Shares of analog and digital signal processing (DSP) chip company Analog Devices (NYSE: ADI) leapt forward this morning as the company turned in a sparkling set of fiscal Q3 financial results. Fueled in part by strong demand for chips aimed at the broadband access and wireless infrastructure end-markets, EPS grew 34% sequentially to $0.43 (excluding an investment-related gain), stomping the First Call mean estimate of $0.37.
Meanwhile, revenues galloped up 85% from a year ago to $701 million. With some aggressive near-term growth guidance from the company thrown in for good measure, several sell-side analysts bumped up their earnings estimates today for Q4 and beyond, propelling the company to within 10% of its all-time high set in June.
Cycle peak? Yeah, right
Lingering jitters about the chip industry "peaking" this summer and starting down along the trailing edge of the semiconductor cycle sine wave appear to have dissipated some in the past week as several chip stocks have bottomed and started to ramp higher. ADI's earnings report adds support to the thesis that the current business upswing still has plenty of legs under it, which will produce continued topline and cash flow growth for the industry on the whole for the rest of this year and well into next year as well.
For its part, ADI's stock has jumped 55% in the past eight trading days alone as investors have seemingly undergone a "should have had a V8" moment of revelation and realized that this company's growth prospects have never looked better.
While it's not out of the ordinary for share prices in this sector to get ahead of themselves from time to time, there are some very solid business fundamentals supporting ADI's current market valuation. To the pleasure of many investors and analysts alike, the semiconductor business is very income statement-oriented, with the main value driver for the various segments almost universally boiling down to topline growth. However, margins also play a crucial role in the value-creation process, and ADI's results over the past year illustrate this principle pretty well.
Margin expansion kicking in
While the company's 85% year-over-year sales growth is impressive, net income more than tripled over the same span. The main cause for that growth discrepancy has been the tremendous leverage that ADI has been able to realize with regards to its operating expenses, especially in the area of its selling, marketing, general, and administrative (SMG&A) expenses. Despite the revenue surge from a year ago, absolute SMG&A expenses rose at less than half the sales growth rate and actually dropped on a percentage basis to 11% of sales from about 14% of sales.
As a result, ADI's operating margin trend over the past year has been stellar:
Quarter Operating Margin
Q399 17.6%
Q499 20.9%
Q100 24%
Q200 27.9%
Q300 31.3%
For the record, the company is shooting for an operating margin of greater than 35% in the next few quarters, with half of the gain coming from gross margin upside and the other half deriving from further operating expense leverage.
The continuation of the ADI margin expansion story sets the stage for continued strong business performance down the road, particularly as the semiconductor industry's underlying growth driver continues to shift away from plain-vanilla data processing in favor of sexier "signal" processing for video and voice applications. Given that backdrop, worries from analysts and commentators that the semiconductor cycle will soon trump the industry's fundamentals appear to be increasingly suspect.
Your Turn:
For more views on ADI's results, head on over to the company's discussion board.
Related Links:
Texas Instruments' Solid State, Fool Plate Special, 7/25/00
Analog Devices investor relations homepage
