Analog Devices Inc (ADI) — Q3 2015 Earnings Call Transcript

Thank you, Jennifer, and good afternoon, everyone. Thanks for joining Analog Devices Third Quarter Fiscal 2015 Earnings Conference Call. You can find our press release and related financial schedules on our Investor page at investor.analog.com. Now before we begin, I want to call your attention to two new items. Number one is about a change around the timing of our future earnings conference calls, and number two is about increasing the level of information we provide investors. So first, starting next quarter, which will be our fiscal fourth quarter, we are going to move our earnings conference call to the morning. After speaking with many investors and analysts, we believe a morning call is a more convenient time for all stakeholders. As a result of this change, starting November 24, 2015, which is our fourth quarter 2015 earnings call, and for every quarterly earnings conference call thereafter, we will issue our earnings release at 8 a.m. Eastern Time. And the earnings conference call will take place two hours later at 10 a.m. Eastern Time. Secondly, we have introduced an investor slide deck, which we call the investor toolkit. And this slide deck or toolkit has been designed to provide investors with even more clarity around our results. We've posted the toolkit on our Investor page at investor.analog.com, and this is something we plan to prepare and post every quarter through our website. So let's get back to today's call. As usual, I'm joined by ADI's CEO, Vincent Roche; and ADI's CFO, Dave Zinsner. Our agenda for today's call will be as follows: First, I will provide a brief overview of our third quarter results, then Dave will review our financial performance in the third quarter and provide our business outlook for the fourth quarter. And finally, Vince will capstone the scripted portion of today's call with his closing remarks. Now as is customary, after our prepared remarks, we'll open up the lines for Q&A. So please note the information we're about to discuss today, including our objectives and outlook, includes forward-looking statements. Actual results may differ materially from these forward-looking statements as a result of various factors, including those discussed in our earnings release and our most recent 10-Q. These forward-looking statements reflect our opinion as of the date of this call, and we undertake no obligation to update these forward-looking statements in light of new information or future events. Our comments today will also include non-GAAP financial measures, which we have reconciled to their most directly comparable GAAP financial measures in today's earnings release, which we've posted on our IR page at investor.analog.com. So with all that behind us, let's get started. So as you've likely seen from our press release, ADI had another very strong performance in the third quarter of 2015. The combined power of our franchise, our commitment to innovation, the diversity of our business and our continued strong execution delivered results that were at the very high end of our guidance range. Revenue in the third quarter of $863 million increased 5% sequentially, and 19% year-over-year, once again establishing a new high watermark for ADI. By end market, the industrial and automotive sectors were about in line with our expectations, while consumer revenue exceeded our plan and more than offset the impact from a weak wireless infrastructure CapEx environment. Now I would like to give you some color on our performance by end market during the third quarter. At 44% of total sales, our highly diversified industrial business was about even to the prior quarter. Strength within industrial verticals, such as aerospace and defense, and the renewable energy sector, was offset by weaker industrial automation sales. End customer bookings in the industrial market were generally stable during the quarter. We believe that there's currently a good match between supply and demand in our industrial business, which is largely serviced through distribution, where we recognize revenue in all regions of the world on a sell-through basis. Now turning to automotive. After growing 13% sequentially in the second quarter, automotive decreased 7% in the seasonally slower third quarter and represented 15% of our total sales. At the current quarterly run rate, automotive represents a $500 million-plus annual business for Analog Devices. Revenue from our hundreds of communications infrastructure customers at 16% of sales declined 22% sequentially, which was the third consecutive quarter of sequential revenue declines in the sector. Revenue from wireline customers represented about one-third of our communications infrastructure sales, and was approximately flat to the prior quarter. A weaker-than-planned wireless infrastructure market in North America and China, combined with customer inventory drawdowns, impacted our performance in the third quarter. We believe that current wireless infrastructure revenue run rates for ADI are artificially low, and that our strong position in this sector will allow us to recover rapidly when this market snaps back, as it usually does without much notice. Consumer revenues at 24% of sales grew significantly over the prior quarter. While prosumer audio/video was stable sequentially, portable applications continue to drive our consumer growth. Our strategy in consumer remains strikingly consistent: we participate in those applications where we can leverage existing core technology to solve our customers' toughest challenges, where we believe our innovation is sustainable and where our technology makes a meaningful difference to the user experience. And by leveraging existing core technology, we further increase the ROI on our R&D investment. So now I'd like to turn the call over to Dave for details of our financial performance in the third quarter. With the exception of revenue and other expenses, Dave's comments on third quarter 2015 P&L line items will exclude special items, which in the aggregate total $30 million. When comparing our third quarter performance to our historical performance, special items are also excluded from prior quarter results and year-over-year results. And reconciliations of these non-GAAP measures to their comparable GAAP measures are included on Schedule E in today's earnings release. So with that, Dave, it's all yours.

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

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

Great. Thanks, Vince. Thank you. We're going to run the call until 6 p.m. So with that operator, let's start the Q&A session.

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

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

Great. Do I get a follow-up?

No. Re-queue.

All right. If you don't ask, you don't get it.

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

I guess. Dave, I want to get a little bit to the margin profile on the consumer business, both on the gross and the operating line. I'm assuming that all of the gross margin decline in the October quarter is because of the increase in consumer. I'm just wondering, it seems like consumer is up a lot in October, but not up as much as July, but the impact to gross margin sequentially is about the same. I'm just wondering if there's anything going on within consumer mix. And I guess, more importantly, how do I think about operating margins in that consumer business? Because clearly there's not as much SG&A expense to that incremental revenue. So is it sort of diluted to kind of gross margins, but accretive to operating margins? Is that the way I should think about it?

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

The question is a follow-up to the two earlier, with regards to the consumer segment. Can you speak to the degree to which you're seeing application and customer breadth with the platform technology that's favorably impacting the third and fourth quarters' results? And from here, what's the opportunity to grow customers and application exposure as you look out to fiscal '16?

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

Yes, Craig. We have over 40 years of experience in developing precision silicon and high-speed silicon. The industrial market primarily focuses on control applications, which are precision-oriented. This technology is predominantly utilized in that area. Different markets influence technology development at varying speeds, leading to fluctuations between markets. There's significant synergy between industrial applications and consumer technology, benefiting both sectors. We serve many thousands of customers and products, and in certain instances, we tailor products to meet specific market and customer requirements. This makes our space very complex and diverse.

I would ask a nonconsumer question. So some of your peers have talked about a slowdown here the last couple months in order rates, especially in the industrial market. I'm just wondering what you're seeing. I do realize you're guiding for the industrial business to be fairly flat this quarter. But just from a macro level, what are you seeing on your order rates?

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

I would add that if you look at the outlooks provided by some of the large distributors for their components business, they are generally operating within a seasonal range, possibly at the lower end. For companies like ADI, which have very little exposure to PCs—essentially none—and are more focused on markets like industrial, we are aligned with what many distributors are also experiencing. Additionally, our revenue recognition policy is very conservative; we only recognize revenue when distributors actually sell the products, so we are likely closer to end demand compared to others in the market. Our inventory levels in the channel are still around 7 to 7.5 weeks, indicating that we are operating within a seasonal range. The decline that some competitors have mentioned hasn’t happened for us, and overall, what we are observing is consistent with what you might have heard from other distributors.

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

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

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

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

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

I believe the communications sector has experienced some challenges, especially in China, due to a halt in the rollout of macro base stations while investigations are taking place. It seems we have reached a low point in the wireless sector, and I don't expect it to decline further from here. However, it's uncertain when it will bounce back. We have received feedback from our OEM customers indicating that a resumption is expected, but the timing remains unclear. I'm not sure if there's anything more you would like to add.

Yes, I believe Dave is correct. The demand from the OEMs on the ADI appears to be stable. As Dave mentioned, I think we've reached the lowest point. So, I believe we are prepared in terms of supply when the demand picks up again, and I expect that to happen sooner rather than later.

Thanks, Ross. I would just like to add that the bookings are stable, which is always a positive indicator for our business. We also reviewed when we last saw these revenue levels in the communications infrastructure sector, and it has been quite some time. Therefore, it is currently very low. Our perspective is that things are at least stable here, and if a recovery is on the horizon, please let me know, but we find it difficult to predict.

Dave, I'm curious about your performance at the high end of the range, especially since the other segments were weaker. Consumer seems to be increasing even more. If you can share, what factors contributed to that upside? Was it primarily timing, like an earlier ramp-up, or was it just the high volume? Looking ahead to October, the range appears broader than usual, mainly driven by consumer. Can you explain the factors influencing that? Are there additional products involved, or are you taking a more cautious approach to the ramp? Any insights would be appreciated.

Yes, thanks, Blayne. The third quarter results were in line with our expectations, reaching the high end of our projected range. We anticipated this outcome, and it reflects our best-case scenario that materialized. This was largely influenced by the performance of the consumer business and the dynamic nature of how production is rolled out. Customer feedback can fluctuate week to week, making it difficult to predict exact progress. We consider various potential scenarios, and fortunately, this one resulted in a favorable outcome. Looking ahead to the fourth quarter, we have a broader range of possibilities. There is a scenario where production ramps up quickly and remains stable, as well as one where it increases but then levels off as inventory targets are met. We are hopeful that our projections are conservative enough to keep us within this range. We have thoroughly analyzed the situation and are confident that our range is appropriate.

What is the right way to think about the long-term business mix? Clearly, the consumer segment is performing well. However, as we know, investors are also drawn to a balanced business model without a heavy reliance on any single customer. So, looking ahead, what mix should we aim for to ensure that the business aligns with this vision?

The strategy is unfolding as planned. Over the past five or six years, we have been directing more of our research and development towards what we view as business-to-business applications, such as industrial, health care, automotive, and communications infrastructure. This is where most of our R&D efforts are focused, and it's also where the majority of our sales team operates, ensuring we seize opportunities by reaching the widest range of customers and applications possible. In the consumer sector, we maintain a highly targeted and focused approach to R&D and customer engagement, operating only in areas where technology significantly enhances user experience and is sustainable over time. Clearly, consumer markets tend to be more volatile than the B2B markets. However, we have a solid mix that allows us to invest in areas that offer longer product life cycles and more sustainable businesses, making the consumer space a worthwhile and reliable investment. As demand shifts between B2B and consumer sectors, so too will our business fortunes. Overall, our commitment is to achieve 2x to 3x GDP growth, maintain gross margins between 65% and 68%, and boost our earnings per share to well above $4. That's our goal, our mission, and what we are working towards.

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

Yes, it's a very good question. So clearly, as you said, China is shifting from we make it to we design it and build it. So we've benefited. This will be actually, when history's written on our fiscal '15 here, we will have posted very, very strong double-digit growth in the industrial sector in China across the board, in fact, in health care, in energy, transmission and distribution of energy in particular, and also industrial instrumentation and automation. So clearly, China is in the process of indigenizing the tech industry there. So we're benefiting from that in terms of our engagements with emerging OEMs in way outside of the consumer, the communications infrastructure and consumer businesses. So industrial's emerging, automotive's emerging, health care's emerging, and we're doing particularly well. I'm pleased with the progress we're making in building out our business there.

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

It has been quite strong and remains steady.

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

In the past, we allocated around 35% to 40% of our entire R&D budget towards various consumer applications. Currently, our spending is more focused and concentrated on areas closely aligned with the company's core capabilities. We are collaborating with market leaders to explore promising opportunities that we believe have long-term potential. This engagement is targeted, and we are dedicated to identifying challenges that allow us to leverage our technology effectively over time. That's the context to consider.

I guess my question is, how do you manage the risk associated with mix, given that consumer is now a larger percentage of sales than I think we've seen in the last 5, 10 years?

The foundation of this company is in the business-to-business space, focusing on communications infrastructure, industrial business, automotive, and healthcare, where we serve thousands of customers and offer hundreds of applications and 20,000 product SKUs. Our research and development efforts are primarily directed towards this core business of ADI, and that will continue into the future. In terms of our strategic perspective, how demand patterns change over time will depend on macro markets and the success of our technology, among other factors. However, I believe we have the right strategic mix, and the outcome will ultimately depend on our execution in the markets.

Do you think your book-to-bill ratio would change if you excluded the consumer ramp? I know you mentioned it's positive right now, but what would it look like without that consumer ramp for the next quarter?

I think it's, yes, roughly 1.

Roughly 1? Even with industrials declining and automotive, I know you mentioned it was somewhat in line, but it was expected to be flat, and it was down 7?

Yes.

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

The integration of Hittite is going exceptionally well. The business is performing strongly, and we are right on target regarding our synergies. I would be eager to hear Vince's opinion, but I can say that the previously distinct Hittite part of the company has essentially merged with the ADI family. In many respects, the distinction between ADI employees and Hittite employees in the RF sector has almost disappeared. This integration has been a great success. Our plans for capital use include future acquisitions, and we are actively exploring various opportunities in that area. We are focused on technology that is highly differentiated and synergistic with our current offerings, where our customers will benefit from our enhanced capabilities or integration that elegantly meets their needs. We continuously assess available opportunities. While I can't guarantee an acquisition within the next year, I believe there is a reasonable chance for some smaller acquisition that could be as impactful as Hittite was for ADI.

Yes, to add some context to what Dave mentioned, we have always been very confident in Hittite's technology and market position. If there was any risk, it was related to the cultural integration of the two companies. We recognized that Hittite's values closely aligned with ADI's, particularly the belief that innovation leads to business success and that engineering excellence is crucial for customer satisfaction. This alignment has indeed played out positively. Observing the collaboration between our engineering teams and our major customers, across various applications in fields like aerospace, defense, instrumentation, and satellite communication, has been impressive. I am very optimistic about the combination of RF and microwave talent throughout the company and what it means for ADI's future growth prospects. I'm very pleased with this development.

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

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

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

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

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

Do you want to take the geographic question?

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

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

How close to full factory utilization are you in the October quarter? And with the consumer mix, has your view changed on managing factory utilizations and internal inventory throughout the year? Is it possible to get kind of steadier utilization throughout a normal year?

We achieved mid-70s utilization this quarter, which is consistent with the previous quarter. I may have mentioned this before, but we are likely to reduce utilization slightly in the fourth quarter. The revenue increases for the fourth quarter will mainly come from foundries, so this will not impact front-end utilization. Ideally, we aim to raise utilization over time, and if you look at the year-over-year data, it has been gradually increasing, positively influencing gross margin. Our objective is to optimize the use of our existing factories to enhance gross margin growth.

It's a bit of a philosophical question. Moving forward, I was curious about your strategy. For companies that have secured substantial consumer business, especially with a significant customer over time, like your analog peers such as Linear, when faced with inevitable price reductions or declines in average selling price, some companies have chosen to exit that market, like Linear. Meanwhile, others, like NXP, have indicated that as long as they're maximizing gross profit dollars, they don't mind if it slightly impacts their gross margin. Clearly, both approaches have proven successful for those companies, but I am interested in knowing what your philosophy will be as we progress.

Our goal is to keep the business we have won. The good news is that we believe the technology has a lot of potential and is highly differentiated. As a result, the customer values it and is willing to pay a premium. Therefore, we anticipate that we will retain it without experiencing significant ASP erosion. However, that will be confirmed over time.

I believe another key part of our strategy is that many technology trends focus on consumer systems that can see, hear, and feel. There are significant macro trends that align well with our technology, particularly at the intersection of the physical and digital worlds. As performance improves, the competition is intensifying, and we need to enhance battery power efficiency significantly. There are numerous complex challenges to address, and they are not limited to a single type of issue. We pursue diversity in each application across our various businesses, exploring different technologies and developing a wide range of products. It’s not just about one product or one customer; it involves many technologies across multiple modalities at the convergence of the physical and digital realms.

Just coming back to the seasonality part of the business. So with consumer being about 30% in the next quarter, how should we think about not just the January quarter, but maybe even the April quarter. So you had some seasonality in the past. I'm just trying to figure out how that's going to play out going forward.

Well, Tore, I'm hesitant to make predictions since we currently have very little backlog to provide clarity on how things will unfold. Typically, we see a decline in the first quarter, around mid-single digits, particularly because a larger portion of our business is in the consumer sector during the fourth quarter, which often results in a significant seasonal drop in the first quarter. I anticipate we may see a decline greater than mid-single digits sequentially in the first quarter, but I'm not completely sure about that. In the second quarter, consumer sales usually remain relatively flat from the first to the second quarter. However, we do experience an upswing in industrial performance, which tends to be our strongest quarter for industrial, providing a good boost sequentially. This is my current outlook, but it's based on limited information regarding market behavior.

Dave, I want to ask quickly about the October run rate on the consumer side. Does that represent the complete opportunity on the mobile side, specifically across multiple platforms with a certain customer? Or is it more about how many units you can sell from this point forward? Are there other platforms you might be able to explore within the consumer space?

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

Sorry to beat this dead horse about macro and seasonality. But is there something that is company specific outside of consumer that you think is helping you provide a more sort of stable/seasonal outlook, versus a more cautious outlook that we have heard from, say, a Linear Tech or a Microchip or a Texas Instruments?

I believe our industrial business consists of broader market segments and more ASSP-oriented markets. It's clear that the broader markets were somewhat weaker, while the ASSP or vertical markets performed slightly better. Vince mentioned diversity in his remarks, and Ali has also pointed it out. The advantage of our diversity is that we operate in various parts of the industrial space, covering both broad and particularly interesting verticals, with some performing better than others depending on the quarter. In the third quarter, when comparing our performance to other players, we notably outperformed in specific verticals such as aerospace, defense, and energy.

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

All right. Great. Well, looks like we have reached the 6:00 hour here. And we appreciate everybody dialing in. So listen, as a reminder, our 4Q '15 results are planned to be issued on November 24, 2015, at 8 a.m. Eastern Time and our conference call should begin two hours later at 10 a.m. Eastern Time. So thanks again everyone for joining us this evening. We look forward to speaking with you again on November 24 at 10 a.m. So good night.