Analog Devices, Inc. ($ADI)

Really delighted to have the team from Analog Devices, join us this morning, Rich Puccio, the Chief Financial Officer. We'll go through my list of questions, but please feel free to raise your hand if you would like to bring up anything. But really warm welcome to you, Rich. Really appreciate you doing this conference.

Thanks, Vivek. Thanks for having us. We appreciate the opportunity. .

SP1 Wonderful. So maybe let's just start with kind of the state of the union, right? -- semis, I guess, understatement. Things are quite exciting. Your business has gone through really stepped up, right, in terms of your growth. So maybe just walk us through how things have evolved since the start of the year, what you expected, what you're seeing right now and then we can walk through the different end markets.

Sure. So I'd say we've been on a journey since the trough of the cycle, and we talked about this, and I've talked about this in prior calls, right? We've had some actually pretty resilient parts of our business that started to show signs of growth as early as the back half we continue to see continuing -- continue to see demand in that area grow those idiosyncratic areas. I'll go back to those in a minute. But what we talked about was we were waiting to see the sort of cycle recovery and what were the signs we would look for in the cycle recovery. And probably 3, 4 quarters ago, I started to talk about what we really haven't seen yet cycle-wise, was the growth in the mass market, broad market part of the industry. And we have now seen over multiple quarters, very significant growth in the mass market part of the business, which for us is 1 of those classic signs of the up cycle. So I would say, as we were progressing throughout the year, we were expecting to see the cycle growth add to the idiosyncratic growth, right? And we've talked about that we were very strong already in ATE, aerospace and defense. -- and some of the stuff that was going on data center in our communications business. And I think what's been a couple of things that from an overall perspective that have been I don't necessarily surprising, but I guess that probably is the best word. The continued acceleration in the ramp in the AI infrastructure spend. And really should just say infrastructure spend because they are also building non-AI data centers out there. But broadly, the infrastructure spend. And the other thing that we're seeing happening and we're just starting to see this now is sort of this halo effect from that infrastructure build impacting the other parts and the other end markets that we serve. So whether it's in the industrial space, the companies that are helping build the infrastructure, whether it's the electric infrastructure, the power infrastructure, et cetera, So in addition to the core products that we've been selling into the data centers, we're starting to see demand in other parts of the end market. I think that's been one of the nice upside pieces of this for us. from an overall perspective. And the other area, and I'm sure we'll talk more about this. For us, that we saw some acceleration earlier than we expected was in automotive. We had said coming out of Q1, despite what we were seeing for the early results in '26 that we were still expecting auto to be a growth business for us, even coming off of record 25. We expect that we could grow year-over-year -- and we saw some evidence of that with some pretty aggressive acceleration in orders in the back half of the last month of our last quarter and some record levels in a couple of our jurisdictions. Those are some pretty positive areas where we did even better than we had thought. And we already had a pretty aggressive view of how we would perform in those areas.

Got it. How do you assess -- Rich, I think you have a unique perspective on the space, right, having come in from an outsider right perspective into this analog story -- so when you look at the quality of orders, the quality of backlog, how do you make sure that it's not double ordering? How do you make sure that this is these are not pulled forward just because everyone is constrained on a relative basis, it might be easier to buy analog products versus, say, leading at logic or DRAM. So how do you assess that?

So a couple of things. When we look at it in a number of ways. One of the things we always look at is we always are mindful of what the long-term trend across semis has been and where we are relative to that growth line, right? Because when you start to ship above that growth -- that consumption line is when you're potentially starting to build inventory. And that's something we focus on. We do not think we're there. And a good example is industrial, right? It's 50% of our business. It was the 1 that declined the most. It's also the 1 that's been growing really strong. But when you look at that business, we're very lean in the channel. We're running a leaner channel than we've run historically. -- in that sort of 6 to 7 weeks, and our channel is predominantly an industrial business. The other thing we look at is just look at the ordering patterns and demand. So if you think 40% of our industrial, for instance, when you look at that, that demand is coming from aerospace, defense and infrastructure. Those are areas where we can clearly go to the end markets and see what is driving that demand. right? And we think that, that is ordering to the current period demand because they're growing so fast. So you feel very good about that. But then that leaves 60% of our industrial business. You say how good do you feel about the growth and the longevity and the legs for that? Well, 60% our industrial business is still approximately 20% below its prior peaks and below that consumption line. right, which means there's still certainly room to run across the broader part of the industrial. And then you go down to the next end market communications. Obviously, we talked about -- I talked about on the call. It's now data center is now 3/4 of our communications business, and that is growing aggressively with the infrastructure build-out. Again, so I feel good that, that's real demand actual build-out. And if you listen to the hyperscalers and the platform companies, CEOs talk, what's constraining them from growing is capacity. So we haven't even scratched the edge for existing demand with capacity. So they're continuing to build. So I feel like that is also real demand. And then you look at auto, and you look at what's going on, where are vehicles trending to grow more? And where for us, ADI specifically, do you see bigger content opportunities? Obviously, EVs for us, we've talked about, give us the best content opportunities. China EVs continue to grow, even if units stay flat there, given their drive for penetration into Level 2 ADAS right? They're talking about trying to move from 10% penetrated in Level 2 ADAS to 20% to 30%. So each jump in that penetration creates more content for ADI in the vehicles, they're producing. And so that shows up in how our auto business has grown, right? Auto today is -- China auto is 30% of our business, record year last year. running very strong again this year. And over a trend line period, if you look over 10 years, even in a flat SAAR environment, we grow low double digits. Over the last 5 years, as the ADAS and immersive cabin experiences have expanded, our business actually grows 15% better than the SAR units. Now in the current environment, our best information I would say that SAAR numbers are probably going to be down to close to 24 levels. So we don't -- we're not facing our growth expectation on units. It is our share and our content. And the other piece of data that is really helpful that we can look and you can look at the percentage of analog parts not analog devices, but analog parts in vehicles over time. And over the last couple of years, you started to see a decline in the dollar value of that content ADI has continued to increase, which we think is 1 of those good evidence points that, in fact, we have been gaining share. And so the strength in that market has been really positive for us. So -- and I don't feel like we've yet seen any of that inventory build behavior. We did in 25 see buy ahead behavior in auto, but we feel like they have burned through that and are now buying back to their normal demand in the period.

Got it. Another, I think, aspect that I would give your team a lot of credit for is actually being very upfront and calling out when you do see that buy ahead behavior and even quantifying it -- and then also quantifying right, where pricing is, right? So I think your team deserves what kind of operational things are you instituting to give you better visibility, right? I mean you have a great AWS background. So how many of those tools are you kind of implementing, right or tools like them, are you implementing to catch again, back to the question of the quality of the demand and backlog that you're seeing.

So it's interesting. Our team has always -- actually when I arrived, has had a an amazing amount of statistical data and tracking around bookings and order rates and backlog tracked very closely some of the most important metrics we look at. We're also building building forecasting tools, leveraging more of the AI, which I think everybody is doing at this point to be able to give us a better signal because 1 of the -- and this is a double-edged sword. One of the good things is we've kept lead times pretty well in check, right? We've talked about it in the past. We have kept -- the vast majority of our product goes out inside normal lead times. We have had some minor -- stretch in some of the real high-mover areas. But in that environment, and this is 1 of the lessons I learned on the other side, in that environment where the lead times stay in check, you don't have a lot of motivation to put orders on the books early. So we see that. Now what we started to see is we're getting more orders out of a quarter beyond where we would historically have had them as things appear to be getting tighter broadly across analogs. So I think -- what we then have to rely on, and these are the things our teams work really hard on is being close to customers to get their outlook on forecast, right? Because thinking about our process, we're building wafers, starting wafers now for 2 quarters out. We don't have 100% of that all booked in the backlog, right? We work aggressively in mechanistically, what our teams are doing every day is getting to customers and encouraging them. Look, we're getting your forecast, but your best way to help us all manage as an industry, you're production requirements is get orders in. So we are starting to see a little bit more visibility from an orders perspective of it is because folks are starting to get more visibility that they're on a sustained growth trajectory, but there still is a little bit of -- we have to be able to get -- continue to get better and better forecast data to map up with the historical -- but I think we've done a really good job. Our team is our manufacturing and global ops teams have been very agile. You've seen we've been able to capture a whole bunch of upside. We just posted a record quarter we've guided another record quarter. So we've been able to capture that. And we've done that while working pretty aggressively to improve our efficiencies make sure we're getting the most out of the factories. One of the other things we talked a little bit about as we think about the need in this growing demand is we've been expanding capacity now since back to the, I think, the big push started around 22%. We said we would double our internal capacity. We would expand the amount of product that we've qualified externally so that it gives us some flexibility. And essentially by the end of this fiscal year, we'll have completed that sort of doubling of capacity. Obviously, just as part of the normal running the company go-forward CapEx model, we've talked about a 4% to 6% CapEx model. if I take your street numbers for this year and next year, you're talking about ongoing capital probably in the $700-ish million which we will continue to look for optimization improvement, replacing and modernizing tools, expanding capacity as we continue to see this growth, right? The macro indicators, as we've all talked about there, we're talking about semis being a $1 trillion industry, I think we're going to be exceeding $1.2 or $1.3 trillion part of the economy this year. So we are continuing to expand our capacity. Even if you look at our production this year, we add wafer -- incremental wafer starts every right, as we continue to add more tooling to keep up. And obviously, we have very strong foundry partnerships where we've got -- we've had no problem getting the capacity we need I mean I would say the challenge we all have in going forward is getting more capacity out of those will become expensive.

It. SP1 On pricing, it seems that the industry took a lot of pricing in, I think, '22 and '23, then not as much in '24 and '25. And now we are starting to see almost everyone's tape letters about -- where is ADI in terms of taking pricing? How much of this is catch up from just the last 2 years where it was subdued. How much of this is just the inflationary pressure that you are seeing? .

So I guess there's 2 pieces to this. One is our pricing philosophy has always been dynamic. But I think the anchor piece of our pricing has always been -- we lead with innovation. We tend to be there first with the solutions for the hardest, most complex problems where you need domain expertise and product expertise, and we're able to capture a ton of value there. So you see that, right? We've talked about having ASPs that are 4x the industry average, right? Another look at that, that we look at that is very informative as we look at our products because as you all know, we have products that produce revenue for 25 years. But if we look at and cut our products and say those that were 10 years and older and 10 years and younger. ASPs are basically doubled in the young 10 years and younger because we continue to add more solutions, more features, more functionality, and we capture more of that value. So that is what primarily drives our pricing. However, we always watch the cost inputs as we go, and it hit the nail right on the head. We had, for a period of time, been absorbing pretty significant inflation in a few areas and we made the determination given it was going to continue that this was the right time to go recover some of the debt. Now this was not a go improve our margins strategy. I mean we're basically trying to hold the margin given the inflation, whether that was significant inflation in gold in the more near-term period here, it's fuel, which means transportation, et cetera. As we think going forward from a pricing perspective, it will continue to be dynamic. We will continue to watch the inputs and outputs because there's still a lot of uncertainty, right? We don't know what the resolution is going to be in the situation in the Middle East. The longer that lasts, the more knock-on effects that's going to have in the supply chain, right? Because it's obvious when straight-up fuel costs go up, we can all see that. but there's an awful lot of things that are petroleum based that are manufactured -- part of the manufacturing process, particularly in the back end. So we'll continue to watch, and it will be dynamic. But the other thing important thing around the pricing, you're absolutely right, in 2022. -- were massive industry-wide pricing increases. I think TSMC did a big price increase and everybody passed it along. But what's been different for us is, as we've talked about, our pricing has remained pretty stable across '24, '25. And then we just did our sort of first big price increase in '26. Now we've talked in the past, we've always had some back and forth on pricing dynamics because of our legacy products that stay around forever, get price uplift, things like that. But this is our first broad increase. We'll continue to watch the dynamic, right? Because we're trying to be prudent and fair to our customers while also trying to maintain the financial model you all expect from us.

Got it. Do you think some of your competitors in, let's say, power semis or other areas are actually taking on pricing even more aggressively than the AI. And if yes, do you think that gives you an opportunity? Or do you think you would rather just keep the pricing envelope you have right now to just expand market share? How do you think about just kind of both sides of that?

So certainly, I've seen copies of probably all the same letters you've seen for what our competitors are doing from pricing without doing a detailed scrub of their cost structures, I don't know if their margin stacking to get incremental profitability out of the pricing work they're recovering. But for us, Look, we want to be share to customers, and we're going to continue to look at what the cost environment is and where we think it's appropriate that the customer share and some of the inflationary pain, we might have incremental price increases. But I would say strategically, like I said, we're trying to get -- recover from the cost we've had historically and will continue to go forward. But for us, the really important pricing piece is what we do in the design-in phase because that stuff tends to be sticky, and that's where our innovation premium shows up. So that's going to be the more important part of pricing.

Got it. And just the last question there, Rich, which is, I just want to clarify that the pricing is not because of shortages. It is because the passing along the cost inflation aspect? Or is it because of true shortages? Because you mentioned your lead times haven't really changed?

So sorry, I forgot that's right there. No, this was not because of shortages. Certainly, like everyone, there are places in the supply chain where things have gotten tighter, but our supply chains have worked to figure that out, and we've been able to keep up with product demand. We've had, as I mentioned, some small extension of lead times in a few places, but the majority of our stuff is still inside standard lead times. So this is not a supply shortage, so we're increasing your price. This is has been -- we've been absorbing costs on your behalf for a while. And we did a really good job offsetting a lot of them. We've seen that. We've had margin accretion pretty continuously coming out of the trough. But we were doing that while also absorbing pretty significant inflation over that period.

Got you. Okay. Now let's talk about the data center across your power and optics and your ATE business, right? It's close to right of sales, which I think is probably the highest, right, if not the highest, among right, your analog peers. So talk to us about -- how do you see the sustainability of that growth, right, among those 3 areas, is there a way to kind of rank order where you're seeing faster growth versus kind of more industry growth and bind with the industry?

Sure. I mean, look, everything I see in read and everything you've probably all seen read is that the AI on the infrastructure build-out is going to continue. And I have heard from any number of sources, including from some of your colleagues that the expectation is at least out into 2030 and 2030 plus we'll continue to need to build a structure because we still have demand to hyperscalers and platform players still have demand that can't fulfill. So I think that, that will continue to drive growth for us. If I look at -- obviously, ATE will continue to grow and you can look at the big ATE providers to see what that looks like. And for us, we've been talking about the power and the optical are pretty much equal parts of our data center portfolio. And I think we talked about it being 3/4 of our business. If I would have pick which 1 of those today, I think, has the bigger growth opportunity. Given the strength of our position in Optical, I think the power 1 provides a potential opportunity for bigger growth. right? If you look at us as a player in the lateral power versus what we could be in vertical power, I think there's a big growth opportunity there. One of the things our team saw was this move continues to see -- and you're seeing in the industry is the move to higher and higher voltages -- the move to 800 volts is going to drive increased demand for products to be able to -- particularly to be able to deliver that sort of last millimeter to the chip, right? And what we're seeing is the technologies out there. One of the ones we talked about is this IVR technology that comes with Empower, -- that can reduce power consumption, 10% to 15%. It also reduces the footprint of that module underneath the polis probably not the right word. The footprint on the board -- it also eliminates some of the ancillary structures that have existed in the current vertical power and makes it a highly efficient structure. So we think our opportunity to be in there as an early player gives us a chance to be a much bigger player in vertical power. Now when you think about how we know if we're being successful there, obviously, part of it is going to be, do we see this continued shift to a vertical power architecture. I think 6, 9 months ago, we were talking about having 1 win in and people were starting to use vertical power more and more of the discussions I have and that our data center team is having is vertical power is going to be a key part of this build. We are going to continue to be power constrained. Science has not caught up yet to fulfill all the power requirements if you look out 10, 12 years. So reducing our loss in the data centers will be critical. Vertical power seems to be the architecture for that. So we'll be watching eagerly along with every other power provider, what happens in the architectural design and then getting in early -- and this is the same in any of these spaces for us. Getting in early at the first rev is where you get to learn and be part of the discussions for what the next rev looks like. because you look out to 2030 and the next evolution of power and the next evolution of what you have to do, those are going to be massive TAM and SAM expansions for companies because if the architecture shifts from where it is today and they build at the rate they're building, and I'm sure 1 of your guys are building a model right now that can tell us how many data centers are going to build, how many racks, how many servers, which means how many VP vertical power units are going to sell, and you'll tell me that when you have it, so we can plan. That's going to be the metric we'll watch in the industry is how aggressive is this architecture adopted as we move into the higher voltages because we've all heard that we're going to pump x megawatts even a gigawatt into it. in the future, that's going to put tons of pressure on the power chain. And I think that's an area where in band of the chain were very strong and getting that last millimeter with IVR will give us an advantage.

Got it. So I know that ADI is well represented in 1 of kind of the custom TPU like projects. What's your opportunity in kind of the broader merchant GPU-like projects? And I guess the bigger question, Rich, is that those GPO customers have multiyear kind of product pipelines that are planned out. How early do you get the visibility about your level of engagement, your market share, right? How do you think about that visibility over the next several years?

So as we've talked about, we've had products in -- whether it's in vertical power or optical that get into the large players, whether they're the platform players or the suppliers into the platform players. So will continue to be aggressive because as I mentioned, getting into the earliest version of products gives you the learning cycles to be part of the road map. So getting early engagement in those. And so we'll continue to watch obviously, where we have wins, we'll be working to get more wins across the peer set. So we feel pretty well positioned. And I would tell you the relationship we have across those companies are very good. They bring us in very early. -- it's not getting any easier to build any of these products. And what they want is somebody to help simplify the complexity. And so the more of that we can do for these customers, the more chances we're going to get to win. So I feel like we're very well positioned there, and our team is aggressively going after it. And I've been involved in a number of conversations already with hyperscalers. Our teams are working across a bunch of the companies to be able to make sure we're positioned across the portfolio to support that scale out.

Got it. One other thing in a different area, this is now related to automotive. I found very interesting is that in your last earnings call, it almost seemed like and you just mentioned it as well, that automotive suddenly started to grow, which is very different than the sense I had when the year started, right, that auto was going to be kind of a subdued year. So did that suddenly change? Or was it always according to plan? Or did you really see a shift in all of the man?

So for us, we actually -- and there was a lot of skepticism. I will admit when we talk to investors after Q1 and told people, hey, Q1 was a little bit better. It's softer than seasonal, but it was better than we expected. Q2, we thought we would still be maybe working off a little bit of this pre-buy but we thought the back half would be strong because we can clearly see our share gain and the content acceleration that's happening in auto. And if you -- and if you look at what's going on in the Middle East, it's going to certainly put more pressure on people buying electric vehicles. the more electric vehicles and more demand. So we have always thought from the start of the year that we would grow -- if you talk to our -- the team that runs our auto business, they would have told you we will, despite a record in '25, we will grow year-over-year in auto. -- what happened was we saw an acceleration literally in the last month of the quarter in auto demand that we were expecting to come in Q3. And I think as they look to the adoption of more and more of the L2 ADAS and potentially L3 ADAS in China, by the end of the year. I think we started to see an order pickup. And as you said, I'll be transparent. We've always been transparent with what we see in the order book. But in this one, we didn't think this was a prebuy. We could see the content increasing and the very specific drive. Now on top of that, that's the China piece, we had record revenues in Europe and Japan and made. So the U.S. is still not doing that. It's been a bit of the laggard. But the other thing that happened which was good. We expected it, but it's also another indicator we hadn't grown -- actually, we had declining BMS for 2 years. We just had our first year-over-year growth quarter in BMS in 2 years. And that's really important for us. And that's indicative of the EV right? Because it's the far right of the EVs is where we get the most out of our BMS. So that's been really important for us. on the auto side.

So it's time to declare the bottom of the auto cycle also. And it's -- or do you want to see some more data points before...

I don't know -- it's interesting. It depends how you define the cycle because every forecast is still shows auto units coming down probably closer to 24 levels, which were -- because obviously 25 came up a little bit from 24% back down to 24%. So I don't know if the units has bottomed out. But certainly for us, the content share is continuing to allow us to grow.

Okay. Next thing on the aerospace and defense business side, which has been pretty strong. There's a lot of media reports about the U.S. potentially, right, and other countries potentially wanting to build out right, the stock of all products. Do you see that in your business also do you have that ability that shows that aerospace and defense can continue to...

Yes. Certainly, there's been public discussion about a number of programs, certainly in the U.S. where the government is going to expand. And we have very good visibility. In fact, in addition to -- you talked about some of the AI data center stuff, we're starting to get a little bit more visibility on higher space and defense. But I would say it's not just a U.S. phenomenon. If you look at what's going on globally, there's going to be build out across the EU as they've upped their spending budgets. -- even we're starting to see more upping of budgets in APAC. And so the aerospace and defense business for us has been a strong growth, and we expect it to continue. And the interesting thing for us is we have obviously a very strong part in the defense part of that. But we also do have a good presence in the space part aerospace and defense. So from -- obviously, some of the products that we're well known for from a comms perspective and the technologies there. So we're going to see -- continue to see growth in LEOs, where we have content in LEOs, right? There's all kinds of press. You read it every day about the number of satellites that are continuing to get launched. Plus, we have a lot of product in the base stations that communicate with the satellites -- so it's a pretty broad brush growth for us. But 1 of the great thing is we have a very broad portfolio that is used across a broad spectrum, but we also -- and we've talked about this in prior calls, Vince has talked about our ability to deliver systems and modules into that market is an incredible value capture for us because, again, they don't want to build if they don't have to. They want to get a module and our continued ability to go up the stack is what's helping us drive bigger and bigger ASPs than the ADAS side. So we feel like that is 1 of those areas that is going to have sustained momentum just given even if things settle down commonly, there's still going to need to be a rebuild and replenish phase. So that helps us get some visibility, and we feel like our product portfolio is well positioned there.

All right. Last 2 very quick ones. Gross margins, we saw, right? You have that onetime kind of 50 basis point benefit from pricing, but it's kind of headed on to the 72.5%, right, which is the in the industry. Are there still incremental opportunities to expand that? And then I have 1 final 1 on use of cash?

Sure. So I would say, yes, but I -- what I would say is probably different is if you go trough to peak. We've gotten a significant benefit of driving utilizations up to more optimum levels than we would have been at the trough. I would say going forward, more of the incremental gross margin improvement will come from further mix change. At this point, we're about a 50% industrial business at peak margins, we between 53% and 54% industrial -- so I would say the 2 things that we'll do it will be mix. And then just pure revenue growth given the flow-through economics and the fact that we have been growing at very high rates and been managing the cost curves pretty aggressively. So I do think there is continued opportunity for accretion. I just don't expect increase in utilization to be 1 of those drivers. I think I mentioned that on the call.

Got you. And the last one, Rich, on just kind of use of cash. So ADI historically has done larger strategic, right, M&A. -- it seems now the focus has shifted a little more to kind of tuck-ins, right, and so forth. So as we look over the next several years, do you think there is still opportunity for more industry consolidation? Or we should AD to just kind of focus on kind of smaller tuck-in type deals?

I think the SP276172717 I think the large consolidations that you talk about continue to be more difficult just given the current concentration and regulatory environment. But for us, and we've talked about this, right? We're focused on, one, the revenue synergies that we've been talking about -- and if you haven't heard me say this before, we're on track to deliver $1 billion of synergies by 27%. In fact, we did hundreds of millions in $25 million and we're going to do hundreds of millions more in 2016. I think that's really important. But we are continuing to rest aggressively invest internally in software and digital capabilities in AI, and those will be areas we continue to look and that's an opportunity where we've talked about where if they can help us solve an existing problem, help us get to market faster. -- help us do more for customers. Those are the kind of acquisitions we're looking at. And or is a good example, right? It gave us some massive acceleration on the time line for a technology that we think is going to be a really important technology for the power delivery going forward. So that will continue to be our core philosophies to make sure we get all those synergies and then evaluate digital software and opportunities as they come through.

Terrific. Thank you so much, Rich. Appreciate you -- thank you very.

Thanks, everybody.