安森美 (ON) 2011 Q2 法說會逐字稿

Welcome to the ON Semiconductor Second Quarter Financial Earnings Call. All lines have been placed on mute to prevent any background noise. After the speakers' remarks, there will be a question and answer session. (Operator Instructions) Thank you. I would now like to turn the conference over to Ken Rizvi. Please go ahead, sir.

Thank you, Tiffany. Good afternoon and thank you for joining ON Semiconductor Corporation's Second Quarter 2011 Conference Call. I'm joined today by Keith Jackson, our President and CEO, and Donald Colvin, our CFO. This call is being webcast on the Investor Relations section of our website at onsemi.com and a replay will be available for approximately 30 days following this conference call, along with our earnings release for the second quarter. The script for today's call is posted on our website and will be furnished via Form 8-K filing. 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 separately on our website in the Investor Relations section.

In the upcoming quarter, we will be attending the Pacific Crest Technology Forum on August 9, the Citi Technology Conference on September 7 and the Deutsche Bank Securities Technology Conference on September 13. 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 believe, estimate, anticipate, 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 earnings release, Form 10-K, Form 10-Qs 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 who will provide an overview of the second quarter results. Donald.

Thank you, Ken and thanks to everyone joining us today. ON Semiconductor Corporation today announced that total revenues in the second quarter of 2011 were approximately $905.8 million, up approximately 4% from the first quarter of 2011. Excluding SANYO Semiconductor, ON Semiconductor historical revenues were up approximately 7% sequentially to approximately $631.5 million in the second quarter. During the second quarter of 2011, the Company reported GAAP net income of $41 million or $0.09 per fully diluted share. The second quarter 2011 GAAP net income included net charges of $73.4 million or $0.16 per fully diluted share for special items, which are detailed in schedules included in our earnings release. GAAP gross margin in the second quarter was 29.4%. Included in our GAAP gross margin is approximately $53 million of special items.

Approximately $31 million relates to the expensing of non-cash manufacturing expenses associated with our SANYO Semiconductor acquisition and approximately $22 million relates to the expensing of appraised inventory fair market value step up. Non-GAAP gross margin in the second quarter of 2011 was 35.2%. Second quarter 2011 gross profit and net income was slightly less than anticipated, due to a more adverse impact from the March 2011 earthquake and resulting tsunami in Japan and manufacturing cost increases from commodity prices in foreign currencies. For SANYO Semiconductor, fab manufacturing activity was approximately 70% of the pre-earthquake second quarter manufacturing forecast. In addition, since the third quarter of 2010, commodity and foreign currency headwinds have impacted total Company gross margins by approximately 200 basis points. Second quarter 2011 non-GAAP net income was $114.4 million or $0.25 per fully diluted share. We exited the second quarter of 2011 with cash, cash equivalents and short-term investments of approximately $868.8 million; a record for the Company.

At the end of the second quarter, total days sales outstanding were approximately 58 days, down approximately 2 days compared with the first quarter of 2011. Internal inventories were down approximately 3 days to 107 days. Internal inventories are still elevated, primarily due to the elevated inventories acquired as part of the SANYO Semiconductor acquisition. Included in our total internal inventory is approximately $14 million of bridge inventory associated with the shutdown of our factories. At the end of the week, we will shut down our remaining fabrication facility in Phoenix. With this closure and the related production move to a site in Malaysia, we expect incremental cost savings of approximately $2 million per quarter.

Distribution inventories in the second quarter increased, as expected, to approximately 11 weeks exiting the quarter. We expect to see distribution inventory dollars decrease in the third quarter. Cash capital expenditures during the second quarter were approximately $85 million. We currently anticipate total expenditures for 2011 of approximately $340 million, which includes SANYO Semiconductor. Now, I would like to turn it over to Keith Jackson for additional comments on the business environment.

Thanks, Don. Now for an overview of our end markets, during the second quarter of 2011, our end market splits were as follows -- the Consumer Electronics end market represented approximately 27% of sales. The Automotive end market represented approximately 20% of sales. Computing end market represented approximately 20% of sales. Industrial, Military, Aerospace and Medical end markets represented approximately 20% of sales. The Communications end market, which includes Wireless and Networking, represented approximately 13% of sales.

On a direct billing basis, no individual ON Semiconductor product OEM customer represented more than 5% of second quarter sales. Our top five product OEM customers during the second quarter were Continental Automotive Systems, Panasonic, Delta, Samsung, and LG. On a geographic basis, our contribution from sales in Asia, excluding Japan, represented approximately 58% of revenue. Our sales in the Americas represent approximately 14% of revenue. Sales in Japan represents approximately 15% of revenue. Sales in Europe represented approximately 13% of revenue during the quarter.

Looking across the channels, direct sales to OEMs represented approximately 56% of second quarter 2011 revenue. Sales through distribution channel were approximately 38% of second quarter revenue and the EMS channel represented approximately 6% of revenue. During the second quarter, ON Semiconductor revenues broken out by our product groups were as follows -- SANYO Semiconductor products group represented approximately 30% of sales. Standard Products group represented approximately 20% of sales. The Automotive and Power group represented approximately 17% of sales. The Digital Mixed Signal and Memory group represented approximately 17% of sales. The Computing and Consumer group represented approximately 16% of sales.

We will publish our quarterly revenue, gross profit and operating income breakout of these segments in our Form 10-Q for the period. Now I'd like to provide you an update of our Japan operations as well as other details of the progress we have made during the quarter. As previously outlined, second quarter results were negatively impacted by the March 2011 earthquake and resulting tsunami in Japan. SANYO Semiconductor revenues in the second quarter were approximately $274 million, and were slightly better than we had anticipated coming into the second quarter. SANYO Semiconductor monthly sales began to stabilize in the month of May and improved in June. Based on our current visibility, we are expecting to see some modest growth in the SANYO Semiconductor revenues in the third quarter of 2011. Thanks in large part to the great efforts and teamwork of our employees, all of our factories in Japan were capable of full production during the second half of May.

Semiconductor manufacturing cycle times, however, have a lag between when the factories can begin full production and when those final products can be shipped to customers. While we anticipate modest sequential growth for SANYO Semiconductor, it will still be lower than normal seasonality, in part due to this lost production. In response to anticipated supply chain disruptions following the Japan crisis, many worldwide customers built up inventory reserves in the first half of the year. Customers continue to adjust their overall order rates based on the availability of all parts for their system solution requirements. We expect this rebalancing of inventory to continue through the third quarter. SANYO Semiconductor has now been a part of ON Semiconductor for more than 6 months. While we faced some unexpected challenges with the earthquake and tsunami in March, we remain excited about the long-term prospects to grow and expand SANYO Semiconductor's products to our global customer base, as well as expand our presence with leading Japanese customers.

SANYO Semiconductor was accretive to our non-GAAP earnings in both the first and second quarter of 2011, even taking into consideration the impact from the March earthquake in Japan. We anticipate that earnings for SANYO Semiconductor will improve from the second quarter levels in the second half of 2011. The integration of SANYO manufacturing and business operations continued as planned during the second quarter with additional progress being made in systems integration, aligning of R&D road maps and cross-selling of SANYO Semiconductor and ON Semiconductor products to our worldwide customer base. We are pleased with the progress. Close to 1,000 SANYO Semiconductor products are now available on the ON Semiconductor website and price book. One example of the successful cross-selling efforts of our sales teams includes a significant design win of a SANYO Semiconductor power device in a North American manufacturer's latest smartphone scheduled to launch this fall.

Overall, revenue growth in the second quarter was driven primarily by the growth of our Industrial, Computing and Consumer Electronics end markets. Looking forward, we expect continued strong demand for our energy efficient solutions for Automotive, Industrial, and Consumer White Goods and expansion of our LED lighting solutions across all market segments. Second quarter automotive sales were down slightly from the first quarter, due to lower automotive sales from SANYO Semiconductor. During the quarter, SANYO Semiconductor sales were negatively impacted by the automotive supply chain disruptions in Japan caused by the earthquake in March. In the second quarter, historical ON Semiconductor, which excludes SANYO Semiconductor, saw slight growth in the Automotive end market. Contributing to the strength were MOSFET sales into anti-lock brake systems and IGBT sales into powertrain systems and direct gas injection applications for North American, European and Korean customers. In addition, during the quarter, we saw continued strength from our external lighting solutions with our European customers.

Based on our current backlog entering the third quarter, as well as new design wins and key automotive systems with expanding content such as LED lighting, powertrain, safety systems and infotainment, we expect the overall Automotive segment to remain stronger than normal seasonality for ON Semiconductor in the second half of 2011. The Industrial end market grew by approximately 22% sequentially, driven by growth in the CMOS Image Sensor business recently acquired from Cypress Semiconductor, as well as continued strength in factory automation in heavy products like motor protection and circuit breaking. During the quarter, shipments of our high voltage MOSFETs to industrial customers more than doubled from the first quarter. In addition, customer demand for industrial power supplies controlling and sensing, general lighting and smart meters continue to drive strong sales of our power management and standard products in the Industrials end market. In the Consumer end market, second quarter revenues increased approximately 3% sequentially. Sales of our standard components in the consumer goods were up approximately 11% sequentially, led by an increased use of our discrete products in home appliances, LCD and satellite TVs. During the quarter, we also secured a significant design win with a major flat panel TV manufacturer for a platform of DC-DC controllers.

The consumer end market holds exciting growth potential for ON Semiconductor in the upcoming years as consumer white goods and appliance customers move to adopt variable speed motors with inverter power systems. These integrated power modules are designed to improve the energy efficiency of washers, dryers, refrigerators, air conditioners and other appliances. Variable speed motors with our products help to enable over 50% reduction in energy usage compared to current motor technologies. The integrated power modules and variable speed motor control technologies acquired as part of the product portfolio of SANYO Semiconductor expands the Company's offerings to more than $10 of [additional conduit] per unit for energy efficient white goods. In addition to the integrated power modules, our solutions include power supplies, user interface and communication chips linking appliances to the smart grid.

Paired with ON Semiconductor's strong customer relationships with leading global appliance customers, we are well-positioned to capitalize on this market opportunity. The Computing end market revenues were up slightly from the first quarter, driven by demand from emerging markets as well as demand from the corporate PC market. During the second quarter, we continued to see strength from our sixth generation of [e-core] controllers and drivers and began shipping our latest AC to DC PWM controllers for several notebook adapter customers. In addition, during the quarter, we saw growth from designs into more than 10 tablet platforms with products ranging from protection devices and power management solutions to audio and system interface solutions. In the Communications end market, which includes Wireless and Networking, revenues were up slightly compared to the first quarter of 2011. Continued penetration of the smartphone market remains a primary growth strategy for the Company.

During the second quarter, we continued to ramp power management products, accelerometer interfaces and clock management products to leading handset customers. We are also first to market with a MHL-interface solution capable of delivering 1080p video. In addition, during the quarter, we began to ramp our integrated passive devices with a major mobile phone power amplifier module manufacturer. Now I'd like to turn it back over to Donald for our other comments and our other forward-looking guidance. Donald?

Thank you, Keith. Third quarter 2011 outlook -- through the month of July, end market conditions have deteriorated. Where we believe we are prepared to support higher growth of higher demand materializes. Given the more challenging global economic climate, we are planning for a broader range of revenue guidance in the third quarter of 2011. Based upon total booking trends, backlog levels and estimated turn levels, we anticipate that total ON Semiconductor revenues will be approximately $895 million to $925 million in the third quarter of 2011. Backlog levels for the third quarter of 2011 represent approximately 90% of our anticipated third quarter revenues. The Company continues to face the adverse cost impact from the weak US dollar and stronger commodity prices.

Any continued strength over current rates in currencies including the Japanese yen, Malaysian ringgit, Philippine peso and Czech Republic koruna will continue to negatively impact our manufacturing cost. Accordingly, we believe it will be difficult to improve on our non-GAAP gross margin percentage in the third quarter. We expect the average selling prices for the third quarter of 2011 will be flat to down approximately 1% compared to the second quarter. We expect total cash capital expenditures of approximately $85 million. For the third quarter of 2011, we expect GAAP gross margin of approximately 33% to 35%. Our GAAP gross margin in the third quarter will be negatively impacted from, among other items, expensing of appraised inventory fair market value step up associated with our acquisitions of approximately $10 million. We expect non-GAAP gross margin of approximately 34% to 36% in the third quarter.

We also expect total GAAP operating expenses of approximately $200 million to $205 million. Our GAAP operating expenses include the amortization of intangibles, restructuring, asset impairments and other charges which are expected to total approximately $15 million. We expect total non-GAAP operating expenses of approximately $185 million to $190 million. We anticipate GAAP net interest expense and other expenses will be approximately $21 million for the third quarter of 2011, which includes non-cash interest expense of approximately $9 million. We anticipate our non-GAAP net interest expense and other expenses will be approximately $12 million.

GAAP taxes are expected to be approximately $8 million to $10 million, and cash taxes are expected to be approximately $5 million to $7 million. We also expect stock-based compensation expense of approximately $12 million in the third quarter, of which approximately $2 million is expected to be in cost of goods sold and the remaining in operating expenses. This expense is included in our non-GAAP financial measures. Our current fully diluted share count is approximately 460 million shares based upon the current stock price. Further details on share count and EPS calculations are provided regularly in our quarterly and annual reports on Form 10-Q and Form 10-K. With that, I would like to start the question and answer session.

(Operator Instructions) John Pitzer, Credit Suisse.

My first one on gross margins, Don, I want to make sure I understood. You said that commodity FX hit gross margins by 200 basis points in the June quarter. Was that sequentially or over what time period? If it was not sequentially, relative to guidance, what fell short?

That was over like the last 12 months before we'd estimated that hit, John. Compared to the guidance, essentially the major delta came from the impact of the earthquake in Japan. The earthquake hit us before we'd closed our first quarter and we had limited visibility of the earthquake. To be perfectly frank and honest, I think we were just too optimistic on the impact to our manufacturing. When I do a little bit of forensic rework, the numbers that we guided to were too high and the impact was more severe, particularly on the manufacturing activity in the front end where we lost, as I mentioned in the call, significant amounts of production, which in an environment where you have a high fixed cost has a very high percentage impact on earned recoveries and on the P&L. That was essentially the major miss. Also, again, we were not helped by the weakening dollar and increased commodity prices. But the major delta was clearly an underestimation of the negative impact of the earthquake and tsunami in Japan.

Then, guys, maybe as my follow-up, Keith, with the wider than normal kind of revenue range for the September quarter, I'm kind of curious, any lingering impact from Japan that's driving that wider range? Or is this all uncertainty being driven by the macro? And from a bottoms up perspective, if you hit the low end versus the high end, where do you think the biggest differential for swing factors are?

I think it is mostly reflective of uncertainty of the end markets. There's very clearly a lot of questions right now on just how robust the consumer builds will be for the fall and the take-up rates as a result of that. So, I think it's really a macro thing. In Japan, there is some questions to this point. We talked about customer inventory balancing where they were unable to get certain types of products and others were available and what impact that will have. But the bulk of it is just macro uncertainty.

Christopher Danely, JPMorgan.

If you could just give us your rundown on the end market outlook for Q3? And then if you could further break that down by assessing what is your opinion on inventory versus demand in each?

Okay. We would expect, as you can see from the guidance, it's slightly up from the previous quarter, so there's no major markets that we expect to drop. We're expecting to see some relative moderate performance in Automotive. The traditional ON side should be flattish to up a bit. The SANYO side is one of those macroeconomic uncertainties because that was targeted all at Japan automotive manufacturing. Give or take there, it's nothing dramatic going on. Industrial, I think still has some strength to run. It may again be one of our stronger sequentially performing segments.

There is still a pretty good demand for energy efficient electronics, making a differentiation in replacement in the marketplace. That actually could be a positive in Japan, where there's a lot of focus right now on energy efficiency. That one's probably going to be one of the stronger ones. Computing, we normally would see a very big pop going into Q3. We're expecting that to be much more flattish. That is reflecting, at least at this stage, apparent less than seasonal demand from the consumer side of the business.

Consumer side, as we mentioned in my script, I think we've got continued opportunity in the white goods for the inverter modules, again, energy efficiency play. There will certainly be some slight builds in the gaming arena, as there normally is. I would say a slightly positive bias in that marketplace overall. Communications is sending us the most mixed signals. At this stage, we think its relatively flat, but the share swaps in the smartphones and the overall demand for smartphones is one of the macroeconomic uncertainties that I mentioned earlier.

Great. Then for my follow-up, is what's happening in Japan and what's happening with SANYO, has that changed your outlook for the SANYO margin ramp over the next 4 to 8 quarters?

It certainly has delayed that ramp. Again, we didn't start reaching full production again until just about the end of the second quarter. We have cycle times in manufacturing that are 3 months or so. So you certainly should expect that to come up slower than we originally anticipated and of course, we originally anticipated a little better revenues in the early months. But the long-term, meaning 2012, remains completely intact. Our actions we're taking in manufacturing there with the consolidations, et cetera, are on track as we presented in earlier meetings.

Okay. Thanks.

Ross Seymore, Deutsche Bank.

Getting back to the gross margin side of things, if the SANYO side was the biggest impact in this quarter, how should we think about the duration of that snapping back? Said another way, when do you expect to get those 2 points? Is it the fourth quarter or is it more 2012?

Well, I think what we stated is that the miss compared to guidance was essentially SANYO. But if you look at the gross margin, it was only slightly down compared to the first quarter. I think we were just optimistic on guidance. That was what I explained. But going forward, we're still going to be faced with this weak dollar and the dollar's got significantly weaker throughout the month of July, even this week, and that's just having a negative impact on our costs.

We've got a lot of manufacturing costs in euros and yen and ringgits and pesos and things like that are all strengthening against the dollar and that is negatively impacting the manufacturing. So we've taken some cost reduction actions, but I think what we stated on the call and the script was we don't expect any big improvements in gross margin until we start to see some of these currency and commodity headwinds reversing and that's not happening now. So I think the midpoint of guidance is roughly flat to slightly down and that's basically our best view today, because of the sheer magnitude of these currency and commodity headwinds. They do have a material impact and looking at what a lot of other companies are seeing, they're seeing the same impact on their business.

Ross, we only give guidance one quarter at a time. We should see a more normal situation in Q4 in Japan. Factories should be back up. You should start seeing some improvement. But to Don's point, the macro environment's not going to be giving us tailwinds, but headwinds, and we don't get the factory closures and consolidations until 2012.

My one follow-up, moving over to the OpEx side of things, can you remind us what's the cost support you received in the second quarter? How much is remaining and what sort of savings you expect to create as the SANYO business gets fully integrated?

The cost savings in the second quarter and the P&L were north of $30 million as anticipated and this is running exactly as scheduled. As Keith mentioned, the manufacturing programs that we are layering over the cost reductions to ensure there's a good handover are progressing appropriately. Everything is on plan and we should be exiting the surplus facilities in the middle of next year, as anticipated.

Great. Thank you.

One point, I just wanted to add. In addition to the headwinds, the more slower economic demand in the market has meant that we have taken down our manufacturing run rates in the third quarter as well, Ross. As you know, that doesn't help your end recovery. So, that's the other element that we are having to face is lower manufacturing activity as we adjust our manufacturing run rates to the current outlook.

Craig Berger, FBR.

Sorry to beat a dead horse here, but what kind of active actions are you guys taking to offset either the currency impacts or the inflationary cost impacts? Where do you get cost efficiencies to offset some of those impacts?

We're doing everything we can. We announced the closure of a factory here. We are moving more production inside the Company and using less subcontractors to a certain extent. We're doing that. Also, we're taking actions on removing gold and replacing it with copper, aggressively doing that. We are looking, as we mentioned, at shutting down, as planned, some manufacturing facilities in Japan.

It's not like our operation guys don't have a big list of to-dos. We are also adjusting our manufacturing run rates so that we don't build inventory and align it with the current lower level of demand compared to what had previously been anticipated. These are all the actions. There's a whole list of them, taking summer vacation as well in the factories, getting rid of expensive weekend shifts and also pushing out capital expenditures that are not necessarily to support current levels of demand. These are all the actions that we're taking and this is all baked into our forecast.

Okay. And then as a follow-up, kind of a two-part follow-up -- part A, you said you got about $30 million of operational support. How confident are you that you're going to be able to backfill those revenues with operational improvements and can you quantify the impacts of closing your fabs next year? And then, the second part of the question is can you just comment on industrial demand out there? That seems to be a sector where we're hearing mixed things. It certainly held up strong for a long time. Is that getting hit by the macro or can that power through it? Thanks.

I'll take the first part and I'll give Keith the pleasure of the second. As far as the operational support, we've always been very transparent. We have a plan that will reduce costs so that when the operational support winds down as anticipated, the closure of the factories will offset that cost. I can assure you that this is still the plan we are executing and that we have more cost reductions identified than the operational support that will be withdrawn, so that gives us some safety factor. We are not concerned that any of the tragic events have derailed our cost reduction plans and as I say, our manufacturing guys have a full plate, but they're still marching to that program.

On the industrial markets, as I mentioned earlier, we do see them holding strong. The macro economy certainly has an impact, but what we've seen is that there are many firms making the capital investments now to reduce their operating costs. And so our products give them the opportunity to significantly lower their energy costs and that has been holding up very well, both in the industrial segment and in the white goods segment.

James Schneider, Goldman Sachs.

One more on the gross margin question -- just in terms of the Japan effect and how those higher cost goods that were manufactured during the earthquake and tsunami are going to flow through the P&L. Is it the case where those higher cost goods are going to still be lingering in terms of their impact on the P&L into Q4 and Q1 or will they be flushed out of the system before that time?

Good question. That was more of a negative impact on the second quarter where we had some older, higher cost finished goods inventory that we had to use to support the revenue and we didn't have the end recoveries of the lower cost front end wafers and die. I don't believe that will be meaningful impact from now on and we are looking forward to a better recovery and actually improved margins in our base SANYO business in the third quarter; nothing too dramatic, but slightly better.

That's helpful. Thanks. If we could maybe comment on your lead times right now, where they are today, what they did in Q2, what you expect them to do in Q3? Generally speaking, are they where you want them to be and do you think there's any kind of impact on a customer ordering behavior from the lead times today?

The lead times have come down from kind of the high teens to the low teens. There's definitely been a contraction in lead times. There's no question that is having an impact in the marketplace on new orders and again, has led to some of that uncertainty in the end markets. So, how much of it is just new order patterns, how much of it is macro market, how much of it is inventory correction, that's the reason we gave a little lighter guidance.

Thanks so much.

Craig Ellis, Caris & Company.

Don, you had mentioned on the last call that you had thought channel inventory would go up in the quarter and it did. What is your expectation for where we exit the third quarter in the channel?

Thank you for reminding me I got it right. We fully anticipate that the inventory will fall, the channel inventory will fall in the third quarter. Should fall on both a dollar basis and on a weeks basis. The trends we're seeing suggest that is underway. That's our anticipation.

Can you say where you'd expect the weeks to shake out at the end of the quarter?

Well, [channel would basically distribution] and most of our distribution business is in Asia. Clearly, was quite a lot of inventory purchased just on the back of the tsunami and with the current weaker global demand I think distribution has a relatively good stock of a lot of products and that we would anticipate that they would move to more leaner asset model, particularly as Keith mentioned, the production lead times have come in. I think that we should start to see a reduction in absolute dollars and weeks this quarter.

Okay. Then as a follow-up, on the CapEx, I think last quarter the range was $310 million to $340 million for the year, now you're at the $340 million. From the $310 million, what's caused CapEx to go to the higher end of the prior range?

Nothing too dramatic, just that the range -- we have, Keith had mentioned there's some exciting projects we're looking at, particularly a bit of a catch-up in things like HIC inverters and the SANYO Semiconductor and we have confirmed that we want to invest there. That's just a normal making sure we invest in the right areas. We have pushed some things out. Clearly, we might not see much of our changing CapEx this year because the pipeline normally has a latency. But what I can tell you is the first part of next year looks like it will certainly not be up over this year and we're building a relatively nice amount of capacity cushion compared to current demand levels. But it takes a bit of time to clean out the pipe.

Sounds good. Thanks, Don.

Tristan Gerra, Baird.

Could you say what utilization rates were in the quarter, excluding SANYO, and what's your expectation for Q3 as you reduce inventories in the channel? Also, embedded in that question, when would you expect your own inventories to get back to the normal low 80s range?

So utilization rates, non-SANYO, were kind of mid-90s in Q2. We'd expect that to go down a bit in Q3, but I don't think it's dramatic in Q3, so maybe toward the low 90s or around 90. That's the inventory question or the utilization question. On the inventory side, inside, I think we're going to be maintaining relatively stable numbers coming down a little bit each quarter as opposed to any big correction going forward.

A lot of the inventories we called out. Quite a lot of inventory from SANYO and some of that's legacy parts and we have a lot of bridge requirement as we close down the factories. We want to be cautious there, making sure that we have enough to meet customer demand. That's something that also doesn't help. We also built up some inventory to facilitate the closure of the facility here that we mentioned. I think you can expect, as we exit next year, the inventory levels will start to move much closer to our historical average.

Okay. So it's probably fair to assume that even though you expect channel inventories to come down in Q3, that we won't be back to the type of 8 week range that you've had? And as such, that this could also have a little bit of headwind on gross margin beyond Q3? Perhaps, would you be able to quantify the impact of the lower utilization rate on gross margin for Q3, what it reverses the commodity cost impact?

As I mentioned to the question from Ross, Tristan, that is already embedded in our guidance for the third quarter and we don't give out guidance for the fourth quarter. But the third quarter is already digesting the [lower] recoveries to make sure that our inventories are relatively flat and don't grow in absolute dollars over the second quarter. That kind of range is what we're aiming at and that is embedded in our third quarter guidance. But I think it's also fair to say that we do have offsets because we can reduce costs, but the raw number, clearly, there is a headwind when you reduce manufacturing activity. But we have offset that by pushing out some expenses, reducing some shift work, taking some vacation, et cetera, to offset that, and that's included in our guidance.

Okay. Thank you.

Chris Caso, Susquehanna Financial.

Wonder if you could discuss a little more about the impact of the Japan earthquake on both Q2 and Q3? I guess most of your peers saw a benefit to Q2, as their customers were apparently building up some inventory in Q2 and that turned into a headwind for Q3. For you guys, the dynamics seem a little bit different because of the direct SANYO exposure. Perhaps you could go into that a bit and just talk to us about why that wouldn't be perhaps a bigger headwind for you guys in the third quarter?

Okay. Second quarter, again, as we mentioned earlier, we were slightly better than we had anticipated. We had enough [whip] and inventory there to offset some of the issues. But frankly, we did not have a big move to create excessive inventory. So we don't think we built a lot of extra inventory in Q2, meaning we didn't have any headwinds going into Q3. What we have in Q3 is a minor amount of the demand side with customer rebalancing some things, offset with increased production. We're actually expecting, as we mentioned earlier, some increase in sales quarter-on-quarter, as opposed to a correction of inventory because we just didn't build the inventory in Q2.

So basically, you don't think you saw the same benefit others saw?

We know we didn't see the same benefit.

To be very specific, our revenue went down and our manufacturing activity went down significantly and that had a negative impact on the P&L which is what explained the miss on the earnings, because we didn't have enough experience to model it correctly. If I had to do it again, I would have modeled it with a lower guidance. Both the manufacturing activity and the revenue should increase this quarter. That's what's embedded in our guidance. We actually got pretty badly hit in the second quarter.

Then just as a follow-up, again, some of your commentary with regard to automotive, it sounds like it's different for the core ON Semi business as opposed to the SANYO business and that sounds a little different what some of the others would say. Could you provide some clarification on that as well?

Absolutely. The core ON business was European, Korean and China. There was very little to no Japan-based automotive business in traditional ON. We've actually seen very strong demand in China for the high end European cars, strong demand in Korea for the Korean cars and the design wins we've had in North America in the new models has taken a nice step up with our lighting products and some of our energy efficiency products in the powertrain. So net-net, we think we're actually gaining share outside of Japan. The SANYO piece was all aimed at Japan and of course was the most disrupted with the earthquake and so that's the dichotomy going on there. In general, I think we're doing much than peers outside of Japan and probably very similarly to them in Japan.

Thank you.

Ramesh Misra, Brigantine Advisors.

Donald, in the past you've said that the weakness in the US dollar had actually helped you, especially in getting market share from some of the overseas competitors. What's the dynamic now and how should we be thinking about share shifts versus costs?

Well, I think historically I made that comment when we were seeing the US dollar weaken against the euro. As you know, we have some very feisty competitors in Europe where we sought that out, particularly for things like the automotive market. So that's certainly applied against European customers fighting in Europe for automotive business. But what we have seen, and this is a new event over the last several years that has accelerated recently, is the dollar weakening against a whole basket of currencies, in particular against things like the Filipino peso, the Malaysian ringgit and also the Japanese yen where we have a lot of manufacturing costs. Also, our subcontracting costs in Asia are rising because of the weak dollar, and then the weak dollar also resulting in speculation in things like gold, oil and copper which we are also big users of.

Just simply copper, you wouldn't think that we were using a lot of copper, but we were doing the analysis the other day and I think the increase in the price of copper is costing us something like $1 million, $1.5 million a quarter additional cost. So as you know, copper has also got a speculative premium in there and just pay the price of that. Oil is another one, too, because of freight. The weak dollar really is impacting a lot of our input costs and our low cost manufacturing costs which are now becoming higher costs. That's what's hitting us now.

Okay. Got it. Are you hedging expenses or hedging activity going up? Then the other thing I also wanted you to remind me of is the number of factories, both front end and back end in Japan currently and where do you see that by mid-2012? Thanks.

As far as the hedging is concerned, there's no easy way to hedge for these things because it's basically our costs are in areas that are where the currencies are appreciating against the dollar and the way to hedge would be to shut the place down and move it to a lower cost place, which by the way, we are looking at. But it's very expensive, these kind of P&L hedging and normally companies in our business don't really do much of that and we are no exception. As far as the manufacturing in Japan, if I do a quick calculation, we have 1, 2, 3, 4 fab sites and a small assembly and test site. A significant amount of manufacturing and a large part of that, as you probably know, is scheduled to be consolidated during the course of next year.

Okay. Thanks very much.

Kevin Cassidy, Stifel Nicolaus.

You had mentioned taking the SANYO products into North America and winning a design there. Just wonder how the progress is or what's the design atmosphere in Japan of taking the core ON products into Japan through the SANYO channel?

It has been met very well. We have gotten access, at very high levels, of the customers there we did not previously have access to. A result of that, we have had a broad package of standard products that have been qualified and approved for use there and we're actually expecting multiple millions of dollars in increased sales in Q4 of the ON portfolio inside of Japan.

Great. And would that be consumer or is that automotive?

In the Q4 time frame, it's mostly consumer. Auto really won't follow until next year.

Okay. Great. Thanks.

Steve Smigie, Raymond James.

I was wondering if you could talk a little bit about linearity of orders through the quarter and into July? I know you said it deteriorated. Would you say that July orders are below June? Is there some like back-to-school stuff not materializing or is it not quite like that?

So from a new order perspective, our lead times were coming in very rapidly as we went through July. The new bookings clearly would have been expected to go down and they usually do in July anyway. I don't know what you're exactly going for there, but it's --

I just know a couple other companies that had said hey, we're not seeing back-to-school bookings coming in and maybe that's just isolated to them and that's not maybe something that's impacting you.

I don't think there's a significant impact on us on the back-to-school piece of the equation.

Okay. Could you talk a little bit about how you guys are perceiving the December seasonality now that you have SANYO on board?

The December seasonality?

Yes.

It basically increased our consumer footprint, gave us some Automotive, but overall the biggest piece of the business, the change was more consumer and so it should look very much like all off consumer businesses. Q4 tends to be flattish to down slightly normally. With the Japan earthquake, I'm not sure that those seasonalities will be predictable, but that's generally what happens in that quarter.

Okay. If I could squeeze one last one in. Apologize if I missed it, but do you break out the SANYO versus ON gross margin?

No. We gave indications, but we don't break it. I think on the call today, what we did say is that the SANYO gross margin underperformed because of lower manufacturing activity. But we will give details when we publish the Q.

Okay. Thank you.

Parag Agarwal, UBS.

Just a question about your guidance, if you look at other selling companies, like microchips and [ninyas] compared to those companies, your guidance is kind of optimistic. Just wondering what is the difference that you guys and them? What is the level of confidence you have in your guidance?

I think there's a few differences between us and many of our competitors. We are a sell-through Company, and as we were mentioning, we think the distributors will be trying to get their inventories down. And so, anybody who's sell-in is probably under more pressure than we are on their revenue lines sequentially into Q3. I think that's certainly an impact there.

We're pretty confident. We're looking at resale rates. We're looking at the OEM orders that we have. As you also know, we're an unusual Company amongst some of the peer group you mentioned in the percentage of backlog we have going into each quarter, which is very, very high. So the simple answer is, we feel pretty good about the numbers as we always do and differences from competitors, the sell-through nature of our business, plus the very high level of backlog that we enter the quarter on.

I apologize, I misspoke. (inaudible) Coming to the second question about the [competing] business, how would you characterize that business in terms of design wins (inaudible) and how do you see that ramping for the remainder of the year?

Let me make sure I understand the question. You're wanting to know the design win rates and changes going into the second half?

Yes. Especially on [SANYO division].

Yes. No, those are quite strong. From a design win perspective, all of the design win piece of that phase is pretty much behind us. It's really just ramps in the models that happen in the second half. As we mentioned before, that should be a positive for us and maybe one of the reasons we're a little less pessimistic than some on what's called back-to-school, et cetera.

Thank you very much.

Thank you for participating. This concludes the ON Semiconductor second quarter financial earnings conference call. You may now disconnect.