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Linear Technology (LLTC) Earnings Report: Q3 2016 Conference Call Transcript

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The following Linear Technology (LLTC - Get Report) conference call took place on April 20, 2016, 11:30 AM ET. This is a transcript of that earnings call:

Company Participants

  • Don Zerio; Linear Technology Corporation ; VP Finance and CFO
  • Lothar Maier; Linear Technology Corporation ; CEO & Director

Other Participants

  • David Wong; Wells Fargo Securities; Analyst
  • Craig Hettenbach; Morgan Stanley; Analyst
  • Ross Seymore; Deutsche Bank; Analyst
  • Evan Wang; Stifel Nicolaus; Analyst
  • John Pitzer; Credit Suisse; Analyst
  • C.J. Muse; Evercore ISI; Analyst
  • Craig Ellis; B. Riley & Co.; Analyst
  • Ambrish Srivastava; BMO Capital Markets; Analyst
  • Vivek Arya; Bank of America; Analyst
  • Cody Acree; Drexel Hamilton; Analyst
  • Steve Smigie; Raymond James & Associates, Inc.; Analyst
  • Harlan Sur; JPMorgan; Analyst
  • William Stein; SunTrust Robinson Humphrey; Analyst

MANAGEMENT DISCUSSION SECTION Operator: Welcome to the Linear Technology Corporation fiscal 2016 third-quarter earnings conference call.

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Today's conference is being recorded. At this time, I would like to turn the conference over to Don Zerio, Vice President of Finance and Chief Financial Officer. Please go ahead, sir. Don Zerio (VP Finance and CFO): Good morning. Welcome to the Linear Technology conference call. I'm joined today by Bob Swanson, our Executive Chairman; and Lothar Maier, our CEO. I would like to remind you that in our presentation today and our answers to certain questions that may follow we may make forward-looking statements that are dependent on certain risks and uncertainties including but not limited to our financial results for future periods, our ability to produce and sell existing products, the timing and introduction of new products and processes and general conditions in the world economy and financial markets. In addition to these risks, please refer to the risk factors listed in the Company's annual report on Form 10-K for the fiscal year ended June 28, 2015 and our subsequent quarterly filings on Form 10-Q. Also, SEC Regulation FD regarding selective disclosure influences our interaction with investors. Accordingly, this conference call will be our forum to respond to questions regarding our estimated financial performance going forward. Should you have questions regarding our estimates of sales and profits or other financial matters for the upcoming quarter, this is a time we are free to respond to your questions. As noted in our press release, which was released yesterday just after the market close, revenue for the March quarter came in at the higher end of guidance at $361.1 million, up 4% from the December quarter. Gross margin increased to 76.2% from 75.7% benefiting from the higher sales base, a full quarter of production in our fabs and certain other manufacturing efficiencies. Recall that our second quarter had less production days in our fabs due to holidays and plant shutdown days. Operating margin improved to 45% of sales, up from 43.1% due to the higher gross margin and one less week of operating expenses as we had 14 weeks in our second quarter. Our effective tax rate was slightly higher in the third quarter at 21.75% versus 19.5% in Q2 on lower discrete quarterly items. Net income and earnings per share were $128.4 million and $0.52 per share. All told, this was a pretty good quarter and we are happy with the results given global macroeconomic conditions that are still providing some headwinds. We beat the midpoint of our guidance, we increased gross margin and operating margin and our bookings increased over the prior quarter at a level that should allow us to grow in the fourth quarter as well. The transportation market continues to grow nicely and we're seeing recovery in the industrial market and to a lesser extent the communications market which has been weak for some time. We're seeing recovery across a broad base including distribution and the smaller and midsize customers. In general, inventories in the channel appear to be in balance and we believe we are shipping to end customer demand. However, there remains pockets of weakness in certain geographies and the computer market remains particularly weak, though that is not a major market for us. We remain cautious given the general business climate but based upon our third-quarter bookings and our current run rate, we are currently projecting revenue to be up 2% to 5% in the June quarter. Turning to bookings by region and market sector. As a reminder, we have posted bookings by market and revenue by geography for the quarter on our website at linear.com under investor relations supplemental information. We post this information by the end of our business date on the day we release our results.


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Total bookings increased for the quarter and we had a positive book-to-bill ratio. Bookings increased in both North America and the international market.

Within international, bookings were up in each of our major geographic regions Europe, Japan and Asia-Pacific. We continue to do particularly well in China as bookings were up the most in that region on the strength of automotive, though our industrial business is growing in that country too. With respect to bookings by market sector, bookings were up in each of our major markets that represent 86% of our business industrial, transportation and communications. In our smaller markets, military space grew modestly while computer and consumer showed declines. The computer market, particularly PCs and notebooks, continue to be particularly weak. Industrial continues to be our largest market at 44% of our bookings, up from 43% the previous quarter. Industrial bookings increased in each of our major geographic regions led by North America and Europe. The breadth of this increase across our customer base is giving us some comfort that the noticeable weakness we experienced in this market over the past several months is in recovery and that the inventory correction that resulted is behind us. We believe we are shipping to end customer demand and the inventories in the channel and at the OEMs are at least stable if not lean. Turning to transportation bookings, this market continues to show the highest percentage growth and it was 24% of our business this past quarter, up from 23%. The increase in bookings in transportation was driven primarily by Asia-Pacific but we saw growth in Japan and the US as well. The US has been a smaller transportation market for us but we are making good strides here and it's up nicely for the quarter in percentage terms and opportunities continues to increase. Europe bookings were down in transportation modestly in the quarter but coming off a relatively strong Q2. Transportation growth in Asia-Pacific continues to be strong and it was our highest region in total transportation bookings, overtaking both Europe and Japan for the first time. As you should know by now, we have been particularly successful with our parts in the China and Korea market. As I have noticed in previous calls, China is all-in on electric vehicles as one part of the solution for their severe air pollution, offering incentives to both businesses and consumers to build and buy electric vehicles including autos, taxis and buses. Our superior BMS parts have won us significant business in China where we enjoy very high market share for battery management systems. Our transportation business in this region should continue to grow strongly for the foreseeable future. Communications remain at 18% of our bookings for the quarter but after two quarters of sequential growth we are hopeful that this market is beginning to show some life. The large base stations and infrastructure piece of this market continues to be weak but that is no longer a sizable piece of our communications business. We are seeing growth in optical, networking and datacom which is the area of the market that we focus. This market was strongest for us in the US while Europe was flat and Asia was down slightly. The computer market was 6% of our bookings, down from 7% last quarter with a decrease primarily in North America where the majority of this business is booked. As stated last quarter, this market is down as expected as it is suffering due to weaker notebook sales and storage devices. This market may continue to decline a bit more for us over the short term as notebook sales continue to decline, but longer term we expect growth opportunities as we have compelling products in development that address the higher end of this market where innovation and superior functionality are still needed. Bookings for military space and harsh environment products increased modestly this quarter and remain at 6% of our business. Military has rebounded slightly from the weakness we experienced in the first quarter while the space business has been somewhat flat for the past year. We do expect the space business to pick up as satellite launch activity increases. This is predominantly a US market, though we do book some business in Europe. Both regions saw an increase in bookings this quarter. Finally, consumer, our smallest end market where we take business opportunistically when functionality and performance still matter, this market decreased 2% of our business, down from 3% last quarter. With regard to where our bookings are actually created, 62% were created internationally and 38% in North America, the same as last period.


Moving to sales, sales increased by 4% from the prior quarter and were down 2.9% from the prior-year quarter. Geographically sales were up the most in Europe followed by North America and Asia-Pacific but were down in Japan which is not unusual as March is typically their fiscal year-end. US sales were up for both OEM and distribution where revenue is recognized on a sell-through basis.

On a regional basis, North America was 28% of our business, up from 27% last quarter. Europe was up to 21% this quarter from 19% last quarter. Japan declined to 13% of our business, down from 15% last quarter, and Asia-Pacific decreased from 39% to 38% of sales but was up in absolute dollars. Turning to the rest of the income statement, gross margin was up from 75.7% to 76.2%. This is a good result, particularly since our overseas assembly and test operations had lower production days due to Chinese New Year. Gross margin was aided by the higher sales base which reduces fixed overhead per unit and an increase in our average selling price to $1.97, up $0.05 from $1.92 last quarter. The fourth quarter is a full production quarter for all of our plants and we expect to grow sales. So I do expect some margin expansion subject to the product mix within sales. R&D decreased $0.2 million sequentially to $69.6 million, primarily due to lower labor and fringe cost as there was one extra week in the prior quarter. In addition, legal costs were down. Partially offsetting these decreases, vacation cost and profit sharing increased. Vacation costs were higher as they were no shutdown days and much less vacation taken in the third quarter than during the holiday season. SG&A decreased $0.4 million sequentially to $43 million. Similar to R&D, this was mostly due to lower labor and fringe cost from one less week in the quarter compared to Q2. In addition, other cost decrease such as advertising, travel and foreign sales costs from foreign exchange. Similar to R&D, these declines were partially offset by higher vacation cost and profit sharing. Operating income increased by $13 million to $162.5 million representing 45% of our sales. Interest and other income increased slightly to $1.6 million on higher invested cash net of small loss from foreign currency transactions. Our quarterly effective income tax rate was higher this quarter at 21.75% versus 19.5% last quarter due to lower quarterly discrete items. Next quarter absent discrete tax items if any we expect our annual effective tax rate to be in the 24% to 24.5% range. Net income for the period was $128.4 million, up $6.9 million and was 35.6% of sales, up from 35%. The average shares outstanding used in the calculation of earnings per share decreased by 116,000 shares. The weighted average of stock repurchases both this period and last period more than offset vesting of employee stock awards. GAAP earnings per share was $0.52, up from $0.50 in the prior quarter. Without the impact of stock-based compensation of $19.9 million diluted earnings per share would have been $0.59 per share. Looking at just a few major components of our balance sheet, during the current quarter the Company's cash, cash equivalents and marketable securities increased by $55.3 million to $1.36 billion net of spending $78.2 million on cash dividends which have been increased to $0.32 per share and spending $32.6 million on stock purchases of approximately 800,000 shares. Capital expenditures for the quarter were $13.2 million. Accounts receivable of $152.9 million increased by $7.8 million on the higher sales base and DSO was 39 days, up from 38 days as we had an extra week of collections in the second quarter. Inventory at $94.2 million was essentially flat versus the prior quarter and we believe to be a good profile to support our business and keep leadtimes relatively short. Our quarterly average inventory turns was up slightly to 3.7 times per year. Looking forward, at the current bookings rate, we are guiding revenue to be up 2% to 5% in the June quarter. Three quarters ago when we announced our revenues for our first fiscal quarter would be down significantly our expectation was that the sudden drop was more of a short-term correction rather than a deep down cycle. At this point it appears that our reading of the tea leaves was accurate. Inventories in the channel now appear to be in balance if not lean. We are shipping to end customer demand, bookings have picked up and our largest market, industrial, appears to be in recovery. However, it is still a fragile market.


. David Wong (Analyst - Wells Fargo Securities):

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Thanks very much. Don, could you give us some feel of your attitude to cash on the balance sheet and use of cash, and in particular what you see in terms of stock repurchases going forward? Don Zerio (VP Finance and CFO): Yes, David, as you know we retired our convertible note. It's been about two years now, and after having debt service for seven years we enjoy not having it. So for the time being, we continue to like not having the debt service. We prefer to use our existing cash to fund our dividend and stock repurchases. And so for the time period that position hasn't changed but it's not that we're necessarily against taking some debt. We've done it in the past, but currently we've chosen to use our existing cash to fund our stock repurchases. David Wong (Analyst - Wells Fargo Securities): Great, thanks. Operator: Craig Hettenbach. Craig Hettenbach (Analyst - Morgan Stanley): Great thank you. Just a question on the comment on China and EVs, just in terms of certainly it's still a small market as a percentage of terms but the dollar content opportunity is much higher. I'm curious to get your thoughts on just from a design perspective and what you're seeing from customers how that influences what you think about the opportunity over the next one, two, three years? Lothar Maier (CEO & Director): When you think about China you know, particularly when what we've talked about is this EV market, it's not just cars, it's taxis and to a large extent it's also buses and some machinery. And when we win business on the BMS side we typically win business around the rest of the car as well. So granted these types of vehicles are still a relatively small percentage the content can be two, three, four, 10 times as much as in a conventional car and the numbers may be were small but appear to be getting quite a bit bigger. If you look at how many plug-in and electric cars China produced in 2015 it was around 300,000 and that's going to double we think in 2016. And right now with the incentives that the Chinese government has put in place, they don't appear to be an end to this. Craig Hettenbach (Analyst - Morgan Stanley): Got it. And if I could just follow up just on the topic of BMS, I think you guys are on your third of fourth generation of products. So just seemingly it is a big opportunity but just kind of things you're doing on a technology front to make sure that you maintain kind of leadership position for these type of products. Lothar Maier (CEO & Director): Yes, and it's interesting because every OEM does it a little bit different. So there isn't like one solution that solves everybody's problems. Some people have efficiency, some people want precision, some customers want communication. So it's a different set of requirements from customer to customer. And so it's just an ever-evolving field. And the requirements are obviously it's precision. The lithium batteries are very expensive, and so if we can make the measurements more precise it means they have to purchase less batteries. When your battery system stops working in a vehicle that's a plug-in or a hybrid the car stops, so they are looking for things like redundancy and backup systems. So it's a pretty complicated product with a lot of different hooks in it and every OEM has a different hot button. Craig Hettenbach (Analyst - Morgan Stanley): Okay, thanks for that color. Operator: Ross Seymore. Ross Seymore (Analyst - Deutsche Bank): Hi guys, congrats on the solid quarter and guide. Just had a question on the ASP side of the equation.


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Don, you mentioned the benefit that that had a little bit to the gross margin. But just kind of more holistically, I think that $1.97 was up nicely sequentially and year over year but I think it's also the highest we've seen for your Company as far as I can find in history. Can you just talk a little bit about what is driving ASPs up for your Company over time and if in the single quarter there was any particularly unique movements?

Don Zerio (VP Finance and CFO): Well I think just in general the strategy change that we made several years ago as you know to defocus out of consumer and more towards industrial and transportation and communication just over the last several years, that strategy in and of itself is going to help our ASP and it did. And you'll also know that we've had good success in our module business which continues to grow quite frankly beyond our expectations. And that's another great product that we continue to see just running. And the ASP on the modules is quite high and we're also talking today about our success with battery management systems which also is a relatively high ASP product. So our strategy in general and the success of certain of our products is continuing to drive ASP higher and it certainly wouldn't surprise us if we got over $2. Lothar Maier (CEO & Director): Yes, just to highlight, we used to have ASPs even greater than $2 for a long period of time. You'd have to go back about 15 years to see that. And as we entered into the consumer business, we saw our ASPs drop. I think the low quarter for us was like $1.38. And then we've seen a steady growth back to what we think is probably likely for us is to get above $2 here in the future. And we feel that way for the reasons that Don said. We've got these BMS products, we have module products. And if you look at virtually everything that we've got in the design pipeline are really products that should warrant prices above $2. Ross Seymore (Analyst - Deutsche Bank): Great and I guess as my follow-up, just switching gears to the industrial side, it's good to see that it's acting better and you gave a lot of color on that. I guess if we could just compare it to a year ago at this time, it looks like your revenues are in the same ballpark for what you reported in the March quarter and seemingly what you're guiding for that subsegment in June. Could you just compare and contrast what gives you the confidence in how you're feeling about that at the same level of revenues today versus a year ago when of course we were on the precipice of that correction short-lived but correction nonetheless in the September quarter? Lothar Maier (CEO & Director): Yes, prior to that correction we were on a pretty good March in terms of improvements in our industrial business. And I think we had a correction for quite frankly reasons I don't fully understand because we didn't lose any customers, we didn't lose any business. And so I think what we're seeing now is that industrial business that roughly a year ago was doing pretty good for us resetting and taking off where we were about a year ago. Ross Seymore (Analyst - Deutsche Bank): Great, thank you. Operator: Tore Svanberg, Stifel. Evan Wang (Analyst - Stifel Nicolaus): Yes, hi, thank you for taking my -- this is Evan Wang calling in for Tore Svanberg. Thank you for taking my question. The first question is on communications. You have talked about the potential of being on a rebound, I was wondering if you can characterize this a little bit based on maybe the bookings from the first couple of weeks so far this quarter as to the steepness of this recovery and going forward even out a couple of quarters if you could? Lothar Maier (CEO & Director): Well, you know any of our markets really don't get driven by what's happened in the first few weeks of a quarter. These things evolve literally over years. And we've seen some stress on our communications business because historically it was roughly evenly split between the base station and the networking part of the business. And over the years what we've been seeing is the base stations, which have become somewhat commoditized, that business declining and the rest of the business was sort of the networking and infrastructure part of the business improving. So I think what we're seeing now is the fact that we've given up most of the base station business. We don't have a lot of base station business to lose anymore.


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And what we're seeing is just the pickup of the networking business which we've been seeing really for years and that's becoming a little bit conspicuous now. There are also some segments in the networking business that are doing well. Don mentioned the optical business.

Wherever there is a lot of innovation is typically where Linear does well. And the optical markets going between 10 G to 20 G to 40 G to 100 to 200, 400 G, as that progression goes there's a lot of technology involved and when that happens that's good for us. So for us the optical market right now is doing quite well. Evan Wang (Analyst - Stifel Nicolaus): Great. My follow-up question is for the longer term, you cited that the macro remains weak. And given the strength and your focus markets, is this still a major concern for you or do you see the strength in these market sufficient to fuel your growth? Lothar Maier (CEO & Director): It's an issue for us. We really like to see some strong global GDP growth so it's an obvious headwind to us. But at the moment I think we've got enough good products and good markets that we can buck that headwind to some extent, but quite frankly we'd have a lot stronger business if we weren't facing headwind like that. Don Zerio (VP Finance and CFO): You know, I mentioned Japan. Japan is weak. There is definitely some seasonality with Japan this past quarter. As I mentioned March is typically their fiscal year end and so they will take less delivery and such. But I think there's some real weakness in Japan. I think they may be affected by China somewhat but there's still pockets of weakness out there. There's not many regions around the world if at all that are experiencing any kind of growth, something 3% or better, I mean you don't even see that, like I said 2% is considered strong. So it's certainly not a great market out there but I think in the markets that we focus we're certainly holding our own and we can't use the macroeconomic environment as an excuse. We have to continue to grow and we think we can do that. Evan Wang (Analyst - Stifel Nicolaus): Thank you very much. Operator: John Pitzer. John Pitzer (Analyst - Credit Suisse): Yes, good morning guys. Thanks for letting me ask the question. Don, in your prepared comments you talked about your expectation for the June quarter for there to be additional gross margin leverage based upon some of the fixed cost absorption maybe offset by mix. Can you help us quantify how much we should see for the June quarter? Is this a similar incremental margin that we've seen in March? And then on a similar vein, if you look at where gross margins are today, and I always feel silly about asking this question, you still have about 200 basis points of upside to where margins were kind of back in that 2010 time period around 78%. Is there anything structurally different about the business today that shouldn't allow you to at some point get back to that margin profile? Don Zerio (VP Finance and CFO): You know, John, you have to remember where we were in the market back in 2010. I mean that was a snapback from the 2008, 2009 credit crisis and recession and so the whole market was if you recall was sort of pedal to the metal. Our factory utilization at that time was very high. We still had some consumer products that were lower ASP but also lower cost that helped get to that very high gross margin. Not that we can't get back there but that's sort of the perfect environment to get back to a gross margin that is in excess of 78%. So I think that's different and you have to look at what that environment is. And secondly, there is some cost to the automotive market, you know the quality and the reliability that is expected. So yes, there's higher ASP there but the cost depending upon which product you're talking about has quite high test cost. So there's that as well. But even on a slightly lower gross margin the gross margin per unit is higher. So we'll make that tradeoff every day. So I mean there's just a lot of variabilities that go into gross margin which is why I can't necessarily give you a target for what our gross margin is going to be next quarter.


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I don't know what the mix is going to be yet. I'm not exactly sure what our capacity level will be in the factory. All I can say is look, we just grew about $13 million and added half a point, 50 basis points.

I don't know if I can promise another 50 basis points. But assuming we grow, assuming we have a relatively sort of constant kind of mix in our products I would expect that we would be able to add to gross margin in total. Whether it's 20 basis points or 30 basis points or even higher I can't say right now. John Pitzer (Analyst - Credit Suisse): That's helpful, Don. And then, Lothar, maybe as my follow-up, a question around growth. And I understand that the compare is probably not fair because there's been a lot of repositioning of the Company. But if you look at the top-line growth since 2010 to the end of this year it's been sort of flattish and again a lot of repositioning within that five-year period. I'm kind of curious as how you think we should think about your growth rate from here given the repositioning and the focus of the Company in the end markets. And if not on an absolute basis relative to where the semi market is growing, how much faster do you think you can grow on an ongoing basis? Lothar Maier (CEO & Director): Yes, I think you've got a pretty good observation there, that 2010 as Don said earlier was kind of a peak. There was a huge downturn and then there was a huge correction in then it corrected again after that correction. And if you look back in the last several years, we've seen steady but modest growth and I think we need two things. One is we need the overall market to get better. And so if we're going to get back to what we always say we'd like to grow or we think we're entitled to grow is 10% we've got to get some decent GDP growth. If you look at our Company from where we're positioned, from a product standpoint, from an end market standpoint, we couldn't be any better positioned than we are presently. So I'm not worried at all about the things that are in our control because I think we've managed that pretty well. We just need a little bit of help from the market and there's no reason why we can't grow 8% or 10% in a year. We do not have a product or a market issue. Don Zerio (VP Finance and CFO): Hey, John, let me just follow up on that. If you go back to 2014, we had about five if not six quarters in a row where year over year we were growing in that high single digit 9%, 10%. And that's what we thought we could do and we thought we could continue to do it when most of the consumer transition was behind us. So all the new business and new opportunities we now felt after several years of replacing business was now additive on top. So we were sort of there. And obviously after 2014 we fell off that pace as did certainly the rest of the market as well. But computer got weak, communications got weak, industrial got weak on us. So again there's some macroeconomic headwinds. But to Lothar's point, with a little bit more stability and a little bit more growth on average around the globe we think we can grow back up at that 10% range and we think we've already shown we can do it, we just need some help from the market. John Pitzer (Analyst - Credit Suisse): Great, thanks guys. Operator: C.J. Muse, ISI Group. C.J. Muse (Analyst - Evercore ISI): Yes, good morning. Thank you for taking my question. I guess first question, when you think about consumer now when we had roughly a $28 million run rate, clearly much more leverage to your three core businesses. How should we think about normal seasonality patterns in this low growth environment coupled with that mix shift? Don Zerio (VP Finance and CFO): For which market? C.J. Muse (Analyst - Evercore ISI): Sorry, I'm thinking in aggregate for you guys. Don Zerio (VP Finance and CFO): I'm sorry, C.J., can you ask that question again? C.J. Muse (Analyst - Evercore ISI): Sure. Thinking about seasonal patterns in the back half of the year, recognizing that you are much more focused to your B2B business and less so on the consumer front and how that translates into what we should expect into the back half of the year.


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So are you asking about sort of the seasonality of our business going forward? C.J. Muse (Analyst - Evercore ISI): That's right. Don Zerio (VP Finance and CFO): Well, you know there used to be sort of a somewhat regular pattern or cycle to our business several years ago. And maybe the consumer component of that that we had that at one time was double digits, maybe that factored into that. So with consumer gone there seems to be maybe less of a normal pattern. But just in general, clearly the first half of the calendar year our fiscal third and fourth quarters is seasonally strong for Linear, particularly because of focus on industrial and transportation. So we assume that that will stay that way going forward. We hope to grow in Q4. Going on beyond that it's very difficult of forecast this business over the next quarter just because of the economy and some variability in the business and our customers. But we would expect that coming out of the fourth quarter, historically the first quarter has been, our first fiscal quarter has been a flattish to up slightly, down slightly type of quarter and then Q2 has generally been, that's the December quarter, has generally been our weaker quarter where we go down slightly, although even this past year that pattern was changed because September was the down quarter and we were recovering in the December quarter. So you look at history and what happens and there is somewhat of a pattern there but it seems to have changed every year. So I'm not sure I would put too much on the seasonality other than clearly the first half of the calendar year tends to be stronger quarters for us. I would think that that would continue absent some major change. I hope that answers your question. Because I didn't really understand it. C.J. Muse (Analyst - Evercore ISI): That's helpful. I guess moving to OpEx, you guided 31% or less of sales for the prior Q and you came in a little above that. Curious what drove that and how should we think about that percentage going into the June quarter? And then if I could just sneak one last question, it would be are you seeing any impact in your business from the earthquake in Japan? Thank you. Don Zerio (VP Finance and CFO): Well, the latter one I don't believe that we're seeing any impact, at least none that we know of yet. So that's the easy one. It's funny, I guess I got caught on the one minor miss I made on the income statement where I did say that I expected to be in the 31% range similar to Q1 if not better. And so at 31.2% that's exactly what where we were in our first quarter, so I think that's what I said. But in fairness I expected it to be a little better. And there's two things that -- and we're not talking about a lot of money. I think to get down to 31% our operating expenses would have been about $600,000 or, $700,000 less, not a lot. But one thing I didn't factor into was surprisingly it is vacation. The way we do our accounting for vacation, I think it's the way most companies do it, is when employees are taking vacation you actually get a P&L benefit and then when they are not taking vacation, vacation charges go up. And it's the way you accrue the vacation accrual. So one thing that I didn't factor is when you have a holiday period like Christmas and New Year's and then we also had shutdowns as well, people use their vacation so that they can get paid rather than taking time off without pay. So this quarter that sort of snapped back the other way because after people use their vacation there's hardly any vacation taken at all. So the impact to that quite honestly was a little higher than I expected. And so at 31.2% quite honestly I would have thought that we would have done a little bit better. But going forward, I think that 31% of sales is give or take is probably where you're going to find us. The second thing there, and I think I've been talking about this the last couple of quarters, is on an annual basis, if you take out stock compensation, our operating expenses are generally increasing in the 3% to 4% range. And that's sort of typical.


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But stock compensation which is non-cash is increasing somewhat higher than that. And it's solely because our older grants that were granted five years ago were granted in the low $30 range. Well, those are falling off of being replaced by higher grants.

So that phenomenon is causing stock compensation to increase quarter over quarter a little faster than the rest of our cash operating expenses. So there's a little bit of pressure there. That will turn around eventually, but for now that's why you might see our operating expenses in total growing maybe a little higher than you'd expect. C.J. Muse (Analyst - Evercore ISI): Very helpful. Thank you. Operator: Craig Ellis, B. Riley. Craig Ellis (Analyst - B. Riley & Co.): Thank you for taking the question and congratulations on the results, guys. Don, the first question is to you and it's just a follow-up on the basis for the guidance. I think you predicated the guidance range on bookings at current rates. So can you just remind us what the monthly bookings linearity would typically look like in the fiscal fourth quarter? Don Zerio (VP Finance and CFO): Well, you know, this past quarter, which is not unusual when you see the bookings, we actually had slightly higher bookings in January but they stabilized pretty well over the quarter enough to allow us to grow as we said. But when you look at January for example it's not unusual that bookings increased coming out of the December calendar year-end. And there might have been some pre-booking for Chinese new year. So that's what you've got to be a little careful when you try to read into the next quarter when you're on the call based upon a couple of weeks of bookings for the current quarter. Because there sometimes ends up being a spike just coming out of the different fiscal periods. I said I think we've seen just in general our bookings per day have stabilized somewhat, so we're hoping that that will continue. We continue to talk to our customers and I think our feedback in general is they are feeling pretty good about their business. We talked about seasonality and Q3 and Q4 are generally stronger for Linear Tech, they are stronger for transportation and industrial. The transportation market continues to grow nicely for us. So just based upon that information that's why we're feeling good about our position, that's why we're feeling pretty good that we can continue to grow in the fourth quarter. And beyond that, we just really don't know. It's very difficult to forecast longer out farther out than the first quarter. So we're just going to have to see what happens. Craig Ellis (Analyst - B. Riley & Co.): Okay, I'm going to take another swing at it because I was looking for something a little bit different. If we look back historically, would we typically see that May and June are about on par with the bookings intensity that would be seen in April or would they typically be north or south? Or is there not a discernible in a pattern to make a call on the intra-quarter linearity by month? Don Zerio (VP Finance and CFO): I don't think there's enough of a pattern other than that generally our bookings in the first calendar, first half of the calendar tend to be relatively strong to fuel the growth in those quarters. You know our leadtimes are relatively short at four to six weeks. So we don't have a bookings that go out months and quarters to let us give us too much insight on the future. Lothar Maier (CEO & Director): Yes, I think what Don is saying is there's a nuance here. I mean typically our bookings and billings are pretty doggone flat through a quarter. And there might be some inventory positioning our customers do at the end of the quarter that picks up the bookings at the beginning of the next quarter. But we're talking about nuances here not -- we don't have a hockey stick type pattern of our business. It's very, very linear both from a bookings and a billing standpoint. Craig Ellis (Analyst - B. Riley & Co.): That's helpful follow-up guys. The follow-up question is to you Lothar, it was helpful to get the color on the communications business. The base station mix out has been well-known, you've been very transparent on that.


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My follow-up question, though, as you look at the trends in optical, networking and datacom, are you seeing differential rates of growth in any of those markets? And if so, where are you seeing the better growth?

And then related to that, can you give us some sense as to the size of those different businesses so we can put that growth in better context inside of communications? Thank you. Lothar Maier (CEO & Director): I would say where there's a lot of potential business for us going forward I would say it's in the optical area. As a mentioned earlier there's a lot of innovation going on there and the use of optical is expanding. It used to be the fiber was for long-haul communications and most of that fiber is in the ground already. And really where fiber is becoming more and more important is shorter distances, within buildings, server rack to server rack in data centers. And so that's the area where very, very high-speed communications is needed and it needs to fit in a very, very small format and heat dissipation is a big issue. So we've got solutions for those types of applications that make that optical market kind of a pretty interesting market for us right now. Craig Ellis (Analyst - B. Riley & Co.): Thanks, guys. Operator: Ambrish Srivastava, Bank of Montreal. Ambrish Srivastava (Analyst - BMO Capital Markets): Hi, thank you and I will borrow the silly hat from John Pitzer from the earlier question. I just wanted to drill in a little bit more on the gross margin. And he was right it's kind of silly to be asking that given where you guys are at. But based on everything you said, the ASPs seem to have a secular trend upwards. On the auto side, should cost, the cost penalty be abating as you improve your yields? And then pick a normalized utilization, shouldn't gross margin then should have a secular upward trajectory if we look out longer term? Lothar Maier (CEO & Director): You know, I think you're right. I mean I think we're being maybe a little bit modest here in that you know if I look back at what happened in 2010, if those that circumstances happened again to us now where if the growth really took off like we were seeing back then, I would feel pretty confident that we could get to 78% gross margins. We're talking about a percentage or two. And our factories are not 100% loaded right now and I think there's some efficiencies we can pick up. But again this is we're talking about a couple hundred basis points. Ambrish Srivastava (Analyst - BMO Capital Markets): Yes, yes. And I wasn't asking for next quarter. So my quick follow-up then is on something you mentioned on the automotive side. You said US you're underrepresented and you're seeing progress. What specific areas are you seeing progress in the US? Thank you. Don Zerio (VP Finance and CFO): Well, I think the, you know there's the vehicle itself and there's the suppliers and we play in all of that. I think clearly to date we've been more accessible with more of the luxury model cars in Europe and Japan and we've been successful with the electric cars in China and that's not to say we haven't been successful in the US, it's just been more so on the international market. But I think that clearly the ADAS opportunities and the autonomous driving vehicle in the future, I think some of the even the big three automakers in the US don't want to be left behind there so they are starting to jump in as well. So I think that type of market I think is coming more so from the US and we certainly think we'll play in there. So in terms of dollars I think internationally tends to the transportation business for us is driven mostly from over there. But we're definitely on a percentage basis are increasing the US bookings and sales. And we think that's going to continue to grow. Ambrish Srivastava (Analyst - BMO Capital Markets): Okay, thank you. Good luck, guys. Operator: Vivek Arya with BoA Merrill Lynch Vivek Arya (Analyst - Bank of America): Thank you for taking my question. First one on transportation, very impressive growth, and I think you mentioned the battery management system and the opportunity there. Could you give us a sense of the competitive landscape?


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Are you the only Company in that space? Do you sense any competition in that space at all? And beyond battery management systems what are the other areas of focus in transportation?

Lothar Maier (CEO & Director): As far as competition, we recognized probably almost a decade ago that there was going to be the emergence of this BMS products. And so we really were first to market with a viable product. And we're in a fourth-generation product right now in production and we've got sixth- and seventh-generation products and beyond in development. And so granted it's getting to be a visible market and competitors recognize it and so there are competitors in this space. But I think we for the foreseeable future have a pretty good technical lead relative to the competition. These are complicated chips. I mean they are very, very complicated. And as I mentioned earlier there is no way that one competitor is going to come in with one chip because every OEM has a different preference of what they want. So there's many variations on the BMS product. So even though we kind of call it a product it's really a family of products. And I think we've got a good technical lead on the competition. In terms of automotive in general there's just great opportunities. The car companies are announcing this 48 volt battery systems, you are going to see them starting with model year 2016, 2017 and beyond you are going to see it really picking up. When that happens there's good opportunities for us. Silicon Valley here is becoming the new Detroit. Every OEM's here in Silicon Valley. A couple of -- there is some speculation there's some new entrants in the automotive business developing in Silicon Valley as well. The one electric car manufacturer here in Silicon Valley is doing well and so I think the domestic market for us is going to be good for automotive. It's been a little bit slow for us when we dealt with sort of the big Detroit automobile companies but we were I think a little bit hard on ourselves because even though we didn't sell too much directly to the OEMs we had a pretty good content in the US cars because they buy a lot of subassemblies from overseas. So what we're seeing now is sort of the indigenous design wins happening in the automotive market in the US which we haven't had really strong up until the last few years. Vivek Arya (Analyst - Bank of America): Got it, very helpful. As a follow-up this is perhaps a broader industry question but when I look at the industrial end market not just for Linear but across the board, in the last few years we have seen very modest 2%, 3%, 4% GDP-like growth. But given that semiconductors are supposed to expand content in most of their end markets, why has growth been so low in industrial? Are there puts and takes around parts of industrial that are growing versus declining and what is an acceptable growth rate in that end market? Thank you. Don Zerio (VP Finance and CFO): Boy, that's a hard one. You know one thing about the industrial business is 40% of our business in our largest market. There is so many customers, so many different types of business in that market it's hard to infer trends and patterns. So I don't think I have a good answer for you and I don't think Lothar does either because he is sitting there shaking his head. But I just think that over the last year or so the global market as you said has been, hasn't been particularly strong and industrial market I think you've got to start with GDP. And so like we said we need help from the market to grow that. But over the longer period of time when you look at the analog market the growth markets have been industrial and transportation. And along with communications as well that's where we focused our business. So we feel confident that this slow growth that you're seeing overall in industrial is going to turn around and grow a bit faster. Again our sales generally have been two or three years out from when we get from our sales and our wins to production. So we see what's going on with our design wins that will ship in a couple of years. So we feel pretty confident that our strategy of focusing on industrial market is a good one and we feel strongly that you're going to see greater growth in industrial than what you've been seeing.


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Thank you. Operator: Cody Acree. Cody Acree (Analyst - Drexel Hamilton): Thanks guys for taking my questions. Maybe just following up there on industrial, can you talk about some of the subsets where you're starting to see some of the improvements in order visibility, maybe some of those pockets that are still struggling GDP dependent? Lothar Maier (CEO & Director): Yes, the industrial market nothing happens fast in analog and nothing happens even slower in fact in the industrial business. But if you kind of step back and look, there's some markets that are doing okay. Sort of the instrumentation market is doing well. The medical business is doing well for us. Anything attached to exploration. Oil and gas right now is not particularly strong because of the obvious reason because of the low gas prices. Certainly if gas prices started to go up again we'd see a pickup in sort of the exploration part of the market. Some of the alternative energy stuff we're starting to see some interest in solar and wind. That could be a good market for us as well in the future. We pick that up in the industrial business. So it's like 1,000 different stories, there's just not a big trend that falls through that market. And it's not made up of big customers. It's lots of medium-size customers. So it's not like one person or one customer dominates this business. Cody Acree (Analyst - Drexel Hamilton): And maybe if I just ask you to read the tea leaves I guess a little bit, as you push through the beginnings of the year and you've started to see these better bookings in parts of comms and throughout industrial and in transport, do you get a sense that this is really just a snapback from an inventory correction or a bit of seasonality? Or are you optimistic that you've built any momentum here that either it would be Company specific or just end market specific that is more than just a bounceback from an inventory correction? Lothar Maier (CEO & Director): I think we had momentum going into just prior to the drop in sales. And as I mentioned earlier, there was no reason for the drop in sales. We didn't lose any customers, we didn't get kicked out of any programs. It just was an inventory reset and I think you're seeing that reset taking place here in the last couple of quarters. And I think we'll pick up the momentum that we had before this inventory correction. And if you look at where we're strong in the industrial and the automotive segments of the analog market, that makes up 50% of the total analog market and it's the only two markets in analog that really have any sort of sustained growth. So it's not like we're in the wrong markets. We're kind of in the right markets and we're strong in those markets and those markets are growing. So I think from a momentum standpoint, I think we're well-positioned. Cody Acree (Analyst - Drexel Hamilton): Thanks, guys. Operator: Steve Smigie, Raymond James. Steve Smigie (Analyst - Raymond James & Associates, Inc.): Great, thanks a lot, guys. I wanted to follow up a little bit on the optical market. I was hoping you could talk a little bit about where you see your strengths are part-wise, so laser drivers, etc.? And as this data center market ramps, are there certain distances, speeds that you are particularly good at that you think you are levered to? Lothar Maier (CEO & Director): It's not so much the speeds, meaning that when the speeds go up there is some huge requirements, there's these very complicated ASICs that are involved in these optical systems. They have many, many power rails that need to be powered and it has to be done with very high efficiency because these things are in very small, compact, not very well cooled locations. So there's a lot of electronics to get this optical stuff to work and I think we've got some good solutions in small footprints. Our micromodules do well in that area. They have a footprint that you can't do discreetly, so those products do well in optical. And it's really in the sort of not the photonics part of it itself, it's in the support of the electronics that go into the photonics. Steve Smigie (Analyst - Raymond James & Associates, Inc.): Okay, great. And then just sorry to nitpick on industrial here, but you guys talked about some pickup here.


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How much of that would be what you talked about a little bit there as just sort of returning back to normal demand post sort of inventory correction versus end market demand picking up versus you guys just having good designs that are taking off? So I guess what I'm trying to get at how much of this is just true end market demand picking up versus good stuff that you guys have done?

Don Zerio (VP Finance and CFO): We think it's a combination of both, really. I mean bookings back three quarters ago they almost fell off a cliff a little bit surprisingly and where customers that were booking at a steady pattern suddenly stopped booking and that was large customers as well as smaller customers. So I think there was a couple of quarters where they took their inventory levels down, maybe to coincide with their own lower growth optimistic growth rates. But even we said back then even though there was weakness and you saw the decline in bookings, most of our customers, and we're talking thousands, were still optimistic about their business and they were growing. So I think it's probably both that they are getting back to their usual levels of booking, their inventories are a good profile. But we think we're growing from there. So we think we've got growth ahead that this is more than just sort of the snapback from a correction. Steve Smigie (Analyst - Raymond James & Associates, Inc.): Great, thank you.

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Operator: Harlan Sur. Harlan Sur (Analyst - JPMorgan): Good morning, thanks for taking my question. Just one question on the emerging products portfolio, you guys mentioned the micromodule products I think in answer to one of the prior questions. It is one of the more interesting product areas because it is more sort of systems-level focus, system and package. Question is what end markets or applications are you guys seeing most traction for these micromodules and how fast do you see these products growing if you look at the pipeline of your design wins? Lothar Maier (CEO & Director): Yes, these micromodules are not designed specifically for any end market. They tend to be for the most part pretty general purpose. We probably initially developed these products to access small- and medium-size customers, customers that we couldn't send our application engineers to visit. So we give them these modules, which like you said is kind of a system in a package, it's a done analog solution, all they have to do is solder it down on a board and that worked. We sell these to many, many small- and medium-size customers who don't have the in-house expertise. Somewhat to our surprise, they've also done very well in large and sophisticated customers who do have in-house analog capabilities but we win that business really on two fronts. One front is because it's done, they get a time-to-market advantage, and two, it's in a footprint that even if they could do the analog design themselves they could never do it in as small of a footprint. So but all those things are not directed to one specific market. We probably initially saw strength in sort of the communications market with the micromodules. Now it's expanded to all over the place. We even have module now that goes into automotive applications and my sense is we're probably going to see more of that as well. So it's not targeted to any specific end market. Harlan Sur (Analyst - JPMorgan): Great, thanks for the insights. Operator: (Operator Instructions) William Stein, SunTrust. William Stein (Analyst - SunTrust Robinson Humphrey): Great, thank you for taking my question. Gentlemen, earlier on the call I think there were a lot of questions around automotive and you have spoken at great length about battery management systems. I'm wondering if you can talk to us, in particular in China, I'm wondering if you can talk to us about demand trends as you anticipate them in the coming year as the incentives that the Chinese government is running right now would seem to annualize in the September timeframe. Do you think that is going to be a headwind to your automotive demand next year? Lothar Maier (CEO & Director): That's a hard read. And all I can kind of say is, well, I read the statistics about what the Chinese government is forecasting in terms of the sales of hybrids and electric and plug-in hybrid vehicles and they are certainly forecasting calendar year 2016 is going to double from what it was in 2015.


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If it's going to double again, I don't know. The numbers are getting to be pretty large. But what we do know is that the market from our customer seems to be pretty strong.

They are all saying they are going to grow going forward. We obviously take what our customers say sometimes with a grain of salt in terms of their forecast. But certainly the reaction we get from our customer base is that this isn't a one-year type of event. The sense is this is going to continue. If you've traveled in China at all the pollution is incredibly bad. And I think they just have to fundamentally do something to address it and this is one of many things that they are doing. William Stein (Analyst - SunTrust Robinson Humphrey): It sounds like your automotive exposure there may be a bit more mix than unit dependent. So that's helpful, I get it. And one more if I can squeeze it in. Defense end markets, we've heard some companies suggest that the bid they are seeing from the big contractors, the larger customers in this space have become bigger and more strategic. And I'm wondering if you're seeing that bidding activity and whether it's turned into any backlog that you might be able to discuss? Lothar Maier (CEO & Director): The mil/space business for us has been pretty steady, meaning it's been 6% of our business for a long time and it tends to grow approximately as the Company grows. But you do make a good point. I can't say I've seen anything but there are some rumblings out there that that might get better. We pick up space in that as well and there's a lot of people out there trying to figure out how to put rockets and satellites into space and we participate in that business as well. So there are some things that allow us to be a little bit optimistic but I can't say I've got anything I can put my finger on. William Stein (Analyst - SunTrust Robinson Humphrey): Well, that's helpful. Thank you. Operator: Gentlemen, it appears we have no more telephone questions at this time. Don Zerio (VP Finance and CFO): Okay, thank you for joining us on our conference call today. We look forward to talking to you again next quarter. Have a good day. Operator: Ladies and gentlemen, this does conclude today's conference. All rights reserved (c) 2014 TheStreet, Inc. Please feel free to quote up to 200 words per transcript. Any quote should be accompanied by "Provided by TheStreet" and a link to the complete transcript and www.thestreet.com. Any other use or method of distribution is strictly prohibited. THE INFORMATION CONTAINED IN EACH WRITTEN OR AUDIO TRANSCRIPT (the "TRANSCRIPT") IS A REPRODUCTION OF A PARTICULAR COMPANY'S CONFERENCE CALL, CONFERENCE PRESENTATION OR OTHER AUDIO PRESENTATION. THE TRANSCRIPTS ARE PROVIDED "AS IS" AND "AS AVAILABLE" AND THESTREET IS NOT RESPONSIBLE IN ANY WAY NOR DOES IT MAKE ANY REPRESENTATION OR WARRANTY REGARDING THE ACCURACY OR COMPLETENESS OF THE TRANSCRIPTS AS PRODUCED, NOR THE SUBSTANCE OF A PARTICULAR COMPANY'S INFORMATION. THE TRANSCRIPTS ARE PROVIDED FOR INFORMATIONAL PURPOSES ONLY. THESTREET IS NOT PROVIDING ANY INVESTMENT ADVICE OR ENDORSING ANY PARTICULAR COMPANY.