Analog Devices F4Q07 (Qtr End 11/3/07) Earnings Call Transcript

Analog Devices, Inc. (ADI)

F4Q07 Earnings Call

November 27, 2007 5:00 pm ET

Executives

Maria Tagliaferro - IR

Jerald Fishman - President, CEO

Joe McDonough – VP Finance, CFO

Analysts

Steve Smigie - Raymond James

John Dryden - Charter Equity Research

Chris Danely - JP Morgan

Robert Burleson - ThinkEquity Partners

Simona Jankowski - Goldman Sachs

Romit Shah - Lehman Brothers

Sumit Dhanda - Banc of America Securities

Craig Ellis - Citigroup

Uche Orji - UBS

Mike McConnell - Pacific Crest Securities

James [Varchez] - Gillford Company

Presentation

Operator

At this time, I would like to welcome everyone to the Analog Devices fourth quarter 2007 earnings conference call. (Operator Instructions) Ms. Tagliaferro, you may begin your conference.

Maria Tagliaferro

Hello, everyone. If you don't yet have our fourth quarter 2007 release you can access it by visiting our website at www.Analog.com and clicking on the home page. This conference call is being broadcast live on the Internet also and from Analog.com. If you go to the investor relations page you can highlight the microphone icon for instructions on listening via the web. We'll also provide a recording of this call that will be available later today within about two hours of the conference call's completion and that will remain online, available via telephone or Internet playback for about a week.

Participating in today's call are Jerald Fishman, our President and CEO; and Joe McDonough, our Vice President for Finance and Chief Financial Officer. We have scheduled about 60 minutes for today's call and in a moment we'll begin with Mr. Fishman's opening remarks.

Before proceeding to that, I do have a few things I would like to clarify for folks regarding today's press release. First of all, during the fourth quarter we signed a definitive agreement with MediaTek to sell our wireless handset baseband chipset and radio transceiver business. This has been accounted for as a discontinued operation during 4Q and all prior-period financial statements have been adjusted to this basis. The transaction is expected to close during 1Q. We expect to report an after-tax gain of approximately $150 million to $160 million in the first quarter, assuming the transaction closes as contemplated in the agreement with MediaTek.

During 1Q, we signed a definitive agreement with ON Semiconductor to sell our CPU voltage regulation and PC thermal monitoring business. This will be accounted for as a discontinued operation beginning in 1Q and this has been reported with continuing operations during the fourth quarter which we're here to discuss today. We expect to report on an after-tax gain of about $52 million to $60 million in the first quarter; and again, assuming the transaction closes as contemplated in the agreement with ON Semiconductor.

In addition, in accordance with GAAP the fourth quarter results include $25 million of expense related to restructuring actions and $4.4 million related to a one-time tax adjustment related to the IRS examination for our fiscal years 2004 and 2005.

In order to provide investors with useful information regarding the financial and business trends relating to our financial conditions and results of operations, and to help our investors better understand how we manage our business, our comments during today's call will make reference to non-GAAP financial measures which exclude these two items.

It's also important to note that our non-GAAP results are adjusted only for one-time or non-recurring items. We are not excluding either stock compensation expense or amortization of acquisition-related intangible assets. These items totaled approximately $18 million or about $0.04 of diluted earnings per share during the fourth quarter. That is a change from our prior quarters when our non-GAAP results excluded these expenses.

We have included reconciliations of these non-GAAP items to their most directly comparable GAAP measures in our earnings release issued earlier today and of course, a copy of that is, as I said earlier, posted to the investor relations section of the website.

In addition, also on the investor relations section of our website we have posted eight quarters of historical data showing the effect of treating the wireless handset baseband chipset and radio transceiver operation as a discontinued operation. This worksheet also shows the reconciliation of the non-GAAP items to their most comparable GAAP measure.

In addition, please note that the information we are about to discuss includes forward-looking statements for purposes of the Safe Harbor provision under the Private Securities Litigation Reform Act of 1995. Such statements include risks and uncertainties. The company's actual results could differ materially from those discussed herein.

Factors that could contribute to such differences include, but are not limited to, those items noted and included 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, the conference call will include time-sensitive information which may be accurate only as of the date of this live broadcast which is December 27, 2007 [sic – November 27, 2007].

With that, we're ready for some opening remarks from our CEO, Jerry Fishman.

Jerry Fishman

Good afternoon to everybody. Certainly, a lot has changed at ADI during our fourth quarter and our early first quarter which creates a lot of moving pieces that may make it a little bit more complicated than usual to understand our Q4 results; and I think even more importantly, the outlook for the future, both strategically and operationally.

In my opening comments this afternoon, I'm going to try to summarize the most important actions that we've taken and more importantly, the implications of those actions going forward. Joe McDonough, our CFO, will also take you through the many charts and reconciliations that we provided with our press release this afternoon and provide as much clarity about the impact of all these changes as possible, after I finish my comments.

In my comments this afternoon, I'll also try to give you a little more color on Q4 and also discuss why we are enthusiastic about what's going to be happen at Analog during 2008. First I'll discuss the rationale and the implications of our planned divestiture of the handset radio and baseband chipset operation, and also the CPU voltage regulation and PC thermal monitoring operation.

As Maria mentioned and we reported, in September of this year we signed a definitive agreement to sell our wireless handset chipset business -- which represented about $50 million of sales in Q4 -- to MediaTek for $350 million. We're planning on an after-tax gain of $150 million to $160 million when the sale is completed. As Maria mentioned, we're going to account for this operation in Q4 in discontinued operations which provides more clarity about our continuing businesses.

The decision to divest the wireless handset radio and baseband operations positively impacted both our gross margins and our operating margins. In the fourth quarter, after accounting for discontinued operations, gross margin improved 140 basis points. Operating margins, excluding $25 million in one-time items, improved 160 basis points.

In November, we also signed a definitive agreement to sell our CPU voltage and PC thermal monitoring product lines to ON Semiconductor. The sales of those products during Q4 totaled approximately $25 million and the sale price was approximately $185 million, which includes a one-year prepaid manufacturing agreement. After accounting for the manufacturing agreement, the assets included in the sale and other costs, the deal is expected to result in an after-tax gain in Q1 of somewhere between $52 million and $60 million. In the first quarter of '08 this business will also be accounted for as a discontinued operation.

Under the manufacturing agreement, ADI is expected to manufacture these products for approximately one year. The activities associated with this manufacturing agreement will also be accounted for in discontinued operations and are expected to more or less breakeven each quarter going forward.

To give you a yardstick to measure the impact of this divestiture, we estimate that in our fourth quarter if we had excluded the CPU voltage regulation and PC thermal monitoring operation through our results as we planned to in Q1, gross margin on a GAAP basis would have reached 60% or 160 basis points higher than we reported. Excluding the $25 million restructuring charge, operating margin as a percentage of revenue would have been approximately 70 basis points higher or 23.3% of revenues from continuing operations. There'll be no material change to the diluted earnings per share.

While the financial rationale for divesting these businesses is very important and is certainly non-trivial, the improved strategic clarity this brings to our ongoing investment decisions is equally – and perhaps more -- important. As you know and as we've talked about in previous calls, we've been working to better focus ADI on opportunities that can produce high and sustainable margins, a good return on R&D investments and higher return on assets and on equity.

Despite a competitive product portfolio and a capable organization at ADI for both product areas, we believe that the investments required to grow and sustain these products were not commensurate with the returns that we at Analog could generate. By selling these businesses we provided a good path forward for our customers, a good opportunity for our employees and much better returns for our investors.

In the wireless handset market, we plan to focus our investments in products where we offer technology that is differentiated and provides stainable value to leading handset manufacturers; products that improve energy efficiency, sound quality, picture quality and the overall user experience. Our analog, non-baseband handset revenues are growing rapidly and we believe we can earn good margins by differentiating our customer's phones and the user experience.

Further, this decision has provided more clarity for our ongoing DSP business. After a strategic rebalancing and reallocation of our DSP investments, we now believe that our general purpose DSP business is correctly sized to translate the already high gross margins, which are comparable to our analog product gross margins, into accelerating operating profits for future quarters.

In power products, our refocused strategy really had three key areas. The first is part of an attach strategy to ADI's core business in high performance amplifiers and data conversion products. This market is characterized by very high margins and moderate growth rates. A portfolio of building block, high-performance power management, supervisory and monitoring components will be the mainstay of this segment of our power management strategy.

The second key area of our power management strategy is to engage closely with selected lead customers in specific markets for more application-specific power management products. We started to develop strong relationships with leading infrastructure customers, both wired and wireless. These customers will continue to push new technology development while offering relatively fast product ramps and good margins.

The third prong of our power strategy is our portable strategy which is aimed at the world's largest consumers of electronic components, the market leaders for cellular handsets and high-end consumer products such as digital cameras. Power management is a key differentiator of those products with better power systems resulting in a very noticeable user benefit of longer battery life.

ADI has a wide range of technologies being applied to the portable market with many opportunities for power products coupled with audio, with MEMS, and with data conversion products that we already produce and sell. The portable market space provides perhaps the fastest revenue ramp opportunities in the power business.

As a result of these actions, we enter 2008 with a much better balanced product portfolio capable of good growth, and also far better clarity of where to invest our R&D dollars going forward.

Now I'd like to move some of my comments to our Q4 performance where my remarks will mostly reflect the continuing operations, unless I say otherwise in my comments. I think by most measures Q4 was a very solid quarter for ADI. Revenues for our continuing operations grew 2% sequentially to $649 million and grew 6% year over year. We recorded a total of $699 million in revenues in Q4 when we included the $50 million in wireless handset radio and baseband products that we sold during the quarter.

For the full year, product revenues from continuing operations grew 7% to $2.5 billion. Our sales growth for 2007 compares favorably to industry growth rates and the growth rates of our closest competitors. In these comments, by the way, I excluded the one-time payment of $35 million that we received in Q1 for granting a license of certain intellectual property from the product revenues that we talked about to make the comparisons more suitable.

Within the fourth quarter, if you look at our revenues by end market we experienced the strongest growth from PC customers and from consumer customers. Revenues from computer customers grew 13% sequentially, which I think is in line with what most of our competitors reported as the general strength in the PC industry during Q4.

During Q4 our consumer product revenues grew 11% sequentially. We saw a very strong growth from products used in digital cameras where we continue to serve generation after generation of cameras sold by the largest market shareholders in the digital camera market. Our sales also grew sequentially in advanced TV systems where we're providing audio, video and connectivity solutions to the market share leaders in that business as well.

Audio, video receivers and digital video recorders also contributed to our growth during the fourth quarter. As a note for the year, video games showed the highest growth in our consumer business.

Revenues from our industrial customers were approximately flat sequentially in Q4. Within the industrial category, revenue growth was strongest in the automotive and defense markets and weakest in the semiconductor automatic test equipment market. Our revenues from communications customers in Q4 declined 7% sequentially. Within the communications category, wireless handset revenues from analog products increased sequentially and year to year during the quarter.

Base station revenues declined sequentially after significant growth earlier in the year. Networking revenues also declined sequentially while revenues from all other communications applications increased in Q4 compared to the prior quarter.

I think the comparisons are more useful for the full year. For the full year, industrial revenues grew 7%, communications revenues also grew 7%, consumer revenues grew 23%, computer revenues declined 17%, primarily due to our strategic decision earlier in the year to begin to transition our power management portfolio away from products used in PCs.

In Q4, our analog revenues grew 1% sequentially and represented 90% of our total revenues. Also in Q4 our DSP revenues grew approximately 7% sequentially.

For the year of 2007, our strongest revenue gains were from converter products which grew over $80 million year over year or 8% year to year and also from other analog products such as RF products and MEMS products. The category that we call other analog products also grew $80 million year to year or 27% year over year.

The gross margins for our continuing operations in Q4 were 58.4% of sales which was down 50 basis points sequentially on a comparable basis. In Q4 we recorded stronger PC and consumer product sales ahead of the holiday period, flat industrial sales and lower communications infrastructure sales. This led to a higher mix of consumer product sales, which generally have lower gross margins below the company average, and a lower mix of base station and automatic test equipment sales which generally carry gross margins that are above the company average.

Operating expenses increased very slightly during the quarter and operating margins were 22.6% of sales, which was equal to the third quarter on the same basis, meaning only continuing operations. These results now include stock option [expense] and amortization of acquisition expenses which totaled $18 million or 2.8% of our revenues and we can attribute $0.04 of diluted earnings per share to those categories in Q4. So in total, our diluted earnings from continuing operations on this basis were $0.39 for the fourth quarter.

We enter our first quarter of 2008 which began in November with backlog for continuing operations that's approximately flat to where we began Q4 and up approximately 8% from the same quarter a year ago. As a result, we're planning for our first quarter sales for continuing operations to be in the range of $610 million to $635 million, which now will exclude the power revenues and that adds up to somewhere between plus 2% and minus 2% sequentially relative to Q4.

We're planning for a more favorable mix of business in Q1 which should allow gross margins to improve slightly in Q1. Operating expenses for continuing operations are planned to decrease slightly. Therefore, we're planning for earnings from continuing operations to be in the range of $0.38 to $0.42 for the quarter. The discontinued operations are planned to more or less breakeven.

As we look ahead to 2008, we're planning for 2008 to be a good year for ADI with a better product mix and many of the ingredients in place for a very strong profit leverage as sales grow.

Our high performance analog performance portfolio, which now represents 90% of our revenues, is in very good shape. The high performance analog market remains one of the best product categories in the semiconductor industry in which to invest and our plan is to continue to invest in areas where we have very high market share, which are amplifiers and converters. These two product categories now represent 66% of our sales, provide an attractive blend to steady growing, long life cycle products and also products that offer compelling technology to very fast-growing markets like digital TVs, communications and medical electronics, just to mention a few of those markets. Our market share in these product categories has been growing over the last several years and our brand is very strong in virtually every region of the world.

As we talked about on earlier calls, we decided in 2007 to significantly raise our investment levels in new analog product categories to raise our growth rate in these products going forward. We added investments in RF technology, primarily aimed at telecommunications infrastructure, where we already sell many other analog products to the leading manufacturers of infrastructure in the U.S., Europe and Asia. We added significant investments in power management which is a very fragmented analog product category, and which we described what our strategy is in that business in some of my earlier comments.

We added investment to the low power converters to support our portable consumer product strategy. Finally, we substantially raised investment levels in MEMS products where we believe the market is experiencing an inflection point in growth as many new application are developing at new cost points. We've already begun to see results on these investments and these products should continue as growth drivers in 2008. We're also poised for very strong operating leverage as revenues increase.

Our profit margins in 2007 were impacted by a number of factors: slower overall industry growth that we all forecasted in the beginning of the year, a higher mix of consumer products, slower industrial market growth after three years of above trend growth, ADI's decision to reduce our inventories for its model levels and our decision to stick with our plan to raise investment levels in our analog business to capture future growth opportunities, despite the fact that industry growth cooled off in the second half of the year.

As we look at 2008, we believe we have margin tailwinds as compared to 2007 headwinds. In 2008, our product portfolio includes a richer mix of faster growing, high margin products. Additionally, by mid 2008 we expect to be in volume production of consumer MEMS products in Asia which will allow significantly lower cost and much more scalability than products currently being built in a relatively small fab here in Boston.

Our inventories are now approaching model levels which will remove the gross margin drag that we experienced from inventory reductions in 2007. We've also taken actions to reduce the cost of our manufacturing infrastructure. We've closed our fabs in California and we are focusing our fabs in Ireland on 8-inch wafers only and we'll be closing our 6-inch lines in Ireland by mid-2009.

Earnings per share leverage comes from both a richer product portfolio and also our buyback program. To accelerate the growth rate of earnings, we bought back nearly 20% of our shares outstanding over the past three years, providing earnings leverage as sales and profits grow. We finance these purchases from our very strong cash flow and also from reductions in our excess cash.

In summary, ADI begins 2008 in a very strong position. Over the past few years we took actions that provide a lot of leverage. We increased our investment in analog products. We divested two businesses at the right time for our stockholders, our employees and our customers and we bought back over 25% of our shares outstanding. These actions were intended to provide very good sales growth while sustaining 60 points of gross margin.

Our plan for 2008 is to constrain spending to approximately half the growth rate of our sales, which positions ADI to grow earnings per share as much or as fast as twice the growth rate of our sales.

With that, I'll turn the conversation over to Joe who's going to make a few comments about all the complexities that we included in our press release.

Joe McDonough

As Maria and Jerry have mentioned, we had a number of non-recurring events this quarter; therefore, we provided a lot of information in our press release to help investors understand both these events and the results of operations. We've also posted, as Maria said, a schedule on our investor relations portion of our website, Analog.com, to provide additional help.

I'll take just a few moments to step through the information which is attached to our press release. After the written description of our results, you'll find several tables labeled schedules A to H. Schedule A is the GAAP income statement. In 4Q, the wireless handset baseband chipset and radio transceiver operation is shown on a single line, net income from discontinued operations. This is an after-tax reporting. During 4Q, we generated $1.5 million of net income from this operation. During the full fiscal year 2007, this operation incurred a loss of $3.8 million. It generated $33 million of net income during fiscal year 2006.

Earnings per share are also split between continuing operations and total ADI. The wireless handset chipset operation had little impact on earnings per share in 2007 and contributed about $0.09 of diluted earnings per share in 2006. A more detailed P&L for this discontinued business is shown on schedule B and a worksheet is included on our website, Analog.com, reconciling these items.

Since the definitive agreement for the sale of the CPU voltage regulation and PC thermal monitoring business was finalized during 1Q, this operation will be treated as a discontinued operation in 1Q. It is included in continuing operations during 4Q. As mentioned, stock-based compensation is no longer being excluded in calculating non-GAAP measures. These amounts are shown on schedule A as footnote 1.

On schedule C, we provide balance sheet data. Assets and liabilities related to the discontinued wireless handset chipset operations are classified on separate lines. Since the products in our wireless handset chipset operations are all manufactured externally, the assets are primarily accounts receivable and inventory.

The balance sheet remains strong, even after repurchasing over $3 billion of stock over the last three years. We ended the year a cash and short-term investment balance of approximately $1.1 billion and no debt. Days cost in inventory declined to 118 days in 4Q from 133 days a year ago. Days sales and accounts receivable were 47 days in 4Q, an increase of one day from a year ago.

Schedule D is the cash flow statement. As a percent of revenue, net cash provided by operating activities continued strong during 4Q at 28% of sales. For the year, we paid $228 million in dividends and bought back $1.6 billion of stock. Our dividend yield is 2.3% at current stock prices.

Schedules E and F provide the revenue trends by end market and by product. These have been commented on in both the press release and during Jerry's comments. A year ago we instituted this detailed quarterly breakdown of our sales to give our investors insight into the performance for our business.

On schedule G we reconcile the GAAP to non-GAAP measures. We no longer exclude stock-based compensation or amortization of acquisition-related intangibles which totaled approximately $18 million in 4Q from our non-GAAP measures. Only one-time or non-recurring gains or expenses are excluded. In 1Q08 the gains from the closing of the planned divestitures will be excluded from our non-GAAP measures.

The final schedule is schedule H, which outlines guidance for 1Q of fiscal year '08. We're giving guidance for 1Q based on continuing operations which I remind you will exclude the planned divestiture of the CPU voltage regulation and PC thermal monitoring business. Therefore, on this schedule we provide information to help investors establish a comparable basis from the 4Q results to the 1Q guidance.

Now we're ready for questions.

Maria Tagliaferro

During today's Q&A period, please limit yourself to one primary question and no more than one follow-on question. We'll give you an opportunity to ask additional questions if we have time remaining for a second round.

Operator, we're now ready for questions from our analyst participants.

Question-and-Answer Session

Operator

Your first question comes from Steve Smigie - Raymond James.

Steve Smigie - Raymond James

A lot of moving pieces here. On the success of some of the growth in the quarter, I was hoping you could talk a little bit about the major drivers in consumer? Also, if you could talk a little bit about the factory that's going to be available for the MEMS production?

Jerry Fishman

In the consumer business, there's a couple of different segments, all of which experienced pretty good growth. We've enjoyed a very strong position in the camera business for many years and we're fortunate to have a very high share of the largest shareholders in the camera business. So that business continued to grow for us.

We have a growing presence in the TV business, both in plasma and flat panel and we have products going to audio, video and some of the connectivity features that these types of TVs have. We have very strong relationships in that business also with very large shareholders in that business, particularly in the mid to high end of that business.

Of course, we have a very good position in the game business. Right now in Q4 that business was mostly capped by our capacity and will remain so for the next quarter or two but certainly the demand for those products was pretty good into Q4.

So it was a fairly broad-based increase in products with some very good customers that are selling extremely well.

Steve Smigie - Raymond James

Can you talk a little bit about the transition to the new facility for MEMS?

Jerry Fishman

We began that process around four or five months ago and as of the last look at that it was right on schedule.

Steve Smigie - Raymond James

When would we expect to see that fully ramped?

Jerry Fishman

I think some time in the middle of the year we should begin to see output from that.

Operator

Your next question comes from the line of John Dryden - Charter Equity Research.

John Dryden - Charter Equity Research

Jerry, the markets were very uncertain this time last quarter on your call, like they have been the last month. Can you comment on how orders have changed versus just last quarter, particularly in your two largest end markets?

Jerry Fishman

I think the order rates were good most of the quarter and we saw good ordering patterns from the market segments we mentioned. In the industrial business the revenues were flat; they were up in some areas, down in some others. Broadly, I think the markets behaved pretty much the way we thought they would and we didn't see a lot of evidence of any real contraction in any of the end markets for the quarter. When we really looked at it relative to what we had thought for the quarter, it came out about the way we thought.

John Dryden - Charter Equity Research

You talked about having a tailwind for earnings going into FY08. Could you comment on specifically low power converters and power management with respect to revenue opportunities above your growth in expenses in those two areas?

Jerry Fishman

The way to think about next year and the way we're thinking about next year is we have a core business that's the horizontal business that we talk about which has shown very good growth over the last couple of years. You can see that when you look at some of the product category data that's on the website. There have been a lot of press releases that we put out over the last couple of quarters.

A very tough year last year; our converter business grew 8% which is a pretty number and the amplifier business grew about 5%. The industrial market over the last couple of years has grown at a very good clip. We have a core business which grows pretty well on average; some years a little bit more than others if there's an economic headwind or tailwind, but that's the core.

I think one of the things that we're excited about for 2008 is we really upped the investment levels over the last year or two in the analog business. As I mentioned, we invested a lot of money in RF technology and low power converters for portable consumer applications and a few others. The plans that we have in place for 2008 indicate those investments, we have good expectations for on top of the base line.

So this year is a little unique, I think, compared to some previous years in that if the base line stays healthy -- time will tell how the economy treats all those products -- but assuming that we don't get at least a headwind on those products, I think the other stuff should accelerate the growth rate. That's why we're pretty enthusiastic about the growth rate that we can achieve in 2008.

Operator

Your next question comes from Chris Danely – JP Morgan.

Chris Danely – JP Morgan

Can you talk about how you expect your gross margins and operating margins to trend after fiscal Q1 and what the drivers will be there?

Joe McDonough

If you look at the gross margins and the mix of business that we have this quarter, as Jerry mentioned, we had a very strong growth in the consumer business and we had a strong growth in the computer business and a decline in the base station and automatic test equipment business. As Jerry mentioned, the base station and the automatic test equipment business are products that tend to have gross margins that are above the company average; the consumer and the computer business have gross margins that are below the company average.

We had a mix of business this quarter that dragged the gross margin, really, more than the 0.5 point decline that shows up in the financial statements. I think some of the result of what was actually a stronger gross margin than we might have expected with that mix of business was a result of some of the cost actions that we've taken over the years; we're seeing some of the benefit of that. We would expect to see that as we go through the year next year. We also would expect to see the mix of business shift back into a more favorable direction as we go through the year.

The industrial business has been flat for some time. We would expect to see that start to grow. We think that there is more of, as Jerry calls it, a tailwind on the gross margin from the mix of business. We had a headwind and we have a tailwind going forward and so that should help the gross margin. Then as we get into 2009 we should start to see the benefit of the Ireland manufacturing facility which is part of the restructuring charges.

We're transferring the production there from our 6-inch line to our 8-inch line. That will happen during the second quarter of '09. Looking forward, we're starting off with a gross margin that is 60% in the fourth quarter if you subtract out the portion of the power business that we plan to sell during 1Q and that's on a GAAP basis.

We think that there is some upward opportunity on the gross margin. I think we shouldn't get carried away with thinking that we can run a business that's significantly above 60% but there certainly is some upward potential there.

As Jerry mentioned, we're also planning to hold the growth of operating expenses to half the growth rate of sales. That has the potential to grow the earnings at twice the rate of sales growth as we go forward.

Chris Danely – JP Morgan

As my follow-up, how do we think about the current mix of business? Are you guys looking at other product lines to rationalize or jettison or are we pretty comfortable with the current mix of business right now?

Jerry Fishman

We always look at a business and decide whether they're good or bad for us over a long period of time. I think right now we're relatively happy with the portfolio we have.

Operator

Your next question comes from Robert Burleson - ThinkEquity Partners.

Robert Burleson - ThinkEquity Partners

On your distribution business are you guys seeing any changes in your orders that you're receiving from your distributors that indicate any kind of increasing or weakening confidence level on their part?

Jerry Fishman

I don't think so. It bounces around week to week and so on, but I think it came out about the way we thought. Our revenues, as you know, don't reflect what's going on with distribution inventories. Our sense is at least in the comments that we got from our sales guys is that the inventories look like they are in reasonable balance and the orders seem to be reflecting end demand and we didn't see any major trends one way or the other during the quarter on that.

Robert Burleson - ThinkEquity Partners

So is your sense that if it isn't the end of the world and we are going to see normal seasonality and steady levels of demand, that distributors would need to maybe build a little bit of inventory here, at least hold it flat?

Jerry Fishman

I can't tell what they'll do for the universe of semiconductor companies, but I think the inventories seem to be in reasonably good balance. I mean, they are being cautious because they don’t know what's going to go on either in the future, but I don't see there's any large disconnect at least for our products, between what their demands on us is and what the demand of their customers is on them.

Robert Burleson - ThinkEquity Partners

As we look at the different end markets going into this, I guess calendar Q4 or a fiscal Q1 for you guys, is there any kind of a change that you are seeing on the communications infrastructure front? Any kind of firming you are seeing there? Also automated test equipment, is there any kind of firming that you would expect in those end markets?

Jerry Fishman

I think in the infrastructure market, there were a lot of build outs of infrastructure equipment in the first half of the year and it tailed off in the second half of the year, given the above trend numbers that we experienced at least in the first half of the year.

The conversations we've had with those customers indicate that they are expecting 2008 to be a good year. They did make some inventory adjustments particularly towards the end of the year which is why our sales from those customers in Q4 were down quite a bit.

I don't think there's anything generically that's going on with those customers that's a bad thing. They bought a lot in the first half, they didn't buy a lot in the second half. I think those are just normal buying patterns and what happens in the infrastructure market. We don't see anything remarkable there one way or the other. It's been a strong business for us. It's a very important business for us. We have a large part of the analog content and base stations in Europe and Asia and America. I think we are in good shape there and I think as the call volumes keep going up and people keep deploying new infrastructure that business should do well.

Robert Burleson - ThinkEquity Partners

And on testers?

Jerry Fishman

Testers have been weak. I think that's not news to anybody, if you look at the comments that the test equipment companies have made. I think that business will go as the semiconductor business goes next year. If the semiconductor business starts picking up I think the ATE business turns on a dime in that; they go from feast to famine very quickly, as they did last quarter.

We will have to see how that goes. Again, I think our position in that business is good. The customer base we have is solid but I think that business swings with a lot of volatility. Certainly last quarter it swung negative. In the future we will have to wait and see how that goes.

Operator

Your next question comes from the line of Simona Jankowski - Goldman Sachs.

Simona Jankowski - Goldman Sachs

Jerry, I think you mentioned that the linearity of your orders looked pretty good during the October quarter. Can you give us a sense of how orders have been so far in November?

Jerry Fishman

I think -- there are no anomalies in here, let’s just say. We don't report our results for the first couple of weeks because it's very hard to extrapolate that into the future. We haven't seen any anomalies in the order rates at all, one way or the other.

Simona Jankowski - Goldman Sachs

I think when you talked about your gross margin for the quarter that just ended you were saying that if did you not include the CPU power management business it would have been about 60%, which is what you were guiding for next quarter as well. So it seems that your expectation is for margins is to be flat, but it seems that you're going to have a better mix next quarter. What's offsetting that?

Joe McDonough

The guidance for next quarter on schedule H in the financial statements is for gross margins for continuing operations to be slightly above 60%.

Operator

Your next question comes from Romit Shah - Lehman Brothers.

Romit Shah - Lehman Brothers

As I look back historically, the January quarter has been one that in good years it is up and in bad years it is down. Can you comment on the backlog entering the quarter? It is flat for the continuing operations. Can you give your perspective on that, please?

Jerry Fishman

I think the seasonality of our business changes with the economy, no doubt. Typically we see the consumer products have a very good build up in Q4 and they go soft in Q1. Whether that happens this year I think will partially depend on what happens at Best Buy over the next couple of weeks, so that's very hard to tell.

Typically we see in our Q1 the industrial business getting a little bit better, particularly in January. So it's really mixed seasonality. We don't really see when you look at the mix of business we have, profound seasonality quarter to quarter anymore. The only quarter that we really see usually very strong seasonality is our Q2. But the other quarters bounce around a little bit a couple of percent and I don't think there's anything more than what you said earlier, good quarters in good economic times; in bad economic times, they're not so good. But I don't think we have the same seasonality given the mix of business that we had many, many years ago.

Romit Shah - Lehman Brothers

It sounds like your perspective on inventories is that the channel and your OEM customers are carrying a low level of supply of ADI parts. Does that give you a lot of comfort that ADI is probably not going to see a sharp downtick in their business next year?

Jerry Fishman

As we look at the business, we go through our planning process like everybody does before the year begins. We went through a pretty extensive planning process in October to try to understand from our sales guys, who are the guys out there calling on the accounts, and our product people who are the guys that have to make these decisions. The numbers converged on a good growth number for next year.

That's an indication that integrates what the customers are saying, what the sales guys think, what the marketing guys think. And I think, as I described earlier, it is a mixture that the base should do okay and some of the other areas should give us a little bit of a growth kick next year. I think those two things are making our field guys feel okay going into the year. We'll just have to wait and see how the year unfolds.

Romit Shah - Lehman Brothers

Your view is that whatever's going on with the overall macro environment you guys have yet to see that impact; at least in your customers’ willingness to order components?

Jerry Fishman

There's always ups and downs each quarter based on things that happen in each market or each geography. When you add it all up, we haven't seen much of an effect of that at all.

Operator

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

Sumit Dhanda - Banc of America Securities

Joe, OpEx down slightly in the January quarter, is this more a function of just product tightening in your existing base business or is there benefit associated with the divestitures and will that continue to percolate through the model in the upcoming quarters? If that's the case, can you quantify some of that benefit?

Joe McDonough

The $25 million restructuring charge that we took this quarter was comprised of $14 million related to the transfer of production to Ireland's from the 6-inch line to the 8-inch line. As I mentioned, the benefits of that are out in 2009.

The other $11 million was related to infrastructure in all different parts of our business -- selling, marketing, G&A, engineering, cost of sales -- and that is related to the fact that we have divestiture of the handset business or the baseband business planned for the first quarter. The benefits of that come some in the first quarter and some during the second quarter.

Sumit Dhanda - Banc of America Securities

So in effect, your lower OpEx guidance for Q1 is reflecting that benefit as opposed to anything else?

Joe McDonough

Yes. You asked a question about how will that continue during the year? As we mentioned, our plan is to hold the growth of operating expenses to half the growth rate of sales. When we're talking about operating expenses, we're talking about the engineering, selling, marketing and G&A. Most of the restructuring that we did is in the overhead categories and that shows up as benefits in the first and second quarter.

During the second quarter, that typically is seasonally a good quarter for us. It's also the quarter when we have our annual raise cycle comes into effect in the beginning of the second quarter so that's a quarter that seasonally, typically has a pick up in revenues and an increase in expenses related to the annual raise cycle.

As the year goes on, we don't have any more of those events such as an annual raise cycle and we do have a plan to, as Jerry said, we think 2008 should be a decent year and so we do have a plan to grow the operating expenses during the year in response to the sales growth but are trying to limit that growth to half the growth rate of the sales.

Sumit Dhanda - Banc of America Securities

I'm assuming that there's not much meaningful savings from the divestiture of the CPU power business? Or is that also incorporated in this outlook that you gave for operating expenses for 2008?

Joe McDonough

Yes, the savings from the Limerick manufacturing facility are all cost of sales related. I think it's important to make it clear that the power products that are being sold to ON Semiconductor, part of that planned transaction is a one-year prepaid manufacturing agreement. Those products are manufactured in that same Limerick, Ireland fab on the 6-inch line that we plan to shut down around 2Q of '09.

The manufacturing of those products, if it all goes according to plan, will stop; the manufacturing of the products for ON Semiconductor will stop and we'll gain the benefits of the cost that we were incurring in manufacturing those products.

Sumit Dhanda - Banc of America Securities

You've guided gross margins slightly higher than 60% based on better mix. Your inventories are where you want them to be at. My recollection is last quarter you thought that you would start to rebuild some inventory in the January quarter. Is that still the plan? If that's the case, is there some benefit associated with the gross margins that we should be thinking about?

Joe McDonough

The plan for the first quarter is for inventories to be roughly flat to maybe down a little bit. We're still a little bit above our model for inventories, but not much. We've converged on our goal. 1Q tends to be a quarter that we do have the holiday season there and that does affect output, typically in the factories, during the holidays. Typically 1Q is a quarter where the manufacturing output is seasonally off a little bit and so that has a little bit of a drag on the gross margins.

On the other hand, we have a pick up, we think, from the mix and we probably have a little bit of a benefit as you say from the fact that we're getting close to our inventory goal.

Operator

Your next question comes from Craig Ellis - Citigroup.

Craig Ellis - Citigroup

Jerry, can you just talk about how much potential there is to pare back or to really streamline the business now that you've made the desktop power announcement with ON?

Jerry Fishman

That announcement is really trying to focus the power business on the places where we think we can make returns that are commensurate with our model for that business. So as you do those things, I think Joe mentioned a little earlier, you look around for that business was absorbing overhead in addition to their direct expenses. Of course, the direct expenses go to ON.

We've taken the opportunity over the last couple of months as we are preparing for these divestitures to reduce the infrastructure costs on the company and that's part of that restructuring reserve that Joe mentioned earlier.

I think what we've really done here, Craig, is we've built ourselves into a cost position and a model where when the revenues start to go up or continue to up and the gross margin stabilizes, as Joe was saying, maybe gets a little bit better through the year at 60 or slightly higher and we constrain the operating expenses substantially relative to the sales growth, if you go through the math, the operating margins move up at a pretty good clip towards the kind of model numbers that we've talked about for quite a while for the business.

That's what we're trying to do. I mean, all the actions we took last year from the handset business to the power products to being very aggressive purchasers of our stock are all geared towards getting the operating margins towards our model numbers and I think we made some good steps on that. If the world doesn't fall apart on us during the year and we get the kind of growth we think, I think we'll make a lot of progress on that in 2008.

That's what we've been trying to do, that's what we've been working on pretty hard for the last year and that's what our plan is for 2008. That's probably the best guidance I can give you on that.

Craig Ellis - Citigroup

It sounds, if I'm hearing you correctly, there are not other businesses that are meaningful that you might be able to pare out. But it does sound like you think you can get into your target operating range by the end of the coming fiscal year.

Jerry Fishman

I'd say that we'll certainly make a lot of progress towards that. It'll depend on what the sales growth rate is for the year. We'll have to see how that unfolds but we can make meaningful progress on that at the kind of rates Joe was talking about each quarter as the revenues grow. Whether we get to that target in Q4, we get to it in 2009 if the revenue growth rates get lower, time will tell.

But we now for the first time --and it's important to say that -- have visibility on how to get there, given that the gap was very large last quarter and that rattled a lot of people. How do you ever get to where you getting to with where you are? I think we've got part of the way there with these moves that we've made and we see our way clear to getting the rest of the way there with what's going to happen in 2008.

So I mentioned earlier that we have now a good mix of products. I think Joe mentioned earlier that that mix is now creating 60 points or so of GAAP gross margins which includes stock option expenses. I think now one of the objectives that becomes very important is to make sure we get the revenue growth here, too.

Joe McDonough

Let me just clarify the target. We've talked in the past about 30% operating margin and that has not included the stock option expense or the amortization of these acquisition intangibles. So we've just absorbed 2.8%, I think, of sales. I think it's reasonable to think in terms of the first step we've got to get to is about 27.5% which correlates to the 30% we talked about in the past.

But the second point is that we've always talked about the growth of earnings per share as our principal objective and the margins as just a means to that end. As we've commented, we think that we have a mechanism to grow the revenues and grow the earnings close to twice as fast as the sales.

The third point that I think is important is in the process of looking at the balance sheet and buying back the stock, we also have focused on the return on equity that we have from the business. I think if you were to look back into 2006, you'd find that our return on equity was something in the 15% range; it's moving up more in the 20% range today and as we go forward, we can see 30% return on equity.

We find the margin just a means to these other ends but it's the growth in the earnings per share and the return that we can get on the equity that we've got in the company that are the principal financial goals.

Craig Ellis - Citigroup

On the last call I think one of the issues the company identified was some constraints on the MEMS manufacturing site. What's the status of MEMS manufacturing and the port over to TSMC?

Jerry Fishman

I think somebody asked that a little earlier. The program is on track. We're still constrained, of course, as we said we would be on the upside right now, but I think as we get out to mid 2008, if it continues to go as well as it's been going, I think we should be in good shape.

Craig Ellis - Citigroup

Lastly, I was surprised with the year-on-year change in the amplifier business. I thought that would be a grower for you; it wasn't. Anything in particular that accounts for the decline that we saw?

Jerry Fishman

Well, it was up 5% year to year. I mean, in a market like we experienced, particularly in the second half of the year, that's not a number that's bad. We're in a business that was up 8% for the full year. Those are numbers that in a market that existed last year and look at the competitive numbers that the competitors have posted, it's a pretty attractive number.

Operator

Your next question comes from Uche Orji - UBS.

Uche Orji - UBS

Jerry, let me just ask you about your sense of the pressure you may be facing from competition around your core business of converters and amplifiers. Given that you've divested the non-core businesses, how have you been able to respond to some of the comments we've heard about competition in converters?

If you can just talk to us about your positioning in this market and your ability to sustain the market leadership position that would be helpful.

Jerry Fishman

Certainly there's competition out there. It's a large product category. It's probably the single most important product category in the analog business and it turns out the only product category that one manufacturer has very significant market share. If you look at amplifiers, you look at power management or any of those product categories you see the market share being a lot more fragmented.

So given that the market is more concentrated with ADI representing such a large part of the market, it's not surprising that we're going to have competition. I think when we look at all the statistics and we visit all the customers, I mean the key to that business is still innovation. We got great some people in the company that for 30 years have been innovating in the converter business and our job is to stay ahead of all the other guys out there. That's challenging work. We have good competitors that are trying to design products like that. Our job is to stay ahead of them and I think we're doing a good job of doing it.

Uche Orji - UBS

On the MEMS you still talk about being constrained. It looks like that would not be for another couple of quarters that we would start to see products out of Asia.

Jerry Fishman

Yes.

Uche Orji - UBS

Within the customers you have in MEMS, are you still the sole supplier to the main controller for the Wii? Do you think business, given the constraints you're facing, they have gone to somebody else? Are you sharing that main controller business with somebody else, given these constraints you're facing?

Jerry Fishman

We have a very strong position with Nintendo on those products. We have a very good road map going forward with Nintendo and I think other than that, I'm not going to comment on what Nintendo's sourcing strategy is.

Uche Orji - UBS

Joe, if you can talk about in terms of the turns business you require in terms of your guidance, is it within the normal range of turns business you require or would it be slightly higher this quarter?

Joe McDonough

No, it should be basically the same which is a reasonable level of turns. We're entering the quarter with the same level of backlog on the continuing businesses.

Operator

Your next question comes from John Dryden - Charter Equity Research.

John Dryden - Charter Equity Research

Joe, could you comment on future buybacks, a comfort level for working capital versus your current $1.1 billion cash, given the $200 million after-tax coming in the January quarter and greater than $150 million free cash flow?

Joe McDonough

I can't comment on the buyback program in the future. We do have $600 million of remaining authorization. We have, I think, a track record of pretty substantial purchases. We do run a program and we put that program in place and keep it in place. That's about all I can really say.

Operator

Your next question comes from Mike McConnell - Pacific Crest.

Mike McConnell - Pacific Crest Securities

Joe, could you just quantify the backlog [inaudible]?

Joe McDonough

All of our systems that track sales backlog and quarters are for the entire business which includes the discontinued operations and so it's been a challenge here to pull the pieces apart to report them the way that we need to. I don't think our 10-K will have any backlog reporting for the continuing business that we'll have in 1Q, so I really am hesitant to comment on that other than to say the backlog is flat quarter to quarter.

There's nothing unusual about our backlog. As we have said in prior quarters, there's not a lot of meaningful information in it because our backlog includes the orders we receive from our distributors. It does not include the orders they get from their customers which are what drive our revenue recognition, when they ship product out to their customers.

Our OEM customers, some place backlog and some place forecasts. So the most meaningful information is that there's not too much of a change that has happened quarter to quarter.

Maria Tagliaferro

Just to clarify, that's no change when we take a look at the continuing operations that'll exist in 1Q. So we have looked at it without the wireless handset and without the CPU voltage regulation businesses.

Mike McConnell - Pacific Crest Securities

But then for our purposes for estimating, we should just assume the same amount of turns requirement?

Joe McDonough

Yes, that's right. That's why we tried to give a range on the revenues of plus 2%, minus 2% for the continuing operations.

Mike McConnell - Pacific Crest Securities

Those turns requirements are somewhere in the mid 30s? Is that correct?

Joe McDonough

I think it's more in the low 40s is what it was this quarter, and that's fairly typical.

Mike McConnell - Pacific Crest Securities

Book-to-bill, what was that in the quarter?

Joe McDonough

Well, it's pretty close to one.

Maria Tagliaferro

I think we've gotten through the message queue. If there's anyone else that missed the second round of questions and wanted to go into the queue again, you can press star one to do that now, otherwise it looks like we're completed.

Operator, is anybody else in the queue for us here?

Operator

Your next question comes from James Varchez – Gillford Company.

James Varchez - Gillford Company

Looking at your industrial end market, the industrial economy domestically has been very strong, internationally very strong. Could you explain where the disconnect occurs between that observation and your experience in your industrial business last year?

Joe McDonough

Well, I think if you look at it over a couple of years in the industrial business, the industrial business grew at very significant rates for a couple of years and I think a couple of the product categories in the industrial business were slower during 2007 than they were in 2006. But I think it's important to realize they grew 7% year over year, which for the industrial business is a very good business.

There were a couple of years where it grew 15% which I think is a little bit more atypical. There's a lot of different segments in there that move in different directions. But if the industrial business for analog devices grows at 7% or 8% a year for the next couple of years, we'll be in very, very good shape. If it grows higher we'll be in even better shape.

So there's actually nothing wrong with a 7% growth in industrial products after a couple of years that we experienced. That's a good result, not a bad result.

James Varchez - Gillford Company

Did I understand your comments, though, that you expect stronger industrial growth in '08 than in '07?

Jerry Fishman

Well, in '08, even though it sort of flattened out through most of the year, I think all the feedback we get in the absence of a big recession or other things that can impact us substantially is that we ought to start seeing some growth in Q1 and certainly into Q2.

Maria Tagliaferro

It's worth clarifying also that this industrial group is a very fragmented group of applications across things that include for ADI, certainly, instrumentation that you find in factory automation, process control, medical imaging, the automotive market we include in our industrial numbers, the automatic test equipment market that serves the semiconductor industry, defense applications, aerospace applications, so all that goes into what we describe as our industrial group.

James Varchez - Gillford Company

Many of which had a very strong year.

Jerry Fishman

Yes.

Maria Tagliaferro

Absolutely.

Jerry Fishman

I think that was reflected in our numbers.

James Varchez - Gillford Company

As a second question, I hear a lot about Rich Tech as being an emerging or stronger competitor, rapid sales growth. Could you characterize their nature as a competitor of yours?

Jerry Fishman

I think exiting the power and PC business makes us a lot less of a direct competitor with Rich Tech than three months ago. I mean we've seen a lot of concentration of companies like Rich Tech in the motherboard PC business, and that's a business that we're divesting because it doesn't fit in our product mix as well.

Asian companies are always a competitive risk. They tend, so far at least, to be mostly in the segments that are single product, very high volume that are very closely aligned with manufacturers in that region; for example, the motherboard manufacturers in Taiwan. So that's a business that is less relevant to us than it was a few months ago.

Maria Tagliaferro

I think that was our last question. I want to thank everyone for joining our call today and we look forward to speaking with you again at the end of our first quarter 2008 earnings. Thanks again, everybody.

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