ON Semiconductor Corp (ON) — Q2 2018 Earnings Call Transcript

Thank you, everyone, for joining ON Semiconductor Corporation's Second Quarter 2018 Quarterly Results Conference Call. I'm joined today by Keith Jackson, our President and CEO; and Bernard Gutmann, our CFO. This call is being webcast on the Investor Relations section of our website. A replay of this broadcast along with our earnings release for the second quarter of 2018 will be available on our website approximately one hour following this conference call, and the recorded broadcast will be available for approximately 30 days following this conference call. The script for today's call and additional information related to our end markets, business segments, geographies, channels and share count are also posted on our website. 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, which is posted separately on our website in the Investor Relations section. During the course of this conference call, we will make projections or other forward-looking statements regarding future events or future financial performance of the company. The words believe, estimate, project, anticipate, intend, may, expect, will, plan, should, 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 from projections. Important factors which can affect our business, including factors that could cause actual results to differ from our forward-looking statements, are described in our Form 10-Ks, Form 10-Qs and other filings with the Securities and Exchange Commission. Additional factors are described in our earnings release for first quarter of 2018. Our estimates may change, and the company assumes no obligation to update forward-looking statements to reflect actual results, changed assumptions, or other factors except as required by the law. As announced earlier, we will host our 2019 Analyst Day on March 8 in Scottsdale, Arizona. If you would like to attend the event and haven't received an invitation, please let us know. During the third quarter, we will attend the Citi Technology Conference in New York on September 6 and the Deutsche Bank Technology Conference in Las Vegas on September 12. Now let me turn it over to Bernard Gutmann, who will provide an overview of second quarter 2018 results.

Thank you, Parag, and thank you, everyone, for joining us today. We delivered yet another quarter of strong financial results which exceeded our guidance and street consensus on all key metrics. Near to midterm outlook for our business remains strong and overhead related to trade policy and tariffs has not had any meaningful impact on our business or outlook. Long-term outlook for our business continues to strengthen driven by our accelerating momentum in automotive, industrial, and server markets. Our margin performance remains strong and continuing expansion in both gross margin and operating margins. Global macroeconomic environment remains stable and we are seeing strong demand for most geographies in the end market. Customers are upbeat about near to midterm outlook. However, the sustaining strong demand has strained the semiconductor industry supply chain. As we indicated in the previous call, to further accelerate our revenue momentum and margin expansion, we are making prudent investments in our manufacturing infrastructure. Now, let me provide you additional details on our second quarter 2018 results. Total revenue for the second quarter of 2018 was $1,456 million, an increase of 9% as compared to revenue of $1,338 million in the second quarter of 2017. GAAP net income for the second quarter was $0.35 per diluted share as compared to $0.22 in the second quarter of 2017. Non-GAAP net income for the second quarter was $0.46 per share as compared to $0.36 in the second quarter of 2017. GAAP and non-GAAP gross margin for the second quarter was 38.1%. On a GAAP basis, our second quarter gross margin improved by 130 basis points year-over-year, and on a non-GAAP basis, gross margin improved by 120 basis points year-over-year. The strong gross margin performance was driven by solid operational execution and improving mixed results from higher contribution from our automotive industrial and server business. Second quarter gross margin was negatively impacted by rising input costs. We anticipate a ramp in additional internal wafer capacity. Towards the end of the year, we expect to partially offset the impact of increased input costs. With tailwinds from additional manufacturing synergies, ramp of internal raw wafer capacity, and continuing mixed improvement, we expect to make strong progress toward our target model in the current year. GAAP operating margin for the second quarter of 2018 was 13.5% as compared to 11.5% in the second quarter of 2017. Our non-GAAP operating margin for the second quarter of 2018 was 16.3%, an increase of approximately 160 basis points over 14.7% in the second quarter of 2017. On a year-over-year revenue increase of 9% for the second quarter of 2018, our non-GAAP operating income increased by 21%. This strong operating income performance demonstrates the leverage and strength of our operating model. GAAP operating expenses for the second quarter were $358 million, as compared to $338 million for the second quarter of 2017. Non-GAAP operating expenses for the second quarter were $318 million as compared to $297 million in the second quarter of 2017. We expect non-GAAP operating expenses as a percent of revenue to decline for the remainder of the year, and we expect to make strong progress in 2018 towards our target non-GAAP operating expense intensity of 21%. Second quarter free cash flow was $117 million and operating cash flow was $270 million. Capital expenditures during the second quarter were $153 million, which equates to capital intensity of 10%. Recall that to meet accelerating demand for our products and to mitigate the impact of steep rising prices of raw wafers, we expect to have a higher level of capital intensity in the current and next year. We continue to deleverage our balance sheet and in the second quarter we used $80 million to pay down our debt. We exited the second quarter of 2018 with cash and cash equivalents of $850 million, as compared to $925 million in the first quarter of 2018. We used $40 million cash to repurchase 1.7 million shares of our stock. At the end of the second quarter, the base of inventory on hand was 122 days, down by a day as compared to 123 days in the first quarter. Inventory increased in absolute terms in the second quarter as compared to the first quarter. A part of the increase was driven by strategic build of inventory of certain raw materials. As I indicated earlier, the semiconductor supply chain is strained and we're making prudent investments to ensure continuity of timely supply of our products to our customers. We intend to continue to build strategic inventory of raw materials until the supply situation stabilizes. We expect our internal inventories to continue to decline in terms of base in the third quarter. Distribution inventory declined quarter-over-quarter in the second quarter. We expect distribution inventories to remain within our normal range of 11-13 weeks in the near term. To mitigate the risks of excessive inventory in the channel, we are proactively managing inventory in the distribution channel. We have implemented systems to ensure that distributors don't carry more inventory than is needed to support 11-13 weeks of resales. For the second quarter of 2018, our lead times were up quarter-over-quarter. Our factory utilization for the second quarter was down quarter-over-quarter. Now, let me provide you an update on the performance of our business units, starting with the Power Solutions Group or PSG. Revenue for PSG for the second quarter was $748 million. Revenue for the Analog Solutions Group for the second quarter of 2018 was $513 million and revenue for the Intelligence Sensing Group, formerly known as the Image Sensor Group was $195 million. Now, I would like to turn the call over to Keith Jackson for additional comments on the business environment.

Thanks, Bernard. The second quarter of 2018 was yet another strong quarter for ON Semiconductor. We delivered strong revenue growth and robust margin expansion which culminated in strong earnings performance for the company. Our momentum continues to accelerate driven by strong traction of our products in automotive, industrial and server markets. Our design win pipeline continues to expand as customers increasingly engage with us for power, analog and sensor semiconductor solutions for the most demanding applications. We continue to strengthen our position as a key provider of enabling technologies for newly emerging and disruptive applications in automotive and industrial end markets. With tailwinds from increasingly favorable macroeconomic conditions and strong momentum in our business, we continue to make strong progress towards our target financial model. While we are benefiting from our leadership in key segments of automotive, industrial, and server markets, overall business conditions remain favorable and demand continues to be strong across most end markets. Pricing continues to be benign as compared to historic trends. Overhang related to trade policy and tariffs hasn't impacted the demand environment in any meaningful manner, and customers are upbeat about near to midterm outlook for their businesses. As I've indicated in recent earnings calls, our business today is driven by sustainable secular growth drivers in the fastest growing semiconductor end markets, as opposed to being driven by macroeconomic and industry cyclicality a few years ago. Through our investments over the last many years in high growth segments and in highly differentiated products in automotive and industrial end markets, we have radically transformed the nature of our business. Customers are increasingly relying on us as a key provider of enabling technologies for newly emerging and disruptive applications in automotive and industrial end markets. Along with strong revenue momentum, our execution on the operations front has been outstanding. Our operating model has shown strong operating leverage. As Bernard mentioned earlier, on a year-over-year revenue increase of 9% for the second quarter, our non-GAAP operating income increased by 21%. Despite increases in certain input costs which have negatively impacted the pace of our margin expansion, our margin drivers remain intact. With the ramp of our internal raw wafer capacity later this year, we should be able to partially offset the increase in input costs. At the same time, shifts towards margin-rich automotive and industrial end markets should drive additional margin expansion. Now I'll provide details on the progress in our various end markets for the second quarter of 2018. Revenue for the automotive market in the second quarter was $454 million, representing 31% of our revenue in the second quarter. Second quarter automotive revenue grew by an impressive 10% year-over-year. For the second quarter, we again saw strong broad-based demand for most product lines, and our momentum in the automotive market continues to accelerate driven by a robust design win pipeline and leadership in the fastest growing segments of the automotive market. During the second quarter, we saw strong demand for image sensors for ADAS applications. Our traction in ADAS image sensors continues to accelerate. With the complete line of image sensors including 1, 2 and 8 megapixels, we are the only provider of a complete range of pixel densities on a single platform for the next generation ADAS in autonomous driving applications. We believe that a complete line of image sensors on a single platform provides us with significant competitive advantage, and we continue working to extend our technology lead over our competitors. Demand for power products for automotive applications continues to grow. With one of the broadest power portfolios in automotive applications, we continue to see strong growth in our power-related revenue for automotive applications. Other growth drivers for the second quarter automotive revenue included power management for ADAS and instrument clusters, LED lighting, start-stop alternators, and 48-volt systems. Also, we are seeing strong growth for our silicon-based power products in the EV/HEV market. Our silicon carbide development remains on track and we expect to see silicon carbide-related revenue from the automotive market in the second half of this year. Recently, we announced the formal launch of our silicon carbide diodes for the automotive market. Our silicon carbide-related design win pipeline is expanding at an impressive rate. We are well-positioned to benefit from the transition to 48-volt electric systems from 12-volt in automobiles. Due to the proliferation of electric systems such as ADAS, infotainment, connectivity, etc., the 12-volt automotive electro system is being burdened by technology. Furthermore, due to ever-tightening global CO2 emission regulations and increased demand for improved fuel economy, light vehicles are in need of more power as electromechanical systems transition to highly efficient full electric systems. The need for higher power in light vehicles is driving the transition to 48-volt electric systems. ON Semiconductor offers an expanding portfolio of 48-volt products including a full line of MOSFETs, integrated power modules, currents and amplifiers, gate drivers and EP devices. Revenue in the third quarter for the automotive end market is expected to be up quarter-over-quarter. The industrial end market, which includes military, aerospace, and medical, contributed revenue of $402 million in the second quarter. The industrial end market represented 28% of our revenue in the second quarter. Our second quarter industrial revenue grew by a solid 14% year-over-year, and strength in the industrial market was very broad-based with all the sub-segments posting robust year-over-year growth. With a broad range of power products for the complete spectrum of voltages starting from low voltage to high voltage, we have one of the most comprehensive portfolios of power devices and modules. We have clearly emerged as a credible alternative to the current leader in the power semiconductor market and consequently, customers are engaging with us at an increasing rate. We expect the demand for our power products for the industrial market to continue to accelerate. While the EV/HEV market is a key driver for our automotive business, we are also seeing complementary growth in our IGBT business driven by charging stations for EV/HEV. Along with our power products, machine vision is rapidly emerging as a key driver of our industrial revenue. As we have indicated earlier, according to independent research firms, ON Semiconductor is the leader in image sensors for industrial applications. We continue to leverage our expertise in the automotive market to address the most demanding applications in industrial and machine vision markets. Both of these markets are driven by artificial intelligence and face similar challenges such as low light conditions, high dynamic range, and harsh operating environments. Revenue in the third quarter for the industrial end market is expected to be down quarter-over-quarter. The communications end market, which includes both networking and wireless, contributed revenue of $249 million in the second quarter. The communications end market represented 17% of our revenue in the second quarter. Second quarter communications revenue declined by 3% year-over-year due to weakness in the smartphone market. While the smartphone market has slowed down during the last few quarters, our content in smartphones has been increasing with every generation of new devices. We expect continued growth in our content on new smartphone devices in the near to midterm. Revenue in the third quarter for the communications end market is expected to be up quarter-over-quarter due to normal seasonality, increased content and a launch of new device models. The computing end market contributed $147 million in the second quarter. The computing end market represented 10% of our revenue in the second quarter. Second quarter computing revenue grew by 17% year-over-year. The year-over-year growth was driven primarily by a ramp in our cloud and server business. We are seeing strong traction in our server business. We are engaged with leading cloud and server players and we are working with leading CPU providers on their next-generation platforms. Our engagement with customers in cloud servers and server ecosystems continues to grow. We expect continued growth in our server business in the near to midterm. In addition to on-board power management, we are seeing acceleration in demand for our mid-voltage and high-voltage power products for server power supplies. Revenue in the third quarter for the computing end market is expected to be up quarter-over-quarter due to normal seasonality and a continuing ramp in the server business. The consumer end market contributed $203 million in the second quarter. The consumer end market represented 14% of our revenue in the second quarter. Second quarter 2018 consumer revenue was up 7% as compared to consumer revenue in the second quarter of 2017. Strength in white goods was a key driver of year-over-year growth in the consumer end market in the second quarter. Revenue in the third quarter for the consumer end market is expected to be up quarter-over-quarter due to normal seasonality. In summary, demand for our products is accelerating, driven by strong customer acceptance of our power, analog, and sensor products for automotive, industrial and server end markets. In the face of strong demand environment and constrained supply conditions in the semiconductor industry, our execution remains solid on all fronts. We're investing to increase our manufacturing capacity and further strengthen our industry-leading cost structure. We have established leadership in highly differentiated power, analog, and sensor semiconductor solutions. Customers are increasingly relying on us as a key provider of enabling technologies for newly emerging and disruptive applications in automotive and industrial end markets. Along with strong revenue performance, we are driving significant margin expansion. We continue to make solid progress towards our target financial model. Now I'd like to turn it back over to Bernard for forward-looking guidance.

Thank you, Keith. Based on product booking trends, backlog levels, and estimated turn levels, we anticipate the total ON Semiconductor revenues will be $1.485 billion to $1.535 billion in the third quarter of 2018. For the third quarter of 2018, we expect the GAAP gross margin to be in the range of 38% to 39% and non-GAAP gross margin in the range of 38.1% to 39.1%. Factory utilization in the third quarter is likely to be flat as compared to that in the second quarter. We expect total GAAP operating expenses of $348 million to $366 million. Our GAAP operating expenses include the amortization of intangibles, restructuring, asset impairments and other charges which are expected to be $29 million to $33 million. We expect total non-GAAP operating expenses of $319 million to $333 million. We expect our non-GAAP operating expenses as a percentage of revenue to decline from current levels during the remainder of the year. We anticipate third quarter GAAP net other income and expense including interest expense will be $32 million to $35 million, which includes non-cash interest expense of $9 million to $10 million. We anticipate our non-GAAP net other income and expenses including interest expense will be in the $23 million to $25 million. Cash paid for income taxes in the third quarter of 2018 is expected to be $11 million to $15 million. We expect our 2018 cash tax rate to be lower than 10%. We expect total capital expenditures of $120 million to $140 million in the third quarter of 2018. We also expect share-based compensation of $19 million to $21 million in the third quarter of 2018, of which approximately $2 million is expected to be in cost of goods sold and the remaining amount is expected to be in operating expenses. This expense is included in our non-GAAP financial measures. Our GAAP diluted share count for the third quarter of 2018 is expected to be in the 445 million to 447 million shares based on current stock price. Our non-GAAP diluted share count for the third quarter of 2018 is expected to be 432 million shares based on the current stock price. Further details on share count and earnings per share calculations are provided regularly in our quarterly and annual reports on Form 10-Q and Form 10-K. For the full year of 2018, we expect to generate free cash flow of approximately $800 million. With that, I would like to start the Q&A session. Thank you, and please open up the lines for questions.

Hi, guys. Thanks for letting me ask a question. Keith, first one for you. At a high level, demand sounds strong across the board and I know you talked about the secular drivers versus the cyclical drivers. But when you're putting this much CapEx to work, how do you think about the magnitude capacity you want to bring online and the duration of the elevated CapEx versus an industry that is cyclical and a macroeconomic expansion that a lot of people will argue is long in the tooth?

Understood. Yes. We have been investing specifically to match the growth we've had for the last couple of years looking in the high single digits, low double-digits. That has put a strain on our overall capacity and frankly, we're looking at economical ways to extend that capacity. So we're not getting ahead of things, we're certainly not putting capacity in place that we expect to be idling. The other piece of it is all of the work we've been doing is going to lead to further cost reductions overtime with more automation as we've been investing. So net-net, we're expecting at least another year of high single-digit growth. We're investing for that and then we should return to a much more normal 6% to 7% growth.

Great. Thanks for that. And then as my follow-up for you, Bernard, on the OpEx side of things, you talked about the OpEx intensity falling through the back half of the year. Obviously, we can do the math on what you just guided to in the third quarter. But in the fourth quarter, typically your revenues go down a little bit seasonally. Is your OpEx guidance that you're actually going to be able to get better OpEx leverage even into the fourth quarter? And then how should we think about next year on that same metric?

The only clarification is on the fourth quarter; we have a few extra days. That is something that will have to be considered. However, we still expect to decrease from the 22% level we had last year and the 21.8% we had in the first half.

Hey. Thanks, guys. Just a follow-up on OpEx. In Q1, that was at the high end of the range you guide for and this quarter I think it was either the high end of the range or above it. So can you just talk about why it has missed the middle of expectations or I guess what has gone wrong so far and what you're doing to fix it going forward?

We were within the expected range in the second quarter, slightly below the high end, but still on target. We aim to boost our investments in research and development in specific areas we’ve discussed, such as silicon carbide and LiDAR, along with all power discrete products. We’ve decided to allocate additional funds to these initiatives. Additionally, we've faced significant higher mitigation costs. Thus, while we anticipate an increase in dollar terms in the third quarter, this will represent a lower percentage of revenue. The primary factor contributing to this is the increased R&D investments.

Yes. And then on the tightness in the industry, can you just talk about what your lead times are doing or what lead times are doing at the competitors as well?

We believe lead times are extended across the board everywhere. We did have a slight increase ourselves in the last quarter. I'm not sure that that will continue to expand. I expect that it will start to normalize quickly as capital expenditures finally catch up in the second half.

Thanks, Keith. Just a clarification, can you just tell us what the lead times were and what is normal?

Normal is kind of low-teens, and we are above that at this time.

Thanks for taking my question and congratulations on good growth and execution. Keith, on the wafer capacity investment, is there something that helps you meet your 40% gross margin target? Or can you actually see that investment driving, beating off that target? I think we sort of know what the cost is of all these investments, but what, and when, and how much is the benefit on that they should see?

Yes. On the actual wafer growing side, it's offsetting a lot of increased costs, but frankly, we need that to handle increased demand right now. It's moderating the overall cost in the supply chain, as opposed to offering real reductions in total because again, we need all the capacity there.

Okay. And then when you started, your top line growth was expected to be about 3% to 4%. You're growing closer to 9%. Is this macro? Is this your specific product cycle? Just how is your visibility to maintain this kind of growth over the next handful of quarters?

Yes. We're very encouraged and it's being driven by specific high growth applications in our target markets. So it's not just a strong economy; it's frankly the acceleration of electronic usage in automotive for safety and automation, and industrial for power savings and new applications to support things like charging stations in the market place. So very encouraged, it's a design win pipeline, it is accelerating faster than we expected and not just a strong economy.

And just last quick one clarification. Bernard, can you remind us how much is left in the buybacks and what would be the trigger to become more aggressive on the buyback side?

The buyback, we had for about $1 billion, we have used, we are still around $600,000 available. We did $40 million in the second quarter which we presented about $1.7 million. Now we are still also being down our debt. As we mentioned in the prepared remarks, we reduced our debt by about $80 million.

Thank you.

All right. Good morning and congrats on the result. Is there a way to maybe clarify how much margin pressure are you seeing right now from the input cost or profitability that you're leaving on the table that will begin to mitigate in the second half of the year?

We've had price increases on substrates from 25% to 40% increase year-over-year and then the lead frame area around 15% year-over-year. Those are very significant pressures. We've been able to partially offset that with some good pricing on our side, not having the declines that we normally see there. Being able to maintain that has partially offset that.

Okay. And then maybe a question for you, Bernard. Getting to the $800 million free cash flow for the year requires a big step up into the second half. Maybe if you could just speak to the components of the acceleration in free cash flow and knowing it's typically a little bit back end weighted.

Yes, Shawn. Thank you. Definitely, historical pattern shows us that the free cash flow generation is substantially back-end loaded and we expect that pattern will continue. We did step up on our CapEx in the second quarter, even beyond 8% to 9% small lift, so expect that will be normalizing to that 8% to 9% and we have some investments as we talked about in working capital. Some of those will be slowing down in the third and fourth quarter. But we expect the operational performance will also help us lift those numbers.

Hi, good morning. Just wanted to follow up on an earlier question. So you've mentioned price increases in substrates and wafers. What was the best impact on your gross margin? And what will be the percent change in your own ASPs embedded in the Q3 guidance?

Take in reverse order, our ASP expectations and the guidance is relatively benign compared to normal, not increasing. Still a slight decline, but not very much. As far as contributions or margin pressure in our results, the raw materials side of the equation represents roughly 40% or more of the costs for the products. So if you use the percentages I gave you, you'll get a rough idea of how much pressure there was.

Okay, great. And then could you tell us on the point of sale, how the sell-through was sequentially in Q2 and whether there was a percent change embedded in your Q3 guidance?

Tristan, can you repeat the question, please?

I was looking at percentage change in point of sales, so the sell-through in Q2 sequentially and...

Yes. Resales in the channel were substantially up and that allowed us to reduce the number of weeks of inventory. It was definitely higher up even than our own internal revenue printout.

And for Q3?

We expect it to be up and about seasonal.

Great. Thank you very much.

Hi. Thank you. Good morning. The first question is on the communications base. It looks like that came in a little better than your expectations. Can you talk about what you're seeing in that space and the expectation as you move into the September quarter?

The September quarter, as you would guess, sees new phone launches, which is the bigger piece of the revenue there. So we are expecting continued sequential increase there per normal. Again, year-on-year comparisons which we gave in our prepared remarks for Q2, certainly things were down. Q3 should see something returning to very similar levels to last year.

Okay, thank you. And just a follow-up, you mentioned in your prepared remarks, silicon carbide. Just a couple of questions on that. Can you talk about when that becomes material in terms of revenue? I guess the expectation that will build in the second half of this year into 2019. Maybe talk a bit about what you expect to differentiate in the silicon carbide space?

Basically, there it is performance-based. In most of our sales, we expect to happen in modules where we get to match performance with our full portfolio. So therefore, we do think there is going to be a competitive edge on total efficiency in the marketplace. That growth again starts here in the second half, but we expect it will accelerate significantly in 2019 and by the second half of next year provide significant revenue.

Thank you.

Yes. Thanks and congrats on good results and momentum. You talked about capacity constraints and that has plagued the industry and one of other competitors as well. I was wondering if you could kind of explain why that is happening? Did the entire industry underestimate the level of demand that's happening? Any thoughts on the capacity constraint environment and one of the reasons?

Well, there are several levels of reasons for constraints. I think the raw material piece of it frankly is under-investment that occurred in both silicon substrate markets and lead frame markets for the last number of years. Again, under-calling if you will, the future demands and that's creating a lot of pressure on the supply chain side and then frankly, on the product side, if you can get through that, some of the disruptive applications have taken off much, much faster than people expected. That combination has provided quite a few constraints in the market.

Bernard, you have mentioned that you believe you'll be able to reach your target model this year. Were you talking about with respect to gross margins? I believe your growth margin target was 40%, achieved in 2020.

We have indicated that we are making good progress towards our goals. The target model remains set for 2020, and while we are working to accelerate and make advancements, we do not anticipate meeting it in 2018.

Good morning. Thanks for taking my question. In the prepared comments, you mentioned that industrial is expected to be down sequentially in the third quarter. Albeit up meaningfully year-over-year, is it just the effects of normal or typical seasonality? Or is there something else in play here?

It's mostly seasonality.

Okay, great. And then keeping on that track of seasonality, you referred from some other peers that in typical seasonality has been almost altered over the past couple of years. Have you seen that in your businesses as well, or are you still speaking to generally historical trends?

I think our company specifically with the M&A that we've done, we've had a change in profile, but directionally, that seasonality is still correct. I would say that in general terms, the Q2 to Q3 has moderated a little bit and it's now around 3% to 4%. It used to be more because you had more computing and consumer and combinations in the number. And now with automotive and industrial, it's a little bit more front-loaded, but hasn't changed materially.

Great. Thank you.

Yes. Thanks for taking the question and congratulations on the execution, guys. Keith, I wanted to follow up on one of the Q&A comments. I think it was in response to Ross' question about CapEx. I think you mentioned that some of the investment that is being made now is because there's a view that high single-digit growth could persist into 2019. I wanted to understand better where that visibility might exist across product groups and is that really related to the strategic groups like industrial and auto, or the business overall?

Yes. It's driven mainly by industrial and auto and the design wins that we have secured there enhance strong visibility on. The server market, also the same situation where we know what those design wins are next year and then in addition to that, I mentioned in the last call, we're getting long-term agreements for supply and those are adding up quickly. So we have much more confidence than we normally would have, looking at a year ahead.

Thanks for that. Then the follow up is for Bernard. Just a housekeeping item, Bernard. Tax rates, should we still expect 10% for this year and the next couple of years, or is it coming in lower than that?

I expect it for 2018 to be lower and that's why I said in the prepared remarks and for the 19%, 20%, 10% is still a good number.

Thanks, guys.

Thank you for the question. I understand that in your prepared remarks, you mentioned not seeing any effects from tariff concerns. However, one of your competitors noted that in the white box market, while you have been performing well, they found that customers were hesitant to hold finished goods inventory. Can you speak to that? Are you experiencing any effects related to this? Also, could you share your broader perspective on tariff concerns?

We have not seen that in any of the businesses yet. The white goods piece, the tariffs got implemented on the consumer white goods some time ago, several quarters ago. So I'm not sure how that plays out, and in the air conditioner market, we have not seen any of those concerns. Quite frankly, we've seen no lack of demand and no hesitation from customers ordering to their run rate.

Great, and one for Bernard. I noticed you changed your range, you narrowed it for a gross margin guidance and I was just wondering what gives you more confidence there? And should we expect that narrow range looking forward?

We were just looking at our historical patterns and we feel confident that we don't need as wide a range for guiding purposes. Historical performance tells us that we should be able to stay within that range.

Thank you, and congratulations on the great result. Keith, you mentioned in your prepared remarks about the increased interest in higher voltage power supplies. Are you noticing any trends? I know Google has stated that 48-volt systems are being introduced in data centers for improved power efficiency. Are you seeing...

Yes. Definitely planning around that, not a lot of revenue today.

Okay. With the same products that you're developing for automotive, be able to play into that?

Same technologies. The products are actually different, but the technologies are the same.

Okay. If I could ask one other. On the internal wafer, I think last quarter, you have said there was slightly less than 15% of your total usage. What's the target? How high of a percentage do you expect to have internal wafers?

We're expecting to bring it up to about that 50% point and that's our target unless the industry continues to experience difficulties.

Yes. Good morning and thanks for taking the question. My first question is a follow up on that same topic about the internal raw wafer supply. Are you seeing any benefit from increased internal supply in your Q3 '18 guidance and when would you expect to have that full 50% from in-house wafers?

Yes. The equipment doesn't really get up and running until the third quarter, which means those substrates won't fall through to our P&L until the fourth. So we should start seeing benefits in the fourth quarter and full benefits by Q1.

It's helpful. A follow-up question on the industrial market and the prepared comments. You mentioned share gain and the strong year-over-year growth. Do you have a sense about how much is just product cycles and just on-demand and how much of it is coming from that share gain that you guys spoke to?

You can look at the industry numbers to figure out what the year-over-year market gains would be and all the delta would be from share gains. I don't know if it's half and half, but it's something in that order of magnitude.

Good morning. Great job on the quarter and the execution. ISG was down about 2% year-over-year, but when you combine it with your industrial business, it's growing about 12%. I understand you've mentioned some headwinds as you transition away from certain commodity segments of the market, which may be masking some growth in your focus areas. You've also previously indicated that the auto-image sensor market is expected to grow about 20% on a long-term CAGR. Is that the rate at which auto ISG revenue is currently trending?

Yes, it is. They're better than 20% growth in the automotive sector and that was offset by getting out of the consumer and handset markets. It is somewhat masking the total level, but we're getting the performance from automotive we expect.

Great. Thanks for the insights there. And consumer, there's been a bright spot where it's been healthy driving a high single-digit, year-over-year growth actually for the last few quarters and this is versus your long-term view of mid to high single-digit year-over-year declines. Help us understand what's been driving the strong year-over-year growth rates and do the trends here and your design win pipeline suggest a better longer-term outlook versus what you guys put out at your last Analyst Day?

Yes. Most of it has been driven by better-than-expected white goods. That market has been good for us and it looks like people there are going for much more efficient solutions on a percentage of their total builds than they used to be doing. So we're getting good traction on our modules there.

Great. Thank you.

Hey, guys. Congratulations on solid numbers and solid guidance. I had two quick questions. Your industrial business sort of exploded up to 14% growth year-over-year, coming down seasonally in Q3. I guess if you don't mind, giving us some insight into what's driving that, what drove that 14% growth and embeds a delta pod that's falling for you on Q3 guide and then I have a follow up.

Yes. That year-over-year growth was driven by many factors. Mostly power products and being used for increased efficiency across the entire industrial market. One of the areas that this caused in flattening is a slowing down in the solar market. Particularly in China as some of those subsidies have been relaxed. So that's creating a little bit of the down, but in general, the market remains robust and we expect again very strong growth on a yearly basis.

Thanks, Keith. And then from my follow up, a couple of other companies that have reported have basically given us some idea of how much of their product is manufactured in China, front and back end. Is there some way for us to think about or some color you can provide us to help us think about that number?

We do assembly test operations in China and I don't have specific numbers with me today, but it's probably in the third range on a dollar value of our total.

Yes. Thank you. Keith, just a follow-up question on lead time. You used to comment around normalizing quickly as capacity comes online. Do you think that's a Q3 or Q4 event in terms of lead times coming in?

No. I think the expansion will start slowing. What happened to us and I think has happened across the industry is that lead times or equipment expanded quite rapidly. So things you ordered last year just now coming into the third and fourth quarter. What I'm expecting is that that growth rate will be offset by equipment actually arriving. So I'm looking for a stop to the growth in the lead times in the third quarter with some opportunity for reduction towards Q4, Q1.

Got it. Thanks. And just a question on the computing market, just researching some growth there and you talked about data center. Any context in terms of legacy, Fairchild portfolio in terms of contribution there and as you see things going forward?

Well, a significant growth in the server arena is really from the legacy, or not legacy, but from the Fairchild acquisition. There is a power stage that they developed or what's growing the fastest in servers right now.

Good morning, everyone. Thank you for allowing me to ask a question. Can someone clarify the industrial guidance for Q3 in relation to seasonal factors? I would also like to ask about the automotive sector, which appears to be the only end market not mentioned in relation to seasonality. Over the past four years, performance has varied, with two years showing a decline and two years showing an increase, but your guidance is positive. What is driving this growth in relation to seasonal factors, content growth, and other influencing elements for September?

Yes. For us it's all content growth because most of the automotive makers take their lines down and convert them for the new models in Q3, which normally causes the disruption and the down part. And this year, the content piece has overwhelmed that.

Thank you, Keith. Based on product booking trends, backlog levels and estimated turn levels, we anticipate the total ON Semiconductor revenues will be $1.485 billion to $1.535 billion in the third quarter of 2018. For the third quarter of 2018, we expect the GAAP gross margin to be in the range of 38% to 39% and non-GAAP gross margin in the range of 38.1% to 39.1%. Factory utilization in the third quarter is likely to be flat as compared to that in the second quarter. We expect total GAAP operating expenses of $348 million to $366 million. Our GAAP operating expenses include the amortization of intangibles, restructuring, asset impairments and other charges which are expected to be $29 million to $33 million. We expect total non-GAAP operating expenses of $319 million to $333 million. We expect our non-GAAP operating expenses as percentage of revenue to decline from current levels during the remainder of the year. We anticipate third quarter GAAP net other income and expense including interest expense will be $32 million to $35 million, which includes non-cash interest expense of $9 million to $10 million. We anticipate our non-GAAP net other income and expenses including interest expense will be in the $23 million to $25 million. Cash pay for income taxes in the third quarter of 2018 is expected to be $11 million to $15 million. We expect our 2018 cash tax rate to be lower than 10%. We expect total capital expenditures of $120 million to $140 million in the third quarter of 2018. We also expect share-based compensation of $19 million to $21 million in the third quarter of 2018, of which approximately $2 million is expected to be in cost of goods sold and the remaining amount is expected to be in operating expenses. This expense is included in our non-GAAP financial measures. Our GAAP diluted share count for the third quarter of 2018 is expected to be in the 445 million to 447 million shares based on current stock price. Our non-GAAP diluted share count for the third quarter of 2018 is expected to be 432 million shares based on the current stock price. Further details on share count and earnings per share calculations are provided regularly in our quarterly and annual reports on Form 10-Q and Form 10-K. For the full year of 2018, we expect to generate free cash flow of approximately $800 million. With that, I would like to start the Q&A session. Thank you, and please open up the lines for questions.

Hi, guys. Thanks for letting me ask a question. Keith, first one for you. At a high level, demand sounds strong across the board and I know you talked about the secular drivers versus the cyclical drivers. But when you're putting this much CapEx to work, how do you think about the magnitude capacity you want to bring online and the duration of the elevated CapEx versus an industry that is cyclical and a macroeconomic expansion that a lot of people will argue with long in the tooth?