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

Greetings, and Happy New Year. Thank you for attending JPMorgan's 20th Annual Virtual CES Technology Forum. My name is Harlan Sur, semiconductor and semiconductor capital equipment analyst for the firm. Very pleased to have Prashanth Mahendra-Rajah, Chief Financial Officer at Analog Devices; and Mike Lucarelli, Head of Investor Relations, here with us as well. I'll be starting off with the first few questions. [Operator Instructions] So gentlemen, thank you. Happy New Year, and thank you for joining us today.

Thank you, Harlan. Delighted to be here. Sorry, we couldn't be with you in person in Vegas. And Happy New Year to everyone who's joining the call.

So I'll kick it off with the first few questions. Core ADI fiscal year '21 revenues, excluding Maxim acquisition, was up 20% to 22% year-on-year on an organic basis. Strong performance and in line with your analog and mixed-signal peer group, despite some of the communications headwinds, right? However, comm should be a tailwind for the team here in fiscal '22 on accelerating global 5G network buildouts on top of continued strong auto, industrial and consumer demand trends. On a pro forma basis, including Maxim, I think the Street has you guys modeled to grow revenues about 12% this fiscal year and better than our industry forecast of up 8% to 10%. So help us rank order your market segments in terms of contribution to growth this year?

Yes. I'd say, it's a tough question to rank order them because all of our markets are looking pretty good right now. And so I feel strong really across the board. So I don't know that I can -- I could give you a particular order. I can tell you, my favorite continues to be the industrial instrumentation, which has that kind of that long life to it and that great profitability. So we're delighted to see that continue to be strong. But in general, really all the markets are doing well. You made a comment in your question about communications. So it may be worth just talking about that briefly. We feel very good about communications on a go-forward basis. So we've got great backlog. The 5G deployments are still very much on track. We saw some of the news this weekend about the negotiations are just putting in a very small delay into the eventual deployment. But again, strong recommitment by AT&T and Verizon to do their deployments. So with the backlog and with the activity that's going on, plus we have some good compares as Huawei is basically now out of our prior year numbers. So we're working off a very clean base and applied in China really comes on top of our current outlook. So I feel good across the board, all end markets, but to the question about comms, feel good the comms will be a growth for us in '22 as well.

Last earnings call, you talked about demand continuing to outstrip supply, positive book-to-bill. Now with the Maxim team and having time to assess their demand and supply situation, is demand still trending ahead of supply for the combined business? And is book-to-bill still trending above 1?

Yes. Yes. So we're 2 months into our fiscal first quarter, and book-to-bill is still above 1. It's a pretty similar story to what we told you in the Q4 earnings call that lead times are stable, which is a good thing. And despite those lead times being stable, we're still seeing growth in orders in excess of our ability to supply, which means that customers know there's predictability to when they're going to be able to get their products because those lead times are stable. And they're still putting orders on us, which means that it's really coming from true demand. So I think what we finally print over the next couple of quarters in terms of end market growth is still going to be a function of our ability to supply and where we put those supplies versus any underlying demand trends. So I'd just remind everyone that demand is strong, but when you see our actual growth by end market, it's probably more influenced by which markets we're feeding versus any underlying trends of demand.

So given your backlog and supply expansion profile, when does the team expect to see some normalization of the situation? Is it mid this year? Is it second half of the year? Is it 2023?

Not soon enough. I think that we're pretty baked through the third quarter -- our fiscal third quarter, and we're optimistic that we will see a good kind of step function increase in our ability to supply in the fourth quarter. So that's when you'll see a more meaningful change in our ability to produce. But until then, we've said before that Maxim didn't make investments in their capacity, so we put all those purchase orders out there. We're waiting for the tools to come in, get them online, get the facilities turned on. And then from the chips that we purchased from our foundry partners, all those commitments have been made, and we're really -- we're not seeing a whole lot of upside in their ability to supply us on a year-over-year basis, given everyone is seeing such strong demand. So outside of some modest improvements we might be able to make with just the engineering efforts on debottlenecking, I'm not sure we're going to see much change in the revenue trajectory for the first couple of quarters. And hopefully, by fourth quarter, you'll see that inflect up.

Question from an investor. Have you seen any changes in customer purchasing patterns in that there -- and what they were ordering earlier? Any cancellations, any pushouts, any rescheduling, anything of that sort of -- anything of that nature?

No, no, good question. I would say, again, cancellations, deferrals, again, no meaningful change there. The trend that we continue to see is, customers searching for sort of that golden screw, where they have most of what they need for a bill of materials. They're waiting on one item. It could be from us or it could be from somebody else, and that tends to be -- we're seeing a bit more of that in terms of the escalations where escalation calls and asks for assistant are really focused on, hey, these are the small number of parts that we need to be able to unlock a lot of our -- from a customer standpoint, a lot of our work in process.

So given your internal capacity expansion plans, given your foundry supplier commitments, I assume you have good visibility on this front, right? So what's the team's line of sight on driving sequential supply growth and therefore, sequential revenue growth over the next few quarters?

Yes. I'll state what I said earlier, Harlan, is our revenue growth for the next couple of quarters is fully constrained by supply. Supply isn't going to move meaningfully until the fourth quarter. You will see a little bit of revenue growth sequentially as we go from pricing actions. I think I mentioned in the fourth quarter earnings call that we had cost increases, which we pushed out through price increases, but the timing didn't quite match up. So we probably have more cost net headwind in '21, and we will have a net tailwind in '22. So that will be reflected in some revenue growth in '22, but the real pickup in revenue is going to come when more supply -- internal supply comes on board, and that's going to be in the fourth quarter.

So there's been also some growing concerns on elevated semi and customer balance sheet inventories potential stockpiling. So when you overlay this on actual like end market inventories and demand dynamics, it still implies chip supply environment, it's going to be pretty tight for an extended period of time. Your distribution inventories, right, channel inventories, which is a big part of your customer mix, is still below your 7- to 8-week target range. Is that still the case today? And when do you expect to get back to more normalized levels? And maybe just as important, your views on inventory levels with your direct customers?

Right. Right. So as a reminder for folks, about half of our revenue goes through distribution. The inventory levels that we have in our distribution partners are well below our desired levels, and that's being reflected in some of the extended lead times that disti has to provide their end customers. We do not see us being able to improve the inventory levels in distribution for the majority of this fiscal year. So I think that distribution is going to run lean for the majority of the year. In terms of inventory levels at end customers, we are watching through distribution. We get data feeds from our distribution. So we're able to see who are they shipping to, what are the inventory levels at various distribution warehouses? And we can see that it again, remains very light across the globe in all end markets. For the half of the customers that we sell direct, we continue to see some of the same metrics that we've talked about before, namely the automobile business that goes through consignment. We can see inventory levels that we have on consignment at our auto partners warehouses are not increasing. So auto inventory levels again remain stable or are actually down from where they were pre-COVID. So we're not seeing a buildup of our particular components at our auto customers. We're still seeing a lot of escalation calls, a lot of calls for folks to try to get access to more senior leaders to try to make their case to get some sort of special handling or special treatment to help meet their demands. Again, as I mentioned, no cancellations, no push out. So it continues to feel like inventory levels at end customers, end markets beyond distribution are not at the healthy levels that customers would want them at.

Perfect. Let's focus a little bit more on sort of the long-term profile for the team. So a number of your analog and microcontroller peers are structurally seeing a higher revenue growth rate, right, 1.5, 2x versus historical average. Just -- and that's being driven by the plethora of end applications and devices that are becoming smarter. They're becoming connected. They're becoming more power efficient, more secure, right? Given the team's favorable portfolio position in automotive, right, electrification, safety, communications, 5G, Industrial, IoT, EV infrastructure, I mean how should we think about the team's ability to drive above-industry growth going forward?

Yes. So we'll share more about our long-term outlook at our Investor Day, which we are now targeting for early April, and we'll probably finalize that date in the upcoming Q1 earnings call. But I will say that, again, the secular drivers that are -- that underpin our B2B growth remain very strong, and we see continued opportunity for us to outperform the markets, particularly given the variety of drivers that we have, both the increasing content as well as our customers becoming more reliant on ADI as a source of their innovation and really their engineering services, which is helping us from a share standpoint as well. So we -- I would say that when you look across the industry, I would expect ADI to continue to be a strong revenue growth over the next coming years and do quite well against our peer comparisons given both the design win portfolio that we have, the underlying innovation that we're continuing to deliver on and really the intimacy that we have with our customers.

Great. On the automotive side, given this is CES, there's always a big automotive focus. And in fiscal '21, excluding IP licensing revenues, there's Maxim revenue contribution, your auto business grew 30% year-over-year, right? And that's versus automotive production that was relatively flattish last year, maybe up slightly. As we move into this year, automotive production is targeted to grow about 9%, 10%. So first, what were the dynamics that drove the outperformance in 2021? And given the focus on safety, advanced driver assist, electrification, like how should we think about ADI's annualized content growth per vehicle going forward?

Yes. Much of the displays that we had planned for CES were actually in the auto space. So we're missing an opportunity to really highlight some of the auto technologies that we're excited about. As we think about the auto business on a go-forward basis, I am extremely optimistic about our ability to outperform versus the market. I guess I break it down into the 4 areas we're focused to pay attention to. Certainly, in electrification, in the EV space, the combined portfolio between ADI and Maxim and BMS puts us in an extraordinarily strong share position and really performance position to capture some of the -- really the strong increase in the number of full EV vehicles that are coming into the market over the next couple of years. We just did a -- just before the shutdown, we did a full auto review, and the design wins are incredibly encouraging. We're -- I only think what we can talk about here. I think we've had a couple more key wins for BMS in Europe, which has not been an area of strength for us. So we're strong. We're very encouraged by how well we're doing in Europe. On wireless BMS, I think we've named 2 customers. We've got a third unnamed large customer that adopted wireless BMS. And we're -- I'm pretty optimistic that in 2022, we will have our fourth wireless BMS design win. So that product is, again, continuing to gain great traction. We don't really have competition there. And the extent to which it really helps our customers redefine how they do their -- their platform designs is pretty incredible. So that's on the EV side. On the infotainment side, the A2B product continues to gain traction where we're still only about halfway through the design wins that we've done. Only about half of those are in production. And even before, some of those are going in for, I guess what I call, Gen 1, we now have customers adopting Gen 2, which includes additional features like noise canceling. We've got a couple customers. I know we've named one, and another customer tweeted about their use of the product. So several customers now introducing the noise cancellation technology. You mentioned with the ADAS becoming really -- much more common spread, that is an excellent setup for Maxim's GMSL product, which is really the standard solution there. And the fourth one, which is really -- I think it doesn't get as much attention as it should is the power portfolio of standard power products. As you move to more fully electric vehicles, every bit of electricity matters, because all of that translates into range. So the ROI on using more efficient power semiconductors, whether it be simple things like LED lighting or basic buck-and-boots capabilities in the vehicle. All of that matters because you can translate that into more range. And range anxiety continues to be one of the biggest concerns for EV consumers. So continue to see some excitement in our ability just to penetrate with the standard power product portfolio into the auto space.

One thing Prashanth said, you're right. On Auto for ADI historically has been kind of an apology tour. I've been here for 7 years, has always been everything is good, but now auto is our second biggest market. It's about 20% of sales, and it's our fastest-growing markets. Prashanth laid out all the growth drivers we have. A lot has changed for us over the past 2, 3 years. It's taken time, but those wins are all in front of us, and we think that's probably one of our fastest, if not the fastest, growing market for ADI going forward.

At our auto partner...

Perfect. On the industrial segment of the market, your industrial business performed pretty strongly. Again, excluding Maxim in fiscal '21, I mean your industrial business was up 29% year-over-year. What were the dynamics that drove the outperformance? And entering this year, if global GDP is set to grow 4%, that's obviously above trend line. How much will your industrial business grow, especially given that we're still in the early innings of factory automation, energy infrastructure investments. There's all these new wireless technologies that require more investments in test and measurement, but how do we -- how should we think about the industrial business this year?

Yes. Harlan, you name many of the key drivers there. So the industrial business was -- did very, very well in '21, very broad-based. Health care, in particular, I think we are booking our sixth consecutive year of health care growth on a full year basis. So we've been comping the strong year that we had, that was driven by COVID in 2020. So 2021 was able to grow on top of that, and we feel great about the industrial momentum that we have going in. The drivers are exactly what you said that there is more effort to evaluate supply chains and to bring manufacturing onshore. I think the semiconductor industry, in particular, the one that's been in the news a lot, but many industries are looking at that exact same challenge of how do we bring more manufacturing closer to where end demand is, so we can avoid some of the challenges that we saw from supply chain disruptions. All of that domestic manufacturing movement is great for the automation business because that is really how you overcome the economic barriers of the lower salary costs that you have in Asia, is by through more automation, continued deployment of technology. And more complicated technology requires more test. And our test and measurement business is doing extremely well because you have to add more testers to be able to get the same throughput. And that is a key piece, I think investors need to understand is that as you move up in the complexity of the products that are being made, whether it be for automotive, consumer, whatever, you have to test all of that. And it takes more time to test these more sophisticated products, which means you need more testers to avoid cutting your production cycle times down to half. So that's great for our business. And then, of course, the laboratory and instrumentation space is doing extremely well because all of these new areas require more sophisticated and precise measurement and that whether it be in health care or really across the board. So the -- our industrial space continues to be a great, long-term, highly profitable driver. And I think that what's encouraging about industrial is just the legs it has on it. It won't always be growing at this strength, but it's over a multiyear period. It's hard to see it not being a continuous tailwind for ADI.

Got a question from an investor. Can you talk about the magnitude of price increases that you see/expect for fiscal 2022, i.e., how many points of organic revenue growth for this year is going to come from pricing versus shipments?

Yes. Mike, do you want to...

Yes, sure, I'll grab that. So it's a good question. Now we won't say it how much. Well, we will...

That's why I gave it to Mike.

It's always good. What we will say is, we talked about in the last earnings call that we should be able to grow 10% across all of our markets. That's without any pricing. So pricing is on top of that 10% shipment growth, and we won't quantify how much it is. What we did say was, our goal is to offset the cost inflation with prices to -- goal to be gross margin neutral. That's kind of the outline we gave to investors, that's what we're going to stick to.

And maybe I'll just add to that and I'll repeat what we said in the fourth quarter that we had cost increases in '21, we had price increases in '21, but on a matching basis, cost increases were ahead of price increases. As we move to '22, you'll see that invert as pricing catches up.

On the communications and data center business, as you mentioned and as we talked about, right, you've got a bit of a -- not a bit, you've got a nice tailwind on the 5G infrastructure side, especially with the non-China guys starting to aggressively deploy their networking buildouts. There's an emerging opportunity, right? Lots of discussion and announcements around open RAN and virtual RAN deployments, greenfield service provider deployments and also private network deployments for industrial, transportation, data center applications. You guys have a pretty broad portfolio in O-RAN and V-RAN, partnerships with the big baseband and processor guys like Marvell, for example. What's your sense on deployments? And when does this emerging subsegment really start to contribute more meaningful revenues for the team?

Yes. Yes, let's do that in 2 pieces. First, just to talk about the communications business. As it is today, again, if you remove China, communications business was up around 30%. If you look at wireless specifically without China, it was up more than 30%. So strong growth in communications business. O-RAN is a very exciting place for us because it is an application that requires the full suite of our technology. So we think of it as really the fully loaded boat of what we can provide. So from a content standpoint, O-RAN is very content favorable to ADI. Today, O-RAN is less than 10, Mike?

Well, less.

Well less than it.

Below 5.

Below 5. Below 5 of our overall communications business as a percentage. So much opportunity to grow. We would expect in our models expect that to be a bit more meaningful contributor in the coming years, but we really don't see the kind of the volume growth of O-RAN till '24, '25. So lots of design activity going on, and you mentioned some of the partners, Marvell being one, Rakuten being another. There are others that we haven't named. So this is a place of growth for us, but I still think the volume is in front of us. So look for traditional sub-6 5G to support the business growth for '22 and '23 O-RAN to begin being accretive to growth '24, '25. And then as you mentioned beyond just the traditional wireless guys, then you also have the deployment of this into private networks, which is going to be a whole other thread of growth in the coming years.

In the data center end market, I don't know if a lot of people knew this or not, but provides Maxim provides a lot of the critical processor power management solutions. For example, NVIDIA's data center, GPUs, NVIDIA's auto, AI, GPUs. I mean Maxim is providing all the power management for that. Maxim was providing the power management for Google's flagship GPU processors for AI and deep learning. I'm sure that there are many opportunities for the core ADI team to capture more analog content in these very complex systems, right? What's the strategy to intercept these cross-selling synergies, especially because I think that the design cycle times are much shorter here. So there's probably a lot more near-term opportunities for you guys to intercept these cross-selling opportunities, but wanted to get your views.

Yes. No, it's a great question. So let's understand where ADI and Maxim today currently operate in the data centers, and that will help identify where the cross-selling opportunities are. As you mentioned, Maxim solves a very tough problem that is getting tougher, and that is these Tier 1 data center guys are jamming more and more on to -- into their confined space data center, and there's a fixed amount of power that's available to run each of these data centers. So with that, the ability to be efficient with your power management becomes more critical, and that is why Maxim is often the vendor of choice for a lot of these flagship brands that you named. ADI's technology really is in the hot swap area. So when you have a data center that's up and running and you want to -- and you need to be able to pull out or take down a particular server to change out a card for whatever reason, the ADI technology allowed you to do that with the shortest amount of time by being able to use our hot swap technology. And therefore, you're not taking the data center or the racks down for the same level of duration as if you would using a different technology. So we're really selling to different end market customers, although they're both data center applications. So there is quite a bit of cross-selling opportunities between those as we look to take more of Maxim's power management technologies to ADI's customers. And as you mentioned, the analog ADI -- traditional ADI to the Maxim customer. We're going to highlight a bit more about this whole cross-selling and revenue synergies that we see in the future in our Analyst Day. That's a key component of our Analyst Day. So we'll get more into it there, but I will say that, that's very much been the work that's been done to date is tagging at a salesperson level. What should you be able to do for customers that were not yours, how to model out what that is, and then how do we incent you to go get those wins and what do you need to make that happen? So there's a very granular level of work going on at the field to identify and charge those very obvious opportunities between the 2 customers.

Question from an investor. What has the team seen in terms of demand from China, especially from some of the local distributors?

So I guess a few things. The -- we have not yet seen the recovery in the communications business. I still believe that that's a possibility. In 2022, we don't have that model in, but we haven't seen that yet. So that does represent upside to our current outlook. On the industrial side, we saw some softening as we were entering into the tail end of the year as manufacturing was beginning to soften up given kind of the economic in the GDP situation there. I don't know that I have a whole lot more to say about the industrial. Automotive continues to be robust for us in China. So automotive hasn't yet seen that inflection. So that seems stable. Comms yet to bounce back, and industrial was softening -- still growing, but just not growing at the rate that it was before earlier in the year.

And I'll add to what Prashanth said. We talked about -- this is -- nothing's really changed over the past 3, 6 months in China. It got weaker kind of over the summer, we saw that. A weaker is still growing and book-to-bill is still well above 1. It just wasn't as strong as it was in the first half of the year. As we go into the new year, our thought is China grows again as a market -- as a geography, not a market.

So on your capital return program, the team is targeting 100% free cash flow return through dividend growth and sustained share repurchases. You've set up in place a $10 billion multiyear buyback program, $5 billion planned through calendar year '22. How should we think about the pacing beyond calendar year '22 for the remainder of the $5 billion of repurchase?

Really, I would tell investors it's a function of how you model out the cash flow generation for '23 and '24, right? We've committed that you'll get 100% of cash flow return -- sorry, of cash flow generated. So you make an adjustment for what we're going to spend on capital, and the rest is coming back to you. So we should burn through that remaining $5 billion, again, depending on your model, in 18 to 24 months, right? It depends on how you forecast that, but it's all coming back to shareholders. And we'll re-up the authorization with our Board to keep that level of reimbursement at a pretty fast clip once we get through the end of calendar '22.

Great. Well, gentlemen, we are out of time, unfortunately. Prashanth and Mike, I want to thank you for your insights today. We look forward to some strong financial performance from the Analog team this year. So thank you again for participating.

Thanks so much, Harlan. Thank you for having us.