Linear Tech Draws Forward

Linear Technology (LLTC - Analyst Report) is a leading OEM of analog and mixed signal semiconductors. March quarter revenue was in-line with consensus expectations, although the EPS exceeded. Forward guidance is for a 1% revenue increase in the next quarter.

Flexible operating structure

Management showed great efficiency in steering the company through the last downturn. This was achieved as a result of the company's flexible operating structure. Even with revenue declining high double-digits, gross margins remained above the 70% range and operating margins were just short of 40%. The company was cash flow positive all throughout.

Past performance has increased our confidence in management execution. We note that despite two quarters of back-to-back double-digit revenue declines, the gross margin dropped only slightly to around 75%, and operating margins dropped to the 45% range. Therefore, we expect continued adjustments to the operating structure that would enable it to cope with current pressures.

The cash position is a positive, given economic uncertainties

Linear has always been a cash-rich company, and management has been returning cash to investors in the form of share repurchases and dividend yields. In December, the Board recommended an increase in the dividend from $0.21 per share to $0.22 per share. The company has increased the rate of dividend every year since 1992. Linear continues to generate strong cash flow, ending the quarter with $4.15 of cash per share, and we believe there is no risk of its being unable to service its debt.

Longer-term growth prospects continue to be strong

The increasing rate of miniaturization and the increasing usage of electronics in the industrial market are expected to drive secular growth for Linear. Management has stated that a significant percentage of its industrial customers were mid-size firms that did not hire a lot of analog expertise. The non-availability of talent makes them more dependent on companies like Linear that would take the extra time to develop products for their specific needs. This makes for solid customer relationships, steady revenue over long periods of time, and also helps to get through periods of weak demand.

Although the current slowdown is disheartening, the auto market will rebound. Trends indicate that the electronic content per vehicle will continue to increase, especially in the areas of infotainment and navigation. Some of the upcoming applications for Linear include collision avoidance, drive-by-wire and heads-up night vision.

The advent of hybrid vehicles is expected to drive new opportunities, although the cost and efficiency of present-day products have to improve in order to make them commercially viable. The company is strongly positioned at leading car manufacturers in Europe and Japan, and there does not appear to be any evidence that it has lost ground at key customers. Around 41% of orders came from these two end markets that are characterized by slow and steady growth, as well as smaller quarterly fluctuations.

The communications market (around 34% of the total business) is a split between handsets and infrastructure. Handset markets are more dependent on consumer spending. They also have shorter life cycles and are, therefore, not indicative of long-term growth prospects. Handsets generated around 6% of revenue in the last quarter, and management does not intend the revenue share to exceed the 9-10% range in the long term.

The infrastructure segment of communications makes up the balance, and is more indicative of the long-term position. The company's PoE and HotSwap circuits are a play in the most happening sections of this market, and are therefore expected to generate above-average growth rates. In a market where almost all analog companies are experiencing revenue declines, Linear's communications business grew over 34%. Although the recession is expected to dampen growth in 2009, we expect a strong comeback in 2010.

Sejuti Banerjea contributed to this post.