The Analog Devices Third Quarter Fiscal Year 2023 Earnings Conference Call was hosted by Michael Lucarelli, Vice President of Investor Relations and FP&A, with Vincent Roche, CEO and Chair, and Prashanth Mahendra-Rajah, CFO, also on the call. The call included forward-looking statements and non-GAAP financial measures. Despite the challenging operating environment, ADI reported revenue of nearly $3.1 billion, with growth in their Industrial and Automotive markets.

ADI's strong profitability reflects its portfolio's resilience and the premium it commands, but it is currently going through a period of customer inventory reconciliation due to the weakening macro backdrop and ADI's rapidly improving lead times. ADI is confident it will return to growth quickly and deliver on its long-term model of 7-10% revenue CAGR, due to its diversified customer and product portfolio and flexible hybrid manufacturing model. It is also well-positioned to capitalize on the growth of sustainable use cases, which currently represent about 1/3 of its revenue, due to its involvement in the evolving electrification ecosystem.

ADI solutions are being used to support the shift to renewable energy sources, such as electric vehicles and global transportation, to reduce greenhouse gas emissions. These solutions are used to upgrade the grid infrastructure, enabling bidirectional flow of energy and providing precision monitoring and data creation at the heart of the digital substation. Fossil fuels are the largest contributor to emissions, and energy consumption is expected to increase by 50% by 2050.

ADI is a leader in energy storage systems, with their BMS technology used in 60% of such systems. Their BMS technology helps to maximize the battery's lifetime value, and is also used in EV charging stations. ADI's eighth generation BMS solution is designed into 16 of the top 20 EV manufacturers, and their wireless BMS solution is also designed into four OEMs. This technology helps to increase range and lower cost, and enable quicker and more cost-effective production cycles.

ADI delivered nearly $3.1 billion in revenue in line with their guidance, driven by year-over-year growth for both Industrial and Automotive end markets. They believe their wireless platform will represent a large portion of their BMS revenue by the end of the decade and they are developing a silicon carbide-based smart switch for bidirectional onboard charging that will reduce charger size and weight. They are confident in their future due to their cutting-edge technologies, talent base, and the increasing semiconductor content per dollar of CapEx.

Analog Devices reported a 7% sequential decrease in Industrial revenue, which represented 53% of total revenue, but a 4% year-over-year increase. Automotive revenue, which represented 24% of revenue, decreased modestly sequentially and increased 15% year-over-year. Communications revenue, which represented 12% of revenue, decreased double digits both sequentially and year-over-year due to an inventory correction. Consumer revenue, which represented 10% of revenue, increased 15% sequentially but decreased 21% year-over-year. Gross margin of 72.2% declined sequentially due to lower utilization and product mix, and operating expenses of $752 million were roughly flat year-over-year and up sequentially. Operating margin of 47.8% contracted 230 basis points year-over-year. Non-op expenses were $57 million, and the tax rate was 11.2%. EPS came in at $2.49 within the guidance range. The balance sheet ended the quarter with over $1.1 billion of cash and a net leverage ratio of 0.8, but inventory dollars increased and days of inventory moved higher to 179.

ADI's CapEx was $325 million for the quarter and they anticipate tax credit and grant funds from the US and European Chips Act. Over the past 12 months, they have generated $3.7 billion of free cash flow and returned nearly $5 billion to shareholders. For Q4, they expect revenue to be $2.7 billion with an operating margin of 44% plus or minus 70 basis points and an adjusted EPS of $2 plus or minus $0.10. This outlook reflects macro softness across all end markets, geographies, and customers due to inventory corrections and improved lead times.

Prashanth thanks the ADI Board, finance staff, and shareholders for their support. He also explains that the company is taking measures to preserve their balance sheet, cash flow, and income statement. They are reducing external wafer purchases and OpEx to decrease inventory. Despite the softer environment, their gross margins will remain at 70%. The company returns 5% of their market cap to shareholders and Prashanth is looking forward to seeing them on the road. They then move on to Q&A.

Vincent Roche suggests that the current inventory correction is due to two factors: the inventory digestion that has been occurring for the past 18-24 months and the macroeconomic situation. He believes that the direct side of their business has already shipped the low-end consumption in the third and fourth quarters, which suggests that the inventory correction may be close to completion.

Prashanth's departure was acknowledged and the next question was asked by Vivek Arya regarding seasonality in Q1. He asked if it could be worse than mid-single digit and if ADI could maintain gross margins above 70%. Svanberg and Lucarelli responded that they are not ready to call the bottom yet and the inventory digestion period could last for a few more quarters. They added that they have been managing their factories and inventories carefully and taking a long-term view to customer demand, avoiding forcing them into long-term supply agreements. They concluded that they expect a recovery in the next two to three quarters and it depends on the macro-economy performance.

Prashanth Mahendra-Rajah discussed the Q4 guide and the need for more turns and positive book-to-bill to achieve better strength in the channel. He also noted that all end markets are down quarter-over-quarter, but that there is no reason to think that the first quarter will be down more than mid-single digits. He also mentioned that the gross margin story was successful, with Q4 being down 17% from the Q2 peak, and still maintaining a gross margin of over 70%. He also reminded everyone of the 14-week quarter in Q1 of 2024.

ADI's Comms business has two components, wire line and wireless. The company is expecting to see a two to three quarter year-over-year decline in reps, which is similar to what their peer rival competitor, TI, experienced. However, pricing and product stickiness is very stable and resilient.

Vincent Roche discusses the malaise in the wire line part of the business, expecting it to recover in the second quarter of the year. He notes that wireless is harder to predict due to dynamic factors, such as 5G deployments in developed countries, but that India has been strong. He also mentions that there are trends that will transcend the inventory digestion problem, such as digital healthcare, aerospace and defense, and sustainable energy.

Prashanth Mahendra-Rajah and Michael Lucarelli discussed how the extra week in Q1 would affect the company's revenue and operating expenses. They stated that, on a 13-week basis, the business is normally down 5%, but with the extra week, it adds 7.5% to both revenue and OpEx. In Q2, the company will experience a 7.5% headwind due to the extra week being removed.

Stacy Rasgon asked about OpEx into the next year, given that the revenue is likely to be down. Prashanth Mahendra-Rajah stated that they would make adjustments on the discretionary side, but would not make meaningful cuts to spending. Michael Lucarelli added that they were aiming to maintain a 70% gross margin and an operating margin of 42-45%.

Prashanth Mahendra-Rajah and Vincent Roche of ADI discuss the Auto end market and its expected performance. They note that ADI has grown for 12 consecutive quarters, and that their outlook is end market units driven. They also point out that there has been an increase in silicon value in cars, and the switch to electrification is in its early stages of adoption, which could provide some growth drivers that transcend any economic malaise.

ADI requires distributors to provide sell-through data on a weekly basis in order to do business with them. This data is used to manage the company and in the second quarter, ADI had gotten ahead of themselves in China and intended to undership China in the third quarter. They are now intending to undership all markets in the fourth quarter to bring channel level inventories down. ADI has limited direct data visibility into their end customers inventory levels, except for those customers with consignment.

Vince Roche discussed that the company has seen their customers' growth accelerating compared to their own, and that they are now able to get their products to customers within 13 weeks. Michael Lucarelli added that the shorter lead times are a good indicator of what customers need to hold in terms of inventory. Toshiya Hari asked if the company would be able to pass on cost savings to customers if foundry pricing improves in 2024, and Prashanth answered that the Days of Inventory (DOI) is currently 50-60 days higher than pre-pandemic levels.

Vincent Roche and Prashanth Mahendra-Rajah answered a question about pricing and the Days of Inventory (DOI) target. Roche noted that the product life cycles for the 75,000 product SKUs are strong and that they are increasing the value of their products each year. Mahendra-Rajah stated that inventory grew by low single digits sequentially and they are confident they will exit Q1 with at least $100 million less inventory value. He also noted that the DOI target will not be 180 days, but that it will not reach 120 days either. The next CFO will be responsible for blessing the model.

Prashanth Mahendra-Rajah explains that the company is under-shipping to help their distribution partners reduce inventory levels, and that lead times have improved. Michael Lucarelli adds that the company typically underships consumption in the first quarter, as it helps reduce inventory.

At the end of the year, customers tend to reduce their working capital, leading to a 5% decrease in consumption in the first quarter. After this, consumption should return to normal, but the macroeconomic conditions of the second quarter are uncertain. Analog Devices will be on the road this quarter, visiting New York, Chicago, Florida, London, and San Francisco.

This summary was generated with AI and may contain some inaccuracies.