Texas Instruments (NASDAQ:TXN) is not a stock for the thrill seekers of Wall Street. The semiconductor veteran often provides more guidance than investors might expect, and significant earnings surprises from TI are rare.
But that does not mean investors should turn down the volume on TI earnings calls. CFO Kevin March and investor relations chief Dave Pahl like to shine new light on burning topics, both financial and technical. Investors and analysts always walk away from the quarterly calls with some fresh insights into how the company works.
Consignment-style inventory management
Weeks of inventory decreased by a week from a year ago to a historically low level of just under 4.5 weeks. This level has decreased over the past few years because we've structurally changed how our inventory is managed in the distribution channel with our consignment program.
This quarter, we continued to support more of our distribution sales from consignment inventory and now have about 60% of our distribution revenue on consignment, up about 15 percentage points from a year ago. With this program, inventory sits on TI's balance sheet and revenue is recognized when our distributors pull products from our consignment inventory that's stored at the distributor's location.
We carry higher loads of inventory on TI's balance sheet with this program, which has several benefits such as minimizing impact due to changes in distribution channel inventory and giving us greater flexibility to meet customer demand.
-- Dave Pahl
This is a radical change from the hub-and-spokes distribution model that TI and other semiconductor makers have been depending on in the past. The new consignment model gives TI a closer view of channel demand and a more direct route to the final customer.
On the downside, Texas Instruments is allowing its balance sheet to look untidy with seemingly bloated inventory levels. Not the worst crime against sensible management I have ever seen, but there is always a stickler investor ready to protest every detail.
The Chinese opportunity
We've been in China for a very long time now. We have, I think, over a dozen sales and R&D sites there. We have both a wafer fabrication facility and an assembly test site there. In addition, we have thousands of customers buying thousands of parts and consequently, we've become a very important supplier to a large number of Chinese companies across a very diverse set of markets.
So we see China as continuing to be a great opportunity for TI regardless of any of the competitive environments out there. Our goal is to operate in China just like we do in the rest of the world, which is to make ourselves an integral part of their success and an indispensable supplier. We're a long way into that already, and we feel pretty good about our position.
-- Kevin March
That is a worthy goal indeed -- 42% of the total revenues already come from buyers in China and Hong Kong. Putting your chip-building and distribution centers close to the massive device manufacturing hubs in China can build the TI order book very quickly. So the next time Apple or Samsung need an analog chip or embedded processor for their newest gadgets, Texas Instruments might stand out as not only a proven product innovator but also a convenient supplier to Chinese manufacturing centers.
The book-to-bill ratio ain't what it used to be
There was a slight change in our book-to-bill on a year-over-year basis.
This quarter was about 0.97. A year ago quarter was 0.94, but frankly because more and more of our orders are coming in on consignment, I think book-to-bill means less and less about where our revenue is going.
-- Kevin March
Book-to-bill ratios help investors understand the money flow through manufacturing businesses. A figure above 1.0 means that order bookings are coming in faster than the company can manufacture, ship, and send invoices to its customers. That is a good thing, and it gives investors a sense of strong revenue visibility for upcoming quarters.
Here, Kevin March noted that the TI book-to-bill ratio sits very close to the important 1.0 level on an upward trend but then asks investors to forget about this good news.
The consignment model is undermining the importance of this metric, since TI tends to fill orders on shorter notice this way. An ideal, 100% consignment sales model would set this figure at exactly 1.0 for all eternity, since incoming orders would get filled and billed right away.
TI will never reach this model of absolute perfection, but the consignment idea can take the air out of this venerable metric anyhow. I will continue to keep an eye on book-to-bill figures as long as TI keeps reporting them, but it is no longer a top priority.
Strategic investments are paying off
You may recall back in late 2010 early 2011 timeframe, we significantly stepped up our investments in [embedded processing] in order to accelerate our product introductions and therefore begin to accelerate our revenue growth. If you take a look at what's happened over the last nine quarters of sequential or continuous year-over-year growth, that strategy has paid off.
So those products are really beginning to take. And as you know, those kinds of products tend to have very long shelf lives, so we expect to see more of the same on that.
-- Kevin March
If you are playing keyword bingo at home, "embedded processing" is often a code name for the Internet of Things. Several years back, TI stepped up its investment in products for this market, and it has started reaping the benefits of that decision.
In the fourth quarter, embedded revenues rose 11% year-over-year. Operating margins more than doubled over the same period as the growth investments from years past result in economies of scale today. March expects margins to continue improving right alongside growing embedded sales volumes. Its R&D investments should drive top-line growth while overhead expenses stay flat.
So, Texas Instruments is heavily involved in the Internet of Things, which is perhaps the most exciting end market for semiconductors today. And it is moving the needle in a big way.
Bonus: Capital management and free cash flows
Two of our three levers for expanding free cash flow per share have been working for us [over the last 10 years], resulting in a 13% compound annual growth rate to free cash flow per share. Our first lever has actually been neutral, in that we have experienced no top-line growth as we shifted our portfolio to Analog and Embedded. With our second lever, we have expanded free cash flow margin through our product mix, 300 mm production, and opportunistic capacity additions, resulting in a very low CapEx spending. And for our third lever, we have made steady accretive stock repurchases, resulting in 39% fewer shares outstanding.
Looking forward, we expect all three levers to be working for us as we work to continue to expand our free cash flow per share. We now expect top-line growth to resume. We expect free cash flow margin to continue to improve to 30% of revenue on a sustainable basis on continued 300 mm expansion and model levels of CapEx, and we expect to continue share repurchases as long as the economics continue to make sense.
-- Dave Pahl
So, the company sees three ways to improve its free cash flows, and two of those have been working in its favor over the last decade. Here is what it looks like in chart form, and it is actually kind of beautiful:
With these two metrics pulling cash flows in the right direction, TI would love to accelerate the whole trend with growing revenues as well. As a reminder, the growth in analog and embedded components has been neutralized by TI moving out of legacy markets such as wireless signal processors.
The wind-down of legacy products has nearly run its course, removing a lead weight from TI revenue growth. Now it is up to the company to execute on its core operations in embedded and analog components. The legacy headwinds will not be there to hold back sales growth much longer -- or to give management an easy excuse if top-line sales do not meet expectations.