安森美 (ON) 2004 Q3 法說會逐字稿

Good day, ladies and gentlemen, and welcome to the ON Semiconductor third quarter earnings release conference call.

At this time all participants are on a listen-only mode.

Later we will conduct a question-and-answer session, and instructions will follow at that time.

If anyone should require assistance during the conference, please press start then zero on your touchtone telephone.

As a reminder, this conference call is being recorded.

I would now like to introduce your host for today's conference, Mr. Ken Rizvi, Director of Investor Relations.

Sir, you may begin.

Thank you, Matt.

Good afternoon and thank you for joining ON Semiconductor's third quarter 2004 conference call.

I am joined today by Keith Jackson, our CEO, and Donald Colvin, our CFO.

This call is being webcast on the Investor Relations section of our website at www.onsemi.com and will be available on our website for approximately 30 days, along with our earnings release for the third quarter of 2004.

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 on our website in the Investor Relations section under the heading, "Annual Reports and Financial Releases."

Now I'd like to highlight our upcoming event calendar.

During the fourth quarter, we will present at the Lehman Brothers Small Cap Conference on November 19th; the CSFB Technology Conference on December 2nd; the Raymond James IT Supply Chain Conference December 8th; and the Lehman Brothers T-4 Conference on December 9th.

During the course of this conference call, we will make projections or other forward-looking statements regarding future events for the future financial performance of the company.

The words "estimate," "intend," "expect," "plan," or similar expressions are intended to identify forward-looking statements.

We wish to caution that such statements are subject to risks and uncertainties that could cause actual events or results to differ materially.

Important factors relating to our business including factors that could cause actual results to differ from our forward-looking statements are described in our Form 10-K and other filings with the SEC.

The company assumes no obligation to update forward-looking statements to reflect actual results or change assumptions or other factors.

Now let's here from Donald Colvin, our CFO, who will provide an overview of the third quarter.

Thank you, Ken, and thanks to everyone who is joining us today.

ON Semiconductor Corporation today announced that total revenues in the third quarter of 2004 were $318.4 million, a decrease of 5 percent from the second quarter of 2004.

During the third quarter of 2004, the company reported a net income of $15.7 million, or approximately 4 cents per share, which included a loss on debt prepayment of $3 million or approximately 1 cent per share.

During the second quarter of 2004, the company reported a net loss of $3.5 million, or 2 cents per share that included the restructuring, asset impairment, and other charges of $0.9 million and a loss on debt prepayment of $27.4 million, or approximately 11 cents per share.

On a mix-adjusted basis, average selling prices in the third quarter of 2004 were up approximately 1 percent from the second quarter of 2004.

The company's gross margin was 32.3 percent, a decrease of approximately 140 basis points compared to the second quarter of 2004 due to a combination of more unit volume and more manufacturing capacity utilization.

EBITDA for the third quarter of 2004 was $64.2 million and included a $3 million loss on debt prepayment.

EBITDA for the second quarter of 2004 was $46.1 million and included the net loss of $28.3 million from debt prepayment, restructuring, asset impairment, and other charges.

A full reconciliation of this non-GAAP financial measure to the company's net income or loss and net cash provided by operating activities prepared in accordance with U.S.

GAAP is included on our website and in our earnings release and our related Form 8-K filed with the SEC today.

During the third quarter, cash and cash equivalents decreased by $25.9 million from the end of the second quarter of 2004 to $231.8 million.

Cash decreased primarily due to the redemption of the remainder of the 2009 senior subordinated notes, which had a cash cost in the quarter of approximately $38 million.

At the end of the third quarter day sales outstanding decreased from 43 days to 44 days at the end of the second quarter, and inventory increased by only $8 million to 87 days on a cost basis despite our more muted level of sales than originally anticipated.

We have taken strong actions during the quarter to mitigate any significant inventory increases.

Capital expenditures during the third quarter were $16 million compared with $18 million in the second quarter.

Distributor weeks of inventories at the end of the quarter were approximately 13 weeks in line with our model.

Now I would like to turn it over to Keith Jackson for additional comments on the business environment -- Keith.

Thanks, Don.

Coming into the third quarter, we anticipated the computing, wireless, and consumer markets to be the main drivers of growth for the quarter.

A breakdown of our third quarter revenues of $318.4 million by end market show that two of these three markets improved over the second quarter on a dollars and percent basis.

Computing increased from 23 percent to 25 percent of sales, and wireless increased from 15 percent to 17 percent of sales in the third quarter.

Consumer increased from 18 percent to 19 percent of sales but declined sequentially on a dollar basis.

The growth of these three end markets was less than anticipated due to a combination of a correction of inventories throughout the supply chain and a more muted level of overall demand.

Due to seasonality automotive decreased to 19 percent of sales from 20 percent in the second quarter, and industrial decreased from 17 percent of sales to 14 percent of sales primarily due to a slowdown of spending within the semiconductor capital equipment markets, and networking fell slightly as a percentage of sales to 6 percent from 7 percent in the second quarter.

During the quarter, sales to our largest OEM customer, Motorola, remained flat as a percent of sales at 8 percent and decreased slightly on a dollar basis to $25.2 million from $26.7 million in the second quarter of 2004.

Our top five customers, excluding distributors for the third quarter were Delphi, Flextronics, Intel, Motorola, and Siemens.

On a geographic basis, our contribution this quarter from sales in Asia excluding Japan increased by 300 basis points to 52 percent reflecting the increased strength we are seeing in our computing and wireless business.

Our sales in Europe and Japan decreased 100 basis points each to 16 percent and 5 percent of sales, respectively.

Sales in the Americas decreased by 100 basis points to 27 percent mainly due to seasonality in the automotive market.

Our channel breakout remains similar to previous quarter.

Looking across the channels, direct sales to OEMs remain flat at 41 percent of sales, distribution remained flat at 48 percent of sales, and the MS channel was flat at 11 percent of sales.

We estimate that approximately 10 percent of sales through the distribution channel was for third-party logistical services for the EMS channel.

Now I'd like to provide you with some details on the progress we have made in several markets.

In the computing space, we saw growth associated with back-to-school and holiday demand.

We continue to demonstrate strength in delivering power management solutions to meet the sophisticated requirements of today's microprocessors, DDR and DDR2 memory applications, and power supplies.

In the third quarter we successfully captured critical design wins with our analog PWM products in major graphics applications that will go into production in 2005.

We also experienced continued success in providing power MOSFET devices into major motherboard applications that are now in full production.

Additionally, we saw success in the third quarter with our new power factor control products for notebook adapters, an example of which is going into a line of 90-watt notebook power adapters.

In the wireless and portable space, we introduced a family of boost converters that simplify the circuit design for light LED applications.

We focused the development of these devices on the expanding array of high-resolution LCD applications in digital cameras, cell phones, and portable gaming platforms.

These devices provide an easy design solution for high-resolution color displays that characterize the evolving portable market.

We also introduced an advanced CMOS analog switch that is well suited for the car kit applications enabling hands-free use of portable phones through the audio systems of automobiles.

Continuing our legacy of earning supplier awards from our customers and awards for the innovation from industry publications, "Electronic Products China" magazine presented us with the Top 10 DCBC 2004 Award for one of our pulse with modulation controllers.

The PWM controller simplifies the design of power supplies for 48 low telecom applications.

This is our second successive Top 10 Product Award from "EPC."

To highlight our continuing success in the electronic service manufacturing space, Jabil presented us with its Best Semiconductor Supplier in Asia Award.

As I noted before, this kind of activity is our ongoing legacy, and we're very proud of it.

It was an honor to receive this award from Jabil, and we are hard at work trying to earn more awards like this.

Now I would like to turn it back over to Donald for updates on our forward-looking guidance.

Donald.

Thank you, Keith.

Outlook for the fourth quarter -- based upon booking trends, backlog levels, and estimated turns levels, we anticipate that total revenues will be flat to down 4 percent sequentially in the fourth quarter.

Backlog levels at the beginning of the fourth quarter of 2004 were down from backlog levels at the beginning of the third quarter of 2004 but represent greater than 90 percent of our anticipated fourth-quarter revenues.

We expect that average selling prices will be down slightly in the fourth quarter of 2004, and while gross margin is expected to decrease to approximately 31 percent, with these assumptions we expect to remain profitable.

For the 2004 calendar year, we still expect cash capital expenditures to remain at approximately $85 million to $90 million.

For the fourth quarter of 2004, we expect a total SG&A and R&D expenses to range between 19 and 20 percent.

With SG&A expenses ranging from 11 to 12 percent of sales, and R&D expenses ranging from 7 to 8 percent of sales.

Included in our overall fourth-quarter guidance, we have anticipated a charge of approximately $2 million associated with the termination of our legacy U.S.

Motorola pension plan.

The plan will be terminated in 2005, and this should be the last year in which we will have to take this type of charge.

We anticipate that net interest expense will be approximately $22 million for the fourth quarter.

We also expect common shares outstanding to be approximately 255 million shares and preferred shares may be convertible into approximately 45 million shares in the fourth quarter.

During the third quarter, FASBE provided new guidance on contingent convertibles that will be effective on December 15th of this year.

The new guidance is expected to have implications for our zero coupon convertible note during the fourth quarter of 2004.

As a result, we anticipate an increase of approximately 26.5 million shares to a fully diluted share count.

Further details on share count and EPS calculations are provided regularly in our 10-Qs and 10-Ks.

Over the last year, we have made significant progress to strengthen our balance sheet, reduce our interest expense, improve our product portfolio, and manage our margins.

These actions have enabled ON to reach profitability for the first time since the fourth quarter of 2000 on significantly more revenue.

The last few months have raised concerns regarding inventory throughout the supply chain.

We are taking the necessary steps to manage and align our inventory and overall expenses to the changing market environment.

With that, I would like to start the Q&A session.

(OPERATOR INSTRUCTIONS)

Our first question is from Michael Masdea of Credit Suisse First Boston.

Your question, please.

I guess the question is on how much flexibility there is in your controlling inventory and your expenses.

Do you plan on actually being able to take inventory down in the fourth quarter, I guess, is the first part?

And then, as we look in the next year and assuming we do have down revenue for the industry, how flexible are you going to be?

You have to shut down some fabs, and what can we think about in terms of profitability?

Yeah, Michael, this is Keith Jackson, and I'll address both of those.

We do intend to take inventory down during the fourth quarter.

This will be down predominantly with less outsourcing, keeping our factories at a higher utilization rate.

I would expect this trend to continue if the market is, as you said, more flat next year we certainly would accelerate those types of activities.

So, flexibility right now is we're about 29 percent outsourced.

The vast majority of that we can do inside, and would elect to do that in a continued soft market.

Great, and then just on the pricing side, walk us through a little bit of how much is more longer term, which is shorter term, and then when you have your major pressing negotiations?

We have quarterly negotiations with much of our customer base.

There is a significant portion of the OEM side that does annual negotiations.

Most of those will be completed by the end of this year.

They started, roughly, the September timeframe.

And, at this point, we can say that we've had some very good results from those negotiations with both increased margins on that business and increased dollar awards.

Just a last quick question, and I'll jump off, is just what the visibility is looking like through your customers?

Are they giving you any feedback on that or are they kind of flying blind also right now?

General trends, they certainly are giving us -- with the shorter lead times in the industry, they give us less hard data.

But at this point, certainly, most things have pointed to what we've been widely advertising in the industry.

They're doing a little bit of inventory correction, but their demand is relatively flat at this point.

Our next question is from Chris Stanley of JP Morgan.

Your question, please.

Thanks, guys, I just have a couple of quickies.

Just to follow up on Mike's question, Keith, so does that mean you think that pricing is going to bottom out or pick up in Q1?

It is too soon to say.

Certainly, there are some pricing pressures as capacity utilization lowers in the marketplace.

We see most of that, as you would guess, in our distribution channel first.

And at this point, it's way too early to call which absolute direction will be there in the first quarter, but we're not seeing any significant pressure at this point in a downward fashion.

Sure, and then, on utilization rates, where do you expect those to be in Q4 and then how would that be looking for Q1, too?

Again, at this point, you know, we're looking at something close to 80 percent, we believe, at this point.

In Q4?

Yes.

Then where do you think that would trend in Q1?

Possibly higher but, again, it's a little early to tell.

The significant piece there is going to be the amount of inventory that is out in the channel.

But, at this point, we think, with the aggressive actions we're taking in Q4, that Q4 will probably be the lower point at this stage.

Sure.

And then you mentioned that you were over 90 percent booked coming into the quarter.

Can you give us a sense of how much turns is less?

Or in other words, to make a short story long, how the first, I guess, three-and-a-half weeks of the quarter has gone?

The order patterns have basically supported the guidance we've given so far.

So nothing tremendous in either direction, but, again, this is pretty early in the quarter at this stage.

Our next question is from Tim Luke of Lehman Brothers.

Your question, please.

Hey, if somebody could just go through that again with respect to the share count -- what we should be using as a fully diluted number in the fourth quarter and again for the beginning of next year with the co-co-arrangement?

There's a complex method that we use because of a two-share count, but there's a quick shortcut.

If you add in the additional shares from the co-co, which are approximately 27 million shares, we are 306 million shares, excluding the co-co (ph) including our stock options.

The grand total there, 306 plus 27, is 333, which is a number I can easily remember.

So we'll try to keep it at that.

You just divide that into your projected after-tax income, and that gives you the EPS.

So it should be in the 333 for December.

333 is including the co-co.

Now, I can say that we are investigating some alternatives on how to handle that co-co, that contingent convertible, but we haven't got any resolution and, as you know, the accounting standards have changed to make -- really, the intention is to count these in the share count.

But we have some possibilities with exporting, particularly since that instrument is trading well under par.

So it seems rather unfortunate to count it at its full share value when it's actually trading under par.

But I have no guarantee that we will be successful, so we prefer to give you a prudent guidance and count it in your projections today.

Right.

In the third quarter, the share count, I think you guided it to 306 or around there, and it was 259, and the reason for the difference there was -- if you could just remind us what that was.

You've got to add on the 45 million shares from the preferred, and if you do that, you'll come (indiscernible) to the 306.

Okay, perfect.

In terms of just the calendar fourth quarter -- could you give us a sense of the segments where you would see some strength sort of on a relative basis?

Well, I think we still -- Keith mentioned it in his script, that in the third quarter we showed some strength in the PC space and in the wireless space, with a rather disappointment, I would say, in the consumer space, and I think that the fourth quarter, we have guided to flat to slightly down.

So we do expect a reasonable strength from these same areas but, obviously, a bit less than we have seen before.

And also, if you're going to see some strength, you'll see some weakness, and I think Keith mentioned the weakness we are seeing as being a little bit automotive, a little bit networking, and a little bit industrial.

So as far as we can see today, the best visibility we have is roughly the same and the mix we had in the third quarter.

And just to be clear, you would expect networking to move lower again in the calendar fourth quarter then?

Probably slightly more -- slightly, maybe flat to slightly more, but not -- networking is not a large part of our business, so it's not too material there.

Our next question is from Mark Edelstone of Morgan Stanley.

Your question, please.

Hi, good afternoon, guys.

The first question, I guess, is on Q3.

If you go back and look at how the quarter played out, did you end up seeing cancellations in backlog, or was it just simply that the turns that you would have expected did not come through?

Because if my memory serves me correctly, on the original guidance for revenues to be up 2 to 5 percent sequentially, I think you entered the quarter with a little bit more than 90 percent of that in backlog.

And if we look at the delta between what the revenues were expected and what they ended up being, is that just all explained by that incremental turns of 8 percentage points or so just didn't materialize, or was there some cancellation that took place as well?

Yes, Mark, Keith again.

The answer to that one is we received literally no turns during the third quarter.

Cancellations, you know, are really not abnormal from any other quarter we've ever seen and, frankly, we did not anticipate a quarter without turns as typically the third quarter turns pretty strong in September and, of course, we have not experienced a quarter without turns since the significant downturn back in 2001.

So the real surprise to us was the lack of turns, the lack of strength, and again explanations we've had from both the distribution channel and our OEMS is really an inventory correction situation.

So the market itself was there.

Turns did not happen.

No significant cancellations occurred, and I think that kind of gets you to the delta.

Right, okay, it makes perfect sense.

I guess when you look at the environment now where it still seems like it is somewhat dicey out there in terms of overall demand and, as you characterized, that it seems like the end markets feel somewhat flattish, obviously, with a seasonal uptick happening here in the fourth quarter.

But obviously not a tremendous amount of momentum and while we certainly would have burned off some inventory in Q3 for the industry as a whole, it still feels like there is some inventory that is yet to be burned off, and with people going into a seasonally weak Q1, is there something that gives you more confidence that the turns profile, albeit you don't need a lot, will actually come through here in the fourth quarter, and you won't find at the end of the quarter that the distie sell-through just didn't happen in December, for example?

Well, I think that scenario you talked about, Mark, was a bit of the reason we're giving some muted guidance here.

We actually have not seen, in recent history, Q1 softening from Q4, which is kind of an interesting trend.

It's starting to be flat to even up as much as a percent or two.

But there is certainly no major change or inflection that we see between Q4 and Q1.

So it's our feeling, at least, with the situation where we had absolutely not turns in Q3, that that did get at a significant amount of the inventory in the supply chain, and so we should see some turns this quarter, and then Q1 returning to more normal patterns.

Okay, great, and just a last question, if I could.

I know that you guys had some additional cost savings scaled into the P&L going into 2005 -- some technology migrations, as an example, into some other overhead reduction programs.

How do those look right now as you look at the business going into, let's say, the first half of 2005, and I know it's hard to forecast the pricing, but do you think that there is enough cost-saving strategies in place here where, if you keep your fabs at reasonably high utilization levels, that you can offset any increment pressure you get in ASPs in the first half of next year?

Yes, that's our objective.

We are working diligently to make sure that margins stay well into the 30s.

We've got an aggressive cost plan next year.

As you know, we announced we're closing one of our wafer fabs in the first quarter.

We are using some of these opportunities of a little softer demand here to try and accelerate that and get at some costs sooner in the year than we might normally have done.

So we are exactly trying to get the cost reductions to offset any lowering of capacity utilization early in the year.

(OPERATOR INSTRUCTIONS)

Our next question is from Craig Ellis of Smith Barney.

Your question, please.

Hi, it's Terence Whelan (ph) for Craig Ellis.

Thanks for taking my question.

Guys, can you give me an indication of how sell-through at distributors track during the quarter?

I know that you started the quarter with about one week additional inventory than you had ending the quarter, yet your deferred income went up about 10 million.

Thanks.

This is Donald here -- we got that question last quarter as well.

The deferred income did go up approximately the same amount that our actual inventories went up at distribution, and we had approximately 12 weeks of inventory at the end of the second quarter and approximately 13 weeks at the end of the third quarter.

Now, I think when I listened to -- I read some of the reports on rival competitors.

They had significantly higher distribution inventory than we did.

We have always said our model is a 12- or 13-week model.

We believe that this quarter, if the projections come through, that 13 weeks will fall slightly.

And I think I mentioned as well last time that the deferred income line on the balance sheet is not a very good proxy for the absolute amount of distribution inventory as it includes reserves, and the total distribution inventory has increased significantly less than the deferred income line since the beginning of the year.

Okay, great, and then on sell-through at distribution -- what does that track sequentially?

Sequentially, again, there was not a major change.

Certainly the end of September was stronger than the July timeframe, but it was not as steep a curve as we normally experience.

Okay, very good, thanks, and then my other question relates to utilization.

I think you said that you're targeting 80 percent for 4Q.

Did you say 3Q was at 80 percent as well?

Approximately.

And then last question -- lead time and where you see those going.

Thanks.

Approximately eight weeks, and that could come in a bit during the fourth quarter but probably not significantly.

Our next question is from Ramesh Misra of C.E. Unterberg.

Your question, please.

Good afternoon, guys.

In terms of factory consolidation, Keith, I think you have previously talked about shutting down your fab in Rhode Island by the end of this year.

Did you just say that it might be happening sometime in Q1 now?

Yes, it will most likely be totally closed in Q1.

So does that mean that the cost savings that you had been anticipating probably are getting pushed out a little bit?

They will come in approximately in line with the original plan, but they'll be, I guess, fully realized in the second quarter and partially realized in the first.

Okay.

In terms of the end markets, industrial tends to be a little stronger in Q1, and I believe automotive tends to be a little stronger as well.

That's correct.

In regards to the industrial, with trends in the capital equipment area kind of beginning to weaken, do you still anticipate an uptick in the industrial segment, going forward?

Yes, we actually saw a very, very hard correction in semiconductor capital equipment during the third quarter, and most of our customers, as we've talked to them, believe that they have taken some very aggressive actions in that basically the worst of it will be behind them here this year.

So we are expecting Q1 to be at least somewhat better than Q4.

Okay, and, very roughly, how much is capital equipment out of that overall industrial segment?

Is it, roughly half or a little less?

Less than half.

Hang on one second -- 30 to 40 is a rough estimation.

Thirty to 40 percent off that 20 percent?

Correct.

Okay, now, with the slowdown kind of continuing in the capital equipment space, how confident do you really feel about that beginning to tick back up?

Of course, everything is on a relative basis.

I believe that, obviously, things were very hot going into this year.

They've cooled down substantially but even the forecast we've seen from the industry on purchases next year are not down by half, they're down a bit.

So I guess the answer is we do believe that with the significant correction that's been taken, next year we'll be able to allow that industry to show some growth.

Our next question is from Lee Zeltser of Needham.

Your question, please.

Hey, guys, if you can give us a book-to-bill figure for the quarter.

We normally don't give out those.

It was slightly below one, and that's the first quarter we've had in the last 12 or so below one.

Okay, and if you could talk about a breakout, either qualitatively or quantitatively by product category.

Generally speaking, the product categories track fairly well with a couple of exceptions -- our high frequency business is very much dependent on networking and semiconductor capital equipment.

So that definitely was down last quarter.

And our analog business actually is trending stronger than the overall company averages.

You know, you gave a bit of a range for fourth-quarter revenues in your guidance.

What are some of the assumptions for flat and then at the other end of the spectrum, down 4 percent there?

Right now we're expecting units to be flat to somewhat up, and the -- of course, the turns and distie sell-through will have an impact on the ultimate outcome, but, at this point, that's kind of a look at that one with potentially some very slight negative impacts on ASP, and perhaps some slight changes in mix.

But, again, both of those are well within that range that we gave you.

Your sense, overall, is that the inventory correction has largely been completed at this point, or how much of an overhang will we see in Q4?

I guess the feel I get from speaking with our customers is that they think it will be pretty clean by the end of this quarter.

They moved pretty quick in Q3, but there is still some overhang into Q4 and by Q1 it's largely behind us.

Okay, I thought I heard you right -- you expect a better Q1 relative to Q4.

Just talk about the drivers there.

Again, drivers there -- you typically have a little bit stronger in the non-consumer areas, which helps us on ASPs.

We have stronger ASPs in those areas.

And we do see continued strength on the consumer side, interestingly enough -- or wireless.

I guess it's more the handset side that tends to still be strong through the Chinese New Year.

That's, I guess, normal seasonality or is that something that you see in your business presently that you'd expect you want to shape out like that?

At this point, clearly, we're still early in that, but, again, that's been the trends the last few years, and I don't have any data that will contradict that at this point.

Our final question is from the line of Craig Ellis of Smith Barney.

Your question, please.

Great, my last question is regarding -- I think you mentioned your capex plan for 2004.

What about 2005 and where will you be sending that capital and has your forecast changed at all in the past quarter?

Thank you.

It's Donald here -- sure, we gave a number '04.

Clearly, with a little bit of a slowdown, less projected revenue than we thought, we will spend less in 2005.

We are still working on these numbers as we get better visibility, but you can assume something in the $60 million range is what we will spend.

We will obviously not be spending as much on capacity as we had previously, but we will continue to spend on capabilities, particularly for technologies to support our growing analog business.

Ladies and gentlemen, this concludes today's conference call.

Thank you for your participation, you may now disconnect.

Good day.