Texas Instruments Management Discusses Q3 2013 Results - Earnings Call Transcript

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Texas Instruments (TXN) Q3 2013 Earnings Call October 21, 2013 5:30 PM ET

Executives

Ron Slaymaker - Vice President of Investor Relations

Kevin P. March - Chief Financial Officer, Chief Accounting Officer and Senior Vice President

Analysts

John W. Pitzer - Crédit Suisse AG, Research Division

Blayne Curtis - Barclays Capital, Research Division

Doug Freedman - RBC Capital Markets, LLC, Research Division

Stephen Chin - UBS Investment Bank, Research Division

Tristan Gerra - Robert W. Baird & Co. Incorporated, Research Division

Stacy A. Rasgon - Sanford C. Bernstein & Co., LLC., Research Division

Vivek Arya - BofA Merrill Lynch, Research Division

Glen Yeung - Citigroup Inc, Research Division

Jonathan Steven Smigie - Raymond James & Associates, Inc., Research Division

David Wong

Tore Svanberg - Stifel, Nicolaus & Co., Inc., Research Division

Patrick Wang - Evercore Partners Inc., Research Division

Ambrish Srivastava - BMO Capital Markets U.S.

James Covello - Goldman Sachs Group Inc., Research Division

Ross Seymore - Deutsche Bank AG, Research Division

Operator

Good day, and welcome to the Texas Instruments Third Quarter 2013 Earnings Conference call. At this time, I'd like to turn the conference over to Mr. Ron Slaymaker. Please go ahead, sir.

Ron Slaymaker

Good afternoon, and thank you for joining our third quarter earnings conference call. As usual, Kevin March, TI's CFO, is with me today. For any of you who missed the release, you can find it and relevant non-GAAP reconciliations on our website at ti.com/ir. This call is being broadcast live over the web and can be accessed through TI's 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 Safe Harbor statement contained in the earnings release published today, as well as TI's most recent SEC filings, for a more complete description.

Our mid-quarter update to our outlook is scheduled this quarter for December 9. At that time, we expect to adjust the revenue and earnings guidance ranges as appropriate.

This was a good quarter for TI. Revenue came in just above the midpoint of our guidance range, growing 6% sequentially and growing 10% if you exclude legacy wireless revenue, which declined to less than 2% of TI revenue in the quarter. Analog and Embedded Processing increased to 80% of TI revenue. The improved quality of our revenue is reflected in record gross margin in the quarter. Kevin will discuss this more in a few minutes.

Revenue growth in the quarter was supported by some of the vertical markets that were especially weak in the second quarter, including computing, game consoles and handset revenue outside of our legacy wireless revenue. Revenue from the communications infrastructure market continued to grow in the quarter. These areas were complemented by a continued strength in our automotive and industrial revenue.

From a year ago, revenue declined 4% due to the decrease in legacy wireless revenue. Excluding this revenue, we grew 3% from the year-ago quarter. On this basis, this was the first quarter of year-on-year growth since the third quarter of 2012. Again, excluding legacy wireless, we expect growth to accelerate to 8% in the fourth quarter at the middle of our guidance range.

The strength of our business model not only provides strong profitability, it also gives us confidence that we can sustainably generate $0.20 to $0.25 of free cash flow for every dollar of revenue. This metric is especially important to our shareholders as our capital management strategy is to return all of our free cash flow to them, except what is needed to repay debt. When measured over the trailing 12 months, free cash flow was 24% of revenue. Over that same period, we returned 133% of free cash flow to shareholders. In the third quarter alone, we returned $1 billion to shareholders through a combination of dividends and stock repurchases.

Earnings in the third quarter were above our expected range, a result of better-than-expected revenue and gross profit, tight operating expense control and some help from discrete tax items.

Let me walk through a few details of revenue. Analog revenue grew 11% sequentially. All 4 Analog product lines contributed to this growth, although Power Management was up the most, followed by High Volume Analog & Logic. These areas benefited from sequential growth across many markets, including those vertical markets that were impacted by inventory reductions in the second quarter.

Embedded Processing revenue grew 8% sequentially, with processors up the most, followed by growth in microcontrollers and connectivity. Processors were driven by applications processor sales into consumer and automotive applications and DSP sales into industrial applications. Microcontrollers were lifted mostly by sales of MSP430 products into industrial applications, as well as sales of microcontrollers into automotive safety applications.

In our Other segment, sequential growth in both product areas was offset by decline in legacy wireless. Legacy wireless revenue fell by $91 million to $57 million as we had expected. This decline was partially offset by growth in calculators and in custom ASIC revenue, which grew as a result of communications infrastructure. Royalties also grew, and DLP product revenue was about even.

Turning to distribution. Resales grew 9% sequentially. Distributors' inventory levels declined by about a day to just over 5 weeks.

Now Kevin will review profitability and our outlook.

Kevin P. March

Thanks, Ron, and good afternoon, everyone. This quarter, gross profit was $1.78 billion, up 13% sequentially. Gross margin was a record 54.8% of revenue and expanded 330 basis points sequentially. I think it is useful to compare this quarter's gross margin to that of the third quarter of 2010, wherein our last high-water mark for gross margin was set at 54.5%. In that earlier quarter, revenue was $3.74 billion, up -- 15% higher than our revenue this past quarter. Factory utilization in that earlier quarter was 8 points higher and our manufacturing capacity was lower since we have not yet brought online our cost-efficient, 300-millimeter analog wafer fab in Richardson, Texas or our yet to be acquired wafer fab in Chengdu, China. We were also still in the early stages of ramping our recently acquired Aizu Japan wafer fab. In addition, Analog and Embedded Processing were also much smaller then, contributing 60% of our revenue at that time.

The conclusion one can draw from this is that due to the structural changes that we've made at TI over the past few years, the quality of our revenue is much higher today. It is more diverse, more profitable and less capital intensive; and we remain better positioned to support future growth from a manufacturing capacity standpoint.

Continuing to operating expense. Combined R&D and SG&A expense of $833 million was reduced by $27 million sequentially. Acquisition charges were $86 million, unchanged from last quarter. Almost all of this amount is the ongoing amortization of intangibles, which is a noncash expense. The restructuring charges and other line of our income statement transitioned from a $282 million gain last quarter to a $16 million charge this quarter. As a reminder, last quarter's gain was due to the transfer of wireless connectivity technology to a customer. This quarter's charge is associated with the shutdown costs from the previously announced factory closings in Houston and Hiji, Japan.

Operating profit was $844 million or 26% of revenue. Our tax rate in the quarter was 23%, a point below our 24% annual effective tax due to discrete items that were included in the third quarter. Our annual effective tax rate is unchanged and 24% is the rate you should use in your models for the fourth quarter. Net income in the third quarter was $629 million or $0.56 per share, which includes $0.01 of discrete tax benefits.

Let me now comment on our capital management strategy, starting with cash generation. Cash flow from operations was $1.15 billion in the quarter. We increased our inventory by $6 million compared with the prior quarter. Inventory days increased by 1 day to 106 days, consistent with our model of 105 to 115 days. Capital expenditures were $124 million in the quarter and free cash flow was $1.03 billion.

On a trailing 12-month basis, cash flow from operations was $3.27 billion, about the same as a year ago. Trailing 12 months' capital expenditures were $402 million, down 27% from the year ago. As a result, free cash flow was $2.87 billion, up 4% from a year ago. Free cash flow was 24% of revenue for the trailing 12-month period, within our expected range of 20% to 25% of revenue. In the year-ago trailing 12 months period, free cash flow was 21% of revenue. Capital expenditures for the past 12 months were 3% of revenue. Our continued low capital spending level is a direct result of the strong capacity position that we have built with our strategic investments of the past few years. The cash flow that will result as we continue to fill up this capacity should be stronger in the years ahead.

I'll note that depreciation expense for the past 12 months exceeded our capital expenditures by $496 million. As a percent of revenue, depreciation was more than 400 basis points higher than our capital expenditures. This is one of the reasons why our free cash flow has been trending higher than our net income. Of course, as depreciation declines at the rate of capital spending over the next few years, gross margin will benefit. Another reason why free cash flow has trended higher than net income is the noncash amortization expense of $80 million to $85 million per quarter, that will remain on our income statement for another 6 years. For the past 12 months, amortization expense was $339 million or about 3% of revenue.

And as we've said, strong cash flow, particularly cash flow -- free cash flow, means that we can continue to provide significant cash returns to our shareholders. In the third quarter, TI paid $308 million in dividends and repurchased $734 million of our stock. Our capital management strategy is to return all of our free cash flow to shareholders, except for what we need to repay debt. In the last year, we reduced our debt level by $500 million. Free cash flow was $2.87 billion and we returned a total of $3.82 billion to shareholders or 133% of free cash flow. We've been able to return more than our free cash flow because proceeds from exercises of employee stock options, totaling $1.28 billion over the past 12 months, have also been an additional source of cash for the company. To break out the cash return, in the past 12 months, we repurchased $2.7 billion of our stock or 95% of free cash flow. Similarly, we paid $1.08 billion in dividends or 38% of our free cash flow.

Fundamental to our cash return strategy and our cash management and our tax practices, we ended the third quarter with $3.59 billion of cash and short-term investments, with 82% of that amount owned by TI's U.S. entities. Because our cash is largely onshore, it's readily available for a variety of uses, including paying dividends and repurchasing our stock. TI orders were about even sequentially and our book-to-bill ratio was 0.97, consistent with seasonal declines in the fourth quarter.

We expect TI revenue in the range of $2.86 billion to $3.10 billion in the fourth quarter. At the middle of this range, revenue would decline 8% sequentially, with about half of that decline coming from the seasonal drop in calculators. The remainder of the decline is consistent with the semiconductor industry's pattern over the past 3 years: 2010, 2011 and 2012, as well as our own history over that same period when legacy wireless revenue is excluded. In the fourth quarter, legacy wireless products should decline to about $50 million. We continue to expect that revenue from these products will essentially be gone as we enter next year. We expect earnings per share to be in the range of $0.42 to $0.50.

In summary, we believe the third quarter provides a preview of what TI is capable of producing as a company focused on Analog and Embedded Processing. The improved quality of our revenue is evident from the higher gross margin and free cash flow generation compared with our past. We also believe our top line performance and potential will become more evident without the steady headwind of declining wireless revenue in the past few years. Our manufacturing capacity position remains strong and we have a good opportunity for continued growth, while maintaining our capital expenditures at lower levels in the years ahead.

With that, let me turn it back to Ron.

Ron Slaymaker

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

Earnings Call Part 2:

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