Analog Devices Inc (ADI) — Q2 2025 Earnings Call Transcript

Thank you, Josh, and good morning, everyone. Before we start the formal part of our earnings call, I'd like to say a few words about Mike Lucarelli. As many of you may know, this will be Mike's last earnings call as he will be leaving ADI at the end of May to pursue a new career opportunity. I want to thank Mike for his many contributions over his 10 years in Analog Devices. Mike has been instrumental in my transition into the Company, and I will be forever grateful for his advice and guidance as I learn the ropes here. I'll miss Mike's insights, optimism, and relentless work on behalf of our stakeholders. Mike, I wish you the best in your new adventure. I'll now turn the call over to Mike Lucarelli, Vice President of Investor Relations.

Thank you, Rich, and good morning, everyone. I have thoroughly enjoyed my time working in Investor Relations, and that's because of all of you on this call from investors to the sell-side to my colleagues at ADI. Vince, it's been a great 10 years. Rich, that was short and sweet, but it was good. And then ADI crew, the Thunder Alley crew, thank you for everything; the past 10 years have been awesome. Jeff, who I hired over six years ago from the sell-side, has been a great asset to the IR team and ADI overall. He will be replacing me as Head of Investor Relations. Now, Jeff, when I started, the stock was $50. It's now $225, 4x; that means you need to drive this stock to $1,000, and I trust you can do that. So let me pass it to you, Jeff, to host today's call.

Thank you, Mike. It's been a privilege working for you. You've taught me many things about semiconductors, ADI, and life in general. So, while I'm sad to see you go, I am excited for the opportunity, and I'm looking forward to it. Now for anyone who missed our earnings press release, you can find it and related financial schedules at investor.analog.com. The information we're about to discuss includes forward-looking statements, which are subject to certain risks and uncertainties, as further described in our earnings release and our periodic reports and other materials filed with the SEC. Actual results could differ materially from the forward-looking information as these statements reflect our expectations only as of the date of this call. We undertake no obligation to update these statements, except as required by law. References to gross margin, operating margin, operating expenses and nonoperating expenses, tax rate, EPS and free cash flow, and our comments today will be on a non-GAAP basis, which excludes 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. References to EPS are on a fully diluted basis. Okay. And with that, I'll turn the call over to ADI's CEO and Chair, Vincent Roche. Vince?

Thank you very much, Jeff, and good morning everyone. Our second quarter results surpassed our expectations on both revenue and earnings. We saw widespread revenue growth with double-digit increases compared to last year across all markets. Despite the challenging operating environment, our strong performance and positive outlook highlight the increasing demand for our outstanding product range, showcasing the resilience and flexibility of our business model. Although we think the changing tariff situation is influencing our customers' choices, the supportive trends specific to ADI that I mentioned last quarter are ongoing. We are increasingly confident that our revenues reached their lowest point in 2024 and that we will see growth returning in fiscal '25. Our long-term success has come from recognizing business shifts early and quickly adapting, allowing us to focus our investments where we can add the most value for our customers. We have invested heavily in capital expenditures in recent years to improve and expand our hybrid manufacturing model, aiding our customers in navigating the complex geopolitical and macroeconomic landscape. We have increased capacity at our existing facilities in the U.S. and Europe, while also adding similar capacity at our back-end facilities. Additionally, we have strengthened our partnerships with trusted foundries globally, including obtaining more 300-millimeter fine pitch technology capacity at TSMC's Japan subsidiary. We have qualified a large portion of our diverse product range, enabling us to swiftly adjust production across different regions. Consequently, our customers now experience greater supply flexibility and resilience than ever before. On the operational side, we are making record-level investments to further enhance our world-class technology stack and improve our customers' experience and interaction with ADI. These investments position us to fully capitalize on the significant opportunities for profitable growth we see across our markets. ADI thrives on innovation that goes beyond short-term macro issues. We concentrate on five key megatrends that consistently shape the future of business, the global economy, and society: autonomy, proactive healthcare, energy transition and sustainability, immersive experiences, and AI-driven computing and connectivity. As a vital link between the physical and digital realms, ADI plays a crucial role in enabling these trends. We continue to lead and innovate in high-performance analog, mixed-signal, and power management technologies, covering everything from sensors to the cloud. Today, customers are seeking more comprehensive solutions from us. Our extensive franchise, combined with the exceptional creativity and broad expertise of our technologists, enables us to provide sophisticated solutions to challenges that others find difficult to address. For instance, as healthcare shifts towards more preventative measures, our ability to accurately and reliably sense and transmit clinical-grade vital signs in ultra-low power environments is driving significant content and revenue growth among key customers in the smart wellness and wearable markets. In clinical settings, our advanced imaging and patient monitoring technologies are facilitating earlier disease detection and diagnosis, leading to more effective treatments and improved patient outcomes. Regarding the autonomy trend, advancements in industrial automation are presenting immense opportunities for ADI. The evolution of robotics from fixed arms to autonomous and humanoid forms is increasing the need for more sensors, edge computing, connectivity, and energy management, significantly enhancing our revenue potential. In the automotive sector, the rise in autonomy levels is driving demand for our sensing, connectivity, and safety solutions across all types of vehicles, from combustion engines to hybrids and fully electric models. Each new generation of automation, whether in industrial robots or vehicles, expands our revenue opportunities substantially. Another example is the ongoing AI-driven computing and connectivity trend, where the rapid adoption of AI is significantly boosting our ATE and data center businesses. Our leadership in ATE highlights the quality of our offerings, as performance is the key factor in this market. Our content per tester can be worth hundreds of thousands of dollars. Looking ahead, we expect that leveraging our mixed-signal and digital capabilities will further reduce testing times and power needs, leading to increased content per tester. With no signs of slowing in AI investments, the demand for GPU, XPU, and high-bandwidth memory testing remains strong, giving us confidence in long-term growth prospects. Additionally, our data center clients are relying on us to address the complex power and connectivity issues that arise from high-performance, always-on AI computing. This has led to a growing demand for our innovative solutions in systems protection, optical control, and power delivery. These examples illustrate how our offerings capitalize on enduring trends that go beyond business cycles, drive an average selling price four times higher than the industry average, and produce exceptional results for both our customers and shareholders. In conclusion, we have effectively anticipated the changes in the ICT industry and have been proactive in our investments for decades. Today, we are well-prepared to deliver the AI-driven Intelligent Edge solutions that will define our future success. Recently, we celebrated our 60th anniversary, a significant achievement that very few public companies accomplish. While this milestone is exciting, I am even more enthusiastic about our future and the vast opportunities ahead. Before I pass it to Rich, I want to express my gratitude to Mike Lucarelli for his outstanding contributions to ADI's success over the years. I wish him the best in his next endeavor. Now, over to you, Rich.

Thank you, Vince. Second-quarter revenue of $2.64 billion came in above the high end of our outlook, up 9% sequentially and 22% year-over-year. Industrial represented 44% of our second-quarter revenue, finishing up 8% sequentially and 17% year-over-year. Our industrial recovery broadened with all subsectors and regions increasing sequentially. On a year-over-year basis, we continue to see strong growth in aerospace and defense and ATE. Automotive represented 32% of quarterly revenue, finishing up 16% sequentially and 24% year-over-year. This record result was fueled by continued strong demand for our leading connectivity and functionally safe power solutions, particularly in China. Additionally, we saw sequential growth in Europe and North America. Communications represented 12% of quarterly revenue, finishing up 5% sequentially and 32% year-over-year. Wireline and data center, which makes up roughly two-thirds of our total communications business, drove our strong growth as AI build-outs continue to increase demand for our power and optical control products. While wireless revenue declined on a year-over-year basis, it did grow sequentially. Lastly, consumer represented 12% of quarterly revenue, finishing flat sequentially and up 30% year-over-year, our third consecutive quarter of robust growth. This reflects our greater share and stronger content position across a diversified list of applications. Now on to the P&L. Second-quarter gross margin was 69.4%, up 60 basis points sequentially, driven by higher utilization. OpEx in the quarter was $744 million, up $57 million sequentially, driven entirely by variable compensation, resulting in an operating margin of 41.2%. Nonoperating expenses finished at $54 million, and the tax rate for the quarter was 11%. All told, EPS was $1.85, up 32% year-over-year and above the high end of our guided range. Now, I'd like to highlight a few items from our balance sheet and our cash flow statements. Cash and short-term investments finished the quarter at $2.4 billion, and our net leverage ratio decreased to one. Inventory increased by $50 million sequentially as we continue to invest in our die bank to support our recovery. Days of inventory decreased to 169, and channel weeks ticked lower. In the near term, we are maintaining our strategy of balancing leaner channel inventories with higher levels of inventory on our balance sheet. Over the trailing 12 months, operating cash flow and CapEx were $3.9 billion and $0.6 billion, respectively. We continue to expect fiscal 2025 CapEx to decrease materially from 2024 and be within our long-term model of 4% to 6% of revenue. Free cash flow over the trailing 12 months was $3.3 billion or 34% of revenue. During that same period, we have returned nearly $2.5 billion to shareholders through dividends and share repurchases. As a reminder, we target 100% free cash flow return over the long term, using 40% to 60% for our dividend and the remainder for share count reduction. Before moving on to guidance for our fiscal third quarter, let me provide additional color on recent demand trends given the current backdrop. Unsurprisingly, buying behavior was a bit choppier than normal as we saw some increased activity around the tariff announcements. This was short-lived, and orders have returned to more normalized levels. Overall, Q2 bookings grew sequentially across all end markets and all geographies, and our backlog entering Q3 is higher than a quarter ago. These signals support our view that our revenue bottomed in 2024, customer inventories are lean, and we are in a cyclical upturn. Now moving on to guidance. Third-quarter revenue is expected to be $2.75 billion, plus or minus $100 million. On a sequential basis, at the midpoint, we expect industrial and consumer to lead our growth, communications to be up and automotive to decline after a very strong quarter. Operating margin is expected to be 41.5%, plus or minus 100 basis points. This includes the impact of our annual salary increases. Our tax rate is expected to be 11% to 13%. Based on these inputs, adjusted EPS is expected to be $1.92, plus or minus $0.10. Now, I'll pass it back to Jeff to begin our Q&A session.

Thank you, Rich. Now, let's get to our 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 a follow-up question, please requeue, so we will take your questions if time allows. With that, can we have our first question, please?

Great. And congratulations to young Mike. Can you discuss automotive; the 16% sequential growth really stands out relative to what peers are seeing? What's driving that, and do you have any sense for if there's any tariff pull-forward in that or just any mitigation that's happening there? Just how are you growing so much in autos?

Thanks, Joe. I'll take that one. So, Q2 was notably stronger than expected. Bookings were strong, and turns were a lot higher than normal. Given some volatility during the quarter, we do think our auto results were aided by pull-in activity. While it's difficult to delineate what was pull-in versus normal, our estimate for pull-in upside is in the high single-digit range. However, buying behavior, as I mentioned, has normalized, and this is why we expect a decline in Q3, actually. Additionally, if you think about it, if you adjust for what we think the pull-in impact was, we're really guiding a seasonally flat Q3 for autos. On the pull-ins, right around the 25% auto tariff news, we saw an acceleration in auto sell-through and orders, most notably in the Americas and in Europe, which were collectively up about 20% sequentially, much better than we had planned. At the industry level, we saw stronger SAAR numbers than expected in the quarter, potentially also explained by consumers getting ahead of the higher prices. So, our hunch is that the upside in auto right around tariffs was not a coincidence. As for China, the other major market for auto, noted last quarter, we expect continued growth, and we had another record, and that is what occurred in Q2. There could have been some pull-in activity, but not nearly as noticeable as what we're seeing in North America and Europe.

Best wishes to Mike as well. So first, you mentioned that you are at a cyclical upturn. I'm curious, how much do you think you are undershipping demand right now? Is it 10%? Is it 20%? How many quarters until this sort of undershipment impact normalizes? When do you think your sales will start to correspond more to end demand rather than just inventory replenishment? I know you just spoke about autos, but I was hoping you could give us some more color on the industrial side as well and the level of undershipment and then the normalization timing for that.

Yes. Thanks, Vivek. I'll take the first part of the question. Yes. I think, look, we're in a period now where we've got cyclical tailwinds. We've kept the channel very, very lean. We've been undershipping industrial significantly, actually. I think more so than any other market over the past two years. My sense is we're getting back to a more normalized convergence between demand and supply in that area. We're still keeping overall inventory, particularly in the channel, very, very lean. As Rich said earlier, putting more inventory on our balance sheet to be ready for the upside. On the industrial side, I think what we're saying is the franchise, the core franchise of the business, automation, broad base of customers, is recovering nicely. We've also seen some excellent examples of green shoots in aerospace and defense and the AI test area, which I alluded to in my script. We have a lot of new wins in health care and automation. So, there's a good blend of the legacy franchise and the new technologies pushing the company. We've got cyclical tailwinds and idiosyncratic tailwinds as well, given the new products in the new applications.

Yes. And Vivek, what I'd add is I would say from a consumption perspective, we're probably still shipping 10-plus percent below the low-end consumption. If you think about the outlook, if you take our guide, embedded in that guide is about 10% growth in Industrial. At that midpoint, we will be shipping to end demand. We'll continue to balance the channel inventory, but I think we will, at the midpoint, be expecting to ship into end demand in Q3.

And Mike, thanks for all the great support over the years, and best of luck in your future endeavors. Industrial Automation, I think you guys touched on it a little bit, which is one of your larger subsegments within industrial, I believe it's about 25% of the industrial segment. This was one of the last large subsegments to show recovery given the tie-in to global manufacturing activity. Did you guys see further sequential growth in industrial automation in April? Coincidentally, trade and tariff historically have driven weakness in automation as manufacturers pull back in the face of uncertainty. Are you seeing any changes in industrial automation order trends recently, especially out of China?

We have continued to see growth. In fact, when we look at where we ended the quarter from an automation perspective, we actually have a book-to-bill in excess of one. We continue to expect that growth to continue into Q3. In fact, if you look at our industrial business across all of the subsectors of industrial, we have positive book-to-bill in all of those areas above one. We feel like that has improved. Obviously, there's uncertainty across the board around the tariffs. So, it's impossible to speculate what that will do, but we've seen growth in bookings and in revenue.

I think it's true as well right across the whole spectrum of applications, automation. We've seen very strong book-to-bill geographically as well. We're in a solid patch right now, but tariffs are definitely weighing heavily. The uncertainty is, I think, causing certain segments to hold back on build-outs. There's no question about the importance of automation; from many dimensions, we're seeing the kind of normal build-outs of automation and more connected flexible factories. My sense is we'll see a CapEx cycle as localization takes root over the coming several years.

Yes. Congrats on the results. Mike, thank you so much. Wishing you the best of luck. Vince, you mentioned this a little bit in your script, but robotics, I know this is a market you have a lot of exposure to. I think there was a slowdown in that market, especially around the pandemic. But now with AI, it seems that we're sort of at an inflection point. So, I was just hoping you could talk a little bit more about that opportunity and some of the design activity that you're seeing on the robotics side.

Yes. Thanks, Tore, for the question. One of the pervasive trends we're seeing is a demographic shift. I think automation of productivity is going to be endemic across the globe. That predates the concern about the need to localize and so forth. The trend is very, very solid. We're entering a new epoch in robotics. More tactile, more precise robotic systems will use a lot of intelligence at the edge. We are collaborating with robotic suppliers and complementary semiconductor partners to enable this new era of highly tactile precision robotics. Everybody is focused on the humanoid robots, but I think there are many steps to take before that; between the big heavy arm robotics and the more mobile tactile robotic systems. Our content typically in a large arm system would be hundreds of dollars, but as we see more opportunities to bring intelligence to the edge, we see the content in these more sophisticated robotic systems could be an order of magnitude more over the coming five to ten years. This is a long-term persistent trend, and I think we're very well positioned at that edge. AI will enable more and more intelligence at the edge, and that's something we're preparing our solutions to incorporate.

First of all, Mike, thanks a lot for all your help and honesty over the years. First, Dave, Paul, now Mike Lucarelli leaving. This is super depressing. Anyway, congratulations in all honesty. Just a question on leverage guys. If we look at the April quarter results and the July quarter guide, your OpEx is basically growing about as much as sales. The guide for the July quarter, even though you don't guide gross margin, implies minimal gross margin growth. Can you just talk about why that's happening? Should we expect some sort of acceleration in leverage going forward? Or should OpEx continue to grow about the same amount of sales along with gross margin?

Chris, I'll take that one. From a near-term perspective, Q2 operating margin was up sequentially despite the big acceleration in variable comp. In fact, our base OpEx was actually flat sequentially. So, that's what you saw in Q2. In Q3, we do expect to see some continued operating leverage, which will get offset by the impact of our annual salary increases as well as our continued growth in the variable. We expect the increase in variable to be lesser than we've seen in Q2. Just as a reminder, the mechanics of our variable compensation plan are tied to the year-over-year growth in operating margin. Given the absence of revenue growth in '24, it was a pretty low year for us. Considering our return to growth here in '25, variable comp is going to grow and continue to grow meaningfully. While we are optimistic we will achieve operating margin percent growth, the increase in the variable in '25 is muting that. However, for '26, we'll be going off of a smaller base, so we expect to get more leverage if we continue the cyclical upturn.

On the gross margin side, at the $2.75 billion guide, we expect to be around 70%, which we've discussed. Baked into that assumption is that we will see the growth in industrial we're anticipating, which, as you guys know, is our most profitable segment. This has been one of our challenges in getting additional leverage. If you look at just the most recent performance in auto, it puts pressure on gross margin, but as we see industrial leading the growth with the anticipated 10% growth in Q3, we expect to get back to around that 70% margin.

It's worth noting, Chris, that where we are adding OpEx to the company, aside from the inflationary pressures, is in engineering. We see tremendous opportunity across more spaces for analog and power technology, but also digital and software. We're judiciously adding talent where we need it. That's a contributor to the OpEx. Long term, we expect to get the returns and growth from these investments.

I have two quick questions just on the demand environment. First, given the auto dynamics, you talked about SAAR, what are your expectations for SAAR and auto builds like into the second half of the year amid all the tariff uncertainty? I think autos are getting hit more by that. Secondly, you are seeing pull forward in auto; you don't seem to be seeing it in industrial. How would you know if the strength you're seeing in industrial is actually true cyclical recovery versus pull forward in the wake of tariffs or uncertainty?

Thanks, Stacy. I'll address the last one. One of the things we looked at as we tried to assess what we thought might be pull-ins is we track our ordering patterns and expectations around what those patterns were. At the start of Q2, bookings were progressing higher than we expected. Then toward the end of March, around the time we heard about the auto tariffs, we saw an acceleration in automotive, which lasted for a couple of weeks, and it has since normalized. But across the other end markets, we did not notice anything unusual from booking trends. They were as expected, and we ended the quarter with a book-to-bill above parity. Bookings were up in all regions. As I said, we didn't see anything anomalous outside the automotive sector.

Generally speaking, from conversations with our industrial customers, it’s somewhat steady as she goes. There’s no particular anxiety around supply. It's a pretty normal pattern, and we're seeing a convergence between shipping and sell-through.

And sorry, I skipped your first question about SAAR. Our expectation is that we'll see SAAR down in the back half. As mentioned, we still get benefits from the continued increase in content to offset some of that pressure, but we expect SAAR to be lower in the second half.

Mike, all the best. Just a question regarding how all of this might affect the second half. Obviously, it's too early to provide guidance here. With respect to auto, do you think this has normalized such that whatever happens going into the second half is really a reflection of true demand? What about the industrial side as well? How should we be thinking about the puts and takes as we go into the second half?

Sure. I'll talk a little bit about Q3. As I mentioned, we do think we benefited from some pull-ins in Q2. But given what we've seen in order rates since and continuing into Q3, we're not expecting any incremental impact from pull-ins in Q3. Our outlook reflects the acceleration in our recovery, particularly in the industrial market, where we're expecting a very strong quarter. We have strong bookings momentum across all applications and geographies. As we think about the back half of the year, if you remember last quarter, we talked about hitting 7% to 10% for full year growth. With what we saw in Q2 and our Q3 outlook, I am more confident than I was a quarter ago that we'll end at the higher end of that range. However, we will continue to be cautious and mindful given all of the tariff uncertainty.

Mike, congrats on the new gig, and Jeff, congrats to you as well, and good luck with the $1,000 stock price. Sorry to keep pulling on this thread, but I did want to ask about industrial again. You were very clear in your commentary about your books and channel inventory. But do you get the sense that there's any element of your end customer restocking, or do you think this is really just an industrial recovery? The sequentials are better than most of your peers reported, even though they did a month ago.

Go ahead, Rich.

I don't think we've seen restocking. I do think that because they are coming off of inventory lows across most of our customer base. We know this because when we look at net new orders, we're seeing new orders come in from industrial customers. They've had lean inventory, and we've seen their purchasing accelerate. But as we said, we’ve been undershipping industrial pretty significantly for the last two years. Heading into Q3, we do not expect undership industrial in Q3.

We use POS signals as well to gauge true demand as closely as possible. Industrial is the area where we've been undershipping most. We seem to be returning to a more normalized pattern of shipping and sell-through.

I'll offer congratulations to young Mike as well. I actually wanted to ask about the plans to outsource versus in-source. Pre-pandemic, you were leaning more toward external options. When you ran out of supply, it became an internal focus. I heard you talking about qualifying external fabs. How are you thinking about this now? Obviously, tariffs are a moving target, but it seems that more diversity in foundry and geographic location is preferable. How are you thinking about it now?

First and foremost, we're in a good place regarding our capacity footprint that is more than twice what it was before the pandemic. We've been investing mainly in CapEx to build out front end and back end to support our growth and give us more resiliency and flexibility. We have more than twice the internal capacity, and we have the flexibility to swing between external and internal. On nodes at 180 nanometers and above, which is where the majority of ADI's revenue is, there has been no external investment for many years. We decided to invest in those nodes because we continue to develop many new products on them. They are crucial to many of our businesses, particularly industrial and automotive. As for the finer geometry nodes below 90 nanometers, we're designing new products in those areas, characterized by immense diversity in semiconductor recipes.

All right. That was our final question. Thanks, everyone, for joining us this morning. A copy of the transcript will be available on our website, and all available reconciliations and additional information can also be found at the Quarterly Results section of our Investor Relations site at investor.analog.com. Thanks again for joining us and your continued interest in Analog Devices.