Analog Devices, Inc. Form 10-Q Summary
Business context and reporting period
Analog Devices designs, develops, manufactures and markets integrated circuits, reported as one operating segment. The filing covers the three and nine months ended August 2, 2014, compared with August 3, 2013; the fiscal year ends on the Saturday closest to October 31.
On July 22, 2014, the company completed its approximately $2.4 billion acquisition of Hittite Microwave Corporation. Hittite results were included prospectively, but its contribution to reported third-quarter revenue and earnings was immaterial because the acquisition closed near quarter-end.
Financial performance and liquidity
| Metric | Q3 FY2014 | Q3 FY2013 | 9M FY2014 | 9M FY2013 |
|---|---|---|---|---|
| Revenue | $727.8 million | $674.2 million | $2.051 billion | $1.956 billion |
| Gross margin | 65.4% | 64.5% | 65.6% | 63.8% |
| Operating income | $202.5 million | $208.3 million | $602.6 million | $553.2 million |
| Operating margin | 27.8% | 30.9% | 29.4% | 28.3% |
| Net income | $180.6 million | $176.2 million | $520.6 million | $471.9 million |
| Diluted EPS | $0.57 | $0.56 | $1.64 | $1.51 |
| Net margin | 24.8% | 26.1% | 25.4% | 24.1% |
Third-quarter revenue increased 8%, while nine-month revenue increased 5%. Nine-month net income rose 10% and diluted EPS rose 9%. Gross-margin expansion reflected improved manufacturing utilization and a mix shift toward higher-margin products.
End-market revenue in Q3 increased 12% in industrial, 8% in automotive and 19% in communications, but declined 19% in consumer. Consumer weakness primarily reflected the sale of the microphone product line in the fourth quarter of fiscal 2013. Analog products represented 91% of Q3 revenue.
Research and development expense increased 9% in Q3 and 6% for the nine-month period. Selling, marketing, general and administrative expense increased 36% in Q3 and 12% year to date, primarily because of approximately $27.1 million of Hittite-related transaction costs and higher variable compensation. These expenses caused Q3 operating income to decline 3% despite higher revenue and gross margin.
Net cash provided by operating activities was $609.3 million for the first nine months, compared with $630.2 million in the prior-year period. Capital expenditures were $134.5 million, and investing cash flow included $1.944 billion of acquisition payments, net of cash acquired. Financing cash flow was $1.701 billion, primarily reflecting $1.995 billion of acquisition-related debt proceeds.
At August 2, 2014, cash and cash equivalents were $2.585 billion and short-term investments were $2.347 billion. Total cash and short-term investments were approximately $4.9 billion, but only approximately $1.1 billion was held in the United States; the company stated that foreign-held cash was intended to remain indefinitely reinvested.
Current debt was $1.995 billion and long-term debt was $872.7 million. The current debt consisted principally of a 90-day, $2.0 billion term loan used to finance the Hittite acquisition, bearing interest at 1.16% as of August 2, 2014 and due no later than October 20, 2014. Management intended to repay it with available cash during the fourth quarter. The company was in compliance with its debt covenants.
Material changes versus the prior comparable period
- Hittite was acquired for estimated total consideration of $2.433 billion, including $2.424 billion in cash and $8.9 million of replacement equity awards.
- The acquisition added preliminary goodwill of $1.345 billion and intangible assets of $669.0 million; purchase accounting remained incomplete at filing.
- Goodwill increased to $1.632 billion from $284.1 million at November 2, 2013, and net intangible assets increased to $695.8 million from $28.6 million.
- Current liabilities increased to $2.623 billion from $570.5 million, primarily because of the acquisition term loan.
- Inventory increased 47% to $415.1 million and days of inventory increased to 151 from 111, partly because of acquired inventory and increased production for anticipated demand.
- Accounts receivable increased 21% to $394.8 million, and days sales outstanding increased to 49 from 44.
- The company paid $337.9 million in dividends and repurchased $169.0 million of common stock during the first nine months. Approximately $934.2 million remained authorized for repurchases.
- Special charges were $2.7 million in the first nine months of FY2014 versus $14.1 million in the prior-year period. The company also recorded $21.1 million of Hittite transaction costs in the current period.
Guidance, outlook, commentary and risks
For Q4 FY2014, management planned non-GAAP revenue of $790 million to $820 million, non-GAAP gross margin of approximately 66.2%, operating expenses of $268 million to $271 million, interest and other expense of approximately $6 million, an effective tax rate of 15.5% to 16.0%, and diluted EPS of $0.66 to $0.70. The guidance excludes specified Hittite purchase-accounting, amortization, transaction-cost and debt-financing items; a complete quantitative GAAP reconciliation was not provided.
Management expects approximately $180 million of FY2014 capital expenditures, consisting of $124 million of ongoing spending and approximately $56 million for new buildings. The company expected quarterly dividends to continue at $0.37 per share, subject to board approval. A $0.37 dividend was declared on August 25, 2014.
Key risks include semiconductor industry cyclicality, demand and order volatility, inventory obsolescence, pricing and competitive pressure, reliance on third-party foundries and suppliers, limited availability of specialized GaAs manufacturing for Hittite, acquisition integration and realization of synergies, foreign currency and international operating risks, tax uncertainty, intellectual-property litigation, product defects, cybersecurity and natural disasters. Distributor price-protection and return arrangements may also cause revenue and margin fluctuations.
The company disclosed a potential $36.5 million liability related to an open U.S. Tax Court matter concerning Section 965 for fiscal years 2006 and 2007. It also disclosed that foreign-held cash may not be readily available for U.S. dividends, repurchases or other domestic requirements without potential tax consequences.
Important facts for investors to verify
- Repayment of the $2.0 billion acquisition term loan by October 20, 2014 and the resulting effect on cash, interest expense and liquidity.
- Final purchase-accounting allocations for Hittite, including goodwill, intangible assets, deferred taxes, inventory and fixed-asset step-ups.
- Actual Hittite revenue, earnings contribution, integration costs and realization of expected strategic benefits after the first full reporting periods.
- Whether elevated inventory and distributor deferred income convert into end-customer demand without material write-downs, returns or price-protection credits.
- Reconciliation of non-GAAP Q4 guidance to GAAP results, including acquisition-related amortization, purchase-accounting charges, transaction costs, debt fees and associated tax effects.
- Resolution and potential cash impact of the $36.5 million U.S. tax matter and other uncertain tax positions.
- Availability of U.S.-held cash to support dividends, repurchases, capital expenditures and acquisition-related obligations.