Texas Instruments Q3 2021 Earnings Report

Texas Instruments EPS Results

• Actual EPS: $2.07
• Consensus EPS: $2.06
• Beat/Miss: Beat by +$0.01
• One Year Ago EPS: $1.45

Texas Instruments Revenue Results

• Actual Revenue: $4.64 billion
• Expected Revenue: $4.67 billion
• Beat/Miss: Missed by -$27.81 million
• YoY Revenue Growth: +21.50%

Texas Instruments Announcement Details

• Quarter: Q3 2021
• Date: 10/26/2021
• Time: After Market Closes
• Conference Call Date: Monday, October 25, 2021
• Conference Call Time: 8:00PM ET

Texas Instruments (NASDAQ:TXN) Inc. (NASDAQ: TXN) is a global semiconductor company headquartered in Dallas, Texas, that designs and manufactures analog and embedded processing chips. The company’s products are used across a wide range of end markets, including industrial, automotive, personal electronics, communications and enterprise equipment. TI’s business emphasizes components that condition, convert, manage and move electrical signals—capabilities that are foundational to modern electronic systems.

TI’s product portfolio includes a broad array of analog integrated circuits—such as power management, amplifiers, data converters and interface devices—as well as embedded processors and microcontrollers used to control systems and run real-time applications. Beyond silicon, the company provides software development tools, reference designs and documentation to help customers integrate its components into finished products. TI designs and manufactures many of its own devices and sells through a mix of direct channels and distributor partnerships to serve customers of varying size and geographic scope.

With roots dating back to Geophysical Service Incorporated in 1930, Texas Instruments has a long history in electronics and semiconductor innovation; an early milestone was the invention of the integrated circuit by Jack Kilby at TI in 1958. The company operates globally, supporting customers and manufacturing activities around the world, and is led from its Dallas headquarters by an experienced executive team and board of directors. TI’s strategy centers on leveraging its process and analog design capabilities to serve broad, durable markets that require reliable, high-volume semiconductor solutions.

Texas Instruments Q3 2021 Earnings Call Transcript

Key Takeaways

• Q3 revenue of $4.6 billion, up 1% sequentially and 22% year-over-year, driven by strength in industrial, automotive, and personal electronics.
• Gross margin reached 68% (+360 bps YoY), operating profit rose 43% YoY, and net income was $1.9 billion (EPS $2.07).
• Lead times remain extended with supply hotspots, and inventory days at 112 are below the 130–190-day target, leading customers to make more selective expedite requests.
• Trailing-12-month free cash flow was $7.1 billion; dividend increased 13% (18th consecutive year) and $4.2 billion returned to shareholders over the past year.
• Investing in RFAB II and 300 mm fabs (including Lehigh acquisition) to expand capacity with higher CapEx; Q4 guidance is $4.22–$4.58 billion revenue and $1.83–$2.07 EPS.

Presentation

[Operator]

Good day, and welcome to the Texas Instruments Q3 2021 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.

[Dave Pahl, VP and Head of Investor Relations at Texas Instruments]

Good afternoon, and thank you for joining our Third Quarter 2021 Earnings Conference Call. 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. Our Chief Financial Officer, Rafael Lizardi, is with me today and will provide the following updates. First, I'll start with a quick overview of the quarter.

[Dave Pahl, VP and Head of Investor Relations at Texas Instruments]

Next, I'll provide insight into third quarter revenue results with some details of what we're seeing in respect to the customers and markets, and I'll also provide details by end market, including some sequential performance as we have the last few quarters. As sequential data begins to be less insightful, we'll move back to reporting only year-over-year per our normal practice. Lastly, Rafael will cover the financial results, an update of our capacity expansion plans, and our guidance for fourth quarter 2021. Starting with a quick overview of the quarter. Revenue in the quarter was $4.6 billion, an increase of 1% sequentially and 22% year-over-year, driven by demand in Industrial, Automotive, and Personal Electronics. On a sequential basis, Analog grew 2%, Embedded Processing declined 5%.

[Dave Pahl, VP and Head of Investor Relations at Texas Instruments]

On a year-over-year basis, Analog revenue grew 24%, and Embedded Processing grew 13%. Our Other segment grew 19% from the year ago quarter. Now let me comment on the current environment to provide some context of what we're seeing with our customers and markets. Overall, the quarter came in generally as we expected across product segments and markets and geographies. Lead times for the majority of our products remained stable, but hotspots continued to exist. However, customers are becoming more selective in their expedite requests, focusing on products that complete a matched set rather than expediting products across the board. This behavior is not specific to any product family, end market, or geography.

[Dave Pahl, VP and Head of Investor Relations at Texas Instruments]

Discussions with customers confirm a high-level interest in our commitment to expanding our internal manufacturing capacity roadmap, including 300 millimeter wafer fabs, RFAB2 in Lehi, or what we call LFAB, and the associated assembly test expansions. These investments to strengthen our manufacturing and technology competitive advantage will provide lower costs and greater control of our supply chain. While there is a growing recognition that the near-term supply-demand imbalance will end at some point, the secular growth of semiconductor content per system will continue to grow, and this requires a robust manufacturing capacity roadmap for 2025 and beyond. Moving on, I'll provide some insight into our third quarter revenue by end market. First, the industrial market was down mid-single digits sequentially and up about 40% from a year ago. The changes both sequentially and from a year ago were generally consistent across the diverse set of sectors.

[Dave Pahl, VP and Head of Investor Relations at Texas Instruments]

The automotive market again grew sequentially and was up more than 20% from the year ago. When comparing to pre-pandemic levels of Q4 2019, revenue is up almost 30%. Personal electronics grew low double digits sequentially and was up low double digits compared to a year ago. The strength sequentially and the year ago was due to mobile phones, PC notebooks, and tablets. Next, communications equipment was down mid-single digits sequentially and was down upper teens from a year ago. Enterprise systems grew sequentially and from the year-ago quarter. Rafael will now review profitability, capital management, and our outlook.

[Rafael Lizardi, SVP and CFO at Texas Instruments]

Thanks, Dave, and good afternoon, everyone. As Dave mentioned, third quarter revenue was $4.6 billion, up 22% from a year ago. Gross profit in the quarter was $3.2 billion or 68% of revenue. From a year ago, gross profit margin increased 360 basis points. Operating expenses in the quarter were $800 million, up 1% from a year ago and about as expected. On a trailing twelve-month basis, operating expenses were 18% of revenue. Over the last twelve months, we have invested $1.6 billion in R&D. Acquisition charges and non-cash expense were $47 million in the third quarter and will go to zero beginning in fourth quarter of 2021. Operating profit was $2.3 billion in the quarter, or 50% of revenue.

[Rafael Lizardi, SVP and CFO at Texas Instruments]

Operating profit was up 43% from the year-ago quarter. Net income in the third quarter was $1.9 billion or $2.07 per share. Let me now comment on our capital management results, starting with our cash generation. Cash flow from operations was $2.4 billion in the quarter. Capital expenditures were $486 million in the quarter. Free cash flow on a trailing twelve-month basis was $7.1 billion. In September, we announced we would increase our dividend by 13% effective this month, marking our eighteenth consecutive year of dividend increases. In the quarter, we paid $942 million in dividends and repurchased $139 million of our stock. In total, we have returned $4.2 billion in the past twelve months.

[Rafael Lizardi, SVP and CFO at Texas Instruments]

Over the same period, our dividend represented 53% of free cash flow, underscoring its sustainability. Our balance sheet remains strong with $9.8 billion of cash and short-term investments at the end of the third quarter. In the quarter, we've issued $1.5 billion of debt in three tranches of $500 million each. The first has a coupon of 1.125%, which is due in five years, the second at 1.9% due in ten years, and the last at 2.7% due in thirty years. This resulted in total debt of $7.8 billion with a weighted average coupon of 2.6%.

[Rafael Lizardi, SVP and CFO at Texas Instruments]

Regarding inventory, TI inventory dollars were up $7 million from the prior quarter, and days were 112, up 1 day sequentially, but still below desired levels. For the fourth quarter, we expect TI revenue in the range of $4.22 billion-$4.58 billion, and earnings per share to be in the range of $1.83-$2.07. The Lehi acquisition closed last Friday, but the costs are not included in our guidance. We will provide those details when we report fourth quarter results. Just as a reminder, the purchase price was about $900 million, and we expect ongoing costs of about $75 million per quarter through 2022.

[Rafael Lizardi, SVP and CFO at Texas Instruments]

We continue to expect our annual operating tax rate for 2021 to be about 14% and our effective tax rate to be about 13%. As you are looking at your models for 2022, without any changes to tax law, we would expect our annual operating and effective tax rates to remain about what they are this year, with a similar quarterly profile of discrete tax benefits that are higher in the first quarter compared to the rest of the year. In closing, we continue to invest to strengthen our competitive advantages and in making our business stronger. Our investments in our long-term roadmap for capacity expansion, both in LFAB and RFAB2 are great examples. As a reminder, our CapEx will be higher on an absolute level as well as a percentage of revenue as we strengthen this advantage.

[Rafael Lizardi, SVP and CFO at Texas Instruments]

We are working through detailed plans of our long-term roadmap, and we'll have specifics of timing and CapEx spending in our capital management call in February. We continue to believe owning and controlling our supply chain will be of growing strategic importance. With that, let me turn it back to Dave.

[Dave Pahl, VP and Head of Investor Relations at Texas Instruments]

Thanks, Rafael. Operator, you can now open the lines up for questions. In order to provide as many of you as possible an opportunity to ask a question, please limit yourself to a single question. After our response, we'll provide you an opportunity for an additional follow-up. Operator?

[Operator]

Thank you. If you would like to ask a question, please signal by pressing star one on your telephone keypad. If you're on speakerphone, please make sure your mute function is turned off to allow your signal to reach our equipment. Again, press star one to ask a question. We'll pause just a moment to allow everyone an opportunity to signal for questions. We will go first to John Pitzer of Credit Suisse.

[John Pitzer, Managing Director at Credit Suisse]

Yeah, good afternoon, guys. Thanks for letting me ask a question. Dave, I know in this sort of environment, seasonality doesn't make a lot of sense, but when you look at the September quarter, I'm just kind of curious. The June quarter came in well above your guidance range. September was well above the midpoint, but still within the guidance range. We're hearing of logistical constraints and supply constraints across the economy. I'm kind of curious, when you look at sort of the lower level upside in the September quarter versus the June quarter, to what extent might have that been supply constraints outside of your control? To what extent do you think it's customers just being more selective about what they're pulling from you? Any color there would be helpful.

[Dave Pahl, VP and Head of Investor Relations at Texas Instruments]

Sure, John, and thanks for the question. Yeah, I really think it depends on the customer's bill of material. I think that there are supply constraints that are, you know, widely reported across the different components. You know, as we, you know, mentioned in our prepared remarks, you know, the behavior that we're seeing that's different, our customers are showing up and requesting, you know, when we have meetings with them, rather than showing up with long lists of devices that they're asking us to expedite, they're really just short lists. They're looking for, you know, particular parts that complete those match sets so that they, you know, can complete those builds for them. It is a different behavior that we're seeing this quarter versus the prior quarters.

[Dave Pahl, VP and Head of Investor Relations at Texas Instruments]

John, follow on?

[John Pitzer, Managing Director at Credit Suisse]

Yeah, just as a follow-on, I know you're gonna give us more color about LFAB expenses and RFABs expenses as we get into next year. I'm wondering if you could just help us set the stage a little bit. Next year is obviously gonna be kind of a capacity build-out year for you. I guess all else being equal, how should we think about the gross margin impact on calendar year 2022 as you layer in these investments?

[Rafael Lizardi, SVP and CFO at Texas Instruments]

Yeah. I'll take that one. First, you know, as you know, you've known us for a long time, we don't manage the business through gross margins. We manage for the long-term growth of free cash flow per share, and that starts with driving the top line. That's why we're making these investments, right? To support revenue growth, and as we do that is extending our low-cost manufacturing advantage that gives us the great structural cost advantage with 300mm. In addition to that, we're controlling the supply chain. Specifically on your question, you know, take RFAB2, all in, that's about a $6 billion expense. About $1 billion of that is the building which, you know, depreciates over 30 years or so.

[Rafael Lizardi, SVP and CFO at Texas Instruments]

The balance of the rest is equipment and we're gonna be putting in that equipment starting next year and over the coming years. With LFAB, obviously a $900 million purchase price, and that, some of that is building, some of that is equipment. Then on top of that, we'll put about $3 billion of CapEx over a number of years as we ramp that up. We'll give you additional details on that and the bigger, longer-term picture of how we're gonna support that, the longer-term growth. We'll give you those details in February at the capital management call.

[Dave Pahl, VP and Head of Investor Relations at Texas Instruments]

Okay. Thank you, John. We'll go to the next caller, please.

[Operator]

We'll go next to Timothy Arcuri of UBS.

[Timothy Arcuri, Managing Director at UBS]

Hi, thanks. Rafael, I was wondering if you could talk about pricing. You know, obviously you're seeing some, you know, increases in your input costs. Can you talk about, you know, whether you're passing those on to customers and sort of how ubiquitous any, you know, price increases on, you know, your side might be?

[Rafael Lizardi, SVP and CFO at Texas Instruments]

Yeah. What I would tell you know, our strategy on pricing has not changed. We regularly monitor that, and our goal is to be competitive. It's really frankly independent of the input cost to the largest degree. Our goal is to be competitive and if prices move higher, we adjust those over time, and we have been adjusting those over time.

[Dave Pahl, VP and Head of Investor Relations at Texas Instruments]

You have a follow-up, Tim?

[Timothy Arcuri, Managing Director at UBS]

I did, Dave. Thanks. I guess I'll ask the same question that I've asked the last, I think, three calls about share repo. It was pretty low again. I guess, is there sort of can you help us think through maybe what the triggers might be for you to start to buy back more stock? Is there a target cash level where maybe you'd say that the balance sheet is getting a little bit overcapitalized and you'd start to, you know, buy back more stock? I'm just kind of, you know, obviously you're not buying back much, but I'm just kind of wondering if you can talk us through what triggers you might be looking for to start that back again. Thanks.

[Rafael Lizardi, SVP and CFO at Texas Instruments]

Yeah. You know, stepping back and just to remind everybody how we think about returns, our objective is to return all free cash flow to the owners of the company over the long term, and we do that through dividends and buybacks. You look at our 18-year history on that, and it's really consistent. In fact, many years, most years, we've averaged well over 100% of return. You know, during that time, we have, I would remind you, we have increased the proportion of the return that comes into dividends. That also plays into that. You know, as long as we think the buybacks are accretive to our long-term owners, we're gonna have some buybacks.

[Rafael Lizardi, SVP and CFO at Texas Instruments]

As you have seen, as you pointed out, the last three quarters, we have, in fact, I don't think there's been a single quarter in the last eighteen years or so that we have not purchased, returned cash to the owners through buybacks in one form or another.

[Dave Pahl, VP and Head of Investor Relations at Texas Instruments]

Okay. Thank you, Tim. We'll go to the next caller, please.

[Operator]

We'll go next to Harlan Sur of JPMorgan.

[Harlan Sur, Executive Director of Equity Research at JPMorgan]

Good afternoon. Thanks for taking my question. On finished goods inventory, most of which I assume is sitting at customer consignment hubs, this has come down faster than overall inventories, right? Finished goods dropped 8% sequentially in Q3, dropped 9% in Q2. They're down 25% from the beginning of this year and down 33% pre-COVID-19, I assume, due to the strong demand profile from your direct customers. How far below normal are consignment inventories relative to your customers' target levels? And is part of the muted Q4 outlook to replenish these very low inventories, or does the demand profile backlog and forecast actually reflect a sequential decline here in the fourth quarter?

[Rafael Lizardi, SVP and CFO at Texas Instruments]

I'll start, and Dave, you want to chime in after that. I think where you're going with that, let me maybe step back. Obviously, inventory levels are below desired levels, right? We're at 112 days. Our target is 130-190 days. You know, clearly we're well below where we wanna be. Inside of that, as you pointed out, finished goods, all finished goods, whether it's in consignment or at our product distribution centers, are the ones that are decreasing most. In fact, even though total inventory levels stayed about flat, slightly up second to third quarter, finished goods decreased, and then WIP and raw materials increased a little bit to offset that.

[Rafael Lizardi, SVP and CFO at Texas Instruments]

You know, our goal, as soon as capacity increases or there's an adjustment in demand, we will build those inventory levels back up to be at more healthy levels. Given our business model, it's just a great bet just given the low obsolescence of our inventory, the diversity of positions, diversity of products that we can afford. Not only we can afford, it makes sense for us to build that inventory, have it ready for the secular growth that we're confident will happen beyond that. You know, I think maybe tactically where you are going on consignment inventory, frankly, those tend to be pretty lean to begin with. That's how that process is designed to just keep a couple weeks.

[Rafael Lizardi, SVP and CFO at Texas Instruments]

I wouldn't expect that by itself to build significantly, purely consignment. What I would expect the build to happen is more at our product distribution centers, and that gives us more flexibility to then ship where the demand is most needed.

[Dave Pahl, VP and Head of Investor Relations at Texas Instruments]

Yeah.

[Rafael Lizardi, SVP and CFO at Texas Instruments]

Do you have?

[Dave Pahl, VP and Head of Investor Relations at Texas Instruments]

No, I think that's well said. I think just tactically where we whether we keep it in our hubs where we would prefer it, or you know, if we push it out to a consignment center, that'll just be reflective of our expectation that a customer will pull it. So that's just a tactical decision. I'd also point out that as you said, Rafael, we do plan to bring on more capacity incrementally as we have each quarter through this year and through the middle of next year. In the back half of 2022, RFAB2 will come online, and then that'll be followed by LFAB, since, as Rafael pointed out, we did close on that factory on Friday of last week. That is on target to come online in early 2023 to support growth in the future. Did you have a follow on, Harlan?

[Harlan Sur, Executive Director of Equity Research at JPMorgan]

Yeah. Thanks. I appreciate the insightful answer. Yeah. Exiting last year, the direct business, which includes consignment, that was about 65% of revenues. Where does that mix roughly sit today? And did the team drive a positive book-to-bill ratio in Q3, if you could maybe quantify?

[Rafael Lizardi, SVP and CFO at Texas Instruments]

On the book-to-bill, we don't think that's relevant, frankly. Mateo haven't disclosed that in a while, and we're not disclosing that anymore. On your first question on percent, I think you asked % of our revenue from consignment, is that right?

[Dave Pahl, VP and Head of Investor Relations at Texas Instruments]

Yeah, I didn't quite.

[Rafael Lizardi, SVP and CFO at Texas Instruments]

Yeah, that's the first one.

[Dave Pahl, VP and Head of Investor Relations at Texas Instruments]

Could you just repeat it to Harlan so we make sure we got it right, what you were asking on the first question?

[Rafael Lizardi, SVP and CFO at Texas Instruments]

Harlan, are you there?

[Harlan Sur, Executive Director of Equity Research at JPMorgan]

Yeah.

[Rafael Lizardi, SVP and CFO at Texas Instruments]

No.

[Harlan Sur, Executive Director of Equity Research at JPMorgan]

Just percentage of

[Rafael Lizardi, SVP and CFO at Texas Instruments]

I think.

[Harlan Sur, Executive Director of Equity Research at JPMorgan]

the overall direct business.

[Dave Pahl, VP and Head of Investor Relations at Texas Instruments]

Direct business.

[Harlan Sur, Executive Director of Equity Research at JPMorgan]

Oh.

[Dave Pahl, VP and Head of Investor Relations at Texas Instruments]

We left last year with about two-thirds of our revenues direct. You know, we expect that percentage will increase over time. You know, we'll provide an update of what we've done with that this year in our February CapEx management call in February of actually what that looks like. Just to say over time that we do expect that will move up, you know, slightly over time. Just the other color with Rafael talking about book-to-bill, as we've got a lot of our revenue on consignment, we've got ti.com, you know, the actual backlog isn't quite as meaningful as what it used to be.

[Dave Pahl, VP and Head of Investor Relations at Texas Instruments]

As he said, it's just not a number that we look at or measure or we've talked about in some time, so it isn't quite as helpful as what it used to be. Thank you, Harlan. We'll go to the next caller, please.

[Operator]

We'll go next to Stacy Rasgon of Bernstein Research.

[Stacy Rasgon, Managing Director and Senior Analyst at Bernstein Research]

Hi, guys. Thanks for taking my questions. For the first one, I wanted to ask about the near-term Micron impact. I know you said $75 million in cost impact in the model next year. Those costs don't go away, right? That's $75 million a quarter is people, correct? Doesn't include depreciation.

[Rafael Lizardi, SVP and CFO at Texas Instruments]

Yeah.

[Stacy Rasgon, Managing Director and Senior Analyst at Bernstein Research]

Anything else, is it just people? Like, how do you think about that, like what that incremental cost long term?

[Rafael Lizardi, SVP and CFO at Texas Instruments]

Very good, Stacy, good direct question. Yes, that $75 million is mainly people and direct costs, not depreciation. Depreciation will not start until about first quarter 2023 when we start production, just the way the rules work on that front. That $75 million, we're still working through the details, but we currently believe that the most likely scenario is that most of that cost will go through the restructuring charges/other line until we start production, right? At that point, the majority of the cost would go to the COR line. Now, the costs actually do increase over time as we increase production, right? I think where you're going is that as that happens, and those costs are then absorbed by revenue, right?

[Rafael Lizardi, SVP and CFO at Texas Instruments]

Now how quickly those are absorbed beyond underutilization, et cetera, that just depends how quickly we ramp that factory, right? You know, clearly at the beginning there won't be, you know, 100% absorption, and we'll get to that at some point. We'll, you know, we're not gonna, you know, that's in 2023, so we'll get to that at some point to give you some details. In February at the capital management call, I think we'll frame it, kind of the bigger picture of that, along with our other CapEx investments, and you'll get a better sense of how that's gonna play out.

[Dave Pahl, VP and Head of Investor Relations at Texas Instruments]

You have follow on, Stacy?

[Operator]

It looks like Stacy has disconnected.

[Rafael Lizardi, SVP and CFO at Texas Instruments]

Okay.

[Dave Pahl, VP and Head of Investor Relations at Texas Instruments]

All right. Okay. If you have a follow-on, let us know, Stacy. We'll go to the next caller, please.

[Operator]

We'll go next to Ross Seymore of Deutsche Bank.

[Ross Seymore, Managing Director at Deutsche Bank]

Hey guys, thanks for letting me ask a question. Dave and Rafael, I want to talk about the quarter you reported and get into some of the supply-demand dynamics. It was the smallest beat to your original revenue guidance you guys have had in a year, and I realize that it's been exceedingly volatile in the last year. I wondered, was that the demand profile changing from those inventories, that selectivity changing that you're talking about? Or did supply play a role in that, where you just couldn't meet up to the demand? Just trying to get what really changed versus whatever level of conservatism you had built into the prior quarters when you beat by bigger deltas.

[Dave Pahl, VP and Head of Investor Relations at Texas Instruments]

Yeah. You, I think you said demand from investors. I think you meant to say demand from customers, right, Ross?

[Ross Seymore, Managing Director at Deutsche Bank]

Yes. Sorry about that.

[Dave Pahl, VP and Head of Investor Relations at Texas Instruments]

Yeah. No, that's okay. Certainly if any investors wanna buy semiconductors from us, we'll be happy to sell them. Yeah. I, you know, I'd just say that overall the quarter, you know, came in as we expected it to, right? That's a statement, you know, as we said in the prepared remarks, and we looked across geographies and products and product groups and end markets, you know, those types of cuts. There wasn't like one area that was underperformed or outperformed what we were expecting. Again, the main thing of what was different this quarter versus last quarter was really where customers were coming in and requesting expedites and upsides from us.

[Dave Pahl, VP and Head of Investor Relations at Texas Instruments]

Those upsides were much, much more narrow and focused just on a few products. That was really what the difference was. If you're looking for, you know, what was different this quarter versus last quarter and those types of things, that's what I would point to say, you know, what's changed in the last 90 days.

[Ross Seymore, Managing Director at Deutsche Bank]

Thanks for the help on that.

[Dave Pahl, VP and Head of Investor Relations at Texas Instruments]

Yeah.

[Ross Seymore, Managing Director at Deutsche Bank]

I guess as my follow-up, a similarly toned question. You mentioned that lead times remain extended but are stable, and then you talked about that whole selectivity dynamic. What would you imagine would change the lead times? Is it gonna be your supply incrementally rising or more so with Lehi? Or is the selectivity something as you guys look back and are students of cycles, is the demand side and that selectivity side more likely to impact the lead times going forward?

[Dave Pahl, VP and Head of Investor Relations at Texas Instruments]

Well, as you know, and you've been through many cycles with us, right? It's always a combination of both. You know, we will continue to add the incremental capacity as we have planned for, you know, some time. You know, certainly as we go out in time, as we get the bigger tranches of capacity coming on with our fab two and then LFAB, you know, we'll be able to make more progress on that front. At some point, you know, we know that, you know, things will change from a demand standpoint. So we, you know, we don't spend time trying to predict that, but we'll be ready for it. We know what we'll wanna do.

[Dave Pahl, VP and Head of Investor Relations at Texas Instruments]

You know, as Rafael talked about, you know, one of the top things there is we'll want to rebuild inventory to prepare for the next time that the demand strengthens. We have a long list of things that we're doing to invest in the company to make it stronger. You know, we won't control the timing of that, but we'll be ready for it for sure.

[Rafael Lizardi, SVP and CFO at Texas Instruments]

Just to emphasize that point, right? When that adjustment happens, whenever that is, we will continue investing in R&D, focus on the areas, auto and industrial, for the secular and long-term growth. We'll continue to invest on CapEx, and to set up the company for the next 10-15 years, with a great long-term roadmap. We will build inventory. That's what, as Dave mentioned, our range is 130-190 days. Frankly, we'll probably end up being at the higher end of that range just because we feel so good about the business model and how good that inventory will be, and how it sets us up for the next upturn on the other side, given the long lead nature of that inventory.

[Dave Pahl, VP and Head of Investor Relations at Texas Instruments]

That's right. Yeah. Okay. Thank you, Ross. We'll go to the next caller, please.

[Operator]

We'll go next to Vivek Arya of Bank of America.

[Vivek Arya, Managing Director at Bank of America]

Thanks for taking my question. I just want to get the supply side right. Are customers not ordering as much from you because they don't have enough from you on the component side, or they don't have enough from others that they need to complete their bill of materials?

[Dave Pahl, VP and Head of Investor Relations at Texas Instruments]

It's both, Vivek. You know, there are instances of both of those. And sometimes it's not even semiconductors, right? It's maybe other components that they may be missing. Yeah, it's a combination of those things. You know, supply chains are complex. Depends on the bill of materials and the systems that they're building. It depends.

[Rafael Lizardi, SVP and CFO at Texas Instruments]

Yeah. Vivek, the nuance change is, you know, 90 days ago, 180 days ago, they were expediting everything, almost regardless of matched set position. Now they're more selective in what they're expediting, right?

[Dave Pahl, VP and Head of Investor Relations at Texas Instruments]

Follow on, Vivek?

[Vivek Arya, Managing Director at Bank of America]

Yes. Thank you. Could you talk specifically to the automotive market? You know, this year it's clear the production has not been all that strong. But auto semiconductor sales have been pretty strong. So as it applies to TI, what do you think has been kind of the interplay between content and mix? Or do you think that there is perhaps inventory stuck in the automotive supply chain somewhere that we should watch out for?

[Dave Pahl, VP and Head of Investor Relations at Texas Instruments]

Yeah. I, you know, I'll comment on automotive. I think I'll even extend it into industrial. You know, those are two markets that we have long talked about that we believe that there is content growth in those markets, content per system. It's easy to see in cars and, you know, well reported on. I know, Vivek, in your reports that you've reported on that, the content growth. You can see it in automotive. It's happening in industrial across 13 different sectors, so harder to see. You know, we invest in all the markets, but we have a strategic focus on automotive and industrial. So you're beginning to see some of the benefits of those, that strategic bias that we have.

[Dave Pahl, VP and Head of Investor Relations at Texas Instruments]

Our channel advantages, the breadth of our products, advantages in those markets as well. There's components of that. That said, any time that we have supply shortages in the industry, customer behavior is always very consistent. That behavior is that they will wanna build inventory to protect themselves. You know, whether they've already begun that or have already done that, they certainly will want to do that. At some point they'll have too much product, and that's what creates the cycles in our industry. You know, it won't surprise us if the cycle comes to an end at some point. We'll be prepared for that, and we'll know what we'll wanna do at that point.

[Dave Pahl, VP and Head of Investor Relations at Texas Instruments]

Thank you for those questions, and we'll go to the next caller, please.

[Operator]

We'll go to Joe Moore of Morgan Stanley.

[Joe Moore, Managing Director at Morgan Stanley]

Great. Thank you. I wonder if you could talk to the hotspots. You know, is there any particular pattern that's driving which products you have in short supply? I mean, it seems like, you know, we see it most in areas like enterprise and some of the personal electronics, you know, higher volume stuff. Is that something that you guys would agree with? Do you think, you know, is there more foundry versus internal fabs? Like, is there anything in particular driving those hotspots?

[Dave Pahl, VP and Head of Investor Relations at Texas Instruments]

Yeah, I wouldn't put it down on any one thing, Joe. Certainly, you know, there's, you know, reports of the tightness across foundries, so obviously we see that as well. There's tightness in some lead frames, so, you know, we see that as well. Other input, you know, raw materials, mold compounds, we have, you know, testers in some cases, some process technologies, some particular products themselves that have a large number of customers. Those hotspots move around as our operations teams will sometimes move capacity from one area to the other. They're not always consistent or persistent.

[Dave Pahl, VP and Head of Investor Relations at Texas Instruments]

Sometimes they are, but sometimes they're not, and there's things that we can do to mitigate those or actually completely alleviate them. That's why as we describe them, you know, it's not just one particular product area or one particular product set that or even one particular market, or even, I'd say even one particular customer that would be impacted by that, as you may see.

[Rafael Lizardi, SVP and CFO at Texas Instruments]

Hey, just to highlight something for maybe new listeners, Dave mentioned the foundries. Only about 20% of our wafers come from foundries. The vast majority, 80%, and growing, with our investments in 300mm, are internal wafers. That just gives us much better control of our destiny and for all the reasons Dave mentioned, and then the low-cost structure or low cost that we get with 300mm.

[Dave Pahl, VP and Head of Investor Relations at Texas Instruments]

Yeah. I think that makes it especially clear why we believe that continues to be a strategic advantage for us in times like this. You have a follow on, Joe?

[Joe Moore, Managing Director at Morgan Stanley]

Yeah. I wonder also with the hotspots, you know, is it a situation where you can't respond to upside in demand, and that's why it's tight? Or are there actual areas where, you know, I know there's always a little bit of this, but on a broad scale, where you're not meeting kind of commitments that you had made because of some of those things that are upstream from you?

[Dave Pahl, VP and Head of Investor Relations at Texas Instruments]

I think there's probably both of those that exist.

[Rafael Lizardi, SVP and CFO at Texas Instruments]

I mean, at 112 days of inventory, it is harder to respond to upsides than if we were at, you know, 150, 160, 190 days, of course. So yeah.

[Dave Pahl, VP and Head of Investor Relations at Texas Instruments]

Yeah. Yeah, for sure. Okay. Well, thank you, Joe. We'll go to the next caller, please.

[Operator]

Our next question comes from Chris Danely of Citi.

[Chris Danely, Head of U.S. Semiconductor Research at Citi]

Oh, hey. Thanks, guys. Dave and Rafael, you mentioned that the lead times haven't really changed, but the expedites are getting better or less bad. Why do you think that is? Do you think that, you know, your competitors are reducing lead times? Do you think that the supply chain has had a little bit of a chance to build some buffer inventory? Why do you think the situation is getting, I guess, either better or less bad?

[Dave Pahl, VP and Head of Investor Relations at Texas Instruments]

Yeah, you know, Chris, I think that's a great question. I don't know that we know the answer specifically to that question, so I think we're trying to stick to the facts that we can observe that behavior change. I think you're offering some good theories of why that behavior may be changing. You know, what we're trying to do is to stick to the facts of what's going on. There's you know, multiple reasons why it might be changing, and we'd rather not venture into you know, guessing or predicting or you know, calling what's driving that behavior. You have a follow on?

[Chris Danely, Head of U.S. Semiconductor Research at Citi]

Yeah, I guess you can leave the guessing and predicting up to us sell-siders. On the,

[Dave Pahl, VP and Head of Investor Relations at Texas Instruments]

Yeah.

[Chris Danely, Head of U.S. Semiconductor Research at Citi]

Since you guys don't talk about gross margin, but you do talk about free cash flow margin, I think you had an all-time high in free cash flow margin in Q3, and it looks like there's some headwinds coming down the pipe in the, I guess, near to medium term. Is there any reason for us to believe that, you know, you've seen your all-time peak in free cash flow margin? Or eventually could it get back above where it was in the most recent quarter?

[Rafael Lizardi, SVP and CFO at Texas Instruments]

Sure. I'll take that, Chris. Chris, you know us very well. You followed us for a long time. You know we do not manage to free cash flow margin percent, right? That is not what drives long-term value for the owners. It is the long-term growth of free cash flow dollars, right? To your point there are some headwinds on that with the CapEx that we're talking about to set up the company well for the future. Of course we're only doing that because we think that is gonna drive even faster growth of the long-term trend of free cash flow dollars. We'll continue to focus on that because we think that is what drives the value for the long-term owners.

[Dave Pahl, VP and Head of Investor Relations at Texas Instruments]

Okay. Thank you, Chris. We've got time for one more call.

[Operator]

We'll go to Tore Svanberg of Stifel.

[Tore Svanberg, Managing Director and Senior Analyst at Stifel]

Yes. Thank you for squeezing me in. As far as the question on controlling the supply chain, you talked about 80% outsourced now. I believe that's kind of the more advanced nodes. But should we assume that that 80% is just going to grow and that you're going to rely less and less on foundries going forward?

[Rafael Lizardi, SVP and CFO at Texas Instruments]

Yeah. So you said 80% outsourced. It's 80% insourced, just to make sure. 80%.

[Tore Svanberg, Managing Director and Senior Analyst at Stifel]

Yeah, sorry.

[Rafael Lizardi, SVP and CFO at Texas Instruments]

Yeah. 80% our own wafers. Yes, that should grow over time as we continue to add these wafer fabs that we're talking about, all on 300 millimeter, which with, you know, the efficiency of 300 millimeter is huge, right? Because what, 300 millimeter wafer accounts for almost 2.3 times a 200 millimeter wafer. These are pretty large wafers for efficiency purposes. In fact, RFAB2 is gonna be bigger than RFAB1. Yeah, it's reasonable to deduce that that percent will increase over time.

[Tore Svanberg, Managing Director and Senior Analyst at Stifel]

Very good.

[Rafael Lizardi, SVP and CFO at Texas Instruments]

Yeah

[Tore Svanberg, Managing Director and Senior Analyst at Stifel]

As a follow-up, and I don't wanna steal your thunder from February, but in the past, you talked about capacity of $22 billion. Obviously, you're gonna go through capacity expansion here for the next 12-18 months. You know, would you share any new numbers with those? I don't know, 25, 28, anything at all?

[Rafael Lizardi, SVP and CFO at Texas Instruments]

Yeah, no. Great question. Thanks for the setup for February. We will talk about that in February. Until then, what I would tell you is, you know, you heard us talk about DMOS6 and RFAB1, roughly, that's the potential of about $8 billion of annual revenue on 300mm. RFAB2, and this is all dependent, highly dependent on mix, right? These are not exact numbers. RFAB2, with that caveat, RFAB2 should add another $5 billion of annual revenue, again, when it's fully equipped, right? Not, obviously not on day one. Lehi should add $3 billion-$4 billion of annual revenue. You know, we're thinking in terms of that, and we're thinking even beyond that, right?

[Rafael Lizardi, SVP and CFO at Texas Instruments]

Because if we, as we look at the company's potential for growth into the next 10 and 15 years, then we're not stopping just thinking in the next 4 or 5 years. We're thinking 10, 15 years. We'll talk about that in February in more detail.

[Dave Pahl, VP and Head of Investor Relations at Texas Instruments]

That's great. I think we can go ahead and wrap up, Rafael, if you'd like.

[Rafael Lizardi, SVP and CFO at Texas Instruments]

Okay. Let me wrap up by reiterating what we have said previously. At our core, we're engineers, and technology is the foundation of our company. Ultimately, our objective and the best metric to measure progress and generate long-term value for owners is the growth of free cash over share. While we strive to achieve our objective, we will continue to pursue our three ambitions. We will act like owners who will own the company for decades, we will adapt and succeed in a world that's ever-changing, and we will be a company that we're personally proud to be a part of and would want as our neighbor. When we're successful, our employees, customers, communities, and owners all benefit. Thank you, and have a good evening.

Participants

Executives

• Dave Pahl, VP and Head of Investor Relations
• Rafael Lizardi, SVP and CFO

Analysts

• Chris Danely, Head of U.S. Semiconductor Research at Citi
• Harlan Sur, Executive Director of Equity Research at JPMorgan
• Joe Moore, Managing Director at Morgan Stanley
• John Pitzer, Managing Director at Credit Suisse
• Ross Seymore, Managing Director at Deutsche Bank
• Stacy Rasgon, Managing Director and Senior Analyst at Bernstein Research
• Timothy Arcuri, Managing Director at UBS
• Tore Svanberg, Managing Director and Senior Analyst at Stifel
• Vivek Arya, Managing Director at Bank of America