Analog Devices, Inc. — Fiscal 2010 Second-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 six months ended May 1, 2010, compared with May 2, 2009. Results reflect a broad recovery in semiconductor demand from the global economic downturn.
Key financial metrics
| Metric | Three months ended May 1, 2010 | Year-over-year change | Six months ended May 1, 2010 | Year-over-year change |
|---|---|---|---|---|
| Revenue | $668.2 million | +41% | $1.271 billion | +34% |
| Gross margin | 65.0% | +990 bps | 63.2% | +740 bps |
| Operating income | $214.1 million | From $57.9 million | $363.2 million | From $77.5 million |
| Operating margin | 32.0% | From 12.2% | 28.6% | From 8.1% |
| Income from continuing operations | $167.1 million | From $51.8 million | $286.7 million | From $76.3 million |
| Diluted EPS from continuing operations | $0.55 | From $0.18 | $0.94 | From $0.26 |
| Operating cash flow | Not separately provided | $492.1 million | From $135.9 million |
Six-month net income was $287.6 million, including $0.9 million of discontinued-operation income. The effective tax rate increased to 21.9% from 16.8% in the second quarter and to 20.9% from 15.4% for the six-month period.
- Second-quarter revenue was led by industrial at $316.2 million, or 47% of revenue, followed by communications at $133.5 million, consumer at $119.5 million, automotive at $83.5 million and computer at $15.6 million.
- Analog products represented 91% of second-quarter revenue; digital signal processing represented 9%.
- Management attributed margin expansion to higher volume, improved manufacturing utilization, wafer-fabrication consolidation savings and a greater mix of higher-margin industrial products.
- Cash, cash equivalents and short-term investments totaled $2.387 billion at May 1, 2010, up $570.8 million from October 31, 2009. Approximately $728 million was held in the United States; substantial cash held by foreign subsidiaries was intended to remain indefinitely reinvested.
- Long-term debt was $383.3 million, principally $375 million of 5% senior unsecured notes due July 1, 2014. The company had not drawn on its $165 million revolving credit facility and was compliant with its covenants.
- Capital expenditures were $34.7 million in the first six months, with fiscal-year 2010 capital expenditures expected to be approximately $95 million.
- Dividends paid in the first six months were $118.4 million. The board subsequently declared a $0.22-per-share dividend payable June 16, 2010.
Material changes versus the prior comparable period
- Revenue growth was broad-based, with second-quarter increases of 54% in industrial, 105% in automotive, 45% in consumer and 31% in computer; communications declined 1%.
- Operating performance improved substantially because of higher demand, better factory utilization and restructuring-related savings. Research and development and selling, marketing, general and administrative expenses increased in dollars, but declined as percentages of revenue.
- Fiscal 2010 special charges totaled $16.5 million for the six-month period, compared with $53.7 million in the prior-year period. No special charge was recorded in the second quarter, compared with $11.9 million in the prior-year quarter.
- Restructuring actions included workforce reductions and closure or consolidation of wafer-fabrication facilities. Management estimated annual savings of approximately $25 million from the Limerick action, approximately $36.4 million from prior cost reductions and approximately $41 million from the Cambridge closure, with additional quarterly savings expected from later actions.
- Deferred income on shipments to distributors increased to $206.7 million from $149.3 million at October 31, 2009. Gross deferred revenue was $289.5 million, reflecting shipments to distributors exceeding their subsequent end-customer sales during the first six months.
- The company repurchased no shares under its public repurchase program during the quarter. Approximately $91.6 million remained authorized, while 2,623 shares were repurchased for employee tax-withholding and option-related purposes.
Guidance, outlook, risks and unusual items
For the third quarter of fiscal 2010, management expected revenue of $695 million to $715 million, gross margin of 65% to 66%, operating margin of 33% to 34% and diluted EPS from continuing operations of $0.59 to $0.61. Operating expenses were expected to grow well below revenue.
- Management believed available liquidity, expected operating cash flow and financing sources would fund operations, capital expenditures, research and development, dividends and potential share repurchases for at least the next twelve months.
- Key risks include semiconductor cyclicality, renewed weakness in global credit markets, customer order cancellations or delays, inventory obsolescence, pricing pressure, manufacturing-yield and capacity constraints, reliance on third-party wafer fabricators, distributor credit exposure, foreign exchange and international operations.
- Approximately 48% of first-half fiscal 2010 revenue came from products fabricated at third-party wafer facilities, primarily TSMC.
- Tax matters under appeal with the IRS involved potential additional liabilities of approximately $46 million for fiscal 2004–2005 and $195 million for fiscal 2006–2007. The company had not accrued these amounts because management believed additional liability was not likely, but adverse resolutions could materially affect future tax expense and operating cash flow.
- The company had $122.7 million of unrecognized, before-tax stock-based compensation cost expected to be recognized over a weighted-average period of 1.6 years.
- The company disclosed that it did not expect further charges from the Sunnyvale or Limerick actions. Remaining restructuring accruals at May 1, 2010 totaled $15.6 million.
- Revenue recognition for distributor shipments is deferred until resale to end customers, creating exposure to distributor sell-through, returns and price-adjustment credits.
Facts investors should verify
- Whether the third-quarter revenue, margin and EPS guidance was achieved and how subsequent demand evolved across industrial, automotive, consumer and communications markets.
- Whether restructuring savings were realized as projected and whether additional charges or impairment costs were recorded.
- The composition, geographic availability and credit quality of the $2.387 billion liquidity balance, particularly cash held outside the United States.
- The outcome of the pending IRS examinations and related tax appeals, including potential effects on cash taxes and earnings.
- Distributor sell-through trends and the increase in deferred income on distributor shipments.
- Exposure to third-party manufacturing capacity, semiconductor-cycle downturns, pricing pressure and foreign exchange movements.