Analog Devices, Inc. (ADI) Earnings Call Transcript & Summary

I guess, we can get started, maybe we'll get a few stragglers. Still morning, I guess, it's sort of morning, yes, late morning, everyone. I'm Stacy Rasgon. I cover the U.S. semiconductor sector here at Bernstein. And it's my great honor to introduce our guest today, the CFO of Analog Devices, Mr. Rich Puccio. Before I start, I want to mention if you have questions you'd like to ask during the presentation or have asked, you have a link to our Pigeonhole form where you can submit them, and we will have time for Q&A at the end. Now all the companies that I cover, Analog Devices is probably one of, if not the most respected, an extremely high-quality franchise in the analog space, particularly as it relates to signal conversion and processing. And they've really transformed over the last -- that was probably 15 years now. I mean they rationalized their product portfolio way back in the days, focusing on high-value applications like whatever the market. They've executed on a really well-done hybrid manufacturing strategy that's offered flexibility as well as supported margins in downturns. They've not been try to take advantage of inorganic opportunities where available to boost the franchise and growth potential. And they're now embarking on more aggressive capital return than we used to see a few years ago, which is good. And to tell us all about it, it gives me great pleasure to introduce Rich. So thank you so much for being here today.

Thank you, Stacy.

So you were here last year too, and I think you just said that was your sort of very first sort of public appearance as a CFO of Analog Devices. So you've been in the job now about a year. Like I'm just curious like what have you -- what surprised you? Any regrets?

So certainly no regrets. And I think when I sat here a year ago, I talked a little bit about one of the surprises to me, even though I did a ton of research before I joined the company, one of the surprises was digging in to see how sticky and how long the products are. And Stacy, you talked about the analog franchise, when you get inside and look and see that we have products that are still producing revenue 25 years after they launched.

Did you still show that chart?

The sediment chart, I think, is what we've gotten to calling that is showed. The thing that became even clearer over the last 12 to 15 months as we continue through what was, for us, the second worst downturn we've ever experienced as a company was the resilience that our business model demonstrated. And big piece of that is what you just described is our hybrid manufacturing process, which gives us a level of flexibility as we go up and down in the cycle to manage the utilization of our factories. But at the same time, the other thing that was happening, and I think this also speaks to our resiliency is our sales teams and field teams were cranking on generating new design wins across our portfolio. So if you go back to the prior years, where we were generating peak amounts of revenue and then followed that with 2 straight years of very strong double-digit growth in design wins. And for us, that's a really good indicator of the potential for growth in the 3- to 5-year out period. So seeing that resiliency in the face of what was a very challenging -- I think Vince has been quoted a number of times saying, it's the worst inventory correction he's seen in his entire career. And for the company to manage through that, and hold the line pretty well considering the severity from a margin perspective, I thought that was an incredible testament to the business model.

Maybe it's worth jumping ahead then to that margin question. So I remember when I first started this job, I think the peak margins of the business were maybe upper 50s. And then there were some actions taken around the financial -- I mean there were some business exits. I think you're one of the few guys who actually get paid to sell a cellular modem business. I don't think anybody else has managed it since. And there were some other businesses. And then there was some portfolio -- manufacturing footprint rationalization back in the days. There was Ireland and Santa Clara, I think, and Cambridge in Massachusetts. And I remember we came out of the financial crisis and all of a sudden now the trough margins were higher than the peak margins used to be. They were kind of like high 50s to low 60s. And there was sort of further improvement. And then you did some fairly accretive acquisitions. You bought Linear, which I think had the highest gross margins like bar none in the space, like mid- to upper 70s and then Maxim, which had 70s. You sort of talked about gross margins probably holding in, in that 70% range. You didn't quite get there, but high 60s for the -- 67%, I think, is where it bottomed maybe-ish?

67% and change.

For the magnitude of the revenue decline that we had around the cycle, I think, is pretty damn impressive personally. So maybe you could talk a little bit about that manufacturing, the hybrid manufacturing strategy. How does that work? Like my understanding is your licensing processes from TSMC and the capacity is fungible. Like how does that actually work? Because there aren't a lot of other companies that have been able to pull something like that off at scale.

Yes. So great points on the margin. And yes, we were disappointed. And in defense of my IR team that built the long-term model in '22. I think they contemplated some downsides. I don't think they contemplated the severity. So for us to hold pretty close to 70%, we felt really pretty close. Really pretty good about that. So if you -- so what the company has done -- what we've done from a flexibility perspective is what you described, we have the ability to produce at this point, the majority of our products can be produced in our own factories or in our external partners.

What percentage of products -- revenue?

So by the end of this year, we expect about 70% of our products to be able to be manufactured internally or externally. And I always caveat this, that's not a statement that we would move 70% of our stuff out. We still tend to run about 50-50 internal, external.

Is that 70% of revenue as well or...

Yes, it's 70% of revenue as well. So if you think about that, what it means for us is when things were going crazy in the upturn coming out of the pandemic, we were able to go external with, and get extra capacity from our foundry partners. And so that helped us mitigate our factories during the peak of the comeback were running way above normalized utilization rates, I think even getting to 100-plus percent at one point theoretically, but significantly above the sort of ideal utilization rates. So -- and then look at the trough -- peak-to-trough drop across any of our end markets.

How much was it's? More than 30%, right?

It was about -- I think it was about 31% or was it -- did it go to 34% in the last quarter. So it was north of 30% peak to trough. And for us to be able to maintain a margin in the high 60s, part of that was our ability to bring capacity back in. Now you can't do it overnight, but with some notice period, we can just bring back some of the products that we might be using at an outside foundry into our factories to help keep the utilizations from going down. Because we talked about this before, right? If you look at the peak margins that you were talking about, say you go back even the most recent peak margins in the '22, '23 time period, where we got operating margins up in the 50s. You look at the revenue drop from then, there were sort of two primary drivers to the margin hit. One was underutilization in the factories and the variances that got thrown off was a very significant headwind for us because we're well below utilization levels that we would be at historically. The other piece of that was at the same time, the industrial was feeling it pretty hard. And so if you go back and look in, I think in '23, our industrial business was about 53% of the overall business. It's also our highest margin business. So now you go back and look at the last quarter, it's down to 44%. And so that is -- those two items were pretty significant downward pressure on the margin. And to hold other than I think 1 quarter, which would dip below to hold greater than 40% operating margin at the bottom of the trough, that is attributable to that factor. Now the other piece that -- because it will come up eventually when you talk about OpEx. The other thing is we have a variable comp plan. It's in our proxy, so I'm not disclosing any state secrets. Our variable comp plan is driven by operating margin percent and revenue growth. So in the trough, there's 0 revenue growth and at 40-ish operating margin, there's not a lot of variable comp. We're now in a period where we're moving up a little bit in the operating margin, but significant year-over-year growth. So you saw it actually because it was in -- I just talked about it in my prepared remarks, the impact of variable comp was the entire growth in our -- sequential growth in our OpEx. So we've been talking about this since I think we gave the guidance in Q4, for fiscal '25, we expected to see less operating leverage than you would normally see in a year with this much revenue growth because we're going from paying very low variable compensation to a pretty significant step-up. But if you think and you move out a little bit longer term or even a year later, the step-up in variable comp, even if we continue to grow in '26 doesn't look like it did in the current year. So we would expect the margin -- operating margin expansion to improve as we get into the outer years. So -- but if you go back to your original question, that ability to swing because we have qualified those products gives us an advantage over many of our competitors.

That must be difficult to measure. You have, what, 100,000 different products?

I think the last count is 125,000. But in fairness, a much -- sorry, what did I say? -- customers, okay. 70,000 products. 75,000 SKUs, I got it backwards. But anyway, if you break it down, a much smaller percentage of the 75,000 SKUs generate the majority of the revenue. So yes, it is. But at any given point, there is a subset of our SKUs that are not moving and the fast movers make up a bigger piece of that. So it does make it a little bit. But yes, kudos to our operations team for their ability to manage that with our external foundries and our internal factories.

Got it. I do want to talk about growth. So you guys have had -- maybe long term is not quite there, but you give like 3-year targets for growth. And it's 7% to 10% at this point off of -- I can't remember what the base was? The base '23? I can't remember. In '22, okay. So we're almost through it. But maybe you could give us a little bit of color on like where does that growth actually come from? And the segue here is, you said something on the earnings call, which I think that was a statement for this year, but you felt confidence in that target. But I mean what are the drivers behind those targets?

Sure. Actually, I'll do a little bit of a recap of how we actually built out the model when we're doing it because I spent a fair amount of time in my first month at the company, trying to make sure I was comfortable with the long-term models. So if you think about the historical growth in the space and say it's a 5% kind of CAGR business. And then we looked at and said, what are the things that differentiate us, whether it's from an idiosyncratic driver or other things that will allow us to grow at faster than that sort of CAGR that we've seen historically. So one, the pricing dynamic for ADI has changed. If you think about the historical Moore's Law world where every year, semis went back and gave back big slugs of their savings to customers. That changed, right? Things became very inflationary. That model did not continue to work, and we've been pretty disciplined. So one of the things we haven't been doing is been giving back large slugs of the price increase. So if you go back again, '22 when we did our Analyst Day, we had a pretty significant portion of our growth, and I think we talked about it was driven by price increase. We saw a pricing tailwind in '23. And then as I've talked about, '24 was pretty stable pricing for us. We expect '25 to be pretty stable. So if you just think about not giving back that pricing gain, we think that's worth at least 1 point of growth off of that 5% baseline. The second piece we've talked about is when we acquired Maxim, we set a target out there to get $1 billion of synergy -- revenue synergies by 2027, okay? So if you think about the progression we're on, in the '24, we did sort of the tens of millions of synergy revenue. In '25, we'll do hundreds of millions, and we are on track to do $1 billion worth of revenue synergies for Maxim. So if you go off of a $10 billion base, that's another point. And the third point is the industry tailwinds where we participate across a number of the sort of current biggest trends, whether it's automation, electrification, robotics, think about all these tailwinds. And the other piece is the idiosyncratic parts of the business where we've got specific design wins and in our end markets that are now producing revenue.

Like what?

So if you think about -- and we've talked a lot about this, this year, ATE, our test business, has been growing gangbusters, and that's being driven by the -- as are many of these being driven by the AI boom, right? You think about the high-performance compute, the high-bandwidth memory, those all require more testers. That's been a big benefit for us. So that has been growing significantly for us. Also on the AI side, if you think about what's going on from a power and connectivity perspective, we see that we have wins in both of those areas that show up in our wireline/data center business, that's strong growth. In our auto end market, we've got GMSL, which is a fantastic technology.

What is that for the audience here?

It's the connectivity for video inside of an automobile. So for us, it's a chip at the edge, which is at the microphone of the camera and -- excuse me, at the camera and then back at the central compute. So that GMSL has been powerful. And that's actually one of our big synergy drivers is GMSL. If you look at aerospace and defense, we've got a number of design wins in there, and that's a market we expect to continue to grow given defense budgets everywhere in the world are being increased. So we think that's a good piece of a tailwind for us. And then the other piece is, as -- over the last number of years, we've significantly diversified our consumer business. And we have a number -- we've talked about this a number of new design wins in that are ramping, and we're seeing growth across the portfolio, whether it's in handsets, whether it's in hearables, wearables, gaming. So those are all areas continuing to grow. And I think we've grown -- where you see that in our consumer business, we've grown consumer, I think, 30% in 3 straight quarters. So we feel really good about those. And those from an aggregate, just in '25, we think those are $500 million worth of incremental revenue. So we think in total, the idiosyncratic and the market tailwinds worth another $1 billion. So that gets you sort of above the midpoint a little -- right around in the 7% to 10% above the midpoint. And then we think that the additional areas just is better execution across the board in those areas can get us to the high end. And so we -- and like we said, we feel pretty good about we're growing. And I did make a comment on the call.

I wanted to ask about that.

Are you going to ask? I'll now let you ask then.

Well, the question is you said you felt for the year, you felt increased confidence about hitting the high end, which is 10%. But I mean, that would actually put Q4 down a ton. Like did you just kind of -- did you misspeak there or like what?

So in hindsight, I would call it a misspeak at the time. I'll tell you what I was really just trying to do was express that I had more confidence in the year '25 than I did 90 days ago, because if you just take a normal seasonal quarter for us, in the fourth quarter, we will be well above 10%, more like 12%.

Unfortunately, you know us, like we do...

You always -- he just soft guided the quarter down, the fourth quarter down 7%, which is not what I intended to do. In fact, the seasonal quarter would put us above the range. That was a confidence statement, not a guide.

Got it.

So sorry for the confusion for anybody who heard that comment, but that was just me being more confident. And look, the confidence stems from -- we started saying in Q2 last year, that we had to hit the bottom, and we were going to start seeing growth. We saw sequential growth in Q3 and Q4. We had our -- we're almost flat in Q1, but a slight decrease in Q1. And then one of the things that happened in Q1 is what we've been waiting for is to see some of the broad market industrial start to grow.

We've been in a downturn there. I don't know, 8 quarters, 10 quarters for you guys, however long it was.

Yes, 2 years. So to see some broad market growth to us was one of the first signs that we were starting to see industrial maybe a start of the cyclical. Well, that trend continued into Q2. We delivered very strong results in Q2, and we're guiding to Q3 with 10% growth. At some level, coming out of that quarter, for us, we were waiting for the -- because typically, you see a bit of an upturn like this when you're starting the cyclical upturn. Because the question has been for a number of quarters, when will we see a more familiar looking upturn. Now do we know the exact slope of that upturn line? No. But does it look like it's getting a little steeper for us right now? Absolutely. And so that's important, tie it back to the first part of this conversation is if industrial starts to outgrow the rest of our business, that's a margin accretive thing for us because at the standard -- at the gross margin line, that's the highest gross margin business we have.

Right. No, no, that makes sense. I guess with that recovery, and it sort of ties to the auto piece as well, right? So auto was pretty strong in the quarter, but you used sort of the dreaded P word on the call. It's funny like as you sort of look at the stock that evening, it was kind of good until you said pull forward in that.

I might have gotten a few snap screenshots of the ticker after that session pointing out my commentary. But thank you, Stacy, for pointing it out again.

I mean look, but I mean to your credit, like we were talking earlier, I mean, you call it like you see it and try to be honest with yourselves and with us, and so I can appreciate that. But I guess, what did you see there that suggests that it was pull forward? And like what are you seeing now? And then I guess the follow-on is the upside in industrial, how would you know that, that's not also pull forward versus just like broader cyclical recovery?

Two great questions. So we obviously track very closely. We run our whole business on POS, right? How things are selling through, and we look at it...

You used to report sell-through actually like versus sell...

We won't comment about what the accounting folks have done to us. But we do run the business on the POS signals, but we also -- so we're looking at POS bookings pretty regularly. And as we watch the quarter progress, we were seeing what we expected as we had forecasted the quarter in growth in bookings across our end markets. And then what we saw was right around the time of the introduction of the auto tariffs, we saw a spike in automotive bookings. We also started to see increased turns business in the automotive space and that lasted through Liberation Day and for about another week. But after about 3 weeks of that anomalous behavior, it sort of normalized back down into the weekly ordering patterns that we would have expected. So when we looked at that, first, we didn't see that kind of anomaly in any of the other end markets. So we don't have perfect visibility that what we said was pull-in was all pull-in. We don't have perfect visibility that we called no pull-ins might have had some. But we didn't see any of the significant anomaly that we saw in automotive. So we talked about on the call that we thought the pull-ins could have been half of our beat from an overall perspective. And seeing it normalize back down was one of the signals for us that it was likely to pull in. It was hard for that to just be a coincidence. And I understand we had lots of discussion and debate about this, but ADI has been -- and this predates me ADI has always been as transparent with the facts as they can. So we continue that trend. Now I think one of the things we've been super focused on is Q3's guide, I'll just talk about automotive, right? Q3's guide, we guided down, but largely, we guided down because of the pull-ins. We don't actually think the pull-ins came from Q3, which is why if you factor out the pull-ins in Q2, we're essentially guiding a seasonal Q3 in auto. Now what we're focused on, and as you and I were talking before we started, our industry is plagued by the lack of longer-term visibility on where things are headed. But we are actively monitoring and tracking what the backlog build looks like in the out quarters because our suspicion is that the pull-in is likely from Q4 or Q1. And so we will watch that, which is why we think that the Q3 is -- today, as we're forecasting it, doesn't really factor in any incremental pull-in activity. Now, the rules change every day. They may have changed again last night.

I have no idea what the rules are.

I thank the three federal judges. So at this point, we're staying very close to our customers. As a matter of fact, we just had our teams out and met with all of our top 100 customers to talk about how things are going and what the rest of the year looks like. And we're not seeing a lot of unusual behavior yet because of the suspension of the tariffs, and we're still in potentially a pause here. So that's the wildcard here. And for us, the impact of tariffs and the thing we worry most about is just the overall macro impact and the potential demand destruction, right? Because you think about the number of places our products go that will wind up getting tariffed if those new tariffs go into place and then the reciprocal tariffs hit, and that could cause some demand destruction. We haven't seen that yet based on the results, but that's the variable we're all planning for.

Yes. I mean that's been my bigger worry. It's not so much the risk of direct tariffs on semis. Even if they're 25% away. Semi ASPs over the last 5 years are up 50% anyways. We can probably handle something like that. But demand destruction, everything else, I don't have any way to get a handle on it. It doesn't sound like you guys do either.

No. And look, we're doing all the things that you'd expect. And I actually was -- I had a conversation with a group of economists at the end of last week, and we're paying attention to how they're forecasting GDP and what that might do and how the various economies might be impacted. And unfortunately, at least everything I've seen and heard is that the economy that GDP is likely most affected by this is the U.S. right? Because China is still forecasting 4-plus percent GDP growth. So we're continuing to watch that, and that will be an important factor for us. But right now, we're most focused on serving customers today, making sure we deliver on our promises because things could change, but we got to serve today.

Got it. Got it. So we'll watch auto into Q4 and Q1 at least. Maybe that's a good segue actually into sort of your geographical footprint. And I'd love to learn a little bit both about your manufacturing footprint as well as your demand footprint. So maybe if we start with manufacturing, you have internal and external. Just like how are you organized like in terms of where the wafers are actually coming from and packaged...

Sure. I'll do the quick tour. So I'll start on the left part of the United States, right? We've got manufacturing capacity out in Oregon and Washington. You come back to the East, we've got manufacturing in Wilmington, Massachusetts, where our corporate headquarter is. We also have manufacturing in Chelmsford, Mass, which is largely in our aerospace and defense manufacturing. And then we've got a factory in Limerick, and those are the -- it's in Ireland, yes, sorry, Limerick, Ireland. And then most of our back end is in Asia. Our internal back-end capacity is in the Philippines, Thailand and Malaysia. And then we've got various partners on the front end from a foundry perspective. Obviously, our largest foundry partner is the big one in Taiwan. And we have multiple OSATs across the Asia Pac region. So if you think about end assembly and test is largely outside the U.S. and wafers are spread across U.S., Ireland.

So pretty diversified like in terms of a global footprint.

Yes. And that will -- that potentially is -- it could be critically important as we move forward, depending on how things shift in the macro and the geopolitical.

And I guess what about like from an end demand standpoint, so your China revenue, if I -- it was, I don't know 20% something like that. It's lower, I think, than some of your peers.

It is. I think our China revenue is about 20%. We ship in -- by headquarters is 20%, by shipping, it's about 30%.

Got it. No, that makes sense. Do you guys have -- there's a lot of companies that talk about like a China for China strategy, just given -- do you have anything like that? Or like how do you think about that?

So we -- I think I might -- maybe I said this, if I didn't. We have design and sales teams in China, and then we have some manufacturing capacity in China. The majority of our stuff is not manufactured in China, but we do have China manufacturing capabilities.

Got it.

With a partner, not our manufacturing.

Okay. So like do you have like local foundry partners in China?

Yes.

Got it. What are your broad thoughts just on the current like China demand situation? Because it seems like -- we've seen like -- I think auto strength has been pretty good in China, not so strong in auto like elsewhere. Industrial maybe is like hit or miss or maybe that's starting to come back. Like what are your broad thoughts on that? And have you seen any impact just given everything that's going on in China?

So interesting, China was the first to go into the downturn for us. It's been the first to come out. We have posted very strong results in China for 3 straight quarters. A big chunk of that has been the auto demand in China. But one of the interesting things and which I think is an important part of this recovery is we saw a pickup in all of the end markets in China in the second quarter. So when we look at that, that is a big change because we were still at least 50% off our highs in all of the end markets in China, except for auto. So now starting to see some growth in the broader market. Our footprint in China is very similar to our global footprint. So seeing growth in the industrial in China is a good strong signal that we're...

Still off the highs, though.

Still off the highs, but a good signal that we're starting that cyclical upturn that we talked about. And the other thing is and when we looked at it, if you just look at the broad macro demand, we exited the quarter with book-to-bills above 1 in all the geographies and essentially almost all of our end markets, I think we were slightly below on auto, but almost at parity. So really strong exiting the quarter from a demand perspective and what we're seeing.

Got it. Your larger peer in China has been rumored to be being very aggressive on price. I think there's a view that ADI is maybe less exposed to pricing and competitive pressures, particularly in China, given the nature of the portfolio and the value-add of the product. Would you agree with that statement? And I guess, like what have you been seeing regarding the competitive environment, both with local competitors as well as the multinationals in China?

So I would say from a pricing perspective, China is clearly the most competitive place. We are not exempted from that competition. I do think that what gives us the ability to withstand some of that competition is, one, we tend to play at the -- we play more at the higher end of the spectrum from a performance and value perspective. We tend to try to be first into a solution where we can leverage our domain expertise. And on top of that, we add our local knowledge and our analog knowledge, which we have a significant amount of history on to be able to capture that high end. And the other thing that we're doing is getting more of the system value or driving system value. So that's -- that's a place where we play a ton...

What does that mean? Is that like software? Or like what is that?

So it is software. It's also the ability to help integrate into various systems and allow them to perform better because of the -- Jeff likes this word, the elegance of our solutions. But the other piece of it is, I guess, two other pieces back to your how we're protected on this is, one, our footprint there is very similar globally. So it's 70-plus percent is industrial and auto, highly fragmented, very, very sticky in the industrial, in particular, very sticky life cycle products. So that's a hard area to attack. And certainly, the design-in phase, the price competition is significant. But we do continue to win there. And we also still continue to capture about 4x the industry ASPs. Now part of what happened...

What are the industry ASPs now?

Rough number, $0.40. And so the other piece of it is if you go to the other end of the spectrum, a lot of the capacity that's being built both locally and in Texas by -- sorry, in China by the local Chinese companies and also what TI said they're building over there is much more of the higher volume SKUs. Our game, as we've talked about, has not been to try to pump out as much silicon as we can. It's to go after the value capture. So you look at the catalog type parts, that's just not a place that we're equipped to compete with somebody like TI given their manufacturing model and their efficiency. So we don't tend to play a lot in this space. And where you're starting to see the local Chinese competitors pick up is in that space, but we are relentlessly paranoid because they will -- they move fast and they're very aggressive, and they will continue to try to work their way up into the higher functions. So our continued drive, and you see this in how we spend our money is to continue to drive innovation and maintain our leading analog franchise.

How much of what you sell into China is maybe replicable by current Chinese skill sets and capabilities? It sounds like you think that those skill sets are evolving and advancing. I'm curious what that might look like in 5 years or even 10 years because clearly, they're being forced into it, right? The Chinese are putting a lot more resources. They have no choice. They're building a lot of capacity. They're going to have to fill it with something. How do you think like longer term -- and again, there's a perception at least that ADI may be more insulated from it because of the things...

Well, I think that -- I always careful to use insulation because I think the threat is real for everybody. I think it is our technological performance advantage and our service advantage that helps protect us. I think that we have a lead of some amount because of our long history and experience and designing an analog is hard and just building capacity doesn't mean you can supply everything that folks need. But I think we have to continue to invest to stay ahead of that or they will continue to take more and more of that market away from us. But I think we have a lead. I think it's hard for them to replicate. Where we've seen them take business in China has tended to be in areas where the performance requirements aren't as high. And if it gets into a it's just okay, then you might pick China. But -- and this applies around the world. If you want the highest performance, you're going to still pick the Analog. And we -- even in this super price competition, we are still accelerating growth in our design wins.

It makes sense. I presume even with price competition, you're coming in above, right? I mean so there's really been a bigger push. I mean Vince used to talk about this push more toward value pricing certainly reverse more than where you were years ago.

Yes. And we are -- like I said, we are super focused on capturing what we get from that innovation and being first.

Got it. Now I guess the same question on the U.S. side. So again, you've got a competitor that's building an absolute ton of capacity here in the U.S. And while that competitor, I believe, actually is actively losing share in China. They've kind of admitted it. They've suggested that like in the U.S., they think it will sort of like more than make up the difference. And how much of a threat is just like -- and they're building, I don't know, what it is, 6 death stars or whatever it is in Texas and Utah, like how do you think about that? And is there a need over time for ADI to actually be more aggressive about actually you've been even building out here in the U.S.

I would say in the near term, building incremental fab capacity is not on the table. If you think about what we've done over the last...

You've [indiscernible].

Well, we essentially, will have doubled -- by the end of this year, we'll have doubled our internal factory capacity from where we were. And so given if you do an outlook on where our revenue is headed and from a growth perspective, we feel very comfortable about the factory footprint we have today. Obviously, we only build at a certain lithography in our internal factories. But today, based on the demand we see going forward, we feel very good about where we are from a capacity perspective. And same thing, the U.S. that I said about China is going after the hardest problems to solve. And one of the things that happened during the pandemic is we got really close to customers. And so what we find now is they come to us very early in their process and say, we have this really hard problem. We need you to solve it. One of the things we hear pretty consistently from customers is, you're doing an amazing job. We love all the work you're doing for us. We want you to do more because they're hard, complex problems and they want to get them solved. And so that has helped us tremendously get out in front of some of these future design-ins and design wins because they bring us in early because we have -- my old boss, and I think I said this before, my old boss said, there's no compression algorithm for experience. We've got 60 years of analog experience so we can solve the hardest problems.

I mean is that basically the simple answer to the question of like how do you compete? Because most of the others, I mean, the big U.S. guys would sort of say similar. TI has been around 100 years, almost. But what is it that ADI does differently even from like the large established guys that would probably try to make the same claim.

I think if you look at them, I think from a relative spend perspective, we invest more of our money in R&D.

What's your R&D? It was 20%?

This year, it was about -- it running about 17% right now, right? So we tend to run -- it's a little bit different. Our first call on capital is R&D versus hardcore capital assets. Now we had a run here for a couple of years that we've spent a ton on capital.

You went to what, 8% or 10% of revenue?

We might have tweaked close to 10% at one point, and we've told everybody we expect to get back down into that 4% to 6% range.

About 30%, right?

No, it is not. No. And our team is very prudent in the way they deploy capital. But this 3-year period was significant for us. Our customers wanted resiliency. And at some level, they're willing to pay for that resiliency, and we see that. So it's been an important thing. But it goes back to how much we spend. We have a significantly higher number of engineers than we had 3 years ago, right? And we have more engineers in more disciplines. So we've hired lots of software people, lots of digital people, and we are ramping up our hiring around AI. We've been hiring for a while because we think that the ability to extract more value out of the core analog franchise comes from having the right digital and software experience.

So when you say you're investing in AI, is that investing in like AI from a product standpoint or AI from like you're using it for yourselves? Or both?

Both. So you think about -- we're using it at the enterprise level. We're using it at the engineering level from a use of it, but we're also deploying it into product. right? Because if you think about the current big AI build is infrastructure and it's data centers, and we're benefiting from that. Lots of companies are benefiting.

And what do you do there, by the way?

So for us, today, our primary exposure is, obviously, our test business benefits for all the testing around the high-performance compute and high bandwidth. But if you go into the data centers, they have our hotspot power products in there. And then we've talked about the new wins where we've got vertical power that's coming online at one of the hyperscalers and it starts shipping for us in the fourth quarter. And then we're already shipping an optical module that's going to go into one of the large high-performance compute companies. So those are the primary areas today in the infrastructure exposure for us. But as we think forward to AI at the edge, right. So that's the transition from large language models more to small language models out at the edge. So being able to do compute closer to where the physical signals meet the digital.

What would you be selling into that?

So for instance, think about a -- I'll give a couple of examples. One that we're already doing is noise cancellations for hearing aid. That sound is incredibly dynamic. If you have a fixed algorithm in the ear piece, you don't -- you can't react as well. We are now shipping with dynamic algorithms, mini AI in the -- say again, neural net, neural nets. So that you can dynamically react to get better noise cancellation. Another example, if you think about where factory automation is moving and robotics and the increased need for that. Of course, as we build more and more factories, there's not enough people to fill them, you need more robotics. But if you think about some of the challenges you face with robotics is power consumption. right? It's latency, right? If you've got a robot that's got to react, that's got to -- you want to -- and security. Well, so having the compute at the edge on the device reduces power consumption, reduces latency and increases security. So the opportunity to build those things into our chips so that in a robot, you can do the compute at the edge where the sensing and the physical data is gathered. So I think that is a -- and you've heard Vince talk about this. I think that is a really big opportunity for us and the next gen of AI is getting AI into our products out at the edge, edge.

So it's interesting. Like on each earnings call, Vince, like he picks a topic and he kind of goes into it a little more depth. And I heard him talking about space and he talked about robotics and AI in health care. What are the areas that you guys, I guess, collectively would be most excited about? Or do I just go back and like listen to the last like earnings calls that what Vince had called out.

I think Vince does a great job calling things out. If you think about some of the broad global trends, our ability to help with the energy transition is super exciting. Think about some of the products we've developed in the automotive space for battery management, grid management type potential, right? The grids around the world are old and need an update...

You have the same technology, by the way, the battery management systems, auto that you're doing versus grid?

Same concept, yes. But it's also -- we're looking at other ways to help them do more intelligence of the sensing on the grid, right, so that they can better manage what they have. So that's a tremendous opportunity. We've talked a lot about robotics. But for us, that continues to be significant, one, because of the need for incremental robotics; and two, the change, right? We're moving from -- we moved from fixed and now we've got autonomous and now we're going to have the humanoid robot. Every move that way is more content for us. So that is super exciting from us -- for us as we look forward. And then one of the parts of the business that has been slow, and we've started to see it finally grow is automation. And going forward, again, following those trends of factory automation, we think that's a huge opportunity for us going forward.

Is that sort of where the incremental R&D dollars are going right now?

So we spend our -- it's interesting. We spend a significant amount of our R&D just on our core analog portfolio. And then we're looking across what are the most impactful areas and where do we spend our R&D, and we're targeting our incremental R&D across these megatrends to make sure we're capturing that going forward.

Got it. What do you guys do on the digital side, if anything? I know you used to have a DSP business. You never talked about it. I don't even know if it's there anymore. But is there anything you do like on the digital? I mean a lot of what you do also be like maybe it's not pure analog, maybe it's like more what people call mixed signal. I don't know.

Well, so we're continuing to actually on the digital and software side to develop products to go into our -- enhance our existing chips. We do have the mixed signal stuff that you mentioned, but we're also working on more compute type products, I would say.

Okay. You don't talk about it anymore.

It's harder to move the needle when you get to be over $10 billion, Stacy.

I hear you. I hear you. Can you talk about the shift? ADI was one of the few companies that actually did attempt to be a consolidator in analog. And I think there was a lot of hesitancy to believe that there was value to be added to this idea that like we can't get cost synergies because you don't want to fire the engineers. And I think you guys have kind of proven over the years that this can work. And you bought at least in my history, at least three companies that we know that was Hittite, which was more of a bolt-on at the time, but reasonably sizable and went well and then.

An amazing technology, I actually worked on their IPO.

Yes, looks like it's gone very well. And then Linear clearly, which was -- that was sort of the first like really big swing and then more recently, Maxim. And even the timing on Maxim was really interesting, when it was 2020, I think we announced it, right? In hindsight, that was a good timing. But I guess, how was that decision made? Like why was the decision made to go out and be a consolidator? And I guess the other side of that, why is M&A now no longer needed? Is it just that you can't or that you don't want to?

So I'll go back to the beginning. I don't think we've made a decision. I know we haven't made a decision to move away from M&A.

Well, I mean, there was a decision that like you -- post Maxim, I mean, maybe this doesn't hold anymore. I don't know, who knows the [ poker ] going to return 100% of cash.

We did say post Maxim, we would, over the long term, try to return 100% of our free cash flow. And I talked a little bit about -- we didn't do that last year. That was pretty conscious given all the turmoil, we were trying to make sure we had a little bit of liquidity. We are very happy with our analog, mixed signal and power franchises. However, we've talked about investing significantly organically on digital software and AI. We are also continuing to evaluate opportunities from an M&A perspective in those spaces. And as you know, from watching our history, we're pretty selective about what we do from an M&A perspective. So we are out looking for opportunities that either help us advance time to market with something we're working on or identifying technologies that could broaden our portfolio and give us ability to solve more complex customer problems. So they're not mutually exclusive, I guess, is my point because we have not done a large acquisition in a long time -- in multiple years.

Is it possible to do large acquisitions anymore?

I would say in the current environment, it would be very difficult to do a large acquisition, just given the regulatory climate and the current level of discord among some of the folks that would have to approve a deal, probably easier to do smaller deals that are domestic or less cross-border. But we will continue to evaluate Stacy, because I do think that's an important part of one of the things we've done well, and we see it as opportunistic. Now what's more likely near term is -- and I hate this word, but everybody use it, more tuck-in type acquisitions that can help accelerate things for us.

Yes. I hate that word. Let's forget that word.

Because everybody has got a different definition of a tuck-in.

I guess. I don't know if I want to ask you what your definition is. I guess on the cash that's on the balance sheet, so you're right, you didn't -- and I totally understand you wanted to build a little bit of liquidity last year. What are your thoughts on that use of cash? You historically had like a 1.5x like leverage target, which you've been running well below. Like does that target still make sense, especially given where interest rates are now?

Yes. I think that when we go through and we do a pretty significant refresh and update and look at what the right balance is from a weighted average cost of capital. Over the long term, I still think that 1.5 is a good target. It's maybe probably a little bit lighter than what you might see across some of our peers from a leverage perspective. But what we've shown in the past is we're willing to up the leverage a bit in times of a big acquisition and then work our way back down, given, as you said, it's been a few years since we've done a major acquisition. We're running a little bit lighter. But that I still think that, that longer term is the right sort of benchmark for us from a leverage perspective.

And I guess within the long-term 100% cash flow returning, do you want to remind the audience like what your thoughts are on the dividend growth versus buybacks?

Yes. So we've continued to grow our dividend. And I think what we try to tell people is we want to grow at 10% through cycle. And so that -- and our typical target and where we try to stay is the dividend, but roughly 40% to 60% of our free cash flow depending on how it shakes out. And then the remainder we'll use for buybacks. So those of you that were watching, obviously, the first half of this fiscal year has been a little bit lighter than the 100%, but that's largely just timing of the -- Q2 is a tax payment quarter, all those things. So we don't do a ton of buyback in Q2. We did about $100 million more in Q2 than we did in Q1. We would expect an acceleration of the buyback in Q3 and Q4 to get us to the 100%.

Got it. Were there any CHIPS Act like impacts on free cash flow coming up or tax credits?

So we talked about this in a couple of our calls. This quarter, just past Q2 was the first time we saw a real cash flow impact from the CHIPS Act. So we had about $100 million of tailwind, which we've been talking about. And that's the biggest -- in the near-term biggest cash flow impact. So far, we're still only seeing minor impacts on our P&L just given the grants we've received are not huge. We've publicly talked about we had a preliminary award for CHIPS Act money. We're still going through the finalization process with the new administration, which is progressing.

Is it?

Yes. yes, we actually feel reasonably good about where we're headed from a -- now part of that is we're continuing to invest and build in the States.

Yes. You build it anyways, so presumably, right?

I think there is some of it that's been -- is continuation, but there's something -- new things that we probably wouldn't do if we weren't getting the funding.

We've got about 1 minute left. We've got a room full of folks here. I mean I'll give you your soapbox, like why should everybody here buy your stock?

So I think it's a great question. So first and foremost, one of the things ADI has been able to demonstrate over the long term is the ability to grow and to generate profits and to generate free cash flow. And as we start to look at the signals that are starting to show up in our business, really important for us to grow industrial and what we wanted people to take away from our Q2 call was industrial seems to be back on a growth pattern, which is a significant needle mover for us. We are -- continue to lead from an innovation perspective and our customers want us to do more. So the opportunity for continued growth is significant. So profitable, lots of free cash flow, and we think there's opportunity to continue growing.

That's fantastic. I think we'll close it out there. Rich, thank you so much. All right. Appreciate it.

Thank you, Stacy. Appreciate it.