TI Beats, Offers Encouraging Guidance - Analyst Blog

Texas Instruments (TXN, or TI) shares appreciated 3.4% in extended trading yesterday after the company reported first-quarter earnings that beat the Zacks Consensus Estimate. Guidance also exceeded expectations on both the top and bottom lines.

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 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 as a percentage of sales trended higher on a sequential basis while remaining below year-ago levels. The tax rate was also higher.

The numbers in detail-

Revenue

TI reported revenue of $2.98 billion, which was down 1.5% sequentially and up 3.4% year over year (slightly better than the guidance of $2.69 billion at the mid-point). Excluding the legacy wireless business, which contributed just $8 million in the last quarter but $210 million in the year-ago quarter, revenue was up 11.2%.

Distributor resales jumped 10% from last year, with both distributor and internal inventories remaining roughly flat.

Segment Revenue

The Analog, Embedded Processing and Other Segments generated 62%, 22% and 16% of quarterly revenue, respectively.

The Analog business declined 1.7% sequentially while growing 11.5% year over year. The solid growth from last year was broad-based across product lines, with power management and HPA being the strongest, followed by SVA and HVAL.

The Embedded Processing segment, which includes the processor, microcontroller and connectivity product lines was particularly strong, growing 8.6% sequentially and 16.9% from last year. Microcontrollers were the strongest, with processors and connectivity thereafter.

The Other segment, which includes DLPs, custom ASICs, calculators, royalties and some legacy wireless products was down 11.7% sequentially and 27.5% year over year. The decline from the year-ago quarter was on account of legacy wireless products.

Management is not proving explanations for sequential changes any longer.

Orders

Net product orders were $3.07 billion in the last quarter, up 8.4% sequentially and 3.7% year over year. Backlog jumped 11.2% sequentially. Turns sales increased 7.4% and were also up strongly as a percentage of revenue.  

Margins

Sequential declines in margins are on account of revenue declines. Margins were however significantly higher than in the year-ago quarter, because of efficiencies and cost control.

TI's gross margin of 53.9% was down 29 bps sequentially and up 625 bps from the year-ago quarter. The solid increase from the year-ago quarter was attributale to better mix (analog and embedded processing is now 82% of revenue) higher utilization rates and greater production efficiency at its fabs. TI is now very close to its long-term gross margin target of 55%. The low-cost manufacturing capacity will continue to expand margins as utilization rates increase.

Operating expenses of $845 million were up 4.7% sequentially. The operating margin was 25.5%, down 197 bps sequentially and up 835 bps from the year-ago quarter. All expenses increased sequentially as a perentage of sales. All except SG&A declined from last year.

The Analog, Embedded Processing and Other segments generated operating margins of 27.1%, 7.9% and 28.6%, respectively. The Analog margin shrank 291 bps sequentially, with Embedded Processing and Other expanding 114 bps and 1,326 bps, respectively. Margins expanded substantially across all segments.

Net Income

The pro forma net income was $559 million, or a 18.7% net income margin compared to $618 million, or 20.4% in the previous quarter and $398 million, or 13.8% in the year-ago quarter. Earnings excluding restructuring gains and acquisition charges were 51 cents in the last quarter, compared with adjusted earnings of 56 cents in the previous quarter and 35 cents in the Mar quarter of last year.

On a GAAP basis, the company recorded a net profit of $487 million, or 44 cents a share compared to a net profit of $511 million, or 46 cents per share in the previous quarter and a net profit of $362 million (32 cents per share) in the comparable prior-year quarter.

Balance Sheet

Inventories dropped 1.0% sequentially to around $1.71 billion, keeping inventory turns at around 3.2X. Days sales outstanding (DSOs) went up from 36 to around 41. TI generated $462 million in cash from operations, spending $77 million on capex, $720 mllion on share repurchases and $325 million on cash dividends. At quarter-end, TI had $4.65 billion in long-term debt and $1.00 billion in short-term debt. During the quarter, the net debt position increased $291 million. It also had net underfunded retirement plans of $89 million.

Guidance

TI provided guidance for the second quarter and raised the tax rate for 2014 from 27% to 28%.

Accordingly, TI expects revenue of between $3.14 billion and $3.40 billion (up 9.6% sequentially at the mid-point), above the consensus estimate of $3.15 billion. Excluding the legacy wireless business in the year-ago quarter, revenue for the quarter would be up 13% year over year.

The EPS for the quarter is expected to be 55 to 63 cents, above the Zacks Consensus Estimate of 52 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.

Considering the capacity TI already owns, future capex will be focused on  technology upgrades and will be limited to 4% of sales. So volume increases will lead to higher utilization rates and stronger gross margins.

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 #3 (Hold), similar to analog peers Intersil, Maxim and Linear Technology. But you could instead consider better-ranked stocks like Seagate STX, Western Digital WDC or SanDisk SNDK, all of which have a Zacks Rank #2 (Buy).