ON Semiconductor Corporation (ON) Q1 2021 Earnings Call Transcript

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ON Semiconductor Corporation (ON 1.08%)
Q1 2021 Earnings Call
May 3, 2021, 9:00 a.m. ET

Contents:

• Prepared Remarks
• Questions and Answers
• Call Participants

Prepared Remarks:

Operator

Ladies and gentlemen, thank you for standing by, and welcome to the ON Semiconductor First Quarter 2021 Earnings Conference Call. [Operator Instructions]

I would now like to turn the call over to Parag Agarwal, Vice President of Investor Relations and Corporate Development. Thank you. Please go ahead.

Parag Agarwal -- Vice President-Investor Relations & Corporate Development

Thank you, Denise. Good morning, and thank you for joining ON Semiconductor Corporation's first quarter 2021 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 2021 first quarter earnings release, will be available on our website approximately one hour following this conference call, and a recorded webcast will be available for approximately 30 days following this conference call. Additional information related to our end markets, business segments, geographies, channels, share count and 2021 fiscal calendar are also posted on our website.

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 also included in our earnings release, which is posted separately on our website in the Investor Relations section. During the course of this conference call, we will make projections or other forward-looking statements regarding future events or future financial performance of the company. The words believe, estimate, project, anticipate, intend, may, expect, will, 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 from projections.

Important factors which can affect 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 Securities and Exchange Commission. Additional factors are described in our earnings release for the first quarter of 2021. Our estimates or other forward-looking statements may change, and the company assumes no obligation to update forward-looking statements to reflect actual results, changed assumptions or other events that may occur except as required by law.

Our Analyst Day is scheduled for August 5. We plan to host the event in New York City, and we look forward to seeing you all in person in the summer. We will send out further details regarding the event in a few weeks.

Now, let me turn it over to Hassane. Hassane?

Hassane El-Khoury -- President, Chief Executive Officer and Director

Thank you, Parag, and taking everyone for joining us today. For the first quarter of 2021, we posted strong results driven by solid execution and broad-based strength across our strategic end markets. We reported revenue of $1.48 billion, up 16% year-over-year. More importantly, our focus on gross margin expansion is beginning to show results with first quarter gross margin increasing by 370 basis points year-over-year and by 80 basis points quarter-over-quarter.

We have taken steps to optimize our product portfolio and channel strategy to ensure that we capture the right value for our products, and these steps will continue to drive favorable and sustainable results. At the same time, we continue to drive cost improvements throughout our supply chain, improving efficiency of our operations and shifting our product mix toward higher margins. We are seeing increased demand across most end markets. And while the strength in the automotive market is well publicized, we also see strength in the industrial market as global industrial activity is gaining momentum.

The steep acceleration in demand has impacted our ability to supply certain products, especially those manufactured by our foundry partners, and in certain pockets, products manufactured internally. We are working diligently with our manufacturing partners to ensure timely supply of our products to our customers, and have taken steps to ensure continued supply to our strategic customers by building inventory on our balance sheet and reducing inventory in distribution channel.

By having better control over inventory, we are able to quickly respond to the needs of our strategic customers. The steep acceleration in demand that we have seen in the last few quarters will likely begin to subside in the second half of the year, but will remain at a very healthy level. We expect supply and demand to get back in balance as demand stabilizes later this year.

On our transformation initiatives, I had indicated in the previous call, our goals to realign our investment and resources to accelerate our growth in high margin businesses. At the same time, we are looking at our pricing practices to identify and address price-to-value discrepancies and are realigning our cost structure across the whole supply chain given the recent increases in material costs. We are productively engaging with our customers to ensure we'll recover these costs, but more importantly, working with our strategic customers to secure long-term agreements to provide better supply and price visibility over the next few years.

Over the last few months, we have made several changes to streamline the organization and improve efficiency. We have brought in leaders with strong execution track records, promoted new leaders from within, all with the focus on accelerating our strategic transformation and capitalizing on the current market strength to set our path for growth and margin expansion over the next five years. My goal is to have an organization that is able to react quickly to changing business condition and is able to make decisions efficiently and objectively in the best interest of shareholders.

I remain bullish on the potential of our company and believe we are uniquely positioned to benefit from the key megatrends in the automotive and industrial markets. These are the fastest growing semiconductor end markets with solid margin potential. We have outstanding assets and a highly talented and motivated workforce. With a disciplined investment strategy and consistent and strong execution, we can maximize the value for our shareholders, customers and employees. We will provide you with greater insights into our strategy and targets at our Analyst Day on August 5.

Let me now discuss a few highlights of our key strategic end markets starting with automotive. We set a new record for automotive revenue in Q1 with revenue of $515 million. This revenue represents 35% of our Q1 revenue and an increase of 17% from Q1 2020. This increase was broad-based, and we continued to maintain strong momentum in our vehicle electrification, automotive MOSFETs, CMOS image sensors, lighting and ultrasonic products.

We continued to see strong momentum in our silicon carbide and IGBT products for electric vehicles, and during the first quarter, we secured significant design wins with leading Tier 1 and global electric vehicle OEMs, few of whom have recently launched marquee platforms. These wins are expected to ramp starting in late '21 and will contribute to the growth we will see over the next few years.

It takes more than technology to win these platforms. Among the most important source of differentiation is our expertise in packaging, which is critical for improving heat dissipation and reducing the footprint of the module. In addition, we have been serving automotive and industrial customers for a few decades and during this time. We have built a vast distribution network, strong customer relationships, solid domain knowledge and a reputation for quality.

Customer feedback on our silicon carbide traction modules has been very strong. The efficiency of our modules is meaningfully higher than that of our competitors, which enables our customers to make favorable trade-offs between the cost of battery and the range of the vehicle. From the sensing solutions in automotive, during the first quarter, we secured a platform win for up to 11 image sensors on a single vehicle, which is expected to ramp in 2022.

The industrial end market, which includes military, aerospace and medical, contributed revenue of $371 million in the first quarter of 2021 at 25% of our revenue. Excluding the impact from geopolitical factors related to a specific customer, our first quarter industrial revenue increased by 22% driven by broad-based demand. In the industrial end market, we continue to see strong momentum for our power modules and various applications with alternative energy being a key area of growth. We are expanding our customer engagement into the EV infrastructure. And we secured our first design win for our silicon carbide power modules for a charging application with an emerging electric vehicle OEM.

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

Thad Trent -- Executive Vice President and Chief Financial Officer

Thanks, Hassane. Let me start by saying that I'm energized to join ON Semiconductor at a very exciting time for our company. We have tremendous opportunities to create value for our shareholders, customers and employees as we execute our strategic transformation. We have the building blocks of a robust product portfolio, excellent teams and operational scale to drive sustainable financial results during this transition.

Now let me comment on the current business environment. During the first quarter of 2021 we saw continuing recovery in business conditions driven by further acceleration in global economic activity. We are seeing broad-based strength across most end markets as semiconductor content continues to increase in the products we encounter in our daily lives. As Hassane mentioned, we continue to benefit from the secular megatrends in automotive and industrial end markets, which now account for 60% of our total revenue. Although the industry and space with severe supply constraints globally, we have supported our customers through a proactive inventory management by taking channel inventory down while holding more on our balance sheet. We believe supply and demand will start to balance later in the year.

Now let me turn to results for the quarter. Revenue for the first quarter of 2021 was $1.48 billion, an increase of 16% over first quarter of 2020 and 2.4% quarter-over-quarter versus normal seasonality of a sequential decline of 2% to 3%. The year-over-year increase in revenue was driven by broad-based strength with automotive and industrial growing by 16% and 17% respectively.

Gross margin for the first quarter of 2021 was 35.2%, a 370 basis point improvement year-over-year and an 80 basis point improvement sequentially. The gross margin improvements are being driven by improved mix to higher margin products, improved utilization and our laser focus on cost structures across the company. Our position was 80% as we ramp production to align with the strong in demand. As we move forward, our fab lighter strategy will allow us to continue to reduce our manufacturing footprint and optimize the mix of products within our fabs to reduce our overall cost structure.

GAAP earnings per share for the first quarter was $0.20 per diluted share as compared to a net loss of $0.03 per share in the first quarter of 2020. Non-GAAP net income for the first quarter of 2021 was $0.35 per diluted share as compared to $0.10 per share in the first quarter of 2020.

Next, let me provide additional color on the performance of our business units starting with the Power Solutions Group or PSG. Revenue for PSG for the first quarter was $747 million. PSG revenue increased by 20% year-over-year due to strength in automotive, industrial and computing end markets. Revenue for the Advanced Solutions Group or ASG for the first quarter was $531.5 million, an increase of 14% year-over-year. In addition to strength in industrial and automotive, ASG benefited from strengthened computing, especially in high end graphic cards. Revenue for the Intelligent Sensing Group or ISG was $203 million, an increase of 9% year-over-year. Strength in ISG was primarily driven by automotive and by computing with the work from home trend remaining strong.

Now let me give you some additional numbers for your models. GAAP operating expenses for the first quarter of 2021 was $395.3 million as compared to $384.1 million in the first quarter of 2020. Non-GAAP operating expenses for the first quarter of 2021 was $324.7 million, an increase of $6 million year-over-year and $32.3 million quarter-over-quarter as expected. This increase is primarily due an increase in variable and stock-based compensation and the normal reset of [Indecipherable] rates going into the year.

Our GAAP operating margin for the first quarter of 2021 was 8.5% as compared to 1.5% in the first quarter of 2020. Our non-GAAP operating margin was 13.3% as compared to 6.6% in the first quarter of 2020, driven largely by higher revenue and gross margin performance. Our GAAP diluted share count was 445.4 million shares and included 12.8 million shares for the in-the-money portion of our convertible notes. Our non-GAAP diluted share count was 432.6 million. Please note, we have an updated reference table on our Investor Relations website to assist you with calculating our diluted share count at various share prices.

So turning to the balance sheet. Cash and cash equivalents was $1.04 billion and we had $1.42 billion undrawn on our revolver. Cash from operations was $218.5 million or 15% of revenue. Capital expenditures during the first quarter of 2021 were $77 million, which equates to capital intensity of 5.2%. As we indicated previously, we are directing a significant portion of our capital expenditures toward enabling our 300 millimeter capabilities at the East Fishkill fab.

Accounts receivable was $684 million resulting in DSO of 42 days. Inventory increased $44 million sequentially to $1.3 billion and days of inventory increased three days to 123 days. Distribution weeks of inventory decreased $113 million to 8.4 weeks from 11 weeks in Q4 and currently is significantly below our target of 11 to 13 weeks. As I mentioned earlier, we proactively reduced the distribution inventory to hold more inventory on our balance sheet to support our customer needs rather than building inventory in the supply chain. Total debt was $3.34 billion and we paid down $154 million in the quarter.

So turning to guidance for the second quarter. A table detailing our GAAP and non-GAAP guidance is provided in our press release related to our first quarter results. Let me now provide you key elements of our non-GAAP guidance for the second quarter. As mentioned, demand remains strong driven by improving global macroeconomic environment and the steep recovery in our markets following the COVID-19 downturn.

Based on current booking trends and backlog levels, we anticipate that revenue will be in the range of $1.57 billion to $1.67 billion. We expect gross margins between 35.8% and 37.8%. This includes share-based compensation of $3.5 million. We expect total non-GAAP operating expenses of $323 million to $337 million in the second quarter. This includes share-based compensation of approximately $20 million.

Capital expenditure is expected to be $110 million to $120 million for the quarter. We anticipate our non-GAAP OIE including interest expense to be $28 million to $30 million. Our non-GAAP diluted share count for the second quarter of 2021 is expected to be 435 million shares. So this results in non-GAAP earnings per share in the range of $0.44 to $0.54.

So to wrap up, I'm optimistic about the opportunities ahead of us, and I'm happy with the execution of our teams across the globe as we embark on our transformation journey. I look forward to seeing you all in August for our Analyst Day in New York.

With that, I'll now turn the call back over to Denise to open up for Q&A.

Questions and Answers:

Operator

Thank you. [Operator Instructions] Your first question comes from Ross Seymore with Deutsche Bank. Your line is open.

Ross Seymore -- Deutsche Bank Research -- Analyst

Hi, guys. Thanks for letting me ask question. Congrats on the strong results and guide. I guess, the first question I had is on the supply side. Obviously, demand is strong across the board, but on the supply side, Hassane, I wondered if there is any impact limiting your revenues from supply limitations either internally or elsewhere in the supply chain? And probably more importantly, any impact of your product rationalization efforts on your total revenues? And then just how that process is going currently?

Hassane El-Khoury -- President, Chief Executive Officer and Director

Yes. Thanks, Ross. So look, the obvious answer is yes. It's impacting our ability to ship to the demand that we have. So revenue could have been higher if we did not have any constraint in a perfect world. However, we are where we are as an industry, but that's not really impacting what we are doing moving forward on the portfolio rationalization task, to your second question, because it's actually helping us. We kind of know already based on the strategic reviews that we've done where we're going to be landing, and we're putting priority on these products especially when it comes to internal utilization. Like Thad mentioned, we have good utilization this quarter, now it's really maintaining to optimization and running the growth and high the margin products within our fabs, and that fits very well with the rationalization, creating more capacity for the products that we want to maintain.

Ross Seymore -- Deutsche Bank Research -- Analyst

That's a perfect segue to my follow-up question, Hassane or Thad, either one of you guys. The utilization, I think, Thad, you said is that 85% already. It's good to see that back to normal levels. Can you talk about some of the drivers of gross margin going forward? The product optimization you just mentioned, Hassane, is an obvious one, but I assume that's going to take a little bit of time to bear fruit. So is second quarter gross margin showing a nice pop? Is that simply the utilization rising again? And kind of what are the steps to get that gross margin from the 36.5% to 37% up to your target range with the four handle?

Hassane El-Khoury -- President, Chief Executive Officer and Director

Yeah. Look, we have launched a gross margin initiative corporatewide. So there is not a single path that caused the margin in Q2 that we guided to. It's really across the board. Of course, some of it is utilization, but we have a laser focus on cost optimization within the supply chain. We have been talking strategically with our customers about some of the cost increases that we have seen, how we passed some of those on.

There is operational efficiencies that we have been doing. We've seen some of that start in the first quarter. And that's why I called it the favorable and sustainable moving forward. That's kind of where you're going to see us clicking up. Utilization will get better over time. But more importantly, where the lift for gross margin is going to be is what I mentioned in the prior answer, as we start shifting more of our internal capacity to higher gross margin products and offload, call it, the legacy or to harvest product lines, that's going to create a mix shift to the higher gross margin. That will come of course with better utilization.

Ross Seymore -- Deutsche Bank Research -- Analyst

Great. Thanks guys.

Operator

Your next question comes from Chris Danely with Citi. Your line is open.

Christopher Danely -- Citi -- Analyst

Hey, thanks, guys. And I'll add my congrats on the strong quarter and outlook. So would you say that the shortages are getting better in Q2 or getting a little worse? And then how do you expect this easing of demand you talked about in the second half of the year? Could we have like a sub-seasonal quarter? Do you expect to go from above seasonal back to normal seasonal?

Hassane El-Khoury -- President, Chief Executive Officer and Director

Yeah. So look, the expectation is really what we are talking with our customers and how, I would call it, the velocity of how fast the demand is coming. I talked last call that the problem has not been really on the capacity per se, it has been on how quickly that demand came and layered on a very strong quarter. So that's the velocity. So when I talk about demand and supply and demand subsiding in the second half of the year or toward the end of the year, I'm not talking about really demand going, call it, weaker or backwards. I'm talking about the momentum, but it will remain at a very healthy and not -- and better than seasonal outlook. So that's where we see the demand. But the balancing of us being able to catch up to the demand is going to happen, I would say, toward the second half of the year.

Thad Trent -- Executive Vice President and Chief Financial Officer

Yeah, Chris, this is Thad. I would just add. If you take the midpoint of our guidance for Q2, that's a record for the company. It's up 9% sequentially. As you look into Q3, I think coming off that high mark, we will be sub-seasonal in Q3 and then probably return to seasonal in Q4.

Christopher Danely -- Citi -- Analyst

Okay. Thanks guys. That's helpful. And then for my follow-up, I guess, between your own input costs and raw material going up, and then any chance for I guess firmer pricing on your products? How do you expect the total impact of that to be toward margins? Do you think it kind of negates everything out or do you think that that could be a little bit of lift to the margins as far as like your own pricing goes versus the input costs?

Hassane El-Khoury -- President, Chief Executive Officer and Director

Pricing is a small portion of our gross margin trajectory, because obviously, right now we are in a favorable environment. But what we are looking for is those sustainable pricing structures and sustainable cost structures that will remain favorable in the up or down. And that's -- you always hear me talk about structural gross margin improvement, that's how we're going to get there.

So to answer your question more directly, there is not a one size fits all. It's not a one-to-one. It's really talking to our strategic customers in order to reset; one is the cost basis, but more importantly, in some cases,

Duration: 71 minutes

Call participants:

Parag Agarwal -- Vice President-Investor Relations & Corporate Development

Hassane El-Khoury -- President, Chief Executive Officer and Director

Thad Trent -- Executive Vice President and Chief Financial Officer

Ross Seymore -- Deutsche Bank Research -- Analyst

Christopher Danely -- Citi -- Analyst

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