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Analog Devices, Inc. (NASDAQ:ADI)

F1Q10 (Qtr End 01/30/10) Earnings Call Transcript

February 17, 2010 5:00 pm ET

Executives

Dave Zinsner – VP, Finance & CFO

Jerry Fishman – President & CEO

Analysts

Romit Shah – Barclays Capital

Jim Covello – Goldman Sachs

Stacy Rasgon – Bernstein Research

Terence Whalen – Citigroup

Uche Orji – UBS Warburg

Christopher Danely – JP Morgan

Tristan Gerra – Robert W. Baird

Craig Ellis – Caris & Company

David Wong – Wells Fargo

Doug Freedman – Broadpoint AmTech

Operator

Good afternoon. My name is Christine and I will be your conference facilitator. At this time, I would like to welcome everyone to the Analog Devices fiscal first quarter 2010 earnings conference call. All lines have been placed on mute to prevent any background noise. After the opening remarks, there will be a question-and-answer period with our analyst participant. (Operator instructions) Thank you.

Mr. Zinsner, you may begin your conference.

Dave Zinsner

Thanks, Christine, and good afternoon everyone. This is Dave Zinsner, Vice President of Finance and CFO. Mindy is out sick, so I am going to handle the intro this time. We appreciate you joining us for today’s call. If you haven’t yet seen our first quarter fiscal 2010 release, you can access it by visiting our website at analog.com and clicking on the headlines on the homepage.

This conference call is also being webcast live. From analog.com select Investor Relations and follow the instructions shown next to the microphone icon. A recording of this conference call will be available today within about two hours of this call’s completion and will remain available via telephone playback for one week. This webcast will also be archived on our IR website.

Participating on today’s call is Jerry Fishman, President and CEO. During the first part of the call, Jerry and I will present our first quarter results as well as our short-term outlook, and then we’ll open it up for questions during the latter part of the call.

During today’s call we will refer to several non-GAAP financial measures that have been adjusted for onetime items in order to provide investors with useful information regarding our results of operations and business trends. We have included reconciliations of these non-GAAP measures to their most directly comparable GAAP measures in today’s earnings release, which is posted on the IR website.

We’ve also updated the schedules on our IR website, which include the historical quarterly and annual summary P&Ls for continuing operations, as well as historical quarterly and annual information for revenue from continuing operations by end market and product type. Those interested in learning more about ADI are invited to listen to a live website of our analyst day taking place on Thursday, March 11th, 2010, at 7:30 AM Eastern. A link to this webcast will be available on our IR website.

I’d ask you to please note that the information we are about to discuss includes forward-looking statements, which include risks and uncertainties. The Company’s actual results could differ materially from those we will be discussing. Factors that can contribute to such differences include, but are not limited to, those described in the Company’s SEC filings, including our most recent quarterly report on Form 10-Q. The forward-looking information that is provided by the Company in this call represents the Company’s outlook as of today, and we do not undertake any obligation to update the forward-looking statements made by us. Subsequent events and developments may cause the Company’s outlook to change. Therefore, this conference call will include time-sensitive information that may be accurate only as of the date of the live broadcast, which is February 17th, 2009

With that, let’s begin with the opening remarks from our CEO, Jerry Fishman.

Jerry Fishman

Well, good afternoon, thanks again for joining us on this afternoon’s call. As you can see from the earnings release that we put out earlier, the first quarter was another very strong quarter for ADI and the beginning of what we hope will be a strong year for ADI. The recovery which began in our third fiscal quarter last year and picked up momentum in our fourth quarter has carried over into our first fiscal quarter of 2010.

Our revenues grew 5.5% sequentially, during the quarter that’s typically a seasonally slow period at ADI, after growing 16% sequentially the prior quarter. We are very encouraged that our industrial revenues grew significantly this quarter. This business spans many different applications in factory automation, process control, instrumentation, automatic test equipment, energy management, military and aerospace, and also healthcare, and is comprised of literally tens of thousands of customers around the world.

Revenues from communications infrastructure and automotive also grew during the quarter. It’s important to note that we are now breaking out automotive from the industrial category where we typically reported automotive beginning for the first time this quarter, given the fact that automotive has now become a more important strategic focus for ADI and is not getting to be a meaningful size relative to the rest of our business.

Importantly, our lead times have remained short and we continue to deliver over 99% of our shipments to our OEM customers within six weeks or less. This is consistent with our performance in the previous quarter and represents what is typical lead times for ADI. Maintaining short lead times reduces the chances of excess ordering by customers.

In addition, distribution inventory has remained stable at approximately eight weeks, which is also consistent with the prior quarter. This of course is positive in the short term as that allows to meet our customers’ requirements on a short-term basis, but I think equally important is the lasting impact that we believe it will have as am I sure ADI remains a trusted and reliable partner to our customers for the longer term.

During Q1 we continued progress for making ADI a structurally more profitable company. Our gross margins improved by approximately 480 basis points sequentially and operating margins excluding restructuring costs are now 270 basis points higher than our most recent peak when quarterly revenue was approximately $60 million higher. We expect to continue to continue to expand the operating margins in coming quarters through gross margin expansion and continuing very tight control of operating expenses. We believe that we can retain approximately 50% of our expense reductions as permanent cost reductions, which is in line with our earlier estimates.

As we entered this downturn, we set in place a strategy to be more focused on products and our markets that value innovation, and also to become a more profitable company. In some cases we increased investments, in others we slowed or ceased investments in areas where innovation was no longer the primary driver. As a result we believe we are very well positioned for solid growth and exceptional profitability going forward as the economies around the world continue to improve.

So now I will turn the call over to Dave, who will provide more detail on our financials.

Dave Zinsner

Thanks, Jerry. Revenue was $603 million, a 5.5% increase from the prior quarter and a 26.5% increase from the first quarter of 2009. Our order strength continued last quarter and we finished the quarter with a higher backlog and a book-to-bill ratio above one. Gross margins were 61.1%, a 480 basis point increase from the prior quarter and a 470 basis point from the first quarter of last year. Although there are many different factors that impact our gross margin, the increase was primarily due to lower infrastructure costs, higher utilization, and a more favorable mix of revenue.

Factory utilization was in the low 60s in the first quarter as we ramped production to match increasing order rates. Should business levels justify it, we can add significant amounts of internal manufacturing capacity quickly and with relatively little additional capital spend. Our goal continues to be to keep our lead times short and reliable.

Operating expenses in the first quarter were $219 million including a $16.5 million restructuring charge or $203 million excluding the charge. This charge along with higher variable compensation expense resulted in higher operating expenses.

The restructuring charge included approximately $5 million related to the final closure of our Cambridge, Massachusetts facility and represents the cost associated with decommissioning of that facility. The other $11.5 million reflects actions taken during the first quarter to continue to sharpen our focus in product development and reduce infrastructure expenses. When fully implemented, we expect these actions will result in savings of approximately $4.5 million per quarter.

The remaining increase in operating expenses was due to higher variable compensation expense, in line with significantly higher operating margins in the first quarter. Variable compensation is primarily based on operating margins, which we believe tightly aligns the interest of our shareholder and our employees, given the historical relationship between operating margins and share price.

Excluding variable compensation and restructuring, operating expenses were flat with the fourth quarter of 2009. Operating margins, excluding restructuring charges were 27.5%, a 500 basis point improvement from the prior quarter.

Excluding restructuring charges, our tax rate was approximately 20.3% more typical for ADI than the unusually low tax rate booked in the previous quarter. We expect the tax rate for the remainder of the year to continue at approximately this level.

For the first quarter, excluding restructuring charges, we earned $0.43 per diluted share, which was an increase of 19% from the prior quarter on a 5.5% increase in revenue despite a change in the tax rate quarter to quarter.

Weighted average shares outstanding increased by 4% to 305 million shares. This is the result of the exercise of stock options that were due to expire in the first quarter and a higher average stock price for the quarter as compared to last quarter.

Now turning to the balance sheet, for the quarter we generated approximately $200 million in free cash flow or 33% of sales and finished the quarter with approximately $2.2 billion in cash and marketable securities with $380 million of debt.

In line with the higher revenue, accounts receivable increased slightly in dollar terms this quarter. However, our days sales outstanding declined by one day to 47 days.

Inventory declined $10 million to $243 million and the days of inventory remained low at 95 days. As I mentioned before, we believe that in inventory levels between 90 to 100 days is an optimal level given our mix of internal and external manufacturing. This keeps our carrying cost of inventory low, but allows us to meet the short lead time requirements of our customers. Inventory distribution increased slightly this quarter in line wit the increased sales in that channel. However, on a turns basis inventory remained flat with the prior quarter.

In summary, from a financial perspective, this was another excellent quarter for the Company.

Now, I will turn the call back over to Jerry.

Jerry Fishman

Well, thanks Dave. With regard to what happened in the end markets for the first quarter, our industrial business, which is now approximately 43% of sales grew 16% sequentially. You should recall as I explained earlier that industrial category no longer includes the automotive sales. We saw a broad based growth across many applications, including instrumentation and process control, test equipment, healthcare, defense and aerospace.

Our revenues from our automotive customers, which now represent in the first quarter 12% of sales, grew an additional 5% sequentially after a few previous quarters of very substantial growth. While certainly some of the strength that we’ve experienced over the last few quarters is likely inventory replenishment, we are also the beneficiary of increasing electronic content per vehicle and also a very strong automotive product portfolio. The increased content in automobiles for ADI is driven by applications in infotainment and safety and in Powertrain electronics.

In the area of safety, for example, the widespread deployment of stability control systems is driving growth for our MEMS gyroscope products. It also appears that consumers are gaining interest in advanced driver assistance features such as lane departure warning and reverse camera console views, many of which use our DSP or data converter and also our RF products.

Our communications business, which is primarily products for infrastructure and to a lesser degree handsets, is now approximately 22% of our revenues. Revenues from communications customers increased 12% sequentially. The growth of this market is being primarily driven by the ramp and deployment of 3G base stations worldwide. While last year growth was dominated by heavy capital spending in China earlier in the year, in Q1 this year the growth was much more diversified. In the developed countries, the need for higher data transmission capacity is the main driver, while in developing countries the need to increase coverage is driving demand.

We also saw an increase in revenues from the wireline communications market. Although today this is still a smaller piece of the communications business, it’s had very steady growth now for many quarters at ADI.

Revenue from consumer related products declined 18% sequentially, which is generally in line with the typical pattern that we see in the consumer business for Analog given our – the months in our first quarter. Our main focus areas in consumer continue to be in home entertainment products and digital cameras and also many portable products.

On a regional basis, revenues grew in all our regions except Japan in line with the consumer business decline and of course Japan in that sense was down sequentially.

So, I would like now to make some closing comments on the outlook and look at it really in the short term and also take a slightly longer term perspective or in at least our view what’s happening around the world.

In our Q2, which we’ve just now begun, we expect industrial sales to be both cyclically and seasonally strong. We expect further strength in the communications infrastructure as a result of additional base station deployments, including what we hope will be a resurgence in our growth in China. We expect consumer sales to be approximately flat sequentially. In total, we are expecting our revenues as we mentioned in our press release to increase to $635 million to $650 million, which would represent a 35% year-over-year increase in our sales at the midpoint of this estimate.

We are planning the gross margins to increase sequentially to 62% to 63% and that would produce operating margins in the range of 29% to 31% in the quarter, and earnings in the range of $0.48 to $0.51.

For reference, in the fourth quarter of ’08, before the recession began, revenues were at a similar level to our Q2 forecast, but our operating margins were approximately five percentage points lower. So overall we believe we are executing well on our plan to deliver good sales growth, and attractive and increasing margins.

I think there is very little doubt that there continues to be a stability in most economies around the world as in many locations around the world unemployment levels remain high and credit is still tight. Nevertheless, our business has broadly strengthened over the past few quarters and order rates and backlog levels are now approaching pre-recession levels.

While the amplitude and the timing of the order recovery suggests that some of the order strength is likely due to a more confident supply chain as the economy recovers, we believe based on feedback from many of our customers in many, many different industries and many countries around the world that companies are generally more confident about the future and have begun to shift from a fear of over investing to a fear of under investing and losing global competitive position. As a result, many of our customers have begun to ramp new product program at a pretty significant rate and certainly that will benefit ADI in coming quarters.

Despite these changing attitudes, which are generally more positive than three months ago, the bar for new investments at many of our customers is still stacked pretty high. Our customers are looking for partners who can consistently innovate to make their products more appealing and more competitive and also those who’ll have a flexible supply chain to respond to changing business conditions.

From productivity improvements at factories around the world to medicines to entertainment, to transportation and many other applications, our customers want products that allow their products to always be connected, to be easily used and to conserve energy. These strengths play very well to ADI’s business strategy, which continues to be as it has for many years to focus on being the very best signal processing company in the world.

In March, during our analyst day, investors will learn a little bit more about the trends we see and how they are driving many, many new opportunities for ADI. So, I hope you will all be able to join us for the webcast of that event.

So, that’s all the formal comments we are going to make today. We’ll now open the line up for questions from analysts.

Dave Zinsner

Thank you, Jerry. During today’s question-and-answer period, please limit yourself to one primary question and no more than one follow-on question. We’ll give you another opportunity to ask additional questions if we have time remaining. Operator, we are now ready for questions from our analysts.

Question-and-Answer Session

Operator

(Operator instructions) Our first question comes from the line of Romit Shah with Barclays Capital.

Romit Shah – Barclays Capital

Thanks guys and great quarter. Jerry, you had three quarters now of pretty substantial growth yet your revenue is still below the prior peak. At what point do you think you’ll catch up with demand or see the business return to more normal or seasonal growth rate?

Jerry Fishman

That’s sort of hard to predict into the future. You know, our sense right now particularly in the way that we are managing the distribution channel is that consumption and the demand we are seeing is not terribly unaligned [ph]. I think over the last couple of quarters we’ve caught up with what has been under consumption. Well, there is probably another quarter where that’s going to be a little bit above the top, but I think ultimately once we get back to sort of where we were, which we expect to be approximately next quarter plus or minus a little bit, I think it will be in a reasonably good balance between what demand – underlying consumption and the demand we are seeing.

Romit Shah – Barclays Capital

Are there any segments within your business where you feel there is still pretty big supply-demand imbalance?

Jerry Fishman

I think for ADI, I don’t see. There certainly was a supply and demand imbalance last year, but I think customers’ inventories, at least what they tell us are reasonably low. The distribution inventory that Dave was saying are relatively flat in terms of turns and weeks of inventory. Our lead times are short so they don’t have a lot of inspiration to be loading up inventories. So at least for ADI, I don’t see that patterns are very unique here.

Romit Shah – Barclays Capital

Okay, thank you.

Operator

Our next question comes from Jim Covello with Goldman Sachs.

Jim Covello – Goldman Sachs

Great, good afternoon guys. Thanks so much for taking the question and congratulations on the great results. This cycle so far you guys have clearly demonstrated better operating margin leverage than in past cycles. What can you do over the next few quarters as business continues to improve to make sure you keep that margin discipline and not let some of the expense creep come back in like it might have in other cycles? Thanks

Jerry Fishman

Well, I think as far as the expense creep we sort of early in the cycle said that some of the expenses that we reduced were going to come back with sales and those are mostly related to variable compensation and commissions. Others were permanent. And I think our sense is that about half of those things, which is consistent with the way we’ve been thinking about it are permanent and half of them are going to come back as the sales go up. So that basically allows us to operate the Company at about $100 million a year of less expenses than we had when we went into this cycle, which is not insignificant for our size.

As far as keeping our hands on the (inaudible) doing the right things, we do have a lot more focus on products and markets that are higher margin and more substantial than we’ve had in the past. I don’t think we are going to revert back to having less focus. So I think that focus is going to continue. I think the entire management group and the employee base is pretty committed to keeping discipline on the expense line and I think with the goal that we set of keeping (inaudible) gains on the operating costs, I think we have a good shot of doing that. I believe the gross margins in the Company is structurally higher. Part of that is of course due to volume and utilization, but another part of it is just due to a much richer product mix and us exiting businesses that had very poor returns over many years over the last two or three years. So, it’s always challenging quarter-to-quarter to predict whether the gross margins are going to be up a point or down a point, but I think we are up here at levels, which are about where – the best we’ve ever been. We have a forecast for next quarter, which will exceed that by quite a bit, and I don’t think there is anything in there other than the world falling apart thus having to bank down utilization and things like that, which are always it’s possible although not probable in the short term. Other than that, I think we have a good chance of not only keeping these margins, but as we’re forecasting for Q2 the margins are likely to expand again in Q2.

Jim Covello – Goldman Sachs

Terrific. Thanks so much.

Operator

Our next question is from Stacy Rasgon with Bernstein Research.

Stacy Rasgon – Bernstein Research

Hi guys, thanks for taking my question. Quick question again on the OpEx, so I know you said you are going to keep half of the gains. Do I define the gains at this point as versus Q408, so ex-restructuring you’d be down $37 million quarterly? And does that mean that basically you’d be creeping about call it $19 million or $20 million a year of those cuts going forward?

Dave Zinsner

No, I think the way you got to look at it is we were at $240 million in Q4 of ’08–

Stacy Rasgon – Bernstein Research

Yes.

Dave Zinsner

What we are thinking is that we brought the OpEx down to about $187 million, so we roughly took it down by a little over $50 million and what we are saying is that we’ll be able to keep half of that difference as we resume back to the revenue levels of Q4 of ’08. So, basically we feel like we permanently took out from the $240 million run rate – burn rate we were in Q4 of ’08, we permanently took out somewhere in the $25 million plus of OpEx expense or an annualized basis a little over $100 million.

Stacy Rasgon – Bernstein Research

Got it. So, some of that’s already started to come back. So this quarter you are if ex-restructuring your OpEx was up, I think it was about 4% or so versus last quarter which is almost about where your revenue was up at this point, revenue was up 5.5%, how do we think about OpEx trending through the year again as revenue goes up because I know more variable compensation is going to kick in as the operating margin continues to increase potentially.

Jerry Fishman

Well, I think one way to think of that is, at least I will give you my view, Dave will give you his, is that we’ve been on a very steep part of the margin improvement curve. We raised the margins five points in one quarter. That tends to, given that most of the bonus payments are tailored to that statistic, it tends to drive it through the yard [ph], I think we have more margin upside as we are predicting for the next quarter, but we are not going to keep getting 500 basis points of margin improvement every quarter, so I think the rates of increase on the variable side is going to start trending downward. It’s still going to go up in dollars, but the rate is going to go down from where it is. The thing that we are focusing on more than anything else is everything acceptance and if we can do what we are trying to do, which is to keep that part relatively flat through the year, I think the operating margins will keep going up and everyone will be very pleased with the operating margins that we are running in the Company.

Stacy Rasgon – Bernstein Research

Got it, thanks. And for my followup, I mean I notice now you are providing the end market breakdown with like a pure industrial, if I compare where you are this quarter to where you were two years ago, so Q108, I notice that for all these particularly in the broader industrial, you are almost back to those levels. I think you are only down about 4% Q1 2010 versus Q1 of 2008. I am not so sure that the industrial markets themselves are only down 4% from that point to this point, so what’s actually driving – I mean is it share gains or is it – I mean we talked about customers moving back to replenishment mode and so forth but I mean what’s – what do you think is actually driving what seems to be probably a greater increase for your industrial sales and even some of your other product categories versus where the market probably is these days?

Jerry Fishman

Well, I think I mean it’s always hard to look at one quarter two years ago versus a quarter now to try to garner any specific, but I think generically, some of the segments within the industrial area for us, which has always been a source of significant investment are just growing faster than the average of the industrial market. If you take areas like the healthcare products, historically in these numbers here the automotive stuff (inaudible) has been growing very well for us. And a few of the other segments where you just have very rich new product cycles going on in that market. So, I’d say that, that business for us is doing a lot better than many outsiders, investors thought and certainly even better than we thought it was going to be a couple of years ago. And part of that is just that we are investing a lot of money in segments within industrial that are pretty high growth relative to most other segments. So I think we have a pretty good outlook for that business over the next couple of years.

Stacy Rasgon – Bernstein Research

Got it guys, appreciate it.

Jerry Fishman

It’s certainly not the stodgy old growth business that some people want to call us.

Stacy Rasgon – Bernstein Research

Got it, got it, thank you guys.

Jerry Fishman

And it makes pretty good margins too.

Stacy Rasgon – Bernstein Research

Yes, indeed.

Operator

Our next question is from Terence Whalen with Citigroup.

Terence Whalen – Citigroup

Hi, thanks for taking my question. The first part relates to – I think last quarter you had talked a little bit about some restructuring and reorganization that you had done internally with regard to the sales force and how your sales force is interfacing with customer accounts–

Jerry Fishman

Yes.

Terence Whalen – Citigroup

And in addition talked a little bit about how that improved some of the granularity of your rolling up of the individual business units financials. I was wondering if you could go into a little bit of details what you’ve learned over the past quarter after implementing that reorganization and also what metric now that you are looking out on an individual business unit level, what you are learning from looking at this new metric? Thank you.

Jerry Fishman

Well, it’s a very important question. Well, let me try to give you a broad answer to it. Now I think from the way – the experience that we had over the last couple of months, we’ve learnt something that we – it doesn’t sound like rocket science. We probably knew all along, but it’s really become true is that customers really value when we approach them from a single point with the breadth of our technology. And that’s the way they prefer to deal with us. They don’t like dealing with many, many different product lines that are basically trying to sell various products to them as compared to really trying to understand how to make them more competitive and therefore what solutions can we bring them to do that in a very cohesive fashion.

So, I think what it really has done is it makes the customers believe that we are a much more strategic partner to them in their particular business. It allows to focus the resources towards customers in a way that we haven’t been able to do before. And it really focuses the sales force on where it is that they ought to be spending their time and attention as compared to trying to react to the request for 47 different product lines for more sales in the quarter. So, you know, those are things that when you listen to me say, well that’s sort of elementary. But for a company that’s grown up as a product oriented company, it really – this new organization has really helped focus what we are doing a lot more than it used to.

Now, is that changing our sales in the quarter right now, I don’t think so, but I think what we are trying is the sales force is better focused on the right accounts. If they go into the customers with a much more cohesive plan, a much more cohesive roadmap, a much more ingrained understanding of what the customers are trying to accomplish, I think that’s going to help us greatly. And we’ve gotten that kind of feedback from some of our very largest customers that in applications where they just found us too complicated to deal with they really appreciate the fact that we are – we understand their application, we got to make them competitive and we are approaching that from a single point.

From the internal metrics standpoint, it gives us a much clearer sense of where we are making money and what the investment levels are relative to the returns I the marketplace, and now when you are product oriented company it’s somehow hard to understand that by market segment. Now, we have a tremendous amount of data that really shows which of the segments growing faster, which of the segments are taking more investment, what are some of the returns that we are getting on the R&D in each of the segments, and as a result of that not in the quarter-to-quarter numbers, but certainly a we put together the yearly plans, we take that into account in what we do about allocating resources to various marketplace.

So, I think in aggregate it’s – it really helped us deal with customers and it helps us to grow [ph] at a more productively allocate resources in the Company, which in companies like ADI it’s very hard oftentimes because of the complexity with 10,000 products (inaudible) customers. I mean that’s really going to sharpen our focus and we’ve already seeing the benefits of that.

Terence Whalen – Citigroup

Thanks for answering comprehensively the broad question. As my followup I’d like to be a little bit more specific with regard to gross margin, we’ve got utilization in the low 60s and we are looking at a 62% to 63% gross margin. Specifically is the longer term gross margin model then going to be closer to 64% to 65%? Thanks

Jerry Fishman

Are you asking that or are you saying that as a conclusion?

Terence Whalen – Citigroup

That was a question, thanks.

Jerry Fishman

Well, when we get to 63% maybe we’ll talk about higher numbers, but we are certainly a lot more enthusiastic about gross margins we can generate this fiscal than we were when we were really struggling. And I think investors were struggling to really think could we ever get to 60%. And I think now we are comfortably past 60% we certainly be very comfortably past 60% next quarter and I don’t think that’s a one-time event either given that we are still not breaking the growth that will allow utilization. So, we’ll see how that goes after another quarter and we’ll update you next quarter.

Terence Whalen – Citigroup

Thanks and a nice job.

Operator

Our next question is from Uche Orji with UBS Warburg.

Uche Orji – UBS Warburg

Can you hear me?

Jerry Fishman

Yes.

Dave Zinsner

Yes.

Uche Orji – UBS Warburg

Alright, thank you very much. I wanted to just follow on same one thing, Jerry, what was your peak utilization rate and I know that’s also that things are going to gross margins, but I just wanted to try to get a handle if we were to get back to peak utilization rate just what could be the optimized [ph] gross margin.

Jerry Fishman

Well, the utilization rate relative to the past years, somewhat complexity right now since we had two more fabs. Last time we were at this thing. One of the reasons the utilization went up this quarter, there are really two reasons, one is we started more wafers, but the other part is we’ve taken a lot of capacity offline. We took the Cambridge fab offline and we took the eight inch fab in Ireland – the six inch fab in Ireland offline. So, those comparisons relative to the past are a little bit more challenging to make.

Now I would say that if utilization goes up our gross margins will go up. That’s intuitive. It’s very hard to quantify that any more definitively than that. At below 60s, we can easily run fabs up until the mid 80s. I think that will have a positive impact on the margins. As Dave mentioned earlier, we can increase our capacity relatively quickly with relatively low capital expenditures. So I think relative to capacity and the margin implications of that I think we are in reasonably good shape.

Uche Orji – UBS Warburg

Great. Can I just ask you about power management, I mean we’ve started to see some numbers (inaudible) close to $40 million of revenue for the quality advantage? Can you talk about you expectations for this business now? What will be the drivers, what’s allowing you to gain traction now and what should we be expecting from this going forward?

Jerry Fishman

Well, our power management business grew this quarter pretty well. It grew fairly substantially year-over-year. And I think there is a couple of reasons for that. One is the fact that the team has been working at it for a couple of years and it’s congealed, and we’ve got a pretty good group of people that are developing some products that our customers say are pretty good. I think another part of it is we’ve focused our product development into areas that we really think we can offer something very unique and the customers value as compared to trying to do things that a lot of other companies can do and you are just in a margin war with them to get those sockets.

And I think the more that we align our power management business with our vertical market segments, we are – we can go into customers where we already have a substantial part of the signal processing bill of materials and we can say you know by the way we can either integrate power management on the signal processing chain or we can offer power management alongside of the signal processing chain and the customers already respect us for our prowess in developing products and they like working with us and that becomes an important ingredient in the overall solution and the more that we focus our product development efforts in those areas as we have for the past year or so I think the more traction we are going to get in that business. So, I think like everything it’s a combination of things, but overall we are doing better in that business than we have in the past and I think there is good expectations that if we continue to really focus that business in the areas I just addressed we can do even better in the future.

Uche Orji – UBS Warburg

Right, thank you very much.

Operator

Our next question is from Christopher Danely with JP Morgan.

Christopher Danely – JP Morgan

Hey, thanks guys, and, yes, I’ll add my congrats on hitting new peak gross margin. On – it seems like the mix and the focus is changing a little bit via the end markets and products. So, can you just give us your sense on where you would expect the highest and lowest relative growth rates for your end markets for the rest of this calendar year?

Jerry Fishman

It’s hard enough to predict what the sales are going to be. The market segments are even more challenging with more granularity. But – because we just don’t have all that – much visibility up until the second half of the year. But I would say that we expect that we’ll get growth across the board, which is where we’ve been seeing – we’ve seen good growth in industrial, we’ve been seeing good growth in communications. I think in the second half of the year the acceleration in communications in hopefully going to come from China; it’s what we now expect. We are seeing good growth in automotive. The consumer business is relatively cyclical. In these quarters they are low, they’ll pick up again when the season changes. So, I don’t think it will be anything unique personally in the segments. I think it will be more typically of what we usually see. Certain quarters we get higher industrial growth, certain quarters we get higher consumer or communications growth, but I don’t think there will be anything unique for the balance of the year that at least we understand right now.

Christopher Danely – JP Morgan

Okay, thanks. And then my followup for Dave, Dave, I think you said three things that the gross margins went up. Where any of those I guess having a bigger factor than the others?

Dave Zinsner

No, they all had a meaningful contribution to the gross margin improvement.

Christopher Danely – JP Morgan

And then can you give us a sense of what your incremental gross margins will continue to be as the utilization rates climb?

Dave Zinsner

You know it’s challenging to do that because we do – some the revenue will come from external manufacturing and in that you don’t get any incremental benefits from – versus the internal, so it’s a kind of a tough metric to really quantify.

Jerry Fishman

There is not an – in respect to that there is not an entire – we can't draw the curve between gross margins and utilization. So it has a lot to do with product mix. I think right now would be sort of – what I think seems to be pretty aggressive guidance for Q2 on the gross margin after what we just achieved. It sort of gives you an indication of at least directionally where we are thinking it’s going to head.

Christopher Danely – JP Morgan

Yes, okay, thanks a lot guys.

Operator

Our next question is from Tristan Gerra with Robert W. Baird.

Tristan Gerra – Robert W. Baird

Hi, just another question on gross margin. You’ve given us the mix – the gross margin sequentially increased, if you look at your revenue guidance, which is very close to what you posted in the second quarter of 2008, your gross margin guidance is also 150 basis points higher than two years ago. How much of this do you think will be mix and then within those that base station play will in those?

Jerry Fishman

Dave?

Dave Zinsner

Yes, I mean I couldn’t answer that question. I mean what really drove the year over – or the comparison from Q408 was we took a lot of infrastructure cost out. We are taking – we took out of Limerick six inch facility and that contributed a lot to our gross margins and then going forward we’ll start to see the benefits of shutting down Cambridge, and that will show up in our P&L and that’s going to be driving the kind of the future performance. So, I’d hazard a guess that it probably didn’t have a meaningful impact from mix or utilization. It was really about fundamentally lowering the cost per unit of our product.

Tristan Gerra – Robert W. Baird

Okay. And eight weeks of inventories at distributors is probably unusually even though that’s stable with the previous quarter. Is your guidance assuming any type of inventory replenishment and what type of feedback do you get from distributors over the next – for the next few quarters?

Dave Zinsner

Well, on a guidance perspective, it doesn’t really matter, because we recognize the revenue once the distributors ships this out of their inventory. So–

Tristan Gerra – Robert W. Baird

And then for the gross margin?

Dave Zinsner

Sorry, what was that?

Tristan Gerra – Robert W. Baird

And then for the gross margin, so are you – is your guidance building the fact that you are going to ramp production to replenish inventories at distribution as well?

Dave Zinsner

Well, as we indicated, we thought some of the drivers in the gross margin from the next quarter would be from utilization, a higher utilization this quarter versus last quarter, but we are also fundamentally lowering the cost per unit. We’ll start to see more benefits from the closures of the two facilities. So that will help as well.

Jerry Fishman

We tend to work very closely with the distributors to keep the inventory in weeks at about a constant rate. Certainly if the sell through in distribution keeps going up the dollars of inventory distribution will go up and that will low utilization a little bit, but that’s – we are trying to keep the weeks or the turns in distribution about constant as we have over the last couple of quarters. That’s how we deal with distributors and that’s how we are planning to continue to deal with them in the coming quarters.

Tristan Gerra – Robert W. Baird

Right. Thank you.

Operator

Our next question is from Craig Ellis with Caris & Company.

Craig Ellis – Caris & Company

Thanks guys. Nice job on the gross margins. With margins above 60%, what options do you have as you look ahead given the tailwinds on utilization, mix, what have you, with either new end markets or new application penetration?

Jerry Fishman

Well, we continue at Analog despite our better focus to have a lot of irons in the fire and I think what we are going to continue to do is invest in the things that we are investing in. That’s sort of occupying most of our bandwidth. We think if we execute on those things we can have a pretty attractive growth rate. We are going to talk a little bit about this in more detail about at the analyst meeting next month here in Boston of what the segments are, where the growth drivers are, and so on. But I think the – the thing we are going to really try to do is just keep focused on the things that we are committed to and I think as we do that, we execute, I think the growth rate will take care of itself.

Craig Ellis – Caris & Company

Okay. And then it’s the followup. Dave, you mentioned an action that triggered $11.5 million charge in the fiscal first quarter. How many other efficiency actions like that do you foresee as you look out over fiscal ’10?

Dave Zinsner

Well, you know, it’s hard to predict. I would say that we are not really anticipating any additional actions like that. But I do think that there are things we can do on the infrastructure side to continue to more efficiently spend our money that will help offset some of the increases we’ll see on the variable comp side and will help us fund other development actions that we might want to take advantage of.

Craig Ellis – Caris & Company

Okay, thanks guys and nice job.

Operator

Our next question comes from the line of David Wong with Wells Fargo.

David Wong – Wells Fargo

Thank you very much. Your guidance, does that include restructuring charges or are you assuming there won't be restructuring charges in the coming quarters?

Dave Zinsner

We are assuming there won't be restructuring charges in the coming quarters.

David Wong – Wells Fargo

So, your OpEx does go up by a fair amount equal – at least offset that whole of restructuring charges $16.5 million is that right?

Dave Zinsner

It’s not going to go back, $16.5 million, is that what you are asking?

David Wong – Wells Fargo

Right, okay. And my second question, have you been able to supply product for the increase in demand you’ve seen in all areas or are there some segments or product types where there are shortages?

Jerry Fishman

In general, we are able to supply pretty much all of our products. I think I mentioned the statistic that to our OEM customers, which are about half of our sales, our largest customers, our lead times are within six weeks. And I think that’s where we like them to be. And that’s where they are. So, we don’t really have a lot of shortages going on in the product group.

David Wong – Wells Fargo

Right. Thanks.

Operator

Our next question comes from Doug Freedman with Broadpoint AmTech.

Doug Freedman – Broadpoint AmTech

Hi guys, given I am playing ping pong between two calls, I hope I don’t step on a landmine here, but has anybody gone into the details on what caused the other section of Analog to be down 22%, can you give us a little insight into what’s happening there–?

Jerry Fishman

It was mostly to do with consumer products and that tends to bounce around a lot with the quarter to quarter numbers. So I don’t think there is any real data there. If you look at the history of that thing, it bounces around quite a bit because it’s much more sort of market specific and customer specific products as compared to the broader categories.

Doug Freedman – Broadpoint AmTech

Okay and is a fair amount in that business still coming from the MEMS segment and are you guys still pretty bullish on your MEMS outlook?

Jerry Fishman

Yes, I mean there is – a lot of the MEMS products are in there. That tends to be very lumpy quarter to quarter. The previous quarter we had a very large one-up in that business as a result of a particular program that won very large customer and he bought enough for the whole – next couple of quarters because it was a ramp of a new product he had. And we didn’t get much business on that last quarter, but our position with that customer for the future is very, very good. So, it’s mostly, as I said, lumpy demand, heavily consumer, and that’s why you saw those numbers.

Doug Freedman – Broadpoint AmTech

Great. And then if I could one last one sort of trying to focus on end market demand. Are you guys able to see if the demand spectrum is broadening? Are you seeing a larger number of customers coming in and ordering or are you just seeing demand from your existing customer base return to a more normal levels?

Jerry Fishman

I think it’s a pretty broad based – at least as we are hearing through the distributors we are (inaudible). And I can't really say if it’s – if they’ve increased their customer base or what the exact details are – the order patterns. But you know we are seeing it in new products and old products, we are seeing it in just across the board in many, many different product areas. And – so I really don’t know the specifics of that if there is any real data in the – are there more customers or the same customers because I just don’t know.

Doug Freedman – Broadpoint AmTech

Alright. I guess may last one, are you feeling or thinking that there is any impact to any of your end markets from supply constraints in one direction or another?

Jerry Fishman

Well, we always worry about that with – some of the lead times out there in the industry are pretty long and you always worry a little bit about is – is that causing people to buy everything faster than they normally would, but we are trying to keep pretty good track of that and it’s not obvious that that’s really impacting things a lot although that’s something we always worry about and we watch it pretty carefully and we’ll have to wait and see how that develops. But it’s certainly not what the customers are saying to us and what our distributors are saying to us. So – but, on the other hand, we are always the last to note. So it’s really hard to predict it.

Doug Freedman – Broadpoint AmTech

Alright. Terrific and congratulations on strong results.

Jerry Fishman

Thank you.

Operator

There appear to be no further questions at this time. Mr. Zinsner, Mr. Fishman, do you have any closing remarks?

Dave Zinsner

Yes, so thanks for participating. We are looking forward to talking to all of you again at our analyst day and just as a remainder that’s scheduled for March 11th, 2010, and it will begin at 7:30 AM Eastern. So have a good day.

Operator

Ladies and gentlemen, this concludes today’s Analog Devices conference call. You may now disconnect.

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Source: Analog Devices, Inc. F1Q10 (Qtr End 01/30/10) Earnings Call Transcript
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