Analog Devices’ (ADI) fiscal fourth quarter earnings beat the Zacks Consensus Estimate by 3 cents, or 4.1%. Revenue beat by 1.9%. Results touched the high-end of management expectations on revenue and gross margin, but exceeded on the operating margin line.
Despite the solid results, Analog Devices shares were down slightly (0.5%) in after-hours trading, as investors discounted investments in the sector. We also note that while earnings continue to beat the Zacks Consensus, the surprise percentage has been trending down over the past 4 quarters. This explains the reason for the relatively small movement in Analog Devices share prices in response to the earnings announcement.
Revenue
Analog Devices’ revenue of $770.0 million was up 6.9% sequentially, 34.7% year over year and at the high end of management’s revenue guidance of $740-770 million (up 3-7% sequentially). The communications and automotive end-markets grew the strongest on a sequential basis and computing was the only area that actually saw a decline. Growth was fairly broad-based across geographies, with the Americas and Japan registering the biggest increases.
Revenue by End Market
The industrial market generated 45% of Analog Devices’ total revenue (up 2.5% sequentially and 56.1% year over year), driven by energy and healthcare sectors, as well as increasing demand from Analog Devices’ broad base of smaller scale industrial customers. Energy efficiency, productivity enhancements and security are fueling the increased spending in the segment. Europe, Japan and China were responsible for the growth in the last quarter.
Communications generated 23% of total revenue, increasing 16.6% sequentially and 47.8% year over year. Analog Devices’ communications business comes from both infrastructure and cell phones, although the focus is on the infrastructure side. Analog Devices did not provoide specific commentary regarding the wireline infrastructure business, stating that wireless infrastructure was the major driver of revenue in the last quarter.
The TDS CDMA phase 4 rollout in China and the gradual replacement of GSM by 3G fueled growth in the last quarter. With mobile operators racing to meet increasing data needs and improving the efficiency of their networks, demand for networking applications in the U.S. is also on the rise.
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. The smartphone business also grew in the last quarter and management stated that Analog Devices’ products were well-received by customers.
Consumer generated 18% of Analog Devices’ revenue. Segment revenue was up 5.3% sequentially but down 5.1% from a year ago, reflective of caution at customers in this segment. Portable media products, digital cameras and other consumer electronics products drove the sequential increase.
The automotive segment (carved out of the industrial segment in the first quarter of fiscal 2010) generated around 12% of Analog Devices’ revenue, growing 11.8% sequentially and 30.8% from the year-ago quarter. The sequential increase in the last quarter was driven by a more robust automotive market, which came off a seasonally weaker period.
The main drivers here continue to be the global recovery, 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 5.7% sequentially and up 3.8% year over year. 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 from the year-ago quarter.
Analog signal processing products (84% of total revenue) were up 7.3% sequentially and 34.3% year over year. Converters, amplifier and other analog products all contributed to the sequential increase. Converters are the largest product line, with a revenue share of over 46%.
Power management and reference products generated 7% of revenue, up 4.2% sequentially and 54.9% 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.
Digital signal processing products (8% of total revenue) were up 5.1% sequentially and 27.5% year over year.
Margins
Analog Devices generated a pro forma gross margin of 67.0%, up 38 basis points (bps) sequentially, 1,074 bps year over year and at the high end of management’s guidance of 66-67%. Gross margins have expanded sequentially in each of the last five quarters. Gross margin improvements continue to come from higher volumes that enable better utilization rates, as well as a more favorable mix of business. Analog Devices expressed confidence that there remains further leverage in the model.
Operating expenses of $230.5 million were flat sequentially and up 19.1% from the October quarter of 2009. However, the operating margin increased 224 bps sequentially and 1,465 bps year over year to 37.1%, better than Analog Devices’ expectations of 35-36%. Both R&D and SG&A expenses declined as a percentage of sales, contributing almost equally to the margin expansion in the last quarter. Of course, the stronger gross margin also helped.
The pro forma net income was $225.0 million, or a 29.2% net income margin compared to $200.3 million, or 27.8% in the previous quarter and $105.6 million, or a 18.5% net income margin in the prior-year quarter. The fully diluted pro forma earnings per share were $0.73 compared to $0.65 in the previous quarter and $0.36 in the October quarter of last year. The EPS was also better than management’s expectations of $0.68 to $0.72.
Since there were no one-time items in any of the quarters mentioned above, the GAAP and non GAAP net income and EPS were same.
Balance Sheet
Inventories increased 4.6% to $277.5 million, with annualized inventory turns increasing slightly from 3.6X to 3.7X reported at the end of the last quarter. Days sales outstanding (DSOs) went up from 45 to 46. Cash generated from operations was around $274.3 million. The company spent $37.8 million on capex and $65.6 million on cash dividends and $35.8 million on share repurchases in the last quarter. The Board of Directors of Analog Devices authorised the purchase of an additional $1 billion worth of share repurchases.
Guidance
Analog Devices stated that while end markets continued to look strong, the company was likely to see higher turns in the business and lower backlog accumulation in the following quarter. This is expected to fetch revenues of $715-740 million, representing a sequential decline of 4-7%, or a year-over-year increase of 19-23%.
Gross margins are expected to come in at 66% and operating margins at 34.5-35.5%, resulting in earnings per share of $0.63-$0.67. Therefore, not just revenue, but margins and net earnings are also expected to decline from the October quarter. Analysts polled by Zacks expected earnings of $0.63 a share when Analog Devices reported, which was the low end of the guided range.
Our Recommendation
Analog Devices shares currently have a Zacks #3 Rank, implying a short term Hold recommendation. This is similar to its peers Microsemi Corporation (MSCC), Fairchild Semiconductor (FCS) and Semtech Corporation (SMTC), which also has a Zacks #3 Rank. The recommendations for the group are not so much because of weak demand, but more because of a stabilization in the growth rate. We do not expect very strong growth rates over the next few quarters for any of these companies, given that initial pent-up demand during the recession has largely been met.
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