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Analog Devices, Inc. (NASDAQ: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 AmericaSecurities

Craig Ellis - Citigroup

Uche Orji - UBS

Mike McConnell - Pacific Crest Securities

James [Varchez] - Gillford Company

Operator

At this time, I would like to welcome everyone to the AnalogDevices 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 byvisiting our website at www.Analog.com and clicking on the home page. Thisconference 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 iconfor instructions on listening via the web. We'll also provide a recording ofthis call that will be available later today within about two hours of theconference call's completion and that will remain online, available via telephoneor Internet playback for about a week.

Participating in today's call are Jerald Fishman, ourPresident and CEO; and Joe McDonough, our Vice President for Finance and ChiefFinancial Officer. We have scheduledabout 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 wouldlike to clarify for folks regarding today's press release. First of all, duringthe fourth quarter we signed a definitive agreement with MediaTek to sell ourwireless handset baseband chipset and radio transceiver business. This has beenaccounted for as a discontinued operation during 4Q and all prior-periodfinancial statements have been adjusted to this basis. The transaction isexpected to close during 1Q. We expect to report an after-tax gain ofapproximately $150 million to $160 million in the first quarter, assuming thetransaction closes as contemplated in the agreement with MediaTek.

During 1Q, we signed a definitive agreement with ONSemiconductor to sell our CPU voltage regulation and PC thermal monitoringbusiness. This will be accounted for as a discontinued operation beginning in1Q and this has been reported with continuing operations during the fourthquarter which we're here to discuss today. We expect to report on an after-taxgain of about $52 million to $60 million in the first quarter; and again,assuming the transaction closes as contemplated in the agreement with ONSemiconductor.

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

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

It's also important to note that our non-GAAP results areadjusted only for one-time or non-recurring items. We are not excluding eitherstock compensation expense or amortization of acquisition-related intangibleassets. These items totaled approximately $18 million or about $0.04 of dilutedearnings per share during the fourth quarter. That is a change from our priorquarters when our non-GAAP results excluded these expenses.

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

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

In addition, please note that the information we are aboutto discuss includes forward-looking statements for purposes of the Safe Harbor provision under the PrivateSecurities Litigation Reform Act of 1995. Such statements include risks anduncertainties. The company's actual results could differ materially from thosediscussed herein.

Factors that could contribute to such differences include,but are not limited to, those items noted and included in the company's SECfilings, including our most recent quarterly report on Form 10-Q.

The forward-looking information that is provided by the companyin this call represents the company's outlook as of today and we do notundertake any obligation to update the forward-looking statements made by us. Subsequentevents and developments may cause the company's outlook to change; therefore,the conference call will include time-sensitive information which may beaccurate 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 ourCEO, Jerry Fishman.

Jerry Fishman

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

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

In my comments this afternoon, I'll also try to give you alittle more color on Q4 and also discuss why we are enthusiastic about what'sgoing to be happen at Analog during 2008. First I'll discuss the rationale andthe implications of our planned divestiture of the handset radio and basebandchipset operation, and also the CPU voltage regulation and PC thermalmonitoring operation.

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

The decision to divest the wireless handset radio andbaseband operations positively impacted both our gross margins and ouroperating margins. In the fourth quarter, after accounting for discontinuedoperations, 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 sellour CPU voltage and PC thermal monitoring product lines to ON Semiconductor.The sales of those products during Q4 totaled approximately $25 million and thesale price was approximately $185 million, which includes a one-year prepaidmanufacturing agreement. After accounting for the manufacturing agreement, theassets included in the sale and other costs, the deal is expected to result inan after-tax gain in Q1 of somewhere between $52 million and $60 million. Inthe first quarter of '08 this business will also be accounted for as adiscontinued operation.

Under the manufacturing agreement, ADI is expected tomanufacture these products for approximately one year. The activitiesassociated with this manufacturing agreement will also be accounted for indiscontinued operations and are expected to more or less breakeven each quartergoing forward.

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

While the financial rationale for divesting these businessesis very important and is certainly non-trivial, the improved strategic claritythis 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'vebeen working to better focus ADI on opportunities that can produce high andsustainable margins, a good return on R&D investments and higher return onassets and on equity.

Despite a competitive product portfolio and a capableorganization at ADI for both product areas, we believe that the investmentsrequired to grow and sustain these products were not commensurate with thereturns that we at Analog could generate. By selling these businesses we provideda good path forward for our customers, a good opportunity for our employees andmuch better returns for our investors.

In the wireless handset market, we plan to focus ourinvestments in products where we offer technology that is differentiated and providesstainable value to leading handset manufacturers; products that improve energyefficiency, sound quality, picture quality and the overall user experience. Ouranalog, non-baseband handset revenues are growing rapidly and we believe we canearn good margins by differentiating our customer's phones and the userexperience.

Further, this decision has provided more clarity for ourongoing DSP business. After a strategic rebalancing and reallocation of our DSPinvestments, we now believe that our general purpose DSP business is correctlysized to translate the already high gross margins, which are comparable to ouranalog product gross margins, into accelerating operating profits for futurequarters.

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

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

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

ADI has a wide range of technologies being applied to theportable 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 rampopportunities in the power business.

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

Now I'd like to move some of my comments to our Q4performance where my remarks will mostly reflect the continuing operations,unless I say otherwise in my comments. I think by most measures Q4 was a verysolid 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 wirelesshandset radio and baseband products that we sold during the quarter.

For the full year, product revenues from continuingoperations grew 7% to $2.5 billion. Our sales growth for 2007 comparesfavorably to industry growth rates and the growth rates of our closestcompetitors. 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 intellectualproperty from the product revenues that we talked about to make the comparisonsmore suitable.

Within the fourth quarter, if you look at our revenues byend market we experienced the strongest growth from PC customers and fromconsumer customers. Revenues from computer customers grew 13% sequentially,which I think is in line with what most of our competitors reported as the generalstrength 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 cameraswhere we continue to serve generation after generation of cameras sold by thelargest market shareholders in the digital camera market. Our sales also grewsequentially in advanced TV systems where we're providing audio, video andconnectivity solutions to the market share leaders in that business as well.

Audio, video receivers and digital video recorders alsocontributed 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 approximatelyflat sequentially in Q4. Within the industrial category, revenue growth wasstrongest in the automotive and defense markets and weakest in the semiconductorautomatic test equipment market. Our revenues from communications customers inQ4 declined 7% sequentially. Within the communications category, wirelesshandset revenues from analog products increased sequentially and year to yearduring the quarter.

Base station revenues declined sequentially aftersignificant growth earlier in the year. Networking revenues also declinedsequentially while revenues from all other communications applicationsincreased 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 alsogrew 7%, consumer revenues grew 23%, computer revenues declined 17%, primarilydue to our strategic decision earlier in the year to begin to transition ourpower management portfolio away from products used in PCs.

In Q4, our analog revenues grew 1% sequentially andrepresented 90% of our total revenues. Also in Q4 our DSP revenues grewapproximately 7% sequentially.

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

The gross margins for our continuing operations in Q4 were58.4% of sales which was down 50 basis points sequentially on a comparablebasis. In Q4 we recorded stronger PC and consumer product sales ahead of theholiday period, flat industrial sales and lower communications infrastructuresales. This led to a higher mix of consumer product sales, which generally havelower gross margins below the company average, and a lower mix of base stationand automatic test equipment sales which generally carry gross margins that areabove the company average.

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

We enter our first quarter of 2008 which began in Novemberwith backlog for continuing operations that's approximately flat to where webegan 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 inthe range of $610 million to $635 million, which now will exclude the powerrevenues 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 Q1which should allow gross margins to improve slightly in Q1. Operating expensesfor continuing operations are planned to decrease slightly. Therefore, we'replanning 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 lessbreakeven.

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

Our high performance analog performance portfolio, which nowrepresents 90% of our revenues, is in very good shape. The high performanceanalog market remains one of the best product categories in the semiconductorindustry in which to invest and our plan is to continue to invest in areaswhere we have very high market share, which are amplifiers and converters. Thesetwo product categories now represent 66% of our sales, provide an attractiveblend to steady growing, long life cycle products and also products that offercompelling 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 lastseveral years and our brand is very strong in virtually every region of theworld.

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

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

Our profit margins in 2007 were impacted by a number offactors: slower overall industry growth that we all forecasted in the beginningof the year, a higher mix of consumer products, slower industrial market growthafter three years of above trend growth, ADI's decision to reduce ourinventories for its model levels and our decision to stick with our plan toraise investment levels in our analog business to capture future growthopportunities, despite the fact that industry growth cooled off in the secondhalf of the year.

As we look at 2008, we believe we have margin tailwinds ascompared to 2007 headwinds. In 2008, our product portfolio includes a richermix of faster growing, high margin products. Additionally, by mid 2008 weexpect to be in volume production of consumer MEMS products in Asiawhich will allow significantly lower cost and much more scalability thanproducts currently being built in a relatively small fab here in Boston.

Our inventories are now approaching model levels which willremove the gross margin drag that we experienced from inventory reductions in2007. We've also taken actions to reduce the cost of our manufacturinginfrastructure. We've closed our fabs in Californiaand we are focusing our fabs in Irelandon 8-inch wafers only and we'll be closing our 6-inch lines in Irelandby mid-2009.

Earnings per share leverage comes from both a richer productportfolio and also our buyback program. To accelerate the growth rate ofearnings, we bought back nearly 20% of our shares outstanding over the pastthree years, providing earnings leverage as sales and profits grow. We financethese purchases from our very strong cash flow and also from reductions in ourexcess cash.

In summary, ADI begins 2008 in a very strong position. Overthe past few years we took actions that provide a lot of leverage. We increasedour investment in analog products. We divested two businesses at the right timefor our stockholders, our employees and our customers and we bought back over25% of our shares outstanding. These actions were intended to provide very goodsales growth while sustaining 60 points of gross margin.

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

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

Joe McDonough

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

I'll take just a few moments to step through the informationwhich 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 incomestatement. In 4Q, the wireless handset baseband chipset and radio transceiveroperation 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 netincome from this operation. During the full fiscal year 2007, this operationincurred a loss of $3.8 million. It generated $33 million of net income duringfiscal year 2006.

Earnings per share are also split between continuingoperations and total ADI. The wireless handset chipset operation had littleimpact on earnings per share in 2007 and contributed about $0.09 of dilutedearnings per share in 2006. Amore detailed P&L for this discontinued business is shown on schedule B anda worksheet is included on our website, Analog.com, reconciling these items.

Since the definitive agreement for the sale of the CPUvoltage regulation and PC thermal monitoring business was finalized during 1Q,this operation will be treated as a discontinued operation in 1Q. It isincluded in continuing operations during 4Q. As mentioned, stock-basedcompensation 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 andliabilities related to the discontinued wireless handset chipset operations areclassified on separate lines. Since the products in our wireless handsetchipset operations are all manufactured externally, the assets are primarilyaccounts receivable and inventory.

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

Schedule D is the cash flow statement. As a percent ofrevenue, net cash provided by operating activities continued strong during 4Qat 28% of sales. For the year, we paid $228 million in dividends and boughtback $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 marketand by product. These have been commented on in both the press release andduring Jerry's comments. A year ago we instituted this detailed quarterlybreakdown of our sales to give our investors insight into the performance forour business.

On schedule G we reconcile the GAAP to non-GAAP measures. Weno longer exclude stock-based compensation or amortization of acquisition-relatedintangibles which totaled approximately $18 million in 4Q from our non-GAAPmeasures. Only one-time or non-recurring gains or expenses are excluded. In1Q08 the gains from the closing of the planned divestitures will be excludedfrom our non-GAAP measures.

The final schedule is schedule H, which outlines guidancefor 1Q of fiscal year '08. We're giving guidance for 1Q based on continuingoperations which I remind you will exclude the planned divestiture of the CPUvoltage regulation and PC thermal monitoring business. Therefore, on thisschedule we provide information to help investors establish a comparable basisfrom 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 oneprimary question and no more than one follow-on question. We'll give you an opportunityto ask additional questions if we have time remaining for a second round.

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

Question-and-AnswerSession

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 thegrowth in the quarter, I was hoping you could talk a little bit about the majordrivers in consumer? Also, if you could talk a little bit about the factorythat's going to be available for the MEMS production?

Jerry Fishman

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

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

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

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

Steve Smigie - Raymond James

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

Jerry Fishman

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

Steve Smigie - Raymond James

When would we expectto see that fully ramped?

Jerry Fishman

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

Operator

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

John Dryden - Charter Equity Research

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

Jerry Fishman

I think the order rates were good most of the quarter and wesaw good ordering patterns from the market segments we mentioned. In theindustrial business the revenues were flat; they were up in some areas, down insome others. Broadly, I think the markets behaved pretty much the way wethought they would and we didn't see a lot of evidence of any real contractionin any of the end markets for the quarter. When we really looked at it relativeto 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 intoFY08. Could you comment on specifically low power converters and powermanagement with respect to revenue opportunities above your growth in expensesin those two areas?

Jerry Fishman

The way to think about next year and the way we're thinkingabout next year is we have a core business that's the horizontal business thatwe talk about which has shown very good growth over the last couple of years. Youcan 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 ofquarters.

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

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

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

Operator

Your next question comes from Chris Danely – JP Morgan.

Chris Danely – JPMorgan

Can you talk about how you expect your gross margins andoperating 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 businessthat we have this quarter, as Jerry mentioned, we had a very strong growth inthe consumer business and we had a strong growth in the computer business and adecline in the base station and automatic test equipment business. As Jerrymentioned, the base station and the automatic test equipment business areproducts 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 companyaverage.

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

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

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

We think that there is some upward opportunity on the grossmargin. I think we shouldn't get carried away with thinking that we can run abusiness that's significantly above 60% but there certainly is some upwardpotential there.

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

Chris Danely – JPMorgan

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

Jerry Fishman

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

Operator

Your next question comes from Robert Burleson - ThinkEquityPartners.

Robert Burleson - ThinkEquity Partners

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

Jerry Fishman

I don't think so. Itbounces around week to week and so on, but I think it came out about the way wethought. Our revenues, as you know, don't reflect what's going on withdistribution inventories. Our sense is at least in the comments that we gotfrom our sales guys is that the inventories look like they are in reasonablebalance and the orders seem to be reflecting end demand and we didn't see anymajor trends one way or the other during the quarter on that.

Robert Burleson - ThinkEquity Partners

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

Jerry Fishman

I can't tell whatthey'll do for the universe of semiconductor companies, but I think theinventories seem to be in reasonably good balance. I mean, they are beingcautious 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, betweenwhat 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, Iguess calendar Q4 or a fiscal Q1 for you guys, is there any kind of a changethat you are seeing on the communications infrastructure front? Any kind of firmingyou are seeing there? Also automated test equipment, is there any kind offirming that you would expect in those end markets?

Jerry Fishman

I think in the infrastructure market, there were a lot ofbuild outs of infrastructure equipment in the first half of the year and ittailed off in the second half of the year, given the above trend numbers thatwe experienced at least in the first half of the year.

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

I don't think there's anything generically that's going onwith 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 theinfrastructure market. We don't see anything remarkable there one way or theother. It's been a strong business for us. It's a very important business forus. We have a large part of the analog content and base stations in Europeand Asia and America. I think we are in good shape there and Ithink as the call volumes keep going up and people keep deploying newinfrastructure 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. Ithink that business will go as the semiconductor business goes next year.If the semiconductor business startspicking up I think the ATE business turns on a dime in that; they go from feastto famine very quickly, as they did last quarter.

We will have to see how that goes. Again, I think ourposition in that business is good. The customer base we have is solid but Ithink that business swings with a lot of volatility. Certainly last quarter itswung 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 orderslooked pretty good during the October quarter. Can you give us a sense of howorders 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 resultsfor the first couple of weeks because it's very hard to extrapolate that intothe future. We haven't seen any anomalies in the order rates at all, one way orthe other.

Simona Jankowski - Goldman Sachs

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

Joe McDonough

The guidance for next quarter on schedule H in the financialstatements is for gross margins for continuing operations to be slightly above60%.

Operator

Your next question comes from Romit Shah - Lehman Brothers.

Romit Shah - Lehman Brothers

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

Jerry Fishman

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

Typically we see in our Q1 the industrial business getting alittle 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, profoundseasonality quarter to quarter anymore. The only quarter that we really seeusually very strong seasonality is our Q2. But the other quarters bounce arounda little bit a couple of percent and I don't think there's anything more thanwhat you said earlier, good quarters in good economic times; in bad economictimes, they're not so good. But I don't think we have the same seasonalitygiven the mix of business that we had many, many years ago.

Romit Shah - Lehman Brothers

It sounds like your perspective on inventories is that thechannel 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 asharp downtick in their business next year?

Jerry Fishman

As we look at the business, we go through our planningprocess like everybody does before the year begins. We went through a prettyextensive 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 whoare the guys that have to make these decisions. The numbers converged on a goodgrowth number for next year.

That's an indication that integrates what the customers aresaying, 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 someof the other areas should give us a little bit of a growth kick next year. Ithink 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 macroenvironment 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 thingsthat happen in each market or each geography. When you add it all up, wehaven't seen much of an effect of that at all.

Operator

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

Sumit Dhanda - Banc of America Securities

Joe, OpEx down slightly in the January quarter, is this morea function of just product tightening in your existing base business or isthere benefit associated with the divestitures and will that continue topercolate through the model in the upcoming quarters? If that's the case, canyou quantify some of that benefit?

Joe McDonough

The $25 millionrestructuring charge that we took this quarter was comprised of $14 millionrelated to the transfer of production to Ireland'sfrom the 6-inch line to the 8-inch line. As I mentioned, the benefits of thatare out in 2009.

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

Sumit Dhanda - Banc of America Securities

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

Joe McDonough

Yes. You asked aquestion about how will that continue during the year? As we mentioned, ourplan is to hold the growth of operating expenses to half the growth rate ofsales. When we're talking about operating expenses, we're talking about theengineering, selling, marketing and G&A. Most of the restructuring that wedid is in the overhead categories and that shows up as benefits in the firstand second quarter.

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

As the year goes on, we don't have any more of those eventssuch as an annual raise cycle and we do have a plan to, as Jerry said, we think2008 should be a decent year and so we do have a plan to grow the operating expensesduring the year in response to the sales growth but are trying to limit thatgrowth to half the growth rate of the sales.

Sumit Dhanda - Banc of America Securities

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

Joe McDonough

Yes, the savings from the Limerickmanufacturing facility are all cost of sales related. I think it's important tomake 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-inchline that we plan to shut down around 2Q of '09.

The manufacturing of those products, if it all goesaccording to plan, will stop; the manufacturing of the products for ONSemiconductor will stop and we'll gain the benefits of the cost that we wereincurring in manufacturing those products.

Sumit Dhanda - Banc of America Securities

You've guided gross margins slightly higher than 60% basedon better mix. Your inventories are where you want them to be at. Myrecollection is last quarter you thought that you would start to rebuild someinventory 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 bethinking about?

Joe McDonough

The plan for thefirst 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'veconverged on our goal. 1Q tends to be a quarter that we do have the holidayseason there and that does affect output, typically in the factories, duringthe holidays. Typically 1Q is a quarter where the manufacturing output isseasonally off a little bit and so that has a little bit of a drag on the grossmargins.

On the other hand, we have a pick up, we think, from the mixand we probably have a little bit of a benefit as you say from the fact thatwe'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 isto pare back or to really streamline the business now that you've made thedesktop power announcement with ON?

Jerry Fishman

That announcement is really trying to focus the powerbusiness on the places where we think we can make returns that are commensuratewith our model for that business. So as you do those things, I think Joementioned a little earlier, you look around for that business was absorbingoverhead in addition to their direct expenses. Of course, the direct expensesgo to ON.

We've taken the opportunity over the last couple of monthsas we are preparing for these divestitures to reduce the infrastructure costson the company and that's part of that restructuring reserve that Joe mentionedearlier.

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

That's what we're trying to do. I mean, all the actions wetook last year from the handset business to the power products to being veryaggressive purchasers of our stock are all geared towards getting the operatingmargins towards our model numbers and I think we made some good steps on that. Ifthe world doesn't fall apart on us during the year and we get the kind ofgrowth 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 beenworking 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 otherbusinesses that are meaningful that you might be able to pare out. But it doessound like you think you can get into your target operating range by the end ofthe coming fiscal year.

Jerry Fishman

I'd say that we'll certainly make a lot of progress towardsthat. It'll depend on what the sales growth rate is for the year. We'll have tosee how that unfolds but we can make meaningful progress on that at the kind ofrates Joe was talking about each quarter as the revenues grow. Whether we getto 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 saythat -- have visibility on how to get there, given that the gap was very largelast quarter and that rattled a lot of people. How do you ever get to where yougetting to with where you are? I thinkwe've got part of the way there with these moves that we've made and we see ourway clear to getting the rest of the way there with what's going to happen in2008.

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

Joe McDonough

Let me just clarifythe target. We've talked in the past about 30% operating margin and that hasnot included the stock option expense or the amortization of these acquisitionintangibles. So we've just absorbed 2.8%, I think, of sales. I think it's reasonable to think in terms ofthe 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 thegrowth of earnings per share as our principal objective and the margins as justa means to that end. As we've commented, we think that we have a mechanism togrow 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 processof looking at the balance sheet and buying back the stock, we also have focusedon 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'smoving 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'sthe growth in the earnings per share and the return that we can get on theequity 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 companyidentified was some constraints on the MEMS manufacturing site. What's thestatus of MEMS manufacturing and the port over to TSMC?

Jerry Fishman

I think somebodyasked 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 weget out to mid 2008, if it continues to go as well as it's been going, I thinkwe should be in good shape.

Craig Ellis - Citigroup

Lastly, I was surprised with the year-on-year change in theamplifier 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 thesecond half of the year, that's not a number that's bad. We're in a business thatwas up 8% for the full year. Those are numbers that in a market that existedlast 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 pressureyou may be facing from competition around your core business of converters andamplifiers. Given that you've divested the non-core businesses, how have youbeen able to respond to some of the comments we've heard about competition inconverters?

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

Jerry Fishman

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

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

Uche Orji - UBS

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

Jerry Fishman

Yes.

Uche Orji - UBS

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

Jerry Fishman

We have a very strong position with Nintendo on thoseproducts. We have a very good road map going forward with Nintendo and I thinkother than that, I'm not going to comment on what Nintendo's sourcing strategyis.

Uche Orji - UBS

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

Joe McDonough

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

Operator

Your next question comes from John Dryden - Charter EquityResearch.

John Dryden - Charter Equity Research

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

Joe McDonough

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

Operator

Your next question comes from Mike McConnell - PacificCrest.

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 arefor the entire business which includes the discontinued operations and so it'sbeen a challenge here to pull the pieces apart to report them the way that weneed to. I don't think our 10-K will have any backlog reporting for thecontinuing business that we'll have in 1Q, so I really am hesitant to commenton that other than to say the backlog is flat quarter to quarter.

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

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

Maria Tagliaferro

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

Mike McConnell - Pacific Crest Securities

But then for ourpurposes for estimating, we should just assume the same amount of turnsrequirement?

Joe McDonough

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

Mike McConnell - Pacific Crest Securities

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

Joe McDonough

I think it's more inthe 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'sanyone else that missed the second round of questions and wanted to go into thequeue again, you can press star one to do that now, otherwise it looks likewe're completed.

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

Operator

Your next question comes from James Varchez – GillfordCompany.

James Varchez - Gillford Company

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

Joe McDonough

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

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

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

James Varchez - Gillford Company

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

Jerry Fishman

Well, in '08, eventhough it sort of flattened out through most of the year, I think all thefeedback we get in the absence of a big recession or other things that canimpact us substantially is that we ought to start seeing some growth in Q1 andcertainly into Q2.

Maria Tagliaferro

It's worth clarifying also that this industrial group is avery fragmented group of applications across things that include for ADI,certainly, instrumentation that you find in factory automation, processcontrol, medical imaging, the automotive market we include in our industrialnumbers, the automatic test equipment market that serves the semiconductorindustry, defense applications, aerospace applications, so all that goes intowhat we describe as our industrial group.

James Varchez - Gillford Company

Many of which had avery 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 beingan emerging or stronger competitor, rapid sales growth. Could you characterizetheir nature as a competitor of yours?

Jerry Fishman

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

Asian companies are always a competitive risk. They tend, sofar at least, to be mostly in the segments that are single product, very highvolume that are very closely aligned with manufacturers in that region; forexample, the motherboard manufacturers in Taiwan. So that's a business that isless relevant to us than it was a few months ago.

Maria Tagliaferro

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

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

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