Texas Instruments (TXN, or TI) reported fourth quarter earnings that were down both sequentially and year over year, but ahead of the Zacks Consensus Estimate by 4 cents or 12.4%. Shares remained depressed however, as guidance disappointed. Management mentioned continued caution at distributors and OEMs, which confirmed the PC market weakness described by Intel (INTC) and Advanced Micro Devices (AMD).     

Revenue

TI reported revenue of $2.98 billion, which was down 12.1% sequentially and 12.9% year over year (slightly better than the mid-point of the recently narrowed guidance range of $2.89 billion to $3.01 billion).

With lead times remaining very low (they dropped to 6 weeks going into the second half of the year), there is reduced visibility into the next quarter.

Inventories at both distributors and OEMs remain extremely lean, with uncertainties in demand and TI's capacity to ship products sooner likely to keep them that way.

Segment Revenue

The Analog business fell 9.4% sequentially and 1.5% year over year. The sequential decline was attributable to broad-based weakness across the HVAL, HPA, SVA and power management product lines. The decline from the year-ago quarter was because of weakness in SVA and HPA, as offset by an increase in the power management product line and flattish performance in HVAL.

The weakness in HPA is not surprising, since the business is closely linked to the computing and consumer markets that are currently in the doldrums. SVA has more of an industrials focus, so was impacted by seasonality and overall market weakness.

Communications infrastructure products were the primary reason for the 6.1% year-over-year increase in Embedded Processing revenue. However, demand for demand for catalog products - mainly Digital Signal Processors (DSPs) and microcontrollers (MCUs) - and products sold into the automotive segment also grew. All product lines contributed to the 9.8% sequential decline.

TI's focus in the wireless segment is on the proprietary OMAP and connectivity products. Segment revenue in the last quarter was down 2.5% sequentially and 56.1% year over year. Baseband products accounted for most of the decline from the year-ago quarter, although it was the only positive in the sequential comparison. OMAP products were consistent with the Sep quarter although down from last year. Connectivity was down from both the previous and year-ago quarters.

The Other segment was down 25.4% sequentially and 6.6% year over year. The decline from last year was on account of expiration of transitional supply agreements associated with acquired factories, as well as lower DLP shipments. ASIC and royalties increased and calculators were flat.

Negative seasonality for calculators was the main reason for the sequential decline, although weakness in DLP and ASICs also contributed. One-time insurance proceeds related to Japan that were received in the previous quarter were also a negative for the sequential comparison.

Orders

Net product orders were $2.72 billion in the last quarter, down 15.0% sequentially and 5.3% year over year. We estimate that backlog growth declined double-digits on a sequential basis, with turns sales dropping by around 11%. These metrics go to show a slowing business at TI.

Margins

TI's gross margin of 48.5% was down 105 bps sequentially and up 324 bps from the year-ago quarter. The gross margin was the net result of weak revenue and low utilization rates. As the mix of of higher-margin analog products increase and lower-margin wireless products (baseband) are eliminated, the gross margin should move closer to the long-term target of 55%.

Operating expenses of $855 million were lower than the previous quarter's $916 million. The operating margin was 19.8%, down 273 bps sequentially, while increasing 138 bps from the year-ago quarter. Both R&D and SG&A increased from the previous and year-ago quarters, although the increases in SG&A were more significant.

The Analog, Embedded Processing, Wireless and Other segments generated operating margins of 25.1% (up 15 bps sequentially), 3.4% (down 870 bps), -124.9% (down 10,861 bps) and 19.1% (down 3,362 bps), respectively.

Net Income

The pro forma net income was $417 million, or a 14.0% net income margin compared to $713 million, or 21.0% in the previous quarter and $524 million, or 15.3% in the year-ago quarter. The fully diluted pro forma earnings per share were 37 cents compared to 62 cents in the previous quarter and 45 cents in the Dec quarter of last year. The pro forma calculations for the last quarter exclude the impact of restructuring and acquisition-related charges on a tax-adjusted basis as well as other items.

On a fully diluted GAAP basis, the company recorded a net profit of $264 million, or 23 cents a share compared to a net profit of $784 million, or 68 cents per share in the previous quarter and a net profit of $298 million (26 cents per share) in the comparable prior-year quarter.

Balance Sheet

Inventories dropped 4.9% to $1.76 billion, which resulted in inventory turns of 3.5X, down from 3.7X in the previous quarter. Days sales outstanding (DSOs) went down from 44 to around 38. TI generated $1.09 billion in cash from operations, spending $96 million on capex, $600 million on share repurchases and $235 million on cash dividends. At quarter-end, TI had $4.2 billion in long-term debt and $1.5 billion in short-term debt.

Guidance

TI provided guidance for the fourth quarter and provided some limited estimates for fiscal year 2012.

Accordingly, TI expects first quarter revenue to come in between $2.69 billion and $2.91 billion (down 6.0% sequentially at the mid-point), which is slightly below the consensus estimate of $2.89 billion. Around 75% of the sequential decline is attributable to the business that TI is exiting.

The EPS for the quarter is expected to be 24 to 32 cents (after adjusting for acquisition and restructuring charges of around 6 cents, well below the Zacks Consensus Estimate of 35 cents.

For 2012, TI expects R&D expenses of1.6 billion, capex of 0.5 billion, depreciation of $0.9 billion and an annual effective tax rate of 22%.

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. The addition of National Semiconductor strengthened its product lineup and brought on board additional capacity.

Therefore, the company is much better positioned today to deal with any spike in demand. The elimination of the low-margin baseband business will be an additional positive for its margins going forward.

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.

However, the softening demand in the near term is reason for concern, since TI is now saddled with a lot of capacity for which it is taking underutilization charges.

Another point to keep in mind is National's huge debt balance, which has negatively impacted the balance sheet.

TI shares carry a Zacks Rank #3 (Hold), similar to analog peer Linear Technology Corp (LLTC).

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Tickers in this Article: TXN, INTC, LLTC, AMD

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