Analog Devices, Inc. Form 10-Q Summary
Business Context and Reporting Period
Analog Devices designs, manufactures and markets integrated circuits and reports one operating segment. This filing covers the three and nine months ended July 29, 2017, compared with July 30, 2016. Results include Linear Technology prospectively from its March 10, 2017 acquisition.
The Linear acquisition had estimated consideration of $15.8 billion, including $11.1 billion in cash, $4.6 billion in Analog Devices common stock and $0.1 billion of replacement awards. Linear contributed $368.6 million of third-quarter revenue and $516.1 million for the nine-month period.
Financial Results and Key Metrics
| Metric | Three Months Ended July 29, 2017 | Three Months Ended July 30, 2016 | Nine Months Ended July 29, 2017 | Nine Months Ended July 30, 2016 |
|---|---|---|---|---|
| Revenue | $1.434 billion | $869.6 million | $3.566 billion | $2.418 billion |
| Gross margin | $766.6 million; 53.5% | $572.3 million; 65.8% | $2.056 billion; 57.6% | $1.560 billion; 64.5% |
| Operating income | $194.8 million; 13.6% | $268.7 million; 30.9% | $606.9 million; 17.0% | $671.1 million; 27.8% |
| Net income | $68.9 million; 4.8% | $230.4 million; 26.5% | $379.6 million; 10.6% | $565.5 million; 23.4% |
| Diluted EPS | $0.18 | $0.74 | $1.10 | $1.81 |
- End-market revenue for the quarter was industrial $700.2 million, automotive $227.5 million, consumer $252.5 million and communications $253.7 million.
- Operating expenses for the quarter included R&D of $275.7 million, SMG&A of $184.0 million and intangible amortization of $112.2 million. Nine-month amounts were $694.9 million, $505.3 million and $199.0 million, respectively.
- Interest expense was $73.1 million in the quarter and $187.3 million for nine months, primarily reflecting acquisition-related financing.
- The quarterly effective tax rate was 45.6%, including approximately $98.2 million of tax expense associated with post-acquisition integration and a $50.5 million benefit from releasing a U.S. tax reserve following favorable Tax Court developments. The nine-month effective tax rate was 15.0%.
- Net cash provided by operating activities was $471.7 million for nine months, down from $793.9 million in the prior-year period. Capital expenditures were $138.9 million.
- Cash used in investing was $6.605 billion, principally due to the Linear acquisition. Financing activities provided $6.119 billion.
- Cash and cash equivalents were $908.6 million at July 29, 2017. Short-term investments were zero on the balance sheet, compared with $3.135 billion at October 29, 2016. Management stated that cash and cash equivalents plus short-term investments totaled $908.6 million at quarter-end.
- Long-term debt carrying value was $8.199 billion, with $8.250 billion of principal outstanding. The company had $4.4 billion of floating-rate debt and estimated that a 100-basis-point rate increase would increase annual interest expense by approximately $44 million.
- The company paid $435.3 million of dividends and repurchased $35.9 million of common stock during the first nine months. The share repurchase program was temporarily suspended following the acquisition.
Material Changes Versus the Prior Comparable Period
- Revenue increased 65% in the quarter and 48% for nine months, driven by the Linear acquisition and broad-based demand growth. Nine-month industrial revenue increased 49%, automotive 37%, consumer 87% and communications 24%.
- Gross margin percentage declined 1,230 basis points in the quarter and 690 basis points for nine months. The principal drivers were acquisition accounting charges, including acquired inventory fair-value step-up costs, acquired technology amortization and depreciation on revalued fixed assets.
- Quarterly net income decreased 70% and nine-month net income decreased 33%; diluted EPS decreased 76% and 39%, respectively. Higher operating expenses, acquisition-related amortization, interest expense and taxes more than offset revenue growth.
- Goodwill increased to $12.242 billion from $1.679 billion and net intangible assets increased to $5.441 billion from $549.4 million, primarily because of the Linear acquisition.
- Debt increased substantially from $1.732 billion of long-term debt at October 29, 2016. During the quarter, the company repaid the $4.1 billion bridge loan and $600 million of term-loan principal, leaving $2.15 billion on the three-year term loan and $2.25 billion on the five-year term loan.
- Accounts receivable increased 45% to $692.6 million and inventory increased 38% to $519.7 million versus October 29, 2016. Gross deferred revenue increased to $586.1 million from $432.3 million.
Guidance, Outlook, Risks and Unusual Items
- Management expected fiscal 2017 capital expenditures of $195 million to $205 million. Nine-month capital expenditures were $138.9 million.
- The board declared a $0.45 per-share dividend payable September 19, 2017. Management stated it expected quarterly dividends to continue at $0.45 per share, subject to board approval and financial performance, outlook and liquidity.
- Management stated that existing liquidity, expected operating cash flow and available financing should fund operations, capital expenditures, R&D and dividends for at least the next twelve months.
- Management expected annual savings of approximately $28.4 million from the early-retirement action and $5.0 million from other workforce reductions once fully implemented. Related fiscal 2017 special charges totaled $49.5 million.
- Linear purchase accounting remained incomplete at the filing date. Additional adjustments to acquired inventory, fixed assets, intangible assets, deferred revenue, liabilities and taxes were possible.
- The company was implementing the new revenue-recognition standard and expected the most significant effect to involve earlier recognition of certain distributor sales, with estimates for returns and allowances. The filing did not provide a clear quantified impact.
- Principal risks include integrating Linear, realizing expected synergies, servicing acquisition-related debt, floating interest rates, semiconductor cyclicality, customer and distributor demand changes, inventory obsolescence, third-party manufacturing dependence, international operations, tax uncertainty, litigation, cybersecurity and compliance with debt covenants.
- Disclosure controls were considered effective. Linear was excluded from management’s year-end internal-control assessment under applicable SEC guidance while integration continued.
Important Facts for Investors to Verify
- Whether Linear integration produces the expected revenue synergies, cost savings and retention of key employees.
- The normalization of gross margins after acquisition inventory step-up charges and the ongoing effect of acquired-intangible amortization.
- Debt paydown, floating-rate exposure, leverage covenant compliance and future interest expense.
- Operating cash-flow conversion and the availability of foreign-held cash for U.S. dividends, debt service and other obligations.
- The final purchase-price allocation and any subsequent measurement-period adjustments or impairment indicators for goodwill and intangible assets.
- The eventual accounting transition and quantified impact of the new revenue-recognition standard on distributor sales and prior-period comparability.
- Demand trends across industrial, automotive, consumer and communications markets, including distributor inventory and price-adjustment credits.