Analog Devices, Inc. — Fiscal 2011 Second-Quarter Form 10-Q
Reporting period: Three and six months ended April 30, 2011, compared with May 1, 2010. The company designs, manufactures and markets integrated circuits and reports one operating segment. Results exclude previously sold baseband chipset and CPU voltage regulation businesses, which are reported as discontinued operations.
Financial performance
| Metric | Q2 FY2011 | Q2 FY2010 | Six months FY2011 | Six months FY2010 |
|---|---|---|---|---|
| Revenue | $790.8 million | $668.2 million | $1,519.3 million | $1,271.2 million |
| Gross margin | 67.6% | 65.0% | 66.9% | 63.2% |
| Operating income | $298.5 million | $214.1 million | $557.9 million | $363.2 million |
| Operating margin | 37.7% | 32.0% | 36.7% | 28.6% |
| Income from continuing operations | $241.8 million | $167.1 million | $457.4 million | $286.7 million |
| Diluted EPS from continuing operations | $0.78 | $0.55 | $1.48 | $0.94 |
| Net income | $241.8 million | $167.1 million | $463.9 million | $287.6 million |
Q2 revenue increased 18% year over year, while six-month revenue increased 20%. Income from continuing operations increased approximately 45% in Q2 and 60% for the six-month period. The six-month net income includes a $6.5 million after-tax gain from discontinued operations.
- Q2 gross margin increased 260 basis points; six-month gross margin increased 370 basis points, driven by higher volume, improved manufacturing utilization and cost-reduction initiatives.
- Analog products represented 92% of Q2 revenue and grew 20% year over year. Digital signal processing revenue grew 4%.
- Q2 end-market growth was strongest in communications, up 34%, automotive, up 28%, and industrial, up 21%. Consumer and computer revenue each declined 10%.
- Research and development expense increased 6% in Q2 but declined to 16.5% of revenue from 18.4%. Selling, marketing, general and administrative expense increased 8% but declined to 13.3% of revenue from 14.6%.
Cash flow, liquidity and capital structure
- Six-month operating cash flow was $413.4 million, or 27.2% of revenue, compared with $492.1 million, or 38.7%, in the prior-year period.
- Cash and cash equivalents were $1.895 billion at April 30, 2011, compared with $1.070 billion at October 30, 2010. Short-term investments were $1.537 billion, producing total cash, cash equivalents and short-term investments of $3.431 billion.
- Approximately $1.247 billion of cash and short-term investments was held in the United States; the balance was held outside the United States and certain foreign earnings were intended to be reinvested indefinitely.
- Investing activities provided $24.1 million, including investment maturities and sales, partly offset by $59.7 million of capital expenditures. Management expected fiscal 2011 capital expenditures of approximately $135 million.
- Financing activities provided $385.8 million, including $515.5 million of debt proceeds, partly offset by $181.2 million of share repurchases and $131.8 million of dividends.
- Total debt consisted principally of $375 million of 5.0% senior notes due 2014, $145 million of term debt due 2013 and $375 million of 3.0% senior notes issued in April 2011 and due 2016. The balance sheet reported $14.5 million of current debt and $892.4 million of long-term debt.
- The company had not borrowed under its $165 million revolving credit facility and was compliant with applicable debt and credit-facility covenants.
Material changes and unusual items
- On April 4, 2011, the company issued $375 million of 3.0% senior unsecured notes due April 15, 2016, generating net proceeds of approximately $370.5 million.
- During the first six months, the company entered into a $145 million term loan facility, repurchased approximately 4.8 million shares for $181.2 million and paid quarterly dividends of $0.22 per share.
- A net $10.8 million tax benefit was recorded in Q2 from settlements of certain IRS matters for fiscal years 2004 through 2007. Remaining disputed matters included potential liabilities of $36.5 million for fiscal 2004–2005 and $157.5 million for fiscal 2006–2007; management believed additional liabilities were not likely and had not accrued them.
- No new special charges were recorded in the six-month period. Prior restructuring actions had generated annual savings, including approximately $36.4 million from operating-cost reductions and approximately $41 million from the Cambridge wafer-fabrication consolidation.
- Deferred income on distributor shipments increased approximately $26.7 million to $269.5 million, reflecting shipments to distributors exceeding their sales to end customers. Future price-adjustment credits and returns could affect revenue and gross margin.
Guidance, outlook and risks
- For Q3 FY2011, management planned revenue of $765 million to $795 million, gross margin of approximately 67.0% to 68.0%, operating expenses flat to down 1% sequentially, and diluted EPS from continuing operations of $0.70 to $0.75.
- Management attributed growth to recovering global economic activity, stronger industrial, communications, automotive and healthcare markets, product focus and manufacturing cost improvements. It expected existing liquidity and operating cash flow to fund operations, capital expenditures, research and development, dividends and potential repurchases for at least the next twelve months.
- Management did not then expect a material adverse effect from the March 2011 Japan earthquake and tsunami, but continued to monitor customer and supply-chain impacts. Japan represented approximately 13% of six-month revenue, and Japan-related consumer sales declined.
- Key risks include semiconductor cyclicality, demand volatility, pricing pressure, inventory obsolescence, reliance on third-party wafer foundries and subcontractors, manufacturing disruptions, international and foreign-exchange exposure, distributor credit and price-protection obligations, intellectual-property litigation, environmental regulation, tax controversies, debt-service requirements and the concentration of cash outside the United States.
- The May 16, 2011 dividend declaration increased the quarterly dividend to $0.25 per share, payable June 15, 2011. Management expected quarterly dividends to continue at that level, subject to board approval.
Investor verification points
- Verify the sustainability of the 67%–68% gross-margin range and the Q3 revenue and EPS guidance.
- Assess whether distributor deferred income, inventory days and accounts-receivable days indicate future demand or channel risk.
- Monitor the effects of the Japan disaster, international economic conditions and semiconductor-cycle changes on end markets and supply availability.
- Review the impact of the new debt, variable-rate term loan and interest-rate swaps on future interest expense and covenant compliance.
- Evaluate the resolution and cash-tax exposure of the remaining IRS transfer-pricing and Section 965 matters.
- Distinguish recurring operating earnings from the $10.8 million tax benefit and the $6.5 million discontinued-operations gain.
- Confirm the availability and geographic accessibility of cash, given that substantial foreign-held funds were intended to remain offshore.