Analog Devices, Inc. (ADI) Earnings Call Transcript & Summary

Okay. Why don't we go ahead and get started. Good afternoon. Thanks for attending JPMorgan's 18th Annual CES Technology Forum here in Las Vegas. I'm Harlan Sur, semiconductor capital equipment analyst for the firm. Very pleased to have Prashanth Mahendra-Rajah, CFO at Analog Devices; and Mike Lucarelli, Head of Investor Relations, here with us. I think what we'll do is we'll just go ahead and kick off the Q&A with both of you here.

Maybe starting off kind of on the near to midterm business environments, supply side fundamentals. Fiscal year '19 for the team, which ended in October quarter, revenues down 2% and better than the overall semiconductor industry trends, with all of your segments outperforming their respective markets, we appear to be near the tail end of the current down cycle. But through this period, the team grew its design win pipeline 15% and you grew your Linear Tech power management design win pipeline by 40%. How does all of this translate into continued outperformance relative to the semiconductor industry growth of kind of low to mid-single-digit percentage type CAGR kind of over the next few years?

Great. Thanks for the set of question, Harlan. So to recap for everyone, 2018, 2019 ADI B2B business outperformed the market and outperformed our peers. As we head into 2020, we feel setup to continue to do the same. The indications that we gave going into -- as a reminder, we had our earnings call in November of 2019. And the indications that we gave going into this first quarter were that we were kind of hitting, what we believe, bouncing along the bottom and should start to see some recovery for the balance of 2020. And I think there's no change to our view on that. The outlook for us on the B2B side remains strong. We're expecting a very strong year in communications, likely to grow year-on-year. And while the automotive environment will probably continue to be flattish, look for us to continue to grow despite of that flat environment. And then, of course, the industrial business, which is the real strength that ADI has seen over the last couple of years is going to continue to perform better than the market.

Great. More on the near term and to follow up on some of your comments. Your guide for the January quarter, revenue is down 15% year-over-year, down 10% sequentially. Weakness still mainly due to just channel inventory drawdown, so being very disciplined, later Chinese New Year's. But the team has called for a resumption of quarter-on-quarter growth in Q2, the April quarter, 5G reacceleration, positive seasonal trends in auto and industrial. Kind of update us, first of all, on the progress of the channel inventory work-downs this quarter and visibility, confidence level on sequential reacceleration in Q2.

Sure. Great. So for the first quarter, we guided our sell-in revenue to be down about 10% sequentially. Now what's behind that are a few things. The way that our fiscal quarters lineup that covers the Christmas holiday period. So naturally, the first quarter for us is usually a bit down sequentially. On top of that, we indicated that going into the end of 2019, the 5G build-out was taking a pause, and we had good indication that was going to resume in 2020 and likely resume beginning in our fiscal second quarter of 2020. Third, while we manage the business to keep our sell-in and sell-through aligned, we ended 2019 with a bit more inventory in the channel than we're comfortable with. We were up to 8.5 weeks. We'd like to keep channel inventory 7 to 8 weeks. So we proactively made a decision in the first quarter to begin reducing channel inventory. So we are going to be selling into the channel less than what we're expecting to sell through. So true demand is actually better than what we are guiding. And then last, as Harlan mentioned, the Chinese New Year falls at the end of our fiscal first quarter. And by doing so, there's usually a change in demand activity because distribution that week is actually very low. So that demand either falls the week before or the week after. So our current guidance reflects the impact of that, and that should correct itself in the second quarter. So a few reasons behind why our fiscal first quarter has been guided down 10% sequentially. But where we sit today and from the order activity we have, we continue to hold the statement that we shared in November that beginning in Q2, we should see continued growth in the business, and we're looking at an attractive second half.

Great. So along those lines, your utilization should be near trough levels this quarter. If you do drive sequential growth in Q2, and Q3 is also typically seasonally up as well, when should we expect the team to start to ratchet fab utilizations higher?

Great. Thank you. So fab utilizations, which really Harlan's asking is a proxy to how our gross margins are going to operate in 2020. So as a reminder, despite a challenging 2019, we finished 2019, on a full year basis, still with model margins of 70%. The fourth quarter was below 70%, but that was largely due to a onetime inventory correction that we took for a large communications customer. And while we do not guide gross margins, we did indicate that going into the first quarter, gross margins would be roughly flat to fourth quarter, largely because of the slowdown in utilizations, some of which is self-induced as we go to correct channel inventory. Coming out of this first quarter correction, we would expect gross margins to improve. We certainly would expect second half to be back to model levels. And then on top of that, we've indicated that we're taking a number of cost-reduction actions that we'll implement over the course of the year, and those reductions include some significant cost savings at the fixed cost structure of our factories. We will be shutting down 2 manufacturing locations. So not just into 2020 but beyond 2020 into 2021, you'll see continued strength in the gross margins.

Great. Why don't we talk about some of the end-market exposure? So turning to your industrial business. It's been a strong area for the ADI team. Last fiscal year, it was down 2%, very diversified business. Factory automation, automated tests, aerospace and defense, health care, it's 50% of your overall business. Help us understand the makeup of this business. Typically, automation tends to be the biggest part of industrial for some of your other analog peers. But I think for the ADI team, your industrial business is actually much more diversified.

It is. Thank you. Thanks for the question. Yes, our industrial is a pretty diverse segment. I'm going to actually pass that one to Mike because I might provide more precision than we normally share externally. So Mike will handle that one.

Sure. Thanks, Prashanth. So yes, Harlan, you're right. It's a very diverse business for us. The biggest portion is instrumentation for us. Within instrumentation, there's electronic test and measurement stuff that tests kind of 5G, tests battery for the electric vehicles. There's radar testing as well. There's memory test, which falls in instrumentation and some scientific instruments. That's about 25% of industrial. Factory automation is big, it's 20% of industrial for us.

Yes.

The second -- it's probably the second biggest, if not the third. Aerospace and defense is about 20%. So they're about equal in size, automation and aerospace and defense for us. And you kind of saw it in 2019, while automation was weak, aerospace and defense for us was quite strong. Next is health care, which is about 10% to 15% of industrial. That was a growth market for us in '19. We think 2020, there was some good demand trends there as well. Energy is just under 10% of industrial and the rest make up kind of broad market. And I think one important thing, as Harlan said, it's a very diverse business for us. Stuff like aerospace and defense, electronic test and measurement, health care, these aren't really GDP-centric businesses. They're very vertical-oriented, and they did have a good year for us in '19 despite the weak macro.

Great. So within that, as you mentioned, one of the big differentiators for the ADI team is aerospace and defense business, strong portfolio of products, much of which came from the Hittite acquisition 5 years ago. Over that period of time, the team has doubled the Hittite revenue run rate to over $500 million. U.S. defense budget for 2020 was just approved, strong $740 billion, up 4% versus 2019. Should be a strong tailwind for the team. Where in A&D does the team have particular leadership? And in the down year for industrial last year, you grew A&D. Does the team anticipate growing its A&D segment at a faster pace in fiscal '20?

Great. Yes, thank you. So maybe let's start with a bigger picture for A&D. So that includes aerospace, that includes some of the space exploration stuff that is happening, and that includes defense. But particularly on the defense side, I'll say that, that is not just U.S. defense that includes allies and areas that -- where there are arrangements for U.S. primes to provide technology to other countries. The -- certainly, a core piece of that to defense space is the Hittite acquisition, which has given us some incredible products and platforms in the RF space, and we've been able to use that to pull in the mixed signal and the power. And fortunately, given kind of the world dynamics today, the defense business has a pretty optimistic outlook for the next couple of years. Defense spending is at meaningful levels and continues to be. I think one thing that people may not always appreciate about the defense business is that, today, in 2019 and certainly in 2020, we are shipping in on designs that were -- or positions that were awarded several years ago. The -- as the primes work through various DoD agencies and get platforms and upgrades or communication transformation projects approved, then they wait for funding. So when funding finally kind of moves down from The Pentagon into the primes and then into us, it can take quite a bit of time. So today's burst of activity that you're seeing for 2019, '20 and continue for several years, these were all wins that happened several years ago. On top of that is the design win activity that we're seeing today from using that Hittite platform to leverage our mixed signal and our power platform, and those revenue opportunities are still in front of us. Anything to add to that, Mike?

No. Good summary. I think one thing you said is, it was a great year for defense last time -- last year, it grew over 20%. I think 2020 is a growth year again for defense for us. But I don't know if it does 20% again. But again, strong growth business, really good gross margins and really good pipeline of business in defense and aerospace.

Yes. Before I move on to comm infrastructure, any questions in the audience? Okay. So on the communications infrastructure side, obviously, 2020 is still early days for 5G networking build-out: 2 flavors, as we all know, of the air interface, sub-6 gigahertz and millimeter wave. You've mentioned the expectation of sub-6 gigahertz being the majority of the consumption in calendar year 2020, something on the -- along the lines of about 80% of the total infrastructure build. The millimeter wave should continue to grow into a larger part of the mix over the 2021 time frame and onwards. Talk about -- first of all, talk about the content opportunity here in sub-6 and then versus millimeter wave for the team.

Yes. Great. Okay. So maybe as a reminder to kind of level set how we think about the business. In 2019, 2020 and likely for a few more years, you -- we expect to continue to see the deployment of massive MIMO technologies across the sub-6. And the rationale behind that is the economic trade for a wireless carrier to spend their capital on deploying massive MIMO technologies versus the alternative use of that money in being able to serve a wider group of customers is a very favorable trade for them. So we expect that demand to continue to be quite strong and driven by good economics for the wireless carriers, primarily in areas where you have congestion. But to make that happen, you have to have some level of available bandwidth. So we see 2020, '21, likely '22 to continue to be the deployment of those massive MIMO technologies in the sub-6. But as those frequencies get fully utilized, then you're going to need to look for alternatives. And that's where that millimeter wave will begin to step in. Millimeter wave is going to be even more content for us versus the sub-6 in large part due to the strength of the Hittite acquisition. But millimeter wave, the economics on it are still going to be a little bit challenging for the wireless customers because of the amount -- because really the distance that they can cover with that infrastructure is going to require more physical deployments. From a content standpoint, I think what we have generally talked about is that on a dollar basis, think about 4x the dollar value content. Now in fact, the value to the customer is well beyond that. But in spirit of sharing some of those economic gains with the customer, we've averaged that at around 4x the content on a 5G versus a 4G. Anything to add, Mike?

Yes. And then the one thing on that going from 4G to 5G is also -- it's about the transceiver but it's also about different technologies. Hittite technologies were selling into 5G we didn't have in 4G. And also, we're bringing -- starting to bring power management into 5G as well.

So along those same lines and the momentum here that's building for 5G. Team was confident enough to call for strong reacceleration in Q2, as you mentioned earlier, Prashanth, the April quarter. And then growth in the overall comm business for fiscal '20, which means double digits sequential growth for the remainder of the year starting in the April quarter. What's driving the team's confidence level here? What's driving the visibility here on the strong growth outlook? And maybe if you can sprinkle within that, the different geographies that are going to be rolling out some of this infrastructure.

Right. Right. Okay. So maybe starting at the top. I'll go back to what I said that the economics for a wireless carrier to deploy 5G massive MIMO using the sub-6 is very compelling in areas where they have high concentration. So from a financial standpoint, that business makes good sense for them. From a share standpoint, we are superbly well situated and somewhat indifferent to who deploys because we have strong share positions across the majority of the carriers. So unlike 4G, where it was a little more sensitive to us as to which of the infrastructure guys won the business, today, we largely are indifferent because we have strong share positions at all of them. So our bullishness comes from a standpoint of the economics make sense. And as long as the economics make sense, the carriers will deploy. And as long as they deploy, we will get more than our fair share because of our -- the strength of our position. Geographically, as we think about what will happen in 2020, to your question, we continue to expect spend in Korea, in China and in Japan in anticipation of the 2020 Olympics and then beginning some deployments in the U.S., probably towards the tail end of the calendar year.

Yes. Great. And then going back to the Linear acquisition, and I remember the Analyst Day and talking about the revenue synergies. And when we think about the Linear team and their leadership in power management, we think about strong synergies in industrial and automotive. But to your credit, I mean, the Analog team has mentioned several times about Linear power management traction in 5G base stations. This is -- and this -- I think you guys have been mentioning this just the past few quarters, but an area where they were not really focused on in 4G, so an incremental opportunity here. Can you guys help us understand what type of power management products you're winning on these 5G base stations? And what the dollar content opportunity is per base station with these new power products?

Yes. I think the way to best understand that is when you are a stand-alone company, providing a power solution that you are competing with a very small number of customers, essentially 5 customers and trying to provide a one product solution to all 5 of these customers in a market dynamic that is very easy to commoditize you. And as you know, Linear did everything they could to avoid that commoditization. But now as part of the ADI family, where we are developing integrated products that bring our Hittite technology, our mixed signal, we are able to bring Linear in where the power management solution can be part of an integrated solution. And that was offerings that were unavailable to them as a stand-alone company. And that is really what is enabling us to provide value to our customers by putting more of the board together for them that is tuned to work together and give them a differentiated product and then pull some of that power opportunities through.

Is that something that's shipping now? Or is that something that's still on the come?

That is still on the come.

Got it. Any -- before I jump into the auto, any questions from the audience for Prashanth or Mike? Okay, let's jump into the auto business. Your business there is 16% of revenues. You've got a longer-term growth rate of high single digits kind of year-over-year growth. You've been rebuilding the Linear design win pipeline in areas like EV, BMS, which has been growing at a double-digits growth rate over the past 4 to 5 quarters. You also have a richer overall design win pipeline in ADAS, autonomous driving, in-car networking. Help us understand the dollar content opportunities per vehicle for the team and remind us on the geographical diversification of the auto business.

Sure. Yes. Well, this is -- it's a timely question here at the -- what to us feels like the car electronics show. Much of what we have on display at the -- at our booth in the south hall today are technologies for our automotive business. So that will include our BMS product that will include our A2B, some of our advanced radar capabilities. So to the -- our presence here is really targeted at our automotive customers with a little bit in consumer and health care. So as we think about the auto business and kind of what do we expect in the coming quarters and coming years, our A2B product continues to be one of the strong suites -- strong products in our suite of suite. This is where we have introduced the ability to deliver audio technology throughout the vehicle in a much lighter and simplified structure that gives significant advantage to the OEMs and their ability to reduce weight and also configure the vehicles differently. We have, I think, 14 -- we have 14 customers signed up. And today, only 7 are shipping. And of the 7 that are shipping, several of them are still in early stages of deployment across their fleet. So we are looking at continued growth in A2B over the coming years. And then we're expanding that with future generations including delivering our superior noise-canceling technologies. So again, creating opportunities for auto manufacturers to re-architect how they think about the vehicle by bringing noise-canceling technology into the vehicle, which could then be traded off for things like sound insulation, which again add weight to the car. So less insulation by using more technology to control the environment in the vehicle. And then the third generation of that will be actually using Linear's products to drive significant amounts of power through that same architecture. So now giving you the ability to put in meaningful speaker systems or microphone technologies with -- using that same simplicity of a wiring architecture. So A2B certainly is a -- is one product that's worth stopping by the booth and talking to the engineers about. The other area I probably want to emphasize is BMS. So we acquired this leading technology with LTC, the highest-performing BMS product, as we move to the second generation of that product that was really focused on driving the cost down. So that cost down, I guess, I'll call it GEN II of BMS, really gives us now the opportunity to be more competitive on pricing or to allow us some recovery on margins versus the original first generation. So that's GEN II. GEN III, which is available at the booth only for select customers to view is our wireless BMS technology. And this is really groundbreaking. This is the ability to change the architecture of how you layer batteries into the vehicle. And there's so much that is released by being able to drive those connectivities in a wireless structure that you don't think about as a consumer. A simple example is you could be shipping a battery configuration to a particular OE who might have a sedan and a sport utility vehicle. The level of robustness that they need on the sport utility vehicle, which could be in a more hostile environment, you have to ensure that all those battery connections stay tight and don't come off as you're off-roading. With a wireless structure, you can create a common architecture that, that OE can use in both environments and just add the number of batteries that are needed to compensate for the different weights of the vehicles. A lot of different capabilities, including the ability to replace or repair batteries much more quickly by being able to pull them out, right? If you can imagine that when you put a battery harness together, you are designing it so that it never comes apart. But when you pull into a service station, what do you want to do? You want to take it apart so that you can service the battery. A wireless structure allows you to change that whole capability. So that's something we're very excited. We have a large customer already signed up for that, and that will be shipping in...

Few years.

In a few years. I guess we're not specifying the timing on that one. Thank you, Mike. And several other customers that are in deep evaluation phase of the same product.

So it feels like you've got a lot of momentum on the product and the design win traction side on automotive. In fiscal '19, your auto business was down about 6%, which was basically in line with global automotive production trends, IHS, and our own auto team is forecasting sort of flattish auto production growth this year, year-over-year declines in the first half, positive inflection in the second half. How are you seeing the auto demand trends in 2020? But more importantly, with the design win pipeline starting to unfold, and I'm assuming you're going to have new model cars rolling out with more of ADI content, can you outgrow -- can you start to outgrow the auto production trends in the market?

So I'll say that our view on auto production for 2020 -- calendar year 2020 in line with JPM is we're thinking flat SAAR. Now on a fiscal basis, that will be down a bit because we do pick up a little bit of the 2019 headwind. In a flat SAAR environment, you should be looking for ADI to outgrow the market mid-single digits. Now the headwinds that we need to overcome despite the growth that we have in the BMS, the A2B and some of the infotainment products is really the -- we still have a meaningful, somewhat slowly declining passive safety business that's continuing to unwind at a rate, and so we have to offset that headwind with some of the growth, and that's why we would expect more sort of that mid-single for 2020 and beyond. Anything to add, Mike? Okay.

Any questions from the audience? We've got one right here. Please wait for the microphone, please. Thank you.

For the A2B and -- can you give a sense of dollar content? And also like with this new battery management system, dollar content per vehicle?

Yes. Thank you. I'm going to turn to my pricing expert on that.

And also, on the passive safety that's declining. Can you give a sense for the rate of decline and the size of the business?

Yes. I think we're public on that. Yes. So the passive safety, call it, roughly $100 million declining at a couple of points a year.

Yes. On A2B, it depends how many nodes there are on a car. It's speakers, it's microphones. It always depends how many there are. More nodes, the more content for us. Every node can be a couple of dollars when you tend the configuration of it for A2B. When you bring things in like audio and noise cancellation, you increase the number of nodes you can support in the car. So there's more nodes we're shipping into than we ever have been. So it's got good stuff there. And then on BMS, you asked about. We've been publicly saying, a car depends on configuration, it depends how big the batteries are. But anywhere between $50, $100 of BMS content and then you add wireless onto that, you can do even more than that.

So $50 to $100?

$50 to $100, depending on configuration.

And then on the A2B like it depends on nodes, but what's an average -- what's the rough range of the nodes?

2 to 15.

Okay. Any other questions? Let's turn to the financials. Through the current down cycle, the team has done, first of all, a great job on managing your OpEx. You drove quarter-on-quarter declines in your OpEx basically through all of fiscal '19. You outlined $135 million of cost savings over the next 2 years. $100 million of that is the manufacturing synergies post the closure of the 2 Linear legacy fabs, but you managed to drive another $35 million in annualized OpEx savings exiting this fiscal year. Is this coming from further LTC cost synergies? Or is this just OpEx cost optimizations you've uncovered across the entire business?

This is really -- so as a reminder, when we purchased Linear, we committed initially to $150 million of cost synergies. And then shortly after that, we committed to another $100 million of cost synergies that was going to be tied to closing 2 facilities, one in California, one in Singapore. So in 2020 of that initial hunt of that sort of $100 million of facility closures, we're able to bring about $15 million of that savings into the -- on a run rate basis into fiscal 2020, with the remaining $85 million happening when we actually shut the lights off on those 2 facilities in 2021. On top of that, Harlan, as you mentioned, we've added another $35 million of OpEx cost reductions, and that OpEx cost reduction is largely coming from optimization of our organization, removing some management layers and the typical kind of opportunities that companies take advantage of -- to constantly be looking at how to be most efficient with investor money.

Great. And my last question, China, today, they are a powerhouse in end product manufacturing, but the longer-term strategy is to capture more of the semi content that flows through their manufacturing value chain with their own silicon. What's your view on where China stands in terms of high performance analog, RF, millimeter wave? I mean how long is it going to take them to develop the core technologies to be able to get close to being able to compete with someone like in Analog Devices?

Yes. So we've been facing competition in China for many, many years. This is nothing new. Certainly, there is an increased focus in China on developing an indigenous semiconductor supply chain. It is our view that as they work through the different elements of the semiconductor industry, high-performance analog is going to be more towards the tail end of that. And the reason comes from a few things. First, the design of high-performance analog while steeped in [ science ] has a certain amount of art to it. And that is that it is the art that we build through our engineering capabilities, and we'd like to say, it takes roughly 10 years to grow an analog design engineer who's had enough of the different experiences where they're able to do independent, innovative design. Second, the dispersion of the product portfolio makes it very hard for a competitor to think about what exactly are you targeting. Our $6 billion or so of revenue can be mapped across over 100,000 customers and over 45,000 SKUs. So when picking your spots on what am I going to -- what problems am I going to solve, you have to take that down to a specific design. And the effort required to develop that design may only have a very small payback because you're working with a highly, highly fragmented market.

Great. Well, we're just about out of time. Gentlemen, thank you very much for joining us. And I appreciate you guys participating in our conference in the last few years. Thank you.

Thank you.

Thank you. Happy New Year.

Happy New Year.