ON Semiconductor Corporation (NASDAQ:ON) Q4 2023 Earnings Call Transcript

ON Semiconductor Corporation (NASDAQ:ON) Q4 2023 Earnings Call Transcript February 5, 2024

ON Semiconductor Corporation beats earnings expectations. Reported EPS is $1.22, expectations were $1.21. ON Semiconductor Corporation isn’t one of the 30 most popular stocks among hedge funds at the end of the third quarter (see the details here).

Operator: Good day, and thank you for standing by. Welcome to the ON Semiconductor Fourth Quarter 2023 Earnings Conference Call. At this time, all participants are in a listen-only mode. After the speakers’ presentation, there will be a question-and-answer session. [Operator Instructions] Please be advised that today’s conference is being recorded. I would now like to hand the conference over to your host today, Parag Agarwal, Vice President of Corporate Development and Investor Relations. Please go ahead.

Parag Agarwal: Thank you, Liz. Good morning, and thank you for joining onsemi’s fourth 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 fourth quarter earnings release will be available on our website approximately 1 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 includes certain non-GAAP financial measures.

Reconciliation of these non-GAAP financial measures to the most directly comparable GAAP financial measures and a discussion of certain limitations when using non-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 the 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 materially from our forward-looking statements are described in our most recent Form 10-K, Form 10-Qs and other filings with Securities and Exchange Commission and in our earnings release for the fourth quarter of 2023.

Our estimates or other forward-looking statements will change and the company assumes no obligation to update forward-looking statements to reflect actual results, change 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 on the call. We are pleased to share our results with you following another year of significant accomplishments as we continue transforming the company to achieve our long-term financial model. Our Intelligent Power & Sensing Technologies accounted for 71% of our revenue in 2023 compared to 62% in 2021 as we have driven our portfolio to strategic areas with higher gross margin. Our revenue from crude products in 2023 increased more than 40% over ’22. Year-over-year, design win growth continues to outpace the long-term revenue growth target we outlined during our Analyst Day. We had a record year of automotive revenue increasing 29% over 2022, driven by both Intelligent Power & Sensing.

We achieved our first $1 billion revenue year for automotive image sensors with design wins increasing more than 50% year-over-year, fueling our future growth with new products. It was a great year for silicon carbide. We shipped more than $800 million in 2023 or 4 times 2022 revenue. Our silicon carbide revenue had the highest growth in the industry, both in terms of dollars and percentage in 2023, delivering an estimated 25% market share. We increased our customer base to more than 600 customers in 2023. Our top 10 customers are geographically distributed with over 50% in APAC, including Korea, followed by the U.S., and we expect to further diversify our customer base in 2024 as European customers ramp production. We continue to make progress on our transition to 200 millimeter with material already running through our manufacturing steps and we announced the world’s largest silicon carbide fab with our expansion in Bucheon, South Korea.

While market reports still project 30% or 40% growth for silicon carbide in 2024, OEM’s latest EV plans indicate a more tapered growth signaling a SiC market growth in the range of 20% to 30%. We still expect to grow at 2x the market growth in 2024 with customers ramping production in both industrial and automotive. Electrification remains a content expansion opportunity for us. Our broad portfolio of silicon carbide and IGBT combined with our high power packaging solutions give us a competitive advantage across all levels of EVs, ranging from HEV to PATV and BEV. In fact, our 2023 hybrid vehicle related revenue nearly doubled year-over-year, while the number of vehicles grew 30%. We have significant content gains across all ex-EVs and specifically up to $350 of content in hybrid electric drivetrains and onboard chargers.

We grow no matter which one gains traction, pun intended. Onsemi is number two in silicon power with best-in-class IGBT and MOSFET technologies. Our overall IGBT revenue nearly doubled over the last two years, driven by market share gains and further penetration in ex-EV and energy infrastructure. In automotive, onsemi is number one in image sensors with 2023 revenue increasing more than 12% year-over-year driven by the shift to higher value 8 megapixel sensors as customers move to better performance options at higher ASPs. 8 megapixel image sensor revenue nearly doubled year-over-year demonstrating the market trend toward higher resolution for ADAS systems. We are also number one in automotive LED lighting, inductive and ultrasonic sensing and we plan to advance our leadership position with our upcoming analog and mixed signal platform.

In Industrial, we are number one in solar and energy storage solutions with our IGBTs, silicon carbide and module portfolio from commercial to utility scale string inverters. Energy infrastructure is still our highest growth megatrend in industrial, where we continue to see demand for our hybrid modules with silicon and silicon carbide. In 2023, the International Energy Agency, or IEA, reported that the world’s renewable energy surpassed 50% growth over 2022, its fastest rate in the past 25 years. Our revenue for energy infrastructure during the same period grew 60%. The IEA predicts that renewable energy is on course to increase by 2.5 times by 2030. For EV chargers, we just released a full suite of Elite sick power integrated modules, enabling bidirectional charging capabilities for DC ultrafast electric vehicle chargers.

Our newly released modules can be used up to 350 kilowatt in EV chargers, the highest in the industry to reduce charging time to 15 minutes for a near full charge. Our broad portfolio of products has enabled us to become a one-stop shop for our customers and the source for the most optimized solutions. It is critical for customers to extract the best performance for their system and using our portfolio to provide a system level optimized solution across our power and sensing technologies remain a competitive advantage. We are also excited about our power opportunity to support the transition to 48 volt. We are already in production with a leading automotive customer on their new 48 volt architecture as we had already planned our portfolio for such a transition.

Last year, we responded to the market uncertainty by focusing on our execution. As demonstrated with more predictable and sustainable financial results, our worldwide teams delivered operational excellence in the face of challenging market conditions without losing sight of innovation to further our leadership position in intelligent power and sensing solutions. We are happy with the progress we’ve made in 2023, having built a resilient business model capable of performing in all market environments. We are now turning to the opportunities for operational improvements in 2024 to achieve our target financial model. In the near term, based on our current outlook and early LTSA signals, we expect continued softness across all end markets through a period of inventory digestion and slowing end demand.

The bottom line is that we will weather 2024 with substantially better financial performance than in prior downturns. Meanwhile, we will continue to invest in extending our leading portfolio, and we will benefit disproportionately as the market recovers. With that, I’ll turn it over to Thad to provide further details on our results. Thad?

Thad Trent: Thanks, Hassane. Our ongoing transformation in 2023 delivered significant improvement towards our long-term financial model. Our ability to proactively navigate through the current cycle while delivering better results than ever in a downturn is a testament to the work our teams have accomplished over the last three years. Today, onsemi is a different and more resilient company, having achieved 2023 non-GAAP gross margin of 47.1%, which is 1,440 basis points higher than 2020, the last year in which utilization was at comparable levels. We maintained revenue of $8.3 billion for the year, non-GAAP operating margin of 32.3% and delivered $5.16 of non-GAAP earnings per share. For the year, we returned 140% of free cash flow to our shareholders through share repurchases and we have $2.4 billion remaining on the buyback authorization we announced a year ago.

For the fourth quarter, we reported revenue of $2.02 billion, non-GAAP gross margin of 46.7% and non-GAAP earnings per share of $1.25, all above the midpoint of our guidance. Looking at the fourth quarter breakdown by end market, our Automotive business of $1.1 billion grew 13% as compared to the quarter a year ago and declined 4% quarter-over-quarter, in line with our expectations. Still, vehicle electrification and advanced safety features are driving upside as demonstrated by our record automotive revenue for image sensors in 2023. Our revenue for Industrial was $497 million, down 10% versus Q4 2022 and down 19% sequentially as anticipated. All segments have been impacted by macroeconomic factors and slowdown in industrial activity. Our automotive and industrial revenue accounted for 80% of our business in 2023 as compared to 68% in 2022, following our strategy to shift to high growth megatrends for the sustainable ecosystem.

In Q4, we exited another $30 million of non-core business and for the full year, we exited $180 million. While we expected customers to find alternative options, the remaining non-core portions of our business are now healthy nearing corporate gross margins and demonstrating the power of our portfolio. Looking at the split between the operating units, revenue for the Power Solutions Group, or PSG was $1.1 billion an increase of 4% year-over-year due to an increase in silicon carbide revenue for auto and energy infrastructure. Revenue for the Advanced Solutions Group, or ASG was $625 million, a 11% decline year-over-year, driven by softness in compute and mobile end markets. Revenue for the Intelligent Sensing Group, or ISG was $308 million, a 13% decrease year-over-year due to a decline in compute and industrial.

In the fourth quarter, our GAAP and non-GAAP gross margin of 46.7% was above the midpoint of our guidance. Our gross margin exceeded expectations despite total utilization decreasing to 66% from 72% in Q3, further validating the structural changes we have implemented over the last three years. We should see the full impact of the decline in utilization materialized in Q1. At East Fishkill, we have already made progress by improving the overall cost structure of the fab making it 50 basis points less dilutive than expected in the fourth quarter. Based on our current outlook, we expect to hold our gross margin above the mid-40% floor with utilization in the mid-60% range. Silicon carbide gross margin also remained above 40% with high profit fall through and we expect to maintain these levels through 2024.

Now let me give you some additional numbers for your models. GAAP operating expenses for the fourth quarter were $330 million as compared to $316 million in the fourth quarter of 2022. Non-GAAP operating expenses were $306 million as compared to $300 million in the quarter a year ago. GAAP operating margin for the quarter was 30.3%, and non-GAAP operating margin was 31.6%. Our GAAP tax rate was 7.8%, and our non-GAAP tax rate was 15.4%. GAAP earnings per diluted share for the fourth quarter was $1.28 as compared to $1.35 in the quarter a year ago. Non-GAAP earnings per share was above the midpoint of our guidance at $1.25 as compared to $1.32 in Q4 of 2022. Our GAAP diluted share count was 440 million shares, and our non-GAAP diluted share count was 434 million shares.

In Q4, we were aggressive with our share repurchases and returned 136% of free cash flow to shareholders through $300 million of buybacks. Turning to the balance sheet. Cash and cash equivalents was $2.5 billion, and we had $1.1 billion undrawn on our revolver. Cash from operations was $611 million, and free cash flow was $221 million or approximately 11% of revenue. Capital expenditures during Q4 were $391 million, which equates to a capital intensity of 19%. We expect 2024 capital intensity to be in the low-teens for the full year ahead of our original plan and driven by our improved silicon carbide manufacturing output on 150 millimeters. Inventory increased by $27 million sequentially and days increased by 13 days to 179. This includes approximately 74 days of bridge inventory to support fab transitions in the silicon carbide ramp.

Excluding these strategic builds, our base inventory decreased $52 million sequentially with days of inventory at 105 days. We continue to proactively manage distribution inventory. Thus the (ph) inventory was down $11 million sequentially with weeks of inventory at 7.2 weeks versus 6.9 weeks in Q3. We have been underserving the mass market through this channel, while we focused on our LTSA commitments. We expect to replenish the channel in 2024 to service the long tail of customers and expect inventory to start to normalize with increase in inventory levels between seven and nine weeks over the next few quarters. Now let me provide you the 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.

Given the current macro environment and our demand visibility, we anticipate Q1 revenue will be in the range of $1.8 billion to $1.9 billion with softness across all end markets. We expect non-GAAP gross margin to be between 44.5% and 46.5%, primarily due to lower factory utilization and continued EFK headwinds. Our Q1 non-GAAP gross margin includes share-based compensation of $5 million. We expect non-GAAP operating expenses of $305 million to $320 million, including share-based compensation of $27 million. We anticipate our non-GAAP other income to be a net benefit of $8 million with our interest income exceeding interest expense. This benefit is a result of the debt restructuring activities we have completed over the last two years, reducing a significant historical drag on the P&L.

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 433 million shares. This results in non-GAAP earnings per share to be in the range of $0.98 to $1.10. We expect capital expenditures of $310 million to $340 million in brownfield investments primarily in silicon carbide and EFK. As we navigate through 2024, we will focus on operational excellence without losing sight of our long-term commitments to our customers and our shareholders. We remain perfectly positioned in the markets where we focus and continue to engage in long-term supply agreements with our strategic customers. We remain confident in our 53% long-term gross margin target as we execute our fab right strategy to optimize factory utilization and drive operational efficiencies across the company.

With that, I’d like to start the Q&A. So I’ll turn it over to Liz to open the line.

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Q&A Session

Operator: [Operator Instructions] Our first question comes from the line of Ross Seymore with Deutsche Bank.

Ross Seymore: Hi, guys. Can you hear me?

Hassane El-Khoury: Yeah.

Ross Seymore: Great. First question is on the automotive side of things. I guess, kind of two parts to it. The silicon carbide side, it sounds like there’s a little bit of a difference between the third-party estimates and what you’re seeing from OEMs. And then last quarter, you talked about some weakness emerging in the Tier 1 guys in Europe. Can you just give us an update on what you’ve seen on kind of that side of the business as well?

Hassane El-Khoury: Sure. Yeah. Look, we started the year regarding the silicon carbide, you know all know what the third-party estimates are. But when you look at customers, even public announced outlook for 2024, the outlook has been tapered down a little bit. From our side, however, it’s purely demand driven. The platforms are qualified. The designs have been shipping. The question now is tied to end demand. And that’s why we’re still very confident in 2x the market growth. The question is, what will the market do in 2024 based on the few announcements that have been made, but it’s a demand driven. We’ll just tag on to demand. And then on to automotive in general, look, we saw softness. I mentioned it in my prepared remarks, it is inventory digestion, but it’s also slowing demand.

You’ll see that in our guide as we work through it. But one thing for us as a very high priority is managing the inventory internally and managing the inventory externally, which means we have been taking utilization down in order to match what we believe the outlook is and when the outlook recover, we’ll get all of that as tailwinds. So that’s the cautious approach we’ve had given the signals we’ve seen. And we’ve seen them kind of come in as we’ve talked about since last quarter, because of the LTSAs are giving us that outlook.

Ross Seymore: Thanks for that. And I guess my follow-up for that. On the gross margin side, it looks like you’re going to hold the 45 floor you talked about before. Can you just walk us through the puts and takes as the year progresses? And perhaps how big of a headwind is the utilization of 65% is going to be the floor on the utilization side approximately how much of an impact is that versus kind of the long-term target of getting back to 53%? Thank you.

Thad Trent: Yeah, Ross. You’re absolutely right. So we plan on holding that mid-40% floor. We think utilization will bottom out around the mid-60s. We’re pretty close to that now. And if you look at our margin today, I think the company has executed very well, which really shows that our Fab Liter (ph) strategy that we implemented two years ago has worked very effectively. And as we execute Fab Right, we’ll continue to drive cost efficiency across that network. What you should think about is every point of utilization is about 15 basis points of gross margin going both ways up and down. So you can kind of think about we’re there, we’ve proactively taken our utilization down. We started taking it down in late ’22, and we’re kind of at that point where we think we can manage through this at this level.

Ross Seymore: Thank you.

Thad Trent: Thanks, Ross.

Operator: Our next question comes from the line of Vivek Arya with Bank of America.

Vivek Arya: Thanks for taking my question. Hassane, I’m curious, what do you think has helped you avoid some of the deeper 30%, 40% kind of peak to crop correction that we have seen at your — several of your peers. And I think kind of related to that, what we’re all trying to grapple with, do you think Q1 is kind of the trough because when I listen to Thad talking about utilization and that you’re close to the bottom, that suggests Q1 is the trough. But do you think of it that way? And should we be modeling kind of seasonal recoveries? So kind of two parts, what has helped you avoid some of the correction and from what you can see today is Q1 kind of the relative trough of the cycle for onsemi?

Hassane El-Khoury: Yeah, Vivek. Thanks for that question. Look, if you think about what helped us navigate better than a lot of our peers given the guide of companies that guided already. And like you mentioned, 20%, 30% is really the fact that we talked about the LTSAs. We talked about how, at a minimum, the LTSAs are going to provide us a phone call when things start getting softer. Those phone calls started happening in industrial before anyone talked about industrial softness. I’m talking six quarters ago, that’s when we started taking utilization down, that’s when we time even more what we ship into the channel to be way closely tied to what we believe the demand is at that point in time. The other thing in automotive, we talked about it in our Q3 earnings over 90 days ago when we talked about we started to see signs because we started getting the calls about the LTSAs and customers wanting to get some relief on the volume.

So those are the tools that we have implemented over the last few years in order to give us that visibility. But it’s not — the LTSAs are not going to solve a demand problem. What LTSAs have done has allowed us to prepare what we do in response to a softer demand environment. And you’ve seen we put a tight management on [indiscernible] inventory. It didn’t bubble up. We’ve actually reduced our utilization. We’ve reduced our base inventory in dollars. All of these are signs of the resiliency we have in our model, which, by the way, all of them will be tailwinds on the other side of that. Now as far as do we — what we believe the trough is Q1 or not. Look, I’m smart enough not to call a bottom until I’m standing on top of the hill looking back at it.

So I’ll let you know when that happens.

Vivek Arya: On silicon carbide, could you help give us some sense of what it was in Q4, what the auto industrial mix is? What’s the implied for Q1? And why tied to a market rate, why not in the past, you have given us very specific and absolute numbers because you had those supply agreements. So why not give an absolute number, why tied to a market rate. So just any more quantification of what silicon carbide did in Q4. What the implied is for Q1 and then kind of an absolute number for this year instead of giving — tying it to a market rate?

Hassane El-Khoury: Yeah. So I’ll first cover on — in Q4, our revenue for silicon carbide went up as we discussed in the Q3 call and as we expected, so it came in line with our expectation. Again, it grew from Q3 to Q4. So that shows both the diversification and the strength in that business that will also remain in 2024 with the growth we’re going to see in 2024. Now the reason we don’t talk about absolute numbers, it is a ramping business, and it is – the lumpiness of a very new ramping business is going to be in silicon carbide like it is with any ramping business that is tied to adoption. That’s the reason we went to 2x market. And by the way, it is what we pecked you at our Analyst Day. So we didn’t really change what we do.

We change the short term more on the long term. We’ve always said we’re going to outgrow the market. We’re going to be 2x the market. That is our trajectory for the next five years that we discussed at Analyst Day. And my comments are, we will remain committed to that trajectory based on the design-ins we have. And as I mentioned on Ross’s question, all the design-ins are done. All the shipments have been made for the ramp to start with a very broad range of customers. The question remains what is end demand going to do. And if end demand is better than what we are forecasting, we’re going to grow better than what we forecast at 2x the market. That’s where I would leave kind of the – I’m going to call it, the short term, which is 2024.

Vivek Arya: Thank you.

Operator: Our next question comes from the line of Chris Danley with Citi.

Christopher Danely: Hello.

Hassane El-Khoury: Hello. Hi, Chris.