Analog Devices, Inc. — Fiscal 2016 Second-Quarter Form 10-Q
Business context and reporting period
Analog Devices designs, develops, manufactures and markets a broad range of integrated circuits. The company reports one reportable segment, consisting of seven aggregated operating segments, serving industrial, automotive, consumer and communications markets worldwide. The filing covers the three and six months ended April 30, 2016, compared with the periods ended May 2, 2015. Fiscal 2016 is a 52-week year ending October 29, 2016.
Financial performance and liquidity
| Metric | Three months ended April 30, 2016 | Year-over-year change | Six months ended April 30, 2016 | Year-over-year change |
|---|---|---|---|---|
| Revenue | $778.8 million | Down 5% | $1.548 billion | Down 3% |
| Gross margin | $510.9 million; 65.6% | Down 80 bps | $988.2 million; 63.8% | Down 200 bps |
| Operating income | $207.4 million; 26.6% | Down 17% | $402.4 million; 26.0% | Down 12% |
| Net income | $170.6 million; 21.9% of revenue | Down 17% | $335.1 million; 21.6% of revenue | Down 13% |
| Diluted EPS | $0.55 | Down from $0.65 | $1.07 | Down from $1.21 |
| Operating cash flow | Not separately provided for the quarter | — | $539.9 million | Up from $512.7 million |
Second-quarter revenue was led by industrial at $385.3 million, automotive at $138.0 million, communications at $175.4 million and consumer at $80.0 million. Consumer revenue declined 27% year over year, communications declined 3%, and industrial and automotive each declined 1%. China revenue increased 11% in the quarter, while revenue declined in the United States, Europe, Japan and the rest of Asia.
Gross-margin pressure primarily reflected lower manufacturing efficiency and utilization. For the six-month period, increased inventory reserves related to consumer products also reduced margin. Research and development expense increased 4% in both the quarter and six-month period, while selling, marketing, general and administrative expense decreased 4% and 8%, respectively.
At April 30, 2016, cash and cash equivalents were $1.120 billion and short-term investments were $2.634 billion, providing total cash and short-term investments of approximately $3.8 billion. Approximately $1.0 billion was held in the United States; most remaining funds were held by foreign subsidiaries and intended to be permanently reinvested. The company states that existing liquidity, operating cash generation and available financing should fund operations, capital expenditures, research and development, dividends and planned repurchases for at least the next twelve months.
Capital expenditures were $48.6 million during the first six months, and fiscal 2016 capital expenditures were expected to be $130 million to $140 million. Accounts receivable were $399.0 million and inventories were $399.5 million at April 30, 2016. Days sales outstanding were 45, compared with 43 at fiscal year-end, while days of inventory increased to 137 from 113.
Debt, capital allocation and material changes
- The company issued $850 million of 3.9% senior notes due 2025 and $400 million of 5.3% senior notes due 2045 in December 2015.
- The $375 million of 3.0% notes due 2016 were redeemed in December 2015, generating a $3.3 million loss on debt extinguishment.
- Long-term debt carrying value was $1.731 billion at April 30, 2016, compared with $495.3 million at October 31, 2015. Interest expense increased to $18.5 million in the quarter and $31.5 million for six months, primarily because of the new debt.
- The company had a $750 million undrawn revolving credit facility expiring in 2020 and was compliant with its debt and credit-facility covenants.
- Six-month financing cash flow was $245.1 million, including $1.235 billion of debt proceeds, $378.2 million of debt redemption payments, $254.6 million of dividends and $345.6 million of share repurchases.
- The board increased the current stock-repurchase authorization by $600 million to $1.0 billion in February 2016. As of April 30, approximately $814.8 million remained available under the program.
- The quarterly dividend was increased to $0.42 per share. A dividend declared May 16, 2016 was scheduled to be paid June 7, 2016.
Guidance, outlook, unusual items and risks
Management expected fiscal 2016 capital expenditures of $130 million to $140 million and expected quarterly dividends to continue at $0.42 per share, subject to board approval. The filing does not provide a specific revenue or earnings forecast.
The company recorded a $13.7 million second-quarter special charge for severance and related benefits covering 123 employees. It expected approximately $12.3 million of annual cost savings once the action was fully implemented. At April 30, 106 of the affected employees remained employed and had to remain employed until involuntary termination to receive severance benefits.
Management continued to invest significantly in research and development, including hundreds of projects, and reorganized its operations to support opportunities associated with the Internet of Things. No goodwill or intangible-asset impairment was recorded.
Key risks include semiconductor-industry cyclicality, weakening demand in consumer and communications markets, inventory obsolescence and reserves, manufacturing underutilization, pricing pressure, dependence on third-party wafer foundries and suppliers, international operations and foreign-exchange exposure, distributor returns and price-adjustment credits, tax disputes and possible changes in effective tax rates, debt-service and covenant requirements, litigation and intellectual-property claims, cybersecurity, natural disasters, and geopolitical or trade restrictions. The company also disclosed a $36.5 million reserve related to an open U.S. Tax Court matter involving fiscal years 2006 and 2007.
The company adopted accounting updates covering debt issuance costs and deferred-tax classification during fiscal 2016. It was evaluating the future effects of several standards, including revenue recognition, leases, financial instruments and stock compensation. Management concluded that disclosure controls were effective as of April 30, 2016, with no material change in internal control over financial reporting during the quarter.
Important facts for investors to verify
- Whether the decline in consumer and communications demand persists and whether industrial and automotive demand improves.
- Whether manufacturing utilization, inventory reserves and product mix restore gross margins toward prior-year levels.
- The pace and profitability of the restructuring actions and the realization of the estimated $12.3 million annual savings.
- The availability and geographic location of cash, including potential tax costs if foreign funds must be repatriated.
- Interest expense, debt maturities, covenant compliance and sensitivity of debt fair values to interest-rate changes.
- Distributor deferred revenue and price-adjustment credits, which could materially affect future revenue and gross margin.
- The outcome of the U.S. Tax Court matter and other tax examinations or changes affecting the company’s low effective tax rate.
- Progress on capital expenditures, share repurchases, dividends and the company’s Internet of Things strategy.