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

Welcome back. I'm Blayne Curtis, semiconductor analyst at Barclays. Very happy to have with us, Analog Devices. From the company, we have Prashanth Mahendra-Rajah, he's the SVP and as well as CFO; and Mike Lucarelli from Investor Relations. Welcome gentlemen. Obviously, you reported over [Audio Gap] retirement and all companies kind of saw similar sharp recoveries midyear. And if we look at your January guidance, you're up double digits year-over-year, maybe off the easy compares. But maybe talk about company-specific tailwinds and just the slope of the recovery here. And then I want to get into kind of your perspective on '21.

Yes. Thank you. Thanks, Blayne. So yes, we reported just a couple of weeks ago. We are -- we had a very strong quarter. I think when we look back at 2020, very pleased that the second half had so much growth on a relative basis to the first half. I think second half was up probably 14%, Mike, versus the first half. When I look forward and think about kind of what -- how we feel the markets are going to work out for us in 2021 based on where I sit today. Industrial certainly is very exciting. Automotive is exciting. Consumer is exciting and probably least exciting just from a tough compare standpoint is comms. But we can talk about that in the time we have here.

Maybe we'll drill into the different segments. I'm kind of curious, just one more high-level question. I think you talked about the channel and inventories of your customers. You talked about catching up, maybe you'd take a few months, on the call. You can talk about where you're seeing areas. I think a few were lean kind of going into COVID, and where you think you'll see take a little bit longer for recovery.

Yes. So again, we just printed our guide 2 weeks ago. And so we're very comfortable on our ability to meet that guide. When I think back, we certainly had some significant supply chain challenges early in 2020, March, April time frame. Things have continued to get better as our operations have come up. We've been able to bring lead times down. We're not quite where we want to be, but we're in pretty good shape, reflective. Inventory in the channel, we finished the fourth quarter below where we wanted to be. I think we were -- we finished sub-6, and we'd like to be kind of in that 7- to 8-week window. So we're going to keep building over the course of 2021. Like most of our peers, we are seeing some pretty strong demand. I don't see that impacting the business right now, kind of in the near term. I feel good about first quarter. But I'm also kind of realistic enough to say we're not going to be immune if this level of demand sustains itself for an extended period of time that we probably will be facing some of the same crunches that some of our peers are facing in -- but for us, it would have to be Q2 or after that.

Yes, I wanted to ask you about that. You're hearing -- you've heard for a while now that kind of trailing edge, there's been some tightness. And clearly, some certain end markets have remained strong and may be strong into next year, like handsets or PCs. They're just filling up these fabs. But now you're starting to hear companies being able -- not able to ship. So kind of just your perspective on the downstream, maybe not your supply chain, but whether you're hearing any rumblings from the supply chain about maybe other components from other companies that would get any shipments.

Yes. I think the -- perhaps if you just think about 2 large trends that are sort of impacting it. First, with the impact of the U.S. ban, we've seen Huawei meaningfully impacted. And the result of that is, we believe a number of competitors all have visibility on that same demand that used to be supplied from Huawei. And this is -- I'm speaking more on the consumer side. So there is likely some duplicative production going on there as they all think they're going to win customers over that used to be Huawei customers. So that's -- it's a very normal process, but unfortunately, it is a cycle that that's going to create. And the other one, I think that folks are clearly aware of is that -- is the growth in some of the processor guys are -- they're growing faster than Intel is, and they're putting demand on those same foundries that used to be sort of captive for -- Intel was captive to itself. So you've got these trends out there that are all putting pressure on supply chain. Even if the overall market doesn't change, just how it's being filled, I think, is creating some dynamics that are going to be -- that are going to play out over the coming quarters and create some challenge for everyone.

Before I get to the end Mark, someone asked me one more kind of high-level question. And this customer guy used to work at Maxim, so don't feel like I'm dumping on them. But M&A has been a part of the strategy for ADI. I think when you did Hittite, when you did Linear, it was very clear franchises that you were buying. And I think the knock on Maxim was they weren't clear #1 in any kind of particular category. And I think you saw your stock kind of trade sideways. I think the question I got was, why now, why all stock? And I think people kind of gotten over that. But I'm kind of just kind of curious to your perspective, why did you feel that you needed to buy Maxim? And really kind of, what can you do with that asset? Because I do -- I do work with these people. I know you can't hire them if you wanted to tomorrow. But what's your plans with Maxim over the next 3 to 5 years? And why was this favorable for the company?

Great. So Maxim has always been on ADI's road map. And I think most people know that this wasn't our first conversation with them, that we've looked at them before, and we've had very fruitful discussions in the past but chose a different path at that time. When we think about where Maxim is today, certainly, they've done a significant amount of transformation, kind of building their business more B2B, which lines up a lot better with kind of ADI's focus. They've done some great work on improving their profitability and starting to get kind of closer to the ADI model. And when we bring these organizations together, we clearly have some cost synergies, and we've been public about the first phase of that being $275 million of cost that we're going to take out in the first 24 months, ideally in the first 18 months. And we've also been clear that there is a second phase of cost synergies, just like we did with Linear, there's a second phase of cost synergies that we're going to work on. But we're not going to share too much details on that until we get the deal closed, and then we can speak to the employees at the sites that may be impacted by such a decision. So plenty of tailwind on the cost side to take out the cost for the foreseeable, let's call it, 2 to 3 years. We also are very encouraged by the success we've had with Linear in attaching products to ADI's core franchises and sort of our anchor products and how well it's worked with Linear when you're in a conversation with the customer and you're able to bring more of the Linear portfolio into that conversation. Linear's going to serve us very well in the broad market, is already serving us very well in the broad market. We see Maxim's power portfolio really helping us out on the vertical side. So good complementary. And I think where we've also been very candid that analog engineering talent is quite scarce. And this is a great opportunity for us to buy a large cadre of very experienced, talented engineers that we, within the whole ADI portfolio now, will be able to really point them towards the opportunities that we think have the highest return. And you'll see the -- you'll see that innovation play out in future years.

I wanted to ask you on a...

[ What was it, ] Blayne? What I was trying to say -- the other piece of it, you talked about it, doing all stock. By doing all stock, we do accrue a lot of cash over the next year, and our leverage ratio is quite low. So what you'll see once we close the deal, we'll have a cash balance well in excess of $3 billion, we'll quickly move to return that cash to our shareholders, creating 100% of our free cash flow. We don't need to have a leverage ratio of sub-1%. And as debt comes due, our next debt tranche, I think is December 21, roll that forward exactly.

Great. Maybe diving in the end markets. I think starting with Industrial. I think at first glance, you look at it, you say, okay, well, it's up double digits year-over-year, how could that be? I think you guys did a good -- I forget, maybe where it was, but you gave some good color as to the components, and maybe you can walk through those again for those listening. I think things like testing being up with 5G made sense. And medical, I know, is one that you've highlighted a bunch. So can you talk about what the tailwinds are that aren't traditional kind of analog -- or industrials people think about? And then you did mention on the earnings call that automation was finally turning. A little bit more color as to what you're seeing there.

Yes. Sure. So maybe, Mike, why don't you start by breaking down the percentage of Industrial, and I'll take the drivers.

You're right. If you looked at the industrial bucket ever since, oh it's industrial, it's -- that's just all there is. It's not all there. There's a lot of different applications within industrial for us. The biggest one is actually instrumentation and test. That's about 25%, maybe a little above 25% of industrial. Number two is aerospace and defense and is about 20%. Automation's also about 20%. Health care is 15%, 1-5 percent. And the next one actually that gains a little bit quite big is energy. When we think of energy, we think of renewables and distribution. That's about 10% of industrial. The remaining probably 10%, 15% is other. This is a really broad-based long tail of business for us. And then you said, the first half of the year, for us, was all about health care, about defense, about space, about tests, like you said for 5G that really carried the torch, while the other 50% of our business was weaker. Rolling into the back half of the year, military remained strong, but the other areas like automation picked up. And really, what you're seeing is kind of a broad-based recovery across the entire industrial portfolio for us. Health care is a little weaker than it has been, not a surprise, it peaked on the pandemic time, but 85% of our industrial business is doing really well and quite strong as you enter '21.

And on automation, I would just add that we've been expecting this for a while now, that automation took a challenge actually in the second half of calendar '19, struggled in most of 2020. And we're seeing that return, certainly driven by the cyclical side of it, but also really this new secular tailwind of the desire to onshore more manufacturing. And with that desire to onshore more manufacturing typically in Europe or U.S., the only way you kind of solve the lack of the labor arbitrage by bringing work from higher -- sorry, from lower-cost locations back to high-cost locations is through automation. So we're -- across the portfolio, whether it be in the power management in isolation; whether it be in the safety sensing technologies that allow these robots and cobots to operate with human operators nearby; the communications that's needed to bring all that information back to central control systems, all that plays very well into a suite of portfolio that ADI has been investing in for a while. So we are -- we're really set up in the sweet spot of this.

Then moving to auto. I think that's an area where you've admitted some past struggles, post Linear. The business also had a -- it's kind of worked through some issues with Linear's business. So I wasn't really expecting it to kind of snap back. Obviously, the markets snapped back here, and I think all have seen autos kind of come back very robustly. When I look at the levels that you were in, in 2018, I wasn't expecting to kind of get back there right away. I think with the latest quarter and guide, you're close. So maybe just talk about the part that's kind of recovery here. And then the part that are the growth factors, the BMS coming back, the A2B. How much of it is the growth vectors? Or -- and how much of it is kind of recovery that you're seeing today?

Yes. So you're right. We've struggled a bit on auto for the past couple of quarters because we've known that we were approaching a crossover point. There were parts of the business that we have been investing in, battery management, infotainment and electrification of the vehicle, that had been growing. But we faced headwinds on the safety side with MEMS and with some of the technology changes in radar that we weren't as well represented on. So we knew we were going to hit a crossover point. I'm not sure we're at that crossover point, so I don't want to predict that the next quarter or 2 are going to kind of continue to see us be strong. I think that we have got a good chunk of our business that is lined up with SAR, that is going to continue to grow. And then kind of the SAR plus growers that we have on there are exactly as you mentioned, the BMS portfolio is doing incredibly well. We are the sweet spot solution for the full electric vehicle. We've been very public on the General Motors win that we've had with the wireless BMS. We have another large win on wireless BMS with another major manufacturer that we haven't shared names on yet, but that's also been a very exciting win for us. On the infotainment side, the A2B portfolio is designed in at over 20 customers, but I think only about half of them are actually in the stages of shipping. One of the pain points about automotive from design win to revenue tends to be long. We've got about half of them shipping. We have next-generation elements of that A2B also coming into place. I think we've been public that I think Hyundai has been public that they are using our next gen, which is noise canceling technology, and we have a few other vendors. Hyundai's one that has been public. And then with Linear, we're now pushing -- I think we're up to 50 watts, something like 50 watts through the same A2B architecture. So now you're talking about having enough power to really drive meaningful kind of speaker without having to use a separate architecture in the vehicle. Maybe you can't drive folks who are putting kind of monster sub woofers in the back seat, but you can go a long way there towards the power requirements for your audio system. So all of that is going to continue to play out over the coming years, and we feel very good that auto's going to be a great story for us. Still have to get past a couple of tough compares on the safety side, but I think we're getting close to that crossover point.

Maybe just some comments on that supply chain. And you look back at the '18 and maybe a SAR of $90 million and maybe you can tell from your SAR related parts, just where you're at. And I think given that auto was from a market perspective, not even an ADI perspective, kind of soft in '19, I think the inventory levels were probably quite low. So maybe just talk about the restocking of inventory in that supply chain and the recovery versus these growth avenues that you just talked about.

Yes. The -- what we're seeing from the auto guys is that there is very healthy demand at the -- as we're shipping into kind of whether it's the Tier 3 to the Tier 1 or in the few cases that we provide directly to the OEM. So the demand is strong. Now it's a little bit unusual to see auto doing so well at a time where unemployment rates continue to be quite high, but our best read on this is the consumer balance sheet is quite healthy. People have -- people who have the ability have been unable to spend the income that they've been earning due to kind of the shelter in place and all the shutdowns. So a lot of that money is expected to be deployed into car upgrades and the automakers are predicting that they're going to enjoy that for the coming year. I am particularly optimistic that electric vehicles are really going to see the tip over point in the coming quarters, and that's really going to be a big driver for us. We are -- our content on an EV is substantially better than on a traditional combustion engine. So we will disproportionately benefit from the growth in EVs.

I want to ask you on just -- I know it's premature, but the combination of Maxim, they obviously had a robust BMS business as well. And when you look out, is it too early for customers to be thinking about the combination of the 2? It's not closed yet, but in terms of the positioning of these 2 businesses, do you think that will kind of create a little too much share between the 2? And kind of just -- BMS as a franchise, as a pro forma, and are you seeing any indications that, that's going to factor into any post-deal positioning?

Yes. I think your question is, are we concerned about -- is it from a regulatory standpoint? Or is it from a customer standpoint of having too much concentration?

Yes. Is it too early for customers to think about 1 plus 1 and do these 2 franchises equal, and they're going to move share elsewhere?

Yes. I would say that we enjoy very high share positions with our BMS portfolio by OE. So there -- when we think of the customers that we're providing our advanced PMS products to, it isn't -- their mindset is not as much about, oh, I need to split share for supply assurance or stay competitive. The incremental benefits that our BMS product brings, because of the precision that we offer has allowed a number of our customers to really give us a very significant amount of share. There are certainly some cases where we have all the share, but I would say that in most of the cases, we just have a dominant amount of their share, because you can't design a battery pack with 2 different BMS systems that don't have -- that don't offer the same level of performance.

Got you. Helpful. Maybe moving to comm, obviously, we've seen -- and you guys were very clear upfront that there would be a bit of a pause after Phase I. I think you're one of the first to try and talk about that. Can you talk about -- as you look into next year, at some point, you should see kind of Phase 2 kick in, but I think you talked on the earnings call as well, a bit of a broadening out. I think U.S. spending, should be a little bit more robust. So just the broadening out of 5G and any perspective on when China...

Yes. The short version is look for Phase 2 deployment in Korea. We feel pretty good about U.S. in the second half of calendar year '21. We are not expecting much deployments in Europe next year. So that would most likely be a '22 event. And we still think that there will be plenty of growth in China. Now how that share in China gets divided among -- between [ Dachong ], between ZTE, Huawei and an international player, it's still to play out. But in 3 out of those 4 situations, we have great positions.

I wanted to ask you, and you've now -- I bought one of these new iPhones. They've got millimeter wave in it. I mean, that's a -- I think of your perspective, it's going to take a little longer, but you do have a very good content position there. Just any thoughts on millimeter wave over the next 3 to 5 years?

Yes. Probably not in the next 3, I think, is our view of that continued kind of advances in the technology, but there is so much -- the economic returns for carriers to deploy massive MIMO sub-6 are pretty significant. And given the kind of the capital constraints of that industry, that's where I would expect continued spend over the coming, kind of 2- to 3-year period and then millimeter wave comes post that. The -- I think what positions us well is, on that massive MIMO sub-6, we have phenomenal share. And the content story actually gets even better on the millimeter wave. So while that is further out, we would expect to do even better as it does move into something that's closer to revenue.

Anything, Mike, to add?

No, I think we've kind of hit on it. It's -- carriers who have sub-6 GHz deploy that first. And then they densify the areas with the millimeter wave. U.S. is in a little unique position. We did -- U.S. did not have sub-6 GHz. They got some with T-Mobile and Sprint combination. We'll have the, auction later this year, so you're going to see a lot more spectrum become available, sub-6. And you'll see that deployed first before you move back to the millimeter wave economic standpoint.

And then can you comment on what you're seeing on the wired side of the business? All the focus has been on wireless, but what are you seeing on wired now and then for next year?

Yes. So our wired business has been growing very well, double digits. It's actually -- it's been overshadowed because of the amount of time we spend talking about wireless. But with the, with conversations like this, where everyone is relying more on video conferencing to conduct business, the amount of fiber that needs to support all that really works to ADI's advantage. Our sweet spot is in the optical switching across the -- in the metro solutions where we can help infrastructure guys push more content through existing fiber and that really -- so the increase in demand that needs to happen to support all the video conferencing activity plays very well to us. We saw that in 2020, and we're optimistic that '21 will also be a good year for us.

Right. Well, with that, we're out of time. I really appreciate you supporting the conference. Good to see you both. And everybody listening, take care.

All right. Thank you, and happy holidays to everyone.