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Operator
Good afternoon.
My name is Ian, and I will be your conference facilitator.
At this time, I would like to welcome everyone to the Analog Devices third-quarter 2006 earnings conference call. (Operator Instructions).
Thank you.
Ms. Tagliaferro, you may begin your conference.
Maria Tagliaferro - Director, Corporate Communications
Hello everyone.
This is Maria Tagliaferro, Director of Corporate Communications here at Analog Devices.
If you don't yet have our third-quarter 2006 release, you can access it by visiting our website at www.analog.com and clicking on the headline displayed on our homepage.
This conference call is also being broadcast live on the Internet.
From analog.com, you can select Investor Relations and follow the instructions there that will take you to the online webcast.
A recording of this call will be available today within about two hours of today's call, and it will remain available via telephone or Internet playback for about one week.
Participating with me today are Jerry Fishman, our President and CEO, and Joe McDonough, VP for Finance and CFO.
We estimate this call including Q&A will take about 60 minutes, but we will be flexible in that regard and stay on as long as we have questions.
We will begin in a moment with comments from Mr. Fishman.
In the remainder of our time, we will be devoted to answering questions from our analyst participants. (Operator Instructions).
There is an important announcement that I would like to make today.
The financial results for the third quarter fiscal year 2006 being discussed today have been reported in our press release, which is found on the website at analog.com.
The results reported are in accordance with GAAP and include approximately $19 million of stock option expense, expenses of approximately $5.7 million associated with previously-announced restructuring actions that are related to the closure of our California wafer fab, expenses of approximately $6.2 million associated with previously-announced acquisition-related actions and tax benefits of approximately $16.8 million.
In order to help investors compare current results to our historical results and thereby better understand the underlying trends in our business and our ongoing operating results, our comments during today's call will at times make reference to non-GAAP results, which exclude these items.
We have included in our press release details of the stock option expense, restructuring and acquisition-related items for all quarters from the fourth quarter of fiscal 2005 through the third quarter of fiscal 2006 and estimates for the fourth quarter of fiscal 2006 -- fourth quarter of fiscal 2006.
Investors can download that information in spreadsheet form from the Investor Relations page of our website.
In addition, please note that the information we are about to discuss includes forward-looking statements for purposes of the Safe Harbor provision under the Securities Litigation Reform Act of 1995.
Such statements include risks and uncertainties.
The Company's actual results could differ materially from those discussed herein.
Factors that could contribute to such differences include but are not limited to those items noted and included in the Company's SEC filings, including our most recent quarterly report on Form 10-Q.
The forward-looking information that is provided by the Company in this call represents the Company's outlook as of today, and we do not undertake any obligation to update the forward-looking statements made by (technical difficulty).
Subsequent events and developments may cause the Company's outlook to change.
Therefore, the conference call will include time-sensitive information (technical difficulty) of this live broadcast, which is August 10, 2006.
With that, let's begin with the opening remarks from Mr. Fishman.
Jerry Fishman - President, CEO
Good afternoon to everybody.
During Q3, there were many moving parts that impacted our GAAP results.
During the quarter, we announced two acquisitions.
We are absorbing costs related to previously-announced restructuring moves.
We finalized the tax settlement with the IRS.
We are absorbing charges of course related to stock option expense.
So as Maria said, we've included a supplemental table with our press release, describing the details of all those items for Q3 and we've also provided forecast of these items as far as we know as of today for Q4.
At the same time, we have many moving parts in our overall business.
So I'm going to concentrate my comments -- my opening comments this afternoon on ADI's business strengths.
As noted in the press release, our revenues were about $654 million, which was up 14% from the same period last year and up about 3% sequentially.
Our converter, amplifier and general-purpose DSP product sales to industrial, consumer and communications infrastructure customers were up sequentially essentially on the plan we had when we began the quarter.
Sales to our wireless handset customers were approximately flat to Q2 levels, while our sales to computer customers declined slightly from the second quarter, both the wireless handset and the computer sales results being relatively flat were below the original plan we had for Q3.
We experienced continuing strong performance from our diverse base of instrumentation, measurement and medical equipment customers.
Automotive revenues also increased slightly sequentially.
Automatic test equipment revenues, which were also part of the broad category of industrial products, declined from Q2 levels as one of our large customers had a major order cancellation by a significant semiconductor manufacturer whose business strategy changed during the past quarter and therefore didn't need that tester.
In aggregate, sales to our broad base of industrial customers, which includes industrial, instrumentation, semiconductor, test equipment, automotive and defense electronics, increased 16% year over year and also 3% sequentially.
Overall in Q3, our sales to industrial customers were approximately 42% of our overall sales, which is very similar to last quarter.
Our sales to communications customers grew 26% year over year and were up 6% sequentially and represented approximately 30% of our total sales.
Within communications, our sales to our wireless base station and networking customers were particularly strong sequentially.
As I mentioned earlier, our sales to wireless handset manufacturers, which represented approximately 12% of our sales in Q3 were flat on a sequential basis and up year over year.
Our base station business, which today represents approximately 11% of our sales were up 13% sequentially and 28% year over year.
Our sales to consumer customers grew 14% year over year and 3% sequentially.
Strong sequential growth in advanced TV and audio products was driven by LCD and plasma TV applications, where ADI supplies a wide array of analog components and also home A/V components where ADI's SHARC DSP has become a de facto industry standard.
Our sales to digital camera customers declined sequentially in line with normal seasonal trends and also in line with our plan but grew on a year-over-year basis.
Our market position remains very strong with leading camera manufacturers as we increase the content that ADI can supply to the newer models of the largest camera companies.
And as a result, we expect a strong seasonal recovery in our digital camera products in Q4.
Consumer customers represented 17% of total sales in Q3, similar to last quarter.
Computer applications represented approximately 11% of our sales in Q3.
Our revenues from computer customers actually declined slightly sequentially in Q3.
General weakness in the computer market coupled with product transitions within ADI's audio and power management product lines were the primary causes of lower-than-expected growth to these customers in Q3.
I will tell you a little bit more about the power management products a little bit later in my comments.
Now, I will move over to talk briefly about our revenues by the product groupings.
During Q3, our analog product sales grew 15% year over year and were up 4% sequentially.
Within the overall analog category, converters were up 12% year over year and 4% sequentially.
Amplifiers were up 20% year over year and 5% sequentially.
In combination, converter and amplifier products comprised 64% of our total sales, and the most recent market share data again indicates that ADI's market share remains extremely high in these product categories.
Power management sales were up 5% year over year and approximately flat sequentially.
Our strategy to focus on portable and server applications was impacted by a general weakness in the computer market and also by our deliberate strategy to continue to withdraw from product areas in power management where the margins are inadequate.
Our sales of other analog product, which includes micromachine products, radio frequency products and clock IC products grew 3% sequentially and 22% year over year.
Power management as a grouping represented approximately 6% of our sales, and other analog products were approximately 14% of our sales in Q3.
During Q3, DSP revenues were flat sequentially and up 11% year over year and totaled 16% of our total sales.
Excluding the divestiture of our DSL/DSP-based ASIC business a few quarters ago, our DSP revenue was up 3% sequentially and 20% year over year.
Our general-purpose DSP products grew 11% sequentially and 15% year over year, representing approximately 7% of our total sales.
On a geographic basis, our sales to European customers grew the strongest sequentially; our sales to US and Japanese customers were approximately flat compared to the just-prior quarter; and we had an increase in sales to the rest of the world, which of course includes China and Southeast Asia predominantly.
All the relevant financial information for Q3 is contained in our press release in great detail, so I'm not going to repeat all that information.
But I would however like to comment on our cash flow and our use of cash in the quarter.
Our cash in our short-term investment balance at the end of the quarter was approximately $2.5 billion.
Our business generated $215 million of positive cash flow for the quarter, which was approximately 32% of our revenues.
We continue to leverage our cash flow to the benefit of our shareholders.
We have been aggressively repurchasing ADI stock.
And in Q3, the pace accelerated with over 9 million shares repurchased for approximately $305 million, while we received $20 million from employee stock programs.
Since our $2 billion buyback authorization began, we have repurchased approximately 10% of our outstanding shares on the open market.
Approximately $670 million is still available for repurchases under this existing authorization.
During the quarter, we paid $58 million in dividends and in September will again pay a dividend of $0.16 a share.
Cash payments of about $15 million were associated with acquisitions and $38 million for capital spending.
As a result of all those items when you add them up, our cash balance declined by $177 million for the quarter.
Looking forward, our book-to-bill ratio as measured by the direct OEM customer orders plus end customer orders placed through our distribution channel was approximately 1 in Q3, down from 1.05 approximately in the second quarter.
So in planning for Q4, we considered really the following factors.
On the positive side, the economies in most regions of the world remains strong, despite increased uncertainty over the last few months due to higher interest rates and of course higher oil prices.
Capital spending forecasts remain strong for the balance of the year and into 2007, although somewhat muted from earlier forecasts this year.
During the later months of Q4, in particular in September and October, we typically benefited from stronger sales to consumer and computer customers -- I think this year, in fact, buoyed by very strong new product cycles in many of our product areas.
Thirdly, on the positive side, our product groups in general are reporting good forward-looking forecasts from their customers, not only for Q4 but also for our 2007, which begins in November.
On the more cautious side, many of our customers seem more concerned with the inventory levels they have than they were three months ago, and that is particularly true with some of our handset customers in Asia.
Overall capacity in foundries is clearly more available than it was just a few months ago, and many of the back-end bottlenecks that we have all been suffering would have been mostly resolved.
As a result, lead-times in general have declined industry-wide in the last three months.
This, of course, has reduced the turns business opportunities in the short-term.
Another thing that makes us cautious is the incoming order rate, which include turn orders, did weaken during our Q3.
So, as we sit around and we stir up the pot, there are many positives.
There is also reasons to be cautious, so we're planning for our revenues to be roughly flat in Q4 to Q3 levels.
We also believe there's some upside to that forecast if our customers' forecasts materialize actually into Q4 shipments.
While the inventory cycles that we've experienced in Q3 have introduced some caution for Q4, as we plan for our fiscal 2007, which as I mentioned begins early November 1st, we're encouraged that our customers remain generally optimistic and that ADI specifically has many drivers to both our top and our bottom line.
Relative to our top line -- number one -- the diversity of applications and the pervasiveness of our signal processing technology continues to be a very stable foundation for our revenue and likely to provide good revenue growth going forward.
Our converter and amplifier products continue to command very high market share.
Our product development teams in these areas are solid, and that should keep ADI at the forefront of these product categories for many years in the future.
We have also -- number three -- raised our commitment levels to win important product segments of the power management category, which has been over the last year or 18 months one of the fastest-growing analog product categories as portable equipment becomes a larger proportion of the available market for electronics equipment.
Today, we have amassed a sizable and an experienced engineering workforce in power management under the direction of a highly capable leader with a proven track record of success.
With our team, with our technology, with our brand, with our sales channel, our plan is to significantly increase our sales of power management products going forward.
Number four, we are increasingly engaged in providing higher levels of analog, [madness] and DSP integration for many high-volume markets, such as automotive electronics and high-end consumer products, which we should begin to see the benefits of in 2007.
Number five, our micromachine-based products are poised to move well beyond our historical focus in airbag safety systems into very high-volume consumer products that run the spectrum from portable media devices to cell phones to game consoles.
Number six, our general-purpose DSP product portfolio continues to grow.
While not yet producing the revenue contribution that we expect and that we need, more design wins move into production each quarter including significant new applications in consumer, communications and automotive products.
Number seven, we will also continue to look for relatively small acquisitions to fill in technology voids and also to quickly penetrate new markets.
All these in aggregate should help ADI achieve our top-line growth model of 15% a year.
We also have many programs in place designed to raise our operating margins to 30%, excluding option expense in the near-term and to a 30% level including option expense in the longer-term.
Clearly, our objective is to keep growing our bottom line faster than our sales.
In moving the bottom line forward, we are now completing our fab consolidation during our fourth quarter, which is by and large unscheduled.
Compared to 2006, we expect this action will reduce our cost of goods sold by approximately $6 million to $8 million per quarter during the first year of FY 2007.
As we consume the higher cost inventory produced in the existing Sunnyvale fab, these savings are planned to increase to $11 million to $12 million per quarter during the second half of 2007.
We also continue to look for opportunities to pruning product lines that are unlikely to meet our operating objectives.
Lastly, over the last six months and actually over the last year, we have been aggressive buyers of our stock, which in the near-term has been slightly accretive and could be even more so as our earnings increase in the future.
So overall, we remain focused on achieving our financial model of 60% gross margins, 30% operating margins on a GAAP basis in the future.
We believe that our technology portfolio, our brand reputation, our cash generation capability are the key levers to achieving those objectives.
Maria Tagliaferro - Director, Corporate Communications
During today's Q&A period, if you would please limit yourself to one primary question and then a follow-on question, we will give you an opportunity to ask additional questions if we have more time.
With that, Operator, could you just please remind our analyst participants how to submit questions?
And then, we will take the first one.
Operator
(OPERATOR INSTRUCTIONS).
Michael Masdea.
Michael Masdea - Analyst
As you walk through a number of the dynamics going on -- it sounds like there's a lot going on -- if you go back to the beginning of the quarter, you were pretty optimistic.
Then, certainly in the fourth quarter, I think given the power management kicking in I know you had a [notebook fab] from other reasons.
Seasonality, you probably thought it was going to be a little better.
Just walk us through each quarter, what you think was the biggest surprise.
Then really, if you kind of take those out of the picture, how you think underlying demand is really, really playing out, even when you factor in some of the lead-times issues.
Jerry Fishman - President, CEO
I think, overall, end demand seems okay in most of the market segments.
The general weakness in the computer segment, I think, was widely commented on by many people during the quarter including some of the guys making the processors.
I think the handset thing, which was the other part of the surprise, sort of flattened out last quarter.
I think also, it has been pretty widely reported at least in many countries in Asia or China or Korea, there was some buildup of handset inventories during the previous quarter, which people started to adjust last quarter.
I think the most generic way to think about demand is what has happened in our industrial business because that really aggregates just a lot of different customers in a lot of different markets.
That business remained pretty strong.
The consumer business was pleasantly strong.
There's been a lot of commentary about how the consumer business was going to weaken.
We had a pretty good, a strong consumer quarter.
We think next quarter will be good too seasonally.
Typically, the third quarter for us is not a strong consumer quarter, but it turned out to be okay as we had thought it would, given the forecasts we had from our customers.
So I would say the only real surprises were the computer sector was weaker -- and that was really a combination of the fact that the market was weaker -- and also we deliberately walked away from a bunch of business that just did simply not meet our margin objectives in that sector.
That's part of what we have been doing to restructure that business over the last couple quarters.
The management of that business has really taken a very strong position -- I think an appropriate one -- that there's no reason for us to sell products at some of the gross margins we were achieving in that business.
Some of that, we have actually managed to raise the gross margin, and other ones we basically are just not going to do.
So, as we look at the overall landscape, that's the sort of pluses and minuses as we (technical difficulty).
Michael Masdea - Analyst
Then, just real quick, with the restructuring, you've generally moved away from some of the less-profitable vertical markets.
But a couple of your acquisitions look to be a little bit more vertical market focused.
Can you walk us through your recent acquisitions and just help us understand why they look to be a little bit more vertical market but it seems the opposite direction where you've been moving your restructuring?
Jerry Fishman - President, CEO
Well, I think on the largest one, which was the Integrant acquisition, I think the way you would think about Integrant is there they are one of the better low-power CMOS tuner companies in the world.
Tuners are going to go into a lot of different products.
And they have a widely dispersed customer base and a very strong capability to proliferate very low-power CMOS technology to many, many markets.
One of the early markets will be mobile TV.
But I think there are many, many other markets in the future.
But basically, we've got a cracker jack team of people that know how to build those products, know how to take it to market and are very well respected by the customer base that they serve.
I think in the longer-term, every market is a vertical to some degree.
Every market where there is a lot of customers and there is increasing concentration is a vertical.
And I think at ADI, our business is going to be made up by serving vertical customers and serving the customers -- the markets where we have 10,000 customers in a particular market segment.
So I think in order to -- at a company of our size, in order to grow the Company, you have to really do both -- you have to serve some of the larger customers, and I think at the same time you really have to continue to build that franchise of the 60,000 or 80,000 customers around the world in every market segment.
I really think you need a combination of both, and that's what the Integrant acquisition was geared to.
As far as acquiring the software stacks on the handset things, I think increasingly our customer base believes you can't be in that business at any level unless you control more of the software.
We'd had a relationship with TTP for many years.
And we thought that was the right thing to do to preserve and expand that market is well.
Fortunately, we actually did that right before TTP was acquired by Motorola, and I think that gives us a path forward for those products with our customers.
So I don't think those are examples of either a vertical or horizontal focus.
I think they are just examples of acquiring the technology we think we need to do the job that we set out to do.
Operator
Sumit Dhanda.
Sumit Dhanda - Analyst
A couple of questions.
First, you had noted that orders weakened through the course of the third quarter.
Can you tell us exactly when the weakness started to manifest itself?
And then, has there been any pickup here through the month of July?
Jerry Fishman - President, CEO
I would say generically, we reported last quarter that in a single quarter, our reported backlog went up $75 million.
We also talked during the last conference call, I believe, about how we didn't really believe that was realistic in one quarter for the order rates to improve that greatly.
It indicated to us that some people were trying to get in line, particularly as the foundries were reported full and the back-end subcontractors were reported not to be sufficiently capitalized to meet a lot of the demand that was going on out there.
I think what basically happened in Q3 is that customers began to believe that they were not at risk for deliveries.
Whereas, three months before when they loaded us up with $75 million of improved backlog, they believed that they were at risk for deliveries.
I think, as a result, the world got a little more uncertain.
There was a lot of stuff going on out there in the world in the last quarter, and I think a lot of customers across many applications began to pull back a little on the amount of inventory they wanted to hold.
I think that's what happened generically across the board.
Some market segments react more quickly to that, but I think we saw that really across the board with many of our customers.
I think the trends through the quarter, month to month, were not really definable.
The order rates in May were below what we thought they would be and they also were in June and July.
I don't think there was any sort of definable trend downward or upward during the quarter.
So I think what really happened is the market basically adjusted to the fact that the lead-times had come in a little bit, and customers were not as concerned about growing their inventories as much as they were three months ago.
I think, if you listen to the commentary or at least the reported commentary of many of our competitors who we listen to a little bit, I think most of them are a little bit more cautious at the margin than they were three months ago.
Certainly, we are as well at least for the coming quarter.
I don't think that has much to do with what will happen in 2007, which I think most people believe is going to be a good year.
But I do sense there's a lot more caution around than there was three months ago.
Certainly, our competitors have reacted to that.
The stock market has reacted to that, and that is not surprising.
Sumit Dhanda - Analyst
So let me just get this clear then.
Do you require significantly higher turns, orders and shipments through August -- well, August, September and October or the remainder of the quarter for that matter -- to hit this flat guidance that you have put out there?
Joe McDonough - VP, Finance, CFO
We have about 65% of that guidance in backlog now.
If you look back a year ago in the third quarter, there was 55% of the next quarter of sales in backlog.
So, as Jerry mentioned, the backlog -- and as we discussed on the last conference call, the backlog had gotten up to levels that were very high on any kind of a trend basis. 65% is still a pretty healthy backlog.
So we require something in the 40% to 45% range returns for next quarter.
Jerry Fishman - President, CEO
If you [account the account] margins.
Joe McDonough - VP, Finance, CFO
Yes, if you assume -- the calculations this quarter were 10% or 11%, which is not an unusual number.
Seogju Lee - Analyst
Joe, You talked about the cost savings starting to help, starting in the second half of fiscal '07 if I heard you correctly.
Jerry Fishman - President, CEO
I'm sorry;
I missed your comment.
Seogju Lee - Analyst
I thought you said that the cost savings would start to have helped you in the second half (multiple speakers).
Jerry Fishman - President, CEO
No.
What I said, specifically, is during the first two quarters, it will be somewhere around $6 million -- $6 million to $8 million a quarter during the first two quarters and about $11 million or $12 million a quarter in the second two quarters.
So we expect it ought to begin to help us in our Q1.
Does that clear it up?
Seogju Lee - Analyst
Yes, that does clear it up (multiple speakers).
The final question I had for you was -- you're talking about a 15% to 20% growth model.
I don't want to belabor this fact, but ADI has really underperformed the rest of the analog peer group here recently. 2006, your revenues are basically going to be flat with 2004.
But just the broader market has grown faster than you have over the last two years.
So help me understand exactly what it is that you're doing so differently, which will help you to get back to start of the promised land.
Jerry Fishman - President, CEO
First of all, we are getting out of some product areas that we don't think are strategically relevant.
We had a very, very strong 2004, so those comparisons are a little bit challenging for us.
But I think generically, the fastest growing part of the analog business over the last couple years -- last two years specifically -- has been in power management, where we have been underpenetrated.
We have significantly upped our investment level in that business.
Because in order to grow at the kind of rates we want to, we have to be a larger factor in that business.
I think, if you look at what the market enabled in the converter and amplifier business, our share at least through partly with the shares that are reported by the external market people have been in fact growing in some cases and flat in other cases.
So I don't think it's a question of our products not doing well over the last year.
It's a question that the power management part of the analog business has been not a large part of our sales and will become a larger part of our sales in the future.
In the overall sense, a large part of the growth for some of our competitors in the last year has been in the handset business, where we have not had a lot of growth for all the reasons that we have talked about.
On the other hand, now, the handset business is a much smaller percentage of our business than it has been in the past.
We see a lot of opportunities to grow that business, particularly on the analog side, in the future.
So I say there's a lot of reasons for optimism about the future.
None of it is a certainty, but I think a model for analog of about 15% year, which is what we have been saying, is about the right model.
I think (technical difficulty), we can grow our earnings a lot faster than our sales, despite some of the things that we have done and some things that we will do in the future.
Seogju Lee - Analyst
The cancellation last quarter, you said 10% to 11%.
What was that in the April quarter?
Can you tell me?
Joe McDonough - VP, Finance, CFO
It was something like that, which is similar to reason quarters.
Operator
Joe Osha.
Joseph Osha - Analyst
On the power management side, I hear you in terms of that being a big market.
But it's a market now, especially on the PC side, that seems to be intensely competitive with declining ASPs, in some cases declining margins.
Why, at this juncture, do you want a piece of this?
Jerry Fishman - President, CEO
I think we want a piece of it where the margins are reasonably high.
There's some very good competitors out there that reliably make good margins in that business.
Albeit, they might not be 75 anymore, but they are in the 60s in terms of the gross margin level.
The other part is that we have a lot of pull into that market by virtue of a much broader product portfolio, and we have a lot of customers that are basically -- been after us to get competitive products on the market.
They really want to buy it from us.
Our belief is if you can build power management products and get margins in the low 60s in that business, that's a pretty good business for us.
I think that would be very welcomed when we looked at our profit margins over the next couple years.
So it's an important market.
I think at the bottom of the market, you are quite right.
That's not a place where we want to be, where we want to invest or where in fact we want to support existing products.
But there are a lot of products out there where we are already selling a lot of content where we can package power management with them.
I think we can do very well relative to companies that really are just selling pinpoint power solutions.
That's certainly our goal.
We want to stay up market in that.
We think we can -- it might not be as profitable on a gross margin line as some of the sort of horizontal products in the analog business.
But again, when we get to be $2.5 million, you have got to have some drivers that can add a lot of sales.
I think power management sales at those kind of gross margins are one of the ways to get there.
That's the way I think about it.
Joseph Osha - Analyst
On the second issue, you have acquired some intellectual properties from TPP Comm.
TPP Comm is now owned by Motorola.
What is the nature of that relationship now?
Do you have an ongoing relationship with them?
Or you have kind of peeled out what you need and you're going to paddle your own canoe from now on?
Or if you can give me some color on it, that would be helpful.
Jerry Fishman - President, CEO
There's a lot of things possible, but we're expecting what we had with TPP is what we're going to get and that in the future we will have other relationships.
If there is a possibility with TTP, maybe we'll do some more stuff with them.
But we don't exactly know how that's going to come out, and we are not counting on that for the future.
Joseph Osha - Analyst
So it's kind of in a state of flux at this point?
You have got intellectual property as a result of the transactions, and the (multiple speakers) --
Jerry Fishman - President, CEO
Yes, and we have taken a bunch of people from them that will be able to support in handset intellectual property.
Operator
Steve Smigie.
Steve Smigie - Analyst
If I could just ask a little bit on the power business, what activity you have in terms of design wins or what stage you are in terms of getting new products into customers?
Jerry Fishman - President, CEO
Well, we have a lot of design wins, but we don't have a lot of revenues on the new stuff yet, since these products are just making it into the marketplace.
We have been in the last quarter or two in the hell where the new ones are doing well and the old ones we're getting out of.
So you don't see a lot of that on the top line.
But I think over the next couple of quarters, our guys -- we just went through a pretty detailed review of that just a couple of days ago, and there's a lot of good stuff out there.
There's no reason why we shouldn't have that be a larger business.
We have good technology.
We have hundreds of people in that organization now that have been cranking to get good products out.
They have a pretty good sense of where they want to be, so I think that's going to be upside for us going forward.
Talking about any particular customer win I think is a little premature.
I would rather report high revenues than make pronouncements about customer wins.
That's certainly what I'm going to plan to be looking at.
Steve Smigie - Analyst
Do you expect to have a significant number of more products coming out or you feel like you've got a lot of the products out already and you have got the design wins and revenues (multiple speakers)?
Jerry Fishman - President, CEO
No, like I said, we have a very large engineering group focused on this thing in many locations around the world from California to Europe to in Asia as well.
They've got a very aggressive product line, and we have financed that over the last six months in particular last year.
We're going to finance it next year.
We have got to play to win in that business, and we believe this is a category that we can win it.
Operator
Adam Parker.
Adam Parker - Analyst
Just so I can understand the guidance, maybe you could put the relevance of the guidance in some broader context.
Why didn't you guys prerelease the results here, given the revenue grows so far outside the range?
How far below that range would the revenue have to be for you to prerelease negatively?
Jerry Fishman - President, CEO
Well, first of all, I don't think it's that far below the range.
It's a couple of percent below the range.
I think there's -- everyone's perception about that.
It's certainly not a quarter we're happy with or that I'm satisfied with, but I don't think this was a kind of quarter that's a massive change of where we were going to be.
We are one of the few companies that actually report their results seven working days after the end of the quarter.
So, by the time you really know what is going to happen, it's a couple of days.
We're trying to understand it, so we can sound and be intelligent on what happened and what the future -- is out there.
That's the judgment we made.
I think if there was a very significant mess much larger than that, I think we would maybe think about it.
Adam Parker - Analyst
So it would be more like $20 million, $30 million or something revenue or something bigger than--?
Jerry Fishman - President, CEO
Yes.
I would say the discussion about the handset market in China was weak is not news to anybody, nor is the fact that there was weakness in the computer sector.
So like I said, it's not a quarter that I'm happy with, that I'm satisfied with.
But on the other hand, I think there are some things going on in the marketplace that are very well understood.
Adam Parker - Analyst
It could just be that one-month lag too.
Joe McDonough - VP, Finance, CFO
I think as Maria said at the outset of the call, though, that we're not accepting the obligation to update the guidance that we're giving.
Adam Parker - Analyst
I get that, Joe.
Thanks.
Jerry Fishman - President, CEO
Thanks for that clarification.
Adam Parker - Analyst
Yes, Joe, thanks.
The second question is about DSP.
Clearly, you kind of evolved your strategy there and sort of switched to being more optimistic about the potential revenue opportunities of DSP than maybe you were a year ago in some of the vertical markets.
Again, here, we are looking at another quarter where analog outgrows DSP.
I think it's something like 10 or 11 the last 13 quarters where that has happened.
So maybe you can help us understand, what do you expect from DSP in the October quarter or the next year?
On a fully burdened basis here, the DSP, was it profitable this quarter?
How many more quarters can you go before you have to be more aggressive with the DSP strategy?
What gives you confidence we are on the cusp of something much better than we have seen the last several years of DSP?
Jerry Fishman - President, CEO
We continue to look hard at where we're getting traction with both small customers and larger customers.
As you can well understand, this business has been under intense review each quarter.
We look at each of the things, and we make a judgment of whether that's the best thing for us to do.
Our DSP business last quarter approximately broke even, even though the revenues were lower than we had thought they were going to be.
Our goal is to keep improving that towards being a contributor to our profitability rather than a detractor.
So we look at that each quarter.
We look at what the customers are saying.
We look at what the organization is saying.
We look at what the financials are, and we decide where we want to be and where we don't want to be.
That's the best I can tell you.
Adam Parker - Analyst
But it doesn't have to, in your mind, grow much faster than the analog to be a good business to remain in?
Jerry Fishman - President, CEO
I don't think it would have to grow a lot faster than the analog business to be a good business to be in.
I think if it grew at the kind of rates the analog business does and we wind up being able to amortize that big engineering nut over a larger amount of sales, I think the incremental profit opportunity there is still very good for us relative to the base we're at.
Adam Parker - Analyst
Maybe I'm trying to understand what you guys put out as your long-term margin goal of 30%.
I think your guidance is something like 19% operating margins for the next quarter, so you need a lot of revenue growth to get that done.
Jerry Fishman - President, CEO
I don't know where you got that number.
Adam Parker - Analyst
Certainly, you guided for higher operating expenses and flat gross profits on flat revenue, right?
Jerry Fishman - President, CEO
Right.
Adam Parker - Analyst
So you have to have lower operating margins than you just reported on a GAAP basis.
Whatever the number is, it's just lower than what you just did.
It's several 100 basis points away from the target goal.
It implies you need a lot of revenue, right?
Jerry Fishman - President, CEO
Well, it implies that we expect this is a growth business.
The fact that we've had very good sequential revenue growth the last couple of quarters and we expect that will continue.
If we didn't expect it will continue, we would have a different conversation.
So I think --
Adam Parker - Analyst
I know, but I guess the very good part is subjective, right.
Because if your long-term model is 15%, you just did 3%; it's below the long-term model.
So it's not -- by that long-term context, it's not that good.
I think that's what the debate -- and then you're guiding flat, so you are basically kind of well below the long-term model this last quarter and this next quarter, right?
So then, --
Jerry Fishman - President, CEO
Yes, look, we have made a judgment that says that there's a lot of parts moving around quarter to quarter and there's a lot of things going on with acquisitions that we have made.
We're trying to get the growth rate up as a result of and a lot of other things we're doing.
Quarter to quarter, those things are going to move along.
But I think that over a very long period of time including last quarter, we have a history of growing the top line -- growing the bottom line a lot faster than the top line.
I don't think there's any reason to think that we won't do that again in 2007.
Operator
Tore Svanberg.
Tore Svanberg - Analyst
In power management, that business seems to be growing less than the industry now for a while.
Are you pretty comfortable that you have all the internal resources to make that a big, successful business?
Are you also considering maybe some potential M&A?
Jerry Fishman - President, CEO
Well, that's certainly a possibility in the future.
I wouldn't want to rule it out.
But right now, we're working hard -- we built a tremendous confidence in that business over the last year in terms of size and experience.
Our goal is to use that competent -- we're absorbing all the costs of that buildup in our operating costs.
Our goal is to have that be a real contributor for us in the future.
That's why we're making very sizable investments in that business.
That's what we're going to try to keep doing.
I've reviewed personally the plan for that business and what they are trying to do, and I think they have got a good shot at achieving their objectives.
Tore Svanberg - Analyst
On internal versus external capacity, once your done with your consolidation plans, how would that look like as far as percentage internally versus externally?
Jerry Fishman - President, CEO
Joe?
Joe McDonough - VP, Finance, CFO
Let me just look at this quarter, how that turned out.
This quarter, our percentage of sales from internal fabs was about 57%.
We have been down 52%, 53% in quarters past about a year ago.
So I think it's reasonable to expect that the ratio of sales from internal fabs to external fans will probably migrate downward toward the 50% - 55% range as we go forward.
We certainly have plenty of capacity in the fabs that we have, which is consolidating some manufacturing into our existing fabs.
There's plenty of footprint opportunity there, some modest capital expenditures to expand out the capacity of those fabs.
So there's no concern that we have about not having enough headroom on the internal fabs.
We also have very strong relationships with external foundries, principally TSMC.
We're not concerned about our access to capacity from the external fabs.
Operator
David Wu.
David Wu - Analyst
On the spending on the DSP side, I guess Blackfin continues to be funded pretty richly.
I was wondering whether you actually can hold those R&D dollars flat into 2007 fiscal year.
The other one has got to do with your bookings.
We have inventory correction in both these, I guess, the low-end cell phone business in Asian markets plus the PC situation.
It doesn't feel like 2004 midyear all over again.
But on the other hand, could it just be as simple as a one-quarter problem that by the end of your Q4, we will clean up and move onward and upward from there?
Jerry Fishman - President, CEO
Let me answer the first question.
We have really flatten out the expenses relative to Blackfin.
We have the core done.
We're doing many, many different spins of that core right now to make it more widely applicable to a wider range of customers.
So I think there's every bit the ability to keep that spending flat or perhaps even a little bit lower in 2007.
On is this a one-quarter phenomenon or not?
I guess time will tell.
We certainly didn't ship in huge amounts of inventory above the consumption rates for many quarters, like happened in 2004.
So I think that is sort of a leading indicator that there shouldn't be all that much inventory out there.
But we'll have to wait and see what happened.
It could turn out that we get a strong bounce back in Q4, and it turns out to be a one-quarter phenomenon.
We'll have to wait and see how that goes.
David Wu - Analyst
What is the lead-time, currently?
Jerry Fishman - President, CEO
Well, it varies tremendously from product to product, but it's probably a little bit lower than it was last quarter.
David Wu - Analyst
Off of eight weeks of--?
Jerry Fishman - President, CEO
Yes, it's a less than that now.
Operator
Ross Seymore.
Ross Seymore - Analyst
Just your look on the inventory and the computing and then the handset site specifically.
What is your view on when you can start to shift closer to end consumption?
Jerry Fishman - President, CEO
It's very hard to say because you don't the details of any of the customers' inventories specifically.
But certainly, we would hope that that would be the case by the end of the fourth quarter.
Ross Seymore - Analyst
So, once we head into the first quarter, you would expect to have an easier comp there and be shipping in line?
Jerry Fishman - President, CEO
That's my opinion right now.
Ross Seymore - Analyst
The Integrant acquisition, is that still about 1 point to percentage growth in the October quarter?
Jerry Fishman - President, CEO
Yes, roughly in that range.
Ross Seymore - Analyst
Then finally, we have talked a lot about of the power management side and acquisitions to get into it or organic growth.
Switching over a little bit to the bigger part of your business in converters and amplifiers, a lot of your competition is talking about making inroads in there.
Albeit slow, there's many of them making small inroads and slow inroads.
Are you seeing any evidence of losing share just even at the margin?
Or is the simple reason that your analog business has underperformed is because you're underrepresented in power management?
Jerry Fishman - President, CEO
I think it's 99% the latter and 1% the former (multiple speakers).
Ross Seymore - Analyst
When do you think what you are exposed to, amplifiers and converters, will start to grow at a rate that exceeds power management?
Jerry Fishman - President, CEO
Are you asking when that would happen?
Ross Seymore - Analyst
Either what end markets have to cooperate; when do you see those end markets cooperating?
Any color you can give on that would be great.
Jerry Fishman - President, CEO
I think the converter market and the amplifier market have a long-term growth rate that's pretty good.
I would expect that in any normal year or any normal quarter, we would get good growth in those businesses.
Certainly, there's not any absence of applications for converter technology in a world that's mostly analog but yet does a lot of digital processing.
Amplifiers are a staple that are always going to be used.
In the home market, there's more competition.
I don't think there's any doubt about that.
The guys in the converter businesses are trying to do power.
The guys in the power business are trying to do converters because everybody is concerned about top-line growth for the next five years.
So I think that when you look out in time, there has been a run-up on the power side, which is heavily influenced by the portable equipments growing faster than the plugged-in equipment.
But I think if you look out over time, there's actually no reason why any of those products should grow any slower or faster than any other products.
I would expect that's probably what is going to happen.
The converter and amplifier business is a great business.
It's probably the highest ASP business in the analog business.
It's the business that has the largest franchise value because it's so entwined in so many applications with so many different customers that even if you have a competitor that gets good product out, it takes five years to get any traction.
The power management business historically has been a little more of a hot product business with larger customers and faster product cycles than we experienced in the converter business.
So I think the general characteristics of the amplifier and converter business are and they remain today to be terrific characteristics.
It's very obvious why many competitors want to be in that business.
But, like any franchise business, we have 2000 converter products and we sell them to 66,000 customers as of last count.
That is sort of hard to make a lot of inroads on, no one customer being a very large percentage of the sales.
That's the whole thing about the franchise nature of the amplifier and converter business -- the fragmentation, the long lifecycles, the high margins, the entrenched customer base on it that have bought from us for so many years.
I think it turns out it will be a lot harder to displace those kinds of products in our customer base than we believe it will be to displace power management competitors in that business because of the franchised nature of the amplifier and converter business.
Having said that, it's always hard to get the other guy's business.
I think we have seen that in power management.
I think many of our competitors have seen that in the converter and amplifier business.
It's easy to hire people and get people working on it, but it's hard to get real products out when the other guy has got 20 years more experience getting those products out than you do.
So in some ways, that protects to some degree our converter and amplifier franchise and makes the power stuff harder.
That's why it has taken us as long as it has to get any real traction in that business.
Ross Seymore - Analyst
It's 6% of your sales right now in power management.
Are you to say that that business is a success in your mind?
Roughly, what percentage of sales would that have to be say a year or two years from now?
Jerry Fishman - President, CEO
That sort of depends on the denominator as well as the numerator.
So I would say that we have 65% or so of our business in the corporation in amplifier/converters and 6% in power management, and the power management market is bigger than the amplifier/converter market at least the parts we serve.
I would say if that wasn't a meaningfully high number, we won't be doing very well in that.
I don't have a firm number in mind, but there's a lot of room to grow there for us.
We are certainly making the investments to be able to do that.
Operator
William C. Conroy.
William C. Conroy - Analyst
Jerry -- maybe this one is for Joe -- can you give us a little bit of detail on the inventory situation and distribution channel?
Joe McDonough - VP, Finance, CFO
Yes, the inventory in the distribution channel rose a bit this past quarter.
I think they might have another day or so of inventory over and above what they've had.
But that's not an unusual level of turns.
They are still at a normal turns level.
William C. Conroy - Analyst
Do you guys anticipate or see any impact from the dissolution of StarCore?
Jerry Fishman - President, CEO
That's always hard to tell.
Certainly, that improves the remaining companies in that business' opportunity.
We always believed that there was a broad opportunity for DSP, and I think StarCore has basically said that it's real hard to do and it takes a lot of stamina to stay at it.
So I think, at the margin, we didn't see them very often.
But certainly at the margin, that makes us even a more viable competitor because there's not many DSP suppliers left out there.
Operator
Bill Lewis.
Bill Lewis - Analyst
Just again, on the 30% operating margin target -- I know you have been asked on it -- but I think you expected to hit it or get close in this fourth quarter.
You are not going to now.
Are there any specific actions you are taking to account for the downturn?
Or are you just hoping to ride it out?
And I guess, related to that, what has to happen for you to get to that target?
Is it purely revenue growth from here?
Or are you talking about anything else you're doing?
Jerry Fishman - President, CEO
As I mentioned a little earlier, we're expecting to get some lift on the gross margins as a result of some of the actions we have already taken.
As we think about the world, you don't change your plan based on what happened in one quarter because you missed the revenues by a couple of percent.
If it turns out that that's the beginning of some economic issues that start going on that force the industry into retrenchment, we will have to decide what to do.
But I think we try hard to look at this thing over many quarters and react as appropriately with that in mind.
So I can't say we will;
I can't say we won't.
We're certainly at the margin putting more scrutiny on businesses because of what happened last quarter, and we will have to wait and see how that all comes out.
Bill Lewis - Analyst
Just related to that, do you have a new target when you think you might achieve it or what it takes to get there?
Jerry Fishman - President, CEO
As we finish up Q4 and we put together our plan for 2007, we will have a better look at the revenue targets and the expense targets and the margin targets.
And we will try to give you a little more color on that at the end of next quarter.
Joe McDonough - VP, Finance, CFO
That 30% objective was at revenues of 715 or 725, so we are obviously a ways away on the revenue front.
Jerry Fishman - President, CEO
About 51,000 a quarter away on the revenue front.
Bill Lewis - Analyst
I know you are not going to want to guide for the first fiscal quarter, your January quarter.
But historically or at least in the last few years, it has been a tough quarter for you.
I don't think you have grown in the January quarter since 2003.
Could you maybe talk about what you think the dynamics might look like, given the weaker results you saw this quarter and looking into the fourth quarter what that might start to look like for you?
Jerry Fishman - President, CEO
I think we'll have to wait and see how we end up in Q4.
The typical seasonal patterns are a little bit more complicated now.
There are so many different variables pulling at the revenue line, both up and down.
So I think we will take a look at where we go in Q4.
We'll take a look at the order patterns.
We'll take a look at the backlogs.
Then, we will give you some sense on that at the end of Q4.
Operator
Mona Eraiba.
Mona Eraiba - Analyst
Could you elaborate more on the handset area with the agent supplier?
I know it has declined to be less significant for you.
But do you see that just a short-term issue, or do you think it's going to continue to shrink?
Jerry Fishman - President, CEO
I think as you go over to Asia and you see what is going on in some of those Asian customers, they are pretty fierce competitors.
We have the probability of TDS-CDMA beginning to deploy next year.
It might be three months; it might be nine months.
But it's going to happen over there.
I think it has been widely reported we have a very strong position in that business in China, particularly from the local market, which TDS-CDMA would supply.
So I think it's very premature to marginalize the Chinese or the Asian suppliers in the phone business.
Mona Eraiba - Analyst
Also, I wanted a further classification of the infrastructure area, which appeared to be pretty strong for you.
Could you just elaborate about how it looks going forward?
Jerry Fishman - President, CEO
We'll have to see what happens going forward, but that's a large business for us.
It's 11% or so of our sales.
It's a business where we would typically show certainly dozens and maybe even as much as 100 different products into a base station, converters and amplifiers and many other analog functions and in some base stations some DSPs.
It really in many ways represents the ideal type of market for analog because it's very product fragmented, it's very performance oriented, and it's a market that pays for if you can build the best converters and other types of products.
So there's a large build-out going on, on the infrastructure side both in Asia and in other places.
I think that's why that business has been so strong.
Mona Eraiba - Analyst
Do you have any specific customer who is big in that area, or are you broadly based with various equipment suppliers?
Jerry Fishman - President, CEO
I think one of our slides that we once showed in [Versity] says that if somebody makes a phone call, it's going through a base station that has our parts in it.
So we have a very broad participation of our products with virtually every base station manufacturer in the world.
Mona Eraiba - Analyst
Around the computer area, do you see any sign of potential recovery as a result of the new product introduction from Intel, the price cuts, et cetera?
Jerry Fishman - President, CEO
Yes, we're expecting that our computer business will do a little bit better in the fourth quarter.
That's typically what happens anyhow seasonally.
On the audio side, we have some good products.
And on the power management side, we have some good products.
So we are hopeful we will get some growth in that sector in Q4.
Mona Eraiba - Analyst
But you don't see a sharp turnaround in that business, since Q2 was unusually weak?
Jerry Fishman - President, CEO
I don't know.
We'll see how that goes.
I'm always loath to make a prediction based on seven days of data this quarter.
Operator
Craig Ellis.
Karen Swalin - Analyst
It's [Karen Swalin] for Craig Ellis.
Could you help us understand then -- I know you are reluctant to give a forecast specifically, given seven days of data.
But given the backlog too, can you help us understand directionally across some of the markets, which markets you might think would be up and which would be down, given the flat guidance?
Jerry Fishman - President, CEO
It's very hard to do that with the product portfolio we have.
So I think we will just have to wait and see what is going to happen in Q4.
I think it's very premature to try to do that.
Karen Swalin - Analyst
Then related to the handset business, it seems like handset sales were flat but vertical DSP was down.
Is that to say that your analog and RF and handsets is maybe performing better than base bands?
Jerry Fishman - President, CEO
Yes.
Karen Swalin - Analyst
Do you expect that trend to recover or--?
Jerry Fishman - President, CEO
Well, I hope both will perform well, but we will have to wait and see.
Certainly, in the handset business, we have tremendous value added on the analog side, and we are working as hard as we can to commercialize on that.
Karen Swalin - Analyst
On the guidance for the improvement in costs, the $6 million for the first two quarters and $11 million for the second -- if we kind of rolled that up, it looks like it would be 160 basis points improvement in gross margin.
Is that a number that we might actually see fall to the gross margin line, or would that be offset by say taking more fabless revenue?
Jerry Fishman - President, CEO
Again, we will have to try to give you some guidance on that when we finish out the quarter and we see where we are headed in the early parts of the year, but a lot of that is based on the product mix.
There were so many variables that it is very hard to predict in advance.
Certainly, our goals have to been get to gross margin up above the 60% level where we are now on the basis that we said.
Certainly, this is one of the areas that could help us do that if everything else holds constant.
Operator
(OPERATOR INSTRUCTIONS).
Louis Gerhardy.
Louis Gerhardy - Analyst
I just wanted to understand you mentioned that you have haircutted (sic) your customers' forecasts a little bit.
Can you just give us a sense of how much you did that?
Was this is a significant cut or a slight cut?
Jerry Fishman - President, CEO
No, I would say it all depends on your perspective on that, but I would say it's probably $5 million, $7 million.
It's sort of 1% of sales, maybe a little bit more, not a lot more than that at least in the quarter.
Louis Gerhardy - Analyst
Then just on the fab closure, if we can just think about the benefit in the January quarter in dollars of the fab closure, can you just give us a sense of what the dollar savings would be in the January quarter?
Jerry Fishman - President, CEO
I think we said earlier, or I think maybe I did, that it was in the vicinity of $6 million to $8 million in the first quarter and the second quarter.
Joe McDonough - VP, Finance, CFO
In the first half (multiple speakers) --
Jerry Fishman - President, CEO
In each quarter in the first half of the year.
Joe McDonough - VP, Finance, CFO
I think it's probably toward the lower end in the first half, the upper end in the second half.
The way it works as we have been manufacturing wafers and inventory out of the old fab, and so that has to work its way through inventory, carrying its old costs into cost of goods sold before we can sell these new products that we manufacture in the new fabs.
So it's just a little bit of a snake that we've got to get through there.
Jerry Fishman - President, CEO
(multiple speakers) We had forecasted that was a $45 million annual running rate number.
Everything we see still says that's the case.
Louis Gerhardy - Analyst
We should see that in the second half of the year, the full benefit?
Jerry Fishman - President, CEO
Yes, we will see certainly the full benefit of that in the second half of the year.
Joe McDonough - VP, Finance, CFO
How we get there along the way remains to be seen.
Louis Gerhardy - Analyst
Jerry, you had mentioned you're still considering, you have it on the table of maybe divesting some businesses or getting out of certain areas.
Can you just give us a sense of how many areas have you identified?
Is there a timeframe that you have established for coming to a conclusion here on anything?
Jerry Fishman - President, CEO
The way I think about is that as we do the -- clearly, every time you have a setback in a particular quarter and we have a very aggressive objective to get the operating margins up, we know the impact of that on our valuation.
So we are not insensitive to that.
So I think we continuously review each business once a quarter.
We have taken some actions.
I expect we will take others in the future.
As we take them, we will let you know.
That's about the best I can say.
Maria Tagliaferro - Director, Corporate Communications
I can't exactly see the queue here during our call today, but I believe we are cleared of all questions remaining.
So I would like to thank everyone for joining us today.
For your calendars, you can schedule the fourth-quarter conference call, which is planned for Tuesday, November 14 at 4:30.
Thank you very much.
Operator
This concludes today's Analog Devices conference call.
You may now disconnect.