(ADI) Analog Devices Misses Earnings Again

Analog Devices’ (ADI) fiscal fourth quarter earnings missed the Zacks Consensus Estimate by 3 cents, or 4.8%. Revenue missed the consensus by 8.2%. Particular weakness in the communications and industrial markets led to weaker-than-expected revenue. This, in turn, impacted margins.

The guidance was also below our expectations, but the market appears to have priced in the weakness, given that other analog players, such as Linear Technology Corp (LLTC), Maxim Integrated Products (MXIM) and Texas Instruments (TXN) also guided below expectations. Therefore, shares did not lose much in after-market trade.

Revenue

Analog Devices generated revenue of $716.1 million, which was down 5.5% sequentially, 7.0% year over year and just within management’s revenue guidance of $715-755 million (down 0-6% sequentially, down 2-7% year over year).

While the industrial segment weakened in line with management guidance, Analog Devices had guided to strength in communications infrastructure that did not materialize.

Revenue by End Market

The industrial market generated 41% of Analog Devices’ total revenue (down 13.9% sequentially and 10.0% year over year). This is a very diversified market for Analog Devices, including the industrial automation, instrumentation, energy, defense and healthcare segments.

The sequential decline in the last quarter was on account of increased caution at customers, as economic concerns led them to further reduce inventories. Management stated that the weakness was broad-based across product lines and geographies. Order flow started to stabilize through October and November. Analog Devices’ full-year performance was good, however, due to strong revenue growth in industrial automation, instrumentation and energy markets.

Consumer, which now includes the computing (1% of fiscal 2011 revenue) and handset (3% of fiscal 2011 revenue) businesses, generated 21% of revenue, up 7.9% sequentially and down 9.3% from a year ago. The sequential increase was on account of seasonal increase in demand for digital cameras, gaming systems and the like. Sales for the year were down, as Analog Devices shifted focus to higher value-added applications that are likely to generate better margins.

Communications generated 19% of total revenue, down 9.2% sequentially and 14.1% year over year. Analog Devices’ communications business comes from both infrastructure and cell phones, although the focus is on the infrastructure side. However, management is now including phones in the consumer segment.

Although revenue in the quarter benefited from the recovery in Japan, this was more than offset by the postponement of the build-out in China and overall inventory reduction across the world due to increased macro concerns. The mobile data segment drove revenue for the year.

The automotive segment generated around 16% of Analog Devices’ fourth quarter revenue, increasing 11.2% sequentially and 20.2% from the year-ago quarter. Growing electronic content in automobiles and strong position at customers offset macro pressures to generate the growth in the last quarter.

The global recovery, better credit availability, as well as increasing electronic content per vehicle, especially in the areas of infotainment, safety and fuel efficiency remain long-term drivers. This, along with increasing demand for high-end vehicles that use Analog Devices products are positives for the company.

Revenue by Product Line

The revenue decline was across all product lines, including analog, power management and digital signal processing (DSP).

Analog signal processing products (85% of total revenue) were down 5.3% sequentially and 6.7% year over year. All product lines within analog (converters, amplifiers and other analog products) contributed to the sequential decline, although other analog products were up year over year.

Converters remained the largest product line for Analog Devices, with a revenue share of over 45%. Amplifiers followed, with a 26% revenue share, while other analog products accounted for 14% of total revenue.

Power management and reference products remained at 7% of revenue, down 3.3% sequentially and 4.5% from last year. The strength in this product line is the result of management’s refocusing of the business over the last few years.

DSPs (8% of total revenue) were down 9.3% sequentially and 12.3% year over year.

Margins

Analog Devices generated a pro forma gross margin of 64.3%, down 294 basis points (bps) sequentially, 274 bps year over year and missing management’s guidance of 65-66%. Gross margins were impacted by a negative mix (more automotive and consumer versus less industrial and communications) and utilization rates dropping (from 78% to 73%), as Analog cut production to lower both internal and distributor inventories.

Operating expenses of $225.2 million were down 2.4% sequentially and 2.3% from the October quarter of 2010, much less than the overall decline in revenue. As a result, the operating margin shrunk 394 bps sequentially and 425 bps year over year to 32.9%.

On a sequential basis, cost of sales increased the most as a percentage of sales, with R&D and SG&A increasing at more or less the same rate. All expenses grew year-over-year as a percentage of sales.

Net Profit

The pro forma net income was $183.5 million, or a 25.6% net income margin compared to $219.9 million, or 29.0% in the previous quarter and $225.0 million, or a 29.2% net income margin in the prior-year quarter. The fully diluted pro forma earnings per share were 60 cents compared to 71 cents in the previous quarter and 73 cents in the October quarter of last year. The EPS was well below management’s expectations of 74 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 dropped 1.4% to $295.1 million, with annualized inventory turns dropping flat sequentially at 3.5X. Days sales outstanding (DSOs) went down to 44 from 45. Cash generated from operations was around $230.2 million. Analog Devices spent $26.3 million on capex, $74.8 million on cash dividends and $82.8 million on share repurchases in the last quarter.

Guidance

With customers continuing to cut inventories and typical first quarter seasonality, Analog Devices will see a weak first quarter. Also, given that the company does not expect to generate any sales during Christmas and the lunar new year, it will effectively have 14 weeks of expenses versus 13 weeks of revenue.

Given this backdrop, revenue for the quarter is expected to decline 5-10% sequentially with the gross margin at 63% (+/- 50 bps), operating expenses of $226-229 million and diluted EPS of 44-51 cents. Analysts polled by Zacks expected earnings of 59 cents a share when Analog Devices reported, well over the guided range.

Our Take

Analog Devices has not had a good quarter, which is not surprising for an analog company in the current environment. However, the thing that concerns us is the areas in which it is seeing weakness. A certain amount of softness in the industrial business may be considered normal for the December quarter, but we are talking about much more than seasonality here. Both the industrial and communications businesses were impacted by economic concerns and increased caution at customers.

We are however encouraged by expectations that these businesses are likely to pick up strongly in 2012. We believe that the company has an attractive portfolio and strong position at customers that would respond quickly to a pickup in demand. In the meantime, cost containment is likely to be a key theme for maximizing earnings.

Analog Devices shares carry a Zacks #3 Rank, implying a short term Hold recommendation.

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