亞德諾半導體 (ADI) 2004 Q3 法說會逐字稿

At this time I would like to welcome everyone to the Analog Devices third-quarter fiscal 2004 earnings conference call.

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

After the opening remarks there will be a question-and-answer period with our analyst participants. (OPERATOR INSTRUCTIONS) Ms. Tagliaferro, you may begin your conference.

This is Maria Tagliaferro, Director of Corporate Communications for Analog Devices.

If you don't yet have our third-quarter 2004 release you can access it by visiting our website at www.analog.com and clicking on the headline displayed on our home page.

This conference call is also being webcast over the Internet.

From analog.com you can select the Investor Relations navigation bar and follow the instructions next to the microphone on the following page.

A recording of this call will be available today within about two hours of the call completion and it will remain available via telephone or Internet playback for one week.

Participating in today's call in no particular order are Jerry Fishman, President and CEO, Joe McDonough, Vice President for Finance and Chief Financial Officer, Brian McAloon, Vice President for the DSP and Systems Products division, Bill Guidice, Vice President for the micro machine products division, Rob McAdam, Vice President for the Analog Semiconductor components division, and Vincent Roche, our Vice President for sales and marketing.

We have scheduled this call for 60 minutes and we're going to begin in a moment with Mr. Fishman's opening remarks.

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

Analysts participating via telephone call can press Star one on the telephone at anytime beginning now and you will begin to queue up for the question-and-answer period.

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 and are difficult to predict.

Risk factors which may affect our future operating results are described in the Company's most recent annual report and on the 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 broadcast August 12, 2004.

With that let's begin with remarks from Mr. Fishman.

Q3 was a mixed quarter at Analog Devices.

While our financial results continued to strengthen, orders weakened and cancellations increased in June and July, resulting in a slightly lower revenues than we anticipated when the quarter began.

Revenues increased to $718 million, which were up 38 percent from the same period last year and up approximately 6 percent sequentially from last quarter but nevertheless were lower than our previously forecasted range of 7 to 10 percent sequential revenue growth that we mentioned last quarter.

Revenues grew in most regions of the world with the strongest growth in North America where revenues grew 10 percent sequentially after growing 18 percent sequentially in the prior quarter.

Sequential revenue growth was weakest in Japan in line with the slowdown in consumer sales and some inventory build in Japan after a 50 percent year-over-year growth in the first half of 2004 in that region.

Revenues grew in all the end markets that we serve with the strongest sequential revenue growth from communications customers.

Specifically in Q3 -- and I am going to throw out a bunch of numbers -- I will say them slowly in case you want to keep track of them -- specifically in Q3 our industrial revenues were up 4 percent sequentially, and 37 percent year-over-year.

Communications revenues were up 9 percent sequentially and 48 percent year-over-year.

Consumer revenues were up 1 percent sequentially, and 37 percent year-over-year and computer revenues were up 7 percent sequentially, and 16 percent year-over-year.

By channel, OEM revenues increased by 9 percent sequentially, and were up 35 percent year-over-year.

Distribution revenues increased 3 percent sequentially were up 41 percent year-over-year.

Gross margins continued to expand to 60 percent, which was up 80 basis points sequentially and represented an incremental gross margin of 74 percent on incremental sales.

Gross margins increased nearly 500 basis points year-over-year same quarter.

Operating expenses declined to 31 percent of sales as we continue to constrain operating expense growth throughout the company.

As a result of higher sales, strong incremental gross margins and continuing site expense controls, operating profits rose to $208 million or 29 percent of revenues, which was up 130 basis points sequentially and more than double the dollar amount from the same quarter last year.

Earnings per share rose to 43 cents and net income was up 11 percent sequentially on a 6 percent sequential revenue gain.

Our balance sheet continued to strengthen with cash increasing by an additional $147 million to nearly $2.7 billion.

Accounts receivable were at 45 days, and inventory remained under tight control at 104 days which is coincident with the levels we achieved over the past few quarters.

As a result of continuing strong financial performance and a very cash rich balance sheet, ADI's Board today approved the stock buyback program of up to $500 million to be implemented at periodic open market purchases or range transactions.

They also authorized a quarterly dividend of 6 cents per share that's payable on September 15.

Given the recent volatility of orders, I am going to devote most of my comments this afternoon to providing as much clarity as possible on industry, geographic and market trends as we see them.

Despite continuing strong consumption by our customers in Q3, net orders which are new orders minus cancellations on ADI weakened in June and July as customers and even more so, distributors adjusted backlog to reflect over-ordering over the past few quarters.

As we mentioned previously orders on ADI had been running well above shipment rates and also consumption rates for the past three quarters as the book-to-bill ratio climbed above 115 percent and orders approached $800 million last quarter.

As the economy became a bit more uncertain in many regions of the world and its fears of impending product shortages really never materialized at least for ADI's products, customers in virtually all our end markets and geographies have reduced safety stocks to more appropriate levels.

We believe that net orders in Q3 were well below consumption levels as customers made these adjustments in a very short period of time as our leadtimes decreased again from about nine weeks previously to now somewhere below six weeks with most of our high-volume products now available off-the-shelf.

While our new orders during Q3 were approximately equal to our sales, on unusually high level of cancellations, resulted in a book-to-bill ratio for the quarter of approximately 0.8.

We believe that our end markets remain generally strong and that our backlog is now adjusted to more normal levels indicative of the very short leadtimes and the absence of over-ordering.

The order patterns at ADI for Q3 differed by region as well.

The U.S. and Europe remain strong but were flat to the immediately prior quarter after very large sequential increases for the two quarters prior to that, which is indicative of continuing strength from industrial customers who comprised a significant portion of our revenues in both the United States and in Europe.

Orders declined sequentially in Japan, mostly as a result of inventory buildup for consumer oriented products in prior quarters and also we believe some seasonality.

Orders declined most significantly in Southeast Asia and particularly so in China after a very large and unsustainable sequential increase over the past three quarters, and also perhaps as a result of government efforts to slow economic growth to more reasonable levels in China.

In total, lower net orders during Q3 seem at this point to us to be the result of a cyclical pause after a few very overheated ordering quarters rather than any harbinger of fundamentally weaker markets ahead.

Going through a little detail on the products, our analog product revenues accounted for 79 percent of our sales and grew by 5 percent sequentially after growing by 15 percent sequentially the previous quarter.

Our analog revenues also increased 41 percent year-over-year in Q3.

Revenue growth, both sequentially and year-over-year was strong in both standard amplifier, converter products and also in more specialized analog products that generally go into many vertical market applications.

Overall our competitive position remains strong.

Our newest analog product gaining traction against all our competitors and the outlook remains very positive for our analog products into next year.

Our DSP revenues grew 9 percent sequentially, and we are up 26 percent year-over-year.

Here too our competitive position in DSP continues to strengthen as both Blackfin and TigerSHARC continue to penetrate a very broad horizontal customer base and many new high-growth vertical markets as well.

By year end we expect to have over 10,000 customers using these new DSP cores, and that should provide meaningful revenue opportunities for our DSP products in 2005 and beyond.

In the short term there remain many mixed signals in the marketplace.

On one hand most economies that we sell our product appeared to be in pretty good shape, which bodes very well for continuation of strength in our industrial business.

Consumer sentiment while a bit more uncertain these three months than the last three months, still from our customers seems pretty good, which makes us optimistic about our success over the next couple quarters in the vertical markets.

But clearly our customers appear somewhat more cautious in the short term, and that creates volatility which makes short term precision of course more difficult.

As we integrate all these variables and there are many variables that are constantly changing here, we are planning for our Q4 revenues to be approximately flat to Q3, which if in fact we do produce revenue growth this year of 33 percent for 2004 compared to the last fiscal year.

To achieve these revenue levels will require between 45 and 50 percent turn (indiscernible) for this quarter depending on how well our current backlog holds.

This level of turns is a very reasonable expectation since very short leadtimes generally lead to a very high percentage of turns business and also that September and October are usually good seasonal months for many of our products.

We expect gross margins and expense levels to remain approximately flat to Q3, which would produce earnings in Q4 in the same range as we achieved this quarter.

Overall we at Analog remain very confident that our signal processing product portfolio is amongst the strongest in the industry, and that we are extremely well positioned for the future.

As many new diverse applications that require high performance signal processing technology are proliferating and all of them require more and more ADI content in every application.

We think it is likely these trends will continue into the future and should provide a platform for continuing strong revenue and profit growth for ADI next year and in the years in the future.

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

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

Operator, at this time we are now ready to take questions from our analyst participants.

(OPERATOR INSTRUCTIONS) Andrew Root with Goldman Sachs.

Question on the Japanese softness.

You guys have done very well in the digital still camera market, there seems to be a little bit overbuild there, was that part of the issue?

Absolutely.

Obviously we looked in great detail at all these numbers since they turned out a little differently than we hoped, and when we looked at this thing by customer by product and every different product sector that we are in.

And when we look at the kind of revenue buildup that we had in Japan over the couple of preceding quarters it was very, very significant.

Certainly part of that was in digital cameras where we have a very, very strong position.

Analog finance at least at this point are in probably 60 or 70 percent of all the digital cameras that are produced in the world and certainly that is the case in Japan as well.

So I guess our sense of what happened over there is they were building a little ahead of what they were really selling and retrospectively that was pretty obvious from their order rates when you look at the year-to-year growth rates on some of these things, they were quite high.

So our sense is that consumer sentiment got a little ahead of itself.

Everybody wanted it, there are plenty of cameras available; they are constantly putting out new models, some of these companies are putting out 7, 8, 10 models a year.

And they got a little more aggressive in these last couple quarters and then they woke up and saw consumer confidence getting a little less so and they looked at their inventories and they started readjusting the backlog pretty well.

From the inputs we get from those customers, maybe 15 or 20 customers that we sell these products to, they are still pretty enthusiastic about their products over the next couple of months as we get out towards the end of this quarter, they are going to start building for the Christmas holiday season.

So at least from the data we have from them, it was mostly related to a little bit more inventory a little bit less optimism.

But those two things where they intersect tends to change the order pattern pretty quickly.

As a follow-up to that in the second half it sounds like still a possibility to see consumer growth again partly due to digital still cameras but do you think there will be other end application divers this year, or is it mostly sort of the inventory being worked through in the existing stuff?

We have very strong design in base and many, many different consumer products.

We have a very strong presence in a lot of AV products; we have a huge design in base now in advanced televisions, new LCD plasma and other advanced TVs and very advanced audio systems.

So we think as we get out towards the end of the year into 2005 there are going to be a bunch of other products.

We have been very enthusiastic about our participation and our progress in the consumer market.

Of course many, many products end products, and many of our products both analog and DSP products as well.

So I don't think any of this has really tempered the enthusiasm we have about our products for the consumer market.

It's just that they got a little ahead of themselves last quarter.

Adam Parker with Sanford Bernstein.

I'm just trying to figure out a little bit more about this guidance here.

If the backlog you said is sort of down near more normal levels now given the cancellations and the normal seasonality in October is about 5 percent, kind of seems like you are baking it much more than normal seasonality, trying to figure out what is the normal turns percentage you get in the October quarter?

Or what makes you think that we're going to get much worse than normal seasonality for October?

I think we are starting off with relatively low backlog because we had just a great deal of cancellations in the quarter.

And there is a lot of signals out there in the marketplace that we don't exactly fully understand.

You read the same things we do, so I think it behooves us to have a plan to run the company that is a little conservative.

And as it is with the backlog we have we need 45 or so percent turns.

We are assuming that the cancellations go down from last quarter to achieve a flat revenue quarter.

So the question is how far out on a limb do we want to go.

And my sense is the way we ought to run the Company and that's the first consideration where we go to, what are we going to do as far as running the Company and spending money and all the other things that we have to decide.

We think that given the very mixed signals out there in the market that it is smart for us to be a little cautious here, and that is what we are doing.

Can you provide a little bit more color on the cancellations?

Where there any specific areas besides the camera that you went through where the cancellations were greater than you would have thought?

The thing that surprised us a little bit because as I said we analyzed this pretty carefully.

We saw cancellations higher than we thought by quite a bit in every region of the world.

We saw a lot of cancellations for analog products.

We saw a lot of cancellations for some of the DSP products.

We saw cancellations in vertical markets.

We saw a lot of cancellations even on a standing product analog business our standard converter to amplifiers, stuff like that.

So it was very -- when we looked across all these customers, all these markets I think what really happened was the leadtimes came in quite a bit, and I think when the customer started plugging in a lot of leadtimes coupled with them being a little more cautious about their outlooks for the future, I think they started canceling orders across the board.

It wasn't related to any one particular market segment or one particular geography.

Southeast Asia was always a little more volatile because of the vertical margin participation Southeast Asia but we saw a lot of cancellations throughout the product groups and throughout most of the geographies.

One last question on the share buyback.

Who and how do you decide when to buy the stock back in the open market?

I mean, how does that decision work on a day-to-day basis?

We have authorization by the Board to buy up to $500,000 million worth of stock at prices we think are attractive.

Who is we, you and Joe?

Yes, Joe and I have a large say in that certainly.

And getting down to the point where it's getting pretty attractive.

Are you planning this thing tomorrow or what?

I think we will pass on that question.

All right.

Bill Lewis with J.P. Morgan.

I guess first just kind of housekeeping.

Could you give what data converters did and amps did in the quarter?

Pardon me?

Could you comment on what the growth or change was in data converters as well as in amplifiers?

I think to a first approximation all our analog product lines grew by about the same amount.

So we said that it was about 5 percent or so sequential growth and that's the kind of growth we saw in all the product lines for the first approximation.

And then I guess on the outlook, you essentially commented you thought the inventory adjustment was complete;

I guess could you maybe elaborate on that in terms of what gives you confidence relative to -- have leadtimes returned to their trough levels or can they overshoot to the downside?

And what gives you the confidence that we'll see growth coming in say the subsequent quarter?

I didn't (indiscernible) the adjustments were so sudden and so large, and as we looked over the last couple weeks of the quarter at least, they really did seem to level off towards more normal levels toward the end of the quarter.

And we have a pretty good idea what consumption rates are for many of those products, and what the real sell through is for some of those products particularly in the vertical markets.

And we keep pretty good track of, so we do not know for sure, and I wouldn't want to persuade you to think that we really know that's going to happen.

It is just when we looked at all the statistics that we track it looks like the extreme cancellation rates that we saw in most of June and part of July have at least leveled off and they are not accelerating.

We view that as a good sign and not different than we usually see when sort of one of these rapid adjustments to backlog is going on.

So it is hard to be precise about that given that we sell to 60,000 customers.

But at least that's our sense right now.

David Wu with Wedbush Morgan Securities.

Yes, Jerry, two questions really.

The first one relates to the communications market was the strongest market last quarter, and I thought the industrial would be.

Can you explain which part of the communications market was so strong and why was it the strongest end market as opposed to the more stable industrial?

The industrial market I think I mentioned in previous calls that grown by quite a bit in the last two quarter given the secular growth rates of industrial products.

So I think what really happened in fact one of the -- it depends on whether you want to see the glass half empty or closed, you want to see it half full, the fact that we held those very large sequential gains that we had over a couple of quarters -- despite the fact that there was mixed signal of factory orders and everything in the U.S. during the quarter, I would sense and view was a good sign.

So in the communications area our wireless business did well.

That includes both our handset business and our infrastructure business.

So it was just a combination of all those different products that have continued to do well.

Now I would also say that a few of those areas like the handset business did not do quite as well as the backlog would indicate that we were going to do.

But we did see good sequential growth in that business last quarter, and the customers remain pretty enthusiastic.

And that is despite the fact that there was a fairly good-sized pull back in China.

So I think I would do -- its very confusing data when you look at the sequential numbers, but the industrial business grew pretty fast sequentially for double-digit rates in the last quarter.

So the fact that it grew by 4 percent or whatever it was is a pretty good results in this period I think.

Can you also elaborate on the cancellation rates, the pure math would say that if book-to-bill ratio is 80.8, I assume that if I took the cancellation must be more than 20 percent of the total backlog went out the door.

That's approximately true.

Which was the bigger hit?

How would you say distributors versus OEMs?

I think the distributor backlog eroded faster than the OEMs.

That is not surprising since their orders were most out of control.

I think typically put a lot of placeholders in there.

We don't pay much attention to those orders, but they are in the backlog.

Right.

So the distributor perturbations were quite a bit more pronounced than the OEM customers.

All right.

I think, David, to put it into context, we generally run somewhere in the 10 percent vicinity for cancellations to backlog in more normal times.

And with larger backlogs going in the quarter we certainly expected cancellation rates to go up a bit.

But we kind of were thinking it might be more in the 15 percent range rather than 20 percent range.

Right, right.

So that is the major sort of change that occurred during the quarter.

And as Jerry said it, it was in the better part of June and July.

Surprised given how weak China was that your handset business and the wireless business was sequentially up.

Yes, it was up but some of that backlog went away at a higher rate, too.

We had expected it to be up even more than it was.

We have a very strong position in China, and our market share there is building.

So we do very well in China except that when we were looking in China at sort of 50 percent sequential increases in orders over time, that was turned out obviously to be a little ahead of the consumption rates there.

We saw some pretty good growth in the broadbased comps business once you move away from these big hot spots.

Greg Ellis with Smith Barney.

First question Jerry, can you comment on what you have seen on the pricing side of the business as leadtimes have come back to six weeks?

For most of our products the price trends are very stable.

The 10 or 15 percent of our product line we are second sources on there has been an increased scramble for business, so those prices are always under a lot of pressure when the demand pattern starts to shift a little bit.

But (indiscernible) 85 percent of our products (indiscernible) remain very stable.

The follow-up to that as we look at your outlook and as you look forward over the next three months, can you provide some color on how you would expect the linearity of the fiscal fourth quarter to come in by month?

And if you can comment on some of the gives and takes that you think will be in play as we look at analog versus DSP and OEM versus distributions?

Typically August is not a great month, particularly in Europe and a few other regions.

And so in some degree in the U.S.

So I think that no matter how you look at it, which is one of the reasons we are cautious about is that if we were counting on September and October being strong months which seasonally it is a trend we often see given that people start buildups for the holiday season in that period.

So I say that at least our planning right now is that August will sort of limp along there, and September a bit stronger and October will get still stronger.

So the quarter will be somewhat back end loaded is our sense.

As we look out into the future given the forecast we have we would expect our analog and DSP business to perform approximately the same way.

There is no inherent reason why one quarter growing faster or not than the other, and we would expect that given the kind of order rates that we saw which we believe are quite a bit below consumption rates that come September and October we start seeing a reasonably good pickup on the order rates.

Is there another part of your question to answer?

You commented on analog versus DSP and how about on OEM versus distribution?

I would say that at first approximation they will track each other.

Our split between OEM and distribution is not quite as pure, it is not just large customers versus small.

We sell to a lot of our large customers overseas particularly in Asia through distribution.

So there's not a lot of meaningful data there.

Nimal Vallipuram with Dresner Kleinwort Wasserstein.

The question is that you might have, you have --.

Pardon me?

Give us an idea how did the end markets do on an amortized basis, like what did the PC market do and how much was the sales from.

I'm sorry.

If I understand what you're saying is the trends and revenue by major end markets?

Walk through our sales to how the end markets themselves are performing, is that right?

Yes and also if you can just give us your exposure to each end market as you have done in the past.

With the, our percentage of sales in the (indiscernible) markets we remained constant to what it has been, so there are really no definitive changes there, that really are beyond rounding.

So I say (inaudible).

Our sense is that the economies in many of the regions that in fact most of the regions that we serve remain pretty good, when you go around and talk to the customers, and you listen to the large industrial customers talk about their results, they are a little bit more nervous because they seen a little bit of a pause here and they are concerned about interest rates and so.

But they are still pretty enthusiastic over the next couple of quarters and that is demonstrated by the order rates we have and the kind of strength we have seen over the last two or three quarters.

I would say the market where the sentiment really changed the most in the quarter for us at least and what our customers are telling us is that the consumer markets that have been really on a (indiscernible) and I think now are sort of getting down to a little bit more rational expectations.

On the other hand there's a very strong product cycle out there which is driving a lot of new products and a lot of new applications.

And I think as a result, they are pretty enthusiastic about next year.

But that of course depends on consumers continuing to buy this stuff, which at least right now looks like they are.

The handset market is going to flow and ebb based on inventories particularly in Asia.

But I think that the handset market is still growing, and our position in the handset market is good.

In the broadband communications market we have a lot of momentum with a lot of new products in that business.

And we are hopeful that is going to be a real source of strength for us next year based on the design wins that we've gotten.

The computer market is going to follow its normal seasonal trends.

You know those trends better than I do.

So I would say there is no real news in the end markets here with the exception that we've seen a slowdown on the consumer side.

Just a follow-up on that Jerry, two of your competitors, Maxim and Linear -- in the case of Maxim they announced their numbers last Friday.

They are still giving guidance for the first quarter which is in the high single digit.

I am not asking you to comment on Maxim or Linear, can you kind of reconcile what's going on here?

Is that because they have a somewhat quite a different end market exposure which I do not believe so.

I'm not going to comment directly on anybody's results, but I can tell you we've looked at this thing ten ways to Sunday because we look at all our competitors every quarter.

And as we see it when you look earlier in the year, including last quarter our analog business grew a lot faster than anybody else's.

Our analog business last quarter grew 15 percent sequentially and I think most of our competitors' analog business grew quite a bit below that.

When you look at our analog business being up sort of 40 percent plus year-over-year, that also I believe compares pretty favorably.

When you look over a long long period of time our businesses track pretty well at least on the cyclical trends.

So our sales growth is at least in our analog business with those guys have grown.

So we don't exactly understand all those things, but our product position is strong.

Our competitive position is strong.

Over a long period of time we've at least grown at the same rates or better.

There is no reason to think that won't continue into the future.

But about commenting about or their comments about what is going to happen in the future I will leave that up to you to discern.

Tore Svanberg with Piper Jaffray.

Going back to cancellations could you give us an indication whether they have accelerated or decelerated the last couple of weeks?

Well, I say -- I repeat what I said a little bit earlier that the cancellations were most extreme in June and early July and they seem to have abated towards the end of July.

A question for Joe, do you expect inventories to be up during this quarter?

We would expect to be able to hold the inventories in our target range of 100 to 110 days during the next quarter.

Of course it depends heavily on the sales levels that we actually achieve.

But I think as Jerry said, the biggest thing that we have to look at is really the economic condition of the world economies.

And that really is the starting point for whether we think this is just something that is a correction on inventory or something more significant.

So we see the same kind of economic indicators that you see and some of them are pretty mixed.

But overall there seems to be a fair sentiment that the economies are in good shape.

So that leads us to believe that it is a matter of just getting through this correction period here.

We probably self-induced some of it by bringing on some capacity and bringing down our leadtimes and that probably contributed to what we're seeing right now.

But we really believe that this is going to work its way through, and that its just a matter of time.

That is the way we are operating the business.

We're obviously being more cautious on the spending front and trying to pull back on spending where we can.

But we are not doing anything sort of rash in terms of not being prepared to service our customers as we go forward.

So we're going to run the factories more or less at the same rate, we are going to pull back on the spending where we can.

And if everything comes together the way that we are planning it which of course we have no idea whether what will actually happen, but we have to plan the business under some assumptions, then the inventory is probably going to grow a little bit in dollars but will stay within our range.

Romit Shah with Lehman Brothers.

I'm wondering if you guys could just provide us what capacity utilization was in the quarter and then also let us know have you made any changes to your plans to bring on additional capacity.

The capacity utilization was in the vicinity of 80 percent this quarter.

Additional capacity that we are bringing on stream really is part of the program that for the most part has already been completed, which was the shift over into the four -- from the four-inch production to the six-inch fabs.

That is behind us.

We've ramped up some capacity in Ireland, and that is behind us.

So we really do have the capacity in place.

There is no change needed there.

And just a follow-up.

I know your target for days of inventories is 100 to 110 days, but with consumption forecasts looking like they are moderating, does that become a concern for you guys at all?

I think the way we tend to look at inventory at Analog is that -- Joe likes to describe it as the fine line in the bananas.

The (indiscernible) inventories on the very long life cycle products, which doesn't create any jeopardy is very low cost to produce, and you know there is no real (indiscernible) since the product life cycles are extremely long.

There are other types of inventory that are in some of the verticals that tend to -- if you don't sell them pretty soon they are not very good.

So we are particularly harsh on making sure that on those products the inventory turns remain extremely high as compared to the products with very long life cycles where we're a little bit more sanguine about that.

Ross Seymore with Deutsche Bank securities.

Jerry, just a quick question on the leadtime commentary with the leadtimes coming in.

Can you give a little kind of -- did it come down mainly because of the supply coming on, or was there something that they saw demand weakening?

I just want to get --

Well its really a continuous loop.

It started coming down of course because a lot more of our capacity came on.

And that inherently lowers leadtime, and at the same time I think customers started plugging in more realistic numbers into their MRP systems of what their demand was.

And I think they started removing some of the placeholders and that's what customers do, that is what distributors do, they don't exactly know what demand is going to be so they put a lot of placeholders out there and the closer it comes to shipping it, the harder they cancel it.

So I think it's a whole bunch of things that in this economy now and with the information flow what it is, it takes -- what used to take six months to compress and it compresses it in six weeks.

That's a good segue into the next question you been through a few cycles yourself here.

Thank you I appreciate that.

That is meant to convey respect.

With the sort of uniform behavior across many different end markets and many different channels all adjusting at once, have you seen something like that in the past?

And if so, how long does that sort of correction tend to last before and it gets back on its feet again?

One of the things with going through a lot of cycles we haven't seen two that are the same.

If you sort of compare this cycle to say, or this (indiscernible) to the orders compared to 2000 cycle which I think everybody is greatest concern out there in technology land right now -- that was a whole different bunch of factors that drove that through the ceiling.

There was free money, there was a communications market that was basically reeling out of control, and there were a whole bunch of things that where actual demand collapsed as well as supply coming on stream.

I think what has happened really here is actually more typical of the cycles that are mostly supply driven, not demand driven.

We haven't seen any real changes in the demand level of our customers.

I think what happens is leadtimes come down very substantially, and I think people are a little nervous about some of the very aggressive projections that they had in the past, and they know they can get the product by calling us up today, and they will have it tomorrow and they say why would they want to carry any inventory risk in that period.

I think that is what is really happening in the last three months.

One quick housekeeping.

What was the turns in your third-quarter?

The turns were somewhere in the vicinity of 35 percent.

Tom Thornhill with UBS Warburg.

Going back a little more detail on some of the things you were just talking about in terms of the buffer stocks and changes in leadtimes -- you mentioned several times that you see customer consumption continuing.

Can you elaborate a bit on how you are able to monitor that in terms of capability to monitor customer inventory of your products or buffer stocks of your products which would give you some insight to what they are consuming?

In the vertical market it's a lot easier than in the horizontal markets where we have so many customers that it's very hard to see that.

But it is a qualitative sense that the people out there are talking to the customers.

It is not a definitive (indiscernible) that we add up all the numbers and this and that.

But if you listen to the customers and go over there, our guys spend a ton of time out there with the customers.

Their sentiment is that they are pretty enthusiastic about the sell through of their products.

They haven't seen any -- with the exception of China probably where there is an artificial clamping of the system there for at least a while.

They are still pretty enthusiastic.

Now will that is that effect?

Absolutely not.

But it is general sentiment that we hear from the customers.

One follow-up on this.

If you look at the amount of buffer stock that got added when leadtimes were moving from 6 to 9 weeks and with a threat of going higher as we went through the Spring, as they come down is there a direct correlation to the customer slowing or stopping orders so he consumes his buffer stock and then gets back online at the 6 week leadtime?

And when do you think that process is completed?

We think a large part of it has been completed, but as Joe said, in these markets you never know.

I think anyone who is sort of fairly definitive on what they thought the orders were going to be, in any short period of time these are -- hasn't been through this before or is not telling himself the truth.

We don't exactly know what is going to happen over the next couple months.

Our sense is and as we said, Tom, we've gone through this over the last couple weeks to where we try to understand what to do about that part of the company, as well as trying to provide some guidance to the investors.

You have to have a point of view and we are pretty harsh questioners of our people about what's going on, and we integrate all these different things going on.

That is the position we've come to.

It turns out we will either be right or wrong.

I think the harder thing to really judge is at what point in time does that really happen.

Obviously we don't think much about August, and so we are into September and October and depending on the timing of that, that converts itself into revenue either in the fourth quarter or first quarter.

But the bigger question is really one of what's going on in the fundamental end markets we serve, and that question is mostly answered by the economic conditions in the world.

And everybody knows there is enough things out there that can disrupt the economies.

And everybody is fearful of that.

But we don't have any way of really gauging that kind of risk.

So we don't temper our plans much by that.

So we look at it from the standpoint of the whole demand in the end markets that we serve for the products that we offer.

And that to us still looks pretty healthy.

So you're not really changing -- you're changing guidance in your near-term, of course, but you are based on what you've seen you are not changing your capacity plan for the -- into the fiscal '05 period or in the other major metrics that you would be working on?

No, we are doing some fine tuning.

We are being a little cautious on the spending side of course, but I think there is nothing that we've seen in this quarter that says that ADI shouldn't be a 20 to 25 percent average grower.

Last year 2003, we grew 20 percent; this year we do these numbers we will grow 33 percent.

There is no reason to think that kind of growth rates and sales and leverage that we believe we can get at the sales increases has changed.

What's really changed is the overages on the order patterns that we saw over the last three quarters.

That's our sense.

That's the way we're going to run the company till we know otherwise and nothing on that sense has changed.

William Conroy with Sanders Morris Harris.

Jerry, can you give us any sense of baked into the guidance is there any differentiation or difference in the mix by end markets.

Or basically are you telling us more or less the end market performance will be flat as well?

I think first approximation there is some seasonality in the end markets.

Some of the consumer products tend to get a little bit stronger going up to the Christmas season.

But I would say those are the kind of trends we see every year.

So I don't think there is any massive change from what we've seen in the past in that.

Can you comment a little bit on the state of inventories at distribution?

Do you feel like distribution specifically has sort of cleaned up its inventory of ADI products et cetera, just give some color there?

We know exactly what the distributors have because we get that every week and we recognize revenue only on they (indiscernible).

And their turns are a little bit less than they were last quarter, they built a bit of inventory out there.

That is inventory that they ordered that we shipped to them.

But their turns are still very normal.

So it is not at all a situation where they are over inventoried.

They had some fairly massive changes in their orders on us.

And a lot less changes on customer orders on them.

So when we look at any of the statistics, we talk about the book-to-bill in terms of the orders distributors placed on us because that's the way we start we looked at it, but if you look at the orders customers are placing on distribution, which is I think a little closer to what consumption turns out to be, those orders have held up a lot better than the orders that our distributors place on us as they try to get their inventories in line.

A. J. Walia with RBC Capital Markets.

Apologize for addressing this question asked earlier.

I'm just trying to understand the dichotomy from a competitors, especially your industrial and communication segment.

You of course are guiding down to flat for the quarter and the dichotomy especially end markets with (indiscernible) communications, has there in your opinion been a marketshare shift in those segments between you and the two nearest competitors Linear and Maxim?

I don't think so.

I think if you look at any -- looking at any particular quarter there is no more of a change this quarter with our guidance in those businesses than there was when our business grew at quite a bit ahead of those guys the quarter before.

There is just sort of changes that happen every quarter, and when you look at it over any rational period of quarters and you look at our growth rates in those segments, as well as any other segments I think our growth rates quite good relative to any of those competitors.

Having a similar question you asked about the cycle itself, a typical cycle lasts about four years in the last thirty years or so and this one started (indiscernible) a bit more than 2.5 years a way into it, do you think there is going to be different?

Will it be longer than four years or shorter going forward?

What is your opinion on that?

I have to admit I have no idea.

You always try to take that into account when you're thinking about the world, but the uncertainty of when the cycle starts, when the cycle ends, it's going to be four years or three years or five years, I really don't have anything to add.

You guys are probably a lot better figuring that out than I am.

When you're going forward you are saying the behavior of the customers and the behavior of inventories in your opinion you think this is a temporary inventory issue and the cycle.

That is our sense right now that is the feedback we are getting from the customers.

And there's no reason why that shouldn't be true because the end markets still look okay.

Louis Gerhardy with Morgan Stanley.

Just wanted to ask you with this uncertainty out there internally from an expense point of view and maybe more importantly from a manufacturing operations point of view how your plans might be changing if at all, it sounds like you're keeping your gross margin guidance pretty much unchanged.

Yes, our sense is that it is actually not that complicated, we have to stop adding expense until we know the answer.

We are going to keep running our factories at approximately the levels that we're running them at because we believe that we're still a growth company and next year is going to be a reasonably good year.

We are just going to tighten up on all the spending to keep the margins up until this is a lot more clear where it is heading.

Looking out at the January quarter that is usually your seasonally slow period.

So with that in mind, do you think the rate of cancellations doesn't change from what you experienced quarter todate, do you think you could have a net book-to-bill of at least 1.0 in the October quarter?

That's certainly our hope based on the amount of cancellations we have.

Certainly that is what we are planning for.

We'll have to see what actually happens.

Okay, then just one last question just in the handset area.

There has been some tier three and four players over in Asia that it appears there might be a growing concern issue with some of these companies.

Are you comfortable with the quality of your accounts receivable at some of these type of customers?

Do you share these same type of concerns?

We are very, very careful in terms of the terms and conditions with those customers.

That not to say we can never get burned, but we have a pretty good track record.

And we sort of watch that like a hawk.

And so we don't know of anything that we're concerned about there.

We have about seven minutes remaining and we do have a couple of analyst participants in the question queue.

So we will go ahead and take the next analyst caller and try to wrap this up on time at 5:30.

Michael Masdea from Credit Suisse First Boston has our next question.

Just to be clear on one of the bigger picture means that you've been talking about, when you are talking about the customers being more cautious that's much more based on kind of macro viewpoints than it is in any changes in consumption.

Is that fair?

I would say that's true.

Is there anything else in your kind of structure of your relationship with distributors and customers that makes it hard for them to cancel orders that we could have some lag effects?

No, we've been debating that.

We have a lot of competitors that are a lot more rigorous about that than we are.

But our sense is that if people want to cancel the stuff particularly on products with the open market products that we can sell to a number of different customers, there is no sense in delaying the agony.

Eventually they are going to -- we're not going to get any more orders if they have inventory.

So trying to smooth out the trends here with our distributors is not something we have done in the past.

We obviously talk about that a lot because it creates some pain and suffering but we sort of say what the market is, that's what it is.

And if they want to -- our custom products that we do are limited market products with customers are a little bit tougher.

But on the standard products which are still a large part of our sales, we tend to have fairly loose policies relative to cancellations.

When we think about your guidance the way to think about it is it is not based on build forecast for consumption, its much more based on what your orders look like.

I think the way to think about it is its our operating plan for how we are going to run the company based on what we're looking at in terms of the end market conditions and the macroeconomic situation.

And our plan is for flat revenues, approximately flat, we don't really have any better idea that anybody else, how many orders are going to come in during the next 13 weeks.

That's going to drive the end result.

And as I said, if those orders came in later in the quarter rather than earlier in the quarter, they might be fourth-quarter revenues instead of first quarters revenues and we don't have any way of knowing the answer to that.

Your guidance is fundamentally it sounds like from what your customers are telling you below what consumption is going to be in the coming quarter.

We have to wait and see how that goes.

I think the way to think about this thing, Michael, is that we sure wish that customers would order every second quarter would be up 8 percent, every third quarter would be this and every fourth-quarter would be 4 percent up and we could run the company, build the products, like that and report the revenues like that and the earnings.

It turns out that's just not the way this business is, it doesn't run that smoothly.

We don't take extraordinary measures to make it appear to be smooth when it isn't.

And it creates a lot of volatility as a result of that.

Like I said, I sure wish it was much more smooth and you could predict this stuff to one or two percent each quarter and be right every single time.

It just turns out that's not the way this business is, which is why we tend to try to plan the company and run it based on what we think the sort of secular or long-term growth rates are in the company.

That is how we add engineering resources.

That's how we add capital.

WE manage our capacity, and as long as we continue to believe that the secular growth rate is still what we believe it is, then we don't make massive changes each quarter.

We just make minor changes to try to be financially responsive on these things.

But (inaudible) in this business with the cycles and the ups and downs and the (indiscernible) and frequency of the ordering patterns which are mostly caused by supply, not demand, you have to have a long-term view of where the business is going because if you try to shake the tail you are absolutely wrong every single time you do it.

Sort of like trying to take stock pricing up-and-down.

You have to look forward and we look forward to what we think is secular growth rate in the business is.

If we think it is still 20, 25 percent we're pretty happy about that.

Thanks for your candor.

Paul (indiscernible) Securities.

I was wondering if you would be willing to toss out a number at this point as to kind of what you're benchmarking capital spending thoughts for next year, your next fiscal year.

I'm sure nothing is set in stone at this point, but what you're thinking along the lines of today.

Well, it is really too early to get into that.

You've been seeing that we have been heading toward 5 percent depreciation as a percentage of sales, and we been holding capital spending down in that sort of neighborhood.

And we've got in place quite a bit of front end capacity upside.

And so -- I think in the first planning point we (indiscernible) start with the same kind of level.

Of course the answer to that will depend on what actually happens as we go forward.

We have plenty of capacity in place; put on a lot of structural capacity on larger wafers.

So I don't see us having in the next year or two a large capital expenditure year.

And we are, we do tend to look at that relative to depreciation levels.

And Joe's idea has always been that if we are heading down to 5 percent that is probably a good guess.

Thank you everyone for participating today.

We look forward to talking to you again during our fourth-quarter conference call, which is scheduled for Tuesday, November 23rd.

For those of you who are still in the queue that we did not get to either go to a second-round or get your question, please give us a call at 781-461-3282 and we will speak to you soon.

Thank you all.

This concludes today's Analog Devices conference call.

You may now disconnect.