ON Semiconductor Corporation
Q1 2015 Earnings Call Transcript

Published: 4 May 2015

[Operator:]

Good afternoon. My name is Jonathan, and I will be your conference operator today. At this time, I would like to welcome everyone to the ON Semiconductor First Quarter Earnings 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. Mr. Parag Agarwal, you may begin your conference.

[Parag Agarwal:]

Thank you, Jonathan. Good morning, and thank you for joining ON Semiconductor Corporation's first quarter 2015 quarterly results conference call. I'm joined today by Keith Jackson, our President and CEO; and Bernard Gutmann, our CFO. This call is being webcast on the Investors section of our Web site, at www.onsemi.com. A replay will be available on our Web site approximately one hour following this live broadcast and will continue to be available for approximately 30 days following this conference call, along with our earnings release for the first quarter of 2015. The script for today's call is posted on our Web site. Additional information related to our end markets, business segments, geographies, channels, and share count is also posted on our Web site. Our earnings release and this presentation include certain non-GAAP financial measures. Reconciliations of these non-GAAP financial measures to the most commonly comparable measures under GAAP are in our earnings release, which is posted separately on our Web site in the Investors section. During the course of this conference call, we will make projections or other forward-looking statements regarding future events or the future financial performance of the company. The words believe, estimate, project, anticipate, intend, may, expect, will, plan, should or similar expressions are intended to identify forward-looking statements. We wish to caution that such statements are subject to risks and uncertainties that could cause actual events or results to differ materially. Important factors, which can affect our business, including factors that could cause actual results to differ from our forward-looking statements, are described in our forms 10-Ks, Form 10-Qs and other filings with the Securities and Exchange Commission. Additional factors are described in our earnings release for the first quarter of 2015. Our estimates may change, and the company assumes no obligation to update forward-looking statements to reflect actual results, changed assumptions, or other factors, except as required by the law. During the second quarter, we will be attending the Jefferies Technology Conference in Miami on May 12, Bank of America Technology Conference in San Francisco on June 3, and Raymond James one-on-one conference in Boston on June 9. Now, let me turn it over to Bernard Gutmann, who will provide an overview of the first quarter 2015 results. Bernard?

[Bernard Gutmann:]

Thank you, Parag, and thank you everyone for joining us today. Let me start by providing an update on overall business results. During the first quarter, we continued to build on our strong order momentum and the strength in orders has continued so far during the current quarter. Our margin expansion trajectory remained intact driven by unrelenting focus on execution, continuing mix shift towards industrial, automotive and smartphone markets, and expanding operating leverage. We believe that we have significant headroom for margin expansion and we remain on track to achieve the margin targets we set at our recent Analyst Day event in February. Our design win pipeline continues to grow driven by wins in automotive, industrial and smartphone end-markets. We haven’t seen any negative impact on demand, pricing, or on our earnings from the much talked about volatility in the global currency markets. Our share repurchase program is off to a solid start. During the first four months of the $1 billion four-year program, we repurchased approximately 120 million of our stock. Now let me provide you an update on our first quarter 2015 results. ON Semiconductor today announced that total revenue for the first quarter of 2015 was approximately 871 million, an increase of approximately 1% as compared to the fourth quarter of 2014. Revenue for the first quarter was negatively impacted by approximately 8 million as compared to the fourth quarter due to strengthening of the U.S. dollar. This negative impact on our revenue was slightly higher than our expectations of 6 million. GAAP net income for the first quarter was $0.13 per diluted share. Excluding the impact of amortization of intangibles and restructuring, and other special items, non-GAAP net income for the quarter was $0.20 per diluted share. GAAP gross margin for the first quarter was 34.5%, as compared to 32.1% in the fourth quarter of 2014. Non-GAAP gross margin for the first quarter was also 34.5%, up approximately 40 basis points quarter-over-quarter due to higher utilization and a favorable mix of industrial and automotive. Average selling prices for the first quarter decreased by approximately 2.5% as compared to the fourth quarter. However, excluding the impact of currency, average selling prices declined by a little more than 1% quarter-over-quarter. Given that we usually see higher ASP declines in the first quarter as newly negotiated annual pricing contracts become effective at the start of the year, we are very pleased with the pricing trends in the first quarter. GAAP operating margin for the first quarter of 2015 was approximately 7.9% as compared to approximately 1.7% in the fourth quarter. Our non-GAAP operating margin for the first quarter was 11.5%, up approximately 120 basis points as compared to the fourth quarter of 2014. Higher gross margin and lower operating expenses were the key drivers for sequential increase in the non-GAAP operating margin for the first quarter. GAAP operating expenses for the first quarter were approximately 232 million as compared to approximately 263 million in the fourth quarter of 2014. Non-GAAP operating expenses for the first quarter were approximately 200 million, down approximately 5 million as compared to the fourth quarter of 2014. We exited the first quarter of 2015 with cash and cash equivalents and short-term investments of approximately 429 million, a decrease of approximately 88 million from the fourth quarter of 2014. Operating cash flow for the first quarter was approximately 84 million as compared to approximately 162.5 million in the fourth quarter. We spent approximately 65 million of cash for the purchase of capital equipment. During the first quarter, we used approximately 39 million for the repayment of long-term debt and capital leases, and issued debt of approximately 6.5 million. We used approximately 97 million to repurchase approximately 9 million shares of our common stock at an average price of $11.20. At the end of the first quarter, approximately 879 million remained of the total authorized amount under the current stock repurchase program, which was announced on December 1, 2014. We remain on track to generate annual free cash flow of 400 million in the near to mid-term. We define free cash flow as cash flow from operations less capital expenditures. Based on current booking trends, we remain upbeat on our near to mid-term outlook. Keith will provide additional details on booking trends. At the end of the first quarter of 2015, ON Semiconductor days of inventory on hand were 119 days, up approximately two days from the prior quarter, in anticipation of higher revenue in the second quarter. In the first quarter of 2015, distribution inventory decreased by approximately 11 million quarter-over-quarter and distributor re-sales declined by approximately 6% quarter-over-quarter. In terms of days, distributor inventory was approximately flat quarter-over-quarter at approximately 10 weeks. For the first quarter of 2015, our lead times were approximately flat as compared to the fourth quarter. Our global factory utilization for the first quarter was approximately flat quarter-over-quarter in the mid-80s percentage range. Now let me provide you an update on performance of our business units, starting with Image Sensor Group or ISG. Revenue for our Image Sensor Group was approximately 171 million as compared to approximately 166 million in the fourth quarter. Aptina was nicely accretive to our non-GAAP EPS and we remain on track to generate $0.08 of non-GAAP EPS accretion from Aptina in the current year. Revenue for our Standard Products Group in the first quarter of 2015 was approximately 303 million, up approximately 2% quarter-over-quarter. Revenue for our Application Products Group was approximately 264 million, up approximately 2% quarter-over-quarter. Revenue for the first quarter of 2015 for our System Solutions Group was approximately 133 million, down approximately 6% quarter-over-quarter. Despite a 6% decline in revenue, SSG was accretive to our non-GAAP net income in the first quarter. Revenue for SSG was negatively impacted by weakness in the Japanese yen as compared to the U.S. dollar and seasonality for the first quarter. As the Japanese fiscal year ends March 31, customers typically reduce inventory levels on their balance sheets during the March quarter, and therefore we see a much more accentuated decline in our SSG revenue in the March quarter. Before I turn over the call to Keith, let me further clarify the impact of volatility in foreign exchanges in our business. In many recent discussions, we have indicated that we have a natural hedge in place due to our highly diversified global manufacturing base, and any headwind to our revenue is offset by corresponding reduction in costs. The strengthening of the U.S. dollar may lead one to believe that our European and Asian competitors should have a cost advantage, but let me point out that the semiconductor supply chain is very complex and diversified and we believe that hardly any competitive advantage is gained from volatility in foreign exchange rates. Competitive advantage in our industry has been, and in our view, will always be derived from innovative products and operational and manufacturing prowess, which provide a sustainable cost advantage. In the recent past, we haven’t seen any meaningful change in competitive behavior by our competitors, even those based in Europe and Asia. Pricing across all end-markets, geographies and product lines has been in line with historical trends. And at this time, there are no indications pointing to any change in competitive dynamics in the industry due to strengthening of the U.S. dollar. Now, I would like to turn the call over to Keith Jackson for additional comments on the business environment. Keith?

[Bernard Gutmann:]

Thanks, Bernard. I’m very pleased with our results for the first quarter and outlook for the second quarter. Despite an overhang of a few macro-related uncertainties and weakness in a few end-markets, we were able to deliver strong results. Our growth momentum continued in the first quarter with sequential revenue growth of approximately 1% exceeding our expectations. Bookings continued at a solid pace in the first quarter and our bookings momentum has remained intact thus far in the current quarter. Bookings have been broad based across various end-markets and customers. We believe that our expansive product offerings and new products for automotive, industrial and smartphone markets are the key contributors for an accelerated pace of bookings. Customer interest in our portfolio continues to increase and customers are increasingly relying on us to enable truly differentiating features in their products. We expect to see launch of many such products enabled by our innovations in the second half of the year and into next year. With increased bookings, our visibility into the remainder of the year has improved significantly. Not only are we seeing bookings for the current quarter, but also for the second half of the year. The robust pace of bookings for the second half of the year is the key driver for our increased confidence for outlook for the remainder of the year. Our design pipeline continues to grow as investments we made during the last few years are yielding strong results. Our focus on key technologies and growth segments has resulted in wins in marquee platforms for smartphones and other fast growing consumer devices. In the automotive segment, our momentum in fast growing advanced driver assist systems market remains intact, and we continue to be market leader with approximately 70% share for image sensors for ADAS-related applications. Interest in our wireless charging solution continues to increase and we are seeing a strong customer pull. In addition to the leaders in the mobile devices, consumer and computing markets, we are engaged in various stages of discussion with key players in the automotive markets. Based on current indications, we expect to see a strong ramp for our wireless charging products in 2016. Now let me provide a brief update on Aptina. We remain on track to deliver $0.08 of accretion to our non-GAAP EPS from Aptina in the current year. Integration of Aptina is expected to be completed towards the end of the current quarter, and we should see higher contributions from acquisition synergies in the second half of the year. We continue to focus on capital efficiency, cash flow generation and capital return to shareholders. As I have indicated earlier, most of the investments needed to achieve a competitive cost structure and scale have been largely completed, and our goal going forward is to leverage our past investments to generate strong cash flows. Generating shareholder returns is a key priority for us and we intend to return most of our free cash flow to shareholders through our $1 billion stock repurchase program. Now I’ll provide some details of the progress in our various end-markets. The automotive end-market represented approximately 33% of our revenue in the first quarter and was up approximately 8% quarter-over-quarter. We continue to gain increasing traction with our image sensors in the automotive market. We have high penetration with our image sensors in the rear view camera market at the OEM level in North America, Japan and Korea. For advanced driver assist systems, our 1 megapixel image sensors continued to ramp in Europe and North America. We benefitted from strong sales of light trucks in North America as we have higher content in light trucks. Our Standard Products Group posted strong quarter-over-quarter growth with record automotive revenue in the first quarter. We continue to grow our sales in the fastest growing applications within automotive. These applications include automotive cameras, ADAS, door electronics, park assist, LED lighting, advanced ignition systems and engine control. Our automotive design win momentum continued in the first quarter of 2015. We continue to add to our design win pipeline for our intelligent power modules from our SSG business. Our latest win is with a major Japanese OEM for an electric radiator fan. Additionally, we were selected by a major European Tier-1 customer to supply our NCV7520 pre-driver, medium voltage MOSFETs and a high-speed CAN for engine management system. In our continuing effort to align ourselves with key global automotive OEMs, we achieved a milestone in North America by being selected by a leading OEM to supply a custom LIN relay driver for a broad range of vehicles. Revenues for the second quarter in the automotive end-market are expected to be up quarter-over-quarter. The communications end-market, which includes both networking and wireless, represented approximately 16% of our revenue in the first quarter and was down approximately 9% quarter-over-quarter, primarily due to normal seasonality and ongoing inventory adjustment in the Chinese handset market. We continue to gain share with the global smartphone leaders and with the Chinese smartphone OEMs, and we expect to see revenue impact of our wins starting in the second quarter. Key drivers of our share gains include our auto-focus and optical image stabilization modules, battery protection FETs, battery chargers, ESD protection and power management ICs. Furthermore, we are winning designs for our RF tuning solutions as penetration of LTE accelerates in the Chinese market. As I indicated earlier, interest in our wireless charging solutions remains strong and we remain engaged with key players in the mobile device ecosystem with wins on new generations of reference platforms. Revenues for the second quarter in the communications end-market are expected to be up quarter-over-quarter. The consumer end-market represented approximately 14% of our revenue in the first quarter, and was down approximately 6% quarter-over-quarter. We continue to increase our penetration in the Chinese white goods market with our intelligent power modules. A key customer in China began production of appliance incorporating our 3-Amp and 20-Amp intelligent power modules. We saw a strong demand for our image sensor solutions from action sports camera customers. Furthermore, demand for our 1080p image sensor for home monitoring applications and B2B conferencing was also a key driver of consumer revenue. Demand from handheld gaming applications was weak due to normal seasonality. We expect to see strong acceleration in demand from action sports camera applications for the remainder of the year. Revenue for the second quarter for our consumer segment is expected to be up slightly quarter-over-quarter. The industrial end-market, which includes military, aerospace and medical, represented approximately 24% of our revenue in the first quarter and was up approximately 2% quarter-over-quarter. Sales were driven on several fronts for this segment including security, scanners, industrial motors, circuit breaking, medical imaging and hearing health. A program transition related to legacy CCD customer negatively impacted our industrial revenue, but this transition was expected and built into our guidance for the quarter. We continue to see strong demand from our industrial customer base. Production ramp of our new design wins in the industrial motor drive space is driving growth for our intelligent power modules. Robust growth in the security market generated strong demand for our image sensing solutions during the quarter. Specifically, we had strong traction with our 1/3-inch, 720p sensor at leading security OEMs in China. Furthermore, China is beginning a large transition to 1080p security cameras, which will utilize our 2 megapixel, 1/3-inch and 3 megapixel 1/3-inch sensors. We are seeing good penetration globally in the top tier machine vision camera manufacturers for the Python 1.3 megapixel, 5 megapixel and 25 megapixel devices. The demand from commercial and residential building segments continues to improve and we saw strong sales for our circuit breaking ASIC. In the medical market, we saw strong growth from our imaging and hearing aid customers. Revenue for the second quarter for our industrial segment is expected to be up quarter-over-quarter. The computing end-market represented approximately 12% of our revenue in the first quarter, and was up approximately 3% compared to the fourth quarter. We believe we are beginning to see the first signs of expected share gains in computing. It appears that customer have begun to shift their computing business to us well ahead of a publicized exit of a major competitor in the computing market. We expect our share gains in the computing market to accelerate in the second half of the year with the launch of Intel’s Skylake platform. Not only should we benefit from share gains on the Skylake platform, but we should also have significantly higher dollar content on the Skylake platform. Revenue for the second quarter for our computing segment is expected to be flat quarter-over-quarter. Now, I’d like to turn it back over to Bernard for other comments and our other forward-looking guidance. Bernard?

[Bernard Gutmann:]

Thank you, Keith. Now for second quarter of 2015 outlook. Based upon product booking trends, backlog levels and estimated turns levels, we anticipate that total ON Semiconductor revenues will be approximately 876 million to 916 million in the second quarter of 2015. Backlog levels for the second quarter of 2015 represent approximately 80% to 85% of our anticipated second quarter 2015 revenues. Our second quarter revenue is being negatively impacted by approximately 3 million due to the strength of U.S. dollar relative to European and Asian currencies. However, the impact to our bottom line from foreign exchange volatility is neutral, as we have a natural hedge in place due to a significant cost base in Europe and Asia. We expect inventory at the distributors to stay flat quarter-over-quarter on a dollar basis. We expect total capital expenditures of approximately 65 million to 75 million in the second quarter of 2015. For the second quarter of 2015, we expect GAAP and non-GAAP gross margin of approximately 34% to 36%. We expect our total GAAP operating expenses of approximately 233 million to 245 million. Our GAAP operating expenses include the amortization of intangibles, restructuring, asset impairments and other charges, which are expected to be approximately 35 million to 37 million. We expect total non-GAAP operating expenses of approximately 198 million to 208 million. We anticipate GAAP net interest expense and other expenses will be approximately 9 million to 11 million for the second quarter of 2015, which includes non-cash interest expense of approximately 2 million. We anticipate our non-GAAP net interest expense and other expenses will be approximately 7million to 9 million. GAAP taxes are expected to be approximately 8 million to 11 million and cash taxes are expected to be approximately 5 million to 7 million. We also expect share-based compensation of approximately 13 million to 15 million in the second quarter of 2015, of which approximately 2 million is expected to be in cost of goods sold, and the remaining amount is expected to be in operating expenses. This expense is included in our non-GAAP financial measures. Our diluted share count for the second quarter of 2015 is expected to be approximately 435 million shares, based on the current stock price. Further details on share counts and earnings per share calculations are provided regularly in our quarterly and annual reports on Form 10-Q and Form 10-K. With that, I would like to start the Q&A session. Thank you. Jonathan, please open up the line for questions.

[Operator:]

[Operator Instructions]. Your first question comes from Ross Seymore with Deutsche Bank. Please go ahead.

[Matt Diamond:]

Good morning, guys. This is actually Matt Diamond calling in on Ross’ behalf. Great results here. The question I have is you decided that there’s – you didn’t see any bookings volatility that your peers have seen. I guess what’s the reason behind that? And are you worried that you’ve yet to see it?

[Keith D. Jackson:]

Yes, obviously we don’t know what we don’t know, but our bookings continue to be strong, so we’ve seen no indication at all of any kind of perturbation. So I guess I don’t know how to answer that one.

[Matt Diamond:]

Okay. And it was mentioned that the bookings strength has given you some increased confidence for the second half of the year. Could you shed a little more light on that, maybe with some end market detail or qualifying it somehow?

[Keith D. Jackson:]

We’re certainly seeing more backlog than is normal for us to place in the third and the fourth quarter. It is driven primarily at this time by the smartphone marketplace, computing marketplace and automotive marketplace. And in all those cases, we’ve got some great new design wins, which are ramping in the second half and those orders are in place now. So those three markets at least look very strong as we go into the second half at this point.

[Matt Diamond:]

Okay, great. Thanks very much.

[Operator:]

Your next question comes from John Pitzer with Credit Suisse. Please go ahead.

[John Pitzer:]

Good morning, guys. Congratulations on the good results. Thanks for letting me ask the question. Keith, I was wondering if you could spend a little bit of time just talking about the competitive landscape for Aptina. I mean clearly the image sensor marketing in auto ADAS is an area of pretty strong strength, but we are getting some signals of sort of industry capacity going up on the image sensor front. How do we think about that relative to the competitive dynamics? And can you talk a little bit about sort of the capacity needs that you have for your own imaging sensor business? Thanks.

[Keith D. Jackson:]

Sure. Well, there are two other very strong players both of which have very significant handset exposure and the capacity on the handset side remains I think a key area for expansion. As you look at the automotive, it’s more than just the ability to produce pixels. You have to have the entire package for the automotive wins, particularly in safety critical applications. And we think we continue to have an edge there with our many years of experience. Relative to capacity, we have been working to increase capacities both internally and with our external partners, and are very comfortable we can see very strong growth and share gains supported for our image sensors this year.

[John Pitzer:]

That’s helpful. Maybe as my follow up for Bernard. Bernard, I’m wondering if you could just walk through the bridge from the current gross margin of about 35% to sort of the target margins, sort of how much revenue growth you need to see to get to that 40% target? How much of it is mix? How much of it is utilization versus other things? Thank you.

[Bernard Gutmann:]

So if I recall from what we presented in the Analyst Day, the number is – our model is for 4 billion, about 250 basis points of that improvement from the existing, approximately 35% to the total is volume-related. Approximately 160 bps is mix and about another 120 was related to what we’ll call manufacturing efficiencies that have continued improvements in the cost structure within our manufacturing footprint. And finally, the last piece was about 60 bps associated with CFA and probe in-sourcing for the existing Aptina acquisition.

[John Pitzer:]

That’s helpful. Thanks, guys.

[Keith D. Jackson:]

You’re welcome.

[Operator:]

Your next question comes from Vivek Arya with Bank of America Merrill Lynch. Please go ahead.

[Vivek Arya:]

Thank you for taking my question and very good results and execution here in Q1. I’m wondering, Keith – I know you’re not seeing much direct impact from all the FX volatility but do you think there is any indirect impact, for example, your distributors behaving any differently or any demand shift from emerging market customers, et cetera?

[Keith D. Jackson:]

We monitor all of that very closely and really have not seen any changes in the environment or the pricing behavior based on the home currency for our competitors. And we haven’t really seen any order pattern shifts in the emerging countries either. Again, most of our industry uses dollar-denominated contracting and so it’s just not something that is able to gather any hold, I don’t think, on the marketplace.

[Vivek Arya:]

Got it. And as my follow up, could you remind us how much exposure you have to the China smartphone OEMs across which kind of products where it makes a difference 3G versus 4G? And how is the overall demand environment shaping up in Q2?

[Keith D. Jackson:]

So most of our exposure is in smartphones both 3G and 4G. Content wise we have more in 4G than we do in 3G. Right now that backlog, as I mentioned in my commentary, we’re expecting to see up here in the second quarter. We’re starting to see some recovery there in China and acceleration in the 4G model. So that’s working quite good for us and we’re very excited as I mentioned earlier about the second half where we’re seeing advanced orders come in quite strongly.

[Vivek Arya:]

All right. And one last quick one. Could you remind us also how much – it was interesting to see your progress in the computing and the PC market because of share gains. Everyone else exposed to PCs is suffering or was suffering in Q1. Could you remind us how much content you have now and how much can it get during the back half as you start to gain more content with Skylake?

[Keith D. Jackson:]

Yes, so depending on the platform in notebooks, we have somewhere between $7 and $12 of content and that goes up by, I think, almost $3 in the Skylake platform when that transitions in.

[Vivek Arya:]

Okay. Thank you.

[Operator:]

Your next question comes from Chris Caso with Susquehanna Financial. Please go ahead.

[Christopher Caso:]

Yes, thank you. Good morning. Just a question on your commentary relative to what we’ve seen from some others, and clearly it doesn’t look like that you’re seeing some of the weakness that others have been talking about. Would you characterize that as perhaps within the end markets? You’re seeing similar commentary from your customers and I’m sure you’ve heard what your competitors have been saying. And is it that ON has specific programs to specific platforms, which are helping you to offset that or is it that you’re just not seeing what the competitors are talking about right now?

[Keith D. Jackson:]

Yes, that question from earlier, the same thing. We clearly have had some platform share gains with our new designs. And so as those start to ramp, generic weakness could be masked. But there’s just no way for us to separate that out based on history. But again from looking at our customer base we have, they seem to be performing fairly well. I will see handset wise, it’s very key which customers you have because the performance between the various customers in that marketplace varies widely.

[Christopher Caso:]

Okay. Thanks. As a follow up, a question about wireless charging and we’re a little closer into the second half right now. I know you got some visibility on some of the Qualcomm reference designs. Can you talk a little bit about more of where we would likely see some revenue coming in from wireless charging designs, and about the timing of when we start to see some of that revenue come in and when the ramp would occur?

[Keith D. Jackson:]

The first models incorporating wireless charging that we’ve seen right now will begin ramping in Q3, and then more models will be coming on each quarter after that.

[Christopher Caso:]

Great. Thank you.

[Operator:]

Your next question comes from Craig Ellis with B. Riley. Please go ahead.

[Craig Ellis:]

Thanks for taking the question and congratulations on the quarterly execution guys. Just wanted to follow up on the prepared comments regarding the Aptina integration. It sounds like that’s going well. But what are the gives and takes as we think about the operating expense dynamics beyond the second quarter given that we’re coming in on the conclusion of integration activities there?

[Bernard Gutmann:]

So in the back half of the year, we expect to see some increase in OpEx associated with our normal inflationary/merit increases as well as some potential for incremental stock-based comp depending on how strong the back half of the year, offset partially by some of the Aptina and other synergies. But in general, it’s slightly up.

[Craig Ellis:]

Okay. And then looking at the growth in the business, it’s coming through I think as the company outlined at Analyst Day. Keith, going back to the capacity side of the equation and the Fujitsu joint venture that the company signed last year, when do you see that starting to contribute to output? And how should we think about the cost structure and the margin performance of parts that are produced under that capacity?

[Keith D. Jackson:]

So that – actually we’ve started manufacturing ramps already here in the second quarter with our partnership there and we’re quite pleased with the progress. That was really all about qualifying our processes in that factory and those are ahead of schedule. From a cost perspective, that cost there is very competitive to slightly better than our Russian factory, and so we’re very pleased on the cost front as well. So what it really gives us is a large runway for growth in 200-millimeter wafer capacity.

[Craig Ellis:]

Thanks, guys.

[Operator:]

Your next question comes from Chris Rolland with FBR Capital Markets. Please go ahead.

[Joseph Gallo:]

Hi, guys. Thanks for the question. This is Joe on for Chris. I was hoping to follow up on the Aptina front. I was just curious what the mix was between outsourced capacity and internal capacity, what do you guys see the utilizations internally are and then with the increased competition there, do you see any impact on pricing?

[Keith D. Jackson:]

Okay, I’ll take those kind of in order. The wafer fab portion today is 100% outsourced. And what we in-source is the probe test and color filter array manufacturing steps. And so for the remainder of this year that is likely mix that will go forward. Our internal capacities are again in the low 80s for that business, and we are continuing to ramp capacity. So, not a lot to talk about on the mix side. From a competitive side, it’s a very competitive market, it has been. We have focused on the highest quality imagers and therefore mainly our design wins based on just outdistancing the competition on technology. And so from that perspective, we think we will be able to increase margins as we go through the year.

[Christopher Rolland:]

Great. That was extremely helpful. And I guess as my follow up, on the communication side, perhaps you can discuss the industry dynamics there, where inventory levels are and then when do you see that segment picking back up?

[Keith D. Jackson:]

Yes, we saw continued inventory burn off in Q1 from the China handset market. We believe that that’s mostly behind us because the orders picked up strongly for the second quarter and are being laid in even stronger for the third quarter. So, from an inventory perspective, I think we left March in a very good situation and what we’re seeing now is the benefits of that for the rest of the year.

[Christopher Rolland:]

Thanks, guys. Congrats on the strong results.

[Operator:]

Your next question comes from Ian Ing with MKM Partners. Please go ahead.

[Ian Ing:]

Yes. I wanted to share my congratulations in a difficult environment. So, first question in wireless charging, could you rank order some of the emerging market opportunities outside of smartphones, whether it’s consumer, PCs or automotive? It looks like Skylake will support wireless charging but I’m assuming that’s more of an older standard that you won’t be involved in?

[Keith D. Jackson:]

Correct. We believe that the computing platforms will change over in 2016 to the newer standards and so we don’t see anything this year from a computing side. We are seeing big pull, as you said, from the wireless first. Following that should be computing in early '16; automotive probably by the end of '16 and a variety of consumer and wearables smattered continuously from now on. So we’re seeing various levels of uptick but all of it really I think is going to be a huge 2016 story.

[Ian Ing:]

Great. Thanks for that. And then my follow up for image sensors, could you talk about the implications of OmniVision getting acquired by a China entity, would that be a positive or a negative? Would that make the China business more competitive, perhaps favoring a local supplier?

[Keith D. Jackson:]

I think over time there can be some influence on the market from a favored China supplier. I think in the short term, there’s going to be lots of confusion and changing; some announced intension to change of manufacturing, et cetera. So we’re looking forward to some short-term opportunities. And then we’re just going to keep driving on the technology side so that our products basically will be favored and the local favoritism won’t matter.

[Ian Ing:]

Great. Thanks, Keith.

[Operator:]

Your next question comes from Steve Smigie with Raymond James. Please go ahead.

[Steve Smigie:]

Great. Thanks a lot and I’ll add my congratulations on the nice numbers and guide. I was just curious, as you ramp the Fujitsu capacity, are you viewing that more as a competitive advantage or is it just that’s where the industry is going, so you got to be there. And just a little context around that, particularly as you got a number of 6-inch wafers going to 8-inch, so if you just tie in the relative shift from 6 to 8? Thanks.

[Keith D. Jackson:]

Okay. Ian’s last question there. I guess the answer is in the analog space in which we perform, the process is really the key differentiator in our product performance. Wafer dimensions can make a difference but basically what we’re doing is we’re taking existing 200-millimeter products and moving them to a new 200-millimeter factory. So it gives us expansion capacity but doesn’t directly change the mix of 6 to 8-inch. The reality is we’re just growing the 8-inch very quickly. 6-inch is staying full but not growing as fast. The net of that is in Bernard’s earlier comments about the mix shift over time is growing more favorable for us but it’s not because of the climb in the older technologies.

[Steve Smigie:]

Okay, that’s very helpful. Thanks. And then just on compute, do you have some sense at this point how much of the share that you’re competitors leaving behind you are going to be able to capture?

[Keith D. Jackson:]

Yes, there’s roughly 30% or so that’s being vacated in the Skylake.

[Steve Smigie:]

And then my question is, do you know how much of that 30% you think you’ll be able to get?

[Keith D. Jackson:]

We are expecting to pick up most of it. I can’t give you exact numbers, but from a design win perspective, we look like we have the opportunity to be over 50% share in that market.

[Steve Smigie:]

Okay, great. Thanks and congrats again.

[Operator:]

Your next question comes from Kevin Cassidy with Stifel. Please go ahead.

[Kevin Cassidy:]

Yes, thanks for taking the question. You had mentioned that average selling prices were better than seasonal after you exclude the FX effect. And even though this was a contract period or starting of a new contract, can you say what the dynamics are there? Why was it a better pricing environment?

[Keith D. Jackson:]

I think it’s a very stable market. We don’t have any major changes from a volume perspective in the industry, and it moves slightly down in the first quarter as it normally does. And you don’t have major amounts of capacity coming on. The net of that is you don’t have suppliers that feel overly anxious about keeping the factories full. And that just gives us a very stable environment.

[Kevin Cassidy:]

Okay, great. And the contracts for this year, the decline for the year, is it better than expected or better than seasonal?

[Keith D. Jackson:]

I think it’s better than expected, better than a normal year, yes.

[Kevin Cassidy:]

Okay. If I can ask one other question about security cameras. You had mentioned that as an area of strength. Can you say – were those commercial or were they consumer cameras?

[Keith D. Jackson:]

The bulk of them are commercial. We’re also in the consumer side, but the bulk of the sales were in the commercial side.

[Kevin Cassidy:]

Okay, great. Thanks.

[Operator:]

Your next question comes from Harlan Sur with JPMorgan. Please go ahead.

[Harlan Sur:]

Hi. Thanks. Good morning. And solid job on the quarterly execution. On SSG, you delivered non-GAAP EPS accretion I believe at 133 million in rev, so nice job on the continued expense discipline there. Maybe you can just tell us directionally how that segment will trend in Q2? And at Analyst Day, you talked about traction and expansion at SSG into wireless, automotive and industrial. What are some of the near-term drivers within these verticals for SSG?

[Keith D. Jackson:]

Okay. So SSG should be up in the second quarter, continued margin expansion there. From a vertical market perspective, clearly we’ve had the most gains in the smartphone arena. Wins at the high end of the camera side have been quite strong. I would follow that with the industrial white goods piece. That market will continue to gain share in and that’s near term. And then 2016 is really going to be the story on the automotive side. Many, many wins so far this year and late last year, but it takes a little over a year to get those into production.

[Harlan Sur:]

Great, thanks for that. And then how do the demand trends in the China white goods market look? It seems like you were looking for growth here in Q2, if you could just confirm that. And how much of that is seasonal versus just great product traction with some of your IPM solutions?

[Keith D. Jackson:]

Yes, normally the first half of the year is stronger seasonally. We are actually seeing some inventory in the China white good marketplace that has slowed some of what we’d call normal pickup in Q2. So we’re actually looking for something that’s fairly flat in Q2 on the white goods side, because of additional inventory there in China.

[Harlan Sur:]

Great. Thank you.

[Operator:]

Your next question comes from Chris Danely with Citigroup. Please go ahead.

[Shaon Baqui:]

Good morning, guys. This is Shaon Baqui calling in for Chris. Great job on the quarter. So I want to circle back on the industrial business. It looks like a couple of your competitors talked about softness there. I was wondering if you guys could give us a little color on what you’re seeing out there in terms of industrial demand?

[Keith D. Jackson:]

Yes, and of course everybody’s industrial is a little different, I’ll just remind you of that. In our case, we have medical, Mil-Aero and the traditional building related industrial all in the same category. We actually saw very strong performance on the medical side with new products picking up in the imaging, medical systems and in hearing aids. We saw kind of flatness on the military side. And then on the building-related piece, we did see some big pickups mostly from new product wins and new generation of technology going into the new buildings.

[Shaon Baqui:]

Okay, that’s helpful. And maybe a more general question. Can you guys kind of rank your end markets in terms of strength for Q2, and how do you expect that to trend – I mean how does that look the rest of the year? Thanks.

[Keith D. Jackson:]

Yes, we try to give you some hints in our guidance. I think the handsets will be up strongest and then you follow that with automotive and industrial, consumer and computing and in that order.

[Shaon Baqui:]

Great. Thanks, again, guys.

[Operator:]

Your next question comes from Betsy Van Hees with Wedbush Securities. Please go ahead.

[Betsy Van Hees:]

Thanks, and let me echo my congratulations as well on the quarter and the guidance. You mentioned the strength that you’re seeing in terms of the bookings that are going beyond the current quarter are smartphone, computing and automotive. It sounds like you’re seeing better that seasonality at this point and I was hoping you could remind us what typical seasonality is for you in the September quarter? Thank you.

[Keith D. Jackson:]

Yes, that’s been changing over the last few years both I think as our mixes change, plus we’re seeing the markets in the last few years having more muted second half than we used to see three or four years ago. So at this stage, generally speaking, the third quarter has a range somewhere between 4% and 8% up on a normal year, and we’re certainly seeing something that looks at least normal for us.

[Betsy Van Hees:]

Thanks for that, Keith, I appreciate that. And then Harlan mentioned about the SSG business and it was down. Does it seem a little bit more than what you were expecting? And you’re going have it grow this quarter. Are we going to see this business grow year-over-year or are we going to look for another decline and then 2016 will be the year of revenue growth for this business?

[Keith D. Jackson:]

You should see revenue growth this year but I will say that the yen is a big impact. That yen movement from a revenue top line side has been a big drag on this. Those numbers going from roughly 80 a little over a year ago to 120 now makes the top line more challenging. On the other hand, with our cost structure there, the bottom line continues to be as you saw quite accretive despite that top line pressure.

[Betsy Van Hees:]

Great. Thanks so much. And once again, congratulations on the quarter and the guide.

[Keith D. Jackson:]

Thank you.

[Operator:]

Your next question comes from Craig Hettenbach with Morgan Stanley. Please go ahead.

[Craig Hettenbach:]

Yes. Thanks. Just following up on some the commentary, the strength you’re seeing particularly in some of the verticals of wireless autos, any thoughts on just the broad-based distribution channel and visibility there? I know you commented inventory is going to be flat, but just kind of from an order perspective and linearity.

[Keith D. Jackson:]

Yes, our data is indicating to us that we actually grew faster in our distribution channel than our distributors did based on their recent releases. So it looks like we’re gaining a little bit of share. That helped us to decline some of the inventories in the first quarter in distribution. And so as we look forward, what we’re looking at is trying to match the demand not grow or shrink inventory at this stage, because we think it’s going to definitely be needed for growth in Q3. But that’s really the way we’re managing it. And in general, again, we’re seeing a pickup in Q2 from all of the distributors and that’s consistent with their public comments.

[Craig Hettenbach:]

Got it. And as a follow up, any update on SSG in terms of just growth outside of Japan and traction you have from a design perspective?

[Keith D. Jackson:]

Well, that’s clearly where all of the momentum has been offsetting the lackluster economy there in Japan. And as I mentioned, the real key designs in the near term is in the handsets and that’s all outside Japan. The white goods, which is a mixture of inside and outside, but more in China than it is in Japan. And then lastly automotive, which will be Japan, North America and Europe based as you get into 2016.

[Bernard Gutmann:]

So right now if you look at Japan, it’s down in the low 30s and it continues going down as a percent of total SSG revenue.

[Craig Hettenbach:]

Got it. Thanks for all that.

[Operator:]

Your next question comes from Gabriela Borges with Goldman Sachs. Please go ahead.

[Gabriela Borges:]

Great. Thanks so much for letting me ask a question and congratulations on the strong results. I want to follow up on some of the earlier questions on the industrial end market. If we separate out the strength in medical for a moment, maybe any color that you could give us on geographies in your core industrial customer base, any changes in demand between geographies? Thanks so much.

[Keith D. Jackson:]

I don’t know that there was a distinct pattern of strength there for us. The industrial is strongest in Europe and North America and in China. China was pretty lackluster but Europe and North America picked up nicely for us.

[Gabriela Borges:]

That’s very helpful. Thank you. And as a follow up, if I may, just any color in near term on puts and takes to gross margin. The step-up that you’re seeing in 2Q, is that primarily utilization or are there any mix shift benefits? And I think the continued progress on the Aptina cost structure as well. Thanks.

[Bernard Gutmann:]

It is the traditional three areas but for the biggest part, it is the revenue uptick that falls through at about a 50% fall through. We should see a little bit of additional benefits on the CFA in-sourcing and a little bit of gradual shift in mix as we continue growing automotive, industrial and smartphones at a faster pace than the other two.

[Gabriela Borges:]

Great. Thanks, again.

[Operator:]

There are no further questions at this time. I will now turn the call back over to Mr. Parag Agarwal.

[Parag Agarwal:]

Thank you for joining the call today. We look forward to see you at various conferences during the quarter. Goodbye.

[Operator:]

Ladies and gentlemen, this concludes today’s conference call. You may now disconnect.