安森美 (ON) 2007 Q2 法說會逐字稿

Good day, ladies and gentlemen, and welcome to the ON Semiconductor second quarter earnings conference call.

(OPERATOR INSTRUCTIONS).

As a reminder, this conference call is being recorded.

I would now like to turn the conference over to your host, Mr.

Ken Rizvi.

Sir, you may begin.

Thank you, Matt.

Good morning, and thank you for joining ON Semiconductor's second quarter 2007 conference call.

I'm 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 second quarter of 2007.

Our earnings release and this presentation include certain non-GAAP financial measures.

Reconciliations of these non-GAAP financial measures to the most directly 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 Citigroup Technology Conference on September 5.

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 10-K and other filings with the SEC.

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

Now let's hear from Donald Colvin, our CFO, who will provide an overview of the second quarter of 2007.

Donald.

Thank you, Ken.

And thank you to everyone who is joining us this morning.

ON Semiconductor Corporation today announced that total revenues in the second quarter of 2007 were $381.2 million, as anticipated, an increase of approximately 2% from the first quarter of 2007.

Total revenues during the quarter included approximately $355.8 million of product revenues and approximately $25.4 million of manufacturing services revenue.

During the second quarter of 2007, the Company reported net income of $63.3 million, or $0.21 per share on a fully diluted basis.

During the first quarter of 2007, the Company reported net income of $54 million, or $0.18 per share on a fully diluted basis.

The Company's total gross margin in the second quarter was 38.3%, an increase of approximately 100 basis points compared to the first quarter of 2007, primarily due to the sale of obsolete leaded parts, which helped margins by approximately 100 basis points and also helped by improved product mix.

Gross margins for product revenue were 41.5%, an increase of approximately 160 basis points during the second quarter compared to 39.9% during the first quarter of 2007.

At the end of the second quarter, day sales outstanding were approximately 41 days.

Total inventory dollars, which include internal inventories and inventories in the distribution channel, declined on a dollar basis sequentially in the second quarter.

Internal inventories increased on a days basis to approximately 86 days, and we built inventory during the quarter to prepare for specific second-half platform ramps.

Distribution inventories in dollar terms decreased by approximately one week to less than 11 weeks.

We continue to see a trend in the overall supply chain where more of the inventory burden is placed upon semiconductor suppliers like ourselves.

Cash capital expenditures during the second quarter were approximately $28 million.

The Company exited the second quarter with cash and cash equivalents of $255.8 million.

During the second quarter of 2007, the Company repurchased approximately $55 million of its common stock, and the board has authorized the Company to repurchase up to an additional 30 million shares of common stock through the second quarter of 2009.

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

Keith.

Thanks, Don.

Now for an overview of our end markets.

During the second quarter of 2007, we saw sequential revenue growth in four of our six end markets - our Computing, Automotive, Industrial, and Networking end markets.

The Computing end market grew by approximately 9% sequentially on a dollar basis and represented approximately 24% of our second quarter product sales.

In the second quarter, we saw the initial Computing platform ramps associated with back-to-school builds, as well as penetration of our new products targeted toward the Computing end market.

Automotive grew by approximately 10% on a dollar basis in the second quarter and represented approximately 18% of our product sales.

This end market was driven by our continued penetration in infotainment systems, such as satellite radios, where we have up to $2 of content and products such as our single-wire transceivers for canned systems.

The Industrial end market represented approximately 14% of our product sales during the second quarter, and the Networking end market represented approximately 7% of second quarter product sales, both growing slightly on a dollar basis as compared to the first quarter.

The Consumer Electronics and Wireless end markets were down slightly in the second quarter, as anticipated, primarily due to fewer game consoles and handsets built by our customers.

We anticipate that both the Consumer Electronics and Wireless end markets will grow in the second half of 2007.

Our Consumer Electronics end market represented approximately 19% of second quarter product sales, and the Wireless end market represented approximately 18% of our product sales during the quarter.

During the second quarter on a direct-billing basis, no OEM customer was more than 5% of product sales, and our top five product OEM customers were - Continental, Delphi, Delta, Motorola, 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, were up 200 basis points and represented approximately 60% of product sales.

Our product sales in the Americas decreased by approximately 200 basis points and represented approximately 20% of product sales.

Sales in Europe decreased by 100 basis points and represented approximately 16% of product sales during the quarter.

And sales in Japan were up 100 basis points to 4% of product sales.

Looking across the channels, sales to distribution channels stayed flat at approximately 52% of product sales.

Direct sales to OEMs decreased by approximately 100 basis points to approximately 38% of product sales.

And the EMS channel increased by approximately 100 basis points to 10% of product sales.

During the second quarter, product revenues broken out by our divisions were as follows.

The Standard Products Group represented approximately 36% of product sales.

The Automotive and Power Regulation Group represented approximately 29% of product sales.

The Computing Products Group represented approximately 23% of product sales.

And the Digital and Consumer Products Group represented approximately 12% of sales.

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

Now I'd like to provide you with some details on the progress we've made.

In the Computing end market, we continue to see strong growth of our power regulators; pulse width modulators; power factor controllers; and multiphase controllers for desktop, notebook, and power supply markets.

We're expecting to see continued growth in the Computing end market for the second half of 2007.

In the third quarter, we anticipate platform ramps of our new controllers and regulator solutions with five major OEMs.

With these new power-efficient solutions and our complementary portfolio of standard products, we are able to provide our customers with a complete power solution for their desktop and notebook needs, enabling us to gain market share versus many of our competitors.

Our GreenPoint energy-efficient power supply solutions continue to meet and exceed the emerging global standards for power efficiency.

In the second quarter, we unveiled the industry's first open ATX reference design that meets the new Energy Star performance requirements for ATX power supplies used in desktop PCs that became effective this month.

To date, we released seven GreenPoint reference design solutions and anticipate releasing an additional three energy-efficient solutions by the end of the year.

In the Consumer end market, we are expecting to see an increase in build activity in the second half of the year, as the major game console manufacturers prepare for back-to-school and holiday demand.

We are also seeing increased design win activity with products featured in our GreenPoint reference designs for LCD TVs.

We currently expect up to $1 of content associated with these GreenPoint-featured products on a number of TV platforms that begin ramping in the third quarter.

In the Wireless end market, we continue to expand our product portfolio and account penetration.

New products in backlighting, DC/DC conversion, battery management, USB and battery protection continue to gain traction and are driving design wins and production with major cell phone manufacturers.

One of our major OEM customers has recently begun to ramp up a new multimedia phone, where we have up to $1.10 of content per device.

Another major Wireless customer is also implementing our over voltage protection ICs on more than ten platforms in the second half of 2007.

Our products and solutions continue to win awards with our customers and within the industry.

One of our PWM controllers won Power Product of the Year award from a major Chinese publication.

This is the fourth consecutive year that the publisher has awarded its best product recognition to ON Semiconductor for a power management device.

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

Donald.

Thank you, Keith.

Third quarter of 2007 outlook.

Based upon product-booking trends, backlog levels, and estimated turns levels, we anticipate that product revenues will be approximately $370 to $380 million in the third quarter of 2007.

In addition, we anticipate approximately $23 million of manufacturing services revenue during the third quarter.

Backlog levels at the beginning of the third quarter were up more than 10% from backlog levels at the beginning of the second quarter of 2007 and represent over 90% of our anticipated third quarter revenues.

We expect that average selling prices for the third quarter will be down approximately 2% sequentially.

We expect our product gross margin and our total gross margin in the third quarter to be approximately flat with the second quarter of 2007.

For the third quarter, we expect cash capital expenditures of approximately $25 million.

For the third quarter, we also expect total operating expenses of approximately 19%, with SG&A expenses at between 10% to 11% of sales and R&D expenses between 8% to 9% of sales.

We anticipate that net interest expense will be approximately $6.5 million for the third quarter and taxes to be approximately $2.5 million.

We currently expect stock-based compensation expense on a pre- and post-tax basis to be approximately $4 million in the third quarter, and this expense is included in our guidance.

Based on the stock price as of the end of the second quarter, our fully diluted share count would be approximately 307 million in the third quarter of 2007.

The fully diluted share count can change based upon a change in the stock price.

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

We will also post a table outlining potential fully diluted share count changes on our website in our Investor Relations section based upon various stock price functions.

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

Thank you, sir.

(OPERATOR INSTRUCTIONS).

Our first question comes from Chris Danely of JP Morgan.

Your question, please.

Can you just talk about gross margin trends after Q3, assuming a normal seasonal growth in Q4 and a decent year next year?

Well, that's a lot of ifs, ands, and buts.

But, in general, Chris, we continue to expect product gross margins to expand with volumes.

So, again, as our revenues go up, we get a very nice fall through on that, something better than 60% or 65%.

So, really, the revenue is the key driver, to answer your question, over time.

From a Gresham perspective, the other piece of that, as we get our analog processes qualified here in the fourth quarter, I would expect that those trends would start to change in the first quarter of next year, as we ramp those products - the analog products in Gresham.

So, basically, Gresham should start moving in a positive direction by the first quarter, and the product gross margins will track very well with the revenues.

Sure.

And, then, how should we expect your internal inventory and utilization rates to trend?

Should they just slowly trend up with sales too?

They should slowly trend up with sales.

There, again, we are running roughly 80% utilized at this point, so we've got a lot of room there to run as the Company grows.

So, again, I would expect those to, again, slowly rise with the rates.

We're not looking to increase inventory in the second half.

In fact, it should come down a bit from a days perspective.

So, at this point, it's really keeping the lid on the inventory while growing the activity rates with the revenue.

Great.

And a last question.

Can you guys just talk about the linearity of your bookings in Q2 and how you feel about the various end markets for the second half of the year?

Okay.

Linearity in Q2.

I mean, it's fairly linear from a bookings perspective.

We had good bookings performance, with book to build greater than 1.

From a market perspective, we would anticipate, based on backlog builds there, that all of the consumer-driven marketplace should be up in the second half, and that includes the computing, the wireless handsets, and the traditional consumer entertainment sections.

So those all should be up nicely.

And, again, this would be, as I would call it, a fairly normal seasonal phenomenon for those consumer markets.

Great.

Thanks, guys.

Our next question is from Michael McConnell of Pacific Crest Securities.

Your question, please.

Thank you.

If we look at the second half of the year with the product cycles that are coming into place, particularly with [Bear Lake] and the game console side, which one do you think would be more impactful to the model?

And how is the initial ramp of Bear Lake progressing?

I'm not sure which will have the most impact at this point.

The game console activity was so low in the first half that I think most would expect the second half to show some significant improvement.

So I think, on a percentage basis, that might have the biggest percentage change.

In a total volume perspective, though, the computing market is much bigger for us.

And those Bear Lake platforms will help in the ramp.

And, again, those are coming along nicely, both from a design win perspective and in our backlog.

And, if we look at the notebook space, which is more an '08/'09 type of event, what have you learned from the desktop side that you can transfer over to the notebook side of the business to try to replicate the successes you've had with Bear Lake, maybe looking out in the future, into '08/'09?

Yes.

I think the key there is really getting penetration at the key OEMs.

So we're using, basically, the same teams of folks and our new portfolio to use the same approach - market approach, if you will.

And, basically, using what we consider to be significantly better energy efficiency in those power solutions is kind of the technical advantage we use.

And then we use our supply chain and assured supply with the purchasing sides.

And that combination is very powerful with our customers.

And then, finally, and you may have mentioned this-- I might have missed it.

What was the utilization in Q2?

Approximately 80%.

Thank you.

The next question is from Craig Ellis from Citi.

Your question, please.

In the breakout by end market, EMS ticked up by a percentage point.

Can you just recap the activity level that you're seeing there and how we should think about the inventory issues that may or may not be at play there?

Okay.

The best we can tell, there's not a significant amount of inventory in EMS.

We're seeing some relatively short lead time orders being placed there.

I think they have picked up, just as a percentage of builds in some of the end markets.

And, of course, you certainly saw some more of the handsets and gaming platforms being built in the EMS channel there at the end of the second quarter.

So, really, I don't think inventory is much in play there from an EMS perspective.

If I look at the trends over the last six or seven quarters, Craig, an actual (inaudible) EMS was significantly higher at the beginning of last year and went through a pretty substantial correction starting in Q4.

So, although, as Keith said, it's up a little bit on a quarter over quarter basis, the absolute year over year trend is down.

So the numbers totally support a balanced inventory position for us.

Okay.

Good.

Secondly, on the manufacturing side, it sounds like the analog process installation is going quite well.

How should we think about the customer diversity of the manufacturing services business?

It is still dominated by LSI.

We do have a couple of other customers there, but LSI is still more than 80% of that total today.

Okay.

And then, lastly for me - you have the 30 million share repurchase program.

How should we think about how you're looking at that in the back half of the year, given the free cash flow that you're generating?

I think it's good that you identify free cash flow, because, once again, if we hadn't bought, we would have been over $300 million.

And that still remains a key point that we are identifying to investors is our strong EBITDA, which also increased significantly quarter over quarter on a free cash flow.

So that gives us some options.

The market, as a surprise to no one, has been a bit turbulent.

So I think it's appropriate that we just look at the different options we have.

And we have shown ourselves to be aggressive buyers of the stock, buying significantly more than 40 million shares over the last year.

We are not kind of like planning to pull the trigger first thing tomorrow morning after our earnings have been digested.

But we remain opportunistic.

So we do have other demanders for our cash.

Remember, we could always pay down some debt at 7%.

So we continue to be opportunistic and look at shareholder-friendly actions, like the ones we've taken over the last year.

Thanks, Don.

Thanks, Keith.

Our next question is from Craig Hettenbach of Wachovia.

Your question, please.

Donald, you mentioned that inventory and distribution channel declined in Q2.

At the start of Q3, have you seen any build activity yet, or when do you anticipate that the channel starts to build a bit more inventory for the seasonality in back half?

What we've been-- We analyze data, and, when we had the analyst day here, we showed some trends over five and six years.

So, as Keith mentioned, a lot of our business is driven by the global consumer.

And it would appear that demand for that really kicks in in the back half of the second half and that the absolute manufacturing activity kicks in somewhere between August and September.

So these are the patterns I've identified as being representative of the type of business environment we have now.

So you would expect, as we go into the second half, to see a slight increase in inventories at the beginning of the period and they're worked off as the manufacturing activity increases towards the middle and second half of the period.

So that's the kind of trends that we have seen in the past, and I don't think this period is any different than the past.

Okay.

And did you guys comment on lead times within the quarter - if there was any movement?

We haven't.

They're approximately nine weeks.

There's not been significant movement there.

There's always a range, but it's still very comfortably in our service models.

Great.

And last question, Keith.

On the handset side, outside of an inventory correction at one of the major OEMs, can you just comment on trends you're seeing at other players and how you view inventory levels in that space going into the back half?

Yes.

I think inventories, again, are in pretty good shape.

We have seen the market shares taken up.

As one OME has had weakness, we've seen it pop up in our other customers.

At this point, I certainly don't detect any overly aggressive builds or approach from the major five guys that we serve.

Thank you.

Your next question is from Louis Gerhardy of Morgan Stanley.

Your question, please.

Can you comment on your plans for factory utilization in Q3?

Yes, we can.

It should be slightly up from the second quarter, not very much but just slightly.

Again, what we're trying to do is keep inventories kind of in check where they're at and just support the delta activity in the sales channel.

Okay.

Your guidance and backlog position implies a drop off in turns in Q3.

Is that normal?

Is there any reason behind this, or are customers just giving you better backlog visibility now?

You know, obviously, you picked up on that.

We did-- We've guided that way.

I don't know how the quarter will turn out.

Normally, we see a significant amount of turns in September.

Again, I don't have a perfect crystal ball here.

But we give guidance based on what we think is prudent.

Okay.

Just on the gross margin front, you had the kick this quarter from the sale of the old parts.

Were these just higher margin parts, or had they been written off or written down before?

And is there anything else out there like this we could reasonably expect in the next couple quarters?

I think the reason why we pulled that out is because we believe this was more of a [bluebird] than a base thing, and these were leaded parts that had been obsoleted that we did some special deals on to remove them from our inventory.

So we calculated that that helped our gross margin by 100 basis points.

And we like to be totally transparent with investors, and we shared that with you.

We also had a little bit better mix, selling more of the ECL stuff.

So a couple of these events mean that we had a slightly higher than anticipated gross margin, and that's why we're guiding relatively flattish gross margins for the third quarter over the second, because the second quarter had been a little bit artificially inflated.

So that's part of the transparent way we try to explain our numbers.

Thank you.

Our next question is from Tristan Gerra of Robert W.

Baird.

Your question, please.

Could you give us an update on the ramp of the two large computer wins that you have for the second half?

Any way you could quantify the potential unit market opportunity relative to the rest of the business?

And are some of those products going to be Gresham-based on that?

Okay.

So, for the Computing segment, I do think that will be a significant growth for us.

Of our forecasted growth for the Company in the second quarter, Computing will make up, from a dollar basis, most of that.

None of those products-- That's not true.

All of the MOSFETs for those platforms actually are coming out of Gresham.

We've now got those in our [Trench II] process.

So the MOSFET portion will be out of Gresham.

The analog controllers will not be coming out of Gresham until the first quarter of next year, when the processes are in manufacturing.

Okay.

Great.

Did Motorola decline as a percentage of sales in Q2, and do you expect to rebound in Q3?

We don't like to comment specifically on customers or give forecasts by customers, Tristan.

You can understand a certain sensitivity there.

But, clearly, as we indicated, one major wireless OEM had some issues.

And we now have a new candidate for our top customer, Keith.

Yes, we do.

So a certain consolidation in the automotive industry will probably lead to a change in the rankings of our top customers.

But we don't like to comment on forward-looking statements for one of our best customers.

Understood.

And then, last question.

What is the percentage of production that was outsourced in the quarter?

And what do you expect this number to be by Q3 and Q4?

It was approximately 21% in Q2.

And I would not expect significant change in Q3 or Q4.

It might go down a point, but not significant changes.

Very good.

Thank you.

Our next question is from Steve Smigie of Raymond James.

Your question, please.

So, if we turn to gross margin, you're guiding flat for this quarter.

I assume that means that, excluding the one-time benefit there, that gross margin is going up sequentially.

Is that more related to utilization, or is it partly the better pricing that you guided to?

What would be sort of the bigger driver of that?

Actually, Steve, we guided to worse pricing.

We guided ASP degradation of about 2%.

So what's happening is the additional utilization is offsetting the one-time benefit in Q2 from the leaded sales and offsetting the pricing degradation.

Okay.

I thought it was 2% to 3% in this quarter, and you guided down 2%.

It is less than last.

A couple of points.

We have said-- I'll let Keith jump here.

But we've said that we'll end up right at 2%, even at 2.5% price degradation.

Because of the conservative way we measure this, we can offset it through things like mix and cost savings.

So it's within the range that we can manage.

So that's one of the reasons why you don't see us getting too nervous about that.

But we always report it on a consistent basis, as there is still a wee bit of price pressure, although it's very manageable.

As far as margins are concerned, we still believe in the model we showed at the analyst day a few months ago, which is that the base business can get to 45% gross margin.

But that will be based upon a higher level of revenue.

And, if you look at how our base business grows, margin is tracking well above 40%.

I think that gives us confidence and should give you confidence that we can reach that target, especially, as Keith said, when we start ramping some of the analog parts at Gresham, which is exactly what we explained at the analyst day.

The pricing seems about in line with sort of normal declines but seems maybe a little bit worse than the past few quarters.

Is that partly as you guys were out trying to pick up some extra business in Computing or something like that?

I would say this pick up extra business is that the end markets have been a little bit challenged.

Tristan was asking about one wireless customer.

Keith mentioned some of the consumers.

So the business environment has not been hunky dory in the first half.

So we're a spunky company, and we don't want to lose market share.

So let's say that that environment should improve in the second half.

But there has been a little bit of an (inaudible) correction.

And, as I stated, some of our customers and some of our end markets have been significantly down over the business trends we had enjoyed in the middle of last year.

So that demands appropriate actions.

But we still print good margins and good sequential improvement.

So we are managing this intelligently, and there's not any kamikaze pricing.

Right.

Sorry; with that last question.

I think you sort of answered this.

But, for the back half, you said it would improve.

Is that-- Again, it's just you have a seasonal build in the back half, and there's just enough demand that utilization is now filling up at most of the competitors and so there's that-- less pressure?

Yes.

Definitely, as the inventory comes down, particularly in the distribution channel, you get much more rational pricing and better utilization across the industry.

That tends to be the thing that helps the pricing.

So, at this point, again we don't have all the answers.

But I would expect Q4 to be less onerous on the ASP degradation than Q3.

Thanks a lot, guys.

The next question is from John Barton of Cowen.

Your question, please.

Keith, you had made a couple comments about manufacturing services and getting your internal processes qual'd in fourth quarter, ramping in Q1 - LSI, etcetera.

When you look at '08, if you think about three levers, your internal manufacturing, LSI services, other customer services, how do you think that develops through '08?

Where do you think you get that fab utilization?

And, just generically, how should we expect to see that unfold?

Well, obviously, it will build from a volume perspective quarter by quarter.

So I would expect to see a significant sequential improvement from a Gresham perspective.

And, of course, that's-- We're highlighting Gresham because of the manufacturing services going on there.

But, in reality, the net margins for us, since we'll be doing less outsourcing, will be very significant in the product business as well.

So, again, I would expect to see a nice sequential build through the year.

What happens is we release the process, and then we release the products and our customers qualify those products.

And, again, that's a process that builds.

So I don't know if it's quite linear, but I would expect the second half to be very substantial and the first half to be incrementally better.

And what's your best guess on LSI trends through the quarter-- excuse me-- through the year?

I think they continue to decline per our agreement.

They've been pretty much on our agreement so far.

I have no reason to believe that that will change.

So they will decline slightly through the middle of next year, when our contract runs out.

And then I would expect further declines - again, nothing dramatic.

But normal-- kind of the same rate of falloff in the second half of next year.

And any other third parties coming up in the mix, to the best of your forecasting ability?

Well, we've got one that should be coming into the mix in Q4 and start to pick up some of that balance.

And then, beyond that, again I don't have good forecasting.

And just a last question on topic.

Current utilization at Gresham - what would your best guess be as you exit '08?

It is a little less than half full right now in Gresham, and I would expect to get that well over 60% or 65% as we exit next year.

Great.

And then a last question, really quick, Donald, just on the tax front.

Any major developments there?

Any significant changes in the coming quarters that we should think about?

No.

I think we still believe $2 to $2.5 million a quarter, John, is good.

We got a little benefit this quarter.

We got an old receivable paid off in Asia, which took it down a little bit; $800,000 I think it was.

But assume $2.5 million of cash taxes and also going forward, just as we explained at the analyst day.

Thank you.

Our next question is from Michael Masdea of Credit Suisse.

Your question, please.

A couple of your competitors have talked about lead times stretching out.

Obviously, you and a number of others have held them kind of tight.

Has there been an impact at all, you think, on the orders or the customer mentality because of those couple that have had some stretching lead times?

We've seen a few of our OEMs start to give us longer lead times.

They're concerned that the September/October ramp time frame will get tight, so they're already giving us some backlog there.

But I don't know that that is a major trend.

I'd say it's more spotty than anything else.

Great.

And then the other thing that stood out to me is your comments on Industrial and Networking a little bit more positive than some others in the first half so far.

Is that product specific, and, then, do you see that sort of catching up with you in the second half?

It has held up pretty strong.

What we've noticed is that a lot of that business for us is in Europe and, I believe, is going into building infrastructure in the eastern part of Europe.

So that's actually held up very well for us for the last couple of years.

And, from what I can tell in the backlog, it should continue to hold up this year.

So I would expect it to be very stable in the second half.

Great.

And just a last quick one from me.

In the analog processes you're putting in, are those customer driven at all, or are those sort of build it and hope that you can get some follow-on customers?

What those specifically are are products that will generate our currently outsourced submicron analog products.

It will allow us to do that internally and also our next generation of PWM controllers internally.

So there's no plans at all to offer that to any external customers?

No plans at all to offer that externally.

Great.

Thanks so much.

Our next question is from Ramesh Misra of C.E.

Unterberg Towbin.

Your question, please.

My first question was in regards to new products.

Can you talk about where they were as a proportion of sales, and can you talk about expected trends over the next few quarters?

So we have mentioned that number, I guess, in the past.

That tends to be running in the 20% of our sales.

It's been relatively stable here this year.

I would expect that it would start going up again in the third and fourth quarter because a lot of those new products are geared at computing and consumer.

And, since those new platforms are ramping, I would expect it to go up a percent or two here in the second half.

Okay.

Are gross margins on these products generally somewhat higher than your overall average, Keith?

Yes, they are.

They tend to be anywhere from 10 or more points higher than the average.

Okay.

You've talked for quite some time about reducing your external manufacturing.

But it's been sticking around that 20% mark.

Are you basically waiting for your ramp up at Gresham for that to happen?

Yes.

The analog processes will help fairly significantly.

And then the other thing that's going on is we've moved more of our internal capital to assembly test.

So, as we leave this year, I would expect that it will be more of our own capacity on the assembly test side.

So it's really Gresham on the analog products and then get the rest of our modules installed on the money we're spending in the back ends here through the end of the year.

Got it.

What part of your testing assembly right now are you outsourcing, and where do you see that?

It is about, actually, 25% or so on the assembly test side today at a large range of external suppliers.

And that's the one that I think we can drive down to the 20% range.

And then the fabs we should be able to drive down in the lower teens.

Okay.

And then, finally, Keith, can you give us an idea of how many manufacturing or foundry customer do you have right now?

And, next year, as LSI starts coming down, do you expect that decline to be offset by these other customers?

We have three or four customers today, and I would expect that number to be fairly stable.

It might go up one or two.

But, frankly, what we're planning on doing is offsetting LSI not with external foundry business but with our internal ramps on our own products.

So that's our primary plan.

If we happen to land some more external ones, then that will be icing on the cake.

I think, when I've been around talking to guys on the Street, I've been explaining that - that the problem of relying upon an external customer is that you rely upon his markets and his business environment.

So that proves more uncertainty into your model.

So we have made significant progress in installing processes that will allow us to use more of Gresham ourselves.

And we have integrated that into our total manufacturing infrastructure.

As Keith said, we're already running very large quantities of MOSFETs there and will start to run other standard analog and other products there shortly.

That's the best way to take advantage of Gresham.

And, also, because of the cost effectiveness of (inaudible), leading-edge technology, it opens the door to significant cost reduction opportunities on our other sites.

So that's what we have been doing.

With all that, we are confident that that's the case.

And if we get the possibility of having a third party take some capacity or run some products there, then we will certainly take that.

But it's icing on the cake, and we're making it work in our forecast, assuming that LSI goes down, as Keith mentioned, but filling the gap through using own technologies and making sure that we rationalize the costs and our overall manufacturing base.

Okay.

Just a very quick follow-up on that, Don.

You mentioned you're ramping up MOSFETs in Gresham.

Now, MOSFETs, clearly, are large geometry products.

What's the rationale to build these larger products at Gresham rather than--

I'll help you with this.

These are our low voltage trench MOSFETs.

So they're actually very small geometry devices, and the fit in some of our smallest packages.

So this is actually a very silicon-efficient set of products.

I'll even go as far as to say is, our one regret is that we didn't do more of them.

The model works very well.

Yes.

So these are not the high voltage ones that use up all the die area that you're familiar with.

Got it.

Okay.

Thanks very much, guys.

Our next question is from Kevin Cassidy from Piper Jaffray.

Your question, please.

A lot of my questions have been answered already.

But, maybe, can you give more details about your plans on the Philippines?

There was a press release about expanding production.

Sure.

Yes.

Basically, that is our primary test house for more complex packages and our analog products.

We are seeing that ramp disproportionately, which is helping drive some of the margins as we get out to next year.

And so the intent is to do more of our manufacturing in house, and that's one of the areas that will be the receiver of that.

So that's a big piece of that expansion.

The other piece is we continue to opportunistically build our back office work force in low cost areas, so we'll be doing that at our factory there in the Philippines, as we've done in eastern Europe and in China in the past.

We've run the numbers on many things, because you've got to be careful with labor cost inflation and the fidelity of employees, staff turnover, and things.

And, when we look at all that, we get pretty comfortable that the Philippines is an excellent place to be based and similar to the success we've enjoyed in former eastern Europe.

We find highly skilled people, native English-speaking, nearly.

So it's a very attractive place for us to not only do development but also back office support functions, and that's something that we are emphasizing going forward.

Okay.

Thank you very much.

Our final question today is from Rahul Khanwalkar of Needham.

Your question, please.

It looks like your auto business grew nicely this quarter.

So I just wanted to know - was it a one-off event?

Was it driven by specific customers?

Or do you expect this growth to be sustained in the second half?

No.

We do think the growth in our automotive business is from our new product entries and our focus on this as a market.

We did put that back on our focus list a couple of years ago, and I think we're seeing the fruits of that.

So we should be growing at least at market rates in that business, which, of course, has seasonality in it.

And Q3 tends to be the weaker season.

But, nonetheless, I expect continued strength and growth in automotive.

We put out a lot of products that go into the infotainment arena and quite a few products that are in the safety area, both of which are growing quite rapidly.

Okay.

And my second question is on your backlog.

It looks like it gives you almost 90% of your visibility for the third quarter.

Now, does that mean that your turns business will be about 10% of your guidance?

Or is it that turns could be higher; hence some of the backlog would not be fulfilled in third quarter?

Or how does the math work there?

The answer to that is it's always some of the above.

Some of the backlog does churn every quarter.

And we could get more than 10% turns.

It's one of those that, when we make our forward-looking guidance, we kind of take our best shot at it and then see what happens.

But, at this point, the models would indicate that we'll have around 10% turns.

Okay.

And my final question is on your capacity utilization.

At what point do we think-- do we expect that your capital expenditure would be stepped up?

Right now, your capacity utilization is 80%, and CapEx is about $25 million.

So is it a steady-state capital expenditure, or will it be stepped up, like, say, 90%--

Yes.

It actually-- We have a model of around 7% of sales on the long term basis.

So, unless there's unusual events occurring, that's the kind of rate we would be expecting.

At this point, I think we're in very good shape and would not expect to see any accelerated capital expenditures.

In fact, it should go down in the second half versus the first half.

And, in the next year, again, we haven't got a full plan yet, but I would not expect to see that stepped up either.

We've got plenty of efficiency in our capital spending to drive very substantial growth.

Okay.

Thanks a lot.

Ladies and gentlemen, this concludes our conference call for today.

Thank you for participating.

You may now disconnect.

Good day.