亞德諾半導體 (ADI) 2007 Q2 法說會逐字稿

Good afternoon.

My name is Laney, and I will be your conference facilitator.

At this time, I would like to welcome everyone to the Analog Devices second-quarter 2007 earnings conference call.

(Operator Instructions).

Thank you.

Ms.

Tagliaferro, you may begin your conference.

Thank you.

Hello everyone.

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

If you don't yet have our second-quarter 2007 release, you can access it by visiting our website at analog.com and clicking on the headline that's on the homepage.

I am joined today by our CEO, Jerry Fishman, and our CFO and VP of Finance, Joe McDonough.

In a moment, we will begin with opening remarks from Jerry.

I would like to take a moment, though, to comment regarding our financial results for the second quarter of fiscal 2007 which was reported today.

In accordance with GAAP, the 2Q results include 17.4 million of non-cash stock-based compensation expenses related to employee stock options, 10.1 million of expenses related to restructuring actions, 2.9 million of expenses related to previously-announced acquisitions, 19 million received in the settlement of litigation against Maxim Integrated Products.

And the provision for taxes includes the tax effects of these items.

In order to provide investors with useful information regarding the financial and business trends relating to our financial condition and results of operations and to help our investors better understand how we manage our business, our comments during today's call will make reference to non-GAAP financial measures which exclude these items.

We have included reconciliations of these non-GAAP measures to their most directly comparable GAAP measures in our earnings release issued earlier today.

A copy of which is posted in the Investor Relations section of analog.com.

In addition, many listeners may recall that the immediately prior quarter, which was the first quarter of fiscal 2007, was a 14 week quarter compared with the typical 13 weeks in a quarter.

Therefore, from time to time during today's call, we will point out the impact of this additional week on historical trends.

Finally, please note that the information we are about to discuss include forward-looking statements for the purpose of the Safe Harbor provisions under the Private 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, 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 us.

Subsequent events and developments may cause the Company's outlook to change.

Therefore, the conference call will include time-sensitive information which may be accurate only as of the date of this broadcast May 22, 2007.

With that, we are ready for our CEO, Jerry Fishman's, opening remarks.

Good afternoon.

Q2 was a very strong quarter for ADI as we reported this afternoon.

Our revenues were $669 million, which was at the very top of the range that we communicated to you last quarter.

Our revenues were up 2% sequentially from the first quarter, which as Maria indicated, was a 14 week quarter while Q2 was a 13 week quarter.

So on a normalized 13 week comparative basis, our revenues grew 10% sequentially.

Revenues for our very broad base of industrial customers, which comprised 43% of our Q2 revenues, were up 6% year-over-year and declined about 1% sequentially.

On a normalized 13 week basis, sales to this group of customers grew 7% sequentially, which is in line with the typical seasonal pattern that we usually experience in our industrial business.

On this basis, within the industrial category, our sales into instrumentation, applications, medical applications, and automotive applications were particularly strong during the quarter.

Our revenues of consumer products increased 26% year-over-year and 4% sequentially which translates to 13% sequentially on a 13 week basis.

As a result of very strong growth of consumer products over the past couple of quarters, our consumer products now comprise 21% of our revenues which is up from 17% of our revenues a year ago.

Consumer growth in Q2 was driven by very strong demand for our products that are used in digital cameras, advanced TVs as well as MEMS-based motion sensors that are enabling new functionality for the most popular video games.

Communications revenues grew 10% sequentially or 18% sequentially on a 13 week basis.

Our growth of sales into communications customers in Q2 was fueled by very strong sales of base station products, particularly in Asia, where new infrastructure buildouts are creating very high demand for our high-performance analog products.

Base stations comprised 11% of our revenues in Q2.

We also experienced good growth in Q2 in our sales to handset customers.

Communication revenues in aggregate comprised 28% of our revenues in Q2.

Our sales to computer customers declined 13% sequentially or 6% sequentially on a 13 week basis but were down 23% year-over-year.

While this decline can be partially attributed to an overall weak PC market, we are also certainly being impacted by declining sales of our older PC power management and also our PC audio products as we deemphasized lower margin products within our portfolio.

Computer product revenues represented 8% of our sales in Q2 as compared to 11% of our sales a year ago.

Overall revenues from our analog products grew 2% sequentially and 8% year-over-year and represented 83% of our revenues.

On a comparable 13 week basis, analog revenues grew 10% sequentially.

Converters and amplifiers together comprised 62% of our revenues in Q2.

We have a strong leadership position in both of those product categories as you know.

And in converters in particular, we continue to hold a very wide margin in terms of overall market share.

In the other analog product categories, we are enjoying very strong demand for our MEMS and our RF radiofrequency products which have been two of the fastest-growing areas of our analog business over the last year.

MEMS motion sensing technology has entered a new growth phase as it proliferates in many new high-end consumer applications including the Nintendo Wii Remote Wireless Controller as has been widely reported.

As a result, MEMS represented 7% of our sales in Q2 and that's up from 4% of our sales in the same quarter last year.

DSP revenues grew 2% sequentially or 10% sequentially on a 13 week basis but were down 13% year-over-year.

The year-over-year decrease was primarily the result of a very tough year-over-year comparison in handset chipsets.

Our general-purpose DSP products represented 7% of our Q2 sales and handset chipsets represented 8% of our sales in Q2.

Geographically, sequential Q2 sales were strongest in Greater China and Japan.

They were flat in Europe and somewhat lower in America and the rest of Asia-Pacific.

And that's of course before adjusting for the fact that last quarter had been a 14 week comparison.

Our non-GAAP gross margins for the quarter were 57.8% of revenues, which is down from 59% last quarter on the same basis.

This is primarily a result of the very strong mix of product sales into consumer applications including advanced TVs, video games, digital cameras, and also as a result of prior handset applications.

Many of these products typically generate somewhat lower gross margins than other products in our product line that sell to a much more fragmented customer base.

It's important to note that exclusive of the mix, the gross margins and the average selling prices on individual products remain generally stable during Q2.

Our gross margins were also impacted by our decision last quarter to continue to constrain utilization levels in our internal manufacturing facility to better balance production levels, demand and inventory levels.

As a result, inventory declined about 1% sequentially and days in inventory declined by seven days to 121 days from 128 days at the end of last year.

Our current plan indicates that utilization rates in our internal factories should begin to increase in our fourth fiscal quarter beginning in August.

Non-GAAP operating expenses grew about 1% sequentially in Q2 and represented 35% of our revenues.

As we indicated to you last quarter, we have decided to increase investment levels during 2007 above our model to invest further in new product development for power management, for low-power converters, and also from MEMS products.

In MEMS, we are also ramping additional capacity at external foundries to support the increased demand we're seeing for these products.

And this certainly in the short term is adding some additional expense.

Non-GAAP earnings per share for the quarter were $0.40.

The net cash flow from operations totaled $239 million or 36% of our total revenues.

Net cash flow from operations less $40 million in capital for the quarter was $199 million, or 30% of our revenues.

During Q2, we purchased $365 million of our stock on the open market which represented 3% of outstanding shares.

Since the beginning our buyback program, we have purchased $2.4 billion of our stock representing 19% of our outstanding shares.

We have approximately $615 million remaining on our current authorization.

We continue to believe that share repurchases are a good use of our cash because they provide significant earnings leverage as revenues and profits grow.

We also paid out $60 million in dividends in Q2 and have declared a similar dividend to be paid out in Q3.

This represents a payout ratio of almost 50% of the GAAP net income earned during Q2.

At these levels, that's the very high end of levels of our peer companies.

At current stock prices, the dividend represents a yield of approximately 1.8%.

Order rates in Q2 remain strong, continuing the pattern that began for ADI in our first quarter.

On a comparable 13 week basis, end customer order rates increased 10% for the quarter.

The book-to-bill ratio is approximately one, indicating that customer demand, ordering patterns, and lead-times seem to be balanced and the market appears to be stable.

We believe this is further evidence that the inventory correction that the industry had been experiencing may have abated.

We believe that the current demand will allow us to support 3Q revenue in the range of 655 to $685 million.

This range reflects the significant revenue increase we achieved in Q2, coupled with a typical summer seasonality that we typically experience in Q3.

Based on our current inventory levels, we are planning to continue to constrain production in our factories during Q3.

As a result, gross margins during Q3 are planned to be approximately flat to Q2.

We currently believe that Q2 and Q3 of this year will be the trough quarters for gross margin as we are planning to raise production levels in Q4 and we anticipate a relatively stable product mix going forward.

In Q3, we are also planning for expenses to be approximately flat to maybe up slightly as we continue to fund investments in analog engineering programs in power management and low-power converters to MEMS while we continue to reduce expenses in other areas to make room for those investments.

Our plan for non-GAAP EPS as a result of that revenue range is planned to be in the 37% to 41% range for the quarter.

In summary, at Analog, the entire organization really delivered this quarter, outgrowing our competitors.

And we achieved strong profits and excellent cash flow.

In addition, we have an outstanding pipeline of new products as a result of the R&D investments we make and what we've made and the products that we released in the past six quarters that have generated last quarter 20% of our sales.

And I think, if history is a good indicator of the future, that bodes well for future sales growth.

For the rest of the year, our priorities remain as follows.

Our analog product business is our highest priority and our performance on these products has been very strong.

During Q2, our converter revenues grew 12% sequentially on a comparable basis to Q1.

Our amplifier revenues grew 7%.

And together, these products represented 62% of our revenue.

This continues a trend that has demonstrated very strong growth in core analog products for the past several years.

We have the clear opportunity to continue to grow these revenues at very solid rates over the next several years as we protect and expand where we are already strong and we invest in new areas that are very fast growing.

Our micromachine products in addition to mainstream automotive safety systems are now designed into some of the hottest consumer products experienced on unprecedented demand as a result of fundamentally altering the user experience.

As a result, our MEMS revenues grew 23% sequentially on a comparable basis to Q1.

And we've also recently begun sampling many other new MEMS products which are receiving great reviews from potential MEMS customers.

We've raised our investment levels for MEMS products to capture these opportunities and we are refining our MEMS manufacturing strategy for the consumer part of the MEMS product business to significantly reduce our costs and raise margins by utilizing foundries for non-critical process steps.

During Q3, our sales of MEMS products will be limited by manufacturing constraints.

However, by early next year in our fiscal year, our new manufacturing strategy will provide ADI the means to respond rapidly to new growth opportunities at good gross margins with higher return on assets employed in the business.

MEMS can be a very large business for ADI, even at our size.

And there are very few competitors around the world that have the requisite know-how to compete with ADI in this area.

In aggregate, our core analog signal processing products, which include MEMS, RF and some other analog signal processing, grew 11% sequentially and represented 76% of our sales for the quarter.

While achieving very strong performance in our core business, we are also working to improve our performance and better focus our power management and DSP products to achieve more consistent growth at much higher margins.

Power management, while amongst the fastest-growing areas in the analog business, have negatively impacted our sales over the past few quarters.

Clearly, getting growth from our power management products represents a tremendous upside opportunity for ADI.

This is I believe a very achievable goal because we already have very strong brand preference in a very fragmented market.

This market is very different than the converter market which one competitor, namely Analog Devices, dominates the sector.

In the power management business, there is no one competitor that dominates the entire sector.

And as a result, there is opportunities to penetrate various fragmented value-added parts of the market.

In recent customer visits that confirmed to me that our power management product roadmap is on the right track to produce significantly differentiated products at good margins and by staying focused on the value-added part of the power management business that we believe we can make this into an important and a profitable business from ADI going forward.

In DSP, based on a strong competitive position for our general-purpose DSP technology and a strong interest from a wide diversity of customers in many market segments and very strong application synergy with our analog products, we believe we can generate solid growth in profits from general-purpose DSP products.

To achieve this, we've taken many actions to better focus our DSP engineering efforts and I believe many more are likely in the future.

I believe that we are now on the right path to achieve higher and more consistent growth from DSP.

And this also represents good upside for ADI going forward.

In summary, I think we're doing very well in product areas that currently represent 75% of our revenues.

And we are working hard to better focus ADI through direct investments toward those areas that we believe can provide sustainable and profitable revenue growth.

Given that we are in the short-term operating ADI below our profit model, we believe this significant upside a hit for us.

We continue to have a model of 60% gross margin and 60% expenses and 30% operating margins.

And the decisions that we're making every day about products, markets, and the use of our very strong balance sheet are being made based on that model.

I think the very best news is that our service (technical difficulty) available market continue to expand as our technology takes on increasingly important roles in medical, in cars, in telecommunications, in consumer products, and virtually every application out there.

Our brand and our reputation amongst the market leaders in these segments is strong, as our relationships with these large customers.

Even in areas where we already have very high market share, such as digital cameras and base stations, there are excellent opportunities to continue to grow our dollar content in these product areas.

We're focused on exceeding the innovation and the service expectation of these customers and growing our share of the signal processing content in a very wide range of applications.

Thank you, Jerry.

Today's call includes a Q&A period where we would appreciate it if you would limit yourself to one primary question and no more than one follow-on question.

We will try to give you an opportunity to ask additional questions after if we have time remaining for a second round.

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

(Operator Instructions).

Michael Masdea.

The question really I have is, if you look at your results on a 13 week basis, you had a substantially above seasonal quarter last quarter.

And then, this coming quarter, it's depending on I guess what timeframe you used.

It's definitely either below seasonality or more in line with seasonality.

But does that suggest to you that what we really just saw was an inventory replenishment that was fairly short-lived?

Was there anything on a demand picture that's changed or the order picture that has changed that makes you think it's something more?

Well, I think, Michael what we really saw is that we had a strong second quarter.

We typically have a strong second quarter that is not really related or unrelated to inventory replenishment.

It's just typically our second quarter on a 13 week running rate is a strong quarter.

This quarter was a little bit stronger than usual, mostly based on a couple of unique things that are going on at Analog Devices which I mentioned in my opening comments.

So, I think the rest of the year, at least our sense is there is -- it's going to unfold the way a typical year would unfold.

And, we get a little seasonality in Q3 because of July.

And you know, by Q4, particularly after August, the revenue starts growing again and we have a strong quarter.

So I think what we're seeing is -- at least our sense is that it's a pretty typical year.

Demand looks good across a lot of the segments.

There was all this confusion about the inventory for a couple of quarters but that's been I think long pass for us.

So, I think we saw a typical Q2 and a little bit better than that.

We're sort of expecting a typical Q3, mindful of the fact that you have the month of July in there which typically is a weak month.

On the other hand, we have a lot of momentum in some of these other areas which might give it some upside.

So, that's what we baked into the guidance.

And I think that's a very typical pattern for us at least you know for Q3.

Maybe taking that a step further on the second question, just if you look at the wireless business, both on the handset side and the infrastructure business, on the wireless business in the past when we see this kind of strength, there is some risk that you have a bit of inventory correction following.

And on the TDS-CDMA side or the China infrastructure side, you could argue maybe there's some risk there because they are rolling out a new technology.

There needs to be some channel fill, etc.

Is there any concern you have?

Are you seeing any sort of fill and then deplenishment of inventory on that front or would you expect to see that as we get into the fiscal third or fourth quarter?

Well, I think there's always -- we had a good quarter.

There's always risk that you suffer the next quarter.

I think all those risks and all those opportunities are baked into the range that we provided.

Chris Stanley.

(technical difficulty) like flattish in Q3 and then trending up in Q4.

Can you talk about gross margin beyond Q4 and especially in light of it seems like the consumer in the wireless space is growing a little bit faster and that's lower margin.

So, how should we look at gross margin longer-term?

This is Joe McDonough.

As Jerry said in his opening comments, we believe that the appropriate gross margin model for the Company continues to be 60%.

This quarter, the gross margin was below what we had expected for the quarter, primarily due to the mix that was heavily in the consumer space coupled with the fact that we reduced the utilization in our factories.

As we mentioned, the inventories declined 1% this quarter.

We're bringing the days of inventory back toward a more normal 100 to 110 day range.

We were up in the 130 day range earlier in the year.

And, we expect to continue to bring the factory -- the inventories back in line next quarter, continue lower than normal utilization rates in the factories.

The overall utilization rate is somewhere in the 70% range.

It varies by factories.

Within our MEMS factory, we are running that at full capacity and perhaps beyond that as Jerry mentioned in order to keep up with the demand and we aren't quite keeping up with that demand.

So, we are developing alternative manufacturing strategies that should be available early in the year that should both enhance the capacity for MEMS products and also improve both the gross margins and the return on assets that we get in that gaming space and other applications for MEMS devices.

The other factories are running at lower utilizations.

And therefore, as we increase the utilization in the factories, that's an opportunity for improved gross margin on the internally-fabbed products.

We're continuing to work with our foundry partners and our back-end partners in terms of the pricing and the margins that we're able to earn on the products in those spaces.

And so we believe that the gross margins are at a trough point here in the current quarter and will continue at that level next quarter and then begin to improve.

And then, Joe, as a follow-up to that, on the OpEx, good job of lowering the SG&A.

And then you guys gave guidance for Q3.

Now longer-term on OpEx, can we expect SG&A to ramp with sales and R&D to ramp a little faster than that?

Or how should we look at it?

Our expectation would be that we will be able to begin to bring the operating expense as a percentage of sales down.

And therefore, the expenses would grow slower than sales.

And our objective is to bring the operating expenses to 30% of sales.

We're about 5% above that right now.

Romit Shah.

I'm still a little bit confused on the outlook for the July quarter.

You guys indicated that bookings were up 10% and it sounds like the strength is fairly broad-based.

Can you just help us think about going forward, what's going to drive the business?

Is it one to two of your different end markets or do you still expect that the growth in orders to be fairly broad-based?

Well, our sense -- again, you talk about the future, it's always in the future here.

But our sense is that this quarter was a little bit anomalous in the strength in the consumer business.

And that's really driven by new products that are really ramping.

And, what happens in that environment which Joe just tread on lightly -- I will make another comment on it -- when you are trying to ramp capacity as fast as we were on some of these consumer products, you don't always do that at optimal gross margins.

The real challenge is to get the product out to the customers so you don't disappoint them and he can keep up with his demands which generally like I said is not gross margin enhancing.

I think that our best sense on the whole outlook part of it is, the orders were up 10%.

The revenues were up 10%.

So I think those are coincident.

The lead-times are relatively stable.

So I don't think we've seen a lot of customers ordering ahead in order to reserve or horde inventory.

We see the market out here as pretty stable.

And there will be a generic growth rate that we normally see.

And what we've experienced in Q2 is a little bit more than normal based on some of the product ramps that we are experiencing.

Our best sense is that that's going to continue.

I think we always at this point put out our range of a couple of percent on each side because it's very, very hard to call what's going to happen in any sector.

We don't know what's going to happen in July, so I think we're trying to be cautious on the range we provide.

But overall, we believe that the business environment is pretty good.

We saw that last quarter and I don't think there's anything that's changed our mind on that from anything we've seen through the second quarter.

It looks pretty good.

As a follow-up, you guys have done a great job in terms of stock repurchase and you still continue to generate very good free cash flow.

Would you consider taking more aggressive steps and specifically raising debt on your balance sheet to fund and accelerate a share repurchase?

Well, that's certainly something we always consider.

What we have announced so far is what we have agreed with the Board.

We are quite understanding of the leverage that's out there and the impact on the earnings in the future.

We've actually bought back almost 20% of the Company over the last few years which has been pretty aggressive.

And we're always looking at different alternatives and we will consider lots of different things to do with our Board every time we talk to them about it.

And that's about as far as we can say today.

Ross Seymore.

You said that your other analog category was -- MEMS was in there.

MEMS was about 7 points out of the total.

How big is the RF transceiver portion?

I don't know if we have that, Maria, do we?

No, I don't think we report that.

Well maybe another follow-up on that then.

The other analog sub-segment growing the fastest but yet I would have to think that the margins are lower in that.

You talked about the consumer versus industrial margins.

But if we think about it from a product type, how does that other analog category compare to the corporate average or the analog average gross margin?

Well, there's a very large mix in there.

We have -- in the RF category for example we have products that sell into base stations which generate very, very high margins.

And we have some products that go into more consumer-oriented products which generate a little bit lower gross margin.

So, even within that category of other analog, it's -- it would be a mistake to think those are lower on the average than everything else we're doing.

There's plenty of those products that generate the very high gross margins that we see in the amplifier and converter business.

So, it is really a mix of different products in many different categories.

Certainly, there are some in there that generate below corporate average gross margins.

But, there's many others that generate above corporate gross margin.

Okay then, I guess as my follow-up, a more general question.

You guys mentioned about getting into some areas like power management and outside the converter and amplifier market and your goals there.

One of the good things about the analog market as a whole you've always said and I agree with is the fact that it's difficult to take or lose market share.

It happens very slowly because of diverse businesses and customer base.

Why would we believe that you guys would have more success getting into power management, etc., than your peers would have trying to get into your businesses?

Well, I think one of the very clear reasons and the thing that's really shaping our product strategy is that if you take a look at the converter business, we have 40% of it.

And nobody else has more than one-third of that roughly.

So, in order to really win in the converter business for somebody else, you've got to attack a pretty big animal that has very, very wide coverage across virtually every product segment in the converter business.

In the power management business, it is quite different.

There's no one person that has a very large position in every segment of the business.

There are segments that are very different than other segments that you don't need to do all the different segments to win it.

And, I think that's a very fundamental difference between the power management business which is not a homogenous market like the converter market is.

And, you can attack it from a couple of different vantage points without attacking or without investing in the broad range of every power management product.

I mean, the only commonality amongst all power management products is they tend to regulate power.

But, other than that, there's a lot of different segments, particularly those segments where we were already selling our converters and amplifiers where if we're very focused and very careful and don't invest in some of the lower margin segments, it's a pretty good business that we think we can get a pretty good revenue and profitable stream on.

If you look within the power management sector, there are a lot of companies out there supplying power management products that make 30% gross profits.

There are other companies out there that are making 70% gross profits.

And, I think the reason is the products segments are different and the kind of products they supply to those customers is different.

Not that this is a great example, but in the past when we went on the desktop, we generated sales pretty quickly.

So, I think if this was a very homogenous market where there was one big animal out there that really the whole specter of power management products covered, I think we would be a lot more concerned of whether we could ever build a position there as many of our competitors found in the converter business.

But, that's not the characteristics of the power management business.

I think the fragmentation gives us a shot to pick our places and do a good job for a very limited set of customers in very specific segments where they want us to be.

I think that's the fundamental difference.

Louis Gerhardy.

This is [Sandeep Bashgar] calling for Louis Gerhardy.

My question is about royalties.

With the ADI collecting royalties in the DSP area in the prior quarter and then again this quarter in converters, is there a new policy in place to protect IP and can we expect more of these royalties going forward?

I heard the first part but I didn't hear the question part.

The question is about royalties.

Yes, I heard the prelude.

I just didn't hear what the question you were asking is.

You collected royalties on the DSP area in the prior quarter and in converters this quarter.

Is there a new policy in place to protect your IP and can we expect more of these royalties going forward?

Yes, I would say that we spend a lot of money on R&D.

And in places where we have spent that money and we have proprietary technology, we are going to protect it.

By the way, that wasn't sort of royalty in Q2.

That was sort of payments for past sins in a lot of ways.

But, yes, I think generically as a company, when we're spending as much as we are in R&D and we go out there into the marketplace and we see people that are trying to get the benefit of it without spending the money on it, I think we're going to collect those payments.

And I think we're -- we don't do that willy-nilly.

We don't do that without a lot of pre-thought because it's expensive to pursue those companies.

And it costs money and it takes the time of our technical people to do that.

But, I think where it is, we have very strong IP.

We think that people should respect it.

And that is a stronger part of what we're thinking now than we did a few years ago.

So, in that sense, it has changed.

But, the principal is exactly right.

If we invest it and we own it and we spend the money on it, we expect people to respect our IP.

Great.

And a quick follow-up on the MEMS business.

Are you able to tell us what percent of it is in consumer versus auto?

No.

I would say the -- we won't tell you the exact percent.

But, the dominant part of that today is still on the automotive side.

But the growth rate is much higher on the consumer side than it is -- and certainly the opportunities are in both.

There's still tremendous opportunities in the automotive sector.

There's more accelerometers in cars.

We're working on gyroscopes for some of the vehicle stability systems and many other things that are going to generate good growth.

But the growth rate in the consumer area as you might expect is faster than it is in the automotive area.

Although, I think both sectors have room for some growth here.

Uche Orji.

Pull for the next one, Operator.

Simona Jankowski.

I just wanted to clarify one thing first.

When you said your orders were up 10%, was that for the 14 weeks and is that more like the equivalent of 2 to 3% on a 13 week basis?

The comment that Jerry made was a comparison from 13 weeks to 13 weeks.

On a 14 week -- well the book-to-bill ratio was one-to-one -- approximately one-to-one.

So, the orders were up the same as our sales.

So you mean that on the equivalent basis it would've been higher than the 10%?

No, that was.

No, on an equivalent basis, it was 10%.

On an actual basis, the end customer growth was basically the same as our sales.

And then just to clarify then again on your guidance, which does appear to be a little bit below normal seasonality and you're going to continue to have strength in a couple of ADI-specific categories like your MEMS business and presumably on the TDS-CDMA side.

So I'm just wondering if you could highlight some of the parts of the business that might be growing at below seasonal trends right now if there are sort of residual inventory issues out there or is there anything with demand.

Just to clarify a couple of the things you brought up, one of the issues that we have for Q3 is that our MEMS production is sort of maxed out.

So, we're going to have a hard time, even though demand is higher, keeping up with that demand based on the manufacturing capacity we have for those products.

So, even though MEMS was a source of strong growth and the order rates are very strong on the consumer products, for at least next quarter, we are having a hard time keeping up with all that demand.

So that's not going to very much add to our sales.

On the TDS-CDMA part of the business, all the signals we're getting from our folks in China is that the infrastructure is being built and that there seems to be an increasing commitment in China to deploy that technology.

I don't think that on the -- certainly on the handset side and even on the base station side is going to significantly impact our revenues in Q3.

I think those are -- particularly on the handset side, that's more I think after Q3.

So, I don't think those are strong headwinds -- tailwinds rather for Q3.

I think we're just expecting a normal seasonal Q3 where July is a little weaker and May and June are stronger.

And that's what's going to happen.

Now, it could very well be that we get surprised on the upside.

But the range we put out is where at least our best guess is where the whole thing turns out, given all the different pieces moving in those directions.

Sure.

And then, just longer-term Jerry, I think you mentioned that you think you can actually consolidate your share in some of your core businesses, like converters, and you are going to expand into some newer growth opportunities longer-term.

Can you maybe just highlight some of those for us?

Well, like, for example, in the converter area, there is an awful lot of growth in very low power converters for portable products.

And we have significantly raised our investment level to make sure that we capture a large part of that going forward.

I think that's an important part of maintaining or increasing our share in the converter market because those are large opportunities out there.

We have a tremendous amount of activity going on in very high-speed converters.

We are building many new converters for some of the more vertical markets like medical equipment where we actually build a product with 128 converters on a single chip to do 128 channels of signal processing on a body scanner.

So, there is just a whole bunch of opportunities there for us to maintain and perhaps increase our share in that business.

And we would be utter fools not to take advantage of that, which is why we've let the spending go up a little bit to do that, particularly in some of these new areas.

So, that is a $1 billion plus business for us.

It generates extraordinary margins.

And despite all the investment that's gone on in some of our competitors, our share is extremely high.

So, that is going to be where -- that is probably our highest priority in the Company.

Uche Orji.

Just a few questions, first for Jerry.

When you talk about MEMS becoming a large business, can you -- are you able to quantify over what timeframe and how big this could become for ADI?

I think we've told you it's about 7% of our revenues now.

So, you can figure out that's in the sort of mid-$40s million per quarter roughly of revenues.

We're really at the beginning period, particularly in the consumer business.

But as I mentioned earlier, there are some new automotive applications where that can actually save more lives than airbags like vehicle stability control.

At least that's what people believe and that's why the legislation in the United States and probably in other countries is moving towards making those mandatory on cars, much the same way airbags were 10 years ago.

So, I think a lot of it has to do with some of the newer product areas that we're doing.

And, the window of opportunity for us or the window of what's possible is still sort of hard to predict.

But, the one big change in our thinking about that business whereas if you look back a year ago, we thought we had some good technology.

It was in a lot of cars' safety systems and that was going to be a business that while it would grow faster than the overall automotive market, would not be a very fast grower, although a very good business.

I think our opinion on both the automotive side and on the consumer side over the last year or so has changed quite a bit about that about what this business can really become.

And one of the very exciting parts about that business is we don't have an awful lot of competition.

Because there's a tremendous amount of know-how that we have developed over 15 years of supplying very high reliability sensors for one of the most demanding markets in the world called the car safety market.

So, I don't really know how big that can be but I know the slope is good.

And the customer take-up is good.

And we're doing well relative to any competitors.

The application breadth is increasing rapidly.

So, we're working on getting the gross margins of that business up.

We think there's the opportunity to do that and we're looking at ways to get a lot more capacity without devoting a lot more assets to that business I think Joe was alluding to.

So it's one of the areas that in the last year for us has become a lot more exciting prospect than it was say two or three years ago.

At what revenue run rates will your gross margin kind of be equal to corporate average?

Well, we will have to wait and see how that all goes.

I think it's a little early to predict that.

But certainly, we're doing a lot of things to raise the gross margins of that business.

And, some of those things are pretty obvious and intuitive and we know how to do.

So, I don't think there's an awful lot of risk in doing that.

But you know, it was a business that previously we weren't too worried about in terms of the opportunity to get gross margin up.

Now, we see a great opportunity to not only get the revenues up but get gross margins moving up a lot faster than the revenues.

And we're pretty committed to doing that.

Just one last question on the utilization rates.

You talk about constraining utilization rates and you're going to be raising it in post the August timeframe.

Especially it's -- should we imply from that statement that you may have had to give up revenues outside of the MEMS area just because utilization rates couldn't keep up with demand for this quarter?

And is there any reason why you wouldn't want to raise it a little bit earlier just in case demand comes to you a little bit ahead of time partly because--?

Well, we're raising it right now as fast as we can raise it.

This is on MEMS.

This is very complex technology.

We actually think about what happens in these products.

There's actually a silicon beam that moves.

So, getting that beam right is real important.

The other thing we're trying to do now which we believe by the early part of our next fiscal year will be achieved is, we're trying to build this thing on a CMOS substrate as compared to a BiCMOS substrate, which fundamentally is a lot lower cost process than a BiCMOS process.

So, we're working as fast as we can on the MEMS side to get as much capacity in place as we possibly can.

We're trying to be thoughtful about that with the cost structure of those -- of that new capacity in mind to be sort of a much more asset-light model for that business than historically it's been.

This is Joe McDonough, just to clarify a point so that we don't provide any confusion on the MEMS business.

The MEMS business is profitable.

It has a nice good operating profit as a percentage of sales.

And what we see are opportunities -- volume opportunities where we would like to respond to those opportunities and obtain gross margins that we think are appropriate.

And so, that's the effort that Jerry mentioned which is underway.

What Joe is basically saying is, he's saying no -- if Nintendo is selling all those parts based on our technology, obviously it is worth something.

And we're going to figure out a way to get the profits of all that stuff to the level that we want and we think it's pretty straightforward to do that.

It's just historically, we didn't anticipate this kind of revenue ramp.

And as a result, we are scurrying around to get the capacity in place at the right cost.

I think that is a fair way to say it.

Sumit Dhanda.

I had a couple of questions.

Joe, could you possibly give us a sense of as you are done constraining your inventory build and your utilization, given everything else being equal and normal seasonality of business, what kind of gross margins do you expect to rebound to, especially given the fact that your target model is 60% and really over what timeframe do you expect to achieve that?

We aren't very far away from the 60%.

So, it's just a question of ramping up the utilization rates in the factory.

And we should be able to achieve the 60% model.

Our objective is not to create an expectation that the gross margins are going to go way beyond 60%.

As Jerry mentioned, the decisions we're making internally within the business are consistent with earning 60% gross margin.

So, we only have a short way to go in order to get back to the 60%.

We do not want to create an expectation that that is likely to happen in either the third or the fourth quarter.

Although in the fourth quarter, we will start moving in the right direction.

Yes, I think a lot more of the profit leverage way to think about it is, we have a couple of points of profit leverage on the gross margin.

And we have a lot more profit leverage on the expense side and we are working on both of those hard.

As it relates to that, the other question I had was, your SG&A line was down fairly dramatically in a 14 week quarter.

So I guess what has really allowed you to achieve that level of cost controls?

And is this one time in nature I suppose?

Well SMG&A, we do have to -- we're providing what we refer to as non-GAAP financials.

And the SMG&A has a few different items running through it, which if you look carefully at the reconciliation from GAAP to non-GAAP, you'll see that they affect SMG&A.

On a non-GAAP basis, the SMG&A in the first quarter was actually up 3% from the fourth quarter.

And, in the second quarter, it was down 2%.

Okay, that clarifies things.

And then, just a couple more follow-ups.

Jerry, based on your commentary about bookings being up 10% sequentially on an apples-to-apples basis, is the implication that despite the increase in bookings, it is mainly turns bookings and the backlog is relatively flat here heading into the July quarter?

The backlog -- the backlog going into the fourth quarter, the total backlog is --

Going into the third quarter --

Going into the third quarter is $403 million.

That's backlog with 13 week delivery times that customers are requesting.

And that is the combined backlog from both our OEM customers and from our distributors, not from the distributors' customers but rather from our distributors.

And how does that compare on a 13 week basis versus--?

So, the way that it compares -- well, backlog doesn't really matter whether it's a 13 week or backlog at any point in time.

Last quarter, we had $419 million worth of backlog going into the first quarter.

But, the difference is, last quarter, the distributor backlog was higher than normal.

This quarter, the distributor backlog has normalized and the backlog from our OEM customers is higher now than it was at the beginning of the first quarter, so the OEM which is our direct customer base.

Our direct customer base backlog was actually 3% higher now than it was at the beginning of the first quarter.

And the distributor backlog really doesn't mean much at all since it is simply a desire from the distributors to build inventory that they would like to carry.

So, we think that the backlog is appropriate at this point in time to sustain the revenue guidance that we gave out and there's nothing abnormal about that.

Then, one final question and I don't know if you really answered this.

But, within your DSP business, your wireless DSPs, two straight quarters of strong growth.

Can you help us understand what is fueling that?

And then, conversely, your general-purpose DSP business was down fairly significantly this quarter, if you could help us understand what happened there.

Well, I think the handset business -- the chipset business we've talked about very often that it is a fairly volatile business.

So, I don't think there's anything to read into that one way or the other.

It's a seasonal and somewhat volatile business for us and that's one of the great challenges for us in that business.

All these businesses bounce around a little quarter to quarter.

I don't think there's a lot of news in that one way or the other that is really relevant to trying to figure out what is going on in those businesses.

They -- all those businesses tend to have sort of narrower customer bases than our general-purpose analog business.

And therefore, it tends to bounce around a little more or less based on what happened to any particular customer in any quarter.

So, I don't think there's anything noteworthy to report there.

That business tends to be a little more volatile quarter-to-quarter than the rest of our business.

And, there's not much more to it than that.

Then one final question, Jerry.

Your efforts to reduce R&D and other businesses, could you highlight what businesses you are targeting for a reduction in R&D?

Well, you know, we've gotten out of a few businesses.

We're really trying to focus the R&D in our DSP business towards places where we think we can build and sustain a viable sustainable, high-margin business.

I think we're focusing the power business on the opportunities that we think are differentiated.

So, all around the Company, we have really tried and we will continue to -- the mission is far from over -- to continue to focus the business on the places that we think are additive to long-term shareholder value for us.

And, it's -- we like to talk about those things sort of after we do them instead of before.

But, there continues to be a lot of things on the plate that we look at.

And you know, we're trying to focus the Company more so than before.

I think you'll see that over the next couple of quarters.

Tore Svanberg.

A couple of questions.

First of all, Jerry, I realize backlog hasn't changed much and lead-times are stable.

But, could you qualitatively just talk a little about visibility?

Are your customers feeling better about business, worse about business, just trying to see where the market stands right now?

I would say you know, it's a conglomeration of a lot of different customers.

And I spent last week in Europe running around to a bunch of our largest customers.

And I would say by and large, the industrial customer base is relatively happy.

They are seeing good opportunities.

They're not saying business is going through the roof.

But, they are saying -- they are seeing things go okay.

I think the -- some of the anomalies this quarter for us in the consumer business, of course, those customers are very optimistic about some of the product cycles they are in.

But I would say when you look across a lot of customers in a lot of markets, I don't -- I think it would be a mistake to think that the world has returned to 2001 and everyone is going to start putting up a ton of sequential double-digit quarters here.

But, I think people believe business is stable and they are relatively optimistic about the next couple of quarters and the next year.

I think generically, that's what we're hearing, which is generically what we believe in the way we're going to manage the Company.

Great, thanks.

And, Joe, I think you mentioned your goal is to get inventory days to about 1 -- 110.

Could you maybe put a timeframe on that please?

Well, we're not panicked to do that.

Our first priority is to be able to have the product that the customers demand.

And, at this moment in time, we think we have that.

And therefore, we've been running the factories a little bit lighter than we had been.

So, it's a balancing act.

But customer service certainly comes first.

So could we maybe get to that range by the end of the year you think?

In the neighborhood.

We aren't very far away from it.

We're only 10 days above it.

Douglas Freedman.

I would like to focus, Jerry, on the operating expenses.

Your guidance is for operating expenses to remain flat to slightly up.

Is that including the 8.5 million that you credited to operating expense this quarter due to the litigation resolution?

When we talk about the operating expenses, we're talking about the non-GAAP operating expenses being flat to slightly up.

It so happens that the GAAP operating expenses will also be flat to slightly up, simply because of the ins and outs that were in there in the third quarter.

But, the way we manage the Company and the way reason that we publish the non-GAAP financial statement is because those are the numbers that we manage the Company on.

They are the expenses that are incurred on a recurring basis to run the business.

And we think that by providing that information, it is useful to the shareholders the way we run the business.

We occasionally have good things and bad things that happen that are one-off-type events.

This quarter, the good thing that happened was the settlement of the litigation with Maxim.

And that produced a credit or reduction of operating expenses in the GAAP P&L this quarter.

That certainly will not repeat next quarter since we don't have another settlement like it that we're planning for.

Was that expected at the beginning of the quarter?

Because I'm just thinking that without that, your operating expenses would have been well above where I think anybody thought they might have come in.

No, we had other -- we have different items each quarter and we publish those in our financials in the GAAP to non-GAAP.

This was the Joe McDonough.

I think what Joe was saying is that if you look at the operating expenses, exclusive of all these things that are coming in extraneously, the operating expenses on what we look at as the sort of non-GAAP way because that's the only way we can understand it are right about -- in fact, maybe even dropped less than where we thought they would be for the quarter and predicted they would be for the quarter.

So, I think that's the numbers.

And all that other stuff -- freight and airplane dollars -- aren't included in any of that stuff.

And what we're saying about the coming quarter is relative to the same baseline, not including all these extraneous ins and outs, the expenses are going to be about flat to that number.

This quarter, you'll notice that there was a restructuring-related expense of $10,116,000.

That was primarily the final expense associated with shutting down the Santa Clara fab.

And you'll see the detail of that in the 10-Q that we just filed this afternoon.

So, the 10-Q is out there.

All the details of this is now out in the public domain.

If I move on and focus on sort of an area that you guys have talked about now sort of repeatedly for a while in the opportunity in power management, I noticed that you are grouping power management and references together.

What percentage of that business is presently reference, given the fact that sort of references sell with your converters and it's a market that you have a pretty good control over.

I really don't have those numbers offhand.

We could try to dig them out and get them.

But, I really don't know.

And I guess, just following up an earlier question, the power management effort you guys have been putting in is -- it has been lengthy, correct?

You started a power management division if I'm correct over 10 years ago.

Today, it's about a $200 million a year business.

Have you looked at the possibility of acquiring other power management players?

As you mention, it's a very diverse market and one in which there has to be opportunity to consolidate.

I think there -- our group does look at a lot of external opportunities and evaluates them against some of the internal developments we're doing and that's always on the screen.

And it's consistently -- or particularly in the last year, it's been on the screen.

So, we'll have to wait and see how that goes.

But, it's still a great -- even know it's been a long haul to get to $200 million, it's -- we think you really got to look forward and say, what have you got in the pipeline?

And what are the customers saying about the products that we're sending them?

I spent a fair amount of time in the field talking to those customers about those products.

And when I hear that the level of enthusiasm of particularly some of these very targeted products, I get enthusiastic that we've got -- it's not a question of power management or references or anything.

It's questions -- can we put products out there that customers want that they will pay for?

I get a very strong sense when I go out there that we have a lot of those products and now is not the time to get fainthearted about that.

Although, I can understand some of the anxiety about all the investment and what we've gotten so far.

These things take a long time sometimes and then you get here.

But if I thought and I was getting feedback from the customers that we didn't have the right products and they didn't think they were significantly better than many of the products out there and they were saying that when you get it to us, we will buy it -- believe me, I'm not a glutton for pain on this thing.

But I just think that we have particularly in a couple of areas some great products here.

And if we see them through and we don't lose our confidence on them, we can generate some good sales and good margins in this business and we should do that.

Now, (multiple speakers) if it turns out to be false, we will have to reevaluate.

But, right now, all the feedback I get from the customers is very positive.

Are you comfortable with the position and where you guys are at on turning around the DSP business?

Clearly, the revenue numbers aren't really showing --

No, I would say that we are -- we've made a lot of moves and there's more to go.

And I think what we're really trying to do is focus that business that was fairly defocused on too many things into doing a couple of things very, very well, particularly those products that are very aligned with the analog part of the business.

And, so I think we've got -- we've still got a lot of room for improvement there and we're working on it.

Craig Ellis.

I just wanted to follow up on some of the power management questions.

Jerry, just as you look at your efforts in power management right now and the resources that you're bringing in to bear on that opportunity, do you feel like you've got the right number of design engineers and field engineers or do you need to do further work on the organization to be at a point where you feel like you're staffed appropriately for the opportunity set that's out there?

Well, you know, there's always the opportunity to do more.

But, our sense right now is we have put in a fairly good chunk of expense into that business in terms of product design, application support, field support.

And I think we've got to make our stance here and say, let's now see that through and let's get to work the revenues and the margins.

So, I don't think that we're going to expand the scope of that very much over the next couple of quarters.

I think now is the time to reap the benefits of the investments that we've made.

And is that a business that should be able to over the course of the next four to five quarters, maybe a little bit longer than that hit the target bottle that you have for the broader business?

Yes, I would say that -- you know, as we -- as I was saying to Joe was sort of repeating later, we're making these decisions based on that model for the business and which says we will have some businesses a little bit below and some a little bit above.

But, the average will be that.

And I don't -- you know, there's many, many examples of particularly segments of the power business that do provide that opportunity.

Our job is to invest in those as compared to getting [way led] into areas that have horrible gross margins.

And that's certainly our intent.

And that's what our product development road map is.

That's what our field plan is.

That's what we're trying to do.

Believe me, we have no interest in building a portfolio of power products that makes crappy gross margins.

Good.

And then lastly, you mentioned a focus on operating expense reduction.

Is there anything other than just trying to be careful in terms of how you are staffing your design engineers and field engineers or is there some other initiative that you have underway beyond just (multiple speakers)?

Well, I think what we're really trying to do is better focus the business.

And, that sort of means that we're constantly evaluating where we're putting the money.

And if we say it's going well, great, we redouble our debt.

And if it's areas that we're not doing well and we can't see a way clear of doing well within a reasonable time, we move investments away from that business.

And we've done some of that.

And I expect there's more to be done in the future.

Tristan Gerra.

What type of top-line rebound do you need in the end of the quarter to see gross margin pick up assuming a typical end of year mix with higher consumer exposure?

This is Joe McDonough.

We are planning to increase the utilization in the factory in the fourth quarter.

And therefore, we would expect to begin to see the gross margins move upward.

We did not quantify that.

I did mention that our goal was 60%.

We aren't too far away from that.

But we do not expect to reach that goal during either the third or the fourth quarter.

We would expect in the fourth quarter to start moving in the right direction.

Okay, and then, could you give us a sense for this coming quarter how the various business segments will be tracking?

I don't think there is anything unique that we would have a prognosis for for Q3.

I think we -- we will have to wait and see how the mix turns out and which business does well and which business doesn't.

We have a large mix of businesses and it's very hard to predict a quarter in advance how any of them on an individual basis are going to perform.

So we will have to wait and see how the quarter turns out and we'll tell you how it turned out.

That's about the best we can do.

David Wu.

I was just curious about the -- Jerry, I noticed that the general-purpose DSP declined in the March quarter by -- I'm sorry, the April quarter by quite a bit.

Was that a one-time thing or is there something strange going on in that business that count for that quarter?

And my follow-up is really on the -- you get to 30% operating margin sometime out there.

What do you really have to do to get there in the DSP side?

Well, I think to get to the corporate model on the margins, I think we'd have to have expense ratios in our business that are commensurate with what the opportunity is and the margins we make.

So I think, the real key more than anything else is to focus on the areas that we want to invest in.

And, that's the way to get there.

Some of it is going to come with revenue growth, but I think a lot of it's going to come through better focus on the things that we really can build a long-term sustainable position in there we want to be in.

On the DSP side, it's really a question of both some more revenue growth but also I think better focus on the things that we really think are going to be significant to the future even within that business.

So, that's where -- I think in the GP business, that business has been growing well sequentially as we have reported.

There was a couple of customer anomalies that particularly on the consumer side that were strong one quarter and a little weaker the next quarter.

But, I don't expect there's any real news there.

On a quarter to quarter basis, that thing bounces around quite a bit.

Okay, well, that's the last question we had in our call queue.

So, I want to thank everyone for joining us today and just remind you to mark your calendars for our third-quarter earnings call, which is presently scheduled for Tuesday, August 21, 2007 5 PM.

Thank you.

This concludes today's Analog Devices conference call.

You may now disconnect.