亞德諾半導體 (ADI) 2004 Q4 法說會逐字稿

Good afternoon.

My name is Miles and I will be your conference facilitator today.

At this time I would like to welcome everyone to the Analog Devices fourth quarter and fiscal year 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.

If you would like to ask a question at that time, simply press star and the number one on your telephone keypad.

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

Thank you.

Ms. Tagliaferro, you may begin your conference.

Hello, this is Maria Tagliafeno, Director of Corporate Communications for Analog Devices.

If you don't yet have our fourth quarter and fiscal year 2004 release, you can access it by visiting our web site at www.analog.com and clicking on the headline displayed on our home page.

This conference call is also being web cast on the Internet.

From analog.com, you select the "investor relations" and follow the instructions from that link.

There's a microphone icon that you can click on at that point.

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

Participating in today's call Jerry Fishman, President and CEO;

Joe McDonough, Vice President of Finance and CFO; also Brian McAloon, Vice President for the digital signal processing and systems products division; and Bill Giudice, Vice President for our micromachine products division.

We've scheduled this call for 60 minutes and we'll begin in a moment with Mr. Fishman's opening remarks.

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

Analysts participating via telephone can press star, 1, on their telephone at any time beginning now to queue up for questions.

I would like to point out that under the provisions of the Private Securities Litigations Reform Act of 1995, this conference call will include forward-looking statements.

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

Risk factors which may affect our future operating results are described in the company's most recent annual report and 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 November 23rd, 2004.

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

Well, good afternoon.

In our earnings release this afternoon we provided a lot of detail on our Q-4, 2004.

Also our 2004 fiscal results for the year, so I'm not going to be repeating a lot of that material in my opening comments.

Instead I'll provide some insight into the 2004 overall results, really in the context of the trends and how those trends could play into 2005 and beyond.

I'll also provide some detail on the trends in Asia after just returning from a two-week visit to that region.

Despite softening demands in our fourth quarter, 2004 turned out to be one of the strongest years in our history.

Our revenues grew 29% for the year, well above what we thought was possible when the year began.

Our revenue growth over the past two years has averaged approximately 25% a year, which is at the high end of what we believe the long-term growth rate is of our business.

We also made great progress in expanding our gross margins, through a record 60% for the third quarter and we maintained gross margins of 59.5% for the fourth quarter, despite lower revenues.

The year gross margins expanded by 410 basis points, above our fiscal 2003, as our cost reduction programs that we initiated over the past few years have permanently reduced our infrastructure costs and our factories are currently running record yields.

We continue to invest very heavily in R&D during the year to support new product programs in Analog and DSP and also MEMS technology.

For the year, our R&D increased by 14%, with just over $500 million.

The payback that we're getting on the R&D is strong as we continue to pioneer new advances -- converter and amplifier technology.

We continue to expand our para-management portfolio towards laptop and more diversified general purpose products.

We continue to proliferate our new DSP cores to a broad horizontal customer base that now approaches 10,000 customers as well as new higher volume vertical markets for DSP.

We've now expanded our MEMS product portfolio to many new consumer and automotive applications for both accelerometers and, more recently, for gyroscopes.

For the year, revenues from new products increased 45% year-over-year and totaled 21% of sales.

As a result of good sales growth, gross margin expansion, and good expense controls, operating profits for the year grew to $700 million, up 87 % from last year and 3 times the growth rate of our sales.

Earnings per share grew to $1.45, up from 78 cents last year.

Cash flow from operations for the year totaled $778 million before expending 146 million in capital.

During fiscal 2004 we provided additional returns to our shareholders via $75 million in cash dividends and by purchasing $137 million of our stock on the open market.

As we look in at 2005, the question on everyone's minds is whether the order weakness that we've all experienced since early summer is an inventory correction caused by over-ordering in the first half of the year or alternatively the harbinger of the end of the current semiconductor cycle.

While our crystal ball is certainly no better than yours, our conclusions are that the end markets for our products remain mostly strong, reported by good economic growth in most regions of the world and that we're in a very strong product cycle, particularly as signal processing technology becomes the prime differentiator and the enabler of electronic equipment of virtually every end market, from industrial to consumer products.

Clearly, the recent volatility in Asia, particularly in China and Japan, has caused revised expectations recently throughout the semiconductor industry.

To better understand the issues in those regions and how 2005 could play out, I've spent the last two weeks visiting customers in that region.

These customers in aggregate represent over $500 million of our current revenues and manufacture primarily wireless and broadband infrastructure products, cellular handsets, and consumer products.

The larger consumer customers in Japan and Korea are today clearly more cautious than they were six months ago, but nevertheless are planning for a good 2005.

They're introducing record numbers of new high-end audio and video products and the channel reaction to these new products appears to be strong.

Particularly noteworthy are new 5-megapixel cameras and the increasing market share for ADI products amongst the leading camera brands.

Also noteworthy were increasing unit forecasts for advanced digital televisions in response to new price points that are now approaching $50 per diagonal inch.

Generally, across our Asian consumer electronics customers, inventories built in the first half were working off and are expected to be in good balance over the next few months.

Therefore we're planning for consumer customers to work off their inventory the first quarter of our fiscal 2005 with holiday shipments that they're going to make which, of course, include the Chinese New Year.

Wireless infrastructure customers report good demand from the carriers and inventories that are today in better balance than they were a few months ago.

While there is significant activity in early orders for 3G equipment, most production today remains the 2, 2.5G , and EDGE base stations, where our Analog products have very strong market share.

This market should remain healthy in 2005.

Customers expect to begin production ramps of 3G infrastructure systems in late 2005.

3G products incorporate not only our Analog ICs, but also our TigerSHARC DSP, which is today the first and the only processor to enable an all-software 3G digital base band, which is a very significant issue to many base station customers as new standards and new features are constantly added.

There is also very significant design activity for broadband access and broadband infrastructure products in China, as new what's called triple play IP set-top boxes that could become the primary source of data, video, and voice content, are being introduced for the local market in China and also for export.

IP set-top boxes link televisions to broadband networks, enabling a wide range of services including video on demand, web browsing, and voice-over IP.

Our Blackfin processor represents a real discontinuity in performance, as do many of our high performance Analog products for this market.

Based on recent inputs during my trip to these customers, they're expecting more deployment on these systems later this year.

Amtech customers in China, while still wrestling with excess inventory, or seeing a resumption of local demand and also some very important new export opportunities.

At the 3G conference in Hong Kong, which was last week, there was an increasing focus on new 3G phones and clearly a lot of debate about 3G standards China.

Estimates for 3G penetration in 2005 range from 5 to 10% of all cell phones.

Clearly, the real issue on carriers' minds in 3G is content and flexibility.

For example, how to sell more services that provide more revenues per subscriber.

Our Blackfin-based SoftFone chipsets, which we announced last week, are a very compelling proposition to many Chinese customers, as is TigerSHARC to 3G base station manufacturers.

In the rest of Asia, adoption of the cell phone ODM model continues to accelerate much as the ODM model has in the PC business.

Asian manufacturers in Taiwan and also in Korea that we spoke to report much higher interest from so-called branded suppliers, particularly as the carriers increasingly ran their own phones.

The ODM model really does favor our SoftFone approach, as it enables faster time to market with new features and early access to higher data rate services that are enabled by EDGE today and in the future by 3G.

All in all, I came away with an impression that while there remain short term issues in the region, most markets are strong and poised for good growth, particularly as we get out into our second quarter and the second half of the year.

Our customers are currently shipping their products at rates well above the current order and shipment rates of ADI products.

Aggregating these visits with feedback from the U.S. and Europe, our plan for 2005 is for some continuing weakness in our Q1, mostly as a result of very low opening backlog and a seasonally short quarter followed by a resumption of growth in our Q2.

We're currently planning for our first quarter revenues to be in the range of 575 to $600 million and for gross margins to remain strong at 58 to 59% and operating expenses to decline sequentially by 3 to 4%.

Based on these assumptions, we'd expect our earnings to be in the range of 28 to 31 cents.

We plan to cautiously manage expenses until growth resumes and then grow our expenses at a fraction of our sales growth rate until we meet our expense ratio targets of R&D at15 to 16% of sales and SG&A at about 10% of sales.

We're planning to run our factories at levels Q1 which anticipate a resumption of growth in Q2.

This is expected to result in first quarter inventory increases of approximately 15 to $20 million above current levels.

Several factors lead us to believe growth will resume in Q2.

Most importantly, much of the inventory buildup is a cause, recent volatility is likely to be absorbed by the end of the first quarter.

This will result in order rates and sales patterns in our second quarter that are more in line with the actual consumption of our products.

We also believe that the first quarter will represent the cyclical low of shipments to ATE customers, which at one time were about 6% of our revenues and now are done to fairly nominal levels in Q1.

Our market share in China, while currently a drag on our revenues, should be a positive factor for the second quarter and beyond, as government economic restrictions dissipate and growth returns to above-average level.

It's interesting to note, in China our revenues grew by approximately 75% a year for the last two years and represented about 14% of our total sales for the year 2004.

In addition, the order rates from end customers to our distributors were well ahead of distributor order rate on ADI during the fourth quarter, indicating that these distribution order rates are also currently well below consumption rates of our products.

And lastly of course, our second quarter is typically a seasonably stronger quarter for ADI as we benefit from our broad base of customers serving the industrial end markets.

In the longer term, we continue to believe that our product position and our customer base can support growing our business at above market growth rates over the next few years.

Signal processing products, both Analog and digital, continue to provide one of the best business models in the semiconductor industry, a business model of high growth, a diversified customer base, and very strong profitability, cash flow.

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'll give you another opportunity to ask additional questions 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 phone.

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

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

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

Your first question comes from the line of William Lewis with J.P. Morgan.

Great.

Thank you.

I guess I have a question about the outlook.

Beyond Q, which you expect to be down, and you're looking to -- resumption of growth in Q2 and presumably into the rest of '05, where are you expecting to see faster growth?

Is it within Analog or DSP and I assume orders are filling in today?

Where do you have the best visibility as you look into Q2 for growth?

Well, I think I -- I mentioned some of those areas in the -- in the opening comments, but you know, I expect our business across the board to get better in Q2.

Our belief, and I think what was confirmed by my visit to Asia, which is where we've seen most of the order volatility in the revenue roll-off, was that most of that's related to phenomena that are basically passing us right now.

It was mostly related to the inventory buildup in the first half.

I mean, I think when you look at the growth rates in the first half of the year, that we were putting up there, you know 35 to 40% year-over-year quarters in a business that sort of had a secular growth rate of 20 to 25%.

You know, in the cool light of day, inventory is building someplace and I think what we saw in the second half was the reversal of that and what the customers are saying is that, you know, particularly in the products that touch consumers where most of the rolloff was, that you know, once Christmas comes and the sell-through is strong and the Chinese New Year comes and the sell-through is also hopefully strong, you know that inventory is going to be mostly depleted and they're going to be back to ordering at rates that really much more closely resemble the consumption rates of our products which now are much higher than the order rates we're seeing.

So if -- if that thesis holds together and the economies around the world hold together, which is our assumption going in, and there's no reason why growth shouldn't resume in Q2, given that our customers are growing.

I mean, their shipments over the last couple of quarters, despite what they've done to the semiconductor industry in this period, have been generally good.

I mean, if you listen to all the earnings releases and the prognostications from the customers that are doing well in their market, they're doing okay.

And you know, the semiconductor vendors have gotten whipped around on the inventory situation pretty hard but at the end of the day it's not necessarily hidden demand that's collapsed, it's mostly the inventory.

So if you do come to believe that the inventory is abating -- and I think there's clear evidence in one of those customers that we visited and many others that it is -- then I think it's a very logical hypothesis that, as the inventory abates -- and if we just got back to consumption levels, that would represent pretty good growth rates after the first quarter.

Relative to Analog and DSP, will DSP continue to grow the fastest?

Well, I think our hypothesis over the last couple of years has been that there's no inherent reason, other than, you know various product cycles, where one might grow faster than the other, that the growth rate should be any different.

You know, we believe that in aggregate, the growth opportunity for Analog in the range we've been talking about are 20, maybe 25%, on the average.

Some years higher, some years lower, and there's no inherent reason why the growth rate of either of those should be higher or lower.

Great.

Thank you.

Your next question comes from the line of Michael with CSFB.

Great.

Thanks a lot.

You know, a lot of us -- you kind of walked through an argument about the man being fined [inaudible] sales picking up, but turns still aren't picking up.

How much of that is just a lead time issue which now, probably, I assume is stabilized, and how much of that is maybe a different approach to the supply chains taking to managing the supply chain?

Both OEMs and the channel.

Is there anything structurally going on?

I don't really think so.

I mean, our sense is that you know, when -- there's plenty of supply out there, customers order for very short lead times.

There comes a point in every one of these cycles whereby you don't have any visibility and the backlog is low and everything people order is for short-term delivery.

A very high percentage of the orders we're getting now are for short-term delivery, because customers know that lead times is short and they can get it.

Now, were they any smarter about planning their supply chains and all that stuff from the last time?

You know, they'd say everyone says they are, but I think the early part of 2004 seemed to indicate to me that when you get right down to it that's not what happens or else we wouldn't have seen, you know, 40%-type year-over-year growth rates early on the year, on the order front.

So I don't know.

Maybe things have changed but it doesn't appear to me that they have.

And kind of following up on the Analog versus digital question, if you look at some vertical integrations, some markets, as well as digital camera handsets, where you're seeing a fair amount of integration among the different pieces of the componentry, is that net-net bringing more digital into the equation for you?

More Analog?

Is there any trend that you're --

I think in the camera business, most of our sales today and so far have been on the Analog side.

And when the Analog front ends, that transformed the image into digital form.

Today in most digital cameras, a lot of the digital processing is done on ASX, so if they want to do MPEG something or other, they do a digital ASX for that and if they want to do something else, they do a digital ASX for that.

What's happening is as the feature set keeps expanding and changing in digital cameras, the requirement for a programmable solution that first, you can change and secondly, that you can run multialgorithms on, is expanding because as you get down to very low lithographies, the cost of spinning ASX is very, very high.

So considering that the camera manufacturers are coming out, in some cases, with 25 to 40 models a year, they don't want to be changing those A chips all that time.

So the opportunity for programmable DSP like Blackfin in cameras has really accelerated.

So I would say that in products like cameras, the opportunity is changing towards being -- from being just Analog to now Analog and VSP in the future.

I think that's true in some other consumer products as well.

On the other hand, if you take a look at things like, you know, some set top boxes, I mean, they're really starting off building their product around the DSPs and in that sense, there's roms for Analog products to attach to that, but a lot of the primary engine in that thing is a highly programmable DSP like Blackfin.

So it really does depend on the product and the application, but I think the one constant in that is having both really helps you.

I don't think there's any doubt about that and being able to go into some of these new applications and apply the entire signal chain and increasingly many of the peripheral functions around the signal chain really does give us an advantage.

There's no doubt about that.

Thanks.

Your next question comes from the line of --

You know and I would say one other answer to that is -- and that's particularly true in Asia where a lot of Asian customers don't have a lot of design capability, so the ability to go in there and say, this is the box you need and here's how to do it, really does help us and I expect that's why in China, as I mentioned, our market share and our sales growth has been so high because we've been able to supply the entire signal path to a lot of those customers who don't have the capability to invent that themselves and they don't have really time and the energy to try to pick off product point solutions in those boxes.

So I mean, that's where the integration and the -- you know, the broad product and technology portfolio really does help us.

Can we take the next question?

Your next question comes from the line of David Wu from Wedbush Morgan Securities.

Good afternoon.

I hope you've recovered from jet lag.

Two questions please.

On the first one is, you mentioned about the requires of turns business.

What kind of turns business do you have to do in Q1 to meet your guidance?

And the other question I have really comes down to the -- when I look at the business that you do, can you even at this point phantom how much of a -- what's your distributor inventory at this point, on a worldwide basis relative to the last quarter?

Do you have any feeling for level of distribution in the channel?

David, this is Joe McDonough.

On the turns question, we ended the quarter with $329 million worth of backlog that is requested for delivery during the next 13 weeks or during next quarter.

And our bookings this quarter were down about 9% from where they were last quarter.

Our cancellations, as I think Jerry may have mentioned, abated as we went through the quarter and we've gotten to levels that are very normal at this point in terms of cancellations.

So with that kind of a backlog -- and this is fairly typical in cycles -- you know, as you see the cycle go in this direction, you get to a point where the backlog gets low, you become very dependent on turns business and the product is readily available.

So I think all the factors that Jerry talked about are what lead us to believe that we'll probably end up with a first quarter that sequentially will be down a bit next quarter and then start to recover into the -- into the second quarter.

So you can see that we need something on the order of half of our business from turns business as we go forward into the next quarter.

From a distribution standpoint, the inventory at distributors went down -- declined this quarter in dollars.

The turns that the disties are running is more or less the same as it was last quarter, probably slightly less turns of their inventory this quarter, but very, very normal.

And consistent with what it's been, you know, similar to what it was at the end of last year during the middle of the year in this sort of period when everybody seemed to want everything that they apparently didn't need.

The turns did go up and push to a little bit of higher levels than is normal but we're at normal turns.

We haven't tried in any way, and it's not our strategy to try to push inventory out to the distribution channel.

We're trying to have inventory available to serve the customers when they need it and trying to keep the lead times as short as we can.

Thank you.

Your next question comes from the line of Andrew Root with Goldman Sachs.

Thanks.

A quick question on the $62 million.

Half of that, I guess Jerry, from your numbers, would be assembly and test.

The other half was [inaudible] wireless communications.

I would assume that the vast majority of that is actually on the handset side because infrastructure has been growing even slowly for people this quarter.

Is that a fair assumption or is it a little bit different?

I think it's a lit bit different.

The infrastructure business as well as the handset business was down last quarter.

That business had been very strong for us earlier in the year and when we went out and visited all those customers, a lot of those were in Europe as well, they reported that they've been the last quarter or two working through that inventory.

So that business -- you know, both businesses were down last quarter.

But in the sequence of it, just to clarify that, I think you mentioned an assumption that it was half ATE and half wireless.

Is that what you --

Yeah, I was just doing the calculations. 6% to a percent or two, although ATE --

No, I think more of it was in the wireless space than in the ATV.

It wasn't 6 to 10 in the previous quarter.

It was 6 to 10 at the peak, which was earlier.

Okay.

That makes complete sense.

Thank you.

The second part of the question relates to distributors.

Is there any way to quantify how much in the quarter you think they reduced their supply by selling it, and what part they were buying in [inaudible] today's terms or percentage of total?

Just take a guess, even by region would be helpful.

The best sort of way we measure that is we look at the bookings that the distributors have on them versus what they're selling out or shipping out and then we look at what they're booking on us relative to what, you know, all that demand is from those end customers.

And what we saw this quarter was that there was a substantially higher book to bill ratio if you will at the distributor level from their end customers than what they turned around and put on us.

Was it 10% high or -- in magnitude -- or more than that or less than that?

It's, you know, something probably in the 10% vicinity would be closer to what it probably is.

Okay.

Thanks very much.

Your next question comes from the line of Tore Svanberg with Piper Jaffray.

Yes, good afternoon.

Given that you're going to be down next quarter and visibility has sort of deteriorated, why would you continue to build inventories and at what point measured by inventory days do you get concerned that it's going too high?

Well, first of all, what we do is we look at the -- the product and the product life cycles.

And we have a portion of our product base that has shorter product life cycles.

They serve some of these vertical markets that tend to have more of the volatility.

For those products, a lot of those are built at foundries and what we do is respond by reducing the demand we have from the foundries for those products.

So we're trying to keep very low inventory levels of the products with the shorter product life cycles.

For the other portion of our business which makes up the majority of our business, the product life cycles are extraordinarily long.

We really run no risk of being in supply rather than out of supply on those products and so we look and take a longer term view of the loading of the factories for those kinds of products and so we look at it and look out over fiscal '05 and look at what we think the demand will be, and as Jerry said, we're expecting the second quarter will be a much better quarter than what we're likely to have in the first quarter and that there's nothing that, you know, is really spooking us in terms of the opportunity for Analog Devices going forward.

So we're planning to run the factories a little bit slower next quarter.

We'll have some holidays in there and so there will be a little less output next quarter but we're not doing anything dramatic.

We're looking forward to the second quarter in trying to be in supply going forward.

I think the -- the balance is, we're reducing the manufacturing costs for the external supply product and we're continuing to run the factories at probably a lower utilization rate next quarter but still looking forward to '05.

I think -- this is Jerry -- one of the great parts of the Analog, the high performance Analog business is that you don't have to jerk your factories around every quarter in response to the order rates and you know, turn the lines down and go through all the disruptions that you have to do only to turn them up in the quarter because you're worried that you're going to build inventory that's going to go bad on you.

I think one of the great parts of the Analog business model for Analog products is that if you build a little inventory in the cycles that's good news, not bad news, because it precludes you from having to jerk the factories around and suffer all the, you know, negatives of doing that when you don't have any inventory risks.

We tend to view that more as a positive than a negative.

And on the question of inventory days, how high they can go?

Well, the inventory days at the end of the fourth quarter were 123 days.

We indicated that we thought the inventory might go up 15, $20 million next quarter, depending on the level of sales and so you can calculate what that works out to be.

But it's levels that we're quite comfortable with, given what we believe is the outlook at this time.

Very well.

Thank you.

Your next question comes from the line of Michael McConnell with Pacific Crest Securities.

Thank you.

The comments pertaining to China that we're going to see some local demand emerge, have you actually started to see some order resumption there?

Can you talk a little bit about just what you're seeing, in China in particular, please?

Yeah I'd say the indications we're getting from our customers are that the order patterns are going to firm up.

So have you seen that the orders yet, though?

Or, is it just --

Well, we haven't seen a lot of the orders yet, no.

Okay.

And then looking at the pricing environment on the DSP front, have we started to see pricing become an issue or has pricing on the DST business been holding relatively firm?

The pricing has been holding relatively firm in both the DSP and the Analog business.

Okay.

And the last question I just had was, relative to your turns requirements at the current time, roughly 45 to 50%, how does that compare to historical levels?

Is that towards the high end or -- could you give us kind of the range of what you've seen usually on the turns?

Sure.

If you go back and if you knew us a long time ago, that would be on the high end.

But if you look back over the past couple of years, we've been, you know, running quarters that are 50, 55% book and bill on the upswings and we've been running 40% on the downside.

And so it's quite normal.

Thank you.

Your next question comes from the line of Jack Romaine with SG Cowen Securities.

Hi.

Could you give us a little bit more detail on the utilization, maybe over some numbers for the past couple of quarters and where you expect it to be next quarter?

Well, the utilization has been running up in the 75 to 80% range for the past few quarters.

Probably be down a bit next quarter.

And if you guys were to cut back on production so that you didn't build any inventory, do you have any sense of where your gross margin would be next quarter?

How much do you want us to cut back?

I mean --

It's a question, I think what we've done is tried to respond to it from the standpoint of what we're planning to do.

And we're looking at it from the standpoint of, as we described, the long product life cycles, the die banks that we have, what we think is appropriate given those -- those products and trying to keep in place the production capacity that we need going forward in order to serve the opportunity that we see out ahead of us.

So I mean, there's -- you know, almost an infinite variety of what we could do that can have, you know, a dramatic effect on the gross margin.

But what we're planning to do, we think, will wind up with a gross margin in the 58 to 59% range.

That assumes, which we typically see, that the pricing environment stays pretty steady which is fairly typical for our product portfolio and that the revenue levels are in the range that we've estimated.

Of course, that all depends on a lot of turns business.

Well, how about in terms of -- you're planning to build inventory to the level about 15 to 20 million in the quarter based on your expectations for demand in Q2.

Is there anything that you could see in your business over the next month or so that would change that view and cause you to cut back on utilization?

Well, probably if you ask that question out in the January time frame, toward the end of January, you know, we'll be looking at what happened and what we think is likely to happen in Q2.

We'll certainly keep an eye on the economic situation around the world as we go through this and certainly listen to other companies in both the electronics industry and semiconductor industry and then we're continually looking at the environment and adjusting what we do.

Okay.

Thank you.

What we're giving you is, you know, our plan that we have now, based on what we know.

Thank you very much.

Your next question comes from the line of Tom Thornhill with UBS Warburg.

Two questions.

One on just the inventory.

Can you give me an estimate of how much excess inventory disty has at this time in terms of weeks of inventory above the target levels that they would like to get to?

We believe that the disties are at the target levels that they would like to be at.

So they're -- okay.

We don't operate the distributors, you know, in a fashion where we're trying to overinventory them.

We're trying to have an appropriate level of inventory for the business level that they're doing.

I mean, sure, there could be, you know 2, 3, 4, 5% -- in that range -- that you know, perhaps given the level of business that we ran this past quarter, that perhaps they could have a little less inventory, but by and large the inventories are at the right level.

They're different in different geographies for the different types of customers.

Okay.

And I guess -- I guess, you know, for those that don't follow us and who don't know us as well, we only recognize revenue when we ship out of distributors.

When the distributor ships to their end customer on a worldwide basis.

So there's -- and we're trying to be transparent as much as we can about the inventory situation.

Okay.

China, the handset customers, do you sense that their share gain or loss which appears to us have been a loss of share in some of those customers in their own markets, that that is stabilizing?

I think the Chinese handset manufacturers are going to continue to do extremely well.

You know, there was some short term action there with Nokia when they dropped their prices and everything, but I think, you know, the way I would look at it is challenging the Chinese on price as a long-term strategy, not necessarily the most effective way to do it.

But I -- you know, I think in the short term that's what's happened so I -- I continue to put a lot of faith that the Chinese will do extremely well in the future in the handset business.

You think the sheer shift there has stabilized at this point in time

Absolutely.

Okay.

And that then would help going into Q2?

Yeah.

Thank you, Jerry.

Your next question comes from the line of Craig Ellis with Smith Barney.

Thank you.

Just a couple housekeeping items here.

On CapEx, what should we be thinking about for the fiscal year?

And on the income statement, the -- for their income and expense line. [Inaudible]

The capital spending as the first approximation would be more or less in the same range as what we've been spending recently. 145, $150 million.

Okay.

And then the other income line?

The other income line this quarter was $13.1 million of income.

And that might go up, say, $1 million next quarter.

Okay.

We're earning a little better return on the investment.

Okay, Joe.

Thanks.

Your next question comes from the line of Ross Seymore with Deutsche Bank.

Thanks guys.

Just a question on the gross margin side of things.

The last time you guys were running at about 575 to 600 million in rev, I think the gross margin was about 55 to 56%?

Being a point above that, can you just discuss what's driving that?

In your guidance --

I thin most of it, you know, you might recall that over the last couple of years, you know, we've taken a fair amount of infrastructure costs out of manufacturing and we've closed some old fabs.

That raises the utilization in the newer fabs.

We're building more of our products around 6 and 8 inch fabs than we were then, so I think it's a lot of the stuff that we've been working on over the past that we've always said as a result of that that at the same revenue levels we could run higher gross margins.

And I think what you just pointed out is the evidence of that.

Moving over to the inventory side, not to -- to harp on that topic too much, but what sort of breakdown are we looking at between die bank and finished goods and raw materials versus what we've seen in the prior quarters?

I would think -- I don't have the data here with me on the call.

We probably have a little more finished goods at the moment than we've had in the past.

You know, you don't sort of come off a quarter like this where the revenues surprise you and are off 12% when you were expecting something different without being prepared to ship to the customers.

So we probably have a little more on the finished goods side, but our bias is toward die bank.

And finally, by my calculations you'll be somewhere around 134 days at the end of the January quarter of inventory.

What sort of growth are you expecting in fiscal '05 to be able to bring that back down to your target range?

We're expecting that the second quarter, it doesn't really -- you know, if you look at the second quarter it doesn't take the second quarter being a lot larger than the fourth quarter that we just finished, you know, and you're -- have pretty good sequential growth from first quarter to second quarter and then it just takes, you know, some normal growth for the balance of the year and -- and the year ends up, you know, being an okay year with a sequential growth that starts you know, being in the range of what we're looking at.

So that's the whole picture as we see it.

And it could evolve to be better than that if the world gets its act together and the demand for signal processing is where we think it can be.

One thing to remember, given all the questions here on the inventories, is that we went through the same kind of issues when the cycle turned down after 2000 and we let the inventory right up, there were a lot of questions that we got and concerns that, my God, that's going to kill the gross margins, you know, once you stop building inventory and in fact, just the opposite happened.

The gross margins kept going up.

So I think we have a pretty good track record of dealing with the inventory in Analog and on one hand keeping the supply good.

On the other hand not disrupting the factories on short term cyclical swings.

And I think that's what's going to happen again.

Great.

Thank you.

Your next question comes from the line of AJ Walia with RBC Capital Markets.

Thanks.

This question is relative more to the cycle of the first half of the year.

What is your end demand presumption for growth, in terms of the first half of the year, sequential growth and sometime in the second quarter.

I mean, with what confidence and demand forecast for the rest of the year?

I can't give you a number right now.

We're -- we even have a wide range of possibilities for Q1 that we talked about.

You know, $25 million on uncertainty in the guidance that we gave you, which is much greater than we usually do for those that follow us for a while.

So I think it would be premature to speculate on trying to get precise on what the growth is in Q2.

What we're saying is that our customers are depleting inventory and they're going to -- you know, we believe they're going to stop depleting inventories.

We're not going to have that much by the end of the quarter and that therefore, the rates that we expect to be shipping and certainly the rates of our orders should more be reflective of what they're actually using.

To try to put a precise number on Q2 now I think is premature.

Other than to say --

-- in demand and Q2 globally?

Pardon me?

Isn't that assuming that there will be a certain amount of seasonal end demand globally in Q2?

Yeah.

I mean, it assumes the world stays together, the economies are pretty good, and we certainly have pretty good design-ins with the leading customers in the segments, so I think if the world holds together, that's probably a good expectation.

And do you expect the gross margins then to sequentially go back up?

I think there's pretty good end-demand right now and that's why the inventory is getting depleted.

So, I mean, we got customers, the consumer customers, the communications customers, the handset customers, the industrial customers -- they're all reporting reasonably good demand.

So it's not like demand has to get a lot better in Q2 for our results to get better.

It just has to stop depleting inventory.

Okay.

Thanks.

I think the first derivative of the gross margin is the level of revenues, you know, and so what we're doing is -- is really looking at fiscal 05 and looking at it from the standpoint of what we believe the opportunity is for the type of products that we offer into the various end applications that we -- I think everybody -- everybody knows.

And our assumption is that that all remains healthy.

If it turns out that's not true, then obviously we're going to have to run the business different than what we're planning to do, but that's not the way we see it at this moment.

Your next question comes from the line of Lewis Verhardy with Morgan Stanley Dean Witter.

Good afternoon.

Questions for Joe and then I have one for Jerry.

Joe, on the cancellations, what was the dollar amount in the fiscal fourth quarter

The cancellations were about half the dollars of what they were last quarter.

Okay.

So that's still above normal, isn't it?

No.

It was a little above normal in the -- you know, for a portion of the quarter there, a little higher than we had expected but it's -- quite normal as we -- as we ended up.

Okay.

And --

It was a little bit rocky for a period.

It began in June and there was a week that would look okay and then there would be a couple of weeks that were bad and now we've had a reasonable period of normality, I guess, is the way I would describe it

Okay.

And when we think about fiscal Q2 and what you're saying there, I mean, shouldn't we be expecting bookings and backlog to be up sharply in this fiscal first quarter in order to, you know, grow in fiscal Q2 sequentially without humongous turns requirement?

You sound like me.

God help you.

That's sort of what I say internally, but I think the reality is, with the kind of lead times that we're offering the customers and the availability of our product, we can actually probably go into Q2 with a pretty healthy turns business and everybody will be happy.

Okay.

So the gross bookings that you've seen quarter to date versus fiscal fourth quarter, I mean, is that -- can you talk about the types of --

Yeah, the way -- I think the right way to look at this quarter is that we're kind of moving ahead along the levels that are required in order to do the level of business that we've described in this outlook.

Okay.

You know, a rocket ship didn't take off but on the other hand, it doesn't look like there's disaster or a train wreck ahead of us either and we're kind of going along the way we would expect it to be but there's only a couple weeks so --

And then for Jerry, just as a result of your trip, I'm just -- to put it in perspective, how much of the -- the changes we've seen here in the last couple of quarters would you attribute to cyclical issues like inventory versus just lower consumption in some end markets?

I think most of it -- I can't give you a real quantitative number on that, but i'd say a considerable portion of it was inventory was exacerbated by you know, by local consumption in China as a result of what the government was trying to do over there.

And that -- you know, sort of impacts not only China but other regions that sell into China.

China is still a huge consumer as well as a producer of stuff, so I think it was mostly related to inventory, a little related to demand, particularly as a result of China.

Okay.

Thank you guys.

Your next question comes from the line of William C. Conroy with Sanders Morris Harris.

Good afternoon.

One sort of a follow-up, and maybe I'm just not seeing it.

Can you explain why you would build inventory in the January quarter and then follow that by slowing the fabs in the April quarter?

Well, I didn't mean to imply that we would slow the fabs in the April quarter.

Okay.

Well, that may explain it then.

Right.

I mean, we're expecting growth in the second quarter so that would absorb the current levels -- I mean, our goal is not to jerk the factories around in this part of the cycle.

And that would imply that we don't do that in the second quarter either.

That we sort of let the inventory grow into the sales there and given that the inventory is good inventory, that's probably the right thing for us to do.

I think I just misunderstood some earlier comments then.

We'll have some holidays during the first quarter that will sort of naturally slow the output out of the factories in the first quarter, but by and large the costs are fixed and we're trying to hold the work force in place.

And --

So the typical semiconductor model, which is heavily influenced by guys who mostly supply commodity ICs is -- you know, every week you look at the order book and then you change the factory loading as a result of the order book each week.

And the reason that -- that's appropriate in that model is because the inventory for them goes stale very quickly.

So if you don't react with a hair trigger for running your factories and commodity ICs, you wind up getting stuck with a lot of crappy inventory you have to write off.

That's a very different model than the high performance Analog model, which is all we build in our internal fabs, where the inventory stays good, so you really have a benefit beyond the margins that Analog ICs run.

You have the benefit of not having to do that.

And I think a lot of people get confused about that and they say, building inventory in a down cycle is a bad thing.

We think building inventory in the down cycle is a good thing.

Got it.

Change gears a little bit and this may be better directed at you, Jerry.

Can you give us a little detail on your sort of state of your industrial markets ex-ATE?

I think we all kind of know where ATE stands and you were very clear on that earlier, but how about the balance of the industrial --

I think it's generally good.

The industrial business for us makes up a wide range of products that vary from process controls to factory automation.

We include in there automotive products, medical products, instrumentation products, so there's . not any one segment.

Each of those segments -- I don't think any one of those segments in the context of the 30, the 35 to 36% that we do in industrial makes it [inaudible] 5 to 6% to that.

But I think generally that business has been strong.

The business grew considerably for the year, it slowed down at the end of the year because it grew so fast in the beginning of the year, but when you talk to the large industrial customers in that category, no, they're saying their business is okay.

I mean, I listen to the same CNBC report that you do every morning when the large industrial companies report their numbers and talk about their businesses and the ones I hear, basically that's what they say and I have no reason to doubt them.

So we're in a good capital spending cycle.

People are trying to automate their factories.

All that bodes well for industrial capital spending, which drives that business.

Great.

Thanks very much.

Your next question comes from the line of Kevin Roddenhof of with Midwest Research Securities.

Thank you.

Just one clarification question first.

You -- you talked about growth rates year-over-year.

Do you think 2005, fiscal 2005, is a growth year?

Well, we hope so.

I mean, on the the -- you know, we have to wait and see what happens.

You start out with some very tough comparisons in the early half of the year when the first half of last year was so strong, but you know, certainly our plan is that we're going to grow this year.

Okay.

I guess if I could ask a second question here on inventories, with inventories being indicated as relatively in line in distribution, is the excess primarily to OEMs then?

Is it safety stock, or is it finished OEM products or -- kind of, where is the excess that's going to weigh in this quarter?

Well, I think as I was saying a little earlier, there's a lot of inventory that -- in finished product, that's going to sell through this quarter.

So --

The excess inventory, I think -- to answer the question, if I understand it correctly -- is that the end customers.

And they've been working off that inventory.

That was inventory that was acquired in the early part of the fiscal year during the period when we saw this -- this sort of hyper growth as it turned out.

And so we supplied that demand that turned out to be inventory that worked [inaudible].

So our assessment is that the shipping rates from our customers to their own end customer is higher than what they're asking us to resupply them with.

At some point that runs the course and that seems to be coming toward the end.

If you go back and look at the history of what happened in 2004, just to give you a -- put a few statistics behind this thing, you know, our first quarter grew 30% year-over-year.

Our second quarter 35, and our third quarter 38% year-over-year.

So it's not surprising that with those kind of growth rates year-over-year in a business that you know, has quite a bit low lower secular growth rate, in the 20 to 25.

There's a bunch of inventory out there.

And I think, very simply, what's going on is those 30 to 38% rates that we were seeing, the excess of that over 20 to 25% has to come out of the system.

Our sense is most of that's going to come out of the system by all the calculations that we do and our customer tells us by the end of the first quarter.

And that's the way we think about it.

And I -- that's our belief of what will happen.

Okay.

If I could ask one last thing.

With inventories tracking higher on your books, do you think that discourages at all better visibility from the OEMs because they know product is going to be readily available?

I mean, do you think this is kind of a change in how business is done or do you think --

No, I think -- you know, irrespective of the company, you know, with very few exceptions, I think customers believe that they can get whatever they want whenever they need it and that's always the case at this time in the cycle.

Okay.

And then they -- you know, I mean they'll go to a period where oh, my God, everyone's turned their fabs down.

There's no inventory and there will be a spike and everyone will start ordering again and you know, that will happen at Internet speed.

Okay.

I'm sorry.

If I could ask one last thing.

On the ATE business, you talked about that potentially bottoming in the next quarter.

Yeah.

Any kind of color you can give on what gives you confidence that that's going to turn around?

Is it just a seasonal thing or --

They are shipping products and we're not shipping much to them in the first quarter so if they just go back to consuming our products at the rates they're excelling through, even though their excel-through, you know, obviously, your capital goods has been affected by the semiconductor cycle.

They just go back to, you know, ordering and us shipping what they're consuming each quarter.

That would be growth for us.

Okay.

Thank you very much.

Operator, we're coming up on 5:30 right now.

We're going to take the next four questions in our queue and then the rest of the analysts, I'll ask them to please telephone into the office here at 781-461-3601 and we can follow up off line.

Next caller please?

Your next caller comes from the line of Sumit Dhanda with Banc of America Securities.

Hi, Jerry.

Question on the outlook.

The -- the implied turns that is roughly I think what you'd given out on your August conference call, but it seems like [inaudible] would have come in flat for November versus August.

Is there anything that gives you confidence that the January quarter, you know, clearly will shape up differently, especially given the way the orders typically shape up in this quarter.

I'm assuming it's a little more front-end loaded

I'm sorry.

Was your question -- is there anything that gives us confidence that Q1 will shape up the way we say?

Yeah, I mean, basically, given the fact that November turns came in a lot lower than you'd initially anticipated and the fact that the January quarter is a seasonably weak quarter.

I don't think we said November turns came in a lot weaker than we said.

I think what Joe said earlier is quite the opposite.

November came in coincident with what we're expecting to get revenues in the range of guidance we provided.

I know.

But I guess I'm talking about the initial side -- because it came in line with the reduced guide.

Like, if I --

We didn't have initial guidance for Q1.

I mean, what we said at the October release was that Q1 was going to be a challenging quarter for us.

Right.

Jerry, I'm talking about the August conference call, the guided turns up 45 to 50 and then --

Oh, yeah.

Well, I mean, what happened basically is that August orders fell off the cliff, you know, September got a little bit better than that.

October got a little better than that.

But not good enough to make up for what happened earlier in the quarter.

So I mean, that's what happened.

And -- and as I said, the best guidance I can give you is that so far, you know, with three weeks into the quarter, which is not a long time, you know, we're seeing order rates and turns business that are coincident with the kind of guidance we've given for the quarter.

That's really all we can say at this point.

Okay.

All right.

Thank you.

Your next question comes from the line of Romit Shah with Lehman Brothers.

Thank you.

You mentioned that revenues for -- for the April quarter, likely to be up.

Are you also expecting margins and profits to be up as well?

Sure.

I mean, our business tracks revenues and we've always had a model for those that look back at the last couple of years, we're -- we get very good leverage on the upside.

Okay.

And then just a follow-up.

You know, China's been a volatile market this year.

Are you guys making a push to maybe diversify your customer base within there and maybe go after some of the, you know, tier one manufacturers on the handset side?

And then also, within the PC space, as I understand it, most of your offering is on the desktop side, and for fiscal year '05 are you guys going to be making a push into the notebook space or have you already started that?

Let me answer the second part first.

We've already -- we've had product development and products out there in the market on the portable side now for a couple of quarters and I think that's going to represent the largest portion of our power business in 2005 and beyond.

On the question of China, and like in most regions, you generally start out there you know, with some large vertical customers because those are the customers where the business is when you first go into the region.

Our goals with Analog in China are to have the business in China that is ultimately as diverse as our business is in the United States.

Thousands of customers of which there are in China and have a business there where you have the same kind of characteristics as many of the diverse customers we have in the United States.

You know, I -- you know, the one inescapable conclusion when you visit China, particularly when you visit it sequentially over -- you know when you haven't been there six months or a year and you go back, is that , you know, the Chinese customers are making enormous progress on every dimension and I think that having a very strong presence in China is really going to help us in the future.

We invested early there.

We invested in infrastructure.

We have a good design presence and application presence in China.

The Chinese customers that are doing well are consolidating some of the companies that aren't doing so well.

We're selling to many of the largest Chinese manufacturers.

That's true in handsets, it's true in infrastructure, it's true in some of the other large vertical markets.

So I think China is going to be a great opportunity for ADI, particularly since, as I mentioned earlier, we can supply the entire reference design over there, which is a big, big deal.

So you know, I think what's been our sort of anchor over the last quarter is, you know, going to become something that really propels us in the future.

And just Joe, really quickly, should we assume 23% tax rate for fiscal year '05?

Something in that vicinity is the right assumption.

Thank you.

Your next question comes from the line of Robert Burleson with Think Equity.

Good evening.

Just a quick question on pricing again.

If you look at the vertical markets in particular, what is your outlook at this point for what pricing's going to do in -- in Q2 for, you know, flat panel displays, optical storage, power management, things like that?

We don't sell a lot of products into flat panel displays which have become a very highly commoditized market.

Most of the display stuff we do is in television, you know, new digital televisions, which you know, increasingly, I mean, sure, there's always price pressure to anything that goes into volume markets but if you can provide a lot of value that differentiates that end product, you can still make very good margins and we've shown that in some of the businesses for the consumer space, like cameras and a few other products.

If you're in a business where all you're doing is supplying commodity stuff that everybody else can do, where there's five different suppliers and everybody's tripping over each other.

Price pressure precludes the kind of margin levels that we run Analog Devices at.

Do you see more people tripping over one another lately?

I think it's part of the cycle for commodity products.

You do.

And the other question is, in terms of your consumption of your products, how is that tracking do you believe Q4 to Q1?

Actual consumption?

Well, it's hard to -- I mean, it's very hard to say on a quarter-to-quarter basis.

I mean, the only thing I could say is that when you talk to the customers, and you look at the -- you know, how many units are they selling and we come back and we look at how many units are we selling for those units that they're selling, we're selling less than they're selling.

I'd say trying to understand the trends of that from one quarter to the next are beyond my ability to absorb, given that we sell to 60,000 customers.

Is it normal for wafer starts to slow in November over October?

For wafer starts for us or for the industry or --

Internally.

No, I think what's difficult is that we always have a holiday period and use that to keep the running rates down a little bit.

We're going to do that this quarter.

The normal --

That's very normal.

I mean, we've had years where the demand is so far over the top that we try to push out the maintenance cycles and all the other stuff, we just get product to our customers so they can wind up building inventory half the time, but that's what happens.

This year is not one of those years so we're going to do what we normally do, which is let the people who work all year take Christmas off this year, and that's very common to what we typically would do.

Gentlemen, your final question of the evening comes from the line of [inaudible] with Krefman Investments.

Yeah.

Hi.

Jerry ,if you could talk a little bit about the revenue opportunity for next year, when you look at next year from an incremental point of view.

What are some of the big buckets for revenue growth?

I think the first bucket is just the broad end market where, you know, I think that's going to do well for us.

But if you'll look -- if your question is about the verticals, you know, I think that of course most of the verticals we serve, there will be some good incremental opportunities there.

The handset business will grow.

I mentioned before some of the IP set top boxes, that's something that's virtually zero this year that will grow.

You know, digital TVs have been -- even though we have a lot of design ends, we don't have a lot of revenues that's going to -- what we think is going to happen really happens, that business, where the price points really cause that thing to begin to take over the Cathode-ray tube TV market and the projection TV market that, you know, that ought to be a good source of incremental revenues.

You know, interestingly, when we go out and talk to our sales guys this year, you know, they have a higher forecast than our product guys do, because they're very close to some of these large incremental opportunities.

They're very bullish about it.

So for us, you know, that's sort of something that encourages us.

When you have you know, as many sales guys as we have out there, they're pretty aggressive about their forecast, then, you know, primarily based on some of the large opportunities.

They can't predict the economies very well and that's probably a good sign for us.

But you know, again, there, you don't know.

But some of those are opportunities that we'd have this year certainly.

If you look at wireless, do you have any large top five type of OEMs signed up for double CDMA chip side?

It all is how you define top price.

The top five by market share.

Well, you see, what's really happening is a lot of the, you know, the top five are going to be buying their products in China and other places.

It's already very good examples of that.

So I think that we've always viewed our market penetration in China and other parts of Asia as a great way to get in ultimately in some of the quote, top five current vendors.

Okay.

Thank you.

Well, thank you everyone for sticking with us as we ran a little long today.

I would ask you to put on your calendars our earnings date for the first quarter conference call which is going to be Thursday, February the 10th, beginning at 4:30 and I thank you all for joining us today.

Good bye.

Ladies and gentlemen, this concludes today's Analog Devices conference call.

You may now disconnect.