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TriQuint Semiconductor (NASDAQ:TQNT)

Q3 2011 Earnings Call

October 26, 2011 5:00 pm ET

Executives

Ralph Quinsey - Chief Executive Officer, President and Executive Director

Steven J. Buhaly - Chief Financial Officer, Principal Accounting Officer, Vice President of Finance & Administration and Secretary

Analysts

Edward F. Snyder - Charter Equity Research

Quinn Bolton - Needham & Company, LLC, Research Division

William Dezellem - Tieton Capital Management

Dale Pfau - Cantor Fitzgerald & Co., Research Division

Aalok K. Shah - D.A. Davidson & Co., Research Division

Nathan Johnsen - Pacific Crest Securities, Inc., Research Division

Parag Agarwal - UBS Investment Bank, Research Division

Vivek Arya - BofA Merrill Lynch, Research Division

Blayne Curtis - Barclays Capital, Research Division

Todd K. Koffman - Raymond James & Associates, Inc., Research Division

Operator

Good afternoon, my name is Latosha, and I will be your conference operator today. At this time, I would like to welcome everyone to the TriQuint Semiconductor Third Quarter Earnings Conference Call. [Operator Instructions] Mr. Steven Buhaly, you may begin, sir.

Steven J. Buhaly

Thank you, Latosha, and good afternoon, everyone, and welcome to our third quarter 2011 conference call. With me today is Ralph Quinsey, our President and Chief Executive Officer. During the call, we will make forward-looking statements about our business and projected financial results. I want to remind you that actual results could differ materially from our projections based on various risk factors, including those described in the press release we issued earlier today and in our reports on Forms 10-K and 10-Q, and other filings with the Securities and Exchange Commission.

All numbers during the call will be presented on a non-GAAP basis. Non-GAAP financial measures report tax on a cash basis and exclude equity compensation charges, entries associated with acquisitions and other specifically identified nonroutine items. These non-GAAP measures are provided to enhance understanding of our core operating performance. A full reconciliation of these non-GAAP measures to our GAAP results is in our press release and is in the investor's section of our website.

I will now turn the call over to Ralph to provide an overview of the quarter.

Ralph Quinsey

Thanks, Steve, and good afternoon, everyone. I will start today by providing an overview of Q3 financial results, and summarizing progress in each of our major markets. Steve will follow with a detailed look at our Q3 financial performance and Q4 guidance. I will then make a few closing comments and open the call for questions.

Our financial results for Q3 were slightly better than our updated guidance issued on September 22. TriQuint's revenue for Q3 was $216 million and EPS was $0.11. Gross margins were at 36.3% and operating expenses were $58.7 million, including $4.1 million of legal expenses related to our antitrust and IP claims against Avago. Compared to Q2, total revenue was down 6% with reduced connectivity revenues in Mobile Devices, weakness in our infrastructure market and softening demand in China. Gross margins declined 5 percentage points from Q2, primarily due to product mix shift into lower margin products and increased cost associated with new product ramps.

With lower-than-expected revenue, we put spending controls in place and we're able to reduce our core operating expenses, excluding litigation cost, by 6% sequentially. Now, I will discuss results and progress for each of our major markets. I will start with a review of our Mobile Devices market, where revenue for Q3 was approximately $152 million, down 5% sequentially. This was below our original expectations, primarily as a result of reduced demand from our largest customer and weakness from our Chinese-based customers, including our distribution partner, Avnet Asia. As expected, we saw a reduction in our connectivity revenues during the quarter as we transitioned from commercial foundry to standard product in support of a wire LAN reference design partner.

Year-to-date, Mobile Devices revenue was up 14% compared to 2010. Year-to-date revenue from 3G/4G applications was up nearly 30% as compared to 2010. These gains were offset by a 58% reduction in revenue from our 2G products, primarily as a result of declines in our legacy CDMA and GSM revenue streams. These declines were driven by our decisions in 2010 to shift capacity and focus from 2G products to 3G, due to supply constraints at that time. We have recently introduced our 4068 device to reengage in the GSM segment. This product provides attractive battery life and very competitive pricing. We have multiple design wins at tier 1 customers and good customer reach through our Chinese distribution partners. Samsung is among our tier 1 customers for this product.

The longer-term story for our content expansion remains intact, with increased demand expected for our industry. We continue to believe the overall market will grow at a rate of about 15% annually over the next several years as 3G penetration levels grow and multiple bands of 4G drive a new wave of revenue opportunities for both power amplifiers and high-performance Duplexers.

Our technology and manufacturing capabilities in each of these areas creates a unique opportunity for TriQuint to be at the leading edge of our integration. We are committed to helping our customers balance size, flexibility and cost for 3G and 4G applications we believe our breadth of capability, including both active and passive devices, nearly doubled the size of our global market and gives us a leg up in defining value-added solutions as compared to competitors who sell only power amplifiers or filters.

We see a variety of architectures deployed today as customers and chipset partners digest the increasing RF content in new devices. Solution size, flexibility and battery life are the critical customer requirements in this [indiscernible] Market. Consumers demand for longer battery life and increased features places pressure on phone designers to reduce circuit board size and create more space for batteries. This growing RF complexity in a phone and the board space it requires is a major challenge for our customers. Our customers are asking for reduced size and increased layout flexibility. One approach is referred to as an MMPA or Multi-Mode Power Amplifier.

This approach is current used by Qualcomm in a recent reference design where TriQuint is the preferred supplier. We are shipping this product now in modest volumes and are targeting customers in China and Taiwan for further design wins and expect revenue from this product to ramp in the second quarter of 2012. We support our customers with a variety of RF solutions, but we believe the largest share volume will migrate from discrete products towards PA-Duplexer integration. The PA-Duplexer approach is modular and flexible, solving both the filter and the amplifier integration problems, and easily supports both high-end and low-end smartphones.

Our current PA-Duplexer solution, known as TRITIUM, tightly integrates the power amplifier and appropriate Duplexer for a specific frequency or band within a smartphone. A smartphone typically has multiple bands. This integrated architecture, which places an amplifier and a Duplexer in nearly the same footprint as a standalone duplexer, offers a clear advantage in layout flexibility and solution size for phone designers.

We are excited to be sampling our next generation TRITIUM product, called the duo, which offers customers 2 power amplifiers and 2 Duplexers in a single small package. These new products integrate the complete transfer chain for 2 frequencies into a single device, bringing higher levels of integration in the smallest RF solution size available to customers. We expect revenue from duo products to begin ramping mid-2012.

Switching to our networks market, revenue for Q3 was approximately $44 million. This was down 5% sequentially and 3% year-to-date. Radio access revenues dominated by base station grew 10% sequentially during Q3, partially offsetting the 15% decline in our Transport revenues. Growth in the Radio Access segment was due to increased end-of-life shipments to our foundry customer.

We expect continued macro softness in the base station market as customers reduce inventory and operate to spend cautiously on infrastructure expansion. However, we do expect commercial foundry revenue to offset this weakness for at least the next couple of quarters.

Lower transport revenue for the third quarter was due to weakness in China, and primarily due to inventory adjustment by our customers. Within transport, our optical revenue declined sequentially, but year-to-date was up 34% from 2010. Point-to-point radio was weak sequentially, but up year-to-date. Cable revenue was up sequentially in Q3, but down year-to-date as compared to 2010. We continue to believe the transport market will be a growth driver as telecommunication companies make investments in infrastructures to support growing traffic and increasing consumer demands for bandwidth. In the short term, we expect transport revenue to return to growth in the fourth quarter.

Now, let me move to the defense and aerospace market. Revenue for Q3 2011 was about $21 million, down 10% sequentially and down 7% compared to Q3 2010. Our D&A revenue is highly dependent upon program timing, which can result in swings quarter-to-quarter. As we have highlighted in previous calls, during 2011, we are winding down the F-22 and B2 bomber programs and we are starting to ramp new programs, such as the Joint Strike Fighter. The F-35 Joint Strike Fighter is a multi-role, multinational aircraft that utilizes critical TriQuint technology, including power amplifiers, bulk acoustic wave filters and other gallium arsenide devices for the phased array radar system.

While 2011 will be a down revenue year for defense, we believe new programs like the Joint Strike Fighter and the EQ-36 ground-based radar system will result in a return to modest growth in 2012 and beyond. We believe even in light of conservative forecast and potential DoD cost reductions, major programs and radar requisites will drive revenue growth to the next 2 to 3 years.

Turning to R&D programs. We continue to be involved in a broad portfolio of contracted research and development sponsored predominantly by DARPA, the Air Force Research Lab and the Office of Naval Research. This year, the contracts total approximately $12 million to $15 million a year in revenue and are primarily focused on the development and manufacturing of GaN technologies for future DoD programs. Revenue in R&D should increase in 2012 as we target participation in additional GaN-related research programs.

Steve will now provide a detailed financial review of the quarter and guidance for Q4.

Steven J. Buhaly

Thank you, Ralph. For the third quarter of 2011, we generated revenue of $216.0 million, down 9% from the third quarter of 2010, and down 6% sequentially. Year-on-year, both Mobile Devices and Networks revenue declined 9%, and Defense and Aerospace declined 7%. Year-to-date, total revenues increased 7% to $669.1 million. Mobile Devices revenue year-to-date was up 14% compared to the prior year, while Networks and Defense and Aerospace declined 3% and 14%, respectively. For the quarter, our revenue split to end markets was Mobile Devices, 70%; Networks, 20%; and Defense and Aerospace, 10%. Please refer to the supplemental data posted on the investor section of our website for a detailed breakdown of our revenue by market.

During the third quarter, Foxconn Technology Group accounted for about 35% of our total revenue and was the only customer that exceeded 10% of revenue. Our book-to-bill ratio for the quarter was 1.05. Our gross margin of 36.3% for the third quarter of 2011 was down sequentially from 41.4%, and down from 42.3% in Q3 of 2010. The gross margin decline was largely due to a worsening product mix within our businesses, costs associated with new product brands and lower utilization in our factories. Operating expenses were $58.7 million or 27.2% of revenue for the third quarter of 2011; and declined $6.9 million from the prior quarter. We were able to reduce operational spending by $3.4 million and lower litigation expenses by $3.5 million.

Tax expense for the third quarter was negligible, reflecting usage of net operating loss carryforwards. On a GAAP basis, we recorded an income tax benefit for the quarter primarily related to the true up of our 2010 income tax provision as a result of filing our tax returns during the quarter. Net income for the third quarter was $19.0 million or $0.11 per diluted share. Total cash and investments decreased about $33.6 million to $147.2 million during the third quarter.

Capital expenditures of $47.3 million were partially offset by $12.4 million of cash flow from operations. Inventory grew by about $22 million and turns for the quarter decreased to 3.5. Accounts receivable increased slightly, and DSO increased 5 days to 59 days at the end of Q3, primarily the result of timing for a single customer payment due in late Q3 that was received in early Q4. Year-to-date capital expenditures have totaled $159.9 million and we expect to spend about another $35 million in Q4 for completion of previously committed capacity expansions.

During 2011, we have expanded total capacity, roughly 40% across our GaAs, SAW and BAW lines. Additionally, we are planning to be internally second source with our Texas 6-inch gas line. This is a copy exact line replicating our Oregon 6-inch gas capabilities on a smaller scale. We expect this line to be fully qualified late in 2011. And the investments we're making in increased capacity will allow us to participate in the strong market growth we anticipate over the next several years. We expect to reduce our capital expenditures in 2012, and our spending will be largely focused on capital for new capabilities versus capacity expansion.

Depreciation expense increased about $16 million during Q3, and will continue to increase as we place additional capital and service over Q4 and Q1. We expect depreciation expense will be about $18 million in Q4 and $21 million in Q1. Return on equity was 11% for the third quarter.

Moving to our financial outlook. We believe fourth quarter revenues will be between $215 million and $225 million. Non-GAAP gross margin is expected to be between 32% and 34%, and non-GAAP operating expenses are estimated to be between $59 million and $60 million, including about $3.5 million of expected litigation expense.

Fourth quarter net income per share is expected to be between $0.06 and $0.08 on a non-GAAP basis. As of today, we are 90% booked to the midpoint of our revenue guidance. Inventory reductions will drive overall utilization of our factories lower in the fourth quarter, negatively impacting gross margins. And as I mentioned earlier, completion of our new 6-inch gas line in Texas is on track and is expected to be placed into service late in Q4. This new line will add about $5 million in costs, including about $3 million in depreciation expense per quarter to our manufacturing operations beginning in Q1 of 2012 and will be a headwind to margin until this factory ramps to sufficient volume.

Prior to our next call, we plan to participate in several investor relations events. On Wednesday, November 16, I will be presenting at the UBS Global Technology & Services Conference in New York City and on Wednesday, December 7, I will be presenting at the Barclays Capital Global Technology Conference in San Francisco. In addition, on January 12, 2012, Ralph will be presenting at the Needham Growth Conference in New York City. Our fourth quarter 2011 conference call is scheduled for February 8, 2012.

I will now turn the call over to Ralph for closing comments and then we will open up the call for your questions.

Ralph Quinsey

Thanks, Steve. I'm enthusiastic about our long-term position and I expect to take advantage of a healthy growth market over the next several years. However, our near-term outlook remains challenging, with stalled revenue growth due to last year's allocation. While customer feedback and product interest remains positive, revenue is well below our original expectation and our participation in Android growth is below market.

Looking forward, I expect normal seasonality for the first half of 2012, with material growth for TriQuint likely delayed until mid-2012, when new products such as the duo family, the MMPA and others begin to ramp in volume. This will drive lower utilization and put pressure on margin for a few quarters.

The ability of this company to generate over 20% annual revenue growth as we have done in the past, remains intact. Our company is financially strong, and we have resolved our capacity constraints. Our roadmap is built on innovative technologies, such as copper bump interconnect and wafer level packaging, that will improve our competitiveness.

During this transition period, we will sharpen our execution and manufacturing with a focus on cost reduction, tightly manage operating expenses and invest in differentiated product for high-value RF solutions. We are investing today in the capacity and capability required for future growth. I firmly believe these investments will lead to superior and sustainable long-term financial results for the company.

Operator, we'd like to take questions now.

Question-and-Answer Session

Operator

[Operator Instructions] And your first question comes from the line of Parag Agarwal from UBS.

Parag Agarwal - UBS Investment Bank, Research Division

Ralph, could you please break down the guidance for the fourth quarter in terms of end markets where you're seeing growth and where you don't see it? And also, could you give some more color as to inland [ph] distribution raised inventory. And also on the mix, you talked about that, the mix has been unfavorable. Any probably will be very helpful.

Ralph Quinsey

For the fourth quarter, what we are seeing growth, I guess it looks like we are flat to up slightly. I would say, in general, we're going to see upside it will be on Mobile Devices. We are seeing inventory burn in the optical space and we know that, that will correct. Whether it corrects in Q4 or towards the end of Q4 into Q1, I'm still unsure.

Steven J. Buhaly

With respect to our own inventory, if you're asking about that, we overbuilt in Q3. As you well know, revenue came in lower than what we had originally expected and came in lower within our production cycle time. So we will be reducing that in the fourth quarter.

Parag Agarwal - UBS Investment Bank, Research Division

Okay. And as far as you see your customer attraction going forward into 2012, what has been the feedback as far as your new products are concerned? And also when do you see the inflection in your revenue? When do you see all the headwinds finally behind you guys?

Ralph Quinsey

Let me answer the second question first. I think it's going to be in the mid-2012 before we see a material growth. First half comparison for next year will be flat at best, I believe. Second half, I believe we'll see some material growth in the second half -- over second half comparison. From a new product perspective, if you go back to 2010, where we were growing much faster than the market for 4 years in a row, in line with our allocation issues, our products were exciting and customers were eager for them, we limited the supply. I believe the customer -- if we would have the supply, we would continue to sell great products. But we've missed that opportunity. We dedicated some capacity in certain areas of our business. But we kept generating new products. As I said, the MMPA that we are on the Qualcomm reference design, I believe it's the best converged solution out there today. We had small amounts of revenue right now, a couple of $100,000 a month, but that I believe will ramp again towards midyear. And then the duo is, I think, an incredibly attractive product for customers, offering very small board size and great flexibility and modularity for both high-end smartphones and low-end smartphones. I think it will be a successful product.

Parag Agarwal - UBS Investment Bank, Research Division

And my last question. After the Texas facility comes online, what will be your total capacity in terms of revenue?

Steven J. Buhaly

That depends a lot on the form that revenue comes in on mix. But I think, broadly, we would be able to support $350 million in revenue.

Operator

And your next question comes from the line of Blayne Curtis from Barclays Capital.

Blayne Curtis - Barclays Capital, Research Division

Maybe first just gross margin. You obviously are getting hit by the new product that's ramping as the poor yields. When you look at March, you obviously got the depreciation coming in. But can you maybe talk about getting those yields up and how to tune that out and whether you could see gross margin see a lift into next year?

Ralph Quinsey

Yes, I agree with you, Blayne. We are seeing some inefficiencies in ramping the new product. We do expect that to improve going forward. How that mixes in Q1, I'm not ready to say. Steve, maybe you can comment on that?

Steven J. Buhaly

I'm not going to give guidance out into 2012. But I'll give you a sense of the factors. I think yields are going to get that better than they were in Q3, where we really did have some ramp inefficiencies. But capacity is going up, as we planned for that. But if revenue is flattish, that's going to just create some additional headwinds for gross margin. And certainly with respect to the 6-inch line, that's likely to occur in the first half of the year.

Blayne Curtis - Barclays Capital, Research Division

Got you. And then you mentioned that you're 90% booked for the December quarter. Can you just refresh my memory as to what you're typically booked for December quarter?

Steven J. Buhaly

Yes, you bet. 90% is actually kind of on a historical basis the number that works for us. If you go back and look in and say, okay, at what level of booking in the non-fourth quarter period did we end up meeting the numbers? It's right at 90%. So I would say we're throwing the ball right down the middle of the alley with this one, and we don't see any unusual circumstances one way or the other that would make you want to do something different.

Blayne Curtis - Barclays Capital, Research Division

Got you. And then, Ralph, I just want to go back your comments about the first half. I thought you said that it would follow normal seasonal pattern, then you said 5 year-over-year. I just want to -- maybe you can refresh memory as to what you call normal or seasonal.

Ralph Quinsey

Yes, so I don't want to guide for the first half, but typically we are down in our consumer-related businesses in the 10% to 15% range in Q1. Typically, we come back in Q2. So I expect to see that and my comparative, my flat comparative at best was a year-over-year comparison for the entire first half. Did that help?

Blayne Curtis - Barclays Capital, Research Division

Yes, thanks. And then maybe just one quick one, Steve, the tax rate given the lower revenue levels is it still 8% next year?

Steven J. Buhaly

You know, I previously guided 15% to 20% a couple of quarters ago. And I'm quite sure we're going to be at the low end of that. The variable I'm uncertain about is we're engaged in some tax planning strategies that involve a cost-sharing arrangement where the U.S. basically sells some of its IP rights to an offshore entity. I haven't seen the number. I'm not sure how we're going to spread that. So that's an uncertain element that I just don't know. So barring that, I think you're right, we'll be at the low end. I'll give an update in the next conference call on that topic.

Operator

And your next question comes from the line of Nathan Johnsen from Pacific Crest Securities.

Nathan Johnsen - Pacific Crest Securities, Inc., Research Division

Clearly, as the year shaped up, you guys have seen slower gains from several of your customers that you had trimmed during the allocation period. I'm just wondering what you think has caused the slower-than-expected sort of re-ramp of those customers? Have they lost confidence in your ability to execute? Or did they say you guys have been off on architecture decisions? Just kind of serious on how you guys kind of get some better traction on some of those customers?

Ralph Quinsey

So the second half revenue is certainly not developing the way that we expected. And primarily, we have lower demand from our largest customer than we had originally planned from, and primarily for legacy products. Layered on top of that, we are seeing fairly widely reported weak infrastructure market. We think that's a macro effect. And then most specific to your question, we are seeing slower than expected traction with Android solutions. And I really think fundamentally we just -- we got a little bit ahead of ourselves on what we thought we could with Android. The market isn't exactly the way we expected it to be when we set expectations a year ago. And the market's moving rapidly. We dedicated some capacity and made some decisions and to be honest with you, Nathan, if I go back and look at it, and I have, I think we made the right decisions. The market has changed some, but I think we made the right decisions. I believe that putting strategic capacity in place is the right decision. I have reviewed our roadmap in detail with an eye for competitiveness. I think we're in strong shape, but we do have to work through the process and I do think that that's going to take until midyear 2012 to really return us to what I think is the type of growth this company can generate.

Nathan Johnsen - Pacific Crest Securities, Inc., Research Division

Great. And then just turning on the Foundry business. It's my understanding that you guys have been shying away from that for competitive reasons. But given kind of the change in dynamics here and clearly the headwinds associated with the new capacity coming online, are you guys potentially looking at changing that strategy as a potential methodology for filling up the fabs?

Ralph Quinsey

About a year and a half, 2 years ago, we really focused our strategy in Foundry and I can summarize by saying we really didn't want to go after high-volume, low-margin business or have a relationship -- as a supplier-customer relationship in that business. That really wasn't part of our core strategy. What we did want to do with their business was to use it as a tool, a strategic tool, to help us engaged with emerging opportunities and bind us with strategic customers. And so in that light, we have executed that strategy. So you're right, there's some customers that we are gracefully backing away from. But there are other customers that we are actively engaging with right now. In so much as far as the strategically using a supplier to offset some of our capacity additions, that's a tricky road to walk down because I believe we're going to need that capacity. And so in much as we can find a customer that is willing to work with us in a fairly elastic and dynamic way, sure we would love to do that. And to be honest, there are some customers out there like that particularly in Asia, that we will work with.

Nathan Johnsen - Pacific Crest Securities, Inc., Research Division

And just one last question for me. Steve, you talked about gross margins in the third quarter being impacted by the inefficiencies of the new product ramps. Was curious if that was also impacting the gross margin guidance for Q4? Or did that effectively work its way out of the system in the third quarter?

Steven J. Buhaly

There's a bit of that left in Q4 but it's improved from Q3.

Operator

And your next question comes from the line of Aalok Shah from D. A. Davidson.

Aalok K. Shah - D.A. Davidson & Co., Research Division

Just a couple of quick questions. And in terms of -- Ralph, in terms of getting new customers qualified for the Texas line, can you describe to us the process and how long we should think about you guys trying go from moving a customer to that line and how long we can before we see some material revenue from that?

Ralph Quinsey

As a function of qualifying the Texas line in total, we will qualify some original products, internal products, and then that will happen late in Q4 is my best estimate at this point. After that, it's up to the customer to go through their qualifications and that will vary customer to customer. We've already started that process and I expect that we'll probably have our first external customer called not too far off from the line calling.

Aalok K. Shah - D.A. Davidson & Co., Research Division

And then just if you could clarify that comment about your transport revenue decline with regard to foundry work, was their specific customer that you're doing foundry for and that customer is end of lifing and they're not going to come back or is there going to get a new product line that they're still waiting to ramp on in the future?

Ralph Quinsey

Yes, just to be clear, if they understand your comments, we think that in networks in total some of the decline in our radio access market will be offset by foundry end of life purchases. And there is a specific customer that is buying end-of-life wafers for the next few quarters, that I think we'll offset that with our end-of-life wafers. I don't expect a follow-on business after that.

Aalok K. Shah - D.A. Davidson & Co., Research Division

Okay, okay. And lastly, you mentioned that you're largest customer. And you're start seeing lower demand than you anticipated. Was there a product cancellation that you weren't prepared for? Or did something else happen along those lines?

Ralph Quinsey

So is was a dynamic situation duration during the quarter and it was push outs of orders on existing products, products that have been the market for some time so we just -- we adjusted to that as went through the quarter.

Steven J. Buhaly

It's actually a pretty normal phenomenon that demand changes. Unfortunately, it happened to be with our very large customer. And so what would normally be just a run-of-the-mill thing becomes a meaningful thing.

Aalok K. Shah - D.A. Davidson & Co., Research Division

Okay. So there wasn't a cancellation of this specific platform that you were are on? Or some...

Steven J. Buhaly

This was lower demand for existing product.

Operator

And your next question comes from the line of Edward Snyder from Charter Equity Research.

Edward F. Snyder - Charter Equity Research

A couple of questions. Ralph, you pre-announced the quarter and said that you're getting lower demand from your largest customer, but your largest customer appear to be about flat quarter-on-quarter based on their report to day. So are you losing share with somebody else? Or was most of the downside still with them and if so, why was it flat? Was it flat to your expectations? Any color would be helpful.

Ralph Quinsey

For Q3, we were down due to reduced demand from our largest customer, and some softness in China and some softness in just the macro environment.

Edward F. Snyder - Charter Equity Research

So most of it, some of it, all of it was primarily concentrated in your -- I mean, your largest customer is very large, 35%. So I'm just trying to get a feel for how much of that effect. And was that a timing issue, meaning that model transitions was clear from public reports that there was a bit of a hiccup in demand from your largest customer from their own products as people were anticipating the new one. Was that just a hold-up formed during this product transition? Or is that new products don't necessarily have the same content as the old ones and so it's an ongoing for you?

Ralph Quinsey

As far as the reason for the demand being reduced it would just be speculation on my part, so I'd rather not say. And then, as far as specifically with our largest customer, but with all of our large customers, I just want to reiterate, that I think we have good positions, we are continuing to have active dialogue and we continue to be a meaningful supplier. I think that if you look at our guidance for Q4, that for our largest customer pans out.

Edward F. Snyder - Charter Equity Research

And you mentioned that maybe a return to sustained growth later in Q2, or in 2012. And it seems to coincide with your dual band pad products, which you've -- I think you've talked about, they go into production first half of next year, do you have any timing on that at all?

Ralph Quinsey

So the duo products, those are the 2-in-1 PA duplexers, we're sampling right now and we expect revenue to ramp, well, about midyear. So anywhere in late Q2 or Q3 about midyear, we're ramping those products.

Edward F. Snyder - Charter Equity Research

You're sampling, there haven't been design wins yet, correct?

Ralph Quinsey

For the duo, we have not claimed design wins yet. For the MMPA we have started to claim design wins. We think that we have a good chance of getting more design wins than the MMPA because we are positioned on their reference design. The MMPA is a little ahead of duos in that process.

Edward F. Snyder - Charter Equity Research

Okay. And then most of the pad business is predominantly focus on one OEM and the turndowns that we're published like a couple of weeks ago, show that they continue to do pads. Is it spreading to other manufacturers? Or are we going to continue to one horserace so far? What's your feeling on this? It's a big debate in the industry completely whether or not pads are going to take off or they're eclipsed and going to start to decline. What's your feeling on that based on your feedback from OEMs and some of the product roadmaps that you're looking at now?

Ralph Quinsey

Yes, that's a great question because customer really don't care about pads, or discretes, or converged or MMPAs. We care about that. They care about battery life, size, flexibility. Ed, as you know, as of 2010, we were on a tear with PA duplexers, largely focused in a narrow customer base but spreading out nicely that we ran into allocation issues. I believe that if we would have had the capacity in place back then, we would have been much more successful in marketing our pads. We are basically limited now in the wider market with a generation because we missed that window, so we're skipping to the next generation for the open market, over the duos, the turbo ones, and very small size, very flexible. It can do a 4-band smartphone with 3 chips and just 24 service button devices around it. It's a very clean layout and set-up, and that's always been our approach, to try to make it easy for designers, make it flexible, so they can move things around. We have the strategic capacity in place, we have the products sampling out. Unfortunately, it's probably going to be midyear before we start to see the revenue. And we are absolutely targeting open market revenues and we're getting good feedback, I have no design wins to report yet, but we're getting good feedback, good reception from customers on those products.

Edward F. Snyder - Charter Equity Research

You're not alone in this. [indiscernible] called this morning talking about dual-band pads is one of their big-lift drives for next year. And I know most of your competitors, although -- especially the ones that are leading in the technologies are making a big deal of it, but it sounds like everybody is offering it, so I was just trying to get a feel for it. It sounds one, you're kind of leading the field in pads to begin with by skipping a generation because of the capacity allocations. We're not seeing as much but customer are coming back to this does approach, a, and then b, what size are we talking about for a typical dual-band pad for the generation you're dealing with now, if you could?

Ralph Quinsey

Yes, so I believe the size is going to be in the 5 X 6, 4 X 6 millimeter range. But I want to step back and I think there's going to be a market for converged solutions like the MMPA and for PA duplexers. I do think the discretes over time will migrate out of products but it will linger. It's just how that market partitions up. I believe that the majority of the market is going to be PA-duplexers, for the volume of the mid-tier and low-end smartphones and the high-end is going to move to something like the MMPA or some other version of converge. we'll supply both solutions, and the argument really is I think most people agree that the argument really is that high end, 10%, 15%, 20% and 25% of the market, most people don't go much beyond 25% of the market. So short answer is, we'll do both. We think the bulk of the market, we've been very consistent in this, is our migration from discrete to PA duplexers for that 4-band and below-type of market, 3G band.

Operator

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

Vivek Arya - BofA Merrill Lynch, Research Division

Ralph, can you help us understand what are the blended content as performed with your largest customer say versus a year ago. Is it the same up or down 5% to 10%, et cetera?

Ralph Quinsey

No. I'm sorry am not going to answer any specific questions about our largest customer relationship based on an agreement we have with the customer.

Vivek Arya - BofA Merrill Lynch, Research Division

Okay. Maybe let me ask a different one then. How was, in general, the pricing environment in this market, obviously you have added a lot more capacity. Do you think it would be a helpful to be more aggressive with price to go after share, or in your experience, is it not a price-elastic industry?

Ralph Quinsey

No, I agree with you that it would be helpful to be aggressive in price and in fact I think the market is moving to more price aggressiveness over the next several quarters. We certainly have taken that position on the low end with the 2G products, an area that we strategically had to exit. We would like to reenter, and so we've been fairly aggressive with price.

Vivek Arya - BofA Merrill Lynch, Research Division

Just one longer-term question. So you mentioned the RF industry can grow 15% or so, but the issue I see is that there are 3 or 4 vendors, but they're also really only 3, 4, 5 main customers. So structurally, do you think can the industry stay profitable on a consistent basis?

Ralph Quinsey

I think there's long-term opportunity for profits in this market for sure. I agree with you that the high concentration of revenue, and so buyers have quite a bit of power and there are multiple suppliers that can support it, about 4, that at least support the market and so it makes it very competitive. So structural changes I think would help.

Vivek Arya - BofA Merrill Lynch, Research Division

And one last one for Steve. Steve, can you help us in modeling gross margins and going forward, for instance, what -- roughly, what revenue level would be required to go back and say above 35% or so gross margins and what is the impact of mix in that analysis?

Steven J. Buhaly

Yes, I think what I'll do is give you a little bit more of the equation. I think if you get kind of a conservative mix of incremental revenue, you could consider about a 50% typical fall through onto the gross margin line from that. And that is a good way to go from where we're at right now, also considering we're going to have a little bit of that headwind in Q1 to model with.

Operator

And your next question comes from the line of Dale Pfau from Cantor Fitzgerald.

Dale Pfau - Cantor Fitzgerald & Co., Research Division

A couple of housekeeping. Can I presume the tax rate for the first quarter is going to be 0, Steve?

Steven J. Buhaly

It will probably round to 0.

Dale Pfau - Cantor Fitzgerald & Co., Research Division

Okay. And when we talk about the depreciation kicking in that fan comes online in the very end of the fourth quarter, where you only get a small increment of that depreciation kicking in the quarter?

Steven J. Buhaly

Essentially, you should think about depreciation as being $18 million in Q4 and about $21 million in Q1.

Dale Pfau - Cantor Fitzgerald & Co., Research Division

Okay. And when we look at the gross margin trend, now certainly you're having some start up issue in yield with the new products going on. When do you think, Ralph, if you can get that behind you and we can actually see that positive contribution margins instead of negative contribution margin?

Ralph Quinsey

Specifically for the ramp up in efficiencies, I believe all those problems are identified, resolved, and it's a factor of moving through the system now to realize the benefits. And that will likely complete in Q4. There's other factors going into Q1 that affect gross margin, but for that specific issue, I believe that will work its way through the system this quarter.

Dale Pfau - Cantor Fitzgerald & Co., Research Division

Okay. And then conversely, when we -- presuming that the duo will begin to ramp midyear, is anything that you have learned from this current ramp applicable to that product? Or are we going to see the same thing?

Ralph Quinsey

We're not planning on having the same issues with the duo. No.

Operator

And your next question comes from the line of Todd Koffman from Raymond James.

Todd K. Koffman - Raymond James & Associates, Inc., Research Division

I wanted to ask a question about your inventories, which have gone up dramatically over the last 6 months. In the face of when you guys yourself were talking about having missed some important design wins because of well-documented capacity constraints you had. And I'm wondering whether the large increase in inventories related to your expectation of having more content in some important products that did not come together?

Steven J. Buhaly

A good question. When we came out of Q4, we were pretty lean. And I think we built inventory from 100 up to 125 or so. And that was safety stock we needed we completed during the allocations. I think subsequent to that, we clearly overshot. And it was inventory -- it was product for business we currently have and demand for those products turned out to be lower than we expected. So it wasn't a case where we built some inventory and we never got the design win. It was existing product where demands were lower than expected, and in fact you saw that on the top line both to some degree in Q2 and a larger degree in Q3, we missed versus our original expectations. And since that accrued within cycle time, that shows up as inventory. We ought to run the business with turns closer to 5 and accordingly, we will be working on that problem in the fourth quarter.

Todd K. Koffman - Raymond James & Associates, Inc., Research Division

This is a follow-up to that, though. The dollar value is so big relative to the unit cost that there must have been some expectation. I mean, you couldn't have been off by that many units. We're talking about tens of millions of units you thought would come together than that demand did not materialize?

Steven J. Buhaly

Yes. Yes. I mean, It's a big business, right? So we, in Q3 built excess inventory just over $20 million. That's about $33 million of revenue, and between ordinary and mix, misses in that aggregate revenue miss, that's what happened.

Todd K. Koffman - Raymond James & Associates, Inc., Research Division

Okay. Totally unrelated. One more quick question. When you've recently haven't had success in some of the design cycle that you've gone after or maybe in -- well, what's been the factor that has precluded you from maybe not having as much success the last 6 to 9 months? Has it been price, performance, relationship?

Ralph Quinsey

Well, it has been capacity. We intentionally did not address some opportunities to get our capacity in order and so that precluded us from being successful in some primarily Android-related ramps. We lost revenue on where we decided to direct our energy was below expectations. But I think the products remain attractive to customers, but we want to make sure when we win design wins that we can support them with capacity. That was the primary issue this year. Most of those decisions we had to make in advance of when they would roll into production, right? So you'd make those decisions ahead of time. We made most of those decision into last year and moving through the early part of the year. We now have our fixed those strategic capacity issues and we're aggressively going back after those opportunities. Were getting good reception from customers. They are of course, moving through the process of evaluation and waiting for this model set of those issues and expect that we continue to win some of those and we lose some, as we have in the past. Material revenue increases I think are going to be really in the mid-2012 timeframe.

Operator

And your next question comes from the line of Quinn Bolton from Needham & Company.

Quinn Bolton - Needham & Company, LLC, Research Division

Just wanted to go back to the pre-announcement in late September. I think you identified a lot of the issues, the infrastructure softness, softness in China and reduced demand from your largest customer yet. Back then, you thought fourth quarter revenue would be up strongly sequentially, so I'm just kind of wondering what's changed over the last month? Have these individual issues gotten worse? Or there's some other factor that sort of contributed to this more modest outlook for the fourth quarter? And then I got a couple of follow-ups.

Ralph Quinsey

Well, we took a look and now, looking at that time, and our outlook is changed, Quinn. And we have seen more pushouts pretty much in the same categories as we saw back then. If you want to add anything to that, Steve?

Steven J. Buhaly

Well, I'll just say, in some ways the trend we saw originally has continued into the fourth quarter where demand has softened primarily from existing business rather than we thought we'd get some new business that didn't occur.

Quinn Bolton - Needham & Company, LLC, Research Division

Okay. And given that this has been a challenging year for revenue, it seems like a lot of the forecast you had earlier in the year proved aggressive. Is there anything you're doing on the forecasting front scrubbing customer forecast or any changes you're implementing to try and tighten up as the forecast head into 2012? Or is this just sort of the nature of the business that tends to be boom and bust cycles and it's hard to get a real handle on forecast 2, 3, 4 months out?

Ralph Quinsey

The short answer is, it's not the nature of the business. We have given it tremendous scrutiny. We are changing and learning and we will do better.

Quinn Bolton - Needham & Company, LLC, Research Division

Great. And then last question for you Ralph. You mentioned that MMPAs. Obviously with the MMPAs integrated the PA or 3 different PAs in a single device, what's the opportunity for the duplexers and those solutions. Do you have the opportunity to sell, the discrete or dual duo band -- I'm sorry, duplexers, next to your MMPA sockets? Is that something that you're also designed into the Qualcomm reference design? Or do the filters tend to be chosen more by the OEMs once they've selected the MMPA's provider?

Ralph Quinsey

Yes. We have the opportunity to sell discrete filters, and in some cases, discrete filters will be the initial form factor. For example, in some of the LTE bands I believe discrete filters will be the initial form factor. We will sell that. The bank has 5 duplexer. I believe that has value as a discrete. Strategically, longer-term, we believe that there is a migration from discrete to integration. That doesn't mean we won't sell discrete, we have been limited in capacity, as we discussed at some length, we corrected those issues. We have good foundation so will pursue the full rest of the market now. I don't think there is a -- in many cases the PA duplexer or the duo is going to be a better solution than discrete and we'll focus our energy there but there are some sockets that lend themselves to a discrete solution over the near term.

Quinn Bolton - Needham & Company, LLC, Research Division

And I'm assuming that the MMPA is one of those architectures that would lend itself to discrete, duplexers or duo duplexers in a package?

Ralph Quinsey

Yes, so for the current MMPA that life cycle is starting now and will run probably for 1 year, 1.5 years. And so I would say, for us, we're probably not going to address duplexers that match right up with MMPA in a discrete format. Other duplexers, I said an LTE band might be in the same platform as the MMPA, but it's unlikely we're going to try and match up with bands 1, 8, 2 and 5.

Operator

And your next question comes from the line of Bill Dezellem with Titan Capital Management.

William Dezellem - Tieton Capital Management

When you look back and do some Monday morning quarterbacking, was it correct to make the decision to put your customers on allocation?

Ralph Quinsey

That was not a decision I took lightly, and it was not the decision that I could really control. The fact was our customers came in with more demand than we were able to supply back in 2010. Some customers gave us great visibility for that, some didn't. So the decision to go on allocation was really one that we ran up into -- it wasn't one that we could avoid. Now if I could just extend your question, the decisions we made and how we went on allocation and the decisions we made about installing capacity and the results that we're getting today, which I'm not happy with, but I have gone back and scrutinized those decisions. And I think that as painful as the period is right now, for the long-term growth of the business, I believe we made more right decisions than wrong decisions.

William Dezellem - Tieton Capital Management

That's helpful. And then a second question is there has been reference in the release, and I think here on the call. One of the factors impacting gross margin being the poor product mix. Would you please describe what's driving that poor product mix?

Ralph Quinsey

I would say there is a switch to lower margin business in mobile devices. I'll give one example. As we begin to ramp up 2G products, those will be at a progressive price point and lower margins. And then, in our networks business where we have product growth in some areas versus other areas, more of short-term impact on product mix. You going to add anything to that?

Steven J. Buhaly

The only thing I'll add is I think the pricing environment is heating up a bit with a more capacity out there then demand is over the short term part of the cycle. And I think we and probably our colleagues in the business are going to have to hustle on the cost side.

William Dezellem - Tieton Capital Management

And if we and understand correctly, the 2G products that you're referencing, those are just inherently going to be lower margin, but the networking products, where you have access inventory, you are basically giving special deals to blow out some of that inventory and those margins should return after you have gone through the inventory, your own internal inventory correction. Did I interpret that correctly?

Ralph Quinsey

I would say no, Bill. There is some inventory in the system. For example, I talked about the optical products. Our revenue is below expectations. That's one of the products that has the higher end of the margin mix. And so the products we are selling are -- compared to that, are low end of the margin. So it's just a matter of what we are selling in the network space, we're not offering any deals to blow out products at this point. And we don't believe the market is open to that.

Steven J. Buhaly

And that's very rare, occasionally we'll have excess and obsolete situation, but you're talking a very small portion of our revenue.

William Dezellem - Tieton Capital Management

And then the final question is, relative to the tax benefit, you -- I think in the opening remarks made reference to that being 2010 true up, would you please discuss that in a bit more detail for us?

Steven J. Buhaly

Not much more detail here but the primary driver was R&D tax credit and little bit different. I would say just the true up of the other factors, but the R&D tax credit was the largest element.

Operator

And we have no further questions at this time, sir.

Ralph Quinsey

Okay. That wraps up the call. Thanks to all participants. I look forward to speaking with you again in our next update.

Operator

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

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