Analog Devices, Inc. — Fiscal 2017 Form 10-K Summary
Reporting period: Fiscal year ended October 28, 2017. The filing is an annual Form 10-K, not a quarterly filing; fourth-quarter information is provided in the unaudited supplementary financial data. Analog Devices is a global high-performance analog, mixed-signal and digital signal-processing semiconductor company serving industrial, automotive, consumer and communications markets.
Business Context and Key Events
- Completed the acquisition of Linear Technology Corporation on March 10, 2017, for approximately $15.8 billion: $11.1 billion cash, $4.6 billion in Analog Devices common stock and $0.1 billion related to replacement equity awards.
- Linear contributed $913.2 million of fiscal 2017 revenue from the acquisition date through year-end.
- Fiscal 2017 revenue mix was industrial 46%, consumer 21%, communications 18% and automotive 15%.
- Approximately 61% of fiscal 2017 revenue came from international markets and approximately 53% was sold through distributors.
- Apple represented approximately 14% of fiscal 2017 revenue; the 20 largest customers represented approximately 35%.
Financial Performance
| Metric | Fiscal 2017 | Fiscal 2016 | Change |
|---|---|---|---|
| Revenue | $5.108 billion | $3.421 billion | Up 49% |
| Gross margin | 59.9% | 65.1% | Down 520 bps |
| Operating income | $1.055 billion | $1.028 billion | Up 3% |
| Operating margin | 20.7% | 30.0% | Down 930 bps |
| Net income | $727.3 million | $861.7 million | Down 16% |
| Diluted EPS | $2.07 | $2.76 | Down 25% |
| Operating cash flow | $1.113 billion | $1.281 billion | Down 13% |
Fiscal 2017 profitability was affected by acquisition accounting, including $358.7 million of acquired-inventory fair-value step-up costs, $83.0 million of acquired-technology amortization and $22.9 million of depreciation related to fair-value adjustments. Interest expense increased to $250.8 million from $88.8 million because of acquisition-related financing.
Fourth-Quarter Fiscal 2017
| Metric | 4Q17 | 4Q16 | Change |
|---|---|---|---|
| Revenue | $1.541 billion | $1.004 billion | Up 54% |
| Gross margin | 65.3% | 66.4% | Down 110 bps |
| Operating income | $448.2 million | $357.0 million | Up 26% |
| Operating margin | 29% | 36% | Down 7 percentage points |
| Net income | $347.7 million | $296.2 million | Up 17% |
| Diluted EPS | $0.93 | $0.95 | Down 2% |
Liquidity, Debt and Capital Allocation
- Cash and cash equivalents were $1.048 billion at October 28, 2017. Including short-term investments, principal liquidity was approximately $1.0 billion; most cash was held outside the United States and intended to be reinvested internationally.
- Debt carrying value was $7.851 billion; principal debt was $7.9 billion, including $4.05 billion of term loans and $3.85 billion of senior unsecured notes.
- The company repaid the $4.1 billion acquisition bridge loan and made $950 million of term-loan principal repayments during fiscal 2017. It subsequently paid another $300 million on November 10, 2017.
- A $1.0 billion revolving credit facility was undrawn at year-end. The company was compliant with applicable debt covenants, including a leverage covenant that begins tightening in May 2018.
- Capital expenditures were $204.1 million. Fiscal 2018 capital expenditures were expected to be $230 million to $270 million.
- Fiscal 2017 dividends declared and paid were $1.77 per share. The board declared a $0.45 per-share dividend for December 2017.
- The share-repurchase program was temporarily suspended following the Linear acquisition; $792.5 million remained authorized for future repurchases.
Material Changes Versus Fiscal 2016
- Revenue increased $1.686 billion, primarily from the Linear acquisition and broad-based demand growth.
- All end markets grew: industrial 58%, consumer 52%, automotive 45% and communications 32%.
- Gross margin declined materially because of acquisition-related inventory, intangible-asset and fixed-asset fair-value adjustments.
- R&D expense increased 48% to $968.6 million, and amortization expense increased 324% to $297.4 million, largely because of the acquisition.
- Net income declined despite higher operating income because nonoperating expense increased $155.5 million, principally from higher interest expense.
- Total assets increased to $21.1 billion from $8.0 billion, including $12.2 billion of goodwill and $5.3 billion of net intangible assets.
- Operating cash flow declined to $1.113 billion, partly because of higher tax payments and working-capital requirements related to post-acquisition integration.
Outlook, Risks and Unusual Items
- 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.
- The company expects continued significant R&D investment and fiscal 2018 capital expenditures of $230 million to $270 million.
- Key risks include integrating Linear, realizing expected synergies, retaining key personnel, servicing substantially higher debt, semiconductor cyclicality, pricing pressure, customer cancellations and inventory obsolescence.
- Approximately 45% of wafer requirements were sourced from third-party foundries, primarily TSMC, creating supplier concentration and capacity risks.
- Backlog increased to approximately $1.2 billion from $700 million, but most orders may be canceled or delayed without significant penalty and management cautioned that backlog is not a reliable indicator of future revenue.
- Fiscal 2017 included $49.5 million of restructuring charges and $69.5 million of Linear transaction-related costs. The effective tax rate was 12.2%, including a $50.5 million benefit from a favorable U.S. Tax Court ruling and approximately $98.2 million of post-acquisition integration tax expense.
- The company planned to adopt the new revenue-recognition standard using full retrospective application in fiscal 2019. The largest expected effect relates to recognizing certain distributor sales earlier, subject to estimated returns and allowances.
- Legal matters were described as ordinary-course claims, and management did not believe current matters would materially affect financial position, results or cash flows. No off-balance-sheet financing arrangements were reported.
Investor Verification Checklist
- Verify the sustainability of post-acquisition revenue growth and the timing of expected Linear integration synergies.
- Reconcile reported margins with and without acquisition accounting adjustments, including the acquired-inventory step-up and incremental amortization.
- Monitor debt reduction, floating-rate exposure and compliance with the tightening leverage covenant.
- Assess the availability of U.S. liquidity given the intended indefinite reinvestment of most foreign cash.
- Review distributor exposure, deferred revenue of $589.5 million, channel inventory and potential price-adjustment credits or returns.
- Evaluate goodwill and acquired-intangible-asset impairment sensitivity, given $17.5 billion of combined goodwill and net intangible assets at year-end.
- Confirm the fiscal 2019 impact of the new revenue-recognition standard and any retrospective changes to reported revenue and margins.
- Consider customer concentration, especially Apple, supplier concentration involving TSMC, and cyclical semiconductor demand.