ON Semiconductor Corp (ON) — Q4 2019 Earnings Call Transcript

Thank you, Sydney. Good morning and thank you for joining ON Semiconductor Corporation's Fourth Quarter 2019 Quarterly Results 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 www.onsemi.com. A replay of this broadcast, along with our 2019 fourth quarter earnings release, will be available on our website approximately one hour following this conference call, and the recorded broadcast will be available for approximately 30 days following this conference call. The script for today's call and additional information related to our end markets, business segments, geographies, channels, share count, and 2020 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 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 the 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-Ks, Form 10-Qs, and other filings with the Securities and Exchange Commission. Additional factors are described in our earnings release for the fourth quarter of 2019. 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 factors, except as required by law. On August 18, 2020, we will host an event for the investment community in New York City to provide a strategic update on our business. At this event, we will update the investment community on our business, strategy, and markets. In addition, we will provide information on our manufacturing consolidation plans and economics of our 300mm manufacturing strategy. We will send invitations for the event shortly. Now, let me turn it over to Bernard Gutmann, who will provide an overview of our fourth quarter 2019 results. Bernard?

Thank you Parag, and thank you everyone for joining us today. Following stabilization in the third quarter, we have seen improving business trends in the fourth quarter. Order trends continued to improve throughout the quarter. We believe that in addition to normalization of the supply chain, improving demand across most end-markets is driving improved order rates. Based on our order rates and conversations with customers, we believe that the pace of recovery is moderate rather than a sharp upturn in demand. Macroeconomic data from most major economies is increasingly favorable, and industrial activity is showing signs of modest improvement. At the same time, we are cognizant of the potential risks arising from the emerging coronavirus crisis, and we are diligently monitoring this rapidly evolving situation. Our traction in our key strategic markets continues to accelerate, and our design-win pipeline continues to grow at a rapid pace. Our content in the fastest growing segments of automotive, industrial, and cloud-power markets continues to increase. Our customers are adopting our solutions for automotive, industrial, and cloud-power markets at an accelerated rate. We believe that a highly diversified customer base, growing content in the fastest growing applications in the semiconductor market, and long life cycle of many of our products should enable us to continue to outperform most of our peers. To accelerate our progress towards our gross margin target, we have begun to make structural changes to our manufacturing footprint. This morning, we announced that we are exploring the sale of our six-inch fab in Belgium. We will provide updates on the financial impact of these actions as we firm up our production transition plans. Keith will further expand on our plans for the Belgium fab later during this call. Along with making structural changes to improve our gross margin, we are streamlining our investments in various markets. Towards this end, we took limited restructuring actions in the first quarter to reduce our operating expenses by approximately $25 million per year. We should begin to see nominal impact of this action in the second quarter of 2020, and full impact should be apparent by the fourth quarter of 2020. Now, let me provide you additional details on our fourth quarter 2019 results. Total revenue for the fourth quarter of 2019 was $1.402 million, a decrease of 7% as compared to revenue of $1.503 million in the fourth quarter of 2018. The year-over-year decline in revenue was primarily driven by well-publicized macroeconomic and geopolitical factors, which have affected the overall semiconductor industry. GAAP net income for the fourth quarter was $0.14 per diluted share as compared to a net income of $0.39 in the fourth quarter of 2018. Non-GAAP net income for the fourth quarter of 2019 was $0.30 per diluted share as compared to $0.53 in the fourth quarter of 2018. GAAP and non-GAAP gross margin for the fourth quarter of 2019 was 34.6% as compared to 37.9% in the fourth quarter of 2018. Fourth quarter gross margin was lower than our expectation due to the combination of certain transitory mix and operational issues. We had an unexpectedly high demand for a low-margin product line in our consumer segment during the fourth quarter. We expect this strong demand to continue in the first quarter as well. We intend to either discontinue this product line or significantly raise prices after the first quarter. On the operations front, we had certain facilities-related and scrap issues. We expect these issues will be resolved by the end of the first quarter of 2020. In the near term, we expect to see headwinds from fixed costs to our gross margins. As you are aware, we expanded our manufacturing capacity in 2018 and 2019. However, revenue has lagged our expectations due to well-understood macroeconomic and geopolitical factors. Therefore, with the addition of manufacturing capacity and lack of revenue growth, we are now facing underutilization charges and higher depreciation expenses. With expected revenue growth in 2020, we should be able to offset the impact from underutilization and depreciation. We expect higher than 50% incremental gross margin for 2020 starting in the second quarter of the year. Our GAAP operating margin for the fourth quarter of 2019 was 9.9%, as compared to 14.8% in the fourth quarter of 2018. Our non-GAAP operating margin for the fourth quarter of 2019 was 12.3% as compared to 16.8% in the fourth quarter of 2018. The year-over-year decline in operating margin was largely driven by lower gross margin. GAAP operating expenses in the fourth quarter were $347 million, flat as compared to those for the fourth quarter of 2018. Non-GAAP operating expenses for the fourth quarter were $314 million, as compared to $317 million for the fourth quarter of 2018. Recall that our 2019 operating expenses included more than two quarters of expenses from our acquisition of Quantenna Communications. The year-over-year decline in fourth quarter operating expenses was driven by aggressive expense control and zero bonus accrual. Fourth quarter free cash flow was negative $21 million and operating free cash flow was $92 million. The fourth quarter free cash flow and operating free cash flow were negatively impacted by one-time payment of approximately $175 million to Power Integrations for previously disclosed settlement of intellectual property litigation. Capital expenditures during the fourth quarter were $112 million, which equates to a capital intensity of 8%. Going forward, we anticipate that a sizeable part of our CapEx will be spent on enabling our 300mm East Fishkill fab. We exited the fourth quarter of 2019 with cash and cash equivalents of $894 million as compared to $929 million at the end of the third quarter of 2019. At the end of the fourth quarter, days of inventory on hand were 123 days, down by five days as compared to 128 days in the third quarter of 2019. Distribution inventory increased slightly but is within our comfort zone. The increase was driven by specific customer programs. Now, let me provide you an update on the performance of our business units, starting with the Power Solutions Group, or PSG. Revenue for PSG for the fourth quarter was $696 million. Revenue for Advanced Solutions Group, previously known as Analog Solutions Group, for the fourth quarter was $507 million, and revenue for the Intelligent Sensing Group was $199 million. Now, I would like to turn the call over to Keith Jackson for additional comments on the business environment.

Thanks, Bernard. I will start by reviewing our progress in 2019, and then touch on our objectives for 2020. Despite the macroeconomic and geopolitical challenges faced by the semiconductor industry in 2019, our execution was solid, and we expect to outperform most of our peers in the analog and power semiconductor group. Our performance in 2019 clearly demonstrates the transforming nature of our business, the strength of our business model, and execution discipline. Our exposure to secular megatrends in automotive, industrial, and cloud-power end-markets has enabled us to outgrow most of our peers. Despite macroeconomic and geopolitical headwinds, key secular megatrends driving our business remain intact. Our content in the fastest growing applications in automotive, industrial, and cloud-power applications continues to grow, and we continue to strengthen our leadership in key markets such as Advanced Driver Assistance Systems (ADAS), power management for servers and 5G infrastructure, and high-power solutions for electric vehicles. We announced our plan to acquire our first 300mm fab, and we expect to start production of our power products at this facility soon. Also in 2019, we closed our acquisition of Quantenna Communications, and we are making solid progress toward launching connectivity solutions for Industrial IoT applications. While we are pleased with our performance in 2019, we understand the need to take aggressive, substantial, and immediate measures to accelerate our progress towards our margin targets. As Bernard indicated earlier, we announced this morning that we are exploring the sale of our six-inch fab in Belgium. We are looking for partners that are willing to enter into an arrangement on mutually beneficial terms that enable smooth and orderly transition for both parties. Our fab in Belgium is an attractive manufacturing asset with a robust tool-set and highly skilled workforce. It is automotive qualified, and its close proximity to the world's leading automotive innovation and manufacturing hub is a very compelling attribute. We believe that our 300mm East Fishkill fab affords us significant flexibility in optimizing our front-end footprint, and we will continue to work to improve the efficiency of our manufacturing network. Recall that in our third quarter 2019 earnings conference call, we announced that we had initiated the process of closing down our six-inch fab in Rochester, New York. We are making strong progress towards ramping production at our 300mm fab in East Fishkill. At this point, we are tracking significantly ahead of schedule, and now we expect to begin initial production in the middle of 2020, as compared to our previous expectation to begin in the latter half of 2020. The results and yields of initial wafer runs have been spectacular. Based on our experience thus far with the East Fishkill fab, we are even more confident that transition of production to this fab will be a major inflection point for our manufacturing cost structure as we consolidate our front-end network. We will provide further details on the financial impact of our 300mm fab transition at our Strategic Business Update on August 18th in New York. In addition to making structural changes to our operational cost structure, we have taken measures to optimize our operating expenses. As previously discussed, we took limited restructuring actions to streamline our investments in certain markets, and these actions are expected to result in annual savings of approximately $25 million. A reduction of approximately $25 million per year should accelerate our progress towards our target operating expense intensity of 21%. Let me now comment on the current business environment. We saw moderate improvement in our order rates in the fourth quarter, and improvement has continued thus far in the current quarter. We believe that this improvement is driven by improving macroeconomic and geopolitical conditions and normalization of supply chain inventories. Macroeconomic data from most geographies suggests improving GDP outlook and modest improvement in manufacturing activity. Data from China pointing towards relatively resilient manufacturing activity has been especially encouraging. Based on publicly available data and inputs from our partners, we believe that the current inventory levels are in line with our near term demand outlook. While we are encouraged by near term trends, we are fully aware of risks emerging from the ongoing coronavirus crisis, and we are diligently monitoring this rapidly evolving situation. Despite the gyrations in macroeconomic and geopolitical environment, we remain focused on our key strategic markets. At the same time, we are taking substantial measures to make structural changes to our manufacturing footprint with the goal of expanding our margins and further improving our industry-leading cost structure. We believe that automotive, industrial, and cloud-power will be the fastest growing semiconductor end-markets for the next five years. With a highly differentiated portfolio of power, analog, sensor, and connectivity products, we are well positioned to outgrow the semiconductor industry as we grow our content in the fastest growing applications in our strategic markets. Furthermore, with improving operational efficiency, we expect to meaningfully expand our margins and grow our free cash flow. Now I'll provide details of the progress in our various end-markets for the fourth quarter of 2019. Revenue for the automotive market in the fourth quarter was $462 million and represented 33% of our revenue in the fourth quarter. Fourth quarter automotive revenue declined 3% year-over-year. Although our automotive revenue declined year-over-year, we continue to see improving trends in the market with ongoing recovery in China. Our momentum in ADAS and vehicle electrification continues to accelerate. During the fourth quarter of 2019, we secured design wins for key platforms for ADAS and in-cabin viewing applications. Our design funnel for ADAS continues to expand at a robust pace. As we noted in our previous earnings call, we have won 16 of the 17 two-megapixel and eight-megapixel platforms awarded in 2019 for level-2 and level-3 vehicles. Our LiDAR and radar products are gaining strong traction, and our design funnel for these products continues to expand at a rapid pace. We believe that we are enabling democratization of LiDAR with a solid-state solution, which is a fraction of the cost of other existing solutions. Our low cost advantage is enabled by a CMOS-based architecture as opposed to that based on exotic materials. Based on our design win pipeline, we expect to have leading share with top five global LiDAR module makers. In addition, customer feedback on our radar solutions has been very positive, and we have emerged as a key contender for the upcoming round of design wins. Based on our engagement with leading radar Tier 1 integrators, we expect to gain a very meaningful share in this market as the next round of designs are announced. On vehicle electrification front, our engagement for Silicon Carbide modules with major global automakers continues to grow. We are seeing strong ramp of our IGBT modules for the drivetrain of electric vehicles in Asia and in Europe, and based on our design wins and backlog, we expect continuing acceleration in this ramp during 2020 and beyond. We are beginning to see ramp in analog power management for ADAS processors. We are engaged with all leading processor providers for the automotive ecosystem, and expect strong revenue contribution from this product line. We expect to see strong growth in our analog power management solutions for instrument clusters, in-vehicle networking, and advanced lighting. Revenue in the first quarter of 2020 for the automotive end-market is expected to be up quarter-over-quarter. The Industrial end-market, which includes military, aerospace, and medical, contributed revenue of $344 million in the fourth quarter. The Industrial end-market represented 25% of our revenue in the fourth quarter. Year-over-year, our fourth quarter industrial revenue declined 12%. While macroeconomic data points to moderately improving manufacturing activity, we haven't seen significant improvement in order activity from our industrial customers. It appears that industrial customers are still in the process of realigning their inventories. Despite soft end-market conditions, key secular trends driving our business remain intact. We are seeing strong traction for our Silicon Carbide modules, and we have commenced shipments of these modules to leading global industrial OEMs. An emerging area of growth for our industrial business is e-commerce. We have built a strong design win pipeline for our CMOS image sensors for warehouse automation and delivery robots. We are engaged with the leading e-commerce retailers on many programs, and we expect strong contributions from this segment of the industrial market. Revenue in the first quarter of 2020 for the industrial end-market is expected to be flat to down slightly quarter-over-quarter. The Communications end-market, which includes both networking and wireless, contributed revenue of $289 million in the fourth quarter. The communications end-market represented 21% of our revenue in the fourth quarter. Fourth quarter communications revenue declined 3% year-over-year. The decline was primarily due to weakness in our smartphone-related business. On a quarter-over-quarter basis, we saw strong growth in our smartphone business in the fourth quarter, but 5G-related business was weak as customers continued to realign their inventories. Revenue in the first quarter of 2020 for the communications end-market is expected to be down quarter-over-quarter. The Computing end-market contributed revenue of $153 million in the fourth quarter. The computing end-market represented 11% of our revenue in the fourth quarter. Fourth quarter computing revenue declined 8% year-over-year. We continue to see strong momentum in our server-related computing business. On a sequential basis, we saw growth in our client computing business driven by improved supply of Intel processors. Revenue in the first quarter of 2020 for the computing end-market is expected to be down slightly quarter-over-quarter. We expect that strength in our server business should help mitigate the impact of normal seasonality. The Consumer end-market contributed revenue of $153 million in the fourth quarter. The consumer end-market represented 11% of our revenue in the fourth quarter. Fourth quarter consumer revenue declined by 10% year-over-year. The year-over-year decline was due to continuing broad-based weakness in consumer electronics. On a quarter-over-quarter basis, revenue for the consumer end-market was flat as compared to our expectation of a decline due to previously discussed unexpected demand for a low-margin product line. Revenue in the first quarter of 2020 for the consumer end-market is expected to be down quarter-over-quarter. In summary, we are taking substantial actions to make structural changes to our cost model with the goal of accelerating our progress towards our target financial model. At the same time, we have accelerated the timeline for production ramp at our 300mm fab, as we now anticipate that initial production will start in the middle of 2020, as opposed to our prior expectation of the second half of the year. Secular megatrends driving our business remain intact, and we are upbeat about our medium to long-term prospects. We are focused on the fastest growing end-markets of the semiconductor industry, and with our design wins, we expect that our content in automotive, industrial, and cloud-power applications will continue to grow. Our performance in 2019 clearly demonstrates the transforming nature of our business, the strength of our business model, and execution discipline. Now, I would like to turn it back over to Bernard for forward-looking guidance.

Thank you, Keith. Our guidance for the first quarter of 2020 does not include the impact from potential supply chain disruption resulting from prevailing coronavirus crises. As we indicated earlier, we are diligently monitoring the situation, but at this time, we don't have enough information on potential impact on our business from this rapidly evolving crisis. Based on product booking trends, backlog levels, and estimated turn levels, we anticipate that total ON Semiconductor revenue is expected to be in range of $1,355 million to $1,405 million in the first quarter of 2020. For the first quarter of 2020, we expect GAAP and non-GAAP gross margin between 33.7% to 34.7%. The quarter-over-quarter decline in first quarter gross margin is driven primarily by annual contract pricing reset. We expect total GAAP operating expenses of $357 million to $377 million. Our GAAP operating expenses include amortization of intangibles, restructuring, asset impairments, and other charges, which are expected to be $30 million to $34 million. We expect total non-GAAP operating expenses of $327 million to $343 million in the first quarter. The anticipated quarter-over-quarter increase in GAAP and non-GAAP operating expenses is primarily driven by acceleration of process transfer activity at our 300mm fab, resumption of variable compensation accrual for 2020, and the end of tactical expense control measures in the fourth quarter of 2019. We anticipate the first quarter of 2020 GAAP net other income and expense, including interest expense, will be $38 million to $41 million, which includes non-cash interest expense of $9 million to $10 million. We anticipate our non-GAAP net other income and expense, including interest expense, will be $29 million to $31 million. Net cash paid for income taxes in the first quarter of 2020 is expected to be $14 million to $18 million. We expect total capital expenditures of $125 million to $145 million in the first quarter of 2020. We are currently targeting an overwhelming proportion of our CapEx for enabling our 300mm fab at an accelerated pace. We expect our CapEx intensity to subside in the latter half of the current year. We also expect share-based compensation of $19 million to $21 million in the first quarter of 2020, of which approximately $2 million is expected to be in cost of goods sold, and the remaining amount is expected to be in operating expenses. This expense is included in our non-GAAP financial measures. Our GAAP diluted share count for the first quarter of 2020 is expected to be 418 million shares and our non-GAAP diluted share count is expected to be 413 million shares, based on our current stock price. Further details on share count and earnings per share calculations are provided regularly in our quarterly and annual reports on Form 10-Q and Form 10-K, respectively. With that, I would like to start the Q&A session. Thank you, and Sydney, please open the line for questions.

Hi, guys. Thanks for letting me ask my question. It's good to see the revenue side turning the corner, and I think that's an important step, but the gross margin side is a big concern for a lot of investors. So, Bernard or Keith, talk a little bit about the greater than 50% incremental fall through going forward, any sort of scale on that? Revenues look like they should be up second quarter year-over-year. Will gross margins take a big step up, and when will some of these fixes really start to be shown on the gross margin side as you work your way towards that four handle target that you have?

Thank you, Ross. We anticipate a greater than 50% fall-through as revenue returns to normal seasonal patterns in the second quarter, as we discussed during the call. We also have some transitional issues affecting our mix and factory operations that we expect to resolve by the end of the first quarter, which should enable us to achieve better than 50% fall-through in the second quarter. Additionally, I want to highlight that we expect to see an improvement of approximately 30 to 40 basis points starting in the second quarter due to the discontinuation of the low-margin OSA contract. As we mentioned, we are considering selling our six-inch facility in Belgium, which will also contribute positively to our gross margin. We remain confident in our long-term growth drivers in automotive, industrial, and 5G sectors. We expect to see a strong rebound in our growth, and we feel encouraged by the progress of the qualification at the 300 millimeter fab, which will also support us moving into 2020 and 2021.

Thanks for the information. As a follow-up regarding operating expenses and margin targets, it seems you're tightening things up, and while some variable costs may return, it appears to be a significant increase. How should we consider the $25 million in cuts? Even with these reductions, it looks like your expenses will be higher than we anticipated, so any insights on the trajectory and when you might reach the 21% operating expense intensity target would be appreciated.

Well, we have that laid out for 2022. We are still absorbing the Quantenna OpEx, which is higher than what we had been running, so that has been the reason for being higher. Definitely taking out 25 million should help us get closer by the end of 2020, but we should be looking at 2021 before we can get to that 21% level.

Thanks, guys. Just a couple more questions on gross margins. So, how big was the impact of the low margin product that kind of ballooned up, and then how big was the facilities and scrap issues impact, and then what exactly were the facilities and scrap issues that you had?

We're not going into many details, but I can confirm that the mix between underutilization/depreciation and one-off items is approximately equal.

Okay, great. Regarding the sale of the Belgian fab, there are a lot of technical difficulties associated with any operations in Belgium. Is there a way to work around those issues or what is the plan for addressing the costs related to that fab?

Yes. So, Chris, we're looking at a similar arrangement that we've made both in Gresham and East Fishkill where we find an interested party, who will be renting the facility as we exit it, and so that's a sales situation you don't encounter any kind of exit costs that you're referring to.

Got it. Okay. Thanks, guys.

Thanks for taking my question. I had a few on margins as well. First, at what revenue level do you expect to get back to your historical 36%, 37% gross margins, and do you think getting to those kinds of gross margins is possible in Q2 or Q3 of this year?

Again, if you take the 50% fall through or better than 50% fall through, we should be able to get back to those levels in the rest of the year for 2020.

Got it, and for my follow-up, I think you mentioned some contract price reset in Q1, I'm curious how were those negotiations this year relative to prior years because there does appear to be somewhat of a gross margin hit, and I think one of the challenges we're facing is to try and discern how much the Q1 gross margin is because of that contract pricing versus underutilization trends. So, if you could quantify how much of this Q1 gross margin, roughly 200 basis points or so below trend; how much of that is because of pricing versus how much due to the underutilization trends? Thank you.

So, as you know, we have a good amount of our annual contracts for OEM that are reset once per year, so we see as a result of that once per year bigger impact. Our characterization is that the contract pricing has been pretty normal as compared to historical trends.

And any impact from underutilization? Is there a way to quantify that, and when will that disappear?

We definitely need revenue increases to help us absorb that underutilization. So, if we have normal seasonal patterns, we should see some goodwill recovery in the second quarter and beyond.

Hi, thank you. Good morning. Just to clarify one of the other comments that you made regarding the underutilization charges. Is what you're saying is that was one of the contributors to the gross margins being below what you had expected? I think you said it was about a half and a half. I just I guess I don't fully understand why underutilization charges will be more than expected if revenue came in with slight upside. Were there changes in production during the quarter, just some clarification please?

Yes, so a couple of comments there. One of them is we did also reduce inventories in the quarter, and the second thing, our mix of external versus internal overt more towards external, which hasn't helped us has caused the underutilization to be bigger, and that was based on the mix of products we had the demand for.

Okay, I guess a lot of us struggled with the go forward is kind of understanding gross margin issues that you saw that it was which was kind of short-term and transient gets better as the year goes persistent. As you said, the 50% plus incremental gross margins I think typically you said in the past, 50% is what you get just on increasing revenue and better fixed cost absorption. So, it is at some point during the year, some of these transition issues go away and we sort of see a step up in gross margins and then you get back to that 50% rate just some clarification around that?

Yes, we said that these transitionary items should last Q4 and Q1, and after Q1 for the most part disappear.

So, we should see some degree of step up as you go into Q2 therefore?

Okay. That's correct.

Yes, thank you. If we kind of look past the temporary impacts, the gross margins, and kind of look to some of the margin tailwinds that could occur in your business, can you discuss in terms of the impact of qualifying the 300 millimeter fab, how much kind of cost benefit increase in utilization rate you think you'll get as you start to transition more process flows to that 300 millimeter fab? And any color in terms of the sale of the six-inch facility in Belgium, what that will do in terms of COGS? What percentage of that manufacturing is of your internal manufacturing, just any color there in terms of trying to weigh the importance of that?

Yes, I'll give you kind of directionally the impacts that you're referring to, we'll give the specific models in August, when we're ready to do that. The 300-millimeter factory, as we mentioned is going to allow us to get some very cost effective products to the market. We expect to see some nice and quick ramp there. So back to Bernard's comment on more than 50% fall through, we think that's a strong contributor to that in the second half of the year. It also enables us to do more in-sourcing in the factory rationalizations, selling of the Belgium factory also will contribute to that. We're not going to give specific numbers at this time but all of those are factors that there's confidence in a much better than 50% fall through as you go through the year.

And just a follow-up on the margins again and you might have touched on this but how low is the gross margin percentage for those consumer products and any color what those products were?

We're not going to get into details by product line but definitely we're substantially below the corporate average.

Okay, thank you.

Hi guys, just following up gross margin again, I mean, you talked about lowering inventories through the quarter but also looks like year-on-year also, it was a headwind in terms of utilization, but just wondering in the past year given utilization numbers, if you had some thoughts on where utilizations were in Q4 that you expect in Q1 and how you expect that to progress?

So in general terms, we expect flattish utilization in Q1.

Got it, and on the industrial side, you mentioned, there's still some realignment of inventory going on. How do you, do you expect that alignment to be mostly done as you go through Q1, you expect industrial to kind of return to some sort of growth in the back half? Thanks.

We think so, we don't know for sure, but our expectation is by the second quarter and definitely by the back half of the year it should be done.

Hey, guys, thanks for the question. About the consumer product again, what was the dynamics for the product, was this a last time buy? Or you kind of expecting more after Q1 and the reason I ask is it ties into the bigger picture story for ON for the last decade, you guys have been talking about moving up the value stack with your products, and the gross margins would follow. This seems like it's a product that was probably not price optimized considering at volume. So I guess are there opportunities to review your entire product line to optimize pricing and eventually helped the margin structure, or even shutter some of these really low margin businesses? Thanks.

Yes, thank you. So really the story there, you've seen the weakness in industrial which is our highest margin business in the company. At the same time, we had unexpected strength in a consumer segment. It is a segment that we were controlling pretty tightly but we had some very strong demand for both Q4 and Q1 of 2020 deliveries. We have now taken the steps we need to dramatically change the profile there and expected to not continue past Q1 from a margin inhibitor. So we do expect if you get Q2 onwards, you'll see continued reduction in the consumer profile and increase in the industrial.

Okay, great. And on the distributor side of things, I think you said distributor inventories increased. I think the last day update we had was maybe 11 to 13 weeks there. Maybe if you could give us an update there and then also you talked about increases from specific customer programs. Maybe you could describe those programs and what are they related to some of the changes at TI for example?

So in general terms, when we said the inventories increased but we're still within our comfort zone, we like to operate at. I can't comment definitively on the customer programs, but they were differently linked, some of the increases were linked to those programs.

Thanks.

Thank you for taking my question. This is B. Riley FBR. Bernard, I would like to revisit the long-term outlook for gross margins. Based on the guidance for the March quarter, we have a target level with a 900 basis point gap. I would appreciate it if you could describe the path to achieving that target, how gradual the progress will be, how much of the gap we can expect to close in 2020 and 2021, and what key factors you have that could influence this outcome.

They align with what we discussed during our analyst day. Incremental revenue plays a significant role, and it was a challenge in 2019. We anticipate that it will improve with better macroeconomic conditions in the upcoming planning period. We expect to return to a healthy growth rate, which will support robust growth. The structural changes we're implementing in manufacturing, along with the ramp-up of the 300-millimeter fabs, should help us achieve savings of 130 basis points or more in manufacturing costs. Additionally, the growth drivers in high-margin markets are expected to contribute gradually over time. Although we've faced a temporary setback due to a one-off consumer situation, we believe the mix will continue to be an important factor in the long term. We will also keep managing our portfolio, which has allowed us to divest certain businesses, aiding our financial position. The factors we've discussed will contribute to significant revenue growth, and it will be crucial for us to execute our manufacturing cost savings and leverage the 300-millimeter fab along with the mix.

But just to clarify that, the drivers are the same, but the gap is much more significant than it was when the target was first established. So which of those variables do you think you can get incremental leverage on, so that we can close that gap and make it to 43%?

I think there was a good chance that we can do more on the manufacturing front. We have a good amount of tools that we can do in flexibility with the new capacity we have four-millimeter but definitely we need the revenue and the target model was predicated on the 5% CAGR, and we started the 2019 with a negative, so that definitely puts a little bit of pressure on in terms of getting it done in the timing that we need.

Yes, I'll cover both automotive and industry. The automotive piece I think there is a feeling that we may see a return to more positive there. I think a lot of the dynamics is going to be accelerating more of the vehicle electrification at faster rates than we've seen in the past, which has a very large increase in our content, which gets us pretty excited about seeing a lot of good growth in automotive as we go through 2020, the industrial side has been weak and it is generally the portion of the business that reflects kind of the GDP side of the equation. We do see that bottoming out, we're starting to see order patterns pickup and like all of the sectors, the inventory piece appears to be getting back in control. So I would expect to see the industrial side start picking up again in the second floor.

Great. Thanks, Keith.

Hi, thanks for taking my questions. Just going back to the strong demand for the lower gross margin products, so that the options, it sounds like, it either discontinue or increase the ASPs. I just wanted to explore that. So in the process, if the decision is made a discontinuous is that because the lower gross margin products also are lower operating margin products also, is it total lower profitability and you just want to get out of that business? Would that be the rationale and if he decided to discontinue, would that hit your utilization rates and then cause a continued challenge for fixed costs absorption or these outsource products? That's the first question. Thanks.

Yes, the answer is yes. This concerns both gross margin and operating margin. Raising prices definitely helps significantly, and it is outsourced.

Okay, I understand. That makes sense. You mentioned resilient manufacturing activity in China. Is this related to our specific markets there? Do you have any insights on whether this is driven by restocking further downstream or if it's genuine end market consumption? Thanks, that's all I had.

Yes, no. This is broad-based in China. And I think it's reflecting the inventories being back in line and still seeing economic growth in China. So I think it's just basically removing some of the headwinds there. And it's a pretty broad-based.

Good morning. Thanks for taking my question. On the improving business trends, can you just discuss them by geography. Last quarter, I think you guys saw some improvements in auto and China continued weakness in EMA stabilization in U.S. Did you guys see the demand profile by geo start to flatten out in Q4 and here in Q1?

So, not a lot of change, some incremental weakness in Europe incremental strength in China, in the U.S. and the rest of the world pretty much on par with what we saw in early Q3 and Q4.

Great. Thanks for that. And Bernard, on the higher OpEx space starting the year, combined with the restructuring options announced today. How should we think about the progression of OpEx as the year unfolds?

Yes. So I would expect OpEx to be definitely not higher than Q1 and flat turning towards slightly down.

Hi, can you hear me guys?

Yes.

Yes.

Yes, I apologize for that. I wanted to return to gross margin, and I'm uncertain if I fully understood the previous response regarding the quantification of the three different factors. How much has underutilization contributed, and will the underutilization charges disappear as we move into Q3, or will there still be lingering charges in Q3 as well?

So what we characterized this as we said about half of the issues were underutilization/depreciation and half were transitionary one-off items. There is a small lag in terms of the impact of underutilization impacts the quarter, and obviously it will depend on how strong seasonally the second quarter is in terms of the rebound revenue, which will dictate how much utilizations will be.

Okay, thank you for the clarification.

Yes. Good morning, guys. Thanks for letting me ask the question. Just wanted to follow up to the extent that you end up getting out of some businesses in the consumer sector going into the second quarter, for modeling purposes, is there any way to try to quantify what the impact might be to revenue going into the June quarter maybe relative to seasonal?

We're still expecting seasonal or better behavior as we go through this year. As I mentioned, we think we're through the inventory correction phase and so you should be seeing in a relatively stable economic environment, you should be seeing a better performance this year without those headwinds, and so, we're really not attributing a significant lessening of that with the consumer business.

That's helpful, and the guys probably shouldn't be that important because it doesn't impact free cash flow. But Bernard, I'm just kind of curious, as you march towards that 40 plus percent target for gross margins. How do we think about depreciation from the December quarter levels? What does CapEx look like especially as you start to really facilitate and build out East Fishkill?

So basically, when we said from the CapEx point of view, we guided for 125 to 145 for a very short-term for the first quarter, and said that a good portion of that CapEx is devoted towards the 300 mm fab, and then we expect that to taper off throughout the year and go to a lower level in 2021. At this stage, I would expect CapEx and depreciation to converge in the pretty much aligned. So I don't expect any significant amount of increased depreciation on our P&L as we normalize the CapEx.

Thank you.

Hi, good morning, and thank you for letting me ask a few questions. Keith, does your commentary on returning to normal seasonality also apply to the 5G infrastructure segment?

Yes, so I think again the comments are similar, I think inventory absorption pieces on track to be behind us here in Q1. So, I would expect that also look much more seasonal, however secularly it's going to grow. And so you can see basically no headwinds to that growth as you get through this year.

As a follow-up, Bernard, I understand that while the cash tax hasn't changed significantly in dollar terms from the fourth quarter, it has increased on a percentage basis. Are there any dynamics in the March quarter related to this, or how does it trend on a percentage or dollar basis after the March quarter?

Cash capital expenditures tend to be inconsistent, and for the first quarter, they are expected to range between $14 million and $18 million. We anticipate that for the entire year, this will account for 10% or less of the profit, but it will still have that lumpy characteristic. Thank you.

Thank you.

Hey, thanks everyone. I wanted to follow up on the consumer gross margin issue. Has Chinese competition played a role in the gross margin issue, either from a specific source or from other competitors?

No, not at all, this was just a business that we thought was going to decline, and then there was a surprise upside. So, that had nothing to do with any new competitive dynamics.

Yes, thanks. Keep your thoughts on the end markets for 2020. It sounds like you said kind of autos, high single-digit growth, could kind of lead industrial near-term is lagging a bit, but just, as you see over the course of the year kind of puts and takes up by end markets?

On the industrial side, we believe it is currently lagging, mainly in areas related to new factory and residential building constructions, which has been a drag. However, the medical segment within this area has been performing well and growing significantly. We anticipate that this positive trend will continue. We see two main changes on the industrial side; first, the energy infrastructure is becoming increasingly favorable, with more solar and wind installations expected to grow throughout this year. Secondly, regarding the building sector, we hope to have resolved the inventory issues by the first quarter, leading to a return to normal seasonal patterns thereafter.

Got it, thanks.

Thank you everyone for joining the call today. We hope to see you at various conferences during the quarter. Goodbye.