Analog Devices Inc..Q4 2019, Letter to the Shareholders
Dear Fellow Shareholders
We are living in a time of astonishing innovation in the Third Wave of Information and Communications Technology (ICT), as we refer to it at ADI. This wave is characterized by ubiquitous sensing, hyper-scale and edge computing, and pervasive connectivity. These technology modalities enable the generation of vast amounts of data that allow us to glean actionable intelligence about the world. As one of the very broadest high-performance analog solutions providers, we play a critical role at the nuanced intersection of the physical and digital domains, by providing the building blocks to sense, measure, interpret, connect, and power the edge. Essentially, ADI is where the data is born.
This era of extraordinary technological change will continue to improve quality of life globally through continuous advancements in areas such as seamless and efficient automation, more sophisticated communications networks, universal and affordable healthcare, environmental integrity, and much more.
Through our research and development (R&D) investments and strategic acquisitions, ADI is better equipped than ever to solve our customers’ toughest engineering challenges from sensor to cloud, from DC to 100 gigahertz, and from nanowatts to kilowatts. And as analog engineering challenges become more complex, our customers are telling us that they want us to provide more complete solutions. This provides ADI with new, attractive opportunities to deliver profitable growth in the years ahead.
Solid Financial Results for Fiscal 2019
In fiscal 2019, we delivered revenue of approximately $6 billion amidst challenging macroeconomic conditions and trade uncertainty. Our business-to-business (B2B) markets, comprised of industrial, automotive, and communications, achieved modest year-over-year growth and outperformed the semiconductor industry again. We delivered industry-leading adjusted gross margins of approximately 70%, adjusted operating margins of more than 40%, and adjusted diluted earnings per share of $5.15.1 Notably, we generated strong cash flow as evidenced by our 33% free cash flow margin, which places us in the top 10% of the S&P 500.
The strength of our innovations and customer engagements, the diversity of our franchise, and our operational discipline have enabled us to consistently deliver strong returns. Over the last five years, ADI has generated a total shareholder return of 148%, or more than double the S&P 500 return.
Our Fiscal 2020 Priorities
As we enter fiscal 2020, I would like to describe the three primary priorities on which we are focused to continue driving ADI’s long-term success.
1. Deepening Customer-Centricity
ADI possesses among the broadest product portfolios, applications expertise, and manufacturing capabilities in high-performance power management and precision and high-speed signal processing technologies, which helps our customers bridge the intersection between the physical and digital worlds.
Throughout the year, we saw robust customer engagement driven by a couple of factors. First, our customers are facing a scarcity of available analog engineering talent and they are increasingly turning to us for that expertise. Second, our customers are encountering more complex challenges in the Third Wave of ICT with digital systems increasingly relying on real-world data to create actionable intelligence.
As a result, we see our customers partnering with us more deeply to gain the full benefit of our technology capabilities and product innovations with relationships starting earlier and lasting longer. As a testament to that, our opportunity pipeline value achieved record levels in fiscal 2019.
2. Efficient Use of Capital
At ADI, we have an intense focus on creating and delivering best-in-class value for our customers and doing so is our first call on capital.
Our success is underpinned by our philosophy that superior innovation drives superior results and we understand that R&D enables our virtuous cycle of innovation-driven success. This is why we invested more than $1 billion in R&D during fiscal 2019. We choose our investment areas judiciously—focusing on what we believe are the most attractive opportunities across our business, particularly in our B2B markets.
Also, given the growing demand for analog technology and the evolving needs of our customers, we have acquired two companies to increase the scale and the scope of our offerings over the past five years.
With the acquisition of Hittite in 2014, ADI became the market leader in high-performance RF and our portfolio now spans the entire frequency spectrum from DC to 100 gigahertz. Since this acquisition, ADI has more than doubled the revenue from this portfolio, and in fiscal 2019, our RF revenue increased more than 30% year-over-year led by growth in industrial and wireless communications.
The acquisition of Linear Technology (LTC) in 2017 added highperformance power management and additional precision signal processing to our portfolio, expanding our offerings to deliver more complete solutions. Our new power management design wins across 5G infrastructure, data center, and automotive are moving to production this year, and we expect a more meaningful revenue ramp in fiscal 2021. This puts us on a path to double LTC’s historical revenue growth rate in the years ahead.
Through our development of cutting-edge innovations and our ability to solve the most difficult problems across a broad array of applications, we generate significant cash flow and are deeply committed to delivering strong shareholder returns. In fiscal 2019, we generated nearly $2 billion of free cash flow and delivered on our target of returning 100% of our free cash flow after debt repayments in the form of dividends and buybacks.
3. Capitalizing on Secular Trends
As the data age rapidly evolves and the demand for edge computing rises, analog technology becomes even more relevant. Currently, a modest 10% of data is generated outside the cloud, and by 2025, this amount is expected to grow to 75%.4 We believe this trend uniquely positions ADI to capitalize in two ways. First, we will be a critical partner in the collection, curation, and communication of our customers’ edge data. Second, with more than 85% of our annual revenue coming from B2B markets, we are well-aligned with the markets driving this increase in data—let me provide you a few examples.
In Wireless Communications, we are pushing the limits of 5G innovation with our market-leading microwave and integrated transceiver portfolio, adding algorithms and optimized power solutions to differentiate our portfolio. These enhancements enable customers to dramatically increase data density, while reducing their radio footprint and power. Importantly, 5G is more than just radio innovation—it requires a complete re-architecting of the core and wireline network to meet the 5G vision of gigabit speeds, low latency, and high reliability. This network expansion is expected to require a significant upgrade to the backhaul system, unlocking another new revenue opportunity.
In Automotive, the center of value creation is pivoting from the internal combustion engine to the electric powertrain and passenger comfort and safety. Again, ADI plays an important role in enabling these advancements. In electric vehicles, our battery management solutions provide customers up to 20% more miles per charge vs. our competition and we are revolutionizing how monitoring and controlling batteries will be solved—and doing so wirelessly. In Level 3+ autonomous vehicles, our high-speed signal processing technology is necessary to deliver the ever-increasing levels of resolution and range required in active safety systems.
In Industrial, the rise of Industry 4.0 and digital factories is increasing the need for more sophisticated sensing, measuring, and actuating solutions. This creates additional demand for our precision signal chain and power management franchises and expands our addressable market for our suite of connectivity and sensor solutions.
Finally, in Healthcare, demographic and economic pressures, coupled with the availability of new sensing and diagnostic capabilities, are opening up a myriad of new opportunities for ADI. This includes mission-critical X-ray systems, where we are pushing performance to new levels with our photonic conversion solutions by reducing dosage intensity, while increasing image fidelity. And, wearable devices with our clinical-grade vital signs monitoring solutions are poised to enable hospital-grade patient monitoring at the home.
Our Sustainable Future
ADI has long been focused on responsible sustainability efforts, but I believe the time has arrived where we not only prioritize sustainability, but also environmental regeneration. To this end, ADI employees will increasingly bring their ingenuity and energy to trailblazing new solutions that restore and replenish natural resources and ecosystems, reduce our carbon footprint and the environmental impact of our operations, as well as partner with our customers and suppliers to reduce the impact on our planet.
To provide just one example, our innovative battery management solutions are at the heart of building more efficient electric vehicles, which helps to curtail tens of millions of tons of CO2 entering the atmosphere. Putting this into perspective, every million ton reduction of CO2 emissions is equivalent to the annual CO2 absorption by over one million acres of mature forest. As we look ahead, we believe we have a bigger role to play in engineering a sustainable future. We will be providing more on our strategy and commitments, which are aligned with the United Nations’ Sustainable Development Goals, in our Sustainability Report this year.
Looking Ahead
Over our company’s 55-year history, ADI has navigated several important transitions because of our ability to successfully sense and adapt to technological, demographic, and economic changes. Our leading technology portfolio and customer relationships, business diversity, and focus on continuous improvement has created a strong business model with both a broad array of optionality and opportunity as well as long-term resilience.
I have been with ADI for more than 30 years, and I can say unequivocally that I have never been more excited about the prospects and opportunities that lie ahead.
Sincerely,
Vincent Roche
President
and Chief Executive Officer
Analog
Devices, Inc.
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