Analog Devices Q3 2021 Earnings Report

Analog Devices EPS Results

• Actual EPS: $1.72
• Consensus EPS: $1.62
• Beat/Miss: Beat by +$0.10
• One Year Ago EPS: $1.36

Analog Devices Revenue Results

• Actual Revenue: $1.76 billion
• Expected Revenue: $1.71 billion
• Beat/Miss: Beat by +$47.87 million
• YoY Revenue Growth: +20.80%

Analog Devices Announcement Details

• Quarter: Q3 2021
• Date: 8/17/2021
• Time: Before Market Opens
• Conference Call Date: Tuesday, August 17, 2021
• Conference Call Time: 8:00PM ET

Analog Devices (NASDAQ:ADI) (NASDAQ: ADI) is a global semiconductor company that designs and manufactures high-performance analog, mixed-signal, power-management and radio-frequency integrated circuits. Its technologies help convert real-world signals—such as temperature, pressure, sound, motion and light—into data that electronic systems can process and use.

The company offers data converters, amplifiers, power-management products, sensors, embedded processors, connectivity solutions and other semiconductor components. These products are used in industrial automation, instrumentation, healthcare, automotive systems, communications infrastructure, consumer electronics and aerospace and defense applications.

Founded in 1965, Analog Devices serves customers worldwide through operations and sales channels spanning North America, Europe and Asia. The company expanded its product portfolio and market reach through the acquisition of Maxim Integrated in 2021. Vincent Roche has served as Analog Devices’ president and chief executive officer since 2013.

Analog Devices Q3 2021 Earnings Call Transcript

Key Takeaways

• Analog Devices reported a record Q3 FY21 with revenue of $1.76 billion (up 21% YoY), gross margin of 71.6%, operating margin of 43.6%, and adjusted EPS of $1.72 (up 27% YoY), driving $2.2 billion in free cash flow (34% margin).
• Demand continues to far exceed supply, with supply rising 4% in Q3 and projected to grow 3% in Q4, creating a backlog extending well into 2022 and making capacity additions the primary constraint on revenue.
• All key end markets contributed to growth: Industrial (57% of revenue) hit over $1 billion in quarterly revenue (up 29% YoY), Automotive (16%) grew 13% sequentially with new BMS and A2B wins, Communications (16%) has bottomed and is set to grow in 2022, and Consumer (10%) rose 16% sequentially and YoY.
• Over $1 billion invested annually in R&D and strategic partnerships—including work with Keysight on O-RAN/6G test solutions and collaboration with Universal Robots on cobots—positioning ADI for future innovation across instrumentation, environmental monitoring, and automation.
• The Maxim acquisition is on track pending China approval; once closed, ADI expects nearly $4 billion in cash, a leverage ratio below 1×, and over $3 billion in annual free cash flow, underpinning continued shareholder returns.

Presentation

[Operator]

Good morning, and welcome to the Analog Devices' third quarter fiscal year 2021 earnings conference call, which is being audio webcast via telephone and over the web. I'd now like to introduce your host for today's call, Mr. Michael Lucarelli, Senior Director of Investor Relations. Sir, the floor is yours.

[Michael Lucarelli, Senior Director of Investor Relations at Analog Devices]

Thank you, Shelby, and good morning, everybody. Thanks for joining our third quarter fiscal 2021 conference call. With me on the call today are ADI CEO, Vincent Roche, and ADI CFO, Prashanth Mahendra-Rajah. For anyone who missed the release, you can find it and relating financial schedules at investor.analog.com. Now, onto the 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 our most recent 10-Q and other periodic reports and materials filed with the SEC. Actual results could differ materially from these forward-looking information, as these statements reflect our expectations only as 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.

[Michael Lucarelli, Senior Director of Investor Relations at Analog Devices]

When comparing our results to our historical performance, special items are also excluded from prior periods. The 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. With that, I'll turn it over to ADI CEO, Vincent Roche. Vince?

[Vincent Roche, CEO at Analog Devices]

Thank you, Mike, and a very good morning to everybody. ADI delivered a second consecutive quarter of record revenue and earnings, despite the challenging supply environment. Our strong performance was driven by continued operational excellence and insatiable demand as semiconductors power the modern digital age. Broadly speaking, the economic recovery continues to take shape with demand still far exceeding supply. We, like many others in our industry, will face a constrained supply environment into 2022. Despite this backdrop, our business continues to achieve record results as our investments and design wins over the last few years are matched with strong demand across our end markets. Looking ahead, the combination of robust bookings, lean inventories, and ongoing capacity additions position ADI to close fiscal 2021 on a high note and continue to grow in the next year.

[Vincent Roche, CEO at Analog Devices]

Moving to our third quarter results, revenue was $1.76 billion, up 21% year-over-year. All markets increased sequentially with industrial and automotive once again achieving records. Gross margin expanded to over 71%, and operating margin to over 43%. Adjusted EPS of $1.72 increased 27% year-over-year. Despite elevated capital spending to increase our capacity, free cash flow over the trailing 12 months was $2.2 billion. This equates to a 34% free cash flow margin, maintaining our position in the top 10% of the S&P 500. Overall, I'm very pleased with our performance and our team's outstanding execution. As you know, at ADI, our ethos of innovation and deep customer engagements ensure that we stay ahead of what's possible.

[Vincent Roche, CEO at Analog Devices]

We invest more than $1 billion annually in R&D, focused on strengthening our core franchises and capturing market opportunities presented by secular growth drivers, which have accelerated in the economic recovery. Now, let me share some recent highlights with you. Our industrial business is our most diverse segment across customers, products, and applications, and features sticky long product life cycles. Our largest industrial segment, instrumentation and test, is comprised of automated test equipment, electronic test and measurement, and scientific instruments. This is truly a performance-driven market that aligns perfectly to our high-performance precision signal chain, power management, and RF portfolios. Importantly, instrumentation and test is aligned with all secular growth trends, from connectivity to EVs to sustainability. The growing technology complexity of these applications requires more testers with more advanced performance capabilities.

[Vincent Roche, CEO at Analog Devices]

Today, ADI is the leader in communications tests, and we're collaborating with Keysight, for example, to advance the development of O-RAN solutions. This partnership will enable the fastest path for designing cost-effective and power-efficient radio units. Looking ahead, we're already beginning to partner with our customers to test emerging 6G technologies. Our innovations in the instrumentation market also have a positive impact on human and planetary health. One particular area is our environmental monitoring business, where there's an increased need for highly reliable and accurate instruments to improve the standard of living globally. Our market-leading portfolio of precision converters enables 10x greater measurement resolution of fine particulate matter, better identifying trace pollutants. The next largest industrial segment is factory automation. Over the last year, many of our customers are rethinking their factory floors and supply chains to make them more resilient, cost-effective, and flexible through automation and connectivity.

[Vincent Roche, CEO at Analog Devices]

To achieve this, our customers will further automate their businesses with intelligent and connected factories and increase their use of robots and cobots. Specifically, cobots require ADI's precision signal chain and power franchises, sensing technologies, and robust wired and wireless connectivity. This new vector of growth increases our SAM opportunity by 3x that of a traditional robot. To that end, our precision motion control business is on track for a record year of design wins, including a recent win at a leading Japanese robotics company for its next-generation cobots. In addition, we're leveraging our domain knowledge and system-level expertise in a collaboration with Universal Robots to design smaller, smarter, and easier-to-use robots that help scale tasks safely and transform workforces.

[Vincent Roche, CEO at Analog Devices]

Well, turning now to our communications business, 5G is beginning to broaden globally, especially in North America, as carriers look to deploy newly acquired C-band spectrum. O-RAN continues to gain momentum also, with several of the largest European carriers setting ambitious 2025 O-RAN deployment targets. This includes Vodafone, where our technologies are very well represented. This quarter, we extended our market-leading position in 5G radio solutions with the introduction of the industry's first software-defined transceiver that includes a fully integrated digital front end. Our innovative radio architecture greatly improves power efficiency, thereby reducing radio weight, size, and carrier expenses. This high level of integration eliminates FPGAs to simplify implementation and facilitate the proliferation of these emerging O-RAN networks.

[Vincent Roche, CEO at Analog Devices]

Our next-generation transceiver platform is already designed in at a major Tier 1 global supplier that is gaining share in these 5G and O-RAN deployments across North America as well as Europe. Stepping back, we expect our communications business to return to growth in 2022. We have strong design momentum, and our geographic mix has shifted with North America, Europe, and Korea representing our largest sources of revenue. Moving now onto automotive. Over the last two years, we've realigned our business to focus on electrification and the in-cabin human experience. We're seeing the benefits of this strategy as we continue to scale our market leadership in battery management, power management, audio systems, and connectivity. Starting firstly with our battery management systems, or BMS, our wired and wireless portfolios provide unmatched accuracy to deliver market-leading vehicle range and can measure all key battery chemistries, including zero cobalt LFP.

[Vincent Roche, CEO at Analog Devices]

Additionally, our solutions incorporate ASIL-D functional safety and an ultra-low power continuous monitoring feature that ensures the battery remains stable even while parked, which is a first in the market. In addition, this quarter marked the first time we recognized revenue for our wireless BMS solution as General Motors prepares to ship its first of 30 EV models powered by the Ultium battery platform. This is just the beginning for this groundbreaking BMS technology as OEMs realize the power of wireless data in scaling their fleets. Turning to audio systems and connectivity, as complexity continues to increase, there's very strong demand for our market-leading audio systems with signal processing, A²B connectivity, and active road noise cancellation. Our solutions offer the highest fidelity performance in the market while reducing vehicle weight, removing nearly 100 lbs per vehicle.

[Vincent Roche, CEO at Analog Devices]

During the quarter, two leading OEMs adopted A²B, and a top 3 European vehicle manufacturer implemented A²B as its audio connectivity standard across its entire fleet. In total, A²B is now designed in at over 30 OEMs, including 18 of the top 20 global automotive companies. Furthermore, interest in our active road noise cancellation feature continues to intensify. We're designed in at nine OEMs, up from five just a year ago, including Hyundai and a leading EV manufacturer. This added capability can more than double the value of our A²B solution. In all, these are just a few of the countless examples of the tremendous work underway at ADI. We remain focused on delivering breakthrough innovations to stay ahead of our customers' needs. In closing, I've never been more confident about ADI's future.

[Vincent Roche, CEO at Analog Devices]

Over the last decade, we've built an industry-leading portfolio with unparalleled breadth and depth of capabilities that's aligned with more profitable end markets. Our portfolio and leadership position will only get stronger with the acquisition of Maxim, enabling us to deliver strong returns in the years to come. With that, I'll hand you over to Prashanth.

[Prashanth Mahendra-Rajah, CFO at Analog Devices]

Thank you, Vince. Good morning, and welcome to our third quarter earnings call. My comment today, with the exception of revenue and non-op expenses, will be on an adjusted basis, which excludes special items outlined in today's press release. ADI delivered exceptional third quarter results underpinned by our ability to increase production. Revenue and EPS reached all-time highs for the second straight quarter, with continued gross and operating margin expansion. If we look at performance by end market, industrial represented 57% of revenue and increased 3% sequentially and 29% year-over-year. Notably, this business surpassed $1 billion of quarterly revenue for the first time. We experienced broad-based strength across applications and geographies. All sub-segments increased double-digits year-over-year except healthcare, given the elevated pandemic demand a year ago.

[Prashanth Mahendra-Rajah, CFO at Analog Devices]

Communications represented 16% of revenue and decreased 21% year-over-year, while up 4% sequentially, with growth in both wireless and wireline. As we outlined last quarter, we believe our communications revenue has bottomed and will continue to grow as 5G deployments broaden globally, especially in North America. Automotive represented 16% of revenue and increased 13% sequentially and 80% year-over-year. Strength was broad-based with double-digit growth across every major application. BMS and A²B remain our fastest-growing applications and both are on track to nearly double in size this year. As Vince shared earlier, ADI has been strategically pivoting resources to focus more aggressively on electrification and the in-cabin human experience. As part of this strategy, we are licensing select radar IP to a large European Tier 1 auto supplier. This resulted in the immediate revenue recognition of $24 million in the quarter.

[Prashanth Mahendra-Rajah, CFO at Analog Devices]

Consumer represented 10% of revenue and increased 16% both sequentially and year-over-year. Our strategy to diversify and grow this business in fiscal 2021 is working as strength across home entertainment, hearables, and wearables more than offset a decline in portables. Now, moving to the P&L. Gross margin expanded sequentially and year-over-year, finishing at 71.6%, mainly due to the cost savings from the LTC manufacturing optimization and the IP license agreement. OpEx in the quarter was $493 million, up modestly sequentially due to a full quarter of merit increases and continued strong variable comp. This netted an op margin of 43.6%, which marks the fifth straight quarter of year-over-year op margin expansion, underscoring the strong leverage in our business. Non-op expenses were $37 million, below our typical quarterly run rate of approximately $43 million due to an investment gain.

[Prashanth Mahendra-Rajah, CFO at Analog Devices]

Our tax rate was approximately 12%, which give us an adjusted EPS at $1.72, including $0.05 of upside attributable to the IP licensing agreement. Moving on to the balance sheet. We finished the quarter with an ending cash balance of $1.5 billion and a net leverage ratio of 1.2x. Relative to the second quarter, inventory dollars increased $16 million, driven entirely by raw materials and work in process. Days of inventory were unchanged at 118, and weeks of channel inventory remain well below the low end of our seven- to eight-week target as sell-through remains stronger than sell-in. CapEx for the quarter was $86 million, up meaningfully sequentially as we continue to add capacity to support our robust and growing order book that now stretches into fiscal 2022.

[Prashanth Mahendra-Rajah, CFO at Analog Devices]

We will continue to increase capacity in the fourth quarter, resulting in full year capital intensity above our long-term model of 4%. Turning to free cash flow, we generated more than $2.2 billion over the trailing 12 months, up 23% from a year ago, and this represented a 34% free cash flow margin. Over the same period, we have returned nearly 85% of free cash flow after debt repayments via $970 million in dividends and over $500 million in share repurchases. Now, on to the fourth quarter outlook. Revenue is expected to be $1.78 billion ±$70 million up sequentially as additional capacity comes online. At the midpoint, excluding the automotive IP licensing revenue, we expect each of our B2B markets to increase sequentially, led by communications and consumer to be up high single-digits.

[Prashanth Mahendra-Rajah, CFO at Analog Devices]

Based on the midpoint of guide, we expect to deliver a record gross margin and for operating margins to be 43.7% ±100 basis points. Our tax rate is expected to fall toward the upper end of our range. Based on these inputs, adjusted EPS is expected to be $1.72 ±$0.11. Before moving to the Q&A, I'd like to give a brief update on Maxim. Our discussions with the Chinese regulatory authorities have been productive, and we're working towards closing within the initial timeframe. We plan on closing no later than the third business day after China approval has been granted. As we shared before, shortly after the close, we will hold a conference call to provide an update on our capital return plans.

[Prashanth Mahendra-Rajah, CFO at Analog Devices]

Once combined, we anticipate having nearly $4 billion of cash on our balance sheet, a leverage ratio well below 1x, and more than $3 billion of annual free cash flow. I'll now turn it over to Mike to start the Q&A.

[Michael Lucarelli, Senior Director of Investor Relations at Analog Devices]

Thanks, Prashanth. 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 re-queue, and we'll take your question if time allows. With that, can we have our first question please?

[Operator]

For those participating by telephone dial-in, if you have a question, please press star then the number one on your phone. If your question has been answered and you wish to be removed from the queue, please press the pound key. If you're listening on a speakerphone, please pick up the handset when asking your question. We'll pause for just a moment to compile the Q&A roster. Your first question is from Vivek Arya of Bank of America Securities.

[Vivek Arya, Analyst at Bank of America Securities]

Thanks for taking my question. When you mention demand far exceeds supply, I was hoping if you could help us quantify that. Are you under shipping by 5%, 10%? How much of a demand cushion does ADI have right now? Kind of part B of that is how much incremental capacity are you planning to bring online in the next year, and is that kind of a proxy for what kind of sales growth we should be looking at? Thank you.

[Prashanth Mahendra-Rajah, CFO at Analog Devices]

Thanks, Vivek. Demand continues to grow across our markets. All end markets are up, and our book-to-bill was above 1.2. Supply is also expanding. We grew 4% sequentially in the third quarter, and at the midpoint, we're going to be up another 3% for the fourth quarter. You look at that math and it says the supply-demand gap is growing, or said another way, backlog is increasing quarter-over-quarter, and it now extends well into 2022. Our view is this gap is likely to persist into calendar year 2022, given the long lead time it takes to add supply in the industry, plus just the broad strength of the demand.

[Vincent Roche, CEO at Analog Devices]

I think the second part of that question, Vivek, I'll just add a little bit of color.

[Vincent Roche, CEO at Analog Devices]

We're layering in investments in CapEx to support our growth objectives, particularly on the back end of our operation assembly and test. We need this capital now to meet the demand, but also in the longer term. We're very, very optimistic about the tailwinds right across our business, from automation to electrification, connectivity, and so on and so forth. The outlook we've just given you is supply feasible, and it is certainly the governor, I would say, right now on revenue for the company.

[Vivek Arya, Analyst at Bank of America Securities]

Thank you.

[Michael Lucarelli, Senior Director of Investor Relations at Analog Devices]

Thanks, Vivek. We'll go to our next question, please.

[Operator]

Your next question is from Tore Svanberg of Stifel.

[Tore Svanberg, Analyst at Stifel]

Yes, thank you. I was hoping you could just elaborate a little bit more on the Maxim merger. You said that you'd still expect it to happen within the timeframe you had announced. I believe you had said the summer of 2021, correct me if that was wrong. Related to that is, again, China the only remaining obstacle before you can close the deal?

[Vincent Roche, CEO at Analog Devices]

Thanks, Tore. Look, our confidence of the closing remains unchanged, and as we said in the prepared comments, our discussions with the Chinese regulatory authorities have been positive and productive, and we're working towards closing within the initial timeframe. China is the only outstanding regulatory approval need at this point in time. I will remind you as well that all of the other regulatory bodies across the globe have approved our deal without condition, without remedies.

[Tore Svanberg, Analyst at Stifel]

Great. Thank you for that, Vince.

[Michael Lucarelli, Senior Director of Investor Relations at Analog Devices]

Thanks, Tore. Go to our next question.

[Operator]

Your next question is from John Pitzer of Credit Suisse.

[John Pitzer, Analyst at Credit Suisse]

Good morning, guys. Thanks for letting me ask the question. Vince, I wanted to pick up on your prepared comments about your industrial business. You're now going into the third consecutive quarter of sort of record revenues in that business. You have to go back to, I think, April of 2018 before, which was the last peak. The fiscal year to date, that business is up about 30% year-over-year. For a lot of investors, they're concerned that perhaps that represents more cyclical excess than sort of structural sustainability. I'm kind of curious, as you break apart your industrial business, what do you think is being driven by the "cycle" versus stuff that's a little bit more sustainable?

[Vincent Roche, CEO at Analog Devices]

Thanks, John. I think, first and foremost, I'd like to remind everybody that ADI's industrial business is built on a foundation of many individual market segments, like automation, instrumentation that I talked about, healthcare, our space business, and energy as it moves to renewables and charging infrastructure, for example, the whole need for grid efficiency and stabilization. That's the foundation. It's a highly diverse business. We've got many tens of thousands of customers, and the life cycles in the business are kind of 15+ years. And it's a very, very, very sticky set of sockets that we've got. Those of you who have followed ADI for a long time will remember about a decade ago, we fairly dramatically increased our focus in terms of R&D, go-to-market activities in ensuring that we could really grow that business.

[Vincent Roche, CEO at Analog Devices]

The last few years have shown that we've been gaining market share across the board there. I think there's a certain amount, John, of—there were a lot of programs that were stalled last year, so there's a certain amount of catch-up there. I do think that the breadth of the portfolio that we now have, the investments we've been making in terms of customer engagement, R&D activities, and the secular trends that we've got, all these concurrent secular drivers are propelling that business beyond the market.

[Michael Lucarelli, Senior Director of Investor Relations at Analog Devices]

I'll add one thing, John. You're right. As you said in our prepared comments, all the markets did increase double-digits year-over-year. Of our six applications that Vince outlined, two are still below pre-peak levels. We do think fiscal 2021 marks a record for all of them, and we don't see why they won't hit another record in 2022, given the strong trends that Vince outlined. With that, we'll go to our next question.

[Operator]

Your next question is from Stacy Rasgon of Bernstein Research.

[Stacy Rasgon, Analyst at Bernstein Research]

Hi, guys. Thanks for taking my questions. I had a question on the pricing environments. Given just the tight supply and the shortage situation, we're starting to see some hints of some of your peers starting to take prices up. I was curious what you guys are seeing in the pricing environment. Are you seeing that? Are you able to actually do that? Are you treating your own pricing environment more conservatively?

[Prashanth Mahendra-Rajah, CFO at Analog Devices]

Thanks for the question, Stacy. I would say that for the results that we printed, pricing is on net neutral. We're passing on cost increase so that we're not impacting margins, but we've made a decision not to take advantage of our customers by structurally increasing pricing in this environment. Our long-term model is unchanged, and that is 70%+. The goal really is to drive the revenue growth and make the trade-offs that are necessary to drive that revenue growth, focusing on delivering on the op margin and the free cash flow.

[Prashanth Mahendra-Rajah, CFO at Analog Devices]

You'll see, if you back out the IP license impact, we had a 71.2% gross margin in the third quarter, and while we don't guide to gross margins, if you impute it from the guide that we gave you, fourth quarter's going to probably be a record for ADI in terms of gross margins.

[Stacy Rasgon, Analyst at Bernstein Research]

Got it. That's helpful. Thank you.

[Michael Lucarelli, Senior Director of Investor Relations at Analog Devices]

Thanks, Stacy. Next question.

[Operator]

Your next question is from Toshiya Hari of Goldman Sachs.

[Toshiya Hari, Analyst at Goldman Sachs]

Hi, guys. Good morning. Thanks for taking the question. I wanted to ask about the comms business. Vince, you talked about 2022 being a growth year. You talked about North America, Europe, and Korea being the key drivers for you guys going forward. How should we think about the shape of the recovery going forward? Is it going to be a fairly gradual recovery? Could it be sort of a V-shaped recovery over the next couple of quarters? When you talk about return to growth in 2022, what sort of implicit assumptions are you making for China? Thank you.

[Prashanth Mahendra-Rajah, CFO at Analog Devices]

Okay, thanks. We're going to split that into two. Let me just quickly talk about what happened, then I'll let Vince speak to it more broadly. In the second quarter, as a reminder, we did call the bottom on comms and said that we would grow on a sequential basis. We delivered that in the third quarter, we are on track to deliver that for the fourth quarter. We believe we're really well-positioned for strong growth into fiscal 2022. Between the two sub-segments there, wired demand remains strong, we expect that to continue as both carriers and data centers continue to do the upgrades to their networks. Wireless, while it's always lumpy, growth in the past quarter was really driven by rest of the world, North America.

[Prashanth Mahendra-Rajah, CFO at Analog Devices]

We do think China bottomed in the third quarter. That should also represent some growth momentum for us as we go forward. Then I'll hand off to Vince to speak more broadly about what we're seeing.

[Vincent Roche, CEO at Analog Devices]

Toshiya, why do I have the confidence I have about 2022 being a strong growth year? Maybe I can unpack that a bit for you. I think our comms revenue mix is seeing a benefit from the rest of world beginning to emerge in 5G. Today, rest of world outside of China is 3x in terms of TAM, that's number one. If you look at then the geographies, North America, the C-band auction's complete. Revenue is really just beginning here. All the indications are that 5G revenue here will accelerate in 2022 and indeed beyond. Europe, I would say a step behind, but we're beginning to see good signs of life in that region. I think it'll be more a late 2022 driver.

[Vincent Roche, CEO at Analog Devices]

We've talked several times on various calls here about O-RAN and what's happening. We're beginning to see revenue. We've talked before about Rakuten in Japan. That business continues to accelerate. European carriers are looking right now to make it also an important part of their 5G offering. I mentioned during the prepared remarks as well that Vodafone is a major player there. We happen to be very well represented in their systems. I'm also having conversations with customers about the use of 5G and O-RAN beyond the classical consumer market. It's early days. The characteristics of flexibility, scalability, quicker time to market, cost savings, and so on, is enabling private networks to be configured in factory environments, for example. That's all still on the come. That gives you a sense for our confidence in 2022 and beyond. Thanks, Toshiya.

[Michael Lucarelli, Senior Director of Investor Relations at Analog Devices]

Thank you. We'll go to the next question.

[Operator]

Your next question is from Ambrish Srivastava of BMO.

[Ambrish Srivastava, Analyst at BMO]

Hi. Thank you. Good morning, folks. I had a question on Maxim. My investment case for ADI has not been Maxim, and you have a very sticky shareholder base who have been with you before Maxim, but I get this question a lot, so I think it's a fair question to ask. If Maxim was not to go through, how do you think about capital allocation? Do you then go back to the playbook and say you would be changing how you think about capital allocation, or you would continue on the M&A path and look at other opportunities? Thank you.

[Prashanth Mahendra-Rajah, CFO at Analog Devices]

Ambrish, let's do this. Let me just remind everyone what the capital allocation policy is today, because I think that we have a very shareholder-friendly capital allocation policy, which is that first call is really to invest in the business. ALthough not a traditional definition, we do consider that organically kind of how we spend our R&D, and that is heavily pointed towards the B2B market. Then we think about inorganic really more as it helps the technology portfolio, or finds other ways to help us become more important to customers. Our commitment is to return 100% of free cash flow to customers. We're at a 1.2x level leverage today. We do not need to reduce debt.

[Prashanth Mahendra-Rajah, CFO at Analog Devices]

Despite the confidence that we have in the Maxim deal closing, in an environment where that was not to have happen, would not look for us to really be changing that view of having all our incremental free cash flow return to shareholders, either through buyback or through dividend. As a reminder, I think over the past three years, we've averaged about a 10% increase in our dividend. A very healthy commitment for our fixed-income focused investors as well as the repo. I think we're on track this year for an all-time high in terms of our repo activity. Back to the M&A, I'm going to hand that one to Vince to talk more about the alternatives there.

[Vincent Roche, CEO at Analog Devices]

As you know, you've seen over the years, we've always acquired very high quality assets, and that will remain to be our view on things in the years ahead as well.

[Ambrish Srivastava, Analyst at BMO]

Okay. Thank you.

[Michael Lucarelli, Senior Director of Investor Relations at Analog Devices]

Thanks, Ambrish. Next caller.

[Operator]

Your next question is from Blayne Curtis of Barclays.

[Blayne Curtis, Analyst at Barclays]

Hey. Good morning. Thanks for taking the question. Just curious on—if you look at the B2B guidance, it's fairly flat as I think industrial probably is flat given the segment guidance you gave. I'm just kind of curious as you look at this, obviously you had strong comments on the bookings. Is that gap really supply, or are you starting to see demand trends start to settle out at this level?

[Prashanth Mahendra-Rajah, CFO at Analog Devices]

That is purely supply. I think I mentioned in maybe the first or second question that book-to-bill for the quarter was over 1.2, and that's across all markets. We're seeing very strong interest in products across all markets. Mike indicated in one of the other Q&As that we're likely to have the industrial markets hit an all-time high collectively for fiscal year 2021, and expect that to continue to be on track to hit another record in FY 2022. Very much a supply-constrained environment.

[Blayne Curtis, Analyst at Barclays]

Thanks. I just wanted to follow up on the gross margin for Prashanth. You indicated the gross margin would be up, and I think that's with the license impact as well. You saw benefit from the Linear. Just curious how much more there is of that as a benefit, and then maybe just talk about utilizations and other pulls on gross margin as you look over the next two quarters.

[Prashanth Mahendra-Rajah, CFO at Analog Devices]

I presume you're asking kind of with respect to the guide. In the fourth quarter, we're not guiding gross margins, we're pretty confident we're going to hit a new record for gross margins. That is coming from the LTC synergies. I think we hit the final phase of closing down the manufacturing operation in California. We still have an opportunity as soon as the supply environment allows us to to get some additional savings out of Asia because we haven't closed that facility yet because we have no time to ship the tools to their new location. Utilization is also going to provide some level of increase. I would say mix is a bit of a headwind into the fourth quarter.

[Prashanth Mahendra-Rajah, CFO at Analog Devices]

Fourth quarters typically have some level of challenges in terms of holiday shutdown, so we need to manage through that, which can provide a little bit of headwind for us as well that we got to work ourselves around.

[Vincent Roche, CEO at Analog Devices]

The foundation for our growth margins being where they are is number one, innovation. We produce the best-performing solutions between the physical and digital worlds, and we get a premium. We get very, very well paid for doing that. Also, the diversity of our product and customer portfolios, 125,000 customers with, I think I've said this before, 85% of our sales come from products that individually contribute less than 0.1%. The pricing environment, as we said earlier on the call, has been very stable, very steady.

[Michael Lucarelli, Senior Director of Investor Relations at Analog Devices]

Thanks, Blayne, for that two-part, one-part question. We'll go to the next caller, please.

[Operator]

Your next question is from Harlan Sur of JPMorgan.

[Harlan Sur, Analyst at JPMorgan]

Good morning. Congratulations on the strong results and quarterly execution. Channel inventories continue to remain below your target seven- to eight-week range. You guys can also monitor direct customer inventories, at least for those that are on consignment programs. Any signs that customers have been able to build inventories? It seems unlikely because the entire value chain appears to be sort of hand-to-mouth from a chip supply perspective. I wanted to get your views. When do you believe customers will be in a position to start to build back inventories? I'm assuming the soonest is sometime in calendar 2022, but wanted to get your views as well.

[Prashanth Mahendra-Rajah, CFO at Analog Devices]

Thank you, Harlan. I'll take that. First, a couple of comments on inventory. Inventory on our balance sheet is up year-over-year and sequentially, that is exclusively due to raw materials and WIP. We can't keep a finished good in stock. When it's produced, it either goes to the customer or it goes into the channel, it goes out of the channel immediately. We are struggling to build finished goods inventory, both in ADI warehouses as well as in our channel partners. Roughly, well, let's say a significant amount of our auto business is on consignment, which gives us good visibility for that direct business as to what's happening there.

[Prashanth Mahendra-Rajah, CFO at Analog Devices]

That is also, we're seeing that demand kind of pull through pretty quickly and no opportunity for those auto customers to build the inventory within their warehouses, but that's on our books. It's still very much hand-to-mouth, and the focus that we have, as we've talked throughout this call and in the prepared remarks, is on increasing our capacity or ability to supply by making some significant investments in capacity. I don't see this balance coming into some sense of normalcy until sometime in calendar year 2022.

[Harlan Sur, Analyst at JPMorgan]

Great. Thank you.

[Michael Lucarelli, Senior Director of Investor Relations at Analog Devices]

All right. Can we have our last question, please?

[Operator]

Your next question is from William Stein of Truist Securities.

[William Stein, Analyst at Truist Securities]

Great. Thanks for taking my question. Prashanth, you just talked about inventory not coming to some level of ability to rebuild anything until sometime in 2022. You talked about the supply-demand balance lasting well into 2022, 1.2 book-to-bill, et cetera. When we look out to the next quarter, the January quarter, typically that's a sequentially down quarter in automotive, industrial, consumer, and for the whole business as well. Given these supply constraints and this very significant backlog, should we think about that seasonality as different in the coming year? Should we expect maybe some visibility to sequential growth for the next several quarters? Thank you.

[Prashanth Mahendra-Rajah, CFO at Analog Devices]

I think the way to answer that would be say that seasonality in today's environment is a bit of a meaningless concept, because revenue growth is really dictated completely by supply. The print for Q1 is likely to be driven by what more capacity we can get online over the fourth quarter to allow us. Again, now we've got a couple of things we need to work through in the first quarter that would be a little bit of an offset. First, there's the holiday season, so we do need to adjust factory capacity for that. Fourth quarter is kind of the key quarter for consumer. That's when they build for the holiday season.

[Prashanth Mahendra-Rajah, CFO at Analog Devices]

There's always going to be a little bit of seasonality impact for consumer just because they don't need it in the first quarter, our fiscal first quarter, as that is the holiday period. Maybe that's kind of where I'll finish. Mike, anything you want to add to that?

[Michael Lucarelli, Senior Director of Investor Relations at Analog Devices]

Sure. I guess if you look back, you're right. We talk about seasonality not being as meaningful now, but just give you a bit of a history lesson. If you look over the past 10 years, you're right. Our B2B markets, I would say in good times, which I would call now good times, is usually flat to down slightly in 1Q. Consumer, I would say in good and even kind of normal times, is down kind of 5% or maybe more in 1Q. With that, I want to thank everyone for joining the call this morning. A copy of the transcript will be available on our website, and all reconciliations and additional information can also be found in the quarterly results section. Thanks again for joining and your continued interest in ADI.

[Operator]

This concludes today's Analog Devices conference call. You may now disconnect.

Participants

Executives

• Michael Lucarelli, Senior Director of Investor Relations
• Prashanth Mahendra-Rajah, CFO
• Vincent Roche, CEO

Analysts

• Ambrish Srivastava, Analyst at BMO
• Blayne Curtis, Analyst at Barclays
• Harlan Sur, Analyst at JPMorgan
• John Pitzer, Analyst at Credit Suisse
• Stacy Rasgon, Analyst at Bernstein Research
• Tore Svanberg, Analyst at Stifel
• Toshiya Hari, Analyst at Goldman Sachs
• Vivek Arya, Analyst at Bank of America Securities
• William Stein, Analyst at Truist Securities