ON Semiconductor Corporation (NASDAQ:ON) Q1 2023 Earnings Call Transcript

ON Semiconductor Corporation (NASDAQ:ON) Q1 2023 Earnings Call Transcript May 1, 2023

ON Semiconductor Corporation beats earnings expectations. Reported EPS is $1.19, expectations were $1.09.

Operator: Good day, and thank you for standing by. Welcome to the ON Semi First Quarter 2023 Earnings Conference Call. At this time, all participants are in a listen-only mode. After the speakers’ presentation, there’ll be a question-and-answer session. Please be advised today’s conference is being recorded. I would now like to hand the conference over to your speaker today, Parag Agarwal, please go ahead.

Parag Agarwal: Thank you, Kevin. Good morning, and thank you for joining ON Semi’s first quarter 2023 quarterly results conference call. I’m joined today by Hassane El-Khoury, our President and CEO; and Thad Trent, our CFO. This call is being webcast on the Investor Relations section of our website at www.onsemi.com. A replay of this webcast, along with our 2023 first quarter earnings release, will be available on our website approximately one hour following this conference call, and the recorded webcast will be available for approximately 30 days following this conference call. Additional information is posted on the Investor Relations section of our website. Our earnings release and this presentation include certain non-GAAP financial measures.

Reconciliation of these non-GAAP financial measures to the most directly comparable GAAP measures and the GAAP financial measures are included in our earnings release, which is posted separately on our website in the Investor Relations section. During the course of this conference call, we will make projections or other forward-looking statements regarding future events or the future financial performance of the company. We wish to caution that such statements are subject to risks and uncertainties that could cause actual results or events to differ materially from projections. Important factors that can affect our business, including factors that could cause actual results to differ from our forward-looking statements, are described in our most recent Form 10-Qs other filing with the Securities and Exchange Commission and in our earnings release for the first quarter of 2023.

Our estimates or other forward-looking statements may change, and the company assumes no obligation to update forward-looking statements to reflect actual results, changed assumptions or other events that may occur except as required by law. Now let me turn it over to Hassane. Hassane?

Hassane El-Khoury: Thank you, Parag. Good morning and thank you all for joining us today. As we continue our transformation, I’m pleased to report another quarter where we’ve exceeded expectations with revenue of $1.96 billion and non-GAAP gross margin of 46.8%, both above the midpoint of our guidance. The current market environment did not deter us from our goals, we have teams around the world, who are committed to operational excellence and I am proud of the results they have achieved in this first quarter. Over the last two years, we centered our transformation around the structural changes that would enable us to better navigate the uncertainty in the semiconductor industry. We streamlined our product portfolio, reduced price to value discrepancies, double down on silicon carbide and improved the overall operations of the company.

We have incredible talent in the company and we have been all hands on deck to solve some of the world’s toughest engineering problems to accelerate the ramp of this next generation technology. Thanks to our team’s relentless efforts we are seeing greater than anticipated silicon carbide results ahead of our internal plan for manufacturing output at every stage of the process from bulls to die to modules. In Q1 alone, these results allowed us to shift nearly double our Q4 revenue and more than half of our 2022 full-year revenue. We are on track to grow our revenue to $1 billion in 2023 and that’s approximately 5 times the revenue of 2022 setting ourselves up for leadership in the silicon carbide market with the majority of the substrate sourced internally.

Demand for electric vehicles, ADAS and energy infrastructure remained healthy amid a broad-based macroeconomic slowdown. While our automotive revenue increased 38% year-over-year, it was flat quarter-over-quarter. We are still supply constrained across several automotive technologies, while in some other technologies, we are cautiously monitoring inventory digestion. In Q2, we expect to see quarter-over-quarter growth in our automotive revenue. In Q1, we shifted our mix to energy infrastructure where there is high demand and high growth. Our industrial revenue in turn increased 1% sequentially instead of the decline we had anticipated. Driven by the need for alternative energy, sources and accelerated by global geopolitical issues, installation of energy storage systems is increasing along with our content that includes silicon carbide and silicon power solutions.

Pricing across our business is stable and we don’t anticipate any changes in the pricing environment. A significant part of our business is secured by long-term supply agreements and pricing in these agreements is fixed for multiple years. Also, as part of our business transformation, we have walked away from price sensitive businesses in non-strategic areas to drive predictable financial results. In Q1, automotive and industrial accounted for 79% of our total revenue, as compared to 65% in the quarter a year ago. When we started our transformation, we targeted 75% of our business to be automotive and industrial by 2025 and we have achieved our desired end result two years earlier. We also improved our demand visibility across all markets with commitments from our customers, new and existing in the form of LTSAs. These LTSAs also help reduce our exposure to the volatility in the consumer and computing markets.

Volkswagen as an example, signed a three-year agreement for more than 100 current production devices giving them the required supply chain sustainability with a major semiconductor partner, our committed revenue through LTSAs increased again in Q1 by $1 billion. We are supporting our customers today while working closely with them on next generation designs for their intelligent power and sensing needs. In addition to the LTSA we announced last quarter, we were recently honored with the 2022 Supplier of the Year Award from Hyundai Motor Group, which recognized ON Semi as a trusted provider for key technology in its ecosystem, offering supply chain resilience and manufacturing sustainability. Customers also recognize us as a strategic partner that provides high value through the entire design cycle, which gives them a competitive edge over their peers.

In March, we launched our new Elite Power Simulation tool to bring complex power electronics applications to market faster through system level simulations, saving design engineers from expensive time consuming hardware fabrication and testing in the early stages of development. This tool will also allow us to get a broader customer reach through our distribution network with a low touch model to design in our products. Global automotive OEMs are choosing to partner with On Semi for the superior performance of our end-to-end silicon carbide solutions. Just last week, we announced an LTSA with ZEEKR, a leading all EV manufacturer in China, who has selected On Semi’s third generation 1,200 volt EliteSiC MOSFET to increase the electric powertrain efficiency and extend the range of its expanding portfolio of high performance electric vehicles.

These EliteSiC power devices deliver improved power and thermal efficiency, which reduced the size and weight of the traction inverters to deliver improved performance resulting in extended driving range and faster charging speeds. BMW Group has also selected On Semi’s EliteSiC to support range extension for their next generation electric vehicles. They secured an LTSA with us to equip their future electric drivetrains with our silicon carbide technology to increase efficiency and system level performance. We also continue to invest in silicon power and as auto OEMs move to Zonal Architecture, we deliver intelligent power solutions that meet all voltage range requirements from 12 volts to 48 volts and beyond. Through these strategic partnerships, we are enabling our customer sustainability efforts, while also working on our own.

We committed to the science-based targets initiative and pledged to set near-term science-based emission reduction targets in line with SPTI criteria and our decarbonization journey to achieve net zero emissions by 2040. Our Q1 revenue for intelligent sensing increased 26% year-over-year. We introduced our new Hyperlux Family of image sensors to support the transition to eight megapixel devices where ASPs can be up to 2.5 times that of one or two megapixel image sensors. Our traction for image sensors in automotive has proliferated into industrial automation and smart retail applications. Our newest eight megapixel image sensor achieved stunning 4K video quality with optimized near infrared response necessary for industrial applications with harsh lighting conditions such as security and surveillance, body cameras, doorbell cameras and robotics.

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The shift out of lower value commodity applications coupled with capacity expansion in differentiated products and packages reduced the supply to demand gap and is driving margin expansion and revenue growth in our focused markets. Automotive and Industrial now account for more than 95% of our intelligent sensing business. Beyond image sensing, our intelligent sensing penetration is expanding with other sensing solutions in our portfolio. We shipped our 1 billionth inductive position sensor IC to Hela, one of the largest automotive supplier, who uses our technology and their drive by wire systems such as accelerator pedal fencing, steering and torque sensors, as well as actuators for pressure boost and turbos. We also lead the market in automotive ultrasonic sensors with more than 20 sensors in one of the latest EV models from a leading European OEMs. In Q1, our intelligent power and intelligent sensing revenue accounted for 69% of our total revenue, as compared to 64% in the quarter a year ago.

As we get ready for the next chapters and with our journey, we are applying what we know. Operational excellence in controlling what we can and executing to our commitments. We have positioned ourselves to lead in our focused markets with superior technology to offer our customers and we have the agility to pivot and adapt to change as required by the business and market environment. And more importantly, we have the team to execute. Now, I will turn the call over to Thad to provide additional details on our financial and guidance. Thad?

Thad Trent: Thanks, Hassane. As Hassane highlighted, we exceeded expectations in the first quarter, which is a testament to our employees around the globe, who are committed to operational excellence. Our ability to focus, invest and execute has provided benefits across all areas of the business and allowed us to maintain our financial targets, while navigating the market uncertainty. We continue to identify and extract operational efficiencies in our business groups and corporate functions, while identifying gross margin expansion opportunities. I’ll start by diving into our results for the first quarter. Total revenue was $1.96 billion dollars above the midpoint of our guidance driven by strength in silicon carbide and energy infrastructure.

In Q1, our silicon carbide manufacturing output was ahead of our internal plans and we nearly doubled our Q4 revenue, increasing our confidence in our past to the $1 billion year. Our automotive business now accounts for 50% of total revenue and at $986 million in Q1 it was flat sequentially, offset by a recovery in industrial revenue. Industrial revenue grew by 1% quarter-over-quarter, surpassing our original projections. We anticipate another stellar year for our Energy Infrastructure business with projected 50% growth over 2022 at accretive gross margins. Revenue for the Power Solutions Group or PSG was $1 billion dollars, an increase of 3% year-over-year and we saw sequential gross margin expansion as our silicon carbide ramp exceeded expectations on both revenue and margins.

Revenue for the Advanced Solutions Group or ASG was $593 million, a decrease of 14% year-over-year and revenue for the Intelligent Sensing Group or ISG was up an impressive 32% year-over-year at a record of $354 million. ISG’s impressive turnaround continues as Q1 was also their 11th quarter of gross margin expansion with record gross margin exceeding 50%. As a corporation, our consolidated gross margin held up nicely. GAAP and non-GAAP gross margin for the first quarter was 46.8% above the midpoint of our guidance, driven by higher than anticipated industrial revenue and improved manufacturing performance for silicon carbide output. We also exited an additional $47 million of revenue in the quarter at an average gross margin in the mid-40% range, bringing the total revenue to-date to $341 million of non-core business exits.

Our non-GAAP gross margin declined by 160 basis points quarter-over-quarter as expected with the ramp up of silicon carbide and EFK headwinds and lower factory utilization of 71% as we continue to slow wafer starts. Q1 was our first quarter of operations since acquiring our 300 millimeter fab in East Fishkill. The current operating cost is much higher than we had anticipated. So the dilutive impact is greater than we previously expected. However, based on our current outlook, we are confident we can realign the cost structure of the fab and drive efficiencies to recover by early 2024. As demonstrated in Q1, we expect to maintain our gross margin trajectory for 2023. Our financial strategy remains unchanged as does our capital allocation strategy.

In Q1, we returned more than 100% of our free cash flow to our shareholders with share repurchases of $104 million. This was the first repurchase from our new authorization, which allows us to repurchase up to $3 billion through 2025. Additionally, we issued $1.5 billion in convertible notes in Q1 with the proceeds used to repay our term loan. This was essentially leverage neutral and highly accretive as we swapped out a portion of our variable rate debt approaching 7% with a fixed rate convert with a coupon of 50 basis points. We also entered a call spread transaction increasing the effective strike price to $156.78 per share, providing significant dilution protection. Now let me give you some additional numbers for your models. GAAP operating expenses for the first quarter were $352.6 million, as compared to $314.1 million in the first quarter of 2022.

Non-GAAP operating expenses were $286 million, as compared to $302.8 million in the quarter a year ago. Non-GAAP operating expenses were below our guidance as we manage discretionary spending across the company given the uncertain macro environment. We also initiated structural changes to ASG to improve operational efficiency by reallocating resources to high growth R&D initiatives, while improving our product development and time to market on industry-leading proprietary products. GAAP operating margin for the quarter was 28.8% and non-GAAP operating margin was 32.2%, a decrease of 190 basis points quarter-over-quarter. Our non-GAAP tax rate was 16.3%, GAAP earnings per diluted share for the first quarter was $1.03, as compared to $1.18 in the quarter a year ago.

Non-GAAP earnings per share was $1.19 above the high end of our guidance. Our GAAP diluted share count was 448.5 million shares and our non GAAP diluted share count was 439.1 million shares. Turning to the balance sheet, cash and cash equivalents was $2.7 billion and we had $1.6 billion undrawn on our revolver. Cash from operations was $408.9 million and free cash flow was $87.4 million or $4.4 of revenue. Free cash flow was negatively impacted by timing of annual bonuses and CapEx payments. Capital expenditures during Q1 were $321.5 million, which equates to a capital intensity of 16.4% for the quarter. As we indicated previously, we are directing a significant portion of our capital expenditures toward silicon carbide and enabling our 300 millimeter capabilities at East Fishkill fab and expect our capital intensity to be in the mid to high teen percentage range for the next several quarters.

Accounts receivable of $880.9 million increased by $38.6 million and DSO of 41-days increased by four days. Inventory increased by $198.1 million sequentially and days of inventory increased by 23 days to 159 days. This includes approximately 43 days of bridge inventory to support fab transitions and the impending silicon carbide ramp. We continue to proactively manage distribution inventory, decreasing inventory in the channel by $79 million sequentially and at historically low levels with weeks of inventory at 7 weeks, compared to 7.3 weeks in Q4. Total debt was $3.5 billion and net leverage is $0.25. In Q1, we accrued $41 million in balance sheet under property, plant and equipment related to the 25% investment tax credit for investments in our U.S. Factories.

This will eventually flow through our income statement as lower depreciation and will receive the associated cash benefit in the future. Let me now provide you key elements of our non-GAAP guidance for the second quarter. The table detailing our GAAP and non-GAAP guidance is provided in press release related to our first quarter results. Our business continues to strengthen with total committed revenue under LTSAs of $17.6 billion, an increase of $1 billion quarter-over-quarter. We expect to recognize approximately $5.8 billion of committed revenue from our LTSAs in the next 12 months in addition to our non-cancelable non-returnable orders. Given the macro uncertainty, we are taking a cautious stance in our guidance. We anticipate Q2 revenue will be in the range of $1.975 billion to $2.075 billion.

We expect automotive and industrial to increase quarter-over-quarter with other markets flat to down as we plan further exits in our non-strategic end markets. We expect non-GAAP gross margin to be between 45.5% and 47.5%, due to lower factory utilization, EFK headwinds and the dilutive impact of ramping silicon carbide, which remains ahead of plan. This also includes share-based compensation of $4.5 million. As we previously stated 2023 will be a transition year for our gross margins and we expect to maintain our trajectory as we manage these temporary headwinds. We expect non-GAAP operating expenses of $297 million to $312 million, including share-based compensation of $28.8 million. We anticipate our non-GAAP OIE will be $3 million to $5 million.

We expect our non-GAAP tax rate to be in the range 15.5% to 16.5% and our non-GAAP diluted share count for the second quarter is expected to be approximately 440 million shares. This results in non-GAAP earnings per share to be in the range of $1.14 to $1.28. We expect capital expenditures of $420 million to $460 million, primarily in brownfield investments in silicon carbide and EFK, which are a more efficient use of capital than the greenfield alternative of building a fab from the ground up. We are very proud of our financial results through this transformation and will continue to deliver value for our shareholders. We are equally pleased with our cultural transformation. On Semi is a very different company today. We challenge the status quo and we hold ourselves accountable to our commitments.

As many of you know, we’ll be holding an Analyst Day in New York on May 16, and we look forward to sharing our future plans to accelerate value for our shareholders. We hope to see you there. With that, I’d like to turn the call back over to Kevin to open the line for questions.

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Q&A Session

Operator: Thank you. Our first question comes from Ross Seymore with Deutsche Bank. Your line is open.

Ross Seymore: Hi guys. Thanks for letting me ask a question. Hassane, I want to ask about the auto side of your business. Investors are getting a little more concerned just about the — that market given that it’s of the few that hasn’t cyclically adjusted. And you guys were flat sequentially versus what you thought would be up a bit and that’s all despite the silicon carbide side, upsiding. So I guess could you just talk a little bit about what you’re seeing there, inventory, demand and perhaps separate the silicon carbide side from the other parts of the business when you give that answer, please?

Hassane El-Khoury: Sure. Look, obviously for silicon carbide, it’s a ramping business for us. You’ve seen tremendous progress in the first quarter, slightly ahead of where we thought we would be based on just the team doing a stellar job ramping the technology, that’s going to keep ramping throughout the year. You can think about it as an uptick in the second-half as we accelerate the — exiting the year on track for the $1 billion that we talked about and every day, we had more and more confidence in those numbers. The rest of automotive, obviously, we have some technologies that remain constrained, so demand is healthy. We remain constrained in our ability to supply to that demand. You can think about that as our silicon high voltage, silicon medium voltage, that not just go to the EV demand, but also a broader aspect of that demand.

Other technologies, we’re monitoring the inventory digestion. As I said in my prepared remarks, that was, kind of, the first quarter where we wanted to look at it. We used that opportunity to drain the distribution inventory where you see we went from 7.3 weeks to 7 weeks and that’s a pretty big number over $70 million of a $1 drained from the inventory, because we wanted to set ourselves up for the uncertainty in the second-half of the year that everybody keeps talking about. So from a demand, I’m comfortable with the EV, that’s a ramping business for us. The rest we’re cautiously monitoring. However, as I mentioned in my prepared remarks, Q2 is an up quarter for us in Q1. So you can think about automotive as we took a breather in Q1 to test the inventory and we’re going to keep ramping for the rest of the year.

Full-year, we’re going to be up from last year, so that gives you kind of an idea on the overall demand as we see it outside of quarter-on-quarter fluctuation.

Ross Seymore: Perfect. Thanks for that. And I guess moving from my follow-up over to Thad on the gross margin side of things. It seems like there were quite a few moving parts, especially the East Fishkill in the silicon carbide side, but the net of it all seems be right in line with your plan. Can you just talk a little bit about those moving parts? East Fishkill is more expensive, but silicon carbide is ahead of plan. Does that still net out to the same trajectory through the rest of the year? Just walk us through those puts and takes and maybe the utilization side as part of that as well, please?