Good day, and welcome to the Texas Instruments Q1 2019 Earnings Release Call. Today's conference is being recorded. At this time, I would like to turn the conference over to Dave Paul. Please go ahead, sir.
Thank you. Good afternoon and thank you for joining our Q1 2019 earnings conference call. Rafael Lizardi, TI's Chief Financial Officer is with me today. 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 as well. 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. For today's call, let me start by summarizing what Rafael and I will be reviewing. I'll be covering the following topics.
1st, a high level summary of the financial results for the Q1. 2nd, I'll provide some details of the Q1 by segment and end market. And third, I'll include some additional color in light of the market weakness we're currently experiencing. Rafael will then review profitability, capital management results, a brief comment on the status of our next 300 millimeter fab and then the outlook. Then we'll open the call for Q and A.
Now starting with the high level summary of our Q1 financial results. The weakness in demand that began in the second half of twenty eighteen continued into the Q1. The weakness was across all markets with the exception of communications equipment. In our core businesses, analog revenue declined 2% and embedded processing revenue declined 14% compared with the same quarter a year ago. Both businesses year end youth year growth decelerated as we expected at this point in the cycle.
Similar to the Q4, embedded remained weaker than analog primarily because it didn't benefit from increasing content in 5 gs. Operating margin decreased in both businesses. Reduced factory loadings affected both businesses, but the impact was greater in analog since more of its supply comes from internal manufacturing. Overall revenue in the Q1 decreased 5% from a year ago and earnings per share were 1.26 dollars including a $0.04 discrete tax benefit not in our original guidance. With that backdrop, I'll now provide details on our performance, which we believe continues to be representative of the ongoing strength of our business model.
In the Q1, our cash flow from operations was $1,100,000,000 As we know each quarter, we believe that free cash flow growth, especially on a per share basis, is most important to maximizing shareholder value in the long term. We remain committed to returning all of our free cash flow to owners. Free cash flow for the trailing 12 month period was $6,000,000,000 up 22% from a year ago. Free cash flow margin for the same period was 38.4% of revenue, up 32.1% from a year ago. We continue to benefit from the quality of our product portfolio that's long lived and diverse and the efficiency of our manufacturing strategy, the latter of which includes our growing 300 millimeter analog output.
We believe that free cash flow will be valued only if it's productively invested in the business or return to owners. For the trailing 12 month period, we returned $8,000,000,000 of cash to owners through a combination of dividends and stock repurchases, demonstrating our confidence in our business model and our commitment to return all of our free cash flow to owners. Moving on, I'll now provide some details of the Q1 by segment and end market and then offer some additional color on the market. From a year ago quarter, analog revenue declined 2% due to high volume and power, partially offset by growth in signal chains. I'll note that the strength in communications equipment minimized analog's decline.
Embedded processing revenue declined by 14% from a year ago quarter due to declines in both product lines, processors and connected microcontrollers. In our other segment, revenue declined 6% from a year ago. Now, given the current weaker market environment, I wanted to provide some additional color on the quarter. As I mentioned earlier, the weakness in demand for our products that began in the second half of twenty eighteen continued into the Q1. Demand came in mostly as expected, although communications equipment was stronger than expected due to shipments of products that support 5 gs.
Next, I'll provide some insight into this quarter's performance by end market versus a year ago. Industrial and Automotive declined mid single digits due to broad based weakness. We continue to focus our investments across 13 secondtors in industrial and 5 secondtors in automotive. Despite this near term weakness, we continue to believe these investments will deliver broad based and diverse revenue growth over the long term. Personal Electronics declined low double digits due to broad based weakness, including mobile phones and PCs.
In contrast, communications equipment grew about 30% year on year and as we mentioned earlier benefiting both from 5 gs shipments as well as an easy compare due to weakness in the year ago period. History would suggest that we should expect this market to be choppy in the future. And then lastly, Enterprise Systems declined. Looking at these end markets on a regional basis, generally all the regions performed consistently excluding the positive effects of communications equipment. So in summary, we continue to focus our strategy on the industrial and automotive markets where we've been allocating our capital and driving initiatives to strengthen our position.
This is based on the belief that industrial and automotive will be the fastest growing semiconductor markets. They have increasing semiconductor content and they also provide diversity and longevity. All of this translates to a high terminal value of our portfolio. Rafael will now review profitability, capital management and our outlook.
Thanks Dave and good afternoon everyone. Gross profit in the quarter was $2,260,000,000 or 62.9 percent of revenue. From a year ago, gross profit decreased due to lower revenue and reduced factory loadings. Gross profit margin decreased 170 basis points. Operating expenses in the quarter were $803,000,000 down about 2% from a year ago and about as expected.
On a trailing 12 month basis, operating expenses were 20.7 percent of revenue, within our range of expectations. Over the last 12 months, we have invested $1,560,000,000 in R and D, an important element of our capital allocation. We are pleased with our disciplined process of allocating capital to R and D, which we believe will allow us to continue to grow our top line over the long term. Acquisition charges and non cash expense were $79,000,000 Acquisition charges will be about $80,000,000 per quarter through the Q3 of this year, then declines about $50,000,000 per quarter for 2 remaining years. Operating profit was $1,380,000,000 or 38.4 percent of revenue.
Operating profit was down 11% from the year ago quarter. Operating margin for analog was 43.2%, down from 45.4% a year ago and for embedded processing was 31.3%, down from 35.4% a year ago. Our focused investments on the best sustainable growth opportunities with differentiated positions will enable both businesses to continue to contribute nicely to free cash flow growth over time. Net income in the Q1 was $1,220,000,000 or $1.26 per share, which included a $0.04 discrete tax benefit not in our prior outlook as we have discussed. Let me now comment on our capital management results, starting with our cash generation.
Cash flow from operations was $1,110,000,000 in the quarter. Capital expenditures were $251,000,000 in the quarter. Free cash flow on a trailing 12 month basis was $5,990,000,000 In the Q1, we paid $724,000,000 in dividends and repurchased 1 point $15,000,000,000 of our stock for a total return to owners of $1,880,000,000 In total, we have returned $8,050,000,000 in the past 12 months consistent with our strategy to return all of our free cash flow. Over the same period, our dividends represented 45% of free cash flow underscoring their sustainability. Our balance sheet remains strong with $4,090,000,000 of cash and short term investments at the end of the first quarter.
Total debt is $5,800,000,000 with a weighted average coupon of 2.91%. Inventory days were 144, up 8 days from a year ago and down 8 days sequentially. We are pleased with the progress we have made replenishing inventory of low volume devices and implementing the next phase of our consignment programs with our distributors. Work in both of these areas will continue in the 2nd quarter. We believe there is strategic value in owning and controlling our inventory and we'll manage it with our long term objectives in mind.
Next, as we mentioned earlier, we want to update you on our next 300 millimeter wafer fab. As you may have seen, we have chosen Richardson, Texas as the site for our next wafer fab. The new building will be on our existing site in Richardson. We have not announced a specific construction timetable yet, but as we indicated during the February capital management call, we would expect to get started in the next few years. Turning to our outlook for the Q2, we expect TI revenue in the range of 3.46 dollars to $3,740,000,000 and earnings per share to be in the range of $1.12 to 1 $0.32 which includes an estimated $10,000,000 discrete tax benefit.
We continue to expect our annual operating tax rate to be above 16% in 2019. In closing, as we said last quarter, we believe that after 10 quarters of year on year growth, the weakness we are seeing is primarily due to the semiconductor cycle. We have just completed our Q2 of year on year declines for TI. If you look at history, cycles are always different, but typically the industry would have 4 to 5 quarters of year on year declines before year on year growth resumes. We're not trying to forecast the cycle, but simply offer some historical perspective.
Given our experience, we will stay focused on making TI stronger for the long term, while remaining diligent in the short term. We continue to invest in our competitive advantages, which are technology and manufacturing, portfolio breadth, market reach and diverse and long lived products. We will continue to strengthen these advantages through disciplined capital allocation and by focusing on the best products, analog and embedded processing and the best markets, industrial and automotive, which I believe will enable us to continue to improve and deliver free cash flow per share growth for a long time to come. With that, let me turn it back to
Dave. Thanks, Rafael. Operator, you can now open up the lines for questions. In order to provide as many of you as possible an opportunity to ask a question, please limit yourself to a single question. After our response, we'll provide you an opportunity for an additional follow-up.
Operator?
Thank We'll go first to Vivek Arya with Bank of America Merrill Lynch.
Thanks for taking my question. I'm trying to think of how to interpret your Q2 outlook. One interpretation is that you're not really seeing much recovery off of Q1, right, which is kind of surprising when we hear of China PMI improving and all the optimism about some signs of recovery. The other interpretation is that maybe Q1 you saw the extra benefit from comm equipment. So if I exclude that, then you are seeing some modest pickup going into Q2.
So I'm just curious how are you thinking about your Q2 outlook versus seasonally which is supposed to be up 7%, 8% sequentially?
Yes, Vivek. I'd say certainly, I can confirm the first part of the question that in Q1 we did get a benefit from comms equipment. That's just in the numbers. I think when we look at our 2nd quarter outlook and we put that together, again, we base that on the orders that we get from customers as well as the demand feeds that we get through our consignment programs. And just as a reminder, about 2 thirds of our revenue come through those consignment programs.
And for OEMs, we'll typically get 6 months of visibility and there is no inventory that sits in front of us in that manufacturing line. So it really is one of the best signals that we can get. And I also would caution that that doesn't mean that that signal can't change very quickly. But so that's how we're basing the guidance for the Q2. And I'll leave the further interpretation to you.
Do you have a follow-up?
Yes. Thanks, Dave. So maybe I ask the question in a different way, have you seen any pickup in orders over the last few weeks versus let's say the 1st few weeks of the year?
Well, I would say that orders behaved normally in the quarter. And again, 2 thirds of our revenue is coming through on consignment. So we'll get an order when that product is due to ship and that happens instantaneously. So orders are probably less of the strongest signal that we'll get than versus that those demand signals that we get from orders. So thank you, Vivek.
And we'll go to the next caller please.
We'll go next to John Pitzer with Credit Suisse.
Yes. Thanks guys. Thanks for letting me ask the question. Rafael, I was wondering if you could talk a little bit about some of the utilization actions you are taking. How much of a hit were they to the calendar Q1 gross margins?
And I guess more importantly, I know it takes time for utilization actions to kind of go through the P and L, but have utilization rates now bottomed? And how do you think about utilization relative to Q2 gross margins and going throughout the remainder of the year?
Yes. Thanks for the question. Let me try to frame that for you a little bit. Over the last couple of quarters, we have talked about how we were going to decrease our wafer starts to adjust to the expectations of revenue, while at the same time, we're going to increase the portion or dedicate a portion of those wafers to building our low volume industrial consignment or industrial buffer parts and also the transition to consignment. So we did those things and our operating plan did reduce and we did take a hit to gross margins in that process and that's what you're seeing in our P and L.
Now what I would sort of take you back to is look at it from a free cash flow standpoint, because ultimately that's what matters, right? What you're seeing from a utilization charges standpoint is a non cash expense. At the end of the day, what we're focused on is allocating capital and allocating cash, right? So by decreasing those wafer starts, what we did was dedicating less cash to that. So in fact, leaving out more cash for the owners of the company, but generating enough inventory or the right amount of inventory to be prepared for the revenue that we want to meet in the future and also to build those buffer inventory stocks so that we're prepared for future quarters and have the ability to meet customer expectations and customer satisfaction, which ultimately is what we're trying to do with that inventory to that so that it helps us position ourselves to meet those customer demands and help with our goal of continuing to grow the top line for a long time to come.
Yes. And just a number on that. I think if you look at our Q1 trailing 12 month free cash flow is at 38.4 percent, that was the same that we had last quarter. So it didn't change much. Do you have a follow on, John?
Yes, Dave. Just going back to the revenue guidance for the calendar second quarter. If you look at how the business has historically performed, I think I need to go back to 2,001 to see a calendar Q2 that was down sequentially and that was sort of in the wake of the tech bubble. Again, I'm just trying to get a sense of what you're seeing in the bottoms up business to potentially have a scenario in there of down sequential revenue. And I guess you mentioned in your prepared comments that the comps business can be lumpy historically.
Is embedded in the Q2 guidance still good lumpiness or would you expect bad lumpiness in the comp sector?
Yes. So I'd say first, if you look over and you know this very well, John, if you look over 10, 15, 25 years of the comms equipment market, that business is lumpy. It's lumpy because of the way that operators put out tenders and then place the orders and the OEMs, our customers have to build to those. So, history just says that you should be mindful of that and that doesn't make it a bad business. It's just an attribute of it.
And so, I think in the Q2, I'd remind you that we just completed the Q2 of year on year declines for TI. It's not it's likely that cycles, as we mentioned in the prepared remarks, can last 4 or 5 quarters. Sometimes they can be shorter and sometimes they can be longer than that. But we're 2 quarters into that. So and for our practice, if there was something significant or unusual going on in our guidance either by an end market or a particular customer, we would make those things clear to help you understand it.
So, okay. Thank you, John. We'll go to the next caller, please.
We'll go next to Stacy Raghavan with Bernstein Research.
Guys, thanks for taking my questions. Again, I want to push on the comm point a little bit. I know analog and embedded have diverged partially because of this. If it wasn't for the upside on common analog, do you think you'd be seeing similar year over year trends without the strength in comm?
Yes, Stacy. As you anticipated? Yes, they would be much closer. I think there's still some differences, but directionally all the end markets are the same and they'd be much closer from year over year decline standpoint. You have a follow-up?
I do. Again, I want to follow-up still on comp. So we're seeing very strong ups. I mean, I guess is the first part of it, is it fair to say that you mentioned this that the upside versus guidance in the quarter that was all comms, so the rest of the business came in as expected. And I guess just secondly, how concerned are you?
What's the possibility that the current strength we're seeing in comp is not actually matched to ending? I know people are worried about like order pull forward and that's what I think from some of the larger customers. Like what are you seeing around those lines around the sustainability of the upside that we're seeing in columnar, I guess over the near term?
Yes. So I'd say that the upside that we saw was almost all from comps. I think that the rest of the markets and businesses, if you looked at it from that way, performed about as we expected. And the comments on what the future of that looks like, I just go back to the statements that we made before and just staring at history of that market, it tends to be choppy. So, would we expect it to be choppy in the future?
We would. That's not a comment on Q2 or 3rd or 4th. It's just a comment of looking at history that market just tends to be choppy. So, okay. Thank you, Stacy.
We'll go to the next caller please.
We'll go next to Mark Lipacis with Jefferies.
Hi. Thanks for taking my question. The first question is, will inventory will your factory loadings go up sequentially in this quarter versus last quarter? Or are they going to be going down? I'm trying to understand if you believe inventories are going to be a source or use of cash this quarter.
Yes. Last quarter, we characterized that because it was more relevant at the time given the inflection point on our revenue. Now that the midpoint of our revenue is about the same as Q1. I think it's time to just not focus on that and focus on the other things that we think are more important longer term, which is our ability to continue to grow the top line as we focus on analog and embedded industrial automotive. And with that, as we focus on growing free cash flow for the long term, as Dave mentioned earlier and we mentioned in the call, despite the drop in gross margin and the drop in utilization, our free cash flow on the trailing 12 month was essentially unchanged from 90 days ago and as a percent of revenue was 38.4%.
Right.
And I think that just speaks to the quality of the business model that top line can change quite a bit. But if you look at that trailing 12 month free cash flow, it just tends to be much more stable. And that just speaks to the quality of the model. Mark, do you have a follow on?
Yes. Thank you. Dave, in your script, you said I may have misunderstood this, but you said that regionally, the business trends were consistent except for communications equipment. I don't think I really quite understand that. I'm hoping you can just spell that statement out for me.
Thank you.
Yes. So that you can there are you could think of the largest manufacturers of communications equipment. We try not to go by customer of who those are, but there are only a couple of regions in which they exist. And so you can imagine that you can connect those 2 pieces of information together. So hopefully that helps.
Thank you, Mark. We'll go to the next caller please.
We'll go next to Toshiya Hari with Goldman Sachs.
Hi, thanks very much for taking the question. I had a follow-up on the comm segment. Dave, you talked about the business being up 30% year over year. What was embedded in your original guide for the Q1?
Well, again, I think that overall our revenue came within the range of our expected guidance. It was in the upper half primarily because of the strength that we saw in comps equipment.
Okay, got it. And then as a quick follow-up for Rafael.
Wanted to
get an update on your thoughts on capital return. Your stock is back up to not quite your 52 week high, but pretty close. How should we think about buybacks versus dividends versus other uses of cash going forward? Thank you.
Yes. No, I'm happy to address that, Toshi. First, let me take everybody back to our capital management strategy, the objectives that we talk about. And when it comes to cash return, our objective is to return all free cash flow to the owners of the company via buybacks and dividends. And within that, we recognize that sometimes you strategically build cash, sometimes you strategically drain cash, right?
So then you can actually return more than 100% of free cash flow as frankly we've done for the last few years. But on the two pieces, so dividends and buybacks. On dividends, the goal is to provide a sustainable and growing dividend and we target to be And then on the repurchases, the And then on the repurchases, the accretive capture of future free cash flow for the long term owner. So that essentially means that. So let me dive a little deeper on repurchases because that's I think that's where your question is going.
We use reasonable assumptions, not aggressive, not conservative, but reasonable assumptions of our expected growth of free cash flow per share for the company for a long time to come. And then based on that, we develop our assessment on valuation of intrinsic value of the company. And then we compare that to their market price and depending on the divergence of those, we buy back. So as long as it's below their intrinsic is higher than market price, we'll be buying back shares and how much it depends on that divergence, right. So you can see our history the last year and a half or so.
We have been returning significantly more than 100% of free cash flow as we do that assessment. But as long as the intrinsic value is higher than the market price, we will buy back shares in the open market. Does that do you have a follow-up?
No, that was his follow-up. We'll go to the next caller please.
We'll go next to Chris Danley with Citigroup. Hi, guys. Your line is open.
Yes. Hey, guys. I have the operator came on. Anyway, my question is on trends over in China. Can you just comment on how the order trends have gone over there over the last 3 months?
Have you seen any stabilization? And then any words you can give us on distribution inventory as well?
Yes, Chris. I would say that as we said in the prepared remarks that really all the regions prepared or performed similarly with the exception of comms equipment that we talked about. All the markets were pretty consistent this quarter. Distributor inventories were up a little more than a day sequentially and to just a little over 4.5 weeks. You have a follow on Chris?
Yes, I do. So a bit of
a longer term question. I'll break with Forum on the call. If we look at your other other revenue, it's like 8% of sales now. And the operating margin has been sort of steadily trending down over the last few years. And I think the most recent quarter, it was 15%.
So it was about 25% below the corporate average. A, why is that operating margin so low? What's going on there? And then B, why not just start shutting down or ending life those products?
Yes. A couple of things on that. Recently, we in this last quarter, we did have a decrease inside of that business within our DLP business, but a lot of that was due to this consignment transition that we have talked about. So that's part of what drove kind of the short term and also maybe some of what the margin issue that you're attributing to. I'd also remind you some of our the acquisition charges, for example, restructuring charges, that's all in that other piece.
Remember, especially on the acquisition charges, that's non cash. So those were that represents cash that went out the door about 8 years ago. So you adjust for that, that maybe gives you a better picture. And lastly, we do have the custom ASIC piece there, a couple of 100,000,000 still left per year there. And over the next 3, 4 2, 3, 4 years that will trend to 0.
The rest of the business should be fairly steady inside of other.
Yes. And the other comment that I would make, Chris, and you can see the seasonality of calculator, not only in the revenues, but you can see it in the operating margin. So almost all of those revenues come for back to school. So, we'll see that at the end of the second quarter and the beginning of third, but obviously the expenses for that business carry out throughout the whole year. So you'll see always you'll see because that revenue comes in, in that short period of time, the operating margins in those two quarters look much nicer.
But and the last comment I'll make and we kind of joke about we should have come up with a more creative name for other, like other good stuff or something like that. So those businesses generate lots of cash for us and they don't take a lot of resources to maintain them. So that's why they remain in the family. With that, I think we've got time for one more caller.
We'll go
next to Joe Moore with Morgan Stanley.
Hi. I
just had a question on the genesis of some of the inventory related weakness you're seeing. We saw last year some of the tightness of things that TI doesn't sell like MLCC capacitors and things like that where the lead times got really inflated. And clearly, that's corrected now. I guess, as you look back on that, do you think that that triggered inventory of TI components to get built? And where do you think we are in sort of that cycle playing its way through in terms of shortages of other components that TI can't control?
Yes. I think Joe that's as you're describing it, that's kind of what drives semiconductor cycles, right? I think that if you think of a customer wherever they are in the world and they start to get notified from their suppliers and our peers that their lead times are going out. Even though ours aren't going out, they may decide to proactively take their inventory position from 6 weeks to 9 weeks over a 90 day period. And that will drive strength in the business overall.
And 90 days later, they decide to go from 9 to 12 weeks of inventory because things look like they're getting even tighter. And then once they get comfortable, it moves back in the other way. So as you watch that play out, we had 10 quarters of very strong growth. Most of that was double digit. I think most people when they looked at that would describe that as above trend and what follows 10 quarters of running above trend is a few quarters that will run below.
So you have a follow on, Joe?
Yes. And I guess, you may have touched on this and I missed
it, but any change in your own lead times over the last 3 months?
Generally, our lead times have remained stable. Even through this through the period of very strong demand, our lead times had remained stable. I think that you can always find pockets just as you can today where we'll work with customers very aggressively to close. And I think another important metric that we track Joe is on time delivery and those have remained very, very high. Other customer service metrics remain very high.
So meaning that if someone does come and order products that at lead time, are we shipping them to the commitments that we've got and those remained high through that whole cycle. And some of the things that we're doing like building inventory of low volume parts during this peak period of weaker demand, we're doing that to ensure that we can continue to deliver product consistently to customers. That's really what's driving that. And that and the visibility that we get through programs like consignment, kind of the combination of those things. We're actually doing other things around inventory positions and order entry.
And we've summarized that as really the belief that there's strategic value in owning and controlling that inventory and keeping it on our balance sheet. So with that, I will turn it over to Rafael to wrap things up for us.
All right. Thanks, Dave. Let me finish with a few comments on key items for you to remember. First, as we mentioned last quarter, we will stay focused on what will make us stronger long term and diligent in the short term. 2nd, we will remain focused on analog and embedded, the best products and industrial and automotive, the best markets and third, we will continue to be disciplined in executing our capital management strategy and remain committed to returning free cash flow to the owners of the company.
Thank you and good night.
That does conclude today's conference. We thank you for your