Good day, and welcome to the Texas Instruments Second Quarter 2017 Earnings Release Conference Call. Today's conference is being recorded. At this I would like to turn the conference over to Dave Paul. Please go ahead, sir.
Good afternoon, and thank you for joining our Q2 '17 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.
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 in the Q2 increased 13% from a year ago. Demand from our products continued to be strong in the automotive market and continued to strengthen in the industrial market.
In our core businesses, analog revenue grew 18% and embedded processing revenue grew 15% compared with the same quarter a year ago. Operating margin increased in both businesses. Earnings per share were $1.03 With that backdrop, I'll now provide details on our performance, which we believe continues to be representative of the ongoing strength of TI's business model. In the second quarter, our cash flow share basis is most important to maximizing shareholder value in the long term. Free cash flow for the trailing 12 month period was $4,000,000,000 and free cash flow margin was 28.5 percent of revenue.
We continue to benefit from our improved product portfolio that is long lived and diverse and the efficiencies of our manufacturing strategy, the latter of which includes our growing 300 millimeter analog output. We believe that free cash flow will only be valued if it is productively invested in the business or return to owners. For the trailing 12 month period, we returned $4,100,000,000 of cash to owners through a combination of dividends and stock repurchases. From a year ago, analog revenue increased 18 primarily due to growth in power and signal chain, each of which grew about the same amount. High volume also grew.
Embedded processing revenue increased by 15% from a year ago due to growth in both product lines, processors and connected microcontrollers by about the same amount. In our other segment, revenue declined $60,000,000 from a year ago, primarily due to custom ASIC and the move of royalties to OI and E beginning in the Q1 of 2017. Now I'll provide some insight into this quarter's revenue performance by end markets versus a year ago. Automotive demand remained strong with most sectors growing double digit. Industrial demand continued to strengthen with broad based growth as most sectors grew double digits.
Personal electronics grew, while results vary by customer. Lastly, communications equipment grew and enterprise systems was about even. We continue to focus our strategy on the industrial and automotive market, which are the end markets where we've been allocating our capital and driving initiatives. This is based on our belief that industrial and automotive will be the fastest growing semiconductor markets due to their increasing semiconductor content and that they'll 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.
Rafael?
Thanks, Dave, and good afternoon, everyone. Gross profit in the quarter was $2,370,000,000 or 64.3 percent of revenue. From a year ago, gross profit increased primarily due to higher revenue. Gross profit margin increased 300 basis points. Operating expenses in the quarter were $812,000,000 And on a trailing 12 month basis, they were 22.3 percent of revenue, which is in the lower half of our model.
Over the last 12 months, we have invested $1,400,000,000 in R and D, an important element of our capital allocation. Acquisition charges were $79,000,000 all of which was the ongoing amortization of intangibles, which is a noncash expense. Operating profit was $1,480,000,000 or 40.1 percent of revenue. Operating profit was up 31% from the year ago quarter. Operating margin for analog was 44.7%, up from 38.2 percent a year ago and for embedded processing was 31.2%, up from 25.4% 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 2nd quarter was 1.0 $6,000,000,000 or $1.03 per share, which included a $28,000,000 discrete tax benefit, about what we expected. Let me now comment on our capital management results, starting with our cash generation. Cash flow from operations was $970,000,000 in the quarter. You will see that while net income was significantly higher than a year ago, that increase was more than offset by a higher tax payment that was driven by our outlook for higher profitability this year.
Inventory days were 133, even with a year ago and within our range. Capital expenditures were $151,000,000 in the quarter. On a trailing 12 month basis, cash flow from operations was $4,560,000,000 Trailing 12 month capital expenditures were $527,000,000 or about 4% of revenue. As a reminder, our long term expectation for capital expenditures is about 4% of revenue. Free cash flow for the past 12 months was $4,040,000,000 or 28.5 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. In the Q2, we paid $498,000,000 in dividends and repurchased $650,000,000 of our stock for a total return of $1,150,000,000 Total cash returned to owners in the past 12 months was $4,050,000,000 Over the last 12 months, we paid $1,880,000,000 in dividends. Outstanding share count was reduced by 1.2% over the past 12 months and has been reduced by 42% since the end of 2004 when we initiated a program designed to reduce our share count. This combined returns of dividends and repurchases demonstrate our confidence in our business model and commitment to return excess cash to owners.
In the quarter, we retired $375,000,000 of debt, and year to date, we have retired $625,000,000 In addition, we issued $600,000,000 of debt in 2 tranches, $300,000,000 each in 4 year and 7 year notes. This leaves total debt of 3 point $6,000,000,000 with a weighted average coupon rate of 1.93%. Our cash management and tax practices are fundamental to our commitment to return cash. We ended the quarter with $2,980,000,000 of cash and short term investments, with our U. S.
Entity owning about 80% of our cash. This onshore cash is readily available for multiple uses. Turning to our outlook. For the Q3, we expect revenue in the range of $3,740,000,000 to $4,060,000,000 and earnings per share to be in the range of $1.04 to $1.18 which includes an estimated $20,000,000 discrete tax benefit. Our annual operating tax rate for 2017 is now about 31% compared with our prior expectation of about 30% due to our outlook for higher profitability this year.
This annual operating tax rate assume no discrete tax no discrete items and is what you will need to use as a starting point for your longer term model. Next, we are assuming discrete tax items of about $20,000,000 $10,000,000 in the 3rd 4th quarters of 2017, respectively. Therefore, the effective tax rate, which include discrete tax items, translates to about 29% 30% in the 3rd and 4th quarters, respectively. These are the quarterly effective tax rates you should use for your 2017 models. I will also remind analysts who are beginning to work the 2018 models that we would expect the discrete tax benefit in 1Q '18 to be higher than what we are projecting for the 3rd and 4th quarters of 2017, but lower than 1Q 'seventeen.
To estimate the 2018 annual operating tax rate, start with 2017 PBT tax at 31%, then apply a 35% tax rate to any incremental profit then model discrete tax benefits by quarter, noting that Q1 is expected to be higher than the others. 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 2nd quarter 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 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?
We'll take our first question from Ross Seymore with Deutsche Bank.
This is Gerald on behalf of Ross. Just one question for me. You detailed how your end markets changed year on year. Could you provide some details on how you estimate they changed quarter on quarter?
Sure, Gerald.
For automotive, basically it increased sequentially with all sectors growing. Industrial, again, we saw a very broad based growth across the sectors, and overall, it also increased. Personal electronics increased with most sectors growing. Communications equipment was about even sequentially in enterprise systems also grew. Do you have a follow on?
Yes, sure.
So you talked in
the past about R and D potentially being a little bit elevated near term. Now you guys came in
a slightly below our model for the quarter. How much longer could R and
D be elevated in order to invest in the business?
I'll take that. First, I would point out that I know you're asking about R and D, but let me address it from an OpEx standpoint. We look at OpEx as a model and our model is 20% to be between 20% 30% of revenue and in stable times to be at the lower half of that. In fact, that's where we've been in the last 2.5 years or so, 23% to 22%. Now we're running at 22% of revenue.
And again, in stable times, we think we can operate there. Now inside of that, there are both in R and D and actually in SG and A, we have various investments that are strengthening our competitive advantages. So on the R and D front, we continue to focus on industrial automotive to continue to broaden our portfolio. On the SG and A side, we're investing on to increase the reach of our channels, ti.com in particular. So we are thinking that we're going to continue to make those investments to strengthen the company.
Okay, great. And we'll go to our next caller, please.
We'll go now to Vivek Arya with Bank of America Merrill
Hi, thanks. This is Adam Gonzalez on for Vivek. First question, maybe could you contrast autos demand now versus say maybe 6 months ago? And industrial is an even larger market for you guys and even though auto tends to get all the attention. Just wondering do they correlate at all?
Can industrial offset any potential demand fluctuations in autos? Thanks. And I have a follow-up.
Sure. Yes. So the strength that we've seen inside of automotive is something that we've seen for probably greater than 4 years now. So and I would attribute that to our early focus on that market, the breadth of our technologies and really just the overall diversity of our position. So we've got 5 sectors inside of automotive that we're investing in.
So that includes infotainment, safety systems, ADAS or advanced driver assist systems, powertrain, which includes EV and hybrid and body electronics and lighting. So we're seeing good growth across those, we call them, sectors that sit inside of the automotive market And really also diversity across subsystem suppliers, across car companies, across geographical regions. So we feel really good about that. Very similar story inside of industrial, very broad based growth. I won't speak to whether they will be connected through economic cycles or not, but both do have increasing content.
So I'd be a little cautious to think that, that increasing content could offset a correction that we may see in the near term in any one given quarter or even in any one given year. But we believe that there will be more content there over the longer term when you're looking 5 10 years, and that's why our investments are higher there. Do you have a follow on?
Yes, thanks. My second question is more on your free cash flow growth. I'm just curious why if you look at it on a trailing 12 month basis, why free cash flow hasn't grown year on year despite your core analog and embedded business is growing in the low double digit range. And what's the catalyst for maybe getting that back to the higher single digit, maybe low double digit range? Thanks.
Yes. Thanks for this is Rafael. Thanks for a chance to clarify that. First, in any given quarter, you're going to have puts and takes on free cash flow, not line of the P and L, but particularly on the cash flow statement. In this particular quarter and also on a trailing 12 month basis, But what you see there is that we had an increased tax payment in 2Q 'seventeen that was primarily due to our outlook for higher profitability this year.
Okay. And we'll go to the next caller, please.
We'll take our next question from Chris Danely with Bank of America Merrill Lynch excuse me, with Citigroup.
Citi, yes.
Yes. I haven't moved yet. Although that's
You haven't moved yet.
I was there 15 years ago. Maybe they're looking at old transcripts.
Yes. It could be.
As long as I'm not unemployed. I had a question on gross margin. So your revenue is basically back to where it was in the 3rd well, I guess, a little bit higher than it was in the Q3 last year, but the gross margins are 2.30 basis points higher. Can you just kind of give us the reasons why they're higher and then what would be the gross margin drivers going forward?
Yes, sure. I'll be happy to address that. So our gross margins in the second quarter '17 ended at 64.3 percent, and that was 300 basis points higher than the same quarter last year. And that just reflects the quality of our product portfolio as we continue to focus on automotive and industrial, but also the efficiency of our manufacturing strategy. And as you know, we are we have the unique advantage of having a 300 millimeter factory that at the chip level provides a 40% cost advantage.
As of 2016, we had about $2,500,000,000 of our revenue running to 300 millimeter and as we continue to grow the company, in this case, analog in particular, and that growth primarily runs to 300 millimeter, then we're going to accrue that benefit over and over and over, and it's a cumulative benefit that really yields some nice results to the gross margin line, but even more important to the free cash flow and free cash flow per share to the owners of the company. You want to follow on, Chris?
Yes. Another thing that is going on out there, at least some of your competitors have talked about their lead times extending. Is that happening at all at TI?
Chris, I'd describe our lead times as continuing to remain stable. We do have pockets where we've got a process or package supply tightness, but we're aggressively working those. But overall, our lead times continue to remain stable. Okay, thank you. We'll go to the next caller, please.
We'll go next to William Stein with SunTrust.
Great. Thanks for taking my question. Sort of a follow-up to the last one. We've heard quite a bit about shortages for complementary products to semis, in particular, on the passive side. And I'm hoping to find out if TI is seeing any sort of capping of its growth opportunities because customers are certainly not going to order parts from you if they can't get a full kit from all of their suppliers.
Are
you seeing that dynamic play out at all?
Yes. Well, I would say, in general, I'm not sure we could see that if it was there. But I'll just remind you that about 60% of our revenues are on consignment. So we'll we've got no inventory of our products sitting in front of the customers' production line that they own, we may have a position that it fits on our balance sheet. And same thing with distributors.
But we actually do get demand forecast from them, and those oftentimes will be several months out, sometimes even as far as 6 months out. And that doesn't mean that they can't change. And I'd say for that, where we do have very good visibility, we won't see anything unusual going on inside of there, no unusual expedites or cancellations or those types of things. Do you have a follow on?
Yes. Maybe you could comment on order linearity through the quarter and book to bill?
Sure. Yeah. So, again, I'll make the comment that we've got 60% of our revenues on consignment. So there we actually don't have orders or backlogs. We only see that those demand forecasts.
So book to bill is less helpful inside of that. But orders, if you look at through the month, they were strong overall and they did accelerate as we went through the quarter and into the month of June. Book to bill overall was 1.06. So and with that, we'll go to the next caller, please.
We'll take our next question from Harlan Sur with JPMorgan.
Good afternoon. Solid job on the quarterly execution, margin expansion and on the outlook. Clearly, macro demand trends are strong in your end markets, similar to last quarter. I'm just wondering if you could just talk about some of the demand trends from a geographic perspective. I think last quarter, you guys saw year over year growth in most of the geographies.
Wondering if you can just provide us with some details on the June quarter.
Sure, Harlan. Year over year revenue was up in all regions, so Asia, Europe, the U. S. And Japan on a year over year basis, and that was true additionally on a sequential basis. So we saw growth very really across the board there.
And just as a reminder, some know this well and some don't, that we track our revenue on where we ship it. So it's not where that product is ultimately consumed. So we may ship into a car manufacturer or Tier 1 car manufacturer in Europe and that car may end up and be sold in China, as an example. So really, it's not a good look through for end consumption by market. Do you have a follow on?
Yes, I do. Thanks for the color there. So on embedded, strong year over year growth in sales, I think your operating profitability was up something like almost 600 basis points year over year. Is this mostly leverage on the OpEx as you drive revenue growth? Or are there some positive mix benefits?
I'm not sure, for example, if some of your of solutions going into automotive carry like higher gross margin profile.
This is Rafael. What I would tell you is that the driver, the main driver of what you're seeing here is the revenue growth as we have over a number of years now. We refocused our investments in Embedded, and now that's really paying off very nicely. They have Embedded has quite a bit of our investment there is in automotive and industrial, just like it is in analog. And then as we have said, those are the best markets and that is that's yielding very nice result.
Great. Thank you, Harlan.
And we'll
go to our next caller, please.
We'll take our next question from Amit Darianni from RBC Capital Markets.
Thanks a lot. Good afternoon, guys. I guess, two questions for
me as well. First off, historically, you guys
have always talked about this 30 to 40 basis points of share gain, I think on an annual basis. I'm just wondering, given the inflection of R and D higher over the last several quarters now, should we start to think about share gains potentially accelerating or share gains happening in places where the margin profile is much richer? And when do you see those benefits transfer for you guys on the revenue line?
Well, I'll take a shot at that. And if Rafael wants to add something, he can jump in. I would just say that as we look and allocate R and D, we're allocating those to the best projects that we can find, ones that are going to produce, get designed into the most customers, into the most markets and have longevity of revenue. And really, mostly that's about finding better opportunities to invest in than trying to just double the number of products, as an example, that we're doing. But we have found more opportunities to make investments.
It's things as our products live longer and repurpose products into adjacent markets, we found opportunities to be able to do that. So, and I'd say just in general, the quality of the opportunity, share doesn't shift very quickly. And so we're not penciling in an inflection point inside of our revenue. But when we look at our competitive advantages, and I'd just say, just as a reminder, all 4 of those working together and the investments that we're making, and that includes the manufacturing and technology, the most visible one there is the 300 millimeter advantage that we have. The broad product portfolio and just the tens of thousands of products that we've got, the opportunity to sell more products to more customers, the reach of the channel market, including ti.com that Rafael had mentioned earlier as well as our sales force, and then just the diverse and long lived physicians.
All those working together, I think, gives us confidence that in the future that we can continue to gain share in that range of 30 to 40 basis points.
Yes. The only thing I would add is, as you know and we talk about it quite a bit, we've been focusing on automotive and industrial for quite some time now because those are the best markets. They have the highest semiconductor content growth, and we're confident that we'll continue to have that for many years to come. So as of the end of last year, 51% of our revenue was automotive and industrial. And obviously, with the growth we're seeing year to date, that number appears to be ticking up that percentage.
So that number increases and we continue driving performance on those 2 segments, then, mathematically, our overall revenue will do better. Right. Mate, do you have
a follow on?
I do. And hopefully, I don't jinx this trend right now. But last 4 quarters, I think in a row, you guys have been pretty much behind of the revenue guide that you guys initially provide. Is there a change in the way you provide guide or you roll up the revenue forecast? Things have actually ended up at the
high end for 4 quarters in a row or
it just happened to be the case?
It's really the latter. When we look at the out quarter, again, we've got 60% of the revenue that we don't have order patterns to look at, but we can actually see the demand patterns that our customers have. And that can move in both directions pretty quickly, right? So even though we've got great visibility there, things can strengthen or weaken very quickly on us, but we do have very, very good visibility for that 60% of our revenue. And the rest of that, we look at we do look at the backlog, we look at order patterns.
Our sales teams provide forecast as well. So we go through a bottoms up and a tops down approach. So the revenue guidance that we gave you for the Q3 is our best estimate of what we think we'll do. Okay. Thank you, Amit.
And we'll go to the next caller, please.
We'll take our next question from John Pitzer with Credit Suisse.
Yes, good afternoon guys. Congratulations on the strong results and thanks for letting me ask the question. Rafael, I apologize if I missed this, but wondering if you could just talk a little bit about OpEx trends going into the September quarter. Typically, it's a seasonally down quarter for OpEx. I'm just kind of curious, is that how we should be thinking about modeling it this September?
Or are there some incentive or variable bonus offsets that might actually have OpEx flat or up sequentially?
Yes. I'll be happy to add some clarity on that. As you know, we don't guide specifically on OpEx or GPM, any line for a matter other than revenue and EPS. But on OpEx and I should say on OpEx, we focus on the model, the 20% to 30%, and we've been operating on the lower half of that. So we like you guys to think about it that way.
I would tell you though, if we had anything unusual going on in OpEx, we would point that out, second to third, and we do not. And we also don't have anything like vacation or compensation adjustments that sometimes or we do see 4th to 1st, for example, we do not have that going on in the second to third position. Yes. And just
to add to that, when you look at our history, we've had some restructurings in the last few third quarters that you may have seen that transition. But as Rafael stated, there's not a seasonal impact that you see inside of Q3 typically. Do you have a follow on, John?
Dave, I just wonder if you
could just talk a little bit more about what you're seeing in the auto market because clearly over the last several years, it's been one of the better semis. But there have been some sort of mix of data points, SAAR is decelerating, you've seen some auto manufacturers actually cutting forecast into the back half of the year. So I guess, how do you think about kind of SAR unit growth versus content growth? And how's the visibility there? And are you seeing things that others might have highlighted last week on their conference call?
Yes. So the one thing that's been clear, our business has grown very strong for 4 years plus now. So and that's really due to the early investments that we had made inside of this market and we continue to make. And again, we're trying to ensure that we're making those investments as broad as we can. So we're not dependent on one particular technology or one type of portion of the demand that's increasing.
And clearly, the I think it's well known that SC content has grown faster inside of autos. And jeez, if you just go down into a showroom, you can see that pretty clearly in any car today versus even just a few years ago. So we're confident that that trend will continue. And we've also seen the announcements, like you've mentioned, that some car companies have reduced their build plans. We certainly continue to monitor those markets overall.
But we're confident in our long term position there, and we'll continue to make those investments. Okay, thank you, John. And we'll go to the next caller, please.
We'll go now to Ambrish Srivastava with BMO.
Hi, guys.
Hi, Ambrish. Hi.
Hey, sorry about that straddling 2 calls and I apologize if this has been answered already. In the reported quarter, where did the upside come versus your expectations going into the quarter?
Yes, Ambrish, it was things were pretty strong really across the board. So we saw growth really in most markets, most geographies and even a lot of the subsectors inside of automotive and industrial.
I would just add 3 quarters of our growth came from industrial and automotive. So that just shows you how strong those were.
Okay. And then yes, I did, Dave. And this is you're kind enough always when we have this topic comes up every couple of quarters. And not surprisingly, we are in economic expansion for a while now, top of the cycle. You have metrics that you look at, which are cancellations, booking, and so you share them quite frequently with us.
So where are we? Where is TI's business on those metrics, Dave? Thank
you. Yes. So I would say that if you look again inside of distribution, our inventory there remains at about 4 weeks. It's actually down sequentially and down from a year ago. Our visibility into customers' inventories, of course, vary depending on if we're on consignment or not.
So with our consigned OEMs, we're not seeing anything that's unusual there, such as that would suggest that we have an issue. And of course, our visibility into inventory beyond what customers manufacture and aspirations is very low overall. So again, cancellations remain low, lead times continue to remain steady. So all of those metrics, I think, really are very similar to what we saw 90 days ago. So thank you, Ambrish.
And I think we have time for one more call.
We'll go next to Craig Ellis with Riley Financial.
Thanks for sneaking me in guys. Appreciate it. Congratulations on the nice execution. I wanted to come back on the gross margin point. So congratulations on getting to 64% in the quarter.
When I look at the
the
5 or 6 quarters, not unprecedented, but looked like a step up. Is that something we should interpret as being more sustainable or were there some either mix items or other lumpy 300 millimeter transition items that contributed to the atypical surge in the quarter?
Yes. This is Rafael. What I would tell you is that any given quarter, the fall throughs would be a little different. In a company the size of ours, there are just a lot of puts and takes inside this big P and L. The more important thing to remember is that we have some fundamental structural drivers that are have increased our GPM percent, and we think we're going to continue increasing our GPM percent for the foreseeable future.
And those are the quality of the portfolio as we continue to focus on the best markets, automotive and industrial and the diversity and positions long lived positions that we get with those where we invest R and D today and we get the revenue for decades to come. And then the other piece is 300 millimeter analog. As I stated earlier, that is 40% more cost efficient than 200 millimeter. And that accrues, meaning you start one part on that and then the next part, you start it on 300 millimeter and the third part and the 4th part and next thing you know, a bigger percentage of your company is running on 300 millimeter and it was only 30% as of 2016, the 30% of the capacity that we have on 300 was used. So we have ample room to continue growing 300 millimeter and accrued benefit to the company.
Got it. That's a good message.
Do you have a follow-up? Yes.
Thank you. Just regarding the end market color you provided in response to an earlier question, Dave. Com sounded kind of flattish quarter on quarter. Can you just refresh our memory in terms of where the company stands with respect to how it's looking at comps from a strategic standpoint and where you see demand as we look around and look at 4 gs infrastructure investments being made globally? Thank you.
Sure. Yes. So comms equipment is 13% of our total revenue. The wireless infrastructure
will be
a sector inside of that, which tends to take a lot of the calls. It's more than half of that end market by itself. So probably somewhere in the mid single digits as a percentage of our revenue. And there, I think when we look at incremental dollars of where we're investing, if I refer you back to our capital management call that we gave back in February, we talked about the fact that we wanted to increase incrementally dollars in both the industrial and automotive markets because that's where we believe the growth will be. With Communications Equipment, view inside of analog, they're actually up because of some of the complexity that's being developed inside of the radio.
So we do believe that, that market will continue to provide great opportunities for us for a very long period of time, but we just don't believe that there's going to be significant growth. We don't know if any carriers that want to take up their CapEx over the next 5 10 years over a longer period of time. So thank you for that question, Craig, and thank you all for joining us tonight. A replay of this call will be available on our website. Good evening.
This does conclude today's conference. Thank you for your participation. You may now disconnect.