安森美 (ON) 2007 Q3 法說會逐字稿

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  • Operator

  • Good day ladies and gentleman and welcome to the ON Semiconductor third 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 follow at that time.

  • (Operator instructions).

  • As a reminder, this conference call is being recorded.

  • I would now like to introduce your host for today's release call, Mr.

  • Ken Rizvi.

  • Sir, you may begin.

  • Ken Rizvi - IR Director

  • Thank you, Howard.

  • Good morning and thank you for joining ON semiconductors third 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 third quarter of 2007.

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

  • Reconciliations of these non GAAP financial measures to the most direct comparables 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 Credit Suisse Technology Conference on November 28 and the Lehman Brothers Global Technology Conference on December 6.

  • We will also open up the NASDAQ Stock Market on November 9.

  • 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 results or events 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 in assumptions or other factors.

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

  • Donald?

  • Donald Colvin - CFO

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

  • ON Semiconductor Corporation today announced that total revenues in the third quarter of 2007 were $402.9 million.

  • As anticipated, an increase of approximately 6% from the second quarter of 2007.

  • Total revenue during the quarter including approximately $381.1 million of product revenues and approximately $21.8 million of Manufacturing Services Revenue.

  • During the third quarter of 2007, the company reported net income of $63.8 million or $0.20 per share on a fully diluted basis, which included approximately $2 million, or $0.01 per share fully diluted associated with restructuring, asset impairment and other.

  • 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.

  • The company's total gross margins in the third quarter was 38.6%, an increase of approximately 30 basis points as compared to the second quarter of 2007, primarily due to higher revenue which was partially offset by a $5 million reduction of internal inventories.

  • At the end of the third quarter, these sales outstanding were approximately 44 days.

  • Internal inventories decreased on a day's basis by approximately six days to 80 days as we depleted internal inventory during the quarter.

  • Distribution inventory and [dollar attempts] were approximately 11 weeks.

  • Cash capital expenditure during the quarter were approximately $34 million.

  • The company exited the third quarter with cash and cash equivalence of $327.1 million up over $71 million from the second quarter.

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

  • Keith?

  • Keith Jackson - CEO

  • Thanks, Don.

  • Now for an overview of our end markets.

  • During the third quarter of 2007, we saw a sequential revenue growth in our consumer driven end markets of consumer electronics, computing and wireless.

  • The consumer electronics end market grew by over 38% sequentially primarily driven by game console builds as well as growth in LCD TV and MP3 platform builds.

  • The consumer electronics end market represented approximately 24% of our third quarter product sales.

  • The computing end market grew by approximately 11% sequentially on a dollar basis and represented approximately 25% of third quarter product sales.

  • In the third quarter, we saw continued computing platform ramps associated with back to school builds, as well as the penetration of our new products targeted towards the computing end market.

  • The wireless end market grew by approximately 3% sequentially and represented approximately 18% of the third quarter 2007 product sales.

  • The automotive, industrial and networking end markets were seasonally down, with automotive representing approximately 16%, industrial representing approximately 11% and networking representing approximately 6% of the third quarter product sales respectively.

  • During the third quarter on a direct billing basis, no product OEM customer was more than 5% of product sales and our top five product OEM customers were, Continental, Delta, Motorola, Sony Ericsson and Samsung.

  • 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 400 basis points and represented approximately 64% of product sales.

  • Our product sales in the Americas decreased by approximately 100 basis points and represented approximately 19% of product sales.

  • Sales in Europe decreased by 100 basis points and represented approximately 15% of product sales during the quarter and sales in Japan were down 200 basis points to 2% of product sales.

  • Looking across the channels, sales to the distribution channel were down by 400 basis point to approximately 48% of product sales.

  • Direct sales to OEMs increased by approximately 300 basis points to approximately 41% of product sales and the EMS channel increased by approximately 100 basis points to 11% of product sales.

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

  • The standard products group represented approximately 33% of product sales.

  • The automotive and power regulation group represented approximately 30% of product sales.

  • The computing products group represented approximately 25% 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 break out of these divisions in our 10Q 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 switch modulators, power factor controllers and multi phase controllers for desktop, notebook and power supply markets.

  • In the third quarter, we continued our design penetration in global OEM desktop platforms and increased our share of analog controllers to over 10% from approximately 3% the previous year.

  • We expect to see continued growth in the computing end market for the upcoming fourth quarter.

  • Our Green Point energy efficient power supply solutions continue to meet and exceed emerging global standards for power efficiency.

  • We recently released two more Green Point reference design solutions for the consumer electronics end market.

  • Our 5-watt power adapter reference design and our 16-watt DSL modem adapter design help our customers around the world develop products to reduce energy consumption in both active and standby modes.

  • We have already released nine Green Point reference design solutions to date.

  • Recently, two major computer manufacturers have included our products in their new 80+ efficient power supplies for desktop power supply.

  • These 80+ efficient power supplies contain up to $3.50 of our content per unit and position ON for continued growth in the high efficiency power supply market.

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

  • We recently won Solectron's Total Cost of Ownership Supplier Award presented to suppliers who demonstrate excellence in quality, delivery, technology, service and flexibility.

  • We also received Best Power Solution Supplier awards from two major consumer products manufacturers, Hisense and Samsung.

  • Additionally, we were awarded Green Partners certificates from three major OEMs, Sony, Samsung and Canon.

  • These partnerships, along with our work with Energy Star, China CECP and other regulatory agencies enable us to continue our leadership position in efficient power management solutions for a variety of end market applications.

  • In the consumer end market, our power efficient products and solutions continue to win designs in the LCD TV end market.

  • Our supply expects to see a compound annual growth rate of approximately 20% over the next four years.

  • We anticipate our SAM for the LCD TV market will increase from approximately $4.50 in 2007 to more than $6 in 2008 based on new product introductions.

  • We've had initial success in this end market with two major LCD TV manufacturers beginning production ramps in anticipation of holiday demand.

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

  • Donald?

  • Donald Colvin - CFO

  • Thank you, Keith.

  • Fourth quarter 2007 outlook.

  • Based upon product booking trends, backlog levels, anticipated manufacturing services revenue, and estimated (inaudible) levels, we anticipate that total revenues will be approximately flat to up 2% sequentially in the fourth quarter of 2007.

  • We also anticipate that approximately $22 million of our total revenues will come from manufacturing services.

  • Backlog levels at the beginning of the fourth quarter in 2007 were up from backlog levels at the beginning of the third quarter of 2007 and represent over 90% of our anticipated fourth quarter 2007 revenues.

  • We expect the average selling prices for the fourth quarter of 2007 will be down approximately 2% sequentially.

  • We expect a product gross margin and a total gross margin in the fourth quarter to be approximately flat with the third quarter of 2007.

  • For the fourth quarter, we expect cash capital expenditures of approximately $20 million.

  • For the fourth quarter, we also expect total operating expenses of approximately 20%, with SG&A expenses at between 11% to 12% of sales and R&D expenses between 8% to 9% of sales.

  • We anticipate that net interest expense will be around $6.5 million for the fourth 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 $5 million in the fourth quarter of 2007 and this expense is included in our guidance.

  • Based on the stock price at the end of the third quarter, our fully diluted share current would be approximately 319 million shares in the fourth quarter of 2007.

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

  • Further details on share count and EPS calculations are provided regularly and are 10Qs 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 assumptions.

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

  • Operator

  • (Operator instructions).

  • Our first question or comment comes from the line of Mr.

  • Romit Shah from Lehman Brothers.

  • Your line is open.

  • Romit Shah - Analyst

  • Thanks a lot.

  • Did you guys buy back any stock in the quarter?

  • Donald Colvin - CFO

  • No.

  • Romit Shah - Analyst

  • Donald, could you just elaborate on that?

  • I notice the cash balance that jumped up to $327 million.

  • Why didn't you guys buy back any stock and if you could just prioritize what are the future uses of cash going forward?

  • Donald Colvin - CFO

  • Sure.

  • I think as a company, we stated with cash we have three uses of our cash.

  • One, we can pay down debt which we've done in the past.

  • Buy back stock which we've also done or invest in the business.

  • I think what we've been stating when we've attended various conferences is that our priority has been to kick the tires on some strategic opportunities where cash would help us facilitate some acquisitions.

  • So, that's why we were not currently prioritizing stock buybacks or debt pay downs.

  • This activity is very much a hit or miss activity and we have announced nothing because we have completed nothing.

  • So our optionality still remains, but we have been saying that we were attributing examination of strategic opportunities rather than pursuing stock buybacks or debt payoffs at the end of the third quarter.

  • Romit Shah - Analyst

  • Okay.

  • And as a follow up, could you just elaborate on the product booking trends you've seen in the last four weeks and why you guys are guiding to accelerating growth here in Q4?

  • Keith Jackson - CEO

  • This is Keith Jackson.

  • I'll cover that one.

  • We tend to remain on the conservative side when we go into fourth quarters relative to turns.

  • The December quarter typically shows us a customer base that wants to have lean inventories going out of their calendar years and so what we normally do is just be conservative on the turn aside for December, Romit.

  • So, I think that's what you're seeing reflected in the guidance.

  • Romit Shah - Analyst

  • Okay.

  • Great.

  • Thank you.

  • Operator

  • Our next question or comment comes from the line of Chris Danely from JP Morgan.

  • Your line is open.

  • Chris Danely - Analyst

  • Thanks, guys.

  • Hey, Keith (inaudible) the PC end market you think is going to be strongest for Q4?

  • Can you just give us your thoughts on your other large end markets, wireless networking, et cetera?

  • Keith Jackson - CEO

  • Okay.

  • Certainly, again, we should see some continued strength in consumer and PCs.

  • I believe that automotive will not see much change quarter on quarter.

  • Our stronger orders there tend to be in the first half of the year and the same with industrial.

  • The networking side actually, again, should be relatively flat going into the fourth quarter.

  • So, I think you're looking at industrial, automotive and networking being relatively flat quarter on quarter.

  • Chris Danely - Analyst

  • How about wireless?

  • Keith Jackson - CEO

  • Wireless may be up slightly.

  • Chris Danely - Analyst

  • Okay.

  • And then Donald, can you talk about gross margin trends after Q4 going into next year?

  • Donald Colvin - CFO

  • Sure.

  • We don't give (inaudible) for next year, but we're very happy to come in just under 39% gross margin at combined end the third quarter and a slight increase over the second quarter.

  • As we go through next year, the mix of our business will change.

  • We will have more product revenues and less manufacturing services revenues.

  • So, I think it's kind of fair to say that seasonally the first half of the year is not as strong.

  • The gross margin will be around the exit velocity depending on the mix and we would expect to draw our gross margin in the second half of next year.

  • I think that's the kind of big picture view we have now, but we have been encouraged by the fact that we saw a sequential growth in gross margin in the third quarter even although we took some proactive measures to reduce our internal inventory by $5 million.

  • We feel pretty happy that we have a strong, stable gross margin on which to build a growth in gross margin next year.

  • Chris Danely - Analyst

  • That leads me to my last question.

  • Do you guys feel comfortable with your inventory right now, so the utilization rate should stay flattish and then trend up in the second half of next year?

  • Donald Colvin - CFO

  • I think that's a very fair observation.

  • If you listened to the detailed comments, our distribution inventory was around 11 weeks, which was pretty near its all time low which I think was just about 10.5 or so.

  • It was flat quarter over quarter, so no growth in distribution inventory.

  • Internal inventories on a dollar basis was down by about $5 million and about eight days, I believe, on a day's bases.

  • We are very comfortable that our inventories are in very good shape and we don't have any inventory overhang going into next year.

  • Chris Danely - Analyst

  • Great.

  • Thanks guys.

  • Operator

  • Our next question or comment comes from the line of Craig Ellis from Citigroup.

  • Your line is open.

  • Craig Ellis - Analyst

  • Thanks and good morning guys.

  • Don or Keith, could you just follow up a little bit more on the handset business?

  • I know you tried to diversify your OEM exposure there.

  • Would you expect broad base growth in the fourth quarter or are you seeing particular strength out of certain OEMs?

  • Keith Jackson - CEO

  • No, I'd say it's more broad based in Q4 and again, it's not very strong growth over Q3.

  • I think the Q3 numbers certainly build a good base for Q4, but there's not going to be an acceleration in that marketplace in Q4.

  • Craig Ellis - Analyst

  • Okay.

  • And then switching over to the pricing commentary, down about 2% in the third quarter expected the same in the fourth.

  • Is that across the portfolio or are you seeing pricing being more intense in a certain part of the business?

  • Keith Jackson - CEO

  • Pricing is usually more intense in our discreet lines versus our analog lines.

  • It's a pretty normal thing.

  • Q3 was a little stronger pressure than we had been experiencing and I think Q4 will be less pressure than Q3.

  • But nonetheless, there have some fairly steady ASP clients throughout the year quarter by quarter and slightly more in discreet versus analog.

  • Craig Ellis - Analyst

  • Okay.

  • And then looking a little bit further out on the CapEx side, any color on what the CapEx spend will look like in 2008?

  • Donald Colvin - CFO

  • I think we showed the guidance for the fourth quarter.

  • We say about $20 million of capital expenditure in the fourth quarter.

  • So if you look at that on a runway basis about $18 million.

  • I think that's roughly the number we're seeing from our bottom-up forecast for next year.

  • Something under $100 million in the $80 million to $90 million range for capital expenditures.

  • Craig Ellis - Analyst

  • Okay.

  • And then just lastly for me, Keith or Don, could you just frame some of the key milestones as we look at the Gresham facility and your ability to port your own analog products into that facility as we go through next year.

  • Keith Jackson - CEO

  • Certainly.

  • We are actually qualifying our first analog products now and so we're pretty excited about that.

  • They'll be some ramp in Q1, but really the end of Q2 will mark some significant volumes moving into Gresham.

  • Our second major analog process should be coming online towards the third quarter and then that will get basically the bulk of the rest of the company's analog products.

  • So, what we're looking for is a very strong second half next year with our analog products in Gresham

  • Donald Colvin - CFO

  • Also in the fourth quarter, we will have more starts of wafers than (inaudible) wafers in the fourth quarter of this year.

  • Right now, we're running trench and some other parts in there and so that's what we said we would do and we made that milestone.

  • Thanks to Gresham, we are able to cut back the capital expenditures in the other (inaudible) and we started the restructuring of our manufacturing base, which is the primary reason you have the $2 million restructuring cost.

  • As more products are running Gresham, we don't require the same size of platform elsewhere.

  • So that's the activities we started in the third quarter.

  • Craig Ellis - Analyst

  • And Don, would those activities be expected just to continue through next year as you continue to ramp up Gresham then?

  • Donald Colvin - CFO

  • We will continue to rationalize our manufacturing footprint as we ramp up Gresham.

  • Exactly.

  • Craig Ellis - Analyst

  • Okay and then just the last follow up on this particular topic.

  • Any indication from LSI in terms of how intensively they would expect to use the manufacturing services beyond the end of the agreement into mid next year?

  • Donald Colvin - CFO

  • I think although that's a take or pay contract, we do anticipate that we will continue to supply LSI through the end of that contract.

  • Right now, the contract officially, the take or pay part, expires in the middle of next year.

  • If and when we get any changes to that, we will announce it, but we do anticipate that we will continue to service them with manufacturing services after the expiration of the take or pay contract and if I get any more color, we will officially announce that once we have any contract in place.

  • Craig Ellis - Analyst

  • Okay.

  • Thanks, gentleman.

  • Operator

  • Our next question or comment comes from the line of Tristan Gerra from Robert Baird.

  • Your line is open.

  • Tristan Gerra - Analyst

  • Good morning.

  • Could you guys comment on the internal inventory reduction, what products or end market and by how much did this impact gross margin in the quarter?

  • Donald Colvin - CFO

  • This was an odd product, really.

  • We took action to make sure that we weren't building too much internal inventory, and I think 86 days we had adjusted to as I stated.

  • We believe that you've got to run that.

  • We can't really build up too much inventory, especially when you go into the year end.

  • So this would basically work in process inventory across all product lines.

  • We always provide measure and control both our internal inventories and our distribution inventories to make sure that we don't have this inventory overhang.

  • I don't think it's fair to say it was product specific.

  • It was just in general, Tristan.

  • Tristan Gerra - Analyst

  • Was there any particular reason that led you to do that?

  • Obviously, your production plans were in the quarter.

  • With this based on this setback or anything else that would have led you to do that?

  • And also just to follow up would be why didn't we see a rebound in gross margin sequentially in Q4 on that basis of adjustment?

  • Donald Colvin - CFO

  • It wasn't based on distribution activities in the (inaudible) distribution.

  • As a matter of fact, our distribution business actually finished off stronger toward the end of the quarter.

  • But it's just prudent (inaudible).

  • As I said, we don't want to continue to increase, so we reduced our manufacturing plans and we have a slight adjustment.

  • We don't anticipate that these inventories will go down in the fourth quarter and that's why we gained approximately flat gross margins for the fourth quarter.

  • Tristan Gerra - Analyst

  • Okay.

  • And then a quick one.

  • When is the designing phase for the (inaudible) platform and where do you stand in terms of power management and wins there?

  • Keith Jackson - CEO

  • The answer to that is again we're seeing various customers ramping at various times on that.

  • And of course, we have a range of wins in that platform.

  • I don't know that I can give you a more specific breakout right now, Tristan.

  • Tristan Gerra - Analyst

  • Very good.

  • Thank you.

  • Donald Colvin - CFO

  • Just one point on that, Tristan.

  • I think when we look at our power management that that goes in cycles and controllers.

  • Right now we've got some design wins (inaudible).

  • This is based on what Keith was saying that the stuff is going to ramp in Gresham in the second half of next year.

  • Tristan Gerra - Analyst

  • Great.

  • Thanks.

  • Operator

  • Our next question or comment comes from the line of Steve Smigie from Raymond James.

  • Your line is open.

  • Steve Smigie - Analyst

  • Great.

  • Thank you.

  • I was wondering if you could comment -- and I apologize for this -- but could you comment on what you think seasonality should be typically in Q1?

  • Keith Jackson - CEO

  • Typically, it is down slightly.

  • We see our automotive, industrial and networking portions of the business actually grow in Q1 versus Q4 and the consumer businesses tend to be softer as the major ramps that they have are for the Christmas and Chinese New Year seasons.

  • So, overall, it tends to be kind of flat to slightly down as opposed to up sequentially.

  • Steve Smigie - Analyst

  • But it's closer to sort of a 1% drop.

  • It sounds like you're saying, versus maybe a 4% drop?

  • Keith Jackson - CEO

  • Yes, I think this year our drop was a bit larger than the normal trend and we're expecting to not have that large of a drop going forward, but again, we can't provide you guidance on that yet.

  • Steve Smigie - Analyst

  • Okay.

  • The pricing was about 2% to 3% in Q3 from what you said.

  • Why do you think that that price is going to start to get a little bit better in Q4?

  • Keith Jackson - CEO

  • We just base our ASPs we kind of look at the backlog, which as you can see is about 90% on the books.

  • We have a fairly good picture of what it's going to look like minus the turns.

  • Just basically feedback from that basis plus our sales channels tells us that the pressure is just slightly less than it was in Q3.

  • Steve Smigie - Analyst

  • Okay.

  • And the last question was just on the manufacturing.

  • Which locations did you rationalize during the quarter?

  • Keith Jackson - CEO

  • We have announced we're closing down one of our factories in Phoenix and so there's actions actively under way there.

  • And we've actually shrunk the activities in our Japan factory as well.

  • Steve Smigie - Analyst

  • Great.

  • Thank you.

  • Operator

  • Our next question or comment comes from the line of Mr.

  • John Pitzer from Credit Suisse.

  • Your line is open.

  • Amit Saraf - Analyst

  • Thanks.

  • This is actually Amit.

  • I was wondering could you comment -- did you see any changes to lead times in the quarter?

  • Keith Jackson - CEO

  • Not significantly.

  • We're still running kind of the 8 to 10 range for lead times on our high volume runners.

  • Really, no significant change.

  • Amit Saraf - Analyst

  • Okay.

  • In your book to bill, can you give us was it above one or was that just below one?

  • Keith Jackson - CEO

  • It should have been just right at one.

  • It couldn't have been much different.

  • Donald Colvin - CFO

  • We don't normally give that.

  • Keith Jackson - CEO

  • We don't normally give that, but --

  • Donald Colvin - CFO

  • Give out any book to build stuff because --what is important is to look at the (inaudible).

  • You get into a lot of (inaudible) like four or five months out and by the time you come to ship them they get rescheduled.

  • So what is encouraging is revenues would be flat to up and our opening backlog for Q4 was up.

  • So the key point we've always pointed to investors has been the backlog coverage for the next quarter.

  • So that's slightly improved, so that's the key point we like to look at.

  • Amit Saraf - Analyst

  • Okay.

  • And then just one last question.

  • I know it's always hard to predict, but can you give us your view on the macro environment and I guess tax within macro, since you guys are so broad-based?

  • Keith Jackson - CEO

  • We do see broad-based things here.

  • I guess we've seen, I guess, what I would consider some surprising resilience in the consumer markets.

  • Despite all of the macro wins and the credit markets and the housing markets in the U.S., we actually have seen that hold up pretty well.

  • So overall, I guess the sentiment here is a cautious one from the company because there are a lot of things out there that are predominantly driven by credit issues.

  • That could soften the demand picture going forward, but frankly, we have not yet seen that happen.

  • So, we cautiously are optimistic that electronics sector will not see significant impact.

  • Donald Colvin - CFO

  • One thing I would state that we clearly see is less volatility in the (inaudible) on our delinquency booking levels than we've seen in previous cycles.

  • Normally what happens is feast or famine in the semiconductors.

  • So, we've seen a lot of supply chain monies from our customers, from our distributors and associated with (inaudible) bookings and lead times and things like that.

  • So, we're seeing a more stable, less volatile environment coupled with observations that Keith mentioned about consumer resilience.

  • Amit Saraf - Analyst

  • Okay.

  • Sounds great.

  • Thank you.

  • Operator

  • Our next question or comment comes from the line of Mr.

  • Michael McConnell from Pacific Crest Securities.

  • Your line is open.

  • Michael McConnell - Analyst

  • Thank you.

  • Regarding the guidance for Q4, is this just a function of customers keeping their forecast to you a little closer to their vest so visibility is a little more muted with respect to maybe the month of December or are you actually -- have you seen some cancellations?

  • Could you just go a little bit more into what's driving the element of conservatism with respect to Q4?

  • Keith Jackson - CEO

  • We have not seen any cancellations.

  • Again, on a seasonal basis, you typically have a broad range of customers who want to have minimal inventories leaving their calendar fiscal years and so typically the amount of turns that you get in the third month of the quarter is much less than what you would expect to see, for example, in the third quarter or second quarter.

  • So it's not about cancellations.

  • It's really just about anticipating what I would call normal customer behavior at the end of the calendar year.

  • Michael McConnell - Analyst

  • With respect to the OpEx in Q3, can you talk a little bit about why that came, at least based on my expectations, higher than I think most people were expecting?

  • Keith Jackson - CEO

  • I think mostly what you saw was increases in R&D and there we're very purposefully increasing the rate of development in Gresham in order to fill up that facility as fast as we possibly can.

  • I think that's the major change you may have from what you were expecting.

  • Michael McConnell - Analyst

  • If we look at next year, should we still expect more of something?

  • Keith Jackson - CEO

  • No, I think from an increase perspective, you pretty much seen what we're going to do their and by the second half of next year it actually should start easing as we get all of our processes up and running.

  • Michael McConnell - Analyst

  • Okay.

  • And with respect to the driving I understand that you're expecting pricing to moderate in Q4, but could you talk about why you saw more pressure maybe than you were expecting in Q3?

  • Keith Jackson - CEO

  • You know, I think that just generic expectations from customers.

  • It's always a very competitive marketplace, but as the volume buys go down in the consumer industry, you see some of the customer power come to play and they're able to get very aggressive on the bigger builds.

  • Again, I think it's going to be a little bit seasonal as the consumer piece of that equation softens in the first half.

  • I think you'll see less pressure and then you'll see more pressure again in the third quarter of next year.

  • Michael McConnell - Analyst

  • Thank you very much.

  • Operator

  • Our next question or comment comes from the line of Mr.

  • Mark [Lapossis] from Morgan Stanley.

  • Your line is open.

  • Mark Lapossis - Analyst

  • Thank you.

  • Thanks for taking my call.

  • On the SG&A, I guess last quarter you were guiding for 10% to 11% of sales.

  • This quarter you're guiding for 11% to 12% of sales.

  • Could you just run through why you're kind of taking up the outlook there and how we should think about the long term operating model?

  • Thank you.

  • Donald Colvin - CFO

  • This is Donald.

  • Just to elaborate on a couple of points.

  • We present our results on a GAAP basis.

  • One can dispute whether our competition does on a non GAAP cash basis is correct, but one of the key points is we do have a lot of stock based compensation and non cash stock base compensation which was around $4 million in the quarter.

  • A lot of that goes into the operating expense particularly the SG&A line item.

  • So, with $4.1 million of non cash stock based compensation in the third quarter.

  • So, that has been trending up as the stock option expense trends up, because we benefited in the past from accelerated vesting for certain options which no longer take place.

  • That and other reasons keep competitive offers have resulted in an increase in non cash base stock expense.

  • That is in the numbers for the third quarter.

  • Plus the R&D expense that Keith mentioned associated with ramping of Gresham facilities.

  • So, these are the two major reasons, plus a bit of bonus as well.

  • These are the two major reasons for -- or three major reasons for operating expense.

  • The guidance we gave for the fourth quarter with operating expense at approximately 20% of revenue is pretty much in line with what we've been seeing for the last few quarters and we don't really see that changing above that 20% next year.

  • But you've got to pull out the pieces in particular temporarily we jacked up the R&D and we don't see that increasing from its current basis and you've got to look at the impact of the non cash stock based expense.

  • Mark Lapossis - Analyst

  • Okay.

  • So, I'm sorry OpEx we should be thinking about in a 20% range?

  • Donald Colvin - CFO

  • (Inaudible).

  • Depending on the top line, 19.5% to 20%.

  • That's the kind of range we will cap.

  • Mark Lapossis - Analyst

  • And you guys like R&D in this 8% to 9% sales range, also?

  • Donald Colvin - CFO

  • More toward 12% for SG&A and 8% to 9% for R&D.

  • These are the models.

  • If you look at what we announced when we had our analyst day, we give our long term strategic model which was $450 million on the top line, 45% gross margin and 19.5% to 20% operating expense.

  • That's the model we still maintain and that's the one we're operating towards.

  • Mark Lapossis - Analyst

  • Okay.

  • Thank you very much.

  • Operator

  • Our next question or comment comes from the line of Mr.

  • Ramesh Misra from Collins Stewart.

  • Your line is open.

  • Ramesh Misra - Analyst

  • Thanks.

  • Good morning, guys.

  • First question was in regards to notebook arena.

  • Keith, you mentioned in the past that this is an area of significant pursuit for ON Semi.

  • Can you give us an idea of how you anticipate that to ramp over the next few quarters, where that portion of the business is out of your overall PC business in the near term and how that trends further out?

  • Keith Jackson - CEO

  • Yes.

  • So, notebooks have been the smallest portion of our PC business.

  • We've been dominantly desktops and servers.

  • In our content, if you go back to '06 inside of a notebook computer the opportunity for content there was less than about $0.50.

  • Over the next eight to 10 quarters, we expect that $0.50 to be ramping up above $8 of content on a fairly regular basis.

  • So, we are expecting significant growth from a content perspective on a quarter by quarter basis and I would expect that notebooks would be a larger percentage of our total, again, on a quarter by quarter basis.

  • There's a number of design wins we've already gotten with our new products, taking that number well over $1.50 for the first quarter of 2008 and again there's a fairly steep ramp in our content capability from there over the next eight quarters.

  • Ramesh Misra - Analyst

  • Okay.

  • So, in the early part of '08, you're still under the $2 mark?

  • Keith Jackson - CEO

  • Still under $2 in the early part of '08, correct.

  • It doesn't get over $2 until the second half of '08.

  • We do expect to see some ramps there using our controllers and that would almost double that number.

  • Ramesh Misra - Analyst

  • Got it.

  • In regards to Gresham, you've talked in the past about pursuing other foundry customers in addition to LSI.

  • Can you provide us an update on where that stands?

  • Keith Jackson - CEO

  • We are expecting to see more of a ramp for high frequency copper processes as we enter next year.

  • We had hoped that would ramp earlier, but as it turns out the customer quals have taken longer than we expected, so we do expect to see some ramps from that sector, but no other significant foundry customers coming on line other than those products.

  • Ramesh Misra - Analyst

  • Okay.

  • And then finally, in regards to the portion of your test and assembly business that you outsource, can you provide an update in terms of pulling that into your China facility and do you expect the proportion that you're outsourcing to actually decline on your test and assembly site?

  • Keith Jackson - CEO

  • Yes, we do.

  • We continue to pull things in and I would expect that that would continue into 2008.

  • The plan there would be to pull out approximately 100 basis points of outsourcing in that sector of year over year.

  • Ramesh Misra - Analyst

  • Okay.

  • Thanks very much.

  • Operator

  • Our next question or comment comes from the line of Craig Berger from FBR.

  • Your line is open.

  • Craig Berger - Analyst

  • Good morning.

  • Thanks for taking the question.

  • We've kind of addressed this, but just to be clear on the foundry business.

  • I think you used to say your break even gross margin would be around $30 million in quarterly revenues and it looks like you were about break even or a little positive this order.

  • So is the new break even level kind of in that $21 million range?

  • Donald Colvin - CFO

  • This is Donald here.

  • Probably under $25 million.

  • Craig Berger - Analyst

  • Under 25?

  • Donald Colvin - CFO

  • The reason being is we reduced the cost basis.

  • So, under $25 million.

  • Craig Berger - Analyst

  • Okay.

  • Next question is can you just help us understand or do you have any insight into what your customer's component inventory levels look like?

  • You grew 6% sequential.

  • I'm trying to understand how much of that is a restocking effect that maybe will not be repeated in Q4 or Q1?

  • Keith Jackson - CEO

  • Generally speaking, customer inventories are in pretty good shape.

  • We talked about the distribution channel.

  • We can measure that very directly with the systems that we have.

  • On the OEM side, again, what we've observed is we're trying to push more and more inventory back to the component suppliers and that is a very noticeable approach that they are taking there.

  • And again, in our checks with the customers they are very lean in that OEM channel as well.

  • So, I would not expect to see any impact on sales based on changes in inventory above and beyond what I described earlier as the normal seasonality for the fourth quarter.

  • Craig Berger - Analyst

  • And on lead times, you guys said there was no change there?

  • What's kind of the range that you guys are operating at?

  • Keith Jackson - CEO

  • Again, the volume products are eight to 10 weeks.

  • Craig Berger - Analyst

  • Eight to 10 weeks.

  • Thanks.

  • Operator

  • Our final question and comment comes from the line of Mr.

  • Kevin Cassidy from Thomas Weisel Partners.

  • Your line is open.

  • Kevin Cassidy - Analyst

  • Thank you.

  • Just a couple more questions about the ASP decline.

  • Can you say which of your competitors were putting the pressure on?

  • Was it Asian manufacturers, European manufacturers, U.S.

  • based?

  • Keith Jackson - CEO

  • You know, the ASPs have been very broad based this year.

  • There's not one misbehaved competitor as it were, nor is it really an acceleration of any Asian-based influence.

  • It is, in my estimation, nothing more complex than there is enough supply to meet all the demands and you've got some very large consumer manufacturers that have very large buying power that end up driving that process.

  • So, the simple answer is there's really not a competitive landscape reaction.

  • I think it's a broad market reaction and I believe those ASP declines are fairly consistent across the rest of our markets.

  • Kevin Cassidy - Analyst

  • Okay.

  • So, how about within your product groups?

  • Which one does it affect the most?

  • Is it digital consumer products?

  • Keith Jackson - CEO

  • It typically affects the standard products group the most.

  • It is, again, felt more in the discreet lines than it is the analog lines.

  • Kevin Cassidy - Analyst

  • Okay.

  • Thank you very much.

  • Operator

  • Ladies and gentlemen, this includes the ON Semiconductor third quarter earnings release conference call.

  • Thank you for your participation.

  • You may now disconnect.