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ON Semiconductor (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

Ladies and gentlemen, welcome to the ON Semiconductor third-quarter 2018 earnings conference call. [Operator instructions] 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, everyone, 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 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. A reconciliation of these non-GAAP financial measures to most directly comparable measures under GAAP are in our earnings release, which is posted separately on our website in the Investor Relations section.

During the course of this conference call, we will make projections or other forward-looking statements regarding future events or 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 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 18th, 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 last several quarters clearly demonstrate the strength of our business and our steadfast operational execution. Despite overhand -- hang 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. Three secular drivers powering our business remain intact, and our traction in our strategic markets, which include automotive, industrial, and cloud -- 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 to 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 million, an increase of 11% as compared to revenue of $1.391 million 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 GAAP basis, our third-quarter gross margin improved by 100 basis points year over year, and on 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 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 wafer capacity toward the end of this year, we expect to partially offset the impact of increased input costs. Our GAAP operating margin for 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 year-over-year revenue increase of 11% for the third quarter of 2018, our non-GAAP operating income increased by 19%. This strong operating income performance demonstrates the leverage and strength of our operating 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 135 -- $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 the 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 third quarter of 2018 with cash and cash-equivalents of $951 million, as compared to $850 million at the end of 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 lower end of our target range of 11 to 13 weeks.

We expect distribution inventories to remain within the normal range of 11 to 13 weeks in the near-term. To mitigate the risk of excessive inventory in the channel, we are proactively management -- 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 to 13 weeks of resales. Earlier in the fourth quarter, we announced the purchase of an incremental 20% share in -- 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 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 performance of our business units, starting with power solutions group, or PSG. Revenue for PSG for the third quarter was $810 million. Revenue for the 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 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 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 manyfold 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 semiconductor end-markets, as opposed to being driven by macroeconomic conditions and semiconductor industry cyclicality a few years ago. Through our investments the over 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.

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 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 lower end of our target range of 11 to 13 weeks. Pricing continues to be benign as compared to historic trends.

Along with our strong revenue performance, our execution on 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 increased -- 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 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 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 by an impressive 12% year over year. Despite some volatility in automotive supply chain, we posted strong year over year and sequential growth in the third quarter. We believe that ongoing content increases, new production introduction, 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 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 automotive ener -- image sensors continues to accelerate. Key factors driving our growth in the automotive image sensor market are significant technology lead over competition, and industry's most expen -- 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 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 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 also it will provide a key differentiating advantage to us as automotive industry moves to sensor fusion architecture for ADAS and autonomous driving. We recorded our first silicon carbide revenue from automotive end-market in the third quarter.We are actively engaged with 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 electrification of drive train. We expect to see strong acceleration in our automotive silicon carbide revenue for foreseeable future. Demand for our power products, 48V 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 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 solid 12% year over year. Ever increasing energy efficiency requirements continue to be key drivers of increase in power management content in industrial systems. We are seeing severalfold 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 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 launch of new smartphone models. As has been the case over 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 in for significant power management content in 5G systems, and we expect to see strong revenue ramp 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 ramp of our analog power management solutions for graphics processors. As we have indicated in previous 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 upcoming generation of processors, we expect to increase our analog content through introduction of new products.

Revenue in the fourth quarter for 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-season 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 third quarter of 2017.

The decline was due to our selective participation in certain areas of 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 white goods market and normal seasonality. In summary, demand environment for our products remains healthy, driven by secular mega trends 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 slowing global economy have not impacted our business in 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 operation -- operational execution remains solid. We have continued to expand our margins and generate strong free cash flow. Now, I would 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 range of $1.48 million to $1.53 billion in the fourth quarter of 2018. Included in our fourth-quarter revenue guidance is approximately $20 million revenue from the manufacturing services provided by ON Semiconductor Aizu, or OSA, which, as I indicated earlier, is our 8-inch -- joint venture in an 8-inch fab. Excluding impact of OSA, our fourth-quarter revenue is expected to be in range of $1.46 billion to $1.51 billion.

Recall that as part of joint venture agreement, we may provide manufacturing services to our joint venture partner for up to six quarters starting with fourth quarter of 2018. For fourth quarter of 2018, we expect gross margin to be in range of 37.1% to 38.1%. Our fourth-quarter gross margin guidance includes negative impact of 50 basis points from the manufacturing provide -- services provided by OSA. Excluding impact of OSA, our fourth-quarter gross margin is expected to be in the range of 37.6% to 38.6%.

We expect total GAAP operating expenses of $348 million to $366 million. Our GAAP operating expenses include 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 dales -- 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 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 fourth quarter of 2018.

We also expect share-based compensation of $19 million to $21 million in 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 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 2018, we expect to generate free cash flow in 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

[Operator instructions] And our first question comes from Chris Daneley with Citigroup. Your line is now open.

Chris Daneley -- Citi -- Analyst

Hey, 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 they started to come in?

Keith Jackson -- President and Chief Executive Officer

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

Chris Daneley -- Citi -- Analyst

And 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.

Chris Daneley -- Citi -- Analyst

OK. And then, for my follow-up, on -- just on the OSA biz. 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.

Chris Daneley -- Citi -- Analyst

Got it. OK. 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 if you look at some of the weaker outlook from the peers 5%, etc. What kind of went through your mind when you contrast the weakness versus the stability or trend that you are seeing? Is it possible you're not seeing the downturn now but perhaps could see later just because either you have products or you had longer lead times? If you could just give us a sense of what's on your dashboard, right? How are order cancellations looking? How is the book-to-bill ratio? Like, 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 contrast, I will point to the fact that our power content, specifically in the markets 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 are being served. But in our case, we really do think it's a 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 kind of problematic areas you 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 actually, 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

OK. Thank you.

Operator

And our next question comes from Shawn Harrison with Longbow Research. Your line is now open.

Gausia Chowdhury -- Longbow Research -- Analyst

Hi, good morning. This is Gausia Chowdhury on behalf of Sean. Within auto, are you seeing any auto production weakness in any region?

Keith Jackson -- President and Chief Executive Officer

We are not seeing any weakness. We are seeing -- this year, unlike like 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 are far offset those.

Gausia Chowdhury -- Longbow Research -- Analyst

OK. Thank you. And then with regards to OSA, do you anticipate that the profitability will -- there'll 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 our prepared remarks, we may serve this for up to six quarters through the first quarter of 2020. And I expect a stable business during that time frame.

Gausia Chowdhury -- Longbow Research -- Analyst

Thank you.

Operator

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

Ross Seymore -- Deutsche Bank -- Analyst

Hi, guys. Just want to follow up on the auto side. Keith, I know you have more content there conceptually. Can you just talk about give or a little more color as to how that's playing out? Historically, even the companies that in aggregate are gaining more content still aren't immune from SAR pulling down.

So any more 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

Yes. I mean, of course, you're never immune from slowdowns in unit production. About our new designs in 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 on the other impact that you could have there, Ross, is significant over inventories, and we've seen the signs of that. So you put it all together, we continue to see good growth.

Ross Seymore -- Deutsche Bank -- Analyst

And 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 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, default through on the decremental revenue if the restructure decrement is about a 50%. In cases of a slowdown, you in-source more of the production this currently outsourced through our it makes to change toward that. On the opex front, variable comp and variable commissions would also be directly proportional to or affected by the reduction in that front.

And then, you take the normal belt-tightening actions that occur in any slowdown.

Ross Seymore -- Deutsche Bank -- Analyst

OK. Thank you.

Bernard Gutmann -- Chief Financial Officer

You're welcome.

Operator

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

Vijay Rakesh -- Mizuho Securities -- Analyst

Yeah. Hi, thanks, guys. Just on the industrial side, I know you mentioned slight softness here in December. Just wondering if you're seeing anything other than the ordinary or suggest 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 that's -- it's not -- it's not significant. So it's slightly down versus flattish. Normal seasonality.

Vijay Rakesh -- Mizuho Securities -- Analyst

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

Keith Jackson -- President and Chief Executive Officer

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 weakness we've talked about. But otherwise, we haven't seen any significant impact, change in backlogs or order patterns.

Vijay Rakesh -- Mizuho Securities -- 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 selling versus sell-through in distribution for the third quarter, and your expectations for the fourth quarter? And in your prepared remarks, you said you're already at the low end of your target inventory range of 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. That we're very happy at the lower 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 -- 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 the sell-in kind of equal sell-through.

Chris Caso -- Raymond James -- Analyst

OK. 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 an impact is $20 million in revenue on -- of about flat -- about zero gross margins, rather. So what's the benefit for taking that step, majority interest?

Keith Jackson -- President and Chief Executive Officer

The reason we [Inaudible] 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 preplanned phase-over in that capacity. So the real issue is we need to fill that out with our products.

And of course, as we do that, the margins for our products are significantly better.

Chris Caso -- Raymond James -- Analyst

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. Thank you for letting me ask a question, and congratulations on the strong results. Keith, I'm just wondering.

Relative to being a cushion within the comps business and the compute business today, what percentage of infrastructure and kind of server cloud hyperscale in each? How those that trend year over year compared to the last year? And what do you think that's going to be four quarters from that?

Keith Jackson -- President and Chief Executive Officer

I'll take them separately. On the computing side, the cloud server business has moved from a 20-ish percentage, 20% of our computing business up at least 10 points from that year on year, so -- and we see that trend continuing into 2019. So 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 on an earlier question a growth margin flow-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 is about 38%. So I'm just kind of curious to what extent will input cost impacting things on a year-over-year basis? And can you just level set us? You gave us the 50% kind of gross margins out there. How should we think about op margins in here?

Bernard Gutmann -- Chief Financial Officer

Yes. So the 50% is obviously a yardstick. We think it is a good representation of a kind of a long-term. I think we do have to -- in between spikes where we are always 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 a steady state. If you -- on top of that, you can add the mix, which should, over time, also get us some incremental amounts. On the op margin, we're still targeting to do our 19% to our target model.

We are done some nice progress, about -- going to about 17.8% in the third quarter. And expect to continue making progress toward that as part of growing opex, half of the pace of revenue growth and getting the gross margin leverage we've just talked about.

John Pitzer -- Credit Suisse -- Analyst

And again, if I can sneak one more there. Glad to see you guys buy back stock in the quarter. Despite that you were still able to grow gross cash and keep them, kind of curious just given where the stock pricing is today, kind of what you are on the buyback and? How do you think about sort of just capital allocation from here?

Bernard Gutmann -- Chief Financial Officer

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

John Pitzer -- Credit Suisse -- Analyst

Perfect. Thanks, guys.

Operator

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

Kristin Sciacca -- Nomura Instinet -- Analyst

Good morning. Thanks a lot 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 [Inaudible] versus being extended over the past year, but you're seeing your lead times are being extended and should be at least with the first half of next year.

Could you maybe give a little bit more color on that, on what is driving that trend?

Bernard Gutmann -- Chief Financial 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 on -- 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.

Kristin Sciacca -- Nomura Instinet -- Analyst

Great. Thank you. And then just switching over to comps. In your prepared remarks, you said you expect the revenues to be flat for next quarter sequentially versus sequential -- versus historically seasonally down.

can you maybe just dig into what trends you're seeing that with remote that above seasonal growth? Is that mainly 5G-related revenue? Or is there some other factors that play into effect there?

Keith Jackson -- President and Chief Executive Officer

It's -- 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 and the new model of handsets that rolled out. And those -- from a build perspective, our customers are still showing as good demand in Q4.

Kristin Sciacca -- Nomura Instinet -- Analyst

Great. Thank you.

Operator

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

Anthony Stoss -- Craig-Hallum -- Analyst

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

Bernard Gutmann -- Chief Financial Officer

So capacity utilization 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 wild 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. And we're increasing our capacity to soon more be dependent on these input costs but not on the not on the -- not on internal -- not on the silicon carbide right now.

Anthony Stoss -- Craig-Hallum -- 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 computing server and in smartphone.

So the question is, within 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 now, and 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 process releases. So we see that as a very positive trend. We believe also our share gains 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, you're setting aside the manufacturing KPs impact your gross margin in the fourth quarter. There's still a decrease of around 50 to 60 basis points, it looks like.

So is that primarily utilization? Or other other factors at play, like input cost 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 good and takes with gross margin? Not looking for guidance budget has some higher-level color. Thank you.

Bernard Gutmann -- Chief Financial Officer

Sure. So in the fourth quarter, the gross margin declined beyond the OSA is mostly just revenue-related utilization. We're guiding to a lower number in the third quarter's actuals. It is approximately a 50% fall-through under decremental revenue, so there is no nothing bigger there.

Contracts or pricing continues being quite benign, and we're seeing that in our -- 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 & Company -- Analyst

OK. Good morning. Could you provide a little bit of color on your CMOS camera business in automotive? You've talked in the past about 70% market share. How's the outlook in that business for next year? Are you [Inaudible] on track or are you seeing any type of delays?

Keith Jackson -- President and Chief Executive Officer

Yes. 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 & Company -- Analyst

OK. 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, we'll have to wait and see what the markets provide.

Tristan Gerra -- Robert W. Baird & Company -- Analyst

Great. Thank you.

Operator

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

Chris Rolland -- Susquehanna -- Analyst

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 some things you talked about on the opex side. Also wondering how you are treating the revenue.

Is it kind of half of that or are you kind of getting 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 that -- is this dynamic changed now in your opinion considering you're no longer like 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 are looking at the holiday season during that time frame. But you have to pay the people so it is mostly affecting opex, but with a 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 time -- long-term pricing trends, we are getting a higher content for sole-sourced products. And so we would expect that would become more muted. The typical 1% to 2% would become more muted each year.

Chris Rolland -- Susquehanna -- Analyst

Got it. And then, just a quick one on linearity. Accounts receivable was up but days are fine there. Is there anything about the 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 difference in our normal patterns.

Chris Rolland -- Susquehanna -- Analyst

Got it. Thanks, guys.

Operator

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

Kevin Cassidy -- Stifel Financial Corp. -- Analyst

Thanks. You mentioned the increased content in handsets in the new models. Can you give us a breakout of the Tier 1 models versus, say, the China-based midrange models?

Keith Jackson -- President and Chief Executive Officer

Yes. 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 Financial Corp. -- 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 for -- 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 Financial Corp. -- Analyst

Great. Congratulations.

Keith Jackson -- President and Chief Executive Officer

Thank you.

Operator

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

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

Good morning. Good to see the ramp in your 5G design wins, medium-voltage products. Can you 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

Yes. It's almost excessively 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 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 will lead you to believe that things could turn differently at this point?

Keith Jackson -- President and Chief Executive 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 previous questions. Could you specify what the book-to-bill was for the September quarter, and more specifically, on the -- for the month of September? Any clarity there?

Bernard Gutmann -- Chief Financial Officer

Yes. We don't normally spell out these numbers, but it was above 1.

Rajvindra Gill -- Needham & Company -- Analyst

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

Bernard Gutmann -- Chief Financial Officer

Not at all.

Rajvindra Gill -- Needham & Company -- Analyst

OK. Got. 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 had 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 indication from customers that that's what's going on.

Rajvindra Gill -- Needham & Company -- Analyst

And last question, just for 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. Appreciate it.

Operator

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

Mark Delaney -- Goldman Sachs -- Analyst

Good morning. Thanks for taking the questions. So maybe an update on how many synergies maybe less to Gs and COGS on Fairchild? And related to that, I think ON product qualifications recently that will allow ON to consolidate factories somewhat faster. And a future downturn, if necessary, this over 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 have said that it will come in throughout '18 and spillover into '19. We are seeing a 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

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

Bernard Gutmann -- Chief Financial Officer

We have -- we always -- it's a matter of what business we always like to have multiple-source qualifications. And we talked about potentially having sound footprint consolidations, which we've also indicated that with the high demands we have right now, we are not executing two, but it is always something that we have in the back of our mines in case we have the disruption or -- in a more -- in a stronger downturn.

Mark Delaney -- Goldman Sachs -- Analyst

Got it. And for my second question, I was just hoping for us 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

Yes. We are not giving specifics on that yet. But as I mentioned, in total, silicon carbide, that would be in the tens of millions this year ramping multiples each year.

Mark Delaney -- Goldman Sachs -- Analyst

Yup.

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 to 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 weakness 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 the content gains in the industrial piece, when you offset for the weakness in China, is pretty close to normal.

Craig Hettenbach -- Morgan Stanley -- Analyst

OK. And in 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 the end of this quarter?

Keith Jackson -- President and Chief Executive Officer

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

Craig Hettenbach -- Morgan Stanley -- Analyst

OK. Thank you.

Operator

That does conclude today's question-and-answer session. I would now like to turn the call back over 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

[Operator signoff]

Duration: 59 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

Chris Daneley -- Citi -- Analyst

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

Gausia Chowdhury -- Longbow Research -- Analyst

Ross Seymore -- Deutsche Bank -- Analyst

Vijay Rakesh -- Mizuho Securities -- Analyst

Chris Caso -- Raymond James -- Analyst

John Pitzer -- Credit Suisse -- Analyst

Kristin Sciacca -- Nomura Instinet -- Analyst

Anthony Stoss -- Craig-Hallum -- Analyst

Craig Ellis -- B. Riley FBR -- Analyst

Tristan Gerra -- Robert W. Baird & Company -- Analyst

Chris Rolland -- Susquehanna -- Analyst

Kevin Cassidy -- Stifel Financial Corp. -- 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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