Linear Technology's (LLTC) CEO Lothar Maier on Q3 2016 Results - Earnings Call Transcript

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Linear Technology Corporation (NASDAQ:LLTC)

Q3 2016 Earnings Conference Call

April 20, 2016 11:30 ET

Executives

Don Zerio - Vice President, Finance and Chief Financial Officer

Bob Swanson - Executive Chairman

Lothar Maier - Chief Executive Officer

Analysts

David Wong - Wells Fargo

Craig Hettenbach - Morgan Stanley

Ross Seymore - Deutsche Bank

Evan Wang - Stifel

John Pitzer - Credit Suisse

C.J. Muse - ISI Group

Craig Ellis - B. Riley

Ambrish Srivastava - Bank of Montreal

Vivek Arya - Bank of America

Cody Acree - Drexel Hamilton

Steve Smigie - Raymond James

Harlan Sur - JPMorgan

William Stein - SunTrust

Operator

Good day and welcome to the Linear Technology Corporation Fiscal 2016 Third Quarter Earnings Conference Call. Today’s conference is being recorded. At this time, I would like to turn the conference over to Don Zerio, Vice President of Finance and Chief Financial Officer. Please go ahead, sir.

Don Zerio

Good morning. Welcome to the Linear Technology conference call. I am joined today by Bob Swanson, our Executive Chairman and Lothar Maier, our CEO. I would like to remind you that in our presentation today and our answer to certain questions that may follow, we may make forward-looking statements that are dependent on certain risks and uncertainties, including, but not limited to, our financial results for future periods; our ability to produce and sell existing products; the timing and introduction of new products and processes; and general conditions in the world economy and financial markets. In addition to these risks, please refer to the risk factors listed in the company’s Annual Report on Form 10-K for the fiscal year ended June 28, 2015 and our subsequent quarterly filings on Form 10-Q.

Also SEC Regulation FD regarding selective disclosure influences our interaction with investors. Accordingly, this conference call will be our forum to respond to questions regarding our estimated financial performance going forward. Should you have questions regarding our estimates of sales and profits or other financial matters for the upcoming quarter, this is the time we are free to respond to your questions.

As noted in our press release which was released yesterday just after the market closed, revenue for the March quarter came in at the higher end of our guidance at $361.1 million, up 4% from the December quarter. Gross margin increased to 76.2% from 75.7% benefiting from the higher sales base of full quarter production in our fabs and certain other manufacturing efficiencies. Recall that our second quarter had less production days in our fabs due to holidays and plant shutdown days.

Operating margin improved to 45% of sales, up from 43.1% due to the higher gross margin and one less week of operating expenses as we had 14 weeks in our second quarter. Our effective tax rate was slightly higher in the third quarter at 21.75% versus 19.5% in Q2 on lower discrete quarterly items. Net income and earnings per share were $128.4 million and $0.52 per share. All told, this was a pretty good quarter and we are happy with the results given global macroeconomic conditions that are still providing some headwinds. We beat the midpoint of our guidance, we increased gross margin and operating margin and our bookings increased over the prior quarter at a level that should allow us to grow in the fourth quarter as well. The transportation market continues to grow nicely and we are seeing recovery in the industrial market and to a lesser extent, the communications market, which has been weak for some time.

We are seeing recovery across the broad-based including the distribution and the smaller and midsized customers. In general, inventories in the channel appear to be imbalanced and we believe we are shipping to end customer demand. However, there remains pockets of weaknesses in certain geographies and the computer market remains particularly weak though that is not a major market for us. We remain cautious given the general business climate, but based upon our third quarter bookings and our current run rate we are currently projecting revenue to be up 2% to 5% in the June quarter.

Turning to bookings by region and market sector, as a reminder, we have posted bookings by market and revenue by geography for the quarter on our website at linear.com under Investor Relations Supplemental Information. We post this information by the end of our business day on the day we released our results. Total bookings increased for the quarter and we had a positive book-to-bill ratio. Bookings increased to both North America and the international market. Within international, bookings were up in each of our major geographic regions, Europe, Japan and Asia-Pacific. We continue to do particularly well in China as bookings were up the most in that region on the strength of automotive though our industrial business is growing in that country too.

With respect to bookings by market sector, bookings were up in each of our major markets that represent 86% of our business, industrial, transportation and communications and our smaller markets, military space grew modestly, while computer and consumer showed declines. The computer market, particularly PCs and notebooks, continue to be particularly weak. Industrial continues to be our largest market at 44% of our bookings, up from 43% the previous quarter. Industrial bookings increased in each of our major geographic regions led by North America and Europe. The breadth of this increase across our customer base is giving us some comfort that the noticeable weakness we experienced in this market over the past several months is in recovery and that the inventory correction that resulted is behind us. We believe we are shipping to end customer demand and the inventories in the channel and at the OEMs are at least stable, if not lean.

Turning to transportation bookings, this market continues to show the highest percentage growth and it was 24% of our businesses that quarter, up from 23%. The increase in bookings in transportation was driven primarily by Asia-Pacific, but we saw growth in Japan and the U.S. as well. The U.S. has been a smaller transportation market for us, but we are making good strides here and is up nicely for the quarter in percentage terms and opportunities continues to increase. Europe bookings were down in transportation modestly in the quarter, but coming off a relatively strong Q2. Transportation growth in Asia-Pacific continues to be strong and it was our highest region in total transportation bookings overtaking both Europe and Japan for the first time. As you should know by now, we have been particularly successful with our parts in the China and Korea market.

As I have noticed on previous calls, China is all-in on electric vehicles as one part of the solution for their severe air pollution offering incentives to both businesses and consumers to build and buy electric vehicles, including autos, taxis and buses. Our superior BMS parts have won a significant business in China, where we enjoy very high market share for battery management systems. Our transportation business in this region should continue to grow strongly for the foreseeable feature.

Communications remained at 18% of our bookings for the quarter, but after two quarters of sequential growth, we are hopeful that this market is beginning to show some life. The large base stations and infrastructure piece of this market continues to be weak, but that is no longer a sizable piece of our communications business. We are seeing growth in optical, networking and datacom, which is the area of the market that we focus. This market was strongest for us in the U.S., while Europe was flat and Asia was down slightly. The computer market was 6% of our bookings, down from 7% last quarter with the decrease primarily in North America, where the majority of this business is booked. As stated last quarter, this market is down as expected as it is suffering due to weaker notebook sales and storage devices. This market may continue to decline a bit more for us over the short-term as notebook sales continue to decline. But longer term, we expect growth opportunities as we have compelling products in development that address the higher end of this market where innovation and superior functionality are still needed.

Bookings for military space and harsh environment products increased modestly this quarter and remained at 6% of our business. Military has rebounded slowly from the weakness we experienced in the first quarter, while the space business has been somewhat flat for the past year. We do expect the space business to pick up as satellite launch activity increases. This is predominantly a U.S. market that we do book some business in Europe. Both regions saw an increase in bookings this quarter.

Finally, consumer, our smallest end market where we take business opportunistically when functionality and performance still matter, this market decreased to 2% of our business, down from 3% last quarter. With regard to our bookings are actually created, 62% were created internationally and 38% in North America, the same as last period.

Moving to sales, sales increased by 4% from the prior quarter and were down 2.9% from the prior year quarter. Geographically, sales were up the most in Europe followed by North America and Asia-Pacific, but were down in Japan, which is not unusual as March is typically their fiscal year end. U.S. sales were up for both OEM and distribution where revenue is recognized on a sell-through basis. On a regional basis, North America was 28% of our business, up from 27% last quarter. Europe was up to 21% this quarter from 19% last quarter. Japan declined to 13% of our business down from 15% last quarter and Asia-Pacific decreased from 39% to 38% of sales, but was up in absolute dollars.

Turning to the rest of the income statement, gross margin was up from 75.7% to 76.2%. This is a good result, particularly since our overseas assembly and test operations have lowered production days due to Chinese New Year. Gross margin was aided by the higher sales base, which reduces fixed overhead per unit and an increase in our average selling price to $1.97, up $0.05 from $1.92 last quarter. The fourth quarter is a full production quarter for all of our plants and we expect to grow sales. So I do expect some margin expansion subject to the product mix within sales.

R&D decreased $0.2 million sequentially to $69.6 million primarily due to lower labor and fringe costs as there was one extra week in the prior quarter. In addition, legal costs were down. Partially offsetting these decreases, vacation costs and profit-sharing increased. Vacation costs were higher as there were no shutdown days and much less vacation taken in the third quarter than during the holiday season. SG&A decreased $0.4 million sequentially to $43 million. Similar to R&D, this was mostly due to lower labor and fringe costs from one less week in the quarter compared to Q2. In addition, other cost decrease such as advertising, travel and foreign sales costs from foreign exchange. Similar to R&D, these declines were partially offset by higher vacation costs and profit-sharing.

Operating income increased by $13 million to $162.5 million, representing 45% of our sales. Interest and other income increased slightly to $1.6 million on higher invested cash, net of small loss from foreign currency transactions. Our quarterly effective income tax rate was higher this quarter at 21.75% versus 19.5% last quarter due to lower quarterly discrete items. Next quarter absent discrete tax items, if any, we expect our annual effective tax rate to be in the 24% to 24.5% range. Net income for the period was $128.4 million, up $6.9 million and was 35.6% of sales, up from 35%. The average shares outstanding used in the calculation of earnings per share decreased by 116,000 shares. The weighted average of stock repurchases, both this period and last period more than offset vesting of employee stock awards. GAAP earnings per share was $0.52, up from $0.50 in the prior quarter. Without the impact of stock-based compensation of $19.9 million, diluted earnings per share would have been $0.59 per share.

Looking at just a few major components of our balance sheet, during the current quarter the company’s cash, cash equivalents and marketable securities increased by $55.3 million to $1.36 billion, net of spending $78.2 million of cash dividends which have been increased to $0.32 per share and spending $32.6 million on stock purchases of approximately 800,000 shares. Capital expenditures for the quarter were $13.2 million. Accounts receivable of $152.9 million increased by $7.8 million on the higher sales base and DSO was 39 days, up from 38 days as we had an extra week of collections in the second quarter. Inventory at $94.2 million was essentially flat versus the prior quarter and we believe to be in good profile to support our business and keep lead times relatively short. Our quarterly average inventory terms was up slightly to 3.7x per year.

Looking forward, at the current bookings rate, we are guiding revenue to be up 2% to 5% in the June quarter. Three quarters ago, we announced that revenues for our first fiscal quarter would be down significantly, our expectation was that the sudden drop was more of a short-term correction rather than a deep down cycle. At this point, it appears that our reading of the tea leaves was accurate. Inventories in the channel now appear to be imbalanced, if not lean. We are shipping to end customer demand, bookings have picked up and our largest market, industrial appears to be in recovery. However, it is still a fragile market. The global macroeconomic climate is not particularly favorable when certain geographies remain weak and GDP of 2% is considered good growth. Nevertheless, we feel good about our strategy and the growth opportunities ahead in the markets where we have focused our resources and product development, particularly in the industrial, transportation and communications markets. These are the markets that will drive the growth in high performance analog and the decisions that we made several years ago and executed upon now leave us well positioned to capitalize.

I will now open up the conference call to questions to be addressed to Bob, Lothar or me. Operator, we are now ready for questions.

Question-and-Answer Session

Operator

[Operator Instructions] Our first question comes from the line of David Wong with Wells Fargo. Please go ahead.

David Wong

Thank you very much. Don could you give us some feel of your attitude to cash on the balance sheet and use of cash and in particular, what you see in terms of stock repurchases going forward?

Don Zerio

Yes. David as you know, we retired our convertible note. It’s been about 2 years now. And after having debt service for 7 years, we enjoy not having it. So for the time being, we continue to like not having the debt service. We prefer to use our existing cash to fund our dividends and stock repurchases. And so for the time period, that position hasn’t changed. But it’s not that we are necessarily against taking some debt. We have done it in the past. But currently, we have chosen to use our existing cash to fund our stock repurchases.

David Wong

Great. Thanks.

Operator

Our next question comes from the line of Craig Hettenbach with Morgan Stanley. Please go ahead.

Craig Hettenbach

Great. Thank you. Just a question or comment on China and EVs, just in terms of certainly it’s still a small market as a percentage terms, but the dollar content opportunity is much higher, I am curious to get your thoughts on just from a design perspective and what you are seeing from customers having influences what you think about the opportunity over the next 1 year, 2 years, 3 years?

Lothar Maier

When you think about China, particularly when we talked about is this EV market, it’s not just cars, its taxis and to a large extent, it’s also buses and some machinery. So it’s – and when we win business on the BMS side, we typically win business around the rest of the car as well. So granted these types of vehicles are so relatively small percentage, the content can be 2x, 3x, 4x, 5x, 10x as much as in the conventional car and the numbers may be were small, but appear to be getting quite a bit bigger. If you look at how many plug-in and electric cars China produced in 2015, it was around 300,000. And that’s going to double, we think in ‘16. And right now, with the incentives that the Chinese government has put in place, there don’t appear to be an end to this.

Craig Hettenbach

Got it. And then if I could just follow-up just on the topic of BMS, I think you guys are in your third or fourth generation of products, so just seemingly it’s a big opportunity, but just kind of things you are doing on the technology front to make sure that you maintain kind of a leadership position for these type of products?

Lothar Maier

Yes. And it’s interesting because every OEM does it a little bit different. So there isn’t like one solution that solves everybody’s problems. Some people have efficiency, some people want precision, some customers want communication. So it’s a different set of requirements from customer to customer. And so it’s just an ever evolving field and it’s – the requirements are, obviously its precision. The lithium batteries are very expensive. And so if we can make the measurements more precise, it means they have to purchase less batteries. When your battery system stops working in a vehicle, that’s a plug-in or a hybrid, the car stops. So they are looking for things like redundancy and backup systems, so it’s a pretty complicated product with a lot of different hooks in it and every different – every OEM has a different hop button.

Craig Hettenbach

Okay. Thanks for that color.

Operator

Our next question comes from the line of Ross Seymore with Deutsche Bank. Please go ahead.

Ross Seymore

Hi, guys. Congrats on the solid quarter and guide. Just had a question on the ASP side of the equation, Don, you mentioned the benefit that, that had a little bit to the gross margin, but just kind of more holistically I think that $1.97 was up nicely sequentially and year-over-year, but I think it’s also the highest we have seen for your company as far as I can find in history. Can you just talk a little bit about what is driving ASPs up for your company over time and if in the single quarter there was any particularly unique movements?

Don Zerio

Well, I think just in general, the strategy change that we made several years ago as you know to defocus on the consumer and more towards industrial and transportation and communications just over the last several years that strategy in and of itself is going to help our ASP and it did. And you also know that we have had good success in our module business which continues to grow quite frankly beyond our expectations and not to know the great product that we continue to see just running. And the ASP on the modules is quite high and we are also talking today about our success with battery management systems, which also is a relatively high ASP product. So, our strategy in general and the success of certain of our products is continuing to drive ASP higher and it certainly wouldn’t surprise us if we got over $2.

Lothar Maier

Yes. Just to highlight, we used to have ASPs even greater than $2 for a prolonged period of time. You would have to go back about 15 years to see that. And as we entered into the consumer business, we saw our ASPs drop. I think the low quarter for us was like $1.38. And then we have seen a steady growth back to what we think is probably likely for us is to get above $2 here in the future. And we feel that way for the reasons that Don said. We have got these BMS products. We have module products. And if you look at virtually everything that we have got in the design pipeline are really products that should warrant prices above $2.

Ross Seymore

Great. And I guess as my follow-up just switching gears to the industrial side, it’s good to see that its acting better and you gave a lot of color on that. I guess if we could just compare it to a year ago at this time, it looks like your revenues are in the same ballpark for what you have reported in the March quarter and seemingly what you are guiding for that sub-segment in June. Could you just compare and contrast what gives you the confidence and how you are feeling about that at the same level of revenues today versus a year ago, when of course we are on the precipice of that correction short-lived, but correction nonetheless in the September quarter?

Lothar Maier

Yes. I mean, prior to that correction, we were on a pretty good March in terms of improvements in our industrial business. And I think we had a correction for, quite frankly, reasons I don’t fully understand, because we didn’t lose any customers, we didn’t lose any business. And so I think what we are seeing now is that industrial business that roughly a year ago was doing pretty good for us resetting and taking off where we were about a year ago.

Ross Seymore

Good. Thank you.

Operator

Our next question comes from the line of Tore Svanberg with Stifel. Please go ahead.

Evan Wang

Yes, hi. Thank you for taking my questions. This is Evan Wang calling in for Tore Svanberg. Thank you for taking my questions. First question is on the communications, you have talked about it potentially being on rebound, I was wondering if you can characterize just a little bit based on maybe the bookings from your first couple of weeks so far this quarter as to the steepness of this recovery and going forward even out a couple of quarters if you could?

Lothar Maier

Well, it’s – any of our markets really don’t get driven by what’s happened in the first few weeks of a quarter. These things evolve literally over years. And we have seen some stress on our communications business, because historically it was roughly evenly split between the base station and the networking part of the business. And over the years, what we have been seeing is the base stations, which has become somewhat commodisized, that business declining and the rest of the business, sort of the networking and infrastructure part of the business improving. And so I think what we are seeing now is the fact that we have given up most of the base station business. We don’t have a lot of base station business to lose anymore and what we are seeing is just the pickup of the networking business, which we have been seeing really for years and that’s becoming a little bit conspicuous now. There are also some segments in the networking business that are doing well. Don mentioned the optical business. Wherever there is a lot of innovation, it’s typically where Linear does well and the optical markets going between 10G to 20G to 40G to 100 to 200, 400G. As that progression goes, there is a lot of technology involved. And when that happens that’s good for us. And so for us the optical market right now is doing quite well.

Evan Wang

Great. My follow-up question is for the longer term, you cited that the macro remains weak and given the strength in your focused markets, is this still a major concern for you or do you see the strength in these markets sufficient to fuel your growth?

Lothar Maier

It’s an issue for us. We really like to see some strong global GDP growth. So, it’s an obvious headwind to us, but at the moment I think we have got enough good products and good markets that we can buck that headwind to some extent. But quite frankly, we have a lot stronger business if we weren’t facing headwind like that.

Don Zerio

You know, I mentioned Japan. Japan is weak. I mean, there was definitely some seasonality with Japan this past quarter. As I mentioned, March is typically their fiscal year end. And so that will take less delivery and such, but I think there is some real weakness in Japan. I think they maybe affected by China somewhat, but they are still like we said there are still pockets of weakness out there. There is not many reasons around the world if at all that experience any kind of growth, something 3% or better. I mean, you don’t even see that. Like I said, 2% is considered strong. So certainly not a great market out there, but I think in the markets that we focused, we are certainly holding our own and we can’t use the macroeconomic environment as an excuse. We have to continue to grow and we think we can do that.

Evan Wang

Thank you very much.

Operator

And our next question comes from the line of John Pitzer with Credit Suisse. Please go ahead.

John Pitzer

Yes, good morning guys. Thanks for letting me ask the question. Don, in your prepared comments you talked about your expectation for the June quarter for there to be additional gross margin leverage based upon sort of fixed cost absorption maybe offset by mix. Can you help us quantify how much we should see for the June quarter? Is this a similar incremental margin that we have seen in March? And then on a similar vein, if you look at where gross margin are today and I always feel silly about asking this question, you are still about 200 basis points of upside to where margins were kind of back in that 2010 time period around 78%. Is there anything structurally different about the business today that shouldn’t allow you to, at some point, get back to that margin profile?

Don Zerio

You know, John, you have to remember where we were in the market back in 2010. I mean, that was a snapback from the 2008-2009 credit crisis and recession. And so the whole market was, if you recall, was sort of pedal to the metal. Our factory utilization at that time was very high. We still had some consumer products that were lower ASP, but also lower cost that helped get to that very high gross margin, not that we can’t get back there, but that’s sort of the perfect environment to get back to a gross margin that is in excess of 78%. So, I think that’s different and you have to look at what that environment is.

And secondly, there is some cost to the automotive market, the quality and the reliability that is expected. So, yes, there is higher ASPs there, but the cost depending upon which product you are talking about has quite high test costs. So, there is that as well, but even on a slightly lower gross margin, the gross margin per unit is higher. So, we will make that trade-off everyday. So, there is – I mean, there is just a lot of variabilities that go into gross margin which is why I can’t necessarily give you a target for what our gross margin is going to be next quarter. I don’t know what the mix is going to be yet. I am not exactly sure what our capacity level will be in the factory. All I can say is, say look, we just grew about $13 million and added a half of – 0.50 basis points. I don’t know if I can promise another 50 basis points, but assuming we grow, assuming we have a relatively sort of constant kind of a mix on our products. I would expect that we would be able to add to gross margin in total, whether it’s 20 basis points or 30 basis points or even higher, I can’t say right now.

John Pitzer

And that’s helpful Don. And then Lothar, maybe as my follow-up, a question around growth and I understand that the compare is probably not there because there has been a lot of repositioning in the company, but if you look at the top line growth, since 2010, to the end of this year, it’s been sort of flattish and again a lot of repositioning within that 5-year period. I am kind of curious as how you think we should think about your growth rate from here given the repositioning and the focus of the company in the end markets. And if not on an absolute basis, relative to where the semi market is growing, how much faster do you think you can grow on an ongoing basis?

Lothar Maier

Yes. I think you got a pretty good observation there that 2010 as Don said earlier, was kind of a peak. There was a huge downturn and then there was a huge correction and then it corrected again after that correction. And if you look back in the last several years, we have seen steady but modest growth. And I think we need two things. One is we need the overall market to get better. And so if we are going to get back to what we always say we would like to grow or we think we are entitled to grow is 10%, we have got to get some decent GDP growth. If you look at our company from where we are positioned, from a product standpoint, from an end market standpoint, we couldn’t be any better positioned than we are presently. So I am not worried at all about the things that are in our control because I think we have managed that pretty well. We just need a little bit of help from the market and there is no reason why we can’t grow 8% or 10% in a year. I doubt – we do not have a product or a market issue.

Don Zerio

John, let me just follow-up on that. If you go back to 2014, we had about five quarters, if not six quarters in a row, where year-over-year we were growing in a high single-digit, 9%, 10%. And that’s what we thought we could do and we thought we continue to do it when most of the consumer transition was behind us. So all the new business and new opportunities we now felt after several years of replacing business was now additive on top. And so we were sort of there and obviously after 2014, we fell off that pace as did certainly the rest of the market as well. But computer got weak, communications got weak, industrial got weak on us. So again there are some macroeconomic headwinds. But to Lothar’s point, with a little bit more stability and a little bit more growth on average around the globe, we think we can grow back up at that 10% range. And we think we have already shown we could do it. We just need some help from the market.

John Pitzer

Great. Thanks guys.

Operator

Our next question comes from the line of C.J. Muse with ISI Group. Please go ahead.

C.J. Muse

Yes. Good morning. Thank you for taking my question. I guess first question, when you think about consumer now when we had only a roughly $28 million run rate, clearly much more leveraged to your three core businesses, how should we think about normal seasonality patterns in this low growth environment coupled with that mix shift?

Don Zerio

For which market?

C.J. Muse

Sorry, I am thinking in aggregate for you guys.

Don Zerio

I am sorry C.J., can you ask that question again?

C.J. Muse

Sure, thinking about seasonal patterns in the back half of the year, recognizing that you are much more focused to your B2B business and less so on the consumer front and how that translates into what we should expect into the back half of the year?

Don Zerio

So are you asking about this sort of the seasonality of our business going forward?

C.J. Muse

That’s right.

Don Zerio

Well, there used to be sort of a somewhat regular pattern or cycle to our business several years ago and maybe the consumer component of that, that we had that at that one time was double-digits, maybe that factored into that. And so with consumer gone, there seems to be maybe a less of a normal pattern. But just in general, clearly the first half of the calendar year, our fiscal third and fourth quarters is seasonally strong for Linear, particularly because of our focus on industrial and transportation. So we assume that, that will stay that way going forward. We hope to grow in Q4. Going on beyond that, it’s very difficult to forecast this business over the next quarter just because of the economy and some variability in the business and our customers. But I mean we would expect that coming out of the fourth quarter, historically the first quarter has been a – first fiscal quarter has been flattish to up slightly, down slightly type of quarter. And then Q2 has generally, be – that’s December quarter has generally been our weaker quarter when we go down slightly. Although even this past year, that pattern was changed because September was the down quarter and we were recovering in the December quarter. So you look at history and what happens and there is somewhat of a pattern there, but it seems to have changed every year. So I am not sure I would put too much on the seasonality, other than clearly the first half of the calendar year tends to be stronger quarters for us. I would think that, that would continue absent some major change. I hope that answers your question.

C.J. Muse

Yes, it does. That’s helpful. I guess moving to OpEx, you guided 31% or less of sales for the prior Q and you came in a little above that. Curious what drove that and how should we think about that percentage going into the June quarter. And then if I could sneak one last question, it would be are you seeing any impact in your business from the earthquake in Japan? Thank you.

Don Zerio

Well the latter one, I don’t believe that we are seeing any impact, at least none that we know of yet. So that’s the easy one. You know it’s funny, I guess I got caught on the one minor miss I made on the income statement, where I did say that I expected to be in the 31% range similar to Q1, if not better. And so at 31.2%, that’s exactly where we were in our first quarter. So I think that’s what I said. But in fairness, I expected it to be a little better. And there is two things that – and we are not talking about a lot of money. I think to get down to 31% that would have – our operating expense would have been about $600,000 or $700,000 less, not a lot. But one thing I didn’t factor into is surprisingly it’s vacation. The way we do our accounting for vacation, I think it’s what the most companies do. It is when employees are taking vacation, you actually get a P&L benefit. And then when you are not taking vacation, vacation charges go up and it’s the way you accrue the vacation accrual. So one thing that I didn’t factor is when you have a holiday period like Christmas and New Years and then we also had shutdowns as well, people use their vacations so that they can get paid rather than taking time off without pay. So this quarter, that sort of snapped back the other way, because after people used their vacation, there is hardly any vacation taken at all. So the impact of that, quite honestly was a little higher than I expected. And so at 31.2%, quite honestly I would have thought we would have done a little bit better. But going forward, I think that 31% of sales is give or take, is probably where you can find us. The second thing there and I think I have been talking about this for the last couple of quarters is on an annual basis, if you take out stock compensation, our operating expenses are generally increasing in the 3% to 4% range. And that’s sort of typical. But stock compensation, which is non-cash, is increasing somewhat higher than that. And it’s solely because our older grants that were granted 5 years ago were granted in the low $30 range. Well, those are falling off and being replaced by higher grants. So that phenomenon is causing stock compensation to increase quarter-over-quarter, a little faster than the rest of our cash operating expenses. So, there is a little bit of pressure there. That will turn around eventually. But for now that’s why you might see our operating expenses in total growing maybe a little higher than you would expect.

C.J. Muse

Very helpful. Thank you.

Don Zerio

Okay.

Operator

Our next question comes from the line of Craig Ellis with B. Riley. Please go ahead.

Craig Ellis

Yes, thank you for taking the question and congratulations on the results, guys. Don, the first question is to you and it’s just a follow-up on the basis for the guidance. I think you predicated guidance range on bookings at current rates. So, can you just remind us what the monthly bookings linearity would typically look like in the fiscal fourth quarter?

Don Zerio

Well, this past quarter and which is not unusual when you see the bookings, we actually had slightly higher bookings in January, but they stabilized pretty well over at the quarter enough to allow us to grow as we said. But when you look at January, for example, it’s not unusual that bookings increased coming out of the December calendar year end and there might have been some pre-booking for Chinese New Year. So, that’s why you got to be a little careful when you try to read into the next quarter when you are on the call based upon a couple of weeks of bookings for the current quarter, because there sometimes ends up being a spike just sort of coming out of the different fiscal periods. But I said I think we have seen just in general, our bookings per day have stabilized somewhat. So, we are hoping that, that will continue. We continue to talk to our customers and I think our feedback in general is they are feeling pretty good about their business. We talked about seasonality. And Q3 and Q4 are generally stronger for Linear Tech. They are stronger for transportation and industrial. The transportation market continues to grow nicely for us. So, just based upon that information, that’s why we are feeling good about our position. That’s why we are feeling pretty good that we can continue to grow in the fourth quarter. And beyond that, we just really don’t know. It’s very difficult to forecast longer out, further out in the first quarter. So, we are just going to have to see what happens.

Craig Ellis

Okay. I am going to take another swing at it, because I was looking for something a little bit different. If we look back historically, would we typically see that May and June are about on par with the bookings intensity that would be seen in April or would they typically be North or South or is there not a discernible enough pattern to make a call on the intra-quarter linearity by month?

Don Zerio

I don’t think there is enough of the pattern. Other than that generally, our bookings in the first calendar – first half of the calendar tend to be relatively strong to fuel the growth in those quarters. You know our lead times are relatively short at 4 to 6 weeks, so we don’t have bookings that go out months and quarters to let us give us too much insight on the future.

Lothar Maier

Yes, I think what Don’s saying is there is a nuance here. I mean, typically our bookings and billings are pretty doggone flat through a quarter. And there might be some inventory positioning our customers do at the end of the quarter that picks up the bookings at the beginning of the next quarter, but we are talking about nuances here, not – I mean, we don’t have a hockey stick type pattern of our business. It’s very, very linear both from a bookings and a billings standpoint.

Craig Ellis

That’s helpful. Follow-up guys. The follow-up question is to you, Lothar, it was helpful to get the color on the communications business, the base station mix out has been well known. You have been very transparent on that. My follow-up question though as you look at the trends in optical, networking and datacom, are you seeing differential rates of growth in any of those markets? And if so where are you seeing the better growth? And then related to that, can you give us some sense as to the size of those different businesses so we can put that growth in better context inside of communications? Thank you.

Lothar Maier

I would say where there is a lot of potential business for us going forward, I would say it’s in the optical area. As I mentioned earlier, there is a lot of innovation going on there. And the use of optical is expanding. It used to be the fiber was for long-haul communications. And most of that fiber is in the ground already. And really where fiber is becoming more and more important is shorter distance, within buildings, server rack to server rack in data centers. And so that’s the area where very, very high-speed communications is needed and it needs to fit in, in a very, very small format and heat dissipation is a big issue. And so we have got solutions for those types of applications that make that optical market kind of a pretty interesting market for us right now.

Craig Ellis

Thanks, guys.

Operator

Our next question comes from the line of Ambrish Srivastava with Bank of Montreal. Please go ahead.

Ambrish Srivastava

Hi, thank you. And I will borrow the silly hat from John Pitzer from the earlier question. I just wanted to drill in a little bit more on the gross margin and he was right, it’s kind of silly to be asking that given where you guys are at. But based on everything you said, the ASPs seemed to have a secular trend upwards. On the auto side, should costs be, the cost penalty be abating as you improve your yields and then pick a normal as utilization, shouldn’t gross margin then should have a secular upward trajectory if we look out longer term?

Lothar Maier

I think you are right. I mean, I think we are being maybe a little bit modest here in that. If I look back what happened in 2010, if those circumstances happened again to us now where if the growth really took off like we were seeing back then, I would feel pretty confident that we could get to 78% gross margins. I mean, we are talking about percentage or two. Our factories are not 100% loaded right now. And I think there is some efficiencies we can pick up. But again, this is – we are talking about a couple of 100 basis points.

Ambrish Srivastava

Yes, yes. And I wasn’t asking for the next quarter. So, my quick follow-up then is on something you mentioned on the automotive side, you said U.S. you are underrepresented and you are seeing progress. What specific areas are you seeing progress in the U.S.? Thank you.

Don Zerio

Well, I think there is the vehicle itself and then there is the suppliers. And we play in all of that. I think clearly to-date we have been more successful with more of the luxury model cars in Europe and Japan and we have been successful with the electric cars in China. And that’s not to say we haven’t been successful in the U.S., it’s just been more so on the international market. But I think that clearly the ADAS opportunities and the autonomous driving vehicle in the future, I think some – I think even the big three automakers in the U.S. don’t want to be left behind there. And so they are started jumping as well. So, I think that type of market I think is coming more so from the U.S. and we certainly think we will play in there. And so in terms of dollars, I think internationally, the transportation business for us is driven mostly from over there, but we are definitely on a percentage basis are increasing the U.S. bookings and sales and we think that’s going to continue to grow.

Ambrish Srivastava

Okay, thank you. Good luck guys.

Operator

Our next question comes from the line of Vivek Arya with Bank of America. Please go ahead.

Vivek Arya

Thank you for taking my question. First one, on transportation, very impressive growth and I think you have mentioned the battery management system and the opportunity there. Could you give us a sense of the competitive landscape? Are you the only company in that space? Do you sense any competition in that space at all? Then beyond battery management systems, what are the other areas of focus in transportation?

Lothar Maier

As far as competition, we recognized probably almost a decade ago that there is going to be the emergence of these BMS products. And so we really were first to market with a viable product. And we are in a fourth generation product right now in production and we have got sixth and seventh generation products and beyond in development. And so granted it’s getting to be a visible market and competitors recognize it and so there are competitors in this space, but I think we, for the foreseeable future, have a pretty good technical lead relative to the competition. These are complicated chips. I mean, they are very, very complicated. And as I mentioned earlier, there is no way that one competitor is going to come in with one chip because every OEM has a different preference of what they want. And so there is many variations on the BMS product. So even though we kind of call it a product, it’s really a family of products. And I think we have got a good technical lead on the competition. In terms of automotive, in general there is just great opportunities. The car companies are announcing this 48-volt battery systems, you are going to see them starting with model year ‘16, ‘17 and beyond. You are going to see it really picking up. When that happens, there is good opportunities for us.

Silicon Valley here is becoming the new Detroit. Every OEMs here in Silicon Valley, there is some speculation, there is some new entrants in the automotive business developing in Silicon Valley as well. The one electric car manufacturer here in Silicon Valley is doing well. And so I think the domestic market for us is going to be good for automotive. It’s been a little bit slow for us when we dealt with sort of the big Detroit automobile companies. But we were I think a little bit hard on ourselves, because even though we didn’t sell too much directly to the OEMs, we had a pretty good content in the U.S. cars because they buy a lot of subassemblies from overseas. And so what we are seeing now is sort of the indigenous design wins happening in the automotive market in the U.S., which we haven’t had really strong up until the last few years.

Vivek Arya

Got it. Very helpful. And as the follow-up, this is perhaps a broader industry question, but when I look at the industrial end market, not just for Linear but across the board, in the last few years, we have seen very modest 2%, 3%, 4% GDP like growth, but given that semiconductors are supposed to expand content in most of that end markets, why has growth been so low in industrial, are there puts and takes in parts of industrial that are growing versus declining and what is an acceptable growth rate in that end market? Thank you.

Don Zerio

Well, that’s a hard one. One thing about the industrial business is 44% of our business is our largest market. There are so many customers, so many different types of businesses in that market. It’s hard to infer trends and patterns. So I don’t think I have a good answer for you and I don’t think Lothar have either, because he is sitting there shaking his head. But I just think that over the last year or so, the global market as you said has been – hasn’t been particularly strong and industrial market, I think you got to start with GDP. And so like we said we need the help from the market to grow that. But over the longer period of time when you look at the analog market, the growth markets have been industrial and transportation. And along with communications as well, that’s where we focused our business. So we feel confident that this low growth that you have seen overall in industrial is going to turnaround and grow a bit faster. Again our sales, generally happen 2 years or 3 years out from when we get from our sales and our wins to production. So we see what’s going on with our design wins that will ship in a couple of years. So we feel pretty confident that our strategy of focusing in on industrial markets is a good one and we feel strongly that you are going to see greater growth in industrial than what you have been seeing.

Vivek Arya

Okay, thank you.

Operator

Our next question comes from the line of Cody Acree with Drexel Hamilton. Please go ahead.

Cody Acree

Thanks guys for taking my questions. Maybe just following up there on industrial, can you talk about some of the subsets where you are starting to see some of the improvements in order visibility, maybe some of those profits that are still struggling and GDP dependent?

Lothar Maier

Yes. The industrial market is – nothing happens fast in the analog and nothing happens even slower, in fact in the industrial business. But if you kind of step back and look, there are some markets that are doing okay, the sort of the instrumentation market is doing well, the medical business is doing well for us. Anything attached to exploration and oil and gas right now is not particularly strong because of the obvious reasons, because of the low gas prices. Certainly if gas prices started to go up again, we would see a pick up in sort of the exploration part of the market. Some of the alternative energy subs where we are starting to see some interest in solar and wind, that could be a good market for us as well in the future. We take that up in the industrial business. So it’s like a thousand different stories. There is just not a big trend that falls through that market. And it’s not made up of big customers, its lot of medium-sized customers. So it’s not like one person or one customer dominates of this business.

Cody Acree

And maybe if I would just ask you to read the tea leaves I guess a little bit, as you push through beginning of the year and you started to see these better booking in parts of comps and throughout industrial and in transport, do you get a sense that this is really just a snapback from an inventory correction or a bit of seasonality or are you optimistic that you have build any momentum here that either because company specific or just end markets specific that is more than just a bounce back of an inventory correction?

Lothar Maier

Yes. I think we had momentum going into just prior to the drop in sales. And as I have mentioned earlier, there is no reason for the drop in sales. We didn’t lose any customers. We didn’t get kicked out of any programs. It just was an inventory reset and I think you are seeing that reset taking place here in the last couple of quarters. And I think we will pick up the momentum that we had before this inventory correction. And if you look at where we are strong in the industrial and the automotive segments of the analog market, that makes up 50% of the total analog market. And it’s the only two markets in analog that really have any sort of sustained growth. So it’s not like we are in the wrong markets. We are kind of in the right markets and we are strong in those markets and those markets are growing. So I think from a momentum standpoint, I think we are well positioned.

Cody Acree

Thanks guys.

Operator

Our next question comes from the line of Steve Smigie with Raymond James. Please go ahead.

Steve Smigie

Great. Thanks a lot guys. I wanted to follow-up on the optical market, I was hoping you could talk a little bit about where you see your strengths are part-wise, so laser drivers, etcetera? And as this datacenter market ramps, are there certain distances, speeds that you are particularly good at that you think you are levered to?

Lothar Maier

It’s not so much the speeds, meaning that when the speeds go up, there are some huge requirements. There are these very complicated ASICs that are involved in these optical systems. They have many, many power rails that needed to be powered. And it has to be done with very high efficiency because these things were in very small, compact, not very well cooled locations. And so there is a lot of electronics to get this optical stuff to work. And I think we have got some good solutions in small footprints. Our micro modules do well in that area. They have a footprint that you can’t do discreetly so those products do well in optical. And it’s really in this sort of not the photonics part of it it’s in support of the electronics that goes into photonics.

Steve Smigie

Okay, great. And then just sort of nitpicking on the industrial here, but you guys talked about some pickup here, how much of that will be what you talked about a little bit there as just sort of returning back to normal demand post sort of an inventory correction versus end market demand picking up versus you guys just having good designs that are taking off, so I am just trying to get at how much of this is just to end market demand picking up versus good stuff that you guys have done?

Don Zerio

I think it’s a combination of both, really. I mean bookings back three quarters ago, they almost fell off the Cliff a little bit surprisingly and where customers that were booking at a steady pattern suddenly stopped booking and that was large customers as well as smaller customers. So I think there was a couple of quarters where they took their inventory levels down, maybe to coincide with their own lower growth, optimistic growth rates. But we said back then that even though there was weakness and you saw the decline in bookings, most of our customers and we are talking thousands were still optimistic about their business and they were growing. So, I think it’s probably both that they are getting back to their usual levels of booking, their inventories are in good profile, but we think we are growing from there. So, we think we have got growth ahead. This is more than just sort of a snapback from erection.

Steve Smigie

Great, thank you.

Operator

Our next question comes from the line of Harlan Sur with JPMorgan. Please go ahead.

Harlan Sur

Yes, good morning. Thanks for taking my question. Just one question on the emerging products portfolio, you guys mentioned the micro module products I think in answer to one of the prior questions. It is one of the more interesting product areas, because it is more of sort of systems level focus system-in package. Question is what end markets or applications are you guys seeing most traction for these micro modules and how fast do you see these products grow and if you look at pipeline of your design wins?

Lothar Maier

Yes, these micro modules are not designed specifically for any end market. They tend to be, for the most part, pretty general purpose. We probably initially developed these products to access small and medium-sized customers, customers that we couldn’t send our application engineers to visit. So, we have them these modules, which like you said is kind of a system in a package. It’s a done analog solution. All they have to do is solder it down on a board. And that worked. We sell these to many, many small and medium size customers who don’t have the in-house expertise. Somewhat to our surprise, they have also done very well in large and sophisticated customers who do have in-house analog capabilities, but we win that business really on two fronts. One front is because it’s done, they get a time to market advantage. And two, it’s in the footprints that even if they could do the analog design themselves, they could never do it in a small of a footprint. And so – but all those things are not directed to one specific market. We probably initially saw strength in sort of the communications market with the micro modules. Now it’s expanded to all over the place. We even have module now that goes into automotive applications. And my sense is we are probably going to see more of that as well. So, it’s not targeted to any specific end market.

Harlan Sur

Great. Thanks for the insights.

Operator

[Operator Instructions] Our next question comes from the line of William Stein with SunTrust. Please go ahead.

William Stein

Great. Thank you for taking my question. Gentlemen, earlier on the call, I think there were a lot of questions around automotive and you have spoken at great length about battery management systems. I am wondering if you can talk to us, in particular in China, right, I am wondering if you could talk to us about demand trends as you anticipate them in the coming year as the incentives that the Chinese government is running right now would seem to annualize in the September timeframe. Do you think that’s going to be a headwind to your automotive demand next year?

Lothar Maier

That’s a hard read. And all I can kind of say is well, I read the statistics about what the Chinese government is forecasting in terms of the sales of hybrids and electric and plug-in the hybrid vehicles. And they are certainly forecasting calendar year ‘16 is going to double from what it was in ‘15. It’s going to double again. I don’t know, the numbers are getting to be pretty large, but what we do know is that the market from our customer seems to be pretty strong. They are all saying they are going to grow going forward. We obviously take what our customers say sometimes with the grain of salt in terms of their forecast, but certainly the reaction we get from our customer base is that this isn’t sort of a one-year type of event. The sense is this is going to continue. If you have traveled to China at all, if the pollution is incredibly bad and I think they just have to fundamentally do something and to address it, this is one of many things that they are doing.

William Stein

It sounds like your automotive exposure there maybe a bit more mix than unit dependent, so that’s helpful, I get it. And one more if I could squeeze it in. Defense end markets, we have heard some companies suggest that the bids they are seeing from the big contractors, the larger customers in the space have become bigger and more strategic and I am wondering if you are seeing that bidding activity and whether it’s turned into any backlog that you might be able to discuss?

Lothar Maier

The mil space business for us has been pretty steady, meaning it’s been 6% of our business for a long time and it tends to grow approximately as the company grows. But you do make a good point. I can’t say I have seen everything, but there is some rumblings out there that, that might get better. We pick up space in that as well and there is a lot of people out there trying to figure out how to put rockets and satellites into space and we participate in that business as well. So, there are some things that allow us to be a little bit more optimistic, but I can’t say I have got anything I can put my finger on.

William Stein

Well, that’s helpful. Thank you.

Operator

And gentlemen, it appears we have no more telephone questions at this time.

Lothar Maier

Okay. Thank you for joining us on our conference call today. We look forward to talking to you again next quarter. Have a good day.

Operator

And ladies and gentlemen, this does conclude today’s conference. We do thank you for your participation.

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