Analog Devices, Inc. — Fiscal 2018 Second-Quarter Form 10-Q
Business context and reporting period
Analog Devices designs, develops, manufactures and markets integrated circuits and reports as one operating segment. The filing covers the three and six months ended May 5, 2018, compared with April 29, 2017. Fiscal 2018 has 53 weeks, with an additional week included in the first six months. Results include Linear Technology prospectively following its March 10, 2017 acquisition.
Financial performance and liquidity
| Metric | Three months ended May 5, 2018 | Year-over-year change | Six months ended May 5, 2018 | Year-over-year change |
|---|---|---|---|---|
| Revenue | $1.513 billion | 32% | $3.032 billion | 42% |
| Gross margin | $1.034 billion; 68.3% | Up from 55.8% | $2.069 billion; 68.2% | Up from 60.4% |
| Operating income | $464.0 million; 30.7% margin | Up 218% | $869.3 million; 28.7% margin | Up 111% |
| Net income | $379.8 million; 25.1% margin | Up 306% | $648.0 million; 21.4% margin | Up 109% |
| Diluted EPS | $1.01 | Up from $0.27 | $1.72 | Up from $0.94 |
| Operating cash flow | Not separately provided | — | $1.107 billion | Up from $861.9 million |
Second-quarter revenue was led by Industrial at $788.3 million, or 52% of revenue, followed by Communications at $287.9 million, Automotive at $238.8 million and Consumer at $198.1 million. Industrial, Automotive and Communications revenue increased year over year; Consumer revenue declined 6%. Approximately 75.7% of six-month revenue was generated outside the United States.
At May 5, 2018, cash and cash equivalents were $806.5 million, including approximately $388.9 million held in the United States. Total debt principal was approximately $7.030 billion, with $6.956 billion of disclosed fair value; carrying value was approximately $7.0 billion. Current debt was $56.0 million. The company had not borrowed under its $1.0 billion revolving credit facility and was compliant with debt covenants.
Six-month investing cash flow used $170.5 million, including $117.1 million of capital expenditures and $52.3 million for acquisitions. Financing cash flow used $1.178 billion, including $1.320 billion of term-loan repayments, $345.0 million of dividends and $29.9 million of share repurchases. Cash declined by $241.3 million from October 28, 2017.
Material changes versus the prior comparable period
- Revenue growth primarily reflected the Linear acquisition, broad-based demand growth and, for the six-month comparison, an additional fiscal week.
- Gross margin benefited from the absence of the $121.1 million acquired-inventory fair-value step-up charge recorded in the prior-year period, a favorable product mix and improved factory utilization.
- Amortization of acquired intangible assets increased to $107.1 million in the quarter and $214.1 million for six months, versus $68.7 million and $86.9 million, respectively.
- Research and development increased 23% in the quarter and 38% for six months, substantially reflecting Linear-related expenses and increased operating spending.
- Second-quarter selling, marketing, general and administrative expense decreased 10%, primarily because acquisition-related transaction costs declined; six-month expense increased 9% due to Linear-related costs.
- The company issued $750.0 million of senior unsecured notes in March 2018 and used the net proceeds to repay part of its five-year term loan. It also made additional term-loan repayments during the six months.
Outlook, unusual items, risks and contingencies
- Management expects fiscal 2018 capital expenditures of $230 million to $270 million. Six-month capital expenditures were $117.1 million.
- The board declared a quarterly dividend of $0.48 per share payable June 19, 2018. Management stated that quarterly dividends are currently expected to continue at $0.48 per share, subject to board approval.
- Management expects approximately $60 million of annual salary, variable compensation and benefit savings once the planned closure and consolidation of the acquired Hillview wafer facility and Singapore test facility are fully implemented over three to five years. Fiscal 2018 special charges related to these actions totaled $42.3 million.
- The Tax Cuts and Jobs Act produced provisional first-six-month tax effects of a $639.7 million deferred-tax remeasurement benefit and a $687.1 million transition-tax expense. The accounting remained subject to revision, and the company had not completed its tax accounting as of May 5, 2018. The transition tax is expected to be paid over eight years beginning in fiscal 2019.
- The company plans to adopt the new revenue standard using the full retrospective method in the first quarter of fiscal 2019. Management expects the most significant effect to involve earlier recognition of sales to certain distributors, together with estimates for returns and price adjustments.
- Key risks include integration and realization of synergies from Linear, substantial acquisition-related debt, semiconductor cyclicality, demand volatility, inventory obsolescence, reliance on third-party foundries and distributors, foreign operations and currency exposure, tax-law changes, trade restrictions, manufacturing disruptions, intellectual-property claims and cybersecurity incidents.
- Gross deferred revenue was $701.3 million at May 5, 2018, up from $589.5 million at October 28, 2017. Management cautioned that distributor price-adjustment credits and returns could materially affect reported revenue and gross margin.
Important facts for investors to verify
- Separate the underlying operating improvement from acquisition accounting, the prior-year acquired-inventory charge and the additional fiscal week.
- Assess leverage, floating-rate exposure and debt repayment capacity; a 100-basis-point rate increase was estimated to change annual interest expense by approximately $4.3 million.
- Track the final accounting for the Tax Cuts and Jobs Act, including the transition tax, deferred-tax remeasurement and future GILTI effects.
- Evaluate the timing and amount of benefits, costs and operational risks associated with the planned facility closures.
- Determine the effect of full-retrospective adoption of the new revenue standard on distributor sales, deferred revenue and historical comparability.
- Monitor international demand, especially Industrial, Automotive and Communications growth versus continued weakness in Consumer.