Good day and welcome to the Texas Instruments Fourth Quarter 2019 and 2019 Year-End Earnings Release Conference Call. Today's conference is being recorded. At this time, I would like to turn the conference over to Dave Pahl. Please go ahead, sir.

Good afternoon, and thank you for joining our fourth quarter and 2019 earnings conference call. Rafael Lizardi, TI's Chief Financial Officer, is with me today. For any of you who missed the release, you can find it on our website at ti.com/ir. This call is being broadcast live over the web and can be accessed through our website. A replay will be available through the web. 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. First, let me provide some information that's important for your calendars. We plan to hold a call to review our capital management strategy on February 4 at 10 a.m. Central Time. Similar to what we've done in the past, Rafael and I will provide insight into our strategy. For today's call, let me start by summarizing what Rafael and I will be reviewing. I'll be covering the following topics: first, a high-level summary of the financial results for the fourth quarter; second, I'll provide some comments about what we're seeing with added insight by segment and end market and explain why we would characterize the market as showing signs of stabilizing; and finally, since this is the end of the calendar year, I'll provide a summary of our performance by end market for 2019. Rafael will then review profitability, capital management results and then the outlook, after which we'll open the call for Q&A. Starting with a high-level summary of the fourth quarter financial results. Revenue was $3.35 billion, a decrease of 10% from a year ago, and EPS was $1.12…

Thanks, Dave, and good afternoon, everyone. Gross profit in the quarter was $2.1 billion or 63% of revenue. From a year ago, gross profit decreased primarily due to lower revenue. Gross profit margin decreased 220 basis points. Operating expenses in the quarter were $798 million, down 2% from a year ago and about as expected. On a trailing 12-month basis, operating expenses were 22% of revenue. For the year, we have invested $1.5 billion in R&D, an important element of our capital allocation. We're pleased with our disciplined process of allocating capital to R&D, which we believe will allow us to continue to grow our top line over the long term. Acquisition charges and noncash expense were $50 million. Acquisition charges will remain at about $50 million through the third quarter of 2021. Operating profit was $1.2 billion or 37% of revenue. Operating profit was down 18% from the year ago quarter. Operating margin for Analog was 42%, down from 47% a year ago; and for Embedded Processing was 25%, down from 30% a year ago. Our focused investments on the best sustainable growth opportunities with differentiated positions will enable both businesses to contribute nicely to free cash flow growth over time. Other income and - net income in the fourth quarter was $1.1 billion or $1.12 per share, which included a $0.01 benefit for items that were not in our prior outlook, as we have discussed. Let me now comment on our capital management results, starting with our cash generation. Cash flow from operations was $1.8 billion in the quarter. Capital expenditures were $163 million in the quarter. Free cash flow on a trailing 12-month basis was $5.8 billion, down 4% from a year ago. In the quarter, we paid $841 million in dividends, an increase of 17% per…

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

[Operator Instructions]. We'll take our first question from John Pitzer with Crédit Suisse.

Congratulations on the solid results. I guess, Dave and Rafael, just relative to the March quarter guidance, at the midpoint, you're guiding down about 3% sequentially, which is in line with kind of historic seasonality for the March quarter. But typically, off the bottom of the cycle, you can get some above seasonal. And at the midpoint, the year-over-year is just modestly getting better from December to March. So I'm just wondering what - if there's anything specific in the March quarter as to why it's not a little bit better than seasonal, and specifically, anything around distribution strategy that might be a headwind in Q1. And then I have a follow-up.

Yes, John, I'll take that, and Rafael can add if he'd like. I think - so to answer the last part of that question, there's nothing in the sequential guidance that would suggest there's any headwinds from distribution. We've talked about before that we would expect as we make the transition in distribution, it will look similar from a revenue headwind as we've seen with consignment. So there will be some there, but we've already got some of the headwinds from the transitions that we've made in consignment. And I think the second part is as we're seeing those signs of stabilization, we talked about that history would suggest that the growth is going to reflect the end demand of the customers and, therefore, the macro economy. So as we go through the year, that's what will be the driving force overall.

Yes. The only other thing I would add is, as Dave mentioned during the prepared remarks, our comms equipment was down year-on-year significantly as there was a tough compare a year ago. Well, 1Q '20 is going to have an even tougher compare on comms equipment. You may recall what was going on in 1Q '19 on that front.

Right. Was growing pretty significantly year-on-year. Okay, John, do you have a follow-on?

Yes. And then my second question is just around the Embedded business. I know that the SIA MCU data is not necessarily the best proxy for that business. But when you kind of compare your results to that data, up until this most recent correction, you guys were sort of consistently outgrowing the SIA MCU data. Your Embedded business has now gone through 5 or 6 quarters of kind of undergrowing. And I'm just wondering if you could help us talk through maybe potential share loss. And I know you talked about CPU specifically being weak within Embedded, is that specific to an end market like comms? Or how do we think about that?

Yes. So first, John, I think you're putting in a good context. And as you've stated, we believe share changes just need to be judged over long periods of time. And so if you look at the revenue performance of Embedded over the last several years, we've had that significant outperformance, as you pointed out, in '17 and '18. Last year, we probably gave some of that back. So I just point out that in the most recent quarter, at the TI level, so Analog and Embedded, we saw that - those signs of stabilization but - in every market, so behaving similarly except communications equipment. So thank you, John.

We'll take our next question from Ross Seymore of Deutsche Bank.

Trying to get to the trajectory and maybe the stabilization in turn. Dave, I know you said it was pretty broad-based on how you upsided the fourth quarter of last year. But can you give us what the sequential changes were by the end markets? I know you gave the year-over-year specifically, but if you could give that for the fourth quarter, that would be helpful.

Yes, certainly, Ross. So these are all sequential compares. Industrial declined mid-single digits. Automotive was about even. Personal electronics declined high single digits. Comms equipment declined about 20%. And enterprise systems grew in the low single digits. Do you have a follow-on, Ross?

Yes. I just wanted to think about the - you talked about shutting down the two 6-inch fabs. You told us about starting up the 300-millimeter. So maybe a two parter, if I may. Can you talk about the utilization plans in the first quarter? And how do we think about CapEx? I know you said you're moving dirt and you have cranes there, but out of that $600 million or $700 million cost that you said for the new 300-millimeter fab, how does that fold in, in 2020?

Yes. So Ross, you asked a bunch of questions there. Let me try. I'll answer the ones I remember. So first, let me emphasize, yes, we're closing two - our two fabs that still have some 150-millimeter equipment. And they're over 50 years old, and they'll be closed by as early as 2023 or as late as 2025, somewhere in that time frame. We have about $1.5 billion of revenue that run through those factories. And of course, we're moving most of that revenue, virtually all, to 300-millimeter, saw a significant cost advantage, as we have talked about over the years. The new factory, so let me talk about the new factory. Yes, we've got dirt moving, cranes are there, plans are underway. We should have the building finished by the end of 2021. And at that point, we can put equipment as needed to support demand. From a CapEx standpoint, you want to model that at 6% of revenue. We just finished 2019 with CapEx at 6% of revenue, and you should model that going forward at about that same level.

Okay. Thank you, Ross.

Our next question comes from Chris Danley, Citigroup.

I'm going to put the hindsight as 2020 theory to the test here. So now that we've kind of gone through this dip and recovery, maybe just talk about why you think your sales and bookings fell off so sharply in late summer. And then what's - why are the customers a little more, I guess, a little more optimistic right now? And then do you feel better about your business now versus, let's call it, six months ago over the summer?

Okay. Well, I'll start off, and Rafael, if you want to add anything. I think as we go through any cycle, they're all similar in a lot of ways and different in others. And to put it in context, you'd have to go back to third quarter of '18. Running up to that, we had 10 quarters of year-on-year growth. So you never know as you're going through that you're going to have 10 or 12 or 14 quarters of year-on-year growth, but you expect at some point that the industry would run below. And so as we started that, we thought we were - what we were seeing was mostly an inventory - industry, rather, correction as we're working through that. Certainly, trade tensions, probably elongated that cycle and part of the reasons why we saw that other leg down later last year. And so - and can you remind me the second part - or do we feel better about the business. I think that strategically, we felt that we continue to stay focused on improving our four competitive advantages. We haven't slowed down investments, and we talk about our fabs underway. If you look at the OpEx investments that we have made, those have stayed steady, focused on areas of diversifying our growth in industrial and automotive. So I think we feel just as good today as we did about the business. The cycles will come and go.

Yes. I would just add, as Dave mentioned, strategically, we are well positioned, have been, that hasn't changed. So we continue to feel as good as ever on that front. And then operationally, we just - we've got to be ready for whatever the market throws at us. So if this was - is going to last longer, we've got to be ready for that, if things are going to head south, but we also got to be ready if things turn around, and then we're going to start seeing year-on-year growth. So - and our business model allows us to do that, and we're well positioned for it.

Great. Do you have a follow-on, Chris?

Yes. Just a longer-term question on the Embedded Processing business. So if you look at the last couple of years, it has materially undergrown the overall business, and we're still running it, I think it's about 10% lower margins than the corporate average. So what are you guys thinking about? What should we be thinking about sort of the long-term goals or aspirations for the Embedded business just in terms of relative revenue growth or profits? Do we expect it to improve or not improve? And if it's not going to improve, is there anything you could do to change that?

Yes. I'll give you a few comments on that. As far as expectations, you mentioned margin. Frankly, that's not - Embedded is lower margin than Analog, but that is a nonissue. As long as their - Embedded contributes to free cash flow growth, that's the measure in stake. Obviously, the top line has gone through some challenges here that Dave talked about earlier. But longer term, with their focus on auto and industrial, in all of our businesses, but that includes Embedded, we feel confident that, that business will grow longer term.

Great. Thank you, Chris.

We'll take our next question from Toshiya Hari of Goldman Sachs.

I was hoping to better understand what you're seeing in the comms business. I appreciate the year ago quarter was a high compare, but the business was down 50%, as Dave you noted. Curious how big Huawei was as a percentage of that decline in Q4. And more importantly, how are you guys thinking about the trajectory for this business into 2020? And then I have a follow-up.

Sure. Yes. So Huawei last year was 3% to 4% of our revenue. That's really unchanged from what it was the prior year. And I think if you look at comms equipment overall, if you'll just look at the shape of the growth curve, you had the year kind of balanced with strong growth in the first part and followed by very weak growth in the second half. So the way that it's behaving, I don't think is - well, it isn't a surprise to us. As we were going through that very strong growth, we tried to remind everyone at the time that, that market is a market that's just choppy. And it's that way primarily in early phases of technology deployment. I think longer term, as we've talked about on our capital management presentation, we don't believe that, that will be a growth driver for us or for the industry, and that's just based on the number of subscribers that are out in the market and what the capital spending by operators will be longer term. So we really think that growth in our industry will be driven by industrial and automotive, and hence, why we've biased our investments into those areas. Do you have a follow-on?

Yes, great. And sort of related to that, Dave, it was encouraging to see R&D intensity or R&D as a percentage of sales pick up in 2019 versus 2018. I mean it had felt like R&D was in decline for a number of years, so it was good to see that pick up. Can you remind us which product areas, technologies, end markets that you guys are focused on? I realize it's going to be industrial and automotive, but if you can give a little bit more color within those two end markets, that would be helpful.

So of course, from an end market standpoint, as you said, is industrial, automotive, that's where we're focusing. From a product standpoint is Embedded and Analog. But of course, inside of that, there's a bunch of pieces. So I'll mention a few. But I mean, at the highest level is - in the case of Analog is Signal Chain and Power. Those are by far the biggest areas. But - and underneath that, there's just a bunch of things. There's the - within Power, there's all kinds of power categories and then within Signal Chain. But Dave, do you want to add something?

Yes. I'll just say when we think of allocating capital to R&D, there's really three major buckets. And the largest bucket is - goes directly to product - creation of new products. We release 300 to 400 new products a year. The other two is kind of a shared, centralized R&D function that develops our process technologies, packaging tools that our engineers use like SPICE models and those types of things. And then the third category is the Kilby Labs where longer term, higher risk investments are made, new materials, new markets and those types of things. So that's where the R&D has been directed. I describe R&D last year as steady and stable. And I think that even in a down market, keeping those investments stable, keeping focused on investing in our four competitive advantages is really important overall. So thank you, Toshi.

We'll take our next question from Harlan Sur of JPMorgan.

Looks like the year-over-year declines have improved quite a bit in auto and industrial, moving from down high single digits year-over-year to down low single digits going from September to December. Of the 18 subsegments within these two end markets or by geography, where do you guys see signs of improvement? Or was it pretty broad-based?

Yes. So it is the latter. It was very broad-based, which I think continues to be encouraging on that front. And again, just given the diversity of our customers as well as the diversity - the intentional diversity of our investments to have that growth be broad-based, it's good to see that that's the way the business is performing. Do you have a follow-up?

Yes, absolutely. As you guys mentioned, looks like the team is now shipping to consumption. The guidance for this quarter is for a seasonal decline. But given that Q2 and Q3 are typically seasonally stronger quarters, do you guys anticipate increasing factory loadings here in the March quarter?

We only talk about utilization and factory loadings when there's significant inflection points. And in this particular comparison, fourth to first, we don't expect a significant inflection point. So we're not talking about it. Of course, wafer load utilization is always a function of what we expect for future growth.

Yes. And we'll vary those based on order patterns and as we see demand come in from customers. So thank you, Harlan.

We'll take our next question from Ambrish Srivastava of Bank of Montreal.

I just wanted to peel back the comments on stabilization. Both these businesses, industrials and autos and specifically, industrials, I forget, but I think there's 12, 13 subsegments. So when you talk about stabilization, I'm assuming - well, you never had any channel inventory buildup. Your channel inventory was pretty normal through the cycle and your lead times never extended out. So can you just help us understand a little bit what's the source of stabilization? Is it - it can't be the channel. So it's the end customer, but then you have thousands of end customers. So what's the right way to think to get comfort that you are seeing stabilization in that business specifically?

Well, Ambrish, yes, so it's reflected in the - stabilization is reflected in the order patterns, the demands that we see through consignment and actually the results themselves. So we went from third quarter where those markets were declining high single digits, 8%, 9%, some of them at 10%, to where all those markets were declining at 3%, 4%. So in those numbers, it suggests that there's a bottoming process. And even though we're holding - in consignment programs, we're holding that inventory on our balance sheet, certainly, our customers have inventory of their products and then they have inventories that are down their channels. So just as the bullwhip effect would suggest that you have a small change in end demand as that moves its way back, that magnifies. So we can see the results of that beginning to abate. Do you have a follow-on?

I did. Free cash flow margin. So you guys have powered through the 25%, 35% range you had given a couple of years ago. And you just had 40% in revenues down, not getting the math right, but somewhere in the high single digit, and free cash flow is down 4%. So would it be fair to assume that the targets should be moved up when we hear you talk about capital allocation in a couple of weeks from now?

So let me take that. So thanks for the cue on that. So we do have the capital management call coming on February 4. So I expect all of you to sign up for that and join us there. And we will talk about the various objectives there. But I'll give you a preview. We're not changing those objectives and specifically, that one that you talked about, we're not. And the reason for that, yes, we just finished a 40% free cash flow as a percent of revenue, but the focus is not that percent, right? The way we maximize value for the owners of the company is growing their free cash flow per share for a long time to come. So we focus on that, and that's how we drive value.

Okay. Thank you, Ambrish.

We'll take our next question from Tore Svanberg of Stifel.

First of all, coming back to the sort of recovery question, I mean, stabilization and eventual recovery. Are you starting to see backlog further out now? Or do you think it's kind of more just in time and kind of just waiting for how macro unfolds throughout the year?

Yes, Tore. Now just for those that aren't as familiar with us, I'll just remind everyone or just point out that 2/3 of our revenues are supported by consignment where we actually don't carry backlog but we do get demand forecast. And most of the time, that's at least six months of demand that we can see. So - and then there's no inventory. As Ambrish was pointing out in his earlier call, there's no inventory between us and those manufacturing lines for those customers. So that's actually the strongest signal that we will get when we're looking at future demand. But certainly, the backlog pays - plays a part of that. So I'd just say that, in general, that it's consistent with the outlook that we have. And our lead times haven't changed - it hasn't really changed at all. So they have remained stable. So that allows customers to have confidence that they can get product when they need it. So do you have a follow-on?

Yes. And I apologize for ending on this topic, but there's a lot of concerns about China in-sourcing, including Analog and Embedded Processing. I was just wondering what the company's strategy is on that topic. I mean is it - is sort of life is normal? Or do you actually have a long-term strategy as it relates to that particular topic?

Yes. I'll start and if Rafael wants to add anything. And certainly, as we worked through the year with the trade tensions and as that has unfolded, we've certainly heard discussions at Chinese customers, them wanting to ensure that they've got alternatives. But in the end, our customers are just very pragmatic, and they're looking for components with the highest performance, the lowest cost, the most dependable delivery. And those are all areas that we're very, very strong competitively in. With that, I'll turn it over to Rafael to wrap things up.

All right. So let me finish with a few comments on key items for you to remember. We will remain focused on Analog and Embedded, the best products, and industrial and automotive, the best markets. Next, we will be disciplined in executing our capital management strategy and remain committed to returning free cash flow to the owners of the company. And lastly, we believe growing free cash flow per share over the long term is what will maximize value for the owners of the company.

Okay. Thank you for joining us tonight. Good night.

This concludes today's conference. Thank you for your participation. You may now disconnect.