Prepared remarks
Good morning, and welcome to the Analog Devices' Third Quarter Fiscal Year 2026 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. Jeff Ambrosi, Head of Investor Relations. Sir, the floor is yours.
Thank you, Danny, and good morning, everybody. Thank you for joining our third quarter fiscal 2026 conference call. Joining me today is ADI's CEO and Chair, Vincent Roche; and ADI's CFO, Richard Puccio. For anyone who missed the release, you can find it at investor.analog.com, along with related financial schedules. 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, 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 nonoperating expenses, operating margin, tax rate, earnings per share 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 earnings per share are on a fully diluted basis. And with that, I will turn the call over to ADI's CEO and Chair, Vincent Roche.
Thank you, Jeff, and a very good morning to you all. Well, as you've seen, third quarter revenue, margin and earnings all exceeded our outlook with growth across all of our end markets, led by data center and industrial, propelling us to the first $4 billion quarter in ADI's history. Demand for our solutions continues to grow, supported by robust AI and defense spending, cyclical momentum and underlying secular content growth across our diversified end markets. Through targeted R&D, we continue to extend the limits of technology performance and accelerate the pace with which we are delivering more comprehensive solutions to our customers' toughest problems. In tandem, investments in our hybrid manufacturing network have enabled us to increase the agility and responsiveness of our supply chain and consistently capture above seasonal growth for more than two years. Now for the rest of my remarks today, I'll focus on how we're helping customers meet unprecedented and still accelerating demand for AI infrastructure and energy systems. The fact that data center capacity is now measured in gigawatts rather than FLOPS and TOPS underscores one of the most defining challenges of the AI era. Power availability has become the primary constraint to further AI progress. Solving this challenge requires more than simply adding more energy; it demands a grid-to-chip system-level approach that encompasses both improving the availability and delivery of energy and extracting the maximum computing power from every watt delivered. Now let me walk you through some of the key elements of our grid-to-chip strategy, starting at the grid where the AI bottleneck begins. As electricity networks become more complex, visibility, efficiency and resilience are becoming critical challenges. Customers are turning to ADI's grid monitoring solutions to illuminate the flow of energy across the network, providing real-time insight into voltage, current, power quality and system health. Our higher-value solutions are helping utilities, energy operators and infrastructure providers to improve efficiency, reliability and utilization. An increasingly essential part of the grid and one of the fastest-growing sectors is energy storage. Here, customers choose ADI's industry-leading battery management technology to help maximize usable energy, improve system efficiency, extend battery life, enhance safety and improve ROI. Expanding and modernizing the traditional grid alone, however, is not enough to keep pace with the speed of AI infrastructure deployment. To accelerate time to power, hyperscalers are increasingly exploring dedicated microgrids, which are opening up additional avenues of growth for ADI. We believe this trend of localizing power will augment our $500 million-plus energy business, which began inflecting in 2025 and has been delivering accelerating growth this year. Importantly, our strong and growing positions across both energy and data center make us a more critical AI ecosystem player, spanning the entire electricity value chain from generation, transmission and storage to distribution through rack power and ultimately, processor power delivery — essentially the vascular system of the data center. Now once the grid makes contact with the data center, AI's extreme energy and information density requirements make ADI's deep expertise and innovation in high-performance power management, sensing and telemetry as well as optical connectivity even more critical. So let me start with our optical franchise as I begin to unpack for you how we're growing our data center business and opportunity by helping our customers resolve the tremendous challenges of energy and information density. When we think about the journey of data through the infrastructure, there are two critical pathways: the data path of electro-optics and the control path, which guides, optimizes and ensures the integrity of the data path. Our focus is on the control path, where we've been setting and extending the industry's performance envelope for decades. Today, the complexity of efficiently moving data at ever higher speeds within and between racks and across data center campuses is growing exponentially. Customers are increasingly relying on ADI to provide essential timing, power management, data conversion, monitoring and control capabilities that enable lasers and transceivers to operate with precision, reliably, efficiently and at the necessary scale for AI workloads. As customers seek to further increase the amount of optical lanes, signal bandwidth or both to accelerate network speeds from 800 gig to 3.2 terabits per second, we believe that we're very well positioned to benefit threefold from unit growth in pluggables and coherent light modules, increasing BOM content and greater share as these transitions unfold. As new architectures, such as optical circuit switching and co-packaged optics gain traction in next-generation large-scale AI clusters, complexity expands even further and our long-term opportunity continues to grow. Based on current design wins and customer commitments, our OCS revenue is poised to approximately double this year, and we're targeting a similar level of growth in 2027. In the nascent CPO space, which we view as a SAM expander, the criticality of ADI's precision control technology further increases as thermal and serviceability challenges rise. So in short, the combination of market growth, expanding content, increasing share and differentiated value creation across data center optics reinforces our confidence that this segment will remain a strong growth vector for ADI over the coming years. Now let me turn to our power franchise. The need for customers to convert and deliver precise increasing levels of power at the rack and compute layers efficiently and safely is driving continued broad-based growth across our portfolio. Customers are leveraging ADI's products and solutions to push for greater than 98% conversion efficiencies, multi-kilowatt power delivery with peak power levels up to two times the rated load and comprehensive protection, telemetry and fault recording capabilities that enhance system reliability and maximize uptime. To put just one of those differentiators in context, the 1% difference between 97% and 98% efficiency may not sound like much, but a 97% conversion efficiency loses roughly 50% more energy through heat than a 98% solution. Over time, that difference compounds in terms of the need for additional cooling infrastructure, stress on equipment and operating costs. We believe our opportunity will continue to grow substantially as power density demands of AI clusters continue to increase. The industry's architectural transition toward 800-volt DC power distribution plays directly into ADI's power management expertise and portfolio. We're seeing a significant design-in uptick for our protection and 800-volt to intermediate power conversion technologies, which can deliver 20 kilowatts of power at industry-leading power densities exceeding 2.5 kilowatts per cubic inch. At the intermediate to core conversion layer, which is one of the fastest and largest growing analog opportunities in the AI era, our combination of advanced power conversion, intelligent system control and real-time telemetry is critical to achieving the necessary power density, efficiency and reliability requirements for next-generation processors to operate at 6,000 amps and sub-1 volt. Our Empower acquisition further enhances ADI's vertical power story by enabling us to take power into the processor package itself. In large-scale AI deployments, these architectural advantages can reduce compute power consumption and temperature by approximately 10% to 15%, which equates to roughly $30 million in annual savings in a 1 gigawatt data center. As with optical, our power pipeline is growing rapidly, and the direction and rate of our R&D investments reflects our belief in the size of the SAM opportunity before us and our confidence that data center power can remain a strong growth vector for ADI over the coming years. So in summary, we believe the architectural shifts underpinning the evolving AI era are increasing ADI's role as a critical partner across the grid-to-chip ecosystem and driving extraordinary opportunity. Our current assessment is that our 2030 data center and energy SAM has more than doubled from what we had envisioned just one year ago. This dramatic expansion is not simply a function of increased AI infrastructure CapEx. It reflects the impact of new markets and architectures that require orders of magnitude more analog content delivered via higher-value solutions. Now stepping back to frame this growth on the larger landscape of ADI's continued evolution, grid-to-chip is but one facet of the first generation of AI characterized by applications largely focused on data centers. The ATE growth we've recently spoken to on these calls is yet another facet. As great as the impact of Generation 1 AI has been so far for ADI, however, we continue to believe that the bigger prize may be in the second generation as AI extends its reach from the data center to the physical world in the form of pervasive robotics, digital health, autonomous mobility and so on. In this now emerging phase, AI must not only support higher-level learning and analytics, but also real-time sensing, inference and responsiveness to complex real-world signals. Our ability to tackle this challenge through our products and solutions in edge-based reasoning informed by deep physical intelligence will extend our AI value proposition across the entire addressable space. We're able to pursue this horizon of AI opportunity as a result of the tremendous optionality built into ADI's business model, which is designed to support both upside growth asymmetry as well as cyclical downside resiliency. This optionality is founded by leveraging our cutting-edge technology stack and domain expertise at the electrophysical interface as well as long-term partnerships with our customers. Our success in AI to date is the latest proof point, and I believe the best is yet to come. And with that, I will hand it over to Rich.
Thank you, Vince, and let me add my welcome to our third quarter earnings call. Revenue in the third quarter was $4.02 billion, finishing above the high end of our outlook and increasing 11% sequentially and 40% year-over-year. Growth was broad-based across markets and regions. Industrial, which represented 49% of our third quarter revenue, finished up 10% sequentially and 53% year-over-year. We saw year-over-year growth across all our industrial businesses, led by ATE, electronic test and measurement, aerospace and defense, and automation. Automotive represented 25% of revenue, finishing up 14% sequentially and 16% year-over-year. Our higher content and share positions globally continue to result in growth well above SAAR. We are seeing diversified strength across customers and products in key secular growth areas, including next-gen ADAS and infotainment systems and also in electric powertrains. Communications represented 16% of revenue, finishing up 18% sequentially and 84% year-over-year. Data center, which now accounts for 80% of our communications revenue, continued to accelerate with more than 100% year-over-year growth in both optical and power. In wireless, we delivered more than 25% year-over-year growth as we continue to execute against cyclical tailwinds. Lastly, consumer represented 10% of quarterly revenue, flat sequentially and up 6% year-over-year. Our diversified consumer business showed strong resilience despite memory-driven challenges. We achieved year-over-year growth across smartphones, hearables and wearables and saw accelerated growth in our B2B-like prosumer franchise. Now on to the rest of the P&L. Third quarter gross margin was 72.5%, down 50 basis points sequentially and up 330 basis points on a year-over-year basis, driven by higher revenue, utilization and favorable mix. OpEx in the quarter was $907 million, resulting in an operating margin at the high end of our outlook or 50%, which is up 100 basis points sequentially and 780 basis points year-over-year, driven by improved gross margin and execution discipline. Nonoperating expenses were $69 million, and the tax rate for the quarter was 13.1%. All told, EPS finished at the high end of our outlook for a record $3.45, up 12% sequentially and 68% year-over-year. Now I'd like to highlight a few items from our balance sheet and cash flow statements. Cash and short-term investments decreased to $2.3 billion, driven by the successful closing of our Empower Semiconductor acquisition on July 7, where we paid $1.5 billion in an all-cash transaction. Our net leverage ratio now sits at 0.9. We increased inventory $83 million sequentially as we continue to build strategic die bank to support accelerating demand. We exited fiscal Q3 with record balance sheet inventory and increased inventory at our distributors. Despite the increases, our days declined to 156 and channel weeks fell below our 6- to 7-week target. Over the trailing 12 months, operating cash flow and CapEx were $5.5 billion and $0.6 billion, respectively. We continue to expect fiscal 2026 CapEx to be within our long-term model of 4% to 6% of revenue. Free cash flow over the trailing 12 months was a record $4.9 billion or 36% of revenue. Over that same period, we returned more than 100% to shareholders through dividends and share repurchases. As a reminder, the durability and strength of our financial model allows us to target 100% free cash flow return over the long term, aiming to use 40% to 60% to support our annual dividend and the remainder for share count reduction. Now moving on to our fourth quarter outlook. Revenue is expected to be $4.3 billion, plus or minus $100 million. Operating margin at the midpoint is expected to be 52%, plus or minus 100 basis points. We expect nonoperating expenses of approximately $80 million and a tax rate of 12% to 14%. Based on these inputs, adjusted EPS is expected to be $3.86, plus or minus $0.15. In closing, our record results and outlook underscore our ability to capitalize on cyclical and secular tailwinds across the AI ecosystem, defense, core industrial and automotive markets. We will continue to balance execution discipline with strategic growth investments to navigate a dynamic macro and geopolitical environment while delivering on our attractive financial model. With that, I'll give it back to Jeff for Q&A.
Thank you, Rich. Now let's get to our Q&A session. Operator instructions: to ask a question, please follow the operator's prompts. With that, operator, can we have our first question, please?
Questions and answers
Operator instructions: our first question comes from Harlan Sur with JPMorgan.
Congratulations on the continued solid execution. On the strong operating margin guidance and therefore, strong implied gross margins, I'm sort of rolling up to about 73.5% gross margin for October, a 100 basis point improvement. Your utilizations are already at high levels. You've talked about mix and volume as the primary drivers going forward. Are these two dynamics driving most of the 100 basis point-plus step-up in gross margins in October? Or is the team implementing more price increases beyond the actions that you took at the beginning of the year, and is that also contributing to the strong gross margin profile as well?
Thanks for the question, Harlan. I'll take this one. For Q3, gross margin came in as expected. We are actually expecting a gross margin increase of about 150 basis points to about 74%. You were spot on: this is driven by favorable mix, higher fixed cost absorption following the higher revenue, and our price adjustments. Looking to the medium term, I'd remind you that we do have a seasonal shutdown coming up in our first quarter, which does create some drag on gross margin, and we are expecting more cost increases — inflation is still a persistent factor. That said, the full extent of our price action, which has been announced, is not captured in Q4. We will get a full quarter of shipments in Q1 with some trailing impact as we review contracts. Overall, we see gross margin hanging in at the Q4 exit level as long as we maintain the revenue and mix that we expect.
Operator instructions: our next question comes from Vivek Arya with Bank of America Securities.
Vince, I'm very interested to hear your thoughts about fiscal 2027. If I look over the last two years, ADI's top line has accelerated, I think, almost every quarter on a year-on-year basis. How much of that do you think has been secular? How much of that has been cyclical? And how much of that has been pricing? If I were to take your Q4 outlook midpoint and assume normal seasonality, it suggests at least a 20% or so plus growth into fiscal 2027. So I'm curious for your high-level thoughts. Are there any areas of constraints? And is there more operating leverage left if indeed your top line were to grow 20%?
We'll take the rest of the call, Vivek, to answer those questions. Let me unpack a little of the story and then Rich can add some commentary as well. Since we called the bottom in the second quarter of 2024, we've seen our strengths manifest through several areas. We're clearly a beneficiary of the defense and the AI supercycles, which I think will persist for many years. Right now, aerospace and defense, ATE and data center are about 30% of ADI and our portfolio is exposed and poised for greater growth, more content and share gains. We're also gaining share across the spectrum of vehicle types, both combustion and EVs. In consumer, we turned a corner two to three years ago and we're seeing content and share gains across mid- to high-end smartphones, gaming, hearables and wearables. I've mentioned the Maxim synergies previously. When we announced the acquisition, we expected $1 billion of synergies. We're well on track and will generate about $700 million this year. I expect we'll hit $1 billion-plus in 2027 as well. The overall cyclical tailwind is also strong across the board. Given the breadth of our portfolio, that lifts all the businesses aside from the asymmetric tailwinds we have. As Rich talked about, we also have a favorable backdrop in terms of pricing, and we've capitalized on those vectors of growth. Our lead times are in good shape. As Rich said, we're sitting on record inventories, but those inventories are intentionally placed and built in place, thanks to the manufacturing agility we've built in with our hybrid model and that we continue to extend the scope of.
Yes. Vivek, what I would add is that with the significant demand we're seeing, we still think we have not seen restocking activity from our customers. They continue to run very lean. Our work over the last two years to balance out inventory, both on our balance sheet and in the channel, has been helpful. As we look into the next quarter, we will continue to stage more inventory in the channel given the acceleration. If you look at consumption patterns, those three big secular drivers specific to our business show real end demand: the massive increase in AI infrastructure spend and the aerospace and defense growth. If you extract those pieces out and then look at the broader parts of our business, most of our business is still shipping well below historical consumption levels. So we think there's still room on both the cyclical part of the upturn and on the secular tailwinds. We continue to see strength across aerospace, defense, ATE and data center.
In summary, we believe we're very well positioned as a company. Things under our control are executing well, but there are external factors such as macro volatility, heightened geopolitical risk and potential rate hikes. AI CapEx could slow or decrease, and there's market volatility. All that said, our expectation is that we'll have a brisk growth year in 2027.
Operator instructions: our next question comes from Stacy Rasgon with Bernstein Research.
On the data center side, you said that 80% of your communications business was now data center, which I found interesting. If that data center piece is doubling, is that the kind of growth rate I should be thinking about for at least the communications segment in 2027, given the vast majority of it is data center? Do you think that communications should be growing close to 100% year-over-year as I start to think about 2027? And within that, can you give any color on what you're expecting for the segment in the near term into Q4?
Stacy, we'll start with the near-term outlook and the end market. At the midpoint of our outlook, we're expecting industrial to be up high single digits, communications to lead the growth led by data center up about 10%, consumer up high single digits and automotive up low single digits. For modeling data center longer term, there are many growth vectors. The market is strong and the end market is growing double digits on CapEx. Importantly, analog BOM content is increasing significantly, particularly as we transition to 800-volt architectures. We're targeting to increase share in many places. At a high level, we expect strength in data center for multiple years to come.
Stacy, rather than give a precise number for 2027 today, our pace put us nearly on track to be twice the size in 2026 over the prior year. My sense is we'll see an extended runway to at least 2030 for strong double-digit growth across the data center market as well as the energy space, which today is about $0.5 billion revenue for ADI. I think by the end of the decade, that business will double.
Operator instructions: our next question comes from Tore Svanberg with Stifel.
Vince, I had a longer-term question about analog. Historically it's been an industry that grew high single digits. With analog now benefiting significantly more from AI infrastructure and, as you said, eventually from physical AI, should we assume that the underlying growth of the analog industry is shifting upwards here, both from a units and a pricing perspective?
Yes. I think it is possible for the analog business to be in the double-digit zone compounded for several years to come. If you look at data center alone, there is expected to be the equivalent of 100 gigawatts of infrastructure built for data centers between now and 2031. Each gigawatt generates $1 billion to $1.5 billion of analog SAM. Problems are becoming more complicated in data center, which will increase the sophistication and pricing of solutions. So it's not unreasonable to contemplate higher growth in the out years from here.
Operator instructions: our next question comes from Mark Lipacis with Evercore.
Vince, thanks for putting a number out there in the double-digit range. The last time ADI revenues were above the long-term 5% to 7% trend was in the late '90s, early 2000s, and there were similar arguments about the Internet build-out and telecom deregulation. Could you compare the secular dynamics you see today versus then, which ended up bringing analog revenues back down to 5% to 7%?
I lived through that period. The concentration then was much higher. Today, more intelligence has been brought into information technology, more edge computing and more intelligent edge. That has increased both the TAM and SAM for the analog sector. ADI's portfolio breadth and depth and the number of places in which we play are far greater. We've built optionality into our business model. We can capture asymmetric upside while retaining cyclical resiliency. The pervasiveness of what analog offers now is much greater. Over the next decades, a lot of economic growth will be built on externalized intelligence. The gravity field of AI will pull many markets with it. From our perspective, the industry is broader and deeper, and we've never had a cycle with this breadth and depth driven by AI.
Operator instructions: our next question comes from Blayne Curtis with Jefferies.
I wanted to ask about data center, and previously you referred to AI exposure that includes ATE. As you look at the growth calculus when the data center part is growing triple digits, how should we frame the opportunity for ATE, and can you share how big that was?
Blayne, in the past we've talked about our AI exposure as ATE plus our data center business. Combined, those are about 20% of ADI. We have a lot of confidence backed by design activity. Our pipeline and design activity with customers is strong in ATE as well as across data center, not just in power but optical as well. That 20% of ADI has a strong multiyear growth tailwind behind it, and we're confident because of design activity, backlog, pipeline and bookings momentum.
Operator instructions: our next question comes from Matthew Prisco with Cantor.
With this strong demand backdrop, how should we think about ADI's supply capabilities as revenues continue to tick higher? At what point do we need to start thinking about capacity additions? Are there any constraints arising in the supply chain today or any areas that could cause pressure going forward?
I'll start, Matt. We are executing well on supply chain. We've been able to deliver above season growth for nine straight quarters, and we're guiding to a tenth. We're continuing to build inventory, expand internal capacity and install new tools in available spaces while also getting more wafers externally. We feel very well positioned for the near and medium term demand. Lead times have started to extend in the industry, but we're working to keep them in check. Demand acceleration is unprecedented in recent memory, but we have a book-to-bill above 1 and not unusually high. We're also getting better visibility with some longer-term orders, which helps us leverage capacity. We continue to add capacity as we go, and we are scenario planning what sustained growth could look like, balancing our hybrid manufacturing with additional external wafers and considering whether we need to add capacity beyond what we've been doing for the last three to four years.
In addition to expanding internal manufacturing, we have several great external partners on both front-end and back-end processes. We are jointly planning with partners for a long view to support the nodes critical to ADI, from lithographically insensitive nodes down to advanced nodes like 5 nanometers and 3 nanometers. That's what we did during the COVID cycle, and we continue to extend the capability of our hybrid manufacturing system. A couple of years ago, the semiconductor industry was expected to reach $1 trillion by 2030; today the outlook is larger. The industry has a big task to get ahead of the new growth trajectory, including ADI.
We'll take our last question, please.
Operator instructions: our last question comes from Joshua Buchalter with TD Cowen.
Congratulations on the very strong results and guidance. The 74% gross margin outlook is pretty staggering and we're back to those 2022 peak levels. It's also coming without much incremental utilization torque. Bigger picture, through the cycle, is that a number you think you can hold and grow off? As we think longer term, can you speak to how you're prioritizing revenue growth versus margins? Is this low-to-mid-70% level one that you intend to manage to long term?
Josh, I do think we can continue to maintain roughly the 74% gross margin level. We will continue to focus on growth investments, some of which may put pressure on margins as we expand revenue growth dollars. But given the balance of our portfolio and the parts that continue to grow, the opportunity to maintain that margin exists. We're getting significant benefit from running factories at higher utilizations, which we expect will sustain throughout this up cycle. We'll balance investments to grow revenue with maintaining that margin. I don't think there's a ton of room to get more margin accretion out of utilization alone. We're still at a 49% industrial mix, so if mix shifts, there's potential upside or at least a way to offset headwinds. We also expect inflation to continue; we'll monitor and track it as we have historically. Overall, we feel in a balanced position for the medium and long term.
One other point: the origin of the high gross margin structure is the innovation premium we attract. Our job is to keep that premium moving, while cycles help deliver manufacturing efficiency. The strategic aspect and the operational aspect together give us many years of runway. Our customers are asking us to tackle more difficult problems and take on more of the work. The breadth and depth of our high-performance portfolio position us well to continue to make the origin of the gross margin a continuing critical part of ADI's value proposition.
This concludes the question-and-answer session. I'd now like to turn it back to Jeff Ambrosi for closing remarks.
Thanks, everyone, for joining us. A copy of the transcript will be available on our website and all available reconciliations and additional information can also be found in the Quarterly Results section of our Investor Relations website, investor.analog.com. Thank you for your continued interest in Analog Devices. Have a good day.
This concludes today's Analog Devices conference call. You may now disconnect.