Analog Devices, Inc. — Fiscal 2010 Third-Quarter Form 10-Q Summary
Reporting period: Three and nine months ended July 31, 2010, compared with August 1, 2009. The filing was signed August 17, 2010. Analog Devices designs, develops, manufactures, and markets integrated circuits and reports one operating segment.
Financial performance and position
| Metric | Q3 FY2010 | Q3 FY2009 | 9M FY2010 | 9M FY2009 |
|---|---|---|---|---|
| Revenue | $720.3 million | $492.0 million | $1,991.5 million | $1,443.3 million |
| Gross margin | 66.7% | 54.1% | 64.4% | 55.2% |
| Operating income | $251.1 million | $78.9 million | $614.3 million | $156.4 million |
| Operating margin | 34.9% | 16.0% | 30.8% | 10.8% |
| Net income from continuing operations | $199.5 million | $65.5 million | $486.2 million | $141.8 million |
| Diluted EPS | $0.65 | $0.22 | $1.59 | $0.49 |
| Operating cash flow | Not separately provided | Not separately provided | $716.9 million | $269.5 million |
Q3 revenue increased 46%, while nine-month revenue increased 38%. Q3 gross margin expanded 1,260 basis points and nine-month gross margin expanded 920 basis points. Management attributed the improvement primarily to higher sales, increased manufacturing utilization, manufacturing-cost reductions, wafer-fabrication consolidation savings, and favorable industrial product mix.
Q3 operating expenses were $229.1 million, including $127.0 million of research and development and $102.1 million of selling, marketing, general and administrative expense. The effective tax rate was 20.6% in Q3 and 20.8% for the first nine months, compared with 18.2% and 16.7%, respectively, in the comparable periods.
At July 31, 2010, cash and cash equivalents were $993.4 million and short-term investments were $1,514.9 million, totaling $2,508.3 million. Approximately $710.3 million of this liquidity was held in the United States; the remainder was held by foreign subsidiaries and was intended to be reinvested indefinitely. Accounts receivable were $357.5 million and inventory was $265.3 million.
Long-term debt was $395.8 million, primarily representing $375 million of 5% senior unsecured notes due July 1, 2014. Interest-rate swaps convert the fixed rate to three-month LIBOR plus 2.05%; the resulting rate was 2.58% at July 31, 2010. The company had not borrowed under its $165 million revolving credit facility and was compliant with its covenants.
Cash flow, capital allocation, and liquidity
- Operating cash flow for the first nine months was $716.9 million, or 36.0% of revenue.
- Capital expenditures were $73.8 million; fiscal 2010 capital expenditures were expected to be $110 million to $120 million.
- The company paid $184.4 million in dividends and received $174.0 million in net proceeds from employee stock-plan activity.
- Cash, cash equivalents, and short-term investments increased by $692.3 million during the first nine months.
- The quarterly dividend was $0.22 per share; a $0.22 dividend was declared on August 16, 2010, payable September 15, 2010.
- Approximately 114.8 million shares had been repurchased for $3.912 billion, with $87.6 million remaining under the authorization at July 31, 2010.
Business trends and material changes
- Industrial revenue was $340.5 million in Q3, up 69% year over year and representing 47% of revenue. Automotive revenue increased 62%, consumer revenue increased 23%, communications revenue increased 24%, and computer revenue increased 32%.
- Analog products represented 92% of Q3 revenue. Power management and reference revenue increased 91% year over year; amplifiers/radio frequency revenue increased 53%.
- Revenue increased in all geographic regions, with the largest Q3 increases in Europe and China. Approximately 81% of nine-month revenue came from international customers.
- Research and development expense increased 18% in Q3, while R&D as a percentage of revenue declined to 17.6% from 21.9%. Selling, marketing, general and administrative expense increased 28%, but declined to 14.2% of revenue from 16.2%.
- Nine-month special charges were $16.5 million, compared with $53.7 million in the prior-year period. The 2010 charges primarily related to workforce reductions, facility closures, and a small intellectual-property impairment.
- Restructuring actions were expected to generate approximately $25 million of annual savings from the Limerick consolidation, approximately $36.4 million from prior cost reductions, and approximately $41 million from the Cambridge facility closure. Additional cost-reduction actions were expected to produce approximately $4 million of quarterly savings when fully implemented in fiscal 2011.
- Discontinued operations contributed $0.9 million after tax in the first nine months, primarily from gains related to prior business sales. The filing states that up to $10 million may still be received from escrow in connection with the Baseband Chipset Business sale.
Guidance, outlook, risks, and unusual items
Management expected fourth-quarter fiscal 2010 revenue of $740 million to $770 million, gross margin of 66% to 67%, operating margin of 35% to 36%, and diluted EPS from continuing operations of $0.68 to $0.72. Operating expenses were expected to increase well below revenue growth.
Management believed existing liquidity, future operating cash flow, and available financing would fund operations, capital expenditures, research and development, dividends, and potential repurchases for at least the next twelve months. The filing cautions that the semiconductor industry remains cyclical and that the recovery in global credit and financial markets was uncertain.
- Key operating risks include economic deterioration, cyclical semiconductor demand, customer order cancellations, inventory obsolescence, pricing pressure, manufacturing capacity and yield constraints, and reliance on third-party wafer foundries.
- Approximately 48% of nine-month revenue was from products fabricated at third-party wafer facilities, primarily TSMC.
- Tax audits remained unresolved. Potential additional tax liabilities described in the filing totaled $46 million for fiscal 2004–2005 and $195 million for fiscal 2006–2007; management had not accrued these amounts because it believed additional liabilities were unlikely, but adverse outcomes could affect tax expense, earnings, and operating cash flow.
- Foreign-currency, interest-rate, credit-market, geopolitical, environmental, intellectual-property, litigation, product-quality, and supplier risks could materially affect results.
- The company had $108.4 million of unrecognized, before-tax stock-based compensation cost expected to be recognized over approximately 1.5 years.
- The company adopted additional fair-value disclosure requirements without a material financial impact. Several new accounting standards effective in fiscal 2011 were still under evaluation.
Important facts for investors to verify
- Whether the projected Q4 revenue, gross-margin, operating-margin, and EPS ranges were achieved.
- Whether demand growth in industrial, automotive, and consumer markets remained broad-based or reflected temporary recovery effects and government incentives.
- Whether gross-margin gains and restructuring savings were sustainable after manufacturing utilization normalized.
- The geographic availability of the $2.508 billion liquidity balance, particularly the portion held outside the United States.
- Exposure to third-party manufacturing capacity, inventory increases, distributor deferred revenue, and potential price adjustments or returns.
- Developments in the unresolved IRS examinations and the potential $241 million of unrecorded tax exposures described in the filing.
- Future cash use for dividends, share repurchases, capital expenditures, debt service, and potential acquisitions.