Analog Devices : Citi Conference Transcript

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EDITED TRANSCRIPT

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

EVENT DATE/TIME: SEPTEMBER 06, 2023 / 3:15PM GMT

OVERVIEW:

Company Summary

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SEPTEMBER 06, 2023 / 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

Jim Mollica

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

Great. Thanks, everyone. What a crowd. I'm still Chris Danely, still the semiconductor analyst here at Citigroup. It's our pleasure to have the dream team from one of our top picks Analog Devices up here. We have Prashanth Mahendra-Rajah, the CFO; we have Jim Mollica, who's VP of Finance; and then we have the Grand Poobah of Investor Relations, Mike Lucarelli. So Prashanth, since you guys were, I believe, the most recent semi company to report, maybe start by sort of repeating what you guys said a few weeks ago on the general tone and outlook and then we'll take it from there.

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

Absolutely, yes. Thanks, Chris. So earnings call was 2 weeks ago now, Mike? Yes, 2 weeks. And I won't go through the numbers, but just sort of give you a context for what we're seeing is as we have been signaling now for a couple of quarters, we began starting to see some softness in the numbers that reflected in the guide we've given for the fourth quarter. That softness is very broad-based. I would say that it is across all end markets and all geographies. The broadness of that softness is what gives us confidence on kind of 2 parameters: one, that it is macro driven versus being a share loss issue; and then the second is, it's lining up quite well with the improvements that we've done on lead times.

So I know we're getting a lot of questions from folks over the last couple of weeks on trying to understand ADI's outlook versus other companies out there. And I think our advice to you would be just keep an eye on lead times because we have pretty high conviction that as lead times are getting back to normality, customers are getting more confident in their ability to hold off ordering until they need something sort of within the stated delivery period, which is helping as we kind of work through some of the inventory correction.

I think the other comment that we've had a lot of questions on, so I'll just jump into it now is my boss made a comment on how we are undershipping end market demand. So folks have asked a little bit to expand on what we meant by that. And I'll give it to you in 2 pieces. First, on the distribution side for our distribution partners, both in the third quarter results and in the fourth quarter guide, we are selling into the channel less than they are selling through. So in the third quarter, we'll range it for you kind of [sub-$50] million in the fourth quarter reflected in the guide is an undershipment of, call it, [$50 million to $100] million. And we'll see where we land on that. It's hard to be so precise. So that's on disti.

On the end market side and the comment that Vince was making is we have the benefit of being able to look at our revenue sales to all of our individual customers, whether they go through disti or whether they go direct. And we can see the growth of our revenue to those end customers. And then Mike's team can pull from FactSet or [Bloomy], the reported revenue growth for each of those publicly traded companies. So we're able to look at a pretty large data set over several years to see how are our customers' revenue growth and how is our growth to those customers and what does that relationship look like.

And if you look at that relationship over different periods of time, but a reasonably long period of time to give you confidence that it's not a near-term anomaly. We can see that third quarter actuals begin to show a good deviation and fourth quarter will be even more. Now fourth quarter is based on sell-side consensus. So wherever those individual customers, analysts have them for the revenue growth for the fourth quarter. But that is sort

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SEPTEMBER 06, 2023 / 3:15PM, ADI.OQ - Analog Devices Inc at Citi Global Technology Conference

of what underwrote Vince's comment on, we feel good that we're getting this inventory behind us because we are fixing the channel ourselves and our customers are fixing their end market inventory. So long answer to a short question, Chris.

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

That's okay. I specialize in those. How about -- the first one would be, and I received this from some folks wandering the halls. You guys have had, I think, for the last year, you've been in the sort of sign curve of things are weaker and then were stable, things are weaker and then were stable. I guess what gives you confidence that your guidance for the next few quarters is low enough? Or is that accurate?

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

Good. I'm going to let Jim Mollica take that and just as background, I also get a chance to do an introduction here. Jim is a 35-year veteran of ADI. He has been a right hand for me for my 6 years here in the CFO role. We are very likely heading external with the CFO search, and Vince will share an update with you on that in the Q4 earnings call, but I want to bring Jim with me, so you get a chance to see sort of the depth of talent that we have and give you reassurance that this is a very strong and very deep finance team.

Jim Mollica

Thanks. I think the -- one of the differences we've seen, if you think back a year, if you step back and from a lead time viewpoint, we were shipping about 1/3 of our products a year ago within a 13-week period, 13 weeks and less. And that got a little better in the first quarter, a little better in the second quarter. But in the third quarter, we kind of leapfrog that up to now we're shipping 85% of our products within 13 weeks. And from a customer viewpoint, although we have been doing a lot of customer checks on their backlog is the demand rail. It's not until that you see those -- that stock reduction in lead times where customers now have confidence that, hey, look, I don't have to actually place as much backlog on the books now and the signal that we're getting from them is [sharper].

So that lead time reduction for us is a key metric for determining what the end customer signal is doing. And we saw a lot of improvement in third quarter. Our goal is to get to something around 90%. And hopefully, we'll achieve that by fourth quarter, but it's really that lead time reduction that gives us confidence that we can actually get to that guided (inaudible).

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

And maybe a quick one on kind of some of the false signals we got from China, which also created a little bit of that sine curve that Chris was talking about.

Jim Mollica

Yes. On the China side, we got, I guess, Prashanth, kind of a false signal at the start of 3Q, if you will, of the latter part of 2Q. So on the China side there, on the channel side, we've actually saw -- from a shipment viewpoint, we're undershipping the channel now so that we can actually work off of that inventory that was actually built up there. And we had basically started that in 3Q, and we'll continue that in the fourth quarter. And that gets, I think, more or less the macro level there going into fourth quarter or certainly not as strong as it was going into the second half of the year if you step back 3 to 6 months.

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SEPTEMBER 06, 2023 / 3:15PM, ADI.OQ - Analog Devices Inc at Citi Global Technology Conference

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

Yes. So a question for the brain trust over here. It sounds like the trigger was the sort of big time step function down in lead times that really triggered the clearing of the backlog. Was there a specific level you saw that when I guess you hit 50%, 60%, 70% of lead times were less than 13 weeks? Or was it a time period? Or was it -- was there anything else more specific that you saw that once we broadcast this to customers, then, okay, they felt more comfortable about taking down their own inventory or maybe it was like anything on the macro side?

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

Yes, yes. Chris, I'd be careful that I wouldn't want anyone to think that it was purely a catalyst of the lead time reductions. I think that was -- we had a multitude of things going on. The economy was clearly softening, everyone expected that given kind of the interest rate environment. The hope that China was going to return to growth, I think, faded over the summer, right? We were all -- we all started the year thinking we're going to come out, they're going to reopen post COVID, and it's going to be boom times. And by the time we got through summer, where we realized that was not happening. Lead times got better and also the efforts that we've been making for a while now to ask for cancellation of orders and kind of the folks to really look through what they really were in need of all of that sort of came together towards the tail end of summer.

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

Yes. I wanted to touch on that as you were the first analog company a year ago to, I guess, proactively manage and start to see some weakness. So can you talk about what caused you guys to go out there and scrub the backlog because it was probably at least a quarter or 2 before anybody else started saying it?

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

Yes. I think a little bit of just sort of the reflection of how we run this company, and we run it really with the long term in mind. It is -- the nature of analog is that it takes a -- from the time you win a stock, it takes a long time before you get the revenues. But once you have the revenues, you hang on to them for several years, in some cases, decades. So it gives us the privilege of not really being worried about kind of the quarterly ups and downs. It's a very durable business with tremendous cash flow generation. So as we saw order cancellations start to pick up last year, there was no reason not to kind of in the spirit of how we've always been very transparent with our investor base to share with you what we see. You can have as much information as we have, and I don't know that it will help you anymore in your decision-making because the world has a great deal of uncertainty out there.

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

Yes. So given that 85% of lead times are within 13 weeks, and we're probably, I don't know, maybe within a quarter or so of whatever the heck is approaching normal these days. Do you feel like the worst is over in terms of the correction for ADI while there might be some little speed bumps or potholes out there? Do you feel like the worst is over for you guys?

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

I would break that into 2 elements. There's sort of true demand, and then there is the inventory correction. We have high conviction that the inventory correction will be behind us by ideally end of our Q1, but maybe stretch it a little bit into part of Q2. And remember, our Q1 ends in January. That means we'll have taken our finished goods down roughly $100 million, we will have undershipped for 2 quarters of distribution, Q3 and Q4. We haven't really made a call yet on what we're going to do for Q1 disti, but I know we're not going to increase. We're not going to ship in above where we are. And then customers will have a chance to do that inventory correction. So I think we will be at normalcy there. What I don't have a sense for, and Mike and Jim can jump in here is there's still this macro element. The rates are up, activity is down. We are really feeling it on

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SEPTEMBER 06, 2023 / 3:15PM, ADI.OQ - Analog Devices Inc at Citi Global Technology Conference

the industrial side. I think, Mike, maybe you want to comment since it's easier for them to hold you accountable than me at the end of next year about the industrial outlook.

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

Sure. I mean, I guess, to your first point, the inventory correction (inaudible) done by kind of 1Q, 2Q time frame. The question is resumption of demand, like what is the shape as you return to demand. There's a lot of demand, whether it's industrial, auto, comms, consumer, there's demand everywhere. But it's just unsure as you get through this inventory reconciliation period, how does that demand pick back up? Is it snap back? Is it slow? We don't know that. And that's the big question we have. If you look at next year, I guess, I'm making a prediction for next year on behalf of Prashanth, so you can blame him if it's wrong. He won't be here. Industrial will probably one of the weaker markets next year -- we'll find you.

Industrial will probably one of the weaker markets next year, but that's not a bad thing. I mean, it's been one of the stronger markets. So I think Industrial is probably down the most next year. But it's not to say there's going to be growth pieces within industrial. And if you fast forward past the next few months, and you get into the back half of next year, we're starting to grow nicely on a year-over-year basis. So the long-term growth is unchanged for ADI. You just have a period of reconciliation given the past 3 years of supply crunch.

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

Okay. Just to touch on that. So you said industrial should be weakest for '24. I would imagine auto is strongest. And then where would comm and consumer fall?

Unidentified Company Representative

Between them.

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

You should run for office. You should run for office. I've seen what we've got coming up next year.

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

There you go. But you're right, industrial by the (inaudible) of the best. I would say consumer -- I won't say, plus/minus, could grow maybe depending

• a lot of unknown in consumer. It's been the weakest. It's probably corrected, and the bottom is behind us. [We're unsure and opaque] there. In communications, I'll say I've been in that market now for 8 years. Whenever it's terrible, it surprise you to the upside. And whenever it's awesome, it's probably to the downside. So it's been terrible. So I'm hopeful that does okay next year, but I'm not going to put my badge on the table for that one. That's it. So I joke in between the 2, but that's kind of where I think.

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

That's fair. And then Prashanth, Mike or Jim, you mentioned that 85% of the products have lead times within 13 weeks. What percentage or figure would you give as normal? Is it 90%, 95%? I know I would imagine it's never 100%.

Jim Mollica

Yes, it's a great question. We got a pretty fragmented tail of products. So it's -- our goal is to get to about 90%. And anything above that, we have a lot of products too that are at 8 weeks. So -- but at the aggregate level, it's hard to get that number really above 90% or in that range just due to

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