(TXN) Texas Instruments Guidance Will Weigh on Shares

Texas Instruments Inc. (TXN) reported third quarter earnings that were up 15.8% sequentially and down 6.8% year over year, exceeding the Zacks Consensus estimate by 10 cents, or 17.5%.

Although TI lowered earnings estimates, the addition of National limited negative estimate revisions. Therefore, overall estimates for the current quarter have remained unchanged while those for the following quarter and fiscal years 2011 and 2012 have gone up a bit. Results were better than the original guidance.

However, while share prices jumped 4.04% during the day, in the hope of a strong quarter, they dropped 1.42% after-hours due to the weak guidance.


TI reported revenue of $3.46 billion, which was up 0.2% sequentially, down 7.3% year over year and at the lower end of the originally guided range of$3.4 billion and $3.7 billion (up 2.7% sequentially at the mid-point). National’s contribution for seven days (since the acquisition) closed was $8 million, excluding which, revenue would have been down 0.3% sequentially and down 7.8% from last year.

On September 8, TI lowered guidance to between $3.23 billion and $3.37 billion (down 4.7% sequentially at the mid-point), citing broad-based decline in demand. However, on a net basis, the top line came in 4.4% higher than the Zacks Consensus Estimate of $3.32 billion.

TI stated that distributor and OEM inventory levels were lean. Distributors lowered inventories during the quarter to align inventories with end demand.

End Market Summary

The secular drivers of the wireless infrastructure market is dependent on data capacity expansion in North America and Europe and 3G build-outs in Asian countries such as China and India. While the last quarter was disappointing and not entirely as management expected, we don’t expect the longer-term drivers to get thrown out of gear.

Additionally, broader market trends, such as increasing data traffic and capacity expansions all over the world, as well as an increased share of the bill of materials (“BOM”) at customers through its integrated offerings will drive growth in this market. The smartphone market on the other hand remains particularly strong, although the connectivity side of the business suffered on account of varying demand at customers.

Management did not shed light on the industrial market in the last quarter, but judging from recent results by other analog companies, such as Linear Technology Corp (LLTC), the industrial market did not do too well in the third quarter and is expected to do badly again in the fourth.

The automotive market was the brightest for TI, continuing to grow double-digits from last year, although slipping on a sequential basis. The business is related to the broader economy, consumer buying power as well as a shortage in supply related to supply chain issues in Japan. Many of the automotive semiconductors are manufactured at Japanese fabs and a significant percentage of automobile manufacturing is also done in the region.

Computing and consumer markets remain soft, similar to conditions witnessed by other analog players.

Segment Revenue

The three major product lines within TI’s core Analog business (roughly 40-30-30 mix) are high volume analog and logic (HVAL), high-performance analog (HPA) and power management. With the addition of National Semiconductor’s business, there is now a fourth component, which the company is referring to as Silicon Valley Analog (SVA).The segment was down 2.0% sequentially and 1.5% year over year.

The main reason for weakness in the last quarter was HPA (used in computing and consumer devices), which was disappointing when compared with both the previous and year-over-year comparisons. HVAL (industrial markets) and power management were flattish on a year-over-year basis. Overall, catalog products had an extremely weak quarter, as did communications infrastructure products.

Automotive fared slightly better, growing double-digits from the year-ago quarter, but declining sequentially. The HVAL product line should improve slightly going forward, as the earthquake-hit Miho facility in Japan started production again.

With catalog products — mainly Digital Signal Processors (DSPs) and microcontrollers (MCUs) — weakening on a year-over-year basis, the Embedded Processing segment declined 6.9% year over year. It also declined 9.6% sequentially, mainly due to communications infrastructure products that came in much weaker than management had originally expected.

TI’s focus in the wireless segment is on the proprietary OMAP and connectivity products. Segment revenue was up 3.9% sequentially and down 24.4% year over year. In the last quarter, this business was a mixed bag, with the OMAP and baseband segments growing, while connectivity disappointed. According to TI, this was due to the mix of business at customers that continued to see stronger demand in the lower-end section, where TI does not play.

TI is more focused on the Wi-Fi end, where demand was 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, such as Broadcom Corp (BRCM) are able to take over. However, TI remains on track to phase out this lower-margin business by the end of 2012.

The Other segment was up 10.3% sequentially and down 2.8% year over year. The sequential improvement was partially attributable to improvement in the DLP business, which had been affected by the Japan crisis and partly on account of insurance claims related to Japan. This was partially offset by the seasonal decline in calculator sales. The decline from last year was broad-based across product lines.


Net product orders were $3.07 billion in the last quarter, down 14.7% sequentially and and 10.5% year over year. We estimate that backlog was down 18.1% sequentially, even as turns sales declined 10.0%. Third quarter orders were softer than expected, considering the usual sales pickup in the second half. Additionally, turns sales were down quite a bit, despite the linearity of orders. Therefore we could be nearing the bottom (possibly in the fourth quarter).


TI’s gross margin was 50.1%, down 64 basis points (bps) sequentially and 446 bps from the year-ago quarter. The decline from both the previous and year-ago quarters was on account of lower utilization rates (due to weak demand) and also the scrapping of some inventories related to customer program cancellations. This was partially offset by insurance collections related to Japan.

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 also help the gross margin move up toward the long term target of 55%.

Operating expenses of $783 million were lower than the previous quarter’s $835 million. The operating margin was 27.3%, up 80 bps sequentially and down 557 bps from the year-ago quarter. Lower R&D and SG&A as a percentage of sales offset the increase in cost of sales to result in the sequential increase. The decline from last year was mostly on account of higher cost of sales, although higher R&D and SG&A as a percentage of sales also contributed.

The Analog, Embedded Processing, Wireless and Other segments generated operating margins of 26.6% (down 150 bps sequentially), 21.0% (down 269 bps), 13.4% (down 125 bps) and 26.5% (down 651 bps), respectively.

Net Income

The pro forma net income was $760 million, or a 22.0% net income margin compared to $685 million, or 19.8% in the previous quarter and $863 million, or 23.1% in the prior-year quarter. The fully diluted pro forma earnings per share were 66 cents compared to 58 cents in the previous quarter and 72 cents in the September quarter of last year. The pro forma calculations for the last quarter exclude the impact of acquisition-related charges.

On a fully diluted GAAP basis, the company recorded a net profit of $613 million, or 53 cents a share compared to a net profit of $672 million, or 57 cents per share in the previous quarter and a net profit of $859 million (72 cents per share) in the comparable prior-year quarter.

Balance Sheet

Working capital management continued to improve in the last quarter. While inventories increased 11.5% to $1.97 billion, this resulted in inventory turns of 3.5X, down from 3.9X in the previous quarter. Days sales outstanding (DSOs) went up from 44 to around 47. TI generated $1.14 billion in cash from operations, spending $193 million on capex, $450 million on share repurchases and $148 million on cash dividends. The company had $4.2 billion in long-term debt, $1.6 billion in short-term debt and net under-funded retirement plans of $589 million.


TI provided guidance for the fourth quarter and some limited expectations for fiscal year 2011.

Accordingly, TI expects revenue to range between $3.26 billion and $3.54 billion (down 1.4% sequentially at the mid-point). The 4-year average sequential decline in the December quarter is 1.4% (excluding the 26.5% decline in 2008). Therefore revenue guidance appears seasonal. Contribution from the National acquisition and the continued planned phase out of the wireless baseband business no doubt impacts this figure.

The EPS for the quarter is expected to be $0.28 to $0.36, way  below the Zacks Consensus Estimate of $0.56. We think this is mainly due to under-utilization and increased costs related to National.

For 2011, TI expects R&D expenses of $1.7 billion (unchanged), capex of 0.9 billion (unchanged), depreciation of $0.9 billion (unchanged) and an annual effective tax rate of 25% (down from previous estimate of 27%).

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.

Additionally, Japan appears to be recovering faster than expected and TI’s Miho facility is already up and running.

The phasing out of the low-margin baseband business also remains on track. While there was a surge in the last quarter, the business will be totally wiped out by the end of 2012.

Despite these positives, the near-term outlook appears extremely gloomy.  TI’s business is under pressure from a weaker-than-expected communications infrastructure business, as well as sluggish computing demand.

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).

Since guidance was extremely weak, we expect estimates to plunge, which could drive down share prices. We therefore have a short term Sell recommendation (Zacks #4 Rank) on TI shares.

We note that other analog players, such as Maxim Integrated Products (MXIM) and Analog Devices (ADI) carry a Zacks Rank of #3 (short-term Hold recommendation), we think because they will not be impacted near term by a major acquisition, such as National’s.

ANALOG DEVICES (ADI): Free Stock Analysis Report

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