Analog Devices, Inc. — Fiscal 2016 Third-Quarter Form 10-Q
Business context and reporting period
Analog Devices designs, develops, manufactures and markets integrated circuits and reports one operating segment. The filing covers the three and nine months ended July 30, 2016, compared with August 1, 2015. The company serves industrial, automotive, consumer and communications markets worldwide.
Financial performance and liquidity
| Metric | Three months ended July 30, 2016 | Year-over-year change | Nine months ended July 30, 2016 | Year-over-year change |
|---|---|---|---|---|
| Revenue | $869.6 million | 1% | $2,417.8 million | (2%) |
| Gross margin | 65.8% | (10) bps | 64.5% | (130) bps |
| Operating income | $268.7 million | 1% | $671.1 million | (7%) |
| Operating margin | 30.9% | Up from 30.7% | 27.8% | Down from 29.4% |
| Net income | $230.4 million | 6% | $565.5 million | (6%) |
| Diluted EPS | $0.74 | 9% | $1.81 | (4%) |
| Operating cash flow | Not separately provided | — | $793.9 million | 12% |
Quarterly net margin was 26.5%, compared with 25.1% in the prior-year quarter; nine-month net margin was 23.4%, compared with 24.4%. The effective tax rate was 10.1% for the quarter and 10.7% for the nine-month period, versus 16.6% and 14.9%, respectively, in the comparable periods.
Cash and cash equivalents were $1.1 billion and short-term investments were $2.7 billion at July 30, 2016. Management reported total cash and short-term investments of approximately $3.8 billion, of which approximately $0.9 billion was held in the United States. Nine-month investing cash flow was an outflow of $661.3 million, primarily reflecting net purchases of short-term investments and $86.2 million of capital expenditures. Financing cash flow was $88.5 million, including debt issuance proceeds, dividends and share repurchases.
Carrying-value debt was $1.7 billion, consisting of the 2023, 2025 and 2045 senior unsecured notes. The company had no current debt at July 30, 2016 and was in compliance with its debt covenants and its $750 million revolving credit facility. Interest expense rose to $18.5 million in the quarter and $50.0 million for nine months, primarily because of debt issued in December 2015.
Material changes versus the prior comparable periods
- Quarterly revenue increased modestly, while nine-month revenue declined 2%.
- Quarterly results benefited from lower intangible amortization and a lower tax provision. Nine-month results were pressured by lower gross margins, higher research and development expense, $13.7 million of workforce-reduction charges and higher interest expense.
- Communications revenue increased 23% in the quarter, while consumer revenue declined 10% and industrial revenue declined 3%. Automotive revenue increased 3%.
- Nine-month revenue declined in industrial, consumer and communications markets, partially offset by 1% growth in automotive.
- The company issued $1.25 billion of senior notes and redeemed $375 million of 2016 notes. It also temporarily suspended its share-repurchase program because of the proposed Linear Technology acquisition.
- Shareholders received $383.5 million of dividends and the company repurchased $368.6 million of common stock during the first nine months, before the program was suspended.
Guidance, outlook, risks and unusual items
- Management expected fiscal 2016 capital expenditures of approximately $130 million to $135 million; $86.2 million had been incurred through nine months.
- The board declared a $0.42-per-share dividend payable September 7, 2016. Management stated that quarterly dividends were expected to continue at $0.42 per share, subject to board approval.
- On July 26, 2016, Analog Devices agreed to acquire Linear Technology for estimated consideration of approximately $14.8 billion, comprising $46.00 in cash and 0.2321 Analog Devices shares per Linear share. The transaction was subject to shareholder and regulatory approvals.
- The proposed acquisition was expected to be financed with approximately $11.6 billion of new debt and approximately 58 million new Analog Devices shares. Bridge financing commitments totaled up to $11.6 billion, with approximately $37.8 million of expected commitment fees and other financing-related fees disclosed.
- The company had incurred $8.3 million of Linear transaction costs through the quarter. Under specified circumstances, Analog Devices could owe Linear a $700 million termination fee; Linear could owe Analog Devices $490 million under other specified circumstances.
- Management cited risks from acquisition approval, integration, substantially higher leverage and interest expense, semiconductor cyclicality, demand and inventory volatility, foreign operations and currency movements, reliance on third-party wafer suppliers, distributor price adjustments, competition, intellectual-property litigation, tax matters and potential manufacturing disruptions.
- The company maintained a $36.5 million reserve related to an open U.S. Tax Court matter involving fiscal 2006 and 2007 tax years. Management stated that the ultimate tax outcome could differ from recorded provisions.
Most important facts for investors to verify
- Whether the Linear Technology acquisition closed on the expected terms and the resulting purchase accounting, synergies and integration costs.
- The amount, maturity profile, interest cost and covenant impact of acquisition-related financing, including the effect on leverage and free cash flow.
- Whether quarterly revenue and gross-margin trends improved across industrial, consumer and communications markets.
- The sustainability of the unusually low effective tax rate and the availability of foreign-held cash for U.S. obligations.
- The timing of any resumption of share repurchases and the company’s capacity to sustain dividends after the acquisition.
- Potential distributor credits, inventory write-downs, restructuring costs, tax liabilities and regulatory or litigation contingencies.