As an analog giant with a gross profit margin of up to 70%, what is ADI worried about?
Latest update time：2019-08-28
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Recently, analog chip giant ADI released its Q3 financial report, which showed that revenue was $1.48 billion, down 5% year-on-year, but higher than the market expectation of $1.45 billion;
net profit was $362 million, down more than 11% year-on-year;
diluted earnings per share was $0.97;
adjusted earnings per share was $1.51, slightly higher than the analyst expectation of $1.22.
Their gross profit margin is as high as 70%.
However, at the subsequent performance exchange meeting, the company put forward their profound insights into the future of the entire industry and the semiconductor market.
The company's CEO Vincent Roche said that although we are experiencing some near-term external challenges, ADI has been and remains focused on achieving sustainable long-term profitable growth.
I want to discuss the emerging vehicle electrification ecosystem that is supporting many foundational industries, from energy to transportation to manufacturing, paving the way for the transition to cleaner energy.
ADI is also focused on using energy most efficiently, and I am proud to say that we play a major role in this new wave of electrification.
We look at automotive electrification from an ecosystem perspective.
For ADI, the origins of our journey began with battery products, then expanded to the ongoing management of electric vehicle battery systems, and then to powering EVs.
The commonality in all of these applications is that they require precision signal processing, control, and power management capabilities, which all involve capabilities that ADI excels in.
Our value journey begins with battery product formation and testing, a time-consuming and complex process where extremely precise measurements are the difference between high-quality and low-quality batteries.
The lithium-ion batteries that power electric vehicles account for almost one-third of the entire cost.
Therefore, OEMs place great emphasis on battery quality and reliability.
Our fully integrated precision signal processing, control and power portfolio enables ADI to provide customers with the highest levels of accuracy, safety and reliability to meet the requirements of battery composition and test processes.
Our solutions reduce battery costs by two-thirds, reduce customer equipment footprint by 4 times, and achieve up to 95% power reuse while reducing environmental impact.
Once battery systems are developed, our opportunities will grow as vehicle electrification applications grow.
In this regard, our technology is a key enabler in the transition from internal combustion engines to clean electric vehicles, which are expected to grow from 2% of global sales to more than 20% in the next decade or so.
In vehicles, the battery management system, or BMS, provides precise monitoring and control of the complex charge and discharge cycles of the battery system.
The accuracy and safety of the BMS are critical because overcharging or undercharging can damage the battery and render it ineffective.
The accuracy of the BMS is also a key determinant of EV performance, and accuracy needs to be maintained under extreme environmental conditions and over a period of use of more than 10 years.
Such application challenges are very suitable for ADI, and we once again use our deep heritage and precision measurement to provide optimized solutions for battery management.
We have the industry's broadest IC product portfolio, supporting all battery voltages from 48 volts to 800 volts, covering entry-level to full-range premium electric vehicle products.
Our products are also designed for harsh environments, giving us 20% more mileage per full charge than our competitors.
We offer the highest level of automotive functional safety, a robust set of safety diagnostics, and are easy to integrate and use.
With these advantages, we now have a leading position in key markets in the United States, Europe, and Asia, and we believe BMS revenue can continue to grow at a double-digit annual rate, and we will continue to drive innovation.
Subsequent developments in our BMS roadmap include architectural innovations that will address the challenges of power density, precision and weight, including the ability to communicate wirelessly and robustly.
Finally, our opportunities extend beyond the car to the charging station infrastructure that powers the electric vehicle.
Charging stations face unique challenges because they have intermittent demand and peak demand.
And they must also efficiently and economically meet consumers’ demands for fast charging for their EVs.
The accuracy of our BMS solutions can reduce the total cost of energy storage systems by one-third by extending battery life by 2x and reducing maintenance costs.
As demand for batteries increases, we are beginning to see a push to extend battery life by enabling reuse for battery and infrastructure applications.
We believe that ADI’s best-in-class measurement capabilities will become increasingly important as the market matures and reuse programs are deployed.
Electrification is therefore a very valuable long-term opportunity for ADI.
It presents many difficult challenges to our customers and opportunities to us.
Through battery management, power conversion, connectivity, and isolation technologies, we provide innovative solutions that enable us to capture revenue growth opportunities in the current and future electrification ecosystem.
Speaking of cooperation with Huawei, the company's head of investor relations, Prashanth Mahendra-Rajah,
said that in the first few weeks of the third quarter, the Department of Commerce added them to the BIS entity list.
ADI immediately suspended shipments of related products.
After a thorough review of export administration regulations and entity list restrictions, we determined that we could legally resume shipping selected ADI products to this customer.
We are monitoring this dynamic situation closely and believe we are well prepared as it evolves.
The scope, duration, and long-term financial impact of the export restrictions remain unclear and difficult to predict.
However, at least in the short term, our shipments to Huawei have been significantly reduced from prior levels.
As a result, we expect sales to this customer to be below the range we previously forecast.
For reference, if we measure the fourth quarter with the business we do with Huawei now, B2B is basically flat.
Operating margin is expected to be approximately 40%, non-operating expenses are expected to decrease by approximately $5 million sequentially, and the tax rate will remain in the 13% to 15% range.
Adjusted EPS is expected to be $1.22, plus or minus $0.07.
In closing, we are pleased with our quarterly results given the current macro and geopolitical environment.
We will manage our expenses prudently while also investing strategically in areas that continue to position us for growth over the long term.
During the question and answer session, the company went into great depth and talked about their views on the industry.
Q:
I think one of the consequences of the US-China trade dispute is that Huawei has established base station business with non-US suppliers.
Can you explain from your perspective whether it is easy for Huawei to do this?
Do you think Huawei is just a temporary problem for your company, or do you think there may be real long-term losses as Huawei tries to reduce its dependence on US component suppliers?
A:
We have been in business for nearly 55 years and we have been competing with companies from all over the world in various business areas.
But I would say that overall, our 5G base station products in radio systems have the highest performance in the industry.
Whether it is the Chinese equipment manufacturers that adopt our products, or the customers in Europe and South Korea, they all think so.
As these products become more and more complex, performance becomes more and more important, and this is what we focus on, and no one can match us in this field.
Regardless of the Huawei situation, we are already well penetrated into all OEMs around the world.
So no matter what happens, we will grow in 2020.
So competition is just one aspect of doing business, and we are ready with the product portfolio that we already have and the products that we are about to launch.
The limitation that we have in supplying Huawei is on the 5G product side, while our traditional 4G products can be shipped and, as far as I know, will continue to be shipped.
So this is also an evolving situation, and we are doing everything we can to meet the needs of all our customers.
Especially in China, we are seeking the licenses that are required to support our operations in the short to medium term.
Q:
Excluding Huawei, your B2B business is said to be flat year-on-year in the October quarter, which is significantly better than your peers. Do
you think bottom-line drivers in industrial and automotive may help you drive year-on-year growth?
A:
Yes, I think it's not just communications, we're very happy with the strength of our industrial business, but if you exclude Huawei, the growth in industrial business was pretty flat year-on-year.
If you turn to automotive, it's down about 10%, communications is also down 10%, if you have to exit the cooperation with Huawei, our communications business will also be up year-on-year again, we think our communications business volume will increase sequentially in the 11th and 12th quarter, which is related to the breadth of our customer base portfolio.
If we take out the B2B and consumer businesses, it's down about 20% for the year.
We have a much more diversified broader base business, particularly in automation.
I think all markets are weak right now given the high capex requirements.
Memory test has been weak for a year now, and it would be a surprise if it continues to be tepid.
I think the area where we see the strongest potential right now is aerospace and defense.
In fact, a record defense budget was just passed in the U.S., which is up about 20% year-on-year, and we're seeing good growth in all of the sub-applications in aerospace and defense.
What's driving a lot of the growth is the combination of Hittite's microwave and RF technology with ADI's mixed signal products, and we're starting to bring LTC more aggressively into that space as well.
That's where the growth is going to be in the aerospace and defense business going forward.
Healthcare continues to do very well.
I think there's a real opportunity, and I think there's an inflection point in the health space.
It's right at the knee of the curve, so to speak.
So we're well positioned for it, whether it's large medical devices or clinical-grade patient monitoring systems.
Electronic test and measurement is also doing very well, again, given the growth in 5G, BMS, very high frequency automotive radar safety systems, and so on.
Q:
You said you expect to grow very well over the next 20 years.
I was hoping you could elaborate on what that is?
This period is when 5G really starts to become popular, because by now many areas have already surpassed 4.5G.
A:
I think 5G is one of the most exciting things that has been introduced in the information and communications technology space in many years.
I believe it will be widely available.
It's in the early stages of deployment now, and we can expect a multi-year development cycle.
I think one of the big things about 5G is that it will really enable B2B users to change their business models and the products they provide to their customers, whether it's industrial, whether it's healthcare, critical connectivity to the system is really important.
So I think it's not about the consumer side, it's more about the B2B side.
Data is doubling every two years, so the need for bandwidth and very low latency is real and will not abate, it will continue to intensify over time.
The only way to address this is to provide more spatial or spectral efficiency.
So I think what we are seeing now are very early deployments, and radio is one of the most important factors in the development and deployment of these new 5G systems.
I think over the next 3 to 4 years, we will start to see the virtualization of the network and the introduction of more aggressive microwave technology, which will be the next generation of 5G technology.
As I said in my previous comments, we are already in a very good position technically.
From a performance perspective, the problem of base station construction is getting more and more serious.
And our investment layout is well ahead of the needs of our customers.
In terms of the breadth and depth of the portfolio, we have it all covered.
I would also point out that LT's power portfolio is also very well suited to market needs.
This will bring another wave of growth, and we will start to achieve this growth in 2020, 2021.
Q:
You talked about electrification and BMS.
I'm wondering if you're seeing an acceleration in BMS and EV design in your conversations with your automotive customers, especially given the challenges of the SAAR environment?
A:
It is very certain that there is a general trend towards electrification of the powertrain, whether it is the equipment manufacturers in Europe, the United States, Japan or Asia.
We are very confident in our BMS product portfolio, which is our fifth generation.
I have also met with several equipment manufacturers in the past quarter, and I can tell you that they have a strong and urgent need to move to electric powertrains.
Currently BMS or electric powertrains account for about 2% of all vehicles, and this may rise by an order of magnitude in the next decade.
So, I think it is very real.
I believe that this trend that we are seeing is becoming more and more intense, which is very good for us.
Q:
I think one of the interesting things about ADI is what you guys are seeing in 5G.
So I wanted to confirm what you guys were talking about in terms of 2020, if we assume that Huawei is completely locked out, do you still believe that we're going to see significant growth in the communications space?
A:
Yes, absolutely.
Communications has a very good share of our entire ecosystem, and there are two sub-areas where we see additional content.
In the products in this system area, our silicon content is about 4 times that of traditional 4G products.
And then when you move to higher frequency millimeter wave, the additional silicon content is more than 4 times, which is also an opportunity for ADI.
This is the opportunity for ADI Hittite product portfolio as well as Linear.
Q:
In the industrial space, you have share.
What do you think the overall market is contributing to the industrial space?
What do you think you can sustain over the next few quarters?
Can you continue to take share from companies like Texas Instruments?
A:
This is a core area, it's about half of our total company revenue.
About seven to nine years ago, we restructured the entire portfolio of the company from an R&D and go-to-market perspective to be more focused on B2B applications, and industrial has been a priority.
So I think we're seeing the benefit of the new products we're able to launch in that area.
We have a lot of exciting new things in the pipeline that are at a critical stage in terms of bringing in revenue.
Our customer needs also continue to evolve, and I would say that seven to nine years ago, we were primarily a component provider.
Now we offer different form factors of solutions, collections of components, more highly integrated products for different types of applications.
So I think in many ways, what we do is a lot of very targeted activities that make us stronger in the industrial space.
Q:
You talked a lot about the BMS side, and I wanted to follow up on that.
When you think about increasing the technology requirements in your portfolio and how you invest, I think it's about 5% of your revenue today, where is that going to be five years from now? And
how do you think about the competitive landscape changing as we start to get into electric vehicles and hybrids?
A:
We're playing the high-end game.
Our product portfolio is targeted at mid- to high-end applications, and we're able to leverage our strength in precision signal processing.
That's really been the backbone of the company for the last fifty years.
I would say in terms of expectations on the growth side, my sense is that it's going to be a double-digit growth over the next few years.
Q:
In terms of outstanding debt, are you focusing 100% of your free cash flow on buybacks and dividends and not on paying down debt?
A:
We generate a lot of cash in our business.
We feel very comfortable with the debt on our balance sheet compared to where we were operating a few years ago, and I don't think we've ever been this cash rich.
We're focused on maintaining our investment grade rating, so we'll be watching the broader interest rate environment and how the rating agencies view us to make sure we maintain our investment grade.
But we're still going to burn a lot of cash.
We just did an adjustment.
We shortened some of our five-year targets a quarter ago.
So expect us to continue to push that.
I would emphasize that we have reduced our equity in 2019.
We'll continue to do that in 2020.
Q:
On vehicle electrification, in terms of your positioning and long-term growth drivers, a lot of suppliers are noticing short-term market weakness in China just from a subsidy perspective and demand uncertainty.
What are you seeing in the short term in China?
A:
We have a market-leading position in the market.
China is a very large market for us.
I would say we did grow L last quarter, but not as much in BMS as in Q2, we are still growing.
It's a large infrastructure deployment business.
We are still growing double digits year to date, and we expect to grow again in Q4, even with the challenges in the Chinese market.
For us, it's not just about managing the battery as efficiently as possible.
We like to grow with the processors that test the battery.
We have LTC capabilities that help make the power more efficient, help expand the business, and we are also in the charging station business.
So for us, it's a much bigger opportunity to play than just focusing on the battery as the entire ecosystem continues to grow to support electric vehicles.
Q:
And in terms of the manufacturing business development and the integration of the actions that you're doing, when do you expect to see some synergies leading to changes in gross margins?
A:
We had a little bit higher inventory this quarter as we started to deliver channel inventory that was necessary to allow us to be able to close facilities in Singapore and California.
So we will need that channel inventory so that we can continue to serve our customers while it helps us get those facilities closed.
Our goal is to start achieving these inventory adjustments through P&L adjustments in 2021, early 2021, which we have announced in previous calls, an increase of $100 million on an operating rate basis.
Q:
On the OpEx side, can you talk about how you think OpEx is going to be in the fourth quarter,
given where the variable comps are on the metrics, or is there room to continue to drive down OpEx, or has it bottomed out?
And I guess given the continued softness in demand that you're seeing, what's the impact on OpEx?
A:
We had a significant reduction in operating expenses versus the second quarter.
We had sequential improvements in the third quarter.
We're taking steps to be roughly flat in the fourth quarter.
We're going to focus on the variable costs that we can control and continue to make OpEx controllable.
As we said before, one of the levers that we have is the compensation that we receive, and that will certainly be a factor in Q4.
Q:
Clearly the macro environment remains challenging and is not getting better in the short term.
How do you compare your view three months ago with your expectations now? Have
things gotten worse than you expected?
A:
I would say that the uncertainty and trade tensions between China and the U.S. have clearly increased.
I think there is uncertainty.
In the short to medium term, the PMI index and GDP have both declined.
So I think the headwinds have strengthened since last quarter.
I think technology is accelerating.
More and more innovation, R&D budgets are very strong in all areas around the world.
So I think clients are optimistic about the future, but investors may be a little less optimistic about the future than they were before the first quarter.
Q:
At the meeting in late May, you were very positive about a potential deal. Has the situation deteriorated now?
A:
I think both sides are working hard and both sides want to reach an agreement, but I think it depends on objective conditions.
The goal in the public domain is what both sides are pursuing tirelessly.
So yes, I would say that the situation now is not as I responded in May.
Q:
How will seasonality affect the January quarter?
Historically, it's been a positive quarter, but I know you've had volatility in the consumer business, and this time, you've got Huawei and the trade war.
What are you expecting now?
A:
I would say this is not a typical period.
I would warn you about that, we don't give an outlook.
Typically, the first quarter is a weaker quarter for us in the B2B business.
The industrial business is typically down.
I think the same is true for the communications market, which we talked about in the fourth quarter being weaker.
These are very volatile times, and I think you'll see an acceleration in the first quarter, which is our outlook for 2020.
But I think it will soon decline again in 2020, but to a lesser degree than in '19.
Q:
I know there's a lot of macro uncertainty right now, but when I look at your automotive and industrial business, it's down 6% year-over-year over the last few quarters.
The guidance you guys gave for October, I think it was up 2% year-over-year, you said industrial was actually flat year-over-year, which is much better than what you've seen in the last few quarters.
So I want to temper your comments on the industrial outlook for the October quarter with all the uncertainty in the macro environment.
It seems like your guidance was a little too optimistic.
A:
We see growth potential in a few specific areas, with aerospace and defense ranking number one there.
Our expectations stem from a number of reasons, budget increases in aerospace and defense, and the strength of the technology portfolio we bring.
Healthcare, as I mentioned earlier, continues to grow.
This is an area where we have been increasing our investments over the past 5-7 years, and it is an area that I remain very optimistic about and will be a very good source of growth for the company for many years to come.
The most meaningful contribution right now is coming from the industrial side, where we see potential to grow the market.
I know you're particularly focused on the change in trajectory in the fourth quarter, and I would remind you that on a year-to-date basis, the numbers that you cited are well ahead of the market overall.
So we're outperforming the market overall.
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