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TXN Reports Solid Q1, Margins Up And More Room To Grow

Texas Instruments TXN, or TI) reported first-quarter earnings of 65 cents that easily beat the Zacks Consensus Estimate of 62 cents. Shares were up 0.97% in response.  

Revenue

TI reported revenue of $3.01 billion, which was down 5.7% sequentially (slightly worse than seasonal) and down 4.5% year over year (below the guidance range of $3.07 billion and $3.33 billion) and just managing to beat the Zacks Consensus Estimate by 0.9%.

The automotive market was again strong in the last quarter (particularly infotainment, hybrid electric vehicle and powertrain systems) with the improvement in industrial being broad-based. The Communications equipment market was consistent with the year-ago quarter (better than in December when it declined 15%). Personal electronics weakened, and while part of the decline was expected the rest was due to weakness in mobile phones. Enterprise systems were down.

Distributor resales were down 4% from last year, with distributor inventories at around 4.5 weeks impacted by weak demand in personal electronics. Internal inventories were up 6.7%.

Management has successfully steered the business into analog and embedded processing applications, which typically yield a more stable business as well as stronger margins.

Segment Revenue

The Analog, Embedded Processing and Other Segments generated 62%, 24% and 14% of quarterly revenue, respectively.

The Analog business fell 9.4% sequentially and 7.7% year over year. HVAL was the biggest contributor to the year-on-year decline, with power management and HPA also weakening. SVA grew however.

The Embedded Processing segment, which includes the processor, microcontroller and connectivity product lines, was up 4.1% sequentially and 8.5% from last year. While the strength from last year was broad-based across Processors, microcontrollers and connectivity products, processors were the strongest. Management said that last quarter’s record performance was attributable to their decision to invest in the embedded business.

The Other segment, which includes DLPs, custom ASICs, calculators, royalties and some legacy wireless products was up 6.5% sequentially but flat year over year. Custom ASICs for wireless infrastructure products again impacted the year-over-year performance.

Net product orders were $3.09 billion in the last quarter, flattish sequentially and down 3.7% year over year.

Margins

TI’s gross margin of 60.6% was up 212 bps sequentially and 299 bps from the year-ago quarter. Management attributed the strong gross margin to the imroving product portfolio (around 87% of revenue comes from high-margin analog and embedded prcessing products) and manufacturing efficiencies (including the benefit from the 300mm plant). Fab utiization remains steady and is likely to remain at the these levels for at least a couple of more quarters, so wasn’t a driver of the gross margin increase. TI has now exceeded its long-term gross margin target of 55% in each of the last eight quarters.

Operating expenses of $856 million were up 18.2% sequentially and more or less consistent with last year. The operating margin was 32.2%, down 363 bps sequentially and up 177 bps from the year-ago quarter. R&D and SG&A were up from both the previous and year-ago quarters. COGS was down from both periods.

The Analog, Embedded Processing and Other segments generated operating margins of 36.1%, 25.0% and 24.2%, respectively. The Analog margin shrank 183 bps sequentially, Embedded Processing expanded 154 bps with Other shrank 2,176 bps. Analog and Embedded segment margins expanded year over year by 71 bps and 66 bps while the Other segment margin shrank 158 bps.

Net Income

There were no one-time items during the quarter. Ongoing restructuring gains and acquisition charges (that are expected to remain steady at around 5 cents over the next five years) were around 8 cents a share. They remain about level on a dollar basis (other than the dip in the December 2015 quarter).

The pro forma net income was $668 million, or a 22.2% net income margin compared to $836 million, or 26.2% in the previous quarter and $656 million, or 20.8% in the year-ago quarter.

On a GAAP basis, the company reported a net profit of 65 cents a share compared to a net profit of 80 cents in the previous quarter and a net profit of 61 cents in the comparable prior-year quarter.

Balance Sheet and Cash Flow

Inventories grew 6.7% sequentially to around $1.81 billion, with inventory turns down from 3.1X to 2.6X. Management said that the inventory buildup was to meet stronger demand in the second quarter. Days sales outstanding (DSOs) went from 33 to around 38. The cash and short-term investments balance was $2.80 billion, down $418 million during the quarter.

TI generated $547 million in cash from operations, spending $124 million on capex, $630 mllion on share repurchases and $383 million on cash dividends.

TI is one of the few technology companies that returns a significant amount of cash to investors. Its management policy is to return cash in the form of both share repurchases and dividends. TI has increased dividends 8.6% over the trailing 12 months, although the amount spent on share repurchases dropped 2.9%. As a result, the total cash returned to shareholders was up 0.9%.

At quarter-end, TI had $2.87 billion in long-term debt and $1.24 billion in short-term debt. During the quarter, the net debt position dropped $416 million. TI also had net underfunded retirement plans of $111 million.

Guidance

TI provided guidance for the second quarter.

Accordingly, it expects revenue of between $3.07 billion and $3.33 billion (up 6.4% sequentially at the mid-point) and better than the Zacks Consensus Estimate of $3.17 billion for the next quarter.

Non-cash amortization charges related to acquisitions will remain in the range of $80 million until the third quarter of 2019, declining to $50 million a quarter for two more years. The annual effective tax rate and the rate to be applied for the second quarter will be around 30%.

The EPS for the quarter is expected to be 67 to 77 cents, better than the Zacks Consensus Estimate of 71 cents.

Recommendation

Texas Instruments reported a better-than-expected quarter and provided encouraging guidance. All signs point to recovering auto and industrial markets, which are helping the company. The communications, personal electronics and other markets are either weak or have moving parts but TI has done well negotiating them.

Internally, the company has always executed rather well. TI, along with chipmaker Intel INTC, remains one of the few semiconductor companies that depend on internal capacity for manufacturing the bulk of its devices. Since the company usually builds out capacity well 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 even while on an expansion plan.

For instance, the 300mm capacity that it acquired a few years back is a huge support for its margins right now. On the call, management said that it was currently using a quarter of the $8 billion in internal capability for 300mm. Using 300mm capacity reduces cost by around 60% (net effect of 2.3X as many chips per 300mm wafer as on 200mm with wafer processing cost at about 1.4X). Therefore, the increased usage of this capability will be a positive for the gross margin going forward.

Overall, 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 note that channel inventories remain very low, meaning that demand is likely to remain strong.

That said, Texas Instruments continues to prudently invest 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 and increasing dollar content at customers, while reducing its exposure to the volatile consumer/computing markets.

TI shares carry a Zacks Rank #2 (Buy). Other stocks worth investing in are NVIDIA NVDA, Taiwan Semconductor TSM and Mellanox MLNX, all of which share the same rank.

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