Analog Devices’ (ADI) fiscal first quarter earnings beat the Zacks Consensus Estimate by a penny. Revenue was more or less in line with expectations. Results were within management’s expectations on revenue and slightly exceeded on the gross and operating margin lines.
Analog Devices shares reacted positively in after-hours trading, rising 1.5%. We also note that while earnings continue to beat the Zacks Consensus, the surprise percentage has been trending down over the past few quarters. This explains the reason for the relatively small movement in Analog Devices share prices in response to the earnings announcement.
Revenue
Analog Devices generated revenue of $728.5 million, which was down 5.4% sequentially, up 20.8% year over year and at the high end of management’s revenue guidance of $715-740 million (down 4-7% sequentially, up 19-23% year over year). All except the automotive end market declined sequentially, while only the computing end market declined from a year ago.
Revenue by End Market
The industrial market generated 46% of Analog Devices’ total revenue (down 3.5% sequentially and up 29.6% year over year). The sequential decline was on account of normal seasonality. Healthcare was particularly strong for Analog Devices, one of the few areas within industrial to have grown sequentially.
New products and pent-up demand related to the credit crisis were the reasons for this strength, according to Analog Devices. The increase from last year was driven by new products and the company’s growing presence in various industrial markets. Energy efficiency, productivity enhancements and security are fueling the increased spending in the segment.
Communications generated 22% of total revenue, down 8.7% sequentially and up 20.6% year over year. Analog Devices’ communications business comes from both infrastructure and cell phones, although the focus is on the infrastructure side.
The reason for the sequential decline was the TDS-CDMA phase 4 rollout in China coming to an end. However, this was aprtially offset by strength in North America and Europe, where bandwidth enhancements drove demand. The wired communications segment benefited from increasing data needs that are encouraging infrastructure investments.
Analog Devices’ converters, amplifiers and RF products are solidly positioned across all fast-growing geographies (particularly the U.S., Europe and China) and should generate very substantial growth for the company.
Consumer generated 17% of revenue, down 10.7% sequentially, but up 2.8% from a year ago, reflective of seasonality and weak consumer spending. The increase from last year is encouraging, indicating that the business grew despite uncertainties in the back half of the year.
The automotive segment (carved out of the industrial segment in the first quarter of fiscal 2010) generated around 13% of Analog Devices’ first quarter revenue, growing 1.4% sequentially and 26.9% from the year-ago quarter. The increases in the last quarter were driven by a strong product portfolio and a more robust automotive market.
The main drivers here continue to be the global recovery, better credit availability, as well as increasing electronic content per vehicle, especially in the areas of infotainment, safety and fuel efficiency. This, along with increasing demand for high-end vehicles that use Analog Devices products are positives for the company.
Analog Devices expressed optimism regarding its ability to continue increasing the dollar content per vehicle, as safety, fuel efficiency and conveniences become essential features of vehicles.
Computing accounted for the remaining 2% of Analog Devices’ revenue, down 4.3% sequentially and 16.9% year over year. Management has taken a policy decision to defocus this market, since it is given to commoditization, making margin expansion difficult. Analog Devices stated that the declines in the last quarter were across all geographies and in line with management’s expectations for the quarter.
Revenue by Product Line
Overall, analog products continued to grow double-digits from the year-ago quarter, while digital signal processing (DSP) products slowed down.
Analog signal processing products (85% of total revenue) were down 4.8% sequentially and up 21.0% year over year. The decline was across all product lines (converters, amplifiers and other analog products), although converters declined the most. Converters remained the largest product line for Analog Devices, with a revenue share of over 45%. Amplifiers followed, with a 27% revenue share, while other analog products accounted for 13% of total revenue.
Power management and reference products remained at 7% of revenue, down 4.1% sequentially and up 37.8% from last year. The strength in this product line is the result of management’s refocusing of the business over the past couple of years, as well as a higher level of business in 2010 versus 2009.
Digital signal processing products (7% of total revenue) were down 12.0% sequentially and up 6.5% year over year.
Margins
Analog Devices generated a pro forma gross margin of 66.2%, down 86 basis points (bps) sequentially, up 508 bps year over year and just over management’s guidance of 66%. Gross margins have expanded sequentially in five of the last six quarters and the sequential decline in the last quarter was related to lower utilization of internal fabs and a weaker mix of business.
Operating expenses of $222.8 million were down 3.4% sequentially and up 9.8% from the January quarter of 2010. As a result, the operating margin declined 150 bps sequentially and 815 bps year over year to 35.6%, slightly better than Analog Devices’ expectations of 34.5-35.5%.
Both R&D and SG&A expenses increased sequentially as a percentage of sales, with cost of sales, G&A and R&D showing increases. However, all expenses saw substantial declines from last year, with cost of sales declining the most, followed by R&D and then SG&A.
Net Profit
The pro forma net income was $203.8 million, or a 28.0% net income margin compared to $225.0 million, or 29.2% in the previous quarter and $136.1 million, or a 22.6% net income margin in the prior-year quarter. The fully diluted pro forma earnings per share was 66 cents compared to 73 cents in the previous quarter and 45 cents in the January quarter of last year. The EPS was also better than management’s expectations of 63-67 cents.
Since there were no one-time items in any of the last two quarters, the GAAP and non GAAP net income and EPS were same. However, the GAAP net income of $120.5 million (40 cents a share) differed from the pro forma numbers discussed above.
Balance Sheet
Inventories increased 2.0% to $283.0 million, with annualized inventory turns dropping slightly from 3.7X to 3.5X. Days sales outstanding (DSOs) went up from 46 to 48. Cash generated from operations was around $216.7 million. Analog Devices spent $25.5 million on capex and $65.8 million on cash dividends and $113.6 million on share repurchases in the last quarter.
Guidance
Strengthening order trends, especially at OEM customers and the end of the inventory correction encouraged Analog Devices to provide a satisfactory guidance for the second quarter. As a result, it expects revenue of $730-760 million, representing a sequential increase of 0-4%, or a year-over-year increase of 9-14%.
Gross margins are expected to come in at 66.5% and operating expenses to increase 2-3%, resulting in earnings per share of 65 to 69 cents. Analysts polled by Zacks expected earnings of 67 cents a share when Analog Devices reported, which was right in the middle of the guided range.
Our Recommendation
Analog Devices shares carry a Zacks rank of #2, or short term Buy recommendation. Given the diversity of its business across product lines, end markets and geographies and the fact that the inventory correction in some of its markets has run its course, we are more positive about the company. Of course, the inventory situation is also positive for Fairchild Semiconductor (FCS) and ON Semiconductor (ONNN), which carry the same rank.
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