Texas Instruments Q4 2005 Earnings Conference Call Transcript (TXN)

Texas Instruments (TXN)
Q4 2005 Earnings Conference Call
January 23rd 2006, 4:30 PM.

Executives:

Ron Slaymaker, Vice President and Manager of Investor Relations
Kevin March, Chief Financial Officer

Analyst:

Michael Masdea, Credit Suisse
Adam Parker, Sanford Bernstein
Glen Yeung, Citigroup
Cody Acree, Stifel Nicolaus
Chris Danely, JP Morgan
Tom Thornhill, UBS
Jim Covello, Goldman Sachs
David Wu, Global Crown Capital
John Barton, Wachovia Securities
Ambrish Srivastava, Harris Nesbitt
Mark Edelstone, Morgan Stanley
Chris Caso, Friedman Billing
Tim Luke, Lehman Brothers
Michael McConnell, Pacific Crest
Joseph Osha, Merrill Lynch
Tristan Gerra, Robert W. Baird

Presentation:

Ron Slaymaker, Vice President and Manager of Investor Relations

Good afternoon and thank you for joining our Fourth Quarter and 2005 Earnings Conference Call. Kevin March TI’s Chief Financial Officer is with me today. To review investor release, you can find it on our website at ti.com/ir. This call is being broadcasted live over the web and can be accessed through TI’s website. A replay will be available to the web. This call will include forward-looking statements that involve risk factors that could cause TI’s results to differ materially from management’s current expectations. We encourage you to review the Safe Harbor statements contained in the earnings release published today, as well as TI’s most recent SEC filings for a complete description. Our mid-quarter update towards outlook is scheduled this quarter for March 6, we expect narrow or adjust revenue in earnings guidance ranges as appropriate with this update. We will observe a quite period beginning on March 1 until the update. In today’s call, I’ll review our highlights of revenue performance and then Kevin will discuss profit performance in the first quarter outlook. After this review, we will open the line for your questions.

Fourth quarter TI revenue of $3.59 billion was even with the third quarter level and grew 14% from a year ago. This was at the lower end of the updated guidance range that we provided in December, primarily due to assembly and test capacity constraint in semiconductor. Even so, semiconductor revenue grew 3% sequentially and was up 15% from a year ago. This was the second consecutive quarter of accelerating year-on-year growth for semiconductor, a trend which we expect to continue into the first quarter. Sensors and Controls revenue grew 8% sequentially and 9% from a year ago. The E&PS revenue declined seasonally by 62% from the third quarter and was down 16% from a year ago.

Semiconductor revenue set a new quarterly record and was accomplished while simultaneously setting a new quarterly record operating margin of 28.1%, especially noteworthy, was another strong quarterly performance by our high performance analog group, which grew revenue 8% sequentially. High performance analog revenue was up 41% from a year ago, reflecting the combination of four consecutive quarters with solid growth and the inventory correction that was underway at TI’s distributors in the year ago quarter. Overall, analog revenue grew 2% sequentially and increased 20% from a year ago. The year-on-year comparison was negatively impacted by about 7 percentage points due to the divestiture of the commodity LCD driver product line in the first quarter of 2005. This revenue was $53 million in the year ago quarter.

In addition to the previously mentioned high performance analog growth, demand for wireless analog product was also strong in both comparisons. TI’s overall wireless revenue grew 4% sequentially and was up 12% from a year ago. 3G revenue was the biggest factor driving our year-on-year growth. Sequentially, in addition to 3G, we had strong growth in a range of 2.5D products, including chipsets sold to ODM customers for low priced handsets to address emerging market opportunities and OMAP application processors for Smart Phone. In addition, our Bluetooth units tripled sequentially as we ramp new programs since production. Overall, DSP revenue increased 2% sequentially and 12% from a year ago, driven in both comparison by wireless.

Let me make a few quick points about our performance overall in 2005. First, our execution in high performance analog was very strong in 2005, with revenue growing 13% from 2004. This growth rate was 50% higher than our closest major competitor. And we exited 2005 with distribution inventory levels of our high performance analog product, lower than they were at the end of 2004, despite resale that were significantly higher. Growth in 2005 would have been several points higher had distribution inventory grown at the same pace as the resale through the year. Nonetheless, we are encouraged at the lean channel inventories will service well in 2006.

Next, I believe we performed well on wireless in 2005 with revenue growth of 14% we entered the year with many predicting that TI would loose market share in the fasting growing 3G WCDMA market. We’re exiting the year having done the opposite. We believe industry shipment that WCDMA handset doubled in 2005. TI doubled our shipments of OMAP application processors and almost tripled our shipments of WCDMA modems in 2005. In both areas, TI holds strong market leadership.

We solidly accomplished our goal to exceed $1 billion of semiconductor revenue in WCDMA in the year. As we enter 2006 a year in which, most expect that WCDMA handsets will double again in terms of shipments. We are confident that we will maintain our market share, if not expand it further. At the same time, we’ve cornered an undisputed leadership position, supplying chips to the rapidly growing emerging market for low priced handsets. In 2006, we expect to extend this lead even further as we ramp volume production of our Single-Chip cell phone product. As in 3G, we are engaged with market leaders for gaining share themselves.

TI shipped more than 400 million units of Digital Baseband devices in total in 2005 and more than half of the world’s cell phones continued to be based on DSP technology from TI. TI has shipped more than 150 million chips in total in 90-nanometer technology, and 65-nanometer process is now qualified in a ramping end of production. This deployment of advanced technology as well ahead of any of our major wireless competitors and it’s a significant differentiator for TI. Our customers are advantaged by our technology allowing them to introduce phones that perform better consume less power, fit into smaller, thinner form factors and cost less.

2005 was a more challenging year for TI’s DLP product line as we entered the year with significant excess inventories at both our form projectors and HDTV customers and their channels. Overall, DLP revenue declined 8% in 2005, however we left the year in a much better position with revenue in the fourth quarter up 10% from the year ago quarter. More importantly our products continue to be enthusiastically received by our OEM customers and consumers alike. We continue to leverage the flexibility and then earn performance advantages of DLP technology as well as continue to build our brand image with consumers.

Recent technology introduction examples include DLP, HDTV chipset that’s the fourth LED illumination and brilliant color technology which extends DLP color processing from 3 colors up to 6 colors. Significantly increasing the number of producible color shades and providing up to a 50% brightness increase. These innovations provide real advantages to consumers and demonstrate a level of technology headroom that is available to TI and our customers with DLP technology. At this point, I have Kevin to review profitability and our outlook.

Kevin March, Chief Financial Officer

Thanks Ron, and good afternoon everyone. As Ron indicated, we are pleased with the progress that we made profitability in the quarter. Excluding stock-based compensation expense, we held our 25% operating margin that we first achieved in the third quarter. Total stock-based compensation expense in the fourth quarter was $86 million or 2.4% revenue. For the year, it was 178 million or 1.3% of revenue. In comparison with the prior periods, please remember the stock option expense is not included in the periods prior to the third quarter of 2005.

TI’s fourth quarter gross profit was $1.73 billion or 48.3% of revenue. The sequential decline in gross profit and gross margin was due to the seasonal decline in graphing calculators with their associated strong margins. Semiconductor gross profit increased due to the high revenue as its gross margins were about the same as last quarter. Operating expenses decline by 32 million or 1% revenue compared with the third quarter. The seasonal decline in paying benefits resulted from holidays and vacation time taken by employees during the quarter was the primary reason for the decline. As you would expect, these trends should reverse the gain in the first quarter.

TI’s operating profit for the quarter was 810 million or 22.6% of revenue. Again, this includes stock-based compensation expenses that were 2.4% of revenue in the quarter. Semiconductor operating margin reached a new record high 28.1% of revenue in the fourth quarter. This was a second sequential increase of 1.5 percentage points and an increase of 11 percentage points from a year ago. For the year, TI’s operating profit of $2.79 billion and operating margin of 20.8% of revenue both set new annual records and reflect profitability gains in semiconductor.

Semiconductor’s operating margin for the year is 23.9% an increase of 5.2 percentage points from 2004. TI’s overall tax rate in the fourth quarter including discrete items was 24%. Net income was 655 million or $0.40 per share in the fourth quarter. Although, we were at the lower end of our guidance range for revenue, we were pleased to be able deliver earnings that were at the top end of our range. For my account, if I summarize the fourth quarter’s earnings per share transitions from $0.38 that we reported in the third quarter. On the plus side, about $0.02 of higher EPS resulted from semiconductor revenue growth about a penny came from lower operating expenses and about $0.02 came from lower tax rate. We called that the third quarter tax rate included cumulative catch up adjustment. On the minus side, earnings per share were reduced by about $0.03 due to the seasonally lower EPS revenue.

For the year, net income increased 25% to $2.32 billion. Only most of the cash flow and balance sheet items for you to review it in the earnings release. Let me make just a few comments. Cash flow from operations was $908 million in the quarter and 3.77 billion for the year. We entered the year with $5.34 billion in total cash. TI used $870 million of cash during the quarter to repurchase 28 million shares of TI common stock. For the year, we used 4.15 billion to repurchase 153 million shares of stock. Average diluted share outstanding were 1.64 billion in the fourth quarter, down 20 million shares in the third quarter. For the year, average diluted shares outstanding were 1.67 billion down almost 100 million shares from 1.77 billion in 2004. Inventory of 1.27 billion at the end of the fourth quarter increased 115 million from the less-than-desired level of the third quarter. Note that almost all of 108 million of the inventory increase remains work-in-process at the end of the fourth quarter. Inventory levels while improved remains below our desired levels, especially in high performance analog die banks and overall finished goods. Days of inventory at the end of the fourth quarter were up 62, up 5 days sequentially and the same as the year ago.

TI orders in the fourth quarter were 3.77 billion about even sequentially. Semiconductor orders were 3.39 billion, up 2% sequentially. Semiconductor’s book-to-bill ratio was 1.05, down slightly from 1.06 in the third quarter. Before I turn to our outlook for the first quarter in 2006, let me remind you that the previously divestiture of TI’s Sensors and Controls operations, to Bain capital is expected to close in the first half of 2006. The financial results for this business will be accounted for at a discontinued operation beginning in the first quarter. This means that its results, excluding a small RFID operation that will remain with TI as part of the semiconductor segment will be consolidated to a single line item on the income statement labeled income from discontinued operations. Its results will not be reported in the company’s revenue, cost of revenue or operating expense lines.

For the first quarter, we currently expect total TI revenues from continued operations to be in the range of $3.11 billion to $3.38 billion. Semiconductor revenue should be in the range of 3.05 billion to 3.30 billion and E&PS should be in the range of $60 million to $80 million. Earnings per share from continuing operations are expected to be in the range of $0.29 to $0.33 in the first quarter. This estimate includes about $0.04 for stock-based compensation expense or about $90 million, a little higher than the third and fourth quarter levels. EPS from discontinued operations is expected to be about $0.03. In 2006, our tax rate will be affected if the US government reinstates the Federal Research Tax Credit which expired at the end of 2005. Our annual effective tax rate was expected to be about 30% and does not assume the reinstatement of this tax credit. For reference, the higher tax rate will negatively impact first quarter EPS by about $0.03 when compared with the 24% rate of the fourth quarter.

For 2006, for continuing operations, we expect R&D to be about 2.2 billion, capital expenditures to be about 1.3 billion and depreciation to be about 1.03 billion. This depreciation estimate reflects the company’s change from an accelerated to a straight line method of depreciation for existing and future property planting equipment beginning in the first quarter of 2006. This change is the result of our studying the pattern of usage of TI’s long led depreciable assets. The study indicated the trend toward more consistent utilization of assets as TI has focused its product portfolio on differentiate products and supplemented its internal semiconductor manufacturing, the supply from foundries. The effect of this change will be reflected on a prospective basis and prior period results will not be restated.

2006 depreciation is expected to decline about $350 million compared with 2005. About half of this decline is the result of the change to the straight line method with a remainder mostly due to TI’s lower capital spending of the last few years. The small amount of the decline will be due to the discontinued operations. In the first quarter, we expect depreciation to decline about $80 million in total, which is about 35 million lower under the new straight line method than it would have been under the prior method. However please note that since depreciation is in inventorial cost, we will see less than 10 million of benefit to pre-tax income from this change in the first quarter. Considering that we entered the quarter with 62days of inventory, where depreciation was calculated under the prior accelerated method.

So in summary, 2005 overall was a milestone year for TI, we set new records for annual revenue, operation margin, operating profit and cash flow for operations in the year. We are very encouraged with the financial health and strategic direction of the company. We believe the actions such as the divestiture of our Sensors and Control segment and the recently announced acquisition of Chipcon, but both serves a high performance analog capabilities will continues to evolve TI into a company that will produce superior revenue and earnings growth on a sustained basis. I should also note that our Board’s recent authorization to reinvest an additional $5 billion in repurchases of the TI common stock that was announced today. This is a statement of confidence in the opportunities ahead for TI and our ability to translate these opportunities into solid financial results. With that, let me turn it back to Ron.

Ron Slaymaker, Vice President and Manager of Investor Relations

Thanks Kevin, and this time, I ask operator to open the lines up for your questions. In order to provide as many of you as possible an opportunity to ask your questions, please limit yourself to a single question. After our response, we will provide you an opportunity for additional follow up. Operator?

Questions & Answers

Operator

Thank you, the floor is now open for questions. If you do have a question at this time please press “*