(ADI) Analog Devices Optimistic Despite Earnings Miss

Analog Devices’ (ADI) fiscal first quarter earnings missed the Zacks Consensus Estimate by a couple of cents. Revenue missed the consensus by 2.1%. All except the automotive end market weakened for the company, although consumer was the weakest of all. Shares slumped 2.56% in response.

While the guidance was also below our expectations, the commentary was more or less as we had expected going by earnings reports from other analog players, such as Linear Technology Corp (LLTC), Maxim Integrated Products (MXIM) and Texas Instruments (TXN).

Revenue

Analog Devices generated revenue of $648.1 million, which was down 9.5% sequentially, 11.0% year over year and just within management’s revenue guidance of $645-680 million (down 5-10% sequentially, down 7-12% year over year).

Analog Devices had previously cautioned about a weak first quarter, due to inventory reduction at customers and lack of sales during Christmas and the lunar new year, which would effectively result in 14 weeks of expenses versus 13 weeks of revenue.

Revenue by End Market

The industrial market generated 45% of Analog Devices’ total revenue (down 7.9% sequentially and 14.6% 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 driven by broad-based declines across customers, markets and geographies. ADI stated that the increased caution at customers due to economic concerns led them to further reduce inventories, although order rates indicated that sentiments were improving.

Communications generated 19% of total revenue, down 13.0% sequentially and 17.7% year over year. Analog Devices’ communications business now constitutes  infrastructure sales alone. Management stated that this business was impacted by general economic uncertainty, regulatory issues in some countries and disruptions caused by the AT&T (T) and T Mobile merger failing.

Consumer, which now includes the computing (1% of fiscal 2011 revenue) and handset (3% of fiscal 2011 revenue) businesses, generated 18% of revenue, down 21.4% sequentially and down 19.9% from a year ago. The greater-than-expected sequential decline was attributed to the flooding in Thailand that impacted production at customers, which impacted demand.

The automotive segment generated around 18% of Analog Devices’ first quarter revenue, increasing 5.9% sequentially and 25.9% from the year-ago quarter. The growing electronic content in automobiles, growing dollar content per vehicle for Analog and increased sales of vehicles helped sales in the last quarter.

Revenue by Product Line

The revenue decline was across all analog and power management products, although digital signal processing (DSP) increased slightly.

ADI signal processing products (84% of total revenue) were down 10.1% sequentially and 11.8% year over year. All product lines within analog (converters, amplifiers and other analog products) contributed to the sequential decline, with converters declining the most, followed by amplifiers and then other analog products.

Specifically, converters were down 11.8% sequentially and 13.5% year over year. Amplifiers followed, with sequential and year-over-year declines of 10.0% and 15.9%, respectively. Other analog products saw a relatively smaller decline of 4.8% from the previous quarter and an increase of 2.6% from a year ago. The three product lines generated 44%, 25% and 15% of quarterly revenue, respectively.

Power management and reference products remained at roughly 7% of revenue, down 15.6% and 15.9%, respectively from the previous and year-ago quarters. These products are generally sold into the consumer market that has been impacted by the Thailand flooding and resultant disruption in the supply chain. Management has refocused the business over the last few years to increase focus on this fast-growing product line.

DSPs (9% of total revenue) were up 2.8% sequentially and 2.5% year over year.

Margins

Analog Devices generated a pro forma gross margin of 63.2%, down 113 basis points (bps) sequentially, 301 bps year over year and in line with management’s guidance of 63% (+/- 50 bps). Gross margins were impacted by lower utilization rates (below 70% in the last quarter from 73%), as Analog tried to keep internal inventories under control.

Operating expenses of $226.0 million were flattish sequentially and up 1.5% from the January quarter of 2010. As a result, the operating margin shrunk 456 bps sequentially and 731 bps year over year to 28.3%.

On a sequential basis, R&D increased the most as a percentage of sales,  with SG&A and cost of sales also increasing. As may be expected, all expenses also grew year over year as a percentage of sales.

Net Profit

The pro forma net income was $139.4 million, or a 21.5% net income margin compared to $183.5 million, or 25.6% in the previous quarter and $203.8 million, or a 28.0% net income margin in the year-ago quarter. The fully diluted pro forma earnings per share were 46 cents compared to 60 cents in the previous quarter and 66 cents in the January quarter of last year.

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 0.7% to $297.2 million, with annualized inventory turns dropping sequentially from 3.5X to 3.2X. Days sales outstanding (DSOs) went down to 43 from 44. Cash generated from operations was around $214.8 million. Analog Devices spent $25.3 million on capex, $74.4 million on cash dividends and $78.4 million on share repurchases in the last quarter.

Guidance

Given improving order trends through January and February, ADI expects industrial revenue to increase in the next quarter. The consumer business is expected to increase slightly in line with normal seasonality. The momentum in the automotive business is also likely to be sustained. However, will likely remain weak for one more quarter and recover thereafter (going by customer feedback).

Management expects second quarter revenue of $655-$675 million (a 1-4% sequential increase) with the gross margin at 64-64.5%, operating expenses of around $226 million and diluted EPS of 48-53 cents. Analysts polled by Zacks expected earnings of 54 cents a share when Analog Devices reported, just over the guided range.

Our Take

Analog Devices had another bad quarter, impacted by economic concerns and caution at customers. However, if management commentary is to be believed, order trends have already started improving, with both January and February coming in notably stronger. As a result, management now expects the first quarter to be the trough for orders, revenue and margins.

Despite the positive commentary, we note that guidance remains below our expectations for the next quarter. We think this is likely to trigger downward revision to estimates, containing price appreciation and keeping the Zacks Rank at #4 (short-term Sell rating).

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