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Executives

Keith Jackson - Chief Executive Officer, President, Director, Member of Executive Committee, Chief Executive Officer of Semiconductor Components Industries LLC and President of Semiconductor Components Industries LLC

Donald Colvin - Chief Financial Officer, Principal Accounting Officer, Executive Vice President, Chief Financial Officer of SCI LLC and Executive Vice President of SCI LLC

Ken Rizvi - Vice President of M&A, Real Estate & Investor Relations and Treasurer

Analysts

Craig Berger - FBR Capital Markets & Co.

Tristan Gerra - Robert W. Baird & Co. Incorporated

James Schneider - Goldman Sachs Group Inc.

Parag Agarwal - UBS Investment Bank

Christopher Danely - JP Morgan Chase & Co

Ross Seymore - Deutsche Bank AG

Kevin Cassidy - Stifel, Nicolaus & Co., Inc.

Christopher Caso - Susquehanna Financial Group, LLLP

Craig Ellis - Caris & Company

Jonathan Smigie - Raymond James & Associates, Inc.

John Pitzer - Crédit Suisse AG

Ramesh Misra - Brigantine Advisors LLC

ON Semiconductor (ONNN) Q2 2011 Earnings Call August 3, 2011 5:00 PM ET

Operator

Ladies and gentlemen, thank you for standing by. Welcome to the ON Semiconductor Second Quarter Financial Earnings Call. [Operator Instructions] I would now like to turn the conference over to Ken Rizvi. Please go ahead, sir.

Ken Rizvi

Thank you, Tiffany. Good afternoon, and thank you for joining ON Semiconductor Corporation's Second Quarter 2011 Conference Call. I'm joined today by Keith Jackson, our President and CEO; and Donald Colvin, our CFO. This call is being webcast on the Investor Relations section of our website, at onsemi.com, and a replay will be available for approximately 30 days following this conference call, along with our earnings release for the second quarter. The script for today's call is posted on our website, and will be furnished via a Form 8-K filing.

Our earnings release in this presentation includes certain non-GAAP financial measures. Reconciliations of these non-GAAP financial measures to the most directly comparable measures under GAAP are in our earnings release and posted separately on our website in the Investor Relations section. In the upcoming quarter, we will be attending the Pacific Crest Technology Forum on August 9; the Citi Technology Conference on September 7; and the Deutsche Bank Securities Technology Conference on September 13.

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, anticipate, intend, expect, plan 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.

Important factors relating to our business, including factors that could cause actual results to differ from our forward-looking statements, are described in our earnings release, Form 10-K, Form 10-Qs and other filings with the SEC. The company assumes no obligation to update forward-looking statements to reflect actual results, change assumptions or other factors.

Now let's hear from Donald Colvin, who will provide an overview of the second quarter results. Donald?

Donald Colvin

Thank you, Ken, and thanks to everyone joining us today. ON Semiconductor Corporation today announced that total revenues in the second quarter of 2011 were approximately $905.8 million, up approximately 4% from the first quarter of 2011. Excluding SANYO Semiconductor, ON Semiconductor historical revenues were up approximately 7% sequentially to approximately $631.5 million in the second quarter. During the second quarter of 2011, the company reported GAAP net income of $41 million or $0.09 per fully diluted share. The second quarter 2011 GAAP net income included net charges of $73.4 million or $0.16 per fully diluted share from special items, which are detailed in schedules included in our earnings release.

GAAP gross margin in the second quarter was 29.4%. Included in our GAAP gross margin is approximately $53 million of special items, approximately $31 million relates to the expensing of noncash manufacturing expenses associated with our SANYO Semiconductor acquisition, and approximately $22 million relates to the expensing of upraised inventory fair market value step up. Non-GAAP gross margin in the second quarter of 2011 was 35.2%.

Second quarter 2011 gross profit and net income were slightly less than anticipated due to a more adverse impact from the March 2011 earthquake and resulting tsunami in Japan, and manufacturing cost increases from commodity prices and foreign currencies. For SANYO Semiconductor, fab manufacturing activity was approximately 70% of the pre-earthquake second quarter manufacturing forecast. In addition, since the third quarter of 2010, commodity and foreign currency headwinds have impacted total company gross margins by approximately 200 basis points. Second quarter 2011 non-GAAP net income was $114.4 million or $0.25 per fully diluted share.

We exited the second quarter of 2011 with cash, cash equivalents and short-term investments of approximately $868.8 million, a record for the company. At the end of the second quarter, total days sales outstanding were approximately 58 days, down approximately 2 days compared with the first quarter of 2011. Internal inventories were down approximately 3 days to 107 days. Internal inventories are still elevated primarily due to the elevated inventories acquired as part of the SANYO Semiconductor acquisition. Included in our total internal inventory is approximately $14 million of bridge inventory associated with the shutdown of our factories.

At the end of the week, we will shut down our remaining fabrication facility in Phoenix. With this closure and the related production move to our site in Malaysia, we expect incremental cost savings of approximately $2 million per quarter. Distribution inventories in the second quarter increased as expected to approximately 11 weeks exiting the quarter. We expect to see distribution inventory dollars decrease in the third quarter. Cash capital expenditure during the second quarter were approximately $85 million. We currently anticipate total expenditures for 2011 of approximately $340 million, which includes SANYO Semiconductor.

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

Keith Jackson

Thanks, Don. Now for an overview of our end markets. During the second quarter of 2011, our end-market splits were as follows: The consumer electronics and market represented approximately 27% of sales. The automotive end market represented approximately 20% of sales. Computing end market represented approximately 20% of sales. Industrial, military aerospace, and medical end markets represented approximately 20% of sales. And the communications end market, which includes wireless and networking, represented approximately 13% of sales.

On a direct billing basis, no individual ON Semiconductor product OEM customer represented more than 5% of second quarter sales. Our Top 5 product OEM customers during the second quarter were: Continental Automotive Systems, Panasonic, Delta, Samsung and LG. On a geographic basis, our contribution from sales in Asia, excluding Japan, represented approximately 58% of revenue. Our sales in the Americas represent approximately 14% of revenue. Sales in Japan represents approximately 15% of revenue, and sales in Europe represented approximately 13% of revenue during the quarter.

Looking across the channels, direct sales to OEMs represented approximately 56% of second quarter 2011 revenue. Sales through distribution channels were approximately 38% of second quarter revenue and the EMS channel represented approximately 6% of revenue. During the second quarter, ON Semiconductor revenues broken out by our product groups were as follows: SANYO Semiconductor products group represented approximately 30% of sales, Standard Products Group represented approximately 20% of sales, the Automotive and Power Group represented approximately 17% of sales, the Digital and Mixed-Signal and Memory Group represented approximately 17% of sales, and the Computing and Consumer Group represented approximately 16% of sales. We will publish our quarterly revenue, gross profit and operating income breakout of these segments in our Form 10-Q for the period.

Now I'd like to provide you an update of our Japan operations, as well as other details of the progress we have made during the quarter. As previously outlined, second quarter results were negatively impacted by the March 2011 earthquake and resulting tsunami in Japan. SANYO Semiconductor revenues in the second quarter were approximately $274 million and were slightly better than we had anticipated coming into the second quarter. SANYO Semiconductor monthly sales began to stabilize in the month of May and improved in June. Based on our current visibility, we are expecting to see some modest growth in the SANYO Semiconductor revenues in the third quarter of 2011.

Thanks, in large part to great efforts and teamwork of our employees, all of our factories in Japan were capable of full production during the second half of May. Semiconductor manufacturing cycle times, however, have a lag between when the factories can begin full production and when those final products can be shipped to customers. While we anticipate modest sequential growth for SANYO Semiconductor, it will still be lower than normal seasonality, in part, due to this lost production.

In response to anticipated supply chain disruptions following the Japan crisis, many worldwide customers built up inventory reserves in the first half of the year. Customers continue to adjust their overall order rates based on the availability of all parts for their system solution requirements. We expect this rebalancing of inventory to continue through the third quarter.

SANYO Semiconductor has now been a part of ON Semiconductor for more than 6 months. While we face some unexpected challenges with the earthquake and tsunami in March, we remain excited about the long-term prospects to grow and expand SANYO Semiconductor's products to our global customer base, as well as expand our presence with leading Japanese customers. SANYO Semiconductor was accretive to our non-GAAP earnings in both the first and second quarter of 2011, even taken into consideration the impact from the March earthquake in Japan.

We anticipate that earnings for SANYO Semiconductor will improve from the second quarter levels in the second half of 2011. Integration of SANYO manufacturing and business operations continued as planned during the second quarter, with additional progress being made in systems integration, aligning of R&D roadmaps and cross selling of SANYO Semiconductor and ON Semiconductor products to our worldwide customer base. We are pleased with the progress. Close to 1,000 SANYO Semiconductor products are now available on the ON Semiconductor website and price book. One example of a successful cross selling efforts of our sales teams includes a significant design win of a SANYO Semiconductor power device and a North American manufacturer's latest smartphone scheduled to launch this fall.

Overall, revenue growth in the second quarter was driven primarily by the growth of our industrial, computing and consumer electronics end markets. Looking forward, we expect continued strong demand for our energy-efficient solutions for automotive, industrial and consumer while[ph] goods, and the expansion of our LED lighting solutions across all market segments.

Second quarter automotive sales were down slightly from the first quarter due to lower automotive sales from SANYO Semiconductor. During the quarter, SANYO Semiconductor sales were negatively impacted by the automotive supply chain disruptions in Japan caused by the earthquake in March. In the second quarter, historical ON Semiconductor, which excludes SANYO Semiconductor, saw slight growth in the automotive end market. Contributing to the strength were MOSFET sales into antilock brake systems and IGBT sales in the power train systems and direct gas injection applications for North American, European and Korean customers.

In addition, during the quarter, we saw continued strength from our external lighting solutions with our European customers. Based on our current backlog entering the third quarter, as well as new design wins in key automotive systems with expanding content such as LED lighting, power train, safety systems and infotainment, we expect the overall automotive segment to remain stronger than normal seasonality for ON Semiconductor in the second half of 2011.

The industrial end market grew by approximately 22% sequentially, driven by growth in the CMOS image sensor business recently acquired from Cypress Semiconductor, as well as continued strength in factory automation and heavy products like motor protection and circuit breaking. During the quarter, shipments of our high-voltage MOSFETs to industrial customers more than doubled from the first quarter. In addition, customer demand for industrial power supplies, controlling and sensing, general lighting and smart meters continued to drive strong sales of our power management and standard products in the industrial end market.

In the consumer end market, second quarter revenues increased approximately 3% sequentially. Sales of our standard components in the consumer goods were up approximately 11% sequentially, led by an increased use of our discrete products in home appliances, LCD and satellite TVs. During the quarter, we also secured a significant design win with a major flat-panel TV manufacturer for a platform of DC-DC controllers. The consumer end market holds exciting growth potential for ON Semiconductor in the upcoming years as consumer white [ph] goods and appliance customers move to adopt variable speed motors with inverter power systems. These integrated power modules are designed to improve the energy efficiency of washers, dryers, refrigerators, air-conditioners and other appliances.

Variable speed motors with our products help to enable over 50% reduction in energy usage compared to current motor technologies. The integrated power modules and variable speed motor control technologies acquired as part of the product portfolio of SANYO Semiconductor expands the company's offerings to more than $10 of addressable content per unit for energy-efficient white goods. In addition to the integrated power modules, our solutions include power supplies, user interface and communications chips linking appliances to the Smart Grid. Paired with ON Semiconductor's strong customer relationships with leading, global appliance customers, we are well-positioned to capitalize on this market opportunity.

The computing end market revenues were up slightly from the first quarter, driven by demand from emerging markets, as well as demand from the corporate PC market. During the second quarter, we continued to see strength from our sixth generation of the VCore controllers and drivers, and began shipping our latest AC-DC PWM controllers for several notebook adapter customers. In addition, during the quarter, we saw growth from designs into more than 10 tablet platforms with products ranging for protection devices and power management solutions to audio and system interface solutions.

In the communications end market, which includes wireless and networking, revenues were up slightly compared to the first quarter of 2011. Continued penetration of the smartphone market remains a primary growth strategy for the company. During the second quarter, we continued to ramp power management products, accelerometer interfaces and clock management products to leading handset customers. We are also first-to-market with an MHL interface solution capable of delivering 1080p video. In addition, during the quarter, we began to ramp our integrated passive devices with a major mobile phone power amplifier module manufacturer.

Now I'd like to turn it back over to Donald for other comments and our other forward-looking guidance. Donald?

Donald Colvin

Thank you, Keith. Third quarter 2011 outlook. Throughout the month of July, end market conditions have deteriorated. While we believe we are prepared to support higher growth of higher demand material ICs, given the more challenging global economic climate, we are planning for a broader range of revenue guidance in the third quarter of 2011. Based upon order booking trends, backlog levels and estimated turn levels, we anticipate that total ON Semiconductor revenues will be approximately $895 million to $925 million in the third quarter of 2011. Backlog levels for the third quarter of 2011 represent approximately 90% of our anticipated third quarter revenues. The company continues to face the adverse cost impact from the weak U.S. dollar and stronger commodity prices. Any continued strength over current rates in currencies including the Japanese yen, Malaysian ringgit, Philippine peso and Czech Republic kroner will continue to negatively impact our manufacturing cost. Accordingly, we believe it will be difficult to improve on our non-GAAP gross margin percentage in the third quarter.

We expect the average selling prices for the third quarter of 2011 will be flat-to-down approximately 1% compared to the second quarter. We expect total cash capital expenditures of approximately $85 million. For the third quarter of 2011, we expect GAAP gross margin of approximately 33% to 35%. Our GAAP gross margin in the third quarter will be negatively impacted from among other items, expensing of appraised inventory fair market value step up associated with our acquisitions of approximately $10 million. We expect non-GAAP gross margin of approximately 34% to 36% in the third quarter. We also expect total GAAP operating expenses of approximately $200 million to $205 million. Our GAAP operating expenses include the amortization of intangibles, restructuring, asset impairments and other charges, which are expected to total approximately $15 million.

We expect total non-GAAP operating expenses of approximately $185 million to $190 million. We anticipate GAAP net interest expense and other expenses will be approximately $21 million for the third quarter of 2011, which includes noncash interest expense of approximately $9 million. We anticipate our non-GAAP net interest expense and other expenses will be approximately $12 million. GAAP taxes are expected to be approximately $8 million to $10 million and cash taxes are expected to be approximately $5 million to $7 million. We also expect stock-based compensation expense of approximately $12 million in the third quarter, of which approximately $2 million is expected to be in cost of goods sold and the remaining in operating expenses. This expense is included in our non-GAAP financial measures.

Our current fully diluted share count is approximately 460 million shares based upon the current stock price. Further details on share count and EPS 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 question-and-answer session.

Question-and-Answer Session

Operator

[Operator Instructions] Your first question comes from the line of John Pitzer of Credit Suisse.

John Pitzer - Crédit Suisse AG

I guess my first one on gross margins, Don, I want to make sure I understood. You said that the commodity FX hit gross margins by 200 basis points in the June quarter. Was that sequentially or over what time period? If not sequentially, I guess relative to guidance, what fell short?

Donald Colvin

That was over the last 12 months before we've estimated that hit, John. Compared to the guidance, essentially, the major delta came from the impact of the earthquake in Japan. And the earthquake hit us before we closed our first quarter and we had limited visibility of the earthquake. To be perfectly frank and honest, I think we were just too optimistic on the impact to our manufacturing and when I do a little bit of forensic rework, the numbers that we guided to were too high and the impact was more severe, particularly on the manufacturing activity in the front end where we lost, as I mentioned in the call, significant amounts of production, which in an environment where you have a high fixed cost, has a very high percentage impact on end recoveries and on the P&L. So that was essentially the major miss. And also, again, we were not helped by the weakening dollar and increased commodity prices. But the major delta was clearly an underestimation of the negative impact of the earthquake and tsunami in Japan.

John Pitzer - Crédit Suisse AG

And then guys, maybe as my follow-up, Keith, with the wider-than-normal kind of revenue range for the September quarter, I'm kind of curious, any lingering impact from Japan that's driving that wider range or is this all uncertainty being kind of driven by the macro? And from a bottoms-up perspective, if you hit the low end versus the high end, where do you think the biggest differential for swing factors are?

Keith Jackson

Yes, I think it is mostly reflective of uncertainty of the end markets. There's, very clearly, a lot of questions right now on just how robust the consumer builds will be for the fall and the take-up rates as a result of that. So I think it's really a macro thing. In Japan, there is some questions, to this point, we've talked about customer inventory balancing, where they were unable to get certain types of products and others were available, and what impact that will have, but the bulk of it is just macro uncertainty.

Operator

Your next question is from the line of Christopher Danely of JPMorgan.

Christopher Danely - JP Morgan Chase & Co

If you could just give us your rundown on the end market outlook for Q3. And then if you could further break that down by assessing what is your opinion on inventory versus demand in each.

Keith Jackson

Okay. We would expect, as you can see from the guidance, it's slightly up from the previous quarter, so there's no major markets that we expect to drop. We're expecting to see some relative moderate performance in automotive. The traditional ON side should be flattish to up a bit. The SANYO side is one of those macroeconomic uncertainties because that was targeted all at Japan automotive manufacturing. So give or take there, it's nothing dramatic going on. Industrial, I think, still has some strengths to run. It may, again, be one of our strongest -- stronger sequentially performing segments. There is still a pretty good demand for energy-efficient electronics, making a differentiation in replacement in the marketplace. And that actually could be a positive in Japan where there's a lot of focus right now on energy efficiency. So that one is probably going to be one of the stronger ones. Computing, we normally would see very big pop going into Q3. We're expecting that to be much more flattish. And that is reflecting, at least at this stage, apparent less than seasonal demand from the consumer side of the business. Consumer side, as we mentioned in my script, I think we've got continued opportunity in the white goods for the inverter modules, again, energy-efficiency play. There will certainly be some slight builds in the gaming arena as there normally is, so I would say, a slightly positive bias in that marketplace overall. And then Communications is sending us the most mixed signals at this stage. We think it's relatively flat, but the share swaps in the smartphones and the overall demand for smartphones is one of the macroeconomic uncertainties that I mentioned earlier.

Christopher Danely - JP Morgan Chase & Co

And then for my follow-up, is what's happening in Japan, what's happening with SANYO, has that changed your outlook for the SANYO margin ramp over the next 4 to 8 quarters?

Keith Jackson

It certainly has delayed that ramp. Again, we didn't start reaching full production again till just about the end of the second quarter, so we have cycle times in manufacturing that are 3 months or so. So you certainly should expect that to come up slower than we originally anticipated. And of course, we originally anticipated a little better revenues in the early months. But the long-term, meaning 2012, remains completely intact. Our actions we're taking in manufacturing there with consolidations, et cetera, are on track as we presented in earlier meetings.

Operator

Your next question is from the line of Ross Seymore of Deutsche Bank.

Ross Seymore - Deutsche Bank AG

Kind of getting back to the gross margin side of things, if the SANYO side was the biggest impact in this quarter, how should we think about the duration of that snapping back and said another way, when do you expect to get those 2 points? Is it the fourth quarter? Is it more 2012?

Donald Colvin

Well, I think we'll be stating this that the [indiscernible] compared to guidance was essentially SANYO. But I mean if you look at the gross margin, it was only slightly down compared to the first quarter. So I think we were just optimistic on guidance. That was what I explained. But going forward, we're still going to be faced with this weak dollar, and the dollar has got significantly weaker throughout the month of July, even this week. And that's just having a negative impact on cost. We've got a lot of manufacturing costs in euros, in yen, in ringgit, in pesos and things like that, are all strengthening against the dollar, and that is negatively impacting the manufacturing. So we have taken some cost reduction actions, but I think what we stated on the call, in the script, was we don't expect any big improvements in gross margin until we start to see some of these currency and commodity headwinds reversing. And that's not happening now. So I also think the guidance is slightly -- midpoint of guidance is roughly flat to slightly down, and that's basically our best view today because of the sheer magnitude of these currency and commodity headwinds. And they do have a material impact in looking at what other companies are seeing, they're seeing the same impact on their business.

Keith Jackson

So Ross, we only give guidance one quarter at a time. We should see a more normal situation in Q4 in Japan. Factory should be back up, so you should start seeing some improvement. But to Don's point, the macro environment is not going to be giving us tailwinds, but headwinds, and we don't get the factory closures and consolidations until 2012.

Ross Seymore - Deutsche Bank AG

I guess, my one follow-up moving over the OpEx side of things, can you remind us what sort of the cost support you received in the second quarter? How much is remaining? And what sort of savings you expect to create as the SANYO business gets fully integrated?

Donald Colvin

Well, the cost savings in the second quarter and the P&L were north of $30 million as anticipated. And this is running exactly as scheduled. And so as Keith mentioned, the manufacturing programs that we are clearing over the cost reductions, to ensure there's a good hand over, are progressing appropriately. So everything is on plan and we should be exiting the surplus facilities in the middle of next year as anticipated. One point I just wanted to add, in addition to the headwinds, the slower economic demand in the market has meant that we have taken down our manufacturing run rate in the third quarter as well, Ross. And as you know, that doesn't help your end recovery. So that's the other element that we are having to face, is lower manufacturing activity as we adjust our manufacturing run rates to the current outlook.

Operator

The next question is from the line of Craig Berger of FBR.

Craig Berger - FBR Capital Markets & Co.

So I guess, sorry to beat the dead horse here, but what kind of active actions are you guys taking to offset either the currency impacts or the inflationary cost impacts? And where do you get cost efficiencies to offset some of those impacts?

Donald Colvin

Well, I mean we are doing everything we can. We announced the closure of a factory here. We are moving more production inside the company and using subcontractors to a certain extent, we're doing that. And also, we are taking actions on removing gold and replacing it with copper, aggressively doing that. We are looking, as we mentioned, shutting down plants, some manufacturing facilities in Japan. So it's not like our operation guys don't have a big list of to dos. So we are also adjusting our manufacturing run rates so that we don't build inventory and align it with the current lower level of demand that we -- compared to what had previously been anticipated. So these are all the actions, there's a whole list of them, taking some vacation as well in the factories, getting rid of expensive weekend shifts and also pushing out capital expenditures that are not necessary to support current levels of demand. So these are all the actions that we're taking, and this is all baked into our forecast.

Craig Berger - FBR Capital Markets & Co.

And then I guess as a follow-up, kind of a 2-part follow-up. Part A, you said you got about $30 million of operational support. How confident are you that you're going to be able to backfill those revenues with operational improvements and can you quantify the impacts of closing your fabs next year? And then the second part of the question is, can you just comment on the industrial demand out there? I mean that seems to be a sector where we're hearing mixed things. It certainly held up strong for a longtime. Is that getting hit by the macro or can that power through it?

Donald Colvin

I'll take the first part and I'll give Keith the pleasure of the second. So I mean as far as the operational support, we've always been very transparent. We have a plan that will reduce costs so that when the operational support winds down as anticipated, the closure of the factories will offset that cost. And I can assure you that this is still the plan we are executing and that we have more cost reductions identified than the operational support that will be withdrawn. So that gives us some safety factor. So we are not concerned that any of the tragic events have derailed our cost reduction plans, and as I say, our manufacturing guys have a full plate, but they're still marching to that program.

Keith Jackson

On the industrial markets, as I mentioned earlier, we do see them holding strong. The macro economy certainly has an impact, but what we've seen is, that there are many firms making the capital investments now to reduce their operating costs. And so our products give them the opportunity to significantly lower their energy costs and that has been holding up very well, both in the industrial segment and in the white goods segment.

Operator

The next question is from the line of James Schneider of Goldman Sachs.

James Schneider - Goldman Sachs Group Inc.

One more on the gross margin question, just in terms of the Japan effect and how those higher-cost goods that were manufactured during the earthquake and tsunami are going to kind of fall through the P&L. Is this the case where those higher-cost goods are going to still be lingering in terms of their impact on the P&L into Q4 and Q1? Or they'll be flushed out of the system before that time?

Donald Colvin

Good question. No, that was more of a negative impact in the second quarter, where we had some older, higher-costs finished goods inventory that we had to use to support the revenue, and we didn't have the end recoveries of the lower cost front end wafers and die. So I don't believe that, that will be a meaningful impact from now on and we are looking forward to a better recovery and actually improve margins in our base SANYO business in the third quarter. Nothing too dramatic, but slightly better.

James Schneider - Goldman Sachs Group Inc.

That's helpful. And then if you could maybe comment on your lead times right now? Where they are today, what they did in Q2, what you expect them to do in Q3? And kind of generally speaking, are they where you want them to be and do you think there's any kind of impact on the customer or in behavior from those lead times today?

Keith Jackson

So the lead times have come down from kind of the high-teens to the low-teens, so there's definitely been a contraction in lead times. There's no question that, that is having an impact in the marketplace on new orders. And again, it has led to some of that uncertainty in the end markets. So how much of it is just new order patterns, how much of it is macro market, how much of it is inventory correction, that's the reason we gave a wider guidance.

Operator

Your next question is from the line of Craig Ellis of Caris & Company.

Craig Ellis - Caris & Company

Don, you had mentioned on the last call that you had thought channel inventory would go up in the quarter and it did. What is your expectation for where we exit the third quarter in the channel?

Donald Colvin

Well, thank you for reminding me I got it right. We fully anticipate that the inventory will fall, the channel inventory will fall in the third quarter both on, it should fall on both a dollar basis and on a weeks' basis. And the trends that we're seeing suggest that, that is underway and that's our anticipation.

Craig Ellis - Caris & Company

And can you say where you'd expect the weeks to stake out at the end of the quarter?

Donald Colvin

Channel basically distribution, and most of our distribution businesses is in Asia, so I think that you can expect -- I mean, I think that clearly was quite a lot of inventory purchase just on the back of the tsunami. And with the current weaker global demand, I think distribution has a relatively good stock of a lot of products and that we would anticipate that they would move to more leaner asset model, particularly, as Keith mentioned, the lead times, production lead times have come in. So I think that we should start to see a reduction in absolute dollars and weeks this quarter.

Craig Ellis - Caris & Company

And then as a follow-up on the CapEx, I think last quarter the range was $310 million to $340 million for the year, now you're at the $340 million. From the $310 million, what's caused CapEx to go to the higher end of the prior range?

Donald Colvin

Nothing too dramatic. Just the range, we have -- Keith had mentioned, there are some exciting projects we're looking at, particularly a bit of a catch up in things like HIC, inverters, and the SANYO semiconductor. And we have confirmed that we want to invest there. I think that, that is just a normal making sure we invest in the right areas. We have pushed some things out. Clearly, we might not see much of a change in CapEx this year because the pipeline normally has a latency. But what I can tell you is, that first part of next year, it looks like it will certainly not be up over this year and that we have a relatively nice -- we're building a relatively nice amount of capacity cushion compared to current demand levels. But it takes a bit of time to clean out the pipe.

Operator

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

Tristan Gerra - Robert W. Baird & Co. Incorporated

Could you say what utilization rates were in the quarter, excluding SANYO? And what's your expectation for Q3 as you reduce inventories in the channel? And also embedded in that question, when would you expect your own inventories to get back to the normal low-80s range?

Keith Jackson

So utilization rates, non-SANYO, we're kind of mid 90s in Q2. We'd expect that to go down a bit in Q3, but I don't think it's dramatic in Q3. So maybe toward the low 90s or around 90. So that's the inventory question or the utilization question. On the inventory side, inside, I think we're going to be maintaining a kind of relatively stable numbers coming down a little bit each quarter as opposed to any big correction going forward.

Donald Colvin

A lot of the inventories we called out, some of them -- not a lot of inventory from SANYO and some of that legacy parts and we have a lot of bridge requirement as we closed down the factories. So we want to be cautious there, making sure that we have enough to meet customer demand. So that's something that also doesn't help. We also build up some inventory to facilitate the closure of the facility here that we mentioned. So I think you can expect, as we exit next year, the inventory levels will start to move much closer to our historical average.

Tristan Gerra - Robert W. Baird & Co. Incorporated

And so it's probably fair to assume that even though you expect channel inventories to come down in Q3, that we won't be back to the type of 8-week range that you've had and as such that this could also heavily rid of your headwind on gross margin beyond Q3. And perhaps would you be able to quantify the impact of the lower utilization rates on gross margin for Q3 versus the commodity costs impact?

Donald Colvin

Well, I think the -- as I mentioned to the question from Ross, Tristan, that that is already embedded in our guidance for the third quarter and we don't give our guidance for the fourth quarter. But the third quarter is already digesting the world recoveries to make sure that our inventories are relatively flat and don't grow in absolute dollars over the second quarter. So that kind of range is what we're aiming at and that is embedded in our third quarter guidance. But I think it's also fair to say that we do have offsets because we can reduce costs. But the raw number, clearly, that is a headwind when you reduce manufacturing activity, but we have offset that by pushing over some expenses, reducing some shift work, taking some vacation, et cetera., to offset that, that's included in our guidance.

Operator

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

Christopher Caso - Susquehanna Financial Group, LLLP

I wonder if you could discuss a little more about the impact of the Japan earthquake on both Q2 and Q3. And I guess most of your peers saw benefit to Q2 as their customers were apparently building up some inventory in Q2 and that turned to a headwind for Q3. For you guys, the dynamics seem a little bit different because of the direct SANYO exposure. Perhaps you can go into that a bit and just talk to us about why that wouldn't be perhaps a bigger headwind for you guys in the third quarter.

Keith Jackson

So the second quarter, again, as we mentioned earlier, we were slightly better than we had anticipated. We had enough whip and inventory there to offset some of the issues. But frankly, we did not have a big move to create excess of inventory. So we don't think we built a lot of extra inventory in Q2, meaning, we didn't have any headwinds going into Q3. What we have in Q3 is a minor amount of the demand side with customer rebalancing some things, offset with increased production. And so we're actually expecting, as we mentioned earlier, some increase in sales quarter-on-quarter as opposed to a correction of inventory because we just didn't build the inventory in Q2.

Christopher Caso - Susquehanna Financial Group, LLLP

So basically, just you don't seem to think you saw the same benefit others saw...

Keith Jackson

No, we know we didn't see the same...

Donald Colvin

To be very specific, I mean, our revenue went down and our manufacturing activity went down significantly. And that had a negative impact on the P&L, which is what explained the miss on the earnings, because we didn't have enough experience to model it correctly. If I had to do it again, I would have modeled it with a lower guidance. And both the manufacturing activity and the revenue should increase this quarter. That's what's embedded in our guidance. So we actually got pretty badly hit in the second quarter.

Christopher Caso - Susquehanna Financial Group, LLLP

Then just as a follow-up, again, some of your commentary with regard to automotive, it sounds like it's different for the core ON Semi business as opposed to the SANYO business, and that sounds a little different than what some of the others would say. Could you provide some clarification to that as well?

--

Keith Jackson

Absolutely. So the core ON business basically was European, Korea and China. There was very little to no Japan-based automotive business in traditional ON. And we have actually seen very strong demand in China for the high-end European cars, a strong demand in Korea for the Korean cars. And the design wins we've had in North America in the new models has taken a nice step up with our lighting products and some of our energy-efficiency products in the power train. So net-net, we think we're actually gaining share outside of Japan. The SANYO piece was all aimed at Japan, and of course, was the most disrupted with the earthquake. And so that's the dichotomy going on there. So in general, I think we're doing much better than peers outside of Japan and probably very similarly to them in Japan.

Operator

Your next question is from the line of Ramesh Misra of Brigantine Advisors.

Ramesh Misra - Brigantine Advisors LLC

Donald, in the past, you've said that the weakness in the U.S. dollar has actually helped you, especially in getting market share from some of your overseas competitors. What's the dynamic now and how should we be thinking about share shift versus cost?

Donald Colvin

Well, I think historically, I've made that comment when we were seeing the U.S. dollar weakening against the euro. And as you know, we have some very feisty competitors in Europe where we slug it out, particularly for things like the automotive market. And so that's certainly applied against European customers fighting in Europe for automotive business. But what we have seen, and this is a new event over of the last several years that has accelerated recently, is the dollar weakening against the whole basket of currencies, in particular, against things like the Filipino peso, the Malaysian ringgit and also the Japanese yen where we have a lot of manufacturing cost. And also, our subcontracting costs in Asia rising because of the weak dollar. And then the weak dollar also resulting in speculation in things like gold, and oil and copper, which we are also big users of. I mean, just simply copper, you wouldn't think that we were using a lot of copper, but we were doing the analysis the other day and I think that the increase in the price of copper is costing something like $1 million, $1.5 million a quarter additional cost. So as you know, copper has also got a speculative premium in there and just pay the price of that. Oil is another one, too, because of freight. So the weak dollar really is impacting a lot of our input cost and our lower cost manufacturing costs, which are now becoming higher cost. That's what's hitting us now.

Ramesh Misra - Brigantine Advisors LLC

Got it. So are your hedging expenses or hedging activity going up? And then the other thing I also wanted you to remind me of is, that the number of factories, both front-end and back-end, in Japan currently and already see that by mid-2012.

Donald Colvin

As far as the hedging is concerned, there's no easy way to hedge for these things because these basically are costs in areas that are -- where the currencies are appreciating against the dollar, and the way to hedge will be to shut the place down and move it to a lower cost place, which by the way, we are looking at. But it's very expensive, these kind of P&L hedging. And normally, companies in our business don't really do much of that and we are no exception. As far as the manufacturing in Japan, I do a quick calculation, we have 1, 2, 3, 4 fab sites and a small assembly test site. So a significant amount of manufacturing and a large part of that, as you probably know, is scheduled to be consolidated during the course of next year.

Operator

Your next question is from the line of Kevin Cassidy of Stifel, Nicolaus.

Kevin Cassidy - Stifel, Nicolaus & Co., Inc.

You had mentioned taking the SANYO products into North America and winning a design there. Just wonder how the progress is or what's the design atmosphere in Japan of taking the core ON products into Japan through the SANYO category?

Keith Jackson

It has been met very well. We have gotten access at very high levels of the customers there we did not previously have access to get. A result of that, we have had a broad package of Standard Products that have been qualified and approved for use there. And we're actually expecting multiple millions of dollars in increased sales in Q4 of the ON portfolio inside of Japan.

Kevin Cassidy - Stifel, Nicolaus & Co., Inc.

And would that be Consumer or is that Automotive?

Keith Jackson

In the Q4 timeframe, it's mostly consumer. Auto really won't follow until next year.

Operator

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

Jonathan Smigie - Raymond James & Associates, Inc.

Can you actually talk a little bit about linearity of orders through the quarter and into July? I know you said it deteriorated. Would you say that July orders are below June? Is it just some of the back-to-school stuff not materializing or is it [indiscernible] like that?

Keith Jackson

So from a new order perspective, our lead times were coming in very rapidly as we went through July. And so the new bookings, clearly, would have been expected to go down and they usually do in July, anyway. So I don't know what you're exactly going for there, but it's...

Jonathan Smigie - Raymond James & Associates, Inc.

There are a couple of other companies that said, and said, hey, we're not still seeing back-to-school bookings coming in. I'm just trying to, maybe that's just isolated to them, and that's not maybe something that's impacting you.

Keith Jackson

Yes. I don't think there's a significant impact on us on the back-to-school piece of the equation.

Jonathan Smigie - Raymond James & Associates, Inc.

Okay. Could you talk a little bit about how you guys are perceiving like a December seasonality now you have SANYO onboard?

Keith Jackson

December seasonality?

Jonathan Smigie - Raymond James & Associates, Inc.

Yes.

Keith Jackson

It basically increased our consumer footprint, gave us some automotive. But overall, the biggest piece of the business, the change, was more consumer. And so it should look very much like all our consumer businesses, Q4 tends to be flattish to down slightly normally. With the Japan earthquake, I'm not sure that those seasonalities will be protectable, but that's generally what happens in that quarter.

Jonathan Smigie - Raymond James & Associates, Inc.

And if I can sneak one last one in, I apologize I missed it, but do you break out the SANYO versus ON in gross margin?

Donald Colvin

No, we give indication, but we don't break it. And I think on the call today, what we did say is that the SANYO gross margin underperformed because of lower manufacturing activity. But we'll give details when we publish the Q.

Operator

Your final question comes from the line of Parag Agarwal of UBS.

Parag Agarwal - UBS Investment Bank

Just a question about your guidance. If you look at other selling companies like Microchips and Linear, compared to those companies, your guidance are kind of optimistic. So just wondering what is the difference between you guys and them? And if -- I mean, what is the level of confidence you have in your guidance?

Keith Jackson

I think there's a few differences between us and many of our competitors. We are a sell-through company. And as we were mentioning, we think that the distributors will be trying to get their inventories down. And so anybody who sell in is probably under more pressure than we are on their revenue lines sequentially into Q3. And I think that's certainly an impact there. We're pretty confident. We're looking at resale rates. We're looking at the OEM orders that we have. As you also know, we're an unusually company amongst some of the peer group you mentioned in the percentage of backlog we have going into each quarter, which is very, very high. So the simple answer is, we feel pretty good about the numbers, as we always do. And differences from competitors, the sell-through nature of our business, plus the very high level of backlog that we enter the quarter on.

Parag Agarwal - UBS Investment Bank

I apologize, I misspoke Linear and Microchip also as well. But coming to the second question about your Computing business, how would you characterize that business in terms of design wins on standard rates price comp and how do you see that ramping through the remainder of the year?

Keith Jackson

Okay. Let me make sure understand the question. So you're wanting to know the design win rates and changes going into the second half?

Parag Agarwal - UBS Investment Bank

Yes, but basically on standard rates.

Keith Jackson

No. Those are quite strong from a design win perspective, I mean, all of the design win piece of that phase is pretty much behind us. It's really just ramps in the models that happened in the second half. And so as we mentioned before, that should be a positive for us and maybe one of the reasons we're a little less pessimistic than some on what's called back-to-school, et cetera.

Operator

Thank you for participating. This concludes the ON Semiconductor Second Quarter Financial Earnings Conference Call. You may now disconnect.

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