[ADI stock] Analog Devices Q1 2021 Earnings Call (2/17/21)

Thanks very much, Mike, and good morning to you all. So I'll start my remarks with a review of our results before providing insight into how we are shaping a more connected, safer, and sustainable future. In the first quarter, we delivered strong results that came in at the high end of our outlook. Revenue was $1.56 billion and increased 20% year-over-year. The strength was broad-based with growth across all end markets, highlighted by a record quarter for our industrial business. We delivered gross margin of 70% and operating margin of nearly 41%. All told, we produced adjusted earnings per share of $1.44. Over the trailing 12 months, we generated $1.9 billion of free cash flow, equating to a 33% free cash flow margin, placing us in the top 10 of the S&P 500. So overall, I'm very pleased with our team's performance this quarter. Now I'd like to discuss how we are advancing our mission of engineering good for the planet, social health, and economic prosperity, which in turn will create long-term sustainable value for our shareholders. Awareness of the world's environmental degradation and climate change, specifically, is growing tremendously with a global call to action building momentum. Semiconductors, as the bedrock of the modern digital economy, have a major role to play in improving our standard of living while protecting our planetary health. At ADI, our technologies sit at the intersection of our customers' and society's most pressing challenges, and we're uniquely positioned to drive positive impact. Our industry-leading portfolio, with its breadth of capabilities, defines the edge of performance and inherently delivers sustainable benefits. With each generation of chip design, we increase efficiency while enhancing the performance of our customer systems. This portfolio supports customers of all sizes and spans industries that are aligned with key secular trends. So today, I'll focus on where ADI is engineering good across the automation, electrification, and connectivity sectors. Firstly, the automation of human routines, factory floors, and supply chains is critical to our future, and the pandemic has further accelerated this paradigm. The World Economic Forum is predicting that by 2025, over half of all tasks will be performed by machines, a first in human history. To support this trend, our industrial customer base is boosting deployments of robots and cobots. Over the next five years, the global robot installed base is expected to increase by about 60%. With industrial motors currently consuming 25% of all the world's electricity, we urgently need to deploy technologies that not only deliver speed and accuracy, safety, and flexibility, but also energy savings. Now let me share a few examples of how our technologies are meeting these challenges in automation. So firstly, variable speed drives can reduce motor energy consumption by up to 40%. In a robot, our precision signal chain, isolation, and power management technologies together increase response time and improve power conversion. Secondly, our time-of-flight sensing technology allows robots to sense and interpret the world around them, so our customers can deploy more robots per square foot and improve worker safety. Thirdly, our AutoSense condition-based monitoring solution patiently identifies motor inefficiencies, enabling customers to proactively optimize and repair machinery. This avoids costly downtime and lowers energy consumption by 10%. Importantly, these technologies that improve motor efficiency and robotic control can save almost one gigaton of annual CO2 emissions, the equivalent of 330 million residential homes. In total, automation is a key component of our industrial business, supporting tens of thousands of customers. We expect this accelerated digitalization to drive continued growth in 2021 and beyond. Now I'll turn to electrification and discuss the important role ADI is playing as consumer demand for greener transportation accelerates. The World Economic Forum predicts that by 2030, there will be approximately 215 million electric vehicles on the road, up exponentially from about 7 million today. ADI solutions are embedded across all phases of the electric vehicle journey, from supporting EV infrastructure to forming and managing the vehicle battery. So I'll share now how our technologies are impacting this ecosystem. First, the shift to renewable energy sources drives great environmental benefits but also creates new obstacles in distribution, transmission, and stability. This requires the smart grid, which can digitally monitor and adjust performance. Our control and sensing technologies are critical to ensuring the grid parameters remain stable and prevent shutdowns. This shift also requires energy storage systems to mitigate intermittency issues related to variable user demand. Here, our high-accuracy monitoring and efficient power conversion technologies help extend systems' battery life by more than 30%. Turning to the battery, which is the most expensive vehicle part, our battery management system, or BMS, enables up to 20 more miles per charge than our competition. As the market leader, over half of the top 10 electric vehicle brands use ADI's BMS technology today. In addition, last fall we introduced the industry's first wireless BMS platform. This has all the benefits of our wired solution by lowering vehicle weights and enabling a scalable battery architecture, paving the way for reuse and storage systems. GM's Ultium platform uses our wireless BMS technology, which is expected to be deployed across 30 different models by 2025. Interest in our wireless BMS technology is rising, and last quarter we recorded our second OEM design win. Importantly, the environmental impact from our BMS capabilities is notable. In 2020 alone, vehicles equipped with ADI's BMS technologies prevented approximately 70 million tons of carbon dioxide from entering the atmosphere. Our solutions utilized at the battery formation stage enable more current density, thereby shrinking our customers' equipment footprint by up to four times and reducing per-channel costs by nearly half. Our technology makes it possible for factories to recycle more than 80% of the energy used during the formation back into the power grid. Based on today's production levels, energy recycling during formation reduces CO2 output by about 1 million tons annually. So all told, electrification not only represents a highly valuable market with long-term revenue growth opportunities, but one that will be critical to the preservation of our precious natural ecosystem. So finally, let me turn to connectivity. In the face of the pandemic, connectivity has been the foundation that is sustaining and empowering our society and the economy. And while the communications market is not known historically for its sustainability benefits, this ability to stay connected and productive from anywhere has also had a positive impact on the environment. A clear proof point is the reduction of global carbon emissions by a record 7% in 2020. By 2030, forecasts suggest mobile traffic will increase by about 17-fold. This exponential increase in wireless data, combined with pervasive cloud computing, puts IP traffic on pace to double every two and a half years. And ADI is playing a critical role in building out the next-generation infrastructure to support this exponential increase in data. From capturing the signal at the base station air interface to transferring the information to the data center, while substantially decreasing power. So ADI has invested ahead and reshaped the 5G radio architecture. Our software-defined transceivers with complementary precision signal chain and power technologies are vital to enabling the 5G massive MIMO architecture. When comparing 5G to 4G, our solutions help deliver a 90% decrease in energy per bit at the air interface by decreasing the channel count by 10x while maintaining the radio's size and thermal performance. With the exponential upswing in data generation, our customers are upgrading their optical infrastructure from 100 to 400 gigabits per second. Our precision signal chain technologies help enable these optical modules to maintain constant power while operating at four times the data rate. And with customers looking to increase to one terabit and beyond, ADI's opportunity will continue to expand. Capturing and transporting data efficiently is important, but computing and data centers is the primary source of energy consumption in the connectivity ecosystem. Currently, data centers generate more than 130 million tons of CO2 per year globally. So this is where the transition from 12 to 48-volt power distribution can reduce power loss and increase compute density. Our 48-volt DC/DC micro modules, power, and power system monitoring solutions are enabling this transition, and according to Alphabet, this approach can improve data center energy efficiency by 30%. All told, ADI is part of the ecosystem enabling greater efficiency in wireless and wired data capture, transmission, and of course computing, and our solutions help our customers to scale their investments and build next-generation networks economically and resourcefully. So stepping back, I'm incredibly proud of the progress we've made on our mission to engineer good, but a lot remains yet to be done. We're focused on partnering with our customers to develop increasingly innovative technologies that create successful business outcomes, enrich people's lives, and leave a greater impact on our world. And so with that, I'll hand it over to Prashanth.

Yeah, just on the lead time question, Ambrish. So we entered our first quarter with what we would have called normal lead times, but during the quarter and into the early part of this quarter, we've seen lead times extend, which I think is pretty consistent with the industry at large. So while we see some hotspots, we're really talking about a few weeks of extension in different places. I will remind you too that we run this company, we run our manufacturing plans, the operating plans are run to POS rather than POA. So what we're seeing right now is a good balance between POS and POA, but as Prashanth said, we're preparing for quite a bit of upside during this year, and we've pretty substantially increased the CapEx in our back end.

Yeah, I think as well, I'll remind everybody that the three-year CAGR for comms has been 7%, and that's with that very, very significant headwind in China. So I think when you look at ADI and the comms business, it's tremendously diverse, many, many hundreds of customers. 5G is a critical part, wireline is an increasingly critical part. So very, very hard to predict in a lumpy business, but our expectation is that when you aggregate enough, we'll produce better than mid-single-digit growth for that business.

Over the next few years, I think, Stacy, we will produce something better than mid-single-digit growth in that business.

Well, that's certainly our expectation. I think in terms of getting to market, the latter part of this year we'll see the start of production. And I think between now and the end of 2023, say, we should expect four to five OEMs to adopt that technology. We have a strong pipeline. But also remember, we have a very strong wired portfolio in BMS. So we've got those two tailwinds working for us. But I think over time, it'll be kind of a hybrid between wired and wireless. But clearly, wireless is the bright star at this point in time. And our expectation is that we'll have at least a handful of OEMs using this technology by the start of 2024.

Yeah, thank you. Thanks for your question. So typically, Q1 is the low point for ADI. We had a reasonably strong first Q compared to kind of normal patterns. But I will stress there's still a tremendous amount of uncertainty out there, and I don't want to get into the business of making strong speculative predictions here. But we can only kind of guide one quarter at a time, particularly in this erratic market. But if I look at the markets and just kind of peel this story back a little bit for you, so our industrial business, which represents about half of the company's revenue, was down, we had two consecutive down years in '19 and '20. But we produced a record quarter in the first. We expect ongoing strength in that business. And one thing I'm very, very pleased about is that the most diverse part of our industrial business is automation. And I think given the strength of our opportunity pipeline, the new products we've got coming to market, I expect to see a multi-year tailwind in the automation part. I think right now in automotive, there's a big push to electric vehicles, and I see that, as I said in the prepared remarks, that is expected to grow by 2030 from kind of 7 million deployed electric vehicles today to over 200 million by 2030. And we talked a lot last quarter about the strength of our cabin electronics business, active noise cancellation, premium audio, our A2B bus deployment, and all that too provides good tailwinds for the company going ahead. Comms, as we've just narrated, was weak in the first half of '21, but really I think that's about the timing of deployments, and my expectation is that that business will snap back in the second half of '21 and continue into '22. Last but not least, our consumer business has shown now a couple of sequential growth quarters, and we no longer have the overhang of one big socket and one big customer. So with the diversity of our business, we're addressing more applications, we've a stronger product portfolio than we had say three years ago. I think we're on a growth track in that business, and we're certainly off to a very, very good start. So we believe that '20 was the bottom of that business, and certainly the signals are that is the case.

Well, you know, I think what you've got to remember is that first and foremost, we're producing and shipping product at record levels. Q2 will be an all-time record for the company. So we're certainly keeping ahead, our investments are keeping ahead of these revenue levels. Obviously, like most of our peers in the industry, there are supply constraints in parts of the business, so we're not able to meet all the demand, particularly in auto, which has been very, very well publicized. And the constraints continue across the front end in wafer procurement and also the back end. But I will remind you too, we produce about half our silicon inside ADI, and the other half we procure with external partners. So I think something else worth noting is that we've been building inventory since last summer in terms of die stock and finished goods, which was heavily depleted during the pandemic shutdown. So as I said, internally we're ramping up our own manufacturing operations, and we've been successful in acquiring additional wafers from our external partners. So I think that's the best I can give you in terms of the atmosphere that we're working within. We're certainly keeping CapEx deployments ahead of where we think the revenue could be this year based on the demand patterns we now see.

Yeah, so Craig, there's a couple of ways to look this. Obviously, the battery side of things is very, very strong. We've more than doubled the size of that since we acquired LTC. And overall, as you know, when I look at, for example, power, the mixed signal portfolio as well as the battery management side of things, we have more than $500 million worth of new revenue going to production this year, and that's just the beginning. So in terms of areas where we're winning, we've got notable wins in communications, in wireless as well as data center and cloud. In automotive, we're strongly attaching to our infotainment business, the autonomous radar systems. And the strongest surge in terms of growth in industrial for the LTC portfolio, the additional cross-selling is instrumentation, test, and micro modules. Generally speaking, across the board, we're seeing very, very strong demand for those products. So I think all that said, we had expected that we would double the LTC growth from kind of 3% to 4% historically to high single digits in a five-year period, and that's quite similar to how we viewed our opportunity with Hittite at the beginning, and what also has materialized. So that's the story in terms of the markets and the expected growth.

Yeah, I'd say, I mean, just Mike can give you some numerical color. I'll just give you a headline here. So what we're seeing, as I said in the preparatory remarks, is an acceleration in the market in general, but we're still well below the previous peak. And given the pipeline of opportunity that we've got, the technologies and the products that we've got, I think the long-term trends are going to be very, very strong, accelerated of course by the obvious need for resilience driven by automation as a result of the pandemic. But Mike, you might want to add.

Maybe just to close on that, CJ, we've been gaining share in industrial, and we've been gaining share over the last couple of years while the market hasn't been as strong. Now you're going to see the compounding effect of a growing market with the benefit of the share that we picked up. So I think you will see significant outperformance for ADI's industrial business versus our peers over the balance of this year. I think healthcare as well, CJ, is worth noting that it still remains considerably above pre-COVID levels. We obviously got a boost during the upsurge in COVID-19. And again, I think this has been growing at kind of 10% for the past five or seven years. It's a multi-year growth market, and we're beginning to see also the acceleration of demand as a result of the pandemic, getting healthcare capabilities to anywhere, so to speak. So I think look, we look across industrial as an area where we've been steering a lot of our R&D over the last decade or so. It's a kind of a long-burn business, but we're seeing the benefits now in terms of strength of our technology pipeline and our customer engagements.