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Analog Devices (NASDAQ:ADI)

F4Q 2012 Earnings Call

November 27, 2012 5:00 pm ET

Executives

Ali Husain - Director of Investor Relations

Jerald G. Fishman - Chief Executive Officer and Director

Vincent T. Roche - President

David A. Zinsner - Chief Financial Officer and Vice President of Finance

Analysts

Terence R. Whalen - Citigroup Inc, Research Division

Ross Seymore - Deutsche Bank AG, Research Division

Aashish Rao - BofA Merrill Lynch, Research Division

James Covello - Goldman Sachs Group Inc., Research Division

Christopher B. Danely - JP Morgan Chase & Co, Research Division

Christopher J. Muse - Barclays Capital, Research Division

Tristan Gerra - Robert W. Baird & Co. Incorporated, Research Division

Doug Freedman - RBC Capital Markets, LLC, Research Division

Sumit Dhanda - ISI Group Inc., Research Division

Jonathan Steven Smigie - Raymond James & Associates, Inc., Research Division

Craig A. Ellis - Caris & Company, Inc., Research Division

Steven Eliscu - UBS Investment Bank, Research Division

Shawn R. Webster - Macquarie Research

Operator

Good afternoon. My name is Samantha, and I will be your conference facilitator. At this time, I would like to welcome everyone to Analog Devices' Fourth Quarter and Fiscal Year 2012 Earnings Conference Call. [Operator Instructions]

Thank you. Mr. Husain, you may begin your conference.

Ali Husain

Thanks, Samantha. Good afternoon, everyone. This is Ali Husain, Director of Investor Relations. We appreciate you joining us for today's call. If listeners haven't yet seen our fourth quarter and fiscal year 2012 press release, or our form 10-K, both may be accessed through our website at investor.analog.com. This conference call is also accessible from the same page. A recording of this conference call will be available today within about 2 hours of this call's completion. It will remain available via telephone playback for a period of time and it will also be archived on the IR website.

In addition, we've updated the schedules on our IR website, which include the historical quarterly and annual summary P&L for continuing operations, as well as historical quarterly and annual information per revenue from continued operations by end market and product type.

Participating with me on today's call are Jerry Fishman, Chief Executive Officer; Vincent Roche, President; and Dave Zinsner, Vice President of Finance and CFO. During the first part the call, Jerry, Vince and Dave will present our fourth quarter and fiscal year 2012 results, as well as our short-term outlook. The remainder of the time will be devoted to answering questions from our analysts and investor participants.

During today's call, we may refer to non-GAAP financial measures that have been adjusted for certain non-recurring items in order to provide investors with useful information regarding our results of operations and business trends. We've included reconciliations of these non-GAAP measures to their most directly comparable GAAP measures in today's earnings release, which is posted on the IR website.

I'd ask you to please note that the information we're about to discuss includes forward-looking statements intended to qualify for Safe Harbor from liability, established by the Private Securities Litigation Reform Act of 1995. These forward-looking statements include risks and uncertainties, and our actual results could differ materially from those we will be discussing. Factors that could contribute to such differences include, but are not limited to, those described in our SEC filings, including our most recent annual report on Form 10-K filed earlier today.

The forward-looking information that's provided on this call represents our outlook as of today, and we do not undertake any obligation to update the forward-looking statements made by us. Subsequent events and developments may cause our outlook to change. Therefore, this conference call will include time-sensitive information that may be accurate only as of date of the live broadcast, which is November 27, 2012.

And with that, I'll turn the call over to ADI's CEO for opening remarks.

Jerald G. Fishman

Well, good afternoon to everybody, and thanks for joining our call. As the press release said, our revenues for Q4 totaled about $695 million, which was up approximately 2% from the previous quarter and down about 3% from the same quarter last year. These results were within the guidance range that we provided last quarter and are relatively strong results in what has turned out to be a very challenging environment. The diluted earnings per share were $0.58, which was slightly above the midpoint of our earlier guidance.

For the full year of 2012, revenue declined just under 10% to about $2.7 billion, which was a reflection of a poor economic environment for most of our fiscal year, coupled with unprecedented global uncertainty, which severely constrained capital spending in virtually all of our served markets. The only exception was our automotive business, which actually grew 11% year-over-year. But even in automotive, we showed some signs of a slowdown in the second half of 2012. Vince, our new President, our newly appointed President, will describe in much more detail the current trends and the outlooks that we see in each of our end markets.

Despite the lower revenues and the uncertainty throughout the year, ADI still produced a very credible result for the year, with gross margins of approximately 65%, operating margins of approximately 31% and operating cash flow of over $800 million, or about 30% of sales. In addition, we enhanced shareholder returns with dividends and share repurchases that totaled over $500 million during the fiscal year. We also ended the fiscal year with net cash -- or the gross cash we have less our debt, at over $3.1 billion.

Today, it's still a very challenging environment in virtually every region of the world. During Q4, the overall orders decreased at ADI, as customers became increasingly more cautious and our distributors reduced their inventories. We believe in Analog today that our current order rates are below the consumption rates of our products. Our book to bill for the quarter fell below 1, and we're entering Q1 with lower opening backlog than we had when we entered Q4 of 2012.

Given the continuing uncertainty out there, we've taken many actions around the company to protect the downside, while ensuring that we'll be ready for a snapback in order rates, which typically occurs with very little notice in our business. First, we began reducing our production levels in Q4, and we're planning to reduce them further in the first quarter to keep our inventory at appropriate levels. While operating our factories well below capacity will certainly reduce our gross margins in the short term, it will provide significant upside leverage, as it has in the past, when revenue growth resumes.

During the last down cycle, when our factories were being utilized at about 67%, our trough gross margins were about 63%. During the upturn, when utilization rates approached 80%, we achieved gross margins of over 67%. We're confident in our ability to achieve these gross margin levels, as business conditions improve, as factory utilization increases and as our product mix reverts to more typical and traditional levels for ADI. Just as in the previous cycle, we're keeping our lead times very short, providing very high service levels to our customers and remaining ready for any changes in market momentum.

Secondly, we've taken action throughout Analog Devices to reduce our expenses corporate-wide by moving resources to the most strategically relevant programs and away from those programs with less long-term potential. We're also planning to gain efficiencies with our new organization, which more closely aligns our product development programs with our customers' requirements. We're also planning a corporate-wide shutdown over the holiday period to give all our employees around the world a very deserved -- well-deserved rest, after a very challenging year, and this will provide temporary expense relief for Analog during the first quarter.

Thirdly, our variable incentive program that is operating for all Analog employees, which is directly tied to our growth rate and our operating margins, will normally modulate expenses in down cycles as it did in the last down cycle. In addition for 2013, we've increased the margin thresholds for incentive payments to levels more consistent with what we believe the business is capable of producing on the average. So therefore, for the same levels of performance, the bonus or incentive payments will be slightly lower. The effect of this change will likely be to reduce incentive payments in -- of 2013, beyond what would be typical and normal in previous times. We believe that these actions will be responsive to the downside, while also preparing us for the upside, which invariably follows in every cycle for ADI over many, many years.

So now I'd like to turn the call over to Vince, for some more detail on our performance and the trends in some of the end markets that we serve.

Vincent T. Roche

Well, thanks, Jerry, and good morning, everybody. Well as expected, our strongest sequential growth was in the consumer end market, which grew by 28% in the fourth quarter. The increase in consumer revenue was broad-based in what was a seasonally stronger consumer quarter, coupled with a strong product cycle for ADI. Our results were particularly good in audio and imaging applications in the portable space. Consumer was about 20% of total sales, up from 16% in the prior quarter.

Communications infrastructure grew by 3% sequentially and was higher than our plan coming into the quarter, which is a very good result, especially after a 10% sequential increase in the prior quarter. Wireless infrastructure growth -- drove the growth this past quarter, a combination of consumers who are buying LTE, or 4G ready smartphones, from companies such as Apple, Samsung and others, and ongoing wireless network build-outs in developed and developing economies is leading service providers to upgrade their networks. U.S. providers are advertising, as you know, their LTE networks and enhancing increased CapEx spending plans.

We also saw activity in the fourth quarter among our base station customers as they began to respond to China's announcement of TD-SCDMA Phase 6 and the 120,000 sites planned, which is twice the 2011 rollout. While GSM and 3G in particular, are the largest portion of our wireless revenue today, LTE, or 4G, is growing quickly, and will be a very significant growth driver in the coming few years. Communications revenue was 20% of total sales, consistent with the prior quarter. While the first quarter is expected to be steady to the fourth quarter, we expect wireless infrastructure deployments to more meaningfully impact our results towards the end of 2013.

Now industrial revenues, which we expected would be stable in the fourth quarter, actually declined 5% sequentially, in line with lower industrial production worldwide as dictated by the ongoing macro weakness and also as a result of continuing reduction in inventories by our industrial customer base. This market represents a myriad of small and midsized customers primarily served through our distribution channel, as well as many of the world's largest industrial equipment makers, and none of these customers had immunity from the decline. Most industrial application already [ph] declined sequentially, including process control, instrumentation and measurement equipment and medical imaging. Regionally, we saw the most pronounced declines in Europe and Japan. Defense and aerospace and medical instrumentation were relatively flat sequentially. The industrial end market represented 44% of total sales in Q4, down from 47% in the prior quarter.

On the automotive side, revenue declined by 4% sequentially, mostly as a result of lower unit sales of automobiles in Europe and in line with widely reported factory slowdowns at automotive manufacturers. While the declining revenue reflected the general weakness in automotive, we saw continued strength in newer products for Advanced Driver Assistance and powertrain efficiency systems, as our customers continued to deploy our innovative products in these growth sectors. Overall, automotive represented 16% of sales compared to 17% in the prior quarter.

Now on an annual basis, automotive was an obvious bright spot, growing 11% during fiscal '12 compared to FY '11, the third consecutive year of double-digit growth. All major automotive application areas grew year-over-year.

Our mix of business in the fourth quarter was anomalous compared to the rest of fiscal '12, as seasonal growth in consumer was further accelerated by new product adoption of key accounts. Beginning in the first quarter, we expect the business to shift to a more typical revenue mix.

So with that, I'll hand you over to Dave, who'll take us through the details of our financial results.

David A. Zinsner

Thanks, Vince. As Jerry had mentioned, fourth quarter revenue increased approximately 2% sequentially to $695 million and decreased 9.8% for the year to $2.7 billion. Our gross margin was 63.8% in the fourth quarter. This was down 180 basis points from the 65.6% we reported in the third quarter and down very slightly from the same period last year when revenues were higher. While an anomalous mix was the key factor, as Vince just described, we also made a decision to further reduce production levels mid-quarter in response to lower industrial and distributor orders, which reduced utilization below our original plan. Utilization decreased from 74% in the prior quarter to 67% in the fourth quarter.

Inventory on our balance sheet remained approximately flat to last quarter in dollar terms and was down on a days basis from 121 days in the prior quarter to 114 days in the fourth quarter. Weeks of inventory and distribution was down by 0.5 week and stood at about 7 weeks exiting the quarter, down from approximately 7.5 weeks in the prior quarter, which is a very significant adjustment in a short period of time. Channel inventories are now well below historical levels. Lead times for our direct OEM customers remained similar to last quarter and are in good control, with virtually all of our shipments to OEMs occurring within 4 weeks.

Operating expenses for the fourth quarter were $228 million compared to $230 million in the prior quarter excluding restructuring expense taken in the prior quarter. The decrease was primarily due to tight control of our expense and also due to our variable compensation model, which is linked to our year-over-year sales change and quarterly operating profit.

Operating profits before tax for the fourth quarter were $215 million or 31% of sales, down 100 basis points from the prior quarter, excluding restructuring charges taken in the prior quarter and a solid result in the current environment. Other expense of $3 million in the fourth quarter was flat to the third quarter and reflects the ongoing run rate of our net interest expense.

Our fourth quarter tax rate was approximately 16%, which represents an adjustment of our annual tax rate from 22% to 20%. We continuously look for efficiencies in our tax structure and based on current assumptions, we expect our tax rate to be approximately 18% for each quarter in fiscal 2013.

Diluted earnings per share of $0.58 in the fourth quarter was above the midpoint of our guidance and up 4% sequentially from the prior quarter on a 2% increase in revenue. For the year, diluted earnings per share was $2.13.

We generated very strong cash flow in the fourth quarter at 34% of revenue or $236 million in operating cash flow. Capital expenditures were $38 million, resulting in free cash flow of approximately $200 million or 29% of revenue for the quarter.

Our accounts receivable balance was down about $6 million versus the last quarter on lower shipments, and our day sales outstanding decreased to 45 days from 46 days in the prior quarter.

During the fourth quarter, we purchased $21 million of our stock and distributed approximately $91 million or 51% of our net income in dividends to our shareholders. For the year, we repurchased $161 million of our stock and distributed $345 million in dividends to our shareholders. We plan to continue to be opportunistic buyers of our stock and to enhance returns to our shareholders. Since the start of our repurchase program, the company has repurchased approximately 129 million shares, or $4.4 billion of company stock. We have approximately $560 million remaining under our board-authorized share repurchase program.

Our cash and short-term investments balance increased $135 million during the fourth quarter and now stands at $3.9 billion, with approximately $1.1 billion available domestically. At the end of the fourth quarter, we had approximately $822 million in debt outstanding, from net cash on a per outstanding share basis was slightly above $10.

On November 26, our Board of Directors declared a cash dividend of $0.30 per outstanding share of common stock, which will be paid on December 18, 2012, to all shareholders of record at the close of business on December 7. At current stock prices, this dividend represents an annual yield of approximately 3%.

In summary, fourth quarter and fiscal 2012 delivered solid results during what turned out to be a very challenging period. So now I'll turn the call back over to Jerry, to discuss ADI's outlook for next quarter.

Jerald G. Fishman

Thanks, Dave. Our current expectations for Q1 revenues is for a decline of between 6% and 12% sequentially, which is certainly a larger decline than we'd normally anticipate in a typical Q1 for ADI. The most significant sequential decline in Q1 is likely to be in our consumer business, where our typical Q1 sales decline is exacerbated by inventory drawdowns after our customers prerelease inventory builds in Q4.

Based on the current forecasts from our largest communication customers and our largest automotive customers, we expect Q1 sales in those market segments should remain relatively flat to Q4 levels. So certainly, the big swing in Q1 will be industrial sales, which span a broad customer base in every geography. While the United States and Europe still comprise the bulk of our industrial sales, China is becoming a more important component of industrial sales over the past few years than it's been historically. Over many, many years of observation in our industrial business, it's very clear to us that industrial capital spending continues to drive our industrial business. And certainly, those trends have been, and are today, being negatively impacted by economic and tax uncertainties in the United States and in Europe and government actions in China.

In addition, many of our largest customers have announced extended factory shutdowns in late December and early January in the holiday period and are continuing inventory reductions. And lastly, our distributors have predicted less than seasonal forecasts for their fourth calendar quarter, of which 2 months overlaps our first calendar quarter.

On the other hand, if you want to look at the glass as half full, which some of us do, inventories at our industrial customers and our distributors are at extremely low levels, and our largest customers report that their business levels are stable and in some cases, improving. And that would suggest that they're going to begin to restock. But on balance, we believe at this juncture with the information we have as of now, it's prudent to be very cautious about what ADI's industrial sales are going to turn out to be in Q1, and we're planning for a sequential decline in this market segment in Q1. I think it's very important to note that we could get surprised in this segment. But it's more likely that any real upturn in our industrial business would occur in Q2 rather than in Q1, although it's still early to predict that.

In response to the weak demand environment that we experienced in Q4 and that we're planning in Q1, we're planning to further reduce factory operating levels in our production facilities, as I mentioned in my opening comments. In Q1, we're planning our factory utilization to drop from 67% in Q4 to the mid to high 50s in Q1, and for inventory dollars to be down, but days of inventory to be about flat given the significantly lower sales in Q1. As a result, we expect gross margins to be approximately 62% in Q1, which hopefully will be the low point of this cycle.

It's important to note, I think, that while changing inventory levels at our distributors don't affect our revenues, since we account for revenues worldwide on a sell-out methodology, when our distributors do start to restock to more traditional levels, it does positively impact our factory loadings and therefore positively impacts our gross margins. Given the strength of our position and the high market share that we enjoy in the industrial end markets, we'll be ready when a snapback in industrial does occur, as it always does. This will drive a better product mix, it will drive higher factory utilization and it will drive extraordinary operating leverage, as we demonstrated in previous cycles.

We're planning for our operating expenses to be down approximately 2% in Q1 based on the actions that I outlined in my earlier comments, and earnings to be in the range of $0.40 to $0.48 for the quarter.

In the longer term, we have an increasingly unique position at ADI, in the analog and signal processing market. We have very strong core technology, particularly in converters, in RF components and other linear functions, in MEMS, in power and in digital signal processing; and a very broad customer base, which provides great stability, but also provides the ability to leverage and bundle this technology into a much more complete and integrated solutions for a customer base that more and more depends on ADI to become their partner.

We're now engaging with customers at much higher levels than in the past, and we get consulted and involved in their architectural and system needs at a very early level. And this will certainly pay off in terms of sales growth and higher margins as business levels stabilize in the future.

The diversity of our end markets and of our 60,000 customers around the world where no consumer represented more than 5% of our sales in 2012, provide some measure of insulation from economic headwinds and product cycles and also, at the same time, provides the prospect of above-industry growth when the external world stabilizes.

Now, we at Analog, the management team and the employees of Analog, have been through difficult periods many time in our history, and we continue to make the necessary trade-offs to position ourselves to respond when the market turns, as they always do. Structural improvements that we implemented in previous years give us an added advantage in navigating difficult periods and allow us to protect the downside while standing ready to capture the upside when conditions get better.

Every time we've gone through one of these cycles, we come back better and we come back stronger, and I expect this time will be no different.

Ali Husain

Great. Thank you, Jerry. Thanks, Vince and Dave. [Operator Instructions] With that, operator, we are now ready for questions.

Question-and-Answer Session

Operator

[Operator Instructions] And your first question comes from the line of Terence Whalen from Citi.

Terence R. Whalen - Citigroup Inc, Research Division

The first question is related to gross margin. It seems like based on the utilization numbers that you've given of mid-50s for next quarter, it's a fairly pronounced action you're taking in the fabs. I guess my question is what's the motivation of that, given that inventory isn't too high? Is that more to just to set yourself up for a trajectory of extending gross margin in the April quarter? And if revenue were to grow in April of say 4% or 5%, would gross margin also bounce back then?

David A. Zinsner

So I'll take a stab at it; Jerry can add color if necessary. We're bringing our utilization down to 50 -- mid-50s levels. That is different than what we did last year at this time. We had a kind of a similar decline in revenue. But we allowed our days of inventory to kind of push up to 121 or 122 days last year. This time around, we're really trying to focus on keeping the days of inventory relatively flat, bringing the absolute dollars of inventory both on our balance sheet and the balance sheets of our distributors down. This is a bit different. The idea is it to get the inventories well balanced and then be ready to get the leverage when the business returns to growth. And as you point out, we had a big turn up in revenue in the second quarter. We have a pretty quick acceleration in the gross margins quickly back to the levels you saw us operate in back in a few quarters ago.

Jerald G. Fishman

Yes, I'd say the other comment, Terry, is that we monitor the order input quite frequently. And just like last quarter, as we monitored the orders, we -- turns for factories down a little harder than we had anticipated. If the order input justifies it -- we don't make these decisions once a quarter, we make them more frequently. And if the orders begin to turn up and we see anything that we believe is sustainable, we can ramp very quickly. And with the levels of inventory that we're carrying, we can respond extremely quickly to any upside our customers provide to us. So I think it's all those phenomena saying we want to manage the inventory responsibly. But we also, at the same time, want to make sure that when business does pick up, that we can respond to whatever our customers ask us for, given that on incremental sales, particularly on the stuff that we build internally, the gross margins are extremely high. So we don't want to miss any of those sales and we don't want to hang any of our customers out to dry. So those are our objectives, really, to keep the inventories under good control and yet, be flexible enough that we can respond very, very quickly to any input order rate increase that we see.

Terence R. Whalen - Citigroup Inc, Research Division

Crystal clear. And as a quick follow-up, really on the OpEx line. You guys did a terrific job in the prior cycle, really reducing OpEx to help improve the operating margin. But when I look over the past 8 quarters, on a revenue that's about down 15% from where it was 2 quarters ago, you're right at the same OpEx bogey. So we've seen OpEx sort of creep back up the past couple of years. What's the message to investors in terms of OpEx discipline here, as we've seen OpEx creep up a little bit relative to sales over the past couple of years?

David A. Zinsner

Well, it did creep up a little bit in the third and fourth quarter on a relative basis. But I think if you go back 8 to 12 quarters, we probably were averaging in the kind of the low 220s -- $220 million in terms of OpEx. That's where we're going to go to roughly in the first quarter. So I think what we're doing is prudently reacting to a little bit more difficult environment. I think we've done -- at least, maybe just me, my perception of this, but we've done a very good job just closely managing OpEx to make sure that it doesn't get away from us while revenue is coming off. So I think in the rest of the year, we'll manage it very closely. And Jerry mentioned a number of actions we're taking in the first quarter. We'll continue to look at it every quarter and not allow it to escalate until we see a big recovery on the revenue side.

Jerald G. Fishman

I think the other perspective on that is that if you look at the OpEx over the last 2 years, for last year -- and I mean our OpEx is the same now, on a running rate basis, as it was 2 years ago. And one of those years had a lot of growth and one had declined. So I think what -- the way we're looking at it, it's hard to look at these things quarter-to-quarter because the revenues fluctuate a great deal. But I think we had very significant operating expense controls in the company, and that the evidence of that is that the operating expenses through a lot of different parts of the cycle have been flat for the last 2 years, roughly.

Operator

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

Ross Seymore - Deutsche Bank AG, Research Division

For the first question, you had mentioned about the variable comp and how that'll be a little bit lower, or the threshold to have it kick in would be a little bit higher. In general, should we think of it at a given level of revenues now, you're going to have a lower level of OpEx, I guess is the first clarification? Then the second part of the question is with the shutdowns that you're having in the January quarter, what sort of OpEx increase should we look at in the April quarter, assuming the shutdowns don't repeat themselves?

David A. Zinsner

Yes, the shutdown is relatively modest. It's a couple of million dollars. And I think we have pretty good control over the OpEx; that we won't allow it to go up, unless the revenues start to grow. And even if it does grow, it'll grow at a fairly modest rate. At a given revenue level, there are some other things that kind of crept in that offset some of the decline mostly on the variable comp piece. So some of it's awash and I think OpEx, we're generally trying to get the business to operate in kind of the low 30s, 30% to 31%, 32% of revenue, and that's what we're kind of target to get back to as business kind of grows.

Ross Seymore - Deutsche Bank AG, Research Division

Great. And I guess as my one follow-up, on the cash flow side of the equation. Can you remind us what your expectations are for CapEx in the first quarter and then for the full fiscal year '13?

David A. Zinsner

We're targeting to be somewhere in the neighborhood of $25 million for the first quarter. We have a general goal to be in the kind of $100 million to $125 million for the year. It obviously depends on how the business operates. If it -- if we see more of a flattish environment, we'll probably be more towards the $100 million. If things start to grow a bit, we'll probably be closer to $125 million.

Operator

Your next question comes from the line of Aashish Rao of Bank of America.

Aashish Rao - BofA Merrill Lynch, Research Division

My question, Dave, typically ADI's gross margins are more a function of utilization rates than product mix. But you noted the analogous mix due to the shift towards consumer. Could you help quantify the impact of both these factors on the gross margin softness in both 4Q and fiscal first quarter?

David A. Zinsner

Relative to the prior quarter or?

Aashish Rao - BofA Merrill Lynch, Research Division

Yes.

David A. Zinsner

I'd say most of the margin shift from the fourth quarter to the first quarter is going to be loading related. Very little of it's going to be related to mix. It'll be slightly beneficial actually the mix. But given that industrial will be down, kind of roughly what the corporate average is down, we're expecting that mix won't be a big factor. So that's fairly, for the most part, mostly loading related. The gross margin shift from the third quarter to the fourth quarter was pretty much a 50-50 split between mix and loading.

Aashish Rao - BofA Merrill Lynch, Research Division

Okay, cool. And then one question, Jerry, I wanted to talk about one of the businesses that doesn't get much attention, and that's the DSPs. And your DSP sales have held up fairly well for the last several years and have outperformed your large competitors' embedded division, where sales are down 10% to 15% over the last year. What do you think are some of the reasons why your DSPs are holding up better? And any color on that would be helpful.

Jerald G. Fishman

Well, I think one reason, I believe, is that we have our -- we don't look at DSP as a sort of separate business on to itself. We're a signal processing company. We look to gear our DSPs towards integration of digital and analog signal processing into more integrated solutions for our customers. I think that selling stand-alone DSPs, and we've talked about that with investors a couple of years ago, is a very, very tough strategy in the market right now. So the real value of DSP for us -- I mean we still sell plenty of individual DSPs, but we also -- and the thing that's really kept it at the levels we need is we're able, from a market segment and a customer standpoint, to provide more complete solutions of analog and DSP together. And that gives us a great advantage relative to most other players in the market. The DSP business is -- we've gotten down to the right expense levels. And I think the group that manages that business have done a pretty good job at doing that, commensurate with what we see the opportunity to be. But we see many, many applications that have developed and will develop in the future, where integrating DSP and analog, very high performance analog together, provides a very compelling solution to our customers. Do you have any other comments on that Vince?

Vincent T. Roche

Yes, just maybe one other piece of color. In terms of the predominance of the segments in that DSP product revenue basis, really industrial, which is very steady, it's very, very diverse in terms of the number of customers that we serve. And we've also -- in terms of raw growth driver, automotive has been the primary push there. So they're the 2 primary markets that comprise the sales of DSP. And we're pretty well matched, I think, with both of them in terms of the, as Jerry said, a more standard product approach in the industrial space and a more targeted match between our DSP and analog technologies in more complete solutions in automotive.

Operator

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

James Covello - Goldman Sachs Group Inc., Research Division

If I could follow up, Jerry, on your comment about -- I think you called the order pattern increasingly more cautious. Was that a function of orders went down a lot in the beginning of the quarter and then stabilized? Or did you see a steady decline in the orders over the course of the quarter and into the month of November?

Jerald G. Fishman

Well, we saw the orders decrease early in the quarter and they did sort of stabilize at those levels for the rest of the quarter. I mean that's the general trend we saw, and I think I'd make the same comments about November.

James Covello - Goldman Sachs Group Inc., Research Division

Okay. And then you made the comment that you thought an industrial -- a recovery in the industrial segment was more likely in Q2 versus Q1. Is that a function of seasonality or what your customers are telling you? Or was there anything to read into that?

Jerald G. Fishman

Well, I think it's all those things. It's that in Q1 for us, particularly with -- the industrial business is 16,000 customers or something out there. So there's a lot of customers that shut down. It's really a days of sale business for part of that in the broad base, and key account business with the large accounts. So typically, what we see in first quarter and given that there's less sales days is we see a decline in the first quarter. And we see a rebound in the second quarter since it's a quarter that's fully -- that's every day and every week are being worked by our customers. Also, I think given the inventory levels that the distributors are carrying and the customers are carrying, I mean and the amount that our industrial business is down relative to where it was, I mean just -- it's got to snap back. The only question is when it's going to happen. And if historical is a good representation of the future, which in the absence of any information, it is, we could see a snapback in that business in the second quarter. That's what we saw last year when the first quarter was down quite a bit. And in the absence of any other information, at least that's the planning assumption that we have right now in running the business. Now...

James Covello - Goldman Sachs Group Inc., Research Division

Very helpful.

Jerald G. Fishman

I mean planning assumptions are just assumptions. But that's our assumption.

Operator

Your next question comes from the line of Christopher Danely from JPMorgan.

Christopher B. Danely - JP Morgan Chase & Co, Research Division

Just a quick follow-up on the bookings question that Jim asked. Is there any sort of common theme or common reason why your customers are telling you that the bookings are falling off? Is it pure inventory? Is it demand? Is it a combination? Is anybody mentioning anything about the fiscal cliff or any other economic problems?

Jerald G. Fishman

Well, I think it's all those things. I mean you go out to see the large customers and it was interesting this morning, there was -- the CEO of Honeywell was on TV, or yesterday or something. And he's sort of indicative of the kind of things that we're hearing from customers that their business levels are not dead. They're relatively stable. Some are even forecasting some growth next year, but there's so much uncertainty out there. In Europe and the United States, based on the same things about government tax policy, all of the stuff that's going on in the economies, that people are just standing still, and that impacts their capital spending budget, in a similar way to it's impacting the capital spending budget in Analog Devices, that at the margin, people just stop spending money until they can get some certainty. And that's just not rhetoric, that's what CEOs around the world are doing right now. But the part that's encouraging to us is that when we visit those companies, #1, they're really, really excited about our technology; #2, they want deeper levels of engagement with Analog as a technology provider and a partner, and they're saying that their businesses are not declining and they're either stable or getting just a little bit better. So all those things say there's nothing fundamentally wrong with that business that a good dose of courage out there in the political environment wouldn't solve.

Christopher B. Danely - JP Morgan Chase & Co, Research Division

And my follow-up is probably for Dave. Dave, do you remember when your utilization rates were this low? I think you guys said somewhere in the mid-50s, and what were your gross margins at the last time the utilization rates were this low? And do you have any figure on incremental gross margins as sales start to pick up?

David A. Zinsner

I think the last time we had utilization at this level was actually in 2009, so gross margins were in kind of the mid-50s. It was a little bit of a different environment, because we had a lot more capacity and business had really fallen off. Absent that, this is kind of an historic low for us outside of the period of time where it was really difficult. Usually, for every 10% improvement utilization, we get about 100 basis points of gross margin improvement. It can vary depending on -- based on mix and there's also loading that we get on the back end, which could be incrementally beneficial. So it has a little bit of a magnifying effect when business conditions improve. But on a rough order basis, I'd say it's at least 100 basis points.

Operator

Your next question comes from the line of P.J. (sic) [C.J.] Muse of Barclays.

Christopher J. Muse - Barclays Capital, Research Division

Yes, C.J. Muse. I guess, first question, I was hoping to dig a little bit deeper on the operating leverage side. And so I guess the first part, as you think about the higher threshold on incentive pay and some of the other actions that you're taking, what kind of incremental savings you would be thinking about looking into calendar '13? And then as a part of that, how should we think about your target in terms of what incremental operating margins should look like in a more normalized recovery period into calendar '13?

David A. Zinsner

Well, we're roughly saving probably in the neighborhood of $20 million a year with the new bonus structure and equivalent level because, of course, there are other things that go in different directions. I would -- if I were modeling OpEx, I think what I would model is a very carefully managed OpEx growth assuming business recovers in the second quarter, which is one scenario. And then if the business kind of continues to improve, we'll be fairly modest in our growth on OpEx. So we should see leverage on the OpEx side during a recovery. Our operating margins, when we were at kind of peak performance on a revenue basis, were up over the 35% level. I think at its peak, we were up above 37%. And assuming we get back to business levels like that, our operating margins will be at similar levels. It's just a matter of dependent on when the revenue kind of moves in it in that direction.

Christopher J. Muse - Barclays Capital, Research Division

That's very helpful. And if I could ask a follow-up, in terms of the 18% tax rate guide for fiscal '13, I guess, what has changed to enable that to be lower? Are you assuming a greater mix outside of the U.S.? Or is that a tax strategy on your part or reduced expectations for fiscal '13 top line?

David A. Zinsner

Yes, we're assuming a similar mix of income domestically versus internationally and internationally within each region. This really has to do with just some tax planning that goes on all the time. And some of the benefit of that tax planning is showing up in next year's numbers, at least we expect it to.

Operator

Your next question comes from the line of Tristan Gerra from Baird.

Tristan Gerra - Robert W. Baird & Co. Incorporated, Research Division

Where do you think LTE could be as a percent of mix 1 year from now? I understand it's probably still below 10% currently. And any views on the trends within infrastructures, specifically between base station and small cell?

Vincent T. Roche

Yes, the -- I would say in the second half of '12, the proportion of our wireless infrastructure business that was LTE or 4G was around 15%. Now I think as we get to the second half of FY '13, that number will probably move to 25% of total. And given that we have increased content to the tune of 20%, 30% depending on the customer from 3G to 4G, that should bode well in terms of revenue upside for the company. Let me see, your second question was regarding?

Tristan Gerra - Robert W. Baird & Co. Incorporated, Research Division

Base station, small cell opportunities.

Vincent T. Roche

Yes. Well, I think the thing to remember when you look at macro versus small cell, both are going to exist -- co-exist in the network. And our expectation is that macro will continue to grow. That's what our customers tell us. That's what the carriers tell us. And basically, to help densify the network, to fill a network out, particularly in terms of being able to supply data needs in urban environments, what we'll see is a pretty steep increase in the deployment of small cell. So what we're looking at is a homogenized network that will have coexistence of macro and small, more point-to-point units and obviously more backhaul optical and cable networking as well as to be able to support the movement of data worldwide. So that's pretty much it as we see it. So I think what you'll see is a huge increase in the number of radios that get deployed. And what we sell into the small cell area is a trickle-down from what we develop for macro cell and have been developing for many, many years now. So there's tremendous leverage as small cell becomes more prevalent in the network.

Jerald G. Fishman

I think just one color comment on that is that the ADI content in 4G is quite a bit higher than it is in 3G.

Ali Husain

So we have a number of people still waiting to ask questions. If we're unable to get your question within the allotted time, you can reach me after the call at (781) 461-3282, but we will continue and try to get to all the calls that we can. So before we take the last few questions, I'd like to mention that our first quarter 2013 earnings release is scheduled for February 19, 2013, after market close and our conference call will begin at approximately 5 p.m. Eastern Time that same day. So we're ready to take the additional questions now. Operator, may we have the next caller please?

Operator

Your next question comes from the line of the Doug Freedman of RBC.

Doug Freedman - RBC Capital Markets, LLC, Research Division

One, could you guys give us a look at sort of the real-time business conditions? I imagine lead times are low right now. And could you give us an idea of what the demand looks like for the month of December, given we're about to start that month?

Jerald G. Fishman

Well, that would sort of be predicting the future, which I mean we're not -- I mean we don't know what demand's going to be in December. We're cautious, particularly in the industrial business because there'll be a lot of shutdowns, as I mentioned earlier. So I think -- our sense and our internal plan is to just treat Q1 and be very, very cautious about what's going to happen because of the holiday period and all the things I mentioned earlier. So we'll have to just wait and see what happens in December. We just don't know.

Vincent T. Roche

On the lead time side of the story, we're shipping within 6-week lead times. We're shipping virtually 99% of the entire portfolio to on-time customer requests.

Jerald G. Fishman

I think the important thing that we're communicating around Analog and I think is worth mentioning tonight is that in the last cycle, when we managed the inventory well, we managed our capacity well and we did very, very well on the upside relative to many of our competitors, who got stuck and couldn't deliver stuff. So I think that's the mantra around Analog is that whatever we do -- and we know we can't predict demand, particularly in these tumultuous environments. But the one thing we can do and that we will do is make sure that we have supply when customers need it, and that's what we're going to do. So we just can't predict in the short term what's going to happen in any month or any week or any -- it's even hard to predict exactly what's going to happen in first quarter. And that's why the guidance range is so wide, and there's so many different factors that would enter into it. Now that's very typical in these cycles because customers know they don't have to give you a lot of lead time, so most of the business again is turns business. It's just the way it is. It's been like that, as you know, for 100 years. It will be like that for the next 100 years.

Doug Freedman - RBC Capital Markets, LLC, Research Division

All right. Jerry and Vince, I'm sorry, I'm a little confused by that answer, because if lead times are 6 weeks, you would have visibility for the month of December, and that's what I was asking for. I wasn't asking for...

Jerald G. Fishman

Are you talking about shipments...

Doug Freedman - RBC Capital Markets, LLC, Research Division

I was asking for what you're seeing.

Jerald G. Fishman

Are you asking about shipments in December or orders in December?

Doug Freedman - RBC Capital Markets, LLC, Research Division

Shipments, what you're seeing from a demand perspective for shipments in the month of December.

Jerald G. Fishman

I think what we're seeing is commensurate with the guidance that we've provided for December. We don't see anything anomalous to the guidance we've provided. That's how we sort of calculate the guidance. The only -- what I was commenting on is the order rate, not the shipment rate.

Doug Freedman - RBC Capital Markets, LLC, Research Division

Okay, understood. If I could, for my follow-up, Jerry, if we look back at the year and we go out to the 30,000-foot level, this cycle was not like any that we've seen in any of the past semiconductor cycles. Can you offer some of your commentary on what you think changed over the last year or 2 that has made it that we really didn't end up with what we would call a normal inventory cycle this year, only really seeing 1 seasonal quarter this whole year?

Jerald G. Fishman

I know, it's confusing, at best. The -- most of the cycles in the semiconductor business are and over many, many years have been based more on supply than demand. And there's always -- the semiconductor industry is always trying to catch up either to the upturn or the downturn and always misses it. So, so many of the cycles are based on just what's low -- how much capacity's there, shortages, double, triple ordering and then a reaction to that. And those cycles, were pretty straightforward and we've seen those many, many times. I think the big difference in this cycle that we've seen is just staggering uncertainty in the customer base, based on partly economic conditions, but also policy issues and tremendous uncertainty of what people are going to do about capital spending, which partially is related to their business levels, but is also related so nobody can figure out what's going to happen in those areas of policy. So I think that that's the difference in this cycle, that I think -- which is why it got shortened from what we'd normally see, why it was very, very to predict in the short term what's going to happen. I continue to believe if the uncertainty gets cleared up and people sort of understand the environment, whatever it is, good, bad or different, I think things will get better. That's our -- that's our sense of what's going on with the market based on what our largest customers and the senior executives at our largest customers are telling us. It's not just an internal theory of Analog. We spend a lot of time out there talking at very senior levels particularly to our industrial customers. And that's what they're telling us, so that's what I believe.

Operator

Your next question comes from the line of Sumit Dhanda from ISI.

Sumit Dhanda - ISI Group Inc., Research Division

[indiscernible] about quantitatively on the turns required for the quarter? Is it similar to what you registered in the October quarter, or higher, lower?

David A. Zinsner

I think you cut off just a little bit, Sumit. But basically, we don't typically quote turns. We don't even calculate them internally, just because a lot of our backlog is associated with orders from distributors, which don't translate into revenue until the distributors ship out the product to their end customers. But I think it's -- just qualitatively, I think it's safe to say that we're in a high-turns environment with limited backlog going into the quarter. And that's been relatively consistent over the last few quarters.

Sumit Dhanda - ISI Group Inc., Research Division

Okay. And then maybe just some more detail on the consumer outlook for the January quarter. Is the big hit that you're taking in call it the audio business or the imaging business? Or is it not distinguishable in terms of the impact from one versus the other in the January quarter?

Vincent T. Roche

Well, we've multiple segments or subsegments under the consumer banner, and we typically see a seasonality decline in the 15% to 20% area. So what you're going to see this particular quarter is something similar. It's going to be all the segments and there's nothing really anomalous there.

Operator

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

Jonathan Steven Smigie - Raymond James & Associates, Inc., Research Division

Steve Smigie. Just with regard to your comments about your -- I guess, your wireless infrastructure business, you said that you expect them to be more meaningful towards the end of 2013. And I'm just wondering, is that suggesting there's going to be some softness sort of in the middle of the year? Or is there -- are there some specific programs you expect to ramp in 2013 that makes it specifically stronger? It's just your comments on…

Vincent T. Roche

Yes, my comment on the infrastructure and comparing the second half of '12 to the second half of '13 is really in relation to the proportion of our business that is 4G, which I expect to increase and ramp during FY '13. So that was really the comment there more so than the particular order of demand patterns across the infrastructure market in general.

Operator

Your next question comes from the line of Craig Ellis of Caris & Company.

Craig A. Ellis - Caris & Company, Inc., Research Division

Jerry, I just wanted to take a step back and look a little bit longer term. As you look out over the course of 2013 calendar and you think about the underlying dynamics in ADI's different businesses, industrial communications, auto, et cetera, and the products that you have and the programs that you're involved in, where do you feel most confident that ADI can drive year-on-year growth in the coming year?

Jerald G. Fishman

Well, that's a real challenging question, given where we are and where we're coming from. So I think in each of the areas, in each of the market segments that are now strategically important to us, industrial and automotive and communications and even parts of the consumer market where we could add real value, I mean we're expecting that each of those is going to get better through the year. We'll see how it goes. We're starting off at a very low level, but I think in the long term, there are certain market segments, as I mentioned, that we're committed to strategically that we think we can change the user experience, get paid for what we do. Customers value us. I think those are the segments we're investing in. Ones that we've come to a conclusion, don't meet those criteria, we don't invest. I think we've shown that over the years and I think each year we go back and reassess what's the good, what's the bad, what's the ugly and we made changes in the portfolio mix each year, and sometimes more frequently. So it's very hard sitting where we're sitting today to say which of the segments are going to drive growth. I mean each of the segments has great opportunities. The real question is how does the market unfold during the year? Mostly on the economics side rather than on what product we have side. I think we're very confident about the product portfolio we have and the relations we have with our customers. For that part, we're consistently and increasingly confident about it. Just you just can't predict what's going to happen with aggregate business levels and sentiment out there, and that's the confusing thing out there. In the absence of that, we'd be very aggressive about what we could achieve in 2013.

Craig A. Ellis - Caris & Company, Inc., Research Division

Okay. And then the follow-up for Dave. Dave, channel inventories are at below normal levels. As you think about where you'd like to manage them in a more normalized environment, how should we think about where inventories would likely normalize as we move through the year next year?

David A. Zinsner

Well, the inventories that I mentioned are down kind of close to 7 weeks, which is definitely below our target levels. I think we'd like to see them be more in the range of 7.5 to 8 weeks. And, I think, probably, we'll be at the lower end of that, certainly, in the early part of the year. But as we kind of push forward through the year, I would expect us to normalize back to that level.

Ali Husain

So we are -- we still have a few callers here. So we'll keep going. Operator, can we have the next caller please?

Operator

Your next question comes from the line of Steven Eliscu of UBS.

Steven Eliscu - UBS Investment Bank, Research Division

First of all on automotive, you -- if we look back at calendar 2011, you were growing in excess of 20% year-on-year. That settled down and now it looks to go negative. Should we think of a rebound as we go through the coming fiscal year back to the 20%-plus type growth rate? Or was there something unique in terms of an inventory build or a set of end products that aren't necessarily selling as well going forward?

Vincent T. Roche

Well, the automotive business has grown very fast in the company over the past 5 years. In the last 3 years, the compounded growth rate is somewhere in the region of 14% or 15%. And automotive is now a much bigger portion of ADI's revenue. It's a bigger number. But I would say the way to look at this thing is that the growth impact is more about the market and declining or muted car sales more so than the adoption of the technology. If anything, I would say the rate of designing of our products across the 3 areas of safety, powertrain and infotainment, is stronger than ever. We're penetrating in regions, our customers in Asia, now that we have not been so successful as in the past in a completely different way now, which bodes very well for the future. So my sense is it's more really about the market demand at the consumer level rather than demand for ADI products.

Steven Eliscu - UBS Investment Bank, Research Division

Okay, that's helpful. And as a follow-up, in the base station market, you talked about a 20% to 30% content increase as we go to LTE. I'm trying to understand, is that a onetime increase in content, because it is showing in your growth rate? Or is there something more long-term secular increase in content as we go to LTE advanced and small cells as we look out to the middle of the decade?

Vincent T. Roche

Yes, between all of the evolution from generation to generation from 2G, to 3G, to 4G, we've typically seen a 20% to 40% increase in the value of the products we sell into those applications, partly because the complexity or sophistication of the products we're providing is greater. The performance increases from generation to generation. And also, we've been expanding our footprints in the -- in all these radio applications. So for example, we're providing a lot more radio frequency technology than we did say 5 or 6 years ago. We're beginning to meaningfully deploy clocking technology as well for timing generation and control. In areas like cable and optical infrastructure, we've a tremendous market share and growing in observation and control circuits. So I think it's really -- it's a function of the complexity of the products commanding a better ASP and also ADI expanding our bond footprint in each of the applications.

Operator

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

Shawn R. Webster - Macquarie Research

Dave, on the change in the tax structure, does that have any impact on your operating cash flow that's generated domestically? And can you remind us what that is?

David A. Zinsner

It does not have any impact on our cash flow for domestic cash flow. It's a -- runs -- it can vary depending on the quarter. But it's probably -- on a rough order, probably about 1/3 of the total cash flow is generated in the U.S.

Shawn R. Webster - Macquarie Research

Okay. And then on the military part of the business, can you remind us how much of that is -- it is as a percent of sales and what your outlook is for there?

David A. Zinsner

It's marginal; it's in the mid-single digits.

Vincent T. Roche

Yes, it's about -- it's roughly about 6% to 7% of the company's revenue depending on when you measure. And it's been relatively steady over the past year.

Ali Husain

Great. So that concludes our Q&A session. A couple of folks that we will get to after the call. We appreciate your participation and look forward to talking with all of you again during our first quarter 2013 earnings call scheduled for February 19, 2013, beginning at 5 p.m. Eastern Time. Thank you very much.

Operator

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

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