Good day, everyone, and welcome to the Texas Instruments Third Quarter 2017 Earnings Release Conference Call. Today's conference is being recorded. At this time, I would like to turn the conference over to Mr. Dave Paugh. Please go ahead sir.
Good afternoon and thank you for joining our Q3 2017 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 atti.com/ir. This call is being broadcast live over the web and can be accessed through our website. A replay will be available through the web.
This call will include forward looking statements that involve risks and uncertainties 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. I'll start with a quick summary of our financial results. Revenue for the Q3 increased 12% from a year ago. Demand for our products continued to be strong in the industrial and automotive market. In our core businesses, analog revenue grew 16% and embedded processing revenue grew 17% compared with the same quarter a year ago.
Operating margins increased in both businesses. Earnings per share was $1.26 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 3rd quarter, our cash flow from operations was $1,700,000,000 We believe that free cash flow growth, especially on a per share basis is most important to maximizing shareholder value in the long term. Free cash flow for the trailing 12 month period was $4,200,000,000 and free cash flow margin was 29.0 percent of revenue. We continue to benefit from our improved product portfolio that is 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 $4,300,000,000 of cash to owners through a combination of dividends and stock repurchases. In September, we announced we would increase our dividend by 24% and also increased our share repurchase authorizations by $6,000,000,000 which together reflect our commitment to return all our free cash flow to our owners. I'll now provide some details by segment. From a year ago, analog revenue increased 16% due to growth in power and signal chain.
High volume was about even. Embedded processing revenue increased by 17% from a year ago due to growth in both product lines, processors and connected microcontrollers. In our other segment, revenue declined $70,000,000 from a year ago, primarily due to custom ASIC and the move of royalties to OI and E, which began in the Q1 of 2017. Now I'll provide some insight into this quarter's revenue performance by end markets versus a year ago. Industrial demand remained strong with broad based growth as most sectors grew double digits.
Automotive demand remained strong with most sectors growing double digits. Personal Electronics was about even with results varying by customer. Communications Equipment grew while results varied by customer. And finally, Enterprise Systems grew primarily due to servers. 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 a belief that industrial and automotive will be the fastest growing semiconductor markets due to their increasing semiconductor content and that they provide diversity and longevity of products, which translates to a high terminal value of the portfolio. Rafael will now review profitability, capital management and our outlook.
Thanks, Dave, and good afternoon, everyone. Gross profit in the quarter was $2,660,000,000 or 64.5 percent of revenue. From a year ago, gross profit increased primarily due to higher revenue. Gross profit margin increased 240 basis points. Operating expenses in the quarter were $787,000,000 and on a trailing 12 month basis were 22% of revenue, within our range of expectations.
Over the last 12 months, we have invested $1,500,000,000 in R and D, an important element of our capital allocation. Acquisition charges were $80,000,000 all of which was the ongoing amortization of intangibles, which is a non cash expense. Operating profit was $1,790,000,000 or 43.4 percent of revenue. Operating profit was up 27% from the year ago quarter. Operating margin for analog was 47%, up from 41.2 percent a year ago and for embedded processing was 34.9%, up from 28.2% a year ago.
Our focused investments on the best sustainable growth opportunities with differentiated positions enable both businesses to continue to contribute nicely to free cash flow growth. Net income in the 3rd quarter was $1,290,000,000 or $1.26 per share. This included a 38 $1,000,000 discrete tax benefit that was $18,000,000 higher than our original guidance for the quarter, adding about $0.02 to earnings per share. Let me now comment on our capital management results, starting with our cash generation. Cash flow from operations was $1,720,000,000 in the quarter, up 18% from a year ago.
Capital expenditures were $186,000,000 in the quarter. On a trailing 12 month basis, cash flow from operations was 4 point $82,000,000,000 Trailing 12 month capital expenditures were $574,000,000 or about 4% of revenue, consistent with our long term expectation. Free cash flow for the past 12 months was $4,250,000,000 or 29 percent of revenue. Our cash flow reflects the strength of our business model. As we have said, we believe free cash flow growth, especially on a per share basis, is most important to maximizing shareholder value in the long term and will be valued only if it is productively invested in the business or returned to owners.
As Dave mentioned already, in September, we announced we would increase our dividend by 24% and also increase our share repurchase authorizations by $6,000,000,000 Our quarterly dividend went from $0.50 per share to $0.62 per share or $2.48 annualized. This is our 14th consecutive year of dividend increases. And over the past 5 years, we have increased the dividend by a compounded average rate of 24%. Our total outstanding repurchase authorization was about $10,000,000,000
at the
end of third quarter. For the Q3, we paid $495,000,000 in dividends and repurchased $650,000,000 of our stock for a total return of $1,150,000,000 in the 3rd quarter. Over the last 12 months, we paid $1,990,000,000 in dividends or about 47% of free cash flow, evidence of their sustainability. Outstanding share count was reduced by 1.5% over the past 12 months and has been reduced by 43% since the end of 2004, when we initiated a program designed to reduce our share count. Total cash return to owners in the past 12 months was $4,320,000,000 This combined returns of dividends and repurchases and a recent announcement to increase the dividend and share repurchase authorization demonstrate our confidence in our business model and our commitment to return excess cash to our owners.
Our balance sheet remains strong with $3,440,000,000 of cash and short term investments at the end of the 3rd quarter, 76% of which was owned by the company's U. S. Entities. This is consistent with our long term objective to have onshore cash readily available for multiple uses. Inventory days were 118, up one day from a year ago and within our expected range.
Our total debt is unchanged at $3,600,000,000 with a weighted average coupon rate of 1.93%. Turning to our outlook. For the Q4, we expect revenue in the range of $3,570,000,000
to $3,870,000,000
and earnings per share in the range of $1.01 to $1.15 which includes an estimated $20,000,000 discrete tax benefit. Our expected annual operating tax rate for 2017 continues to be about 31%. For Q4 2017, we expect our effective tax rate to be about 29%, which includes about $20,000,000 of discrete tax items, up from our previous guidance of $10,000,000 This is the rate you should use for your model for Q4. For 2018, we're providing you with our quarterly tax rate expectations for both the operating and effective tax rates. You can find this detail on our Investor Relations website under the Financial Summary Data section.
Now to wrap up, we remain focused on growing free cash flow per share over the long term and investing to strengthen our competitive advantages. We believe our Q3 results continue to demonstrate our progress. 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 the opportunity to ask questions, please limit yourself to a single question. After our response, we'll provide you an opportunity for additional follow-up. Rebecca?
Thank you. Ladies and gentlemen, a question and answer session will be conducted electronically. And first, we'll go to Vivek Aryo at Bank of America Merrill Lynch.
Hi, thanks. This is Adam Gonzalez on for Vivek. So my first question is last year you guided Q4 pretty conservatively and ended up reporting growth that was about twice as fast. How would you contrast the demand environment this year versus last year? The reason why I bring this up is because your Q4 outlook down 10% seems to be below seasonal.
And I'm wondering if that outlook really holds true, what are the areas of weakness that you're seeing that's driving this? Thanks.
Yeah. So I think that if you look at our guidance, I'd say that we're not indicating that anything is atypical that's occurring. And I'd just remind you that whenever we've had something that's been unusual, whether that's been by market or by sector or sometimes even by customer. We've been pretty clear on that and would share it and we have got nothing to share. So I just point out that if you look at the range of our guidance that's going to vary and can comprehend several different scenarios.
And at the midpoint on a year on year basis will grow about 9%, which we consider to be pretty robust. So do you have a follow on?
Yes. I guess looking at your free cash flow per share growth, the last couple of quarters it's kind of trended below the longer term 8% to 10% that you traditionally see. I'm wondering why that is and what are the catalysts to get that back up to where it has been? Thanks.
Yeah. Adam, thanks for giving me opportunity to talk about that. On free cash flow, it grew 4% on a trailing 12 month basis and that is compared to a higher number for revenue on the same basis. And the difference is higher working capital, particularly accounts receivables and tax payments. If you look at the accounts receivable from 3Q 2015 to 3Q 2016 that actually drained whereas from 3Q 2016 to 3Q 2017 it built.
So that is a source of cash in one case and a use of cash in another case. But and in the case of the tax payments, we had a higher disproportionately higher tax payments in the most recent comparison versus the previous trailing 12 month comparison. Great.
Thank you, Adam. Let's tell Vivek we said hello. And we'll go to the next caller please.
Next we'll hear from Hal and Sur with JPMorgan.
Good afternoon and solid job on the quarterly execution, the free cash flow generation and the capital return. Clearly, the demand trends are pretty strong in the markets that you serve. Maybe you could just talk about the demand trends from a geographical perspective. I think last quarter you saw year over year growth in most geographies. I'm just wondering if the strength continues to be broad based?
Yes, Harlan. I would say that certainly the demand was broad based. If you look across our product lines, we've got 65 to 70 different product lines and the demand was very strong across those as well as strong across the region. So we had revenue up in 3 of the 4 regions year on year in Europe, Asia and the U. S.
And it was about even in Japan. So and again, I just always remind that when we give regional color that's where we ship the product, that's what we can measure. Where that product actually ends up from a regional standpoint, we really don't have visibility into. You have a follow on?
Yes. Thanks for the color there. On the OpEx front, great operating leverage. You drove 12 percent sequential growth in sales, but your OpEx declined by 3%. So you guys are driving some serious leverage here.
The OpEx as a percent of sales is actually just below your target range. And so I guess the question is what drove the sequential decline in the OpEx? And how should we think about the OpEx profile just over the next few quarters?
Yeah. I'll take that. For OpEx, we think of that in terms of from a model standpoint, we think of it as a percent of revenue on a trailing 12 month basis. And for the last couple of years, we've actually been running at about 23%. And in the current trailing 12 months, we're about 22% of revenue.
So we have said that in stable environment, which we are, we can run-in the bottom half of our expectations of 20% to 25%. So we've been running at about 22%. So that's well within that. Now of course OpEx to us OpEx are investments. And obviously that goes for R and D.
But even inside of G and A, we think of a large portion there as investments. So in R and D, of course, we're focusing on industrial automotive, because those are the best markets where the semiconductor growth is happening. But on the G and A front, we have many investments there on ti. Com and demand creation just to continue building on our reach of channels reach of markets competitive advantage that we have talked about. Before we go to the next call, I'd like to just make a comment on the previous question on working capital.
I want to stress that while our accounts receivables increased in that last comparison, the day sales outstanding actually decreased by one day. So it's a 34. So that just goes to show you the how healthy the account receivable balance is. I wanted just to clarify that.
Okay. Great. Thank you, Harlan. And we'll go to next caller please.
From Deutsche Bank, Ross Seymore.
Hey, this is Jerry Long on behalf of Ross. Thanks for letting us assess the question. Just asking about the general end markets here. Could you provide some end market detail in terms of how they trended quarter on quarter in addition to year on year?
Gerald, if you look at industrial, it increased with most sectors growing. And again, we've got 14 secondtors there, so fairly broad based. Automotive increased with most sectors growing. Personal electronics increased as one would expect as you move into the holiday builds with most sectors we're growing there. Commons equipment was even and enterprise systems grew due to both servers and projectors.
Do you have a follow on?
Yes. Just a question on the report here. So your September quarter revenues exceeded the high end of your prior guidance and the first time about a year that happened. However, gross margins expanded just 20 basis points. I think we were expecting more.
So given the magnitude of the revenue beat, why didn't higher revenues result in more than 20 basis points of gross margin fall through?
Yes. What I would tell you is that generally what we suggest or what we recommend to analysts and investors to think about our pull through in the 70% to 75% range. But that is over the long haul over a relatively long amount of time. In any one quarter that pull through can be a little different. Now for example, in the comparison versus a year ago, which arguably I would argue is more relevant and it has more time obviously in between.
That was close to an 85% fall through, right? The increase in gross margin was 240 basis points, just as an example as a comparison to the sequential basis.
Okay. Thank you, Jared. We'll go to the next caller please.
We'll go to John Pitzer with Credit Suisse.
Yeah. Good afternoon, guys. Congratulations on the strong results. I guess my first question, I'm just kind of curious when you look at year over year growth now for the core business Analog and Embedded, you've had very healthy sort of double digit year over year growth. I'm wondering if you could kind of comment to what extent you think that share gains to what extent you think that is just easy compares to what extent you think that might be a little bit of overheating relative to customer order activity.
And you did a fantastic job on your own balance sheet kind of managing inventories. I'm wondering if you could give us some color around customer inventory levels.
Yes. So John, I think that if you look at general market conditions, they're similar to 90 days ago and certainly continue to remain strong. However, I think it's still yet to be seen how long that will extend over how long of a period of time. So we've got no indications of inventories growing or double ordering. And like I pointed out last quarter, history suggests we never really see that those types of things ahead of time.
But I think again it's important to qualify what we can see. So we've got really good visibility into our distributors' inventory and that remains at about 4 weeks. It's even both sequentially and year on year. Our visibility in customer inventories will vary depending if we're on consignment or not. So for our consignment OEMs, we hold that inventory on our balance sheet.
And we don't see any unusual signals or other things like expedites that would suggest that there's issues inside of that. And our visibility of course in inventory beyond that and down our customers' channels, we just can't see that of course. So we just remain focused as we have for a long time focusing on both our internal manufacturing and internal inventory strategies. And we're focused on trying to keep lead time steady, which they have delivery metrics really high, because that's what gives customers confidence that they can get the product when they need it. So you have a follow on John?
Yes, I do for Rafael. As I think Carlin mentioned you guys did a fantastic job on operating leverage in the quarter. When you look at absolute operating profits though, there's still a pretty meaningful gap between the embedded business and the analog business. And I think you've commented in the past that theoretically there's no reason why that gap can't close over time. I'm kind of curious when I look sequentially, the operating leverage in the embedded business was particularly I think the fall through was almost 86% Q on Q.
I'm just kind of curious have we reached a scale point in that business where we would expect follow through to be higher from here on out and that gap to close more quickly? Any comments around that would be helpful.
Sure. Well, your point, the profitability of that business has in fact improved significantly. On a year on year basis, profit for operation is up 673 basis points. But at the end of the day, the main objective here is to grow free cash flow. We think that is we believe that is what really drives value for the owners of the company.
So and then return all that free cash flow to the owners. So we're not particularly focused on any one of those percentages, because there are many ways to drive that free cash flow. And one of them is expanding the margins. But then the other one is growing the top line at the same margin, right? So that's the key message that we're the key objective that we're trying to achieve.
Okay. Thank you, John. We'll go to the next caller please.
Now we'll come from Stacy Rasgon with Bernstein.
Hi, there. This is James Williams and Shirley Cohen for Stacy. Sorry if we missed it, but we were just wondering what a book to bill was for the quarter?
Book to bill was
It was 1.0. 1.0, yes. 1.0. And again, we always we give that number. I would say that always be cautious with it because we've got 60% of our revenue that's on consignment that we don't carry any backlog or don't get any orders in advance.
So that's part of the reason why we don't focus on it. Do you have a follow on?
Yes. I guess, we were just hoping for some more color on the OpEx and why it was a bit light and just how you see that trajectory going forward?
Well, it came in about as expected. So I wouldn't characterize it as a bit light. And as I mentioned earlier on an earlier question on a trailing 12 month basis, which is how we think is appropriate to look at is coming at 22%. I think in the last couple of years, it's been at 23%. So it's trended a little down in over the last few years, but it's well within our the bottom half of our expectations of 20% to 25%, which is our expectations when things are stable, which they are now.
Okay.
Thank you. We'll go to our next caller please.
TJ Muse with Evercore.
Yeah. Good afternoon. Thank you for taking my question. I guess first question forward look outlook on gross margins. Can you talk about what you're expecting mix wise and whether that fits in with an incremental gross margin around 70% or there kind of puts and takes around that?
On gross margins, what we have said before and we'll continue to say really hasn't changed our guidance on that is that our general expectation is to our revenue to fall through at about 70% to 75% and that's over the long haul, right? Not in any 1 quarter. So you should think about it that way. And as we continue to grow the top line driven by our investments in analog embedded from a product standpoint and industrial automotive from an end market standpoint, we expect to continue gaining share and that additional revenue to fall through at above those rates. Follow on, C.
J?
Yes, please. Could you provide an update on where you are on the 300 millimeter? Interested in terms of utilization rates as well as some of the work you're doing on the back end and other fronts to drive even higher incremental margins? Thanks.
Yes, you bet. I think, as C. J. Asked that question, there are a couple of callers on the line and listening that aren't familiar. But we've got 4 competitive advantages, the first of which is our manufacturing and technology.
And I think the 300 millimeter is a good example of that strength. The other three just quickly are the breadth of the product portfolio, our channel advantages, which includes the size of our sales force in ti.com. And then just the diversity and longevity of our across markets and sectors and customers and products, which I think leads for investors high confidence and a high terminal value of that product portfolio. But why 300 millimeter matters is that we've got a structural cost advantage. So with that larger wafer size, we hit 40% lower cost on the chip when we manufacture that.
And most chips in the industry are built on 200 millimeters. So we started this year, we had about 25% of our 300 millimeter capacity footprint utilized. Essentially most of the analog growth this year and as we have seen for several years is supported by 300 millimeter. We'll actually give an update to that in our February capital management call on what the precise numbers are. But that revenue continues to grow on 300 millimeter and we continue to see the benefit.
So thank you for that question, C. J. And we'll go to the next caller please.
William Stein with SunTrust.
Great. Thanks for taking my question. You've had for several quarters strength in automotive and industrial and that continued to meet in the quarter you just reported. In the outlook, I'm wondering if there's any change in terms of the relative strengths of your expected results by end market?
Yes. Well, as you know, we don't provide color below the top line. But certainly, if there was anything significant there, we'd call out and I can tell you there isn't anything significant. And I think if you look at that strength inside of industrial and automotive, I think as we look at Q3 as it has for some time, that strength has been very broad based. So we've got 14 secondtors inside of industrial.
Most of those have been growing double digits some time. We continue to direct our investments across those 14. So it's a very intentional investment and return. Same thing in automotive. So we've got diversity across 5 different sectors.
All 5 of those are contributing to growth. And that diversity is across the product lines, it's across geographies. So we feel really good about that strength.
Do you
have a follow on?
Thanks, Dave. I do one more. We're aware that there's been a change in compensation to distributors. It's been pretty well publicized I think relative to paying them for demand so called demand creation. I'm wondering if there are still benefits to be made by TI, if there was anything squeezed out in the quarter just reported or anything that's still on the come either in December or beyond from that change in sort of how you work with distribution?
Thank you.
Yes. So, again, we don't we no longer do pay for demand creation as you indicated. Distributors, of course will continue to play a role in order fulfillment for our customers. So those relationships have been evolving, especially as the reach of our channel advantages continues to strengthen. So as I mentioned earlier even in this call that that is a unique advantage and includes both ti.com and the size and scale of our sales in AppStream.
So those changes were began implementation from 3 years ago for any accounts where we had direct TI resources that represented about 80% of the TAM. And then later last year, we implemented changes with the remaining 20%. So I'd say a good portion of that is worked through. And we won't be it's not significant enough that it's going to make any of these earnings conference calls. So we just continue to invest in our demand creation activities and we feel really good about the results that that is producing.
So with that, I think we've got time for one more call. Operator?
And then I'll come from Amit Shaw with Nomura and Smith.
Great. Hey, Dave. How are you? Great.
I just I was trying to ask about the revenue growth. If you look at sort of growth over the last 12 months, I mean semiconductor demand, it just seems like there's a resurgence here. We certainly see that looking at the performance of your analog and embedded businesses. And that is more than just it's coming from more than just consumer confidence and how they're managing inventories. And I'm just curious if you look at the performance of analog and embedded over the last 12 months, has it changed your outlook for the long term growth of the company?
Yeah. I don't think so, Ramead. I think that we're fortunate that we've got investments in capacity and we've got a product portfolio that is very, very diverse. It's rich in automotive and industrial, which are the best growing parts of the market. And I don't think that that changes our outlook over the long term.
And the best signal that we get from customers are orders. So we're able to respond to those as things continue to strengthen and strengthen from here. And if they go the other way, we've got a playbook ready to go if that were to happen. So you have a follow on?
Yes. I mean you talked about automotive. And one of the things that we see is that this shift to electric vehicles has a lot of momentum and that with electric powertrains, we could see demand for power semiconductors accelerate. And I'm just curious how you guys think about the opportunity in electric vehicles. Is that a sub segment that TI is uniquely positioned for?
Yeah. I think that our investments in automotive are really directed across 5 different sectors. So powertrain is one of them, which is primarily EV. So but if you look at the other spaces like infotainment, cluster, passive safety, ADAS or advanced driver assist systems and body electronics and lighting, we're very, very intentionally directing our investments across those areas. So certainly as EVs become a higher mix of units that are sold on an annual basis, we'll benefit from that.
But we're not dependent on it. And I think if I bring you back to our 4 industry marches forward to economists for as the industry marches forward to autonomous driving or the mix of EVs. Those are things we'll benefit from, but our business model isn't dependent on them. So, we're real excited with the diversity of design wins that we have there. And we think we've got a lot of runway there as well as inside of industrial.
So with that, we'll wrap up tonight's call. And thank you all for joining us. A replay of this call is available on our website. Good evening.
Ladies and gentlemen, that does conclude today's presentation. And we do thank everyone for your participation. And you may now disconnect.