ON Semiconductor Corporation
Q3 2015 Earnings Call Transcript

Published: 1 Nov 2015

[Operator:]

Good afternoon. My name is Connor and I will be your conference operator today. At this time, I would like to welcome everyone to the ON Semiconductor Third Quarter 2015 Earnings Conference Call. [Operator Instructions] Parag Agarwal, Vice President of Investor Relations, you make begin your conference.

[Parag Agarwal:]

Thank you, Connor. Good evening and thank you for joining ON Semiconductor Corporation’s third quarter 2015 results conference call. I am joined today by Keith Jackson, our President and CEO, and Bernard Gutmann, our CFO. This call is being webcast on the Investor section of our website at www.onsemi.com. A replay will be available on our website 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 third quarter of 2015. The script for today’s call is posted on our website. Additional information related to our end markets, business segments, geographies, channels and share count is also posted on our website. Our earnings release and this presentation include certain non-GAAP financial measures. Reconciliation of these non-GAAP financial measures to the most directly comparable measures under GAAP, are in our release, which is posted separately on our website in the Investors section. During the course of this conference call, we will make projections or other forward-looking statements regarding future events or future financial performance of the company. The words believe, estimate, project, anticipate, intend, may, expect, will, plan, should or similar expressions are intended to identify forward-looking statements. We wish to caution that such statements are subject to risks and uncertainties that could cause actual results to differ materially from projections. Important factors which can affect our business, including factors that could cause our actual results to differ materially from our forward-looking statements are described in our Form 10-Ks, Form 10-Qs and other filings with the Securities and Exchange Commission. Additional factors are described in our earnings release for the third quarter of 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 fourth quarter, we will be attending the Credit Suisse Technology Conference on December 1 in Scottsdale, Arizona. Now, let me turn it over to Bernard Gutmann who will provide an overview of the third quarter 2015 results. Bernard?

[Bernard Gutmann:]

Thank you, Parag and thank you everyone for joining us today. Let me start by providing you an update on overall business results. As many of our peers in the semiconductors industry have noted, the global macroeconomic environment remains challenging. Despite a rather challenging macroeconomic environment, we were able to deliver relatively strong growth driven by share gains and ramp on our design wins across multiple end markets. Although our revenue grew at a reasonable pace in the third quarter being a broad-based analog company exposed to multiple end markets and geographies, we are not totally immune from the impact of prevailing economic challenges. We saw weakness in the communications end market and broad-based weakness in China. In response to soft macroeconomic conditions, we have taken a number of measures to control cost and expenses. These measures include permanent actions such as targeted headcount reductions and temporary measures such as shutdown of facilities during holidays and elimination of non-critical spending across the company. The impact of these cost reduction measures is reflective in our guidance for the fourth quarter. We are fully prepared to take further actions to reduce our cost and expenses if the macroeconomic conditions continue to be challenging. Now, let me provide you an update of our third quarter 2015 results. ON semiconductor today announced that total revenue for the third quarter of 2015 was approximately $904 million, an increase of approximately 3% as compared to the second quarter of 2015. GAAP net income for the third quarter was $0.11 per diluted share. Excluding the impact of amortization of intangibles and restructuring and other special items, non-GAAP net income for the third quarter was $0.23 per diluted share. GAAP and non-GAAP gross margin for the third quarter were 34.1% as compared to 34.6% in the second quarter of 2015. The 50 basis points of sequential decline was largely driven by lower utilization in the third quarter as compared to the second quarter, unfavorable product mix and ASP pressure in certain markets. We experienced stronger than expected growth in computing and consumer, whereas growth in automotive and communications lagged expectations. Keith will provide additional details on the end markets in his prepared remarks. Average selling prices for the third quarter decreased by approximately 2% as compared to the second quarter of 2015. Despite the sequential revenue growth of 3% in the third quarter utilization of our factories was lower as compared to the second quarter. We reduced utilization of our factories to manage internal and distribution channel inventory levels. GAAP operating margin for the third quarter of 2015 was approximately 7.7%, flat quarter-over-quarter. Our non-GAAP operating margin for the third quarter was 11.8%, down approximately 50 basis points as compared to the second quarter of 2015 primarily due to lower gross margin in the third quarter. GAAP operating expenses for the third quarter were approximately $239 million as compared to approximately $237 million for the second quarter of 2015. Non-GAAP operating expenses for the third quarter were approximately $202 million, up approximately $6 million as compared to the second quarter of 2015. As expected, annual merit increases which become effective in the third quarter were the primary contributor for the higher operating expenses in the third quarter as compared to the second quarter. We exited the third quarter of 2015 with cash, cash equivalents and short-term investments of approximately $558 million, a decrease of approximately $20 million from the second quarter. Operating cash flow for the third quarter was approximately $128 million as compared to approximately $102 million in the second quarter. We spent approximately $65 million of cash for the purchase of capital equipment. During the third quarter, we used approximately $30 million for the repayment of long-term debt in capital leases and we used approximately $100 million to repurchase approximately 9.4 million shares of our common stock at an average price of $10.64. At the end of the third quarter, approximately $640 million remains of the total authorized amount of $1 billion under the current stock repurchase program which was announced on December 1, 2014. We remain fully committed to our $1 billion stock repurchase program. At the current pace, we are tracking significantly ahead of ratable repurchases in our stock repurchase program. We believe that at current level the stock price does not reflect the potential of our company and use of our excess cash to repurchase our stock is a compelling investment. At the end of the third quarter of 2015, ON Semiconductor days of inventory on hand were 116 days, down approximately 2 days from the prior quarter. In the third quarter of 2015, distribution inventory decreased by approximately $21 million quarter-over-quarter and distribution re-sales increased by approximately 1% quarter-over-quarter. In terms of days, distribution inventory declined to the lowest level in approximately the last year. For the third quarter of 2015, our lead times were approximately flat as compared to the second quarter. Our global factory utilization for the third quarter was down slightly as compared to the second quarter. As I had indicated earlier, our factory utilization was lower than expected as we reduced loadings to manage inventory levels. Now, let me provide you an update on performance by our business units. Starting with Image Sensor Group, revenue for our Image Sensor Group was approximately $189 million, up approximately 9% over the second quarter. The revenue for our Standard Products Group for the third quarter of 2015 was approximately $312 million, up approximately 1% quarter-over-quarter. Revenue for our Application Products Group was approximately $275 million, up approximately 5% over the second quarter. Revenue for the third quarter of 2015 for the System Solutions Group was approximately $128 million as compared to $136 million in the second quarter. A steep decline in appliances related revenue in China and broad-based weakness in Japan contributed to weaker than expected revenue from our System Solutions Group. Now I would like to turn the call over to Keith Jackson for additional comments on the business environment. Keith?

[Keith Jackson:]

Thanks Bernard. Let me start with comment on the business trends in the third quarter. Bookings during the third quarter were stable and we did not see any significant variation in booking trends throughout the quarter. From a revenue perspective we saw weakness in Americas, Japan and China. Gains in the security market helped us offset much of the weakness in China. As Bernard indicated in his prepared remarks the global macroeconomic environment remains challenging, which we believe is leading to weaker than seasonal trends in our business. However, we are not seeing noticeable change in the underlying fundamentals of our business. Bookings thus far in the current quarter have been stable and current trends point to improving business conditions early next year. Although the current macroeconomic environment poses significant challenges to our business, we continue to outpace the industry in revenue growth as our design wins convert to revenue. Our strategy of focusing investments in automotive, industrial and smartphone markets is yielding strong results. And I believe that our momentum in these markets should accelerate in 2016 as we launch additional new products. As Bernard indicated in his prepared remarks, in response to a slowing demand environment we have taken a number of measures to manage our expenses. At this time we don’t see the need for a deep cut in our operating expenses, but if the macroeconomic environment continues to deteriorate we will act to realign our costs with revenue. Now I will provide some details of the progress in our various end markets. The automotive end market represented approximately 31% of our revenue in the third quarter and was approximately flat quarter-over-quarter, despite a weaker seasonality in the third quarter. Demand remained strong for our image sensor solutions driven by the increased adoption of rear view cameras and ADAS safety systems. Our LED driver business continues to show growth driven by increased usage across all vehicle segments. Additionally, we saw good results in our automotive related power management analog products business as switch mode power supplies continue to proliferate in light vehicles. Finally, our power MOSFET business continues to grow as we continue to expand our portfolio and package options. Our automotive related design win pipeline continues to grow at a rapid pace. During the third quarter we secured design wins for our VGA image sensor to support the 2018 United States mandate for rear view cameras. We also won design for a substantial sensor interface IC opportunity for powertrain applications in Europe. For body electronics we secured an important win at a key European automotive Tier 1 integrator for our smart FET products for relay replacements. Revenue for the fourth quarter in the automotive end market is expected to be flat quarter-over-quarter. The communications end market which includes both networking and wireless represented approximately 18% of our revenue in the third quarter and was up approximately 2% quarter-over-quarter driven by ramp of new programs during the third quarter. We continue to increase our presence with the key players in the smartphone market and so far this year we have posted robust year-over-year growth in revenue from a few strategically important smartphone customers. We continue to be on track with our wireless charging program and we expect to see initial revenue ramp starting in early 2016. Revenues for the fourth quarter in the communications end market are expected to be down quarter-over-quarter. The consumer end market represented approximately 15% of our revenue in the third quarter and was up approximately 7% quarter-over-quarter driven by seasonality and ramp of new programs for the action sports camera market. In the third quarter a leading customer in the action sports camera market launched three new cameras using our image sensors. Growth in the consumer was also driven build of video game consoles ahead of the holiday season. Appliance related consumer revenue declined sharply in the third quarter due to seasonality and excess channel inventory in China. Revenue for the fourth quarter for our consumer segment is expected to be down quarter-over-quarter due to normal seasonality. The industrial end market which includes military, aerospace and medical represented approximately 23% of our revenue in the third quarter and was approximately flat quarter-over-quarter. We saw broad based weakness in the industrial market. However, share gains in the security market helped us offset much of the weakness. We have seen a significant slowdown in demand from our large global industrial OEMs. We believe that a softening macroeconomic condition, especially in China, is the primary driver of slowdown in demand in the industrial end market. Residential construction remains a bright spot in the industrial market and we continue to grow our share in the residential circuit breaker market. In the security market sales of our image sensors grew by more than 20% quarter-over-quarter. We also saw strength in other industrial sub-segments such as our machine vision for our CMOS and CCD image sensors. We expanded the Python family of high performance global shutter sensors with the introduction of various members of the Python family raging in resolution from 10 megapixels to 25 megapixels. Revenue for the fourth quarter for our industrial segment is expected to be down quarter-over-quarter. The computing end market represented approximately 13% of our revenue in the third quarter and was up approximately 10% compared to the second quarter driven primarily by ramp in Intel’s Skylake platform. We believe that not only our content has increased in a significant manner on the Skylake platform, but we are also gaining share. We expect our market share gains and content increase to continue in 2016. Revenue for the fourth quarter in our computing segment is expected to be flat quarter-over-quarter. Now I would 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 fourth quarter 2015 outlook, based on product booking trends, backlog levels and estimated turns levels, we anticipate that whole ON Semiconductor revenues will be approximately $830 million to $870 million in the fourth quarter of 2015. Backlog levels for the fourth quarter of 2015 represent approximately 80% to 85% of our anticipated fourth quarter revenues. We expect inventory at distributors to decline quarter-over-quarter on a dollar basis. We expect total capital expenditure of approximately $55 million to $65 million in the fourth quarter of 2015. For the fourth quarter of 2015, we expect GAAP and non-GAAP gross margin of approximately 32.6% to 34.6%. We intend to reduce our factory utilization in the fourth quarter as compared to the third quarter to manage our internal and channel inventories. We expect total GAAP operating expenses of approximately $225 million to $237 million. Our GAAP operating expenses include the amortization of intangibles, restructuring, asset impairment and other charges which are expected to be approximately $37 million to $39 million. We expect total non-GAAP operating expenses of approximately $188 million to $198 million. The sequential decline of approximately $9 million is driven by our expense reduction measures. We anticipate GAAP net interest expense and other expenses will be approximately $13 million to $16 million in the fourth quarter of 2015, which includes non-cash interest expense of approximately $6 million. We anticipate our non-GAAP net interest expense and other expenses will be approximately $7 million to $10 million. GAAP taxes are expected to be approximately $2 million to $6 million and cash taxes are expected to be approximately $5 million to $8 million. We also expect share-based compensation of approximately $11 million to $13 million in the fourth 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 fourth quarter of 2015 is expected to be approximately 418 million shares based on the current stock price. Further details on share count and earnings per share calculations are provided regularly in our quarterly and annual reports on form 10-Q and form 10-K. With that I would like to start the Q&A session. Thank you. And Connor please open up the line for questions.

[Operator:]

[Operator Instructions] Your first question comes from the line of Ross Seymore with Deutsche Bank. Your line is open.

[Matt Diamond:]

Hi, gentlemen. This is actually Matt Diamond on Ross’ behalf. Thanks for letting me ask a question. It was said that you are going to take utilization down in the fourth quarter to manage channel inventory levels. I am curious, do you see that as a one quarter phenomenon or given the broad-based weakness that you and many of your peers are feeling, is this something that could carry over into the beginning of 2016 as well?

[Keith Jackson:]

I believe we are nearing the end of that. We have reduced our channel inventory and dollars every quarter this year. And we are now operating toward the leanest in that channel that we have with inventories. Remind you that we recognized revenue on a sell-through basis, and frankly, the distribution channel globally has been reducing their inventories, which does not impact our revenue. So, at this point, we see that happening again in the fourth quarter. But as I mentioned I think we are near the end of that cycle as we have reached the leanest points that we can still rationally service our customers.

[Bernard Gutmann:]

And to clarify, we have reduced factory utilization not only in the fourth quarter, but also in the third quarter as a result of that and in the second quarter.

[Matt Diamond:]

Duly noted. And the OpEx cuts, it was mentioned that some of them are going to be permanent. I am curious as to what extent, are they permanent and to what extent could they come back in 1Q if macro ends up being actually a little bit better than expected?

[Bernard Gutmann:]

So, it’s a mixture of probably half and half.

[Matt Diamond:]

Okay. And last question, there has been a lot of chatter about M&A recently. You have been involved in it heavily in the past, but at your Analyst Day, you committed to some internally focused goals much to the refreshment of shareholders. I am curious, have your views on the M&A changed at all in the current environment, if you could just comment on that I am sure that would be greatly appreciated?

[Keith Jackson:]

Yes. We remain committed to returning capital to shareholders. As Bernard mentioned in his remarks, we believe that we will continue strongly buying our stock back at prices we believe are under the long-term value. And any M&A would fit within that framework, so we plan on continuing that. We also mentioned in our conferences that we think tuck-in for technology gains is the best strategy for us. We still believe that. As the industry accelerates in some of its consolidation, we will have to take that into account to make sure we do protect the company, but our primary focus again is capital return to our shareholders.

[Matt Diamond:]

Excellent. Thanks very much.

[Operator:]

Your next question comes from the line of Vivek Arya with Bank of America Merrill Lynch. Your line is open.

[Vivek Arya:]

Thanks for taking my question. I am trying to get a better picture of trends from your prepared remarks. I think one place you mentioned that current trends point to improving trends, but when I look at the lower OpEx and the lower utilization it appears that you are still somewhat cautious and I know in general you tend to be conservative. So, what is your read of the macro environment? Is it just weak visibility? Are customers still feeling nervous? What is your general read of that demand environment?

[Keith Jackson:]

And my read of the demand environment is there is very slight growth globally. It’s not a contraction. The end markets are not growing nearly as much as they were in places like China, but they are not contracting dramatically. So, we think what we are seeing mostly is a supply chain correction. And so therefore, the cuts and changes we are doing reflect some near-term actions to protect profitability, but not an expectation of any significant change in market demand.

[Vivek Arya:]

Got it. Very helpful. And as a follow-up, you mentioned supply chain effects could you help us quantify what was sell-in versus sell-out trends during the quarter and how many weeks of inventory – distribution inventory do you have versus what is normal?

[Bernard Gutmann:]

So, our normal range has been somewhere around 11 weeks and we have been, as Keith mentioned earlier, decreasing inventory in the channel every quarter throughout this year. As we mentioned in the remarks that we have decreased inventories by $20 million and in terms of weeks, we are at the lowest point in the last year – under 10 weeks.

[Vivek Arya:]

Got it. Thank you.

[Operator:]

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

[John Pitzer:]

Yes, good afternoon guys. Thanks for letting me ask the questions. Keith, this might be a little bit on the nitpicking side, but in the prepared comments you talked about ASPs being down about 2% sequentially. And I can’t remember the quarter that they haven’t been sort of flat to down one. So, I am just kind of curious you talk about kind of pricing pressure picking up, can you elaborate there anymore how much of this was mix driven? Do you think this is going to continue? And how do I think about pricing going forward during the soft period?

[Keith Jackson:]

Yes. We normally see, John, pricing pressures increased when the market makes changes. And in this case, I think the third quarter slowdown and the supply chain and reduction by distribution puts some unexpected pressure on the competition and so they reacted with a little more pricing to try and offset that. So, I really don’t see that as a continued trend. I would be surprised to see that continue into the first quarter.

[John Pitzer:]

That’s helpful guys. Maybe as my follow-up, gross margins came in a little light in the September quarter. And I guess I am just trying to figure out if you could help me better understand the bridge from here to kind of your ‘17 target of 40% longer term. I am just trying to figure out how much of this is going to be mix dependent, how much of this is going to be just more efficiently using your fixed assets? Any help there would be appreciated.

[Bernard Gutmann:]

Yes. Obviously, the slowdown that we saw right now is putting – making the transition to the 40% more prolonged. We are – we based off that 40% on a $4 billion revenue and what we have seen right now going on this year with sub-seasonal growth has made the transition to that goal more challenging. Mix definitely is a substantial portion. We talked about that in the Analyst Day. It is a significant portion of the transition. And self help or better use of manufacturing assets is another one that will definitely contribute a lot, but we still need the revenue to get there. It’s a combination of all three.

[John Pitzer:]

And I can take a last quick one in – the compute guidance for Q4 to be kind of flat – little surprising to me given how early we are in the Skylake ramp. So, are there moving parts within that where older platforms are declining and Skylake continues to grow or help me understand the flat guidance in Q4?

[Keith Jackson:]

I think there is some opportunity for improvement there and it really all depends on the mix of units that the computing industry builds during Q4. So, we have taken a shot at what we think will be the conversion to Skylake rates in Q4, but I believe that we have certainly called that – certainly in a fashion that allows for some upside.

[John Pitzer:]

Thanks, guys.

[Operator:]

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

[Chris Caso:]

Yes, thank you. Good afternoon. Just first question on gross margins and maybe just looking a little bit in the shorter term, can you talk about the impact on gross margins from utilization versus mix and I guess ASP and how that changes into the fourth quarter? Obviously, it would seem that the utilization is kind of the easiest lever to move here and seeing how much benefit that would have going forward if that were to get better?

[Bernard Gutmann:]

Yes. So, with the complex network and product set that we have, it’s pretty difficult to completely isolate those. I would still characterize the Q3 and Q4 being driven largely by utilization and probably the second order by mix and ASPs.

[Chris Caso:]

Right. And just within the utilization, could you remind us – does that impact the gross margins in the same quarter, is there a quarter lag?

[Keith Jackson:]

It is typically in the same quarter although there is a little bit of a lag based on how we cycle through.

[Chris Caso:]

Okay. And within the communications market based on what you had talked about for the third quarter and the sequential decline in the fourth quarter, the seasonality there doesn’t seem to be quite that strong and obviously there is a lot of different dynamics with different OEMs going on there. Maybe you could just outline what you are seeing in that segment and why the seasonality isn’t quite as a strong as we have seen in the past?

[Keith Jackson:]

Yes. So, our third quarter – we were expecting much more growth in the handset business. What we did see definitely is a slowdown in China on the build rates and certain OEMs losing some share, which netted up to a modest growth in Q3. Q4 normally is not a growth sequentially and so we think it’s perhaps more normal seasonality in Q4 than not.

[Chris Caso:]

Great. Thank you.

[Operator:]

Your next question comes from the line of Christopher Rolland with FBR & Company. Your line is open.

[Christopher Rolland:]

Hi, guys. Thanks for the question. You guys mentioned you are on track with your wireless charging program and expect to see initial revenue ramp starting in early ‘16. So what kind of design activity are you guys seeing there, do you guys have a design beyond the Qualcomm reference design and what kind of guys are picking it up – are they Chinese guys or from other geographies?

[Keith Jackson:]

So the initial ramps are all with the Qualcomm reference platform and they are from Asia, not necessarily China the first ones, but the China handsets right behind that. For more of the transmit and pad side it will be more towards mid-year for us.

[Christopher Rolland:]

Okay, great. And then also when we look at your various end markets in 4Q, there were mostly downs there and not much more description, can you guys kind of force rank that for us to give us an idea of what might be worse than others?

[Keith Jackson:]

Okay. Let’s see here, typically I guess – I think we got it here. The consumer will probably be down the most followed by comms and then industrial and then auto and computing we said were flat.

[Christopher Rolland:]

Okay, great. Thank you so much guys.

[Operator:]

Your next question comes from the line of Craig Ellis with B. Riley. Your line is open.

[Craig Ellis:]

Thanks for taking the question. Keith, I just want to go back to your comments about seeing an improved business environment in the first quarter, can you go into some more detail in terms of the things that you are seeing that won that confidence?

[Keith Jackson:]

Yes. We – our booking and backlog going into the first quarter as compared to where we were this time last quarter and as compared to our normal seasonality are stronger than both of those things. So what we are seeing as I mentioned earlier, I believe a lot of this is inventory correction and we are seeing the signs that perhaps that is through and we are seeing the orders being placed for Q1 more in line with the market demand.

[Craig Ellis:]

Thanks for that. And the follow-up question is for Bernard. Bernard, there has been a very robust and I think well appreciated move with the buyback on the part of investors. Are we at a level where we can now more confidently look at averages over the last three quarters for what the company should be repurchasing as we look ahead or how do we think about the intensity with which you will execute the buyback program?

[Bernard Gutmann:]

The way I would answer it is obviously we will look at the market and the stock price. We are definitely way ahead of the ratable portion. I would view in general being ratable over the 4 years. And at the same time we do have to take into account the debt repayments we have through all time that might moderate or increase the timing during the specific quarters.

[Craig Ellis:]

Anything stand out on next year’s debt repayment schedule that we should be aware of?

[Bernard Gutmann:]

Well, we have a few things here and there. We have the convert of about $357 million due in December of ‘16.

[Craig Ellis:]

Thank you.

[Operator:]

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

[Steve Smigie:]

Great. Thanks a lot guys. And Keith, I will say thanks for making the comments about the potential impact here. You did a good job of calling it back in October. Just curious on some of the reference [ph] on the earlier gross margin question, I think at Analyst Day you had talked about potentially moving some manufacturing into some outsourced facilities in Japan and I think those were going to be lower cost. So I was just curious is that happening or does the environment – the software environment make that less likely and if it is happening, how does that sort of play out for benefits to gross margin in the coming year?

[Keith Jackson:]

Yes. It is happening and its happening at the fastest rate we are able and quite frankly ahead of our expectations. I think two primary benefits there. One, certainly will be a cost basis. But the other one is going to be capital reductions. So, the key for us Steve, is getting all of our processes and products qualified and that is a process that takes longer than we would like, but involves our customers. But we are seeing a good ramp there. And I would expect that ramp to continue through 2016, both relieving the pressure on capital expenditures and improving margins. Just to put it in perspective, though at this stage we are running much less than 5% of our total production there and next year we hope we can get that up in the high teens.

[Steve Smigie:]

Okay, great. Thanks. I just wanted to follow-up on the ADAS space and the cameras there. I think you got a pretty good tie in there to Mobileye. There is noise coming out of other players about trying to get into that processor market, do you work with other guys to try to be positioned as that ramps, your cameras work there or is it not a major issue?

[Keith Jackson:]

No, we do reference designs with all of the players in that marketplace.

[Steve Smigie:]

Okay, great. If I could sneak one last one, just in terms of the reduction in utilization to adjust for the inventory, you guys have talked about reducing inventory throughout the year and being at record lows, is the move to reduce inventory here about that you just want to keep taking it lower to be cautious or is there certain – there is sometimes different pieces of inventory move up and that’s why you have to work them down?

[Keith Jackson:]

I guess we believe in controlling the inventory. Anytime you let that get away from you the results are very bad. And I think you may have seen that with some other announcements. And so we are just a believer in keeping a tight lid on that. We also believe that as the market turns it gives us much more upside potential.

[Steve Smigie:]

Okay, great. Thank you.

[Operator:]

Your next question comes from the line of Vijay Rakesh with Mizuho. Your line is open.

[Vijay Rakesh:]

Hi guys. Thanks. Just on the overall distributor [ph] and channel inventory, I know you mentioned that it came down, how much did it come down percentage wise quarter-on-quarter and what’s your historical levels be?

[Bernard Gutmann:]

So it came down approximately 8%, 9%, and we are almost at the lowest level – we are close to the lowest level ever.

[Vijay Rakesh:]

Got it. And if you look at the two big markets automotive and industrial, where are channel inventories now in those segments and if you could give us some more color by geography, how it looks like in China and U.S., Europe? Thanks.

[Bernard Gutmann:]

The auto market, I think the inventories there are in very good control. I don’t see any excesses in that channel. In industrial there are some excesses in China. Just frankly, we mentioned some of those earlier on the call. So, maybe a quarter’s worth is something that I would keep in mind there. And then geographically the Americas and Europe generically tend to be in pretty good shape.

[Vijay Rakesh:]

Got it. And just last question here on the wireless side, I know you mentioned you have in the press release you said design wins in the handset side, obviously it’s been a little delayed, how do you see that ramp happening through next year? Thanks.

[Keith Jackson:]

Okay. So I think you are referring to wireless charging. And again we get our first handsets that ramp kind of February timeframe. And then more handsets will come on in the second quarter and third quarter, etcetera. So, it’s really kind of one major platform in through one and then more after that.

[Vijay Rakesh:]

Thanks a lot.

[Operator:]

Your next question comes from the line of Ian Ing with MKM Partners. Your line is open.

[Ian Ing:]

Yes. Thanks. First question for Bernard on the expense controls, so after the targeted headcount reductions how much of your cost structure is fixed cost and how much is potentially variable such as doing things like shutdowns, looking at variable compensation, etcetera?

[Bernard Gutmann:]

We think this is a difficult question. Definitely as you said there is a bonus and to some extent stock-based comp which we quote what those numbers are in the press release, it’s $11 million to $13 million that are purely – that can change with results. You can make any cost variable if you need to. So in tough conditions we will make sure that we make every cost variable except maybe depreciation. But right now we don’t feel we have the need to – based on what we see as the long-term demands.

[Ian Ing:]

Okay, great. And then automotive markets holding up, it looks like fairly nicely September as well as the December guidance. I mean, is this really all ADAS and camera product cycles or are you somehow having more favorable OEM exposure? Also, are you seeing any China weakness? You would think China would have some contingent to the European auto suppliers.

[Keith Jackson:]

Yes, sure. So, I will start with the last first. China growth has definitely slowed to a trickle. So, the growth in the auto market is much slower than it was a year ago. Our growth however is really not just the cameras. That certainly is the most spectacular piece of the growth. But our design wins have been growing throughout the car led by our lighting solutions – front headlights, tail lights, interior lighting, our safety solutions and our body power electronics.

[Operator:]

Your next question comes from the line of Rajvindra Gill with Needham & Company. Your line is open.

[Rajvindra Gill:]

Yes, thanks for taking my questions. The first question has to do with OpEx, as you kind of talked about that you are bringing OpEx down to reflect a different reality in terms of overall growth rates. And clearly, worldwide GDP growth rates are coming down and that’s having an effect of the industry. How should we think about OpEx growth going into 2016 or just your overall theory? Will that grow in line with revenue growth or do you want or always going to manage a process where revenue growth is going to outstrip OpEx growth?

[Bernard Gutmann:]

In general terms, revenue growth should outstrip by some factor the OpEx growth. At the same time, we need to balance and make sure that we are investing enough in our R&D. But in our target model, we have – we are basically accounting on about 100 basis points of leverage on the OpEx line over the next two years.

[Rajvindra Gill:]

I am sorry, what was that, 100 basis points?

[Bernard Gutmann:]

Yes.

[Rajvindra Gill:]

And my next question is really has to do with the overall economy. You mentioned that this is more of a supply chain adjustment versus a contraction in demand, but it seems like the industry has been in an inventory correction mode for the last three to four quarters ever since October of last year mainly driven because of China slowdown. So, under an environment where you have maybe low growth and the supply chain is rebalancing itself, I mean, how should we look at your business going forward? You guys have been able to grow over the market this year around 10%,11% year-over-year in ‘15, but going forward in the low growth environment, how should we look at the – your business and where there are opportunities where you are going to be able to grow above the market?

[Keith Jackson:]

Yes. We still believe we are going to be out-growing the markets and as Bernard mentioned we are not immune. So that the absolute rate may change a bit, but we still believe in the models we did show at Analyst Day and in the three focused markets you should be looking at mid to upper single-digit growth for those markets, which would give you a blend number pretty close to mid single-digit growth over the next several years. The inventory correction, again, I think the industry geared up for a China that was growing at 8%, 9%, 10% across the board in the industrial and electronic sectors. That clearly has stalled and it has taken several quarters to kind of get that in shape, but as I mentioned earlier, I think we are also pretty close to the end of that correction.

[Rajvindra Gill:]

Thank you.

[Operator:]

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

[Tristan Gerra:]

Hi, good afternoon. Could you remind us what the percentage of Aptina today is consumer driven and what type of market share Aptina has in automotive today and where could it get next year?

[Bernard Gutmann:]

Okay. So, the consumer portion of Aptina is really more on the ISG side.

[Keith Jackson:]

Right. I will just have to step in. We don’t track Aptina any longer. We do our total imaging sector, but we can give you those percentages.

[Tristan Gerra:]

Okay.

[Bernard Gutmann:]

It is probably 15% of the total – probably driven to some extent by the sports action camera more than anything else.

[Tristan Gerra:]

Okay. And what type of market share gain do you see and also if you could maybe give us an update on the gross margin progress that you expect as you reduce the consumer exposure in that business next year?

[Keith Jackson:]

So, I will cover the growth piece and then let Bernard talk about gross margins. We are expecting double-digit growth in imaging for the company next year mostly driven by automotive, which has our best margins. And we think that story stays intact. Some of the other markets like the security market, where we have been gaining a lot of market share there will probably grow but not grow as fast.

[Bernard Gutmann:]

And from the margins point of view, first I would like to say we are on track to deliver what we said when we purchased the company, which is an $0.08 accretion or more in 2016 and $0.10 in 2016. We have seen improvements in the gross margin from the level when we purchased them, which was in the middle to high 20s. We are still not at the desired place. It’s taking us a little bit longer as we have – as we are still selling some legacy parts into mobile that will continue for a while. But in general, we are very happy and excited about the performance of this acquisition giving us the, as Steve mentioned, double-digit growth as well as the nice bottom line accretion.

[Tristan Gerra:]

Great. Very useful. Thank you.

[Operator:]

Your next question comes from the line of Chris Danely with Citi. Your line is open.

[Chris Danely:]

Hey, thanks guys. On the OpEx cuts, is that going to be pretty evenly weighted between R&D and SG&A and then assuming we get back to some semblance of normal seasonality next year of revenues declined….

[Bernard Gutmann:]

In general terms, yes, it is pretty much across all the P&L geographies within OpEx.

[Chris Danely:]

And so if we assume that revenue is down a little bit in Q1 seasonally, would you be able to hold OpEx flat? Could it go down again? And then if we just plug in kind of normal seasonality for next year just in terms of the comps you get like flattish growth. So, in a flattish revenue growth environment, would you guys look to just keep OpEx flat, would you cut a little more, what would be the thought process be there?

[Bernard Gutmann:]

We would have to look at it in more detail, but in general terms, yes, we would be able to do that.

[Chris Danely:]

And then last question, Sanyo Semi was that still breakeven?

[Bernard Gutmann:]

It was virtually breakeven. It is close to $1 million.

[Chris Danely:]

Yes, thanks guys.

[Operator:]

Your next question comes from the line of Shawn Harrison with Longbow Research. Your line is open.

[Shawn Harrison:]

Hi, good afternoon. First question is just a clarification, if you could help me out with the auto exposure by geography, just China, U.S. and Europe?

[Keith Jackson:]

Just in order of sizing, Europe is our largest market followed by the U.S. and then Asia broadly, little larger market shares in Korea, but China is now in the 10% or so range.

[Shawn Harrison:]

Okay, very helpful. I believe earlier you cited that maybe $4 million of the OpEx cuts give or take were permanent, what percentage of maybe the cost coming out of COGS this quarter will be permanent versus we will come back as you roll into the new year?

[Bernard Gutmann:]

In general terms, we have the same effort to reduce COGS both across COGS and OpEx. Now, in the case of COGS, the reductions are more directly related with the factory activity. So, it is much more difficult to see how many are permanent versus temporary. I would say that in the case of COGS, it’s probably a little bit more on the variable on the temporary side than the OpEx.

[Shawn Harrison:]

Okay, thank you.

[Operator:]

Your next question comes from the line of Harlan Sur with JPMorgan. Your line is open.

[Harlan Sur:]

Hi, good afternoon. Thanks for taking my question. On your commentary on trends pointing to a potential improvement in the first half – first part of next year, Keith, you mentioned confidence levels being driven by slightly higher backlogs in Q1, better booking trends for the out-quarter. Is it more of a return to seasonal trends or is that being driven more by new product ramps? And I know it’s early, but any color on what segments or programs or end markets have a higher likelihood of driving that potential improvement early next year?

[Keith Jackson:]

Yes. I think there is a significant amount of our design positions. So, for example we expect the percentage of computers built on Skylake will continue to increase which gives us a non-seasonal growth – or much above seasonal growth opportunity. We mentioned some of the wireless wins that will continue to ramp in that first quarter. Seasonally we also see automotive and industrial usually pick up in the first quarter. We think that will continue to happen. But in general my comments were around seeing things that were potentially a little better than seasonal as the first quarter is starting to shape up.

[Harlan Sur:]

Great, thanks for that color. Then within your comms outlook for the fourth quarter you addressed the mobile device sub-segment, I am just wondering directionally, qualitatively what are you seeing in the wired, wireless and data center networking segments of the market? Thank you.

[Keith Jackson:]

So the datacenter and wired portion of our business is quite small. It’s less than 5% of our exposure. And we don’t see any significant trends worth talking about there. The handset piece, again normally we do see more builds in the third quarter than we see in the fourth quarter and that looks seasonal to us as opposed to continued inventory reduction.

[Harlan Sur:]

Great, thank you.

[Operator:]

Your next question comes from the line of Craig Hettenbach with Morgan Stanley. Your line is open.

[Craig Hettenbach:]

Yes, thanks. Keith, just picking up on the comment around the industry consolidation and protecting the company as it accelerates, just given standard products markets are pretty fragmented, it seems for analog, just curious in terms of things like scale you think about or technology pieces with those comments?

[Keith Jackson:]

Yes. I would say technology is something we watch heavily and our visibility to invest at appropriate rates, so we can grow above the market is something that’s quite important. If you see too many companies consolidate in that analog space, you fall behind in your ability to continue to invest at rates that will allow you to continue to be relevant. So, really that’s the thought process that we look at as we go forward.

[Craig Hettenbach:]

Got it. Thanks for that. And then just a question on the current environment, particularly within China, which has seen the reset, as you kind of went through late summer into early fall here, any comments specifically about China in terms of the level of bookings activities or how far along you think you are in terms of that inventory reset particularly within distribution?

[Keith Jackson:]

I think we are getting pretty close in most of the markets in China with the exception of the appliances and some of the industrial. Those two areas, I think will continue to contract supply chain wise in the fourth quarter and maybe early first quarter. But the rest of it seems to be getting pretty well-balanced. And so, I am not sure what else I can comment on.

[Craig Hettenbach:]

That helps. Thanks.

[Operator:]

[Operator Instructions] Your next question comes from the line of Gabriela Borges with Goldman Sachs. Your line is open.

[Gabriela Borges:]

Good afternoon. Thanks for taking my question. Maybe just a follow-up on the earlier questions on the image sensor group, maybe if you could talk a little bit about your differentiation in the automotive market and the industrial market and if you are seeing any change in the competitive environment as those end markets continue to grow secularly? Thank you.

[Keith Jackson:]

Yes. So, very different markets and different dynamics, in the auto sector it really is differentiated on our technologies and focus of how we have gone after the systems level performance in automobiles. And so we have got some great IP, some great systems approaches and great partners in the systems area which we think gives us a very, very strong situation. Additionally, the automotive safety standards or ASIL standards become very important. And our history and experience there in automotive, I think gives us an advantage over the competition. On the industrial side it is very competitive. Many of those applications are not technology differentiated. And so there it is really more about having the right products at competitive costs and we have been working diligently since our acquisition there to make sure we are using the ON network and able to generate good margins as that business has high demand, but generally again is much more cost competitive than any of the other markets. And I think we are making great progress there. Margins for that business have been coming up steadily – I think we have got 500 basis points or so of improvement this year.

[Gabriela Borges:]

That’s very helpful. Thank you. And as a follow-up if I could on the bookings trends and the booking patterns that you saw in the third quarter, maybe if you could just comment on linearity and when you got a sense that weakened macro might be weighing on the bookings patterns which are leading to the below seasonal 4Q guide? Thanks.

[Keith Jackson:]

Yes. So in my prepared comments, we talked about pretty stable bookings environment throughout Q3. Normally they accelerate very strongly towards the end of the quarter. So as you hit September you usually see a significant improvement in that rate. That did not happen. So, we would have started recognizing that if you will in September.

[Gabriela Borges:]

Maybe just one last clarification if I could, on fourth quarter what would you typically expect to see in terms of bookings linearity? Thanks.

[Keith Jackson:]

They would normally tend to decline as you go through the quarter. You get a lot of short-term turns in October and by December everybody is pretty happy. So in general you would expect a decline as you go through the quarter.

[Gabriela Borges:]

It makes sense. Thank you.

[Operator:]

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

[Parag Agarwal:]

Thank you for joining the call. This concludes the call for today. Goodbye.

[Operator:]

This concludes today’s conference call. You may now disconnect.