ON Semiconductor's CEO Discusses Q4 2011 Results - Earnings Call Transcript

| About: ON Semiconductor (ON)

ON Semiconductor (ONNN) Q4 2011 Earnings Call February 8, 2012 5:00 PM ET

Executives

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

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

Keith D. 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

Analysts

John Pitzer - Crédit Suisse AG, Research Division

Christopher B. Danely - JP Morgan Chase & Co, Research Division

Mark Lipacis - Jefferies & Company, Inc., Research Division

Gabriela Borges - Goldman Sachs Group Inc., Research Division

Ross Seymore - Deutsche Bank AG, Research Division

Terence R. Whalen - Citigroup Inc, Research Division

Craig Berger - FBR Capital Markets & Co., Research Division

Christopher Caso - Susquehanna Financial Group, LLLP, Research Division

Ramesh Misra - Brigantine Advisors LLC

Tristan Gerra - Robert W. Baird & Co. Incorporated, Research Division

Craig A. Ellis - Caris & Company, Inc., Research Division

Patrick Wang - Evercore Partners Inc., Research Division

Dean Grumlose - Stifel, Nicolaus & Co., Inc., Research Division

Parag Agarwal - UBS Investment Bank, Research Division

Jonathan Steven Smigie - Raymond James & Associates, Inc., Research Division

Operator

Ladies and gentlemen, thank you for standing by, and welcome to the ON Semiconductor Fourth Quarter and 2011 Financial Earnings Call. [Operator Instructions] Thank you. I would now like to turn the conference over to Ken Rizvi. Please go ahead, sir.

Ken Rizvi

Thank you, Stephanie. Good afternoon, and thank you for joining ON Semiconductor Corporation's Fourth Quarter and 2011 Annual Results 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 fourth quarter and year ended 2011. The script for today's call is posted on our website. 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 on our website in the Investor Relations section.

In the upcoming quarter, we will be attending the Morgan Stanley Technology, Media, Telecom Conference on February 28 and the Susquehanna Financial Group's semiconductor conference on March 6 and the Wedbush Technology, Media & Telecom Conference on March 7.

During the course of this conference call, we will make projections and 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 risks 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 guidance, are described in our Form 10-K, 10-Qs and other filings with the SEC.

Additional factors are described in our earnings release for the fourth quarter and 2011, which include uncertainties regarding the ongoing impact of the flood in Thailand.

Our estimates may change and 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 fourth quarter and 2011 annual results. Donald?

Donald A. Colvin

Thank you, Ken, and thanks to everyone joining us today. ON Semiconductor Corporation today announced that total revenues in the fourth quarter of 2011 were approximately $767.9 million, a decrease of approximately 14% from the third quarter of 2011.

During the fourth quarter of 2011, the company reported a GAAP net loss of $8.8 million or $0.02 per fully diluted share.

The fourth quarter 2011 GAAP net income included net charges of $67.2 million or $0.15 per fully diluted share from special items, which are detailed in schedules included in our earnings press release.

GAAP gross margin in the fourth quarter was 31.1%. Non-GAAP gross margin in the fourth quarter was 32.9%. Fourth quarter 2011 non-GAAP net income was $58.4 million or $0.13 per share on a fully diluted basis.

We exited the fourth quarter of 2011 with record cash, cash equivalents and short-term investments of approximately $901.5 million.

At the end of the fourth quarter, total sales outstanding were approximately 54 days, down approximately 1 day compared with the third quarter of 2011.

ON Semiconductor's internal inventories were approximately 110 days. Included in our total internal inventory is approximately $41 million of bridge inventory, primarily related to the consolidation of certain factories.

Distribution inventories were down approximately 6% on a dollar basis in the fourth quarter and were at approximately 12.5 weeks exiting the fourth quarter. We expect inventory in distributors to continue to decline on a dollar basis in the fourth quarter of 2012.

Cash capital expenditures during the fourth quarter of 2011 were approximately $57 million, bringing 2011 capital expenditures to approximately $316 million.

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

Keith D. Jackson

Thanks, Don. Now for an overview of our end markets. During the fourth quarter of 2011, our end market splits were as follows. The automotive end market represented approximately 23% of sales. The consumer electronics end market represented approximately 23% of sales. The industrial, military, aerospace and medical end markets represented approximately 21% of sales. And the computing end market represented approximately 18% of sales. And the communications end market, which includes wireless and networking, represented approximately 15% of sales.

On a direct billing basis, no individual ON Semiconductor product OEM customer represented more than 5% of fourth quarter sales. Our top 5 product OEM customers during the fourth quarter were Continental Automotive Systems, Panasonic, Delta, Samsung and Sony.

On a geographic basis, our contribution from sales in Asia, excluding Japan, represented approximately 55% of revenue. Our sales in the Americas represented approximately 17% of revenue. Sales in Japan represented 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 61% of fourth quarter 2011 revenue. Sales through the distribution channel were approximately 32% of fourth quarter revenue, and the EMS channel represented approximately 7% of revenue.

During the fourth quarter, ON Semiconductor revenues broken out by our new product groups were as follows: the automotive, industrial, medical and military aerospace products groups represented approximately 29% of sales. SANYO Semiconductor Products Group represented approximately 28% of sales. The Standard Products Group represented approximately 25% of sales and the Computing and Consumer Group represented approximately 18% of sales. We will publish our yearly revenue, gross profit and operating income breakout of these segments in our Form 10-K.

Now I'd like to provide you with some details of other progress we have made. In the fourth quarter, our production capacity was negatively impacted by the devastating flood in Thailand, which primarily impacted our SANYO Semiconductor segment. Given the severity of damage to our internal manufacturing facilities in Thailand, we made the decision to migrate our internal production out of Thailand and into other locations within our global internal and external manufacturing network.

The migration and ramping of production capacity at our other locations is progressing very well, thanks to the tremendous efforts of our team.

While our SANYO Semiconductor revenue in the first quarter of 2012 will continue to be negatively impacted by lower production capacity, we are expecting SANYO Semiconductor revenues to be approximately flat compared to the fourth quarter of 2011.

Orders that were fulfilled out of finished goods inventory in the fourth quarter of 2011 will begin to be fulfilled in the form -- from production capacity at other locations within ON's overall manufacturing network in the first quarter of 2012. We anticipate full recovery of our production capacity during the second quarter of 2012.

We exited 2011 with leadership positions in several of our focus end markets and applications. In the computing market, we hold the #1 position in Vcore power management for desktops and the #2 position in Vcore power management for notebooks. In addition, we also retained our #1 market share position for AC-DC power conversion and power adapters for notebook computing.

In the emerging market for energy-efficient white goods, we are now the industry's second largest supplier of integrated power modules with approximately 24% market share. We're also the market share leader in a variety of other product categories, including standard op amps, industrial ASICs, hearing aid, SoCs, linear voltage regulators and silicon-based protection devices.

Now let's review the progress and results in our focus end market and applications. The automotive end market reported record annual sales of approximately $739 million in 2011, up approximately 60% from 2010. Year-over-year growth in the automotive market was helped by our acquisition of SANYO Semiconductor. Yet even when excluding SANYO Semiconductor, our sales into this end market were up approximately 21% in 2011 compared to 2010.

Revenue growth was driven primarily by increased units, as well as a continued proliferation of electronics into entry and mid-level vehicles.

In addition to continued strong demand for our powertrain, automotive body and safety solutions during 2011, we also saw a strong acceptance of our products for the China auto market, including adoption of our Park Assist ASICs, LED lighting solutions and audio infotainment solutions.

Overall, ON Semiconductor continued to gain share within the automotive segment and can service up to $90 of content per average vehicle.

In the Consumer end market, ON Semiconductor reported record annual sales of approximately $895 million in 2011. This segment experienced an annual increase in sales of approximately 132%, with the addition of SANYO Semiconductor. Sales into this end market were negatively impacted in the fourth quarter by supply chain disruptions as a result of the flood in Thailand. We continue to see the Consumer segment as a strong end market for the company.

Our SANYO Semiconductor division helped drive sales during the quarter with motor drivers for a leading multifunction printer customer and delivery of IPMs for industry-leading inverter washing machine manufacturers.

We saw an increase in our overall Consumer Products business in Japan with our cross-selling efforts of historical ON Semiconductor products to traditional SANYO customers. Additionally, we received several product awards including 2 for our BelaSigna voice capture SoC used in consumer audio, smartphones and tablets. We received EDN China's Innovation Award in our Digital Signal category and Electronic Engineering Product World's Editors' Choice Award.

Looking into 2012, we expect strong sales from our IPM products for white goods, such as air conditioners, washers and refrigerators, as well as sales of our lens autofocus and optical image stabilizer system ICs for digital still cameras and smartphones.

In the Computing end market, annual revenues grew by 14% to approximately $660 million. These record levels were driven by continued proliferation of our products, such as our energy-efficient Vcore power management solutions, MOSFETs, bus switches, protection devices, thermal products and standard products, as well as through the acquisition of SANYO Semiconductor.

Our extensive product portfolio enables us to service up to $11.50 per notebook, up to $10 per ultrabook, more than $13 of content for high-end desktop computers and up to $24 per server.

During the quarter, we grew sales of our power adapter products to top-selling reader tablet makers and for digital image module customers. Other successes include a major battery MOSFET design win with a leading computer manufacturer of both tablets and notebooks.

In the fourth quarter, this end market was impacted by the supply-chain disruptions as a result of the flood in Thailand. As the supply chain begins to recover, we are expecting a nice recovery of sales in this end market.

Annual revenues in the Industrial, Medical and Mil/Aero end market grew by 28% to record levels of approximately $665 million in 2011. If we exclude the SANYO Semiconductor revenues in this end market, sales grew by approximately 14% in 2011 when compared to 2010.

During 2011, we saw a growth from heavy industrial applications, such as building automation, as well as circuit breaking and motor control devices. In addition, we saw growth in areas such as smart metering, lighting control, in HVAC and in building networks, such as security and fire protection systems.

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

Donald A. Colvin

Thank you, Keith. First quarter 2012 outlook. Our SANYO Semiconductor divisions revenue in the first quarter of 2012 will continue to be negatively impacted by lower production capacity as a result of the Thailand flood. We are, however, expecting SANYO Semiconductor revenues to be approximately flat compared to the fourth quarter of 2011, as orders that were fulfilled out of finished inventory in the fourth quarter will begin to be fulfilled from production capacity at other locations within our global manufacturing network in the first quarter of 2012. We also believe that the historical ON business will be seasonally down in the first quarter of 2012.

Based upon product booking trends, backlog levels and estimated turns levels, we anticipate that total ON Semiconductor revenues will be approximately $720 million to $760 million in the first quarter of 2012. Backlog levels for the first quarter of 2012 represent approximately 80% to 85% of our anticipated first quarter 2012 revenues.

We expect the average selling prices for the first quarter of 2012 will be down approximately 2% to 3% compared to the fourth quarter of 2011. We expect total cash capital expenditures of approximately $60 million to $70 million in the first quarter and total capital expenditures of approximately $250 million to $275 million for 2012. This forecast includes the expected $50 million of additional capital expenditures related to the restoration of capacity post the Thailand flood.

For the first quarter of 2012, we expect GAAP and non-GAAP gross margin of approximately 31.5% to 32.5%. We also expect total GAAP operating expenses of approximately $195 million to $200 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 $180 million to $185 million. We anticipate GAAP net interest expense and other expenses will be approximately $21 million for the first quarter of 2012, 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 and cash taxes are expected to be approximately $4 million to $5 million. We also expect stock-based compensation expense of approximately $8 million to $10 million in the first quarter of 2012, 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.

We believe the first quarter of 2012 represents the bottom of the current semiconductor cycle. As previously announced, we expect the negative impact of the Thailand flood to primarily impact our SANYO Semiconductor segment revenue in the first quarter. We anticipate that SANYO Semiconductor sales will be approximately flat compared to the fourth quarter of 2011 and should see improvement in the second quarter as more production capacity comes online.

Our current fully diluted share count is approximately 460 million shares based on 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 10-K.

With that, I would like to start the Q&A session.

Question-and-Answer Session

Operator

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

John Pitzer - Crédit Suisse AG, Research Division

I guess, Don, my first question relative to the SANYO revenue stream, can you help us differentiate what was the impact of kind of the cycle soft past versus the capacity issues you had in Thailand? I think on the last conference call, you talked about a potential $60 million kind of revenue hit in the December quarter, $40 million to $60 million kind of going forward. Can you just update us on those numbers?

Donald A. Colvin

Sure. I think as we go further away from the flood, we recover a lot better. And the cycle, as you had mentioned, becomes very difficult to distinguish from the actual flood. But I mean I think we made the call early in October, that we saw this being much more meaningful than the earthquake. And as it turned out, that was the right call. We see many people mentioning this later. So probably something in the $60 million range was appropriate for the fourth quarter. As we go with this quarter, it's probably less, probably not in the $40 million. But as we go forward, we see the actual cycle hitting the SANYO revenue as well, John. So it's very difficult. We do see some recovery. We don't give guidance for more than one quarter, and history has shown that's smart. We see recovery going into the second quarter, but I think it's very difficult to distinguish what is the impact of the cycle going forward from the flood. One thing is sure, the flood certainly did not help a lot of our Japanese customers who've seen a negative impact this year as there was to other Asian suppliers.

John Pitzer - Crédit Suisse AG, Research Division

And then, guys, as my second question, as you fold more of the SANYO capacity into your existing network, can you just update us on the target margins and the time to get there? And then I'm just curious, Keith, how sticky are the SANYO products? How concerned are you about market share losses as you try to reramp this capacity? How should we think about that?

Donald A. Colvin

Well we've always said that our model, our total blended model for the ON business was something like a low 40s gross margin and for the SANYO business, was something in the mid-30s, as we continues the restructuring, as we completed our restructurings for SANYO. So on the gross margin, obviously it's dependent on the speed of recovery of the revenue to reach that. So the quicker, the sooner we can get higher revenue back to historical levels, we can get to that gross margin, which would, in our corporate model, be a combined gross margin, goes up to 40%. And the low 40s for ON, 30s for SANYO business, but it's very much dependent on the gross margin front of revenue recovering to pre-flood levels.

Keith D. Jackson

And, John, relative to stickiness on that SANYO revenue, really, there's about less than 30% of that, that is multisource kinds of products that are easily replaced. Most of that is either sole-sourced or at least design-specific types of products, which are more difficult to replace. We have been very careful, as you might imagine, with our customers to make sure we can supply them what they have to have during the tough times, so that they don't have the incentive or, frankly, the time in the design cycle to lose those sockets. So I guess in general, it's pretty sticky. Some of the standard components we've already announced, that we did some obsolescence on very bad margin products. So there's a piece of it that we've said is about $20 million per quarter that may be gone, and then offset later in the year as we ramp both our camera autofocus products and our power modules for the white goods area.

Operator

Your next question comes from the line of Christopher Danely with JPMorgan.

Christopher B. Danely - JP Morgan Chase & Co, Research Division

So it sounds like you're guiding the ON business down in line with normal seasonality, and if SANYO wasn't impacted by Thailand, I mean it sounds like that will be roughly normal, so do you think we're back to normal seasonality in the semiconductor industry?

Keith D. Jackson

The down part right now definitely feels a bit seasonal. If you look at the 2 big markets that are displaying that habit, it is the Computing and Consumer, both of which are off approximately the same percentage as they normally would be. We look at the inventories in Asia are a bit lean, but there's still a lot of, I think, hesitancy to place a lot of backlog right now. So net-net, we get a lot of that every January and February, and so it feels pretty normal.

Christopher B. Danely - JP Morgan Chase & Co, Research Division

Great. And then as my follow-on, I know you guys don't normally forecast more than a quarter out, but if you could just talk about what normal seasonality would be for a combined ON/SANYO entity in Q2, Q3? And then how, given normal seasonality, how would gross margins and OpEx trend in that environment?

Donald A. Colvin

Seasonality, fairly easy to predict. Basically, the change in the total company is a little bit more consumer than we used to have, but also a little stronger automotive. And so when you balance those 2 things out, your Q1 should be your low point in a normal seasonal year. You should build 2% to 3% or 4% in Q2, and then kind of 5% to 8% in Q3. And then it's roughly flat in Q4, plus or minus 1%. So that's really not a dramatically different profile, maybe 1% or 2% in the quarter transitions might have changed.

Christopher B. Danely - JP Morgan Chase & Co, Research Division

And then the margins and the OpEx?

Donald A. Colvin

I think in the margins, I mean this is very difficult because you've got to depend on the mix and all the rest. But I mean I think we could look at something in the 400 to 500 basis points improvements in margin -- over the fourth quarter, 400 to 500 over the first quarter as well, as we go through the year depending on the mix. And as far as OpEx is concerned, we're not planning to spend a lot more OpEx. Obviously some things we would love to restore, like the bonus program. So probably $5 million to $10 million additional OpEx is potential, the exit quarter of this year compared to the first quarter guidance.

Operator

Your next question comes from the line of Mark Lipacis with Jefferies.

Mark Lipacis - Jefferies & Company, Inc., Research Division

On the pricing environment in the -- I believe in the press release you said you're expecting average pricing to decline 2% to 3%. What has it been over the last several quarters? If you could just play that back. And is this -- are you expecting a little bit more of a dramatic decline in pricing this quarter?

Keith D. Jackson

This quarter will be somewhat similar to last quarter. But this quarter is more normal and last quarter was a little higher than normal. We do our annual contracts, and they all reprice in the first quarter, so that tends to be our heaviest quarter loss in a normal year, and that is true for this year. If we look at our quarterly negotiated ASP declines, they're much less than 2%. So really, it's the first quarter that captures all the annual and semiannual negotiations. So we would expect that this will be the toughest quarter this year. And the only common compared to past is Q4 was a little bit abnormally higher than normal.

Mark Lipacis - Jefferies & Company, Inc., Research Division

Keith, when you say higher than normal, does that mean the decline was less than normal or the decline was more normal?

Keith D. Jackson

The decline was higher than normal. So normally, we'd see 1% to 2% in the fourth quarter rather than 2% to 3%.

Mark Lipacis - Jefferies & Company, Inc., Research Division

Okay, I understand. And then on the backlog, I believe you said on the order backlog covers 80% to 85% of the guidance. Can you remind us, how has the quarter backlog coverage tracked over the last several quarters or the last couple of years? What is the normal range?

Keith D. Jackson

So for those that followed us a long time, ON normally had very high coverage going into each quarter around 90% or so. When we acquired SANYO, they had a very different pattern. They have very little of their orders on the books. And so it's been running that 80% to 85% since we've done an acquisition in the first quarter of 2011.

Operator

Your next question comes from James Schneider with Goldman Sachs.

Gabriela Borges - Goldman Sachs Group Inc., Research Division

This is Gabriela Borges on behalf of Jim. You talked about the traditional ON business being down seasonally in 1Q. Could you provide some more color on the end market trends from that?

Keith D. Jackson

Certainly. Computing is down, probably the largest percentage-wise, and that is reflecting the hard drive shortage on top of normal seasonal trends. The handset is down in Q1, but that looks pretty much like seasonal trends. They're always down in the first quarter. And the other consumer goods, like televisions and audio players, also down pretty similar to normal. So in essence, the one that stands out is computing is a little stronger than the normal trend.

Gabriela Borges - Goldman Sachs Group Inc., Research Division

Understood, that's helpful. And then as a follow-up, if I may. It's been a few days since Chinese New Year. Have you seen any changes in ordering pattern since that time?

Keith D. Jackson

Certainly we've seen some changes. They have not snapped back briskly, but they are certainly improving. There's still a lot of, what I call, wait-and-see going on in Asia. So folks are waiting til they have to place those orders. And with very short lead times, they don't have to place them yet for Q2. So while our Q2 position is improving over the Q1 position, and we're fairly comfortable this is the bottom. It's not a big rush to place orders because we still have very short lead times.

Operator

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

Ross Seymore - Deutsche Bank AG, Research Division

Okay, just a question on the production capacity. What sort of impact do you think that has on your March quarter guidance? And is that something that once you get the production capacity up to full in the second quarter, as you said, should be able to fill in right in on top in that quarter?

Keith D. Jackson

Again to Donald's earlier comments, it is not as easy as just guessing what backlog and capacity is because our customers have been impacted. My comments on disk drives, for example, are a great example for that. And we're somewhat dependent on how fast that snapback will be based on those events. But in general, we should have the capability of doing, in the second quarter, something like $40 million or more from a production capability perspective.

Ross Seymore - Deutsche Bank AG, Research Division

And then the follow-up question on the gross margin side of things. Donald, in an answer to an earlier question, you said from kind of first quarter to fourth quarter you could go up roughly 4 to 5 points. How much of that increase is revenue-dependent? And how should we contrast that with building in your fab closures, efficiency gains at SANYO, et cetera? So how much is kind of under your control even excluding the revenue assumption?

Donald A. Colvin

I'd say about 80% is of that is revenue-dependent. Because remember, the SANYO factories are supported by the parent SANYO Electric, the ones we're closing down, so we've got some support. So in closing down these factories, we will not make the same absolute expense savings in our P&L because they are supporting the factories for us. So that will be more neutral than one would expect. Now we are closing down legacy ON factory, and we will benefit from the higher utilization in our existing factories as we ramp up the stuff that comes out the closed factories. So I'd say that, that's probably 20%, 25% of the margin improvement, but certainly 75%, 85% is dependent on the top line.

Ross Seymore - Deutsche Bank AG, Research Division

And how much of that cost-sharing have you guys used up, or minus what the total is of the timing and how much you have left?

Donald A. Colvin

The cost-sharing was a 2-year program, and it was supporting activities that we didn't really need. So it was running at approximately $40 million or so a quarter. And we will use most of what was initially intended, but slightly less. And we will -- we are still planning, despite floods and earthquakes, which has slowed us down, to meet the intended closure of the excess facilities in the time scale we initially anticipated.

Operator

Your next question comes from the line of Terence Whalen with Citi.

Terence R. Whalen - Citigroup Inc, Research Division

This one is on SANYO. If we kind of fast-forward 4 quarters from now when cost supports are no longer a factor and once the factory closures have occurred, what type of revenue level at SANYO will be required to get to that targeted 36%, 37% gross margin?

Donald A. Colvin

Well as I've said, I didn't say 36%, 37%. I said mid-30s. So give me some slack, and I don't know whether the market will be at that this year. But certainly, if we can get back to something in the mid-200s, then we should be able to touch on exit velocity close to 30%. I'm not sure that we can reach that peak at cruising altitude gross margins this year. But as we ramp some new products, particularly these HIC products next year and we improve P&L discipline and margin management, which we're also working on, and then we should really start to reap the benefit of that next year. So I think it's probably more a second half 2013 time frame, and we're talking about revenue in the high 200 and gross margin in the 30s, mid-30s.

Terence R. Whalen - Citigroup Inc, Research Division

Okay, very helpful. And then the follow-up question is regarding capital expenditures. After the $250 million that you target in 2012 and taking into account 2011 CapEx, what's the net impact on an annualized margin or depreciation number? And also what sort of a CapEx build should we be thinking about for 2013?

Donald A. Colvin

These are very -- good technical questions there, my friend. I think we're talking about the CapEx probably takes up our annualized capital expenditures by something in the $15 million to $20 million range. I think one of the positives for us in this slowdown is that we will be able to reduce our capital expenditures. And so we were -- net of the Thailand recovery, our capital expenditures this year are about $200 million, just over $200 million. We are spending just over approximately $50 million to recover from Thailand, which we anticipate all that cash to be paid for from insurance. I think our first glance into 2013 suggests something approximate to the $200 million level, significantly less than the over $300 million we spent last year. So that is the silver lining, and the current slowdown is that the economies and capital expenditures should be able to improve our cash flow.

Operator

Your next question comes from the line of Craig Berger with FBR Capital Markets.

Craig Berger - FBR Capital Markets & Co., Research Division

So I guess my first question is on the SANYO biz, if it is the high 200s to get to those margins, is that -- what time frame is that feasible in, would you say? I guess I'm trying to understand how much of that business comes back and recovers.

Keith D. Jackson

I think Donald's answer earlier was kind of mid to late 2013, definitely a recovery from the current levels this year, but I don't expect the high 200s this year. I expect that next year.

Craig Berger - FBR Capital Markets & Co., Research Division

How much should we plan for this year?

Donald A. Colvin

Well mid, somewhere in between.

Keith D. Jackson

Yes, somewhere in between. And again, it's driven by some -- a lot of new product growth in power modules and in the camera electronics.

Craig Berger - FBR Capital Markets & Co., Research Division

And then as a follow-up, can you just help us understand where were lead times and utilizations in the fourth quarter and how should we think about those trending?

Keith D. Jackson

The lead times should be approximately stable this quarter versus last quarter, and there's a range of things depending on product. But in general, less than 6 weeks. And so I don't expect that to change much here in the first quarter.

Craig Berger - FBR Capital Markets & Co., Research Division

And utilizations?

Keith D. Jackson

Basically, it's in the 70s, and again, not much change quarter-on-quarter from a utilization perspective.

Craig Berger - FBR Capital Markets & Co., Research Division

And then lastly, can you just clarify because there was a lot of talk on seasonality. It seems like with this annual business recovering some, it could be better than seasonal once we get past the first quarter.

Keith D. Jackson

Certainly, we're not going to give Q2 yet, but certainly, circumstances are setting up. So you've got some relatively lean Asian inventories, you've got new capacity, which will help meet some of the delinquency caused by the Thailand floods. And so there is certainly the possibilities of such things. But again, we're not calling Q2 at this point.

Craig Berger - FBR Capital Markets & Co., Research Division

Very lastly, did you guys mention how much inventory came out of distribution in the fourth quarter?

Donald A. Colvin

6%, as we gave a percentage. I think it's fair to say that because of the slowdown in Asia, distribution resales fell as well. Our distribution inventory is down about 18% from the peak. But because of the fall in resales, the weeks are still in the 12% to 13% range. We do expect that, that will fall again this quarter.

Operator

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

Christopher Caso - Susquehanna Financial Group, LLLP, Research Division

Just to follow up on your comments on distribution inventory. Do you get the sense that we're pretty close to the levels where the distributors want to be with regard to inventory levels? And I guess that question goes for the customers, too, given the declines that we've had over the past several quarters.

Keith D. Jackson

Yes, I'll give a geographical answer to that. We actually had the fortune to have all of our distributors and many of our customers in Phoenix last week for meetings. And all of them globally were comfortable with the levels they had. But within that range of comfort, there's very lean inventories in Asia, making them comfortable, and I would call quite robust levels in North America and Europe, which made them comfortable. And each of them were viewing that through a lens of what's going to change here coming into Q2. And I think there's still a lot of uncertainly in Asia, but the North America and Europe markets were indeed expecting to burn off or have demands increasing significantly for them. So net-net, they're all pretty happy. Our data kind of shows, looking at the end system sales versus our sales out, it says there's still a gap being built. In other words, they're underconsuming or underordering semiconductors based on what they're building. So again, in general, people are feeling pretty comfortable. We feel pretty comfortable. But the pace of change and when that might turn around is still up in the air.

Christopher Caso - Susquehanna Financial Group, LLLP, Research Division

Sure. As a follow-up, with regard to the industrial and the automotive markets, typically those markets are a little stronger in Q1. You're still guiding those down, and I guess is that still a situation where you still got customers burning through inventory or I guess maybe those distributors you spoke to last week probably were able to give you some color on that as well?

Keith D. Jackson

Yes. Actually auto and industrial, pretty flat going into Q1. Those 2 I did not mention earlier as being down. Those are actually going to be fairly flat, plus or minus a very small amount. So maybe not the up we normally see traditionally, but certainly they're not down.

Operator

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

Ramesh Misra - Brigantine Advisors LLC

Can you talk about the ordering activity that you saw late in Q4 and so far into Q1 in terms of linearity?

Keith D. Jackson

It's been fairly linear. Obviously -- well maybe not obviously, but Chinese New Year, there was a bit of a hiatus. There weren't any orders placed that week. But then when they came back, we did see an improvement over the December trends. So I would basically say we've been improving since December if you ignore the week of Chinese New Year.

Ramesh Misra - Brigantine Advisors LLC

Okay. And how are you, in general, doing in the Japanese market? I would think that with the strength in the yen, that would potentially help you increase your cross-selling, especially...

Keith D. Jackson

Our cross-selling activities are going very well. They're ahead of our expectations. The design wins were accelerated by the Thailand disasters as folks looked for alternative sources, and that is actually looking quite good for us. As far as total dollars, they've kind of gotten lost in the weak markets here in Q4 and Q1. But actually there's a very, very good trend for us. We're quite happy.

Ramesh Misra - Brigantine Advisors LLC

Okay. And similarly in that, what are you seeing in Europe?

Keith D. Jackson

Europe is pretty stagnant, not really seeing much change there at all.

Operator

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

Tristan Gerra - Robert W. Baird & Co. Incorporated, Research Division

Your gross margin guidance for Q1 is down just slightly given the decline in revenues for Q4 and Q1. Is there a bit of a lagging effect? I mean you mentioned that your utilization rates will be flattish. Or anything that helps gross margin for Q1?

Donald A. Colvin

I think that we had a little bit of usual year-end stuff. We had good mix of product in the fourth quarter and slightly higher revenues. That's basically what we're missing in the first quarter. So basically a slightly different mix and slightly lower revenues. That's all there is to read into that.

Tristan Gerra - Robert W. Baird & Co. Incorporated, Research Division

Okay. And then you mentioned during the Q&A about delinquencies that you think you're going to start catching up with -- in Q2. Can you quantify that in terms of how much you're missing from a revenue standpoint in Q1 or maybe as a percentage? And what do you expect to catch up in Q2?

Keith D. Jackson

Yes. I guess we'll try again. I don't know if I'll make it any clearer. There's about $40 million worth of demand that has been placed or expectations set for delivering we can't get to in Q1. Whether that will really be there or not is more dependent on what happens to our customers to some degree. So it may not be -- I mean it may or may not actually be $40 million. It could be $30 million or $50 million. There's no way for us to tell because they've obviously been impacted by the same floods that we were.

Operator

Your next question comes from Craig Ellis with Caris & Company.

Craig A. Ellis - Caris & Company, Inc., Research Division

Keith, just wanted to follow up on the PC comments. You indicated that, that would be one of the weakest areas Q-on-Q in 1Q. When do you expect to see orders start to rebound in that business? Would that be later 1Q or would it be more 2Q for you?

Keith D. Jackson

I think it'll be mostly Q2 from what we've been hearing. They may have to start placing orders in late March, but we're expecting the bills to ramp into Q2.

Craig A. Ellis - Caris & Company, Inc., Research Division

Okay. And then, Don, just to detail, there've been some fair market inventory valuation and Thai inventory charges and COGS. Are those behind us now? Or is there still some of that coming in the first quarter?

Donald A. Colvin

I think these are behind us. We had to write-off essentially all the inventory, which was badly damaged. And then we did the assessment of the SANYO inventory, so these adjustments are behind us now.

Operator

Your next question comes from Patrick Wang with Evercore.

Patrick Wang - Evercore Partners Inc., Research Division

Don, just a quick clarification, the CapEx you gave for the year was this net of the effect of the warranty you're expecting?

Donald A. Colvin

We gave a gross -- it's not a warranty, Patrick. It's just we're getting insurance proceeds I was mentioning going out on the call.

Patrick Wang - Evercore Partners Inc., Research Division

Right, exactly that's what I meant to say. This is net of the...

Donald A. Colvin

The number I gave included, if I will repeat what I said, capital expenditures of approximately $250 million to $275 million for 2012, and this includes the expected $50 million of additional capital related to the restoration of capacity lost in the Thailand flood.

Patrick Wang - Evercore Partners Inc., Research Division

Okay, that's covering that insurance?

Donald A. Colvin

It's included. And that's why I said, if you go forward to next year, barring any more floods, we should be $200 million, $225 million range, something like that, which is significantly less than the $300-plus million we spent last year.

Patrick Wang - Evercore Partners Inc., Research Division

And then Keith, can you talk quickly about maybe the next couple of milestones you're looking for that give you more confidence in our recovery today?

Keith D. Jackson

Well clearly the CEO's favorite milestone is more backlog. We kind of enjoy that. Like I said earlier, we have very short lead times. And to see a pickup in Q2, we would expect to see continued building of that order pattern in backlog as we go through March. And so certainly we're looking at that on a weekly basis to see the buildup in that. The other piece of it would be to see confidence return, specifically in Asia, relative to the economy there. There's just -- there's no other word I would use other than, I would call it, uncertainty. And in times of uncertainty, people are going to sit on those orders until they absolutely are convinced that they need to turn loose of them. So a little bit of confidence-building in the overall economy in Asia would help a lot. That's a milestone for you, but really, we watch the order patterns and expect them to improve through March.

Patrick Wang - Evercore Partners Inc., Research Division

Got you. And then the last question, can you -- I guess, Don, can you talk to us, just the insurance claim actually impacted your fourth quarter or first quarter margins for OpEx?

Donald A. Colvin

We netted the proceeds in the fourth quarter against the restructuring costs, so when we give our non-GAAP results, Patrick, we exclude any proceeds from insurance. And our outlook for the first quarter is constructed in a similar way. Any proceeds from insurance we will not -- are not included in our guidance, and we will pro forma the nonrecurring costs, these nonrecurring proceeds out of our P&L.

Operator

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

Dean Grumlose - Stifel, Nicolaus & Co., Inc., Research Division

This is Dean Grumlose calling in for Kevin Cassidy. As we look ahead for the ramp of Romley-based server platforms, can you provide a view on whether your content in this new generation of server products will increase or stay flat? Or what guidance can you provide in that?

Donald A. Colvin

It should increase somewhat. I don't have figures for you right now.

Dean Grumlose - Stifel, Nicolaus & Co., Inc., Research Division

Okay. And as additional question, following Chinese New Year, do you believe you had enough time for everything there to stabilize, to see where the trends are? Or do you think there's still more information that will come in the next few weeks?

Keith D. Jackson

Actually, we haven't quite. So most of our sales in Asia are through distribution. We get lagging sell out or sell-through the numbers from that channel that are generally 1 week to 2 weeks behind. So we don't really even know what the answer is for the week after Chinese New Year yet. However, having said all those things, indications are improvement, but not dramatic. And I attribute that to very short lead times. So I am expecting to see pertinent data over the next few weeks.

Operator

Your next question comes from the line of Parag Agarwal with UBS.

Parag Agarwal - UBS Investment Bank, Research Division

The first question is on foreign exchange. Is the weakening of euro causing any impact on your gross margins especially given that European companies also might get aggressive due to a weaker euro.

Donald A. Colvin

The euro has actually got weak. But then, it got stronger again. So actually today it is back to where it was 2 months ago. So I'd say that there's nothing that I can put my finger on. I would say generally, we have more costs than revenues derived from the euro. And so the weakening of the euro actually should help our margin. It did slightly weaken, but as I said, it's now got stronger again. So no impact.

Parag Agarwal - UBS Investment Bank, Research Division

Okay, perfect. And the $40 million of delinquencies you were talking about, is that all related to competing? Or is there something else in there as well?

Keith D. Jackson

No, there were consumer products in those numbers as well. So basically it was all of the products supplied out of that factory, which have a profile not too dissimilar from the total company profile.

Operator

Your last question comes from the line of Steve Smigie with Raymond James.

Jonathan Steven Smigie - Raymond James & Associates, Inc., Research Division

Keith, I was hoping you could comment a little bit on some technology changes in terms of core voltage regulation. So on the server, it seems like in some upcoming generations, we'll see more digital power management. I'm just curious on any time you see in terms of that potentially migrating down more into the desktop and notebook areas where you guys are pretty strong, and it seems like it should be probably at least a couple of years. I was wondering if that make sense to you. So any thoughts on that will be helpful.

Keith D. Jackson

Yes, it'll be several years, and it'll be very price-dependent. The digital solutions tend to be much more expensive. And particularly in the notebook areas, there is a lot of price sensitivity, but also in desktop. So basically the adoption is certainly significantly slowed by the price points. From a technology perspective, we are looking to address those desires, if you will, for the more digital control in a cost-effective way as our way of combating the trend long term. And so we expect to continue to hold our market share by finding more cost-effective digital methods.

Jonathan Steven Smigie - Raymond James & Associates, Inc., Research Division

Okay. And just in general, are you guys seeing any new entrants coming in or any players exiting on this market?

Keith D. Jackson

No real change at all either in or out from what we can tell and talking with our customers in the last 9 months.

Operator

At this time, there are no further questions. I would like to thank everyone for their participation in today's conference call. You may now disconnect.

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