Good day, ladies and gentlemen, and welcome to the ON Semiconductor 4th Quarter 2016 Earnings Conference Call. At this time, all participants are in a listen only mode. Following management's prepared remarks, we will host a question and answer session and our instructions will follow at that time. As a reminder to our audience, this conference may be recorded. It is now my pleasure to hand the conference over to Barak Agrawal, Vice President of Corporate Development and Investor Relations.
Sir, the floor is yours.
Thank you, Brad. Good morning and thank you for joining ON Semiconductor Corporation's 4th quarter 2016 quarterly results conference call. I'm joined today by Keith Jackson, our President and CEO and Bernard Gutmann, our CFO. This call is being webcast on the Investor Relations section of our website at www.awnsemi.com. A replay of this broadcast, along with our earnings release for the Q4 of 2016 will be available on our website approximately 1 hour following this conference call, and the recorded web broadcast will be available for approximately 30 days following this conference call.
The scripts for today's call and additional information related to our end markets, business segments, geographies and channels are also posted on our website. Our earnings release for this presentation includes certain non GAAP financial measures. A reconciliation of these non GAAP financial measures to most directly comparable measures under GAAP are in our earnings release, which is posted separately on our 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 the future financial performance of the company. The words believe, estimate, project, anticipate, intend, may, expect, will, plan, should or similar expressions are intended to identify forward looking statements.
We wish to caution that such statements are subject to risk and uncertainties that could cause actual events or results to differ materially from the projections. Important factors, which can affect our business, include factors that could cause actual results to differ from our forward looking statements. Business, including factors that could cause actual results to differ materially from our financial statements, are described in Form 10ks, Form 10 Qs and other filings with the Securities and Exchange Commission. Additional factors are described in our earnings release for the Q4 of 2016. 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 law.
As indicated in our prior earnings release call, we continue and revised compliance and disclosure interpretations of the use of non GAAP financial metrics by U. S. Listed companies by the U. S. Securities and Exchange Commission, the company has revised its practice with respect to guidance and use of non GAAP measures.
Please see the earnings release for additional information. We will be holding our 2017 Analyst Day on March 10 in Phoenix, Arizona. If you haven't received an invitation to the event, please request an invitation to the Investor Relations section of our website or contact us. For all synergy related discussion on this call, we have used Fairchild's 2015 results as a base for our comparisons. Now, let me turn it over to Bernard Gutmann, who will provide an overview of the Q4 2016 results.
Bernard?
Thank you, Parag, and thank you everyone for joining us today. We handedly exceeded our revenue and margin guidance for the Q4 of 2016 and posted strong free cash flow performance. Accelerated progress on Fairchild integration, improving demand environment and solid execution of our organic business were the key drivers of better than expected results. Now, let me provide you additional details on our Q4 2016 results. Total revenue for the Q4 of 2016 was approximately $1,261,000,000 an increase of approximately 33% as compared to the Q3 of 2016.
4th quarter revenue included a contribution of approximately $358,000,000 from our acquisition of Fairchild Semiconductor, which closed on September 19, 2016. Revenue performance of our organic business and that of Fairchild was significantly better than normal seasonality. Our organic business, which excluded Fairchild, grew by approximately 7% year over year during the Q4. GAAP net income for the 4th quarter was $0.26 per diluted share. GAAP income before income taxes for the 4th quarter was approximately $18,200,000 as compared to $87,300,000 in the 3rd quarter.
Non GAAP income before income tax for the 4th quarter was approximately $132,000,000 Net cash paid for taxes in the 4th quarter was approximately $8,200,000 and diluted shares outstanding were approximately 427,000,000 Non GAAP income before tax for the 3rd quarter was approximately 100 $7,000,000 Net cash paid for taxes in the 3rd quarter was approximately $6,500,000 and diluted shares outstanding were approximately 420,000,000. GAAP gross margin for the 4th quarter was 30.5% as compared to 34.6% for the 3rd quarter. Non GAAP gross margin for the 4th quarter was 35.2% as compared to 35.9% in the 3rd quarter. Better than expected non GAAP gross margin in the 4th quarter was driven by strong progress on Fairchild integration and higher than expected revenue. GAAP operating margin for the Q4 of 2016 was approximately 4.4% as compared to approximately 4.9 percent in the prior quarter.
Our non GAAP operating margin for the 4th quarter was 12.9%, flat as compared to the 3rd quarter. GAAP operating expenses for the 4th quarter were approximately $329,000,000 as compared to approximately 282 for the Q3 of 2016. Non GAAP operating expenses for the Q4 were approximately 281,000,000 dollars as compared to approximately $218,000,000 in the 3rd quarter. Although our revenue exceeded the higher end of the guidance, operating expenses were close to the midpoint of our guidance range. Again, solid progress on synergies from Fairchild and strong execution on our organic business were the reasons for strong operating expense performance.
The sequential increase in operating expenses was driven primarily by the inclusion of the 1st full quarter financial results for Fairchild in the 4th quarter and higher variable compensation accrual resulting from improved operating performance. We had strong free cash flow performance in the 4th quarter. We define free cash flow as cash flow from operations, less capital expenditures. 4th quarter free cash flow was approximately $179,000,000 as compared dollars as compared to approximately $97,000,000 in the 3rd quarter. Operating cash flow for the 4th quarter was approximately 229,000,000 dollars and capital expenditure was approximately $50,000,000 Operating cash flow for the Q3 was approximately 133,000,000 dollars and capital expenditures were approximately $36,000,000 We exited the Q4 of 2016 with cash, cash equivalents and short term investments of approximately $1,028,000,000 as compared to approximately $880,000,000 in the 3rd quarter.
Subsequently in January, we used approximately $445,000,000 to redeem all of the outstanding 2.625 convertible senior subordinated notes due 2006 Series B. At the end of the Q4 of 2016, days of inventory on hand adjusted for fair market value step up were 113 days, flat as compared to the Q3. In the Q4 of 2016, distribution inventory days were approximately flat as compared to the Q3. For the Q4 of 2016, our lead times were approximately flat quarter over quarter. Our global factory utilization in the 4th quarter was slightly up sequentially.
Now let me provide you an update on performance by our business units, starting with the Power Solutions Group or PSG. Revenue for PSG was approximately $620,000,000 Revenue for our Analog Solutions Group for the Q4 of 2016 was approximately $469,000,000 Revenue for the Image Sensor Group was approximately $171,000,000 dollars Now, I would like to turn the call over to Keith Jackson for additional comments on the business environment. Keith? Thanks, Bernard. I'm very pleased
with our results for the Q4 of 2016. For the 1st full quarter that includes the results from Fairchild, we are off to a solid start. We exceeded our revenue guidance and we posted strong free cash flow and margin performance. Our results for the 4th quarter provide clear evidence of strong execution on the integration of Fairchild and the results also validate our strategic and financial rationale for the acquisition. At this point, we are tracking significantly ahead of our planned synergy target for Fairchild.
The performance of Fairchild to date has far exceeded our expectations, and we expect to see positive revenue synergies as a result of the combination of these two companies. We are very encouraged by the significantly above seasonal revenue performance by Fairchild in the 4th quarter and current indications point towards continued strength in Fairchild's revenue in the near term. During the Q4, bookings for Fairchild were at highest level when compared to bookings during the last 3 years. We are seeing significant cross selling opportunities in various end markets as we leverage customer relationships, sales reach and distribution network of the combined company to win designs. We continue to make strong progress in the integration of Fairchild, and we are tracking significantly ahead of our planned synergies targets.
We are on track to begin in sourcing of Fairchild's back end operations by the end of the year. IT and systems integration is progressing well, and we expect to complete that part of the integration in the Q4 of the current year. We've achieved sizable synergies related to purchasing, planning and other related functions in the cost of goods sold. We continue to make significant progress on operating expense rationalization and exiting the Q4 of 2016, we have been able to realize significant operating expense synergies. As I stated earlier, our solid progress in integration of Fairchild is reflected in our results for the Q4 of 2016.
We remain very comfortable with achieving our annual synergies run rate target of $160,000,000 exiting 2017. As we have indicated in our previous announcements, this $160,000,000 annual run rate target is based on Fairchild's results for full year 2015. While we are realizing synergies from Fairchild, we are keeping a tight control on cost structure of our organic business. We will provide further updates on the financial and strategic impact of the acquisition at our Analyst Day on March 10, 2017. Let me now comment on the business trends in the 4th quarter.
During the Q4, demand trends and bookings were generally healthy across most end markets and geographies. End market trends were generally in line with expectations. Recent commentary from customers points to an improving demand environment. I'm very optimistic about our prospects for 2017. Our business remains strong and our momentum in our strategic markets, which include automotive, industrial and communications continue to grow.
Our design win pipeline continues to grow driven by our innovative products in the automotive, industrial and communication markets. Examples of such products include power integrated modules, USB Type C, image sensors for ADAS in industrial markets, LED lighting for automotive market, server and cloud power management and other power management, analog and sensor products for our strategic end markets. Furthermore, our strong engagement with our distribution partners and a disruption in the distribution supply chain due to actions taken by certain of our competitors may provide us with additional revenue tailwind. I am very excited about the cash flow potential of the new company. With synergies from Fairchild and strong execution and cost control, we are well positioned to drive meaningful growth in our free cash flow in the current year and following years.
Now I'll provide details of the progress in our various end markets. With inclusion of Fairchild's results for a small part of the 3rd quarter and for full Q4, the normal quarter over quarter comparison that we have historically provided is not quite as meaningful for the Q4. Therefore, I will limit my remarks to a qualitative summary and limited quantitative data. The automotive end market contributed revenue of approximately $378,000,000 and represented approximately 30% of our revenue for the 4th quarter. We continue to see strong demand for our image sensors and integrated co processors for ADAS applications.
Safety requirements driven by NCAP and star ratings are driving steep adoption of ADAS and a higher number of cameras and vehicles. We continue to grow our technology and market leadership at ADAS, and we are actively engaged with leading global automotive OEMs and Tier 1 suppliers on many ADAS related programs. We are also seeing cascading of our Park Assist solutions down to mid range vehicles from high end vehicles. We continue to reinforce our leadership in automotive LED lighting and adoption of our front and rear LED lighting driver solutions continue to accelerate globally. Revenue in the Q1 for the automotive end market is expected to be up quarter over quarter.
The industrial end market, which includes military, aerospace and medical, contributed revenue of approximately $278,000,000 and represented approximately 22% of our revenue in the 4th quarter. In the machine vision market, we continue our momentum with our Python line of image sensors, and we are seeing a strong demand for our power integrated modules in the solar market. We saw noticeable strength in our medical imaging business in the 4th quarter. Addition of medium and high voltage MOSFETs and IGBTs from Fairchild should help us accelerate our growth in the industrial market. Revenue in the Q1 for the industrial end market is expected to be up quarter over quarter.
The communications end market, which includes both networking and wireless, contributed revenue of approximately 279,000,000 dollars and represented approximately 22% of our revenue in the Q4. In the smartphone market, we benefited from ramp of new platforms by global and Chinese OEMs. We are seeing increasing adoption of fast charging in USB Type C and smartphone market, and we are well positioned to benefit from accelerated penetration of these technologies. We are leveraging our relationships in the smartphone ecosystem to cross sell Fairchild's products, and customer reception of our combined portfolio has been strong. Revenue in the Q1 for communications end market is expected to be down quarter over quarter.
The computing end market contributed revenue of approximately $147,000,000 and represented approximately 12% of our revenue in the 4th quarter. As there are many common participants in the PC, server and cloud markets, we are leveraging our relationships in the PC market to win designs for Fairchild's server and cloud related products. We expect that server and cloud could be a growth driver for our computing revenue. Revenue in the Q1 for computing end market is expected to be down quarter over quarter. The consumer end market contributed revenue of approximately 179,000,000 and represented approximately 14% of our revenue in the 4th quarter.
Revenue in the Q1 for consumer end market is expected to be down quarter over quarter. In summary, I'm very excited about our prospects in the current year and beyond. Fairchild integration is off to a solid start and progress thus far has exceeded our plans. Customer interest in the portfolio of the combined company appears to be very strong and we are seeing early evidence of positive revenue synergies. We expect to generate strong free cash flow and aggressively delever our balance sheet.
Now I would like to turn it back over to Bernard for our forward looking guidance. Bernard?
Thank you, Keith. Based on product looking trends, backlog levels and estimated turns levels, we anticipate that whole on semiconductor revenues will be approximately $1,215,000,000 to 1,265,000,000 dollars in the Q1 of 2017. Backlog levels for the Q1 of 2017 represent approximately 80% to 85% of our anticipated 1st quarter revenue. We expect inventory at distributors to be flat quarter over quarter on a dollar basis. We expect total capital expenditures of approximately $60,000,000 to $70,000,000 in the Q1 of 2017.
For the Q1 of 2017, expect GAAP gross margin in the range of 33.4% 34.8% and non GAAP gross margin in the range of approximately 34% to 36%. Factory utilization in the Q1 is likely to be down sequentially. We expect total GAAP operating expenses of approximately $302,000,000 to $330,000,000 Our GAAP operating expenses include the amortization of intangibles, restructuring, asset impairments and other charges, which are expected to be approximately $31,000,000 to $45,000,000 We expect total non GAAP operating expenses of approximately $271,000,000 to 2.80 $5,000,000 We anticipate 1st quarter GAAP net other income and expenses, including interest expense, will be approximately $37,000,000 to $41,000,000 which includes non cash interest expense of approximately $4,000,000 to 6,000,000 dollars We anticipate our non GAAP net other income and expense, including interest expense, will be approximately $33,000,000 to 35,000,000 dollars Cash paid for income taxes in the Q1 of 2017 is expected to be approximately $16,000,000 to 20,000,000 dollars First quarter cash tax payment is anticipated to be significantly higher than the remaining quarters of 2017, primarily due to the required timing of payments for prior year's taxes for certain of our non U. S. Subsidiaries.
We expect full year 2017 cash paid for income taxes to be approximately 10% of 2017 non GAAP pre tax income. We also expect share based compensation of approximately $15,000,000 to 17,000,000 dollars in the Q1 of 2017, 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 Q1 of 2017 is expected to be approximately 424,000,000 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 Forms 10Q and Form 10 ks.
With that, I would like to start the Q and A session. Thank you. And Brian, please open the line for questions.
My pleasure, sir. Our first question will come from the line of Chris Donley with Citigroup. Please proceed.
Hey, thanks guys. Now that you and Fairchild are officially joined at the hip, can you just talk about the sort of combined OpEx and revenue seasonality trends for the rest of the year?
So in general terms, as we have said, we are ahead of our plan in achieving synergies. And as Keith said in the prepared remarks, we'll keep the ON expenses the ON legacy expenses pretty much in control and continue delivering the OpEx synergies as we have planned.
On the revenue side, one of the things to watch is the increased content as a percentage on the wireless side. So there is still going to be some seasonality that looks consumer like, but we think it's going to be much more moderated. So the Q1, as you can see, a little less than 2% sequential. You should still see strong growth in the second and third quarters, and then the 4th quarter should be approximately flat. So it will have some additional content from the handset side, but in general, be much more muted in the Q1.
Great. And for my follow-up, Bernard, can you just be
a little more specific on the OpEx? Do you think that this level in terms of dollars you can go down from here?
Or should we expect it
to go up and then but less than sales?
So right now, we're guiding for the Q1 to go down. It will be going down to a midpoint of $278,000,000 which is $3,000,000 less than in the Q4 of the total OpEx.
Okay. Thanks.
Thank you. Our next question will come from the line of Vivek Arya with Bank of America. Please proceed.
Thank you for taking my question and congratulations on the good results. First question on the pricing environment, number of your peers in semis have spoken about a more favorable pricing environment. Are you seeing that also? And I just want to see if there is a way to tie if the improvement is there to your target of getting 40% gross margin at some point?
Yes. We are seeing an improved environment, a little less pressure out there. We still do our annual contract renegotiations in the Q1, so there's still some ASP pressure. But as far as the relative performance, it's much lighter than it's been than the last year. So our pricing has typically been down 1% to 2% per quarter.
And as that lessens, of course, it would help us significantly on our gross margin
expansion. Thanks. And for my follow-up, you did just over $718,000,000 or so in image sensors last year, which was down somewhat versus the prior year. I understand there is a good part of image sensors, which is tied to autos and there is a bad part, which is tied to phones and consumers that you have been deemphasizing. Could you help us quantify what the proportions are?
And when do you think the headwinds on the bad part will be over, so you can start growing the segment in line with the growth trends that it's exposed to?
Yes. Our automotive portion grew in excess of 25 percent last year. The declines were all coming out of the consumer and consumer like applications. We expect most of this, if not all of this, to be behind us in the Q1. So you should see overall market results going forward.
Okay. Thank you.
Thank you. Our next question will come from
the line of
Chris Casa with CLSA. Please proceed.
Yes. Thank you. Good morning. The first question, wonder if you could expand on some of your comments about the better seasonality in the Fairchild's part of your business. What specific areas were driving that better seasonality?
And then also, I believe that you're still counting the Fairchild revenue on a sell in basis. Could you give some color on the sell in versus sell through in that Fairchild part of the business?
Okay. On the better seasonality in the Q4, really saw a little more strength than normally Fairchild sees in that handset segment and broadly based in their distribution businesses.
And from the revenue recognition, indeed, Chris, Fairchild is on a sell in mode. We do not intend to change them to sell through. As a matter of fact, we are in the process of continuing with our improvement in the way to estimate shipping credit and at some point of time and we'll announce it, we will convert the whole company to sell in.
Right. But just following up on that, I guess, if you could maybe talk about the distributor inventory from Fairchild and I guess just that better seasonality, it wasn't driven by the distributor inventory going up that actually it was end demand. Is that your view?
It was actually end demand. Inventories distributor inventories for Fairchild products were flat quarter over quarter as compared to Q3.
Great. Okay. And just as another follow-up, your commentary indicated you're going to start in sourcing some of the Fairchild back end business, I think you said by the end of the year. Could you talk about the timing of when that starts to impact your margins and perhaps give us some details about the magnitude of that?
Yes. It will primarily be in 2018 starting with the Q1.
All right. Thank you.
Thank you. Our next question will come from the line of Craig Ellis with B. Riley. Please proceed.
Thanks for taking the question and congratulations on the strong results guys. Keith, I wanted to start following up on some of your prepared comments with regards to what you're hearing from customers. You said that some of them are talking about increased demand. Can you be more specific in terms of end market areas and geographies where the team is seeing that uptick? So those are very broad based comments.
We're seeing that broadly. I will say that very strong feedback coming from the industrial side of the business where the combined company now has some pretty significant leverage, also from the communications sector and to a lesser extent the automotive sector. Thanks. And then the follow-up, going through the businesses, it was clear that there's just a range of revenue opportunities for the combined company, whether it's cross selling and PC and wireless, potential for distribution share gain, revenue synergies down the road. Can you rank the top revenue opportunities with the combined company as it would impact this year's growth that you see for 2017?
The distribution side certainly I think is a significant opportunity, but it crosses all market segments. So it's not limited to a specific segment. Relative to what we've seen so far on upsides, I would say, the handsets and industrial would be the 2 leading areas.
Thanks, guys.
Thank you. Our next question will come from the line of John Pitzer with Credit Suisse. Please proceed.
Yes, good morning guys. Thanks for me asking the question. Keith, just a little bit more detail on the Fairchild handset strength. I'm just kind of curious to what extent you kind of view this content gain? Was there any geographical patterns that you could sort of highlight on the Fairchild strength in the calendar Q4 would be helpful?
Yes. Clearly content gains on the rapid charging front, we see that globally. We also saw Fairchild picking up significantly in the China based handsets over previous cycles. And so those two factors together are providing upside.
That's helpful. And then as my follow-up guys, just as you think about moving the core ON business from a sell through to a sell in model this year, Can you help us understand how that might impact sort of the quarterly revenue patterns? Kind of what's the strategy to mitigate the impact of that change in revenue rec and when in this calendar year do we expect it to hit the most?
So in general terms, I don't expect any significant change. Our change in distribution inventory, which drove the sell through adjustment, has been fairly moderate over the last several quarters. It normally if you look at it historically, it has been a very modest amount. As far as timing, we are still in discussions with our auditors and as soon as we are ready, we'll announce it. I expect it to be somewhere in the first half of this year, but that's dependent upon us completing certain tasks.
Thanks guys.
Thank you. Our next question will come from the line of Tristan Gerra with Baird. Please proceed.
Hi, good morning. Given the very low inventories in the channel, what's the potential for the channel to
rebuild inventories ahead of the
second half? And if so, what's the mix shift or even pruning and which will also of some mix shift or even pruning and which will also help your margin profile?
We normally do see a modest uptick in distribution inventories in the Q1 as they prepare for 2nd quarter and third quarter ramps. It is it's not substantial, but it could be up 5% or so in a normal environment. Their motivation very much they're driven now by the return on working capital. And so I think there's a lot of discipline out there to prevent overstocking. And right now, I think you'll see the economic trends maybe plus a little bit in the first half, but nothing more significant than that.
Okay. And what type of utilization rate do you expect in Q1 that's embedded in your guidance?
Low 80s.
Great. Thank you.
Thank you. Our next question will come from the line of Ross Seymore with Deutsche Bank. Please proceed.
Guys. Just wanted to follow-up on that last question. I was a little surprised your utilization was going down in the March quarter just given the preparation for normal strong seasonality in the second and third quarter. Can you just describe why that decision is being made?
Yes. It's not significantly down, but it is down. We have we take the opportunity, That takes a little bit of the capacity out while we're doing that.
And then I guess as a follow-up on the OpEx side of things. Bernard, last quarter on the call, we talked about OpEx to revenue and there was some debate about 22% or slightly less than that 21% etcetera. Is that a framework that you could update us on?
We'll basically be updating you on that at the Analyst Day. Right now, what I can say is that in the Q1, our guidance is $278,000,000 and it's down from the Q4.
Great. Thank you.
Thank you. Our next question will come from the line of Steve Smiggy with Raymond James. Please proceed.
Great. Thanks a lot guys and congrats on a nice start to Fairchild and the good beat and raise here. Just wanted to ask about auto a little bit further. Is it fair to say that that's probably going to be your strongest growth driver this year? And if so, without pinning you down, can you give us some sense of what the range of growth might be for 2017?
Yes. So it should be our strongest area, and we're looking for something in the high single digit growth rate for the year.
Okay, great. And as my follow-up on that, typically on auto, I think you get to see platforms well in advance. So is it fair to say that given the design wins you're seeing, we would expect 2018 could be a pretty solid year there as well? And just a housekeeping item for the tax rate, does that 10% extend into calendar 2018 as well? Thanks.
So on the auto side, yes, we do get to see those in advance and we continue to be excited by our building backlog there on the design win inventory. So things should continue strengthening into 2018.
And on the tax rate question, we have said in the past and continue saying that our tax rate will inch itself to about 10% to 12%. So in 2018, it will be probably a little bit higher than 10%.
Okay, great. Thanks.
Thank you. Our next question will come from the line of Rajvindra Gill with Needham and Company. Please proceed.
Yes. Thanks for taking my questions and congrats as well. So if I look at the core Fairchild the core ON business in 2016 is a little bit probably slightly down, most likely flat for 2016. As we but in exiting in Q4, it was up about 7% year over year. So the growth rate is kind of reversing course and accelerating.
Can we talk a little bit about what you are thinking about in terms of the kind of long term growth rate for the core on semiconductor business or is that no longer relevant now that we have cross selling opportunities with Fairchild?
Noah, it's relevant. And we were roughly flat last year. And basically what we did was we were withdrawing from the consumer portions of the image sensor business and that was offset by growth in the rest of Core On. And so that led to kind of the flattening for the totals. What we actually see is continued share gain in the markets that we're pursuing.
And I would expect that shift, as we mentioned in the image sensor piece, to be over this year. So you should see us growing at faster than the overall semiconductor market rates.
Great. So we've seen strong growth in 2016 out of automotive, communication and computing numbers that are in the 15%, 16% range for the business. If we look at Automotive specifically, can you talk a little bit about ADAS and the number of kind of camera based image sensors that are going to be proliferated in these vehicles over the next 1 to 2 years or 3 years? And how your kind of competitive position is in that market? Because it seems like the proliferation of ADAS systems are going to generate a significant amount of cameras?
Yes, they are. We believe we've been winning about 70% of the ADAS cameras for the new platforms based on the design win feedback we get from our customers. And we believe that that portion of the market again will be growing greater than 25% a year. So we're expecting extremely strong growth from cameras. The exact number of cameras per car is going to vary by model line and location around the world, but that 25% kind of increase per year is a great baseline to use.
And Bernard, last question and then I'll step back in the queue. Before you had mentioned the free cash flow combined basis is expected to be about $500,000,000 to $600,000,000 in 2017, dollars 700,000,000 in 2018 and $800,000,000 in 2019. It just seems based on the kind of preliminary numbers in Q1 that actually the cash flow could be for this year could be higher than that, higher than the $500,000,000 to $700,000,000 or maybe on the upper end of the range. Can you talk a little bit about that, the cash flow?
We are relatively excited about the free cash flow opportunities. We think again we can be in that $500,000,000 to $600,000,000 and obviously the higher the better. But we are very confident with our prospects and execution on Fairchild that we should be able to get definitely within that range.
Okay, great. Thank you.
Thank you. Our next question will come from the line of Mark Delaney with Goldman Sachs. Please proceed.
Yes, good morning and thanks very much for taking the questions. First question is a follow-up on the Fairchild synergies. You talked about making very good progress with those. Is it just that you're going to be able to realize some of the cost synergies earlier than you previously anticipated? Or should we think about upside to the total dollar amount of the Fairchild cost synergies?
Well, we clearly are getting things earlier. We uncover more opportunities as we go along, and I would expect at the right time, we'll be
You said above seasonal for you said above seasonal for some of the Fairchild parts. Do you have any visibility about how well the shipments that ON was making in the Q4 into the handset market, especially China have been able to sell through, especially now that we've gone through the remainder?
Yes. We have seen no inventory backup in that area. And a part of the perhaps a little better Q1 seasonality than normal is because there wasn't the normal clog up in the China market.
That's helpful. Thank you very much.
Thank you. Our next question will come from the line of Sean Harrison with Longbow Research. Please proceed.
Hi, good morning and congrats on
the results. Just wanted to follow-up on the synergies question. I think last time you said you were beyond $75,000,000 of OpEx synergies realized and I think around $30,000,000 of COGS synergies, but where are we at, I guess, in earning 2017 on that number?
We're still very confident about achieving the $160,000,000 as we have been reiterating in our discussions. And as Keith said, we are a little bit ahead of pace, but definitely confident about the 160
Okay. And then a brief, I guess, follow-up, twofold. 1, just the CapEx expectation for the year and second, we've been hearing a lot more about wireless charging maybe becoming a bigger thing
in the market in 2017. If you could talk about just what you're seeing in wireless charging, please? So on the CapEx expectation, our 6% to 7% of revenue model continues being the one we're using.
On the wireless charging side, certainly we are seeing more interest on the high end phones and some rumors of maybe some major platforms. I'm afraid we're going to have to wait for those announcements to
say more. Thank you. Our next question will come from the line of Chris Rolland with Susquehanna. Please proceed.
Hey guys, congrats on the quarter. So you guys mentioned Fairchild's server power. You guys said that you suspected it could be a growth area for you guys. If you could maybe expand there and then also talk about the upcoming Pearly release, do you get any additional content gains there? Thanks.
Yes. So we think we've got an opportunity for about $25 to $30 per server. And for us, it will be all share gains since there was no prior participation. We do see design wins there. I think it's too early to call market share overall, but we should see some nice growth this year in that server area.
Okay, great. And your comments about early evidence of revenue synergies, I don't know if you guys can quantify that. If you can't, that's fine. But perhaps you can talk anecdotally or give some examples about how you guys are generating these top line synergies. Are they like combinations of product sets or sales teams or new distribution channels that maybe Searchout had that you guys didn't?
Or are they direct relationships? How are you how do you think you're going to be able to generate those top line synergies?
Well, they're coming across very broadly. So in many cases, you do have sales teams that had exposure to different portions of our customers' business and that's having a positive impact. In some cases, just our ability to deal with the distribution market was stronger, helping the Fairchild side out. And in many of our industrial customers, they were perhaps more of a Fairchild long term customer. Now getting exposure to the offerings from on has created opportunities.
So it's very broad based and as we said, very encouraging after the Q1.
Great. Well, congrats on the progress. Nice quarter.
Thank you.
Thank you. Our next question will come from the line of Kevin Cassidy with Stifel. Please proceed.
Thanks for taking my question. On image sensors, you had said that it was up 25% for the automotive. Can you say what percentage of revenue automotive represents?
Approximately 20%.
Okay. Do you have exposure to the drone market?
Yes, we do. It's still very small.
Okay. And then on the dollar content in servers, how does that compare to dollar content in PCs?
It's higher. So not quite double, but around double.
Okay, great. Thank you.
Thank you. Our next question will come from the line of Harsh Kumar with Stephens Inc. Please proceed.
Hey, guys. Congratulations on great quarter and guidance. I was wondering, you mentioned that you're tracking ahead of synergies so far. I was wondering if you could give us an update on perhaps what are some of the big blocks that need to be accomplished in 2017 with Freightchild?
So the bigger one in 2017 per se is the completion of the integration of our ERP systems towards the end of the year. And there is still some rationalization of some of the R and D expenses that we're going through. Those are the major 2. As we've talked about in the prepared remarks, we should also start seeing some of the benefits on the COGS side for in sourcing towards the end of the year, but it's mostly a 2018 phenomenon.
Got it. Thank you. And then, some of the other companies that have reported, Keith, have talked about worse than normal seasonality because of some handset delays, a couple of handsets in China, one company has said and then one in Korea. I was wondering, you just mentioned that your comm business will be down sequentially, which is expected. But I was wondering if you are seeing worse than normal seasonality as well?
No, we are not. We're definitely not seeing worse than normal. I think it has the potential to be slightly better than normal.
Great. Thanks.
Thank you. Our next question will come from the line of Harlan Sur with JPMorgan. Please proceed.
Hey, good morning and congratulations on the solid results. With the 2 weeks now post Chinese New Year's, and I know you guys just talked about trends in the handset segment, I wanted to just get your views on the sell through trends coming out of that across the industrial and auto end markets in China?
Okay. Our actually our post Chinese New Year activity picked right back up to where it was pre Chinese New Year. So very solid and encouraging for not only this quarter, but the buildup for Q2.
Thanks for the insights there. And one of your competitors, they're a top 5 supplier of power MOSFETs. I think they've talked recently about having supply constraints within their business as they transition their manufacturing operations, both in the December quarter and here in the March quarter. Wondering if the ON team has been able to pick up some design win share as a result of some of these perturbations?
Yes. Normally those perturbations are really tactical. They're not so much design win, but where you're sharing market share, you'll pick up a little bit more if one of your competitors has some hiccups. And I would put it more in that category rather than a real design change.
Okay, great. Thank you.
Thank you. Our next question will come from the line of Craig Hackingbach with Morgan Stanley. Please proceed.
Yes, thank you. Question on gross margin. Can you talk about the performance of Fairchild's gross margin in the December quarter? And then as you go forward, just kind of the mix between utilization benefits as well as end market mix, what you see as the biggest driver for gross margins?
Sure. So we don't disclose separate gross margin for Fairchild as we have now really totally integrated them within our numbers. But in general terms, when we look at it, it should be at or better than what we were expecting.
Okay. And then just in terms of drivers from here, can you talk about the influence of
The drivers are the same that we have mentioned. It's the 50% fall through on incremental revenue throughout the year. It's the mix changes as we continue shifting our production and our revenues towards higher gross margin areas like automotive, industrial and comm. It is also the benefit of the synergies that we are talking about the size and scale.
And then as my follow-up, Keith, on you mentioned industrial a couple of times in terms of strength. Can you talk about just seasonality in terms of the first half of the year tends to be strong versus just any inflection you're seeing from a customer demand perspective?
Normally, you do see a pickup Q2 and a little bit in Q1. So usually first half is a little stronger than second half for industrial. I do think that market itself is growing moderately from a GDP perspective, but we should see some customer gains per the synergies we talked about on the revenue line.
Okay.
Thank you. Thank you. We have follow-up questions from the line of Ross Seymore with Deutsche Bank. Please proceed.
Hi, guys. Thanks for letting me end the queue again. Just wanted to get a little more detail on the deleveraging goal. I know you paid down that $445,000,000 convert post the end of the first or the Q4, but can you just talk a little bit about the progression going forward, the goals you're shooting for and what the blended interest rate is going to be?
Sure, Ross. Thank you. So our plan, our stated plan is to delever to a target of about 2x net leverage, which pretty much should take us the brunt of the next couple of years and we'll be aggressively pursuing it with the nice free cash flow that we should be generating every quarter.
And the blended interest rate that you guys are going to have now going forward?
So the blended interest rate is somewhere in that. Our major tranche is the term loan B, which is LIBOR plus 3.25%, so it's about 4%. All the others are at about or lower than that. So in general terms, close to 4%.
And I guess as my last follow-up, because of the comps being a little bit difficult looking backwards, that 2 times net leverage that you're talking about a couple of years out, where does that stand now in your definition of the EBITDA from the prior year?
So if you do it with the pro form a for Fairchild on a full year basis and the synergies, you're looking at somewhere under 3 times on the net leverage.
Perfect. Thanks guys.
Thank you. There are no further questions in the queue. So at this time, I would now like to hand the call back over to Parag Agrawal, Vice President of Corporate Development and Investor Relations for closing comments or remarks. Sir?
Thank you for joining
the call today. We look forward to seeing you at our Analyst Day on March 10. Thank you. Bye bye.
Ladies and gentlemen, thank you for your participation on today's conference. This does conclude the program and you may all disconnect. Everybody have a