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EXHIBIT 13-1
MANAGEMENT ANALYSIS
COMPANY OVERVIEW
Analog Devices, Inc. ("Analog" or the "Company") designs, manufactures and
markets a broad line of high-performance linear, mixed-signal and digital
integrated circuits ("ICs") that address a wide range of real-world signal
processing applications. The Company's principal products include
general-purpose, standard-function linear and mixed-signal ICs ("SLICs") and
system-level ICs. The latter group includes general-purpose digital signal
processing ICs ("DSPs") and application-specific devices that typically
incorporate analog and mixed-signal circuitry and a DSP core.
Nearly all of Analog's products are components, which are typically incorporated
by original equipment manufacturers ("OEMs") in a wide range of equipment and
systems for use in communications, computer, industrial, instrumentation,
military/aerospace, automotive and high-performance consumer electronics
applications.
The Company sells its products worldwide through a direct sales force,
third-party industrial distributors and independent sales representatives.
Approximately 46% of fiscal 1997 revenue was derived from customers in North
America, while most of the balance was derived from customers in Western Europe
and the Far East.
RESULTS OF OPERATIONS
FISCAL 1997 COMPARED TO FISCAL 1996
Fiscal 1997 sales of $1,243 million were up 4% year to year, despite a sluggish
first half of the year. The first half of the year was adversely affected by
excess inventories at end customers which had accumulated during the prior year
when lead times had increased due to manufacturing capacity constraints. During
the second half of fiscal 1997 demand increased and sales growth resumed.
Standard linear IC product sales contributed significantly to Analog's growth
during fiscal 1997. SLICs are primarily high-performance, single-function
devices. The majority of SLIC revenue was attributable to sales of data
converters (analog-to-digital and digital-to-analog) and amplifiers. The
Company's products were sold to a broad customer base throughout the world with
virtually all channels of distribution and all geographies showing increased
sales. Recently introduced high speed products contributed to this growth.
Products used in communications and imaging applications experienced good growth
during fiscal 1997. SLIC sales represented 61% of the Company's total sales
during fiscal 1997 compared to 57% during fiscal 1996.
Sales of system-level IC products declined slightly as the Company experienced a
decline in sales of computer audio products, GSM (Global System for Mobile
Communications) cellular phone chipsets and products used in automatic test
equipment. System-level ICs include general purpose DSP ICs and multi-function
devices that feature high levels of functional integration on a single chip.
Most of the multi-function ICs are mixed signal devices, others are linear-only
devices. System level IC product sales represented 35% of the Company's total
sales during fiscal 1997 compared to 38% during fiscal 1996.
Sales of assembled products continued to decline during fiscal 1997 and
represented only 4% of the Company's total sales during fiscal 1997 and 5%
during fiscal 1996. Assembled products include multi-chip modules, hybrids and
printed board modules.
Sales to North American customers increased significantly over fiscal 1996.
Sales in Europe and Japan remained essentially flat in comparison to the prior
year. A decline in sales in Southeast Asia was attributable to the decline in
computer audio sales partially offset by an increase in SLIC sales in the
region. As a percentage of total net sales, sales outside North America were 54%
in fiscal 1997 as compared to 58% in fiscal 1996. For further detail regarding
geographic information, see Note 3 in the Notes to the Company's Consolidated
Financial Statements.
Gross margin was 50.0% of sales for fiscal 1997 compared to 50.3% for fiscal
1996. The slight reduction in gross margin for the year-over-year period was
principally due to a change in the mix of products sold and increased costs
associated with new manufacturing facilities.
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Research and development ("R&D") expenses increased approximately 10% in fiscal
1997 to $196 million or 15.8% of sales. This increase was mainly due to the
continued development of innovative SLIC products and processes and higher
spending in the development of new products and technologies targeted for the
communications, computer and automotive markets, including initiatives in
general-purpose digital signal processing, system-level ICs for modem and
wireless communications applications, RF signal processing, broadband wired
communications, micromachining technology and accelerometer products. The
Company believes that a continued commitment to research and development is
essential in order to maintain product leadership in its existing products and
to provide innovative new product offerings, and therefore expects to continue
to make significant investments in research and development in the future.
Selling, marketing, general and administrative ("SMG&A") expenses were $192
million, a decrease of $4 million from the $196 million recorded in the prior
year. This decline was principally the result of the Company's commitment to
constrain spending during the recent period of slower sales growth, along with
reduced bonus payments to employees. As a result, SMG&A expense as a percentage
of sales fell to 15.4% from 16.4% for the year earlier period.
In total, operating expenses as a percentage of sales remained essentially flat
at 31.2%, consistent with the Company's emphasis on maintaining tight control
over operating costs in order to gain better operating leverage on increases in
revenue.
The Company's operating income ratio decreased slightly to 18.8% of sales for
fiscal 1997, compared to 19.0% for fiscal 1996, as a result of all of the
factors cited above.
The effective income tax rate decreased to 24.4% in fiscal 1997 from 25.5% in
fiscal 1996 due to a shift in the mix of worldwide income and due to a larger
R&D credit realized in fiscal 1997 compared to fiscal 1996. Since it is not
assured that the Company will realize capital gains income, the Company has
included on its balance sheet a valuation allowance of $5.6 million at November
1, 1997. The valuation allowance balance was $7.4 million at November 2, 1996.
The net change in the valuation allowance for the fiscal year ended November 1,
1997 was due to the expiration of unused capital loss carryforwards for tax
purposes.
Net income increased 4% to $178 million in fiscal 1997 compared to $172 million
in fiscal 1996. Earnings per share in fiscal 1997 increased $.01 to $1.04 from
$1.03 in fiscal 1996.
The Company has not yet adopted Statement of Financial Accounting Standards No.
130, "Reporting Comprehensive Income" and Statement of Financial Accounting
Standards No. 131, "Disclosures about Segments of an Enterprise and Related
Information" which will require adoption in fiscal 1999. The Company is in the
process of determining the effect of the adoption of these statements on its
consolidated financial statements and related disclosures.
The impact of inflation on the Company's business during the past three years
has not been significant.
FISCAL 1996 COMPARED TO FISCAL 1995
Net sales of $1,194 million in fiscal 1996 increased 27% from fiscal 1995.
Fiscal year 1996 sales growth was attributable to significant increases in sales
volumes of both the Company's standard linear IC and system-level IC products as
worldwide demand for precision integrated circuit products increased in the
first half of fiscal 1996. During the third and fourth quarters a broadbased
inventory correction by end users, customers and distributors in response to the
shorter leadtimes available for many products from the Company and other
suppliers caused sales levels to be flat with the second quarter.
Sales of the Company's standard linear IC products contributed significantly to
Analog's growth. Standard linear IC sales, however, declined as a percentage of
total sales, accounting for 57% of total sales in fiscal 1996 compared to 64% in
fiscal 1995 due to the high sales growth for system-level IC products. The
growth in sales of standard linear ICs was driven by the greater use of standard
linear IC products in new high-volume applications in wireless and broadband
communications, computer and consumer markets including digital cellular
handsets and base stations, video applications and imaging applications. In
fiscal 1996, the distributor channel was a significant growth channel for the
Company's standard linear IC product line.
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Sales of system-level ICs experienced rapid growth as the Company achieved gains
in its general-purpose digital signal processing products and mixed-signal ICs
for application-specific system-on-a-chip solutions. The largest end user market
growth for the Company's system-level IC products was in wireless communications
applications, including digital mobile phones and base stations. As a percentage
of total sales, system-level IC products increased to 38% of total sales
compared to 28% in fiscal 1995.
Sales of the Company's assembled products continued to decline and as a
percentage of total sales decreased from 8% to 5% over this same period.
In fiscal 1996, sales to North American customers increased significantly over
fiscal 1995. Sales to customers outside North America, primarily Europe and
Southeast Asia also increased significantly. European growth resulted from the
Company's penetration of applications in the communications market, particularly
in handsets and base stations used in the GSM digital cellular telephone system.
The increase in sales to customers in Southeast Asia was due to increased demand
for products in the hard disk drive, communications and computer products
segments. Sales in Japan increased slightly. As a percentage of total sales,
North American and international sales accounted for 42% and 58%, respectively,
whereas the comparable percentages were 44% and 56% in fiscal 1995.
Gross margin was 50.3% of sales in fiscal 1996 compared to 50.7% of sales in
fiscal 1995. The reduction in gross margin was principally due to a lower
proportion of standard linear IC products in the mix of products sold, which
generally have higher gross margins than the Company's system-level IC products.
The reduction in gross margin in fiscal 1996 was also attributable to increased
costs associated with increased capacity combined with the leveling off of sales
in the latter half of the year.
R&D expenses for fiscal 1996 increased 32% from fiscal 1995 as the Company
continued to invest in new product development. As a percentage of sales, R&D
expenses were 14.9% in fiscal 1996 compared to 14.3% in fiscal 1995.
Selling, marketing, general and administrative expense growth in fiscal 1996 was
5.9%, increasing from $185 million in fiscal 1995 to $196 million in fiscal
1996. SMG&A expenses declined as a percentage of sales to 16.4% in fiscal 1996
compared to 19.6% in fiscal 1995, consistent with the Company's goal of
constraining SMG&A spending growth to a rate significantly below sales growth.
The increase in SMG&A expenses in absolute dollars was primarily related to
higher employee bonus payments associated with improved revenue and
profitability levels, and greater product advertising and related promotional
costs and commissions in support of the Company's product lines and customer
base.
Operating income grew 44% to 19% of sales compared to 17% of sales in fiscal
1995. This performance gain reflected the combination of accelerated demand for
the Company's products and continuing commitment to growing expenses more slowly
than sales.
Nonoperating income of $1.7 million in fiscal 1995 improved to $3.6 million in
fiscal 1996. Interest expense in fiscal 1996 increased from fiscal 1995 as a
result of the issuance of $230,000,000 of 3 1/2% Convertible Subordinated Notes
in December 1995 but this increase was more than offset by increased investment
income as a result of the positive spread between the 3 1/2% coupon rate and the
investment rates achieved on available cash balances through fiscal 1996.
The effective income tax rate increased to 25.5% in fiscal 1996 from 25.2% in
fiscal 1995 due to earnings growth in higher tax rate jurisdictions including
the U.S. The Company maintained a valuation allowance for deferred tax assets of
$7.4 million at November 2, 1996 based on management's assessment that
realization of such deferred tax assets was not assured for book and tax capital
losses. The valuation allowance balance was $10 million at October 28, 1995. The
net change in the valuation allowance for the fiscal year ended November 2, 1996
was a decrease of $2.6 million as a result of the utilization of book basis
foreign tax credits and the use of capital tax loss carryforwards.
The growth in sales, improved operating performance and lower nonoperating
expenses yielded a 44.1% rise in net income to $171.9 million or 14.4% of sales
in fiscal 1996 compared to $119.3 million or 12.7% of sales in fiscal 1995.
Earnings per share in fiscal 1996 grew 37% to $1.03 from $0.75 in fiscal 1995.
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LIQUIDITY AND CAPITAL RESOURCES
At November 1, 1997, the Company had $341 million of cash, cash equivalents and
short-term investments compared to $300 million at November 2, 1996. The
Company's operating activities generated net cash of $297 million, or 24% of
sales, and $144 million, or 12% of sales, in fiscal 1997 and fiscal 1996,
respectively. Investing activities used $237 million in fiscal 1997 and $305
million in fiscal 1996 while financing activities generated $15 million in
fiscal 1997 and $301 million in fiscal 1996. The Company's primary source of
funds in fiscal year 1997 was net cash generated by operations. The issuance of
long-term convertible debt which generated $224 million was the primary source
of funding in fiscal 1996.
Accounts receivable of $256 million at the end of fiscal 1997 increased $22
million or 9% from $234 million at the end of fiscal 1996. This increase
resulted principally from the $28 million increase in sales from the fourth
quarter of fiscal 1996 to the fourth quarter of fiscal 1997. The number of days
sales outstanding remained flat and as a percentage of annualized fourth quarter
sales accounts receivable was 19.2% at the end of both of these periods.
Accounts receivable reserves and allowances increased from $15 million at the
end of fiscal 1996 to $40 million at the end of fiscal 1997. This increase was
caused by additional reserves deemed necessary particularly in South East Asia
and reserves required because of increased activity in the N.A. distributor
channel.
Inventories rose $7 million or 3% over the prior year to $226 million at the end
of fiscal 1997. Inventories as a percentage of annualized fourth quarter sales
decreased to 17% for the year ended November 1, 1997 from 18% for the year ended
November 2, 1996.
Accounts payable and accrued liabilities increased $6 million or 4% compared to
the balance at the end of fiscal 1996 due principally to increased expense
activity related to higher revenue and increased capital expenditures in the
fourth quarter of fiscal 1997 when compared to the year earlier period.
The Company's principal investment activities during fiscal 1997 were in support
of its manufacturing facility improvement programs and included capital
expenditures of $179 million and an investment of $42 million which was a second
installment on an 18% share in a wafer fabrication facility on a joint venture
basis with Taiwan Semiconductor Manufacturing Company ("TSMC") and a further
deposit of $12 million paid to Chartered Semiconductor Manufacturing Pte., Ltd.
("CSM"), a wafer fabrication company in Singapore.
Capital expenditures in fiscal 1997 of $179 million, were $55 million lower than
in the prior year when major capacity expansion programs were underway. The
expenditures in fiscal 1997 included the ongoing expansion and upgrade of the
Company's existing wafer fabrication facilities in Wilmington, Massachusetts and
Limerick, Ireland. During fiscal 1997 an additional wafer fabrication facility
in Cambridge, Massachusetts was made available for the production of the
accelerometer and other micromachined products. In addition, the Company
continued the development of the six-inch wafer fabrication module located in
Sunnyvale, California. This facility is still in the process of being upgraded
and modernized and a CBCMOS process is being developed and the facility is
expected to ramp during fiscal 1998. Also, during fiscal 1997 production began
in the Company's new assembly and test site in the Philippines. These expansion
programs caused depreciation expense to increase to $101 million in fiscal 1997
from $82 million in fiscal 1996.
During fiscal 1996 the Company entered into a joint venture agreement with TSMC
and other investors for the construction and operation of a semiconductor
fabrication facility in Camas, Washington. For a total commitment of $140
million, the Company acquired an 18% equity ownership in the joint venture,
known as WaferTech. The first installment of $42 million was paid in fiscal
1996. The second installment of $42 million was paid in December 1996 and the
remaining installment of $56 million was paid in fiscal 1998, on November 3,
1997.
In March 1997 and June 1997, in accordance with a previous agreement, the
Company made two payments of $6 million each to CSM for a total deposit of $20
million. In fiscal 1996 the Company provided $8 million to CSM under this
arrangement. This deposit is classified in the balance sheet line item, "Other
assets." Under the terms of this agreement, the deposit will guarantee access to
certain quantities of sub-micron wafers through fiscal 2000. If the Company does
not purchase the minimum quantities under the agreement, the deposit will be
forfeited for the value of the wafer shortfall up to the total amount of $20
million. At the end of the agreement term, the Company's deposit will be
returned, net of any forfeitures.
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The Company currently plans to make capital expenditures of approximately $300
million in fiscal 1998, primarily in connection with the continued improvement
of its manufacturing facilities. Depreciation expense is expected to increase to
approximately $144 million in fiscal 1998 as a result of these additions.
In fiscal 1997 financing activities generated cash of $15 million. The issuance
of common stock under stock purchase and stock option plans generated cash of
$19 million, and proceeds from equipment financing generated cash of $7 million.
These increases were offset by $11 million of cash used for the repayment of
capital lease obligations and various other items resulting in net cash
generated of $3 million.
At November 1, 1997, the Company's principal sources of liquidity included $341
million of cash, cash equivalents and short-term investments. Short-term
investments at the end of fiscal 1997 consisted of commercial paper,
certificates of deposit and Euro time deposits with maturities greater than
three months and less than six months at the time of acquisition. The Company
also has various lines of credit both in the U.S. and overseas, including a $60
million credit facility in the U.S. which expires in 2000, all of which were
substantially unused at the end of fiscal 1997. At the end of fiscal 1997, the
Company's debt-to-equity ratio was 33%.
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's fixed rate debt obligations and related interest rate swap and cap
agreements are subject to interest rate risk. For example, 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. An increase in interest rates would not
significantly increase interest expense due to the fixed nature of the Company's
debt obligations. 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 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 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 foreign 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
November 1, 1997. Relative to foreign currency exposures existing at November 1,
1997, 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 to 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.
LITIGATION
For information concerning certain pending litigation involving the Company, see
Note 8 in the Notes to the Company's Consolidated Financial Statements.
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FACTORS WHICH 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 is exposed to the risk of
obsolescence of its inventory depending on the mix of future business. 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 such as the
communications, computer and automotive segments of the electronics market,
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 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 Company has increased substantially its manufacturing capacity through both
expansion of its production facilities and increased access to third-party
foundries; there can be no assurance that the Company 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,
and such reliance involves several risks, including reduced control over
delivery schedules, manufacturing yields and costs. In addition, the Company's
capacity additions will result in a significant increase in operating expenses,
and if revenue levels do not increase to offset these additional expense levels,
the Company's future operating results could be adversely affected, including
the potential adverse impact on operating results for "take or pay" covenants in
certain of its supply agreements. The Company's business is subject to rapid
technological changes and there can be no assurance that products stocked in
inventory will not be rendered obsolete before they are utilized by the Company.
The Company also believes that other semiconductor manufacturers are expanding
or planning to expand their production capacity over the next 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 fiscal 1997, 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 supply agreements
that include "take or pay" covenants with suppliers located in Southeast Asia
("SEA") and as part of these arrangements, the Company has $26 million on
deposit with two of these suppliers. The Company also has a $21 million
investment in one of these suppliers. In addition, the Company's major partner
in its joint venture, WaferTech, is TSMC which is located in the SEA region. The
Company is therefore subject to the economic and political risks inherent in
international operations, including the risks associated with the ongoing
uncertainties in the economies in SEA. 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.
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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 8 in 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 already has installed Year 2000 compliant software in many of its
major systems. A task force is engaged in the ongoing effort to complete this
activity for the balance of the Company's systems. The cost of these efforts is
not expected to be material. The Company presently believes that the Year 2000
issue will not pose significant operational problems. However, Year 2000 issues
could have a significant impact on the Company's operations and its financial
results if modifications cannot be completed on a timely basis; unforeseen needs
or problems arise, or if the systems operated by our customers, vendors or
subcontractors are not Year 2000 compliant.
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.
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