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Exhibit 13.1
MANAGEMENT ANALYSIS
COMPANY OVERVIEW
Analog Devices, Inc. (Analog, ADI or the Company) is a world leader in the
design, manufacture and marketing of high-performance analog, mixed-signal and
digital signal processing (DSP) integrated circuits (ICs) used in signal
processing applications.
As of the end of fiscal 1999, approximately 40% of Analog's revenues came from
the communications market, making it the Company's largest and fastest-growing
served market. Communications applications include wireless handsets and base
stations, as well as products used for high-speed access to the Internet,
including ICs used in ADSL and cable modems and central office networking
equipment.
Analog serves the PC market with products that monitor and manage power usage,
process signals used in flat panel displays and LCD projectors and enable PCs to
provide CD-quality audio. Analog also serves the high-end consumer market with
products used in digital cameras and camcorders, DVD players and surround sound
audio systems. Analog provides a broad array of products to the industrial
market, including products for automatic test equipment and for the digital
speed control of AC motors.
Analog's products are sold worldwide through a direct sales force, third-party
industrial distributors and independent sales representatives. The Company has
direct sales offices in 18 countries, including the United States. Approximately
46% of fiscal 1999 revenue came from customers in North America, while most of
the balance came from customers in Western Europe and the Far East.
The Company is headquartered near Boston, in Norwood, Massachusetts, and has
manufacturing facilities in Massachusetts, California, North Carolina, Ireland,
the Philippines and Taiwan. Founded in 1965, Analog Devices employs
approximately 7,400 people worldwide. The Company's stock is listed on the New
York Stock Exchange under the symbol ADI and is included in the Standard &
Poor's 500 Index.
RESULTS OF OPERATIONS
Sales were $1,450 million in fiscal 1999, $1,231 million in fiscal 1998 and
$1,243 million in fiscal 1997. The significant growth in the use of analog,
digital and mixed-signal ICs to address the signal processing needs of the
growing broadband and wireless communications, computer and computer peripherals
markets was the main reason for the sales increase in fiscal 1999. In addition,
a recovery in the semiconductor industry generally, partially offset by a
decline in Automatic Test Equipment (ATE) sales, contributed to the sales
increase in fiscal 1999. Sales declined slightly during fiscal 1998 from the
levels achieved in fiscal 1997, primarily due to a decline in sales of Global
System for Mobile Communications (GSM) cellular phone chipsets and a decline in
disk drive product sales as a result of the disposal of the disk drive IC
business in fiscal 1998. These declines were partially offset by an increase in
analog IC sales. Sales of assembled products continued to decline in fiscal 1999
and accounted for 3% of the Company's net sales in fiscal 1999, down from 4% in
the prior fiscal year. Assembled products include multichip modules, hybrids and
printed circuit board modules.
Demand for the Company's communications, computer and consumer products resulted
in sales increases in all geographic regions during fiscal 1999. Sales to North
American customers increased 8% over fiscal 1998. Sales in Europe in the first
half of fiscal 1999 had declined from prior year levels but as the fiscal year
progressed, demand increased resulting in a relatively flat level of sales year
over year. Sales in Japan increased 23% as demand increased for the Company's
products as the Japanese economy continued its recovery. Sales in other
Southeast Asian countries in fiscal 1999 doubled from the levels achieved in
fiscal 1998. The increased demand was attributed to the increased use of the
Company's products in the communications and computer products market, both of
which experienced significant growth during the year.
Sales to North American customers increased 9% during fiscal 1998 over the
levels achieved in the prior year, due to increased sales of analog IC products.
In Europe, sales declined in fiscal 1998 from the levels achieved in fiscal
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1997, primarily due to a decline in GSM sales. Sales in Japan during fiscal 1998
remained flat to the levels achieved in fiscal 1997. Sales in other Southeast
Asian countries declined during fiscal 1998 primarily because of a decline in
the sales of disk drive IC products, which was partially offset by increases in
the sale of analog IC products.
Gross margin increased to 49.3% of sales in fiscal 1999, from 47.8% in fiscal
1998. This increase was primarily attributable to higher sales and tight control
of internal manufacturing spending. The decline in gross margin from 49.9% in
fiscal 1997 to 47.8% in fiscal 1998 was principally due to a reduction in demand
in fiscal 1998, which caused the Company to reduce production rates,
particularly in the second half of the year.
Research and development (R&D) expense was $257 million in fiscal 1999, compared
to $219 million in fiscal 1998. As a percentage of sales, R&D spending remained
flat at approximately 17.8%. The Company expects to continue the development of
innovative technologies and processes for new products targeted for broadband
and wireless communications applications, imaging, audio and high-performance
power and thermal management products for computer and consumer product
applications. The Company believes that a continued commitment to research and
development is essential in order to maintain product leadership with its
existing products and to provide innovative new product offerings, and therefore
expects to continue to make significant R&D investments in the future. In fiscal
1998, R&D expenses increased approximately 12% to $219 million, or 17.8% of
sales, up from 15.8% of sales in fiscal 1997.
During the second quarter of fiscal 1999, the Company acquired two DSP tools
companies, White Mountain DSP, Inc. of Nashua, New Hampshire and Edinburgh
Portable Compilers Limited, of Edinburgh, Scotland. The total cost of these
acquisitions was approximately $23 million with additional cash consideration of
up to a maximum of $10 million payable if the acquired companies achieve certain
revenue and operational objectives. In connection with these acquisitions, the
Company recorded a charge of $5.1 million for the write-off of in-process
research and development.
Selling, marketing, general and administrative (SMG&A) expenses were $210
million in fiscal 1999, an increase of $3 million from the $207 million recorded
in the prior fiscal year. As a percentage of sales, SMG&A decreased from 16.9%
for fiscal 1998 to 14.5% for fiscal 1999 due to continued control over spending
despite sales increases. In fiscal 1998, SMG&A expenses increased $15 million
from the $192 million recorded in fiscal 1997. This increase was primarily
attributable to an $8 million charge related to collection difficulties
experienced by the Company. As a result, SMG&A expenses as a percentage of sales
increased from 15.4% in fiscal 1997 to 16.9% in fiscal 1998.
Including the impact of the write-off of in-process research and development,
the Company's operating income was 16.7% of sales for fiscal 1999. The Company's
operating income for fiscal 1998, including the impact of a $17 million
restructuring charge and a $13 million net gain on the sale of its disk drive IC
business in fiscal 1998, was 12.8% of sales. The Company's operating income was
18.8% of sales for fiscal 1997.
The Company's equity interest in WaferTech, LLC, a joint venture with Taiwan
Semiconductor Manufacturing Company and other investors, resulted in a loss of
$1.1 million in fiscal 1999, compared to a loss of $9.8 million in fiscal 1998.
This change was the result of the Company's completion of the sale in fiscal
1999 of approximately 78% of its equity ownership in WaferTech. As a result of
this sale, the Company's equity ownership in WaferTech was reduced from 18% to
4%. The Company sold 78% of its investment to other WaferTech partners in
exchange for $105 million in cash, which was equal to 78% of the carrying value
of the equity ownership at October 31, 1998.
This investment is now recorded under the cost method.
The Company's effective income tax rate increased to 23.6% for fiscal 1999 from
20.6% in fiscal 1998 due to a shift in the mix of worldwide profits.
Additionally, in fiscal 1998 the Company utilized $5.6 million of capital loss
carryforwards for tax purposes, which reduced the Company's valuation allowance
from $5.6 million at November 1, 1997 to $0 at October 31, 1998. The effective
tax rate for fiscal 1997 was 24.4%.
In the fourth quarter of fiscal 1998, the Company changed its accounting method
for recognizing revenue on all shipments to international distributors and
certain shipments to domestic distributors. The change was made with an
effective date of November 2, 1997 (the beginning of fiscal 1998). Prior to the
change the Company had historically deferred revenue on most shipments made to
domestic distributors until the products were resold by the distributors to end
users, but recognized revenue on shipments to international distributors and
certain shipments to domestic distributors upon shipment to the distributors,
net of appropriate reserves for returns and allowances. As a result of this
accounting change, revenue recognition on shipments to all distributors
worldwide is deferred until the products are resold to the end users. The
Company believes that deferral of revenue and related gross margin on shipments
to distributors until the product is shipped by the distributors is a more
meaningful measurement of results of operations because it better conforms to
the substance of the transaction considering the changing business environment
in the
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international marketplace; is consistent with industry practice; and will,
accordingly, better focus the entire organization on sales to end users and,
therefore, is a preferable method of accounting. The cumulative effect in prior
years of the change in accounting principle was a charge of approximately $37
million (net of $20 million of income taxes) or $0.21 per diluted share.
For fiscal 1999, net income increased 65% before the fiscal 1998 change in
accounting principle, and 139% after the change in accounting principle, to $197
million, and diluted earnings per share was $1.10. For fiscal 1998, net income
before the cumulative effect of the change in accounting principle was $119
million, and diluted earnings per share was $0.71. Net income after the
cumulative effect of the change in accounting principle was $82 million for
fiscal 1998, and diluted earnings per share was $0.50. Net income was $178
million for 1997, and the diluted earnings per share was $1.04.
In June 1998, the Financial Accounting Standards Board issued Statement of
Financial Accounting Standards No. 133, (FAS 133), "Accounting for Derivative
Instruments and Hedging Activities." This statement provides a comprehensive and
consistent standard for the recognition and measurement of derivatives and
hedging activities. In July 1999, the Financial Accounting Standards Board
issued Statement of Financial Accounting Standards No. 137, which defers the
effective date of FAS 133 for one year. Accordingly, the Company will adopt FAS
133 during fiscal 2001 as required. The Company is currently evaluating the
impact of FAS 133 on the results of operations and financial position.
In March 1998, Statement of Position 98-1, (SOP 98-1), "Accounting for the Cost
of Computer Software Developed for or Obtained for Internal Use" was issued. The
Company is required to adopt SOP 98-1 in fiscal 2000. The Company believes that,
based upon current circumstances, the effect of adopting the standard will not
have a significant impact on the results of operations or financial position.
In December 1999, the Securities and Exchange Commission issued Staff Accounting
Bulletin 101, (SAB 101), "Revenue Recognition in Financial Statements." SAB 101
summarizes the application of generally accepted accounting principles to
revenue recognition in financial statements. The Company does not expect SAB 101
to have a material effect on the results of operations or financial position.
The impact of inflation on the Company's business during the past three years
has not been significant.
LIQUIDITY AND CAPITAL RESOURCES
At October 30, 1999, the Company had $762 million of cash, cash equivalents and
short-term investments compared to $305 million at October 31, 1998. The
increase in cash, cash equivalents and short-term investments was primarily due
to operating cash inflows of $427 million (29% of fiscal 1999 sales), $105
million received in January 1999, related to the sale of the Company's
investment in WaferTech and lower capital spending. The Company's operating
activities generated net cash of $225 million, or 18% of sales in fiscal 1998.
Investing activities used $358 million in fiscal 1999 and $187 million in fiscal
1998, while financing activities generated $22 million in fiscal 1999 and used
$62 million in fiscal 1998. The Company's primary source of funds in fiscal 1999
and fiscal 1998 was net cash generated by operations.
Accounts receivable of $267 million at the end of fiscal 1999 increased $60
million or 29% from $207 million at the end of fiscal 1998. This increase
resulted principally from a $133 million increase in sales from the fourth
quarter of fiscal 1998 to the fourth quarter of fiscal 1999. Days sales
outstanding improved from 63 at the end of the fourth quarter of fiscal 1998 to
56 at the end of the fourth quarter of fiscal 1999. As a percentage of
annualized fourth quarter sales, accounts receivable was 15.5% at the end of
fiscal 1999, down from 17.4% at the end of fiscal 1998.
Inventories declined $26 million, or 10%, from the prior year to $249 million at
the end of fiscal 1999. Inventories as a percentage of annualized fourth quarter
sales decreased to 14% for the year ended October 30, 1999 from 23% for the year
ended October 31, 1998. Inventory levels had increased at the end of fiscal 1998
as demand levels had declined in the second half of fiscal 1998. As demand
increased through fiscal 1999, inventory levels declined.
Net additions to property, plant and equipment of $78 million for fiscal 1999
were funded with a combination of cash on hand and cash generated from
operations. Capital spending in fiscal 1999 was down substantially from the $167
million spent in fiscal 1998. The decrease in capital expenditures was
attributable to the Company's efforts to constrain all spending, including
capital expenditures, until sales growth resumed. The Company currently plans to
make capital
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expenditures of between $200 million and $250 million in fiscal 2000.
Depreciation expense is expected to increase to $150 million in fiscal 2000.
During the second quarter of fiscal 1999, the Company acquired two DSP tools
companies, White Mountain DSP, Inc. of Nashua, New Hampshire and Edinburgh
Portable Compilers Limited, of Edinburgh, Scotland. The total cost of these
acquisitions was approximately $21 million in cash and $2 million in common
stock of the Company, with additional cash consideration of up to a maximum of
$10 million payable if the acquired companies achieve certain revenue and
operational objectives. These acquisitions were accounted for as purchases, and
the excess of the purchase price over the fair value of assets acquired was
allocated to existing technology, workforce in place, tradenames and goodwill,
which are being amortized over periods ranging from six to ten years. In
connection with these acquisitions, the Company recorded a charge of $5.1
million for the write-off of in-process research and development. In the fourth
quarter of 1999, the Company invested an additional $4 million in WaferTech.
In fiscal 1999, financing activities generated cash of $22 million. The issuance
of common stock under stock purchase and stock option plans generated cash of
$34 million, and proceeds from variable rate borrowings generated cash of $2
million. These increases were offset by $14 million of cash used for the
repayment of capital lease obligations.
As of March 11, 1999, the Company had converted $229,967,000 of the $230 million
principal amount of its 3-1/2% Convertible Subordinated Notes (Notes) due 2000
into an aggregate of 10,983,163 shares of the Company's common stock, and the
remaining Notes were redeemed by a cash payment of $33,000. As a result of this
conversion, the Company's debt-to-equity ratio was reduced to 7% as compared to
31% in the prior year.
At October 30, 1999, the Company's principal sources of liquidity were $762
million of cash and cash equivalents and short-term investments. In addition,
the Company has various lines of credit both in the U.S. and overseas, including
a $60 million credit facility in the U.S. that expires in fiscal 2000. These
lines of credit were substantially unused at October 30, 1999.
The Company believes that its existing sources of liquidity and cash expected to
be generated from future operations, together with current and anticipated
available long-term financing, will be sufficient to fund operations, capital
expenditures and research and development efforts for the foreseeable future.
QUALITATIVE AND QUANTITATIVE DISCLOSURE ABOUT MARKET RISK
The Company has fixed rate debt obligations and related interest rate swap and
cap agreements. An increase in interest rates would not significantly increase
interest expense due to the fixed nature of the Company's debt obligations.
Because of the size and structure of these obligations, a 100 basis point
increase in interest rates would not result in a material change in the
Company's interest expense or the fair value of the debt obligations and related
interest rate swap and cap agreements for fiscal 1999 and fiscal 1998. The fair
value of the Company's investment portfolio or related interest income would not
be significantly impacted by either a 100 basis point increase or decrease in
interest rates in fiscal 1999 and fiscal 1998 due mainly to the short-term
nature of the major portion of the Company's investment portfolio and the
relative insignificance of interest income to the consolidated pre-tax income,
respectively.
As more fully described in Note 2 (h) in the Notes to the Company's Consolidated
Financial Statements, the Company regularly hedges its non-U.S. dollar-based
exposures by entering into forward exchange contracts, foreign currency option
contracts and currency swap agreements. The terms of these contracts typically
are for periods matching the duration of the underlying exposure and generally
range from three months up to one year. The short-term nature of these contracts
has resulted in these instruments having insignificant fair values at October
30, 1999 and October 31, 1998. The Company's largest foreign currency exposure
is against the Japanese yen, primarily because Japan has a higher proportion of
local currency denominated sales. Relative to foreign currency exposures
existing at October 30, 1999 and October 31, 1998, a 10% unfavorable movement in
foreign exchange rates would not expose the Company to significant losses in
earnings or cash flows or significantly diminish the fair value of its foreign
currency financial instruments, primarily due to the short lives of the affected
financial instruments that effectively hedge substantially all of the Company's
year-end exposures against fluctuations in foreign currency exchange rates. The
calculation assumes that each exchange rate would change in the same direction
relative to the U.S. dollar. In addition to the direct effects of changes in
exchange rates, such changes typically affect the volume of sales or the foreign
currency sales price as competitors' products become more or less attractive.
The Company's sensitivity analysis of the effects of changes in foreign currency
exchange rates does not factor in a potential change in sales levels or local
currency selling prices.
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LITIGATION
For information concerning certain pending litigation involving the Company, see
Note 11 of the Notes to the Company's Consolidated Financial Statements.
FORWARD-LOOKING STATEMENTS
The "Management Analysis" and other sections of this report contain
forward-looking statements that are based on current expectations, estimates,
forecasts and projections about the industry and markets in which the Company
operates, management's beliefs and assumptions made by management. In addition,
other written or oral statements that constitute forward-looking statements may
be made by or on behalf of the Company. Words such as "expects," "anticipates,"
"intends," "plans," "believes," "seeks," "estimates," variations of such words
and similar expressions are intended to identify such forward-looking
statements. These statements are not guarantees of future performance and
involve certain risks, uncertainties and assumptions thaT are difficult to
predict. (See "Factors That May Affect Future Results" below.) Therefore, actual
outcomes and results may differ materially from what is expressed or forecast in
such forward-looking statements. The Company undertakes no obligation to update
publicly any forward-looking statements, whether as a result of new information,
future events or otherwise.
FACTORS THAT MAY AFFECT FUTURE RESULTS
The Company's future operating results are difficult to predict and may be
affected by a number of factors including the timing of new product
announcements or introductions by the Company and its competitors, competitive
pricing pressures, fluctuations in manufacturing yields, adequate availability
of wafers and manufacturing capacity, changes in product mix and economic
conditions in the United States and international markets. In addition, the
semiconductor market has historically been cyclical and subject to significant
economic downturns at various times. The Company's business is subject to rapid
technological changes and there can be no assurance, depending on the mix of
future business, that products stocked in inventory will not be rendered
obsolete before they are shipped by the Company. As a result of these and other
factors, there can be no assurance that the Company will not experience material
fluctuations in future operating results on a quarterly or annual basis.
The Company's success depends in part on its continued ability to develop and
market new products. There can be no assurance that the Company will be able to
develop and introduce new products in a timely manner or that such products, if
developed, will achieve market acceptance. In addition, the Company's growth is
dependent on its continued ability to penetrate new markets where the Company
has limited experience and competition is intense. There can be no assurance
that the markets being served by the Company will grow in the future; that the
Company's existing and new products will meet the requirements of such markets;
that the Company's products will achieve customer acceptance in such markets;
that competitors will not force prices to an unacceptably low level or take
market share from the Company; or that the Company can achieve or maintain
profits in these markets. Also, some of the Company's customers in these markets
are less well established which could subject the Company to increased credit
risk.
The semiconductor industry is intensely competitive. Certain of the Company's
competitors have greater technical, marketing, manufacturing and financial
resources than the Company. The Company's competitors also include emerging
companies attempting to sell products to specialized markets such as those
served by the Company. Competitors of the Company have, in some cases, developed
and marketed products having similar design and functionality as the Company's
products. There can be no assurance that the Company will be able to compete
successfully in the future against existing or new competitors or that the
Company's operating results will not be adversely affected by increased price
competition.
The cyclical nature of the industry has resulted in sustained or short-term
periods when demand for the Company's products has increased or decreased
rapidly. The semiconductor industry and the Company have experienced a period of
rapid increases in demand during fiscal 1999. The Company has increased its
manufacturing capacity over the past three years through both expansion of its
production facilities and increased access to third-party foundries. However,
the Company cannot be sure that it will not encounter unanticipated production
problems at either its own facilities or at third-party foundries, or that the
increased capacity will be sufficient to satisfy demand for its products. The
Company relies, and plans to continue to rely, on assembly and test
subcontractors and on third-party wafer fabricators to supply most of its wafers
that can be manufactured using industry-standard digital processes. Such
reliance involves several risks, including reduced control over delivery
schedules, manufacturing yields and costs. In addition, the Company's
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capacity additions resulted in a significant increase in operating expenses. If
revenue levels are not sufficient to offset these additional expense levels, the
Company's future operating results could be adversely affected. In addition,
asset values could be impaired if the additional capacity is underutilized for
an extended period of time. Also, noncompliance with "take or pay" covenants in
certain of its supply agreements could adversely impact operating results. The
Company believes that other semiconductor manufacturers have expanded their
production capacity over the past several years, and there can be no assurance
that the expansion by the Company and its competitors will not lead to
overcapacity in the Company's target markets, which could lead to price erosion
that would adversely affect the Company's operating results. In addition, the
Company and many companies in the semiconductor industry, rely on internal
manufacturing capacity located in California and Taiwan as well as wafer
fabrication foundries in Taiwan and other subcontractors in geologically
unstable locations around the world. Such reliance involves risks associated
with the impact of earthquakes on the Company and the semiconductor industry
including temporary loss of capacity, availability and cost of key raw materials
and equipment, and availability of key services including transport.
In fiscal 1999, 54% of the Company's revenues were derived from customers in
international markets. The Company has manufacturing facilities outside the U.S.
in Ireland, the Philippines and Taiwan. The Company also has a supply agreement
that includes "take or pay" covenants with a supplier located in Southeast Asia
(SEA) and as part of this arrangement, the Company has $20 million on deposit as
well as a $27 million investment in the common stock of the supplier. In
addition to being exposed to the ongoing economic cycles in the semiconductor
industry, the Company is also subject to the economic and political risks
inherent in international operations, including the risks associated with the
ongoing uncertainties in many developing economies around the world. These risks
include air transportation disruptions, expropriation, currency controls and
changes in currency exchange rates, tax and tariff rates and freight rates.
Although the Company engages in certain hedging transactions to reduce its
exposure to currency exchange rate fluctuations, there can be no assurance that
the Company's competitive position will not be adversely affected by changes in
the exchange rate of the U.S. dollar against other currencies.
The semiconductor industry is characterized by frequent claims and litigation
involving patent and other intellectual property rights. The Company has from
time to time received, and may in the future receive, claims from third parties
asserting that the Company's products or processes infringe their patents or
other intellectual property rights. In the event a third party makes a valid
intellectual property claim and a license is not available on commercially
reasonable terms, the Company's operating results could be materially and
adversely affected. Litigation may be necessary to enforce patents or other
intellectual property rights of the Company or to defend the Company against
claims of infringement, and such litigation can be costly and divert the
attention of key personnel. See Note 11 of the Notes to the Company's
Consolidated Financial Statements for information concerning certain pending
litigation involving the Company. An adverse outcome in such litigation may, in
certain cases, have a material adverse effect on the Company's consolidated
financial position or on its consolidated results of operations or cash flows in
the period in which the litigation is resolved.
The Company's software applications have been updated to accommodate the new
Euro currency. System testing was completed during the fourth quarter of
calendar 1998 and the Euro functionality was implemented as planned on January
1, 1999. No major system-related issues were encountered and none are
anticipated. The impact, either positive or negative, of the Euro on the
European economy generally and on the Company's operations in Europe in the
future is unknown at this time.
Because of these and other factors, past financial performance should not be
considered an indicator of future performance. Investors should not use
historical trends to anticipate future results and should be aware that the
trading price of the Company's common stock may be subject to wide fluctuations
in response to quarter-to-quarter variations in operating results, general
conditions in the semiconductor industry, changes in earnings estimates and
recommendations by analysts or other events.
YEAR 2000
Over the past six years the Company made significant investments in new
manufacturing, financial and operating hardware and software. These investments
were made to support the growth of its operations; however, the by-product of
this effort was that the Company had year 2000 compliant hardware and software
running on many of its major platforms. The Company established a task force to
evaluate the remaining systems and equipment and upgrade or replace systems that
were not year 2000 compliant. The cost of this effort, which commenced at the
beginning of fiscal 1998 and continued through fiscal 1999, was approximately
$10 million.
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The Company's computer systems and equipment successfully transitioned to the
year 2000. However, there may be latent problems that surface at key dates or
events in the future. The Company has not experienced, and does not anticipate,
any significant problems related to the transition to the year 2000.
Furthermore, the Company does not anticipate any significant expenditure in the
future related to year 2000 compliance.
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