Analog Devices Inc (ADI) — Q3 2025 Earnings Call Transcript

Thank you, Josh, and good morning, everybody. Thanks for joining our third quarter fiscal '25 conference call. Joining me today on the call is ADI's CEO and Chair, Vincent Roche. For anyone who missed the 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, nonoperating expenses, operating margin, tax rate, EPS and free cash flow in 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. With that, I'll turn it over to ADI's CEO and Chair, Vincent Roche.

Thank you, Rich, and a very good morning to you all. Well, our third quarter revenue and earnings exceeded our expectations. And for the second quarter in a row, we achieved double-digit year-over-year growth across all of our end markets. While geopolitical and macro uncertainty continues to cloud the outlook, we believe ADI's innovation-driven, resilient, highly diversified business model positions us to continue to successfully navigate these challenges. The accelerated recovery of our industrial business, encompassing instrumentation, automation, health care, aerospace and defense, and energy management is a case in point. As you've heard us detail on prior calls, our industrial recovery began in the aerospace and defense and instrumentation sectors, driven by our strong product and customer portfolio positions as well as spending growth in defense and AI infrastructure. We're now seeing double-digit year-over-year growth across the entire industrial portfolio. For today's call, I'm going to focus on our $1 billion-plus industrial automation business, which was the last sector to return to double-digit growth. Its market dynamics and trajectory are expected to bring long-term expansion. Companies have long invested in automation systems to gain first-order productivity, efficiency and quality benefits. Today, a new wave of adoption is being driven by economic and demographic pressures and enabled by the potential to transform and accelerate business through leverage of real-time Intelligent Edge data. ADI's high-performance technology stack and deep domain expertise are crucial to customer success in this highly sensed, securely connected software-driven era and the new robotic modalities that are emerging. It's predicted that the convergence of compounding macro and AI-enabled technology factors will drive robust double-digit growth within the robotics market for the foreseeable future. ADI's ability to deliver exceptionally accurate physical representations and enable faster insights at the edge has become even more essential as the market migrates to next-generation autonomous robotic systems. Our long history of robotics has given us a deep understanding of the sector's hardest problems and degraded opportunities. We're investing to maintain our performance edge and analog while capturing increasing levels of system value. In addition, we're building ecosystem partnerships and deploying experts and an increasingly broad suite of technologies to enrich and deepen our customer collaborations. We expect this multi-pronged approach to unlock significant ASP and margin expansion for our automation business. Following the proven path we've successfully executed in other markets such as aerospace and defense and health care. Now let me share a few examples of our strategy in action. Earlier this year, we partnered with Teradyne Robotics. Our solutions for precision positioning and dynamic motion control are helping Teradyne increase their value proposition to the logistics industry through higher-performance cobots and autonomous mobile robots or AMRs. In the agricultural sector, where labor shortages are prevalent, high-precision robotic systems are increasingly filling the gap. In addition, these systems' enhanced collection capabilities are enabling higher crop yield while reducing water and chemical usage levels. A growing portion of our robotics revenue is coming from this sector as we help customers solve their toughest challenges through our sensing, connectivity, and energy management solutions. In the health care sector, robot-assisted surgery systems minimize invasiveness and improve patient outcomes through enhanced system precision. And we're leveraging our leading precision technology franchise to successfully attach more of our power management, connectivity, and sensing content to the more innovative systems being designed and employed. This year, we're achieving robust growth and expect continued momentum as the proliferation of automated surgical procedures further expands our opportunities in this space. Overall, the near and medium-term outlook for robotics is compelling, supported by increasing revenue and the burgeoning opportunity pipeline. From this strong foundation, we're extending into the next promising era of robotics, namely humanoid and other highly dexterous robot form factors, and creating a potentially exponential growth opportunity for ADI. Our content in humanoid robots is likely to be several thousands of dollars, but that's basically a 10x increase over the content in today's cutting-edge AMRs. The primary reason for this content multiplier is the explosion in sensor and actuator counts. Every joint and point of contact requires accurate sensing and precision motor control, and every sensor and actuator drives the signal chain and power management opportunity for ADI. To further capture this flourishing opportunity, we're investing in higher-level application-specific solutions that integrate multiple sensing modalities, such as pressure, vibration, depth, acoustics, vision, and positioning with high accuracy, ultra-low power signal chains, functionally safe power management, and AI algorithms powered by robotics foundation models. Simultaneously, we're collaborating with NVIDIA on a range of digital twin simulation programs and reference designs for humanoid and other robotic systems to accelerate development and AI training for our customers. This work is particularly relevant for high-value applications such as dexterous manipulation of cable assemblies in data centers and, of course, in automotive manufacturing, to name just one. We are combining ADI's unique sensor expertise and our latest advances in robotics policy training techniques to enhance realism in NVIDIA's Isaac Sim and substantially shorten our customers' innovation timelines. So, in summary, we're capitalizing on growth in advanced robotics today and investing to capture even more value in the future. Ultimately, the strategy of investments and customer impact of our robotics business is a microcosm of our approach across ADI, mainly on covering and tackling the hardest innovation challenges at the intelligent physical edge and leveraging our industry-leading technology portfolio and expertise to solve them. As we turn our attention to the end of fiscal '25 and the beginning of the new fiscal year, we're focused on executing our strategy and capitalizing on cyclical and idiosyncratic momentum. Despite the geopolitical and macro turbulence, we remain undeterred and excited by the tremendous growth opportunities that we see over both the near and long terms. And with that, I'm going to pass it on to Rich.

Thank you, Vince. Now on to our third quarter results. Revenue of $2.88 billion came in above the high end of our outlook, up 9% sequentially and 25% year-over-year. Industrial represented 45% of our third quarter revenue, finishing up 12% sequentially and 23% year-over-year. Our industrial recovery has continued with sequential growth across all subsectors and regions, and year-over-year growth accelerated across all major applications led by our automatic test equipment business, fueled by increasing AI investment. Additionally, our aerospace and defense business had a record quarter. Automotive represented 30% of quarterly revenue, finishing down 1% sequentially and up 22% year-over-year. Double-digit year-over-year growth continues to be driven by our leading connectivity and functionally safe power solutions. Communications represented 13% of quarterly revenue, finishing up 18% sequentially and 40% year-over-year. Our wireline and data center business, which is roughly two-thirds of total communications, grew double digits sequentially and year-over-year as increasing AI demand continues. Wireless also grew double digits both sequentially and year-over-year. And lastly, consumer represented 13% of quarterly revenue, finishing up 16% sequentially and 21% year-over-year, marking the fourth straight quarter of double-digit year-over-year growth. We continue to see strength across handsets, gaming, hearables, and wearables. Now on to the rest of the P&L. Third quarter gross margin was 69.2%, and operating margin was 42.2%, up 100 basis points sequentially and year-over-year. Nonoperating expenses finished at $57 million, and the tax rate for the quarter was 11.9%. All told, EPS was $2.05, above the high end of our guided range and up 30% year-over-year. Now I'd like to highlight a few items from our balance sheet and our cash flow statement. Cash and short-term investments finished the quarter at $3.5 billion. Our net leverage ratio remained virtually flat at 1.1. Inventory increased by $72 million sequentially in support of the cycle recovery. Days of inventory declined to 160, and channel weeks ticked lower. We are continuing to execute our strategy of keeping leaner channel inventories while maintaining higher levels on our balance sheet. Over the trailing 12 months, operating cash flow and CapEx were $4.2 billion and $0.5 billion, respectively. We continue to expect fiscal 2025 CapEx to be within our long-term model of 4% to 6% of revenue. Free cash flow over the trailing 12 months was $3.7 billion or 35% of revenue, and we have returned $3.5 billion in cash to shareholders over the last four quarters. 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. Now on to our fourth quarter guidance. Revenue is expected to be $3 billion, plus or minus $100 million. On a sequential basis, at the midpoint, we expect industrial, communications, and consumer to increase, with the fastest growth in industrial. Automotive is expected to decline. Operating margin is expected to increase to 43.5%, plus or minus 100 basis points. Our tax rate is expected to be between 11% and 13%. Based on these inputs, adjusted EPS is expected to be $2.22, plus or minus $0.10. In closing, our strong results and outlook for continued growth, especially in the industrial market, reinforce our view that 2025 will close as a strong recovery year for ADI. However, we are mindful of the continued uncertainty facing customers with respect to tariffs and are monitoring the impacts closely. We believe we are well-positioned to successfully navigate an evolving global operating environment, thanks to the optionality enabled by the diversity of our markets, applications, and products and the resilience of our hybrid manufacturing strategy. With that, let's go to our Q&A session. We ask that you limit yourself to one question in order to allow us for additional participants on the call this morning. If you have follow-up questions, please requeue, and we will take your questions if time allows. Operator, can we have our first question, please?

Industrial was up 7% last quarter and 11% this quarter, and it seems like it will be very strong again in fiscal Q4. Can you discuss whether you're now shipping more than what is being consumed in these markets? How do you assess the current situation? Are we currently in a phase of inventory build in these markets? How do you evaluate the duration of this trend?

Since we identified the bottom in Q2, our industrial segment has become the most profitable and has shown sequential growth each quarter. Recently, as we discussed, this growth has picked up pace. For Q4, which is typically a down season for industrial, we anticipate growth in the low to mid-teens quarter-over-quarter. This reflects a robust outlook. Importantly, the growth is occurring across all industrial sectors, such as instrumentation, automation, aerospace, defense, health care, and energy infrastructure, as well as in all geographical areas. This is a signal that we are experiencing a cyclical upturn. Additionally, we have mentioned in previous quarters that our channel inventories remain quite lean, and we believe end demand is still significantly below consumption levels. We expect to see some alignment with end demand in the fourth quarter. As I noted earlier, we observed a slight decrease in channel inventory weeks due to end demand being higher than our projections. Looking ahead, we continue to see positive signs in aerospace, defense, and ATE, which gives us confidence about our industrial outlook both in the near and long term.

Great job on the quarterly execution. What you guys had anticipated last earnings call, gross margins for Q3 to be closer to 70%, but actually, actuals were actually closer to 69%. I assume it's because of the upside and the lower-margin communications business, which was up 17% sequentially. So potentially mix related. Is that a fair assumption? And then on Q4 at the midpoint of your guidance range, are you guys assuming that gross margins are improving sequentially?

Yes. So I'll take that one. So yes, we did have an implied increase in the margin. However, we did have an unexpected lower utilization during the quarter, which kept us from growing our gross margin on a sequential basis. However, the utilization is back on track, and we expect it to resume its increase. And in Q4 at the midpoint, we do expect to get back to a 70% margin. Had we not had the disruption in the utilization in the third quarter, we actually would have grown sequentially, but the mix piece, as you mentioned, because we still are only at 45% industrial mix in the third quarter, would have kept us from fully getting to 70%.

Congrats on the continuous recovery here. Vince, I had a question on the automation revenue. I think in the past, you've talked about this sort of being a 15% grower, and that's certainly above the corporate average. I'm just curious, given everything that you're seeing now in humanoids, in robotics, reference designs with some key GPU plays and so on and so forth. Are you starting to see perhaps an acceleration to that 15% growth target going forward?

Yes. Thanks for the question, Tore. So yes, the automation business for ADI is multiple hundreds of millions of dollars on an annual basis. And it's our sense that by 2030, we can double the size of that business given the strength of the R&D pipeline, the opportunity pipeline that we have, as well as some of these new modalities that are coming into play as demographic and macro pressures lean on putting more and more manufacturing capability closer to points of consumption. There's obviously a security issue as well as supply chain security issues. So, all those factors, I think exogenous and endogenous factors point to strong growth in that business. Also, as I pointed out in the prepared remarks, we're seeing a lot of these sensing modalities come to bear. And every one of those sensors or actuators that our customers are putting in place require very precise sensing, control, and data processing. So for all those reasons, we feel very optimistic about the state of this business and the potential to grow and double it over the next 5 or 6 years.

In response to your earlier question, you mentioned that you're noticing positive developments in various sectors of industrial. Given the strength observed in Q2 and Q3, do you think ADI can continue to grow at least at a seasonal rate or possibly above that as we look toward Q1? If so, what is the typical range of seasonality to help us adjust our models?

Vivek, I'll start. From a Q1 perspective, as we've said before, we don't guide to Q1, but we do expect that we'll be able to grow that seasonally. And obviously, for us, on an overall perspective, the first quarter tends to seasonally be down in the low single digits.

Yes. So I think as we look into the new year, I believe industrial will be a very, very strong part of our momentum in the coming year. And as Rich narrated in part of Q&A here, from just the supply-demand side of things, we're still seeing customers in digestion phase of their excess inventories, and particularly in the broad market, which has been a significant piece of the industrial business in the past, where we're still seeing the demand there quite light. So there's still kind of a normalization to take place, which should boost the industrial sales in the coming quarters as well as our position with new products and our position with customers and new applications, so in the automation space. We've got aerospace and defense, which has been incredibly strong. In fact, in some ways, we're supply limited in that business. So I think that will be the bedrock of the next several quarters of the company's performance.

I was wondering if you could provide a little bit more color on what you're seeing in the automotive market. I believe last quarter, you referenced some pull-in activity. Did you, in fact, see that occur in the quarter? And if so, from what regions? And then going forward, maybe talk a little bit about what's driving the sequential decline you expect in the next quarter? And any color you can provide on regions or customer OEM types would be helpful.

Thank you, Jim. We continue to perform strongly in the automotive sector, especially in connectivity and power management, generating significant auto revenue. We anticipate achieving record levels of auto revenue for 2025. Our gains in content share within next-generation ADAS and infotainment systems are contributing to this growth, along with some order acceleration we discussed in Q2, and we believe this trend continued into Q3. However, we foresee a decrease in Q4, which is why we expect lower figures for that quarter. This aligns with our previous discussions regarding last quarter’s results, where we anticipated pull-ins would likely affect either Q4 or Q1, and it appears to be unwinding in Q4. From a sizing perspective, this current quarter has exceeded the upper range of our guidance, primarily due to auto pull-ins. Notably, this time, the pull-ins in Q3 were from China, whereas in Q2, they were from North America and Europe. While we cannot predict exactly how things will unfold, we believe that the behavior of our automotive customers, along with expiring EV credits and potential tariff-related production issues, leads us to adopt a more cautious outlook for the near term. Nevertheless, we are still on track for our third record year in automotive over the last four years, reflecting our content and share gains. Historically, we tend to outperform SAAR volumes with content gains, enjoying a double-digit benefit from both share and content, positioning us well for the medium and long term.

So on the auto points, and I guess relative to industrial. So, I mean, you're guiding auto down 15% sequentially as those pull-ins kind of ease. But industrial, you're guiding up, I don't know, you said low to mid-teens, which would put it up in the mid-30% year-over-year. What are you seeing differently on the trend in industrial versus what you saw in auto that gives you confidence that the strength you're seeing industrial has not also pull forward?

So what we talked about last time as the indicators, Stacy, for what we thought were pulling where we saw unplanned growth in areas, and we saw the anomalous bookings behavior that happened around the tariff announcements and reversals. Things normalize. We have not seen that kind of behavior in industrial. In fact, the bookings trends have followed the trends we were expecting. It's impossible to say there isn't some minor amount maybe in any of the businesses, but we haven't seen anything outside of auto that would give us an indication as any meaningful pull-in in our business.

Could you provide some insight into why the utilization rates decreased, where they currently stand, your expectations for their future direction, and any other factors that may impact gross margins moving forward?

I think we had, as Rich said, a one-time event in our European fab during the last quarter. That was the primary dampening effect on the gross margin. So it became an absorption issue. I wouldn't say as well, pricing has been very, very steady. And as our mix improves on the industrial side of things, we get the benefit of that in the gross margin. And I don't expect a repeat of what was a one-time event in one of our factories in the last quarter to repeat.

So I know you always like to ask me this question. They're increasing, where we're not yet back to utilization levels we were obviously in the pandemic era nor do we expect to get all the way there. But we are continuing to increase, as I mentioned, other than this one-time hiccup, which is now behind us. We are back increasing as given the growth we're seeing and the planned starts in the factories, we're getting higher utilizations.

I think we have often discussed the capital expenditures we have invested to enhance the resilience of our internal fabs at ADI. We have more than doubled the size of the internal fabs primarily supporting the industrial business. We are managing that cost, and as the industrial business continues to grow, our ability to absorb those costs improves as well. It's important to keep these factors in mind.

A couple of minutes ago, you mentioned supply limitations in aerospace and defense. I wanted to follow up on that and ask where those supply constraints might be originating. Additionally, are you experiencing any supply constraints in other areas of your industrial business as it strengthens?

No, I think we've just seen a tremendous increase in demand. It takes time to establish the necessary capacity and tooling in the aerospace and defense sector. This is a highly diversified business with a complex range of products. Each quarter, we are adding more capacity, but demand continues to grow. It’s a very high-quality challenge we are facing. Demand is outpacing our current manufacturing capabilities, but we are investing in capital expenditures and tools to ensure we seize the opportunity. Most of what we do is sole-sourced, as these are proprietary products. We have also expanded our footprint with an essential internal factory for manufacturing our aerospace and defense solutions, and we have been equipping that facility. Overall, we are in an increasingly better position, but the challenge remains one of high-quality demand growth.

Yes. I want to clarify for you, Joe. We are deploying tools into the aerospace and defense manufacturing during the third and fourth quarters to address some of the stresses mentioned. Overall, we have sufficient supply to meet all of our near-term demand that is currently on the books.

I think the rest of the industrial business is in good shape overall regarding supply.

Congratulations on the strong results. I apologize for being overly critical in a quarter that was objectively good. However, I wanted to ask about gross margins. A couple of quarters ago, you mentioned that $2.7 billion was the level at which you would achieve a 70% gross margin, but it appears that this is now around $3 billion. Could you clarify what has changed and how we should view this moving forward?

Thank you, Josh. We have discussed this frequently, and I believe part of our ongoing conversation is that reaching $2.7 billion and returning to a 70% margin depends on achieving a more typical industrial mix. Currently, as you can see, we are at only a 45% industrial mix, while in the past we had a significantly higher percentage. We have stated that it's essential to have that mix. The mix is indeed changing as the industrial sector grows. If we consider our expectations for Q4, based on the industrial growth we have mentioned, we anticipate ending Q4 with approximately a 49% industrial mix, which is one of the reasons we believe we will return to the 70% margin range in the fourth quarter. As we noted earlier, this is also constrained by the mix, as the industrial segment is our most profitable business.

Just wanted to pivot over to the OpEx side of things. Any sort of color for your fiscal fourth quarter? And probably more importantly, as we look into fiscal '26, I know you guys have a big variable components to your OpEx. This year, it looks like it's up, I don't know, high teens and something like that in fiscal '25. Any sort of color on how the FX would relate to revenues in fiscal '26.

From a fiscal 2025 perspective, assuming the midpoint for Q4, we expect to achieve about 100 basis points of operating leverage compared to 2024. I am confident about this because at the start of the year, we anticipated a flat operating leverage due to significant headwinds from variable compensation. However, we are now positioned to deliver additional leverage, primarily driven by gross margin expansion. As we discussed, our operating expenses are growing at a higher rate than usual, influenced by the previous year's low bonus payouts, which were impacted by no revenue growth and muted margins in 2024. This situation allowed us to maintain a 40% operating margin during a challenging year. With a return to significant growth, our variable compensation is normalizing to a higher level compared to the previous year's low payouts. Looking ahead to 2026, I anticipate that the acceleration we experienced from variable compensation will decline, although we expect to maintain variable compensation in a growth year. Given the new baseline for 2026, we foresee continued leverage in revenue growth, as the increase in variable compensation will not be as dramatic as it was from 2024 to 2025. All these expectations depend on revenue growth, which we are projecting from a top-line perspective.

Just a question on business in China right now. And you mentioned in some of your earlier comments that China auto was strong last quarter. Could you give us some sense of what the totality of the China business looks like? And again, in that case, even outside of auto, is there any fear of any pull-forwards within that business or any anomalies that you may have seen within the China business in the last quarter?

Sure. We've discussed that China is a highly competitive market for us, but I remain very confident in our ability to succeed and grow there, which has been the case for decades. In terms of our market positioning, we typically command a premium for our performance, known as the innovation premium, where performance is crucial. This encourages customers to choose us, leading to higher average selling prices. This situation also poses challenges for competitors who offer products that are merely adequate. Overall, we feel strong from a competitive standpoint. Additionally, scale is extremely important, especially in Analog where we have a wide array of components. With six decades of experience and 70,000 SKUs, we have built a robust portfolio that is particularly relevant in diverse industrial applications. Over the past few quarters, we have highlighted that China has been at the forefront of our recovery. We've achieved record auto results this year, along with record design wins for 2024, and we expect continued growth in design wins for 2025. Our outlook for China is quite optimistic over the next three to five years based on the trends we are observing. While we have emphasized the strength of the auto sector in China, it’s worth noting that we have also begun to see year-over-year growth across all industrial end markets. However, aside from automotive, many of these other end markets are significantly below their previous highs, with some down by more than 35%, and others still 50% off their peaks. We believe there is still potential for growth from a medium to long-term perspective as the market continues to recover.

All right. Thanks, everyone, for joining us this morning. And with that, a copy of this 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.