Business Context and Reporting Period
Company: Analog Devices, Inc.
Filing Type: Form 10-Q (Quarterly Report)
Period Ended: May 3, 2008 (Second Quarter of Fiscal 2008)
Business Overview: Analog Devices designs, develops, manufactures, and markets a broad range of integrated circuits. The company operates in one reportable segment. During the first quarter of fiscal 2008, the company sold its Baseband Chipset Business to MediaTek Inc. and its CPU voltage regulation and PC thermal monitoring business to ON Semiconductor Corporation. These businesses are reported as discontinued operations.
Key Financial Metrics
| Metric (in thousands, except per share) | Three Months Ended May 3, 2008 |
Three Months Ended May 5, 2007 |
Six Months Ended May 3, 2008 |
Six Months Ended May 5, 2007 |
|---|---|---|---|---|
| Product Revenue | $649,340 | $597,483 | $1,263,249 | $1,188,748 |
| Gross Margin | $396,021 (61.0%) | $361,228 (60.5%) | $771,824 (61.1%) | $760,892 (62.2%) |
| Operating Income | $157,185 | $134,206 | $303,098 | $303,617 |
| Net Income (Continuing Ops) | $129,892 | $125,578 | $251,740 | $282,031 |
| Net Income (Total) | $133,086 | $125,356 | $503,805 | $278,583 |
| Diluted EPS (Continuing Ops) | $0.44 | $0.37 | $0.84 | $0.82 |
| Diluted EPS (Total) | $0.45 | $0.37 | $1.68 | $0.81 |
| Cash & Short-term Investments | $1,185,179 (as of May 3, 2008) | |||
| Net Cash from Operating Activities | N/A | $330,963 | $446,786 |
Material Changes vs. Prior Period
- Revenue Growth: Product revenue increased 9% year-over-year for the quarter and 6% for the six-month period. Growth was driven by the Industrial (up 10%) and Communications (up 20%) end markets, partially offset by declines in the Computer market (down 12%).
- Discontinued Operations Impact: Total Net Income for the six months ended May 3, 2008, includes a significant one-time gain of $246.98 million (net of tax) from the sale of the Baseband Chipset and CPU voltage regulation businesses. Excluding these discontinued operations, income from continuing operations decreased slightly year-over-year for the six-month period due to lower nonoperating income and the absence of a $35 million one-time IP license revenue recorded in the prior year.
- Operating Expenses: Research and Development (R&D) expenses increased 6% year-over-year for the quarter, primarily due to higher salary and bonus expenses. Selling, Marketing, General and Administrative (SMG&A) expenses increased 15% for the quarter, largely due to the absence of an $8.5 million litigation settlement reimbursement received in the prior year.
- Nonoperating Income: Nonoperating income decreased significantly year-over-year due to lower interest rates, lower invested cash balances, and the absence of litigation settlement proceeds and investment gains recorded in the prior year.
Guidance, Outlook, and Risks
Outlook (Third Quarter Fiscal 2008):
- Revenue: Expected to be in the range of $650 million to $665 million (equal to or up 3% from Q2).
- Gross Margin: Expected to be approximately 61%.
- Operating Expenses: Expected to increase slightly from Q2.
- Diluted EPS (Continuing Ops): Expected to be approximately $0.43 to $0.45.
- Diluted EPS (Discontinued Ops): Expected to be approximately $0.02 to $0.03.
Management Commentary: Orders remained strong in the second quarter. Management notes that the operating plan does not factor in potential effects of ongoing financial market uncertainty which could lead to a more cautious stance from customers.
Risks and Contingencies:
- SEC Investigation: The company is in the process of settling an SEC inquiry regarding stock option granting practices. The settlement involves a $3 million civil penalty for the company and a $1 million penalty for the CEO, with no admission of wrongdoing. No restatement of historical financial results is expected.
- Legal Proceedings: A class action lawsuit regarding option granting practices is pending; the company intends to vigorously defend against it.
- Tax Uncertainties: The company has $11.2 million in liabilities for uncertain tax positions. The IRS is auditing fiscal years 2004-2007, with potential adjustments related to R&D credits and foreign manufacturing issues.
- Liquidity: While the company holds significant cash, a large portion is held in foreign subsidiaries and is not immediately available for U.S. requirements (dividends, buybacks) without repatriation. A new $165 million credit facility was established in May 2008 to supplement U.S. cash needs.
Investor Verification Checklist
- Discontinued Operations: Verify the sustainability of earnings by excluding the $247 million one-time gain from discontinued operations when analyzing long-term profitability.
- Revenue Mix: Monitor the continued growth in Industrial and Communications sectors versus the decline in the Computer sector to assess demand trends.
- Restructuring Savings: Track the realization of expected annual cost savings ($50 million from Sunnyvale closure, $30 million from reorganization, $25 million from Limerick consolidation, and $15 million from overhead reduction) to confirm margin expansion.
- Stock Repurchases: Note that the company repurchased approximately 5.8 million shares for $165.4 million in Q2, with $140.4 million remaining under the current $4 billion authorization.
- Tax Rate Volatility: Review the effective tax rate (22.6% for Q2) and monitor the resolution of IRS audits and the impact of the expiration of the R&D tax credit.