In September 2012, Texas Instruments (NASDAQ:TXN) declared its intention to stop focusing on smartphones and tablets and to instead expand its OMAP footprint in embedded applications, which it believes offers greater potential for sustainable growth compared to mobile devices. As part of it restructuring efforts TI took a number of steps to reduce its overall expense base. However, it does not expect to realize any significant gains from restructuring in its Q4 2012 earnings, which it reports Tuesday, 22 January.
Despite the sluggish macro environment, TI registered a 2% and 5% sequential increase in its Q3 2012 revenue and gross profits respectively. However, with a 5% sequential decline in orders last quarter, TI expects to witness significant downside in its Q4 2012 revenue.
We feel that that a decline in orders for TI’s analog and embedded processor division is more on account of macro factors as we believe that the two divisions are the primary growth engines for TI. Though TI’s future in the wireless business remains uncertain, we believe the company’s strength in analog and embedded processors will help it regain the growth momentum in the future.
Analog And Embedded Processing To Be The Primary Growth Engines
Generating strong cash flow and investment returns, the analog and embedded processor divisions remain the focus areas for TI. While the wireless division posted a 5% q-o-q decline, TI’s analog and embedded businesses registered marginal increases in revenue in Q3 2012. However, on account of macro weakness, majority of TI’s customers continue to maintain a lean inventory due to which it expects a sequential decline in almost all its business divisions in Q4.
Nevertheless, with new product launches, TI continues to expand its analog and embedded portfolio every quarter. It registered an increase in it share in the analog segment last quarter. With the acquisition of National Semiconductor and some other companies’ fabrication and equipment and factories, TI has added around $7 billion worth of incremental revenue generating capacity in the last few years. While the excess manufacturing capacity gathered over the years might weigh on the short term growth, we feel the same will help TI further increase its market share in the analog division in the future.
Low Level Of Factory Utilization Could Impact Margins
Amid a slowdown in the semiconductor industry, the additional manufacturing capacity has led to lower factory utilization which in turn has put pressure on gross margins. Barring a sudden jump in 2010, TI’s gross margins have witnessed a y-o-y decrease from 2007 to 2011. The increased costs associated with the incremental capacity has negatively impacted margins.
At 51.3%, gross profits increased by 5% sequentially in Q3 2012. A significant portion of the increase can be attributed to the $60 million business interruption insurance proceeds from the Japan earthquake settlement. Also, owing to the soft demand and excess manufacturing capacity, TI registered a slight increase in its under utilization charges in Q3 2012, which it expected to further increase in Q4.
Last year, TI announced its decision to close down two old factories in Japan and Texas by the second half of 2013. The company claims that it has no plans to take any more capacity offline. However, it intends to further reduce its operating expense in light of the lower revenue target.
TI feels that the excess capacity gives it a competitive edge over other players in the analog market. While the weakness in demand may persist for a few more quarters, the company is confident that it can continue to manage its operations efficiently and keep margins in control.
No Significant Benefit From Wireless Business Restructuring
Exiting the smartphone and tablet markets, TI is now focused on expanding the OMAP footprint in embedded applications such as automotive, industrial equipments, enterprise communications, etc. The company feels that the embedded markets offer greater potential for sustainable growth compared to mobile devices. It intends to leverage its wireless connectivity solutions in a broader set of embedded applications which require fewer resources and less investment.
As a result of its restructuring initiative, TI announced its intention to cutback 5% of its global workforce to reduce expenses in the wireless business. It plans to provide a range of assistance w.r.t. compensation benefits and job search for the affected employees, because of which it estimates $325 million in additional expenses in Q4.
Despite the extra cash outlay, TI did not expect any substantial restructuring benefits in Q4. However, it estimates its restructuring initiative to translate into annualized savings of approximately $450 million by the end of 2013.
We will update our price estimate of $35.72 for TI post the Q4 2012 earnings release.