The Conduct of a Semi-Conductor: Analog Devices Inc.

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Analog Devices (NASDAQ: ADI) engages in the design, manufacture, and marketing of analog, mixed-signal, and digital signal processing integrated circuits (ICs) used in industrial, automotive, consumer, and communication applications. The company recently declared its fourth quarter earnings, generating a gross margin of 63.8%, down by 179 basis points (bps) sequentially and 52 bps year over year, below management’s gross margin prediction of 65%.

Measurable Aspects

Analog Devices has had a big turn up in revenue in the second quarter, yet fell short of expectations. It reported fourth quarter earnings per share of $0.58, generating revenue of $695.0 million. This was up by 1.7% sequentially.

The net income of the company was $179.2 million, or a 25.8% net income margin. This is better than $169.8 million, or 24.9%, in the previous quarter and $183.5 million, or a 25.6% net income margin, in the year-ago quarter.

The company has allowed their inventory to increase up to 121 or 122 days, with the main objective to keep the inventory under control and yet be flexible enough to respond in time to any increase in quarterly demand.

Moreover, there have been very significant operating expense controls by the company, evident in the fact that operating expenses have been roughly flat in the last two years despite massive fluctuations in revenue. Moreover, special charges related to restructuring activity were absent in the last quarter.

Looking Forward                  

Management hopes to soon accelerate back to the gross margin levels at which it operated a few quarters ago. The primary reason for the gross margin decline was the change in sales mix, which favored lower-margin products in the last quarter. Therefore, management has decided to reduce production to align inventories with demand, which will cause the utilization rate to drop.

The communications segment of the company now constitutes infrastructure sales alone. This business should continue on an uptrend, as there is great focus on 4G and LTE by leading phone makers, such as Samsung and Apple, and Analog Devices has offerings for both the traditional and 4G networks. Thus it stands to gain when there is any increase in demand. Additionally, it has higher content in the 4G segment, which along with its position should positively influence revenue growth.

Areas to be considered

Analog Devices has a very diversified market, including the industrial automation, instrumentation, energy, defense and healthcare segments. The macro weaknesses of the company have resulted in the industrial customers decreasing their orders and cutting their inventories, quite contrary to the management’s optimism. Europe and Japan are the weakest markets for Analog.

The company faces direct competition from NXP Semiconductors (NASDAQ: NXPI), STMicroelectronics (NYSE: STM) and Texas Instruments (NASDAQ: TXN), each one of them a strong player in the market.

NXPI posted a third-quarter profit of 50 cents per share on Nov. 1, which was 1 cent higher than the average forecast. Moreover the CEO of the company is optimistic that Near Field Communications (NFC) will take off in the following year. as a result of this the company, being a leading supplier of NFC chips, shall grow.

STM is a global leader in the semiconductor market, serving customers across the globe. It is found everywhere microelectronics make a positive and innovative contribution to people's life. Company management has announced that they will present the company’s new strategic plan on Monday, Dec. 10, 2012 before the European stock markets open. In 2011, the company's net revenue was $973 million, which is quite high in comparison to ADI’s revenue of $695 million.

TXN is engaged in the design and sale of semiconductors to electronics designers and manufacturers worldwide. The company's strengths can be seen in multiple areas, such as its increase in net income, expanding profit margins, good cash flow from operations, largely solid financial position, reasonable debt levels, and notable return on equity.

Takeaway advice

Analog Devices has a significant percentage of its revenue coming from the industrial and automotive markets, both of which are expected to remain sluggish in the near term as macro concerns continue to have an impact on its customers. Additionally, the company is now expecting a sharp reduction in its consumer revenue, which will make matters worse.

Given these negatives, it is not surprising that the predictions of the management are again below expectations. Moreover, the present uncertainty in key markets is expected to continue in the future. Therefore I do not expect Analog Devices to report better results over the time period and would recommend a short term selling of the company’s stock.

garimaarora has no positions in the stocks mentioned above. The Motley Fool owns shares of NXP Semiconductors. Motley Fool newsletter services recommend NXP Semiconductors . Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. Is this post wrong? Click here. Think you can do better? Join us and write your own!

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