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Texas Instruments , or TI) reported second-quarter earnings that grew 37.4% sequentially and 52.6% year over year, easily beating the Zacks Consensus Estimate. Guided revenue and earnings were more or less in line with expectations, which is why the announcement had a negligible impact on the share price.

 

Revenue was more or less in line with expectations, with the higher mix of analog and embedded processing products contributing to profits. The communications equipment market was again TI’s strongest, with industrial and automotive also remaining generally strong. Personal electronics was, however, impacted by softness in phones and tablets that previously used its baseband products.

Expenses came in lower than expected due to cost discipline and the benefits of restructuring.

The numbers in detail-

Revenue

TI reported revenue of $3.29 billion, which was down 10.4% sequentially and up 8.0% year over year (slightly better than the guidance of $3.27 billion at the mid-point). Excluding the legacy wireless business, which contributed just $5 million in the last quarter but $148 million in the year-ago quarter, revenue was up 13.4%.

Distributor resales jumped 15% from last year, with distributor inventories remaining at the same level. Internal inventories grew slightly.

Segment Revenue

The Analog, Embedded Processing and Other Segments generated 61%, 21% and 18% of quarterly revenue, respectively.

The Analog business grew 8.6% sequentially and 14.3% year over year. Power management was the main driver of growth from the year-ago quarter although HPA, HVAL and SVA also grew.

The Embedded Processing segment, which includes the processor, microcontroller and connectivity product lines, was particularly strong, growing 7.2% sequentially and 13.8% from last year. Growth from the year-ago quarter was driven by processors and microcontrollers, with connectivity also growing.

The Other segment, which includes DLPs, custom ASICs, calculators, royalties and some legacy wireless products was up 21.2% sequentially but down 13.2% year over year. The decline from the year-ago quarter was on account of legacy wireless products.

Orders

Net product orders were $3.33 billion in the last quarter, up 8.5% sequentially and 6.1% year over year. Backlog grew 4.4% sequentially for the second straight quarter but remained 15.7% below the year-ago level. Turns sales increased 10.1% sequentially, contributing roughly the same percentage of sales as the previous quarter.  

Margins

Margin expansion in the last quarter was largely on account of revenue growth.

TI’s gross margin of 57.1% was up 327 bps sequentially and 561 bps from the year-ago quarter. The gross margin benefited from significantly higher volumes in the last quarter  as well as lower underutilization charges and production efficiencies.

The mix (analog and embedded processing is now 82% of revenue) was not favorable on a sequential basis but did have a positive impact on the year-over-year comparison. TI exceeded its long-term gross margin target of 55% in the last quarter and its low-cost manufacturing capacity will continue to expand margins as utilization rates increase.

Operating expenses of $821 million were down 2.8% sequentially (management expected flat sequentially). The operating margin was 32.2%, up 665 bps sequentially and 890 bps from the year-ago quarter. All expenses declined as a perentage of sales from both the previous and year-ago quarters.

The Analog, Embedded Processing and Other segments generated operating margins of 33.3%, 14.8% and 36.0%, respectively. The Analog margin expanded 617 bps sequentially, Embedded Processing 687 bps and Other 746 bps. As may be expected, operating margin in the Other segment shrank year over year because of the declining contribution from the legacy wireless business.

Net Income

The pro forma net income was $761 million, or a 23.1% net income margin compared to $559 million, or 18.7% in the previous quarter and $513 million, or 16.8% in the year-ago quarter. Earnings excluding restructuring gains and acquisition charges were 70 cents in the last quarter, compared with adjusted earnings of 51 cents in the previous quarter and 46 cents in the year-ago year.

On a GAAP basis, the company recorded a net profit of $683 million, or 62 cents a share compared to a net profit of $487 million, or 51 cents per share in the previous quarter and a net profit of $660 million (46 cents per share) in the comparable prior-year quarter.

Balance Sheet

Inventories increased 1.8% sequentially to around $1.74 billion, keeping inventory turns at around 3.2X. Days sales outstanding (DSOs) went up from 41 to around 42. TI generated $775 million in cash from operations, spending $80 million on capex, $743 mllion on share repurchases and $323 million on cash dividends. Spending on share repurchases and dividends increased 13% and 32%, respectively.

At quarter-end, TI had $4.39 billion in long-term debt and $254 million in short-term debt. During the quarter, the net debt position increased $224 million. It also had net underfunded retirement plans of $98 million.

Guidance

TI provided guidance for the third quarter.

Accordingly, TI expects revenue of between $3.31 billion and $3.59 billion (up 4.8% sequentially at the mid-point) and roughly in line with the consensus estimate of $3.44 billion. Excluding the legacy wireless business in the year-ago quarter, revenue for the quarter would be up 8% year over year.

Restructuring charges will be negligible and non-cash amortization charges related to acquisitions will remain at the current level for the next five years. The tax rate will remain at around 28%.

The EPS for the quarter is expected to be 66 to 76 cents, with the mid-point in line with the Zacks Consensus Estimate of 71 cents.

Recommendation

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.

TI, along with chipmaker Intel , remains one of the few semiconductor companies that depend on internal capacity for manufacturing the bulk of its devices. But since it has the policy of building out capacity ahead of demand, it is able to make opportunistic purchases. As a result, it is able to contain capex at up to 4% of sales while building out assembly and test capacity in China and adding equipment  to both the new Chinese fab and the 300mm fab in Texas.

While we remain optimistic about TI’s compelling product line, the differentiation in its business and lower-cost 300mm capacity that should in combination drive earnings, we recognize that the channel is more conservative than it has been before.

TI shares carry a Zacks Rank #2 (Buy). Other stocks worth considering include Intel, STMicroelectrnics and Analog Devices .

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