ADI

Business Context and Reporting Period

Company: Analog Devices, Inc.
Filing Type: Form 10-Q (Quarterly Report)
Reporting Period: Three and six months ended April 29, 2006 (Fiscal Year 2006)
Business Overview: The Company designs, develops, manufactures, and markets a broad range of integrated circuits, operating in one reportable segment. Key end markets include industrial, consumer, communications, and computer sectors.

Key Financial Metrics

Material Changes vs. Prior Period

• Revenue Growth: Net sales increased 6.6% in the quarter and 6.8% year-to-date, driven by a 13% increase in industrial end markets and a 13% increase in consumer end markets. Communications revenues were flat, while computer revenues declined slightly.
• Margin Expansion: Gross margin improved by 170 basis points in the quarter and 100 basis points year-to-date, primarily due to increased sales of higher-margin products.
• Stock-Based Compensation (SFAS 123R): The Company adopted SFAS 123R on October 30, 2005. This resulted in a $17.0 million expense in the quarter and $37.6 million year-to-date, reducing diluted EPS by $0.03 and $0.07 respectively.
• Nonoperating Income: Increased significantly due to a $13.0 million gain on the sale of the DSP-based DSL ASIC and network processor product line to Ikanos Communications, Inc.
• Restructuring: Special charges of $1.0 million were recorded in the six-month period related to the closure of a wafer fabrication facility and reorganization of product development programs.

Guidance, Outlook, and Risks

• Q3 2006 Guidance:
  • Revenue: Expected to be in the range of $675 million to $685 million.
  • Gross Margin: Planned to be approximately the same as the second quarter (approx. 59.1%).
  • Operating Expenses: Planned to increase by approximately 3% due to profit sharing and commissions.
  • Diluted EPS: Expected to be in the range of $0.38 to $0.39. This includes an estimated $0.06 per share impact from stock-based compensation, restructuring, and the planned acquisition of TTPCom assets.
• Capital Allocation:
  • Dividends: Board declared a cash dividend of $0.16 per share, payable June 14, 2006.
  • Share Repurchases: Repurchased 6.2 million shares for approximately $238 million in the quarter. Total repurchases under the program reached approximately $1.025 billion as of April 29, 2006. The Board authorized an additional $1 billion in repurchases in March 2006, bringing the total authorization to $2 billion.
• Risks and Contingencies:
  • SEC Settlement: Reached a tentative settlement regarding stock option granting practices. The Company will pay a $3 million civil penalty; CEO Jerald G. Fishman will pay a $1 million penalty. No restatement of historical financial results is deemed necessary.
  • Litigation: Pending patent infringement lawsuits filed by Biax Corporation and Gregory Bender. The Company intends to vigorously defend these claims and does not believe they will have a material adverse effect.
  • Acquisition: Agreed to acquire intellectual property and engineering resources from TTPCom Limited for approximately $23 million to support GSM/GPRS/EDGE modem software.

Investor Verification Checklist

• Impact of SFAS 123R: Verify the sustainability of earnings excluding the one-time adoption impact of stock-based compensation ($17.0M in Q2, $37.6M YTD).
• Restructuring Costs: Monitor the execution of the California wafer fabrication facility closure, with an estimated $18.4 million in additional expenses expected for the remainder of fiscal 2006.
• Product Line Sale: Confirm the non-recurring nature of the $13.0 million gain from the sale of the DSL product line when forecasting future nonoperating income.
• SEC Settlement Terms: Review the final administrative order language regarding the stock option investigation settlement.
• Supply Chain Concentration: Assess risks related to reliance on Taiwan Semiconductor Manufacturing Company (TSMC) as a sole-source supplier for certain wafers.