Analog Devices, Inc. — Fiscal 2017 Second-Quarter 10-Q Summary
Business Context and Reporting Period
Analog Devices designs, manufactures and markets analog integrated circuits and reports one operating segment. The filing covers the three and six months ended April 29, 2017, compared with April 30, 2016. On March 10, 2017, the company completed its approximately $15.8 billion acquisition of Linear Technology Corporation; Linear’s results are included prospectively from the acquisition date.
Key Financial Metrics
| Metric | Three Months Ended April 29, 2017 | Year-over-Year Change | Six Months Ended April 29, 2017 | Year-over-Year Change |
|---|---|---|---|---|
| Revenue | $1.148 billion | 47% | $2.132 billion | 38% |
| Gross margin | 55.8% | Down 980 basis points | 60.4% | Down 340 basis points |
| Operating income | $145.8 million | Down 30% | $412.1 million | Up 2% |
| Operating margin | 12.7% | Down from 26.6% | 19.3% | Down from 26.0% |
| Net income | $93.6 million | Down 45% | $310.7 million | Down 7% |
| Diluted EPS | $0.27 | Down from $0.55 | $0.94 | Down from $1.07 |
| Operating cash flow | Not separately provided | — | $836.0 million | Up from $539.9 million |
Interest expense increased to $71.6 million in the quarter and $114.3 million for the six-month period, primarily due to acquisition-related borrowings and debt issuance costs. The effective tax rate was negative 7.9% for the quarter and 2.9% for the six months, benefiting from foreign tax rates and a $15.0 million state tax credit valuation allowance release.
At April 29, 2017, cash and cash equivalents were $5.7 billion and short-term investments were $490.6 million. Total debt principal was approximately $13.0 billion, consisting of $4.1 billion of bridge debt, $4.8 billion of term loans and $4.0 billion of senior unsecured notes. The company had a $1.0 billion undrawn revolving credit facility and was compliant with applicable debt covenants.
Material Changes Versus the Prior Comparable Period
- Revenue growth reflected higher demand across all reported end markets and $147.5 million of Linear revenue. Excluding Linear, quarterly revenue increased 28% and six-month revenue increased 28%.
- Quarterly end-market growth excluding Linear was 20% in industrial, 9% in automotive, 156% in consumer and 4% in communications. Consumer growth was particularly affected by stronger portable-consumer demand.
- Gross margin declined primarily because of acquisition accounting adjustments, including $121.1 million of acquired-inventory fair-value step-up costs, $17.6 million of acquired developed-technology amortization and $8.3 million of depreciation from acquired fixed-asset step-ups.
- Research and development expense increased 47% for the quarter and 32% for the six months, while selling, marketing, general and administrative expense increased 70% and 46%, respectively. The increases principally reflected Linear-related costs, higher compensation and acquisition expenses.
- Amortization expense increased to $68.7 million in the quarter and $86.9 million for the six months because of acquired intangible assets.
- The company recorded $49.5 million of fiscal 2017 special charges, including $41.3 million for an early-retirement program and $8.1 million for workforce reductions. Expected annual savings after implementation were approximately $28.4 million and $5.0 million, respectively.
- Shares outstanding increased substantially because approximately 55.9 million Analog Devices shares were issued as acquisition consideration. The share-repurchase program was temporarily suspended.
Cash Flow, Liquidity and Capital Allocation
- Six-month operating cash flow was $836.0 million, or 39.2% of revenue. Investing cash flow used $7.0 billion, including $9.7 billion of net cash paid for acquisitions. Financing cash flow provided $11.0 billion, primarily from acquisition-related debt financing.
- Accounts receivable increased 32% to $630.4 million and inventory increased 72% to $647.9 million from October 29, 2016, mainly due to the acquisition.
- On May 10, 2017, the company repaid $100 million on each of its three-year and five-year term loans. On May 19, 2017, it repaid all $4.1 billion of bridge loans.
- Management stated that existing liquidity, expected operating cash flow and available financing should fund operations, capital expenditures, research and development, and dividends for at least the next twelve months.
- Fiscal 2017 capital expenditures were expected to be $200 million to $220 million; $75.3 million had been spent during the first six months.
- The board declared a quarterly dividend of $0.45 per share on May 30, 2017. Future dividends remain subject to board approval.
Guidance, Outlook, Risks and Unusual Items
The filing does not provide specific revenue or earnings guidance. Management expects continued significant research and development investment and anticipated annual savings from workforce actions once implemented.
- Integration of Linear, including personnel, information technology systems, controls and operating infrastructure, remains a key execution risk. Acquisition accounting and goodwill allocation were still preliminary at the filing date.
- The company expects approximately $0.1 billion of net tax expense in the third quarter of fiscal 2017 from remitting approximately $3.6 billion of legacy foreign cash to support integration and other needs.
- Revenue recognition for certain distributor sales is subject to returns and price-adjustment credits. Gross deferred revenue was $527.7 million at April 29, 2017, and changes in distributor credits could materially affect revenue and gross margin.
- Adoption of the new revenue-recognition standard may change the timing of distributor revenue recognition. The company was evaluating early full-retrospective adoption.
- Floating-rate debt outstanding at quarter-end was approximately $9.1 billion; a 100-basis-point increase in interest rates was estimated to increase annual interest expense by approximately $91 million before the subsequent bridge-loan repayment.
- Other principal risks include semiconductor cyclicality, demand volatility, inventory obsolescence, competition and pricing pressure, reliance on third-party manufacturing, international operations and tax exposure, intellectual-property litigation, cybersecurity, manufacturing disruptions and the ability to service acquisition-related debt.
- The company retained a $36.5 million tax reserve pending the IRS appeal period at quarter-end. On May 30, 2017, after the appeal period lapsed, it released $45.3 million, including accrued interest.
Most Important Facts for Investors to Verify
- Post-acquisition revenue growth, gross-margin recovery and the extent to which acquired-inventory and intangible amortization charges normalize.
- Linear integration progress, final purchase-accounting adjustments, goodwill allocation and realization of expected synergies and cost savings.
- Pro forma leverage and interest expense after the May repayment of bridge debt and term-loan principal.
- Liquidity available in the United States versus cash held offshore and the tax cost of repatriating foreign cash.
- Distributor deferred revenue, price-protection exposure and the eventual impact and adoption method of the new revenue-recognition standard.
- The effect of the $45.3 million tax-reserve release and approximately $0.1 billion anticipated foreign-cash-remittance tax expense on subsequent-period results.