ON Semiconductor Corporation
Q3 2012 Earnings Call Transcript

Published: 1 Nov 2012

[Operator:]

Good afternoon. My name is Holly, and I'll be your conference operator today. At this time, I would like to welcome everyone to ON Semiconductor Corporation's Third Quarter 2012 Financial Earnings Conference Call. [Operator Instructions] I would now like to turn today's conference over to Ken Rizvi. Please go ahead, Sir.

[Ken Rizvi:]

Thank you, Holly. Good afternoon and thank you for joining ON Semiconductor Corporation's Third Quarter 2012 Conference Call. I'm joined today by Keith Jackson, our President and CEO; and Bernard Gutmann, our CFO. This call is being webcast on the Investor Relations section of our website at onsemi.com and a replay will be available for approximately 30 days following this conference call, along with our earnings release for the third quarter of 2012. The script for today's call is posted on our website. On our -- our earnings release in this presentation includes 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 be attending the Credit Suisse Technology Conference on November 27. 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, should 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-Qs and other filings with the SEC. Additional factors are described in our earnings release for the third quarter of 2012. Our estimates may change and the company assumes no obligation to update forward-looking statements to reflect actual results, change assumptions or other factors. We've realized that many people on the East Coast are still working through the recovery from Hurricane Sandy. Our thoughts and concerns are with the families, investors and analysts that had been impacted. We are hopeful that everyone is safe and wish for a quick recovery. Now let me turn it over to Bernard Gutmann.

[Bernard Gutmann:]

Thanks, Ken. And thanks to everyone joining us today. Before I go to our financial results for the quarter, let me provide a quick overview of my background and my thoughts of the financial strategy for the company. I'm excited about the opportunities for ON Semiconductor and the ability to lead a strong finance team as our new CFO. I understand the requirements to be successful in a cyclical industry, having over 30 years of semiconductor experience. Most recently, I served as the group CFO for SANYO Semiconductor, as well as the head of our corporate financial planning and analysis team. In these and other roles during my career, I have been directly involved in all aspects of the company's business planning, operations and strategy. In addition, I have been heavily involved in the financial integration of our 9 acquisitions, including leading our efforts to drive operational synergies and, as needed, driving restructuring on a corporate level to ensure strong cash flow generation from the business. From a financial strategy standpoint, moving forward, we plan to focus our efforts on 3 major areas

[Keith D. Jackson:]

Thanks, Bernard. Now for an review of our end markets. During the third quarter of 2012, our end market splits were as follows

[Bernard Gutmann:]

Thanks, Keith. Fourth quarter 2012 outlook. Over the last several quarters, our business has been negatively impacted by the overall slower global economy, and in particular, the slowdown of growth in China. The slower growth environment has impacted a number of our key end customer market for ON Semiconductor including consumer electronics, computing, automotive and industrial. The slower growth environment has rippled through the supply chain and we are seeing the lowest levels of distribution inventory in the Asia-Pacific region since the 2008 and 2009 financial crises. We are optimistic that as the demand environment improves, especially in China, we will see a replenishment of the supply chain and increased demand for our products. Based upon product booking trends, backlog levels and estimated turns levels, we anticipate that total ON Semiconductor revenues will be approximately $650 million to $690 million in the fourth quarter of 2012. Backlog levels for the fourth quarter of 2012 represent approximately 80% to 85% of our anticipated fourth quarter 2012 revenues. We anticipate that average selling prices for the fourth quarter of 2012 will be down approximately 2% compared to the third quarter of 2012. We expect total cash capital expenditures of approximately $50 million in the fourth quarter of 2012. Our capital expenditures for 2013 are expected to come down significantly to approximately $150 million. For the fourth quarter of 2012, we expect both GAAP and non-GAAP gross margin to be approximately 30% to 32%. We also expect GAAP operating expenses of approximately $175 million to $185 million. Our GAAP operating expenses include the amortization of intangibles, restructuring, asset impairment and other charges, which are expected to total approximately $15 million. We expect total non-GAAP operating expenses of approximately $160 million to $170 million. We anticipate GAAP net interest expense and other expenses to be approximately $15 million for the fourth quarter of 2012, which includes noncash interest expense of approximately $5 million. We anticipate our non-GAAP net interest expense and other expenses will be approximately $10 million. GAAP taxes are expected to be approximately to be $3 million to $5 million and cash taxes are expected to be approximately $2 million to $4 million. We also expect stock-based compensation expense of approximately $6 million in the fourth quarter of 2012, of which approximately $1 million is expected to be in cost of goods sold with the remainder in operating expenses. This expense is included in our non-GAAP financial measures. Our current fully diluted share count is approximately 450 million shares based on the current stock price. 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] Your first question comes from the line of Chris Danely, JPMorgan.

[Christopher B. Danely:]

The annual revenue level is now and how long do you think it will take to get the breakeven down to $200 million?

[Ken Rizvi:]

Chris, can you repeat that question? We only got the first part of it.

[Keith D. Jackson:]

Or the second part of it, yes.

[Christopher B. Danely:]

Can you just go through approximately what the SANYO revenue levels are right now and then how long you think it will take you to get the breakeven down to $200 million?

[Bernard Gutmann:]

So the revenue, as you'll see in our segment reporting in the third quarter, was $193 million, down from $205 million in the third -- in the second quarter of 2012. The actions we're putting in place are going to take us to probably the -- in the second half more towards the third quarter of 2012 to get to that breakeven.

[Christopher B. Danely:]

Sure. I assume you mean third quarter of 2013.

[Bernard Gutmann:]

Correct, sorry.

[Christopher B. Danely:]

And then as for my follow-up, I mean, I guess assuming the SANYO revs are going to be down this quarter along with everything else, what's the plan or how do we get the revenue back to $200 million?

[Keith D. Jackson:]

The revenue programs have been in place, Chris, for some time. The real issue here is current impact with the Japan-based customers. Specifically here in Q4, we're seeing the drop-off due to the conflict over the islands with China and the subsequent impact of the boycott. So we really think that relative to the revenue base, our underlying base, it's still there in our cross-selling programs, and design win registrations are up substantially. So we are expecting growth in 2013. The wildcard there is return to normalcy in the China-Japan relationship. But certainly even with our without that, you should see increases next year.

[Operator:]

Your next question comes from the line of John Pitzer, Crédit Suisse.

[John W. Pitzer:]

Keith, I guess maybe just looking to December outlook, can you just walk through from an end market perspective how you expect the trends to vary relative to the midpoint of the overall guidance?

[Keith D. Jackson:]

Yes. So from a down perspective, we'll use the normal ones that have a little amplifier on them, consumer certainly is normally down. We see the gaming console builds taper off and a lot of the TV builds, et cetera, normally. On top of that, is the issue I mentioned a moment ago with some of the tensions between China and Japan causing the Japanese consumer companies which are over half of our SANYO business revenues to be much softer in China. So the consumer, what I would say, is the #1 hit from a sequential negative and from the midpoint to the downside will be just how much longer or how big the impact really is on these boycotts.

[John W. Pitzer:]

Okay. And as a follow-up, maybe as a follow-on to Chris' question about SANYO, when do you think you get back to kind of where the peak revenues were? Maybe a better way to ask the question, relative to where revenues peak, kind of in the September time frame for SANYO, how much of that revenue is still available to come back versus stuff that you guys have just kind of chosen not to participate anymore?

[Keith D. Jackson:]

Yes, we still believe that exiting next year, you have the opportunity to get back into that $250 million range. Our peaks were up closer to $290 million. And of that $290 million, about $25 million or so we obsoleted and do not ever expect to get back. And then that other $25 million is really a matter of when, not if. But certainly, looking from where we're at and as I mentioned to Chris, the design activity, we can see getting back into that range by the end of next year.

[Operator:]

Your next question comes from the line of Terence Whalen with Citi.

[Terence R. Whalen:]

I also wanted to welcome Bernard and best of luck in your role, Bernard. The first one is specifically regarding China demand, if we put aside the issue of China and Japan tension for SANYO just for a second, maybe talking about the core ON business, can you give us any insight into how near-term demand trends in China have proceeded through the third quarter into the fourth quarter, what you're looking for in terms of any signs of improvement? Thank you.

[Keith D. Jackson:]

They definitely softened in September. And we saw even further signs of inventory contraction at all of our customer base there in China. So definitely, some more of a contraction as we went through September and then has continued into October, pardon me. Relative to how long that will go, as Bernard mentioned in his part of the earlier dialogue, we are now at all-time lows in the distribution channel there. It can't go much lower than this. And so, unless there is something that takes the demand, and demands down dramatically, you should expect to see that start to recover as we exit Chinese New Year next year.

[Terence R. Whalen:]

Okay. Terrific. And then a follow-up question is if you can briefly remind us sort of what the target profitability model is now that we have a small adjustment to the structural profitability of SANYO, that would be helpful to understand sort of what your near-term and intermediate-term target profitability models are in specific revenue levels?

[Bernard Gutmann:]

So we are working now on a longer-term model to be discussed at the Analyst Day in February. Or as we mentioned for the short-term, we expect to bring down the breakeven point to achieve break-even levels in the second half of 2013 for the SANYO levels. And on the ON legacy side, is a function really of how fast the recovery will occur to get back to normal levels. Based on what we can see right now, it looks like the possibilities and based on looking at how the historical patterns have gone, we should be seeing a second half that's showing a nice recovery.

[Operator:]

Your next question comes from the line of James Schneider, Goldman Sachs.

[James Schneider:]

Could you maybe talk a little bit about the pricing trends you're seeing across the different product lines right now. Are there any particular product lines where you're seeing more aggressive pricing and do you see any change in that pricing behavior going forward?

[Keith D. Jackson:]

Yes. Third quarter did see an acceleration or an increase in some of the pricing pressure. Predominantly, the spot markets through distribution for turns as the markets weakened through September and again the feedback looked weaker, certainly there was more aggressive behaviors in the marketplace. So most of that is with the high-volume standard products businesses. But it was certainly a little bit stronger in 3 than it was in 2. We're not seeing that intense pressure continue. It does seem to be returning to more normal levels as we get into Q4. And I think the marketplace understands the real demand picture and stops chasing phantom business.

[James Schneider:]

That's helpful. On then a follow-up, on the utilizations, can you talk about where those came out in Q3, where you expect them to go in Q4 and then separately, any contemplation of capacity reductions beyond the Ivy shutdown you already talked about?

[Keith D. Jackson:]

So our front-end utilization is kind of running in the 70s, with the back ends near 90%, you get a blended average for the company about 80% or so in Q3. They should be approximately the same in Q4, not a significant difference. As we look at the factory network beyond Daizu, there are some opportunities as we go through 2013. We're not prepared to announce those at this stage, but we do think there is at least one more opportunity in the assembly network. But our wafer fab network is pretty robust and as the markets recover, should be appropriate for our growth.

[Operator:]

Your next question comes from the line of Chris Caso, Susquehanna Financial.

[Christopher Caso:]

I wonder if you could address some of the comments as you talked about the release -- some of the stabilization of orders you referred to in the release. I assume that's kind of along the lines of what you just said on pricing where, I guess, we took a step down and now we're kind of sitting along these levels. Could you give some color on that?

[Keith D. Jackson:]

Yes, I'll give you a little more color on that. I mean we've traced bookings, billings, patterns for well more than a decade now. And clearly, the bookings trends precede the billings trends. And so we -- I've been seeing declining backlogs and declining bookings trends through September. But then as we entered October, those actually started picking up again. So what we're seeing now is people starting to place backlog in for Q1, Q2. And those levels are at higher rates than we were seeing as we entered Q3. So we're starting to see that stabilize and start to turn up and generally again from a billings perspective, a quarter or so after that, you typically see that the sales go up as well.

[Christopher Caso:]

And I guess as a follow-up to that, I assume you guys don't want to provide guidance on Q1. But I guess, does that give you any sort of confidence that in Q1, we could see some better than seasonal trends or at least some stabilization as we exit the calendar year?

[Keith D. Jackson:]

I think it's too early to call that one. Again, I mentioned some of the geopolitical pressures going on that are really difficult for us to call. But when we see that -- when we see that those bookings rates starting to come up and people starting to place longer-term backlog, again, certainly, if you haven't found the bottom, you're within one quarter of the bottom.

[Operator:]

Your next question comes from the line of Kevin Cassidy with Stifel.

[Kevin E. Cassidy:]

You had mentioned VCore business being up 5% from -- in the third quarter over the second quarter. In a down PC market, that's impressive. Is it related to Ivy Bridge transition or is it something else?

[Keith D. Jackson:]

It is. It's increased share on Ivy Bridge.

[Kevin E. Cassidy:]

Okay. And do you think you will increase share again -- as we go to Haswell with Intel's processors?

[Keith D. Jackson:]

Yes, we believe that we will increase share on the VCore side again in Haswell.

[Kevin E. Cassidy:]

And what is it in particular that you've done differently with your product?

[Keith D. Jackson:]

It's really just continuing to make more efficient controllers at good price points in the marketplace. And, of course, having established a reputation for quality and reliability as a supplier. So good product, good performance and good pricing.

[Kevin E. Cassidy:]

And maybe if I could just ask one other. About the tablet, you said $1.50 of content, what's been your content in other tablets?

[Keith D. Jackson:]

The only tablet that is selling in huge volumes, the number is less than $0.50. But in general, about $1.50 to $2 is our content in most tablets.

[Operator:]

Your next question comes from the line of Steve Smigie, Raymond James.

[Elizabeth Howell:]

This is Elizabeth Howell calling in for Steve. Just going back to the strength in VCore with Intel, just wondering in terms of ARM trying to move up the chain to get into sort of more PCs and servers and capturing more market share there. How does this affect your business and how are you positioned to capture this growing segment, do you think?

[Keith D. Jackson:]

Yes. The ARM processors tend to be much power points and they tend to be put into applications that have far fewer peripherals and so the total power requirements are less. And so it's less about architecture and more about application. So what you have is the tablets look more like cell phones than they do PCs and so there's less power content, less power needed. And so you drive down to that kind of $1 to $3 range of opportunity versus something like an Ultrabook that still has all of the bells and whistles being north of $10.

[Elizabeth Howell:]

Okay. Great. Thanks. Just one more, in terms of your expectations for end market, you still went through consumer being a little bit weaker than normal seasonality, but what are you expecting for like communications, industrial, auto?

[Keith D. Jackson:]

I think the industrial will continue to be soft. Again, not significantly different but certainly softer than Q3. The auto, there will be some strengthening from an ON Semiconductor perspective in automobiles. And the -- let see what else, what other markets, computing should continue to be soft as well.

[Elizabeth Howell:]

And communications?

[Keith D. Jackson:]

Communications, the handset side, it's kind of a sideways market, handsets up a bit and some of the infrastructure down a bit.

[Operator:]

Next question comes from the line of Nick Clare, Robert Baird.

[Nicholas A. Clare:]

I'm calling in for Tristan Gerra. I guess, first, could you touch a little bit on how SANYO's gross margin was in 3Q and what you're expecting from it in 4Q?

[Bernard Gutmann:]

The gross margin for SANYO was -- in the neighborhood of 20% for the third quarter. And we expect it to be a little bit lower in the fourth quarter.

[Nicholas A. Clare:]

Okay. And when you look at the inventory situation that you've touched on this briefly in your comments, but what's the current inventory situation like specifically at SANYO, and what type of reduction, I guess, is built in specifically for them into the 4Q guidance?

[Bernard Gutmann:]

So the inventory that puts SANYO are in a much higher position than that we have for the average ON, north of 150 days. And that's because their business model was more predicated on building to forecast and having inventory available to satisfy the customer demands on a very, very short lead time. As we integrate our planning system and they allow us to start working on reducing substantially those levels. In the meantime, we are trying to do it with more manual processes and that is taking us longer. So we are expecting a small reduction in the fourth quarter, but nothing out of the ordinary. Maybe a couple of days as we manually work through these.

[Operator:]

Your next question comes from the line of Chris Danely, JPMorgan.

[Christopher B. Danely:]

I just have a couple of quick follow-ups. So Keith, on the pricing side, you said that it got a little bit worse during the quarter, but you're seeing it stabilize now?

[Keith D. Jackson:]

Yes.

[Christopher B. Danely:]

Okay. And then going into next year, would you expect to see any real change in that?

[Keith D. Jackson:]

Not really. Again, competitive behavior is always interesting, but when people see the market softening and they think there might be something there, they're certainly more aggressive when they understand the end demands. So as we saw in 2008, 2009, we didn't see any really abnormal behaviors for very long at all, because people figured out what was there and wasn't. So I guess what I'm saying, I think that's happening again. People were a little surprised, I think, by the softness in Q4. It was not generally expected. And so there was certainly some September flurry of activity. But I think we're getting back now to normal competitive behaviors.

[Bernard Gutmann:]

One additional clarification is that we do have annual contract going into effect in Q1, so normally, as a normal pattern of ASP, we do have a stronger decline in the first quarter followed by less.

[Christopher B. Danely:]

Okay. And then, I guess, a follow-up for Bernie. So the OpEx cuts you guys are announcing this quarter, those are in addition to the restructuring activities you announced last quarter, correct?

[Bernard Gutmann:]

Yes. We are implementing additional cuts that will improve OpEx beyond what we said last quarter.

[Christopher B. Danely:]

Great. And then just my last one, so you said the SANYO gross margin is around 20%. Now what's the goal there? If you get back above $200 million in revs considering the OpEx cuts?

[Bernard Gutmann:]

Well, I would say that at that -- at those levels, it's in the middle 20s. However, that intrinsically, that business should be giving us higher, so if we get our long-term model should be higher than that. But by reaching a breakeven, it will be in the mid-20s.

[Operator:]

At this time, there are no further questions in queue. We'd like to thank everyone for participating in today's ON Semiconductor Corporation's Third Quarter 2012 Financial Earnings Conference Call. You may now disconnect.