to gross margin.

Is that in Q4, though? Does that happen in Q4 or Q1?

Well, it will happen during Q4. Of course, not changing. It doesn't affect EPS. So it's just going to move -- and we don't guide the specific lines, right? But if it qualifies in December 1, 1/3 of that will go into COR and then all of it will be there for first quarter, right? If you qualify December 31, then all of it will be in restructuring in fourth quarter, and then all of it will move in first quarter.

Just to clarify, that's already in [indiscernible] profit. In third quarter, it's been there. It's just moving above the lines into the gross profit.

Into gross profit. It's being in profit from operations the entire time all of this year. The first part of your question, big picture, we will give you an update in about 4 months at the capital management with all the puts and takes. But what I would tell you is that -- well, short-term, we expect our change -- our CapEx expectation for 2022 have not changed. That is $2.6 billion to $2.8 billion for this year; depreciation, about $1 billion for this year. I'm talking 2022. Bigger picture, as I said earlier, the CHIPS Act, great legislation. We're very excited about that. That is going to decrease on a net basis. our investment because we're going to get a 25% reduction from the investments that qualified and manufacturing investments in the United States. But on the other hand, as I alluded to earlier, our confidence around our long-term growth prospects have only grown over the last 6 to 12 months based on the secular trends based on input from our customers. So we feel really excited about that. The net effect of those 2 and whatever that does to our CapEx plans, we'll tell you about that in February.

You have a follow-on, Stacy?

I do. I wanted to ask about OpEx. So it's been running in the $800 million range, plus or minus, for quite a while. And frankly, people are wondering how you've been keeping it there. in such an inflationary environment. It is now ticking up, but it's ticking up as revenues are falling. I guess why is it increasing now where is it didn't increase before and what happens going forward? Because if I would just hold it flat on the revenue guide going forward to do something like 19% of revenue, so it is still below your kind of what you've talked about in terms of long-term targets for OpEx. So how do we think about that? Why is it growing now versus before? And how do we think about where the range might go going forward?

Yes. So here's how we think about it. Step back, for the last 5.5 years, really, we've been running OpEx on a trailing 12-month basis, which is how I prefer to look at it at $3.2 billion. Pretty consistently, we're really steady hand over that time. Our hiring has been very consistent during that time. And that is underpinned by our long-term expectations on growth. And inside of that, R&D has actually moved up. SG&A has moved down inside of that $3.2 billion, but it's been really consistent on that. This last quarter for the first time, it ticked up to $3.3 billion on a trailing 12-month basis. And I would expect that to continue ticking up over the next many quarters and years as we continue stepping up our investments. And that is, a, driven by the higher investments but, b, inflation is playing a factor. It's clearly wage inflation. We're not immune to that. So that is also affecting and will continue to affect those trends.

We have Blayne Curtis from Barclays.

I had 2. Maybe just a clarification, though, on Stacy's question because you said, but I didn't hear anything negative to net off of 2 positives. So I'm just kind of curious, and I guess we'll see what March brings, and I'm happy if you want to comment on that. But it seems like at least personal electronics is back to where you were in '19/'20. It seems like industrial is going to kind of get back there. And at that point, you're building inventories. You had more capacity than demand. So if we do go back to those levels and you're adding more capacity, I'm just trying to understand is still the view that you'll build inventory like you do in '19 and '20 and still roll out the capacity for the long-term.