Analog Devices, Inc. — Fiscal 2013 Third-Quarter Form 10-Q
Business context and reporting period
Analog Devices designs, develops, manufactures and markets integrated circuits, primarily analog products, and reports one segment aggregating five operating segments. The quarter ended August 3, 2013; the nine-month period is compared with the period ended August 4, 2012. Fiscal 2013 has 52 weeks, while fiscal 2012 had 53 weeks, including one additional week in the first nine months.
Financial performance and liquidity
| Metric | Three months ended Aug. 3, 2013 | Year-over-year change | Nine months ended Aug. 3, 2013 | Year-over-year change |
|---|---|---|---|---|
| Revenue | $674.2 million | (1%) | $1,955.6 million | (3%) |
| Gross margin | 64.5% | Down 110 bps | 63.8% | Down 90 bps |
| Operating income | $208.3 million | (2%) | $553.2 million | (9%) |
| Operating margin | 30.9% | Down 20 bps | 28.3% | Down 200 bps |
| Net income | $176.2 million | 4% | $471.9 million | Approximately flat |
| Diluted EPS | $0.56 | Flat | $1.51 | Down from $1.54 |
| Operating cash flow | Not separately provided | — | $630.2 million | Up from $578.5 million |
Net income represented 26.1% of revenue in the quarter and 24.1% for the nine months. Operating cash flow was 32.2% of nine-month revenue. Capital expenditures were $74.5 million, and management expected approximately $125 million of fiscal 2013 capital expenditures.
Cash and short-term investments totaled $4.45 billion at August 3, 2013, including $460.1 million of cash and cash equivalents. Approximately $1.32 billion was held in the United States; management stated that foreign-held cash was intended to be reinvested indefinitely and was not readily available for U.S. dividends or repurchases.
Long-term debt was $872.1 million. The company had $375 million of 3.0% senior notes due in 2016 and $500 million of 2.875% senior notes due in 2023. It had not borrowed under its $500 million revolving credit facility and was compliant with applicable debt covenants, including the facility’s 3.0-to-1.0 leverage covenant.
Dividends paid during the first nine months totaled $300.0 million. The board declared a subsequent quarterly dividend of $0.34 per share, expected to total approximately $105.6 million. Approximately $561.0 million remained available under the stock repurchase authorization, although no shares were repurchased under the public program during the quarter.
Material changes versus the prior comparable period
- Revenue declined primarily because of broad-based weaker demand, a weak global economic environment and one fewer operating week in the nine-month comparison.
- Quarterly end-market revenue increased 5% in automotive and 1% in communications, but declined 3% in industrial and 6% in consumer. For the nine months, industrial declined 3%, automotive 1%, consumer 6%, and communications increased 1%.
- Gross margin declined because of lower manufacturing utilization as production was adjusted to demand and inventory levels.
- Operating income declined more sharply for the nine months because of lower revenue, lower gross margin and $14.1 million of fiscal 2013 restructuring charges, compared with $8.4 million in the prior-year period.
- Net income benefited from a lower effective tax rate: 9.6% for the quarter and 11.4% for the nine months, compared with 19.0% and 21.5%, respectively. Benefits reflected international tax restructuring, research and development tax credits and the reversal of certain prior-period tax liabilities.
- The company redeemed its $375 million 5.0% notes, repaid the remaining $60.1 million term loan balance and issued $500 million of 2.875% notes due 2023. The debt refinancing resulted in a $10.2 million net loss on extinguishment.
- Inventory declined 9% from November 3, 2012, and days of inventory declined from 114 to 109. Deferred income on distributor shipments increased, reflecting a mix shift toward higher-margin products.
- Nine-month selling, marketing, general and administrative expense included $6.3 million of accelerated stock-based compensation following the death of the company’s former CEO.
Guidance, outlook, unusual items and risks
Management planned fourth-quarter fiscal 2013 revenue of approximately $675 million to $700 million, gross margin of approximately 65%, operating expenses up approximately 1%, an effective tax rate of 14% to 15%, and diluted EPS of $0.55 to $0.61. Management expected quarterly dividends to continue at $0.34 per share, subject to board approval.
Notable items include restructuring charges, the debt-extinguishment loss, the $11.0 million treasury-rate-lock gain to be amortized over the 2023 notes’ term, tax benefits that reduced the current effective tax rate, and contingent consideration of $8.3 million related to the Lyric acquisition. The company had an unresolved tax matter with a potential liability of $36.5 million but stated that an additional liability was not considered likely and had not been recorded.
Key risks include semiconductor cyclicality and uncertain global demand; pricing pressure and competition; manufacturing utilization, yields and supply-chain availability; dependence on third-party wafer foundries and distributors; distributor price-protection and return obligations; foreign exchange and international operating risks; tax-rate volatility; product warranty, intellectual-property and litigation exposure; information-technology disruptions; environmental compliance; and the restricted U.S. availability of foreign-held cash.
Most important facts for investors to verify
- Whether fourth-quarter revenue and diluted EPS fell within the stated ranges and whether the expected 14%–15% tax rate was sustainable after fiscal 2013 tax benefits.
- Whether gross-margin recovery to approximately 65% occurred as manufacturing utilization and inventory levels normalized.
- The extent to which foreign-held cash constrained future U.S. dividends, repurchases, acquisitions or other capital allocation.
- Debt-service requirements, covenant compliance and the effect of refinancing on interest expense and liquidity.
- Distributor deferred revenue, price-adjustment credits, returns and channel inventory trends.
- Progress in realizing the estimated $17 million of annual savings from fiscal 2013 restructuring actions.
- Potential exposure from the unresolved $36.5 million tax matter, contingent consideration and other litigation or indemnification obligations.