ON Semiconductor Corporation
Q3 2009 Earnings Call Transcript

Published: 5 Nov 2009

[Operator:]

Welcome to the ON Semiconductor third quarter earnings call. (Operator instructions) Thank you. I would now like to turn the conference over to Mr. Ken Rizvi. Sir you may begin.

[Ken Rizvi:]

Thank you. Good afternoon and thank you for joining ON Semiconductor Corporation’s third quarter 2009 conference call. I am joined today by Keith Jackson, our President and CEO and Donald Colvin, our CFO. This call is being webcast on the investor relations section of our website at www.onsemi.com and will be available for approximately 30 days following this conference call along with our earnings release for the third quarter of 2009. The script for today's call is posted on our website and will be furnished via a Form 8-K filing. Our earnings release and this presentation include certain non-GAAP financial measures. Reconciliations of these non-GAAP financial measures to the most directly comparable measures under GAAP are in our earnings release and posted separately on our website in the Investor Relations section. In the upcoming quarter we will present at the Credit Suisse Technology Conference on December 1st and the Barclays Global Technology Conference on December 9th. 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. The words believe, estimate, anticipate, intend, expect, plan or similar expressions are intended to identify forward-looking statements. We wish to caution that such statements are subject to risks and uncertainties that could cause actual events or results to differ materially. Important factors relating to our business, including factors that could cause actual results to differ from our forward-looking statements, are described in our Form 10-K, Form 10-Q’s and other filings with the SEC. The company assumes no obligation to update forward-looking statements to reflect actual results, changed assumptions or other factors. Now, let’s hear from Donald Colvin, our CFO, who will provide an overview of the third quarter results. Donald?

[Donald Colvin:]

Thanks Ken, and thanks to everyone who is joining us today. ON Semiconductor Corporation today announced that total revenues in the third quarter of 2009 were $472.9 million, an increase of approximately 13% from the second quarter of 2009. During the third quarter of 2009, the company reported GAAP net income of $29.9 million or $0.07 per fully diluted share. The third quarter 2009 GAAP net income included net charges of $41 million, or $0.09 per fully diluted share, from special items, which are detailed in schedules to our earnings release. Third quarter 2009 non-GAAP net income was $70.9 million or $0.16 per share on a fully diluted basis. We exited the third quarter of 2009 with cash, cash equivalents and short-term investments of $470.2 million, a record high in the company’s history. In addition, we exited the third quarter with the lowest net debt position in the company’s history as a publicly-traded company of approximately $425 million. At the end of the third quarter, total days sales outstanding decreased from the second quarter by approximately four days to approximately 51 days. ON Semiconductor’s total internal inventory was also down from second quarter levels by approximately six days to 81 days. Included in our total internal inventory is approximately $4 million of inventory written-up to fair value related to our acquisitions and approximately $30 million of bridge inventory built in preparation for our announced closures of front-end manufacturing lines. Distribution inventories were at the lowest level in the company’s history exiting the third quarter on a week’s basis at approximately nine weeks. Cash capital expenditures during the third quarter of 2009 were approximately $9 million. We currently expect capital expenditures for 2009 of approximately $75 million. The increase from previous expectations is due to initial construction costs in the Philippines which will enable the consolidation of assembly and test operations in that country. Now I would like to turn it over to Keith Jackson for additional comments on the business environment.

[Keith Jackson:]

Thanks Don. Now for an overview of our end markets. During the third quarter of 2009, our end market splits were as follows

[Donald Colvin:]

Thank you Keith. Fourth quarter 2009 outlook. Based upon current product booking trends, backlog levels and estimated turns levels we anticipate that total revenues will be approximately $480-495 million in the fourth quarter of 2009. Backlog levels at the beginning of the fourth quarter of 2009 were up from backlog levels at the beginning of the third quarter of 2009 and represent over 90% of our anticipated fourth quarter revenue. We expect that average selling prices for the fourth quarter will be down approximately 1-2% sequentially from the third quarter of 2009. We expect cash capital expenditures of approximately $25 million in the fourth quarter. For the fourth quarter, we expect GAAP gross margin of approximately 38-39%. Our GAAP gross margin in the fourth quarter will be negatively impacted from among others expensing of appraised inventory fair market value step up associated with our acquisitions of approximately $2 million and stock based compensation expense of approximately $3 million. We expect non-GAAP gross margin of approximately 39-40%. Non-GAAP gross margin excludes special items which we expect to be approximately $5 million. For the fourth quarter of 2009, we also expect total GAAP operating expenses of approximately $130-135 million. Our GAAP operating expenses include the amortization of intangibles, stock based compensation expense, restructuring, asset impairments and other charges which total approximately $25 million. We also expect total non-GAAP operating expenses of approximately $105-110 million. This is up slightly from third quarter levels due the reinstatement of full salary levels. We anticipate interest and other expenses will be approximately $10-11 million for the fourth quarter. We also anticipate non-cash interest expense of approximately $8 million from the adoption of FASB Staff Position No. APB 14-1 relating to our convertible senior subordinated notes. GAAP taxes are expected to be approximately $5 million and cash taxes are expected to be approximately $2 million. We also expect stock based compensation expense of approximately $12-13 million in the fourth quarter. Our current fully diluted share count is approximately 440 million shares based on the current stock price. This includes the full impact from performance based restricted stock units that should vest over a three year period based on meeting certain financial hurdles. Further details on share count and EPS calculations are provided regularly in our quarterly and annual reports on Form 10-Q and Form 10-K. With that, I would like to start the Q&A session.

[Operator:]

(Operator instructions) The first question comes from the line of Parag Agarwal – UBS.

[Parag Agarwal:]

On your guidance you indicated that you were booked about 90% at the beginning of the quarter. Can you give some color on the booking trends since the beginning of the quarter so far?

[Keith Jackson:]

The booking trends have been very strong. We continue to see our customers requesting things pulled in. I would anticipate no troubles with getting the turns for the quarter.

[Parag Agarwal:]

Also can you comment about the lead times how they are stretching? Have you been able to meet all the demand or have you been capitally constrained at all?

[Keith Jackson:]

Our lead times have been stretched out approximately 11 weeks for this quarter versus 9 in the previous quarters. They have stretched. No, our customers are requesting more than we can deliver this quarter.

[Parag Agarwal:]

Looking at the general environment what is your view of the demand beyond Q4 in the sense of what your customers are telling you as we head into 2010, especially about industrial and auto sectors.

[Keith Jackson:]

We are getting a picture from our customers their demand continues to strengthen. They are more bullish about the first quarter than we have seen in many years. So I guess I would say it is a very positive outlook by the customers. They are backing that up with orders in advance of that so right now I would have to say it is a fairly positive environment. Automotive, I do believe specifically will do some tapering off because the incentive programs are over and they will catch up with their inventory build sometime early next year.

[Operator:]

The next question comes from the line of James Schneider – Goldman Sachs.

[James Schneider:]

To put the previous question a bit differently how should we think about Q1 seasonality and the concept of that? Clearly you have done a couple of acquisitions, most notably AMI, which has different seasonality than the historical business. How should we think about Q1 being stronger or weaker than normal and what is normal?

[Keith Jackson:]

Normal has been roughly down 3-8 or approximately 5% sequentially. If you look at the last 10 years or so that would be normal. Clearly our customers are indicating to us, as I mentioned earlier, a more positive attitude than we normally would see but I can’t give any guidance beyond Q4 right now. We will frankly have to wait to the end of the quarter to know the story. Right now at least the customers are appearing a little more positive than they have in the past at this time of year.

[James Schneider:]

On the factory network can you give us an update on what your utilization rate was in the quarter and roughly what your incremental follow through is right now?

[Keith Jackson:]

For Q3 kind of low 80’s utilization rate. I believe our fall through to the bottom line was about 70% of each incremental dollar produced.

[James Schneider:]

Donald, can you help us with the OpEx and how much of the temporary cost reductions you instituted have yet to come back? Is all of that captured in the Q4 OpEx guidance or is there still more to go?

[Donald Colvin:]

Most of it is in the Q4 guidance. We still have some temporary salaries from senior members of staff, the VP’s and above, and we have some shut down at year-end in North America for the support staff. I think you can see just about all of it is in the numbers bar about $5 million or so.

[Operator:]

The next question comes from the line of Chris Danely – JP Morgan.

[Chris Danely:]

Just to follow up on the OpEx question, for Q1 do you expect GAAP and non-GAAP OpEx to go down?

[Donald Colvin:]

If we are going to be restoring something we would expect more of a slight trend upward in the first quarter. But I think I gave the range there. On an apples-to-apples basis something like $5 million would be restored by the first quarter. The remaining amount of the exceptional measures coming back in. But I will remind the audience here even at that level on a similar basis we were running at approximately $136 million in the third quarter of last year so we have baselined our business to a much lower level of operating expense.

[Chris Danely:]

Can you give us your two cents on each of your major end markets and how you feel about them? Maybe perhaps touch on where you think they are in the inventory replenishment stages and in particular in light of the recent chatter on the PC market and the Cash for Clunkers in auto?

[Keith Jackson:]

I am very familiar with the recent chatter and will preface everything I say based on what our customers are telling us for their demand for our products. In the PC space that continues to strengthen. They continue to ask for more pull ins and they are probably the most positive bias going into next year on a sequential basis. Normally, as you know, that market is down considerably. Certainly what we are hearing from the mobile computer makers is it may not be as severe. Again, that is what they are telling us and time will tell. Automotive, clearly the Cash for Clunkers from an end automotive sale when that expired we saw a rapid drop in automobiles sold shortly after those programs ended in each of the countries. They are still needing to do some supply chain replenishment but I do expect that will start rolling off next year as I mentioned earlier in the call. The rest of the markets are going to be I think a little closer to seasonality. The consumer market, wireless markets, etc. I would guess would be a little bit more close to seasonal as we look forward based on the customer comments we are getting right now.

[Operator:]

The next question comes from the line of John Barton – Cowen.

[John Barton:]

You made a comment earlier you are seeing customers do pull ins and you pretty much repeated it in response to Chris. Do you view that specifically as your customers are seeing things selling through to the end customer faster than they originally thought vis a vie your backlog and that is the main driver of the pull ins?

[Keith Jackson:]

I think we do and I would point you to two or three things around that. Most notably some of the high volume markets we have are served mostly through distribution particularly computing, wireless and consumer out of Asia. We are at all time lows in our inventories. In fact by over a week’s worth of supply all time lows. So there is no detectable inventory build that we can find in the chain and of course our internal inventories are down as well. What we are seeing, to the contrary of inventory building we are still seeing inventory depletion as we go into the end of the quarter. So I guess the simplest answer I can give you is I haven’t seen anybody giving us any kind of signals they are going to be slowing down any time soon.

[John Barton:]

You made the comment that orders were already being placed for Q1 kind of beyond the normal trend you would see. If you looked at your Q plus one backlog how would that compare? Obviously last year is not a good comparison.

[Keith Jackson:]

It would be stronger than a normal year.

[John Barton:]

Can you quantify that any further?

[Keith Jackson:]

I’m trying not to give numbers but let’s just say it is very similar in magnitude to what we had going into the fourth quarter at the same time.

[Operator:]

The next question comes from the line of Craig Ellis – Caris & Co.

[Craig Ellis:]

Given how lean inventories are both on hand and in the channel how should we think about the way the company wants to manage those as you go through and ultimately exit the fourth quarter? Do you intend to rebuild them at all or do you really want to keep them where they are presently?

[Keith Jackson:]

So there is really not much I can do to impact the fourth quarter because frankly we are sold out from a full model perspective. So I don’t really expect to do much replenishment in Q4. As I mentioned before I think everything is being consumed. What we would like to do as we enter next year if we get some seasonal softness as is normal we would like to actually build a little bit of that back in the first half so that we can drain it off again in the second half.

[Craig Ellis:]

Then as a follow-up to that, how should we think about the planned facility shut downs as we go through 2010?

[Keith Jackson:]

We will be closing our six inch facility in Idaho at the end of this calendar year right at the end of December. We would start seeing impact of that in the beginning of 2010 and as you bleed off some of that inventory that would accelerate through the year. You should see full quarters of that in the Q2 and Q3 timeframe next year. Our discrete facility we are closing in Phoenix because of the high demand right now is not going to close probably until about midyear meaning you will start seeing that impact in the second half.

[Operator:]

The next question comes from the line of Craig Berger – FBR Capital Markets.

[Craig Berger:]

On the revenue guidance, last quarter you were over 90% booked. You beat it by several points. What are the assumptions you are making regarding Christmas in turns of what is baked into your revenue guidance?

[Keith Jackson:]

So the turns question I think we kind of put our numbers out there. We need less than 10% and we had very strong turns bookings through October and so I don’t anticipate issues there. We try and anticipate end of year behavior by our customers and build that into our forecast as well. As I said right now the customers are still giving us a very positive bias in momentum into the first half of the year.

[Craig Berger:]

A clarification, how much is stock comp assumed in the fourth quarter in OpEx?

[Donald Colvin:]

We gave that out in the guidance.

[Keith Jackson:]

You didn’t give it out by OpEx.

[Donald Colvin:]

On the OpEx line it is about $2-3 million of the total is in COGS and so the delta is in OpEx so if you look at what I gave as guidance we stated that the stock expense is $12-13 million and approximately $10 million of that would be in OpEx.

[Operator:]

The next question comes from the line of Tristan Gerra – Robert Baird.

[Tristan Gerra:]

How should I look at utilization rates at Gresham currently versus the overall company and any targets you have for next year?

[Keith Jackson:]

Gresham has ramped very nicely for us. In fact as we look at our plans next year we will be moving out some of our Trench MOSFETs which were the first things in the factory in favor of more integrated circuit products because we will be quite frankly about out of capacity with the existing tool set and the existing mix. So it is ramping nicely. I think again as our projections here is we are going to have to start moving products around to take best advantage of that factory.

[Donald Colvin:]

That is one of the things that is underpinning our nice improvement in gross margin is that we are loading Gresham well and as Keith mentioned we have a good pull through in the delta revenue and the last part of that is we are recovering a lot more costs at Gresham and that is truly coming the corner very nicely.

[Tristan Gerra:]

What was the mix of ECL business in the quarter as Cisco orders have rebounded? What was the impact, the positive impact of mix on the gross margin?

[Keith Jackson:]

We actually had our lowest ECL revenues in quite awhile in the third quarter. I do understand Cisco had good numbers but our sell through for that business was actually about $11 million or so.

[Operator:]

The next question comes from the line of Kevin Cassidy – Thomas Weisel Partners.

[Kevin Cassidy:]

I wonder if you could give us a little more description of PulseCore’s annual revenue and who some of their key customers are?

[Keith Jackson:]

Kind of backwards looking they were approximately $10 million in the last 12 months and their largest customer would be Samsung.

[Kevin Cassidy:]

You are coming into your contract negotiation period for 2010. Can you say what that looks like and what the ASP erosion might be for 2010?

[Keith Jackson:]

It is always tough, as you know, negotiation wise. From what I can tell on the contracts so far it looks fairly consistent with the declines we have seen in the market this year so in other words there is no acceleration in that.

[Operator:]

The next question comes from the line of Analyst for Ross Seymore – Deutsche Bank.

[Analyst for Ross Seymore:]

Can you tell us what your headcount was at the end of the quarter and in light of the strong demand where do you think your headcount will end up at the end of the year?

[Donald Colvin:]

Most of the headcount we have are in manufacturing and I think we are at about 13,000 people but headcount is not such an important indicator for ON because we can add a lot of people in low cost manufacturing areas. I think the main thing we look at when we manage the business we look at our gross margin which covers where most of the people are working and we look at our operating expense and I think I already gave the guidance to the operating expense and that is where the most expensive headcount are. So we don’t really see total company headcount as being a meaningful measure.

[Analyst for Ross Seymore:]

Your utilization rate you mentioned is already in kind of the low 80’s. What level are you comfortable with you are getting to the right efficiency whether not too hot or not too cold?

[Keith Jackson:]

Somewhere around 90 is a sweet spot. It gives us the flexibility to service unexpected customer needs and keeps us full enough that we get some pretty good returns on that overhead.

[Operator:]

The next question comes from the line of Gus Richard – Piper Jaffray.

[Gus Richard:]

In terms of your notebook business are you starting to see the build for Capella or is that some of the pull you are getting?

[Keith Jackson:]

We are seeing the initial orders coming in December deliveries.

[Gus Richard:]

Is that some of the hurry up?

[Keith Jackson:]

That is some of the hurry up although it is a pretty small quantity as compared to the total.

[Operator:]

The next question comes from the line of Brian Piccioni – BMO Capital Markets.

[Brian Piccioni:]

We have seen a lot of volatility in US currency relative to global currencies. Has that been helpful or a hindrance to operating performance?

[Donald Colvin:]

I think in general I would say the weak dollar helps the demand for the final product whether it is a TV or a PC, an iPod, phone or whatever. Most of the fundamental consumer products are denominated in dollars so the weak dollar makes it cheaper for the European and the non-dollar based economies to buy these products. I think generally it helps US exporters like ourselves. If we see too dramatic variations especially against currencies where we have manufacturing activity it causes some instability in our earnings. What we have to be very careful of is if the weak dollar has an offset in commodities, if it results in a rapid rise in oil, copper, gold, then that is negative for us because we do have a large consumption direct and indirectly of oil through freight, gasses and chemicals, molding compound and we use a lot of copper through [freight]. As long as the weak currency doesn’t have an offset in a big increase in commodities then it is generally positive to us.

[Operator:]

The next question comes from the line of Ramesh Misra – Brigantine Advisors.

[Ramesh Misra:]

I don’t expect you to provide much granularity with regard to AMI business going forward, but with the downturn behind us I was hoping you could at least provide a qualitative view into how the AMI business has trended? Basically are we back to pre-recession levels at AMI?

[Keith Jackson:]

It has pretty much trended with the rest of our business. There has not been a substantial deviation from the balance of our businesses at the company. In other words they seem to be tied to the same markets and market responses as the other businesses. No they haven’t fully recovered yet but yes they have recovered.

[Ramesh Misra:]

Can you provide an update on your China back end facility? Help us understand why you are ramping up in the Philippines instead of China.

[Keith Jackson:]

We have three major assembly test sites and they each have an expertise which gives us some additional efficiencies in each of those factories. In China we build our smallest packages and they are extraordinarily good at doing very, very high volumes of small things. In Malaysia we do our power packaging, where again they are focused on high power products which tend to be larger and more material intense. In the Philippines they focus on our analog and mixed signal products. As is consistent with what we have told you in the past our focus in investment has been in the analog and mixed signal area to continue to drive up our margins. So we are seeing the fastest growth there and hence we need to make more investments.

[Ramesh Misra:]

Can you remind us when the next major principal payments are on your long-term debt?

[Donald Colvin:]

We have a major payment to pay off the zero coupon of approximately $100 million which is due in April of next year. As of the end of September that is a major portion of the current due long-term debt of $166 million, $100 million is the remainder of our zero coupon convert in April of next year. I can also remind the listeners that initially this was a $260 million facility that we proactively repurchased on the market at a discount. So although it was originally $260 million there remains only $100 million and we fully intend to repay that in April of next year.

[Operator:]

The next question comes from the line of Steve Smigie – Raymond James.

[Steve Smigie:]

I just wanted to follow-up on that last question. It seems like you have the $166 million in short-term debt. What are the plans for further debt pay down? You are at a great all-time low of net debt. That seems to continue to improve assuming even a normalish year next year you will be throwing off a lot of cash and I was just wondering how much you plan to pay down. I think you have some Chinese and Japanese loans that seem pretty cheap you could refinance. How much gets refinanced versus paid?

[Donald Colvin:]

Three points. We will continue to pay down debt and that we think is a great way of increasing shareholder value and we have historically had a lot of debt compared to a lot of our competitors so paying that down we see as very positive. If you look at what happened in the third quarter we generated approximately $70 million in cash. If you consider what that can do over the next five quarters at a similar run rate then you will get to a situation where at the end of next year net debt won’t be zero but it will be not far from zero. That is what we would continue to like to do with our business. We have shown ourselves to proactively buy back the bond when there is an arbitrage opportunity on the market. We will do that. You can assume we will continue to reduce that debt, purchasing it where it makes sense and generating cash so our net debt falls. As far as the debt in Asian countries or overseas is concerned, that certainly gives us some flexibility because it makes good sense to finance activities in these countries locally. For instance, Keith mentioned the Philippines activity. We are financing the building there locally and that makes good sense that our off-shore activities have local financing, good sense from an operational and tax standpoint and also from a treasury standpoint because it optimizes the amount of cash we have available in the U.S. to pay down debt proactively. So that is central to our financial management to continue to reduce the debt burden on the company.

[Operator:]

The next question comes from the line of John Vinh – Collins Stewart.

[John Vinh:]

A follow-up question on your comments on pull-ins. Similar to that did you see any push outs or pull ins out of the extended gold week holiday in China? Also related to that was Windows 7 a factor as well? Did you see any sort of pull ins related to that in the quarter?

[Keith Jackson:]

On the golden week comment, we were anticipating a strong end to the third quarter as people would normally prepare to get their materials in advance. As it turns out that was not a significant event. We had run rates pre and post that which were very similar. I guess we didn’t see a golden week impact as dramatic as we would have expected. Relative to Windows 7 we know there was some pre-build activity that did go on there but dominantly what we have seen the growth in is on the netbook side and the notebook side really has just been to fill whatever demand is out there. I don’t know that I could give you a Windows 7 windage in either direction.

[John Vinh:]

Also on gross margins you seem to be doing pretty well there in terms of rebounding on gross margins. Can you give us an update on where you see peak margins and what sort of timeframe can we get to that point?

[Donald Colvin:]

I think it was on the last conference call that I gave our model which was $525 million model and something like a 43% gross margin, 23% operating expense, 20% to 21% operating income all on a pure non-GAAP basis. That was to support the earnings model. I told people afterwards in Q&A that if you plotted that simply as an objective on where we had been coming from you see we are tracking well to the line. I think this quarter is another illustration to the fact that we are well on the way to achieving that objective. Our guidance for next quarter again confirms we are well on the way. We unfortunately cannot control the end markets. We can only control how much we spend. We will make sure we manage our business to do that. We don’t know what the business is going to be in the second half of next year. The only thing we can say is that we are confident there is a positive momentum in our business for the fourth quarter and the outlook at this stage for the first quarter is also encouraging. Hopefully we can reach that $525 million, 43% gross margin sooner rather than later.

[Operator:]

The next question comes from the line of Gus Richard – Piper Jaffray.

[Gus Richard:]

On the non-cash charge on interest, are you going to put that in your pro forma or not?

[Donald Colvin:]

Sure. I think we pulled that out because it is a pretty esoteric charge related to the finance interest on the converts. When we give our pro forma earnings we pull out that non-cash charge.

[Operator:]

The next question comes from the line of Chris Danely – JP Morgan.

[Chris Danely:]

When do you think you will be able to bring those lead times in?

[Keith Jackson:]

I will answer in reverse order. We are hopeful we will be able to bring lead times in towards the end of the first quarter. Obviously the demand picture between then and now will determine whether that is successful. We are hopeful we can start getting some progress in Q1. Industrial and communications, I would see those right now from an industrial perspective actually strengthening as we enter next year. Across that sector some of the things we put in there are some of the test equipment vendors, etc. and we are seeing some nice pickups there. We also have a lot of the building infrastructure stuff and we are starting to see the general lighting market is picking up for some of that activity. I would say a positive bias on industrial and in communications you saw the relative releases here recently by companies in this sector and that again seems to be firming up in a positive direction for us.

[Operator:]

This concludes today’s conference. Thank you for your participation. You may now disconnect.