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TXN Beats Zacks Consensus, Margin Expansion Story Continues

Texas InstrumentsTXN , or TI) reported second-quarter earnings of 76 cents that easily beat the Zacks Consensus Estimate of 72 cents. Shares were up 1.11% in response.

Texas Instruments Inc. (TXN) Street EPS & Surprise Percent - Last 5 Quarters | FindTheCompany

Revenue

TI reported revenue of $3.27 billion, which was up 8.8% sequentially (better than seasonal) and 1.3% year over year (within the guidance range of $3.07 billion and $3.33 billion) and ahead of the Zacks Consensus Estimate by 2.1%.

The automotive market was again strong in the last quarter as electronic content per vehicle continues to increase (led by infotainment and also other areas like hybrid electric vehicle and powertrain systems) with broad-based improvement in industrial (half the segments grew) Communications equipment was up but personal electronics weakened, possibly because of continued weakness in mobile phones. Enterprise systems also grew.

Management has successfully steered the business into analog and embedded processing applications, which typically yield a more stable longer-lived business as well as stronger margins. On the call, management said that TI has been picking up market share in both the fragmented Analog and Embedded Processing markets.

The company continues to return cash to investors in the form of share repurchases and dividends.

Segment Revenue

The Analog, Embedded Processing and Other Segments generated 62%, 23% and 15% of quarterly revenue, respectively.

The Analog business grew 8.8% sequentially and down 0.2% from the year-ago quarter. In the year-over-year comparison, HVAL and power management sales were weaker, offsetting stable sales in HPA and SVA.

The Embedded Processing segment, which includes the processor, microcontroller and connectivity product lines, was up 3.6% sequentially and 9.4% from last year. The revenue split between the three product lines was 45%-45%-10%. Connectivity is the fastest growing part with applications across diverse markets; processor growth is next (mainly coming from the auto and communications infrastructure markets) while the growth in microcontrollers is coming from the industrial market. Similar to the previous quarter, the strength was broad-based across all product lines with processors leading the growth. Management focus in this business is on long-lived products, so that's where current investment is going.

The Other segment, which includes DLPs, custom ASICs, calculators, royalties and some legacy wireless products was up 7.0% sequentially but down 3.9% year over year. Calculators, royalties and custom ASICs impacted the year-over-year performance with DLPs partially offsetting the negative impact.

Net product orders were $3.33 billion in the last quarter, up 7.8% sequentially and 2.1% year over year.

Margins

TI's gross margin of 61.2% was up 56 bps sequentially and 300 bps from the year-ago quarter. The company's gross margin has been improving consistently as more production shifts to its 300mm line (this results in a 40% cost benefit at the die level). Reducing depreciation on its fixed assets is also a contributing factor. Fab utiization remains steady and mix relatively consistent at these levels, so these factors aren't likely to remain gross margin drivers in the future. Over time, TI expects to take the incremental gross margin to 70-75% of sales, or around 2 to 7 points higher than it is today.

Operating expenses of $886 million were up 3.5% sequentially and up 1.6% from last year. The operating margin was 34.1%, up 195 bps sequentially and 295 bps from the year-ago quarter. All expenses declined sequentially as a percentage of sales but R&D was up slightly from last year.

The Analog, Embedded Processing and Other segments generated operating margins of 37.7%, 25.0% and 33.1%, respectively. The Analog margin expanded 158 bps sequentially, Embedded Processing expanded 7 bps with Other expanding 897 bps. Analog and Embedded and Other segment margins expanded year over year by 219 bps, 547 bps and 330 bps, respectively.

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 $779 million, or a 23.8% net income margin compared to $668 million, or 22.2% in the previous quarter and $695 million, or 21.5% 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 65 cents in the previous quarter and a net profit of 66 cents in the comparable prior-year quarter.

Balance Sheet and Cash Flow

Inventories grew 3.9% sequentially to around $1.88 billion, with inventory turns up slightly from 2.6X to 2.7X. Management said that the lower cost of inventory enabled the company to generate more days of sale at similar dollar values. So there does appear to be some buildup that may be burnt off in the second half of the year when sales pick up. Days sales outstanding (DSOs) were almost consistent at around 38. The cash and short-term investments balance was $2.54 billion, down $261 million during the quarter.

TI generated $1.07 billion in cash from operations, spending $158 million on capex, $527 mllion on share repurchases and $382 million on cash dividends.

TI is one of the few technology companies that return 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 8.2% over the trailing 12 months, although amount spent on share repurchases dropped 4.4%. As a result, the total cash returned to shareholders was consistent with the trailing 12 months of 2015.

At quarter-end, TI had $2.98 billion in long-term debt and $637 million in short-term debt. During the quarter, the net debt position dropped $245 million. TI also had net underfunded retirement plans of $108 million.

Guidance

TI provided guidance for the third quarter.

Accordingly, it expects revenue of between $3.34 billion and $3.62 billion (up 3.5% sequentially at the mid-point) and better than the Zacks Consensus Estimate of $3.39 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 is unchanged at around 30%.

The EPS for the quarter is expected to be 81 to 91 cents, better than the Zacks Consensus Estimate of 81 cents.

Capex target remains at 4% of revenue including expansion of 300mm capacity for Analog production.

Recommendation

Texas Instruments reported a better-than-expected quarter and provided encouraging guidance. All signs point to strengthening auto and industrial markets, which are helping the company. The communications market is also improving, with personal electronics and other markets weak or have moving parts but TI continues to do 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 the Richardson fab (RFAB) can be built up to produce up to $5 billion in 300mm Analog demand. A second 300mm fab has been qualified which will be split between Analog and Embedded production. Using 300mm capacity reduces cost by around 40%. Therefore, producing more of its chips at 300mm facilities will be a continued 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.

Texas Instruments also 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.

TEXAS INSTRS Price, Consensus and EPS Surprise

TEXAS INSTRS Price, Consensus and EPS Surprise | TEXAS INSTRS Quote

TXN shares carry a Zacks Rank #4 (Sell). Semiconductor stocks worth investing in right now are NVIDIA NVDA , Taiwan Semconductor TSM , Intel and Semtech Corp SMTC . While NVDA and TSM have a Zacks Rank #1 (Strong Buy), the other two carry a Zacks Rank #2 (Buy).

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The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.


The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.

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