Analog Devices Inc.’s broad product portfolio paid off massively in the recently-ended quarter with sales and profits exceeding forecasts on solid growth across most segments. Even as investors cheered its results, however, concerns have also cropped up about ADI’s rising exposure to the consumer electronics market with analysts wondering if it can fend off any negative impacts of the sector on long-term growth.
The management played down these concerns during a conference call with investors, noting ADI sells into hundreds of markets and continues to leverage its broad portfolio of more than 20,000 products – many of them proprietary offerings – into multiple end-equipment sectors, including industrial segments such as aerospace, defense and the renewable energy industry. President and CEO Vincent Roche pointed during the conference call to opportunities opening up in regional markets, including China where the company sees pent up demand from the communications infrastructure sector.
“While we continue to have a strong position with U.S. and European manufacturers, we still have opportunity ahead as we increasingly serve the Asian market,” Roche told analysts. “The near-term volatility in communications infrastructure gives us no pause about the long-term upward trend in this market. The facts are that 4G penetration is low, data consumption is increasing exponentially, and radio density is also increasing.”
ADI undoubtedly had a strong performance in the just-ended fiscal third quarter. Revenue soared to a record $863.4 million, in the three months ended Aug. 1, up 19 percent, from $727.8 million in the comparable quarter of fiscal 2014. Net income rose to $216.5 million, or 68 cents per share, from $180.6 million, or 57 cents per share, in the fiscal 2014 third quarter. Sales in the ongoing quarter are forecast to jump also at a double-digit clip, according to David Zinsner, Analog Devices’ CFO. On the basis of this outlook, analysts on average are forecasting the company will report revenue of approximately $3.36 billion for fiscal 2015, representing a 17 percent increase from the $2.87 billion it posted in fiscal 2014.
“In total, we're planning for revenue in the fourth quarter to be in the range of $880 million to $940 million, which represents an increase of approximately 2 percent to 9 percent sequentially,” Zinsner said. “At the midpoint of this range, revenue of $910 million would represent an increase of 12 percent year-over-year. We expect gross margins in the fourth quarter to be approximately 65.5 percent, given a likely mix of business. We are anticipating operating expenses in the fourth quarter to increase between 1 percent and 3 percent sequentially, lagging our expected sequential revenue growth in the fourth quarter.”
Surging demand from the consumer electronics market – and especially from a specific but unidentified customer – contributed to Analog Devices’ recent sales surge in the last two quarters and the momentum is expected to carry it to a solid annual performance. Analysts estimate sales into the consumer market now account for about 30 percent of the company’s revenue and expressed concerns about its ability to maintain this performance considering the vagaries of the sector and the company’s own history of trying to avoid a major exposure to any particular industry.
Company executives defended its involvement in the consumer market and assured investors the wide breadth of ADI’s products combined with its careful management of inventories as well as proprietary offerings would help it avoid any problems in the sector. The stronger and higher sales into consumer electronics doesn’t imply ADI has abandoned its focus on business-to-business applications, according to Roche, the CEO, who added the company is able to extend most of its technologies into various end-markets.
“As we do across all our businesses, we look for diversity in each application in terms of the types of technology that we can apply and the number of products that we can develop,” Roche said. “So, it's not a tale of one product, one customer; it's a tale of many, many different types of technologies across many, many different modalities there in terms of that intersection of the physical and digital worlds.”
This same point was emphasized by Ali Husain, director of investor relations, during the conference call. Husain noted ADI reviews its product portfolio constantly to ensure a good demand and supply balance across multiple technologies, anchored by what he described as a strategy of trying to build a “sustainable moat around the business” to offset weaknesses in any particular market segment with strength at other segments.
“Our strategy in consumer remains consistent,” Husain said. “We participate in those applications where we can leverage existing core technology to solve our customers' toughest challenges where we believe our innovation is sustainable, and where our technology makes a meaningful difference to the user experience. And by leveraging existing core technology, we further increase the ROI on our R&D investments.”
ADI and its competitors have other industrywide challenges, though. The company has expanded its outreach to OEMs in emerging Asian economies and has in recent years been scoring some successes in the region and especially in China. However, the Asian market has also come under pressure since the beginning of the year with demand from the communications equipment segment stalling although ADI executives said they believe the weakness should end soon.
Companies in the region will be compelled to jack up capital equipment expenditure in response to consumer demand for the latest wireless technologies, according to Roche, who noted that “4G penetration is low, data consumption is increasing exponentially, and radio density is also increasing.”
Perhaps the strongest factor analysts believe will continue to help ADI achieve its goal of beating the semiconductor and electronics industry growth rate is the company’s strategy of spreading its research and development budget over a wide range of products and applications. Over the course of the last five years it has concentrated a majority of R&D expenditure on the business-to-business market while devoting between 30 and 40 percent on targeted segments of the consumer electronics industry. This strategy has given ADI a strong position with the leading consumer electronics companies while assuring it can remain a leading player in other sectors, Roche said.
“What we spend [on consumer electronics] is quite constrained and we’re playing with market leaders. That gives us the opportunity to apply the best of our technology over the long-term,” Roche said. “The foundation of this company is the business-to-business space, the communications infrastructure, the industrial business, automotive and healthcare where we have many thousands of customers, hundreds of applications, 20,000 product SKUs, and the R&D is largely pointed there. So that is the core business of ADI, and will remain so into the future. I think we've got the right strategic mix here, and the rest is down to how well we execute in the markets.”
So far, the company’s ability to deliver on its promises isn’t in doubt. Even the analysts who raised questions about its higher exposure to the consumer electronics market still gave ADI’s management kudos for delivering solid quarter-over-quarter results. They just wanted assurance the management could keep the “volatile” consumer electronics market from spoiling what appears to be a good story.
That’s a tough request but one the company believes it can reasonably satisfy based on its deep look into end-market consumption.
“The transparency we have around demand and supply is very strong,” Roche said. “Our sense is that there is a good balance between consumption and supply at this point in time. As a company, we measure only end customer bookings [and] that’s what we base our understanding of demand on.”