亞德諾半導體 (ADI) 2005 Q3 法說會逐字稿

Good afternoon.

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

At this time I would like to welcome everyone to the Analog Devices third-quarter 2005 earnings conference call. (OPERATOR INSTRUCTIONS) Thank you.

Ms. Tagliaferro, you may begin your conference.

Hello.

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

If you don't yet have our third-quarter 2005 release, you can access it at Analog.com by clicking on the headline displayed on our homepage.

This conference call is also being broadcast live on the Internet.

From Analog.com select investor relations and follow the instructions shown next to the microphone icon.

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

Participating in today's call are Jerry Fishman, President and CEO, and Joe McDonough, Vice President for Finance and CFO.

We will begin in a moment with Mr. Fishman's opening remarks.

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

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

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

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

Also, this conference call will include time-sensitive information that maybe accurate only as of the date of this live broadcast, which is August 11, 2005.

Finally, pursuant to SEC Regulation FD, this conference call is open to all investors who wish to listen.

This is the forum to ask any questions about our estimates for revenue and profits going forward.

Any questions you have regarding our income statement, balance sheet and any other financial matters should be asked during this call as this is the time we are free to respond to these questions.

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

Good afternoon.

ADI’s third-quarter revenues, as you've seen in our press release, totaled about $582 million, which was down about 3.5% sequentially from Q2, which was in line with the estimates that we provided when we updated the quarter on August 2.

Revenues were sequentially higher in Japan, they were approximately flat in North America, and they were down in Europe and Southeast Asia.

Our sales to industrial customers grew slightly during the quarter with continuing strength at our broad-based instrumentation customers that was offset, or partially offset, by seasonal weakness in the automotive product area and continuing cyclical weakness in semiconductor automatic test equipment.

More recently our ATE customers have reported higher orders in recent months, which should begin to translate into higher ATE revenues for ADI in future quarters.

Industrial customers comprised the highest percentage of revenue in Q3 at approximately 41% of our total sales.

Our sales to computer customers also grew sequentially, primarily driven by notebook computers.

Revenues from computer customers totaled approximately 16% of sales for the quarter.

Our sales to consumer customers grew sequentially as high-definition TV and audio systems ramped production.

We're very well positioned for the consumer business with many of the top brands and many of the new models that are coming out as we enter a seasonally stronger period for consumer products.

Our revenues from consumer customers for Q3 totaled 16% of sales.

Sales to broadband and to wireless communication customers declined sharply in Q3, particularly amongst Asian handset customers, as we mentioned in our most recent update.

Revenues from communications customers totaled approximately 27% of our sales in Q3 with about a third in wireless handsets, about a third in wireless infrastructure, and the remaining third in other communications products which includes broadband, optical, and other networking applications.

Now I'd like to review the revenue in Q3 by product category.

Our analog product revenues were approximately flat to Q2 levels after growing 6% the previous quarter, and analog revenues totaled approximately 84% of our total sales in Q3.

Our sales of converter and amplifier products remain strong, and together these two product categories represented 65% of our sales in Q3.

We also experienced good bookings performance in our newest power management products which are very attractive to notebook makers and to other end markets where it ADI technology commands a high percentage of the bill of materials.

Among DSP products our revenues declined 17% sequentially, primarily due to declines in handset and broadband products.

Our general-purpose DSP sales grew sequentially, driven by industrial, instrumentation, medical imaging, and consumer audio applications.

Our Blackfin revenues also continued to ramped in Q3.

Gross margins in the third quarter were 58.1 percent of sales, which was up 70 basis points from last quarter, primarily as a result of higher margin revenue mix and also the benefit of product cost reductions that we've achieved in recent quarters.

As planned, factory utilization rates declined in Q3 to approximately 60% compared to 65% in Q2.

Inventory dollars declined by about $5 million sequentially.

Our operating expenses declined by 4% sequentially and are now down 9% for the same period last year.

Operating expenses declined primarily as the result of very tight control over expenses, along with the effect of lower bonuses, lower licensing fees, and lower legal expenses that we incurred during the quarter.

As a result, operating profit grew slightly to $134.6 million, or 23.1% of revenues, and earnings per share grew to $0.32, up from $0.31 last quarter.

Our balance sheet remained very strong in Q3.

Free cash flow was $161 million, or 28% of sales, which is calculated as cash flow from operations of $180 million, reduced by the $19 million of capital expenditures.

We returned $37 million to shareholders in dividends, up from $22 million returned in dividends in Q2.

Our balance sheet increased -- our cash balance increased by $167 million to $2.78 billion at the end of Q3.

During the quarter we did not buy back any shares for the quarter.

Orders per shipment in the next 13 weeks were up sequentially with particular strength in July and were above our revenue levels in Q3.

Our backlog per shipment in Q4 from both OEM customers and distributors grew to $341 million, which is up 11% from our reported backlog of $306 million last quarter.

As we plan for our Q4, we're certainly in the early days of the quarter, but we're planning for a gradual recovery that began six months ago to continue through Q4.

Demand in most of our end markets remain good with particular strength in the broad-based industrial markets, which today represent over 40% of our revenues, as well as positive seasonal trends in the consumer and the PC markets.

Specifically for Q4, we're planning for our revenues to grow in the range of 1 to 4% sequentially.

To achieve this plan will require slightly lower turns orders given our higher opening backlog.

Our leadtimes remain very short, as they have been.

And we intend to keep in short as business levels continue to improve.

Our current leadtimes are very similar to last quarter with 80% of our product available within 5 working days, 10% within 4 weeks, and the balance within 8 weeks.

On average our leadtimes are well under 4 weeks, which should keep ADI in a very high turns environment.

At these revenue levels we expect our gross margins to continue to improve modestly depending on the product mix of our revenues in Q4.

We're planning for inventory to continue to decline in dollars.

We're also planning for Q4 expenses to be up slightly in dollars.

This would produce earnings per share in the range of $0.32 to $0.34 for the quarter.

Looking longer-term, our core analog and general-purpose DSP products are performing well and earning very high returns on our investments.

These products represent continuing opportunity for strong growth and strong operating leverage.

These products cumulatively represented approximately 85% of our Q3 revenues.

The remaining 15% of our revenues are derived from standards-based vertical DSP products, which require high levels of ADI software and sales support, high levels of product integration, and have been a drag on our growth and our profits for the past few quarters, albeit after a very strong performance in these products last year.

In some cases the market dynamics have shifted, which has caused rapid shifts in our customers' market share, particularly in Asia where our vertical DSP sales have been historically concentrated.

Going forward we need to react to the current market conditions and focus our resources on the areas where we can earn good and stable long-term returns on our R&D investment.

This will generally involve, first, continued focus on the horizontal DSP market where the business model is very similar to our analog products and where innovation drives good growth and high profits; second, by focusing on shallow, mid-sized DSP vertical markets in automotive, industrial, instrumentation and consumer products.

The shallow verticals are high-performance analog and DSP-intensive.

They provide more stable growth, and we can earn higher margins through innovations that help our customers differentiate their products.

And third and last, we must invest far more selectively in what we call deep vertical DSP markets which are typically standards-based communications verticals that are very support intensive, the products are less differentiated, they're more volatile and they are inherently lower margin products.

Clearly signal processing technology is in demand and pervasive throughout the electronics industry, but all the opportunities in signal processing are certainly not equal.

It's our goal to focus our investments going forward on customers and our markets that are willing to pay for the innovation that we can enable.

Thank you, Jerry.

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

We will give you an opportunity to ask additional questions as we go through our second round.

We're estimating it will take about an hour to go through questions, but if we do have a number of people left in the queue we will continue until we get past all the questions.

With that, Operator, we're ready to get started

(OPERATOR INSTRUCTIONS) Romit Shah, Lehman Brothers.

Jerry, I hear you with the handsets being weak, but just if my calculations are right looking at your analog business sales are down about 13 to 14% year-over-year versus your con group where sales on average look like they are down about half as much.

Just wondering if you could just discuss your market share position in some of the segments where ADI has been a leader, like data converters and amps, and maybe give us an explanation for why sales in analog have lagged some of your peers.

I think the sales in the two product categories were the strongest.

Together converters and amplifiers comprise about 65% of our total sales.

They have been quite competitive this year.

And I think when the market share statistics ultimately come out in the converter and amplifier business, I think we will have at least held the share and probably gained share in those markets.

We suffered a lot more than our competitors did in the analog space on the ATE part, which was 6% of our sales and went down by almost $30 million a quarter year-to-year.

So that was a large, large hit in our analog business that many of our competitors didn't really suffer from.

I think our segments are a little bit different.

Our competitors tend to have more business in power management than in the converter and amplifier markets.

So I think that was a large part of the difference.

I think when history is written, if you look at the long-term trends in our analog business versus any of our competitors, I think you have to reach the conclusion that our share overall is stable, if not getting better.

And I think the product categories that we're in are going to show much more buoyant recovery than some of the other product categories that are increasingly more competitive, like power management.

So I think our analog business is doing great.

The categories we're in are doing well.

The product portfolios, the customers that we talk to, and our scan of the competitive environment indicate those businesses are very strong.

I think different companies have different segments that are strong and weak, but the parts that we have chosen to emphasize are doing extremely well.

This is Joe McDonough.

There are different amplitudes too in this comparison because the quarter that you're comparing it to, third quarter '04, was a quarter where the analog business was up 41% year-to-year.

So we were up very strong a year ago in the quarter, and that's the quarter you're comparing against.

I think there's always different patterns quarter-to-quarter and year-over-year numbers and everything.

But I think if you look at the thing that really matters, which is the long-term growth rate of our analog business, it really is second to none.

Thanks.

Just a follow-up.

The gross margins -- your gross margins today at a little over 58% are on significantly lower revenues.

Should we think that the upside in gross margins is north of 60% given some of the cost reductions you've taken in manufacturing or is this more of a mix issue and as DSP comes back we should assume gross margins probably peak out around the 60% level?

We will have to wait and see how that develops.

Certainly the richer the analog mix, the higher the gross margins.

And we have taken a lot of costs out of analog manufacturing and that's going to help us in the future.

I think the important thing to remember is we're still operating (indiscernible) internally at 60 or so -- around 60% utilization.

We're draining inventory.

So I think that there is a lot of opportunities for gross margin improvement in analog devices.

Thank you.

Adam Parker, Sanford Bernstein.

Why did you not buy back any stock during the quarter?

We have our algorithms for where we like to go in and we didn't have that come into place during the quarter.

So we'll have to wait and see how that develops in the future.

Can you share anything about this algorithm?

Does it include the price or your judgment of the value of the Company or --?

It is mostly to do with price, of course.

So basically then we can conclude you don't think the stock is cheap?

I didn't say that at all.

That could be your interpretation.

My sense is we have different points; we look at it each quarter; we try to pick the points where we want to be active.

And as we looked at it last quarter, those points -- the stock rode up pretty fast and we didn't get a lot of stock at the points we had picked for the quarter.

We look at that each quarter.

We're looking at it again right now relative to the expectations going forward, and we will make those judgments during the quarter.

It's not a static model.

We take a hard look at that each quarter and decide where it is we want to be.

So you do it once a quarter or is it more than that that you --?

It's usually once a quarter, and we modulate that from time to time as we go through the quarter.

These aren't hard and fast rules.

We have a large buyback authorization from the Board.

We intend to use it.

And we're going to look for the right spots to do it, much as anybody else would (multiple speakers)

The follow-up I have is just on the cash.

You have about 20% here of your market cap in cash again.

You're obviously tremendously overcapitalized, but you're letting this cash balance grow every quarter, so --

I would say if you look back over time, over the last four quarters we bought back $500 million worth of stock before this quarter.

We raised our dividend quite a bit.

We have a lot of appetite to do both in the future if things continue to go like this.

So I don't think we're just sitting by or we have a record of sitting by over the last year of just not buying any shares and the like.

We look at it each quarter.

Some quarters we will buy a lot, some quarters we won't buy any, some quarters we will buy some, and I think that's the way you ought to think about it.

To clarify the way it works, there's a program that we put in place at the beginning of the quarter that was based on market conditions at that moment in time and then the price from there move upward and out of the way of the program.

So program is a new program this quarter?

We will look at it again now we're free.

We have blackout periods too that we're subject to.

We now free after today's call, I guess from 48 hours, to put a new program in place.

Joe and I take a look that hard look at that.

We go through it with the Board, and we determine the points where we want to be.

So your appetite for an acquisition or building a 300 mm fab or something hasn't changed --?

(multiple speakers) build a 300 mm fab.

You've got enough money to afford one now, Jerry.

It's not a question of affordability, it's a question of the intelligence of (inaudible).

Don't leave the wrong impression.

Nothing has changed in terms of the uses of cash, the desire to return the cash to the shareholders.

Within the past few weeks for obvious reasons we have been blacked out.

Due to these market conditions here and early in the quarter, we put a program in place and it just didn't take -- it didn't hit.

Thanks.

Mona Eraiba, Rosetta Group.

I just need some clarification about you seemed to be hinting about an the DSPs with vertical markets that required a lot of software support.

Are you considering to shift away from those markets, and how much are those areas are for you percentage of revenue.

I think -- well, first of all, those -- I think roughly that's about 15% of our sales.

I think what we're really saying is if you really look at the DSP market for us there are really three separate bucket.

The first bucket we basically provide our DSP chips and a very aggressive toolset that allows customers to do all their own development.

These are generally customers that have very high engineering capability in the companies and they take our chips and they take our tools and they go develop their own applications.

These are generally customers that takes a while to get that done because they are writing the wrong code.

And eventually they get into the market, they sell our products, and they use our DSPs.

In the middle bucket are the same kind of customers, but they tend to be sort of focused around various applications.

And for those customers we our provide chips, our tools, and a very thin layer of application support, sometimes maybe including the operating system that they will use to develop their products.

Those -- both businesses are very good businesses for analog; very consistent with our business model.

They're not very unstable.

You can predict it.

There is many customers.

And the profit margin characteristics of those businesses are very good.

What we call the very, very deep verticals are basically customers where you have to do 100% of their product development.

You have to have the chips, you have got to have the software, you've got to have all the application software, you've got have the engineers camped out there to get it all to work right.

The support requirements doing this sort of system on chip business are enormous.

And you would think that given that we would do so much of the work for the customers who basically don't have much engineering that we get paid well for that.

But it turns out if you go back and you look all the system on a chip stuff for the last 20 years, that's not really what happens.

So we're looking at that saying that we have to be a lot more selective of where we're investing money in those kind of verticals where we take all the cost upfront, we provide all the support, and the margin opportunities and are not nearly as good as in the rest of the DSP business.

And it's much more volatile, which we're losing our appetite for.

Would you say how big is that area percentage-wise?

Percentage of what?

Of revenue.

Well, I would say that that is somewhere around 15% of our revenue.

Around 15%?

Yes.

And that's mainly the handsets --?

It's handset products.

It's broadband products where we go in and solve an entire broadband problem.

Those are the two primary areas.

Thanks.

David Wu, Global Crown Capital.

My question really has a little bit more to do with have you already started the process of disengagement?

I don't argue with anybody that DSL business is not the greatest, nor competing with people like MediaTek in Taiwan is the greatest (inaudible) the world, but I was wondering whether if in fact I look at your R&D numbers that were down significantly in Q3, that you have already started this process of disengagement from those deep verticals as you said.

I think the best that I'm going to say on that is that we've been reviewing where we want to invest our money very carefully in analog over the last couple of quarters, and we're continuing to.

As soon as we sort of figure out exactly what we will do then we will tell everybody.

But I think the general guidelines that I laid out earlier in my comments and again in response to an earlier question is about as far as I'm going to go on that today.

Okay, A quick follow-on.

The tax rate has dropped to 21% in Q3.

Joe, is this a number that we should be using for Q4 and also next fiscal year?

It's kind of hard to determine within 1% where the tax rate winds up. 21, 22% is probably the best estimate for next quarter.

I assume that's for the next year as well.

We don't have any operating plan we're prepared to discuss yet for next year.

Thank you.

Tom Thornhill, UBS.

Jerry, if you could go back to this DSP question, if I listen to what you're saying it sounds to me like you're getting ready to disengage from some of the handset DSP business.

Or is this sort of a speech out the window that says only you will stay in it only if you can get paid for it?

I think it would be -- the way we think about the handset business, just to try to clarify that a little bit, is we think of it in the context of the wireless business.

The world is clearly headed in the wireless direction.

It starts off in the early machinations of the wireless -- or the handset business, but there's an awful lot of wireless out there that's happening now and is going to happen in the future.

So I think it would be a serious mistake to think that Analog Devices is not going to be a player in the wireless business.

Now, having said that, clearly the handset business over the last couple of quarters has not been a great business for us.

The revenues have declined significantly.

The market dynamics have shifted.

So we've got to find places in the handset business where we can make a good return on the R&D investments and where as part of a general strategy that ultimately supports us being an important player in the wireless business in aggregate.

We're well along on that, and I'm very confident that we will figure out ways to earn a good return in the overall wireless business, a piece of which will likely be parts of the handset business.

I think that's the way to think about what I'm saying.

So more specialized in wireless and perhaps a defensible niche in handsets, maybe like TDSCDMA?

Yes, there are a lot of niches -- there are a lot of places in the handset business rather than slugging it out in the commodity part of that business where I think we can make a contribution and we will make a contribution.

And some of that same technology will be broadly applicable in other parts of the wireless market where it much, much easier to make a good return.

Thank you very much.

Nimal Vallipuram, Benchmark Company.

Just going back to this same point, is it fair to say that -- a couple of questions I have here is that it seems like whenever you try to focus on a high-volume vertical market, whatever the reason, that you're facing this price pressure or too much competition, which might not be conducive to your margin model, does that mean that as you explained earlier that there are some sort of a hybrid market where you can use your horizontal and vertical model?

Can you give us an idea of what those markets are in the sense that are they going to be high-ticket items like the base station router market, or is there something else which you can do where you don't have to face the kind of competition you face in the high-volume market?

I think that's a very good summary of where we're headed in that business.

If you take a look the automotive market for us, we have very significant opportunities where we can use products like Blackfin where we go in and we provide Blackfin, a bunch of analog stuff; we provide the modicum of an operating system and the rest of it is up to the customer.

And I think we have seen very significant take up in those markets.

It's not a market where there's sort of a new product model every three months.

It's not a product area where we see a huge amount of cutthroat competition and market shares shifting around every three months.

There's many other examples of that in the consumer markets -- the high-end audio market; in industrial products; in machine vision systems; in network security systems and surveillance systems; in high-definition video-conferencing systems.

These are all what we would call opportunities where there's a couple hundred million dollars of available market, and we can get $100 million of it.

And we can get it with a Class 1 customer list.

And that's the place where we can make the largest contribution going forward.

Just a follow-up, if I may.

Just to shift gears, you said that your orders from the PC market sequentially has been pretty good.

Yes.

I don't want you to comment on that.

Given what is being said as we speak right now in the Dell conference call, can you be a bit -- can you add a bit more color on where that demand is coming from?

Is it more oriented to notebook?

If that is the case, what's going on in the desktop market?

It's much more related to the notebook computer area where we up until the last couple of quarters have not had a very significant product entry and now we do.

So it's much more related to share in those businesses than unit volumes.

Thank you, Jerry.

Thanks a lot.

Sumit Dhanda, Banc of America Securities.

A couple of quick questions.

First, Jerry, you commented on July orders being strong.

I know it's only about 10 days into August, but could you perhaps give us a flavor of whether that trend has continued so far this quarter?

I think we will leave it at the July orders.

We've been worrying about a lot of things other than what the orders have been over the last couple of days.

But I think generically we've seen an uptick in the order rates in July.

I think that's a good sign.

We have a little more backlog going into the quarter.

That's a good sign.

So I mean, at least as we stand here in the second week of the quarter in trying to come up with what we think will happen, we're reasonably enthusiastic about what we've seen so far.

We try to make these projections and we try to communicate our plan very early in the quarter.

So we have many other people that listen to the conference calls that either don't predict it at all or wait until the tenth week or so to predict it.

So I think we're trying to basically communicate that what our plan is for the year -- for the quarter based on everything that we see as of the date we put the plan together, which was last week.

So that's about as much as we can do.

We're still sort of hostage to the forecasts of our customers.

I think when we start out with a little bit more backlog, we start -- we are a little bit more confident.

But the world changes at very rapid pace and we try to zero in on a plan within a very narrow range of what the sales could be given the diversity of our business.

That's about the best we can say about the order patterns.

That's fine.

And then the plan that you have in terms of growth for the October quarter, can you help us understand, are you expecting a rebound, especially in the vertical DSP business?

Or do think mostly it's going to be analog, which is going to carry the day?

We don't really know because we won't know until the quarter is over.

I would expect that we will see some growth in both our DSP business and our analog business, and exactly where that comes from, it's way too early in the quarter to predict.

You mentioned that your vertical DSP business is about 15% or so of sales.

What then is general-purpose DSP as a percentage of your total sales because analog is about 84%?

I'm just trying to reconcile the percentages here.

Joe, do you have those numbers there?

It's in the high single digits.

Is the assumption then that the vertical DSP business is less than 15?

How does it add up to 100?

In other words --

The total DSP is 17.

We told you the analog business plus our general-purpose DSP business was about 85% of our sales; that the vertical DSP stuff, what we call the deep vertical DSP stuff, was about 15% of our sales.

So the first 85% include general-purpose DSPs.

That would imply that it's 84% of analog according to your press release, so there's only 1% of general-purpose DSPs?

No.

Let me try to help here.

When we talk about 10% of our sales being in handsets, that includes DSPs and analog products that are sold into handsets.

As Jerry says, there's a good place for us in wireless technology on an ongoing basis, and that includes in analog, that includes an opportunity for DSP.

Then in another description of our business we talk about product categories, product categories being analog products and DSP products.

Within DSP products we've got general-purpose products and we've got some of these vertical market DSP products.

The total DSP sales are 17% of sales.

Within that 17% we've get general-purpose.

And the general-purpose are 7% of sales.

So 7 of 17 is general-purpose (multiple speakers) of the DSP goes into vertical.

What we call this vertical DSP category has some analog content in it.

That's the confusion.

By the way, it's pretty good analog content.

We aren't even organized internally along these lines of analog products and DSP products (multiple speakers)

One final question.

I'm just curious, the trends within -- at least with the component suppliers with 3G infrastructure in particular have been pretty good.

But it seems like that wasn't a highlight for you in the just-reported quarter.

Could you comment on why you're not seeing the bigger pickup there?

You're just talking about the wireless infrastructure?

Yes, wireless infrastructure.

We saw a very significant pickup, as you might recall, in the second quarter in that business.

And that sort of hung in there in the third quarter, but didn't grow a lot from those businesses.

From second to third quarter that was one of the largest growth drivers of our total growth last quarter.

In the second quarter, that is.

Thank you very much.

Craig Ellis, Smith Barney.

Just cycling back on inventory, it sounds like you want take inventory down again in the fiscal fourth quarter.

So I assume that you're not counting on any gross margin help from manufacturing utilizations.

Is that fair?

The manufacturing utilization will probably improve a bit next quarter.

But the real driver on the gross margin will continue to be the benefits of some the cost reductions that we've undertaken.

So we'll have a combination of the benefits of the cost reductions, a little bit better utilization, hopefully a mix of business that includes a bit more DSP, and that drags down the margin a little bit.

And we believe we have the plan calls for an improving gross margin.

Where are we, Joe, in terms of the cost reduction initiatives that you have?

How much longer can this (indiscernible)

I don't want to imply that we haven't completed them.

The way that inventory costs, is you put the cost of inventory and then it stays in inventory until the products comes out of inventory on a first-in, first-out basis.

So basically, if we have 128 days of inventory, it takes 128 days before the old higher costs will work their way out of inventory and the new lower costs can start coming through.

Does that make sense?

Yes, got it.

And then lastly, it sounds like you're not expecting any leadtime expansion, at least in the current quarter.

As you look out over the next six months, is it possible to get leadtime expansion, or do you think we're going to -- given where utilization rates are not only with ADI, but more broadly in on-hand inventories are we in an environment where leadtimes should just stay lower?

I think at least for -- the past three months it's very hard to look out.

I'd say for the next couple of months it's very likely that the leadtimes are going to stay about where they are for us.

I can't comment on the rest of industry, and no I can't comment on whether customers start getting nervous about supply and start ordering up, and then of course you always have the problem of leadtime.

At least as we see the world right now it's relatively stable.

Leadtimes are stable.

They are very low, and I would expect at least through Q4 for them to stay like that.

We're trying hard to keep the leadtimes short.

Absolutely.

Thanks guys.

Louis Gerhardy, Morgan Stanley.

Just on sort of the last train of thought in terms of leadtimes, can you help explain why the backlog was up so much in a quarter when you missed the revenue and leadtimes aren't really changing?

What are the areas that are contributing to that type of strength sequentially?

And is the mix of vertical market DSP in the backlog about at that 10% level Joe described?

The backlog is up both in the orders that we get from our distributors and the orders that we get from our OEM direct customers.

And the backlog is up also in some of these DSP product areas.

Now, the way we react to supplying our customers is we have products that have long life cycles, we have die bank inventories, and we try to keep short leadtimes.

We have other products which include these vertical market products that to a large extent we're building them to order.

Therefore, there's a reasonably long cycle time for some of those products.

And if the orders come in and on July there's not much chance that they are going to get shipped out right away.

I think the answer is the backlog was up in both the analog product area and the DSP area for the quarter.

Okay.

And then given some of the changes you're talking about, especially in the vertical market DSP area, whether you're looking out one or two years, is there an update you can give us to your financial model, specifically operating margins, that once these changes you're talking about are implemented what we could expect on the operating margin line?

I think it's a little premature to do that.

Clearly the kind of things that we're thinking about generically are geared towards operating a higher margin business that we are right now.

So I think all of those things are positive relative to our model.

The exact way that shakes out, I think we would like to finalize what we want to do and take a hard look at that.

Generically, it ought to improve the model.

We still believe that the milestone that we're aiming at next is 30% operating profit.

Okay.

And can you just give us --?

The way we typically do that is once we get close to that or achieve it then we take another look at it.

So we are unlikely to discuss anything different than that until we come within sight of it.

Can you just say what your book-to-bill was, or a little more color on what happened there?

It's over 1, I think Jerry said in his comments.

I'd say that's where we would leave it.

Bookings are always hard and we have talked about that many, many other quarters.

So it's not like that is (multiple speakers)

Let me help with a couple of the components there.

The cancellations remained low this quarter.

The turns business was approximately 50% of the quarter's business.

The book-to-bill was over 1.

And we talked about the 13 week backlog, or the backlog for delivery next quarter, which is $340 million or so.

That helps.

Thanks a lot.

That's about as much, I think, as you need.

That's great.

Thank you.

Tristan Gerra, Baird.

Your dedication to stay in the mobile phone market, is that just based on looking at potentially changing the product mix that you're selling in this market, or do you also see signs of new phone design activity at some of the Asia-based mobile phone OEMs you're selling into that makes you confident that sales are going to rebound in '06, and market share?

I think it's a whole combination of a lot of things.

The market shares in that region float around each quarter quite a bit.

And it's our continuing belief that the market over there is shifting heavily toward the ODM model.

We have talked about that before.

And I think over the next year or two that's really going to become a very important part of that business over there.

I think our product mix is getting richer.

That's going to help.

And I think our customer base is getting better.

So all those things give us some confidence that at least that part of the business should get better over the next couple of quarters.

But I'd say that I would also go back to what I said earlier, that we have got to figure out place of that market, and there are such because the market is fragmented and it is going to fragment further as many of these new applications are developing.

Some of the new applications will have voice and video.

Some will have voice and cameras.

Some will have a bunch of other things.

So I think that market is fragmenting, and I think there are opportunities in that market where important technology can get paid for.

There are other places in that market where no matter what you do you can't get paid for it.

I think we're going to gravitate in the handset business towards those parts of the handset business where we can get a return on our R&D.

On the consumer side, what opportunities do you see in advanced codec technologies, specifically in the set-top box market, IP video?

And how would you characterize your design activity in this area?

Can you repeat -- I didn't quite get what you said.

Advanced codec technologies in set-top box with the rollout of IPTV in Europe and Asia and also in the US in '06 and what type of design win activity are you seeing for your DSP-based products in this area.

That would be H2C4VC1 (ph).

It turns out that we do have a number of design wins with Blackfin-based products and IP set-top boxes, mainly in Southeast Asia where Blackfin has been able to hold its own and in fact show performance benefits over standard ASIC solutions.

Basically in their set-top boxes Blackfin is running the MPEG and the H.264, as well as doing some advanced audio functionality.

So the number of those designs, the market in Asia seems to be a little bit delayed in terms of the deployment of those technologies in China.

But with the design wins that we have, once the carriers actually start to deploy, we think we're in a reasonably strong position going forward.

I think the way to characterize that business, just to go back to what we were saying earlier, is we would view that as what we call a shallow vertical.

That's not a market that we're going to go into, or we're going into.

We're going to do the soup to nuts, including all the software development, all the support and all that kind of stuff.

This is a business where we're going to ship product, we're going to give them an application layer, and we'll to give them toolsets, and the rest of that is up to them.

Great.

Thank you.

Seogju Lee, Goldman Sachs.

Just wanted to ask a question about ESO expensing.

You'll start following Q4.

And just if you could ballpark that and how you're looking at it; if you plan to do it on a straight Black-Scholes or binomial method.

Thanks.

The actual date for us to begin is our first fiscal quarter, which begins in November.

So at the conference call at the end of this next quarter we will certainly have all the information to respond to the question that you're asking.

We're in the process of resolving and finalizing some of those questions.

Great.

Thanks.

Just a follow-on question.

You mentioned also that broadband area, there is weakness there.

If you could just give a little color in what the expectations are going forward?

Thank you.

I think we have a lot of different participation in broadband.

In some parts of that market we supply a lot of components.

And in that sense that's a good business for us.

They make good margins.

They sell well.

And we've got some great customers on that.

In some of these what we would call the deep vertical part of the broadband business, that for us has turned out to be a fairly cyclical business.

There are some quarters that are great and there are other quarters that are not so great.

And it's one that we look at, and we look at it against our objectives, and we try to figure out how it is possible in that business in the very deep vertical part of that of trying to solve the entire customers problem of what we ought to be doing.

And that is certainly one of the things that we're looking at hard right now.

Thank you.

Michael Masdea, Credit Suisse First Boston.

A couple of quick ones.

As we start to take a look at you guys refocusing on your spending and how you're going to spend, etc., should we -- just to set expectations should we expect more gradual changes or is it going to be more step function depending on what you decide?

I think we will have to wait to see how that turns out.

Fair enough.

And then the other thing is some of your competitors are talking more and more about the converter space especially.

Can you just walk us through -- and they've shown some pretty good growth.

Can you walk us through where especially in converters you think you have the most market share and you might even be still gaining share and holding your own?

I think in the converter markets one of our greatest strengths is we probably sell 2 or 3000 converter product to 60,000 customers.

So I think that we tend to focus on the converter market at the very high end of that both in terms of speed and in terms of dynamic range and accuracy.

I think there's a lot of chatter out there in the market and a lot of people talking about a lot of different products.

But I think if you really talk -- listen to the customers who ultimately decide, I think they're pretty convinced that we not only have a very, very high share of that market and have historically -- we have had share and it's been building every year -- but our product portfolio now is probably the strongest in our history in the converter business.

So there's press releases and chatter, and then there's who's getting the sales.

Does your end-market exposure there mimic your overall market exposure or is there any shifts?

I would it's probably consistent.

Thanks a lot.

We have about four people left in the first round of questions queue, so if you did want to ask a follow-up you can press the star key and the number one to get back into the queue.

Operator, can we get the next question please?

William Conroy, Sanders Morris.

First, I think a quick one.

Was there any material change in headcount during the quarter?

No, I don't think --

No, I don't think we would consider it material relative to 8400 people.

Secondly -- maybe this one is for you, Joe -- how much of your PC business now is focused on notebooks?

Can you just even ballpark that for us?

I don't have that number off the top of my head.

I'm sorry.

We don't have that.

Thanks very much.

But clearly that's where the product portfolio is aimed.

Whatever it is now it is growing every quarter as a percentage.

I think that's what the trend is going to continue to do.

One of the difficulties just in getting data at that level is that we characterize products and customers in order to derive end-market type of data.

And so obviously the same customers that produce notebook computers produce desktop computers, and so a lot of our insight into that is derived from internal company meetings and business reviews, which aren't aimed at that much precision on the data.

Got it, thanks.

Ross Seymore, Deutsche Bank.

One quick question on the analog business in the July quarter.

If we go back to your original guidance, it looked like for the total business it was so flat to up 3.

We would probably think that analog was expected to grow in there, so that came in a bit at the low end of the range.

While that was in line with your peers, it was at the low end of the guidance nonetheless.

Can you just explain what happened that brought that down to the lower end please?

I would say there were probably two things there.

One was you might remember in the second quarter we had seen a slight uptick in the ATE business, and we had projected that that was going to probably continue and go up a little bit in the quarter.

And it turns out it actually went down in the quarter.

So that tends to swing around the numbers a little bit.

The other part is we suffered on the analog side of the handset business as much as we did on the DSP side.

So when the handset business came in lower that sort of brought down the analog side as well.

I would say the last thing that was a little bit lower was the automotive market was a little bit lower.

Mostly -- we talk about our micromachine products as analog products since they really are.

And that was down a couple of million dollars sequentially after it went up pretty well in the second quarter, in line with what's going on in the automotive industry where they build a lot of cars in Q2 and they try to sell them in Q3.

I think those were the things that were a little bit lower than we would have thought.

The baseline converter business, the amplifier business, and most of the mainstream products were right about where we thought.

And then that ATE business, earlier comment -- I think in your prepared comments you mentioned that it's being about 6% of sales and then dropping 30 million year-over-year.

Is the 6% what it was a year ago or what it is now?

It's what it was a year ago.

I can figure out the math from that.

And then we've spoken a lot about the inventory that you have and what's happening there.

In the channel, what's been going on from your perspective with your distributor customers?

From the distributors' customers?

No, from your (indiscernible), what do you see in the channel, what's their inventory doing, etc.?

Their inventory levels declined -- of our products declined 7% this quarter.

And that -- they declined in the third quarter from the second quarter, and they declined in the second quarter from the first quarter.

So they've now declines one, two, three quarters in a row.

If you had to talk about the number of weeks or however you want to gauge it, it seems that that has to be below the historical average.

Is this something hat we're just going to have to deal with or is the channel refusing to hold it, and therefore you guys are enough to hold onto more inventory?

I think the way you should think about that is the distributors for the our managing their working capital much more tightly than they ever did in the past.

And so the number of days of inventory that they used to be willing to carry and needed to carry has changed.

What also has changed is our response to carrying die band, trying to keep the cycle times low, and trying to be responsive to their needs.

So the ultimate goal is to actually have one inventory source that you can ship from very quickly in order to meet all customers' needs.

That ideal world will never happen, so there will always be channel inventory out there.

But I think it's reasonable to assume that the distributors are able to operate and service their customers with lower levels of inventory than they have in the past.

And if they don't, we will.

So you basically think this is the just -- the just-in-time world is going to apply going forward?

I certainly would like the just-in-time world to apply going forward.

Everybody tells me that won't happen.

But I think what we will see is less and less inventory in the aggregate.

And we're seeing that in the distribution channel, and we aren't seeing any real difficulty in supplying the customers.

And then the last question, would you expect to start buying back shares again as we go forward into the October quarter?

I think we will go back and take a look at all the factors that we look at and we will make some decisions on that during the quarter.

We're committed to buying stock back.

As I said earlier, we look for the right points to do that in, and we will continue to do that.

Great, thank you.

The next question, Operator?

I believe it comes from Jeremy Kwan at Piper Jaffray.

Jeremy Kwan, Piper Jaffray.

Just a question on the power management.

It sounds like that segment of the business is growing quite nicely.

Can you give us an idea of what percent of sales this is currently comprising?

I don't know that we have those (multiple speakers) rough guess --

No, we don't have it broken out (multiple speakers) for analog.

We don't have that.

It's a few percent.

It's probably under 5% of our sales to date.

Besides the notebook segment, can you tell us what other areas you're targeting?

It looks like you have got some products like hot swap and cell chargers and things like that.

We do.

So it's not just PCs and notebook stuff.

There's a very broad product portfolio that will not only go into PCs, but to digital cameras and a bunch of other things where we have a lot of content where we can drag along a lot of power management and where power management is real important.

We have a line of hot swap products and we're going to sell them into a lot of things, servers, as well as PCs.

So what we really are attempting to do in the power management business is pick the spots where the margins are high, where if we can do something better than the competition the customers will pay for it and stay out of the business where there's a bunch of products out there, everyone has got the same product, and it becomes an auction.

There is a part of the power management business that is highly commoditized.

That's not the part that we're after.

Can you give us an idea of when you expect these new non-notebook areas to begin contributing to more meaningful revenue?

I think we have pretty good expectations for that for next year, and we'll have to see how that all materializes.

Just another question on the -- in terms of your own internal inventory.

Can you give us an idea of where you feel comfortable -- at what level would you feel keeping inventories as measured in days relatively flat?

Our goal on inventories is for 100 to 110 days of inventory.

That isn't something that we feel that we need to get to immediately.

Our goal is to be able to keep the leadtime short, keep the factories reasonably loaded when we have the type of capacity that we have right now.

And each quarter we set a plan for the next quarter.

Our plan for next quarter is to reduce the inventories again slightly in dollars and over time to get to 100 to 110 days.

Thank you very much.

Jack Romaine, SG Cowen.

Could you a little bit more about your gross margins?

Specifically what I'm trying to understand is a separation between the affects due to mix and maybe the trends within the margins in analog and DSP.

There's not an easy analysis that we can supply you with on that.

We've got a whole lot of factors going in different directions.

I think the gross margin came out a little bit better than we had planned for the quarter despite the fact that sales were lower.

That certainly had to do with the mix of business, which was a richer mix of analog business, which has higher margins.

All the other elements I think were pretty much on plan.

How about looking into next quarter?

Can you give us any plan for utilization?

The plan for utilization this quarter was in the 60% range.

Last quarter it was 65.

Next quarter the utilization will go up a bit.

How about longer-term trends in operating expenses?

I think we're going to continue to keep those under a lot of pressure.

Part of that is going to be we're working on some of the areas that we want to invest in and where we don't want to invest in.

But overall we're going to keep that under great pressure because it's too high relative to our sales and we expect that we'll get good leverage as the sales go up.

I can't give you exact numbers and how we will do that because it's very dependent on the investments that we make and what we decide to do in some areas.

But I think you can -- you may take away that we're going to keep that under very significant pressure because the operating expense level as a percentage of sales in analog is too high today.

Okay, thank you very much.

Manish Goyal, CRES Investment.

I have two questions.

First one, wireless.

You said that you expect your customer mix to get better and you expect your product mix to get better.

Could you amplify on that what you mean by customer mix to get better?

And when you say product mix to get better are you thinking about WCDMA?

I think it is all those things.

I think the opportunities for the -- to penetrate some larger customers via the ODM channel are very significant.

If you really -- if you go out and talk to the top three or four handset manufactures in the world, I think each of them has plans to significantly increase the amount of products they are accessing through the ODM channel, and I think they have to do that.

There are just too many models and too many features, too many phones and too many things going on for them to continue with a model where they're basically doing most of that, if not all of that, themselves.

I think through that there's a possibility for analog to get a richer mix of customers in that channel.

I think the feature set is getting better as well as the duoist (ph) phones that our customers delivering right now have much more rich multimedia capabilities.

They've been working on that for a while.

A couple of them fell behind.

I think they are delivering or their introducing these new phones over the next couple of months and that will increase the sort of content mix of our stuff.

Certainly as we get out to future standards of 3G and the Chinese equivalent of that there's lots of opportunities to increase the mix as well for us.

So I think what we're really thinking in that business is as that business continues, or really now is just beginning to fragment, there are opportunities for us with some different customers, and some different models with some different content than there's been before where most of our customers historically, or many of them -- I shouldn't say most, but many -- we had to go in there and do the whole engineering job for them.

And I think the opportunity is now for that not to be the case going forward, and that will really help the business model for us in that part of the market.

Jerry, second question is just the continuation of Jack's prior question on operating expense.

Perhaps you can share at what revenue level or at what timeframe do you expect to achieve your target operating model of 30%?

For operating margin?

Yes, operating margin target of 30%

That's a hard question to answer given all the different machinations of things we're thinking about for the future.

So Joe, I don't know if you want to take a stab at (multiple speakers)

A year ago we had $718 million worth of sales and we were pretty much there.

So there's no reason to believe we can't do at least that good.

We should do better.

We should really do better.

So that partly answers my question.

So you think that as you get back to that revenue level you think you can achieve that margin (indiscernible)

We would be very disappointed if we couldn't do that.

Great.

Thank you so much.

Apjit Walia, RBC Capital Markets.

This is actually Jos Rashid (ph) here.

Could you characterize the pricing environment, especially for your analog products and (indiscernible) this quarter?

And what's the outlook for the next quarter?

I think the pricing environment in the analog side is very stable.

There is 10% of the business which gets to sort of commoditized, but for the largest part of our business the price is relatively stable.

There's always price pressure in everything you do.

Customers are looking for lower-cost products, and they are forced to price it down for the newer generation of products that come out and everything.

But I think that there's no definitive shifts that are markedly changing the stability of the average selling prices in the analog products.

Certainly there's been a lot of pricing pressure on some of these very highly charged, high-volume DSP verticals. but on the analog business I'd say the pricing environment is very stable.

Thank you very much.

Alan Brochstein, Piedra Capital.

Thanks for taking my call.

I know somebody was joking earlier about buying a 300 mm fab, but I guess I would be curious about -- you guys historically haven't done acquisitions.

I just want to make sure that -- especially if there's a little bit of revenue pressure as you deemphasize certain components of DSP market would your outlook change on doing acquisitions?

No.

I guess my second question is can you elaborate a little bit on -- it sounded like in your prepared comments you said that the -- I'm sorry, in response to someone's question you said that the market is becoming commoditized, but (indiscernible) power management business --

I said there were some segments in the power management business that were becoming commoditized and they tend to be the lower performance part of the power management business.

There's 20 companies that deliver power management products.

The real challenge in that business is to stay at a level that supports our business model.

We're certainly going to do that, particularly since the investments we're making are very selective in that regard.

But the low end of that business is commoditized -- no, the low end of the whole analog business is fairly commoditized.

There's only a third of the whole analog market, in my opinion, that is worth being in, at least for analog devices.

There is two-thirds of it that is not much better than being in lots of businesses.

So the analog market itself is not a homogenous market and it's highly fragmented by performance.

And I think it's going to continue to.

That creates the opportunity for companies like ADI and other high-performance analog companies to differentiate their margins from many other people.

I would expect that if you looked in the commodity part of the analog business, the margins are very poor.

I think there are some parts of the power management business where the margins are very poor.

There are some parts of the converter markets that the margins are very poor, and the amplifier markets as well.

So it's really -- the challenge is to stay out of that part and just stay where customers will continue to pay for performance.

That's certainly what we've built analog devices around and where we're going to keep building analog devices in the future.

Thank you very much.

Paul McWilliams, Indie Research.

Thank you for taking my question.

What's your split between internal and external fabrication?

Hold on one second.

It's on your fab (ph) sheets.

Your next question

Hang on.

Joe's still looking.

We're still looking for the answer here.

I apologize.

It wasn't the vicinity of 55 to 60% internal this quarter.

At what geometry level do you make that split?

Generally -- inside analog devices would generally stop at somewhere around .35 and in a few cases .25.

And everything below those lithography levels, including the minicases (ph) of those lithography levels, we outsource.

Excellent.

Thank you very much.

Mona Eraiba, Rosetta Group.

Jerry, is there any signs of life in the ATE segment?

The only signs of life that I could report is that I read the same press releases of our customers as I'm sure you do, and in the last quarter's announcements it looked like a few of the large ATE customers, particularly the one in our backyard here in Boston, indicated their orders -- they had seen an increase in their orders for the first time in five or six quarters.

We view that as a good sign going forward.

But you haven't seen any pickup from them because a lot of them still have some inventory?

Yes, I would say that I think that's absolutely true.

Typically what happens in the ATE product area is a lot of the products that they buy from us are very specialized products.

And they buy them and they take them when they order them.

That generally means that they carry a little bit extra inventory during these cycles.

So typically if they see an increase in their orders it takes a quarter or two for us to see the increase in our orders.

So (indiscernible) pick the exact time, but you can very accurately predict what the trend line will be.

Thank you.

I think we have gone through the entire queue for today's call.

I just wanted to remind everyone that the fourth-quarter earnings call will be scheduled after the close of market November 15.

The release will be out at 4 PM and then the call will start promptly at 4.30 Eastern time.

Thank you, everyone, for your participation today, and we look forward to speaking with you in the near future.

This concludes today's Analog Devices conference call.

You may now disconnect.