Analog Devices : Citi Transcript

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ADI.OQ - Analog Devices Inc at Citi Global Technology Conference

EVENT DATE/TIME: SEPTEMBER 08, 2022 / 3:15PM GMT

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SEPTEMBER 08, 2022 / 3:15PM, ADI.OQ - Analog Devices Inc at Citi Global Technology Conference

C O R P O R A T E P A R T I C I P A N T S

Michael C. Lucarelli Analog Devices, Inc. - VP, IR and FP&A

Prashanth Mahendra-Rajah Analog Devices, Inc. - Executive VP of Finance & CFO

C O N F E R E N C E C A L L P A R T I C I P A N T S

Christopher Brett Danely Citigroup Inc., Research Division - MD & Analyst

P R E S E N T A T I O N

Christopher Brett Danely - Citigroup Inc., Research Division - MD & Analyst

Thanks. Good morning. I'm still Chris Danely, still here at Citi for the time being, kidding, not kidding. I'm still in Citi. Friendly neighborhood semiconductor analyst. It's our pleasure next to have our top pick. Thanks for coming, guys. I'd feel pretty bad if my top pick didn't show up at my tech conference - Analog Devices. Why is it our top pick? As you know, we're slightly cautious on the semiconductor industry this year. We call ADI, the igloo in the semiconductor nuclear winter that we're going through. One of the most defensive stocks out there, but you also have some nice margin expansion, some nice growth opportunities. And I believe there's still some opportunities from the Maxim acquisition as well.

So here today to talk about it is Prashanth Mahendra-Rajah, the CFO. We also have Mike Lucarelli, the Grand Poobah of Investor Relations at ADI. And since you guys were, I believe, one of the most recent semiconductor companies to announce earnings a few weeks ago. Prashanth, if you could just maybe give a brief recap and then we'll dig in from there as far as [global set].

Prashanth Mahendra-Rajah - Analog Devices, Inc. - Executive VP of Finance & CFO

So we had our earnings call, I think, 2 weeks ago now, and we had a lot of internal debate on what should the message of that call be. There was certainly a house view. We could say, record results for the third quarter with a record outlook for the fourth quarter, and record backlog for the company and sort of call it quits there.

Christopher Brett Danely - Citigroup Inc., Research Division - MD & Analyst

Well, I just call you a microchip.

Prashanth Mahendra-Rajah - Analog Devices, Inc. - Executive VP of Finance & CFO

But we decided to go a bit further and share what we believe is maybe the beginning of an inflection that we think will probably be a little more broad-based than ADI. And notably, we called out a couple of highlights. First, while our backlog did grow overall as it has for the last several quarters, we did see the growth in that backlog, the rate of growth start to slow down a bit. Our industrial and our automotive businesses still had a backlog above 1. If you had asked me in the first or second quarter, I would have said, well above 1. So a noteworthy call out there. Our consumer business was just at parity. And again, prior quarters would have been expanding. And our communications business was just a hair below parity kind of in the high 0.9. So order activity did show a change.

The other change that we called out that I think got quite a bit of attention on our earnings call was we look at a metric during this particular supply-demand environment that we refer to as cancellations. Cancellations is the total orders canceled in the numerator and the denominator is our total backlog. For the last several quarters, cancellation was very steady at sub 5%, and we would have described it as mid-single digits, but sub 5%. And in the third quarter, we saw that move to above 5%, but still, we would define in mid-single digits. So 2 kind of noteworthy items that we just wanted to, in the spirit of transparency, share with our investors that we were beginning to see some changes in the macro environment that they were reflecting on us. But again, from a business standpoint, we have in excess of 12 months' worth of bookings. We're sitting on record

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SEPTEMBER 08, 2022 / 3:15PM, ADI.OQ - Analog Devices Inc at Citi Global Technology Conference

backlog that we haven't put an exact number out there, but I can tell you that it is well north of $12.5 billion. And with kind of current production capacity limits, we expect to continue to print some very strong results for the foreseeable future.

Q U E S T I O N S A N D A N S W E R S

Christopher Brett Danely - Citigroup Inc., Research Division - MD & Analyst

So when did you notice, I guess, this change in the rate? Was it like midway through the quarter at the beginning of the quarter? Was it the last week of the quarter?

Prashanth Mahendra-Rajah - Analog Devices, Inc. - Executive VP of Finance & CFO

Yes, I would say that it was towards the tail end of the quarter, maybe the last month of the quarter when we started seeing things move around. And that could be perhaps why some of our peers who report on a different cycle than us hadn't seen some of the changes.

Christopher Brett Danely - Citigroup Inc., Research Division - MD & Analyst

I know customers give a laundry list of excuses. What were, I guess, the top 2 or 3 excuses as to why there were a slight increase in cancellation? Was it inventory? Was it demand?

Prashanth Mahendra-Rajah - Analog Devices, Inc. - Executive VP of Finance & CFO

I think what's most important, Chris, is that the cancellation of orders that happened, none of those were for deliveries in the fourth quarter and very little for deliveries in the first quarter. So these are, given that the industry and ADI has such extended lead times, these are folks adjusting their production planning requirements for products that they expect to be shipping in the, sort of in the second half of calendar 2023.

Christopher Brett Danely - Citigroup Inc., Research Division - MD & Analyst

That's interesting. And was there any rhyme or reason in terms of geo or end market or was it…

Prashanth Mahendra-Rajah - Analog Devices, Inc. - Executive VP of Finance & CFO

We would have called that out, again in the spread of transparency, we would have called that out. So it was very broad based from both a market and a geographic standpoint.

Christopher Brett Danely - Citigroup Inc., Research Division - MD & Analyst

Okay. And so you talked about backlog that still looks great. Maybe run through the, I guess your main end markets in terms of industrial, comm, auto, et cetera, which you feel most confident about? And I guess, what you're a little more worried about?

Prashanth Mahendra-Rajah - Analog Devices, Inc. - Executive VP of Finance & CFO

Yes. So I feel great about all of those end markets over a medium-term position kind of over the near term, what's on our mind. We feel that defense and health care are going to continue to be strong growth markets for the foreseeable future. I'll go out on a limb here and say that I would personally be surprised if our defense market isn't able to show year-over-year growth for the next sort of 5 to 7 years really given just the backlog

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SEPTEMBER 08, 2022 / 3:15PM, ADI.OQ - Analog Devices Inc at Citi Global Technology Conference

of design wins that, that that team has been able to accomplish. And as those continue to kind of move through the procurement process with various DoD and prime contractors.

Health care, again, also, we are on our, I think this will mark our seventh, Mike?

Michael C. Lucarelli - Analog Devices, Inc. - VP, IR and FP&A

Yes.

Prashanth Mahendra-Rajah - Analog Devices, Inc. - Executive VP of Finance & CFO

Our seventh year of double-digit growth for health care, and there's no sign of that abating, the design win activity, and the complexity of problems that we are solving with our health care customers suggests that that has tremendous tailwind. For the rest of the industrial, probably 2 areas that we're just observing right now, the automation business, the underlying trend on that still remains very strong as more companies are moving manufacturing to be closer to the customers or to get the geographic dispersion of their manufacturing base, they require more automation to help solve the labor arbitrage challenge. If you move production out of Asia and you're going to put it into the U.S. or Europe, you want a solution that has fewer employees working at the factory line and you solve that through more automation, and we have a suite of technologies that kind of hits what's required there from safety to motion sensing, communication, power management, et cetera.

The instrumentation test business, that's probably one that I think we'll continue to watch. The trends on that, again, continue to stay strong. And as long as we see continued activity in the deployment of more complicated devices that need to be tested and measured. That's going to play to our strength. But certainly, some of that is going to follow some of the capacity requirements that we see in markets like automotive and so forth.

Our automotive trends that's probably the hardest one for me to read. I feel very strong about the secular trends that we are enjoying in automotive. For the last couple of quarters, Mike, we've been doing 30% growth. And I think if you're watching SAAR data, that's more flattish. We can isolate all of that growth to a few key secular drivers. We can isolate it to the technologies that we sell into electric vehicles, which are unique to EVs, the BMS technology. We can isolate it into the design wins that are ramping in our A to B portfolio, which helps improve the audio and infotainment experience in the car. We've got 18 OEs who have chosen ADI as their solution for that technology, 18 out of the top 20 OEs, and only about half of them are in production. So that's going to continue to grow despite what SAAR does. And what am I missing?

The third one, Chris, I think you've referenced in some of your research is Maxim GMSL, the Serial Link technology, which sort of helps with the architecture of how you move data around in a car. What's the unknown on that is, and this is more probably a Prashanth view than an ADI view. I'm a little concerned about, I know there's a view that SAAR is at the bottom. I don't know that SAAR is at the bottom. I think that kind of with some of the macro headwinds that are out there, I would be mindful of auto sales for 2023.

Christopher Brett Danely - Citigroup Inc., Research Division - MD & Analyst

Meaning people buy less cars in a recession? I want to touch on a few things. I guess, first, start with China because you guys have a pretty large defense business. We just had a couple of companies in semis last week at certain parts of their product portfolio banned from selling into certain entities in China. Is there any exposure there for ADI? Is that a risk? I just had a couple of people ask me that in the hall.

Prashanth Mahendra-Rajah - Analog Devices, Inc. - Executive VP of Finance & CFO

So let's talk about our China business. We do about 20% of our business in China that's on a design-in basis. We are a bit more unique. I think than some of our peers in that we have a really top-class engineering team in China that helps do kind of a unique IP development and application development for our Chinese customers. And as a result, I think that's an important market for us that we're going to continue to be in for years

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SEPTEMBER 08, 2022 / 3:15PM, ADI.OQ - Analog Devices Inc at Citi Global Technology Conference

and years to come. There are certain restrictions on what we can sell into that market and that already applies to some of our defense products. So much of that has already been constrained.

Probably I think the one caveat, I think that investors may be aware of but should be aware of is historically, when the U.S. government has made certain restrictions on what companies can do. There's been a level of kind of advanced warning that maybe you'd be given. So you've time to prepare and also maybe share a countervailing view. Our sense from what we've heard is that the last announcement it sort of caught a lot of people by surprise.

Christopher Brett Danely - Citigroup Inc., Research Division - MD & Analyst

Yes, definitely. Speaking of China, one of your peers also sells to China mentioned that they were impacted earlier in the year by the China shutdowns and said earlier this week that they could be impacted by the additional China shutdowns. You guys didn't appear to be impacted by the shutdowns earlier this year. Is there any risk with seemingly millions of people in cities taken offline essentially? Is that a risk?

Prashanth Mahendra-Rajah - Analog Devices, Inc. - Executive VP of Finance & CFO

When we talk about that record backlog that includes a record backlog in China. I think we did call out maybe on the earnings call, Mike, we did call out that if you look at the specific segment of China consumer that was particularly soft. But as a percentage that's low single digits maybe revenue. But beyond that, the engagement and the demand activity remains very strong.

Christopher Brett Danely - Citigroup Inc., Research Division - MD & Analyst

You guys have had a super strong China franchise for quite some time. Not just in comm but elsewhere. Can you just talk about what have the keys been for ADI to be so successful there?

Prashanth Mahendra-Rajah - Analog Devices, Inc. - Executive VP of Finance & CFO

I think really what has been different for ADI in China is Vincent's commitment to partner with our customers regardless of their geographic location and putting technical resources in China that can help our Chinese customers with the same type of design activity that we would do with them in other geographies. And I think we had a press release a couple of years ago about establishing a regional headquarters where we're continuing to make investments in the China kind of team on the ground and we remain committed to that. Again, it's an important market for us that allows us to serve those customers in a very, very strong manner. And frankly when the Maxim deal was announced, I recall it Vince was contacted by some very large Chinese customers sharing their appreciation of bring the ADI service model to the Maxim portfolio is a win for us.

Christopher Brett Danely - Citigroup Inc., Research Division - MD & Analyst

We had dinner with the Intel CEO last night and said he doesn't think thankfully that Taiwan is going to get invaded by China in the next 5 years. I know certainly you guys use some foundry folks in Taiwan. What's your take on the perceived threat? And have you done some sort of mitigation strategy with other foundry customers, just in case?

Prashanth Mahendra-Rajah - Analog Devices, Inc. - Executive VP of Finance & CFO

Maybe some type of military outcome in Taiwan I think is a low risk but I do believe that unification is going to remain a priority and hopefully, that will find a way through more diplomatic channels. But having said that it's less about the risk of what would happen from a unification standpoint and more just good business diversification. This is an island that is also subject to a variety of natural disasters. We saw what COVID can do from

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