Analog Devices : Q1 2023 Transcript

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ADI.OQ - Q1 2023 Analog Devices Inc Earnings Call

EVENT DATE/TIME: FEBRUARY 15, 2023 / 3:00PM GMT

OVERVIEW:

ADI reported revenue of $3.25b and adjusted EPS of $2.75. Co. expects 2Q23 revenue to be $3.2b, plus or minus $100m and adjusted EPS to be $2.75, plus or minus $0.10.

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FEBRUARY 15, 2023 / 3:00PM, ADI.OQ - Q1 2023 Analog Devices Inc Earnings Call

C O R P O R A T E P A R T I C I P A N T S

Michael C. Lucarelli Analog Devices, Inc. - VP, IR and FP&A

Prashanth Mahendra-Rajah Analog Devices, Inc. - Executive VP of Finance & CFO

Vincent T. Roche Analog Devices, Inc. - CEO & Chair of the Board of Directors

C O N F E R E N C E C A L L P A R T I C I P A N T S

Ambrish Srivastava BMO Capital Markets Equity Research - MD & Senior Semiconductors Research Analyst

Christopher Brett Danely Citigroup Inc., Research Division - MD & Analyst

ChristopherJamesMuseEvercoreISIInstitutionalEquities,ResearchDivision-SeniorMD,HeadofGlobalSemiconductorResearch&SeniorEquityResearchAnalystHarlan Sur JPMorgan Chase & Co, Research Division - Senior Analyst

Stacy Aaron Rasgon Sanford C. Bernstein & Co., LLC., Research Division - Senior Analyst

Tore Egil Svanberg Stifel, Nicolaus & Company, Incorporated, Research Division - MD

Vivek Arya BofA Securities, Research Division - MD in Equity Research & Research Analyst

P R E S E N T A T I O N

Operator

Good morning, and welcome to the Analog Devices First Quarter Fiscal Year 2023 Earnings Conference Call, which is being audio webcast via telephone and over the web. I'd like to now introduce your host for today's call, Mr. Michael Lucarelli, Vice President of Investor Relations and FP&A. Sir, the floor is yours.

Michael C. Lucarelli - Analog Devices, Inc. - VP, IR and FP&A

Thank you, Gigi, and good morning, everybody. Thanks for joining our first quarter fiscal '23 conference call. With me on the call today are ADI's CEO and Chair, Vincent Roche; ADI's CFO, Prashanth Mahendra-Rajah. Anyone who missed the release, you can find it and relating financial schedules at investor.analog.com. On to the disclosures. Information we're about to discuss includes forward-looking statements, which are subject to 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 and 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. Our comments today will also include non-GAAP financial measures, which exclude special items. When comparing our results to our historical performance, special items are also excluded from prior periods. Reconciliation 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 release.

And with that, I'll turn it over to ADI's CEO and Chair, Vincent Roche. Vince?

Vincent T. Roche - Analog Devices, Inc. - CEO & Chair of the Board of Directors

Thanks very much, Mike, and good morning to everyone. Well, I'm very pleased to share that ADI continued to execute exceptionally well in the first quarter of fiscal '23 despite continued macroeconomic uncertainty. Revenue was $3.25 billion, up 21% year-over-year. Strength was broad-based with all B2B markets up single digits. Gross and operating margins were 74% and 51% respectively, and adjusted EPS achieved another record at $2.75. Our continued success is driven by a relentless focus on customer collaboration, a growing demand for our innovative technologies and strong operational execution. We play a long game and are excited about what the future holds for us. To ensure that we capture the opportunity

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FEBRUARY 15, 2023 / 3:00PM, ADI.OQ - Q1 2023 Analog Devices Inc Earnings Call

ahead, we've been steadily increasing investments in R&D, manufacturing capabilities and in partnerships that deepen our value to our customers now and over the long term. For example, in R&D, we've invested $1.7 billion over the trailing 12 months to strengthen our core franchises and capture market opportunities presented by secular growth drivers.

Over this same period, we've invested $750 million in CapEx to enhance the resiliency of our internal semiconductor manufacturing operations. These investments not only increase our operational resiliency, but also modernize our fabs to better address our sustainability ambitions.

As mentioned in our press release, our industrial and automotive businesses remain strong as we gain market share. So this morning, I want to focus specifically on our industrial business, which continues to grow significantly despite the macroeconomic backdrop. Now from a big picture perspective, the industrial market is the bedrock of ADI, representing more than half of our total revenue. It's also our most diverse and profitable business segment with tens of thousands of customers and products that sustain revenue streams for decades. Additionally, ADI's industrial revenue is derived from high-performance technology in mission-criticalCapEx-intensive equipment across the myriad applications.

Our leadership position has been strengthened over the last decade as we intensified our focus in this market and invested over $5 billion in R&D activities to capture the opportunity across the hundreds of applications that characterize the industrial sector. This space is inherently fragmented and the unmatched breadth and depth of ADI's portfolio uniquely allows us to address our customers' needs across the full spectrum of applications with core component building blocks to application-specific solutions that encompass analog, digital and algorithms.

Today, we're seeing the rise of new industrial applications that require more sophisticated and more complex architectures as machines become more intelligent and more sustainable. This is driving more semiconductor content per dollar of CapEx, unlocking new opportunities for our portfolio. While this transformation is benefiting all of our industrial applications, including healthcare and aerospace, let me share how we're winning in industrial automation and instrumentation more specifically, and discuss the burgeoning opportunity across the electrification ecosystem.

So starting first with Industrial Automation. Here, our customers are upgrading their factories with more automation and connectivity to increase output with greater energy efficiency. ADI's broad portfolio helps customers create these more resilient and flexible footprints while lowering their carbon emissions on the journey to net zero. As an example, at a leading U.S. robotics manufacturer, we've won additional content across power, sensing and GMSL connectivity. Our systems approach reduced our customers' design time and increased our content per cobot by 4x.

Also in the last quarter, our IO-Link solution was designed in at multiple leading industrial automation customers. These solutions are critical for delivering robust connectivity to the edge of the factory floor.

Turning our attention now to our instrumentation and test business. This subsector is highly aligned to secular growth trends from connectivity to AI-assisted compute to electrification, to drug discovery and gene therapies. The consistent thread across this diverse set of applications is the growing complexity that requires more advanced metrology and test. The results, our average content per system is now 2 to 3x higher. Further, the localization of semiconductor supply is providing additional tailwinds for our test business. We've secured multiple design wins in North America as well as Asia for memory and high-performance compute.

And finally, on to one of our fastest-growing areas, the electrification ecosystem. The collective need for a more sustainable future is driving massive growth in electrical grid infrastructure.

Now let me share 2 examples with you. First, industrial and automotive companies have announced more than $300 billion of investments in greenfield gigafactories, essential to the production of batteries to proliferate the electrification ecosystem. These Gigafactories will drive additional demand for our formation and test solutions critical to producing higher density batteries. Further, given the inherent safety hazards of using higher cell voltages, these factories will also provide new growth vectors for ADI. In our sustainable energy franchise, we're leveraging our industry-leading automotive BMS solutions into energy storage systems for electrical grids and fast-charging infrastructure. We've won designs at leading EV infrastructure manufacturers in North America, Europe and Asia, putting us on a path to more than tripling this business in the coming years.

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FEBRUARY 15, 2023 / 3:00PM, ADI.OQ - Q1 2023 Analog Devices Inc Earnings Call

Of course, while no market is fully immune to adverse economic cycles, our industrial business is highly diversified and aligned with secular trends. This has translated to more durable revenue streams with sales in this sector increasing more than 25% over the trailing 12 months despite a weakening economic backdrop. But looking ahead, we see continued strength in this franchise as the breadth and depth of our portfolio, our deep customer collaborations and design win pipeline momentum underpin our new phase of profitable growth.

So in closing, ADI's business model is diverse, resilient and rich with opportunity. I'm very optimistic about what our future holds as we drive enhanced value for our customers, employees and shareholders, as well as society at large. And so with that, I'll hand you over to Prashanth.

Prashanth Mahendra-Rajah - Analog Devices, Inc. - Executive VP of Finance & CFO

Thank you, Vince. Let me add my welcome to our first quarter earnings call.

My comments today, with the exception of revenue, will be on an adjusted basis, which excludes special items outlined in today's press release. First quarter revenue of $3.25 billion finished at the high end of our outlook, driven by continued share gains in industrial and automotive.

Our B2B markets represented 89% of revenue, up 25% year-over-year and increased 2% sequentially despite our first quarter typically being down.

Now let's look at performance by end market. Industrial, our most diverse and profitable end market represented 52% of revenue and hit another all-time high. This business has grown sequentially for 12 consecutive quarters. All markets increased year-over-year, led by automation, sustainable energy, instrumentation and test. Automotive, which represented 22% of revenue, also achieved another record, increasing 29% year-over-year and 6% sequentially. All applications grew double digits year-over-year as our market-leading positions across battery management and in-cabin connectivity continued to deliver significant growth.

Communications, which represented 15% of revenue, grew 18% year-over-year. As expected, comps declined slightly sequentially as strength in wired was offset by softness in wireless due to the timing of 5G deployments. And lastly, consumer, which represented 11% of revenue was down 5% year-over-year and declined 14% sequentially given weaker market trends and seasonality.

Now on to the rest of the P&L. Gross margin of 73.6% expanded 170 basis points year-over-year on favorable mix and cost synergies. OpEx was $733 million, down slightly sequentially as we balance strategic hiring with the tight discretionary spend and synergy capture. Given our strong operating leverage, combined with the synergy savings, our operating margin was 51.1%. Importantly, we have already captured nearly all of the $400 million cost synergy goal. As such, our communication will now turn to the revenue synergy opportunities from our combined portfolio and our complementary customer base with Maxim.

Recall that Anelise, our Chief Customer Officer, unveiled how we are strategically approaching these synergies during our Investor Day, and Vince has routinely highlighted some of these compelling opportunities over the past few quarters. To that end, we are closely monitoring and measuring progress from opportunity to design win, to new revenue. And while it is still early, design win momentum to date has exceeded our expectations. This gives us increased confidence in achieving our $1 billion-plus revenue synergy opportunity that we outlined at our Investor Day.

Non-op expenses were $60 million and the tax rate was just over 12%. All told, EPS came in at $2.75, up 42% year-over-year and hitting a new record.

Moving to the balance sheet. We ended the quarter with approximately $1.7 billion of cash and a net leverage ratio below 1. Days of inventory increased to 155 while channel inventory remains below our target level. Recall that last quarter, we outlined our strategy to rebuild strategic die bank and hold more finished goods inventory on our balance sheet as we moderate shipment into the channel during this time of inflection.

Moving on to cash flow. CapEx for the quarter was $176 million and $764 million over the trailing 12 months, representing 6% of revenue. We continue to expect CapEx to be high single digits as a percentage of sales in 2023 and then decline in subsequent years to our long-term target of mid-single digit. These investments will double our internal revenue output exiting next year and support strategic swing capacity between our

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FEBRUARY 15, 2023 / 3:00PM, ADI.OQ - Q1 2023 Analog Devices Inc Earnings Call

fabs and our foundry partners. The flexibility of our hybrid model across different geographies enhances our resiliency and offers our customers additional optionality.

Over the trailing 12 months, we generated $4.3 billion of free cash flow or 34% of revenue. Over this period, we have returned $4.7 billion to shareholders or over 100% of free cash flow via $3.1 billion of buybacks and dividends of $1.6 billion. We just raised our quarterly dividend by 13%, marking our fifth consecutive double-digit increase and 19 consecutive years of increases. This is a testament to our durable operating model that has generated positive free cash flow for 26 consecutive years. As a reminder, we target 100% free cash flow return. The dividend is the cornerstone of this policy, and we look to increase our dividend at a 10% CAGR through the cycle, with remaining cash used for share count reduction.

Now similar to prior quarters, I'd like to give a brief update on the operating backdrop. First, on markets. Industrial orders, as Vince highlighted, remained the strongest followed by automotive, while comms and consumer remain weak. Given the rapidly changing environment, we are diligently working with our customers to remove orders that they may no longer require.

At the same time, we have increased our supply by growing our internal output and working with our foundry partners. These actions have reduced our lead times with half of our portfolio now shipping in under 13 weeks. Despite this, backlog coverage remains around 1 year of revenue. As such, we expect our book-to-bill will remain below parity over the next couple of quarters as our backlog returns to more normal levels. Given these dynamics, we are guiding second quarter revenue to be $3.2 billion, plus or minus $100 million. We expect continued sequential growth in our industrial and automotive markets and another sequential decline in our communications and consumer markets. At the midpoint of our outlook, revenue will be up high single digits year-over-year with our B2B markets up over 10% once again. Operating margin is expected to be 51% plus or minus 70 basis points.

Our tax rate is now expected to be between 11% to 13% for the year. This guide reflects the new U.S. tax requirement to capitalize R&D expenses for tax purposes, resulting in higher upfront cash tax payments, but lowers our effective tax rate temporarily due to the deferred tax accounting requirements.

Based on these inputs, adjusted EPS is expected to be $2.75 plus or minus $0.10. In all, the macro backdrop remains uncertain. However, we remain cautiously optimistic in the near term given the resilient strength across our industrial and auto businesses, which represent over 75% of our revenue.

Longer term, we remain well-positioned to drive growth, enabled by our diverse, high-performance portfolio aligned with the key secular trends at the Intelligent edge.

Let me now pass it back to Mike for our Q&A.

Michael C. Lucarelli - Analog Devices, Inc. - VP, IR and FP&A

Thanks, Prashanth. We'll begin the Q&A session. We ask that you limit yourselves to 1 question in order allow for additional participants in the call this morning. If you have a follow-up question, please re-queue, I'll take your question if time allows. With that, we have our first question, please.

Q U E S T I O N S A N D A N S W E R S

Operator

(Operator Instructions) Our first question comes from the line of C.J. Muse from Evercore ISI.

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