Analog Devices, Inc.
Q2 2014 Earnings Call Transcript

Published: 21 May 2014

[Operator:]

Good afternoon. My name is Doris, and I will be your conference facilitator. At this time, I would like to welcome everyone to Analog Devices' Second Quarter Fiscal Year 2014 Earnings Conference Call. All lines have been placed on mute to prevent any background noise. After the opening remarks there will be a question-and-answer period. Please limit yourself to one question to ensure that management has adequate time to speak to everyone. (Operator Instructions) Thank you. Mr. Husain, you may begin your conference.

[Ali Husain:]

Great. Thank you, Operator. Good afternoon, everyone. This is Ali Husain, Director of Investor Relations. Thank you for joining us here for our second quarter 2014 earnings call. With me today are Vincent Roche, ADI's President and CEO; Dave Zinsner, ADI's Vice President of Finance and CFO; and Maria Tagliaferro, Director of Corporate Communications. During the first part of today's call, Vince and Dave will present our second quarter results and our outlook for the third quarter. The rest of the call will be dedicated to Q&A. If you missed our press release, you can find it and all related schedules on ADI's Investor Relations website at investor.analog.com. Now today's conference call can also be accessed from our Investor page and a replay of today's call will be made available within two hours of the calls completion. During today's call, we may refer to non-GAAP financial measures that have been adjusted for certain non-recurring items in order to provide investors with useful information regarding our results. We have included reconciliations of these non-GAAP measures to their most directly comparable GAAP measures in today's earnings release, which is posted on our Investor Relations website. Before we begin today's call, I'd like to review the Safe Harbor statement. Please note that the information we are about to discuss includes forward-looking statements intended to qualify for the Safe Harbor from liability, established by the Private Securities Litigation Reform Act. These forward-looking statements include risks and uncertainties, including but not limited to those described in our Form 10-Q filed earlier today. Our actual results could differ materially from the forward-looking statements made on this call. Subsequent events and developments may cause our outlook to change and we do not undertake any obligation to update the forward-looking statements made by us today. Therefore, this conference call will include time-sensitive information that may be accurate only as of the date of the live broadcast, which is May 20, 2014. Now before we begin with today’s prepared remarks, a couple of housekeeping items for me. First, ADI will be hosting an Analyst Day on June 17th in New York and I’d welcome you all to listen in. Links to the webcast and management presentations will be available at ADIs Investor page at investor.analog.com. And secondly, our third quarter FY14 earnings call is schedule for August 19, 2014, beginning at 5 p.m. Eastern. So with all that behind us, I will now turn the call over to Vincent Roche, ADIs President and CEO for his opening remarks.

[Vincent Roche:]

Thanks, Ali. Good afternoon, everyone. And thank you for joining us today for our second quarter 2014 earnings call. As you can tell from the press release, the second quarter was a very good quarter for ADI. Revenues of $695 million grew 11% sequentially and our operating model showed very good leverage converting the sequential revenue increase into a 20% increase in diluted earnings per share, excluding special items. On a year-over-year basis, revenues grew 5% with the corresponding 13% increase in diluted earnings again, a very strong operating results. Both revenues and earnings in the second quarter were above the high-end of our guidance. During our last earnings call, we spoke about our largest customers becoming more optimistic about their growth prospects and overall improving order rates on ADI, and I am happy to report that these trends continued in our second quarter. In addition to continued optimism at our largest customers, total orders were higher than in the prior quarter across all our end markets and we finished the quarter with a book-to-bill that was above 1. These trends coupled with inventories that are in good position and recovering demand for capital goods, we believe are positive signs for our business in the third quarter ’14. Turning to our performance by end market in the second quarter note, our revenue growth was broad-based and it was led by seasonal and secular strength in the Industrial, Communications Infrastructure and Automotive markets, which represented 89% of our total sales. Our Consumer business grew sequentially also. The Industrial end markets, which are typically seasonally strong for ADI in the second quarter, turned in an even better performance than we had planned and grew 13% sequentially and represented 47% of our total sales. All of the major application areas within Industrial grew sequentially with the strongest growth from the instrumentation sub-sector, which was up significantly, driven by increased demand across our broad base of instrumentation customers. But also by higher than anticipated demand from wireless and semiconductor test equipment, areas which benefit from our very advanced analog and mixed-signal capabilities, industrial, automation, healthcare, energy and defense also were up in the second quarter. On a year-on-year basis, our industrial business grew 5%. By region industrial sales in Europe and North America which together account for over two-thirds of our industrial sales grew in the double digits in the second quarter. Industrial sales in China, Japan and the rest of Asia also registered strong sequential growth. The Industrial sector is indeed the backbone of ADI with a very diverse customer base of tens of thousands of customers and long lifecycle products with sustainable profitability. We believe the Industrial sector has the potential for both market growth rates driven by the need for more intelligent, connected and energy efficient products. Revenue from Communications Infrastructure customers increased 11% sequentially and 25% year-over-year, well, ahead of our plan for the quarter. Wireless infrastructure sales surge in the second quarter driven by strong base station deployment in China and the capacity buildouts in the U.S. ADI’s technology in this wireless applications is focused on the radio signal chain where the spectrum is digitized and where innovation in radio architectures not only leads to higher ADI content per system but also its critical to improving the coverage, capacity and efficiency of wireless networks. The wireless networks are already strained and the burden placed on them is set to increase with the adoption of more and more 4G enabled devices. In addition, consumers typically are engaging in very high bandwidth application on the 4G devices with activities such as video, music and gaming. Therefore, the demand for data is growing at a much faster clip than the rate of device unit growth, compounding this issue our newer nodes that we are connecting, for example, in the area of machine-to-machine communication and even in 4G enabled wearable devices. As a result, carriers continue to invest in their networks and are benefiting from increased per user revenue to help fuel that CapEx spend. Moving forward, we believe that demand in the networks will continue to out pace supply and that the limited availability of spectrum will continue to drive the need for more advanced radio solutions where ADI has been focusing its RF and converter R&D. The fundamental demand for increased wireless traffic, full time connectivity and more and more connected nodes we believe should drive growth in this business for ADI in 2014 and well beyond. Moreover, several opportunities exist for ADI to leverage this core technology into other areas such as industrial devices, instrumentation equipment and healthcare applications, so that anything that can be connected to the club vein will be connected safely and securely. Our wireline business also grew sequentially, primarily as a result of our strong pipeline of designs and 100-gig optical applications, where customers are benefiting from our precision plucking, timing and control technologies. In automotive, revenue increased 9% sequentially, with all three of our focus application areas experiencing growth. At combination of increasing content and vehicle unit growth helped to fuel our automotive growth this quarter. Safety revenues improved over the prior quarter as new vehicles accelerate adoption of radar-based advanced driver assistance systems for collision avoidance. Powertrain revenues also grew as our battery monitoring technology and start/stop applications continue to gain wider adoption in high volume vehicles. Recently, Ford announced that it plans to offer start/stop technology on 70% of its U.S. model range by 2017. And in Europe start/stop technology is already found in 45% of the latest model vehicles with demand in that region also set to rise as consumers off for the technology and indeed government mandates kick in. By region, demand for premium vehicles in China and the U.S continued to be strong and the European vehicle market has also begun exhibiting modest growth, combining to deliver stronger revenue for ADI. On a year-on-year basis, our automotive business grew 10%, which was the fifth consecutive quarter of year-on-year revenue increases in this business. We see plenty of runway ahead for ADI’s automotive business as we work with the leading OEMs and Tier 1 suppliers to develop safer, smarter and more fuel efficient vehicle as car manufacturers accelerate the use of silicon to further differentiates their offerings. And finally, Consumer revenues, which accounted for 11% of total sales in the second quarter, grew 5% over the quarter prior, which was the first sequential revenue increase in this sector in five quarters and it’s the culmination of a very purposeful shift in the mix of our investment profile. This quarter sequential revenue performance was largely due to an increase in prosumer audio/video applications with digital cameras and portable applications flat to the prior quarter in the aggregate. So overall this quarter we had a very good performance across the broad diversity of markets we serve due in large part to the significant investments we are making at ADI to be well ahead of market trends, but also as a result of a very purposeful reshaping of our product portfolio over the last several years. So, with that, I'll turn it over to Dave. who will take you through some of the details of our financial results and after he does that, I’ll come back and provide our outlook for the next quarter and give you some of my thoughts on where ADI stands today. Dave?

[Dave Zinsner:]

Thanks, Vince, and good afternoon, everyone. As Vince mentioned, our second quarter was a very good quarter for ADI with both revenue and diluted earnings above the high-end of the guidance. Revenue in the second quarter was $695million, which was up 11% sequentially and up 5% year-over-year. Gross margin in the second quarter was 66.1%, up 100 basis points from the 65.1% we achieved in the prior quarter. Factory utilization in the second quarter increased to the mid 70s from the prior quarter’s mid 60s level. Our plan for the third quarter is for utilization to be approximately flat to the second quarter which on higher expected sales should further decrease our days of inventory. Inventory in the second quarter on a day basis decreased to 115 days from 121 days and on a dollar basis increased by $8.5 million to $298.4 millions as we positioned our inventory for higher expected sales in the third quarter. Turning to inventory in the distribution channel, inventory distribution on a dollar basis was modestly higher than in the prior quarter and weeks of inventory in distribution was at 7.5 weeks consistent with the prior quarter. Overall, orders were very strong for ADI during the second quarter and customer orders increased sequentially and our book-to-bill was above 1. Our flexible and robust manufacturing and supply chain operations executed very well responding to the increase in orders flows while maintaining lead times at four to six weeks. Excluding special items operating expenses in the second quarter increased 5% sequentially lagging well behind the 11% increase in revenue and in line with our model to constraint the rate of operating expense growth to no more than half the rate of sales growth. Most of the sequential dollar increase in operating expenses was the result of higher variable compensation which is paid to ADI employees based on year-over-year revenue growth and operating profit targets and also due to more days of business in the second quarter. Headcount in the second quarter remained essentially flat to the previous quarter’s level. Excluding special items as a percent of sales, operating expenses in the second quarter declined 180 basis points compared to the prior quarter. During the past 18 months, while uncertainty was the prevailing sentiment in the global economy, we continue to increase investments in areas we believe represents significant growth opportunities for ADI over the long term. And we did so primarily by tuning our product and technology portfolio and redirecting existing spending. With generally improving sentiments and positive sign from our customers, we are prudently increasing our spending in strategic high performance signal processing markets while staying true to ADI’s financial model. We believe we can make these investments while keeping tight control of our expenses. And we expect expense growth to continue to lag sales growth. Excluding special items, operating profits before tax increased to $220 million or 31.7% of sales, which is 270 basis points higher than in the prior quarter and 170 basis points higher compared to the same quarter in the prior year. Other expense of approximately $3 million was flat to the first quarter and is primarily reflection of the ongoing run rate of our net interest expense at current debt level. Our second quarter tax rate was 13.8% slightly higher than our plan resulting in an adjustment to our anticipated full year tax rate to 13.5%. We expect our tax rate to be approximately 13.5% for the next two quarters. Excluding special items, diluted earnings per share of $0.59 increased 20% over the prior quarter and 30% year-over-year and was above the high-end of our guidance. Cash flow in the second quarter continued to be very strong. We generated 34% of our revenue or $238 million in operating cash flow. CapEx was $44 million resulting in free cash flow of $194 million or 28% of revenue. We returned approximately $138 million to shareholders through dividends and share repurchases. On a trailing four quarter basis, dividend payments and share repurchases totaled 81% of our free cash flow and compared to the prior quarter, our share count was approximately flat. Our 2014 plan is for capital spending to be approximately $180 million, of which about two third relates to ongoing capital equipment spend and about one third relates to new facilities and upgrades to existing facility which is all part of our long-term investing for growth strategy. Our cash and short-term investment balance increased by about $106 million during the second quarter and now stands at $4.8 billion with $1.3 billion available domestically. At the end of the second quarter, we had approximately $870 million in debt outstanding, resulting in a net cash position of $3.9 billion. In line with our capital allocation strategy, our Board of Directors declared a cash dividend of $0.37 per outstanding share of common stock. This will be paid on June 10, 2014 to all shareholders of record at the close of business on May 30, 2014. At the current stock price, this dividend represents an annual yield of approximately 3%. Our total shareholder return, which is calculated as the change in stock price plus cumulative dividend paid on a one-year basis was 17% and on a three-year average growth rate basis was 12% through the end of the second quarter. In summary, this was a very successful quarter for ADI. The leverage in our model was evident throughout our results, which were better than planned. On a year-over-year basis, revenue growth of 5% generated diluted EPS growth of 13%. We believe that the investments we have been giving and we have been making give us a strong design win pipeline that sets us up well for good growth and good profitability going forward. So now I’ll turn the call back over to Vince who will discuss ADI’s outlook for the third quarter.

[Vincent Roche:]

Thanks Dave. Well, we begin our third quarter with a higher opening backlog than at the start of the second quarter. Our order rates remain solid and inventories are in good position. As a result, our plan for third quarter revenues -- we have planned for third quarter revenues to grow sequentially in the range of 1% to 5%. We're expecting our industrial and communication markets to grow and for automotive and consumer businesses to be approximately flat to second quarter levels. And in industrial, we believe that the improving macroeconomic picture and more positive sentiment is translating into higher capital spending, which is driving robust order activity throughout our industrial customer base. And communications infrastructure which is likewise tied to capital spending, we expect the 4G deployments in China and the U.S. to continue in the third quarter contributing to our plan for sequential growth in this end market. And in automotive and consumer, we expect that normal seasonal patterns will prevail and for revenue from these markets to be approximately flat to second quarter levels. Gross margin should increase approximately 50 basis points as utilization stays at the mid 70s level, which is flat to the second quarter. Accordingly, we expect gross margin drop through on incremental sales to be in the mid-70s, again similar to second quarter levels. In line with our model, we are planning for operating expenses to increase at half the rate of sales growth. As margins improve and we grow our revenue year-over-year, our variable compensation expense will increase. In addition, in the third quarter, we’ll have the full quarter of the annual salary increases, which went into effect in April. With OpEx growth lagging our anticipated revenue growth in the third quarter, operating margins are planned to expand to the 32% to 33% range, delivering additional leverage. Based on these estimates and excluding any one-time items, diluted earnings per share are planned to be in the range of $0.60 to $0.64. So in closing, we had a strong quarter in the second quarter of our fiscal ‘14 and we have a solid outlook for the third quarter. We continue to expand margins as factory loading increases and expenses remain under tight control. And we will continue generating strong earnings leverage and strong free cash flow, which we will use to further improve shareholder returns. Our investments are well positioned in signal processing applications where we believe we can gain more share of wallet with our customers as they look to collaborate with ADI to embed sensing, processing, connectivity and increasing levels of control and monitoring into their diverse products. Over the past few years, we've made great strides in retargeting our strategy to focus on industrial, communications, infrastructure and automotive applications and carefully selecting consumer entry points. We've been redirecting our investments accordingly, all the while increasing investments in advanced technologies to seed our future growth. We have the highest quality technology and the best people positioning us very well for the favorable macro trends and energy efficiency, safety, health care and ubiquitous sensing and connectivity. Now it really comes down to execution and harnessing the power of our innovation to meaningfully impact our growth rate. We have the talent, the right strategy, the heritage and the perseverance it takes to be successful and to continue generating strong financial performance for our shareholders. Thank you.

[Ali Husain:]

Thanks Vince. I'd like to remind everyone that during today's Q&A period, please limit yourself to one question, so we can get everyone on the line. We plan to run today's call until 6 p.m. Eastern, so if time remains at the end, we will keep the lines open and give you an opportunity to ask another question at that time. So with that, operator, we can now start taking questions.

[Operator:]

(Operator Instructions) Our first quarter question comes from the line of David Wong with Wells Fargo.

[David Wong:]

Noting that your planning to keep utilization unchanged even with the expectation of rising sales in July. Do you expect to be holding that projection in future quarters too or should we expect production and utilization will rise after the current quarter if sales keep going up?

[Vincent Roche:]

Yeah, I think if sales keep going up, we’d expect utilization over time to rise.

[David Wong:]

Okay. Great. So how do you make the decision about when you’re going to increase production. Are there specific parameters that you’re looking at?

[Vincent Roche:]

Yeah, really, you got to remember that half of our production is actually bought through outside boundaries. So some of it is a mix element that the operation guys take into account, some of it is that we’re trying to move our days of inventory down from where we started the year at 121 days and try to get it down to where we’d like to be which is a 110 days. So that plays into it. And then there is some anticipation around what distributors are going to do in terms of keeping their inventory carry and how much inventory we have to carry for certain customers that require us to hold inventory for them at their location and depending on that dynamic, it can play into it. So there’s a lot of moving pieces obviously David to this that go into it. We found that the manufacturing team here is excellent. They had a really good deed on this and we pretty much followed their queue in terms of what utilization should be in any one quarter.

[David Wong:]

Okay. Great. Thanks.

[Ali Husain:]

Thanks, David. We will move on to our next question, please.

[Operator:]

Our next question is from the line of Chris Danely with J.P. Morgan.

[Chris Danely:]

Hey. Thanks, guys. Can you just give us a little color commentary on the sales upside? Was there some sort of hockey stick during the quarter? Was it just a gradual sort of linear increase and then maybe talk about the goes little bit? I think you mentioned that Europe showed some modest growth, was that better than expected, just little bit of color there?

[Dave Zinsner:]

Now every one speaking in two questions, okay. So, I will take the first part and maybe, Vince you can talk about the geography. So, I would say that in general, thing strengthened through the quarter and we saw a good strength, really pretty much across the board in areas that we care about like in the automotive space, in the industrial space and in the comms space. And so I don’t think there was anyone end market that surprised us. It was pretty much the entire business, just performing better than perhaps we anticipated going into the quarter. And then I will let you answer, Vince, the geography question.

[Vince Roche:]

Yeah. So as we said, Chris, we had great strengths virtually 90% of our business now comes from the core markets of industrial communications infrastructure and automotive and Europe is a very strong player in all three of those sectors. So, we saw good linearity through the quarter and good strength in all those areas with both large and small customers.

[Ali Husain:]

Thanks, Chris. And I guess, we will move on to our next question.

[Operator:]

Our next question is from the line of Jim Covello with Goldman Sachs.

[Jim Covello:]

Good afternoon, guys. Thanks so much for taking the question. My one question would just be around -- you mentioned within industrial in particular instrumentation and then semi-test within that. That business has been kind of depressed for a while. Some of the customers there saw big order recoveries this quarter. Any visibility on the sustainability or the continued pickup there, which you guys have very good and unique exposure to? Thanks.

[Vince Roche:]

Well, Jim, our business in instrumentation has really two sectors to it. It’s got the multi-product, multi-customer which is the classical, very, very distributed instrumentation business and then we have the many product, few customer business which is the ATE related sector. So, I think we expect to see the first part of the business be very diverse part of instrumentation continue to grow really steadily, I think towards this next quarter. And who knows on the peer ATE business which is very-very lumpy. But it's driven by or has been driven by the automotive and semi conductor test areas and we think as well at some point, it’s going to be a raise in the building out of equipment for the mobile space, so very-very hard to read that piece of it. But I think overall the instrumentation business will be steady in the third quarter.

[Jim Covello:]

Thanks very much.

[Ali Husain:]

Thanks, Jim. We will move on to our next question, please.

[Operator:]

Our next question is from the line of Craig Hettenbach with Morgan Stanley.

[Craig Hettenbach:]

Yes. Thank you. I had a question on business and distribution and I know you guys recognized revenue on sell-through, but it looked like deferred income to distribution was up 9% sequentially. So just trying to get a sense of your inventories still feels on the lean side yet, that's a decent size increase sequentially. So, kind of, what you are hearing from distributors and what that might suggest in terms of the pipeline of business there?

[Vince Roche:]

Yeah. Good question. So as you point out, deferred margin was up 9%. Sometimes, I would point out that that moves around not only from a -- because of revenue changes but also because the cost of units change, so that does have an impact. We did see a little bit of rise in inventory in distribution, but it was kind of in line with the revenue growth. So as a result, the days of inventory stayed pretty much the same as it did in the prior quarter. There was towards the end a pickup in their shipments to distribution and so we did have some amount of distributor revenue that was in transit. So it isn’t counted in our days of inventory but nevertheless, left our docks and kind of moved over, or is in process of moving over to the balance of the distributors. And that did kind of raise the deferred income a bit higher and probably it was more a result of holidays and so forth that cause that. I do think though, the fact that distributors are growing inventory in line at least with their revenue growth that suggests that there is some optimism about in the next couple of quarters in distribution or at least, the next quarter in distribution. And as they do see the next quarter being pretty strong, outside of the next growth kind of hard to predict but they will do. But I do look at it as a favorable sign.

[Craig Hettenbach:]

Got it. Thanks a lot for that color, Dave.

[Ali Husain:]

We will move on to our next question, please.

[Operator:]

Our next question is from the line of Craig Ellis with B. Riley.

[Craig Ellis:]

Thanks for taking the question and nice job on the quarter, guys. My question is more longer term. When I look at the guidance, it looks like the implications of the end market growth means that communications will be at record revenues and you’ve been knocking that out pretty consistently with automotive as it goes higher as a percent of mix. But when I look at industrial, we are still about 10% to 15% below the peaks for that end markets. So as you look at the different in-demand drivers and the products that ADI has, what do you think it takes from here to get that particular end market back to the levels that you saw again in the mid-2011 timeframe?

[Vince Roche:]

Yeah. Remember, in 2011, there was the whole Tsunami situation which dramatically over inflated demand. So that was a big-big factor. But I think we’ve had a lot of talk with a lot of industrial customers over the past six months and I think the general consensus is that there is going to be a steady improvement in the spend of CapEx, in industrial plants and automation equipment in the years ahead here, because particular in U.S. the age of manufacturing equipment has began to really creek. It’s getting old and there is a natural replacement cycle that is going to starting to take place here, at least in the U.S. and I believe Europe as well. But I think as the macro situation continues to kind of gently improve, that bodes well for the industrial business. So, I think, you’ve got to look at that business as well over a very, very long period of time. So we're bullish based on the product crop that we have, the customers we are engaging with across the globe and what we hear, the sentiment we hear and the evidence that we see in terms of increasing CapEx spend.

[Craig Ellis:]

Is that really the factory automation and industrial process control part of that business, Vincent or I assume you are not speaking of the medical part of industrial so. I was just trying to know that down and understand what sub-segments you are referring to here?

[Vince Roche:]

Yeah. It’s really industrial automation and I think the instrumentation business as well will continue to improve. So, energy too is a fairly modest business really. I believe we’ve seen some improvement in latter months as well in that area.

[Craig Ellis:]

Thank you.

[Vince Roche:]

I’m specifically not talking with healthcare, when I talk about the industrial sector here.

[Ali Husain:]

And the instrumentation and automation pieces of that industrial business clearly take up a good chunk of what we do in industrial so. Thank you, Craig and we will move onto our next question.

[Operator:]

Our next question comes from the line of Doug Freedman with RBC Capital Markets.

[Doug Freedman:]

My question and congratulations on the strong results as well, guys. Dave, a question for you, when we look at the variable comp now starting to kick in, how do I think about the way in which that program works, when you're going to probably feel maybe a seasonal decline in the business starting off next fiscal year? Will we see both OpEx numbers come down? I know you just -- if we look back at the January ‘14 quarter, there was a small decline. But I don't know that the variable comp was a big part of that.

[Dave Zinsner:]

Well, Doug, I think the key component -- well, there are two components to it. One is and it’s 50-50. Half of it is driven off of year-over-year revenue growth. So to the extent that the sequential decline, if there is one from the fourth quarter to the first quarter, still drove a year-over-year revenue growth but probably no impact to that 50%, depending on what year-over-year growth rate we are talking about. To the other piece, the other 50% is kind of the self-correcting piece, that’s related to operating margin percentages and that does obviously come down if revenue were to decline because of some pressure on operating margins and that if it self corrects little bit on the variable comp. So, I guess net-net, the variable comp should come down in a situation where we have a sequential decline which is typical in the first quarter. But it probably won't be to the magnitude you might think of.

[Doug Freedman:]

Okay. Great. Thank you for that color.

[Dave Zinsner:]

Sure.

[Ali Husain:]

Thanks, Doug. And we will move on to our next question, please. Thanks.

[Operator:]

Our next question is from the line of Stacy Rasgon with Sanford Bernstein.

[Stacy Rasgon:]

Hi, guys. Thanks for taking my question. I wanted to delve a little bit into the communication infrastructure. So it sounds like you seem to be seeing both cyclical as well as potentially secular strength in this. I was wondering if could give us a feeling for how much longer you believe the 4G build out that we are seeing right now are going to take place and maybe give us a little more color on the secular aspect of this in terms of content increase, how much is your content for base station increasing as well migrating? And how much is left in this com infrastructure leftover we are seeing right now has?

[Vince Roche:]

Yeah. Let me take your second question first, Stacy. So, increase per system per antenna basically in terms of the overall content that we ship into these base stations.

[Stacy Rasgon:]

For 4G systems.

[Vincent Roche:]

For 4G systems. And when it comes to what we see in terms of demand here, so as I’ve said before, the infrastructure business is very, very lumpy, but I think what we’re starting to see and playing that was, obviously China is very, very strong, very hot at the present time, but America also continues the densification of the network and we are seeing companies like Sprint up their CapEx and continue to build the infrastructure there. There are also trials taking place in Europe. Now Europe is at long last beginning to wake up to the need to replace and upgrade its network to 4G. So I think what we’re seeing is a major shift towards 4G. In fact, it will be we think towards the end of this year probably be 50% of our total unit shipments into those particular base station units and that likely be the trend. We see continued growth in that business throughout the year and we will take next year as it comes, but I think at least from the signs we see at the present time we have lot of cost for optimism.

[Stacy Rasgon:]

Got it. That’s helpful. So my follow-up, I just wanted to ask quickly, you said you were building some of our CapEx was being spent on new facilities, could you give us some color on that, what if it, is that assembly in test, is that wafer fab, what are you building out?

[Vincent Roche:]

Good question. So of the $180 million or so that was spent this year about $60 million of it is related to plants and equipment I guess or plants rather. The most significant piece is a new design center in Ireland that we agree to put in. We are actually getting some systems from the Irish government as well. There is another couple of pieces that are, we have a small building getting build in facilities, that’s related to -- that is related to manufacturing, so that is back end test. And then we have an upgrade of the building in Greensboro which is also design related so that’s more of an engineering building.

[Ali Husain:]

Thanks Stacy. And we will move on to our next question.

[Operator:]

Our next question is from the line of Romit Shah with Nomura.

[Romit Shah:]

Just want to get back to the April results, which were clearly much better than your comps reported in with the March quarter end. And it just seems like the reversals from what we’ve seen in prior periods. I was kind of curious how much of this is one month lag versus new product traction that could be dragging something that’s more sustainable?

[Dave Zinsner:]

Well, I think it’s a combination of many things. Obviously given that our business is very, very CapEx centric, that as the macro environment gently improves that helps. I think pretty clearly in the automobile, communications, infrastructure sectors in particular we’re getting a lot of new product growth traction. So I think it’s a combination of those two things really.

[Romit Shah:]

Okay, thank you.

[Dave Zinsner:]

Thanks.

[Ali Husain:]

Thanks, Romit. Move on to our next question.

[Operator:]

Our next question is from the line of Ross Seymore with Deutsche Bank.

[Ross Seymore:]

Congrats on the strong quarter and guide. It is high level question for you. In the last couple of years we’ve seen a good strong first half of the year in semiconductors and then the second half is slowed down whether for macro reasons or otherwise. You definitely sound a lot more confident while book to growth is looking like this year. Can you give us a little bit more color on why you are confident, any sort of data points, duration of backlog, anything along those lines that helps us understand the longer-term confident that you guys are displaying now? Thank you.

[Vincent Roche:]

Ross, thanks for the question. So what we see I think the facts are we have very, very little visibility on the quarter, I mean that’s a fact, but I can tell you that our customers in CapEx areas in the automotive customers are seeing good backlog right through the significant portion of the year coming. I have said before that from talking to customers across the globe, particularly industrial customers who involved in plant automation and process control very, very sophisticated process control systems. There is just a general improvement in the sentiment and their confidence to actually lay out CapEx. So our customers select CapEx on them. So I think it’s a combination of the gradually improving macro environment, the stability there and I think as we said our business is so CapEx sensitive that we pay very, very close attention to what our industrial customers and infrastructure customers tell us and things are just generally better know than they were last year let’s say.

[Ross Seymore:]

Great, thank you.

[Ali Husain:]

Thanks, Ross. Move on to our next question please.

[Operator:]

Our next question is from the line of Steven Smigie with Raymond James.

[Vincent Sgherza:]

This is a Vince filling in for Steve. I was hoping if you can go into a detail as far as what the size and growth of your MEMS business currently is?

[Vincent Roche:]

We don’t typically go into more detail than we provide in the -- on the earnings release and the in the K or in the Q.

[Vincent Sgherza:]

Okay, all right. In that case could you go into a little detail about on you front end solutions as far as how much is currently done in-house and what incremental target would be?

[Dave Zinsner:]

In total or related to MEMS?

[Vincent Sgherza:]

In total.

[Dave Zinsner:]

In total, okay. So we do about 50% of the wafers internal and the other 50% we source from outside foundries, and that’s actually been pretty consistent almost since I have been here it feels like. So I wouldn’t say we had a particular target in mind, although we do like to keep our internal fabs as full as possible. Lot of it’s based on the particular process that product has been designed in depending on whether it’s very fine line or CMOS running at some (indiscernible) generally it usually goes outside and through the other processes and things that kind of go above 0.18 or 0.25 micro, we generally do insight. The way things have been trending and the way our products have gained traction, it just appears that we seem to be on this kind of normalized level of above 50% internal and 50% external. So I don’t see any reason why that would change.

[Vincent Sgherza:]

Great, thank you.

[Vincent Roche:]

Thanks, Vince. And I guess we have some events on the call tonight. So we will move onto our next question.

[Operator:]

Our next question is from the line of Vijay Rakesh with Sterne Agee.

[Vijay Rakesh:]

Hi, guys. A good quarter. Just a question on the comp side, it’s up nicely 10% sequentially. But when you look at China, how much of that 400,000, 500,000 base station rollout is done and do you see an acceleration -- reacceleration of comp going to the second half?

[Vincent Roche:]

Yes, I really can’t answer, I just don’t have the -- I really don’t have the number in terms of how much of the original contract has already been spent. The indications are that we will have another good quarter in the third quarter in China. So that’s pretty much in terms of the evidence I can give you. I don’t have any more granularity than that.

[Vijay Rakesh:]

Got it. And on the consumer side, you mentioned strength on prosumer. Is that mostly power management that you are doing in the -- what are you driving on to the consumer side?

[Vincent Roche:]

Yes. So it’s a mixture, it’s actually a mix of many, many different things, it’s DSPs, we have high end DSPs in there. We sell a lot of converters into connectivity products, linear products, in areas like studio broadcast, in media systems for enterprises for example. So it’s a great mixture, it’s a lot like horizontal business with lots of customers and lots of different products.

[Vijay Rakesh:]

Got it. Thanks.

[Ali Husain:]

Thanks, Vijay. And we will move on to our next question Operator.

[Operator:]

Our next question is from the line of Blayne Curtis with Barclays.

[Blayne Curtis:]

Thanks for taking my questions. I was wondering if you could going back to the consumer segment, you saw rebound off the bottom but then flat, I would assume July and October be seasonally stronger quarters. Because wondering if you just talk about what’s going on there and then address the opportunity for some of these as you call biosensors or heart rate sensors obviously when to watch small volumes but can you just talk about the longer term opportunities there for you?

[Vincent Roche:]

As we’ve always said, we pick our entry points in the consumer markets very, very carefully, particularly the portable area. So we participate in areas where we can find audio, sensor, and the imaging type application where we leverage our core technologies that we are purpose for those applications. So my sense is, yes, the beginning of the year will be better. And I again that’s a business that’s very programmatic and very hard to predict quarter-on-quarter, but overall I think we are playing in the right places with the right customers and right technologies. And I believe as I have said before I believe the bottom of the re-profiling of our consumer business and things will improve gradually. I think, we’ve got a good base of business now. And with some of these newer applications that we’re playing in, we’ll see some decent growth in future, including the vital signs monitoring application, where again we’ve developed technology for clinical applications that we have repurposed for some of these vital signs monitoring in consumer areas.

[Blayne Curtis:]

Got you. And then just a quick one for Dave, I just want to make sure your inventory levels, are you getting get your target this quarter based on the revenue guide that you gave and then we can think about utilization in terms of revenue for October and beyond?

[Dave Zinsner:]

I think it will come down. I’m not quite sure that we’ll get down to a 110 day target. I would say that we’re looking for a glide path 210 days by the end of the year.

[Blayne Curtis:]

Got you. Thanks.

[Ali Husain:]

Thanks, Blayne. Move on to our next question Operator.

[Operator:]

Our next question is from the line of CJ Muse with ISI Group.

[CJ Muse:]

Yeah. Good afternoon. Thank you for taking my question. I guess specific to industrial segment, curious what impacts recovery in Europe has had on that business? And then if I could sneak in a second question, was hoping you can talk bigger picture about your strategy for power management. You guys clearly a leader in data conversion and amplifiers, curious, kind of think about your focus on that business? Thank you.

[Dave Zinsner:]

Okay. I’ll take the second one which is the power management question and I’ll pass it on to Vince to answer the first one. So, on the power management side, our strategy is somewhat kind of selective. What we try to do is develop power solution that fit along side our signal processing solution in an effort to provide kind of a complete holistic solution to the customer. So, we’re not trying to be a broad-based supplier of power. We’re trying to pick our spots where we’re very strong on an application spaces in signal processing and then pull along the power. And quite honestly, it’s a situation where customers are actually asking us for that. They want to complete kind of the out of the box solution and powers the important part of powering and signal processing. And so in those instances when they want us to marshal all the resources to bring forth the solution, we leverage our power capability to do that.

[Vincent Roche:]

Yes. So with regard to Europe, the areas of primary strength for us over the last quarter or two really has been the areas with an industrial automation, instrumentation. Our healthcare business is healthy, doing quite well, but the standard performers really at this point in time right now are automotive and communications infrastructure not surprisingly given the strength of Europe in those particular areas.

[CJ Muse:]

Great. Thank you.

[Ali Husain:]

Thanks, C.J. And we’ll move on to our next question, Operator.

[Operator:]

Next question is from the line of Stephen Chin with UBS.

[Stephen Chin:]

Hi, thanks for taking my question and congratulations on the solid results and guidance.

[Vincent Roche:]

Thank you.

[Stephen Chin:]

Vince, I just wanted to get some more color on the future R&D or these investments in the future growth areas. Can you provide some color on how you are prioritizing those investments and whether you are looking at more from further enhancing, expanding gross margins or is it operating margins that you’re looking at, or is it maximizing the investment that you have on the internal wafer front-end fab investments and so forth?

[Vincent Roche:]

Well, our investment strategy really is to find as many attractive opportunities as we can in the B2B space, which is industrial communication infrastructure and automotive and very selectively fix spots in the consumer area, where we can play and really make a difference. We’re a signal processing company. We think there’s a tremendous future for ADI in the signal processing space. And as Dave said, we’ve increased our OpEx and specifically trying to find ways to increase the strength of our portfolio and converters. We’re picking every spot. We’re really pushing performance there. Our linear products, we’ve been increasing spend in areas like RF and microwave, increasing our spend in our MEMS technology, which traditionally has been very, very strong in the automotive area. We continue to see a lot of upside there. We are also diversifying our MEMS technology now into industrial application. That just gives you a sense for how we’re viewing things. So, number one job for us is to make sure that we keep our core, we defend our core and growth, so that’s job number one. And we’ve increased our impetus as well in looking for new ways of growth that can leverage our technology in new and exciting applications in areas that maybe connect our tech, the real world to the cloud for example. So we see signal processing as a great space to be and we’re focusing more and more and more in the B2B area in that technology space.

[Ali Husain:]

And as you mentioned Vince, that’s now about 89% of our total sale. So, I hope that answered the question, Stephen. We’ll move on to our next question.

[Operator:]

Our next question is from the line of Ian Ing with MKM Partners.

[Ian Ing:]

Yes. Thanks and I share in my congratulations. So, for Dave, you have a nice capital return strategy, 80% of free cash flow return to investors. Any room to re-visit that or do you have new product investments? It looks like TI is running close to 100%, Maxim has been running above 80, perhaps they talk about something tomorrow at the Analyst Day.

[Dave Zinsner:]

I think what right now, we’re going to kind of stick with the 80%. We’ve already been doing it for about a year. I think Vincent announced that at this call last year, so I want to see how that goes for a while. There is, I think a desire on our part to put some of the cash to use in other ways and tuck in M&A and so forth. So, I just want to keep something available to that purpose. And quite honestly, I think, 80% is a pretty good return on cash in my opinion, particularly when a good chunk of that is coming in the form of the dividend, which is consistently paid year in and year out and actually grows year in and year out. So for now, we’ll stick with the 80 and we’ll revisit it perhaps at another date.

[Ian Ing:]

Excellent. Thank you.

[Ali Husain:]

Thanks Ian. Another question Operator.

[Operator:]

Yes. Our next question is from the line of William Stein with SunTrust Robinson Humphrey.

[William Stein:]

Good afternoon. Thanks for taking my questions and again, congrats on the good quarter and the outlook.

[Vincent Roche:]

Thank you.

[William Stein:]

Understanding that you have a mix of what you manufacture internally and externally. Can you give us an idea at what revenue level and utilization level do you think you likely start seeing lead time stretch and kind of bumping into point where you need to add more fundamental capacity, not just kind of design capacity that you’ve discussed earlier?

[Dave Zinsner:]

Yes. So the wafers we manufactured internally, we’re obviously rolling into mid 70s. We have pretty decent runway before we run into a challenge just in a quick capacity. We have actually more clean room space than that. And so equipping it is relatively inexpensive and can be done relatively quickly, such that if you say that right now roughly $350 million or so of our revenue comes from internally sourced wafers. I think we could easily double that, if not more before we ever have to worry about something on the front end. So I’ll love when that problem arises but I don’t see that problem coming forth anytime soon. On the external side, we have a pretty focused set of foundries that we use and because of the volume that we purchase from them, we tend to have a lot of clout. So we’ve been in the situations where in the past where things have upturned quite significantly. And in fact, this quarter being an example of one. And we get very, very good reaction from our foundry partners in order to meet that demand. So again, these are foundries that have very, very good capacity. And we tend to be a lagging edge node for them. So we get -- I don’t think we’re going to run into an issue there. And then on top of that, one of the reasons we carry -- right now 115 but hopefully gliding down to a 110 days of inventory, which is not an insignificant amount of inventory is because we want to make sure we keep lead time short. So we have a lot of buffer inventory both around our balance sheet and with the distributors to make sure we keep lead time very short. So I think in the last, certainly in the last time, I’ve been here which is five years and I’m going to guess in the last 10 years. I think we’ve ever had lead times stretch out beyond four to six week that we’ve been operating in. So I don’t think that that’s going to be much of a risk for us.

[William Stein:]

Great. Thank you.

[Dave Zinsner:]

Thank you.

[Ali Husain:]

Thanks Will. And looks like we’re a few minutes short to the hour and I look at Christina here and she tells me there’s no one left in the queue. So with all that I would like to thank you for keeping very good time. And just a reminder again, ADI will be hosting our Analyst Day on June 17th in New York. I invite everyone to listen in. Links to the webcast and presentations will be available at the adiinvestor.analog.com webpage. And secondly, that our third quarter FY ‘14 earnings call is scheduled for August 19, 2014 beginning at 5 p.m. Eastern. So thanks again for tuning in everyone. Good night and we look forward to seeing you on June 17th.

[Operator:]

This concludes today’s Analog Devices conference call. You may now disconnect.