Analog Devices, Inc.
Q3 2015 Earnings Call Transcript

Published: 19 Aug 2015

[Operator:]

Good afternoon. My name is Jennifer, and I'll be your conference facilitator. At this time, I would like to welcome everyone to Analog Devices' Third Quarter Fiscal Year 2015 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. I would now like to turn the conference over to your host for today, Mr. Ali Husain, Director of Investor Relations. Please proceed.

[Ali Husain:]

Thank you, Jennifer, and good afternoon, everyone. Thanks for joining Analog Devices' third quarter fiscal 2015 earnings conference call. You can find our press release and relating financial schedules at our Investor page at investor.analog.com. Before we begin, I want to call your attention to two new items. Number one is about a change around the timing of our future earnings conference calls and, number two is about increasing the level of information we provide investors. So, first, starting next quarter, which will be our fiscal fourth quarter, we're going to move our earnings conference call to the morning. After speaking with many investors and analysts, we believe a morning call is a more convenient time for all stakeholders. As a result of this change, starting November 24, 2015, which is our fourth quarter 2015 earnings call, and for every quarterly earnings conference call thereafter, we will issue our earnings release at 8

[David A. Zinsner:]

Thanks, Ali, and good afternoon, everyone. The third quarter of 2015 turned out to be another strong quarter for ADI, with revenue increasing to a record $863 million and diluted earnings per share of $0.77, both at the high-end of the range. Gross margin in the third quarter of 66.1% was down 40 basis points from the prior quarter and was well within our gross margin model range of 65% to 68%. Factory utilization in the third quarter was about even to the prior quarter. Inventory on a day's basis in the third quarter increased by one day to 128 days, and on a dollars basis, increased by $30 million, primarily related to the positioning of inventory for higher expected consumer revenue in the fourth quarter. Deferred revenue on shipments to distributors on a dollars basis increased by 6% from the prior quarter and distributor inventory on a week's basis was at 7.5 weeks, which is within our model range and consistent with the prior quarter. Operating expenses in the third quarter increased 2% sequentially, lagging well behind the 5% sequential increase in revenue as we continue to manage operating costs very tightly, allowing us to gain more operating leverage in our model. As a percent of sales, operating expenses in the third quarter declined 90 basis points compared to the prior quarter and declined 210 basis points compared to the same period a year ago. Operating profit as a percent of sales has been on a steady march upward starting in the first quarter of 2014 when it was 29% of sales. In the just completed quarter, operating profit was approximately 500 basis points higher at 34.2% of sales, increasing sequentially and year-over-year and well within our operating model range of 32% to 36% of revenue. Other expense in the third quarter was approximately $6 million. We expect our net interest expense to be approximately $5 million in the fourth quarter. Our third quarter tax rate was approximately 15%, which is also the rate we expect in the fourth quarter. Excluding special items, diluted earnings per share of $0.77 increased by 5% over the prior quarter, and 22% year-over-year and was at the high-end of our guidance range. At the end of the third quarter, our cash and short-term investment balance was $3.1 billion, with approximately $700 million available domestically. We had approximately $870 million in debt outstanding, which resulted in a net cash position of $2.2 billion. During the third quarter, capital expenditures were $35 million. Our capital expenditure plan for fiscal 2015 is to be between $155 million and $160 million. Our financial model generates strong cash flows, and we are committed to returning cash to our shareholders. For the trailing 12 months, we generated free cash flow of $822 million, or 25% of sales, and returned $784 million, or 95% of that free cash flow to shareholders in the form of dividends and share repurchases. Today, we announced that our board of directors declared a cash dividend of $0.40 per outstanding share of common stock, and that will be paid on September 9 to all shareholders of record at the close of business on August 28. So in summary, the third quarter was another very successful quarter for Analog Devices. So now, I'll turn to our fourth quarter outlook, which, with the exception of revenue, is on a non-GAAP basis and excludes special items that are outlined in today's call and release. While order trends in the industrial market are stable, we're entering the seasonally slower fourth quarter for our industrial business, and as a result, expect this sector to decline somewhat from the third quarter levels. In automotive and communications infrastructure, order rates are also stable. And we, therefore, expect these markets to remain about even to the third quarter levels. In consumer, we expect to benefit from strong seasonal and cyclical trends, leading us to plan for continued strong revenue growth in the fourth quarter. So, in total, we're planning for revenue in the fourth quarter to be in the range of $880 million to $940 million, which represents an increase of approximately 2% to 9% sequentially. At the midpoint of this range, revenue of $910 million would represent an increase of 12% year-over-year. We expect gross margins in the fourth quarter to be approximately 65.5%, given a likely mix of business. We are anticipating operating expenses in the fourth quarter to increase between 1% and 3% sequentially, lagging our expected sequential revenue growth in the fourth quarter. One line item that we expect to exclude from our fourth quarter non-GAAP operating expenses is a special charge of approximately $220 million, associated with the conversion of our Irish defined benefit plan to a defined contribution plan. This conversion will give people employed by ADI's operations in Ireland more ownership in their own retirement assets, and will benefit the company by eliminating a growing, long-term liability while reducing expense volatility that is typically associated with these defined benefits plans. Based on these estimates, and excluding this and other special items, diluted earnings per share is anticipated to be in the range of $0.79 to $0.87 in the fourth quarter. At the midpoint of this range, diluted earnings per share is expected to grow 20% year-over-year which would be a great result relative to our EPS model of 8% to 15% growth. So now, I'll turn the call over to Vince for closing remarks.

[Vincent T. Roche:]

Thanks, Dave, and good afternoon, everybody. As we've talked about in today's remarks, the third quarter was another excellent quarter for ADI, reflecting the combined power of our strong execution and our balanced approach to growth, profitability, and shareholder returns. At ADI, we continue to focus on superior and sustainable innovation, and we leverage our investments across diverse applications and customers. Today, ADI's 20,000 strong product offerings are in thousands of applications at over 100,000 customers, helping them sense, measure, interpret, and connect the physical world. It is quite true to say that wherever the toughest signal processing challenges lie, be they on a factory floor or indeed at the outer edge of our solar system, customers are increasingly relying on ADI's product and applications knowhow to help navigate the new intersection between the physical and the digital worlds. Just this past quarter, for example, ADI's mixed-signal processing capability was onboard the New Horizons deep space probe, providing critical measurement and conversion capability to the spacecraft as it navigated past the surface of Pluto. In industrial applications, we see factory automation and control, or as some call it industrial IoT, as the next driver of industrial revitalization. Other industrial applications that fall within this umbrella include smart agriculture and smart cities. All these applications leverage our current product offerings as we help our customers carve out new ways of using our technology and, in many ways, helping them unlock new sources of value in this emerging industrial IoT. One of the areas that most excites me about the impact of our innovation is in healthcare where we have been investing for some time now. Here our focus is on critical care imaging applications and clinical-grade vital signs monitoring. Today, ADI's working with several of the world's leading research institutions and systems OEMs to drive game-changing advancements in the performance, impact, and affordability of medical electronics devices, helping shift healthcare delivery to point of care and greatly improving the lives of countless patients. In automotive, active, predictive, and passive safety systems, precision power train control systems, and high quality multimedia systems require a proliferation of sensors and actuators, which in turn place ever-increasing demands on signal processing technologies as do government mandates. These are an excellent match for our offerings. In addition, while we continue to have a strong position with U.S. and European manufacturers, we still have opportunity ahead as we increasingly serve the Asian market. The near-term volatility in communications infrastructure gives us no pause about the long-term upward trend in this market. The facts are that 4G penetration is low, data consumption is increasing exponentially, and radio density is also increasing. But in order for carriers to continue densifying their networks, our customers must solve the significant challenges associated with making the most efficient and flexible use of available spectrum, while at the same time reducing power and systems cost. ADI's software defined radio and transceiver technologies help solve these very tough challenges, while also delivering a lower total cost of ownership to our customers and in the process driving growth for ADI. In wireline infrastructure, we focus primarily around the timing and control of the signal path and optical communication systems where the engineering challenge requires very high performance timing and precision processing. The move from 10G and 40G to 100G systems to satisfy burgeoning data demand further creates strong growth opportunities for ADI. Overall, our mixed-signal, RF, and microwave technologies are in increasing demand for many thousands of customers. And we are continuing to invest aggressively to capture the growing opportunity available to us. So, in summary, we remain committed to growing our revenues at 2-times to 3-times GDP, to grow diluted earnings per share by 8% to 15% annually, and achieve our EPS goal of $4 to $5 by 2020. Finally, let me end by saying that the uncertainty in the macro environment is not new to any of us. At ADI, we take a long-term view, and we believe that innovation is the cornerstone of business success. While we manage our investments conservatively, we execute our strategy aggressively. So we are confident that our ethos of innovation, our leadership in signal processing, and our alignment to favorable macro trends will allow us to outperform and continue delivering strong returns to our shareholders.

[Ali Husain:]

Great, thanks, Vince. Thank you. All right, folks, during today's Q&A session, please limit yourself to one question. We're going to run the call until 6

[Operator:]

Our first question comes from Chris Danely with Citi.

[Christopher Brett Danely:]

Hey, thanks, guys. Just a question on the, I guess, the consumer end market. Obviously this is a pretty strong performance this quarter and the previous quarter. For the January quarter, do you think consumer can continue to increase, and what would be the factors there?

[David A. Zinsner:]

Good question, Chris. Typically, the first quarter for consumer is seasonally down. So I think we would expect, year-over-year, it would be up, but my guess is sequentially it will be down because that's typically what happens seasonally in that business as kind of the Christmas season gets behind us.

[Christopher Brett Danely:]

Great. Do I get to follow up?

[David A. Zinsner:]

No. Re-queue.

[Christopher Brett Danely:]

All right. You don't ask you don't get it.

[Ali Husain:]

Thanks for the question, Chris. This is Ali here. I think this is a good opportunity to remind folks, on the line here, about the ADI story and why we believe ADI offers investors, what we believe is a unique combination and a fairly balanced approach to all three things, revenue growth, operating leverage, and shareholder returns. So in terms of revenue growth, we believe we're tied to the right end markets with the right technologies and products. For example, about two-thirds of our sales are from industrial and automotive and over two-thirds of our sales are from products and technologies where we, in fact, lead the market. So we believe that forms a pretty good wide, sustainable moat around the business. Number two, in terms of operating leverage, as Dave mentioned in his prepared remarks, we've marched those margins up about 500 basis points over the last several quarters, and we still have about 200 basis points of operating margin leverage remaining in our model. And lastly, in terms of shareholder returns, as you all know, we've committed to returning 80% of our free cash flow to shareholders. We also have a target to increase our EPS by 8% to 15% annually. We have an EPS target of $4 to $5 per share, which when you look at the trailing 12-month number here, we've been kind of in the $2.80 ZIP code. So we believe that $4 to $5 EPS target is a meaningful one for investors. So, all said, we believe we've got a pretty good balance of revenue growth, leverage, and shareholder returns going. So thanks for the question, Chris. Feel free to re-queue. And we'll get to our next question. Thanks.

[Operator:]

This question comes from John Pitzer with Credit Suisse. John William Pitzer - Credit Suisse Securities (USA) LLC (Broker) Yeah, good afternoon, guys. Thanks for letting me ask a question. I guess, Dave, I want to get a little bit to the margin profile on the consumer business both on the gross and operating line. I'm assuming that all the gross margins declined in the October quarter is because of increase in consumer. I'm just wondering, it seems like consumer is up a lot in October but not up as much as July. But the impact to gross margins, sequentially, is about the same. I'm just wondering if there's anything going on within consumer mix. And I guess, more importantly, how do I think about operating margins in that consumer business? Because clearly, there's not as much SG&A expense to that incremental revenue. So is it sort of diluted to kind of gross margin, but accretive to op margin? Is that the way I should think about it? Thanks.

[David A. Zinsner:]

Well, there's a lot of puts and takes in both the third and fourth quarter. Gross margins are a little bit dilutive in the consumer business, obviously, but it's relatively modest compared to the corporate average, but there are a whole lot of other businesses that are going up and down, and so collectively I think mix was actually pretty flat for the third quarter. We think the fourth quarter probably mix will impact it a little bit negatively. I think the gross margins really were down in the third quarter mostly as a result of inventory reserves we took, again, some last-time builds related to Hittite as we transitioned some of the production away from one foundry and into another foundry. The old parts we took a reserve on for the levels that were beyond, I think, about a year. On the operating margin side, the incremental consumer business is accretive. That's why we saw gross margin expansion this quarter, and that's why we think the midpoint of our guidance will see operating margin expansion in the fourth quarter as well. So it's obviously, we were leveraging a lot of existing technology that we've invested over the course of a decade, probably, to be able to serve the consumer business. And so, as a result, the ongoing R&D expense isn't terribly significant. John William Pitzer - Credit Suisse Securities (USA) LLC (Broker) That's helpful, Dave. Thank you and congratulations on the strong results.

[Operator:]

This question comes from Craig Ellis with B. Riley.

[Craig A. Ellis:]

Thanks for taking the question, guys, and congratulations on the performance. The question is a follow up to the two earlier, with regards to the consumer segment. Can you speak to the degree to which you're seeing application and customer breadth with the platform technology that's favorably impacting the third and fourth quarter's results? And from here, what's the opportunity to grow customers and application exposure as you look out to fiscal 2016?

[David A. Zinsner:]

Well, precision technology, we're attempting to leverage that across all of our end markets and all of our customers. The specific product that is driving some of the demand for next quarter is specific to one customer, and in a lot cases, we work with those customers to customize the technology for their needs, and obviously as we do that, we don't give that to another customer to be able to utilize. So, I mean, I don't know if this answers your question, Craig, but our fundamental tenet is to take our technology and leverage it to as many customers as we possibly can and as many end markets as we possibly can.

[Vincent T. Roche:]

Yeah, Craig, we have a 40-year-plus heritage of developing silicon, precision silicon, high-speed silicon. But the precision silicon is – the industrial market is largely about control type applications, which is precision oriented. So that's the primary market for that technology. And as you get different markets driving technology at different rates and you get a ping pong between one market and another. So there's good leverage from the industrial type applications into consumer for that technology, but also vice versa. So many, many thousands of customers, and we have – the business there is largely about many thousands of customers, many thousands of products. But in some cases, we customize products for markets and indeed customers. So it's a very, very complex diversified space.

[Craig A. Ellis:]

Thanks, guys.

[Operator:]

This question comes from Tore Svanberg with Stifel, Nicolaus.

[Tore E. Svanberg:]

Yes, thank you. Great results. I want to ask a non-consumer question. So some of your peers have talked about the slowdown here in the last couple of months in order rates especially in the industrial market. I'm just wondering what you're seeing. I do realize you're guiding for the industrial business to be fairly flat this quarter, but just really from a macro level what are you seeing on your order rates?

[David A. Zinsner:]

I would say, so, in general, our order rates were pretty stable. They were stronger, obviously, in the consumer business. They were a little softer in the industrial business. But not atypical for this period of time given that July and August are months in which a lot of industrial customers take the opportunity to shut down their production for some period of time. And so, we normally see a little bit of a softer patch in terms of order levels. But it was very typical relative to other third quarters, so we didn't really see anything anomalous in the order patterns that would suggest there's macro weakness out there or anything like that.

[Tore E. Svanberg:]

Great. Thanks.

[Ali Husain:]

And the only thing I'd add to that, Tore, is when you look at generally some of the outlooks provided by some of the large distributors out there for their components business, they're generally operating in some level – some seasonal range. They may be operating at a lower end of that seasonal range. But I think for folks like ADI where we don't have a lot of PC exposure. In fact, our PC exposure is probably nil. And we're levered to the kinds of markets, particularly in the industrial space for example, that do play, I guess, in – I guess, fairly closely, I guess, with some of the distributors are also exposed to, number one. Number two, our revenue recognition policy is extremely conservative. We only recognize revenue when distributors sell through, so we believe we're probably a little closer to end demand than maybe some of the other folks out there, so. And then lastly our weeks of inventory in the channel are still at sort of 7 weeks, 7.5 weeks. And our sense of it is that we're operating in some kind of a seasonal range here. The bottom hasn't dropped off, I'd say, as maybe some of the competitors out there have maybe spoken about. But I think generally our sense is that what we're seeing is generally in line with probably what you've heard from some of the other distributors out there.

[Tore E. Svanberg:]

That's helpful. Thank you very much.

[Operator:]

This question comes from Chris Caso with Susquehanna Financial.

[Christopher Caso:]

Yes, thank you. Just a follow up question with regard to the automotive market. And that was also a market that looked like it was a bit weaker than perhaps you had planned coming into the quarter. Would you consider the order rates there also to be stable? Obviously there's a lot of macro concerns in there. What are your customers telling you with regard to the market?

[David A. Zinsner:]

At this point, that business is stable. I mean, the third quarter is generally a softer quarter again for the automotive space. Again, it's for the same reasons that the industrial business is generally sees some weakness in the summer months, automotive guys tend to take some production downtime particularly in July. It was kind of on the lower-end of our normalized range that we would have expected, so it wasn't out of the norm, maybe just a little bit weaker. And of course, this is always tough to call with any form of certainty. But the order rates were stable in auto. My guess is they will be at least flat in terms of shipments next quarter if not a little bit better, and so I think that business is behaving as we would expect.

[Christopher Caso:]

Great. Thank you.

[Operator:]

And this question comes from Vivek Arya with Bank of America.

[Vivek Arya:]

Thanks for taking my question. It's related to the automotive space. When we look at the growth so far this year, it's sort of been flattish. And the question is, is this just tied to some specific customer patterns? Or is it just lumpiness? Or do you think some other consolidation or M&A might be required to get growth rates up to what a lot of the peers are reporting.

[David A. Zinsner:]

I mean, I think we have a really good pipeline of opportunities in that business. And Vince and I have spent the last several weeks really kind of going through their pipeline with them. And we're excited about really in every sub-segment within automotive and infotainment and in safety, in power train, the opportunities we see out there in the future for automotive. Every so often you get a year where because of the way the models kind of roll out and the timing of where our products get designed into those customers. Sometimes you get a year that is a little softer. And that's made up usually by another year where things are very strong. One year I think we grew 25% year-over-year. Another year I think we grew 4%. So this is pretty much in the norm. Our goal is to grow this business kind of high-singles, maybe even into the double-digit range over time, and we'll have certain years that do better than others. But if you look at the pipeline, we think we've got the opportunities to allow us to drive good growth in that business.

[Vivek Arya:]

Great. Thanks and congrats again on the execution.

[Vincent T. Roche:]

Thank you.

[Operator:]

This question comes from Ross Seymore with Deutsche Bank.

[Ross C. Seymore:]

Hi, guys. Can you go into a little more detail on what's going on in the comm side? We know that China was weak for others and you split out the wireline versus the wireless side, but the confidence you have that you're under-shipping demand and any sort of guess as to when that might snapback?

[David A. Zinsner:]

I think communications, as you know, has seen some weakness particularly in China, given what we think is kind of a stoppage of rollout of macro base stations while they do some investigations. We think we've kind of reached the bottom of what we might experience, and that it's unlikely to get any lower from here on the wireless space. But it's anybody's guess as to when that kind of resumes. We have gotten – and Vince can probably add more color to this – we have gotten input from our OEM customers that it will resume, and it's really just a question of when at this point getting the answer.

[Vincent T. Roche:]

Yeah, I think Dave is right. At least the demand from the OEMs and ADI is stable. And as Dave said, I believe we've hit the bottom. So I think we're – let's say, we're primed and ready to go in terms of supply line when the demand kicks back, which I believe will be much sooner than later here.

[Ross C. Seymore:]

Great. Thank you.

[Ali Husain:]

Thanks, Ross. And the only thing I'd add to that is the bookings are – as we mentioned in the prepared remarks, the bookings are stable, which is always a good sign in this business. And we did go back and look to see when the last time we were at these kind of revenue levels in the comms infrastructure space, and it's been a long time. So it's very, very low. And our sense is that things are at least stable here. And if you can call the recovery on it, let me know. But it's always harder for us to do it. So, all right, well, thanks for the question. We'll get to our next caller.

[Operator:]

This question comes from Blayne Curtis with Barclays.

[Blayne Curtis:]

Hey, thanks for taking my question. And I'll offer my congrats as well. Dave, I was just curious, you came in at the high-end of the range, but the other segments are weak. So, consumer is up even more. To the extent you can talk about it, I know it's hard, what drove that upside? Was it more timing? Maybe the ramp happened earlier? Or was it just the sheer volume? And then as you look to October, it's the wider range than usual, particularly given it looks like it's mostly consumer. Can you talk about what the puts and takes there are as well? Is there other products or is it just you're being taking a more conservative angle on the ramp? Any help there? Thanks.

[David A. Zinsner:]

Yeah, sure. Thanks, Blayne. So the third quarter did come in within the range. Clearly, it was at the high-end of the range. So we did have a scenario in which we were going to get to this level. It doesn't come as a complete surprise. I would say that that was our kind of best case scenario, and that, that actually played out. And, obviously, that had a lot to do with the consumer business and the fact that these ramps can be dynamic in terms of how the production gets rolled out. And you get input from the customers, but that is changing week-to-week. And you never know really how things are going to progress. And so we take a couple of different scenarios that might occur, and it just so happened that this one ended up being the more positive outcome. We, again, do that for the fourth quarter, and that is why we have a wider range. There's obviously a scenario in which the production ramps fast and stays stable within the quarter. There's a scenario obviously in which it ramps up, but then they get to their inventory levels that they need, and things pause for a little bit. So we hope that we've been conservative enough in the forecast to make sure that we stay within this range, and I think we have tortured this quite a bit, as you might imagine. And we feel pretty confident that we've got the right range in there.

[Blayne Curtis:]

Perfect. Thanks.

[David A. Zinsner:]

Sure.

[Operator:]

This question comes from Ambrish Srivastava with BMO Capital Markets.

[Ambrish Srivastava:]

Hello?

[Ali Husain:]

Hey, Ambrish.

[Vincent T. Roche:]

Hi.

[Ali Husain:]

You're on.

[Ambrish Srivastava:]

Hi. Sorry, I'm on the road. Just wanted to make sure I could be heard. Just a question on the overall business mix, what is the right way to think about longer-term the business would look like? Clearly, consumer is doing great for you, but, as we all know, the investor base is also attracted to the balanced – Ali, as you were pointing out, the balanced business model, no real concentration to a customer. So longer term, what's the right way to think about – what is the mix that will make you folks feel comfortable, "okay, this is kind of how the business should look like?" Thank you.

[Vincent T. Roche:]

Well, the strategy's playing out as we've designed it. We have, let's say, over the last five years or six years, been steering more and more of our R&D towards what we consider to be business-to-business applications, like industrial, healthcare, automotive, and communications infrastructure. That's where the lion's share of our R&D is placed. And that's where the lion's share of our sales force works as well to ensure that we grab the opportunity by covering the broadest base of customers and applications that we can. We've always said, in the consumer area, that we have a very, very targeted, focused play in terms of R&D and customer engagement, and that we play only in spaces where our technology makes a huge difference to the user experience, and where the technology we believe is sustainable over time. So, clearly, the consumer markets are more volatile than, let's say, the B-to-B markets, but we've got a good blend, I think, as a company in terms of being able to invest in the areas that give us the longer product lifecycles, the more sustainable businesses and I think a good bet and a very sustainable investment in the consumer space. So, yeah, over time, as demand moves between one sector or the other, B-to-B versus consumer, so will go the fortunes of the business. But I think overall what you've got to look at is the commitment that we've got to delivering 2-times to 3-times GDP, gross margins in the 65% to 68% range, and getting our EPS well above $4. So that's our goal, that's our mission, and that's what we're delivering.

[Ambrish Srivastava:]

Thank you.

[Operator:]

This question comes from Steve Smigie with Raymond James.

[J. Steven Smigie:]

Great. Thanks a lot, guys. I was hoping you could talk a little bit more about China, and specifically, can you talk about if industrial orders for China were any different from other regions. As you look more longer term, obviously, there's been a lot of talk in the news about this China shift to a different economy where they're not just the manufacturing hub of the world and investing more in the service economy, et cetera. So does that suggest you that maybe there's some lower opportunity for industrial growth for you guys into the future?

[Vincent T. Roche:]

Yeah, it's a very good question. So, clearly, as you said, China's shifting from we make it to we design it and build it, so we've benefited. This will be, actually, when history is written on our fiscal 2015 here, we will have had – we will have posted very, very strong double-digit growth in the industrial sector in China, across the board, in fact, in healthcare, in energy, transmission and distribution of energy in particular and also industrial instrumentation and automation. So, clearly, China is in the process of indigenizing the tech industry there, so we're benefiting from that in terms of our engagements with emerging OEMs in way outside of the consumer – communications infrastructure and consumer businesses. So industrial's emerging, automotive's emerging, healthcare's emerging. And we're doing particularly well, and pleased with the progress we're making in building out our business there.

[J. Steven Smigie:]

Great. Thanks. And the part about the short-term in China versus other regions in industrial?

[Vincent T. Roche:]

It's been very, very – it's been quite strong, and it remains steady.

[J. Steven Smigie:]

Great. Thank you.

[Operator:]

This question comes from Romit Shah with Nomura.

[Romit J. Shah:]

Yes, thank you and congratulations on what looks like a very solid fiscal 2015. Vince, ADI has this history of being in and out of the consumer market, and if I look at the October quarter it looks like consumer will be roughly 30% of sales. And my guess is that portable will account for a substantial portion of that. So my question is, what's your confidence, or visibility, into sustaining your position here in this high-volume program?

[Vincent T. Roche:]

Well, we have in the past, I think, in many cases, we have at one point in time about five years or six years ago, we were spending about 35% or 40% of the entire R&D budget of the company in many, many different applications within consumer. I think the way to think about this time, the spend is quite constrained. It is in an area that is very, very close to the core capability of the company, and we're playing with market leaders. We're playing with the leaders and defining really exciting opportunities together that we think have really got legs over the long-term. So it's a very focused engagement, and we are really concentrating on uncovering those problems that give us the opportunity to apply the best of our technology over the long-term. I think that's how to think about.

[Romit J. Shah:]

I guess my question is how do you manage the risk associated with mix given that consumer is now a larger percentage of sales than I think we've seen in the last five years, 10 years.

[Vincent T. Roche:]

Well, the foundation of this company is the business-to-business space, it's the communications infrastructure, it's the industrial business, automotive, healthcare where we have many, many thousands of customers, hundreds and hundreds of applications, 20,000 product SKUs, and the R&D is largely pointed there. So that is the core business of ADI, and will remain so into the future. So, in terms of how – I'm telling you how we're strategically viewing it, how demand patterns evolve over time will depend on macro markets, will depend on the success of our technology, and so on and so forth. But I think we've got the right strategic mix here, and the rest is down to how well we execute in the markets.

[Ali Husain:]

Okay, thanks, Romit. We'll get...

[Romit J. Shah:]

Okay. Thank you.

[Operator:]

This question comes from Stacy Rasgon with Bernstein Research.

[Stacy Aaron Rasgon:]

Hi guys, thanks for taking my question. Do you think you're booked – what would your book-to-bill be if you took out the consumer ramp? I know you said it's positive right now. What would it be if you took the consumer ramp for next quarter out?

[David A. Zinsner:]

I think it's, yeah, roughly one.

[Stacy Aaron Rasgon:]

Roughly one? Even with industrial falling and automotive I know you said it was sort of in line, but it was supposed to be flat, it was down 7.

[David A. Zinsner:]

Yep.

[Stacy Aaron Rasgon:]

Okay. Thank you, guys.

[David A. Zinsner:]

Okay. All right, thanks.

[Operator:]

This question comes from Craig Hettenbach with Morgan Stanley.

[Craig M. Hettenbach:]

Thanks. Just a question on Hittite, just a couple quarters in now. Just how the integration's going? And then just bigger picture, as you think about capital allocation and your appetite for M&A versus buybacks and dividends.

[David A. Zinsner:]

Okay, well, the Hittite integration is going fantastic. The business has done great, and we are exactly on plan in terms of our synergies. And really – I'd be interested to hear Vince's take, but I would say it's almost as if that whole, prior Hittite aspect of the company's completely gone away. They're part of the ADI family. They operate – in a lot of ways you can't tell the ADI employees from the Hittite employees in the RF part of our business. So it's been a tremendous success. Our intended use of capital does include acquisitions going forward. And we continue to look at different opportunities in that space. As you know, we're looking for technology that is highly differentiated, that's really synergistic with what we're doing with our customers, where our customers will see value in us having that capability or where we think that will integrate with some of the things we do in a way that just kind of elegantly provides a solution to the customer. And so we continually monitor what opportunities are out there. I wouldn't guarantee that we're going to do an acquisition in the next year, but I think it's a reasonable probability that there will be some tuck-in kind of opportunity for us over the next year that could be just as dynamic as Hittite was for the ADI business.

[Vincent T. Roche:]

Yeah, I think just to add a little bit of color to what Dave has said, in terms of Hittite, I mean, we were always very, very confident in the technology, the market position of Hittite. So really if there was a risk, it was going to be around the cultural integration of the two entities. So we knew that the value system at Hittite was very, very similar to ADI's in terms of the belief that innovation drives business success, that engineering excellence is really what matters in that business to customers. And that's exactly how it's played out. And I think when you watch as I do the interaction of our engineering teams with our biggest customers out there and across the board in many, many different applications, not just in communications, but the leveraging of that technology into areas like aerospace and defense instrumentation, satellite communications, it's really tremendous. So I have enormous optimism and confidence about the combination of the RF and microwave talents across the entire company and what it means to the future growth prospects of ADI. So, great, delighted with it.

[Craig M. Hettenbach:]

Got it. Thank you.

[Operator:]

This question comes from William Stein with SunTrust.

[William Stein:]

Great. Thank you for taking my question. I'm wondering if you can dig a little bit more into the wireless part of the business? Understanding that we're seeing a pause in China and the business is down quite a bit from its prior peak, I'm wondering what gives you confidence that we're at the bottom and that you see a snapback in relatively short order? Thank you.

[David A. Zinsner:]

Well, I think, it's two reasons. One, the order rates have stabilized over a fairly long period of time, and usually when things are weakening, you see it in the order rates pretty quickly. And then the other thing is Vince and some of the business unit leaders, they're regularly going out to the larger OEMs that supply into this space, our customers, to get a pulse of what's going on. And the feedback from those customers is that they have obviously reduced their order flow to us to this level for reasons that we're all well aware of. But their expectation is that they're going to turn those order levels back up at some point within the next couple of quarters. So we don't know exactly when that'll happen. It could happen in the late part of next quarter, it could be first quarter before it happens. But given that the OEMs are telegraphing that to us, that gives us some confidence that we're at the bottom and that, in all likelihood, we'll see it turn back up at some point here.

[William Stein:]

Great. Thanks, and congrats on the quarter.

[Vincent T. Roche:]

Thank you.

[Operator:]

This question comes from Amit Daryanani with RBC Capital Markets.

[Amit Daryanani:]

Thanks a lot. Good afternoon, guys. I guess a question on your free cash flow conversion numbers. It was around 19% this quarter as a percent of sales. The last four quarters it's been around 25% I think. What do you think it takes it to get to within your target of 28% to 32%? And as consumer gets bigger, does that have any impact to your free cash flow generation as you go forward?

[David A. Zinsner:]

Well, that's a good question. I think, really, when you look at this quarter because of the ramp in the consumer business, that requires us to lay out a fair amount of cash to our foundries to build up the inventory to be able to support that demand. And so our working capital number, I think, if you looked at it relative to the past several quarters, you'll see it's actually quite a bit more negative than in most quarters. I think that's part of it. We were in the trailing edges of spending a bit on building infrastructures. That's mostly behind us now. And so I think that starts to improve. And then lastly, we pay our variable compensation every other quarter. It just so happened to be this quarter we paid out half a year's worth of variable compensation. And so that hit us as well. So this was, like, the perfect storm of all the things kind of going against us on a free cash flow basis. But we analyzed this quite a bit particularly recently, given that the number was a little bit below our benchmark. And we feel pretty confident that we will be within that range in relatively short order once we kind of get to a normalized state in terms of working capital, in particular related to the consumer business.

[Amit Daryanani:]

Perfect. Thanks, and congrats on the quarter.

[David A. Zinsner:]

Sure.

[Vincent T. Roche:]

Thank you.

[Operator:]

This question comes from C.J. Muse with Evercore ISI.

[C.J. Muse:]

Good afternoon and thank you for taking my question. I guess curious in terms of the macro demand picture and whether or not you're seeing any softness geographically? So that, I guess, primarily a question around auto and industrial and what you can share there cycle-wise and demand-wise. And then I guess if I could sneak a second one in, did you have a 10% customer in the quarter? Thank you.

[David A. Zinsner:]

Do you want to take the geographical question?

[Vincent T. Roche:]

Yeah, let me talk about the geo thing a little bit. So I think, overall, just to give you a little bit of color there, so Europe, I would say, not surprisingly the industrial sector's a little weak. Europe tends to take a pause. And I'd say the industrial sector in particular was maybe a little weaker than we had expected. So I think as well North America, industrial was also relatively weak, some sectors were better than others. And I think when you look at China and Asia-Pacific, automotive was quite soft, and it's well publicized that the communications infrastructure was weak, but at least the patterns have stabilized there.

[David A. Zinsner:]

And then in response to the 10% customer, we did have one customer for the quarter that was greater than 10%.

[Ali Husain:]

Thanks, C.J. I think that was two questions, so.

[David A. Zinsner:]

No re-queuing.

[Ali Husain:]

Anyway, we'll let it be. All right, we'll get to the next question, operator.

[Operator:]

This question comes from Ian Ing with MKM partners.

[Ian L. Ing:]

Yes, thanks for taking my question. How close to full factory utilization are you in the October quarter? And with the consumer mix, has your view changed on managing factory utilization and internal inventory throughout the year? Is it possible to get – have a steadier utilization throughout a normal year?

[David A. Zinsner:]

We were in the mid-70%s for utilization this quarter. That was similar to where we were last quarter. I don't remember if I said it before, but we're probably going to take utilization down a little bit in the fourth quarter. All of the ramp in revenue for the fourth quarter at least from a front end perspective will come from foundries. So it won't affect utilization in any way on the front end.

[Ian L. Ing:]

Thanks.

[David A. Zinsner:]

Sure. Now ideally, over time, we're working to get that utilization up, and it has been – I think if you look at it on a year-over-year basis, it has been steadily kind of moving up a little bit, and it has been helpful to gross margins. So that is our goal to make better use of our existing factories to drive gross margin expansion. So next question.

[Operator:]

This question comes from Jim Covello with Goldman Sachs.

[James V. Covello:]

Hey, guys. Thanks for taking the question. Congratulations on the terrific results. Kind of a philosophical question going forward. I wondered what your approach will be for folks who have won a lot of consumer business or ramped a lot of consumer business in particular with one big customer, over time, some of your analog peers, someone like a Linear. When that product comes up for invariable price declines or ASP declines, some analog companies have kind of walked away from that business, like Linear. Others like NXP have said, "look, as long as we're maximizing gross profit dollars, we don't care if it hurts our gross margin a little bit." Obviously either approach is fine, both companies have been incredibly successful with those different approaches. But I wonder what your philosophy will be on that as we go forward?

[David A. Zinsner:]

Well, our goal is "we won this business, our goal is to keep it." And the good news is we think it's technology that has a lot of legs to it, that it's highly differentiated. And as a result, the customer values it and pays a premium for it. So our anticipation is that we will not lose it, nor will we have massive ASP erosion as a result. But that'll be borne out over time.

[Vincent T. Roche:]

Yeah, look, I think another aspect of the strategy here is that a lot of technology trends center around these types of consumer systems being able to see, being able to hear, being able to feel. And I think there's some great macro trends there that speak very well to the types of technology that we have, that sit at the intersection of the physical world and the world of the digital. So, and as the performance goes up, the space is getting tighter and tighter, battery-powered efficiency has got to become greater and greater. There's some really chunky problems to be solved there, and not just one type of problem, there's many, many different problems. So we seek as we do across all our businesses, we look for diversity in each application in terms of the types of technology that we can apply, the number of products that we can develop. And so it's not a tale of one product, one customer, it's a tale of many, many different types of technologies across many, many different modalities there in terms of that intersection of the physical and digital worlds.

[Ali Husain:]

Next question.

[Operator:]

This question comes from Tore Svanberg with Stifel.

[Tore E. Svanberg:]

Yes, thanks for letting me ask a follow up here. Just coming back to the seasonality part of the business. So with consumer being about 30% in the next quarter, how should we think about not just the January quarter, but maybe even the April quarter? So you've had some seasonality in the past. I'm just trying to figure out how that's going to play out going forward.

[David A. Zinsner:]

Well, Tore, you're asking me to whip out the crystal ball here, which, I don't know, might be on the fritz. I would say that sitting here today, with almost no backlog to really tell for certain how things are going to progress, that the first quarter, which is typically down mid-single-digits. Given that there's a more significant percentage is likely to be in the consumer space in the fourth quarter, and that that has normally a more dramatic seasonal decline in the first quarter, we're likely to be more than mid-single-digits down sequentially in the first quarter, but I'm not certain of that. And then in the second quarter, generally consumer seasonally is relatively flat first quarter to second quarter. But we have this lift in industrial, this tends to be our best quarter for industrial in the second quarter, and that gives us a good lift for the second quarter sequentially. And so that is how I would model it out right now having limited information as to how things kind of behave.

[Ali Husain:]

Thanks, Tore.

[Tore E. Svanberg:]

That's very helpful. Thank you, Dave.

[David A. Zinsner:]

Thanks.

[Ali Husain:]

Next question, please.

[Operator:]

This question comes from John Pitzer with Credit Suisse. John William Pitzer - Credit Suisse Securities (USA) LLC (Broker) Yeah, guys. Thanks for letting me ask a follow up. Dave, just real quickly, when you look at the October run-rate on the consumer side, does that now represent kind of your full opportunity on the mobile side, i.e., multiple platforms with a certain customer, or and hence from here, it's more of a unit story or there's actually potentially other platforms that you guys could penetrate within the consumer space?

[David A. Zinsner:]

I don't think I would suggest that the back half of the year we're going to have any specific additional platforms, but our goal over time is to expand in every end market in terms of opportunity. So, over time, I think, there is an opportunity to do that.

[Ali Husain:]

Great. Thanks, John. John William Pitzer - Credit Suisse Securities (USA) LLC (Broker) Thank you.

[Ali Husain:]

Next question, operator.

[Operator:]

This question comes from Vivek Arya from Bank of America.

[Vivek Arya:]

Thanks for letting me ask a follow up. And sorry to beat this dead horse about macro and seasonality, but is there something that is company-specific, outside of consumer, that you think is helping you provide a more sort of stable/seasonal outlook versus a more cautious outlook that we have heard from, say, a Linear Tech or Microchip or Texas Instruments.

[David A. Zinsner:]

Well, I do think that the industrial business for us is made up of these kind of broader market – end markets, and then these more ASSP oriented markets. I think it's safe to say that the broader markets were a bit weaker and that the ASSP or vertical markets did a little bit better. And I think somewhere in Vince's remarks he talked a lot about diversity. I think also Ali talked about it as well. I mean, that's the benefit of diversity is we're in so many different parts of the industrial space, both the broad market and very interesting verticals and some do better than others, depending on the quarter. But I think that really, if I had to, like, line our performance up in the third quarter relative to what I saw from some of the other players, I would say where we outperformed seemed to be in some of the specific verticals like aerospace and defense and energy and so forth.

[Vincent T. Roche:]

As you know, we're on a sell-through basis across the globe as well, so the transparency that we have around demand and supply is very, very strong. So our sense is that there's a good balance between consumption and supply at this point in time. And we, as a company, measure only end customer bookings. So that's what we base our understanding of demand on. And so what we're reflecting to you is what we see.

[Vivek Arya:]

Thank you. Very helpful.

[Ali Husain:]

All right, great. Well, looks like we have reached the 6

[Operator:]

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