Skyworks Solutions' (SWKS) CEO Liam Griffin on Q3 2016 Results - Earnings Call Transcript

| About: Skyworks Solutions, (SWKS)

Skyworks Solutions, Inc. (NASDAQ:SWKS)

Q3 2016 Earnings Conference Call

July 21, 2016 17:00 ET

Executives

Mitch Haws - Investor Relations

Liam Griffin - Chief Executive Officer

Don Palette - Chief Financial Officer

Analysts

Vivek Arya - Bank of America/Merrill Lynch

Atif Malik - Citigroup

Timothy Arcuri - Cowen & Company

Blayne Curtis - Barclays

Steve Smigie - Raymond James

Edward Snyder - Charter Equity

Cody Acree - Drexel Hamilton

Anthony Stoss - Craig-Hallum

Kulin Patel - BMO Capital

Craig Hettenbach - Morgan Stanley

Harsh Kumar - Stephens, Inc.

Craig Ellis - B. Riley

Mike Burton - Brean Capital

Vijay Rakesh - Mizuho

Quinn Bolton - Needham & Company

Chris Caso - CLSA

Operator

Good afternoon and welcome to the Skyworks Solutions’ Third Quarter Fiscal Year 2016 Earnings Call. This call is being recorded. At this time, I will turn the call over to Mitch Haws, Investor Relations for Skyworks. Mr. Haws, please go ahead.

Mitch Haws

Thank you, operator. Good afternoon, everyone and welcome to the Skyworks third fiscal quarter 2016 conference call. With me on the call today are Chief Executive Officer, Liam Griffin and Chief Financial Officer, Don Palette.

Before we begin, I would like to remind everyone that our discussion will include statements relating to future results and expectations that are or maybe considered forward-looking statements. Please refer to our earnings press release and other SEC filings, including our annual report on Form 10-Q, for information on certain risks that could cause actual outcomes to differ materially and adversely from any forward-looking statements made today. Additionally, the results and guidance we will discuss today are from our non-GAAP income statement, consistent with the format we have used in the past. Please refer to our press release within the Investor Relations section of our company website for a complete reconciliation to GAAP.

With that, let me turn the call over to Liam.

Liam Griffin

Thanks, Mitch and welcome everyone. Q3 marked another quarter of solid execution on the part of the Skyworks team. We exceeded our guidance, returned over $240 million in cash to our shareholders, and importantly, continued to broaden our design win pipeline, setting the stage for sustained market outperformance.

Looking at the results in more detail, we delivered revenue of $752 million ahead of our guidance; expanded gross margins to 50.9%, up 190 basis points year-over-year; produced operating income of $275 million, with operating margins over 36%. Finally, we generated $1.24 in earnings per share, $0.03 above consensus. Execution on revenue and margins, along with operating cost discipline were all key elements of this performance. In addition to the strong financial results, we continued to gain broad market traction. Specifically during the quarter, we powered Huawei’s P9 phone, incorporating 10 unique devices, including our SkyOne systems across low, mid and high bands; launched advanced carrier aggregation capabilities across a suite of premium and value tier accounts, including Samsung, Motorola as well as Oppo, Vivo and ZTE. We secured design wins for Continental’s 4G LTE automotive systems, captured digital attenuator and multimode repeater designs at Audi, and enabled enterprise radio for Google’s 3.5 gigahertz band ecosystem.

We also achieved several other milestones, including surpassing production of 2 billion filters cumulatively from our joint venture with Panasonic; ramping SkyBlue innovative technology for enhanced power management in LED flash drivers; commencing volume production of proprietary diversity received solutions and supporting the world’s first headcam with LTE connectivity in 4k video streaming. These major wins and others demonstrate our expanding customer and end market reach across both mobile platforms and the Internet of Things.

At this point, I will turn the call over to Don for a more in depth review of our financial results.

Don Palette

Thanks, Liam and thanks again for joining us, everyone. We appreciate it. Revenue for the third quarter was $751.7 million and that’s ahead of our guidance. Gross profit was $382.3 million or 50.9% of revenue and that’s in line with our guidance and up 190 basis points from the third quarter last year. Operating expenses were $107.6 million. That consists of R&D expense of $70.2 million and SG&A expense of $37.4 million. We generated $274.7 million of operating income, translating into a 36.5% operating margin.

Our cash tax rate was 12.7%, resulting in net income of $238.1 million or $1.24 diluted earnings per share, $0.03 ahead of our guidance. Our cash tax rate is now projected lower for fiscal 2016 at 14%. The Q3 rate was favorably impacted by a year-to-date adjustment from the prior 14% – 14.7% annual rate.

Turning to a summary of our third fiscal quarter cash flow metrics, we invested $57 million in capital expenditures with depreciation of $54.6 million, generated $141 million in cash flow from operations. We returned over $240 million to shareholders via dividends and the repurchase of 3 million shares during the quarter. Looking at product mix for the third quarter of fiscal 2016, integrated mobile systems was 55% of revenue, broad markets was 29% and power amplifiers was 16%.

Now, moving on to our fourth fiscal quarter business outlook. Based on the broad market traction, our new program ramps as well as the content gains Liam has outlined, we expect fourth quarter revenue to be up 10% to 11% sequentially to $831 million at the midpoint. The double-digit revenue growth we expect in Q4 followed by continued growth into our first fiscal quarter will reduce inventory. We have level loaded our factories and positioned ourselves well to address a series of new filter-rich program ramps with leading customers. For fiscal Q4, we suggest modeling gross margin at 51%. It’s worth noting that our Q4 gross margin guidance implies a 100 basis point improvement versus the prior year fourth quarter even with a lower revenue base.

Looking at OpEx, we expect R&D and SG&A expenses to be flat with Q3, reflecting continued cost structure discipline. Below the line, we anticipate around $1 million in interest and other expenses, a cash tax rate of 14%. We expect share count to be roughly 190 million shares, driving fourth fiscal quarter fully diluted EPS of $1.43. Lastly, we also announced today that our Board has authorized an 8% dividend increase and a new 400 million stock repurchase program, underscoring the confidence we have in our business model and our ability to deliver superior returns to our shareholders.

And with that, I will turn the call back over to Liam.

Liam Griffin

Thanks, Don. Our third quarter execution highlights our differentiated competitive positioning and the strength of our business model. We are levered to powerful secular technology forces and we have spent the last decade aligning the company to capitalize on these strategic macro trends, propelling our mobile IoT and broad market opportunity. First is the explosive growth of mobile data across the vast set of applications and usage cases, driving performance from device to cloud and beyond. Next, we are seeing an ever-increasing expansion of connected things, with tens of billions of newly connected devices brought to market over the next 5 years. And finally, we address a tremendous ecosystem and new economy that thrives on the ability to leverage high-speed and secure connectivity at the heart of their business. Enabling these connections is the sweet spot of our franchise.

In mobile, we have growing content positions across all of the world’s premier OEMs, leveraging our unique capabilities to meet our customers’ increasing need for higher performance solutions. We are also building momentum in broad markets, particularly in IoT, with engagements at leading players, including Amazon, ARRIS, Cisco, Fitbit, GE, Google Nest, Honeywell, Itron, LG and others. Our success here has been brought about by a broad and growing list of wins in adjacent markets like industrial, energy management, security, health and fitness and the smart home. Today, we participate in all of these verticals through our suite of diverse technologies, including support for WiFi, ZigBee, Bluetooth, GPS, small cell and LTE standards. At the same time, we are building presence in key verticals like automotive, with leaders such as Continental, Audi, Ford, Kia, GM and Volkswagen.

Underpinning all of our solutions is the skyrocketing demand for wireless data. Whether it’s Facebook, Amazon, Netflix, Google or Tesla, there is a powerful and expanding ecosystem, monetizing and relying upon efficient, high speed, low latency, seamless and secure connections. This ecosystem spans across enterprise to e-commerce to social media and a burgeoning set of entirely new applications fueled by connectivity. In an effort to facilitate this massive and growing wave of data delivery, creation and movement in storage, our customers are implementing methods to improve performance with carrier aggregation, received diversity, MIMO and ultimately 5G capabilities. This dynamic requires a continuous increase in the levels of analog and mixed signal performance, enhanced power efficiency, high-precision filtering as well as configurable systems integration capabilities. Skyworks’ suite of products and system solutions are squarely aimed at resolving the intense performance demands facing our customers.

So to summarize, we delivered above guidance results in the quarter, driven by increasing global demand for high speed connectivity coupled with strong operational execution. And as our guidance reflects, we are planning for sustained market outperformance with operating leverage and strong cash flow generation. Clearly, we remain well positioned to realize our vision of connecting everyone and everything all the time.

That concludes our prepared remarks. Operator, let’s open the lines for questions.

Question-and-Answer Session

Operator

[Operator Instructions] And the first question comes from the line of Toshiya Hari of Goldman Sachs. Please go ahead.

Unidentified Analyst

Hi, this is Charles on for Toshiya Hari. Thanks for taking the question. I was wondering with inventory at these levels, can you kind of walk through some of the content and unit assumptions that underpin your confidence in being able to get inventories down going into Q1?

Liam Griffin

Sure. Well, as we discussed in the prepared remarks, lot of that inventory is filter driven and really filters that are designed into known programs with known ramps in the second half, not only transmit solutions, but also receipt side technologies, some GPS technologies and an expanding set of customers now that will be taking those filters and those solutions into their applications. So the lion’s share of that material, that inventory, largely filters is really lined up relative to second half ramps with known customers so and a very clear demand curve.

Don Palette

And just to follow-up generically on the inventory and just keep in mind that that inventory growth that you are seeing in the Q3 is it supports the second half. Volumes were up about 11% quarter-over-quarter and then there is growth as we continue in the fiscal Q1 of ‘17. There were multiple things that Liam was talking about burning the inventory down. I am just going to give you the summary of why the level is where it’s at. The level, we were level loading factories to meet that second half demand. The share gains in filters especially silicon is driven by new programs. There is specific growth assigned to some ramps and there is essentially no risk with any of – risk with this inventory. We also had a new hub arrangement for a large customer in Asia. That’s a one-time stocking bump in inventory. And some of the projected product mix into Q4 just has longer lead times for some of the outsourced materials and it’s primarily silicon wafer. So the bottom line, we are very confident in the decline going forward and getting the turns back towards historical levels. So this is a short-term issue that we are working through based on those dynamics.

Unidentified Analyst

Got it, that’s helpful. And then as a follow-up, I guess with the – given the buyback, could you just maybe run through some of your thoughts on M&A and your strategy on diversification via M&A?

Liam Griffin

Sure. Well, I mean we first and foremost are committed to running our core business. And we think there is great opportunity to leverage not only our strength in mobile, but now you are hearing more and more about our opportunities in broad market, specifically IoT. So we are committed to that. Now in parallel, we have a disciplined view on M&A, but we certainly are looking at potential opportunities. We will share more with you as they come about. But we are focused on our core, but have the powder, the balance sheet and the opportunity to certainly augment that with M&A as needed.

Operator

Okay, thank you. And the next question comes from the line of Vivek Arya of Bank of America/Merrill Lynch. Please go ahead.

Vivek Arya

Thanks for taking my question. For the first one, Liam I was wondering if you could just give us a sense of the overall demand environment, obviously the industry has come through an inventory correction at your largest customer, are we past all those problems, so now we should start to expect more normalized growth, if you could address that. And also if you could take it more broadly to the trends you are seeing at your Korean and Chinese customers, I think basically, I think investors want to understand, are we past some of the issues we saw in the first half and it’s a more normalized growth environment going forward or is the industry still struggling with a little bit of the inventory issues that came about in the first half?

Liam Griffin

Sure, Vivek. I will take both of those questions. Well yes, I mean we have been through a challenging first half of the calendar year, for sure. And I think that’s been well publicized and reflected in our numbers in the past. We are seeing improving conditions right now. We are seeing all of our Tier 1s grow. And more importantly, we are seeing our content position expand and their need for the content expand. So the dynamic around performance and our ability to resolve performance with systems level solutions is coming together quite well. And you can see in this guide 10% to 11%, pretty solid guide up into Q4. We feel that that’s sustainable. We expect – so early for Q1, but we do expect to be up again into Q1, so that’s kind of a broad statement. And if you look at China and Samsung, both of those opportunities, China being more of a broad opportunity with some of the flagship names like Huawei doing very, very well for us and China will be one of our faster growing areas. Samsung, we got content gains on the GS7. That’s looking good this year. Samsung will be probably a 15%-plus account for us year-over-year. We are lining out for the GS8. So what you can look at here at a high level is this continuous need for performance and Skyworks’ ability to address not only our core positions in SkyOne and some of the transmit chain, but also an increasing position in analog and increasing position in the receive side, WiFi and other technologies that will allow us to grow our share.

Operator

Okay, thank you. And the next question comes from the line of Atif Malik of Citigroup. Please go ahead.

Atif Malik

Hi. Thanks for taking my question. A question on the gross margins, I mean your gross margin were a smidge below the 51% guidance you gave, even with the higher revenue level and broad markets doing better and your guidance of 51% is flat on higher revenue, can you just talk about incremental gross margins, we have not seen these lower committed gross margins in the last like six quarters, so can you talk about the puts and takes on your gross margin line and should we be thinking about 60% incremental gross margins moving forward and also a 53% mid-term model that you have shared in the past? And I have a follow-up.

Don Palette

Yes, sure. We will talk about the incremental contribution margin that we saw in Q3, being that that was a down revenue quarter, was actually a number that was very good in the high 40s. And when you are in down revenue, you want the number to be below which you are normally posting, so that’s good. When you do look at the guidance, we are at about 52.5% on an incremental basis and that’s simply reflective of the backdrop, the unique elements that we highlighted in the Q4 inventory. Going forward when you are looking at our earnings model opportunity, the 53% is absolutely still our target. And we expect these incremental margins very, very quickly to get back to the 58% kind of level, which is what we have communicated consistently externally. So there is no issues there. We are just working through this the inventory issues and the tough backdrop issues that Liam mentioned, but nothing else specific.

Atif Malik

Great. And then you mentioned in your prepared remarks about the low, mid and high socket wins in the Huawei phone, can you just talk about why we don’t see you in mid and high band in some of the other flagship models in India and Korea and in the U.S. and if you guys are planning to get to those sockets or maybe the specifications of the Huawei phones are different than those other devices? Thanks.

Liam Griffin

Yes. No, that’s a great question. So first off, I will tell you we are encroaching some of the mid and high bands organically with enhanced performance in our TC SAW factory. And as noted in the prepared remarks, we have shipped over 2.5 billion filters, all of which were consumed by our systems solution. So we are not a discrete filter company. Having said that, our performance levels not only with the filter, but the entirety of the system, so if you think about what customers want from us is they want solutions that resolve this tremendous complexity. And those solutions from Skyworks are really system level. They include our own gallium arsenide HBT process that we have in-house, our SOI process, our deep IP and switching, our ability to craft MCMs for very, very low loss and high efficiency, delivering a complete module. So our modules can often include our own TC SAW. We have been able to move the TC frequency up to mid-band. And in some cases, if the frequencies are not applicable for TC SAW we can address by our foundry partners for bulk. So that’s what you are seeing now in the Huawei phone. I think you will continue to see us extend our reach in frequencies and continue to do what customers want, really simplify their solutions, give them the best end-to-end efficiency and the best systems level performance.

Operator

Okay, thank you. And the next question, it comes from the line of Timothy Arcuri of Cowen & Company. Please go ahead.

Timothy Arcuri

Thanks a lot. I guess I am still trying to understand the inventory. You said that you are building ahead of the ramp, but the revenue is guided down like $50 million year-over-year at the midpoint. So, I would have thought that if you are building for more content gains that you would think that the revenue guidance would have been a little bit better year-over-year. So, is the answer really that it’s going to sell through more in the fourth calendar quarter? Because I guess if you could commit to a big up fourth calendar quarter, then the inventory build would make a little more sense. I am wondering if you can comment on that? Thanks.

Don Palette

Part of the sell-through, you will see both the Q4 and then into Q1 as well. You will see both of those, so that’s clearly part of it.

Liam Griffin

Yes. And then also just recall that we have 3x the size of our filter franchise so to speak. When we get the deal with Panasonic, we had one site in Kadoma. We have added a large site in Osaka. We have many more customers now that are engaged with us with filter-based solutions. So, we are running that larger factory, running that larger footprint in high-performance filters, there is more WIP, there is more inventory, and there is more programs by which we are going to sell into. So, that’s the difference when you look at year-over-year. The size of our filter franchise is quite a bit bigger. The number of customers that we address is quite a bit larger. And specifically in the second half calendar year, you are going to see that action come to bear and we are going to see the inventories come down as well.

Don Palette

I am sorry, one thing that I wanted to add to is that when you look at the build that we had this quarter it’s all raw materials and WIP. There is literally no finished goods build, very little. So, that just supports that future growth opportunity.

Operator

Okay, thank you. And the next question is from the line of Blayne Curtis of Barclays. Please go ahead.

Blayne Curtis

Hi, guys. Thanks for taking my questions. Maybe just when you look at the September guidance, just trying to better understand what you are embedding in there, if you can talk about what you think broad markets will do into September? And then assuming that’s not down a ton, it looks like the integrated mobile is down year-over-year. Obviously, your largest customer has a got unit headwind to deal with. You have content gains offsetting. Is there any other headwinds that you are dealing with in integrated mobile?

Liam Griffin

Well, I mean I think for the most part if you look at the quarter here, we are speaking Q4 guide, we are still – there is some headwind in some ways of mix, legacy mix SAW that it really hasn’t come to bear. But we have factored that in. We are seeing overall growth. If you were to exclude our largest customer, we are up 10% to 12% year-over-year in the quarter. So, I mean, some of the headwinds with our larger customers still are reflected in our numbers. We are growing the non-core PAB business quite well and that’s IoT. That’s diverse and you received technologies that are quite new for us. Our WiFi business is strong. All those portfolios look very good on a year-over-year basis. And we are starting to get out of the inventory hold that we mentioned with some of our larger customers. And things definitely look better in the second half with respect to that.

Blayne Curtis

Liam, just on broad markets, you had a very strong quarter in June despite the divestiture was up. Could you just talk about the trajectory down into September?

Liam Griffin

Yes, will be up a little bit in September, probably 5% to 8%. I will tell you this though within broad market, IoT is it will be up 10% to 15%. And year-over-year, IoT is probably headed for high-teens. So within the broad market space, what you have there, Blayne, is some markets that are doing quite well IoT. We also have some legacy markets like infrastructure that are great markets and have super margin, but just have been flattish in terms of top line. So, the blend together looks good, but IoT is the sweet spot within broad. It’s really special for us right now.

Operator

Okay, thank you. And the next question comes from the line of Steve Smigie of Raymond James. Please go ahead.

Steve Smigie

Great. Thanks a lot. You introduced a whole bunch of new products here such as the digital attenuators and antenna tuning, etcetera. Can you talk a little bit about how much of your content on the phone now comes from outside of pad type device? I know there is lots of SKUs out there, but just trying to get a sense of how broad you are getting now across the phone outside of just some more classic parts?

Liam Griffin

Yes, no, that’s a great – I don’t have an exact stat for you, but I will tell you, it’s definitely increased over the last year and it will increase in the second half of this year. Some examples you have mentioned us talk about diversity you received. I mean, this is some real elegant proprietary technology that Skyworks has created. It levers our filter technology. It levers our LNA, low noise amplifier expertise, our switching and again that configurability with our own MCM. Great technology and what it does is just tremendous, tremendous improvements in the downlinks portion of the phone. And if you think about the way typical usage cases that broke on phone, downlink is critical. So, we provided great enhancement to downlink speed. That’s one area that is relatively new for us and it should be a big growth driver. Some of the SkyBlue technology that we mentioned before is unique for us, driving power efficiency through the system. We have had WiFi for quite a while, but now what we are starting to see is MIMO WiFi in some of the leading flagship phones. Our content virtually can double with MIMO. There is a lot of great things happening, antenna tuning and other points, GPS for location-based services. If you think about we have talked about the ecosystem with some of the big tech players now engaged in mobile, a lot of these folks are involved in payment. They want to know exactly where people are, precise location. We have a GPS portfolio now that is really emerging and increasing attach rate with some of our customers. So, all those things blend in. And you are seeing definitely a larger increase in kind of the nontraditional pad business, although that remains core, but a bigger swing now to some of these newer devices.

Steve Smigie

Okay, great. Thanks. And I was just wondering, I mean obviously as other folks mentioned, it’s been a little tough with some big customers out there being challenged, but do you have some sense of when you think you may – what quarter you might return to year-over-year growth rates?

Liam Griffin

Yes, year-over-year – okay, so ‘16 to ‘15?

Steve Smigie

Right, yes. So, I mean, is it possible to say like March of ‘17, would that be a quarter where we would expect to start to see sort of year-over-year growth rates resuming?

Liam Griffin

Yes, yes absolutely. Okay, I got your question now. Yes. I mean, certainly, we get through the second half year. Obviously, we are coming off of a $752 million, 10% up. We expect to be up again in Q1. We don’t have a full guide yet for that quarter. But I think when we get into the March quarter we should be back on track with year-over-year growth. And then just also just to remind you, I think we mentioned it before, but even in the September quarter, we are looking at comparable levels of operating income percentage, so comparable levels of profitability even at lower revenue. So, it has been a challenging period for us, the last couple of quarters. But I think you can see some financial discipline here at least in the P&L.

Don Palette

Yes. And you will see sort of normal sequential growth pattern starting again, but the year-over-year, as Liam says, is going to be in the second quarter when we see that.

Operator

Okay, thank you. And the next question is from the line of Edward Snyder at Charter Equity. Please go ahead.

Edward Snyder

Thanks a lot. Filters, you mentioned over 200 – or 2 billion of those filters, but probably like 37 are TC SAW. Is the big expansion in Panasonic facility all for TC SAW, Liam or would you get into SAW manufacturing? And if you do, how is that going to impact the GM, because I know think you are finding those on the outside world now? And then the second question, on the competitive environment when you are done, please?

Liam Griffin

Okay. No, a great question. So, yes, certainly the filters that we produce thus far have largely been TC SAW. And as you know well, I mean that as a flavor of high-performance filters that’s in high demand and it’s allowed us to lever that up into SkyOne systems for low and in some cases, mid-band. And it’s been served us very well. Now, going back to standard SAW filters is actually quite easy. It’s fewer process steps. You will eliminate the silicon dioxide plating. It’s a cheaper process for us. And you are correct that we do still spend quite a bit of money outside for a third-party SAW. So, there is potential opportunity for us to bring that in-house. And then finally that site in Osaka has the ability. It’s a phenomenal site, class 10 clean-room, beautiful facility and we do have the opportunity to expand further and higher frequencies if needed.

Edward Snyder

Okay. And then you are clearly number one in TC SAW, but by a distant margin here. So, it sounds like your expansion plans are going to be even further. Now, in the competitive environment, I mean it seems like it’s shifting pretty dramatically here. Marotta has already stated this losing share to largest customer this year. And it looks like that’s all to you, but then you are also splitting the little [indiscernible] with Qorvo. You didn’t do that last year. Qorvo has also entered the DRx section at Samsung where they weren’t last year. So, how do you see, Liam, the competitive environment shaking out in say, calendar year 2017? Are the Japanese firm which are disappearing, I mean, you guys got Panasonic [indiscernible] – are they going to disappear faster than say Qorvo shows up at some of these sockets? And is all this going to be kind of a footnote to overall TAM growth in the RF section in ‘17? I am just trying to get your view of the bigger picture. Thanks.

Liam Griffin

Yes, yes, that’s a lot. Let me try to help you with that. So, I will tell you what we see. We see the performance nodes going up and up and up, with each successive generation whether it be our largest customer over the next two or three down, we really see that happening. And that’s actually – that’s propelled our growth more than anything, our ability to hit the more challenging architectures and do it with profitable solutions and integrated solutions that served us very, very well. We are confident that you will be able to see content gains with all of the leading accounts, regardless of baseband partitioning. We are agnostic to baseband. We work with Qualcomm. We work with Intel. We work with MediaTek, Hisilicon, all of those players. And so we don’t expect any issue with that. But yes, competitively the companies that can hit the performance and the companies that can do that elegantly and unburden our customers with these daunting challenges that they are facing, those are the ones that are going to win and we will be at the top of that list. I mean that’s the whole essence of Skyworks to try to drive a strategy around performance, integrate as much as we can, work with our customers, listen to what they need, it may be different. Every account wants something different, but be flexible enough, leveraging our internal capabilities, leveraging [indiscernible] for highly configurable devices, picking the right flavor of filter, but really looking at systems performance from input to output. If we do that well, our business will follow.

Operator

Okay, thank you. And the next question is from the line of Cody Acree of Drexel Hamilton. Please go ahead.

Cody Acree

Thanks for taking my question. And maybe just continuing on that theme with your expansion in capacity and really seeing significant expansion at Qorvo and at Broadcom as well, are you concerned at all about the supply-demand balance of this industry as we get that over the next few quarters?

Liam Griffin

Yes. Cody, its funny if you look at what is happening in these devices now, it is incredible. The filter count that is absolutely required by our customers and just by virtue of the crowded spectrum that we see. So there is going to be I think a shake on who is going to wind and who isn’t going to win based on how we put those filters into a complete system. Our customers really are less interested in buying discrete components today and more interested on those highly efficient engines that we spoke of. So we are very confident with our ability to address and as you know from history with Skyworks, we are very disciplined on our CapEx and we are careful with where we invest. So we certainly know where our filter strategy is going and our ability to win. And with respect our competition, we have competed with Avago and Qorvo and others for years and years and we certainly like our outlook here at Skyworks.

Cody Acree

And just trying to get maybe a little clearer picture on the September guide, I know you have been asked and answered these questions about inventory, but do you believe that you are still dealing with anything that’s either causing you to be conservative or weighing a bit on that 10% to 11% guide, you got obviously there a major customer build that you are prepping for, you got some seasonality happening, you got what appears to be a relatively healthy market in China, maybe I think I am just a bit surprised that this wasn’t a bit stronger guide?

Liam Griffin

Sure. Yes. I mean 10% to 11% is I think is a pretty healthy move up for us. Yes. There has been of course some lingering effects of legacy platforms that we have had to manage through and that is be managed through, so all of that is reflected in the numbers. I will tell you one thing that we really need to highlight here again is absent our largest customer, we are up 10% to 12% year-over-year. And also across mobile, we are specifically expanding our content reach. It was a question that was asked earlier on the call. But the percentage of revenue we derive in mobile with technologies that are really more like analog mix signal, that percentage is going up. Our IoT business looks very strong right now, our broad market business looks very strong. It’s been a tough opening two quarters of the calendar year, quite frankly. And we are coming out of that now. Is there some lingering headwinds that are reflected in the number, yes possibly so, but that’s in the guide.

Operator

Okay, thank you. And the next question, it comes from the line of Anthony Stoss of Craig-Hallum. Please go ahead.

Anthony Stoss

Hi guys. Just drilling down with further Liam on China, can you talk about how much it was up in June, do you expect it to be up also in the September quarter, what percent in China currently makes for your business overall total revenues and what you think the inventory in the channel looks like in the China? Thanks.

Liam Griffin

Sure Tony. Well at a high level, China is about 25% of our company revenue. And they were up sequentially more than 10%. They look good in the second half calendar year. I think one of the accounts that we highlighted in the prepared remarks was Huawei. We have got a great position there, not only with the P9 phone that we mentioned, but with the Honor series and others. There is also another opportunity in China I think most of you know. But China is a tremendous export player to the rest of the world and there are still 2 billion to 3 billion people out there that have no connectivity. And so we are able to speed that through our partnerships with MediaTek and Spreadtrum and even Hisilicon that often make models that will go to India, the Middle East, Africa and some of the other emerging markets. So we look good there. The recent numbers in China have been strong. We are also seeing, I think some of these came through some of our peer group’s calls as well. We are seeing a move more towards five modes from three modes, so that increases our content. The recent carrier data shows some better pickup in 4G, LTE. That’s good. So for the most part, China has been actually really an improving story here in the last few months.

Operator

Okay, thank you. And the next question, it comes from the line of Ambrish Srivastava of BMO Capital. Please go ahead.

Kulin Patel

Hi, it’s Kulin Patel for Ambrish. Thanks for taking my question. On China, we also heard from others talk about strength in China recently, are you concerned about overbuilding there, given the strength in China?

Liam Griffin

No, we are not concerned about overbuilding. We have – one of the larger accounts we have in China now we have moved to a hub arrangement, which is again part of the inventory issue. But it’s fully lined up, you can’t overbuild in that environment, so you basically just meet your customers’ hub needs. They pull the open market, broad customers in China. We work very closely with MediaTek and some of the other baseband partners to get a broad forecast. Some of the solutions that we sell into that ecosystem are fungible. So they can be sold to multiple customers. That will net out the puts and takes of kind of broader market within China. But no, we feel very, very solid about the inventory dynamics and revenue dynamics with respect to China. We have been in that market for a long time. We were a 2G player, a 3G player. And now actually with 4G and our ability to expand reach, the market for us now is probably the best it’s ever been.

Kulin Patel

Thanks. And a quick follow-up, earlier in the year you talked about divesting Trans-Tech I think with a ceramic filter company and I think in your last 10-Q, it looks like you are no longer divesting this asset, can you talk about what would maybe changed your mind on that?

Don Palette

To answer your question specifically, they continue to be part of a business. We haven’t gone ahead with that sale. And it’s just the business that at this point, we are comfortable keeping. And we think that there is some growth opportunity going forward associated with it.

Operator

Okay, thank you. And the next question, it comes from the line of Craig Hettenbach of Morgan Stanley. Please go ahead.

Craig Hettenbach

Yes, thank you. Just going back to the inventory build, do you think this will be kind of a one quarter issue or is it something that it takes kind of into the December quarter to work down. And then any kind of sense of just for the gross margin impact that you are seeing as you have to throttle back a bit?

Don Palette

Yes. As far as where we think it’s going to be, it’s going to be flat to slightly down going into this quarter. But remember, that’s also supporting higher revenue growth going forward, so some of that is the impact of the revenue growth. The turns are going to begin to move back to historical levels. So as far as the velocity of the inventory, you are going to see us get back there very, very quickly.

Craig Hettenbach

Got it. And then just going back from a dollar content perspective as you look into the fall and upcoming launches, just a general sense as to how you feel about the growth in dollar content?

Liam Griffin

No, we feel very positive about the growth in dollar content. And I know I have said it a couple of times already in the call, it’s really twofold. It’s continuing to do well in our core business and our core opportunities in mobile, but also getting a larger region to some of these other opportunities within a handset. And you will see that going out by leading customers.

Operator

Okay, thank you. The next question is from the line of Harsh Kumar of Stephens, Inc. Please go ahead.

Harsh Kumar

Hi, Liam. First of all, congratulations on your new position. One of the questions we get a lot from investors is about your bar strategy or lack of it, how many of the upper end slots and filters can TC SAW address and eventually what would you guys have to do to be able to get to that upper level of filters?

Liam Griffin

Sure, thanks Harsh. Well, as I outlined earlier, we can address the upper level of filters today. We just we do it with foundry partners, for example. We would love to be able to build it in-house and that’s something that’s not out of our reach. It just isn’t there today. Our TC SAW capability has moved up in frequency where it was largely just a low band play, maybe 600 meg and 900 meg. We now have technology well over 1 gig, getting close to 2 gig and 2.5 gig. And again, back to what I was mentioning before, we don’t have an appetite for selling discrete filters. So, when we sell a filter, it is wrapped within a complete system. So, the filter contributes some level of performance. But you also have your HBT, your switch, your MCM and your ability to minimize losses within your layout. So, a lot – and that – with Skyworks, virtually all of that I mentioned is controlled in-house. So, think about us as a system solutions player. Filters play a role in that system. But the entirety of the architecture is what matters. So, we have won programs with Huawei. We are close with some other customers. There maybe a few opportunities where optimal filter performance is the number one requirement. That maybe the case for some of the discrete applications or maybe some super high performance, high-band sockets. Today, perhaps we can’t address that. But we have the engineering talent, the filter assets and the people and the processes in place to continue to push that envelope and grow them.

Harsh Kumar

Great. And for my follow-up, Liam, what is the – what are the one or two major focus areas for you in the first 12 months of your CEOhood?

Liam Griffin

Yes, yes, sure, thanks. Well, number one, we definitely want to continue this push by leveraging our core in mobile and taking advantage of this expanding opportunity that we mentioned, receive side technology, WiFi technology, GPS, power management and others and try to create the same systems level approach in that section that has worked so well for us in SkyOne and in transmit. That’s one. The second is stepping up in IoT. I mean, this is the market we talked about for the last few years. We talked about broad market. But within that, the IoT landscape and the class of customers that we engage with today is phenomenal. And we have a unique opportunity, because most of the players in IoT feature one or two connectivity topologies. We have WiFi. We have Bluetooth. We have ZigBee. We have low-power technology. We have power management. And we have tremendous know-how on how to make connected things work and make them work wirelessly. So, we are excited about that. We are going to put more resources around that part of our business. Some other opportunities that have really come along nicely, albeit still quite small, are markets like automotive. We are being pulled into some of the premier players that we mentioned in the opening remarks bringing in full LTE modules and automotive very high performance, high-reliability modules that’s looking good. So we are going to fire on all of those cylinders and then from there continue to drive with the best people and the best execution in our space.

Operator

Thank you. And the next question is from the line of Craig Ellis of B. Riley. Please go ahead.

Craig Ellis

Thanks for taking the question. I will start with a question for Don. Don, if I approach the gross margin issue in a different way. As you look at getting from where you are back to those 58% incremental gross margins and prioritizing the improvement drivers that can close that gap, what’s on the list? It sounds like getting inventory down is one item. I think I heard you mentioned that filter in-sourcing is another, but what else is on the list? And how quickly did those different factors come into play and really provide tailwinds for the margin structure of the business?

Don Palette

Yes, they come in very, very quickly. Part of it when we talked about the inventory issue and the level loading that’s been going on, I mean even though the hybrid model serves us really well, we were able to pull in a down quarter as we are able to pull production capacity and externally. You are still not, during this period, we weren’t running completely full. So, that’s going to be something that’s very quickly going to get us back up into the incremental margin track. And that’s a big driver of this. And then the other thing is the new product launches as we move forward. We have said we are very focused on every new generation of products going to provide incremental margins. So, that will all be in the mix as we move forward. We are excited about some of the IoT opportunity, as Liam talked about. So, those are the things, Craig, that – and we have a lot of confidence in the visibility to get down the road to the 53% target. That’s still in front of us, for sure.

Craig Ellis

Okay. And then the follow-up is for Liam. Liam, Skyworks I think has been well-known for an above industry average grower. It doesn’t look like it’s playing out that way this year, but we understand the challenges that exist with the large customer. The question is, how patient will you be with the business in getting back to above industry average growth organically? And at what point, will you feel like you have to press for M&A to diversify the business and get back to some of the growth rates and relative growth rates that we are used to seeing from the company?

Liam Griffin

Sure, Craig. That’s a great question. Well, first of all, I am committed and have great confidence that the organic business, the organic franchise will be an outperformer in terms of growth. Now, we are a bigger company than we were a couple of years ago. There is some level of maturity in unit growth and mobile, which has been the biggest market for us, but we are able to augment that with the share moves that we have talked about. And think again about the usage case that the entities that use mobile technology and what they want and it’s daunting. So, I think it will be solid in core mobile. And I am very comfortable with the opportunity with TAM given some of the new architectures and roadmaps that we have visibility into. Broad market needs to become much more of an IoT play for us. I think that’s really what broad markets means now. And we have great solutions for it. I think we need to put more people behind it, more engineering and help folks behind that. That should work. Now, in parallel, M&A is absolutely an opportunity for Skyworks. We have a tremendous balance sheet. We generated a ton of cash. And I think we will be able to do the right deal when it comes about. But having said all of that, day to day, we are running the franchise, optimizing the franchise, doing everything we can to continue to put the growth up, the margins up, and satisfy our customers. M&A is another area that we will continue to pursue.

Operator

Okay, thank you. Next question is from the line of Mike Burton of Brean Capital. Please go ahead.

Mike Burton

Hey, guys. Thanks for letting me in. So, obviously we are a little early to be talking about the December quarter. But given your visibility into product ramps and kind of inventory levels, how do you think we should be thinking about the December quarter relative to kind of normal seasonality? I think it’s been bouncing around quite a bit, but kind of in the mid-single digits historically?

Don Palette

Yes, Mike. I think at this point, again we can provide some color on it. We are not in the guiding the numbers, but I think if you look at sort of the historical growth opportunity of high single-digits. That’s a number that I think is reasonable for your modeling right now when you think about that opportunity.

Mike Burton

Great. Thanks. And then Don also your thoughts on OpEx going forward, anything relative to BAW development or anything else that we should think about as we frame out our models? Thanks.

Don Palette

No, I mean, the BAW OpEx, the engineers that we have and the joint venture or the operations in Japan are already in the run rates. And then the investments we make will continue to be the headcount, which is primarily going to be engineering focused. That’s tended to be where we have done it. And I would go ahead and model after the December quarter, if you are adding about 2 million a quarter from that level I think that’s a reasonable assumption as we move forward. You can see during these last three quarters that with the backdrop we have been dealing with, we have done a good job of managing that number fairly flat during that timeframe. But going forward, we will be making investments and that will be primarily headcount.

Operator

Okay, thank you. And the next question is from the line of Vijay Rakesh of Mizuho. Please go ahead.

Vijay Rakesh

Hi, guys. Just on the filter capacity, how much capacity are you adding this year, and is the TDK completely in-sourced now?

Don Palette

Could you repeat that?

Vijay Rakesh

In terms of filter capacity, how much capacity are you adding this year? And I know you are sourcing some filters from TDK, is that completely insourced now?

Liam Griffin

Yes, I mean the filter capacity right now we are in pretty good shape. There is a possibility as we try to move into certain specialty filters and perhaps move up in frequency. There could be additional CapEx. But we have – we made a very robust move in capital, expanding our line that we talked about. We now have about 3x the capacity that we had a couple of years ago. Again, with a number of platforms and customers lined up to consume that. So, that’s where we are in filters. And yes, we do continue to buy standard devices, standard filters from third-parties, TDK one of those and that’s potentially something that could change over time, but right now that they are a supplier for some of our filters, that’s correct.

Vijay Rakesh

Got it. And on the BAW side, you guys have talked about building out your own BAW filters, you have licensed it, where are you in that roadmap? Thanks.

Liam Griffin

Yes. I mean, we are still looking into that as what is the right path to continue on that pace. And we absolutely plan to play in high-band. We are playing in it now. I talked about the Huawei platform and there are a few others. So, that’s something we will give you a little bit more color on perhaps in the next call, but it’s an area that we absolutely understand what’s needed to win. We are winning today with our current strategy and we will look at enhancing our strategy as we go forward.

Vijay Rakesh

Thank you.

Operator

Okay, thank you. And the next question is from the line of Quinn Bolton of Needham & Company. Please go ahead.

Quinn Bolton

Thanks for taking my questions. Liam, just wanted to ask as you look back over the last year given some of the inventory problems, especially with large customers, to the extent, you had more of your products flowing through consignment hubs? Do you think that would have limited some of the volatility you had seen in the business? And if so, is there a push to try and bring more customers into consignment hubs going forward? And then I have got a follow-up for Don.

Liam Griffin

Yes. Quinn, well hindsight, you never know how it would look, right. So consignment hubs, some of our customers demand it. And we work with them on it and its fine. Others, they don’t operate with that model and it works out fine, too. I think we have unique situation here in the early part of the year. I think all of us in tech, at least in mobile ecosystem in our peer group felt the wrinkles on that. We have learned from it to some degree. But I don’t know if that would have been mitigated or altered with a different supply chain model. Ultimately, the products that we build go into end products that get sold through the channels. So I think that ultimately that’s all going to level out at some point, so we are not too concerned about it. Again we have one of our larger customers now in Asia that is requiring a hub arrangement with us. So we have work through that and that was actually part of our inventory here that Don mentioned.

Don Palette

One-time build there, yes.

Liam Griffin

But there isn’t anything significant around being in or out of the hub consignment play.

Quinn Bolton

Got it. Okay. And then for Don now with the higher dividend and new share repurchase is 40% of free cash flow to shareholders still a good target, are you thinking of moving that up to a higher level?

Don Palette

We have been running a little higher than that. I think you use 50%, that’s kind of a good – that’s just as we are trying to model, I think that’s fair.

Quinn Bolton

Okay, great. Thank you.

Operator

Okay, thank you. And our final questions come from the line of Chris Caso of CLSA. Please go ahead.

Chris Caso

Yes. Thank you. Just some clarification from some of the earlier comments, particularly with regard to utilization plans in the second half of the year, as the inventory comes down, are you expecting the utilization levels in the facilities to remain constant and I guess according to the answer to that question, what impact on gross margins…?

Don Palette

No, as we go forward, we actually we would expect them to go up slightly. We have kept those factories fairly full with the hybrid. But if anything, as you look into the earnings growth we go forward, we expect that to come up little bit. So that’s a positive impact to the margins as we move forward obviously, whenever we can maximize the internal capacity.

Chris Caso

Great, that’s clear. Thanks. And just the follow-up with the comments on China, you understand it sounds like you feel comfortable with what you are shipping against demand levels in China right now, just to be clear, are you expecting growth from your China customers in the second half versus the first half?

Liam Griffin

Yes. Chris, we are. We are expecting. And I think what we are seeing saying is kind of a nice bundle of higher performing players that are adopting some of that real rich content that we spoke about. That’s one area. And then the second area and kind of the value tier, we are seeing a nice move here in customers that become exporters into emerging market, so it’s twofold. Performance is going up in China. We are starting to see some real richness, Huawei’s one example. There is few others, Xiaomi is one. And then we are also seeing this great emerging market play that allows us to MediaTek and Spreadtrum and others to participate in an opportunity to connect that 3 billion unconnected. So it’s twofold, and second half will be stronger in China.

Chris Caso

Very helpful. Thank you.

Liam Griffin

Thanks.

Operator

Okay, thank you. And ladies and gentlemen, that concludes today’s question-and-answer session. I will now turn the call back over to Mr. Griffin for closing comments.

Liam Griffin

Thank you, operator and thank you all for participating on today’s call. We look forward to seeing you at upcoming conferences and events. Thank you.

Operator

Okay, thank you. And ladies and gentlemen, that does conclude today’s conference call. We thank you for your participation. You may now hang up.

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