Analog Devices’ (ADI) fiscal second quarter earnings beat the Zacks Consensus Estimate by 11 cents, or 16.2%. Revenue was also better than expectations, beating by around 6.0%.
Results exceeded both management and our expectations on revenue and gross lines. Strong revenue growth across product lines, markets and geographies, operating leverage and a lower tax rate contributed to the results.
Analog Devices shares reacted positively in after-hours trading, rising 4.5%. Not surprising, since the average positive surprise in the preceding four quarters was just 6.04%.
Revenue
Analog Devices generated revenue of $790.8 million, which was up 8.5% sequentially, up 18.3% year over year and at the high end of management’s revenue guidance of $730-760 million (up 0-4% sequentially, up 9-14% year over year).
Around 24% of quarterly revenues were generated in the Americas (up 10.3% sequentially), Europe brought in 29% (up 20.9%), China 20% (up 4.4%), Japan 12% (down 10.9%) and the rest of Asia 15% (up 8.4%).
The consumer end market declined both sequentially and from last year, while the computing end market only declined from a year ago. All other markets grew both sequentially and year over year.
Revenue by End Market
The industrial market generated 49% of Analog Devices’ total revenue (up 14.1% sequentially and 21.5% year over year). This is a very diversified market for Analog Devices, including the industrial automation, instrumentation, energy, defense and healthcare segment.
The sequential increase in the last quarter was primarily driven by process control and instrumentation products, although management stated that all other areas also gained momentum in the last quarter.
Analog Devices stated that the strength in demand was coming from both large OEM and small players, signifying stronger demand trends. Management was very optimistic about continued growth through 2011, citing strong expectations at Siemens AG (SI) and ABB Ltd (ABB), two of Analog Devices’ largest industrial customers.
Energy efficiency, productivity enhancements and security are fueling the increased spending in the segment.
Communications generated 22% of total revenue, up 7.8% sequentially and 32.1% year over year. Analog Devices’ communications business comes from both infrastructure and cell phones, although the focus is on the infrastructure side.
The strength in the last quarter was due to the increasing adoption of smartphones, which pushed up data demands in North America, Europe and also China. With carriers scrambling to build capacity to meet the growing demand, wireless infrastructure products, particularly base stations were very strong.
Analog Devices stated that TD-SCDMA equipment sales in China was less than 10% of revenue in the last quarter, indicating its strong market position and the level of buildouts in other parts of the world. The company expects buildouts in China to resume in the second half of the year.
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 substantial growth for the company.
Analog Devices continued to see sequential declines in the wired communications segment (due to budget constraints), although year-over-year comparisons trended up.
Consumer generated 14% of revenue, down 8.6% sequentially and 7.5% from a year ago. Analog Devices attributed the decline to weakness in Japan, as well as in certain other parts of the world. Also, while the portable devices market grew in the last quarter, home entertainment aplications were flattish, while digital camera products declined.
The automotive segment (carved out of the industrial segment in the first quarter of fiscal 2010) generated around 13% of Analog Devices’ second quarter revenue, growing 12.2% sequentially and 27.3% from the year-ago quarter. The increases in the last quarter were driven by a strong product portfolio that enabled the company to take advanatge of the growing demand for automotive electronics.
The global recovery, better credit availability, as well as increasing electronic content per vehicle, especially in the areas of infotainment, safety and fuel efficiency continue to drive results. 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, up 6.8% sequentially and down 13.5% 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 segment was impacted by competitive pricing pressures and uncertain demand in the last quarter.
Revenue by Product Line
Overall, analog products continued to grow double-digits from the year-ago quarter, while digital signal processing (DSP) products continued to slow down.
Analog signal processing products (85% of total revenue) were up 8.9% sequentially and 19.7% year over year. The increase was across all product lines (converters, amplifiers and other analog products), although amplifiers were the strongest.
Converters remained the largest product line for Analog Devices, with a revenue share of over 44%. Amplifiers followed, with a 27% revenue share, while other analog products accounted for 14% of total revenue.
Power management and reference products remained at 7% of revenue, up 5.2% sequentially and 20.7% from last year. The strength in this product line is the result of management’s refocusing of the business over the last few years.
Digital signal processing products (8% of total revenue) were up 7.7% sequentially and up 3.7% year over year.
Margins
Analog Devices generated a pro forma gross margin of 67.6%, up 137 basis points (bps) sequentially, up 253 bps year over year and better than management’s guidance of 66.5%. Gross margins have expanded sequentially in six of the last seven quarters and the sequential expansion in the last quarter was related to higher volumes, higher utilization of internal fabs and a stronger mix of business.
Operating expenses of $235.7 million were up 5.8% sequentially and 16.2% from the April quarter of 2010. However, the operating margin expanded 214 bps sequentially and 571 bps year over year to 37.7%.
This was possible because cost of sales, R&D and SG&A expenses all declined as a percentage of sales both on a sequential basis and when compared with the year-ago quarter.
Net Profit
The pro forma net income was $245.3 million, or a 31.0% net income margin compared to $203.8 million, or 28.0% in the previous quarter and $167.3 million, or a 25.0% net income margin in the prior-year quarter.
The fully diluted pro forma earnings per share was 79 cents compared to 66 cents in the previous quarter and 55 cents in the April quarter of last year. The EPS was also much better than management’s expectations of 65-69 cents.
Since there were no one-time items in any of the quarters, the GAAP and non GAAP net income and EPS were same.
Balance Sheet
Inventories increased 3.8% to $293.8 million, with annualized inventory turns reamining flat at 3.5X. Days sales outstanding (DSOs) were also flat at 48. Cash generated from operations was around $196.6 million.
Analog Devices spent $34.1 million on capex and $66.0 million on cash dividends and $67.6 million on share repurchases in the last quarter. It also raised $370.5 million in debt.
Guidance
Analog Devices stated that order trends were strong throughout the quarter, with the company ending at a book-to-bill ratio greater than unity. The company’s customers in the industrial, automotive and communications infrastructure markets have signalled growing demand.
Management also expects the consumer market in Japan to recover in the third quarter. As a result, Analog Devices now expects revenue of $765-795 million, representing a sequential decline of 0-3%, or a year-over-year increase of 6-10%.
Gross margins are expected to come in at 67-68% and operating expenses to be flat to down slightly sequentially, resulting in earnings per share of 70 to 75 cents. Analysts polled by Zacks expected earnings of 70 cents a share when Analog Devices reported, which was at the low end of the guided range.
Our Recommendation
Analog Devices shares carry a Zacks rank of #3, implying a short term Hold recommendation. While Analog Devices is seeing improving trends for 2011, particularly in the industrial, automotive and communications infrastructure markets, the company has no exposure to the computing vertical, which is expected to grow very strongly this year on the back of tablets from Apple Inc (AAPL), Samsung, HTC, Hewlett-Packard Company (HPQ) and the like. Analog Devices will not be able to participate in this growth.
On the other hand, its results were impacted by the disaster in Japan, so there is a certain amount of uncertainty with respect to its revenues from the consumer segment.
As a result, we are more positive about its analog peers Monolithic Power (MPWR) and Microsemi Corporation (MSCC), which are ranked #2 (implying a short-term Buy recommendation), as well as ON Semiconductor (ONNN), which is ranked #1, implying a short-term Strong Buy recommendation.
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