Business Context and Reporting Period
Analog Devices, Inc. designs, develops, manufactures and markets mixed-signal integrated circuits and reports one operating segment. This Form 10-Q covers the three and six months ended May 4, 2019, the second quarter and first half of fiscal 2019. Fiscal 2019 has 52 weeks versus 53 weeks in fiscal 2018, so the first six months included one fewer week than the comparable period.
Financial Performance and Position
| Metric | Q2 FY2019 | Q2 FY2018 | Six months FY2019 | Six months FY2018 |
|---|---|---|---|---|
| Revenue | $1,526.6 million | $1,563.5 million | $3,067.7 million | $3,130.4 million |
| Gross margin | 67.7% | 68.6% | 67.6% | 68.5% |
| Operating income | $469.7 million | $502.6 million | $925.5 million | $944.4 million |
| Operating margin | 30.8% | 32.1% | 30.2% | 30.2% |
| Net income | $367.9 million | $400.3 million | $722.9 million | $693.6 million |
| Diluted EPS | $0.98 | $1.06 | $1.93 | $1.84 |
| Effective tax rate | 9.9% | 9.0% | 10.6% | 14.9% |
- Six-month operating cash flow was $1,042.6 million, or 34.0% of revenue, compared with $1,107.2 million, or 35.4%, in the prior-year period.
- Capital expenditures were $166.2 million; investing cash flow was negative $170.8 million.
- Financing cash flow was negative $975.1 million, including $377.2 million of dividends, $328.6 million of share repurchases and $350.0 million of debt repayments.
- Cash and cash equivalents were $713.6 million at May 4, 2019, down from $816.6 million at November 3, 2018. Approximately $267.7 million was held in the United States.
- Principal debt outstanding was $6.025 billion, with carrying value of approximately $6.0 billion. Current debt was $374.2 million and long-term debt was $5.612 billion.
- The company had a $1.0 billion revolving credit facility expiring July 10, 2020 and was compliant with applicable debt covenants.
- Accounts receivable were $686.0 million and inventories were $608.1 million at May 4, 2019. Days sales outstanding increased to 42 from 40 at fiscal year-end, and days of inventory increased to 111 from 107.
Material Changes Versus the Prior Comparable Period
- Q2 revenue declined 2%, net income declined 8%, diluted EPS declined 8%, and operating income declined 7% year over year. For the first six months, revenue declined 2%, while net income increased 4% and diluted EPS increased 5%.
- Gross margin decreased 90 basis points in both the quarter and six-month period, primarily due to lower internal wafer-fabrication utilization and a higher mix of lower-margin products.
- Industrial revenue declined 6% in both periods, consumer revenue declined 32% in Q2 and 26% year to date, automotive revenue was broadly flat in Q2 and declined 1% year to date, while communications revenue increased 31% in Q2 and 32% year to date.
- SMG&A expense declined 5% in both periods and R&D expense declined 1%, partly offsetting lower gross profit.
- Q2 special charges increased to $8.2 million from $1.1 million. First-half special charges were $29.9 million versus $58.4 million, primarily reflecting workforce repositioning, facility consolidation and acquired intellectual-property write-offs.
- Interest expense declined by $5.1 million in Q2 and $14.4 million year to date, principally due to lower debt-related costs following term-loan repayments.
- The first-half comparison benefited from lower taxes. The prior-year period included significant discrete effects from the 2017 Tax Cuts and Jobs Act, while fiscal 2019 included benefits related to GILTI accounting and completion of transition-tax accounting.
Guidance, Outlook, Commentary, Risks and Unusual Items
- Management expects fiscal 2019 capital expenditures to be approximately 5% of fiscal 2019 revenue. The filing does not provide a clear numerical revenue or earnings outlook.
- Management expects quarterly dividends to continue at $0.54 per share, subject to board approval. A $0.54 dividend declared May 21, 2019 was expected to total approximately $199.7 million.
- The company expects existing liquidity, operating cash generation and available financing to fund operations, capital expenditures, R&D, dividends and other needs for at least the next twelve months.
- Analog Devices plans to close the Linear-acquired Hillview wafer facility in California and Singapore test facility over the next two to four years, transferring production and testing to other facilities and external partners.
- Material contingencies include an approximately €43.0 million Irish transfer-pricing assessment, excluding penalties and interest. The company disputes the assessment and has not recorded an additional liability. Irish Revenue is also auditing fiscal 2014 through 2017.
- The company adopted revenue recognition guidance retrospectively, recognizing most distributor revenue upon shipment and estimating returns, price protection and other distributor credits. It also adopted income-tax guidance that increased retained earnings by $331.0 million at adoption and increased deferred tax assets and liabilities by approximately $1.7 billion and $1.3 billion, respectively.
- Key risks include semiconductor cyclicality, demand and inventory volatility, customer and distributor concentration, lower manufacturing utilization, reliance on third-party foundries and suppliers, trade restrictions and tariffs, international operations, debt service, tax audits, acquisition integration, cybersecurity, intellectual property and product liability.
- The company entered into an interest-rate swap associated with up to $1.0 billion of future debt issuance. Based on $1.4 billion of floating-rate debt, a 100-basis-point rate increase would change annual interest expense by approximately $14.3 million.
Facts Investors Should Verify
- Whether communications growth offsets continuing weakness in industrial and consumer demand and whether the gross-margin decline is temporary or structural.
- The pace and total cost of the Linear facility closures, workforce repositioning and related restructuring actions.
- The outcome and potential broader exposure from the Irish transfer-pricing assessment and audit.
- Debt maturities beginning with the $75.0 million term loan and $300.0 million senior notes due in 2020, together with the company’s refinancing plans.
- Distributor estimates for stock rotations, price protection and returns following the change to shipment-based revenue recognition.
- Whether cash held outside the United States can be accessed without additional withholding or state taxes if U.S. liquidity requirements increase.
- Progress toward the approximately 5% fiscal-year capital-expenditure target and continued dividend and repurchase capacity.