Linear Technology Corp

February 15, 2017

Linear Technology Corp. (LLTC-NASDAQ) $64.65

Note: This report contains substantially new material. Subsequent reports will have new or revised material highlighted.

Reason for Report: 2Q17 Earnings Update

Prev. Ed.: Nov 4, 2016: 1Q17 Earnings Update

Brokers’ Recommendations: Neutral: 87.5% (14 firms); Negative: 12.5% (2 firms); Positive: 0.0% Prev. Ed: 13, 2, 0

Brokers’ Target Price: $59.88 (↑$0.77 from last edition; 8 firms) Brokers’ Avg. Expected Return: (7.4%)

Note: A flash update was done on Jan 18, 2016 (2Q17 Earnings Update)

Portfolio Manager Executive Summary

California-based Linear Technology Corporation (LLTC), together with its subsidiaries, designs, manufactures and markets various linear integrated circuits. The company markets its products worldwide through direct sales staff, electronics distributors and a network of independent sales representatives.

Key factors for determining an investment strategy for Linear Technology are as follows:

 Linear Technology’s two largest end markets are communications and industrial.  Linear Technology’s products have a wide range of applications and consequently, most of its client manufacturers offer a great variety of device types to a broad range of customers. This gives Linear Technology a vantage point in the highly competitive and fragmented circuit markets.  Key competitors of the company include: Analog Devices Inc. (ADI), Intersil Corp. (ISIL), Maxim Integrated Products, Inc. (MXIM), National Semiconductor Corporation (NSM) and Texas Instruments (TXN).

Competition: Linear Technology operates in the analog sector where competition is increasing. Greater competition means slower revenue growth rates and more margin pressure. Analog market leader Texas Instruments is increasing its focus on high-performance analog by diverting most of its investments toward it as well as setting a goal of growing its analog business at a compound annual growth rate (CAGR) of 20% over the next five years. National, Maxim, Analog Devices and Intersil remain squarely focused on high-performance analog. Small, fabless analog manufacturing companies such as Monolithic Power Systems and O2Micro, are also gaining momentum. Finally, certain Taiwanese vendors like Richtek could also begin to affect Linear Technology more as their solutions move further up the design value curve.

© Copyright 2016, Zacks Investment Research. All Rights Reserved. Of the 16 analysts in the Zacks Digest Group covering the stock, 87.5% were neutral and the remaining 12.5% had a negative stance. Target prices provided by the analysts range from a low of $44.00 to a high of $64.00, with the average being $59.88.

Cautious – (Neutral or equivalent rating) – 14 analysts or 87.5% – The analysts remain cautious owing to the fact that the analog semiconductor industry is facing intense competition. Moreover, the semiconductor cycle prefers companies with high leverage, whereas Linear is at a disadvantage due to its high inventory, which makes it an under leveraged company. Adding to the woes is the negative impact of macroeconomic adversities like low oil prices, a stronger U.S. dollar and slowing GDP growth in the U.S. & China.

Bearish (Negative or equivalent outlook) – 2 analysts or 12.5% – These analysts remain cautious about the global outlook. They believe that if macro conditions continue to be weak, there will be channel retrenchment.

Feb 15, 2017

Overview

Key investment considerations as identified by the analysts are as follows:

Key Positive Arguments Key Negative Arguments  Leader in innovation: Linear Technology remains a  Risk from equity markets: The analysts value the high-performance analog market leader in terms of stock at a significant premium to other chip stocks and innovation. Its strong technical approach to business believe Linear Technology to be more susceptible to allows it to have a leading edge in emerging markets, operational downturns in a business with short lead such as, Power over Ethernet (PoE) and large screen times. digital TVs.  Risks to market share: Share loss to HPA and  Strong segment performance: Linear Technology’s Standard Analog appears to be taking a toll on Linear industrial and communications businesses are Technology’s revenue growth. expected to continue to report solid growth.  Excessive dependence on the ‘turns’ business:  Strong financial position: The company's financial Linear Technology is seen as dependent upon the model generates strong cash flow, which can be used ‘turns’ business. for stock repurchases and other shareholder-friendly  Currency risk: A major portion of Linear Technology’s initiatives. revenues comes from international markets, which are  Low cost strategy: Linear Technology’s proprietary accompanied by risks of currency fluctuations, tariffs, products and low cost manufacturing continues to trade barriers and government regulations. drive profitability.

Linear Technology Corporation is engaged in the designing, manufacturing and marketing of linear integrated circuits. Products include amplifiers, comparators, voltage references, monolithic filters, linear regulators, AC-DC converters, battery chargers, data converters, communications interface circuits, radio frequency signal conditioning circuits and other analog functions. Its products are used in various applications, including telecommunications, cellular telephones, networking products, such as optical switches, notebook and desktop computers, computer peripherals, video/multimedia, industrial instrumentation, security monitoring devices, consumer products, such as digital cameras and MP3 players, complex medical devices, automotive electronics, factory automation, process control and military and space systems. Linear Technology markets its products through a direct sales force and electronics distributors, as well as through a network of independent sales representatives to customers in diverse industries worldwide. More information on the company is available on its website www.linear.com.

Zacks Investment Research Page 2 www.zackspro.com In July 2016, Linear Technology announced that Analog Devices has agreed to acquire its business in a cash and stock deal worth $30 billion. Per the agreement, Linear shareholders will receive $46.00 in cash for each share and an additional 0.2321 of Analog Devices common stock for each Linear share.

In the fiscal first quarter of 2017, Linear Technology’s stockholders approved the merger agreement. The deal is expected to be completed by the end of the first half of calendar year 2017.

Note: The company’s fiscal year ends on Jun 30; fiscal references differ from the calendar year.

Feb 15, 2017

Long-Term Growth

Linear Technology, being one of the best-positioned companies in the high-performance analog sector, remains confident of its strategy and the ability to maintain steady growth.

It is in the business of designing and marketing analog integrated circuits for major companies. The portfolio of products provide a synergy between analog and digital electronics medium in communications, consumer, medical, military, aerospace and others. It manufactures power management, data conversion and wireless sensor network products among others.

The high-performance analog sector is the most attractive in the chip industry, with favorable characteristics including a large market opportunity, diversified customer base, end-market exposure, high margins, stable chip pricing, low capital intensity, long product lifecycles, stable demand trends, a diffused competitive environment, moderate to high barriers to entry and opportunities for product differentiation. Many companies find this sector appealing but limited analog design expertise indicates that only the top companies can supply truly high-performance solutions.

The company believes that its future sales growth would be the strongest in the automotive power management market, driven by broad applications, such as illumination, safety, engineering control and eventually hybrids. It also indicates that the consumer market remains competitive and would most likely be its slowest growth area. Standard products are projected to grow strongly, especially on the industrial side, which is the strongest sales segment.

The analysts find management adept at navigating the industry's cyclical ups and downs. Further, the company’s chip design engineers are among the world's best at integrating field effect transistors and designing state-of-the-art high-voltage and low-power solutions. The analysts also unanimously believe that Linear Technology and other such companies stand to benefit from global megatrends toward ‘green’ energy efficiency, device portability and longer battery life as well as from increasing focus on energy efficiency resulting from increasing oil prices. These trends should drive power management chip growth above the overall semiconductor growth rate. Feb 15, 2017

Zacks Investment Research Page 3 www.zackspro.com Target Price/Valuation

Provided below is a summary of valuations and ratings as compiled by Zacks Research Digest:

Rating Distribution Positive 0.0% Neutral 87.5%↑ Negative 12.5%↓ Avg. Target Price $59.88↑ Digest High $64.00 Digest Low $44.00 No. of Analysts with Target Price/Total 8/16

According to the analysts, risks to the price target include: (1) lower-than-expected revenues in the industrial and automotive markets, (2) decline in demand for analog goods and systems, (3) technology and new product development postponements 4) macroeconomic uncertainties (5). Intensifying competition (6) inventory stock at distribution and end customers (7) reduction in industrial and automotive spending or analog content (8) Slowdown in global auto growth (9) weaker comm infrastructure markets (10) inventory overhangs in the channel and (11) Supply chain disruptions

Recent Events

On Jan 17, 2016, Linear Technology announced fiscal 2Q17 earnings results. Highlights are as follows:

 Total revenue was $375.8 million, up 8.3% year over year and 0.5% sequentially.

 GAAP EPS was $0.50, compared with $0.47 in the previous quarter and $0.50 a year ago.

 Cash, cash equivalents and marketable securities were $1.61 billion compared with $1.52 billion in the prior quarter.

Revenues

Linear reported revenues of $375.8 million in the fiscal second quarter, up 8.3% year over year and 0.5% sequentially. The figures were slightly above the Zacks Consensus Estimate of $374.0 million. The increase in revenue was driven by strong growth in the company’s Communication and Industrial markets.

Outlook

For the fiscal third quarter of 2017, Linear did not provide any guidance as its acquisition by Analog Devices is expected to be completed soon.

The acquisition is expected to be accretive to non-GAAP earnings and cash flow going forward. The companies expect to realize $150 million in annual cost synergies in the first 18 months following the closure.

Zacks Investment Research Page 4 www.zackspro.com Also, management expects the deal to expand Analog Devices’ total addressable market to $14 billion from $8 billion, allowing it to tap phenomenal demand in some of the most attractive markets, namely industrial, automotive and communications infrastructure markets.

Majority of the analysts remain positive about the acquisition. They believe that the merger of these two companies will create an analog industry leader across a huge range of products and across key markets. The analysts believe that these two firms also have complementary product portfolios. Therefore, they anticipate many cross-selling opportunities in the future, which will help in driving growth in an increasingly challenging market environment.

Margins

Pro forma gross margin was 76.3%, up 35 basis points (bps) sequentially and 63 bps year over year, driven by a richer product mix.

Operating expenses of $113.8 million increased 0.7% sequentially and 0.4% year over year. As a percentage of sales, research & development remained the same, while selling, general & administrative expenses decreased from the year-ago quarter. As a result, operating margin of 45.5% was up 30 bps sequentially and 246 bps year over year.

GAAP net income was $124.0 million or 50 cents per share compared with $115.1 million or 47 cents in the previous quarter and $121.5 million or 50 cents a year ago. Excluding merger-related charges, pro forma earnings were $132.2 million versus $130.2 million in the previous quarter and $121.5 million in the year-ago quarter.

Outlook

Management did not provide any gross margin guidance for the upcoming quarter.

Earnings per Share

According to the company’s press release, Linear’s 2Q17 earnings were $0.50 versus $0.47 in the previous quarter.

Outlook

Management did not provide any EPS guidance for the upcoming quarter.

Zacks Investment Research Page 5 www.zackspro.com