Analog Devices, Inc. (NASDAQ:ADI) Barclays 2022 Global Technology, Media and Telecommunications Conference December 7, 2022 5:30 PM ET
Company Representatives
Prashanth Mahendra-Rajah – Executive Vice President of Finance, Chief Financial Officer
Mike Lucarelli – Investor Relations
Conference Call Participants
Blayne Curtis – Barclays
Blayne Curtis
I’m Blayne Curtis. With us, up next from Analog Devices, Prashanth Mahendra-Rajah, he’s the CFO and I thought maybe you just reported.
Prashanth Mahendra-Rajah
We did.
Blayne Curtis
It might make sense in this case for you to maybe kind of recap a little bit. Obviously, you know the cycle’s been the topic. You know I think Analog’s taking a little bit longer to kind of you know correct and see it. I mean you have seen some areas. Maybe walk us through you know a few minutes on that, and then we can jump into questions.
Prashanth Mahendra-Rajah
Yes, yes, great. I do want to congratulate you Blayne. We got the request from you to come out for your conference. Mike and I said, “Oh, we got to support Blayne. We got to figure out how to make this work.” So we were actually out here for some other meetings. We Ubered up just really for two hours to take care of this for you, and about three days after we agreed to come out here, you downgraded us, so well done.
Blayne Curtis
Not ideal.
Prashanth Mahendra-Rajah
All right. So, as you said we reported.
Blayne Curtis
You’re the bigger man, you know.
Prashanth Mahendra-Rajah
So, as you said, yeah we – our fiscal year ends in October, and so we reported our FY ’22 just prior to the Thanksgiving weekend. So let me just kind of take you through the highlights. It was a pretty incredible year as it has been for many companies in the semiconductor space. We grew revenue about 25%, 26% year-on-year. Extraordinary gross margins, you know pushing up into 74%, operating margins getting into the high 40s.
Out of that $12 billion plus of revenue, we did roughly 4% share reduction through repo, about $3.5 billion on top of another $1.5 billion of dividends. So very strong capital return from that very strong revenue growth, and extraordinary margins, which is really a reflection of what is unique to ADI, and that is we’re an innovation-driven company, and we look for those high margins to be representative of the R&D that we spend.
Question-and-Answer Session
Q – Blayne Curtis
So just in terms of – and actually, you know you guys walked in and we were talking about the review you’re going to give me. I mean, I do think you’ve been looking at the market realistically and you know I think, in terms of the way you look at your order book, you talked about kind of trying to scrub it. I was wondering if you could just walk us through that process.
Prashanth Mahendra-Rajah
Sure.
Blayne Curtis
And obviously backlogs have gotten crazy. I mean they are beyond what you know probably will end up being shipped. But how do you sort through that and figure out… [Cross Talk]
Prashanth Mahendra-Rajah
Yes, let me give some context on Blayne’s question. So in a normal environment – if there is such a thing anymore, but in a normal environment, we would have about eight to 10 weeks of backlog going into a 13-week quarter. And then in the quarter we would look to find anywhere between three to five weeks of orders to ship and kind of close that quarter out. We are currently siting, and this is as of two weeks ago with the fourth quarter earnings call. We’re sitting on – instead of an average of nine weeks, we’re sitting on more than 52 weeks of backlog.
So, a very big delta there that we are trying to get our arms around. Some of that is clearly a reflection of extended lead times and customers putting orders in anticipation that they are unclear what their future demand is, so get their orders in now.
What we have been doing as Blayne referenced is, we’ve been actually putting a very concerted effort, and I think contrary to some of our peers to encourage customers to cancel their orders. So working through the process with our distributors as well as our end customers, to get as much of those orders off the books and try to get that backlog to represent true demand.
So how do you do that? Its art and science. There’s clearly the conversations that you have with customers and the encouragements, and frankly, when we did a pricing action, we opened up a window and said, “Hey, if you don’t like the pricing action, this is a good time for you to let us know and cancel your orders and kind of move through that process of encouraging them to do that.” And there is a part that is more data-driven, where we look at here’s the orders from a customer, we look at what you’ve historically taken from us.
We look at what we’ve shipped to you in the past and sort of triangulate and say, ‘that looks to be unreasonable. So we are going to proactively go ahead and cancel out on you and force you to reenter, but when you enter, you reenter at the back of the line.’
Blayne Curtis
You know when people say, what’s the channel looks like, you know usually people are talking just the disti channel. You know I think that’s obviously when things are short, but this has been a sell through everything, right? So it’s not a really great read. It’s really the end customer that I think are back you know. So that was good that you said, look what we brought out on our balance sheet, like and put it in their hands, because they don’t even know where the demand is. But how do you gauge where the inventory levels are at that end customer? I think you just partially answered it.
Prashanth Mahendra-Rajah
Yes. So not an easy answer, but let me – first, ADI runs its business internally on POS or on ship through. So, if you talk to the management team, the numbers that are in their head are what has gone to end customers either directly or through distribution. We do not – we kind of create this reporting framework of shipping to distributors, largely for investors, because we’re required to by the SEC, but it is not how we run the company.
So we really do use the end demand signals to drive the business. And all of our distributors are required as a consequence of doing business with us, to provide weekly data on who they are selling to, the destinations, the pricing, tons of information that allow us to look at the business really on a sell-through framework.
When we think about inventory levels that are with end customers, and I know that’s on a lot of people’s mind, I would – I’d break that into areas that we have good visibility on and areas that we’re trying to reconcile disparate facts. So, where do we feel better? We feel better about automotive. And when you look at our sales in ’22, up roughly 30%-ish year-over-year, so I’ll call it flattish. So a big delta there that some folks from the outside would say, ha-ha, there’s proof of significant inventory build for ADI in the automotive channel.
We then look at what did we sell into automotive. We break that apart into what we can correlate very clearly to factors like electric vehicles and the growth in EVs, because clearly our BMS product is going into EVs, and we are confident that that’s not sitting in inventory. Our A2B product, which is going into infotainment systems, and we know that there are design wins that are moving through customers. So even in a flat SAAR environment, more models are deploying A2B. Maxim had a similar product called GMSL.
So there’s a couple of ways that we do that. And when we finish that out, we’re left with, and with our pricing in there as well. We’re left with, call it mid-single-digit growth that we can’t explain. So for a lack of knowing where that is, we would say that’s kind of our risk on inventory for automotive, is call it, mid-single digit on a year-over-year basis.
Industrial, what we’re trying to reconcile is, we look at our data and our trends against a variety of macro indicators and we have, we’ve got a number of ways that we do relatively good correlations and regression analysis that says, hey, if this is what’s happening in the macro, this is what should be happening to these businesses.
We talk with our customers and whether these are executive conversations or through the sales force, we get a very different view. They are still asking for product. They still feel in the industrial market. They still feel very bullish about what’s in front of them and what they need from us. So that’s the part where we’re a little less comfortable, because the two don’t reconcile.
Blayne Curtis
Good answer and you actually pulled forward some questions. I’m glad we talked and we might circle back. But I wanted to just, on the supply side it’s interesting, you know that you had – you had talked as a company that you’re moving more externally, and then I think through the pandemic, I think you’re now maybe shifting back internal. So I do want to talk on that decision, to try to own more of your capabilities. But I’m obviously kind of curious of your perspective. As you look at some of your competitors, you have Microchip adding a 300 millimeter fab maybe. It just kind of blows my mind that people are adding this much capacity, TI has got three fabs.
I mean, Analog was a mature industry, predictable growth, you know good stewards of capital, and there seems to be this like recent move to add a lot of capacity, both your peers [ph] are talking about adding fabs. Now how does that play out for Analog as a whole? In terms of you know supply/demand we’re already now potentially moving to oversupply. Everybody seems to be adding inventory on the balance sheets, right? So, you might have that… [Cross Talk]
Prashanth Mahendra-Rajah
So, let me do that quickly and then I’ll come to the ADI specific answer. Where I guess I would say is that as we have seen a slowdown in Moore’s Law or maybe just kind of advancing to finer and finer lithographies, existing geometries are getting longer life and therefore, what would have normally moved, if not moving, and you’re going to, I think you’re going to see more steady out at existing nodes and that’s there.
So, I’m not overly concerned that there’s going to be excess analog capacity, because I do believe that the market is clearly coming to Analog. That that is where the Intelligent Edge is going to be and that’s clearly the drivers, the secular drivers that we are enjoying and that some of our peers support more Analog content in everything.
From an ADI strategy, we have always been committed to hybrid manufacturing. So just to clarify something, Blayne said, we are not changing that strategy. We are not moving to more internal. So our long-term model is still to have a good balance between what we can make internally and what we – where we use our foundry partners. Some of that reliance on foundry partners is because there are technology nodes that we would never do internally.
For example, I believe the coms team is taping out certain products now for test at 5 nanometers. We would never in our lifetime try to go do 5 nanometers internally. So there are reasons based on the technology that we need to build out the functions that we serve our customers, that we will need our foundry partners.
We also use them for supply surge. So the capital that we’ve been investing to expand our internal manufacturing is all swing capacity. And by swing capacity it means that every tool that’s coming online can be used as a replacement for what is done outside ADI. It does not mean it will be used to bring capacity inside, but it gives us that flexibility.
So during peak growth periods where there is significant demand for our products, we will rely on our foundry partners. During times where there may be a slowdown in demand due to macro conditions, we have the ability to notify our foundry partners usually with about a quarter’s notice, that we are not going to make certain wafer starts there, bring those internal to us, keep our fab utilizations high. So the goal for us is, we want fab utilizations high during periods of real strong demand and moderately high during periods of softer growth, and that’s what gives us that confidence in the gross margin model we gave you in April, of a 70% floor through the cycle, which is again an extraordinary number since many of our peers can’t even get to 70% at peak.
Blayne Curtis
In terms of the – you know the dual supply, is that something that’s in place today or are you still – I mean it is a long process.
Prashanth Mahendra-Rajah
It is, it is.
Blayne Curtis
You have to qualify.
Prashanth Mahendra-Rajah
No, thank you. Yes, it’s in place today. When we did our Investor Day in April, we were kind of in the mid-20s. Now we’re kind of getting to the mid-30% in terms of coverage of SKUs. We’ll make significant progress in 2023, and by the time we exit ‘24, we’ll have close to 70%, a little north of 70% of our SKU coverage that we can make internally or externally.
Blayne Curtis
It is – with this kind of this CHIPS Act Gold Rush, is that something that’s not of interest to you given this model that you’re laying out or… ?
Prashanth Mahendra-Rajah
Well, the CHIPS Act often misunderstood has three pieces to it, so let’s go through the three pieces. The first is a straight up tax credit for any capital that you spend in the U.S. So we, like all of our peers are going to take advantage of that cash credit and you’ll see us, that is for tools that are placed in service starting January 23. So that will be a check and ADI will take advantage of that.
The second is funding for a national semiconductor technology center, and the idea is to create these semiconductor research hubs around the country that can really work on very advanced ideas in research.
We expect to be the lead for the analog mixed signal, NSTC. We’ve been involved very closely with the Department of Commerce in shaping how the NSTC structure should be evolved, and then the third piece of that is grant money where commerce is encouraging companies to add significant capacity in a more ecosystem environment.
We are planning to make proposals as part of the expansions of some of our existing fabs. I don’t expect those grants to be meaningful from an Investor Analysis. But as we talk about internally, there is no reason to turn away free money, so we will go through that process.
Blayne Curtis
Well, I was intrigued and this is more of another kind of getting your perspective on the analog market, because I think a big part of the answer is it’s not a direct threat to you. But China try to go after things like modems and memory unsuccessfully. They seem to be pilling a lot of money into MCUs and low-end analog. I think you’ve positioned the company to be high-end industrial auto, but I am just kind of curious of your perspective on those efforts and whether you see anything in the market, maybe you sit next to or whether that’s going to be successful or not in terms of their efforts there?
Prashanth Mahendra-Rajah
Yes. I think it’s a bit of an ROI challenge and if – with enough money you can make good progress, reverse engineering, anything that’s really available to some extent? I mean, maybe not the most advanced lithographies, but you can make good progress from – in reverse engineering. You need to have enough volume to be able to underwrite that investment.
So why does it get challenging for companies like 3Peak, Silergy and others to move up into the higher analog space is, you have to put significant R&D into a particular, let’s say, you focus on a particular ADI capability. But you’re only going to be able to capitalize that opportunity against a small set of the market.
And even then it takes you, as our investors know, it takes you a long time to go from design in to a meaningful revenue ramp. So it becomes a very difficult economic challenge to solve, but if you look at something like an MCU, which has a much higher volume, because similar SKU can be used across a wide range of end market, it’s easier to make that math work.
Blayne Curtis
I want to go back to some of these end markets. You did a good job explaining autos. Industrial, you said it’s harder. Can you walk us through – I mean you break it out, I think as six groups.
Prashanth Mahendra-Rajah
That’s right.
Blayne Curtis
At one point, I mean they are all kind of hit records. I think medical kind of came off of it, but I think they are all still…
Prashanth Mahendra-Rajah
No, I think medical, so let me go through our end markets, right? So health care is on its seventh year of double-digit growth, and we remain pretty confident that that’s likely to continue for the foreseeable future based on our pipeline. Our aerospace and defense business again is not subject to some of the same macro trends that are plagued the rest of the industry, but again a very steady grower and very good profitability.
Then we have our industrial automation business and the Industrial Automation business has really been benefiting from the move to onshore more manufacturing. And the way to think about the return analysis for our customers is that if you are going to move manufacturing out of Asia, out of China, wherever it might be, you have to overcome the fact that whether you put it in the U.S. or Europe, you’re going to be dealing with a much higher labor cost and the way to payback now to pay for automation becomes much easier, because you have the ability to use fewer U.S. or European workers, particularly in an environment where it’s very hard to get manufacturing workers and the manufacturing labor shortage, both the U.S. and Europe are facing right now, that becomes a very, a much more easier economic return.
So factories are putting more money into the automation efforts and that is a secular trend that we feel is going to continue to drive this business. It will be lumpy just based on capital deployment, but very – we feel very good that this is – that’s a trend that will drive the business for several years to come.
What am I missing here? I’m missing.
Blayne Curtis
Test and measurement.
Prashanth Mahendra-Rajah
Sorry? Of course, test and measurement which is sort of a hidden gem in ADI, because we have extraordinarily high market share. So our instrumentation and test business is where our technology is used for the precision and high-speed testing needed by test and measurement, by scientific instruments. It is a – the nature of that market is that you need tremendous accuracy, and because we, that’s our specialty really is that precision, we end up with a predominantly high market share in that space. That’s probably the market that is going to be most subject to sort of the macro activities.
We still have great demand, and we see the demand that is being put on. You know for example, all the capital that’s being deployed in the semiconductor industry often uses our instrumentation products. But, we also see that volumes are falling for end markets like memory and that may also have an impact. So that one we’ll keep an eye on over the next couple of quarters to see how much of that will impact us. So, I have great confidence longer term, but I’m more cautious in the near term.
And then we have a new group, which is our energy business. It’s still a bit smaller from a size standpoint, but energy has been seeing significant demand as the amount of electricity and energy that’s being used by moving parts, motors, etc. is a substantial amount of our global energy consumption. And there’s a variety of ADI technologies that can help improve the efficiency of that and that is getting more traction as part of the effort for a lot of our customers to think about how to be more sustainable.
Blayne Curtis
When I see about communications, you know I think [inaudible]. I mean this is an area that you had a really interesting kind of 5G story. I mean, I guess how do you think about that business kind of going forward. So maybe the two pieces, what’s going on in the near term in terms of supply chain inventories and…
Prashanth Mahendra-Rajah
So our communications business, think of as two pieces. One, wireless, which is really, we are a very key enabler and extraordinarily high market share in 5G radio networks. And then on the wired side, you’ll see us in data center power and in the optical connectivity.
On the wireless side, our view is that for 2023, expect limited activity in the U.S. and Europe, certainly Europe given what’s going on there, but we would even say the U.S. The big deployment in 2023 is going to be India, and I think it’s public information that the two European infrastructure carriers have carved up that market and we have, as I mentioned, we have extraordinarily high share of both.
So as long as India goes forward with its deployment of 5G system, that will prove to be a good year for us in the wireless market. I would expect Europe will, Europe still has to solve their 5G gap. They are far from it. It’s not going to happen in ’23. Unclear, given the Ukraine situation, whether it’s going to happen in ’24, but that would be, that is going to be on the come and when it does, it will – that business will come to us.
Blayne Curtis
And in terms of the inventory in that channel and time to work through, is there a way to kind of think about it? Can you walk me through it?
Prashanth Mahendra-Rajah
Yes, I would say that we are shipping into the two Europeans who plan to deploy into India. And beyond that, we don’t have a lot of visibility that would suggest there’s excess wireless inventory out there.
Blayne Curtis
I want to go back. You did a good job with auto math, but I want to go back to it, because it’s been really the toughest end market to get a handle on, right? You have production at lower than [inaudible], so that should make you feel better. You have trends like ADAS and EV that are clearly here to stay and going to keep going. There’s been that other piece where I think some of the cars that have EV have a lot more content, and then you also have this kind of like mix where I think when people can’t make everything, they’ll just make a lot more high end and the consumer was just lapping it up.
Prashanth Mahendra-Rajah
Right.
Blayne Curtis
When you did that math, how do you think about those two variables in terms of the mix of cars, because I’m assuming – I don’t know the exact math, but I’m assuming your BMS and A2B is probably a third or something, maybe not even, I don’t know…
Prashanth Mahendra-Rajah
Yes, I would have to check with Mike what’s public on that. So I’m not going to answer that unless Mike, do you want to speak up loud enough for the mic.
Blayne Curtis
Doesn’t matter.
Mike Lucarelli
So the – in a flat SAAR environment, I have extraordinarily high confidence that we will do double-digit revenue growth. We have enough secular drivers in the shift to electric vehicles and the amount of content we’re putting on electric vehicles plus the design wins we have on a number of our key technologies, you know A2B being one, GMSL being the other, where we know those products are continuing to deploy and as they continue to deploy that there are model, there are car models that are coming out in future years that have already selected our technologies, they are just yet to hit production. So it’s a great place for us right now.
On the BMS side, I think this is well known. We have a pretty high share position in BMS relative to the Number 2, and then of course we’re the only company that has a wireless BMS that’s actually in production and been designed in by three large OEs. General Motors is public. The other two are not, and then a small racecar company, LOTUS, which has also been public.
Of those, you could argue whether General Motors is shipping because they’re still very early in the Cadillac Lyriq and the Hummer, so all that revenue growth is in front of us.
Blayne Curtis
And I spent a lot of time talking about what could go wrong, right? I mean, in terms of ’23, ’24, I mean is there any areas or end markets that you’re excited about and maybe you don’t get enough questions on in terms of people focusing on it?
Prashanth Mahendra-Rajah
I think Blayne, the – we are trying to position the company to be prudent given the macro environment. The conflict that we have inside is that the leadership team is saying that there are some challenges out there in the global world. We need to be ready and mindful and we want to be very thoughtful in our spending and our positioning.
But the sales organization is coming in saying, that’s not what we’re hearing from our customers, we’re going to have a great year and getting those to reconcile I think is where there’s that conflict, because the folks who are close to the customers are saying, we came through this pandemic and the supply chain disruption extremely well. We have been really applauded by our customers for the strength of our service and our delivery. We have been applauded by customers for being able to continue to help them solve complex problems and bring innovation, which is moving their products forward. So the relationships we have with our customers are extraordinarily – I would say, our peak levels, and the market is coming to us.
I mean the investments that are being done are all happening at the analog edge, and that’s our sweet spot. So with the market coming to us, with our customers feeling good, management team are the ones that are leaving that kind of bearish tone inside the company saying, “Hey, we hear all that. But we need to be prudent, we need to be careful and let’s be mindful of how we spend and position ourselves until we get more visibility”. And I did mention manufacturing guys are saying, “Well, we have a year of backlog. What are you talking about?
Blayne Curtis
With that we’re out of time. I appreciate you making the time from your Board meeting to come see your favorite [inaudible] analyst. Hopefully, we can convince you to come to another event at some point.
Prashanth Mahendra-Rajah
All right.
Blayne Curtis
All right. Thank you.
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