Texas Instruments TXN, or TI reported third-quarter earnings that sailed past the Zacks Consensus Estimate of 67 cents. The company did much better than expected because end market weakness was less than anticipated. Shares soared 9.4% in response.
Revenue
TI reported revenue of $3.43 billion, which was up 6.1% sequentially and down 2.1% year over year (within the guidance range of $3.12 to $3.38 billion) and beating the Zacks Consensus Estimate by 4.3%.
The automotive market was particularly strong in the last quarter, with all segments growing from last year and three of the five segments TI targets growing double-digits. Industrial flattened with the seven stronger segments offsetting the seven weaker ones.
Personal Electronics grew despite the weak PC market as TI saw strength at one customer. Communications equipment was down from last year due to a 30% decline in the wireless infrastructure market. The softness in DLP projectors impacted enterprise system revenue.
Distributor resales were up 6% from last year, with distributor inventories at around 4 weeks. Internal inventories were down 6%.
Management has successfully steered the business into analog and embedded processing applications, which typically yield a more stable business as well as stronger margins.
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 9% over the trailing 12 months, although amount spent on share repurchases dropped 2%. As a result, the total cash returned to shareholders was up 2%.
Segment Revenue
The Analog, Embedded Processing and Other Segments generated 64%, 21% and 15% of quarterly revenue, respectively.
The Analog business grew 6.5% sequentially and 1.5% year over year. HVAL was the major driver, with SVA also contributing. Power management was consistent with the year-ago quarter and HPA declined.
The Embedded Processing segment, which includes the processor, microcontroller and connectivity product lines, was up 5.1% sequentially and 2.0% from last year. Microcontrollers and connectivity products strengthened versus the year-ago quarter but processors weakened.
The Other segment, which includes DLPs, custom ASICs, calculators, royalties and some legacy wireless products was up 5.9% sequentially but down 18.6% year over year. Custom ASICs for wireless infrastructure products again impacted the year-over-year decline and DLPs were also down.
Net product orders were $3.44 billion in the last quarter, up 5.5% sequentially and up 3.0% year over year.
Margins
TI’s gross margin of 58.2% was up 4 bps sequentially and down 14 bps from the year-ago quarter. Higher volumes and more efficient 300mm manufacturing drove the gross margin were positives. The mix of analog and embedded processing revenue remains high at 85% of revenue. The decline from the year-ago quarter was volume-related. TI has now exceeded its long-term gross margin target of 55% in each of the last six quarters.
Operating expenses of $833 million were down 4.5% sequentially. The operating margin was 33.9%, up 273 bps sequentially and 38 bps from the year-ago quarter. All expenses declined sequentially as a percentage of from last year with only COGS being marginally higher on a sequential basis.
The Analog, Embedded Processing and Other segments generated operating margins of 37.2%, 24.0% and 34.1%, respectively. The Analog margin expanded 168 bps sequentially, Embedded Processing expanded 443 bps with Other 428 bps. The Embedded segment margin also grew year over year by 797 bps while other segment margins shrank.
Net Income
There were no one-time items during the quarter. Ongoing restructuring gains and acquisition charges (that are expected to remain steady over the next five years) went up from 7 cents to around 8 cents a share. They remain about level on a dollar basis.
The pro forma net income was $798 million, or a 23.3% net income margin compared to $695 million, or 21.5% in the previous quarter and $826 million, or 23.6% in the year-ago quarter.
On a GAAP basis, the company reported a net profit of 76 cents a share compared to a net profit of 66 cents in the previous quarter and a net profit of 77 cents in the comparable prior-year quarter.
Balance Sheet and Cash Flow
Inventories dropped 6.0% sequentially to around $1.48 billion, with inventory turns down from 2.9X to 3.2X. Days sales outstanding (DSOs) went from 40 to around 39. The cash and short-term investments balance was $2.74 billion, down $571 million during the quarter.
TI generated $1.41 billion in cash from operations, spending $139 million on capex, $790 mllion on share repurchases and $348 million on cash dividends.
At quarter-end, TI had $3.13 billion in long-term debt and $1.00 billion in short-term debt. During the quarter, the net debt position dropped $181 million. TI also had net underfunded retirement plans of $171 million.
Guidance
TI provided guidance for the fourth quarter.
Accordingly, it expects revenue of between $3.07 billion and $3.33 billion (down 6.7% sequentially at the mid-point) and better than the Zacks Consensus Estimate of $3.12 billion for the next quarter.
Non-cash amortization charges related to acquisitions will remain in the range of $80- $85 million until the third quarter of 2019, declining to $50 million for two more years. The annual effective tax rate will be around 30%.
The EPS for the quarter is expected to be 64 to 74 cents, better than the Zacks Consensus Estimate of 62 cents at the mid-point.
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 because of management’s strategy of focusing on these markets, the company is likely to be less affected.
Both Intel INTC and Advanaced Micro Devices AMD were impacted by the PC market weakness and Microsoft MSFT, which reports after the bell today, should also see the effects. But this couldn’t touch TI not only because it had already defocused the segment but also because of the one customer that pulled it through.
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, along with chipmaker Intel remains one of the few semiconductor companies that depend on internal capacity for manufacturing the bulk of its devices. But since it has the policy of building out capacity 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 any expansion plan.
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, driving factory loadings and therefore, sustainable margins (within management’s targeted range).
TI shares carry a Zacks Rank #4 (Sell). But after this quarter, estimates will likely move upward, which could lead to a revision in this rank.
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