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

Very good. Good afternoon, everyone, and welcome to the Stifel 2020 Virtual Cross Sector Insight Conference and the Analog Devices fireside chat with management. My name is Tore Svanberg. I'm a managing director and senior analyst at Stifel covering analog, connectivity and processor semiconductors. It is my pleasure to introduce ADI this afternoon. With us from the company on the line, we have Vince Roche, who is the company's President and Chief Executive Officer; and also Mike Lucarelli, who is Senior Director of Investor Relations. So with that, I am going to get started. [Operator Instructions] And with that, I'm going to turn it over to Vince and ask him to give us a brief introduction to ADI, especially to the benefit of those companies that may not be that familiar with ADI. Thank you very much.

Thanks very much, Tore. Great to be with you this afternoon. So we're a leader in the analog and mixed signal and power parts of the semiconductor space. We're a 55-year-old company. So we've built up a lot of tacit and very, very specific knowledge in the business over those at many, many decades. Last year, our revenue was $6 billion. And our free cash flow margins tend to be in the kind of low 30s to mid-30% level, and that puts us in the top 10% of the S&P 500. So I think the way to think about ADI is that with 70 points of gross margin, typically, we are a hardware company operating at software margin kind of levels. We're highly diversified. We have upwards of about 50,000 product SKUs. We sell our products to about 125,000 customers globally. And that is deeply embedded in the B2B market, where we sell more than 90% of our products. So that's a very brief synopsis story of ADI.

Yes. Thank you so much. And I do suspect most people know the company. So with that, let me get into the more recent discussions. So these are very dynamic times in the semiconductor industry. Are there specific things the company is doing to strengthen the business during the current downturn? I've always heard that from CEOs, Vince, that the time to strengthen something is really during a downturn. So if you could elaborate on that, please.

Yes. So I think we have 3 pillars in which we build our activities. One is making sure that we use our capital very efficiently. So we've taken some actions in the short term here to make sure that we keep our balance sheet and P&L in very, very good shape to enable us to invest long term in the R&D programs and the customer engagement activities that are critical to us. So specifically on the R&D side, we're spending more than 95% of our R&D, over $1 billion in the B2B space. In areas like health care, where we're doubling down, we're actually increasing our spend there. We have a great position in advanced communications networks, namely 5G radio systems as well as advanced wireline technologies, particularly in optical networks. Obviously, our -- 50% of the company is in the industrial space, 50% of our revenue is there. And we're beginning to see the green shoots on the Industry 4.0 set of things where software-defined input/output systems, condition-based monitoring, robust connectivity and many new types of sensors like 3D depth-sensing are being used. So we're making sure that we have -- we've got wrapped focus and attention paid to those areas. So I would say we're conserving the balance sheet. I think we're in good shape regarding the inventory levels that we're holding right now, balancing supply and demand very well. But we always take a long-term view to our markets, our customers and we're also in the process of getting the kind of remaining synergies from the acquisition of LTC on the balance sheet. So those are the primary items, Tore. As a 55-year-old company, we've always taken a long-term view to the world. And we're also spending probably 5% of our R&D in new advanced interesting technologies that will come to market over the next 5 to 7 years.

That's very, very helpful. And you touched a little bit upon it, but are there anything that you are perhaps not investing in as much? I'm kind of thinking about pre versus post-COVID-19. Are there any areas that you're perhaps a bit more excited about before COVID-19 that now you are deemphasizing somewhat?

Yes. So I think in automotive, in particular, the safety side of automotive is not as -- particularly the autonomous driving side of things. I've always believed that we were more optimistic than was probably warranted across the entire industry, both at the OEM level as well as the semiconductor level. So that's an area where we have reduced spending, but we remain very committed in the automotive sector to our infotainment business, where we have a very strong audio platform based around our SHARC DSP technology. We've also been reconfiguring and reimagining how bus structures are used to move media around the car. And our A2B bus now has penetration at most of the OEMs globally. And on top of that, we're adding new modalities like active noise cancellation, as an example. So electrification is another spot where we're increasing spending. We're just -- we're sampling our fifth generation now of battery management metrology systems. And our fifth generation will be a wireless version which is exciting to the OEMs out there because it reduces weight and cost and increases reliability in the car. So that's the area, Tore, automotive specifically, where I'd say, there will be -- there's a lot of damage, obviously, done through COVID-19 that has added more stress to a market that was already stressed during FY '19. So automotive, we're very committed to the electric powertrain and infotainment and making sure that we connect our power franchise as well across the board, but safety investments we have taken down considerably.

Yes, that makes sense. And on your recent earnings call, you updated investors on the company's 3 key priorities, including, one, the efficient use of capital; two, maximizing customer impact; and then three, capitalizing on secular trends. Could you give us an update on each one of those and especially in light of new opportunities that may emerge here in the current downturn?

Yes. So maybe I'll start with the secular trend. So clearly, our health care business has gotten a great boost. It's around -- in FY '19, it was around 7% of the company's total revenue, so the demand there is very brisk. We have really 2 parts of that business. We have a standard product business that enables us to sell many different types of products into products like -- into OEM systems like ventilators, respirators, patient monitors. But we're also trying to really bring leading-edge technology to bare to enable the new types of technology that the health care system will need, to make it more affordable, to make it more accessible and really to put a focus on wellness. So we have a suite of new and exciting clinical grid vital signs monitoring technologies that we're beginning to test in the market now and that we will launch sometime during FY '21. Automation and Industry 4.0, as I mentioned earlier, we're beginning to see the green shoots there. It's -- I think the issue -- we've seen the fragility of the supply chain globally through this crisis here. So what is becoming pretty clear is that the whole supply chain will hybridize more. There will be less dependence on human labor, a lot more automation. And as the supply chain sovereignizes or regionalizes as well, particularly in high-cost regions like America, the only way to enable efficient costs -- cost-efficient factory automation is to use machinery. And areas like process automation as well will use a lot more cobotics-type technology. But I'd say the emphasis in expensive regions like Germany and America, it will be on machines rather than human labor. I think as well, if -- I've mentioned wireline and 5G, so I won't go into any more depth there. If I look as well at the -- customer impact is really, really important to us as an area of focus. And I'd say the virtualization of the engagement with the customer is something that we've learned a lot from. And in fact, the engagement hasn't slowed down at all. Our applications teams across the globe are solving our customers' most vexing and complex problems. And we're doing our best to make sure that their programs get to market on their time schedules. So I'd say, overall, the pipeline that is well over $20 billion for ADI is healthy, is continuing to grow, and that pleases me greatly, particularly during this crisis. And I talked as well a little earlier on about the efficient use of capital. First call on capital at ADI is -- are the R&D activities and the customer activities. But we've taken the actions necessary to keep our cash flow and our balance sheet healthy. So those are the 3 areas, Tore, and those -- that's kind of a very high-level summary of the things that we're doing.

Yes. No, that's very helpful. And maybe if I can just zoom into a few specifics, if you don't mind. And let me start with 5G, which is obviously a very dynamic market right now. It obviously has some politics elements to it. And I think what's so unique about ADI, of course, is that you have this software-defined technology that allows you to be a bit more nimble and you can kind of pivot from place to place, if you have to. Can you maybe talk a little bit more about that, please?

Yes. So we approached that market with a set of platforms. We have, as you mentioned, software-defined transceiver technology. We have microwave technology. We have power technology. And those technologies are applicable to all the players, all the OEMs in 5G. So yes, there's a lot of turmoil there, but we have good penetration at all the OEMs globally, whether they're in Europe, whether they're in Asia, all parts of Asia, all the various players, and whatever happens in terms of embargoes, whatever happens in terms of share movements, ADI is well positioned to benefit, I think, from the strength in diversity of technology that we have and the penetration that we've got across the board. So there was -- for example, there was one customer last year that was -- we were prohibited from selling to, and in spite of that, we still managed to grow the business last year. So when I look at 5G, there's multiple years yet of adoption of that technology. I think the early stages are about the consumer. The later stages over the next 2, 3 years will be about the adoption of that technology into more kind of B2B applications, like health care, like industrial machines, like automotive. So our microwave is yet -- our microwave technology is pretty much in all the trials out there, the short distance direct transmission microwave systems. So I think that's ahead of us yet in terms of upside, and that will combine quite nicely with our sub-6 gigahertz transceiver technologies. And I think I mentioned a little earlier on as well that we're attaching power, so we're bringing the LTC portfolio into the 5G and wireline sockets, actually, in these advanced optical communications networks as well. So that represents a good upside for ADI where thermals really matter. So clever power design really, really plays a part. And it really plays into the skill set of our LTC power franchise.

That's very helpful. And maybe this is just my perception, Vince, but when you think about 5G, you think about Massive MIMO. The market opportunity is pretty tremendous. Yet, when I look at the competitive landscape, a lot of your competitors are smaller players. Why do you think some of the other more traditional, larger analog companies haven't emphasized the RF opportunities like Massive MIMO as much? Is it just simply because they were late or any other reasons?

Well, I think, Tore, we've been playing this game. Since I've joined ADI, I think -- when I joined ADI, 2G was in it's -- I think it was still just in planning stage. But -- so we've played in 2G, 3G, 3.5G, 4G, 5G, we'll play in 6G when it comes along. But also, we have taken a very, very systemic view of 5G. We got ahead of our competitors and really thought about the problem, not as a series of semiconductor circuits that were looking for homes, but we decided what the architecture of the radio needed to look like and to make it as easy as possible for our customers to adopt and use our technology and to be able to incorporate multiple bands in a given spectrum, for example, to be able to do it very low power, lower cost per channel and to be able to get the spectral purity that they needed. So I think we thought about the problem earlier than anybody. And also, it's important to remember, 5 years ago, we acquired Hittite Microwave. So the years of combined insight that Hittite brought to the table as well around how to optimize RF and microwave systems played a big, big part in solving the problem as well. So I think it was much greater suite of capabilities than we've ever had combined with an early mover's mentality and solving the customer's problem at a very, very systemic level when it came to rearchitecting the radio.

Very good. And I apologize, Vince, for asking one more question on 5G, but I know it's very important for investors these days. So you very recently announced the collaboration with Marvell, I believe it was a few months ago. Could you talk a little bit more about the rationale behind that collaboration? And are you starting to see the fruits of working with more of a processor company to attack the market?

Yes. Well, I think we have a very, very broad suite of technology that works with many different types of digital solution. Sometimes, the customer builds the solution internally. They have foundry, their digital intellectual property, on an independent fab. Sometimes, it will be flexible fabric. Sometimes, it will be a customer who request us to work with some of the leading-edge digital players out there. So Marvell are very complementary to ADI in terms of technology capabilities. And we're delighted to be working with them. They're a very, very capable company. And it's a very, very good relationship. But there's many, many ways to skin the cat, so to speak, when it comes to combining the mixed-signal RF and digital technologies, and Marvell is one great route to do that.

Very good. If I can move on to the industrial business. And you talked a lot about factory automation and Industrial 4.0, and that being an important trend. But obviously, now in the downturn, when we think about Industrial, we also think about thousands of small and medium businesses. Maybe you could talk a little bit about how ADI is managing through the sort of pulling forces therebetween potentially lower demand from small and medium businesses as the economy continues to struggle versus some of these secular trends that you're seeing with Industrial 4.0?

Yes. It's a good question. I would say, I mean, even in our second quarter, which we reported there just a few weeks ago -- actually, our automation, the industrial automation business, which is comprised of tens of thousands of customers, grew quarter-over-quarter. So I think what we're seeing today is certain parts of the business are doing well. I think anybody who's making automation and process -- factory automation and process automation equipment for, for example, food production has tended to do quite well. And so China as an economy has woken up. I mean they've been taken out of their coma fastest. So my sense is that the signs of life are quite good in the small and medium enterprises there. So I think our job is to make sure that we have balanced our inventories correctly for the demand that we see. We run the company on a POS basis. And as I said, the parts of the industrial business are doing fine. And you've got to also think of industrial in multiple sectors. When we report, half our revenue is industrial. 15% of that is health care. You've got to extract that. You've got to look at the instrumentation part. And what I see happening is that the scientific instrumentation part is doing quite well. Instrumentation for the diagnostics of early-stage product development, diagnostics that are used in medical labs, for example, that equipment is doing quite well. The instrumentation part, the automated test equipment part, which is comprised of a few -- several large customers, is doing particularly well when it comes to the testing of processing and memory technology for data centers, for example, and also anything connected to 5G and advanced networks, doing quite well. So the industrial business, Tore, and of course, the last part then is automation and process automation -- factory automation, process automation, that piece has been most impacted, I'd say, over actually the last 6 quarters, not just by COVID-19. So it's a tale of many parts as our industrial business, which is one of the beauties of this thing. It's tens of thousands of products, tens of thousands of products in multiple different segments with very, very different dynamics.

Yes. That's very helpful. [Operator Instructions] So moving on to another topic that is becoming pretty important among investors, which is manufacturing. It was a pretty sleepy topic there for a while, but it's become a new and important topic, especially given the semiconductor dynamics between the U.S., China and Taiwan. Now your largest partner on the foundry side is in Taiwan. Do you see any risks with that partner? And what are you doing to mitigate some of the political risk that has emerged the last few months?

Yes. So let me try and unpack. I think most of the impact is related to -- in fact, all of the impact right now or the tension is around the sourcing of silicon, the fabrication of silicon products. So we make 50% of our fabing is inside ADI in the EU and America. So the other 50% is external. And the largest portion of that is with TSMC, but we also have important relationships with companies like GLOBALFOUNDRIES and Vanguard, for example, and some others. So with regard to TSMC, typically, many, many of the recipes that we use to make our silicon, we have the capacity to make them inside ADI or with TSMC. And so there's a regular movement depending on demand loading between TSMC and ADI. I would say, in terms of risk, it's the more advanced process nodes, the really deep, deep of submicron nodes. And you've seen recently, I mean, there's a lot of movement of foot in America if you like to sovereignize the manufacturing of the really deep submicron technologies for the long term. So yes, TSMC is really important to ADI, and we are all the time evaluating the risks and looking to mitigate those risks, both internally and externally.

Very good. And now we only have a few more minutes left. But I wanted to ask you an important question on the IP and product positioning. So ADI is a leader in high-end signal conditioning. I mean the company has had the highest share of the data converter market for as long as I remember. Obviously, in RF and power management, the company continues to be a leader. Are there technologies or product verticals you believe ADI is missing? Or do you have enough in the sandbox now for a long time to obviously build a much bigger ADI?

Well, obviously, Tore, we've been flexing our balance sheet over the last 5 years with the acquisition of Hittite on the microwave and RF side. And with the acquisition of LT, we got the highest performance power franchise in the industry. So I think when it comes to analog and mixed-signal technologies, we're very, very well positioned. We've been making -- even in the interim since acquiring LT, we have acquired some smaller companies that have very, very targeted, say, system domain know-how with good algorithmic technology that we can bring to areas like automotive into health care, into consumer, into the industrial space like condition-based monitoring. So that activity continues on. In fact, in the quarter just gone, we announced the acquisition, I think, of 2 separate companies that are related to Industry 4.0 as well as consumer and automotive. So the way to think about the acquisition strategy now is that we will continue to buy target pieces of technology that make a difference in a particular application.

Very good. So with that, we've run out of time. So thank you, everyone, for participating on today's Stifel ADI CSI call. Also wanted to send my gratification to Vince and Mike, for joining today's call. Really appreciate it. And I wish everybody a good afternoon and stay safe and healthy. Thank you very much.

Yes. Thank you, Tore. Best wishes. Bye-bye.

Thank you.

Thank you. Bye-bye.