Maxim Integrated Products, Inc.
Q2 2015 Earnings Call Transcript

Published: 23 Jan 2015

[Operator:]

Good day, ladies and gentlemen, and welcome to the Maxim Integrated second quarter of fiscal 2015 conference call. [Operator Instructions] I would now like to introduce your host for today's program, Kathy Ta, Managing Director, Investor Relations. Please go ahead, Kathy.

[Kathy Ta:]

Thank you, operator, and welcome, everyone, to Maxim Integrated’s fiscal second quarter 2015 earnings conference call. With me on the call today are Chief Executive Officer Tunc 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 Kiddoo:]

Thanks, Kathy. I will review Maxim’s second quarter financial results. Revenue for the first quarter was $567 million, down 2% from the first quarter and slightly above the guidance midpoint we provided last quarter. The modest quarter on quarter decline was primarily driven by weaker demand for communications infrastructure products. Demand for mobility products across our customer base was modestly better than expected. Last quarter, we announced our plans to lower Maxim’s cost structure, driven by the weakness we have experienced in our consumer business. We are on track to our plan to reduce operating expenses in specific product lines where the return is no longer adequate. We expect to fully reflect $10 million in quarterly operating expense savings in our upcoming June quarter. We are also on track to our 18-month plan to reduce costs through the closure of our fab in San Jose, which has supported low volume manufacturing and process technology development. In addition to these cost reductions, we plan to stop investment in the consumer MEMS and touch lines of business, which will enable us to save an additional $3 million to $4 million a quarter. We expect to realize these additional savings over the next two quarters. Together with our previously announced plans, these changes will substantially lower our cost structure to improve profitability at any revenue level. In the December quarter, our consumer business was up strongly sequentially, above our expectations, due to our diversification efforts and stronger demand. Our largest mobility customer now represents roughly 15% of revenue, up modestly from last quarter, but down significantly from 28% of revenue in fiscal 2013. Our revenue mix by major market in Q2 was approximately 33% from consumer, 27% industrial, 23% communications and data center, 12% automotive, and 5% computing. 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 down sequentially more than expected, primarily driven by weakness in our enterprise server business after a strong September quarter. We also saw broad-based weakness in optical infrastructure equipment in the quarter. Our automotive business was up sequentially as we continue to see electronic content growth in cars, with a broad base of customers and products. And finally, our computing business was down sequentially. Trying to the P&L, Maxim’s gross margin, excluding special items, was 60.3%, just above the midpoint of our forecast. Sequentially, gross margin was impacted by lower utilization. Internal fab utilization declined from 71% in Q1 to 60% in Q2. Special items in Q2 gross margin included intangible asset amortization from acquisitions and accelerated depreciation from the closing of our San Jose fab. Operating expenses, excluding special items, were $216 million, down from $220 million in the prior quarter. The decrease in operating expenses was driven primarily by overall tight spending controls, including the initial savings from our restructuring activities. Special items in Q2 operating expenses included normal acquisition-related charges, charges related to the restructuring we announced last quarter, including the closure of our San Jose fab and reduction in operating expenses, and the impairment of the goodwill and other assets related to our MEMS business as a result of our decision to stop investment in consumer MEMS. Q2 GAAP operating income, excluding special items, was $126 million, or 22% of revenue. The Q2 GAAP tax rate, excluding special items, was 20.7%, in line with expectations and up from 16.9% in Q1, due to one-time benefits in the prior quarter. The reinstatement of the R&D tax credit for calendar year 2014 had a minor benefit to our Q2 results. The catch up for the first half of calendar 2014 was part of our prior fiscal year, and therefore, we reported this as a special item in the quarter. The balance of the credit will be spread over fiscal year 2015. GAAP earnings per share, excluding special items, was $0.33, above the high end of our guided range, primarily due to slightly higher revenue and lower operating expenses. Turning to the balance sheet and cash flow, during the quarter, cash flow from operations was $173 million, or 30% of revenue. Inventory dollars were approximately flat from last quarter. Modest declines in consumer inventory were offset by increases in industrial and automotive inventory to improve delivery performance to those customers. Inventory days ended at 124, down one day from Q1. Inventory in the channel remained approximately flat at 54 days, within normal levels. Capital additions were $17 million in the quarter, which were more than offset by $24 million in proceeds from property sales. Capital additions, even excluding the proceeds from sale of properties, are well below depreciation, enabling free cash flow to grow faster than earnings. Trailing 12 month free cash flow ending in Q2 was $662 million, or 28% of revenue. This represents a 13% increase over a year ago. Share repurchases totaled $60 million in Q2, as with bought back just over 2 million shares. We also paid $79 million in dividends to our shareholders. The yield on our quarterly dividend of $0.28 per share is approximately 3.4% at yesterday’s closing stock price. Overall, total cash, cash equivalents, and short term investments increased by $62 million in the first quarter, to $1.38 billion. Moving on to guidance, our beginning Q3 backlog is $378 million. Based on this beginning backlog, and expected turns, we forecast Q3 revenue of $565 million to $605 million, which reflects strong growth in automotive, a seasonal uptick in industrial, and the beginning of new product shipments into mobility opportunities. We expect all of our segments to be up in Q3. Q3 gross margin, excluding special items, is forecasted at 58% to 62%, flat from the prior quarter, due to lower factory utilization in Q2, offset by higher utilization and spending controls in the current quarter. Special items in Q3 gross margin are estimated at approximately $32 million, primarily for amortization of intangible assets and accelerated depreciation from our restructuring activities. Q3 operating expenses, excluding special items, are expected to be down again from the prior quarter, reflecting reduced spending in targeted product lines and continued tight expense controls. Special items in Q3 operating expenses are estimated at approximately $4 million for amortization of intangible assets. Our Q3 tax rate, excluding special items, is estimated at 21% to 23%. For Q3 GAAP earnings per share, excluding special items, we expect a range of $0.32 to $0.38. For fiscal year 2015, due to the sale of capital assets, net capital expenditures are expected to be below the low end of our target range of 3% to 5% of revenue. We expect to continue to repurchase shares in Q3 consistent with our buyback matrix. In summary, we believe our long term financial strategy of growth, leverage, and return is on track. Our revenue performance in the second quarter was better than expected and our guidance reflects better than seasonal growth in the third quarter. We are taking targeted steps to reduce spending to improve profitability at any revenue level. This includes the actions announced this quarter to stop investments in consumer MEMS and touch product lines. 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 Tunc to further discuss our business.

[Tunc Doluca:]

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. Every year, I visit our global offices to discuss our company direction and strategy with employees. Today, I’m joining you from Munich. Bruce and Kathy are at our headquarters in San Jose. In November, Munich was also the site of Electronica, the world’s largest industrial technology trade show. Here, we showcased our latest technology that will enable the smart factories of the future, wearable medical devices, and mobile payment systems. And, at the recent CES event in Las Vegas, excitement in smartphone, wearable, and automotive markets was certainly on display. We showed customers our pipeline of new automotive technologies in infotainment, safety, and driver assistance applications. As 2015 gets underway, we are seeing growing business momentum in our automotive and industrial businesses and evidence that our diversification strategy is beginning to bear fruit in consumer. Our December quarter revenue performance was above the midpoint of our expectations, driven by our diversification efforts in consumer and continued strength in our automotive business. As this momentum picks up in these businesses, we are staying financially disciplined. We’re on track to achieve the cost reduction plans that we announced last October. These plans included reducing R&D spending in targeted areas and reducing manufacturing costs with the scheduled closure of our San Jose fab. As we demonstrated last quarter, we’ve continued to take actions that will improve Maxim’s profitability and enable more focused investment in top line growth. In keeping with this plan, we’re choosing to focus our resources on product areas where we believe we have a leading market position and stop investment in areas with lower return. As a result, we have decided to stop investment in consumer MEMS and touch. Both in touch and in consumer MEMS, we did develop state-of-the-art solutions that deliver superior performance. However, the competitive dynamics of these market opportunities are no longer consistent with Maxim’s business objectives. Consequently, we have decided to stop further investment in both of these product lines. While these are clearly difficult decisions to make, these actions will improve Maxim’s profitability profile. So let me next provide some color on our major markets, starting with consumer. Our December quarter revenue was down significantly from the same quarter of last year. However, demand from our largest mobility customer appears to be stabilizing, and we see validation that our diversification strategy in mobility is working. Our December quarter consumer end market revenue was strongly up from the September quarter, better than our expectations. The growth was driven by better performance at our leading mobility customer and an uptick in revenue from other mobility customers in both tablets and in shipments for a wearable product. We expect that this market will be up again in March, with the launch of a new flagship phone at our leading mobility customer and continued shipments for a wearable product. 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. So let me next turn to the industrial market. Our December quarter industrial business was up 3% from the same quarter of last year, but sequentially down in line with seasonality. Our largest distribution partner, Avnet, is again our largest account at 19% of total company sales. We are excited that our relationship with Avnet has become far more strategic over the last five years. Avnet has increasingly served as an extension of our sales team, generating new design registrations for Maxim’s broad portfolio of industrial products. As a result, our revenue with them has grown over 70% over the last five years. In calendar 2014, Avnet achieved a new milestone by surpassing their stretch goal of a half a billion dollars in resales for Maxim. Turning to our vertical industrial markets, financial terminals were flat and medical devices and smart meters were down in December. In financial terminals, we are seeing growth in mobile payment market and have received numerous design registrations for our new comprehensive reference design platform. This mobile payment platform is enabling new, emerging customers to enter into the growing mobile payment market. In medical, Maxim’s wellness measurement microcontroller for wearable medical applications was recognized by Electronic Products as their 2014 product of the year. In smart meters, we see continued deployment projects in Asia but are experiencing a sequential decline in that business due to a slowdown in the U.S. utility meter market. To date, we have not seen a strong correlation between smart meter project plans and the recent lower prices of fossil fuels. Looking forward, we project March quarter industrial revenue to be up, driven by sequential growth in all of our vertical and core industrial markets, except for automatic test equipment. Let me now provide some commentary on our distribution business. Globally, end market resales were down 4% sequentially, in line with seasonality. Overall, we saw 54 days of inventory in the channel at the end of the December quarter, which was down one day from September and in line with historical averages. We continue to observe a relatively healthy pattern in our distribution business, and are starting to see signs of positive momentum in the first half of calendar 2015. Our December quarter automotive business was up 33% from the same quarter last year, reflecting solid content growth in high end and midrange cars and a broadening customer base. Our automotive business was sequentially up in December, better than typical seasonality and in line with our expectations. In the March quarter, we expect automotive to be strongly up, driven by our solid pipeline of design wins, which are launching in the next model year cars. A broad set of infotainment applications remains the largest driver of our growth in this business. Going forward, we expect that safety and driver assistance content, known as ADAS, will be a significant growth vector for Maxim in automotive. Today, we serve the driver assistance market in two ways, through power management, with powerful processor chips for ADAS and in high speed video links of camera systems around the car. We expect these areas will experience healthy double-digit growth rates for years to come. Next, let me discuss communications and data center. Our December quarter communications and data center business was down 8% from the same quarter of last year, and was sequentially down strongly. We experienced broad-based weakness across our portfolio of products in this segment. We are seeing a pause in the implementation of optical telecom infrastructure and base station deployments, driven primarily by inventory adjustments by our customers. In enterprise servers, we experienced a period of inventory drawdown at leading customers, following a strong September quarter. We are still seeing signs of an industry transition from traditional servers to new architectures that are optimized for cloud computing. However, we do not expect revenue from these wins until the second half of calendar 2015. We expect our comms and data center business to rebound in March with the resumption of communications infrastructure deployment. We anticipate our enterprise server revenue profile to remain flat from December. In the computing market, December revenue was down 6% from the same quarter of last year and down sequentially as well. We expect computing to be up in March. Now, to summarize our view of the March quarter, we expect all of our businesses, including consumer, to be up in March. We expect automotive to be strongly up as we deliver on our robust pipeline of design wins for the next model year cars. We also expect consumer to be up, with the initial ramp of the new smartphone at our leading mobility customer and shipments for a wearable product at another customer. Communications and data center and industrial are expected to be up from a weak December, and computing is also expected to be up. In closing, we are managing our portfolio and making tough decisions to adapt to the changes in our business environment to improve Maxim’s profitability. These decisions enable us to continue to invest in growth areas for the company. We’re showing excellent progress in growing revenue for new power efficient applications in all of our markets and we are executing on our strategy to broaden our revenue base in mobility. Kathy, I’ll now turn the call back to you.

[Kathy Ta:]

Thanks, Tunc. That concludes our prepared remarks, and we would now welcome your questions. In the interest of reaching everyone in the queue, we would like to ask that you ask just one question with one follow up. Operator, please begin polling for questions.

[Operator:]

[Operator instructions.] Our first question comes from the line of Ross Seymore of Deutsche Bank.

[Ross Seymore:]

I guess the first one is on the consumer business, and specifically the mobility side. If you could just give a little bit more color on what exactly was the surprise in the quarter? It seemed like the Samsung side bounced back by about 30% sequentially. And how do you manage that process looking forward, so we don’t get back to that position that we’ve hit in the last couple of years where that concentration became a negative?

[Bruce Kiddoo:]

I think what we saw was kind of a normal inventory correction from Samsung [unintelligible] on some of their older products. But we did see, particularly on the Note 4, which had, as you recall, a late launch in the September quarter, so we really got the full benefit of that launch in the December quarter. And so that came in a little bit stronger than our expectations, and so I think that was an upside. And then just in kind of the general market of wearables, I think we saw a little bit more strength than we had expected going into the quarter. When we look at our forecast going forward, when we look at the next quarter, Q3, we actually think Samsung’s probably flat to maybe even down slightly. And I think overall, we expect it to stay in the current range, given the diversification within mobility and kind of the growth in our other markets. So it is something we pay attention to. Obviously, the decision that we announced today around consumer MEMS and touch would also be an area where it kind of shows we’re focused on the areas where we can achieve profitable, sustainable growth. And so I think that’s another area that should give people comfort that we’re going to manage this business in a more sustainable way going forward.

[Ross Seymore:]

And I guess as my follow up, Bruce, you talked a lot about opex and the incremental cuts that you just mentioned in the touch side of things. Can you give us an idea of the trajectory for the March and the June quarter? And is the math as simple as taking the September opex and taking either $13 million or $14 million off of that to get you to the total cuts that will be in place by the June quarter?

[Bruce Kiddoo:]

I think when we look at this, we have identified $10 million that would be out of the June quarter. We’re on track for that. We said the one offset to that would be to the extent that our overall profitability increased, and therefore our profit sharing accrual would offset that. So I think that’s the only thing that kind of offsets that $10 million savings. The $3 million to $4 million that we identified for the additional reductions for touch and MEMS will achieve that over the next six months. The full benefit of that will be realized in Q1 of 2016. So some of this is obviously when you’re dealing with restructuring activities, some of them take some time to implement, and so that’s why that takes a little bit of time to execute on that.

[Operator:]

Our next question comes from the line of Harlan Sur with JPMorgan.

[Harlan Sur:]

On the March quarter and the growth there, it’s sort of in line to maybe slightly better than the seasonal trends. You know, automotive up, industrial up, consumer up, and so on. If I look back historically, the June quarter also tends to be another solid quarter with follow through from automotive, industrial, consumer, and maybe a little bit of help from computing as well. So just given your view on the current fundamental environment, would the team expect normal seasonality in June? Maybe if you could just talk about some of the potential puts and takes here?

[Bruce Kiddoo:]

I think when we looked at the March quarter, actually, when we look at sort of the past four years with this kind of post-recession, we actually see it’s been down about 1% to 2%. And that was really because kind of the ex-Samsung or consumer business is normally down in the March quarter. I think one of the reasons you’re seeing that up 3% at the midpoint this quarter is really two things

[Harlan Sur:]

And then auto and industrial, it’s now 40% of your business. Specifically, on the automotive, I think as you guys mentioned, it was up 33% year over year in the December quarter. I think in the prior quarter it was up like over 40%. What’s the confidence level on driving automotive growth on a double digit year over year trajectory this calendar year? And then maybe if you could just talk about some of the drivers within that?

[Tunc Doluca:]

In automotive, we are getting great results, and we’re very happy for that. Obviously, everybody knows this is a market that you invest in for a long time to get to good revenue. And the good part of that is we’ve done a lot of that investment and continue to do so. And since the product lives and design-ins are very long, you can depend on revenue that you’re getting that has started, to continue. And what we’re doing is we’re early in this ballgame, so we keep adding revenue on top of that with new design wins, and really not seeing much end of life yet, because we entered the market more recently. So that’s why we have some confidence that into the future, we’re going to see double-digit growth for several years to come. In terms of the types of products that we sell or the types of technologies that we sell, most of our revenue actually comes from the infotainment side of the business. But we’re also seeing new additions now in the safety and driver assistance certainly is one part of the business. And in that segment, for example, we do have technology that we’re selling, and we’re seeing great success for power management. As I mentioned in my prepared remarks, the processors are getting more and more computationally powerful, and that requires special dedicated power management products. We’re having success there. Actually, part of that success is coming from IP that we developed for mobility. So that shows the power of actually making these technologies for one market and our ability to sell it in another. The second piece is really moving data around from video cameras that are used in all kinds of safety, where cameras are now being placed on multiple sides of the cars. And this high speed data really has to criss-cross the car to get to these processors. So on the safety side, power management and products that we make for moving of data, [surdes] products, as we call them. We also have products that revenues are now modest, but we believe they’re going to grow into the future, for keyless go, for example, systems that we’ve designed and developed. All kinds of radio products for conversion, direct RF to bits technology that we call, where you can convert either satellite radio or digital audio broadcast directly from RF to bits for the digital processors. So these are the main areas, and we also have investments in growth that’s coming in the future for hybrid and electric vehicles, where we do the battery management functions inside of these products. So very broad product base, since product lives are long and most of the wins have been more recent. With each new generation of win, we’re adding on top of old wins that we’ve got, and that’s why we have confidence going into the future of double-digit growth for years to come.

[Operator:]

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

[John Pitzer:]

Tunc, for a lot of us, this wearable market is a relatively new market and clearly in your prepared comments, you talked about it adding to December and adding again to March. I’m wondering if you could help us think about how we should be modeling wearables relative to your content. Is this sort of a December/March build, and then the follow-through is going to be dependent upon sell through? Or how should we think about modeling this maybe relative to flagship launch of phones that we’ve seen in the past in your business model?

[Tunc Doluca:]

I’ll be really honest with you. We know the content we have, obviously, and in previous calls, we did answer questions. All of you were very interested in the dollar content, but we couldn’t really disclose all that. But we have stated that in one of these wearables that’s high end, the content could be close to what we get in a smartphone, for example. Now, in terms of the sell through and the build pattern that our customer is going to use, we really don’t have a lot of details of that, frankly. And it is very hard to predict, I believe, because the acceptance level by consumers is not known. So the shape of that curve, how much we build in the first couple of quarters and what follows is very difficult for us to predict. And I think a lot of people, obviously our company and in the investment community, are trying to figure this out. But we also don’t have a really good answer, frankly.

[John Pitzer:]

Maybe as a follow up for Bruce, just on the gross margin line, plus or minus, you guys have kind of been at that 60% level for a bit now. I’m just kind of curious, is there a revenue level we should be thinking about to break out above the high end of that 58% to 62% range? Or is there a timeline relative to some of the restructuring that we should start thinking about kind of breaking out of the high end of that range?

[Bruce Kiddoo:]

If you think of the two things that are going to drive gross margin, one is utilization and the other one is the restructuring, are the two key things. I think from a utilization point of view, obviously with the challenges we had last summer around our largest customer and utilization dropped, in this last quarter we were down at 60%, we think now that there’s stability at that account. The ability to start driving up utilization, as all the rest of our businesses continue to grow nicely, I think that will provide the growth in the utilization, and I think you can kind of track that over time. I think we even provide a chart in our supplemental earnings presentation around utilization levels, and you can track that with revenue. The other side is the restructuring, and as we’ve said, the savings there, the $10 million related to the San Jose fab closure is over 18 months, and really we’ll see that in FY16. But that’s going to get you about a point and a half, if you think of $10 million, a point and a half of gross margin by itself. And then some of these other actions, specifically around MEMS, we did have some equipment for MEMS, which as a result of these actions, kind of the depreciation expense associated with those will go down. So if you put all that together, I think our view is our 61% to 64%, there’s no reason structurally we should not be able to operate in the upper half of that range. If we get utilizations kind of back over the 80%, we get our restructuring plan in place, that’s sort of our model to get that up into the upper half.

[Operator:]

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

[Jim Covello:]

Just following up on John’s question, since you had made the comment there that now that your biggest customer is stable, we kind of go back a year, we thought the biggest customer was stable and we were looking forward to higher utilization rates at that point. So I guess compare and contrast today to back then, if you might. And then if you could share with us what your plans are on a qualitative basis for utilization rate increases over the next couple of quarters, that would be great.

[Tunc Doluca:]

On your first question, you’re reminding us of some of the painful moments that we went through last year. When we look into the future this year, what we’re seeing is that essentially the content we’ve got is pretty close to what we had in the prior phone. We have reduced both our customer, and as a result, we have reduced the unit volume forecast for the phone, which we had not done that aggressively last year. So we really have moderated what our expectations are in terms of the unit sales of their flagship phones. And another headwind we had last year was the effect of, in their midrange phones, the decisions they made on their processors also resulted in some amounts of loss for us, which is not present right now, because that business is not in our plans at all. So we basically have reduced the views that we’ve got, or the forecasts that we have, compared to last year. And certainly, our largest customer has done the same. So that’s why we feel better than we did last time. And the other piece of this is that they are a smaller piece of our business right now anyway, compared to where we were last year about this time. So all of this gives us some confidence that this year hopefully will not be a repeat of what we saw last year. Now, you’re going to have to remind me of the second question.

[Jim Covello:]

In conjunction with that, on a qualitative basis, if you could tell us what directionally you’re thinking about utilization rates over the next few quarters.

[Tunc Doluca:]

Yeah, so, in terms of utilization rates, we do expect, if all goes as planned, we do have revenue that’s expected to go up next quarter as we forecasted. That obviously will begin to help. I don’t think in the very near term we’re going to get to the utilization levels that Bruce mentioned, which are probably further out, at higher revenue levels. But it will all depend on that revenue level, and it will be pretty close. If you, Bruce, indicated that we actually do have a chart of utilization levels versus margin. But you can also look at utilization levels versus our revenue as well. We didn’t put that on that same chart, but it’s a pretty easy exercise. And that will give you some idea of what revenue levels we get to the utilization levels that are in the upper end are to us much higher than 60%, or the old levels, which are about 80%, can still be achieved. So it’s hard to tell the timing, but I don’t believe that we’re really that far away in terms of revenue increase that we might see in the coming quarters.

[Operator:]

Our next question comes from the line of Stephen Chin with UBS.

[Stephen Chin:]

First, an area I wanted to drill down on was the decision to move away from the consumer MEMS and touch sensor business. Firstly, can you talk about how this might impact some of your investments in other non-consumer areas? Because if I remember correctly from your analyst day, some of these technologies were, I think, targeted to be applied into automotive and maybe some other adjacent areas. And secondly, does this impact your biosensor investments at all?

[Tunc Doluca:]

So, let’s take them one at a time. You really were asking about the impact of stopping investments in consumer MEMS and in touch and other areas. That question is, there is some impact. ] First of all, let me just clarify, make sure that we’re clear about it. So even though we’re stopping investment in consumer MEMS, we really are taking those resources and going to apply them to automotive. And that business, we can continue to grow, because the superior performance of our products are valued by their customers. Now, we obviously have to resize the amount of investment and that will be done over the next couple of quarters so that we have the R&D portion commensurate with the size of that market. That decision really, obviously we’re investing in automotive, so that answers that question. The second was on touch. We had said that we could use that technology and we’d use it to support automotive customers or applications as well. Obviously, with stopping an investment, that really is not going to work. So that will have some impact on the automotive side of the business. The investment in bio and environmental sensors are pretty much independent of this, so those go forward, where we can add value in mobile with those types of sensors. We are seeing traction, and we do continue to invest in those as a growth area.

[Stephen Chin:]

And as my follow up, wanted to ask about the enterprise power management business. You guided that to be flat for this quarter. Was wondering if, I guess with the new Grantley server cycle still ramping up, what is the old Voltera business exposure there, and kind of longer term, what do you expect for how that is to perform later in the cycle?

[Bruce Kiddoo:]

So when we look at our server business in the near term, I think as most people know, we see softness at our largest customer, and that’s kind of been playing out over the last year. The large enterprise server OEM customers have not done as well in that market, and so that has impacted Voltera business. I think as far as the next generation platforms, I think we knew kind of going into the acquisition that that was not going to be as strong as an opportunity for Voltera, and so from that point of view, any ramps in that area aren’t as meaningful for us. And really, the thesis going into the acquisition was around moving into the cloud computing area, and as Tunc mentioned in his opening remarks, we believe that’s a very good opportunity for us. We believe we’re having very good traction working with some of the large cloud providers and doing servers that are optimized for the cloud environment. And that’s an area where we believe in early FY16 we should be able to start seeing the initial ramps of those efforts. That will take time to ramp overall, but I think the initial indications are very good.

[Operator:]

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

[Ambrish Srivastava:]

Bruce, I had a question on the 30% operating margin goal. Is it fair to assume then, based on your earlier comments, that you’re essentially baking in a seasonal June quarter and combined with the cost savings and utilization going on, that’s the plan to hit that 30%?

[Bruce Kiddoo:]

Yeah, so I think given the impact that we had last summer from a revenue point of view, I think that kind of put a question on the timing of when we would achieve the 30%. Obviously, we’re being very aggressive, as we announced last quarter and this quarter, on the spending side, and certainly, the other side of that is, from a revenue point of view. So from our point of view, without giving guidance, obviously, for the fourth quarter, and as I indicated, there’s still open questions there, I wouldn’t necessarily get down to a specific quarter. I think we’ve talked about revenue levels where we should be able to get close to the 30%, and certainly, our commitment is we’ll just keep driving until we get to it. But I think tying it down to a specific quarter right now is still probably a little bit early.

[Ambrish Srivastava:]

So what’s the revenue level, if you could please remind us again?

[Bruce Kiddoo:]

I think most people, and we’ve just kind of directed people back to June of last year, when we were kind of around 645 or so of revenue, and we were at 25% of operating margin, and then you identify kind of the three points from the restructuring that we identified last quarter. We had some inventory reserves back in June of last year, and so that got you kind of four points, and then either you need a little bit more revenue or a little bit more cost cuts. So I think sort of in the mid-600s is where I think most people have sort of kind of modeled that opportunity to get to a 30% op margin. I will say, as evidenced by the actions that we’ve taken, we’re clearly focused on this. We’re clearly continuing to manage our spending and we remain optimistic that we’re seeing the sustainable growth pattern for us.

[Ambrish Srivastava:]

Thank you for the clarification, Bruce, and I gave you guys a hard time last earnings call. You guys are clearly taking concrete actions and helping those who have stayed with you. My quick follow up, then, for you, Tunc, is we talked about China for a while. When you talk about diversification of customers, is China a factor that will start to kick in as we exit this year?

[Tunc Doluca:]

So, on the Chinese front, just to give you a state of the union right now, we remain at a relatively low revenue level. I assume your question was about our smartphone sales, not all the other business that we have. Is that correct?

[Ambrish Srivastava:]

Yes, Tunc, on your mobile side.

[Tunc Doluca:]

So on the mobile side, we’re at a relatively low revenue level with the Chinese smartphone market. We do have content in multiple Chinese OEMs, and it’s primarily driven by our power SOC sockets, and just beginning on some audio DSM products. But it does take time to build these relationships with these customers. And the challenge that we face is that there are a lot more SKUs than in the other two large smartphone OEMs. So it takes time to really be able to get design wins in these multiple SKUs and really build momentum. So I think that as I said, it’s kind of relatively low right now. I do expect us to begin to grow next year. But it really is an effort to diversify the base, but it’s not really going to be as large as the two customers that dominate this market, because there are so many different models to win, and it takes a lot more product. So our strategy in China is to take the IP that we internally developed for some of these functions and find ways, with minimal R&D, on making products that are fewer features for the Chinese market. Because in general, as you can tell from their own phone ASPs, the content is much less than it is in a flagship phone from the leading customers. So it will contribute to revenue, increase revenue, next year, but in the end, it really does not make a huge difference in terms of revenue we can achieve from them.

[Operator:]

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

[Blayne Curtis:]

I just wanted to follow up on the mobile side. When you look at, over the last five, six years, you’ve had some fits and starts with products, and you’re making the decision to get out of your MEMS and touch, which I think people were asking for you to do last call, so I applaud you for doing that. I’m just curious, as you look at some of the new sockets you’re winning, how do you look at this being sustainable? You talked about integration as being kind of the glue. Some of the content that you’re adding may not be integratable together. Just kind of curious, as you look at your portfolio of mobile, will you have to make some hard decisions on some of your other products down the road?

[Tunc Doluca:]

These are decisions that we have to review and make and kind of see what the market dynamics are for each of these products. And currently, if I were to categorize it, we’re going into the future, we’re investing in three areas in mobile. One of them is power, which has always been our strong position in that market. It’s pretty well known. The second one really has been in audio, and that’s a market where I would say we were a late entrant, and one might say we shouldn’t have done that either, but we really turned it with new technology that’s highly valued by the customer, and began to grow that rev at multiple customers. And the third area that we’re investing in is basically sensors, meaning biosensors and environmental sensors and so on. And you are correct, these products have to be refreshed every cycle and every year, but we do have strength in that area. We’re very agile in product development and new technology adoption. And the fact that the needs change every year is actually good in one aspect, because it leaves little room for competitors to be able to duplicate our efforts. Now, having said that, periodically, we look at what the prospects of each product line is, and if one doesn’t look like it’s going to have the returns that fit our business objectives, then we get out. And on the other hand, if we find some that we can really show and demonstrate real value to a customer, we’ll get in. So it’s a dynamic field, and we’ve got to keep making the decisions of being able to invest in some and not invest in others when the time comes.

[Blayne Curtis:]

And then I did want to ask you, you know, the opposite of mobile is probably auto. Now reposing MEMS to auto, that business you bought was originally focused there. So were you able to keep that effort going as you’re focused on mobile? Or are you starting over again in that end market, because it does take quite a long time to get wins ramped there?

[Tunc Doluca:]

Actually, thanks for asking that question. It allows me to clarify. So, when we did acquire Sensor Dynamics, and they had an effort in mobility - you a very good memory - they had an automotive effort, an automobility effort, so you remember that well - but at the time of that acquisition, we actually kept both developments alive. Obviously, the mobility one was pretty visible, and we talked about that, because it was quick ramp to revenue. But we did develop automotive products that have really good failsafe features and high levels of accuracy. So we did continue with our automotive investments. So currently, what we’re going to do is really put the resources that are appropriate for automotive and continue on the path to get to revenue. And it will take, obviously, more time to get the automotive revenue, but regardless of that, we do know that we have differentiated technology and great IP in that acquisition that will help us. So it’s a continuation, really. It’s not a switch from one to the other.

[Operator:]

Our next question comes from the line of Michael McConnell from Pacific Crest Securities.

[Michael McConnell:]

Bruce, just a clarification. So the comment that your largest customer would be flat to slightly down in the March quarter, is that just the difficult compare versus the December quarter and the growth that you got there that was not expected? Or should we think more of the benefit from the new flagship phone coming out being more impactful to the June quarter, to you?

[Bruce Kiddoo:]

Yeah, and I think when we said flat to slightly down, that was as a percent of revenue. I think I was kind of responding to Ross’s question there about kind of managing the concentration level. So overall, that business could actually be probably flat to slightly up, if you look in absolute dollars. But the overall business, with the strength that we’re seeing through our diversification efforts within mobility, with the strong growth that we’re seeing in automotive, and really, we had indicated all of markets are going to be up, was why I responded to Ross’s question that as kind of a percent of the business it could be flat to slightly down. That said, in answer to your comment that you made, you are correct in that it was stronger in the December quarter than we thought, from that point of view. I think most people kind of think that the Note 4 and the S5 were probably better than feared, and we’ve seen some stabilization there. So I think that’s a positive. So kind of the quarter on quarter compares are impacted a little bit by that. And the flipside is, again, I think your comment is accurate, around sort of the ramp of the new phone and is Samsung going to be a little bit more prudent in how they manage that ramp, both for the March quarter, and I would suggest even, we don’t know of course, but potentially, for the June quarter, to try to manage inventory levels a little bit better coming out of the launch.

[Michael McConnell:]

And then just on the wearable device, the benefit from a build standpoint to the company, will that continue, do you think, into June? Or at that point, when we get into the June quarter, it’s really going to be dependent on sell through for a continuation of that?

[Bruce Kiddoo:]

I think as Tunc indicated, we just don’t know, from that point of view. A, I don’t think we have unique insights into what the sell through and demand for this product will be, and B, if we did, we couldn’t say. But the short answer is we don’t know. I think we know what we’re told, and I think certainly it’s going from kind of nothing to something, and so I think that’s going to be positive for us. We have good content, and then it’s just up to how well this product sells.

[Operator:]

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

[Craig Hettenbach:]

Just following up on the wearables, outside of just the focus on kind of a flagship wearable coming out, can you give any color in terms of what you’re seeing from a design perspective, and then how broad of a category you think this could be from a customer basis, as you move forward?

[Tunc Doluca:]

From our design wins and the products that we have in some of the wearables that are out there, if you exclude the flagship one that’s coming out, and I like your term flagship, we had not thought about using that, we do have content, and most of the content we’ve got in other wearables is currently most are around power management type products. And obviously, the advantages we provide there is the level of integration, just trying to shrink the size of the overall solution, because in a smartphone, if we consider the space is limited, in a wearable, it’s even more limited. So as a result of that, in some fitness applications and some specialty health applications, and just basic smart watch applications at other customers, we’ve been able to win many power products. Having said that, the volumes are not really that high for this category, and in my view, maybe the suppliers have not really found that killer app that every consumer wants to have. But we do have the right technologies for that, and it really plays to our strengths. Integration, [unintelligible] power operation, these are all very important, so the battery management function has become very important for the customer and in turn they turn to us to give them solutions that can fit into the application. But the uptake from the end consumer has really not been that strong. And most of you already know this. I’m not telling you anything new.

[Craig Hettenbach:]

And then as a follow up, good to see the discipline around the MEMS and touch. If I would extend that further, can you touch on just your view of thinking how you approach return on R&D investment, particularly in areas like mobile that could be a little more volatile and rapid change in product cycles? So looking out in time, how you’re looking to invest in that market versus maybe some other verticals that are stickier?

[Tunc Doluca:]

The way we think about it is that we do understand, obviously, that the mobile market or consumer markets in general can be a lot more volatile, which means their risk profile is higher. The good news is that whether you’re succeeding or not, the feedback you get is quicker as well, which is good. But when we’re making decisions on allocating resources, we try to pick projects or product lines that have higher returns, basically, so that it offsets the higher risk, just like any investment decision that you make in that market versus the other markets. And from a return time viewpoint, you really get the returns in two or three years rather than seven or eight years that you get in automotive. But the decision process is just that. We expect higher returns in those markets than we do in longer lived products, or more sticky markets, like in automotive or industrial or communications products. So that’s the way we think.

[Bruce Kiddoo:]

And I think just as Tunc said, we always are looking for those opportunities where we think we have a sustainable advantage and which meets our profitability targets. A perfect example, as Tunc talked about, one of our invest areas is in power management within mobility. We’ve had a power management socket since 2008 at least, when I joined, in the first 3G Samsung phone, and have held that power management socket. So I think to the extent that we provide true value to the customer, and it’s a sustainable differentiation, we’re able to hold that and, I think as most people know, at a good return. I think the key question is where are those markets where that’s difficult to do, and as you can see by our decisions today, if we don’t think we have that advantage, then we will make that decision and stop the investment.

[Operator:]

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

[Tore Svanberg:]

First, on the consumer MEMS, was that a decrease based on profitability metrics, or is it more the size of the market, maybe meaning customers are starting to in-source that technology more?

[Tunc Doluca:]

On the consumer MEMS side, it is actually an interesting - and I’ll give you some of the background I gave in my prepared remarks. We and our team, and I’m really proud of our team, they were able to develop, in my mind, a great product. It had far lower power consumption and much better stability or accuracy than the products that we saw out there. However, these performance features we realized were really not valued by the customer. Not valued means that they were not willing to pay the prices that we required to get our profitability metrics. So when we realized that, and this happened actually pretty recently, frankly, that was the dynamic in the market that caused us to realize that having a great product, but the customer’s not needing that performance, is a signal that it would be hard for us to win sockets at the profitability levels that we expected in the market.

[Tore Svanberg:]

And maybe as a follow up to Bruce, Bruce, when you look at gross margin and utilization, would it be accurate to think that what really helps utilization would be more your industrial and automotive businesses while your consumer businesses have less of a positive benefit on utilization?

[Bruce Kiddoo:]

In general, our industrial products, more of them are done internally, and our consumer products can be done generally both internally and externally. So industrial growing is a positive thing for utilization, but we’re also very actively managing, even for those products that can be done internally or externally, to find the right balance, to maximize our internal fab loading, while continuing to support our external partners. And so while one can be done more internally and the other can be done both, I think we try to manage both to maximize utilizations.

[Tore Svanberg:]

And if I can just sneak in one quick cash flow question, so right now capex is at 3% of revenue. How long can you stay there before we start to see a new capex cycle?

[Bruce Kiddoo:]

Our view is we don’t see another major capex cycle, and that’s primarily because the next-generation technology after 90 nanometer will be outsourced completely. And so from that point of view, we don’t see a major fab requirement. We have plenty of available space to grow in our test capacity, and we continue to look at opportunities to begin to do more of an outsourcing of that as well. So I think for us what really drives capex today is A, as the business continues to grow you need to continue to add testers, and then to the extent that we are looking at very specific technology development to help us truly differentiate our products, whether that’s in maybe some of these sensor products, there’s investment there as well. But overall, I think we believe our capex is coming in at a very low level in this quarter, because I think most people know, we normally net out kind of the purchase of assets with the sale of assets. This quarter we actually had that, that number actually was a negative, meaning the proceeds were greater than the expenditures. But even without that, like you said, we were at the very low end, 3%, and obviously we were a negative number if you count the proceeds.

[Kathy Ta:]

Operator, I think we have time for one more question.

[Operator:]

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

[Steve Smigie:]

I wanted to talk quickly about the financial terminals. Could you go through a little more about the correlation you’re seeing between the growth in mobile payments in the U.S. and the increase in demand for financial terminals?

[Tunc Doluca:]

In terms of financial terminals, we do have a good market position in what I would call the fixed terminals in the market. This is a business we’ve actually developed, almost over a decade or even more. But what we’re seeing now is that many vendors or many people that want to make payments, they want the capability to do mobile payments. And that really opened up a whole new market opportunity for us. Our highly integrated solutions are really best suited for these tight spaces, and the security requirements we know how to meet, because we have made generations of products that meet the certification requirements for security. And what we’re seeing is a lot of activity by actually new entrants coming into the field. That’s what I said in my prepared remarks. And with our reference designs, actually, we’re making it very easy for new people to make these mobile payment terminals. And we see that as the large growth area all over the world, not just in the U.S., but in Europe as well as in Asia. So it is a good growth opportunity for the company, and we’re seeing a huge number of design wins basically because of the fact that we have the product and we have the reference design.

[Steve Smigie:]

From a macro standpoint, given all the weakness we’ve seen in Europe, does this have any material impact on the most recent quarter, and do you see it having any impact on the March quarter?

[Tunc Doluca:]

You’re essentially asking about the global economics and what’s happening and what’s the effect of that going to be on Maxim. We certainly do watch what happens in Europe and we do see the no growth environment, so to speak. And we do see some of the slowing that’s coming from China. The U.S. continues to be stronger in terms of growth. We look at the industrial market, which is probably the broadest base that we’ve got and probably the best signal of what the economic activity is like. But we really are not, even though we watch this very carefully, and I’d be wrong if I said that we would not be affected by some major global economic issue. All the indications we see so far don’t show that. We’re seeing the resales are healthy, and really not seeing a major slowdown in these regions. So the signals are not there, but obviously, all of us in the company kind of look at the news coming through, and that is indicating these slowdowns in actually two areas, Europe and China.

[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.

[Kathy Ta:]

Thank you, operator. This does conclude Maxim Integrated’s conference call. We would like to thank you for your participation and for your interest in Maxim.