亞德諾半導體 (ADI) 2002 Q4 法說會逐字稿

At this time I would like to welcome everyone to the analog Analog Devices Analog and Analog Devices third quarter conference call.

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

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

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

If you would like to withdraw your question, press star then the number 2 on the your telephone keypad.

You may begin your conference.

Hello.

This is Maria Taleaferro Director of Corporate communications for Analog Devices.

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

This conference call is also being watt 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 with 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 will begin with Mr. Fishman's opening remarks.

Good afternoon.

My name is Corey and I will be your conference facilitator.

I would like to welcome everyone to the Analog Devices fiscal 2002 earning conference call.

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

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

If you would like to ask a question press star and the number 1 on the telephone keypad.

If you would like to withdraw your question, press star and the number 2 on the telephone keypad.

Thank you.

Maria Taleaferro, you may begin your conference.

Thank you very much.

This is Maria Taleaferro.

This is Maria Taleaferro Director of Corporate communications for Analog Devices.

If you don't yet have our fourth quarter release, you can access is it by visiting our website at www.analog.com and clicking on the headline on our home page.

This conference call is broadcast live on the internet as a webcast.

If you prefer to listen to the webcast click on Investor Relations at the ADI home page and follow the instructions shone next to the microphone.

We are recording this call.

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

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

The earnings release and ADI website contain replay instructions for you.

Participating in today's call are Jerry Fishman, president and CEO, Joe McDonough, Vice President for finance and CFO, and joined by members of the senior management team Brian, Vice President of The DSP products division as well as frank, Vice President of for the micromachine products division.

We scheduled to call for 60 minutes.

We'll be with Mr. Fishman's opening remarks.

The remainder of the time will be devoted to answering questions.

Analysts participating via telephone may press star 1 any time beginning now to queue up for questions.

Under the provisions of the private securities reform act of 1995, this call will contain forward-looking statements.

These statements are not guarantees of future performance and involve certain risks, certainties and assumptions which are difficult to predicts.

The risk factors are described in the company's most recent report on form 10-K filed with the secrets and exchange commission.

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

Today's earnings release contains pro forma and GAAP results.

Also this call will close time-sensitive information that may be accurate only as of the date of this live broadcast which is November 19.

This call is the property of Analog Devices, any redistribution, rebroadcast of this call or any form without express written consent from ADI is strictly prohibited with.

That let's begin with opening remarks from Mr. Jerry Fishman.

Good afternoon.

Our sales for the fourth quarter as you saw in our press release were $456 million which was up sequentially from last quarter and pro forma earnings per share was 16›.

Both revenues and earnings were in line with the guidance that we provided in last quarter's conference call.

During the fourth quarter our strongest sales growth was from our broad-based distribution customers which increased approximately% sequentially, following a pattern of mid-single digit quarterly increases in the channel that began earlier in the year.

OEM sales declined slightly as large vertical market customers continued to reduce inventories in response to uncertainty in many markets.

I'll describe the market segment patterns later in my comments.

Gross margins increased sequentially by 50 basis points to 54.5% due to a more favorable mix of business and also due to stable average selling prices primarily due to our proprietary product division in high end analog and DSP products.

Operating expenses decreased primarily as a result of having a full quarter of restored salaries and continuing selective hiring of design and field application engineers.

We again have made key engineering hires in Q4 from competitors who were struggling financially or are no longer attractive environments for the most creative analog and DSP engineers.

It's our engineering talent pool that will lead us to the next upcycle and allow for us to outperform our competition.

The current plan calls for plat operating expenses in the first quarter and planning to continue to constrain expenses throughout 2003 and beyond until our operating expense ratio reaches our model of 25% of revenues.

Operating margins improved by 40 basis points to 15.8% despite relatively flat sales.

Our balance sheet remains strong during Q4 with cash levels at quarter end of approximately $2.9 billion.

As planned, we continue to build buffer inventory to prepare for the transfer of products to our newer fixed 8 inch fab.

The dye bank bills and wafer purchases to support increasing revenues and digitally intensive markets reduced in inventories growing from 135 days -- from 126 days last quarter.

Since we've now mostly completed the build of dibank buffers and well positioned with foundry wafers we anticipate inventory will be approximately flat in our Q1.

As revenues grow throughout 2003, we would expect days inventory to decline toward our model of 100-110 days.

Gross margins plans to remain flat in our first quarter as reduced costs approximately offset reduced production levels.

As revenues grow in future quarters, we expect to benefit from reduced manufacturing costs and gain good gross margin leverage going forward.

Accounts receivable days remained at 46 days despite tough economic conditions.

Cash flow this quarter was $58 million before expending $16 million on capital expenditures and $98 million on the repurchase of 4.4 million shares of ADI stock at an average price.

Capital expenditures plan to remain low as we have ample installed capacity more than double internal production levels.

Order rates from OEM customers were flat to Q3 levels in Q4 with a book to bill ratio of approximately 1.0 for the quarter.

End customer orders received by our distributors for ADI's products were approximately flat to Q3 levels.

Orders placed by distributors on ADI declined 15% sequentially as distributors worked to reduce inventories and to increase their cash flow.

As a result channel inventories declined in the fourth quarter.

Most note worthy, I think, was the order patterns during the quarter were extremely nonlinear.

Predictably for August orders improved for September and improved dramatically in October.

And that has continued into early November and that's true in distribution and from OEM customers.

Orders were the strongest from wireless communications customers, computer customers are automotive customers and high end consumer customers.

We also for the first time in many quarters experienced higher orders from industrial customers, particularly in the United States.

Orders from other communications customers for broadband and wireless infrastructure remained weak during the quarter.

Orders were strongest in the United States for the quarter but strengthened in all regions of the world in October.

Our sales to communications customers grew modestly in Q4 after growing substantially in Q3 with strength in wireless appliances off setting continuing weakness in broadband and infrastructure products.

Our strange in wireless was for a broad range of products including the SoftFone GSM chip set and other analog products.

Revenues from computer customers grew slightly in Q4 primarily as a result of more ADI content per PC and as a result of market share gains by both ADI and our largest customers.

Our product position in market share and P.Cs remains strong particularly in power management and measurement products and advanced audio signal processing products where we enjoy extremely high market share.

Consumer revenues experienced another revenue of good growth in Q4.

Demand for high end DVD players, digital cameras were strong and also areas where we enjoy high market share.

Revenues from industrial customers world wide were approximately flat during Q4 but orders for industrial products increased from Q3 levels.

Within the industrial market we saw the greatest increases in medical instrumentation, industrial automation and process control applications.

Revenue patterns from industrial customers as we said in previous quarters were likely follow capital spending trends world wide.

In the most recent U.S. commerce department October 31 report on U.S. capital spending contains interesting and we believe very encouraging data on industrial capital spending.

This report indicated that capital outlays for technology from machine tools and other long-lasting equipment increased 3.5% sequentially this quarter after increasing 3.3% the prior quarter after a nearly 18-month low in which these sequential growth rates declined quarter after quarter.

Overall capital spending statistics are matched by continuing decline in nonresidential spending for construction.

Our best guess at this point is that our industrial business will continue to recovery as the world economies continue their recovery.

Overall our market conditions remain much the same as we have said last quarter.

Demand for product to touch consumers as approved.

Those that support telecommunications infrastructure are not seeing rely increases and the industrial base which represents between 35-40% of our revenues is slowly improving as the economy returns to more normal growth rates.

I now like to talk more about some of the trends in our analog and GPRS business and micromachine business and our sense of what the most likely scenarios we see are going forward.

Analog revenues was 79% of total ADI revenues during Q4 and grew by approximately 1.7% sequentially to $360 million for the quarter.

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

This is the case that we have continued to build significant share in our analog business over the past four-year period and we did that in up cycles and down cycles.

Order rates for analog products were up significantly from October from August and September running rates.

Most note worthy in our analog business was higher order rates in October for converter and amplifier products, both where we enjoy high market share and a diversified customer base.

Most of the strength in our analog business business business is a result of new product programs.

We are introducing record numbers of products through the cycle and the designing rates are encouraging.

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

We use financial strength during the cycle to extend our competitive lead further.

Today we are receiving 80% of our analog revenues from proprietary products.

As we mentioned in the past, we've undertaken a program now to transition the internal manufacturing of older products that are currently produced on 4 inch wafers to existing more more than wafer facilities around the world.

This program will first extend the life cycles of our older products and will also reduce our manufacturing costs significantly.

As revenues grow, this should allow us to improve the growth margins to levels approaching that of the best analog competitors.

Once this transfer is complete, we can double our current analog volume with little additional capital and triple the output with only modest expenditures.

This will have the effect of reducing appreciation expenses as a percentage of sales as sales grow and lowering infrastructure costs.

Our DSP business continued and grew by 4.6% sequential.

This growth is the result of stronger vertical markets and equally importantly the high rates of tiger shark DSPs as a horizontal market.

The competitive strength of our DSP cores reported 10% sequential revenue growth in our general purpose DSP sales in Q4 which represents sales to the broadest and more profitable segment of the DSP market.

We're also very enthusiastic about our prospects of wireless telecommunications infrastructure, wireless appliances, high end products and military applications for DSP.

As DSP revenues grow, we have substantial operating leverage over higher volume.

During Q4 we also continued our industry leadership in micromachine products with the introduction of the first Silicon gyro scope.

This product has generated world wide attention since it offers a truly revolutionary improvement in size and cost for rate sensors much as sensors rev lose lose illusionizesed in 1990.

It 1/100 the size of existing products and provide high margins to ADI.

New costs and size points for gyros will allow rate technology for motor applications as well as new industrial and commercial applications such as robotics, control, flight control and navigation systems.

Many industry experts believe micromachine technology will be one of the most significant technologies for the next decade and could produce industry wide revenues approaching $5 billion over the next five years.

We've now shipped over 100 million machines accumulatively to the most demanding customers in the world and today have the only high volume production facility in the world for integrated micromachine products.

This business is now contributing to ADIes profitability after many, many years of investment.

We expected micromachine's initial sensors will become critical components of communications, consumer and industrial applications in addition to more centers, side air bags and rollover applications in audibles.

Given the intensity of our integrated products, we count them as a growing part of our analog business.

We're currently planning for approximately flat sales in our Q1.

If the strength that we've seen in our order rates we've seen over the last seven weeks continues we can see sequential growth in Q1 which would be a great result in a tough market in a seasonably weak quarter.

We are mindful of the seasonality of Q1 which includes a two week holiday period for many customers and still volatile conditions in many of the end markets we serve.

Assuming the revenues are flat, gross margins, operating expenses, earnings and inventories are planned to remain flat also in Q1.

Assuming favorable market conditions, we would expect a seasonally strong Q2.

Looking forward despite the currently unsettled environment we've all been in, sales of [] equipment will continue to grow as it has reliably grown over the past 30 years.

Recent data seems to indicate the bottom was a few quarters ago as we saw in ordering patterns from our customers.

And the semi-conduct equipment will continue to increase growing to perhaps 0% of electronic equipment up from 15% today.

We believe that high-performance analog and DSP are likely to be the highest product categories in the semiconductor market as signal processing technology continues to grow the highest growth markets.

As we analyze the processing contents of equipment to virtually every end market segment coupled with leadership technology and analog in DSP which are becoming the bricks and mortar of the processing age, we believe it's significant to add 25 growth rate which is 1.5-2% of the overall market.

We plan to grow our expenses well below the rate of revenue increases and [INAUDIBLE] for good gross margin leverage as we get the benefit of cost reduction as higher fab as revenue grows.

Therefore, we would expect earnings growth rate well above the growth rate of our sales.

In summery, we are planning to continue to gain market share in the most critical signal processing product categories and building significant operating leverage as sales increase.

Through the last up cycle and down cycle we continue to build our technology and product portfolio.

We have strengthen our organization.

We've reduced our infrastructure cost and at the same time produced remainable margins.

Since the cycle began in 1999, we are one of the few companies in the semiconductor industry that is operating at revenue levels well above levels when the cycle started.

We manage the company better than starting.

Our margins of this cycle approached the peak of the last and remain ahead of the margins over the last cycle.

As the markets turn and increasing evidence they are beginning to turn, albeit slowly, we are well positioned to outperform the market as we've been doing over the last four years.

Thank you, Jerry.

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

We'll give you another opportunity to ask following questions if time is remains.

Operator, we are ready for questions.

For any of the analysts, if you have a question press star and the number 1 on your phone.

If your question is answered and you wish to be removed from the queue, press star and the number 2.

If you are listening on a speaker phone please pick up the handset when asking your question.

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

Maria Taleaferro, please go ahead.

Our first question comes from Ross Seymour at Deutsche Banc.

Thank you very much.

I had a question when you mentioned about the seasonality, if that continues strong you might be up in the first quarter.

In a typical year, how long can that positive seasonality run.

Does it go into early December or shut down earlier than that?

Generally what happens is November is usually an okay month that's coincident with October.

This quarter October was stronger so hard to tell and keeps up to around Christmas time.

Christmas tends to get weak and a strong January.

And generally a strong second quarter because we have a couple more weeks of sales in the second quarter than the first quarter.

What I was trying to say is that we really did see a disconnect in October.

On the other hand August was weak.

If that continues maybe we can get more sequential growth.

Typically our fourth quarter is flat to our third because of that seasonality.

If it did turn out that we got some and not trying to say we will get some but saying if the order rates continue, we could, and that would be a strong sign for Q2.

Great.

And one follow up.

With the orders tailing off 15%, you said, does that create any worry for you that your OEM customers need to pick up the slack to get to the flat number?

I think what I said is that the orders that distributors put on us were down 15%, but the orders that are -- that our distribution customers put on distributors was flat for the quarter.

That order rate of our distribution, of our distributors on us are as much to do with inventory levels than with demand.

Great.

Thanks for the clarification.

Next question comes from Will Cotter.

Yes, can you hear me?

Yep.

Last quarter in your press release you told us what percentage of sales came from turns business and gave a protection of this quarter.

You expected a 38% this quarter versus 34% last quarter.

You didn't mention if it's a significant number and can you give it to us?

This is Joe McDonough.

The turns came in pretty close to last quarters rate and that was primarily because of the churn that went on in September as Jerry mentioned.

We saw a September being a working capital adjustment.

And so we saw cancellations in there that led to higher returns.

As Jerry said, the main thing about the channel is that that was our strongest channel where we saw the revenues up 6% sequentially.

As you know we measure our revenues when they ship the product off their shelf.

So you can look at their inventory and our inventory as one in the same in terms of serving the end market.

So when we look -- when we give out the turns talking about the turns ratio for the company as a whole which includes the OEM and the disty and had a higher turn ratio, the So when we look -- when we give out the turns talking about the turns ratio for the company as a whole which includes the OEM and the disty and had a higher turn ratio, the OEM was in line with what we expected. was in line with what we expected.

Thank you.

The next question is from Michael Mastias from C.S.F.B..

Gross margin went up, is that a mix shift on the DSP side?

A little of each.

Related to product mix.

I think I mentioned that our general purpose DSP business had good revenue growth.

When our horizontal or general purpose grow grows faster than the vertical business is has a positive impact on gross margin.

I think that was probably the most important shift in there.

Great.

And one follow-up on the wafer build at the foundries, what drove that.

That's not due to the transition, is it?

Related to the wireless handset?

Related to products that are digitally intensative.

Some of those are analog products build on foundries so it's a wide swath of products.

And what drove that given there is low utilization rates at the foundries now.

Something structurely that changed?

The order rates for the products look good right now.

Great.

Thank you.

The next question comes from Adam Parker with Sanford Berstein.

Hi, Adam.

Jerry, a lot of times you talk about in the conferences the long-term growth rates for the high-performance analog and DSP business and talk about 20-25%.

I think about your exposure to end markets and 20% computer, 28% wireless or whatever it is and try to reconcile the product with ADI with lower growth forecast for the major end markets.

You mentioned something about the content of electronic equipment increasing to 20% to 15, can you talk more about that and how do you reconcile the difference between end market growth rates and your penetration?

That's a good question.

Two phenomena going on there at the same time.

The first phenomena, of course, is that if you look over the last 25 years, the semiconductor content, the equipment has been creeping up here.

Used to be 6-7%.

Now 16%.

I think it's logical to predict if you look at history that that will go up to 20% so that's sort of one leg of growth of why it is that it will grow faster than the end markets.

Of course, the even more important event is that even with the semiconductor category, these if you look at all these end markets there dramatically adopting signal processing capability to all their new equipment and that's because almost every piece of equipment people want multiple media capable, they want to be portable.

They want to be connected.

All that adds up to processing equipment.

When you start going through the math of increasing semiconductor content an increasing portion of the content being signal processing and an increasing amount of signal processing being high end analog and DSP stuff, it's easy to come to the conclusion that we have at least an opportunity if we execute to grow at 1.5-2 times the growth rate of the semiconductor market.

By the way, that's what's going on for five years.

You don't apply the argument that semies overtime have captured a disproportionate share and rollover or deacceleration in the decrease.

You know, in the depths of the cycle of the down cycle, there's always a lot of theory of why the world is coming to an end.

For the suppliers in the markets supplying commodities, there's trouble ahead and a lot of explanations and statistics are out there in the industry demonstrate that.

If you have the right stuff and you can get paid for your technology and in the right product spaces, there's great opportunity out there.

And that's what we believe.

We saw it through the upcycle and downcycle and our sense is we'll see it again as the cycle begins to turn.

One follow-up.

How do you get the supply driven pricing power required for an upcycle in the industry in the first half of 2003 with utilization rates at the current levels.

Do you anticipate you'll get pricing power and anything about the fact you have a more benign pricing environment than other semiconductor customers.

Maybe you don't get the same leverage as they do in pricing power.

It's hard to determine what other companies get in terms of leverage but you're right our pricing environment is fairly benign.

The business always has the ability to take lower prices but has the has never been part of what we do.

The leverage on the upcycle has to do with cost improvements we've made and amtizinging over a larger volume.

That's where our leverage is.

I can't speak for the rest of the semiconductor industry.

I meant about pricing power.

Could -- do you not require pricing power at all to get revenues up?

A little but that's not what we are counting on.

Thanks.

Analog has a history of introducing these products where you can get paid for them.

The reason I mentioned the gyro scope not because of sales next year but the [INAUDIBLE] product.

It's not surveys or don't see data quest and yet you can create a new market and get paid for it.

That's the thing that is we've been trying to do and what we believe is our future.

I'm going to take another question now from Bret Miller from A.G. Edwards.

A couple questions.

You didn't talk about the backlog existing the quarter.

If you could talk about that?

This is Joe McDonough.

As Jerry mentioned in the OEM channel, the book-to-bill ratio was one until we ended the quarter with pretty much the same backlog.

We did see as Jerry mentioned a decrease of 15%.

In the bookings quarter to quarter, so our disty backlog is down 15%.

Nevertheless there's plenty of product around between the shelves and our shelves and serve the end market there.

We are seeing in October in particular since the beginning of October continued strength in growth in the disty channel as well.

The backlogs ended the 3-week backlog is what we typically talk about.

That's the backlog where the customer typically wants it ended at $262 million.

And one quick follow-up.

In the last conference call you mentioned you had strong momentum looking into the bay station market for Q4 4 and Q1.

Did that change somewhere here in the quarter as we went through?

I tell you what happened is we saw a good uptick in that a quarter or so ago and didn't see follow through this quarter.

Apparently what happened in the bay station market is some of the customers got low on inventory.

They replenished it but we didn't see follow through on consumption on that last quarter.

Our next questions comes from David Woo.

Will the general purpose esp grows, it seems to be historically that's a broad indication of strength, is that something to hang our hat on the fact that your general purpose DSP grew and industrial base turned [ Inaudible ] this thing is actually on a cross of getting better as opposed to the PC business which goes up and down rapidly.

And goes good sometimes and not so good.

What we tend to look at is the broadest indicator of what's going on out there is what's happening in the 50,000 customers.

When the general purpose DSP business picks up and when distribution business in terms of sell-through getting the order rates which tend to be related inventory, when those two things move up, we get encouraged by that.

But on the other hand I'm still cautious about the world.

I think we've seen those kind of things before and you have to see it for another quarter or so before you really take it to the bank.

There's no doubt when we see that kind of strength in the broadest customer base that that's a good sign for us.

Also, by the way, a good sign for gross margins.

That part of the DSP business is where the very high margins reside.

Can you help me with one other thing?

Has there been an historic league lead [ Inaudible ] if your broad-based customers are looking healthier, could it lead or lag the markets?

Generally they lead them, but not in every case.

I think the most significant data that we have alongside of what's been going on for the last couple of months is the data that I cited earlier about what's going on with industrial capital spending in the United States.

For us that has been a more reliable leading indicator than anything else.

One of the interesting thing is when everybody believes that the world is getting better in the early spring, one of the reasons we were cautious is we hasn't seen the statistics starting to move up.

This time we're seeing the order rates pick up from the rate of customers and seeing industrial sort of nonresidential construction capital spending moving up over the last couple of months which is more indicative of consumption than where customers might or might not be doing with the inventory.

In this market if you want to be optimistic there are reasons to be.

If you want to be pessimistic, you can find a bunch of reasons to be pessimistic.

We are playing it the way we see it.

The next question comes from Lewis Gerhart of Morgan Stanley.

Good afternoon and thanks for the sellout information.

That's helpful.

You were mentioning the [INAUDIBLE] down.

Can you take a look at it separately and break out the trends between converters and amplifiers.

Joe, you want to take over here?

What what we did is we did go in opinion look at running rates in September and October.

No matter which way you cut it, you see the same thing and very much as Jerry described, August was expectedly weak, September was better and things have picked up in terms of on the demand side and in October from a running rate disappoint and that is more true in the converters and general purpose DSP where a lot of the products were sold.

All down 15% sequentially?

No, the 15% is simply the orders that the distributors put on us which, you know, primarily was a result of the credit tightening where they tried to manage their working capital better.

So what we've seen now is the customers have turned around and placed a lot of orders on us.

We look down below that to look into the products, end customers and where you see the strength in the converters amplifiers.

And, Joe, could you just refresh us on the benefits we'll see from the fab reduction, the amounts and how much we've seen already on timing?

Looking forward, what we are planning to do is to hold our inventories flat next quarter and on flat sales we are planning to have gross margins more or less flat.

That requires taking down the manufacturing expenses.

We would expect to realize some of the benefits from the four-inch fab transitions and expect to be able to reduce the external wafer purchases we have and bring the manufacturing expenses down as well since we have inventoried the products to supply our current demand.

Imagine we see the full impact.

The full impact will occur over the course of the year.

We will wind up with a lower Kroft structure, much higher variable margins on the products we build in our 6 and 8 inch fab and as our plan increases we will see the margin lift.

One of the hard parts is it's different than other companies because in the only 4 inch FABs, we are running products in some cases 15-20 years old that have many variations, products tailor to unique processes that are complicated.

While some people around the company believe we can do that faster, other people that are a little more thoughtful believe that the last thing we want to do is put our customers at risk on these types of products.

For two reasons.

One the customer depend on us and second they are incremental gross Montreals.

We are taking a deliberate approach on this transition which means it's going to stretch out and at the end what we want to make sure is we still have the customers and transition these products to larger diameter wafer.

When you do that with digital products it's straight forward-looking.

When you do it with analog, the larger wafers introduce a lot of complications.

You have to be careful and make sure the characteristics are the same as the 4 inch and why it does stretch out over a period of time.

I would say risked a verse on that.

The next question comes from nemal from DRKW.

Can you give add about what the exposure of end markets are?

I have different numbers.

This is Joe McDonough again.

The end markets are roughly slightly less than 40% of the industrials.

The communication is somewhere in the 35% range.

The consumer market is more than 10% and the computer market is 15% or so.

On the communication process, can you give us full color on the station and handset?

Yeah, it's roughly sort of half of our communication sales go into the wireless portion of the market and, you know, that's a combination hard to determine exactly but it's a combination of handsets where we have the chipsets.

Portable devices where we have components in there. pdas and other things.

It's roughly half in the wireless.

Just a follow-up.

Just on the inventory numbers you've indicated that your motto was 110 days and due to the reasons you gave us that inventory numbers have gone down a day, you are planning to keep that flat going next quarter.

Do you face any risk, I mean, given the fact [ Inaudible ] do you place any risk having to write down or write off any of the inventory at least in the DSP phase and what expectations are you building in terms of future demands for all the inventory to be absorbed in a reasonable time?

This is Joe McDonough again.

The way we go about that is we take reserves for the inventory stockpiles that we have and on the products that you've described, the products tend to be lower.

We are carrying relatively low inventory stocks.

The products associated with that or if we have too much inventory we've taken reserves to keep the net inventory for those products down.

For the products that are in the 4 inch wafer FABs, we have been building in two forms.

One are the bridge stock to get from here to there, another one is in some cases enough product to make sure we don't short the customers.

In the latter cases we've taken healthy reserves against those since we probably won't sell everything that we build.

In the case of the broad spectrum of the analog, we have policy that is require products more than a year old start to hit reserves, we start to have more than a year's supply against expected demand, so we think we're on a regular basis taking the right levels of reserves to avoid the surprises you're alluding to.

You can always get your prize but in the past we've done okay.

Thanks.

Good quarter.

The next question comes from Byron Woo at Bear Stearns.

A couple of quick questions.

One, what percentage of revenues came from the foundry, external foundry partners?

Roughly in the 40% range.

And since it's greater than your DSP business, are you planning with the new 6-8 inch capacity to bring some of the mix signal back in house or do you want to continue to use foundries.

As a clarification it's closer to 30% typically than 40 and that's our entire DSP business.

Some of the analog stuff we build on CMOS.

The question about would we bring in the foundry stuff internally, that's always a lever that we can utilize.

We hope not to do that but if the volumes in the FABs look anemic, we have the ability to do that through a subset of the product.

And based on wafer capacity, what is your current utilization?

You mean internally?

Yeah.

Certainly in the 4 inch FABs, it's high.

In the 6 and 8 inch, it's in the 60% range.

Different manufacturing processes.

And 4 inch, when you say high, what do you mean by that?

Trying to transition and shut those down as quickly as possible and build our buffer stock as quickly as possible.

We are running the FABs as hot as we can with the labor pool that we have.

Thanks a lot.

Next question from Doug Lee Banc of America.

Joe, just want to make sure I get a clear picture of the gross margin trend if things start to recover in the second quarter.

Inventory levels will be flat in the first quarter.

As we grow low to mid-single digits in the second quarter, will be too off setting.

Lowering inventory.

We'll get benefits from the FAB transition, should margins therefore hold steady or do you think we'll see margin expansion.

We should start to see, margin expansion.

That's what we'll have to update you on the first quarter, there's not much question as we go forward from there and the revenues start to lift and we get low variable costs relative to the revenues that we receive.

So that's the point where we should start to see good margin improvement.

Okay.

Thank you.

Thank you.

The next question comes from Triston Garret.

I wonder if you can give us the mix of production between 6-8 inch FABs this quarter and what to expect the next quarters.

We don't have that information with us here.

Okay.

You know, that's all of our internal production.

We're moving toward the manufacturing being primarily 6 inch with 8 inch primarily in Ireland.

And we have had room there for more than doubling our current revenues with the existing capacities, just put a little labor into it and triple our capacity with modest capital spending.

Okay.

And just a follow-up question, what's roughly the breakdown between OEM revenues, worldwide.

Roughly half.

Thank you.

Our next question comes from Bill Conroy at Sanders Morris.

Just a clarification and we danced around the subject on the call.

Would you say that your shipments are equal to end market consumption.

Where you are you relative to end market consumption?

Is that ahead of your shipment or still inventory out there or at parity.

Can you give an amount there?

Again these are all guesses in a lot of ways so you can't take them too seriously.

In the distribution channel probably coincident with current consumption and the OEM channel our sense is there was still inventory liquidation going on last quarter.

Okay.

As a quick follow-up, can you give us more detail of where you saw the strength in the computer side?

More on the complexions, not so much your products.

What did you mean applications.

Desktop, notebook, server.

We have a good position in all three.

The part of the market that seems to be the strongest now is the laptop part of the market.

We did see strength on -- all through the market.

Not any defineable trends other than laptops running a little bit hotter.

Thank you very much.

Joe Tow at Lehman Brothers has the next question.

You mentioned strength in the wireless.

Can you talk about your process on wireless handset side, you mentioned solutions, you are seeing more of a demand from your customers.

Thanks, a lot.

Brian, you want to talk about that.

Sure.

This is Brian here.

We've seen a pretty broad basis of demand and a broad base of customers out there.

Probably saw management on shark who are distributing Vodafone in Europe and that phone which integrates a camera and we've got a complete GSM chipset and functions in there.

Basically I would say that most of the customers out there are using analog and digital-base processors and then a significant percentage assigned to use chipsets.

Most of the customers selling are based on chipsets also use pro management.

As you break it down by region, we have been extraordinarily successful in China where we are shipping to eight different customers there and either ramping or at reasonable volumes as of now.

In addition to that we have six customers in Korea, four in Taiwan and a host of them also in Japan.

At different stages of development.

More encouraging for us is the fact we are now into second generation and third generation designs with these folks and especially encouraging is the fact they are on a broader percentage trying to adopt RF chipsets into the new designs.

Right.

Thanks a lot.

Okay.

Joe Oshsa from Merrill Lynch has the next question.

Hi, guys.

Nice quarter.

Just to return to the inventory issue a bit.

I know some of that is related to the process transition.

If things don't pan out through the quarter as you expected, is there any risk that you've got a lower utilization rate perhaps more than you thought in order to keep the inventory under control?

I think going into the first quarter we pretty well set the utilization rates for the quarter.

If things didn't pan out the way I thought, I suppose we would wind up with an inventory build.

But I think when we look at it and take a look at demand all the time and rebalance the loadings against the expected demand and then we've been looking at how the 4 inch transitions are going, they've been going extremely well.

We think we kind of got it right.

You can't say you never get deprived.

And the second question, bigger picture question, you guys have done a great job staying on top of costs, can you give me insight to what the target model looks like at this point and what level of revenue nord to get there.

We have been targeting to get ourselves back up to the peak levels at revenues lower than what it took last time.

We don't know exactly what that is.

Our target is if we had 700 million of revenue a quarter, we'd like to be where we were before in margin terms.

That depends a lot on the mix.

Depends on the rate of growth of different things.

That certainly is our goal.

And looking forward through next year, our plan to have a plan that we run the business by and our plan is for a growth year next year.

We talked about the second quarter.

Third and fourth are less clear at this point.

We are expecting things will carry on through the year and see margins improvement throughout the year.

Okay.

Thank you very much.

Thanks.

Woody Calieri has the next question.

Thanks.

Can you hear me?

Yes.

You talked about a strong quarter.

Given that almost 60% of your business is related to consumer, computer or communications which should be down as cap spending is down.

Where would we get the strength to have a stronger second quarter as opposed to a flat quarter?

Generally the reason that the second quarter is stronger is you have two more weeks.

Probably it's true that the first quarter is not flat as we are predicting if it was that we had a full quarter.

Just on if the running rates stay about the same as it does during Q1, you get two more weeks and get more growth.

Without any real changes in the end markets.

And that's enough to offset the normal seasonality.

Yeah, that's our sense.

Sometimes if you're in a robust end market, you get better than that.

Sometimes in a crappy end market it's less than that.

We looked at this for 30 years.

While the mix is different, in the absence of sort of discontinuties, that's what happens for us.

And the business has the strongest quarter in the second quarter.

As Jerry mentioned, we are seeing signs of life in the industrial market and that's seasonalbly a strong market.

The reality of it is we'll know a lot more in January than today.

I said the patterns we are expecting is for earnings to be doing fine until Christmas and Christmas is light and come back in January and hope for a good month.

By the end of January we'll have a sense of Q2.

In terms of gross margins, we talked about it once but I'm having confusion.

I expect that margins would dip down a little as we work toward the inventory as the higher costs have been sold from the older products working its way through so we have second and third quarter lower growth gross margins and see the advantages of the transition.

Don't forget that as we shut these down we are taking the cost out.

So what we are left with is some of the products have transitioned over, running in the 6 inch FABs.

We are seeing product out of inventory.

The most important factor is that we are taking the cost out.

And the products built in the 4 inch FABs at today's cost have good margins.

Not like we're taking a lousy business and moving it into a lower cost structure, we are taking a good business and making it even better.

Appreciate your time.

Okay.

Scott Randal has the next question.

Hi, Scott.

Great.

Jerry, I wonder if you can expand a little bit for 2004, long-term growth 25%, [ Inaudible ] given all the uncertainties out there certainly, do you still feel comfortable looking at your growth relative to the industry?

Yeah, our sense has been that, you know, in the absence of new data, history is a good indicator of the future.

If you look back at last five-year period, you see that that's really what's been going on.

First the whole analog market and DSP market is growing above growth rates.

Within the segments, we've been gaining shares.

I mean again nobody in their right mind would try to predict the future accurately.

As we look forward from all the tops looking at the markets and what's happened over the years, we are sitting today, that's a relyistic objective.

Got it.

And finally on the industrial, if you look at that as an opportunity for growth, you see as much opportunity to increase the electronic content along the line as well as analog and DSP.

In other word looking at electronic growth [ Inaudible ].

As I said earlier, the one thing that's been very reliable if you look at 20 plus years of data is that the electronic content has been increasing.

I don't think anyone would suggest that's going to change.

The other thing that is reliable is the signal processing part of the semiconductor industry has been growing in terms of growth rates relative to the semiconductor market.

That's true in the industrial market.

Just look at machine tools if you look at medical equipment.

It's been true in the automotive industry for a long time.

Cars and micromachines wuJun example.

Many others in terms of auto functionality and electronics going into cars.

Electronic and semiconductor content is going up despite of everyone's look at that now as a trough for the cycle.

Relative to what we are doing with signal processing, those are not ridiculous assumptions.

Great, thank you.

Thanks.

I have a couple of questions left and we are coming up on an hour now in the conference call so I think we should be able to keep the extra four questions.

Brandy Brandon.

Thank you.

I wonder if you can talk about where you see the convergence with DSP and the applications for that in your universe.

Sure.

Brian here.

We're shipping black fin to over a thousand customers around the world there.

Getting a reasonable sense of where acceptance is in the marketplace.

Certainly as you point out a number of people using the processor and risk applications that has an instruction set architecture which is consumer friendly so people are using it because of high core density capability to replace risk processors out there.

In addition to that we've seen black fin when over asix designs.

Because they are more expensive because of mass costs when you get down to .13.

People are assigned especially with the higher speed and capability of black fin migrate their asic designs to a more programable platform.

Lastly we've seen black fin win designs away from the folks where processing capability of black fin is favored by people in the spga space where they have signal processing space.

As we look forward, obviously when you bring out a general-purpose DSP, the market can in the general purpose DSP spaces it's public sized to be between 500-700 million not including the handsets.

Now as you look at the risk space and the potential for black fin within that area and also as a replacement for as ICs specifically in portable applications like cameras and so forth and then look at a small portion of the spga market, the term for black fin has increased over the traditional space.

So we are quite excited about the potential in these new expanded areas and restructuring accordingly and say the company to really take advantage of those.

Thank you.

Okay.

Next we have Bruce.

Jerry, I wanted to ask you about the strong uptern turn in October.

Sounds like you were surprised like many of your peers.

Sounds like that strength continues in November but obviously the end markets are not quite growing as fast as the uptick has been.

What do you think is going on?

Do you think inventories got too low and went to a natural restocking.

The early signal of a strong pickup in the end markets or what are your thoughts on that?

That's when you can't figure it out you go back to the overall market data.

One of the reasons I was more encouraged, I'm usually skeptical of all this stuff so we look hard at the end market data.

When you start seeing sort of high-tech capital spending going up now for a couple of months, that is the first good sign that it's substantial that we've seen in quite a while.

So I think at the margin, people are starting to buy a few more things.

If we are typical of most other companies, the hardware starting to break down and people need stuff and only so long that companies go forward without redoing their base there.

That's not going to be true [snearls] in -- necessarily for all markets but certain sectors it could be true.

We'll have to see.

As you know there's been a few head fakes and people get confused looking at short-term data and we'll have to see.

Until we really understand what's happening, we are trying to run the thing as conservatively as we can, keeping the expenses under tight control, the inventory under tight control and have to wait and see what happens over the next couple of months.

Quick followon, DSP is the strongest within DSP, what was the split in the quarter between handset and bay station and what are the trends from revenues last quarter?

Joe?

The way that sort of breaks out is obviously the handsets were stronger than the bay station.

We don't have a breakout specifically of which is in each, but the recent trends are strong across the board this October demand strength.

Right.

And wireless as a percent of total, Joe, used to run 8-10%?

I think the way that -- you know it's hard for us, as you know we get these 50,000 customers out there and a lot of them in the communication business, I guess 35% --

I'm sorry I missed that number.

35% of total sales are winding up in [compun]cation and our best guess is half of that is winding up in the wireless state.

Okay.

All right.

And as we said earlier, John, some of that is handset, some of that is pda and loops that go into a lot of other things.

Some of that that is identifiable in the verticals.

A large part that goes towel to all the customers that we are not sure of what the end application is.

And a good chunk of our analog component business in the wireless state.

Right.

Okay.

Thanks, very much.

The last question comes from Manish Goyle.

My questions have been answered.

Great.

Then that completes today's conference call.

On behalf of Joe McDonough and Jerry Fishman, I'd like to thank you for your interest and taking the time to join us today.

We look forward to talking with you again during the first call February 13.

Thanks, very much.

This concludes today's Analog Devices call.

You may now disconnect.