Linear Technology Corporation F1Q09 (Qtr End 09/28/08) Earnings Call Transcript

Oct.15.08 | About: Linear Technology (LLTC)

Linear Technology Corporation (NASDAQ:LLTC)

F1Q09 Earnings Call

October 15, 2008 11:30 am ET

Executives

Paul Coghlan - Chief Financial Officer

Lothar Maier - Chief Executive Officer

Robert H. Swanson, Jr. - Co-Founder and Executive Chairman

Analysts

Doug Freedman - American Technology Research

Ross Seymore - Deutsche Bank Securities

Craig Hettenbach - Goldman Sachs

Tore Svanberg - Thomas Weisel Partners

John Pitzer - Credit Suisse

Craig Ellis - Citigroup

Auguste Richard - Piper Jaffray

Christopher Danely - JP Morgan

Uche Orji - UBS

Joanne Feeney - FTN Midwest Securities Corp.

Craig Berger - Friedman, Billings, Ramsey & Co.

Steven Smigie - Raymond James

Krishna Shankar - JMP Securities

David Wu - Global Crown Capital

Sumit Dhanda - Banc of America Securities

Robin Lee – Spherix Capital

Dan Murphy – O’Connor

Alec Berman – AMPAC Research

Steve Rosston - Glynn Capital Management

Operator

Welcome to the Linear Technology Corporation Fiscal 20089 first quarter earnings conference call. (Operator Instructions) At this time, for opening remarks and introductions, I would like to turn the call over to Paul Coghlan, Chief Financial Officer.

Paul Coghlan - Chief Financial Officer

Today I am joined by Bob Swanson, our Chairman, and Lothar Maier, our Chief Executive Officer. Welcome to our call. I will give you a brief overview of our recently completed first quarter in fiscal 2009 and then address the current business climate. We will then open up the conference call for questions to be directed at Bob Swanson, Lothar and myself. I trust you’ve all seen copies of our press release which was published last night.

First, however, I’d like to remind you that except for historical information, the matters we will be describing this morning will be forward-looking statements that are dependent on certain risks and uncertainties, including such factors among others as new orders received and shipped during the quarter, the timely introduction of new processes and products, and general conditions in the world economy and financial markets. In addition to these risks, which we described in our press release issued yesterday, we refer you to the risk factors listed in the Company’s Form 10-K for the year ended, June 29, 2008, particularly management discussion and analysis of financial condition and results of operations. Secondly, SEC regulation FD regarding selected disclosure influences our interaction with investors. We’ve opened up this conference call to enable all interested investors to listen in. The press release and this conference call will be our forum to respond to questions regarding our estimated financial performance going forward. Consequently, should you have any questions regarding our estimates of sales and profits, or other financial matters for the upcoming quarter, as well as how they might impact our income statement model and our balance sheet, this is the time we are free to respond to these questions.

As you can tell from our press release there is a significant difference between our actual performance for the September quarter and our guidance for the December quarter. The company had a solid September quarter with growth in sales and profits. Operating income was 49% and profit before tax was 46% of sales. The company grew revenues for the sixth consecutive quarter and has continued to increase its positioning in industrial communications infrastructure and automotive end markets while diminishing its presence in margin-sensitive consumer-related end markets.

However, the extraordinary negative developments in the world-wide financial markets in recent weeks will undoubtedly impact business spending and confidence. We have already seen a slowness in our bookings in the month of October. How long and how deep this impact will be is very difficult to forecast. As managers we can control spending and deploy our talent to best position Linear growth and profitability when the markets return.

As a reminder, in 2001 Linear managed its business through the dot-com bust. We remained highly profitable as a percent of sales and continued to be cash-flow positive. As we stated in our press release, we expect similar execution now and believe profit before tax, even in declining revenues, can remain above 40% of sales and that we can generate positive cash flow in this environment.

Strategically, we believe industrial communications infrastructure and automotive will be attractive markets, driven by the advances in communications capabilities, industrial innovation, and the need for energy and fuel efficiency.

I would now like to spend a few minutes discussing the quarter we just completed. In a difficult economic environment, but before the financial markets melt-down, we had a reasonable quarter, as we grew sales, remained highly profitable and continued our strategic emphasis of focusing on traditional analog markets.

Sales increased 1% from the previous quarter within the range of flat to 2% that we had forecasted in our last conference call. Revenue was $310.4 million, up from revenue of $307.1 million for the previous quarter.

Net income increased 4.3% and earnings per share 4.3%, also, being $0.48 up from $0.46 last quarter.

On a pro forma basis, without the impact of stock-based compensation, EPS would have been $0.53 versus $0.51 and net income would have been $118.4 million versus $114.4 million in the June quarter. So the impact of stock-based compensation was 10% of net income, or $0.05 at the EPS level.

For the quarter just ended our GAAP return on sales was 34.7% and our pro forma return on sales was 38.1%.

Operating income increased in absolute dollars and as a percentage of sales, improving from 47.1% last quarter to 48.6% this quarter.

Gross profit decreased by 3/10 of a point, primarily due to lower ASPs associated with increased shipments into consumer-related markets prior to the holiday season. This was more than offset by a reduction in legal expenses.

The company also benefited from a discrete tax item, as the company reached a negotiated settlement with the IRS on the treatment of its ETI, which is extra-territorial income, benefits in past years. Consequently, the company’s tax rate for the quarter was 25%, down from its ongoing projected tax rate of 29.5%.

During the quarter the company’s cash and short-term investments increased by $55.2 million, net of spending $23.1 million to purchase 737,000 shares of its common stock. For the 90th consecutive quarter the company had positive cash flow from operations.

The Board of Directors again authorized the company to pay a cash dividend of $0.21 per share. The dividend will be paid on November 26, 2008, to stockholders of record on November 14, 2008. At current stock prices this represents a yield of greater than 3%.

In summary, we continue to have an excellent business model and are therefore able to remain both highly profitable and cash-flow positive. Our return on assets was 25%.

In April of 2007 the company entered into an accelerated share repurchase, or ASR, which enabled it buy back 27% of its shares outstanding. This ASR, and the associated debt, has improved our returns on equity and invested capital. Our debt is modest to our cash generation capabilities and our current ratio is 6.4 to 1.

Our ending on hand inventory of distribution is within historic turns levels and lead times have remained unchanged at 4 to 6 weeks.

Now I would like to address the quarter’s results on a line-by-line basis, staring with bookings. Bookings were down marginally from the prior quarter and our book-to-bill ratio approximated, but did not equal, 1. Compared with the prior quarter, international bookings were unchanged while absorbing the summer vacation impact in Europe. In the USA, however, bookings were down modestly as the deteriorating economic environment impacted both U.S. OEM and distribution business.

At this time every quarter we give you a breakdown of our bookings percentages by end markets to give you insight into those markets that drive our business. We continue to strive to improve the accuracy of this market data and have made some improvements going into fiscal 2009. These improvements have been primarily in the area of international distributor bookings. To help you to continue to focus on trends I will give you the previously reported Q4 numbers, new Q4 numbers, and Q1 numbers done on a similar basis as the new Q4 numbers.

Industrial and communications continue to be our largest areas. Industrial was previously reported at 33% of our Q4 business. This has been restated to 36% and the percentage for Q1 was down 1 point to 35%. This decrease is primarily attributable to U.S. distributions.

Communications, previously reported at 36%, was restated at 30% and was down one percentage point to 29% on a comparative basis in Q1. The major change between methodologies here was in the cellular handset area, which was restated from 11% to 7% in Q4. This change resulted from more accurate distributor data. Q1 at 7% was similar to Q4 restated in the handset area.

Going forward, we are combining communications infrastructure and networking as large customers are evolving to serve both of these areas. This area decreased marginally from 23% in Q4 to 22% in Q1.

Computer was previously reported as 12% of our Q4 business. This has been restated to 10% and the percentage for Q1 rose to 12%. This area is generally seasonally strong going into the return-to-school and the holiday seasons.

Automotive was previously reported as 8% of our Q4 business. This was restated to 9% and the percentage for Q1 was 8%. This is an area that is suffering in the economy now, however, given the move to more fuel-efficient vehicles, it is an area of emphasis for Linear. We recently introduced a part for data re-monitoring in hybrid and electric vehicles, which has received early acclaim. In addition, we continue to distinguish Linear as a high-quality supplier in important international manufacturers.

Consumer was previously reported as 5% of our Q4 business. This has been restated to 9% and the percentage rose to 10% in Q1. Certain customer installable automotive after-market products, such as GPS systems we believe more properly belong in the consumer category. This increase of 1% again related to product build up by customers prior to the holiday seasons.

Finally, the military space and harsh environment products remained unchanged at 6% for both Q4 methodologies and for Q1.

In summary, we believe the data is now more accurate and we continue to have very good diversity by end markets, which contributes to our leadership positioning in high-performance analog.

Note that 54% of our bookings were created internationally, up slightly from last quarter.

Moving from bookings to sales, product sales grew 1.1% from the prior quarter and 10.3% from the similar quarter in the prior year. Sales were down modestly in the USA in both OEM and distribution. However, this was more than offset by growth internationally.

Asia was our strongest area, improving from 38% to 42% of our sales. USA decreased from 29% to 27% of sales, Japan remained at 13%, Europe decreased from 20% to 18%, in line with normal seasonal flows.

Gross margins. Gross margin was 77%. This impressive number validates our strategy of selling unique, high-performance analog semiconductors into a broad customer base. This gross margin percentage decreased by 3/10 of a point this quarter. This decrease was largely due to a decrease in ASP, from $1.61 last quarter to $1.47 this quarter, in line with the increase in consumer-related sales prior to the holiday season. The strengthening U.S. dollar was marginally helpful in the gross margin area.

R&D. R&D at $50.9 million decreased by $1.0 million and also decreased as a percentage of sales from 16.9% to 16.4%. Labor increases were more than offset by decreases in stock compensation charges, mask costs, and other expense items.

SG&A. Selling, general, and administrative costs, at $37.1 million, decreased significantly by $3.5 million and concurrently decreased as a percentage of sales from 13.2% to 11.9%. Legal expenses were abnormally high in Q4 and as projected, returned to more historic levels in Q1.

As a result of the above, operating income increased by $6.2 million, or 4.3%. Operating income as a percentage of sales increased from 47.1% to 48.6% and continues to be at industry-leading levels.

Interest expense, at $14.4 million, was similar to last quarter. Interest income of $7.0 million decreased $2.1 million due to a gain in Q4 from the sale of a strategic investment in a private company.

Within the interest income line, increases in funds invested offset decreases in the average interest rate. As the government responds to the economic crisis by lowering interest rates, this will probably result in a reduction in interest income next quarter.

Pre-tax profits as a percent of sales improved from 45.4% to 46.2% of sales. Our tax rate was 25% versus 26% last quarter. Both quarters had an ongoing effective rate of 29.5% and each quarter was impacted by non-recurring discrete items. In Q1 the company negotiated a settlement with the IRS on the deductibility of its export tax benefits, referred to as ETI, for several years under audit. Going forward, we will be favorably impacted by the resumption of the deductibility of the R&D credit, which was recently re-enacted by Congress. Our ongoing effective tax rate should decrease to 28.5% from 29.5% last quarter.

This quarter we should also have a discrete tax benefit relating to the retroactive reinstatement of the R&D credit. This discrete item would bring our overall tax rate for the upcoming quarter in line with the 25% tax rate shown for Q1.

The major tax-savings items that will support our effective rate are: the benefits from our tax holidays overseas; our tax-exempt interest; our domestic manufacturing tax benefits; and the R&D credit.

The resulting net income of $107.6 million is an increase of $4.5 million from the previous quarter, due largely to the increase in sales, lower legal expenses, and a lower tax rate. The resulting return on sales improved to 34.7% from 33.6% reported last quarter.

The average shares outstanding used in the calculation of earnings per share decreased by 923,000 shares during the quarter. During the quarter the company bought back 737,000 shares in the open market. Also, the reduction in the company’s stock price during the quarter reduced the number of diluted shares outstanding. These reductions were partially offset by stock option exercises during the quarter. The resulting EPS, or earnings per share, was $0.48, an increase of 4.3% from the prior quarter, and an increase of 20% from $0.40 in the first quarter of last year.

Moving to the balance sheet. Cash and short-term investments increased by $55.2 million. During the quarter the company bought back 737,000 shares of its common stock for $23.1 million. $145.4 million was provided by operations. $47.4 million was paid in cash dividends, and $23.1 million was used to purchase fixed assets. Our cash and short-term investment balance is now $1.022 billion and represents 61% of total assets.

Accounts receivable of $163.2 million increased by $1.8 million from last quarter. This increase was mostly a function of the increase in sales. Our day sales in account receivable were 48 days, similar to last quarter.

Inventory at $55.5 million decreased $551,000 from the $56.0 million reported last quarter. Most of this modest decrease was in raw materials and finished goods. Our inventory turns was 5.1x, similar to the last several quarters.

Deferred taxes and other current assets increased by $12.0 million from the June quarter, primarily due to an increase in pre-paid taxes on our inter-company transactions and an increase in our interest income receivables due to the timing of our quarter end.

Property, plants, and equipment increased by $12.7 million. We had additions of $23.064 million and depreciation of $10.345 million. Most of the additions were for fab equipment and for building improvements for clean-room expansion in our Milpitas fabrication plant and for test equipment in our foreign plants.

We had planned to spend $65.0 million on capital additions in fiscal 2009 and now believe that will be reduced to roughly $50.0 million and have depreciation of roughly $41.0 million for fiscal 2009.

Other non-current assets totaling $77.2 million were largely unchanged.

Moving to the liability side of the balance sheet. Accounts payable increased $1.1 million, primarily due to increased capital equipment purchases. Accrued income taxes, payroll, and other accrued liabilities increased by $33.1 million. The largest items here are profit sharing accrual, income taxes payable, and accrued interest payable on our convertible debt.

The largest impact within the quarter was in accrued income taxes. No tax payments on the current year’s liability were required in the first quarter, whereas two payments are required in the second quarter.

Deferred income on shipments to distribution decreased this quarter, as our shipments to U.S. distributors were roughly $2.0 million less than they had shipped out to their end customers. Our accounting on shipments to U.S. distribution is conservative. We do not record a sale nor income in our results of operation until the distributor ships the product out to its end customer.

We continue to closely control our inventory of distribution to properly position the inventory without any unneeded build-up.

Deferred tax and other long-term liabilities decreased by $5.1 million due to several tax-related items.

Changes in the stockholder equity accounts were primarily the result of the usual quarterly transactions for net income, dividends paid, and employee stock activity. The company announced that it will again pay a $0.21 per share quarterly cash dividend, having raised it in January of this year from $0.18 to $0.21 per share. The company began paying a dividend in 1992 and has increased it every year since and currently now pays a greater than 3% yield.

Looking forward. I would like to close out our introductory comments by re-visiting our guidance. The credit crisis has had a big impact on our guidance. As recently as early September our business was tracking to have a positive book-to-bill ratio and we were expecting to again guide to flat to low-single-digit revenue growth.

However, once the credit crisis hit and began to deepen, more of our customers became cautious and began to curtail their orders. Data on diminishing factory utilization rates and on rising unemployment claims was published. These dramatic changes have made forecasting difficult.

Field sales personnel forecasted reduced sales in the 10% range, however they cautioned whether their customers had yet fully adjusted to changing economic events. We have begun to receive some cancellations and push-outs from consumer-oriented customers, adjusting their expectations of likely holiday-season sales. Automotive retail sales have been off dramatically and this is bound to have a ripple effect on the economy.

Given the negative impact of the credit crisis in the past few weeks, even though the major governments have taken steps to improve the situation, we believe it will take some time to restore business confidence and that has led us to increase our range of quarterly impact from 10% to 20%. We believe this is a change in demand patterns and not a case of losing production or design opportunities at our customer base.

We want to emphasize that in a similar difficult economic period in 2001, during the dot-com bust, we remained very profitable and cash-flow positive. Many of our expenses are variable and we have had experience at adjusting these costs to meet current demand.

Even at the forecasted diminished sales ranges, we forecast profit before tax remaining above 40% of sales.

I would now like to open up the conference call to questions to be addressed to either Bob, Lothar, or myself.

Question-and-Answer Session

Operator

(Operator Instructions) Your first question comes from Doug Freedman - American Technology Research.

Doug Freedman - American Technology Research

It’s clearly a very challenging environment. Can you offer us a little bit more color on, anything you can offer as far as geography, who is seeing this credit crunch first, what does sort of the sellout look like already? Any more color you can offer on what your customers are telling you as far as how this is changing their behaviors would be helpful.

Lothar Maier

Maybe I can add a little bit of color to that. From a geography standpoint, the issue really for us, I think, showed up first in North American. So North America was probably where we sensed this reduction in business first. But reasonably quickly, as we got into the current quarter, we’re seeing the orders slow down not just in North America but it’s spreading pretty much to all the locations that we sell into. And pretty much we see it in most of the end markets that we sell into, as well.

So I would say it was maybe first detected in North America but we are seeing it pretty much around the globe. And if there’s any one bright spot, it may be China out there still. But in general, it’s pretty much all of our end markets and all of our geographies.

Doug Freedman - American Technology Research

Can you offer, what is happening, is it any difference between OEM and distribution? Are you seeing distribution not want to carry inventory here? How much of this do you think is sort of an inventory pull down versus a demand pull down?

Lothar Maier

We think it’s more a demand pull down than an inventory correction. Although we see it equally distributed through OEM and through distribution, so we haven’t seen an inordinate emphasis coming from distribution. So we think it’s pretty balanced but if we had to lean one way or the other, it would probably be more OEM-related.

Doug Freedman - American Technology Research

And are you seeing a change in behavior, not just from the order rates, but sort of on the engagements with your engineers? Is there like a complete lack of urgency on new product introductions? Any color you can offer as far as your customers’ response in terms of the way in which they’re going to run their business.

Paul Coghlan

I think from an engineering standpoint it’s still pretty much business as usual. We have sensed nothing changing from how engineers are willing to engage with us. This will probably cause some programs to be pushed out a little bit but in terms of willingness to meet with you and talk to you, there’s been no change.

Lothar Maier

And I think, judging from past down turns, a lot of times companies try to invent or innovate their way out of these down turns and be well-positioned when the markets pick up with new products that would be attractive to the purchasing customer base.

Doug Freedman - American Technology Research

Paul, if you could, take a swag at what you think the impact to gross margins is going to be as a result of the lower shipment levels.

Paul Coghlan

Well, there’s going to be some impact throughout the lines on the income statement. What we said in our introductory comments and in our press release is that the income before tax line we had 46% income before taxes, a percent of sales. And we think we can maintain that above 40%. Now how that distributes among the lines, it remains to be seen as to what the sales level is and how we handle our reduction in costs. But judging by previous periods, I don’t think it would be very dramatic at the gross profit margin.

Operator

Your next question comes from Ross Seymore - Deutsche Bank Securities.

Ross Seymore - Deutsche Bank Securities

Can you give us a little more color on why you’re sure it’s broad-based and nothing Linear-specific, as far as losing design wins, etc.

Paul Coghlan

Sure. We are a broad-based supplier. We go through what our end markets distribution are every quarter. Lothar, in response to the first question, told you we are seeing the downturn in consumer-related businesses, automotive-related businesses, and other businesses. We also commented on in our introductory comments that we don’t know of any programs of any significance that we’re out of other than the normal recurring things and that by and large all of the programs we’re in we’re remaining in. And it’s just a general demand pullback we sense.

And maybe it’s more noticeable to us because we are such a broad-based supplier, compared to a lot of our competitors and more evenly distributed through end markets, that we’re seeing it across all of those markets.

Lothar Maier

I think the other point is that the abruptness of the change. We were tracking throughout last quarter pretty much right on track in terms of having an even book to build and the change occurred really in the last couple of weeks of September. You’re not going to get designed out across broad market areas in a two week period. So it was just a very abrupt change.

Ross Seymore - Deutsche Bank Securities

Then I guess given that you talked about the bookings slowing in October as well, can you give us just a rough idea, even by the largest sub-segments of your end market bookings, how those may look for the December quarter?

Paul Coghlan

That’s difficult to do at the moment. I think the area we’re seeing the most pull back initially would be in consumer-related type end products, as they’re quickly adjusting what they think this holiday sales period will be for them. So I think that’s the area we’ve seen the most initial response. But we are seeing it somewhat across the board.

Ross Seymore - Deutsche Bank Securities

And could you just give us a rough idea of kind of fixed versus variable costs on your op-ex lines just so we can get an idea how to model those?

Paul Coghlan

No. I can tell you that, as I said earlier, we think that profit before tax will remain above 40%, so that’s not a very dramatic change from the 46%. And depending on what the sales level, it could be close to the 46%. So while we’re talking about relatively small changes, I think, in each of these operating lines, but how we pare back our expenses and which directions we go to do that, you might have some subtle changes in the lines but I don’t think it will be dramatically skewed one line towards the other.

Operator

Your next question comes from Craig Hettenbach - Goldman Sachs.

Craig Hettenbach - Goldman Sachs

Paul, all these cycles have different nuances. Any similarities, or differences, in this cycle compared to prior ones in terms of how business is developing?

Paul Coghlan

Yes. I think that prior cycles were more concentrated to particular events. Like if you go back to the dot-com bust, a lot of that was in the networking area. It was very, very much centered in high tech and if you will, our industry kind of caused that to happen. You go back into the 90s, you had the kind of the Asian currency meltdown. That was very brief, that downturn. This one is really caused by a credit crunch so this is caused beyond companies. We weren’t the ones that pushed this boulder off the ledge. This was done within the credit markets.

And you’ve had a massive reaction among not just the U.S. government but all the Western governments and other governments are starting to follow trend. You know I’ve got gray hair, I’ve been doing this for a long while. This is unique to me, this particular down turn. And then the impact it’s having across communities. I mean, I have lots of friends that keep talking to me about their 401k plans. And I just think this is of a different nature, this particular turn down.

Now I think companies are generally pretty strong. You have companies have pretty good balance sheets. You have companies in pretty good cash positions. So we’ll have to see, if credit frees up, how quickly people can get back to somewhat business as normal.

Craig Hettenbach - Goldman Sachs

If this environment remains difficult, particularly within higher-volume consumer-type markets, would you expect to kind of de-emphasize a bit in terms of where that meets your gross margin profile? Or how would you approach in just a kind of near- to intermediate-term basis if pricing gets more difficult in some of those end markets?

Paul Coghlan

We’ve always been very profitable. And the only way you can be very profitable, comparatively, to your peers is that you sell unique parts, and that those parts have a demand. So that even in down markets, if you go back to the dot-com bust for example, Linear Technology’s sales at that time, and that’s the most dramatic turn down we’ve ever seen, our sales in the course of a year went down 47% then. We’re not saying that’s going to happen this year, but just as a frame of reference.

And our return on sales went from the low 40%s to 38%. So although we had a turn down in demand in that time, we were able to maintain our margin structure. So I think that any products we’re in, even presently in now, where competitors had an equal solution but would sell it much more reasonably, particularly in the consumer area, we would not have been successful there currently.

So I think we’re going to continue our strategy of having unique parts, continue to try to sell them at their market value, and hope that the end customer enjoys this differential and it’s technology and it helps it differentiate in its market place.

Robert H. Swanson, Jr.

Yes, there’s absolutely no point in taking a piece of business that doesn’t make money. In any market.

Craig Hettenbach - Goldman Sachs

Lothar, in the automotive market, given the turbulence there, how quickly would you expect, from a design in process, to see an adjustment in terms of new designs for automotive?

Lothar Maier

I think the design in processes in automotive is fairly long. It takes usually a couple of years for designs to take place. So the design in activity, I believe, is going to continue and it’s going to continue to be strong. Really for a couple of reasons.

One is every automotive customer that we deal with has got very active and very aggressive programs. They’re implementing hybrid and electrical vehicles. And so that’s going to, I think, continue to go forward independent to what happens in the market place. And we’ve got a lot of great products that are lined up to service those markets.

And I think the overall contents, electrical contents, electronic contents, of a car is going to continue to grow. It may slow a little bit in the short term but that march is going to continue to march strong going forward.

So I think the design in activity is going to continue to be strong. I think there may be some shorter-term impact where there’s just fewer cars being sold that’s going to have a near-term impact. But the analog and electronic contents in cars is just going to continue to grow.

Operator

Your next question comes from Tore Svanberg - Thomas Weisel Partners.

Tore Svanberg - Thomas Weisel Partners

Your guidance range is quite wide. I assume that’s tide to the level of turns business that you’re expecting, or is there anything else in that assumption?

Paul Coghlan

Well, the biggest difference for us is just what’s going on in the credit markets. Normally we give you a tighter range because the macro economic conditions are similar quarter to quarter and we have a pretty good sense of customer bookings we’re expecting to receive. Our lead times have remained the same. They’re four to six weeks. But now you’ve got, on top of anticipating bookings beyond our lead time, within the quarter, there’s this overhang of how are people going to react to the macro economic events. How are they going to react to the credit crunch? Are they going to feel that their business is going to be curtailed? So that’s hard to project.

As I said in my introductory comments, our sales forces thought we would be down by

going to happen, that caused us at the management level to expand that probability, to keep it in the range of 10% 20%.

So we’re just less sure, to be quite frank with you.

Tore Svanberg - Thomas Weisel Partners

And then also you mentioned you had the ability to manage some costs going forward. Is the company overall now moving into a very conservative scenario where you’re expecting this potential downturn to last quite a while or are you now just focused on the next quarter?

Paul Coghlan

I think initially we’re focusing on next quarter. I mean, it’s hard to project how far this will go. So we’re looking at some ways to be economical and then next quarter. We’ve done this in the past, and done it successfully. And then I think we’re kind of at a turning point now. So we want to see how the quarter plays out, we want to see what the macro economic responses are, we want to see what overall business confidence looks like at the end of the quarter. And then if we need to make further adjustments at that time, then we’ll make them.

Tore Svanberg - Thomas Weisel Partners

And lastly, and just out of curiosity, what triggered the re-classification of bookings this quarter versus other quarters?

Paul Coghlan

We actually have gotten better data. So when we looked at it, actually the catalyst behind it was Bob Swanson, to be frank with you. He said he thought the data probably could be updated a little bit. And we looked at it, and particularly our international distributors. We had been taking data from them and we got deeper into their business a little bit and deeper into how it was actually distributed among end markets.

So this is never precise because it’s based on us allocating customers to end markets. And technologically we’re getting a little better at the front end of an order in trying to ascertain what end market it belongs in. We had these improvements, we wanted to wait until a year end and a new year to bring them forth. So that’s why we issued them this quarter.

Operator

Your next question comes from John Pitzer - Credit Suisse.

John Pitzer - Credit Suisse

Paul, just a clarification so I understand clearly, the bottoms-up sales forecast is looking down 10% for December but you are kind of implying a more conservative tops-down view of the world, is that the right way to look at things?

Paul Coghlan

That is. That is absolutely correct. But the sales guys also caution with theirs that they talk to purchasing agents and they say they hope these folks have incorporated into their estimates the general macro economic events. And they kind of said they’re not sure if they have or have not.

So what we did is we looked at the roll up sales forecast, we pulsed the sales guys a little more, we looked at the October activity, we did what we think reasonable manages would do. We looked at that and that’s what cause us to broaden the range.

John Pitzer - Credit Suisse

And Paul, I know this is probably a little bit of an unfair question, but if you look at the small sample size of companies that have reported in semis, including Intel, Maximus, and Altera, you guys are giving significantly worse guidance. You talked a little bit about you being maybe more broad-based and that’s the reason why. I’m just kind of curious, you’ve been through a couple of cycles now. Why do you appear to be an outliner here? Is it your shorter lead times just giving you a more accurate picture of real term and so we’re going to see companies come out and you’re not going to be an outliner or is there something else going on?

Paul Coghlan

Well, I mean, first sticking with the current facts and then I’ll project as to whether we’re still an outliner a quarter from now than we thought. But starting initially, one of the areas we had some improvement in was computer and that was about the only area. If I told you our bookings quarter-to-quarter, on the new methodology, increased in computer from 10% to 12%. So Intel is very strongly in the computer business. Maximus is probably more in that business than we’re in that business. So I think that we’re kind of the first broad-based supplier to come out.

Secondly, I think you need to look at all of the competitors and look at relative lead times among competitors. Our lead times are typically the shortest among all of our competitors. So that there’s a shorter reaction time between when we have a sales down turn and when the market sees it.

Now, we think that’s the best way to run your business because you don’t build inventory inappropriately and etc., but in dramatic shifts like this we’re the first to notice that impact. So I think it’s probably a little early to say that we’re an outliner and will remain an outliner. But we’ll have to see what the other companies say, both this quarter and next quarter.

John Pitzer - Credit Suisse

And help me understand the strategy around managing inventory on your own balance sheet and fab loadings and how do you think the disti channel is going to react relative to an inventory draw down? Clearly in the last several quarters we’ve all been under the assumption that inventory has been lean. But now that demand is softening here, what would you expect?

Lothar Maier

Maybe I can comment on the factory inventories. Certainly we’re going to adjust the output of our factories, both our wafer fabrication assemblies, to more closely match what the sales are. So we will make adjustments to that and manage that and we’ve shown in the past that we’ve been able to do that very well. And we plan to react very quickly to the changes.

Paul Coghlan

And I think from a distributor standpoint, you know, I told you our deferred income got reduced last quarter because we shipped less into the U.S. distribution channel than it shipped out so I think distis to some extent are already trying to react to what the realities of the market place are.

On the other hand, distis are, they have a responsibility to us, that they have adequate inventory that they can supply the customer base. So I think wherever you have companies that are highly leveraged, there will be a little more pressure on them managing their balance sheets and their payables, and companies like us, from an inventory standpoint, we don’t want to build excess inventories in our factories and Lothar addressed that.

Robert H. Swanson, Jr.

You know, a lot of our shipments go to both distributors and contractors. And both of those businesses are cash-sensitive businesses. So we know that they are going to take a very hard look at running their business to conserve their cash.

John Pitzer - Credit Suisse

And Paul, in this type of uncertain environment it’s always good to have a nice cash cushion on the balance sheet, but given that you guys tend to generate cash in just about every environment, any strategy around the debt and convert here or is this just not the environment that you’re going to think about potentially buying some of that stuff back?

Paul Coghlan

I think we’re always open-minded with our cash. It’s good to have cash. We’re always open-minded at looking to best deploy it. You know, not too long ago we bought back a lot of stock in the open market. This is also a time, though, when cash is kind of king. So that you want to be well positioned with your cash going into a down turn. So I think those are decisions we make on an ongoing basis and we’ll continue to look at those.

Operator

Your next question comes from Craig Ellis – Citigroup.

Craig Ellis - Citigroup

Paul, could you provide a little bit more color in terms of what the company is seeing presently from an order-intensity standpoint? Our check showed, and I think you guys have said this, that order intensity just moderated as we went through September, but have we kind of bottomed out and are things stabilizing here, or do you continue to see just a lower and lower level of order activity?

Lothar Maier

Yes, we saw the business slow down in the second half of September and it’s kind of tracking along that path. But it hasn’t changed dramatically from that level. But on the other hand, we’re trying to make decisions here on a very small amount of data. You know a couple of weeks in this quarter doesn’t make the entire bookings for the quarter. But it dropped down, and as Paul said, we bracketed our guidance between kind of what the run rate business is and what the guidance we got from our field sales.

Craig Ellis - Citigroup

Okay, Lothar, so for now it feels like we’re bouncing along the bottom. And can you just refresh us on how we should think about the linearity of the quarter as we go through October, November, and December?

Paul Coghlan

Let me just interject one thing, to supplement Lothar’s comments. He emphasized we have only had a few days of data points in October. And it’s difficult to extrapolate because you have definitely had a downward trend but there are a couple of days that up-an-up strong so you get a little bit optimistic and then you have another day that’s down a bit. So it’s not a steady line downward. On the other hand, the overall trend has been down.

And then relative to linearity going forward, it’s just very, very hard to project in this environment.

Craig Ellis - Citigroup

Can you draw any parallels between where we are versus the 2001 time frame? If we look back at our models, then the first quarter of the down turn wasn’t so bad, it was really the second quarter that was the most painful. As you guys look at the business now, what’s the risk that that’s the type of environment that’s unfolding?

Paul Coghlan

I don’t know the answer. I will tell you that in 2001 it was much more concentrated in technology. Particularly in networking areas and communications infrastructure. There had been a massive over-build out and lots of inventory in isolated customers. Whereas other parts of the economy were pretty much immune to it.

So that I think comparing this to that, for us, we think it will be different. This one, on the other hand, this is a situation where a lot of business people, a lot of consumers, both in each category, have been spooked by this down turn in credit. And people don’t know what to expect in credit and don’t know what overall economic spending patterns will be, not just in the U.S. but in Europe and Japan for sure, and potentially Asia.

So I think this one is going to be different. If you pin me to the wall, my guess is it wouldn’t be as dramatic, as short, as the one in 2001, but it might be longer. But I’m not an economist and I don’t know and we’re not making plans in that regard yet. We’re just kind of seeing how this plays out.

Robert H. Swanson, Jr.

You know, in 2001 we saw the bubble building. And so what happened was we basically tried to get customers to be realistic. And we got to the point where we had 16 weeks of non-cancellable backlog. So it’s true that when the bottom fell out, we had an extra quarter of back log that could not be cancelled. So we were able to basically buck the tide for a quarter then reality hit home to us.

That’s not what happened this time. A different cause of the problem and at this time we had a normal backlog, not one that was insulated with three or four months of non-cancellable backlog.

Craig Ellis - Citigroup

For many in the sector, rising raw materials prices were pressuring gross margin, earlier this year. How long will it take before some of the commodity price decreases that we’ve seen turn around and become a tail wind, as it were, to gross margins?

Paul Coghlan

Well, certainly the currencies are starting to get more favorable. The U.S. dollar is becoming stronger. Relative to commodities, I think it’s early to say whether they will soften. One big commodity for us is gold because we put gold on almost all of our chips. And that was something we had mentioned to you in earlier quarters. Our cost had risen pretty dramatically. Gold stabilized a bit but at a very high price because in these economic uncertain times gold becomes an area of investment, not just an area of raw material.

Lothar Maier

Again, the only thing that we’ve already factored in is the increases we’ve seen in energy costs, so as energy costs maybe turn back around again we might see a benefit from that. But those are really our largest sort of raw material costs.

Operator

Your next question comes from Auguste Richard - Piper Jaffray.

Auguste Richard - Piper Jaffray

Over the last 15 years, I think I recall in 1998 and 2000 and now you’ve had a pretty dramatic reduction in guidance going forward, and the other analogs are going to be a little more gradual as numbers come down, and I was just wondering is there a reason for this? It’s just an observation I’ve had.

Paul Coghlan

Well, I think our lead times are shorter than most other guys and that therefore we would see it sooner. Now, in 2001, as Bob mentioned, we actually saw this freight train coming and told customers to either adjust their order patterns or they needed to give us 30 and sometimes longer commitment for us to build the product. It’s been different this time.

So I think we’re broad-based, which in this particular environment, with low lead times. And maybe that’s why we’ve seen it sooner.

We like to think it’s because we manage our business well. It looks like in this individual quarter, to you, when we forecast that maybe we don’t, but we actually think we’re managing it well. We stay pretty close to what’s going on in the external environment and to us it shouldn’t be surprising that with what’s going on in the credit markets that that would be having an impact on business confidence.

So we were, frankly, surprised that people weren’t forecasting that there might be a big hit right around the corner for some companies.

Robert H. Swanson, Jr.

It’s this massive, massive credit problem that affects all of our businesses, virtually all of our businesses. If this doesn’t have an impact on everybody, then maybe we are over-reacting.

Auguste Richard - Piper Jaffray

Not to beat a dead horse, when I look at your performance relative to your peers over the last four to five quarters you guys have been outperforming. This guidance kind of brings your year-over-year numbers closer to your peers. Is this a regression to the mean? Is that a possible explanation?

Paul Coghlan

I would think not, in the following vein only. This has been a reaction to the credit crisis. If the credit crisis hadn’t of happened, we told you that at the start of September we were tracking to a positive book-to-bill ratio and we were going to guide flat to up for this quarter. So I think we still would have been cumulatively ahead of the pack.

What happened is this massive curve ball came in, which is this credit crunch. And I think that’s going to readjust the markets for everybody. So we’re not seeing that we’re losing market share, we’re not seeing we’re losing design ins, we’re not seeing that we’re less popular with our customers. We’re not seeing any of that.

What we are seeing is a customer base that’s been shaken by the credit crisis and a customer basis that’s saying that’s going to impact their businesses, their cash flows, and their reaction to it. And we’re seeing that reaction and we’re reporting that to you.

Operator

Your next question comes from Christopher Danely - JP Morgan.

Christopher Danely - JP Morgan

Just a couple of quick clarifications. Paul, did you say you will try to hold op-ex roughly flat in terms of dollars going forward or were you trying to reduce it?

Paul Coghlan

No, we will probably reduce it. What I did say is we would maintain our return, our pre-tax return on sales above 40%.

Christopher Danely - JP Morgan

Maybe I misunderstood but you guys have seemed to focus on keeping those gross margins pretty high whether business is good or bad. Assuming this down turn lasts for a while and pricing gets fairly competitive throughout next year, will you continue to maintain your gross margins in the 76% to 77% range or would you look to maybe get a little more aggressive and keep your market share?

Paul Coghlan

Well, there’s certainly fixed costs that I can’t adjust. I told you that we have a good variable cost structure but we don’t have total only variable costs. So to the extent of that, and I mentioned to you, we spent $23.0 million on fixed-asset additions this quarter to do certain plants expansion that had we known this credit crunch was coming we might have delayed.

So I’m going to have some depreciation and other fixed costs that will impact my gross margin because I will have a reduced sales number to offset them against. The variable costs within those categories, I think I will able to adjust those pretty well and maybe adjust those to what’s going on in sales, give or take a little bit and that’s why I gave you the 40% guidance.

Relative to pricing, we are often in a situation where what we are we have a part that’s it’s a proprietary situation. So as long as to the end customer there’s still value in his end product that our part goes in, there shouldn’t be a lot of price attrition for us.

Lothar Maier

And let me just add that chasing low-margin and no-margin businesses is not something that we’re going to do because of the business conditions that are here right now. So we’re going to sell into markets where we can distinguish ourselves and continue to get the types of margins that our business has typically generated.

Christopher Danely - JP Morgan

Okay, so you guys have pretty much toed the line on gross margins previously. No change to that thesis?

Robert H. Swanson, Jr.

It’s not like the company has been unaggressive in pricing. We’ve always been aggressive in pricing. We just don’t take business that makes no profit. And so we don’t see any point to change that now.

Christopher Danely - JP Morgan

I was just wondering if there was any change to your sort of gross margin model, gross margin attitude, and it sounds like there’s none.

Paul Coghlan

Right. But we’re trying to share with you our approach in that area is probably more complex and more varied than you have considered in the past. I think many of you folks think we’ve got some cross-over line we never go below and none of us make a decision, it’s just a computer program that does it.

So the reason you’re getting a long-winded answer to your question is you’ve phrased it too simply. As though it’s a very un-complex approach we take.

Operator

Your next question comes from Uche Orji – UBS.

Uche Orji - UBS

Can you just talk about each of the segments in terms of your guidance, how should we think about the range for each of the segments? Will they all be equally down more than 10% in Q4 as your guidance would account for or will there be areas that will perform and areas that will not perform?

Paul Coghlan

That’s very hard for us to do. We’re so broad-based, it was hard enough for us to do this on a global basis. But one thing we will say is that the consumer-related businesses, which are usually strong going into this holiday period, those are usually weaker in the March quarter. So those ones will probably be more impacted. But to break it down more finely than that, by each end market, that’s difficult for us to do.

Uche Orji - UBS

In terms of the buy back you have outstanding, given that most companies are kind of going into the cash conservation mode, will you still be on track to do those buy backs or will you kind of take your foot off the gas pedal right now a little bit?

Paul Coghlan

You know, we had a massive buy back a year and a quarter ago, a year and a half ago. And since then we’ve been buying back not as aggressively, a little bit per quarter. So I think we’re going to look at all of that and look going forward as to how best manage our cash. You know, we have a lot of cash, this is a good time to keep a lot of cash. It also might be a good time to do some opportunistic things. So we just have to decide how to do that but we haven’t made those decisions yet.

Uche Orji - UBS

Now, within what you’ve seen so far, what’s happened to lead times in general? Can you quantify that by any chance?

Lothar Maier

Certainly our lead times have remained the same. We typically keep short lead times. In general, normally in a down market, lead times for everybody contract but our will stay relatively short.

Operator

Your next question comes from FTN Midwest Securities Corp.

Joanne Feeney - FTN Midwest Securities Corp.

I’m wondering, you’ve spoken a lot about the credit constraints and I’m wondering two things. One, are you actually hearing from your distributors or your OEMs that they themselves are currently credit-constrained and therefore cannot purchase your parts, or do not want to add them to inventory because of those constraints, or is it more that they perceive that the broader credit constraints our there are going to reduce demand from their customers?

Paul Coghlan

First of all, no customer ever tells us that they are in a credit bind, because they would be scared to death what we would do at that point in shipping to them, to be frank with you. On the other hand, the sense we’re getting is they’re not just, they’re certainly telling us that they think this overall credit crunch is going to impact their customer base. I think implicit in their comments to that is that they also have to manage their cash.

So those customers or those folks in a distribution or a contract manufacturing basis that typically run on small margins with a fair amount of debt, I think we suspect and that they’ll be as careful as they can and what we want to make sure is that they’ll continue to grow our business or treat our business fairly and that they will be a good channel of distribution for us.

But I think that whole dynamic will become a little tighter.

Joanne Feeney - FTN Midwest Securities Corp.

And then on a separate point, on the communication side, are you able to determine or sense whether there’s a greater or lesser slow down on the wireless infrastructure versus the networking side of the business?

Lothar Maier

I’m not sure that we’ve got the resolution in our data to say that. I mean, we’ve seen things generally get slow but between wireless and networking I’m not sure I could tell you much difference.

Joanne Feeney - FTN Midwest Securities Corp.

Can you perhaps elaborate then on infrastructure in general versus Smartphone, because you talked about that going well last quarter.

Lothar Maier

As Paul said, consumer is an area that if we have to comment where things have slowed down a little bit more than business in general, and to us, we kind of categorize cell phones, at least in our business thinking, as a consumer item. And I would say that’s an area where business has slowed down a little bit more.

Operator

Your next question comes from Craig Berger - Friedman, Billings, Ramsey & Co.

Craig Berger - Friedman, Billings, Ramsey & Co.

Can you help us understand the sensitivity of your revenues to global GDP? If global GDP falls a point next year, what’s the impact on your revenues?

Paul Coghlan

No, I can’t answer that. We don’t have economists on staff and that’s just tough for us to do. We’re $1.0+ billion company, $1.2 billion at the run rate last quarter, and it’s just, we sell high-end, kind of unique parts. To be frank with you, we don’t spend much time at all worrying about global GDP.

Craig Berger - Friedman, Billings, Ramsey & Co.

I know you said lead times are stable as far as six weeks, can you comment on your ability to service turns requests and is there a possibility that people are just stripping orders our now while things are falling but may inevitably come back to you with turns requests?

Lothar Maier

Yes. We generally, in the past are very good at responding to turns request. With 4 to 6 week lead times, generally we have got to be able to turn the business very quickly. Our manufacturing times are much longer than that. We’ve got some internal practices that allow us to keep the turns very quick. But just even under normal circumstances we normally are dependent on 50% to 60% of our sales in any quarter are tied to turns and it has made us pretty agile in being able to respond to customers’ orders. Even though our typical lead times are 4 to 6 weeks, on an expedited manner we can sometimes do much better than that.

Craig Berger - Friedman, Billings, Ramsey & Co.

What are your current times and what might they go down to and what’s the impact on gross margins there?

Lothar Maier

Lead times for us we’re forecasting to be in the order of 4 to 6 weeks, which is what we’ve historically had. It’s kind of hard for me to predict how that’s going to change throughout this particular quarter.

Craig Berger - Friedman, Billings, Ramsey & Co.

I’m sorry, can you answer that on fab utilizations? What are fab utilizations now, where might they go and what is the impact on gross margins?

Lothar Maier

Fab utilizations, typically our factories are utilized pretty much at the run rate of the sales. So if our sales, we are running virtually at full utilization of our wafer fabs and if sales drop, we’re going to become proportionally less utilized but we’re going to make adjustments to the outputs of those factories to compensate for the reduction in demand. So if sales go down like 10% we will adjust the output of our factories to compensate for that.

Craig Berger - Friedman, Billings, Ramsey & Co.

So what would be the impact on gross margins?

Paul Coghlan

We’ve already told you on the profit before tax we think we can stay above 40% and we were at 46% last quarter. All of that is distributed through the income statement. I think we’ve given you some guidance on how we think that will come out.

Operator

Your next question comes from Steven Smigie - Raymond James.

Steven Smigie - Raymond James

Looking at op-ex in the last cycle, it seemed like you kept the dollars on the R&D a little bit stronger in terms of percentage of revenue versus the SG&A. It seems like you took SG&A down a little bit more aggressively than R&D. So would that sort of be the general pattern you follow here and do you see any weakness and opportunities for a strong such as yourself to continue with high levels of R&D to continue to win client business?

Paul Coghlan

R&D is very, very labor-intensive, as you might imagine. There are costs, mask costs, etc. but it’s very labor intensive. SG&A, although labor-intensive, has a lot of other. It’s kind of a catch-all area. You have legal expenses, advertising expenses, you have a plethora of areas where if you want to tighten your belt, and in times like this when people do tighten their belts, there are some opportunities there to reduce your costs.

Now there are still opportunities in the R&D area. We have some variable costs as they relate to our labor costs and in the past we have been able to do some there. But that’s how we think we will treat both of those lines.

Operator

Your next question comes from Krishna Shankar - JMP Securities.

Krishna Shankar - JMP Securities

You indicated that the credit crisis has impacted you dramatically. Can you talk about what percent of your revenue mix is with OEM and distributors and to what extent is this due to distributors being unable to finance inventory? And could you just give some color on the impact on the distribution channel and their smaller customers about financing their inventory?

Paul Coghlan

Well, we don’t know of any situations yet where a distributor said to us that they can’t buy any more from us because they can’t finance their inventory. On the other hand we do know that credit is tightening and we do know that the distributors who deals mostly with smaller clients, especially here in the U.S., that the distributors are nervous about their client base and we think will try to manage their assets as best as possible.

But if your question is do we have a list of guys we can tell you, not naming them but specifics, who have called us and said they are now out of money and the bank won’t give them any, we don’t have that yet.

Robert H. Swanson, Jr.

But again, to repeat something I said earlier, a lot of OEM sales go through contract manufacturers. And they are the ones that pay us and our sense is that is a cash-sensitive business, also, so we just anticipate that everybody is going to looking at their cash and trying to figure out how to optimize it. One way is to make sure their inventories are not one day longer than they need to be.

Krishna Shankar - JMP Securities

As you [inaudible] the recent actions the government took to help credit improve, what end markets do you think will recover more quickly coming out of this down turn? Is it telecom networking infrastructure, high-end hardware, can you give us a flavor for the rate of recovery in different end markets that you see for the next three to six months?

Paul Coghlan

To be frank with you, no. I mean we don’t know how these government actions are going to take place, whether they will be more market-specific, one market to another. We don’t really know the answer to that. What we do know is what the governments are trying to do is say that they’re going to try to free credit up, so that if you have a reasonable business, you’ll be able to get credit. That probably means if you have a marginal business it’s going to be more difficult to get credit. And those marginal businesses and strong businesses are going to permeate all different end markets. So I mean, we really don’t have the economic granularity to answer the question you’ve asked.

Krishna Shankar - JMP Securities

I was just asking about your direct conversations with OEMs. Do you sense that they are putting major new say telecom networking infrastructure programs on hold or new consumer high-end projects. Do you sense that design activity has pushed out or cancelled or any of those conversations that you’ve had?

Paul Coghlan

No, we don’t think design activity has been pushed out. What we think is this has caused a degree of real concern and what’s happening is that customers are just pausing. They’re curtailing what they’re doing. They haven’t come to us and said they’ve made massive, strategic changes in the past two weeks. On the other hand, they’ve definitely said they are going to slow down their orders and see what happens.

So this is very much in flux at the moment, but the overall trend is slow it down and that’s what we’re seeing.

Now a quarter from now there may be more specific projects where people tell you what they’ve done specifically, but the moment we think that the cry from the bridge down to the boiler room is slow it down.

Operator

Your next question comes from David Wu - Global Crown Capital.

David Wu - Global Crown Capital

I’m just wondering, two things, quickly. I forgot to write down the percentage of your business going through distribution in the last quarter. And the other thing I was wondering is usually in the March quarter, in particular in the U.S., the distributors for industrial products tend to be better, on a seasonal basis, relative to your December quarter. In past recessions do those seasonal trends go out the window entirely or do they merely get moderated?

Paul Coghlan

It depends on the nature of the recession. So that in the dot-com bust a lot of our distributors who sold into the industrial environment, and a lot of our industrial customers, didn’t have as big an impact on down turn in sales as networking and communications infrastructure people did. This one feels a little more broad-based, the one we’re in now.

On the other hand, you’re correct. March is normally a quarter where companies that are strong in industrial and communications infrastructure environment typically do better. Distributors have more days to sell, Europe has less vacation days, that’s usually the start of a budget period for a lot of companies that have calendar year ends. So we think that will probably continue to prevail, that in the March quarter you will have more strength in those areas and less strength in consumer once you’ve gone out of the holidays season.

David Wu - Global Crown Capital

How big is your distribution business, by the way, the last quarter.

Paul Coghlan

That’s been hard for us to quantify because we have different natures of distributors. For example, in the U.S. you have your kind of classical distributor where you ship to him, he ships out to little guys.

In places like Japan, we do almost all of our business through distributors, more because they’re a logistic channel for us than that they go find customers. We actually have a big sales force in Japan, finds a lot of the customers, including the very big customers, but it gets booked through a distributor.

And then Europe tends to be a little bit more like the U.S. I guess their distributors.

So we have this kind of blend of distributors. But if you said, well, the guy has got the name distributor, I don’t care what variety he is.

David Wu - Global Crown Capital

Classical distributors, which does not include Japan, what roughly would the business be as a percentage of total in Europe and the U.S.

Paul Coghlan

It would be about 50%.

David Wu - Global Crown Capital

So roughly half, outside of Japan.

If we have a long recession, but not as deep as the one in 2001, I assume that allows you more time to adjust your costs. Am I correct?

Paul Coghlan

Yes, you’re correct. But we’ve been pretty adroit at adjusting costs relatively quickly. So I mean, we haven’t told you that it’s going to take us a long time to adjust our costs. We think we can react pretty quickly.

But if it’s a longer recession, what adjustments you make, you’ll have to keep those in place for a longer period of time. And also, if it turns around quickly, we’re also very quick to react. So our hope is it turns around, but at the moment, certainly going into the next quarter, we don’t see that happening quickly.

David Wu - Global Crown Capital

So this is basically, to summarize this conference call so far, what you’re telling us is that you’re the leading canary in the coal mine, telling us that there’s a freight train coming. Relative to the people who have reported so far. Yours is by far the worst.

Paul Coghlan

Yeah, we’re at the front. We’re broad-based, which would support that thesis you have. We have low lead times, which supports that thesis you have. So we’re just telling you what we are. We’ll leave it to you to extrapolate whether we’re the canary.

Operator

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

Sumit Dhanda - Banc of America Securities

Paul, a couple of questions for you. Did you indicate what the turns requirement would be for this quarter relative to last quarter to hit the mid-point of your outlook?

Paul Coghlan

It’s about the same. It’s the high 50s.

Sumit Dhanda - Banc of America Securities

The other general question I had for you was on your cancellation or your reserve policies to distributors. Is it any different than what it is for other companies? In other words, do you have stricter cancellation policies? Is that possibly a reason why you typically see a steeper fall off, if I look at history versus other peers within the analog group?

Paul Coghlan

I would doubt that. We’re pretty disciplined so distributors know us, that we’re disciplined with our receivable, and we’re disciplined within the contracts that they have stock rotation rights and they need to stay within those and we don’t allow them to expand those.

But I don’t know all my competitors, how they deal. But I don’t know of distributors telling me that I’m radically different than the other analog guys. So I would think I’m probably a little more disciplined maybe, but still pretty close to the other guys.

Sumit Dhanda - Banc of America Securities

In terms of Linear strategy, you’ve gone through a process de-emphasizing the consumer segment, refocusing on other places where you think there’s content growth opportunities, where you can differentiate yourself. But assuming that expectations are normalized across the board here, your December 2008 revenues are going to be flat with what they were two years ago, suggesting over a normalized period of time, basically the lack of any growth. And so how do we think about that because that suggests underperformance or maybe just in-line performance versus the industry at best. As an investor, how do we think about the actions that you’ve taken and why they’re not really bearing significant fruit, at least on the surface?

Paul Coghlan

Please be patient with me with this. I don’t know, you’ve picked one data point for your comparison, which is the December 2008 forecast, in the teeth of a huge world-wide credit crunch. And you’ve taken that and drawn an extrapolation.

Sumit Dhanda - Banc of America Securities

No, I have not done that. That credit crunch impacts your entire peer group. And we can pick whatever point you want to pick. We can pick 2008, an 2007, in aggregate, and compare that to 2008 and 2007, for everybody else in your peer group. I don’t think that the conclusion necessarily changes unless you want to disabuse me of that notion. I’m just curious as to why, despite all these efforts, it seems like we’re, at least based on the data and the forecast you’re giving, we seem to be back to square one.

Robert H. Swanson, Jr.

Let me weigh in on that a little bit. Several years ago we had a very high percentage of business in both what everybody considers consumer business and if you throw in handsets, it was a significant piece of our business, approaching 1/3. Today it’s much less than that. So it is true that in the last two to three years the company has been focusing on markets like, re-focusing on markets like the industrial, the communications market. And sort of a new engine of growth for us, the automotive market, while de-emphasizing those markets that weren’t contributing, they weren’t defensible, they weren’t contributing any profit and so two and a half years later the company continues to be, remains very healthy, from a profit and cash point of view.

Now maybe one of the unfortunate things is one of the markets that is a long-term market for us, a market that is normally less volatile and we believe will pay us good margins for our products, is automotive. Now who would have guessed that automotive would have been hit with a credit crisis? But automotive is one of those businesses that unfortunately is very sensitive to credit. So maybe that’s bad luck in the short term but it’s certainly where we want to be in the long term.

Paul Coghlan

And you made a comment, you said pick any period I want, I think because I challenged that you included December. If you back out our December guidance and you look at the last six quarters, we’ve grown each of the six quarters and none of our competitors have done this. So if you want to compare us with the analog guys over the last six quarters, I think you’ll see we’ve grown better, we’re at the top end of the pile. Or very close to the top end.

Robert H. Swanson, Jr.

And on the surface, while those two data points show flat sales, there has been a significant substitution of business that wasn’t defensible, quickly becoming non-profitable, replacing business that is defensible and is profitable.

Sumit Dhanda - Banc of America Securities

Let me just shift gears. Any color you can offer on the sell through rates that the distributors have been seeing recently, ever since the slow down started to occur? I’ll call it the middle of September through the middle of October. Has that mirrored the booking patterns you’ve seen? Have sales been poorer or maybe slightly better versus a [inaudible] ?

Paul Coghlan

Well, U.S. distribution, I think the sell through has been a little less in the last quarter than the previous quarter. And I think U.S. distribution will be anticipating sell through this quarter will be less than it was last quarter. And then other distributors, depending on geographic areas, some are like that and some in some geographic areas are having a little better sell through.

The U.S. for sure has been getting poorer.

Sumit Dhanda - Banc of America Securities

Can we safely assume that the tax rate stays at about the 25% level for the foreseeable future?

Paul Coghlan

The effective tax rate, as I said, will be 28.5% for the foreseeable future. You have these discrete items that come in and out. Now, there’s a new accounting pronouncement a few years ago, 1048, and it has resulted in a lot of these items every quarter. So my guess is we’ll be in and around that range for a couple of quarters, but I think the effective overall rate is 28.5%. Next quarter I do know of some discrete items relative to the R&D credit. Quarters out, those discrete items depend on timing.

Operator

Your next question comes from [Ali Pharr] – Spherix Capital.

[Ali Pharr] – Spherix Capital.

I just have a question. There is sort of a crisis of confidence and I think this guidance that you’re giving, for lack of a better word, is disastrous. It’s sort of fueling the fears that investors have that are we at the middle, are we at the end, or at the beginning of this slow down. Now, every company that has reported so far, Maximus, Altera, Intel, as one of my peers pointed out, they have experienced the weakness, they talked about it, everybody acknowledged the impact of this credit crisis in our industry. But again, your guidance of down 10% to 20% is just too high.

And then some explanations that are put out there is that some of the other companies are saying they have sort lead times, Altera has short lead times. They saw the weakness of this economic slow down earlier in the year. That’s why we’re seeing a decline in their revenues. Like Maximus down 5% year-over-year, PI down 3% year-over-year, ATI up slightly. And even if you take the 15% down for your December quarter, you’re year-over-year revenue is up 8%. So their explanation is that they saw the slow down first, you are seeing it last. The reason you are seeing it last is because you have a lot of proprietary products that distributors and contract manufacturers, that finally they are sort of trying to take their inventories down. And also as management, you tend to be more conservative.

So again, just to rebalance, and this may be a tough question in terms of what’s your judgment, can you just sort of give us a real picture. Like there were some discussions that maybe you’ve bought some shares both in a networking company and a consumer company here in Silicon Valley. Maybe that has had a disproportionate impact. And the fact that internationally you recognize your revenues fell in through distributors. So sort of give us a balanced perspective, if you can, because I’m telling you, a lot of people are reading into this just disastrous guidance that you’re giving.

Paul Coghlan

Well, that’s a long and well-thought out question. I think some of it is how you perceive it. Bob mentioned earlier that if you go back two years or three years, Linear started a process of de-emphasizing to some extent, those parts of consumer business that weren’t keyed towards high performance and were really more commodity in nature and where the end customer cared less about the actual performance of a product and more about the price of it. And where that encompassed about 1/3 of our business, or a little more back then, it’s now much more down towards the lower 20% bracket of our business.

And we had started that several years ago and in the early time frame we were growing not as quickly, or just about the average of analog guys, and people were saying to us, gee, are you falling behind? And we said, no, we think we’ve got a right strategy, look a the profit lines and the answer will be there.

And then the last six quarters we’ve outperformed folks. And what we’ve done, is we have really good products, we’ve done really well, we think, in that time frame. Now, because there’s a big credit crunch, and now because of short lead times, we’re adjusting our forecast in December, Ali, you’re saying, well gee, those last six quarters, maybe they really didn’t happen that way.

Maybe in those last six quarters was all your competitors saw the down turn coming sooner than you did. And they had some clairvoyant sense that there would be these credit crunches and issues like that and business was softening and you didn’t. We don’t think that’s accurate. We think we actually did outperform in that period.

We think now, relative to this particular period, your question as to whether is it a Linear-specific issue [on this], or could you be seeing it first more accurately than others. We do have low lead times, we do have lower lead times than other folks. We have been operating that way for years and think it’s the best way to run our business.

So that we do think in this short period now, where everyone is reacting to the credit crunch, we might see it sooner. And we think that’s why we’ve given you, to use your term, this disastrous forecast for December. We think the range is an accurate range.

So these things you can spin it whatever way you want, I guess. You can say let me just look at December like an earlier caller said, well, let me take the quarter of December guidance and compare that with two years ago and say you guys have made no progress and done nothing in the interim.

So you can spin these things any way you want. The bottom line from us is we have remained very profitable, very cash-flow positive, outperformed our peers in those metrics. We’ve also outgrown them in the last six quarters, except the one we’re in now.

Now the one we’re in now, the December quarter, because of this credit crunch, it’s going to be a difficult quarter for us. We should probably have this same question three quarters from now and see how everybody’s doing there quarters from now. And then you maybe have a better sense of balanced data as to whether other guys saw something happening before we did or whether they didn’t, we just outperformed them and now everybody is going to have a credit crunch problem.

Operator

Your next question comes from Dan Murphy – O’Connor.

Dan Murphy – O’Connor

Two questions on things that are in your control I think. The first one, when your customers look at your balance sheet, do they look at your gross cash on the balance sheet or do they look at your net cash, cash minus debt?

The second question is, and you talked about it earlier in the call when you forecast interest income for the December quarter, can you weight for us the pros and cons of continuing to invest in low-interest rate securities on the balance sheet, buying back debt, I guess the bonds putable in 210 are yielding close to 12% if not more, buying maybe the longer-term convertibles, and then buying back stock. And the pros and cons for the company for doing either of those three?

Paul Coghlan

The first question, I think most customers when they look at us they look at our products we sell, our payables records. I don’t know too many of them that look at the cash and compare it to the debt and do a debt-to-cash analysis of us. Maybe those that are initially giving us credit would look at that. But the debt, I think most people think we have the cash generation capabilities to easily handle the debt.

Relative to your second question, what we have had, we have bought back a lot of stock. I’ve told you that, you’re aware of that. Times like this, when your stock is under a lot of pressure, and your debt is under pressure, those could be opportune times to do something in either of those two areas. These are also times when pressure arises because cash is very critical. And people are saying keep your powder dry and as you make your way through difficult times make sure you have plenty of cash and plenty of headroom there because it would be very difficult to raise it, external to the company.

So I think your question is a very good question and I think as a company we would look at all three of those alternatives and as we made decisions a while ago to buy back some stock, we made about six quarters ago, we will keep looking at these and decide what’s the prudent thing to do in the time frame.

Dan Murphy – O’Connor

If you thought that this cycle might be longer than the dot-com cycle but not quite as severe, you have a maturity in 2010 that’s trading substantially below par. Wouldn’t using some cash to buy that back below where it’s going to mature in 2010 be a smart decision?

Paul Coghlan

One could certainly argue that that would be a smart decision, to do something like that. Again, you have to look at when you said that I said that the dot-com bust, that this would be less steep but maybe a little longer, I certainly wasn’t holding myself out as an economist. I don’t know how long this is going to be. The dot-com thing lasted a while.

But certainly when you just look at it from a cash utilization point, if you’re very, very confident you could keep all your cash or grow your cash, using some of it if you thought you had excess cash, this would be a prudent time to do that.

Robert H. Swanson, Jr.

I’m certainly not an economist either and I probably shouldn’t even weigh in on this, but the dot-com bust was a real collapse of demand. This is a problem of credit, a credit crunch, and a loss of confidence. If that loss of confidence gets corrected quickly, then the improvement could be quick also. But how in the heck would we know what the right answer is to that question?

Dan Murphy – O’Connor

One might also argue that your convertible bonds due in 2010 trading in the 80s might also be a loss of confidence and one of the things in your control would be to take advantage of that by buying some back. I mean, to hold on to your cash, you’re going to have to pay them back at that put date at 100 or go out of business. I don’t know, if this is a rationality and just a pause in an air pocket with the credit cycle, maybe one of the ways to take advantage of that is on your balance sheet.

Paul Coghlan

That’s a good input.

Operator

Your next question comes from Alec Berman- AMPAC Research.

Alec Berman – AMPAC Research

You talked before about the proprietary products and their large percentage, can you say approximately how of the designs you’re going after right now, if you look at the whole catalogue, what percent of those do you think are things where you sit down with a customer and it’s really just you and that one customer working on a specific design versus where there actually is another person competing for the socket?

Lothar Maier

I think it’s very rare that there’s a pin-for-pin replacement part for an LTC product. That’s not very frequent. There are more likely comparable solutions that a customer can put together that solves whatever problem they’re trying to solve. So the fact that there are not a lot of pin-for-pin parts, you know, some of our consumer stuff, where people have copied them, over time there might be a few. But for new products and for the majority of our products, there really isn’t a direct replacement.

Most of the competition is really how the implementation of the customer is done. And so one of the strengths that we have is we’ve got a really, really strong analog field applications organizations and that’s how we get our proprietary parts designed in and that’s one of the advantages that we have. That’s been a strength in the past and I think going forward, as the economic times get more difficult and many of our customers have less and less analog expertise in-house, that we will continue to be successful in helping customers design in our products. And once they’re designed in they really are in a proprietary position.

Operator

Your next question comes from Steve Rosston – Glynn Capital Management.

Steve Rosston - Glynn Capital Management

You made a good point about the transition in your business two to three years ago where you focused more on the industrial and more traditional analog products and less on the commodity-consumer products. Can you give us a little more data than you have in terms of how much of your business needed to roll off and where are you now and where will you go in the future in terms of taking away less profitable revenue on the consumer side and how long will it take to ramp up the longer lead time to production, industrial products and auto products, that you’re replacing that consumer business with?

Lothar Maier

Over the last few years, as Bob mentioned, we’ve de-emphasized a lot of the consumer business and replaced it with a lot of what we think is much more defensible business. To the outside investor it kind of looks like things were a little bit flat, but behind the curtain a lot of changes took place. I mean, we talked about earlier how the consumer portion of our business went from being 1/3 to closer to 20%, where it is presently. And you’re looking at $100.0+ million worth of business that we used to have and that we used to sell into the consumer market and which we’ve now replaced with more defensible business.

Steve Rosston - Glynn Capital Management

Can you expand beyond that? Because I know that sometimes it takes two to four years for your more traditional analog products to get to production. That wasn’t the case with the shorter time frame to consumer products. Given the design talent you shifted, what do you expect the change to be and when, from the shift of that design talent from the consumer products two to three years ago to the industrial products that are now more coming on line?

Robert H. Swanson, Jr.

When we look at our data, the involvement in handset and other consumer products hit a peak in our FY2005. It was at the beginning of 2006 that we said, look, we need to make some changes here for the long-term strategic health of the company and we did that. Now, looking in at 2009, we expected the consumer and handset business to fall even more. In fact, fall to half of what it is now. We expected industrial and automotive and some other key markets that we believe are in the better long-term alignment with our strategy to improve. And we expected our total sales to improve.

The credit crunch was a curve ball that we weren’t anticipating. But whatever the sales are, the mix, at the end of 2009 and 2010, will be more in the direction of the shift that we started way back in 2006. So, it’s a two to three to four year cycle.

Steve Rosston - Glynn Capital Management

But that cycle started two years ago.

Robert H. Swanson, Jr.

That’s right. And we were feeling real good about 2009, about both the level of sales and the mix of sales, and then out of the blue came this credit crunch, that certainly was not on any our radar screens.

Steve Rosston - Glynn Capital Management

So, Bob, just so I understand I make sure I understand what you’re saying, in the consumer are, you expected it to drop it from now about 20% to significantly less as the more business rolled off, but your design ins were strong enough in the industrial and auto area that that would have been more than replaced in the fiscal 2009 period?

Robert H. Swanson, Jr.

That’s exactly right. And I think in FY2008 not only did we replace maybe as much as $100.0 million worth of business, not only did we backfill that, but we grew by another $92.0 million. Internally we were hoping, and had expectations that we might be able to put together a similar year in FY2009.

Operator

Your final question comes from Doug Freedman – American Technology Research

Doug Freedman – American Technology Research

I received a couple of questions, Paul, on your comments about turns orders, saying it’s the same percentage. Just for clarity, can you explain how that works for people and I take that to mean that you’re basically going to book and ship and maintain your backlog at a constant level and if anything, your backlog coverage of the percentage of dollars might actually increase. Would that be fair?

Paul Coghlan

What I do is I look at what I estimate the sales for the quarter will be and then I look at how much of that I have already in my backlog. And then I take that percent and the reciprocal of that is the turns that I need. And normally the number approximates lead times. So if I have a high-50%, say 55% to 60%, that approximates the lead time. And my lead times are 4 to 6 weeks out of a 13-week quarter. So what I do is I look at the estimated sales we have and then compare that to the backlog that’s going to ship in the quarter and that’s how I come up with the turns number.

Operator

There are no further questions.

Paul Coghlan

Thank you very much for your attention today. It was a good call. You asked a lot of intelligent and perceptive questions. Going forward, we would like you to concentrate on we know we gave guidance that was different than you may have expected, and we think our guidance is going to prove that it’s accurate throughout the economy. We think that this is going to be a time when a premium is placed on good solid companies, companies that have good cash-flow generation, good income generation capabilities, we have a dividend which is greater than 3% of our stock now, so we think we’ve been through times like this before, we’ve done well in those times and come out stronger, and we think that will happen this time as well. And we wish you all a good day.

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