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Item 7. Management’s Discussion and Analysis

2021-02-05 compared with 2020-02-20 · 59 added, 67 removed, 132 unchanged (49% of the section changed)

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We design, make and sell semiconductors to electronics designers and manufacturers all over the world.

For many years, we have run our business with three overarching ambitions in mind.

First, we will act like owners who will own the company for decades.

Second, we will adapt and succeed in a world that is ever changing.

And third, we will be a company that we are personally proud to be a part of and that we would want as our neighbor.

When we are successful in achieving these ambitions, our employees, customers, communities and shareholders all win.

Our business model is designed around the following four sustainable competitive advantages that we believe, in combination, put us in a unique class of companies:

• A strong foundation of manufacturing and technology.

We invest in manufacturing technologies and do most of our manufacturing in-house.

This strategic decision to directly control our manufacturing helps ensure a consistent supply of products for our customers and also allows us to invest in technology that differentiates the features of our products.

We have focused on creating a competitive manufacturing cost advantage by investing in our advanced analog 300-millimeter capacity, which has about a 40% cost advantage per unpackaged chip over 200-millimeter.

To strengthen this advantage, we are moving forward with our plan to build our new 300-millimeter wafer fabrication facility in Richardson, Texas, as 300-millimeter wafers will continue to support the majority of our Analog growth.

• Broad portfolio of differentiated analog and embedded processing products.

Our customers need multiple chips for their systems.

The breadth of our portfolio means we can meet more of these needs than our competitors can, which gives us access to more customers and the opportunity to sell more products and generate more revenue per customer system.

We invest more than $1 billion each year to develop new products for our portfolio, which includes tens of thousands of products.

• Reach of market channels.

Customers often begin their initial product selection process and design-in journey on our website, and the breadth of our portfolio attracts more customers to our website than any of our competitors’ websites.

Our web presence and global sales and applications team are advantages that give us unique access and insight to about 100,000 customers designing TI semiconductors into their end products.

• Diversity and longevity of our products, markets and customer positions.

Together, the attributes above result in diverse and long-lived positions that deliver high terminal value to our shareholders.

Because of the breadth of our portfolio, we are not dependent on any single product, customer, technology or market.

Some of our products generate revenue for decades, which strengthens the return on our investments.

Our strategic focus, and where we invest the majority of our resources, is on Analog and Embedded Processing, with a particular emphasis on designing and selling those products into the industrial and automotive markets.

We believe these markets represent the best growth opportunities over the next decade or longer, due to increasing semiconductor content.

Additionally, analog and embedded processing products sold into industrial and automotive markets provide long product life cycles, intrinsic diversity and less capital-intensive manufacturing, which we believe offer stability, profitability and strong cash generation.

This business model is the foundation of our capital management strategy, which is based on our belief that free cash flow growth, especially on a per-share basis, is important for maximizing shareholder value over the long term.

We also believe that free cash flow will be valued only if it is productively invested in the business or returned to shareholders.

The combined effect of our ambitions, business model and sustainable competitive advantages is that we have continued to build a stronger company.

Over time, we have gained market share in Analog and Embedded Processing and grown and returned all free cash flow to our owners.

Technology is the foundation of our company, but ultimately, our objective and the best metric to measure progress and generate long-term value for owners is the growth of free cash flow per share.

Our strategy to maximize free cash flow per share growth has three elements:

A great business model that is focused on analog and embedded processing products and built around four sustainable competitive advantages.

The four sustainable competitive advantages are powerful in combination and provide tangible benefits:

A strong foundation of manufacturing and technology that provides lower costs and greater control of our supply chain.

A broad portfolio of analog and embedded processing products that offers more opportunity per customer and more value for our investments.

The reach of our market channels that gives access to more customers and more of their design projects, leading to the opportunity to sell more of our products into each design and gives us better insight and knowledge of customer needs.

Diversity and longevity of our products, markets and customer positions that provide less single point dependency and longer returns on our investments.

Together, these competitive advantages help position TI in a unique class of companies capable of generating and returning significant amounts of cash for our owners.

We make our investments with an eye towards long-term strengthening and leveraging of these advantages.

Discipline in allocating capital to the best opportunities.

This spans how we select R&D projects, develop new capabilities like TI.com, invest in new manufacturing capacity or how we think about acquisitions and returning cash to our owners.

Efficiency, which means constantly striving for more output for every dollar spent.

We believe that our business model with the combined effect of our four competitive advantages sets TI apart from our peers and will for a long time to come.

We will invest to strengthen our competitive advantages, be disciplined in capital allocation and stay diligent in our pursuit of efficiencies.

Finally, we will remain focused on the belief that long-term growth of free cash flow per share is the ultimate measure to generate value.

Management’s discussion and analysis of financial condition and results of operations (MD&A) should be read in conjunction with the financial statements and the related notes that appear elsewhere in this document.

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• Our segments represent groups of similar products that are combined on the basis of similar design and development requirements, product characteristics, manufacturing processes and distribution channels, and how management allocates resources and measures results.

During 2020, we reorganized the product lines within our Analog segment to simplify our business structure into our Power and Signal Chain product lines.

These changes had no impact on our previously reported consolidated financial statements or on our reportable segment results.

See Note 1 to the financial statements for more information regarding our segments.

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Increases and decreases in factory loadings tend to correspond to increases and decreases in demand.

• For an explanation of free cash flow and the term “annual operating tax rate,” see the Non-GAAP financial information section.

• All dollar amounts in the tables are stated in millions of U.S.

Our results of operations discussed below provides details of our financial results for 2019 and 2018 and year-to-year comparisons between 2019 and 2018.

Our results of operations provides details of our financial results for 2020 and 2019 and year-to-year comparisons between 2020 and 2019.

Discussion of 2018 items and year-to-year comparisons between 2019 and 2018 that are not included in this Form 10-K can be found in “Management’s discussion and analysis of financial condition and results of operations” in Part II, Item 7 of the Company’s Annual Report on Form 10-K for the year ended December 31, 2019.

Impact of COVID-19

The coronavirus (COVID-19) pandemic and its follow-on effects are impacting and will likely continue to impact business activity across industries worldwide, including TI.

Therefore, we remain cautious about how the economy might behave for the next few years.

The impact to our lead times and ability to fulfill orders was minimal in 2020.

However, depending on pandemic-related factors like the potential of local manufacturing restrictions on our factories, we could experience constraints in fulfilling customer orders in future periods.

The coronavirus pandemic remains dynamic with uncertainty around its duration and broader impact.

We continue to monitor and assess the situation and address implications to our business, supply chain and customer demand.

We have long had a business continuity plan in place for unforeseeable situations, like we have seen with COVID-19.

Additionally, over the past several years, we have invested in building inventory and expanding our global internally owned manufacturing footprint.

Investing in these capabilities has given us flexibility, such as the ability to build products across multiple manufacturing sites.

These investments have helped to minimize disruptions, but may not be sufficient to eliminate them.

Results of operations

In 2019, we continued our focus on analog and embedded processing products and the industrial and automotive markets.

Together, these products and markets represent highly diverse opportunities with thousands of applications and long-term growth potential.

Our strategic focus is on analog and embedded processing products sold into six end markets:

industrial, automotive, personal electronics, communications equipment, enterprise systems and other.

While all end markets represent good opportunities, we place additional strategic emphasis on designing and selling those products into the industrial and automotive markets, which we believe represent the best growth opportunities.

Gross margin of 64.1% reflected the quality of our product portfolio, as well as the efficiency of our manufacturing strategy, including the benefit of 300-millimeter Analog production.

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Our cash flow from operations of $6.14 billion underscored the strength of our business model.

Free cash flow was $5.80 billion and represented 40.3% of revenue, up from 38.4% a year ago.

During 2019, we returned $5.97 billion to shareholders through a combination of stock repurchases and dividends.

Our strategy is to return all free cash flow to shareholders.

Our dividends represented 52% of free cash flow, underscoring their sustainability.

For an explanation of free cash flow, see the Non-GAAP financial information section.

Free cash flow was $5.49 billion and represented 38.0% of revenue.

During 2020, consistent with our commitment to return free cash flow to owners, we returned $5.98 billion to shareholders through a combination of dividends and stock repurchases.

Our dividend represented 62% of free cash flow, underscoring its sustainability.

Details of financial results – 2020 compared with 2019

Revenue of $14.38 billion decreased $1.40 billion, or 9%, primarily due to lower revenue from Embedded Processing and Analog.

Gross profit of $9.16 billion was down $1.11 billion, or 11%, primarily due to lower revenue.

As a percentage of revenue, gross profit decreased to 63.7% from 65.1%.

Revenue of $14.46 billion increased $78 million, or 1%, primarily due to higher revenue from Analog, partially offset by lower revenue from Embedded Processing.

Gross profit of $9.27 billion was up $105 million, or 1%, due to higher revenue and increased factory loadings.

As a percentage of revenue, gross profit increased to 64.1% from 63.7%.

Operating expenses (R&D and SG&A) were $3.15 billion compared with $3.19 billion.

Acquisition charges of $288 million were non-cash.

Acquisition charges were $198 million compared with $288 million and were non-cash.

See Note 7 to the financial statements.

Restructuring charges/other was a credit of $36 million due to the sale of our manufacturing facility in Greenock, Scotland.

Restructuring charges/other was a charge of $24 million due to an Embedded Processing action, compared with a credit of $36 million due to the sale of our manufacturing facility in Greenock, Scotland in 2019.

Operating profit was $5.89 billion, or 40.8% of revenue, compared with $5.72 billion, or 39.8% of revenue.

Other income and expense (OI&E) was $175 million of income compared with $98 million of income.

Other income and expense (OI&E) was $313 million of income compared with $175 million of income, which increased primarily due to higher royalty income.

See Note 12 to the financial statements.

Interest and debt expense of $190 million increased $20 million due to the issuance of additional long-term debt.

Our provision for income taxes was $711 million compared with $1.11 billion.

The decrease was due to lower income before income taxes and a lower annual operating tax rate.

Our provision for income taxes was $422 million compared with $711 million.

The decrease was due to higher discrete tax benefits, which included a $249 million benefit from the settlement of a depreciation-related uncertain tax position and, to a lesser extent, higher U.S.

tax benefits, partially offset by higher income before income taxes.

Our annual operating tax rate, which does not include discrete tax items, was 14% compared with 16% in 2019.

We use “annual operating tax rate” to describe the estimated annual effective tax rate, as explained further in the Non-GAAP financial information section.

We use “annual operating tax rate” to describe the estimated annual effective tax rate.

Our effective tax rate, which includes discrete tax items, was 7% in 2020 compared with 12% in 2019.

See Note 4 to the financial statements for a reconciliation of the U.S.

statutory income tax rate to our effective tax rate.

statutory corporate tax rate to our effective tax rate.

Net income was $5.60 billion compared with $5.02 billion.

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Segment results – 2020 compared with 2019

Analog (includes Power, Signal Chain and High Volume product lines)

Analog (includes Power and Signal Chain product lines)

2020 2019 Change

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Operating profit % of revenue 45.1 % 43.8 %

Analog revenue decreased due to Power, High Volume and, to a lesser extent, Signal Chain.

Operating profit decreased primarily due to lower revenue and associated gross profit.

Embedded Processing (includes Connected Microcontrollers and Processors product lines)

Analog revenue increased in both product lines about evenly.

Operating profit increased due to higher revenue and associated gross profit.

Embedded Processing (includes microcontrollers and processors)

2020 2019 Change

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Operating profit % of revenue 28.9 % 30.8 %

Embedded Processing revenue decreased in both product lines, led by Processors.

Embedded Processing revenue decreased.

Operating profit decreased due to lower revenue and associated gross profit.

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At the end of 2020, total cash (cash and cash equivalents plus short-term investments) was $6.57 billion, an increase of $1.18 billion from the end of 2019.

Accounts receivable were $1.07 billion, a decrease of $133 million compared with the end of 2018.

Days sales outstanding were 29 at the end of both 2019 and 2018.

Accounts receivable were $1.41 billion, an increase of $340 million compared with the end of 2019.

Days sales outstanding at the end of 2020 were 31 compared with 29 at the end of 2019.

Inventory was $1.96 billion, a decrease of $46 million from the end of 2019.

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Additional sources of liquidity are cash and cash equivalents, short-term investments and a variable rate, revolving credit facility.

Cash flows from operating activities for 2019 were $6.65 billion, a decrease of $540 million primarily due to lower net income.

Cash flows from operating activities for 2020 were $6.14 billion, a decrease of $510 million primarily due to an increase in cash used for working capital, partially offset by higher net income.

Our revolving credit facility is with a consortium of investment-grade banks and allows us to borrow up to $2 billion until March 2024.

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As of December 31, 2020, our credit facility was undrawn, and we had no commercial paper outstanding.

Investing activities for 2019 used $1.92 billion compared with $78 million in 2018.

Capital expenditures were $847 million compared with $1.13 billion in 2018 and were primarily for semiconductor manufacturing equipment in both periods.

Short-term investments used cash of $1.14 billion in 2019 and provided cash proceeds of $1.07 billion in 2018.

Investing activities for 2020 used $922 million compared with $1.92 billion in 2019.

Capital expenditures were $649 million compared with $847 million in 2019 and were primarily for semiconductor manufacturing equipment and facilities in both periods.

Short-term investments used cash of $241 million in 2020 compared with $1.14 billion in 2019.

Financing activities for 2020 used $4.55 billion compared with $4.73 billion in 2019.

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Tax Cuts and Jobs Act.

See Note 4 to the financial statements.

(d) Includes minimum payments for leased facilities and equipment and purchases of industrial gases under contracts accounted for as operating leases.

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We consider the following accounting policies to be those that are most important to the portrayal of our financial condition and that require a higher degree of judgment.

Revenue recognition

Based on management’s assessment of the revenue recognition criteria, we generally recognize revenue from sales of our products to distributors upon shipment or delivery to the distributors.

For our consignment arrangements with distributors, delivery occurs and revenue is recognized when the distributor pulls product from consignment inventory that we store at designated locations.

Recognition is not contingent upon resale of the products to the distributors’ customers in either scenario.

Revenue is recognized net of allowances, which are management’s estimates of future credits to be granted to distributors under programs common in the semiconductor industry.

These allowances are not material and generally include special pricing arrangements, product returns due to quality issues, and incentives designed to maximize growth opportunities.

Allowances are based on analysis of historical data and contractual terms and are recorded when revenue is recognized.

We believe we can reasonably and reliably estimate allowances for credits to distributors in a timely manner.

In determining net income for financial statement purposes, we must make certain estimates and judgments in the calculation of tax provisions and the resultant tax liabilities and in the recoverability of deferred tax assets that arise from temporary differences between the tax and financial statement recognition of revenue and expense.

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Compared sentence by sentence after normalising whitespace, quotation marks, case and digits, so re-formatting and restated figures do not read as changed language. Wording changes appear as one removal and one addition. The current filing and the prior one are authoritative.

What changed 10-K

Item 7. Management’s Discussion and Analysis