Analog Devices : J.P. Morgan Conference Transcript

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EDITED TRANSCRIPT

ADI.OQ - Analog Devices Inc at JPMorgan U.S. All Stars Conference

EVENT DATE/TIME: SEPTEMBER 18, 2023 / 9:00AM GMT

OVERVIEW:

Company Summary

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SEPTEMBER 18, 2023 / 9:00AM, ADI.OQ - Analog Devices Inc at JPMorgan U.S. All Stars Conference

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

Vincent T. Roche Analog Devices, Inc. - CEO & Chair of the Board of Directors

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

Harlan L. Sur JPMorgan Chase & Co, Research Division - Executive Director and Head of U.S. Semiconductor & Semiconductor Capital Equipment

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

Harlan L. Sur - JPMorgan Chase & Co, Research Division - Executive Director and Head of U.S. Semiconductor & Semiconductor Capital Equipment

All right. Good morning, and again, welcome to JPMorgan's 14th Annual U.S. All Stars Conference here in London. My name is Harlan Sur, the semiconductor and semiconductor capital equipment analyst for the firm. Very pleased to have Vincent Roche, Chairman and Chief Executive Officer of Analog Devices here with us this morning.

For those of you that don't know the Analog Devices team, a leader in high-performance, mixed signal, RF analog semiconductor chips, strong position in power management, very strong position in signal chain processing, right, both analog and digital, which is the technology that bridges the real (sic) [digital] world to the physical world, best-in-class gross operating free cash flow margins, strong capital return program, very diversified business, right, Industrial, Automotive, comms infrastructure, 90% of total revenue. So Vince, thank you for joining us today.

Vincent T. Roche - Analog Devices, Inc. - CEO & Chair of the Board of Directors

Thank you, Harlan. Great to be here. Same time, same place, different year.

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

Harlan L. Sur - JPMorgan Chase & Co, Research Division - Executive Director and Head of U.S. Semiconductor & Semiconductor Capital Equipment

Exactly. So to that point, about a year ago, at this very conference, the team was driving 25% year-over-year growth in the business, positive book-to-bill trends, but you did call out order deceleration, some pickup in cancellations, which in hindsight did signal sort of the start of the negative cyclical inflection for the ADI team, but for the industry as a whole.

So kind of take us through the dynamics over the past year and more importantly, your view on the cyclical dynamics in your business sort of going forward?

Vincent T. Roche - Analog Devices, Inc. - CEO & Chair of the Board of Directors

Yes. Thank you. So -- yes, we had our earnings call, third quarter earnings call just a few weeks ago. Actually, in the third quarter of '22 or fiscal '22, we did call what we thought was the peak at that point in time. And we got through the pandemic. We had a supply chain crash in FY '20, FY '21, basically, what happened across the industry as we tried to squeeze 15 or 16 months' worth of shipments into 12 months. So we're in catch-up mode.

And the shortage itself drove some panic. And we've been trying to get, so we were chasing supply for 2.5 years. I think for the next year or so, we'll be chasing demand. I mean, as we called out on the earnings call, we have a belief that what we have right now is an inventory overhang that will take -- at least, in ADI, will take us somewhere in the region of 6 months to correct. But we are seeing some stabilization. We suffered a lot of cancellations for the last 6 or 9 months. We've begun to see that moderate somewhat. So what we're getting now is our backlog into a shape that we would consider in pre-pandemic terms to be more normal.

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SEPTEMBER 18, 2023 / 9:00AM, ADI.OQ - Analog Devices Inc at JPMorgan U.S. All Stars Conference

So that's where we are. I think '24 will be a year of flushing inventories across the industry. And I believe we'll get back into a more normalized growth pattern in FY '25.

Harlan L. Sur - JPMorgan Chase & Co, Research Division - Executive Director and Head of U.S. Semiconductor & Semiconductor Capital Equipment

Perfect. Looking at ours and consensus revenue profile, we are modeling, as you mentioned, right, continued softness in the business for the next 2 quarters. Peak-to-trough revenue decline of around 18%. About the same magnitude of the decline as the last cyclical downturn, 2018, 2019, yet the team is driving low 40% operating margins to the trough, right, of this cyclical downturn versus the prior 2 cyclical trough op margin levels of 37% and 28%.

So help us understand the strategic, the structural changes that are driving the continued improvements in through-cycle profitability and earnings power.

Vincent T. Roche - Analog Devices, Inc. - CEO & Chair of the Board of Directors

Yes. Well, look, we have a tremendously diversified portfolio, as you pointed out in your opening remarks. We cover all the critical market sectors in advanced communications, immersive consumer, Industrial has many, many different parts of it, including digital health care, factory automation, Industry 4.0, advanced instrumentation for scientific research, automatic test equipment, and so on and so forth.

5G systems, now we're starting to get into the early stages of building 6G systems. So we're present in all the critical applications that drive modern socioeconomic life and we happen to have more than 100,000 customers in our portfolio. We've got 75,000 product SKUs with life cycles, for example, in the Industrial that are 17 years plus. So the stickiness of the franchise is really, really, really strong.

So for us, getting our products -- getting our new products designed into a customer that's where we face the price elasticity, if you like. But once we get our products designed then pricing is very, very stable and the substitution costs in our business are very, very high. So the business model has settled in such a way that we're able to capture the innovation upsides. Then we have, once we get our products established, the stickiness, the stability is very, very strong. We've also been able to steadily increase our average selling prices. So that helps, obviously, top line growth. And I think as well our additional scale on the manufacturing side has helped us to get our cost structures into a place that they haven't been.

All that said, what we're seeing now are higher highs and higher lows as well.

Harlan L. Sur - JPMorgan Chase & Co, Research Division - Executive Director and Head of U.S. Semiconductor & Semiconductor Capital Equipment

If I look back -- if we look back at the team over the past 20 years, you've grown your revenues at about a 9% CAGR, 30% faster than the overall semiconductor industry. You've grown your earnings and your free cash flow at about 11% to 13% CAGR over that period of time. Some of the growth has been organic, but most of it -- well, some of it has been inorganic, but majority has been organic, right?

On a go-forward basis at the last Analyst Day, you put out a target, revenue growth rate of 7% to 10% per year, earnings about 10% to 12% and $15 per share of earnings power in fiscal '27. Peak of this current cycle, right, the most recent earnings cycle you're already driving $11 of annualized earnings power. So what's the confidence level in the team attaining your forward earnings power target of $15 in '27?

Vincent T. Roche - Analog Devices, Inc. - CEO & Chair of the Board of Directors

Yes. So what gives us great optimism. We are very much an innovation-driven company, and we're spending $1.7 billion plus in R&D every year. That's always the first call on the company's capital. So our product portfolio is stronger than ever. We're investing more to get ahead of customers' needs in all these critical application areas that I mentioned.

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SEPTEMBER 18, 2023 / 9:00AM, ADI.OQ - Analog Devices Inc at JPMorgan U.S. All Stars Conference

We have also so many concurrent secular tailwinds to push us ahead. It's unprecedented, the number of secular tailwinds across the Industrial, advanced communications, immersive consumer, Automotive as well, of course, these tailwinds, we've never had such a richness of concurrent secular tailwinds in our history. And I've been in the business over 40 years now. And typically, each cycle in each decade was driven by one particular technology modality.

The early 2000s, it was Internet. 2010 plus, it was smart phone and cloud. Now we're seeing the electrification of the automobile. We're seeing more and more technology used in automobiles. In fact, cars and transportation systems are using 10% more silicon every year with more and more software. So all these things are conspiring the digitalization of society, digitalization of the economy. So we're very well positioned, as I said, from a customer perspective, from a market-dynamic perspective with a better portfolio than ever. And through some acquisitions we've done as well, we've built a very strong power management portfolio. But we are still underrepresented there. We see that as an enormous opportunity for ADI to continue to gather share, to do more attachment between our mixed-signal portfolio and our power portfolio.

So we put all those things together, we feel confident that 7% to 10%, when we get back beyond this current inventory in digestion cycle, that we'll get back into a more normalized pattern. And I suppose the big question is the rate of recovery of the China economy. So that will have some effect on the upper end of that growth expectation.

Harlan L. Sur - JPMorgan Chase & Co, Research Division - Executive Director and Head of U.S. Semiconductor & Semiconductor Capital Equipment

A big part of the above-industry revenue growth profile has been obviously -- it's powered by your design win pipeline, right? Last year, fiscal '22, you grew your design win pipeline by over 10%. How is 2023 tracking so far relative to that number? And what areas of the portfolio or end market exposure is the team really seeing sort of the strongest expansion in sort of the $4 (sic) [$4 billion] pipeline?

Vincent T. Roche - Analog Devices, Inc. - CEO & Chair of the Board of Directors

Well, we continue to grow the size of that opportunity pipeline. Some of it we get from, as I said, the market trends where I mentioned earlier in the conversation here that we're getting more ASP for product now than we've ever. Every year, we increase the ASPs of our products. And that's driven by the innovation strength of the products we're developing. We're building more complete solutions for our customers. We're adding software to hardware. So all these things increase the content value of ADI's products for our customer.

So I talked about the need to be able to connect our power management portfolio more directly with the strength of our mixed signal, where we have tremendous share. So as I said, the opportunity pipeline. This year, again, in '23, it will grow about another 10% or 12%. So all that gives us tremendous confidence in the potential growth of the company in the years ahead. Paying, we focus our business development efforts on making sure that pipeline is not only growing in absolute terms, but that the conversion rates are also increasing.

Harlan L. Sur - JPMorgan Chase & Co, Research Division - Executive Director and Head of U.S. Semiconductor & Semiconductor Capital Equipment

You talked about continuing to build out the power management portfolio. You've done a phenomenal job on the organic growth side. Part of that power management portfolio unlock revolves around unlocking synergies with some of the acquisitions that you've done, right, Hittite, Linear Tech. Now you're in the midst of unlocking about $1 billion per year of revenue synergies by fiscal '27 via the Maxim acquisition, right, that you completed in 2021. And we can already see some of this unfolding right with Maxim GMSL attached to your A2B connectivity solutions. We also see it within your battery management portfolio also with your focus on factory automation. Where are you in that journey to $1 billion with the Maxim team and your confidence level on getting there by fiscal '27?

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SEPTEMBER 18, 2023 / 9:00AM, ADI.OQ - Analog Devices Inc at JPMorgan U.S. All Stars Conference

Vincent T. Roche - Analog Devices, Inc. - CEO & Chair of the Board of Directors

Yes. Well, the pipeline -- the opportunity pipeline that we have would suggest that we're well on track. I think you've pointed out the critical components of that journey in terms of the revenue synergies with Maxim. My sense is we'll probably get to the target we had a little earlier than we had expected. Of course, what happens in the economy will have some effect on that.

Harlan L. Sur - JPMorgan Chase & Co, Research Division - Executive Director and Head of U.S. Semiconductor & Semiconductor Capital Equipment

Yes. U.S. and European Chips Act bills were both past last year. Key focus right is to motivate more manufacturing in the U.S. and EU, to drive more focus on manufacturing leadership as well as for business continuity planning, in terms of supply chain diversification, geopolitical risk mitigation. You have fabs, both in U.S. and Europe. What's the status of grant disbursements, timing of incentive tax credits? And more importantly, has the team seen an acceleration in customer engagements that are looking to source more of their semiconductor value, right, from the Analog team going forward?

Vincent T. Roche - Analog Devices, Inc. - CEO & Chair of the Board of Directors

Yes. It's a very straightforward question with a very complex answer, but I'll do my best to answer it for you. So right now, we make about 50%. We fabricate about 50% of our silicon inside ADI, and we have 3 fabs in the U.S., we've 1 here in Europe, in Ireland. And then we procure another 50% of our silicon outside with partners like TSMC for example.

And that hybrid model -- that hybrid manufacturing model has been a mainstay within the company now for many, many years. In times of very, very strong demand, we are able to use flexible supply from partners, for example, we're able to get more capacity from partners. When the market is in a lull, like it is now, we can bring more of our manufacturing needs inside, which helps us manage utilization, protect our gross margins.

So over the last -- of course, one of the big questions in our customers' minds over the last 3 years has not just been kind of the tactics of supply, it's been around how do we ensure resiliency in our manufacturing operation and to be able to create some surety of supply beyond Taiwan. And so we've been on an investment track. We've massively, in our terms, increased CapEx, we have typically run our CapEx model of between 4% and 6% of revenue. In FY '22, that would have been about 12%. That's the peak of our investment cycle, for capital equipment from manufacturing. In FY '24, we'll invest about $1 billion.

So to cut a long story short, when an advanced digital node is considered for CapEx. You're looking at $15 billion. You're building 300-millimeter wafers, you need about $15 billion of spend. The most popular node inside ADI today. So advanced digital is 3 nanometers today. The most popular node inside ADI today in terms of new product development is 180 nanometers. That was digital leading edge 28, 30 years ago. So the equipment we buy, the -- obviously, there's been a tremendous amount of amortization. We're using 200-millimeter wafers. So we've been able to just about double the output of our internal factories for $1.5 billion, $1.6 billion.

So we're well down the track. We're actually -- we've licensed technologies from our critical partner. And by the end of '24, early '25, we'll be producing volume of these products in our factories in Ireland and the U.S. So the more advanced nodes, we use 55, 40, and now there is 28 nanometers and so on and so forth. We use partners. They're obviously on 300-millimeter wafers. We use partners. So to cut a long story short, we've obviously capitalized -- we will have completely capitalized these equipment needs by the end of '24.

And we have been public with our announcement of EU funding for our operation in Ireland. We've gotten pretty significant funds from the EU for both manufacturing grants, but also for R&D grants. And that's been confirmed that we have applied for CHIPS Act funding in the U.S. as well from both manufacturing as well as R&D grants. We expect to hear where we stand with that by the end of the year, but we're optimistic about our prospects there.

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