ON Semiconductor Corporation
Q2 2007 Earnings Call Transcript

Published: 31 Jul 2007

[Operator:]

Good day ladies and gentlemen and welcome to the ON Semiconductor's Second Quarter 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. [Operator Instructions]. As a reminder, this conference call is being recorded. I would now like to turn the conference over to your host Mr. Ken Rizvi. Sir, you may begin.

[Ken Rizvi:]

Thank you, Matt. Good morning and thank you for joining ON Semiconductor's second quarter 2007 conference call. I am joined today by Keith Jackson, our CEO; and Donald Colvin, our CFO. This call is being webcast on the Investor Relations section of our website at www.onsemi.com and will be available for approximately 30 days along with our earnings release for the second quarter of 2007. Our earnings release in this presentation includes certain non-GAAP financial measures. Reconciliations of these non-GAAP financial measures to the most directly comparable measures under GAAP are in our earnings release and posted on our website in the Investor Relations section. In the upcoming quarter, we will present at the Citigroup Technology Conference on September 5th. 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, estimate, intent, expect, plan or similar expressions are intended to identify forward-looking statements. We wish to caution that such statements are subject to risks and uncertainties that could cause actual events or results to differ materially. Important factors relating to our business, including factors that could cause actual results to differ from our forward-looking statements are described in our Form 10-K and other filings with the SEC. The Company assumes no obligation to update forward-looking statements to reflect actual results, changed assumptions or other factors. Now let's hear from Donald Colvin, our CFO, who will provide an overview of the second quarter of 2007. Donald?

[Donald Colvin:]

Thank you, Ken and thank you to everyone who is joining us this morning. ON Semiconductor Corporation today announced that total revenues in the second quarter of 2007 were $381.2 million. As anticipated, an increase of approximately 2% from the first quarter of 2007. Total revenues during the quarter included approximately $355.8 million of product revenues and approximately $25.4 million of manufacturing services revenue. During the second quarter of 2007, the Company reported net income of $63.3 million or $0.21 per share on a fully diluted basis. During the first quarter of 2007, the Company reported net income of $54 million or $0.18 per share on a fully diluted basis. The Company's total gross margin in the second quarter was 38.3%, an increase of approximately 100 basis points compared to the first quarter of 2007, primarily due to the sale of obsolete leaded parts, which helped margins by approximately 100 basis points and also helped by improved product mix. Gross margins for product revenue were 41.5%, an increase of approximately 160 basis points during the second quarter compared to 79.9% during the first quarter of 2007. At the end of a second quarter, days sales outstanding were approximately 41 days. Total inventory dollars which include internal inventories and inventories in distribution channel declined on a dollar basis sequentially in the second quarter. Internal inventories increased on days basis to approximately 86 days and we brought inventory during the quarter to prepare for specific second half platform rounds. Distribution inventories in dollar terms decreased by approximately one week to less than 11 weeks. We continue to see trend in the overall supply chain, where more of the inventory bubble is placed upon semiconductor supplier like ourselves. Cash capital expenditures during the second quarter were approximately $28 million. The Company exited the second quarter with cash and cash equivalent of $255.8 million. During the second quarter of 2007, the Company repurchased approximately $55 million of its common stock and the Board has authorized the Company to repurchase up to an additional 30 million shares of common stock to the second quarter of 2008. Now I would like to turn it over to Keith Jackson, our CEO for additional comments on the business environment. Keith?

[Keith Jackson:]

Thanks Don. Now for an overview of our end markets, during the second quarter of 2007, we saw sequential revenue growth in four of our six end markets, our computing, automotive, industrial and networking end markets. The computing end market grew by approximately 9% sequentially on a dollar basis and represented approximately 24% of our second quarter product sales. In the second quarter we saw the initial computing platform ramps associated with back-to-school bills as well as penetration of our new products targeted towards the computing end market. Automotive grew by approximately 10% on a dollar basis in the second quarter and represented approximately 18% of our product sales. This end market was driven by our continued penetration in infotainment systems such as satellite radios, where we have up to $2 of content and products such as our single wire transceivers for CAN systems. Industrial end market represented approximately 14% of our product sales during the second quarter, and the networking end market represented approximately 7% of second quarter product sales, both growing slightly on a dollar basis as compared to the first quarter. Consumer electronics and wireless end markets were down slightly in the second quarter as anticipated, primarily due to fewer game consoles and handsets built by our customers. We anticipate that both the consumer electronics and wireless end markets will grow in the second half of 2007. Our consumer electronics end markets represented approximately 19% of second quarter product sales and the wireless end markets represented approximately 18% of our product sales during the quarter. During the second quarter on a direct billing basis, no OEM customer was more than 5% of product sales and our top five product OEM customers were Continental, Delphi, Delta, Motorola and Siemens. Our top manufacturing services customer was LSI as anticipated. On a geographic basis, our contribution this quarter from product sales in Asia excluding Japan were up 200 basis points and represented approximately 60% of product sales. Our product sales in the Americas decreased by approximately 200 basis points and represented approximately 20% of product sales. Sales in Europe decreased by 100 basis points and represented approximately 16% of product sales during the quarter, and sales in Japan were up 100 basis points to 4% of product sales. Looking across the channels, sales to distribution channels stayed flat at approximately 52% of prior product sales. Direct sales to OEMs decreased by approximately 100 basis points to approximately 38% of product sales, and the EMS channel increased by approximately 100 basis points to10% of product sales. During the second quarter, product revenues broken out by our divisions were as follows. The Standard Products Group represented approximately 36% of product sales, the Automotive And Power Regulation Group represented approximately 29% of product sales, the Computing Products Group represented approximately 23% of product sales and the Digital and Consumer Products Group represented approximately 12% of sales. We will publish the quarterly revenue, gross margin and operating margin breakout of these divisions in our10-Q filing. Now I'd like to provide you with some details on the progress we've made. In the computing end market, we continue to see strong growth of our power regulators, false pulse width modulators, power factor controllers and multiphase controllers for desktop, notebook and car supply markets. We are expecting to see continued growth in the computing end market for the second half of 2007. In the third quarter, we anticipate platform rounds of our new controllers and regulator solutions with 5 major OEMs. With these new power efficient solutions in our complimentary portfolio of standard products, we are able to provide our customers with a complete power solution for the desktop and notebook needs, enabling us to gain share... market share versus many of our competitors. Our Greenpoint energy efficient power supply solutions continue to meet NXE, the emerging global standards for power efficiency. In the second quarter, we unveiled the industry's first open ATX reference design that meets the new energy star performance requirements for ATX star supplies used in desktop PCs that became effective this month. Today we've released 7 Greenpoint reference design solutions and anticipate releasing an additional 3 energy efficiency solutions by the end of the year. In the consumer end market, we are expecting to see an increase in build activity in the second half of the year as the major game console manufacturers prepare for back-to-school and holiday demand. We are also seeing increased design win activity with products featured in our Greenpoint reference designs for LCD TVs. We currently expect up to $1 of content associated with these Greenpoint featured products on a number of TV platforms that begin ramping in the third quarter. In the wireless end market, we continue to expand our product portfolio and account penetration. New products in back lightning, DC/DC conversion, battery management, USB and battery protection continue to gain traction and our driving design wins and production with major cell phone manufacturers. One of our major OEM customers has recently begun to ramp up a new multimedia phone, where we have up to $1.10 of content per device. Another major wireless customer is also implementing our over... voltage protection ICs on more than 10 platforms in the second half of 2007. Our products and solutions continue to win awards with our customers and within the industry. One of our PWM controllers won the Power Product of the Year award from major Chinese publication; this is the fourth consecutive year that the publisher has awarded its best product recognition to ON Semiconductor for a power management device. Now I would like to turn it back over to Donald for other forward-looking guidance. Donald?

[Donald Colvin:]

Thank you, Keith. Third quarter 2007 outlook; based upon product booking trend, backlog levels and estimated tons levels, we anticipate the product revenues will be approximately $370 million to $380 million in the third quarter of 2007. In addition, we anticipate approximately $23 million of manufacturing services revenue during the third quarter. Backlog levels at the beginning of the third quarter were up more than 10% from backlog levels at the beginning of the second quarter of 2007, and represent over 90% of our anticipated third quarter revenues. We expect the average selling prices for the third quarter will be down approximately 2% sequentially. We expect our product gross margin and our total gross margin in the third quarter to be approximately flat with the second quarter of 2007. For the third quarter, we expect cash capital expenditures of approximately $25 million. For the third quarter, we also expect total operating expenses of approximately 19%, with SG&A expenses between 10% to 11% of sales, and R&D expenses between 8% to 9% of sales. We anticipate the net interest expense will be approximately $6.5 million for the third quarter, and taxes to be approximately $2.5 million. We currently expect stock-based compensation expense on a pre and post tax basis to be approximately $4 million in the third quarter, and this expense is included in our guidance. Based on the stock price as of the end of the second quarter, our fully diluted share count will be approximately 307 million in the third quarter of 2007. The fully diluted share count can change based upon our change in the stock price. Further details on the share count and EPS calculations are provided regularly in our 10-Qs and Ks. We will also post a table outlining potential fully diluted share count changes on our website and our Investor Relations section, based upon various stock price assumption. With that, I'd like to start the Q&A session. Question And Answer

[Operator:]

Thank you, sir. [Operator Instructions]. Our first question comes from Chris Danely of J. P. Morgan; your question please.

[Chris Danely:]

Thanks and good morning guys.

[Donald Colvin:]

Good morning.

[Keith Jackson:]

Good morning.

[Chris Danely:]

Can you just talk about gross margin trends after Q3, it's in a normal seasonal growth in Q4 and a decent year next year?

[Keith Jackson:]

Well that's a lot a ifs, ands and buts, but in general Chris, we continue to expect product gross margins to expand with volumes, so again as our revenues go up, we get a very nice fall through on that something better than 60%, 65%. So really the revenue is the key driver to answer your question overtime. From a Gresham perspective, the other piece of that, as we get our analog processes qualified here in the fourth quarter, I would expect that those trends will start change in the first quarter of next year as we ramp those products, the analog products and Gresham. So basically, Gresham should start moving in a positive direction by the first quarter and product gross margins will track very well with the revenues.

[Chris Danely:]

Sure. And how should we expect your internal inventory and utilization rates to trend, do they just slowly trend up with sales due?

[Keith Jackson:]

They should slowly trend up with sales, I am... I mean there again we are running roughly 80% utilized at this point, so we've got some lot of room there to run as the company grows and so again I would expect those to again a slowly rise with the rates. We are not looking to increase inventory in the second half, in fact it should come down a bit from a days perspective, so at this point is really keeping a lid on the inventory while growing the activity rates with the revenue.

[Chris Danely:]

Great. And the last question, can you guys just talk about the linearity of your bookings in Q2 and how you feel about the various end markets for the second half of the year?

[Keith Jackson:]

Okay, linearity in Q2 I mean, that's fairly linear from a bookings perspective. We had good bookings performance, with book to bill greater than one. From a market perspective, we would anticipate based on backlog builds there that all of the consumer driven marketplace should be up in the second half. That includes the computing, the wireless handsets, and the traditional consumer entertainment sections, so those all should be up nicely and again this would be as I would call it, a fairly normal seasonal phenomenon for those consumer markets.

[Chris Danely:]

Great thanks guys.

[Operator:]

Our next question is from Michael McConnell with Pacific Crest Securities, your question please.

[Michael McConnell:]

Thank you. If we look at the second half of the year, would the product cycles that are coming into place, particularly with Bear Lake [ph] and the game console side, which one do you think would be more impactful to the model and how is the initial ramp of Bear Lake progressing?

[Keith Jackson:]

I will...I am not sure which will have the most impact at this point, the game console activity was so low in the first half that I think most would expect the second half to show some significant improvement so I think on a percentage basis that might have the biggest percentage change. In a total volume perspective though, the computing market is much bigger for us and those bear lake platforms will help in the ramp and again those are coming along nicely both from a design win perspective and in our backlog.

[Michael McConnell:]

And if we look at the notebooks space which is more an '08, '09 type of event, what have you learnt from the desktop side that you can transfer over to the notebook side of the businesses to try to replicate the success that you had with bare lake maybe looking out of in the future into '08 '09?

[Keith Jackson:]

Yes, I think the key there is really getting penetration at the key OEMs and so are using basically the same teams, folks and our new portfolio to use the same market approach if you will, and basically using what we consider to be significantly better energy efficiency in those power solutions is kind of technical advantage we use and then we use our supply chain and assured supply with the processing sides and that combination is very powerful with our customers.

[Michael McConnell:]

And then finally you may have mentioned this, I might have missed it. What was the utilization in Q2?

[Keith Jackson:]

Approximately 80%.

[Michael McConnell:]

Thank you.

[Operator:]

Your next question is from Craig Ellis of Citi, your question please.

[Craig Ellis:]

Thanks guys. In the break up by end market, EMS picked up by 1 percentage points. Can you just recap the activity bubble that you are seeing there and how we should think about the inventory issues that may or may not be applied there?

[Keith Jackson:]

Okay. I mean, the best we can tell, there is not a significant amount of inventory in EMS, we are seeing some relatively short lead time, orders being placed there. I think they have picked up just as a percentage of builds in some of the end markets and of course you certainly saw some more of the end sets and gaming platform being build in the EMS channel there at the end of second quarter. So really, I don't think inventory is much in play there from an EMS perspective.

[Donald Colvin:]

So have a look at the... if I look at the trends over the last six, seven quarters Craig and I should find EMS was significantly higher at the beginning of last year and went through a pretty substantial correction starting in Q4. So although as Keith said it's up a little bit on quarter-over-quarter basis, the absolute year-over-year trend is down, so the numbers totally support a balanced inventory position for us.

[Craig Ellis:]

Okay good. Secondly, on the manufacturing side, it sounds like the analog process installation is doing quite well. How should we think about customer diversity of the manufacturing services business?

[Keith Jackson:]

It is still dominated by LSI, we do have a couple of other customers there, but LSI is still more than 80% of that total today.

[Craig Ellis:]

Okay. And then lastly from me, you have the 300 or the 30 million share repurchase program, how should we think about how you are looking at that in the back half of the year given the free cash flow that you are generating?

[Donald Colvin:]

I think it's good to identify free cash flow because once again if we hadn't bought we would have been over $300 million, but that still remain the key point that we are identifying to investors is our strong EBITDA will also increase significantly quarter-over-quarter and the free cash flow, so that gives us some options. The market has some supply chain environment has been a bit turbulent, so I think it's appropriate that we just feel look at the different options we have and we have shown ourselves to be aggressive buyers of the stock, buying significantly more than 40 million shares over the last year. We are not kind of like planning to pull a trigger first thing tomorrow after the earnings will be digested, but we remain opportunistic and so we do have other demands for our cash. Remember, we could always pay down some debt, at 7%. So we, we continue to be opportunistic and look at shareholder friendly actions, like the ones we have taken over the last year.

[Donald Colvin:]

Thanks Don. Thanks Keith.

[Operator:]

Our next question is from Craig Hettenbach of Wachovia, your question please.

[Craig Hettenbach:]

Yes, thank you. Donald, you mentioned that inventory in distribution channel declined in Q2. At the start of Q3, have you seen any build activity yet or when would you anticipate that the channel starts to build a bit more inventory for the seasonality in the back half?

[Donald Colvin:]

We have been reanalyzed data than when we had the analyst day here we showed some trend over five or six years. So as Keith mentioned, our business is driven by the global consumer and it might appear demand for that really kicks in in the back half of the second half and that the absolute manufacturing activity kicks is somewhere between august and September. So these are the patterns of identifying, has been representative of the type of business environment we have. So you will expect as we go into the second half to see a slight increase in the inventories at the beginning of the period and they are worked off as the manufacturing activity increases towards the middle and the second half of the period. So that's the kind of trends that we have seen in the past and I do think that this period is any different than the past.

[Craig Hettenbach:]

Okay. And did you guys comment on lead times within the quarter, if there was any movement?

[Keith Jackson:]

We haven't, there are approximately nine weeks. It's not been significant movement there. There is always a range, but it is still very comfortably in our service models.

[Donald Colvin:]

Right. And last question, Keith on the handset side, outside of the inventory correction one of the major OEMs, can you just comment on trend you are seeing at other players, and how you view inventory levels in that space going into the back half?

[Keith Jackson:]

Yes, inventories again are in pretty good shape. We have seen the market shares taken up as one OEM has had weakness. We have seen it pop up in our other customers. At this point, certainly don't detect any overly aggressive builds or approach from the major five guys that we serve.

[Craig Hettenbach:]

Thank you.

[Operator:]

Your next question is from Louis Gerhardy of Morgan Stanley; your question please.

[Louis Gerhardy:]

Yes, good morning. Can you comment on your plans for factory utilization in Q3?

[Keith Jackson:]

Yes, we can. It should be slightly up from the second quarter, not very much but just slightly. Again, what we are trying to do is keep the inventories kind of in check where they are at and just support the Delta activity in the sales channel.

[Louis Gerhardy:]

Okay. Your guidance in backlog position implies a drop-off in turns in Q3. Is that normal, is there any reason behind this or customers have given you better backlog visibility now?

[Keith Jackson:]

You know obviously you picked up on that. We did... we guided that way, I don't know how the quarter will turn out. Normally, we see a significant amount of turns in September. Again, I don't know have a perfect crystal ball here, but we give guidance based on what we think is prudent.

[Louis Gerhardy:]

Okay. --

[Keith Jackson:]

We --

[Louis Gerhardy:]

On the gross margin front you had the kick this quarter from the sale of the old parts, were these just higher margin parts or had they been written-off or written-down before and is there anything else out there like this we could reasonably expect in the next couple of quarters?

[Donald Colvin:]

Well, I think the reason why we pulled off is because we believed that it was more of a blue bug than base I think and these were waited an obsolete [ph] that we did some special deals on to remove them from our inventory, so we calculated that. That helped our gross margin by a 100 bit. And they like to be totally transparent with investors and we share that with you. We also had a little bit better mix than we were in the ECO stuff, so a couple of these event means that we had a slightly higher than anticipated gross margin and that's why we are gaining relatively flattish gross margins for the third quarter over the second, because the second quarter had been a little bit artificially inflated. So that's type of the transparent way we try to explain our numbers.

[Louis Gerhardy:]

Thank you.

[Operator:]

Our next question is from Tristan Gerra of Robert W. Baird; your question please.

[Tristan Gerra:]

Good morning. Can you give us an update on the ramp of the two large computer wins that you have for the second half. Any way you could quantify the potential unit margin opportunity, what it is for the rest of the business and some of those products are going to be Gresham based on that?

[Keith Jackson:]

Okay, so for the computing segment, I do think that will be a significant growth for us of our forecasted growth for the company in the second quarter, computing will make up from a dollar basis, most of that. None of those products, that's not true, all of the MOSFETs for those platforms actually are coming out of Gresham, we now wrap those in our Trench 2 process. So the MOSFET portion will be out of Gresham, the analog controllers will not be coming out of Gresham until the first quarter of the next year when the processes are in manufacturing.

[Tristan Gerra:]

Okay great. Did Motorola decline as a percentage of sales in Q2 and you expect to rebound in Q3?

[Donald Colvin:]

We don't like to comment basically on customers or get forecast by customers first and you can't understand there are certain sensitivity there. But clearly, I said... we indicated one major wireless OEM had some issues and we know of the new candidates for our top customer keys, yes we do. But so certain consolidation in the automotive industry will probably veto a change in the rankings of our top customers, but we don't like to comment on forward-looking statements for one of our best customers.

[Tristan Gerra:]

Understood. And then last question, what is the percentage of production that was outsourced in the quarter and would you expect this number to be by Q3 and Q4?

[Keith Jackson:]

It was approximately 21% in Q2 and I would not expect significant change in Q3 or Q4, it might go down a point but not significant changes.

[Tristan Gerra:]

Very good, thank you.

[Operator:]

Our next question is from Steve Smigie of Raymond James; your question please.

[Steve Smigie:]

Great thank you. As we turn to the gross margin, you are guiding flat for this quarter. I assume that means that excluding the one-time benefit there that gross margin is going up sequentially. Is that more related to utilization or is it partly about the better pricing that you guided to, or be sort of the bigger driver of that?

[Keith Jackson:]

Yes actually Steve, we guided to worse pricing, we guided ASP degradation of about 2% so what's happening is the additional utilization is offsetting the one-time benefit in Q2 from the leaded sales and offsetting the pricing degradation.

[Steve Smigie:]

Okay, so it's 2 to 3 in this quarter and guided to down 2 in --.

[Keith Jackson:]

Well, it is less than last, but yes.

[Donald Colvin:]

We... couple of points; we've said that is there a rate key jump in here. But we said that round about 2%, even 2.5% price degradation because of the conservative way we measure this, we can offset it through things like mix and cost savings. So as within the range that we can manage and so that's one of the reasons why we don't see us getting too nervous about that, but we always report on a consistent basis as there is still a little bit of price pressure, although its very manageable. As far as margins are concerned, we still believe in the model we showed at the analyst day a few months ago, which is at the base business that can get to 45% gross margin. But that will be based upon a higher value of revenue and if you look at how our base business gross margin is tracking well above 40%, I think that gives us confidence and should give you confidence that we can reach that target especially as Keith said, when we start ramping some of the analog product which is exactly what we explained at the analyst day.

[Steve Smigie:]

The pricing seems about inline with sort of normal declines, but it seems a little bit worse than perhaps a few quarters. Is that partly as you guys were trying to pick up some extra business in computing or some thing like that?

[Donald Colvin:]

At the... I would say this pickup extra business is that the end markets have been a little bit challenged, you know Tristan was asking about one wireless customer, Keith mentioned some of the consumers. So, I mean the business environment has not been hunky dory in the first half. So, we are a spunky company and we don't want to lose market share. So, let's say that environment should improve in the second half, but there has been a little bit of an inventory correction and as I stated, some of our customers in some of our end markets have been significantly down over the trend... business trends we had enjoyed in the middle of last year. So, that demands appropriate actions, but we still print good margins and the good sequential improvement. So, we are managing this intelligently and does not any kamikaze pricing.

[Steve Smigie:]

Alright. And sort of... sorry, the last question, I think you already this but do the back half you said, improved. Is that again, its just you have a seasonal build in the back half and there is enough demand that utilization is out filling up it than most of your competitors and so there is less pressure?

[Keith Jackson:]

Yes, definitely as the inventory comes down particularly in the distribution channel, you get much more rational pricing and better utilization across the industry and that tends to be the thing that helps the prices. So, at this point again we don't have all the answers, but I would expect Q4 to be less onerous on the ASP degradation than Q3.

[Steve Smigie:]

Thanks a lot guys.

[Operator:]

Last question from John Barton of Cowen, your question please.

[John Barton:]

Thank you. Keith, you had made a couple of comments about manufacturing services, and getting your internal processes got out, and the fourth quarter ramping in Q1, LSI etcetera. When you look at '08 if you think about three levers, your internal, manufacturing, LSI services, other customer services, how do you think that develops through '08, where you think you get that fab utilization, just generically how should we expect to see that unfold?

[Keith Jackson:]

Well, obviously it will build from a volume perspective quarter by quarter, so I would expect to see significant sequential improvement from a Gresham perspective, and of course that's we are highlighting Gresham because the manufacturing services going on in there, but in reality the net margins forces will be doing less outsourcing will be very significant in the product business as well. So again, I would expect to see a nice sequential build through the year. What happens is we release the process and then we release the products and our customers qualify those products and again, that's a process that builds. So I don't know if its quite linear, but I'd expect the second half to be very substantial and the first half to be incrementally better.

[John Barton:]

And what's your best guess on LSI trends for the quarter, or through the year?

[Keith Jackson:]

I think they continue to decline per our agreement, they have been pretty much on our agreement so far, I have no reason to believe that that will change. So they will decline slightly through the middle of next year when our contract runs out and then I would expect further declines again nothing dramatic, but normal kind of the same rate of fall off in the second half of next year.

[John Barton:]

And any other third parties coming at the mix to the best of your forecasting ability?

[Keith Jackson:]

Well, we got one that should be coming in to the mix in Q4, and start pickup some of that balance and then beyond that, again I don't have good forecasting.

[John Barton:]

And just last question I will top it, current utilization at Gresham and what would be your best guess be as you exit '08?

[Keith Jackson:]

It is little less than half full right now in Gresham and I would expect to get that well over 60%, 65% as we exit next year.

[John Barton:]

Great, and last question I could, Donald, just on the tax front, any major developments there, any significant changes in the coming quarters that we should think about?

[Donald Colvin:]

I know, I think we still believe 2 million, 2.5 million a quarter, John is good. We got a little benefit this quarter, we got an old receivable paid off in Asia, which took it down a little bit, a 100 those I think it was. But assume 2.5 million of cash taxes, and also going forward, just as we explained at the analyst day.

[John Barton:]

Thank you.

[Operator:]

Our next question is from Michael Masdea of Credit Suisse, your question please.

[Michael Masdea:]

Good afternoon. Some of... some couple of your competitors have talked about reconstruction and obviously you have never have held them kind of tight. But there have been an impact as I think on the orders of the customer mentality because of those couple that have had construction lead times?

[Keith Jackson:]

We have seen a few of our OEMs start to give us longer lead times, they are concerned that the September-October ramp timeframe will get tight, and so they are already giving us some backlog there. But I don't know if that is a major trend, so I'd say its more spotty than anything else.

[Michael Masdea:]

Great. And then, moving at split up measured; your comments on industrial networking a little bit more positive than some others in the first half so far. Is that product specific, and then do you see that sort of catching up with you in the second half?

[Keith Jackson:]

it is held up pretty strong, and what we have noticed is that a lot of that business for us is in Europe and I believe is going into building infrastructure in the Eastern part of Europe, so that's actually held up very well for us in the last couple of years. And from what I can tell on the backlog, it should continue to hold up this year. So I would expect it to be very stable in the second half.

[Michael Masdea:]

Okay. And just the last quick one from me here, in the analog processes that you are putting in, are those customer-driven at all or are those sort of build up and hope that you can get some follow on customers?

[Keith Jackson:]

What those be specifically are our products that will generate our currently outsourced sub micron analog products, allow us to do that internally and also our next generation of PWM controllers internally.

[Michael Masdea:]

And so there is no plans at all to offer that to any external customers or is that --?

[Keith Jackson:]

No plans at all to offer that externally.

[Michael Masdea:]

Great. Thanks so much.

[Operator:]

Our next question from Ramesh Misra of C.E Unterberg Towbin, your question please.

[Ramesh Misra:]

Hi good morning gentlemen. My first question was in regards to new products. Can you talk about where they were as a proportional sales, and can you talk about expected trends over the next few quarters.

[Keith Jackson:]

So we have mentioned that number I guess in the past, that tends to be running in the 20% of our sales. Its been relatively stable here this year, I would expect that it would start going up again in the third and fourth quarter because a lot of those new products are geared at computing and consumer and since those new platforms are ramping, I would expect it to go up 1% or 2% here in the second half.

[Ramesh Misra:]

Okay. Are gross margins on these products generally somewhat higher than your overall average key?

[Keith Jackson:]

Yes they are, they tend to be any where from 10 or more points higher than the average.

[Ramesh Misra:]

Okay. You have talked for quite some time about reducing your external manufacturing, but it's been sticking around that 20% marketing. Are you basically waiting for your ramp up at Gresham for that to happen or --?

[Keith Jackson:]

Yes, the analog processes will help fairly significantly and then the other thing is going on is we've moved more of our internal capital to assembly test and so as we leave this year, I would expect that will be little more round the capacity on the assembly test side. So, its really Gresham on the analog products and then get the rest of our modules installed on the money we are spending in the back ends here through the end of the year.

[Ramesh Misra:]

Got it. What part of your test and assembly right now are you outsourcing it and where do you see that --?

[Keith Jackson:]

It is about actually 25% or so on the assembly test side today and a large range of external suppliers and that's the one that I think we can drive down to the 20% range and then the fabs we should be able to drive down in the lower teens.

[Ramesh Misra:]

Okay. And then finally, Keith, can you give us an idea of how many manufacturing of 100 customers do you have right now and next year as LSI starts coming down, do you expect that decline to be offset by these other customers?

[Keith Jackson:]

So we have 3 or 4 customers today and I would expect that number to be fairly stable, it might go up 1 or 2, but frankly we are planning in doing is offsetting LSI not with external foundry business but with our internal ramps on our own products. So that's our primary plan. If we happen to lands more external ones, then that will be icing on the cake.

[Donald Colvin:]

I think we have been talking to guys in the street I have been explaining that the problem overlying upon an external customer is that you rely upon his markets and his business environment, and so that puts more uncertainty into your models. So we have made significant progress in installing processes that will allow us to use more of Gresham on our sales, and we have integrated that into our total manufacturing infrastructure. As Keith said, we are already running very large quantities of MOSFETs there and we will start to run other standard analog and other products there shortly. The active base we to take advantage of Gresham, and also because of the cost effectiveness of an 8-inch leading edge technology, it opens the door to significant cost reduction opportunities on other sides. So that's what we have been telling people that we are confident that that's the case and if we get the possibility of having a third party to take some capacity, or run some products there, then we will certainly take that. But it's icing on the cake and we are making it work in a forecast assuming that LSI goes down as Keith mentioned, but filling the gap through using our own technologies and making sure that we rationalize the cost and our overall manufacturing base.

[Ramesh Misra:]

Okay. Just a very quick follow-up on that. Don, you mentioned you're ramping up MOSFETs in Gresham. Now MOSFETs clearly are larger geometry products. What's the rationale to build these larger products at Gresham rather than the --?

[Donald Colvin:]

Yes, these are... I'll help you there. These are our low voltage Trench MOSFETs. They are actually very small geometry devices, and they fit in some of our smallest packages. So this is actually a very silicon efficient set of products.

[Keith Jackson:]

I will even go as far as to say, our one regret is that we didn't do more of them.

[Ramesh Misra:]

So the MOSFETs fitted well --

[Keith Jackson:]

The reason is not the high voltages ones that use up all the dye area that you are familiar with.

[Ramesh Misra:]

Got it. Okay, thanks very much guys, bye.

[Operator:]

Our next question is from Kevin Cassidy from Piper Jaffray; your question please.

[Kevin Cassidy:]

A lot of my questions have been answered already, but may be can you give more details about your plans on the Philippines? There was a press release about expanding production there?

[Keith Jackson:]

Sure. Yes, we are basically that is our primary test house for more complex packages and our analog products. We are seeing that ramp disproportionally which is helping drive some of the margins as we get off to next year and so the intent is to do more of our manufacturing in-house and that's one of the areas that will be the receiver of that. So that's a big piece of that expansion. The other piece is we continue to opportunistically build our back office work force in low cost areas and so we will be doing that at our factory there in the Philippines as we've done in Eastern Europe and in Chine in the past.

[Donald Colvin:]

We run the numbers on many thing s because you got to be careful with labor cost inflation and the fidelity of employee stock turnover and things and when we look at all of that, we get pretty comfortable that the Philippines is an excellent place to be based and similar to the success we have enjoyed in former Western Europe. We find highly skilled people, native English speaking so its very attractive place for us to not only do development but also back office support functions and not some thing that we are emphasizing going forward.

[Kevin Cassidy:]

Okay thank you very much.

[Operator:]

Our follow up question today is from Rahul Khanwalkar of Needham; your question please.

[Rahul Khanwalkar:]

It looks like your auto business grew nicely this quarter, so I just wanted to know was it a one-off event, was it driven by specific customers or do you expect this growth to be sustained in the second half?

[Keith Jackson:]

No, we do think the growth in our auto motive business is from our new product entries and our focus on this as a market, we did put that back on our focus list a couple a years ago and I think we are seeing the fruits of that. So we should be growing at least at market rates in that business, which of course has seasonality in it and Q3 tends to be the weaker season, but nonetheless I expect continued strength and growth in automotive. We put out a lot of products that go into the infotainment arena and quite a few products that are in the safety area, both of which are going quite rapidly.

[Rahul Khanwalkar:]

Okay. And my second question is on your backlog. It looks like it gives you almost 90% of your visibility for the third quarter. Now does that mean that your turns business will be about 10% of your guidance or is it that turns could be higher and some of the backlog would not be fulfilled in third quarter? Or how does the math work?

[Keith Jackson:]

The answer to that is it's always some of the above, some of the backlog does turn every quarter and we could get more than 10% turns. It's one of those that when we make our forward-looking guidance, we kind of take our best shot at it and then see what happens. But at this point, the models would indicate that we will have around 10% turns.

[Rahul Khanwalkar:]

Okay. And my final question is on your capacity utilization, at what point do we think do we expect that your capital expenditure would be stepped up. Right now your capacity utilization is 80% and CapEx is about $25 million, so is it a steady state capital expenditure or will it be stepped up, I'd say 90% CapEx?

[Keith Jackson:]

Yes, it actually we have a model of around 7% of sales on the long-term basis and so unless there is unusual events occurring, that's the kind of rate we would be expecting. At this point, I think we are in very good shape and would not expect to see any accelerated capital expenditures; in fact it should go down in the second half versus the first half. And in the next year again, we haven't got a full plan yet, but I would not expect to see that stepped up either. We've got plenty of efficiency in our capital spending to drive very substantial growth.

[Rahul Khanwalkar:]

Okay. Thanks a lot.

[Operator:]

Ladies and gentlemen, this concludes our conference call for today. Thank you for participating. You may now disconnect. Good day.