Maxim Integrated Products, Inc.
Q1 2015 Earnings Call Transcript

Published: 24 Oct 2014

[Operator:]

Good day, ladies and gentlemen, and welcome to the Maxim Integrated First Quarter of Fiscal 2014 Earnings Conference Call. [Operator Instructions] As a reminder, today's program is being recorded. I would now like to introduce your host for today's program, Kathy Ta, Managing Director Investor Relations. Please go ahead, Kathy.

[Kathryn Ta:]

Thank you, Jonathan, and welcome, everyone, to Maxim Integrated Fiscal First Quarter 2015 Earnings Conference Call. With me on the call today are Chief Executive Officer, Tunç Doluca; and Chief Financial Officer, Bruce Kiddoo. I would like to highlight that we have posted a supplemental financial presentation to our Investor Relations website. The information in this presentation accompanies the financial disclosures in our earnings press release and on this conference call. During today's call, we will be making some forward-looking statements. In light of the Private Securities Litigation Reform Act, I'd like to remind you that these statements must be considered in conjunction with the cautionary warnings that appear in our SEC filings. Investors are cautioned that all forward-looking statements in this call involve risks and uncertainty and that future events may differ materially from the statements made. For additional information, please refer to the company's Securities and Exchange Commission filings, which are posted on our website or available from the company without charge. Now I'll turn the call over to Bruce.

[Bruce E. Kiddoo:]

Thanks, Kathy. I will review Maxim's first quarter financial results. Revenue for the first quarter was $580 million, down 10% from the fourth quarter and at the low end of the guidance range we provided last quarter. This decline was primarily driven by lower smartphone volumes at our largest Mobility customer. The continued weakness in our Consumer business was the catalyst for our decisions regarding product line investments and technology development methodology. We are finalizing structural changes to lower our cost structure to improve profitability at any revenue level. These plans include focused OpEx reductions, mostly in R&D in specific businesses where the return is no longer adequate; closure of our fab in San Jose with supported low-volume manufacturing and process technology development; continued tight spending controls company-wide. Together, when fully implemented, these actions are estimated to achieve $20 million in quarterly savings. Approximately half the savings will be in operating expenses and will be achieved before Q4 of fiscal 2015. The fab closure savings will reduce COGS and are currently estimated to require 18 months to fully realize. Outside of Consumer, our businesses serving the Industrial, common data center and Automotive end markets performed within our expectations for the quarter and delivered 20% year-over-year growth. Our revenue mix by major market in Q1 was approximately 30% from Consumer, 28% Industrial, 26% common data center, 11% Automotive and 5% Computing. In the quarter just completed, our Consumer business was down sequentially below our expectations due to continued weakness in smartphones, primarily at our largest Mobility customer. Our largest Mobility customer now represents roughly 13% of revenue, down significantly from 27% of revenue in fiscal 2013. Our Industrial business was down sequentially as expected, driven by normal seasonal trends in our core Industrial end market. Our Communication and Data Center business was flat sequentially as expected, driven by strength in our enterprise server business, offset by weakness in Communications infrastructure, largely due to the China 4G LTE rollout. Our Automotive business was down sequentially in line with seasonality. And finally, our Computing business was flat sequentially. Turning to the P&L, Maxim's gross margin excluding special items was 61.6%, above our forecast and up from 60.4% in the prior quarter. Gross margin benefited from lower inventory reserves and overall cost controls. Special items in Q1 gross margin included intangible asset amortization from acquisitions. Operating expenses, excluding special items, were $220 million, down from $227 million in the prior quarter. The decrease in operating expenses was driven primarily by lower bonus accrual and overall tight spending controls. Special items in Q1 operating expenses included acquisition-related and restructuring charges. Q1 GAAP operating income excluding special items was $137 million or 24% of revenue. The Q1 GAAP tax rate excluding special items was 16.9%, down from 19.9% in the prior quarter due to one-time credits. Special items in the Q1 tax rate include a $22 million credit related to a prior acquisition. GAAP earnings per share excluding special items was $0.38, in line with our guided range, primarily due to higher gross margin, lower operating expenses and a lower tax rate, offset by lower revenues. Turning to the balance sheet and cash flow. During the quarter, cash flow from operations was $117 million or 20% of revenue and down from the prior quarter due to the payment of our annual employee bonus in Q1. Inventory dollars were up 5% or $16 million. This increase was primarily due to inventory built ahead of a customer product launch that was delayed and to improve delivery performance for Industrial and Automotive customers. Inventory days ended at 125, up 22 days from Q4. Half of this increase was from increased inventory and the other half from lower COGS. We accept -- we expect to bring down absolute inventory levels and days by reducing factory loadings this quarter, but we forecast both to remain temporarily elevated above historical levels as we continue to carry material related to an anticipated product launch. Inventory in the channel remained approximately flat at 55 days, within normal levels. Net capital additions totaled $21 million in Q1, down from the prior quarter and at 3.7% of revenue, slightly below the midpoint of our long-term target range. Net capital additions are lower than depreciation, enabling free cash flow to grow faster than earnings. Trailing 12-month free cash flow ending in Q1 was $672 million or 27% of revenue. This represents an 11% increase over a year ago. Share repurchases totaled $63 million in Q1. We also paid $80 million in dividends to our shareholders. The yield on our quarterly dividend, up $0.28 per share, was approximately 4.1% at yesterday's closing stock price. Overall, total cash, cash equivalents and short-term investments decreased by $53 million in the first quarter to $1.32 billion. Moving on to guidance. Our beginning Q2 backlog increased by $2 million to $379 million. Based on this beginning backlog and expected turns, we forecast Q2 revenue of $540 million to $580 million, which reflects a cautious view of smartphone and tablet shipments at our largest Mobility customer as well as shipments into other Mobility opportunities being later than we had expected. Outside of Consumer, we expect Industrial to be slightly down seasonally, Communications and Data Center down and Automotive up in Q2. Q2 gross margin excluding special items is forecasted at 58% to 62%, down from the prior quarter due to lower factory utilization in Q1 and the current quarter. Special items in Q2 gross margin are estimated at approximately $19 million, primarily for amortization of intangible assets. Q2 operating expenses excluding special items are expected to be flat from the prior quarter, including a full quarter of our annual merit increases offset by continued tight expense controls. Special items in Q2 operating expenses are estimated at approximately $4 million for amortization of intangible assets. The estimates for Q2 special items for both gross margin and operating expenses exclude any charges associated with the planned restructuring activities. Our Q2 tax rate excluding special items is estimated at 20% to 22% due to lower international profits. For Q2 GAAP earnings per share excluding special items we expect a range of $0.26 to $0.32. For fiscal year 2015, net capital expenditures are expected to be at the lower half of our target range of 3% to 5% of revenue. We expect share repurchases in Q2 to be consistent with the prior quarter, adjusted for market conditions as appropriate. In summary, we believe our long-term financial strategy of growth, leverage and return is on track. We are taking targeted steps to reduce R&D and manufacturing spending to improve profitability at any revenue level. We had strong year-over-year revenue growth in every one of our segments outside of Consumer and we forecast demand in line with seasonality in the December quarter. We remain committed to our 30% operating margin target, which will benefit from expected revenue growth and planned spending reductions. And finally, we remain focused on growing free cash flow and returning cash to shareholders as demonstrated by our growth in trailing 12-month free cash flow and industry leading dividend yield. I will now turn the call over to Tunç to further discuss our business.

[Tunc Doluca:]

All right. Thank you, Bruce, and good afternoon to everyone on the call. We appreciate your interest in Maxim Integrated, and thank you for joining us today. I want to say upfront that we're disappointed with our results. We are taking the necessary actions to drive the long-term growth and profitability of Maxim. Our September quarter revenue performance was at the low end of our expectations, driven by continued weakness at our leading Mobility customer in their flagship smartphone and tablet products. We expect this weakness to continue into our December quarter. While we are gaining content in each product generation at this customer's flagship products, we do not expect the snapback of that business to historically high levels. This reality was the catalyst to drive several difficult decisions that will improve Maxim's profitability and enable more focused investment in top line growth. Bruce discussed our cost reduction plans in his prepared remarks. The R&D reductions he outlined will enable us to focus investment in our growth businesses with higher returns while reducing overall R&D spending. In manufacturing, we are making a strategic shift of advanced node process technology development through a new collaboration with our foundry partners. As a result, we have decided to close our San Jose fab, which is used for both development and low-volume manufacturing. We plan to commercialize the leading-edge special technologies developed in San Jose by transferring our manufacturing capability to a combination of internal and external factories. This action will structurally improve our operational efficiency and will help realize phased benefits over the next 18 months. While these are clearly difficult actions, they are an outcome of investment decisions we make to adjust to changes in market conditions, return on investment profiles and long-range technology development roadmap. Our overall company strategy of mixed signal and analog integration is bearing fruit and I'm confident in our long-term growth prospects. This is evidenced by the strong year-over-year revenue growth performance of every one of our segments outside of Consumer. We remain committed to growing our Mobility business through increasing content opportunities, broadening our customer revenue base and the new platform, such as wearable devices. Now with that commentary as a backdrop, let me next provide some color on our major markets, starting with Consumer. We understand investor concerns about the declines in this business, driven by lower unit volumes of high-end smartphone demand from our largest Mobility customer. The cost reductions we're articulating today will enable our organization to be structurally aligned to our changed environment. Our Mobility business remains profitable and in line with our corporate targets. We remain committed to growing this business. Our September quarter consumer end market revenue was strongly down from the June quarter, driven by significant flagship smartphone unit weakness at our leading Mobility customer. While we expected this weakness at this customer, conditions continued to weaken during the quarter due to lower build of their newest product. We expect that this end market will be down again in December, below our earlier revenue expectations. We also believe that the December quarter will be the trough in Consumer for Maxim. At our other large Mobility customer, we have significant design wins with revenue from tablet platforms contributing to our September and December quarters. Our December guidance does not currently include revenue from a new wearable product at that customer because we lack visibility as to launch timing. We are making progress in winning designs and building business relationships at Chinese smartphone manufacturers. However, in the near term, we expect this to remain a relatively small portion of our consumer revenue stream. Let me next turn to the Industrial market. Our September quarter Industrial business was up 7% from the same quarter of last year, but sequentially down, in line with seasonality. A year ago, we took a fresh look at our business model in our broad-based core Industrial market segment. We instituted changes in our processes and organization that enable our customers and channel partners to have greater ease of doing business with Maxim. These changes have helped our largest distribution partner, ABnet, to become our largest account at 19% of total company sales in the September quarter. Turning to our vertical Industrial markets. Financial terminals and smart meters were strongly up in September, driven by growth in mobile payment terminals and smart meter deployment projects in Asia. The growth in these vertical markets was offset by a decline in automatic test equipment as end customers have added test capacity in prior quarters. Looking forward, we project December quarter Industrial revenue to be slightly down, in line with seasonality. Let me now provide some commentary on our distribution business. We experienced about flat end market resales overall, with higher resales in Asia offsetting seasonally weaker resales in Europe. Globally, days of inventory was 55 at the end of the September quarter, which was flat with the June quarter and in line with historical averages. Although we are still seeing a relatively healthy pattern in our distribution business, we are mindful of the increasingly negative macro data points coming out of Europe and Asia and are monitoring the environment closely. Our September quarter Automotive business was up 43% from the same quarter of last year, reflecting solid content growth in high-end and mid-range cars and a broadening customer base. Our Automotive business was sequentially down in September, driven by typical seasonality. In the December quarter, we expect Automotive to be up, where our solid top line of design wins is enabling better than seasonal performance. The broad set of infotainment applications remains the largest driver of our growth in this business. Next, let me discuss Communications and Data Center. Our September quarter Communications and Data Center business was up -- sequentially flat. The majority of this year-over-year growth is through our acquisition of Volterra, with the balance of the growth from broad-based wins across our Communications and Data Center portfolio. We saw particular strength in the server and data center market, which was driven by strong demand for Volterra products. We have reached the 1-year anniversary of our acquisition of Volterra. Our customers have faced revenue headwinds in the server end market. However, I'm very pleased with the progress we made in introducing Volterra technology for cloud computing and communications infrastructure applications. We are seeing increasing signs of an industry transition from traditional servers to new architectures that are optimized for cloud computing. Throughout last year, we've built solid engagements with both new and traditional server and data center customers and I'm pleased to report that we have new design wins with large cloud leaders. These will begin to ramp in calendar 2015. Additionally, Volterra Technology has enabled design wins and new communications opportunities which will also begin to ramp in 2015. Outside of Volterra, our optical RF and power products showed modest sequential declines due to exposure to 4G LTE infrastructure in China. Our cable infrastructure business continues to grow with adoption of our advanced data converter products. We expect our Comms and Data Center business to be down in December with expected growth in base stations to be more than offset by declines in other communications infrastructure and servers. In the Computing market, revenues in September were flat, better than we expected, driven by short-term strength in our Notebook business through older Volterra products. We expect Computing to be down in December, driven by a decline in Notebooks. So to summarize our view for the December quarter, we expect revenue from the Industrial market to be slightly down with seasonally lower core Industrial sales. We expect Automotive to be up as we deliver on our robust pipeline of design wins. We expect Consumer to be strongly down with softness in smartphones and normal year-end inventory management at our leading Mobility customer. Our December guidance excludes revenue from a new wearable product. Communications and Data Center is expected to be down from a strong September and Computing is expected to be down after recovery over the last 2 quarters. In closing, while we experience continued softness in our Consumer market, we are managing our portfolio to adapt to the changes in our business environment. We are showing excellent progress and growing revenue from new power-efficient applications in Industrial, Automotive, Communications and Data Center markets, and we are executing on our strategy to broaden our revenue base in Mobility. Kathy, I will now turn the call back to you.

[Kathryn Ta:]

Thanks, Tunç. That concludes our prepared remarks, and we would now welcome your questions. [Operator Instructions] Jonathan, please begin polling for questions.

[Operator:]

[Operator Instructions] Our first question comes from the line of Blayne Curtis from Barclays.

[Blayne Curtis:]

Tunç, obviously, the weakness in the mobile supply chain, that customer hasn't done well. So you said December will be a trough. What gives you that confidence? Obviously, you had to reinvent yourself every year with new phones. Do you have good visibility that you'll be able to maintain your content and, therefore, see a trough? And then in that segment, why are you excluding the wearables? Do you just not want to miss it again and just being conservative?

[Tunc Doluca:]

Well, in terms of your question about why do we think it's going to go up from here, we do have lots of activity, obviously, at our major Mobility customer, so we know which sockets we're trying to win and we have some confidence in winning those sockets. And in terms of your question about wearables, we split it out and we didn't want to put it in this quarter because we don't really have good visibility and we thought it would be more prudent to not put it in.

[Blayne Curtis:]

Okay, great. And then just, Bruce, on gross margin, obviously, the mobile business probably has the worst gross margin so you should see a benefit. Why the downtick in the gross margin and maybe within that where are your utilization rates?

[Bruce E. Kiddoo:]

Yes. Thanks, Blayne. I think most people know actually, the gross margins for our Mobility business is good, right? And just so you know, a little bit below corporate average, so that doesn't pull it down very much. The reason for the downtick is utilization. Right? We were at about 71%, 72% in the September quarter and we're probably going to be in the mid to low-50s in the December quarter. So that's really what's driving it down.

[Kathryn Ta:]

Thanks, Blayne.

[Operator:]

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

[James V. Covello:]

First, one is kind of just a strategic or philosophic question. How do you think about the difference between working to diversify the customer base within consumer and handset versus just setting a lower target for what that should represent as an overall percentage of the business?

[Tunc Doluca:]

Well, okay, so our strategy in Mobility going forward is really to be able to grow that business, and we believe that we can achieve both of those at the same time. So we're trying to make sure that we do get design wins in other customers as well as in other applications at that one customer so that we're diversified along the 3 lines that we talked about before. We want to diversify along technologies, and we're doing that with products that we're developing and winning, in sensors and audio, for example. And we want to diversify along customers, so we're making efforts at the other largest customer to win designs, and we have some wins in their tablets and the new wearables that are going to come out. And we also are working in China to get design wins in, what I would call, more the middle- to high-end tier phones in China. So we believe that we can really achieve our goals by going along both vectors and being able to diversify customers, but also grow the business at the same time in Mobility.

[James V. Covello:]

Okay. And then for the follow-up, I guess if utilization is going to be down into the 50s in the December quarter, would you anticipate it again at that level in the March quarter? Or would you anticipate taking the utilization back up in the March quarter?

[Bruce E. Kiddoo:]

So partially, it depends on the demand, of course. But in addition to that, as you've seen, right, inventory ticked up in the quarter and we're certainly working to bring that back down. Plus, we built ahead for a large product launch that's primarily going to be in the March quarter. So I would expect, once we've gotten through that kind of worked down the inventory and then start kind of building again for that launch in the third quarter, that utilization should go up.

[Operator:]

Our next question comes from the line of Tore Svanberg from Stifel.

[Evan Wang:]

This is Evan Wang, calling in for Tore. I would just like to ask you for some clarification on your R&D restructuring. Is the cutback in cost specific to customers? Or is it more across-the-board?

[Tunc Doluca:]

So remember -- so the restructuring we talked about had 2 components

[Evan Wang:]

Got it. More product-related. I was also wondering if you could make a comment about the macro environment. You had mentioned that you're seeing some more data on the weakening and I was wondering if you can compare what this -- what you're seeing as compared to last year? And how extensive do you think this weakening could be?

[Tunc Doluca:]

Well, we actually -- I didn't really talk about weakening. We said that what we're seeing right now wasn't pretty much -- in the broad market, it was pretty much what you expect seasonally. It's really not worse than that. And it's really not much different than last year, if I remember correctly. So the only caution I mentioned in my prepared remarks was that there are some negative news coming out of Europe and China. But if we just forget the headlines, news headlines, and look at what's the inventory in the channel, what's the resales look like, we really are not seeing something that tells us that there's a weakening demand.

[Operator:]

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

[Craig Hettenbach:]

Just following up on the consumer and some restructuring. Part of the strategy has been to kind of grow outside of the core power management. Will that impact that in terms of where you're investing and some of the growth drivers you might see over time?

[Tunc Doluca:]

No, actually. I mean, we've done some trimming in some of the product areas or plan to do. But power continues to be a market where we're very strong and have very good advantages against our competitors, so our investments pretty much in that area do continue. And we've done some adjustments in some of the product lines, or plan to do, in the Mobility area. But the product lines that we have talked about investing in overall, those continue. The types of products we're investing in changed a little bit.

[Craig Hettenbach:]

Okay. And then as you look at the business overall and as Consumer comes down a bit, do you envision kind of diversifying the business through organic growth? Are you looking at tuck-ins or any other ways you're looking to kind of change the end market mix over time?

[Bruce E. Kiddoo:]

So Craig, this is Bruce. I'll take that. Certainly, we have our strategies to aggressively grow the business and organically. And as we've shown outside of Consumer, all of the markets are up. Combined, non-consumer, up 20% year-over-year. So we're certainly focused on organic growth and we think we're doing a good job in that area. We do expect, once we sort of kind of work through the near-term Mobility issues, that as we're able to broaden that base, we're able to grow our Mobility business as well. From an acquisition point of view, we said we're certainly aware of what's going on in the industry right now and the beginning of consolidation. Certainly, we're a very financially strong, stable profitable company. We don't have to do acquisitions, but if there's a high-quality asset out there that we can get at a reasonable price, that's something we'll look at. I would say if you kind of go through the criteria, certainly, it has to fit within our strategy, all right? We have to be able to make money, all right, and deliver shareholder value. And then to the extent it helps from a diversification point of view, that's a positive, but that's not at the top of the list.

[Operator:]

Our next question comes from the line of Vivek Arya from Bank of America.

[Unknown Analyst:]

This is Shankar [ph] , in behalf of Vivek. I have a question on the OpEx. If I'm not mistaken, you said on a quarterly basis, that savings would be $20 million a quarter. Is that -- and it's probably going to be complete by the end of fiscal '15. How do we think about the OpEx coming out of the income statement on a quarterly basis from now onwards til that point?

[Bruce E. Kiddoo:]

I didn't quite hear the end, but let me just kind of address it. So we've said that we've identified $20 million in quarterly savings. We said about half of that is above the line related to the closure of our San Jose fab and we said about half is related to operating expenses. So around $10 million savings to operating expenses. We do expect that kind of going into Q4, we should be able to -- Q4 of this fiscal year, we should be able to realize those savings. For the above-the-line savings and the closure of the fab, that's a very complex process. We have a number of, I would say, proprietary process technologies that we need to move, both to either other internal fabs or to our foundry partners. So that can take -- that will take up to 18 months. We may see some benefits along the way, but that's a very complex process. We're still kind of working on those plans of how -- what that timing looks like, so it's difficult at this point to say how that $10 million goes over time. But it's certainly going to take some time and -- for the total process, about 18 months. And if you recall, a number of years back, we did -- the Dallas fab shutdown. And again, that took about 18 months for us to execute on that. So did I answer your question?

[Unknown Analyst:]

Yes. I have a follow-up. So I don't know if it's -- you have enough visibility in the first half, but given what you see right now, what do you think the first half seasonality is going to be? Is it going to be the normal seasonality on the different segments? Or do you see any difference related to what you see there?

[Bruce E. Kiddoo:]

Yes. At this point -- well, first off, we don't give guidance out to that time period. What we're seeing today is normal seasonality, really across all of our businesses. Obviously, Mobility is at a lower level right now because of the issues at our largest customer. But off that low base, if we look at the December quarter, everything we're expecting, kind of the normal inventory correction at Samsung [ph] , Industrial down slightly seasonally, actually Automotive is up and common data center, those are all in line with seasonality. And as Tunc said, while we're -- we read the paper. We're aware of concerns out there on the macro front. As we look at the data, as we look at what's happening in our business, we're not seeing anything that's out of line with what we would expect.

[Operator:]

Our next question comes from the line of Ambrish Srivastava from BMO.

[Ambrish Srivastava:]

Tunç, I'm a little confused. So the actions you are taking on the cost savings, great. But you keep saying that you're looking to grow the Mobility business and, in fact, just to quote you, you said, "the strategy going forward is to grow this business." That has been the strategy for as long as I can remember. So I don't see any real changes to the mobile side. My question is why not take -- why not recognize that you cannot really grow this business and why put shareholders through this tumultuous, volatile, wild [indiscernible] exploit? Why not sell this business, there are buyers out there, China to grow a semiconductor exposure. So that's what I'm struggling. I don't see real change to your consumer exposure. And then I have a follow up after that.

[Tunc Doluca:]

So I mean, the Mobility business, while we do agree that it's volatile and now we're on a down cycle, please also remember the fact that it really grew and carried the company for many years. So it is a business that is profitable and the profits are -- and we do see a huge growth opportunity in that business. After all, it is 30% of Analog, so it's not a market that one can ignore. And it's true that it is -- there's more variability in it, but we have taken measures in the company to offset that variability. We moved to a [indiscernible]. We are executing on the plan to get this diversity that we need in the market, in our product portfolio so that it's not as variable as it was in the past couple of years. So I think it's a good growth opportunity for the company. And our other markets do also benefit from technologies that come out of Mobility because Mobility is leading edge. Many of these technologies that we are developing, first from Mobility, for instance, the sensors technologies, they have the applications in medical, they have the applications in Industrial and they have applications in Automotive. So I think as a whole, the company is stronger with Mobility as part of it, not separated from it.

[Ambrish Srivastava:]

Okay. My quick follow-up then is as you have -- as you really align the footprints on the manufacturing side, how should we be thinking about CapEx as a percent of sales?

[Bruce E. Kiddoo:]

Yes, so this is Bruce. I'll take that. I think we guided in our Investor Day that we took our CapEx from 5% to 7% down to 3% to 5% of revenue. I think you saw this quarter, we're at 3.7%. And when we think about for the full fiscal year, we should be in the lower half of that 3% to 5%, sort of in the 3% to 4% of revenue. So clearly, as -- just like the closure of the San Jose development fab really reflects kind of more collaboration with our external partners, the same applies from a production point of view, and that strategy has been in place for many years now and so that's really what's allowing us to drive down our CapEx as a percent of revenue and, of course, the benefit of that is the significant growth in our free cash flow certainly that we've been seeing. We saw free cash flow growing 11% over the last trailing 12-month period. And so again, I think we feel like we're -- we have a structural change in our cash flow model going forward.

[Operator:]

Our next question comes from the line of Steve Smigie from Raymond James.

[Jonathan Steven Smigie:]

What target would you have for insource and outsource after closing San Jose? And as part of that, was the San Jose restructuring contemplated even before we saw this in the softness here on the mobile side?

[Tunc Doluca:]

So in terms of the changes we made to San Jose, it was something that we thought eventually would come because as we went to finer and finer geometries, in terms of new process technology developments, that fab is really not equipped to be able to do that. So eventually, we were cognizant of the fact that we were going to do some of this technology development with foundry partners that were capable of doing these technologies, frankly more easily than we do. So the catalyst here was kind of to move this into making this decision, probably, a little bit earlier than we do have, given the normal conditions. So I think that eventually, that's something that was going to happen in the company. In terms of the manufacturing output from that fab, it really is not that much, looking at the total output from Maxim. So it really does not impact that much internal versus external manufacturing for the company in the short term. In the longer term, it'll really depend on how much we can grow the Mobility business because some of the technologies that are used are used in our Mobility product lines.

[Jonathan Steven Smigie:]

And as my follow-up, I was hoping you could talk a little bit about the design wins that you do have in Mobility business, but in the complexity of the products you're winning with. So your -- one of your goals has been to diversify the customer base and you've been working on that. So just hoping to get some more color on the successes that you have seen and what's driving that?

[Tunc Doluca:]

So I think that there isn't a lot of information out there about what types of products we win in power, so I assume you're not asking about that. But in other technologies, in our diversification efforts, I gave a couple of broad examples. One of them was for audio and the second one was for sensors. I talked about those in previous questions or my prepared remarks. But the products where we win there are relatively complex. If you look at the sensor products, we -- last year, we announced our heart rate monitor products, which are fairly complicated, but they're single function, if you think of it that way. And the most recent product from the -- that was announced, the note [ph] product from our largest customer. We do have a UV sensor in that product, which is also fairly complex, that's able to provide user information about sun exposure or radiation exposure. The products that we make for audio, for -- to improve the sound quality, they're also pretty complex and involve algorithms to get the most -- the highest level of sound and the highest quality of sound out of really small speakers, and that's not a small feat at all. So many of these products where we're are relatively complex parts in the mobility market.

[Operator:]

Our next question comes from the line of Chris Caso from Susquehanna.

[Christopher Caso:]

To start, if I can go back to one of the earlier questions, and it was just a little unclear to me with regard to the start, when we would start to see some of the results of the OpEx savings. And is it right to assume that -- really, that we don't see any meaningful reduction from these savings until the fiscal fourth quarter? And as a follow-on to that, you guys did put an operating margin target out at the last investor meeting by the end of fiscal '15. Is that goal still on the table?

[Bruce E. Kiddoo:]

Sure. So from the operating expenses, you're right in that we've said we should be able to achieve that $10 million in savings, really effective in our fourth quarter of 2015. That said, we've been managing OpEx very tightly already and if you've noticed, we guided flat for the December quarter, even though this is the time when we normally OpEx goes up because we have our merit increases in the -- that are effective in September. So from that point of view, I think we already are managing it. We already are seeing some of the benefit of our controls, but that -- these additional cuts that we've talked about, we'll be able to see in the fourth quarter. And if you could remind me, what was the follow-up?

[Christopher Caso:]

The operating margin target.

[Bruce E. Kiddoo:]

Yes, absolutely. I mean, I think we're still committed to that 30% margin target. Certainly, our commitment is demonstrated by the kind of the announcements that we've made today, very substantial as far as shutting factories and reducing investment in various product lines. So we're absolutely committed to that. We've always said we need some level of revenue growth in order to achieve that. And so we're not going to get it at $560 million or $600 million. We've always said we needed some level of revenue growth. But certainly, these cuts that we've made today, I mean, these give you about 3 points of Op margin improvement. And so certainly, this is helping us get to that 30%.

[Christopher Caso:]

Okay, that's good. Just as a follow-on then, with regard to the channel inventory, and you're now back to kind of a more normal 54 days, I think, is the number that you said. Do you expect that the channel is going to leave the inventory at these levels? Obviously, there's some uncertainty out there that you guys spoke to. I guess the question is do you see the distributors kind of trying to hold inventory at these levels? And maybe you could identify the level of risk if they decide to bring that down a little bit.

[Bruce E. Kiddoo:]

So I do think this is probably the -- this is the level, really, for the last 3 years. It's been in the 50 to 55 days. We had 1 quarter, March of 2014, where it dipped below 50, and then right away, in June of 2014, they brought it back up to like you said, this kind of 54, 55 days. So I think from that point of view, they're comfortable at this level. If you think about any impact, if they did change, I think that's hard to quantify because we haven't seen much. Just as a data point, right, our international distribution business is on a sell-in basis and that's about 2/3 of our distribution revenue, whereas as our U.S. distribution business is on a sell-through point of view. So we're even a little bit mixed on the sell-in and sell-through, so it's not necessarily going to have, if they start to lower that inventory, have a pronounced effect.

[Operator:]

Our next question comes from the line of David Wong from Wells Fargo.

[David M. Wong:]

With your fab shutdowns and proposed R&D restructuring and things, are there any specific manufacturing technologies that you are no longer going to be able to do in-house and that you'll will be forced to outsource?

[Tunc Doluca:]

Yes. So in terms of manufacturing technologies, we do have a new generation of mobility-type process that was planned to come online and that basically will entirely be done outsourced. And that decision, we'd actually taken a little while ago. So it's not really recent. So that will be basically outsourced. In terms of the other technologies that our San Jose fab develops, they're mostly sensor-based, and that will be a mix. Some of those will be done in-house and some of those will be done outside.

[David M. Wong:]

Great. And do you have a long-term target for what percentage of your manufacturing will be outsourced?

[Tunc Doluca:]

We really have not -- we're not trying to achieve a target. We're trying to make sure that we keep our internal fabs loaded and essentially, make decisions based on where we're going to run a newer technology, like the one I mentioned. So the ratio of how much is outsourced or insource-ed is going to depend on how the business grows, probably. So if we get lots of growth in some of our newer Mobility products, it'll be more outsourced.

[Operator:]

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

[Craig A. Ellis:]

Bruce, I was just a little unclear with the responses to Chris' question on the optimization, say, things that are part of R&D and SG&A. Are you saying that some of the new program savings are in the current quarter's guidance or not? If not, why wouldn't they be if it's staff action, which typically can be done pretty quickly?

[Bruce E. Kiddoo:]

Yes. So those -- the current guidance does not include the actions that drove the $10 million in below-the-line savings. I was just trying to identify that not even withstanding today's announcements, we've been managing OpEx and kind of tightening the belt company-wide. We do think that it will take some amount of time, maybe we get a little bit of benefit in the March quarter. I think it just depends on whether these are U.S. or international. We're going to do it right and we're going to do it respectfully for these employees. So I think from a modeling point of view, we've said we'll get that benefit in Q4 when we give guidance. If there's an opportunity and we achieve some benefit in the March quarter, we'll let you know.

[Craig A. Ellis:]

And then the follow-up question is for Tunç. Tunç, Maxim has positioned itself as a company that intends to outgrow its peers and in many years, you've been successful at that. It's hard to see it in the near future. And given the significant shift in revenue mix, do you think you still have the revenue mix ingredients to do that and to do it at the intensity that you previously targeted?

[Tunc Doluca:]

I think we do. I mean, we have -- we do have headwinds in Mobility, as we've acknowledged. But if you look at, for instance, the rest of the product line, we actually have grown very strongly. Bruce mentioned the number year-over-year was 20%. Now that did include one acquisition. But even if you should take that out, it was double digits, low double-digit-type growth organically. So we know that, that part of the business, our strategy is working. We are winning sockets. Our Analog integration strategy is working, and in all of the markets, except for Mobility, we've been able to grow at a rate that is faster than the Analog industry has been growing at. I believe that the Mobility market, with the changes we've made, with the diversification that we're getting, we're going to get that back on a growth path, too. So once we do that, then we should be able to achieve these long-term goals that I articulated at the Investor Day back in May.

[Craig A. Ellis:]

And do you feel that's a fiscal '15 possibility? Or is that something that's really more of a fiscal '16 possibility?

[Tunc Doluca:]

I mean, looking at how fiscal year '15 started in the first 2 quarters, I think it'll be a challenge to do that this year.

[Operator:]

Our next question comes from the line of John Pitzer from Credit Suisse.

[John William Pitzer:]

Jumped on a little bit late, so I apologize if I ask a repeat question. But Tunç, the assumption that the Consumer business troughs in the December quarter, is the basis for that the fact that your largest handset customer won't have lingering sort of issues of their own going into 2015? And on that front, there's a school of thought that perhaps, they're going to go through a significant revamp in the number of SKUs they use to address the market. Given your integration capabilities, is that an opportunity for you going forward?

[Tunc Doluca:]

So it's really not that easy to predict that. So if you do reduce the -- if they do reduce the number of SKUs, it depends on whether they do that at the high-end, mid-end or low-end of their phones, the -- in the high-end, they actually are pretty reduced already. So I don't really see a big change in that regard. But in any case, when SKUs are reduced, if you have the high-integration products that can go across all platforms, then it should be a benefit for you. But the reason -- the real reason I'm calling it a local minimum for this quarter is because we do see -- a new product launch does start with them typically at the beginning of the calendar year. And we also do have some wins, even though the timing is not -- the timing visibility is not there at our other customers. So comp -- and then we have wins in new revenues that we're getting from the tablets at the other large customers. So when I combined all of these, they really do look like we should be able to grow the business in the first or the second half of the fiscal year.

[John William Pitzer:]

That's helpful, Tunç. And then as a follow-up, getting to the nonconsumer segments, Automotive has been a big winner for you guys, not only this year, but over the last several years. But when you look at sort of Industrial, Comm, Data Center buckets, while you've had good year-over-year growth this year, you're just now getting back to levels that you saw back in early of 2011, which, given sort of the secular tailwind of increasing silicon content and some of the acquisitions you've done, it seems like a 3.5-year period to get to flat isn't necessarily great growth. Can you help me understand what happened over that 3.5-year period and, I guess, more importantly, why you think you're poised to see kind of accelerating growth from here?

[Tunc Doluca:]

So in those other markets that you mentioned, first of all, we -- just let's break it down a little bit because it's easier to understand it that way than expect it from me, frankly. So if you look at the broad base of the Industrial market, we really did make some structural changes 3 or 4 years ago on how we approach distribution, for example. We, as a company, in early 2000 -- beginning in the early 2000s actually have lost a lot of market share through distribution and we made many changes in 2009, '10, '11, in those years, to make sure that we're able to really win better for -- in our broad base business to broad customers. And those changes are beginning to show effects now and I think they're going to show even more effects in the future. But many of those changes take time because they then translate to design wins and then translate to revenue. And you know that especially in the Industrial business, that does take a while. So we have made some changes. I do agree that we're just reaching back to the level we were at maybe 2 or 3 years ago, but I think that in terms of a design win strategy viewpoint, some of those changes are going to take effect. We also changed the way we're addressing that market. I've mentioned that in my prepared remarks, that we formed a special business unit, that whose job is to really sell what we've got more effectively, get more for our R&D dollars we spent in the past. And we have a much more distribution customer-friendly approach now in order to win those small and medium business accounts. So yes, I acknowledged it. We were coming back to the levels we were at a few years ago. But definitely, in terms of growth in the future, we've made some fundamental changes that have the ability to be able to continue to grow this business.

[Operator:]

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

[Ada Menaker:]

This is Ada, calling in for CJ. Could you maybe provide a little bit more granularity on your R&D reductions? And in particular, how that's going to impact your plans to reaccelerate growth in the Consumer division?

[Tunc Doluca:]

Okay. So when you say granularity, you're asking for specifics on which product lines and so on? Or something else?

[Ada Menaker:]

Just the type of programs that you'll be looking at.

[Tunc Doluca:]

Well, it's -- I don't think we're at a point that we want to disclose that right now, but we have some areas in Mobility where we did see the return opportunities are not really sufficient to continue the level of investment that we had. So I don't really want to disclose exactly which product lines those were, it kind of discloses it also to our customers and our competitors. But it's -- it really is targeted in terms of which product lines we want to do, we just want to keep it to ourselves.

[Operator:]

Our next question comes from the line of Romit Shah from Nomura Securities.

[Romit J. Shah:]

Bruce, the dividend this quarter ironically is right in line with the midpoint of EPS guidance. In other words, the payout ratio is 100%, probably -- I guess, probably a little bit less on a cash earnings basis. But if Mobility continues to be under pressure, I know you guys are talking about a bottom here, but the trend has been down. If Mobile continues to be under pressure, is there a risk that you may have to cut the dividend?

[Bruce E. Kiddoo:]

No, there's 0 risk, Romit. I think, as you know, right, certainly from a cash flow point of view, we generate substantially more, and you look at it from a free cash flow payout, kind of right around 50% or so, so there's tremendous protection there. In addition to that, right, you've seen that with our CapEx coming down, right, so at this point in time, depreciation is probably kind of 2x CapEx. Depreciation this last quarter was around $40 million, $41 million, while CapEx was $21 million. So free cash flow margin and -- is -- free cash flow is growing substantially better than earnings from that point of view. So no. I think the reductions in CapEx is allowing us to grow our free cash while we work [indiscernible]

[Operator:]

This does conclude the question-and-answer session of today's program. I'd like to hand the program back for any further remarks.

[Kathryn Ta:]

Thank you, Jonathan. This concludes Maxim Integrated's conference call. We would like to thank you for your participation and for your interest in Maxim.

[Operator:]

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