David A. Zinsner – Vice President-Finance and Chief Financial Officer
Ali Husain – Director-Investor Relations
Analog Devices Inc. (ADI) Credit Suisse 2013 Annual Technology Conference Call December 3, 2013 12:30 PM ET
Why don’t we go ahead and get started this morning? Welcome everyone to the presentation of Analog Devices. It’s my pleasure to introduce both Dave Zinsner to my immediate left, the Chief Financial Officer of ADI and Ali Husain, the Director of Investor Relations.
In lieu of me asking my first question of position of the company, which usually allows me to – kept my breath between meetings. Dave has put together a couple of slides that he is going to go through and then we’re going to open up into a Q&A format. Hopefully this will be an illuminating conversation, because there is not a lot of light on the stage, but Dave, I’ll turn things over to you.
David A. Zinsner
I just put together a few slides for those that are unfamiliar with the company. Most of you I see familiar faces, but most of you obviously know a lot about ADI, but for those who don’t let me just go through just a few high level slides, give you a sense of what we’re about.
So this is a breakdown of our business by product type. You can see converters, I don’t know what that color is, bluish color. That’s about 50% of our business, is made up of data converters. These convert analog signals to digital signals or digital signals to analog signals.
Another quarter of business is amplifiers or RF products and these are exactly what you might think. They amplify the signal or they capture a signal. In each case we have the number position on a high performance side and data converters were number one position at 50% market share and on the high performance amp side, we have about 48% of share.
And then the rest of our business is broken down into three components. One is power management. A lot of other companies have a much larger position in power management and a lot smaller position in the converter and amp space. We take the other tact. We generally focus in the converter amplifier space and we have a small kind of niche position in power management.
We also have some digital capability. So we do have a digital DSP line. And then everything else we can’t figure out where to put it. We dump it into other analog. A lot of big significant portion of that business is actually MEMS product. We make a MEMS motion sensor, most of those products go into the automotive space that sense the relative position of the vehicle and generally it activates some sort of safety system or fire [indiscernible] or so forth.
That’s generally how we breakdown. If you look at our market share over time, both in converters and in high performance amps you can see that the market share over the most recent last four, five years have been steadily kind of trending upward and goes to, I think some of the questions in our earnings call that we had last week, seem to have some question around, are we loosing share. I think we can effectively say based on third-party data [indiscernible] we have been gaining share in the significant positions we have.
One of the reasons and again we had thresh in the call, our growth rate has been relatively rapid in the more recent periods, the last few years and so one of the questions is what is really driving that. And of course everyone is suffering from slower growth environment given the macro environment that we operate in. But for us we’ve also had something going on within the business where we’ve steadily been kind of shifting our R&D resources away from products that go into the consumer space and invest more in the areas like industrial, automotive and comp infrastructure.
And so, although those businesses have done pretty well, the consumer business has compressed and so that has kind of driven the growth rates for the [indiscernible] level, barely reading that, but I can remember what I said, getting old. And then also the other thing, fundamental thing about our business is what we’ve done recently. Analog Devices has always been a very profitable model, but more recently over the last four, five years we’ve generally kind of restructured both on the cost side and on the operating expense side to get better margins.
And so you can kind of see and we have been operating, I think prior to the 2008 period and generally running around 60% gross margin and we did some things to fundamentally improve those gross margins. And last quarter we had, I think, 65.6% gross margin. So it’s 500 basis points better in terms of gross margin than we had in the past and that obviously translates into higher operating margins.
And we’ve also done some things around both [indiscernible] and investments within R&D and in SG&A to also kind of lift up the operating margin. So we had always been kind of in the low 20s to 25% operating margin and today we generally go kind of high 20s into the lower mid 30s and we’ve operated as high as the high 30s in terms of operating margin.
I’m getting really questions I commented on and hopefully it’s evenly reflected [ph]. And we also do a lot to return cash to shareholders. We’ve been steadily ramping our dividends. I’ll change this and invest like that and also doing buybacks to further augment. We’ve provided or given back $7 billion both in the form of stock repurchases and dividends over the last seven years or eight years. And that’s it.
David A. Zinsner
And now your can ask questions.
Because you ended with the dividend question and sort of the cash back to shareholder, which will become a more important theme within the Analog space. I think you guys have kind of turn out a longer term target of 80% of your free cash flow is kind of what you want to get back to investors. Year-to-date I think you’re closer to 55ish percent. How should we think about the catch up, if that’s the right term to use? And you started to aggressively buyback stock the end of the last quarter.
David A. Zinsner
Is that the preferred mechanism to get to that 80% level from here?
David A. Zinsner
Yes, so I think that there are obviously two forms to get cash back to shareholders. One is in the form of dividends. One is in form of share repurchases. The dividend, I would generally expect that to be about – kind of the 80 that would be two-thirds, 70% of how we get cash back to shareholders. The idea around the buyback was, and as we look back in history the problem of buyback generally has been most companies when they feel good about things that’s when they go and buy back the stock and generally that’s been of a tiny perspective, kind of the worse time to buyback a stock. It’s generally I need stock [indiscernible].
So what we wanted to do was try to be a little bit more disciplined around that and try to take advantage of the volatility that’s going to always exist in the stock price and hopefully by on the debt. So let’s not to say, I’m going to sit there and time Armageddon, I know when Armageddon hits, we’re going to buyback stocks. But it was more around the stock kind of trends along, it has some periods worth it sounded, the idea was to buy the stock during those good periods.
I think in the way we tuned the buyback programs, we – it’s never really got to the identified depth that was supposed to in order to trigger the buyback. So what we did was we kind of tuned the – retuned the buyback program, so that smaller amplitudes would cause up to buyback the stocks and we did that really in the last month of the quarter in November.
So we bought so it obviously triggered the buybacks, we bought back, I think $46 million was the buyback in dollar terms, so it equates about a 1 million shares of stock, but that was really one month of the quarter. So I think you can kind of extrapolate that out over a three months timeframe to say. It was probably on a normalized basis like a 3X, so it would be in the $150 million, $140 million – $150 million.
And is the philosophy to offset solution interaction bring down?
David A. Zinsner
So to bring back to share count, I kind of roamed around in relating to your question, so the idea is to buy, it’s definitely get back 80% of the cash flow at a minimum. And so good chunk of that obviously could come from the dividend to buyback, we now retuned to make sure that the buyback gives back the rest. And we do have a little bit of catch up to go, because we were kind of under the 80% threshold in prior quarters.
So I think you will see hopefully it starts, it ramps up and goes beyond my wildest dreams and you never actually end up having a trigger of the buyback, but I’m smart enough to know that there will be periods in terms of where volatility plays in favor of the buyback program. And so I would expect that we will return more than 80% in 2014.
Did you guys just recently reported earnings on, my guess is that next question is not going to be originally probably asked few hundred times in the last four or five days, but if you look at the guidance for your January quarter, and while it is inline with sort of three year seasonality, you go back further seasonality over the last three years down 5% to 10%, the 10-year number I think it sound closer to 3% to 5%, and so can you – I wonder if you could put the guidance into perspective. There hasn’t been a trend that the later you reported as the chip company the worse your guidance seemed to be relative to earlier reports. And so is this a function of momentum leaning for the industry, is this still macro overhang, is this issue that the consumers still coming down as a percent of your mix, kind of give us the sense as to why you got really did?
David A. Zinsner
Yes, as in all cases, there is a combination of things that drive. I keep saying that in macro world has really not turned out in a significant way. I think we said on the call, we do – we are hearing from customers they are kind of marginally more optimistic about this year than they were in 2013. And they were more optimistic in 2013 than they were in 2012.
So that’s a good sign, the things could be on a path of recovery. This quarter is an interesting quarter in that we have three periods of time within this quarter for us mainly because we have this kind of October to January or November rather to January kind of quarter, that we have three periods within that quarter where we have this kind of softness recourse. One, is obviously during the Thanksgiving period not surprisingly North America tends to be a little soft during the Christmas period, most of Europe and U.S. are softer which of course all the calendar quarter companies will experience, but then we have the added effects of the [indiscernible] New Year will hit us at the end of January which last year didn’t happened in the second quarter.
So the good news is we got likes of weakness things that happened, kind of behind us in the first quarter and hopefully the second quarter is a lot better. So I will guess that factoring in – this extra kind of week of malaise [ph] will calling into the January quarter probably caused that two points sequentially.
We also sold our microphone business and that probably added another point of softness due to our number relative to what peers might have seen or relative to our normal seasonality. And there was on the margin, a little bit more weakness in consumer, this coming quarter, because of this kind of transition away from investments. I’m not completely away, but in certain cases away from investments in the consumer space and more into the industrial, comm infrastructure and automotive.
So I think, you strip away all the things and then starts to line it up, I think it tracks very closely to what every other peers that, and I think it tracks pretty closely to longer term kind of seasonality. I think it’s a reasonable conclusion is that given that you got all that weakness, it all hit you in one quarter, should the second quarter be pretty good quarter. I think, yes, it’s early to tell and we don’t have backlog yet for next quarter. But I do think that the logic would tell you that second quarter lines up [indiscernible].
And then Dave, you mentioned that consumer has been a headwind for you guys and I think on the supply, it kind of peak to the mid-20 level and you’re down now, I mean 15%.
David A. Zinsner
Conceptionally, how do you think about the consumer opportunity? Is that 15% to 25% the right opportunistic range or now at the low end or do you think that longer term is just not a great market for you to be in relative to your overall corporate margin profile?
David A. Zinsner
Yes, it has a little left to do. I will say we don’t sit there and think about all that across below some magic threshold on gross margin. But this is not a good business right now. I think we look at it more kind of from the standpoint of saying, can we do something unique and innovative and differentiate it that customers are really going to see the value and face the value, and then of course transcend into gross margin.
But that’s really the way we go at it, and we run a number of different areas where you just – you couldn’t make that case any more, and so we shifted the investments away, and we used to – that’s in a real drag on our growth rate. I think most of that is actually kind of behind them so.
I think the businesses where we’re in today are there either areas that we do still have some differentiation or we have differentiation because they operate like industrial businesses, they have long life cycles, like consumer kind of – audio systems and so forth and broadcast [indiscernible].
But as now we look at the consumer business say, okay, what’s the future, what we do? I do think that there are opportunities particularly in kind of more affordable areas where we do have innovative technology, that I think intersects with what those customers need and where we can sustain over a number of generations from technology that could be really innovative for the customer and provide good value to ADI and so.
My guess is that we probably have hit the low point in terms of percentage of revenue for consumer. I doubt it gets up to 25% value. I don’t know it has that biggest swing. I think it can grow in at rates that are relatively consistent with the rest of our businesses like automotive and differ, and should stay roughly in this percentage, and may be a little more, and may be back to that level depending on the quarter and the cycles.
And [indiscernible] by the way for ADI speak that’s company structure.
There is a couple of ways to out grow the industry. One is to be levered to teams will be in [indiscernible] that are just growing faster. The other is market share. The good news, bad news of your dominate sharing converters and amplifier, it’s hard to see the share gains and so as we as investors think about your growth related to peers, what are the top three, you think growth drivers, is it allow you take to out perform your peer group?
David A. Zinsner
Well, I’m going to give you one and then I’m going to transition to something that more strategic. So the one area that I think, clearly has opportunity as well are corporate average and probably a lot of business is outside of ADI, is the automotive space. I mean there is a ton and we’ll continue to be a significant amount of semiconductor content increasing semiconductor content within automotive account.
And this is a very difficult place to play. This isn’t something you rollout a [indiscernible] Armageddon and get in the automotive space. I was at one of the leading module guys in automotive continental I visited them maybe three weeks ago. And they flashed up the list of demand, the portion they expected from customers, and one of them was their quality level with zero parts per million. And that was virtually impossible, and we have a – our quality level to half a parts a 1 million for the company which is incredible low.
I mean that’s probably best-in-class in the industry, and they are expecting zero. So they don’t really expected to get zero but it sets the tone of what they really want and what they value. So to get to that level of quality is really, really difficult and get the performance and all those other things that they required.
So I think that is a position where we have good, most around it, we have very good technology. We also have MEMS which not a lot of other analog companies have, and it’s a thing we – it’s a technology that we can really exploit in that into that space.
The other thing, I would tell you which is an other area concluding automotive in differ and in the industrial spaces. The other advantage I think we have as a customer to out grow or as a analog company is to out grow, is we have this kind of entire signal chain understanding which most of the analog players in the space, they are mainly more focused power or they have little bit compete this. And most of the customers out there and this was one of my – I don’t visit customers often, because all they want to talk about is payment terms, when I come, but I did go out there and we got through the payment term discussion and what is really amazing about them is, their need now is increasingly to push a lot of the R&D design of to the suppliers.
They’ve got a limited amount of resources. They can put in hardware or software so they putted it mostly in the software space, they put half – few guys, few people is doing hardware and they just don’t have the resources to be able to provide complete system. So that’s incumbent on the supplier really do that and they are very few companies that have a really good breadth of capability in that space. And that’s the way, I think overtime, we out grow all the competitors in a lot of different markets. And not just in one specific unique market it is about creating systems that just elegantly solve the problems that the customers are looking for, and looking for to be solved in a way that very few company can do.
Did your well leveraged anyone of coverage universe see that comm infrastructure market, maybe one of the audience have been waiting for that TD-LTE build-out in China or just the LTE build-out in general. As you look out over the next couple of quarters, how would you characterize the demand outlook for the comm infrastructure space?
David A. Zinsner
Yes, so here again I’ve taken opportunity to point out my customer visit, so I, like everyone else, has been frustrated by that – one of the thing that ramped and you hear a different story everyday. Of course I’m talking to guys that run the comp business and even they don’t seem to know. And a lot of them were telling me that really the OEM can’t even accurately predict that, basically to miss that. And then I was visiting, call it a large OEM is Europe, and we were discussing when they’re going to roll out and they were giving me this gobbly goop thing and I went, holy crap, they don’t even know. I mean they have no idea.
So I think based on the processes that takes place in order to get everything all set up to be able to deploy base stations, most of those things have been ticked off. So my guess is that we’re within the next six months and we start to see some ramps, but I hesitate to promise that because there is so many things that enter into that equation. One of the guys was telling me that at the end of day in China a lot of these decisions were made at the province level. And so even though I think analysts that run around and say, I know how much Huawei has gotten, I know how much Ericsson has gotten, really at province level they’ll be able to like change it in the mix. So it’s very difficult to say exactly when it’s coming, but I do think 2014 probably we’ll start to see the ramp. I doubt you’ll see the whole gesture of the 200,000 base stations in the 2014 based on…
Something is not as cheap as it was a year ago, but by historical standards it’s still pretty cheap. We talk a little about your organic growth opportunities. What’s the view on inorganic opportunities?
David A. Zinsner
So I think – well, we’ve always been looking for M&A opportunities. I’d say we’re pretty thoughtful about it. We have a high bar to get through for us to do an acquisition. And I think that for us we start with the customer and what the customer wants and think about what technologies we have within ADI that can solve that solutions and what things we can do at ADI to bolt-on. And then if there is one other thing out there, technology that we don’t have, then we’ll go look forward and try to acquire it and that’s really our strategy.
It’s not about – I mean, we don’t do it based on some mathematical principle of attrition, dilution because everything is accretive right now. We don’t do it because we got a hole burning in our pocket because we got a lot of cash, because we just have easily returned that to shareholders and do acquisitions with. It’s really fundamentally about the technology and whether we think we need it and can do it organically.
Any questions from the audience? David, another one from me then, more of an industry wide question, we talked about this, thirsty camel outside, but when you look at the FIA data and the Analog and you look at the ASP data, it is horrendous looking chart. Analog is supposed to be one of the spaces were ASPs don’t play in to the equation. It’s more about quality. It’s more industrial, automotive, infrastructure and consumer and yet every month including the class weekend when the FIA data came out, pricing got first. Everyone I talked to in the intellectual space were not seeing it and yet almost every company in my covered space is having company specific growth issues. Help me square the circle.
David A. Zinsner
Yes, I probably can’t square that. So I think it’s pretty obvious that there is a deep pressure in Analog. I’d say a lot of it is focused in the consumer space and obviously the reason we pulled off the microphone business was for that very reason. I mean, it has gotten, and the prices are surely gone too challenging.
So I think in a low growth environment, particularly when the larger OEMs in the consumer space are now of relatively small growth and that are purchasing a tonne of volume, they can command a lot of price control and so that creates ASP pressure. And so I think there is.
In industrial space, I’d be totally honest that I have not seen pricing pressure. And then even in the automotive space, we have kind of our normal price declines that we have to provide to the automotive space. That hasn’t deteriorated in any ways.
The [indiscernible] space, it kind of depends on the customers, some of them are obviously are way more focused on the cost versus performance and we try to steer our business into the areas where we think we can do performance rather than cost. But this is a competitive industry and there are price reductions.
Any other questions from the audience? With that Dave, we will end the discussion here. I really appreciate your time for me. Ali, thank you. Thank you everyone for showing up.
David A. Zinsner
[No Q&A session for this event]
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