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ADI.OQ – Q3 2022 Analog Devices Inc Earnings Call

EVENT DATE/TIME: AUGUST 17, 2022 / 2:00PM GMT

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AUGUST 17, 2022 / 2:00PM, ADI.OQ – Q3 2022 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 of Semiconductor Research & Senior Research Analyst Blayne Peter Curtis Barclays Bank PLC, Research Division – Director & Senior Research Analyst

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

Ross Clark Seymore Deutsche Bank AG, Research Division – MD

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

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

Toshiya Hari Goldman Sachs Group, Inc., 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 Third Quarter Fiscal Year 2022 Earnings Conference Call, which is being audio webcast via telephone and over the web. I’d like now to 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, Matt, and good morning, everybody. Thanks for joining our third quarter fiscal 2022 call. With me on the call today are ADI’s CEO and Chair, Vincent Roche; and ADI’s CFO, Prashanth Mahendra-Rajah. For anyone who missed the release, you can find it and relating financial schedules at investor.analog.com.

Now on to the disclosures. The 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 as these statements reflect our expectations as of 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. Reconciliations of these non-GAAP measures to their most directly comparable GAAP measures and additional information about our non-GAAP measures are included in today’s earnings release. Please note, we’ve also published our annual ESG report last quarter titled Future Forward. You can find it on the IR web page. And with that, I’ll turn the call over to ADI’s CEO and Chair, Vince. Vince?

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AUGUST 17, 2022 / 2:00PM, ADI.OQ – Q3 2022 Analog Devices Inc Earnings Call

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

Thank you, Mike, and good morning to you, all. Well, I’m pleased to share that we executed very well amidst a dynamic macro backdrop. We delivered another quarter of record results, driven by continued operational excellence, strong financial discipline and resilient demand for our diverse portfolio of innovation-rich products. Revenue was $3.1 billion, up 24% year-over-year on a combined basis and above the midpoint of our outlook. Strength was broad-based with double-digit growth in every end market.

Our third quarter profitability reflects ADI’s innovation premium and strong operating leverage with gross and operating margins of 74% and 50%, respectively. Adjusted earnings per share of $2.52 finished at the high end of our outlook, marking another new high. I’m exceptionally pleased with our results, and I want to thank our employees for their continued hard work and dedication to our success, and importantly, to the success of our customers.

At ADI, innovation is ingrained in our culture, fueled by an unwavering commitment to robust R&D investments. Over the last 12 months, we’ve invested over $1.7 billion in R&D. A key facet to our innovation-driven success is our dedication to extensive and deep customer engagements, which enables us to collaborate with them in solving their toughest problems.

Now I’d like to share some recent customer highlights. In Automotive, we reinforced our market-leading position in BMS with wins at 2 premium European auto manufacturers. One of these wins was with our wireless BMS solution. This marks the fourth OEM to adopt wireless BMS as customer interest continues to build for this unique technology. In sustainable energy, we announced a design win with Enel Group on the quantum edge device used to digitally monitor electric grids. ADI’s unmatched precision measurement capabilities are critical to creating a more resilient and flexible grid to help advance efficient electrification globally.

In health care, the recently released wireless hospital monitoring system by GE Healthcare in Europe uses ADI solutions across signal chain, power, RF MCUs and sensors. This wearable system enables wireless continuous monitoring to detect patient deterioration earlier, helping to improve outcomes.

Today, I’d like to profile our $1.5 billion-plus consumer franchise, a business that plays an important role in our long-term profitable growth strategy. Given the recent negative data points surrounding the consumer end market, one may wonder why highlight this market now. But that’s just the reason our consumer business is built differently. In the third quarter, we posted our seventh consecutive growth quarter. And while we are not immune to macro slowdown, we have aligned this business to the high end of the market where performance really matters and into applications where our differentiation is truly valued.

The composition of our consumer franchise is indeed unique. Approximately 30% of our revenue comes from long life cycle prosumer applications, including next-generation conferencing systems, professional audio/video and home theater. The remaining revenue in consumer relates to portables, including fast-growing wearables and hearables as well as premium smartphones.

Taking a step back, over the last 5 years-plus, we have reconfigured our consumer business to increase diversity across customers, products and applications to better drive growth and limit volatility while enhancing profitability. The addition of Maxim further enhances our diversity and expanded our portfolio. Over this time, we’ve increased our product SKUs to just over 10,000 and expanded our customer count to more than 3,000. Importantly, the composition of this business is quite similar to our B2B markets, with no single product contributing more than a couple of percentage points to total ADI sales.

The velocity of innovation in the consumer market is appealing. It allows us to accelerate technology development and commercialize solutions quickly at scale. Over time, we take these breakthrough solutions into other markets to create new waves of growth and drive strong profitability and cash flow. For example, we have leveraged our consumer audio expertise into the automotive market. This capability was demonstrated at our Investor Day where we showcased an electric vehicle with Dolby Atmos that uses our SHARC DSP and software that was first proven in the consumer business.

Additionally, we’ve also leveraged R&D investments from our core franchises into the consumer market. To that end, our high-precision converters and industrial instrumentation, for example, have been repurposed to solve similar challenges for stabilization in smartphone compass and pressure

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AUGUST 17, 2022 / 2:00PM, ADI.OQ – Q3 2022 Analog Devices Inc Earnings Call

sensing in wearables. Not only have we created a highly diverse and profitable business but also one that is aimed at key growth drivers that position us to grow at a high single-digit rate over the long-term.

For example, our prosumer growth has been revitalized as companies implement future of work plans that encompass more immersive enterprise video conferencing. Here, the breadth of our portfolio across DSP, analog, mixed-signal and power management enables us to solve the entire customer challenge from high-bandwidth connectivity to video resolution and sound quality.

And turning now a moment to the portables market. In hearables, we shift into the majority of premium wireless stereo earbuds. Our newest offerings include software-augmented hearing algorithms and optimized power that reduces size and improves audio fidelity while increasing our value per system by over 3x. In wearables, we’re a leader in personal wellness products with our sensing solutions designed into over 50% of products today. There is a convergence of these personal wellness products and clinical-grade vital signs monitoring solutions that could unlock new opportunities for ADI. And in premium smartphones, we’re expanding our share and content at key customers, which is providing us additional diversification and stimulating new growth vectors.

An emerging opportunity is the Metaverse. ADI’s breadth of hardware, software algorithms and domain expertise gives us an ability to provide complete sub-system solutions. While we’re still in the early days, of course, momentum is building, and we have design wins in multiple next-generation AR/VR headsets. Across all these consumer applications, power management is becoming ever more critical. Customers are adding more features into smaller spaces, while consumers are demanding longer battery life. Maxim doubled the size of our low-power portfolio and increased our consumer power SAM by over $1 billion. We’re already beginning to see the cross-sell benefits of our complementary customer bases and synergistic portfolios with wins in both wearables and conferencing systems.

So in summary, I’m very encouraged with the strides we’ve taken to reignite growth in our consumer business, and with a record opportunity pipeline and significant synergy potential, I believe we’re in a position to deliver consistent growth over the long-term.

Now before passing over to Prashanth, I’d like to make some comments on the current business environment. Obviously, the macro backdrop is dynamic and it’s clear that we’re at an inflection point. Economic conditions are beginning to impact demand with orders showing — orders slowing later in the quarter and cancellations increasing slightly. Prashanth will provide additional details on these dynamics in his remarks.

ADI successfully navigated macro challenges many, many times before in our 57-year history. We’ve created a premier analog franchise with an unmatched diversity of products, customers and applications. And we’ve invested in a hybrid manufacturing model that better adapts to demand fluctuations. These characteristics instill a resiliency into our business to mitigate market weaknesses, sustain profitability and enable investment in our business through economic cycles to focus on playing our long game. And with that, I’ll hand it over to Prashanth.

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

Thank you, Vince. Let me add my welcome to our third 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. Third quarter revenue of $3.1 billion finished above the midpoint of our outlook and marked our sixth consecutive quarterly record. If we look at third quarter end market performance, industrial, our most diverse and profitable end market, hit another all-time high and represented 50% of growth — excuse me, 50% of revenue.

Growth was broad-based with each of our major applications increasing sequentially. Industrial revenue has now grown more than 20% year-over-year for 7 straight quarters, underscoring ADI’s strong position and secular content growth across applications. Automotive, which represented 21% of revenue, achieved another record, increasing 28% year-over-year. The better mix of higher-content premium vehicles, combined with our growth engines of BMS, GMSL, A2B and better value capture is driving our outsized growth versus SAAR.

Communications, which represented 16% of revenue, achieved a quarterly record, with strong year-over-year growth in both wireless and wireline. Sequentially, wireline outpaced wireless with growing demand for our optical and power portfolios as carriers and hyperscalers invest to meet the ever-growing demand for data. And lastly, Consumer represented 13% of revenue and has now grown year-over-year for 7 consecutive quarters.

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AUGUST 17, 2022 / 2:00PM, ADI.OQ – Q3 2022 Analog Devices Inc Earnings Call

As Vince highlighted, the diversity and growing design momentum across portables and prosumer is enabling us to grow despite the consumer market slowdown.

Now on to the rest of the P&L. Gross margin was 74.1%, up 250 basis points year-over-year, driven by higher utilization, favorable mix and synergy capture. OpEx in the quarter was $747 million, which reflects a full quarter of higher-than-normal merit increases. Operating margin increased 650 basis points year-over-year, finishing at 50.1% toward the high end of our outlook. Non-Op was $48 million and the tax rate for the quarter was 13.2%. All told, EPS came in at a record $2.52, up 47% versus the third quarter of 2021.

On the balance sheet, we ended the quarter with over $1.5 billion of cash and equivalents. Days of inventory increased to 129, while channel inventory remains below the low end of our target range of 7 to 8 weeks. For cash flow, CapEx for the quarter was $165 million and $526 million over the trailing 12 months, just under 5% of revenue. We continue to expect elevated CapEx investments through 2023 to support the strategic expansion of our hybrid manufacturing model. And these investments will strengthen our resiliency and support our long-term growth outlook of 7% to 10% CAGR.

Over the trailing 12 months, we generated over $3.7 billion of free cash flow or 34% of revenue. Included in our free cash flow are onetime deal-related costs which amount to about 3% of revenue. With the intra-quarter volatility, we opportunistically increased repo activity to $906 million. And after approximately 1 year post the close of Maxim, we’ve repurchased $4.4 billion worth of shares, putting us on track to exceed our $5 billion commitment by the end of fiscal ’22.

Including dividend payments, we’ve returned approximately $6 billion to shareholders over the last 12 months or more than 6% of our market cap. As a reminder, we target 100% free cash flow return. We target to allocate 40% to 60% of our free cash flow to support a 10% dividend CAGR through the cycle, with the remaining cash used for share count reduction.

Now before we move to the outlook, I want to provide some additional details around demand. In third quarter, our order book remained strong and backlog increased to a new record, stretching well into mid-2023. However, orders moderated later in the quarter, and as a result, book-to-bill was down from a quarter ago but still well above 1. By market, we are seeing strength persist in both Industrial and Automotive, which together represent over 2/3 of our sales, while Consumer and comms were a bit softer. We also saw a modest increase in cancellations and was not specific to any end market or geography.

Given these dynamics, coupled with the macro backdrop, we believe it’s prudent to take a more cautious stance. As such, we are only forecasting slight sequential revenue growth to $3.15 billion, plus or minus $100 million, despite bookings, backlog and higher supply that would all suggest stronger growth. At the midpoint, we expect all end markets to grow quarter-over-quarter. Op margin is expected to be 50.3%, plus or minus 70 bps. Our tax rate is expected to be 13% to 14%. And based on these inputs, adjusted EPS is expected to be $2.57, plus or minus $0.10.

More broadly, while the macro backdrop is dynamic, our business has several aspects that position us quite well to manage further headwinds. These include our diverse end market exposure, coupled with strong secular drivers that will help buffer our top line. The flexibility of our hybrid manufacturing model gives us confidence in maintaining our 70% gross margin floor. And we also have several OpEx layers to support our industry-leading margins and maintain a solid return of cash to our investors. So in closing, my confidence to our path of $15 of EPS in the next 5 years remains high. Let me now give it back to Mike for the Q&A.

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

Thanks, Prashanth. Let’s get to the Q&A session. (Operator Instructions) With that, can we have our first question, please, Matt?

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Analog Devices Inc. published this content on 17 August 2022 and is solely responsible for the information contained therein. Distributed by Public, unedited and unaltered, on 17 August 2022 22:23:04 UTC.

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