Analog Devices Q2 2024 Earnings Call Transcript

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Provided by Quartr
May 22, 2024

There are 13 speakers on the call.

Operator

Good morning, and welcome to the Analog Devices Second Quarter Fiscal Year 20 24 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, Vice President of Investor Relations and FP and A. Sir, the floor is yours.

Speaker 1

Thank you, Gigi, and good morning, everybody. Thanks for joining our Q2 fiscal 2024 conference call. Moving on the call today are ADI's CEO and Chair, Vincent Roche and ADI's CFO, Rich Puccio. For anyone who missed the release, you can find it and relating financial schedules at investor. Analog.com.

Speaker 1

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 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 and non operating 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.

Speaker 1

When comparing our results to our historical performance, special items are also excluded from prior periods. Reconciliations of these non GAAP measures to the most directly comparable GAAP measures and additional information about our non GAAP measures are included in today's release. And with that, I'll turn it over to ADI's CEO and Chair, Vince.

Speaker 2

Thanks very much, Mike. Good morning and a big welcome to you all. So in the second quarter, a strong focus on execution resulted in revenue of $2,160,000,000 with profitability and earnings per share finishing above the high end of our outlook. With 2Q now behind us, we believe we've With 2Q now behind us, we believe we've passed the low point of this cycle. Notably, global manufacturing PMIs, which are highly correlated with our core business are improving, customer inventories are stabilizing, and our bookings have improved for a 3rd consecutive quarter.

Speaker 2

Our growing optimism remains guarded, however, as short term economic and geopolitical uncertainty persists. As such, we will continue to manage the near term with great discipline as we fund and execute against our longer term strategic priorities to drive increasing levels of value for all of our stakeholders. So with that framing, I'd like to share some examples with you of how we are continuing to strengthen ADI's high performance franchise across all markets and creating unique growth drivers that will be additive to what we hope will be a strong cyclical recovery. For example, in healthcare, we have exciting wins in areas such as the rapidly expanding surgical robotics market where the performance of our precision signal processing and connectivity solutions is critical. And in the fast growing continuous glucose monitoring space, we've won multiple opportunities across several customers.

Speaker 2

Our unique digitally enabled analog front end solutions increase the accuracy and power efficiency of sensors and extend battery life from days to weeks. In industrial automation, the growth of the digital factory is accelerating upgrades to higher bandwidth, deterministic industrial Ethernet that can support up to 10 times the number of edge devices across the factory floor. We believe our leadership position with key customers will create a durable revenue stream beginning next year that can grow to several 100 of 1,000,000 of dollars as deployments ramp over time. Turning to automotive, our solid performance is being driven by the proliferation of higher content vehicles that use more power management, more connectivity and an increasing number of sensor platforms that open new signal processing opportunities for ADI. The increasing content per vehicle is a pervasive trend across all vehicle types combustion engines, hybrids and full EVs.

Speaker 2

For example, in advanced safety, we've increased our GMSL design wins from 12 to 15 of the top 20 OEMs and expanded our engagements at 2 European and 1 Korean OEM who intend to deploy our high performance, high bandwidth connectivity solution across a larger share of their fleets. We've also seen strong attach for our functionally safe power, which is used with sensors and displays in ADAS systems and recently increased share at the leading global car manufacturer. In electrification, we've expanded our battery management system share at leading Chinese OEMs and more than doubled our BMS share in upcoming European OEM model launches and 2 manufacturers intend to deploy our higher content wireless solutions starting next year. Now I'd like to use the rest of my prepared comments today to share our perspective on the role that artificial intelligence is playing and will play at ADI in the future. This technology has clearly reached a tipping point and our AI opportunity spans from sensor to cloud.

Speaker 2

While we've been adding algorithmic and software intelligence to our products now for decades, we've expanded the scope and pace of our investments in recent years. Today, we are increasingly leveraging AI in and around our products as well as in our operations to more fully meet our customers' needs and extend our industry leadership. We're deploying AI internally to help accelerate engineering development, enhance manufacturing efficiency and create a better customer experience. But the majority of our activities are centered around product portfolio innovations that position us to take advantage of AI's enormous potential. We see this business opportunity coming in 2 distinct waves.

Speaker 2

The first wave focused on infrastructure is now underway and as we all know is growing very rapidly. In order to tackle the intensified energy and processing demands of AI Compute Systems, data center customers are investing in new vertical power architectures. As we highlighted previously, our vertical power technology, which can reduce power losses by up to 35% compared to existing architectures, is gaining traction with hyperscalers. We continue to leverage our heterogeneous integration expertise to create more efficient, smaller vertical power solutions that deliver more value and enable us to capture more share in this nascent space. Power efficient computing though is just one challenge the AI ecosystem faces.

Speaker 2

Data must also be transported efficiently, securely and at much, much greater speeds. This is driving wireline customers to upgrade connectivity infrastructure, sparking a transition to 800 gigabit and 1.6 terabit optical modules. At the electro optical interface, our ability to provide high performance solutions that integrate analog, digital and memory in a reduced form factor is indeed a key differentiator. Our high precision controller was recently designed into a 1.6 terabit optical module used in the next gen AI systems of the high performance compute leader. In industrial, AI is fueling extraordinary demand for high bandwidth memory and high performance compute.

Speaker 2

This in turn is driving a new growth vector for our instrumentation and test business, particularly in SoC and memory test. We're working with key players globally to enable faster digital scan speeds, higher channel density and the improved energy efficiency necessary to scale production of AI systems. The significantly greater amount of ADI content in these systems is positioning our high performance compute and memory test sectors for record revenues in the near to midterm. The opportunity ahead for ADI is to compound the impact of first wave by bringing application specific AI models and high performance compute right down to the physical edge, creating greater system value with added improvements in latency, power efficiency, security and cost. So let me share some examples of how we are working to amplify this 2nd wave.

Speaker 2

For example, in acoustic systems, we are combining our application specific algorithms with ultra low energy processing hardware to enrich our audio platform offerings. We're also developing a mixed signal processor with embedded neural networks that enable a system to learn and adapt to the highly variable nature of sound in real time. Excitingly, we have strong traction with multiple customers in this area. Now in the same vein, we're leveraging our rich domain expertise with our growing processing capabilities to enhance our advanced connectivity platform in next generation 5 gs radios. For example, we've implemented the 1st AI enabled technology, combining an energy efficient real time neural network with an AI assisted development tool to give customers the ability to solve their linearization challenges in a fraction of the time.

Speaker 2

In our power management platform, we're using AI to address the arduous challenge of tuning power trees for volatile consumption patterns in data centers. Our solutions reduce complexity for power engineers and compress the time required from weeks to hours, helping to lower costs and of course accelerate time to market. The ADI is always operated at the physical edge where the world's most important real data is born. As multimodal AI becomes more pervasive at the edge and a diversity of sensor types is used to unearth deeper insights, we expect to see an explosion of demand that will accelerate growth for our broad signal chain as well as power portfolios. In short, ADI's AI future looks bright across the continuum of sensor to cloud.

Speaker 2

So in closing, I'm very proud of how our team has executed in one of the largest downturns the semiconductor industry has seen. More importantly, I've never been more excited about how we're positioned for the future and what it holds for ADI. And so with that, I'm going to hand it over to Rich.

Speaker 3

Thank you, Vince. And let me add my welcome to our Q2 earnings call. As a reminder, our Q1 2024 was a 14 week quarter. So we are going to limit our comparisons this quarter to year over year only. 2nd quarter revenue of $2,160,000,000 finished above the midpoint of our outlook.

Speaker 3

This result was down 34% year over year. Industrial represented 47% of revenue in the quarter and was down 44% year over year. As expected, all applications were impacted by inventory digestion. However, Aerospace and Defense revenues outperformed broader industrial. Automotive represented 30% of revenue and was down 10% year over year.

Speaker 3

Continued growth in our leading connectivity and functionally safe power franchises balanced broad based declines elsewhere. Communications represented 11 of revenue and was down 45% year over year. Inventory digestion and weaker demand impacted both our wireline and wireless businesses. And lastly, consumer represented 11% of revenue and was down 9% year over year with growth in portables, partially offsetting declines across other applications. Now let's move from the top line to the rest of the P and L.

Speaker 3

2nd quarter gross margin was 66.7 percent, down sequentially and year over year, driven by unfavorable mix, lower revenue and lower utilization as we continue to reduce inventory. Operating

Speaker 1

expenses in

Speaker 3

the quarter were 598,000,000 dollars down significantly year over year, driven by lower variable compensation and strong organization wide execution on cost control. Operating margin of 39% exceeded the high end of our outlook. Non operating expenses finished at 64,000,000 dollars and the tax rate for the quarter was 10.6%. The net result was EPS of $1.40 above the high end of our outlook. Our financial position is solid, and I'd like to call out a few items from our balance sheet and cash flow statement.

Speaker 3

We ended Q2 with more than $2,300,000,000 of cash and short term investments and a net leverage ratio of 1.1. During the quarter, we raised $1,100,000,000 of debt for general corporate purposes, including upcoming debt maturities. Inventory decreased $74,000,000 sequentially and days declined to 192 from 201. As planned, we reduced channel inventory this quarter with weeks ending at approximately 8. Operating cash flow for the quarter and trailing 12 months was $800,000,000 $4,300,000,000 respectively.

Speaker 3

CapEx for the quarter and trailing 12 months was 188,000,000 and $1,200,000,000 respectively. We continue to expect fiscal 2024 CapEx to be roughly $700,000,000 which is a reduction of approximately 45% versus 2023 as our hybrid manufacturing investment cycle tapers. Not included in these figures are the benefits from both the European and U. S. Chips acts.

Speaker 3

During the last 12 months, we generated $3,100,000,000 of free cash flow or 29% of revenue. Over the same time period, we have returned roughly 110 percent of our free cash flow via dividends and share repurchases. As a reminder, our policy is to return 100 percent of free cash flow to our shareholders over the long term. Now I'll turn to the 3rd quarter outlook. Revenue is expected to be $2,270,000,000 plus or minus $100,000,000 up 5% sequentially at the midpoint.

Speaker 3

Once again, we expect sell through to be higher than sell in. At the midpoint, we expect all B2B markets to increase sequentially with the fastest growth in industrial and for consumer to exhibit seasonal strength. Operating margin is expected to be 40% plus or minus 100 basis points. Our tax rate is expected to be between 11% 13%. And based on these inputs, adjusted EPS is expected to be $1.50 plus or minus $0.10 Before passing it back to Mike to begin Q and A, I'll share some final thoughts on our near term.

Speaker 3

As Vince indicated, we believe we are at the beginning of a cyclical recovery as our bookings increased throughout the quarter and we exited 2Q with a book to bill above parity for the first time in well over a year. No doubt, cyclical transitions can be challenging, but they also provide opportunity for outsized business acceleration when approached with a balance of fiscal discipline, smart risk taking and strong execution. ADI has always excelled in these areas, and we look forward to driving outstanding value for our stakeholders in the quarters to come. With that, I'll pass it back to Mike for Q and A.

Speaker 1

Thanks, Rich. Let's get to the Q and A session. We ask that you limit yourself to one question in order to allow for additional participants on the call this morning.

Operator

Our first question comes from the line of Tore Sviennberg from Stifel.

Speaker 4

Yes, thank you and congratulations on finding the recovery here. I had a question about the outlook for Q3, specifically in Industrial. I think you indicated that you expect Industrial to be the strongest performer this quarter. I was hoping you could talk a little bit about what's behind that strength between end market demand, inventory replenishment and if there's any sub segments within industrial that's driving that outperforming growth? Thank you.

Speaker 3

Sure, Tore. This is Rich, and I'll take that one. So industrial obviously is our most diversified and profitable end market, and it's weathered an unprecedented broad based inventory correction over the past year. Importantly, we expect Q2 was the bottom for industrial, and it will grow in the second half starting here in 3Q. Stronger PMIs are supporting the broad based bookings we've seen for the 3 consecutive quarters now.

Speaker 3

And as mentioned in the prepared remarks, we're planning to reduce channel inventory further in Q3, which impacts industrial more than any other market. This will be more than a year of undershipping consumption, one reason we believe inventory headwinds have stabilized for industrial. Given these dynamics and the exciting design wins and AI related tailwinds in our instrumentation and test business, which Vince alluded to, we feel strongly we are at the beginning of the industrial recovery.

Speaker 2

I think one other piece of color, Tore, is that the obviously, the Aerospace and Defense business is doing well. We've a lot of high prospects for that over the coming years. But I think in general, geographically, it's been on the upward in terms of demand and across most of the segments and particularly the ones that Rich pointed out.

Speaker 1

And Torrey, on the outlook comment, you're right that just to clarify what we said, Of the B2B markets, industrial grow the fastest. Consumer will grow faster than industrial in 3Q. So if you want to just kind of back it down a little bit, consumer is probably growing about 10% sequentially and industrial is probably closer to mid single digits and the other two markets are probably a little bit below that industrial level, but all markets should grow in 3Q.

Speaker 4

Very helpful. Thank you.

Operator

Thank you. One moment for our next question. Our next question comes from the line of Stacy Rasgon from Bernstein Research.

Speaker 5

Hi, guys. Thanks for taking my question. I wanted to ask about the book to bill. So it's above 1. Is it above 1 in all the segments Or is it just above 1 in industrial?

Speaker 1

Yes. It's actually so good questions. It's above 1 in all end markets, not all applications within end markets are above 1 though. And if you think about the shape of that bookings throughout the quarter, we talked about last earnings call, bookings improved and it started below parity and exit the quarter above parity and that's across all markets and geographies. Again, I reiterate it's not all applications and we talked a little bit about on the last question about what applications are above 1.

Speaker 1

You can think of some instrumentation, some automation, some aerospace and defense within industrial. So broad based improvement in bookings across all markets and geographies is really the main takeaway.

Speaker 5

Got it. That's helpful. Thank you.

Speaker 1

Thanks, Stacy.

Operator

Thank you. One moment for our next question.

Speaker 6

Our next question comes from

Operator

the line of Toshiya Hari from Goldman Sachs.

Speaker 7

Hi, good morning. Thank you so much for taking the question. I wanted to ask about the back half of the calendar year and how you're thinking about the shape of the recovery. Vince, you've lived through many cycles. I think typically the same way we underestimate the magnitude of the pace of the downturn, we collectively underestimate the pace of the upturn.

Speaker 7

So I'm curious if you expect this upturn to be similar to past cycles and we kind of follow those patterns or do you see anything in the marketplace today or anything from customers that would indicate something materially different in terms of the shape of the upturn? Thank you.

Speaker 2

Yeah. Thanks, Sashir. So, yeah, look, first off, we believe we've seen the bottom of the cycle. And as Mike indicated, the stronger PMIs that we've seen, particularly in the industrial sector, give us a lot of confidence and there's a strong correlation between our industrial business, which is about half of the company's total revenue. So, and as we've said now a few times, bookings and backlog coverage out for the next several months beyond this quarter would give us strong indications that we expect continued growth during the second half of the year.

Speaker 2

I'll also point out, I think, for 2025, we will have a brisk growth year. That's my sense. And we're asked all the time, what's the shape going to be? Well, I don't really know what the exact shape is going to be, but I think we're on the upward trajectory. We have confidence in that across the board.

Speaker 7

Thank you.

Speaker 1

Thanks, Toshiya.

Operator

Thank you. One moment for our next question. Our next question comes from the line of Vivek Arya from Bank of America Securities.

Speaker 8

Thanks for taking my question. Vince, what is the right way to understand the true change in end demand if we set aside all the inventory fluctuations? For example, is it worthwhile seeing what the distribution sell through do year on year in Q2? What is the assumption for Q3? And does that inform us in any way about can Q4 be seasonal, whatever is the version of seasonality.

Speaker 8

I'm just trying to see, right, the right apples to apples way of looking at what is end demand doing setting aside all this inventory noise?

Speaker 2

Yes. Look, I think it's very hard to answer that question simply because when history is written, we're going to get the average of what's happened pre pandemic and post pandemic. So there's been so much ringing in the system, demand overshoot and then demand undershoot. But my sense is that certainly from our perspective, I think we're very well positioned to be able to capture the upside if things grow faster than we expect. We've got a lot of inventory on the balance sheet.

Speaker 2

We've kept inventory closer to ADI less downstream. And with the we've got as well a tailwind here from AI, which I think is going to be a multi year tailwind. So we've got that pushing us along. But at the same time, we've got still we've got high interest rates. We've got still relatively high inflation in many places.

Speaker 2

So I think ultimately the size of the recovery and the pace of the recovery will have a strong economic and geopolitical tone to it. But I mean, overall, my sense is, we'll see good growth for the remainder of this year and strong growth in 2025. And beyond that, I think we've got many, many growth drivers that we feel very confident about. We're selling more value into each of our customers and each

Speaker 1

of our

Speaker 2

segments. And I feel good about the place that semis are in as an industry right now as well in terms of overall demand. As the edge becomes more intelligent and the cloud builds out. So but very, very hard to give you an answer on the puts and takes, I mean, the dynamics of the relatively near term are hard to decode. But what we can tell you is, given where PMIs are at, given where our demand is at, we're in a recovery phase.

Speaker 3

Yes. And Vince, I would add to that. While it's impossible to get perfect visibility into our end customer inventory, certainly the signals that we monitor tell us that customer inventories are much healthier than they were previously as we entered into the second half. And this is also aided by our belief that we have been under shipping under consumption for over a year now both in the channel and direct. But that's the only reason quantification,

Speaker 8

right, of what the sell through has been in the reported quarters year on year?

Speaker 1

Yes, I can help you out there, Rebecca. I think your question is kind of what sell in versus sell through. We talked about last year and we've got we talked about reducing the channel inventory by about $100,000,000 We achieved that in our 2Q. We had to do a little better than that. As you look to 3Q, we'll reduce channel dollars again, but not by that much, not nearly 100, much less than $100,000,000 So we're getting more normal in the channel as our weeks are coming down into our target range.

Speaker 1

So that normalization is helping some of the growth, but sell through is also increasing in 3Q from 2Q, which is really how we drive the business and look at for indication. As you fast forward to 4Q, if these bookings continue, we don't know. There's no reason to think we won't be more in balance in 4Q from a ship in versus ship out perspective as well. And then we'll see how 1Q goes from there.

Speaker 9

So I think that's kind of

Speaker 1

the question you're asking is there's piece Rich talked about and Vince talked about, about the customers' inventory that's leading out. If you look at us and what we're shipping in the channel, that's also normalizing, setting us up for a good second half in 2025.

Speaker 7

Thank you.

Operator

Thank you. One moment for our next question.

Speaker 6

Our next question comes from

Operator

the line of Christopher Danley from Citigroup.

Speaker 10

Hey, thanks, gang. Can you talk about the gross margin drivers from here? Maybe touch on utilization rates and inventory trends. And some of your competitors have talked about pricing returning to historical norms. If that happens, can you still get the gross margins back to the previous peak?

Speaker 3

Sure. I'll take that one. From a gross margin and utilization perspective, we talked a little bit about this in the Q1 call. We expect both utilization and gross margin bottomed in our Q2. However, we do expect the pace of gross margin expansion in the second half to be modest.

Speaker 3

And specifically for Q3, we anticipate gross margin a bit above 67%. Looking from here, gross margins expansion is going to be dictated by continued revenue growth, mix of business and utilization. From a balance sheet perspective, since our peak in Q3, we've reduced balance sheet inventory significantly, including over $70,000,000 in Q2. For the Q3, we expect to reduce inventory again by a lesser amount than in Q2. Overall, we executed pretty strongly against our inventory reduction goals, while mitigating the impact on gross margin, leveraging our dynamic hybrid manufacturing model.

Speaker 3

One of the things that's been super helpful in protecting us in this trough is the flexibility to swing capacity back into our fabs to help maintain utilization. We've done that effectively, which is why we called the floor on utilization. So I expect that utilizations as the demand continues to increase, will start to increase and aid in our margin expansion. From a channel and as Mike mentioned, from a channel perspective, our goal was to reduce by $100,000,000 which we achieved. We will reduce an additional amount in Q3 to a lesser degree.

Speaker 3

And ultimately, we expect that this will get us firmly back into our target range of 7 to 8 weeks of inventory in the channel.

Speaker 2

Yes. Let me make a comment on the pricing side of things. So across the portfolio, our pricing has been very, very stable, and I expect that to continue. Our products are very sticky. The franchise is very, very it's very diversified.

Speaker 2

It's got lots of long life products in it. And we tend to hang on to our sockets for, I think, on an average more than a decade. So clearly, where the competition is for the new sockets, right? But AVI has the premier innovation system in the analog mixed signal space. And we've been pushing that innovation.

Speaker 2

While others are focused on volume, we're focused on value. So I think it's a very, very different approach to things. We're not a commodity supplier at all. So we're not immune to price pressure, but we are more protected. I think we have a better moat because of the innovation value that we generate.

Speaker 2

And I'll note as well, our ASPs are more than 4 times the average. And it's our innovation premium that enables us as well to capture more value and to produce the kinds of gross margins that we do.

Speaker 3

Great. Thanks guys. Thanks,

Operator

Chris. Thank you. One moment for our next question.

Speaker 6

Our next question comes from

Operator

the line of Ross Seymore from Deutsche Bank.

Speaker 11

Hi, guys. Congrats on marking the trough and turning the corner. Vince, I wanted to ask a bigger picture question. I think it's been 4 years since you guys bought Maxim and I believe it was 4 years prior to that with Linear. So how are you looking at the M and A environment?

Speaker 11

And are there any kind of pieces to the puzzle that you wish you

Speaker 2

had? Yes. Thanks, Ross. So yes, we've always acquired assets that get ADI ahead of customers' needs. We tend to take a long term view, get ahead of our customers' needs.

Speaker 2

Obviously, we've been very, very selective. I will say, Ross, it's fair to say that in terms of scale and scope of analog high performance franchise, we are where we need to be. So analog, mixed signal power, we've got a wonderful power franchise now. But we've been adding, I alluded in my remarks or stated in my prepared remarks that we have been putting more software content, more digital content, and we've also been for about 7 or 8 years now developing machine learning, neural networking capability. So those are areas where as the world becomes more and more software defined, that is clearly an area where ADI has been organically investing.

Speaker 2

I think right I think right now, we're really focused on making sure that we fully capture all the synergies from the revenue synergies from Maxim. And but when we have we're always looking by the way, we're always looking for assets. But clearly, I think analog is complete and it's other areas we're now looking.

Speaker 1

Thank you. Thanks Ross.

Operator

Thank you. One moment for our next question. Our next question comes from the line of Mark Lipacis from Evercore ISI.

Speaker 5

Hi, thanks for taking my question. This is for you, I think, if you look at your if you adjust your revenues for the step function increase that you had for pricing, It looks like on a unit basis, you're shipping 25% below the trend line. And I don't think you shipped that far below your long term trend line since the world financial crisis. And at the same time that's happening, you talked about your customers lowering the supply chain lowering inventories, you're lowering inventories. And it seems like there's a real risk that the industry is setting up for you and the industry is setting up for like a really tight supply environment, maybe even as they're early as the end of this year or early next year.

Speaker 5

And I'm wondering how do you think is there a risk that we enter that kind of a scenario? And it seems like your customers never learn about trying to get their inventories right and the order see you on time. So like is there something that's changed in your operations that will enable you to adjust to that what has historically happened, which is your customers overshoot on the downside on their inventories and then come in at the last second when things are really tight? Thank you.

Speaker 2

Yes. Well, yes, I think surging demand is a problem of a high quality. And as we have virtually 200 days of inventory in our balance sheet, stage primarily at the die stock level. So that gives us a tremendous amount of output that we could bring within weeks to the market. It's a question of packaging and test to a first approximation.

Speaker 2

Obviously, we're carrying finished goods as well. We have also spent $2,500,000,000 plus on making sure that we have internal capacity in our 4 internal fabs to be able to meet the demands across the nodes that produce most of the revenue for ADI. We've got great partners, partners like TSMC, for example, who are a critical part of our hybrid manufacturing model. So I think in terms of the ability to be able to address a really short order snapback is good, just given the coverage that we've got with internal inventories. Our distributors are carrying virtually 8 weeks as well of inventory.

Speaker 2

And then we've got all this new capacity. We've more than doubled the internal capacity on the critical nodes that address every single market that we participate in. So I think in terms of manufacturing agility, inventories, we're in good shape.

Speaker 1

Very helpful. Thank you. Thanks, Mark.

Operator

Thank you. One moment for our next question.

Speaker 6

Our next question comes from

Operator

the line of Harlan Sur from JPMorgan.

Speaker 9

Yes, good morning. Thanks for taking my question. Great job on the quarterly execution. Within your distribution business, it's about 60% of your overall revenues. You can monitor sell through in your real time, which allows the team to tightly control the inventories into this channel.

Speaker 9

On the direct business, less visibility on consumption, levels of inventory here. I think direct customer orders to you are probably the best indicator of where they are in terms of their inventory targets. So is the return to quarter on quarter growth in July and second half optimism on growth being driven by order growth at direct customers as well? And then just any qualitative differences on the residual excess inventory, disty versus direct?

Speaker 1

Yes. Hi, Arlen, it's Mike. Yes, the direct orders we talked about are direct orders as well as channel orders, but what's driving the growth is direct sales out of the channel on a sell through basis as well image directly to our end customers. So yes, it's not about we're not growing because the channel is refilling. We're growing because there's real demand out there on the end market level across all of our markets.

Speaker 3

We expect to reduce both balance sheet and channel inventory further in Q3 while growing.

Speaker 1

Does that answer your question, Harlan?

Speaker 9

Yes, it does. Thank you.

Speaker 5

We'll go

Speaker 1

to our last question, please.

Operator

Thank you. One moment for our next question.

Speaker 6

Our next question comes from

Operator

the line of Joseph Moore from Morgan Stanley.

Speaker 12

Great. Thank you. I wanted to also touch on your margin profile. You used to peak with operating margins in kind of the low 40s and now you're as you said you would in a very difficult trough, you're troughing it for the full year probably above 40. So that's pretty good structural improvement.

Speaker 12

Can you talk about that? What's going on if you sort of look over a decade? Why is your through cycle margin profile going up so much?

Speaker 3

Yes. So I think a couple of things, right. As we've talked about, the resiliency of our manufacturing process allows us to swing capacity in and out, which allows us to offset some of the down cycle pressure on margins because we're able to keep utilizations at a higher level given that swing capacity. Obviously, we continue to look for productivity and are executing on productivity improvements across all of our internal fabs. So I think that helps.

Speaker 3

And then if you think at an overall operating margin perspective, we've been demonstrating and we'll continue to demonstrate pretty strong operational control over expenses. When we look, will continue to see expansion in the margin as we grow. And as revenue returns to a growth phase, we will get comfortably back into our long term margin model. Yes. I think Joe as well in addition to

Speaker 2

what Rich has said, it's important to point out that 1st and foremost, we're innovation centered. And if you look at the vintage bands of our products in each of the segments, the big segments that we address industrial, automotive consumer and communications, we're seeing ASP increases year on year. We're putting more value into our products. We're capturing more value. So I think that is kind of the root of things when I look forward.

Speaker 2

That's I mean, that's what's happening to that's the origin, if you like, of the margin story for ADI. Our diversity helps us a lot. Our franchise isn't as price sensitive as many. And as I said earlier, life cycles matter. When we get our products designed and the pricing is tremendously stable.

Speaker 2

The other thing that's been happening from a price dynamic over the last several years is that whereas Moore's Law kind of taught everybody that we could give back lots of the value that was generated in prior years in the New Year, that has stalled, that has stopped. We are sunk roughly to 0 now. We don't give price away. We compete for sockets and compete in innovation, but that is really the origin of ADI's margin story.

Speaker 1

All right. Thank you, Joe. And thanks everyone for joining us this morning. A copy of transcript will be available on our website and all reconciliations are there as well. Have a great Memorial Day weekend and thank you for listening in on ADI's call.

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Analog Devices Q2 2024
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