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Texas Instruments (TXN - Analyst Report) reported first quarter earnings that were down 18.4% sequentially and 28.6% year over year. However, the Zacks Consensus Estimate dropped 5 cents since the company announced its third quarter results, helping the adjusted earnings to exceed the estimate by 13 cents. Shares appreciated 3.7% in after-hours trading, more than making up for the 1.8% decline during the day.
On March 8, TI lowered earnings expectations from 20 cents to 17 cents citing weak demand for wireless products. However, management stated in the first quarter earnings call that the first quarter should be regarded as the bottom, with growth returning in the second.
TI reported revenue of $3.12 billion, which was down 8.7% sequentially and down 8.0% year over year (in the middle of the originally guided range of$3.02 billion to $3.28 billion and just over the revised guidance range of $2.99 billion to $3.11 billion). 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. Revenue also fell short of the Consensus Estimate, missing by 1.9%.
Distributor inventory levels remained at the historic low of 6.5 weeks, as sell-in more or less mirrored sell-outs, according to TI. Management mentioned that improving demand had driven internal inventory growth and as a result, the company was ramping up production.
End Market Backdrop
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 appears to be recovering faster than expected, and the addition of National’s solid product lineup should drive strong overall results for TI this year.
Similar to trends noticed by other technology companies with automotive exposure, TI is seeing particular strength in this market. Automotive products grew double-digits on a sequential basis and were also strong when compared with the year-ago quarter. 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, although with the alleviation of the HDD issue, computing markets may be expected to look up. The first quarter is typically a slow one for the consumer market and management said that there was limited visibility here.
The core Analog business, comprising the HVAL, HPA and power management product lines declined year over year. The inclusion of revenue from the newly acquired business (SVA) was therefore the main reason for the 9.8% increase in analog revenue. Sequentially, the segment was about flat (down 0.5%), as growth in SVA offset decline in HVAL while the other two categories remained flat.
With catalog products -- mainly Digital Signal Processors (DSPs) and microcontrollers (MCUs) -- and communications infrastructure remaining weak, the Embedded Processing segment declined 11.3% from the year-ago quarter. The increase in automotive revenue could not offset this negative. However, segment revenue was up 7.0% from the previous quarter, as both auto applications and communications infrastructure increased with catalog products staying flat.
TI’s focus in the wireless segment is on the proprietary OMAP and connectivity products. Segment revenue in the last quarter was down 48.3% sequentially and 43.3% year over year.
Baseband products, which shrunk to 3% of revenue ($87 million) was the major driver of the declines from both periods. Connectivity products were impacted by relative weakness in smartphones and tablets, declining from both periods.
OMAP, on the other hand, grew strongly from the year-ago quarter, although it declined sequentially from the fourth quarter when customers launched new products.
The Other segment was up 5.0% sequentially and down 11.4% year over year. The decline from last year was on account of weakness in DLP, as well as the end of transitional supply agreements, especially the one with Spansion. The sequential increase was solely on account of $65 million received from insurance claims related to the disaster in Japan.
Net product orders were $3.24 billion in the last quarter, up 12.9% sequentially and down 9.5% year over year. We estimate that backlog jumped 10% sequentially, even as turns sales imrpoved by around 15%. This was the second straight quarter of double-digit increases in turns sales. The level of turns seems to indicate that customers are either less cautious, or building inventory for new product launches -- either of which would be positive for TI.
TI’s gross margin of 49.7% benefited from the insurance claim received. It expanded 379 bps sequentially, while declining 189 bps from the year-ago quarter. The decline was mainly on account of low utilization rates as factory loadings stayed at around 50%. 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 $971 million were higher than the previous quarter’s $918 million. The operating margin was 18.6%, up 19 bps sequentially and dpwn 821 bps from the year-ago quarter. All except cost of sales increased as a percentage of sales from both the previous and year-ago quarters, although R&D increased the most followed by SG&A in both periods. Cost of sales dropped sequentially, and even the increase from last year was not as significant.
The Analog, Embedded Processing, Wireless and Other segments generated operating margins of 21.1% (down 337 bps sequentially), 7.6% (up 490 bps), -6.7% (down 2,221 bps) and 8.7% (up 3,950 bps), respectively.
The pro forma net income was $491 million, or a 15.7% net income margin compared to $563 million, or 16.5% in the previous quarter and $668 million, or 19.7% in the year-ago quarter. The fully diluted pro forma earnings per share were 42 cents compared to 49 cents in the previous quarter and 56 cents in the March 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 $307 million, or 26 cents a share compared to a net profit of $298 million, or 26 cents per share in the previous quarter and a net profit of $666 million (56 cents per share) in the comparable prior-year quarter.
Inventories increased 3.6% to $1.85 billion, this resulted in inventory turns of 3.4X, down from 4.2X in the previous quarter. Days sales outstanding (DSOs) went up from 41 to around 43. TI generated $449 million in cash from operations, spending $103 million on capex, $300 million for repayment of commercial paper borrowings, $300 million on share repurchases and $195 million on cash dividends. At quarter-end, TI had $4.2 billion in long-term debt, $1.1 billion in short-term debt and net under-funded retirement plans of $647 million.
TI provided guidance for the second quarter and provided some limited estimates for fiscal year 2012.
Accordingly, TI expects second quarter revenue to come in between $3.22 billion and $3.48 billion (up 7.4% sequentially at the mid-point). Normal seasonality is around a 5% sequential increase, so the company certainly appears to be past the bottom.
The EPS for the quarter is expected to be 30 to 38 cents, well below the Zacks Consensus Estimate of 39 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% (could change with re-instatement of federal R&D tax credit that expired at 2011-end).
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. The addition of National Semiconductor strengthens its product lineup and brings on board additional capacity. Therefore, with improving end markets, order rates have started picking up, which should translate to attractive topline growth in the next few quarters.
The phasing out of the low-margin baseband business also remains on track. Revenue dropped significantly in the last quarter and is expected to be totally wiped out by the end of 2012.
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.
Moreover, in 2011, TI has 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 fourth quarter of 2011, 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.
Therefore, despite near-term gross margin issues, we see the business looking up and expect strong earnings growth this year.
Another point to keep in mind is National’s 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).
Therefore, similar to analog peers Intersil Corp (ISIL - Snapshot Report) and Linear Technology Corp (LLTC - Analyst Report), we have a short term Hold recommendation (Zacks Rank #3) on TI shares.