Business Context and Reporting Period
Analog Devices, Inc. designs, manufactures and markets integrated circuits and reports one segment comprising five operating segments. This unaudited Form 10-Q covers the three and nine months ended July 30, 2011, compared with July 31, 2010. The company operates on a 52-53 week fiscal year ending on the Saturday closest to October 31.
Financial Performance and Liquidity
| Metric | Q3 FY2011 | Q3 FY2010 | 9M FY2011 | 9M FY2010 |
|---|---|---|---|---|
| Revenue | $757.9 million | $720.3 million | $2.277 billion | $1.992 billion |
| Gross margin | 67.2% | 66.7% | 67.0% | 64.4% |
| Operating income | $278.8 million | $251.1 million | $836.7 million | $614.3 million |
| Net income from continuing operations | $219.9 million | $199.5 million | $677.4 million | $486.2 million |
| Diluted EPS from continuing operations | $0.71 | $0.65 | $2.19 | $1.59 |
| Operating cash flow | Not separately provided | Not separately provided | $670.4 million | $716.9 million |
- Q3 revenue increased 5% year over year; nine-month revenue increased 14%.
- Q3 operating margin was 36.8%, compared with 34.9%; nine-month operating margin was 36.7%, compared with 30.8%.
- Net income margin from continuing operations was 29.0% in Q3 and 29.7% for the nine months, versus 27.7% and 24.4%, respectively, in the comparable periods.
- Q3 effective tax rate was 20.0%; the nine-month rate was 18.4%, compared with 20.6% and 20.8%, respectively.
- At July 30, 2011, cash and cash equivalents were $1.358 billion and short-term investments were $2.157 billion, totaling $3.515 billion. Approximately $1.168 billion was held in the United States; the balance was held by foreign subsidiaries and certain amounts were intended to be reinvested indefinitely.
- Net cash increased $287.8 million during the first nine months, to $1.358 billion. Capital expenditures were $96.7 million, dividends paid were $206.8 million, and share repurchases were $247.4 million.
- Total debt consisted principally of $375 million of 5.0% notes due 2014, $375 million of 3.0% notes due 2016, and a $145 million term loan due 2013. The balance sheet reported $14.5 million as current debt and $875.8 million as long-term debt. The company was in compliance with applicable debt and credit-facility covenants.
- Inventory increased to $299.3 million from $277.5 million at fiscal year-end, and days of inventory increased to 110 from 100.
Material Changes Versus the Prior Comparable Period
- Growth was led by industrial, automotive and communications markets. Q3 revenue increased 8% in industrial, 21% in automotive and 10% in communications, while consumer declined 14% and computer declined 16%.
- For the first nine months, industrial revenue rose 18%, automotive 26% and communications 22%; consumer declined 8% and computer declined 12%.
- Analog products represented approximately 92% of Q3 revenue and increased 6% year over year. Other analog revenue increased 25%, while converter revenue was approximately flat.
- Gross margin expanded 50 basis points in Q3 and 260 basis points for the nine months, primarily due to higher sales, improved manufacturing utilization and manufacturing-cost reductions from wafer-fabrication consolidation.
- Q3 operating expenses were broadly stable, while nine-month research and development expense increased 5% and selling, marketing, general and administrative expense increased 7%.
- Revenue declined 4% sequentially in Q3 after a 9% sequential increase in Q2. Management attributed the decline partly to inventory corrections following customer stocking related to the Japan earthquake and tsunami, as well as customer order delays caused by shortages of other components.
- Interest expense increased because of the new 3.0% notes and term loan, while interest income declined because of lower interest rates.
- The nine-month results benefited from a $10.8 million tax benefit related to IRS settlements and other tax items, including reinstatement of the federal R&D tax credit. A $6.5 million after-tax gain from discontinued operations was also recorded.
- On June 9, 2011, the company acquired Lyric Semiconductor for consideration valued at $27.8 million, including $14.0 million of cash and $13.8 million of contingent consideration. The acquisition added $12.2 million of in-process research and development and $18.9 million of goodwill.
Guidance, Outlook, Risks and Unusual Items
- Management planned Q4 FY2011 revenue of $715 million to $755 million, gross margin of approximately 65% to 66%, operating expenses flat to down 3% sequentially, and diluted EPS from continuing operations of $0.60 to $0.68.
- Fiscal 2011 capital expenditures were expected to be approximately $125 million, primarily for manufacturing facilities.
- Management expected quarterly dividends to continue at $0.25 per share, subject to board approval. A $0.25 dividend was declared on August 15, 2011.
- Key risks include semiconductor cyclicality, customer demand volatility and order cancellations, inventory corrections and obsolescence, dependence on third-party wafer fabricators and other suppliers, manufacturing disruptions, pricing competition, foreign-exchange and interest-rate exposure, global economic and credit-market conditions, the continuing effects of the Japan disaster, tax uncertainties, intellectual-property litigation, cybersecurity, environmental regulation and the concentration of cash outside the United States.
- Deferred income on shipments to distributors increased to $277.5 million from $242.8 million at fiscal year-end. Revenue is deferred until distributors resell products, and future price-protection credits or returns could affect reported revenue and gross margin.
- The company had $804.3 million remaining under its $5 billion share-repurchase authorization and repurchased approximately 6.5 million shares during the first nine months.
- The company stated that existing liquidity, expected operating cash flow and available financing should fund operations, capital expenditures, research and development, dividends and planned repurchases for at least the next twelve months.
Important Facts for Investors to Verify
- Reconcile the Q4 guidance with the 4% sequential Q3 revenue decline and the planned reduction in gross margin.
- Assess whether inventory days and deferred distributor income normalize or signal further demand correction.
- Review the location and repatriation restrictions on the $3.515 billion liquidity balance, particularly the amount available in the United States.
- Monitor leverage, variable-rate exposure and covenant compliance following the 2011 debt issuance and term loan.
- Evaluate the sustainability of margin expansion after restructuring savings and manufacturing-utilization benefits.
- Review the remaining IRS Section 965 matter, which carried a potential $36.5 million liability and was not accrued because management considered an additional payment unlikely.
- Assess exposure to Japan, international customers, third-party manufacturing capacity and semiconductor industry cyclicality.