Analog Devices, Inc. (ADI) Q3 2012 Earnings Report, Transcript and Summary

Good day, ladies and gentlemen, and welcome to the Maxim Integrated Products Third Quarter 2012 Earnings Release Conference Call. [Operator Instructions] As a reminder, this program is being recorded. I would now like to introduce your host for today's program, Mr. Venk Nathamuni, Managing Director of Investor Relations. Please go ahead, sir.

Thank you, operator and welcome, everyone to Maxim Integrated Products Fiscal Third quarter 2012 Earnings Conference Call. With me on the call today are Chief Executive Officer, Tunç Doluca; and Chief Financial Officer, Bruce Kiddoo. During today's call, we will be making some forward-looking statements. In light of the Private Securities Litigation Reform Act, I would 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, all available from the company without charge. Now I will turn the call over to Bruce.

Thanks, Venk. I will review our third quarter financial results. Revenue for the third quarter was $571 million, down 3% from the second quarter. Our revenue mix by major market in Q3 was approximately 41% for consumer, 27% industrial, 17% communications and 15% computing. Our consumer business declined slightly, due to seasonal trends. Our industrial business was flat as distributors stopped producing inventory. Our communication business was down slightly due to continued weakness in base stations, partially offset by the end of the inventory correction in fiber optics. Our computing business was down across most segments. Gross margin, excluding special items, was 60.4%, essentially flat with the prior quarter. Unfavorable variances from lower utilizations were offset by lower spending and lower inventory reserves. Special items in Q3 gross margin were intangible asset amortization from acquisitions. Operating expenses, excluding special items, were $214 million, down 4% from Q2. Salary expense declined in Q3 because Q2 was a 14-week quarter. Special items in Q3 operating expenses were primarily acquisition-related charges. The impairment of excess manufacturing assets and a gain from the sale of a building. Special items and discontinued operations were approximately $32 million in after-tax gain from the sale of our clock synchronization and next-generation 12-gig storage product lines. Q3 GAAP operating income, excluding special items, was $131 million or 23% of revenue. The Q3 GAAP tax rate, excluding special items, was 24% compared to 26% in the prior quarter due to ongoing improvements from our international tax structure. Special items in the Q3 tax rate included prior period cost-sharing expenses related to our international restructuring. GAAP earnings per share, excluding special items was $0.33, down slightly from $0.34 in Q2 as lower operating expenses and lower tax rate offset the lower revenue. Turning to the balance sheet and cash flow. During the quarter, cash flow from operations was $196 million or 34% of revenue. Inventory declined slightly to 89 days from 91 days in the prior quarter. Inventory in the channel, excluding catalog distributors, increased 1 day to 57 days. In dollar terms, general inventory declined by 4%. Net capital expenditures totaled $44 million in Q3, as we invested in long-term manufacturing capacity and new facilities, offset partially by the sale of a building. Free cash flow was $140 million or 25% of revenue. Share repurchases totaled $29 million in Q3 as we bought back 1.1 million shares. Finally, in Q3, we paid $64 million in dividends to our shareholders. Overall, total cash, cash equivalents and short-term investments increased by $119 million in the third quarter to $936 million. Moving onto guidance. Our beginning Q4 backlog is $388 million, up approximately 6% from the prior quarter. Based on this beginning backlog and expected turns, we forecast Q4 revenue of $590 million to $620 million or up approximately 6% at the midpoint from Q3. Q4 gross margin, excluding special items, is estimated at 60% to 63%, improving due to higher revenue, associated higher utilization and strong spending controls. Other variables that may influence Q4 gross margin include product mix and inventory reserves. Special items in Q4 gross margin are estimated at slightly over $9 million, primarily for amortization of intangible assets. Q4 operating expenses, excluding special items, are expected to be up 2% to 3% sequentially, less than half of the revenue increase. The increase in OpEx is due primarily to higher variable bonus and moving costs for our new headquarters building. Special items in Q4 operating expenses are estimated at $4 million, primarily for amortization of intangible assets. This excludes potential items that may occur during the quarter. Our Q4 tax rate, excluding special items, is estimated to decline to 20% to 24%. For our fiscal year '13, we are now expecting a tax rate, excluding special items, in the low 20s. For Q4 GAAP earnings per share, excluding special items, we expect a range of $0.37 to $0.41. Capital expenditures in Q4 are expected to increase over Q3 due to investments in manufacturing capacity expansions and new facilities. Due to these items, we expect fiscal year '12 CapEx to be above our business model, 5% to 7% of revenue. We expect fiscal year '13 CapEx to return to our business model. Finally, our Board of Directors approved a payment of a cash dividend of $0.22 per share, approximately a 3.2% yield at yesterday's closing stock price. I will now hand the call over to Tunç to discuss our business. Tunç Doluca: Thank you, Bruce. Thank you all for joining our call and good afternoon. Let me start by highlighting 3 key developments. One, gross margin exceeded our guidance, and was virtually unchanged from the previous quarter despite the revenue decline. Utilization improved and our manufacturing organization did a great job controlling spending in a very challenging quarter. These resulted in better earnings per share than projected. Two, we continue to actively manage our portfolio by increasing investments in key product lines while divesting non-core businesses. In January earnings call, we have discussed the sale of our clock synthesis and synchronization product lines. During the March quarter, we also sold our 12-gig storage product line to PMC-Sierra. Three, business conditions and orders improved in all 4 major markets. Let me next turn to our just-completed quarter and give you an overview of lead times and bookings. During the March quarter, order lead times remained virtually unchanged from the prior quarter and bookings improved noticeably, resulting in a book-to-bill ratio comfortably above 1. Our delivery lead times were unchanged. I will next provide some color on our major markets. I will start with consumer. We expect this market to be up strongly, led by resumption of growth in our smartphone business, following a seasonally slow March quarter. Beyond cell phones, production has started of design wins in Japanese digital video and DSLR cameras, with our unique USB charging chip. And production is ramping of an e-reader that also uses our USB charger. We continue to execute our long-term strategy in the mobility markets. Let me expand on this. During our last earnings call, we had mentioned potential Power SoC design wins at 2 additional top-tier smartphone customers. We began shipping small quantities to both customers in the March quarter. Although we are currently designed into a limited number of handsets at each, it opens the door for us to proliferate our Power SoC to other platforms offered by these customers. We're extremely excited about the upcoming announcement of a new smartphone platform by one of our key Asian customers. Our dollar content in this new platform is higher than in prior successful smartphones due to higher levels of complexity and integration. We're also anticipating the launch of a new phone by another Asian smartphone supplier. It will be the first smartphone to ship with a Maxim Power SoC and audio codec inside. Second, let me discuss industrial. We project June quarter industrial revenue to be up slightly. We expect growth in the security and automotive segments to be offset by a decline at 2 specific medical customers. The largest segment of industrial is control and automation. this segment has a broad customer base, buying predominantly through the distribution channel. We believe that these customers and the sales channel have consumed inventories and are now ordering at end-consumption levels. In medical ultrasound imaging, we have several high-voltage design wins for switches and pulsers. These products have industry-leading performance and are manufactured on a proprietary high-voltage process we developed that was optimized for this application. Third, communications. We project revenue to be up slightly. The base station market is rebounding as inventory returns to normal levels. However, this is partially offset by continuing softness in traditional telecom. At Mobile World Congress, there was a lot of excitement about small cells. We've enhanced our leadership position in RF for small cells with a strategic investment in Scintera Networks, a leading provider of adaptive signal processing solutions for wireless communications. Maxim's state-of-the-art high-performance RF transceiver solutions, coupled with Scintera's novel analog pre-distortion technology, will offer superior small cell RF solutions. We believe our partnership will enable rapid deployment of power efficient, small cell base stations to cellular infrastructure OEMs and network operators. Fourth, in the computing market, revenues will be up, led by Data Storage systems and financial terminals. Here, we expect to benefit from Intel's Romley chipset rollout, as system vendors ramp new storage systems that use our 6-gig SAS expanded products. Additionally, we are seeing renewed strength in our older 3-gig SAS products, as customers fill the demand for increased storage capacity. In financial terminals, we have a design win at yet, another Chinese manufacturer that is now ramping into volume production with our secure microcontrollers. At the conclusion of my prepared remarks, I'd like to thank Vijay Ullal for his 22 years at Maxim. Vijay drove positive changes in our supply chain, led new market development and the acquisition of companies and technologies to name a few of his accomplishments. Vijay is leaving to pursue other opportunities. I congratulate Chae Lee for his promotion to Senior Vice President and he's taking over the reins of our mobility and consumer solutions group from Vijay. Chae has 24 years of industry experience and joined Maxim in 1999. He started our custom cell phone PMIC, now called Power SoC product line, established solid executive-level customer relationships and led the extremely successful Handheld Power Business Unit since its formation. Chae's combination of leadership and execution ability makes him uniquely qualified to spearhead our efforts in the consumer and mobility markets. I will now turn the call back to Venk.

Thank you, Tunç. That's the end of our prepared comments. We would now welcome your questions. [Operator Instructions] Operator, please begin polling for questions.

[Operator Instructions] Our first question comes from the line of Romit Shah from Nomura.

Bruce, I noticed that gross margin was much better than my estimate for the March quarter but I missed the explanation as to why.

Sure, Romit. I think 2 things helped us here. One is, we worked real hard from a spending controls point of view, spending within the pad end of line supply-chain management, pretty much across all of the discipline there and so, we did much better from a spending control point of view and the team kind of really came through. The second piece there was utilizations were better than we thought. Bookings were strong for the quarter, reflected in our guidance for Q4. So those are were the 2 things. Really it was the return of utilizations and the strong spending controls.

Okay. And just sticking with gross margins. If I look at your gross margin -- if I look at your revenues over the last 2 years when they've been above $600 million, you've posted gross margin of at least 63%. And today, you're guiding a little bit over $600 million, and I think at the midpoint, 61.5%. It seems conservative. I'm just curious why we wouldn't see 63-plus percent gross margin if your revenues are in that $600 million to $650 million run rate?

Sure. I think the one thing you have to remember is as we're ramping up and utilizations are ramping up, there's always one quarter lag on the benefit of those utilizations. So as utilizations ramp, we were at 72% in Q2, we were 76% in Q3 and we expect that to probably get around 80% in Q4 for fab utilizations. As that ramps, there's always a little bit of a lag from the benefit on the gross margin side.

Fiscal '11, where was capacity utilization running? Was it north of 90%?

It was right around that number. But once we get around 90%, that's almost fully-utilized.

Our next question comes from the line of Vernon Essi from Needham & Company. Vernon P. Essi - Needham & Company, LLC, Research Division: Tunç, I was wondering if you could revisit a scene that we heard a lot about a year ago and I haven't heard much of it since from some of the larger analog players and that's the 300-millimeter implementations. I know things probably haven't been favorable for that strategy lately but can you give us all an update on how that looks from your perspective going into this year, and how that might play out for the industry? Tunç Doluca: Sure. Well, I can talk more about how it affects Maxim more than the overall industry. But essentially, this was a strategy that we put in place, started working on, I'd say about probably 3 years ago and we qualified and began production last year in the fall of 2010 or so. Today, obviously, it is now -- we're producing more of our wafers in that technology. In fact, it was somewhere around 30% of our production starts last quarter, so it is helping us in 2 ways. Number one, it's helping us maintain the margin targets that we have. And number two, it's really providing us with a great deal of capacity that we actually need right now as we are ramping basically most of our smartphones, big chips or high-integration products. So it is an important piece of our strategy, and it is working really well for us right now for both of those reasons. In terms of the rest of the industry, I think one of our competitors obviously has this themselves as well. We're really -- it's difficult to comment about exactly how they're utilizing it and so on. But I can tell you that for Maxim, it's working really well right now. Vernon P. Essi - Needham & Company, LLC, Research Division: And if I can just sort of dig into that a little deeper. I don't know if you disclosed this but what was your level of integration in terms of percentages this quarter?

Vernon, this is Bruce. It's was about 35%. Vernon P. Essi - Needham & Company, LLC, Research Division: Okay. And then earlier, you had made comments and even in the last call, you made the same comment about the integration of an audio codec and I just want to be clear on this. Is this the same program you discussed the last time? Or are you getting incremental wins in the smartphone area with that? And then I guess furthermore, this is definitively on the same piece of silicon, this is not sort of a collateral cross sell win, correct? Tunç Doluca: Yes. So I assume you're talking about, on my prepared remarks, I mentioned a win. In that particular win, these were separate ICs. They were not integrated onto one chip. So we got wins for -- we essentially had wins for the Power SoC and we also got a win for a codec chip that we have and they're not on the same piece of silicon.

Our next question comes from the line of Steve Smigie from Raymond James. Jonathan Steven Smigie - Raymond James & Associates, Inc., Research Division: I was wondering if you can talk a little bit about how operating expenses might look into the coming fiscal year. I mean, I think back in December, you talked about you had, I think, restrained the expenses a little bit to get through a more difficult quarter. Are you going to see any expenses come back in like for -- when can Maxim come back, something like that, that will make fee dollars going up a little bit as we get to the next fiscal year?

I don't think you're going to see anything out of the ordinary from an operating expense point of view. We'll have our normal focal increase in the September, the month of September. And so, our fiscal Q2 or the December quarter always sort of takes the step up. But I think if you look at the guidance we just gave at up 2% to 3%. So that gets you to a $218 million to $220 million range. That's still below where we were at in Q1 of 2012. So I think we've done a pretty good job of continuing to manage expenses. One of the areas that Tunç talked about in his prepared remarks was around how we're kind of balancing investments in some of our key growth areas with portfolio management and the divestiture of other businesses that may not be as strategic to our long-term growth. Jonathan Steven Smigie - Raymond James & Associates, Inc., Research Division: Okay, great. And just for my follow-up question. I was wondering if you can comment on some of the next -- for the rest of the -- for this calendar year, how you sort of see growth for your consumer category. I guess the bulk of that's probably handset business? Because you said near term, it's recovering. I mean, is that going to be a double-digit grower this year, do you believe? Tunç Doluca: I can't make really, comments for way towards the end of the year. But the 2 effects that we're seeing right now, number one is obviously, we're entering typically, there's an increase in handset or smartphone sales that occur in the June quarter and in the September quarter. So we got that effect going on. And in addition to that, we are adding a couple of new production ramps with 2 new customers. Although those are a limited number of models but they still help. And the other effect that we're seeing is that the products that we now ship into the most modern phones have a lot more complexity and content. So that's also giving us a tailwind, because the average dollar content goes up as well. So if you include all of those things, as I said, we guided that our revenue would increase strongly especially in the June quarter. And that does mean double-digit-type growth that we expect.

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

This is Aashish Rao for Vivek. A question on handsets. Historically, you've had high exposure to the Korean lenders but you just highlighted 2 other designs ramping at 2 Asian vendors. Perhaps you could give us some color on your current handset customer mix? And how you see that changing over the course of the fiscal year '13? Tunç Doluca: Okay. So first of all, you're correct. We've got a very strong position at one Asian customer. We've added 2 more, as I mentioned. And those 2 were really not -- not both of them are in Asia, by the way. And those are just beginning. The way these relationships begin is that we kind of have to prove ourselves first, winning a couple of cell phone models and that's essentially what's happened and -- at these 2 new vendors I talked about. And what's happened recently was that we actually began to ship those models. So we had won the design but hadn't begun shipping. And as the year progresses, I expect those designs to proliferate to other models at those 2 vendors. The exact timing of when that's going to happen and what the volume is going to be is hard to predict. But clearly, a part of our strategy is to be able to supply to more than one large customer of ours. So from our viewpoint actually, that is going pretty well. So we're pretty strong at one, 2 more that we're adding right now. And we're also ramping at another Asian customer that we had some business in, but we believe we're going to get more content in some of their newer phones. [indiscernible] as I mentioned, they'd have the both codec win and the Power SoC.

All right, cool. And one more question, this one on computing. I mean, sales sure are down about close to 50% from peak. I mean, you've been exiting some other commodity notebook and desktop PC power management businesses. I think last year, you said your PC exposure was about 7%, 8% or so. Perhaps you can remind us what it's at currently and timing around when we can see the segment begin to grow again from your investment areas such as storage, servers, data centers and financial terminals?

This is Bruce. I will answer the first half that. The notebook computers were about -- they're probably down to about mid-single digits right now as a percent of total revenue. So that has continued to drift down as we kind of reallocate resources to higher growth markets. Tunç Doluca: I didn't get the second part of that question, did you?

Yes. Like, I mean, do you expect computing to now grow in FY '13? Tunç Doluca: So the biggest piece there always is the PC piece. And as Bruce mentioned, we're really not very heavily investing in it unless we find some areas that we can differentiate. So I don't really think that, that's going to be a growth market for us this year [indiscernible] also.

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

It's Jim Schneider in for Jim Covello. I was wondering, Tunç, I think you talked about you believe you're shipping at end consumption levels in some markets so as with some areas of industrial? Can you talk about maybe broadly speaking, across your end markets, any areas where you're thinking you're shipping most under consumption? Tunç Doluca: Yes. The comment that I made was mostly about industrial. So let me just go over it very briefly here. So in the industrial market, we were under-shipping in demands in the past as customers and distribution was reducing their inventory levels. We believe right now that we were really shipping at end-customer demand in those markets. However, those same -- the same channel and customers are really not replenishing the inventory that drew down. That's why we're not seeing a big increase in demand. So we believe that our orders and our shipments are pretty much balancing what their -- at their consumption rates in industrial. I also talked a little bit about communications, especially on the base station market. There was a pretty big buildup of inventory in that channel, and we believe that, that's now been consumed. And now, we're beginning to ship at the levels that the customers are consuming the end product. Whether that channel is going to rebuild its inventory or not, we don't really quite know. We don't know what their intentions are. In the other markets, like in mobility, I think they were pretty much shipping at the consumption levels and we -- when we look -- when we do our analysis and look at inventory levels in those other markets, they look to be pretty normal and there doesn't seem to be a desire from customers to actually increase their inventory level. So in those 3 markets that I've mentioned, we really were pretty much, shipping at the consumption levels of that equipment.

So it sounds like you're not under -- you don't feel you're under-shipping in any end markets at this point. Tunç Doluca: It doesn't feel like it to us.

Got it. And then as a follow on, on the utilization question, can you just quantify for us what your utilization rate is today versus what it was one quarter ago, please?

Sure. Fab utilization rate in Q3 was 76%. In Q2, it was 72%. And just as a reference point, in Q1, when we were at $636 million in revenue, it was at 89%. And as I said, as our business bookings continue to come in nicely, we expect that utilization rate to increase to probably right around 80% or so.

Our next question comes from the line of Uche Orji from UBS.

Can I just make sure I understand how the utilization rate metrics work? Because from earlier conversations, you outsourced some stuff to some offshore partners, foundry partners. How much is outsourced at the moment, if any?

Yes. It's about half of our fab manufacturing production is currently outsourced to our 3 foundry partners.

I see. So Tunç, you described your partners as shipping to end consumption. Is the increase in utilization rates designed to match that or are you anticipating to raise your inventory just to make sure that you have enough in case demand does come back strongly? Tunç Doluca: Well, we've -- if you look at our inventory days, they actually are below what we'd like to have in general. Bruce, it was 89?

89. Tunç Doluca: It was 89 days last quarter and our goal is really 90 to 100. But there's other variables that work into that, like how much of your inventory is coming from outsourced foundries versus in-house and so on. So our goals are really pretty simple. We want to have enough inventory so that we can support customers with about 6-week lead times. And we're comfortably able to do that right now. We're actually -- our delivery capabilities are slightly under that and they have been so for a couple of quarters. So we believe that our inventory levels are good. We have, as you can tell, we have available capacity in our fab, internal fabs and there is also some available capacity in the external foundries, strategic foundries as well. So our inventory positions are pretty comfortable and we have additional capacity available. So we can -- if the demand goes up higher, we're really able to support that. When we do our calculations, we think that we have fab capacity. If it all comes in the right mix, I have to give you that warning, to support up to almost $1 billion of revenue per quarter. So we're really in good shape in terms of capacity right now.

Just one more question. In terms of the commentary you made about base station and wireline, do you have any insight as to what that may mean by region? So when you talk about basic and rebounding, obviously we know that North America seems to be doing better with some of the key customers there is in CapEx. But any comments or any insights you can provide toward our reach, that's going to be helpful. Tunç Doluca: Yes that's going to be -- I mean, it's pretty broad based and I don't have the specific data in front of me, so I'd rather not comment on it since it's not in front of me.

Let me just try something else on the regional mix as well. In industrial, when you were describing industrial exposure, what are you seeing by region on that front? And also, in your conversations with your customers, what do you think the inventory levels are related to history and I'm assuming its below historical levels and could you give me an insight as to whether this is going to be a new normal for inventory levels or what will be the categories for them to review this back to what maybe at the level it had been prior to the current restocking? Tunç Doluca: So let me just take the first portion. So this is -- you mentioned there when you talk to your customers and the truth of the matter is we talk to very few customers in the industrial market, very broad-based. And the main people that we talk to, to get market information is really the distribution channel. So it depends on what their intentions are going to be, because we're further removed from the customer in that space. But the general feedback we were getting is that they appear to be comfortable with the inventory levels that they carry. It's a little bit under what we actually would desire. Frankly, they're about in the high-50s and we really want it in the mid-60s is what we desire. But I think they are comfortable with suppliers being able to support them with products. So until something changes there and they get the feeling that there's any kinds of concerns on the supply side, I think they're going to pretty much, be at these levels. So it's all going to be determined by all of us in the analog industry and with the suppliers and whether we begin to extend lead times and so on.

Our next question comes from the line of Shawn Webster from Macquarie.

On the tax item, looks like you're seeing better expectations for -- or a lower tax rate going forward. How much of that was related to the one-time, I guess, international tax restructuring and what exactly was that event?

Sure. I think the move from sort of mid 20s to low 20s was primarily related to the same effect that caused the one-time charge. And really, what that one-time charge was in Q3, we added some new countries to our international structure, which would then allow us to get a greater percentage of our revenue at a lower rate. And because we're achieving this greater international participation in our structure than we originally assumed, we actually need to increase the startup cost-sharing accruals. So basically, think of it as we're getting more benefit from our international structure, therefore, we need to make sure that those original kind of cost sharing accruals reflect at that higher participation. So we have to kind of make some adjustments for some prior period accruals, and that's really what you're seeing from the one-time charge. That's a non-cash charge. It's really a provision from that point of view. And as we indicated, to the extent that we bring it down into the low 20s, it pays for itself very, very quickly.

Okay. And then a couple more questions. One is on the divested businesses. You had a gain on it in the quarter. Did those -- how much in revenues did those business units contribute and were they above your corporate average in gross margins, one. And then secondly, I was wondering, you said your backlog at the end of March, it looks like it grew roughly 6% sequentially. Has it continued to grow over the course of April?

So as far as the 2 businesses go, the storage next-generation 12-gig product line that we sold, if that the next-generation, we're actually just now ramping our 6-gig product line. And that product's life cycle is usually 3 to 5 years. So we don't expect, within the next couple of years, any impact related to the sale of that next-generation storage product line. As far as the clock synchronization product lines, the revenue impact to that was immaterial from our overall corporate revenue point of view. Tunç Doluca: And you also add the gross margins that we shouldn't -- that's no longer our business, so we should not be commenting about this gross margin.

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

One question on the demand side of the equation. Can you talk about how much of your revenues came from disti and then the demand patterns in the distribution side of the equation versus the OEM side?

Sure. About 30% of revenue was from the distribution channel. When we look at our distributors, they actually had a really good quarter. We saw the kind of the bookings on Maxim was up 26%. That compares with overall Maxim bookings of up 12%, so we had a good quarter from a distribution point of view. End market bookings, these are the bookings from the distis customers on the distis were up 10%. So we're continuing to see that strong end-demand that I think other folks have been seeing in the industrial market. I think from -- compared to the OEMs, Tunç has given commentary around our mobility business. Obviously, we're being -- we're seeing that business up strongly. And so, we're seeing booking patterns that reflect that strength.

As my follow-up, switching over to the OpEx side of things. Bruce, I think you highlighted that in the September quarter, I believe you said, is when you have your annual merit increases. Can you just remind us how we ballpark that as far as either a percent of revenues or total absolute dollars please?

Yes, it's usually about a couple percent impact for the full quarter impact.

A couple percent up sequentially?

Yes.

Great. And then I guess, one last one if I could sneak in. Inventory reserve charges, what were they? Did you have them in the fiscal third quarter and do you expect to have any in the fiscal fourth, please?

Sure. And just to make sure on that prior question, Ross, that 2% up, that full quarter impact is in December. In the September quarter, we only have one month of that, we only have it for the month of September from a modeling point of view. So from that point of view -- I'm sorry, what was the other question?

The gross margin. I believe in the December quarter, you had significant inventory reserves as a headwind to gross margin. You thought you'd still have those in the March quarter. I'm just wondering, did they exist in the March quarter and do you expect them to exist in the June quarter?

Yes. We always have some level of inventory reserves. It's usually about right around 1% of revenue or so. That's the normal range. In the December quarter, they were significantly higher than that. I think we talked about it. It impacted gross margins by about 1 point. They came back down into the normal range in the March quarter and we, from a modeling point of view, we always just sort of assume that we'll have that same level.

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

I think one of the things you guys have talked about over the last 2 quarters was this initiative of taking some of the product out of foundry and bringing it into your internal fabs. I know that's been a project that's been around for a while. Was that a contributor to the March quarter gross margin upside or June quarter? And perhaps, you could tell us what the status of that is. Is there a future gross margin benefit we can expect from that initiative? Tunç Doluca: Sure. So just to bring you over to the same page. So the subject was that most of the demand coming for our mobility products coming in, our most advanced technology that's in production. And currently, we're producing most of those wafers at our strategic foundry partners. And we had an effort in-house to actually bring it up or qualify at a couple of our internal foundries so we could rebalance the load and increase the utilization of our internal fabs. So that product is ongoing. There was some delay in the qualification at our San Antonio fab but we are catching up and we expect to qualify that process this quarter. We really didn't ship any production wafers since it's not qualified in the March quarter. So that had no effect. So we didn't see the positive effect of what we would get by increasing our internal utilizations. We do expect that we'll qualify one of our internal fabs this quarter and we actually will begin to make starts as well. And in our second internal fab, we expect to qualify that by the end of the year. So we'll be able to source that process technology from -- 2 internal and 2 external fabs.

Is there a way of quantifying the gross margin benefit or the utilization benefit that you'd be able to get once that first fab is qualified, and then when it's complete with the second tab?

We manage our capacity and our fabs to try to run around 90% utilization. And by bringing in the S18, which Tunç talked about, basically what that's doing is that's replacing some older technologies that are falling off. And so, this is actually just really maintaining kind of the full utilization of our internal fabs. And so I think from that point of view, it allows us to operate our fabs at the most efficient level where we've been before. So I don't think this will increase our 61% to 64% gross margin target model.

Okay, great. And just one follow on, if I can. You talked about the content increase at one of those high-profile smartphone wins. As you look forward, is that something you expect more broadly across your smartphone exposure such that you think you guys might be able to grow a little faster than the growth we might see in the smartphone? And I guess, that has something to do with market share at that lead customer as well. Tunç Doluca: Yes. Our general direction is really to provide more and more functionality and complexity to our customers. And why do we do that? It's pretty simple. They want it from us because it makes it easier for them to design these phone platforms quicker. And it also saves them space on the overall PC board. And in many cases, also increases their battery life. So the direction is going to be in adding more and more functions and complexity to the products. And that should really lead to us being able to capture more of the ESP inside of each of these smartphones. The rate at which that progresses is going to be different at each customer. It's going to depend on how much they really want to trust us to be able to supply that. And obviously, it's going to be -- the leading customers are the ones that are going to be -- that have been with us for the longest, which is exactly what we're seeing right now. So we definitely have plans to increase the complexity and the content in these Power SoC products that we make. And that should, if we execute that strategy well, it should be able to increase our unit sales, as well as our market share because of the higher dollar content. I mean, just to give you an idea, I don't know if this was asked in a previous call or not, but we still believe we have a lot of runway in that market, where our share in smartphones, in terms of the analog available market, this is probably in the mid-teens, and we should be able to, with the strategy that I mentioned, more complexity in adding a few more OEMs be able to increase that going into the future.

Our next question comes from the line of Terence Whalen from Citi.

The first question here is regarding the touch controller market for handsets. Yesterday, one of your competitors actually announced that they're exiting that market in light of increasing competition from both Taiwanese and Korean competitors. I wanted to just get an assessment of your view of that market. How that's evolved over the past several months with regard to competition. Tunç Doluca: Well, the touch market, I have to admit, humbled us a little bit. It is a very competitive market. There's multiple suppliers in it and the sockets turned out to be more sticky than we thought. And in some cases, we actually believe that we'd won the designs and it turned out that the customers -- and we reported on these design wins, by the way. And it turned out the customers wanted to reduce the risk. So they essentially -- they remained with the incumbent supplier. So that, from selling of a single touch unit that just does that function and that function only for a phone, we see that continue to be a very competitive market with a lot of pressure in terms of pricing and so on. But that is a technology now that we have in our arsenal. We have a very good technology and when the time comes and the customers are ready for it, it's a technology that we can put inside of our Power SoC products. So from a technology building standpoint, it's been good for us. And it is -- it truly is a product that performs well under very noisy conditions, which is the biggest concern of most of the handset manufacturers. But the market is -- it's pretty competitive as I said and I assume that it's going to remain that way for quite a while.

And then as my follow-up, I think earlier today, Avnet actually made the comment that they were beginning to see some early signs of lead time stretching in certain components. I just wanted to get your take on whether or not you've seen that yet? And what your expectations are over the next couple of quarters, given what your customer conversations are indicating about the second half. Tunç Doluca: So when you say lead time extensions, you mean by the suppliers, I assume?

Correct. Tunç Doluca: Yes, so we're -- I mean, in terms of in the analog field, first of all, we are not having any lead time extensions ourselves. That's the most important point to make. We do have enough capacity and we have enough inventory to be able to support our customers. We've not seen -- basically, I've read the summaries of some of our competitors in the field and they were not talking about lead time extensions for themselves. So it doesn't appear like there's a capacity shortage in the field, at least not yet. And it looks like suppliers are in reasonably good shape. How it will turn out 6 months from now, it’s going to depend on how the demand grows. But we're not -- we don't have any visibility that says that the lead times are going to extend in the near future.

Our next question comes from the line of JoAnne Feeney from Longbow Research.

One more question on the fascinating topic of smartphones. So the problems over at TSMC and the constraining upset that Qualcomm has talked about, I was just wondering if that had any impact on what you expect to see in terms of orders throughout the calendar year? And if there's any other spillover for you guys from that? Tunç Doluca: Yes. We actually don't really see an effect on us from the shortages. I assume you're talking about the shortages in 28-nanometer technology there. We have -- obviously, we did hear about it. We evaluated what the impact is going to be on Maxim. We took that account when we were giving our guidance for the quarter. But the impact really is not -- I mean, it's not perceivable in terms of the products that we sell. So we don't think that, that's going to have an impact on what happens at us in terms of our sales of our products, especially our Power SoCs.

Okay, excellent. And then perhaps on the automotive side, could you give us an update on how your demand is looking there and how your various products are proceeding? Tunç Doluca: So on the automotive side, essentially we had going into -- from the December to the March quarter, we had strong growth in the automotive field. We, in the near -- I mean in the future, in terms of this quarter and the June quarter, we expect increasing demand for our products, mostly coming from infotainment products that we sell into Japan, and also the ramp up of our some Keyless go products. So there's some areas we are definitely seeing more demand than others in that space. Long term, we continue to invest in this market. I think it's going to be a good growth market for the company because of all the technology we have to offer, but also for the amount of electronics that keeps increasing inside of each car. So corporate-wide, we have investment in the sensors field, especially in the motion sensor area. We have investments in infotainment products for power, for RF products, and as well as high-speed serial communications products. And finally, we have investments in battery monitoring technology. So all of those are going to be good opportunities for the company. And I'm really encouraged by the fact that our customers really do like the technology we have to offer. And that will result in growth for us in the long term.

And due to time constraints, we will take one more question. Our final question comes from the line of Doug Freedman from RBC Capital.

If I could start with Tunç. You guys have talked about your strategy of higher integration products and you've been very successful with that in the wireless market. Can you talk about any progress you've made on taking similar strategy to tangential markets? Tunç Doluca: Yes. So if you look at our high integration product sales, about half of it is going into -- probably more than half now because of the great growth we've had in smartphones into the mobility market. We have made high integration products for other markets as well, obviously. And those products are also being successful. I mean, we've got them in SoCs that we sell into smart meters for example, it's a pretty good example of a success story that came to us, as you know through the acquisition of Teridian almost about a couple years ago. But we've been continuing to grow that business and the customers really like the fact that they can buy one product and be able to do all of the functions they need inside that application. Also in the smart grid area, we've got high integration products to do the power line communications. That's another field that's interesting from a customer standpoint. In automotive, customers keep asking for high integration solutions and we're absolutely trying to make those products for them. And they're asking for it because it really gives them a smaller solution as well as higher reliability because they can reduce component count inside of the car. So that's another space where we've seen the need for high integration products. In the comms market, we've invested very steadily in small cells and mostly in femto cells, where we can put an entire RF transceiver including the data conversion piece on a single piece of silicon. And in fact, in that market, we really -- in the femto cell market, we have the commanding market share for RF transceivers today. And all that technology we have can easily be put into micro cells or small cells that are a little bit different than femto cells, so that's another area that requires high integration. So we're pretty much seeing this across-the-board. And the market where it's probably going to come last and it's going to be the broad industrial base. But even in that space, we have some ideas about how to really deliver solutions to our customers and make their jobs easy. I mean that's basically the goal of the company. So I think essentially, this strategy that we've got of giving high integration solutions to our customers is being well received by our customers. And I think we're going to continue to make progress every year on how many design wins we're getting in all 4 markets, frankly, to grow our business.

If I could, I'm going to give you a little warning. This is sort of a 3-parter since I'm up against the clock. You mentioned the femto cell market. Can you give us a sense of when the timing -- what the timing and the uptake of that is? And then you also had the acquisition of SensorDynamics. Could you give us an update on the progress of the gyro development there? And then the last part of the 3-parter is the Powerchip has been in the market with some rumors out there that their fab is for sale. Is that going to have any impact on you? Have you looked at that? Do you think you need to make $300 million asset investments? Tunç Doluca: So let me take them in the order you asked. Yes, so the first one was on femto. We have been in these designs and we have been shipping production units for this. And it's really how fast the ramp is going to be which is really unclear. I don't think I can make good comments about how fast that ramp is going to be. All I can say is that we have our first-generation products in production today and we're already in the process of preparing our second generation products, essentially for LTE solutions. Our current solutions are mostly for CDMA and 3G products, so it's really hard to figure out what the ramp rate is going to be. It's going to depend very heavily on what the service providers want to do. Because in most cases, they're trying to get subscribers who are outside of their coverage to stick with them, and that's how the femto or in some cases, give away femto stations to consumers. So not a good answer for you, but that's all I know right now in terms of being able to predict how fast the ramp is going to be. On the SensorDynamics front, we're actually making good progress. Our goals were really to make -- to begin to make these products or produce these products in our own facilities and we're making good progress on that. It will be some time before it's completely qualified because the current products that we sell are for the automotive markets and there's some qualification processes that are extensive in that market. We're also making good progress on making our first consumer gyro products. Those are going on very well and we've got some initial products that we're evaluating in the lab. So that's going very well in my view as well. So we're pretty much on plan is the short answer in the SensorDynamics front. Your last question was on Powerchip, the 300 millimeters supply. As you know, 300 millimeters, we don't do in-house, we all do it outside and at one strategic foundry, which is Powerchip. Whether -- I do, I have read and we obviously know by talking to them about their plans and any fail that they have doesn't really involve the fab that we're using. Therefore, we're in pretty good shape. Eventually, we have to look at all our options and see if we do have to add another source of supply and we probably will. But we don't really -- we're not in a position right now to announce when it's going to be and who it's going to be. But as soon as we make those decisions, we will let you all know what's going to go or what's going to happen.

Thank you, operator. This concludes Maxim's conference call. Thank you all for your participation and for your interest in Maxim.

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