Good afternoon. We're gonna start our next session, and we're pleased to have Analog Devices for our next session. We're pleased to have Vincent Roche, CEO, and the Chairman of the Board of Directors. Thank you, Vincent.
Thank you, Tim, for having me.
Great! Well, let's just start, you reported two weeks ago now, and business deteriorated a bit more than you expected at that time, or than you thought three months prior. But your lead times have also fully normalized, and bookings were actually up sequentially, which I take as an optimistic sign.
Yeah.
Can you just talk about the overall demand environment, in maybe some of your more important end markets, and what was particularly worse than you expected it to be three months ago?
Yeah. So I think, what you said is correct, that, you know, our bookings got back to a more normal pattern. Lead times, of course, now are back to normal. More than 95% of our products now are shipping with 13-week or, you know, thereabout lead times. So, I think, that gives customers the opportunity to decrease the amount of inventory they hold on their balance sheets. You know, they see normality being restored. So in terms of... And, yeah, cancellations were way, way down. In terms of what performed more, weakly than we had expected, it was really the industrial sector. And the industrial sector for ADI, you know, it's 50% of ADI's business, and it has four major pieces to it. It's got, factory automation, instrumentation, aerospace and defense, and digital healthcare.
And it was really the factory automation part of that that performed at a rate that was a bit of a surprise to us. But within that, you had to look again at which part, and it was really, I'd say, you know, it's a business characterized by tens of thousands of customers, and it was really the small and medium-sized enterprises that suffered most. And I think a lot of that is attributable to the rising interest rates, the cost of capital, and, you know, generally speaking, our customers turning to, you know, towards the end of the year with this new interest rate environment, just protecting working capital, essentially.
As you look at autos, for example, how do you see that end market? It's been holding up a bit better than I think-
Yeah
... some of us had thought that it might.
Yeah.
So can you talk about that? Do you think it's a crack that just has... Or it's a market that has yet to crack, or you're optimistic that maybe it might not crack?
Well, look, it's been a business that has been using more and more of the electronics that we build for in-cabin experience, for the electrification of the vehicles with battery management systems, safety systems, and power management. So it's quite a diversified business for ADI. And I would say there are kind of two parts of the portfolio. The newer electronics for BMS, for things like multi-bit serial links, gigabit serial links. Those things have been increasingly, you know, been gaining momentum. These are newer products, a lot of new activity. And they've kept a pretty brisk rate of growth. You know, where we see more, I would say, normalization of consumption are in the kind of the older products, the more established applications that are not growing as fast.
But when I look into 2024, I still think automotive will be perhaps the strongest segment for ADI. You know, we're seeing. In general, what we're seeing in automotive is, you know, 10%-15% more silicon used in each new car platform. I believe that will be the case to the end of at least the end of the decade. And, you know, we're benefiting from more sensors being used in cars. The electrification, I've mentioned, the battery management systems, and we have two modalities there, both the more established wired technologies, but we're now at the early inception of our wireless technologies as well, and I think that creates a whole new growth strand for ADI. We have five major OEMs signed up for that technology, which is yet really to deploy.
So, yeah, I'm optimistic about automotive for 2024. Of course, the big governor is what happens to the SAAR. But, you know, even if SAAR moderates or declines somewhat, we still believe we'll be able to hold our position.
How about pricing? It's actually held up pretty well.
Mm-hmm.
Better than what I think some of us felt that it would have. Why, when you sort of go back and you sort of you know, deconstruct, why has it held up better? Is it, is it just the fact that, you know, foundry pricing hasn't come down, and so as you're passing on foundry pricing, maybe if it comes down, that's when pricing comes down? Or is there something bigger at work where you think that the price increases have staying power or that pricing itself has?
Well, you know, even pre-pandemic, you know, we've a franchise that's based on basically more than 100,000 customers, 75,000 products SKUs, and we're never the most sensitive element in a customer's system when it comes to pricing. So, typically, when we get a design established in the industrial business, those sockets will last for 17 years on average. And then consumer is somewhere between three and five years. But when we get the socket, when we get the design, the pricing is very, very steady over the life of the product. So, you know, these are very sticky products. Many, many places in which we play, so there's a tremendous diversification of applications.
you know, the prices that we install, the, the increases that we put on our customers during 2021 and 2022, they will stick largely. you know, if there are more price increases in the future, we will simply pass back on the cost of goods, essentially.
You know, price gets negotiated at the time of the design-in.
Mm-hmm.
Throughout the life of that design, I'm sure that customers come and say, "I want a lower price because business is worse, and, you know, I'm selling fewer widgets than I thought I was gonna sell." Do you grant price concessions versus where the price was originally? Or is there some schedule built in, you know-
Yeah
... up front?
Well, it depends. Yes. I think typically, if there are price decreases in the portfolio over time, that is agreed upfront. It tends to be based upon, you know, it's a, it's a volume-to-price relationship. So if the volume occurs that we've agreed upfront and there's a certain price reduction associated with that, then we, we honor that, obviously. But there are parts of the portfolio as well, where we actually increase prices. We inflate prices over time, typically older vintages, you know, that we maintain for 20 years, 30 years, 40 years. So it's, it's... The pricing story has two very different dynamics to it.
Yeah, I guess, I guess what I'm getting at is that it sounds like there really isn't a reason for you to give price concessions, nor is there a reason to believe that price will go down, other than the fact that your foundry prices go down and you can pass that on?
Correct.
Okay. Can we talk about China? I mean, we could spend the next 20 minutes talking about China, which I'm sure that most of your meetings were, you know, most of the questions were about China. But, you know, we tore down the BYD EV, and we've done two of these teardowns. And people were, I think, surprised to see that BYD did their own BMS. Can you talk, not about BYD in particular, but can you talk just about how exposed you feel in China to local China competition?
Yeah, well, look at our business in China is distributed over several, you know, tens of thousands of customers. Again, we deploy many thousands, many tens of thousands of product SKUs. And again, once we get the design-ins established, those products tend to last. We have a sole source portfolio. We have very little substitution of our portfolio once the products are in life. And yeah, there's no question that there's an uprise in the indigenization program in China. But ADI plays at the highest end of the performance spectrum, whether it's industrial, whether it's automotive, healthcare, communications. And as long as there is a market for high-performance technology, ADI will be the first choice. So, yeah, I believe there will be, you know, a continuing activity to displace foreign suppliers in China.
But at the end of the day, as I said, I believe, as we're seeing today, actually, if you look at our opportunity pipeline, which is the best leading indicator for what might happen in the future, that pipeline is increasing in size. So we have sticky products, many tens of thousands. And, yeah, there will be, I think, places in the vertical market where the BYDs will be, perhaps capable of building their own technologies. But again, I don't expect that ADI will be displaced at the high end of that game.
It seems to be... I mean, there are a couple of constellations, as I call them, in China, one being Huawei and one being BYD. And so those are kind of unique examples. So it seems to me like that's a unique, I don't wanna call it a one-off, but it seems to me like that's just a unique situation where there's a constellation of semiconductor suppliers and capabilities such that they could do something like that.
Yeah. Yeah, I think as well, it takes a certain amount of scale, you know, to be able to verticalize your business, to build your own silicon, or at least design your own silicon, have it built. But the majority of you know, our customers in areas like China are small and medium size, and I believe that will be a merchant market for the long term.
And do you, I mean, even within China, do you feel that I mean, there's the dynamic of, okay, there's a local Chinese supplier that is coming in with a part that is cheaper than yours, and maybe it's a lower-end part, and so the, you know, customer is gonna go with whoever has the lowest price. But then you hear someone like Aptiv is out on a public call. Aptiv is talking about, you know, qualifying a bunch of Chinese suppliers, and, you know, I get 50 emails from people, you know, that just amps up all the concerns about China. Do you think that it, that there is gonna be a content requirement that will to some degree, protect you?
Or, because that's what I thought until I heard the Aptiv comments, and then I was thinking: Well, geez, maybe it just is really all about price and cost, that's it. So how did you hear the Aptiv comments, and were you surprised to hear what they said?
Well, look, I think, there are really two markets in the analog space. There's the commodity market, which is the lion's share of the revenue pool, and then there's the high-performance part, of which we have a very, a very significant share as a company. And I don't believe, by the way, that this is a black-and-white situation where you will have displacement, you'll have Chinese suppliers, Japanese, whatever it is, in any part of the world, any region, where you'll see complete displacement of, you know, one particular legacy sector replaced by another sector. I think, you'll see a mix change. There will be parts of the business that are perhaps more commodity, less performance-driven, where cost will matter more.
We, as a company, our whole value, you know, our whole proposition is based on building and selling value. I think that gives us a moat, a defensive moat, to some extent, to a large extent, and we keep getting better at playing that game each and every year.
You know, you've been through a lot of these cycles and seen a lot of things. And what are you taking forward from what happened during this past cycle and how—I mean, obviously it took longer for things to crack for, you know, some of the analog companies because things got so tight and there was, you know, LTAs, and there were things that just pushed out an inevitable cycle. But there were other dynamics about this cycle that are truly seem to be maybe structurally different going forward. So what did you learn about this cycle that you'll take forward at, to make ADI a better company going forward?
Well, I think, you know, every cycle has, you know, the same output. You're either overshooting or undershooting, but the inputs tend to be different. I mean, this was a very, very unusual situation in the sense that in 2020, we had a supply chain fracture, and in 2021, we were all expected to ship essentially 16 months' worth of goods in 12 months. But I think we learned that our hybrid model was tremendously valuable to ADI during the cycle. And if we ever had any designs to kind of build everything internally, we gave up. If we ever had that, we gave up that ghost because it helped us enormously to have, you know, when supply was very, very short, to have partners who could help us build the supply line that we needed.
You know, also. So I think carrying that forward with us is really, really important. You know, I think in general, we all learned that the resilience of the analog supply chain was seriously questioned because of lack of investment over many, many years. So we invested some of our own capital to build up certain parts of our semiconductor manufacturing capability, particularly on the front end, at 180 nanometers and above, but also on the back end. So we've accelerated investments to capture what we believe will be a very brisk growth cycle moving ahead.
And do you feel, I mean, you know, certainly for smaller nodes, you have foundry relationships. How quickly, if you decide - you know, you have a competitor who's saying, "I'm gonna be as vertically integrated as I can be." But it works to have partnerships if a foundry can be very flexible and can provide you what you need-
Yeah
... in a fairly short amount of time. How did you manage that during the upturn? Because you didn't have as many shortages as a company, for example, who had their own manufacturing. So how did you manage that with your foundry partner?
Well, you know, going into 2020, 2021, we had agreements up front as to what the, you know, what the outlook was for, capacity need from each of our key suppliers on the silicon side of things. And, you know, as demand was modulated above those forecasts, our partners were able to supply us. So that flexibility, you know, our factories were full internally. So having that, that extra capacity and that flexibility outside was tremendously important. As I said, if there was any, ever a notion that we were going to verticalize and build everything inside, during the pandemic, we saw the power of a hybrid model and the flexibility.
And then on the, you know, the downside, when demand dampens, we're able to make sure that we keep the utilization factors in our factories, you know, at high levels to protect our cost structures and our margins.
Also, can you talk about how proactive you've been about managing down channel? You've been a bit more proactive than your peers have been.
Yeah.
You know, obviously, your year-over-year comps are the worst among your peers right now. But that's, to me, that's simply the result of the fact that your comps were so high in the upturn because others didn't have supply, and you did. So it just is math, really, and so, you know, you should have a better inflection off the bottom.
Yeah.
But, you've also been more actively, or more proactive in terms of working down channel.
Yeah.
So, that's also another factor that should help you off the bottom as well.
Exactly. Yeah, we know that, we're under shipping our largest customers. You know, the analysis shows us that we're shipping it at a rate that's below their, their sell-through. And, you know, we run ADI on a POS signal, so we pay very close attention to what's happening at the, in terms of sell-through. We don't look at sell-in. That, that's a piece, but that's a second-order derivative. So we're looking very clearly at what's selling through. We set up our factory, you know, the factory outputs based on what we believe the, the POS signal is telling us. And, we also have not in any way. We're keeping the channel lean. We're keeping more inventory on our balance sheet, keeping the channel lean.
I think all that gives us the opportunity, when the cycle inverts here, and we start to see growth again, we get more control over where the goods are moving, to big customers and small customers, and that, you know, we manage effectively, what we believe to be the true needs based on POS.
This is a difficult question to answer, I'm sure, but in as much as you can tell, how much do you think you're under shipping demand to—just in aggregate?
Um-
Consumption, I mean.
Yeah, it's probably right now in the region of 15%-20%.
That much? Okay. Obviously, it'll take a while for that to come back because you have to normalize inventories-
Right.
and, you know, channel has to come back. Got it. Can we just talk about turns? So typically, I think you need about 15% of turns in a given quarter. You're not back to that level yet. If turns, you know, it sounds to me like if turns return to normal, that would be upside to what you're guiding for Q4 and your outlook into Q1.
Right.
So you're not really counting on turns coming back. Is that correct?
Yeah. Well, the bookings are improving, but we're still, we've still got pretty healthy backlog in the short term. You know, when the recovery happens, we're going to see turns. That'll be one of the indicators that we're getting back onto a solid growth path again. Turns will improve fairly dramatically, I think.
Let's talk about maximum revenue synergies.
Yeah.
Where do you stand relative to that billion-dollar target? I think, I think the target is by 2027, is the target. Sounds to me like you could get there faster than that. Can you just walk through that?
Yeah. So, what we're seeing is, in terms of revenue synergies, I'd say, what we're seeing is great strength in automotive. We're seeing an uptick in our data center business, and in areas like, clinical-grade wearables in the healthcare space, for example. So we're optimistic, based on what we're seeing in terms of, of design-ins. You know, we're beginning to see serious revenue begin, particularly in the automotive sector, areas like GMSL, power management, for example. So my sense is, the billion-dollar target that we've set for 2027, we will do. I mean, the big governor in all this, of course, is what happens to the macroeconomy.
But one thing I'm sure about is that the consumption of semiconductors in general will continue to grow at a brisk pace, I think, over this coming decade, given the importance of semiconductors to our social lives and our economic lives. So, you know, whatever happens in the short term, I'm still optimistic that we will get that billion-dollar revenue target in the bag by 2027.
I guess it depends on how quickly these product ramp, you know, design wins ramp.
Yeah.
You can only control the wins.
Mm-hmm.
You can't control how quickly things ramp.
Mm-hmm.
I mean, is it conceivable that you could get half of that by fiscal 2025? Like, is that a conceivable number?
It's possible. It's possible.
And what's... Is there an end market where you feel, you know, out of all your key end markets, what's the biggest piece of that $1 billion?
Automotive.
Automotive?
Automotive. It's everywhere. It's in cabin. I mean, it's the GMSL, the transport systems, power management, the electrification of the vehicle, the battery, all the battery stuff there. And then there's a lot of established analog electronics that support those functions that I just mentioned. So, it's right through, essentially, you know, the whole spectrum of cars, from combustion engines through electric vehicles. But we don't participate in the combustion engine electronics itself.
Yeah, I mean, what really sets you apart is just the sheer diversification of your end markets. And you have the most exposure, I would say, to true industrial and, well, industrial end markets, as you said before. When you guide where to invest money, I mean, obviously, you're gonna invest in automotive. We've talked about that. But within industrial, where do you guide your R&D dollars?
We see big opportunities. So industrial, it tends to be the first call on, you know, on the R&D. And that business has four major components to it: factory automation, aerospace and defense, digital healthcare, and instrumentation. And we see a big opportunity in factory automation. For example, the conversion of factory systems and that conversion between OT and IT. We've a big play there in terms of the connectivity solutions, the edge fabrics, the software defined input/output systems. So that's a significant opportunity. Industry 4.0, gigafactories, big, big opportunity for ADI. So we're investing heavily in that, bringing intelligence, robotics, you know, automation systems as well. Aerospace and defense, it's probably the only area right now where we're seeing supply constraints.
We do a lot of our high-speed technology development specifically for that sector, so we're doubling down on that. So that encompasses a lot of microwave technology, you know, very, very high bandwidth data conversion systems. So generally speaking, I would say digital healthcare is another, another area. We're seeing an upsurge in the need for our newer instrumentation, automatic test equipment, solutions for things like AGI and the build-out of the new versions, the new generations of data centers that need to be built to handle AGI. So, I mean, that's, those are some of the vectors that we're investing in, in the industrial space. Obviously, automotive is the next in terms of, you know, a bucket of opportunities, into which we're putting a lot of R&D capital as well, for all the things we just talked about.
Has it put... I mean, with a little bit more than 70% of your revenue coming on a 180 nanometer and above, in the past, there was a pretty steady stream of used tools where you could have a very good, you know, very, very low, you know, capital intensity because of that, because of that, influx.
Yeah.
That really has. It's not fully gone away, but it's not as robust as it used to be.
Right.
So, yet you are really cutting CapEx quite a bit. But how, how do you think about the pressures that that puts on the model going forward? Is that a, is that a factor to consider, or is it just not that big of a deal?
Well, let me give you a couple of specifics. So by the middle of 2025, we will have more than double the internal factory capacity. And we've been able to do that for approximately $1.5 billion-$1.6 billion. We are spending another $600 million-$700 million to upgrade our capabilities in Asia, pretty much the test capabilities. We do very little assembly inside ADI. And, so, you know, basically, for $2.25 billion, we will have more than double the output of ADI's factories. That's the nature of the analog business. And, you know, these assets we'll be using in 30 years-40 years' time. So it's a really different economic proposition to building fabs to handle 3-nanometer digital technology.
You still feel, when you, when you laid out the financial model, you had a $15 earnings number. Do you still... I mean, things have changed a lot, so, you know, it's, it's a, it's a longer way-
Yeah
To get there from where you are now. But, I mean, is that still in the cards?
I think it's reasonable. You know, that's predicated on being able to grow this business 7%-10% per year. As I said, I think 2024 could be a tough year, but I think 2025 and beyond, we'll get back into a more normal growth pattern. So I still feel comfortable with all the growth vectors that we have, you know, as tailwinds in the business. You know, it used to be that you get one tailwind at a time. You know, in the early 1990s, it was digitalization of media, PCs. Early 2000s, it was the internet. But now we have... You know, we're digitalizing every part of physics, biology, and chemistry.
You know, we've got all these secular tailwinds, Industry 4.0, digitalization of healthcare, you know, the transition to electrification of the transportation system. All these different things are concurring and giving us a stronger tailwind in the business than we've ever had in our history.
And just as a last question, having been through these cycles before, what is the most important KPI that would make you more optimistic about the business? Because to me, you know, having covered these businesses for a long time, it's like bookings are everything. I mean, when bookings start to turn around, that's the single most important KPI, and they actually have.
Yeah.
I mean, bookings are bottom. Now, they've, you know, they've been quite low-
Yeah.
But the fact that they're getting better ought to make you more optimistic.
Yeah.
Yet you still sound somewhat cautious about next year. So I'm just trying to... Is there a better KPI than bookings?
Yeah. Look, the demand we see over time is driven by an opportunity pipeline. So that is the leading indicator. To me, the most important set of data at this point in time is the opportunity pipeline. That tells us how we're doing by market segment, by customer, in terms of, you know, growing the pipeline through all the stages of pre-production. So that will determine ultimately how strong those bookings are over the long term.
Got it. Well, we're out of time. Thank you, Vincent.
Thank you, Tim.
Appreciate it.
Good conversation.