Texas Instruments Inc. (TXN) reported fourth quarter earnings that were down 1.5% sequentially and up 37.2% year over year, beating the Zacks Consensus estimate by 8 cents, or 12.7%. TI’s results were particularly heartening given the 3.66% average surprise percentage in the four preceding quarters and the lack of estimate revisions in the past few months.
Therefore the 2.45% decline in share prices could only be because of the continued decline in orders. TI stated — similar to analog peer Linear Technology Corp (LLTC), which reported last week — that the inventory correction had more or less run its course and results would improve going forward.
TI picked up some share last year, mostly at the expense of National Semiconductor Corp. (NSM). Share gains are likely to continue, since TI’s served markets continue to expand and the company has the required capacity to cater to this demand.
Revenue
TI reported revenue of $3.53 billion, which was down 5.7% sequentially, up 17.3% year over year and in the middle of the guided range of $3.36 billion to $3.64 billion (a sequential decline of 2.7%-10.2%). Revenue was more or less in line with the Zacks Consensus Estimate of $3.51 billion.
The PC market started turning around in the last quarter, with TI’s battery management products seeing some fresh demand. Some LCD TV customers saw inventories come down to normal levels and are expecting to place fresh orders in the first quarter, according to TI. The communications and automotive markets were sluggish compared to the third quarter, although up nicely from last year. Industrial markets slowed down as expected.
Both internal and distributor inventories grew during the quarter, although TI stated that increases were commensurate with demand and excess inventories in the LCD TV and PC markets were worked down.
Segment Revenue
All segments were down sequentially but up from the year-ago quarter. The wireless segment was the weakest.
The Analog segment was down 4.0% sequentially, Embedded Processing down 7.1%, Wireless flat and Other down 13.7%. The baseband business was 12% of revenue, declining 3.7% sequentially and 9.2% from the year-ago quarter. Excluding the baseband business, wireless segment revenue increased 4.9%.
All three major product lines within TI’s Analog business (roughly 40-30-30 mix) – high volume analog and logic (HVAL), high-performance analog (HPA) and power management – declined sequentially. While power management products were the weakest given their exposure to the PC market, both HPA (used in computing and consumer devices) and HVAL (industrial markets) also declined.
However, all three product lines contributed to analog market share gains. Also, while HPA fueled the 20.2% year-over-year increase, both HVAL and power management grew double-digits, according to TI.
While catalog products — mainly Digital Signal Processors (DSPs) and microcontrollers (MCUs) — declined sequentially, the Embedded Processing segment was also impacted by slowdown in the communications infrastructure and automotive markets. Growth of 30.6% from the year-ago quarter was however due to a higher level of business, with both the catalog products and served end markets helping.
TI’s focus in the wireless segment is on the proprietary OMAP and connectivity products. However, while OMAP grew both sequentially and year over year, connectivity products declined sequentially. Additionally, the declines in the baseband business, which TI is phasing out hurt both sequential and year-over-year comparisons.
The bulk of the baseband revenue comes from a single customer, Nokia Corp. (NOK) and TI is committed to meeting Nokia’s requirements until other vendors, such as Broadcom Corp (BRCM) are able to take over. However, TI remains on track to phase out this lower-margin business by 2012.
The Other segment was up 22.7% from last year. TI is benefiting from its DLP and custom ASIC products here, which fueled growth from the year-ago quarter. Calculators witnessed the usual fourth quarter seasonality, hurting sequential comparisons.
Orders
Net product orders were $3.13 billion in the last quarter, down 8.7% sequentially and 4.0% year over year. We estimate that backlog declined 18.4%, with turns sales increasing 7.4% sequentially. While a fourth quarter decline in orders is not unusual, the decline appears to be somewhat more than normal seasonality.
Of course, the higher turns are encouraging and seem validate what TI said about improving demand going forward. In this context, the additional capacity should be most welcome.
Margins
The gross margin was 53.0%, down 150 basis points (bps) sequentially but up 14 bps from the year-ago quarter. TI stated that the lower utilization rate played a key role in bringing down the gross margin, not just because of the additional capacity, but also because of management’s decision to lower utilization with a view to bringing inventory down to more acceptable levels.
As demand picks up and some of the new designs (analog and embedded processing products) get into volume production, gross margins should move up toward the long term target of 55%.
Operating expenses of $782 million were higher than the previous quarter’s $808 million. The operating margin was 30.8%, down 208 bps sequentially and up 132 bps from the year-ago quarter. The weaker gross margin was the primary reason for the sequential decline, although slightly higher SG&A as a percentage of sales also helped. Higher R&D and SG&A ( as a percenatge of sales) were almost equally responsible for the improvement over December 2009.
The Analog, Embedded Processing, Wireless and Other segments generated operating margins of 32.1% (up 87 bps sequentially), 26.6% (down 123 bps), 23.5% (down 13 bps) and 60.0% (up 1,471 bps), respectively.
Net Income
The pro forma net income was $845 million, or a 24.0% net income margin compared to $863 million, or 23.1% in the previous quarter and $651 million, or 21.7% in the prior-year quarter. Fully diluted pro forma earnings per share were 71 cents compared to 72 cents in the previous quarter and 52 cents in the December quarter of last year.
The pro forma calculations for the last quarter exclude the impact of restructuring charges and a one-time gain on the sale of some assets on a tax-adjusted basis.
On a fully diluted GAAP basis, the company recorded a net profit of $928 million, or 79 cents per share (78 cents after deducting $14 million of profits for unvested RSUs to which dividend equivalents were paid) compared to $859 million (72 cents per share) in the previous quarter and a net profit of $655 million (52 cents per share) in the comparable prior-year quarter.
Balance Sheet
Working capital management continued to improve. While inventories increased 6.7% to $1.52 billion, this resulted in inventory turns of 4.4x, down from 4.8X in the previous quarter. Days sales outstanding (DSOs) went down from 43 to around 39. TI generated $1.23 billion in cash from operations and spent $301 million on capex, $600 million on share repurchases and $153 million on cash dividends. The company did not have any long-term debt, although long-term liabilities totaled $983 million at quarter-end.
Guidance
TI provided guidance for the first quarter and some limited expectations for fiscal year 2011.
Accordingly, revenue is expected to range between $3.27 billion and $3.55 billion (down 3.3% sequentially at the mid-point). The 5-year average sequential decline in the March quarter is 5.0%. The Zacks Consensus Estimate is currently $3.3 billion, at the lower end of the range. The EPS is expected to be $0.54 to $0.62.
For 2011, TI expects R&D expenses of $1.7 billion, capex of 0.9 billion, depreciation of $0.9 billion and an annual effective tax rate of 30%.
In Summary
Texas Instruments is prudently investing its R&D dollars into several high-margin, high-growth areas of the analog, embedded processing and wireless markets, which has led to important design wins. However, the company was impacted by weak demand in the PC market and certain areas of the consumer market, which impacted its results in the second half of 2010. However, TI’s better-than-seasonal first quarter guidance is encouraging and indicative of strengthening demand, in-mix inventories and possible share gains.
The phasing out of the low-margin baseband business also remains on track and should generate some margin expansion every quarter. This, along with a stronger mix and cost control will continue to generate solid cash flow.
We are particularly optimistic about TI’s compelling product line, the increased differentiation in its business, lower-cost 300mm capacity and possibly aggressive pricing strategy (in the next few quarters) that should in combination drive earnings momentum.
That said, we would like to point out that additional capacity, while bringing down lead times, would also increase costs, so if demand does not pick up soon, there will again be downward pressure on earnings.
As such, we believe our long term Neutral recommendation on the shares is justified. We also do not see any near-term catalysts that could drive shares higher and are therefore comfortable with our short term Hold recommendation (Zacks Rank #3) on TI shares.
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