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ON Semiconductor Corporation (NASDAQ:ON)
Q3 2018 Earnings Conference Call
Oct. 29, 2018, 9:00 a.m. ET

Contents:

  • Prepared Remarks
  • Questions and Answers
  • Call Participants

Prepared Remarks:

Operator

Good day, ladies and gentlemen. Welcome to the ON Semiconductor Third Quarter 2018 Earnings Conference Call. At this time, all participants are in a listen-only mode. Later we will conduct a question-and-answer session and instructions will follow at that time. If anyone should require operator assistance, please press "*0" on your touchtone telephone. As a reminder, this call is being recorded.

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

Parag Agarwal -- Vice President of Corporate Development and Investor Relations

Thank you, Chris. Good morning and thank you for joining ON Semiconductor Corporation's third quarter 2018 quarterly results conference call. I'm joined today by Keith Jackson, our President and CEO, and Bernard Gutmann, our CFO.

This call is being webcast on the Investor Relations section of our website at www.onsemi.com. A replay of this broadcast, along with our earnings release for the third quarter of 2018, will be available on our website approximately one hour following this conference call and the recorded broadcast will be available for approximately 30 days following this conference call. The script for today's call and additional information related to our end markets, business segments, geographies, channels, and share count are also posted on our website.

Our earnings release and this presentation include certain non-GAAP financial measures. Reconciliations of these non-GAAP financial measures to the most directly comparable measures under GAAP are in our earnings release, which is posted separately on the website in the Investor Relations section.

During the course of this conference call, we will make projections or other forward-looking statements regarding future events or the future financial performance of the company. The words believe, estimate, project, anticipate, intend, may, expect, will, plan, should, or similar expressions are intended to identify forward-looking statements. We wish to caution that such statements are subject to risks and uncertainties that could cause actual events or results to differ materially from projections.

Important factors which can affect our business, including factors that could cause actual results to differ from our forward-looking statements, are described in our Form 10-Ks, Form 10-Qs, and other filings with the Securities and Exchange Commission. Additional factors are described in our earnings release for the third quarter of 2018. Our estimates may change and the company assumes no obligation to update forward-looking statements to reflect actual results, changed assumptions, or other factors, except as required by law.

As announced earlier, we will host our 2019 Analyst Day on March 8th in Scottsdale, Arizona. If you would like to attend the event and haven't received an invitation, please let us know.

Now, let me turn it over to Bernard Gutmann, who will provide an overview of third quarter 2018 results. Bernard?

Bernard Gutmann -- Chief Financial Officer

Thank you, Parag, and thank you, everyone, for joining us today. We delivered yet another quarter of strong financial results. Our results for the third quarter and guidance for the fourth quarter of 2018 have exceeded expectations on all key metrics. This strong financial performance was driven by our multiple secular drivers in various end markets and by solid execution on the operational front. Our robust financial results over the last several quarters clearly demonstrate the strength of our business and our steadfast operational execution.

Despite overhang of trade tensions, rising bond yields, and fears of slowing global growth, overall demand environment remains favorable. We have seen a few spots of some weakness, especially in greater China region in industrial and white goods segments. However, we have been able to offset this softness in greater China with strength in other markets. Our near- to mid-term outlook for our business remains healthy, driven by significant increase in our content in automotive, industrial, and cloud power solutions for data centers and 5G deployments. Secular drivers powering our business remain intact and our traction in our strategic markets, which include automotive, industrial, and cloud power, continues to be strong.

Although we are confident in our near- to mid-term outlook, we are managing our business in a very prudent manner. Our channel inventory remains at the lower end of our target range of 11-13 weeks and we have meaningfully reduced days of inventory on our balance sheet. At the same time, we continue to invest in our operations and in our R&D efforts to drive long-term growth in our key strategic markets and to improve our profitability.

Now, let me provide you details on our third quarter 2018 results.

Total revenue for the third quarter of 2018 was $1.542 billion, an increase of 11% as compared to revenue of $1.391 billion in the third quarter of 2017. GAAP net income for the third quarter was $0.38 per diluted share as compared to $0.25 in the third quarter of 2017. Non-GAAP net income for the third quarter was $0.57 per diluted share as compared to $0.44 in the third quarter of 2017.

GAAP and non-GAAP gross margin for the third quarter was 38.7%. On a GAAP basis, our third quarter gross margin improved by 100 basis points year-over-year, and on a non-GAAP basis, gross margin improved by 80 basis points year-over-year. This strong gross margin performance was driven by solid operational execution and by improving mix, resulting from higher contribution from our automotive, industrial, and server businesses. On a year-over-year basis, third quarter 2018 gross margin was negatively impacted by the rise in certain input costs. With the anticipated ramp in additional internal raw wafer capacity toward the end of this year, we expect to partially offset the impact of increased input costs.

Our GAAP operating margin for the third quarter of 2018 was 15.7%, as compared to 12.7% in the third quarter of 2017. Our non-GAAP operating margin for the third quarter of 2018 was 17.8%, an increase of approximately 120 basis points over 16.6% in the third quarter of 2017. On a year-over-year revenue increase of 11% for the third quarter of 2018, our non-GAAP operating income increased by 19%. This strong operational performance demonstrates the leverage and strength of our operational model.

GAAP operating expenses for the third quarter were $355 million, as compared to $347 million for the third quarter of 2017. Non-GAAP operating expenses for the third quarter were $322 million, as compared to $296 million in the third quarter of 2017.

Third quarter free cash flow was $228 million and operating cash flow was $358 million. Capital expenditures during the third quarter were $130 million, which equates to capital intensity of 8.5%. Recall that to meet increasing demand for our products and to mitigate the impact of the steep rise in prices of raw wafers, we expect a higher level of capital intensity for this year and next.

We continue to de-lever our balance sheet and in the third quarter, we used $65 million to pay down debt. We exited the third quarter of 2018 with cash and cash equivalents of $951 million, as compared to $850 million at the end of the second quarter of 2018. We used $75 million of cash to repurchase 3.6 million shares of our stock in the third quarter.

At the end of the third quarter, days of inventory on hand were 116 days, down six days as compared to 122 days in the second quarter. Distribution inventory in terms of weeks declined quarter-over-quarter in the third quarter and, currently, distribution inventories are at the lower end of our target range of 11-13 weeks. We expect distribution inventories to remain within the normal range of 11-13 weeks in the near-term. To mitigate the risk of excessive inventory in the channel, we are proactively managing inventory in the distribution channel. We have implemented systems to ensure that distributors don't carry more inventory than what is needed to support 11-13 weeks of resales.

Earlier in the fourth quarter, we announced the purchase of an incremental 20% share of the manufacturing joint venture for an 8-inch wafer fab located in Aizu-Wakamatsu, Japan. With this purchase, ON Semiconductor now owns 60% share in the joint venture and, consequently, we will report operational results of this joint venture in our consolidated financial statements beginning in the fourth quarter of 2018. We have named the joint venture ON Semiconductor Aizu Co. Ltd., or OSA. As part of the joint venture agreement, we may provide manufacturing services to our joint venture partner for up to six quarters, starting with the fourth quarter of 2018. We expect revenue from manufacturing services to be approximately $20 million per quarter at a nominal gross profit.

Now, let me provide you an update on the performance of our business units, starting with Power Solutions Group, or PSG. Revenue for PSG for the third quarter was $810 million. Revenue for Analog Solutions Group for the third quarter of 2018 was $532 million and revenue for the Intelligent Sensing Group was $200 million.

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

Keith Jackson -- President and Chief Executive Officer

Thanks, Bernard. Third quarter of 2018 was yet another strong quarter for ON Semiconductor. We continued on our trajectory of delivering strong revenue growth and robust margin expansion. Overall demand for our products continues to be healthy, despite concerns related to trade tensions, rising bond yields, and expectations of slowing global growth. However, as Bernard noted earlier, we have seen a few spots of some weakness, especially in greater China region in industrial and white goods segments.

The key driver of our business is significant content increase in many applications in automotive, industrial, cloud server, and 5G infrastructure end-markets, as opposed to underlying unit growth in these end markets. In the automotive end market, vehicle electrification and active safety are expected to drive steep growth in our addressable content for power devices and image sensors. In the industrial market, need for power efficiency in industrial systems is expected to drive many-fold increase in power products from our PSG business unit. In the cloud server market, we continue to see solid growth for analog power management products from our ASG business unit. In 5G infrastructure market, we are seeing many-fold increase in our medium voltage power content as compared to that in 4G and 3G systems.

Our business today is driven by sustainable secular growth drivers in the fastest growing semiconductors end markets, as opposed to being driven by macroeconomic conditions and semiconductor industry cyclicality a few years ago.

Through our investments over the last several years in high-growth segments and in highly differentiated products in automotive and industrial end markets, we have radically transformed the nature of our business. A significant part of our business comes from highly differentiated power, analog, and sensor products for automotive, industrial, and cloud power end markets. We continue to strengthen our position as a key provider of enabling technologies for newly emerging and disruptive applications in automotive and industrial end markets.

Overall, business conditions remain favorable and demand continues to be healthy across most end markets. We have noticed some weakness in greater China region in industrial and white goods segments, but we have been able to offset that weakness with strength in other areas. In fact, we continue to sign long-term supply agreements with our customers. On the supply side, we believe that inventories in semiconductor supply chain are generally healthy and we do not see any signs of excess inventory with our distributors and customers. In fact, as Bernard indicated in his prepared remarks, our inventory at our distributors is toward the lower end of our target range of 11-13 weeks. Pricing continues to be benign as compared to historic trends.

Along with our strong revenue performance, our execution on the operational front continues to be outstanding. Our operating model has shown strong operating leverage. As Bernard mentioned earlier, on year-over-year revenue increase of 11% for the third quarter, our non-GAAP operating income increased by 19%. We achieved this solid margin performance in spite of significant rise in input costs. We remain on track to ramp our internal raw wafer capacity by the end of the current year, and with this ramp, we should be able to partially offset the increase in input costs. At the same time, mix shift toward margin-rich automotive, industrial, and cloud power end markets should drive additional margin expansion.

Now, I'll provide details of the progress in our various end markets for the third quarter of 2018.

Revenue for the automotive market in the third quarter was $464 million and represented 30% of our revenue in the third quarter. Third quarter automotive revenue grew by an impressive 12% year-over-year. Despite some volatility in the automotive supply chain, we posted strong year-over-year and sequential growth in the third quarter. We believe that ongoing content increases, new production introductions, and share gains drove our strong revenue performance, despite reports of volatility in global automotive supply chain.

We expect that secular trend of meaningful semiconductor content increase in automotive will continue for the foreseeable future, regardless of temporary changes in market dynamics. With a strong portfolio of power, analog, and sensor products, we are well-positioned to disproportionately benefit from tremendous increase in semiconductor content driven by electrification, active safety, and fuel efficiency in automotive.

Our momentum in the automotive image sensors continues to accelerate. Key factors driving our growth in the automotive image sensor market are significant technology lead over competition and the industry's most extensive product portfolio, giving customers more choices than before. With a complete line of image sensors, including 1, 2, and 8 Megapixels, we are the only provider of a complete range of pixel densities on a single platform for the next-generation ADAS and autonomous driving applications.

Furthermore, with our recent acquisition of SensL, we now have capability to provide LiDAR sensors, in addition to image sensors, radar, and ultrasonic sensors. We are the only semiconductor supplier with the capability to provide all four types of sensors for ADAS and autonomous driving. We believe that this capability will not only drive significant content increase for us but will also provide a key differentiating advantage to us as the automotive industry moves to sensor fusion architectures for ADAS and autonomous driving.

We recorded our first Silicon Carbide revenue from automotive end markets in the third quarter. We are actively engaged with the leading global automotive OEMs on many Silicon Carbide projects. We expect Silicon Carbide will be a significant driver of our automotive content increase, driven by the electrification of the drive train. We expect to see strong acceleration in our automotive Silicon Carbide revenues for the foreseeable future.

Demand for our power products, 48-volt systems, and LED lighting products remains strong. We are also seeing strong adoption of switch mode power management systems for camera systems and radar systems. In addition, we are seeing strong growth for our silicon-based power products in the EV/HEV market.

Revenue in the fourth quarter for the automotive end market is expected to be up quarter-over-quarter due to normal seasonality.

The industrial end market, which includes military, aerospace, and medical, contributed revenue of $400 million in the third quarter. The industrial end market represented 26% of our revenue in the third quarter. Our third quarter industrial revenue grew by a solid 12% year-over-year.

Ever-increasing energy efficiency requirements continue to be the key driver of increases in power management content in industrial systems. We are seeing several-fold increase in our power content in many industrial systems. In the industrial end market, we are benefiting from our comprehensive power product portfolio encompassing the complete voltage range. Design activity for power products in the industrial market remains strong and we are engaging with leading global industrial OEMs on their next-generation designs. Within the industrial market, we are seeing strong traction for our Power Integrated Modules for applications in alternative energy market.

Machine vision is another area of strong growth in the industrial market. With recently introduced X-class image sensors, we expect to further strengthen our leadership in machine vision and robotics markets.

Revenue in the fourth quarter for the industrial end market is expected to be down quarter-over-quarter, as opposed to seasonality of flat sequential revenue. Weaker than seasonal growth in our industrial business is driven primarily by softness in the greater China market.

The communications end market, which includes both networking and wireless, contributed revenue of $314 million in the third quarter. The communications end market represented 20% of our revenue in the third quarter. Third quarter communications revenue increased by 13% year-over-year.

In the third quarter, we benefited from the launch of new smartphone models. It has been the case over the last few years, our content in new-generation smartphones continues to increase in a meaningful manner.

On the infrastructure front, we are beginning to see ramp of our high-efficiency medium-voltage power products for 5G systems. We expect that our power content in 5G infrastructure systems will be many times that in 4G or 3G systems. We have been designed for significant power management content in 5G systems and we expect to see strong revenue ramps with increased deployment of 5G infrastructure.

Revenue in the fourth quarter for the communications end market is expected to be flat quarter-over-quarter as opposed to normal seasonality of sequential decline.

The computing end market contributed revenue of $163 million in the third quarter. The computing end market represented 11% of our revenue in the third quarter. Third quarter computing revenue grew by 16% year-over-year. The year-over-year growth was driven primarily by accelerating strength in our cloud power business and the ramp of our analog power management solutions for graphics processors.

As we have indicated in prior earnings calls, we are engaged with leading cloud and server players and we are working with leading processor providers on their next-generation platforms. With the upcoming generation of processors, we expect to increase our analog content through introduction of new products.

Revenue in the fourth quarter for our computing end market is expected to be approximately flat quarter-over-quarter, as opposed to normal seasonality of sequential decline. Continuing ramp of our cloud power business is the primary driver of better than seasonal trend in our computing business.

The consumer end market contributed revenue of $200 million in the third quarter. The consumer end market represented 13% of our revenue in the third quarter. Third quarter 2018 consumer revenue was down 1% as compared to consumer revenue in the third quarter of 2017. The decline was due to our selective participation in certain areas of the consumer electronics market.

Revenue in the fourth quarter for the consumer end market is expected to be down quarter-over-quarter, primarily due to softness in the white goods market and normal seasonality.

In summary, demand environment for our products remains healthy, driven by secular megatrends in industrial, automotive, and cloud power markets. The key driver of our business is significant content increase in many applications in automotive, industrial, cloud server, and 5G infrastructure end markets, as opposed to underlying unit growth in these end markets. Trade tensions, rising bond yields, and expectations of a slowing global economy have not impacted our business in a significant manner.

We have established leadership in highly differentiated power, analog, and sensor semiconductor solutions and we believe that customers are increasingly relying on us as a key provider of enabling technologies for newly emerging and disruptive applications in automotive, industrial, and cloud power end-markets.

While our business remains healthy, we are fully cognizant of risks arising from potential slowdown in global economy. We are very prudently managing our business with aggressive and proactive inventory management to respond quickly to any changes in market conditions. Our operational execution remains solid. We have continued to expand our margins and generate strong free cash flow.

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

Bernard Gutmann -- Chief Financial Officer

Thank you, Keith. Based on product booking trends, backlog levels, and estimated turn levels, we anticipate that total ON Semiconductor revenue is expected to be in the range of $1.48 billion to $1.53 billion in the fourth quarter of 2018. Included in our fourth quarter revenue guidance is approximately $20 million revenue from manufacturing services provided by On Semiconductor Aizu, or OSA, which as I indicated earlier, is our joint venture in an 8-inch fab. Excluding the impact of OSA, our fourth quarter 2018 revenue is expected to be in the range of $1.46 billion to $1.51 billion. Recall that as part of the joint venture agreement, we may provide manufacturing services to our joint venture partner for up to six quarters, starting with the fourth quarter of 2018.

For the fourth quarter of 2018, we expect gross margin to be in the range of 37.1% to 38.1%. Our fourth quarter gross margin guidance includes the negative impact of 50 basis points from the manufacturing services provided by OSA. Excluding the impact of OSA, our fourth quarter 2018 gross margin is expected to be in range of 37.6% to 38.6%.

We expect total GAAP operating expenses of $348 million to $366 million. Our GAAP operating expenses includes the amortization of intangibles, restructuring, asset impairments, and other charges, which are expected to be $29 million to $33 million. We expect total non-GAAP operating expenses of $319 million to $333 million in the fourth quarter. The quarter-over-quarter increase in our non-GAAP operating expenses in the fourth quarter is primarily driven by three additional days in the fourth quarter of 2018 as compared to those in the third quarter of 2018.

We anticipate fourth quarter 2018 GAAP net other income and expense, including interest expense, will be $32 million to $35 million, which includes non-cash interest expense of $9 million to $10 million. We anticipate our non-GAAP net other income and expense, including interest expense, will be $23 million to $25 million.

Cash paid for income taxes in the fourth quarter of 2018 is expected to be $8 million to $12 million. We expect total capital expenditures of $135 million to $145 million in the fourth quarter of 2018. We also expect share-based compensation of $19 million to $21 million in the fourth quarter of 2018, of which approximately $2 million is expected to be in cost of goods sold, and the remaining amount is expected to be in operating expenses. This expense is included in our non-GAAP financial measures.

Our diluted share count for the fourth quarter of 2018 is expected to be 428 million shares, based on current stock price. Further details on share count and earnings per share calculations are provided regularly in our quarterly and annual reports on Form 10-Q and Form 10-K.

For the full year of 2018, we expect to generate free cash flow in the neighborhood of $800 million.

With that, I would like to start the Q&A session. Thank you and, Chris, please open up the line for questions.

Questions and Answers:

Operator

Ladies and gentlemen, if you do have a question at this time, please press "*1" on your touchtone telephone. If your question has been answered or you do wish to remove yourself from the queue, please press "#". To prevent any background noise, please place your line on mute once your question has been stated.

And our first question comes from Chris Danely with Citigroup. Your line is now open.

Christopher Danely -- Citigroup -- Analyst

Thanks, guys. I remember in previous calls you've talked about some extension in lead times. Can you just comment on what lead times are doing these days? Are they remaining stretched or are they starting to come in?

Keith Jackson -- President and Chief Executive Officer

They haven't changed. So they're remaining longer than normal.

Christopher Danely -- Citigroup -- Analyst

Keith, when do we expect those to come back in?

Keith Jackson -- President and Chief Executive Officer

Obviously, depending on market conditions, that can vary. But at this stage, we see them remaining stable at least through the first half of next year.

Christopher Danely -- Citigroup -- Analyst

Okay. And then for my follow-up, just on the OSA business, were you contractually obligated to do this thing for six quarters? Or maybe just give us some of the history behind that?

Keith Jackson -- President and Chief Executive Officer

Yes, we are indeed obligated. That was part of the original deal.

Christopher Danely -- Citigroup -- Analyst

Got it. Okay. Thanks, guys.

Operator

And our next question comes from Vivek Arya with Bank of America Merrill Lynch. Your line is now open.

Vivek Arya -- Bank of America Merrill Lynch -- Analyst

Thanks for taking my question. Keith, I'm sure you looked at some of the weaker outlook from the peers, like Texas Instruments and Cypress, etc. What kind of enters your mind when you contrast their weakness versus the stability or strength that you're seeing? Is it possible you're not seeing the downturn now but perhaps could see it later, just because either you have the products or you had longer lead times? If you could just give us a sense of what's on your dashboard. How are cancellations looking? How is the book-to-bill ratio? How do we contrast this difference between what some of your peers are reporting versus the strength that you are seeing?

Keith Jackson -- President and Chief Executive Officer

So, our forecasting is done the same way. We look at our backlog and profiles that are going on from customers and our new orders, etc., as we get into the quarter. If you want to talk about contrasts, I will point to the fact that our power content, specifically in the markets that I talked about, we believe to be substantial and different from any of our competitors. And that is indeed where most of the strength is. So, I think there's a little bit of product mix between companies that shows up and also which customers being served. But in our case, we really do think it's strong demand on a content basis in the markets we mentioned.

Vivek Arya -- Bank of America Merrill Lynch -- Analyst

Got it. And for my follow-up, could you help us quantify your rough exposure to the two kind of problematic areas mentioned, the China industrial and white goods? When do you think those areas can start to stabilize or we don't have that visibility quite yet?

Keith Jackson -- President and Chief Executive Officer

We don't have visibility on that quite yet. We service the consumer piece -- or, excuse me, the white goods piece in China through distribution. And they are not giving us any indication of when that might come back at this stage. But it's a relatively small portion of our total business.

Vivek Arya -- Bank of America Merrill Lynch -- Analyst

Okay. Thank you.

Operator

And our next question comes from Shawn Harrison with Longbow Research.

Guasia Chowdhury -- Longbow Research -- Analyst

Hi, good morning. This is Guasia Chowdhury on behalf of Shawn. Within auto, are you seeing any auto production weakness in any regions?

Keith Jackson -- President and Chief Executive Officer

We're not seeing any weakness. We are seeing this year, unlike last year, some shutdowns for them to have kind of their maintenance periods. That didn't occur last year. But as I mentioned before, our content gains have far offset those.

Guasia Chowdhury -- Longbow Research -- Analyst

Great. Thank you. And then with regards to OSA, do you anticipate that the profitability will be a drag on profitability through 2019? Any idea on the timing would be helpful.

Bernard Gutmann -- Chief Financial Officer

So, as we said in the prepared remarks, we may serve this for up to six quarters, i.e. through the first quarter of 2020. And I expect a pretty stable business during that timeframe.

Guasia Chowdhury -- Longbow Research -- Analyst

Great. Thank you.

Operator

And our next question comes from Ross Seymore with Deutsche Bank. Your line is now open.

Ross Seymore -- Deutsche Bank -- Analyst

Hey, guys. I just wanted to follow up on the auto side. Keith, I know you have more content there conceptually. Can you just talk a little bit or give a little more color as to how that's playing out historically? Even the companies, as an aggregate, are gaining more content still aren't immune from SAR pulling down. So, any color you can give on some of the specifics, as far as why you're able to offset it. At least in the long-term, I get, but the near-term color.

Keith Jackson -- President and Chief Executive Officer

Yeah. I mean, of course, you're never immune from slowdowns in unit production. But our new designs and the models that are now ramping, 2019 models, the content gains there are in the double-digit range. And so, therefore, if your SAR comes down a percent or two, you still see strength coming on. And so the only other impact that you could have had there, Ross, is significant over-inventories and we've seen no signs of that. So, you put it all together, we continue to see good growth.

Ross Seymore -- Deutsche Bank -- Analyst

Thanks for that. And then as my follow-up, just switching over to the margin line, perhaps for Bernard. If the weakness that others are pointing to ends up hitting you guys, either the duration or the magnitude is greater than what you guys currently see for whatever reason, how should we think about how gross margin and OpEx can be flexed proactively if that negative scenario plays out?

Bernard Gutmann -- Chief Financial Officer

So, we will do what we have normally done in the past on the gross margin front. The fall through on the decremental revenue, if there is such a decrement, is about 50%. In cases of a slowdown, you in-source more of the production that's currently outsourced. So our mix would change toward that. On the OpEx front, variable comp and variable commissions would also be directly proportional to or affected by the reduction on that front. And then you take the normal belt-tightening actions that occur in any slowdown.

Ross Seymore -- Deutsche Bank -- Analyst

Okay. Thank you.

Operator

And our next question comes from Vijay Rakesh with Mizuho. Your line is now open.

Vijay Rakesh -- Mizuho -- Analyst

Yeah, hi. Thanks, guys. Just on the industrial side, I know you mentioned slight softness here in December. I'm just wondering if you're seeing anything out of the ordinary or is it just normal seasonality there?

Keith Jackson -- President and Chief Executive Officer

In general, it's normal seasonality except some slight weakness in the China marketplace, as we discussed. And it's not significant. So, it's slightly down versus flat-ish on normal seasonality.

Vijay Rakesh -- Mizuho -- Analyst

Got it. And as you go into first half, this piece on the worries from your peers about visibility and tariff impact, just bigger picture with another 25% hike on January 1st, I guess. Have you, as you talk to your customers in Asia and especially emerging markets, are you seeing any worries as they look out? I know it's a little bit farther away but thanks.

Keith Jackson -- President and Chief Executive Officer

Yeah. The only worries we've seen have been in China on some of the consumer-type marketplaces. And, basically, concerns there, I think, are reflected in the weaknesses we've talked about. But, otherwise, we haven't seen any significant impact, change in backlogs or order patterns.

Vijay Rakesh -- Mizuho -- Analyst

Great. Thanks.

Operator

And our next question comes from Chris Caso with Raymond James. Your line is now open.

Chris Caso -- Raymond James -- Analyst

Yes. Thank you. Good morning. The first question is on distribution. And can you talk about sell-in versus sell-through in distribution for the third quarter and your expectations for the fourth quarter? And in your prepared remarks, you said you were already at the low end of your target inventory range in distribution. Can you clarify what you mean by proactively managing inventory? Are you seeking to bring down the level of distribution inventory further?

Keith Jackson -- President and Chief Executive Officer

I think we're happy at the low end of our range. In fact, we're very happy at the low end of our range. And what we've done with our distributors there is help them with visibility in our systems and manage the order patterns so that we stay there. So, the real objective is to stay pretty close to the bottom half of that range as we go through the cycles or through the seasonality, I should say.

Bernard Gutmann -- Chief Financial Officer

And that would imply that sell-in would kind of equal sell-through.

Chris Caso -- Raymond James -- Analyst

Okay. Got it. Thank you. Just following on with OSA and the rationale for moving to the majority interest, was that something that you needed to do? And I guess I just ask that -- it seems like the impact is $20 million in revenue with about zero gross margins, rather. So what's the benefit for ON taking that majority interest?

Keith Jackson -- President and Chief Executive Officer

The reason we wanted the majority interest, quite frankly, is we wish to use all of that capacity over time. This is a structured phase over to make that happen and they have customers that need to be supported. And so as part of the whole deal, we had a pre-planned phase over in the capacity. So, the real issue is we need to fill that up with our products and, of course, as we do that, the margins for our products are significantly better.

Chris Caso -- Raymond James -- Analyst

Okay. Thank you.

Operator

And our next question comes from John Pitzer with Credit Suisse. Your line is now open.

John Pitzer -- Credit Suisse -- Analyst

Yeah. Good morning, guys. Thanks for letting me ask a question and congratulations on the strong results. Keith, I'm just wondering, relative to being a cushion, within the comms business and the compute business today, what percentage is sort of infrastructure and kind of server/cloud, hyperscale in each, how does that trend year-over-year compared to last year and where do you think that's going to be four quarters from now?

Keith Jackson -- President and Chief Executive Officer

I'll take them separately. On the computing side, the cloud server business has moved from 20% of our computing business up at least 10 points from that year-on-year. And we see that trend continuing into 2019. So, a very significant increase in the cloud server portion of the total business.

On the infrastructure piece, it has always been the smaller portion of our communications business. But, again, from a percentage basis, it's come up a couple of points year-on-year.

John Pitzer -- Credit Suisse -- Analyst

That's helpful. And then maybe a quick one for Bernard on the margin front. Bernard, you mentioned in an earlier question a gross margin fall-through of about 50%. If you look over the last four quarters, excluding the quarter just reported, you were sort of above that. I think the incremental op margin was averaging about 56% -- I'm sorry, gross margin. Op margin was about 38%. So, I'm just kind of curious to what extent were input costs impacting things on a year-over-year basis. And can you just level-set us? You gave us the 50% kind of gross margin drop-through. How should we think about op margin drop-through?

Bernard Gutmann -- Chief Financial Officer

Yeah. So, the 50% is obviously a yardstick. We think it is a good representation of kind of a long-term thing. Yeah, we do have in-between spikes where we are a little better or not. In the long run, we also have the mix impact that will also push us to have higher than 50%. The 50% is just at steady state. On top of that, you can add the mix, which should, over time, also get us some incremental amount. On the op margin, we're still targeting to do our 19% through our target model. We've done some nice progress, got to about 17.8% in the third quarter, and expect to continue making progress toward that as part of growing OpEx at half of the pace of revenue growth and getting the gross margin leverage we just talked about.

John Pitzer -- Credit Suisse -- Analyst

And then, guys, if I could sneak one more in there, glad to see you guys buy back stock in the quarter. Despite that, you were still able to grow gross cash. Keith, I'm kind of curious, just given where the stock price is today, kind of what your view is on buybacks and how we should think about sort of just capital allocation for the year?

Bernard Gutmann -- Chief Financial Officer

So, we have taken a balanced approach toward paying down debt as well as buying back shares. The buying back shares, we announced in the second quarter that we're going back into the market and we'll obviously take a look at dislocations that occur in the market as we go through that.

John Pitzer -- Credit Suisse -- Analyst

Okay. Thanks, guys.

Operator

And our next question comes from Krysten Sciacca with Nomura Instinet. Your line is now open.

Krysten Sciacca -- Nomura Instinet -- Analyst

Good morning. Thanks for letting me ask a question and congrats on the good results. I just wanted to follow up on the lead time question. A lot of your peers are noting that lead times are actually falling a bit to more stable or normalized levels versus being extended over the past year, but yet you're seeing your lead times remain extended and should be at least for the first half of next year. Could you maybe give a little bit more color on that, on what is driving that trend?

Keith Jackson -- President and Chief Executive Officer

Yeah. Again, it has been the significant content increase we've had, primarily in medium and high-voltage marketplaces. And it is quite stable, it's just longer than normal. So, we're not really seeing any volatility in the numbers. But the demand remains high and so those lead times will remain extended.

Krysten Sciacca -- Nomura Instinet -- Analyst

Great. Thank you. And then just switching over to comms. In your prepared remarks, you said you expect the revenues to be flat for next quarter sequentially versus historically seasonally down. Can you maybe just dig into what trends you're seeing that would promote that above seasonal growth? Is that mainly 5G-related revenue or is there some other factors playing into effect there?

Keith Jackson -- President and Chief Executive Officer

Certainly, 5G is a factor, although it's early in that ramp out. So, that's some of it. The other piece, frankly, is just content increases we had in the new models of handsets that rolled out. And those, from a build perspective, our customers are still showing us good demand in Q4.

Krysten Sciacca -- Nomura Instinet -- Analyst

Great. Thank you.

Operator

And our next question comes from Anthony Stoss with Craig-Hallum. Your line is now open.

Anthony Stoss -- Craig-Hallum Capital Group -- Analyst

Hey, guys. My congrats on the strong execution as well. Bernard, can you give us what your capacity utilization was in Q3 and any thoughts on where you think it might be in Q4? And then, lastly, on Silicon Carbide, do you expect the bulk of your wafers to come from external sources or internal? Thanks.

Bernard Gutmann -- Chief Financial Officer

So, capacity utilization in the third quarter in the mid- to high-80s. Expect that to be similar, maybe coming down slightly, in the fourth quarter. And then the Silicon Carbide, we are outsourcing the raw wafers. We have long-term agreements on that front. We do internally our own raw wafers for regular silicon and we talked about that several times, that we are increasing our capacity to serve more and be less dependent on this input cost. But not on the Silicon Carbide right now.

Anthony Stoss -- Craig-Hallum Capital Group -- Analyst

Great. Thank you.

Operator

And our next question comes from Craig Ellis with B. Riley FBR. Your line is now open.

Craig Ellis -- B. Riley FBR -- Analyst

Yeah. Thanks for taking the question and congratulations on the execution in the quarter. The first question is related to content gain. Keith, you pointed out good things happening in compute in server and in smartphones. So, the question is, with Intel having three server product transitions in 4Q '18, 4Q '19, and then 2020, what do you expect will happen with ON's server content with those transitions? And then on the smartphone side, is the content gain we're seeing really more of a second-half dynamic or would you expect to be gaining content with first-half model launches as well?

Keith Jackson -- President and Chief Executive Officer

On the computing side, our content will continue to go up with the new processor releases. So, we see that as a very positive trend. We believe, also, our share gain should be going up. So, similar to what went on in the notebooks a few years ago, we are expecting a continued positive story on the compute side.

In the handsets, the ones that will launch in the first half of next year will also have that increased gains so that should also, again, be a good story relative to seasonality.

Craig Ellis -- B. Riley FBR -- Analyst

Thanks. And then the follow-up question is for Bernard. Bernard, setting aside the manufacturing piece impact to gross margin in the fourth quarter, there's still a decrease of around 50-60 basis points, it looks like. So, is that primarily utilization or are there other factors at play, like input costs or pricing? And then, as we look ahead to the first quarter, I think that's when the company would typically see more of its large customer, long-term contract renewals occur. Can you just help us with the gives and takes with gross margin? Not looking for guidance, but just some higher level color. Thank you.

Bernard Gutmann -- Chief Financial Officer

Sure. So, in the fourth quarter, the gross margin decline beyond the OSA is mostly just revenue-related. Though utilization, we're guiding to a lower number than the third quarter's actuals. It is approximately a 50% fall-through on the decremental revenue so there is nothing bigger there. Contracts or pricing continues being quite benign and we're seeing that also in our annual contract negotiations.

Craig Ellis -- B. Riley FBR -- Analyst

Thank you.

Operator

And our next question comes from Tristan Gerra with Baird. Your line is now open.

Tristan Gerra -- Robert W. Baird -- Analyst

Okay. Good morning. Could you provide a little bit of color on your camera business in automotive? You've talked in the past about 70% market share. How is the outlook in that business for next year and are you ramping on track or are you seeing any type of delays?

Keith Jackson -- President and Chief Executive Officer

Yeah, the 70% is for ADAS. Overall, I think we're about 55% if you include all viewing in cars. We see that continuing. I think, again, we believe we have increased that a bit for next year's models and so we expect that to continue to ramp up in double digits next year.

Tristan Gerra -- Robert W. Baird -- Analyst

Okay. And then any changes that you expect to see in terms of pricing patterns as you enter renegotiating agreements for next year?

Keith Jackson -- President and Chief Executive Officer

Our pricing patterns this year have been quite benign, as Bernard talked about. I would expect, going into next year, the first quarter should be better than normal. But obviously, the rest of the year will have to wait and see what the markets provide.

Tristan Gerra -- Robert W. Baird -- Analyst

Great. Thank you.

Operator

And our next question comes from Chris Rolland with Susquehanna. Your line is now open.

Christopher Rolland -- Susquehanna -- Analyst

Hey, guys. Congrats on the outperformance versus some of your peers here. That was pretty impressive. So, I believe there may be three extra days in the quarter, at least I think you talked about on the OpEx side. I was wondering how you are treating the revenue. Is it kind of half of that or are you counting it kind of as zero? And then just back to pricing. So, previously, ON, way back in the day, we used to talk about 1% to 2% price decreases quarter-to-quarter. Is this dynamic changed now, in your opinion, considering you're no longer highly commoditized products?

Bernard Gutmann -- Chief Financial Officer

So, let me answer the three extra days. Historically, when we have had -- our experience on the three extra days is that you really get very little in terms of extra revenue because you're looking at the holiday season during that timeframe. But you have to pay the people so it is mostly affecting OpEx with very little offset in the incremental revenue. And it's part of our revenue guidance, already embedded.

Keith Jackson -- President and Chief Executive Officer

On the long-term pricing trends, we are getting a higher content for sole source products. And so we would expect that that would become more muted. That typical 1% to 2% would become more muted each year.

Christopher Rolland -- Susquehanna -- Analyst

Got it. And then just a quick one on linearity. Accounts receivable was up but days are fine there. But is there anything about linearity and booking trends through the quarter? Was there any sort of a deceleration at all in the month of September?

Bernard Gutmann -- Chief Financial Officer

The linearity has been pretty steady. We haven't seen any massive changes there. From the revenue point of view, Q3 is typically back-end-loaded and Q4 is typically front-end-loaded, but we're not seeing any different than our normal patterns.

Christopher Rolland -- Susquehanna -- Analyst

Got it. Thanks, guys.

Operator

And our next question comes from Kevin Cassidy with Stifel. Your line is now open.

Kevin Cassidy -- Stifel -- Analyst

Yeah, thanks. You had mentioned the increased content in handsets in the new models. Can you give us a break out of the Tier 1 models versus, say, the China-based mid-range models?

Keith Jackson -- President and Chief Executive Officer

Yeah. So, most of them are higher end models and it's about half China-based and half non-China OEM-based when you add it up in aggregate. That's been a fairly stable position. We strive to have some balance in that market because picking winners and losers is a difficult job.

Kevin Cassidy -- Stifel -- Analyst

Right. Great. And on your raw wafer capacity, what's the goal for the total percentage of in-house wafer production and where does it stand right now?

Keith Jackson -- President and Chief Executive Officer

So, the production, based on the capital investments we made this year, will get us to about 50% internal supply. And I don't see that shifting significantly in 2019.

Kevin Cassidy -- Stifel -- Analyst

Great. Congratulations.

Keith Jackson -- President and Chief Executive Officer

Thank you.

Operator

And our next question comes from Harlan Sur with J.P. Morgan. Your line is now open.

Harlan Sur -- J.P. Morgan -- Analyst

Morning. Nice job on the quarterly execution, guys. Good to see the ramp in your 5G design wins, medium voltage products. Can you guys just help us understand where these wins are situated? Is it primarily power supply or the compute DSP processor, power management, or signal chain? Any color here would be appreciated.

Keith Jackson -- President and Chief Executive Officer

Yeah. It's almost exclusively the power-related products for 5G in all instances.

Harlan Sur -- J.P. Morgan -- Analyst

Great. Can you guys just, maybe at a high level, kind of discuss the order trends thus far here in the December quarter? I know it's a bit early but normal seasonal quarter-on-quarter trend for the team is kind of flat to down 2% in the March quarter. Anything that you're seeing that would lead you to believe that things could play out a bit differently at this point?

Bernard Gutmann -- Chief Financial Officer

Currently, we don't have any visibility that would indicate otherwise.

Harlan Sur -- J.P. Morgan -- Analyst

All right. Thank you.

Operator

And our next question comes from Rajvindra Gill with Needham & Company. Your line is now open.

Rajvindra Gill -- Needham & Company -- Analyst

Yeah. Thank you and congrats as well. Just some clarification on the previous questions. Could you specific what the book to bill was for the September quarter? And more specifically for the month of September, any kind of clarity there?

Bernard Gutmann -- Chief Financial Officer

We don't normally spell out these numbers but it was above one.

Rajvindra Gill -- Needham & Company -- Analyst

Okay. And there wasn't any signs of kind of abnormal order cancellations or order rescheduling?

Keith Jackson -- President and Chief Executive Officer

None at all.

Rajvindra Gill -- Needham & Company -- Analyst

Okay. Got it. And just another follow-up on that. In terms of your Q4 guidance, and it might be difficult to elucidate this, but how much do you think the guidance is related to any kind of pull-in of demand from early next year ahead of the tariff increases? I know you have a lot of semi content gains in auto, industrial, cloud server, etc. Any kind of clarity on that?

Keith Jackson -- President and Chief Executive Officer

We really don't have any indication that that's what's going on. And, again, if you look at the percentage of products that are imported back into the U.S., I don't know how significant that could be. But, certainly, we've been given no indications from customers that that's what's going on.

Rajvindra Gill -- Needham & Company -- Analyst

And last question, just housekeeping. What's the tax rate expected for '19?

Bernard Gutmann -- Chief Financial Officer

Approximately 10%.

Rajvindra Gill -- Needham & Company -- Analyst

All right. Thanks again. I appreciate it.

Operator

And our next question comes from Mark Delaney with Goldman Sachs. Your line is now open.

Mark Delaney -- Goldman Sachs -- Analyst

Yes, good morning. Thanks for taking the questions. So, I'm hoping for an update on how many synergies may be left to achieve in COGS from Fairchild. And related to that, I think ON had planned product qualifications recently that would allow ON to consolidate factories somewhat faster in a future downturn, if necessary, than some of the past downturns. So, can you give us an update on what ON may have done on that front and what it could mean for your cost structure?

Bernard Gutmann -- Chief Financial Officer

Sure. So, on the synergies, we basically had said that it would come in throughout '18 and spill over into '19. We are seeing good traction on that. We are, I would say, not completely done but getting close to being done on that front.

On the other question, what was the other question?

Mark Delaney -- Goldman Sachs -- Analyst

I thought you had qualified certain products out of multiple factories.

Bernard Gutmann -- Chief Financial Officer

We have. We always, as a matter of business, we always like to have multiple source qualifications. And we talked about potentially having some footprint consolidations, which we have also indicated that with the high demands we have right now, we are not executing to. But it is always something that we have in the back of our minds in case we have a disruption in a stronger downturn.

Mark Delaney -- Goldman Sachs -- Analyst

Got it. And for my second question, I was just hoping for some more clarity about how much revenue ON is recognizing currently in automotive from Silicon Carbide products and how you expect that to come in for 2019. Thanks very much.

Keith Jackson -- President and Chief Executive Officer

Yeah. We are not giving specifics on that yet but, as I mentioned, in total, Silicon Carbide would be in the tens of millions this year, ramping multiples each year.

Operator

And our next question comes from Craig Hettenbach with Morgan Stanley. Your line is now open.

Craig Hettenbach -- Morgan Stanley -- Analyst

Great. Thank you. Keith, if I can contrast just some of the markets in terms of what you're seeing. So, stability in automotive versus some weakness in industrial. Can you just talk about some of the demand signals you're seeing in each of those instances from customers?

Keith Jackson -- President and Chief Executive Officer

So, again, we've seen very positive demand signals. Bernard mentioned a book to bill over one. That is in aggregate and comprehends the weaknesses we talked about in China consumer and industrial areas. So, both of them, I would say, are seasonal. The automotive piece is higher than seasonal because of content gains and the industrial piece, when you offset for the weakness in China, is pretty close to normal.

Craig Hettenbach -- Morgan Stanley -- Analyst

Okay. And then China, where you are seeing some weakness, can you talk about kind of when that developed within the quarter and how it's looking into this quarter?

Keith Jackson -- President and Chief Executive Officer

That actually started developing in the third quarter and I'd say kind of the August timeframe. So, it wasn't the end of the month and it stabilized very quickly after some initial adjustments.

Craig Hettenbach -- Morgan Stanley -- Analyst

Okay. Thank you.

Operator

That does conclude today's question-and-answer session. I would now like to turn the call back to Parag Agarwal, VP of Corporate Development and Investor Relations, for any further remarks.

Parag Agarwal -- Vice President of Corporate Development and Investor Relations

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

Operator

Ladies and gentlemen, that does conclude today's conference. Thank you for your participation and everyone may disconnect. Everyone, have a great day.

Duration: 58 minutes

Call participants:

Parag Agarwal -- Vice President of Corporate Development and Investor Relations

Bernard Gutmann -- Chief Financial Officer

Keith Jackson -- President and Chief Executive Officer

Christopher Danely -- Citigroup -- Analyst

Vivek Arya -- Bank of America Merrill Lynch -- Analyst

Guasia Chowdhury -- Longbow Research -- Analyst

Ross Seymore -- Deutsche Bank -- Analyst

Vijay Rakesh -- Mizuho -- Analyst

Chris Caso -- Raymond James -- Analyst

John Pitzer -- Credit Suisse -- Analyst

Krysten Sciacca -- Nomura Instinet -- Analyst

Anthony Stoss -- Craig-Hallum Capital Group -- Analyst

Craig Ellis -- B. Riley FBR -- Analyst

Tristan Gerra -- Robert W. Baird -- Analyst

Christopher Rolland -- Susquehanna -- Analyst

Kevin Cassidy -- Stifel -- Analyst

Harlan Sur -- J.P. Morgan -- Analyst

Rajvindra Gill -- Needham & Company -- Analyst

Mark Delaney -- Goldman Sachs -- Analyst

Craig Hettenbach -- Morgan Stanley -- Analyst

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