ON Semiconductor Corporation
Q3 2008 Earnings Call Transcript

Published: 2 Nov 2008

[Operator:]

Good afternoon. My name is Jody and I will be your conference operator today. At this time, I would like to welcome everyone to the ON Semiconductor third quarter earnings release conference call. All lines have been placed on mute to prevent any background noise. After the speakers remarks, there will be a question and answer session. (Operator instructions) Thank you. I would now like to turn today's call over to Ken Rizvi. Please go ahead, sir.

[Ken Rizvi:]

Thank you Jody. Good afternoon and thank you for joining ON Semiconductor’s third quarter 2008 conference call. I am joined today by Keith Jackson, our CEO, and Donald Colvin, our CFO. This call is being web cast on the investor relations section of our website at www.onsemi.com and will be available for approximately 30 days following this conference call, along with our earnings release for the third quarter of 2008. The script for today’s call is posted on our website and will be furnished via a Form 8-K filing. Our earnings release and this presentation include certain non-GAAP financial measures. Reconciliations of these non-GAAP financial measures to the most directly comparable measures under GAAP are in our earnings release and posted separately on our website in the investor relations section. In the upcoming quarter, we will present at the Credit Suisse Technology Conference on December 3rd. During the course of this conference call, we will make projections or other forward-looking statements regarding future events or the future financial performance of the company. The words believe, estimate, anticipate, intend, 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, Form 10-Q’s 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 third quarter 2008 results.

[Donald Colvin:]

Thank you Ken, and thanks to everyone who is joining us today. ON Semiconductor Corporation today announced that total revenues in the third quarter of 2008 were a record $581.5 million, an increase of approximately 3% from the second quarter of 2008. During the third quarter of 2008, the company reported GAAP net income of $61.2 million or $0.15 per share on a fully diluted basis. Third quarter 2008 GAAP net income included net charges of $39.2 million, or $0.10 per share on a fully diluted basis, from special items, which are detailed in schedules to our earnings release. Third quarter 2008 non-GAAP net income was $100.4 million or $0.25 per share on a fully diluted basis. On a mix-adjusted basis, average selling prices in the third quarter were down approximately 2% from the second quarter of 2008. The company’s gross margin in the third quarter including special items was 38.1%. Non-GAAP gross margin in the third quarter was 41.5%. Adjusted EBITDA for the third quarter was a record $140.9 million. We exited the third quarter of 2008 with cash and equivalents of approximately $418 million or approximately $97 million more than the second quarter. At the end of the third quarter, total days sales outstanding were approximately 44 days. ON Semiconductor total inventory was approximately $309 million or 78 days which was down approximately 3 days from the second quarter. Included in our overall inventory is approximately $12 million of inventory associated with the write-up to fair value from our recent AMIS acquisition. Subsequent to the close of the quarter, we completed the acquisition of Catalyst Semiconductor. The acquisition is expected to add approximately $24 million of inventory, which includes approximately $7 million of inventory associated with the write-up to fair value. Distribution inventories were approximately 11 weeks at the end of the third quarter. Cash capital expenditures during the third quarter of 2008 were approximately $31 million. Now, I would like to turn it over to Keith Jackson for additional comments on the business environment.

[Keith Jackson:]

Thanks Don. Now for an overview of our end-markets. During the third quarter of 2008, our end market splits were as follows Computing end-market represented approximately 23% of third quarter 2008 sales. The Communications end-market which includes wireless and networking represented approximately 21% of sales. The Automotive end-market represented approximately 17% of third quarter sales. The Consumer Electronics end-market represented approximately 18% of sales. Industrial, Military, and Aerospace represented approximately 17% of sales and Medical represented approximately 4% of sales. During the third quarter on a direct billings basis, no ON Semiconductor product OEM customer represented more than 4 % of sales. Our top 5 product OEM customers were Continental Automotive Systems, Delta, Hella, Motorola and Sony-Ericsson. On a geographic basis, excluding ON Semiconductor’s historical manufacturing services revenue, our contribution from sales in Asia, represented approximately 60% of revenue. Our sales in the Americas represented approximately 21% of revenue and Europe represented approximately 19% of sales during the quarter. Looking across the channels, sales to the distribution channel were approximately 36% of third quarter revenue. Direct sales to OEMs represented approximately 52% of revenue and the EMS channel represented approximately 12% of revenue. During the third quarter, ON Semiconductor revenues broken out by our divisions were as follows. The Custom and Foundry Product Group represented approximately 29% of third quarter sales. The Standard Products Group represented approximately 22% of sales. The Automotive and Power Regulation Group represented approximately 20% of sales. The Computing Products Group represented approximately 20% of sales and the Digital and Consumer Products Group represented approximately 9% of sales. We will publish the quarterly revenue, gross margin and operating margin break-out of these divisions in our Form 10-Q filing for this quarterly period. Now, I would like to provide you with some details of other progress we’ve made. Subsequent to the end of the third quarter of 2008, we closed the acquisition of Catalyst Semiconductor. With the combination of ON Semiconductor’s global footprint, effective channels of distribution, and top-tier customer relationships, we expect to be able to support a broader and deeper penetration of Catalyst’s overall product portfolio. In the Computing end-market we continue to see penetration of our controllers, audio amplifiers and MOSFET products. After seeing double digit growth in the second quarter of 2008, we saw approximately 3% sequential growth in the third quarter. We believe we continue to gain traction and share with our analog products for both the desktop and notebook markets. In a normal environment, we would expect this to enable continued growth of our computing business in the fourth quarter. Unfortunately, our penetration of products into the desktop and notebook end-markets have been more than offset by the slowdown of build rates from our customers due to the overall economic slowdown. While it is unclear when this end-market will recover, we believe we remain solidly positioned as a leading supplier of power management chipsets in computing. In the Consumer end-market, we saw strong sequential growth of over 25% from the second quarter of 2008. This growth was largely driven by the game console builds for the holiday period. We have a variety of products ranging from controllers, to MOSFETs, to discrete devices to service the challenging power management requirements of this end-market and continue to maintain a solid market share position with two of the three leading game console manufacturers. The Communications end-market, which includes the Wireless end-market and the Networking end-market, saw strong sequential growth in the third quarter of 2008 fueled primarily by the growth of our wireless products. We had record handset revenues during the quarter driven by continued penetration with four of the five leading handset OEMs as well as strong growth from a leading smart phone manufacturer. Our portfolio of over-voltage, ESD protection devices, switches and audio amplifiers saw strong demand from our customers during the third quarter. We continue to see benefits from the acquisition of AMIS. In the third quarter we won our first design with a leading Asian handset vendor using our Belsigna 250 product with noise cancellation capabilities. This product is a complete, low-power programmable audio processing system that enhances the sound quality in embedded and portable digital audio devices and is gaining strong design momentum with our customer base. As anticipated, we saw a slow down in our overall automotive business in the third quarter driven primarily by a more than seasonal decline of automotive sales. Given the continued global tightening of credit for large ticket items such as autos, we currently anticipate a continued slow period of sales to the automotive end-market in the fourth quarter. The appreciation of the dollar is also expected to negatively impact our European automotive revenue in the fourth quarter. Once the economic environment stabilizes, we believe we are strongly positioned with the leading automotive OEMs through our design, sales and supply chain resources along with our broad portfolio of ASICs, CAN and LIN products, motor control products, MOSFETs and discrete devices. The industry and our customers continue to recognize our position as a leader in energy efficient products and solutions. Our GreenPoint reference designs along with our industry leading supply chain enable our customers to deliver energy efficient solutions while also shortening their time to market. Electronic Products China magazine presented us with a “Top 10 DC-DC 2008” award for our family of integrated switching regulators that are designed to deliver high efficiency and increased power density, enabling customers to provide power management, reduce their systems costs and simplify embedded designs. This is the sixth consecutive year that ON Semiconductor has won this award. Samsung Electro-Mechanical also honored ON Semiconductor as a Tier 1 best supplier for our outstanding achievements in meeting their challenging requirements in product quality, energy-efficient technology and supply chain efficiency. We also received the ‘3 Star Excellence Award’ from Raytheon Network Centric Systems and the ‘2008 Customer Satisfaction Award’ from Raytheon Missile Systems. Now, I would like to turn it back over to Donald for other comments and our other forward-looking guidance. Donald.

[Donald Colvin:]

Thank you Keith. Fourth quarter 2008 outlook. Our September actual ending backlog plus normal fourth quarter seasonal turns should have pointed towards flattish revenue in the fourth quarter of 2008 versus the third quarter of 2008. However, throughout the month of October, we have seen our business conditions deteriorate for the fourth quarter. Turns activity has dried up, our distributor re-sales have slowed down and some backlog has been rescheduled from the fourth quarter of 2008 into the first quarter of 2009. Based upon current product booking trends, backlog levels, manufacturing services revenues and estimated turns, we anticipate that total revenues will be approximately $500 million to $550 million in the fourth quarter of 2008. Over the last several weeks, we have seen a dramatic appreciation of the U.S. dollar. This change in currency negatively impacts our revenue in the fourth quarter by approximately $10 million sequentially or approximately 2% and is already embedded in our overall revenue guidance. Backlog levels at the beginning of the fourth quarter of 2008 were down from backlog levels at the beginning of the third quarter of 2008 and now represent over 95% of our anticipated fourth quarter revenues. We expect that average selling prices in the fourth quarter of 2008 will be down approximately 2% sequentially. We expect cash capital expenditures of approximately $30 million in the fourth quarter, total cash capital expenditures of approximately $105 million for 2008. This is down from our prior guidance for capital expenditures of approximately $120 million to $130 million for 2008. Given the current macro environment, we currently anticipate reducing our capital expenditures further in 2009. For the fourth quarter, we expect GAAP gross margin of approximately 37.0% to 38.0 %. Our GAAP gross margin in the fourth quarter will be impacted from, among others, expensing of appraised inventory fair market value step up associated with the acquisitions of AMIS and Catalyst Semiconductor. We also expect non-GAAP gross margin of approximately 39.5% to 40.5%. Non-GAAP gross margin excludes special items of approximately $13 million. For the fourth quarter we also expect total GAAP operating expenses of approximately $160 million to $164 million, with GAAP SG&A expenses of approximately 13% to 14% percent of sales and GAAP R&D expenses of approximately 13% of sales. Our GAAP operating expenses include in-process research and development associated with the Catalyst acquisition, the amortization of intangibles, stock based compensation expense, restructuring, asset impairments and other charges which total approximately 6% of sales. Beginning in the fourth quarter, GAAP operating expenses also include the additional operating expense from Catalyst Semiconductor of approximately $5 million. We also expect total non-GAAP operating expenses of approximately $130 million to $134 million or approximately 25% of sales. Non-GAAP operating expenses exclude special items such as in-process research and development associated with the Catalyst acquisition, the amortization of intangibles, restructuring, asset impairments, stock based compensation expense and other charges of approximately $30 million. We anticipate that net interest expense and other expenses will be approximately $10 million to $11 million for the fourth quarter of 2008 and cash taxes to be approximately $2.5 million to $3.5 million. We also expect stock based compensation expense of approximately $9 million to $10 million in the fourth quarter of 2008. Our current fully diluted share count is approximately 415 million shares based on the current stock price, which includes approximately 410 million of common stock and approximately 5 million shares related to options, convertibles and RSUs. Our currently fully diluted share count also includes approximately 13 million shares associated with the Catalyst acquisition. Further details on share count and EPS calculations are provided regularly in our 10Qs and Ks. Over the last month, we have seen an impact on our business from the current economic headwinds and global credit tightening. Our customers have expressed more caution on their business outlook and we have adjusted our forecasts to reflect the current order trends. Given the macro economic uncertainty, we remain focused and committed to generating strong cash flows by continuing to execute on our manufacturing and operational cost reduction programs, and disciplined approach to capital expenditures. Even in this challenging environment, we believe we will generate north of $50 million of free cash flow in the fourth quarter. With that, I would like to start the Q&A session.

[Operator:]

(Operator instructions) Your first question comes from the line of Chris Danely with J.P. Morgan.

[Chris Danely:]

Guys, can you just talk a little bit about general OpEx and gross margin trends going into next year?

[Keith Jackson:]

So, on the OpEx trends, we would expect them in raw dollars to come down as we enter next year, you know, kind of reflecting the lower run rates that we’ve had since Q3, and so again we will keep that prudent and continue to manage that in a downward fashion. On the gross margins we’re going to have less capacity utilization in Q1. We will be doing the appropriate factory closures for the appropriate amount of time. We will be accelerating the factory exits that we announced last year and taking other measures to try and preserve as much as the gross margin as can be. So Donald, I don’t know if you have other things to add.

[Donald Colvin:]

Sure. Obviously we’re in a challenging environment as we cannot rely on historical backlog numbers et cetera for projecting the future. I tried to explain in our notes, in our observations, that the month of October has been very atypical and indeed if you look at companies announcing towards the end, their guidance was much more negative sequentially then those who announced at the beginning. So clearly our business conditions are deteriorating and that gives a big uncertainty on the outlook for next year. So it is very much – it is really too early to tell the gross margin is going to be a function of the revenue, but we’re taking all necessary actions to ensure that we don’t grow our inventories, and you probably noticed last quarter that we didn’t – we reduced our inventories. Our distribution inventory is well at the low end of the range. Our internal inventories came down by around 3 days and so we’re continuing to manage our business in a tight way. And so that I think will allow us to have the best gross margin profile going forward and as I said on concluding remarks, we still believe that they will generate a very healthy the cash flow both in the fourth quarter and also in the first quarter, but we cannot quite put a finger on what the revenue will be in the first quarter. And that is going to be the biggest variable in determining the gross margin Chris.

[Chris Danely:]

Sure Donald and hence my follow up on the cash. Yes, you guys are generating plenty and you have over $400 million of cash on the balance sheet and now that your buddies at Atmel thanks, but no thanks. What can we expect you to do as far as your cash goes? Are you guys looking at more share buybacks given the debt and destruction in semis, would we expect some debt paid down or will you just hold it and look to build cash?

[Donald Colvin:]

Well we don’t want to become a bank even though banks are getting cheaper everyday.

[Chris Danely:]

Think about it.

[Donald Colvin:]

But I would just say that we always try and run the business in a shareholder friendly manner and we have obviously a lot of options to do with our cash and we don’t plan to hold it indefinitely. But yes we heard unfortunately that Atmel doesn’t want to talk. We’re considering our options. So I won’t comment on that but I would say that one thing with the whole premise of the Atmel deal would be a creative to earnings. And so this is something that we still believe is possible. The final form of that deal has clearly not been determined and we clearly cannot go forward this year as they have refused to talk with us. But we haven’t determined what our way forward will be and so I’m not in a position to announce any spectacular stock buybacks or anything like that at this moment in time.

[Chris Danely:]

Okay, thanks.

[Operator:]

Your next question comes from the line of John Pitzer with Credit Suisse.

[John Pitzer:]

Thanks guys. Thanks for taking my question. Donald first question for you, when you look at the new December guidance what is the expectation for turns in the quarter?

[Donald Colvin:]

Well basically from that one, none.

[John Pitzer:]

I am sorry. You said none.

[Donald Colvin:]

None.

[John Pitzer:]

And then you know Donald if you ex-out the currency impact for the quarter you are still going kind of a better than the peer groups albeit it is still down sequentially. How much of that is still catalyst quarter to quarter and how much of that do you think is some share gains in some of the other businesses you are running right now.

[Donald Colvin:]

Keith talked about the share gains. The Catalyst numbers are not all that high because we don’t have a full quarter of Catalyst and we also have to take some of the accounting adjustments that reduced the Catalyst revenue. So if you want to think John simply basically the currency offsets more or less the Catalyst to us. So net-net they kind of offset each other. But – so that is a way to look at it. So one offsets the other, currency is offsetting catalyst. But Keith do you want to talk about the share gains.

[Keith Jackson:]

Yes, I mean, share gain is something we have done steadily every quarter. We never know in any market conditions exactly what is going on a daily basis but I would expect we would surely continue to gain share when the quarter is over as well. These acquisitions we have done this year have actually improved our customer relationships and their perception of ON as a long-term supplier and survivor in this market. So, quite frankly we are feeling pretty good about the relative position. And again everybody forecasts what they are. We will see at the end of the quarter just how much share was gained.

[John Pitzer:]

And then guys just last question from me. Donald, relative to your statement about the Atmel acquisition being accretive. I guess just given how fluid the overall macro environment is, how comfortable are you making that statement relative to the valuation when (inaudible) microchips out there.

[Donald Colvin:]

Remember what we were paying there was no specific price. It was an amount up to – amount based upon certain assumptions that microchip per order price of $5, which was refused. So we always maintained that the businesses that we were interested in will fit very well into the ON infrastructure both as distribution infrastructure and manufacturing infrastructure and that the deal would only be moved forward if we was accretive. We could not – we have to persuade our board it is accretive and we have to persuade our shareholders it is accretive. And we do not need to rush out and borrow money tomorrow or yesterday to put that financing in place. It is something that we will probably have to do or look out next year. We’re not committed to any one source of financing. We have many multiple sources of financing. And we would only move forward on a deal if it is accretive and we can demonstrate that in a clear and unequivocal manner to our shareholders and to our board. So there has been a lot of publicity [ph] on this deal. I wouldn’t comment on why or where these rumors come from but some of the stuff is being purely ridiculous, suggesting that we were ready to borrow at ransom rates in order to satisfy our obligations. So this is a clear nonsense. The deal was always determined in an accretive opportunity and everything we know suggest it can be and we can see how we can best move forward with that.

[John Pitzer:]

Perfect very helpful thanks guys.

[Operator:]

Your next question comes from the line of Tristan Gerra with Robert W. Baird.

[Tristan Gerra:]

Give us an update on the migration of capacity Gresham so far and whether that is going to – what type of contribution in utilization rates do you think that is going to add by year-end excluding, of course, deterioration in end markets?

[Keith Jackson:]

Yes the deterioration in the markets Tristan has slowed down the ramp that the expected in Gresham without question. You know, the products we are moving in there are moving relatively on schedule. Since our last call nothing slipped. We continue to qualify new products, we continue to put new process in et cetera. So really what has changed is some of the end markets that we were hoping to fuel some of that growth have definitely slowed. So we’re still at this point little less than half full in Gresham. We’re continuing the work now that we have Catalyst we have actually accelerated the work to get the (inaudible) processes in there and other types of things for next generation products. So the simple answer is we remain focused on that but the market itself is definitely slowing down some of that progress.

[Tristan Gerra:]

Okay and then could you talk about dynamics in notebooks and also on the multimedia platform and provide an update on the ramp of products that you are acquired from ADI. And who had mentioned briefly on the call about market share but any more specifics you could give us there.

[Donald Colvin:]

Yes, I don’t know about specifics on that. We have done with ADI all that we hope to do. But it is more than just ADI for computing. It is really the combination of the ON business with the ADI business that has given us a great position in both the desktops and the notebooks. Those continue to grow. We had record quarters in Q3. Q4 may not be the same records but there is still going to be represented, I believe, when the quarter is over some nice share gains in that marketplace. So, you know, I can’t give numbers and I certainly can’t project shares as we get into 2009, but I do believe we’re going to find that that share will continue to increase.

[Tristan Gerra:]

Great thank you.

[Operator:]

(Operator instructions) Your next question comes from the line of John Barton with Cowen.

[John Barton:]

Thank you very much. I was hoping to get a better feel for the given the takes off the revenue guidance of $500 million to $550 million. Donald or Keith you mentioned that you are going into the quarter I think you said you are 95% booked and as of today you are 100% booked. Earlier in the call you talked about some push outs of backlog from Q4 into Q1, the recent weakness et cetera. So when you say you are 100% booked to which end of the range or the midpoint of the range? Is that or look that another way how much room do we have for potential further push out and do you think that is the forecast, but you think you will get them, and again just the variance within that range, how are you thinking about it?

[Donald Colvin:]

So – obviously we give ranges and this one is wider than we normally give for a reason. There is uncertainty out there. When we gave the range though we factored in a very wide expectation on customer behavior. We have certainly seen the entire supply chain starting to protect cash which means lend it out as fast as they can and so we have comprehended that in our guidance. The midpoint of our guidance is something we always feel comfortable with. You’ll notice that we normally give you numbers that are like 90% booked to the numbers and this is 95% this time. So perhaps we are being a little more cautious than we have in the past but the point is, it is anybody’s guess, just what may change in customer behavior over the next few months and that is going to be dealing with macroeconomic factors, Christmas sell through et cetera, et cetera. So, I guess the simple answer is we only give guidance we feel comfortable with. Yes, there is a wider range this time because we think there is wider external factors to impact that, but we are also still feeling as good as we do in any quarter about that range of guidance.

[John Barton:]

As my follow up, you know, you talked in your prepared remarks Keith about the design win for the Belsigna 250 out of AMI. I am curious, was that a design win that was well in the works when you acquired the company and this is just proof that customers aren’t concerned with the change of ownership or is it something you were able to lever because of your historical involvement with this customer and now taking in new products and potentially how you see that going forward?

[Keith Jackson:]

Actually this is an example of combination of the companies being much stronger. We highlighted that particular one. There are two other ones that have gone on in the notebook computing marketplace with the same platform here in the last few months as well. So really what is happened is we have taken the relationships that we have and the understanding of some of the consumer based markets that we have and starting using the great technology we picked up from AMI.

[John Barton:]

Thank you.

[Operator:]

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

[Craig Ellis:]

Hi, thanks for taking the question guys. The first question is on pricing. It looks like from the quarter and from the guidance that pricing is behaving in a pretty normal way but is that in fact what you are seeing in. And I think now it is about the time you typically go into annual OEM pricing discussions. As you go into those, what are you in hearing from OEMs?

[Keith Jackson:]

So the quarter is pretty typical, but quite frankly the numbers Craig for us are pretty much set as you enter a quarter. Since we’re not going for a lot of turns we never have a lot of turns to make. Those numbers are very stable or at least predictable I should say within a range of reason. So I think that that guidance is pretty conservative and you know I will just point out quickly that between the currency at 2% and the ASP at 2% you know, you start off kind of in the whole even though your units haven’t moved at all at this point. So the second part of your question which is really about OEM contracts for next year, there is little question that our customers would love to see more price declines. They’re having a tough market place, which is being reflected back to us. Frankly, we’re going to do what needs to be done to maintain our position but obviously you know there is – with the macroeconomic environment that is not a lot of (inaudible) left for any of the suppliers in this marketplace either. So, I’m not expecting dramatic changes from the rates that we have been seeing.

[Craig Ellis:]

So that is helpful Keith. And then Don you talked about CapEx perhaps going down next year versus this year, can you quantify how significant that decline might be?

[Donald Colvin:]

Well I don’t want to give an exact number because I still remain – I still want to keep our level of optimism the business will come back, but you know, capital expenditure is a brakes we can put on, which have a major impact on cash preservation and just to repeat what I said in the prepared comments we had previously guided for 2008 for something in the 120 to 150 million range, which is the midpoint of 125 and we now see in 2008. This is the current year Craig that capital expenditures of 105. So that is a saving of $20 million this year alone. Now normally next year would have been $130 million to $140 million and I think it is fair to say without limiting our capability that we are currently planning on significantly less than 100. And so these are the kinds of buttons that we can push on to ensure that the company generates healthy cash flows even in the most difficult of market conditions.

[Craig Ellis:]

That is helpful. Thanks Don. Thanks Keith.

[Operator:]

Your next question comes from the line of Suji De Silva with Kaufman Bros.

[Suji De Silva:]

Hi guys. I am trying to follow up – may be follow up on the last question. I’m trying to understand the (inaudible) of your gross margin through the ‘09 timeframe. Can you talk about whether the product mix gives you some more pricing ability to kind of resist pricing pressure and also on the capacity side, what is your capacity growth going to be into a sort of the ‘09 environment or what are the major –

[Keith Jackson:]

Suji let me kind of start this and Donald could add as he wishes. So first of all from a mix perspective we have been adding to the company’s portfolio through acquisitions and we have been spending all of our R&D on high margin new products. So, I would expect the mix will continue to be a favorable impact for us as we go forward and that has been a favorable impact for us all through ‘08. So as each of these acquisitions we have been hitting have opportunity for opportunity for better than corporate margins, I would say that is something that ought to be a strong favorable for us. I’m not going to be giving you forecast for next year at this time but I expect that to be a good one. The capacity utilization, we’re – as you just heard Donald say we have been slowing down on the capital expenditures, a good portion of the capital during 2008 were for cost reduction purposes and for new capabilities on the technology side. So the amount of actual capacity being added is relatively small and then on top of that, we previously announced we’re going to be closing a 4-inch fab, a 5-inch fab, and a 6-inch fab during 2009. So net-net our utilization will get much better through the year because of reduced total capacity inside the company. So I think we’re doing the right things to manage that and keep the margins up as best as they can be in the environment and with that I don’t know Donald if you have anything to add.

[Donald Colvin:]

Well I think clearly Keith you put your finger right on the hotspot and that is successful acquisitions that we have made this year having (inaudible) gross margin. And clearly that has given us a wider range of higher margin products that put us in a much better posture to face this more challenging environment. If you just ask the analyst on the call to look at the evolution of the company year-over-year, we have just completed a record quarter. Tremendous improvement in cash flow something like 40% of EBITDA year-over-year. We are not sitting on our warhorse; we are wrestling with the challenges of reducing capital expenditures and ensuring that the business is well positioned to face these challenging times going forward. But the real gross margin is going to be the determined by revenue and that is not a call that we’re not brave enough to make in this environment.

[Suji De Silva:]

It is really helpful. Thank you guys.

[Operator:]

Your next question comes from the line of Doug Rudisch with Brookside Capital.

[Doug Rudisch:]

Hi guys thanking for taking the question. Just circling back on the potential Atmel transaction. I continue to be fascinated at this day and age especially after Yahoo that we have a company or board of directors turning down an offer for $5.00 a share for a company you are earning a nickel. But relative to your point that the deal was always structured as an option and would only be done if it would be accretive. I guess that is three questions there. One is accretion could be a function of how you finance it but it is also a function of how much you pay for it. And then secondarily it is also a relative trade off versus other things you can do with that capital in terms of buying back your own stock. And given you are not bound to close on the deal if your company earned somewhere in the range of a dollar on a mid-cycle basis and if you’re trading at five times earnings wouldn’t any deal for those Atmel asset have to be massively accretive for you guys to push forward relative to other potential uses of your capital?

[Keith Jackson:]

Well, I mean there is a lot of – (inaudible) question there Dough but I do remain optimistic that we will not continue over the long term to trade at five times earnings and we will get back to a more normalized business environment. And we have successfully implemented acquisitions that we believe that makes us a much more attractive company to our customers and improves our financial performance and solidity. And that is why we’re looking at this and we will continue to be interested in this type of opportunity. Clearly there are temporary disruptions in the market because of macro uncertainties and so I don’t think fair and reasonable the price is continuing forever but they clearly have made everything more challenging. You are right. But the – but silver lining on the refusal to talk is certainly that the next phase in this transaction is impossible before sometime next year, and by which time hopefully capital markets will allow a lower cost of capital hurdle and basically using our normalized run rate our numbers still show that this has the potential to be accretive as long as we get the capital markets to return to a more normalized basis. And you are right –

[Doug Rudisch:]

The other part of the delay until next year also means that you get a further look at your own run rate in terms of the economics you are generating and the economics that business is generating. So is it reasonable to assume that you guys are reasonable people and to the degree you would proceed it is only becomes a relative question of a, whether or not it is a creative and b, whether or not it is better than other options for your capital?

[Donald Colvin:]

So Doug I am going to have to step in. We’re not really announcing what our next steps or specific plans at this point. The only thing I will comment to we are more than just reasonable people. We have demonstrated that we only do things that create shareholder value and I don’t know why would change in the future just because of the current environment.

[Doug Rudisch:]

Right thanks guys. I appreciate it.

[Operator:]

Your next question comes from the line of Craig Berger with FBR Capital Markets.

[Craig Berger:]

Hi guys. Thanks for taking my questions. Can you comment on your automotive exposure, where geographically is it, what are you providing within the car and what is the kind of the outlook. How depressed are things already and how much more depressed could we get from here?

[Donald Colvin:]

So, you know, it is kind of a wide range of there. First of all from a geographic exposure you have got today about – exposure about half in North America, half in Europe – well actually 40%, 40% and the balance in Asia. So it is fairly well split as compared to a few years ago but that is where our customers are not where the end products go. We have found that our customers now in Asia are making them for the other markets, the guys in the U.S. are making them for Europe, guys in Europe are making them for the U.S. So I’m not sure you can conclude the end to car sales from where we sell our products. Relative to how bad it is, where we are used, we are used throughout the entire car. We got a pretty good balance between the engines, engine control, the motor controls and all of the body and in the infotainment. The fastest growing portion has been infotainment and we have seen that that segment is certainly continuing to grow even though the cars have gone down and stagnated because all the new models are using more electronics in the infotainment area. So, net-net, you know, we are not sure there is a lot more go give from an electronics perspective. We think a lot of that is taken out already in the Q3 and Q4 run rates. So, I guess, I would be surprised if there is much deterioration as we get into 2009.

[Craig Berger:]

Next question. A lot of your competitors are talking about increased turns environment, low visibility, low orders on the book, more turns being – more driving the business here. You guys are actually baking in less turns into the guidance, which seems contradictory relative to the environment. Can you provide any guidance?

[Donald Colvin:]

We have seen over the years that we have a little different profile on our backlog but we normally don’t get a lot of turns in Q4. It is usually a single digit millions kind of number. What we are seeing now is we think there is none. And while I would agree with our – what you said about the competitors telling about low visibility which is a way to translate that our customers aren’t sure. So they are not going to place orders till they have to have it. I guess, I would be surprised if you saw anybody asking for orders today for delivery in December. It is just – just does not make sense from a macro economic perspective that if you don’t need it already and you didn’t know you’re going to want it all of a sudden.

[Craig Berger:]

That is helpful. Last question, your – the midpoint of the OpEx guidance was up about $2 million. What is the Catalyst impact and what are the opportunities for reduction next year?

[Donald Colvin:]

Well, Catalyst is up 5, that is the – the portion we will get this quarter is $5 million up. So, net it is reflecting about a $3 million reduction from previous quarter in our run rates. We are certainly continuing to look at the rest of the quarter and response is there. So, certainly I think we have given you a range that if anything it is aggressive, or conservative, I should say.

[Craig Berger:]

Can I get one more quick one, what is the specific acceleration in manufacturing consolidations you are going to take next year?

[Donald Colvin:]

Okay, so we had planned for 3 factory closures at the end of the year and right now we are looking at how we can accelerate those. Not prepared to give you a specific quarter answer yet, but you can just imagine for a moment that we are trying to pull those into the first half.

[Operator:]

Thank you. Your next question comes from the line of John Vinh with Collins Stewart.

[John Vinh:]

Thanks for taking my question. I guess the question on your operating model, obviously given the macro headwinds it seems like you would be challenged to get to your target model by the end of next year. Can you maybe talk about how this change is? How you look at your (inaudible) of the model and going into the end of next year. Can you maybe talk about kind of some of the new metrics that we should be looking at and sort of sounds like $600 million on the top line might be a little challenge? Gross margin is 45%, can you address those?

[Donald Colvin:]

Well obviously we are facing a little difficult times than we did at the beginning of the year, but we still think the pick up will be – is logical. We were pretty close in previous occasions if we get to the 45% gross margin and we will manage our operating expenses in the low 20s. So, we still believe that we will be able to run our business with more than 20% operating income and for that is our objective and that would give well over $1 a share in earnings. So that is what management is committed to – trying to deliver. It clearly that is the model we exposed at the beginning of year. Conditions have changed and so we don’t really see that in the near term. That is supposed to move on. I mean cycles do (inaudible) some sales and as I said we are not brave enough to give guidance for the first quarter. So, second we don’t – we are even less braver for the second half of next year. But conditions will improve and, you know, whatever it takes we will stick to our [ph] business the actions that Keith mentioned, factory closures. We have also mentioned consolidation of ERP systems, elimination of duplication, control of our operating expense, all the different things that we know how to do, cutting back capital expenditures, all these things which will save depreciation. All these things will help improve our gross margin and that is what we will continue to do so that when we come through this tough period we will be fitter and a stronger company able to deliver the same objectives. You don’t change your strategy, just because you have some difficulties.

[John Vinh:]

Great and then my second question is if you look at your guidance and you look at your end markets, it sounds like obviously automotive is the most exposed. Is it kind of a safe assumption to assume that all your end markets will be sequentially down next quarter and related to that can you maybe talk about some of the end markets that seem to be a little bit more resilient than automotive is to the economic downturn?

[Donald Colvin:]

So, at this stage I guess just to reiterate my comment on automotive. I think it is basically flattish as we go forward from the drops we saw in Q3. So, I am really not seeing deterioration per se there. The automotive manufacturers are taking a lot of shutdowns in Q4, but that is already reflected in the backlog and the guidance that we have given. So, I am really not seeing further deterioration there, just to reiterate that one. So, yes it softened in Q3. It won’t be getting better but I don’t see a lot worse in automotive. The other markets, right now the end market for handsets seems to be holding up fairly well. I am seeing signs that the supply chain is trying to lean itself out, which means you are not going to seeing component suppliers increasing here quarter-on-quarter and normally Q1 for that is pretty soft. So, I would not be looking for any great strength in handsets. Computing seems pretty stable, not seeing major movements in any direction, down slightly probably in the some of the desktop arenas but again nothing that I would highlight as being extraordinary or out of the normal. And then the industrial and medical and Mil aero [ph] are again – are not moving a lot. So, the reductions, a bit in automotive, a bit in computing, and bit in handsets. It is just – it is a global thing and no segment is standing out right now in either direction.

[Operator:]

Your next question comes from the line of Patrick Wang with Wedbush Morgan Securities.

[Patrick Wang:]

Hi, guys. I want to talk real quick about inventory. You guys, it looks like you did a good job managing that into the third quarter with that coming down on your balance sheet but I think you accept that the inventories were at 11 weeks last quarter and that is about up from a week from the second quarter, can you talk a little bit about why it went up and how you think these two results are going to trend going forward?

[Donald Colvin:]

Yes, that is pretty much rounding here. It was slightly under 11 in Q2 and right at 11 in Q3. It is really not up a day, I mean a week. It was pretty much rounding. What we see going on. The distributors clearly have a self interest in maintaining their cash flow by minimizing just the inventory. 11 weeks is around the low end that we have ever operated. We have gotten down to 10.5 at the very lowest end and 13 was the normal model. So, we are certainly not expecting to be lower or more if there is a slowdown in resales as we suspect they are going to be ordering less. So, on a dollar basis I would expect the answer they will start coming down in inventory on a days basis, it will adjust itself within a quarter or two back into that 11 range.

[Patrick Wang:]

Okay, great. And thanks for that. That was helpful. And second just in terms of utilization, can you talk about what I guess general utilization [ph] in the third quarter. I think you mentioned that it is going to go down in the first quarter here, but just any additional color you can provide there?

[Keith Jackson:]

Yes, you know it is kind of mid 80s as we finished Q3 and on (inaudible) basis actually more like high I should say, (inaudible). I would expect that to sag into the mid 80s to lower 80s as we go forward but not much worse than that.

[Operator:]

Your next question comes from the line of Kevin Cassidy with Thomas Weisel Partners.

[Kevin Cassidy:]

Thank you. Just comment on market share. You mentioned that you are in 4 or having revenue growth at 4 of the 5 handset manufacturers. I wonder if some day you will be talking about 5 out of the 5.

[Donald Colvin:]

Well, you know, hope springs eternal. We have got some pretty neat products and technologies that we continue to try and penetrate that fit the account width and time will tell. The energy is being expanded, we will have to wait for the results.

[Kevin Cassidy:]

Okay, and same for game consoles, is it 2 out of 3?

[Donald Colvin:]

I guess, I wouldn’t say the expectations are locked there. We actually do have some design wins going on in the controller sections, the hand controllers at the third one. And again we will see if those design wins turn into production wins here over the next quarter.

[Kevin Cassidy:]

Okay, thank you.

[Operator:]

Your next question comes from the line of Romit Shah with Barclays Capital.

[Romit Shah:]

Hi, I hate to go back to that now, but you know Donald on the last call, I felt like your message was that you know, hey we are in uncertain times, and as a result are not going to have access to as many sources of financing and especially if the cash balance goes down and so the bias therefore is to do a debt pay down and it is still not clear to me why you guys have decided to deviate from that strategy?

[Donald Colvin:]

Well, I mean, there are multiple variables there in and everyone can look at it a different way and I respect their judgment even if I don’t necessarily agree with them. I mean the real – the fundamental premises, we believe and everything we have learned is under normal financing conditions, this deal has the potential to be accretive and a previous question I had outlined, they are multiple variables, alternative uses of money, cost of money, how much you pay, what you buy and so those there is a lot of variability. We have executed transactions that we are very, very comfortable with and I invite everyone to look into our third quarter actual results and see the benefit that these transactions have given to both cash generation and performance improvement and compare us – compared to some of our competitors that having made acquisitions just to see how much better off we are. So, those multiple variables were met to take into account. We still believe there is a pony [ph] in there. Guys have been working in the industry for more than 30 years. We can recognize things that we can manufacture in our factories and turn a very positive cash flow using things that we are expert at doing. That is why we are in this industry. That is why we are not doing something else. But you know, we won’t pursue that blindly for ever and that is why we have emphasized that our primary motivation is accretion and it is not based upon some maybe with share gain calculations, that will be based like we did with the acquisitions we made or simple synergies and introducing the economies of scale that we have in our manufacturing and distribution network. We still think that pony is there and the many variables on how much we have to pay, how we pay for it, when we have to pay for it. So, we are still far too away to run away and hide.

[Romit Shah:]

If I could, that is definitely then I guess the profile of your acquisitions, AMI and then here with the Atmel assets, there is good expense leverage, they are accretive. But the other side of that is, you know, these businesses haven’t really demonstrated any sort of growth and I think the Atmel assets, you see the negative growth over the last couple of years. Just as a consequence to doing these deals, I am just wondering if the company, you know, is bringing down its long-term sales growth potential, I don’t Keith if you want to comment on that?

[Keith Jackson:]

I will address that one. You know, clearly the other piece of it. Donald mentioned that we are not looking to do a lot of magic on growing these assets to make them accretive. So, the criterion is you know you do them if you can get the accretion with your operational excellence, but the expectation is that you are going to grow them with our supply chain skills and our customer access and so with each of the acquisitions we have made we have been out there growing the business at the accounts and seeing some good returns. So, we haven’t seen the traditional drop off, if you will, in revenues with these. So, from a growth rate perspective in normal times I understand that the (inaudible) that you just made, I don’t know what normal times are anymore, but certainly I think we have the opportunity with our global sales infrastructure to grow these businesses much more than they have been grown in the environment they are in. I mean, you are talking about a company that does this for a living everyday and does an outstanding job of servicing our customers, gives them good pricing, gives them good delivery options et cetera, et cetera. And so, we do expect to grow these businesses faster than they are being grown as they are in the current state.

[Donald Colvin:]

And you know when we talk of growth, our primary motivation in growth is not just to grow sales for the sake of sales, is to grow earnings. EPS, earnings per share, and you heard me repeating, our model is to drive more than a $1 of share of earnings. That is a model that we presented to you guys at the beginning of the year and that is the one management is still committed to and acquisitions we believe at reasonable price that could fit into our manufacturing infrastructure could help accelerate that process.

[Operator:]

Ladies and gentlemen we thank you for participating in today’s conference call. You may now disconnect.