安森美 (ON) 2006 Q4 法說會逐字稿

Good day, ladies and gentlemen.

Welcome to the ON Semiconductor fourth quarter earnings release conference call.

At this time all participants are in a listen-only mode.

Later we will conduct a question and answer session and instructions will be provided at that time. [Operator Instructions] As a reminder this conference call is being recorded.

Introducing your host, Mr. Ken Rizvi, sir you may begin.

Thank you, Jim.

Good morning and thank you for joining ON Semiconductor's fourth quarter 2006 conference call.

I am joined today by Keith Jackson, our CEO, and Donald Colvin, our CFO.

This call is being webcast on the Investor Relations section of our website at www.onsemi.com and will be available for approximately 30 days along with our earnings release for the fourth quarter of 2006.

Our earnings release in this presentation includes certain non-GAAP financial measures.

Reconciliations of these non-GAAP financial measures to the most direct comparable measures under GAAP are in our earnings release and posted on our website in the Investor Relations section.

In the upcoming quarter we will present at the Morgan Stanley Technology Conference on March 7th and Citigroup Small and Midcap Conference on March 15th.

During the course of this conference call we will make projections or other forward-looking statements regarding future events or the future financial performance of the Company.

The words estimate, intend, expect, plan or similar expressions are intended to identify forward-looking statements.

We wish to caution that such statements are subject to risks and uncertainties that could cause actual events or results to differ materially.

Important factors relating to our business including factors that could cause actual results to differ from our forward-looking statements are described in our Form 10K and other filings with the SEC.

The Company assumes no obligation to update forward-looking statements to reflect actual results, change assumptions or other factors.

Now let's hear from Donald Colvin, our CFO, who will provide an overview of the fourth quarter and 2006 annual results.

Donald?

Thank you, Ken, and thank you to everyone who is joining us today.

ON Semiconductor Corporation today announced that total revenues in the fourth quarter of 2006 were $401.6 million as anticipated, a decrease of approximately 5% from the third quarter of 2006.

Total revenues during the quarter included approximately $364.5 million of product revenues and approximately $37.1 million of manufacturing services revenue.

During the fourth quarter of 2006 the Company reported record net income of 87.4 million or $0.27 per share on a fully diluted basis.

This included a 10.2 million benefit or $0.03 per fully diluted share in restructuring asset impairment and others.

Fourth quarter 2006 results also included approximately $3 million associated with stock based compensation expense due to our adoption of FAS 123R share based payment.

During the third quarter of 2006 the Company reported net income of $76.8 million or $0.23 per share on a fully diluted basis.

Third quarter 2006 results included approximately $2.9 million associated with stock based compensation expense.

On a mixed adjusted basis average selling prices in the fourth quarter of 2006 were down approximately 2% compared to third quarter of 2006.

The Company's gross margin was 39.3%, up approximately 120 basis points compared to the third quarter of 2006.

This was primarily due to less obsolescence from conversion to lead free parts, improved product mix and higher than expected capacity utilization.

Product margins were 42.1% during the fourth quarter of 2006 compared to 40% during the third quarter of 2006.

EBITDA for the fourth quarter of 2006 was 114.4 million compared to EBITDA for the third quarter of 2006 of 106.3 million.

Total revenues for 2006 were 1.532 billion, an increase of 22% from 1.261 billion in 2005.

During 2006 the Company reported net income of 272.1 million.

That included a restructuring asset impairment and other benefit of 6.9 million.

During 2005 the Company reported net income of 100.6 million.

That included 3.3 million in restructuring asset impairments and other charges.

The Company's gross margin increased by approximately 530 basis points to 38.5% in 2006 from 33.2% in 2005.

During the fourth quarter of 2006 the Company used cash on hand and net proceeds from issuance of $448 million in convertible notes to reduce its senior pipe facility to approximately $200 million and repurchased 40 million shares or approximately 12% of its then outstanding shares of common stock. 10 million of these shares were purchased directly from TPG and its affiliates, the Company's largest shareholder.

Even with these financial actions the Company exited the fourth quarter with cash, cash equivalents and short-term investments of $268.8 million, approximately flat with the third quarter of 2006.

At the end of the fourth quarter day sales outstanding were reduced to approximately 40 days.

In turn our inventories increased slightly to approximately 79 days and distribution inventories in dollar terms remained relatively flat at just over 11 weeks.

Cash capital expenditure during the fourth quarter were approximately $13 million.

Now I would like to turn it over to Keith Jackson, our CEO, for additional comments on the business environment.

Keith?

Thanks, Donald.

Now for an overview of our end markets.

During the fourth quarter of 2006 we saw growth in our computing, wireless and automotive end markets.

Our largest end market was the computing end market, which represented approximately 24% of fourth quarter 2006 product sales and grew approximately 3% sequentially.

Growth in this end market was driven by continued account penetration of our BR controllers, trench MOSFETS, Gig drivers and DDR memory controllers.

Wireless, our second largest end market, grew 12% sequentially and represented approximately 21% of our fourth quarter product sales driven by continued success at four of the five major cell phone manufacturers.

The consumer end market represented approximately 21% of product sales during the quarter and declined sequentially, as anticipated, primarily due to a slowdown of game console builds during the quarter.

The automotive end market was up slightly on a dollar basis and represented approximately 15% of product sales.

The industrial end market was flat on a dollar basis and represented approximately 13% of product sales during the quarter and the networking end market was down slightly on a sequential basis and represented approximately 6% of product sales.

Shipments to Motorola represented approximately 7% of product sales in the fourth quarter.

Our top five OEM customers on a direct billing basis for the fourth quarter were Delphi, Delta, Motorola, Samsung and Siemens.

Our top manufacturing services customer was LSI as anticipated.

On a geographic basis our contribution this quarter from product sales in Asia, excluding Japan, remain flat at approximately 60% of sales.

Product sales in the Americas decreased by approximately 100 basis points and represented approximately 19% of fourth quarter sales.

Product sales in Europe remained flat at approximately 16% and sales in Japan were up 100 basis points to 5% of product sales.

Looking across the channels, sales to the distribution channel increased by approximately 300 basis points to approximately 51% of product sales.

Direct sales OEMs remain flat at approximately 37% of product sales and the EMS channel decreased by approximately 300 basis points to 12% of product sales, primarily due to a slowdown in game console builds during the quarter.

We also estimate that approximately 20% of sales through distribution were for third party logistical services for the EMS channel.

During the fourth quarter product revenues broken out by our new divisions were as follows-- the standard products group represented approximately 34% of product sales.

The automotive power regulation group represented approximately 28% of product sales.

The computing product group represented approximately 26% of product sales and the digital and consumer products group represented approximately 12% of product sales.

We will publish the quarterly revenue, gross margin and operating margin breakout of these divisions in our 10-K filing in late February.

Now I'd like to provide you some details on the progress we've made. 2006 was another great year for the Company.

We grew revenues by 22% during the year and gross margins by 530 basis points to 38.5%, the highest annual gross margin in the Company's history.

During 2006 we also had net income of 272.1 million and earnings per fully diluted share of $0.80, both records for our Company.

Our consumer driven end markets of computing, consumer electronics and wireless grew faster than the end markets they served in 2006 and we anticipate our new design wins and continued account penetration in these end markets will enable us to continue our success in the upcoming year.

While we currently expect to see some mild seasonality in our business in the first quarter of 2007, we anticipate a strong second half of the year with second half product revenues growing by at least 10% compared to the first half of 2007.

Given the current market environment, outlook from our customers and design wins, it should begin ramping in the second quarter.

We also believe the first quarter represents the bottom of the cycle for ON Semiconductor.

Our computing revenues grew by over 22% in 2006 driven by our SAN penetration with new products such as our Dual edge Vcore controllers, trench MOSFETS and synchronous butt controllers.

Our solution engineering centers, or SECs, targeted towards the computing end market in Portland and Taipei have been a major driver of our success in the end market.

These SECs enable us to work directly with our customers to help solve their power management needs and develop more proprietary power management solutions.

We see the SECs as a direct investment in both our customers' and our success.

The computing SECs has helped us win more than 10 significant new design wins in the computing end market in 2006 and we expect 2007 to be another strong year for our computing business.

In the first half of this year we also anticipate opening an additional SEC in San Jose targeting the computing, consumer electronics and networking end markets.

Our consumer business was another strong driver of growth for ON Semiconductor in 2006.

This business grew by over 24% in 2006 driven primarily by our [SAM] expansion and the consumer game console and MP3 markets.

As anticipated during the fourth quarter of 2006, we saw a slowdown in game console builds.

While we anticipate some small declines in this business in the first quarter of 2007, we expect to see builds beginning to ramp again in the second quarter of 2007.

In the upcoming year we also anticipate seeing strong growth in the flat panel market where we now have a content of up to $4 per flat panel display compared to a content of approximately $1.50 to $2.00 in 2005.

Our new greenpoint referenced designs are working to set the global standard for power efficiency and pave the way to meet the emerging one watt standby power requirements for flat panel displays in consumer game consoles.

We will introduce two new greenpoint reference designs in the upcoming months to enable our customers to meet this emerging standard.

Our wireless business was also a strong contributor to our overall success in 2006 growing by approximately 25%.

We continue to drive account penetration and new product development with four of the five major cell phone manufacturers.

Once again, our SEC in Seoul focused on this end market as well as our global FAE support network has enabled ON Semiconductor to gain an increasing level of confidence from our cell phone customers regarding our ability to develop leading edge protection, filter and switching chip sets to help with their power management needs.

While we believe there will be some seasonality associated with this end market in the first quarter of 2007 due to over inventory at the cell phone manufacturers, we believe our array of low VCE set bipolar junction transistors, our low capacitor quarter rays for ESD protection as well as our broad portfolio of filter and analog switch products will enable us to continue our strong growth in this end market in 2007.

In 2006 we had record shipments of more than 30 billion units to our end customers.

Further evidence demands for our products remain robust.

We continue to help solve their power management problems through innovative product and design solutions.

Our products and our ability to exceed our customers' expectations continue to win us awards from publications, our channel partners and our customers.

We recently received the 2006 innovation awards from ED in China for our leading products in the network and communication category as well as the power devices and module category.

The National Electronics Distributors Association also awarded ON Semiconductor with the Manufacture of the Year award.

This award recognizes the manufacturer and supplier that best exemplifies the spirit of partnership in the electronic distribution industry.

Now I'd like to turn it back over to Donald for our other forward-looking guidance.

Donald?

Thank you, Keith.

In the fourth quarter the Company executed a series of transactions including raising 484 million in gross proceeds through a convertible note offering reducing our senior pipe facility from over 500 million to approximately 200 million and repurchasing approximately 400 million or 12% of our then outstanding shares of commons stock.

Given the relatively low principal amount, approximately 200 million, that now remains in our senior secured credit facility, we intend to refinance this facility this quarter to enable the Company to have more financial flexibility for actions such as stock and debt repurchases as well as reducing the interest we pay to be more on par with current market rates.

First quarter 2007 outlook-- while our underlying business activity remains relatively flat in the first quarter of 2007 compared to the fourth quarter of 2006, we have four less business days in the quarter compared to the fourth quarter.

This is a primary reason for our expected revenue decline.

Based upon product booking trends, backlog levels anticipated manufacturing service revenue and estimated turns levels, we anticipate that total revenues will be approximately 368 to 378 million in the first quarter of 2007.

We also anticipate that approximately 25 million of our total revenue will come from manufacturing services revenue during the first quarter.

While backlog levels at the beginning of the first quarter of 2007 were down slightly from backlog levels at the beginning of the fourth quarter of 2006, they still represent over 90% of our anticipated first quarter 2007 revenues.

Due to the full impact of annual contract negotiations, we expect average selling prices for the first quarter of 2007 to be down approximately 2% sequentially.

We expect that our product gross margin to be approximately 39% and our manufacturing services gross margin to be approximately breakeven in the first quarter of 2007.

In this quarter we intend to keep our internal inventory relatively flat as we prepare for platform ramps associated with design wins and expectations of increased revenue in the second quarter.

For the first quarter we expect cash, capital expenditures of approximately $55 million primarily due to carryover from the fourth quarter of 2006 where we only spent approximately $13 million in cash capital expenditures.

For the first quarter we also expect total operating expenses of approximately 19 to 20% of revenue with SG&A expenses at approximately 12 to 13% and R&D expenses at approximately 7%.

We anticipate that net interest expense will be 7.5 million for the first quarter of 2007 and taxes to be around $3 million.

We expect stock based compensation expense on a pre and post tax basis to be around 3 to 4 million in the first quarter of 2007 and this expense is included in our guidance.

We expect our fully diluted share count to be approximately 295 million in the first quarter of 2007 based on today's share price, which includes approximately 287 million of common stock and approximately 8 million shares related to options and our convertibles.

Further details on share count and EPS calculations are provided regularly in our 10-Qs and 10-Ks.

With that I would like to start the Q&A session.

[Operator Instructions] To participate in the Q&A session as possible please limit yourself to two questions. [Operator Instructions].

Mark Edelstone of Morgan Stanley.

Hey guys, nice job on the operating results here.

For Keith or Donald you mentioned that ASPs were down 2% sequentially in the fourth quarter.

I think that was a little bit more than what you had initially expected and I'm just wondering if that is all mix related?

And then I guess more specifically, do you have kind of an apples to apples comparison so to look at what ASPs were like on an unweighted basis.

And then similarly for the Q1 ASP erosion is that mix weighted or unweighted.

Mark, this is Keith.

In both cases when we quote the ASP numbers it is as close as we can get to an apples to apples, product to product change so it's not weighted or mix adjusted.

On a mix adjusted basis the ASP decline would have been significantly less than 2%.

So really it is a phenomenon.

If you look at what happens with ASPs we renegotiate our annual contracts in the fourth quarter.

Some of those take effect in the fourth quarter so the backlog gets repriced and then the rest of them get repriced in the first quarter, which means typically for us our fourth quarter and first quarter end up being the largest sequential changes in ASP in a negative direction and yes it was a little bit higher than we thought because we had some, frankly, some very big contracts that although they didn't move very much, just the magnitude of them kicking in in Q4 was a little bit more than we expected.

It obviously makes the product aspersions look that much better then.

Nice job there.

And then I guess can you just give us an update on what the manufacturing services look like as you go through 2007?

Where do you stand specifically in qualifying additional customers?

Just on that the margin stuff and the ASP stuff we did stay at you know 1 to 2% and because of the annual contracts we were gaining say probably closer to the higher end so there was no surprise and we did also state, as Keith mentioned I think, the mix is going to help us so that really came through.

So I mean there was I'd say it's actually in line with what we were anticipating.

As far as the manufacturing services, we stated on the last call between 100 and 110 million for calendar year 2007.

We see a 25 million for the first quarter.

We also are still looking for additional partners.

We stated that that would be more of a second half story and that remains still the case today so we do have a fixed contract with LSI, which runs through 2007 and 2008.

It terminates the middle of 2008 so that guarantees a minimum revenue but essentially the model we tell the Street roughly 100 to 110 million at breakeven for the manufacturing services and that's the way we will operate in the first half of the year.

We are actively engaged in trying to find partners to improve that performance in the second half but nothing to announce on that today.

Thanks a lot, guys.

Nice job.

Craig Ellis with Citigroup.

Donald, you talked about 10% growth as you exit the year, or excuse me 10% growth in the back half of the year relative to the first half and I think that that's fairly seasonal for you but can you talk about the way that your mix might shift over the course of the year relative to the new segments that you've got, digital consumer, computing, high dome power etcetera?

I'll answer that one actually.

Yes we knew-- we're feeling very good.

In fact, I just went through a review this last week with our sales team where we looked at each customers and each platform design win that we've got in our major segments and so we're feeling very good about growth this year.

Specifically I would expect our computing mix to increase as we go through the year.

We've got some pretty exciting platforms there.

We've also introduced our first controllers designed specifically for AMD, which expands our opportunity in the market and we're sampling our notebook controllers at this point so in both cases a fairly substantial increase in the markets we serve there in computing so I think that's going to be a very, very strong story for us.

We're also feeling pretty good about growth in our consumer and digital piece, the MP3 players and the handsets, a lot of new products in there and our dollar content opportunity has gone up again in 2007 so we think there is going to be a unit increase in both of those markets year-on-year and since units really drive our sales, we think those will be the two strongest growth stories for 2007.

From an ASP perspective the type of content we're adding is very good margins for the Company and I would expect that our margins will-- or the mix, if you will, of margins-- will continue to increase in the second half so that we can exceed the 2006 performance.

Just on the subject of gross margins you guys did a nice job on a product basis exiting the year at 42% and that was versus 35% the prior year.

Any parameters about how we can look at your run rate exiting 2007, Keith?

That's going to be a bit more problematic for me to say right now but again I think we will be able to increase that this year and then we'll have to look at the absolute run rate and loading factors and all of the other stuff we normally look at before I can give you a better forecast on that one, Greg.

Okay thanks and then lastly, Donald, how should we think about the potential for further share buyback either in the quarter or just as we go through the year?

I had mentioned I think we talk about gross margins in the fourth quarter but one of the things that's fantastic if we look at the results is the amount of cash that the Company has thrown off and I'll let everyone do their diligent [fun] there but this is a real mean cash generating machine and we will on the back of a strong business prospects that Keith alluded to we will continue to throw off tons of cash this year and so we are in the process of negotiating our bank facility to get us a lot more flexibility but we anticipate that our new bank facility will be in place before the end of this quarter and that will allow us the flexibility to do actions like buying back stock that was so effective in the fourth quarter.

So I think it's going to take us a few more weeks to do that, Greg, but as we look forward to the second half of the year we will weigh out the opportunities.

Obviously when we launched the last program of the recapitalization, the stock was a lot lower than it is so the more successful we are the less attractive it is to buy back stock so I'm hoping we're going to be very successful and, therefore, we will look at other things like repaying some of the higher interest rate debt that's still outstanding.

We still have debt that's costing us over 7% and that's obviously a rate share target of opportunity.

So yes that's something that's on the radar screen.

Yes that's something we're very interested in.

We will get the flexibility to do it.

We will generate the cash to permit us to do that but we will have to-- you know we'll work it for where we get the biggest bang for the buck going forward.

Thanks for the color, guys, and nice job on the quarter.

Michael Masdea with Credit Suisse.

Clearly amazing job on the gross margin side.

Can you walk us through, Donald, kind of how much each one of those pieces contributed and if there's any more flex in any of those pieces from where we are now?

Specifically on what business are you referring to there, Michael?

The obsolescence, the product mix and utilization so I assume product mix you expect to continue to richen utilization where we--

I think we see it probably at least we roughly split between the three of them.

We had like a 300 basis points improvement so you could just say roughly one third, one third, one third and obviously, as Keith mentioned, as we go into the second half of this year our manufacturing activity should actually be a nice contributor.

Mix will also be a contributor but I would not expect product obsolescence to be a permanent contributor to gross margin.

So it's probably a couple of hundred basis points of that that can snap back and can get richer as we include our manufacturing utilization.

You probably also heard, Michael, that we are going to be spending over $50 million in cash capital expenditures in the first quarter and we've geared up our capital expenditure to target the second half build that Greg mentioned so that equipment will be coming in and that should greatly improve our manufacturing capability to address the second half opportunities.

Great and from a visibility and order perspective could you just walk us through kind of how orders sort of went during the fourth quarter and also how they've sort of been trending from the first quarter and also sort of talk a little about the turns environment last quarter and this quarter.

You know I think we've said that the backlog, the bookings still remain relatively strong.

It's not-- I'd say warm but not super hot right in the way I see it in the second quarter of last year but still warm and there was no really remarkable trend.

I think it continued pretty constant throughout the whole of the fourth quarter and we're seeing reasonable bookings in the first quarter and in the first month.

I think it's also fair to say that as we work through the backlog that was entered during the hot spring of last year, we now get to a situation where we require slightly more turns business.

That's well within the norms that we have seen and the tracking is in line with what we would expect.

So, we still come in with over 90% of the anticipated revenues on the backlog and when I talk of this is just only product revenues.

The numbers would be even higher if we take into account total revenues probably.

But, just over 90% of product revenues and we require a minimum about of turns, which are tracking well.

We would expect that as we go through the year our dependence on turns will reduce, especially since we see a stronger second half.

There will come a moment when the backlog will grow ahead over shipments and the requirements on turns will reduce.

This is normal in the cycles.

We have like six, seven years of data that supports the ebb and flow of turns business.

What were turns last quarter and what was book to bill, sorry?

Well we never get really, we never give a book to bill because backlog is something that can move all over the place especially when you are entering orders at six months and you're really only shooting the main thing is one quarter.

And what we did state is that the backlog for this quarter was slightly more than the backlog for the fourth quarter.

So that would mean that in the three month period, which we pay attention to then, our book-to-bill ratio was slightly under one.

That would be the way you could in fur from that.

But we don't like to give book-to-bills.

We never have and I think Keith and I agree we never will because it is very misleading.

And the turns last quarter that you actually did?

We had very modest turns, single digits, yes.

But we did start last quarter with over 90% of backlogs, more single digits turns.

Probably a bit higher turns this quarter.

Our next question is from Chris Danely with JP Morgan.

Thank you this is Famee for Chris Danely.

Even though great job on the gross margins, I just had a question on lead time.

Where were they exiting both quarter and what kind of trends do you anticipate in the first half?

We had fairly flat lead times in the fourth quarter and entering into the first quarter.

I don't expect those to start extending until the March-April time frame.

You know this is particularly with the work down in inventory in the wireless hand set business.

I expect we will be able to keep up with the pace here during Q1 and it's not until the Q2 ramps start to show up that we'll start seeing some extending.

So kind of that the eight to ten week range is a reasonable expectation for Q1.

And John Barton with Cowan your line is open.

Donald, you commented on the break-out of the contribution of gross margins being a third, a third, a third.

I think what you were referring to is that product gross margins of September was 40% going to 42% and change in December.

If I read your guidance correctly, it looks like it goes a 39% in the December quarter.

What is contributing to that decline?

Is it purely utilization or are there other unique situations within there please?

Okay, so poof what a tough this one, especially this early in the morning for me.

The 300 basis points I was referring to was, when we gave our guidance, we said 38 to 39% gross margin on the product revenue for the fourth quarter and we've actually told the guys on the one-on-one before whatever we thought we were tracking more toward the higher end of that range.

So, we actually up-sided that 39 to just over 42, John, and that's why I was explaining the 300 bips was 300 point higher than the highest part of our guidance range and that was made up of, with you know worse reserves, better mix and higher capacity utilization that we referred to.

So as we go into the fourth quarter, we don't see any benefit from either capacity utilization, no kickers from there, and mix should be relatively constant and we see no benefits from any reserves so we think we will be back to where we though we would have been and we will give the guidance for the fourth quarter so back to 39%.

John I would add, we were up in capacity utilization from what we anticipated.

I don't want to mislead anyone.

We were definitely hit a low point in capacity utilization for the year end Q4.

John, I would add we were up in capacity utilization from what we anticipated.

I don't want to mislead anyone.

We definitely hit a low point in capacity utilization for the year in Q4.

The capacity utilization in March quarter will actually be up sequentially?

It should be up slightly.

All right.

And then, Keith, if you could elaborate, you touched on the fact that game console demand will be down slightly in the March quarter.

How do you see that materializing beyond the March quarter?

It should start picking up in the second quarter.

The forecast we have from all of those manufacturers look like they will start to build again in the second quarter.

And, of course, the peak quarter for that industry is always Q3.

So we would anticipate that pattern this year.

Craig Hettenbach, Wachovia Securities.

Following up on some of the design win momentum in the desktop space, can you just talk about dollar content today compared to maybe one or two years ago within desktops?

Yes.

If you look at the dollar opportunity that we have in a given desktop today that number is approaching $8 per motherboard and if you go back a couple of years that was less than four, so it's more than double.

So just on a dollar content basis the other thing that's changing though, Craig, is the number of boxes that we can address and so by expanding ourselves from the Intel platform and including AMD and by expanding into the notebook range you take that additional dollar opportunity and you give yourself more opportunities.

So the net of that drove some very good growth last year and I expect that will also be our strongest growth this year.

Okay and then within the auto market you mentioned it was relatively flattish or slightly up, could you just talk about your sense as when you might see an inflection point and some return to growth within autos?

Yes.

I think-- you know we have a good proportion of our business basically split between North America and Europe.

The Europe side has been growing nicely.

The North American manufacturers have been struggling of late.

I think they've got to work through some of their issues, but again I would start guessing that the next model year builds around you know late Q3 early Q4 of this year we would start to see some positive inflection there.

Chris Caso, Friedman, Billings, Ramsey Group, Inc.

I wonder if you could talk a little bit about the competitive environment?

It sounds like your lead times have been pretty stable.

What have you guys been seeing out of your competitors that maybe is different this time around from other cycles?

We have not seen as much panic, as it were, as the capacity utilization started to fall from the demand.

In times past we would see an extreme amount of stuffing of distribution and pricing roll off to make that happen.

Certainly there is going to be some inventory builds and distribution by our competition, but they are nowhere near as significant, nor was the pricing required as significant this time around.

So I would say a much more stable environment this year this time than we've seen before in past cycles.

And I guess back to one of your earlier-- two of your earlier comments.

One, talking about Q1 probably being the bottom of the cycle for you guys and then with respect to some of the ASP decline you expect this quarter being the result of annual pricing contracts.

Does that give you the ability to flatten out pricing as you go into Q2?

What do you guys think may happen as you get into Q2?

Yes.

I think, again, this is-- don't normally give you projections out that far, but I would expect that the pricing pressures would ease from the rate it looks like we'll hit in Q1 as we go through the year until we get to that annual negations again in Q4.

So it should be more moderate in the middle part of the year.

How much of your business would be on annual pricing contracts, as opposed to sort of spot pricing?

Well, we have no spot pricing.

We do-- I would say 80% of the business is either quarterly negotiated or annually negotiated and on the annual part I don't have a precise figure there, but that certainly from an influence perspective is going to be in the 30% range of the business.

That gives us an idea.

Thank you.

Romit Shah, Lehman Brothers.

Nice job, guys.

One clarification, is it typical that you have four less shipping days in Q1 or is it specific to this year?

No, that's not typical.

It does vary on cycles.

It gets longer and shorter the differences from time.

This happens to be one of the longer ones for us, so it's not "typical".

Okay and then on game stations, Keith, a couple suppliers have commented on upside for Q1 from Xbox and PS3.

Can you just elaborate on why you're expecting what seems to be a more conservative outlook for volumes in Q1?

Yes.

What I'm basing that on is that all of our game console manufactures give us an estimate of the number of boxes they're going to build and certainly some of the game boxes are down, but none of them are up significantly.

So when you net all that out when we look at the total number of game boxes being build quarter-on-quarter we don't expect that to be up.

We expect it to be down slightly.

Within that I don't want to get specific because I don't like to talk about specific customers.

There are some that are up a little, but in total of game boxes we believe there will be less game boxes built in Q1 than there were in Q4.

Okay.

Could you just elaborate on the account penetration in computing?

It sounds like notebooks are new opportunities for you this year, but also sensing that your content is increasing in desktops.

Can you just comment on that and any market share you think you've captured in the last 6 months?

Well, I think we've clearly been capturing a lot of market share.

You can see our growth rates there compared to that market place and compared to the competition, it has been up very nicely.

What I will say is that most of our wins are occurring in the Taiwan ODMs and we've had very significant business from those ODMs in working with HP.

So we've seen a lot of growth in those areas over the last year.

Tristan Gerra, Robert W. Baird and Company.

What percentage of your outsourcing do you plan on migrating to Gresham by the end of '07?

What could be the percentage longer term and what incremental margin will you expect to generate on that portion of the business?

We outsourced about $9 million of our wafer manufacturing in the fourth quarter and so we've actively looking at the fourth quarter of last year, so we're actively looking at targets of opportunity there for Gresham.

So I mean I think it's fair to say half at least of that is our target.

It takes time because you've got to re-qualify parts, so sometimes it's better to leave it where it is and wait until the new part is introduced, so you don't have the re-qual, but clearly you can see that with a 9 million run rate of potential wafers that could be manufactured in Gresham that gives us a rich target of opportunity.

The only thing is we're impatient because we've got the capacity, but that's something that we believe we can convert at least half of that 9 million we outsourced in the fourth quarter into Gresham by the end of this year.

In addition to that, we are also launching parts in Gresham that we make on site that we can make much more cost effectively and better parts in Gresham, particularly TrenchFET and we launched that program in the fourth quarter of last year and we've been very happy with the results of that.

And a third action we're taking is that we are launching new parts that take advantage of the excellent capabilities of Gresham and we should start to see some results from that in the middle of the year.

So it's all small steps in the right direction and clearly, as we mentioned, it would help if can get the manufacturing partner an additional one to offset some of the costs there, but we don't necessarily need that.

We always stated that we were getting Gresham for strategic reasons to help us overhaul our whole product portfolio and technology and we are very comfortable and happy that we are doing that.

It's just to accelerate profitability that a manufacturing partner would be attractive.

All right, I appreciate it.

And also, how much of this trend do you see for the second half of this year is driven by new products and market share gains, versus the macro environment?

In the computing sector, where I expect the strongest growth, we do expect that market to be up this yea, Tristan, up stronger than '06, but not nearly as significantly as our growth.

So I would say that we would be gaining significant share in our expectations, as we did in 2006.

On the handset side, again, I think our market share penetration will be faster than the growth rate in the handsets.

And again, it's because of the new products and the dollar content per phone giving us more leverage over the roughly 10% unit increase that we're expecting in the cell phone industry.

Ramesh Misra, C.E. Unterberg.

In terms of your CapEx plans for Q1, what is the area of focus for that, front end, backend Gresham or any particular product areas?

Well, minimum Gresham doesn't require much capital expenditure.

It's just purely a few things, but in general when we're looking at capital expenditures we are favoring basically a lot of the backend because of packaging and non availability of competitive prices from subcontractors.

There's been a big tightening in our backend product chain and core prices have risen.

They have cut back-- subcontractors have cut back their investment and so that's something that's been an area of focus for us.

And then in the front end some of our Bipolar and BiCMOS technologies have received, as Keith mentioned, particularly in computing space a world of market acceptance, so we've had to invest in some of these areas to relieve bottlenecks and increase our capacity there.

So that gives a kind of rough color and we're probably thinking of something like 100, 110ish capital expenditure for the year, something in that range, which we continue to monitor making sure that we are not missing opportunities.

So we have a high hurdle rate, but we monitor that and I think it's also interesting to see that a large part of that is focused in the front end of the year so that the capacity will be in place for mid-year, so that we can reap the harvest in the second half.

Okay and then a question on your manufacturing services revenues.

What are some of the reasons for the sizable decline in Q1 or I guess another way to ask it is that if Q4 manufacturing services revenues were not just higher than your guidance, but quite significantly higher from that roughly $100 million annual run rate, can you talk about some of the reasons in that regard?

Thanks.

So that's a problem when you do well, you've got to live up to it all the time and we know all along that this contract was going to fall off and so we've had a few upsides, but that's already included in our numbers now.

So I mean it was anticipated.

We said 100 to 110 last time.

That still stands and I mean it's just the normal fall off of the contract and, as I've mentioned in the previous answer, we will be ramping our own parts, but that takes time bringing in our technologies there and qualifying the parts and transferring activities.

So that's much more of a backend second half for these activities.

So there's a kind of lull, a calm in the first half where we are running down the existing contracts and haven't managed to replace it, activity for activity with new contracts.

What I can say, is that as far as the production is concerned we may be a bit under utilized.

As far as the engineering is concerned in developing new processes and technologies for our use we're fully utilized and so that's why we bought the place is to give us access internally to capabilities that we did not have.

And as we see in the backend a tightening of backend supply and non cost effective subcontracting, we are also seeing that changes in the front end, so having our own internal capabilities that gives us the opportunity to continue to improve our cash flow and drive our EBITDA and that was one of the main reasons we bought the facility is to ensure that our EBITDA remains healthy and strong and well in the 20s like we've published in the fourth quarter.

Okay, great.

Thanks, very much, guys.

Greg Berger, Wedbush Morgan Securities

You guys talked a lot about utilization rates, but did you actually say what the utilization was in the quarter?

We didn't actually say, but we can, Greg.

I think a blended number was in the low 80s-- low to mid 80s.

Low to mid 80s on utilization.

Thank you.

And can you just talk a little bit about-- just do weeks of inventory?

Sure.

It's just over 11 and so, again, it remains lower than our model and at the low end of what we normally see and certainly from a cycle-to-cycle comparison dramatically lower than it normally is at this point.

Thank you.

And then let's see here.

On the wireless side you mentioned some excess inventory.

Is that more on the chip side, is it more on the devise side and when did you see some of that inventory build?

Yes, it's mostly on the end phone side.

We have not seen any substantial growth in the channel, if you will, for the products we sell-- the semiconductors we sell.

It's really more order rates lessening because there's too many handsets at the end manufacturers.

Thank you.

And then just last question for me, with respect to these VR11 controllers that you're ramping up into the PC market, what's really your competitive advantage there versus the competition that's allowing you to win some of this share?

Is it price?

Is it features or performance?

Is it service?

And the answer is, yes.

We believe that we've got advantages in each of those areas.

This new architecture we use that we call the duel edge gives much better power efficiency, so we think it gives you, if you will, performance and feature enhancement.

We also know that we've got very good cost structure and to boot with that, of course, an outstanding reputation for service and supply.

So that combination has been a winning combination.

I don't think it's one thing.

I think it's really the whole package.

Thanks for the color and congratulations on a strong 2006.

Quinn Bolton, Needham & Company.

Really two questions for Donald.

Donald, you were discussing the less obsolescence due to the lead free transition I think.

Was that actually did you reverse some reserves and that gave you sort of a one time benefit or was it that in the past quarters you'd just been taking some charges associated with the packaging that you're now no longer having to take?

I'm just trying to get a sense as to whether that was a one time benefit or whether it was just reduced sort of charges?

No.

It was reduced charges compared to previous quarters, as the lead free is now behind us.

I mean contrary to lots of opinions lead free was not a positive for us.

Some people had kind of hypothesized that lead free was a boon and that we, but in actual [fight] we had to reserve a significant amount of inventory, so that reserve had to be established.

So the delta between Q4 and Q3, Q3 we were still reserving.

Q4 we didn't need to reserve as we had shipped in the fourth quarter and remaining backlog covered us the reserves for early exposure.

So that was basically less reserves rather than a reversal.

And are you selling that sort of previously reserved inventory and that's why you're seeing some of the margin benefit?

No.

The margin benefit was we did not have the same need for reserving in the fourth quarter as we did in the third.

That's basically the main growth of that.

We actually analyzed stuff that we had written off and I think we published that in exhaustive detail in our Qs and Ks and in actual fact there wasn't a big delta of a sale of no value inventory.

That's something that we disclose in our footnotes so that wasn't really much of a change in that in the fourth quarter over the third quarter, Quinn.

Okay and then the second question just, assuming that the backlog is filling in nicely for the second half of the year, say 90 days forward, I assume you guys start to build internal inventories maybe through the second quarter in anticipation of the stronger second half?

Yes.

The expectation now is we'll be approximately flat here in Q1, not needing to build much.

We'll probably concentrate on getting a little more wafers running in the factories, but taking down the finished goods kind of balance this quarter out and then in Q2 we will have to build some inventory in anticipation of the Q3 ramps.

Okay so capacity utilization probably benefits from just overall higher revenues in the second quarter plus some internal inventory build, so could see some good gross margin delta Q2 to Q1?

Yes.

I would expect Q2 to be up from Q1 due to utilization and, of course, we're still driving mix on top of that.

Steve Smigie, Raymond James & Associates.

I was wondering if you could comment if you're seeing any inventory issues at EMS?

I think some of the other people out there have had that and if you could give at least a reasonable amount of EMS business.

So EMS inventory build or--?

Right, I mean several of the other companies in the sector said that part of the reason they've seen weakness is there's too much of their inventory in the EMS channel and so that backed up on them.

I was just wondering if you were seeing that as well?

Yes, I don't know that we see a significant backup.

Certainly the order rates from EMS were the sharpest drop off in Q4 and into Q1.

Whether that's inventory or, as I alluded earlier in my announcement there, we believe it's just lower build rates in the consumer sector and handset sector for Q1 that has been driving that.

Whether it's actual inventory or build rates, Steve, unfortunately I can't give you a mix on that, but for us we're not seeing a significant inventory build of our products at EMS.

Okay.

The other question was given you had the four days here that you're missing in this quarter, does that mean-- and you should indicate that's not normal-- would that mean that we would expect Q2 over Q1 growth to be better than seasonally normal?

I actually don't know.

Give me one second here I'll check.

Okay, so I just had it explained to me that it's not significant in Q2.

The extra days we'll get this year are in Q4.

Q4.

So we can kind of make up for the being down a lot in Q1 in Q4, so it's not going to be in Q2.

Okay, all right.

Thank you.

[Kevin Cassidy], Piper Jaffray.

I want to go back to the ASP being down 2% with the new contracts.

That seems to be lower than the normal years.

Am I right with that?

You know it is a very moderate rate because, again, when you think about annual contracts in essence you've got a whole year to look at versus the sequential nature that you get on the quarterly contract.

So it typically is a bigger reduction for those annual ones that shows up in one quarter and so it does have a bigger impact, but relative-- again I'll just go back to comments I've made several times-- relative to our normal anticipated ASP declines, this was a very modest year.

We normally would see something in the 6 to 8 range on an annual basis.

In '06 and going into '07 looks much more moderate than that more down in the 4% to 5% range.

Do you have an explanation of why that is?

Are customers--?

Well, again, I think there's two our three things going on there.

One, I think there's better inventory management in the industry, which leaves to a little less panic and swings in factory utilization.

Again, us running kind of mid 80s in Q4, which is probably going to be the low point for us, is a substantial improvement over being down in the low 70s in previous cycles.

So I do think that's a piece of it, inventory control being a big one.

And then secondly, we do believe that there's been less investment made in our types of products from a capital basis this cycle versus last, which means that there's likely to be more stability.

And then lastly, at least with the North American and European competitors we have, they seem to be more profit minded than they have in the past cycles, meaning that they're doing less irrational pricing.

You know we have been saying this for the best part of the last two years that-- you know and we've even presented this at our analyst day that we're seeing less severity in the cycles and particular there are certain macro economic effects.

A lot of our competition in non-semiconductor are European and Japanese companies, so the weak dollar is clearly another positive and they may be helping underpin the lack of or the reorienting of competitive pressure that Keith mentioned.

Also, some of our U.S. competitors in the analog area have moved to higher pastures, the 60% gross margins type pastures, which gives us a little bit more headroom in some of the areas where we saw some competitive pressure before.

So overall, this is what we've been trying to convince investors for the last few years that we see ourselves in a much more benign pricing environment.

And as Keith mentioned, a lot of our business is on contract.

Very, very little of it is on spot.

We start with a full backlog over 90% in the beginning of just about every quarter, so that is another sign that it's not such a volatile business.

We also still maintain aggressive cost reduction programs.

So the type of price pressure that Keith mentioned it can and will be offset by cost reduction programs in our manufacturing area.

So all that together plus the conservative way that we measure price declines where we don't take into account the pricing curve and the volume is a very conservative apple for apple basis.

It means that when you have a price reductions in the 1 to 2% range, they are pretty benign and that is a very comforting beginning to the year.

Great.

Thank you.

Ladies and gentlemen, that does conclude the On Semiconductor fourth quarter earnings release conference call.

Thank you for your participation.

You may now disconnect.