亞德諾半導體 (ADI) 2005 Q2 法說會逐字稿

At this time I would like to welcome everyone to the Analog Devices second quarter 2005 earnings conference call.

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

After opening remarks, there will be a question-and-answer period with our analyst participants. (OPERATOR INSTRUCTIONS).

Thank you.

Ms. Tagliaferro, you may begin your conference.

Hello.

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

Our second quarter 2005 press release is available on our Website right now at www.analog.com.

We issued the release about 90 minutes ahead of schedule today and I did want to give you a brief explanation of what happened.

There was basically a computer glitch that enabled one of the wire services to access the release ahead of schedule.

So, we decided that the best thing to do was to issue it early.

And I do apologize for any inconvenience that may have caused everyone.

But on the bright side, you had plenty of time to read it.

And we're going to get right into the call in just a minute.

I just need to cover a few items.

As you know, this is a live broadcast and you can access it directly or by the Internet.

We are also recording this call and you can access that within about two hours of its completion, also available via telephone or via the Internet.

Participating today will be Jerry Fishman, President and CEO of Analog Devices, Joe McDonough, Vice President for Finance and CFO, and we also have with us today Brian McAloon, whop is Vice President for the Digital Signal Processing and Systems products division.

We're expecting today's call to last 60 minutes and we will begin in a moment with Jerry's remarks.

(OPERATOR INSTRUCTIONS).

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

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

Risk factors which may affect our future operating results are described in the Company's most recent annual report and Form 10-K filed with the SEC.

Also, this conference call will include time-sensitive information that may be accurate only as of the date of this broadcast, May 12, 2005.

With that, let's begin with Jerry's opening remarks.

Good afternoon.

By now I'm sure given the time here you have all read the press release.

And in the press release, as we typically do, we provided a great deal of detail about our Q2 results.

So, as a result, I don't plan to repeat all of the data that was in the press release in my opening comments.

Instead, I think it is more constructive to focus on six key points with respect to our second quarter, and also to reflect a bit on the implications of those points going forward.

So, let me go through them in order here.

Number one, clearly our revenues from our broad customer base is improving but at the same time some of the vertical markets remain challenging.

Overall, many of the end markets we serve experienced very solid revenue growth in Q2 both sequentially and also year-over-year.

The very broad base of customers we have for our converter products, our amplifier products and our general purpose DSP products showed the strongest growth in Q2, as evidenced, really, by the 11% sequential growth that we achieved in the industrial market, which includes many diverse end applications and tens of thousands of customers around the world.

In addition, many important end markets, including digital still cameras, automotive and wireless base stations, also grew in Q2.

We even, at long last, recorded some growth, albeit small growth, from ATE customers after a few quarters of very significant sequential declines.

At the same time, the wireless handset market, the desktop PC market and sections of the broadband markets all declined in Q2.

And most of that is related to either continuing overhang of inventory and in some cases, particularly the wireless segment, we think mostly seasonality now.

So this quarter, I think, very clearly illustrated the benefits of ADI's very diversified end market participation strategy.

So, that's really the first point, about the very broad base of customers improving.

The second point, I think, is that our core products are growing again strongly.

Our converter, amplifier and general-purpose DSP products each delivered double-digit sequential revenue growth in Q2.

And these categories in aggregate represented almost 70% of our Q2 revenues.

Our strategy of focusing on world-class core technology for converters, amplifiers, and DSPs, and applying that technology to general purpose and application-specific products continued in Q2 to yield very strong results.

Now, this quarter, we again raised the bar in analog-to-digital converter technology with the availability of two new high-speed ADC converters, both of which represent breakthrough performance and breakthrough functionality.

These 14 and 16-bit converters not only provide very high sampling rates and high resolution, but they also deliver very high accuracy and much higher accuracy than any competing product by a very wide margin.

As a result, base station customers that utilize our new 9445 14-bit A-to-D will be able to design flexible platforms and build base stations that support more call traffic and drop fewer calls.

Both of those are important benefits for the operators who buy base stations.

Our 9446 16-bit A-to-D converter is 25 times faster than any competitive product, with the accuracy that is required for high-speed instrumentation customers who are trying to develop entirely new capabilities in their systems.

These new products really are further examples of why ADI's data converters are increasingly becoming a defining component in diverse electronics applications, because of our technology's ability to enhance the capabilities of our customers' end products.

In digital cameras for example, we applied our core converter technology and application-specific analog front-ends amongst increasingly other functionalities as well.

Because the image quality continues to be dictated by the capability of the converters inside the analog front-end, our position continues to strengthen.

We believe that this could drive the ADI camera market share from over 50% in 2004 to hopefully approaching 70% in 2005 as we ramp production at the world's largest camera manufacturers both in Q2 and, we believe, for the balance of the year.

We have also applied this strategy of developing world-class core technology to our DSP products as well.

In Q2 we began to see, really, the first production ramps from our Blackfin DSP customers.

Blackfin customers span a very diverse range of applications of medical, factory automation, communications, and also consumer applications.

And we believe that in Q2 we saw a very early and positive sign of an emerging DSP franchise for ADI.

Point number three is we believe our gross margins in Q2 are now at the top (ph) levels for this portion of the cycle.

The favorable mix of revenue from converter, amplifier and general-purpose DSP products helped us to achieve gross margins that were slightly better than we had expected.

We slowed production in our factories to around 65% utilization from about 70% last quarter, and at the same time we reduced inventory by $5 million sequentially, while still delivering 57.4% gross margins for the quarter.

Inventory has also declined at our distributors by approximately 15% from Q1 to Q2.

And of course, that impacted our factory loadings.

During April, restocking orders from distributors increased, which suggests that distributor inventories are now below the levels that distributors require to meet their expected demand in the future.

We are planning for our gross margins to improve in Q3 towards 58%.

Despite lower utilization in our manufacturing plant, we expect gross margins to increase primarily as a result of the anticipated benefits of product cost reductions that we have achieved over recent quarters.

Point number four is we still have significant expense leverage going forward.

We maintained very tight control of operating expenses in Q2, keeping them virtually flat to Q1 levels and slightly down from year-ago levels.

Still, expenses today remain well above our goal of 25% of our sales.

While we have always believed that aggressive R&D investment, properly managed, produces innovative products that command high gross margins from our customers, and in turn these high gross margins support high R&D investment, we're also at the same time working to improve the productivity of our R&D investment to eventually bring it into line with our goal.

Continued vigilance and increasing focus on engineering and SG&A expenses represents some of the greatest leverage still ahead for Analog Devices.

Point number five.

Our business model continues to provide for extremely strong free cash flow.

We have been working over the last couple of quarters, as we mentioned previously, to return the cash that we generate to our shareholders.

We have returned $146 million to shareholders in Q2 by buying back approximately 3.4 million shares of our stock for $124 million and by paying out $22 million in dividends.

For the past three quarters, since we announced our buyback in August, we have generated approximately $474 million of cash flow from operations and we spent $84 million on capital.

Therefore, over the same period we have generated $390 million of free cash flow, or 21% of sales, and returned $489 million of cash to our stockholders.

We also announced today in our press release that our board declared a dividend of $0.10 a share for Q2, up from $0.06 last quarter.

And the board also approved an additional $500 million of buyback, which we hope we would use over the next 12-month period.

Point number six is although we are very enthusiastic about our Q2 results, we of course remain cautious going forward.

As a result, we're planning for our revenues to be in the range of flat to up 3% from Q2 levels in Q3.

This revenue plan is really based on three factors.

First, the backlog for shipment in Q3 grew by approximately 4% compared to the previous quarter and totaled approximately $306 million by the end of Q2.

This backlog includes both OEM and distribution backlog.

Further, we have an additional $100 million in OEM (technical difficulty) forecast, which substitutes for backlog and a large part -- an increasing part of our large OEM customers.

Therefore, we have visibility into approximately $400 million in Q3 shipments.

However, we expect that some of our backlog will be canceled and some of our customer forecasts will not convert into shipments.

So, therefore, turns orders, or orders we received and shipped in the same quarter, will of course be required to achieve the balance of our revenue plan.

Secondly, given our very short lead time, we remain in a very high turns environment where many of our customers are still waiting until the last minute to order, which, of course, to some degree limits our visibility.

Currently today, 80% of all our products are available to customers within a one-week lead time; a further 10% are available within four weeks, and the remaining 10% require more than eight weeks.

The longer lead time products tend to be more customized products with a much narrower customer base, and we usually build a large part of that backlog almost to order.

On average, our lead times are well under four weeks and we're ready to supply our customers with product as their demand increases.

Short lead times, of course, remain short.

And they typically result in much higher turns orders.

And that's certainly the environment that we are in today.

Thirdly, most of the revenue increase that we saw in Q2 is weighted towards the industrial end markets.

This is a very important part of our business; it's over 40% of our sales.

And it's the most profitable part of our business.

And the fact that that's improving, of course, is a very good sign.

But, I think for most of us who have followed the industrial market, we know that the industrial market very often demonstrates some seasonality in the summer months, particularly in July.

So, in aggregate, with flat to 3% sales growth, and our plan for improvements in gross margins, and our plan for relatively flat operating expenses in our plan -- in aggregate, our plan for Q3 is for diluted earnings per share to be in the $0.31 to $0.33 range.

So, that completes my formal comments.

I guess we would be happy now to answer any questions that you might have that you haven't been able to get from both our press release and my opening comments.

Thanks, Jerry.

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

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

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

(OPERATOR INSTRUCTIONS).

David Wu, Global Crown Capital.

Good quarter.

I was calling to find out what is the status of these Chinese handset manufacturers?

They've been collecting inventory for quite a few quarters.

Have we gotten to the end of that part yet?

And the second one, I just want to clarify whether your operating rates will actually be -- factory loading would improve in Q3, based on what you know today?

I will take the first one.

Joe can take the operating question.

You know, our belief is that the correction that has been going on there in China is mostly corrected.

I think the correction in China was really based on two things.

Number one, that there was a ton of inventory over there.

And I think, secondly, the local indigenous Chinese manufacturers were having a hard time in the market for a while there.

So, those two things in aggregate really put a crimp on, at least our sales, and virtually everybody's sales into the Chinese handset market.

Our take from our customers is that's mostly behind us.

Chinese companies now come out with some really exciting new products.

They're beginning to export their products outside of China to many other countries, which we have always believed is a very important part of their market development.

So our best sense is that that correction is pretty well over.

In our handset business, we're starting this quarter with a little bit more backlog than we did last quarter which we think is a good sign.

So, it's always hard to predict that part of the market, but our sense is that we believe that's mostly behind us, David.

On the utilization, our plan for next quarter is for the utilization to decline a bit.

We'll start to see some of the benefits of product cost reductions that will start coming into the P&L.

And as a result, we expect the gross margins to improve a bit.

Joe, when you talk about product reduction are you talking about that 4-inch, 6-inch conversion, or something else?

Well, there's a combination.

There are cost reductions in some of the external wafer purchases and back-end costs.

There are yield improvements that have come through our factories.

And our inventory accounting, as you know, is on a first in, first out basis.

So the old costs get hung up in -- the old higher costs get hung up in inventory until they turn through, and then eventually wind up (indiscernible) the lower costs find their way into inventory and out of inventory and into our P&L.

So, next quarter we'll expect to start to see some of the benefits of those lower costs coming into the P&L.

Our sense, David, is that we can run these kind of gross margins up there towards 58 with (indiscernible) utilization is -- we believe that is a good sign.

Yes.

I was thinking about 75 and 80 kind of gross margin (multiple speakers)

We'll have to wait and see how that materializes.

Michael Masdea, Credit Suisse First Boston.

The first question is really on what the kind of customer mentality is.

Is there any way for you guys to back out this -- and I'm looking at this bottom here -- back out how much of it is really semiconductor phenomenon and how much is your customer phenomenon?

And then a second question is on the lead times.

How much of this do you think is just cyclical as we head towards the trough of the cycle, and how much of it is (indiscernible) and going to be with us as we experience the upturn, and will we do that with lower visibility than we normally have?

I'm not quite sure of the question, what you were getting at there.

Maybe you could phrase it a little differently.

The first question?

Yes.

The first question really is just trying to figure out how much of this bottom that we're seeing is your customers' (indiscernible) getting better and how much of it is just the fact that you've probably got inventory in the right position in the supply chain?

I think it's always -- we have so many customers in so many diverse markets;

I don't think any one description describes what is really going on.

Our sense has been through this -- and we mentioned in the last quarter we thought we were getting towards the bottom of that -- that there was phenomenal growth in the market and also in our revenues in 2004, well ahead of what real demand was.

A lot of customers got ahead of themselves.

For us, that was primarily apparent in the handset market and the ATE market.

And most of the declines we saw were in those two businesses.

I think now, both of those phenomenon after six months are sort of working themselves out.

Most of the customers when you talk to them seem to think business is okay.

And that's why last quarter we were sort of confident enough to try to predict, or have a plan anyhow, that we would actually get revenue growth this quarter when a lot of people were very skeptical about that.

So, our sense is the markets haven't changed a hell of a lot, but the way the inventory is falling through the system is now more positive than it was six months ago.

I think demand in the consumer customers has been pretty good.

In a lot of the end markets it's been pretty good.

So, I think this is much more a phenomena that is mostly inventory related rather than end market related.

There are some end markets that everybody is struggling.

And I don't think there's many people saying that they're getting a big lift out of broadband right now.

I think there is a clear seasonality in the handset business.

I think most people have reported that the PC market has been a little weak.

So, I think those are all just parts of what happens in those markets.

But, there are many other markets that are doing pretty well.

We talked about a few of those.

So, I think it's sort of a mixed bag.

But overall demand, I think, remains okay.

That's helpful.

And then, the lead time issue; how much is cyclical versus secular do you think?

I don't know.

Our strategy is continuing to emerge as we learn more each year.

You know, our strategy is to keep our lead times as low as possible and to try to get to a point where customers don't feel pressurized to place very long-term orders that jerk around our factories.

So, I think whenever there's adjustments in lead times, that always causes customers to call us a little bit and say well now the inventories are lower; we can wait even longer.

But that's very hard to read, Michael.

So, I would say there's not much going on there.

I think customers believe lead times are low and they're treating their vendors like that.

Ajay Walia, RBC Capital Markets.

I think, Jerry -- just something similar to the last question -- I'm trying to understand your cyclical growth.

Your year-over-year growth seems to still be going down.

You peaked somewhere in the middle of '04 and it's continuing the guidance.

I'm trying to understand when do you think that will (indiscernible) the actual year-over-year growth?

We will have to actually see the quarter.

It would be hard to imagine with the guidance we gave that it will trough in Q3.

But, probably by Q4 we will be back on the year-to-year path.

I think the reason that we're still seeing year-over-year declines is when we look in the early parts of last year, we were putting up 30, 35% year-over-year numbers.

So, I think we're now -- we're on the other side of that curve now.

I think right now the much more important numbers are the sequential numbers, which give us a sense of which way the business is heading directionally.

You know, a lot of different companies went into the cycle at different times and come out of the cycle at different times, but we are still facing, at least this quarter and the third quarter, some real tough comparisons to some record quarters which were, clearly, quarters where the shipments we made were well above consumption for a couple of quarters in the early to mid part of 2004, which is why we're seeing these kind of comparisons.

And in terms of -- it's a question that is more macro (indiscernible).

There seems to be a little bit of a disconnect or dichotomy (indiscernible) analog companies like yourself and some of the competitors have seen good numbers -- maybe not spectacular numbers.

But at the same time, some of the lower (indiscernible) analog companies are beginning to see fairly good numbers.

So, I'm trying to understand -- usually it's the other way around with this type of cycle.

Can you explain that?

I think the low-end stuff is more commoditized.

So, that just rises and falls with distribution and just -- it's basically a commodity.

They sell like commodities.

I think the high-end products tend to more closely track sort of consumption.

So, I wouldn't read much into that.

If I had my choice of which place to be, there isn't any doubt that I'd pick to be in the high-end.

And you can tell that from the margins.

You can tell that from the quality of the earnings.

So, I think the high-end analog place is still, I think, second to any place in this planet.

It's the best place to be.

And I think these kind of short-term fluctuations of what happens in and out of the cycles are really more noise than signal.

And based on that, between the two, the corporate and consumer, you didn't mention that consumer was (indiscernible).

I'm trying to understand -- if you were to say where there's weakness between the two, corporate and consumer, where would you say that is right now?

I'm sorry; between --?

Between enterprise spending and consumer.

Well, I don't know.

I think from what our folks tell us, the enterprise market is getting a little bit better.

And for us, a large part of our success in the consumer market is penetration of new applications.

So, we're not necessarily great bellwether for all the semiconductor markets' success or failure in a consumer market.

So, our sense is that as long as we continue to get in some of these emerging markets, these cameras or some of the new digital TVs where we also saw good sequential growth, I think we are going to be mostly -- what happens to us in the consumer market is going to be mostly related to new products.

Adam Parker, Sanford Bernstein.

Can you talk -- I just have two issues -- one on the operating expenses.

Again, when you compare it to some of the other companies out there, the OpEx as you guys said is a lot higher.

And I'm just trying to figure out is that due to DSP business?

Why do you have outsized R&D requirements for your analog business versus those other guys?

And how do you measure your efficacy of that R&D investment to sort of make sure it's constantly right-sized?

That's a good question.

I think at our analog business, R&D is not outsized relative to most of our -- the good analog competitors.

I think it's right in line with the kind of numbers in R&D that the good analog competitors have.

The thing that gives us another leg of that R&D has been the DSP business.

And as I have been trying to be pretty clear on over the last year or so, that business has outsized R&D relative to its current sales.

And the reason we do that is because we believe that is going to be one of the best growth opportunities going forward.

So, in the analog business itself, we're right in the pack with the best companies.

And the additional R&D is mostly related to DSP, where the R&D divided by the sales is way to high today.

Can you quantify that a little bit?

What percentage of your R&D goes to DSP versus analog?

I think I'm going to stay away from that.

Okay.

On the SG&A side, can you help just so that the other half of the OpEx side -- is there anything you can do in absolute dollar reductions there?

You know, is it still going to be the path of just growing the revenues and holding it as tight as possible?

I think, Adam, as we see it right now that is going to be the preferred path, where -- we have a very sales-intensive product line.

And we think having a lot of applications people out there is a real smart thing for us to do relative to our customers.

We're also in a very significant buildup of selling resources in China which we think over the next couple of years will really help us.

Now, if it turns out we come to believe in the future that the whole industry isn't going to grow and we're not going to grow, we will have to, of course, reevaluate that.

But, based on our assumptions of long-term growth rates we think we can achieve, and the fact that we're still producing pretty good profit margins here and pretty good cash flow here, I think our sense is to not make major changes in that strategy in the near-term.

And we will have to wait and see what happens in the long-term.

The other question was not about OpEx, just about the wireless sector.

It seems like there have been some grumblings there that you maybe were going to get your digital base stand into one of the major top tier wireless OEMs for 3G, perhaps one of the Asian ones.

Is there any -- can you talk at all about your progress in 3G DSP, and what you think your market share will be there a year or two from now?

Because there is some notion out there that you guys will lose a lot of share in 3G.

And maybe you could help us with what your view is and why you think it will stay positive to increased?

I mean, our sense is we have a very competitive product with 3G out there.

Particularly in the China market, we're developing very quickly.

And there was a lot of speculation out there a couple of years ago that there we're going to lose position in GSM and GPRS and EDGE.

And I think there's always speculation out there, particularly by some of our larger competitors.

But, I think we have good products.

We have good solutions.

We have good customers.

And I think we will do just fine in that market.

So, do you expect an announcement from a major wireless OEM in calendar '05, or how should we think about --?

I don't know.

We will have to see about announcements from large OEMs.

I tend to -- we tend to try to think about running the Company by getting the revenues, not the press releases.

Okay.

But, you've said in the past that you -- it's been concentrated toward Chinese and Taiwanese.

I think we have a lot of resources there -- between China and the ODM (ph) markets, where increasing amounts of the design is being done now, we think that is our best opportunity.

We have some very large OEM accounts outside of China and we hope to perpetuate those accounts into the 3G market.

So, my sense is that we will continue to do just fine in that business.

Any market share numbers, or you don't want to go there?

No, I don't think we want to go there.

Bill Lewis, JP Morgan.

I also I guess have a question a little bit about handsets, which is -- in the DSP business, you talked about general purpose versus application-specific.

What is the rough breakdown between those?

And I guess how large is the handset business for you guys?

I guess that's really my question.

We don't specifically publish the breakdown of that specifically by product line.

But, I would say if you thought about it in the range of 10 to 15%, that would probably be about right in the handset business for us overall.

In total.

And I guess as we look at the DSP business, is it really a diversification opportunity here versus a handset play?

Should we think of the handset opportunity as a flatter opportunity?

A lot of the growth is likely to come over the next year or two in the general purpose business, or do you see them at the same rate?

Certainly that is why we are in the DSP business.

Our goal has always been to build the franchise in DSP among thousands of customers that very closely replicates the franchise we have in the analog business.

Now, DSP is a very R&D-intensive business.

So, in order to fund that R&D so we can continue to build out the GP business, the general purpose business, it's sure nice to have one to higher volume verticals where you could amortize some of that R&D in.

But, if we weren't convinced that in that vicinity of half of our DSP business will be GP DSP business, I don't think -- I don't believe we would be in that business today.

So, it's not half today, but you would expect it to trend that way?

That's correct.

The verticals always grow with new products a little bit faster than the diverse horizontal market.

But, like I said earlier in the comments, we're seeing some very positive trends in numerous other markets.

And that really encourages us about our Blackfin in particular.

Tore Svanberg, Piper Jaffray.

I'll keep it to two questions.

First of all, it looks like cancellations are really low right now.

Yet in your guidance, you tend to assuming cancellations.

Could you maybe give us a range or a number that you are assuming?

Well, the cancellations, as Jerry mentioned, declined again this quarter.

As a percentage of the opening backlog it was under 10% canceled, which is a low number.

Now of course, the backlog itself is (technical difficulty).

So, we are assuming that the cancellations will run at about the same rate next quarter.

Okay.

And the second question relates to your analog front-end product line.

You talked about how well you have done in the digital still camera market and you expect some significant share gains there.

Can you apply that same discussion to the digital TV marketplace please?

Sure.

We have a very large part of a lot of the content in digital TVs with the exception of the large media processor in the middle.

And surprisingly, what's consistently (indiscernible) markets, as TVs go digital there's more and more analog content.

There's analog content behind every one of those connectors in the system, and a bunch of other places in the system as well.

So, we're doing very well with some of the leading CD manufacturers.

And it's always hard to predict what share is going to be this early in the market development.

But, we're doing very well in that market.

Maneesh Goyal, TIAA-CREF.

Two questions again.

On the broadband business side, are you expecting that business to decline going forward, or is this business you would like to get aggressive on?

It seems like the pricing is quite (indiscernible) and some of the competitors are exiting.

What is your strategy going forward?

We have some good technology in some of the higher-end applications.

So, we're hopeful that will improve over time.

We're not very aggressive on the low-end stuff.

When you say higher-end applications, what are you referencing?

Applications where voice and data and video are all converging.

And people really need pretty high performance in those systems.

As far as low-end stuff that's going to sell in Circuit City for $10, that is not where we're focusing.

When should we expect those products to ship?

I would love to be able to tell you that.

The next question was as a follow-up on what Adam was asking earlier.

It seems like if I look at your operating expense run rate and your target to get to 25% of your revenues, it seems like the revenues will have to get to around $850 million or so, about 40% higher than where you are today, to get closer to your operating model.

Although not possible, it seems like you're not going to see those revenues in the next six to eight quarters.

Don't you think that sort of warrants that you may want to take a little bit more stringent effort in cutting back on operating expenses?

That is something that we always consider.

And as we look forward and try to understand the hand that we're going to get dealt based on the confluence of our products and what is going to go on in the market, that is always something we look at.

But, nothing to be done there?

I'm certainly not going to make any forecast of that this afternoon.

Romit Shah, Lehman Brothers.

If I look back of the last -- the end of the last fiscal quarter, you closed January on a very solid note and it sounds like business may have moderated after that.

And then this last quarter -- you mentioned that April was very strong.

And some of your competitors are sort of hinting that May is not as strong.

I was wondering if we could get a read from you on maybe the follow-through in May.

And Jerry, perhaps your thoughts on this trend which we have seen over the last five, six months.

Given it's only May 11, I'm not going to probably comment much about May.

But I would say that the order patterns month-to-month are lumpy.

I think everybody has seen that.

There are very strong months or not so strong months.

There's a lot of remaining uncertainty out there in the marketplaces.

So, I don't think that it's real smart to interpolate going forward any months, either positive or negative into a trend.

I think overall, integrated over the last couple of months we have seen sort of an upturn in the business generically across a very broad base of customers.

And we're sort of hopeful that that continues, even though it's not at a tremendously high growth rate.

But I think it would be a mistake to try to sort of get a sense of what's going to happen over the next six months by what happens in this week or next week or this month or last month.

I think there are a lot of very confusing signals out there that remain.

Just a follow-up question.

In looking at your guidance of flat to up 3%.

It sounds like DSP is going to be driving the business for the next couple of months.

Number one, how sustainable do you think that is.

And number two, baked in your sales guidance, what assumptions are you making for growth in your OEM business?

Now we're getting down to a level of detail that we just don't really have.

But I can just talk qualitatively about that.

Basically the guidance is based on -- I mentioned a few of these things in the opening comments.

We have a little bit higher backlog.

We are concerned about what will happen in the industrial business in July.

Of course that is always sort of a week month for us.

The order patterns remain somewhat volatile.

I think that we're trying to develop -- we're trying to run the Company on a relatively conservative plan.

And we're trying to communicate to our investors what that plant is.

That is all we know.

We look at the backlogs.

We look at all the rates.

We look at the large customers.

We listen to their distributors.

We go through endless analyses about turns and backlogs and cancellations.

And when you have as many customers as we do in as many geographies as we do, we can fill up seven mainframes with spreadsheets on this stuff.

Our job is basically to try to integrate all that and come up with something that we're going to run the Company on for the next 90 days.

And that is what we communicated.

Beyond that, we really don't have much else to say.

Craig Ellis, Smith Barney.

The first primary question.

A number of your end markets were firing on all cylinders.

Industrial a good example.

ATE certainly was not.

What are you seeing in ATE right now, Jerry.

And does it give you confidence that we can actually have an upwards inflection as we get into the back half of the year, or does it look more like we're bouncing along the bottom considering the inventories that customers would have on hand?

Our sense is that we are going to see slow steady growth from where we are for the next quarter or two.

That is the assumption that is baked into our plans.

That is based on, really, two phenomena.

One is how much equipment is going to get ordered.

And the other one is what share of the equipment that gets sold is going to have our stuff in it.

We picked up a few new customers recently that are not yet in our sales mix, but we hope over the next couple of quarters will be, at least to some extent.

And certainly our customers are telling us it's not going to get any worse, because it really can't get any worse.

So, our sense is that is baked into our plans is slight improvements over the next quarter or two.

That's helpful.

Switching gears a little bit to manufacturing and inventory.

As you think about your utilization levels, would you expect to be increasing utilization by the time you exit the quarter, or are you still at a point where utilization is coming down right now?

Well, we will have to see how the orders materialize during the quarter.

Joe gave you a sense of what he thinks it's going to be for the quarter on the average.

I think it is way too early for us to say what we're going to do on a month-to-month basis, which is the way we look at it.

Maybe if I can just sneak one last one in.

Looking at the very nice dividend increase you gave of $0.04, you increased the dividend about $0.02 a year ago.

Can you just give us some insight as to how the Board looked at the size of the dividend increase that you just made, and how you're balancing an increased dividend over time along with your share buyback activity?

It's a very careful balance and we did consider this question very carefully with our Board before deciding.

Our sense was or is that dividends remain a preferable way to return money to stockholders, because that really benefits all stockholders.

And we have a lot of stockholders, particularly some of our newer stockholders over the last year or so, that are income investors.

And they have a very marked preference to dividends.

And they have told us what they like is good yield and increasing dividends.

So, we're trying to respond to them by doing that.

There are many other investors that really think that buying stock back and getting the dilution down is a good strategy and sets us up as earnings increase for good accretion on that.

That is, of course, to some degree tempered by the interest we can earn on our cash.

So, it is a very complex balance between the two.

And we think that given our cash generation capability both today and what we think it will be going forward, that we think a mix of those is a good strategy for the widest base of our stockholders.

Tristan Gerra, Robert Baird.

Given that you expect internal inventories to be flat in Q3, your revenue guidance is flat to up slightly and utilization rates coming down a bit, are we to assume that we should see some further decline in inventory levels in the channel, or is it more in terms of a cautious outlook into the summer months?

Is the question whether or not we would expect to see a decline in the inventories in the DSP channel?

Right.

In relation to what you have said about your revenue guidance and utilization rates coming down a bit this quarter.

Our first priority is customer service and trying to keep the lead times as short as we possibly can in order to be responsive to the customers when they need the product.

And those customers are served both through the DSP channel and through our own inventories.

Our preference is to keep the distributors loaded with a minimal amount of inventory in order to meet those requirements, and for us to have the balance of the inventory required and to be able logistically to respond quickly to the needs of their customers.

So, we will continue to react to the demand patterns that we see week to week, month to month as appropriate throughout the quarter.

Does that answer your question?

That's helpful.

A follow-up on the Chinese handset market.

And I know you have commented on that already.

If we look at GSM and GPRS, can you talk about the local competition and whether you feel the market has become more difficult, or is it just a function that any market share shift with the Chinese handset OEMs versus the U.S. OEMs?

I think the Chinese handset manufactures have gone through a lot of learning experience over the last couple of quarters.

And when it first started it was a fairly undisciplined business over there.

I think there's still a tremendous push with all their customers, and certainly that impacts the Chinese handset manufactures, for more features and more capability on phones.

And I think that is particularly what is stimulating the EDGE market right now.

And we have a very good position on EDGE because it turns out there's not many other solutions despite all the press releases and the rhetoric out there on EDGE right now out there.

So, I think the Chinese handset market is maturing.

I think there's consolidation over there.

The good companies are going to survive.

The bad companies are going to disappear.

The Chinese companies are getting much more expert at exporting and really trying to understand the needs of the export markets.

So, I think I wouldn't necessarily write off the Chinese handset manufacturers yet.

I think in any business like handsets or TVs or cameras, or any high-volume product, the Chinese are going to be a very, very important competitor.

Now, they will stumble around a little bit as they get the hang of it.

But, I still believe -- and I have been to many of those accounts very often -- that anyone who's going to bet against Chinese handset manufacturers is making a serious mistake.

Ross Seymore, Deutsche Bank.

A quick question on the competitive dynamics, especially on the analog side of things.

A lot of us spent some time down in Texas earlier this week and listened to some lines about increased competition within high-performance analog.

Can you just comment on any changes you have seen in the competitive landscape?

Well, I think there's more people talking about the high-end business.

That is fairly typical in (indiscernible) cycles.

But, there's a lot of people out there that would like that business, including the place where you have been.

Now, I think at the end of the day it's a hard business.

It's highly fragmented.

Performance really matters.

Brand really matters.

So, I think that while there's a lot of people showing interest, and that's been the case over the last three to four years, there's not a lot of shift in the market share.

In fact, analog's market share over the last five years has gone up quite a bit.

So, I think it is something we always worry about and we always keep focused on.

We have to make sure that we keep the R&D up and we keep the product line refreshed.

And when anyone thinks of designing a new converter, that they think of analog first.

So, it's sort of interesting.

I just came back -- once a year we have an event which is called our General Technical Conference where we invite roughly half our engineers back to Boston to talk about all of the new things they're doing.

And I go to that.

I do the talk and I also go to some of the presentations and the like.

And I can say that when you come back from that and you sit and integrate the amount of new ideas and new products and new concepts that ADI's converter engineers are thinking about for the future, that is going to be one very, very tough franchise to crack.

I realize that pricing really is never the predominant metric when making a buying decision, but have you noticed for as close to apples-to-apples parts as you can get that the ASPs have been under more pressure recently?

Or is it not really a meaningful amount?

I think the ASPs are always under pressure by customers because they're trying to get their costs down.

Our job is to continue on to the next generation and get more from functionality.

So, while the price per function keeps going down -- and it always has in the converter business -- the average selling price you get doesn't necessarily go down, because you're adding much more functionality.

I mean, converters -- that's almost a $1 billion business for analog.

The margins are good and we see no discernible downtick in our converter margins.

A little bit on the gross margin side of things.

With the 40 basis point drop quarter-over-quarter, could you quantify how much of that drop had to do with utilization, and by chance what impact mix had?

There really are so many factors going in different directions that it's very hard to quantify that in a meaningful way.

I think qualitatively we could probably say the utilization affected the gross margins down and the mix affected the gross margins up.

Maybe one last question on that topic then.

Assuming that we have a normal seasonal pickup in the latter half of this year where handsets pick up in some of the industrial stuff, because it's typical slowdown in the second half of the year, do you still expect your gross margin to be able to rise?

We gave you our plan for Q3.

We'll have to see how the world develops after that.

I think it's fair to say there's no change in our outlook for the opportunity on the gross margin front.

We still believe that we have in place the mechanisms to get the gross margins to the 60% level.

As the business improves we increase the utilization of the factories.

And the rate and the pace of that is dependent on the mix of the business and the pace of growth.

One last housekeeping question.

Where do you expect, given a flat share price, the share count to be in the July quarter?

It will probably be in the 380 million share range.

It also depends on our activity on buybacks.

And the impact that the movement of the stock price in either direction has on the treasury stock calculation for stock options.

Sumit Dhanda, Banc of America Securities.

Two questions.

Jerry, you mentioned that converters, amplifiers and general-purpose DSP all grew double digits and they account for 70% of revenues.

Were there one or two product lines in particular which declined significantly, because that is what the math here would suggest?

It declined across a whole bunch of product lines that didn't decline very much.

We mentioned that we had a lot of weakness on the (indiscernible) management products.

We had some decline in broadband products.

And that is true in both analog and DSP.

We had some decline in handset products.

Some of that is analog and some of that is DSP.

I would say those are the primary areas of decline.

Joe, in terms of the backlog plus the forecast and the implication on turns last quarter, I think you said if you accounted for the forecast, turns would have been about -- the trends required were 32%.

If you do the same math for this quarter it is roughly 34% or so.

Is that accurate?

Do you need slightly higher turns based on this new calculation methodology, or am I missing something?

That is in the right range.

It depends on the cancellations, the assumption for cancellations.

Okay.

This is not science here.

This is our best estimate of what is going to happen.

Jack Romaine, SG Cowen.

With the change in focus on lead times that is occurring not only in ADI but across the industry, has that changed the way that you manage your inventory?

Should we assume a different target level than the 105 to 110 days that you've talked about in the past?

No.

That doesn't change the target levels of inventory.

Then, you mentioned the weakness in desktop power management.

How's your audio codec business doing?

Have you seen increased competition there and what is the outlook on that?

Well, we have seen increased competition at the low-end of that business.

Like any part of our product line is the people who want performance and the people that don't care.

On the low-end there's a lot of pressure.

We're not very present in the low-end of that business.

We think as you go forward, at least from what I listen to the product line reviews, there is a great opportunity going forward to do audio functionality that people are going to pay a little bit more for.

So, I think that business has gone through some sort of lows over the last couple of quarters as we sort of backed away from some of the very low-margin part of that business.

But, at least if I -- if what our guidance is saying comes true, we ought to see some recovery on that over the next couple of quarters.

Just one last one.

On the Blackfin product, you talked about the start of a ramp here.

Can you give us any kind of stats on where you are, where you want to be, profitability?

Anything you can share with us?

I think where we want to be is having 1000 or 5000 customers delivering systems using Blackfin.

We have all the sort of foundations in place for that to happen.

We began to see a few of those start to move towards production, which makes us a little more enthusiastic this quarter.

If you want to hear a little more color on that maybe Brian ought to --

(multiple speakers).

We saw some stuff start going into production with Blackfin and some reasonable volumes start to kick in; the IP set-top box; deployments in China started for us with three different manufacturers; the EDGE handset stuff that Jerry mentioned a little bit earlier on started to come in.

But on a broader base, there's a whole variety of home media audio server customers, audio -- autotelematics.

There's even wireless load speakers, vision recognition.

So, it is all over the place but it's very, very promising at this stage.

I think the thing that's encouraging to me is even our most aggressive competitors now sort of publicly admit that Blackfin is having an impact.

And I think that is a great endorsement for the product.

This is Maria.

We're coming up on our hour but we still have quite a few people in the queue.

So, operator, we're going to continue taking questions.

William Conroy, Sanders Morris.

A couple of questions.

One more on the inventory.

With the lead times, Jerry, that you're citing, a lot of this must be held at finished goods.

Is that a situation that you see continuing in perpetuity now or is that temporary?

Our goal is to have our back-end cycle times be very, very low so we can hold most of it in finished goods.

So, I think over time probably the mix is going to shift heavily towards wafers and die bank as compared to finished goods.

But right now, our finished goods position is very strong.

The other side is the distribution inventory is finished goods.

And so, the finished good levels have always been the combination of what they have and what we have.

So, with a greater focus on the logistical effort and the combination of their inventory and our inventory, it is quite possible that there's no more finished goods required, and perhaps less.

In terms of R&D, are you continuing to add staff there?

And if so, how are you holding spending flat?

What is going on in the other areas if you're continuing to move headcount up?

We're not (technical difficulty) very much in R&D or any other place in the Company right now.

R&D is always a factor of people that work for us, people that consult for us, masks (ph) that we generate; it's not just headcount in R&D.

And we're really trying to keep a lid on the total of those.

And certainly one aspect of that is keeping the headcount relatively flat.

Sergio Lee (ph), Goldman Sachs.

Just a couple of housekeeping questions first.

The tax rate going forward -- how should we think about that?

In the same vicinity that it's been in recent quarters.

So, around 20% or so?

It's 22%.

22%.

Sorry.

And then in terms of the turns in the quarter, did you give that number?

No, we didn't.

But it's slightly over 50%.

And then just if you could give an update on the MEMS business, that would be great.

Actually, the MEMS business is doing very well for us right now.

You know, we have our usual base in the automotive business which is a combination of accelerometers.

And more recently our gyroscope is having a real good run and getting designed into a lot of automotive applications.

And I think probably some of the best news is that we now are developing a fairly significant customer base outside of automotive that are going to use our micro machine products in a wide range of applications that start at handsets and are in a lot of other consumer products and things like that.

So, our goal has always been to keep our focus on the automotive stuff but diversify into some other end markets, particularly those kind of markets where we sell a lot of our analog and our DSP products.

So, we are actually quite pleased with the way our MEMS business is doing right now.

And as you expand the MEMS business into a broader range of markets, how do you see the margins trending in those markets?

I think the margins -- a lot of the MEMS products are vertical products where the gross margins are below the corporate average but the operating margins can be pretty good.

But I would say that is really what the business model for the MEMS business is.

Louis Gerhardy, Morgan Stanley.

What was your MRP business in the April quarter?

Can you give us a sense of the percent of revenue?

The forecast quarters is I think what you're talking about.

Is that correct?

Yes.

The forecast backlog at the end of the quarter, as Jerry said, was just over $100 million.

And it was in the same vicinity at the beginning of the quarter.

I thought you had suggested that it would be around 25% of revenue on the last call, or about 150 million of revenue.

I'm just wondering if --

You're probably thinking of the percentage of our OEM revenue.

Our business is approximately half through the distribution channel and half of it direct with end customers.

And the only place that we take forecast orders are from those OEM or direct customers.

So your outlook for MRP business as a percent of your revenue for the fiscal year doesn't sound like it's changed that much then.

More and more customers will continue to switch to forecast rather than direct orders.

We had -- in the last quarter we had some major customers that were switching.

This quarter we did not.

So there hasn't been too much of a change in that business this quarter.

That's why I think you really have to look at the subtotal of those, because quarter-to-quarter and customer-to-customer that changes each quarter.

And it doesn't -- if you just look at one it doesn't give you a very solid indicator of what is really happening within demand, which is why you really have to look at both, which is why starting last quarter we began to talk about both.

Just on -- can you give us a sense of how the bookings improved sequentially, either book to bill, range, or however you want to do it?

The book to bill during the quarter was slightly over 1.

Finally, just on other income, it was up quite a bit on the flattish cash balance after the stock buyback.

What were the dynamics there?

Interest rates.

Joe is doing a better job.

The market is changing.

Joe Hasha (ph), Merrill Lynch.

First for Joe.

Looking at FAS 151, which actually this was being discussed down in Texas the other day, and some of the limitations that it imposes on inventory and cost versus expensing them.

How is that likely to change the approach in terms of how you look at cost in terms of inventoriable cost versus period cost?

This is the unused factory?

Exactly.

That shouldn't have any impact on us given the way we have been doing it is more or less in accordance with that.

Your cost of product does tend to go up and down based on what your utilization rates are.

But you're saying that that is within the bounds of what is --?

The unfavorable variances we have been expensing.

I guess a question for Jerry.

As I look at the DSP business -- and, obviously, there's always going to be this element of how much you want to be in the verticals.

Do you think that you can basically keep the R&D flat or relatively flat in dollar terms as you scale this business, or is that at least the objective?

Yes.

Okay.

So, we should have -- the gross margin is what it is.

The revenue is what it is.

But, the operating costs should essentially allow all of your gross margin to fall through?

That is the objective?

I would say a very significant part of it.

Paul Leming, Soleil Securities.

I was wondering if you could talk about how long you can keep capital spending at the level it has been running at the last couple of quarters, when you see it starting to nudge back up?

And then secondarily, you walked through the pieces that show that you have essentially been returning all of your free cash flow to shareholders over the last three quarters.

What you really haven't talked about is the cash still sitting on the balance sheet.

If you look at ADI's cash relative to its market cap, that ratio is the highest at ADI of any of the 15 largest semiconductor companies.

Could you talk about why you feel the need to carry such high cash balances?

Or conversely, how you're thinking about either putting that cash to work or returning it to shareholders?

I think I will turn it over to Joe.

I think we are indicating the sense of the Board through the increased dividend, the authorization for an additional buyback, and the actions that we have taken over the last nine months, which are significant changes in the way that has been approached in the past.

And so, until there is more to announce from the Board, I think we shouldn't comment further on that.

But you should take it as a signal that this issue is being discussed and the interest of the shareholders are being considered.

On the other question that you raised, the capital spending, we have a plan for this year which is about $105 million.

We haven't yet put the capital spending plan together for next year, so we don't have anything to discuss on that yet.

Could I just follow-up on that and ask -- if I can ask it this way.

How far off in the future is really the next major upsurge where it's not 100 to 150 million capital spending year, but maybe a 250, 300, 400 million capital spending year?

Is that five years off, three years off in your mind?

If you can predict the growth rate we can predict the answer to that question.

But I think generically we have a lot of capacity in place in analog today.

And we are operating the factory as we mentioned at very low utilization.

We are continuing to make yield progress which gives us even higher effective capacity.

So, I would say the next very large capital expenditure is off in the future, given our very low levels of utilization.

It's unlikely to be in the near-term.

Kevin Rottinghaus, Midwest Research.

A couple of things.

You mentioned consolidation of the Chinese ODM and OEM channel and the handset side.

Any impact or any color you can give there on how much that has happened, and if you think more is coming what impact that will have on your business?

I think the smaller and less viable companies, the companies that can't really keep up with the R&D, the companies that can't figure out how to get a channel outside of China going -- I think those companies are going to disappear.

We have been very cautious about over the last year or two of trying to deal with the companies in China that we think are going to be the survivors.

And so far I think we're okay on that.

And we are always very cautious about that.

But I think that's what has happened.

And you think the market share has more or less balanced out between the global OEMs, or at least the Chinese manufacturers have stopped losing market share in that market now?

I think they will over the next couple of quarters with all the new product offerings and their increasing focus towards exporting product.

We'll have to wait and see.

So, it's always hard to predict whether that will be next quarter or the quarter after.

But I think in the future, if you look out in time, the Chinese are going to be very, very big handset manufactures.

And like I said, I don't think I would bet a lot of money against that.

The second thing on the restocking and distribution.

Could you talk about when that started?

And is there any way to quantify how much has been done already, how long it will take, how much that actually contributed to growth?

First of all, let me say to those who haven't heard this before that we only record a revenue when the distributor sells it out.

So, any restocking of distribution doesn't impact our revenues at all.

And we are one of the very few companies that actually looks at revenues like that.

So, any changes in their stocking positions either up or down don't impact our revenues.

We saw the restocking beginning mostly in April.

Are they closer to where they want to be?

They're getting there.

Returns were this past quarter about as high as they have ever been in terms of the number of times they turned their inventory on the average for the quarter.

So that would suggest that their inventory levels have gotten down to levels that are probably below where they would like to be.

On the other hand, all the distributors are looking at working capital more carefully.

And therefore, they're trying to work with their suppliers in a way that they can operate with less inventory, just as we are.

So I would expect their turns to continue to increase in the future as we all get our logistical systems better coordinated.

That, of course, begs a very interesting question of what happens when demand really starts to pick up and there's no inventory out there in the channel.

So that is the thing we're really trying to manage to make sure we keep our lead times low so we don't go back into the huge distribution orders, trying to fill it, getting OEM customers in trouble, reporting 40% quarter-over-quarter, or year-over-year numbers, and back into the circus that everyone has been in over the last couple of years.

Last thing, on the industrial side.

I know you have talked about slowdown potentially in July.

Do you have any thoughts on how sustainable the pickup in industrial might be, and how much of the growth is coming from constant additions in some end markets like automotive?

How much of this is true organic demand?

I think, like the answer to all these questions, there's always a little bit of each.

If you just take the automotive example that you mentioned before, clearly the electronics content and the signal processing that is going inside cars now -- be it in sensors for engine control, be it in telematics systems, or a whole host of other, braking systems, safety features -- there is a huge increase in the average amount of electronics going into new cars now.

So I think that is more of what is going to dominate our growth in automobiles than what is going to happen with the secular growth rate of the automobile market.

I mean, the content is going up each year at a pretty good clip of dollars per car of electronics in cars.

And in other parts of the market, if you take the medical (indiscernible), if you look at CAT scanners and PET scanners and all the other things that are being bought right now, they have thousands and thousands of channels of data.

And so, again, its as much more content as it is more end units, if you know what I mean.

So I think there's two phenomenon going on.

Clearly there's been a pickup in the business at industrial accounts in the end demand for their units.

But on top of that, there is a pickup in the amount of content we get in each unit.

So it's really hard to quantify that.

But, qualitatively that is what is going on.

What about in just for example auto?

Could you talk about the content growth there for ADI, year-over-year how much content has gone up?

Maria, (indiscernible)?

We'll try to get a better understanding of that as we go forward, but we would just be picking numbers now that really I couldn't substantiate.

If you keep asking us that we'll try to get a better sense of that in the future.

Thank you.

And thank you to everyone for your participation today.

We look forward to talking with you all during our third-quarter conference call which we do have scheduled for Thursday, August 11, beginning at 4:30.

And I really hope the press release will be out at 4:00.

Thanks.

This concludes today's Analog Devices conference call.

You may now disconnect.