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

All right. Let's go ahead and get started. Greetings and Happy New Year, and thank you for attending JPMorgan's 21st Annual CES, Semiconductor Tech and Automotive Conference. My name is Harlan Sur, semiconductor, semiconductor capital equipment analyst for the firm. Very pleased to have Prashanth Mahendra-Rajah, Chief Financial Officer of Analog Devices; and Mike Lucarelli, Head of Investor Relations, here with us today. For those of you that don't know the Analog Devices team, leadership position in mixed signal and RF analog semiconductor, a strong position in power management and strong position in signal chain processing, both analog and digital, which is the technology that bridges the physical world to the digital world and a key focus for the team, best-in-class gross operating and free cash flow margins and a very diversified business with industrial, automotive and communications infrastructure segments, representing around 85% of total revenues. So with that, gentlemen, thank you for joining us this morning.

Thank you, Harlan, great to be here.

So I'm going to start off with the first few questions, and we can open up for the audience. ADI's fiscal '22 revenues on a like-for-like basis up 26% year-over-year. Your core B2B markets of Auto, Industrial, Comm Infrastructure up 30%, better versus the industry data for the analog segment of the industry, which was up low 20% last year. As we look ahead into this year, the team is well positioned to weather the weaker global macro demand trends given the high exposure to auto, industrial, and comm infrastructure with very low exposure, 2% to 3% exposure to the weaker segments of the market, namely consumer PCs and smartphones. The market has the company growing revenues up low single digits this fiscal year and better than our industry forecast. So help us rank order your market segments in terms of demand sustainability this year in the face of a weaker macro environment.

Yes. Okay. Great. Thank you. Pleasure to be here, and thank you all for joining us, including those on the web. So we had a pretty spectacular 2022. Harlan took you through the numbers as we look forward to 2023. And as a reminder, our fiscal started on November 1. So we'll be finishing our first quarter here in a couple of weeks. As we look forward to 2023, we feel very good about the current guidance we have in there for the first quarter. And at this point, we still have considerable backlog that we are working through that give us confidence for the first half. When I think about the end markets that we're most excited about, order activity for our Industrial business continues to be the strongest of the -- of our end markets and particularly in Industrial, we're excited about our health care business, our aerospace and defense, given the current geopolitical environment, our energy business, which has been seeing some pretty strong growth, given what's going on with energy prices here and the technology we provide to help people manage that. And then as Harlan mentioned, our Automotive business that grew, I think, almost 30% last year on a relatively flat SAAR. And again, we -- much of that is content driven with our electric vehicle growth as well as our infotainment and GMSL products that we picked up from Maxim. So the auto -- in a flat SAAR environment for 2023, if SAAR remains flat, I'd expect Auto to be up double digits as well. And then perhaps the other one that we're a little optimistic on as well is our wireless comms. We are looking for 5G deployment to continue as planned in India. And if 5G does deploy as scheduled in India, then we feel optimistic that we could see some year-over-year growth for our wireless business. So for those of you here in person at CES, I encourage you to swing by our booth. We have a pretty big display of our automotive technologies out there. I think we actually have a -- we have a electric car there, which has a couple of hundred dollars of ADI content on it. So a good juncture to see why we do so well in auto.

So last earnings call, so in summary, then it sounds like you feel very confident on the growth prospects for Industrial, for Automotive and maybe a little bit in the wireless comp side of the business. Last earnings call, the team mentioned that bookings stabilized middle of the October quarter and into the January quarter. And in particular, order trends continue to remain strong in auto and industrial end markets. Have you seen order trends continue to remain relatively stable? And you did mention Asia China weakness last earnings. I mean have you seen any demand changes by geography?

Yes. Yes. Thanks, Harlan. I guess a couple of things that we can update on today that versus -- and maybe I'll start by just doing a quick recap of what we saw in 2022 to give context. So in the first half of 2022, we saw extraordinarily strong orders. As a result of those, very strong orders, we saw backlog build to levels that we really haven't seen in the company where our backlog exceeded our ability to ship by several quarters. So we were looking at backlog that went out more than 1 year. In the third quarter, we started seeing that order rate begin to decline at a meaningful rate. And in the fourth quarter, we saw that begin to stabilize. Now over that same period, the team has been working very aggressively with our customers to review what they have on order from us and where appropriate, clean some of that backlog out so that we can get a true signal of what is demand. What do they need in the current quarters versus what they're in line for because lead times were so high. That the order activity, particularly in Industrial has been relatively stable on a gross basis, but the cancellation activity, again, which was driven by ADI to as an effort for us to clean up that backlog has been progressing. And as a result, I would -- I'd expect our first quarter book-to-bill ratio to probably be below 1, and that's a good thing for us because we are trying to look at how do we bring that backlog inside of 52 weeks. Again, for those of you who have followed us, you know that typically, our backlog would only cover about 9 to 10 weeks. So we're well ahead of what we would normally be, and we need to bring that down to kind of get our demand and our supply aligned. So good progress from the sales team working with customers for cancellations. And I think that's probably the update for today.

Perfect. And -- so in terms of cancellations and pushouts and/or lead times, have they changed in a meaningful fashion?

Lead times are improving. Lead times are definitely improving, but they are very node-specific. So it's dependent on the manufacturing process. So we like lead times to be, in general, 6 to 8 weeks and on average, today, again, that's a very broad average because there's a wide distribution. But on average, we're still measuring them in months. So more work to do. I would expect that it will be another quarter or 2 at least before we start to get lead times back to where they need to be. One of the key steps to improving lead times is clearly getting the backlog down to more reasonable levels.

Got it. So is the way to interpret the book-to-bill less than 1 is that more a function of overall, new bookings being relatively stable, and that's been offset by sort of your team sort of flushing through the current book of business and just making sure that customers are going to take what they previously ordered.

Largely, yes. So let me say it a little bit differently, that we think of orders on a gross basis and then we offset that with cancellations that happened in the quarter. So orders on a gross basis in Industrial continue to be the strong point and our other markets not quite as strong. And then cancellations are spread across all markets -- all end markets. On top of that, I think what we're also just beginning to see a bit more of now and we'll be mindful of this over the coming weeks and share more in the earnings call is as China has reopened and relaxed some of its COVID restrictions, we are certainly seeing a higher level of disruption in China that is being driven by employment limitations where what our teams are telling us is that there's a great deal of disruption going on now as COVID is spreading the fear of COVID given the relaxation. So it will probably be a choppy couple of weeks until everyone gets on the other side of the Chinese New Year to see where that settles out. But the same group feels very optimistic about the recovery after that. The business is well poised for growth. We just need folks back to work across China to start driving that.

Sounds like Automotive is incrementally weaker relative to, I think, your prior views. What are the dynamics shaping the more recent view?

Yes, Harlan, I would say that investors need to be watching the production numbers. What is SAAR going to do? I feel very confident that we will outperform SAAR at a meaningful rate. There's no risk to the secular drivers that are behind our growth there. And as I mentioned, you can get a good flavor of that, if you swing by the booth today at CES. What is unknown to us is how is that production going to roll out. Clearly, the growth in electric vehicles is not as strong as it is, but it is still clearly growing better than IC.

Right. Okay. And that goes back to your prior view, which is if SAAR is flattish this year, team is going to grow their automotive franchise.

Correct.

So many semiconductor companies are struggling with excess inventory work down, especially in consumer-focused markets. Obviously, you guys have low exposure there. In core Auto and Industrial, the inventory dynamics appear to be different. And for ADI, we think that high-performance analog is one of the golden screw component. So customers probably have not been able to accumulate much in the way of excess inventories of your products. Do you agree with that? Do you hear that from your customers that high-performance analog, power management, I mean these are the products that are tougher to get.

Yes. I don't know that I can comment specifically to the golden screw, but I would add maybe some additional context, that for our Automotive business -- and we've talked about this in prior quarters. For our Automotive business, when we look at the growth we saw in 2022, where we grew 30% or so above the market car production. We've been able to do a very detailed and thorough analysis to identify roughly 25% of that growth to come from a couple of core items, namely the growth in electric vehicles and our BMS products sales as a result of that, given our very high share there. The growth in our A2B franchise, which were design wins that we had won in prior years and just given the cycle time of those going from design win into production. So we can see that clear growth. The growth in GMSL, which is Maxim's Datalink product that helps connect cameras, radars, LiDARs, et cetera, within the vehicle. And then, of course, some pricing action that we took. So we're able to explain the overwhelming majority of our outperformance as not being inventory related. There's a little bit in there, as I mentioned, call it, 5%, 6% that could be inventory. But as we also know, and I'm sure investors view, there's been a growth in more premium models on a comparable basis, kind of pre-COVID. So that could also account for some of that unexplained growth. But worst case, it is a little bit of inventory building, but we know that it's relatively modest. So we feel good about our auto inventory. And then that's validated by our ability to look through to those customers where we have inventory on consignment and we can see that consignment inventories are not elevated.

Distribution or channel inventories, which is a big part of your customer mix, it's been below your 7- to 8-week target range over 2 years now. Do you expect to keep channel inventories at low levels in this period of uncertainty, just kind of keep things tight there?

In channel inventory, let's talk about the benefit that our distribution partner provides us, it is coverage. So what is important for us is to build channel inventory with high dispersion of SKUs versus high quantity of fewer SKUs. So that is the -- when we are not growing channel inventory, it is because of our desire to make sure that we have breadth of coverage versus a -- having a distributor have 100 units of 1 part versus 1 unit of 100 parts. So that's the value they provide to us. So we do -- we will get channel inventories back to a healthy level. It's going to take us probably a couple more quarters because that is dependent on our production plans and building through the variety of products that we have. As a reminder, for investors, we have about 75,000 different SKUs. So it takes a lot of production plan to be able to run through all of those SKUs.

Let's talk about the design win pipeline. First, before I go on to design win pipeline, revenue synergies and end markets, anybody have any questions? So on revenue synergies, the team noted that design win pipeline is beginning to benefit from cross-selling of the Maxim portfolio on track to achieve targeted $1 billion in revenue synergies over the next few years. In particular, the team had highlighted 3 areas of revenue synergies: Automotive GSML, Industrial Process Control and then just broader sort of power management and power market synergies, right? What has the team seen -- where is the team seeing the most traction? And could you provide some color on how the team is leveraging its customer relationships and your anchor product positions with your core high-performance analog products to pull through the breadth of the portfolio.

Sure. Sure. So maybe some definitions for us to help people understand some of the terminology that we use. So at ADI, when we manage the opportunities that we have for us to grow the revenue we use a relatively rigorous data-driven model that captures the sales as it goes from an opportunity, which is where sales was identified, hey, here is an opportunity for us to bid on a specific product for a customer's need. If we win that selection, it goes from an opportunity to a design-in. Not all opportunities go to design-in. A customer may choose not to use us at that point or the project may not go forward. From design-in, the next phase is design win. Design win is where the product has begun to ship to that customer. And again, what's the transition from design-in to design win is we may be working with 1 assembler or 1 person in the supply chain, but a customer's end solution may use a different outcome. So it may not be the partner that we've been working with that may not be that their choice goes forward. But otherwise, a design-in will become a design win and then it will start ramping to peak revenue. So we track each of those individual phases. It's a process that ADI has used for years. I will say that as we've acquired companies over time, it is a process that seems to be unique to us, certainly with the rigor that we have on it because neither Maxim nor Hittite or Linear had this level of focus and granularity in tracking the projects as they move through these various stages. When we look at our design-in activity for 2022, so that means opportunities that we won and we have gone to a design-in. In 2022, the dollar value of that is up over 10% -- over 10% thanks, Mike, over 10% versus 2021. So that's a great indicator for us that our plans to kind of grow this business at a 7% to 10% model is on track because we're 1 year in, and we're seeing that strong 10% on a design-in leading indicator. I would also say that when we gave you our cost synergy numbers, we probably had a little bit of hedge in there. But as we've talked about, we've greatly exceeded the cost synergies that we expected from Maxim. What we learned in that process is that scale matters, and we found that we were able to really extract a lot more value from the Maxim deal than we had originally intended. We feel a similar level of optimism now on the revenue synergies. So having learned what we did from Linear and using that same kind of tools that we have and knowing how to make this success, we -- I would say that the internal view on our ability to deliver revenue synergies with Maxim are probably higher than they were when we did Investor Day, which was in April, so that is 9 months ago.

Perfect. Let's move on to the Automotive segment. Given that this is CES, Automotive is obviously always a big focus. In fiscal '22, this is including Maxim. So like-for-like, your Auto business grew like 31% year-over-year relative to auto production, right, of high single digits type of growth. And the team has talked about the growth areas within auto of BMS, GMSL, A2B, functional safety. This represents over $1 billion of your automotive revenue or 40% of your sales. Can you talk about how much this segment grew in fiscal '22 and whether the team can sustain its 20%-plus targeted growth CAGR should auto SAARs remain flattish or even decline?

Yes. So I think that comes back to the -- what is the assumptions that you have on automotive production, right? But what can I say with respect to those key growth drivers. On the A2B platform, it is essentially the standard now. Almost every OE is using A2B, but it is only about halfway through its deployment. So again, thinking of those different phases, over -- pretty much everyone has designed it in, but we haven't hit design win for all of them, I think only half of them -- yes, about half of them are actually shipping. So there's still significant growth as they move from design-in to design win and begin shipping. So we feel great about A2B. The value on that is so compelling in terms of the economic value that we're delivering to our customers on that. On GMSL, GMSL, we have really taken advantage of what Harlan referred to as the cross-selling benefit. Where did Maxim have particular strengths with a customer, where did ADI have strength with the customer and be able to use strength that we have with those customers to bring GMSL in. So the design-in on GMSL is giving us great, great optimism for -- one of the reasons why we feel even better about the revenue synergies coming from Maxim. And then for BMS, I think people know that we are the market share leader by quite a bit. I think we have been public, if not, I will be public now that in 2022, we won 8 -- we won 8. We lost 1. Of the 1 we lost the sales team is telling us that, that customer is coming back around too. So it may not be a loss for us right now, but -- and of those 8 that we won, 2 were wireless BMS. Again, wireless BMS is where it's a place that we really don't have competition on. So it's a tremendous franchise for us. For customers who are in the room, we do have a display at CES for our next-gen BMS. It's not accessible to the general public, but on an invite-only basis, you can go into the back room and you can see some pretty amazing things that we're working on for next-gen BMS.

I think you guys have talked about a BMS pipeline of around $4 billion. How big is the BMS business today? And how should we think about the growth into that $4 billion opportunity over the next few years?