Parag Agarwal - ON Semiconductor Corp. Bernard Gutmann - ON Semiconductor Corp. Keith D. Jackson - ON Semiconductor Corp..

Ross C. Seymore - Deutsche Bank Securities, Inc. Christopher Brett Danely - Citigroup Global Markets, Inc. Vivek Arya - Bank of America Merrill Lynch Chris Caso - Raymond James & Associates, Inc. Craig A. Ellis - B. Riley FBR, Inc. Vijay Raghavan Rakesh - Mizuho Securities USA, Inc. Rajvindra S. Gill - Needham & Company, LLC Shawn M.

Harrison - Longbow Research LLC Christopher Rolland - Susquehanna International Group Anthony Joseph Stoss - Craig-Hallum Capital Group LLC Tristan Gerra - Robert W. Baird & Co., Inc. Mark Delaney - Goldman Sachs & Co. LLC John William Pitzer - Credit Suisse Securities (USA) LLC Craig M. Hettenbach - Morgan Stanley & Co.

LLC Betsy Van Hees - Loop Capital Markets LLC.

Good day, ladies and gentlemen, and welcome to the ON Semiconductor Third Quarter 2017 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 be given at that time.

I would now like to turn the conference over to Parag Agarwal, Vice President of Corporate Development and Investor Relations. You may begin..

Thank you, Sonia. Good morning, and thank you for joining ON Semiconductor Corporation's third quarter 2017 quarterly results conference call. I'm joined today by Keith Jackson, our President and CEO; and Bernard Guttmann, our CFO. This call is being webcast on the Investor Relations section of our website at www.onsemi.com.

A replay of this broadcast, along with our earnings release for the third quarter of 2017 will be available on our website approximately one hour following this conference call, and the recorded broadcast will be available for approximately 30 days following this conference call.

The script for today's call and additional information related to our end markets, business segments, geographies, and channels are also posted on our website. Our earning release and this presentation includes certain non-GAAP financial measures.

Reconciliation of these non-GAAP financial measures to most directly comparable measures and to GAAP are also in our earning release which is posted separately on the website in the Investor Relations section.

During the course of this conference call, we'll make projections or other forward-looking statements regarding future events or future financial performance of the company. The words believe, estimate, project, anticipate, intend, may, expect, will, plan, should, or similar expressions are intended to identify forward-looking statements.

We wish to caution that such statements are subject to risk and uncertainties that could cause actual events or results to differ materially from projections.

Important factors which can affect our business, including factors that could cause actual results to differ from our forward-looking statements are described in our Form 10-Ks, Form 10-Qs, and other filings with the Securities and Exchange Commission. Additional factors are described in our earnings release for the third quarter of 2017.

Our estimates may change, and the company assumes no obligation to update forward-looking statements to reflect actual results, changed assumptions or other factors except as required by law. For all synergy-related discussion on this call, we have used Fairchild's 2015 results as a base for all comparisons.

Now, let me turn it over to Bernard Gutmann who will provide an overview of third quarter 2017 results.

Bernard?.

Thank you, Parag, and thank you everyone for joining us today. Our execution momentum remains intact, and we once again delivered solid financial results, which exceeded our guidance and Street consensus for all key metrics.

Our consistent solid execution and robust financial results over the last many quarters demonstrate the strength of our operating model and strong market acceptance of our broad portfolio for automotive, industrial, and communications end markets. We once again generated strong free cash flow and demonstrated solid operating leverage.

I am very pleased to announce that at the end of the third quarter, we were able to achieve our target net leverage ratio of 2 times, significantly ahead of schedule. We calculate net leverage ratio by dividing our net debt at principal value by adjusted EBITDA, excluding stock-based compensation for the last 12 months.

This aggressive deleveraging within approximately one year of close of the Fairchild acquisition is a testament to our strong strategic rationale for the acquisition and to our solid execution on the integration front. We have now reached the point where we can consider reinitiating our capital return program.

Our business remains strong and, indication from customers and macroeconomic data point to continuing strength in demand across most end market and geographies.

Our past investments in automotive, industrial, and communication end markets are yielding strong results and we are very well positioned to benefit from sustainable secular driver in the fastest-growing segment in the semiconductor market.

At the same time, our highly diversified customer base with no end customer contributing more than 5% of our revenue insulates us from volatility that occurs from time to time in various end markets and geographies. Our free cash flow regeneration remains strong and we once again delivered robust free cash flow performance during the third quarter.

During the first nine months of the year, we generated free cash flow of $658 million. For 2017, we now expect free cash flow in the range of approximately $700 million, higher than our earlier expectation of $600 million to $650 million. As a comparison, we generated free cash flow of approximately $371 million in 2016.

Now, let me provide you additional details on our third quarter 2017 results. Total revenue for the third quarter of 2017 was $1.391 billion, an increase of 46% year-over-year and an increase of 4% as compared to revenue in the second quarter. GAAP net income for the third quarter was $0.25 per diluted share.

GAAP income before income tax for the third quarter was $168 million as compared to $143 million in the second quarter. Non-GAAP income before income tax for the third quarter was $203 million. Net cash paid for taxes in the third quarter was $13.4 million and diluted shares outstanding were 427.5 million.

Non-GAAP income before income tax for the second quarter was $171.1 million. Net cash paid for taxes in the second quarter was $17.1 million and diluted shares outstanding were 425.9 million. GAAP gross margin for the third quarter was 37.7% as compared to 36.8% in the second quarter.

Non-GAAP gross margin for the third quarter was 37.9%, an impressive increase of approximately 100 basis points over the 36.9% in the second quarter. This strong gross margin performance was driven by solid operational execution and revenue performance.

Improving product mix also contributed to higher gross margin with tailwinds from additional manufacturing synergies from Fairchild, mix improvement, and portfolio optimization, we remain on track to achieve our target non-GAAP gross margin of 40% by 2020.

GAAP operating margin for the third quarter of 2017 was 12.7% as compared to 11.5% in the prior quarter. Our non-GAAP operating margin for the third quarter was 16.6%, an increase of approximately 190 basis points over the 14.7% in the second quarter. On a revenue increase of 4%, our non-GAAP operating margin increased by 17%.

This strong operating income performance demonstrate the operating leverage and strength of our operating model. GAAP operating expenses for the third quarter were $347 million as compared to $338 million for the second quarter of 2017.

Non-GAAP operating expenses for the third quarter were $296 million, as compared to $297 million in the second quarter. We have strong free cash flow performance in the third quarter. We define free cash flow as cash flow from operations less capital expenditures.

Third quarter free cash flow was $238 million, and operating cash flow for the third quarter was $328 million. Third quarter free cash flow and operating cash flow included $30 million from a licensing arrangement related to our exit from the mobile image sensor business. Capital expenditures during the third quarter were $90 million.

Capital intensity based on non-GAAP revenue during the first nine months of the year was 5.3%, significantly below our target model of 6% to 7%. We expect that capital expenditures in the fourth quarter will increase and capital intensity for 2017 is expected to be in the range of 6% to 7%.

As I indicated earlier, we expect free cash flow for 2017 to be approximately $700 million, higher than our previous expectation of $600 million to $650 million. We exited the third quarter of 2017 with cash and cash equivalents of $901.2 million as compared to $871.6 million in the second quarter.

We used approximately $200 million in the third quarter – $200 million in the third quarter of 2017 for the prepayment of debt. At the end of the third quarter of 2017, days of inventory on hand were 109 days, up slightly by a day as compared to inventory days at the end of the second quarter.

Distribution inventory in days was down in the third quarter as compared to the second quarter. Given the outlook for continuing strength in demand in the near to mid-term, we want to maintain adequate level of inventory to service our customers. For the third quarter of 2017, our lead times were up marginally quarter-over-quarter.

Our global factory utilization for the third quarter was up sequentially. Now let me provide you an update on performance by our business units starting with Power Solutions Group or PSG. Revenue for PSG was $706 million.

Revenue for our Analog Solutions Group for the third quarter of 2017 was $492 million, and revenue for the Image Sensor Group was $193 million. Now, I would like to turn the call over to Keith Jackson for additional comments on the business environment.

Keith?.

Thanks, Bernard. Once again, I am very pleased with our results. Our third quarter results clearly demonstrate the strength of our portfolio for automotive, industrial, and communications end markets.

Through our investments of the last many years in high-growth segments and in highly differentiated products in automotive, industrial, and communication end markets, we have radically transformed the nature of our business.

Our business today is driven by sustainable secular growth drivers in the fastest growing semiconductor end markets, as opposed to being driven by macroeconomic and industry cyclicality a few years ago.

With approximately 75% of revenue coming from automotive, industrial, and communications end markets, we are overwhelmingly exposed to the fastest-growing segments of the semiconductor market.

Our traction in high-growth areas such as ADAS, electric vehicles, silicon carbide, machine vision, industrial power management, et cetera, continues to accelerate and remain very optimistic about our near and long-term prospects.

We believe that we are in the early stages of realizing benefits of our investments in the automotive and industrial end markets. And increased adoption of ADAS, electric vehicles, hybrid electric vehicles, machine vision, robotics, et cetera, should drive further acceleration in our revenue.

We continue to invest in the automotive and industrial end markets as we believe that these markets will be the fastest-growing semiconductor end markets. Along with strong revenue growth driven by secular growth drivers, our operating performance has been solid.

We have demonstrated strong operating leverage through solid gross and operating margin improvement. Our operating profit growth significantly exceeded growth in our revenue, and our free cash flow generation thus far this year has significantly exceeded our free cash flow in 2016.

We further expect expansion in our margins as we realize further benefits from synergies from Fairchild and from our gross margin improvement initiatives. Based on our progress thus far, we feel very confident in our ability to achieve our targeted financial model by 2020, provided there is no significant adverse change in macroeconomic conditions.

We expect to grow faster than the semiconductor industry, driven by sustainable secular growth drivers in margin-rich automotive and industrial end markets. This revenue growth should drive operating leverage coupled with mix shift towards higher-margin products.

Further margin expansion should come from optimization of Fairchild's manufacturing operations. Divestiture of non-core and under-performing businesses should further contribute towards margin expansion. We continue to make good progress on our divestiture program.

As we announced last quarter, we have monetized our mobile CMOS image sensor IP, and another announcement related to divestiture of another business should come out shortly. Customers are increasingly engaging with us for key-enabling technologies for emerging applications.

We are very well positioned to benefit from secular growth drivers such as adoption of electric vehicles. We are making strong progress in our silicon carbide program and, currently, we are sampling products to many global automotive customers. We expect to see silicon carbide related revenue from automotive customers in the second half of 2018.

We continue to extend our leadership in ADAS, and as I indicated in the last earnings call, we are engaged at a very early stage with key players in artificial intelligence for automotive, machine vision, and robotics applications.

We believe that our early engagement with leaders in AI will result in significant competitive advantage for us as adoption of AI accelerates in ADAS, machine vision, and robotics applications. We are making strong progress in our cloud and server power management business and our revenue for this business accelerated sharply in the third quarter.

For USB Type-C, we have on the market the lowest power and most comprehensive solution comprising of power delivery, controller, re-drivers, multiplexers, switches, and protection devices.

For the third quarter, our USB Type-C related products posted strong revenue performance, and we expect robust growth in our USB Type-C related revenue going forward. In addition to secular revenue drivers, we are benefiting from cross-selling opportunities arising out of the combined customer base of ON Semiconductor and Fairchild.

As I have indicated earlier following our acquisition of Fairchild Semiconductor, customers are increasingly relying on us as a credible alternative to the market leader for a broad range of power management solutions. We continue to make strong progress in the integration of Fairchild.

We recently achieved a major milestone in the integration process by completing the integration of Fairchild's IT systems. We solidly remain on track to begin realizing manufacturing synergies from Fairchild toward the end of the year as we start insourcing of Fairchild's backend operations.

We expect to exit 2017 with annual synergies run rate of $180 million. Our target of annual synergies run rate of $240 million by the end of 2019 remains unchanged. Let me now comment on the business trends in the third quarter. During the third quarter, demand trends and bookings were strong across most end markets and geographies.

Supply-demand dynamics in the third quarter were stable as compared to supply demand dynamics in the second quarter. There is no meaningful change in lead times or distribution inventory levels from the second quarter of 2017. Pricing continues to be benign as compared to historic trends.

Our customers are upbeat on demand for their products, and they expect the strength in demand to continue for the near to midterm. Now I'll provide details of the progress in our various end markets for the third quarter of 2017.

Revenue for the automotive market in the third quarter was $411 million and represented 30% of our revenue in the third quarter. Third quarter automotive revenue grew by 32% year-over-year and was approximately flat quarter-over-quarter.

For the third quarter, we again saw strong demand in a seasonally weak quarter for our CMOS image sensors, power management products, mixed-signal A6 and sensor interface products. Our revenue grew strongly year-over-year in most geographies.

As I indicated earlier in the prepared remarks and on previous calls, we are very well positioned to benefit from the adoption of ADAS and electric vehicles. We expect to see our first silicon carbide related revenue from automotive customers in the second half of 2018.

In the fourth quarter, we expect to see a ramp of our IGBTs for electric vehicle traction motors in China. We are seeing ramp of our IGBTs and FETs for electric vehicle charger designs. We are working with leading ecosystem players on power management solutions for processors and other related applications in automotive.

Revenue in the fourth quarter for the automotive end market is expected to be up quarter-over-quarter. The industrial end markets, which includes military, aerospace, and medical, contributed revenue of $349 million in the third quarter. The industrial end market represented 25% of our revenue in the third quarter.

Third quarter industrial revenue grew by 51% year-over-year and by 1% as compared to the industrial revenue in the second quarter. Overall demand from industrial market remains healthy. We are seeing strong growth for our PYTHON line of image sensors for machine vision applications.

We are also benefiting from demand of our power modules and power management semiconductor solutions for industrial applications. As we have indicated earlier, we have leveraged our expertise in consumer power modules and adapted many of our consumer power modules to industrial applications.

We continue to see solid strength in Fairchild's portfolio for the industrial market. With expanded capabilities in power modules and the addition of Fairchild's portfolio, we have one of the most comprehensive portfolios in the market for the industrial power management.

Customers are increasingly relying on us as a credible alternative to the current market leader.

In addition to benefits from secular growth in the industrial end market driven by increased automation and the need for higher energy efficiency, we should see incremental upside to our revenue driven by share gains as customers reduce their reliance on a single provider.

Revenue in the fourth quarter for the industrial end market is expected to be down quarter-over-quarter. The communications end market, which includes both networking and wireless, contributed revenue of $282 million in the third quarter. Communications end market represented approximately 20% of our revenue in the third quarter.

Third quarter communications revenue grew by 50% year-over-year and 9% quarter-over-quarter. Third quarter communications revenue was negatively impacted by our exit from the mobile image sensor market in the second quarter of 2017.

However, the launch of new platforms and continuing increase of our content in the major platforms more than offset the decline in mobile image sensor revenue. As I noted earlier, we are seeing strong traction for our USB Type-C solutions in the smartphone market.

We expect strong growth in our USB Type-C related revenue from the smartphone market going forward. Revenue in the fourth quarter for the communications end market is expected to be down quarter-over-quarter due to normal seasonality. The computing end market contributed revenue of $157 million in the third quarter.

The computing end market represented 11% of our revenue in the third quarter. Third quarter computing revenue grew by 58% year-over-year and 16% quarter-over-quarter. The growth in computing was driven by strength in both client and server solutions.

Our server business is off to a solid start with an impressive revenue performance in the third quarter. We are engaged with market leaders for cloud and server platforms, and we are very encouraged by early feedback on our cloud and server solutions.

Revenue in the fourth quarter for computing end market is expected to be down quarter-over-quarter due to normal seasonality. The consumer end market contributed revenue of $192 million in the third quarter. The consumer end market represented 14% of our revenue in the third quarter.

Third quarter consumer revenue grew by 59% year-over-year and by 2% quarter-over-quarter. Continued strength in white goods was a key driver of consumer-related revenue in the third quarter. Revenue in the fourth quarter for the consumer end market is expected be down quarter-over-quarter due to normal seasonality.

In summary, we continue to deliver solid results driven by strong execution on all fronts.

Through our investments over the last many years in high-growth segments and in highly differentiated products in automotive, industrial, and communications end markets, we have been successful in transforming ON Semiconductor into a company driven by sustainable secular growth drivers in the fastest-growing semiconductor end markets.

From a company driven by macroeconomic and industrial cyclicality, we are making strong progress towards our target financial model, and we are increasingly confident of achieving the target model (22:31) significant macroeconomic downturn.

We have shown impressive expansion in our margins and our free cash flow generation has increased at a rapid pace. Now I'd like to turn it back over to Bernard for forward-looking guidance.

Bernard?.

Thank you, Keith. Before I go into the details of the fourth quarter guidance, let me point out that the fourth quarter has two extra days as compared to the third quarter of 2017. As the fourth quarter is predominantly front-end loaded, we don't expect incremental revenue due to the extra two days in the quarter.

However, we will have to bear fixed costs and operating expenses for the two extra days in the fourth quarter, and these costs will have slightly negative impact on gross margin and operating expenses for the fourth quarter.

Based on product booking trends, backlog levels, and estimated turns levels, we anticipate that the total ON Semiconductor revenues will be $1.325 billion to $1.375 billion in the fourth quarter of 2017. Backlog levels for the fourth quarter of 2017 represent 80% to 85% of our anticipated fourth quarter revenue.

For the fourth quarter of 2017, we expect GAAP and non-GAAP gross margin in the range of 36.3% to 38.3%. Factory utilization in the fourth quarter is likely to be down sequentially. We expect total GAAP operating expenses of $324 million to $345 million.

Our GAAP operating expenses include the amortization of intangibles, restructuring, asset impairments, and other charges which are expected to be in the $30 million to $37 million. We expect total non-GAAP operating expenses of $294 million to $308 million.

The increase in operating expenses in the fourth quarter as compared to those in the third quarter is primarily driven by two extra days in the fourth quarter.

We anticipate fourth quarter GAAP net income and expense, including interest expense will be in the $33 million to $36 million, which includes noncash interest expense of $8 million to $9 million. We anticipate our non-GAAP net other income and expense, including interest expense will be in the $25 million to $27 million.

Cash paid for income taxes in the fourth quarter of 2017 is expected to be $17 million to $21 million. Cash taxes are higher in the fourth quarter due to the timing of 2017 tax payments between quarters as recorded by the tax authorities in the jurisdictions we do business. We expect our 2017 cash tax rate to be 10%.

We expect total capital expenditures of $140 million to $160 million in the fourth quarter of 2017. As I indicated earlier, our capital intensity in the fourth quarter of 2017 will be higher to compensate for the lower capital intensity in the first three quarters of the year. Our target of 6% to 7% annual capital intensity remains unchanged.

We also expect share-based compensation of $16 million to $18 million in the fourth quarter of 2017, of which approximately $2 million is expected be in cost of goods sold, and the remaining amount is expected to be in operating expenses. This expense is included in our non-GAAP financial measures.

Our GAAP diluted share count for the fourth quarter of 2017 is expected to be in the 431 million to 433 million shares based on the current stock price. Our non-GAAP diluted share count for the fourth quarter of 2017 is expected to be 428 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 Forms 10-Q and 10-K. With that, I would like to start the Q&A session. Thank you. And, Sonia, please open up the line for questions..

Thank you. Our first question comes from the line of Ross Seymore of Deutsche Bank. Your line is now open..

Hi, guys. Thanks for letting me ask a question. The first one's for Keith. Keith, you mentioned a couple times in your script about the company being less cyclical in addressing more secular growth. So, I guess a two-pronged question.

First, can you talk about what you think makes the company less cyclical? And then second, there's a lot of investor concern on the cyclical side of the equation.

Can you give us your view on where we are in the cycle?.

Certainly. I think the first comment on secular is really looking at longer-term growth trends. We've mentioned many times in automotive that the electrification and automation there is going to be driving significant growth independent of economic cycles. We have the same kind of feeling about industrial.

There are a lot of applications there where we're automating buildings, we're looking at automating manufacturing et cetera, and those trends will supersede any kind of economic cyclicality. So, we think those are the two dominant drivers making us much more secular.

Secondly, relative to how we see the cycle, we continue to see strength on all fronts from our customers. And as we look out to – we don't see any macroeconomic landmines on the horizon. And so as a result, we expect to see continued growth into a longer-than-normal semiconductor cycle..

Thanks for that. And then the follow-up question is for Bernard. On the margin and free cash flow, great job on those metrics. As we look forward, can you give us an update on where we are for the Fairchild integration? I believe you said you had about $65 million of synergies remaining, and you talked about the backend consolidation kicking in.

Can you just walk us through the major steps to get that incremental $65 million, please?.

The majority of it comes, as you stated, from the insourcing of assembly and test activities which will start ramping towards the end of this year and will really ramp into 2018. We have launched multiple CapEx programs associated with that, and they're all in the works. So, we expect that to start really in earnest as we go into next year..

Great. Thank you..

Thank you. Our next question comes from the line of Chris Danely of Citigroup. Your line is now open..

Hey. Thanks, guys. I think in the first part of the call you mentioned lead times had gone out a little bit. And then, Keith, you said that they haven't materially changed.

So, can you guys just maybe give us a sense of what would be a sort of an aggregate of your normal lead times and where they are right now? And when would you expect those to get back to normal?.

Yes. They've been operating not too far from the mid-teens for some time. They went up marginally here in the last quarter. Some of the capital we're bringing in here in Q4 should start to alleviate that by the middle of next year..

And so, you said they went up a little bit.

Did they go up by a day? Two days? A week? A weekday? How much did they go up?.

Not even – a day or less..

Oh, okay. And the second question would be just on the capital structure. You said you might be able to institute the capital return program. Maybe just talk about how we should think of the debt pay down going forward and then what a capital return program would look like..

So, as debt matures naturally, we have redeemable debt, at that time we'll continue paying debt down. And we'll be discussing with our board the capital allocation policy going forward..

Great. Thanks, guys..

Thank you. Our next question comes from Vivek Arya of Bank of America Merrill Lynch. Your line is now open..

Thanks for taking my question, and congratulations on the good results and execution. One more on the capital returns program, since you did tantalize us with that remark in your prepared comments.

Keith, are you more – are you favoring more a buyback program or an initiation of dividend? Because when I look at the free cash flow yield, it was 7% to 8% on the stock right now, so quite attractive. The other option, of course, is to consider additional M&A and maybe expand gross margins beyond the 40% target.

So, without any quantification, if you could give us some additional color on which way you're leaning, that would be very helpful..

We have active authorization for stock buyback. But the board is discussing whether there are other means similar to what you just discussed that might be better in the long term for the shareholders. And so, we won't give any more clarity to that until next quarter..

I see. And then in terms of the competitive landscape, we have heard more noise coming out of Sony in terms of their intention to compete in the automotive image sensor market. I understand these relationships with customers tend to be long-term, so there's probably no change in the near-term.

But just longer term, how do you see your technology position in the automotive image sensor market versus Sony or any other competitor?.

Yes. We continue to drive technologies specific to automotive that we think are a competitive advantage across the board. We also have many years of experience in automotive reliability and quality, along with cyber security and functional security.

So, we think we've got a lead there that we can maintain with continued investments specific to the automotive industry..

And the same question from a cost perspective, how do you think your cost basis compares with some of your competitors who might have higher volumes just because they are engaged in the smartphone industry?.

Yes. We believe we continue to be cost-competitive there, having driven like we do in all of our product lines, very good supply chains, and very good manufacturing efficiencies..

Okay. Thank you..

Thank you. Our next question comes from Chris Caso of Raymond James. Your line is now open..

Yes. Thank you. Good morning. Wonder if you could talk a bit about seasonality, both in terms of what you would consider to be normal seasonality in the fourth quarter and how your guidance shapes up against that. As we look into next year, there are a lot of moving parts as we go into Q1.

But now that Fairchild's been on the books for quite a while, where do you see normal seasonality in Q1?.

Thanks, Chris. So, we believe our normal blended seasonality for the fourth quarter is in that 2% to 4%, so approximately 3%, which we believe that our guidance matches that normal seasonality. Fairchild had a more pronounced seasonality than ON, but the combined blended average is that approximately 3%.

For Q1, we look in that range of zero of 2% down..

Okay. And going forward, just with regard to pricing, given the tight supply conditions industry-wide, I'd have to imagine that pricing is favorable and likely coming down less than where your costs are.

With that in mind and also the annual price negotiations you guys typically have in Q1, what should we think about pricing as we go into next year? And what potential impact could that have on margins as we look into 2018?.

So, normally, we see 5% to 6% price erosion a year. We are currently experiencing less than that rate, and I would expect that to continue into next year. Our annual cost reduction internally, we try to target to be faster than those price erosions. And so, I would expect to see margin pick-up.

Exact basis points, I'm not sure I can give a forecast on, but it should be quite favorable in our margin gains towards our targets..

Got it. Thank you..

Thank you. Our next question comes from Craig Ellis of FBR B. Riley. Your line is now open..

Yes. Thanks for taking the question and thanks for getting the changed name right. Keith, first, congratulations on the numerous accomplishments in the quarter.

Two, if we just look at this year's free cash flow generation at $700 million and think about what that means over the three-year target model period, that's $2.1 billion of value creation flexibility that you now have in the business.

So, as you look at the $2 in earnings per share target for 2020, one, how much does this year's expanded free cash flow increase your confidence in attainability? And two, doesn't it mean that there's significant pull-in potential from 2020, given the levers that you now have at your disposal?.

So, thanks, Craig. Definitely, we are very happy with the free cash flow evolving right now. It does provide us a significant amount of increased confidence that we will be able to achieve our promised target model. And indeed, it would point into potentially even accelerating that target..

All right. And then the follow-up is on the PC business, obviously, very strong quarter there.

And the question is how much of the sequential growth came from gains in the server businesses? And as we look to 2018, how should we think about the evolution of mix between the legacy PC business and the growth of the company is now realizing with server power?.

Most of that did come from server power, and I would expect going forward that, that will be the increases that you see. For a lot of reasons in the end markets, the kind of personal computer use has flattened out and plateaued. So, it's really – we're looking for growth from the server power side..

Thanks, guys..

Thank you. Our next question comes from Vijay Rakesh of Mizuho. Your line is now open..

Yes. Hi, guys. Just looking at 2018, there is a lot of worry around the automotive side but content continues to grow.

Is there a way you can take a look in the crystal ball and see how – tell us how 2018 looks just automotive-wise?.

Yes. So, obviously, we have the same forecast everyone has on SAAR. We're looking at the low 1%, 2% ranges. But from a content perspective, significant more adoption on ADAS we think gives us kind of the high single-digit opportunity in 2018..

Got it. And then as a camera ADAS supplier, you guys have worked and collaborated with NVIDIA and Mobileye. You mentioned AI, can you talk to us what you're doing there? And what is the book-to-bill in automotive here? Thanks..

Okay. Those are diverse questions. Book-to-bill continues to be above 1 in automotive as, frankly it is in all our markets right now, so I'm not going to give those numbers. On the AI front, there's two areas that we collaborate on. One is with the power for AI.

It's going to – there's significantly more compute power and this is a part of our power supply program. And then secondly, interfacing with all of the sensors and the sensor interface products is predominantly where we interface with the AI people directly on the signal side..

Thanks..

Thank you. Our next question comes from Rajvindra Gill of Needham & Company. Your line is now open..

Yes. Thank you, and congrats as well. Question on the silicon carbide traction you're getting.

I just want to get some clarification, are you selling both the silicon carbide substrates, the wafers, as well as the power RF devices that are built on those silicon substrates? And along those same lines, kind of how would you characterize the competitive landscape in silicon carbide in terms of capacity and technological capability?.

So, we are only selling silicon carbide power devices. We don't sell substrates, and that market is growing quite rapidly. It needs more than one supplier and there are I think two or three total competitors out there.

So, we see a lot of healthy growth there in a market that is going to explode, quite literally, from a growth perspective in 2018, 2019 timeframe..

And just one follow-up on that as well because I agree with that assessment. From my perspective, the biggest advantage of silicon carbide power device is their ability to do high-frequency switching at lower temperature than silicon.

I was wondering if you could describe some of the advantages, from your perspective, and what's driving the adoption on for that technology?.

Yes. You get much higher efficiencies in your power conversion, which means you don't have to do as much cooling, and that removes a lot of cooling weight from the automobiles giving them longer battery lives, et cetera. You also get much more dense power solutions, so they can be much smaller to get the same performance..

Great. Thank you..

Thank you. Our next question comes from Shawn Harrison of Longbow Research. Your line is now open..

Hi. Good morning. First question, just a two-parter on the communications business.

How much of just walking away from mobile image sensor business did that cost you into the September quarter? And then, are you expecting to see maybe less than seasonal headwinds as we move into the March quarter given the later launch of the iPhone this year?.

So, the direct revenue quarter-on-quarter between two and three was a $12 million reduction that we saw in that. From a year earlier, it was much higher but quarter-on-quarter about $12 million. Yes, there were later launches for certain other phones. We do expect to have the opportunity for a stronger than normal seasonality in Q1.

How much is yet to be determined..

Perfect. And then as a follow-up, if I may, if we look at the typical step-up you see in OpEx going into the March quarter, variable (42:17) other things.

How much of that on a dollar basis may step up, understanding that there's a little bit of an extra two day dynamic here in the fourth quarter?.

With the extra two days going away, I expect that the OpEx will be down..

Down on a sequential dollar basis? For the March quarter?.

Yes..

Perfect. Thank you..

Thank you. Our next question comes from Christopher Rolland of Susquehanna International Group. Your line is now open..

Thank you for the question, and great quarter, guys. So, divestitures, maybe any more details on the mobile divestiture or at least IP agreement? And also you mentioned another pending divestiture that you guys might be doing. Is it bigger or smaller than the mobile one? And how many other opportunities do you kind of see to divest in businesses..

Details will be coming out in the 10-Q, but that mobile business has completed its divestiture. The other ones we referred to will be smaller than that one that will be announced here in this quarter..

Great. And then back to your position, more around the silicon carbide stuff, and your position in high power as well, maybe you want to describe that.

Does silicon carbide open up a bunch of new markets for you in higher power? And then also, what are your feelings on GaN? Are you now significantly favoring silicon carbide over GaN?.

Okay. Silicon carbide, we're supplying today into the industrial market. Basically it goes in the modules, power modules that we have, IGBTs in today. So, some of it is displacement of IGBTs with silicon carbide in the same modules, giving us higher efficiency.

And some of it, to your point, does open up new applications where either power density or thermal capacity are most important. GaN will continue to grow at a much slower pace. Our belief is that silicon carbide will be growing very, very quickly but gallium nitride power devices will take off much more slowly..

Great. Thanks, guys..

Thank you. Our next question comes from Anthony Stoss of Craig-Hallum. Your line is now open..

Hi, guys. Nice quarter. Within your implied CapEx guide of next year, call it $350 million, is the Fujitsu strategic investment, is that part or included or is that on top of it? And also, Keith, do you expect your normal 75%, 25% internal versus external manufacturing to change in 2018? And then I had a follow-up..

So, the Fujitsu joint venture is not included in that number. That's recorded in a different place on the cash flow statement. So, it is incremental on top of the regular CapEx..

Okay.

And then as a follow-up, in terms of the divestitures that you're alluding to happening in Q4, how much revenue have you been anticipating in your Q4 revenue guide as part of that?.

It would actually – I mean, it's negligible. The answer to that is, again, we're anticipating that move and so there's nothing in the guidance..

Got it. Thank you..

Thank you. Our next question comes from Tristan Gerra of Baird. Your line is now open..

Hi. Good morning. As a follow-up to the prior question from Chris, and given the extension of backlog that we generally see in analog, you probably have very good visibility into early next year. Any sense of how Q1 is currently shaping? You have already mentioned what type of seasonality we should be expecting..

Yes. So, it's shaping up strong compared to normal seasonality. But again, specific metrics will have to wait..

Okay. That's great. And then at the beginning of this year you highlighted some areas that you thought could really drive growth in auto specifically, automotive sensors and LED headlights. Today you've mentioned your expectations for ADAS to be a high single-digit growth. So, I'm assuming that's your CMOS sensor business.

You also talked about silicon carbide. Any sense of the, first, any other areas within automotive that you would consider as a driving factor for 2018? And also, if you could talk about the incremental dollar opportunity that you see from silicon carbide per car..

Okay. So, for clarification, the upper single-digits is for total automotive growth, not just in those applications. Things like ADAS are actually in the 20s-percent growth year-on-year, and LED headlights are in the high teens. So, the aggregate number is high single-digits, just for clarity.

So, we are expecting very fast growth in the developing areas inside the car, but we have a large business that includes internal combustion engines that is not growing as fast. So, the net of that is high single-digits. And then as far as other areas, there are many areas in the car growing.

They're replacing all the motors with new brushless DC motors. We've got the EV and hybrid electronic applications that can add up to $200 per car and silicon carbide certainly is a contributor to that. But in those modules, it could be $40 to $50 additional for silicon carbide..

That's very useful. Thank you..

Thank you. Our next question comes from Mark Delaney of Goldman Sachs. Your line is now open..

Yes. Good morning. Thanks for taking the questions. First question is on factory utilization rates. I know it was mentioned as ticking up again this quarter. I think as of 1Q it was in the mid-80s.

So, can you level set us on where factory utilization is at this point and is it over 90%?.

It is approximately the high-80s to 90%. It's not above..

Got it. Thanks for that. And then for a follow-up question specifically on the industrial market, Keith, I know you said down in the fourth quarter and I know seasonality is always tough, some years it's been down and for my model, some years it's been up.

If you could just elaborate a bit more on what you're seeing in the industrial market and what's the reason for the guidance to be lower sequentially in 4Q?.

We're just giving that guidance based on the broad-based exposure we see in the marketplace. There is nothing that stands out as being a problem. Maybe a pause, but there's no problems..

Got it. Thanks very much..

Thank you. Our next question comes from John Pitzer of Credit Suisse. Your line is now open..

Yes. Good morning, guys. Thanks for letting me ask the questions and congratulations on the strong result. Bernard, I wanted to go back a little bit to the Fujitsu deal and hope that you can give us some understanding of what the incremental CapEx burden would be.

And I'm assuming if there's an incremental CapEx burden to that deal, there's an incremental positive running through the P&L.

So, is Fujitsu part of the 2020 margin target plan or is it above and beyond that, and can you quantify that?.

Definitely, it's part of our factory footprint plans. When we announced it on October 10, we basically said that getting to that incremental 30% in ownership will cost us $18 million.

That's a very, very cost-effective way of getting incremental capital, much better than if we had to buy just the pure equipment, and it will definitely give us a significant amount of 200 millimeter incremental capacity that will help us relieve some of the tightness we have in some of our packages in markets..

Just to clarify, it's part of the 2020 margin plan or this would above and beyond?.

No, it's part of it..

Okay. That's helpful..

It's part of getting the required capacity to get to deliver the revenues associated with the plan..

Perfect. And then, Keith, I wanted to go back to Ross' first question about just where we are in the cycle. When I look at your business, sort of direct disti and EMS, the direct numbers would clearly suggest that things aren't overheating. I think you were up about 1% sequentially, 4% year-over-year.

But when you sort of look at disti up 16% year-over-year and then EMS up 18% sequentially and 20% year-over-year, can you just – is there anything going on in the mix of business that would argue things moving more towards disti? And I guess specifically in the calendar third quarter, was there a program at the EMS side that drove revenue up sequentially that much? I know it's a small part, but just trying to get an understanding of disti and EMS and what's driving the growth there..

Yes. A couple of very significant factors. One is we have grown significantly model-year-over-model-year with customers in areas like cell phones that use distribution and EMS as their primary sources. So, basically, outgrowing with some of those customers. Secondly, of course, Fairchild, big impact on that.

They were much more distribution than ON was from a legacy perspective, and those numbers flow through as well. So, a combination of what was traditionally OEMs moving more into the EMS disti channel plus Fairchild really have changed the nature of that number.

But we track very closely – continue to track very closely the sell-through, even though we are now on sell-in, and we continue to drive inventories down. So, we just don't see any signs of overheating..

And then if I could sneak one last quick one in. Bernard, just on the free cash flow, great to see you raised the guidance for the full-year to $700 million. But given that we've done nine months already, it kind of only shows about a $40 million to $45 million free cash flow number for the calendar fourth quarter.

I'm assuming there's a level of conservatism in that.

But are there period costs that you can also talk about in Q4 that might be impacting free cash flow for the quarter?.

Definitely, we are trying to be prudent in the way we forecast. But as I also mentioned, we are going to spend a lot more CapEx in the fourth quarter as compared to what we spent in the first nine months. Our guidance is $140 million to $160 million in CapEx for the fourth quarter as compared to $90 million in the third quarter..

Great. Thanks, guys..

Thank you. Our next question comes from Craig Hettenbach of Morgan Stanley. Your line is now open..

Yes. Thank you. Just had a question on the cycle, particularly lead times if I look at how you're managing through what's been titans (53:58) across the industry versus some peers and we've heard of lead times extended further.

Just anything that you've been able to do to kind of help maintain the lead times not extending out as much as some others have seen..

I think the biggest impact this cycle, which is a strong cycle right now, has been working with our distributor partners to make sure that we did not increase inventory there. That typically is what has the biggest impact on lead times is overordering and distribution..

Got it. And if I can ask a follow-up on the silicon carbide, as you mentioned, there's a couple of players in this market.

Can you just talk about your visibility then as you talk to 2018 programs, kind of where you are from a design perspective and how you see that building up over time?.

Yes. As I mentioned, in the industrial sector, we've had offerings for a while and so, have good visibility on that growth. And our first automotive win is going to production Q3 of 2018..

Thank you..

Thank you. Our next question comes from Betsy Van Hees of Loop Capital Markets. Your line is open..

Good morning, and thanks so much for taking my questions, and congratulations on the strong quarter and guidance. Thanks so much for providing us the typical seasonality for Q1.

Given that you've got Fairchild under your belt for quite a long time now, I was wondering if you could walk us through what typical seasonality is for the quarters Q2, Q3, and Q4 of the combined companies. It would be very helpful for modeling purposes. Thanks..

Thank you. So, the second quarter is typically in that 3% to 4%. The third quarter, approximately the same. And then the fourth quarter is down that 3%, just like we talked about earlier..

Thanks, Bernard. That was very helpful. And then Keith, in the past, you've talked about wireless charging and it's been in your prepared remarks and I see you don't mention it this time. So, I was wondering if you could give us an update on where things stand with wireless charging. Thanks..

Sure. So, wireless charging has been, again, nothing new, much slower to develop than we anticipated. And most of the applications appear to be going for multimode charging which we've introduced devices for now.

The big driver there we expect to be handsets, and we expect to see, again, some improvement here in 2018 but for 2017 was not a significant event..

Thanks so much. Appreciate that, Keith, and once again, congratulations on the strong results and the guidance..

Thank you..

Thank you. And ladies and gentlemen, this does conclude our question-and-answer session. I would now like to turn the call back over to Parag Agarwal for any closing remarks..

Thank you everyone for joining the call today. We look forward to seeing you at various events during the quarter. Goodbye..

Ladies and gentlemen, thank you for participating in today's conference. This concludes today's program. You may all disconnect. Everyone, have a great day..