Texas Instruments (TXN) reported third quarter results that beat the Zacks Consensus Estimate by 3 cents. Revenue beat the consensus by 2.1%.


Revenue of $2.88 billion was up 17.2% sequentially, the second straight quarter of 17%+ growth. However, revenue declined 15.0% on a year-over-year basis, the fourth consecutive quarter of double digit decline.

Then again, the rate of decline slowed somewhat, indicating that the company is coming out of the recession. The sequential increase was driven by normalization in the market, as customers stopped reducing inventory and started increasing production.


Segment Revenue
All four segments contributed to the revenue surprise. The Analog business increased 20.4%, Embedded Processing was up 12.3%, Wireless 12.3% and Other 20.1%. The three major businesses within Analog, high volume analog and logic (HVAL), power management and high-performance analog all contributed to the increase. Power management revenue also grew from the year-ago period, driven by battery management, gauges and chargers for notebooks and handheld devices.

Embedded Processing was driven by strength in catalog products (particularly microcontrollers for consumer applications and industrial applications such as air conditioning systems in Asia), DSC and high-end automotive infotainment systems. The DSC business was driven by video security systems and high-performance audio/video receivers.

The increased demand for connectivity products used in smart phones continued to drive Wireless sales. This portion of the business was up 18% sequentially and down 8% year over year.

The baseband business, which generated $450 million in the last quarter, increased 10% sequentially and declined 33% from the year-ago quarter. Basebands currently contribute 16% of total TI revenue, although management is in the process of phasing out this business by 2012.


Net product orders were $3.1 billion in the last quarter, up 11.1% sequentially and down 3.7% year over year. We estimate that backlog was up 17.6%. Turns sales increased 5.4% in the last quarter, assuming average lead times stayed in the 12-week range.


Operating Results

The pro forma gross margin for the quarter was 51.7%, up 559 basis points (bps) from the previous quarter’s 46.1%, the second straight quarter of significant gross margin expansion. The reason for the continued improvement in gross margins is the higher level of revenue, higher utilization rates, an improving mix of analog and embedded processing business, as well as production efficiencies.

Operating expenses of $657 million were higher than than the previous quarter’s $645 million. The operating margin was 28.9%, up 903 bps sequentially from 19.8%. Most of the increase was related to the lower COGS (as a percentage of sales), although lower R&D and SG&A expenses (as a percentage of sales) also contributed. The Analog, Embedded Processing, Wireless and Other segments generated operating margins of 25.8%, 19.1%, 16.3% and 43.3%, respectively.

The pro forma net income was $586 million, or a 21.0% net income margin compared to $374 million, or 15.2% in the previous quarter and $763 million, or 22.5% in the prior-year quarter. Fully diluted pro forma earnings per share was 46 cents compared to 29 cents in the previous quarter and 57 cents in the September quarter of last year.

The pro forma calculations for the last quarter exclude the impact of restructuring charges, deferred stock compensation expenses and amortization of intangibles on a tax-adjusted basis. On a fully diluted GAAP basis, the company recorded a net profit of $538 million (42 cents per share) compared to $260 million (20 cents per share) in the previous quarter and a net profit of $563 million (42 cents per share) in the prior-year quarter.


Balance Sheet

Working capital management improved during the quarter. While inventories increased 5.0% to $1.1 billion, this resulted in inventory turns of 5.0X, compared to turns of 4.3X in the June 2009 quarter. Days sales outstanding (DSOs) decreased from 46 to 45 days.

Cash generated from operations was $834 million. The company used $251 million to repurchase 10.5 million shares, $226 million on capex and $138 million on cash dividends. The company did not have any long-term debt, although long-term liabilities totaled $803 million at quarter-end.


Management provided guidance for the second quarter. Revenue is expected to range between $2.78 billion and $3.02 billion (down 3.5% to up 4.9% sequentially), a pretty wide range. The lower backlog entering the quarter could have prompted management to exercize caution in calling the guidance. The guidance also assumes a sequential decline in the calculator business, which management estimates at around $115 million.

The EPS is expected to be 42 cents to 50 cents. Management continues to expect R&D expense of around $1.5 billion, capital expenses of $800 million and depreciation expense of $900 million for the year. The annual effective tax rate is now expected to be 28%, compared to previous expectations of 27%.
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