ON Semiconductor Corporation (ON) Earnings Call Transcript & Summary

Okay. Let's go ahead and get started. Good morning again. Thank you for attending JPMorgan's 18th annual CES technology forum. Very pleased to have the team from ON Semiconductor: Keith Jackson, Chief Executive Officer; Bernard Gutmann, Chief Financial Officer. I've asked Keith to start us off with the ON team and what they're showcasing here at CES, and then we'll go ahead and kick off the Q&A. So Keith, Bernard, thank you very much for joining us this morning.

Well, thank you. We're always excited. CES is an opportunity to see customers and what they're working on coming to fruition as we work with them during the year. Every time we come to CES, there's more and more automotive. And we're excited that there's a great deal around the ADAS portion of that, making cars safer and more autonomous. And each year, we get to showcase more opportunities there. What we're seeing this year in that area, just very briefly, is you're seeing more in-cabin applications for things, checking the status of the driver, whether they're distracted or drowsy, checking the status of what might be child car seats left occupied, et cetera, so there's even more applications for our sensors there. Continued refinement of protecting the vehicle from external threats, which means a combination of ultrasonic, where we participate, the cameras themselves, imagers and then LiDAR and radar combinations. And so we do see a lot of diversity in approaches from our customer base, but all of them are using more and more sensors and looking at how to find a good cost point. And so the things we're talking with our customers about this year is how to fuse some of the intelligence around that, making it more cost effective and making it more, frankly, safety effective by making sure the appropriate data, the most important data, is what gets processed in this age of big data. So on the automotive side, we see that on [ AS ]. And in electric vehicles, maybe not as much on the showroom floors there, but the electric vehicle trend continues quite strong. We get a big content gain, combustion engine, about $100 of content for ON, and in electric vehicle up to $500 worth of content in that drivetrain portion. So we're pretty excited about that. We think that will continue. You have global fuel emission standards tightening continuously, pushing everyone to the electric vehicles. And of course, everyone wants to be cleaner and greener. So we think those are great trends, and we're showing the latest things that we have in those areas. Also, looking at our new connectivity portfolio in WiFi and expanding that out from the service providers into the industrial and automotive sector, we'll be having teams talk about our progress on that here. And then, of course, from a power perspective in the server and 5G arena, we are talking to folks about our controllers that we're adding into that process, giving us another $25-or-so content. So all those things are pretty exciting for us.

Yes. No, great. Thank you for that overview.

Maybe we'll start off with the near term. 2019, obviously, marred by the broad-based weakness in the industrial market on trade-related slowdown. Auto production, I think IHS forecast, is down 6 -- was 6 -- was down 6% in 2019. Weakness in consumer white goods. You and your peers under-shipped consumption for the better part of 2019. You came into Q4 with stabilizing business conditions and some return to normal seasonal trends. Is that sort of how you're still seeing kind of the near-term environment?

Yes. I think, as we entered the fourth quarter, we talked about the inventory correction portion of the business being about over, still believe that to be the case. And that under-shipping piece, of course, is always painful. I think, as we look into 2020, we think that's behind us. And so you should have, at a minimum, the sales for semiconductors to be at the consumption growth rate of your GDP-driven economies. Might be a little better in some cases because they got quite lean in Asia. But in general, I would say that we are optimistic for a return to good growth in 2012.

So along that lines, thinking about 2020, as we think about the December quarter, normal seasonal for ON in March is about kind of down 1% to 3% sequentially. Given the bookings trends, backlog, maybe some of the replenishment trends that maybe still might be happening, combined with what appears to be continued stabilization in sort of overall demand trends, is that kind of how you're thinking about the March quarter, kind of along those kind of more seasonal lines?

We're not ready to give guidance on the first quarter yet, March quarter. I would say, again, as we entered the year, as -- we saw stabilization in the markets that we supported in that inventory correction behind us, certainly seeing all of the markets with a positive vector as opposed to what we were seeing in Q3.

From a supply-side perspective, channel inventories and OEM inventories, you exited Q3 with weeks of inventory metrics being within your target range after a few quarters of work-downs. Are inventories still within target ranges and the team feels like they're shipping to consumption trends at this moment?

Yes, we believe we can maintain target ranges there. Quarter-to-quarter, there are some shifts because if you're expecting some good growth the next quarter, you sometimes have a little more just destocking the previous quarter. But we think that range is very manageable and don't see any reason to break that model.

How does -- the one big difference this year versus last year is Chinese New Year's is 11 days earlier. Does that impact the demand dynamics for the March quarter?

No. We get that -- asked that question every year. It's either later or it's earlier. And the reality is it's a week every year where you don't ship anything or book anything in Asia, and it really doesn't matter which week it falls in. You might get more or less comfort. The earlier it is, maybe you can feel better sooner because the return to normalcy you get to see a week earlier in the system. But as far as overall results, it doesn't matter.

Anything that you've observed from a geographical perspective broadly across the business? In the last quarter, last earnings, you talked you saw some strength in China while Europe continued weak. But across the whole business, anything, any outliers that you're seeing, any improving trends, any degrading trends that you're seeing from a geographical perspective?

Yes, I think, geographically, you see the markets in each region pretty much matching what you see in their PMIs and GDPs, not a lot of difference from that everywhere. I think the surprises we had entering the quarter were a little more strength in automotive in China than we were expecting. But that would have been really the only exception to kind of, whatever you're seeing in the PMIs, you're going to be seeing in the markets.

From a factory utilization perspective, you've been very disciplined. The team took down utilizations to the mid-60% level, committed to keep it at these levels until you see some signs of a demand pickup. Assuming that we head into 2020 where you do start to approach kind of more normal seasonal trends, which would mean stronger June quarter or stronger September quarter, would you anticipate utilizations going up ahead of that?

Yes. So we would be expecting 2020, based on the data we have now, to look more seasonal or better but certainly more seasonal. And so that means we get a 4% or 5% growth in Q2. And we have to start running our factories in advance of that. So you should see the pickup in utilization precede the revenues.

So in the March quarter, we should start to see utilizations heading higher. Okay. Great. Maybe moving to some of the product segments. So the auto business was down 3% on a year-over-year basis last quarter. China and EMEA continued to be contributors to the decline. Overall, auto production is looking to be -- in 2020 looking to be flat versus down 6% in 2019. However, on a sequential basis, you guys actually saw a meaningful increase in revenues from Greater China, as you mentioned in your guidance for the fourth quarter. Are you starting to see demand trends starting to stabilize? And any commentary from -- you said China was strong in automotive. Any other commentary from a geographical perspective in automotive?

Yes. I'll be careful on China comment. It just stronger than expected. I don't want people to think it's returned to the double-digit growth that they had in their SAAR. That, it would not be correct. Our content story, we think, is really good. We think you've got on a flat SAAR an opportunity to grow 6% or more just on content year-on-year. So as you get a stabilization in the SAAR, we are expecting to see nice gains again. And it can be better than that if the adoptions of EV are quicker than as modeled. But in general, a flat SAAR is a good thing for the industry. And last year, you had not only a reduced SAAR, but you had inventory corrections with lots of anxiety behind that. So my expectation is that if you have a flat SAAR, you certainly will see the content gains, and you may see some replenishment inventory-wise because they got quite [ lean ].

So that's interesting because a lot of the third-party research guys like IHS, for example, are forecasting flat SAARs for 2020. I think you said in a flat SAARs environment maybe that's more of a floor, 6% sort of growth on content alone. But if you look at 2020 and some of the new models that you have ramping and so on, would you expect to be at that 6% range, potentially better than that, potentially lower than that?

Certainly, it could be better. The one -- we know all the platforms we're designed into, and we get pretty excited about all the new content. We never quite can predict which models sell and which don't. So we tend to be a little more conservative in aggregate. But the opportunity, if you looked at our long-term model, was really 8% to 9% growth for automotive. We haven't changed that opinion but just normal caution going into it, [ trying to set up for it ].

Thinking about the design win pipeline in auto, again thinking about maybe in the next 12 to 18 months, you've got a lot of product cycles in EV and ADAS and lighting and so on. What do you think is going to be the bigger driver?

Near term, the ADAS piece dollar-wise is going to be the biggest contributor. That's being adopted, whether it's EV or not. It's being adopted in all models. Obviously, high end has more content than low, but it keeps getting driven -- features keep getting driven down in the model. So I think dollar-wise, that will be the biggest, the EV piece of it, big dollar content for us. The question there is from a sales perspective what will the consumer buy. So I think that will be kind of second place in that growth story.

On the ADAS front, obviously, the team leads the market in auto image sensors, 60%-plus share of the auto image sensor market, 80% in ADAS. The design win traction is strong. You guys announced that you won 16 out of the 17 2- and 8-megapixel opportunities that came up for grabs. In the past, this business has kind of driven a 20% kind of growth CAGR. Is the business still growing at this type of growth rate? And talk about the competitive landscape here and the barriers to entry because we keep hearing about competitors wanting to break into this market because it's such an attractive market, but the barriers to entry, I think, are quite high.

Barriers to entry are high. We continue to have very strong position there. It is based on our capability and the fact you can reuse the software and machine learning platform to platform, making it very easy for our customers to improve their capabilities with smaller investments. And we continue to drive our imaging technology specifically for automotive, giving us superior performance. And there are some very demanding use cases there for automotive with the contrast rates, et cetera. So we feel very good about our technology lead. A lot of folks are trying to break in, as you mentioned the statistics there. We're not going to win 100%, but it's still very high. And so we remain very excited about that.

On the new product front, the team is ramping its -- hopefully, I pronounce this correct, its VE-Trac power module platforms based on your IGBT leadership for electric vehicles. Few competitors are actually providing full module solutions for EV. So what's the design win traction been like in this area? And is the team already driving revenues from these high-dollar content module platforms?

Yes, we already have revenues. We started ramping last year in the traction modules. We do make all of our own content. We think we get better performance capabilities, better power density and efficiency. And that's been recognized by our customers, with significant ramps coming this year in our dual-side cool modules. And also our single side will grow quite a bit. So that's been an area of great traction and that continues for us.

Give us an update on your GaN and silicon carbide power portfolio. You guys talked about a growing portfolio of next-generation products based -- focused on power solutions. As a leader in the power or powertrain system market, how is the ON team positioned as it relates to these next-generation technologies? I know the team is ramping silicon carbide-based products into automotive and industrial applications. Talk about how you see these new technologies driving sort of growth over the next few years.

Yes, we've been investing in both sets of technologies for a number of years. Most of our sales today for silicon carbide are in industrial because, frankly, that's where the biggest TAM is. There's been some early adoption by one car manufacturer of silicon carbide. We do see that proliferating, as you get to the back half of this year, at more carmakers, and we think we're well positioned for that. We think you have to have a total solution there to be a viable long-term candidate. And we've been investing in making our own substrates as we do with silicon, giving us, I think, a better position from a cost perspective and a better position from a technology perspective in being able to tune the performance of the devices. So we do see lots of continued good growth for silicon carbide. Gallium nitride has some applications. We are seeing that in battery-charging kinds of places, et cetera. Been much slower to take off from a market perspective, but we do expect to see more traction in late 2020, early 2021.

Before I move on to your industrial segment, does anybody have any questions in the audience? Wait for the microphone, please.

Just a quick follow-up on the auto business. Looking for just a little bit more granularity, if possible, because there's a lot of concern out there regarding the European complex with the second round of major regulatory changes coming in the second half of '20, how that could affect the lineups, but you have a really rich content gain story there if you're positioned with the right OEMs in the right geographies. So any further color on that would be pretty helpful given this big uncertainty. We saw what happened with WLTP. It was a real big mess for a couple of quarters.

Yes, we -- our largest automotive sales are European-based. And so we think we're very well positioned there. Our observation would be that the emission standards are -- have already driven all the OEMs to be introducing EV models of all their platforms this year. And so we think from a platform perspective the EV models will proliferate very significant in 2020. From a sales perspective, I think we're not in a position to call whether they will get significant displacement or not. But certainly, from an activity on new model platforms, it's been very intense in Europe.

There's a question back there.

Can you elaborate a little bit more on the comments you made regarding silicon carbide? You made mention that the vertical integration is -- you guys see that as a key differentiator. Can you talk about sort of the value proposition that you guys have in selling to the industrial and the auto end markets as a proven supplier into those markets in terms of reliability and quality, whatnot relative to the difficulty in actually manufacturing the silicon carbide itself? Can you just elaborate on that a little bit?

Yes. So I think there's a few questions wrapped up in that. The reliability is just paramount in both automotive and industrial for power products. We're putting some pretty extreme use cases out there. And when things go wrong, they go very wrong. And so that experience for us has been critical. It has driven some philosophy of us building our own modules because then you have more control over what's going on. And we think we can get, as I mentioned earlier, more power density than competitors can and/or some of the folks that are just module houses buying dye. So that's -- that vertical integration there, we think, is pretty key for providing reliable and rugged products. Going all the way down to the substrate piece. Really, silicon carbide, once you have the substrate, is not dramatically different than other silicon processing. So the real key and the real cost benefit is in the substrate. And so we have been putting efforts into that, made no secrecy of that. We think we can take a lot of costs out, and we think we can, again, continue to integrate and get more reliability in that substrate process. So we think those are key, don't want you to think that means we're going to make 100% of our substrates. We only make about 50% of our silicon substrates today. We like having that internal flexibility, but we'll continue to be buying on the open market as well.

Let's move over to industrial. It's another large part of your business, 26%, very diversified. You guys lead with power modules, motor control, power transistors, image sensor solutions. Maybe talk about some of the trends that you're seeing in that business currently. And maybe highlight some of the different subsegments within industrial.

Yes, it is broad. And if you hear us talk about looking at the future, it becomes the fuzziest because of that breadth and because many of the end applications are very dependent on government actions around the world. So subsidies in the infrastructure and subsidies in building and easy money flow, those things matter with the industrial side. I can kind of pick apart a few pieces of that. We put our medical business in there. We actually see that as a strong growth vector. It's not a large part of our business, but it's growing very rapidly, and it's all about personal medical devices. Everyone wants to get into that game. And frankly, it's an affordable point. And we're seeing continued good growth and traction in that piece. The infrastructure piece, as I mentioned, is very much motivated by government policies. We saw softening in like solar infrastructure, for example, middle of last year. That seems to have been kind of digested, and we're seeing a pickup again there globally for demand in that piece of the infrastructure. But that can change again with government policies, so it makes it a little less easy to follow. And then the building-related things, so the big HVAC, the lighting controls, the thermostat controls, et cetera, et cetera, that's very much driven by the economy of building. And it weakened in China last year. We haven't seen big signs of pickup there yet, but we've been pretty steady in the Americas and Europe. So I think those are kind of macro pieces.

Got it. Let's talk about your cloud power. You've got some very unique and new content growth opportunities there. Cloud power, a combination of your server power management and 5G infrastructure power solutions. On the server side, how much of the current strength in cloud server power is the re-acceleration of the cloud spending CapEx cycle versus dollar content step-up as you look into the next server CPU refresh cycle, which kind of kicked off with Intel's Cascade Lake last year? And you have Ice Lake 10-nanometer this year. How do you see the -- and then how do you see the content increasing over the next few years?

Yes. So we started to see our pickup with the power module side of that business with content we didn't have before in the servers, and we saw that in '19. We see that continuing. That market again got a little soft in the middle of the year. We're starting to see it pick back up. So we think the inventory correction is over there. Story for us next is we get another $25 of opportunity with our controllers which will be coming out later this year. And so that'd be the next big content piece and, hopefully, some continued share gain with the technologies that we have.

In 5G, we're at the start of the 5G upgrade cycle. You guys lead with your medium-voltage power FETs. 5G brings more baseband processing requirements, more radio power requirements, more power supplies for additional base station. What does this mean for ON? And as we move from sub-6-gigahertz to millimeter wave, do you expect content step-up once we make that transition as well?

Yes, as we mentioned, it's been a big deal for us because we're really not part of the 4G infrastructure. And so we moved the hundreds-of-dollars base station in 5G, pretty exciting. As you go to millimeter wave, our content will double again. And this is all about the power needed for those transmissions. And so that will continue to be a growth story. It -- I think the ramps there are going to be geographic and lumpy, but we're looking forward to good growth in that sector for many years.

Let's talk a little bit about operations and financials. So on the 300 millimeter acquisition back in April, you guys announced 300-millimeter fab acquisition from GLOBALFOUNDRIES. I think it's a great addition for ON. It provides the company with access to leading-edge 45-, 65-nanometer capacity for future products but also low product costs, 300-millimeter manufacturing capability for your core analog and power products. First phase was to start to ramp some of your power products this year, calendar year '20. What's the status of the ramp?

Yes, we're making great progress and getting good results on those initial MOSFET and IGBTs, which is the first thing we're going to put in there. As we mentioned, those are supporting the growth in automotive and industrial that we've been talking about. So we're starting there, and we're seeing great progress. We're seeing good results, and we'll start the qualification process here very shortly. So we still think we're on track for kind of second half of this year full manufacturing shipments. So we're excited about that. It does give us a good cost platform but also gives us a very capital-effective growth platform.

On the analog front, obviously, one of the few guys that has 12 inches, Texas Instruments. And they always talk about a 15% to 20% total product cost reduction on 12 inch versus 6 inch, 8 inch. How does the ON team think about total product cost savings of your power or analog products on 12-inch versus your existing 6-inch, 8-inch manufacturing lines?

Yes, we really don't have power on 6 inch any longer. It's 8 inch, and we operate in some extremely low-cost parts of the world. So we've got some very good cost structure. May not get the percentage gains that TI quotes, but certainly it will be more effective in the long run for us at 12 inch because, again, our capital costs are going to be lower. Depreciation costs are going to be lower. So we're still very excited about the gains there. Is it 20%? Is it 18% or 15%? A little less obvious to me at this point.

During the last Analyst Day, you guys laid out a new 2022 target financial model, $7.1 billion revs, 43% gross margins, 22% operating margins, $3 EPS, roughly $2.90 to $3 of free cash flow per share. From where we are today at 36% gross margins, what are the different vectors to get you to that sort of 43% gross margin target?

So we're still targeting to achieve that model for gross margin, which is where we have the biggest contributing growth. We have 4 main vectors. One is revenue growth. That's about 40% of the total improvement or 200 basis points. Second one is mix, whereby we expect to have a lift of about 120 basis points due to the fact that our highest-growth end markets are also the ones that have the best gross margins, and the flip side occurs with the ones that we expect to either be flat or declining. Third element is manufacturing cost reductions which we have 130 basis points. And as you were mentioning earlier, we believe that the East Fishkill acquisition enhances that, the ability to achieve that. And last but not least is the 40 basis points coming from small divestitures for, like, nonstrategic and less-profitable businesses. So we believe we're still very, we believe, as Keith was mentioning earlier, very much on target based on our secular growth drivers. The revenue growth in 2019 was obviously not a good start, so that will put pressure in terms of achieving the $7.1 billion. So the timing of that is still TBD. Other than that, we believe that the model is intact, and we're still pursuing it.

Great. And then just last question. In terms of the -- you had some opening comments about that, Keith. In terms of the Quantenna acquisition, it expanded the team's reach, obviously, into broadband access markets. It bolsters your wireless IoT connectivity portfolio, especially in industrial and auto. You're about a half year into the acquisition. Can you kind of just discuss the progress in developing products to go after industrial and auto kind of IoT connectivity-type solutions?

Yes. We announced at the time we were expecting kind of an 18 months to 2-year cycle to get that completely through. I'm pretty excited about how the teams have come together. So we took teams at ON with low power expertise in connectivity. Those teams have merged. They've got the joint projects launched, and they're well along the way. So I still very -- feel very comfortable with that timing. And I think the idea exchange has been invigorating, looking at the opportunities we can for performance enhancements to make us more competitive. So we're very happy with that integration.

Great. Well, we're just about out of time. Keith, Bernard, thank you very much for joining us. And really appreciate you guys participating in our conference the last 10 years, I think, yes.

Thank you.

Thank you.