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Edited Transcript of ON earnings conference call or presentation 5-Aug-19 1:00pm GMT

Q2 2019 ON Semiconductor Corp Earnings Call

PHOENIX Aug 30, 2019 (Thomson StreetEvents) -- Edited Transcript of ON Semiconductor Corp earnings conference call or presentation Monday, August 5, 2019 at 1:00:00pm GMT

TEXT version of Transcript

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Corporate Participants

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* Bernard Gutmann

ON Semiconductor Corporation - CFO, Executive VP & Treasurer

* Keith D. Jackson

ON Semiconductor Corporation - CEO, President & Director

* Parag Agarwal

ON Semiconductor Corporation - VP of IR

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Conference Call Participants

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* Anthony Joseph Stoss

Craig-Hallum Capital Group LLC, Research Division - Partner & Senior Research Analyst

* Christopher Caso

Raymond James & Associates, Inc., Research Division - Research Analyst

* Christopher Adam Jackson Rolland

Susquehanna Financial Group, LLLP, Research Division - Senior Analyst

* Christopher Brett Danely

Citigroup Inc, Research Division - MD

* Craig Andrew Ellis

B. Riley FBR, Inc., Research Division - Senior MD & Director of Research

* Craig Matthew Hettenbach

Morgan Stanley, Research Division - VP

* Harlan Sur

JP Morgan Chase & Co, Research Division - Senior Analyst

* Harsh V. Kumar

Piper Jaffray Companies, Research Division - MD & Senior Research Analyst

* Jamison Yeol Phillips-Crone

BMO Capital Markets Equity Research - Associate

* Mark Trevor Delaney

Goldman Sachs Group Inc., Research Division - Equity Analyst

* Matthew D. Ramsay

Cowen and Company, LLC, Research Division - MD & Senior Technology Analyst

* Rajvindra S. Gill

Needham & Company, LLC, Research Division - Senior Analyst

* Ross Clark Seymore

Deutsche Bank AG, Research Division - MD

* Shawn Matthew Harrison

Longbow Research LLC - Senior Research Analyst

* Tristan Gerra

Robert W. Baird & Co. Incorporated, Research Division - MD and Senior Research Analyst

* Vijay Raghavan Rakesh

Mizuho Securities USA LLC, Research Division - MD of Americas Research & Senior Semiconductor Analyst

* Vivek Arya

BofA Merrill Lynch, Research Division - Director

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Presentation

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Operator [1]

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Good day, ladies and gentlemen. Welcome to the ON Semiconductor Second Quarter 2019 Earnings Conference Call. (Operator Instructions) As a reminder, this call may be recorded.

I would now like to introduce your host for today's conference, Parag Agarwal, Vice President of Corporate Development and Investor Relations. Please go ahead.

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Parag Agarwal, ON Semiconductor Corporation - VP of IR [2]

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Thank you, Chris. Good morning and thank you for joining ON Semiconductor Corporation Second Quarter 2019 Quarterly Results Conference Call. I'm joined today by Keith Jackson, our President and CEO; and Bernard Gutmann, our CFO. The call is being webcast on the Investor Relations section of our website at www.onsemi.com.

A replay of this broadcast along with our earnings release for the second quarter 2019 will be available on our website approximately 1 hour following this conference call, and the 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 certain non-GAAP financial measures. 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 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-Ks, Form 10-Qs and other filings with Securities and Exchange Commission. Additional factors are described in our earnings release for second quarter of 2019. Our estimates or other than forward-looking statements 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.

During the third quarter, we will attend Jefferies 2019 Semiconductor, Hardware and Communications Infrastructure Summit in Chicago on August 27, Citi Global Technology Conference in New York on September 5 and Deutsche Bank Technology Conference in Las Vegas on September 10.

Now let me turn it over to Bernard Gutmann, who will provide an overview of our second quarter 2019 results. Bernard?

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Bernard Gutmann, ON Semiconductor Corporation - CFO, Executive VP & Treasurer [3]

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Thank you, Parag, and thank you, everyone, for joining us today.

Geopolitical and macroeconomic factors impacted our second quarter revenue. Sharper-than-expected broad-based inventory correction, especially in the automotive market, was the driver of lower-than-expected revenue in the second quarter. Furthermore, we saw weakness in our communications revenue as we temporarily halted shipments to a major customer to comply with U.S. Federal law.

Despite headwinds to our top line during current cyclical downturn in the semiconductor industry, our execution continues to be solid and we continue to post strong margin and earnings performance. So far, in the current downturn, cyclicality in our revenue and margins has been lower than that of our peer group. Our performance thus far speaks to the transformed nature of our business and our focus on highly differentiated power, analog, sensor and connectivity products for automotive, industrial and cloud power end markets.

Key secular trends in automotive, industrial and cloud power end markets remain intact, and we continue to make prudent investments to strengthen our competitive position in our strategic end markets and to further improve our industry-leading cost structure. Our design win pipeline in key growth areas continues to expand at a rapid pace.

Though the second quarter was challenging from the revenue perspective, current booking trends point towards stabilization in business conditions. Demand trends from automotive customers have stabilized, and bookings from communications customers have improved. We believe that distribution inventory correction should be nearly complete by the end of the third quarter or early Q4 of 2019. Although we are seeing stabilization in demand at lower level of revenue, we're not seeing much evidence of any meaningful recovery in demand.

While we are encouraged by the stabilization in business conditions, we are cognizant of risks arising from unforeseen geopolitical and macroeconomic events, and we are managing our business to adjust to the near-term volatility in demand. We have taken measures to control our operating expenses in line with relatively soft business conditions.

We believe that a highly diversified customer base, exposure to the fastest-growing semiconductor end markets and long life cycle of many of our products should help us better navigate the current slowdown in demand as compared to broader analog and power semiconductor industry. We remain upbeat about our future, and, as I noted earlier, we are making prudent strategic investment to strengthen and build our leadership in key strategic markets and to improve our cost structure.

In the second quarter, we closed the acquisition of Quantenna Communications, which we believe will strengthen our presence in connectivity applications for industrial and automotive end markets. We also recently announced our plans to add the first 300-millimeter fab to our manufacturing network in a phased transaction over the next 4 years. The addition of this fab in a staged process should accelerate our progress towards our 2022 target financial model, enable savings of approximately $1 billion in capital expenditures over the next several years and provide sufficient capacity to support our long-term growth at a highly competitive cost structure.

Now let me provide you details on our second quarter 2019 results. Total revenue for the second quarter of 2019 was $1.348 billion, a decrease of 7% as compared to revenues of $1.456 billion in the second quarter of 2018. The year-over-year decline in revenue was primarily driven by well-publicized macroeconomic and geopolitical factors, which have impacted the overall semiconductor industry.

GAAP net income for the second quarter was $0.24 per diluted share as compared to $0.37 -- $0.35 in the second quarter of 2018. Non-GAAP net income for the second quarter was $0.42 per diluted share as compared to $0.46 in the second quarter of 2018.

GAAP gross margin for the second quarter was 37%. Non-GAAP gross margin for the second quarter was 37.1%. Year-over-year, our second quarter 2019 non-GAAP gross margin declined by 106 basis points primarily due to lower revenue. Despite a meaningful quarter-over-quarter decline in revenue in the second quarter, we delivered solid gross margin performance, with gross margin flat as compared to that in the first quarter.

Our GAAP operating margin for the second quarter of 2019 was 11.7% as compared to 13.5% in the second quarter of 2018. Our non-GAAP operating margin for the second quarter of 2019 was 15.7% as compared to 16.3% in the second quarter of 2018. The year-over-year decline in operating margin was driven largely by lower gross margin.

GAAP operating expenses for the second quarter were $341 million as compared to $358 million for the second quarter of 2018. Non-GAAP operating expenses for the second quarter were $288 million as compared to $318 million in the second quarter of 2018. The year-over-year decline in second quarter operating expenses was driven by aggressive expense control, 0 bonus accrual and the reversal of bonuses accrued in the first quarter of 2018 -- 2019.

Second quarter free cash flow was $69 million and operating cash flow was $222 million. Capital expenditures during the second quarter were $154 million, which equates to a capital intensity of 11%. We exited the second quarter of 2019 with cash and cash equivalents of $885 million as compared to $940 million in the first quarter of 2019. We used to $50 million of cash to repurchase 2.6 million shares of our stock during the second quarter.

At the end of the second quarter, days of inventory on hand were 137 days, up by 9 days as compared to 128 days in the first quarter of 2019. This increase in inventory was driven primarily by the inclusion of Quantenna's results for a few days during the second quarter and by the fair market value step-up of Quantenna's inventory. Had we included Quantenna's results without fair market value step-up for the entire second quarter, our days of inventory at the end of the second quarter would have been 132 days, up 4 days as compared to 128 days in the first quarter. We intend to lower the days of inventory in our balance sheet in the third quarter.

Distribution resales increased meaningfully in the second quarter over the first quarter. Distribution inventory in terms of weeks declined in quarter-over-quarter in the second quarter and is now within our target range of 11 to 13 weeks. We expect to see further reduction in our distribution inventories in terms of days in the third quarter.

As we noted in our previous earnings conference call, we're aggressively managing our distribution inventory to ensure healthy level of inventory and distribution channel. We believe that in addition to secular growth drivers in automotive, industrial and cloud power markets, our proactive management of distribution inventory has been a key reason behind relatively lower level of volatility in our revenue over the last several quarters as compared to volatility in revenue of our peers.

Now let me provide you an update on performance of our business units, starting with Power Solutions Group, or PSG. Revenue for PSG for the second quarter was $701 million, revenue for the Analog Solutions Group for the second quarter of 2019 was $462 million and revenue for Intelligent Sensing Group was $185 million.

Now I would like to turn the call over to Keith Jackson for additional comments on the business environment. Keith?

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Keith D. Jackson, ON Semiconductor Corporation - CEO, President & Director [4]

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Thanks, Bernard. Our execution remains strong despite demand weakness in the overall semiconductor market. In the second quarter, we delivered strong margin and earning performance despite strong headwinds from geopolitical and macroeconomic factors. While the near-term business conditions are tepid, the foundation of our business, with exposure to a secular megatrends in automotive, industrial and cloud power end markets, remain solid. With strong execution discipline, we are well positioned to navigate through the current soft patch in demand.

Much-anticipated recovery in demand conditions has not materialized yet, but current booking trends point towards stabilization of demand trends. Based on commentary from our distribution partners, it appears that ongoing inventory correction in the distribution channel should be nearly complete by the end of the third quarter or early fourth quarter. While we have strong visibility into the distribution channel, geopolitical and macroeconomic factors are difficult to forecast. No matter what direction business conditions take, we are well prepared to respond in an expeditious manner.

Despite the current slowdown in demand, we continue to make prudent investments to strengthen our competitive position and to further improve our industry-leading cost structure. During the second quarter, we announced the completion of our acquisition of Quantenna Communications, a provider of market-leading connectivity semiconductor solutions for WiFi. We believe that connectivity capability is a primary requirement for success in the industrial IoT market.

As we have announced earlier, we intend to leverage Quantenna's market-leading connectivity capabilities to gain technological leadership in the connectivity market for industrial IoT. At the same time, we will continue to invest in Quantenna to grow its carrier business. Current customer feedback has been very positive, and customers are excited about the benefits of the combined technical, financial and market resources of Quantenna and ON Semiconductor will bring to them.

Integration of Quantenna is on track, and the teams are working on product road maps and on achieving synergies targets. Due to ongoing stress -- softness in the semiconductor industry, Quantenna has experienced a slowdown in its businesses as well and is expected to be mildly dilutive in the third quarter. However, as we realize synergies and reduce costs, we expect that Quantenna will deliver targeted accretion.

We're also making strong process towards ramping our production at 300-millimeter East Fishkill fab in upstate New York. Process development for porting our power products has started and is progressing at a rapid pace. We are solidly on track to start shipping our first 300-millimeter power products from East Fishkill fab in 2020. As we've indicated earlier, our 300-millimeter East Fishkill fab accelerates our progress towards our 2022 target model, enables efficiencies in our manufacturing network and further strengthens our industry-leading cost structure. We believe that the ramp of our 300-millimeter production will be a major inflection point in our manufacturing strategy and in our manufacturing cost structure.

Key secular trends driving our business remain intact. Our momentum in our key strategic markets continues to accelerate. We continue to see meaningful increases in our content in automotive, industrial and cloud power applications. We believe that automotive, industrial and cloud power end markets will be among the fastest-growing semiconductor end markets for a long time.

In the automotive market, acceleration adoption of electric vehicles and active safety should drive strong growth in our power semiconductor and sensor businesses. In the industrial market, we are seeing strong traction for our power semiconductors driven by higher power efficiency requirements for industrial systems.

In the cloud power market, we are seeing robust growth for our analog power management products for servers and power semiconductors for 5G infrastructure markets. The current slowdown in demand driven by macroeconomic and geopolitical factors does not change our view on our long-term growth potential.

Now I'll provide details of the progress in our various end markets for the second quarter of 2019. Revenue for the automotive market in the second quarter was $434 million and represented 32% of our revenue in the second quarter. Second quarter automotive revenue declined by 5% year-over-year. Asia, including Greater China, was the primary contributor to this year-over-year decline. Weakness in the U.S. and European automotive markets also contributed to this year-over-year decline.

On a quarter-over-quarter basis, we saw some stabilization in automotive revenue from Greater China region in the second quarter. We expect that year-over-year decline in China light vehicle production units to moderate in the second half of the current year. On a global basis, we expect that global light vehicle production in terms of units will decline by 3% to 4% year-over-year in 2019. U.S. and European automotive units will likely decline by 2% to 3% range year-over-year in 2019.

We continue to see a strong adoption of our products in vehicle electrification, active safety and in various analog power management applications, and our content in automotive applications continues to grow. Content in applications such as EV/HEV, LED lighting and in-vehicle network is growing in a meaningful manner. We're seeing strong customer interest for our silicon carbide products, and our customer engagement is growing worldwide. Customer interest in our silicon carbide modules for traction inverters and onboard chargers has been very strong, and we are engaged with many customers for their upcoming EV platforms.

Demand for our silicon-based power products for vehicle electrification continues to accelerate, and we are seeing strong growth in our power MOSFET business. In the current quarter, we are starting preproduction of high-voltage IGBT modules to support customer ramps in the fourth quarter and in 2020.

In ADAS applications, momentum for our sensor products continues to grow. We continue to gain traction with our portfolio of automotive image sensor products, and our customers are increasingly relying on us to provide them with complete product suite for automotive applications. As I have indicated before, we are the only provider of automotive image sensors with a complete portfolio of 1-megapixel, 2-megapixel, and 8-megapixel image sensor.

Adoption of rear- and surround-view cameras as well as increased volumes from Level 2 and 3 ADAS and autonomous vehicles systems continue to be a catalyst for growth. We continue to grow our strategic engagements for automotive RADAR products, and we have delivered first evaluation samples to our customers.

Our analog power management products for ADAS, instrument clusters as well as in-vehicle networking solutions continue to grow at a healthy rate. Growth within our advanced lighting, power management and LED drivers solutions continues to be strong globally.

Revenue in the third quarter for the automotive end market is expected to be slightly up quarter-over-quarter as opposed to seasonality of sequential decline in revenue.

The industrial end market, which includes military, aerospace and medical, contributed revenue of $363 million in the second quarter. The industrial end market represented 27% of our revenue in the second quarter. Year-over-year, our second quarter industrial revenue declined by 12%. Greater China region has been the primary source of weakness in the industrial market but we have recently seen stabilization in business trends.

We believe that our product offerings for increased power efficiency requirements for the industrial systems will allow us to take advantage of the secular megatrends ahead. We continue to see increased momentum with our mid- and high-voltage power semiconductor products such as FETs and IGBTs and modules in the industrial end market. We continue to see strength in the China solar market with our power modules and IGBTs, and our breadth of customer engagements in China continues to expand.

Within industrial, we are gaining traction in medical with our Bluetooth low-energy products. Our technology and design expertise is well recognized by our customer base, and we expect strong growth in the future. We continue to see strong demand for our products in implantable devices, personal diagnostics and in hearing health markets.

Revenue in the third quarter for the industrial end market is expected to be down quarter-over-quarter due to normal seasonality and ongoing softness in the industrial end market.

The communications end market, which includes both networking and wireless, contributed revenue of $248 million in the second quarter. The communications end market represented 18% of our revenue in the second quarter. Second quarter communications revenue increased by 7% year-over-year. Much of the year-over-year increase was driven by strength in the 5G ramp. Smartphone-related revenue in the second quarter was also up year-over-year. We did not have meaningful revenue from Quantenna in the second quarter as the acquisition closed on June 19.

As noted earlier, our 5G-related revenue in the second quarter was disrupted as we halted shipments to a major customer in accordance with U.S. federal law. We have now resumed partial shipments to this customer in accordance with U.S. law. Despite near-term uncertainty, current engagement with our customers points to meaningful deployment rates for 5G systems in the near to midterm.

On the smartphone front, our revenue grew year-over-year. We expect to see increase in our content in new platforms slated for launch later this year. Revenue in the third quarter for the communications end market is expected to be up quarter-over-quarter due to launch of new smartphone platforms and inclusion of Quantenna's results for a full quarter.

The computing end market contributed revenue of $139 million in the second quarter. The computing end market represented 10% of our revenue in the second quarter. Second quarter computing revenue declined by 7% year-over-year. However, our server business posted very solid growth on a year-over-year basis during the second quarter.

We are seeing a temporary pause in our servers business in the current quarter as customers adjust their inventory levels. In future generations of server platforms, we expect meaningful increase in our content. Revenue in the third quarter for computing end market is expected to be down quarter-over-quarter due to a decline in our client and server businesses.

The consumer end market contributed revenue of $164 million in the second quarter. The consumer end market represented 12% of our revenue in the second quarter. Second quarter consumer revenue declined by 21% year-over-year. The year-over-year decline was due to continuing broad-based weakness in consumer electronics and white goods markets and our selective participation in these markets. Revenue in the third quarter for the consumer end market is expected to be down quarter-over-quarter.

In summary, thus far in the current downturn, cyclicality in our revenue and margins has been lower than that of our peer group. Our performance speaks to the transformed nature of our business and our focus in highly differentiated power, analog, sensor and connectivity products for the automotive, industrial and cloud power end markets. We are seeing stabilization in business trends in our key markets. However, demand continues to be sub-seasonal as macroeconomic and geopolitical factors continue to weigh on in demand. We believe that ongoing distribution inventory correction should be nearly complete by the end of the third quarter or early fourth quarter 2019.

Despite current weakness in the business trends across the industry, secular megatrends driving our business remain intact and we are upbeat about our medium- to long-term prospects. We are focused on the fastest-growing end-markets of the semiconductor industry. And with our design wins, we expect that our content in automotive, industrial and cloud power applications will continue to grow. To adjust to slowing macroeconomic environment, we are currently are prudently managing our business with sharp focus on controlling expenses. Our operational execution remains solid.

Now I'd like to turn it back over to Bernard for forward-looking guidance. Bernard?

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Bernard Gutmann, ON Semiconductor Corporation - CFO, Executive VP & Treasurer [5]

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Thank you, Keith. Based on product booking trends, backlog levels and estimated turn levels, we anticipate that total ON Semiconductor revenue is expected to be in the range of $1.355 billion to $1.405 billion in the third quarter of 2019.

For the third quarter of 2019, we expect GAAP gross margin to be in the range of 35.2% to 36.2%, and non-GAAP gross margin to be in the range of 36.7% to 37.7%. We expect total GAAP operating expenses of $349 million to $369 million. Our GAAP operating expenses include the amortization of intangibles, restructuring, asset impairments and other charges, which are expected to be $34 million to $38 million.

We expect total non-GAAP operating expenses of $315 million to $331 million in the third quarter. The quarter-to-quarter increase in operating expenses for the third quarter over those of the second quarter is driven primarily by the inclusion of Quantenna's results for the full quarter, process transfer costs related to the 300-millimeter fab at East Fishkill, annual merit increase and the absence of bonus reversal, which significantly lowered second quarter operating expenses.

We expect to see a meaningful decrease in Quantenna-related operating expenses as we realize target synergies and reduce costs. Offsetting increase in third quarter operating expenses are savings resulting from tight operating expense controls.

We anticipate third quarter of 2019 GAAP net other income and expense, including interest expense, will be $38 million to $41 million, which includes noncash interest of $9 million to $10 million. We anticipate our non-GAAP net other income and expense, and including interest expense, will be $29 million to $31 million.

Net cash paid for income taxes in the third quarter of 2019 is expected to be $11 million to $15 million. We expect total capital expenditure of $125 million to $135 million in the third quarter of 2019. We also expect share-based compensation of $21 million to $23 million in the third quarter of 2019, 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 third quarter of 2019 is expected to be 414 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 Chris, please open up the lines for questions.

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Questions and Answers

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Operator [1]

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(Operator Instructions) And our first question comes from the line of Ross Seymore with Deutsche Bank.

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Ross Clark Seymore, Deutsche Bank AG, Research Division - MD [2]

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As for my first one, one for Keith. I know you guys are guiding to basically the same sort of sub-seasonality by about 5 points as everybody else, but last quarter you talked about an improvement in bookings that gave you confidence in the back half. Now you're talking more about a stabilization and you think the inventory correction is going to be done at the end of this quarter or next. I guess what changed quarter-over-quarter? Is it just the obvious trade war tensions rising? And what gives you the confidence that the projection this time is something that you're willing to make after last time proving too optimistic?

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Keith D. Jackson, ON Semiconductor Corporation - CEO, President & Director [3]

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Yes. I think without question, 2 things happened during the second quarter. The geopolitical piece was much more pronounced than anticipated. And as the quarter went on, as you are aware, those impacts got more significant.

The second piece is we did see more inventory correction going on than we had anticipated based on backlog trends going into the quarter at some of the OEM sides as well. So the combination weakened during the quarter, and I think that's what led to the results we had. As we look forward in dialogue with the customers and looking at what's going on geopolitically, things have been stabilizing more. Certainly, the biggest impact from U.S. sanctions, we believe, we comprehend at this stage, which we did not have going into the second quarter. And so we've got more confidence in what I would call stabilization at this point.

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Ross Clark Seymore, Deutsche Bank AG, Research Division - MD [4]

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That's great. And as to my follow-up question, one for Bernard on gross margin and inventory. I know you talked about bringing inventory down in the third quarter. Can you talk a little bit about what that's doing to your gross margin in the near term? And now that we have the GLOBALFOUNDRIES acquisition, the 300-millimeter fab as well as the Quantenna acquisition, talk about the path to the low-40s gross margin target. Does that get expedited? Any sort of updates on the steps we should follow over the next year or so towards that 43% target you laid out at your analyst meeting?

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Bernard Gutmann, ON Semiconductor Corporation - CFO, Executive VP & Treasurer [5]

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Sure, Ross. Thank you. So inventory correction in the third quarter -- internal inventory correction is expected to occur but on a mild basis. We don't expect that, that will have a significant impact on our gross margin. And as you can, see our guidance for overall gross margin is slightly better sequentially than Q2. Definitely, the -- both the acquisitions that we announced this quarter of Quantenna and of the phased approach for East Fishkill should be tailwinds that will help us achieve our gross margin targets for 2023. So we feel pretty good about those. And we'll continue with our normal 50% fall through on incremental revenue. And in the short term, this been a little bit of a headwind, but we expect that as the inventory correction in the secular drivers take course, we expect that will continue also being a significant help.

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Operator [6]

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And our next question comes from the line of Chris Danely with Citigroup.

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Christopher Brett Danely, Citigroup Inc, Research Division - MD [7]

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I guess one more question on macro. At least according to Twitter, we've got another $300 billion in tariffs coming down the pike here in the next month. How do you think that impacts you guys? And did your guidance change after the update came? Or do you think that, that could be a little bit of downside out there?

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Keith D. Jackson, ON Semiconductor Corporation - CEO, President & Director [8]

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We saw the tweets as well and the reactions to it. I think our belief is that this is comprehended in the guidance that we've given. They are tariffs and the tariffs themselves have not been the issue for our revenues so far. What we expect to see is potentially some market share changes from our customers as a result of this. But the overall end markets, I would not expect significant destabilization.

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Christopher Brett Danely, Citigroup Inc, Research Division - MD [9]

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Okay. Great. And then for my follow-up, just to drill down on a couple of Ross' questions. So on inventory, what's the -- I guess, the goal for your internal inventories and when do you think would get there? And then on OpEx, can we expect OpEx to drift down on a dollars basis for the next couple of quarters as you guys start to squeeze some synergies?

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Bernard Gutmann, ON Semiconductor Corporation - CFO, Executive VP & Treasurer [10]

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Let me answer them in reverse. The OpEx, we expect those to stabilize and then in 2020 comes down as we get the benefits of the synergies that we talked about for Quantenna, which we talked about being $26 million, about $16 million of those in OpEx and about $10 million in COGS. The inventory goal in the midterm, I expect those to come down to about 120 days. And right now we are at 132 when you pro forma that out for Quantenna's full -- like a full quarter.

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Operator [11]

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And our next question comes from the line Vijay Rakesh with Mizuho.

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Vijay Raghavan Rakesh, Mizuho Securities USA LLC, Research Division - MD of Americas Research & Senior Semiconductor Analyst [12]

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Just a couple of questions. On the -- when we look on the China side, just wondering what your content is on the -- on autos in general in China now and how do you see the EV market going into next year.

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Keith D. Jackson, ON Semiconductor Corporation - CEO, President & Director [13]

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On EV, we expect continued growth despite the macroeconomic conditions and number of cars sold globally. We expect that percentage will continue to rise and it will be led in China. So we would be expecting some recovery there in China for automotives on that basis. Globally though, we're not looking for a large pickup in total units of cars sold.

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Vijay Raghavan Rakesh, Mizuho Securities USA LLC, Research Division - MD of Americas Research & Senior Semiconductor Analyst [14]

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And in terms of content in the...

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Keith D. Jackson, ON Semiconductor Corporation - CEO, President & Director [15]

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From a content perspective, for the electric vehicles, it's up to about $400 per battery car. And then if you move to a Level 2 ADAS systems, you get another $150 per car from a year-on-year basis. So pretty significant content changes.

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Vijay Raghavan Rakesh, Mizuho Securities USA LLC, Research Division - MD of Americas Research & Senior Semiconductor Analyst [16]

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Got it. And I don't know if you've talked about content as contribution in the September quarter, and I assume that is again well above your corporate rate, right?

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Bernard Gutmann, ON Semiconductor Corporation - CFO, Executive VP & Treasurer [17]

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So in Quantenna, we are not disclosing the details. We normally don't disclose customers or individual sub-end markets. It will be integrated within our ASG group. And we believe we are on track with the synergy and the integration plans. And as we mentioned in the call, the market for WiFi has also suffered the same weaknesses on a macroeconomic and inventory corrections, and therefore we talked about being mildly diluted in the third quarter but on plan with the long-term plans.

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Operator [18]

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And our next question comes from the line of Vivek Arya with Bank of America Merrill Lynch.

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Vivek Arya, BofA Merrill Lynch, Research Division - Director [19]

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I'm curious how you're managing utilization in Q3 and what will help growth margins recover from here. Will it be an improvement in mix? Are there any other operational things that you are putting in place? It was good to see gross margin kind of hold in there in Q2, but I'm just wondering what other drivers from here on to your longer-term goals.

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Bernard Gutmann, ON Semiconductor Corporation - CFO, Executive VP & Treasurer [20]

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The same ones that we have elaborated in the Analyst Day for the long term: the mixed effect, the fall through in the incremental revenue, manufacturing cost savings, some divestitures in small scale. And we also talked about the 2 different -- the 2 acquisitions we just closed in this quarter, Quantenna should be accretive to gross margin and so should the East Fishkill acquisition. In the short term, we also take normal tactical cost reductions, more insourcing and tighten the belt just on discretionary spend even at the COGS level, and that should also help us shore up the numbers in the short term.

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Vivek Arya, BofA Merrill Lynch, Research Division - Director [21]

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Okay. And then on the computing business for Q3, I believe, Keith, you mentioned it could be down. I'm trying to reconcile back with stabilization in the PC market and just the growth, because a new CPU is coming out in Q3. Could you give us a sense for where you're seeing the headwinds? Is it more on the unit side? Is it more on the content side in your computing business?

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Keith D. Jackson, ON Semiconductor Corporation - CEO, President & Director [22]

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Yes. It is definitely related to units and definitely has some of the macroeconomic impacts. One of the things we do believe is that the Q2 numbers had some significant amounts of ship-aheads over the concern with tariffs being imposed and increased.

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Operator [23]

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And our next question comes from the line of Anthony Stoss with Craig-Hallum.

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Anthony Joseph Stoss, Craig-Hallum Capital Group LLC, Research Division - Partner & Senior Research Analyst [24]

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Most of my questions were asked, but maybe you can provide more color on the size or expected size of the silicon carbide business in '19 and where you see it grow for 2020? And also just to be clear, your comments related to Huawei that you have more visibility, does that include your ability to ship to the comm side?

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Keith D. Jackson, ON Semiconductor Corporation - CEO, President & Director [25]

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Taking the last one first. I think we do have more visibility in our ability to ship into the comms piece of that. Clearly, there's still impact on the 5G portion, but the handset business seems to be an area that can be shipped. So more clarity on Huawei at this stage. And Of course, we are applying for further exemptions as you would expect.

From -- for the silicon carbide perspective, we do see that continuing to grow at an extremely rapid pace. We're not expecting '19 to be in the hundreds of millions of dollars, but certainly toward the triple-digit millions.

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Operator [26]

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And our next question comes from the line of Matt Ramsay with Cowen.

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Matthew D. Ramsay, Cowen and Company, LLC, Research Division - MD & Senior Technology Analyst [27]

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Yourselves and other companies, obviously with the automotive challenges in the industry, have given a little bit color specifically on the market in China. I wonder if you guys might sort of remind us what percentage of your automotive business is China consumed today roughly. And just how that business might be trending differently than some of the business in automotive outside of China?

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Keith D. Jackson, ON Semiconductor Corporation - CEO, President & Director [28]

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Well, trend-wise, actually I mentioned that we've seen stabilization. That market took a pretty steep double-digit drop on a year-on-year basis globally and so that's a very significant and most significant action on a worldwide automotive basis. We think that China overall, when you look at the numbers, contributes around 25%-or-so total automotive. That is an estimate because clearly we ship things to other parts of the world that are still being imported in China. But roughly a quarter.

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Matthew D. Ramsay, Cowen and Company, LLC, Research Division - MD & Senior Technology Analyst [29]

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Got it. And as a follow-up from us, you had mentioned, Keith, in your commentary that customer feedback around the Quantenna deal was quite strong. I wonder if you might elaborate on that and what particular verticals or what type of customer engagement there have been and discussions since you closed the deal that might shed a light on where you're going with that technology stack.

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Keith D. Jackson, ON Semiconductor Corporation - CEO, President & Director [30]

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Yes. So their existing customer base, as you're aware, basically is the ones that we would -- have been referencing there. They're looking at, I guess, more assured supply, having a stronger financial backing there. From the span-out piece, we've been talking to industrial IoT customers about our plans to expand offerings into that portion of the business. And they've also been quite excited by taking some high-performance solutions and combining it with the rest of our IoT solutions.

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Operator [31]

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And our next question comes from the line of Ambrish Srivastava with BMO.

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Jamison Yeol Phillips-Crone, BMO Capital Markets Equity Research - Associate [32]

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This is Jamison calling in for Ambrish. So first, I was wondering if you guys could comment on your lead times in power. Where are they now versus the peak? And also what are they doing compared to normal levels?

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Keith D. Jackson, ON Semiconductor Corporation - CEO, President & Director [33]

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Our lead times still continue to be kind of mid-teens. This is down definitely from year-ago levels by 4 or 5 weeks and slightly longer than what we would call normal for the industry as there are still some constraints in our power business?

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Jamison Yeol Phillips-Crone, BMO Capital Markets Equity Research - Associate [34]

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Okay. Great. And then my follow-up is regarding your East Fishkill fab. I was wondering with the lower demand that you guys are seeing, does this affect any ramp of any sort there? Do you plan on, I guess, pulling things in or pushing things out given the increased supply that you'll have from there?

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Keith D. Jackson, ON Semiconductor Corporation - CEO, President & Director [35]

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No, it doesn't change any of our expectations there. We're still moving full steam ahead. As I mentioned earlier on the EV trends, the automotive trends and the 5G trends, we're expecting significant and continued growth in those power businesses next year, so there's no changes anticipated there.

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Operator [36]

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And our next question comes from the line of Mark Delaney with Goldman Sachs.

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Mark Trevor Delaney, Goldman Sachs Group Inc., Research Division - Equity Analyst [37]

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The first question is related to pricing. In prior calls, I think you commented...

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Bernard Gutmann, ON Semiconductor Corporation - CFO, Executive VP & Treasurer [38]

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On pricing in general terms we still are seeing a pretty benign environment as compared to what we have seen in previous years. So no real change from that.

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Operator [39]

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And our next question comes from the line of Tristan Gerra with Baird.

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Tristan Gerra, Robert W. Baird & Co. Incorporated, Research Division - MD and Senior Research Analyst [40]

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In terms of the Quantenna being impacted by the macro trend, was there also any company-specific event, such as any share loss, that would have impacted revenue for Quantenna versus your prior expectation? And also, if you could quantify perhaps the EPS dilution that you expect from Quantenna in the quarter?

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Keith D. Jackson, ON Semiconductor Corporation - CEO, President & Director [41]

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So as I mentioned, we did visit all of Quantenna's customers since the acquisition. And without exception, they have all cited softness in their business and no share loss of any kind.

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Tristan Gerra, Robert W. Baird & Co. Incorporated, Research Division - MD and Senior Research Analyst [42]

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Great. And -- yes.

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Keith D. Jackson, ON Semiconductor Corporation - CEO, President & Director [43]

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I was going to say on the earnings per share, like we said, there's not meaningful contribution in quarter 3.

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Tristan Gerra, Robert W. Baird & Co. Incorporated, Research Division - MD and Senior Research Analyst [44]

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Okay. Great. And then could you comment on your utilization rates that's embedded in your Q3 guidance?

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Keith D. Jackson, ON Semiconductor Corporation - CEO, President & Director [45]

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Yes. They are low-70s. It should be very similar to Q2.

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Operator [46]

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And our next question comes from the line of Christopher Rolland with SIG.

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Christopher Adam Jackson Rolland, Susquehanna Financial Group, LLLP, Research Division - Senior Analyst [47]

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In your opinion and in comparison to others, why do you think it took so much longer for your adjustees to start making these adjustment -- inventory adjustments here? Was it -- do you think it was in the long lead times that you guys had? Or are there some more market-specific issues or end product-specific issues that you guys have that others don't?

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Keith D. Jackson, ON Semiconductor Corporation - CEO, President & Director [48]

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I do believe mix is a contributor to the behaviors there. Companies with more power content have seen less of the corrections and seen it later.

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Christopher Adam Jackson Rolland, Susquehanna Financial Group, LLLP, Research Division - Senior Analyst [49]

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Understood. And maybe you guys can talk about cycle times. And if you expect lead times to approach cycle times, is that something you're contemplating in this down-cycle or not?

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Keith D. Jackson, ON Semiconductor Corporation - CEO, President & Director [50]

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On a product basis, you certainly have seen a narrowing of the gap between manufacturing cycle times and lead times. They're not -- don't normally collapse inside our manufacturing lead times in good markets or bad.

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Operator [51]

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And our next question comes from the line of Craig Ellis with B. Riley FBR.

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Craig Andrew Ellis, B. Riley FBR, Inc., Research Division - Senior MD & Director of Research [52]

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I wanted to pose a couple of intermediate-term questions on a few of the end markets. Keith, as you look at automotive, nice to see it growing in the third quarter. Do you sense that the underlying dynamics in that business, content gain, rising EV caution, et cetera, mean that this is an inflection quarter where we could be back to sustained growth? Or are there some headwinds coming in the fourth quarter that would mean it's more bouncing along the bottom?

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Keith D. Jackson, ON Semiconductor Corporation - CEO, President & Director [53]

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In terms of units sold, we don't see a significant improvement in the fourth quarter globally. We're not looking for that. We do think that the number of models adopting EV and the number of models adopting Level 2 ADAS will be increasing for the 2020 car model years. And so we should see that offset even flat or slightly down in Q4 total unit numbers. So we are expecting a return to growth as you exit this year.

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Craig Andrew Ellis, B. Riley FBR, Inc., Research Division - Senior MD & Director of Research [54]

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That's helpful. And then the follow-up is on cloud power. So it sounds like the base station business is getting some strong traction. Server isn't helping just because of ship-aheads. The first part of the question is when do you think those will both be working in your favor? And on base stations specifically, as you interact with our customers, what are the unit numbers for base station builds that they're talking about for this year and next year?

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Keith D. Jackson, ON Semiconductor Corporation - CEO, President & Director [55]

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Yes. When we talk growth, we're over 60% growth year-on-year in those cloud power and -- applications. And so yes, very, very significant growth. We don't actually have any units I can give you specifically in the forecast, however.

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Craig Andrew Ellis, B. Riley FBR, Inc., Research Division - Senior MD & Director of Research [56]

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And timing on when server can help cloud power?

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Keith D. Jackson, ON Semiconductor Corporation - CEO, President & Director [57]

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I'm expecting that to be certainly as we enter 2020.

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Operator [58]

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And our next question comes from the line of Raji Gill with Needham & Company.

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Rajvindra S. Gill, Needham & Company, LLC, Research Division - Senior Analyst [59]

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A question on automotive. If we assume auto continues to grow in Q4, it looks like the segment would be down about less than 2%. I think you had indicated that overall light vehicle production is going to decline 3% to 4%. So I just wanted to get a sense, is that kind of roughly what you're expecting? And how does that, I guess, reconcile with dollar content gains in power and ADAS? If it is the case, there'll be a slight improvement over the unit decline, not as great. So just I would like to get some color on that.

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Keith D. Jackson, ON Semiconductor Corporation - CEO, President & Director [60]

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Yes. So again, I think it really is the ON content story there, not the units. The other piece of what you've seen so far this year is inventory correction at the suppliers to the automobile industry. So the units themselves can be down 2%, 3% or whatever, but the inventory piece or the import reduction piece contributes the rest. And as I mentioned before, I do expect, as we get into Q4, the additional content story will take over and you'll see continued growth for us.

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Rajvindra S. Gill, Needham & Company, LLC, Research Division - Senior Analyst [61]

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Okay. That's helpful. For my follow-up question, you talked about booking trends pointing towards stabilization. Is this mainly based on your distributors, your customers in China who basically said we've finished the inventory correction and we're going to at least kind of rebuild slowly? Or just kind of characterize what's driving the stabilization in bookings. Is it just purely what we've done with the inventory correction and we're kind of going to go -- we're going to be bouncing off the bottom from here on out? Just any insight on that.

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Keith D. Jackson, ON Semiconductor Corporation - CEO, President & Director [62]

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Yes. A couple of comments. One, we did mention that we expected continued distribution inventory declines in the third quarter, and we think that'll be about the end of it. So it's really not a big destocking change in attitude. We have seen stabilization actually increases from backlog in China. Whereas they were declining pretty rapidly beginning the year, those now look to be done with the inventory correction and starting to increase.

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Operator [63]

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And our next question comes from the line of Harlan Sur with JPMorgan.

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Harlan Sur, JP Morgan Chase & Co, Research Division - Senior Analyst [64]

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Maybe just to follow up on that previous question. So on the weaker industrial trends, especially Greater China, you guys are starting to see signs of stabilization. Any specific subsegments where you're starting to see this stabilization, factory automation, building automation? Any color here would be great.

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Keith D. Jackson, ON Semiconductor Corporation - CEO, President & Director [65]

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It's across the board in China that kind of are starting to see the increases there. So no one market stands out.

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Harlan Sur, JP Morgan Chase & Co, Research Division - Senior Analyst [66]

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Okay. And then on the distribution inventory, it came down nicely in Q2, will be down again in Q3. Resales were up sequentially in June. So relative to, let's say, your flattish guide for Q3 ex Quantenna, how much are you anticipating resales up sequentially in Q3? Looks like autos will be up. Do you expect industrial resells to be up sequentially as well?

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Keith D. Jackson, ON Semiconductor Corporation - CEO, President & Director [67]

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We are expecting to see sequential increases in the resales. They all matched pretty much in the commentary I gave by market. We see normal ramps in communications in the third quarter. We'll see some ramps on the automotive side, but those will be reflecting -- Q3 extra resales will be reflecting the market commentaries.

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Operator [68]

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And our next question comes from the line of Harsh Kumar with Piper Jaffray.

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Harsh V. Kumar, Piper Jaffray Companies, Research Division - MD & Senior Research Analyst [69]

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I wanted to revisit the question on OpEx. As you look to integrate Quantenna, I'm assuming your September guidance Quantenna OpEx is built into it. How should we think about the sort of synergies kicking in? And to what extent do you -- is there a goal that you would give us on a percentage basis with how we should think about on OpEx basis longer term?

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Bernard Gutmann, ON Semiconductor Corporation - CFO, Executive VP & Treasurer [70]

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So our long-term goal for OpEx is the same 21% as we have elaborated in our Analyst Day. We are on track to do the plans for synergies for Quantenna. When we announced Quantenna, we talked about synergies being about $26 million. About $16 million of those in OpEx and in COGS, and they will be coming in and become meaningful in 2020.

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Harsh V. Kumar, Piper Jaffray Companies, Research Division - MD & Senior Research Analyst [71]

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Okay. And then for my follow-up, I was curious if you could size how much business you're not able to do with Huawei as you look to get these licenses. If there's any color you could give us on that front that'd be helpful.

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Bernard Gutmann, ON Semiconductor Corporation - CFO, Executive VP & Treasurer [72]

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We normally don't give any details on specific customers. But as we said in our prepared remarks, we have partially resumed the shipments on -- to the customers that were affected.

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Operator [73]

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Our next question comes from the line of Shawn Harrison with Longbow Research.

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Shawn Matthew Harrison, Longbow Research LLC - Senior Research Analyst [74]

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On the commentary about distribution and in the inventory corrections, I guess that commentary seemed to be a little bit ahead of the more negative tone you all had last week. And I was wondering if your inventory corrections maybe ending earlier, a function of the power products you sell being in higher demand or managing inventories little bit more aggressively than others?

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Keith D. Jackson, ON Semiconductor Corporation - CEO, President & Director [75]

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Yes. As I mentioned, certainly mix has an impact on what goes on there. But we've also talked over the quarters about how we have a little better control system and much better visibility. So reacting appropriately and never getting too overstocked is also a piece to that equation.

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Shawn Matthew Harrison, Longbow Research LLC - Senior Research Analyst [76]

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And then as a follow-up, if I may. Bernard, free cash generation this year is probably a little bit light versus the typical curve. Maybe you can talk about how you would expect to see free cash flow generation in the second half of the year?

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Bernard Gutmann, ON Semiconductor Corporation - CFO, Executive VP & Treasurer [77]

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Typically, if you look at seasonality of our free cash flow, it is back-end loaded typically in the third and even more meaningfully in the fourth quarter. So we expect to see some catch-up playing throughout the rest of the year.

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Operator [78]

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And our next question comes from the line of Chris Caso with Raymond James.

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Christopher Caso, Raymond James & Associates, Inc., Research Division - Research Analyst [79]

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Just a question following up on distributor resale. And obviously, you and everyone else are reporting on a sell-in basis now. Can you help us to quantify how much the distribution inventory reduction has been a headwind in the second quarter and what's contemplated in our third quarter guidance? How significant is that?

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Keith D. Jackson, ON Semiconductor Corporation - CEO, President & Director [80]

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So in both quarters, there is a significant reduction contemplated. And I don't know that we're giving specific numbers there, Chris, but certainly they're meaningful. And we expect leaving the third quarter to be toward the lower end of our normal operating guidance or just the inventory.

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Christopher Caso, Raymond James & Associates, Inc., Research Division - Research Analyst [81]

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Right. As a follow-up then, any comments about how we should look about -- look at December? And obviously, there's a lot of moving pieces on a macro, but with what you said on distribution inventory, I suppose that would be a tailwind as sell-in and sell-out converge. Any other things we should be thinking about with respect to December?

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Keith D. Jackson, ON Semiconductor Corporation - CEO, President & Director [82]

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Yes. We only give guidance 1 quarter at a time. But I would reiterate that we expect the distribution inventory correction to be largely over in Q3 of this year.

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Operator [83]

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And our last question comes from the line of Craig Hettenbach with Morgan Stanley.

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Craig Matthew Hettenbach, Morgan Stanley, Research Division - VP [84]

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A question for Keith on autos. And understanding it is a very challenging backdrop, particularly in China. But it's also unusual in the quarter as reported to see a big delta. And so if you can just give some color in terms of this cycle, what you're seeing from Tier 1 suppliers and OEMs and how they're maybe managing inventory that led to a much bigger drag in Q2?

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Keith D. Jackson, ON Semiconductor Corporation - CEO, President & Director [85]

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Yes. Our -- a lot of dialogue occurred there, as you might have expected. And I do believe that many of the auto suppliers remained more optimistic longer than I've seen in the past and then decided to take some fairly decisive inventory corrections as they got through the second quarter. So from my perspective, that's what's different this Q2 versus any of the others we've experienced.

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Craig Matthew Hettenbach, Morgan Stanley, Research Division - VP [86]

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Got it. And then just a quick follow-up. You've commented about distribution inventory and expectations into Q3. Any thoughts from an OEM perspective? I know that's been little bit of a drag as well, but just how you see OEM inventory into Q3?

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Keith D. Jackson, ON Semiconductor Corporation - CEO, President & Director [87]

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Again, just this is more qualitative than quantitative. As we talked to our customer base, and particularly in the auto sector, we think they are largely going to be corrected at around the same time into Q3 to beginning of Q4.

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Operator [88]

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And that does conclude this question-and-answer session. I would now like to turn the call back to Parag Agarwal for any further remarks.

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Parag Agarwal, ON Semiconductor Corporation - VP of IR [89]

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

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Operator [90]

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Ladies and gentlemen, thank you for participating in today's conference. This does conclude today's program. You may all disconnect. Everyone, have a great day.