Texas Instruments Incorporated (TXN) Earnings Call Transcript & Summary

Delighted and honored to have the team from Texas Instruments join us, Rafael Lizardi, the Chief Financial Officer; and Mike Beckman from the Investor Relations team, very delighted that…

Good to be here. Thank you very much .

Thank you. What I'll do is start with my questions, but please feel free to raise your hand if you had something that you would like to bring up.

But maybe, Rafael, let me just kick it off at the high level. Perhaps give us a state of the union. Now we are almost kind of middle of the year. How has the demand and the inventory situation developed so far this year?

Yes. Well, let me step back and just remind everyone of our plans, our investment plans that we've put in place and where we are on those and why we're doing that first. The why we're putting these plans in place -- we put these plans in place and we're executing to them is, one, the secular growth in semiconductors in Analog and Embedded and in particular, in auto and industrial. And we all can see -- have a lot of examples of what's going in there and what's driving that with automation, electrification, safety, that's driving that secular growth. Second, our position in those markets is tremendous. So about 3/4 of our revenue now is in auto and industrial. So we're playing in the best places. And then the last piece of that is the -- I'm sorry, the geopolitically dependable capacity that we're putting in place that our customers are clamoring for. And that just puts us in a great place to have capacity at scale outside of China and Taiwan.

Okay. So maybe let's kind of pick up from that. From what you said, does it mean that the $5 billion per your CapEx plan that you have, is there any scenario in which it can change?

Let me first -- I'm going to answer that question directly. But first, let me walk you through what we're getting for that investment. I'm going to break it down in about 4 pieces, okay? First is RFAB2. RFAB2, we built that factory 4 or 5 years ago, and we've been equipping it since then. We have about 2 years left of putting equipment in the factory. That's the factory that's going to be the workhorse of the next upcycle. Because that factory, if you go back to 2020, we actually left some money on the table. We could have done more, and had we had RFAB2 ready, we would have done more. So we don't want to miss out on that. So that's RFAB2. We're also -- RFAB2 is one where we're shutting down an old factory -- an older factory, 150- to 100-millimeter factory, and we're moving those products to RFAB2. And as they move from 150 to 200 to 300, they're a lot more cost efficient, okay? So that's RFAB2. LFAB1 is the factory that we bought from Micron in 2021, and we have been qualifying and equipping, since they already had equipment, but we have to put additional equipment on that. Think of that factory as a transfer factory. We don't need growth to fill that factory. What we're doing is moving loadings that we've had, and we continue to have to a large degree, in TSMC and UMC, and we're moving them internally. When we do the trade-off, the cost trade-off is huge. We've gone from paying about $2,500 per wafer to, essentially, a $200 per wafer cost on a variable cost basis because the factory is already there, right? The people are already there. That factor is in the middle of -- it has already qualified some processes. We still need to qualify additional processes. And then we have to go part by part and qualify this and send samples to customers that it takes a while. Let me tell you one more point on RFAB2 and Lehi 1. The ITC -- the 25% ITC credit applies to those only expires in 2026. So that's another consideration that we have to take into account that we -- from that standpoint, we want to maximize the equipment that we put there through 2026, because anything that we put in '27 and beyond does not get a 25% credit. Okay. So that's for those 2 factories. Now let me go to SM1 and 2. That's a new Sherman facility. At some point, it's going to have 4 fabs, 1, 2, 3 and 4. For now, we're building 2, 1 and 2. One, it's going to be a full fab. In fact, it's almost done. It's going to start getting equipment in third quarter and then -- and by equipment, I mean a pilot line. So it's, essentially, think of it as 5% capacity worth that we have to put in place, one-of-a-kind tools so that we can have a pilot line and start churning out products and then we send samples to customers so they can qualify them. That's SM1. SM2, think about bare concrete shelf. That is just a shelf. That is just so that it's there, ready for a potential if we need it, we can then move very quickly to put a clean room and then equipping that. Then the last piece of that is LFAB2. LFAB2 is going to be a 3-level fab, a pretty large fab in Lehi, in Utah, right next to LFAB1, but it's going to behave like an extension of LFAB1, meaning that we don't have to qualify it separately. Once LFAB1 qualified and a customer says, "Check. I'm going to take products from LFAB1." LFAB2 Is just another floor of LFAB1. It's just an extension. We do our own -- install the tools, our own simple qualification 2 by 2 and then we start ramping. That, we broke ground this year, but that can be done on a modular basis. Of course, equip the concrete, you kind of put in place all at once. You don't have to -- but the clean room, you can do more modularly. And of course, the equipment, you can also do very incremental. And then to answer your question, we're going to spend $5 billion this year and next year to do those things that I described. For 2026, can we accomplish what I just described with less than $5 billion? Possibly, in fact, very likely, but we're in the process of understanding that. We'll give you more information on that over time.

Okay. What is changing that view versus 3 months ago?

Time has passed, and we have more information to assess where we want to go. And at the end of the day, look at the big picture, right? We spent about $2.5 billion in '21, $2.5 billion in '22, $5 billion in '23. We're going to spend $5 billion this year, $5 billion next year and then the remaining $5 billion that we just talked about in '26. You add that up, that's $25 billion. So could we potentially shave $1 billion or $2 billion from that and still accomplish everything that we want to accomplish, that's a possibility. But in the big scheme of things, it's $1 billion or $2 billion out of $25 billion investment cycle.

I see. And then, Rafael, even longer term, I think the plan was that you would have a few years of this $5 billion and then the exit would be 10% to 15% kind of CapEx intensity, right? So that's more kind of top line base. But even that 10% to 15% is much higher than what TI used to have, right? Like in the past, you were kind of low mid-single-digit right, type of CapEx. So why is it so much more inflationary to put this kind of capacity now versus before?

Yes, I'll tell you what, forget about that 10% to 15%, frankly, because that is -- that 10% to 15% was a function of revenue growth. So if revenue was headed towards a very high number, then, of course, we would have to put additional CapEx in order to equip those factories. Just as I mentioned, SM2, we would then have to equip; LFAB2, we will then have to equip. But if -- but that depends on revenue growth. So if revenue growth is not there, then we don't have to spend anywhere near that.

Okay. But I mean, doesn't 10% to 15% automatically take care of what the revenue level is?

Well, it depends on the revenue. You tell me the revenue, and I'll tell you what -- I'm saying facetiously, but depending on that revenue growth. So for example, the 15% corresponded to a 10% CAGR from 2022, at $20 billion, you do 10% CAGR out to the end of the decade, that would have corresponded to a 15% CapEx at that point. If instead of that, we're at a 7% CAGR, that would have corresponded to a 10% CapEx intensity. If you are lower than that, then it's less than that.

Okay. So let's say, we get past this inventory correction. Do you think that your addressable opportunity is growing at a 7% CAGR? Or a 10% CAGR?

Let me put it this way. Go back to peak-to-peak analysis of the last 2 semiconductor cycles. So 2014 to 2018, 2018 to 2022. What happened in those years? From 2014 to 2018, of course, that's 4 years, we grew at 21%, the peak-to-peak. From 2018 to 2022, that's another 4 years, we grew at 27%. If you fast forward, just use that same math, and get to potentially what could be the next peak in 2026, you can get to roughly $24 billion to $26 billion of revenue. And you also should consider that in 2022, we were constrained as far as how much we could have shipped. So we could have shipped more than the $20 billion. While I'm -- while we're talking about this, let me also comment on the fall-through to gross margins. If you look at our growth -- our fall-through, through gross margins, in those peak-to-peak years of 2014 to 2018, these are just in our financial statements. I'm not making any predictions. This is -- I'm just telling you what the actuals are. 2014 to 2018, that fall through ex depreciation was about 90%. It was actually a little more than 90%. And then you go 2018 to 2022, do the fall-through again ex depreciation, it was also about 90%. So now is it going to be 90% in the future? Not necessarily. For example, part of the reason we moved so high was that we were doing less personal electronics more auto and industrial. Now that we're 75% auto and industrial, there's less tailwind on that, but we should still do very well on that fall through.

Got it. I thought one of the reasons TI suggested a kind of move towards a 10% growth model was that a lot more of the business is coming from auto and industrial. Like, even in those years, your auto and industrial, right, definitely grew at a very nice kind of double-digit CAGR where some of the weakness and the volatility was on the consumer side. Like, for some of those years, a large smartphone customer was the largest customer for TI, right, not as much so I would imagine now. So doesn't that mix shift towards auto-industrial make it more likely that you can grow at that 10% base…

I'd tell you what. I prefer not to speculate on that. But what I'm confident -- I can confidently tell you is that if it grows 10%, we'll be ready. And that is what this plan gives us, okay? That is why it's so important that we complete these investments that we're making as we -- as I described RFAB2, Lehi 1, Lehi 2, SM1, the shell in SM2. Because if, in fact, we have a 10% CAGR, or even a higher CAGR, because of the factors that you just described, we don't want to leave any revenue on the table and we wouldn't. Just like I described, we'll have tremendous optionality to put more equipment in SM1, more equipment in LFAB2 and even finish, accelerate the clean room in SM2 and ramp that up as well.

I would just add that, automotive and industrial, that is a factor in it. That didn't happen by accident. That was a bias toward auto and industrial from an R&D perspective. And it's not just 1-year bias. It's been a longer-term bias. So as you pointed out, those markets have grown at a faster rate than the overall. They're a higher percentage of our revenue today. Is that potentially something that's going to drive our growth faster over time? We want to be right for it and it's -- again, it's not by accident.

All right. If more than half of the customers for automotive and industrial are outside the U.S., why do I need to have all of my capacity in the U.S.?

Because the -- well, you don't need to have it all in the U.S. You want to have it where it's geopolitically dependable. But the U.S. is a great place to have fabs. Now that we are at par with the CHIPS Act on the 25% ITC, and we'll see what happens on the grants, we don't have anything to announce on that. But at some point, we should hear, and we should have something. But now that, that is at par, on an even playing field, the U.S. is a great place to put fabs. Texas, in particular, we get tremendous advantages there. Of course, we have fabs there. It's easier to deploy additional fabs. Electricity cost is very favorable there. The access to talent is also really good. So I'd put Texas next to any country, at this point, in terms of building additional semiconductor fabs.

Got it. Absolutely. So I can understand that from a supply perspective, I'm trying to think that -- does it become -- is it a factor in terms of share gains? Because when we talk with a number of your peers, right, who have a hybrid strategy where they are -- sure, many of them are still dependent on Taiwan, but TSMC is building out more fabs in Japan. So why isn't the capacity access they have in Japan give them that dependable capacity at a much lower capital intensity than what TI is doing?

The difference is -- it's a good question. The difference is how many fabs are TSMC building in Japan? Like, one, right? How many are they building in Europe? Like, one. How many are they building? So a customer that's looking for a check-the-box, a, I have dependable capacity because I'm building my -- I'm buying from ADI and their they're sourcing out of -- they could source out of Japan? They could check a box on a PowerPoint slide. But if something actually happens where the fabs are not -- the supply is not available coming out of China or Taiwan, all those customers are going to be asking for the same parts from the same fabs in Japan and Europe and other places. Now we don't have that problem. And we're going to have those fabs in the United States, as I described earlier, and all available with plenty of capacity.

At scale is essentially what it means. Right.

But have you, Rafael, actually seen that in practice? I understand the concept. But if, practically, our customers saying, "Yes, I was planning to give a part to whoever else, but I would rather give it to TI because you have that fab capacity in the U.S."

It's an excellent question. CEOs of our customers will tell you that twice a day and 3 times on Sunday. But when it comes down to the designers actually putting in the part, you have to be competitive. You have to be competitive with price. You have to be competitive with the part that you're putting out. You have to have deliveries, inventory available. So it gets more tactical when it comes down to the actual designing and winning the sockets. But at the high level, the CEOs and the chief purchasing officers and they're influencing on the designers, yes, we are seeing that.

With deadline, dates. They want to get certain percentages, too. I mean, they are actively trying to do that.

Which why we're doing the same thing with our supply chain. And we are largely diversified and dual, triple source. But in places where we're not fully or not to the level that we won, we're doing the same thing. We're looking for other sources so that we have our own geopolitically dependable capacity when it comes to mold compound, lead frames, wire, et cetera, for our various operations.

I see. At a recent conference, Haviv mentioned that there is -- whether it's a plant, whether it's a trend line or something that can get Texas Instruments to potentially about this $12, right, per share and you manage your business for free cash flow per share. So where does that $12 number come from? Is that a trend line? Like, what needs to happen for TI to hit those…

It's not -- okay. Go back to the peak-to-peak comment that I made earlier, okay? 2018 to 2022 or you can do 2014 to 2018, the growth rate's there. And by the way, it happens to be 4 years in between those and 4 years from 2022 happens to be 2026. So it actually works out pretty well. Do that, do the fall-through at similar rates. In fact, do it a little less, don't use 90% percent. Use 80% to 90%, pick 85%. Do that, model it away, and it's not hard to get to -- and the CapEx, as I said, I haven't given you a number, but it doesn't have to be $5 billion in CapEx. You do that math, you get to a very healthy free cash flow per share.

I see. Is that how you're kind of putting all your CapEx and OpEx plans in place to get to that number conceptually at some…

Conceptually, yes. And we want to be able to maximize the revenue opportunity. So as I -- if you account for -- the math that I just gave you doesn't even account for the fact that we -- our revenue was compressed in 2022, doesn't account for potential issues of geopolitical tensions that could give us an even bigger opportunity. It doesn't account for the fact that auto and industrial could accelerate growth. This is why we want to be prepared to do even more than that.

I see. And does this change in CapEx plans -- Rafael, does it change the depreciation schedule that you have given for the next several years?

At this point, I've only given depreciation for this year and for next year. I haven't given anything beyond that. So that is not changing because the CapEx for those years has not changed. But at some point, we'll give you and beyond or at least '26 and beyond or at least '26. We'll see how often we give it. And of course, that -- if we spend less CapEx, that's going to drive the increase in depreciation lower. And then we also have to take into account the grants whenever we hear about that and how that affects that. Clearly, we can only bring it down, right, versus what it would have been.

Got it. And from what we have seen, right, many other companies who have gotten the CHIPS Act funding, it has been -- so of course, ITC, you mentioned, right? So that is already part of the financials that you are reporting, right, so far. But what we have seen with others is about that 15%, right, or so, broken out in terms of grants and loans. Is that sort of the structure that we should contemplate for TI?

Well, what you have seen so far is less than 15% on average. We've seen roughly...

10% to 15%, right?

Yes. But it depends. It depends on the timing of projects. So we'll have to see what the Department of Commerce offers and where we land on that.

I see. And when we look at that denominator of that CapEx, is that all of RFAB2 and LFAB and all the Sherman fabs and LFAB2? Like, what is the denominator that Department of Commerce could be potentially looking at and say, okay, I need to this fund this percent of that?

What I'd tell you in that is, I think, their focus is projects that are happening now through 2030. So they're focused on the shorter -- so for example, Sherman 3 and 4, they're not even -- they're probably not going to be in the picture, right, because we're not talking about building any of those anytime soon.

I see. So if I look at CapEx, let's say, $5 billion towards $4 billion, right, somewhere $20 million to $25 million, is that kind of the rough math between now and 2030?

We will comment when we get the information. You're trying to ask many questions on that, but I don't have any information to give on the grants.

Okay. And just the last thing. Let's say you get a grant, does that also then impact your depreciation schedule?

Yes.

Because then, this will be net CapEx. So what you have given for this next year could be…

That's right. Well, I doubt that it would affect next year because it would most likely be longer term than that, but it would affect, for sure, 2026 and beyond versus what it would have been. That doesn't mean it's going to be lower than 2025. It may just not increase as much as they would have otherwise, [ depreciation ]…

I see. Right. Because where I was going with that is because that formula does affect, right, as much as you manage the business for free cash flow, we look at gross margin for sure.

Right. So on that point, let me just give you a quick update on that. At the last earnings call, I think I told you, depreciation for this year between 1.5% and 1.8%, but we're going to be at the lower end of that. For next year, 2% to 2.5%, we're also going to be at the lower end of that.

Got it. Okay. So whenever you hear about the grant, does that kind of move that a little bit? Or that's more '26…

It should not move -- definitely not '24 and unlikely that it moves to 2025. It will likely move 2026, which I haven't given an update on.

Got it. So that only changes. Okay. The second thing I wanted to ask you is back to the demand side. So you did guide June to grow, right, sequentially?

Right. Our midpoint -- at our midpoint.

At the midpoint, would you consider that seasonal? Would you consider it not -- like, should we think June is now a normal quarter? Or you still think you are battling inventory headwind that the end market has not really stabilized. So I'm just trying to understand where we are in the spectrum moving to normal. Are we there…

Want to take a shot at that and -- yes, go ahead.

So I think it's important to remember that this cycle has had this end markets "moving out of phase with each other" dynamic. So it's probably hard to answer the question directly of whether seasonal and the current guide. But I think we're starting to see this first-in/first-out phenomenon kind of playing out, right, because you saw personal electronics was the first to correct. It started seeing some sequential growth middle of last year. Industrial had some sectors that began correcting late 2022. You had a set of sectors that kind of hung in okay in '23, and then late '23, joined and also begin to correct. Everything further corrected fourth quarter. But then in last quarter, first, we saw mixed results. There were some of those earlier sectors, flat; some grew; some still down, on the later sectors to correct, down double digits. So more mixed results there. And again, kind of following that first-in/first-out has been what seems to have been so far materializing. Automotive was the last to begin correcting for us. I think fourth quarter, it was down mid-single digits. First quarter down, also mid-single digits. Obviously, it didn't fall off a cliff. We'll see where it lands. And obviously, the guide speaks for itself. But yes, I think that's what we're seeing so far. I don't know if you have anything to add, Rafael?

No.

No. Okay. So automotive, do you think that is in a better state than industrial? Like, if you had to think about where TI gets back to seasonal trends in the back half, is it more likely to happen with industrial? Or more likely with automotive?

Well, what I would tell you, just as Haviv said last week at the Bernstein Conference, we expect a shallow dip in automotive.

And I think we want to be ready for whatever eventuality comes out in any of those markets from an inventory perspective. But obviously, automotive has its own unique growth trends underneath it. The secular growth there has obviously been very strong the last several years. The EV transition is a piece of that. I also think there was an inventory component. And that supply chain evolved a bit over the last several years. So all that plays into what this could look like. As Rafael said, it probably has a little more of a shallow cycle to it, but we'll have to see.

All right. Not to parse words, so have you seen a shallow dip in auto already? Or is that shallow dip yet to come?

Well, you've seen some of it in our first quarter results and our guidance, pick our midpoint embeds there. I mean auto and industrial are 75% of our revenue. So our midpoint reflects -- what happens to our midpoint is showing in our...

But are they both increasing?

Well, we're not going to comment on second quarter. I'm just saying our guidance, and if you look specifically at our midpoint, in second quarter embeds, it's consistent with what I just said.

Okay. Next thing, Rafael, there's a lot of debate about what does all this buildup of capacity in China mean, right, from a competitive perspective for you? So first of all, how much is China domestic kind of demand as a percentage of your sales? And have you seen any design-outs for TI based on the capacity that's being built up?

Yes. No, good question. So let's talk about that. So roughly speaking, we published this in our Ks and our Qs, right, about 20% of our revenue comes from companies that are headquartered in China, okay? In fact, as of the last quarter, it was 17%, okay?

17%. Yes.

So that means that 83% of our revenue is obviously non-China, so United States and Europe primarily. Those customers -- let me start with those customers, care deeply about having geopolitically dependable capacity, okay? And so -- and it's largely -- they are largely unaffected by whatever SMIC and HH over there, they [ try ] to spend to build foundry, okay? Now on the 17% that is in China, we compete there very well, okay, and just because the foundry throws money at something doesn't mean they're going to beat us. We have our competitive advantages to rely on and it starts with our manufacturing and technology. And we just went through our footprint, at our 300-millimeter footprint and cost leadership there. But it's not just about cost and the footprint. It's also about the broad portfolio and the sales channels and the longevity, but let's talk about the portfolio, right? We have already over 100,000 parts and counting, right? So every year, we're turning out more and better parts and family of parts. When you're competing, particularly in industrial and automotive, you need a family -- families of parts. You don't just need 1 or 2 parts. Personal electronics, frankly, it is easier to come out with one part that is perfect for this particular application, and you optimize it just for that, for a phone that's going to sell 100 million units, okay. That's hard -- we can compete there too, but it's easier for an entrant, a newcomer to go in, partner with a foundry and go after that. Industrial and automotive, it's a lot harder. You need families of parts and you need the reliability, you need the inventory position, the capacity. And then on top of that, many of those customers in China also export. They're not just selling into China, they export. So they care about the geopolitical ramifications of their choices. Finally, I mean, one more, it's not an all-or-nothing decision. Many of these customers have multiple boards that they have, some boards with TI, some boards with the local, and they can flex -- I'm talking in China, and they can flex how much they have, depending on the situation, depending where they're shipping, et cetera.

Right. But when we look at how much China was, as a percentage of sales for a lot of the fab equipment, right, tool companies, it was over 40%. So what capacity are they building? Like is it all consumer? Like is it all -- like there is 0 overlap with what TI is doing?

I'm sure there's no 0 overlap. There -- I mean, is it an ideal situation? Of course not, okay? So it is a risk, but it's a risk that I think we can manage and we are managing for the reasons that I described earlier.

Makes sense. Finally, on pricing, I think you have been kind of more measured in your approach, saying that industry pricing over time could get back to kind of the historical trends of low single digit. I think many of your peers have kind of maintained a flattish profile. So when you say low single-digit decline, is that because that is what you're seeing? Or is that just because of the conservatism in how you…

Frankly, no, that's what we're seeing. That's what we're seeing.

You are actually seeing prices go down?

Yes, we're seeing that.

And that is in -- as you design a new devices for the customer, they open up their board and you have opportunity, the pricing discussion has moved back into that engagement with customers. There was a period there during '21, '22, where that wasn't the -- that wasn't in the conversation very much. Obviously, that's come back very much like it was prior to 2020. And so it -- our base case assumption as you start to see that, I would also add that we exercised a lot of restraint, I think, in pricing in '21 and '22. Obviously, we did price to the market and as market moved up, we moved with it, but I think there was more restraint from us. So I think over time -- or like I said, our base case assumption is low single-digit decline. And that's just based off similar trends that we have seen in engagement with customers that we saw prior to the last cycle.

Right. So some clarification. This is not the price going back to where it was before. The rate of decline going back to what it was before the pandemic, okay? So prices ran up, now they're declining 4%, 5% a year or so. That's one clarification.

By 2%, 3-ish.

Yes. The other clarification, it depends on the end market, it depends on the region, it depends on customers. So there are some end markets where you're not seeing much of that. And it also depends more than half of our revenue, I don't know, 60% to 70% is a multisource margin. So those are more price sensitive. The parts that are more ASSP, more unique, they're less price sensitive, okay? So it happens. But in aggregate, yes, 2% to 3%, 4% declines on an annual basis is what we are seeing so far and what we expect in the -- for the foreseeable future.

Do you think the fact that you're building a lot more capacity makes you a little more open to having the pricing discussion? Or that's not…

It gives the ability to compete, but that's not -- it doesn't drive us to that. And we price to market. If our cost was 2x, 3x what it is today, there will be some portions of the market where we wouldn't even be playing.

So are you then surprised when you hear your peers on public conference calls say that there is no change in pricing while you're getting a price discount?

Yes and no. I think I'm a little surprised. But there are some -- they don't compete -- our U.S. and European competitors or at least some of them don't compete to the extent we do in multisource. Now they like to say that we only do multisource or even commodity. That's not true. We also compete in their backyard. But in addition to competing with the high end, the innovation, the ASSPs, we also compete in the multisource type of space.

Okay. Perfect. And before we close, Rafael, just any update on your kind of return of cash plans that as the free cash flow starts to, right, improve from here, do you think we should start to see buybacks start to resume, right? What changes…

So I don't have anything to announce on that front. But high level, I'll tell you -- let me answer it this way. The reason why you have seen our buybacks decrease over the last couple of years versus what we've done before is because primarily of this CapEx investment cycle. All else being equal, that's the most important capital allocation, more than buybacks. So that's why you have seen the buyback decrease. You've also seen us take on debt, increase the cash on the balance sheet. So as the CapEx is behind us or mostly behind us, right, we're almost past the midpoint at this point. In fact, we are past the midpoint, then it's likely that you see a shift on the capital allocation.

On that optimistic note, thank you so much, Rafael.

All right.

Thank you, Mike, for your time.

Thank you.

Thanks, everyone.