Analog Devices, Inc.
Q2 2007 Earnings Call Transcript
Published:
- Operator:
- 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) Ms. Tagliaferro, you may begin your conference.
- Maria Tagliaferro:
- 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’m joined today by our CEO, Jerry Fishman, and our CFO and VP of Finance, Joe McDonough. In a moment we’ll 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
- Jerald G. Fishman:
- 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 from 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 to be used in digital cameras, advanced TVs, as well as MEMS-based motion sensors that are enabling new functionality for the most popular videogames. Communications revenues grew 10% sequentially or 18% sequentially on a 13-week basis. The growth of sales to communications customers in Q2 was fueled by very strong sales of base station products, particularly in Asia where new infrastructure build-outs 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. Communications 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, or 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 deemphasize 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 revenue. 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 category, we’re enjoying very strong demand for our MEMS and our RF radio frequency 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, videogames, digital cameras, and also as a result of higher 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 is important to note that exclusive of the mix, the gross margins and the average selling prices on individual products remained 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 7 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 for MEMS products. In MEMS, we are also ramping additional capacity at external foundries to support the increased demand we are 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 in the open market, which represented 3% of outstanding shares. Since the beginning of our buy-back 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 pay-out 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 remained strong, continuing the pattern that began for ADI in our first quarter. On a comparable 13-week basis, end customer order rate increased 10% for the quarter. The book-to-bill ratio is approximately 1, 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 million to $685 million. This range reflects the significant revenue increase we achieved in Q2 coupled with the 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 and 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’ve made and the products that we’ve released in the past six quarters that have generated last quarter 20% of our sales. 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
- Maria Tagliaferro:
- 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:
- (Operator Instructions) Our first question comes from the line of Michael Masdea.
- Michael Masdea:
- Thanks a lot. 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, depending on I guess what timeframe you use, 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? Or is there anything in the demand picture that has changed or the order picture that’s changed that makes you think it is something more?
- Jerald G. Fishman:
- I think, Michael, what we really saw is that we had a strong second quarter. We typically have a strong second quarter. That’s 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. I think the rest of the year, at least our sense, is it is going to unfold the way a typical year would unfold. We get a little seasonality in Q3 because of July and by Q4, particularly after August, the revenue starts growing again and we have a strong quarter. So I think what we are seeing is at least our sense is that it’s a pretty typical year, that 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 passed 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 us some upside. So that’s what we baked into the guidance and I think that’s a very typical pattern for us, at least, for Q3.
- Michael Masdea:
- Maybe taking that a step further on the second question, if you look at the wireless business, both on the handset side and the infrastructure business, and 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 TD-SCDMA side, or the China infrastructure side, you could argue maybe there’s some risk there because they are rolling out a new technology and there needs to be some channel fill, et cetera. Is there any concern you have, or 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?
- Jerald G. Fishman:
- I think there’s always -- when you have 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 have provided.
- Michael Masdea:
- Thanks a lot.
- Operator:
- Your next question comes from the line of Chris Stanley.
- Chris Stanley:
- -- in Q3 and then trending up in Q4, could you talk about gross margin beyond Q4, and especially in light of it seems like the consumer and the wireless space is growing a little bit faster and that’s lower margin, so how should we look at gross margin longer term?
- Joseph E. 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 are 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. 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 are continuing to work with our foundry partners and our back-end partners in terms of pricing and the margins that we are 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.
- Chris Stanley:
- As a follow-up to that, on the op-ex, good job of lowering the SG&A, and then you guys gave guidance for Q3 and now longer term on op-ex, 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 that?
- Joseph E. McDonough:
- Our expectation would be that we will be able to begin to bring the operating expenses as a percentage of sales down and therefore the expenses would grow slower than sales. Our objective is to bring the operating expenses to 30% of sales. We are about 5% above that right now.
- Chris Stanley:
- Got it. Thanks, guys.
- Operator:
- Your next question comes from the line of Romit Shah.
- Romit Shah:
- Thanks. 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 the growth in orders to be fairly broad-based?
- Jerald G. Fishman:
- Well, our sense -- again, when you talk about the future, it’s always in the future 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. What happens in that environment which Joe just tread on lightly, I’ll make another comment on it. When you are trying to ramp capacity as fast as we were, in 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 customer so you don’t disappoint them and he can keep up with his demands, to 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 coincidence. The lead times are relatively stable so I don’t think we’re seeing a lot of customers ordering ahead in order to reserve or pouring inventory. We see the market out there 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 a range of a couple of percent on each side because it is very, very hard to call what is going to happen in any sector, and we don’t know what’s going to happen in July, so I think we are trying to be cautious on the range we provide. But overall, we believe that the business environment is pretty good and we saw that last quarter. I don’t think there’s anything that’s changed my mind on that. From anything we’ve seen through the second quarter, it looks pretty good.
- Romit Shah:
- Thanks. 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 an accelerated share repurchase?
- Jerald G. Fishman:
- Well, that’s certainly something we always consider. What we’ve announced so far is what we’ve agreed with the Board. We are quite understanding of the leverage of the that’s out there and the impact on the earnings in the future. You know, we’ve actually bought back almost 20% of the company over the last two years, which has been pretty aggressive. And we are always looking at different alternatives and we’ll 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.
- Romit Shah:
- Thank you.
- Operator:
- Your next question comes from the line of Ross Seymore. Ross, your line is now open.
- Ross Seymore:
- You said that your other analog category was -- MEMS was in there, MEMS was about seven points out of the total. How big is the RF transceiver portion?
- Jerald G. Fishman:
- I don’t know if we have that number. Do we? No, I don’t think we report that.
- Ross Seymore:
- 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?
- Jerald G. Fishman:
- Well, there’s a very large mix in there. 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 either within that category of other analog, it would be a mistake to think those are lower on the average than everything else we are 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 were some in there that generate below corporate average gross margins but there are many others that generate above corporate gross margin.
- Ross Seymore:
- Okay, and 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 is difficult to take or lose market share. It happens very slowly because of reverse businesses and customer base. Why would we believe that you guys would have more success getting into power management, et cetera, than your peers would have trying to get into your businesses?
- Jerald G. Fishman:
- Well, I think one of the very clear reasons, and the thing that is 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 a third of that, roughly. So in order to really win in the converter business for somebody else, you have 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 is no one person that has a very large position in every segment of the business and -- I mean, there are segments that are very different than other segments that you don’t need to do all the different segments to winning. I think that’s the very fundamental difference between the power management business, which is not a homogenous market like the converter market is. 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. The only commonality amongst all power management products is they tend to regulate power. But other than that, there area lot of different segments, particularly those segments where we are already selling our converters and amplifiers, where if we are very focused and very careful and don’t invest in some of the lower margin segment, it is 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. I think the reason is the product segments are different and the kind of products they supply to those customers is different. I think in -- 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 had the whole spectrum 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.
- Ross Seymore:
- Thank you.
- Operator:
- Your next question comes from the line of Louis Gerhardy.
- Louis Gerhardy:
- This is [Sandhit] calling for Louis Gerhardy. My question is about royalties. With 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 should we expect more of these royalties going forward?
- Jerald G. Fishman:
- I heard the first part but I did not hear the question part.
- Louis Gerhardy:
- The question is about royalties.
- Jerald G. Fishman:
- Yes, I heard the prelude. I just didn’t hear what the question you were asking is.
- Louis Gerhardy:
- You collected royalties in 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?
- Jerald G. Fishman:
- I would say that we spent 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. By the way, that wasn’t royalty in Q2. That was payments for past sins in a lot of ways, but yes, I think generically as a company, when we are spending as much as we are in R&D, 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 are going collect those payments. We don’t do that willy-nilly. We don’t do that without a lot of pre-thought, because it is expensive to pursue those companies and it costs money and it takes 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’s changed but the principal is exactly right. If we invest in it and we own it and we spent the money on it, we expect people to respect our IP.
- Louis Gerhardy:
- 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?
- Jerald G. Fishman:
- No, 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 are working on gyroscopes for some 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 some room for some growth here.
- Operator:
- Your next question comes from the line of Uche Orji. Sir, your line is now open.
- Maria Tagliaferro:
- Move to the next one, Operator.
- Operator:
- Your next question comes from the line of Simona Jankowski.
- Simona Jankowski:
- Thank you. 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?
- Joseph E. McDonough:
- 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.
- Simona Jankowski:
- So you mean that on the equivalent basis, it would have been higher than the 10%?
- Joseph E. McDonough:
- No, on an equivalent basis, it was 10%. On an actual basis, the end customer growth was basically the same as our sales.
- Simona Jankowski:
- Okay, and then just to clarify, again in your guidance which does appear to be a little bit below normal seasonality, and you are going to continue to have strength in a couple of ADI specific categories like your MEMS business and presumably on the TD-SCDMA side. I was just wondering if you could highlight some of the parts of the business that might be growing at below seasonal trends right now. Is there still residual inventory issues out there or is there anything with demand?
- Jerald G. Fishman:
- 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 are 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 is not going to very much add to our sales. On the TD-SCDMA part of the business, all the signals we are 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 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 tailwinds, rather, for Q3. I think we are just expecting a normal, seasonal Q3 where July is a little weaker and May and June is 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.
- Simona Jankowski:
- 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 even expand into some newer growth opportunities longer term. Could you maybe just highlight some of those for us?
- Jerald G. Fishman:
- Well, for example, in the converter area, there is an awful lot of growth in very low power converters for portable products. 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’s just a whole bunch of opportunities there for us to maintain and perhaps increase our share in that business. We would be utter fools not to take advantage of that, which is why we have 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 has 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.
- Simona Jankowski:
- Thank you very much.
- Operator:
- Your next question comes from the line of Uche Orji.
- Uche Orji:
- Just a few questions, first for Jerry; when you talk about MEMS becoming a large business, are you able to quantify over what timeframe and how big this will become for ADI?
- Jerald G. Fishman:
- Well, I think we’ve told you it’s about 7% of our revenues now, so you can figure out that’s in the mid $40 million per quarter roughly of revenues. We are really at the beginning period, particularly in the consumer business, but as I mentioned earlier, there’s some new automotive applications that can actually save more lives than airbags, like vehicle stability control, or 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 in 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 are doing and the window of opportunity for us, or the window of what’s possible is still 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 grow 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. 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’ve 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 are doing well relative to any competitors, and the application breadth is increasing rapidly. So we are working on getting the gross margins in that business up. We think there’s the opportunity to do that and we are looking at ways to get a lot more capacity without devoting a lot more assets to that business, as 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.
- Uche Orji:
- At what level your run-rate will your gross margins kind of be equal to corporate average?
- Jerald G. Fishman:
- Well, we’re have to wait and see how that all goes. I think it is a little early to predict that but certainly we are doing a lot of things to raise the gross margin for 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 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 the gross margin moving up a lot faster than the revenues. We are pretty committed to doing that.
- Uche Orji:
- Just one last question on the utilization rates. You talk about constraining utilization rates and you are going to be raising it in -- post the August timeframe. Should we imply from that statement that you may have had to give up revenues outside of the maintenance area just because utilization rates couldn’t keep up with demand for this quarter? Is there any reason why you wouldn’t want to raise it a little bit earlier, just in case demand comes in a little bit ahead of time, partly because --
- Jerald G. Fishman:
- We’re raising it right now as fast as we can raise it. This is very complex technology. When you 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 are trying to build this thing on a CMOS substrate as compared to a bi-CMOS substrate, which fundamentally is a lot lower cost process than a bi-CMOS 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 are trying to be thoughtful about that with the cost structure of that new capacity in mind to be sort of a much more asset light model for that business than historically it’s been.
- Joseph E. 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. 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.
- Jerald G. Fishman:
- What Joe’s basically saying is he’s saying if Nintendo is selling all those parts based on our technology, obviously it is worth something and we have 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 did not 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’s a fair way to say it.
- Operator:
- Your next question comes from the line of Sumit Dhanda.
- Sumit Dhanda:
- I have a couple of questions; Joe, could you possibly give us a sense, 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%? Really, over what timeframe do you expect --
- Joseph E. McDonough:
- Well, 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 are 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’s likely to happen in either the third or the fourth quarter, although in the fourth quarter we will start moving in the right direction.
- Jerald G. Fishman:
- I think a lot more of the profit leverage -- the way to think about it is we have a couple of points of profit leverage on the gross margin. We have a lot more profit leverage on the expense side and we are working on both of those. Hard.
- Sumit Dhanda:
- 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 what really allowed you to achieve that level of cost control? Is this one-time in nature?
- Joseph E. McDonough:
- We do have to -- we are providing what we refer to as non-GAAP financials and the SG&A has a few different items running through it, which if you look carefully on the reconciliation from GAAP to non-GAAP, you will see that they affect SG&A. On a non-GAAP basis, the SG&A in the first quarter was actually up 3% from the fourth quarter, and in the second quarter it was down 2%.
- Sumit Dhanda:
- 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 was mainly turns bookings and the backlog is relatively flat here heading into the July quarter?
- Jerald G. Fishman:
- The backlog for the -- the backlog going into the fourth quarter, the total backlog is --
- Maria Tagliaferro:
- Going into the third quarter.
- Jerald G. Fishman:
- 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.
- Sumit Dhanda:
- How does that compare on a 13-week basis versus --
- Jerald G. Fishman:
- 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 is actually 3% higher now than it was at the beginning of the first quarter. The distributor backlog really doesn’t mean much at all. 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 is nothing abnormal about that.
- Sumit Dhanda:
- Okay, and then one final question, and I don’t know if you’ve already 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. Thanks.
- Jerald G. Fishman:
- Well, I think the handset business, the chipset business we’ve talked about very often that it is a very 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 try to figure out what’s going on in those businesses. All those businesses tend to have 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 at 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 bit more volatile quarter to quarter than the rest of our business. There’s not much more to it than that.
- Sumit Dhanda:
- Okay and then one final question, Jerry, your efforts to reduce R&D in other businesses, could you highlight what businesses you are targeting for reduction in R&D?
- Jerald G. Fishman:
- Well, 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 are focusing the power business on the opportunities that we think are differentiated, so I think all around the company we’ve 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. We like to talk about those things after we do them instead of before, but there continues to be a lot of things on the plate that we look at. We are trying to focus the company more so than before. I think you will see that over the next couple of quarters.
- Operator:
- Your next question comes from the line of Tore Svanberg.
- Tore Svanberg:
- Good afternoon. 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 bit about visibility? Are your customers feeling better about this, worse about this? I’m just trying to see where the market stands right now.
- Jerald G. Fishman:
- I think it is a conglomeration of a lot of different customers and I spent last week in Europe running around to a bunch of our largest customers. I would say by and large the industrial customer base is relatively happy. They are seeing good opportunities. They are not saying business is going through the roof but they are saying they are seeing things go okay. I think 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 think it will 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 and the way we are going to manage the company.
- Tore Svanberg:
- Thanks, and Joe, I think you mentioned your goal is to get inventory days to about 100, 110. Could you maybe put a timeframe on that, please?
- Joseph E. McDonough:
- Well, we’re not panicked to do that. Our first priority is to be able to have the product that the customers demand. 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.
- Tore Svanberg:
- So could we maybe get to that range by the end of the year, do you think?
- Joseph E. McDonough:
- In the neighborhood. We aren’t very far away from it. We’re only 10 days above it.
- Tore Svanberg:
- Great. Thank you very much.
- Operator:
- Your next question comes from the line of Doug Freedman.
- Doug Freedman:
- Thanks for taking my questions. I would like to focus 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 expenses this quarter due to the litigation resolution?
- Joseph E. McDonough:
- When we talk about the operating expenses, we are 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. The way we manage the company and the reason that we publish the non-GAAP financial statements 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 are planning for.
- Doug Freedman:
- 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.
- Joseph E. McDonough:
- No, we had other -- we have different items each quarter and we publish those in our financials, in the GAAP to non-GAAP.
- Jerald G. Fishman:
- 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 non-GAAP way because that’s the only way we can understand it, are right about -- in fact, maybe even a drop 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. You have all that other stuff -- aren’t included in any of that stuff and what we are 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.
- Joseph E. McDonough:
- This quarter you will 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. You will 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.
- Doug Freedman:
- If I move on and focus on an area that you guys have talked about now repeatedly for a while and the opportunity in power management, I notice that you are grouping power management and references together. What percentage of that business is presently referenced, given the fact that sort of references sell with your converters and it is a market that you --
- Jerald G. Fishman:
- I really don’t have the numbers offhand. We could try to dig them out and get them but I really don’t know.
- Doug Freedman:
- Following up an earlier question, the power management effort you guys have been putting in is -- it’s been lengthy, correct? I mean, you started the 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 mentioned, it is a very diverse market, one in which there has to be opportunity to consolidate.
- Jerald G. Fishman:
- I think our group does look at a lot of external opportunities and evaluates them against some of the internal developments we are doing, and that’s always on the screen. It’s consistently -- particularly in the last year it’s been on the screen so we will have to wait and see how that goes. But it is still a great -- even though it’s been a long haul to get to $200 million, we think you really have to look forward and say what do you have in the pipeline and what are the customers saying about the products that we are sending them. I spend 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 got -- I mean, it’s not a question of power management or references or anything. It’s a question of 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 there. 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 weren’t saying when you get it to us, we’ll buy it, believe me -- I’m not a glutton for pain on this one. 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’ll -- we can generate some good sales, good margins in this business and we should do that. If it turns out that it turns out to be false, we’ll have to reevaluate but right now, all the feedback I get from the customers is very positive.
- Doug Freedman:
- 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 --
- Jerald G. Fishman:
- No, I would say we’ve made a lot of moves and there’s more to go. I think what we are 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. So I think we still have a lot of room for improvement there and we are working on it.
- Doug Freedman:
- Thank you.
- Operator:
- Your next question comes from the line of Craig Ellis.
- Craig Ellis:
- Thanks. I just wanted to follow-up on some of the power management questions. Jerry, as you look at your efforts in power management right now and the resources that you are bringing 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 are staffed appropriately for the opportunities that’s out there?
- Jerald G. Fishman:
- Well, there is always the opportunity to do more but our sense right now is we’ve put in a fairly good chunk of expense into that business in terms of product design and 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 the revenues and the margins. So I don’t think we are 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.
- Craig Ellis:
- 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 model that you have for the broader business?
- Jerald G. Fishman:
- Yes, I would say that as we -- as I was saying and Joe was sort of repeating later, we are making these decisions based on that model for the business, which says we’ll have some businesses a little bit below and some a little above, but the average will be that. There’s many, many examples, particularly segments of the power business, that do provide that opportunity and our job is to invest in those as compared to getting led into areas that have horrible gross margins. That is certainly our intent and that’s what our product development roadmap is. That’s what our field plan is and that’s what we are trying to do. Believe me, we have no interest in building a portfolio of power products that makes crappy gross margins.
- Craig Ellis:
- 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 --
- Jerald G. Fishman:
- I think what we are really trying to do is better focus the business. That sort of means that we are constantly evaluating where we are putting the money and if we see it’s going well, great, we redouble our bet, and areas that we’re not doing well and we can’t see a way clear of doing well within a reasonable time, that we move investments away from that business. We’ve done some of that and I expect there’s more to be done in the future.
- Operator:
- Your next question comes from the line of Tristan Gerra.
- Tristan Gerra:
- What type of client rebound do you need in the quarter to see gross margin pick up, assuming a typical end of year mix with higher consumer exposure?
- Joseph E. 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 quantify that. I did mention that our goal was 60%. We are not too far away from that but we do not expect to reach that goal during either the third or the fourth quarter. We just would expect in the fourth quarter to start moving in the right direction.
- Tristan Gerra:
- And then could you give us a sense for this coming quarter how the various business segments will be tracking? Thanks.
- Jerald G. Fishman:
- I don’t think there’s anything unique that we would have a prognosis for for Q3. I think 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 will tell you how it turns out. That’s about the best we can do.
- Tristan Gerra:
- Thank you.
- Operator:
- Your next question comes from the line of David Wu.
- David Wu:
- Good afternoon. I was just curious about -- Jerry, I noticed that the general purpose DSP declined in the April quarter by quite a bit. Was that a one-time thing or is there something strange going on in that business that accounts for that quarter? My follow-up is really on the -- to get to 30% operating margin some time out there, what do you really have to do to get there in the DSP side?
- Jerald G. Fishman:
- I think to get to the corporate model on the margins, I think we have to have expense ratios in our business that are commensurate with what the opportunity is, it’s in 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 if it is going to come with revenue growth but I think a lot of it is going to come through better focus on things that we really can build a long-term sustainable position and that we want to be in. On the DSP side, it is really a question of both -- it’s 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. I think in the GP business, that business has been growing well sequentially. As we reported, there were 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-on-quarter basis, that thing bounces around quite a bit.
- David Wu:
- Thank you.
- Maria Tagliaferro:
- Okay, well that’s the last question that we had in our queue so I want to thank everyone for joining us today and just remind you to mark your calendar for our third quarter earnings call which is presently scheduled for Tuesday, August 21, 2007, 5
- Operator:
- This concludes today’s Analog Devices conference call. You may now disconnect.
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