Parag Agarwal - Senior Director of Investor Relations Bernard Gutmann - Chief Financial Officer, Principal Accounting Officer, Executive Vice President, Treasurer, Chief Financial Officer of Semiconductor Components Industries LLC, Executive Vice President of Semiconductor Components Industries LLC and Treasurer of Semiconductor Components Industries LLC Keith D.

Jackson - Chief Executive Officer, President, Director, Member of Executive Committee, Chief Executive Officer of Semiconductor Components Industries LLC and President of Semiconductor Components Industries LLC.

Matt Diamond - Deutsche Bank AG, Research Division Vivek Arya - BofA Merrill Lynch, Research Division Gabriela Borges - Goldman Sachs Group Inc., Research Division Craig A. Ellis - B. Riley Caris, Research Division Christopher Rolland - FBR Capital Markets & Co., Research Division Tristan Gerra - Robert W. Baird & Co.

Incorporated, Research Division Ian Ing - MKM Partners LLC, Research Division Jonathan Steven Smigie - Raymond James & Associates, Inc., Research Division Dean Grumlose - Stifel, Nicolaus & Company, Incorporated, Research Division Betsy Van Hees - Wedbush Securities Inc., Research Division Vijay R.

Rakesh - Sterne Agee & Leach Inc., Research Division Christopher Caso - Susquehanna Financial Group, LLLP, Research Division Vinayak Rao - Morgan Stanley, Research Division.

Good afternoon. My name is Vanessa, and I will be your conference operator today. At this time, I would like to welcome everyone to the Third Quarter 2014 Earnings Conference Call. [Operator Instructions] I would now like to turn the call over to Mr. Parag Agarwal. Please go ahead, sir..

Thank you, Vanessa. Good afternoon, and thank you for joining ON Semiconductor Corporation's Third Quarter 2014 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 at www.onsemi.com.

A replay will be available at our website approximately 1 hour following this live broadcast and will continue to be available for approximately 30 days following this conference call, along with our earnings release for the third quarter 2014. The script for today's call is posted on our website.

Additional information related to our end markets, business segments, geographies, channels and share count is also posted on our website. Our earnings release and this presentation includes certain non-GAAP financial measures.

Reconciliation 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 the 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.

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 the third quarter of 2014.

Our estimates may change, and the company assumes no obligation to update forward-looking statements that reflect actual results, changed assumptions or other factors. I take this opportunity to remind you of our 2015 Analyst Day, which we plan to host on February 26, 2015, in Scottsdale, Arizona.

We will be mailing formal invitations and further details on our 2015 Analyst Day shortly. Also, during the current quarter, we will be attending the Crédit Suisse Technology Conference in Scottsdale, Arizona on December 3. Now let me turn it over to Bernard Gutmann, who will provide an overview of third quarter 2014 results.

Bernard?.

Thank you, Parag, and thank you, everyone, for joining us today. Let me start by providing an update on overall business results. For the third quarter, our core business was impacted by a slowdown in orders in the second half of September.

This slowdown continued into October, but in the past few weeks, we have seen a recovery in orders for shipments in the first half of 2015. This recovery in orders leads us to believe that the fundamentals of our business remain strong, and we see no evidence to suggest a drastic shift in demand patterns for our products.

We remain confident in strength of our -- in the strength of our business, and prevailing supply-demand dynamics in the industry remain favorable with low levels of channel inventories.

However, we remain cognizant of developments on global macroeconomic and geopolitical fronts, and we are prepared to align our business with any changes in the demand environment. Integration of our recent acquisitions of Truesense and Aptina Imaging is progressing well.

We remain on track to deliver projected financial results provided at the time of announcement of our acquisition of Aptina.

For the third quarter, Aptina was slightly accretive to our non-GAAP net income, which excludes the impact of such items as costs related to restructuring, fair market value step-up of inventory, amortization of intangibles and other special items. Keith will provide additional color on the progress of Aptina and Truesense.

Now let me provide you an update of our third quarter 2014 results. ON Semiconductor today announced that total revenue for the third quarter of 2014 was approximately $834 million, an increase of approximately 10% as compared to the second quarter of 2014.

Included in our third quarter results is the contribution from our acquisition of Aptina Imaging, which closed on August 15, 2014. GAAP net income for the third quarter was $0.09 per diluted share.

Excluding the impact of amortization of intangibles and restructuring, step-up valuation of inventory and other special items, non-GAAP net income for the quarter was $0.21 per diluted share. GAAP gross margin for the third quarter was 34.1% as compared to 36% in the second quarter of 2014.

Non-GAAP gross margin for the third quarter was 35.6%, down approximately 60 basis points, quarter-over-quarter. Non-GAAP gross margin in the third quarter declined quarter-over-quarter, primarily due to the inclusion of Aptina in our financial results. Gross margin for Aptina is currently below that of our core business.

However, as we had indicated at the time of announcement of the acquisition, we expect to see a steady improvement in Aptina's margins going forward, as we integrate Aptina's operations with ours. On a year-over-year basis, our non-GAAP gross margin improved by approximately 80 basis points.

This improvement in non-GAAP gross margin was driven by improved operating performance and significant progress in restructuring of the System Solutions Group, partially offset by the inclusion of Aptina in the third quarter results. Average selling prices for the third quarter decreased by approximately 2% as compared to the second quarter.

GAAP operating margin for the third quarter of 2014 was 6.9% as compared to 10.8% in the second quarter. Our non-GAAP operating margin for the third quarter was 13%, down approximately 40 basis points as compared to the second quarter of 2014.

Inclusion of Aptina's results in our financial results was the key driver for sequential decline in the non-GAAP operating margin for the third quarter. On a year-over-year basis, our non-GAAP operating margin improved by approximately 90 basis points in the third quarter.

GAAP operating expenses for the third quarter were approximately $227 million as compared to approximately $191 million for the second quarter of 2014. Non-GAAP operating expenses for the third quarter were approximately $189 million, up approximately $16 million as compared to the second quarter of 2014.

The sequential increase in non-GAAP operating expenses was driven primarily by the inclusion of Aptina and a full quarter of Truesense in our results. We exited the third quarter of 2014 with cash and cash equivalents and short-term investments of approximately $495 million, a decrease of approximately $106 million from the second quarter of 2014.

Operating cash flow for the third quarter was approximately $92 million as compared to approximately $152 million in the second quarter. We spent approximately $67 million of cash for the purchase of capital equipment and approximately $372 million for the purchase of Aptina.

We borrowed approximately $230 million from our revolving line of credit to finance the acquisition of Aptina.

During the third quarter, we used approximately $33 million for the repayment of long-term debt and capital leases, and we used approximately $23 million to repurchase approximately 2.6 million shares of our common stock at an average price of $9.23.

At the end of the third quarter, approximately $89 million remained of the total authorized amount under the current stock repurchase program. We intend to utilize this remaining amount of $89 million before the end of the current stock repurchase program in August of next year.

We remain on track to generate annual free cash flow of $300 million to $400 million in the near to midterm. We define free cash flow as cash flow from operations less capital expenditures. We expect our capital expenditure should remain in the current range of 6% to 7% of revenue in the near to midterm.

At the end of the third quarter, ON Semiconductor days of inventory on hand were 123 days, up 4 days from our prior quarter. Excluding the impact of fair market value step-up of Aptina's inventory, days of inventory at the end of the third quarter were 121 days.

I would like to point out that in calculating the number of days of inventory, even though we used quarter-ending inventory number for Aptina, we used only 6 weeks of COGS, as the acquisition closed on August 15.

Adjusting Aptina's COGS for the full quarter, days of inventory, excluding fair market value step-up, at the end of the third quarter would have been approximately 110 days.

In the third quarter of 2014, distribution inventory was up approximately $12 million quarter-over-quarter, and distributor resales increased by approximately 1% quarter-over-quarter. In terms of days, distributor inventory was up marginally quarter-over-quarter and remained within the 9-week range in the third quarter of 2014.

For the third quarter of 2014, our lead times were approximately flat as compared to the second quarter. In the third quarter, our global factory utilization was in the high 80% range as compared to the mid- to high-80% range in the second quarter.

Now let me provide you an update on performance of our business units, starting with our newest reporting segment, the image-sensor group or ISG. This segment incorporates our acquisitions of Aptina and Truesense, our imaging business acquired from Cypress in 2011 and our optical sensor business.

Revenue for our image-sensing group was approximately $104 million as compared to approximately $24 million in the second quarter. Included in ISG's results for the third quarter is the contribution of approximately 6 weeks from Aptina and a full quarter from Truesense.

Revenue for our Standard Products Groups for the third quarter of 2014 was approximately $317 million, up approximately 4% quarter-over-quarter. Revenue for applications product group was approximately $266 million, down approximately 4% quarter-over-quarter.

Revenue for the third quarter of 2014 for the System Solutions Group was approximately $147 million, down approximately 4% quarter-over-quarter. The performance of the System Solutions Group continues to improve steadily, and in the third quarter, SSG was accretive to our non-GAAP EPS, with contribution of approximately $0.01.

In line with our stated goal, we expect SSG to be accretive to our non-GAAP net income for the full year of 2014. Non-GAAP EPS and net income exclude the impact of such items as cost related restructuring amortization of intangibles and special items.

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

Keith?.

Thanks, Bernard. Although our third quarter results and outlook for the fourth quarter were impacted by a slowdown in order patterns, we believe that our business remains strong. Based on the order activity during the second half of October, we believe that the recent pause in order activity was temporary.

As Bernard indicated in his remarks, we've seen a recovery in order activity during the past few weeks. While the data thus far is limited and business conditions can change quickly, based on current trends, we believe that business conditions should improve significantly in early 2015.

Despite the recent slowdown, supply-demand dynamics continue to be favorable, with lean inventories in the supply chain. In addition to normalization in business conditions, our design wins and a vastly expanded portfolio of image sensors from our recent acquisitions should enable us to drive strong growth.

Our outlook for our key strategic markets, which include industrial, automotive and smartphones, remains intact and we will continue to invest to drive growth in these market segments. Customer response to our acquisitions of Truesense and Aptina Imaging has been very encouraging and has exceeded our expectations.

A number of leading OEMs and integrators have reached out to us with intent to partner with us for next-generation of Image Processing Systems for automotive and industrial applications.

The acquisition of Aptina and Truesense has opened new doors for us and positioned us to further increase our presence with key accounts in automotive and industrial end markets.

With the heightened level of customer activity, and our existing design win pipeline, we are increasingly more confident of delivering strong financial performance for Aptina and Truesense. We believe, we now have in place an optimal operational structure, which will enable us to generate significant operating leverage from revenue growth.

Restructuring related to the System Solutions Group is effectively complete, and we are beginning to see positive impact on our margins and earnings from SSG. We remain on track to realize full impact of the $4 million quarterly savings by first quarter of 2015 from the closure of our back-end manufacturing facility in Japan.

Performance of our core business remains strong. We plan to complement the strength of our core business with strong performance by our recent acquisitions of Aptina and Truesense. We are looking forward to a higher level of EPS accretion from these acquisitions in 2015 and beyond.

Now I'll provide some details of the progress in our various end markets. The automotive end market represented approximately 29% of our revenue in the third quarter and was up approximately 7% quarter-over-quarter. Contribution from Aptina was a key driver of sequential growth.

Solid design win activity continued during the third quarter and included strong adoption for our SmartFET, LED driver, MOSFET, intelligent power modules, igniter and protection solutions.

These wins specifically address body electronics, lighting, active safety and powertrain applications, which are at the core of our automotive customer alignment strategy. During the quarter, we received a commitment from a major Korean OEM for body electronics and lighting solutions for next-generation vehicles.

Additionally, we secured a win at a key Tier 1 customer for body computer applications, in which our relay driver and SmartFETs have been designed into a high-volume program for a major European OEM. Our image-sensor business for automotive continued to gain traction worldwide, with acceleration adoption of our rear view camera solutions.

During the quarter, we expanded our rear view image sensor product portfolio with the introduction of an innovative VGA system-on-chip for high-performance applications. Standard product revenues for automotive hit record highs this quarter, driven by MOSFETs, rectifiers, small signal, zeners and protection devices.

On the new product front, a key milestone was achieved with the qualification of our latest IGBT igniter solution, which utilizes an Ignition IGBT from our Application Products Group and a control IC developed by our System Solutions Group. Revenue for the fourth quarter for our automotive segment is expected to be up quarter-over-quarter.

The communications end market, which includes both networking and wireless, represented approximately 19% of our revenue in the third quarter and was up approximately 20% quarter-over-quarter, driven by ramps of new programs and contribution from Aptina.

Despite an impressive 20% sequential growth, our communications revenue lagged our expectations due to softness in the Asia-based smartphone market. We continue to gain market share in the smartphone market with our battery protection, battery chargers, protection devices, filtering and power management ICs.

Traction for our autofocus and image stabilization solutions for smartphone camera modules remains strong, with a ramp of new wins at Chinese smartphone OEMs. Demand for our lithium-ion battery MOSFETs continues to accelerate, led by broad-based adoption across various smartphone OEMs.

Our DC-to-DC power management, protection and filtering products continue to maintain their momentum with strong ramp at global OEMs and at a Chinese smartphone vendor. We gained multiple design wins on Chinese smartphone platforms for display power, LED drivers, camera modules and battery solutions.

Revenue for the fourth quarter for our communications segment is expected to be down quarter-over-quarter. The consumer end market represented approximately 16% of our revenue in the third quarter and was up approximately 5% quarter-over-quarter. Contribution from Aptina was a key driver of sequential growth.

Production ramps began during the quarter for our MOSFETs, ESD protection and custom VGA device solutions for several leading game console manufacturers for new holiday models. Shipments continue to ramp during the quarter for multiple imaging devices to customers, manufacturing action sports cameras, gaming consoles and various video applications.

In particular, we are gaining traction among action, sports camera customers with our new 1.4 micron pixel sensor that features the speed to capture full 8 megapixel sensor resolution at a rapid 30 frames per second.

Standard product sales in the consumer products were up quarter-over-quarter, specifically for home electronics, gaming and set-top box applications. We experienced declines in the consumer white goods market due to normal seasonality. However, our design wins in the white goods market should drive strong growth in the near to midterm.

Design wins for our intelligent power modules and fan motor drivers at a key Chinese home appliance maker should begin to ramp in this current quarter. We are completing regulatory approvals for our newest intelligent power modules, which have been designed in by several white goods customers to replace products from a key competitor.

Production of these intelligent power modules will be ramping before the year end. Revenue for the fourth quarter for our consumer segment is expected to be approximately flat quarter-over-quarter.

The industrial end market, which includes military/ aerospace and medical, represented approximately 22% of our revenue in the third quarter and was up approximately 13% quarter-over-quarter. The sequential growth was driven primarily by the contribution from Aptina and Truesense.

Within the industrial segment, we continue to see strong demand for industrial circuit breakers, medical imaging, security cameras and magnetic card swipe readers for mobile point-of-sale applications.

Revenues during the quarter were driven by continued sales of mixed signal ASIC solutions to customers for building automation, health-care CT scanners, point-of-sale readers, meter-to-meter communications, machine vision for glass inspection and bar code scanning.

During the quarter, we shipped our first production volume of PLC modem ASICs to a key smart meter maker in Asia. We continue to gain traction with our image sensors in 720p and 1080p security camera applications, and we are increasing market share with our top tier suppliers in China.

Our now expanded image sensor portfolio continues to find new applications, including drones, smart vacuum cleaners, smart helmets and molecular sensors. Industrial-related revenue from our Standard Products was led by major customers for power supplies, control sensing and general lighting.

In our Medical Product Group, we introduced a cutting-edge technology called Struix, which enables us to deliver semi-custom solutions to the portable and wearable medical market. Customers have been extremely pleased with this technology as it reduces design time, development risks and costs associates with fully customized solutions.

Revenue for the fourth quarter for our industrial segment is expected to be up quarter-over-quarter. The computing end market represented approximately 14% of our revenue in the third quarter and was up approximately 7% compared to the second quarter. Aptina was a contributor to the sequential growth in the computing market.

Sales in the computing end market benefit from stabilizing PC unit shipments and a continued migration to Haswell and Broadwell platforms, on which we see improved market share. We also benefited from our SAM expansion strategy, with ramping sales of VCore controllers commencing for channel motherboards.

In addition, we continue to see strong demand for our MOSFETs and protection products in PCs and hard disk drives. Revenue for the fourth quarter for our computing segment is expected to be down quarter-over-quarter due to seasonality.

In other news, our Ezario 7100 DSP system-on-a-chip for hearing health was named Promising New Life-Saving Technology of the Year by the Annual Creativity in Electronics, or ACE, Awards, sponsored by EE Times China, EDN China and ESM China. Also, Flextronics honored us with their 2014 Strategic Supplier Award.

Also, Celestica recognized ON Semiconductor as an honoree in its 2013 Total Cost of Ownership Supplier Awards program. Now I'd like to turn it back over to Bernard for other comments and our other forward-looking guidance.

Bernard?.

Thank you, Keith. Before I get into the details of guidance for the fourth quarter, let me draw your attention to various moving parts in our guidance for the quarter. First, the fourth quarter of 2014 is unusually long, with 96 days as compared to 91 days in the third quarter.

The longer quarter should result in higher operating expenses, but we are not expecting much revenue upside from the extra number of days due to the holidays in various parts of the world. Second, fourth quarter results will incorporate the full contribution from Aptina as compared to approximately 6 weeks in the third quarter.

Third, we plan to reduce factory loadings in the fourth quarter. And last, our results include recent acquisitions of Aptina and Truesense, which add more than $600 million of annual revenue on a trailing basis. Therefore, the range of our guidance for a few items, in absolute terms, is wider as compared to the historic -- to their historic trends.

Now for the fourth quarter 2014 outlook. Based upon product booking trends, backlog levels and estimated turns level, we anticipate that total ON Semiconductor revenues will be approximately $835 million to $875 million in the fourth quarter of 2014.

Backlog levels for the fourth quarter of 2014 represent approximately 80% to 85% of our anticipated fourth quarter revenues. We expect that average selling prices in the fourth quarter of 2014 will be down by approximately 1% to 2% as compared to the third quarter of 2014.

We expect inventory at distributors to fall quarter-over-quarter on a dollar basis. We expect total capital expenditures of approximately $60 million to $70 million in the fourth quarter of 2014.

For the fourth quarter of 2014, we expect GAAP gross margin of approximately 31.8% to 33.6% and non-GAAP gross margin of approximately 33.4% to 35.5% -- 35.4%. The quarter-over-quarter decline in gross margin for the fourth quarter is driven primarily by the decline in organic business and the inclusion of Aptina's results for the full quarter.

We expect total GAAP operating expenses of approximately $237 million to $249 million. Our GAAP operating expenses include the amortization of intangibles, restructuring, asset impairment and other charges, which are expected to be approximately $32 million to $34 million.

We expect total non-GAAP operating expenses of approximately $205 million to $215 million. The increase in operating expenses in the fourth quarter over the third quarter is driven by the inclusion of Aptina for the full quarter and a longer fourth quarter as compared to the third quarter.

We anticipate GAAP net interest expense and other expenses will be approximately $9 million to $11 million for the fourth quarter of 2014, which includes noncash interest expense of approximately $2 million. We anticipate our non-GAAP net interest expense and other expenses will be approximately $7 million to $9 million.

GAAP taxes are expected to be approximately $7 million to $10 million, and cash taxes are expected to be approximately $5 million to $7 million.

We also expect share-based compensation of approximately $11 million to $13 million in the fourth quarter of 2014, 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 diluted share count for the fourth quarter of 2014 is expected to be approximately 442 million shares based on our -- 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. With that, I would like to start the Q&A session.

Thank you. And, Vanessa, please open up the line for questions..

[Operator Instructions] Your first question comes from the line of Ross Seymore..

Actually, Matt Diamond on behalf of Ross. I'm -- I wanted to ask you about the Aptina gross margin. It sounds as though it left you some dilution in the gross margin this quarter now. I know that it was mentioned that you expect some -- that pretty steady increases there.

But any sort of timeline you could give as to when Aptina could reach the corporate average gross margin-wise?.

Well, if you look at what we announced at the time of the DA, we said that the gross margin was going to steadily improve and reach that by -- in about 1.5 years, and next year, it should reach, if I recall, 33% average. And we should deliver $0.08 of EPS..

Understood. And just for a little bit of specificity.

How much did Aptina contribute revenue-wise in 3Q? And how much do you expect it to contribute in 4Q?.

Well, if you look at our segment reporting that we are publishing and we talked -- and I talked about in the prepared remarks, our revenue in the ISG group grew from $24 million to $104 million, of which the bigger -- biggest contribution is Aptina..

Aptina, okay. And finally, just on a bigger picture, it was mentioned earlier in the year that about 65% of core on revenues, we're going to be from legacy products and 35% from, presumably, higher-margin new products.

I'm curious, has that dynamic, is that still largely in play? And if it is, have those percentage changes -- have those percentages changed given the, one, the end demand dynamic, and two, the recent acquisitions of Aptina and Truesense?.

Yes. I think I'm going to interpret your question literally. We had 65% coming from our core investment areas, industrial, automotive and smartphones, which had higher margins, not legacy versus more advanced or higher margin. So it's really -- margins are really driven more by the sectors that we service than by the age of the product.

So net-net, we've given you the percentages there for Q3. We anticipate that automotive and handset revenues will continue to outpace the rest of the revenues in the company..

Your next question comes from the line of Vivek Arya..

I think you had mentioned that there was some pickup that you saw in order activity.

I'm curious, is it broad-based? Is -- what end markets? What geographies? And is that abnormal? Is that normal to be picking up at this time? If you could just give us a little bit more color on what you are seeing in real time in terms of demand environment?.

Sure. It is relatively broad based. And the abnormal and normal, frankly, the slowdown was a little stronger than we normally see in September, and then the pickup is a little bit stronger than we normally see it in October. So I would say, in this case, the pickup is certainly stronger than we normally see..

Got it. And you mentioned that computing could be down in Q4 due to normal seasonality. Are you seeing any weakness beyond normal seasonality in PCs? Because a different vendor was implying big order cards and excess inventory of components tied to PCs and I was curious what you are seeing..

We saw their comments. We think the market is extremely normal in seasonality and will be down in the very low single digits quarter-on-quarter..

Got it, very helpful. And then one last question. Where are you in terms of Aptina integration? I think when you had made the acquisition, you were planning to start in-sourcing some of the production and assembly and I was wondering where you are in that process.

And overall, what are the next milestones we should look forward to?.

Yes. So integration happens on many fronts. From a manufacturing perspective, the in-sourcing that we discussed will really start to hit fully in first quarter of 2015. Our people systems will be live in January 1, and the financial systems are in a range of completion that will be totally behind us mid-next year..

Your next question comes from the line of Gabriela Borges..

I would like to ask a follow-up on the Aptina questions. Just in terms of the gross margin, getting that gross margin up to the corporate average.

With the acquisition now closed, maybe you could give us a little bit of granularity on the drivers of getting gross margins to get up and where that upside could come from?.

Yes, sure. So big factors there. We talked about the in-sourcing of manufacturing. The first stage of that actually kicks in early next year. But as we go through 2015, we will continue to in-source more and more of that product, which will give us kind of a quarterly improvement opportunity.

Secondly, we do believe, from a growth perspective, we will be outpacing our automotive and industrial growth, where our highest margins are. So the mix will kick in. And then lastly, our new products, which they're coming out in very rapid fashion now, have much improved margins over the older counterparts that they're replacing.

So manufacturing on the gross margin plus the markets we serve, plus new products..

That's helpful. And as a follow-up, if I may, just on the distributor inventory commentary from the prepared remarks. I think you mentioned it was up slightly in the September quarter and then would come down in the December quarter.

Any additional color you could provide on what you're hearing from distributors in terms of resale of the channel inventory would be very helpful..

Okay. Yes, just the inventories, certainly, we're sell-through, so I don't want to mislead anything on there. But their inventory, they tend to be very closely managed, particularly in Asia. And as the order pattern slowed in the September time frame, their orders on us also slowed. So we're staying in a very lean 9-week range.

We'd like to see more like 11, and as a result, we're carrying a little bit more internally than we normally do. From an order pattern perspective, I think the -- again, they're strengthening in the resales is what we're hearing as we've gone through October..

Your next question comes from the line of Craig Ellis..

I'd like to take a little bit deeper up in automotive, both on a near-term and a longer-term dynamic.

Near term, can you talk about some of the gives and takes that you're seeing by geography in the sequential sales strength? And then longer term, the business looks like it should be up to about 30% of sales and it is one of your highest-growing end markets.

So over the next 12 to 18 months, where do you see the mix of the business evolving to?.

Okay. So from a geographic perspective, we saw slight weakenings in Europe, but the other markets were in pretty good shape and continue to grow. On the more midterm range, where do we see automotive? I certainly see that this could become 1/3 of the business in the next couple of years..

Then the follow-up, Bernard. On the -- on manufacturing utilization, prepared remarks indicated that it would decline in the fourth quarter.

Can you quantify how much you'd expect it to decline? And then, given that there's some in-sourcing, can you comment on where that in-sourcing would occur and how that would impact utilization in the first quarter?.

So the utilization, as we said, is in the high 80s. I would expect that it would tone down to the mid-80s during the fourth quarter. We're going to take advantage of certain of the holidays to also give preventive maintenance and also to do good inventory management.

The in-sourcing of the CFA operation is not a significant component in terms of changing the overall total company utilization. It is just that we acquired this function or this manufacturing function from a third party and are going to run it ourselves..

Okay. And then last from me on operating expense. Can you talk about some of the gives and takes as we look beyond the calendar fourth quarter? I'm not asking for specific guidance, but there would likely be synergies from the Aptina deal there, but there's also cost of living adjustments.

So what are some of the pluses and minuses as we look at the intermediate term from where we are in 4Q?.

So in general terms, I would expect the overall operating expenses to still remain in that 22% to 24% of revenue, about 23% being absolute dollars for next year. The synergies should be offsetting the -- any inflationary increases. They remain fairly flat..

Your next question comes from the line of Christopher Rolland..

The question. So wanted to follow up there and understand what it is that gives you guys confidence that the slide's sort of over. Is it bookings for 1Q '15? I think you said you were 80% to 85% filled for this quarter.

I was wondering, how does that compare to prior 4Qs that you've had? And then how are you doing on coverage for 1Q, backlog coverage for 1Q versus where you would normally be this far out?.

So we normally enter quarters 80% to 85% covered and we normally take -- our bookings profile fills up fairly long based on the mix we have of industrial and automotive. So again, that's a very normal thing. I would expect that by the time we get to Q1, we'll also be in similar shape from a percentage coverage perspective..

Okay, great. Also, in terms of lead times, we've been tracking those. They sort of rose all through the year and then downticked a little bit last quarter. I think a lot of that was back-end manufacturing related. That was perhaps the constraint there.

Did you fix that? Did you put more online? Is that why lead times came down? Or is this partially demand related?.

Lead times were very slightly down during the quarter, they're almost flat. And yes, we've been installing additional capacity all during the year. So obviously, revenues have been going up.

Lead times didn't collapse dramatically from a market perspective, as you can see from our results, so really it's just capacity keeping up, capacity investments keeping up with what we're doing market-wise..

Okay, great. If I could just squeeze one more in there. Aptina, I guess, if you just do the numbers, it sounds like an $80 million contribution from Aptina. That was just 6 weeks with, I guess, 7 more to go here rolling on in 4Q. That would put us at a run rate well beyond the $532 million that they did last year.

Is that just the seasonality in the business? Or should -- or did we actually see an uptick in growth there?.

Well, it is -- if you actually look at the Aptina number itself, it's about $72 million, a little bit less than $72 million. And indeed, it was also a seasonal pattern of -- in the August, September time frame..

Your next question comes from the line of Tristan Gerra..

Could you remind us what percentage of your production is currently outsourced? And how will that ratio change once you're in-sourcing Aptina?.

So approximately 25% to 28% is outsourced in total. And with Aptina, even with the in-sourcing there, that number will not change appreciably..

Yes. With Aptina, right now, the portion that we're in-sourcing is a very small fraction of the total manufacturing. Most of it will remain, at least in the short term, with the foundries and subcontractors..

Okay.

And then, sorry if I've missed it, could you tell us what revenue is embedded in your Q4 guidance for both Aptina and Sanyo?.

Sanyo, fairly similar numbers to what you saw in Q3. And Aptina, I actually don't know.

Our IC numbers, are we showing those?.

It's fairly in line with what we had communicated when we did the DA, in that same range..

Your next question comes from the line of Ian Ing..

The pickup you're seeing in recent weeks, how much is the -- how of it is the overall semiconductor cycle versus company-specific program ramps? And given now the visibility into 2015, obviously, that sort of longer-lead-time orders, is that for any particular products or applications? And why are you assuming that the first quarter is sort of broad-based visibility?.

Yes, it's fairly broad based. I think, earlier from our comments, you can see that the handset market, we believe, is a little softer overall, the normal seasonality. But all of the other markets are behaving seasonal or better..

Okay, great.

So it's overall semiconductor cycle, you think, for the December quarter?.

I think -- I don't think there's a change in cycle. Like I said, I think there's some reaction to a slowdown in the handset market that's temporary and everything else is pretty seasonal, from what we're seeing..

Okay, great. And then computing, driving that down seasonally. Remind me how much exactly is that in your mind. And how much of that is share gains, obviously, inner sales guiding PCs down towards....

Yes. So normal seasonality there is low single digits and that's where we expect it to be..

Yes. Any exposure, OEMs versus distribution channel, in computing? Obviously, AMD saw some weakness in the distribution channel..

Again, most of the comments you'll hear from our competitors are because they're sell-in. Since we're sell-through, we see the end markets and we're just not seeing any corrections at all in the end markets..

Your next question comes from the line of Steve Smigie..

Just a quick question here on Aptina. Now that you've put together a pretty big portfolio of parts there between them and Truesense and other stuff you already had.

How have the conversation been going with your customers? I mean, is it a realization that you're obviously focusing there and you become to a go-to player in that space?.

Yes. No, it's been really exciting and I've had the opportunity to personally get out and talk with some very big customers. They all see it as a plus. They see it as ON bringing some much-needed infrastructure and security of supply to a company that had some great technology but didn't have the critical mass that they like to see.

So that combination has been really exciting and we're getting a lot of pull from the big customers out there..

Great. I think also during the quarter, you announced a joint venture with Transphorm. I think at APAC, you also demoed some products in conjunction with some nitride transistors.

So I'm just curious, what does that JV do for you guys? What's the opportunity there?.

Yes. We're working together to basically accelerate introduction of products into the end market. And from our perspective, the internal manufacturing is not quite released yet, but we can get the wafer fab from a release source at our partners, and we're doing the packaging and working with our systems customers on in-solutions..

Okay, great.

And then just on the gross margin, is there -- now that you have Aptina included, is there a particular revenue level that you might point to where you could potentially see yourselves get to the high 30s or some sort of milestone, I guess, now that you've got Aptina involved, as a way to think about gross margins?.

Yes. I think it's more. As Keith mentioned earlier, the achievement of the synergies on the CFA as well as the shift over time in margin more than an absolute revenue growth level. And I believe -- and we plan on addressing that in much more detail at the Analyst Day next February, with a more longer-term view of things..

Your next question comes from the line of Kevin Cassidy..

This is Deam Grumlose calling in for Kevin.

I was wondering if you could provide a little bit of color around your PC power management business, particularly around whether you're benefiting from Bay Trail, Ivy Bridge, various Haswell designs?.

Yes, the Haswell and Broadwell solutions have been ramping during Q3, so they're a bigger portion of the total. We think we have significant share gains there. And so I don't know what else you're looking for there, but we think the trends are favorable from a share perspective as we continue to go through the year..

Okay.

Are you seeing traction yet in SkyLake? Or is that -- is it too early to comment on that?.

It's really too early on that one. I mean, design-wise, things are exciting, but it's too early to get final decisions..

Your next question comes from the line of Betsy Van Hees..

In regards to Aptina, when you guys had your conference call and you talked about the acquisition, you focused a lot on the industrial and automotive. And now that it's a part of the company, it seems like you guys are going to be focusing on the overall product line more into the computing area as well as the other more low gross margin.

Is that how we should be looking at things, that the overall business is going to grow or....

No. Yes, I think the overall business will grow. The main strategy is you focus on automotive and industrial, which we think will help drive margins, but then you can sell the products you develop into a broader marketplace. And so there is no reason not to sell them into the broader marketplace. Our intent was never to completely exit other markets.

It's just really focus the investment where the growth and the margins are..

Okay, great. And then, Bernard, you've typically given us the gross margin breakout for the System Solutions Group, Sanyo..

So for this quarter, the System Solutions Group was approximately 22% on a non-GAAP basis..

Okay.

And speaking of operating expenses, I was wondering, as we're looking at Q1 and synergies, are we going to get some synergies at all in Q1? Or are we going to obviously get the uptick that we're going to normally see from FICA and things like that? So how should we be looking at OpEx with the addition of Aptina and synergies there?.

We're right now in the way to specifically guide for Q1, but the synergies in general should be gradually coming throughout the year, with the completion towards the half or back half of the year..

Okay. And then my last question is, in your prepared remarks and you guys talked about it, you said the slowdown you saw was broad based and then the pickup, again, has been broad based.

Is there any specific market that came back a little bit sooner or weakened faster and came back sooner? I was wondering if you could kind of help us there understand what's happening in the industry..

Yes. In my earlier comments, we saw more slowing than expected in the handset market in Q3. But from a recovery perspective, it's pretty broad based..

Your next question comes from the line of Vijay Rakesh..

Yes.

Just looking at the automotive and industrial side, can you talk about what are the design wins there that you're seeing in both those key markets? And how do you -- what's your -- how do you see the overall market there as you look out into mass [indiscernible]? Any weakness in any geography?.

Okay. So auto, in my prepared remarks, we went through quite a bit of details, but we have a very broad presence in automotive. We're seeing significant pickups from a revenue perspective in all of the lighting applications, the imaging applications and the safety applications at a faster pace than you would expect on the powertrain side.

But generically, we're seeing good growth in every part of the automobile as they try and get more fuel efficiency as well as safety. Industrial, again, very broad market for us. We talked about lighting. We talked about controls in automation and, again, really good applications there.

So I think the design win side of it is, it's just extremely broad because it's a big focus for the company. From a market trend perspective, I mentioned there's a little softening in Europe in the last quarter. We don't see signs that, that is turning into a malaise. I think the in-registrations there are actually fairly stable.

And we see continued growth in both Asia and North America. So we've got a very positive outlook on that. And on the industrial side, we're seeing much more willingness by our industrial customers to upgrade their technologies, particularly incorporating some of the newer wireless standards and energy standards across our portfolio.

So we see that as a positive trend as well. So having said that, I would say I would expect a little better performance in both of those markets next year than this..

Got it. And last question here.

When you look at the -- obviously, there's a sell-through, but when you look at the channel inventories in your auto, industrial, how do those look in the different geographies?.

Again, order patterns are good across the board in industrial and automotive..

Your next question comes from the line of Chris Caso..

Maybe I can just kind of go back to your overall comments, Keith, and you've been through a number of semiconductor cycles yourself. It sounds like some of the slower activity you saw was fairly brief and we've seen brief slowdowns before in industry, but this would seem to be exceptionally brief.

Maybe comment on what you see now versus perhaps some of the more typical slowdowns and what sort of visibility gives you confidence in the brevity of some of the slower conditions that you identified?.

Sure, and I have been through quite a few. I think what we're seeing really different pattern than in the past in the sense that we've had several years now of low GDP growth and so -- and that's reflected in low semiconductor growth, and, frankly, think that in the first half of the year, we got a little too exuberant in the handset market.

And as a result, had great first half numbers and more normal performance in the third quarter, which people were expecting, again, more great performance. So I think it's more an expectation issue than anything else. Again, as I look across the broad markets, most of them are behaving seasonally.

There was a little bit more of a correction on the handset side. I do see that as temporary. But I don't see a broad-based slowdown or the beginning of a down cycle in any of the numbers we're seeing..

And furthermore, the inventory levels at the [indiscernible] keep being quite lean, at the 9-week range, which, in prior cycles, they have typically crept up to higher levels..

All right, okay. And just as a quick follow-on. I know one of the goals you guys have had this year was a -- some share gains in the handset market. To what extent have you guys been able to realize that this year? And has that been a contributor on a year-over-year basis now you're looking at the seasonal....

Yes, I think it has. I think it's been very positive. I think year-over-year, we're well up over 20% without acquisitions. And so we've been very pleased with our progress in that market..

Your next question comes from the line of Craig Hettenbach..

This is Vinayak Rao calling for Craig. I had a question on China.

Could you just talk about briefly in terms of demand trends you saw in September and especially as you move into October in China?.

Yes. I mean, that is one of the primary places for the handset market, so we did see more slowing than expected on the resales in September. But we again have seen a pickup in order patterns in October that give us encouragement that it was a pretty short-lived correction..

Got it.

And looking at the broad-based markets in China, like exposure you had to white goods?.

Yes. On the white goods market, seasonally, it's down in Q3. We provide a lot of products to things like air conditioners, et cetera, and so it looks to be fairly seasonal, looks very similar to what we saw last year..

Got it, that's helpful.

So my follow-up is on like cash usage, like how are you guys thinking about cash going forward? Like, can we expect a step-up in buybacks post Aptina?.

So as we mentioned in prepared remarks, we are poised to generate a good amount of cash, in the $300 million to $400 million, in the near to midterm. We will continue using our approved board share repurchase program.

We'll have some debt that will be -- have to be paid down on a mandatory basis, approximately $40 million in the fourth quarter, and that's pretty much it for the short term..

We have reached the allotted time for questions. I will now turn the call back over to Parag Agarwal for closing remarks..

Thank you, Vanessa. Thanks for joining the call today. Please feel free to call us with any questions. Goodbye..

This does conclude today's conference call. You may now disconnect..