Analog Devices, Inc. (NASDAQ:ADI) Q4 2022 Earnings Call Transcript

Analog Devices, Inc. (NASDAQ:ADI) Q4 2022 Earnings Call Transcript November 22, 2022

Analog Devices, Inc. beats earnings expectations. Reported EPS is $2.73, expectations were $2.58.

Operator: Good morning, and welcome to the Analog Devices Fourth Quarter and Fiscal Year 2022 Earnings Conference Call, which is being audio webcast via telephone and over the web. As a reminder, this event is being recorded. I’d now like to introduce your host for today’s call. Mr. Michael Lucarelli, Vice President of Investor Relations and FP&A. Sir, the floor is yours.

Michael Lucarelli: Thank you, Betsy, and good morning, everybody. Thanks for joining our fourth quarter and fiscal 2022 conference 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. On to 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 in our periodic reports and other materials filed with the SEC. Actual results could differ materially from the forward-looking information as these statements reflect our expectations only as 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. And with that, I’ll turn it over to ADI’s CEO and Chair, Vince. Vince?

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Vincent Roche: Thank you, Mike, and good morning to you all. Well, I’m really extremely pleased to share that we delivered another record quarter, capping off what was a better year for ADI. Our fourth quarter revenue was $3.25 billion, and adjusted EPS was $2.73, and both at the high end of our outlook. For the fiscal year, revenue was $12 billion, up an impressive 26% year-over-year on a combined basis. Our Industrial, Automotive and Communications markets delivered all-time high revenues, and our Consumer business continued to grow despite industry-wide weakness. Adjusted EPS increased by nearly 50% to $9.57. We also delivered on our commitment to return 100% of free cash flow to shareholders in ’22, returning $4.6 billion through share repurchases and dividends.

These results not only exemplify the strength of our portfolio, but also our deep customer focus and the hard work of our employees to fortify ADI’s brand. To that end, in my recent conversations with customers, the message has been very clear. While we’re not immune to supply disruptions, ADI’s service, quality and support throughout this challenging time continues to be outstanding. Importantly, this sentiment is shared by customers of all sizes and across all markets. As a result, our customers are calling upon ADI to engage in longer term, more strategic collaborations to develop solutions that further empower the intelligent edge. So to ensure we remain at the forefront of technological advancements and customer service. We invested $1.7 billion in R&D and $700 million in CapEx in FY’22.

Now let me start with R&D. Our investments are targeted at strengthening our foundational high-performance Analog franchises as well as moving up the stack to create more complete solutions for our customers. A prime example is our Apollo platform, which we previewed at our Investor Day in April. Apollo is a flexible high-speed signal processing platform with unmatched levels of functionality, integration and performance, making it ubiquitous for all customers, but especially appealing to those in the broad market. During the quarter, we began sampling this innovative platform with our aerospace, communications and instrumentation customers and their feedback has been extremely positive. Turning now to the operations side. Over the last year, we invested a record amount of CapEx to increase our manufacturing output.

And in 2023, we are, once again, investing aggressively in our U.S. and European factories to significantly expand our capacity. These investments will create a more flexible and cost-effective hybrid manufacturing model by increasing our swing capacity to around 70% of revenue in the coming years. Our R&D and supply chain investments are essential to support our design win pipeline, which expanded by more than 10% in ’22. This growth was led by our automotive energy systems and digital healthcare businesses. Notably, our growth in Automotive was underpinned by battery management systems, or BMS, which now has an opportunity pipeline nearing $4 billion. This year, eight new manufacturers designed in our BMS solutions, including two that plan to utilize our wireless platform.

Our strong leadership position combined with increasing EV penetration globally, gives me great confidence in our future growth prospects. Looking now at some selected design activity in the quarter. In industrial automation, we were designed into an advanced diagnostic system that monitors machine health at a global supplier for energy exploration. Our system solution approach enables an approximate 50% reduction in size and lowers wiring costs meaningfully. In aerospace and defense, we won RF module programs at multiple defense prime contractors. Our modules integrate hundreds of components to simplify the design process for our customers, while increasing our content from hundreds to thousands of dollars per system. In industrial instrumentation, we secured wins at two market leaders of next-generation high-voltage testers for electric vehicles and renewable energy systems.

The combination of our high voltage processes and precision technology enables us to deliver accurate, reliable, and efficient testing required to scale the manufacturing of these systems. And lastly, in Communications, we expanded our leadership in 5G radio systems with our transceiver portfolio winning additional share at key suppliers. These new wins position us even better as 5G networks roll out globally, especially in India, and ORAN begins to proliferate. Importantly, our design pipeline is beginning to benefit from cross-selling our ADI and Maxim portfolios. This puts us on a path to achieve our target $1 billion in revenue synergies. For example, at a European auto manufacturer, we built upon our strong audio connectivity position to cross-sell our high-speed GMSL technology, connecting their advanced driver systems.

We’re also capturing new opportunities with GMSL in the Industrial market. Last quarter, for example, our technology was designed into autonomous order fulfillment systems at one of the largest e-commerce companies. We’re also making great inroads with our broader power portfolio, where our opportunity pipeline increased by double digits last year. Our increased breadth is helping us to better match customers’ performance and power trade-offs across more applications, expanding our power SAM to nearly $10 billion. For example, at a leading European industrial customer, our position in mid-voltage power for distributed I/O control systems enabled us to pull through additional power content and precision signal chain sockets, thereby doubling our content per system.

Our expanding pipeline and significant revenue synergy opportunities instils greater diversity and resilience into our business, while adding new growth vectors. And taken together, I’m confident in our ability to bend the growth curve and move from our historical mid-single digit growth rate to our long-term model of 7% to 10%. So in summary, while the macro crosscurrents are creating an abundance of uncertainty, ADI has successfully navigated many slowdowns over the course of our 57 year history. The strength of our franchise allows us to invest through business cycles, ensuring we continue to deliver breakthrough innovation, deepen our relevance to our customers and capture the emerging secular opportunities at the intelligent edge. And so with that, I’ll pass you over to Prashanth.

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Prashanth Mahendra-Rajah: Thank you, Vince. Let me add my welcome to our fourth 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. We closed fiscal 2022 as our second consecutive year of record revenue and profits. We delivered sequential growth each quarter, achieving a new all-time high of $12 billion in revenue; gross margins of 73.6% increased 270 basis points due to favorable product mix, stronger utilization and cost synergies; operating margin of 49.4% increased 700 basis points, reflecting strong execution on OpEx synergies’ and adjusted EPS increased nearly 50% to $9.57. For the fourth quarter, revenue was $3.25 billion, finishing at the high end of our outlook.

As I cover the performance by end market, both for the quarter and full year, my growth comments are on an adjusted combined basis where applicable. Industrial, our most diverse and profitable end market hit another all-time high and represented 51% of quarterly revenue. Growth was broad-based with each major application increasing sequentially and year-over-year. For the year, Industrial expanded 29% with growth in each business. Notably, digital healthcare was up over 30% and has now achieved seven straight record years. This consistent success in healthcare underscores the breadth of our ICs and subsystem solutions in a key secular growth market where such performance is critical. Automotive, which represented 21% of quarterly revenue, achieved another record year, growing both sequentially and year-over-year.

For the year, Auto was up 31%, a favorable mix of premium vehicles, our growing BMS, GMSL, A2B and functional safe power franchises, combined with enhanced value capture drove significant growth compared to SAAR. Together, these franchises of BMS, GMSL, A2B and functional safe power represent over $1 billion of Automotive revenue. Communications, which represented 15% of quarterly revenue, achieved another record quarter with strong sequential growth in wireline, while our wireless business was about flat. For the year, Comms grew 27%. In wireless, our strong position in radio signal chains is enabling the 5G rollout globally. And in wireline, our optical and power portfolios benefited from the continued demand for bandwidth. Lastly, Consumer represented 13% of quarterly revenue and was up modestly sequentially and flat year-over-year.

Despite a challenging year for the broader industry, Consumer finished up 8%. This growth is a testament to how we have diversified our Consumer business and the innovation premium our products command. Today, approximately 30% of revenue is derived from long life cycle prosumer applications, including next-gen conferencing systems, professional AV and home theater, while the remaining revenue in Consumer relates to the faster-growing wearables and hearables as well as premium smartphones. Now I’ll move down the P&L for the fourth quarter. Gross margin was 74%, up 310 basis points year-over-year driven by favorable product mix and synergy capture. OpEx was $744 million, down slightly sequentially due to the realization of additional synergies.

And operating margin increased 800 basis points year-over-year, finishing at a record 51.1% as we exited the year with roughly $350 million of synergies realized across OpEx and cost of goods in our run rate. This incredible pace of synergy capture would not have been possible without the dedication of our integration office and the cross-functional teams that supported them. Non-op expenses were $57 million, and the tax rate was 12.2%. All told, adjusted EPS came in at $2.73, up 58% year-over-year. Moving on to the balance sheet. We ended the quarter with approximately $1.5 billion of cash and equivalents and our net leverage ratio continues to remain below 1. Days of inventory increased to 140 while channel inventory was once again below our target range of 7 to 8 weeks.

Let me provide some additional details on our inventory. But first, during these uncertain times, we believe it is prudent to temporarily hold more finished goods on our balance sheet instead of shipping into the channel. This provides us with enhanced flexibility to better align supply with end customer demand across regions and markets. Second, raw material and WIP are increasing as we begin to rebuild our die bank. Over the last couple of years, our die bank was drastically reduced. And in some cases, sits 50% below optimal levels. Die bank inventory is highly cost efficient and it’s critical for customer service as it can be used for different markets and customers. We believe higher inventory is crucial to reducing lead times as we look to return to our 4- to 8-week target service level over time.

Given these actions, we expect inventory to increase in the near term before trending back down as we balance die bank rebuild with finished goods depletion. Moving to cash flow items. CapEx was $305 million for the quarter and $699 million for the year or 6% of revenue. As we outlined at our Investor Day, we expect elevated CapEx through 2023 at around high single digits as a percentage of revenue. For fiscal 2022, we generated $3.8 billion of free cash flow or 31% of revenue. This is lower than normal given our higher capital intensity and onetime transaction and restructuring costs. These near-term headwinds were not unexpected when we outlined our long-term free cash flow target at our Investor Day and we remain committed to growing free cash flow to 40% of revenue.

As a reminder, we target 100% free cash flow return. We aim to grow our dividend at a 10% CAGR through the cycle with the remaining cash used for share count reduction. And during the year, we returned more than 100% of free cash flow to shareholders. We repurchased $3.1 billion in shares, reducing share count by nearly 4%, while paying $1.5 billion of dividends. So let me close with a brief update on the current operating backdrop. As we noted last quarter, the uncertain and slowing macroeconomic environment has had some impact on demand. However, after a couple of months of slowing orders, we saw bookings stabilize during the quarter at what we’d consider relatively normal levels for entering our first quarter. Not surprisingly, bookings remain the strongest in the Industrial and Auto, while Communications and Consumer are weaker.

We’re guiding first quarter revenue to $3.15 billion, plus or minus $100 million. Given this environment, we thought it might be helpful to be a little more prescriptive in our outlook by market. So in the first quarter, we expect Auto to be up slightly sequentially; Industrial about flat; Comms to decline by mid-single digits; and Consumer to be down double digits sequentially. At the midpoint of our outlook, revenue will be up high teens year-over-year and our B2B markets increasing over 20%. Op margins are expected to be 50% plus or minus 70 bps. Tax rate is expected to be between 12% to 14%. And based on these inputs, adjusted EPS should be $2.60 plus or minus $0.10. So stepping back, we are well positioned in the near term, but the environment remains highly variable and dynamic.

ADI like the rest of the industry is not immune to a softer macro environment; and thus, we remain cautious, yet optimistic. Longer term, we have over a year of backlog and continued momentum in our pipeline. We also have high flexibility with our hybrid manufacturing model and several OpEx levers in our toolkit to support our industry-leading margins and maintain robust cash returns to shareholders. So let me now pass it back to Mike for the Q&A.

Michael Lucarelli: Thanks, Prashanth. Now let’s get to my fair part of the call, the Q&A session. We ask that you limit yourself to one question in order to allow for additional participants on the call this morning. If you have any follow-up question, please queue and we’ll take your question if time allows. With that, can we have our first question, please?

Q&A Session

Operator: Our first question today comes from Tore Svanberg with Stifel.

Tore Svanberg: Yes, thank you, and congratulations on another record quarter. Vince, a question for you. When you talked about the design wins, some of the design win activity, we continue to hear more and more of the system solutions. And I was just wondering if you could add a little bit more color on how your growth is being driven by higher ASPs? So I’m not suggesting higher pricing, right? I’m talking about higher ASPs because all of your products, obviously, moving up the value chain to more of a system solution type perspective.

Vincent Roche : Yes. So thanks, Tore. Firstly, if you look at our ASPs compared to the Analog sector, we have a 3x multiple. And versus our closest competitor, we have a 5x multiple, and that diversion has been growing over the last several years. So, we decided quite a while ago that across the markets and the applications that we really cared about that what was really important for us to do was boil down the increasing complexity that our customers are dealing with in their product development systems and activities. And so essentially, what we’ve done is we’ve taken that complexity into ADI. We get to the other side of that complexity with the quality of our innovations and our ability to be able to couple many, many different facets of our portfolio together in areas like power management.

We’re building these 3D stacked module systems, sometimes with ASPs of hundreds of dollars. If you look at our 5G radio systems, same thing. We combine microwave. We combine data conversion, power, digital algorithms and so on and so forth. So we have — within the company, we believe in diversity of technologies, solutions customers and that choice of business model, Tore, at the end of the day and how we execute it gives us the richer ASPs when compared with our competitors.

Michael Lucarelli: Go to next question please.

Operator: The next question comes from C.J. Muse with Evercore.

C.J. Muse: Thank you for taking the question and happy early Thanksgiving. I guess I was hoping to probe a bit more around the cautious but optimistic view. You talked about orders stabilizing and a backlog that extends out 12 months. So I guess, first question, can you talk about what kind of scrubbing you’ve done on that backlog? And then secondly, based on that, how does that inform your outlook heading into fiscal ’23?

Prashanth Mahendra-Rajah : Let me take that and help give some color on the demand, order booking. So if you step back and think about last year, the first half of the year, we had orders at historical highs. And then last quarter in the earnings call, we called out that orders are beginning to slow, and that’s a decline actually continued into the fourth quarter. However, we saw orders start to stabilize about midway through the fourth quarter and into the first couple of weeks here of the first quarter. So there was bookings our strongest in Industrial and Auto, not surprising and weaker in Comms and Consumer, which I reflected in the guide. From a geo standpoint, we’d say that not surprising. We’re seeing weakness in Asia, especially China, but North America and Europe are holding up well.