Parag Agarwal - Vice President-Investor Relations and Corporate Development Bernard Gutmann - Executive Vice President and Chief Financial Officer Keith D. Jackson - President, Chief Executive Officer & Director.
John William Pitzer - Credit Suisse Securities (USA) LLC (Broker) Christopher B. Danely - Citigroup Global Markets, Inc. (Broker) Christopher Caso - CLSA Americas LLC Vijay R. Rakesh - Mizuho Securities USA, Inc. Ian L. Ing - MKM Partners LLC Craig A. Ellis - B. Riley & Co. LLC Tristan Gerra - Robert W. Baird & Co., Inc. (Broker) Ross C.
Seymore - Deutsche Bank Securities, Inc. Rajvindra S. Gill - Needham & Co. LLC J. Steven Smigie - Raymond James & Associates, Inc. Kevin E. Cassidy - Stifel, Nicolaus & Co., Inc. Harlan Sur - JPMorgan Securities LLC Mark Lipacis - Jefferies LLC Harsh V. Kumar - Stephens, Inc. Shawn M. Harrison - Longbow Research LLC Craig M. Hettenbach - Morgan Stanley & Co.
LLC.
Good day, ladies and gentlemen, and welcome to the ON Semiconductor Second Quarter 2016 Earnings Conference Call. At this time, all participants are in a listen-only mode. Later, we will conduct a question-and-answer session and instructions will follow at that time. I would now like to introduce your host for today's conference, Mr.
Parag Agarwal, Vice President Investor Relations and Corporate Development. Please go ahead, sir..
Thank you, Christy. Good morning and thank you for joining ON Semiconductor Corporation's second quarter 2016 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 "Investors" section of our website, at www.onsemi.com.
A replay will be available on our website approximately one 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 second quarter of 2016. 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 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 "Investors" 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 from the 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 the second quarter of 2016.
Our estimates may change, and company assumes no obligation to update forward-looking statements to reflect actual results, changed assumptions, or other factors, except as required by the law.
During the third quarter, we will be attending the Citi Technology Conference in New York on September 7 and Deutsche Bank Technology Conference in Las Vegas on September 14. Now, let me turn it over to Bernard Gutmann, who will provide an overview of the second quarter 2016 results.
Bernard?.
Thank you Parag, and thank you everyone for joining us today. Let me start by providing an update on overall business results. We posted yet another quarter of strong business results, driven by continued focus on expanding margins and maintaining strong cost discipline.
We delivered strong gross margin and operating margin performance, and our revenue exceeded the high end of our guidance for the second quarter. As I indicated in our earnings call for the first quarter, we continue to work on optimization of our business, manufacturing footprint, and cost structure, with an objective of achieving our target model.
We believe that our margins have significant headroom to improve from current levels, and we have levers that we can pull to improve our profitability, even if revenue growth lags our expectations due to macroeconomic factors. We will provide additional details as specific business improvement measures are implemented.
Now, let me provide you additional details on our second quarter 2016 results. ON Semiconductor today announced that total revenues for the second quarter of 2016 was approximately $878 million, an increase of approximately 7% as compared to the first quarter of 2016. GAAP net income for the second quarter was $0.06 per diluted share.
Excluding the impact of amortization of intangibles and restructuring, pre-funding interest related to our acquisition of Fairchild, and other special items, non-GAAP net income for the second quarter was $0.21 per diluted share.
GAAP and Non-GAAP gross margin for the second quarter was 35.1%, meaningfully above the mid-point of our guidance range, which was 34.3%. GAAP and Non-GAAP gross margin in the first quarter of 2016 was 33.7%.
The significantly better than expected gross margin performance in the second quarter was largely driven by higher utilization, richer product mix, and improved operational efficiency. Average selling prices for the second quarter decreased by approximately 2% as compared to the first quarter.
GAAP operating margin for the second quarter of 2016 was approximately 8.6%, as compared to approximately 7.1% in the prior quarter. Our non-GAAP operating margin for the second quarter was 12.3%, up approximately 170 basis points as compared to the first quarter of 2016, primarily due to higher revenue and gross margin.
GAAP operating expenses for the second quarter were approximately $233 million, as compared to approximately $217 million for the first quarter of 2016. Non-GAAP operating expenses for the second quarter were approximately $200 million, as compared to $189 million in the first quarter.
The increase in operating expenses as compared to the first quarter was driven by higher revenue and relaxation of certain cost control measures that were put in place in the prior quarters in face of challenging business conditions.
Operating cash flow for the second quarter was approximately $104 million, as compared to approximately $115 million in the first quarter. Operating cash flow for the second quarter was impacted by approximately $24 million due to interest expense related to pre-funding of Fairchild transaction.
Excluding the $24 million interest expense related to pre-funding of Fairchild transaction, our operating cash flow would have been up approximately $13 million over the first quarter. We also placed approximately $68 million in escrow to cover a few items related to prefunding of the Fairchild transaction.
This amount will be returned to us at the time of close of the transaction. During the second quarter, we spent approximately $52 million of cash for the purchase of capital equipment and used approximately $28 million for the repayment of long term debt and capital leases.
We exited the second quarter of 2016 with cash, cash equivalents and short term investments of approximately $588 million, a decrease of approximately $31 million from the first quarter.
Excluding the impact of the amount placed in escrow and interest expense related to the prefunding of the acquisition, our cash balance at the end of the second quarter would have increased by approximately $61 million.
At the end of the second quarter of 2016, ON Semiconductor days of inventory on hand were 120 days, down approximately eight days from the prior quarter. In dollar terms, inventory on balance sheet declined by approximately $10 million as compared to the first quarter. We expect further decline in balance sheet inventory days in the third quarter.
In the second quarter of 2016, distribution inventory days declined by approximately half a week as compared to the first quarter, and distributor re-sales increased by approximately 7% quarter-over-quarter. Accounts receivables went up by approximately $59 million or by 3 days in the second quarter as compared to the first quarter.
The sequential increase in accounts receivable was primarily due to the timing of shipments. Following the end of the second quarter, receivables have returned to their normal level. For the second quarter of 2016, our lead times were up slightly as compared to the first quarter.
Our global factory utilization for the second quarter was up as compared to the first quarter. Now let me provide you an update on the performance of our business units, starting with Image Sensor Group, or ISG. Revenue for ISG was approximately $173 million, up approximately 3% as compared to the first quarter.
Revenue for Standard Products Group for the second quarter of 2016 was approximately $310 million, up approximately 9% quarter-over-quarter. Revenue for the Application Products Group was approximately $273 million, up approximately 9% over the first quarter.
Revenue for the second quarter of 2016 for System Solutions Group was approximately $123 million, up approximately 8% quarter-over-quarter. Now, I would like to turn the call over to Keith Jackson for additional comments on the business environment.
Keith?.
Thanks, Bernard. I will start with an update on our acquisition of Fairchild Semiconductor, and then I will provide commentary on current business trends and on various end-markets. Based on the feedback from various regulatory agencies, we expect to close the Fairchild transaction around the end of the current month.
We are working to obtain the last of necessary approvals in the U.S. and China, and we will provide updates as further events unfold. I must also caution that despite our confidence in closing the Fairchild transaction this month, events outside of our control could result in unanticipated delay.
The ongoing consolidation in the semiconductor industry has further validated the strategic and financial rationale driving our acquisition of Fairchild. The acquisition of Fairchild adds highly complementary products and capabilities to our portfolio and enables us to deliver compelling value to our customers, shareholders, and employees.
Teams from the two companies have been busy planning for integration. Our preparations are further confirming the financial and strategic rationale for the acquisition. As a result, we believe that we will be able to meet or exceed the financial targets we provided to the investment community at the time of the announcement of the acquisition.
We plan to provide further updates on the financial and strategic impact of the acquisition immediately after the close of the transaction this month. Let me now comment on the business trends in the second quarter.
During the second quarter, the pace of bookings improved meaningfully over the first quarter and commentary from customers was generally positive. The strength in bookings has continued into the current quarter.
Though we are experiencing improved bookings, the macroeconomic data continues to be a mix of good and bad news, and the business conditions remain subdued.
We continue to manage our business prudently, and we are directing our investments towards areas in automotive, industrial, and mobile device markets that will enable us to drive both top line and bottom growth.
Examples of such areas include ADAS, LED lighting in automobiles, machine vision, medical, image stabilization and autofocus, and power management in a broad range of applications. Our design win pipeline remains strong and continues to grow. Now I'll provide some details of the progress in our various end-markets.
The automotive end-market represented approximately 36% of our revenue in the second quarter and was approximately flat quarter-over-quarter. On a year-over-year basis, our automotive revenue grew by approximately 15%.
We continue to outgrow the market driven by our leadership in fast growing segments of the automotive markets such as ADAS and active safety, LED lighting, power devices, and networking solutions. We've clearly established ourselves as a technology and market leader in ADAS.
We continue to reinforce our leadership position and we are now enabling future autonomous driving vehicles through our expertise in automotive, CMOS image sensors. We are working with all major auto OEMs and Tier 1 integrators to define next-generation platforms.
In Korea, we are benefiting from adoption of surround view cameras in vehicles, with strong wins for our CMOS image sensors in multiple upcoming models. We are seeing acceleration in revenue for our recently launched 1 megapixel and 2 megapixel CMOS image sensors for in-cabin driver monitoring applications.
During the second quarter, we secured a win for our LED rear lighting solution with a leading European OEM for future models. We also secured wins for new ASICs from European Tier 1 integrators for start/stop alternators and ultrasonic park assist applications.
During the second quarter, we saw strength in specialized products for infotainment, safety, and powertrain applications. Demand for products from our Standard Products Group was strong as well.
The T6 MOSFET family from our Standard Products Group continues to receive strong acceptance from customers for steering, braking, engine, and transmission control applications.
Although there have been a few data points suggesting a slowdown in automotive unit sales, we believe that we can continue to grow our automotive revenue in the high-single-digit percentage range annually, driven primarily by content gains.
Revenue in the third quarter for automotive end-market is expected to be flat to down slightly quarter-over-quarter due to normal seasonality. The industrial end-market, which includes military, aerospace, and medical, represented approximately 23% of our revenues in the second quarter and was up approximately 15% quarter-over-quarter.
The growth in the industrial market was driven by strength in the security cameras, machine vision, medical, and general lighting related applications. In the medical market, we continued our momentum in the hearing aid market with our Ezairo platform. We are leveraging our strength in the hearing aid market to expand into other related areas.
We are seeing strong growth in the glucose monitoring applications, and we are targeting this market with new products. We also experienced growth in medical imaging applications in the second quarter. In the machine vision market, our PYTHON series of CMOS image sensors continued to grow at a rapid pace.
Our CCD image sensors for industrial applications also grew at an impressive pace in the second quarter driven by demand for machine vision applications, such as flat panel inspection.
We expect continued growth in our machine vision revenue driven by increased automation in manufacturing, and investments by industrial companies in upgrading their manufacturing capabilities. Revenue for the third quarter for industrial end-market is expected to be flat quarter-over-quarter.
The communications end-market, which includes both networking and wireless, represented approximately 18% of our revenue in the second quarter, and was up approximately 11% quarter-over-quarter, due to seasonality and the ramp of new design wins in various platforms.
Our design win pipeline for mobile devices continues to grow and we remain well positioned with global smartphone makers, as well as with China-based smartphone OEMs. Our strategy of broadly focusing on all players in the smartphone market and driving revenue through wins on major reference design platforms is yielding strong results.
During the second quarter, we experienced strong growth in our filters, protection and low dropout regulators for multiple platforms. Our content on various platforms continues to grow. Our optical image stabilization and auto-focus products continue their strong traction with China based smartphone OEMs.
We are well positioned to benefit from our wins for protection, EEPROMs, LDOs and op-amps on multiple platforms, which we expect to ramp in the second half of the year. Revenues in the third quarter for communications end-market are expected to be up strongly quarter-over-quarter due to normal seasonality, and ramp of design wins in new platforms.
The consumer end-market represented approximately 11% of our revenue in the second quarter, and was up approximately 5% quarter-over-quarter. The white goods market, which has been weak due to excess channel inventory of finished goods posted strong growth in the second quarter. Other growth drivers included gaming and set top boxes.
Revenue for the third quarter for consumer end-market is expected to be up quarter over-quarter due to normal seasonality. The computing end-market represented approximately 12% of our revenue in the second quarter, and was up approximately 15% compared to the first quarter.
The growth in computing market was driven by the much anticipated ramp of the Skylake platform. We also benefited from strength in power supplies for servers and workstations. Revenue for the third quarter for computing end-market is expected to be up quarter-over-quarter due to normal seasonality and the continuing ramp of the Skylake platform.
Now, I would like to turn it back over to Bernard for forward-looking guidance.
Bernard?.
Thank you, Keith. Now for the third quarter of 2016 outlook. Based on product booking trends, backlog levels, and estimated turns levels, we anticipate that total ON Semiconductor revenues will be approximately $885 million to $925 million in the third quarter of 2016.
Backlog levels for the third quarter of 2016 represent approximately 80% to 85% of our anticipated third quarter revenues. We expect inventory at distributors to be flat quarter-over-quarter on a dollar basis. We expect total capital expenditures of approximately $45 million to $55 million in the third quarter of 2016.
For the third quarter of 2016, we expect GAAP and non-GAAP gross margin of approximately 34.6% to 36.6%. Factory utilization in the third quarter is likely to be flat as compared to the second quarter. We expect total GAAP operating expenses of approximately $225 million to $237 million.
Our GAAP operating income include the amortization of intangibles, restructuring, asset impairments, and other charges, which are expected to be approximately $25 million to $27 million. We expect total non-GAAP operating expenses of approximately $200 million to $210 million.
We anticipate GAAP net interest expense and other expenses will be approximately $31.5 million to $41.5 million for the third quarter of 2016, which include non-cash interest expense and pre-acquisition interest expense of approximately $22 million to $29 million.
GAAP net interest expense includes interest related to the prefunding of acquisition of Fairchild Semiconductor. We anticipate our non-GAAP net interest expense and other expenses will be approximately $9.5 million to $12.5 million. Cash paid for income taxes is expected to be approximately $5 million to $9 million.
We also expect share based compensation of approximately $13 million to $15 million in the third quarter of 2016, 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 third quarter of 2016 is expected to be approximately 420 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. With that, I would like to start the Q&A session.
Thank you, and Christy, please open up the line for questions..
Thank you. Our first question is from the line of John Pitzer of Credit Suisse. Your line is open..
Yeah. Good morning, guys. Thanks for letting me ask the question. Keith, just my first question. I'm sure you saw this morning that Fairchild also reported earnings, put up very strong revenue results, but the margin profile, I think, was a lot weaker than a lot of us were expecting, gross margins down sequentially versus expectations for them to be up.
I'm wondering since they don't have a conference call, can you give us some insights relative to the work you've done through your integration team to exactly what's going on? Should I view this margin profile as Fairchild just really trying to cream themselves up before you take receipt of the asset, or how should I think about that?.
Well, I can't share specifics on them since we've not closed the transaction yet, but I would not anticipate the margin profile that you see as a continuing expectation. I think they will bounce back nicely in the near future..
That's helpful. And guys, maybe for my follow-up, Bernard, you talked about in your prepared comments some levers you could pull to improve profitability. Good revenue results this quarter and the guide. OpEx was a little bit higher than I would've thought.
Can you just elaborate a little bit about some of those levers; and, I guess, help me better understand relative to revenue growth, how should I think about OpEx growth?.
Sure, John.
So, on the levers, we have talked about those in the past being manufacturing footprint, being also potential migration from 6-inch to 8-inch, just in general productivity improvements, our normal operational improvements in the factories, also potential look now that we are a bigger company, but potentially not focusing on certain areas or divesting for certain less profitable areas.
And in general, we said on a normal amount we are 50% volatile on incremental revenues. Leverage on operating expenses, we should still see there, and we had a few things in the second quarter that contributed to OpEx being higher.
Some of it was indeed the fact that we had taken some temporary measures to offset cost in the fourth and first quarter, which now, we have went back to lower levels. We also had a few expenses associated with the Fairchild transaction that we did not pro forma out, that are contributing to that level.
In general terms, right now, our expectation is that OpEx is – we are not going to change our investment levels in OpEx, and the only increases we should expect are inflationary increases. In the third quarter, our expenses are going up because we have our full co-merit (23:19) increase, that's the main reason our operating expenses are going up..
Thank you..
Thank you. And our next question is from the line of Chris Danely of Citigroup. Your line is open..
Hey. Thanks, guys. On the end market results, it looks like auto was a little below guidance, but PC was a little above guidance.
Can you just talk about what led to the beat and the miss on those end markets?.
Yeah. So, on the automotive side, we actually had two customers that were doing some inventory correction for their company-specific situations, which had a little less growth in automotive than we had anticipated. And on the computing side, the adoption of the Skylake platform was actually slightly faster than we expected going into the quarter.
So that gave a nice pop to the computing segment..
Great. And then my follow-up relates to the Fairchild acquisition. So it looks like NXP is going to spin out their Standard Products business.
Do you anticipate any impact, good or bad, to your business/the Fairchild business?.
Not significant. Basically, the NXP business does not match the Fairchild profile to a high degree, so really not expecting much of a change there..
Great. Thanks, guys..
Thank you. And our next question is from Chris Caso of CLSA. Your line is open..
Yes. Thank you. Good morning. Keith, wondering if you can just go through what would be the remaining milestones for the Fairchild deal closing and your conviction in getting there, as you currently expect, by the end of the month? In addition, the Fairchild update this morning talked about likelihood of selling their ignition IGBT business.
Is this a requirement for closure of sale (25:15)?.
Okay. So, on the closing milestones, we've been in communication with the FTC and had quite a few exchanges there. We believe that we're in a situation where we're going to have satisfactory conditions to close here shortly. The Commissioner (25:37) still have to vote on that but we're not anticipating further issues.
The ignition IGBT business, that was referred to, is actually ON Semi's ignition IGBT business that is being sold and we do expect that also to be closing shortly as part of the Fairchild merger deal..
Okay. Thank you. And as a follow-up on automotive again, you talked about in your commentary high-single-digit growth. I assume that's over a longer term timeframe. Can you talk about some of the elements that get you there? And in addition, there's obviously some concern in the industry now about automotive units in total.
How sensitive is your auto growth both in the near-term and short-term to units versus content?.
Yeah. So that high-single-digits is actually true year-on-year including this year. So it's not a future event. It's actually we expect that in 2016 as well.
And it's really based on the adoption of the adaptive safety, the advanced safety features and the adaptive driving features, we thing, is going to be at a pace such that even with little to no growth in automotive unit sales, we will still see that kind of rate with our automotive content specifically because we have such a good position in the areas that are being adopted in new models so aggressively..
Great. Thank you..
Thank you. And our next question is from Vijay Rakesh of Mizuho. Your line is open..
Yeah. Thanks guys. Good quarter and guide here. Just back on the automotive side, when you look at – just looking at the health of that industry, how is channel inventory for you and for the industry in general, and if you could give us some geographic color on that inventory side. Thanks..
Yeah. In general, we've got good inventory positions around the world. I mentioned earlier a couple of customers had a little bit more than they desired in the second quarter that was mostly in Japan. But the rest of the world seems quite healthy..
Got it. And as part of your Fairchild acquisition, do you expect any fab consolidation both for you or for the combined? Thanks. That's it..
Yeah. We'll give more details on that after we close the transaction, but over the longer term, we will continue to reduce our footprint into larger, more efficient factories..
Great. Thanks a lot..
Thank you. And our next question is from Ian Ing of MKM Partners. Your line is open..
Yes. Thank you. So it looks like we'll get an update on the magnitude of financial targets once you close the acquisition.
But my question is, given you got more time to prepare, should we expect any changes on the pace of synergies over the next 18 months once the deal closes?.
In general terms, we feel very optimistic about achieving or exceeding those targets. We have basically stated that we will get about, exiting (28:58) velocity of about 50% of those synergies after six months, and that's still is in our plans, and the completion of the rest within the next 12 months..
Great. Thanks. And I'm just trying to reconcile some of the commentary, industrial up 15%. Obviously, that's pretty robust. I mean, it feels like some of that should be replenishment versus true end demand.
Yet your channel inventory is down half a week, I mean I'm just trying to reconcile how industrial could be up so strongly with channel inventory down. Perhaps industrial specific was actually up. Thanks..
That is – first of all, seasonally, the first half is the best for industrial. And so you got a strong seasonal headwind. And then specifically, we actually did have some very, very good performance in that marketplace with the design wins we had.
So we're sure there's some share gain in there as well, but it is normal for that market to be up strongly in the second quarter..
Okay. Thank you..
Thank you. Our next question is from Craig Ellis of B. Riley. Your line is open..
Thanks for taking the question. I just wanted to follow up on that outlook commentary for the wireless business.
You mentioned program ramps and seasonality, but could you be more specific with respect to the ramps that you're seeing, either by geography or by class of customer, Tier 1, Tier 2, et cetera?.
Well, we're expecting broad expansion in both China and non-China handsets as you go through the third quarter. It is the time that most of our customers launch their new models. And of course, they do all those builds for the fourth quarter starting in September. So it's really broad based and reflects the profile of our customer base..
Thanks, Keith. And then the follow-up is on the announced self-help initiatives from last quarter. I think it was $15 million in manufacturing and $8 million in OpEx, and that was SSG specific, I believe.
Was any of that benefit realized in the reported quarter? And if not, when would we expect to see that hit the income statement?.
You should start seeing that in the third quarter..
Thanks, guys..
Thank you. Our next question is from Tristan Gerra of Baird. Your line is open..
Hi. Good morning. Given your commentary of flat inventory dollars at distis for Q3 and reconciling with your revenue guidance for the quarter.
How many weeks of inventories would that translate into exiting Q3 at distis?.
It'll be approximately 10 weeks..
Great.
And then what products you're seeing lead time increases, and also is there any specific end market driver, and what's the lead time range that you're seeing currently for your products?.
So we have kind of an 8-week to 15-week range and some of the end markets driving that are wireless as we just mentioned with some very nice ramps in the third quarter and then in specific spots in industrial..
Great. Thank you..
Thank you. Next question is from Ross Seymore of Deutsche Bank. Your line is open..
Hi, guys. Keith, a question for you on the communication side of things. You talked about the customer specific design wins and ramps in the third quarter. There's been some concerns about excess inventory potentially building up in China and creating a need for some burn off in the fourth quarter.
How are you seeing that end market?.
We have not seen that to-date. Certainly, we service that market a lot through distribution and those inventories are actually getting leaner. So we've certainly not seen any of that yet..
And I guess my second question on the computing end market.
You mentioned that the Skylake ramp was helpful in the quarter, how far through that progression do you believe we are?.
We're still in the low 25%, 35% range of Skylake versus other platform. So we think it still takes to the end of the year before that becomes the majority platform..
Thank you..
Thank you. Next question is from Rajvindra Gill of Needham & Company. Your line is open..
Yes. Thanks and congrats on good results. I wonder if you could talk a little bit about the seasonality given kind of the commentary you talked about the specific end markets, and indications of some stabilization in the industry. Any thoughts in terms of kind of seasonality patterns as we go into the second half..
Yeah. So, normally, our industrial market, I'll just start with that one, is stronger in the first half than it is the second. So it kind of gets flattish as you get in to the third quarter.
Computing normally would increase in the third quarter, but specifically there are increases that are going to be due to Skylake platform ramps as opposed to more computers being built. Handsets almost always go up in the third quarter, that's when they launch new platforms and get ready for the seasonal builds at the end of the year.
So that's usually up strongly. Consumer also tends to be up in the third quarter, again, pre-builds for the holiday seasonality – and have I missed any? Automotive. Automotive for us normally is slightly down in the third quarter as automobile companies take down their plants for new tooling on the new models for a week or two.
So it's just slightly down to flat but then picks up again in the fourth quarter..
Okay. That's helpful. And can we talk about some of the – Bernard, some of the gross margin drivers as we go into next year. You're benefiting from kind of a favorable mix shift while utilization rates are kind of flat.
Can you talk a little bit about kind of how you foresee the business mix over the next two to three quarters impacting the margins?.
Sure. In general terms, mix will be a tailwind. We are purposefully focusing on automotive, industrial and wireless. All three have better-than-corporate-average gross margins. Obviously, there is some seasonality balance within that, but in general terms, the mix should be a favorable.
And in general, just on utilization, our fall through model shows about a 50% incremental contribution to the bottom line based on incremental revenue. So, in addition to that, that's we had talked about. We announced the $15 million footprint consolidation that will help us as we go into the 2017 timeframe.
And as we have said, we will be announcing more things as they become clear in the future..
Thank you..
Thank you. Our next question is from Steve Smigie of Raymond James. Your line is open..
Great. Thanks a lot. I'll add my congratulations on the nice results. I was hoping you can comment a little bit more on PC as you look forward, or computer in general. So, you guys are, obviously, getting dollar content and share on Skylake.
What does that growth look like over the next couple of years? And does it make sense at this point, given your success there to maybe go a little bit harder after the server market?.
Yes. So, on the PC front itself, we expect the Skylake transition to largely be over as we enter next year. So from a dollar content perspective, there are no big drivers for 2017. Share gain, obviously, as things we can continue to drive, but dollar content should be relatively stable through 2017.
For the server area, there are more opportunities there, in specifically the power area. And we do expect to have offerings in 2017 for that..
Okay. Great.
And then just maybe I am parsing too finely, but your comments on the macro seem a little bit more upbeat than the last quarter, and I was just wondering if you're just getting a better – little bit better read from customers that's giving you some more confidence, or am I just reading too much into what you said?.
Yeah. No. Actually, bookings have been up strongly and they've been much stronger in the summer season as this approach than we normally see. So, from an order pattern perspective, we're very encouraged, but from a macro perspective listening to the financial prognosticators on the news is not so exciting.
So, I'm not sure how to reconcile those, Steve, but from the order patterns, we're very pleased..
Thank you..
Thank you. Our next question is from Kevin Cassidy of Stifel. Your line is open..
Thanks for taking my question. Just with lead time stretching and inventory coming down, slight increase in utilization, is there – and maybe, Keith, to add onto your comment about your customer bookings increasing.
Could it be that they're concerned of lead times stretching further?.
Could be. Basically, we've been in a I guess a very lean position for a long time now, and certainly, individual customers may be coming a little more sensitive to that with the ramps of particularly handsets in the third quarter..
I see. And coming into the quarter, there was concern over image sensor from one of your competitors where the earthquake in Japan had damaged a factory.
Did you see any increase in bookings due to that?.
There may have been some temporary sales impact, but it was certainly over in the second quarter..
Okay. Great. Thank you..
Thank you. Next question is from Harlan Sur of JPMorgan. Your line is open..
Good morning and thank you for taking my question.
From a bookings and backlog perspective, can you just give us some color on demand patterns by geography here in the September quarter?.
Yeah. I'll let Bernard answer. I don't know that there's any huge discernible win (39:45). The handset market is pretty much all China for us from a build perspective, and so that's going to show the strongest profile..
Yeah. But in general terms, the relative strength we're seeing is pretty much across all the geographies..
Great. Thanks for that. And what were your specific utilizations in Q2? I know last call you had expected them to trend kind of in the high-70% range but looks like you guys drove a level that was higher than that..
Yeah. And just slightly above 80% in Q2 and expected to be very similar in Q3..
Great. Thank you..
Thank you. Next question is from Mark Lipacis of Jefferies. Your line is open..
Hi. Thanks for taking my question. Keith, I think over the past 10 years of M&A, I believe you've been articulating the view that the markets had still been too fragmented to buck the normal quarterly ASP pressures that you guys have reported over time.
And I'm wondering if you saw that with the Fairchild acquisition, does the industry get concentrated enough to the point where you're in a position to start resisting some of those downward ASP pressures. That's all I had. Thank you..
Yeah. I wish I could say that. It's really got a lot more consolidation to go before the supplier side of it, the semiconductor side that has enough strength against a very consolidated customer base..
Thank you..
Thank you. Our next question is from Harsh Kumar of Stephens. Your line is open..
Yeah. Hey, guys. First of all, congratulations on good numbers. Two questions. If you look at the comm business, I think you're guiding for really good growth..
Yes..
... that's doing well as well and then I had a follow-up..
Okay. You cut out there.
Can you please repeat the question?.
Yes. So, within comm, I think you're guiding for really good growth.
Is all of that from mobile or is the core networking business doing as well?.
The majority of the growth is handsets. The networking side is a much smaller portion for us and continues to grow, but the handsets will be the story in Q3..
Got it. And for my follow-up, I think – would you remind us when – assuming you close the deal in about the end of the month, when would you start to expect the synergies? Is it mostly OpEx? And then your commentary suggested you're talking about meeting or exceeding those.
Have you seen something new perhaps that you can share with us?.
So the answer is they'll start showing up in the fourth quarter. I think as we planned and spent more time there, I think we've confirmed what we expected and we now have solid plans in place for execution. So we've got high confidence as opposed to new discoveries..
Thank you..
Thank you. Next question is from Shawn Harrison of Longbow Research. Your line is open..
Hi. Good morning. Two questions on, I guess, interest expense.
Number one is do you have an updated number in terms of what you anticipate the interest expense will be for the debt associated with Fairchild? And then also is it safe to assume that you're still planning on the debt to be put to you in November, and then you would retire that debt?.
So for the Fairchild debt, we have a term loan B for $2.2 billion at a LIBOR plus 4.50%, with the LIBOR floor of 75 basis points. And we will also draw $200 million on our revolver at a slightly better interest rate. And yes, the current plan is to retire the – convert them when it becomes due in December..
And then as a brief follow-up, maybe I'm parsing this too closely, but is your commentary or your view on automotive production, has it declined now given what you've seen over the second quarter, or you are more just commenting on what you're seeing on news headlines versus the incoming kind of production rates to your business?.
We have not seen order rate declines or inventory growth in the channel for us on automotive. The commentary on Q3 is very specific to model changeovers, and as again, very normal course of business..
Perfect, and congrats on the quarter..
Thank you. Next question is from Craig Hettenbach of Morgan Stanley. Your line is open..
Yes. Thank you. Yes. Keith, just following up on the commentary about bookings in business versus macro and certainly strength in the business.
Any other context whether it's a year ago, the industry kind of had to go through an inventory correction that weighed, do you think that inventory has just been matched better to demand, or anything else that you can help in terms of given that context of the business versus just what the subdued macro?.
Yeah. I think there is no question that there was inventories being worked off in the first half. I think we commented on that in the first quarter. Areas like white goods, for example, look like they have pretty much worked through that and in the computing and consumer segments likewise.
So, I think the Q2 numbers and inventory reductions that we've seen in our supply chain indicate to me that most of those have been taken care of now, and so, you're seeing just a bit of normal market behavior..
Got it. And then just a follow-up for Bernard, just on inventory. If I look at 120 days that's kind of within your 110 to 120 days target.
Will Fairchild influence that in terms of as you bring that mix of business on and how the type of inventory you guys would like to hold?.
In general terms, I expect that demand will not change drastically. They have been reducing their inventories over the last couple of quarters in a nice way, so they're going to be aligned or slightly lower than our numbers.
But in general terms, obviously, we will look at from the synergistic point of view there is opportunity to take inventories out. We will do that, but I don't expect it to meaningfully change our model..
Got it. Thank you..
Thank you. And that concludes our Q&A session for today. I'd like to turn the call back over to Mr. Parag Agarwal for any further remarks..
Thank you, everyone for joining the call today. We look forward to seeing you at various conferences during third quarter. Good-bye..
Ladies and gentlemen, thank you for participating in today's conference. This does conclude today's program. You may all disconnect. Everyone, have a great day..