Analog Devices’ (ADI) fiscal second quarter results beat the Zacks Consensus estimate by 5 cents. Revenue beat by 3.8%. Results exceeded management expectations on revenue, margins and earnings.
 
Shares sunk 2.65% during the day, but gained back 2.36% after hours in response to the news.
 
Revenue
 
Revenue of $668.2 million was up 10.8% sequentially, 40.8% year over year and better than management’s revenue guidance of $635-650 million (up 5-8% sequentially). The sequential strength was driven by the industrial and automotive markets, although the only segment that declined slightly was communications.

Revenue growth was seen across all geographies except Japan. The increase from the year-ago quarter reflects a higher level of business, particularly in the automotive, industrial and consumer segments.
 
Revenue by End-Market
 
The industrial market generated 47% of total revenue (up 21.6% sequentially and 54.1% year over year), driven by broad-based strength across applications, such as instrumentation and process control. The Americas and Europe regions were particularly strong. Beginning in the first quarter, automotive revenue is being broken out separately and year-over-year comparisons have been adjusted accordingly.
 
The automotive segment generated around 13% of revenue, growing 11.8% sequentially and 105.1% from the year-ago quarter. The main drivers here continue to be the global recovery, as well as increasing electronic content per vehicle, especially in the areas of infotainment and safety. Although stimulus programs helped results to an extent, ADI typically does not cater to the lower-end vehicles that have received most of the funding.
 
Communications generated 20% of total revenue, down 1.5% sequentially and 0.9% year over year. The wireline business saw sequential growth for the fourth straight quarter and the 20% increase in the last quarter was particularly encouraging. The segment would have performed better if the Chinese base station orders were not pushed out into the fiscal third quarter.

Relative strength in other areas of the business, such as networking applications, optical, microwave and satellite was not enough to offset the weakness in the wireless business. The long term driver for wireless is 3G base station deployment all over the world, due primarily to the need for deeper penetration in developing countries and for greater data volume transmission in developed countries.
 
Consumer generated 18% of revenue. Segment revenue was up 1.5% sequentially but 45.1% from a year ago, reflecting a higher level of business. Digital cameras and portable media products started strengthening in the last quarter.
 
Computing accounted for the remaining 2% of revenue, up 2.7% sequentially and 31.1% year over year. The increase was attributable to the ongoing recovery in the market. Management has taken a policy decision to avoid this market, since it is given to commoditization, making margin expansion difficult.
 
Revenue by Product Line
 
Both analog and DSP products witnessed strong double-digit growth in the last quarter.
 
Analog signal processing products (84% of total revenue) were up 10.1% sequentially and 38.3% year over year. The sequential increase was fueled by amplifiers and other analog products, partially offset by a low single-digit decline in converters. Converters are the largest product line, with a revenue share of nearly 46%.
 
Digital signal processing products (9% of total revenue) were up 10.7% sequentially and 49.3% year over year.
 
Power management and reference products generated 7% of revenue, up 20.1% sequentially and 64.9% year over 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 the ongoing recovery across all served markets.  
 
Margins
 
The pro forma gross margin was 65.0%, up 391 basis points (bps) sequentially, 993 bps year over year and better than management’s guidance of 62-63%. The gross margin improvement has been going on for a few quarters now and it is mainly driven by manufacturing efficiencies that resulted from some fab closures, higher volumes that enabled better utilization rates and a more favorable mix of business, which included a larger number of higher-margin industrial products.
 
Operating expenses of $220.4 million increased 8.6% sequentially and 15.0% from the Apr quarter of 2009. However, the operating margin increased 457 bps sequentially to 32.0% compared to management’s expectations of 29-31%. While the higher gross margin was the primary reason for the increase, both R&D and SG&A expenses also contributed, declining as a percentage of sales.
 
The pro forma net income was $167.3 million, or a 25.0% net income margin compared to $136.1 million, or 22.6% in the previous quarter and $63.7 million, or a 13.4% net income margin in the prior-year quarter. The fully diluted pro forma earnings per share were $0.55 compared to $0.45 in the previous quarter and $0.22 in the Apr quarter of last year. The EPS was also better than management’s expectations of $0.48 to $0.51.
 
Since there were no one-time items in the last quarter, the GAAP EPS equaled the non GAAP EPS at $0.55, compared to the GAAP net income of $120.5 million ($0.40 per share) in the previous quarter and $51.8 million, or $0.18 per share in the year-ago quarter.
 
Balance Sheet
 
Inventories increased 1.8% to $248 million, with annualized inventory turns remaining flat sequentially at 3.8X. Days sales outstanding (DSOs) were down from 47 to 45. Cash generated from operations was around $278 million. The company spent $17.5 million on capex and $59.6 million on cash dividends in the last quarter.
 
Guidance
 
Strong orders in the fiscal second quarter helped grow the ending backlog at both OEMs and distributors. This is expected to fetch revenues of $695-715 million, representing a sequential increase of 4-7% or a year-over-year increase of 41-45%. Gross margins are expected to come in at 65-66% and operating margins at 33-34%, resulting in earnings per share of $0.59-$0.61.
 
We currently have a Neutral recommendation on Analog Devices shares.

Read the full analyst report on “ADI”
Zacks Investment Research