Maxim Integrated Products' (MXIM) CEO Tunc Doluca on Q3 2017 Results - Earnings Call Transcript

| About: Maxim Integrated (MXIM)

Maxim Integrated Products, Inc. (NASDAQ:MXIM)

Q3 2017 Earnings Conference Call

April 20, 2017 5:00 pm ET


Kathy Ta - Managing Director, IR

Bruce E. Kiddoo - SVP and CFO

Tunc Doluca - President and CEO


Harlan Sur - J.P. Morgan

Ross Seymore - Deutsche Bank

Ambrish Srivastava - BMO Capital Markets

Tore Svanberg - Stifel, Nicolaus & Company

Vivek Arya - Bank of America Merrill Lynch

Srini Pajjuri - Macquarie

John Pitzer - Credit Suisse

Christopher J. Muse - Evercore ISI

Craig Hettenbach - Morgan Stanley

Christopher Danley - Citi Investment Research

Toshiya Hari - Goldman Sachs

David Wong - Wells Fargo

Steven Chin - UBS

Christopher Rolland - Susquehanna

William Stein - SunTrust Robinson Humphrey

Cody Acree - Drexel Hamilton


Good day, ladies and gentlemen, and welcome to the Maxim Integrated Third 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.

And now, I'd like to introduce your host for today's program, Kathy Ta, Managing Director, Investor Relations. Please go ahead, Kathy.

Kathy Ta

Thank you, Jonathan. Welcome everyone to Maxim Integrated's fiscal third quarter 2017 earnings conference call. Joining 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 on our SEC filings. Investors are cautioned that all forward-looking statements in this call involve risks and uncertainties, 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 Bruce.

Bruce E. Kiddoo

Thanks Kathy. Before I discuss the details of our results, I would like to highlight that our revenue guidance for the June quarter includes $15 million to $20 million of revenue due to the start of the transition to sell-in revenue accounting for distribution. The split of this revenue is roughly a half in the industrial market, a third in the comm market and the remaining portion across the other end markets.

Overall, we continue to successfully execute on our business transformation. Our third quarter revenue results were above the midpoint of our guidance, above typical seasonality and up 5% from the same quarter a year ago. Our guidance for the fourth quarter is up sequentially and strongly up from the same quarter a year ago. We achieved our 65% gross margin target ahead of schedule in Q3 and expect to be able to sustain this high quality of earnings in the coming quarters.

The improvements in our revenue growth have been driven by content gains in our automotive business, growth in factory automation and core industrial products and diversification across a broad base of customers, platforms and technologies in consumers. With that, let me discuss Maxim's third quarter financial results.

Revenue for the third quarter was $581 million, up 5% from the second quarter and above the $575 million, midpoint of our guidance. Our revenue mix by major markets in Q3 was approximately 28% from industrial, 26% consumer, 21% comm and data center, 21% automotive and 4% computing. It is worth highlighting that industrial is now our largest business and that industrial plus automotive is nearly 50% of total Company revenue.

Let me now turn to the distribution channel. Distribution comprised 42% of Maxim's revenue in the March quarter, a record-high percentage for Maxim. Resales were down sequentially and end market bookings were flat. We ended Q3 with 63 days of inventory in the distribution channel, up six days from Q2. The increase in days was driven by lower resales, particularly at the start of Q3 during the winter holiday season. However, the resales trend improved as we progressed through Q3 and we are forecasting strong resales in Q4.

Turning to the P&L, Maxim's gross margin excluding special items was 65.2%, an increase of over 100 basis points from the prior quarter, driven by strong operational execution on our manufacturing transformation. We closed the Dallas bump fab, as planned, within the quarter. Special items in Q3 gross margin included intangible asset amortization from acquisitions and accelerated depreciation.

Operating expenses excluding special items were $187 million, up slightly from the prior quarter due to higher employee profit-sharing, partially offset by continued cost controls, consistent with our operational plan. Special items in Q3 operating expenses included acquisition related charges and restructuring charges.

Q3 GAAP operating income excluding special items was $192 million. Operating margin at 33% of revenue is significantly up from the prior quarter and is up from 27% in the same quarter a year ago. The 500 basis point improvement in operating margin over the same quarter last year was driven by our manufacturing transformation and focused R&D investment strategy.

Q3 GAAP tax rate excluding special items was 15%. GAAP earnings per share excluding special items was $0.56, above the high end of our guided range and up 37% from the same quarter a year ago.

Turning to the balance sheet and cash flow, during the quarter, cash flow from operations was $221 million, or 38% of revenue. Inventory days ended at 109, flat from Q2. Inventory dollars were up 2% from the prior quarter. Capital expenditures were $8 million in the quarter. Capital expenditures are well below our normalized level of $26 million per quarter of depreciation.

Trailing 12-month free cash flow ending Q3 using net capital expenditures was $819 million or 36% of revenue and up 20% over the same quarter last year. Our free cash flow yield is approximately 6% at yesterday's closing stock price.

For capital returned, share repurchases totaled $57 million in Q3 as we bought back approximately 1.3 million shares. Dividends totaled $93 million in the quarter or $0.33 per share. The dividend yield is approximately 3% at yesterday's closing stock price. Overall, total cash, cash equivalents and short-term investments increased by $69 million in the [second] [ph] quarter to $2.16 billion.

Moving on to guidance, our beginning Q4 backlog was $382 million. Based on this beginning backlog and expected turns, we forecast Q4 revenue of $590 million to $630 million. This includes the $15 million to $20 million due to the start of the transition to sell-in revenue accounting for distribution. As our guidance indicates, Q4 revenues are expected to be up sequentially and strongly up from the same quarter last year, driven by automotive and industrial and revenue diversification in consumer.

Q4 gross margin excluding special items is forecasted at 65% to 67%, benefiting from continued execution of our manufacturing transformation and higher distribution revenue. Special items in Q4 gross margin are estimated at approximately $11 million, primarily for amortization of intangible assets.

Q4 operating expenses excluding special items are expected to be flat to the prior quarter with continued cost controls offsetting higher profit-sharing accruals. Special items in Q4 operating expenses are estimated at approximately $2 million, primarily for amortization of intangible assets.

Our tax rate for Q4 excluding special items will be 15%, flat from Q3. We expect this rate to be applicable for the remainder of this fiscal year and for fiscal year 2018. Our Q4 GAAP earnings per share excluding special items, we expect a range of $0.59 to $0.65.

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 Q4 to be consistent with our annual commitment to return 80% of free cash flow to shareholders.

In summary, we expect Q4 revenue to be up sequentially and strongly up from the same quarter last year. We are diversifying our revenue profile in consumer and growing content in automotive and industrial, which is helping to lower variability, and we are achieving our profitability in free cash flow targets ahead of schedule.

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

Tunc Doluca

Thank you, Bruce. Good afternoon to all the participants on the call. We appreciate your interest in Maxim Integrated and thank you for joining us today. Our strong growth in the March quarter enabled us to exceed our revenue and profitability targets. This momentum was led by automotive and industrial growth, relative to the March quarter of last year. Our return to growth and strong profitability confirms that our R&D investment strategy and manufacturing transformation are on track and delivering great results.

Let me discuss our business. First, I will comment on automotive. Our automotive business delivered exceptional results in the March quarter, growing 13% sequentially and up 26% from the same quarter last year. Our most significant incremental revenue continues to come from infotainment content. Our highly efficient power management products for infotainment applications enabled us to strengthen customer relationships in automotive and earn new design wins for our Serial Link USB and LED lighting products.

In the quarter, we saw a flurry of activity by customers to architect the car of the future. Car manufacturers are exploring alternative uses of our Serial Link products to move vast amounts of data within the car. They are finding ways to use our high-speed Serial Link technology to connect head units to vision cameras, radar, LIDAR and remote tuner systems. In the next few years, we expect to generate significant Serial Link business serving infotainment and driver assistance applications at multiple customers. In addition, during the quarter we recognized new design wins for battery management systems for electric vehicles, primarily from our European customer base.

Our June guidance for automotive reflects the following. First, our March quarter revenue results were exceptionally strong and provide a larger base for sequential comparisons. Second, changes in government incentives for electric vehicles are weakening China battery management product demand. Third, we are seeing signs of the weaker auto market in the U.S. As a result, we expect our June quarter automotive business to be sequentially flat from a very strong March quarter, and strongly up from the same quarter last year.

Let me next turn to the industrial market. Our March quarter industrial business was strongly up from the same quarter last year, and normalizing for the sale of our energy meter business, our industrial business was up double digits. Within industrial, the core segment was also strongly up from the same quarter last year, driven primarily by factory automation products in the areas of interface and power management.

Strong growth in factory automation has delivered year-over-year increases in our core industrial business for the last four quarters, and drove 16% sequential growth in the March quarter, well above seasonality. We expect growth to continue in core industrial.

As factories are modernized, our IO-Link solutions enable direct network access to sensors on the factory floor using existing cabling. A major Japanese automotive manufacturer has recently decided to implement sensors within its worldwide plants using Maxim's factory automation solutions, including our family of IO-Link products.

IO-Link adds data transmission and communication capabilities to devices such as sensors and actuators. This is a critical capability as manufacturers implement flexible and distributed process control at the robot level in modern factories.

In the June quarter, we expect industrial to be up sequentially, with modest growth from a very strong March quarter and the balance driven by the transition to sell-in revenue accounting that Bruce mentioned earlier. Core industrial, with particular strength in factory automation content, remains the strongest contributor to our expected growth. Together, automotive and industrial markets contributed 49% of total Company revenue in the March quarter.

Let me discuss communications and data center next. In the March quarter, communications and data center was flat compared to the same quarter last year. Revenue was up strongly sequentially. Growth in the same market is led by data center with strong customer adoption of our 100G optical products used in high-speed data center applications. We saw good sequential growth in the communications infrastructure as well.

We expect continued momentum in 100G optical products. We also expect the communications infrastructure market to be up sequentially across a broad base of products. Part of this increase is driven by the transition to sell-in revenue accounting.

Finally, let me turn to consumer. In the March quarter, our consumer business was sequentially down with lower content in smartphones, as expected. Our business at Samsung was below 10% of Company revenue. March consumer revenue was better than expected due to a broader revenue base.

In the June quarter, we expect consumer to be up sequentially, with decreasing revenue from smartphones more than offset by strong growth in wearables, tablets, peripherals and gaming products. We continue to see new opportunities in consumer products such as hearables and wearables. These emerging areas play to our technology strengths in power management, audio, sensors and low-power micros. We expect to benefit from this diversification in the June quarter.

In closing, our performance demonstrates that our strategy to grow our revenue is working. Our automotive business continues to grow strongly. New factory automation applications are enabling multiple consecutive quarters of significant year-over-year growth in our core industrial business. We are growing our 100G optical business within data center applications and making excellent progress in diversifying our consumer revenue in wearables, tablets, peripherals and gaming systems.

Our growth is enabling us to approach our profitability goals that we established two years ago when we embarked on our manufacturing transformation and focused R&D initiatives. Our revenue growth, greater profitability and growing cash flow enable us to remain a leader in the return of capital to shareholders and to maximize shareholder value.

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

Kathy Ta

Thanks Tunc. That concludes our prepared remarks and we will now open the call for questions. We would like to continue the same Q&A process as we used last quarter. We will take one question from each caller, so we can get to more people in the queue. If you have more than one question, please go back into the queue. We will try to get 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 Harlan Sur from J.P. Morgan. Your question please?

Harlan Sur

Congratulations on the solid results and the outlook. On the better gross margins, 100 basis points better than guide for the March quarter, and another 100 basis points step-up here in June, question is, how much of that is due to the Dallas bump fab closure and how much of that is just due to kind of higher levels of revenues and/or other efficiencies? And is the June gross margin reflective of all the manufacturing cost initiatives that you've outlined or is there still more of that on the come? Thank you.

Bruce E. Kiddoo

Harlan, this is Bruce. I'll take that. So the Q3 gross margin of 65.2%, we hit our long-term goal there. That really had no benefit from Dallas, right. That kind of closed at the end of the quarter. So we didn't see any benefit from that. It was basically just continued blocking and tackling, right, the benefits of the transformation that we've done, the continued improved utilization at our remaining internal fab, and just kind of cost controls across the board.

I will say, it came in a little better than we had originally anticipated. Part of that was just execution and part of that there is always a lot of factors that sort of flip both ways and sort of more than less kind of came up on the positive side this time. So we did have some benefits there.

That said, we continue to forecast very strong gross margin for Q4, kind of the midpoint of 66% gross margin. Again, that continues just to sort of benefit from this ongoing transformation. I think once you change the culture and you get the momentum around kind of controlling costs, I think you continue to see that beyond what we initially expected. We will get a little benefit as well from the shift to sell-in. But it's clearly up even without that benefit.

So your final question as far as, is there still more? I don't think we've seen the full benefit of Dallas. That said, in addition to that, we have some other long-term tailwinds that we have talked about in the past, the most significant of which is this kind of convergence of depreciation to CapEx. In Q3, kind of the normalized depreciation was $26 million in the quarter and CapEx was $8 million. That's a little low, right. If you think of kind of the midpoint of our range of 2%, say you're going to be at $12 million or $13 million a quarter. That's still a substantial gap to close. That's going to happen over multiple years, but that will be a nice tailwind for us.

We're also going to have the benefit as we kind of work through the long-term supply agreement we have with TowerJazz for our ex San Antonio fab. That allows us to kind of the take or pay goes down and we can now move more so that we can get better loading at our internal fab and some of our other boundaries. And so that's a benefit.

And then finally, industrial being our largest business now, distribution revenue at the highest it's ever been at 42% of revenue, and this is in March, this has no benefit of the shift in sell-in. So that's just kind of straight up benefit there.

So, normally mix isn't a big part of what drives our gross margin, but I think long-term this shift where industrial and distribution are becoming large portions of our business will help from a tailwind as well. So, I mean I think we feel good on gross margin, I think we have worked very hard to execute and it's starting to flow through the P&L and driving EPS and cash flow.

Harlan Sur

Great execution. Thanks Bruce.


Our next question comes from the line of Ross Seymore from Deutsche Bank. Your question please?

Ross Seymore

Just wanted to follow up on the sell-in change, Bruce, if you could just walk through conceptually what the implications are for the revenue side of the equation and for the gross margin side of the equation as we get into the September quarter, because is it one that the June quarter was elevated in a couple of areas and that's a one-time benefit or is there some additional sell-in revenue recognition that has to work its way through into September?

Bruce E. Kiddoo

Sure. So this is the start of the transition. Just to remind folks on the call and investors listening, the U.S. was generally on a sell-through basis, North America was on a sell-through basis and our international distributors wire on a sell-in basis. As we have gone through, this year we have focused a lot on our sales transformation and being able to sell to the broad market, and so we have put a lot of effort into kind of transforming our distribution business. And as part of that, we sort of looked at what are the terms that we offer, and in looking at our North America business, kind of from just applying GAAP and kind of the way we transformed our business, the shift to sell-in is more appropriate.

And so, we had two main distributors in North America. One is shifting out because of kind of the way the terms fit and confidence in the reporting systems that we get from them, and so we are doing that one this quarter. We said that's the $15 million to $20 million of benefit this quarter. That will not repeat in Q1. So we need to make sure folks out there doing their models don't just start off that higher base.

That said, to be very clear, this is revenue that we earned. It was on the balance sheet. We were going to recognize it eventually. So this is, it is real revenue, it should count against if you look at kind of annualized revenue and EPS, from that point of view. This is distribution business, so it's above the corporate average gross margin. And so, as I kind of indicated to Harlan's question, there is some benefit in the June quarter from that.

That said, sort of kind of the ongoing benefits of our transformation in gross margin, we expect gross margin to continue to remain very strong. And so from that point of view, I mean there is always puts and takes, but I think there will be sort of, when we look at September, clearly the revenue will not benefit from that, but I think from a gross margin point of view, I think you will see less impact from that point of view. So does that answer your question, Ross?

Ross Seymore

Yes. Thank you.


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

Ambrish Srivastava

I wanted to focus on the auto business, and Tunc, as always you guys are very transparent. What was going to be my first question, the year-over-year growth, and you guys have done a fantastic job in growing the auto business, but the year-over-year growth is decelerating, and you talked about China as well as the U.S. slowdown. To my knowledge, first time at least I'm hearing a company talk about a slowdown which has been feared by investors and everybody for a while. Can you please talk about the visibility that you have, do you expect the year-over-year to decel as we go through the next couple of quarters or you think this is something that you don't have a lot of visibility in, or how should we think about it? Thank you.

Tunc Doluca

Thanks for that question. I think it is something that we did want to talk about in more detail, so you asking it is great. So essentially just to recap, automotive did have a very strong Q3. It was up 26% year-over-year. And if you really take a look at Q3 plus Q4, or half year, combined we are still up in the high teens year-over-year despite the fact that we guided flat for Q4.

Now having said that, we obviously take a good close look at what happened here and we outlined some of the other reasons other than this great quarter we had in Q3, and we do see this weakness in BMS in China. This has been lumpy business in the past, but it has grown for us now. So it's got a bigger effect on the overall automotive revenue. And it really is determined in a large part by incentives that the government puts in place. So it is pretty hard for us to actually predict that frankly. The rest of our BMS business is a lot more stable, the ones coming from other regions, but this one really depends on how those incentives are put in place.

Now long term, despite the lumpiness, we think there are some underlying reasons in China, mostly about pollution in the air, that will drive more electric vehicles and I think the government will continue to incentivize it. But I think the decisions come out in discrete form which affects demand. So that's one piece.

The other piece is, I think as many of you following the auto business have followed, in the U.S. we did notice some softness in sales, and just looking at our product sales into that market, we are seeing that to be weaker than the other regions.

So those are I think the two, other than the strength we had last quarter, are the two things we see fundamentally. However, the fundamentals continue to be strong for us. The design win pipeline forecast is very robust for infotainment and ADAS and electric vehicles as well. So we do expect this business to grow in the future in the double digits range for multiple years.

But my experience in the past has always been that you never grow in a straight line, frankly, and I think we're just seeing a temporary effect in this quarter. But long-term, we like this business. I think most of our investors like it because it's sticky, it's stable, the sockets are there for multiple years, and no fundamentals have changed in the last quarter.


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

Tore Svanberg

Congratulations on the results. Bruce, you talked about sell-through being a little bit weak earlier in the quarter and then it kind of strengthened, and then you're expecting I think you said pretty strong sell-through in the June quarter. Can you just elaborate a little bit on that please?

Bruce E. Kiddoo

So I think when we look at the third quarter, I thank we indicated resales were down sequentially, they were down 3%, which is basically in line with seasonality, maybe just one or two points weaker than seasonality. If you sort of look at that by geography, I think for us, and it's been a similar story the last couple of quarters, the Americas has been weak and it continues to be weak. And so that's just an issue that we are continuing to work on and to address.

I would say, China and Japan were kind of in line with seasonality, and these are kind of normally some – resales are a little bit slower for both of those countries. EMEA was actually up strongly, which normally is again in line with seasonality. So I think the main weakness there in the third quarter was really the Americas, and I think everybody else was kind of as expected.

When we do look forward to Q4, we are seeing very strong resale forecast. Again, when we look at the different countries, both probably led by Japan, as we have had good business there with some of our gaming opportunities, some of the automotive, so that's done well, and then we are also seeing sort of some expected strength in Europe and China as well.

So, overall I think we are comfortable with kind of where we are at in the channel. We did see a slight uptick in the days, and so our target is at 55 to 60, we are at 62, and with the expectation for strong resales in the June quarter, I think we are comfortable with where we are sitting there. Basically the inventory is a couple of days above our target, but really in expectation of strong resales this quarter.

Tore Svanberg

Very helpful. Thank you.


Our next question comes from the line of Vivek Arya from Bank of America Merrill Lynch. Your question please?

Vivek Arya

Tunc, I'm wondering, in terms of use of cash, do you think either from a Maxim or if you could comment from an overall industry perspective, are we at a plateau in semis M&A or do you see additional consolidation potential in the industry beyond just small tuck-in deals? Because when I look at Maxim, your core business has stabilized, it's doing quite well. The consumer headwinds have sort of reversed and gross margins are definitely tracking better than expectations. So what will be the trigger for you to consider additional M&A and take advantage of your very strong balance sheet? Thank you.

Tunc Doluca

So, I mean we look at all possible ways to grow cash flows in the Company. Obviously the organic ones are ones that are completely in our control, and as you noted, we made a bunch of changes that made us stronger as a company. But one of the levers that we always have is to look at whether we can grow by acquiring other assets as well.

But we also have some guidelines as to how we want to do that, and frankly, we wanted to be close to what we know how to run, which is businesses, analog and mixed-signal. We need any asset that we acquire, when we acquire it to be at least be able to get to the margin structure that we have as a company. And third is [indiscernible] our pick. So we look at what is the ROI in that investment. And we always have our eyes open. And that's one of the reasons why we do want a reasonable amount of capability or capacity to be able to do that.

Having said all that, your other question is, will the M&A continue? I think that you opened up with that. And I think it will because the semiconductor industry is not growing as fast as it used to in the past. So I think everybody has criteria probably similar to what Maxim has, and that will probably in my view kind of slow things down a bit, but I think that in general, as long as debt is cheap, I think everybody is kind of looking at this as a growth opportunity. But we want to make sure that we are also very careful in our decisions in terms of growing with acquisition.


Our next question comes from the line of Srini Pajjuri from Macquarie Securities. Your question please?

Srini Pajjuri

Bruce, I just want to go back to the gross margin optimism that you commented about. Obviously you said the distribution is helping gross margins a bit. Just want to understand if you're seeing any better pricing trends given all the consolidation? I do look at the SA data and it doesn't seem like there is an evidence that pricing is getting any better, but I just want to hear your thoughts. Thank you.

Bruce E. Kiddoo

I think it kind of ties with the prior question around consolidation, and I think as our industry consolidates and there is just less semiconductor companies, I do think there are benefits across the board to margin, and whether that's in dealings with our suppliers or distributors or customers. And so, I think from that point of view, I think there is the opportunity to kind of fully capture value for the products that we sell. I think that's always been our goal and I think it's always a negotiation.

And as far as how much of that value we keep versus our customers get to capture from us, and I think to the extent that consolidation is occurring, I think that that's helpful to us from a pricing point of view. It's not something that we look at as some short-term opportunity. We think this is something that we obviously kind of have strategic partnerships with our customers. But over a long term, we do think that's probably another tailwind to gross margin. I would say it's more subtle and it's not one we'll all be able to call out at some point in time and say, hey, we are up 50 bps because of pricing, I think it's more, I think it provides, in my sense the best way to characterize, as an underlying support for our gross margin. Whereas in the past I think chip companies were always having to sort of offset pricing reductions and I think that pressure probably abated a little bit.

Tunc Doluca

So just for me to add to that, I think most of the companies that are higher-quality companies have gotten a lot more disciplined on this, and I think that that helps. But as Bruce said, it's going to be difficult for us and for many other companies to say, we got this margin because we were able to get better control of prices. Very subtle and slow and distributed over many, many products.


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

John Pitzer

Bruce, I'm not sure if you mentioned when your second distributor in the U.S. is going to move to a sell-in. Could you help us understand when that might happen and would you expect sort of an equal amount? I guess just in general, as you think about sell-in versus sell-through, sell-in tends to create more volatility than sell-through in rev rec. And so, are you guys thinking about your own inventory levels differently as you try to manage a sell-in rev rec model versus a sell-through rev rec model or how should I think about that?

Bruce E. Kiddoo

So your first question, obviously we'll transition it when it's appropriate to transition, and this is more based on sort of kind of application of the accounting rules, from that point of view. My sense is, it's highly likely it will be in FY 2018, and if I had to do an over/under, it's probably more likely to be in the first half of FY 2018 than the second half. But that hasn't been determined yet, right, and that's something we continue to evaluate every quarter from that point of view as far as what is the proper accounting for that.

As far as the transition to sell-in on a global basis, certainly it's something that as a CFO makes me a little bit nervous. We are very transparent on what our channel inventory is. We are very transparent on what our goals are and it's something we manage very closely internally to make sure that we stayed disciplined there and that we don't build up too much, or to be clear that we don't have too little out there as well, right. We believe, the ability of our distribution partners to have inventory to support small customers is important. So getting that, kind of from an asset management point of view, getting the right level and candidly the right products in distribution I think is important to it.

And as far as your last question on our thoughts on our own inventory process, again I don't think that the difference between sell-in to sell-through changes that much from kind of any buffer inventories that we carry in our books. Obviously to the extent that we are selling into distribution, we expect them to carry the buffer. And so from that point of view, that's not a key area of our buffer plans for us.

And then I guess finally, I think you also asked about the magnitude. Most likely it will be larger, maybe 50% or more larger than what we are currently looking at.

John Pitzer

That's helpful, Bruce. Thank you.


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

Christopher J. Muse

I guess for my question I was hoping perhaps you could quantify expected growth in the consumer segment? If my math is right, it sounds like it's in high single digits. And then I guess, would love to hear your thoughts how you're thinking about seasonality into the second half of the year, particularly as it relates to your largest customer. Thanks.

Tunc Doluca

Okay, so I'll take that one. So in terms of seasonality or providing forecast for longer than a quarter, we haven't been doing that for a while and we really don't want to do it. The visibility is really not that clear, especially in consumer into that space.

And your question was about consumer growth, and I do want to answer that. I mean in the short term, our goal is really to simply stabilize our consumer revenue. And the mechanism we are using for that is to get diversification, as Bruce and I mentioned, by winning in end equipment other than smartphones and winning in wearables and some hearables, tablets, gaming, all kinds of other things, and also wining at other customers, even in the smartphone space, to be able to diversify that.

So, I think the way to think about it in the short term is to see if we can really make it not go down, like it used to in the past. We have made great progress in that space last year. And I think that our ability to diversify the business is going to help us also in terms of stabilizing it. But I think we won't be able to give any guidance for next quarter or next year.


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

Craig Hettenbach

Tunc, appreciate all the color on the automotive market. Just maybe taking that a step further when you think about some of the very near term headwinds, anything from a change of customers in terms of build plans or how are they kind of reacting to if you call it kind of a mild slowdown for parts of the automotive business?

Tunc Doluca

Frankly, when we are looking into our guidance numbers and if we are trying to make some sense out of it, what we found is really nothing that was really very obvious frankly. I mean it took us a while to dig in and figure out the answers. So we are not really seeing some big signal from any sector that says there is a big slowdown going on, other than China. I think in China the incentive thing was pretty obvious and it was one of the important things that we saw right away.

So, I'm afraid we are not going to be able to give a lot more insight into what's going on overall in the automotive market, and I think our information is kind of it is filtered through too many layers before it gets to us, because most of our sales are into Tier 1s and they sell into multiple regions. So it's not very easy to get the information you are asking for.

Bruce E. Kiddoo

Yes, I guess the good news about our automotive business has been it's broadly diversified and we sell across, as Tunc said, multiple Tier 1s and some OEMs across multiple regions with multiple products. That's what makes it a very nice business. It's like the old industrial business that was always a great business and is still a great business, but very difficult to articulate exactly what's causing that business to go up or down in the short term.

But of course that's why, A, it's a great long-term business for us, and B, while we have the confidence that while there is always going to be some kind of quarterly variations, as Tunc said, long-term we are still highly confident that this will be a very strong growth business for us for many years to come.


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

Christopher Danley

Just a little more clarification on the auto slowdown, so when did the slowdown start, was it push-out to cancellations, do you think it can get worse, and then do you think things will be back to normal by next quarter?

Tunc Doluca

So I mean we didn't really see any signs that were like a big push-out or a cancellation or anything like that. It's just from the information that we were getting in giving or looking at what the revenue is going to look like for the current quarter, it looked like there is – we had such good growth in the previous quarter, I think that's really the biggest effect here compared to all the other ones we talked about. And if you kind of do a moving average, we are still on a really nice growth curve and we have no reason to believe that that moving average has suddenly had a big change in slope. So, no – I understand what you are asking, you're saying, was it some big events that occurred, and that is not the case.

Bruce E. Kiddoo

If anything, we had a tremendous quarter.

Christopher Danley

Okay. Thanks.


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

Toshiya Hari

I wanted to follow up on gross margins. Bruce, when you think about your business over the next couple of years in terms of manufacturing footprint, business mix, customer concentration or diversification, is the mid 60s to high 60% range kind of the new steady-state or do you think you can aim for 70% or higher on a multi-year basis? Thank you.

Bruce E. Kiddoo

So, we are doing really well on gross margins, and we set a goal to go from kind of 60%-61% to 65%. I think the Company executed phenomenally and I think we got to our 65% and we got there earlier than we thought. We clearly are now guiding to something above that and we believe there's tailwinds that will help us and support our gross margin going forward.

That said, I don't think we're prepared to update the model from a commitment point of view. I think we'll continue to evaluate this. We are kind of going through our planting season right now. Our fiscal year ends in June. And so we'll get a good sense of what that gross margin looks like out for the next three years. I mean right now, we're just focused on execution and delivering kind of the best gross margin we can, and I think when it's appropriate, we'll look to update the model. But for now, I think we're just going to continue to execute and I think we'll continue to be able to deliver gross margins in the range we're at now.

Toshiya Hari

Got it. Thanks so much.


Our next question comes from the line of David Wong from Wells Fargo. Your question please?

David Wong

Bruce, you ran through roughly how the extra revenue from the change to sell-in recognition was divided amongst your various end market segments. Can you give us some idea of what the year-over-year growth numbers look like by segment, if we back out this transition?

Bruce E. Kiddoo

I have about 20 pieces of paper in front of me and I don't have that piece of paper in front of me. So we'll get back to you. I don't have that.

David Wong

Okay, fine, thanks.


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

Steven Chin

I had one on the comm and data center business, if I could, just given some of the benefits from the distributor sell-in revenue recognition for that division, could you possibly provide a little more color on how that segment might be performing for this June quarter if you were to back out that sell-in benefit? And also, specific to the comm infrastructure portion, how is I guess the overall demand or inventory levels for that part of your business, because I know that can be lumpy, and given some of the I guess downward bias in telco CapEx I think in China and even here in Verizon recently, if you're seeing any effects of that? Thank you.

Bruce E. Kiddoo

I'll answer the numbers and I'll let Tunc give the color on the business. As far as I mean we are guiding our kind of comm and data center business up in Q4, the change to sell-in doesn't have changed that. If we hadn't had that, it would be up as well. So from that point of view, there is no qualitative change in our guidance. As far as your other questions, Tunc?

Tunc Doluca

So in the near term, we did project comms and data center to be up quarter over quarter and we do see growth both in the optical data center side and the infrastructure side, both of them. Your question about lumpiness certainly is true for the comms infrastructure side of the business and we don't really have enough of an exposure to be able to tell what the inventory levels are at our customers. Obviously we know what it is at our distributors. And we are not aware of issues there. But we don't know what it is at the customers.

Over the long term, the biggest growth driver for us is going to be on the cloud data center side of this business. I think we have talked about in the past about our investments, especially on the optical data communications within a data center application, and that business is doing really well. This is the 100G gigabit per second connectivity business we've had.

It's been a great business for us because we've made the right decisions on architecture and how to help our customers design the modules for this, especially on the laser driver side, and we are confident that we're going to see a transition to 100G because it's faster speed and better, lower power consumption for these systems. And we are really at the early innings in that growth. I mean we began to see demand starting back in the December quarter and now we are seeing continued growth and we continue to see year-over-year growth in optical.

So I think that that one is really a transition from lower frequency to higher frequency in a market that's already growing. So that's all helping us and giving us a lot of tailwind in this data center and comms business.


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

Christopher Rolland

Just to follow up on auto again, and once again congrats on another great quarter there and what's been a really terrific year, in your last Analyst Day you said that that segment will grow 2x the overall auto market, but there is some belief that SAR could be flat or even modestly down this year, so that rule of thumb kind of breaks down. So I guess my first question is, on a flat SAR, what do you think we could do for auto? Is the double-digit scenario that you alluded to still achievable there? And then secondly, if the SAR does decline, it's probably because of the lack of subsidies in China. Do you guys happen to know your NGO exposure? I know it can be tough, but do you know China versus EU versus North America for example?

Tunc Doluca

Okay, so that's a lot of questions in there, but let me just tell you what we said and then we can get back into the question you were asking. So basically, at our Investor Day, which was a little bit over a year ago, and at investor meetings that we've had, at various conferences, we've said the automotive unit sales we believe or the reports we were getting were basically in the low single digits range. And the analog selling to that as a content was growing at a rate that was faster than that, perhaps twice that rate, which puts you in the high single digits range. And we said that we can see comfortably that we could grow at at-least twice that, because we've been growing at 3x that in the past.

But we know those are all big numbers. I mean our automotive business is now large. It's 20% or over 20% of the Company revenues. And we did tell investors that we might get down in time to the higher double-digit range or high teens range.

So, even if the auto sales numbers has a reduction, the semiconductor content in cars is still growing, and that's not going to change. So we expect that even if, and we are not saying that there will be car sale unit reductions because we don't have that insight, but even if that happens, the content still continues to grow in cars. And because of the decisions we made on where to invest, which is doing even better than the content, we can see us growing at twice the rate of analog semiconductor growth in cars.

So that's why we feel good about the fact that we can see us growing in the high teens for the Company for multiple years. Now in that, there will be some modulation by number of cars sold, but we are still seeing growth that's kind of in addition to the unit car growth for the Company.


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

William Stein

Despite all the puts and takes by end market and the strength in automotive in March and I'd say the sub-seasonal expectation for June, overall revenue traction is still pretty good. Meanwhile, we've heard from some other semi companies and maybe some discussion in the channel of shortages of products and lead times extending. I'd love to hear your comments as to whether you're seeing that either in any of your business portfolio, any variations from normal expectations there, and whether you're seeing other complementary product shortages that are maybe causing a problem sort of through the supply chain affecting you?

Tunc Doluca

Let's just take cost first. If you look at our lead times that we are providing to our customers, we have not seen any change in our side. I think we are doing pretty well in terms of capacity and our ability to respond to our customers. So that's part one of the answer.

From other suppliers, I think we are not seeing that as a general trend. I did read the Qualcomm report from yesterday and they did talk about some lead time extensions of one of their processors. So we are aware of that and I'm sure all of you are aware of that, because that came out publicly. But other than that, we are not hearing this as a general trend in the industry. And we certainly don't have it ourselves. So that's the extent of input I can give on that question.


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

Cody Acree

Tunc, maybe similar to the color you gave on the automotive segment longer-term, what are your thoughts on the long-term growth rates in the industrial segment and maybe any visibility you have to activity beyond the factory automation segment?

Tunc Doluca

So I think the best visibility we have got long term industrial is really in factory automation. We are seeing the results of investments that we have made in that starting back in 2012 in that range, and that really is giving us good growth. We also in addition had some initiatives last year and in the last few years about growing our other products in our core industrial segment that are going to our small and medium-sized businesses, and I think we are very encouraged by what Bruce quoted earlier that our distribution business had grown tremendously to get to a larger percentage of the Company revenues.

So, there are in the core industrial segment I think the fact that we have invested in areas that help factory automation and that help build factories that are more productive, that involves distribution of decision-making so to speak to the factory floor, those are all great tailwinds for the Company. That's tailwinds for power management products, it's tailwinds for our interface for industrial grade communications products. So I think, long-term that will be a good growth vector for the Company.

In addition, as you know, we also have some vertical industrial markets that we've invested in. Those are I'd say a bit more lumpy compared to what we see in core industrial in terms of growth. But in that space, we have also seen great strength more recently in like automated test equipment. We have done pretty well in that segment. We've got some good business there in security. We have got some good business there in medical.

So, those investment areas that we chose, we chose very carefully and this was part of our more focused effort. So, the longer term, I think the industrial growth for us will be there. It won't be as large as automotive, when I said it's in the high teens for automotive, I don't think it's going to be that large, but it will still be a significant growth driver for the Company.

Kathy Ta

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


Certainly. Then our final question comes from, it's a follow-up from the line of Ambrish Srivastava from BMO. Your question please?

Ambrish Srivastava

Thanks for squeezing me in again. I just had a quick clarification. For the sell-in impact, Bruce, do you expect it to continue in the September quarter or it's a one-time impact?

Bruce E. Kiddoo

So for the $15 million to $20 million that we are talking about this quarter, it's a one-time effect. We do have one more distributor that we have to transition, John asked about that, and we expect that to happen in FY 2018. And if I had to, more likely than not, it will probably be in the first half of FY 2018. But again, that's more dependent on sort of kind of the accounting assessment. So there's one more, and it will be larger in that it is probably over 50% larger impact.

Ambrish Srivastava

Okay, I apologize if I missed that.

Bruce E. Kiddoo

The key thing is, for September, I mean at this point from a modelling point of view, I just assume that what we're seeing this quarter is a one-time and you got to kind of do whatever growth you're going to assume for the September quarter, do it off. Don't include this one-time impact.

Ambrish Srivastava

Got it. Thank you very much.

Kathy Ta

Okay, so I think that was our last question. So I would like to thank everyone for participating. That concludes today's conference call. We would like to thank you for your participation and 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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