亞德諾半導體 (ADI) 2006 Q1 法說會逐字稿

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  • Operator

  • Good afternoon.

  • My name is Katina and I will be your conference facilitator.

  • At this time, I would like to welcome everyone to the Analog Devices first-quarter 2006 earnings conference call.

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

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

  • Ms. Tagliaferro, you may begin your conference.

  • Maria Tagliaferro - Director of Corporate Communications

  • Hello, everyone.

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

  • If you don't yet have our first-quarter '06 release, you can access it by visiting our website at analog.com and clicking on the headline displayed on the home page.

  • This conference call is also being broadcast live on the Internet, accessible from that same page.

  • And a recording will be available later today, probably in about two hours after the call's completion.

  • Participating in the call will be Jerry Fishman, our President and CEO, and Joe McDonough, Vice President for Finance and Chief Financial Officer.

  • I would like to bring your attention to an important item pertaining to our first-quarter results and today's discussion.

  • ADI implemented FAS 123R in the first quarter of fiscal 2006, and as a result, we recorded $20.6 million related to stock option expenses in the first quarter.

  • In the fourth quarter of 2005 and in the first quarter of fiscal 2006, we also recorded charges associated with our previously announced restructuring.

  • These restructuring-related charges totaled 6.9 million in the first quarter of 2006 and 31.5 million in the fourth quarter of 2005.

  • During today's conference call, our remarks will refer to results excluding these special items because we believe this will help investors compare our current results to our history and thereby better understand the underlying trends in our business.

  • In addition, 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 performance and involve certain risks, uncertainties and assumptions which are difficult to predict.

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

  • Also, this conference call will include time-sensitive information that may be accurate only as of the date of this live broadcast, which is February 9, 2006.

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

  • Jerry Fishman - President and CEO

  • Well, good afternoon and thanks for joining us here this afternoon.

  • As is typical in our previous quarters, we've provided a great deal of detail in our press release, which by and large I don't plan to repeat.

  • But I will attempt to provide a little more insight into comments that we made in the press release about Q1 and also about the outlook going forward.

  • In general, our first quarter of 2006 turned out to be pretty much the way we had planned it.

  • The revenues were up 7% relative to the same quarter last year, and they were essentially flat sequentially.

  • The highest sequential growth came from our industrial and our communications customers.

  • And in line with normal seasonal trends that we talked about last quarter, sales to consumer customers and computer customers were down sequentially in Q1, as is very typical in previous years.

  • By end market, industrial customers represented about 41% of our revenues, computer about 13, communications about 31, and consumer about 15% of our revenues.

  • Comparing our first quarter to the same period a year ago, our sales to our very broad base of industrial customers grew 16% year over year, which we believe reflects a generally good economy worldwide that is generally stimulating higher industrial capital spending by a large base of our industrial customers.

  • Our sales to consumer customers grew 18% year over year, really fueled by the popularity of many different audio and video products.

  • Our sales to communications customers increased slightly year over year, as growth from infrastructure applications, including wireless base stations, central office equipment and optical networking systems were offset by a decline in cell phone and broadband modem customer sales during the quarter.

  • Within communications, base stations comprised approximately 10% of our total sales.

  • Handsets were 12% of our total sales, and this 12% included sales of our baseband chipset, as well as power management products, display drivers and radio frequency ICs, all of which -- all those of which are analog ICs.

  • The balance of our communications-related sales, or 9% of sales, stem from a very broad array of optical and networking products.

  • In January, we announced that we have signed a definitive agreement to divest our DSP-based DSL and networking ASIC product line.

  • During Q1, sales of these broadband products were approximately $12 million or 2% of our total sales.

  • We expect to complete this transaction in the near future.

  • We plan to continue to invest in line drivers and other analog and general-purpose DSP products for this market.

  • Also, as we described in our press release, our sales to computer customers were down year over year.

  • During our first quarter, sales of our analog products grew 11% year over year and were up 2% sequentially.

  • Converter sales were up 9% year over year and amplifier sales were up 18% year over year.

  • Power management sales were down 12% year over year as we integrated our power management devices for cellphones onto the baseband chip and revenues from our older desktop power management products declined more than our new revenues for portable products increased.

  • Other analog products, such as micromachine products, radio frequency products, phase-locked loops, clock ICs, interface ICs, amongst many, many other analog products, grew 23% year over year.

  • Converters represented approximately 41% of our sales, amplifiers 19%, power management products 7%, and other analog products represented 15% of our total sales.

  • In total, approximately 82% of our sales in Q1 were derived from our analog products.

  • During Q1, our DSP sales declined sequentially and also year over year.

  • Our general-purpose DSP revenues, however, which represent approximately 7% of our total revenues, grew 19% year over year.

  • As Maria described during the beginning of the call, in the fourth quarter of '05 and the first quarter of '06, we incurred restructuring-related charges.

  • And also during the first quarter of 2006, we adopted the new accounting rules for stock options and began expensing stock options.

  • My remarks will refer to results excluding these special items because, as Maria mentioned, we believe it helps investors compare our current results to our history and thereby better understand the underlying trends in our business.

  • Gross margins for the quarter improved to 59.2% of sales, which is up 90 basis point sequentially and 140 basis points from the same period last year as the mix continues to shift to higher-margin products, meaning not only more internally manufactured analog products, but also a richer mix of general-purpose DSP product sales.

  • While our factory utilization was the same as the previous quarter at about 60%, our inventories grew in dollars and days compared to the previous quarter as we purchased more wafers from external foundries in preparation for Q2 revenue growth and also to provide a buffer against the tightening of back-end subcontractor capacity.

  • We believe that we have adequate wafer capacity both internally and externally to respond to higher revenues without extending our leadtimes.

  • Operating expenses were approximately flat sequentially and were down from the same period last year.

  • As a result of higher gross margins and flat expenses in Q1, operating profits grew to 25.7% of sales and diluted earnings per share grew to $0.37, slightly ahead of the plan that we had for the quarter.

  • For the first quarter, cash flow from operations totaled $175 million or 28% of our revenues.

  • We spent approximately $20 million in capital, producing free cash flow of $155 million or 25% of sales.

  • During Q1, orders grew approximately 7% sequentially, with particular strength from the distribution channel, which represents a broad array of customers across virtually all the markets that we serve.

  • We believe that this increase is the result of distributors preparing for strong sales growth in Q2, and also, to some degree, is in response to lingering concerns about industry back-end capacity.

  • While our leadtimes are largely unchanged from the previous quarter and remain short, capacity shortages at back-end subcontractors have resulted in extended leadtimes for some products.

  • We are planning for a good Q2 with particular strength from our analog products, which are planned to grow between 5 and 6% sequentially.

  • We expect the strongest analog growth will come from seasonal strength among industrial and consumer customers.

  • We are planning for sequential growth in all our analog product categories in Q2.

  • Our DSP revenues will likely be down slightly in Q2 as we will have divested our DSP-based DSL, ASIC and network processor products, which totaled almost $12 million in revenues in the first quarter.

  • We are planning for sequential sales growth in general-purpose DSP products in Q2.

  • So in aggregate, when we add all that together, we are planning for our second-quarter revenues to be in the range of 635 to $650 million, based on what I've mentioned earlier.

  • We are planning for gross margins to continue to improve and to reach our goal of 60% in Q2 as the utilization rates of our factories is planned to increase.

  • For the balance of 2006, our gross margins will be dependent on the mix of our product sales and our factory utilization.

  • After our California wafer fab closes, we believe we will also benefit from further cost reductions, which should further positively impact our gross margins in the future.

  • We are planning for expenses to grow approximately 2% in the second quarter due to annual salary increases, which we implemented recently, and increased bonus payments in line with our improving operating performance.

  • The benefits of our restructuring actions that we've talked about previously are expected to offset much of the annual salary increases.

  • Increasing margins and minimal expense growth should provide very strong operating leverage for ADI in Q2.

  • Our plan is for operating margins to again increase sequentially and for earnings per share to be in a range of $0.39 to $0.41, up from $0.37 for the first quarter.

  • Overall, our plan is for 2006 to be a very good year for ADI.

  • Our analog product portfolio is very strong in converters and amplifiers, where we have high market share.

  • And also, we have been building momentum in other analog product categories.

  • In power management products, where we have historically been underpenetrated, we will benefit from our customers' desire to buy total solutions from a single vendor.

  • Our micromachine products are gaining significant traction in many new consumer products where motion and position sensing provide new capability for new applications in cellular phones and also in video games.

  • And the recent release of our three-axis product greatly reduced the complexity and the cost of motion sensing integration.

  • As you know, we have been working to better focus our DSP R&D on markets where we can earn a better and a more consistent return and we are planning to continue to do so.

  • The momentum building for our general-purpose DSP products is the direct result of these efforts.

  • Many new consumer, automotive and networking applications should begin to ramp production later this year.

  • We believe that we can significantly improve the focus of our DSP business going forward, and that will positively impact our earnings as a result of this process.

  • The feedback that we received from the recent consumer show in Las Vegas was extremely strong, and for those who visited with us, they really saw firsthand how high-performance analog and DSP technology together are at the heart of so many new products.

  • Increasingly, the most sought-after features in virtually every type of electronic equipment are enabled by high-performance signal processing technology.

  • ADI's core technology is quite literally everywhere.

  • Our products help our customers' products stand out against competitors, and that unique value to our customers should help us get more than our fair share of the market with very, very good profits.

  • Maria Tagliaferro - Director of Corporate Communications

  • Thank you, Jerry.

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

  • We are anticipating the call to last about 60 minutes, and we will try to get to all the questions that we have.

  • We will give you an opportunity to ask an additional question after the first round is complete.

  • Operator, we are now ready for questions from our analyst participants.

  • Operator

  • (OPERATOR INSTRUCTIONS).

  • Bill Lewis, JPMorgan Securities.

  • Bill Lewis - Analyst

  • On your guidance for the second quarter, just to clarify, how much revenue are you including in your guidance for the DSL business that is going to be sold later this quarter?

  • Joe McDonough - VP-Finance and CFO

  • This is Joe McDonough.

  • There's very little revenue in the second-quarter plan.

  • Bill Lewis - Analyst

  • So almost the full 12 million you guided -- it is on the order of a couple million dollars?

  • Jerry Fishman - President and CEO

  • Yes, I think the way to think about it is it's about 2% of revenue growth for the quarter.

  • And that's about what we're expecting to come out of the total.

  • Bill Lewis - Analyst

  • And then just on the other components of the revenue, do you expect any change to tax rate -- I noticed it was slightly higher -- or interest income, which was actually lower, maybe, than you expected in the recent quarter?

  • Joe McDonough - VP-Finance and CFO

  • Next quarter, we would expect the interest income to be up a bit -- the non-operating to be in the range of $24 million on operating income next quarter.

  • And the tax rate always depends on the mix of business in any quarter.

  • It has not moved significantly.

  • It is in the 22, 23% range.

  • Operator

  • Sumit Dhanda, Banc of America Securities.

  • Sumit Dhanda - Analyst

  • Joe, I had a question on the benefits of the restructuring.

  • Could you help us understand how much of that benefit has already started to flow through [technical difficulty]?

  • Joe McDonough - VP-Finance and CFO

  • Yes, the largest restructuring action that we have announced is the closure of the California wafer fab.

  • And as we have indicated, that is a process that goes on through this year, closes at the end of the year.

  • And we derive the benefit of it with reduced manufacturing expenses beginning in fiscal '07.

  • All of the other actions have been things that we have done in just operating our business in order to try to make the kinds of strategic decisions that are required.

  • And so they have had different effects in different quarters.

  • And what we are seeing, and it's very consistent with what we had expected, that during the second quarter, our annual merit increases take effect at the beginning of February.

  • So that's the beginning of second quarter.

  • And as you know, merit increases typically are in -- somewhere in the mid-single-digit range.

  • And then on top of that, there's benefits, and we are earning more profits, and so that does trigger some more bonus payments.

  • So the 2% increase that we're seeing in the second quarter in our plan is a second-quarter phenomenon, I think is the way to describe it, because it happens each year in the second quarter.

  • That typically is a quarter that seasonally is a strong quarter for us.

  • So the salary increases are timed for that.

  • But the 2% salary increases -- expense increase that we are planning is less than half of what the salary cost will go up.

  • Sumit Dhanda - Analyst

  • I guess another way of asking this, then, is as you look past the April quarter into the July quarter, does it make sense to assume that the rate of operating expenses [technical difficulty] so dramatically, even [technical difficulty]?

  • Joe McDonough - VP-Finance and CFO

  • I think for purposes of planning, what we are trying to do is to hold the operating expenses very flat going forward through the balance of year.

  • There will probably be some slight increase.

  • We are planning for a good year, revenue growth and profit growth.

  • So there will be some slight increase of those expenses.

  • But we are trying to hold them to a very low rate.

  • Sumit Dhanda - Analyst

  • Also, with the -- I guess with the divestiture of the DSL business, any benefits there that you could talk about --?

  • Joe McDonough - VP-Finance and CFO

  • Yes, those expenses are already factored in -- those benefits are factored into the second-quarter plan.

  • That transaction is likely to close very soon.

  • Sumit Dhanda - Analyst

  • And that's a full -- almost a full quarter worth of benefits?

  • Joe McDonough - VP-Finance and CFO

  • Not quite, but almost.

  • Yes.

  • Sumit Dhanda - Analyst

  • And then one final question -- could you tell us what the backlog did [technical difficulty]?

  • Joe McDonough - VP-Finance and CFO

  • What we have indicated is that the bookings were 7% above the revenues for the quarter.

  • The bookings were up 7% quarter to quarter.

  • Sumit Dhanda - Analyst

  • So was the backlog up sequentially?

  • Joe McDonough - VP-Finance and CFO

  • The backlog was up quite a bit going into next quarter as well.

  • And that primarily is in the distribution channel, as the distributors have placed quite a few orders on us.

  • As you know, we only recognize revenue when the distributors sell the product out to their customers.

  • So the backlog that we have is simply orders from them to us.

  • Sumit Dhanda - Analyst

  • And so does the effective turns number [technical difficulty]?

  • Joe McDonough - VP-Finance and CFO

  • I'm sorry -- I couldn't hear you.

  • Sumit Dhanda - Analyst

  • The effective turns required to [technical difficulty]?

  • Joe McDonough - VP-Finance and CFO

  • Turns -- the turns business for next quarter.

  • This quarter, it was a little less than 50%, so a little bit less than last quarter.

  • And next quarter, we need somewhere in the mid 40% range of turns.

  • Operator

  • Romit Shah, Lehman Brothers.

  • Romit Shah - Analyst

  • Nice job on the margins.

  • Jerry, ADI's outlook for the analog business look like it's in line with just what we've seen historically for the April quarter.

  • Can you just us give us a sense, looking at bookings and backlog, do you think the current momentum is sustainable, and in terms of seasonality, should we think about the April quarter being the strongest sequential growth quarter for the year?

  • Jerry Fishman - President and CEO

  • Well, I think -- it is always hard to say, because now in our analog business, we have a lot of consumer products as well -- cameras and TVs.

  • Typically, the strongest industrial quarter for us is the second quarter.

  • No doubt, that has been the case for many, many years, partly because we have more days of sales in distribution.

  • And that's just the way the patterns are.

  • So to the extent that the mix of business is the way it used to be, the second quarter is usually a very strong quarter.

  • I think now we have, like I said, other types of products, which changes that a little.

  • But typically, even with that, the second quarter usually is a very strong sequential revenue quarter for the analog business, third quarter a little less.

  • So in the fourth quarter, a little less so than that, and the first quarter is usually our weakest quarter in the analog business because we basically lose two weeks of distribution sales during the Christmas period.

  • So I think the fact that the analog business was up sequentially, the orderbook on the analog side is very strong -- all the signals we are getting from the customers in the analog business are good.

  • So I think that continues to make us believe that the analog business is going to go up.

  • Clearly, the aggregate guidance for next quarter is tempered a little bit by losing almost $12 million sequentially on the DSP side.

  • But other than that, it looks like a very typical Q2 for us.

  • Romit Shah - Analyst

  • My follow-up is I was a little surprised to hear your power management business was down last year.

  • Could you just discuss what you're doing to turn that business around and what your outlook is for the power management business in 2006?

  • Jerry Fishman - President and CEO

  • Well, there were two basic reasons why it was down.

  • One is we had a lot of power management sales in the same quarter last year that were stand-alone products that we sold into cellphones along our baseband.

  • Right after the first quarter of last year, we integrated that power management onto the analog baseband.

  • So we sort of -- those sales go out of power management into the analog baseband sales.

  • The second thing that has gone on is that there has been a very -- there's been a lot of price pressure on the desktop power management products.

  • I think everybody knows that.

  • And so even though you've got some unit growth, it sort of hurts you on the topline.

  • And the last thing is that sort of did not offset the -- we have a much, much stronger portable mobile power business than we did a year ago.

  • But it just takes a little bit more time for those revenues to start to ramp.

  • So I would say that one of the real upsides that we are counting on for this year in our analog business is much better performance out of our portable products.

  • And I think we will see how that goes.

  • You can never guarantee it.

  • But a lot of that stuff is based on a lot of good design-ins with a lot of portable customers.

  • So that's sort of the summary as I see it.

  • Operator

  • David Wu, Global Crown Capital.

  • David Wu - Analyst

  • I want to clarify one thing, and that is you did not mention anything about the leadtimes.

  • Given the tightness in the back end, how have you managed to hold your leadtimes exiting Q1?

  • And the fact that you already had 60% gross margin by the second quarter, what should I think about it long term in terms of the margin model that you initiated or discussed a few quarters back in terms of either R&D percentage of revenue or operating margin?

  • Jerry Fishman - President and CEO

  • That's about four questions in there, David.

  • I think, first of all, the fact that business got better in Q2 was not a great surprise to us.

  • All around analog, we said during the last cycle that we're going to try to position the inventory so that when business picks up, you don't extend the leadtimes.

  • And I think we've generally been successful in doing that.

  • I think we always have to be careful in our analog business when a fair percentage of that goes through distribution that the distributors don't jerk around the factories, and therefore wind up building a lot of inventory and screwing around with the leadtimes.

  • So we very carefully controlled what happens in the distribution channel, I think a lot better than we did in previous cycles.

  • So we are working hard to do that.

  • Like I said, the main reason the inventories are up this quarter was mostly related to external wafers that our guys decided to purchase a little bit ahead because they were concerned about some of the back-end capacity issues that I think have been well reported in the industry.

  • I believe that the fact that we got to 60% on $621 million of revenues is a good sign.

  • Joe McDonough - VP-Finance and CFO

  • Jerry, we're getting there next quarter.

  • Jerry Fishman - President and CEO

  • Next quarter -- 600, whatever it is -- sorry, Joe.

  • Good thing I have Joe here on my left to keep me honest.

  • And I think the last time we got up there, we were well over $700 million worth.

  • So far so good.

  • David Wu - Analyst

  • So if you hit $700 million, what should I -- sometime in the future, what should we look forward to in terms of gross quarter operating margin?

  • Jerry Fishman - President and CEO

  • I think if you tell us the mix, we could tell you the gross margin.

  • As you know, the business is highly -- the gross margins quarter to quarter are highly dependent on the mix.

  • So I think we will just have to look at that quarter by quarter.

  • I think what we have seen here is a good sign.

  • Starting next year, we have some good momentum based on this fab closing down, which is worth not insignificant amounts of gross margins.

  • I think we said there’s 40, $45 million of cost savings when those fabs are going down.

  • So I think we'll just have to wait and see how that materializes over the next couple of quarters as we better understand what the product --

  • David Wu - Analyst

  • [multiple speakers] basically is holding pretty constant relative to last quarter?

  • Joe McDonough - VP-Finance and CFO

  • David, what was the first part of that comment?

  • David Wu - Analyst

  • The leadtimes are holding pretty constant relative to the previous quarter.

  • Joe McDonough - VP-Finance and CFO

  • As Jerry mentioned, you have to look across the product portfolios.

  • There are some products that have been affected by the back-end situation.

  • And therefore, leadtimes of those products have stretched out.

  • There are other products that we have kept in stock, and the leadtimes are still good, and we are trying to -- our objective continues to be to keep the leadtimes short.

  • And so we are starting next -- this quarter.

  • We purchased some external wafers, as Jerry said, beyond what we had originally planned.

  • Those wafers are going to move their way through the back end and into finished goods in order to try to address some of the leadtime issues.

  • So we are trying to hold the leadtimes down.

  • I don't think there's any question, as Jerry said, that the orders the distributors have placed on us this quarter are probably larger than the appetite that they're currently seeing from their customers.

  • But recognizing the situation with the tight back end, they want to be in a position to supply their customers when their customers' demand arises, and they probably believe that's during the second quarter.

  • Jerry Fishman - President and CEO

  • I think, Dave, the other way to think about it is we talked about it a lot in the last cycle, how the distribution channel got out of control on us, where they stuffed us out with orders.

  • We extended all the general leadtimes.

  • And that resulted in a lot of double and triple ordering.

  • This time in the cycle -- eventually you've got to learn something -- and this time in the cycle, we are working hard not to let that happen.

  • Operator

  • Louis Gerhardy, Morgan Stanley.

  • Louis Gerhardy - Analyst

  • Nice job with margins.

  • On the last call, with regards to divestitures, you mentioned when, not if, and you followed through with a DSL move.

  • I'm just wondering what's your answer to the question this time -- this quarter?

  • Jerry Fishman - President and CEO

  • Well, I think the answer is that we are continuing to try to focus our business toward the highest profit opportunities in DSP, particularly the [R&D vehicles] in that business.

  • And we look at that constantly.

  • And as we decide that a business no longer meets our model or is not well-placed for the future, we will take action on those.

  • And that's about all I should say.

  • Louis Gerhardy - Analyst

  • And then just thinking about the DSL business, now that you've divested it, but you are going to stay in the ASE and line-driver area, have you seen any signs yet that now that you are not competing with some of the other chipset companies out there that the opportunity for your line-drivers analog front ends has become that much larger?

  • Jerry Fishman - President and CEO

  • Well, that is certainly the message I have given our sales force.

  • We will see how that plays out.

  • But certainly, conceptually, that's been an issue that might help us, but we'll have to wait and see how that really turns out.

  • Louis Gerhardy - Analyst

  • And then just in power management, can you just talk about maybe from a product point of view or just an end market perspective what some of the areas you think you'll see the best growth in over the next couple of years?

  • Jerry Fishman - President and CEO

  • Well, again, it's always hard to predict that long in advance.

  • But there's really two parts of the power management business for us.

  • One is sort of the vertical part.

  • The other is the sort of horizontal part.

  • In the vertical part, in a lot of product areas where we have a large part of the content, like phones and TVs and a bunch of other products, even handsets to some degree, where we control a lot of the bill of materials, the fact that our customers have gone to competitors for those kinds of solutions is not their first choice of what to do.

  • Now, all our customers would like to buy that stuff and certainly put us on their integration path of integrating a lot of that stuff onto some of the mainstream products that we already sell them.

  • So I think part of our business will naturally gravitate towards vertical markets where we have a very, very strong presence.

  • There's another part of the power business which is more generic in nature, where you can start off with what we would call sort of standard power cells or standard power products.

  • And everybody wants something a little bit different, but we modify or in some cases just sell standard products to -- and that's another part of our strategy.

  • So it's really a dual strategy.

  • The longest leadtime for us has been to get sort of the cores done so that we can rapidly adapt those cores to applications as they develop.

  • We have been investing a lot in this business.

  • We've brought in some tremendous people to help us do that.

  • There will probably be others in the future.

  • So I think that we are building some momentum there.

  • You know, it is the largest segment in the analog business that we are underpenetrated in.

  • I believe it is one of the better opportunities for analog going forward.

  • It is all upside for us, and we are working hard to gain some of that.

  • Operator

  • Tore Svanberg, Piper Jaffray.

  • Tore Svanberg - Analyst

  • Just to clarify -- when you gave us those breakdowns earlier, analog being 82%, that included the ASIC business and the DSP business, correct?

  • Joe McDonough - VP-Finance and CFO

  • Yes.

  • Jerry Fishman - President and CEO

  • I'm sorry?

  • Joe McDonough - VP-Finance and CFO

  • Yes, it did.

  • Tore Svanberg - Analyst

  • So theoretically, then, that 82% should go up next quarter.

  • Joe McDonough - VP-Finance and CFO

  • Yes, there is some portion of that business that is actually analog, but most of it is DSP.

  • Tore Svanberg - Analyst

  • And if I could just look at your capacity now, external versus internal, including some of the restructuring that you've done, when it's all said and done, what will that look like, external versus internal, on the front-end side?

  • Joe McDonough - VP-Finance and CFO

  • It shouldn't look very different in terms of -- right now in this quarter, the sales that we have were derived approximately -- I think it is 57% of the sales this quarter were produced in our internal fabs.

  • And approximately 43% were produced externally through our fab -- wafer fab partners.

  • So the amount each quarter that is produced internal or external is driven by the demand for our product, not by the capacity we have.

  • When we finish the closure of the fab, we still will have plenty of internal capacity easily, which can easily double and probably even triple our sales with very small incremental capital expenditures.

  • So there's not a capacity question with respect to the actions that we are taking.

  • The reason for closing the fab is simply to reduce the overall cost structure of our internal manufacturing organization.

  • Tore Svanberg - Analyst

  • Very well.

  • And just looking at next quarter, I think you mentioned 60% gross margin on slightly higher utilization.

  • What number should we look at for that?

  • Joe McDonough - VP-Finance and CFO

  • I don't have the exact utilization for next quarter.

  • That's a combination of all our different factories.

  • It's slightly higher.

  • The 60% gross margin, as you know, has been our goal for a long time.

  • And we have been taking a lot of actions over a long period of time that have been aimed at getting ourselves in a position where we could achieve a 60% gross margin and be able to still have this mix of business where we have, obviously, some products that earn less than 60%.

  • Some products earn more.

  • The variable margin, obviously, on the products we produce internally is very high.

  • The variable margin on the products we produce at wafer fabs -- that cost is all a variable margin.

  • So as Jerry said, the gross margin going forward is mostly dependent on mix.

  • But we have quite a few things in terms of just continued utilization of the internal fabs that help to improve the margin.

  • Closing the fab next year will help to improve the margin.

  • On the other hand, the growth of some of these businesses that have the very high volume opportunities are often built at external foundries and the gross margins we earn are typically a little bit less than the overall Company average.

  • So our gross margin going forward -- we think if we can run a business that consistently produces a 60 or slightly better gross margin, that is a great business.

  • Operator

  • Seogju Lee, Goldman Sachs.

  • Seogju Lee - Analyst

  • Just a follow-up on gross margin.

  • Just to clarify -- in terms of it reaching 60% in Q2, you're talking excluding ESO, just to clarify?

  • Joe McDonough - VP-Finance and CFO

  • I'm sorry, we are talking on the same basis that Jerry has been discussing it.

  • It does not include the expenses associated with restructuring or stock options.

  • Jerry Fishman - President and CEO

  • (indiscernible) is we have 59.2 this quarter.

  • Seogju Lee - Analyst

  • And then if I think about that in terms of the benefits associated with the disposal of the DSL and the ASIC business, how should I think about what the incremental benefit on the gross margin is, associated with that?

  • Jerry Fishman - President and CEO

  • I think it's important to remember that's only 2% of our sales.

  • Joe McDonough - VP-Finance and CFO

  • It is all in the guidance we are giving.

  • Jerry Fishman - President and CEO

  • It's in the guidance we are giving and it helps us a little bit at the margin, certainly, but it is only 2% of our sales.

  • So, you know, you need a -- it does not move the needle on a -- when you're shipping $600 some odd million, very much.

  • But certainly, it moves it in the right direction.

  • Seogju Lee - Analyst

  • And then just one last question -- in terms of the cash on the balance sheet, just if you could update us in terms of your strategy there?

  • Thanks and good luck.

  • Jerry Fishman - President and CEO

  • Well, last quarter, we basically took all the free cash flow and 25% of it went back in dividends and 75% of it went to stock purchases -- we purchased roughly $125 million worth of stock last quarter.

  • We are constantly reviewing our cash situation to see what the right mix of returning cash to our shareholders are.

  • But that's what we did last quarter.

  • We'll have to update you on how we think about that in the future.

  • Operator

  • Tom Thornhill, UBS.

  • Tom Thornhill - Analyst

  • Jerry, on gross margins, again, congratulations on that.

  • But if we're getting close to 60 here, if mix stays the same and you get the benefit of the California fab, my conclusion would be '07 would be somewhere in the low 60s on this basis.

  • Is that -- am I headed in the right direction?

  • Jerry Fishman - President and CEO

  • Well, there are so many variables there, but directionally, as we said, the fab closure in California is worth quite a bit of money.

  • And it translates into not insignificant amounts of gross margin.

  • So I would say that as prices hold and the world treats us right and everything goes the right way, we'll get the benefit of that as soon as we close the fab.

  • Tom Thornhill - Analyst

  • And is that coming through in changes in depreciation?

  • Or is it largely in the out-of-pocket direct expenses associated with operating the fab?

  • Joe McDonough - VP-Finance and CFO

  • It's largely the operating costs.

  • But let me just come back to this mix question.

  • The mix really has two different elements to it.

  • One is the portion of product that we manufacture internally or externally.

  • So, for instance, a converter that is used in the front end of a digital camera is typically manufactured at a foundry because it is a digital CMOS process --

  • Jerry Fishman - President and CEO

  • Fine line.

  • Joe McDonough - VP-Finance and CFO

  • Fine line digital CMOS.

  • So that kind of product typically has pretty good margins.

  • But on the other hand, the variable margin for that is a lot lower than the converter that we manufacture in our internal fabs, where the costs are mostly fixed; it is very little variable cost.

  • So that has a big difference, which one of those two products we sell.

  • Jerry Fishman - President and CEO

  • Even though they are both analog.

  • Joe McDonough - VP-Finance and CFO

  • They are both analog products.

  • They are great products.

  • They are leadership technologies.

  • Now, there is also other products, and this is where we are making some of the strategic decisions, that the gross margins have been lower than what we would -- the businesses that we would like to be in.

  • And those kinds of products tend to be in some of these very competitive vertical markets.

  • And they can influence the gross margin quite a bit.

  • So the assumption that the mix stays the same is probably the only assumption that is not the right one to be making as we go forward.

  • If we look at next quarter, some of the factors that influence the gross margin and getting to the 60% next quarter are the utilization rate will go up a bit.

  • The broadband business -- those products did have a lower gross margin, so that certainly helps the gross margin.

  • But on the other hand, we are looking for a resumption of growth in some of the consumer products and other products that the sales have been lower this quarter.

  • Those products are manufactured externally and have a slightly lower gross margin than the overall average.

  • So that brings it down a bit.

  • So we put the plan together.

  • We have a loading plan for the factories.

  • We have a sales plan.

  • We put it all together and look at it.

  • And it looks to us like a 60% gross margin plan.

  • And that is what leads us to say that it looks like next quarter, we believe we can accomplish the goal that we have achieved.

  • Looking out to a year from that now, it's very difficult because the mix of the business really does become the prominent driver.

  • On the other hand, looking out at the business that we are in and the opportunities we have, we believe we can continue to operate the business with a very strong gross margin.

  • Jerry Fishman - President and CEO

  • So I think the summary of all those comments is the mix is very dependent.

  • We've done a lot of things within the business to put generic gross margin upward pressure in the business because we think that the opportunity is there; we are committed to do it.

  • That's the reason we decided to close our fab in California.

  • How it all goes through, how much is consumer versus industrial, which is essentially what Joe was saying, how much is this or that -- there's very attractive businesses for us at a very high volume that might run 55% gross margin in some cases.

  • Our strategy is we think those are great businesses.

  • We're going to stay in them and we're going to try to increase those businesses.

  • So it really does depend on what the mix of business that we have, and we are taking actions that, if the mix holds, will help our gross margins.

  • And if the mix goes against us, defensively we'll have some sort of stuff that helps us on the defensive side.

  • And each quarter, we will try to update you on sort of what the mix is and what our expectations are.

  • But we sell 10,000 products to 60,000 customers in six major vertical markets, at least, and trying to get real specific about that within a point or two on gross margins, looking out a year, is very, very challenging.

  • I think the takeaway, really, Tom, is that we are doing things to fundamentally reduce the cost structure of the Company.

  • Some of those are pretty significant things.

  • We are doing that both for offensive and defensive reasons.

  • We hope the offensive part comes true.

  • But we've got to be prepared that if -- with the business that we have, that 55 or 58 or 56% gross margin really starts increasing, we're certainly not going to walk away from that business because it is below 60.

  • I think that's the way --

  • Tom Thornhill - Analyst

  • [multiple speakers] judge your businesses as to where you want to put focus as you look at your operating model, is the primary metrics at which you make decisions about where to place focus or emphasis, is it gross margin?

  • Is it operating margin?

  • Is it operating profit dollars?

  • Jerry Fishman - President and CEO

  • Our take is what investors want us to do is grow our earnings per share.

  • That has always been the case.

  • That's what creates momentum in the earnings and that's what creates momentum, I think, in our stock price.

  • So our fundamental assumption is that if we grow our earnings per share at a very rapid rate, everybody would be very, very happy.

  • Now, I think we do look at gross margins, because I believe that to some degree, gross margins are an indication of the quality of your technology.

  • So I think it's a very complicated formula.

  • We don't have something that says we will never invest in a product that we don't think we can get 60 points of gross margin on.

  • On the other hand, we say to ourselves we have a great business and generating a lot of momentum and earnings per share is our strategy.

  • So we'll have to deal with that as well.

  • So it's really not any one thing.

  • It's really what we are really trying to do is have momentum in our earnings per share, subject to the fact that gross margins are an indication of the quality of your technology.

  • So that's the best I can tell you.

  • That's the way we think about it when we look at R&D decisions.

  • We are not maniacal about it; we don't have any sort of number that says if it is 56, we don't do it; if it's 58, we do.

  • Or if it is 62, it is great, and if it's 60.5, it is not.

  • But all those are just considerations we look at and when we think about how do we get momentum in earnings per share.

  • Operator

  • Craig Ellis, Citigroup.

  • Craig Ellis - Analyst

  • Jerry, I wanted to take just a little bit longer-term view here and look at the revenue growth side of the story.

  • If we were to look out into 2006, and into 2007, you mentioned when you talked about this year being a good year, traditional analog, the general-purpose DSP (inaudible), and then some new growth drivers like micromachine and motion-sensing products -- can you focus in on those latter two categories, general-purpose DSP and some of your new growth drivers, and talk about how those might grow over the next two years?

  • Jerry Fishman - President and CEO

  • Well, again, you are asking for my opinion, I guess, because of course, nobody knows.

  • But I think the momentum we have in the general-purpose DSP market, I believe that that will present an opportunity for above-average growth for us over the next couple of years.

  • Was the second one the micromachine stuff?

  • I think the micromachine product, given the fact that most of those product sales over the years have been in automobiles, I think now that we are in some of the consumer applications, in some communications applications, I believe that business has the potential to outgrow the average as well.

  • So we've got a couple of things out there that could do that.

  • There are other areas that -- who knows?

  • We'll have to wait and see how that happens.

  • But certainly, those two that you mentioned ought to be accretive to our growth rate.

  • On the other hand, they are not very big businesses right now.

  • So you shouldn't get too carried away with that.

  • You know, I think another one that should grow at more than our growth rate is our power management business.

  • We've taken a lot of steps.

  • We're spending a lot of money.

  • We've got some great people in that business.

  • So I would be disappointed if we could not do above the market on that.

  • So that is where we sit.

  • Craig Ellis - Analyst

  • So is it fair to summarize that very strong traditional analog business with growth engines in power management, general-purchase DSP and things like micromachines?

  • Jerry Fishman - President and CEO

  • Yes, I think that is exactly right.

  • Our position in converters and amplifiers is very strong.

  • But when you have 40-some-odd-percent of the converter market and 45% of the high-performance amplifier market, it's hard to get a lot of growth out of share gains.

  • So what you've got to do is basically assume you're going to grow in line with the market on that stuff.

  • And you've got to assume that other stuff is going to grow a little bit faster.

  • That is basically what happened in the first quarter.

  • We said that the other analog category was the fastest-growing category in our analog business.

  • And that's sort of representative of the point that I'm trying to make.

  • Operator

  • William Conroy, Sanders Morris.

  • William Conroy - Analyst

  • Jerry, I was hoping you could give us a little bit more detail on the power business and specifically as you look out, and in your opinion, when do you think we get sort of the crossover or a return to net growth between what's going on in your PC power management business and what's going on on the portable side?

  • Jerry Fishman - President and CEO

  • Well, I can just say our plan is for that to happen in the second half of the year.

  • William Conroy - Analyst

  • And are the applications on the portable side similar to what you have been doing on the PC?

  • Jerry Fishman - President and CEO

  • A lot of our sales on PC so far have been on the desktop.

  • So a lot of the fundamental technology is not very different.

  • But when you are building a power port for a portable instrument, it is a very different challenge than building one on a desktop.

  • So a lot of the base technology is the same, but the applications are very different than the requirement, and the functionality -- I mean, even if you look inside a laptop, there's probably five times the power management available market as on a desktop.

  • And a lot of them are different products.

  • Some of the core technology is the same, but the products are very different.

  • William Conroy - Analyst

  • And as a follow-on, although I'm changing gears on you, can you talk a little bit about the DSC market?

  • How is that treating you?

  • Is it still as robust as it was?

  • Has it turned down?

  • Kind of just give us an update on digital still camera.

  • Jerry Fishman - President and CEO

  • Digital still camera sales are doing very well for us.

  • We have very high market share with the largest companies.

  • It is interesting, the smaller companies selling digital still cameras are starting to consolidate, as you might expect.

  • Fortunately, in the camera business, we have the highest market share with the largest customers.

  • So that business continues to do well for us.

  • Our goal in the camera business is to get just more of the content beyond the analog front end, which is primarily what we've been supplying them.

  • So there's a lot of other functions in cameras -- there's power functions, there's display functions, there's lens driver, there's the things that control some of the lens characteristic.

  • There might actually be some micromachine products in those in the future.

  • So our basic goal is to sort of hold our share on the front end and build content on all the other functions in the camera business.

  • So I think if we execute, we have a very good chance of doing that.

  • In the general-purpose DSP business, for those -- I know Maria and Joe reported that there were a lot of sell-side analysts at our booth in Las Vegas.

  • And I think Joe and Maria met with many of you.

  • And I think you could see firsthand of the multitude of different products that are using some of our newest DSP cores.

  • And it's been a struggle because it's taken a long time for those products to get into production.

  • But I think when you see the real products and you see the takeup of those types of products, I think there's every reason to be optimistic.

  • And many of those newer cores that are going into many of those applications have pretty good profit characteristics.

  • So it's always hard to predict the exact buildup.

  • But that's what we have been betting on in the DSP business.

  • And by God, that bet's going to pay off one of these days, soon, I hope.

  • Operator

  • Michael McConnell, Pacific Crest Securities.

  • Michael McConnell - Analyst

  • I wanted to just get some more clarity with respect to the trends near term.

  • You were saying -- you had said that computer sales were very strong.

  • I guess I'd like to understand -- does that mean that direct sales were a little bit weaker than you were expecting?

  • Or was the fact that orders were up 7% -- I guess I'm trying to figure out why we're not getting a little bit stronger guidance with respect to April [technical difficulty]?

  • Jerry Fishman - President and CEO

  • Well, I think the sales came out pretty much the way we had thought.

  • We thought they were going to be about flat.

  • They turned out to be about flat.

  • Perhaps if we didn't get bogged down at the back end, we would've gotten a few million dollars more.

  • But it wasn't a significant factor in our sales.

  • So our sales were about where we thought.

  • The industrial stuff and the communications stuff were great.

  • The computer stuff and the consumer stuff, as is typical in our quarter, was down sequentially.

  • In the consumer business, when we look at our backlog going into Q2, it's good.

  • So that's why we are enthusiastic about that business going forward.

  • So I think the way you've really got to look at our guidance is that we are 2% off on that, just due to the fact that we're not going to have the business that we had last quarter in the DSL business.

  • That's about 2% of growth.

  • If you sort of add that on to what our guidance is, it's pretty good guidance for Q2, indicating that it looks like we think business is pretty good and we're going to have a good quarter.

  • Michael McConnell - Analyst

  • And just a quick one just on the model -- tax rate and income expectations for April?

  • Joe McDonough - VP-Finance and CFO

  • The tax rate, our plan is in the 22, 23% range for the tax rate.

  • And the non-operating income next quarter is in the $24 million range.

  • Operator

  • Michael Masdea, Credit Suisse First Boston.

  • Michael Masdea - Analyst

  • There's just one question.

  • Joe, or either one of you, actually -- last year, you guys talked about some changes in the way the customers are managing the supply chain with some move to a more forecast-based set of systems.

  • And then we heard from Cisco this week talk about trying to drive a leaner supply chain.

  • Is there changes you're seeing in that whole supply chain/order management that we should be aware of, or anything that seems different to you or could be different going forward?

  • Jerry Fishman - President and CEO

  • I missed the -- could you repeat the Cisco comment?

  • Michael Masdea - Analyst

  • Yes, Cisco was talking about driving basically towards a leaner, meaner supply chain than they have in the past and making some structural changes.

  • Joe McDonough - VP-Finance and CFO

  • Does that mean fewer vendors?

  • Jerry Fishman - President and CEO

  • I think that means less inventory for them and more for us.

  • I think that's what it means, Joe.

  • Yes, I mean, I think everybody's trying to push the inventory to everybody.

  • I don't think that has changed.

  • When business is in different phases, the power shifts on that.

  • But I don't think it is significant for us, Michael.

  • I think that we try to keep very good track of what's going on with the distributors.

  • We try to keep very good track of what's going on with your subcontractors, who -- yet another inventory point.

  • Everybody’s learned a lot about how to do that.

  • We're trying to reflect that learning in how we manage both of those channels.

  • So -- but to be direct in response to your question, we don't see much of an impact on that from companies like Cisco.

  • I think it's clear -- the large companies don't want to carry any inventory.

  • I mean, that's their definition of supply change chain management.

  • On the other hand, they want it available with no leadtime.

  • So, welcome to the semiconductor industry.

  • Michael Masdea - Analyst

  • And when you think about that from a cyclical perspective, does that increase the inventory beta for this industry, or does it decrease it, now that -- ?

  • Jerry Fishman - President and CEO

  • Well, I think what you really have to do is really work on your cycle times because it is clear that customers don't want to order up in advance.

  • And yet, they have demands, because they can't forecast their business at all compared to any other business that can't forecast it.

  • So I think what we have to do is be able to have a situation where we have good die banks, which is a low-cost inventory point.

  • For most of our products, there's not a lot of obsolescence risk because the lifecycles are so long.

  • And we are quite willing to take risks on building some die bank, because the inventory doesn't go bad.

  • For the products that have very short lifetimes, there's always a battle on that.

  • In one sense, we know the customers want them quickly.

  • On the other sense, we are not willing to take a lot of inventory risk because if we are wrong, we wind up eating the inventory.

  • So we have done, I think, by and large a pretty good job of that.

  • We have not had any real write-offs when the cycle came this time.

  • And our goal is to really balance that and make sure that we don't have those kind of things happen to us.

  • But I tell you, it is a constant battle.

  • The leadtimes are still short.

  • The customers are still ordering with no leadtime.

  • And they are expecting us to be able to deliver.

  • And if you don't, there's always the risk that they will just double and triple order.

  • But I think we are -- we have been at it quite a while.

  • We are a little bit smarter than the last cycle.

  • And we are trying to manage that as carefully as we can.

  • Operator

  • Rohit Pandey, HSBC.

  • Rohit Pandey - Analyst

  • Can you give us some more details on the industrial part of the business?

  • How big was the ATE segment in there, and are you seeing increased demand in that segment during the tight capacity utilization?

  • Jerry Fishman - President and CEO

  • Sure.

  • I would say without going through a ton of numerical detail, that segment comprises what we call real industrial products, which is products like instrumentation, motor control, medical instrumentation, power meters and a bunch of other what we would call practical industrial products.

  • Of the 41%, that's probably 25 of the 41%, roughly.

  • ATE business is about 2 or 3% of our sales.

  • Automotive stuff is about 7%.

  • Military is about 5 or 6%.

  • That all adds up to about 41% of our sales.

  • Now you can't take each of those categories as financial data because a lot of the stuff goes through distribution.

  • Sometimes it is hard to sort of classify exactly what type of product it's going into.

  • So the ATE business was up for us a little bit the last quarter.

  • But it is considerably below where the peak was of the last cycle.

  • And it was a little surprising to us that we didn't see more strength in that, given that there's back end capacity shortages throughout Asia.

  • But if the ATE business is like it has always been in the past, you never see it till it hits you over the head.

  • And typically what happens is for about six months after their demand increases, they are burning off old inventory, and then they come at you like a ton of bricks and want everything yesterday.

  • We have talked to our ATE customers.

  • We let them know that if they want to get some product, they've got to start letting us know.

  • And I am sure they are going to respond that.

  • So I think at the peak our ATE revenues were over 6.5% of our sales.

  • They are below 3% of our sales right now.

  • So I think we've got a long way to go in that business.

  • And we really have not seen massive increases in orders, although the business did grow well sequentially last quarter.

  • Rohit Pandey - Analyst

  • Switching gears, again at the industry level, you and your competitors are actually trying the 60/30 model for achieving it before your timeline, as are your competitors.

  • How much room do you think is there at those kind of margins for analog guys?

  • How many players can be at that kind of margin level?

  • Do you think it should become more competitive or --?

  • Jerry Fishman - President and CEO

  • Well, the analog market has always been a sort of bifurcated market where there's a low end, there's a midrange, there's a high end.

  • I still believe that in the high end, you can earn very good margins.

  • Can you earn on the average 75% or 70%?

  • I think it is harder -- and still get growth.

  • But I think there are many product areas where you can get those margins.

  • There are other product areas where it is harder.

  • Industrial products tend to be the product areas that have the highest gross margins, mainly because of the fragmentation.

  • There's not one big application.

  • There are many applications.

  • If we can deliver a higher-performance product, our customers get more money from their customers by differentiating the product.

  • But mostly, because it is dominated by products -- it is very fragmented products that go into a very fragmented customer base with extremely long lifecycles.

  • I think that's why the gross margins are as high as they are.

  • With the margin, are more people trying to get business?

  • Absolutely.

  • They've been doing that for the last five or 10 years.

  • It is hard to do.

  • And so I don't think you've seen much changes in the competitive landscape going on in the industrial part of the business.

  • You know, there's a lot of swapping around in some of the higher-volume businesses -- there's people in, there's people out, there's new products.

  • So that part, certainly the market shares bounce around a lot more.

  • But I think in the industrial part of the business, where we view is the core franchise of analog, you don't see a lot of shifts in the share.

  • You don't see a lot of differentiation year to year with the customer base.

  • We have a great reputation in that business.

  • We have great products.

  • We have great customers.

  • And I think that is going to continue to be the core franchise of Analog Devices.

  • Rohit Pandey - Analyst

  • So you think that different competitors are approaching the 60/30 model from different end markets?

  • Jerry Fishman - President and CEO

  • I really think you have to ask them.

  • Operator

  • Ross Seymore, Deutsche Bank.

  • Ross Seymore - Analyst

  • One quick question on the inventory side of things.

  • You talked about the distie bookings being the relatively stronger area.

  • If you are more or less ordering ahead -- I won't necessarily call it double ordering -- but ordering ahead nonetheless on the front end because you're worried about the back end and people are doing the same sort of ordering ahead on the back end itself, how do you really avoid the double ordering that is happening on both ends of that spectrum affecting you?

  • Jerry Fishman - President and CEO

  • Well, we work hard to really look at -- the primary place where we really see that more than anything else is in distribution.

  • That's what we see in every cycle.

  • And clearly, if we would supply all the stuff that the distributors want and crank our factories up to do that, clearly there will be a lot more volatility in the business.

  • We try to look at historic order patterns.

  • Look, any time any company that is serving the base of customers that we serve says their backlog is up 12% or 20% or any of those kind of things -- you know that demand hasn't gone up that fast because we've all been doing this for a long time.

  • So what we are trying to do, and the reason that we don't like to put out explosive headlines on order growth or backlog growth or any of these other things that people tend to get very excited about, is because we know what the generic growth rate of this business is.

  • And responding to some of these large perturbations and claiming victory that the world has all of a sudden changed and what was a 15% business is now a 40% business -- that's not how we run Analog.

  • And we try hard not to respond to that.

  • And hopefully, we are going to do that.

  • It is always tempting to respond to that.

  • Every time you see it, you say, by God, the world has changed.

  • And everything is great and we are back to the days of 30 or 40% year-over-year growth -- I don't think that is going to happen.

  • So we work hard not to act like that is going to happen and not run our factories like that is going to happen.

  • And that is what we're trying to do.

  • Will some of our sales growth, if these kind of order trends keep up, be above consumption rate?

  • Probably.

  • But we are working hard to do a better job than the last cycle on that.

  • Ross Seymore - Analyst

  • Then maybe a related question.

  • If you just look at what you believe the distie inventory level is exiting your quarter, how does that on a week's basis or however you want to judge it -- how does that compare to any sort of historical average?

  • Are we at the normal level?

  • Above?

  • Below?

  • Could you give any color on that?

  • Joe McDonough - VP-Finance and CFO

  • Yes, we are well below, because I think the same characteristics that you're talking about, whether we're talking about at our customers, trying to keep the inventory down, or we are trying to improve the cycle times -- the distributors have their own issues with respect to financing the cost of their capital.

  • And so for a long period of time, over the past few years, they have been interested in driving down the levels of inventory.

  • What we have been working on is to try to keep this product available, the leadtimes as short as we possibly can, and we would actually prefer to keep the inventory until the end customer actually needs to consume it.

  • Now that is the real challenge.

  • And it probably never will be achieved.

  • But that is the challenge.

  • There is no benefit, really, to anyone to move the inventory along either to the distributor or to the end customer if it isn't needed in the consumption of their products.

  • All that does is provide some sort of false signal that stimulates some other type of action that didn't have to happen.

  • So we are all working on the solution to that problem.

  • And I think in general, there's a better job being done today than there was a few years ago.

  • But there's still a lot of room for improvement.

  • Jerry Fishman - President and CEO

  • I think Joe has been a real hawk around the Company on this concept, which I think is very atypical in the industry now, that we are a lot better holding the inventory than the distributors because we have a much wider reach.

  • And I think slowly but surely, that's the way the model for the industry's going to get to.

  • It used to be that distributors had inventory in 100 different places.

  • And you get it overnight.

  • Nobody else could ship it overnight.

  • But they ship inventory out of central warehouses.

  • Any customer can get the inventory in the same time from us as they can from a distributor.

  • So that's not a real benefit of a distributor.

  • The distributors have many, many other benefits.

  • But that's certainly not a big advantage.

  • If we can keep the inventory centralized, we can serve a much broader array of customers with lower inventories than putting it out in the distribution channel.

  • We long ago reached the conclusion that a sale to a distributor is not a real sale.

  • So we have no incentive to put inventory in distribution at all.

  • In fact, we have a disincentive to do that.

  • So, I think the world is going to change.

  • Joe is quite right that their cost of capital -- at the margins they make, they shouldn't and can't afford to carry a lot of inventory like in the old days.

  • And I think they are very savvy about that.

  • They're not going to do that.

  • Operator

  • Kevin Rottinghaus, FTN Midwest Research.

  • Kevin Rottinghaus - Analyst

  • On that same topic, I guess maybe what was spurring the question is you talked in the beginning about bookings from distributors picking up because they were ramping up for better sales.

  • I guess if it's not your product, do you think they're building inventory of other people's products?

  • Jerry Fishman - President and CEO

  • Well, I think what I'm saying is that distributors typically have a very strong Q2.

  • The distribution business in general, although we do serve some very large customers through distribution overseas, the distribution business in general is a days business.

  • So if you have X amount of -- you do about the same amount per day all the time.

  • And if you have 10 or 12 less selling days, you have 10 or 12 less selling revenues in those 10 or 12 days.

  • I think historically, since distributors, the largest part of our businesses that distributors serve is our industrial business, they generally have a good February, March and April.

  • They typically build some inventory in advance of that.

  • That's not at all atypical.

  • It's not related to leadtimes.

  • It's not related to any of that stuff.

  • I think last quarter, in the orders they placed on us -- and by the way, I think the orders they placed on everybody else, most likely -- they want to get a little ahead of the waiting.

  • Joe said, and I think he's quite right, that the inventories in distribution are low, and they are a little bit afraid of getting caught.

  • So I don't think for anybody, us or anybody else, you ought to pay a lot of attention to the orders that people are talking about that they're getting if some of those orders are orders distributors are placing on them.

  • I don't think it is a very relevant thing.

  • I know we've seen some of the commentary by competitors -- order rates are up 20%.

  • That's great.

  • The world is back to 2000.

  • Everything is wonderful.

  • I don't believe that, personally.

  • I hope it is true, but I'm not planning for that to happen.

  • On the other hand, I think Q2 the distributors are planning on to be a good quarter.

  • And they are trying to stage inventory to be ready for that.

  • And I think that's no different than we have seen every Q2 in a normal year.

  • Kevin Rottinghaus - Analyst

  • On your guidance on the PC side with notebooks maybe starting to hit their stride in the second half, you talked about some of the complexities, notebooks versus desktop.

  • Is the notebook product portfolio -- is it in line?

  • Are the design wins there for the second half?

  • Are those things that kind of develop in the first half and then start to hit in the second half?

  • Jerry Fishman - President and CEO

  • Well, I never count a design win until we actually ship something.

  • Everybody claims design wins on everything.

  • But I think based on -- when I reviewed that business last time and it was Robbie McAdam who runs our analog business, including our power management business, reviewed it, I mean, there's a lot of reason to believe that we're going to get some momentum in the second half in that business based on design-ins that occur.

  • But like I said, we will wait and see till we ship the products and we can proclaim victory.

  • And then we will proclaim victory.

  • I always am skeptical about everything until we ship it.

  • But I think the product portfolio is a lot stronger.

  • I think the customer base is good.

  • The customers we are supplying to want us to be there.

  • They want our technology.

  • So I think that right now, it's an opportunity for us for the future that is good.

  • That's what I really believe.

  • Kevin Rottinghaus - Analyst

  • And then just a last thing.

  • On the general-purpose DSPs, on the Blackfin design wins, it seems like they've kind of been popping up for the last several quarters.

  • Have those started to move to production?

  • Or do you have better visibility when they will?

  • Or is it just that these are long leadtime design-ins, or--?

  • Jerry Fishman - President and CEO

  • Well, they are certainly long leadtimes, because not only do customers have to buy the chips, they have to -- they do all their own software development for what they do.

  • So it has been longer than we thought.

  • I am very frustrated that it hasn't built faster, as you know.

  • But I think when I look at the list of products that it is in and I look at the customer lists and I look at the diversity of applications that are good applications, they are consumer applications, they are industrial applications, they are automotive applications -- I think you probably saw some of those out at -- if you were out at CES -- I mean, they are going to go into production.

  • And it's hard to call the exact quarter.

  • But I am fairly optimistic about that.

  • And the forecasts our guys have are good.

  • Again, we will proclaim victory when we turn those forecasts into revenues.

  • Kevin Rottinghaus - Analyst

  • That's not necessarily a meaningful driver for the April quarter?

  • Jerry Fishman - President and CEO

  • Well, I think our G-P [DS] sales forecast for the second quarter is good.

  • And I think if we make that, we'll have even more confidence about Q3; so that is the way I'll say it.

  • Maria Tagliaferro - Director of Corporate Communications

  • We actually have a number of people still waiting to ask questions, and we're coming up on quite a few minutes past the hour.

  • So we are just going to take one more question here live.

  • And then please give us a call back here at the office at 781-461-3282 to the rest of the folks who we are not going to get to in the queue today.

  • So operator, can we have the last question?

  • Operator

  • Robert Burleson, ThinkEquity Partners.

  • Robert Burleson - Analyst

  • With handset, can you talk about the performance of your handset business relative to what you would have [technical difficulty]?

  • Jerry Fishman - President and CEO

  • Well, our performance for the handset business relative to our expectations a year ago was lower.

  • We had a great amount of growth in 2005 -- 2004, 2005.

  • We didn't grow the business as fast as our plan was for many, many different reasons.

  • On the other hand, I would say that if you look at some of the product announcements that we've just made, we actually just recently introduced our entire 3G portfolio.

  • That's both for regular 3G, and we think even more importantly, for TD-SCDMA, which is the national standard in China.

  • I have seen reports in the press and I have seen some of the analysts that write on the Chinese market recognize that we have a very strong position in China on TD-SCDMA.

  • And if that standard really goes along the way people are predicting it will, we have a very strong position when that happens.

  • You know, we have had a partnership with Datang, which is widely viewed as the largest IP holder of that standard in China.

  • And we have some very good products that are really making phone calls, not just part of a PowerPoint slide presentation, on that standard.

  • And we are going to be demonstrating many of those things at the GSM conference or the 3G conference next week in Spain.

  • So I think our goal has always been in that market to move up-market to areas that we can really get paid for what we do.

  • I think some of these new product offerings, both for wideband CDMA and the Chinese standard, we believe will help us towards that objective.

  • On the other hand, handsets are 12% of our sales.

  • Almost 40, 45% of that is analog content, not the baseband, which everybody is fixated on.

  • And that part of the business is doing pretty well also.

  • So we are hopeful that with a better mix, we'll have a more stable and hopefully more profitable business, even though that business' profit margins have been reasonably good, even though the sales have been disappointing in that business in the last year.

  • Robert Burleson - Analyst

  • And just quickly on assembly and test, that has been a bottleneck all over the place, not just in the sort of analog and mixed signal space.

  • I'm wondering is there any sort of mounting pressure on the subcontractors there, sort of industrywide to actually increase their capital spending?

  • Jerry Fishman - President and CEO

  • Yes, there's lots of pressure.

  • Subcontractors, many of them, even the large ones, don't have very great capital structures.

  • They got murdered in the recession.

  • And they have been very circumspect about adding capacity as a result.

  • But I think if you listen to some of the comments around the industry and the pressure that suppliers are putting on them to add capacity, they will.

  • They are raising capital.

  • They are increasing their capital spending plans.

  • They are trying to get ahead of this wave before it collapses on their heads.

  • So absolutely.

  • I think most vendors are putting a lot of pressure on them to get moving before it turns into a shortage and all the sort of things that happen when there are shortages.

  • Maria Tagliaferro - Director of Corporate Communications

  • All right.

  • And thank you to everyone for participating on our call today.

  • We will look forward to talking with you again during our second-quarter conference call, which is scheduled for Thursday, May 11, 4:30 PM Eastern Time.

  • Goodbye.

  • Operator

  • This concludes today's Analog Devices conference call.

  • You may now disconnect.