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Maxim Integrated Products Inc. (NASDAQ:MXIM)

Q2 FY08 Earnings Call

January 31, 2008, 5:00 PM ET

Executives

Paresh Maniar - Executive Director, IR

Bruce E. Kiddoo - VP - Finance

Tunc Doluca - President, CEO, Director

Vijay Ullal - Group President

Pirooz Parvarandeh - Group President

Analysts

Tore Svanberg - Thomas Weisel Partners

Jeff Rosenberg - William Blair & Company

Romit Shah - Lehman Brothers

Craig Ellis - Citigroup

Ross Seymour - Deutsche Bank

Simona Jankowski - Goldman Sachs

Sumit Dhanda - Banc Of America Securities

John Pitzer - Credit Suisse

Doug Freedman - American Technology

Manish Goyal - TIAA

Operator

Thank you for standing by. Good day and welcome to Maxim Integrated Products Second Quarter 2008 Earnings Release Conference Call. Today's call is being recorded. At this time for opening remarks and introductions I'll turn the call over to Mr. Paresh Maniar, Executive Director of Investor Relations for Maxim Integrated Products. Mr. Maniar, please go ahead.

Paresh Maniar - Executive Director, Investor Relations

Thank you, operator and welcome everyone to our fiscal second quarter 2008 earnings conference call. With me on the call today are Chief Executive Officer, Tunc Doluca; Group President, Pirooz Parvarandeh; Group President, Vijay Ullal; and Vice President of Finance, Bruce Kiddoo. There are some administrative items that I would like to take care of before we cover our result. First, we will be making forward-looking statements on this call and in light of the Private Securities Litigation Reform Act, I would like to remind you that the statements we make about the future, including our intention or expectations or predictions of the future, including but not limited to possible statements regarding bookings and turns orders, revenues and earnings, inventory and spending levels, manufacturing efficiency or capacity, projected end-market consumption of our products, the estimated time to complete our restatement project and any other future financial results are forward-looking statements. If we use words like anticipate, believe, project, forecast, plan, estimate or variations of these words and similar expressions relating to the future, they are intended to identify forward-looking statements. It is important to note that the company's actual results could differ materially from those projected in the forward-looking statements. Additional information about risks and uncertainties associated with the company's business are contained in the company's SEC filings on Form 10-K for the year ended June 25, 2005. Copies can be obtained from the company or the SEC.

Second, in keeping with SEC's fair disclosure requirements, we have made time available for a question-and-answer period at the end of today's call. This will be your opportunity to ask questions of management concerning the quarterly results and expectations for the next quarter. An operator will provide instructions at that time. We again request that participants again limit themselves to one question and one follow-up question during the Q&A session. Before I hand the call over to Bruce, I want to remind you of the contents of our January 31, 2007 press release, which reported that due to stock option accounting matters, Maxim expects to restate its financial statements. Since the company has not yet issued restated financial statements, we are unable to provide detailed GAAP or non-GAAP financials for the quarter ended December 29, 2007. As a result, all numbers contained in our press release and discussed on this call exclude all stock-based compensation. These numbers should be treated as estimates only and are subject to change.

Our press release dated January 17, 2008 provided an update on the progress of the restatement process. Consequently, no additional comments will be made regarding this issue.

I'll now pass the call over to Bruce

Bruce E. Kiddoo - Vice President, Finance

Thank you, Paresh. I will begin by reviewing the results of our most recently completed December quarter starting on certain items from the income statement. Overall, we are very pleased with our results as we met or exceeded our guidance for all key metrics. Consistent with our guidance, net revenues for the second quarter were $540 million, an 8.6% increase from the same quarter last year and a 3.3% increase from the first quarter of fiscal 2008. As we guided, this increase was driven by strength in our cell phone, computing peripherals, and consumer entertainment segments.

For the four major end markets comparing Q2 to Q1, revenue from the consumer, industrial and the communications end markets were each up mid-single digits, while revenue from the computing end market was up slightly. Consequently, our revenue mix during Q2 shifted slightly from the previous quarter resulting in 31% from computing, 29% from consumer, 21% from industrial, and 19% from communications.

Q2 gross margins excluding stock-based comp and non-recurring charges improved by 50 basis points compared to Q1, consistent with our business model that gross margins will fluctuate within a stable range. The improvement over Q1 was due mainly to our continued inventory management, resulting in lower inventory reserve requirements.

Q2 operating expenses, excluding stock-based compensation and non-recurring items increased 2.9% sequentially over Q1 including the test compared to 3.3% revenue growth. Our performance exceeded our guidance, which was to grow Q2 operating expense lower than revenue excluding the test. Non-recurring items during Q2 were $9 million as the cost of the restatement effort was partially offset by a gain on the sale of property.

Turning to the balance sheet, total cash, cash equivalents and short-term investments decreased by $180 million during Q2. Strong cash flow generated from the P&L was offset due to $106 million for two fiscal-year '08 income-tax payments in the quarter, $94 million for the previously announced goodwill payments related to expired stock options, $63 million for the Vitesse acquisition plus $60 million for dividends and $77 million for property and equipment.

Inventory, excluding stock-based compensation, defined for the second consecutive quarter as we continue to manage it carefully. CapEx totaled $65.9 million in Q2 and average days sales outstanding increased slightly from 45 to 47 days.

Regarding bookings and backlog, during Q2, Maxim recorded net realizable bookings of $476.4 million, down 9% from $523.2 million in Q1. We attribute this decline in bookings to three factors. The first factor was seasonality. 60% of our revenue comes from the computing and consumer end markets. Our bookings in the December quarter have been down sequentially in three of the last four years including this year. Second, there was a plant fire at one of our key customers. We expect to recovery of this business in Q4 as the factory is rebuild. And third, customer concerns about the macro environment. As a result of this decline in bookings, our beginning current quarter backlog of net realizable revenue for Q3 is $303.5 million.

Based on the beginning backlog and orders received so far, we expect Q3 revenues to be between $475 million and $495 million, the decline is primarily due to the factors listed previously. By end market segment, the cell phone, notebook and computing peripherals are expected to be down. This decline is partially offset by strength in our recently acquired storage product business and recent design wins in the ATE Segment.

Finally, we note that including the current year, Q3 revenue in the March quarter has been sequentially down for Maxim in three of the past four years.

Moving to gross margin, our recent success in bringing capacity online at our strategic manufacturing partner Epson and our improving yields in cycle time have increased the effective output OF Maxim fabs. This allows us to consolidate and optimize fab operations. As part of this ongoing process, we've started to ramp down and eventually shutdown of our smallest production wafer fab in Dallas. We expect this process to take approximately 18 months. The benefit of this fab consolidation is expected to be approximately $18 million in annual cost savings when complete.

Concerning Q3 gross margins, the benefit of the fab closure will not immediately offset the impact of the lower revenue. Therefore we anticipate Q3 gross margins will decline due to lower overhead absorption but expected to be within our target range.

To improve our R&D efficiency and ensure we're investing in growing high margin businesses, we have decided to reduce our investments in RF Wireless and Telecom. In RF Wireless, we're discontinuing investments in low-margin handset RF transceivers. In Telecom, we are delaying additional R&D investments pending market acceptance of recently introduced products. As a result of these R&D reductions, we anticipate a $15 million annual benefit to operating expenses with the full benefit starting in Q4.

In Q3, we expect operating expenses to be flat with Q2 as a partial quarter savings from the business unit restructuring are offset by the full quarter impact of our Storage Products acquisition and a new 401(k) matching program. This was announced last summer and has been well received by employees.

As a result of these restructuring actions, Maxim expects to take a one-time charge of $10 million before asset impairment costs which are yet to be determined. Concerning cash flow, in Q3 we again expect strong cash flow from the P&L while many of the items impacting Q2 cash flow will be greatly reduced or be zero.

I will now hand the call over to Tunc to provide additional comments and guidance.

Tunc Doluca - President, Chief Executive Officer, Director

Thank you Bruce. Thank you all for joining our call and good afternoon. Firstly, I'm very pleased with our company's execution during Q2. We hit the midpoint of revenue guidance, our gross margins were stable, OpEx grew at a slower pace than revenue, reduced our inventories and lead-times to customers declined for the fourth straight quarter.

With respect to the short-term revenue outlook, I am somewhat cautious about the economic environment. While our Q3 revenue guidance is explainable by normal seasonal patterns, our revenues also appear to be impacted by the concern our customers have about the global economic outlook. You can be assured that we will be mindful of our spending during this period.

On a longer-term basis, I'm very encouraged by the opportunities for growth. I believe Maxim is taking the steps necessary to allow us to effectively compete in these growth markets. I will talk about a sampling of these later. Maxim's culture has evolved over the last year. The P&L metrics that we implemented are highlighting key decisions that we must make to stay competitive. We see evaluation of our investment areas and cost savings opportunities is now embedded in our culture. These will become a mainstay at our company. We will not shy away from existing poor performing product lines and we will be increasing our investments in those business units and product lines that have the best profitable growth prospects. The decisions that we made during the quarter have been in the works for some time. Our review process has allowed us to react quickly to the short-term reduction revenue without impacting our long-term growth prospects.

Let me now discuss significant developments in our four major end markets. First the computing market, which includes notebook PC, storage, computing peripheral, server and financial terminal segments. I'll highlight the notebook and storage segments today. The notebook PC unit sales is projected to grow 20% to 25% per year as notebooks displace desktops. The notebook motherboard power market has now become highly competitive, however. Here we are pursuing sockets where which we can differentiate our products. On the other hand we are uniquely positioned to gain market share in Audio, Display and Battery Management segments. The Notebook and Desktop monitor LCD segment... Display segment is seeing significant growth with new design wins in Korea and Japan where we have displaced incumbent suppliers. We expect our revenues in this segment to increase substantially in upcoming quarters. Our design know-how, close relationship with all the major LCD display manufacturers and proprietary process technologies position us well in this fast-growing market.

For notebook battery packs we have started sampling a new generation of single chip battery controls. These new ICs offer the smallest and most accurate fuel gauging solution for this rapidly-growing segment. Our unique mix signal flash technology and design know-how made this possible.

Turning to the Storage segment, we see and ever-increasing appetite for mass storage. Corporate data and consumer video storage needs to drive this. In the coming years 3 Gig to 6 Gig Serial Attached SCSI transition will present the unique opportunity from Maxim. We now have a confident team and customer relationships to capitalize on this transition. Our newly added storage products development team has hit the ground running and is on track to deliver samples to meet customer schedules. Next the consumer market, this is the highest growth major market for us. In consumer we include cell phone, entertainment, LCD TV, digital camera and media player segments.

In the Cellular segment, there are two important trends that drive growth for Maxim. Number one, our market share of cell phone power management is increasing as we expand beyond CDMA into UMTS and GSM, GPRS cell phones. And number two, there is a growing demand for thinner and more powerful mobile devices and accessories. Maxim is well positioned to capitalize on this growth. There's an emerging need to integrate power, audio, video, touch screen and USB interface into a single analog base-band chip. Our IP diversity and specialized process technologies put us in a unique position to meet this need. Such performance has become difficult to achieve by base-band competitors migrating to advanced digital CMOS process technologies.

Here are three design win examples of Maxim capitalizing from this trend. Number one, we were the smallest, best performing UMTS power management IC for Qualcomm base-band has been designed to four high-volume cell phones at three major cell phone manufacturers. Number two, an IC combining power and audio for Qualcomm base-band has also been designed into several UMTS phones. We have a clear advantage over the competition and performance and level of integration. And number three; we won sockets of three major cell phone suppliers for an audio subsystem IC combining speaker and headphone functions. Third, the communications market including Networking, Datacom, Telecom and base-station segments. Growth in the base-station segment is fueled by the deployment of GSM EDGE platforms in the emerging economies of the world such as in China and India.

We have enjoyed significant design wins with our high integration RF products. Our design innovation and proprietary process technology uniquely position us here. The Base-station, Networking and Data Communication segments require efficient delivery and control of power. This lowers the operating cost and minimizes the environmental impact. We have one important sockets with the family of integrated fab power management products.

Finally, the industrial market including ATE, automotive, medical, instrumentation and measurement segments. While more modest in growth overall, this is a high margin market. We are well positioned now to expand our market share. Here are a few examples why. In the ATE segment, we have captured significant market share by winning designs with products designed in our proprietary [inaudible] electronics process technology in new tested platforms.

Next let me give some color on the automotive segment. One growth driver in this segment is the increasing need to provide safety features in the car that require robust high-speed data transport. Our products fulfill this need and are being well accepted by our customers. These products ramp into production next year. Rapidly increasing fuel prices are driving the need for fuel efficient cars such as hybrid-electric vehicle. Due to its high energy, density and lightweight we anticipate a transition to lithium batteries.

We are uniquely positioned here with our design know-how and proprietary process technology. Case in point, our charger and modular products for hybrid-electric vehicles has won our first major design win at a major Japanese battery customer. In other growth areas, the electricity meter segment in regions like China, Europe and India, utilities are converting millions of meters from mechanical to electronic watt meters. New, high integration Maxim products have scored design wins in this market. We are uniquely able to provide the combination of high accuracy data converters, and embedded micro-controllers.

In the medical segment, our high-voltage ultra sound products have been very well received. The need for our high-integration and low power consumption products is driven by the desire for ultrasound machines to be portable. With the unique technologies we fulfill this need. Let me now turn to our sales strategy initiatives. Our agreement with Avnet to become our global partner was a major milestone achieved during Q2. This will produce incremental revenue growth for us, particularly in the industrial market. This new initiative will result in several things.

Number one, increase revenue as we address a new set of customers. Number two, better gross margins and number three, leverage R&D by selling existing products more effectively. With the Avnet agreement in place, we have successfully executed on all five initiatives that we laid out in early 2007. In 2008, we will focus on new product development execution. We will constantly investigate changes required, speed development time and improved R&D efficiency.

In closing, we believe our strong performance in Q2 and the restructuring actions taken in Q3 clearly demonstrate we are executing to our strategy. This will position us well to compete effectively in the marketplace, generate growth, high profit margins and strong cash flow. Pirooz?

Paresh Maniar - Executive Director, Investor Relations

That is the end of our prepared comments, we would now welcome your questions. Please limit yourself to one question with one follow-up. Operator will you please begin polling for question?

Question and Answer

Operator

[Operator instruction] Our first question comes from Tore Svanberg from Thomas Weisel Partners.

Tore Svanberg - Thomas Weisel Partners

Yes. Just a couple of questions, first of all you talked a little bit about R&D efficiencies this year. I'm just wondering, how different is that from what you've done in the past. Have you put in some new programs? I'm just trying to understand a little bit what you mean by that?

Tunc Doluca - President, Chief Executive Officer, Director

Well, we've done multiple things to improve this. And we also know that there are more things to do. First of all, the most important change that we have made is the business unit's collaboration effort. That's going to help immensely because we're having experts in each business unit together to make a combined product rather than each business unit trying to develop similarly functioning building blocks. We also invested heavily last year and continued to this year in moving the company to a EDA platform that's uniform and we believe that's also going to improve our efficiency. And thirdly, we are going to make sure that we form teams of people that are really adapting to the market needs for their particular product lines. In other words we've divided up groups where we take a group of sprinters or those that have to quickly develop a product in one group whereas others that are designing high-performance products in other groups. This way we set the right culture in each one of these organizations.

Bruce E. Kiddoo - Vice President, Finance

And this is Bruce. Additionally, as far as driving R&D efficiency by giving the profitability goal to each one of the business units, we're really making sure that all of our investments in R&D are going to be matched by acceptable financial returns. And so that's another area where we're really scrubbing where our investments are today and making sure that those are the best investments for us and we're allocating our scarce investment dollars most efficiently.

Tore Svanberg - Thomas Weisel Partners

Okay. Thanks. And just a follow-up. When should we expect to see a full benefit of the new Avnet relationship? I understand it's an ongoing one, but I am just trying to understand if there is a point in time where you will start to see a stronger impact?

Tunc Doluca - President, Chief Executive Officer, Director

All right. I think... this is Tunc. I think that that's going to be a gradual process to get these design wins using the wide sales in FE force of the distributor. So, I think its impacts will probably start more like in a year or so. But it will be a very gradual process.

Bruce E. Kiddoo - Vice President, Finance

Having said that, I think the success so far has been very well received. Avnet is very excited. There is a lot of energy behind this, which previously we didn't have within our distribution channel. So, I think we are very pleased with the results so far and that the strategy is kind of executing on track.

Operator

Thank you. Our next question comes from Jeff Rosenberg from William Blair & Company.

Jeff Rosenberg - William Blair & Company

Hi. First on the R&D savings, the $15 million annually, is that all something that comes out of R&D expense or how does that... how was that achieved overall in terms of how it runs to the P&L?

Bruce E. Kiddoo - Vice President, Finance

Yeah, that's primarily R&D expense.

Jeff Rosenberg - William Blair & Company

So, that's a pretty significant cut in overall R&D budget, can you talk a little bit more about the rationale behind that?

Bruce E. Kiddoo - Vice President, Finance

Well, again, it's just looking at the businesses that we are investing in and making sure that we are investing in high margin growth businesses. And I think as you know a lots of the times, you start investment in certain businesses based on a certain economic forecast and then either the ramp of that business delays or the market acceptance of certain technology gets delayed and it's no longer prudent to continue investing in that. So, again, this was just kind of our ongoing process to take a look at our investments, and make sure that we are investing in the right businesses, and these were some businesses within our wireless and telecom where we felt that the returns just didn't justify the current investments.

Jeff Rosenberg - William Blair & Company

Okay and then maybe just on the flip side of that, can you talk about your efforts to add to the R&D team overall, the hiring environment and your ability to sort of to add headcount to the circuit design team?

Bruce E. Kiddoo - Vice President, Finance

Yeah, I think right now, we are being prudent of our operating expenses given the decline in revenue in the third quarter, that there we are looking for opportunities where we can where we decreased investment in one area to the extent we can shift that investment over to some of the high growth businesses. So, we are clearly looking to optimize our portfolio, but at the same time in the short term we are mindful of the need to achieve our profitability goals through operating expenses.

Operator

Thank you. Our next question comes from Romit Shah from Lehman Brothers.

Romit Shah - Lehman Brothers

Yeah, thanks for taking my question. I realize it's a difficult environment, but and I think we've seen a double-digit sequential decline for Maxim since 2001, Tunc, can you just comment on where you are seeing particular weakness among your four segments and if there has been any meaningful market share loss? Thank you.

Tunc Doluca - President, Chief Executive Officer, Director

Hi. So, there is... first of all, there are several reasons for the decline and Bruce mentioned this before that. Number one was the normal seasonality we expected. As you know, 60% of our revenues comes from the consumer and computing markets and we do, we have seen that trend in the past. And also some customer caution due to the macro economic concerns and thirdly Bruce mentioned this effect we had from a plant fire at one of our customers. But in general, the... if you look at those four market segments, the ones that were essentially the weakest were those two in terms of revenue projections for Q3. However, we do have a solid number of design wins, as I mentioned and we are confident in our long-term strategy. So, I believe that we will resume growth in the long-term where short-term visibility is kind of poor.

Romit Shah - Lehman Brothers

Have you guys seen an increase in cancellations either in the prior quarter or here in January?

Bruce E. Kiddoo - Vice President, Finance

Nothing material. The other thing, I just want to comment is actually in our fiscal year 2005, we were actually down 8% and again at that time period it was both the seasonality and there was an inventory correction occurring out there. So again I think when we look at this year it's a combination of the seasonality in the macro environment. So I don't think this is completely aligned with what we are seeing in the current... in a similar environment in past years.

Romit Shah - Lehman Brothers

I don't have the data, but just if you go back say 5, 6. 7 years, has the mix of business by end market changed dramatically, in other words, was that 60% that came from, that is coming from computing and consumer significantly lower around the 2000, 2002 time period?

Bruce E. Kiddoo - Vice President, Finance

Yes it certainly was. The company has been investing in the consumer business for... in the last few years, so absolutely that mix has changed.

Romit Shah - Lehman Brothers

Okay. Thank you.

Operator

Thank you. Our next question comes from Craig Ellis, from Citigroup.

Craig Ellis - Citigroup

Thanks. Bruce, you mentioned that gross margins would decline in the current quarter, but stay within the target model. Can you remind us what the target model range is for gross margin?

Bruce E. Kiddoo - Vice President, Finance

Right. We like to target on a… excluding stock-based compensation it's about 64% kind of plus or minus 100 basis points. And we expect this to be kind of comfortably within that margin.

Craig Ellis - Citigroup

Okay and then as we think about the businesses’ ability to take some expense out as you just stay aligned with end market capabilities, can you talk about your confidence to grow operating margins through the year. I know on the last conference call when the company talked about its long term financial plan, you do hope to get operating margin leverage. Can we get that beginning in the June quarter and how significant can it be over fiscal 2009?

Bruce E. Kiddoo - Vice President, Finance

And certainly we are still committed to that and I think the actions that we took as far as restructuring are a good evidence of that. Obviously when you have a quarter where revenue is down, it's very difficult to reduce operating expenses to that level and it probably wouldn't be prudent on a long tem basis for us to do that. And having said that in quarters when revenue is growing, we are clearly going to take steps to maximize that leverage in the P&L, so that we can achieve our goal. And you can be very confident that we are continuing to look at this and to manage our OpEx to achieve that goal.

Craig Ellis - Citigroup

Okay and then Tunc for, just given some of the reallocation to resources and moving away from certain businesses, are you still confident that the business is one that can grow at a 15% rate on an annual basis.

Tunc Doluca - President, Chief Executive Officer, Director

Well, in the long-term that's the target we've set for ourselves, but I think it's realistically speaking it will be somewhere in between 10% and 15%.

Bruce E. Kiddoo - Vice President, Finance

Greg, I think as we've said as well, we are going to... our target is to grow faster than the industry and we think our strategy is kind of the businesses that we are attacking will allow us to do that, that said if the industry is going to be in a lower growth rate 6% to 8%, we think we can get maybe 200, 300 basis points above that. So big part of that depends on where the industry is, as far as what our long-term growth will be.

Operator

Thank you. Our next comes from Ross Seymour from Deutsche Bank.

Ross Seymour - Deutsche Bank

Hi guys, just looking at the revenue guidance and the three reasons you gave for why it's down. If you could give us any color about quantifying those three reasons and as part of the seasonality as far as the seasonality part of those three. Why wouldn't you go up in the calendar fourth quarter, if you are still seasonal or up more than your peer group at least?

Bruce E. Kiddoo - Vice President, Finance

Well we were obviously, as you know, 3.3% in our calendar fourth quarter. I think as far as providing quantification on the breakdown between the three items it’s… we can't and its difficult to quantify that, certainly the macro economic concerns and the seasonality as well. So I think that's difficult clearly if we look at the businesses we're in, though the seasonal businesses are the ones which are down the most and so that’s why we are comfortable with that in saying… in sighting seasonality.

Ross Seymour - Deutsche Bank

So is normal seasonality absent the other two? So for us thinking forward on Maxim something like down 5, down 7, just give us an idea of what we should think is normal and then we can add one off things like the macro fears [ph] and plant fires as they occur?

Bruce E. Kiddoo - Vice President, Finance

Our mix is still changing, so I don't want to kind of be tied down to what that, percent down is, as our mix of businesses continues to evolve. I mean I think the other thing to be aware of is obviously we had a strong... our fiscal Q1 was up 6%, so that was strong growth. And when we look at our calendar year 2007 compared to our competitors. We are still one of the top, fastest growing analog companies. And so, we are comfortable that from that point of view. If you look at it over a full year period, our strategy is still working. And as Tim said, I think we are still very comfortable with our growth strategies going forward.

Ross Seymour - Deutsche Bank

Great. Thank you.

Bruce E. Kiddoo - Vice President, Finance

Yes.

Operator

Thank you. Our next question comes from Chris Danely from JPMorgan.

Unidentified Analyst

Hi. Good afternoon. This is [inaudible] for Chris Danely. You already talked about relative weakness in the computing and consumer end-markets. Could you tell us what your expectation is for your other two major markets, industrial and communications, is that seasonal, below seasonal or --?

Tunc Doluca - President, Chief Executive Officer, Director

I didn't really... I didn't get. Can you ask that one more time?

Unidentified Analyst

Yes. I was... I just wanted to find out a clarification on the relative strength of your various end markets. You talked about the computing and consumer end markets being below seasonal next quarter but what about industrial and communications, do you see any softness there or is it going to be seasonal?

Bruce E. Kiddoo - Vice President, Finance

Yes. I think there is... we're seeing the industrial market will probably be relatively flat maybe up slightly. We actually did see above average growth in Q2 for the industrial market, so we think that maybe get off to that a little bit in Q3. And as far as the communications market, again, that looks relatively flat with the current quarter.

Unidentified Analyst

Okay. Thanks. And then one other follow-up question on the segments where you said you were gaining market share. You said that you were doing pretty well in battery management. Is there any other segment that you think you are gaining market share in?

Tunc Doluca - President, Chief Executive Officer, Director

Well, there are several segments that we are gaining market share in. We are gaining market share in LCD displays whether therefore monitors for TVs or for notebook panels. We also are gaining market share in what we call analog base-band circuits for cell phones and also in battery I think you already listed that yourself. In several other markets where we are gaining share are in the ATE market. I think I have covered most of them unless Bruce or Vijay you have got some other...

Bruce E. Kiddoo - Vice President, Finance

Yes. I think you have covered most of them. The other ones I would add are we talked about gaining market share in the medical market and the ultrasound market. The other one is the successes that we've had in the automotive market with regard to high-speed data transport. We've been a leader in this area with regard to our innovations and a lot of the products that we come out with have been essentially first-to-market and our customers really like them. So, those certainly contributed to our growth and our market share gains.

Operator

Thank you. Our next question comes from Simona Jankowski from Goldman Sachs.

Simona Jankowski - Goldman Sachs

Hi, thank you. I just wanted to follow up on the question about seasonality, in an attempt to sort of normalize for that, if we take your two quarter revenue growth between December, when you should be seasonally stronger than March, and we compared that to some of your competitors such as Linear, Intersil or National Semi, it still seems that it is a little bit weaker for you guys. And I guess, I just want to understand are you embedding in your guidance more macro conservatism than some of your peers or what gives you confidence that you are not in fact losing share or maybe that the re-statement and de-listing isn't having an impact on your customer behavior?

Bruce E. Kiddoo - Vice President, Finance

Yes. Certainly we haven't seen any direct evidence of losing share, certainly due to the re-statement or related items like that. I think from our point of view, when we look at our business, I think we are still comfortable with our growth over that period. I mean there are some certain things as far as the macro environment and the seasonality that hit us hard here. The battery, the fire at our one customer for battery management also hurt us as well. But overall, I think when we look at our design wins and by the various segments, I think we are still very comfortable that our strategy is working. And again, I think if we just go back and look at kind of the calendar year '07 performance over a full four quarter period, we are still one of the top growers within the analog market.

Simona Jankowski - Goldman Sachs

Did the fire... did that amount to a percentage or two percentage points of revenue?

Bruce E. Kiddoo - Vice President, Finance

We are not going to give the exact number, but it did have a meaningful impact.

Operator

Thank you. Our next question comes from Uche Orji from UBS.

Unidentified Analyst

Hi, this is Parag [ph] for Uche. Just wanted to get a clarity on your investment priorities going forward, what would be the key areas of investments and where the growth is going to come from? Is it going to be consumer or computing and also if you could lay out your plans for [inaudible]?

Tunc Doluca - President, Chief Executive Officer, Director

Well, we are investing in all these areas. We are investing heavily in consumer as we have said before, because we think that's a very high growth area, and we can really introduce to the market highly differentiated products that are high performance, for cell phones, media players, LCD TV type products. We are investing in industrial market as well. You've seen some evidence of this with design wins in ATE and also in automotive, which we count in industrial. We are also investing in computing, we got healthy notebook unit sales growth and we are essentially getting a lot of design wins by investing in R&D and the display area and the battery area. And we are investing in the storage market as you know, we acquired a company to help us gain market share in that area, and finally we're investing in communications as well. So the company, really still continues on it's path to be a diversified company, in all these major markets.

Unidentified Analyst

As a follow up regarding the suggested restructuring savings, could you provide a time line as to when we can start seeing the savings and how long they are going to last, I mean how long they will be stretched?

Bruce E. Kiddoo - Vice President, Finance

For the R&D restructuring, we expect to see that savings beginning in the full quarter impact in Q4 and for the fab savings we have made some immediate reductions this week, that said, the entire process to transfer all these production over to our other fabs will take over 18 months and we are going to see that savings kind of build over that time period.

Operator

Thank you. Our next question comes from Sumit Dhanda from Banc Of America Securities.

Sumit Dhanda - Banc Of America Securities

Hi guys, I had a couple of questions. First, you know, Bruce the backlog is down about 20%, you are guiding down about 11%, seems to suggest higher turns in the quarter, can you help us to get some confidence on why this is achievable, especially given your concerns or your customers concerns on the economic impact?

Bruce E. Kiddoo - Vice President, Finance

Sure I mean I think if you look at it from more from a bookings point of you, bookings were down 9% and that's you know our guidance at the mid-point is down 10%. Certainly our goal is to be, always hit or guidance just like we delivered in Q2, so I think you can be very confident that the number we put out there is a number that we're confident we are going to hit. When looking at backlog, there is lot of things that's kind of moving in and out of there and so it's harder to make that comparison. I think looking at bookings, prior quarter bookings are usually the best determinant of the next quarter revenue.

Sumit Dhanda - Banc Of America Securities

Yes just a follow up on that. Is it fair to assume the booking thus far for January have been, than normal below seasonal and are you anticipating in acceleration in the back half of the quarter because that seems to be the expectation that probably semiconductor companies in terms of how they expect the linearity of the quarter to shape up?

Bruce E. Kiddoo - Vice President, Finance

We don't give information on quarter to date booking. It's generally that can be misleading, more certainly at this point not prepared to give a forecast on what booking are for the entire quarter given that current environment.

Sumit Dhanda - Banc Of America Securities

Only just to ask a different question on your strategy on operating expenses sort of a two-fold question. One, I understand you are trying to control operating expenses but your forecast for revenues in Q1, again down a little over 10%, but your OpEx has become flat. I would have though I would see a deeper cut to your SG&A line. I understand you can't pair down to the bone but at least a bigger incremental effect? And then I guess the second question is you are bringing down your R&D expense, I just wanted to get a sense of as you are pursuing an ASSP type strategy, there is clearly a ramp up in R&D expenses until you get volume to defer [ph] that R&D expense over. And so, how does that... have you factored that in if you are thinking about how your R&D outlook or how your R&D run rate will change in regard to 2008.

Bruce E. Kiddoo - Vice President, Finance

Certainly. So, I think first half as far as the further reductions, we did take these reductions. It was offset primarily by our 401(k) matching program, which was announced last summer to be effective starting in our fiscal Q3. And certainly from an employee morale point of view this was something that was very well received and something we're committed because obviously we believe that employee morale is obviously a key focus item for us as a management team. And as far as the investment in R&D, I think the key message that we're trying to send here is that it's not that we're investing less in our key growth markets, we are just making sure that where we invest our R&D dollars are in the high margin, high growth businesses. And so, we are going to continue to invest in those businesses where we are going to get the growth run. We are just making sure that there is not other investments out there that weren't projected to drive that growth and that's really the result of what we announce today.

Sumit Dhanda - Banc Of America Securities

One last quick question. Can you quantify what that impact from the 401(k) changes ticking in is and also can you give us a sense of what’s the OpEx relating to the test storage business was last quarter because you sighted that you might see more operating leverage?

Bruce E. Kiddoo - Vice President, Finance

We are not going to provide that detail. I think if you kind of do the math on the savings, partial quarter savings for the R&D restructuring, you can kind of get back into what the additional cost was for the 401(k) in the test.

Operator

Thank you. Our next question comes from John Pitzer from Credit Suisse.

John Pitzer - Credit Suisse

Yes. Good afternoon guys. Thanks for taking my question. Just back on the plant fire, did you guys tell that you'd recoup all that revenue in the June quarter and again just given the concerns around market shares trends, any color you can give us on what that magnitude might have been? And then my second question is just realizing how diverse your business is, anything you can give us color relative to pricing trends and what you are seeing in the marketplace around pricing it would be great?

Tunc Doluca - President, Chief Executive Officer, Director

Yes. This is Tunc. I will take that question. So, in terms of the plant fire, you know we really don't want to quantify how much it is. But, our customers who has taken all the actions that they needed to take, in terms of get back into full production in Q4. So, that is their current schedule and we sincerely hoped that they'll be able to do that. And in terms of pricing pressure, we've got... our ASPs have remained constant quarter-over-quarter, just to give you a reference point on that.

John Pitzer - Credit Suisse

And just back to the plant fire, does that mean that your June quarter should see a nice bump up because of the re-ramp of that plant.

Bruce E. Kiddoo - Vice President, Finance

I don't think there is going to be snap act, but certainly it should ramp back up to its prior levels. That’s the process over time as they bring production back on-line?

Operator

Thank you. [Operator Instructions]. Our next question comes from Doug Freedman from American Technology.

Doug Freedman - American Technology

Thanks for taking my question. If you look at your longer term plan from a wafer sourcing, can you let us know what you think, how much you want to be internally sourced versus how much you want to be purchasing from your foundry partners?

Vijay Ullal - Group President

Yes, this is Vijay. I think we've stated this before in a previous call, and we're still very consistent about that. In long-term, we want to have about 25% or 30% of our capacity in external foundries or our strategic partner, which is Epson. And the technologies that we would be putting into those of external foundries or Epson would be of leading-edge technologies which with the higher integration chips will go into those kind of processes. So, that's our strategy and it has stayed the same for quite a while now.

Doug Freedman - American Technology

All right. Terrific, so with the plant closure there is still no change in that percentage? Just want to make sure of that. And Bruce could you talk a little bit about the inventory. Over the past couple of quarters we have seen inventory reserves move around a little bit. Is that stabilizing now, and is there any real change to or you're comfortable with the inventory levels as well as sort of what's the make-up of that inventory?

Bruce E. Kiddoo - Vice President, Finance

Yes. I think we continue to manage inventory very well. As we said, this is the second quarter in a row that our inventory excluding stock-based comp has gone down. As well this quarter we... our inventory reserves were lower this quarter than they were last quarter. So, we're spending a significant amount of energy to better manage our inventory. And so, I think we are comfortable that there is a lot of management attention in this area and that we are being successful.

Doug Freedman - American Technology

All right. My last one is, we've seen a big move in sort of the analog talent pool moving towards design centers. Maxim, I believe has several design centers around the country and globe, see the same thing at many of your competitors. Can you spend a little bit of time talking about the efficiency of these design centers and whether they are proving to be successful for talent acquisition and R&D effectiveness?

Tunc Doluca - President, Chief Executive Officer, Director

Yes, this is Tunc, I can comment on that. First of all Maxim was one of the first companies to start this trend probably in the early 90's. And we currently have about 30 design centers around the world, most of those are actually in the U.S., but there are a significant number both in Europe, and in Asia. Many of those design centers are very productive, especially when they reach what I would call critical mass. But what we've found is that as long as you find a capable leader then you will get to have productive design center. So the… essentially today's data communication and connectivity you can have means that almost everybody has accessed to whatever they need to have across the whole company. So, we really believe that it's a successful strategy and it has worked well for us.

Operator

Thank you. Our next question comes from Manish Goyal from TIAA.

Manish Goyal - TIAA

Yes hi, thank you. Question is regarding your operating expenses. Should we expect a decline in operating expense and similarly decline in your fab shutdown from September quarter. So for example, if you're planning to save $18 million annually there will be a roughly $4 million type of decline in your COGS or it will be absorbed in some other programs?

Bruce E. Kiddoo - Vice President, Finance

Well, so on the… above the minor the COGS area right, we do expect to see that savings the $18 million savings, when we are complete with the process. Certainly that will be slightly offset to the extent that we have to ramp up other fabs, but that will be strictly based on demand and will be supported by revenue. On the below the line, we will see that savings in Q4, the full benefit of that now. And as we said we are, at this point being very mindful of where we are at from an OpEx point of view versus our revenue and so we are going to be watching expenses closely. That said once we get back on to a revenue growth in subsequent quarters we will look for selective investments.

Manish Goyal - TIAA

So, what is not clear to me is that you are putting $33 million of savings, gross savings and then you're saying there will some ramp up in other fab and you are increasing the 401(k) matching. What is the net savings of these restructurings?

Bruce E. Kiddoo - Vice President, Finance

Well I think it is difficult to give the net of the entire business. Right I think we said if you look at Q3 we said OpEx was going to be flat and we having given guidance out for Q4 certainly we are still working very hard in order to manage our OpEx and manage that effectively. We are not going to provide guidance for out over time with all the pluses and minuses but clearly we are managing that and we are going to make sure we have that leverage.

Operator

Thank you. [Operator Instructions]. Our next question comes from Andrew [ph] from Raymond James.

Unidentified Analyst

Great, thank you. Talking about medical end market given the continued investment here, is this the business you feel holds less susceptibility to macro economic uncertainty? And also in addition to high voltage ultrasound what are some of the other key applications you are targeting here?

Pirooz Parvarandeh - Group President

Well this is Pirooz talking. I think the medical market traditionally has been a much more stable market. I think that's probably a common statement throughout the industry. I think what we are seeing in the medical market, the areas of focus are two-fold. One is on the ultrasound area that we have already talked about where we offer capabilities for the high voltage products that are required in that market in addition to some high speed processing that is required for analog finance [ph]. So we believe that that market is going to be a growth market in addition to the fact that there is a transition occurring in that market with regard to these ultrasound machines becoming more portables. So technology challenges are going to be increasing and I think we are well positioned to benefit from that. So that's as far as the medical… the ultrasound market goes. We’ve had continuing investment in the Blood Glucose Meter market as well and so again our ability to create products that are high-performance low power certainly play well into that market and we believe that to be a very stable market as well. I don't know if I answered your question.

Unidentified Analyst

Well great, great, yes. Thank you. I just have a short follow-up, you mentioned the market share gain in LCD TVs, separate from the consumer market as a whole can you quantify any above seasonal growth at LCD TVs during the first half of 2008 given the strength of consumer spending in this area.

Tunc Doluca - President, Chief Executive Officer, Director

No I won't be able to quantify it, but it has been a good growth area for us, especially with our power management products. Some of our Gamma Correction Buffers and also some of our audio products.

Unidentified Analyst

Well great. Thank you very much.

Operator: Thank you our next question comes from Lawrance from Venture Capital [ph].

Unidentified Analyst

How are you? Can you perhaps talk about inventory and channel inventory with your customers right now and if you look at the sort of the three issues you broke out for why you have the big sequential decline and you assume that your seasonal decline is somewhere usually between 1% and 3%, so let's put it at 3%. And then if you consider the GDP, I guess, in the fourth quarter will be about 3% or 4% lower than it was last year, give back 3% or 4%. That would suggest that the... the fire issue was probably somewhere around 3% or 4%. Is that the right way to think about that?

Bruce E. Kiddoo - Vice President, Finance

Yes, I won't say that's too high of an estimate for the fire.

Unidentified Analyst

Okay. So greater than 1 and less than 3, basically?

Bruce E. Kiddoo - Vice President, Finance

Sure.

Unidentified Analyst

Okay. And in terms of inventory in channel and the customers?

Bruce E. Kiddoo - Vice President, Finance

Yes, we did see a slight increase in our inventory... in the inventory channel… in the distributor channels. We attribute that primarily to the... those kind of the overall macro economic environment. We don't have any real concern there right now, but again it’s tough to get visibility out there.

Unidentified Analyst

And in the event that your customers get a little more bullish on the economy because of Fed rate cuts or whatever, how fast do you think... how much... how fast can you deliver product? In other words, can you make up what you have lost in the first month, the quarter as things pick up in March?

Tunc Doluca - President, Chief Executive Officer, Director

Yes, we should be able to respond very well actually because of some of the initiatives we had last year. We have improved our cycle time significantly in our manufacturing process. We also have built a healthy buyback inventory. So that's all going to enable us to respond very quickly if we see a change.

Unidentified Analyst

Can you give us a sense of what your long-term operating margin goal is? We are not going to say you are going to get there this year, but you have to think about how you wanted to run the business two, three, four years from now. What operating margin are you all targeting?

Bruce E. Kiddoo - Vice President, Finance

Sure. I think when we look at our overall model right, we kind of long-term are targeting gross margins around the 64% plus or minuses as we have talked about before. We look at the OpEx at the kind of 20% to 22%, excuse me, R&D at 20% to 22%, and SG&A at 5% to 6%. And so if you look at that that sort of get you to kind of a mid to high 30%... 30% operating margin.

Operator

Thank you.[operator instruction].

Paresh Maniar - Executive Director, Investor Relations

Ladies and gentlemen, we are trying to limit this call to about one hour and it's about that time. So thank you for your participation. This is the end of our call. We look forward to the next time that we will be speaking to you again.

Tunc Doluca - President, Chief Executive Officer, Director

Goodbye.

Operator

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

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Source: Maxim Integrated Products, Inc. F2Q08 (Qtr. End 12/31/07) Earnings Call Transcript
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