Good morning, and welcome to the Analog Devices Second Quarter Fiscal Year 2016 Earnings Conference Call, which is being audio webcast via telephone and over the Web. I'd like to now introduce your host for today's call, Mr. Ali Husain, Treasurer and Director of Investor Relations. Sir, the floor is yours. .

Great. Thanks, Jennifer. Good morning, everyone. Thanks for joining the Analog Devices Second Quarter 2016 Earnings Conference Call. You can find our press release, relating financial schedules and the investor toolkit, which includes additional information that we believe will be useful for investors, and all that is at investor.analog.com.

As usual, I'm joined by ADI's CEO, Vincent Roche; and ADI's CFO, Dave Zinsner. .

So before we start, let's get through some disclosures. Please note the information we're about to discuss, including our objectives and outlook, includes forward-looking statements.

Actual results may differ materially from these forward-looking statements as a result of various factors, including those discussed in our earnings release and our most recent 10-Q.

These forward-looking statements reflect our opinion as of the date of this call, and we undertake no obligation to update these forward-looking statements in light of new information or future events..

Our comments today will also include non-GAAP financial measures, which we've reconciled to their most directly comparable GAAP financial measures in today's earnings release, which we've posted at investor.analog.com. .

And with that, let's get started. Revenue in the second quarter totaled $779 million, which was up 1% sequentially and down 5% from the prior year.

On a sequential basis, our business-to-business or B2B markets of industrial, automotive and communications infrastructure experienced broad-based demand, growing 9% sequentially and more than offsetting a weak consumer market. .

So let me give you a little color on our performance by end market. While overall macro trends were fairly mixed during the quarter, ADI's highly diverse industrial markets grew 11% sequentially and represented 49% of revenue.

All of the major application areas within industrial such as factory automation and industrial instrumentation grew sequentially in the seasonally strong second quarter. And we also had a particularly strong performance in the aerospace and defense vertical..

The automotive market at 18% of sales grew 9% sequentially in the seasonally strong April quarter. Growth was broad-based across all of our automotive-focused applications of safety, ADAS, powertrain and infotainment..

Turning now to communications infrastructure. Last quarter, we had talked to you about a nascent recovery in this market, and we're happy to report that this trend continued during the second quarter.

Revenue from communications infrastructure customers at 23% of sales increased 4% sequentially, with both wireless base station and wireline applications revenues increasing over the prior quarter. .

After troughing in July of last year, communications infrastructure revenues have grown at a slow and steady pace. And we believe we're still in the early stages of a recovery in this market. So in total, ADI's B2B markets of industrial, automotive and communications infrastructure grew 9% sequentially in the second quarter. .

In the consumer market, revenues decreased 37% sequentially. At current quarterly run rates, we believe that our consumer business is at trough levels. In total, consumer represented 10% of revenue in the second quarter. .

So now I'd like to turn the call over to Dave for details of our financial performance in the second quarter. With the exception of revenue and other expense, Dave's comments on our second quarter P&L line items will exclude special items, which, in the aggregate, total $33 million for the quarter.

When comparing our second quarter performance to our historical performance, special items are also excluded from prior quarter and year-over-year results. And reconciliations of these non-GAAP measures to their comparable GAAP measures are included on Schedule E in today's earnings release. .

So with that, Dave, it's all yours. .

Thanks, Ali, and good morning, everyone. Our strategy to focus on diverse products, customers and markets enabled really good performance in the second quarter. We also repurchased $214 million of our stock in response to price volatility, which enabled the third consecutive quarter of share count reduction..

Revenue in the second quarter totaled $779 million and diluted earnings per share was $0.64, with both results above the midpoint of guidance. Gross margins of 65.8% increased 360 basis points from the prior quarter, primarily on lower inventory reserves and on factory utilization rates that increased to the low 70s. .

Inventory on a dollars basis decreased $5 million sequentially and on a days basis increased to 138 days as we staged inventory for an anticipated consumer revenue ramp and managed Hittite-related last-time buys. We expect both dollars and days of inventory to decrease over the next 2 quarters..

Turning to inventory in the distribution channel. Inventory in distribution on a dollars basis was modestly higher than in the prior quarter, and weeks of inventory in distribution decreased to 7 weeks from the prior quarter's 7.5 weeks. .

Operating expenses increased 3% sequentially to $272 million, in line with our plan. Operating profit before tax of $240 million increased 12% sequentially and as a percent of sales expanded 300 basis points to 30.8%. Other expense in the second quarter was approximately $13 million, and that represents the run rate of our net interest expense. .

Our second quarter tax rate was approximately 12%. We expect our non-GAAP tax rate for the remaining 2 quarters of the year to be approximately 12.5%. Excluding special items, diluted earnings per share of $0.64 increased 14% over the prior quarter..

Our business franchise forms the foundation of our strong balance sheet. At the end of the second quarter, we had $3.8 billion in cash, net cash of $2 billion and a leverage ratio of 1.3x EBITDA.

We also have $1.7 billion of liquidity in the U.S., which we plan to use for investments in our business and for general corporate purposes, including dividends, share repurchases and acquisitions..

During the second quarter, free cash flow as a percent of revenue increased 190 basis points from the prior year to 37.8%. Excluding a onetime item, over the last 12 months, ADI has generated $1 billion in free cash flow.

And over this period, we have also returned that $1 billion to shareholders through dividends and share buybacks, effectively returning 100% of free cash flow over the past 12 months..

During the quarter, we paid $130 million in dividends to shareholders, and earlier this week, our Board of Directors declared a cash dividend of $0.42 per outstanding share of common stock. This will be paid on June 7, 2016 to all shareholders of record at the close of business on May 27.

At the current stock price, this dividend represents an annual rate of about 3%..

M&A is a key part of our strategy to accelerate technology leadership and revenue growth. During the quarter, we acquired SNAP Sensor, giving ADI the ability to provide very high-dynamic-range industrial imaging solutions in Smart City and Smart Building applications. .

So in summary, this was a good quarter on several fronts. The diversity and breadth of our business, coupled with strong execution, enabled revenue and diluted earnings per share results that were above the midpoint of guidance. And our capital allocation strategy enabled a significant return of cash to shareholders..

So now turning to our outlook and our expectations for our third quarter, which, with the exception of revenue expectations, is on a non-GAAP basis and excludes special items that are outlined in today's release. We're planning for another quarter of sequential revenue growth in the third quarter.

In our B2B markets, we are seeing stable order rates across the industrial, automotive and communications infrastructure sectors, and as a result, we are planning for aggregate sequential demand in these B2B markets to be largely seasonal in the third quarter.

Importantly, we expect our B2B markets, in the aggregate, to grow in the mid- to high single digits on a year-over-year basis in the third quarter. .

In the consumer market, good design traction in the portable sector leads us to plan for sequential revenue growth in this market, although it is likely that this revenue growth will be back end-loaded and occur late in the third quarter. .

In total, we're planning for revenue in the third quarter to increase sequentially and be between $800 million and $840 million. We expect gross margins to remain stable to their second quarter levels despite utilization rates in the low -- in the 60s range as we expect lower spend levels and manufacturing efficiencies to offset the lower absorption.

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We estimate that operating expenses will be up slightly in the third quarter but that they will lag our expected sequential revenue growth, and we expect even greater operating leverage in the fourth quarter. Based on these estimates and excluding any special items, diluted earnings per share are planned to be in the range of $0.66 to $0.74..

We firmly believe that our future success is within our control. To that end, we are partnering with customers and innovating with impact to drive business success and more importantly, shareholder return. With a strong business model and a focus on the right end markets, we're confident that we can drive ADI's non-GAAP EPS to up to $5 by 2020. .

Great. Thanks, Dave. All right, so folks, before we get to Q&A, let's run through the format. [Operator Instructions] And so with that, operator, let's start the Q&A session, and folks on the line can ask questions of either myself, Vince or Dave. .

[Operator Instructions] Our first question comes from the line of Tore Svanberg with Stifel. .

Just a question on your communications business. You said it's been steadily improving since, I guess, almost a year ago now, but that was still in the early days of some good momentum there.

So can you just elaborate a little bit on that, perhaps, maybe both on the wireless and on the wireline side, please?.

Yes. So Tore, as you point out, I'll start and Vince will, I'm sure, finish up. But we troughed around the third quarter of last year. And obviously, a lot of the weakness last year was related to China investigations.

That seemed to run its course, and we've been steadily improving up to the levels that I think we saw right around the second quarter of last year. I think our position in the marketplace is quite strong. We literally have -- any OEM that's building base stations or else infrastructure communications equipment uses our radios.

We also expect that over the next few quarters, we'll start to see a more meaningful rollout of small cell activity in China. We think that will be a good growth driver. We have the lead position from a technology perspective in integrated transceivers, which is going to be the technology of choice in that space.

So I think we're in great competitive position. The smart cell activity is going to help drive some momentum just aggregately in the marketplace. And then this whole headwind that we saw in China has started -- has run its course, obviously, and we're starting to see the recovery there.

So the momentum and the wind is behind our sails at this point in the communications space. Obviously, it can be lumpy at times, but right now, based on the order flow, we're quite optimistic about the comm space. .

The next question is from Ambrish Srivastava with BMO. .

I had a question on the guidance, and I'm just trying to understand the consumer guidance. And we're notoriously bad in trying to predict Apple units.

But if you look at the guide, it looks like it could be a factor of either lower units than what most of us were modeling for or lower ASP or just the overbuild was so high that it's taking a longer time for all that to bleed through the channel.

What's the right way to think about it?.

I think the way to think about -- I guess you're talking about the third quarter. I think really, the third quarter, as you compare it against the third quarter of last year, is really the dynamics around when the buildup is going to occur this year versus when it occurred last year.

I think because we were a new player in that particular application with a new product, our customer ramped a few months earlier than typical for their semiconductor vendors in an effort just to make sure they had everything in the pipeline they needed.

I think now we're going to be more consistent with most of the other semi vendors out there that supply into this particular application. And really, that means that we really don't see the demand pickup until the July time frame.

So it's probably going to be more of a end of third quarter and more into the fourth quarter this time versus last year, where it was more of a ramp in the third quarter. I would point out that we have -- well, I should say we suspect we have more dollar content in that particular application this year versus last year.

And so from a BOM perspective, we will actually be in a better position, and so it obviously, at the end, depends on how the demand of the end product goes. But assuming that goes fine, we will actually see pretty good growth. .

Your next question is from Amit Daryanani with RBC Capital Markets. .

This is Jeriel on behalf of Amit. I guess looking to industrial business, it's been down year-on-year for a few quarters now. It looks like, given guidance, it might grow year-on-year in the July quarter.

Will we see the growth accelerate as we get into the back half of 2016 and then into 2017?.

Industrial is hard to predict out 4 weeks so I don't know that we're out -- we're ready to predict what it's going to do out several quarters. I would say that, yes, from our guidance, you can interpret that we suspect the industrial business is going to be up year-over-year in the mid-single digits or so, yes.

And as a result, we think we're back in a recovery phase there. It had been weak probably related to kind of the phenomena around oil and gas weakness and maybe some currency issues. That seems to have run its course. And as a result, we think we're back on a recovery trend in the industrial space.

The one area of that business that's actually beaten the kind of the macro headwinds has been the aerospace and defense business. That's done very well for us even despite the weakness we've seen out there on the macro side. And as it looks out into the future, it looks like that business will continue to be a pretty strong business for us. .

Your next question comes from John Pitzer with Credit Suisse. .

Dave, I just want to talk a little bit about the gross margin guidance for the July quarter. If I look on a year-over-year basis, gross margins are going to be down a little bit year-on-year despite the fact that I think you said in your prepared comments that the B2B business should be up, actually, kind of high single digits year-over-year.

Can you just help me kind of square that circle and help me better understand why margins wouldn't perform better if B2B is showing such good year-on-year growth?.

Yes. It's a good question, John. We're actually going to bring utilization down in the third quarter into the kind of 60s level. It was actually, I think, in the 70s last year.

And that's really -- when we looked at our inventory levels, even though most of the inventory build was related to things within our control, like ramping up for the consumer ramp and also for the buildup related to some foundry transfers that are going to occur related to our Hittite business, we really wanted to keep inventory in check.

And so we thought it would be a good idea to bring the inventory down in the products that get -- or related to the products that get manufactured internally. So that's really why we approached it that way.

Now we're probably going to bring it down, I don't know, somewhere in the 10 percentage point range at least, and that normally would have 100 basis point negative impact on us.

But what we're going to -- what we think we can do is take some of the costs out of the factory in the third quarter, and we think we'll make some improvements from an efficiency perspective. And those things combined will offset a lot of that headwind, and as a result, we think we'll be generally flat. .

Your next question is from Stacy Rasgon with Bernstein Research. .

I wanted to dig in a little bit on automotive. Over the last couple of quarters, you sort of talked about expecting a bit of a second half lift in that business. But now you're sort of talking about seasonal in aggregate for Q3.

And frankly, given the rest of the guidance you're talking about, if industrial is up like in the mid-single digits year-over-year and the overall B2B is up in the mid- to high, like I'm coming up with auto probably flat to down year-over-year and probably down decently sequentially, which, I think, would be seasonal.

But neither of those things seem consistent with a lift in the back half.

So are you sort of backing off on that statement that you made previously? Or like how should we be thinking about automotive as we move through the rest of the year?.

Stacy, we've had stellar growth. We've pointed out before that there's one particular area that we've had a headwind. We believe now that headwind has abated. We've had good growth in areas like infotainment. Advanced Driver Assistance and the powertrain area, we've had good growth.

Specifically in active and passive safety, we've had some issues, and as I said, I believe the headwind is -- has abated there now. So my sense is that with the programs we have in place, we'll start to see -- we've bottomed out in the auto MEMS area in terms of the declines.

So we will be back on a growth track over the coming months and into the -- during 4Q. So I think the worst is behind us there, and we'll get back into a decent growth pattern from here on and through FY '17. .

But is it fair to say that your Q3 outlook for auto was probably flat to down year-over-year then?.

No, Stacy. Let me just point out -- let me just make a slight correction here. I think when Dave was talking about mid- to high singles in the third quarter on a year-over-year basis, I think the comment was specific to the B2B market. Industrial, we expect to be up on a year-over-year basis in the very low single digits.

And so as a result, I think when you look out to the third and fourth quarter, what we're expecting to see in the automotive business is to see some modest year-over-year growth that we think we can accelerate through the back half of the year here.

I hope that -- does that help?.

Yes. .

Your next question is from Craig Hettenbach with Morgan Stanley. .

Just a question on that increase in cash returns just really stepping up the last couple of quarters. I mean, clearly, you guys are generating a lot of cash and have a very strong balance sheet.

But just wanted to kind of get your sense of how much is opportunistic versus how much may be providing a read on the M&A side, what might be out there and how you're approaching that. .

Well, we still have $3.8 billion of cash, so it's not like it's massively influential to how we're thinking about M&A. We're still interested in acquisitions, and that's part of our strategy. Obviously, we have a high bar on those acquisitions, so they don't come every quarter.

But we do want to have some dry powder available to us to make those opportunistic acquisitions that, a, can be very strategic for us in terms of driving growth and are very synergistic with what we're doing from a customer perspective; but, b, also deliver a very good financial performance and hopefully accelerate our earnings growth.

As far as just the level of buyback that we had in the last couple of quarters, I'd say it's a couple of things. One, it's somewhat programmatic in that when the stock has these dips in the stock price, we take advantage of that and buy stock back.

And so I'd say over the last couple of quarters, there were those periods of time where that happened, and on the average, we bought a bit more back than we had been in the past. And also, we just fundamentally believe that the best is yet to come for us.

And we think that, that $5 target is a doable target for us, and if that's a doable target, then buying at this price is a pretty attractive price. So those 2 things combined drove us to be a little bit more aggressive with the buyback over the last couple of quarters kind of in response to both the stock price and our expectations on value. .

Your next question is from Craig Ellis with B. Riley. .

I wanted to follow up on the increase on both automotive and industrial. Those businesses, in the outlook, look like they're back to nice year-on-year growth.

So my question is since those are both businesses that have significant application diversity, where are you seeing the strongest year-on-year gains? And where, within those businesses, do you still have subsegments that would be below last year's level? And what's the prospect for those to reach new highs?.

Well, specific to the industrial area, we've seen tremendous growth in the aerospace and defense area over the last number of quarters. And that's been also bolstered through the acquisition of Hittite. That's helped us a lot. We've been able to combine the franchises of both companies and eke more growth out there.

I'd say broad-based instrumentation across the globe has done well. And if you extract oil and gas from the factory and process automation side of things, we've seen good growth there, too. And geographically, I would say in the recent term here, both Europe and China have seen particularly strong growth.

On the kind of the muted side there, I'd say on the slower growth side of things, the automatic test equipment and energy sectors have been more turbulent. Energy is flatter, but the ATE thing has been quite turbulent. So that's kind of the picture in terms of the puts and takes on the markets, the subsectors and geographies there.

As I said earlier, in terms of automotive, we've seen stellar growth in infotainment, in powertrain and Advanced Driver Assistance, and we've been dealing with this headwind on the automotive -- the passive safety and active safety side of things. Geographically, if I look at automotive, again, America has been very respectable.

Europe has been stronger, and China and Japan have been relatively flat. So that gives you, I think, a picture of both of those sectors from a subsegment and geographic standpoint. .

Your next question is from Vivek Arya with Bank of America. .

Just on the Q3 outlook, I think you may have addressed it at different parts of the call.

But could you just give us some more color on each of the B2B segments, how you expect them to trend on a sequential basis and more importantly, how that compares to what you thought, say, 2 or 3 months ago about those segments?.

Yes, sure. I can take a crack at it. So industrial, I would say, sequentially is probably going to be up in the low single digits. Automotive is likely to be down in the low single digits.

I'd point out that that's probably better than what they normally see seasonally given we have July in our quarter, and that tends to be a soft month for the automotive market. And then comms is probably close to mid-single digits, somewhere in that range. I'd say it's pretty consistent with where we thought we would be a few months ago.

Nothing has changed. The macro is hanging in there nicely. The order flow in all 3 of these markets has been pretty good. We're obviously always running the business cautiously in the event that something in the macro gives us a hiccup. But that hasn't happened, and we're, I guess, pleasantly surprised or happy that that's how things panned out for us.

And so hopefully, this continues. .

Your next question comes from Steve Smigie with Raymond James. .

This is Vince Celentano on for Steve. I had a question.

Has there been any more progress in getting your force touch technology adopted at OEMs, either within mobile or in other end markets? I guess, in general, what's your plan going forward with this technology?.

Well, that product source is based on a core technology that we use in multiple applications, in industrial, automotive and so on and so forth. So it's not a case -- the product sector is specific to one application, but the technology is usable in many, many different applications.

It's based on our precision signal processing expertise that we've been developing for decades. So as I said, we're, all the time, looking to diversify, be it consumer, be it industrial. But whichever sector, all those products are based upon the core high-performance precision signal processing platform that we've been developing for decades. .

Yes. And Vince, just as a point, we don't comment on individual customers or products. So appreciate the question, but we'll move on to the next caller. .

Your next question is from Ross Seymore with Deutsche Bank. .

You gave great color on the wireless side of your comms business.

Can you just give us a similar update on what you're seeing on the wireline side and maybe remind us what the split between those 2 portions of your comms business end up being these days?.

Yes. So 2/3 of our business is wireless, and then the other 1/3 is wired. There's several applications within wired, but probably, the most prominent is control that goes into the optical signal. Obviously, that market is doing quite well because there's a move towards 100G, and that's obviously beneficial to us.

So it's been on a pretty steady -- the good news on this one is it hasn't had the lumpiness that the wireless business has had. So it's been on a pretty steady growth trajectory. It moves around based on seasonality, but year to year, it's been pretty steady and solid. .

Yes, we've been successful at moving between the various generations of optical transceivers from 2.5 gig right up to 100 gig now and beyond. So we've built a nice franchise, again, based on our signal -- our precision signal processing portfolio, where we're providing sophisticated and very, very precise control of the optical signal chain.

So that's the primary part, as Dave said, of our wireline business. Other aspects in which we have a good position are in the data packs and control pads in cable infrastructure. But by far, wireline is dominated by the optical technology that we -- the optical products that we provide. .

Your next question is from Romit Shah with Nomura Securities. .

I just wanted to talk about consumer. My understanding is January '15 was the last quarter before you guys started booking force touch revenues, and in that quarter, consumer was about $95 million. This last quarter, consumer was down to $80 million, so it implies that the business overall was down about 16% from that Jan '15 baseline.

And I guess excluding force touch, your legacy consumer business was down even more than that. And so I was hoping you guys could talk about the performance of that business and legacy consumer, in particular, and your expectations going forward. .

Yes. Legacy consumer has been for -- it's a huge number of different applications. We have a steady strong business in areas like high-end digital consumer for home and for enterprise, and that's been doing well and continues to do well. It's a very, very modest investment for the company.

So my sense is that's been growing at kind of the low single digits for many, many years. My expectation, again, given that it looks a lot like our B2B business in terms of design cycles, product cycles, that will continue to be a modest growth story for ADI in the years ahead. And it leverages.

We do very, very little specific product development for that sector. In terms of the remainder of the business, it's lumpier by nature. And we have a good -- as best we can tell, we read the signals pretty well, and we're managing supply and demand on the basis of what we're reading in those more volatile portable consumer applications. .

I appreciate the comments. I just -- I don't know that I'm coming away with a clear understanding for why the legacy business has contracted this much over what's been, what, 5 or 6 periods. .

Yes. Well, it's been -- it has been a headwind for 6 years or so, 6 or 7 years ago mainly because of the digital still camera business, which has been kind of a -- obviously, everybody's using their phones to take most of their pictures, and so that business has kind of -- has waned a bit.

It's down at this point now as we sit in 2016, a pretty nominal level at this point, and so I wouldn't anticipate it being much of a headwind going forward. There is a certain amount of people that will always buy digital SLR cameras. I'm looking over at Ali because he's one of them. So I think at this point now, it's probably stabilized. .

Your next question comes from Doug Freedman with Sterne Agee. .

If I could ask a question regarding the consumer business as well.

When we look at sort of the business coming back in, with handsets contributing materially here, how do we think about the incremental margin, both up, but as well as when it ramps down, especially given the actions you seem to be taking as far as managing the factory, which may be not coincident with the ramp-up that you're going to see in revenues?.

Yes. So all of this product gets manufactured in a foundry, a third-party foundry, so it doesn't necessarily affect utilization levels. So really, it comes down to what we price the product at and what we pay the foundry and the back end to produce the parts.

And the margins are respectable margins, and there's a little bit of a mix degradation by having that business, but it's not significant. I think it runs in the tens of basis points up or down based on whether we have it in a quarter or we have a meaningful amount in a quarter or not a meaningful amount in a quarter.

But other than that, I don't -- wouldn't suspect we have much volatility in gross margins from it. .

I guess another way, Dave, just to ask the question, if we were to exclude the impact of this business year-on-year, would you expect gross margins to be up next year?.

Excluding consumer, would we expect gross margins to be up?.

Yes, yes.

Excluding impact of the consumer ramp-up and ramp-down, would I expect to see some gross margin improvement year-on-year?.

Yes, yes. .

Your next question comes from Chris Danely with Citi. .

This is Philip Lee calling on behalf of Chris. You guys mentioned just the inventory was down to 7 weeks this quarter.

How is this versus maybe last year? And how do you expect it to turn the rest of the year?.

Yes. Typically, the second quarter tends to be a trough of just the inventory levels just because it tends to be a really big quarter for ship-outs. And we're kind of, on a shipment basis, kind of running it pretty consistently. So I wouldn't glean too much from it other than the fact that it's at a healthy level.

Seven weeks is exactly where it should be in the second quarter, and that's very healthy. My guess is that in the third quarter, it will start to trend back up to 7.5 weeks and then kind of stabilize until next year's second quarter. .

Your next question comes from Harlan Sur with JPMorgan. .

On the strength in industrial, you mentioned aerospace and defense as an area of particular strength. Was this segment up year-over-year? And was it more commercial or defense-related programs that are driving the strength? I know that there are some programs both in commercial satellite and radar.

There's also some defense program initiatives like some fighter jet upgrades and so on.

And what's the program pipeline look like for the remainder of the year?.

Okay. I'll take a little bit of a crack at that, and anybody can join in. It was up year-over-year in the second quarter. It likely will be up year-over-year for the full year unless something changes significantly. Most of the growth that we've seen has been in high-performance RF specific to military applications.

We've got a lot of that technology, obviously, when we acquired Hittite. They were already servicing that market in a relatively meaningful way. And their design wins over several years ago are starting to translate into revenue, and that's obviously driven the growth in that business. The expectation over the next 3 to 5 years is quite positive.

I think the areas that -- where radar applications are deployed are areas where the military is spending more in. And so as a result, that, coupled with the fact that now we have a really commanding position in that marketplace, leads us to assume that this market for us is going to be a nice driver of growth over the next 3 to 5 years. .

Commercial aircraft is another space where more and more of our technology is being used for all different kinds of signal processing, radio upgrades, control and so on and so forth. And also, satellite, commercial satellite, is an area that's becoming more and more dominant, if you like, particularly for commercial application.

So I think overall, when you look at what's been happening and what will happen, that aerospace and defense business will continue to grow for the company at good rates. .

Your next question comes from Mark Lipacis with Jefferies. .

Perhaps, for you, Dave. You were successful in the past in finding tax-efficient ways to use overseas cash for M&A.

And I was wondering if you would describe the M&A environment today as being a target-rich one? And of the targets that you're looking at, is there a good potential to use overseas cash tax-efficiently like you have in the past?.

Good question. Well, I mean, there are lots of ideas in the pipeline. It goes through a number of stage gates. And as it gets closer and closer to the point in which we're going to pull the trigger on it, those bars are -- get higher and more difficult to get through.

So I think that from an ADI perspective, I don't think anything's changed in terms of whether you'll see us do a ton of acquisitions on a very frequent basis. I just don't think that's our model. But there are areas that we think make a lot of sense in terms of acquisitions, and those are the areas we're focused on.

And so I suspect we will be doing them from time to time to help augment what we're doing organically. From an acquisition -- from a tax perspective, it's always fact specific as to whether -- which cash we can use depends on where it's located and where their operations are and so forth.

But to the extent that it checks all the boxes, I'm sure we could do something similar to what we did with Hittite. .

Your next question comes from Ian Ing with MKM Partners. .

I had a question on Hittite.

I mean, what was the magnitude of the last-time buys in the April quarter? What are the expectations in subsequent quarters? And as customers start looking at developing 5G infrastructure, are there some opportunities here for Hittite and microwave products? I know largely, microwave is for backhaul at the moment and communications. .

Yes, Hittite will help us a lot in the 5G space. And given our strong position in 4G and our strong relationship with all the OEMs who are developing 5G applications, we think we're in a great position to really take a commanding position in the 5G space.

On the -- I don't have the number off the top of my head, unless you know it, Ali, off the top of your head. But second quarter represented the peak amount of builds that we were going to have associated with Hittite. And so as quarters progress now, it should slowly be coming down.

I'm going to guess it added somewhere between 7 and 10 days to our inventory levels because of those transitions. As I said, you'll see a kind of a steady improvement. The one thing is we built up a lot of inventory for stuff that has long life cycles, and so it will take some time for us to get all the way down to 0.

It might take 5 years, maybe even 7 years to get down to 0. But the good news is that the headwind aspect of the inventory build is behind us and now it becomes a tailwind going forward. .

Your next question is from Stephen Chin with UBS. .

A question on the communications wireless business. I was wondering -- just given some of the comments around small cells, I was wondering if you could talk a little bit about your revenue sensitivity to deployments regarding small cells versus base stations just given the different levels of content and also the unit deployments.

And also if you have any further visibility into -- beyond the current quarter regarding CapEx for either small cells or macro base stations. .

I think we're in a very good position in both macro cells and small cells. As more and more of the usage of cellular equipment is in building, there may be a switch to small cells over time, but it's not going to be a growth switch from macro to small. I think there's always going to be a mix of both.

So we're very well positioned irrespective of whether our customers are deploying macro or small cells. And in terms of content, obviously, the small cell has less content than the large cell. But we have -- in terms of the radio, we've got almost the entire radio in the small cell given the strength of our software-defined transceiver technologies.

So I think what you'll see is the deployment will continue on the macro side. There will be an upsurge in small cell over the remainder of this year into next year. And we're very well positioned irrespective of whether it's macro or small.

What was the second part of the question?.

CapEx. .

CapEx. I think the way to look at the CapEx discussion is in -- terms of innovation, the innovation in base stations is really happening at the radio level to increase spectral efficiency and flexibility. So there's an increasing amount of the hardware spend going into the radio over time.

And with the strength that we have in the franchise, we've got in terms of mix signal and RF and microwave technologies, I think we're very well positioned given the strength of our relationships and the fact that we've skewed R&D over the last 5 years more heavily towards wireless applications.

Irrespective of what happens, I believe it will be a fairly stable CapEx environment in terms of the ratio of services, software and hardware. But I think we're well positioned as a company to grab additional share there given, as I said, the strength of our technology and customer positions. .

Your next question is from Ambrish Srivastava with BMO. .

I just had a couple of follow-ups. Just on the A&D strength, is this more primarily Hittite benefiting from your channel? Or is it more a result of the last-time buys? And then a little bit longer term, when do we expect to see jointly developed products between Hittite and ADI? And I realize it takes a while for that to pan out.

And then a second quick follow-up. Dave, you mentioned that in consumer, you'll have more content. Is that because you're -- because I can't imagine ASP going up.

Are you designing out sockets from -- that somebody else had?.

That's a lot of questions, Ambrish. Okay. So on the aerospace and defense side, I would say -- I would characterize the growth as products designed back in the Hittite days in a lot of cases, some on our own products, back many years ago, that now -- because it takes a while for that stuff to turn around and become revenue.

And so that's really what's driven the performance at this point. It hasn't been related to Hittite being a part of ADI yet.

The opportunity pipeline has significantly expanded because of the acquisition of Hittite and because of our ability to both sell more of what Hittite sells or makes into that market and also what we make and try to drive that into that market.

And so I think that we'll start to see some revenue synergies next year and probably be relatively modest next year but begin to ramp significantly over time. And it's probably on the opportunity side of peak revenues. It's probably $100 million of opportunity.

So not all of that we'll close on, but it's a significant amount of synergies that we were able to get by combining Hittite and Analog Devices. .

Yes. In terms of your product development question, the combination of Hittite, maybe on the design side of things, we acquired the technology to enable us to broadly apply microwave technology and build a real leadership franchise in the high end of communications infrastructure, general communications, even industrial instrumentation.

So we already have very, very good synergy between the design teams in looking at the next 5G application -- in the 5G application, the next generation of Advanced Driver Assistance, where there's a lot of microwave technology needed. So we'll start to see the first combined products hit the market over the coming year.

And beyond there, I think you'll see more complete solutions from ADI, the combination of the old ADI and Hittite together, in many, many different markets. .

Okay. So then on the consumer side, we can't comment specifically on whether or not we're displacing somebody and, if so, who. But I can tell you that we have more sockets in the next generation than we did in the last generation, and that's what's driving the BOM to be higher at this time. .

And Ambrish, just a slight housekeeping note from me. When you talked about the last-time buys, those are last-time buys that we made on foundry. So that didn't impact the revenues, really, in the aerospace and defense side. Okay. Thanks for the question. .

Your next question is from Stacy Rasgon with Bernstein Research. .

One more quick follow-up on consumer. You said that the ramp was going to happen late in Q3, which seemingly would imply potentially a fairly big Q4 sequential ramp as you annualize that.

Can you give us some feeling for what the trajectory of that consumer business into Q4 ought to look like? And do you think that it could be -- would it be up or would it be down year-over-year versus last year? Because I think Q4 of last year was the peak. .

Yes. Definitely hard to predict exactly how the trajectory is going to work out. But I would say it's going to be -- you could -- if we end up shipping in the last, say, 2 or 3 weeks of July, we're going to probably be shipping at that level through the entire fourth quarter, so you can interpret that what you want.

But it's going to be a meaningful ramp in the consumer space in the fourth quarter, at least, as things have lined up so far. On a year-over-year basis, I think given the fact that there was probably -- or shipped in -- and I think we can safely say in the fourth quarter versus what was consumed, and that drove a lot of inventory in the channel.

I think on a year-over-year basis, we're likely to be down in the consumer space. But I think from a sequential basis, it'll look quite nice. .

And so just to clarify, so we're talking something like a $30 million sequential increase in Q3, all of which may be happening potentially in the last couple of weeks.

So, I mean, if we're annualizing that for 3 months in the following quarter, if you're shipping at that rate, I mean, this could be -- you were talking something like $100 million, maybe even more, sequentially into Q4 that we could see in terms of increase.

Is that the right way to think about that?.

Yes. It's obviously tough to predict, but you're probably in the zip code at this point. .

And by the way, if that did happen, as Dave mentioned, I think, in the prepared remarks, the operating margin leverage we expect to see in the fourth quarter would be pretty strong. .

Your next question is from John Pitzer with Credit Suisse. .

Just staying on the topic of consumer and for both Dave and Vince. Investors have been somewhat critical about your exposure here over the last 2 or 3 quarters because it tends to be volatile, tends to be commoditized. We always worry about how long you can hold on to the business.

And you guys have done sort of a great job talking about the trajectory for this fiscal year, and when you initially got this business, I think you talked about 2 years of visibility. I'm wondering if you could just talk, longer term, how we should think about the consumer bucket.

And Dave, you've talked about in the past your need just to be strategically engaged with certain customers to broaden out your footprint. Maybe you can talk about your ability to have broadened out that footprint with this customer as we go into fiscal '17. .

Yes. So obviously, they don't give us a ton of visibility, but next year, as much as we can tell, looks to be in pretty good shape for 2017 for this customer.

And as I said, we actually got more sockets this time around and held the prior socket, all of which are high-performance parts that -- and that's really what we're trying to focus on with that customer or with any customer, quite honestly, not only in the consumer space but outside of the customer space in the B2B markets.

And that's -- we're going to maintain that strategy going forward. And I think there is enough to win at that customer and in the consumer space to drive growth in the consumer business.

And as you point out, longer term -- and it's not even just this particular customer, but there are a handful of customers that have -- certainly have consumer exposure but that are more broadly focused in other markets because a lot of this stuff is converging.

And so we want to be attached to those customers as they think up new ideas, that we can come up with new technologies to help define their parts and make them better, and that's what we're going to do. And so that's where we direct our research and development dollars.

It's worked out for us here, and my guess is there'll be other things that we do for this customer and other customers in other markets that will help them and help us. .

The user experience becomes more and more sophisticated in these applications. That's in our wheelhouse. We play on the edge of the physical and the digital, so it gives us more opportunity.

But as Dave pointed out, we're looking for the really hard-to-solve problems in these applications, where we can hopefully get multiple generations' worth of momentum and where we can get the kind of margin performance ratio that we expect. .

Your next question is from Vivek Arya with Bank of America. .

Just, Vince, longer term, is the current top line growth rate acceptable to you? And if it is not, do you think it's time to consider larger and more transformative acquisitions? And how do you think about the -- whether it's the accretion metrics or anything else that we should keep in mind because the macro environment has stayed somewhat sluggish, and you have managed to navigate through that quite well.

But I'm just curious whether -- even with this navigation, is the top line growth acceptable to you? And if not, what can you do about it?.

Well, we've said publicly that we are committed to generating over $4 of EPS by 2020. We remain committed to that. And when we first offered that target to the investor community back in '14, we said that we expected our revenue, our top line to grow at the rate of 2 to 3x GDP, whatever that is, and we remain optimistic about that.

We're investing at a level in terms of R&D and field -- customer engagement that -- and given what we see in terms of the design activity, the customer engagement activity, we remain committed to that top line target. Another component of, obviously, being able to get towards that EPS target over time is to do careful M&A.

And so that is the mix, and we are committed to our targets. We believe in the growth story. And as I said, we will use our balance sheet wisely to get some more high-performance technology that will enable the company to grow at an even greater rate over time. .

And as far as just the acquisition measures, we use -- there's probably 15 of them that we use. Obviously, accretion plays a factor in it. We look at kind of the relative valuations of the cash flow of the business that we're looking at to determine whether we're paying a good price for it.

We want businesses that grow and that help us drive our growth faster than we are growing today. So that's a key component, and we believe that, that can happen. And obviously, we think we're looking for things where we can get synergies. Sometimes, that's cost. Sometimes, it's cost and revenue. And so those are things that kind of influence us.

Sometimes, when we're doing tuck-ins like SNAP Sensor, which we talked about in the prepared remarks, there isn't much in terms of financials to hang your hat on in the early stages.

And so then it really comes down to whether or not the technology really was going to make a difference in our customer's application and ultimately, the user experience. And that tends to rule the day when it comes to those tuck-ins. .

Is there any push from customers to have more integrated solutions? That's where I was coming from, that if you are the leader in converters, does it help to gain access to other areas because that's what your customers might be asking you to do?.

Yes, it's integrating all the time. We're developing -- we're moving more and more to a systems level solution. And so that requires us to have more and more technology, some of which we do acquire, a lot of which we actually build internally. .

Yes. I think what we acquire depends very much on the type of segment we're addressing. The reason we bought SNAP Sensor was to help us move up the stack, to make our solution more complete.

We've got a very strong DSP, high-performance signal processing technology platform and product base, onto which we needed to add some algorithmic value in that particular imaging application. So yes, what we acquire and what customers are asking us to do very much is application and market segment-dependent. .

Your next question comes from Steve Smigie with Raymond James. .

So last quarter, you mentioned that orders are positive but that you felt that your customers were a little bit worried about the overall weaker macro.

Have you seen any changes in their general outlook since the last call?.

No, I think they're pretty much the same. They're cautiously optimistic. The macro has held in there. The order flow has been good. Customers think they're going to -- I think, in aggregate, think they're going to see modest growth this year. But they're obviously very cautious. They're keeping their inventory levels lean.

We see that, obviously, at the disti level as well. So that's -- I think it's pretty consistent through the whole year, really. .

And your next question is from Ross Seymore with Deutsche Bank. .

Dave, one follow-up to a question you asked -- or answered earlier on the gross margin side. I know you said you're taking utilization down by roughly 10% sequentially in the third quarter.

Can you just talk a little bit about why you're doing that, considering that you said that the comms business is in the early stages of recovery? You're now past the headwinds on the auto side, where you had the design loss on the passive safety, et cetera.

If everything in your core is starting to grow year-over-year, what led you to the decision to cut utilization that substantially?.

I mean, I don't know that it's significant, but we had 138 days of inventory, and we want to get that level down. And we felt like we should address it now rather than wait. I would -- like I said in the prior question -- or answer to the prior question, I think a lot of the inventory is related to product that was manufactured in foundry.

But nevertheless, we got to work all of the levers to get the inventories to where we want them to be, and this seemed like an appropriate place to pull it down. The comms one doesn't influence us a ton because there isn't much of that, that gets done in internal foundries or internal fabs.

Really, it's in the industrial space, which is -- kind of plugging along at kind of a low growth rate at this point. So it seemed like we weren't taking a big risk by adjusting the production there. I would say that I think it's a 1-quarter event.

When you take down inventory levels and you take down the utilization rates, generally, you shut the factory down. And so we'll be taking, I think, on average, 2 weeks to shut down in our internal fabs. I would suspect that we will be back to not doing that in the fourth quarter, and so utilization should come back up again in the fourth quarter. .

Great. One other housekeeping one. You were gracious enough to say your content is going up with a specific customer. Relative to what you had in the prior generation, is the content increase, just order of magnitude, a similar amount to the prior socket, half, double? Any sort of color directionally would be helpful. .

Yes, I probably have to avoid these kind of pricing things. It's not to the level of the prior socket. Let's put it that way. .

Okay, great. Well, it looks like Ross was our last question, so we'll close out the call. As a reminder, our third quarter 2016 results will be issued on August 17 at 8 a.m., similar to this quarter, and we'll have the earnings call at 10 a.m. So that does it for us here. Thanks for joining us this morning. We look forward to talking to you soon. .

Thank you. This concludes today's Analog Devices Conference Call. You may now disconnect..