Analog Devices, Inc.
Q2 2008 Earnings Call Transcript

Published: 21 May 2008

[Operator:]

Good afternoon and welcome to the Analog Devices second quarter 2008 earnings conference call. (Operator Instructions) Ms. Kohl, you may begin your conference.

[Mindy Kohl:]

Good afternoon everyone. This is Mindy Kohl, Director of Investor Relations for Analog Devices. If you do not yet have our second quarter 2008 release, you can access it by visiting our website at www.analog.com and clicking on the headline on the homepage. This conference call is also being broadcast live on the Internet. From www.analog.com, select Investor Relations and follow the instructions shown next to the microphone icon. A recording of this conference call will be available today within about two hours of the conference call's completion and will remain available via telephone or Internet playback for one week. Participating in today's call are Jerry Fishman, our President and CEO, Robert McAdam, Vice President and Head of Analog business and Joe McDonough, our Vice President for Finance and CFO. We have scheduled this call for 60 minutes. Jerry Fishman will present our fiscal second quarter results during the first part of the call and the remainder of our time will be devoted to answering questions from analyst participants. We’ll begin in a moment with Jerry’s remarks but first I’d like to take a minute to bring your attention to some new information we posted on the IR section of the website this afternoon. This information has been provided in response to requests from many of you for historical continuing operations data which reflect the divestitures of both the wireless handset modem chipset and PC voltage regulation and thermal monitoring businesses. The schedules we provided present both quarterly and annual historical information for product revenue from continuing operations by end market and product type. Additionally we posted historical quarterly and annual summary P&Ls for continuing operations. Next please note that the information we’re about to discuss includes forward-looking statements for purposes of the Safe Harbor provisions of 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 described in the company’s SEC filings including our most quarterly report on Form 10-Q which was filed earlier today. The forward-looking information that is provided by the company in this call represents our 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 this conference call will include time sensitive information that may be accurate only as of the date of the live broadcast which is May 20, 2008. With that I’ll turn the call over to Jerry for opening remarks.

[Jerry Fishman:]

Good afternoon. As you can tell by our press release our second quarter of 2008 was a very strong quarter for ADI. Our revenues grew 6% sequentially to $649 million, were up 9% year-over-year. And that was certainly well ahead of the plan that we started with at the beginning of the quarter. During my comments this afternoon I will be from time to time referring to the information on our Investor website that Mindy just mentioned, which provides a pretty good analysis of our revenues for our continuing operations over the past five years segmented by both end-market and also by product type. We believe this data will help investors better understand the most important trends in our business and we expect and we hope that you’ll find it useful, because it took plenty of work to get it all done. Revenues from our industrial customers grew about 8% sequentially in Q2 and 10% year-over-year. We enjoyed very good sequential growth in Q2 in most industrial applications with the largest increases in instrumentation, automatic test equipment or ATE, automotive products, and medical products. In aggregate for the quarter industrial end-market which includes all those different sub segments comprised approximately 50% of our revenue during the quarter. Industrial revenues have been growing significantly at Analog now for many years. The five-year compounded annual growth rate for industrial products is about 13% and as a result revenues have grown over 80% during this period. The industrial market which I mentioned is now about half our sales really does represent the backbone of ADI. It’s our most diverse customer base with many different application areas including industrial instrumentation, process control, parameters, security products, automatic test equipment, medical products, defense products, and automotive products. These applications generally require our highest performance technology, support very long lifecycles and earn gross margins above the company average. Our brand is extremely strong amongst those customers and we often receive the first call from designers at leading industrial customers to help them design their new systems. Also emerging are new industrial applications in Southeast Asia and in greater China which represent very high growth potential for ADI in addition to our traditionally strong industrial base in the United States and in Europe. This quarter we also continued our penetration of fast growing automotive and medical applications which are very analog and DSP intensive and we also call part of our industrial product category in all the data that we present. In automotive ADI continues to drive innovation in safety systems, power train electronics, and in entertainment applications as well. We’ve now expanded our safety system focus beyond airbags, to such new areas as electronic stability control systems, which use our MEMS Accelerometers and Gyroscopes and advanced driver assistance systems for accident avoidance which us our highest speed converters and amplifiers, our radio frequency products and in many cases our DSPs. Our high performance analog products are also being used to devise new better re-monitoring systems and breaking sensor interfaces while our SHARC and Blackfin DSPs are being used in new entertainment systems in high end automobiles. In the medical market we have focused on furthering our lead in the most advanced CT imaging and ultrasound systems which utilize highly integrated, high speed converter technology from analog devices. We believe that continued strength of the more classical industrial applications and new growth opportunities in automotive and medical applications, should keep industrial revenues growing at solid rates going forward. Revenues from our communications customers in Q2 grew about 10% sequentially and 20% year-over-year. The sequential growth in the communications market was principally driven by very strong growth in revenues from base station applications and we also saw growth from optical and networking infrastructure products. In aggregate communications applications represented about 25% of our sales last quarter. Our wireless base station revenues grew significantly both sequentially and year-over-year with leading base station manufacturers around the world that are producing GSM, 3G and TDS CDMA equipment in the China market. We have long enjoyed very high market share in high performance data converters and base stations and we’re now gaining share in the bill of materials with our F components such as mixers, variable gain amplifiers, modulators, clock controls, phase lock loops, and more recently digital power controllers. These new functions have significantly increased the size of the opportunity available to ADI in base stations and are the source of a lot of our very significant revenue growth this quarter. Our analog revenues from handsets declined sequentially in Q2 in line with industry trends but were up substantially year-over-year. We have been very successful with leading handset manufacturers in supplying highly differentiated, high value added audio, power management, camera control, and display and also sensor products. This business represents substantial opportunities for ADI as design ends move into high volume production. Consumer revenues experienced small sequential and year-over-year declines in Q2 not surprising given the slowdown in consumer spending in response to the uncertain economic environment. Consumer revenues represented about 20% of our revenues in the second quarter. Our market position in consumer products remains very strong in both digital cameras and advance digital TV, particularly with the largest market share holders and top brands in Japan, who continue to garner a premium price in the market by creating the better user experience. In both of these applications areas we continue to expand the market available to ADI by creating new functionality that gives our customers a competitive edge and also commands premium prices. For example in cameras, we now provide new stereo sound chips as digital cameras now often include motion video, and we also sell products that are lens drivers to control focus on cameras. We are also now beginning to sample a highly integrated power management solution to our leading camera customers. These new functions complement our very high market share in the analog front ends that we’ve been supplying for many years. In addition we’re nearing the end of our capacity constraints in supplying MEMS motion sensors for consumer electronics. We continue to execute on our plan to supply the first real production quantities of consumer MEMS sensors manufactured by TSMC this quarter with volumes increasing through the rest of the year. Now looking at our product revenues our analog products increased 6% sequentially last quarter and 8% year-over-year. By any standard this is a very solid performance and certainly it’s a solid performance relative to the market and many of our closest competitors. Our converter products grew 6% sequentially and 9% year-over-year. Converters remain our largest and our most diverse product family at ADI and contributed 46% of our revenues in the quarter. Our converter revenues have grown now at a compounded growth rate over five years of 13% per year which is well ahead of the market and as a result we have continued to gain share during this period. Very recent statistics published in the March by the Gardener Group or Dataquest indicate that ADI’s share in converters increased to approximately 37% in 2007, over two times that of our closest competitor who actually lost some share in 2007. Other industry analyst data which utilizes a much [inaudible] definition of what our converter product is indicates that ADI share in 2007 was between 43% and 47%. But by any measure even though there are competitive shifts amongst smaller converter competitors ADI continues to be the company that customers most often choose for the essential functions of analog to digital and digital to analog conversions. Amplifiers grew about 10% sequentially in Q2 and were up 10% year-over-year as well. This is a very solid performance for these products relative to the market and other competitors who reported their amplifier sales over the past couple of months. Amplifiers contributed 23% of our revenues in the second quarter. Industry analysts estimate that our share of the overall amplifier market which includes both high performance and commodity amplifiers is approximately 20%. We don’t participate very much in the commodity amplifier category. With respect to the performance category we estimate that our share is approximately twice that or approximately 40%. Our amplifier products have grown at a compounded annual rate of about 10% per year over the last five years. In the category of what we call other analog, includes specialized signal processing solutions, such as MEMO and RF products or radio frequency products. Revenues from the other analog product category grew slightly in Q2 and contributed 16% of our revenues in the quarter. Our other analog product category has grown very significantly over the past five years. The three product categories of data converters, amplifiers and what we call other analog which in aggregate provide analog signal processing functionality represented about 85% of our sales last year. In aggregate, those signal processing categories have grown at a compound annual rate of about 13% per year for the last five years and 8% per year for the past three years despite difficult industry conditions in the market over the last two or three years. Power management products make up the balance of our analog portfolio. We have focused our product development on industrial, communications and consumer applications where we can leverage our position as the leading supplier of converters, amplifiers, and other signal processing functions to customers who already know and already respect ADI’s technology and also our ability to help them through very complex new designs. We are focused on providing the industry’s smallest high performance linear regulators, and switching regulators for portable applications, high performance switching controllers for industrial applications and precision monitoring products for infrastructure and for networking applications. In fact during Q2 we introduced the first digital power controller for mission critical IT and communications applications including cellular base stations and we plan to introduce a number of new products through this year. To date we’re very pleased with our customers’ response and their desire to consider power as an adjunct to our signal processing products. In the second quarter our power management revenues grew 4% sequentially and were up 16% year-over-year and represented about 5% of our total revenues. Our general purpose DSP revenues also grew well in Q2; grew 6% sequentially and 18% year-over-year and represented about 9% of our total revenue. During the second quarter we experienced strong demand for both our SHARC and our Blackfin product families across a diverse set of end applications and many thousands of customers. Gross margins for our general purpose DSP products approximated our corporate average gross margins in Q2 supporting our view that customers do value our technology as evidenced by the high gross margins in that business. In addition we continue to see advantages of having DSP technology in our product portfolio. For example in many new designs, customers typically select the DSP to the microprocessor early in the design cycle which gives us a very early look into their total system design which is an important strategic advantage relative to our analog only competitors. As we’ve noted in previous calls, having completed a divestiture of the more commodity-like DSL products and the cellular base band [modem] product lines which were both R&D intensive and lower margin, our full focus now is on our general purpose DSPs where we can exploit synergies with our analog portfolio in applications such as communications, automotive, and home entertainment products. Recent industry data indicates that ADI holds a leading market share of the overall general purpose DSP market and we believe this business fits well with our current business model and presents a good growth opportunity particularly amongst the many thousands of customers that ADI has served over many years. As I mentioned earlier our revenues grew 6% in aggregate to $649 million and our gross margins were about 61% or about flat to last quarter. The positive impact of a favorable mix of industrial and communications revenues was partially offset by very strong sales of automotive products which carries somewhat lower gross margins and also the impact of lower margin consumer MEMS products. As I mentioned earlier we are on plan to open up additional capacity for our consumer MEMS products through our relationship with TSMC in Taiwan. More business transferring to TSMC should provide us with significant cost reductions and much greater scale for these products later this year. Our operating expenses grew about 4% sequentially which was directly in line with our plan for the quarter. Expense increases were mostly the result of annual salary increases which we implemented early in the quarter. The headcount at ADI remained approximately flat to Q1 levels in line with our plan to modulate expense growth for the remainder of 2008 to achieve good operating leverage as sales increase. Our operating profits increased to $157 million or 24.2% of sales which was up about 40 basis points sequentially. Our earnings from continuing operations were $0.44 which was up 10% sequentially from the $0.40 we reported in Q1 on the same basis. On a year-over-year basis, operating profits increased 17% and earnings per share increased 19% representing significant leverage on a 9% year-over-year increase in revenue. In addition our balance sheet and our cash flow continue to be very strong during the quarter. Our operating cash flow was $154 million after a reduction of $67 million of taxes on gains of last quarter’s sales of businesses. Combined the $221 million that we generated last quarter represented 34% of our revenues. Capital expenditures were about $31 million or about 5% of sales. Inventory declined by $11 million sequentially or 3% in Q2. Days in inventory as a result decreased from 127 days last quarter to 115 days at the end of this quarter which is beginning to approach our target levels. Accounts receivable at the end of the quarter also decreased by 2% compared to last quarter while day sales outstanding declined by four days from 51 to 47. During the quarter we repurchased 5.8 million shares of our stock or 2% of the outstanding shares for approximately $165 million. Since our program began we’ve repurchased almost 30% of our outstanding shares for $3.9 million and the average cost of all the shares we repurchased was approximately $34.00. During the quarter we also paid out $53 million in dividends and the Board has authorized an increase of the dividend from $0.18 per quarter to $0.20 per quarter per share which now represents 45% of second quarter earnings from continuing operations. We ended the quarter with about $1.2 billion of cash and no debt. Approximately $1 billion is held outside the United States in various foreign subsidiaries. Orders remain very strong for ADI during the second quarter. End customer orders on our distributors and OEM orders increased sequentially by 4% and 6% respectively from first quarter levels. We continue to experience very strong turns environment where many customers are placing orders for delivery during the quarter and our backlog entering the quarter was approximately flat to the backlog that we had entering last quarter. Our operating plan for Q3 is for revenues to be in the range of about $650 million to $665 million or about flat to up 3% to 10% sequentially. Gross margins are estimated to be approximately 61% and operating expenses will increase only very slightly. However our plan does not factor in any potential effects of ongoing financial market uncertainty which could translate into a more cautious stance from our customers. We’ll just have to wait and see how that materializes during the quarter. If the operating plans achieved the earnings from continuing operations as expected to be in the range of about $0.43 to $0.45, and the earnings from discontinued operations is expected to add another $0.02 to $0.03 to that. Clearly ADI enjoyed a very strong quarter in a tough economic environment. The important ingredients in our success in Q2 are the good returns that we’re getting on the significant investments that we made over the last few years and also and equally important, the reshaping of our product portfolio to focus on high growth, very profitable segments where customers value innovation because it really does change the user experience. As you’ll observe in all the schedules that we’ve now put on the website our product portfolio is now focused on end markets and products that have grown faster than the market and produce above average returns. By keeping our focus on innovation we believe we can continue to grow our sales and earnings at very attractive rates going forward. In addition we’ve increased the returns to shareholders by using our strong balance sheet and cash flow to repurchase now almost 30% of our stock in the open market over the past few years. We’ve also increased our dividend per share which now represents 45% of our earnings and a yield of about 2.3% at current stock prices. So I think in summary when investors look at ADI now I would suggest that there are really five important things to consider. ADI has had a 40-year history of innovation in signal processing which has provided strong growth at very attractive margins and is now better focused than in our recent past with a stronger portfolio than we’ve had before. While industry growth rates have certainly modulated in the past few years, signal processing is growing much faster than the semiconductor market in general since new generations of electronic equipment are more dependent on signal processing than ever before. ADI’s unique technology and strong market position should continue to provide the foundation for attractive growth rates going forward as a result. ADI is holding or gaining share in product areas where we’re strong, namely converters, amplifiers and general purpose DSPs and gaining share in new product categories such as radio frequency products, and MEMS products. Other initiatives such as power management could provide further upside beginning in 2009. ADI has a stable diversified base of industrial customers which provide solid growth and exceptional margins and now represents approximately half our revenues. ADI has the opportunity to achieve three to four points of sales operating leverage as we make progress towards our model of 27% to 28% operating margins which includes 2% to 2.5% of expense for stock options. ADI’s exceptional cash flow provides the opportunity to further enhance shareholder returns and I think as an aside also demonstrates the quality of our earnings.

[Operator:]

(Operator Instructions) Your first question comes from the line of Craig Hettenbach – Goldman Sachs

[Craig Hettenbach:]

Jerry you mentioned qualifying TSMC for the MEMS product, can you just give a little more color in terms of some of the applications over the next 12 to 18 months particularly within consumer that you think you’ll drive some growth within MEMS?

[Jerry Fishman:]

With our supply being very limited, most of our consumer MEMS products were going towards video games and we’ve talked about that quite a bit in the past and we’ve only really been able to sample other applications for some of those products. I think as we go forward we first of all have an opportunity to use that with other broader spectrum of motion sensing consumer gains with other gain producers that we’ve been short on supply to be able to do. But there’s a myriad of other applications for MEMS products and microphones and switches and just a whole raft of other things that we believe that we’re going to be able to really get scale on now to be able to do. I think getting clear on the capacity and the scale that we can produce these products at now with the, what I think to be a very important side benefit that the, we’ll be able to access much lower cost structure at TSMC where we can build those in a large modern fab that have large scale will help us. So I think it’s really the combination of we’ll be able to expand into other applications and we’ll be able to make higher margins on the MEMS products than we’ve been making on the consumer side. So we’re looking forward to that transition I can tell you.

[Craig Hettenbach:]

You spoke that orders were strong in the quarter, can you give us a sense of linearity as you went through the April quarter and then into the beginning of May here.

[Jerry Fishman:]

I think it was pretty linear during the quarter. We always experience a little softness around the Chinese New Year at the very beginning of the quarter but we anticipated that because it comes every year. So I’d say to the first approximation one of the things we were most excited about during the quarter is the quarter was quite linear.

[Operator:]

Your next question comes from the line of Romit Shah – Lehman Brothers

[Romit Shah:]

Jerry on the last call you took a decent haircut to your guidance to account for the macroeconomic. Do you have the same mindset this quarter, or do you feel like you’ve got a more clear view of how the quarter is going to trend?

[Jerry Fishman:]

There’s always a lot of risk out there. We try to put out some guidance on what our plan that we’re operating the company under. Certainly we did better than our plan last quarter and we were able to respond to it even though we had planned for numbers that were below what we actually achieved. So I think we have good production levels in our factories so we have to operate the company under a plan and that’s what we indicated. The plan is if it turns out that its better than that we’ll be able to respond to it and if it turns out its worse than that we’ll have to respond to that too. There is a lot of uncertainty out there so I think getting ahead and being very aggressive on the guidance isn’t a very smart thing to do for us or anybody else right now. But we’ve seen good strength in our business last quarter. The order rates were higher than we thought. We captured a large portion of those orders so we haven’t really seen any weakness as a lot of people have been anticipating based on what’s going on in the financial markets, but who knows, in that sense you probably have a better guess with that than we do. But what we’re trying to communicate is basically what the plan is that we’re going to operate the company under for the quarter and if it turns out better we’ll be able to respond to it.

[Romit Shah:]

It seems as the year progresses you’re going to be more dependent on your consumer business to grow the top line, can you give us some feedback from some of your largest consumer customers?

[Jerry Fishman:]

Well I think by and large they’re, we had a reasonably good consumer quarter. We expected to get more revenues on the consumer side, a little bit less revenues on the industrial side when we started the quarter. But there are still plenty of cameras being sold and TVs being sold and video games are jumping off the shelf so we’ll see. We haven’t taken a very aggressive stance on that for next quarter. Where as typically you’d see a stronger third quarter for us in the consumer business so our guys in the product groups tend to read the newspapers and they’re cautious on that. We’ll have to see and I think all that’s wrapped up in the plan that we put together for the quarter.

[Romit Shah:]

You did a good job reducing your internal inventories; did you lower your production rates as well?

[Joe McDonough:]

The production rates during the quarter were pretty similar to last quarter, nothing dramatic.

[Operator:]

Your next question comes from the line of Craig Ellis – Citigroup

[Craig Ellis:]

Jerry it sounds like some of the upside in the quarter was driven by industrial, does that mean that the communications was in line or was that also a little bit better than what you expected?

[Jerry Fishman:]

I think both the industrial and the communications were a little bit better than we thought. Typically in our second quarter we generally see a good lift in the industrial business because there are more sales days and there’s not a lot of holidays and that tends to drive the sales of that up. We were a little bit more cautious going into the quarter about that business than we typically would be and that’s the result of what guidance that we put out for the second quarter was. It turned out that there was no reason to be cautious about either of those businesses because they both did what we would typically see in our second quarter.

[Craig Ellis:]

Switching to the industrial business, that’s one that is typically seasonally strong in the first half, less so in the second half, but a lot of the infrastructure development globally is dependent upon infrastructure or industrial related products, how should we think about the seasonality of that business in a year like this?

[Jerry Fishman:]

I think that the guidance that we put out is sort of our typical guidance. If you go back and look at a lot of years in our third quarter we usually see a few percent up and sometimes it’s a little higher than that. Sometimes a little lower than that but that’s in line with we’ll get some growth in the industrial business, we’ll get a little growth in the consumer business so it tends to be a quarter that we don’t see extraordinary ups and downs in any business in a normal year. Where we have excursions from that it’s typically due to the economy or just the whole world moving strongly one way or the other. So I think what our guidance represents for this quarter is a sense that third quarter is going to be about a typical quarter for Analog and that’s what our plan is based on.

[Joe McDonough:]

One point on the industrial business that’s worth noting is that in aggregate industrial represents 50% of the revenues of the company. But about half of that or 25% or 26% of the revenues of the company is in the core classic industrial space. The rest of it is in medical and automotive, automatic test equipment and military so those are the sub segments that are categorized as industrial in the aggregate for the company.

[Jerry Fishman:]

Those by the way tend to be a little less seasonal than the industrial, the core industrial business which tends to be related to how many days you have in the quarter as much as anything.

[Operator:]

Your next question comes from the line of Sumit Dhanda - Banc of America Securities

[Sumit Dhanda:]

Jerry I wanted to dig a little deeper into your gross margins in the reported quarter, now you indicated that production levels stayed pretty flat and that the better mix of industrial and com had been offset by auto and consumer MEMS, what I’m having a little trouble with is industrial and com are two thirds, even [axe] autos, and I’m assuming auto and consumer MEMS are no more than 15% of the business so why was the drag as much as it was in terms of offsetting any benefit from what’s obviously a very high margin in industrial and com business?

[Jerry Fishman:]

I think there are a lot of different aspects of the gross margin. The automotive business which had a significant amount of growth, we don’t make the corporate margins in that partly because just automotive products are a little bit lower in margin but also because the MEMS products are below the margin also and that turned out between the MEMS stuff and the automotive stuff to drag our gross margins down a little bit. So I think the way to look at it is 61% is a pretty good gross margin. Its going to vary a little bit based on a lot of different things but overall 61% is good particularly given the fact that we had as many or some tailwinds and some headwinds there that moved that. I think without the headwinds it would have been higher, but you always have some headwinds. I think in aggregate we’ve been reasonably consistent in saying that we thought 61%, maybe it’ll go up a little bit from there is a good gross margin for the company and that’s the mix that we’re investing towards.

[Sumit Dhanda:]

On the operating margin side, clearly the target is to get them up four or five points from current levels; you had some annual salary increases this quarter, how should we think about you getting there. Is it that the OpEx structure from here on out until your next annual raise is going to be relatively flat no matter what the revenue line does or is there a specific revenue target level you think allows you to get to those operating margin targets given the fact that your gross margins are going to be roughly flat from here from your earlier comment.

[Jerry Fishman:]

I think the way to think about it is that we had a jump on the expense line, mostly related to the salary increases as mentioned. We’re going to keep the, the headcount by the way last quarter was relatively flat to the quarter before so I think that in the coming quarters that’s still our plan and therefore the expenses if the revenues grow with the kind of rates that we’re planning for, the expenses will grow at rates well below the revenue growth rates. And as a result of that we expect to get good operating leverage going forward. All I can tell you is that the [expenses] are going to grow at a rate lower than the sales growth rate. That’s our plan and we’ll modulate that as the circumstances determine we should. But I don’t have a number for you saying when we get to $700x million we’ll be at that target. We’re going to make steady progress towards getting to that target. Its one of the highest priorities in the company now. We know how to do that, we’ve done it many times before and a large part of doing that is mostly under our control. We’re spending a lot of money on R&D, a lot of money on sales and marketing and I think we’re going to grow into those expenses as the revenues grow. Once we say we’re going to do that it’s a good bet that we will because we control a lot of those variables.

[Sumit Dhanda:]

You’ve invested in power obviously the salary increases happen every year, are there other areas where you think you need to invest above trend line or do you think, do you feel really comfortable of the fact that most of the investments are behind you and you can reasonably grow the OpEx line at half or a third of the rate that the revenue growth is going to come in at?

[Jerry Fishman:]

We’re really upped the expense levels in the company last year in some of these new areas to get some more sales growth and I think its good to see that we are getting sales growth in those areas which is why our revenues were so much better than most of our competitors this quarter. I don’t think there’s another sort of increment that we’re thinking of that we’re not already investing in at pretty high levels so I think that the challenge for us and what we’re planning to do is get the benefits of those investments in the sales line without raising the investment levels very much from where we are. So we don’t have another category where we raise the expense levels considerably in last year that we’re going to raise them again this year. That’s just not what’s in our plan now. So I think it is a reasonable expectation that we can grow the revenues a lot faster than we are going to grow the expenses. That’s discipline that we have in the company, we as a management group have made that determination and that’s the way we’re going to run the company going forward.

[Operator:]

Your next question comes from the line of Tristan Gerra - Robert W. Baird & Co.

[Tristan Gerra:]

In power management what type of gross margin should we expect near-term as you continue to win the business and what product lines specifically are you focusing on right now?

[Jerry Fishman:]

We’re not going to make a projection on the gross margins in any particular product area but it’s an analog product. The kind of markets we are addressing, we think in aggregate can support the kind of gross margins that we’re running in the company and that’s certainly the objectives that we have for that business.

[Tristan Gerra:]

You reiterated that last quarter the utilization rates were pretty much in line with the previous quarter, given the trend what should we expect in terms of utilization rates for this quarter?

[Joe McDonough:]

You should expect the utilization rates to remain about the same. There’s no significant affect on the gross margin that’s likely to be caused by a significant change in the way that we run the factories. I think one of the points that we tried to make in putting up some of the schedules that you’ll see on the website, is and we’ve broken the revenues over a long period of time of continuing operations between the different product types, the different end markets and what you’ll see there is that 85% of the company’s revenues are derived from converters, amplifiers and analog signal processing excluding the power management part of the business. And so a substantial portion of the investments that we make in engineering and other operating expenses are going toward that 85% of the business. It’s the other 15% of the business where there is an opportunity for growth. There’s a little bit of a disproportionate engineering spend in the other 15% but its not terribly significant and that’s the portion of the business that does have an opportunity if we can get it right to grow the revenues since the power management revenues are a small portion of the business. But there’s nothing now that we’ve disposed of some portion of that business, there’s nothing in that power management business that is substantially different at the gross margin level from the company as a whole. It’s a little bit less, but it’s not substantially less any more. So the gross margin I think as Jerry said, the 61% gross margin is the gross margin that we believe is a very good gross margin in the semiconductor industry. It’s slightly above the gross margin model for the company and from quarter-to-quarter it will vary a little bit above or below 61%. But for a change from 61.2% to 61% to try to find out the root cause of it, we have tens of thousands of products across a whole lot of different end markets and there are a lot of different gross margins in that mix. So there’s not any one item that has caused a 2/10th of a point change in the gross margin.

[Operator:]

Your next question comes from the line of Chris Danely – JP Morgan

[Chris Danely:]

Just another question on gross margin and this is more looking into the second half of the year so in general the industrial market is a little bit stronger in the first half and that’s your higher margin area, as we get into the second half of the year, in the general the MENS and the consumer which is lower margin tends to be a little bit stronger, you said your gross margin should osculate around 61% so is it fair to expect a little bit of potential weakness in gross margins in the second half of the year?

[Joe McDonough:]

We don’t that to that degree. The core industrial business which is the portion that you’re talking about is 26% or so of the total sales of the company. That business has been growing quite nicely over the past couple of years. There’s nothing terribly unusual about it from quarter-to-quarter we had some pretty good growth this quarter in base stations. There are reasons to believe that business continues to be pretty good. The automatic test equipment business is another business that turned out to be okay this quarter. And I think it’s kind of hard as we look out through the second half of the year to try to estimate exactly what the gross margin impact will be as a result of a slightly different mix in the overall business but we do believe that we have a good mix of businesses. We’ve got them aligned in a way that we think we can produce 61%, 60%, 61% type of gross margins, maybe a little more then that from time to time. It’s just a very good portfolio of businesses.

[Chris Danely:]

One thing that Jerry mentioned was moving the MEMS production to TSMC, how much should that benefit the margins and then when do you expect that to be a material impact to your model?

[Jerry Fishman:]

Its important to realize that the MEMS products are [48%] of our sales, I think roughly, so I think all these are just normal things that go on in the context of trying to run our business. We transfer production that gives us scale and its going to help us on the gross margins but there are so many moving parts as Joe was saying when you’re selling ten thousand products to a hundred thousand customers, that small, what happens in one product line in the quarter might change the gross margins 10, 20, 30, 40, 50 basis points but that’s what really happens so I think the way to think about Analog is that 61% is a good number. Like Joe said maybe it’ll go up a little, maybe it’ll go down a little in any particular quarter because of the mix or because of yields or because of any problems or opportunities that we might get and that the leverage that we’re going get is on the operating expense level and the way I would describe it is, I would take all the business I could get at 61 points of gross margin because its an enormously profitable business. And the challenge and the opportunity for us is to get the operating expense ratios down so we can get the operating margins moving. And that’s the way we’re trying to plan and run the company right now.

[Operator:]

Your next question comes from the line of Steve Smigie – Raymond James & Associates

[Steve Smigie:]

On the MEMS capacity you have, can you say on a dollar basis what that is and can you remind me would there by any potential backend constraints on manufacturing capacity for MEMS?

[Jerry Fishman:]

I think I mentioned MEMS is about 8% of our sales so that runs about $50 million plus or minus a quarter. The consumer MEMS products are the ones that have been the most capacity constrained because that’s the place where we’ve seen the biggest, the most steep revenue inclines that we’ve had. There’s not much more we’re going to say about that other than certainly if we had more capacity we would have gotten more sales out of that this year and now that we do have capacity it’s going to really help us on both the front of scale and cost. So with the margin it gives us a little tailwind on the margin but on $50 million of sales you don’t get a lot of tailwinds on any particular thing. You need everything moving right to get the gross margins up from here. But the thing, I think the way to think about it is that we have a business that even at these margins, is generating 33% of our sales and cash every quarter. That’s a pretty attractive business. We think we can constrain the expenses to get the margins up by three or four points which will make it an even more attractive business but I think that the concept of running 60 plus odd percent gross margin makes it a pretty attractive investment given the returns we’re getting below that. The gross margins will go up and down a little bit. And it could be that in a quarter or two we come back and we say well the mix has shifted and the margins will be a little higher because of this or that or we successfully executed some cost reduction programs that combined with all the other things we’re doing around the company will move the margins up. And we hope that happens. But I want to reemphasize that the primary leverage we have is on the expense line which is mostly in our control.

[Steve Smigie:]

You did a nice job increasing the dividend and buying back shares, can you talk a little bit about what that looks like over the next year in terms of more buybacks or increasing dividend. Is there a certain percentage per year you want to be increasing the dividend?

[Jerry Fishman:]

Certainly we’ve bought a lot of stock back and as I mentioned earlier a large portion of our cash balance is overseas in line with the cash generation capability over many years of our Irish subsidiary, so given that, in order to execute a lot more buybacks we’d have to borrow some money which we’re certainly quite willing and able to do given the strength of our balance sheet. It’s a little bit unsettled out there to borrow money so we’re being a little bit cautious about that. But I think over a long period of time certainly we have the opportunity to keep deploying our cash to raise shareholder returns in both dividends and buybacks and we will continue to depending on the conditions out there in the market that might either go up or down from where it is, but we’ll just have to wait and see how credit conditions are out there. We still have a good [inaudible] cash; it’s just that right now most of that resides offshore.

[Operator:]

Your next question comes from the line of Uche Orji – UBS

[Uche Orji:]

On the comments you made on the base station market being strong, do you have any color as to what region and what type of products that’s driving this strength at the moment and any insight as to how sustained that has, that has remained in today’s current quarter?

[Jerry Fishman:]

I think what I said in the earlier comments I believe is that we saw a pretty good strength from some of the older GSM base stations, some of the new 3G base stations and of course we have a very, very strong position in China on [TDF CDMA] base stations and the way to really think about the strength that we’re seeing is its really a combination of just the strength we’ve had on the converter side which is one of the primary product areas that we serve base stations with but all the new RF products that I mentioned in the opening comments that we’ve put out into the market which is one of the areas that we’ve significantly increased our spending rates on last year, are really adding to that so its not just the unit volumes of base stations that we’re seeing good growth in, it’s the fact that we’re getting a lot more dollars per base station that we sell into. Of course the product mix that we have right now is much broader than it was a year or two ago. So that’s a place that really is a market that requires the highest performance products that we make throughout the company in virtually every area. So a lot of our products are defined with that end market in mind because it’s the most performance hungry market that we serve. So we have good positions with virtually every base station manufacturer around the world. In one quarter it might be stronger in China, the next quarter in Europe, and the next quarter in the US. But we’re well positioned with the largest base station manufacturers in virtually every geography.

[Uche Orji:]

I know you said your operating rates were the same as last quarter but is there any way for us to kind of quantify what these rates were in your factories and related to that also is I know you’ve been in a mode of bringing your inventory level down to a target, as you mean that, that will mean lowering your operating rates. If you’re above target and you start to increase your operating rate is it possible that this could be a factor that could influence gross margin in the future?

[Joe McDonough:]

The utilization rates are somewhere in the 65%, 70% range within the factories, probably closer to the 70% number but that’s, our factories produce about 55 or 58 or some number of our sales, the rest of it is produced in external factories. I think that you should not assume that there is a meaningful change in the utilization rates or the gross margin as a result of our inventory goals getting from 115 days to say 110 days or 105 days. Our primary purpose in running our factories is to have product available for the customers when they want to buy it. And we manufacture thousands of different products and our primary objective is to have them available because we make a large profit every time they say they’d like some of it. So there’s nothing about this gross margin, that there’s a point here a point there that’s some sort of a magic bullet. But there’s an awful lot about it that’s very complicated and running the business in order to achieve a 61% gross margin. I think the growth of the company in the earnings is and most of the actions that we take within the company in terms of investing in R&D and other things that we do in disposing of businesses are focused on the growth of the revenues and analog signal processing which is our converters, amplifiers, RF and the MEMS and some of the other analog signal processing products. Last year in 2007 they grew 10%, that’s 85% of our revenues grew 10%. Over the last three years it grew 8%. Over the last five years it grew 13%. So we believe we have a portfolio that has some pretty good growth characteristics that exceed the growth opportunities in the semiconductor industry as a whole and that’s where most of the focus and attention within the company goes. At the same time we try to produce gross margins that are above 60% which we’re doing.

[Uche Orji:]

I just wanted to know if, let’s say if it was 70% or 75%, if you got back to those levels would that be material contributions in gross margins is simply the question.

[Joe McDonough:]

No I don’t think you should assume that.

[Jerry Fishman:]

I think we’ve said in previous quarters that we are consolidating our two [wafer] fabs in Ireland to one [inaudible] fab, and that will start showing some results and some momentum on that in 2009 as we finalize that transition. That’s a complicated transition because there’s so many products in there but that should give us a little bit of a tailwind on the margin line as well.

[Operator:]

Your next question comes from the line of Doug Freedman – American Technology Research

[Doug Freedman:]

Can you talk a little bit more about what you’re really seeing out in the marketplace? We’ve recently heard from probably your largest competitor, Texas Instruments about their aspirations to grow the analog business 20%. They overlap with you probably the most of anybody. What are you seeing out there in terms of ASP trends and just what you’re seeing as far as just the competitive nature of the marketplace?

[Jerry Fishman:]

I think the analog category itself is a very non-descript category because there’s very many different segments in there. There’s product segments, there’s performance segments, and so it’s not a homogenous market even though a lot of people describe it as that. Our sense is in the commodity part of the analog market which is sort of half of it, or 60% of it depending on how you count it, that’s probably as good a place to be as making logic. The performance doesn’t matter, it’s a commodity product, and people primarily buy that on price. The aggregate market doesn’t grow at nearly those rates because of the continuous price pressure and the fact that the products are not worth that much to the customers. I think in the high performance part of the market, you can still differentiate the customers’ products by what you do. We can change the sound or change the image or whatever, a new video game with motion, or whatever, that to me is probably one of the most attractive segments in the semiconductor market because you can get paid for what you do. Because our customers can get paid for what they do. And if they pick a better product they can get incrementally more money from the customers. Sony goes in and or any of the premier brands of TVs, they get more money for the TVs than, because the picture is better, or at least the brand is better. So our sense is in that part of the market where performance really matters and differentiation really matters you can get paid for your products and you can earn a very good return on them. Now what the market growth rate is going to be, there’s as many theories about that as there are people making theories and we think that the signal processing or the high performance part of that will outgrow whatever the semiconductor market is. There’s varying opinions about what that growth rate can be but our sense is for the kind of products we make at Analog growth rates of 10% to 15% a year on the average care creditable. I think for the commodity analog market I’d be surprised if that market grew more than 5% a year because you can’t get paid for the products so without commenting on what any competitor thinks or not, our sense of the market is that in the high performance area if you do your job right you could build a business that grows 10% or 15% a year. You can make extraordinary returns at it. You can generate tremendous amounts of cash and relative to most businesses that’s pretty attractive, which is why we spend all the money we do in getting those products out. So beyond that we’ll see what the growth rates are. I think our belief is that if you do a good job, you get 10% to 15%, other people have different views of that and we’ll just have to see which one comes out.

[Doug Freedman:]

You have been really good at sort of divesting those businesses where you couldn’t capture the value you were looking for, what’s your thought now about taking the cash flows that you have and moving, swinging the pendulum in the other direction and start acquiring some of those other companies that are coming to market with things that do have high value in them?

[Jerry Fishman:]

Certainly that’s an opportunity for us. We think we have a good hand now, a good portfolio but there’s lots of smaller companies that have products that can enhance our portfolio and we look at a lot of those companies. You have to be careful on these acquisitions because they’re hard and they’re complicated. Most of them don’t work so well when you get all done with it but there are such opportunities and we look at a lot of them. We certainly have the financial structure to do that if we find one we like.

[Operator:]

Your final question comes from the line of John Pitzer – Credit Suisse

[John Pitzer:]

I was just wondering how you’re viewing the strength in your coms business just relative to the Beijing Olympics, are you worried that some of the strength is driven by a pre-build ahead of the Olympics which could lead to a worse than seasonal trend in the second half of the year?

[Robert McAdam:]

No I think that, yes certainly Jerry mentioned [TDS CDMA] and an increase in our [TDS CDMA] base station business but that is, we’ve already brought base station to communications infrastructure business so that really doesn’t move the dial significantly. It helps us but the strength is much more broad based then that across our regions.

[Jerry Fishman:]

I think the thing I mentioned before is really the most important thing to take away is that what we’re trying to do and what we’ve been successful this year in doing is vastly expanding the bill of materials that’s available to us in those products so that’s at least if not more of a driver than unit volume of base stations right now.

[Mindy Kohl:]

Well thank you very much to everyone for your participation today and we look forward to talking with all of you again during our third quarter conference call scheduled for Tuesday, August 19th at 5