ITEM 7. Management's discussion and analysis of financial condition and results of operations
Overview
We design and manufacture semiconductors that we sell to electronics designers and manufacturers all over the world. Technology is the foundation of our company, but ultimately, our objective and the best metric for owners to measure our progress is through the growth of free cash flow per share over the long term.
Our strategy to maximize long-term 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) A strong foundation of manufacturing and technology that provides lower costs and greater control of our supply chain.
(b) A broad portfolio of analog and embedded processing products that offers more opportunity per customer and more value for our investments.
(c) 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.
(d) 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. In the following discussion of our results of operations:
• 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. See Note 1 to the financial statements for more information regarding our segments.
•When we discuss our results:
◦ Unless otherwise noted, changes in our revenue are attributable to changes in customer demand, which are evidenced by fluctuations in shipment volumes.
◦ New products do not tend to have a significant impact on our revenue in any given period because we sell such a large number of products.
◦ From time to time, our revenue and gross profit are affected by changes in demand for higher-priced or lower-priced products, which we refer to as changes in the "mix" of products shipped.
◦ Because we own much of our manufacturing capacity, a significant portion of our operating cost is fixed. When factory loadings decrease, our fixed costs are spread over reduced output and, absent other circumstances, our profit margins decrease. Conversely, as factory loadings increase, our fixed costs are spread over increased output and, absent other circumstances, our profit margins increase.
• For an explanation of free cash flow, see the Non-GAAP financial information section.
• All dollar amounts in the tables are stated in millions of U. S. dollars.
Our results of operations provides details of our financial results for 2022 and 2021 and year-to-year comparisons between 2022 and 2021. Discussion of 2020 items and year-to-year comparisons between 2021 and 2020 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, 2021.
The coronavirus (COVID-19) pandemic and its effects are impacting and will likely continue to impact market conditions and business operations across industries worldwide, including at TI. Therefore, we remain cautious about how the economy might behave for the next few years and continue to monitor potential impact on our operations.
After a sustained period of growth, a market correction began in 2022. As a result, demand for our products weakened, and we expect this to continue into 2023. During this time, we will continue to manage our operating plan and expenses with a steady hand as we focus on long-term investments to strengthen our competitive advantages.
Results of operations
Our strategic focus is on analog and embedded processing products. We sell our products into six end markets: industrial, automotive, personal electronics, communications equipment, enterprise systems and other. While all of these end markets represent good opportunities, we place additional strategic emphasis on designing and selling our products into the industrial and automotive markets, which we believe represent the best long-term growth opportunities. Gross margin of 68.8% reflected the quality of our product portfolio, as well as the efficiency of our manufacturing strategy, including the benefit of 300-mm production.
Our focus on analog and embedded processing allows us to generate strong cash flow from operations. Our cash flow from operations of $8.72 billion underscored the strength of our business model. Free cash flow was $5.92 billion and represented 29.6% of revenue. During 2022, we invested $3.37 billion in R& D and SG& A, invested $2.80 billion in capital expenditures and returned $7.91 billion to shareholders through dividends and stock repurchases.
Details of financial results - 2022 compared with 2021
Revenue of $20.03 billion increased $1.68 billion, or 9.2%, due to higher revenue from Analog and, to a lesser extent, Embedded Processing. This increase benefited from higher prices and the mix of products shipped.
Gross profit of $13.77 billion was up $1.40 billion, or 11.3%, primarily due to higher revenue. As a percentage of revenue, gross profit increased to 68.8% from 67.5%.
Operating expenses (R& D and SG& A) were $3.37 billion compared with $3.22 billion, as a result of increased investments in R& D and inflation.
Restructuring charges/other was $257 million compared with $54 million due to integration charges at our Lehi, Utah, manufacturing facility in both periods, which were partially offset by gains on sales of assets in 2021. The charges associated with our Lehi facility transitioned to cost of revenue once production began in December 2022. See Note 11 to the financial statements.
Operating profit was $10.14 billion, or 50.6% of revenue, compared with $8.96 billion, or 48.8% of revenue.
Other income and expense (OI& E) was $106 million of income compared with $143 million of income. See Note 11 to the financial statements.
Interest and debt expense of $214 million increased $30 million due to the issuance of additional long-term debt. See Note 8 to the financial statements.
Our provision for income taxes was $1.28 billion compared with $1.15 billion. This increase was primarily due to higher income before income taxes and lower discrete tax benefits compared to 2021. Our effective tax rate, which includes discrete tax items, was 12.8% in 2022 compared with 12.9% in 2021. See Note 4 to the financial statements for a reconciliation of the U. S. statutory corporate tax rate to our effective tax rate.
Net income was $8.75 billion compared with $7.77 billion. EPS was $9.41 compared with $8.26.
Segment results - 2022 compared with 2021
Analog (includes Power and Signal Chain product lines)
2022 2021 Change
─────────────────────────────────────────────────────────────────────────────────────────
Revenue $ 15,359 $ 14,050 9
Operating profit 8,359 7,393 13
Operating profit % of revenue 54.4 52.6
Analog revenue increased in both product lines, led by Signal Chain. Operating profit increased primarily due to higher revenue and associated gross profit.
Embedded Processing (includes microcontrollers and processors)
2022 2021 Change
───────────────────────────────────────────────────────────────────────────────────────
Revenue $ 3,261 $ 3,049 7
Operating profit 1,253 1,174 7
Operating profit % of revenue 38.4 38.5
Embedded Processing revenue increased. Operating profit increased primarily due to higher revenue and associated gross profit.
Other (includes DLP
®
products, calculators and custom ASIC products)
2022 2021 Change
───────────────────────────────────────────────────────────────────────────────────────
Revenue $ 1,408 $ 1,245 13
Operating profit * 528 393 34
Operating profit % of revenue 37.5 31.6
*Includes acquisition charges and restructuring charges/other
Other revenue increased $163 million, and operating profit increased $135 million.
Financial condition
At the end of 2022, total cash (cash and cash equivalents plus short-term investments) was $9.07 billion, a decrease of $672 million from the end of 2021.
Accounts receivable were $1.90 billion, an increase of $194 million compared with the end of 2021. Days sales outstanding at the end of 2022 were 37 compared with 32 at the end of 2021.
Inventory was $2.76 billion, an increase of $847 million from the end of 2021. Days of inventory at the end of 2022 were 157 compared with 116 at the end of 2021.
Liquidity and capital resources
Our primary source of liquidity is cash flow from operations. Additional sources of liquidity are cash and cash equivalents, short-term investments and access to debt markets. We also have a variable-rate, revolving credit facility. As of December 31, 2022, our credit facility was undrawn, and we had no commercial paper outstanding. Cash flows from operating activities for 2022 were $8.72 billion, a decrease of $36 million due to higher cash used for working capital as we continued to strategically build our inventory, offset by higher net income.
Investing activities for 2022 used $3.58 billion compared with $4.10 billion in 2021. Capital expenditures were $2.80 billion compared with $2.46 billion in 2021 and were primarily for semiconductor manufacturing equipment and facilities in both periods, including the purchase of our 300-mm semiconductor factory in Lehi, Utah, during 2021. Short-term investments used cash of $826 million in 2022 compared with $1.65 billion in 2021.
As we continue to invest to strengthen our competitive advantage in manufacturing and technology as part of our long-term capacity planning, our capital expenditures are expected to be higher than historical levels. In August 2022, the U. S. government enacted the U. S. CHIPS and Science Act, which provides funding for manufacturing grants and research investments and establishes a 25% investment tax credit for certain investments in U. S. semiconductor manufacturing. We expect to receive the cash benefit associated with the investment tax credit for qualifying capital expenditures in future periods and to apply for other incentives provided by the legislation.
Financing activities for 2022 used $6.72 billion compared with $3.14 billion in 2021. In 2022, we received net proceeds of $1.49 billion from the issuance of fixed-rate, long-term debt and retired maturing debt of $500 million. In 2021, we received net proceeds of $1.50 billion from the issuance of fixed-rate, long-term debt and retired maturing debt of $550 million. Dividends paid in 2022 were $4.30 billion compared with $3.89 billion in 2021, reflecting an increased dividend rate, partially offset by fewer shares outstanding. We used $3.62 billion to repurchase 22.2 million shares of our common stock compared with $527 million used in 2021 to repurchase 2.9 million shares. Employee exercises of stock options provided cash proceeds of $241 million compared with $377 million in 2021.
We had $3.05 billion of cash and cash equivalents and $6.02 billion of short-term investments as of December 31, 2022. We believe we have the necessary financial resources and operating plans to fund our working capital needs, capital expenditures, dividend and debt-related payments and other business requirements for at least the next 12 months.
Non-GAAP financial information
This MD& A includes references to free cash flow and ratios based on that measure. These are financial measures that were not prepared in accordance with generally accepted accounting principles in the United States (GAAP). Free cash flow was calculated by subtracting capital expenditures from the most directly comparable GAAP measure, cash flows from operating activities (also referred to as cash flow from operations).
We believe that free cash flow and the associated ratios provide insight into our liquidity, our cash-generating capability and the amount of cash potentially available to return to shareholders, as well as insight into our financial performance. These non-GAAP measures are supplemental to the comparable GAAP measures.
Reconciliation to the most directly comparable GAAP measures is provided in the table below.
For Years Ended December 31,
2022 2021
─────────────────────────────────────────────────────────────────────────────────────────────────────────────────────────────────────
Cash flow from operations (GAAP) $ 8,720 $ 8,756
Capital expenditures (2,797) (2,462)
Free cash flow (non-GAAP) $ 5,923 $ 6,294
Revenue $ 20,028 $ 18,344
Cash flow from operations as a percentage of revenue (GAAP) 43.5 47.7
Free cash flow as a percentage of revenue (non-GAAP) 29.6 34.3
Critical accounting estimates
Our accounting policies are more fully described in Note 2 of the consolidated financial statements. As disclosed in Note 2, the preparation of consolidated financial statements in conformity with U. S. GAAP requires management to make estimates and assumptions about future events that affect the amounts reported in the financial statements and accompanying notes. Management believes it is unlikely that applying other estimates and assumptions would have a material impact on the financial statements. 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.
Income taxes
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.
In the ordinary course of global business, there may be many transactions and calculations where the ultimate tax outcome is uncertain. The calculation of tax liabilities involves dealing with uncertainties in the interpretation and application of complex tax laws, and significant judgment is necessary to (i) determine whether, based on the technical merits, a tax position is more likely than not to be sustained and (ii) measure the amount of tax benefit that qualifies for recognition. We recognize potential liabilities for anticipated tax audit issues in the United States and other tax jurisdictions based on an estimate of the ultimate resolution of whether, and the extent to which, additional taxes will be due. Although we believe the estimates are reasonable, no assurance can be given that the final outcome of these matters will not be different from what is reflected in the historical income tax provisions and accruals.
As part of our financial process, we must assess the likelihood that our deferred tax assets can be recovered. If recovery is not likely, the provision for taxes must be increased by recording a reserve in the form of a valuation allowance for the deferred tax assets that are estimated not to be ultimately recoverable. Our judgment regarding future recoverability of our deferred tax assets may change due to various factors, including changes in U. S. or international tax laws and changes in market conditions and their impact on our assessment of taxable income in future periods. These changes, if any, may require adjustments to the valuation allowances and an accompanying reduction or increase in net income in the period when such determinations are made.
Inventory valuation allowances
Inventory is valued net of allowances for unsalable or obsolete raw materials, work in process and finished goods. Statistical allowances are determined quarterly for raw materials and work in process based on historical disposals of inventory for salability and obsolescence reasons. For finished goods, quarterly statistical allowances are determined by comparing inventory levels of individual parts to historical shipments, current backlog and estimated future sales in order to identify inventory considered unlikely to be sold. A specific allowance for each material type will be carried if there is a significant event not captured by the statistical allowance, such as an end-of-life part or demand with imminent risk of cancellation. Allowances are also calculated quarterly for instances where inventoried costs for individual products are in excess of the net realizable value for those products. Actual future write-offs of inventory for salability and obsolescence reasons may differ from estimates and calculations used to determine valuation allowances due to changes in customer demand, customer negotiations, technology shifts and other factors.
Commitments and contingencies
See Note 10 to the financial statements for a discussion of our commitments and contingencies.
ITEM 7A. Quantitative and qualitative disclosures about market risk