Maxim Integrated Products' (MXIM) CEO Tunc Doluca on Q1 2017 Results - Earnings Call Transcript

| About: Maxim Integrated (MXIM)

Maxim Integrated Products, Inc. (NASDAQ:MXIM)

Q1 2017 Earnings Conference Call

October 20, 2016 5:00 pm ET


Kathy Ta - Managing Director, IR

Tunc Doluca - President and CEO

Bruce E. Kiddoo - SVP and CFO


Ross Seymore - Deutsche Bank

Blayne Curtis - Barclays Capital

Craig Hettenbach - Morgan Stanley

Amit Daryanani - RBC Capital Markets

Ambrish Srivastava - BMO Capital Markets

Christopher Danley - Citi Investment Research

Harlan Sur - J.P. Morgan

Toshiya Hari - Goldman Sachs

Tore Svanberg - Stifel, Nicolaus & Company

Christopher J. Muse - Evercore ISI

Jonathan S. Smigie - Raymond James

William Stein - SunTrust Robinson Humphrey

Ian Ing - MKM Partners

Christopher Rolland - Susquehanna

Steven Chin - UBS

Adam Gonzalez - Bank of America Merrill Lynch

Cody Acree - Drexel Hamilton

Delos Elder - Jefferies


Good day, ladies and gentlemen, and welcome to the Maxim Integrated First Quarter of Fiscal 2017 Conference Call. At this time, all participants are in a listen-only mode. Later, we will conduct a question-and-answer session and instructions will be given at that time. [Operator Instructions] As a reminder, today's program is being recorded. I would now like to introduce your host for today's program, Kathy Ta, Managing Director of Investor Relations. Please go ahead, Kathy.

Kathy Ta

Thank you, Jonathan, and welcome everyone to Maxim Integrated's fiscal first quarter 2017 earnings conference call. With me on the call today are Chief Executive Officer, Tunc Doluca, and Chief Financial Officer, Bruce Kiddoo.

I would like to highlight that we have posted a supplemental financial presentation to our external Investor Relations Web-site. The information in this presentation accompanies the financial disclosures in our earnings press release and on this conference call.

During today's call, we will be making some forward-looking statements. In light of the Private Securities Litigation Reform Act, I'd like to remind you that these statements must be considered in conjunction with the cautionary warnings that appear in our SEC filings. Investors are cautioned that all forward-looking statements in this call involve risks and uncertainty, and that future events may differ materially from the statements made. For additional information, please refer to the Company's Securities and Exchange Commission filings which are posted on our Web-site.

Now, I'll turn the call over to Tunc.

Tunc Doluca

Thank you, Kathy, and good afternoon to everyone on the call. We appreciate your interest in Maxim Integrated and thank you for joining us today. Before I discuss the results of the last quarter and some of the dynamics we are anticipating in our near-term outlook, I would like to share a few thoughts about Maxim's longer-term view with you.

Our strategy to diversify and grow our Company revenue is working. First, our automotive business expands each year at a rate well above market. We are capitalizing on increased content opportunities in infotainment, safety and battery management systems and winning designs by providing high-performance products to a broad range of customers. Second, we are growing our factory automation content, which has supported year-over-year increases in our core industrial business for the last two quarters. We forecast this to continue for reasons I will discuss later. Finally, we are diversifying our consumer revenue across a variety of tablets, wearables, peripherals, smartphones and gaming systems. This is helping stabilize our consumer revenue.

This diversification is helping to offset the revenue impact of a product cancellation by our leading mobility customer. Our guidance reflects no further shipments for the Note 7 product. We supply the same components for the Note 7 phone as the flagship Galaxy S7 platform. This gives us flexibility to support our customer as they switch production to the Galaxy S7. Given our overall performance in the quarter and our view forward, I remain confident that we are on track to continue to deliver long-term value for our shareholders.

Let me now turn to our quarterly results and outlook by major market. First I'll comment on automotive. Our September quarter automotive business was modestly down but slightly better than our expectations. We maintained the $100 million quarterly revenue run rate we achieved in the previous quarter. Automotive was strongly up from the same quarter of last year, reflecting our continued content growth and strong adoption of new products by our customers. In the December quarter, we expect automotive to be up sequentially with increases in battery management systems for electric vehicles and continued growth in infotainment content.

We are investing for a robust future in automotive across emerging applications. In the quarter, we realized a significant design win for our Surround View serial link solution for ADAS applications. In battery management systems for electric vehicles, we have OEM wins in China, Korea, Japan, Europe and the United States. Overall, we continue to diversify our footprint across a broadening customer base. Our momentum in automotive applications draws from our strong technology franchise in high-performance power management.

Let me next turn to the industrial market. Our September quarter industrial business was down sequentially and in line with seasonality. Our core industrial segment was up from the same quarter last year, driven primarily by factory automation products in the areas of interface, signal chain and power management. Our strong brand enables automation customers to trust us and build their solutions with our products.

In the quarter, we released our new Pocket IO reference design that is a showcase of Maxim's differentiation in factory automation solutions. Several years ago, we had identified that customers needed smaller footprint and lower heat generation as they shift from centralized control systems to distributed control on the factory floor. Through Maxim's proprietary high-voltage process technologies and decades of experience in circuit design, we are able to reduce the size and improve the efficiency of voltage regulators.

For robust industrial grade interface in communications, Maxim packs high-voltage I/O transistors more densely than competitors, while minimizing heat generation. We will feature this and other new products for industrial and automotive applications at the upcoming Electronica Show in Munich. Together, automotive and industrial markets contributed close to half of total Company revenue in the September quarter.

Next, let me discuss communications and data center. Our September quarter comms and data center business was down, with the decline driven by soft communications infrastructure spending. The optical portion of this business was up sequentially as we saw continued momentum with multiple customers for 100-G data center applications. Looking ahead to the December quarter, we expect communications and data center to be down with strength in data center optical more than offset by declines in communications infrastructure and legacy products.

On the 48V front, the deployment of our products in data center is expected to be delayed beyond calendar 2017 due to a change in requirements for the targeted lead project. Despite this delay in deployment, we are confident in the technical merits of our 48V architecture to deliver higher efficiency and smaller footprint solutions in the data center.

Let me finally turn to consumer. Consumer was up in the September quarter above our expectations. Diversification in our consumer business is enabling greater stability in our business profile. We have grown content in peripherals and wearables. We have content in most of the advanced smart-watch brands on the market. We have a small but growing product platform in gaming systems. We are increasing revenue across multiple product categories at a major U.S. mobility OEM. And we have grown content in audio and standard products in smartphones outside of the two largest OEMs. We expect consumer revenue will be down in the December quarter, with lower revenue at our leading customer partially offset by ramps in a variety of other platforms and customers.

In closing, our performance demonstrates that our strategy to diversify our revenue sources and grow our top line is starting to bear fruit. We continue to grow our automotive business well above market. New factory automation applications are enabling year-over-year growth in our core industrial business. And we are diversifying our consumer revenue in wearables, tablets, peripherals and non-flagship smartphones. We are delivering greater profitability and cash flow growth, which enables us to remain a leader in the return of capital to shareholders.

With that, now I'll turn the call over to Bruce for a summary of our financial performance.

Bruce E. Kiddoo

Thanks Tunc. I want to start by highlighting improvements in our revenue performance. Our first quarter revenue results were at the midpoint of our guidance, which was above normal seasonality and flat from the same quarter a year ago. Our guidance for the second quarter is up from the same quarter a year ago in a challenging environment. These improvements are driven by diversification in our overall Company revenue as we expand our automotive business, grow in factory automation and broaden our base of products, platforms, and customers and consumers.

Now I will discuss Maxim's first quarter financial results. Revenue for the first quarter was $561 million, down 1% from the fourth quarter. Our revenue mix by major markets in Q1 was approximately 31% consumer, 26% from industrial, 21% comm and data center, 18% automotive and 4% computing.

In the September quarter, our automotive business was modestly down sequentially, slightly better than our expectations. Our industrial business was down sequentially, in line with normal seasonality and with continued strength in factory automation products. Our communications and data center business was down sequentially, with continued momentum in our optical products for the data center offset by soft communications infrastructure spending. And finally, our consumer business was up sequentially, above our expectations due to product diversification.

Let me now provide some commentary on our distribution business. Distribution comprised 39% of Maxim's revenue in the September quarter. Globally, resales were up sequentially and end market bookings were also modestly up. We ended the September quarter with 62 days of inventory in the distribution channel, down six days from the June quarter. This significant decrease in days was driven by increased resales in North America, Japan and China.

Turning to the P&L, Maxim's gross margin excluding special items was 64%, flat from the prior quarter, driven by continued execution on our manufacturing transformation. Special items in Q1 gross margin included intangible asset amortization from acquisitions and accelerated depreciation.

Operating expenses excluding special items were $184 million, down slightly from the prior quarter, reflecting the continued cost controls, consistent with our operational plan. Special items in Q1 operating expenses included acquisition related charges and restructuring charges.

Q1 GAAP operating income excluding special items was $176 million. Operating margin at 31.3% of revenue is flat from the prior quarter and is up from 27.2% in the same quarter a year ago. The 410 basis point improvement in operating margin over the same quarter last year was achieved at flat revenue relative to a year ago, driven by our manufacturing transformation and cost-saving initiatives.

Q1 GAAP tax rate excluding special items was 18%, a fixed rate for FY 2017. GAAP earnings per share excluding special items was $0.48, $0.01 higher than the midpoint of our guided range.

Turning to the balance sheet and cash flow; during the quarter, cash flow from operations was $123 million or 22% of revenue, reflecting our annual profit-sharing payout to employees. Inventory days ended at 101, down one day from Q4, and inventory dollars were down 2% from the prior quarter, reflecting overall tight controls.

Gross capital expenditures were $14 million in the quarter. Capital expenditures are below our normalized level of $27 million per quarter of depreciation, enabling free cash flow to outpace earnings. Trailing 12-month free cash flow ending in Q1 using net capital expenditures was $769 million or 35% of revenue and up 16% over the same quarter last year. Our free cash flow yield is approximately 7% at yesterday's closing stock price.

Share repurchases totaled $58 million in Q1 as we bought back approximately 1.5 million shares. We also paid $0.33 in dividends per share, which totaled $94 million in the quarter. The dividend yield is approximately 3.4% at yesterday's closing stock price. Overall, total cash, cash equivalents and short-term investments increased by $37 million in the first quarter to $2.27 billion.

Moving on to guidance, our beginning Q2 backlog was $371 million. Based on this beginning backlog and expected turns, we forecast Q2 revenue of $520 million to $560 million. As our guidance indicates, Q2 revenues are expected to be down sequentially and up from the same quarter last year, with strong growth in automotive, seasonal performance in industrial and diversification in consumer revenue.

Q2 gross margin excluding special items is forecasted at 63% to 65%, flat from the prior quarter, as we continue to realize significant benefits from our manufacturing transformation. Special items in Q2 gross margin are estimated at approximately $13 million, primarily for amortization of intangible assets.

Q2 operating expenses excluding special items are expected to be up slightly from the prior quarter, as continued cost savings offset the impact of our annual salary adjustments. Special items in Q2 operating expenses are estimated at $2 million, primarily for amortization of intangible assets.

And our tax rate for Q2 excluding special items will be 18%. For Q2 GAAP earnings per share excluding special items, we expect a range of $0.40 to $0.46. For fiscal year 2017, gross capital expenditures are expected to be within the target range of 1% to 3% of revenue. And finally, we expect buybacks in Q2 to be consistent with our annual commitment to return 8% of free cash flow to shareholders.

In summary, we expect Q2 revenue to be in line with seasonality and up from the same quarter last year. We are diversifying our revenue profile which is helping to lower variability, and we continue to execute on our manufacturing transformation and cost-reduction initiatives which enable us to continue driving profitability and free cash flow growth.

With that, I'll turn the call back over to Kathy.

Kathy Ta

Thanks Bruce. That concludes our prepared remarks and we will now open the call for questions. We would like to continue the same Q&A process that we used last quarter. We'd like to take one question from each caller so that we can get to more people in the queue. And if you have more than one question, please hop back into the queue. We're doing this in the spirit of getting to as many of you as possible. Jonathan, could we please have our first question?

Question-and-Answer Session


[Operator Instructions] Our first question comes from the line of Ross Seymore from Deutsche Bank. Your question please?

Ross Seymore

Overall, I know, Tunc, you said that the calendar fourth quarter guidance included none of the Note 7, but I wondered if you could give a little more color on what we should expect going forward, are you seeing any kind of brand-wide impact on that customer that could impact the beginning of next year or is there some push-out in the potential impact into the March quarter for your Company?

Tunc Doluca

This is pretty hard for us to be able to really forecast. We're looking to see how Samsung deals with identifying and communicating the root cause. But clearly, this is a big change for them, cancelling an entire program, and the implication that's going to have on consumers, on their buying habits, is pretty unclear to us. So, obviously it makes it harder for us to really project what the revenues are going to be coming from Samsung in our fiscal Q3 and Q4. So, I think overall, it's really difficult to be able to say what's going to happen.

Now having said all that, we do – as I said in the prepared remarks, the same products are used in the short term on the Galaxy S7 as the Note 7. So we are able to support their production needs as they expand their production and sell-through they are trying to do on the Galaxy S7. At the same time, even though there is uncertainty in terms of what's going to happen to Samsung, we're really happy how much we've been able to diversify the business and find other customers, other applications, other platforms, and that's really helping stabilize the consumer revenue. So, it's kind of a mixed bag, hard to say.


Our next question comes from the line of John Pitzer from Credit Suisse. Your question please?

Unidentified Analyst

This is [indiscernible] calling for John. I had a question specifically about auto. One, you said auto was modestly better than expectations. Was that entirely due to BMS better than your outlook? And I guess trending forward, how do you see content growth in the near and short-term relative to that segment, relative to now that you guys have a $400 million annual business, expecting growth maybe to moderate a little bit lower than what you've seen in terms of the 30% range?

Bruce E. Kiddoo

I'll take the first half and Tunc can take the second. I think just on the forecast point of view, we had expected it to be down due to the inventory correction a little bit more than normal seasonality, and it came in – it was still down, but just it was a few points better. So, just a modest beat from that point of view. And yes, BMS was good, but I still think it's just kind of overall strength in the business. Tunc?

Tunc Doluca

On the longer-term question that you asked, basically we feel good about our growth trajectory. We have a very broad set of customers. We have a broad set of products that we are selling. We continue to have good content opportunity for power management systems as well as our serial link products. So, I think we're going to continue to grow double-digit rates. I mean, we come down from the 30% or so we had in the previous years, probably slowly, but I think there are still multiple years of double-digit growth for the Company.


Our next question comes from the line of Blayne Curtis from Barclays. Your question please?

Blayne Curtis

I just wanted to ask on the 48V program, you said it was delayed with some different specs. So, you had considered that a win. I was curious if it's going to be re-evaluated and whether it's still win and just delayed or whether it's something you have to re-win?

Tunc Doluca

So, as I said in the prepared remarks and as you noted, it was really a change in the specifications, which kind of didn't fit exactly what our product was doing. I think that we had warned you in the past, I guess these warnings do come true sometimes, that when the ramp of these products, especially of new products at new customers, it's pretty difficult to time correctly. But I think that in terms of the technical merits of the 48V architecture that we have presented to our customer and to the market now are good. It's just in my view a matter of timing before it does get picked up on a program that's a better fit for the performance and the capabilities of our product. So, in my view, it's more of a push-out than restarting from scratch, if you want to put it that way.


Our next question comes from the line of Craig Hettenbach from Morgan Stanley. Your question please?

Craig Hettenbach

Just following up on some of the prepared commentary around BMS, and it looks like from a diversification perspective by geo, you've seen a lot of traction. So, can you talk about just the adoption of that product and anything in terms of timeline as you see that market inflecting into next year and beyond?

Tunc Doluca

So, for BMS, I mean first of all this is a market that we maybe started talking about last year a lot, but it is a market or a business we've been in for a long time. We've been in it for probably over 10 years in terms of technology development. What we're really seeing is that electric vehicles volumes are going up. Granted, they are still far lower than the market size for gasoline powered cars, but it is picking up. And what we're seeing is this pickup is very strong in China, and that's partially because China is really combating their air pollution problem and the government is providing incentives to increase the number of electric vehicles on the roads. So, that's really helped us a lot in terms of getting design wins with many products that we actually had developed multiple years ago and attaining those design wins, and that's ramped pretty quickly.

But the wins, as you noted, are not just for that region. We're seeing our products get good acceptance for every single geography, every single OEM in all the geographies that I mentioned in the prepared remarks. And what's helping us win is the fact that we really know how to make robust products, that's very important, accuracy is very critical for these customers, and the communications is important to make sure that our customers have reliable systems.

So, my view is that electric vehicles are going to continue to grow. A lot of it is because they basically don't generate any byproducts. And I think as batteries get advanced, then you get more miles per kilowatt hour, I think the adoption rate is going to even accelerate. But it is still going to be I think for many years still smaller than gasoline cars, but with a much higher growth rate into the future.

Craig Hettenbach

Got it. Appreciate the color.


Our next question comes from the line of Amit Daryanani from RBC Capital Markets.

Amit Daryanani

I guess my question is, really it's nice to see I think year-over-year growth being implied in the December quarter guide with the midpoint, I'm curious do you feel comfortable that this year-over-year growth can sustain throughout fiscal 2017 or is there something that we should be aware of maybe in the March quarter with a difficult compare that it doesn't continue on?

Bruce E. Kiddoo

So I'll take that. I mean, certainly when we look at kind of our growth drivers, automotive is doing great and that's an obvious one, that will continue to grow strongly, especially when we look out into the first half of calendar 2017 which kind of a strong seasonal period for that.

We have confidence in our core industrial business, and for the second quarter in a row in Q1 it was up year-over-year, and kind of based on our expectations, we expect that to continue to grow in the December quarter. And again, that core industrial, it's a stronger seasonality in the first half of the calendar year. So, I think that part of our business is looking good.

When you look at our consumer businesses, as Tunc just said, I think we've done a very good job of kind of diversifying our consumer business in addition to our largest customer. And so, we've seen kind of very solid growth, whether that's in wearables, whether that's in China mobility, whether that's at the other large OEM. And so, I think those businesses are all on a good path.

Clearly, the one aspect, with our largest customer there is some uncertainty, right. We can't predict that, Tunc talked about it, and we're just going to have to monitor that situation and see how it develops.

Amit Daryanani

Thank you. That's really helpful.


Our next question comes from the line of Ambrish Srivastava from BMO.

Ambrish Srivastava

We're going with the Canadian banks in order. I had a question on the top line. And Bruce and Tunc, back at the Analyst Day, the data center 48V opportunity was highlighted as one of the key growth drivers. So now thinking out beyond a couple of quarters, was that being pushed out beyond calendar 2017? Do you have something that fills that hole, also because now Note 7, and who knows what's the ultimate impact of that, but does that create a revenue hold for you guys?

Bruce E. Kiddoo

So I'll take it. I mean the 48V was always an FY 2018. We had always said it was sort of kind of starting to ramp in the summer or second half of calendar 2017. So I think from an FY 2017 point of view, it really has no impact. We continue to do well in our data center businesses, growing strongly off a small base, just off of the 100-gig optical, and we still feel good about that. We had talked about how we had some early ramps in 12V with the cloud customers, and I think that will continue to ramp.

So, certainly having the 48V push-out, I think it has at this point more of kind of a near-term strategic question in that just the timing of that, but I think overall, I think with optical, with 12V and then eventually with 48V, it may slow down that ramp obviously, but I think long-term we're still, as Tunc said, confident that we have the right product for the customers' needs.

Tunc Doluca

One decision Bruce and I made there was not to try to predict timing of these things anymore. We've told you about the opportunity but then we won't tell you when would that actually starts. We'll say, it started now.

Ambrish Srivastava

A good decision, guys. Thank you.


Our next question comes from the line of Chris Danley from Citi. Your question please?

Christopher Danley

In terms of the problem in Note 7, can you talk anything about it and have you heard any problems from the Galaxy line as well? Can we confirm that it's not a Maxim issue? And then, on the flip side, for whatever comes out next, could that mean you get some increased content on whatever the Note 8 or whatever the next generation is?

Tunc Doluca

Okay, so in terms of what the cause of the problem is, we really can't comment. We're waiting for Samsung's root cause and filing an analysis and really don't have any more insights until they let us know or let the market know basically. So, until there's a final report from Samsung, there's really nothing that we can add.

The only thing that we do know is what I mentioned in the prepared remarks. In terms of Maxim's content, the same interface power management IC is being used on the Galaxy S7 phones, the earlier phones as well as the new ones. So our product is basically the same. And on your question, I mean you did ask about, is there anything happening on the Galaxy S7, we are not aware of any similar issues.

And your final question is, how does this change our opportunities in the future model, like a S8 or a Note 8? That is early to talk about. Obviously, Samsung is trying to get to what the issue is, and in terms of content and timing of the next phone, those are not determined yet.


Our next question comes from the line of Harlan Sur from J.P. Morgan.

Harlan Sur

Good afternoon and solid job on the quarterly execution. If I recall, the team had targeted to shut down the Dallas bump fab kind of beginning of next calendar year, which would have unlocked probably another 100 basis points of gross margin expansion. Can you guys give us an update on that initiative? Do you still anticipate more margin upside coming from that initiative looking into the first half of the calendar year? And you had mentioned just in general getting to 65% gross margins maybe sooner rather than later. If it's not the bump fab, what are some of the initiatives that are going to get you to that 65% target sooner rather than later?

Bruce E. Kiddoo

Yes, Harlan, your memory is good. The last major item of our manufacturing transformation is the shutdown of this small bump fab in Dallas. We are on track to complete that in our fiscal Q3, the March quarter. The benefits of that as they kind of flow through the P&L, we expect to get that in the summertime, whether that's in the Q4 or Q1 timeline. We're very confident that we're going to get to that 65%. We got to 64% earlier than we thought, you are right. And then I think as we execute now on the last step, we'll get to that 65%. So, very confident that's going to happen in probably the Q4, maybe Q1, just depending on how the accounting works on the benefits as we shut that down.

And then I think just in addition, we know from a long-term tailwind – certainly we still have depreciation at kind of this last quarter $27 million and CapEx at around $15 million to $16 million. So, as that depreciation kind of comes down towards the CapEx rate, there will be a long-term tailwind for gross margin. Difficult to predict that because that happens over many years, but it is just another helpful item for gross margin.

Tunc Doluca

One more thing on the Dallas bump fab, I think where Bruce said we are pretty much on schedule, just to give you some more confidence, we've done all the major qualifications. So, there's a few little things to do. So that effort is on schedule for sure.

Harlan Sur

Great. Solid execution. Thank you.


Our next question comes from the line of Toshiya Hari from Goldman Sachs.

Toshiya Hari

On automotive, can you talk a little bit about the demand environment and the competitive landscape, specific to infotainment? I ask because some of your peers seem to be growing nicely like you guys, then you have others that seem to be increasingly challenged.

Tunc Doluca

So your question was specifically more about automotive infotainment system. So, I mean that's been a great growth area for us. We've got a good product line and we have a pipeline with more good products coming. We find that the performance of our products are things that our customers are highly desiring and they are willing to design them in, and we're really not – as long as we have good products, and we do, we are able to win those design and grow the business. So, it really is a function of what the performance and differentiation your products have. And it looks like the investments we've made in the past 10 years are paying off because we have a very strong product portfolio.

Bruce E. Kiddoo

And in addition to infotainment, which is by far the largest part of our business today and continues to do very well, as Tunc talked about, the ADAS business which today is very small but certainly over the next five years, because everything happens a little bit slower in automotive, the technology that we have around power management and SerDes technology that's been applicable to infotainment will also be applicable to the ADAS and driver systems and autonomous driving. So that's a good future growth driver. And then Tunc also commented earlier on electric vehicles and our position there. And again, that's just more kind of waiting for that market to get some critical mass and higher volume. So, I think overall we still feel very confident in our automotive business, and when we look out even at the December quarter, we expect kind of based on what we're seeing today to kind of stay over that 20% year-over-year growth rate.


Our next question comes from the line of Tore Svanberg from Stifel. Your question please?

Tore Svanberg

Tunc, I was hoping you could elaborate a little bit on your optical communications business. I believe these are TIAs and CDRs for 100-gig optical. Is the momentum there sort of strong enough to be able to grow the overall communications revenue or is it still sort of too small to offset the sluggishness in what we're seeing on the infrastructure side with spending?

Tunc Doluca

From the guidance we gave in the prepared remarks, you can tell that it's really not large. It's growing strongly but it's really not large enough to completely offset the challenges we're seeing on the infrastructure and on the legacy product side. But the products are the ones you mentioned. Actually, the product line is TIAs and laser drivers, and sometimes that also comes with some SerDes applications, but the stronger products and the strong acceptance is really for products where we've actually integrated them as transceivers rather than separate parts, that's where the customers are liking our solutions. And the acceptance rate is very high, and I think in previous calls we also mentioned that we were winning at pretty much all of the major cloud customers for these products.

I do have to admit that there are some challenges, although it's not affecting us too much, so far there are some challenges in terms of the supply chain for other products. But despite that, the business is nicely growing. As I said, it is not big enough yet to overcome the rest of the business in the comms infrastructure area.

Tore Svanberg

Very helpful. Thank you.


Our next question comes from the line of C.J. Muse from Evercore.

Christopher J. Muse

I guess a question on the supply chain, curious if you can share with us your thoughts around inventory and the distribution channel, and given how I guess hand-to-mouth the supply chain acted in the first half of the year, given demand trends are starting to open up a bit, whether you're seeing perhaps a bit of willingness to hold onto more inventory there or not?

Bruce E. Kiddoo

So when we look at the channel, I think the good news is that resales were up nicely. I think they were up 6% overall in Q1. So, very good strength there, and really when kind of it was North America, Japan, China, kind of all up double-digits sequentially from a resales point of view. So that's a very positive sign. Thus, with strong resales, of course that helped to bring down our inventory, and you may recall, we were at 68 days last quarter and I talked about how that – we just thought that was too high and we wanted to bring it down. We were able to bring it down six days, down to 62, and that was really, we kind of sold through that buffer inventory that North America had been holding onto as a result of their ERP implementation. But you can see there was the strong resales there as well.

We have very strong demand in Japan right now, both from an automotive point of view and some gaming opportunities there. And then in China, again we had good resales. The inventory came down but we have been trying to, as we've mentioned, kind of increase our overall inventory level. And so, while resales went up, we kind of kept inventory flat or even slightly up there to kind of keep that days of inventory at the right level.

So, I think overall, I think we see kind of good resales, inventory came down kind of to where we wanted it. Probably it will take it down or try to get it down a few more days to get it to 60 or a couple of days below that, and we are finding that our channel partners are working with us to get the right inventory level in the channel to support the business.


Our next question comes from the line of Steve Smigie from Raymond James.

Jonathan S. Smigie

I just wanted to follow up on the comments on factory automation. You talked about having some success with products in terms of networking being diversified throughout the factory. That's a service that's been out there for a number of years now. So, I was just wondering where we are in terms of that, are we still just starting to ramp the revenue there? And sort of tied into that, you talked at Analyst Day about Maxim going back to its roots in power, and so I was hoping you could sort of give us an update on the progress you've made since then in terms of where you wanted to get on that.

Tunc Doluca

So, on the factory automation front, yes, you are absolutely [indiscernible]. We've talked about this for a few years now, but the fact that there was more need for distribution of the control to the factory floor was something that we could see coming almost five or six years ago. So we were preparing the products for it. I'd say, we are kind of in the beginning of this transition. In industrial, everything moves slowly, and whatever we're seeing today in terms of increased design wins of our products and ramping of the revenue, it occurs at a much lower rate, and I think we're still in the early days.

What's really helping us in terms of winning these designs is the fact that we have a good brand and the customers trust us for our products, but they really like the fact that with our I/O linked products for industrial communications, with our very robust and low-powered digital inputs and outputs – even though these are called digital I/Os, their interface is really analog when they go out to the real world on long cables and so on. So we've got great products for that.

And one area that we really had not invested much in probably up to about five or six years ago was really in power management. So we now have a pretty good line of high-voltage, 60V or so, very efficient power management products and the customers are loving these because as they try to reduce the heat dissipation of their systems, these products are really helping them out. All our industrial comms parts are new power management products as well as our digital input/digital output products.

So, just to summarize, I think we got a good strong product portfolio, but when you look at the ramp of these products, it's still going to be at slower rate. I mean the projected rate of growth by third parties is 6% for this market, and we should be able to grow at least at that rate as a Company.

Bruce E. Kiddoo

I mean just to kind of give another context, we've looked at our factory automation, it's actually now just kind of ticked over 10% of the Company revenue. So it's become a major part of our business, and when people think of industrial, you think of all these kind of small markets within that, but clearly factory automation is a large part, and at Tunc indicated, we're seeing good growth out of that and I can say in the first quarter it grew in the high single-digits year-over-year.

So we are seeing asset growth, and I think there's a sense here, and nothing happens overnight, but factory automation could turn out to be similar to automotive in that there is a really nice content story going on here where through the products that we are selling and through kind of the changes that Tunc talked about within factories that the semi companies supplying into factory automation could do better than some of the OEMs who make the equipment. And so, still early to make that victory call yet, but it does feel at this point similar to kind of what we saw in automotive, whatever that was five years ago when we broke out automotive for the first time at 10%.

Tunc Doluca

So, on your other – you were only allowed one question, but you did ask a second. I'll answer it anyway because I think it applies to everybody. Your other question was, are you making – how well a progress are you making on your return to your roots or power management? I think we're doing very well. If you look at our R&D allocation, it's increased. I think we put it into the right markets. We had also at the Investor Day, we talked about new process technologies that we were developing for power management. We're on schedule with those. So, from my point of view, it's looking very good in terms of strengthening an already strong product portfolio better for the future of the Company.


Our next question comes from the line of William Stein from SunTrust.

William Stein

I'm hoping to talk a little bit about capital allocation. I think a year ago many investors expected Maxim might have been a target for acquisition, but I think the Company has talked more about potentially using cash flow to acquire companies. I think there might have been a tiny acquisition during the quarter. Can you confirm that and then talk about where you are in the process of considering more consolidating news?

Bruce E. Kiddoo

When you said capital allocation, I thought you want to talk about dividends and buyback. But no, we did not do a small acquisition during the quarter. And then when we think about consolidation overall, we do believe that we can be an acquirer. It's something we definitely look at. We've talked about kind of how we think about it and that we do think scale is helpful. I think scale benefits everyone right now, whether you're actually doing the acquisitions or not, just because there are fewer companies and that provides for kind of an improved positioning in the marketplace with customers, suppliers and throughout the supply chain. So we do think there are some benefits.

To the extent we do a deal, it will be consistent with our strategy. We'll stick to analog with similar margin and cash flow profile or after synergies. I would say the biggest issue for us right now is, when we look at companies that fit our filters, a lot of them look very expensive to us right now. And so, we're going to continue to be very disciplined. Obviously, we have the scale to be successful without doing a deal. We've been driving profits through our transformation. And as you can see, we've been working very hard on sort of our return to growth strategy. And as Tunc said last quarter, you have to go through zero to get to positive numbers, and we did that in Q1 and for our guidance we're actually showing year-over-year growth in Q2. So I think there is lots of value we can still create as a standalone company as well.


Our next question comes from the line of Ian Ing from MKM Partners.

Ian Ing

Question on gross margins, could you remind us when is the next reset for negotiated wafer cost from Tower and what's the lag in terms of that flowing into COGS, and I know you're not guiding for gross margins, but perhaps thoughts on magnitude there?

Bruce E. Kiddoo

Our agreement with TowerJazz is a multiyear, it's a long-term, over 10 years. Within that agreement, there is price take-downs over time. We haven't given the exact kind of years that that happens. We did say upfront, there would have to be some time for TowerJazz to be able to qualify their processes and ramp products for their other customers. So I don't think that's a near-term benefit for us. I think near-term it's going to continue to be the Dallas fab closure that will get us to our 65 points.

But in addition to kind of the depreciation convergence down to CapEx that I did talked about earlier, long-term the price breaks that are in our long-term foundry agreements will be helpful, but again I think that's a longer-term tailwind, not something you're going to see quarter over quarter.

Tunc Doluca

Plus the terms and the timing and all that is confidential anyway. We're not allowed to disclose it.

Bruce E. Kiddoo


Ian Ing

Okay, thank you.


Our next question comes from the line of Chris Rolland from Susquehanna. Your question please?

Christopher Rolland

At your Analyst Day, you guys gave an update on your power products in comms and data center. I think it was probably about half of that segment and at the time it was growing at an 11% CAGR, double-digits for the three years prior. It seems like we've probably just from that have had a de-acceleration or deceleration there. Maybe you can talk about that deceleration, and looking forward, does 48V, does that help accelerate growth in that segment for you guys?

Tunc Doluca

I think that we did provide what percentage of the comm and data center business was power management. I kind of remember the slide, I don't remember the numbers unfortunately, but I don't think we provided which piece of it was growing at what rate. So I think that we'd have to think about that answer. I don't think we have that answer here.

In that market, obviously we do have our 48V initiatives, but we do have 12V products as well that can obviously help us. Somebody asked before, the timing change in the 48V is definitely a headwind but it's not the only product there we've got in comms and data center. We've got products for hot-swap, we got protection products, we got 12V BOLs, there is all kinds of products in that market. I don't believe we've provided a breakdown of which segment in comm and data center was going to grow at what rate.


Our next question comes from the line of Steven Chin from UBS.

Steven Chin

I had one on gross margins. In terms of the whole diversification theme that was highlighted several times, I think your consumer and automotive businesses combined represented about half of total Company sales. Just given some of the implied diversification, either in terms of customer or product sales mix within that half of your business, I was wondering if there's any potential meaningful positive uplift to gross margins because of that adversity.

Bruce E. Kiddoo

I think when we look at our business, historically mix hasn't been a big part of what drives gross margin. In the past, it was utilization, and then most recently it's really been about kind of cost cutting and our transformation. I think as most people know, obviously the industrial business is very profitable. The comm business is a profitable business as well. And then when you look at the consumer and the automotive business, they are both just a little bit below corporate average, but for both kind of relatively high volume businesses. I think we do a very good job of developing differentiated products that deliver value to our customers and they are willing to recognize that, and then continuously trying to drive down our cost structure to have the lowest possible cost structure. So I think, overall, as we have our diversification, I don't think that's going to have a big change on the mix or the gross margin trajectory.

Tunc Doluca

And just to add a little more color, if you look at the changes that have really been happening, it's more of automotive revenue growing and consumer really going down, and as Bruce said, margins are really not that much different between the two. Therefore, that's not the thing that's affecting our gross margin going up. It's mostly the restructuring effort, as Bruce said.


Our next question comes from the line of Adam Gonzalez from Bank of America Merrill Lynch.

Adam Gonzalez

I'm asking on behalf of Vivek Arya. Just any impact from the ongoing wave of consolidations, [indiscernible] there's discussions about Qualcomm and XDA together and ADI and Linear having gotten together, anything, any comment from you guys, positive or negative, and how it might impact Maxim?

Tunc Doluca

So, in terms of – the ones that obviously that is closest to us would be the ADI-Linear one, and to some extent, to a lesser extent probably Intersil buying Renesas. So near term we haven't really seen much of an impact from these announcements on the business. I think long-term, consolidation benefits to industry overall, including Maxim even if we are not an acquirer in that timeframe.

I think we're just going to continue to compete with these companies, and basically my view is that many of the analog products really don't have a big pull-through effect. For example, companies combine and then they have separate product lines. I think customers are making decisions based on the merits of each product and not really being affected by the fact that somebody has two or three product lines that they are selling together to a customer. That's been at least my experience.

So I don't think that's going to have a big impact in terms of us being more challenged with our product line. So we're not really seeing much of an impact, and because of the way analog products I know are being designed by customers, I don't think there is going to be a big impact from the merits of saying one product line helps sell another product line.


Our next question comes from the line of Cody Acree from Drexel Hamilton.

Cody Acree

Can you maybe give a little bit of more color on the industrial side outside of factory automation, maybe that 15 or so percent of revenue that's not factory automation, some of the trends that you're seeing, and then maybe what is the longer term growth that you expect for that piece of business?

Tunc Doluca

So we do have some other businesses that we classify in industrial, maybe some of the segments are things like medical and utility meters. There is automatic – there is just a whole litany of other product lines, which when taken one at a time are actually pretty small frankly for the Company. But if you do look at our growth, those other markets because they're small, they actually swing quite a bit quarter to quarter, but I think that we have good investments in these. I think that like in the medical space, we've got some good products. In [ATE] [ph], it's kind of very high performance parts and they swing quite a bit quarter to quarter. And we pretty much highlight this I think almost in every call where ones that is baked up or baked down. But overall, I think those markets right now in year-over-year comparisons are not doing as well as the control and automation markets are for us.

Bruce E. Kiddoo

And I would just add to that in addition to what Tunc said is, within what we call kind of core industrial or sort of the general purpose, that's about 18% to 20% of revenue, and yes, the factory automation is a little over half of that. But in those other kind of just general purpose, core industrial like sold through distribution, we have been seeing kind of overall year-over-year growth in those businesses. So again, and Tunc talked about, sort of our return to our roots and really trying to kind of sell back into that kind of the legacy industrial core product business and our areas of kind of the products we're developing and focusing on the distribution channel and really focusing on the long tail, we have started to see some results there. And of course we all know, this is a very good margin business.


Our next question comes from the line of Delos Elder from Jefferies.

Delos Elder

I'm asking on behalf of Mark Lipacis. You mentioned some challenges in the 100-gig optical supply-chain. I'm wondering if you could elaborate on those, what they are and when you think they might be resolved?

Tunc Doluca

Actually I think on the call I don't really have much data on what they are. In many cases, our customers don't really disclose that information. But we do know that some of the highest performance pieces of that on the module piece are more challenged. And frankly speaking, there's not that many parts in there. There's lasers and some receivers and mostly it's our parts. So, maybe it might be that it's on the laser side.

Kathy Ta

Jonathan, I think we have time for just one more question.


Our final question is a follow-up from the line of John Pitzer from Credit Suisse. Your line is open.

Kathy Ta

Okay, I think we lost John at the end. So I think we'll wrap up there. That concludes today's conference call. We would like to thank you for your participation and for your interest in Maxim.


Thank you, ladies and gentlemen, for your participation in today's conference. This does conclude the program. You may now disconnect. Good day.

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