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Avago Technologies Limited (NASDAQ:AVGO)

F1Q12 Earnings Call

February 22, 2012, 5:00 p.m. ET

Executives

Thomas Krause – VP, Corporate Development

Hock Tan – President CEO

Doug Bettinger – SVP, CFO

Analysts

Romit Shah – Nomura Securities

John Pitzer (Patrick) – Credit Suisse

Blayne Curtis – Barclays Capital

Edward Snyder – Charter Equity Research

Terence Whalen – Citigroup

Joanne Feeney – Longbow Research

Mark Lipacis – Jefferies

Aalok Shah – DA Davidson

Ian Ing – Lazard Capital Markets

Brendan Furlong – Miller Tabak

Operator

Good day ladies and gentlemen, and welcome to the first quarter 2012 Avago Technologies Limited Earnings Conference Call. My name is Alishia and I will be your operator for today. At this time, all participants are on a listen-only mode. We will conduct a question-and-answer session towards the end of the conference. (Operator Instructions).

I would like to turn the call over to Mr. Tom Krause, Vice President, Corporate Development. Please proceed.

Thomas Krause

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 first quarter and fiscal year 2012. If you did not receive a copy, you may obtain the information from the Investor section of Avago’s website at avagotech.com. This conference call is being webcast live and a recording will be available via telephone playback for one week. It will also be archived in the Investor section of our website at avagotech.com.

During the prepared comments section of this call, Hock and Doug will be providing details of our Q1 fiscal year 2012 results, background to our Q2 2012 outlook, and some commentary regarding the business environment. We will take questions after the end of our prepared comments.

In addition to US GAAP reporting, Avago reports certain financial measures on a non-GAAP basis, a reconciliation between GAAP and non-GAAP measures is included in the tables attached to today’s 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 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. Hock?

Hock Tan

Thank you, Tom. Good afternoon, everyone. I’m going to start today by reviewing some of the recent – some of our recent business highlights, and then Doug will provide summary on the first quarter financial results.

Now as you may have seen from our earnings announcement just out, revenue for the quarter of Q1 fiscal ’12, was at the top end of our guidance at $563 million, down 10% from last quarter, but up 2% year-on-year from the first quarter 2011.

Now results for our wireless communication end market came in much stronger than normal seasonality, and our wide infrastructure, wireline markets, was basically holding up in line with expectations.

The gains is fairly favorable to end markets, however, we saw – we experienced a rather down industrial end market. Now generally, [inaudible] conditions have the biggest impact on industrial market. In particular, we are seeing industrial spending in China continuing to be weak, and that has also continued to impact demand from our industrial OEM customers worldwide.

As we have also discussed previously, we also have seen the impact from the flooding in Thailand, which had exacerbated our ability to ship our industrial products last quarter. But as we see here today, I feel demand for our product has stabilized in this industrial segment, and in some situations may actually be recovering. However, we forecast to that some spending uncertainty remains, especially in Europe and in emerging economies.

In summary, we now believe our industrial business has bottomed but we only see limited signs of a recovery.

So now let’s turn to results from each of our targeted markets. We think our wireless communications targeted market, as you know, we manufacture FBAR Duplexers, Power Amplifiers, some light and proximity sensors and optical navigation devices for feature rich and smart mobile phones. We also produce RF components for wireless Base Stations.

Sales, from our wireless communication targeted market represented 45% of our first quarter revenues, and our revenue from this market declined 2% from the preceding quarter, but rose 26% above Q1 last year.

Now to remind everyone, seasonality in wireless for us typically means revenue decline in the low double-digit on a percentage basis in Q1, but we obviously showed much stronger than typical seasonality – seasonal performance, and there’s a good reason for that. We have been, and will remain focused on picking programs where we can insert content, products with high content that is very differentiated from more standard commodity light products.

Lately we saw the benefits of picking the right programs this particular quarter, and frankly, we would have grown sequentially in RF if not for our OSM and Base Station component business been down.

Looking ahead to the second quarter, fiscal 2012, we expect this momentum to carry in to what would have been another typically weak seasonal quarter. As a result, we expect overall wireless revenue to be slightly up compared to Q1.

Next, within wide infrastructure, as also you may know, we design high-speed SerDes ASICs, as well as produce optical transceivers for enterprise networking, data centers, switching, and high-speed computing applications.

Revenue from the wide infrastructure represented 29% of our total Q1 sales. Our sales from this end market declined 8% over Q4, but grew 6% from that of a year ago, from the quarter a year ago. Revenues from wide infrastructure were in line with our expectation, right at the beginning of the quarter.

To give you a little more color, there won’t – we experienced here during this quarter correction in supply chain among several large OEMs in this segment. Notwithstanding, we managed to offset these because certain of our larger OEMs showed strength in carrier routing and data center switching.

Turning to Q2, with supply chain, pretty much normalized today. We expect overall revenues from wide infrastructure market to increase mid-single digits quarter-on-quarter, driven by continued strength in call routing, and increase in sale of our ASICs and proprietary fiber optics in to data center applications.

Next, in industrial and automotive electronics, with manufacturing and sell optocouplers, motion encoders, and industrial fibers. Net revenues from this end market accounted for 20% over Q1 2012 revenues. Revenues here declined 29% compared to the prior quarter and declined 31% from the same quarter a year ago.

In the – demand continued to soften during this quarter, but we also experienced a rather dramatic supply chain correction, with not just our distribution channels, but with also some of direct OEMs and industrial OEMs as well.

Looking at resale however, specifically North America held up. Europe and China were down significantly, Japan was down only slightly, and overall, worldwide resales were down just around 10%. The gains, as I mentioned earlier, quarter-on-quarter revenue decline in shipped in revenue, I should say, up 29%.

As I also said earlier, it does look like we are now at the bottom in industrial, even though we don’t see clear signs of a recovery. Accordingly Q2, we expect revenue for industrial to be up mid-single digits as we replenish some of our resale inventory, even though we do expect resale to remain flattish in this current quarter.

Finally, in consumer computing peripherals, target markets, we manufacture navigation sensors, optical mice, and motion sensors for printers. Revenue from this target market represented only 6% of our first quarter 2012 sales. Revenue here increased 27% of a small base [inaudible] from last quarter, and grew 14% year-on-year. We expect this business to be somewhat down in Q2.

So in summary, let me say wireless was strong, wide infrastructure maintained, and industrial was significantly down due to supply chain contraction and continuing weak macro conditions.

Looking forward to Q2, we expect trends to remain much the same, wireless and wide infrastructure continue to look good, and the macro situation stabilizing. Industrial should be flat to slightly – somewhat up. In other words okay. And as a result, we believe total revenue for Q2 will increase our guidance between 1% to 4% as compared to Q1.

So with summary, let me now turn the call over to Doug, for a more detailed review of our first quarter fiscal 2012 financials.

Doug Bettinger

Okay, thanks, Hock. Good afternoon everyone, thanks for joining the call. Before reviewing the first quarter fiscal 2012 financial results, I want to remind you that my comments today, as always will focus primarily on a non-GAAP results. A reconciliation of our GAAP and non-GAAP data is included with the earnings release that we issued today. And it’s also available on our website at avagotech.com.

Revenue of $563 million in Q1 represents an decrease of 10% from last quarter and an increase of 2% versus the same quarter a year ago. the sequential decrease was at the high end of our guidance. Revenue from our wireless and consumer target markets came in better than we expected, and revenue from our industrial market came in well below our expectations, as Hock told you. I mentioned revenue in the consumer market benefited from a discrete IP sale.

Resales in distribution declined in Q1 relative to Q4. Our sales in the distribution channel were down much more than the decline in distribution resale, and as a result of that, inventory and distribution obviously has declined. And while resales declined in Q1, we expect them to be flattish to slightly up in Q2.

Q1 gross margin was 50.6%. This was down from last quarter and essentially at the midpoint of our guidance. Gross margin was affected by a number of factors this quarter. The biggest driver of the sequential decline in gross margin was lower revenue from our high-margin industrial end-market.

Relative to our expectations, our lower margin wireless business was strong, and our higher margin industrial business was soft. This negative mix was partially offset from non-product related revenue, again, the discrete IP sale that I mentioned.

Additionally, we realized greater than forecasted cost reductions at our wireless business. And I just point out, a potential negative impact of the additional spending that we needed to incur from the Thia flooding, was largely offset by insurance claims.

During the quarter, R&D expenses decreased $1 million to $78 million due to tight cost control. SG&A decreased just by $5 million to $44 million, also driven by those same cost controls, but additionally, driven by a reduction in our litigation expenses. As a percentage of sales, R&D increased to 24% while SG&A remained at 8% of net revenue.

Income from operations decrease by $28 million sequentially to $163 million, and represented 29% of net revenue. Q1 income from operations compares with income from operations of $191 million in Q4 and with $169 million in Q1of last year. Taxes of $5 million for Q1 were slightly higher than guided at $4 million due to the jurisdictional mix of income.

These results translated into net income of $156 million, which is down 16% from last quarter. Q1earnings per diluted share of $0.62 compares with $0.73 in Q4, and net income in Q1 of 2011 was $165 million, or $0.65 per diluted share.

Total share-based compensation in Q1 was $11 million. The breakdown of expense for Q1 includes $1 million in cost of goods sold, $4 million in R&D, and $6 million in SG&A. In Q2, we anticipate share-based compensation will be approximately $14 million, growing as we complete our annual equity grants this quarter. And just a reminder, the company’s definition of non-GAAP net income excludes share-based compensation expense.

So now let me now move to the balance sheet. Days sales outstanding came in at 50 days. This was up 2 days from the prior quarter, due to the impact of Chinese New Year on our collections. Inventory came in at $192 million, which was down 1% from last quarter. And this translated to days on hand of 63 days. I do think it’s possible that inventory can grow somewhat next quarter.

And now cash flow. At the end of the quarter, our cash balance was $819 million. We generated $139 million in operational cash flow. During Q1 we repurchased and canceled approximately 2.6 million shares, and this consumed $79 million of cash.

Capital expenditures in Q1 were $47 million, which was slightly higher than our expectations for the quarter, and this was due to expenses associated with bringing secondary facilities online after the Thia flooding.

We expect CapEx in Q2 will be in the range of $52 to $57 million. The sequential increase is due to – the capacity additions in our wireless factory that we mentioned last quarter. Also in Q1, we paid more than $40 million in annual bonus payments that were based on our fiscal year 2011 performance.

And finally, on December 31, 2011 we paid a quarterly cash dividend of $0.12 per ordinary share, which consumed $29 million of cash. This dividend was raised by $0.01 from the prior quarter.

And just to round out the cash flow discussion, I thought I’d point out, now that we have been returning cash to equity holders for five quarters, accumulatively we have paid $115 million in dividends, and have consumed $172 million in share buybacks.

Now let me review the balance of our non-GAAP guidance for the second quarter of fiscal 2012. This guidance reflects our current assessment of business conditions, and we do not intend to update this guidance. Revenue is expected to increase 1% to 4% sequentially, gross margin is expected to be approximately 50.8%, plus or minus 75 basis points, operating expenses are estimated to be approximately $124 million, which is up slightly from Q1, interest and other is forecasted to be approximately 0, taxes are forecasted to be approximately $7 million, and finally, the diluted share count forecast is for 254 million shares.

That concludes my prepared remarks. Operator, please open up the call for questions.

Question-and-Answer Session

Operator

(Operator instructions). And the first question comes from the line of Romit Shah with Nomura, please proceed.

Romit Shah – Nomura Securities

Hey, thanks guys. Hock, I had a couple of questions on the industrial business; just given that sales are down close to 40% from the peak and at the same time, you know, you’re seeing signs of resales at least stabilizing, it would just seem, you know, it’s just a matter of when, it’s a matter of timing in terms of when the industrial business will snap back, do you – can you give us some visibility into that?

Hock Tan

Well, you got everything right so far, the only thing that I didn’t say, and it was purposely, so was when it will snap back, the answer is I don’t know when, Romit. But we do see, and this might me clutching at straws, and [inaudible] being able to see what you see, that’s no further deterioration – that’s pretty clear what we’re saying. But, we see some improvement, but is that big enough say that it’s a snap back happening? No, so my answer is very limit of finds of recovery, though things are not getting worse in the industry.

Romit Shah – Nomura Securities

In terms of, you know, near-term bookings patterns, have you seen any sort of noticeable change post Chinese New Year, whether it’s industrial, or some of the other segments?

Hock Tan

We see very different booking patterns for this different segments actually, which maybe I didn’t make clear enough in my remarks, but it is, it is a very mixed market what we see out there. Wireless business, as you probably heard me say, continuously very strong in the way they both – a wide infrastructure is also varies robust in the way bookings is happening. Industrial, obviously, over the last four, five months has been very weak, six months [inaudible], it has improved somewhat, and but not meaningful enough, and sustained enough for me to pass any judgment at this point, other than to say, we’re pretty sure resale is holding up at flat. It’s kind of at a bottom, snap back, or recovery – it’s not that clear yet. And because the improvement we’ve seen so far in industrial, and we’ve seen it, it’s really because inventory is down so low, people have to replenish. The question is, after they replenish, what then? And the data is still not out there, but it’s replenished and we are filling this replenishment, which is part of the reason why we are seeing industrial this quarter, Q2, we are guiding to be up single digits, mid-single digits. It is the replenishment. It is not necessary and a fundamental recovery, or snap back, of industrial spending. Now, that might change if emerging economies start driving, spending in [inaudible] industrial infrastructure one more time, as they did in 2010. But, that’s the thing, it’s not very obvious as of yet.

Romit Shah – Nomura Securities

Is that, Hock, is that a China-specific comment?

Hock Tan

It’s a very China-specific comment, but it also could enter at extra extent to the likes of Russia, Brazil, and India, but China is obviously the big one in the market.

Romit Shah – Nomura Securities

Okay, thank you.

Doug Bettinger

Thanks, Romit.

Operator

And the next question comes from the line of Terance Whalen with Citi, please proceed.

Hock Tan

Hi, Terence.

Operator

And [inaudible] we will hook up to the next question. The next question comes from the line of John Pitzer with Credit Suisse, please proceed.

John Pitzer (Patrick) – Credit Suisse

Hi, this is Patrick Walters calling in for John Pitzer. I had a question on channel inventories, it looks like they came down a bit during the quarter, I was just wondering if you could give us some color as to where they are in a day’s basis, and how that compares to historical levels?

Doug Bettinger

You know, we don’t really quantify it, except I’ll tell you it was down fairly significantly from the prior quarter, and it’s still in the range that we would characterize as a normal range, but we don’t quantify it.

John Pitzer (Patrick) – Credit Suisse

Okay, thanks, that’s helpful. And then one other question, you guys had sales impacted a little bit by Thailand during the quarter, and I was just wondering if you could maybe give us some quantification there, I think you initially thought 10 to 20 million was the type of range?

Hock Tan

In terms of revenue, I think the impact was closer to 10 then 20, when all and said is done.

John Pitzer (Patrick) – Credit Suisse

All right, awesome, thanks, and I – congratulations on the good quarter.

Doug Bettinger

Thank you.

Operator

And the next question comes from the line of Blayne Curtis with Barclays, please proceed.

Blayne Curtis – Barclays Capital

Thanks, good afternoon guys. Hock, on the wireless business, you’re looking for slight growth, you had a bit of headwind, you know, you had one customer doing quite well, and then had some implications that – with the sequential guidance, does that mean you’re kind of through those types of headwinds – that I know of have been small, but you saw a big correction, is that coming back? Just some color on the different segments on the wireless would be helpful, thanks.

Hock Tan

Okay, well, [inaudible] let there are some several parts of that broadly, but yes, there are more than one customer that is giving us – that who are growth drivers for us, especially in this current quarter, more than one customer, though it’s an obviously we are picking the winners fortunately, in driving up business. But to answer your second part, and that continues, and a lot of that continues strength relates to the handsets smart phone business on RF. The OFN business, which is what you are mentioning, referring to, it’s no longer a headwind, neither is it a tailwind, it’s kind of slack-ish at this low of a level that we have indicated last quarter. So, it’s neither helping, nor acting as an headwind in this whole thing, it’s purely RF in our mobile handsets, and there is also some benefit, but not very much from wireless infrastructure, but my best guess on wireless infrastructure this quarter is at best flat.

Blayne Curtis – Barclays Capital

And then, just one clarification for Doug, the IP sales in consumer, I don’t know if you want to quantify it, but does that come at 100% gross margin, because you know, you were originally looking for that to be down instead of that being up – just trying to figure out what the impact there was.

Doug Bettinger

Yes, it’s not 100% margin, but it is pretty high.

Operator

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

Edward Snyder – Charter Equity Research

Thank you very much. If you could, Doug, what – any 10% customers on the quarter and what do you think your wireless concentration is now? It’s seems a preponderance if not the vast majority would be from one customer.

And then also, several of your competitors already fueled a dual-band PAD and are showing that. Are you offering a similar part now or do you plan to offer one before year end?

Doug Bettinger

So I’ll pick up the first couple and then I’ll let Hock chime in a little bit on the color. So wireless last quarter, Ed, I guess was 45% of revenue and that was up from the prior quarter. I think the prior quarter was low 40s, 42 I think if I remember the number right. And it’s not any one customer, Ed, it’s across the board; pretty much any OEM that’s shipping Smartphones in the marketplace is buying parts from Avago. It’s pretty much pervasive across the spectrum. So it isn’t driven by one customer necessarily, it’s very, very broad based. And then you’re – your question about architecture, could you say that one one more time.

Edward Snyder – Charter Equity Research

Sure. We’ve seen several of your competitors on these calls show a product in the dual-band PAD, a new architecture that – that are being offered now or by mid-year or so and given this looks to be something that’s catching traction with some of the bigger Smartphone OEMs, I was wondering, do you have a product out there now, or do you plan on being in production with one this year?

Hock Tan

Ed, Hock Tan here. We talk about PAD architecture, in fact, last conference call or the one before that. PAD architecture, which is [inaudible] with power amplifier in the module, something we’ve been promoting for a while, and obviously, we do it with our FBAR very nicely. And this is something that’s been going on, nothing rather unusual. Now, some OEM customers who has a preference for it versus others who prefer to use discrete components and we address them where they [inaudible] in terms of one you mentioned is concentration of revenue in wireless. You know, our concentration is pretty spread out among many [inaudible] because as I mentioned, we chase programs, none of them customers on product, products that we can differentiate ourselves. So we have a lot of our products, all of them multiple phone makers. In fact, just about every major OEM and Smartphone maker, we probably have at least one if not multiple programs. And that’s because of the nature of our product. You know, we have integrated modules, front-end modules that has both power amplifier and duplexes already shipping in many customers including in Korea and a few other places. We already did talk about PADs as perhaps a [inaudible] on the derivative of the structure down the road.

So it’s really nothing new and it’s not a concentration issue, it’s just the fact that we have products and they’re similar that’s spread across multiple OEMs. And in those – in programs, where again, we tried to price ourselves where the customer is willing to pay a premium.

Edward Snyder – Charter Equity Research

But I’m specifically talking about dual-band PADs. I understand PADs have been around for a while and then used in architectures going back two or three years now, but it appears that the industry is moving to these new dual-band devices, [inaudible] and [inaudible] have both shown product and it is – it looks like to be favorable to one of your largest customers. So I was just specifically asking about that.

And Doug, I take it by your comments that you didn’t have any 10% customers this quarter?

Doug Bettinger

Ed, in the past we have had Cisco as a 10% customer and the key will be out in a couple of weeks and you can check back.

Operator

And the next question comes from the line of Terence Whalen with Citi. Please proceed.

Terence Whalen – Citigroup

Hi. Thanks for taking the question and congratulations on the results. This question is a little bit of a higher-level question on the wireline business. If I think about 1.5, 2 years back to your Analyst Day, that was sort of the commencement of what, at that point, was a three-year growth runway for the wireless business including the [inaudible] business doubling and the optical business enjoying a transition to proprietary from standard. From that sort of high-level construct that we developed a year and a half ago, can you perhaps give us an update on where we are in that growth cycle and what new developments have sort of come up over the past year and a half to give you confidence in the continued growth of the [inaudible] business and the continued margin improvement in optical. Thank you.

Hock Tan

Thank you. That was – that’s very good question and looking back, [inaudible], that’s the white infrastructure business is still very much, the train of it is still very much in line with what we laid out in terms of a strategic plan, two, three years ago. It continues to be tracking up in our view and not perfectly as we like to see it, but one never gets it perfectly in the sense that optical business is probably growing faster in some ways than our [inaudible] business but having said that, on a total combined basis, still tending along the same direction, what’s also interesting is – and we said that two, three years ago, we see this product – this segment to expand fairly fast in gross margin, product margin, gross margin and that’s exactly also what’s happening.

Revenue may not be as fast as we like it to be but not far from that. But our gross margin is certainly running higher than our expectations three years ago. So overall, net-net, we’re pretty pleased with it.

Terence Whalen – Citigroup

Okay, terrific. And my follow-up question is, Avago’s recently named along with Qualcomm and Broadcom by Huawei for a longer-term supply contract. Perhaps you can sort of address what your prospects are in the Chinese Smartphone market, particularly given the OEM landscape you see and particularly given the standards that they use among them, TDLTE versus FTLD?

Hock Tan

Well, it’s – well, obviously, we have – I mean, Huawei, ZTE and a few other Chinese phone makers are very good customers of Avago and in some of those key customers, we provide components in the – as you correctly hit on, Smartphones. Components for the Smartphones as well as, I should add, as with Huawei, ZTE, data cups. These will be among the two largest producers of data cups in the world and we provide them with specific components that are very, very high performance, very low [inaudible], which is what they like. And that’s how we develop the strategic relationship for our products and we continue to have that. I won’t exactly say that we – they’re a huge, huge customer to us, they’re very important customers and strategic and the components we provide meets the performance specs very well. Again, same old strategy. Do we see ourselves as a mass market producer in China for component for Smartphones? No. We’re not. We don’t, for instance, produce in 2G EDGE market at all, but we obviously are producing in the [inaudible] CDME markets which China does play in within the Chinese market and we have also product offerings into TDLTD and to some extent, TDSME. And those are the A list where we end to play and the high end Smartphones where they produce them. But those are not necessarily the high-volume that sales in China. Those are more the high-end niche markets, Smartphone markets I think China exported by people like Huawei, ZTE into more developed countries.

Terence Whalen – Citigroup

Thanks. I appreciate the insight.

Doug Bettinger

Thanks Terence.

Operator

And the next question comes from the line of Joanne Feeney with Longbow Research. Please proceed.

Joanne Feeney – Longbow Research

Great. Thank you. If we could go back to the industrial side for just a minute, given that there has been this rather steep drop off in revenues since your peak, I’m wondering, first of all, if you could split up for us your share of the decline, I know due to the Thailand flooding, you paid about 10 million, but then was 90% of the rest the inventory correction or are you seeing also sort of a bottoming demand and that went down?

And the second part of my question is, what do you see your margin potential [inaudible] so far off of it’s peak when it does come back? Do you have a different view of your long-term gross margin given where we are today?

Hock Tan

Okay, let’s answer the second question first because we like that better. You touch an interesting point. Our gross margin as we’ve always said, has been expanding year after year, quietly but expanding and of course, overlaying it quarter by quarter we have up and down space on seasonality and unique situations of each product and you all know that industrial has the highest product margins, white infrastructure is somewhat above average now and wireless is somewhat below average. And the mix of it comes up very interesting. In Q1, the mix with way it is, yeah, it is not, as Doug pointed out, a quarter where we expect our gross margin to be stupendously glamorous and yet we’ve got – okay, 50.6%. So industrial starts snapping back or recovering, do we expect gross margin to be at a different plateau? Yes. We say that every year and every year it comes in at a different level of plateau. It just happens a bit differently as we go through a quarter of the year.

Doug Bettinger

But Joanne, I’ll remind you, our long-term model was non-GAAP gross margin, 50 to 53. We’re not changing that at this point, but that’s still the long-term model.

Hock Tan

Thanks, Doug, for reminding me. Right. But your point is still, it’s a reflection of phenomena that year on year, we tend to improve our gross margin 100, 150 basis points, 100 to 200 basis points a year, not the same every year. And we still maintain that model, 100, 150. Don’t let anyone [inaudible] quarter led you too far astray because it just ends up about then. But the thing we find ourselves very pleased about is even in Q1’s revenue mix, which is not entirely favorable for margin, we do manage to come in at a level that is obviously at a different plain from what it was, the same mix we placed two years ago. That is for sure.

And coming back to your first part of the question on industrial revenue and mix and all that, the bottom line is, we do not believe we lost market share at all. Now, as you know, in industrial, most of our revenue goes in – goes – is sold through distributors. To be precise, 80% of the revenue in industrial goes through distributors. And on the other item I want to point out is Q1, our revenue, which is shipping, most of that is shipping to distributors, dropped sequentially almost 30%, to be precise, 29%. Yet our resales out of distributors dropped only 10%. So you would say the gap here, the difference here is all about reducing channel inventory in the pipeline. And I might add, we did similar, the remaining 20% industrial, we have a similar positioning, the similar phenomena happening on the distribution sitting in our direct industrial OEM customers. So most of it, not all, but most of that reduction, sequential reduction is coming out of inventory.

But I should add, resales did drop 10%, so that was a general weakening of overall industrial demand from our perspective. That resale, as we pointed out, and I like to obviously emphasize that in the content of this question, we have now seen it flatten in the sense that we’re about almost one month into the end of last quarter, it’s more than flattened since Chinese New Year. It has picked up slightly. As Doug said, flat to up slightly.

Joanne Feeney – Longbow Research

Great. Thanks so much for that extra detail. That really helps. And then, if I could, on the wireless side as a whole, so you know, you had at least one major customer wrapping up Smartphone roles this last quarter and you also remarked that you would have one cutting down their inventories as the typically do at that time of year. I'm wondering if the one that was ramping up more quickly than you expected or the one that was taking down inventory perhaps did less of that, or if there’s a third factor involved, perhaps other OEMs [inaudible] more quickly than you expected? And what does that tell us about the dynamics of Smartphone builds for you guys throughout the rest of this year? Is it severely ramping up now or you know, how should we think about the ramp of the Smartphone year end of the rest of the year?

Hock Tan

Your first question, all three. That’s my answer, all three things were happening. All three were happening and I’m not trying to be caviler in the way I answer you, it’s just that think of us first as not your pervasive component supplier to all handsets in the world. We only supply in the first place to very niche areas, Smartphones. Now, you may say Smartphones is growing very fast, it’s still, what, 30% of all phones, handsets shipped out and that’s all we supply. And then we do supply some in feature-rich phones and we’re strong in CDMEs. CDME phones, we have. But Smartphones, it’s 30%. And Smartphones, there are areas in particular of bands of [inaudible] and 3G, where we are strong, we supply and others we’re not, we don’t supply. And then there’s some with different phone architecture that uses PADs, as I mentioned earlier, be it one bands or two bands that we supply and those where they don’t – and those particular PADs that have those particular requirements using FBAR, we definitely supply. And there are others that don’t, that [inaudible], we don’t supply. So it’s a mix and match, it’s pick and choose and if we pick the winners, we do very well. And I guess in Q1, we picked a lot of winners. Q2, we expect to pick the same winners as the momentum goes. For the rest of the year, I’d like to think we’ll continue to pick all winners and losers. So we’ll continue to drive our revenue growth we expect for the rest of this calendar year because once you have that going, you keep going for generations.

Joanne Feeney – Longbow Research

Okay. Thanks so much for the help.

Doug Bettinger

Thanks, Joanne.

Operator

And the next question comes from the line of Mark Lipacis with Jefferies. Please proceed.

Mark Lipacis – Jefferies

Thanks for taking my question. On the wireless side, assuming there’s growth, Hock, can you give us a sense of whether you believe that the growth is going to be driven more from the FBAR side or the power amp side?

Hock Tan

Well, it’s actually – a lot of it is power amp for now temporarily. And part of it because that’s a lot – we have a lot of content on this – and I should say, if you look at it this past quarter though, it’s a mix of both. But going forward, with the 8960 chip set coming in, the super chip set, the multi-band PA that we have talked about previously will probably drive a lot of content for us in PAs. Also that would be normally the case. So we see an increase of that. Having said that, FBAR is still an FBAR based module would still be a big chunk of it, it’s just that that would be a high-end mix of multiple PAs that drives it.

By the end of the year, we might be back to normal where FBAR would become the dominant, especially with PADs running it.

Mark Lipacis – Jefferies

That’s helpful. And can you give us the framework for thinking about how or what determines how deeply a penetrated FBAR would become in the market and maybe even specifically in the LTE segment? Thanks,

Hock Tan

Thanks. Okay, it is – it’s a story of a life in terms of a model. It’s a very good representation. What it is is FBAR [inaudible] just because it provides much better, much different shape and selectivity performance for reception of signals. The only thing is it’s price higher, so a lot of people don’t – a lot of OEMs chose not to use it if their performance is not that critical and they traded off by using filters instead of FBAR. But where they – they like the performance and they like the power FBAR produces, generally consumers like power and the phone maker can afford it, they use FBAR. Now, there are some bands, some spectrum of – wireless spectrum that makes it very important to use FBAR because the modulation schemes and the signals makes it very hard to use – to have – to allow SAR to perform well. And one example is CDME. The CDME bands prefer to use the FBAR just to get a minimum level of performance. And in 3G, [inaudible] certain bands are banned too, also like – in fact, require the use of FBAR. Then we start going to LTE. And as we move to LTE phones, LTE spectrum tend to be more tricky and more of LTE spectrum are scattered all over the map in terms of whatever is available, especially in North America. And one example is, for instance, Verizon LTE, which is running at about 700 megahertz. As you know, the Verizon LTE sits next to the public safety radio band. And so it’s important, you don’t – one doesn’t cross over to the other, and so selectivity of signals becomes important, you don’t want crossed interference and therefore using FBAR becomes more and more critical when you want to upgrade in the spectrum at a band next to a public band. Another example is, you know in the case of – as you all know you’ve heard of the example of light squared where there’s interference with the World GPS system. Now the World GPS uses filters like FBAR to keep a single [inaudible]. So that’s where FBAR comes into very, very good use and when you start using complex [inaudible] for LTE, which has to be interoperable with 3G and 2G, you get more and more band stuck together with WiFi, you have the problem of what we call co-existence, which means interference of signals that operate a very – bands very close to each other. Then you want to use FBAR. So getting folks more complicated, as they become smarter, they run more bands, you start to need to use FBAR.

So that’s in the short, in a summary fashion, a long answer to your basic question which is, is the trend heading to FBAR and my answer is yes, absolutely. As you go into LTE more and more, the tendency to use FBAR becomes much higher.

Mark Lipacis – Jefferies

Thanks, Hock.

Doug Bettinger

Thanks, Mark.

Operator

And the next question comes from the line of Aalok Shah with DA Davidson. Please proceed.

Aalok Shah – DA Davidson

Hey, guys, just a couple quick questions. Hock, just to follow up on Terence’s question about the wireline business a little bit. You were ramping up with some of the OEM this last couple quarters and I'm curious how much runway do you think you still have in terms of ramp with those customers. And then Doug, just real quickly for you, litigation expenses were down in the quarter. Was that just a function of the calendar and probably ramp back up as we go through the next couple of quarters?

Hock Tan

To answer the first question, a lot of our design wins, in fact to be precise, about half our design wins in ASIC 30’s and in proprietary fiber have not even began to really ram yet. So I think we have pretty good – and we still have runway on our existing designs of another couple years. And as you know, it’s a continual process. We’ll continue to accumulate more and more design winds hopefully at a rate higher than we did in the past. So we will continue to grow this business, but to answer your question, they fill quite a bit of runway because a lot of the designs have not even began to ramp.

Doug Bettinger

And then to look at your litigation expenses, you probably know, litigations spending to the extent that you’re going to trial with somebody can be lumpy, up a quarter, down the next. What you saw over the last couple of quarters is we’ve resolved several lawsuits, so the run rate of litigation spending has come down.

We’ve got one big suit that’s coming in the summertime where I expect spending will tick up a little bit when we get close to that (Triquent) litigation, and it’ll be lumpy. It’ll be up and down depending on what’s happening with that case.

Aalok Shah – DA Davidson

Great, thanks a lot.

Doug Bettinger

Thanks, Aalok.

Operator

And the next question comes from the line of Ian Ing with Lazard Capital Markets. Please proceed.

Ian Ing – Lazard Capital Markets

Yes, great, thank you. You talked about kind of an unexpected wireless cost reduction, so could you talk about the utilization of your R fabs going from to January to October? And your expectations going forward as your demand increases, but also your capacity and CapEx investment increases? Thanks.

Doug Bettinger

Ian, this is Doug. You know, utilization isn’t super high right now in the wireless fab. I think last quarter, it was probably running around 50%. And that was fairly consistent from the quarter before it. So it’s not ramping up or ramping down. We put capacity in place for those peak revenue quarters, which tend to be in the back half, at least seasonally in the back half of the year where utilization moves up. And so that’s when you would expect to see utilization move up. And as we put capacity in place, the profile of utilization really won’t change much. And to remind you what we’re doing with that capacity, we’re putting it in places – it’s essentially bringing some stuff that’s outside the company inside the company.

Ian Ing – Lazard Capital Markets

Okay, great, and then optics, you talked about helping the wireless infrastructure grow some. Could you talk about more what’s driving that? Is it your OEM exposure succeeding in the market? Is it the number of channels going up? Is it sort of shifting from SFP to XFP to 16-gig optics, etcetera? Thanks.

Hock Tan

Excuse me, would you mind …

Doug Bettinger

I'm not sure we understand the question, Ian.

Ian Ing – Lazard Capital Markets

Just trying to understand the drivers of the optic’s growth that you’re guiding to. And sort of what’s behind that. Is it OEM exposure or it sort of content growing up?

Hock Tan

Broad perspective, just for future guidance, we see a string in optics, fiber optic interconnection for a couple reasons. One is carrier routing where we supply a lot of content, proprietary content, continues to be very strong. And I suspect a lot of it going to carrier opting, call routing is typically using back [inaudible], major back [inaudible]. And we see that to continue to be very strong. Typically North America, also to some extent in China, though that may be tapered off somewhat, but we can see strength from that in Q2 following Q1.

And the other area that continues to show strength for optical is, we’ve got a lot of increasing content and a lot of content into data centers and the conversion to 10G in internet. And the conversion to 16G in storage, fiber channel.

Ian Ing – Lazard Capital Markets

Okay, so 10 gig Romley and 16 gig in storage.

Hock Tan

Right

Operator

(Operator instructions). And the next question comes from the line of Brendan Furlong with Miller Tabak. Please proceed.

Brendan Furlong – Miller Tabak

Good afternoon, everybody. One quick question on LTE. Regarding integrations of LTE at the end of last year had various power performance issues. And you had a high color content on those LTE phones. As we get a new generation of LTE ramping the back half of this year, do you still have the same high dollar content or the re-architecting of LTE a little bit, you know, lower your bond a little bit? Thank you.

Hock Tan

I'm trying to think, and the reason is, I'm trying to think your question in that regard. No, I think we had a lot of content last year because of a unique nature of a phone that uses YMIX. There were YMIX phones last year, and that was great content. And that was not obviously a very sustainable phenomenon, but sustainable phenomenon, which is strictly – and I consider YMIX as L4G, which is the same generation LTE, so forgive me if I seem to confuse you. But one last year, our stringing content was YMIX, but the LTE side really didn’t have that strong, huge content. And the content the second half of the year one generation later will increase. To answer your question, yes, it will increase. As you heard in earlier questions, you’ll increase to the point where you’re starting to have more jewels that run with more and more with [inaudible] simultaneously. But in more just running just to give you band.

Modules that run with two bands and potentially even more down the road, so content will increase as phone, Smartphone become universally more prevalent in the sense that you don’t make a phone to run just one carrier by itself. You try to make the phones that can roam, and will run many, many bands, which includes the content. And that just happens to be the nature of LTE phones. And so that’s happening, this thing increasing content. Not LTE per se, but LTE adds to the complexity of world Smartphones. And that enables people like us to add more content.

Brendan Furlong – Miller Tabak

Excellent, thank you very much.

Doug Bettinger

Thanks, Brendan.

Operator

Ladies and gentlemen, this concludes the question and answer session for today’s call. I would now like to hand the call over to Mr. Tom Krause for closing remarks.

Tom Krause

Thank you operator. Before we close, I’d like to remind everyone that Avago will present at Morgan Stanley’s technology conference in San Francisco next week, February 28th. These presentations will be webcast live and archived for replay in the investor section of Avago’s website.

Thank you for participating in today’s earnings call. We look forward to talking with you again when we report our second quarter fiscal year 2012 financial results in late May. Thank you.

Operator

Thank you for your participation in today’s conference. This concludes the presentation, yo may now disconnect.

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