Analog Devices, Inc. — Fiscal 2018 First-Quarter Form 10-Q
Business context and reporting period
Analog Devices designs, develops, manufactures and markets analog integrated circuits and reports one operating segment. The quarter ended February 3, 2018 included 14 weeks, compared with 13 weeks in the prior-year quarter ended January 28, 2017. Results include Linear Technology prospectively following its March 10, 2017 acquisition.
Financial highlights
| Metric | Q1 FY2018 | Q1 FY2017 | Change |
|---|---|---|---|
| Revenue | $1.519 billion | $984.4 million | Up 54% |
| Gross margin | 68.2% | 65.9% | Up 230 bps |
| Operating income | $405.3 million | $266.3 million | Up 52% |
| Operating margin | 26.7% | 27.0% | Down 30 bps |
| Net income | $268.2 million | $217.1 million | Up 24% |
| Net margin | 17.7% | 22.1% | Down 440 bps |
| Diluted EPS | $0.71 | $0.69 | Up $0.02 |
| Operating cash flow | $388.7 million | $322.6 million | Up 20% |
Revenue growth reflected the Linear acquisition, broad-based demand growth and the additional fiscal week. End-market revenue was $743.6 million in Industrial, $284.3 million in Communications, $252.2 million in Automotive and $238.5 million in Consumer. Consumer revenue declined 12% year over year, primarily because of lower demand for portable consumer applications.
Gross margin benefited from a mix shift toward higher-margin products and favorable factory utilization, partly offset by acquisition accounting costs, including $32.7 million of developed-technology amortization and $7.3 million of depreciation from fixed-asset fair-value adjustments. Operating expenses included $107.0 million of intangible amortization and $57.3 million of special charges.
The effective tax rate was 20.9%, including provisional discrete effects of the Tax Cuts and Jobs Act: a $639.7 million deferred-tax remeasurement benefit, a $687.1 million transition-tax expense and a $10.0 million excess stock-compensation tax benefit. The tax accounting remains subject to revision.
Cash, debt and liquidity
- Cash and cash equivalents were $827.6 million at February 3, 2018, down from $1.048 billion at October 28, 2017. Management also identified $306.0 million of cash and held-to-maturity investments excluded from recurring fair-value tables.
- Operating cash flow was $388.7 million; capital expenditures were $63.2 million; financing cash outflows were $548.0 million, including $420.0 million of debt repayments and $166.7 million of dividends.
- Total debt principal was $7.480 billion, with $7.385 billion classified as long-term debt and $50.0 million as current debt. The company had $3.6 billion of floating-rate debt; a 100-basis-point rate increase would increase annual interest expense by approximately $16.3 million.
- The $1.0 billion revolving credit facility was undrawn, and the company reported compliance with debt covenants. Management believes liquidity and expected operating cash flow are sufficient for at least the next twelve months.
- Accounts receivable were $709.8 million and inventories were $559.7 million. Gross deferred revenue related to distributors was $656.3 million.
Material changes and unusual items
- The $15.8 billion Linear acquisition materially increased revenue, intangible amortization, operating expenses and debt-related interest expense. Acquisition accounting remained incomplete at filing.
- The company recorded $41.2 million for planned consolidation of the acquired Hillview wafer-fabrication facility and Singapore test facility, expected to occur over three to five years. The action is expected to generate approximately $60 million of annual savings once fully implemented.
- An additional $16.1 million of workforce-reduction charges was recorded. The prior-year quarter included a $41.3 million early-retirement charge and $8.1 million of workforce-reduction charges.
- The company adopted ASU 2016-09, affecting stock-compensation tax accounting, cash-flow classification and diluted share calculations.
- Revenue recognition under ASU 2014-09 is scheduled for the first quarter of fiscal 2019 using the full retrospective method. The principal expected impact concerns recognition of certain distributor sales at shipment rather than upon resale to end customers.
Guidance, outlook and risks
No specific revenue or earnings guidance was provided in the filing text. Management expects fiscal 2018 capital expenditures of $230 million to $270 million and expects quarterly dividends to continue at $0.48 per share, subject to Board approval. A $0.48 dividend was declared after quarter-end, payable March 20, 2018.
Management expects continued significant research and development investment. The company temporarily suspended share repurchases following the Linear acquisition, although $792.5 million remained authorized and management expected to resume repurchases over the long term.
Key risks include integration of Linear and realization of expected synergies, servicing acquisition-related debt, semiconductor cyclicality, demand and inventory volatility, distributor price adjustments and returns, reliance on third-party wafer foundries, manufacturing disruptions, international and foreign-exchange exposure, tax-law uncertainty, competition, product liability and intellectual-property claims, cybersecurity, and compliance with debt covenants.
The provisional transition-tax liability was approximately $751.1 million, intended to be paid over eight years beginning in fiscal 2019 without interest. The company had not completed its accounting for all effects of the Tax Cuts and Jobs Act, including GILTI and state and local tax implications.
Investor verification points
- Separate the effects of the 14-week quarter and Linear acquisition from underlying organic growth.
- Verify the final tax accounting for the Tax Cuts and Jobs Act and its effect on cash taxes and the effective tax rate.
- Monitor acquisition integration, facility closures, restructuring execution and realization of the projected $60 million annual savings.
- Assess leverage, floating-rate exposure, debt maturities and compliance with the revolving-facility leverage covenant.
- Review the eventual full-retrospective impact of the new revenue-recognition standard, particularly distributor revenue and deferred revenue balances.
- Track inventory, deferred distributor revenue, price-adjustment credits and end-market demand, especially in Consumer.