Dave Pahl - VP & Head of IR Rafael Lizardi - CFO

Adam Gonzalez - Bank of America Merrill Lynch Chris Danely - Citigroup William Stein - SunTrust Harlan Sur - JP Morgan Amit Daryanani - RBC Capital Markets John Pitzer - Credit Suisse Ambrish Srivastava - BMO Craig Ellis - B. Riley Financial

Good day and welcome to the Texas Instruments Second Quarter 2017 Earnings Release Conference Call. Today’s call is being recorded. At this time, I’d like to turn the conference over to Dave Pahl. Please go ahead, sir.

Good afternoon and thank you for joining our second quarter '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 second quarter increased 13% from a year ago. Demand for our products continue to be strong in the automotive market and continue 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 from operations was $917 million. We believe that free cash flow growth especially on a per share basis is most important to maximizing shareholder value in the long term. Free cash flow for the trailing 12-month period was $4.0 billion, and free cash flow margin was 28.5% 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 returned to owners. For the trailing 12-month period, we returned 4.1 billion 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 through 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 million from a year ago, primarily due to custom ASIC and the move of royalties to OI&E beginning in the first quarter of 2017. Now, I’ll provide some insight into this quarter’s revenue performance by end market versus a year ago. Automotive demand remains strong with most sectors growing double digits. Industrial demand continued to strengthen with broad-based growth as most factors grew double digit. 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 markets which for the end markets where we have 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 will 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 $2.37 billion or 64.3% 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 million and on a trailing 12-month basis, they were 22.3% of revenue, which is in the lower half of our model. Over the last 12 months, we have invested $1.4 billion in R&D, an important element of our capital allocation. Acquisition charges were $79 million, all of which was the ongoing amortization of intangibles, which is a non-cash expense. Operating profit was $1.48 billion, or 40.1% of revenue. Operating profit was up 31% from the year-ago quarter. Operating margin for Analog was 44.7%, up from 38.2% 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 enabled both businesses to continue to contribute nicely to free cash flow growth. Net income in the second quarter was $1.06 billion or $1.03 per share, which included $28 million discrete tax benefit above what we expected. Let me now comment on our capital management results, starting with our cash generation. Cash flow from operations was $917 million 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 our year ago and within our range. Capital expenditures were $151 million in the quarter. On a trailing 12 month basis cash flow from operations was $4.56 billion. Trailing 12-month capital expenditures were $527 million 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 $4.04 billion or 28.5% 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 second quarter, we paid $498 million in dividends and repurchased $650 million of our own stock for a total return of $1.15 billion. Total cash returned to owners in the past 12 months was $4.05 billion. Over the last 12 months, we paid $1.88 billion 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 combine returns of dividend and repurchases demonstrate our confidence in our business model and commitment to return excess cash to our owners. In the quarter we retired $375million of debt and year-to-date, we have retired $625 million. In addition, we issue $600 million in debt in two branches, $300 million each in four year and seven year notes. This leads total debt of $3.6 billion 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 $2.98 billion of cash and short-term investment, with our U.S. entities owning about 80% of our cash. This onshore cash is readily available for multiple uses. Turning to our outlook for third quarter, we expect revenue in the range of $3.74 billion to $4.06 billion and earnings per share in the range of $1.04 to $1.19, which includes an estimated $20 million discrete tax benefit. Our annual operating tax rate for 2017 is now about 31%, compared with our prior expectations of above 30% due to our outlook for higher profitability this year. This annual operating tax rate assumes no discrete items and it's what you will need to use at the starting point for your longer term model. Next, we're assuming discrete free tax items of about $20 million and $10 million in the third and fourth quarter of 2017 respectively. Therefore, the effective tax rate which include discrete tax items translate to about 29% and 30% in the third and fourth quarter respectively. These are the quarterly effective tax rates you should use for your 2017 models. I will also remind analyst who are beginning to work with 2018 model that we would expect the discrete tax benefit in 1Q '18 to be higher than what we’re projecting for the third and fourth quarter of 2017, but lower than 1Q '17. To estimate the 2018 annual operating tax rate start with 2017 PDP tax of 31% than apply a 35% tax rate to any incremental profit. Then model discrete tax benefits by quarter, knowing that first quarter 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 second 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 your questions, please limit yourself to a single question. After our response, we'll provide you an opportunity for an additional follow-up. Operator?

Thank you. [Operator Instructions] We will take our first question comes from Ross Seymore with Deutsche Bank.

This is Jerald, on behalf of Ross. Just one question from me. You detailed how your end markets change year-on-year. Could you provide some details on how you estimate they change quarter-on-quarter?

Sure, Jerald. 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 and enterprise systems are showing also good growth. Do you have a follow-on?

Yes, sure. So you talked in the past about R&D potential is being a little bit elevated in near term now you guys came in further to our model for the quarter. How much longer could R&D be elevated in order to invest in the business?

I'll take that first. I would point out that I know you are asking about R&D, but let me address it from on OpEx standpoint. We look at that OpEx as a model and our model is turning to be between 20% and 30% of revenue I mean stable times to be at the lower half of that in fact that's why we've been in the last 2.5 years here so, 23 to 22, now we are running at 22% of revenue and again in stable times we think we can operate there. Now, inside of that they are both in R&D and actually in SG&A, we have various investments that are strengthening our competitive advantages on the R&D front. We continue to focus on industrial and automotive to broad -- continue broaden portfolio. On the SG&A side, we invested on to increase the reach of our channels ci.com in particular we are thinking that we are going to continue to make those investments to strengthen the Company.

Okay, great and we will go to our next caller please.

We will go now to Vivek Arya with Bank of America Merrill Lynch.

Hi, thanks, this is Adam Gonzalez on for Vivek. First question, maybe could you contrast auto demands now versus say maybe six months ago? Anyhow industrial is an even larger market where you guys even though auto tends to get all your attention. Just wondering, did it correlate at all? Can industrial offset any potential demand fluctuations in autos? Thanks and have follow-up.

Sure, yes. So, the strength that we've seen inside of automotive is something that we've seen for probably greater than four years now. So, I'd attribute that to our early focus on that market, the breadth of our technologies and really just the overall diversity of our position. We’ve got five sectors inside of automotive that we are in investing in. So that includes infotainment safety systems, ADAS or advance driver assist systems, power train, which includes EV and hybrid and body electronics and lighting. So we are seeing good growth across those comms vectors that sit inside of the automotive market. And really also diversity, across sub-system 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 to speak to whether they'll be connected through economic cycles are not, but both do have increasing content. So, I’d be a little cautious to think that increasing content could offset correction that we may see in a 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 long-term when you’re looking five and 10 years and that’s why our investments are higher today. Do you have a follow on?

My second question is more on your free cash flow growth. I’m just curious why if you look at on a trailing 12-month basis, why free cash flow hasn't grown year-on-year despite your core NOI embedded businesses growing into 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 -- on in line with the P&L, but particularly on the cash flow -- on the cash flow statement. In this particular quarter and also on a trailing 12-month basis, but what you see there is we had an increased tax payment in 2Q ’17, that was primarily due to our outlook for higher profitability this year.

Okay. And we’ll go through the next caller please.

We will take our next question from Chris Danely with Bank of America Merrill Lynch -- excuse me with Citigroup.

I had a question on gross margin. So your revenue is basically back to it was in the third, well I guess little bit higher than it was in the third quarter last year, but the gross margins are 230 basis points higher. Can you just kind of give us the reasons why they are 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 second quarter of ’17 ended at 64.3% and that was 300 basis points higher than in the same quarter last year. And as you reflect 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 have the unique advantage of having 300 millimeter factory that at the chip level provides 40% cost advantage. As of 2016, we had about 2.5 billion of our revenue running to 300 millimeter and as we continue to grow the Company, and in this case the Analog in particular, and that growth primarily runs through 300 millimeter then we're going to accrue that benefit over and over and it's a cumulative benefit that really yield some nice results. Through the gross margin line about in more important to their free cash flow and free cash flow for share to for the owner of the Company.

Do you have follow-up, Chris?

Another thing that's going on out there at least some of your competitors have talked about their lead time extending. Is that happening at all at TI?

Chris, I described our lead times continuing to remain stable, if we do have pocket where we got a processor package, supply tightness, but we’re aggressively working those. But overall our lead times continue to remain stable.

Okay thank. We'll go to go the next caller.

We will go next to William Stein with SunTrust.

It's sort of a follow-up to the last one. We’ve heard quite a bit about shortages for complimentary products SME's in particular on the faster aside. And I'm hoping you find out, if TI is seeing any sort of tapping of its growth opportunities because customers are certainly not going to order, parts if you think they can get a full kit from all their supplier racing that dynamic play at all.

I would say in general, I'm not sure we could see that if that was there. But I'll just remind you that about 60% of our revenues are on consignment, so we got no inventory of our products sitting in front of the customer's production line that they owned. We may have position that one of our balance sheet and same thing with distributors but we actually do get demand forecast from them and those often times will be several months out, sometime even as far as six months out. And that doesn’t mean that they can't change. And I would say for that where we do have very good visibility and won't see anything unusual going on inside of there, no one usual expedites or cancellations or those types of things. Do you have follow on?

Maybe you could comment on order linearity through the quarter and book to bill?

Sure, 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 forecast. 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 will go to the next caller please.

We will take our next question from Harlan Sur with JP Morgan.

Solid job on the quarterly execution margin expansion on the outlook, clearly macro dimensions are strong in yearend markets similar to our last quarter. I'm just wondering, if you could just talk about some of the dimensions from a geographic perspective. I think last quarter you guys saw year-over-year growth in of 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 and 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 of those as well some don’t that the we attract our revenue on where we ship it, so it's not where that product is ultimately keeps in as so we may ship in to a car manufacturer or Tier 1 car manufacturer in Europe and -that's car may end-up and be sold in China as an example. So, it's really is 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 leveraged on the OpEx as you drive revenue growth? Or are there some positive mix benefit? And I'm not sure for example if some of your processes solution is going into automotive carry like higher gross margin profile?

Well, this is Rafael. What I would tell you that the driver the main driver of what you are seeing near is the revenue growth as we have a over a number of years now we've refocused our investments in embedded and now that really being up very nicely. They have embedded has a quite a bit of our investment there is in automotive and industrial just like it is in Analog and then those as we have said those are the best markets and there is that's giving very nice results.

Great. Thank you, Harlan, and will go to our next caller please.

We will take our next question from Amit Daryanani from RBC Capital Markets.

I guess two questions from me as well. First off historically that you've always talked about this 30 to 40 basis points of share gained actually on an annual basis. I'm just wondering given the inflection of R&D high over the last several quarters now, should we start to think about share gains potentially accelerating or share gains happening in place 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&D, worth allocating those to the best projects that we can find one so that we are going to produce, it get designed into the most customers into the most market and have longevity of revenue. And really mostly that's about finding better opportunities to invest in and trying to just settle the number of products as an example that we're doing. But we have found more opportunities to make investments its things as our products will live longer and repurpose products into adjacent markets that we found opportunities to be able to do that. So and I think just in general the quality of the opportunity share doesn’t shift very quickly. And so we are not penciling in an inflection point inside of our revenue. But when you look at our competitive advantages and -- I just say, just as a reminder, all four those together and the investments that we are making, and that includes the manufacturing and technology, the most visible one there is the 300 millimeter advantage that we have. The broader portfolio and just the tens of thousands of products that we’ve got the opportunity to sell more products to 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 in line with positions, all those working together, I think this is confidence that in the -- in the future that we can continue to gain share in that range 30, 40 basis points.

The only thing, I would add is, as you know we talk about it quite a bit we’ve been focusing on our industrial for quite some time now because they’ll start advance, there’s kind of benchmark that they have the highest semiconductor content growth. And we are confident that will continue to have that for -- for many years to come. So as of the end of last year 51% of our – of our revenue was automotive and industrial and obviously with the growth we are seeing year-to-date that number appears to be picking up that percentage. So that numbers increases and we continue drive in a performance on those two segments. Then mathematically overall revenue will do better.

Amit, do you have follow-on?

I do and hopefully I don’t jinx the strength right now. But last four quarters I think all you guys have been pretty much at the high end of our revenue guide that you guys initially provide. Is there a change in the way you provide guide? Or you rolled up the revenue forecast that things have actually ended up at the high for four quarters in a row? Or is it just happened to be the case?

It’s really the later, when we look at the out quarter, again we’ve got 60% of the revenues that we don’t have patterns to look at, but we can actually seeing the demand patterns that that our customers have. And that can move in both directions pretty quickly, right. So even though we got great visibility there, things can strengthen or we can very quickly on us. But we do have very, very good visibility for that 50% of our revenue. And rest of that we look at, we do look at the backlog, we look at order patterns and our sales teams provide forecast as well. So, we go through our bottoms up and tops down approach. So, the revenue guidance that we gave for the third quarter is our best estimate of what we think we’ll do. Okay.

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.

Rafael, I apologize if I missed this. But, what I think 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 offset 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 that matter, 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 in the lower half of that. So we like, you guys to think a lot that way. I would tell you though if we had anything unusual going on an OpEx, we would point that out second to third and we do not. And we also don’t have anything like vacation or compensation adjustment that sometimes or we do see fourth to first for example. We do not have that going on in a second to third concession.

Just add to that when you look at our history we had some restructuring in the last few third quarters that you may have seen that transition that Rafael stated. There is not a seasonal impact you see inside the third quarter typically. Do you have a follow-on, John?

Dave, I was wondering if you could just talk a little bit more about what you're seeing in the auto market because clearly over the last several year, it's been one of the better semis, but there have been some sort of mix data points, starts decelerating, you've seen some auto manufactures actually coming forecast in the back half of the year. So I guess how do you think about kind of solid unit growth versus content growth? And how is 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 been clear, our business has grown a very strong for four years plus now, so and that’s really due to the early investments that we had made inside of this market, 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 ending on one particular technology or one type of portion of that demand that’s increasing. And clearly I don’t think it's well know that actually content has grown faster inside auto's and if you 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 bill plan, we certainly continue to monitor those markets overall but we're confident in our long-term position there and we will continue to make those investments. Okay thank you John and we will go to the next caller please.

We will now to Ambrish Srivastava with BMO.

Sorry about that straddling two calls and I apologize if this has been answered already. In the reported quarter, did the upside comp 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 market, most geographies and even lot of the sub sectors inside of automotive and industrial.

And with that, three quarters of our growth came from industrial and automotive. So that just shows you how strong those were.

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're in an economic expansion for a while now, top of the cycle. You have metrics that you look out with your cancellations, booking and so you share them quite frequently with us. So where are we, where is TI's on those metrics Dave. Thank you.

I would say that if you look again inside of distribution, our inventory there remains at about four weeks is actually down sequentially and down from a year-ago. Our visibility in the customers inventory is of course very depending on if for on consignment or not so with our consigned OEMs were not thinking things that's unusual there such as expedite that would suggest that we have an issue, and off course our visibility and the inventory beyond with customers manufacturing operations is very little overall, so again cancellations remained low lead times continues to remain steady. So all of those metrics I think really our very similar to what we saw 90-days ago. So I think you Ambrish and I think we have time for one more call.

We will go next to Craig Ellis with B. Riley Financials.

I wanted to come back on the gross margin point so congratulations on getting to 64% in the quarter. When I look at the incremental for the quarter, it was 79%, which is above the 68% to 69% level but that it had been for the last five or six quarters, not unprecedented but look 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 million transition items that contributed to be atypical surge in the quarter?

Yes, this is Rafael. Well, we would tell you any given quarter the follow through will be a little different. In our company the size of ours are there is just a lot of puts and takes inside this big P&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 are in a continue increasing our GPM percent for a forcible future. And those are the quality of their portfolio as we continue to focus on the best market that are more even an industrial and the diversity and possessions and long live possessions that we get with those where we invest our R&D today and we get the revenue for decades to come. And then the other piece is 300 millimeter Analog as stated earlier that is 40% more cost efficient than 200 millimeter. And that accurse me and you starting one part on that and then in the next part you started on 300 and the third part and the fourth part and you making it all a bigger percent in terms of your company's is running on 300 millimeter and it was only the 30% as of 2016 and the 30% of the capacity we have on 300 which used. So we have ample room to continue growing 300 millimeter and accrue benefits to the Company.

Do you have a follow on?

Yes, thank you. Just regarding the end market color you provided in response to earlier question Dave. Comps are going to be flattish quarter-on-quarter. Can you just what pressure maybe in terms of where that the Company stands with respect to how it's looking at comps from a strategic standpoint and where you see demand is as we look around and look at 4G infrastructure investments being made globally? Thank you.

Sure. Yes, so comps equipment is 13% of our total revenue the viral or debt infrastructure will be sector inside of that which tends to take a lot of the calls it's more than half of that end market owned by itself so pricing more in the mid-single digits as a percentage of our revenue. And you know there I think when we look at incremental dollars of where we are investing. And if I refer you back to our capital management call that we get stay back in February, we talked about the fact that we wanted to increase incrementally dollars in both the industrial and automotive market because that’s where we believe the growth will be. With communications equipment, I would say that we got some caveats depending on which business we are looking at. In Embedded, I would say that those investments are down versus where say where maybe five years ago. But on the same view inside of Analog, they're actually up because the some of the complexity that, 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 is going to be significant growth, we don’t know if any carriers that want to take up the CapEx over the next 5 and 10 years, over a long period of time. So, thank you for that question, Greg 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.