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Avago Technologies Limited (NASDAQ:AVGO)

F3Q2011 Earnings Call

August 23, 2011 5:00 pm ET

Executives

Jacob Sayer – VP of Business Development and IR

Hock Tan – President and CEO

Douglas Bettinger – CFO

Analysts

Terence Whalen – Citi

Ross Seymore – Deutsche Bank

Vank Nathamuni [ph] – JP Morgan

Blain Curtis – Barclays

John Pitzer – Credit Suisse

Vijay Rakesh – Sterne Agee

Brendan Furlong – Miller Tabak

Sanjay Devgan – Morgan Stanley

Aalok Shah – D.A. Davidson

Rafi Hassan [ph] – Jefferies

Mike Burton – Kaufman Bros.

Edward Snyder – Charter Equity Research

Operator

Welcome to the Avago Technologies Limited Third Quarter Fiscal Year 2011 Financial Results Conference Call. At this time, for opening remarks and introductions, I would like to turn the call over to Jacob Sayer, Vice President of Business Development and Investor Relations. Please go ahead, sir.

Jacob Sayer

Thank you, operator, and good afternoon, everyone. Joining me today are Hock Tan, President and CEO; and Doug Bettinger, Chief Financial Officer of Avago Technologies.

After the market closed today, Avago distributed a press release and financial tables describing our financial performance for the third quarter of fiscal year 2011. If you did not receive a copy, you may obtain the information from the investors section of Avago's website at avagotech.com.

This conference call is being web cast live and a recording will be available via telephone playback for one week. During the prepared comments section of this call, Hock and Doug will be providing details of our Q3 fiscal year 2011 results, background to our Q4 2011 outlook, and some commentary regarding the business environment. We will take questions after the end of our prepared comments.

In addition to U.S. GAAP reporting, Avago reports certain financial measures on a non-GAAP basis, to provide it in addition to and not as a substitute for the comparable GAAP measures.

A reconciliation between GAAP and non-GAAP financials is included in the tables attached to today's press release. Comments made during today's call will primarily refer to our non-GAAP financial results.

Please refer to our press release today and our recent filings with the SEC for information on the specific risk factors that could affect our business and financial condition and cause our actual results to differ materially from the forward-looking statements made on this call.

At this time, I would like to turn the call over to Hock Tan. Hock?

Hock Tan

Thank you Jacob. Good afternoon, everyone. I'm going to start today by reviewing some of the recent business highlights, and then Doug will provide a summary of the third quarter financial results.

As you may have seen from our earnings announcement, revenue for the quarter was at the top end of our guidance at a record 603 million with net revenue up 8% from last quarter and up 10% year-on-year from third quarter 2010.

Interestingly though, each of our target markets performed much as we guided during the course of – in the third fiscal quarter. Now there is little doubt that there exists today uncertainty with regard to the direction of the global economy, the electronics equipment supply chain will undoubtedly be adversely affected, probably has been by any economic downturn with semiconductors at the tail end of this chain, which could obviously have knock-on effects for our business.

Nonetheless, we have continued to gain traction with our large OEM customers and largely as a consequence, we continue to expect to see our business grow through the balance of this fiscal year.

Now let us turn to the results from each of our target markets. Within our wireless communications market, we manufacture as you may know, FBAR duplexers, power amplifiers, light and proximity sensors, and optical navigation devices for feature-rich and smart mobile phones. We also manufacture RF components for the wireless base station market.

Turning to fiscal Q3, sales from our wireless communications market represented 37% of our third quarter revenues. Our revenue from this target market grew 10% from the preceding quarter, and rose 8% above the same quarter last year. This performance was roughly in line with our expectations for the quarter. Growth in Q3 was driven by increased strength in our wireless infrastructure business and by the seasonal growth in handsets driven particularly by the launch of new LTE and WiMax smart phones in North America.

This was offset somewhat by weakness with a large OEM in the optical finger navigation product line. We continue to be encouraged by our momentum as our parts were designed into 37 new handset platforms during Q3. I have to add that our best – while it is of interest to note I should say that our business model in wireless is predicated upon certain handset OEMs pushing for differentiated performance, which we can deliver through our components.

Obviously our success in this segment is based on those OEMs being winners in the marketplace. We believe we have recently been successful with those winners. As a result, we anticipate revenue in this target market will again increase in the high single to low double digits compared to Q3 as those winning OEMs launch their next generation smart phones.

Turning to wired infrastructure, as you may know too, we design high speed SerDes ASICs and manufacture Optical Transceivers for enterprise networking, data center switching and high speed computing applications. Now revenue from the wired infrastructure market represented 28% of our total Q3 sales. Our sales from the wired infrastructure market grew 6% over Q2 and grew 37% over the same quarter last year.

Again revenue from this target market grew pretty much as we expected at the beginning of the quarter. We benefited from strong demand in storage networking, which drove growth in our 8 GB and newly introduced 16 GB fiber channel solutions in Q3. We also ramped our 12 channel, 120 GB proprietary transceiver modules to supercomputing applications. During this same quarter Q3, we saw strong double-digit growth from our

SerDes ASIC business due to strength in next generation datacenter switching.

Finally demand was saturated during the quarter by strong orders for proprietary parallel optics sold into core routing applications in China during the same quarter. Now looking forward to Q4, we believe the Q3 bounce in the core routing business in China will likely recede. But this will be offset by continued strong ASIC SerDes ramp. Accordingly, we expect overall that revenues from the wired infrastructure market will be flattish for us quarter-on-quarter.

In our industrial and automotive electronics target market, we manufacture and sell optocouplers, and in addition today motion encoders and industrial fiber. During Q3 net revenue from this market accounted for 30% of our total revenue, it grew 7% compared to the prior quarter and grew 5% from the same quarter a year ago. Now during this Q3 growth came mainly from continued strength in demand in Japan and China. This was offset somewhat by softness in North America and Europe due largely to supply chain adjustments during the quarter.

All indications however are that our large industrial OEM customers will continue to grow in this coming Q4. However, we do expect inventory adjustments to continue in the supply chain, particularly among component distributors. Nevertheless, inventory of our parts has remained tight in those channels, and consequently we expect our industrial revenue to be roughly flat sequentially during Q4.

Finally, in consumer and computing peripherals, we manufacture as you know navigation sensors for optical mines and motion sensors for printers, and revenue from this target market represented only 5% of our third quarter 2011 revenues, and increased 10% from the preceding quarter, but shrunk 34% year-on-year. With muted seasonality expected in this market, we estimate that our Q4 revenue from the consumer side will be roughly flat again as compared to Q3.

So to summarize three basic points, with the volatile and uncertain environment that we currently see, we forecast conservatively that three of our four target markets, namely wired, industrial and consumer to be roughly flat sequentially in Q4. Secondly, given lean inventory levels in our supply chain, we do not expect to get whipsawed by external adjustments during this quarter.

And thirdly, in wireless we believe we have picked winners, and we are benefiting from the launch of their next-generation smart phones during the quarter, which will drive our growth in our wireless target market. All of this put together leads us to expect revenue in Q4 fiscal '11 to increase between 2% to 5% over last quarter.

With that summary, let me now turn the call over to Doug for a more detailed review of third quarter fiscal 2011 financial results.

Douglas Bettinger

Great, thanks Hock. Good afternoon, everyone. Before reviewing third quarter fiscal 2011 financial results I want to remind you that, as always, my comments today will focus primarily on our non-GAAP results. And as Jacob pointed out, a reconciliation of our GAAP and non-GAAP data is included with the earnings release that we issued today and is also available on our website at avagotech.com.

Record revenue of $603 million in Q3 represents an increase of 8% from last quarter and an increase of 10% versus same quarter a year ago. And as Hock reviewed, the sequential increase was at the top end of our guidance and revenue from each of our target markets came in much as we expected at the beginning of the quarter. Resales from our distribution partners grew slightly in Q3.

At the end of Q3 distribution inventory was at a level consistent with the prior quarter in terms of days on hand, and we continue to keep a very close eye on our supply chain and remain comfortable right now with the level of inventories that we see, and I think Hock has already talked to you about that.

Q3 gross margin was 51.7%. This was consistent with our expectations going into the quarter. Stronger growth in our wireless target market was balanced with growth from our higher margin industrial market to keep gross margin roughly flat quarter-on-quarter.

During the quarter, R&D expenses increased $8 million sequentially to $81 million. The majority of this increase was from investments that we've made in our wired and wireless business. SG&A also increased by $4 million to $54 million. Some of the increases in both R&D and SG&A were driven by higher salaries that resulted from our annual review cycle, as well as higher bonus accruals that we made during the quarter. Higher operating profit and design-win momentum drove the increase in bonus accruals. Additionally, higher sales pushed commissions up a bit.

As a percentage of sales R&D remained at 13%, SG&A remained at 9% of net revenue. Income from operations increased by $10 million sequentially to $177 million, which is a new record for Avago, and it represented 29% of net revenue. Q3 income from operations compares with income from operations of $167 million in Q2 and with $164 million in Q3 of last year. Taxes for Q3 came in lower than guidance at $1 million due to a change in estimate related to the utilization of certain R&D tax credits, the timing of which was driven by the filing of our US Federal returns.

These results translated into net income of $176 million, which is up 7% from last quarter. Q3 earnings per diluted share of $0.68 compares with $0.64 in Q2, and net income in Q3 of 2010 was $152 million or $0.61 per diluted share. Our total share-based compensation in Q3 came in at $11 million. The breakdown of this expense for Q3 includes $1 million in cost of goods sold, $4 million in R&D, and $6 million in SG&A. In Q4, we anticipate share-based compensation will again be approximately $11 million. Just a reminder, the company’s definition of non-GAAP net income excludes share-based compensation expense.

So now let me move to the balance sheet. Days sales outstanding was 43 days. This was down 4 days from the prior quarter. Inventory came in at $200 million, which was up 3% from last quarter in dollar terms. This translated to days on hand of 63 days, which was down two days from Q2 and is at the lower end of our inventory model. I think we were pleased with our management of working capital in Q3.

At the end of the third quarter, our cash balance was $704 million. The primary change in cash came from $211 million in cash provided by operations. Capital expenditures in Q3 was $24 million and that compares with $19 million last quarter. We expect CapEx in Q4 to be in the range of $35 million to $40 million. The sequential increase will be driven by new mask sets in our ASIC business, as well as capacity additions in our wireless factory.

With Q4 CapEx in the range I referenced, our full year spend will be very close to the estimate we provided at the beginning of fiscal 2011.

On June 30, 2011, we paid a quarterly cash dividend of $0.09 per ordinary share, which consumed $22 million of cash. This dividend was raised by $0.01 from the prior quarter. And finally, during Q3 we repurchased and cancelled approximately 1.9 million of our ordinary shares, which consumed $68 million of cash.

Now let me review the balance of our non-GAAP guidance for the fourth quarter of fiscal 2011. This guidance reflects our current assessment of business conditions and we do not intend to update this guidance. Revenue is expected to be up 2% to 5% sequentially driven by anticipated growth in our wireless target market. Gross margin is expected to be 51.5% plus or minus 75 basis points. This decline is due to the projected growth in our wireless target market.

Operating expenses are estimated to be $132 million. This is down slightly from Q3. Interest and other is currently expected to be approximately zero. We’re forecasting taxes to be approximately $4 million, and finally the diluted share count forecast is for 256 million shares.

So let me summarize, during Q3 we generated record revenue at the top-end of our guidance and maintained margins. Coming into the fourth quarter, we see growth coming from the ramp of new designs at large OEM customers.

And finally, I thought I’d let you know that as we are completing our annual operating plan during the coming quarter, I’ll intend to provide an update to our long-term business model during our 2011 fiscal year end conference call, which will be scheduled for early December.

And that concludes my prepared remarks. Operator, if you will please open up the call for questions at this time.

Question-and-Answer Session

Operator

(Operator instructions) Your first question comes from the line of Terence Whalen with Citi. Please proceed.

Terence Whalen - Citi

Thank you for taking my question. Congratulations on the results. This one is a higher level question perhaps for Hock. Hock given the uncertainties on the macro side in the current environment, can you talk a little bit about how you adjust for that uncertainty. When you visit your regional sales offices and as you construct guidance in the out quarter, I’m trying to ascertain what level of conservatism is constructed into your industrial and wireline outlook?

Hock Tan

Well, you know, Terence that is a very interesting process question and we’ll try to address that. We set our goal, our quarterly targets for our sales organization within the first week, by the end of the first week of the quarter of every quarter itself, so no different. We set it about two weeks ago, almost three weeks now, three weeks ago, and I guess it's and when we said it I mean we basically said it keeping in mind the most current and anticipated market conditions, and our designs that we have embedded out there in the marketplace.

What we basically have done is then track it against the bookings we have received the prior quarter and the bookings we’ve received since then, and I guess at this stage the level of bookings we’ve achieved in a sense in this company towards the target we're talking about, we probably have reached over 80%. So, that gives us a certain level of comfort and in many ways some level of conservatism in setting the guidance we’re setting to you today.

Terence Whalen - Citi

Okay, terrific, next question [ph] just in relation to the wireless business. Obviously, you're doing quite well there. Do you refer specifically to the ramps that multiple OEMs, my question is specifically regarding LTE (inaudible) content, can you give us a rough understanding of how many models or perhaps how many units of LTE in this year, if you could answer because in 2012 that would be also very helpful? Thank you.

Hock Tan

I mean, you broke up quite a few places, but if I can gather from reading between the blanks, you’re basically asking how many platforms or how many different models of LTE handsets we are designing or are currently designing and how many might be in 2012. I presume what we’re seeing is the launch last quarter and continues this quarter, and we’re probably seeing probably in excess of 10 different platforms or models this year alone.

For next year, we’ll probably see most of our 37 design-in platforms I articulated in my prepared remarks, probably related to LTE as well, and most of that would happen next year.

Terence Whalen - Citi

Okay. Thank you and congratulations to you guys.

Hock Tan

Thanks.

Douglas Bettinger

Thanks Terence.

Operator

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

Ross Seymore - Deutsche Bank

Hi, can you guys hear me okay?

Hock Tan

Yes.

Douglas Bettinger

We can hear you clear Ross.

Ross Seymore - Deutsche Bank

It is going to put on a robocop voice, but anyway on the wireless side of things, can you talk a little bit about what you are seeing with new product launches and how that’s driving your growth versus normal seasonality, and is in fact seasonality in whatever sort of core business you have in there acting normal or is there anything a little bit different?

Hock Tan

Well, I guess, it’s hard to tell to be frank, Ross. And I guess I was trying to struggle with kind of putting that out. It’s hard to tell whether seasonality in handsets, in mobile, this quarter Q4 or Q3, I should say, is normal or possibly muted, and not to mention the quarter is not over by any means, the second half is far from over. But it’s hard to tell and particularly as I’ve tried to mention in some of my remarks, you have multiple handset OEMs out there now, and you see some really gaining and you see some not so gaining.

And for someone like us, a player like us where, as I mentioned, our business model is about not going for market share but really more going for sockets, design sockets in platforms that customer really appreciate, apprise – not apprise, but a performance differentiation. We pick and choose and we pick and choose on those design sockets and because we pick and choose, we don’t see the entire market when we consolidate everything together, and we pick some winners and we pick a lot of winners, we come out looking very good, and that’s pretty much what we think we’re seeing this Q4 that we are in. It could well happen the other way, but fortunately we certainly do believe we are picking a bunch of winners this current quarter.

Ross Seymore - Deutsche Bank

I guess, continuing on that theme, as you pick the winners, does that in some way mute your seasonality in that business or as we look forward, typically your January quarter down. I know you’re only guiding one quarter out, but if we’re driven by new product launches more so than seasonality, does that have implications for your overall seasonality as we look into the weaker quarters of the year?

Hock Tan

It could. Interesting point you mentioned that and in fact that’s what we love to have happened, but I don’t want to get you guys carried away and say it won’t that it won’t happen. I am sure it does at some level of seasonality, no matter, even among the winners in this business. It’s just that if we’re clever enough to keep picking the winners, it does possibly muted even in the weaker quarters, but I don’t know if that will happen. We only look forward one quarter at a time.

Ross Seymore - Deutsche Bank

Right. Thank you and congrats.

Hock Tan

Thank you.

Douglas Bettinger

Thanks Ross.

Operator

Your next question comes from the line of Vank [ph] with JP Morgan. Please proceed.

Vank Nathamuni - JP Morgan

Hi, thanks for taking my questions. As we look at your industrial end markets, it looks like it’s at record revenue revels, despite all the concerns about the macro slowdown. Now you obviously talked about getting some design wins at large OEMs. So what is the level of conservatism that is built into it given all the concerns that we have about macro demand overall?

Hock Tan

Well, I guess the most obvious level of conservatism we try to put in is this. Last quarter, we tried to track all our major industrial OEM customers across a range of regions. We are not just tracking one region, we are tracking across the board, and if we do that I would say on average – with an average, they grew about 8%, 9% sequentially, the industrial end customers, and we grew 7%, in fact maybe even slightly below 7%.

As I said, for some regions we were making sure we keep our inventory in our distributors – most of this for the main distributors under tight control. This quarter Q4, the same data we look at what likely grow 3% to 4% sequentially for them, and we are saying we are probably going to be flat, and we have pretty lean inventory in our distribution channel, and hopefully in the rest of our supply chain out there that would enable us to perform that way. So, hopefully we think we have adjusting some level of uncertainties in this.

Vank Nathamuni - JP Morgan

Okay. That is helpful, and then on to gross margins and a question for Doug, you’ve had a pretty substantial improvement in revenues over the last few quarters, and it appears that gross margins have kind of flattened about 49%, 49.5% on a GAAP basis. Can you tell us what are some of the key drivers for gross margins, is it more of a mix issue or if it’s utilization or some combination?

Douglas Bettinger

Yes Vank, as I’ve mentioned on a couple of previous calls, what really drives gross margin at Avago is product mix. It’s end market to end market, there is differences in gross margin in each of our end markets, and I tried to describe in my prepared remarks, industrial was strong and it offset little bit of growth in wireless last quarter.

And when I look at our guidance for the current quarter, we have growth in wireless, which has gross margin a little below the corporate average and that is why gross margin is down, call it, 20 basis points in the coming quarter, but what drives it quarter-to-quarter and year-on-year is the product mix. I think if you look, year-on-year, we're still up about 100 basis points or so if I remember the numbers right, which is what we're trying to drive the company to.

Vank Nathamuni - JP Morgan

Okay. Thank you very much.

Douglas Bettinger

Thanks Vank.

Operator

The next question comes from the line of Blain Curtis with Barclays. Please proceed.

Blain Curtis - Barclays

Hi, guys. Congrats on the great results and guidance. Just following up on that question on gross margins, Jacob, as we look forward, I would assume that the wireless business will continue to outperform, so that mix will continue to go that way. So, just how do you think about that shape of the gross margin as that layers in, and obviously it's a big problem to have with the growth, but you had talked about 100 basis points per year, is that still possible given the new mix and obviously you can proceed with some of the slowdowns in the other businesses?

Douglas Bettinger

Yes, Blain this is Doug not Jacob, and I'll take the call. Yes, you know, we're not forecasting beyond one quarter as this point but you have puts and takes in each of the end-markets. One thing I would point you to is we're very encouraged by the momentum in the growth in the wired infrastructure end-market. Hock mentioned a lot about the ASIC division, as well as some of our proprietary optics. The gross margin profile of the proprietary products in that end-market are quite good, and so, as those grow that helps expand gross margin and countervailing that sometimes in some of the other end-markets you could have growth that is a little bit low. As we look at it, over a longer term horizon, we still feel like we have an ability to expand gross margin.

Blain Curtis - Barclays

Great, thanks. And then just one more Doug, on the ramp with the 30s it’s obviously helping you offset some of this weakness. Can you just talk about where you are in that ramp [ph]?

Douglas Bettinger

Yes, we’re still in the early innings Blain. I mean it’s – we’ve talked consistently about a three year horizon where we believe we’ll be able to double that business, and we’re really in the first year of that ramp.

Blain Curtis - Barclays

Okay, and then just maybe just one final one on the optical nav, what the – any sort of magnitude or color you can give as far as what your expectation is, obviously one customer bringing another source, but so you have other customers that you shifted there?

Douglas Bettinger

Yes, I mean, you have one customer that does lot of business there and that one customer is potentially down a little bit in the current quarter and that’s what we’re seeing. And you’re right, we have many other customers that buy those devices, but one kind of pushes the direction of the business with that all and that’s what’s going on with all of them [ph].

Blain Curtis - Barclays

Thanks.

Douglas Bettinger

Yes, thanks Blain.

Operator

Your next question comes from the line of John Pitzer with Credit Suisse. Please proceed.

John Pitzer - Credit Suisse

Hi, good afternoon guys. Congratulations. Hock, I was wondering if you could talk a little bit about what you think the impact of the Japanese earthquake earlier in the year was relative to both the wireline business where we’ve actually heard other chip guys talk about customers not being able to procure parts and also within the industrial business. And if you think it’s been additive to industrial how worried are you about maybe an inventory correction that needs to recur there, especially given that you guys are sell in and not sell through?

Hock Tan

Right, and for all intents and purposes, we’re trying to make it as much sell through as possible too, by the way, but that aside, what the Japanese tsunami and followed by I guess the nuclear reactor issue was in my view, and you’ve heard that too from other semi guys and other companies out there when they announced their results, it probably, in fact more than probably it did create a kind of a bubble of demand, a bubble of orders in the June quarter this year, and which receded and more than receded and which probably went the other direction, and it is still going in the other direction in this September quarter that we are in, calendar quarter.

It’s I guess pretty normal, what we think is happening is there was over-ordering in the June quarter because people worried about shortages, component shortages especially and it backlashed this September quarter. So guess what, I mean in this kind of behavior is more than likely that you will go back up the other direction maybe to a more muted version of it in the December quarter. I think we’re seeing a big part of that happening.

Now one may presume that that could also be due to weak economic performance as well and that could well be also true. It is hard to breakout one from the other, but you have to remember in the September quarter, there is some seasonality downwards in terms of activity, but I also think the bigger chunk of it is supply chain adjusting first one way, then the other way and possibly in December and other way one more time. And the question for us is to try to see through this all and manage through this all with our distributors because the key bottom-line is what is – just not end resale as much as end demand of our OEM customers that we really focus on.

John Pitzer - Credit Suisse

And then, Hock, as my follow-up question just getting back to LTE on the front end module front. I’m just kind of curious I think you talked about 37 phones you’re designed into, where do you think your share will fall out as we look out over the next 6 to 12 months within the LTE ramp, and remind us again of what kind of dollar content per phone we should think about for Avago as LTE handsets really start to ramp next year?

Hock Tan

I’m not trying to avoid your question, because the fact of the matter is first and foremost the dollar content per phone on LTE varies quite dramatically phone by phone. It depends on whether they use discretes or front-end modules and how many bands they go – that each phone carries. Some have more much more bands than other, and so there is a big variation. It could range from anywhere from $3 content per phone as much as $5, $6, but that aside, main thing is we don’t really focus on market share.

Our business model is really to getting to those sockets where we are either first there – first to market in that particular socket offers so into that socket or that we have a performance differentiation that enables us to win a socket versus anybody else, and I’ll be the first to admit in many cases, we don’t have that differentiation and we don't – we generally don’t try to take the business because we are not able to make a price differentiation too, which is not our business financial model. So, we don’t really track market share, and if you ask me as you did this question, I don't really know because I never really try to look at it that way, nor encourage any of my general managers to do likewise.

John Pitzer - Credit Suisse

And then Hock maybe I could sneak in one more for Doug. Doug, you talked about your belief that you still have opportunities to grow margins over time. Can you kind of walk through the two or three things that you think are the biggest pressure points in improving gross margins from here?

Douglas Bettinger

I mean, what it really comes down to, John, as we have talked consistently about or tried to anyway is growth in incremental revenue from proprietary designs where we believe – and to us proprietary means sole source designs, and as those become a bigger and bigger percentage of the revenue profile here, on average they have better gross margin than the corporate average and that expands gross margin. That’s still very much the story and as we look at the design wins and the things we're tracking over the next year or two, we still see a roadmap to be able to continue to do that.

Hock Tan

I’ll give you an example, for instance, in storage networking, you know, 8 FB is replacing 4 GB and will soon we just see the launch of 16 GB. The price of a 16 GB today, with the new product launch is a few times that of an 8 GB, still one product and so that helps a lot, not just on price but on margin.

John Pitzer - Credit Suisse

Perfect. Thanks guys.

Hock Tan

Thanks John.

Operator

Your next question comes from the line of Vijay Rakesh with Sterne Agee. Please proceed.

Vijay Rakesh - Sterne Agee

Hi guys. Just looking at your wireless comm business. It looks like it's growing almost 15%, 20% year-on-year organically. How do you see that as you look at next year on that business the wireless comm side?

Douglas Bettinger

Wireless comms next year.

Hock Tan

Wireless comm that's hard to figure. We never look that far ahead. I guess, we expect, we like it to be fairly moderate and grow at about the same percentage year-on-year, maybe slightly more, somewhere between 15% and 20% will be nice.

Vijay Rakesh - Sterne Agee

Got it, and you mentioned seven new handsets platforms here. Is that into seven OEMs and how do you break that out?

Douglas Bettinger

Vijay, just to clarify, Hock talked about 37 new design wins and it’s with multiple handset OEMs.

Vijay Rakesh - Sterne Agee

Okay, got it. Thanks.

Hock Tan

Thanks Vijay.

Operator

Your next question comes from the line of Brendan Furlong with Miller Tabak. Please proceed.

Brendan Furlong - Miller Tabak

Good afternoon. Thank you. On your industrial business, I don’t know if you can delineate somewhat between your large customers the signs of industrial rolling over. But some factory automation, robotics, your customers like AVB seem to be doing okay. If you can just kind of delineate within your industrial – little bit softer on what’s holding up better?

Hock Tan

By end markets, interesting. Well, inverters, especially a lot of inverters that go into renewable energy that we all talked about before have kind of taken a breather here, because there’s been a slowdown on renewable energy, some of it to do with government subsidies, some of it to do with some technical challenges. So we’ve seen inverters have kind of taken a bit of a slowdown. On the other side on servo drive motors [ph], we still see fairly strong demand out there, especially on the major large OEMs, industrial OEMs, servo drives and guys who sell motor systems as well are still having a very, very strong period – still in a very strong period, and these are people like Japanese guys and German guys.

Then I’m trying to say that because I usually don’t try to mention customer names. But then the other side and finally the last area of factory automation, factory automation, it goes in lumps. There’s a lot of that going on, especially in the last couple of quarters when there is a quite a few factories being built, car factories especially, being built in different locations whether it be China or even Germany, and Eastern Europe and we’ve seen very good demand for that. That’s probably still better than inverters, but not as strong as servo drive.

Brendan Furlong - Miller Tabak

Okay, great. Thank you and then I guess as a follow-up, you mentioned the 16 GB storage a couple of minutes ago. I am just wondering what you're on that industry transition from 8 to 16, what’s your traction there? Who do you think your main customers will be and what’s the growth rate looking like for you?

Hock Tan

Well, our big claim to fame there is we sell optical transceivers that enable this whole transition. As you know we’ve done 2 GB, years ago, again 4 GB, 8 GB, and on the 16 side no different we’re very much into lot of traction into that design, it is just starting – very early stage of a ramp and adoption and obviously it is advancing [ph] greatest whenever you get on the front-end of the curve is not the leading edge. It is actually a very, very great profitable and growing business.

Brendan Furlong - Miller Tabak

Okay, excellent. Thank you very much.

Hock Tan

Thanks Brendan.

Operator

Your next question comes from the line of Sanjay Devgan with Morgan Stanley. Please proceed.

Sanjay Devgan - Morgan Stanley

Hi guys. Thanks for taking my questions and congratulations on the quarter. Just a quick question on the standard fiber product business, there has been a lot of talk about inventory burn in that part of the market. I was wondering if you could give us your sense on how that market is shaping up. Where we are in terms of the inventory burn? Any color on that would be helpful.

Hock Tan

Well, first and foremost, I would like to make a differentiation between enterprise, which is more networking and data centers, computing and transport, which is more long-haul metro systems, fiber optic transport, more of telecoms versus enterprise, which is more networking and stuff like that. On the enterprise side, we do not see that much excess inventory in the system at all. I cannot really with any major authority talk to you about the telecoms, or transport side because we do not participate much at all in that sector.

Sanjay Devgan - Morgan Stanley

Okay, great. And then just as a follow-up Hock you talked about the 37 different design wins on the wireless side. I was wondering if you can give us an update on utilization rates for your products internally, and where you expect it to go next quarter.

Hock Tan

I don’t – are you referring to factory capacity utilization?

Sanjay Devgan - Morgan Stanley

Yes, your internal utilization and how do you expect that to trend as you kind of ramp up these new design wins, and what do you feel about your kind of capacity longer term in terms of capability to meet the demand?

Hock Tan

Okay. Well, we tried to keep our factory running at around 80% is the optimum level, and then we add an incremental capacity as we start exceeding 80% to 90% and ideally is in that range. So, last quarter Q3, we were running close to that. This quarter Q4, normal seasonality, we would probably bring it – will bring it down somewhat and don't forget we are also using outsourcing for our wireless business. So, our wireless business make us also tweak in such a way that we are using quite a bit of outsourcing now too.

Sanjay Devgan - Morgan Stanley

Great. Thanks. I appreciate it.

Hock Tan

Thanks Sanjay.

Operator

Your next question comes from the line of Aalok Shah with D.A. Davidson. Please proceed.

Aalok Shah – D.A. Davidson

Hi, congratulations on a good quarter. Hock, one quick question for you, one of your wireless competitors has noted that they're going to be getting some supply of Band 2 solutions, I would assume with FBAR filters and with your litigation with Triquint how do you view this new competition, is there reason to believe that they wouldn't be infringing on any of your patents?

Hock Tan

Number one, on patent infringement suit, I really, I'm not at liberty actually to go divulge in much detail in it, you know, why, because we are in litigation and in our litigation, we have not only patent infringement, we also have an antitrust suit going on. So sorry about that, but really I'm not at liberty to talk much about it. But having said that, I'll point out that, yes, we're aware of a Japanese player providing samples or initial samples of FBAR what you call FBAR acoustic wave, which is kind of similar technologies at FBAR filters, but we see that every now and then.

I mean, there are other players who have done that before. You have to keep in mind we are on probably the 9th or 10th generation of FBAR today, and these people have great engineering skills to do that and are probably much earlier in the product life cycle development in terms of product generation. We have probably shipped billions of those units, and that's pretty tough to be able to produce this effectively, efficiently, and do that. So, this is about market competition to if it really prevails to come in. We've seen that every now and then from other players out there, and I assume we will continue to see that.

Aalok Shah – D.A. Davidson

And Doug, just real quickly, I don't want to beat the dead horse, but can you describe your linearity in the July quarter specifically around the industrial and automotive segment and did you see it a little bit more front-end loaded?

Douglas Bettinger

Linearity in industrial specifically, no it wasn’t necessarily front-end loaded. It was fairly linear during the quarter.

Aalok Shah – D.A. Davidson

And do you expect that to kind of be the similar pattern in this quarter?

Douglas Bettinger

Hard to tell. Hock described to you what our booking coverage is. It’s around 80% right now. Just looking at how that booking lays out, it’s again fairly linear.

Aalok Shah – D.A. Davidson

Okay, great. Thank you.

Douglas Bettinger

Thanks Aalok.

Operator

Your next question comes from the line of Rafi Hassan [ph] with Jefferies. Please proceed.

Rafi Hassan - Jefferies

Hi, thanks for taking my questions. I have couple of questions, one on FBAR, one on SerDes. Can you provide some color on the revenue mix within wireless in terms of integrated versus discrete [ph]?

Hock Tan

That’s a tough question, integrated versus discrete. What you really mean when you say integrated is you mean front-end modules?

Rafi Hassan - Jefferies

Right.

Hock Tan

Front-end modules, front-end modules in our wireless business probably comprise right now about no more than about 25%, maybe 30% of our wireless revenues.

Rafi Hassan - Jefferies

Okay. Regarding SerDes, last quarter you mentioned some of your customer inventory levels have been higher. Can you break it down for this quarter? What is the wireline component inventory compared to what you have versus what is out there in the OEM for SerDes and transceivers both?

Hock Tan

I can’t really tell you. Our customers let alone do not give us that kind of information. If we find it, we have to guess and it’s hard for me to want to want to guess and speculate in this call, so really we don’t have that kind of information that you’re asking.

Rafi Hassan - Jefferies

Okay, one last one if I can, what is the typical time delay between your sales of transceivers and end market equipment deployment?

Hock Tan

Say that again.

Rafi Hassan - Jefferies

What is the typical time difference between your sales and the transceiver that gets into the equipment at the end market?

Hock Tan

You're talking about optical transceivers?

Rafi Hassan - Jefferies

Right.

Hock Tan

It varies. It can be as short as one week, and it can be as long as two months, but typically it’s closer to one month or less.

Rafi Hassan - Jefferies

Okay. Thank you.

Douglas Bettinger

Thanks Rafi.

Operator

Your next question comes from the line of Mike Burton with Kaufman Bros. Please proceed.

Mike Burton - Kaufman Bros.

Hi guys, thanks a lot and congratulations on the great results. So, you just mentioned that approximately 25% are front-end modules, is that mix in wireless, is that increasing in the October quarter going forward? Thanks.

Hock Tan

Yes, it's increasing in the October quarter.

Mike Burton - Kaufman Bros.

Okay, we'll expect that to continue to weigh out on margins a little bit as we model out. Is that correct, are we approaching 50% or just kind of a ballpark there?

Douglas Bettinger

Again, we don't give specific numbers on specific parts, but we do know FEMs tend to have a little bit lower gross margin because they pull things along at low gross margin.

Hock Tan

To be able to forecast that, it's hard to tell. This thing goes up and down quarterly on a fairly volatile manner. I think 30% is about the right level it is at.

Mike Burton - Kaufman Bros.

Perfect. Thank you for that color, and then on the OpEx side, it looks like it is coming down nicely in the October quarter. Is that more on the R&D or SG&A side and can we start – not to get too at you [ph] Doug, but can we start using 20% as a long-term target?

Douglas Bettinger

I'll give you the long-term target next quarter. We've got one that’s out there. It’s R&D 14ish, 13% to 14% of revenue and SG&A 8% to 9% is probably what I’m going to tell you next quarter as well.

Hock Tan

I think you may be trying to understand is when – part of one reason why it went up was, as Doug said, we accrue for bonuses for the year, and we basically put as true up for about three quarters of the year in Q3. So, we won’t have to do that in Q4.

Douglas Bettinger

That’s why it’s guided down next quarter. We had a catch up in bonus accruals in Q3.

Mike Burton - Kaufman Bros.

Okay, great. And then lastly for CapEx for FY ‘12 is that going to be in similar range as well, and your preferences on use of cash going forward? Thanks again.

Douglas Bettinger

Yes, you know CapEx is kind of 4% to 5% of revenue and CapEx is always lumpy. It can be up one quarter, down the next. It depends on timing of equipment delivery or new mask sets. So, that’s kind of what you’ve got going on there. What was the...

Hock Tan

Use of cash.

Douglas Bettinger

Use of cash. I think you’ll expect to see us continue doing what we have been doing, which is we’ve had a dividend in place. We’ve raised it fairly consistently and the board just last quarter authorized a share buyback program, and we’ll assess that quarter-by-quarter, but I wouldn’t expect anything besides that.

Hock Tan

Thanks Mike.

Operator

Your next question comes from the line of Edward Snyder with Charter Equity Research. Please proceed.

Edward Snyder - Charter Equity Research

Thanks a lot. A couple of questions if I could, first off, the inventory weakness or the industry weakness you saw in North America and in Europe, general economy, is it focused in a particular product, and I mean could you talk Japan and Asia, I’m just curious about what’s causing that trend and how you see it extending out. And then to the FBAR filter question earlier, there have been a lot of samples out there but one of your major competitors has got a lot of excess capacity now in that technology and I know, he is pursuing one of your most lucrative areas which is Band 2 FBAR that you dominated. How do you see, what's included in your guidance for wireless the non-FEM stuff in terms of pricing? Do you expect pricing to remain firm for all your premium parts or are you expecting an erosion to accelerate a little bit? And I have a follow-up. Thanks.

Hock Tan

Okay, let's start with at FBAR assumption competition. Well, in our handset business, we always assume for the same product a certain degree of a steady degree of ASP erosion over time through the product life cycle, no surprise as I'm sure to you guys and we continue to do that. We typically do that for – we probably typically see at least anywhere from 3% to 4%, 5% a quarter of ASP erosion, which we offset with cost reduction on our side, but we expect to see that for the same product going through its product lifecycle.

So this is no different. In terms of – that's always built in our assumptions but in terms of what does it imply going forward for our mix of products, and that's really not overall I think, we will continue to compete whether it's FEMs, front end modules or discrete elements and we’ll continue to compete on both sides. So, I mean, we address it in a fairly long term manner rather than try to be rather tactical, and not dropping prices just to give our competitors in any particular – or winning sockets in any particular socket, so all that stuff it’s not really within the purview – within the context really, our long-term business model.

As I said, our long-term business model is to provide products that have a price differentiation. So, if our competitor comes with a product that's very similar, we’ll try to find a way to make one that performs better and basically trying to maintain our price premium, and we will continue to do that. That's the call of this company’s business model, bet it FBAR, fiber optics, optocouplers, any of the products we sell.

SerDes the same way. That's very, very typical of what we do. It’s not about competing on price. Taking that pattern, on the case of industrial, on your question, yes, in Q3 I did remark that we see some softness in Europe and US, North America, likely because of inventory adjustment with distribution and your question was is it end demand that's weak versus distribution adjustment?

You could be right, it could be a combination of both. But in Q3, which ends July, or part of it falls into the June quarter, as I mentioned earlier, they were typically across the board globally in many markets. A small bubble of demand because of Japan, the events in Japan. So you think you’ll grow higher. What we have done is we have been very tight in ensuring that we do not, our distributors do not get over shipments of parts from us in that quarter.

That may account for some of the softness we see in North America and Europe. Basically, we do not try to ship to one base specifically, one base on what I consider somewhat of an excessive demand because they are concerned of shortages. For the same reason in the September quarter because our inventory is now pretty lean out there, we hope –- we try to ensure that the shipments we are making to distributors will reflect the resale that they see with their end customers in all our end markets as well.

Edward Snyder - Charter Equity Research

Great, and the few points that you just made, you don't like to compete on prices and that your performance is usually better, or more advanced than your competitors, which is where you get your proprietary wins. Things are pretty well established in one of your big, front-end module wins, traffic in this quarter is new hybrid device which is kind of cutting-edge to begin with, but there are other competitors out there with even more advance solutions.

I am sure you've heard of them and whether they are single-ended designs or converged devices, and while it hasn't shown much of that yet, do you see yourself accelerating in some of those products that you're now going to be competing on the converge thing instead of just hybrids or do you just anticipate the market is not going to move to that solution in the long run? It's not something that to worry about in terms of competitive pressure that obviously very successful win and one of the big smart phone win this year?

Hock Tan

You know Ed, we've shown over the last several years, where we have been ramping up our wireless business. We're very good at managing in a way what the market needs. We think so and we've been very good consistent with that coming out with products that market wants at least key OEMs want and we've been also very good at differentiating in some of those sockets, I wouldn’t say all the time.

Our components such that have [ph] added to those OEMs those sockets we win. There are some we don’t. We are unable to differentiate although OEMs don’t see a value in it, and those very often we don’t win, and that’s fine, but we have been able to sufficiently win enough that we are able to grow our business fairly consistently if you look over the last four years. So, I know what you brought up is the latest item, but we have faced a lot of those strategic product decisions and technology decisions over the last four years and we will I’m sure address that also in appropriate manner.

Edward Snyder - Charter Equity Research

Thanks a lot.

Hock Tan

Thank you Ed.

Jacob Sayer

Thanks Ed.

Operator

There are no further questions in queue at this time. I would now like to hand the conference back over to Jacob for any closing remarks.

Jacob Sayer

Thank you, operator. Before we close, I’d like to remind everyone that Avago will be present at Citigroup’s Investor Conference in New York on September 8, and at Deutsche Bank’s Investor Conference in Las Vegas on September 13. These presentations will be web cast live and archived for replay in the investors section of Avago's website. Thank you for participating in today's earnings call. We look forward to talking to you again when we report our fourth quarter and fiscal year 2011 financial results in early December.

Operator

That concludes Avago's conference call today. You may now disconnect.

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