ON Semiconductor Corporation
Q3 2011 Earnings Call Transcript

Published: 3 Nov 2011

[Operator:]

Good afternoon. My name is Gerri, and I will be your conference operator today. At this time, I would like to welcome everyone to the ON Semiconductor Third Quarter Financial Results Conference Call. [Operator Instructions] I'd now like to turn the call over to Ken. You may begin.

[Ken Rizvi:]

Thank you, Gerri. Good afternoon, and thank you for joining ON Semiconductor Corporation's Third Quarter 2011 Conference Call. I'm joined today by Keith Jackson, our President and CEO; and Donald Colvin, our CFO. This call is being webcast on the Investor Relations section of our website at onsemi.com, and a replay will be available for approximately 30 days following this conference call, along with our earnings release for the third quarter. The script for today's call is posted on our website, and will be furnished via Form 8-K filing. Our earnings release in this presentation includes certain non-GAAP financial measures. Reconciliations of these non-GAAP financial measures to the most direct 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 be attending the Credit Suisse Technology Conference on November 30. 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, explain or similar expressions are intended to identify forward-looking statements. We wish to caution that such statements are based on information currently available and 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 earnings release, Form 10-K, Form 10-Q and other filings with the SEC. The factors described in our earnings release include the uncertainties regarding the ongoing impact of the flood in Thailand. Our estimates may change and the company assumes no obligation to update the forward-looking statements to reflect actual results, changed assumptions or other factors. Now I'd like to turn it over to Keith Jackson, who will provide a few comments regarding our operations in Thailand. Keith?

[Keith D. Jackson:]

Thanks, Ken. And thank you to everyone for joining us today. Before going into the details of our third quarter results, I wanted to make a few comments regarding our operations in Thailand that have been impacted by the severe flooding in the country, as well as our announced closure of our Aizu wafer fabrication facility in Japan. The Thailand flood is a natural disaster of unprecedented scale that has killed hundreds of people, damaged thousands of factories, forced hundreds of thousands of employees out of work and impacted the lives of millions. As we have discussed in prior releases, the relentless flooding in Thailand has had a significant impact to our employees, their families and their operations located in that country. The company has approximately 1,800 employees and approximately 350 contractors in Thailand, which represents approximately 9% of our global workforce. I'm grateful that our employees remain safe at this time and our sympathy goes out to the people of Thailand. We have 2 main facilities in Thailand. One is located in the Rojana Industrial Park and another is located in an industrial park in Bang Pa In. Our Rojana Industrial Park operations produced approximately 10% to 12% of our worldwide output as measured by third quarter 2011 revenues, and our operations in Bang Pa In produced approximately 2% to 3% of our output as measured by third quarter 2011 revenues. We have not been able to access either of these facilities in Thailand. Today, our preliminary estimation is that we will be able to enter both locations for large-scale recovery within the next 1 to 2 months, with earlier access for the purpose of assessing damage. Site security measures are being coordinated with the government and industrial park resources by our local security staff. During 2011, we have faced 2 significant, sizable natural disasters

[Donald A. Colvin:]

Thanks, Keith. While the flood had no impact on our financial results in the third quarter of 2011, it will impact our financial results in the fourth quarter and well into 2012. For the third quarter of 2011, ON Semiconductor announced that total revenues were approximately $898 million, down approximately 1% from the second quarter. During the third quarter of 2011, the company reported a GAAP net loss of $49.4 million or $0.11 per fully diluted share. The third quarter GAAP net loss was impacted by $65.4 million of restructuring, asset impairment and other charges, which are primarily related to the restructuring and asset impairment over announced closure of the Aizu, Japan factory, as well as other special items. The complete special items are detailed in schedules included in our earnings release. GAAP gross margin in the third quarter was 29.1%. Included in our GAAP gross margin is approximately $53.6 million of special items. Non-GAAP gross margin in the third quarter of 2011 was 35%. Third quarter non-GAAP net income was $110.5 million or $0.24 per share on a fully diluted basis. We exited the third quarter of 2011 with cash, cash equivalent and short-term investments of approximately $837.7 million. During the quarter, we repurchased $53 million of principal value of a 2.625% convertible senior subordinate notes. At the end of the third quarter, total days sales outstanding were approximately 55 days, down approximately 3 days compared with the second quarter of 2011. Internal inventories were down approximately 6 days to 101 days. Included in our total inventory is approximately $12 million of bridge inventory associated with the shutdown of our factories. Distribution inventories were approximately 11 to 12 weeks exiting the third quarter. We expect the weeks of inventory at distributors to decrease in the fourth quarter. Cash capital expenditures during the third quarter were approximately $86 million. Now, I would like to turn it back over to Keith Jackson for additional comments on the business environment. Keith?

[Keith D. Jackson:]

Thanks, Don. Now for an overview of our end markets. During the third quarter of 2011, our end market splits were as follows

[Donald A. Colvin:]

Thanks, Keith. Fourth quarter 2011 outlook and other forward-looking guidance. There are a number of significant factors that are impacting our guidance and will influence our financial performance in the fourth quarter of 2011. As discussed previously, our operations in Thailand remains suspended. We still have no access to our facilities and we are working to bring up production capacity at other locations. In addition, some of our customers, suppliers and subcontractors have also been impacted by the flooding in that country. We currently estimate that the negative impact to our revenues directly related to the flooding of our Thailand manufacturing facility is estimated to be approximately $60 million in the fourth quarter. Our SANYO Semiconductor division will experience the vast majority of this revenue reduction, resulting from the Thailand flood. Our overall cost will be negatively impacted by a number of factors, including the under-absorption of our manufacturing and operating support overhead. Given the fixed cost nature of the SANYO Semiconductor division, we believe the reduction in revenue will result in approximately $45 million lower total net income for the company in the fourth quarter as a result of the flood in Thailand. In addition, we believe the flood in Thailand will negatively impact our operational earnings by approximately $0.10 in the fourth quarter of 2011. The preceding flood-related impact is included in our guidance below. Our guidance, however, does not include any impact to our suppliers, subcontractors and customers nor any restructuring asset impairment or other unusual or incremental charges and expenses we may incur during the fourth quarter as a result of the flood in Thailand and our efforts to restore production capacity. Additionally, our guidance reflects only our current assessment of the Thailand flood situation. And as we have indicated, the situation and our related understanding of its impact to our business continues to change and evolve. From a cash standpoint, we will attempt to limit our investment in flood mitigation equipment purchases to approximately $50 million that we expect to receive as part of the insurance claims related to the Rojana Industrial Park facility. Based upon product booking trends, backlog levels and estimated turns levels, we anticipate that total ON Semiconductor revenues will be approximately $740 million to $780 million in the fourth quarter of 2011. This guidance includes the estimated revenue reduction as a result of the flood in Thailand outlined previously. Backlog levels for the fourth quarter of 2011 represent approximately 80% to 85% of our anticipated fourth quarter 2011 revenues. We expect the average selling prices for the fourth quarter of 2011 will be down approximately 3% compared to the third quarter. We expect total cash expenditures of approximately $65 million in the fourth quarter and total capital expenditures of approximately $320 million to $330 million for 2011. For 2012, we currently anticipate capital expenditures of approximately $225 million to $275 million. This forecast includes the expected $50 million of additional anticipated capital related to the restoration of capacity post the Thailand flood. For the fourth quarter of 2011, we expect GAAP gross margin of approximately 26% to 28%. Our GAAP gross margin in the fourth quarter will be negatively impacted by, among other items, lower sales as a result of the Thailand flood, the SANYO inventory valuation adjustment and the expensing of appraised inventory fair market value step-up associated with our acquisitions of approximately $24 million. We expect non-GAAP gross margin of approximately 29% to 31% in the fourth quarter. Our gross margin will be negatively impacted by lower sales as a result of the inventory correction occurring within the overall semiconductor supply chain, as well as the flood in Thailand and the associated under absorption of our manufacturing network. We also expect total GAAP operating expenses of approximately $195 million to $205 million. Our GAAP operating expenses include the amortization of intangibles, restructuring, asset impairments and other charges, which are expected to total approximately $15 million. We expect total non-GAAP operating expenses of approximately $180 million to $190 million. We anticipate GAAP net interest expense and other expenses will be approximately $22 million for the fourth quarter of 2011, which includes noncash interest expense of approximately $9 million. We anticipate our non-GAAP net interest expense and other expenses will be approximately $13 million. GAAP taxes are expected to be approximately $2 million to $4 million, and cash taxes are expected to be approximately $4 million to $6 million. We also expect stock-based compensation expense of approximately $6 million in the fourth quarter of 2011, of which approximately $1 million is expected to be in the cost of goods sold and the remaining in operating expenses. This expense is included in our non-GAAP financial measure. We believe the current inventory correction should be over by the end of the fourth quarter of 2011. As previously announced, we expect the negative impact of the Thailand flood to continue well into 2012. We are taking actions to offset this loss of manufacturing capacity. By the end of December, we should have better visibility on our recovery plan for 2012. We currently believe we have excess manufacturing and operating overhead as a result of the impact of the flood in Thailand. We will complete a review of our overhead costs by the end of the fourth quarter of 2011 in order to begin to align our cost structure with our target operating model. Unless otherwise noted, our guidance does not include any restructuring, asset impairment or other unusual or incremental charges and expenses we may incur during the fourth quarter as a result of the flood in Thailand and our efforts to restore production capacity. Our fully diluted share count is approximately 455 million shares based on the current stock price. Further details on share count and EPS calculations are provided regularly in our quarterly and annual reports on Form 10-Q and Form 10-K. With that, I would like to start the Q&A session.

[Operator:]

[Operator Instructions] Your first question comes from the line of Christopher Danely with JPMorgan.

[Christopher B. Danely:]

Donald or Keith, can you just talk about what signs you're seeing that lead you to believe that we'll be done with the inventory correction by the end of this quarter?

[Keith D. Jackson:]

This is Keith. We're definitely seeing changes in booking patterns. People starting to order more product. And in working with our distributors, we're also looking at modeling out their inventory corrections. And again, I think in both cases, it's pointing us towards here at the end of this year being about the bottom.

[Christopher B. Danely:]

And let's say, you guys weren't impacted by the flood in Thailand, what do you think your overall sort of sales would look like, all else being equal?

[Keith D. Jackson:]

Well, I think you can add the $60 million back into the number we've just forecasted for you. Because that's really the Thailand fund piece. And what you're left with is down quarter-on-quarter, partly due with the market, partly due with the inventory correction. And at this stage, we can't give you a precise mix, but it's probably close to half and half.

[Christopher B. Danely:]

Yes. How much of this do you think is demand versus inventory, and what are the customers saying about their demand?

[Keith D. Jackson:]

Yes. So again, I guess about half of it is probably end markets, which means kind of a 4% to 5% drop in the end markets and another 4% to 5% drop from inventory corrections. So that's kind of where I was guiding you there, and that's fairly consistent with what we're hearing.

[Christopher B. Danely:]

Great. And then for my last question, can you just run through the end markets and which you see recovering first, and which might be taking a little while longer?

[Keith D. Jackson:]

We definitely see a continued strength in automotive and the white goods portion of consumer. We're not sure from a recovery part, if you to call it recovery, I don't know if that's the right word, but industrial has the most unknown outlook at this stage. They were down pretty substantially in Q3. They look like they're going to be also not showing much signs of strength in Q4. So I think that's the one I've got the least visibility into. But all the rest of them, we're expecting some positive impact from the Chinese New Year that comes up in Q1.

[Operator:]

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

[John Pitzer:]

I guess, Keith or Don, I just want to make sure I'm doing the math right. Thailand was approximately $100 million of revenue in the third quarter, it's going to be sort of a $60 million hit in the fourth quarter. Does that imply that you're finding sort of availability in other factories to recoup $30 million, plus or minus, is that how I should think about it?

[Keith D. Jackson:]

Well, a piece of that is inventory and a piece of that is alternative manufacturing. There's a combination of the 2, John.

[John Pitzer:]

And, I guess, if Thailand takes longer to bring back up, where could that hit be kind of in the calendar first quarter? If you think about capacity you could move within your global network, how might that look into the March quarter?

[Keith D. Jackson:]

We really don't give guidance that far out. I think our team is finding good solutions for the products. I think we would say we're fairly confident we'll have the majority of the problem solved by the time we get to Q2. In between then and now, I really don't want to forecast a recovery rate.

[John Pitzer:]

And then, Keith, you talked a little bit about customer order patterns picking up and that giving you some confidence that we'll be through the inventory correction in Q4. Just out of curiosity, given the 10% to 15% of your capacity just kind of went offline, why isn't that the customers are ordering just for fear that they can't get the parts, and that that's more of a sign of what's happening in Thailand than kind of a bottoming in the cycle?

[Keith D. Jackson:]

Yes, we do see some of that activity, it's not widespread. But we're getting calls on products that the ON network makes that were not impacted in Thailand to see if we have excess of supply because other suppliers were impacted there. And so we do see some of those orders, but it's really not a large percentage at this stage.

[John Pitzer:]

And then my last question. Donald, if you go back to the last quarter, you had some gross margin headwinds around FX and commodity pricing in the June quarter. You did a good job in the September quarter. Any update there from a cost perspective on the gross margin line?

[Donald A. Colvin:]

Well, I think the big issue in gross margin is the overhead absorption. And so I think the foreign exchange stuff has kind of stabilized. The dollars kind of stabilized, gold, copper. So that's actually not been a negative, incremental negative into Q3 and into Q4 as you have mentioned. But I think what we've got now is the absorption. We're having to reduce sort of factory rates to reduce our inventories and with low demand as the inventory reduction takes place in the channel. So that's having a negative impact on our gross margins. And it's going to take some time to work our way through that, but I mean that's the nature of the business. If you pull apart the Thailand flood, this is a normal, albeit painful semiconductor inventory correction. That's what we are paid to manage. And so we have taken actions to restore our gross margins once demand comes back to its normalized levels. And as Keith mentioned, we've got additional actions to restore the capacity for Thailand and get back to normal levels there too.

[Operator:]

Your next question comes from the line of Ross Seymore with Deutsche Bank.

[Ross Seymore:]

The $60 million impact you talked about in Thailand for the fourth quarter. From your comment earlier, Keith, about hopefully having this taken care of by the second quarter. Should we assume that, that $60 million impact is about as bad as it gets on a quarterly basis?

[Keith D. Jackson:]

At this stage, Ross, we don't have any better data. I mean, as we mentioned in our call here, this is based on the best information we have at this stage. So barring any other information, I would yes, but we don't have any other information.

[Ross Seymore:]

Got you. Then for my one follow-up, just looking at your OEM and distributor split, it looks like your DSP business was down about 19% sequentially and your OEM was up about 12% by those percentages you gave. Could you just talk a little bit about the dynamics there, especially on the DSP side, considering you're a sell-through company, that seems like a pretty large number.

[Keith D. Jackson:]

Well, actually, that's exactly where you would see it on a sell-through company. So our sales hold up pretty well in the third quarter competitively on a sell-through basis, but we started seeing that inventory correction in the third quarter from a distribution sell-in perspective. So when we measure those numbers on a sell-in basis, they're actually as significant as anyone else's.

[Operator:]

Your next question comes from the line of James Schneider with Goldman Sachs.

[James Schneider:]

Just in terms of the gross margin trajectory and where we go from here, what do we have to see for gross margins to start moving up? Is it just revenue growth from here or are there other levers here you can pull in the cost side to make things start to move up?

[Donald A. Colvin:]

Well, obviously, we are -- this is Donald here. Obviously, we are going through everything we can and particularly with portfolio management. But if you just -- if you take aside the Thai-impacted business, we would expect our gross margins to go back to recent levels in the second half of next year. That's the kind of trajectory we're working to. But then you've got the impact of Thai, we expect by the middle of next year to have that handled with additional capacity. And then the other lever we can pull on is looking at our portfolio management and favoring higher-margin products. So these are the classic things we're doing. We've also mentioned, as far as gross margin is concerned, the closure of the factory in Aizu, which is a high-cost location. That capacity will be absorbed in lower-cost locations, and the benefit of that will also be felt in the second half of next year. So just the classic levers, as we grow the top line, replace the capacity lost and shut down the factory in Aizu, with looking at favoring, trying to rebalance to a richer portfolio mix, all that will help our gross margins.

[James Schneider:]

Fair enough. That's helpful. And then just in terms of pricing environment, I think you talked about ASPs being down about 3% in the quarter, maybe a little bit worse than it has been recently. Can you talk about where you're seeing that pricing pressure and in what markets and how long you expect that to continue, if at all?

[Donald A. Colvin:]

So on this ASP metric, we have always used the same measure we've used now for about 15 years. It tends to be a little bit conservative and that it kind of exaggerates a bit the ASP pressure. But we've used it consistently as a measure and reported it ever since I've been here. So I do think it does tend to exaggerate a little bit the impact on the P&L, but that's just an aside comment. But basically seeing that essentially in standard, more commoditized products. Obviously, ASICs, are not reducing the price of ASICs. So it's basically standard commoditized products. And if you read some of the scripts as I do of our competitors, it looks like they are enjoying the same pleasure as we are of a dynamic pricing environment.

[Operator:]

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

[John Vinh:]

Just a follow-up on the Thailand disruptions. Can you talk about the primary end markets that are impacted by the capacity there?

[Keith D. Jackson:]

It was a fairly broad mixture of end markets. We had some of the standard product discrete business in there, which services literally everything. We had some products aimed at motor controls, which could be in fans for PCs or in some of the disk drive industry, probably some consumer goods in there, as well, but a fairly wide range.

[John Vinh:]

Got it, got it. And then my follow-up is, as you start to find alternative sources of capacity, can you talk about, are you having to requalify those components every time you do that? And then can you talk about, it sounds like your service levels have been impacted there, do you have some buffer inventory that you can kind of lean on in the near term?

[Keith D. Jackson:]

Okay. So both questions, yes, we also always qualify that process in times of trouble is actually fairly speedy. Our customers work with us quite closely so that the supply can go uninterrupted. So definitely, there's qualifications involved. We want to make sure the quality of the product is appropriate before we ship anything. On the other hand, it doesn't take the normal quarters to get that done. Relative to the alternate sources, they do come up fairly quickly. We're finding idle capacity, as we mentioned before, inside of our network and through subcontractors. And so it's a quite quick process right now to get everybody back on track.

[Operator:]

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

[Christopher Rolland:]

This is Chris Rolland in for Craig. If you guys could maybe just talk about sort of inventory overhang in some of your end markets, which end markets do you think may have the biggest hot spots or danger points?

[Keith D. Jackson:]

I don't know that I would give you any. We had -- if you go to the distributor behavior, they don't do inventory by market. If you go to the OEMs, frankly, we had very similar behavior across the board, all of our OEMs last year. They were very aggressive in ordering in the first half of the year, and then when they got their supply chain full, they've all backed off. There's really no pattern that points to the market.

[Christopher Rolland:]

Some other companies have talked about industrial as, potentially, being one of those markets, have you seen that?

[Keith D. Jackson:]

Well, our industrial sales were down in Q3 versus Q2. And definitely, I do believe a piece of that was, they found their supply chain quite full and didn't need to order as much.

[Christopher Rolland:]

Okay. Also some of our checks, we've heard your lead times for your ASICs business were particularly long. Has this sort of given you a chance to catch up? And what have lead times done there?

[Keith D. Jackson:]

Lead times are relatively stable now. They are down from their peaks. They're not quite down to their mends, but they've been quite stable now for 2 quarters.

[Operator:]

Your next question comes from the line of Steve Smigie with Raymond James.

[Jonathan Steven Smigie:]

Just with regard to March, and I know you guys don't specifically guide for that at this point. But given what's happening in terms of markets and inventory corrections, et cetera, should we be thinking about March more as a seasonal quarter or more non-seasonal because we'll be recovering? Just, I'm following up because you had sort of indicated you thought we were in the recovery phase or we're through the inventory correction. Any color you're willing to give there?

[Keith D. Jackson:]

Again, we can't give you a guidance on the March quarter. From an end market perspective, I think we can say we're looking for something that's close to seasonal plus or minus whatever inventory corrections are still being made. A lot of the growth now in the electronics industry is coming from the emerging markets. Chinese New Year has a significant importance in that. It happens early this year, so we're kind of expecting something from a consumer basis that looks pretty similar to normal. Again, plus or minus whatever inventory is left to correct.

[Jonathan Steven Smigie:]

And just one quick other one. Just on the interest expense for 3Q, I think you gave relatively similar guidance on that last quarter. If I just take the number you reported for interest expense and back out the $9 million. I get something that's $7 million lower than what I was thinking. Am I making mistake in my math there? Or was there some reason the interest expenses is lower in September quarter?

[Donald A. Colvin:]

I think the interest expense is cash and others, so there's translation in there. So we've had some translation variations. But I think it's fair to say that the cash interest expense is running about $8 million or $9 million per quarter. So it's going to stay that way. And any difference would just be the delta because of translation.

[Operator:]

Your next question comes from the line of Terence Whalen with Citi.

[Terence R. Whalen:]

If we were to look beyond the near-term disturbances in Thailand, for the SANYO business, I believe, historically, you thought you might be able to get to something close to a 35% gross margin at around a $300 million quarterly run rate. How does what's going on now structurally affect the margin level, if you were to return to that sort of a run rate?

[Donald A. Colvin:]

Well, I think that still remains totally doable and, indeed, we were simulating that this morning. What's probably fair to say is that we probably need to achieve our gross margin targets and our target model at a lower level of revenue because we have to be realistic. Some of the revenue that's going to be lost, we will not get back. And that is something that we are assimilating, and but still are aiming for that target gross margin. But realistically, it's probably going to be a number inferior to $300 million, Terence.

[Terence R. Whalen:]

Okay, great. You actually preempted my third question. So my third question was, if we're to think about operating cash flow, you've actually run a fairly steady $120 million to $135 million, the past 3 quarters. To what degree will that be affected? I'm trying to match that up against your $250 million CapEx for next year. To annualize that, what free cash flow could be in 2012?

[Donald A. Colvin:]

Well, I think you can expect -- I mean, our EBITDA is another proxy for that. We've been running the EBITDA at the $170 million range for the last 3 quarters. It's actually remarkably stable. So I think you can expect to see that being negatively impacted by the flood, particularly next quarter and the first quarter, as Keith mentioned. And then as we mitigate that, returning to its historical levels in the second half of next year. That's the best visibility we see. Obviously, we have a lot of work to make that happen. But as you say, we know how to generate cash. One thing I will draw your attention to is that one positive of the current environment is that we are able to cut back our capital expenditures, and that will be a positive to cash flow. And another thing that I would reiterate is that we don't expect the Thailand-specific recovery investments to be superior to our insurance reimbursement. So that will not be a negative to cash flow from the equipment investments and requalified investments. Obviously, there will be a P&L impact in Q1 and Q4 as a direct result of the lost revenue.

[Operator:]

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

[Tristan Gerra:]

Excluding SANYO, where are your utilization rates currently, and when do you expect to back up utilization rate? Is the pick up in orders that you see so far in Q1 sufficient for that to happen, or is it more of a Q1 type of trend?

[Keith D. Jackson:]

Yes, we don't expect to increase utilization in Q4. I think it will be early next year. But certainly, not in Q4.

[Tristan Gerra:]

Okay. And in terms of contract pricing, what should we infer about pricing trends for next year based on the, I guess, the recent negotiations that ON Semi has been taking?

[Keith D. Jackson:]

Yes, most of the near-term pressure comes from the short-term orders in Asia. So that's where the majority of the pressure is coming from. I don't know that I would translate that as being something that is going to carryforward to all of next year. We do our annual negotiations in the fourth quarter and the first quarter, as you know, for that base of our customers that do it annually. Those numbers look much more normal. So really it's a lot of pressure, short term, with the corrections going on in the inventory and Asia driving most of the increased ASP pressure.

[Operator:]

Your next question comes from the line of Ramesh Misra with Brigantine Advisors.

[Ramesh Misra:]

Keith, first, this question is for you. Your backlog coverage for Q4, obviously, is down, yet you're saying that order of patterns are improving. So I guess you're counting on turns business to improve. I just wanted to get a little more color.

[Keith D. Jackson:]

Yes, as compared to previous quarters, we are expecting more turns. And it comes from a variety of sources but not the least of which the way we measure that will be sell-through from distributions. So our sell-through from distribution above what we sell in will look like a turn, the way we calculate it.

[Ramesh Misra:]

Got it, okay. In regards to CapEx for 2012, obviously, it looks like a pretty sharp decline. Is there something we should be reading into that? Or are there things that you kind of already invested in and now you don't...

[Keith D. Jackson:]

No. We made a lot of big investments this year to set up the infrastructure for growth, and so we don't have to repeat a lot of those next year. So we've got the brick and mortar and the factories and the facilities and the plumbing, and all those things kind of behind us. So now, it's just incremental equipment.

[Operator:]

Your next question comes from the line of Chris Caso with Susquehanna Financial.

[Christopher Caso:]

I was wondering if you could address, as we go forward, the leverage that we might expect on incremental revenue. And typically, what we've done in the past is looked at incremental margins, I think in the 50s generally. Given both the addition of the SANYO business as well as the impact of the flood in Thailand, is it the right thing to think about going forward?

[Donald A. Colvin:]

I think that's fair. Obviously, I did have some illusions that we -- once we established the ramp pattern with conviction, we will examine our fixed overhead. But aside from that, I think that's a fair assumption, in the 50s. I think that the incremental contribution from the SANYO business is higher, because they have a higher fixed and they're only slightly lower. But I think that's a fair assumption to use.

[Christopher Caso:]

Okay. And I guess going forward, just to clarify the impact of the Aizu closure next year. Was -- I guess, that wasn't included in the support payments they have provided, so the Aizu closure does provide...

[Keith D. Jackson:]

No. The Aizu factory is a traditional ON factory. And so that is a true $8 million a quarter savings from the current run rate.

[Operator:]

Your next question comes from the line of Kevin Cassidy with Stifel, Nicolaus.

[Kevin Cassidy:]

The $60 million impact coming from the SANYO product, was that mostly sold into Japan?

[Keith D. Jackson:]

No. It was a mixture. I think it's very similar to the overall business. About 1/3 or so goes into Japan, the rest goes into Asia.

[Kevin Cassidy:]

Okay. Are there employment agreements in place in Thailand?

[Keith D. Jackson:]

We have employment regulations there. There's no individual agreements, but there's a government regulated set of standards we have to follow.

[Donald A. Colvin:]

As far as, obviously, the employees that we have there cannot be gainfully employed. And like all other companies, I think, we are paying them -- guarantee them 6 months from the flood, salary. But in the overall scheme of things, the labor costs are not really a huge swing factor. That's not going to dramatically change the P&L.

[Operator:]

Your next question comes from the line of Mark Lipacis with Jefferies.

[Mark Lipacis:]

Assuming you can get most of the capacity transferred by the second quarter, can you give us a sense as to how much your revenues that are coming through the Thailand facilities are at a material risk of being permanently lost to competition? And as part of that, Keith, you said, at the high level, you had hoped by Q2 of next year, you'd hope to have most of the capacity accounted for in other places. Is that -- did you mean like the beginning of Q2 or end of Q2?

[Keith D. Jackson:]

I think from a manufacturing perspective, the beginning. From a volumes out, obviously, we have cycle times involved. So financially, that will spread out beyond the beginning of Q2. But I think we'll have solutions in place prior to the second quarter. And relative to what won't come back, we don't know yet. We don't have enough information to answer your question. A significant portion of that business is, we believe, differentiated by our performance on those products, so we're fairly comfortable with most of that revenue. Some of it is multi-sourced and we would think that would be more at risk. But again, there's only about 1/3 of that revenue that was from the multi-sourced discrete nature.

[Operator:]

Your next question comes from the line of Craig Ellis with Caris & Company.

[Craig A. Ellis:]

Don, on the $100 million in potential insurance recovery. First, are you expecting any of that to be recovered in the fourth quarter? And 2, when it is recovered, what line will we see that booked in?

[Donald A. Colvin:]

Well, the actual fact, we don't expect $100 million. The Rojana factory, we had the maximum amount of $50 million. So all things are between fixed cost, variable, business interruptions, inventory, that we will max out the $50 million insurance. I believe that, that probably will be paid early next year. As far as the other factory, we have a $50 million coverage for the other site, but we are not expecting the claims to be anything like $50 million. I'm not going to give away our negotiating position with the insurance companies, but it's certainly unrealistic to suggest anything like $50 million of damage there. And how would that be handled? I think a lot will depend on how we settle with the insurance companies. But clearly, there's property damage, equipment damage that will be first priority, and the allocation will be determined afterwards with the insurance companies.

[Craig A. Ellis:]

And then just a clarification on something that's come up earlier. I know there's, I think, 4 fabs that are either in the process of being shut down or have shut down between Phoenix, Aizu, Gunma and Gifu. Which of those are going to result in incremental cost savings versus may have had operational support? Is it the latter 2 that had some operational support?

[Keith D. Jackson:]

So the Phoenix factory, which is closed, closed at the beginning of Q3, will have positive impact on our cost reductions. We should start seeing that by the first quarter as inventories are depleted. Aizu, also fits that category, traditional on site. There is no support from SANYO, no connection to SANYO. So all of that savings of $8 million a quarter should be direct. The Gunma and Gifu do have some operational support. So of those, 2 of the 4 fit the category of having operational support.

[Operator:]

Your next question comes from the line of Sujee De Silva of ThinkEquity.

[Sujeeva De Silva:]

For the $60 million gap that you have, I know you said by the second quarter next year, you probably get that back on. Is that -- can you give us a sense of how far along you can be within 3 months on that, based on actions you're taking outside...

[Keith D. Jackson:]

No. We really can't -- again, we really can't forecast specific revenue recoveries. And even my comments were meant to be, we have solutions, I don't -- I'm not trying to forecast when all of the revenue is back. It's just too early. I'm not being evasive. It's just too early.

[Sujeeva De Silva:]

Understood. That's fair. In terms of the Chinese New Year being earlier, is it possible at all to get a sense of how many growth points you're benefiting from versus the typical-timed Chinese New Year in the fourth quarter, is that something you can pull up?

[Keith D. Jackson:]

That's really difficult when you're looking at the down quarter, to give you that answer. So I don't know how much impact will be there. I think we are more hopeful than we normally are for December sales and December turns. But until December comes, I just really don't know.

[Sujeeva De Silva:]

Okay. Last question. Industrial should be down again for a second quarter in a row. Is there something perhaps different about the way industrial is played out that it wouldn't recover after 2 quarter drop? Because typically, it takes 2 quarters and then it recovers. Is there something different going on this time?

[Keith D. Jackson:]

No. There's really nothing going on there. And as long as global GDP doesn't take a dramatic hit, I would expect that it should recover. The industrial story, may be mostly an inventory correction story.

[Operator:]

Your next question comes from the line of Brian Piccioni with BMO Capital Markets.

[Brian J. Piccioni:]

You mentioned in the outlook section of the news release, but of course your guidance can't -- or doesn't anticipate the impact to customers and suppliers. And of course, over the last few weeks, we've seen a number of companies, like companies in the disk drive industry and so on, seemed to be severely impacted. I was wondering if you could give us some sense for whether the outlook that you've given has any information in it with respect to suppliers and customers, or whether it's simply a case that you haven't been informed yet as to the impact of those affected companies?

[Keith D. Jackson:]

Yes, so the guidance includes all of the information we have as of yesterday, which does have some significant impact from some of the disk drive manufacturers already built-in. What it doesn't have is all of the impact because we just don't know all of it. But certainly, everything we know is in that number.

[Brian J. Piccioni:]

Okay, great. And I know the question is a bit off the beaten track, but obviously it's late in the call so I figured I'd ask it. Can you maybe speak towards how things are going with respect to -- you mentioned earlier, for example, a win in a TV for ON power supplies, is basically selling SANYO product to traditional ON customers and ON product into traditional SANYO customers.

[Keith D. Jackson:]

Yes, that's actually making good progress. We've had very good reception from the customers. The database that we track on those design wins and business awards is growing at a fairly good clip. So we're actually quite pleased with that portion of the transition right now.

[Operator:]

Your last question comes from the line of Betsy Van Hees with Wedbush Securities.

[Betsy Van Hees:]

As we look at Q3 on your product segments, the way you break it out. SANYO appears to be up 8% and all your other categories were down, ranging from 2% to 13%. I was wondering if you could help us for Q4, excluding the impact from Thailand, how should we be modeling those product groups within the range that you gave of revenue being down excluding Thailand?

[Keith D. Jackson:]

So I would say that, ignoring Thailand for a moment, both SANYO and ON are down about the same percentage. And then SANYO is impacted much more dramatically by Thailand.

[Betsy Van Hees:]

Okay. But in terms of -- like for example, computing and consumer, it was down 13% quarter-over-quarter. Are you expecting it to be within that range, is it -- excluding the Thailand impact? Or is it above? I was wondering if you could help kind of categorize for us the different product group and how much...

[Keith D. Jackson:]

You mean by marketplace?

[Betsy Van Hees:]

Yes. So you have automotive and power...

[Keith D. Jackson:]

I'm not sure I can give you that guidance. I don't know that I have it split out in that fashion.

[Betsy Van Hees:]

Okay. Fair enough. And then in terms of the gross margin impact, are we looking at, excluding what's happening with SANYO, is there any greater gross margin pressure in certain product categories?

[Keith D. Jackson:]

Well, the greatest pricing pressure is coming in our multi-market businesses, the discrete business. The Standard Products Group, I guess, is seeing the most significant pricing pressures. But beyond that, from a factory perspective and utilization, the internal cost piece, there's really no differentiation between any of them.

[Betsy Van Hees:]

Okay. And my last question in regards to Thailand, you mentioned that you have property damage and equipment damage. Are you possibly looking at maybe not rebuilding a new facility in that factory and going somewhere else, is that a possibility?

[Keith D. Jackson:]

We have not really evaluated all of our options there. We will -- once we get into the factory and can make an assessment, we will evaluate all options. But at this stage, we're not speculating.

[Operator:]

This concludes today's question-and-answer session. Thank you for calling the ON Semiconductor Third Quarter Financial Earnings Call. You may now disconnect your lines at this time.