Tic-tac-toe, investors want to know: After beating analyst estimates in each of the last two quarters, can Analog Devices (NYSE:ADI) make it three in a row? We find out when the semiconductor maker reports its fiscal third-quarter 2007 earnings Tuesday afternoon.

What analysts say:

  • Buy, sell, or waffle? Two dozen analysts follow Analog Devices, with half giving it a buy rating, 10 more a hold, and two saying sell.
  • Revenues. On average, they expect to see sales rise just 1% to $671.8 million.
  • Earnings. Profits are predicted to fall 16% to $0.36 per share.

What management says:
CEO Jerald Fishman characterized Analog Devices' second quarter performance as "very good," with the "strong demand" that emerged January continuing in Q2. And if you can judge a CEO's sentiment by the actions of his board, then Analog Devices' June announcement of a billion-buck buyback suggests Fishman sees more good news ahead. And yet, when he translated his sentiment into numbers, Fishman predicted that Q3 would bring with it somewhere between $655 million and $685 million in revenues, a 57% gross margin (flat sequentially, below trend, and down 310 basis points year over year), and $0.33 to $0.37 per share in GAAP profits. Hmm, seems that "very good" is a relative term, and actual profits growth may still be a ways off. 

What management does:
Rolling margins have reversed their upward trend relatively recently. The rolling gross and net just started dropping, while operating margins have put together back-to-back declines. That said, Analog Devices still grosses more on its revenues than do rivals Texas Instruments (NYSE:TXN) and STMicroelectronics (NYSE:STM), while yielding the gross margin advantage to smaller players such as Maxim (NASDAQ:MXIM) and Linear Technology (NASDAQ:LLTC).

Margins

1/06

4/06

7/06

10/06

2/07

5/07

Gross

58%

58.5%

59%

59.5%

59.6%

59.2%

Operating

23.9%

24.9%

25.8%

26%

25.6%

24.7%

Net

17.6%

18.5%

18.8%

21.4%

22.3%

21.3%
All data courtesy of Capital IQ, a division of Standard & Poor's. Data reflects trailing-12-month performance for the quarters ended in the named months.

One Fool says:
Analog Devices' trouble starts at the top line, so let's begin our analysis there. According to Fishman:

Gross margin [in the second quarter] declined compared to the immediately prior quarter primarily as a result of higher sales of products used in consumer electronics and cellular handsets, which generally carry slightly lower gross margins than the Company average. Gross margin was also adversely affected by the Company's decision to continue constraining utilization levels within internal manufacturing facilities to better balance production, demand, and inventory levels. As a result, inventory declined 1% in the second quarter of fiscal 2007 compared to the immediately prior quarter. 

So to summarize, Analog Devices' gross is falling because (1) its product mix has shifted toward less expensive products (it will need to ramp sales to make up the difference); and (2) it is slowing down its production, working less efficiently and spreading its fixed costs out among fewer products (again, the solution being higher sales.) See a pattern here? To thrive, it looks to me like the key will be achieving significant sales growth -- tomorrow's anticipated 1% just won't cut it.

What did we expect out of Analog Devices last quarter, and what did we get? Find out in:

Fool contributor Rich Smith does not own shares of any company named above. The Motley Fool has a disclosure policy.