Zacks_Analysts' Blog : TI Beats but Guides Below Estimates - Analyst Blog

Texas Instruments (TXN) reported fourth quarter earnings that were down 25.8% sequentially and 31.4% year over year. However, given that the Zacks Consensus Estimate has shrunk 16 cents since the company announced its third quarter results, adjusted earnings managed to exceed the estimate by 25.6%. Shares appreciated 3.6% in after-hours trading.

On December 8, TI lowered earnings expectations from 32 cents to 23 cents citing weak demand across most end markets.

Revenue

TI reported revenue of $3.42 billion, which was down 0.8% sequentially, down 3.0% year over year and in the middle of the originally guided range of$3.26 billion and $3.54 billion (down 1.4% sequentially at the mid-point). A full quarter of National’s contribution and a stronger wireless business offset weakness in other areas. The top line ultimately came in 5.2% higher than the Consensus Estimate of $3.25 billion.

Distributor inventory levels were at a historic low as they continued to cut down during the first two months of the quarter. Demand was quite strong in the month of December, which pushed up orders during the month. Therefore, TI’s internal inventories were also reduced significantly.

End Market Summary

The secular drivers of the wireless infrastructure market are data capacity expansion in North America and Europe and infrastructure build-outs in Asian countries such as China and India. Additionally, broader market trends, such as increasing data traffic and capacity expansions all over the world, as well as an increased share of BOM at customers through its integrated offerings should continue to drive growth in this market.

The industrial market remained weak as expected, impacting overall results of the company.

TI’s automotive products had another good quarter, continuing to grow double-digits from last year, although staying flat on a sequential basis. The business is related to the broader economy, consumer buying power as well as issues in Japan and China, where a significant percentage of automotive semiconductors and automobile manufacturing is done.  

Computing and consumer markets remain soft, similar to conditions witnessed by other analog players. The flooding in Thailand impacted TI’s analog business, however conditions started to improve in December.

Segment Revenue

The core Analog business, comprising the HVAL, HPA and power management product lines declined in the last quarter, with HPA declining the most. The newly acquired business (SVA) also declined (when compared to its performance before the acquisition). However, the sequential improvement of 8.9% and year-over-year growth of 11.7% in segment revenue was entirely on account of the inclusion of a full quarter of SVA results.

With catalog products -- mainly Digital Signal Processors (DSPs) and microcontrollers (MCUs) -- impacted due to their exposure to the industrial market, the Embedded Processing segment declined 18.0% and 17.8% from the previous and year-ago quarters. The automotive side of the business did well however. 

TI’s focus in the wireless segment is on the proprietary OMAP and connectivity products. Segment revenue was up 24.5% sequentially and down 5.9% year over year. In the last quarter, the segment saw broad-based growth, with OMAP being the strongest (because of new products) and both connectivity and baseband segments also growing on a sequential basis.

The connectivity business has not done very well in 2011 because the two largest TI customers did not do so well. The connectivity business has been the weakest over the last few quarters, as TI’s customers did not do that well. Although business improved on a  sequential basis, TI remains more focused on the Wi-Fi end, where demand remained slower in the last quarter.

The baseband side of the business did well in the last quarter, as Nokia Corp (NOK),which generates the bulk of TI’s baseband revenue, took more product. TI is committed to meeting Nokia’s requirements until other vendors are able to take over. However, TI remains on track to phase out this business by the end of 2012.

The Other segment was down 29.0% sequentially and down 20.1% year over year. Other than the seasonal decline in calculators, the DLP business was sluggish off a strong third quarter and custom ASICs were impacted by softness in the communications infrastructure market.

Orders

Net product orders were $2.87 billion in the last quarter, down 6.5% sequentially and 8.3% year over year. We estimate that backlog was down over 32% sequentially, even as turns sales imrpoved by around 26%.

Fourth quarter orders were much weaker than seasonal, but this was not unexpected given the problems ravaging the PC market right now. However, the fourth quarter could have been the bottom, since order levels started improving in December, with TI seeing a strong pick up in turns sales. 

Margins

TI’s gross margin was 45.3%, declining 479 bps and 776 bps from the previous and year-ago quarters. The decline was mainly on account of lower utilization rates (as factory loadings were reduced to a little over 50%. However, acquisition-related writeup costs and charges for excess baseband inventory also contributed.

The gross margin is likely to remain lower than the mid-fifties percentage range until revenues are back to the levels they were at last year. Some of the new designs (analog and embedded processing products) getting into volume production should help the gross margin move up toward the long term target of 55%.

Operating expenses of $918 million were higher than the previous quarter’s $783 million. The operating margin was 18.4%, down 893 bps sequentially and 1,242 bps from the year-ago quarter. All expenses increased as a percentage of sales from both the previous and year-ago quarters, although cost of sales increased the most, followed by R&D and then SG&A.

The Analog, Embedded Processing, Wireless and Other segments generated operating margins of 24.4% (down 216 bps sequentially), 2.7% (down 1,825 bps), 15.5% (up 206 bps) and -30.8% (down 5,729 bps), respectively.

Net Income

The pro forma net income was $563 million, or a 16.5% net income margin compared to $760 million, or 22.0% in the previous quarter and $845 million, or 24.0% in the prior-year quarter. The fully diluted pro forma earnings per share were 49 cents compared to 66 cents in the previous quarter and 71 cents in the December quarter of last year. The pro forma calculations for the last quarter exclude the impact of restructuring and acquisition-related charges.

On a fully diluted GAAP basis, the company recorded a net profit of $298 million, or 26 cents a share compared to a net profit of $613 million, or 53 cents per share in the previous quarter and a net profit of $928 million (78 cents per share) in the comparable prior-year quarter.

Balance Sheet

Working capital management continued to improve in the last quarter. While inventories dropped 9.0% to $1.79 billion, this resulted in inventory turns of 4.2X, up from 3.5X in the previous quarter. Days sales outstanding (DSOs) went down from 47 to around 41.

TI generated $970 million in cash from operations, spending $152 million on capex, $300 million on share repurchases and $193 million on cash dividends. At quarter-end, TI had $4.2 billion in long-term debt, $1.4 billion in short-term debt and net under-funded retirement plans of $661 million.

Guidance

TI provided guidance for the first quarter and some limited expectations for fiscal year 2012.

Accordingly, TI expects revenue to range between $3.02 billion and $3.28 billion (down 7.9% sequentially at the mid-point). Normal seasonality is a 3-4% sequential decline and we think the expectations for the quarter are tempered by the impact of the Thai floods, as well as slow recovery in Industrial markets.

The EPS for the quarter is expected to be 16 to 24 cents, way below the Zacks Consensus Estimate of 33 cents.

For 2012, TI expects R&D expenses of $2.0 billion, capex of 0.7 billion, depreciation of $1.0 billion and an annual effective tax rate of 28%.

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.

We 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.

TI will also benefit from its acquisition of National Semiconductor, which strengthens its product lineup and brings on board additional capacity.

The phasing out of the low-margin baseband business also remains on track. While revenue growth continued in the last quarter, the business will be totally wiped out by the end of 2012.

TI has also announced the closure of a couple of 6-inch facilities in Hiji, Japan and Houston, Texas, transitioning the remaining products to more advanced facilities. Of the $215 million in charges, $112 million were taken in the last quarter itself, with the remainder to be spread out over the next seven quarters. The restructuring is expected to generate annual savings of $100 million a year.

However, with industrial, computing and communications infrastructure end markets remaining extremely sluggish, utilization rates are expected to remain low. Although the inventory depletion in the last quarter could help to a certain extent, the positive impact on utilization will not be tremendous. The factories being shut down contributed just 4% of TI’s business in 2011, so this would help to a certain extent. At the same time, the addition of National further increased capacity, which will negatively impact margins in the near term (due to under-utilization).

National also came with a huge debt balance, which has negatively impacted the balance sheet. A significant portion of this debt is short-term, so there could be a near-term impact on cash (TI could choose to cut share repurchases).

We therefore have a short term Hold recommendation (Zacks Rank #3) on TI shares.