Analog Devices Inc
NASDAQ:ADI
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Analog Devices Inc
Earnings Call Analysis
Q3-2024 Analysis
Analog Devices Inc
Analog Devices reported third-quarter revenue of $2.31 billion, which exceeded their expectations and was a sequential increase of 7%, although down 25% year-over-year. The company saw particular strength in its industrial and communications segments but continued weaknesses in automotive due to production cuts and inventory management among customers【4:0†source】.
Industrial, the largest segment contributing to 46% of the total revenue, improved by 6% sequentially but declined 37% year-over-year. Automotive, accounting for 29% of revenue, remained flat sequentially and decreased 8% year-over-year. The communications sector showed a 10% sequential increase but was down 26% year-over-year【4:0†source】.
The company’s gross margin for the quarter stood at an impressive 67.9%, up by 120 basis points sequentially. Operating expenses rose slightly to $619 million, while operating margins hit 41.2%. ADI ended the quarter with $2.5 billion in cash and short-term investments; inventory decreased by $51 million【4:0†source】【4:1†source】.
For the fourth quarter, Analog Devices expects revenue between $2.3 billion and $2.5 billion, representing a sequential increase at the midpoint. Operating margin is forecasted at 41%, and EPS is anticipated to be around $1.63. Despite economic uncertainties, the company is optimistic about long-term growth driven by strong design wins and secular trends in digitalization and electrification【4:0†source】【4:1†source】【4:10†source】.
Analog Devices continues to make strategic investments in high-performance analog solutions, targeting sectors like factory automation, energy efficiency, and secure connectivity. They highlighted the potential of new technologies in AI, automotive electronification, and advanced robotics, underscoring their robust R&D pipeline and market appetite for their products【4:0†source】【4:1†source】【4:2†source】【4:6†source】.
The company acknowledged the cautious optimism required due to ongoing economic and geopolitical uncertainties. Despite the cyclical bottoming out observed in the second quarter, a balanced approach between fiscal discipline and strategic investments is necessary to navigate the fluctuating demand environment【4:0†source】【4:1†source】【4:6†source】.
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Good morning, and welcome to the Analog Devices Third Quarter Fiscal Year 2024 Earnings Conference Call, which is being audio webcast via telephone and over the web. I'd now like to introduce your host for today's call, Mr. Michael Lucarelli, Vice President of Investor Relations and FP&A. Sir, the floor is yours.
Thank you, Kevin, and good morning, everybody. Thanks for joining our third quarter fiscal 2024 conference call. With me on the call today are ADI's CEO and Chair, Vincent Roche; and ADI's CFO, Rich Puccio. For anyone who missed the release, you find it and relating financial schedules at investor.analog.com.
Onto the disclosures. The information we're about to discuss includes forward-looking statements, which are subject certain risks and uncertainties, as further described in our earnings release and our periodic reports and other materials filed with the SEC. Actual results could differ materially from the forward-looking information as these statements reflect our expectations only as the date of this call. We undertake no obligation to update these statements except as required by law.
References to gross margin, operating, nonoperating expenses, operating margin, tax rate, EPS and free cash flow in our comments today will be on a non-GAAP basis. These exclude special items. When comparing our results to our historical performance, special items are also excluded from prior periods. Reconciliations of these non-GAAP measures to the most directly comparable GAAP measures and additional information about our non-GAAP measures are included in today's earnings release.
And with that, I'll turn it over to ADI's CEO and Chair, Vincent Roche.
Thanks very much, Mike, and a very good morning to you all. With stronger demand for our high-performance product portfolio and skillful execution resulted in third quarter revenue of more than $2.3 billion, operating margin north of 41% and EPS of $1.58, all above the midpoint of our outlook. These favorable results, combined with improved customer inventory levels and order momentum across most of our markets, increased my confidence that our second quarter marked the cyclical bottom for ADI.
By optimism remains guarded however, this challenging economic and geopolitical conditions are limiting a sharp recovery. We continue to balance near-term fiscal discipline with strategic investments in our long-term growth initiatives, positioning ADI to capitalize on the extraordinary opportunities that we see ahead.
Now I'd like to draw attention to our industrial end market, which is our largest, most diverse and most profitable business, generating durable revenue streams that last close to 2 decades on average. As our business begins to recover from the pandemics volatility, we're excited about the tremendous long-term growth opportunities of the industrial market. We offer our customers an unparalleled suite of high-performance solutions stretching from antenna to bits, sensor to cloud and nanowatts to kilowatts.
Our extensive technology portfolio, combined with our deep domain expertise and engineering muscle has enabled us to secure leading positions across the most attractive industrial sectors. Now with growing digital software and algorithmic capabilities, augmenting our cutting-edge and our portfolio, ADI is strongly positioned to solve our customers' most difficult challenges in factory and process automation energy efficiency, secure connectivity and many, many more.
To illustrate the power and potential of our industrial franchise, let me share with you a few examples of how our recent innovations are unlocking new revenue streams and positioning us for strong growth in the years ahead. For example, our instrumentation and test business which include scientific instruments, electronic test and measurement and automated test equipment is essential to the important scientific and technological advancements of the digital era.
Within automated test equipment, for example, our next-generation solutions increased channel density and throughput while reducing energy consumption by up to 30% per system. These are crucial parameters for testing complex, high-performance compute GPUs and high-bandwidth memory systems for AI. As the AI infrastructure [indiscernible] remains a priority for global hyperscalers, we expect growth to continue into 2025 and indeed well beyond.
Turning now to aerospace and defense, which has been our most resilient business during this downturn. ADI's domain expertise in high-performance portfolio across RF and Microwave, high speed and precision converters, power and MEMS, uniquely positions us to deliver complete edge solutions, offering our customers scale, velocity and lower total cost of ownership.
As an example, we're building upon our programmable Apollo Signal Gen platform today to create full software-defined [indiscernible] communications and sensor systems which has the potential to increase our SAM by 5x in commercial, defense and aerospace communication systems. Indeed, we see a path to double-digit revenue growth in this sector in 2025, fueled by several high-value design wins that are going to production.
In automation, though we've seen a slower recovery to date, we remain strongly confident in its future growth potential as the benefits of increased productivity are ever more clear. Customers are prioritizing enhanced digitalization and IT/OT integration on the factory floors. Their deployments of in-line instrumentation and advanced robotics are driving the need for more sensing, edge processing, secure connectivity and car management.
Within robotics, we're seeing a progression from fixed arm machines to autonomous and mobile robots to eventually humanoid robots. This evolution creates additional opportunities for our precision signal chain franchise, and sensing connectivity and motion control subsystems with fully isolated and efficient power solutions can drive content from hundreds of dollars in robots today to thousands in autonomous and humanoid robots.
What is additionally exciting about these advances, is their broad applicability beyond factories such as surgical robots and imaging systems in health care. ADI's products have the potential to dramatically improve a surgeon's effectiveness through a more precise surgical experience with lower latency connectivity. Additionally, patients gained the potential benefits of shorter hospital stays and fewer complications. The evolution in robotics is expected to unlock billions of dollars of potential opportunity for our high-performance Analog, mixed signal, power connectivity and sensing solutions. We see the potential for a doubling of our robotics revenue in the years ahead.
Turning now to energy transmission and distribution. Our customers are modernizing and digitalizing the electrical grid to respond to exponentially accelerating energy demand, driven in part by the proliferation of electric transportation and rapid AI adoption. This process is resulting in a grid that is distributed dynamic and bidirectional, a paradigm shift from the past model of linear, stable supply.
We're working with traditional suppliers and disruptors to enable the necessary intelligence for the new grid from decentralized power plants to the distribution edge. We're leveraging our analog and algorithm capabilities in cutting-edge energy monitoring and management solutions. Additionally, our battery management technology increases capacity and improves energy utilization in the grid's renewable energy storage systems. This reimagined intelligent grid of the future has the potential to expand our SAM by over $10 billion and creates tailwinds for our energy franchise for many years to come.
Given the synergies across our industrial portfolio, our pace of innovation and the emerging signs of market recovery, we're optimistic for our industrial business that has turned the corner and '25 will be a robust growth year.
So in closing, our investments in high-performance Analog solutions are enabling us to intersect with and leverage the numerous concurrent secular trends that transcend the business cycle and will propel us into the future. Our commitment to our customers' success and to impactful innovation will be the path that carries us there, ultimately increasing long-term shareholder value.
And so with that, I'm going to turn it over to Rich, who will take you through the numbers.
Thank you, Vince. Let me add my welcome to our third quarter earnings call. Third quarter revenue of $2.31 billion came in above the midpoint of our outlook finishing up 7% sequentially and down 25% year-over-year. Industrial represented 46% of revenue in the third quarter, finishing up 6% sequentially and down 37% year-over-year. Every major application increased sequentially, except for automation, which declined at a much slower pace than it had in previous quarters. Automotive represented 29% of revenue finishing flat sequentially and down 8% year-over-year.
We saw continued double-digit growth year-over-year for our industry-leading connectivity and functionally safe power platforms. Conversely, automotive production cuts are extending inventory digestion across customers, particularly impacting our legacy automotive and electrification businesses. Communications represented 12% of revenue, finishing up 10% sequentially and down 26% year-over-year. slowing customer inventory digestion enabled both wireless and wireline growth sequentially.
And lastly, consumer represented 14% of revenue, finishing up 29% sequentially and increased year-over-year for the first time since 2022. We saw diversified growth across applications with notable strength in portables and gaming.
Now let's move from the top line to the rest of the P&L. Third quarter gross margin was 67.9%, up 120 basis points sequentially, driven by higher revenue, higher utilization and favorable mix. Operating expenses in the quarter were $619 million, up modestly sequentially, driven primarily by higher variable compensation. Operating margin of 41.2% exceeded the high end of our outlook. Nonoperating expenses finished at $70 million, and the tax rate for the quarter was 10.8%. The net result was EPS of $1.58 which finish near the high end of our outlook.
Our financial position is solid, and I'd like to call out a few items from our balance sheet and cash flow statement. We ended Q3 with more than $2.5 billion of cash and short-term investments and a net leverage ratio of 1.2. Inventory decreased $51 million sequentially and days declined to 178 from 192. As planned, we reduced channel inventory further this quarter with weeks ending near the low end of our 7- to 8-week target.
Operating cash flow for the quarter and trailing 12 months was $0.9 billion and $4 billion, respectively. CapEx for the quarter and trailing 12 months was $154 million and $1 billion, respectively. For fiscal '24, CapEx is tracking to our $700 million plan, which is down roughly 45% versus 2023 as our hybrid manufacturing investment cycle tapers. Not included in these figures are the anticipated benefits from both the European and U.S. CHIPS Act.
During the last 12 months, we generated $2.9 billion of free cash flow or 30% of revenue. Over the same time period, we have returned $2.8 billion via dividends and share repurchases. As a reminder, our strategy is to return 100% of our free cash flow to our shareholders over the long term.
Now I'll turn to the fourth quarter outlook. Revenue is expected to be $2.5 -- $2.4 billion, plus or minus $100 million, up 4% sequentially at the midpoint. We expect sell-through to be roughly equal to sell in this quarter. At the midpoint on a sequential basis, we expect industrial and consumer to increase communications to be flattish and automotive to decrease.
Operating margin is expected to be 41%, plus or minus 100 basis points. Our tax rate is expected to be between 11% and 13%. And based on these inputs, EPS is expected to be $1.63 plus or minus $0.10.
In closing, our third quarter results and fourth quarter outlook support our view that we have passed this cycle's trough. However, challenging economic and geopolitical conditions are limiting a faster demand recovery.
I will now give it back to Mike for Q&A.
Thanks, Rick. Let's get to our Q&A session. [Operator Instructions] With that, we will have our first question, please.
[Operator Instructions] Our first question comes from Tore Svanberg with Stifel.
Great to see the turn here. Vince, could you maybe elaborate a little bit more on this sort of mixed environment, right? Because inventories have bottomed -- excess inventories at bottom. At the same time, end demand seems to be kind of mixed. So as you navigate through this period, could you elaborate a little bit on your visibility? How is backlog trending? Are you finally starting to see new products ramping more into production because these are typical signals that you want to see at the beginning of a new cycle?
Yes. Thanks, Tore. Well, I'd say, I mean, first and foremost, we run this company on [indiscernible] signals. That's how we plan our production, how we run the company operationally. So we pay very, very close attention to what's happening in terms of the end market demand. And my confidence has increased since last quarter that indeed 2Q was the cyclical bottom. We've exited 3Q with very, very lean channel inventory. We've taken inventory of our own balance sheet, though, we're positioned with a very, very healthy backlog of inventory on our own balance sheet so that the anticipated demand upsurge that we expect in '25. We're very, very well equipped and ready to meet that.
So in the fourth quarter, as we've said, we expect to see continued sequential growth. And indeed, we'll also see, I think, particularly in the industrial area, continued improvement on customer inventory levels. So look, it's all -- the whole recovery the ramp of the recovery will depend on the macro situation. But nonetheless, given the design wins, we have a record design win pipeline in the company. So we're facing many, many secular tailwinds with a very strong pipeline, very, very good supply line and with a very, very lean inventory on the customer's balance sheet. So that gives me the optimism, Tore, that we're very, very well positioned coming into the new year.
Our next question comes from Joseph Moore with Morgan Stanley.
My question is on the trajectory of automotive versus industrial. It seems like automotive entered into a inventory correction a little bit later and so far has been much less severe. I guess you sort of talked about some ongoing headwinds in that space. Can you just talk about what overall drawdown might you expect in automotive? And where are we and customers kind of drawing down safety stock inventory?
So Joe, this is Rich. I'll take a crack at that one. So I'll just level set a little bit from our perspective and what we're seeing in the market cars continue to become more electric and software-defined, which is also driving our semi-content growth largely trying to address increased battery densities, more sensors, displays. And we do expect that, that is going to be a long-term tailwind to our business.
However, and this is where we're starting to see some of the pullback, the vehicle market has softened in the near term. We're seeing our customers pull back on their production. And at this point, we're seeing them start to choose to burn off some inventory. So we are seeing that, right? The softness is evidenced in our results. Auto has been down year-over-year for 2 straight quarters, and we expect it will be down again in 4Q.
And from a bookings perspective, we did see a decline in bookings in auto, in particular, we've seen inventory digestion in our legacy auto and in our BMS portfolios, and we expect that that's going to continue into at least the fourth quarter, particularly when you consider the challenging purchasing environment that currently exists for customers.
However, to your question around the peak to trough, unless SAR returns to pandemic levels, we don't see the peak to trough being nearly as dramatic as we saw in our other end markets. The underlying secular growth trends that I described, driving higher semi-content. Also, we've continued to see more penetration in value capture across all vehicle types, whether it's ICE, plug-in hybrid, electric or full electric in the fastest-growing applications. If you think about that ADAS, digital cockpit and electrification. So we will be down, but we don't expect that the cycle depth to be as severe as we saw, for example, in industrial.
And I guess as a follow-up, are you seeing that behavior any different regionally is the China automotive market different than the Western markets in terms of where they are?
No. I'd say, overall, it's pretty unanimous across all markets. I'd say [indiscernible] did okay. We talked about some design and ramping there. So that's helping offset some of the softness. But as an overall comment, auto is a bit weaker today than it was 90 days ago, whether it's North America, Europe or Asia.
Our next question comes from Vivek Arya with Bank of America Securities.
Vince, glad to hear about your optimism about turning the cyclical corner. Do you think the environment allows for sequential growth to continue into Q1? It seems like industrial could grow. Autos, I'm not sure, given some of the bookings commentary and consumer tends to be down seasonally. So just conceptually, how should we model the shape of this recovery into Q1?
Yes. Well, at this point, it's hard to call given that the environment is still a little -- let's say, it's a bit of this equilibrium. But I think, generally speaking, we would probably expect to see a bit of a seasonal decline in the first quarter and then bounce back in the second. I think that's the sentiment. But overall, I maintain my outlook that we would see a brisk growth here in '25.
[indiscernible] a little about the seasonality question. It's been a few years now since we've seen seasonal trends in our business. You're right, if you look back over the past 10, 15 years for ADI, consumer is down 10% plus sequentially in 1Q, and the [indiscernible] markets of industrial, auto and comms are down low single digits. And as Vince said, there's probably -- there's no belief today that we'd be any better than seasonal, given where we are today. But we'll update through 90 days and probably feel about 1Q.
Yes. I think the big modulator for us will be what happens in industry in particular. And what I can tell you is that the various C-suite conversations I've had with our industrial customers would suggest that their optimism is also strong for '25.
Our next question comes from Timothy Arcuri with UBS.
I just wanted to ask on that answer. So you were above seasonal in fiscal Q3 or above seasonal fiscal Q4. It sounds like you're not willing to commit that you're going to be above seasonal in fiscal Q1. The streak is modeling like 5% or 6% above seasonal for fiscal Q1. Was there something that happened in bookings? Did bookings like slow in the last couple of weeks or the last month or something to make you not want to commit to the fact that fiscal Q1 would be above seasonal or just that it's 90 days away and you just don't want to comment on it?
I'll start out on the [indiscernible] expectations, and then Rick will talk about bookings. We never guided 1Q. I think -- the [indiscernible] expectation for 1Q. I think [indiscernible] is up everyone a better than seasonal for calendar 4Q or fiscal 1Q, I hope of [indiscernible] snapback. I would say, yes, there are things that have changed in 90 days, but we're optimistic about '25 in the full year. We just don't know if it is above seasonal in that outlook for a good year '25. I'll pass to Rick [indiscernible] some of the bookings dynamics.
Yes. So Tim, from a bookings perspective, up until Q2, as we talked about, we've seen 3 straight quarters of broad-based bookings improvement. However, Q3 was different we saw continued bookings growth for industrial, consumer and communications, but we did see automotive orders decline, which resulted in a modest drop in our total bookings during the quarter. We did still end with a book-to-bill around parity. And if I look at it from a geographic perspective, regional bookings were the weakest in Europe Americas was modestly weaker, which offset bookings growth in Asia.
Our next question comes from Toshiya Hari with Goldman Sachs.
It was good to see inventory on your balance sheet come down again and you guys spoke to channel inventory coming down as well. As you look forward, what are your thoughts on utilization rates internally how are you engaging with your foundry partners? And what's embedded in your October quarter outlook as it pertains to the channel?
So as I noted in the last call, we said both utilization and in fact, gross margins had bottomed in Q2, and that is proving to be true. From an inventory and a channel perspective, the expectation is we will ship to end demand. We are currently at the very low end of our range in the channel at 7 to 8 weeks. And I think we've mentioned previously, if we saw continued improvements, we would start shipping to end demand. So we will do that in the fourth quarter.
Obviously, when it comes to the balance, we've hybrid manufacturing system, which enables us to keep utilization rates as high as possible internally. And when our factories run out of capacity, then we have lots of choices externally, for silicon capacity. So obviously, we've got a lot of inventory on the balance sheet and our factories are well, well capable of improving utilization rates as the demand continues to improve over the coming quarters.
As a quick follow-up, I think your internal utilization rates last quarter were in the mid-50s, if I'm not mistaken. Are you at or above 60% at this point? Or -- can you comment on that?
We haven't given outlook on utilization nor do we give the rate. I would say they were lower last quarter [indiscernible] higher here in 3 and 4Q. And they're well off the normal level of, I'll call it, 85 [indiscernible] utilization. And if you [indiscernible] low context is what does [indiscernible] utilization ramp? Was [indiscernible] for gross margins. If you look at the decline in gross margins over the past year or so, [indiscernible] have the decline relates to utilization. The other half relates to the mix. So you can see as utilization pick up, what that means for gross margin expansion. .
Our next question comes from Stacy Rasgon with Bernstein Research.
I was hoping you could give us a little more granularity on the segment guide for next quarter. I know you said industrial and I think consumer up and auto down. Any more further color on that, like is consumer usually up, is it up double digits? Is industrial up mid-single, auto down by low single like? Any further color you could give us on the segments would be helpful.
Sure, Stacy. I'll grab that one. Yes. So let's start with consumer, you're right, consumer is up about double digits again, about 10% or so embedded in our outlook. And [indiscernible] has another, I'll call it, solid growth quarter, probably high single digit sequentially. Communications is about flattish, plus minus, depending on how things go here. And autos, the weak market, as we discussed a little bit earlier on the call, is down low single digits sequentially.
Got it. That's helpful. And if I could give a quick follow-up, just -- how are you thinking about OpEx growth in the next quarter? It was pretty well under control this quarter. Is there anything that drives that up? Like what do you think about the OpEx trends as you're going to the end of the year?
So Stacy, I'll take that one. So obviously, we exceeded the high end of our outlook in the third quarter, given the beat on gross margin and revenue as well as our continued cost management. Our Q4 guide obviously does imply a modest margin contraction sequentially, despite our expectation for higher revenue and gross margin. The main driver of that is our increase for merit increases that will go into effect during the fourth quarter. So that will be a downward pressure as we head into the fourth quarter.
I mean the big margin number on our OpEx, Stacy, is obviously the bonus. And that, obviously, with a declining profit and revenue over the past several quarters. that dropped accordingly. Now with increase with growth in revenue and improvement in profitability, that will obviously increase. But that's self-funding, so to speak.
Got it. And what should the OpEx go up then?
For our fourth quarter outlook, I would -- the sequential increase in OpEx is around 5%.
Our next question comes from Chris Danely with Citi.
First, just a little clarification on inventory in the auto market. Vince, you've said, I think at the beginning, you talked about inventories very lean out there, but then you're also saying that there's inventory digestion going on in the automotive market. Can you just expand on that a little bit?
[indiscernible] overall customer inventory. Yes, I think every market [indiscernible] different cases on inventory digestion. We feel good about industrial consumer comms have really normalized inventory levels. There aren't pockets on the auto side, that's still, I'll call it, digesting. I mean, production levels have been cut over the past quarter, whether it's an ICE car or an EV car that impacts inventory levels and desire to hold inventory on their balance sheet. With that standpoint, Chris, I don't know if, Vince, you have anything to add?
I think, Chris, overall, we've seen -- the worst is behind us, I think, in industrial, consumer and comms market. But automotive, I think, is a sector where we will see some inventory digestion issues into the -- at least the early part of 2025.
Great. That's helpful. And then just a quick clarification on industrial. How would you characterize your, I guess, bookings/visibility on the industrial market now versus 3 months ago? Is it roughly the same? Or has it improved a little bit?
Chris, it's Rich. I would say our visibility is pretty consistent. And as we talked about, we're seeing continuing growth sequentially across all of the sub-elements of industrial with the exception of automation, which we are seeing improvements, but not yet seeing growth.
Our next question comes from Harlan Sur with JPMorgan.
So for fiscal '23, China domestic consumption, you gave us about 18% of your total revenues or the worst performing geography. Last couple of quarters where bookings in China have been growing sequentially. Did that translate into sequential revenue growth out of the region in the July quarter? And then it looks like orders from the China region grew sequentially in July. How are they trending so far quarter-to-date? Are you still seeing sort of positive signs out of this region?
Yes.ewe continue to see strong performance from a bookings perspective in China. We did see double-digit growth across industrial, auto and comms being slightly offset by a decrease in consumer. So China does continue to perform well, and our design win and our pipeline there are very strong.
Our next question comes from Joshua Buchalter with TD Cowen.
Maybe you can walk through some of those puts and takes in the gross margin into the October quarter. back the envelope, I'm getting to roughly stable sequentially despite the revenue increase, and I imagine utilization is improving as well. How much of that is mix? And in particular, any changes in the pricing environment as we get sort of through this digestion into what I would imagine is a more competitive environment?
Yes. I would say it's -- as we previously mentioned, it is significantly impacted by the favorable mix. Obviously, we get a benefit out of the revenue upside. From a pricing perspective, and I've talked about this before, we continue to see a pretty stable pricing, and I do expect that to continue. Obviously, it's different by geography and for big and small customers. But on balance, we are continuing to see stable pricing and expect we will see that going forward.
Once our products are installed in a particular customers design, they tend to -- I mean in the industrial business, they will stay for decades, and pricing is very, very stable there. Where the pricing or the competitiveness [indiscernible] for new sockets, new wins, but nothing is new there. We, as a company, we play in the high end of the game in terms of innovation, service, support and so on and so forth. So thats the game we play and we will continue to play. We've significantly higher ASPs than most. And those ASPs increase with each new generation of [indiscernible]. So I think overall, as Rich said, the pricing environment is stable. And so I don't see that as a headwind on margin.
Thanks, Josh. I think that's all the time we have for questions today. I thought we had a little more time, but it's August. You guys can go out there and enjoy the weather a bit. So thanks for joining the call. We look forward to future calls with you guys, and have a great rest of summer.
This concludes today's Analog Devices conference call. You may now disconnect.