亞德諾半導體 (ADI) 2003 Q1 法說會逐字稿

Good afternoon. My name is [Adrian] and I will be the conference facilitator. At this time I would like to welcome everone to the Analog Devices first quarter fiscal 2003 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 for the analyst participants. If you would like to ask a question at that time, simply press star, then the number 1 on your telephone key pad. If you would like to withdraw your question, press star, and the number 2 on your telephone keyboard. Ms. Taleaferro you may begin your conference.

Hello everyone, this is Maria Taleaferro, Director of Corporate Communications here at Analog Devices. If you don't yet have our first quarter release, you can access it by visiting our website at www.analog.com and clicking on the headline displayed on the home page. This conference call is also being broadcast live on the Internet as a webcast. If you prefer to tune in to the webcase, you can click on the investor relations link from the Analog Devices home page.

This call is 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 via the Internet. The earnings release contains replay instructions, or you can visit the investor relations page on the Analog Devices site. Participating in today's call will be Jerry Fishman, President and CEO, Joseph McDonough, Vice president for Finance, and CFO, and also Brian McAloon, Vice President for the DSP, Media and Communications Products Division.

We scheduled this call for 60 minutes. We will 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 Litigation 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 10-K, filed with the Securities and Exchange Commission. Also, this conference call will include some time sensitive information that may be accurate only as of the date of this live broadcast, which is February 13, 2003. This call is the property Analog Devices. Any redistribution, retransmission, or rebroadcast of this call in any form without the express written consent of Analog Devices is strictly prohibited. With that, let's begin with Mr. Fishman's opening remarks.

Good afternoon. Our sales for Q1 were $467 million, which was up about 19% from the same period last year, and up approximately 3% sequentially from last quarter. Diluted earnings per share under GAAP accounting principles were 16 cents which was up from 6 cents in the same period last year and up from 9 cents last quarter on the same basis. Excluding acquisition related charges, EPS for Q1 was 17 cents, versus 16 cents last quarter on a comparable basis. Both our revenues, and our earnings were slightly ahead of our earlier expectation that we communicated in the conference call last quarter.

During Q1, our strongest revenue growth occurred in the OEM channel which grew approximately 5% sequentially. Distribution revenues were flat, which was a strong result in the quarter with 8-10% fewer selling days. Both our analog and our DSP revenues both grew sequentially during the quarter. Gross margins were 54.2%, while inventories declined by $12 million sequentially, from 135 days to now 125 days. Q1 gross margins were really the result of a 20 basis point improvement due to conditioning manufacturing cost decline which was slightly more than than offset by a 50 basis point decline, as a result of a richer mix of DSP products, which carried somewhat lower gross margins than our Analog products. Average selling prices for both our analog and our DSP products remained stable in Q1.

We continue to tightly control operating expenses in both engineering, and SMG & A, were approximately flat for Q4. Excluding acquisition related charges and restructuring costs, operating margins expanded to 16.4% of sales from 16.8% last quarter. With revenues up 19% from year ago, net income increased over 50% from a year ago.

Our balance sheet continued to strengthen in Q1. In addition to lower inventories, accounts receivable declined to a record 45 days, 46 days last quarter. And cash increased by $102 million after spending $15 million on capital. Our cash now totals $3 billion. We are planning for cash flow to remain strong throughout the year as profits remain strong, as day's inventory continue to decline and as capital expenditures remain light, since we have ample capacity already in place to grow our revenues significantly.

Overall, in Q1, orders for shipment in the last 13 weeks grew by approximately 9% from Q4 levels, continuing the recovery that began four quarters again. Orders grew sequentially in both the OEM and also the distribution channels. The book-to-bill ratio was slightly above one for the quarter. Orders on our distributors by our customers, also grew sequentially in the quarter. Chronologically, orders in November were strong, December weakened noticeably and January was very strong order month for ADI. We're encouraged by these order patterns in what normally is a very seasonally tough period.

Geographically, orders were the strongest in Southeast Asia and Europe and weaker in North America and Japan, particularly in distribution, where inventories continued to decline. Overall, our strongest sales were to communications customers for wireless appliances and bay stations, as well as for broadband access products. We also saw sequential growth from computer customers during the quarter. Sales from consumer customers declined in Q1, after a significant growth in Q4 in anticipation of the holiday period. While orders from industrial customers increased sequentially, sales to industrial customers were approximately flat in Q1 in line with a short distribution quarter.

Overall, communications represented approximately 35-40% of our Q1 sales, computer products, about 15%, consumer products about 10%, and industrial products about 35-40%, and these are generally in line with what we've seen in the most recent quarter. Analog revenues grew slightly in Q1, and were approximately 78% of our total revenue. Our analog business continued to produce high margins and exceptional cash flow. As in our overall product portfolio, our strongest analog growth was derived from the wireless market both the bay stations and also for handsets. While we've always enjoyed very high market share for analog products and bay stations, we have dramatically improved our product position for other analog products and handsets.

Our RF protectors are becoming the defacto standard in many handsets today. To date we have shipped over 50 million RF detectors. Our newest direct conversion radio has been recently released and sampled to many customers around the world to a very, very positive review as the highest performance and most integrated radio on the market today. Our high speed converters have long been the converter of choice for the analog-based band. Most recently, we've released a new highly integrated power amplifier that integrates our leading radio frequency detector technology with a unique power amplifier architecture.

And finally, we've recently announced new power management products for both CDMA and GSM handsets. Together with a new very competitive digital base band processor, ADI is today one of very few vendors that can provide the entire signal change and most of the power management for a wide range of wireless appliances. Interestingly, approximately 75% of our sales in Q1 in the handsets were derived from analog products during the quarter. We also saw a continuing growth in analog products used in personal computers.

Our share continues to build in audio signal processing, as we continue to introduce innovative hardware and software solutions for leading PC manufacturers. We also continue to provide advanced power management, control and monitoring functions for next generation Pentium processors, as our relationship with Intel continuing to strengthen. While sales of analog consumer products dipped 16% sequentially in Q1, in line with typical seasonality after a very strong Q4, our product portfolio for digital cameras, for camcorders, flat panel displays, DVD players and other high end entertainment products, continues to expand. Interestingly, our sales of analog products for consumer customers while down sequentially in Q1 were up 45% from the same period last year.

Our strongest product family continues to be our converter products, which represents 45% of our analog sales and 35% of our total sales. In Q1, our converter revenues grew 23% year over year and a few percent sequentially. Our market share has now grown to 40%, based on current SIA statistics as we continue to outgrow the converter market. In Q1, we introduced 18 new converter products, including many architectural breakthroughs and low power, high speed conversion, as well as new architectures for high precision converters as well.

Today for every resolution, from 12-18 bits, ADI provides the highest speed converters in the market. Our converter revenue is derived from many thousands of horizontal converter products sold to tens of thousands converter customers around the world and also for many vertical customers, for whom we adopt this technology for more application specific products. Our newest converter and amplifier products include many standard products that are being designed in record numbers for broad industrial customer base, as well. As economic conditions gradually recover, our strong designing base with industrial customers will offer ADI the opportunity to achieve above market growth with industrial customers, as well.

Our analog revenues today, are 50% higher than when the cycle began four years ago, well ahead of our closest competitors, in the high performance analog space. This indicates that we've continued to build market share over the past few years, and the gap seems to be widening. Our analog business remains a great business for ADI. In addition to gaining market share in the most important and the most product categories, we significantly reduced our infrastructure costs, which will facilitate higher gross margins as volumes build. Pricing remains firm, and we believe our customers recognize that we have the most capable high performance analog team in the industry.

Our DSP product sales also continue to recover in Q1, growing by 9% sequentially, and marking the fifth quarter of sequential DSP growth. Our strongest growth in Q1 in DSP was derived from our general purpose or horizontal DSP products, and wireless chip set sales, both of which increased by over 10% sequentially. In the general purpose DSP market, the market has begun to recognize the technical superiority of both Blackfin and TigerSHARC architectures, and our customer base for both of the products is expanding. With these disruptive architectures, we have very high performance signal processors with programmable functionality that has never been seen before. These breakthroughs will expand the market for the DSPs to new mainstream applications where DSPs have not been previously utilized.

The Blackfin architecture integrates a very high performance DSP, a media processor for multimedia and also a micro controller for system control, all in a single easy to use and easy to program platform. TigerSHARC builds on ADI's leadership in 32 [INAUDIBLE] DSPs. TigerSHARC's leadership is floating point processing and IO performance and nonchip memory bandwidth creates the fastest floating float and fixed point DSP on the market. Each core represents industry leading performance in each product category.

Today, these two cores make ADI an obvious choice for general purpose programmable DSPs and also for a wide range of vertical applications. Over the next few months, we will be formally announcing the details of the power and the architecture of these new DSP products, and we invite you to stay tuned, over the next few months, for the details of these products. Overall, our DSP business has vastly transformed from just a few years ago. We've now claimed the technical high ground in both fixed and floating point processors, we've increased our gross margins, and we've been able to amortize our R&D costs in DSP, over now, much higher volumes. And we've only just begun to see the revenue ramps in our newest DSP cores.

Our micro machine business also continues to do well. These integrated sensors are primarily used today in air bag safety systems in automobiles, an industry that continues to hold up pretty well even in these tough times. To date, we've now shipped more than 100 million sensors to the most demanding automotive customers in the world.

In addition, we've introduced our new revolutionary iMEMS Gyroscope and we've already sampled over 500 customers with the gyroscope with very, very positive feedback. In fact, we've been notified by two of our key automotive customers that our gyro has been selected for use in their new rollover detection systems. Production for this application will begin in the third quarter of this year for one of those customers and early next year for the other. We expect our accelerometers and our gyros will be used in a wide range of emerging applications, in addition to new automotive safety and positioning applications. For example, single handed menu scrolling, map canning or web browsing without the use of a stylus or push buttons and hand-held devices are just a few of the new applications where this technology is relevant.

We're in an excellent position to expand the iMEMS market, given the fact that ADI had signal conditioning technology, that goes with our commercial sensors and today is the only high-volume dedicated iMEMS manufacturing facility for integrated iMEMS products in the world. We announced in January that Frank Weingold, who has run the iMEMS business and has been with ADI for more than a decade, plans to retire and Bill Guidice has joined us as the new Vice President, General Manager for the Micromachine Products Division. Frank has done a tremendous job for ADI and helping to build our micromachine business and we'll certainly miss him. Bill will lead our efforts to expand the application for iMEMS technology throughout the consumer, the communications, the computer and the industrial equipment markets as well as continuing new applications in the automotive market. This strategy should make iMEMS technology another important vehicle growth for Analog over the next few years.

We're currently planning for Q2 to continue the recovery that began four quarters ago. With somewhat higher opening backlog based on the order strength in Q1 and a seasonally stronger period in Q2, we're planning for Q2 revenues to grow in the vicinity of 3-5% sequentially. If the ordered strength that we've seen in January continues, we would be at the top end of that range. We'll need slightly more than 50% in terms business since Q2, which is similar to levels that we've achieved in previous quarters in an environment where customers still continue to order very short-term delivery.

We of course continue to be mindful of the uncertain economic environment and many of the end markets, and note that a large percentage of our orders are still being placed in very short-term delivery. At that revenue level, we're flat, slightly higher gross margins than Q1, depending mostly on the relative mix of analog and DSP sales, expenses growing only nominally and operating margins should, therefore, continue to expand. We're planning for inventories to be approximately flat in dollars, days inventory continue to decline, and for continuing strong cash flow in Q2. This would translate into EPS of approximately 17 cents in Q2. Looking out in a slightly longer time, despite the continuing unsettled environment we're operating in, we remain very enthusiastic about what we can achieve over the next few years.

Despite doomsday predictions about the demise of the semiconductor industry, the semiconductor contest of electronic equipment will continue to increase as it has reliably done for many, many years. To be sure, it will be more important than ever to be in the right product spaces. We continue to believe the right place is high performance analog and DSP, which are the bricks and mortar of the new age of signal processing that will drive solid growth and profits for those who use this technology. We intend certainly to be one of those companies. These are exhilarating times for those of us who are trying to steer our companies through these very turbulent times. We're proud of what we've accomplished during this cycle at ADI. Through the peaks and through the valleys, we've never lost confidence in our people and never lost confidence in our products, and we've made many of the right decisions to increase market share, to reduce our costs and to deliver strong cash flow. As the recovery continues, we hope to reward our investors, also, with above average stock appreciation in the future.

Thank you, Jerry. During today's Q and A period, please limit yourself to one primary question and no more than one follow-on question. We will give you an opportunity to ask an additional question if we have time remaining. Operator we're now ready for questions from our analyst participants.

For any of the analysts participating by telephone dial-in, if you have a question please press star and the number 1 on your telephone. If your question has been answered and you wish to be removed from the queue, please press star and the number 2. If you are listening on a speaker phone, please pick up your handset when asking your question. We'll pause just for a moment to compile the Q & A roster. Please go ahead.

Our first question comes from David Wu at Webb Bush Morgan Security.

Good afternoon. And congratulations on a good quarter.

Hi, David.

Hi. I had one clarification and one question. The clarification was: Jerry you mentioned that the gross -- you know, when are we seeing the improvement in manufacturing efficiency from your shutting down of exiting those two four inch paths, have we seen it in Q1? Or are we yet to see those improvements?

Well, I think as we've been saying, David, the real bang for the buck on those, you know, cost shifts -- cost reductions we've had in manufacturing occur when we really increased the volumes, in those six and eight inch Fabs and as those businesses recover, as the industrial business recovers, you know, we will, as those Fabs start to crank up a little bit, that's when we will see the most significant or benefits in the gross margin of our analog products. And you know, we hope that will happen over the next couple of quarters. We've said, we continue to believe we have a lot of gross margin leverage in the analog business as a result of these transformations, and I think as soon as the revenues start to pick up meaningfully, we will see that in the gross margins. So the direct answer to the question we've seen it a little of it so far, but I think the largest improvements in the analog gross margins will be in the future. As the Fabs get better utilized.

Six and eight inch?

Yes.

And a question -- I was reading my notes before the call, and it seemed that, Jerry, you're betting on, you know, the industrial markets being stronger than they turn out to be. I mean I'm not complaining that the mix was a little different.

Yeah.

But can you explain what caused this mix of customers, mixed difference between what you were, you know, -- in November and now.

I think the largest change in that was -- had to do with distribution. A large part of the industrial customer base is handled by distributors, particularly in the United States, and I think distribution, you know, was not a real strong quarter, particularly in the December. So I think the -- we actually saw some good signs of life in many of our large OEM industrial customers, but, you know, a reasonable business service for distribution, distribution, you know, just goes on a day sales, basis, and turned out to be a little weaker than we would have hoped last quarter.

Was that a seasonal factor?

I think in distribution, it is primarily how many days of selling do they have. So you know, we probably over -- we were a little over optimistic about what they would achieve in what is normally would be a pretty slow quarter. The good news in that, I would say, David, is that the orders from industrial customers increased pretty well last quarter so hopefully we will begin to see that in our sales this quarter.

I think the other observation on that channel was that November started off very good. December was probably weaker than we expected and January came back stronger than we probably had anticipated, so we've seen during the last, you know, since the beginning of the year, some pretty good business for that channel. Of course, it is too early to tell, you know, at what rate what sort of pace goes for the next quarter. But I think that is the industrial channel.

Generally, David, when we see in a pickup in the order, in a particular segment, we usually see a pickup in the sales the next quarter. We don't know exactly what is going to happen because so much of the quarter is still turns business, but we did see a pretty good pickup in the order rates from industrial customers during the quarter.

Thank you.

Thank, David. The next question comes from Credit Suisse First Boston, Michael Masdea.

Thanks. You guys talked about why the gross margin was a little bit weaker. You didn't mention inventory. Did inventory have any impact?

Well, the inventories were down 12 million dollars. We brought today's -- I think we had indicated last quarter that our goal was to hold the inventories flat. We actually did a bit better than that and brought the inventories down $12 million, down from 135 days to 125 days. And so the inventories we think are under pretty good control.

Do they have an impact on the margins, though, in the quarter.

The margins for the most part are driven by the mix of the businesses, as Jerry said, during this quarter. That's the biggest impact. It's a pretty complex equation. Our Fab transition from the four inch to six inch Fab is moving right on schedule. We did get some of the benefit of that during this quarter in one of the Fabs, we're getting more benefit during the next couple quarters, and -- but on the other hand, we are still operating at low utilization levels in those Fabs. We did have holiday shutdown, so it's a bit complex. But everything is moving right along the way we had hoped it would.

And looking forward on that line, can you talk a little bit how you expect the [INAUDIBLE] mix to continue to trend for the year, and also, I thought there was a certain fixed charge that was coming out of your cog line as you were shutting down and transitions some of the Fab. Should we not model until any kind of fixed cost coming out of the margin line?

The fixed cost that you may be referring to was the depreciation charge that ended in the fourth quarter. So we do not have an ongoing fixed charge associated with those Fabs. With the four inch Fabs.

Relative to the question on the mix, nobody really knows that. As I mentioned the visibility it is not great. We are going to get 50% of our business that turns this quarter. We don't have much visibility for Q3 and Q4 so it's very hard to predict what the mix of business will be a couple quarters out. Obviously, the more the mixed goes toward the analog side, the better impact it has on a gross margins, because the margins are higher in the analog business, and also because we get better utilization of these new six and eight inch Fabs that we're shipping over. So I think we will have to wait and see how the mix of business turns out. And it's really hard to predict that looking forward.

Great, thanks. +++ q-and-a.

The next question comes from Aneesh Goyl from New Berger Berman.

Could you discuss what end markers do you expect to grow sequentially and what end markets do you expect to decline sequentially and I have one follow-up.

Based on the best we can sort out now, which again, of course, we continue to say is limited visibility, you know, we think that the consumer market is going to come back, mainly because it was down last quarter, and our penetration and our product position in that business is extremely strong. So that went down sequentially last quarter. We expect that to be up sequentially this quarter. I mentioned a little earlier that our orders --industrial -- in the industrial space were up last quarter so we would expect our sales to industrial customers to be up a little bit in the second quarter. That's seasonally, what generally happens. Our computer revenues will probably be up a little bit and the real wild card, you know, it will be hard to -- it's hard to forecast what will happen in the communications market. There is a lot of different segments there. The wireless part has been growing very strong. You know, whether that continues to grow at those rates -- there is a lot of different opinions about that over the next quarter or so. You know, we have a very, you know, midline assumption in there for our communications business. So our best guess is we will see varying amounts of growth in each of the segments for the quarter. And we will have to wait and see how that develops.

And do you have any analog or mixed signal design around the chip, and can we hear some announcements in coming months?

Yeah, I think if you look at the Intel reference design that they're going to talk about at at GSM World Congress, which I believe is next week, you will see that alongside their base band and flash stuff, you would see our [INAUDIBLE] radio. So we've been working with Intel on that program for quite a while. And also, you will see alongside there, our analog base band converter. So we're well represented with the Intel Manitoba.

Thank you so much.

Thank you. The next question comes from Rolf Seymour at Deutsch Banc.

Thank you, and congratulations on a good quarter. One question on the gross margin line. In looking at the GAAP version and then the pro forma version, is the delta between the 54 1/2 last quarter, and the 53.2 GAAP last quarter, is that the same sort of delta between GAAP and what pro forma would have been this quarter?

That gap last quarter was solely the additional depreciation that we took, as a result of our plan to transition from 4-6 inch Fabs, and it was in the third quarter last year and also in the fourth quarter. It is not in the first quarter.

Okay. Fair enough. And then on the backlog, a question earlier asked about the mix in general. Does your backlog -- first, if you can give us the hard number on that, and then the second point, does the backlog profile exhibit the same sort of DSP versus analog strength that you showed this quarter?

Jerry, you want to take a whack at that?

Yeah, the backlogs are up slightly from last quarter. Our backlog for delivery during next quarter -- we look at it for backlog for delivery during the next 13 weeks -- it is something in the vicinity of $270 million. And it probably has more or less the same profile. If anything, the DSP-based business probably has a bit more backlog content, more coverage, and the other products tend to be shorter lead times.

Yeah, the confusing part of that is that -- in that sense, you know, it's very difficult to take the percentage of the backlog that's DSP, and project that as a percentage what's going to be of your sales next quarter, because the DSP products tend to be ordered with slightly longer lead times, and the analog product, right now, are being ordered with sort of no lead time. So generally, we'll see a much higher percentage of turns business in our analog business than the DSP business. With the backlog Joe quoted, and you always get cancellations and the backlog moves around a little bit -- we will need somewhere around 50% of our sales business this quarter which is not terribly different than the last couple quarters in an environment where, particularly in the analog business, people are still waiting to the last minute.

And is this quarter typically a back-end weighted one for you?

No I would say this quarter -- there is no reason why it would be back-end weighted.

Thank you.

There is nothing unusual, when we look at the cancellations. They're kind of in the same range as they've been for the past couple quarters. There are no unusual signals we're seeing in the backlog. It's just as everybody is saying, if you look at backlog is visibility, there is not enough of it. But on the other hand, there's quite a bit of appetite coming in in terms of sort of short delivery-type orders.

Great. Thank you.

The next question comes from Bella Perrin, from [DR Gmb].

Hi, Gary. First of all, good quarter at a very bad time. Congratulations on that. The second one, the last couple of months, it seems like almost everyone who has -- who can manage the band design seems to be designing -- announcing, you know, chip set solution for handsets and are you one of the first to go into the market, I think one of your customers is in Taiwan. Can you give us an idea of what is going on there? And it looks like TI has done very well in the market by giving everything except radio amplifier or radio transceiver. Since -- can you give us an idea what are you trying to do, like try to give as much as possible to the customer and hold their hands and so on.

Sure, I mean no doubt with the PC market being pressurized and telecommunications being pressurized, everyone is looking and salivating about the 400 million unit handset market out there. And you know, in particular, as the model seems to be shifting, as we talked about in many previous quarters toward the ODM model, where people want to, you know, the -- in China and Taiwan and a lot of other locations, where people just want a reference design that they can just call up and buy the components and get the hardware and software and not have to do much other than assemble and be a channel. You know, that certainly favors companies that have more and more of the content than companies that have, you know, just one part of the content which creates a very risky situation for those companies. You know, it turns out that when you look at that, of course the whole spectrum of all the companies that are talking about that stuff, there's still very few companies, that can, you know, do the entire analog signal chain and do the DSP signal chain and do the power signal chain, and including the, you know, power amplifier as well as the RF detectors and the analog based bands and all that stuff. There is a lot of very challenging technology there. So you know, our sense is that when we look at, you know, our Othello offering, particularly our latest one which seems to have really caught on with a lot of the customers, the fact that we are now beginning to sample a very integrated power amplifier, which includes our detector technology. As I said earlier, the converter technology is debated. We have a very competitive digital based band and we have all the power management. I think that, you know, the model that most people are using in that market now, you know, really does favor those that can supply more of the content.

You know, obviously, we're planning to take our Blackfin core into this market. You know, that has a particular appeal. And when you -- when we, you know, finally in the next couple months disclose all the operating characteristics, some of the architectural characteristics, of Blackfin, which you will hear a lot more about in the next couple months, that will become pretty obvious why that, amongst many other markets, why Blackfin is a particularly core, in the handset as well as other -- many other wireless appliances. So I think, yeah, it's 400 million units a year. Everyone is going to be interested in that. But I think it's a real challenge to have, you know, the right analog, radio, and DSP technology to be able to do that. And I think, you know, the -- we're going to get part of it. We are not going to get all of it, we're not probably not going to get most of it, but we're going to get a pretty good share, and we're going to look for those applications and those technologies in phone where we can do something that really enhances what our customers are doing, and we can get paid for it. And you know, that's an important part of the business for us. As I mentioned earlier, you know, with all the hoopla about the digital based band, last quarter, we got, you know -- 75% of all the revenues we had in handsets were analog. And that's something that I think is very surprising to a lot of people who follow that market, that, I think, the only thing that is relevant in a hand set is the digital based band.

Just a follow-up on that. When you are going to go up. [INAUDIBLE] Would the design be one with Intel chips or are you going to compete with Intel? What is the intent?

I think in some ways we are going to be a partner and, other ways, I guess we will compete. As far as the, you know, the analog stuff, which is in the reference design, we're certainly a partner. You know, we think that there are various segments in the cell phone market where, you know, our base band is a more appealing alternative. There are other segments where, you know, what Intel has done in integrating the flash and, you know, there are strong arm processors, going to be an alternative that some customers like. So we think there is going to be opportunities on both sides of that. And we always did. When we first talked -- for those that remember about our partnership with Intel, you know, there were always a lot of questions about are we going to be competitors or collaborators or what? We always thought there that there would be opportunities for both. And we thought that the market would naturally gravitate on the digital base band, you know, towards whichever core was particularly more appealing for a particular segment of that market. And I think that's exactly what's going to happen.

Thanks, Jerry.

Thank you. The next question comes from Jack Romaine at SG Cowen.

Thank you. You guys have talked about the shut down of the four inch wafer facilities, generating 60 million in fixed cost savings throughout the year. Is that still the correct number to be thinking about?

Yes, that's the correct number and we are already realizing some of it and it will carry on during the next couple quarters.

And can you give us a little bit better idea on how -- what your utilization looks like right now, and how that may change after these facilities are completely taken out of service?

Well, the utilization, you know, is sort of somewhere in the 50 to 60% range at the moment. It's down a bit probably in the first quarter than it was in the fourth quarter, Simply because of the holiday shutdowns, if you measure utilization in terms of output. But if you look at it from the standpoint of what are we taking offline, we're probably taking offline 15% of our overall capacity. But on the other hand, what we're left with is the ability to easily double our output with the existing capacity, and we can triple our output with a very modest incremental investment.

Okay. Great. Thank you.

Next question comes from Scott Randall at Sound View Technology.

Thank, good afternoon. Jerry, I wonder if you can talk a little bit more long term relative to current design activity you're seeing among your industrial customers, and how you might look at the revenue growth from those customers over the next, I don't know, four or five quarters, based on that level of design activity.

Sure, well, you know, our industrial customer base. There tends to be a very heavy concentration of standard products. Now, increasingly, there is some applications that require sort of variations on the theme, but what we've always seen in the industrial customer base is performance wins. In other words, if you can have the highest speed converter at every level of resolution or the lowest current amplifiers at each speed level, generally those are the products that get favored by industrial products -- by industrial customers. So you know, for that market in particular, we focus on making sure that our core converter and amplifier technology, you know, stays well ahead.

You know, the applications in the industrial domain are very, very varied. They go from, you know, processed control, industrial control -- in that category, we lump medical instrumentation. You know, our products are very well represented in some of the new imaging medical imaging products, CAT scanners, all other times of body scanners, all other types of medical instrumentation. It's just a very, very wide spectrum where the last ounce of performance really, really does matter and those are applications that we've always been in the middle of. Those are applications where, you know, our type of technology tends to be very appealing. And it's also applications where we get very good returns on our investment.

So you know, the industrial sector has always been a very key sector, still 35-40% of the sales, and we expect that, you know, has the opportunity to grow at a pretty good rate in the future. So that it will always be 35-40% of our sales. We don't expect that that's going to go down to 20 or 25. We think that is an important market and we're investing in those customers and the products for those customers, like -- investing in the products for those customers.

The relative design activity relative to [INAUDIBLE].

It's very high. If you listen to our FAEs and you listen to our field people, it's actually surprisingly high. When you look at some of the communications customers, those are the programs that, you know, every time you look, this one gets cancelled and you look for the design manager that you're working with, and he's sort of not there anymore. But the industrial customers haven't seen that vast swing in their fortunes. They have certainly been modulating inventories up and down, but their business hasn't modulated that much, so they're still a very healthy amount of design going on in industrial customers, as they're trying to get more and more productivity enhancing products out there. And basically get ready for one of these days when industrial capital spending really starts to take off again.

Great. Thanks very much.

The next question comes from Joe Osha at Merrill Lynch.

Hi, yeah. Hi Maria. Hi, Jerry. First it seems like every quarter we ask this question. I'm wondering if you have a sense as to what, you know, actual end demand is at this point, and whether, you know, whether you think you're selling to it, whether you still think you're under selling on demand and kind of on the back of that, wafer distribution what you think customer inventories look like. And then I do have one other question.

I think, you know, as we say every quarter when everybody asks that question, all we have are guesses on that, because nobody really knows. But what the customer seems to be telling us in aggregate, it varies in each of the market segments. In some cases, they're still trying to get inventories down. Everybody continues to have a model now that inventory is bad -- turn, you know, a lot of inventory turns is good. Everybody knows that, or at least believes that product is quite available. So I think people are saying they can operate with no inventory or very low inventories, or inventory levels that are lower than they've ever operated at before, and that model works as long as capacity is much higher than demand. You know, as soon as people start squeezing the lead times a little bit, I expect their strategy will change a little bit. But our sense is still that many of our customers are still working off inventory.

Any particular area, Jerry? Obviously, communications infrastructures, you know, is a candidate. Outside of that, do you see anything?

I think even in the industrial markets, customers are still working off inventory. You know, PC manufacturers want to carry zero inventory. So I think, you know, the consumer guys tend to be a little closer to the market and try to stay current with that. But I would say in every other market, our sense is that our customers are still playing it pretty lean on inventory.

Okay. And then -- thank you and then just a second question, last one. I remember we talked in the past about you wanting to sort of stay away from -- in the DSP business, you know, large verticals and sort of concentrate on being, you know, standard product horizontal supplier. It sounds to me like you're kind of getting sucked back into the cell phone market here is. Is this a strategic shift? Or am I missing something?

A little bit of each, I'd say. We develop our DSP cores for these horizontal market for these tens of thousands of customers, that are ultimately going to use DSPs. You know, we think that with the advent of new cores like Blackfin, that is going to even open up the DSP market to customers that have never used DSPs before. You know, on the other hand, we have to be confident in the fact that wireless products are going to be an important market in the future. Maybe it's handsets, maybe it's PDAs, but everybody wants everything to be wireless and portable and connective and have multimedia capability, and I think for companies our size, that it's the only way to try to amortize some of the R&D that we do for the horizontal market.

So I would say the direct answer to your question is we still invest primarily for the horizontal markets, and we try to generate and develop the highest performance core as we can generate, where we see opportunities. And in some of the verticals, and that might be hand sets one day, or digital still cameras the next day, or any vertical, where we can use R&D, that we've basically done for the horizontal markets and leveraged that into a couple of vertical marks, you know, we think that's a smart strategy for Analog Devices. Sometimes that will be handsets, sometimes that will be bay stations, sometimes it will be digital consumer products, sometimes it will even be industrial products that are very, sort of, vertically oriented industrial products. But the important thing is we develop the core technology for those horizontal customers and we use the verticals more opportunistically than we do the horizontals.

Okay. So it sounds like it is really sort of a opportunistic.

I would say, yeah, our strategy is really -- remains the same. There are opportunities in the verticals to use that technology. And you know, basically in those verticals, the R&D expenses are not very high because we've already made the investments in the cores. So you know, while the gross margins might not be as high as in the analog business, you know, the operating margins in those sectors can still be pretty attractive because we've already spent the money on the R&D. The other part is that when you look at some of these verticals, we've actually done pretty well. You know, we've -- in the vertical called computers, you know, we've got an enormous position, and the audio stuff, we probably provide one out of two audio solutions in every -- in all PCs in the world right now. That sort of a vertical we've done pretty well. The consumer sector is in many cases the ultimate vertical. We take our high speed converters and make customized analog front ends for digital still cameras. In the wireless base, handsets are one, and PDAs are another, and there's a zillion other wireless supplies. So I hope I didn't give the impression we are going to stay away from vertical markets. I think we have to be very very clear that we develop the technology for the horizontals and we very, very carefully see where there are verticals that we can utilize that technology -- get paid for it. And that's our strategy.

Okay. Thank you very much, Jerry.

Okay.

Next question comes from Brian Woo at Bear Stearns.

Hi, most of my questions have been answered, but I was wondering if you could tell me what the rough mix is within DSP, horizontal versus vertical applications.

Um --

Roughly. Is it half vertical or --

It varies tremendously with what happens in some of the verticals. It is probably in the vicinity of 40% in the horizontal markets right now, you know, then 60% in the verticals. That changes. We expect that as Blackfin and TigerSHARC catch on as cores with a much wider range of customers, that can conceivably go back to the 50/50 or at least that's our sense right now.

Okay. That was it. Thanks a lot.

We actually -- we're a little less than 10 minutes to go before our our hour. We've got several people still in the queue so if -- well we're going to keep on going beyond our 60 minutes and try to get to everybody, okay? The next call is from Joseph Tou at Lehman Brothers.

Thanks a lot. Nice quarter, guys. In terms of handsets, just trying to get an idea of how big handsets are as a percentage of your revenue right now and then, going forward, maybe a year from now, given the stuff that you're doing with Intel and given the power amplifier you introduced the other day, how big can that get?

Well, we don't report our, you know, segment data beyond the growth segments like communications and consumer. We think that gives our competitors a tremendous amount of competitive information that we're not very anxious to do.

How about another way. Communications right now is 35-40%. Is that going to change dramatically?

No I would say, I would say that if you look out and there's always peaks and valleys of that depending on the various segments, but I would say, if you looked out a year, it wouldn't be terribly different than it is today. You know, I think it got a little overheated in the year 2000. On communications it got up to 45%, maybe even a little bit higher, when the infrastructure, communications business, was you know, sort of way ahead of itself. But I would say ranges like we've given you are about the ranges that we would anticipate over the next couple years, to the best of our ability to predict that far in advance.

Great. Just one clarification. You mentioned turns for the next quarter are going to be about 50%. What are were they this quarter?

About the same.

About the the same. Thank you.

Next question is from Woody Caliari at Midwest Research.

Thanks, good afternoon, folks nice work on the inventory. I had a question on -- it's my understanding you guys have severed the relationship with Pioneer as a distributor, and I was wondering what happened to that product? Will that transfer over to [Arrow] after the acquisition, or does it get pushed into the distribution channel?

That inventory is not -- first of all is not a very large number. And it's in the process of being dispositioned in multiple of different ways. Some of it they keep and service some of their customers. Some of it moves over and a little bit of it probably comes back. We restock the distributors, you know, with what they believe is more appropriate. We look at inventory in the distribution channel as simply a stocking point for our own inventory. And so we do that every week. We look at the levels of inventories, and we try to keep the inventories in the proper size so that the distributors can service their customers.

But did you recognize any of it with the end of the relationship with quarter, or --

No.

Or in the inventory total?

It's not a large number. We only recognized distribution revenue when it moves on to an end customer. And, obviously, if it stayed behind and was never coming back, that would be the end for that item. But it's not a very large number.

Okay. So a small amount. But nothing that would be material?

I'm not sure there was any this quarter.

Okay. And second, could you provide a little guidance on what depreciation for the next quarter should be, with that fixed charge taken out.

Well, the depreciation this quarter was I believe in the $42 million range. And it will probably be somewhere in the $44, $43, $44 million range next quarter.

So fairly flat. And then last, I think you had said you expected PCs to be up this quarter on a sequential basis. Given that most people are looking for PCs to be down, is it increased content or you just have a real strong order backlog? Could you give us a little --

One of the reasons that we're probably a little bit ahead of that curve is, you know, there are some markets out there that -- our sales are much more dependent on our penetration than they are, you know, what happens, how many PCs were sold. And our audio stuff is each quarter getting a little stronger in terms of work, people using it, our pair maximum products are getting a little stronger each quarter and more PC manufacturers are doing it. So that's much more the issue for us, than how many PCs get sold next quarter. Sure we would like more. But we can only deal with the hand that's dealt us on how many PCs get sold and we can do better than that by getting more penetration, which is what we have challenged our guys to do and looks like they are doing a pretty good job of that.

So you don't see anything in PCs different but you're doing much better than everybody else.

We're doing a little bit better. I don't think we're going to have large growth of PCs next quarter, but some growth is better than a decline.

Thank you for your time.

Next question is Jack Garretty at TKM.

Just a quick one. I want to check on capital expenditure. I remember the budget is around 60 million for this year. Is that still the same? And I think you mentioned -- maybe you didn't mention utilization rate, is it 60% last quarter; that still about the same?

The utilization rate, as I mentioned earlier in the call, was somewhere between 50-60, down a little bit this quarter due to the shutdowns that we had. The capital expenditures this quarter were $15 million -- probably be in the same range next quarter. For the year, I think we were talking about $70 million for the year. But we're obviously getting off to a slow start against that.

We'll have to see what happens in the second half of the year. So it will probably be in that range.

Okay. That's fair enough. Thanks a lot.

Okay. The next question comes from Adam Parker at Sanford Bernstein.

I don't know if I'm reading too much into this, but your guidance of flat to slightly higher gross margins in Q2 versus Q1. Given the current revenue guides for Q2, you would normally expect 100 basis points plus in margin expansion based on the incremental margins from these revenue levels. Is there a reason for the caution? Is it due to increased DSP mix or other factors, or what is going on with the gross margin?

As we indicated for this quarter, we saw most of the growth in the DSP side of the business. We don't really have a good idea of exactly what the mix is for next quarter. We do know that we're running the factories in the very short run, you know, in response to the current levels of demand. And so the leverage that we're going to get on the gross margin comes as we see a pickup in the demand for those products that are manufactured in those factories. They tend to have a lot higher gross margin. And we are just trying to be cautious in terms of guidance that we're giving.

So you're making your gross margin guidance more cautious than your revenue guidance, essentially?

It's mostly because we don't exactly understand what the mix is. You know, if the mix turns out to be very heavy analog and heavy industrial, that has higher gross margins it will be better. If the mix tends to be much more DSP centered, tends to come in on the low end. So it's very -- there are so many different things going on as Joe was describing with the conversions to the, you know, wafer -- four inch to six and eight inch wafers and the mixed shift and the variation of gross margin between the product lines, that you know, within half a point of gross margin, it's very, very difficult to predict that 13 weeks in advance.

Sure I'm just taking the scenario of stay 5% sequential revenue growth which at your current moment in time you indicated you would be at the high end of the revenue, yet you still have a flat -- in your of range for gross margins. One assumes that 5% revenue growth, even with a mixed issue, you would still get gross margin expansion.

Well, I think another way to look at it is the drop through down to operating margins. And we're tending to look at it and say, you know, something in the 50% range of the incremental sales dropping through down to the operating margins, and that sort of feels about right.

Okay.

But, the real thing to take away from it, I think the comments, are that the real leverage that's ahead of us in the analog business, which is what we've been working so hard to get over the last 12-18 months, is when the analog revenues that we produce internally really start picking up, and when those start picking up we will see those improvements that we've been talking about in the absence of any other catastrophic event occurring. And until we see that, it will be heavily dependent on the mix of the business.

Thanks for your time.

Next question is from Louis Gerhardy at Morgan Stanley.

Nice quarter. Question on operating margin. Joe, you just mentioned 50% incremental fall through. Are you including things like profit sharing in there already? Is that something that would start going forward? And with the 50%, is that pretty much a rule of thumb we could use for the next year? Or just for next quarter?

Well, you know, I think that it's just a guideline of what we think is pretty good drop- through, given that we don't know exactly what the mixed business is, and given that, as we do march on and get the profitability moving way up in terms of a percentage of sales, we do have to start rewarding our people with raises in some form of participating in that profit growth. On the other hand, we're going to keep the expenses extraordinarily tight going forward until we get the ratios to the levels that are our models. So you know, we look at that and say that kind of drop-through would be pretty good. In the next quarter, we intend, as Jerry said, to hold the operating expenses very flat. To the levels that they're at this quarter.

Okay. Just a quick follow-up, if I could. You have spoken about the analog and DSP business, but if you look at it from a an operating margin perspective, you had 16% this last quarter. Can you just give us a sense of what the analog contribution is and what the DSP is?

We are not going to report operating margins by business segment, but, clearly the analog business operating margins are still quite a bit higher than the DSP operating margins. We're not going to report the operating -- it's very complicated because some of the R&D is shared. There is just too many complicating factors to report that as a reliable indicator of what's happening in each of the businesses, so we've never done that, and we're not likely to do that in the future.

Thank you. Nice quarter again.

Thank you.

Thank you. Next call comes from [Tory Steinberg] at US Bancorp Piper Jaffray.

Good afternoon this is actually Jeremy Kwan calling for Tory. Jerry, you mentioned the OEM and distribution orders, sequentially. Can you give us breakout in OEM distribution?

What percentage of our business is each?

That's right.

Let me give you a little feeling on that.

Last quarter, we had said that we saw the distribution orders lagging a bit. Distributors were continuing to work off their inventories to manage their working capital. And that continued a bit this quarter, so that we saw the book-to-bill ratio and the distribution channel opened below one and the OEM channel above one. But we've seen the distributors continue to work off their inventories. Their turns sort of went up, and we've seen their order pattern -- their orders in the aggregate to be much stronger than they were a quarter ago. As a result of -- and that's what gives us the confidence that they are starting to look at reaching the levels of inventory that they believe they need to replenish. But we look mostly to what's going on out their door to their end customers. We look at that every week and as I said earlier, that's what we've seen the pattern of increased strong in November, weakened in December and then picked up quite a bit in January.

As a follow-up, you mentioned 50% turns requirement and the analog business typically tends to see a higher turns requirement, can you talk about what your expectations are for the analog business alone, what kind of turns you're expecting for this quarter and what it was last quarter?

We don't have that information. Our sense is that, certainly, in some of the vertical markets, we're building more to order, and, therefore, we have probably higher backlogs. In some of the analog products, where we have parts that are readily available on the shelf, people don't order them if they think they can get them right away.

Thank you very much.

Thanks, Jeremy. Next question comes from Solomon Smith Barney, Jonathan Joseph.

Good afternoon. Thank, you mentioned, Jerry, that broadband access was strong, DSP was strong, Asia was strong. It sounds like your DSL business came back. Maybe the Taiwan [INAUDIBLE] that you had several quarters ago is starting to kick in.

That business was off the cliff for a while. Last quarter it was -- that's what I think I would take out of the profits.

And then, with regard to wireless handset business, you know, you alluded to the fact that there are different opinions, and I guess you mean within industry. There's certainly is different opinions within the investor base as to whether we're looking at cellular handset inventory, excess inventory -- are your customers giving you any sense one way or the other, whether inventories are a little bit high on the handset side, in line, or light?

Well, the lion share of our customer base turns out to be in Asia. You know, those are generally customers that seem to be gaining share of the overall market. At least in the handset market. We're trying to keep as close as we can to that, John. And you know, the best feedback we have from our guys who just came back from there is that -- I think we're not expecting the rate of growth that we've seen in that over the next couple of -- over the last couple of quarters to happen in the next couple of quarters but we're expecting that neither -- that the collapse and have a massive inventory correction, at least our customers. That may or may not be representative of the overall market because our customers are a little bit different than large European handset manufacturers.

So I mean our plan is that it's not going to fall apart. The growth rate that we've seen is going to tail off a little bit, but the growth rate we've seen over the last couple quarters has been sort of high. So I think it will level off over a quarter or two and it will revert whatever the market growth multiplied by our penetration of what that market turns out to be.

Thanks very much.

The next question comes from Bill Conroy at Saunders Moore.

Good afternoon. Two quick ones. The first one is what is the ultimate inventory goal?

Well, our goal, as we've said, is 100-110 days is where we're trying to get to.

Okay. And the other --

And that's low, if you look back at our own sort of history. You know, the nature of our business, the number of products we have, we tend to run higher than that. But we think that that is where we would like to get to.

Right. And as a follow-on, I want to say a quarter ago, as you guys were talking about bay stations, I want to say the comment was made that maybe you hadn't seen follow through. The business had come up and maybe come back down and now are you seeing it come back up. Can you give us more detail on the bay station business specifically and what you see is going on there?

I think if you look beneath the top line comment that it got better, it mostly got better in China. And you know, the Chinese station manufacturers are beginning to penetrate that market, and we're doing pretty well amongst them. I wouldn't necessarily say that we've seen a very broad increase in the bay station business across many geographies and many customers and many areas. I think as we look forward in that business, that it's still going to be an important business for us. It has been important for us in the analog stuff where we've had very good position and we think some of our new DSP cores, our TigerSHARC, is going to be very low received in that market, are going to get some very good traction. 3G bay stations are starting to take off and other standards, so I don't think there is any real definable uptrend there, across a broad range of customers, other than what we've seen in China this quarter.

That's helpful. Thanks very much.

Thank you. Okay we're going to get a second round of questions here. Jack Romaine is on again from SG Cowen.

Could you guys please give us some sort of idea on the total revenue contribution from TigerSHARC and Blackfin, just a range. Are we talking less than five million per product or 5-10 million? And could you give us a longer range target where you think they could be in a year or so?

We're fot going to bring out the revenue by product but I would say it is a very, very low percentage of our DSP business right now. It's been sampled and used and evaluated by, you know, literally thousands of customers around the world today. But the production ramp-up and those things, it is not going to really occur till the end of this year and into next year. So I think that -- one of the really exciting things for us now about our DSP businesses, most of what we are seeing the growth in is not even in these cores. If we look at the contribution of what these cores could be, if we look out a two to three year perspective, I think the contribution of those cores could be very significant, particularly as these cores allow you to penetrate applications with DSPs that have never used DSPs before. We will be a lot more specific about that as we come out with our formal announcements in the next quarter or so in these products. To direct to what your question is, it's a minimum contribution in dollars and there is a lot of customers that are using them right now and [INAUDIBLE].

Thank you.

Okay. Last question comes from David Woo at Webb Bush. Hi, David.

Hi. Just one, two clarifications. Can you give us an idea about how big is the iMEMS business?

Yeah, --

In the 5-10% range of your total business?

Our iMEMS business is -- it's about 100 million dollars a year.

Okay. And just -- I've got --

Joe tells me it is a little bit higher. Maybe $120 million a year.

Okay. And in terms of distribution, when you say the backlog -- the distribution book to bill was under one, are you talking about the distribution to you or customers book to distribution?

We're talking about distributors to us. The book-to-bill ratio, in distribution with our -- you know, -- from our customers, relative to book, is slightly above.

So the good news is that the -- your distributors are doing better than they are reflecting to you?

Yeah, the good news is that the customers are buying the product off of the distributors and at the same time, the distributors are still reducing their inventories.

Okay. I guess that trend sounded like it's coming to an end.

We hope so. I think, David, we don't -- we don't think it's the end of the day, that makes a big difference. We look at it as an inventory point. So the most important thing we focus on is what is happening between the distributor and their end customer. And that's where we did see a pickup in revenue as I said in the month of January, following a pretty poor December. And that's where we have seen, you know, the bookings from the end customers, the distributors being above one.

For the whole quarter, right?

For the whole quarter.

The whole quarter. Since you don't recognize revenue until your distributor ships, it is not really meaningful.

That's right.

At least it gives you a look at what the distribution channel looks like.

That's right. We pay most of our attention to inventories in the channel and that's what we really focus on.

We watch that every week. We aren't trying to get distributors to put orders on us and then cancel.

Thank you very much. Have a good one.

Thank you, David. And thank you to everyone for joining us. That concludes the call. I'll just leave by reminding you that the second quarter, 2003 earnings release is scheduled for just after the market close on Thursday, May 15. And we'll hold our conference call approximately 4:30 that same day. That completes today's conference call. I would like to add that Analog Devices 2002 annual report to stockholders is now available. Hard copies can be obtained by phoning us at investor relations or visiting the web page. We also invite you to visit us at investor conferences taking place over the next several months. Analog Devices will be at conferences including Goldman Sachs on February 26, Morgan Stanley on March 3, Merrill Lynch, April 30 and Credit Suisse First Boston on May 1. On behalf of Jerry Fishman, Joseph McDonough, and Brian McAloon, I would like to thank you all for your interest in Analog Devices and for take can the time to join us today. Goodbye.

This concludes today's Analog Devices conference call. You may now disconnect.