Analog Devices, Inc. — Fiscal 2019 First-Quarter Form 10-Q
Reporting period: Three months ended February 2, 2019, compared with the three months ended February 3, 2018. Fiscal 2019 had 52 weeks versus 53 weeks in fiscal 2018; therefore, the current quarter included one fewer operating week. Prior-period figures were retrospectively restated for adoption of ASU 2014-09, Revenue from Contracts with Customers.
Business Context
Analog Devices designs, develops, manufactures and markets mixed-signal integrated circuits. It reports one operating segment and serves industrial, automotive, consumer and communications end markets. Revenue is generated through distributors, direct customers and other customers, including government-related customers.
Financial Performance and Liquidity
| Metric | Q1 FY2019 | Q1 FY2018 | Change |
|---|---|---|---|
| Revenue | $1.541 billion | $1.567 billion | Down 2% |
| Gross margin | $1.040 billion; 67.5% | $1.072 billion; 68.4% | Down 90 basis points |
| Operating income | $455.8 million; 29.6% of revenue | $441.8 million; 28.2% | Up 3% |
| Net income | $355.0 million; 23.0% of revenue | $293.2 million; 18.7% | Up 21% |
| Diluted EPS | $0.95 | $0.78 | Up $0.17 |
| Operating cash flow | $371.8 million | $388.7 million | Down 4% |
- Revenue declined primarily because of the shorter fiscal quarter. Industrial revenue fell 7% to $728.1 million, automotive declined 2% to $259.5 million, and consumer declined 21% to $208.3 million. Communications revenue increased 34% to $345.2 million.
- Gross margin declined because of a higher concentration of lower-margin products.
- Operating income benefited from a $35.5 million reduction in special charges and a $9.6 million decrease in selling, marketing, general and administrative expense, partly offset by lower gross margin.
- The effective income tax rate was 11.2%, compared with 21.9% in the prior-year quarter. The current-quarter rate benefited from foreign tax rates, the FDII deduction, a $5.1 million GILTI-related deferred tax benefit, a $7.5 million transition-tax benefit and $4.3 million of excess tax benefits from share-based compensation.
- Cash and cash equivalents totaled $605.9 million at February 2, 2019, including approximately $231.7 million held in the United States. Accounts receivable was $713.7 million and inventories were $593.2 million.
- Capital expenditures were $91.0 million. Cash used in investing activities was $96.2 million, while financing activities used $486.1 million, including $227.1 million for share repurchases, $177.7 million for dividends and $100.0 million of debt repayment.
- Total debt principal was $6.275 billion, with carrying value of approximately $6.2 billion. The company had $1.7 billion of floating-rate debt; a 100-basis-point increase in rates would increase annual interest expense by approximately $16.8 million.
Material Changes Versus the Prior Comparable Period
- Net income and diluted EPS increased despite lower revenue, primarily because of lower special charges, lower nonoperating expense and a substantially lower tax provision.
- Special charges were $21.8 million, compared with $57.3 million in the prior-year quarter. The current-quarter charge included $20.7 million for workforce repositioning and acquired intellectual-property write-offs.
- Research and development expense was essentially flat at $287.4 million, while selling, marketing, general and administrative expense decreased 5% to $167.3 million.
- Share repurchases increased substantially to $227.1 million from $7.9 million. Approximately $2.4 billion remained available under the repurchase authorization at quarter-end.
- Cash declined by $210.7 million during the quarter, primarily because of dividends, repurchases, debt repayment and capital expenditures.
- Adoption of ASU 2014-09 changed distributor revenue recognition to generally occur upon shipment and increased the retrospectively adjusted prior-period revenue by $48.2 million. Adoption of ASU 2016-16 increased retained earnings by $331.0 million and materially increased deferred tax assets and liabilities.
Guidance, Outlook, Risks and Unusual Items
- Management expects fiscal 2019 capital expenditures to be approximately 4% of revenue. The filing does not provide clear quantitative revenue or earnings guidance for the next quarter or full year.
- Management stated that existing liquidity, expected operating cash flow and available financing should fund operations, capital expenditures, research and development, dividends and other expected needs for at least the next twelve months.
- The company expects quarterly dividends to continue at $0.54 per share, subject to board approval. A $0.54 dividend was declared on February 19, 2019, payable March 12, 2019.
- The company is consolidating certain Linear-acquired manufacturing operations, including planned closures of the Hillview wafer facility in California and the Singapore test facility over two to four years. Cumulative related special charges were $44.1 million at quarter-end.
- An Irish tax assessment of approximately €43.0 million, or $49.0 million at February 2, 2019, remains disputed. The company has not recorded an additional liability and intends to appeal. Irish Revenue also initiated a transfer-pricing audit covering fiscal years 2014 through 2017 after quarter-end. An unfavorable outcome could materially affect future tax expense and earnings.
- Key risks include semiconductor cyclicality, demand volatility, distributor estimates for returns and price protection, inventory obsolescence, dependence on third-party wafer foundries and suppliers, manufacturing disruptions, competitive pricing, foreign exchange and interest-rate exposure, trade restrictions, intellectual-property claims, cybersecurity incidents, and the ability to integrate Linear and service acquisition-related debt.
- The company recorded a $34.2 million fair value liability for an interest-rate swap entered into to hedge interest rates on up to $1.0 billion of future debt issuances.
- Management concluded that disclosure controls were effective and reported no material change in internal control over financial reporting during the quarter.
Important Facts for Investors to Verify
- Assess the comparability of year-over-year revenue and end-market trends given the one-week difference between fiscal quarters.
- Verify whether the communications recovery and weakness in consumer, industrial and automotive demand persisted in subsequent quarters.
- Monitor gross-margin performance and product mix, particularly the impact of lower-margin products.
- Reconcile earnings growth to the unusually low 11.2% tax rate and determine the sustainability of foreign tax benefits, FDII, GILTI and other discrete items.
- Track the Irish transfer-pricing assessment and related audits, including potential effects on tax liabilities and future earnings.
- Evaluate debt maturities, floating-rate exposure, covenant compliance and the company’s ability to fund dividends, repurchases and capital expenditures while reducing leverage.
- Review the execution, costs and operational effects of the Linear manufacturing-facility closures and workforce-repositioning actions.