Analog Devices : Evercore Conference Transcript

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ADI.OQ - Analog Devices Inc at Evercore Semiconductor & Semiconductor Equipment Conference

EVENT DATE/TIME: SEPTEMBER 07, 2023 / 2:00PM GMT

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SEPTEMBER 07, 2023 / 2:00PM, ADI.OQ - Analog Devices Inc at Evercore Semiconductor & Semiconductor Equipment 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

Matthew Patrick Prisco Evercore ISI Institutional Equities, Research Division - Associate

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

Matthew Patrick Prisco - Evercore ISI Institutional Equities, Research Division - Associate

So hello again. I am Matthew Prisco semiconductor analyst at Evercore ISI. And I'm joined today with Prashanth Mahendra-Rajah, CFO of ADI; and Michael Lucarelli, VP of IR.

ADI, a leader in the high-performance analog arena with best-in-class exposure, some of the industry's strongest megatrends over the coming decade, including electrification, safety, industrial automation, digital health care, just to name a few. So we're honored to be hosting this fireside chat as one of Prashanth's last hurrahs as CFO of ADI before riding off into that sunset after 6 very successful years. So thank you both for joining us today.

As for formal to the chat, I have a number of questions to run through, but we'll save some time at the end for audience Q&A if there should be any. But given the intense focus on cycle today, I would like to open with few more near-term questions.

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

Matthew Patrick Prisco - Evercore ISI Institutional Equities, Research Division - Associate

To kick off, the magnitude of the guide down last quarter, I think, caught many off guard. And now we're looking at ADI revenues down 6%, 7% in '23 and '24 versus peers closer to flattish this year up mid-single digits next year on average. So what do you attribute as the primary factors driving this delta? And what are the factors that would drive -- that would close this gap in performance relative to the Analog group?

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

Sure, sure. So before I begin, thank you guys for joining us. As Matt said, this is going to be one of my last ones. I did want to say that with some of the organizational changes here, we were questioning whether we'd actually come today. But we decided that -- and for those of you who may not know, Matt is without a doubt, sort of the best junior analysts out there. So we told the Evercore team we would come here provided that he did the Q&A today.

Matthew Patrick Prisco - Evercore ISI Institutional Equities, Research Division - Associate

Thank you very much for that. I appreciate it.

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

Really, if you haven't got a chance to know this kid, you should. On the question. So here's how I think about what we did. For the last year, we sort of called -- maybe was it September of last year, Mike?

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SEPTEMBER 07, 2023 / 2:00PM, ADI.OQ - Analog Devices Inc at Evercore Semiconductor & Semiconductor Equipment Conference

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

Yes, a year ago.

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

Yes. About a year ago, we started talking about deceleration in orders and increase in cancellations. So over the last year, we've been very aggressively working with customers to encourage them to cancel orders on ADI. We knew that the backlog as happens to everybody during these -- the supply-demand imbalances, had gotten a bit out of whack. And so we were working hard to bring that down.

At the same time, we've also been expanding capacity in our fabs, limerick in Ireland as well as our Beaverton, Oregon facility where we've been putting in expansion that is partly being funded by the U.S. and European CHIPS Act. So the combination of working with customers to rightsize their orders and us improving our capacity has allowed our lead times to improve significantly. So we are now shipping 80%, 85% of our SKUs within a 13-week lead time.

And to Matt's question, how do you think about ADI versus peers? I have extreme confidence that sort of our performance is a reflection of the overall macro and lead time improvement. And why do I say that? We are an incredibly diversified business. You guys who follow us know that we are in multiple end markets and multiple geographies with a very high customer count and SKU count.

The deceleration that we've seen is very broad-based. So nothing else can really be driving that level of broad-based softness unless it's being driven really by macro factors and those macro factors really are the kind of the softening economy in U.S. and Europe, China, which is, I'm sure we'll get to is in really bad shape.

And then the improvement in lead times, which is increasing sort of customer confidence that I don't need to keep ordering on you for -- with uncertainty in the future. Now I can sort of hold off my orders until I'm sort of within that 8- to 13-week need, and then I can drop you the orders, and you'll turn it fast.

Anything else to add to that, Mike?

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

No, I think you're right, because I mean we've been improving lead times. We made a very large jump this year. And at the beginning of this year, we were about 50% within 13 weeks, now we are 85%. But really, where we saw the biggest change when we went from about 70% in 13 weeks to 85%. That change there last quarter is when we saw, like Prashanth said, broad-based customers reaching out us, like you know what, we have enough inventory. We're going to reduce our inventory because we know we can get product from you.

And it was quick and fast. And it didn't surprise us. We knew it was coming, but it is surprising how quick it came down. But I do think we did a good job working with the customer to understand what's going on, is inventory digestion or demand? And they said, well, right now, it's inventory digestion, but the demand for your products and those secular trends you talked about, Matt, are still there. So it's getting through this period of inventory reconciliation, on the other side of that is strong demand.

Matthew Patrick Prisco - Evercore ISI Institutional Equities, Research Division - Associate

Got you. So given this ongoing inventory digestion and certainly uncertain backdrop, you guided the January quarter in line with normal seasonality. What's driving the confidence here to call that seasonal growth, particularly from a somewhat conservative company historically? Are there are there green shoots today in any areas that may be bottoming or upside in areas, maybe not as apparent to us?

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SEPTEMBER 07, 2023 / 2:00PM, ADI.OQ - Analog Devices Inc at Evercore Semiconductor & Semiconductor Equipment Conference

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

Yes. I'd say 2 things. First, the January quarter guide is not going to be my responsibility. So it's quite easy for you to put a number out there. But really more practical -- I don't know that we guided the January quarter. I want to be very clear that we don't guide out beyond the -- beyond the kind of the current quarter. What we indicated was that based on what we've seen, on a 13-week basis, we would expect January to be seasonally down. And at that point, that remains our best view right now, but I wouldn't go as far as to interpret that as a guide.

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

Yes. No, I agree. Because the question on the call was about 13 to 14 weeks, I just try to help people walk through the math. Prashanth said, seasonal is down 5% and next week at 7.5%. So [calculate] the delta, that's what it would be if it was normal times. You're right to think -- in like normal times, usually, I'll say 2 things. One, inventory digestion, but two, 4Q is not usually down 12%. So our best view, as you know, is it's down, how about that, in 1Q. We'll see how much it's down. But we do think the worst is probably behind us as you go into next year.

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

That we do, that we do.

Matthew Patrick Prisco - Evercore ISI Institutional Equities, Research Division - Associate

Perfect. That's helpful. So now you talked about the inventory digestion lasting 2, 3 quarters, which would imply inventory at roughly normalized levels exiting the year. So can you walk us through the visibility that you have into this dynamic, both for disti and direct and what allows to make the confidence in that goal?

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

Sure. I'm going to actually do it in 3 pieces, one that you didn't mention, which is -- so we think about our inventory as what is the finished goods that is on ADI's books, what is the inventory that is in the -- on the balance sheet of our distribution partners, [aero], Macnica, Excelpoint, et cetera, and then what is the inventory that's in our end customers, who either buy directly from us or buy via distribution.

So we had mentioned in prior quarters that we were holding more finished goods inventory on our balance sheet, keeping it a little -- keeping it away from distribution because we were having matching challenges given the supply/demand imbalance. We wanted to make sure that we did not put product into a distributor like send it to Japan and then find out that, that product is actually needed in Europe where it can't get moved as easily.

So inventory on ADI's balance sheet got a little higher than we would normally carry. We've told -- we said to folks in the earnings call that by the -- as we exit the first quarter, expect our finished goods inventory in ADI to be down. Our goal is about $100 million.

On the distribution side, we undershipped disti in the third quarter. We undershipped kind of in the, call it, 0 to 50 range. And for the fourth quarter guide that we've given you, the $2.7 billion, that includes another $50 million to $100 million under ship. So sell-through is expected to be above sell-in, which also goes back to your first question on the softness in the guide.

For the last piece, which is the hardest one for anyone to really get their hands on and that is end market inventory. What Mike's team has done is they have -- they've been tracking a data set which is looking at the sales of ADI products to ADI customers whose information is publicly available over a period of multiple years, I think 5, 6 years, something in that range.

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SEPTEMBER 07, 2023 / 2:00PM, ADI.OQ - Analog Devices Inc at Evercore Semiconductor & Semiconductor Equipment Conference

We know -- so you pick any one of our publicly-traded customers, we know how much we're selling to them every quarter, and we know their revenue growth because that is publicly available information. So we correlate that over a very large data set. Individually, there can be always reasons why a company might be growing faster than we're growing into them or vice versa. But at an aggregate level, we see a nice correlation that our revenue growth ties to our customers' growth, which is what you'd expect.

In the third quarter, we saw that meaningfully begin to deviate. And when we take sell-side consensus for that same customer population for the fourth quarter against the implied revenue shipments we have in our $2.7 billion guide, we see that begin to deviate even more. So that's sort of giving us the confidence at a qualitative level that end customers are continuing to sell through to -- or consume product for their deliveries, but not putting the orders on us or not taking inventory from us, which is a reflection back to the lead time comments.

Matthew Patrick Prisco - Evercore ISI Institutional Equities, Research Division - Associate

Very clear. In a typical cyclical backdrop, the upturns and downturns, always faster and steeper than expected. So with that said, how do you think about ADI's positioning from a revenue perspective into this eventual upturn, given unique characteristics of this cycle? Would it be as steep as the past given the secular underpinnings or more muted given kind of rolling nature?

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

Yes. Well, I'll let Mike talk to the business side. I will say from a company's income statement side. What you should be looking for is as we have taken the OpEx spend down. As we've indicated in the call, we'll take roughly $50 million out this quarter, and we'll try to hold that level for the next 2 quarters.

As we've taken inventory levels down, and we have swung in to help mitigate the impact of utilization decline, when the recovery comes in, I think you'll really see kind of the goose to the profitability is we lever that pretty quickly. You'll see pretty strong op leverage.

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

And to your point on the revenue side, I think go back to long-term model we released about 18 months ago, I think we're very confident in that 7% to 10% long-term growth. We've been above that for a couple of years, we're below that here. I think you use that as your trend line and kind of modulate around there, we feel very good about that.

And I think we built that up from a bottoms up and tops down. We did build it in a downturn in that long-term model. So as long as it comes back year after the down, I'm very confident in that 7% to 10% because that's one thing I did. I would say when we built that model, we had a down year, but after that came back, semis do. We were down 5%, you might be up 10%, 15% the next year.

But all the growth drivers are still there. We're confident in our design win pipeline. So think about the long-term 7%, 10%, understand that this is a year of inventory digestion, which I think we all knew was going to happen after 3 years of strong growth, and then go back to that long-term growth of 7% to 10% versus historical 5% and that's a big delta for a company like ADI. If you can grow 3% faster, 8% versus 5% on a compounding business that has that much operating leverage and free cash flow, it's a great investment. That's why I think about the business over the long term.

Matthew Patrick Prisco - Evercore ISI Institutional Equities, Research Division - Associate

Perfect. So next, I would like to shift to the pricing backdrop. A couple of weeks ago, you talked about resilient trends across markets. Makes sense given stickiness of current wins. But I think bigger question is how are the pricing conversations been going in new design discussions, which would begin to manifest in the P&L 2, 4 years out? Any signs of recalibration there?

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