ON Semiconductor Corporation (NASDAQ:ON) Q4 2022 Earnings Call Transcript

ON Semiconductor Corporation (NASDAQ:ON) Q4 2022 Earnings Call Transcript February 6, 2023

Operator: Good day, and thank you for standing by. Welcome to the onsemi Fourth Quarter 2022 Earnings Conference Call. Please be advised that today’s conference is being recorded. I would now like to hand the conference over to your speaker today, Parag Agarwal, Vice President of Investor Relations and Corporate Development. Please go ahead.

Parag Agarwal: Thank you, Christa. Good morning, and thank you for joining onsemi’s fourth quarter 2022 quarter 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 2022 fourth 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 events or results 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-K and Form 10-Qs in our filings with the Securities and Exchange Commission and in our earnings release for the fourth quarter of 2022.

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, and thank you all for joining us today. 2022 has been an excellent year for onsemi, and nothing makes me prouder than to share our latest progress after closing the second year of our transformation. Our worldwide teams have yet again delivered outstanding results, allowing us to deliver the most successful year in the company’s history, with record revenue of $8.3 billion in 2022, an increase of 24% year-over-year, with earnings growing 3x faster than revenue. Our gross margin of 49.2% increased 880 basis points for the full year and 1,650 basis points since we began our transformation journey. From our manufacturing footprint to our product portfolio and go-to-market strategy, we have transformed all facets of our business and set ourselves up to win in the fastest-growing megatrends of the automotive and industrial markets.

We earned ourselves a position in the S&P 500 this past year, and we created more value for our shareholders than ever before. The uncertainty in the macro environment has impacted demand, and we have seen a slowdown in some areas of our business, which include consumer, computing and parts of industrial. Demand for our automotive business remains healthy as automakers have been catching up on production levels. In Q4, our automotive business grew 54% year-over-year, 13% quarter-over-quarter and accounted for 47% of our total revenue as compared to 35% in the quarter a year ago. Our industrial business grew 6% year-over-year in Q4 and accounted for 26% of our total revenue. While we saw softness in parts of our industrial business in Q4, demand for energy infrastructure and medical applications, such as continuous glucose monitors and hearing aids, remain strong.

We continue to extend our leadership in silicon carbide with our customers who value the leading performance of our silicon carbide modules and our end-to-end supply chain capabilities. In 2022, we shipped more than $200 million in silicon carbide revenue. We remain on track to deliver $1 billion in 2023 based on committed revenue from LTSAs, and we now have more than $4.5 billion of committed silicon carbide revenue between 2023 and 2025. By focusing on the areas where we provide the most value to our customers, we have positioned ourselves with the market leaders in the fastest-growing segments in automotive and industrial. The top automotive OEMs are not only choosing onsemi for silicon carbide, but for our worldwide class intelligent power and sensing solution.

In automotive, we have seen tremendous momentum with silicon carbide, and we believe that vehicle electrification will be a long-term driver for our business. We expect to remain supply constrained for the next several years even as we aggressively add capacity to our Hudson, Czech Republic and South Korea manufacturing sites. As we recently announced, Volkswagen Group has selected onsemi as a corporate strategic supplier to provide the silicon carbide modules that enable a complete traction inverter solution for its entire fleet of next-generation electric vehicles. onsemi will deliver its EliteSiC 1200-volt traction inverter power modules. These modules facilitate a small footprint and full weight system solution, which will support the front and rear axle inverters in a large range of VW models.

We already shipped more than 500 different devices to Volkswagen Group, including IGBTs, MOSFETs, image sensors and power management integrated circuits and this expanded engagement to include our silicon carbide further strengthens our partnership with one of the largest carmakers leading the charge in vehicle electrification. In 2022, we began to recognize revenue at Tesla from silicon carbide shipments and expect revenue to see a continued ramp in 2023. We have also expanded our partnership beyond silicon carbide and image sensor to numerous power and analog solutions, totaling over 300 different part numbers. Jaguar Land Rover signed a seven-year long-term supply agreement to adopt onsemi’s silicon carbide for their next- generation platforms and other solutions for their 11-kilowatt onboard chargers and other xEV application.

This LTSA also provides Jaguar Land Rover with the supply assurance for their current production model across onsemi’s broad portfolio of power solutions. In addition, Hyundai Motor Group selected onsemi’s EliteSiC family of silicon carbide power modules for their high-performance electric vehicles. Onsemi’s EliteSIC silicon carbide modules increase the efficiency and lower the weight of the traction inverters extending electric vehicle range and improving performance. Our high-power density SiC modules deliver the most innovative package technology to reduce power losses associated with DC to AC conversion, along with reduced size and weight of the traction inverter to extend EV range and increase performance. We remain just as focused on our engagement with Tier 1s, where we are seeing a steep increase in onsemi content for upcoming EV select platforms and advanced safety applications.

We recently secured a win with a major Tier 1 for a marquee European platform that includes more than $1,800 of content across our portfolio of silicon carbide and other intelligent power solutions for traction inverters. These are just a few of our recent wins in the fastest-growing automotive applications, giving us confidence in our outlook for this business and our $1 billion revenue year for silicon carbide. As the leading automakers accelerate the transition towards vehicle electrification, increased autonomy and advanced safety, they are choosing onsemi as their preferred partner for the performance of our silicon carbide solutions and vertical integration from substrates to state-of-the-art modules, for our world-class image sensors and for the breadth of our complementary intelligent power intensive portfolio, and for our manufacturing excellence and supply assurance.

In industrial, while fourth quarter revenue declined 10% over Q3, we expect our traction in energy infrastructure and medical applications to offset the softness we are seeing in the legacy parts of this business. The global energy crisis is triggering an acceleration in alternative energy deployment with solar as the most installed renewable power capacity by 2027, tripling from 2021. This accelerated deployment trend is reflected in our revenue for energy infrastructure, which increased 75% year-over-year, above our forecast of 60% growth. Our newest 200-kilowatt wins with leading energy storage system suppliers contained nearly $370 of content per system in silicon carbide and other power solutions. Last month, we announced our partnership with Ampt, the world’s #1 DC optimizer company for large-scale solar and energy storage systems.

Ampt uses our EliteSiC silicon carbide critical power switching application. Customers like Ampt expect leading-edge technology, and our silicon carbide solution meets the high performance and reliability standards required for these renewable energy applications. In addition to our alternative energy opportunities, our customer LTSAs are providing demand visibility into the broader industrial market where we expect our growth to come from over-the-counter hearing aid and emerging requirements in factory automation. We are at the beginning of a transition cycle where our award-winning inductive position sensors and new generation image sensors engineered for robotics and scanning provide better performance and lower power. We have spent the last two years making structural changes in all areas of the company to improve the resiliency of our business.

We are a different company today. We have rationalized our product portfolio and manufacturing footprint, we are leading in the fastest-growing markets, and we are now getting the true value for our products with multiyear commitments from our customers. We will not be distracted with the current market environment and remain focused on our execution against our near-term objectives and our long-term strategy. Our customers are planning well beyond 2023, and they are investing with onsemi to deliver leading-edge technologies that address complex intelligent power and sensing requirements in automotive, industrial and cloud power markets. We will grow faster than the markets we plan. And our traction in silicon carbide, coupled with the demand visibility that long-term supply agreements support us, leave me confident that with a disciplined approach in 2023, we will continue to meet our customers’ expectations and deliver on our commitments to our shareholders.

Now I will turn the call over to Thad to provide additional details on our financials and guidance. Thad?

Thad Trent: Thanks, Hassane. Let me first start by going through our full year’s performance, followed by results for the quarter and wrap up with guidance for the first quarter. As Hassane mentioned, our results have only been possible because of incredible effort of our worldwide teams. I want to thank our employees for embracing our fast-paced transformation and going above and beyond for our customers. A year where the macro environment and geopolitical uncertainties were front and center, we remained steadfast in our execution to achieve a record financial year for onsemi. Our 2022 revenue closed at $8.3 billion, an increase of 24% year-over-year, primarily driven by strength in our automotive and industrial businesses.

Photo by Christian Wiediger on Unsplash

Our non-GAAP gross margin of 49.2% increased 880 basis points year- over-year, achieving our target model of 48% to 50% for the full year. Our non-GAAP earnings per share was $5.33 compared to $2.95 in 2021, growing 3x faster than revenue. We just closed the eighth quarter since the beginning of our transformation, and our continued success is a direct result of the structural changes we’ve made to improve the resiliency of our business. The company’s transformation has taken shape by optimizing three key areas of our business: our manufacturing footprint, our product portfolio and our go-to-market strategy. In 2022, we divested four subscale fabs to improve our cost structure. We completed the acquisition of East Fishkill fab in New York, which became part of our manufacturing network on December 31.

We further reduced price-to-value discrepancies to maximize value for our technology investments. We exited volatile and highly competitive businesses, allowing us to walk away from $294 million of noncore revenue to date at an average gross margin of 26%. We’ve pivoted our portfolio to high-margin products and end markets with auto and industrial exiting the year at 73% of total revenue versus 59% in Q4 of 2020. We exited the year with $16.6 billion of signed LTSAs across our entire portfolio. We increased our new product revenue by 34%, and we increased the design win funnel by 38% year-over-year. These structural changes have yielded a threefold increase in free cash flow since the start of our transformation, growing approximately 4x as fast as revenue, with 2022 coming at a 20% free cash flow margin.

Our strategy has driven radical improvements in the performance of our business units, and these businesses are now best-in-class among their immediate and broader peer group. For example, our Intelligent Sensing Group’s transformation has yielded a high growth, high operating margin business. ISG is now comparable to peers who typically command valuation multiples at premiums of more than 2x the industry average. ISG exited Q4 with record gross margin of more than 49%. By rationalizing the portfolio and exiting low-margin consumer- facing markets, ISG’s gross margin has improved by more than 1,600 basis points since the start of our transformation and the revenue mix is now more than 90% high-margin automotive and industrial. ISG revenue of $1.28 billion in 2022 increased 73% over 2020, driven by the transition to higher-resolution sensors at elevated ASPs. As I mentioned earlier, we assumed ownership of our 300-millimeter fab in East Fishkill on December 31.

This fab is a key enabler of our brownfield manufacturing strategy by providing incremental capacity for our silicon power products that we are transitioning from our fab in Korea to create capacity for our silicon carbide ramp. In addition, the EFK fab provides us with the capabilities to support long-term growth for our intelligent sensor business. Since the acquisition closed on the last day of the year, there is no P&L impact in Q4, but the acquired assets are now reflected on our balance sheet. Turning to results for the fourth quarter. As I mentioned, Q4 was another quarter of strong results. Total revenue was $2.1 billion, an increase of 14% over the fourth quarter of 2021 and a 4% decline in quarter-over-quarter. Record automotive revenue of $989 million increased 13% quarter-over-quarter and 54% year-over-year to 47% of our total revenue as compared to 35% in the quarter a year ago.

Industrial revenue grew by 6% year-over-year, but declined by 10% quarter-over-quarter, primarily due to macroeconomic factors. As Hassane mentioned, our energy infrastructure and medical businesses continue to grow despite macroeconomic headwinds. Revenue from intelligent power and intelligent sensing accounted for 69% of our total revenue in Q4. Intelligent power grew 18% year-over-year and intelligent sensing grew by 47% year-over-year, both driven by continued growth in the automotive and industrial markets. Revenue for the Power Solutions Group, or PSG, was $1 billion, an increase of 10% year-over-year. Revenue for the Advanced Solutions Group, or ASG, was $701 million, an increase of 8% year-over-year and revenue for the Intelligent Sensing Group, or ISG, was a record $354 million, an impressive increase of 44% year-over-year.

GAAP gross margin for the fourth quarter was 48.5% and non-GAAP gross margin was 48.4% and above the midpoint of our guidance. Our non-GAAP gross margin declined by 90 basis points quarter-over-quarter, with our planned ramp in silicon carbide and lower factory utilization at 74% as we proactively slowed wafer starts from the beginning of the year. We also exited an additional $17 million of revenue in the quarter at an average gross margin of 40% bringing the total to date to $294 million of noncore business exits. GAAP operating margin for the quarter was 33.5% and non-GAAP operating margin was 34.1%, an increase of 550 basis points year-over-year and a decrease of 130 basis points quarter-over-quarter. GAAP earnings per diluted share for the fourth quarter was $1.35 as compared to $0.96 in the quarter a year ago.

Non-GAAP earnings per share was $1.32 as compared to $1.09 in the fourth quarter of 2021. We remain confident in the sustainability of our long-term gross margin model of 48% to 50% despite near-term headwinds from silicon carbide start-up costs and our ramp at EFK. As we enter 2023, we are maintaining tight control of our wafer starts, managing inventory levels, and we remain disciplined in our spending. We expect continued favorability as we plan to exit more than $400 million of low-margin business. And starting in 2024, we’ll start recognizing $160 million of gross margin benefit as we transition our wafer supply from the divested fab. Now let me give you some additional numbers for your models. GAAP operating expenses for the fourth quarter were $316 million as compared to $352 million in the fourth quarter of 2021.

Non-GAAP operating expenses were $300 million as compared to $306 million in the quarter a year ago. Non-GAAP operating expenses were below the midpoint of our guidance as we proactively manage spend across the company. For the fourth quarter, our non-GAAP tax rate was , our GAAP diluted share count was 448 million shares, and our non-GAAP diluted share count was 440 million shares. We repurchased 1.3 million shares for $90 million in the fourth quarter. For the full year, we repurchased 4 million shares for a total of $260 million at an average price of $65.13 per share, which was 16% of 2022 free cash flow. Turning to the balance sheet. Cash and cash equivalents increased 19% sequentially to $2.9 billion, and we had $1.5 billion undrawn on our revolver.

Cash from operations was $731 million and free cash flow was $380 million or 18.5% of revenue. Capital expenditures during the fourth quarter were $340 million, which equates to a capital intensity of 16% for the quarter and 12% for the full year. As we indicated previously, we are directing a significant portion of our capital expenditures towards silicon carbide and enabling our 300-millimeter capabilities at the East Fishkill fab and expect our capital intensity to be in the mid- to high teens percentage range for the next several quarters. Accounts receivable of $842 million declined by $15 million and DSO of 37 days increased by 1 day. Inventory increased by $41 million sequentially and days of inventory increased by 7 days to 136 days.

This includes approximately 26 days of bridge inventory to support fab transition and the impending silicon carbide ramp. We continue to proactively manage distribution inventory, decreasing inventory in the channel by $10 million sequentially and at historically low levels with weeks of inventory at 7.3 weeks compared to 6.9 weeks in Q3. Total debt was $3.2 billion and net leverage is approaching zero. We accrued $15.7 million on our 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 we will receive the associated cash benefit in the future. Let me now provide you key elements of our non-GAAP guidance for the first quarter.

A table detailing our GAAP and non-GAAP guidance is provided in the press release related to our fourth quarter results. We continue to see strong demand from our automotive end market, driven by electrification and ADAS and accelerating ramp of our silicon carbide business. We continue to see softening in certain industrial applications, and we expect increased weakness in our nonstrategic end markets that we plan to exit. Given the macro uncertainty, we are taking a cautious stance on our guidance. Despite a slowing macroeconomic environment, our business continues to strengthen with total committed revenue under LTSAs of $16.6 billion, an increase of $2.5 billion quarter-over-quarter. We expect to recognize more than $5 billion of revenue from our committed LTSAs in 2023 in addition to our non-cancelable nonreturnable orders.

We anticipate Q1 revenue will be in the range of $1.87 billion to $1.97 billion, with continued strength in automotive amid softness in all other end markets. We expect non-GAAP gross margin to decline, to be between 45.7% and 47.7% due to lower factory utilization and the dilutive impact of ramping silicon carbide and EFK, which is within our expected range of 100 basis points to 200 basis points and 50 basis points to 70 basis points, respectively. This also includes share-based compensation of $3.4 million. We expect 2023 to be a transition year for our gross margins as we manage the temporary headwinds. We expect non-GAAP operating expenses of $298 million to $313 million, including share-based compensation of $23 million. We anticipate our non-GAAP OIE to be $21 million to $25 million.

We expect our non-GAAP tax rate to be in the range of 15.5% to 16.5% and our non-GAAP diluted share count for the first quarter is expected to be approximately 441 million shares. This results in non-GAAP earnings per share to be in the range of $1.02 to $1.14. We expect capital expenditures of $340 million to $380 million, primarily in brownfield investments, which are a more efficient use of capital and the greenfield alternative of building a fab from the ground up. As a company, we become much more agile, controlled and purposeful in our execution, and we’ll benefit from our disciplined approach in 2023 and beyond. Given our confidence in our strategy to invest for long-term profitable growth, we remain committed to a balanced capital allocation strategy to drive shareholder value.

With a threefold increase in free cash flow, a strong balance sheet and our net leverage approaching zero, we have increased flexibility into one capital towards our shareholder return program. Today, we announced that our Board of Directors has approved a new program authorizing up to $3 billion of share repurchases through 2025, representing twice that of the last authorization, which expired at the end of last year. This is aligned with our stated strategy of returning 50% of free cash flow to shareholders over the long term. And finally, we hope you’re saving the date for our Analyst Day in New York on May 16. We look forward to sharing more of our long-term vision at that time. And with that, I would like to turn the call back over to Christa to open the line for questions.

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Q&A Session

Operator: And our first question will come from Ross Seymore from Deutsche Bank.

Ross Seymore : First question for either of you guys. In the first quarter, guiding down about 9% sequentially. I know you said auto is staying strong and everything else is kind of softening. Can you give a little bit more color on the puts and takes with exits, et cetera? And then perhaps more importantly, how those trend throughout the year between the end segments within that $5 billion of LTSAs you plan to represent?

Thad Trent : Yes, Ross, this is Thad. So if you look at the planned exits that we have for Q1, we think we’ll exit up to another $75 million in the first quarter. As we’ve always said, this will be market-dependent, but we do kind of see that in the cards here. In terms of overall what we’re seeing for Q1, we’re looking at automotive continuing to be strong. Think about it as kind of low single digits. We think industrial is down kind of low single digits. And the rest, consumer, compute, other, being down pretty significantly to make up that — the rest of it to be down approximately 9% for the quarter. I think for the year, it’s hard to tell at this point. I think we see auto remains strong. I think industrial kind of being potentially flat year-on-year and the rest of the business being down slightly or down, but it’s obviously too early to tell what’s going to happen long term.

Ross Seymore : And then on the gross margin side of things, it seems like that’s holding in well despite the utilization dropping and all the other headwinds. It doesn’t seem like there’s any surprises. Any sort of linearity about how the buckets work throughout the year, the exits being a positive, the silicon carbide side and the East Fishkill being negative? Is that something that peaks out in the headwinds in the beginning of the year and then lessen? Or is the shape a little more back-end loaded? Anything you could provide on color on that would be helpful.

Thad Trent : Yes. Look, you know that, right? I mean there’s no surprises here on where margins are coming in. We’re really happy with where we’re performing. All of the ramps in silicon carbide and EFK are playing out just as we would expect. We think these headwinds kind of peaked probably Q2, Q3. We think by the end of this year, we’ve got silicon carbide, the headwinds there have gotten to parity and the margins for average at that point after all these headwinds are behind us. But we’re pretty happy with the performance and the tracking of gross margin at this point, right on track with what we’ve been telegraphing for a couple of quarters ago.

Operator: And our next question comes from Vivek Arya from Bank of America.

Vivek Arya : I just wanted to dig into the silicon carbide comments. It seemed like you are reaffirming the $1 billion commitment for this year. And I think you raised the longer-term outlook by $0.5 billion to $4.5 billion. I was wondering, Hassane, if you could give us some more color on what’s helping to drive that upside? And as kind of part B of that question, how should we think about any incremental headwinds on the cost or the gross margin side as you bring on more internal material supply? Are you getting the yields? Are you getting the performance? Are you getting what you need from your internal supply? Or will you have to rely more on external wafers that could change the profitability of your silicon carbide business?