Linear Technology (LLTC) reported third-quarter 2013 earnings that were in line with the Zacks Consensus Estimate. The weaker-than-expected revenue guidance indicates limited growth prospects in several important markets, such as communications infrastructure and computing.
Revenue
Linear reported revenue of $314.5 million, up 3.0% sequentially and up 0.7% year over year, roughly in line with management’s guidance range of a 1-4% sequential increase. Management stated that order rates improved early on in the quarter and there was a steady flow through the quarter, accounting for the improved revenues and orders in the quarter.
Japan and the Asia/Pacific proved to be the weaker geographies for Linear. Japan was impacted by deflation from a government-instituted stimulus, China was impacted by Chinese New Year-related softness and the Asia/Pacific overall saw seasonally softer consumer sales. Europe on the other hand was particularly strong due to seasonal strength in the industrial and automotive end markets.
The revenue distribution by geography was as follows: the Asia/Pacific region (ex-Japan) 37%, down 2.3% sequentially, the U.S. with 29% (up 3.0%), Europe 20% (up 21.2%) and Japan 14% (down 3.8%).
Orders
The mix of orders was favorable for Linear. The company saw strength in the industrial and automotive areas, which are management focal points, while consumer and computing softened slightly
The industrial market remains the largest contributor with a 43% share. Orders were up high single-digits on a sequential basis. The industrial business remains broad-based across geographies and end markets and Linear is capitalizing on the growing demand for energy efficiency in this market.
Automotive, the other focus area accounted for 18% of quarterly orders. The strong double-digit increase from the Dec quarter was mostly because of Japan and Europe, which were supported by modest growth in the U.S. and a flattish Asia/Pacific. Similar to other semiconductor providers, such as Analog Devices (ADI), Fairchild Semiconductor (FCS) and Intersil Corp (ISIL), Linear’s performance in this end market stems from the growing electronic content in vehicles.
However, communications remained the second largest market with 20% of total orders. Linear stated that the low-single-digit increase was attributable to slight increases at most large telecom infrastructure and networking customers. Cell phones remained well below 1% of total bookings, so did not affect segment performance much. The number of smartphones and tablets in the market today (and those ready to hit the market this year) indicate wireless infrastructure spending will not go away.
Over the last few years, Linear has reduced its exposure to the consumer segment and contained exposure to the computing segment because of the typically low margins and significant seasonal fluctuations. Over the next few years, mobile electronic computing goods with a consumer flavor are likely to grow faster than any other segment. Therefore, Linear will lose out on this opportunity.
Aerospace/defense accounted for 6% of total orders, impacted by U.S. government budget constraints. This resulted in declines from both the previous and year-ago quarters.
Orders showed good linearity and were up in both the U.S. and internationally (although Japan declined). As a result, both orders and backlog increased in the last quarter and the book-to-bill was also positive.
Margins
The gross margin for the quarter was 74.8%, up 41 bps sequentially and down 34 bps from the comparable quarter of the prior year. The ASP grew dropped a penny to $1.84 in the last quarter, but was higher than the $1.81 in the year-ago quarter. Unit growth was positive on a sequential basis and slightly negative compared to the year-ago quarter.
While Linear’s gross margins remain very attractive, the company is now saddled with some excess capacity and employees that management does not want to cut. Therefore, it is expected that margins will get back up as and when sales and therefore utilization rates pick up.
Operating expenses of $97.0 million were up 2.8% from the previous quarter’s $94.4 million. The operating margin of 44.0% expanded 50 bps sequentially because the slight decline in R&D offset the slight increase in SG&A expenses (as a percentage of sales).
The net income for the quarter was $116.3 million or 37.0% of sales, compared to $94.1 million or 30.8% in the previous quarter and $103.5 million or 33.1% of sales in the year-ago quarter. Earnings including a couple of cents of debt discount amortization were 46 cents, up from 38 cents in the previous quarter and 42 cents in the Dec quarter of 2011.
Balance Sheet
Inventories increased 1.6% sequentially, with inventory turns dropping staying relatively flat at 3.7X. Days sales outstanding (DSOs) dropped from 43 to 41. The company ended with cash and short-term investments of $1.45 billion, up $155.1 million during the quarter.
Guidance
Management provided limited guidance for the fourth quarter of fiscal 2013. Accordingly, revenue is expected to increase 1-4%, much better than normal seasonality. The operating income is expected to grow in absolute dollars but remain consistent as a percentage of sales. The effective tax rate will be 25%. Capex is expected to $15-20 million for fiscal 2013.
In Summary
Linear’s third-quarter earnings were helped by the positive mix, as lower-margin segments softened while higher-margin segments grew strongly. The company’s business is well-diversified among core markets, such as industrial, automotive and communications infrastructure. Its computing business has been hit by weakness in the PC and notebook areas.
Linear also includes tablets, server and storage revenue here, so the consistent decline in segment revenue indicates that growth in other areas is not being offset by weakness in the core computing segment. While this means that the company is not benefiting from the strong growth opportunity, it also means that it is probably leaving lower-margin opportunities on the table (a long-time management strategy).
Linear has always maintained strong gross margins and when conditions worsened following the latest recession, it took all the necessary steps (shut-downs, slower hiring, reduction in profit sharing, etc.) to maintain margins in the weak demand environment. While these actions have optimized costs, Linear continues to carry some extra capacity that remains under-utilized.
Another positive is the extreme caution that distributors have shown in recent times, which indicates that distributor inventories remain very lean. Therefore, Linear should benefit from its operating leverage and lean channel inventories when demand picks up.
