Texas Instruments Incorporated. (NASDAQ:TXN) Credit Suisse 26th Annual Technology Conference November 29, 2022 10:55 AM ET
Company Participants
Haviv Ilan – Chief Operating Officer of TI
Conference Call Participants
Chris Caso – Credit Suisse
Chris Caso
Our next presentation is Texas Instruments, which I’m sure you all know. Here from TI is. So Haviv thanks for attending. And maybe as I kind of jump right in and
Thank you Alright, everyone. Good morning. Sorry, my microphone fell off. So welcome back. So again, I’m Chris Caso covering semiconductors here for Credit Suisse. Our next presentation is Texas Instruments, which I’m sure you will know. Here from TI is Haviv Ilan, Chief Operating Officer of TI. So Haviv thanks for attending.
Haviv Ilan
Thank you.
Question-And-Answer Session
Q – Chris Caso
And maybe as I kind of jumped right in, and we were speaking about it a little before the what’s on all investors’ minds right now is the cycle and kind of what’s the same and what’s different in this cycle. And I think what’s interesting for TI as you guys have been through a number of cycles yourself, you certainly do not manage the business around the cycle. And I think that’s some been some of the controversy this year is that you are looking out, for a 10-year plan. But, perhaps you can give some perspective and you’ve been through some cycles yourself about, perhaps what you may see, similar and different to past cycles from what you have right now, because you have seen some weakness in some areas and some areas some strength.
Haviv Ilan
So Chris thanks. I’ll start with a high level comment about what you described and how we use cycles and we’ve had plenty of them I had some more. And in general we do, we never ignore the cycle. We watch it but we do spend 90%, 95% of our time on how to get prepared for the next opportunity or looking beyond the cycle. Especially with many of the actions we take. They have long lead time in terms of how do they convert the results. So if you think about getting capacity in place, getting our inventory in the right levels, that’s where I spend a lot of my time and not ignoring the cycle watching it. But, it’s going to do what it wants to do. We have to think beyond that. And that’s where the energy of the company is, it has to be.
Specifically yeah, and the cycle has been in some ways different because maybe not all markets are behaving the same. And we’ve seen PE and notebooks so personal electronics and notebooks starting in Q2. They’ve talked about; we’re seeing spreading weakness and industrial in into Q3. And then automotive is still holding, but I’m not going to try to predict what it’s going to do and when. But my high level view is that they usually correct. So that would be my guess, if I have to, as Dave mentioned, during the last call, the last earnings call.
Chris Caso
Yes. And saying that, not necessarily because you know something, but perhaps because you don’t know, and not really…
Haviv Ilan
We don’t know, exactly. You simply don’t know. But do they usually behave the same? Maybe yes. So that would be high level guess.
Chris Caso
Right. It may be good to get in the industry a little bit. And it’s you know, one of your competitors, analog devices had reported recently, and they talked about some stabilization. And they had started to see some cancellations back in the summer, and expressed some caution on that. And more recently the optimism was there was some stabilization in orders. It didn’t exactly get that from, from you, folks on your recent earnings call. So I’m wondering if you maybe contrast, what, what you’re seeing, and maybe, is it somewhat different than we heard from ADI?
Haviv Ilan
Yes, I think I don’t have a lot to add here to what Dave said. In October, we left to let the quarter run its course and we’ll see what it did in January, when as we really pulled back. I will say that industrial again, if you look at the, the secular growth, industrial, we are excited about it. And that’s why we spent so much time preparing for that next opportunity because content deletion in industry less visible than what you see in automotive, but it’s across all the sectors, all the end equipment’s. We are excited about that, and it will drive, it’s a big engine that will drive the industry in the next 10 years and beyond. I think it’s in the early phase of change, and adoption of semis’.
I will also say that our position in industrial and automotive has been stronger than it ever was. We finished 2021 at above 60%. So again, as I said, our eyes on what it can do in 2025 2030 and getting the company ready for that opportunity.
Chris Caso
Right. And that seems to be precisely why you’re embarking on the CapEx program that you are and spending for that. What Dave has told me in the past which is a mantra in the company that you’d rather be three years early than three months late.
Haviv Ilan
Absolutely.
Chris Caso
Right. And unfortunately, over the last year and a half, the whole industry, and certainly I put myself in that shoes of was surprised that at the resiliency of the macro, post COVID. And, and there was some opportunity that was lost, due to shortages, not having the capacity in place. And I suppose that’s why you’re embarking on this, this program.
Haviv Ilan
Yes. And again, we have embarked on the program, even before the cycles. Think about RFAB2, we have started that investment back in the previous cycle, and we didn’t get a lot of cheering at the time. Why are you, why are you investing in a downturn time but could offer to be even earlier for us and would serve us even during that cycle? That the answer is yes. So again, I want to be prepared for the next opportunity. But in generally, if you go to the way TI performed in a cycle and what we have seen I think we’ve done okay, the beginning of the cycle was a little counterintuitive to us internally, but which was very convinced. Let’s run the factories open and full capacity in the second quarter of 22 of 20. Sorry, demand was vanishing. During that time, there was no demand and it served us very well. We built a nice level of inventory that served us almost through the middle of 21 but we ran out I ran out of gas and that’s part of the lessons learned to your point of how we prepare for the next one.
So getting capacity ahead of demand and having it at the right level, but also the right location and this concept of, we call it geopolitically dependable capacity that can ease customer minds of where the parts are coming from. And can I rely on TI for the long-term, that’s a very important parameter. The second one is, as I mentioned before, getting the right level of inventory, because our parts, most of them have these unique attributes of diversity and longevity. So building ahead, that inventory by — powered by power at the right levels, according to the future, potential demand of them could serve us very well for the next opportunity. So I spend the majority of my time on the on the couple of these actions.
Chris Caso
Right. If we go back to what you said around middle of 2021, when you started to run out and you ran the FABS hard before that, but then things got tighter. At that time, TI was often, one of the first companies that that your customers had talked about of, of being a being short. And of course, you’re the largest in the industry. So perhaps that’s it, do you feel that you the shortages that happened 2021 2022 put you in any competitive disadvantage? Or is it just simply a function of you are the biggest guy on the block. So in an industry, that’s short, that you’re the first one that comes to customer is going to speak about because you’re the largest?
Haviv Ilan
First, I think there is a barometer of that just statistically. I mean the breadth of our product, the number of customers and also our decision to support all of them. So in a way, you can say, say, hey, let’s don’t select the customer base, you’re going to support and maybe make life a little easier. But we said no, we’re going to support all of your customers, even if you’re a smaller industrial customer in Europe, and you don’t have the voice or the pockets that the big customer has. We took that approach; it’s a very hard one, because you kind of have maybe more folks to take care of. And statistically, you’ll have maybe even more challenges, but the team has done very well. And not only that, we grew in all markets, we bias the growth into industrial into automotive across a very high breadth of customers, and I think it will serve us very well.
But even more than that, customers especially in industrial and automotive are paying for more attention to these issues. Because first their bill of materials is now more based on semi’s compared to before, because end equipment’s are being re redesigned with more electronics in them. And us having the plan that we have with RFAB2, in production with Lehi ramping in Q4 this year. That’s a great strategic advantage for us because customers do care about this capacity coming online, especially on the 130 to 45 nanometre. Think about analog product; think about flash based products for embedded. Having that capacity and already ramping now, and heading in the right location is a great advantage. And I think customers are turning to us and we’ll see that materializing in the years to come right.
Chris Caso
Right. I want to pivot to that a bit and speak about your manufacturing strategy is different than most of your competitors. And what your competitors have been doing largely now is moving into sort of a long term supply agreement situation with customers, the large customers and that’s being backed up since mostly competitors use some degree of foundry being backed up as long-term and supply agreements from the foundry. Do — how is TI’s approach give you an advantage because you have the captive capacity. So perhaps that makes it less important for you to enter a long-term supply agreement because you don’t have a secondary agreement with a foundry partner. It’s your own capacity. But the other side is you want to keep your FABS loaded as well. So how does TI do that? And how is it different than what maybe ADI might do?
Haviv Ilan
Chris, I think it is different. In the sense that we own our manufacturing plant, we put an aggressive plan to have as we said capacity head of supply and we tell our customers, you don’t need to write these long-term agreements with TI. Now we do have discussions with customers. When they understand the level of investment and they understand the where the capacity comes from. I do believe they turn to us but we don’t we don’t have in that discussion because I think it’s simply not good customer service because customers would have changes in the next five and 10 years and they want to have that flexibility, and I think just better customer service to have the capacity ahead of the demand having the right level of inventory so they can count on us as they grow their business. And then you talk about those many customers, and we have 10s and 1000s of them that you can write LTAs with all of them. And some of them don’t have the financial means even to commit to such a deal. And I think serving these customers as is as important to us. So I do believe that, again, we’ve stayed very disciplined to our competitive advantage of controlling our supply chain, controlling its costs. Just in we’ve done it for years, I mean, we’ve come with this strategy 10, 15 years ago, but I think customers get it now. And they, they do realize that what we do, sir, is going to serve them very well.
Chris Caso
So maybe to paraphrase and correct me, if I’m wrong, it’s a case of where TI is making that investment and ahead of demand. And whereas, because you do it yourself, you can make that decision on your own and see where the where the market is going, whereas perhaps the competitors have to convince the foundry that to make that investment, have to make some commitment to it, whereas you control that decision on your own.
Haviv Ilan
It’s controlling the decision. The confidence we have is high in as part of the company’s has grown. I mean, we came with that plan earlier in 22, during the capital management call, and since then, we’ve talked with so many customers. So since then our excitement, our confidence in our plan has grown. It is a big debt. It’s a big spend to build a 300-millimeter wafer fab. It’s not an easy investment. But again, the secular growth of what the market will do and our position in these markets and our ability to control our supply plan I think will pay dividends in the long-term. So yeah, agree with what you said.
Chris Caso
What leverage do you have? And I think, the investor concern that kind of goes around with that is, well what happens and what happens if we hit a downturn you’re making, you’re making that capital investment, you have to go through a period of underutilization. Are there ways that you that you mitigate that in the event of a downturn event, it’s not that different this time, we do see automotive and industrial slow? Or is that a case of TI is just willing to take that risk right now, looking at it over the 10-year lens that it’s going to be better for you over a 10-year period?
Haviv Ilan
It’s a good question. From a high level, it’s kind of the latter meaning, we can time our investment to the cycle, because by the time the market wants to go up, again, it’s going to be too late to meet investments. So we – and the lead times of building these factories are years. This is not measured in quarters. So we do have to stay very disciplined about it. And again, we don’t ignore this cycle, but we don’t we don’t let it lead our strategic decisions.
But having said that, there is always tactics. So these factories are very efficient. So running our material or parts there versus old technologies is important. We announced closure of last 150-millimeter wafer fabs, so we can — the for through of running the factories for either building the inventory to the levels you want, or just getting the nice cost advantage, when you run the variable cost to run a wafer in a 300-millimeter wafer fab which is just so much better, we will take these tactical decisions. So we are thoughtful about it, but again, can’t led the cycle slow us down in getting ready for the next one.
Chris Caso
Right. Maybe pivot a bit. And one of the things I always think is interesting with analog companies is the R&D process and the product selection process. We always felt that was a differentiator, just making investments in the right place at the right time not chasing the market being ahead of it. Maybe you could speak to how TI does that?
Haviv Ilan
Absolutely, Chris. And growing up in R&D, and then going into the business and spend most of my career there. It’s actually an exciting process that we run. And our — is everything that we do our approach to R&D has always been steady and in long term. Maybe not everything is shows on the P&L because we also had some restructuring in the last 10 years that we have to go we had to go through. But if we just take analog, for example. So we had a very steady hand on the analog investment over 20 years, okay? And continuously grew up portfolio, continuously grew market share, and the way we do it and people talk about broad and breadth of products, but the fact of the matter is that each and every product has to be very competitive. It has to be at low cost, it has to be high performance. And otherwise over time, you fall out of competitiveness. So we pay a lot of attention on that topic. We have 10s and 1000s of products, into hundreds of product families into 65 product lines, and it’s a granular, detailed work that we do. I think the way we spend R&D is against steady hand, but very efficiently, I do believe in the concept of scarcity when you when you put R&D in play, because that’s how the team would choose the best opportunity and get the best party, the best return on investment over time.
And I think TI is becoming better and better at that. So again, our commitment to R&D investment is always been there. I will say, if I refer to the past decade, we did have a lot of moving parts getting out of wireless, the comms business and making some big shifts in R&D. That’s more or less I mean, there was always fixes and shifts you do. But most of that work is behind us. So I’m very excited about the future. We are now we’ve based our R&D in the areas we want to have. The last work we’ve done was on the embedded side. And from here on, I expect a very steady hand on R&D moving forward.
Chris Caso
Right. And you mentioned embedded. That was going to be next question is that’s one of the areas that you sort of have changed your focus. Is that well, I mean, one is from an R&D and investment standpoint, is that done? And then what does that mean for sort of embedded growth going forward? Does that become a small piece of revenue over time, as some of the R&D has been reallocated?
Haviv Ilan
So again, the embedded R&D was not reduced. It was, as you said, reallocated into the best opportunities, and I’ll describe it in a high level. We’ve done that three years ago, I think. We embarked upon it. And most of that hard work is done meaning get your R&D based on the best product portfolio, and we think about it as how do you align your investment to your competitive advantages? So manufacturing technology, can you build these products internally. Lehi is a great example. It will enable us that 65-nanometer flat 45-nanometer parts, that’s where embedded is, is mainly based in. Think about the breadth of our portfolio. Can we concentrate on prototypes that have this idea of they can serve multiple customers, and multiple end equipment, multiple sectors, and that’s, that’s where we are taking that investment, and then use the channel advantage to get them into customers and design the mean.
So that work is a from a restructuring, from an R&D retuning is done. It’s the hard part, as I said, the product is starting to come out. And that’s where the excitement is. We are seeing the early indicators of that business can be performing very nicely for our future. I have very high confidence with what I hear from my sales team, and how they reallocated their resources to go and put their energy around these parts. And it will be a great contributor to free cash flow growth.
Now we are not trying to match margins to the analog product. We do think about how can that embedded business, generate cash for us and free cash flow per share growth and it can. So I don’t want to tell you an exact timing. But most of the hard work to your point is I think it’s behind us.
Chris Caso
Okay. I guess maybe I’ll take a pause here. If there’s any questions in the audience, or let you think about them in a second. Randy, you want to ask one?
Unidentified Analyst
[Indiscernible] a short term question on China, how you’re seeing the low end of the market pricing competition inventory demand, if that has much impact in the mid-to-long-term? How much you see the impact of localization or local suppliers ramping up?
Haviv Ilan
So China market and how much of it? I think we reported Dave shipping to China, it’s about 50%. But if you look at revenue, we shipped to customers headquartered in China, it’s about 25%. That would be the number. So that’s your first part of the question. And again, China has been a very competitive market for us for several years now. And yes, we do see competition, the local competition, as you said, and these are hungry, aggressive companies that we compete against, but the market is growing, and it’s big, and we want to play there. So we are competing. And we tell internally to our team say China is going to be harder, but it’s still a great opportunity. So we are very committed to that to that opportunity. I will say that again, the competitive advantages for us in China play big factors so you mentioned you know price but controlling our manufacturing and our costs. I mean, we are competing with fab less and AT less companies, okay? And these, these folks, the foundries that they use or the AT, they don’t give the price for free, okay? There is a margin stacking there. So I think we can be very competitive on costs. The breath that we have is just un comparable. So I most of this competition, and I see if 65 product lines in the company. The typical competitor in China usually attacks half a product line or couple of product families, just because it’s very hard to build that right. It takes time and expertise in technology, and many, many years. And the breath is helping us because when you engage with the customer, and you have a set of parts of the offer, that’s it’s a big advantage. And when you move into this, the market that we serve, automotive, but especially industrial, you do have to reach many of the customers. And that’s you need to scale here. This is why you see most of these competitors kind of more narrow or more vertical in terms of the product offering and the same on the markets, they attack, because they do look for a high level of concentration of revenue per socket, if you will, because otherwise, you need the scale and the breadth to go attack it. And that’s how we address the competition there. I always tell to my team, if you’re going to be on power with the same price, same performance, same level of service, as a local competition, you will lose, okay? So you do have to be ahead. So if it’s a tie, it’s going to go away. But I think our ability to compete in China is wrong. And I think it’s even growing with the investments we’re making.
Unidentified Analyst
Question, just on pricing environment. Some of your competitors that use more foundry, they’re selective price increases and they’re passing it on. How do you see TI just industry pricing and your pricing outlook into next year?
Haviv Ilan
Yes, so I like to separate cost and price, right. So to me pricing is set by the market, and we always had a steady hand on that, thinking about the long-term, opportunity for us to share, again to gain share. And we that’s how we price. We price with a very steady hand like everything we do. Now, when the market turns up, and prices go up, we react, we don’t, we just don’t ignore that. And pricing did contribute to some of the growth in the last couple of years. But our approach is always, always make pricing non barrier for customers to adopt us. But that’s not how we gain share customers turn to us not because low price they turn to us, because what we have our capacity, the breadth of the product portfolio, the performance, the breadth of the technology, and the process technology we have, and that’s how, high performance analog works. So I don’t think that’s going to change in the future.
Chris Caso
If I could follow on that, because the reason and what most of your competitors say is they’ve raised prices, because their input costs have gone higher foundry costs for in particular. And if you’re using TSMC, TSMC had to raise price in order to make investments in lagging edge because they needed to get the same margins between both. In your case, your investment, your costs are still going higher. The used tools that you got financial crisis, that those no longer available, so your prices going up, perhaps, do you feel that your costs are going up at a lesser rate, such that you can either be more pricing, say price aggressive but more attractive to customers? Or that you don’t have to follow those same steps? Is it work out to be a competitive advantage for you?
Haviv Ilan
Yes, I think there is a competitive advantage here on the way we control our costs and I’ll touch upon it in a minute. But at the end of the day, why did prices go up? It’s always like supply and demand mismatch right? Demand was high supply was scarce and that’s what happened and does it fix over time? It depends on how faster it does it depends because you’re right the investments are you know the intensity of these messages and desire. The access to use tools for companies like TI also is — if I look at Alpha-1 versus Alpha-2. It’s a big difference. And even Lehi that we bought a year ago it’s a mix because we got a shell and we got some use tools but also to augment the factory with new tools because you can find these used tools like it used to before.
However, the return over the long-term is still wonderful. So even with newer tools, that is a great investment or a great ROI for TI. And that’s why we are embarking upon that investment. Now, regarding do we have a better control of our cost? I think we do. I mean if you just – you mentioned foundries look at their margins and what they did, right? So we when we control our input costs, and we are not immune or insulated for inflation. But when you own your manufacturing capacity, I think it’s a competitive advantage. And I think it will serve us in the years to come, and it will fall through to your question.
Chris Caso
But do you think longer-term, that this elevated cost of manufacturing analog now is now sort of a permanent phenomenon such that, we’re not going to go back to where we were five years ago, where these use tools were available. This is something that’s permanent. And therefore, the pricing increases that we’ve seen in the permanent because one of the investor concerns is the pricing is going to come back down once demand slows down.
Haviv Ilan
Yes, I would say and again, the way we plan forward and still decided to make the investment, we believe capacity investment or capacity, or capital intensity, let’s call it is not going down. So I think that’s a fair assumption. That’s how we make assumptions. And that’s how we decide to make decisions, whether we want to invest or not. And what the industry will do will determine pricing, meaning is there going to be — if I’m worried of oversupply. I’m not very worried about it. What we know is that to support our growth or our ambitions, we need to make the investment, because there is no free capacity out there that you can just grab you put your hands on. So we want to control our destiny. We do want to make the investment. I think it will pay off. And that’s the direction we are taking Chris. I don’t know, hopefully, that helps.
Chris Caso
Yes, No it does. And one final one, and with regard to kind of how this affects cash flow going forward, certainly cash flow is how you manage the company. And now that, we’ve kind of set this this investment level, it doesn’t sound like necessarily that the capital investment needs to go higher from where you are right now. And I suppose that as you start to utilize the, the new fab and such, that we should start to see the cash flow results, starting 23, 24 as we’re kind of at this new level of CapEx, revenue grows, whatever, as we get through whatever downturn we’re going to see, and you start to see that in your in your free cash flow, is that an accurate description?
Haviv Ilan
Yes, again, the unknown is what the cycle wants to do and what’s the shape of it going to be. But if you look beyond if you just take a trend lines, this is where as you said, these investments, you don’t need to wait 10 years for that to fall through to your point, meaning once you put the investments, fab is moving wafers, the variable cost to run them is very attractive. And that’s what we intend to do. Now free cash flow is a parameter not only of your CapEx, it’s also what revenue will do, for example, and that’s where we as I said before, we have to think about it in the long-term. The — but when we run the what ifs, assuming that our assumption that the market can grow in a higher rate because of the secular changes in industrial and automotive because of content addition. And if that sits on a certain trend line that we believe in, and we make that investment and I’m not talking about a specific year, but free cash flow per share can grow very nicely. And it will have to come from top line growth, mainly because there is not a lot of margin leverage we have left. But our confidence of that investment falling through and being a great producing great results on free cash flow per share is very high. And maybe we’ll, we’ll end with that. We’re out of time.
Chris Caso
Yes, that’s a good way to end. Haviv, thanks I appreciate it.
Haviv Ilan
Thank you.
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