Updated from July 20 Investors took a skeptical view of the latest financial report from Texas Instruments ( TXN). After the close Tuesday, the wireless chip giant met Wall Street expectations for the second quarter and said it has headroom for further improvements in its operating margins. Management also said it expects sales of TI's cell-phone chips to grow faster than the broader handset market in the second half of the year, and said it doesn't expect to be hurt by troubles at leading handset customer Nokia ( NOK). Still, the stock was recently down 98 cents, or 4.5%, to $20.78 after trading as high as $22.30 early in the session. "Texas Instruments delivered strong
fiscal second quarter results and projects a solid fiscal third quarter outlook, which, given the recent weakness in the stock, should be viewed positively by investors," summed up Tai Nguyen of Susquehanna Financial Group in a morning note. Nguyen noted that on the conference call yesterday, TI management sought to allay investors' concerns that the company's wireless business could be hurt by trouble at leading customer Nokia, which has pledged to cut prices on handsets to win back lost market share. Last week Lehman Brothers analyst Tim Luke cut his rating on TI stock to equal weight from overweight, citing the potential for trickle-down pressure on TI's gross margins from Nokia's moves. Lehman Brothers hasn't done recent investment banking for TI. On the company's conference call, head of investor relations Ron Slaymaker disputed that concern: "Most of our handset customers operate on longer-term contracts on pricing," he explained. "What they're doing in the short term does not come back to TI in terms of lower pricing on what we sell to them." In a Wednesday morning note, Nguyen acknowledged that investors may still be concerned that weakness among TI's handset manufacturing customers, namely TI, could result in decelerating growth at TI. In that vein, a $137 million sequential increase in inventory might be taken as evidence that demand is abating. But judging from TI's first- and second-quarter results, he said, there's reason to believe the company can successfully manage the inventory growth "as well as a disruption from a 10%-plus wireless revenue customer. As such, we believe Texas Instruments appears well-positioned for sustainable growth entering the seasonal stronger half." (He has a net positive rating on the shares; Susquehanna doesn't do investment banking.)
Among other potential trouble spots in TI's report, the company reported a 2% sequential drop in semiconductor orders, noted CIBC's Rick Schafer. And despite better-than-seasonal sequential semiconductor revenue growth of 8% for the just-ended quarter, he called guidance for 0% to 7% semiconductor revenue growth "a bit lower than seasonal." Also, TI's gross margin increased but, at 45.7%, fell short of Schafer's estimate of 46.4%, due to an adjustment in the contract of one key TI licensee (which led to a $30 million drop in high-margin royalty revenue). But Schafer concluded: "While investors will likely focus on margins and bookings woes, we believe the key takeaway was TI's performance in the wireless business, which grew 15% sequentially. Investors had been concerned all quarter that market share issues at Nokia and price cuts at handset OEMs would hurt TI. Clearly, trends in 2.5G, 3G, OMAP, and chipsets outweigh these issues." He called the wireless performance "comforting" and said TI "is set for a strong second half of 2004 and 2005." Schafer has a sector perform rating on the shares. The Dallas-based company delivered second-quarter revenue of $3.24 billion, up 39% from last year's levels and slightly above the consensus estimate for $3.23 billion. Gross profit margins amounted to 45.7% of revenue, up 70 basis points from the prior quarter and 820 basis points from last year's levels on higher revenue. Net income amounted to $441 million or 25 cents a share, in line with estimates and up from $121 million or 7 cents a year ago. TI said semiconductor revenue of $2.78 billion rose 44% from last year's levels and 8% from the prior quarter, prompted by strong demand for digital signal processors (also called DSPs) and analog products. Wireless chips saw a revenue increase of 15% from the prior quarter, while high-performance analog was up 13%, and digital light processors were up 10%. TI also said its inventory increased $137 million from the prior quarter in order to meet customer plans for product sales into the second half of the year. Days of inventory increased to 66 days from 64 days at the end of the first quarter. But Chief Financial Officer Kevin March called those levels "reasonable" for the second quarter. "We had been working a number of quarters to build our inventory to get to desired levels and to meet unexpected upside demand from any of our customers," he told TSC. "We believe inventory came into balance in the second quarter. That's reinforced by what we saw on sales figures, the signals we're getting from customers that their inventory is more to their desired levels, and they reflect that by not putting orders in quite so far out in time." TI said it expects handset volume growth, which raged along at 30% in the first half of the year, to slow a bit in the second half. In an interesting twist, that outlook contradicts an assessment issued simultaneously Tuesday afternoon by wireless chipmaker RF Micro Devices ( RFMD), which
predicted that handset sales in the second half of calendar year 2004 will be stronger than in the first half of the year.
In any case, TI's March said the company should post above-market growth in the second half of 2004 as it increases its content per handset with its digital baseband processors and supporting silicon and application processors. In a statement, Chief Executive Officer Rich Templeton called TI's recent revenue growth "excellent" and said the company believes that its semiconductor business has gained share in the first two quarters of 2004. The wireless business saw second-quarter growth across a broad base of customers and a broad mix of products, TI said. "With stable depreciation and a lower expected profit-sharing accrual next year, TI is well-positioned to continue to deliver higher levels of profitability as revenue expands," Templeton said. For the third quarter, TI forecast revenue of $3.20 billion to $3.44 billion, compared with the consensus estimate of $3.38 billion. Earnings should be in the range of 26 cents to 29 cents, compared with analyst expectations for 28 cents. TI expects semiconductor sales to be flat to up 7% in the second quarter, forecasting a chip sales range of $2.78 billion to $2.98 billion. On the conference call, management addressed concerns that TI could be hurt by trouble at leading customer Nokia ( NOK), which has pledged to cut prices on handsets to win back lost market share. Last week Lehman Brothers analyst Tim Luke cut his rating on the stock to equal weight from overweight, citing the potential for trickle-down pressure on TI's gross margins from Nokia's moves. Lehman Brothers hasn't done recent investment banking for TI. But on the call, head of investor relations Ron Slaymaker disputed that concern, explaining, "Most of our handset customers operate on longer-term contracts on pricing. What they're doing in the short term does not come back to TI in terms of lower pricing on what we sell to them." In line with improving revenue growth rates and operating margins, TI also said today that it increased its profit-sharing accrual from $70 million in the first quarter to $100 million in the second quarter, while forecasting accruals of about $85 million in the remaining two quarters of the year.