Analog Devices' (ADI) CEO Vincent Roche on Q3 2014 Results - Earnings Call Transcript

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 |  About: Analog Devices Inc. (ADI)
by: SA Transcripts

Operator

Good afternoon. My name is Jennifer, and I will be your conference facilitator. At this time, I would like to welcome everyone to Analog Devices' Third Quarter Fiscal Year 2014 Earnings Conference Call. All lines have been placed on mute to prevent any background noise. After the opening remarks, there will be a question-and-answer period. Please limit yourself to one question to ensure that management has adequate time to speak to everyone. (Operator Instructions)

I would now like to turn the conference over to your host for today, Mr. Ali Husain, Director of Investor Relations. Please proceed.

Ali Husain

Yes, thank you, Jennifer. And good afternoon, everyone and thank you for joining our third quarter fiscal 2014 earnings call. If you would like to view our press release, you can find it an all relating financial schedules on our Investor Relations page at www.investor.analog.com. Now, we have a couple of unique items this quarter that I would like to call your attention to before we begin today's call. The most important of which is that we closed the Hittite acquisition on July 22, which was 10 days before the end of our fiscal Q3. Thus we have about 10 days of activity with Hittite in our third quarter. So during today's prepared remarks, we've generally excluded Hittite's contributions to our third quarter results unless we otherwise specify. And we've done this in order for investors to better understand our performance during the third quarter. In high level, Hittite contributed approximately $5 million to our third quarter sales and there are three related schedules on our Investor page that I would like to highlight. First, for the revenue end market disclosures, we have classified $3 million of the $5 million revenue contribution from Hittite into our communication infrastructure business. And $2 million of the $5 million contribution from Hittite into our industrial business. Second, for the revenue by product type schedule. We have classified almost the entirety of the $5 million from Hittite to our amplifier radio frequency product group. And third, we have provided summary P&L including reconciliations for the 10 days of Hittite's contributions to our fiscal third quarter across the mainline items of the P&L. And all these schedules can be found on our Investor site at www.investor.analog.com.

Today's call will include non-GAAP financial measures that have been adjusted for certain special items in order to provide investors with useful information regarding our results and outlook. As I mentioned earlier unless otherwise specified, today's discussion about our third quarter results will exclude Hittite's performance and were applicable the acquisition related cost and expenses associated with the transaction. We have included reconciliations of these non-GAAP financial measures to their most directly comparable GAAP measures in today's earnings release, which is posted on our IR web page.

In addition, today's discussion about our fourth quarter outlook exclude acquisition related expenses and transaction cost as outlined in our earnings release. Please also note that the information we are about to discuss including ADI's objectives, plans and goals in our fourth quarter outlook includes forward looking statements. These forward looking statements include risk and uncertainties including but not limited to those described in our Form 10-Q filed earlier today. Our actual results could differ materially from the forward looking statements made on this call. Subsequent events and developments may cause our outlook to change and except as required by law, we do not undertake any obligation to update the forward looking statements made by us today to reflect subsequent events or circumstances. Therefore this conference call will include time sensitive information that maybe accurate only as of the day of the live broadcast which is August 26, 2014.

So now let's get started. With me on the call today are Vincent Roche, ADI's President and CEO; Dave Zinsner, ADI's Vice President of Finance and CFO; and Maria Tagliaferro, Director of Corporate Communications.

During the first part of today's call, Vince and Dave will present our third quarter results and our outlook for the fourth quarter. The rest of the call will be dedicated to Q&A.

So let's get started and I would like to turn the call over to Vince for opening remarks.

Vincent Roche

Thank you, Ali. Good afternoon, everyone. And thank you for joining our call this afternoon. As you likely have seen from the press release, ADI had a very good third quarter. In addition to our strong financial performance which I'll talk about in a moment, we are also extremely pleased with our acquisition of Hittite Microwave which we closed towards the end of our third quarter. This acquisition of RF, microwave and millimeter wave technology fits our growth strategy perfectly, allowing us to provide more complete solutions for our customers and deliver stronger returns to our shareholders. As I visit our customers and employees, there is a clear momentum and enthusiasm for how this addition to ADI's capabilities, strengthen our long-term position and demonstrates our commitment to doing what it takes to keep our customers and our company out in front.

Now we close this transaction within about six weeks of the announcement, a very quick pace that we aim to maintain as we continue to integrate our two companies. As Ali noted previously, Hittite contributed only about 10 days to our fiscal third quarter, so I'll exclude Hittite's results and acquisition related items from my comments on our third quarter performance.

In the third quarter, ADI revenue totaled $722 million, increasing 4% sequentially and 7% year-over-year which was near the high end of our third quarter guidance. Diluted earnings per share excluding special items were $0.63, growing 7% sequentially and 11% year-over-year which were also near the high end of our guidance. Now let's take a look at how each of our end markets performed during the quarter.

Revenue from communication infrastructure customers at 23% of total sales increased 5% sequentially and 17% year-over-year which was in line with our planned for the quarter. Wireless infrastructure sales were the primary driver of this growth as ADI's radio offerings benefited from continued 4G deployments in the US and in China and emerging regions also build out their wireless network across virtually all communication standards. Our communication infrastructure business is well positioned and diversified across all key players and key regions. Today for example well over two thirds of our wireless communication infrastructure revenue relates to base station deployment outside of China even though deployments in China tend to grab the majority of the headlines.

Our wireless business also grew sequentially primarily as a result of our strong pipeline of designs in 100 gig optical applications. Year-to-date, communication infrastructure has grown 17% over the same nine months period in fiscal 2013 as carriers worldwide continued building out their mobile service networks helping drive demand for ADI's wide range of high performance radio transceiver solutions.

Now turning to industrial. Our highly diversified industrial end market at 48% of total sales, turned in better than planned performance growing 7% sequentially in the third quarter and 11% year-over-year. All sub segments within industrial grew sequentially and grew year-over-year. Now among the sub segments the strongest sequential revenue growth was in the industrial automation, instrumentation, aerospace and energy sectors. The aerospace and energy sectors were responsible for both half of our industrial growth in the third quarter and were key drivers of our better than planned industrial sales. Within the instrumentation sub segment, electronic test and measurement drove most of the growth. Revenue from the balance of applications within instrumentation including semiconductor ATE was stable to the prior quarter. Year-to-date, industrial has grown 7% over the same nine months period in fiscal 2013, reflecting an improving macro environment and increased capital spending. These trends are combining to drive demand for ADI's suite of high performance sensing signal conditioning, data converters DSPs and RF and microwave technology, and are being used by our customers to create more intelligent, connected and energy efficient products.

Automotive revenues decreased 4% in the third quarter which was in line with a seasonally slow period for ADI in this market. Year-over-year, sales in this segment grew 8% reflecting continued strength in North America and China vehicle markets, increasing content per vehicle and growth in worldwide premium vehicle sales. Automotive in total represented 18% of our total sales in the quarter. Year-to-date, automotive has grown 11% over the same nine months period in fiscal 2013. During a period when the underlying rate of vehicle unit growth has averaged about 4%. This revenue performance is in line with our goal of growing our sales in this market by at least twice the rate of vehicle unit growth. ADI's strength along the entire signal chain is particularly well suited to the automotive market, where our auto grade sensors, signal conditioning, data converters, RF and microwave and DSPs are increasingly enabling car manufacturers to deliver more efficient engine, intelligent collusion avoidance and mitigation system, and in cabin infotainment systems, all of which we believe will help drive sustainable, long-term growth for ADI.

And finally consumer revenues which accounted for 11% of total sales in the third quarter grew 4% sequentially. This quarter revenue performance was largely due to an increase in prosumer audio video application while digital camera and portable applications were flat to the prior quarter in the aggregate. Year-to-date consumer revenues have declined 24% over the same nine months period in fiscal 2013 primarily as a result of the divesture of the microphone product line.

So with that I'll turn it over to Dave who will take you through some of the details of our financial results.

Dave Zinsner

Thanks, Vince. And good afternoon, everyone. The third quarter was another solid quarter for ADI. As Vince mentioned, since the acquisition of Hittite closed near the end of our third quarter, Hittite's contributions to ADI's results were limited to approximately 10 days. In my prepared will also exclude Hittite's results and the acquisition related items unless I specify otherwise. Sales in the third quarter increased to $722 million and diluted earnings per share grew to $0.63. Gross margins in the third quarter were 66.5%, up 40 basis points from the 66.1% we achieved in the prior quarter due to a better mix of business as our sequential revenue growth this quarter was led by the industrial and communication infrastructure market.

Compared to the prior year, gross margin increased 200 basis points on higher factory utilization and a better mix of business. Approximately 50% of our revenue is from wafers produced in our internal fab. In the third quarter, utilization rates in our fabs remained stable to the second quarter at mid -70s levels. We expect our factory utilization to be down slightly in the fourth quarter. Excluding acquisition related inventory, days of inventory increased to 117 days from 115 days and are expected to remain at similar levels in the fourth quarter. On a dollar basis, inventory increased by $13 million over the prior quarter as we took a proactive approach to external wafer purchases for this quarter and we plan to take the same approach next quarter. Weeks of inventory in distribution were approximately 7.5 weeks consistent with the prior quarter. Our revenue recognition policy is to recognize a 100% of our distribution revenue only when our distributors sell out the end customers. Total end customer orders increased in the third quarter compared to the second quarter and our book-to-bill was slightly above one. Lead times remain similar to last quarter with virtually all of shipments occurring within our stated lead time of 4 to 6 weeks.

Operating expenses in the third quarter increased 3% sequentially compared to the 4% sequential increase in sales. This was primarily due to a range of short term item and as we move into the fourth quarter, we expect expenses to be relatively flat excluding Hittite and acquisition related item.

Operating expenses as a percent of sales in the third quarter declined 30 basis points compared towards the prior quarter. Operating profit before tax increased to $235 million or 32.5% of sales which is 80 basis points higher than in the prior quarter and 160 basis points higher compared to the same quarter in the prior year.

Other expense of approximately $4 million was flat to the prior quarter. We are planning for interest expense in the fourth quarter to be approximately $6 million which is lower than our prior expectation of $8 million as we anticipate repaying the short-term debt financing related to the acquisition earlier than initially anticipated. In FY15, we expect net interest expense to be approximately $5.5 million for quarter. Our third quarter tax rate was 13.4%. We expect our fourth quarter tax rate to be approximately 15.5% to 16% as a result of income from the Hittite acquisition being taxed at a higher rate.

For 2015, we expect the tax rate to be approximately 14.5%. Excluding special items, diluted earnings per share in the third quarter were $0.63. Cash flow in the third quarter continued to be very strong. Excluding an $18 million use of cash by Hittite, primarily related to the acquisition, we generated $232 million or 32% of sales in operating cash flow. And CapEx was $42 million, resulting in free cash flow of $190 million or 26% of revenue. Our FY2014 plan is for capital spending to be approximately $180 million of which about two third or 4% of sales relates to ongoing capital equipment spend and about one third or 2% of sales relates to new facilities and upgrades to existing facilities. In line with our capital allocation strategy during the quarter, we distributed $116 million in dividends to our shareholders. In addition, we repurchased 1.1 million shares or $57 million of our stock with approximately half repurchases occurring towards the end of our third quarter as our stock buyback program responded to a lower stock price.

On August 25, 2014, our Board of Directors declared a cash dividend of $0.37 per outstanding share of common stock. This will be paid on September 17, 2014 to all shareholders of record at the close of business on September 5. At the current stock price, this dividend represents an annual yield of approximately 2.9%. Including Hittite, our cash and short-term investment balance increased by $125 million over the prior quarter and stood at $4.9 billion with $1.1 billion available domestically.

During the quarter, we raised approximately $2 billion in additional debt financing to fund the acquisition of Hittite. It is anticipated that the $2 billion in short-term debt financing will be repaid by the end of this week. This is expected to bring our growth cash and short-term investment balance to approximately $2.9 billion with $870 million in debt resulting in a net cash balance of $2.1 billion. And following the repayment, we expect our domestic cash and short-term investment balance to remain at $1.1 billion.

Lastly, including Hittite, total sales in the quarter was $728 million and diluted earning per share excluding acquisition related item were $0.63. Notably, Hittite revenue grew 9% sequentially and 12% year-over-year in the three period which ended June 30. In addition, over the 12 months ended June 30, Hittite generated $100 million in operating cash flow and $87 million in free cash flow which of course are great results and highlight the strength of this RF and microwave franchise.

So now I'll turn the call over to Vince who will discuss ADI's outlook for the fourth quarter. The fourth quarter outlook Vince will discuss will include a full quarter's contribution from Hittite and excludes acquisition related items as we outlined in today's earnings release.

Vincent Roche

Thank you, Dave. In general, we are expecting a stable environment across all our business. In industrial and communication infrastructure, with a higher overall sales in the fourth quarter as we had a full quarter's revenue contribution from Hittite to these end markets. On an organic basis, we are planning for industrial to decline somewhat from third quarter level and for communication infrastructure and automotive to exhibit modest sequential sales growth. We are planning for consumer sales to be higher in the fourth quarter in line with typical seasonal patterns. In total, we are planning for sales in the fourth quarter to be in the range of $790 million to $820 million. We are planning for gross margins in the fourth quarter to be approximately 66.2% given our plan for low utilization rates and the slight mix shift. We are planning for operating expenses to be in the range of $268 million to $271 million. Based on this estimate, diluted earning per share in the fourth quarter are planned to be in the range of $0.66 to $0.70 which include an estimated 8% contribution from Hittite and excludes acquisition related items.

So in closing at the mid point of our fourth quarter guidance ADI's fiscal year 2014 is expected to finish with year-over-year sales growth of 8% and diluted earnings per share growth of 11% excluding special items. We are focused on driving earnings growth and to that end we are running the company to achieve annual EPS growth of 8% to 15%. And our target EPS of $4 to $5 by fiscal 2020. And I along with all the employees at ADI are committed to this goal. Thank you very much.

Ali Husain

Thanks, Vince and Dave. So I would like to remind everyone that during today's Q&A period, please limit yourself to one question so we have a chance to talk to all our callers this evening. We intend to keep the lines open until six so after we get through the first round of questions, we will give you an opportunity to ask another question if time remains. So operator, with all that let's start taking questions.

Question-and-Answer Session

Operator

(Operator Instructions) And our first question comes from the line of David Wong.

David Wong - Wells Fargo

Thanks very much. Dave, following this acquisition, do you foresee the need for any restructuring involving material cash charges going forward?

Dave Zinsner

Related to the acquisitions specific?

David Wong - Wells Fargo

Yes.

Dave Zinsner

I don't think so. I think we have essentially accrued most of it. There might be a small to minimize charge for few items here or there but I think for the most part we have spent the lion share of the cash already.

David Wong - Wells Fargo

So you don't see any significant reduction in headcount from the combined company?

Dave Zinsner

I think we to the extend -- you mean from cash flow -- there maybe obviously we do expect some synergies and so I think that there will be some cash flow associated with those synergies. But I think relative to the cash flow payments we've made to date which were mainly related to legal and bankers and so forth that will be relatively small.

Operator

The next question comes from the line of Jim Covello

Jim Covello - Goldman Sachs

Question. On the gross margins, Dave, I know you said factory utilization will be down slightly for calendar Q3. Is that the only impact in terms of margins going down a little bit quarter-over-quarter or is it mix part of that too? Thanks.

Dave Zinsner

Yes, good question, Jim. So there is -- I would say its probably three components. Two going negative and one going positive. So my guess is that mix will contribute negatively about 50 basis points from an organic standpoint because on an organic basis we do think industrial is coming down and that does affect mix. So we think that mix will probably impact us by 50 basis points. And then on top of that we are expecting some impact from utilization which probably will be in the neighborhood of another 10 basis points. So those two items will negatively impact us by about 60 basis points. Offsetting that to some extent is Hittite which obviously has gross margin that are higher than our corporate average. And so that will be accretive to the company's gross margin by about 30 basis points. And so that's on a net basis we get down around 30 basis points.

Operator

Our next question comes from Vijay Rakesh.

Vijay Rakesh - Sterne Agee

Thanks for taking my question. Vince, I am curious about your commentary on the overall demand environment. Because there is a school of thought that perhaps things are overheating when we look at the 17% growth that you mentioned in comp infrastructure or the double digit growth year-to-date that you have in the automotive market. Obviously, I understand that there is very strong content gain as part of that. But as you look out over the next couple of quarters, how do you come -- where do you come out on this overall view of there we are in the cycle and growth rate expect you are seeing, are they sustainable over the next one or two quarter?

Vincent Roche

Yes. We've paid a lot of attention. Thanks for asking the question. We paid a lot of attention to inventories through our channel, our indirect channel and also with our customers. And is our sense that across our business in the industrial, automotive and communication infrastructure space in particular that there is actually a good balance between supply and demand. And I think you will have seen as well from the comments made by our large distributors in their fairly recent earnings releases as well. The book-to-bill is even for the summer months here is very, very healthy. And the book-to-bill is above unity at this point in time. And that coupled with the distributor inventory which is running at a very, very normal level of around 7.5 weeks, makes us believe that there is a very, very good balance between supply and demand. And that's essentially our thinking at this point in time.

Vijay Rakesh - Sterne Agee

And then as a follow up. When I -- I know that your attention is obviously more to fundamental and your business but I can't help but ask about the stock that since you had acquired Hittite, the stock has in a sort been under pressure, it has underperformed the stocks and the broader market this year. Do you think there is something that investors are not getting at or basically what would be the catalyst for the stock to start reflecting the value accretion from this acquisition?

Dave Zinsner

I think we are new into the acquisition game. And so I think we do have to put up the numbers first to get these -- those stock react and we are very confident that we will get the -- in fact I think the accretion in the fourth quarter is up around kind of high single digit now as a percent. We do expect to get around 10% accretions in 2015. I think we will get mid teens in 2016. We are confident about that. But I think to some extent we have to show that we can execute to that level. Given that it has -- the stock has been a little bit weaker and we do have a buyback program in place. We did take the opportunity obviously to buyback more stock than we have in the last few quarters. So we at least took the opportunity that was presented to us, used to be a lower stock price and get some shares off the market and down our share account and hopefully accelerate the earnings through that.

Operator

And your question comes from the line of Ross Seymore with Deutsche Bank.

Matt Simon - Deutsche Bank

This is actually Matt Simon on Ross's behalf. Thanks for let me ask a question. I want to talk about your automotive results in the quarter. It was down 4% sequentially. I know that it's a little bit slower time here seasonally but it still appears is though it's a little bit below those of your peers, the result of peers. If you could give your thoughts about why that might be and what ADI needs to do to potentially catch up with the peer group?

Vincent Roche

Well, I think the way to look at this business, first off the third quarter for the automotive business typically and we have seen this over the last three years has been down seasonally. So I don't think there was a massive surprise. I think as well you can't really look at the business on quarter and sequential basis. It's a very problem driven business. And I think the way to look at ADI's performance in the automotive segment over the entire course of FY14 here is that year-to-date we are up 11% against an end market that's up about 4%. So there is almost 3x in terms of ADI content per car growth, per car unit growth. So I think, as I said we will see an improvement in the fourth quarter, we will see a sequential improvement. So they are essentially the facts as I can present them to you.

Operator

And this question comes from the line of Steve Smigie.

Steve Smigie - Raymond James & Associates

Thanks a lot guys. I was hoping you could talk little bit about how you see gross margin progressing over the next several quarters? Just in context, it seems like just wafer buying here has maybe utilization impact and also the impact from mix. So as we get to stronger seasonal period and I think wafer buying would we expect to see a pretty decent jump two three quarters out.

Dave Zinsner

Yes. So the wafers that increased the inventory levels were external wafers. So they had little to no impact in terms of our factory utilization and didn't really impact our gross margin level. I think and of course we don't have crystal ball as to how the first quarter is going to progress but typically seasonally the first quarter is down 5%, 6%, 7% sequentially. And so ordinarily that quarter we do see a lower gross margin number because we start to reduce production, starting early or in the later in the fourth quarter and then rolling into the first quarter. Although, however I would expect that to recover in the second quarter. Usually the second quarter is really good quarter for industrial. We start to get the benefit of not only the mix improvement in that quarter but also the fact that the factory is kicking back in at a pretty good rate and so we start to see the gross margin pick back up again and help elevate those margin hopefully beyond the levels that we are even at today. Additionally, there are always a thing that we do and we've been doing over the past eight or ten quarters to kind of incrementally improve the gross margins through more discipline around pricing and some focus in terms of cost of manufacturing and the cost of -- kind of call it external material I guess you call it, to improve the gross margins. And I think that we are starting to hit on cylinders in that regard. So there should be some reasonable momentum there as well. So I am optimistic that we can improve gross margins from these levels. And I think 66.5%, 66.2% depending on what quarter we are talking. A pretty down good gross margins anyway. They are the envy of probably almost all of the S&P 500 but we are looking to try to get them up from here as we talked about at the Analyst Day, given that we have a model to be -- to high end to be at 68%. So that's certainly the goal I think we will make progress towards that goal over the course of next year.

Ali Husain

And Steve, as Vince mentioned in his opening remarks, we are running the business to grow EPS at the rate of 8% to 15%. So that's important for us. And we will move on to the next question. And thanks for calling in from vacation, by the way Steve.

Operator

And your next question comes from the line of Tore Svanberg with Stifel, Nicolaus & Co., Inc.

Tore Svanberg - Stifel, Nicolaus & Co., Inc.

Yes, thank you. Vincent, hoping you can elaborate little bit on the industrial market. You guided that this is to be down sequentially. Is that just seasonality or is there anything else going on in that market at this point?

Vincent Roche

Well, it is mainly seasonal. Typically we see a decline in the fourth quarter. And the primary reasons for the sequential decline are really the ATE markets. It's not a huge surprise that as you'll have seen from the large manufacturers of ATE equipment that they are expecting the fourth quarter to be somewhat dull or the same period that coincides with our fourth quarter to be down. But I think overall, it's been -- it will have been a great year for ADI. It will be up 11% in the quarter and in Europe. We're up 9% over the year-to-date nine months. We will be up 7%. So I think that's a very strong performance and there's nothing untoward or anomalous in the fourth quarter. Overall, we will have had a very, very good year, here.

Tore Svanberg - Stifel, Nicolaus & Co., Inc.

Very good, thank you. And congratulation on closing the Hittite deal.

Operator

And your next question comes from the line of Ambrish Srivastava with BMO Capital Markets

Ambrish Srivastava - BMO Capital Markets

Thank you. Ali, I am not going to calling from my vacation, sorry. I might have missed it if you guys gave it up. In your guidance what is the contribution from Hittite?

Dave Zinsner

In the fourth quarter?

Ambrish Srivastava - BMO Capital Markets

Right, in the guidance.

Dave Zinsner

It's more into $76 million to $78 million.

Ambrish Srivastava - BMO Capital Markets

Okay. And then maybe just trying to step out of the quarterly Q-over-Q. If you look at the design activity, within industrials and autos, what is different this year versus a year ago? Where are the major segments that you are seeing new design opportunities for ADI? That was it. Thank you.

Vincent Roche

Well, it's a great question. We obviously pay a lot of attention to what's happening in the opportunities space because that's essentially the future of the company. And I think if you talk with our sales force, you talk with our marketing people, and you look at the engagement between the engineers of ADI and the customers engineers, I would say at this point in time, the activity is up very significantly over this time last year and certainly, two years ago. You know, we are basically engaging on bigger programs everywhere. We are pulling more of the bill of materials together for our customers. Of course, with the Hittite acquisition as well, there's a tremendous desire from our customers to combine the strength of ADI's mixed signal with the very, very high-performance Analog signal processing component from Hittite. So think overall, there's great strength in the industrial sector. I think as a company, we have made a huge amount of progress over the last four or five years in meaningfully engaging with a very large customers on programs that are mission-critical to them. Across America, Europe. Interestingly, for ADI, in the past couple of years, in areas that we're particularly pleased with our performance in the industrial sector is in Asia. We are seeing strength in the automation sector, the instrumentation sector. Those two areas in particular. And energy, of course, in areas like China. So overall the activity is up. The scale of programs, the scale of engagement we are talking with the customers across automotive, industrial communications infrastructure. Puts us, I think, in a whole new game and I think bodes well for the future of the company.

Operator

And your next question comes from the line of Craig Hettenbach with Morgan Stanley.

Vinayak Rao - Morgan Stanley

Hi, this is Vinayak Rao calling in for Craig. My question was on the Hittite acquisition. I know it's been just a month. But could you comment on how the integration is progressing? Like any negative, positive surprising on the way? And also, like any plan for in-sourcing to manufacturing on Hittite?

Vincent Roche

So let me -- yes, thanks for asking the question. So, I think overall the integration is very smooth. There's geographic proximity between the companies, largely about 70% of Hittite's people are here in Massachusetts. Of course, we sent through our RF and microwave activity largely in Massachusetts as well from the ADI site. So I think we knew before we acquired Hittite that cultural match would be very, very good. And so far, we have seen tremendous engagement between the engineers on both sides, in terms of creating a joint vision to use the capabilities of both sides in a very synergistic way. And to build a roadmap that starts putting this company on the growth back towards $1 billion. We've got a $500 million business now and we believe that we can grow this business to $1 billion in the not too distant future. Customers are very excited. Customers you know particularly in the aerospace area, aerospace and defense area, that's where Hittite I think had a lot more focused than ADI and we are being drawn in to bring all the pieces of the combined companies together. That's very, very encouraging. Our field activity, there is, I think if you talk with the ADI field sales force there, there's tremendous acceptance of the possibilities and we are starting to see the opportunity pipelines get loaded up with a lot of new opportunities that the ADI sales force, which was about 15 or 20 times bigger than the Hittite sales force, is now able to create leverage on the 1000 products that we've gained. So, overall, I think we are opening new doors. There's a lot of excitement on the engineering side. Now, we are in the execution phase and we are keeping a very close eye on the growth and the cost synergies. I'm very, very optimistic at this point in time.

Dave Zinsner

And answer to your second question on the wafer volume, at the moment, we have no plans to move wafers away from any of the foundries, internally. That could change over time, but right now our operating assumption and what we assumed in terms of accretion by 2016 assumed that the wafers remained pretty much at the foundries there currently being sourced from.

Operator

And your next question is from Stephen Chin with UBS

Stephen Chin - UBS

Hi, thanks for taking my questions. First one is on Hittite. If I can drill down a little deeper in terms of the quality of the design wins that Hittite has. Is there much seasonality in their business? Or is the growth largely design win ramp with based tech growth?

Dave Zinsner

I think you've got to separate it between the industrial business which is largely a defense business which is definitely very programmatic. And then the communication business will largely I assumes kind of track with our communication business, which generally doesn't have a seasonal kind of pattern to it. It's more or less kind of trends with when there are big deployments of wireless technology across the globe or in any one area of the globe. So that's what it starts to pick up. So I would say, in both cases, it tends to be more product specific and market specific as probably those markets are behaving on cyclical basis.

Stephen Chin - UBS

Got it. As a follow-up, just in reference to the higher inventories in the quarter from the externally sourced wafers, was wondering if you could provide more color on that? Is that due to some big product launch that you guys make sure have supply for? Is there tightness in terms of supply at your foundries for that process node? That's helpful. Thanks.

Dave Zinsner

Yes, thanks. So there are a couple of products that could be ramping over the next couple of quarters. And so we are in some cases anticipating that a little bit and making sure we have that volume in-house. Because sometimes those ramps can be unpredictable. On top of that, there is some concern that wafers might get tight over the course of the next quarter. And we're not certain that will happen, but the way we operate is very much focused on lead times. We try to keep lead times very, very short and so for us, it's better to err on the side of having the wafers in- house ready to react when demand is there and not impact lead times in any way. That's kind of our approach. My guess is that will carry us through the fourth quarter. And after that, I think we'll have a very good sense of both what we can expect in terms of wafer capacity and how various products will ramp over the course of the next four or five quarters. So I would expect that kind of gets to a normalized level within a quarter or two beyond the fourth quarter.

Operator

And your next question is from Ian Ing with MKM Partners.

Ian Ing - MKM Partners

Yes, thanks a lot, not on vacation, here. So you've got exposure now to some new wireless opportunities, things like microwave infrastructure and small cells. But when we talk to OEMs, it looks like main stream adoption of these kinds of topics is going to depend on big capacity upgrades happening. So right now the focuses more on expanding 4G coverage, which is more of a macro sale solution. So when do you expect capacity upgrade this 1000 times as you alluded to at the Analyst Day?

Vincent Roche

Well, yes, clearly, when you look at the facts here, in the communications infrastructure sector, you know there's so far by the way there's only 180 million 4G LTE subscriptions on a worldwide basis. And remarkably only 80% of those are concentrated in three countries. The US, Japan and Korea. So I think as the adoption rate of 4G starts to accelerate here, as it is doing in areas like China, for example, we are going to see the adoption of the smaller cells to really densify the network. And my sense is from everything that we know from our customers that will begin to happen I think in earnest sometime in 2016 onwards. So I think the largest part surely of our business at the present time is macro. We are very, very well positioned with our transceiver technologies and our enabling these smaller cell designs that are in trial. And starting to move into production over the coming year. So I think the next year, year-and-a-half will be dominated by macro and then a will be a mixture somewhere after that of macro and small cell

Ian Ing - MKM Partners

And you think microwave is going to be driven more by capacity, also, more mainstream microwave applications?

Vincent Roche

Yes, well, obviously, as the network densifies and you've got to move a lot of data into the back all sector, I think microwave will scale accordingly with the increase in data, data bandwidth needs.

Operator

And your next question is from the line of Blayne Curtis with Barclays.

Blayne Curtis - Barclays

Hey, good afternoon, guys. Dave, I am assuming you are not going to back out Hittite going forward. It's kind of following up on a previous question of that $77 million, is the right of way to think of the split by segment kind of that 60:40 of that little stub period and then directionally will Hittite mirror what you are seeing in your core business? Or maybe you can just even give kind of better color directional with Hittite?

Dave Zinsner

I think it's reasonable to assume, it's basically 60:40 maybe 55:45, somewhere in that range. Then, Blayne, what's the other part of your question? I wasn't quite getting it.

Blayne Curtis - Barclays

In terms of the guidance, is that Hittite business going to be directional what you guided your organic into Q3?

Dave Zinsner

Yes, well, I think so. The fourth quarter is certainly behaving very similar to what we see in communications and industrial. And so I'm going to guess that next year we start to see very similar patterns with Hittite relative to those two specific end markets which are the communications and industrial pace.

Blayne Curtis - Barclays

I was meaning your fiscal Q4 October just-- for the guide directionally, should be similar to your fourth quarter?

Dave Zinsner

Yes, for the fourth quarter for sure, yes.

Operator

And your next question is from the line of CJ Muse with ISI Group.

Unidentified Analyst

Hi, guys. This is (inaudible) calling in for CJ. I was wondering if you could discuss your tax rate a bit and maybe provide some of the color around what you are going to do in order to lower to reflect kind of what your rate has been historically.

Dave Zinsner

Okay, so the tax rate -- I will take a flyer at this. You tell me if I am answering the question. We're going to increase-- -- we are going to have our tax rate increase in the fourth quarter to 15.7% that will have the effect of bringing our full-year tax rate up to 14.1%. And that's because the Hittite income is taxed at a higher rate. However, over the course of really this quarter and next quarter, it starts to become infused into our kind of worldwide structure, where revenue is generated in jurisdictions that it's generated in. If cash flow is retained there. And so the tax rate for Hittite should begin to come down to relatively similar levels as compared to the ADI tax rate. Having said that, Hittite has a larger portion of their income generated in the US. So on a pointed basis, their tax rate; it's going to be a bit higher than ours. So I think that combination will have the effect of driving our worldwide tax rate for next year to be in the neighborhood of 14.5%. So a little bit north of what we are -- that what we run as a company because we've been running in the mid 13% level. But still relatively strong. And really by doing that, we've really taken Hittite tax rate down from what was kind a US statutory rate of about 35% down to something in the high teens.

Operator

(Operator Instructions) And our next question is from the line of Stacy Rasgon with Sanford Bernstein.

Stacy Rasgon - Sanford Bernstein

Hi, thanks for taking my questions. I first wanted to touch on the OpEx a little bit. So we are running now in Q4 at the higher rate, which is fully in with Hittite. How do you think about that OpEx trajectory trending next year? I was thinking you would have -- so your typical step ups for comp and everything else maybe offset by a few synergies and reductions from the deal. So how should we think about that trajectory trending next year?

Dave Zinsner

Yes, I mean we are in the process of doing our planning for next year. So I will put the horse before the cart -- the cart before the horse, rather. Too much if I start throwing out numbers. But I do think that some of the momentum or increases we see in operating expenses this year had to do with the fact that we finally rolled over after couple of years of decline in revenues. We rolled back over to revenue growth. And that had the effect of kind of really a relatively big step up in operating expenses to handle the additional bonus payments or variable compensation that gets paid out when that happens. As growth rates level loft, hopefully at levels around these levels or maybe a little bit higher, I would expect that the pressure on the bonus starts to subside. And we start to not see headwinds associated -- increasing headwinds associated with variable compensation. So for the most part, because I think what we are going to have a mantra here, is that we will pretty much keep our core expenses relatively flat, notwithstanding inflationary increases that happen for salary increases and so forth. And so there won't be the pressure on OpEx that we see in the past. And then we are going to see some benefit from the Hittite acquisition in terms of synergies. That will kind of bring those up -- those OpEx levels back in check. That was a long-winded way of saying, we really don't know the number you, but we are working on it. We are going to keep it pretty constraint.

Stacy Rasgon - Sanford Bernstein

I guess the reason I asked you, your EPS target of 8% to 15% growth, have you backed into the required revenue growth, so that implies revenue growth of about 10% which to me would suggest you would still be reflecting increased variable compensation from that revenue growth. Are you looking to get that kind of revenue growth or aren't you? And what effects do expect that to have on the OpEx? It's got to be one of the other, doesn't it?

Dave Zinsner

Correct. Yes. We are going to keep -- I think you will see -- I don't know what revenue growth is going to be like next year, we haven't even worked up the plans yet. But our goal for OpEx is to keep it really tightly constrained.

Operator

And your question is from the line of Doug Freedman with RBC Capital Markets.

Doug Freedman - RBC Capital Markets

Thanks for taking my questions. Congratulations on a strong quarter. My question has to do with your ability or the company's capacity to participate in additional accretive acquisitions. You still have plenty of cash on the balance sheet. Is there some sort of number at which you see or minimum threshold of cash? And how long do you think the integration timeframe is that you can get back into the market?

Dave Zinsner

Well, I think we have a relatively accelerated integration plan that goes over the course of 120 days or so, that will get the lion's share of the integration complete. We'll still obviously have little mix and match that we have to take care of over the course of the year. But I think the next four months or so will be pretty focused on integration of Hittite into our operations. And from there, I think we have a pretty good ability to focus on something else if we want to. Or quite honestly, focus on getting the revenue synergies out of Hittite and getting our own business in the right place. From a minimum cash perspective, we generate cash flow as a company pretty much in every circumstance. I think in the first quarter, 2009, which is probably our most significant drop-off in revenue probably in our history, we still generated, I don't know somewhere in $50 million of free cash flow that quarter. So, we can live on a very tight level of cash without taking much risk. I'd say, ideally, we would like to carry about $1 billion of cash just for dry powder sake. However, we do also have additional debt capacity to the extent we need to tap into that. And that's pretty meaningful what we have available to us, without impacting our debt rating. So we clearly have the flexibility to do M&A when and if Vince thinks it's the right thing to do. We obviously have a very high bar in terms of acquisitions. I don't think we are going to run off and do a ton of M&A. This one was really the right business with the right set of products that just gelled perfectly with the things we were doing internally. And made just unbelievably good strategic sense for us and for our customers. And I think the bar on a go forward basis would be those characteristics would have to hold true in other deals. So we will see how it goes. We're always looking around and kicking the tires on things. But I don't think you'll see us do one every other quarter or something like that. We are a company that prides ourselves on our ability to develop innovation internally first and foremost. And we do M&A when it's a perfect opportunity that really meets the customer's expectations. Hopefully I can do.

Vincent Roche

Just to add a little more color talking about David said, we've been really focusing this company more clearly on business-to-business type end applications. And whatever we do in the future, whether it's organic, whether it's through M&A, we'll have to address that kind of focus space that we have and our mantra is, has been, that we grow this company and the whole future of this company is based on the quality of the innovation that we have. It's based on having diversity in the businesses and the applications that we address. And ultimately, we've got to be able to produce great returns. So it's very, very high bar and we think that Hittite certainly is well over that bar. And that's essentially the lens through which we’ll view any future activity in the acquisition space.

Ali Husain

Jennifer, it looks like we have a couple of callers here that have re-queued. So I think we are going to go back to really earning their keep tonight. Let's see, who do we have on the line, operator?

Operator

And your next question is from the line of Ian Ing, MKM Partners

Ian Ing - MKM Partners

Following the other Analog products up 9% quarter-over- quarter according to your filings that's largely MEMS sensors for the auto market. But that again, auto was down 4%. So are there some new applications from MEMS sensors or something else going on?

Vincent Roche

Well, you know, we have -- obviously, we built our MEMS around the automotive space. That's how we essentially took technology and started building products of high-quality, high standard. And we have many new homes for the basic technology. We've developed for example, the world's lowest power, highest accuracy MEMS inertial sensing device that gets used in for example, and healthcare applications, in industrial applications. So our focus has been really on automotive but now we are in a position where we start to expand the portfolio, expand our reach and get into a new range of applications, specific to MEMS.

Dave Zinsner

And then on top of that, on the other Analog side, we lump almost anything we can't clearly defined because it got all kinds of functionality, we dump into other Analog as well. And increasingly, more of our products are coming under that definition. So I think that has driven a lot of the growth another Analog and one of the reasons why eventually I just want to kill these product classifications because they start to not have any meaning on a go forward basis when all these core capabilities all start to get integrated into single systems.

Vincent Roche

For example, another area that falls under the banner of other Analog is isolation technology. So it started again. As I said like MEMS, it started as a technology development inside the company that we start to build products, specific products from, now those products or that technology is being integrated into some of our conversion technologies and linear technologies. So as Dave said, it's getting hard to classify with the basic building blocks do their thing and many of these things are classified under other Analog today, but there's more and more and more cross pollination between the technologies in our portfolio.

Ali Husain

Thanks, Vince. I think we will get to our last caller of the night.

Operator

And our final question comes from the line of Blayne Curtis with Barclays.

Blayne Curtis - Barclays

Hey, guys. Thanks for squeezing me. And I was just curious, you guided consumer as seasonal. And I guess you haven't had really anything seasonal for a while. Just curious what you meant by that and are there a chance that business has been down year-over-year in October and if so what's the driver?

Vincent Roche

Well, our consumer business really has two components to it. It's the broad based prosumer which looks a lot actually like our B2B businesses. It's got lots of applications, lots of products, lots of customers across the globe. And for example, enterprise media processing systems, the remainder of the business is pretty much portable type applications such as cameras, portable devices such as tablets and smartphones and so on so forth. It tend to be very programmatic, it tend to be very, very large off driven, it is our sense based on our backlog, based on our knowledge of the applications that we will see some growth based on seasonality effects as well as you know there is always new programs. These programs are replenishing themselves particularly in the portable type area about every 12 months, so there is always new stuff coming and so it's a mix of those two components. The more enterprise oriented prosumer combined with the more volatile really type of portable applications.

Dave Zinsner

I think an answer to that kind of second part of your question, Blayne; I do think that we probably will be down year-over-year in consumer, even though it's going to be sequentially up. But I think that this maybe hopefully the last quarter we were in that position. It has been turning the corner really beginning I think in the second quarter of this year. But still haven't quite recovered back to levels of last year or the year before, so hopefully this will be the last quarter that we see kind of year-over-year declines and we start to see some growth next quarter, in the first quarter.

Vincent Roche

Yes. Big part of the decline that we register this year incidentally is because of the divesting of our microphone business which was factored into our FY13 number. So as Dave said, I think the strong headwinds that we had their by through essentially refocusing our spent from consumer into more B2B applications over the last five years will starting to see the bottoming out and expect to see some tailwinds from here on.

Ali Husain

All right, thanks Blayne. And helping us finish stronger tonight. So just a reminder, our fourth quarter FY14 earnings call is scheduled for November 25, 2014. That will begin at 5 PM Eastern. So thanks again for tuning in tonight, everyone. Have a great night.

Operator

This does conclude today's Analog Devices' conferece call. And you may now disconnect.

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