Maxim Integrated Products Follow-up

Yesterday we commented on Maxim’s (MXIM) earnings report, saying:

Although revenue declined, inventories rose 5.1%, in keeping with our thesis that there is too much capacity. Furthermore, property, plant and equipment (a proxy for manufacturing capacity) rose 7.9%, in keeping with our theory that the inventory situation is going to get worse.

We have now had a chance to review the Earnings Call Transcript (Thanks SeekingAlpha!) and we have a few more observations. First, their guidance calls for lower sales going forward, and inventory reductions in the distribution channel.

Tunc Delugha, Group PresidentThank you Jack. After six straight quarters of bookings increases, during the first quarter we experienced an order rate decline. During the quarter, we recorded $507 million in gross bookings, a 9% decline from the $557 million level of the previous quarter. Approximately $40 million of the reduction was due to customers placing their orders closer to the requested ship date by one week, and another $7 million of the decline was due to one customer changing its order to adjust-in-time format.

Worldwide, distributor bookings on Maxim during the first quarter were lower than the orders that they received for Maxim parts from their customers by about $20 million. This implies distributors were reducing their inventory during the quarter. Bookings from 4 of our end equipment markets were up and 15 were down. Geographically Japan and Korea bookings were up while the other four regions were down.

We believe over ordering in the fourth quarter [ending June] to ensure fourth quarter and the first quarter shipments was the major factor. Our 12-month backlog declined to $415 million at the end of the first quarter compared to $429 million at the end of the fourth quarter. Our beginning 90-day backlog for the second quarter is $365 million, relatively unchanged from the beginning 90-day backlog for the first quarter of $366 million. We currently expect second quarter revenues to be flat to 4% below the first quarter level.

This begs a question: if channel inventory was already too high, what is going to happen when all the capacity additions start churning out more chips? If inventory was too high and the industry was cutting production it would be one thing, but this is just the opposite.

For Maxim, this debate is less significant than for many other companies, because a large portion of Maxim’s products are specialized chips made specifically for certain purposes. As such, there is less manufacturing competition for them and they maintain a longer shelf life. Still, when the chips are piling up and the company is still adding capacity, at some point one will have to give – and when it does so it will likely hurt gross margins. In answer to an analyst question regarding the company’s growth plans, the chairman answered:

Jack Gifford, Chairman, President and Chief Executive Officer

Well, in the quarter that we’re in right now, we’re going to produce about $16 million more, that means that capacity is in place and if we shipped all those and they were in mix, we would be able to ship $634 million in that quarter. We are running at about 75% of our fab capacity at that level and that’s installed capacity.

So growing capacity, growing inventories and declining sales, all when production is at just 75% the maximum possible level. Doesn’t sound like a tasty recipe to us.

Disclosure: Author is long IShares MSCI Japan Index (EWJ) at time of publication.

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