TI Beats Estimates, Shares Rise

Zacks

Texas Instruments (TXN, or TI) reported first-quarter earnings that were down sequentially but up year over year. More importantly, earnings beat the Zacks Consensus Estimate of 31 cents by 4 cents or 14.3%. Investors were upbeat about TI’s results, so shares remained buoyant during the day and appreciated an additional 1.7% in extended trading.

Revenue

TI reported revenue of $2.89 billion, which was down 3.2% sequentially and 7.6% year over year (slightly better than the mid-point of the recently narrowed guidance range of $2.80 billion to $2.91 billion).

With lead times remaining very low (they dropped to 6 weeks going into the second half of 2012), visibility remains low. Additionally, inventories remain lean at all customers and particularly at distributors, which further reduced inventories during the quarter.

Segment Revenue

TI changed the segment reporting structure in the last quarter, with the wireless segment being dissolved and relevant portions being included in the remaining segments.

The Analog business fell 1.3% sequentially and 2.3% year over year. TI attributed the year-over-year decline primarily to SVA, which continues to shift to a consignment model. HVAL and HPA also declined and were offset by increase in the power management product line. HVAL and power management product lines negatively impacted the sequential performance.

The Embedded Processing segment, which now includes the processor, microcontroller and connectivity product lines grew 2.7% sequentially and 3.9% from last year. The year-over-year increase was driven by microcontrollers and connectivity products supported by flattish processor sales. Microcontrollers also increased on a sequential basis.

The Other segment, which now includes DLPs, custom ASICs, calculators, royalties and some legacy wireless products was down 11.5% sequentially and 24.5% year over year. All except DLP products and royalties declined from the year-ago quarter. Insurance proceeds received in the year-ago quarter also made comps difficult.

The sequential decline was driven by legacy wireless, custom ASIC and royalties as offset by increase in calculator revenue and consistent DLP revenue. The legacy wireless products target the volatile smartphone and tablet markets and are being phased out by TI. Therefore they were responsible for much of the decline in segment revenue from both the previous and year-ago quarters.

Orders

Net product orders were $2.96 billion in the last quarter, up 8.8% sequentially and down 8.6% year over year. We estimate that backlog increased sequentially, with turns sales increasing by around 9%. TI currently generates around 45% of its revenue from the consignment model, which is having a positive impact on turns sales.

Margins

TI’s gross margin of 47.6% was down 88 bps sequentially and 210 bps from the year-ago quarter. The gross margin was the net result of weak revenue and low utilization rates. In addition, year-over-year comps were difficult because of insurance proceeds received in that quarter. The gross margin remains well below the long-term target of 55%.

Operating expenses of $878 million were higher than the previous quarter’s $855 million. The operating margin was 17.2%, down 261 bps sequentially and 142 bps from the year-ago quarter. All expenses increased sequentially as a perentage of sales. However, the decline from the year-ago quarter was mainly because of the lower gross margin, as the decline in R&D more than offset the increase in SG&A.

The Analog, Embedded Processing and Other segments generated operating margins of 18.2% (down 690 bps sequentially), 1.2% (down 77 bps) and 13.0% (up more than 51 percentage points), respectively.

Net Income

The pro forma net income was $398 million, or a 13.8% net income margin compared to $417 million, or 14.0% in the previous quarter and $400 million, or 12.8% in the year-ago quarter. The fully diluted pro forma earnings per share were 35 cents compared to 37 cents in the previous quarter and 34 cents in the Mar quarter of last year. The pro forma calculations for the last quarter exclude the impact of restructuring and acquisition-related charges, as well as discrete tax items.

On a GAAP basis, the company recorded a net profit of $362 million, or 32 cents a share compared to a net profit of $264 million, or 23 cents per share in the previous quarter and a net profit of $265 million (23 cents per share) in the comparable prior-year quarter.

Balance Sheet

Inventories dropped 3.2% to $1.70 billion, which resulted in inventory turns of 3.6X, up slightly from 3.5X in the previous quarter. Days sales outstanding (DSOs) went up from 38 to around 42. TI generated $360 million in cash from operations, spending $84 million on capex, $679 million on share repurchases and $232 million on cash dividends.

At quarter-end, TI had $4.2 billion in long-term debt and $1.5 billion in short-term debt. During the quarter, the net debt position moved up slightly. It also had underfunded retirement plans of $196 million.

Guidance

TI provided guidance for the second quarter and provided some limited estimates for fiscal year 2013.

Accordingly, TI expects first quarter revenue to come in between $2.93 billion and $3.17 billion (down 5.7% sequentially at the mid-point), which is more or less in line with the consensus estimate of $3.04 billion. Legacy wireless products are expected to decline by around $60 million, or 30% sequentially. The rest of the business is expected to be up 8.5% (in line with normal seasonality.

The EPS for the quarter is expected to be 37 to 45 cents, below the Zacks Consensus Estimate of 41 cents.

For 2013, TI expects R&D expenses of 1.5 billion, capex of 0.5 billion, depreciation of $0.9 billion and an annual effective tax rate of 22%.

In Summary

Texas Instruments is prudently investing its R&D dollars into several high-margin, high-growth areas of the analog and embedded processing markets. This is gradually increasing its exposure to the industrial and automotive markets, while reducing its exposure to the volatile consumer/computing markets.

The last few years have also seen other analog companies, such as Linear Technology (LLTC) and Maxim Interated Products (MXIM) increasing focus on these areas. These markets have better secular drivers (energy efficiency in industrial and increasing electronic content in automotive). They also generate higher margins. Therefore, this strategy along with higher utilization rates may enable the company to move closer to its long-term margin targets.

We therefore remain optimistic about TI’s compelling product line, the increased differentiation in its business and lower-cost 300mm capacity that should in combination drive earnings in the longer term.

However, while improved growth prospects are driving results for analog peers such as Analog Devices (ADI) and Maxim, TI is going through a transition where its declining wireless revenue and extra capacity are likely to restrict earnings growth. TI shares therefore carry a Zacks Rank #3 (Hold), while most of its peers have a Zacks Rank #2 (Buy).

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