亞德諾半導體 (ADI) 2002 Q3 法說會逐字稿

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  • Operator

  • Good afternoon.

  • My name is Lacey, and I will be your conference facilitator.

  • At this time, I would like to welcome everyone to the Analog Devices' third quarter fiscal 2002 earnings conference call.

  • All lines have been placed on mute to prevent any background noise.

  • After the opening remarks, there will be a question and answer period with our analyst participants.

  • If you would like to ask a question, press star then the number 1 on your telephone keypad.

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  • You may begin your conference.

  • - Director of Corporate Communications

  • Hello.

  • This is Maria [TALEAFERRO] Director of Corporate Communications for Analog Devices.

  • If you don't yet have our third quarter release, you can access it by visiting our website at www.Analog.com.

  • This conference call is also being webcast live.

  • If you prefer to tune into the webcast, do so by clicking on investor relations from the ADI home page.

  • You can follow the instructions shown next to the microphone icon.

  • This call is also being recorded.

  • The recording will be available today within about two hours of the conference call's completion, and will remain available for one week.

  • The recorded call will be available by telephone and by the internet.

  • The earnings release contains replay instructions or visit the investor relations page of the website to access the recording.

  • Participating in today's call are Jerry Fishman, President and CEO, and Joe McDonough, Vice President for Finance and CFO.

  • We have scheduled this call for 60 minutes.

  • We'll begin in a moment with Mr. Fishman's opening remarks.

  • The remainder of our time will be devoted to answering questions from our analyst participants.

  • Analysts participating via telephone can press star 1 on their telephone at any time beginning now to ask a question.

  • I would like to point out that under the provisions of the private securities litigations reform act of 1995, this conference call will include forward-looking statements.

  • These statements are not guarantees of future performance and involve certain risks, uncertainties and assumptions which are difficult to predict.

  • Risk factors which may affect our future operating results are described in the company's most recent annual report on form 10K filed with the Securities and Exchange Commission.

  • All references to financial results discussed during today's call will refer to pro forma results.

  • Today's earnings release includes both pro forma and GAAP results.

  • Also, this conference call will include time-sensitive information that may be accurate only as of the date of this live broadcast, which is August 15th.

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  • Any redistribution, retransmission or rebroadcast of this call in any form without the expressed written consent of Analog Devices is strictly prohibited.

  • With that, let's begin and take our opening remarks from Mr. Fishman.

  • - President and CEO

  • Well, good afternoon.

  • Thank you for joining us today to learn a little bit more about what happened Q3 and what our outlook is for the next few quarters.

  • Sales in our Q3 were approximately $445 million, which were up 8% sequentially from last quarter and pro forma earnings per share were 15 cents.

  • At these levels, both revenues and earnings were in line with the guidance that we provided in last quarter's conference call.

  • Analog and DSP sales both increased sequentially with Analog sales up 6% sequentially and DSP sales increasing by 17% sequentially.

  • During our third quarter, both OEM and distribution sales increased sequentially with OEM growth of 12% and distribution growth of approximately 4%.

  • This is the first time in many quarters that our OEM customers substantially contributed to our sequential growth.

  • However, later in the opening comment, I'll describe when I segments most of this growth was derived from.

  • Gross margins increased sequentially by 60 basis points to 54%.

  • Gross margins were also up 110 basis points from last year's Q3 when sales were above the current levels and we had a somewhat richer Analog mix, which is generally a little more profitable.

  • Operating expenses increased 6% sequentially as we predicted last quarter, primarily as a result of the complete restoration of salaries after a full year of forced reductions, and also continuing selective hiring of design and field applications engineers.

  • We've made some very key engineering hires in Q3 from competitors who are struggling financially or are no longer in an attractive environment for the most creative engineers.

  • Since early this year, we've now nearly doubled our field applications support force worldwide to support our new products, and the poor economy we've been in has allowed us to attract some extrodinarily talented and very experienced field applications engineers.

  • It is this group of design and applications engineering talent that will lead us up to the next cycle and provide the opportunity for us to outperform all our competitors as we've done throughout the cycle.

  • Our current plan now calls for only nominal expense growth in our Q4 and also into 2003 until our operating expense ratio returns to our model of 25% of revenue.

  • Operating margins improved by 120 basis points to 15.4%.

  • As we continue to get good operating leverage as sales increase.

  • Our balance sheet remained extremely strong in Q3.

  • Given continuing signs of business recovery, we've begun to increase internal and external production levels to respond to current and likely future demands.

  • In addition, as we noted last quarter, we've begun to build die bank buffers as we accelerate our plans to transition internal manufacturing from our older 4 inch fabs to more modern six and eight-inch fabs around the world that are currently underutilized.

  • We anticipate inventories will grow next quarter as we complete the builds and then we'll begin to decline in early 2003.

  • Given our continuing, very complex product mix, our inventory goal remains 100 to 110 days.

  • Accounts receivable day sales outstanding declined in the quarter from 49 days last quarter to 46 days, in part due to a very linear shipment quarter.

  • Our cash balance increased by approximately $45 million to now $2.95 billion.

  • Capital expenditures for the quarter were only $14 million as we have ample installed capacity to more than double internal production levels.

  • We anticipate continuing low capital expenditures into 2003.

  • This will also provide very good margin leverage as sales continue to increase.

  • So overall, in summary, Q3 turned out to be just about what we'd expect it.

  • Just a little while ago, this afternoon, we put out a press release that our board of directors has authorized us to purchase up to 15 million shares of our stock in the open market.

  • We believe these purchases will be very attractive investment for ADI.

  • Orders for delivery in the next 13 weeks increased by a few percentage last quarter after increasing by 40% in our Q2.

  • Overall, our book to bill ratio remained above one and backlog for shipment in Q2 increased by 6% to approximately $285 million.

  • The order patterns were mostly linear throughout the quarter, including July, which is typically, of course, a weak seasonal month.

  • Orders were strongest for wireless communications appliances and infrastructure and for high-end consumer products.

  • PC-related orders were weak, as PC component inventories grew substantially during Q2 with most of our customers.

  • Orders for industrial customers increased modestly, in line with the gradual recovery of the economies in most regions of the world.

  • Orders were strongest for us in Japan and southeast Asia and in Europe.

  • Orders in the United States remained depressed, primarily as a result of continued weakness in the large U.S. telecommunication customers and only gradual improvement in many large U.S.-based industrial accounts.

  • Sales to our communications customers grew substantially in Q3, primarily as a result of continuing strengths in a broad range of power management, radio frequency, and DSP products for wireless handsets, for PDA's, and for many other wireless appliances.

  • A large part of the strength was in southeast Asia and, in particular, in China.

  • While base station revenues were up only slightly, orders from base station manufacturers for Q4 and Q1 delivery increased more significantly.

  • At 2.5G base stations are currently deployed and 3G base stations deployed in the future.

  • We're extremely well positioned with both Analog and DSP products to meet the most demanding needs of bay station manufacturers around the world.

  • Broadband revenues were approximately flat sequentially, at levels that are still well down from the peak.

  • DSL chipset revenues increased sequentially, primarily as a result of continued deployment of DSL's using ADI chipsets in southeast Asia and also in Europe.

  • Sales to other communications applications, which represent thousands of horizontal communications customers in every region of the world also increased sequentially as inventories returned to more normal levels.

  • Communications represents approximately one-third of our current revenues.

  • Based on customer feedback, we're expecting modest growth from communications customers in our Q4.

  • Revenues from computer customers declined in Q3 as a result of excess inventories that many computer OEM's caused by a continuing weakness in PC sales and the fact that they bought up a lot of inventory in Q2.

  • Nevertheless, our product position and market share remains very strong, particularly in power management and measurement, flat-panel displays and also in most advanced audio signal processing that goes into PC.

  • The computer market represents just over 15% of our current sales, and our sense is based on the current information we have, that our sales to computer customers will increase in our Q4.

  • Consumer revenues experienced another quarter of strong sequential growth in Q3.

  • Demand for high-end DVD player, digital cameras and high-end audio products, all areas where we enjoyed substantial market share remained robust.

  • Consumer products represented over 10% of our Q3 revenues, and we expect continuing growth from consumer companies in our Q4.

  • Revenues from industrial customers worldwide were approximately flat during Q3, but orders increased from Q2 levels.

  • Continuing weakness in the U.S. was offset by good sequential strength in southeast Asia and Japan within the industrial market we saw the greatest increases in medical instrumentation, industrial automation, and process control applications.

  • Revenue patterns from industrial customers will likely very closely follow capital spending trends worldwide.

  • Our best assumption is that this business will continue to recover gradually as the world economies continue their gradual recovery.

  • Industrial customers represented approximately 40% of our total Q3 revenues.

  • Based on stronger order trends from industrial customers in Q3, we would expect modest sequential revenue growth from industrial customers in our Q4.

  • And our sense of overall market conditions, remain much as what we said last quarter.

  • The demand for products that touch customers has improved, those that support telecommunication infostructure, and that the industrial base is slowly improving as the economy returns to more normal growth rates.

  • So now I'd like to move on and discuss some of the trends in our Analog and DSP businesses and also our sense of some of the most likely scenarios going forward.

  • Analog revenues was 79% of our total record in Q3, and as I mentioned earlier, grew approximately 6% sequentially.

  • Our Analog business today is operating at levels approximately 50% above the levels when this cycle began in early 1999, which is significantly higher than the overall Analog market, and also higher than many of our best high-performance Analog competitors.

  • This indicates that we have continued to build share in our Analog business over the past four-year period, and we've done that both in up and down cycles.

  • Most of the strength in our Analog business is the results of the very significant progress we've been making in our new product programs.

  • In fact, the lion's share of our growth in the Analog business is coming from products that have been introduced over the last 18 months.

  • We've been introducing record number of products throughout the cycle and the design-end rates of these new products are very encouraging.

  • Today, we have nearly 2,000 analogs, engineers at ADI in 20 locations around the world, working on the most advanced and highly integrated analog products in the industry.

  • We've used our financial strength during the cycle to even extend further our competitive lead.

  • Today, in our Analog business, we're receiving approximately 80% of our sales from proprietary products.

  • As we mentioned last quarter, despite the continuing strong growth in margin performance of our Analog business, we've undertaken a program to transition the internal manufacturing of older Analog products currently produced on four-inch wafers to more modern internal six and eight-inch facilities this.

  • This program will extend the life cycles of our older products while significantly reducing our infrastructure costs to produce these products as volumes increase.

  • This program, once completed, will reduce manufacturing costs by approximately $60 million per year and improve the gross margins of our analog business to levels approaching that of our best analog competitors.

  • In addition, once this transfer is complete, we can double our current analog volume with little additional capital and triple our analog output with only modest capital expenditures.

  • Our DSP business grew 17% sequentially, and now represents 21% of ADI's total revenue.

  • The strong sequential DSP growth is the result of stronger vertical markets, wireless, wire line and consumer DSP chipset sales, but also, and equally importantly, the high customer acceptance rate of our new black fin and tiger shark DSP's in the horizontal markets.

  • After an lighting many competitive DSP, the DSP laboratory, Berkeley design technologies out in California, as well as many customers, have today recognized that ADI has now claimed the technical high ground for high-performance DSP's, and that holds extremely well for our revenue growth over the next few years.

  • We're also very enthusiastic about our prospects for DSP in some of the vertical segments and wireless and telecommunications infrastructure and wireless appliances and high-end consumer products and our military and security applications as well.

  • As DSP revenues grow, we have very substantial operating leverage in this business as we amortize the currently high R&D investments over much higher volumes.

  • Based on the higher opening backlog and consistent ordering patterns from our customers throughout our Q3, we're planning for continued sequential revenue growth in our Q4.

  • Our best sense right now is Q4 revenues will increase to approximately $450 million to $460 million.

  • To achieve this goal, given $285 million of opening backlog, would require approximately 38% turns business, and that's down from 44% last quarter.

  • While our opening backlog could suggest an even stronger Q4, we're very mindful of the seasonality of Q4 and the still very volatile conditions in many of the end markets we serve.

  • Gross margins should continue to improve and operating expenses should be up only nominally.

  • This is plan to produce pro forma earnings per share of approximately 16 cents for Q4, which would be up about 7% sequentially from Q3.

  • Looking forward, we believe that the high-performance analog and DSP markets are likely to be the highest growth product category in the entire semiconductor market and single processing drives the growth market.

  • As we analyze the increasing signal content of electronic equipment and virtually every market segment, coupled with our technology leadership and high-performance analog and DSP, which are becoming the bricks and mortar of the signal processing age, we believe it's reasonable to plan for 25% average compounded growth rates for revenues going forward.

  • Clearly, some of this growth will be derived from growth in the end markets we serve, but we'll also be benefiting from increased penetration of high performance analog, DSP, and many new applications, and also our increasing market shares in these product categories.

  • Again, this creates an opportunity for ADI to grow at rates well above the average growth rate of the semiconductor market going forward.

  • We would expect to produce earnings growth rates at above these rates as we experienced strong operating leverage on both the gross margin and the operating expense lines.

  • Through the last up cycle and also the down cycle, we've continued to build our technology and product portfolio, we've significantly strengthened our organization, we've reduced infrastructure costs through the company, and at the same time we produced very respectable margins.

  • Since the cycle began in early 1999, we're one of the very few technology companies that today are operating at revenue levels well above those of early 1999.

  • We're very pleased with our performance throughout the cycle.

  • Our trough margins of this cycle approached the peak of the last cycle, and remain well ahead of the trough of the last cycle.

  • As the end markets turn and there's increasing evidence that they are beginning to turn, albeit slowly, we're expected to outperform the market as we've been now doing the past four years.

  • - Director of Corporate Communications

  • Thank you, Jerry.

  • During today's Q&A period, please limit yourself to one primary question and no more than one follow-up question.

  • We will give you another opportunity to ask additional questions if we have time remaining.

  • Operator, we're now ready for questions from our analyst participants.

  • Operator

  • For any of the analyst participants, by telephone dial-in, if you have a question, please press star and then the number 1 on your phone.

  • If your question has been answered and you wish to be removed from the queue, press star then the number 2.

  • If you're listening on a speakerphone, pick up the handset when asking your question.

  • We'll pause for a moment to compile the Q&A roster.

  • Ms. [TALEAFERRO] please go ahead.

  • - Director of Corporate Communications

  • Okay.

  • We're ready to take our first question from Adam Parker of Sanford Bernstein.

  • Yeah, hi.

  • You stated in the past a couple times that you expect 25% revenue around the DSP business over the next few years.

  • I'm just wondering, is that still your expectation, and in coming up with that, what do you assume about unit growth and ASP decline in getting your growth rate?

  • And further, on the DSP space, in the 17% sequential growth, can you comment on the general purpose DSP space, what kind of growth did you get there?

  • Thank you.

  • - President and CEO

  • Well, as far as the growth rate, what we said is that we expect our entire business, looking at a 25% average compound to growth rate, and I think that's probably true for both the analog and the DSP business.

  • I forget the second part of the question.

  • - Director of Corporate Communications

  • The general purpose --

  • - President and CEO

  • yeah, we saw growth in both our general purpose DSP business and the vertical market DSP business.

  • Probably a little bit stronger growth in the verticals, a little bit less growth in the horizontals, but still we saw good growth in both the horizontal and the verticals, and the horizontal markets, we're getting most of the growth as prototype orders from our tiger shark and our black fin products, which are new products that people are just beginning to design in in volume, and we'll start to see the growth rate in the horizontal markets, I think catching up to the growth rates in the vertical marks as those markets move into more production-oriented rather than prototype cycles.

  • And passing the growth rates from the verticals or --

  • - President and CEO

  • Well, I guess our sense is if we look at our DSP business over time, you know, we think that the horizontal DSP business will be approximately the same size at the vertical DSP business.

  • Okay.

  • And the other question was if you assume the 25% average compounded growth for DSP what assumption are you making about unit growth versus average selling price decline to get there?

  • - President and CEO

  • I think in the -- you know, it really depends in the horizontal markets, I think there's very little average selling price decline.

  • In the vertical markets, there continues to be average selling price decline, particularly in the very high-volume verticals, so I think it will be a combination of very stable pricing in the horizontal markets and continued average selling price declines in many of the high-volume verticals.

  • Okay.

  • Can you quantify at 35% unit growth, 10% price decline, or anything like that in the vertical markets?

  • - President and CEO

  • I think it's very hard to do that, because there's such different patterns in every vertical market.

  • Okay.

  • Can I just switch gears just to another topic?

  • If you think about, you know, in your guidance for revenue here, what are you saying about the turns business, why do you think it will be down in this quarter versus last quarter as a percentage of your sales and what are you assuming about the OEM sales sequentially?

  • - President and CEO

  • I think we're saying we've always liked to operate the company with sort of 65% or so, with two-thirds of our business in backlog, when we start the quarter, that's sort of a comfortable level for us, and it's our goal, as we come out of this cycle, it's very likely what will happen, is that both the ordering patterns and the way we address the orders will result in us getting back to a more normal backlog that's, you know, more predictable and easier for us to operate our factories.

  • So, you know, certainly our goal is that, you know, we would have less turns business, little higher backlog, and I think we like to run the business with somewhat higher backlog than we've been running the business at, you know, in the last couple of quarters when, you know, the outlook was so poor.

  • So we're going to deliberately try to build a little backlog this quarter and that's the reason why we think that the turns will be a little bit less.

  • Okay.

  • Thank you.

  • - Director of Corporate Communications

  • Thank you, Adam.

  • Our next question is Ali Farr from the Gallian Group.

  • Go ahead.

  • Good afternoon.

  • Your percentage of revenues being manufactured internally in 2002, approximately, and what is your objective for that in 2003?

  • - President and CEO

  • Joe, do you have that statistic handy?

  • - Vice President of Finance and CFO

  • Well, the percentage of the product that's manufactured internally is something, we don't have it exactly, but somewhere between 60% and 70% right now.

  • - President and CEO

  • I think probably the best way to think about that is that in our DSP business, virtually 100% is purchased, the wafers are purchased from foundries and our analog business, a relatively small percent, is purchased outside most of the analog business you know, the analog products we build internally.

  • I don't think that any definitive change is going on in that over time.

  • There is a portion of our analog business that is designed and produced on industry available C lots, but the lion's share of our analog business is still produced internally and will likely continue to be over time.

  • So I think the percentage of that will have more to do with the ratio between our analog and DSP business than what actually is going on within the analog business.

  • All right.

  • And then the second question, if I may, some research shows that the amount of chip inventory in both distribution and contract manufacturers [INAUDIBLE], and across many sectors of communications, wireless and PC have come down 5% in Q1, another 5% in Q2, so inventories, it seems, has subsided quite a bit.

  • Can you give me your sense, whether you agree with that, and if so, do you believe that the order that you're receiving now more track in consumption, or do you think there is some misalignment there?

  • - President and CEO

  • Well, I think that the -- we've read the same statistics you've had, and we've listened to the same comments like that to our customers, we think inventories of customers primarily and distribution also have gone down.

  • The only place where we saw the inventories were actually too high last quarter, was that PC manufacturers, because I think they went out in Q2 and sort of stocked up a lot, so our orders, our sales from the PC customers were actually, as I mentioned were down last quarter.

  • Our sense now is they're back in balance, and the feedback we're getting from the PC OEM's is that next quarter we're going to see some sequential growth again.

  • But I think by and large, what you pointed out is real.

  • The inventories are coming down, and to a first approximation, you know, I think that the consumption rates and the order rates are getting to be in reasonably good balance with a few exceptions.

  • Thank you very much.

  • - Director of Corporate Communications

  • Thank you.

  • Charles Bouche is next with Bear Stearns.

  • This is Brian for Charles.

  • Can you comment on a little bit about your capacity utilization at this time and talk a little bit about lead times and ASP's?

  • - President and CEO

  • Well, our capacity utilization in our analog business is still very low, still hovering around 50% or so, Joe, would you say?

  • - Vice President of Finance and CFO

  • Yeah, probably building a little die bank in the four-inch fabs as we, you know, ready ourselves to convert that product and produce the six-inch fabs, and so the four-inch fabs are running a little bit above that, but overall --

  • - President and CEO

  • overall about 50%.

  • We have plenty of upside here without too much capital, the point we're trying to make.

  • Does that answer the question?

  • Yeah, and then --

  • - President and CEO

  • lead times, there's been no definitive change one way or the other.

  • I think customers in general are still ordering product with very short lead times, and, you know, in one segment or another, you see minor shifts in quarter to quarter, but by and large, the lead times, the customers have given us are still very short.

  • So maybe two to four weeks or?

  • - President and CEO

  • yeah, sometimes less.

  • It really depends on the product, you know, for the vertical markets where the volumes tend to be higher, we tend to manufacture a bit more in response to the ordering patterns for those volume customers, and for the broad base of our business, that's stocked in the channel and stocked at analog, and, therefore, the lead times there, you know, remain, and they should be, pretty reasonable.

  • And the final part of the question was just ASP's in general, are they holding up or?

  • - President and CEO

  • Actually, you know, 80% in our analog business, 80% of our products are proprietary and through the cycle, both the up cycle and down cycle, we don't see large changes in ASP.

  • I think that's one of the great parts of the analog business, if you're in the high-performance analog business, and you have to proprietary products your prices remain remarkably stable.

  • We see no evidence that that's changed at all.

  • That's certainly true in our DSP business, and I think the only place where you really see any kind of price movement is, you know, in sort of the 15%, 20% of our analog business, which there are second sources for, you know, when business is tough, of course, everybody goes out there and fights for orders, but overall, that's very minimal part of our overall business.

  • Great.

  • Thanks a lot.

  • - Director of Corporate Communications

  • Okay, the next call is from Jack Gehrty of Gerard Klauer and Madison.

  • Good afternoon.

  • I just had a question on a new product that I saw in a release called the Soundmax, digital audio system.

  • I think you were talking about it to -- I was wondering how that was rolling out and what you thought the success that might have in the PC market.

  • - President and CEO

  • The Soundmax analog brand we established a year or two ago, in supplying high-performance audio into PC's and other types of equipment like that, you know, that product line is done and is doing extremely well.

  • We have very, very high market share in virtually the entire PC market, we're easily supplying 50% of all the audio function at of PC's today.

  • So we've really got something there, and it's been doing well and every expectation we have looking over the next year or so, which is as far as you can look in these things, the market share will stay very high in that business.

  • We've got a real good compelling solution.

  • We have the largest PC OEM's that are pretty committed to us, and that business is very, very good business for us.

  • Is that displacing some of the card business, perhaps, Jerry?

  • - President and CEO

  • Sure.

  • I think almost every PC now has high-performance audio function at built into it.

  • You know, used to be you had to buy a sound card or something, and, you know, there's always -- almost no PC's now that don't come with high-performance audio installed and Soundmax really makes that possible.

  • Great, thank you very much.

  • - Director of Corporate Communications

  • Okay.

  • Next is Jack Romaine of SG Cohen.

  • Thanks.

  • In terms of your Analog business, the growth rate here is a little bit lower than some of your competitors.

  • How should we reconcile that?

  • - President and CEO

  • I don't think you really should reconcile that.

  • The way to think about this thing is there's a lot of people that have different markets that they're -- you know, have products in, and some vary from time to time, but I think the most compelling statistic is if you go back to when the cycle started, which was early 1999, our analog business, including last quarter, is up 50% from where when the cycle began, which is, in most cases, 2x the rate of any analog competitor and in fact there are many analog competitors that are shipping product now at the same rate they were in the early part of 1999.

  • So I'd say that, you know, when you look across, you know, wide spectrum of time and cycle, our analog business has significantly outgrown the market and virtually every analog competitor.

  • We expect that will continue going forward.

  • Were there any particular segments that were stronger or weaker than other, for instance, data converters, high-performance amplifiers --

  • - President and CEO

  • Yeah, the strongest segment we had in the analog business were data converters.

  • Data converters, if you add them all up -- of course, analog are, what, 35% of our sales, Joe, of our total sales and higher percentage of the analog sales.

  • If anything our leading converters is getting larger.

  • So in the most important segment, we grew quite a bit above the average of the analog business, and, you know, like I say, that business is getting stronger each quarter.

  • So we feel real good about where we are in the analog business, and, you know, we believe that, you know, if you look forward, the analog business will probably grow as about as fast as our DSP business, which is something a year or two ago we weren't so sure of.

  • And within data converters, would you estimate you have greater than -- maybe in the range of 40%, 45% market share?

  • - President and CEO

  • I'd say it's in that range.

  • Okay, thank you.

  • - Director of Corporate Communications

  • Okay, next question comes from Joe Osha at Merrill Lynch.

  • Good afternoon.

  • Can you hear me?

  • - President and CEO

  • Yeah.

  • - Vice President of Finance and CFO

  • Yeah.

  • This is -- I'm sorry, Matt Chan for Joe Osha.

  • Just two quick questions.

  • In regards to the DSP business, can you refresh us on your partnership with Intel involved and whether you expect any complex of details [INAUDIBLE] grows?

  • - President and CEO

  • I think our partnership with Intel, just to bring you up current on that, to develop the black fin core, which we each put resources into when we both, you know, owned the rights to do whatever we wanted with the core.

  • You know, Intel, I think has announced that their primary thrust on the black fin core is to productize it for the vertical markets like handsets and our primary thoughts with black fin is the horizontal markets and also many of the other vertical markets where we think black fin is particularly well suited.

  • So really, the oval act between Intel and Analog is very, very minor, so for those applications, handsets where people Intel solution, then, you know, we get a pretty good play out of all the analog and mixed-signal content in those application, which, it turns out -- for those applications that prefer black fin and, you know, in the handset or any other vertical application, we really doesn't see Intel too much.

  • So I think when we look back at it, we've gotten pretty much what we thought out of that.

  • We have a great, you know, sort of partner at Intel, and we don't intersection the market in a very, very small fraction of applications.

  • Great.

  • My next question is perhaps for Joe.

  • When do you expect the four-inch, six-inch transition program, do you expect the programs to start significant gross margin improvement in any one quarter?

  • - Vice President of Finance and CFO

  • Last quarter we began that conversion of our four-inch production and over into our six-inch fabs, and last quarter, we announced that we expect it, when that program is complete in early fiscal 2003, to have about a $60 million cost savings for us, and that still looks pretty realistic.

  • Thank you very much.

  • - Director of Corporate Communications

  • Okay, thank you.

  • We have a question now from John Joseph at Solomon Smith Barney.

  • Yes, good afternoon.

  • Jerry or Joe, could you go into gross margins in a little more detail in some of the impacts, positive or negative, on gross margins over the next couple quarters, including the fact that inventories still expected to grow a little bit, and once that growth is done with, perhaps in the October quarter, Joe, would you expect there to be some negative impact on gross margins in addition mix and utilization rates?

  • Thanks.

  • - Vice President of Finance and CFO

  • Yeah, the grot margin obviously has a number of different drivers to it.

  • One is the mix of the business.

  • This quarter, we had a stronger mix of the DSP business than the analog, and there are somewhat lower margins, gross margins in the DSP business.

  • We certainly expect, as we go forward, that we'll start to see, as Jerry said, the growth rates of the two come closer in line.

  • We will realize the benefits of the four-inch fab conversions in early 2003, and that will save us about $60 million a year, and that's a pretty significant positive impact on the gross margin as we go forward.

  • And we also would expect to see the utilization rates of our internal fabs climb as the demand strengthens, and, you know, certainly it doesn't cost much more to build an extra wafer in a fab that's underutilized.

  • So we continue to believe that there is very strong gross margin leverage going forward in response to the business environment.

  • - President and CEO

  • We certainly don't expect, I think a natural extense of what Joe said, any one quarter we'll see a falloff of that based on any of these items that Joe talked about.

  • I mean, we see our relatively smooth progression of increasing gross margins going forward.

  • Okay, questioning follow-on.

  • Jerry, you suggested you may build some backlog this quart, even though you're guiding revenue is up slightly.

  • Does that mean your book to bill ratio you would expect to be above one this quarter as well?

  • - President and CEO

  • Yeah, I mean, if we look at our internal forecasts, that's certainly what they say.

  • I think that -- yeah, we have to be realistic, it's real hard to predict to within, you know, decimal points here, and I think in the environment we're in with the, you know, volatility that exists from some of the end markets and all of the chatter out there but what's going to grow and what's not, and the fact that August is generally not a strong month, I think we're trying to be a little cautious here.

  • Okay.

  • But you would expect under a cautious scenario book to bill ratio could be slightly above one?

  • - President and CEO

  • Yeah, that's certainly our current plan.

  • Okay, thanks.

  • - Director of Corporate Communications

  • Thank you.

  • Joseph Tow is next with Lehman Brothers.

  • Thanks a lot.

  • You guys mentioned that you saw a little bit of weakness in the PC side with some high levels of inventory of your customers.

  • How much of that, do you think is potentially related to the merger of some of your larger customers?

  • - Vice President of Finance and CFO

  • Well, it's certainly some comments we've had from our sales and our product people about that, and that's certainly a part of it, but I think this was even more widespread than that.

  • You know, given our market share, particularly on the audio side, we have a good beat into what's going on with inventory, with a wide swath of customers, and we saw that in the customers you're mentioning, but saw it in other customers as well, but on the more positive side, those customers have also told us that inventory is all washed out right now, and they're anticipating some growth next quarter and they're anticipating, therefore, that we'll see some growth in that segment and stuff we ship to them this quarter.

  • Okay.

  • Just one more follow-up question.

  • You mentioned that this quarter was pretty linear.

  • The October quarter, is that the same type of linearity or is it more back and fourth?

  • - Vice President of Finance and CFO

  • well, it's always hard to predict.

  • We would have thought going into the quart they're July would be a weak month, usually that is.

  • And we didn't see any real, you know, monthly or seasonal patterns during the quarter.

  • You know, we're starting out the quarter in August.

  • Typically that's a weak seasonal month.

  • We haven't done enough in August to know one way or the other.

  • But typically the pattern in Q4 is that August is on the weak side, September and October are very strong.

  • Whether that plays out this quarter, we'll just have to wait and see what happens in August, September, and October.

  • Okay, thanks a lot, guys.

  • - Director of Corporate Communications

  • Thank you.

  • Next question comes from Louis Gerhart at Morgan Stanley.

  • Good afternoon.

  • - President and CEO

  • Hi.

  • Just a quick follow-up on the comments about data converters.

  • Did data converters grow sequentially in the double digits, then?

  • - President and CEO

  • Data converters sequentially, look at that -- grew at a level close to 10%.

  • Okay, thank you.

  • And my questions were on the manufacturing operations, in terms of the inventory increase next quarter, give us a sense of how much in dollars we could expect it to go up?

  • - President and CEO

  • Joe?

  • - Vice President of Finance and CFO

  • Yeah growth next quarter should be lower than it was this past quarter.

  • And fairly significant component of that is the four-inch wafer die-back we're building, and so, that will continue for one more quarter at the current rates, and then it should abate.

  • - President and CEO

  • It's also true that a significant part of the inventory build is on externally produced products, because we're see ago pretty good rampup in the sales rates of those products that are produced in external foundries, so it's sort of a mix of, you know, the -- you know, one more quarter on the dye buffer, and then, you know, the consumption rate inventory build on the foundry board products.

  • Okay.

  • - Vice President of Finance and CFO

  • Sort of half and half right now on the inventory bill.

  • Okay.

  • And you had mentioned one transition, the four-inch analog to the six-inch.

  • Are there any other major ones that you've got going on right now, and if so, what would be an expected completion date?

  • - President and CEO

  • Well, the major one right now is the four-inch to six and eight inch.

  • That's a massive project given that you the analog business is typified by products that, you know, we sell 9,000, 10,000 different products, these products, in many cases, have 20-year life cycles, so we have a long list of products to transition to six and eight-inch wafers, which is not a simple thing to do.

  • So it's also the area where we think, you know, we have the largest margin disconnects between ADI in our analog business and some of the other high-performance.

  • So we think that's where the most leverage is, so we're most of the way completed on the -- getting all of our testing done in Asia, so we think the combination of the -- moving all the testing to Asia, doing this transition and, you know, four, six, eight-inch wafer, that will result, as Joe was saying, in the six and eight-inch fabs being much higher utilized, and you couple that with all the work we've been doing in distribution to get our -- we think those are the three fundamental elements that are going to significantly improve our analog gross margins.

  • You know, not that they were weak, but, you know, it's always been our goal to have our analog gross margins, and it's certainly there's no rocket science involved here in be as good as anybody in the analog business, and these programs are aimed at closing that gap.

  • Okay.

  • Have you had to last time buy many analog products as you make this transition?

  • - President and CEO

  • Well, that's a very small part of it.

  • You know, we typically, as a company, given the long life cycles of our products, don't like to go to our customers and say, you have to buy all those, because we'll continue them.

  • Part of the advantage of long-life cycle products is you can make a lot of money over them over a lot of years.

  • Part of the burden of a long life-cycle product, you have to keep making them, so our goal is more to figure out a path forward to make those products as compared to a lot of the long, you know, sort of last-time buys that really annoy our customers.

  • So, you know, we've done that in a few cases, but the lion's share of what we're trying to do here is -- is get all these products to be built, to be able to be built on 6 and 8-inch wafers and mostly what we're doing is avert the risk to our customers that will have wrinkles in bringing those products up.

  • Thank you very much.

  • - Director of Corporate Communications

  • Okay, the next question comes from [INAUDIBLE] of Newburgher Berman.

  • Unidentified

  • Yeah, hi, the question is again on gross margins.

  • If I look at all the things that you talked about, utilization rate and move toward six-inch, move toward -- for testing, how does that really quantify, is it reasonable to expect almost 60% gross margins at 550 million dollars in revenues or higher?

  • - President and CEO

  • You're talking about the whole business or analog business?

  • Unidentified

  • Yes, total business.

  • - President and CEO

  • I think we'll have to -- it's a little bit hard to predict that without understanding what the mix between our analog and DSP businesses are.

  • I think the way to think of it is that -- in the last cycle, we got up to high 50s.

  • And I think what we believe is we can get up to those kind of levels at revenue levels below where we got up to them last time, and I think the largest part of, you know, how we do that and what the revenue levels are has to do with what the mix is between our analog and our DSP business.

  • And, also, I'd say what the mix is between our horizontal DSP business, our vertical DSP business.

  • Unidentified

  • But you just said a few questions ago that you expect the growth of analog and DSP business to remain roughly comparable, and the last cycle your DSP business was much larger percent of your revenues hampering your gross margin, so why should your gross margins not be higher than 60% if the DSP business is to grow in line with your analog business?

  • - President and CEO

  • I'm saying that that is a real possibility.

  • I think we have to be -- you know, we're cautious about that until we really see that, in fact, the businesses are growing at the same rate, and we have a couple of these things behind us.

  • The assumption we'd get the margins of this company up 60% or above are realistic assumptions if we can execute what we're doing here.

  • Unidentified

  • Great, thanks so much.

  • - Vice President of Finance and CFO

  • I think when we talk about the 25% growth rate, we're talking about the long-term growth rate for the company, certainly the business environment improves in fiscal '03, the way that even modestly the growth rate for fiscal '03 should be higher than that given the platform we're working off of.

  • During that period of time, the mix of business could certainly be different than the 25% longer-term growth rate, and that will affect the absolute growth -- gross margin in any quarter during the next year and a half or so.

  • Unidentified

  • Good, thank you so much.

  • - President and CEO

  • I think the take away for this whole thing is with these things we've been doing, they really should have very positive impact on the gross margins going forward.

  • I don't think there's any doubt in our minds about that.

  • - Director of Corporate Communications

  • Okay, next question comes from Michael [MASTIA] of CSFB.

  • Yeah, thank you.

  • You mentioned wireless handsets and what's going on in southeast Asia and com being strong, but it seems you have more traction outside of that from what we're able to see, including the base band.

  • Can you talk about, you know, what percentage of your business is now, what it can be and if that's becoming more of a core focus for you guys?

  • - President and CEO

  • I think we've been pretty consistent in saying that a large part of our strategy in the handset business has been on the analog side.

  • It turns out we have a good DSP base band that goes along with our analog stuff and with it comes traction, particularly in southeast Asia.

  • You know, I think there's an awful lot of technical reasons for that.

  • You know, many of our customers by virtue using our chipsets were the first out there, you know, 2.5 G, and there's some -- we have good customers on that.

  • I think strategically, our focus is not to have a very large and definitive presence in selling DSP base band chip, which we continue to believe are continuously commoditizing, there's opportunistic business there.

  • We have a product, it's a good product, we have some good customers, and they like our stuff, so we'll sell some of 'em.

  • But I don't think that really changes our strategic intent in that business.

  • Great, thanks.

  • And on the four, six-inch transition, get more granular, you talked about accelerating depreciation and did you talk about the 60 million yearly savings by 2003.

  • Can you talk about the order of magnitude, is that accelerated depreciation, how much we talking?

  • - Vice President of Finance and CFO

  • if you look in our press release this quarter, we did have a table in there that are the adjustments from our earnings under generally accepted accounting principles in order to adjust for these restructuring items and some acquisition related items.

  • And the restructuring additional depreciation is listed there as a separate item across the sales of about $33.2 million.

  • Great.

  • How far along are you on the cost savings?

  • Have you seen any of that so far?

  • Are we very early on that?

  • - Vice President of Finance and CFO

  • No, those will come in the early part of '03.

  • So none so far?

  • - Vice President of Finance and CFO

  • Well, some, but, you know, not meaningful yet.

  • Great.

  • - President and CEO

  • The largest cost savings are once you shut down your four-inch fabs and now you start loading up your six-inch fabs, that's where you really see the cost savings, as Joe said, early 2003.

  • Thanks.

  • - Vice President of Finance and CFO

  • And that program is right on track.

  • - Director of Corporate Communications

  • Okay, I realize we're coming up on 60 minutes, but we do have a number of people still waiting to have questions, so we're going to continue and take our next question from Nemal [INAUDIBLE] of D.R.K.W.

  • This call is for Jerry.

  • First of all -- The question is that you seem to be somewhat -- really seem to be telegraphing that when it comes to building inventory building die banks you believe the rest of [break in audio] You think that end market demand from number of end markets would be somewhat [INAUDIBLE].

  • But if you look at the next quarter guidance, it is improving slightly from last quarter.

  • I guess what my question is when you look at the end markets right now and about three months ago, has your optimism increased or decreased in terms of demand?

  • - President and CEO

  • We don't know a lot more than you guys know about that.

  • We saw a huge increase in our order rate in Q2, we saw less of a sequential rise in Q3, most of that was expected given the seasonality of our Q3.

  • I think what we really believe is that we really just don't know, that's really what we are trying to say.

  • There are a lot of signs at a lot of the end markets that things are getting better, but every other day you read 'oh my, the wireless business is going to hell,' or 'the computer business is going to hell,' or 'the consumers are not spending,' or 'the industrial economy will have a double dip,' and I think with all those external signals, what we're trying to do is run the business conservatively and not get ahead of ourselves.

  • Believe me, if the business is there, and, you know, we'll get it, you know, and we'll do very well, but I think in the face of all the uncertainty that people are describing every day, I don't think it's prudent for us to try to get ahead of that wage.

  • We're mindful of what the other companies have said, we're mindful what our customers are saying, and I think the smart thing for us to do right now, with all those is to be cautious, and that's what we're trying to do.

  • Just a follow-up question, Jerry.

  • Given that if the demand doesn't materialize to the extent we're expecting, are there any chances of an inventory write-down in your case?

  • - President and CEO

  • Well, there's always the chance of that.

  • On the other hand, you know, most of our products are very long life-cycled products, and most of our products are for many, many customers, so typically, you're not faced with that, unless you get caught in some vertical where you have one customer with a lot of -- you know it goes down the drain or something.

  • So that's always possible, but that's -- I don't believe it's very likely.

  • Just a third question, the final one.

  • What would be the tax rate, effective tax rate going forward?

  • - Vice President of Finance and CFO

  • Yeah, this is Joe McDonough.

  • We think that the current quarter's 22% tax rate going forward is, you know, looks pretty reasonable.

  • All right, thanks a lot.

  • - Director of Corporate Communications

  • Thank you.

  • Next question is from Robert Jaworski, Jefferies Group.

  • Hi.

  • If I could ask what your interest expense was in the quarter and if you have guidance for Cap Ex and D&A the next quarter.

  • - Vice President of Finance and CFO

  • interest expense?

  • Yes.

  • - Vice President of Finance and CFO

  • Interest expense was the interest on our convertible debt.

  • The Cap Ex going forward is $14 million.

  • Fourth quarter.

  • And D&A?

  • Depreciation, amortization.

  • - Vice President of Finance and CFO

  • It's pretty much in the same range it was this quarter, which was $41.5 million, I think.

  • Okay.

  • Thanks a lot.

  • - Director of Corporate Communications

  • Thank you.

  • Next, we have a call from US Bancorp Piper Jaffray, Tori Slinberg go ahead.

  • Yes, good afternoon.

  • Jerry, if we look at more the longer-term prospects of high-performance analog, and it has a lot of categories, if you look at some of those main categories, which ones of those do you think is going to grow faster, and are you seeing any more competition in one area over the other?

  • - President and CEO

  • Well, our sense is the best opportunity in the analog business isn't data converters.

  • The reason for that is, first of all, the growth rates are the highest, because it is the only way you can get a real signal into a computer.

  • Secondly, it's the part that is one of the more fragmented businesses, meaning there's no one customer that uses the largest percentage of those.

  • We probably have 20,000 customers that buy our converter products and sell a thousand different converter products that make that up.

  • Face also amongst all the analog categories the most technically challenging to do.

  • So when you look at the technical challenge, fragmentation and growth rate, I don't think there's any doubt that converters are the single best place to be in the entire analog business.

  • There's no doubt that we're not the only ones that know that, and, you know, there's a lot of people trying to converters, and certainly there's competition out there, but I think when you really look at the success of that competition, and you look at how we're doing in terms of our market share continuously building our brand getting better, I think we're going to do just great in that business.

  • And on that same topic, looking at the current quarter, was the gross margin different in any of those sub-categories?

  • - President and CEO

  • No, I'd say to a first approximation, probably the gross margins are best in the converter business, a little bit less in the amplifier business and a little bit less in the other categories, but it's fairly hoe mom news.

  • Very good.

  • Thank you.

  • - Director of Corporate Communications

  • Okay, the next question is from Triston Guerra at Prudential Securities.

  • Hi, good afternoon.

  • A question on your fab transition, wanted to get a sense of the bit between six and eight-inch fabs as a percent of production once the shift is completed.

  • - President and CEO

  • We don't really have that off the top of our heads, so you could probably get a hold of Maria a little bit later and she'll try to construct that for you.

  • Okay.

  • Also, could you give us a sense of the trends in the distribution in the quarter versus the previous quarter?

  • - President and CEO

  • Well, I think we said our distribution revenues were up 4% sequentially.

  • You know, we've looked at all of the statistics from most of our competitors, 4% compares pretty favorably with that, so I don't think the distribution business has been strengthening quarter by quarter for the last two or three quarters, distributors, at least the ones we talked to about our product line, seem to be enthusiastic.

  • The book to bill ratio from their customers to our distributors, in other words the end customers on distribution, remained over one again this quarter.

  • So I'd say overall, the distributors are, you know, cautious, but I think they're reasonably enthusiastic about what's going on, at least for our products right now.

  • Thank you.

  • - Director of Corporate Communications

  • Thank you.

  • Our next question is from Bill Conrow at Saunders Moore.

  • Good afternoon.

  • I was hoping to just get a little bit more definition, not to beat a dead horse, around the transition we can expect, as you transition to the larger wafers, and specifically, you mentioned that you're picking up kind of -- you picked up no benefit in the previous quarter, can we expect to see some benefit as the quarters will allow, or will there be sort of this -- the waterfall effect of all of a sudden, as the quarter rolls on?

  • - Vice President of Finance and CFO

  • No, I think the -- what we should convey is that we expect the gross margins to continually improve sequentially each quarter, assuming that there's sequential revenue growth each quarter, which is our current expectation, and the reason for that is that we are running three different four-inch fabs that convert at different times, and, you know, obviously the conversion process itself is a bit more gradual than, you know, one day you turn the lights out.

  • And is the 15 million dollar figure that you guys have pegged, does that also take into account the higher revenue, or if, for the sake of argument, we slash line revenues from here, but you achieve the transition, do we actually see a decline when all is said and done of $15 million a quarter?

  • - Vice President of Finance and CFO

  • Yes.

  • Okay, great.

  • Thanks very much.

  • - Director of Corporate Communications

  • Okay.

  • David Woo is next of Wesbush Security.

  • Yes, two questions.

  • First, Jerry the last time we had a conference call, you talked about the products and used 18 months ago, what percentage those revenues were.

  • Can you sort of look at Q3 and say what were those contributions?

  • - President and CEO

  • Yeah, the Q3 contributions, for the last 12 months, about 25% of our total revenues.

  • The analog or the DSP?

  • - President and CEO

  • Well, the whole company.

  • And that's 18 months.

  • - President and CEO

  • And that's just for part of the last six quarters.

  • And last quarter, that statistic is 21%.

  • Okay.

  • Good.

  • The other thing I was trying to get is, I thought you only had one four-inch plan and I heard there were three four-inch fabs?

  • - President and CEO

  • Yeah, one four-inch fab in Boston, one four-inch fab in Ireland and one four-inch fab in sunny California.

  • So all these -- when did these three four-inch fabs get closed or just one of those get shut down?

  • - President and CEO

  • Well, as Joe was saying, that's going to be a gradual process, beginning in Q1.

  • Oh, I see.

  • - Vice President of Finance and CFO

  • Just so we make it clear, we also have six-inch fabs in each of those locations and we have an eight-inch fab in Ireland as well.

  • So, you know, we have a number of different fabs, and what we're doing is converting the production of our four-inch line into our six-inch lines.

  • - President and CEO

  • Right.

  • Yeah.

  • When it's all done, would it take the whole fiscal '03 to get it done?

  • - Vice President of Finance and CFO

  • No.

  • - President and CEO

  • No, no.

  • I'd say probably by the time we get out six months into the year, we should -- if things go alone the way they have been going, they should be pretty well there.

  • Okay.

  • Because I want to ask a question on the analog part of the gross margin story.

  • You've done the Philippines, you know, to do the back end, and when you finish, let's say, by the second half of fiscal '03 on your four-inch, six-inch conversion, really, even if the operating rates -- they stay at the current levels, your gross margins shouldn't be any different from either a maximum or a linear, 70% plus.

  • - Vice President of Finance and CFO

  • On our analog business -- that's certainly our goal.

  • - President and CEO

  • The way we look at this thing is, you know, our selling prices are higher, and with these moves we're going to make, they should be very little difference in our cost structure, if any.

  • Yeah, and those guys have probably are running at about 50% offering rate, so it's not like 80% offering rate to get those kinds of gross margins.

  • - President and CEO

  • No.

  • Okay, thank you.

  • - Director of Corporate Communications

  • Thank you.

  • Next question is from Ross Seymour of Deutsche Banc.

  • Hi, just, first of all, nice quarter.

  • And then, most questions have been asked, but you noticed on the computing business that you said it started to act a little bit better recently.

  • When you typically see the bill that begins for the seasonal period?

  • - President and CEO

  • About a week before they need the parts.

  • Well, that answers my second question, there's not going to be much lead time this year versus later.

  • You think it's a fair assumption to believe that that sort of seasonal build, if anything, occur a little bit later, even though the strength could still be there?

  • - President and CEO

  • It's hard to tell, but, I mean, I've been after our guys on that, too, and the response I get from our guys is that typically, you know, they give you a lot of forecasts, but they don't buy until a week before they need it.

  • Right.

  • - President and CEO

  • So it's hard to tell.

  • And in the past, you've made good strides getting more into the laptop business.

  • Of the 15% in PC's, could you split that between desk top and laptop for us?

  • - Vice President of Finance and CFO

  • Not offhand, but you're right, we're getting a much higher percentage than we did in the past in lap tops, but I can't tell you offhand what that statistic is.

  • Okay.

  • So the success ratio on the power-management side, especially with P4, that's met your expectations?

  • - President and CEO

  • Yeah, that's doing just great.

  • great.

  • Good quarter again.

  • - President and CEO

  • Thank you.

  • - Director of Corporate Communications

  • Okay.

  • Just a couple questions remaining.

  • The next question is from John Spypeck at [INAUDIBLE].

  • I had a question, going back and checking the DSP numbers, and the most recent quarter, 21%, and I believe 23% in the last quarter, I was just wondering if it grew 16%, how did it decline as a percent of sales?

  • - Vice President of Finance and CFO

  • The percentage of sales has gone up about 2% from about 20% last quarter to 22, is what I'm seeing. somewhere in the 21%, 22%.

  • It's gone up, actually.

  • I'm not -- I'm not quite sure about the 23% number.

  • Okay.

  • Well, in the press release last time, it shade 77% of revenue of analog sale, I'm assuming the remaining was 23%, which is DSP?

  • - Vice President of Finance and CFO

  • yeah, give us a call and we can follow up on that and we'll search it out.

  • Okay, great, thank you.

  • - Director of Corporate Communications

  • Well, then, I guess that concludes the call for today.

  • I want to thank everybody for their participation, and, also, just to remind you that we'll be on our fourth quarter conference call Tuesday, November 19th, which begins approximately 4:30 eastern time.

  • Thank you all very much.

  • Operator

  • This concludes today's Analog Devices conference call.

  • You may now disconnect.