Good day, ladies and gentlemen. Welcome to the ON Semiconductor Third Quarter 2018 Earnings Conference Call. At this time, all participants are in a listen only mode. Later, there is a question and answer session and instructions will follow at that time. As a reminder, this call is being recorded.
I would now like to introduce your host for today's conference, Bharat Agarwal, VP of Corporate Development and Investor Relations. Please go ahead, sir.
Thank you, Grace. Good morning and thank you for joining ON Semiconductor Corporation Q3 2018 quarter 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 Investor Relations section of our website at www.awnsemi.com. A replay of this broadcast, along with our earnings release for the Q3 of 2018, will be available on our website approximately 1 hour following this conference call, and recorded broadcast will be available for approximately 30 days following this conference call.
The script for today's call and additional information related to our end markets, business segments, geographies, channels and share count are also posted on our website. Our earnings release and this presentation include reconciliation of these non GAAP financial measures to most directly comparable measures under GAAP are in our earnings release, which is posted separately on the website in the Investor Relations 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 you caution that such statements are subject to risks and uncertainties that could cause actual events or results to differ materially from projections.
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 Form 10 case, Form 10 Qs and other filings with the Securities and Exchange Commission. Additional factors are described in our earnings release for the Q3 of 2018. Our estimates may change and the company assumes no obligation to update forward looking statements to reflect actual results, changed assumptions, other factors, except as required by law. As announced earlier, we will host our 2019 Analyst Day on March 18 in Scottsdale, Arizona. If you would like to attend the event and haven't received an invitation, please let us know.
Now let me turn it over to Bernard Gutmann, who will provide an overview of Q3 2018 results. Bernard?
Thank you, Farag, and thank you everyone for joining us today. We delivered yet another quarter of strong financial results. Our results for the Q3 and guidance for the Q4 of 2018 have exceeded expectations on all key metrics. The strong financial performance was driven by our multiple secular drivers in various end markets and by solid execution on the operational front. Our robust financial results over the last several quarters clearly demonstrate the strength of our business and our steadfast operational execution.
Despite overhang of trade tensions, rising bond yields and fears of slowing global growth, overall demand environment remains favorable. We have seen a few spots of some weakness, especially in Greater China region in Industrial and Whitegoods segments. However, we have been able to offset this softness in Greater China with strength in other markets. Our near to midterm outlook for our business remains healthy, driven by significant increase in our content in automotive, industrial and cloud power solutions for data centers and 5 gs deployments. Secular drivers powering our business remain intact and our traction in our strategic markets, which include automotive, industrial and cloud power continues to be strong.
Although we are confident in our near to midterm outlook, we are managing our business in a very prudent manner. Our channel inventory remains at the lower end of our target range of 11 to 13 weeks and we have meaningfully reduced days of inventory on our balance sheet. At the same time, we continue to invest in our operations and in our R and D efforts to drive long term growth in our key strategic markets and to improve our profitability. Now, let me provide you details on our Q3 2018 results. Total revenue for the Q3 of 2018 was $1,540,000,000 an increase of 11% as compared to revenues of $1,391,000,000 in the Q3 of 2017.
GAAP net income for the Q3 was $0.38 per diluted share as compared to $0.25 in the Q3 of 2017. Non GAAP net income for the Q3 was $0.57 per diluted share as compared to $0.44 in the Q3 of 2017. GAAP and non GAAP gross margin for the Q3 was 38.7%. On a GAAP basis, our 3rd quarter gross margin improved by 100 basis points year over year and on a non GAAP basis gross margin improved by 80 basis points year over year. This strong gross margin performance was driven by solid operational execution and by improving mix resulting from higher contribution from our automotive, industrial and server businesses.
On a year over year basis, Q3 2018 gross margin was negatively impacted by the rise in certain input costs. With the anticipated ramp in additional internal wafer capacity towards the end of this year, we expect to partially offset the impact of increased input costs. Our GAAP operating margin for the Q3 of 2018 was 15.7% as compared to 12.7% in the Q3 of 2017. Our non GAAP operating margin for the Q3 of 2018 was 17.8%, an increase of approximately 120 basis points over 16.6% in the Q3 of 2017. On a year over year revenue increase of 11% for the Q3 of 2018, our non GAAP operating income increased by 19%.
This strong operational performance demonstrates the leverage and strength of our operational model. GAAP operating expenses for the Q3 were $355,000,000 as compared to $347,000,000 for the Q3 of 2017. Non GAAP operating expenses for the Q3 were $322,000,000 as compared to $296,000,000 in the Q3 of 17. 3rd quarter free cash flow was $228,000,000 and operating cash flow was 358,000,000 dollars Capital expenditures during the Q3 were $130,000,000 which equates to capital intensity of 8.5%. Recall that to meet increasing demand for our products and to mitigate the impact of the steep price in prices of raw wafers, we expect a higher level of capital intensity for this year and next.
We continue to delever our balance sheet and in the Q3 we used $65,000,000 to pay down debt. We exited the Q3 of 2018 with cash and cash equivalents of $951,000,000 as compared to $850,000,000 at the end of the Q2 of 2018. We used $75,000,000 of cash to repurchase 3,600,000 shares of our stock in the 3rd quarter. At the end of the 3rd quarter, days of inventory on hand were 116 days, down 6 days as compared to 122 days in the Q2. Distribution inventory in terms of weeks declined quarter over quarter in the Q3 and currently distribution inventories are at the lower end of our target range of 11 weeks to 13 weeks.
We expect distribution inventories to remain within the normal range of 11 to 13 weeks in the near term. To mitigate the risk of excessive inventory in the channel, we are proactively managing inventory in the distribution channel. We have implemented systems to ensure Q4, we announced the purchase of an incremental 20% share of the manufacturing joint venture for an 8 inches wafer fab located in Aizu Wakamatsu, Japan. With this purchase ON Semiconductor now owns 60% share in the joint venture and consequently we will report operational results of this joint venture in our consolidated financial statements beginning in the Q4 of 2018. We have named the joint venture ON Semiconductor Aizu Company, Ltd or OSA.
As part of the joint venture agreement, we may provide manufacturing services to our joint venture partner for up to 6 quarters starting with the Q4 of 2018. We expect revenue from manufacturing services to be approximately $20,000,000 per quarter at a nominal gross profit. Now let me provide you an update on the performance of our business units, starting with Power Solutions Group or PSG. Revenue for PSG for the Q3 was $810,000,000 Revenue for the Analog Solutions Group for the Q3 of 2018 was $532,000,000 and revenue for the Intelligent Sensing Group was $200,000,000 Now, I would like to turn the call over to Keith Jackson for additional comments on the business environment. Keith?
Thanks, Bernard. Q3 of 2018 was yet another strong quarter for ON Semiconductor. We continued on our trajectory of delivering strong revenue growth and robust margin expansion. Overall demand for our products can trade tensions,
rising brawn yields and expectations of slowing global growth. However, we saw some weakness, especially in Greater China region in Industrial and Whitegoods segments. The key driver of our business is significant content increase in many applications in automotive, industrial, cloud server and 5 gs infrastructure end markets as opposed to underlying unit growth in these end markets. In automotive end market, vehicle electrification and active safety are expected to drive steep growth in our addressable content for power devices and image sensors. In industrial market, need for power efficiency in industrial systems is expected to drive manyfold increase in power products from our PSG business unit.
In the cloud server market, we continue to see solid growth for analog power management products from our ASG business unit. In 5 gs infrastructure market, we are seeing many fold increase in our medium voltage power content as compared to that in 4 gs and 3 gs systems. Our business today is driven by sustainable secular growth drivers in the fastest growing semiconductor end markets as opposed to being driven by macroeconomic conditions and semiconductor industry cyclicality a few years ago. Through our investments over the last several years in high growth segments and in highly differentiated products in automotive and industrial end markets, we have radically transformed the nature of our business. Significant part of our business comes from highly differentiated power, analog and sensor products for automotive, industrial and cloud power end markets.
We continue to strengthen our position as a key provider of enabling technologies for newly emerging and disruptive applications in automotive and industrial end markets. Overall business conditions remain favorable and demand continues to be healthy across most end markets. We've noticed some weakness in Greater China region in industrial and white goods segments, but we've been able to offset that weakness with strength in other areas. In fact, we continue to sign long term supply agreements with our customers. On the supply side, we believe that inventories in semiconductor supply chain are generally healthy, and we do not see any signs of excess inventory with our distributors and customers.
In fact, as Bernard indicated in his prepared remarks, our inventory at our distributors is towards the lower end of our target range of 11 to 13 weeks. Pricing continues to be benign as compared to historic trends. Along with our strong revenue performance, our execution on the operational front continues to be outstanding. Our operating model has shown strong operating leverage. As Bernard mentioned earlier, on year over year revenue increase of 11% for the Q3, our non GAAP operating income increased by 19%.
We achieved this solid margin performance in spite of significant rise in input costs. We remain on track to ramp our internal raw wafer capacity by the end of the current year, and with this ramp, we should be able to partially offset the increase in input costs. At the same time, mix shift towards margin rich automotive, industrial and cloud power end markets should drive additional margin expansion. Now I'll provide details of the progress in our various end markets for the Q3 of 2018. Revenue for the automotive market in the 3rd quarter was $464,000,000 and represented 30% of our revenue in the 3rd quarter.
3rd quarter automotive revenue by an impressive 12% year over year. Despite some volatility in the automotive supply chain, we posted strong year over year and sequential growth in the 3rd quarter. We believe that ongoing content increases, new production introductions and share gains drove our strong revenue performance despite reports of volatility in global automotive supply chain. We expect that secular trend of meaningful semiconductor content increase in automotive will continue for the foreseeable future, regardless of temporary changes in market dynamics. With a strong portfolio of power, analog and sensor products, we are well positioned to disproportionately benefit from tremendous increase in semiconductor content driven by electrification, active safety and fuel efficiency in automotive.
Our momentum in the automotive image sensors continues to accelerate. Key factors driving our growth in the automotive image sensor market are significant technology lead over competition and the industry's most extensive product portfolio, giving customers more choices than before. With a complete line of image sensors, including 1, 2 and 8 megapixels, we are the only provider of a complete range of pixel densities on a single platform for the next generation ADAS and autonomous driving applications. Furthermore, with our recent acquisition of Sensil, we now have capability to provide LiDAR sensors. In addition, are the only semiconductor supplier with capability to provide all 4 types of sensors for ADAS and autonomous driving.
We believe that this capability will not only drive significant content for us, but will also provide a key differentiating advantage to us as the automotive industry moves to sensor fusion architectures for ADAS and autonomous driving. We recorded our 1st silicon carbide revenue from automotive in markets in the Q3. We are actively engaged with the leading global automotive OEMs on many silicon carbide projects. We expect silicon carbide will be a significant driver of our automotive content increase driven by the electrification of the drivetrain. We expect to see strong acceleration in our automotive silicon carbide revenues for the foreseeable future.
Demand for our power products, 48 volt systems and LED lighting products remain strong. We are also seeing strong adoption of switch mode power supply systems for camera systems and radar systems. In addition, we are seeing strong growth for our silicon based power products in the EVHEV market. Revenue in the 4th quarter for the automotive end market is expected to be up quarter over quarter due to normal seasonality. The industrial end market, which includes military, aerospace medical contributed revenue of $400,000,000 in the 3rd quarter.
The industrial end market represented 26% of our revenue in the 3rd quarter. Our Q3 industrial revenue grew by a solid 12% year over year. Ever increasing energy efficiency requirements continue to be the key driver of increases in power management content in industrial systems. We're seeing several fold increase in our power content in many industrial systems. In the industrial end market, we are benefiting from our comprehensive power product portfolio encompassing the complete voltage range.
Design activity for power products in the industrial market remains strong and we are engaging with leading global industrial OEMs on their next generation designs. Within the industrial market, we are seeing strong traction for our power integrated modules for applications in alternative energy market. Machine vision is another area of strong growth in the industrial market. With recently introduced X Class image sensors, we expect to further strengthen our leadership in machine vision and robotics markets. Revenue in the Q4 for the industrial end market is expected to be down quarter over quarter as opposed to seasonality of flat sequential revenue.
Weaker than seasonal growth in our industrial business is driven primarily by softness in the Greater China market. The communications end market, which includes both networking and wireless, contributed revenue of $314,000,000 in the 3rd quarter. The communications end market represented 20% of our revenue in the 3rd quarter. 3rd quarter communications revenue increased by 13% year over year. In the Q3, we benefited from the launch of a new smartphone models.
It has been the case over the last few years, our content in new generation smartphones continues to increase in a meaningful manner. On the infrastructure front, we are beginning to see ramp of our high efficiency medium voltage power products for 5 gs systems. We expect that our power content in 5 gs infrastructure systems will be many times that in 4 gs or 3 gs systems. We've been designed in for significant power management content in 5 gs systems and we expect to see strong revenue ramps with increased deployment of 5 gs infrastructure. Revenue in the Q4 for the communications end market is expected to be flat quarter over quarter as opposed to normal seasonality of sequential decline.
The computing end market contributed revenue of $163,000,000 in the 3rd quarter. Computing end market represented 11% of our revenue in the 3rd quarter. 3rd quarter computing revenue grew by 16% year over year. The year over year growth was driven primarily by accelerating strength in our cloud power business and the ramp of our analog power management solutions for graphics processors. As we have indicated in prior earnings calls, we are engaged with leading cloud and server players and we are working with leading processor providers on their next generation platforms.
With upcoming generation of processors, we expect to increase our analog content through the introduction of new products. Revenue in the Q4 for our computing end market is expected to be approximately flat quarter over quarter as opposed to normal seasonality of sequential decline. Continuing ramp of our cloud power business is a primary driver of better than seasonal trend in our computing business. The consumer end market contributed revenue of $200,000,000 in the 3rd quarter. The consumer end market represented 13% of our revenue in the 3rd quarter.
Q3 2018 consumer revenue was down 1% as compared to consumer revenue in the Q3 of 2017. The decline was due to our selective participation in certain areas of the consumer electronics market. Revenue in the Q4 for the consumer end market is expected to be down quarter over quarter, primarily due to softness in white goods market and normal seasonality. In summary, demand environment for our products remains healthy, driven by secular megatrends in industrial, automotive and cloud power markets. The key driver of our business is significant content increase in many applications in automotive, industrial, cloud server and 5 gs infrastructure end markets as opposed to underlying unit growth in these end markets.
Trade tensions, rising bond yields and expectations of slowing global economy have not impacted our business in a significant manner. We've established leadership in highly differentiated power, analog and sensor semiconductor solutions and we believe that customers are increasingly relying on us as a key provider of enabling technologies for newly emerging and disruptive applications in automotive, industrial and cloud power end markets. While our business remains healthy, we are fully cognizant of the risks arising from potential slowdown in the global economy. We are very prudently managing our business with aggressive and proactive inventory management to respond quickly to any changes in market conditions. Our operational execution remains solid.
We have continued to expand our margins and generate strong free cash flow. Now I would like to turn it back over to Bernard for forward looking guidance. Bernard?
Thank you, Keith. Based on product booking trends, backlog levels and estimated turns levels, we anticipate that expected to be in the range of $1,480,000,000 to $1,530,000,000 in the Q4 of 2018. Included in our Q4 revenue guidance is approximately $20,000,000 revenue from the manufacturing services provided by ON Semiconductor Aizu or OSA, which as I indicated earlier is our 8 inches is our joint venture in an 8 inches fab. Excluding the impact of OSA, our 4th quarter revenue is expected to be in the range of $1,460,000,000 to 1,510,000,000 dollars Recall that as part of the joint venture agreement, we may provide manufacturing services to our joint venture partner for up to 6 quarters starting with the Q4 of 2018. For the Q4 of 2018, we expect gross margin to be in the range of 37.1% to 38.1%.
Our 4th quarter gross margin guidance includes the negative impact of 50 basis points from the manufacturing services provided by OSA. Excluding the impact of OSA, our 4th quarter gross margin is expected to be in the range of 37.6% to 38.6%. We expect total GAAP operating expenses of $348,000,000 to $366,000,000 Our GAAP operating expenses includes the amortization of intangibles, restructuring, asset impairments and other charges, which are expected to be $29,000,000 to 33,000,000 dollars We expect total non GAAP operating expenses of $319,000,000 to $333,000,000 in the 4th quarter. The quarter over quarter increase in our non GAAP operating expenses in the 4th quarter is primarily driven by 3 additional days in the Q4 of 2018 as compared to those in the Q3 of 2018. We anticipate 4th quarter 2018 GAAP net income and expense including interest expense will be $32,000,000 to 35,000,000 dollars which includes non cash interest expense of $9,000,000 to $10,000,000 We anticipate our non GAAP net other income and expense including interest expense will be $23,000,000 to $25,000,000 Cash paid for income taxes in the Q4 of 2018 is expected to be $8,000,000 to 12,000,000 dollars We expect total capital expenditures of $135,000,000 to $145,000,000 in the Q4 of 2018.
We also expect share based compensation of $19,000,000 to $21,000,000 in the Q4 of 2018, of which approximately $2,000,000 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 Q4 of 2018 is expected to be 428,000,000 shares based on current stock price. Further details on share count and earnings per share calculations are provided regularly in our quarterly and annual reports on Form 10Q and Form 10 ks. For the full year of 2018, we expect to generate free cash flow in the neighborhood of $800,000,000 With that, I would like to start the Q and A session.
Thank you. And Chris, please open up the lines for questions.
And our first question comes from Chris Danley with Citigroup. Your line is now open.
Hey, thanks guys. I remember in previous calls you've talked about some extension in lead times. Can you just comment on what lead times are doing these days? Are they remaining stretched? Are they starting to come in?
They haven't changed. So they're remaining longer than normal.
Keith, when do we expect those to come back in?
Obviously, depending on market conditions, that can vary. But at this stage, we see them remaining stable at least through the first half of next year.
Okay. And then for my follow-up, just on the OSA biz, were you contractually obligated to do this thing for 6 quarters or maybe just give us some of the history behind that?
Yes, we are indeed obligated. That was part of the original deal.
Got it. Okay. Thanks, guys.
And our next question comes from Vivek Arya with Bank of America Merrill Lynch. Your line is now open.
Thanks for taking my question. Keith, I'm sure you looked at some of the weaker outlook from the peers, the Texas Instruments and Cypress, etcetera. What kind of went through your mind when you contrast their weakness versus the stability or strength that you are seeing? Is it possible you're not seeing the downturn now, but perhaps could see it later just because either you have different products or you had longer lead times? If you could just give us a sense on what's on your dashboard, right?
How are order cancellations looking? How is the book to bill ratio? Like how do we contrast the difference between what some of your peers are reporting versus the strength that you are seeing?
So our forecasting is done the same way. We look at our backlog and profiles that are going on from customers and our new etcetera, as we get into the quarter. If you want to talk about contrast, I will point to the fact that our power content, specifically in the markets I talked about, we believe to be substantial and different from many of our competitors. And that is indeed where most of the strength is. So I think there's a little bit of product mix between companies that shows up and also which customers are being served.
In our case, we really do think it's a strong demand on a content basis in the markets we mentioned.
Got it. And for my follow-up, could you help us quantify your rough exposure to the 2 kind of problematic areas you mentioned, the China industrial and white goods? When
do you
think those areas can start to stabilize or we don't have that visibility quite yet?
We don't have visibility on that quite yet. We service the consumer piece or excuse me, the white goods piece in China through distribution. And they are not giving us any indication
of when that might come back
at this stage. But it's a
And our next question comes from Shawn Harrison with Longbow Research. Your line is now open.
Hi, good morning. This is Gassia Chowdhury on behalf of Shawn. Within auto, are you seeing any auto production weakness in any regions?
We're not seeing any weakness. We are seeing this year, unlike last year, some shutdowns for them to have kind of their maintenance periods that didn't occur last year. But as I mentioned before, our content gains have far offset those.
Great. And then with regards to OSA, do you anticipate that the profitability will there will be a drag on profitability
e. Through the 1st quarter. For up to 6 quarters, I. E. Through the Q1 of 2020.
And I expect a pretty stable business during that timeframe.
Thank
you. And our next question comes from Ross Seymore with Deutsche Bank. Your line is now open.
Hi, guys. Just want to follow-up on the auto side. Keith, I know you have more content there conceptually. Can you just talk a little bit or give a little more color as to how that's playing out historically even the companies that in aggregate are gaining more content still aren't immune from sour pulling down. So any more color you can give on some of the specifics as far as why you're able to offset it at least in the long term I get, but the near term color?
Yes. I mean, of course, you're never immune from slowdowns in unit production. But our new designs and the models that are now ramping 2019 models, the content gains there are in the double digit range. And so therefore, if your SAAR comes down 1% or 2%, you still see strength coming on. And so the only other impact that you could have had there, Ross, is significant over inventories, and we've seen no signs of that.
So as you put it all together, we continue to see good growth. Thanks for that.
And then as my follow-up, just switching over to the margin line, perhaps for Bernard. If the weakness that others are pointing to ends up hitting you guys either the duration or magnitude is greater than what you guys currently see for whatever reason, How should we think about how gross margin and OpEx can be flexed proactively if that negative scenario plays out?
So, we will do what we have normally done in the past. On the gross margin front, the fall through on the decremental revenue, if there is such a decrement is about a 50%. In cases of a slowdown, you in source more of the production that's currently outsourced, so our mix would change towards that. On the OpEx front, variable comp and variable commissions would also be directly proportional to or affected by the reduction that front. And then you take the normal belt tightening actions that occur in any slowdown.
Great. Thank you.
You're welcome.
And our next question comes from Vijay Rakesh with Mizuho. Your line is now open.
Yeah. Hi. Thanks, guys. Just on the industrial side, I know you mentioned slight softness here in December. Just wondering if you're seeing anything out of the ordinary or is it just normal seasonality there?
In general, it's normal seasonality except some slight weakness in the China marketplace, as we discussed. And that's it's not significant. So it's slightly down versus flattish normal seasonality.
Got it. And as you go into first half, there's been some worries from your peers about visibility and tariff impact, just bigger picture with another 25% hike on January 1, I guess. Have you as you talk to your customers in Asia and especially emerging markets, is there are you seeing any worries as they look out? I know it's a little bit farther away, but thanks.
The only worries we've seen have been in China on some of the consumer type marketplaces. And basically concerns there, I think are reflected in the weaknesses we've talked about. But otherwise, we haven't seen any significant impact, change in backlogs or order patterns.
Great. Thanks.
And our next question comes from Chris Caso with Raymond James. Your line is now open.
Yes, thank you. Good morning. The first question is on distribution. And can you talk about sell in versus sell through and distribution for the 3rd quarter and your you clarify what you mean by proactively managing inventory? Are you seeking to bring down the level of distribution inventory further?
I think we're happy at the low end of our range. In fact, we're very happy at the low end of our range. And what we've done with our distributors there is help them with visibility in our systems and manage the order patterns so that we stay there. So the real objective is to stay pretty close to the bottom half of that range as we go through the cycles or through the seasonality, I should say.
And that would imply that sell in kind of equal sell through.
Okay, got it. Thank you. Just following on with OSA and the rationale for moving to the majority interest, was that something that you needed to do? And I guess I just asked that it seems like that an impact is $20,000,000 in revenue on but about flat was by 0 gross margins rather. So what's the reason what's the benefit for On taking that majority interest?
The reason we have the majority interest quite frankly is we wish to use all of that capacity over time. This is a structured phase over to make that happen, and they have customers that need to be supported. And so as part of the whole deal, we had a preplanned phase over in that capacity. So the real issue is we need to fill that up with our products. And of course, as we do that, the margins for our products are significantly better.
Okay. Thank you.
And our next question comes from John Kitzer with Credit Suisse. Your line is now open.
Yes, good morning guys. Thanks for letting me ask the question and congratulations on the strong results. Keith, I'm just wondering what would it be a cushion within the comms business and the compute business today? What percent is sort of infrastructure and kind of server, cloud, hyperscale and each? How does that trend year over year compared to last year?
And what do you think that's going to be 4 quarters from that?
I'll take them separately. On the computing side, the cloud server business has moved from a 20 ish percentage 20 percent of our computing business up at least 10 points from that year on year. So and we see that trend continuing into 2019. So very significant increase in the cloud server portion of the total business. On the infrastructure piece, it has always been the smaller portion of our communications business.
But again, from a percentage basis, it's come up a couple of points year on year.
That's helpful. And then maybe a quick one for Bernard on the margin front. Bernard, you mentioned in your earlier question a gross margin fall through of about 50%. If you look over the last four quarters, excluding the quarter just reported, you were sort of above that. I think the incremental op margin was averaging about 56% I'm sorry, gross margin.
Op margin was about 38%. So I'm just kind of curious, to what extent were input costs impacting things on a year over year basis? And can you just level set us you gave us the 50% kind of gross margin drop through. How should we think about op margin drop throughs from here?
Yes. So the 50% is obviously a yardstick. We think it is a good representation of a kind of a long term thing. Yes, we do have in between spikes where we are always better or not. In the long run, we also have the mix also get also get us some incremental amount.
On the op margin, we're still targeting to do our 19% for our target model. We have done some nice progress, got to about 17.8% in the Q3 and expect to continue making progress.
And then guys, if I could take one more in there. Glad to see you guys buy back stock in the quarter, Ash. So Keith, I'm kind of curious just given where the So
So we have taken a balanced approach towards paying down debt as well as buying back shares, the buying back into the market.
Perfect. Thanks guys.
And our next question comes from Kristen Sciacca with Nomura Instinet. Your line is now open.
Congrats on the good results. I just wanted to follow-up on the lead time question. A lot of your peers are noting that lead times are actually falling a bit to more stable or normalized levels versus being extended over the past year, but you're seeing your lead times remain extended and should be at least through the first half of next year. Could you maybe give a little bit more color on that on what is driving that trend?
Yes. Again, it has been the significant content increase we've had primarily in medium and high voltage marketplaces. And it is quite stable. It's just longer than normal. So we're not really seeing any volatility in the numbers, but the demand remains high and so those lead times will remain extended.
Great, thank you. And then just switching over to comps, in your prepared remarks you said you expect the revenues to be flat for next quarter sequentially versus historically, seasonally down. Can you maybe just dig into what trends you're seeing that would promote that above seasonal growth? Is that mainly 5 gs related revenue? Or is there some other factors playing into effect there?
Certainly, 5 gs is a factor, although it's early in that ramp out, so that's some of it. The other piece, frankly, is just content increases we had in the new models of handsets that rolled out. And those from a build perspective, our customers are still showing us good demand in Q4.
Great. Thank you.
And our next question comes from Anthony Stoss with Craig Hallum. Your line is now open.
Hi, guys. My congrats on
the strong execution as well. Bernard, can you give us what your capacity utilization was in Q3? And any thoughts on where you think it might be in Q4? And then lastly on silicon carbide, do you expect the bulk of your wafers to come from external sources or internal? Thanks.
So capacity utilization in the 3rd quarter in the mid to high 80s. Expect that to be similar, maybe coming down slightly in the 4th quarter. And then silicon carbide, we are outsourcing the raw wafers. We have long term agreements on that front. We do internally our own raw wafers for regular silicon and we talked about that several times that we're increasing our capacity to serve more and be less dependent on this input cost, but not on the internal not on the silicon carbide right now.
Great. Thank you.
And our next question comes from Craig Ellis with B. Riley FBR. Your line is now open.
Yes, thanks for taking the question and congratulations on the execution in the quarter. The first question is related to content gain. Keith, you pointed out good things happening in compute and server and in smartphones. So the question is, with Intel having 3 server product transitions in 4Q 2018, 4Q 2019 and then 2020, what do you expect will happen with on server content with those transitions? And then on the smartphone side, is the content gain we're seeing really more of a second half dynamic?
Or would you expect to be gaining content with first half model launches as well?
On the computing side, our content will continue to go up with the new processor releases. So we see that as a very positive trend. We believe also our share gains should be going up. So similar to what went on in the notebooks a few years ago, we are expecting a continued positive story on the compute side. In the handsets, the ones that will launch in the first half of next year will also have that increased gains.
So that should also again be a good story relative to seasonality.
Thanks. And then the follow-up question is for Bernard. Bernard, setting aside the manufacturing JVs impacted gross margin in the 4th quarter, there's still a decrease of around 50 to 60 basis points, it looks like. So is that primarily utilization or are there other factors that play like input costs or pricing? And then as we look ahead to the Q1, I think that's when the company would typically see more of its large customer or long term contract renewals occur.
Can you just help us with the gives and takes with gross margin, not looking for guidance, but just some higher level color? Thank you.
Sure. So in the Q4, the gross margin decline beyond the OSA is mostly just revenue related though it's utilization. We're guiding to a lower number in the 3rd quarter's actuals. It is approximately a 50% fall through on the decremental revenue. So there is nothing bigger there.
Contracts or pricing continues being quite benign, and we're seeing that also in our annual contract negotiations.
Thank you.
And our next question comes from Tristan Gerra with Baird. Your line is now open.
Okay. Good morning. Could you provide a little bit of color on your CMOS camera business in automotive? You've talked in the past about 70% market share. Is the outlook in that business for next year?
And are you wanting on track? Or are you seeing any type of delays?
Yes. The 70% is for ADAS. Overall, I think we're about 55% if you include all viewing in cars. We see that continuing. I think, again, we believe we have increased that a bit for next year's models.
And so we expect that to continue to ramp up in double digits next year.
Okay. And then any changes that you expect to see in terms of pricing patterns as you enter renegotiating agreements for next year?
Our pricing patterns this year have been quite benign, as Bernard talked about. I would expect going into next year, the Q1 should be better than normal. But obviously, the rest of the year, we'll have to wait and see what the markets provide.
Great. Thank you.
And our next question comes from Chris Rolland with Susquehanna. Your line is now open.
Hey, guys. Congrats on the outperformance versus some of your peers here. That was pretty impressive. So I believe there may be 3 extra days in quarter, at least I think you talked about on the OpEx side. I was wondering how you are treating the revenue.
Is it kind of half of that or are you counting it kind of as 0? And then just back to pricing. So previously on way back in the day, we used to talk about 1% to 2% price decreases quarter to quarter. Is this dynamic change now in your opinion considering you're no longer like highly commoditized products?
So let me answer the 3 extra days. Historically, when we have had our experience on the 3 extra days is that you really get very little in terms of extra revenue because you're looking at the holiday season during that timeframe, but you have to pay the people. So it is mostly affecting OpEx, but very little offset than the incremental revenue. It's part of our revenue guidance already embedded. On the long term pricing trends, we are getting a higher content for sole source products.
And so we would expect that that would become more muted than typical 1% to 2% would become more muted each year.
Got it. And then just a quick one on linearity. Accounts receivable was up, but days are fine there. But is there anything about linearity and booking trends through the quarter? Was there any sort of a deceleration at all in the month of September?
The linearity has been pretty steady. We haven't seen any massive changes there. From the revenue point of view, Q3 is typically back end loaded and Q4 is typically front end loaded, but we're not seeing any difference in our normal patterns.
Got it. Thanks, guys.
And our next question comes from Kevin Cassidy with Stifel. Your line is now open.
Thanks. You mentioned the increased content in handsets and the new models. Can you give us a breakout of the Tier 1 models versus say, the China based mid range models?
Yes. So most of them are higher end models, and it's about half China based and half non China OEM based when you add it up in aggregate. That's been a fairly stable position. We strive to have some balance in that market because picking winners and losers is a difficult job.
Right. Great. And on your raw wafer capacity, what's the goal for the total percentage of in house wafer production? And where does it stand right now?
So the production based on the Quebec capital investments we made this year will get us to about 50% internal supply. And I don't see that shifting
And our next question comes from Harlan Sur with JPMorgan. Your line is now open.
Good morning. Nice job on the quarterly execution guys. Good to see the ramp in your 5 gs design wins, medium voltage products. Can you guys just help us understand where these wins are situated? Is it primarily power supply or the compute DSP processor, power management or signal chain?
Any color here would be appreciated.
Yes. It's almost exclusively the power related products for 5 gs in all instances.
Great. Can you guys just maybe at a high level kind of discuss the order trends thus far here in the December quarter? I know it's a bit early, but normal seasonal quarter on quarter trend for the team is kind of flat to down 2% in the March quarter. Anything that you're seeing that would did you believe that things could play out a bit differently at this point? Currently, we don't have any visibility that would indicate otherwise.
All right. Thank you.
And our next question comes from Rajvindra Gill with Needham and Company. Your line is now open.
Yes. Thank you and congrats as well. Just some clarification on the previous questions. Could you specify what the book to bill was for the September quarter and more specifically on the for the month of September, any kind of clarity there?
Yes. We don't normally spell out these numbers, but it was above 1.
Okay. And there wasn't any signs of kind of abnormal cancellations or order rescheduling?
None at all.
Okay, got it. And just another follow-up on that. In terms of your Q4 guidance, and it might be difficult to elucidate this, but how much do you think the guidance is related to any kind of pull in of demand from early next year ahead of the tariff increases? I know you have a lot of semi content gains on auto industrial cloud server, etcetera. Any kind of clarity on that?
We really don't have any indication that that's what's going on. And again, if you look at the percentage of products that are imported back into the U. S, I don't know how significant that could be. But certainly, we've been given no indications from customers that that's what's going on.
And last question, just the housekeeping. What's the tax rate expected for 2019?
Approximately 10%.
All right. Thanks again. Appreciate it.
And our next question comes from Mark Delaney with Goldman Sachs. Your line is now open.
Yes. Good morning. Thanks for taking the questions. So looking for an update on how many synergies maybe left to achieve in COGS from Fairchild. And related to that, I think On had planned product qualification recently that would allow ON to consolidate what ON may have done on that front and what it could mean for your cost structure?
The synergies we basically had said that it would come in throughout 2018 and spillover into 2019. We are seeing a good traction on that. We are, I would say, not completely done, but getting the other question. What was the other question? I thought you had Yes, we always as a matter of business, we always like to have multiple source qualifications And we talked about potentially having some footprint consolidations, which we have also indicated that with the high demands we have right now, we are not executing to, but it is always something that we have in the back of our mind more in a stronger downturn.
And for my second question, I was just hoping for some more clarity about how much revenue on is recognizing currently in automotive from silicon carbide products and how you expect that to come in for 2019? Thanks very much.
Yes. We are not giving specifics on that yet. But as I mentioned, in total, silicon carbide would be in the tens of 1,000,000 this year ramping multiples each year.
And our next question comes from Craig Hettenbach with Morgan Stanley. Your line is now open.
Great. Thank you. Keith, if I can contrast just some of the markets in terms of what you're seeing, so stability in automotive versus some weakness in industrial. Can you just talk about some of the demand signals you're seeing in each of those instances from customers?
So, again, we seen very positive demand signals. Bernard mentioned a book to bill over 1. That is in aggregate and comprehends the weaknesses we talked about in China consumer and industrial areas. So both of them, I would say, are seasonal. The automotive piece is higher than seasonal because the content gains in the industrial piece when you offset for the weakness in China is pretty close to normal.
Okay. And in China, where you are seeing some weakness, can you talk about kind of when that developed within the quarter and how it's looking into the second of this quarter?
That actually started developing in the 3rd quarter. And I'd say the kind of the August time frame. So it wasn't the end of the month and it stabilized very quickly after some initial adjustments.
Okay. Thank you.
That does conclude today's question and answer session. I would now like turn the call back to Parag Agarwal, VP of Corporate Development and Investor Relations for any further remarks.
Thank you everyone for joining the call today. We look forward to seeing you at various conferences during the quarter. Thank you and bye bye.
Ladies and gentlemen, this does conclude today's conference. Thank you for your participation and everyone may disconnect. Everyone have a great day.