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Maxim Integrated Products (NASDAQ:MXIM)

F2Q07 Earnings Call

February 7, 2007 5:00 pm ET

Executives:

Paresh Maniar, Executive Director, Investor Relations

Tunc Doluca, President and Chief Executive Officer

Pirooz Pavarandeh, Group President

Alan Hale, Interim Chief Financial Officer

Analysts:

Romit Shah, Lehman Brothers

Parag Agarwal, Jefferies & Company

David Wu, Global Crown Capital

William Lewis, JP Morgan

Michael Masdea, Credit Suisse

Sumit Dhanda, Banc of America Securities

Louis Gerhardy, Morgan Stanley

Craig Ellis, Citigroup

Simona Jankowski, Goldman Sachs

Ivan[?], Piper Jaffray

Krishna Shankar, JMP Securities

Jeff Rosenberg, William Blair and Co.

Ross Seymore, Deutsche Bank

Doug Freedman, AmTech Research

Steve Smigie, Raymond James

Presentation

Operator

Thank you for standing by. Good day and welcome to the Maxim Integrated Products Q2 2007 earnings release conference call. Today’s call is being recorded. At this time, for opening remarks and introductions I will turn the call over to Mr. Paresh Maniar, Executive Director, Investor Relations for Maxim Integrated Products. Mr. Maniar, please go ahead.

Paresh Maniar, Executive Director, Investor Relations

Thank you, operator, and welcome to our fiscal Q2 2007 earnings conference call. With me on the call today are Tunc Doluca, President and Chief Executive Officer, Pirooz Pavarandeh, Group President, and Alan Hale, Interim Chief Financial Officer. Our other Group President, Vijay Ullal, is out of the country on business and unable to participate in this call.

There are two administrative items that I want to address before we cover our results. First, we will be making forward-looking statements on this call. In light of the Private Securities Litigation Reform Act, I must remind you that statements which we make about the future, including our intentions, expectations or predictions of the future, including but not limited to possible statements regarding bookings and turns orders, revenues and earnings, inventory and spending levels, manufacturing efficiencies or capacity, projected end market consumption of our products, and any other future financial results are forward-looking statements.

If we use words like anticipate, believe, project, forecast, plan, estimate or variations of these words and similar expressions relating to the future, they are intended to identify forward-looking statements. It is important to note that the company’s actual results could differ materially from those projected in the forward-looking statements. Additional information about risks and uncertainties associated with the company’s business are contained in the company’s SEC filings on Form 10-K for the year ending June 25, 2005. Copies can be obtained from the company or the SEC.

Second, in keeping with the SEC’s fair disclosure requirements, we are making time available for a question and answer period at the end of today’s call. This will be your opportunity to question company management concerning the quarterly results and expectations for the next quarter. An operator will provide instructions at that time.

I want to remind you of our recent announcement that the special committee of the Board just completed its review of certain past stock option grants and our historical stock option granting practices. As a result, we just began the process of restating our financial statements and expect to record non-cash stock-based compensation charges on financial statements from FY 2000 to 2005 and the related interim period through March 25, 2006.

At this time, we do not know the amount of such charges in the aggregate, nor for any particular period. We will not speculate on that amount during this call. Due to the pending restatement, we cannot provide detailed GAAP or non-GAAP financials for the quarter ending December 23, 2006. Therefore on this call we will not provide any specifics about our gross margin, operating margin, operating expenses, inventory or other items that might be affected by stock-based compensation adjustments. All numbers for Q2 FY 2007 discussed on this call are not final and should be considered estimates only.

We are assembling the data needed for the restatement process and the team here is gearing up and starting to work hard to complete the restatement as soon as possible. There is a substantial amount of work to be done. Remember we are looking at over 24 quarters of data from time periods up to seven years ago. We need to determine not only what the stock-based accounting charges should be, but also how those charges impact cost of goods sold, inventory, R&D, SG&A, taxes and many other income statement and balance sheet items.

While we cannot change the past, we are focusing on going forward. We will complete the restatement as soon as possible, get our financial statements on file with the SEC and improve the company's stock option granting practice. Because of legal constraints, we will not make any additional comments on this issue, either during the prepared remarks or in the Q&A portion of this conference call.

I will now turn the call over to Alan Hale, our interim CFO.

Alan Hale, Interim CFO

Thank you, Paresh. Within the constraints that Paresh just discussed, I will describe several elements of our fiscal Q2 2007 results and the ending financial position which we hope you'll find useful and informative. Net revenues for Q2 were $497 million, down 1.1% from Q1 and up 11.6% from the same quarter last year. Gross turns orders during fiscal Q2 2007 were $222 million, of which $132 million was shipped for revenues within the quarter. For comparison purposes, turns orders for Q1 FY 2007 were $233 million, of which $138 million was shipped for revenues within Q1.

Similar to other companies in the semiconductor industry, Maxim also experienced a softening of orders from certain end markets, but in our case this softness was largely offset by gains in high volume end markets led by larger than anticipated turns orders in the computing market. As we've noted in previous conference calls, these high volume markets, such as notebook PCs, provide lower gross margins than our more traditional end markets. Consequently our sales mix shifted in Q2 toward lower gross margin products, resulting in an approximate 1.3 percentage point sequential decline in gross margin. I say 'approximate 1.3 percentage point' because of the pending restatement.

In addition, on a sequential basis, Q2 2007 gross margins were further impacted by approximately two percentage points due to incremental inventory reserve actions. The majority of this margin decline relates to a write-off of leaded inventory. In addition, Maxim's inventory accounting policies generally require products not expected to ship within the next 12 months to be reserved. The recent semiconductor industry sales slow down prompted our business units to scale back their forecasts, which pushed out the expected sale dates of certain products to beyond 12 months. This scheduling in turn drove the need for incremental inventory reserve actions taken during the quarter.

Let me now turn to operating expenses. We estimate that excluding stock-based compensation, below the line spending increased by 2.5%. In other words they were 2.5% higher than the previous quarter. As a result of Maxim's continued hiring of valuable engineering talent, we expect the addition of this talent to positively impact revenue two to three years down the road.

I will now highlight a few items on our balance sheet. In the quarter, cash, cash equivalents and short term investments decreased $78 million to $1.3 billion after the company paid out $50 million in dividends, $99 million for property, plant and equipment and $116 million for income tax payments. Due to the then-ongoing enquiry into our stock option grant practices, there was no stock buy back during the quarter. Accounts receivable decreased $15 million during the quarter to $277 million. Our DSOs decreased slightly from 53 days at the end of fiscal Q1 2007 to 52 days at the end of fiscal Q2 2007.

Bookings and backlog: during fiscal Q2, our 12-month backlog declined to $403 million at the end of Q2. That compares to $415 million at the end of fiscal Q1. Our beginning 90-day backlog for Q3 is $343 million compared to the beginning 90-day backlog for Q2 of $365 million. During the quarter, we recorded $500 million in gross bookings, a 1% decline from the $507 million level of the previous quarter. Those bookings are expected to generate $477 million in future net revenue. Based on the Q3 beginning backlog and the turns orders received so far this quarter, we project Q3 revenues to be down from 3% to down 6% from the revenues we recorded in Q2 FY 2007.

I will now turn the call over to Tunc, who will provide additional highlights.

Tunc Doluca, President and Chief Executive Officer

Good afternoon, everybody. First I'd like to speak about our markets, and this format will be a little bit different from our previous conference calls. As you know, Maxim continues to be well diversified amongst the computing, high-end consumer, industrial and communications markets, roughly a quarter each. Our business is divided roughly equally among these markets, except for small changes we might see QoverQ.

Let me give you some color on each one of these markets. The computing market consists of personal computers, servers, peripherals, storage and financial terminals. In this market, as Alan previously mentioned, we have increased our bookings in Q2 compared to Q1. That specifically came in the notebook market. The high-end consumer bookings in Q2 were down from Q1, mainly due to high seasonal heavy ordering patterns that occurred back in fiscal Q1. This market consists of handsets, smart phones, digital televisions, digital cameras etc, all types of equipment that you're all familiar with.

We see this market as a major growth driver for us in the future. The industrial market is highly diverse, consisting of conventional industrial and medical devices, automatic test equipment, instrumentation, automotive and military products. Our bookings in Q2 were basically flat from Q1, but we know that the industrial market provides good revenue and profit stability due to the products' long lives. Q2 communications bookings were also basically flat from Q1. Networking, telecommunications, and base stations are our primary end markets in this group.

I would like to reiterate my commitment to the five long-term strategies that we first presented at our analyst day in May 2006. We reaffirmed those strategies during our last conference call. Specifically, these were first, to focus on defining and pursuing high value-added large markets; second, to partner with major electronic manufacturers; third, to strengthen our core technical competencies; fourth, to maintain end market diversity and fifth to attract and retain talented employees.

The first two strategies, to define and pursue high value added large markets and to partner with major electronic manufacturers are already bearing fruit. During the cyclical upturn of 2005/2006, we believe that our revenues grew at a faster rate than the companies with whom we have most closely identified. Thus far in the current cyclical downturn as Maxim's sequential revenue during the past quarter and our guidance for the current quarter show, we are performing relatively well.

I would now like to highlight five major near-term initiatives that I will be driving at Maxim. Not surprisingly, the first initiative is continued focus on gross margins. Our business units are being closely monitored to ensure that they quickly address the measures that we detailed to you during our previous conference call. These measures are working through the system and as you remember, some had long-term impact and some had short-term impact but we must be cautious to ensure that we do not damage any key customer relationships. This is very important for us.

Rest assured that gross margins are now watched not only by the business unit executives, but awareness has diffused throughout all rank and file employees. At this point we believe that our gross margins will begin to stabilize in Q3, excluding the effects of stock-based compensation. My second initiative is to improve our on time delivery performance. As part of this initiative, in 2007 we will take the steps necessary to reduce the time between the start of a wafer lot to product shipment, which is also known as manufacturing cycle time, by approximately three weeks. This change will enable us to manage inventory better and this is an issue of which I am very conscious.

Improving our on time delivery performance will also be more responsive to customers and we all know how that translates into more business for the company. Obviously we will be vigilant with capital spending and keep spending at historical levels. We will also be opportunistic in slow times to invest in our future.

The agreement that we announced today with Epson is a part of this initiative. Not only will it give us access to state of the art processing technology, but it will give us diverse capacity that we may need to support customers in high volume markets. The third initiative, we intend to foster improved collaboration amongst our business units. Instead of operating as independent entities as occurred in the past, our business units will be strongly encouraged to exploit synergies in product development and in marketing to maximize Maxim's penetration of our target markets. We are reviewing realigning the business unit product lines if necessary to optimize these synergies.

Fourth, we will be enhancing how we measure and evaluate our business unit executives. We will hold them even more accountable for the financial outcome of their businesses. We will give larger weight to the growth and profit contribution by each business unit and we'll be setting growth and operating margin goals tailored to each business unit's technologies and target end markets. Our focus will be to ensure that our revenue growth does indeed translate to corresponding earnings growth. At times of cyclical down turns like the one we are going through now, we will control non-essential spending but opportunistically add head count in critical engineering areas to invest in our future.

Fifth, we are beginning a review of our sales and distribution strategy to further support customers of all sizes. By achieving these five initiatives, we will be even more successful at seizing the growth opportunities that we see in the market place for high performance, mixed signal analog products, the core of our business. This demand for mixed signal products is stated loudly and clearly from our key customers, with whom we have established high level relationships. We are, in fact, one of the few companies that can provide such high performance products in the market.

On a final note, over the last several weeks many of you asked about our employees. This came from shareholders and analysts as well. I am proud to note that our people are standing very tall. Many have voiced their commitment to the company's focus and to management. I have spoken to countless employees myself and also heard it through their managers. They are all rising to opportunities before us. They are highly valued as an essential part of a successful and dynamic company. They remain proud and excited to help make unique products that enable the technological revolution that we see all around us today. I intend to build upon this renewed human energy as we move the company forward.

I would now like to have Pirooz join our discussion. He will provide an insight into design win activity and the key products that we introduced during Q2.

Pirooz Pavarandeh, Group President

Thank you, Tunc. Within the business unit, we went around and compiled information that we thought was very relevant. You know, that was of significance. Things of the nature of design wins, new product introductions, industry awards and recognition by our customers as a preferred vendor and we came up with over 60 different items we though it would be noteworthy to talk about. Of course we don't have the time to talk about all of them, so we're going to summarize these very briefly.

In the ATE market, we've had design wins at a very significant ATE vendor, a tier one vendor, which translates into tens of millions of dollars of lifetime revenue for that particular product. It's an electronics chipset for memory testers and Maxim is uniquely positioned in this market because there are not many people who can participate in this market actively. We beat out our major competitors for this socket and our product really provides the lowest power and highest density, which is important for these next generation automatic test equipment products.

What enabled us to do that was a combination of a proprietary process technology that we have, which is optimized for these applications, and also the fact that we have a very rich portfolio of IT in this area. This is something that not many companies have with these capabilities. Another market area in the automotive area, we have achieved preferred and essential supplier status at two tier one automotive customers. This is clearly a signal and a recognition of Maxim's importance in this market. Achieving such a status clearly gives us new opportunities and I think our automotive customers are recognizing the value that Maxim has to offer.

As we have talked in the past, this market offers us several billion dollars of served available market opportunities. We've had significant design wins in different parts of the car and in different product areas such as infotainment, steering control, digital communications throughout the vehicle, battery backup systems in hybrid vehicles and so on. Again it's a very broad area of applications that we have had design wins in.

Tunc Doluca, Group President

After Pirooz I'll come back again and talk a little about base stations and cell phones. In the base station area, we continue to have major design wins in tier one accounts. In this area we've got two product lines that have been very successful. We make RF products for the front end and also data converter products that go in the data conversion portion of the signal. In the RF end we've got a state of the art by CMOS silicon [germane?] technology which enables us to make products that really enhance the performance of a base station and provide it at a lower cost. This proprietariness gives us a lot of ability to win designs at major customers.

In the data converter area we've had design wins and WiMAX base stations as well as 3G base stations. It's another area that we're establishing our presence. In cell phones, we continue to win designs in power management ICs as well as for fuel gauging. We introduced some new products. As you know, we're one of the few vendors that provides highly integrated ICs as well as some high performance building blocks for cell phones and we've won designs at major customers in Japan, Korea, the U.S. and Europe, so pretty much globally.

Many of these phones are phones that are well advertised, you can see them on TVs and in magazines, and many of them contain Maxim products. On other functions, we've been very successful with our mobile TV tuners. They provide far better sensitivity than our competitors'. This allows the end products made to have better coverage. We provide products in the smallest package technology available, wafer level packaging and achieved over 50% market share in Japan, which is in most cases where many of these new high-tech gadgets initiate their run over the world.

As also have increased other audio function penetration in cell phones and audio sub systems. We're able to make products that drive more efficiently like very thin speakers that enable thinner phones and we also have design wins in major Korean cell phone makers and one in the U.S. for an audio sub system which we'll be ramping very soon. In the high-end consumer area in cameras, our success also continues. Not only in the power management area, but we've introduced a new battery fuel gauging product that provides a lower cost point, so the penetration of fuel gauging we expect to increase in cameras. We also introduced a new generation of power management ICs that are smaller than the ones that have been highly successful in the past. We believe that will continue as a success. We also introduced some very small video filters that we'll be able to shrink the size of the cameras even further.

Pirooz Pavarandeh

I'll talk about two other areas. In LCD panels we've had significant design wins. Specifically we've had design wins with a new generation of smart gamma buffers. This has allowed us to increase our market share in that market segment. These products really allow these LCD panels to have improved image quality in the form of sharpness and contract. We have a significant technical contribution to make there. In addition to that on the same LCD panels, we have highly integrated power management ICs that are very cost effective and that are very well tailored and suited for monitor applications that are larger than 19 inches across.

In the video area we've introduced a new generation of amplifiers which we call direct drive video amplifiers. This is a patented technology. These products are the first of their kind to work at very low voltages, as low as 1.8 volts. They have the lowest power in the industry. They allow our customers to eliminate bulky external components which not only saves them cost but also enables them to have thinner, portable devices like cameras, multi media phones and personal media players.

In the video area, we've also had design wins for video filters for set top boxes and this is quite a family of different products that have achieved this kind of market penetration. We've won in leading set top box makers across the world, in China, U.S., Korea and Europe.

Tunc Doluca

Briefly, I'd like to say a few words about some of our security products that also have been very well received. A product we made for point of sale customers, for example, received product of the year award from Electronic Products, essentially because it eliminates over 40 external components. So it'll be a very successful product for us. We also continued to grow our portfolio and design wins as well in the authentication products we make for consumables and printers. That's an area that's going to be a good growth area for us, mainly because we have a proprietary interface standard that makes those products very valuable to our customers.

Paresh?

Paresh Maniar

Operator, this is the end of our prepared remarks. Could you please ask for questions?

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Questions-and-Answer Session

Operator

Certainly. Operator instructions. Our first question is from Romit Shah, Lehman Brothers.

Q - Romit Shah, Lehman Brothers

Thanks. First just a clarification on gross margins. Alan, you were saying that there was a 1.3% impact to gross margins from mix and then another 2% from an inventory write down, so total gross margins were down 3-3.5%. Is that correct?

A - Alan Hale

That's correct.

Q - Romit Shah, Lehman Brothers

Then Tunc, your comment about gross margins stabilizing in fiscal Q3, are you referring - I guess the way to say this is gross margins stabilizing for next cycle? Or are you also thinking this is a number you can hold if you scale the business to $3 billion?

A - Tunc Doluca

I think we talked about all the measures that we put in place last time. Obviously some of those measures have short-term effects and some of them can only have effects in the long term. I think we're going to be stabilizing our margins in the short term now. It's very difficult for me to see what's going to happen in the quarter behind that, but in the long term, we can get to the $3 billion level with a plan to have our margins in the low 60s, and that's our target.

Q - Romit Shah, Lehman Brothers

Last question, you guys gave us some great color on - is that on some of these high volume markets - are there any particular high runners to think about within these different segments for the second half of the year?

A - Tunc Doluca

When you're asking about high runners, are you talking about markets or functions?

Q - Romit Shah, Lehman Brothers

Product lines within a particular business or specific applications that you think will drive up that average growth for the second half of the year, or say end of the next up cycle?

A - Tunc Doluca

Okay. Well I think in terms of markets, as I said in the prepared remarks before, we do expect the high-end consumer market to be a big growth driver for us in the long term. I think all of us are pretty familiar with that market. It's high-end cell phones, digital cameras, digital television, all of these markets. Into these markets, Maxim actually provides a lot of different functions so it's difficult for me to pin it down on one or two but we have highly integrated products for power management, we have similarly for audio, we have many products for video, so in all of these different mixed signal products we're going to see a lot of growth for Maxim into the future in those markets that I just talked about.

Operator

Our next question comes from Parag Agarwal, Jefferies & Company.

Q - Parag Agarwal, Jefferies & Company

Could you comment on the distribution inventories out there?

A - Alan Hale

The data suggests that distribution inventories are exactly in line with demand and turn approximately seven times a year which is unchanged for many quarters at Maxim.

Q - Parag Agarwal, Jefferies & Company

Many of your competitors have been saying that the March quarter should be the quarter. Do you also feel the same, or is yours a bit different from theirs?

A - Tunc Doluca

It's difficult for us to exactly predict that, but if we look at what our business units are forecasting for the future, they're forecasting growth beginning in Q4, but as I said that's just the forecast from the business units and it's really difficult for us to pinpoint.

Q - Parag Agarwal, Jefferies & Company

Do you see the lead times expanding or are they the same?

A - Tunc Doluca

In terms of lead times, are you talking about the lead times customers are giving us, or what we're giving them?

Q - Parag Agarwal, Jefferies & Company

What customers are giving you - or, actually if you could give me both the numbers?

A - Tunc Doluca

In terms of the lead times that we're getting from our customers, they actually expanded slightly in Q2 and by about four or five days or so. In terms of the lead time we gave our customers, they actually went up in Q2, mainly because there was a lot of unforecasted demand coming from the computing market, but all indications are that our lead times will be coming down in Q3.

Operator

Your next question is from David Wu, Global Crown Capital.

Q - David Wu, Global Crown Capital

The question, I have a clarification, Alan, when Tunc said about the gross margins stabilizing, does he mean before or after the inventory write down that we went through in Q2? Secondly, on this Seiko Epson deal, this is a fairly large, according to the press release I saw this morning, a fairly large percentage of a fab in Japan that you're using. Where are you using it specifically for and what is the implication for gross margins now that you're using flex foundry capacity for these high end consumer products and also notebooks? Lastly on the question of employee retention I was just wondering were you changing your compensation for these people to be less reliant on stock options, which was hot a decade ago but not very hot these days, to a heavier cash component for the incentive comp?

A - Alan Hale

The comment regarding stabilizing gross margins in the next quarter refers to after the inventory reserves.

Q - David Wu, Global Crown Capital

Do you expect the kind of inventory reserves that you've been booking Q1 and Q2 to continue to Q3?

A - Alan Hale

The exact number of dollars that gross margins are impacted by inventory reserve actions is not determinable until the end of the quarter. Inventory reserves are a function of demand and on hand inventory. They are matched and the first 12 months of on-hand inventory is deemed saleable. That is Maxim's accounting policy. Generally anything beyond that is reserved. I would not expect inventory reserves to be as high as they were in Q2 FY 2007, given their relatively large size in Q2 2007.

A - Tunc Doluca

Alan is not expecting it and we're not expecting it as a company to be as large as this quarter. But there's also some unknown factor which has to do with how the chip demand forecast changes by the business units. David, your second question was on Epson and I didn't write it down, so now I've forgotten it.

Q - David Wu, Global Crown Capital

The Epson, according to the Seiko Epson release, they have an 8-inch fab up north in Japan and about 10% of that fab output is dedicated to Maxim for the next business year. I was wondering what is this flex capacity used for and what does it mean therefore in Maxim's gross margins, now that you're going to use more of these fabs for assume these high volume consumer or notebook-related businesses?

A - Tunc Doluca

In terms of the Epson fab, we will be putting our newer technology there to start with, so your comment that it will be processes that are geared towards high integration, that's correct. When we looked at the effects on gross margin, it really will not be noticeable. It will not really have an effect. This flex model will not really have a big effect, especially in that agreement we made to our gross margins going forward.

Q - David Wu, Global Crown Capital

What about employees - are you changing your comp to be more cash and less stock options moving forward?

A - Tunc Doluca

In the past two years, we have already made some adjustments in our comp structure. In terms of stock options, we still value that as a great way to reward employees and we're currently in the process of looking as to how exactly to structure that. I won't be able to give you an answer today, but stock options are something the company continues to be committed to providing to its employees.

Q - David Wu, Global Crown Capital

You have a total turnover ratio that you measure. One hears these days, I guess, that the turnover - that there are analog companies around your neighborhood or elsewhere that are getting Maxim employees they could not have gotten several years ago. I wonder whether in terms of turnover, what metrics are you seeing today versus what it was three years ago?

A - Tunc Doluca

In terms of our turnover rate, if you were to compare it to three or four years ago I would say that it's higher. But it's still not significant for the company. It's not something that - of course we would like it to be zero, but we have to live with reality and I know that even though we do have a turnover rate, we are able to increase our engineering headcount QoverQ. We're doing fine. Of course, when our competitors are talking about getting employees from Maxim, they're comparing to a time when our turnover rate was almost zero, so any number that's bigger than zero is going to look like something significant, but it really is not for us.

Q - David Wu, Global Crown Capital

Is it in the 3-5% range?

A - Tunc Doluca

No, it's much lower than that. It's probably 1-2%.

Operator

Our next question is from William Lewis, JP Morgan.

Q - William Lewis, JP Morgan

Tunc, could you talk about - you introduced the notion on the last call about these complex products. Can you give us an update on what percent of the business represents these complex products? You also talked about maybe taking a new approach to pricing, the new pricing strategy. Can you maybe talk about some actions you took in the quarter and what the reaction has been with your customers?

A - Tunc Doluca

The first part of your question, you asked what percentage of the business is highly complex products. First of all, it's not something that we drive and measure every quarter. It happens because the customers are asking for it to happen. Last year's number was about 18% and this year's number will eventually probably be higher than that, but I don't know exactly what it's going to be. I believe we predicted it to be about 25 if I remember right from the analyst meeting. We're probably going to be somewhere between 18 and 25 this year. Your second question was…?

Q - William Lewis, JP Morgan

Really around pricing. Some of the lessons you learned from the early stages in these higher volume markets - you talk about maybe taking a different approach to pricing, what steps you've taken and how the reaction has been.

A - Tunc Doluca

The reaction has been pretty much what we expected when we talked last time. I think in the prepared remarks, we said that we were concerned about customer relationships so we have been very cautious in doing this. We've done it in cases where we know it's not going to hurt our future relationships. Most of the pricing effects that we spoke about were really for new design wins that we were trying to get. It is really difficult to do price increases once you're in the socket and have won the design. I'm sure you would hear that from many of our competitors as well. We've been very cautious. Obviously if we could do it on existing designs, we tried to do it. I would say that the measure we put in place was really for future design wins.

Q - William Lewis, JP Morgan

A second question if I could on your expenses. You said opex was up 2.5% this quarter, kind of a flat environment on increased hiring - can you talk about what the outlook is for expenses from here given the downturn, what your appetite is for continuing to hire at these levels over the next couple of quarters?

A - Tunc Doluca

Our current - what we're doing right now is obviously we need to control our below the line spending and we put in some measures to do that like controlling travel expenses, expenses on advertising and so on, but in terms of hiring we want to continue to be hiring opportunistically, especially in the engineering areas. So I expect in terms of head count just to continue to add engineers to the company in Q3 and Q4. That obviously is investment that we're making in the future and it would be short sighted for me to go and cut that completely just because we've seen a few flat quarters of revenue.

Operator

Your next question comes from Michael Masdea from Credit Suisse.

Q - Michael Masdea, Credit Suisse

Alan, could you give us an idea of the trend on inventory and if you could also going forward what you expect to do with inventory or turns?

A - Alan Hale

First of all, for Q2, inventories were essentially flat after the inventory reserve actions were taken. This is without stock-based compensation. The next quarter, we will build inventory in an effort to stage the product for when demand rebounds. We need to improve the way our inventory matches our unforecasted demand and this is a way to do it. It's an opportunity to get ahead and we will be doing that during the upcoming quarter.

A - Tunc Doluca

Essentially it's very similar or almost exactly the same as we've done in the past. We take these periods where the demand slows down and in those periods we build the banks so that the next time we have an upturn like we had in 2005/2006, we can make sure that we're ready for our customers.

Q - Michael Masdea, Credit Suisse

That makes sense. I guess I was a little surprised to hear that customers are expanding their lead times on you a little bit if I heard that correctly. Can you just give us a little more color around why you think that is, especially in a lower order environment, why you think they'd be doing that?

A - Tunc Doluca

First of all, the change is really not that significant in my mind. It didn't change by weeks, it only changed by three or four days. Essentially, to me, it indicates that they have more confidence in their being able to build and ship their product.

Q - Michael Masdea, Credit Suisse

This is the last question. Your discussion on those five points in the near term you're going to be working on, one of which was around the manufacturing cycle time. Is the ultimate goal here to try to keep stability in those lead times that you have for your customers and keep them fairly short, or tell us what the ultimate goal with the lead time management is?

A - Tunc Doluca

It's really - the program we're instituting is really a reduction of cycle times. That will have some effect on lead times we quote to customers, but our real goal is to get our cycle times shorter and that's going to enable us to better control our inventory. More importantly, especially in these more dynamic markets, the high growth markets, enable us to respond to our customers' needs more quickly. That's the objective of that initiative.

Operator

Our next question comes from Sumit Dhanda, Banc of America Securities.

Q - Sumit Dhanda, Banc of America Securities

I had a couple of questions. I wanted to touch back on the gross margins. Alan, it wasn't clear to me that the gross margin outlook for Q3, whether that is flat ex the reserves or after including the reserves, because you indicated a lack of clarity on exactly what the reserve profile would look like.

A - Alan Hale

The expectation for Q3 gross margins is that it will be no worse than what they were in Q2 and Q2 includes the inventory reserve action.

A - Tunc Doluca

I think that even without the inventory reserves, if you take that out completely we're talking about flat.

Q - Sumit Dhanda, Banc of America Securities

So then is the implication - so there's no further deterioration in mix? I guess that's the first question I'd ask. Then the second question, are you not seeing any benefits which I think have been alluded to previously from improved efficiency at your San Antonio fabs?

A - Tunc Doluca

Can you ask that again?

Q - Sumit Dhanda, Banc of America Securities

Right, so the first question is the implication here is no further deterioration in margins from mix? And I guess as a follow up, you previously indicated about a couple of quarters ago that you're not seeing the kinds of efficiencies you'd like to see from your San Antonio facility and that would start to manifest itself as a benefit to gross margins in out quarters. My question is, are you seeing that or are you not, and if not, why not?

A - Tunc Doluca

In terms of the efficiencies out of San Antonio, we are beginning to see those but it's very gradual. If you look at all the things that are changing all at once, it's very difficult to quantify that in these numbers we're giving.

Q - Sumit Dhanda, Banc of America Securities

Let me just ask a 10,000 foot level question as it relates to your operating model. When the change was initially instigated under Jack's watch, the idea was you would control below the line spending even while your gross margins took a hit as your mix moved to a higher volume, lower margin product and that will help stabilize operating margins. If I look from the peak, the decline in gross margins has been mirrored by the decline in your operating margins. How should we really think about number one your target model in the first place, from an operating perspective, and you know, is that just basically going to fluctuate now with your gross margins and your top line growth trajectory?

A - Tunc Doluca

In terms of our future, I already gave guidance on what our targets are for our gross margins in the long term. I think in general, our below the line spending will not grow as fast as our revenue. We do want a model in which we have profit and earnings growth and that's our goal. I think what was communicated before, we were achieving and we've come to a pause now in the cycle but once we're out of the cycle, we will be able to continue with what Jack articulated in the past.

Q - Sumit Dhanda, Banc of America Securities

I guess my question is it doesn't seem to have played out that way so far, so as the new CEO do you have - not a gross margin target, but an operating margin target in mind? A normalized operating margin for the company if you will?

A - Tunc Doluca

I do have some numbers in mind, but why don't we discuss that on the next conference call?

Q - Sumit Dhanda, Banc of America Securities

Let me just ask one final question. You indicated that notebook demand really helped sales and offset some of the weakness in other areas. In terms of your design wins, are they concentrated more on Intel-based platforms, AMD-based platforms? Could you quantify that?

A - Tunc Doluca

We have the design wins on both platforms. In terms of AMD, the AMD reference design contains Maxim products so I think we've probably been more successful there, frankly. However, you know the share between Intel and AMD, so I'd say that we've got design wins in both areas, not just one or the other.

Operator

Our next question comes from Louis Gerhardy, Morgan Stanley.

Q - Louis Gerhardy, Morgan Stanley

A couple of questions. First on the issue of mix, I can understand an unfavorable mix situation in the December quarter, but usually the first half of the calendar year is a much richer mix for your guys with the industrial markets and distribution. You're not talking about seeing it in the march quarter. Is that - I'm just trying to understand what that is telling us. Is it describing more pricing pressure in the non-industrial markets, or is it just a sign of lackluster demand in industrial channels? Any comment?

A - Tunc Doluca

In terms of bookings, the industrial market bookings in Q2 were relatively flat. Usually we get longer lead times in terms of the industrial market. What we're seeing essentially is that the business levels in Q3 in the industrial market are not really increasing that much. That probably helps explain some of the trends that we're seeing in terms of gross margin predictions for Q3.

Q - Louis Gerhardy, Morgan Stanley

Your computing bookings are described as being up. That just seems a little bit unusual given the Santa Rose transition is still out there a ways. Was that share gains, do you think, in certain product areas? If so, can you describe which type of products that was for?

A - Tunc Doluca

That's kind of difficult for me to predict exactly. All I do know and that's what I'll share with you is that in fiscal Q1, most of the customers - especially in the notebook market, were very cautious with the amount of demand they saw. Therefore we did not get a lot of bookings in Q1. In Q2, really a lot of them roared back saying that there was very robust demand for notebook PCs. A lot of the bookings and actually it was a lot of turnable bookings that were booked in Q2 from those customers. If it had come linearly I think it would not have been this high of a bookings level in Q2, but it didn't. Most of it came in Q2 instead of being split into Q1 and Q2. I don't know how to predict whether we got market share gains or not.

Operator

Our next question comes from Craig Ellis, Citigroup.

Q - Craig Ellis, Citigroup

Tunc, you mentioned the focus on improved delivery times as one of the near-term initiatives. Are there any capex consequences to that and can you just update us on how we should look at the capex outlook? I think we went into the quarter thinking that capex would be less than almost $100 million. Why the up tick in the quarter?

A - Tunc Doluca

In terms of capex, first of all I want to say that it's an important metric for us. We're very conscious of it and very careful of capex spending. We really have put in place the capacity to really fuel or be able to supply our growth that we expect next year. That's why some of the numbers that you're seeing are somewhat higher than what we had said before. We will continue to be very opportunistic into the future. It turns out that usually times of low market demand are good times for Maxim to acquire either fabs or equipment for fabs. In general, we were really getting ready for a big expansion in demand both in FY 2007 and our business units are forecasting a ship demand for next year that's high so that's why the capex was on the high side for this year.

Q - Craig Ellis, Citigroup

So as we look at the last three quarters running in high teens, capex to sales, how should we think about the next three to four quarters?

A - Tunc Doluca

I think in terms of capex going forward in the next couple of quarters they will be in the lower range than what you saw in the past two quarters.

Q - Craig Ellis, Citigroup

So being kind of half or lower than that, then?

A - Tunc Doluca

It will be lower. However, as I said, if we do find something opportunistic for us to buy that might change.

Q - Craig Ellis, Citigroup

Secondly, you mentioned three near-term initiatives that related to internal reviews - sales and distribution; business unit alignment; and I think there was one that related to consequences and maybe gross and operating margins. When will those be initiated and when do you expect to include those and when would you expect to realize benefits out of those reviews?

A - Tunc Doluca

It's probably best to go through them one at a time. In terms of the first one, that one was the gross margin one. I think that's something we're going to have to do continuously. It's really important that we focus on it right now because it's particularly important but I think it's something that's going to be going in perpetuity in terms of watching the profitability of the company. The business units really being on top of it much more than they have been in the last couple of years. One of the other ones you mentioned was the sales. We are going to look at that and if we decide to make any changes, we will make them in the next two quarters so probably by the end of the fiscal year we'll have a plan in place and that strategy really will help us better service our large customers as well as our small customers. That's our purpose, on how to use distribution and direct sales in order to be able to expand our revenues into the future. One other area that I mentioned was this collaboration amongst business units and possibly realigning them. That also is going to occur in the next I would say by the end of this year. More of it happening this quarter and maybe some more to follow in Q4. So I think did I cover all of the ones you asked, or was there another one?

Q - Craig Ellis, Citigroup

I think you actually hit them all. As a follow up on the sales and distribution, do you envision that one of the possible consequences could be adding to your sales staff?

A - Tunc Doluca

Adding to our sales staff? That's going to depend. We're looking at that. As you know, we have an internal distribution arm called Maxim/Dallas Direct. That's been pretty effective now but it could become more effective possibly if it had more staff so that's something that we're looking into.

Q - Craig Ellis, Citigroup

Lastly, thanks for all the color thus far, you've outlined today a number of operational objectives but you've got a balance sheet with a very high amount of cash. You generate significant free cash flow quarterly. Can you just set forth your thinking on how you would use your free cash flow, either with share buyback or potential acquisitions - how can you use that to help deliver shareholder value?

A - Tunc Doluca

That's something we're looking at I think in broad sweeps. The way we were using our cash in the past will most likely continue into the future, so we do want to look again this year at whether we want to increase dividends which we'll probably do. We also want to buy back our stock. Once we're able to do so - as you know, we haven’t been able to do so for a while. Acquisitions are something that constantly we have people looking at inside the company. Whenever we see something very opportunistic, we go after it but we really don't want to take a lot of risk in that area. We want to make sure that we make considered decisions in any acquisition that we've got. That's probably why we've not seen many acquisitions by Maxim in the past.

Operator

Our next question comes from Simona Jankowski, Goldman Sachs.

Q - Simona Jankowski, Goldman Sachs

I just wanted to clarify one thing on your gross margin guidance again for next quarter, which sounded like you're guiding for about flat. It seems like within that you might see some benefit from taking a smaller inventory reserve versus what you took last quarter. In addition, you'll be building some inventory which might potentially otherwise help margin. I'm just wondering given these two positive effects, why the gross margin guidance is still about flat. In other words, are there offsetting effects there from either pricing or mix?

A - Tunc Doluca

I think you kind of summarized things pretty well there. You know, we want to be cautious on predicting what our gross margins are going to be so I think we want to leave it in this approximate range. Operationally I think they're going to be about flat. We're really unable to completely predict what's going to happen within inventory reserves. I think we should just leave it at what we said.

Q - Simona Jankowski, Goldman Sachs

Okay, but it's just that you're unable to say whether the pricing and/or mix effects are going to stabilize in Q2? As in the calendar of Q2? Q1.

A - Tunc Doluca

Say that again?

Q - Simona Jankowski, Goldman Sachs

Do you know, stripping away the effects of inventory reserves and the inventory build, just looking at two of the factors that impact margin, one of them being pricing and the other one being mix, would you be able to comment on those two specific factors if they have stabilized now, or do you think those two might still continue to be a negative effect on margins next quarter?

A - Tunc Doluca

I think it will be relatively flat, as you take out these other effects that you talked about.

Q - Simona Jankowski, Goldman Sachs

Okay. The second question might be for Alan - you commented on long-term guidance for growth margins in the low sixties - would you be able to give also an opex as a percent of sales long-term guidance?

A - Tunc Doluca

It wasn't Alan, it was me that said that about our gross margin long-term targets. On opex, you know, we're going to have to work on our company model some more, so in the future we'll give that.

Q - Simona Jankowski, Goldman Sachs

Lastly, on the changes you're going to make in your manufacturing cycle times, can you just give us a few more specifics on exactly what kind of changes you'd be implementing to make that improvement? It sounded like a pretty aggressive goal. I think you might have mentioned three weeks, and I just wanted to understand the different levers you can pull to achieve that.

A - Tunc Doluca

It's an achievable goal and I have given it to the two people that run manufacturing for me and I'm expecting them to come up with the answers. I'm confident that they will be able to, so right now I'm not going to be able to give you a specific answer as to how they're going to do it. I gave them the goal, they believe they can do it and I'm sure they're going to pull through.

Operator

Our next question comes from Tore Svanberg, Piper Jaffray.

Q - Ivan[?], Piper Jaffray

This is Ivan calling for Tore. You've got an inventory that's been written down. Is there any possibility it could be used again still later, or even more generally could you please characterize the inventory that you're writing down?

A - Tunc Doluca

The inventory, you're talking about the write-down in Q2?

Q - Ivan[?], Piper Jaffray

Yes.

A - Tunc Doluca

There's always a possibility that it might be sold in the future, but what we're saying is that it's more unlikely than not. That's why we decided to write it off. Actually, that especially holds true for the leaded inventory. The reason I say that is because you know, there's been this move in multiple countries and continents to get lead out of electronic equipment. It actually has caused a lot of problems also for some customers of ours that still want to use leaded because they're not sure about the reliability of the lead-free product. But in general, the customers are moving away from leaded inventory so it's more unlikely for that to be sold, even though the possibility is not zero, mainly because some customers are just not moving from building leaded products.

Q - Ivan[?], Piper Jaffray

Regarding your comments on gross margins stabilizing, I was wondering if that means - how that plays in with your pursuit of higher volume market. Does that mean you may not be willing to trade off some gross margins for top line of growth?

A - Tunc Doluca

Are you asking a more long-term question?

Q - Ivan[?], Piper Jaffray

Yes.

A - Tunc Doluca

I think in the long term, I continue to believe that the growth of this company is going to come from these high volume markets and it's going to come from making highly integrated products. It's not really just because of something that I came up with, but it's what the customers have been telling us. They're driving us to do this and I firmly believe that the companies that don't have a strategy like this one will not be able to grow revenue and hence grow profit. We will continue to make products that are for these highly integrated and high volume markets but all we're going to do is continue and probably be more selective in taking on business or taking on projects in terms of their profitability.

A - Pirooz Pavarandeh

This is Pirooz, I could add some comments here. With regard to these highly integrated products, really Maxim is a highly diversified company, not only in terms of our end markets but also in terms of our product lines. I think there is also another axis of diversification that needs to be talked about, which is really the complexity of the products. It's like a risk management activity and with these highly integrated products, as Tunc said, our customers are demanding it from us but internal to the company there are very strong measures to make sure that we are making sane decisions with regard to which projects we're pursuing. If we do pursue a project that is highly integrated that has a high investment in design man months, we are watching it like a hawk to make sure that investment is well managed and the risk of it is well managed. Not only in terms of the execution but also in terms of the gross margin impact.

Operator

Our next question comes from Krishna Shankar, JMP Securities.

Q - Krishna Shankar, JMP Securities

As you bring up the Seiko Epson, fab, what will be the mix of (inaudible) using the Seiko foundry in terms of your production mix 12-18 months out?

A - Tunc Doluca

Can you repeat that? I missed the beginning.

Q - Krishna Shankar, JMP Securities

I'm trying to get a sense for your production or revenue mix between your internal fab versus the Seiko Epson foundry 12 months from now and the impact on the gross margin.

A - Tunc Doluca

I see. You know, it's really too early to be able to answer that question but I'll be able to give you an answer in the next conference call.

Q - Krishna Shankar, JMP Securities

Okay. Can you give us some outlook as to the mix between the standard high-volume product or the high-volume, highly integrated SoC products versus the more standard linear products 12 months from now?

A - Tunc Doluca

First of all, the delineation we made was between high integration and building blocks. There wasn't an 'and high volume' in there when we gave those numbers. So in terms of integration, as I said, at 2006 it was about 18%. We expected this year to go higher. I really don't know what the exact numbers are going to end up being this year. I do expect this percentage to go up to about 25% in the near term and even higher when we go up out - over 30% when we go out another year and a half or two years.

Q - Krishna Shankar, JMP Securities

Have you talked about growth in operating margins for these two different product types?

A - Tunc Doluca

No. In the past, we have not talked about it and going into the future I'd rather not separate these out and talk about them either.

Operator

Our next question comes from Jeff Rosenberg, William Blair and Co.

Q - Jeff Rosenberg, William Blair and Co.

My question relates to the strategy with the highly integrated products as well. With the things you've just said in the last few minutes and what you said before about where you're really focused with your new initiatives, it's your view that you're kind of going forward with the same aggressiveness towards pursuing these highly integrated products and the issues you've had in the recent past are all about execution and not about whether or not it's just a more difficult business, and you want to balance how much of that you go after - is that fair to say?

A - Tunc Doluca

Some of that is fair to say but not all of it. One of the comments was that it's - it is a difficult business. It definitely is more difficult for a company to execute - not just Maxim but any other company - because the schedules are typically short. They're very demanding because there is so much engineering content in them. They typically ramp quickly, therefore you have to be ready with your cost reductions and everything. It should be clear to everybody that it's a more difficult business for any company to be able to succeed in. It is a necessity for a company in this business to grow, so we do have to continue to pursue it in addition to having our stability from our building block type products. I think that the company - we've learned many lessons in terms of execution and we've come one step further and each time we learn of a lesson we make sure everybody in the company knows about it. I think in terms of our future, it's an essential part of it, so we will continue on this part to become really good at - or maybe great at - doing these high integration products.

Q - Jeff Rosenberg, William Blair and Co.

It sounds like from what you're saying you don't expect it to be - your targets in terms of how much of the business it will represent looking out a couple or three years have not changed. Do you expect the level of increase to be about what you've talked about historically?

A - Tunc Doluca

That is correct.

Q - Jeff Rosenberg, William Blair and Co.

My last question on this is competitively, obviously you compete much less with the guys that you've historically been compared to. What can you say about the competitive environment in this area now that you've learned more from that perspective as to who you're competing with and how they've been able to execute relative to you? What's your view of the competitive environment in this category?

A - Tunc Doluca

It's very difficult to give color. It is competitive. As you said, the competitors are a lot fewer than our previous competitors. I think we do very well in terms of engineering value added and in terms of at least that metric, the customers are seeking our products. We do have some shortcomings in terms of our ability to ramp the product quickly and that's the reason for one of the initiatives I have - being able to reduce our cycle time. That's an integral part of the strategy.

Operator

Our next question comes from Ross Seymore, Deutsche Bank.

Q - Ross Seymore, Deutsche Bank

I just wanted to get into the potential realignment of the business unit. Tunc, if you could just talk about what some of the goals are, if in fact you follow through on that and whether it be on the revenue side or the cost side of the equation?

A - Tunc Doluca

The reason for the realignment really is to be able to execute more efficiently in terms of the product design. It really has nothing to do with revenue or the cost. But it's really to execute better on product design and be able to present to the customer a Maxim face that represents all types of different products that go into that same piece of equipment. It's really mostly to be able to get our product lines that have similar products either functionally or that have similar products going into specific end equipment - you know, one of those two criteria - to see if we can better align them to be more efficient in product development and in the sales of the product. It's really a view in that direction, it's really not a cost saving - it doesn't have a goal like that.

Q - Ross Seymore, Deutsche Bank

Is that something we should view as something more of an evolutionary change or do you have some sort of hard goal that you expect to have that sort of realignment done in a certain time frame?

A - Tunc Doluca

I would see it more as an evolutionary change because I think we can constantly look at this - and we have in the past too. We have made product line changes in the past. I believe that we probably need to make a few more in the short term now than in the past. Going forward, it's something that we continuously want to evaluate and see if we can be a better company overall.

Q - Ross Seymore, Deutsche Bank

The other question on kind of aligning to those sorts of customers, from a big picture point of view, as you go into the normal seasonality that falls throughout the calendar year, do you have a greater gross margin challenge because of mix in the second half of the calendar year than you do in the first all things being equal? If so, as we go into the second half of this calendar year, do some of the cost cuts that you're putting in place, are they large enough to offset that or do we have to worry about gross margins directionally in the second half of the calendar year as well?

A - Tunc Doluca

Frankly it's not something that I've analyzed in that way. Maybe it is something we ought to do, but we haven't really analyzed it in that way.

Q - Ross Seymore, Deutsche Bank

Maybe just bring it shorter term then - these new customers that are more vertically oriented ramp like you talked about in the preamble in this call - you said notebooks got bigger and that hurts your margins a bit - I would assume it's relatively fair to think that that would apply in the second half of the calendar year as well. Is there something wrong with that logic?

A - Tunc Doluca

I wouldn't say there's something wrong with it but you also have to consider that what happened in Q2 in notebooks is - I wouldn’t say that's very seasonal because in the past, a lot of the purchasing for notebooks was done towards the end of the Q1 months. This - what happened right now is really not something that's been happening in the past. Or maybe it has, but it's not a repeating event. It's really difficult for us to predict and say well, in 2007 the same thing is going to happen.

Operator

Our next question is from Doug Freedman, AmTech Research.

Q - Doug Freedman, AmTech Research

Just some quick details on the stock buyback - you said there was no stock buyback. Was there any share dilution? Can I get a share count?

A - Tunc Doluca

I think it's inappropriate to give out share count information during this time.

Q - Doug Freedman, AmTech Research

Okay. Alan, you mentioned inventory was flat during the quarter. Was that in dollars or days?

A - Alan Hale

Dollars and again it's after the inventory reserves were taken and again it's excluding the effect of stock-based compensation.

Q - Doug Freedman, AmTech Research

For Q1, do you believe that your Q1 revenue guidance puts you at a level that's above or below what you believe market consumption of your products will be?

A - Tunc Doluca

When you say Q1?

Q - Doug Freedman, AmTech Research

Your fiscal Q3, excuse me. The March quarter.

A - Tunc Doluca

I was thinking about what you said so you're going to have to repeat it…

Q - Doug Freedman, AmTech Research

For the March quarter, your revenue guidance - do you think that that puts your shipments at above or below the consumption of your products at your end customers?

A - Tunc Doluca

Actually that's pretty hard for us to say. I think it's probably about even.

Q - Doug Freedman, AmTech Research

One last one. When we exit the options issues, have you given any thought or looked at the way in which the company has historically valued the stock option expenses and whether there's a way that you can come up with a different valuation method that might help out with the GAAP accounting regulation rules?

A - Alan Hale

The GAAP accounting rules provide guidance on all the variables that go into that calculation. I don't want to get bogged down in a GAAP accounting discussion regarding stock compensation valuation charges. Perhaps if you want to discuss that afterwards we can. I think though, from what you've heard today, is that the company will view options as an essential to motivating engineers to align their interests with the shareholders and produce better results than they would without stock options. The issue of how heavy stock options will be used is to be determined.

Operator

Our next question comes from Steve Smigie, Raymond James.

Q - Steve Smigie, Raymond James

A couple of quarters ago, you guys talked about roughly getting in the neighborhood of 300bps of gross margin improvement if you figured out how to better ramp production or hold back on announcing products for higher volume products to make sure your yield is right. Also about figuring out how to do pricing correctly on higher volume products. I'm just curious if you had seen any of that benefit come through yet or if you're still thinking about it in that way?

A - Tunc Doluca

Do you remember exactly what was said?

Q - Steve Smigie, Raymond James

I think Jack was saying that initially you'd had some problems with figuring out how to price the higher volume products and that you were pushing some of those pricing decisions further up in the organization on one hand. On the other hand, you were saying that you were announcing products too soon before you really had your yields up or the past that wouldn't matter but in the current environment the volumes are so high that you'd end up running negative gross margins on the products because you ramped so much faster. He'd mentioned about a 300bps gross margin recovery as you sort of addressed some of those problems. I'm just curious where you stand on that.

A - Tunc Doluca

Okay. It's very hard to keep good quantified measures on this, but the measures that we mentioned in the last quarter pretty much had some of the content or items you talked about. They are having an effect, but it's going to be very hard for me to exactly quantify it. Some of them, as I said before had short term effects but many of those measures actually have I would say a longer term effect. In other words, we need to make sure that we don't get into gross margin difficulties way early when we're designing our products, when we're announcing them and so on and not try to fix them by controlling price at the last minute when the customer's already designed the product in. It's my belief that those measures we put in place will have a longer-term effect and it won't be seen one quarter after you put them in place.

A - Alan Hale

If I could add some more color to that as well, I think Tunc mentioned in the beginning statements that we are essentially seeing a cultural revolution or a high level of anxiety and awareness of the gross margin focus that the company has. This is really permeated throughout the organizations that are responsible for the pricing of the product. In addition to that, I think one of the other measures that Tunc talked about which was to hold accountable our various business unit executives for the profit and loss of their businesses - sometimes there are… This is really elevating the pricing decision. This is higher up within the chain of command, that's number one. Number two is that we will be - a particular transaction in the scheme of things may not look - we need to provide tools to our business unit executives to make sure that they understand the consequences of their actions in aggregate. I think those are some of the measures we're going to be working on to make sure that at a grass roots level and at a business unit executive level we have all the necessary tools and the anxiety to control this.

Operator

Our next question is a follow up from Sumit Dhanda, Banc of America Securities.

Q - Sumit Dhanda, Banc of America Securities

I had a question around inventories. It seems like the reserve last quarter - the rough amount seems to me to suggest a write-down of about 10% of the dollar inventory you had in store and so this is the second straight quarter where you've taken a reserve. Clearly it's not clear whether you see a reserve this quarter of that same magnitude, but given that backdrop, why increase production to increase inventory this quarter to begin with?

A - Tunc Doluca

In terms of production, we're not really increasing it that significantly, frankly, and I think that we had mentioned before we really need to use these periods where the demand is slow to be able to replenish our dye bank, because that's what we draw upon when the demand comes later. We lived through this in the past, where if we didn't come in with sufficient inventory into an upturn then we would have many unhappy customers. I don't want to repeat that again.

Q - Sumit Dhanda, Banc of America Securities

I guess my point is that the forecasting hasn't necessarily been stellar to begin with, so why press the case here? Understandably the demand will come back, but do you think the issue is really having enough inventory to make sure you're able to supply the demand or to perhaps focus internally on forecasting the mix of inventory in light of ostensibly some pretty significant inventory reserves that you're taking?

A - Tunc Doluca

It's both. We're both - we focused internally both on getting the right inventory there but also making sure that when we do build this inventory we're building it on products that have longer lives than others. We're controlling the inventory in that manner. Remember that a lot of the write off that came this quarter was because of this leaded inventory issue which really - I don't know if there's going to be some other material that's going to be banned in the future, but that really was an event that occurred in 2006 and I don't think that's going to repeat unless as I said there's another material that gets banned. Unusually high numbers is unusual for us.

Operator

Our next question is a follow up from Louis Gerhardy, Morgan Stanley.

Q - Louis Gerhardy, Morgan Stanley

You probably got the tax credit in the quarter, I'm just wondering what the normalized tax rate with R&D credit will be going forward? Just on the Seiko Epson deal, will you only be producing there products that Maxim has designed, or is there a possibility for you to run some of Seiko's own mass sets there?

A - Alan Hale

On the tax rate question, the long-term tax rate at Maxim has been 33 plus or minus a little bit and I would expect that to remain intact going forward.

A - Tunc Doluca

In terms of the Epson fab, your question was are we going to run Epson's wafers in that fab?

Q - Louis Gerhardy, Morgan Stanley

Have you acquired the rights to run any of their mass sets in that fab, or are you just running Maxim design only through that facility?

A - Tunc Doluca

I see. Our current plan is to run Maxim designs only for us, however Epson will continue to utilize a large portion of that fab in the short term for their own demands.

Operator

Our next question is a follow up from David Wu, Global Crown Capital.

Q - David Wu, Global Crown Capital

I just want to get one thing straight. As I remember the conversation we had in the last quarterly analyst's call, there was a significant number of targets where your gross margin was in the teens that you were shipping, so by eliminating - I believe there were something like seven or 17 of these wonderful projects - the gross margin would naturally be going up. Is that something we can count on as the calendar year unravels or unfolds, and maybe that's more meaningful than the seasonality that we've been used to in the past? Because you're going through some very strange times these days.

A - Tunc Doluca

Was there seven to 10 products?

Q - David Wu, Global Crown Capital

I think we isolate a number of products. There were a significant number of projects that had a remarkably big impact on your gross margin. That was talked about in the last conference call. I assume that those things were either going to be done away with or disappear from your shipments soon?

A - Tunc Doluca

Well it's a mix. Some of them will improve their costs so their gross margins will be better with the measures we talked about. Some of them, you know, we are asking that we don't get designed into the new generation unless the price is different, but many of them will continue to sell, because they do have a positive effect on our profits and they also are key for us to be able to win the next generation design. I think it's a mix of solutions that we've got for that list and I remember the list you're talking about. This was I think the top 20 negative gross margin contribution products.

Q - David Wu, Global Crown Capital

I remember that number - the number of products was relatively small, but the impact on overall gross margin was remarkably big. I was wondering when do these problem children get fixed? Generally can we think about that as the end of calendar 2007 or do these things last longer than that?

A - Tunc Doluca

First of all let me make a statement that's true. In terms of our focus on our top 20 negative contribution margin products, that will always be there. There will always be something that's got negative contribution margins. So the focus on the company will be to make sure that we continuously reduce the amount of negative contribution margins those top 20 products will have. That's the focus we've got. That's really the metric that we will go after, but those products will not disappear over night because some of those products, in fact many of them are products we sell to some of our - those key 20 customers we talked about. Most of our efforts in those areas are to transition those customers to our newer generation products where we've got a better cost structure and a new technology etc. Usually that's the way they transition.

A - Pirooz Pavarandeh

So I think as Tunc mentioned, many of these products are high volume products that are sold to our strategic customers. In some instances, if not all or many, those products were entry points for Maxim into a new market and therefore there were several issues, you know. We made pricing - we made mistakes with regard to the pricing. We potentially didn't have sufficient experience with regard to that class of product so we went through a learning curve on those products. To answer your question, these products are not going to drop off a cliff immediately. They have a natural lifecycle within those customers, some of them have a one-year lifecycle, some of them potentially have a shorter lifecycle. Something like within six months to a year, you're probably going to see a significant drop off in volume on those products because we're encouraging our customers to go to the next generation product. Again, just to put things in perspective, these products - some of them have turned out to be door openers for us. In other words, yes, there is a gross margin impact in the short term, but it's provided us value in the sense that we've learned from those products so that we can make the next generation better. We have been good suppliers to our customers and they value that. That's got a long-term strategic value to us. There are benefits from these things - granted that there are negatives in terms of the gross margins, but we are trying to preserve a long-term outlook from our business and trying to grow it strategically that way.

Q - David Wu, Global Crown Capital

The reason I ask this question really is that I'm sure there will always be a top-20 bad products, but those were very low margins and with your tightening in standards I assume that over time even the bad products aren't going to be as bad as this bunch. What I'm suggesting - is there a natural improvement in gross margin at the company, irrespective of all the other things that you're doing? Just by putting these products at your first batch?

A - Tunc Doluca

It absolutely helps, I don't know if you recall, but we went through this, remember, in a wireless chipset back in the beginning of last year, where we had to prune it. In that case, we were able to do it because - very quickly as a matter of fact - because it was not that strategic of a product for us. This pruning, absolutely David, is correct. It's going to help but it's going to take some time I think is what proves it.

Operator

Thank you. There are no further questions in the queue at this time. I'd like to turn the program back to our hosts for any closing remarks.

Paresh Maniar

Thank you, Operator. This concludes Maxim's conference call. We thank you for your continued participation and interest in Maxim.

Operator

Thank you, ladies and gentlemen, for your participation in today's conference. This does conclude the program, you may now disconnect. Good day.

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