Business Context and Reporting Period
Analog Devices, Inc. designs, develops, manufactures and markets integrated circuits and reports as one operating segment. This Form 10-Q covers the three and nine months ended August 1, 2015, compared with August 2, 2014; the balance sheet is compared with November 1, 2014. Results include the July 2014 acquisition of Hittite Microwave Corporation, which expanded the company’s high-performance signal-processing portfolio.
Key Financial Metrics
| Metric | Three Months Ended August 1, 2015 | Year-over-Year Change | Nine Months Ended August 1, 2015 | Year-over-Year Change |
|---|---|---|---|---|
| Revenue | $863.4 million | 19% | $2.456 billion | 20% |
| Gross margin | $569.0 million; 65.9% | Up 50 bps | $1.617 billion; 65.8% | Up 20 bps |
| Operating income | $265.3 million; 30.7% of revenue | Up 31% | $722.2 million; 29.4% of revenue | Up 20% |
| Net income | $216.5 million; 25.1% of revenue | Up 20% | $600.6 million; 24.4% of revenue | Up 15% |
| Diluted EPS | $0.68 | Up $0.11 | $1.89 | Up $0.25 |
| Operating cash flow | Not separately provided | Not applicable | $709.8 million | Up from $609.3 million |
Revenue Mix
- Third-quarter revenue by end market was industrial $384.2 million, automotive $130.1 million, consumer $206.8 million and communications $142.3 million.
- Consumer revenue increased 155% year over year in the quarter, primarily from higher portable-sector demand. Industrial revenue increased 10%, automotive was essentially flat, and communications declined 14% due mainly to weaker wireless-base-station demand.
- For the nine-month period, industrial revenue increased 17%, automotive 1%, consumer 77% and communications 14%.
Liquidity, Capital Resources and Debt
- Cash and cash equivalents were $557.5 million at August 1, 2015, and short-term investments were $2.542 billion, totaling approximately $3.1 billion in liquidity.
- Approximately $656.2 million of cash and short-term investments was held in the United States; most remaining liquidity was held by foreign subsidiaries and intended to be permanently reinvested outside the United States.
- Net cash used in investing activities was $369.7 million, including $245.1 million of net purchases of short-term investments and $108.2 million of capital expenditures.
- Net cash used in financing activities was $348.7 million, including $365.5 million of dividends and $115.3 million of share repurchases.
- Debt carrying value was $873.2 million, consisting principally of $375.0 million of 3.0% senior notes due April 2016 and $500.0 million of 2.875% senior notes due June 2023. The 2016 notes were classified as current.
- The amended revolving credit facility provides borrowing capacity of up to $750.0 million and expires July 10, 2020. No borrowings had been made, and the company was compliant with its 3.0-to-1.0 leverage covenant.
- Management stated that existing liquidity, operating cash flow and available financing should be sufficient for operations, capital expenditures, research and development, dividends and potential repurchases for at least the next twelve months.
Material Changes Versus the Prior Comparable Period
- Revenue and operating income benefited substantially from the Hittite acquisition and broad-based demand increases. Hittite-related amortization increased operating expense by $23.0 million in the quarter and $71.0 million for the nine-month period.
- Gross margin improved modestly because of a higher-margin product mix and lower acquisition-related amortization, partly offset by higher demand reserves for last-time-build inventory.
- Research and development expense increased 15% in both the quarter and nine-month period, reflecting acquisition-related activity, higher employee costs and variable compensation.
- Third-quarter selling, marketing, general and administrative expense declined 10%, primarily because acquisition-related transition costs decreased by approximately $20.3 million. Nine-month expense increased 7% because of higher operating, employee and compensation costs.
- The effective tax rate increased to 16.6% from 8.5% in the quarter and to 14.9% from 11.9% for the nine-month period. The filing attributes the rates primarily to the geographic mix of earnings and discrete tax items.
- Inventory increased 15% from year-end to $424.5 million, and days of inventory increased to 127 from 109, reflecting production to support anticipated higher demand.
- Current liabilities increased to $1.058 billion from $709.1 million, mainly because the 2016 notes became current and deferred distributor income increased.
Guidance, Outlook, Commentary and Unusual Items
- Fiscal 2015 capital expenditures were expected to be $155 million to $160 million, including approximately $16 million for new facilities and upgrades.
- The board declared a $0.40-per-share dividend payable September 9, 2015. Management expected quarterly dividends to continue at $0.40 per share, subject to board approval.
- The company expected to contribute approximately $210 million in the fourth quarter to settle existing and future liabilities for active and deferred participants in its Irish defined-benefit pension plan as benefits are converted to a defined-contribution arrangement. Retired participants’ benefits were expected to be bought out through annuities.
- Distributor revenue is deferred until resale to end customers. Gross deferred revenue was $388.3 million and gross deferred cost of sales was $81.0 million at August 1, 2015. Future price-adjustment credits, returns and channel conditions could materially affect recognized revenue and gross margin.
- The company completed its Hittite purchase accounting during the quarter and recorded $4.4 million of related goodwill and deferred-tax adjustments during the first nine months.
- The company was evaluating the impact of the new revenue-recognition standard, expected to apply beginning in fiscal 2019. No material impact had yet been determined.
Principal Risks and Contingencies
- Semiconductor demand is cyclical and results may fluctuate with economic conditions, customer demand, product mix, pricing pressure, inventory levels and technological changes.
- The company relies on third-party wafer foundries, assembly and test providers and other suppliers; approximately 50% of annual wafer requirements were sourced from third-party foundries. Hittite’s GaAs supply chain included a transition away from a principal foundry.
- Foreign operations create exposure to currency movements, political and regulatory developments, tax changes, limits on repatriation and disruptions in China and other international markets.
- Foreign cash may not be readily available for U.S. dividends, repurchases, debt service or acquisitions without potential additional taxes.
- Potential tax liabilities include a $36.5 million reserve related to an open U.S. Tax Court matter for fiscal years 2006 and 2007 and approximately $66.4 million of unrealized tax benefits at August 1, 2015.
- Risks also include inventory obsolescence, distributor credits and defaults, intellectual-property litigation, product warranty or indemnity claims, cybersecurity incidents, natural disasters, environmental compliance and government-contracting requirements.
Facts Investors Should Verify
- Whether the strong consumer and Hittite-related growth persisted after the third quarter and how communications weakness developed.
- The timing and funding of the expected approximately $210 million Irish pension contribution.
- The company’s ability to refinance or repay the $375 million of notes due in fiscal 2016 without reducing capital returns or increasing leverage.
- Inventory aging, demand reserves, distributor deferred revenue and potential price-adjustment credits.
- The ultimate effect of the new revenue-recognition standard and the resolution of outstanding tax matters.
- Whether third-party foundry capacity and the GaAs supplier transition affect product availability, costs or customer deliveries.