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ON Semiconductor Corp
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Ladies and gentlemen, thank you for standing by, and welcome to the ON Semiconductor Fourth Quarter 2020 Earnings Conference Call. At this time, all participants are in a listen-only mode. [Operator Instructions]
I would now like to hand the conference over to one of your speakers today, Parag Agarwal, Vice President of Corporate Development and Investor Relations. Sir, please go ahead.
Thank you, Michelle. Good morning and thank you for joining ON Semiconductor Corporation's fourth quarter 2020 quarterly results conference call. I'm joined today by Hassane El-Khoury, our President and CEO; and Bernard Gutmann, our CFO.
This call is being webcast on the Investor Relations section of our Web site, at www.onsemi.com. A replay of this webcast, along with our 2020 fourth quarter earnings release, will be available on our Web site 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 calendars are also posted on our Web site.
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 Web site in the Investor Relations section.
During the course of this conference call, we will make projections or other forward-looking statements regarding our 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-K, 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 2020. 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.
We have changed the date for our Analyst Day. Now, we plan to host our Analyst Day on August 5, 5th of this year instead of on March 5. With the recent change in leadership of the company, we believe that we will need -- we will be able to provide and form a completed view of our updated strategy and financial targets of August 5.
Now, let me turn it over to Hassane. Hassane?
Thank you, Parag, and thank you everyone for joining us today. I want to start by expressing how excited I am to be a part of this [solid] [Ph] company and its incredibly talented and motivated workforce. I will start by sharing with you the initial observations and updating you on the process we will use to evolve the future strategy and direction of the company. I will then address our fourth quarter 2020 results, and turn the call over to Bernard to discuss financials and forward-looking guidance.
I took the role as CEO because I could clearly see the tremendous potential we have even as I looked at it from the outside. Having been in the role for a few months now, I can see a company with outstanding assets, including a highly talented and motivated workforce, intellectual property, sales channels, products, customer relationships, brand, and industry-leading operational prowess, to name a few. We are focused on the right markets which are the fastest growing semiconductor end markets with solid margin potential. I am excited about the opportunities we have in front of us to maximize the value for our shareholders, customers, and employees.
As I dove deeper into the company during the last eight weeks I have been positively surprised, and have grown increasingly bullish about our prospects. The opportunities in front of us far exceed my initial expectations, and I am working with my team to turn these opportunities into a strategy with a credible execution plan. I'm very confident that we will be able to deliver the full potential of the company to our stakeholders. At this time, I don't have all the answers to what the future strategy and direction of the company will be, however, I will walk you through the process we will be following to get there and be able to share the details with you at our Analyst Day, in August.
It should come as no surprise that our primary value driver will come from our gross margin expansion initiative. At this time, we aim to maintain the over-market revenue growth in our strategic markets, while being opportunistic in others. We will focus on maximizing free cash flow to de-lever our balance sheet and set us up to remain a consolidator. To achieve our objective of maximizing shareholder value, we are ready to make substantial changes in our strategy, business, and organization. We have begun the process of reevaluating our current product portfolio and our investments across the board. We will reallocate investments and resources to accelerate our growth in high-margin businesses, away from non-differentiated products and markets which have had a historically low margin profile.
We will reduce complexity, streamline the organization, and improve efficiencies. After realigning our investments with our products and market strategy, we will double down on R&D to accelerate growth and margin expansion. We will rationalize our manufacturing footprint to align with our investment priorities and new corporate strategy. Our primary goal is to reduce volatility in our margins and maximize return on our manufacturing investments. Our product strategy will drive our manufacturing footprint and capital investments. We intend to transition to a lighter fab model in which our margins are not as heavily influenced by our fab loadings. As you can already tell, we have hit the ground running, and we are making progress in a short period of time. We will provide you with greater insight into our strategy and targets at our Analyst Day, on August 5. In the meantime, we plan to continue to provide updates as we make progress.
Now, moving on to the fourth quarter 2020 results, revenue for the fourth quarter of 2020 was $1.45 billion, an increase of 3% year-over-year. We saw a steep improvement in demand in the fourth quarter, and the momentum has continued thus far in the current quarter. The surge in demand is driven by a broad-based improvement in global macro economic conditions, and lean channel and end market inventories. The automotive end market had the steepest recovery in the fourth quarter. Based on current demand trends and the global macro outlook, we expect to continue to see above-seasonal demand trends in the near-term.
On the supply side, we have been able to manage our customers' requirements for products thus far. As semiconductor vendors increase supply and customers fulfill pent-up demand the temporary supply-demand imbalance should subside in a few quarters. Let me discuss a few highlights of our key strategic end markets, starting with automotive. Revenue for the automotive market in Q4 2020 was a record $491 million, and represented 34% of our revenue and an increase of 6% from Q4 of 2019. Our 2020 automotive revenue declined by 7.5% year-over-year but significantly outperformed the 2020 global automotive production unit which declined by 16% over the same period. The significant outperformance was driven by increasing content for our products and fastest-growing applications in the automotive market.
Our design win funnel continues to expand. We won ADAS and viewing sockets on many of the recently announced platforms. We also secured a win for our LiDAR products with a European automotive OEM. We expect this win to ramp later this year. Another significant design during the fourth quarter was with a major tier 1 for our sensor module which features a lens integrated in a sensor pocket package for in-vehicle experience application. We continue to see strong momentum for our silicon carbide and IGBT product for electric vehicles, and expect to see strong ramp in our EV-related revenue with various models going production in 2020 and 2022. The industrial end market, which includes military, aerospace, and medical, contributed revenue of $384 million in the fourth quarter of 2020 at 24% of our revenue.
Year-over-year, our fourth quarter industrial revenue increased by 2%, this increase was driven by broad-based pickup in global industrial activity, partially offset by geopolitical issues related to a specific customer. In the industrial end market, we continue to see strong momentum for our power modules and alternative energy applications. Our customer base for power semiconductor and alternative energy has expanded by approximately 50% in 2020. We expect to see strong growth in this business as the U.S. administration is focused on the reduction in global carbon emissions. We are seeing strong traction for machine vision factory automation applications with our exit XGS family of image sensors. In the communications end market, we expect strong growth in 2021 for our 5G-related revenue driven by increased 5G capital expenditure by carriers.
Now, I will turn the call over to Bernard to provide additional details on our financials and guidance. Bernard?
Thank you, Hassane. During the fourth quarter of 2020, we saw continuing recovery in business conditions driven by robust growth in global economic activity. Order activity accelerated sharply across most end markets as customers are ramping production and replenishing inventory to meet the steep increase in end market demand. Along with the strong broad-based recovery in macroeconomic conditions, secular mega trends in automotive, industrial, and cloud power markets continue to drive our business. Gross margin improvement is the primary strategic priority for the company.
As Hassane indicated in his remarks, we are going to do a detailed review of our product portfolio. The primary objective is to reallocate our capital to drive margin expansion and growth. Our revised product strategy will determine our capital expenditures and investments in other resources needed to support the business. We will update you with our progress as we go through the process. We are on track with our manufacturing consolidations win and discussions are ongoing with various parties regarding the previously announced intended sales of our fabs in Belgium and Niigata, Japan. We have closed our operations and sold the fab in Rochester, New York, and we should begin to realize annual savings of $15 million starting in the first quarter of 2021.
Now, let me provide you additional details on our results. Total revenue for the fourth quarter of 2020 was $1.45 billion, an increase of 3% as compared to revenue of $1.40 billion in the fourth quarter of 2019. The year-over-year increase in revenue was driven by growth in our key strategic end market. GAAP net income for the fourth quarter was $0.21 per diluted share, as compared to a net income of $0.14 per diluted share in the fourth quarter of 2019.
Non-GAAP net income for the fourth quarter of 2020 was $0.35 per diluted share as compared to $0.30 per diluted share in the fourth quarter of 2019. GAAP and non-GAAP gross margin for the fourth quarter of 2020 were 34.4% as compared to 34.6% in the fourth quarter of 2019. The year-over-year decline in gross margin was driven primarily by a weakening U.S. dollar against currencies in most regions in which we operate our manufacturing facilities.
Our GAAP operating margin for the fourth quarter of 2020 was 11.6% as compared to 9.9% in the fourth quarter of 2019. Our non-GAAP operating margin for the fourth quarter of 2020 was 14.2%, as compared to 12.3% in the fourth quarter of 2019. The year-over-year increase in operating margin was driven largely by lower operating expenses. GAAP operating expenses for the fourth quarter of 2020 were $329.6 million as compared to $346.8 million in the fourth quarter of 2019.
Non-GAAP operating expenses for the fourth quarter of 2020 were $292.4 million as compared to $313.6 million in the fourth quarter of 2019. The year-over-year decrease non-GAAP operating expenses was driven primarily by restructuring and cost saving measures undertaken by the company.
Fourth quarter 2023 cash flow was $284 million and operating cash flow was $400 million. Full-year 2023 cash flow increased to $501 million from $160 million in 2019, despite a 5% decline in revenue.
Capital expenditures for the fourth quarter of 2020 were $116.4 million, which equates to a capital intensity of 8%. As indicated previously, we're directing most of our capital expenditures worth enabling our 300 millimeters capability of the East Fishkill fab. Total capital expenditures for 2020 were $384 million. We exited the fourth quarter of 2020 with cash and cash equivalents of $1.081 billion as compared to $1.654 billion at the end of the third quarter of 2020. The decline in our cash balance was primarily related to the repayment or 2020 convertible note principle at maturity in December 2020.
At the end of the fourth quarter of 2020 days of inventory on hand were 120 days, down 13 days as compared to 133 in the third quarter of 2020. At this time, we're comfortable with the level of our balance sheet inventory. In the fourth quarter of 2020, distribution inventory decrease marginally at sales through the distribution channels increased significantly quarter-over-quarter. Distribution inventories are within our target range of 11 to 30 weeks.
Now let me provide you an update on the performance by our business units starting with Power Solutions Group or PSG. Revenue for PSG for the fourth quarter was $716 million. Revenue for the Advanced Solutions Group or ASG for the fourth quarter was $522 million and revenue for Intelligence Sensing Group or ISG was $208 million.
Moving on to guidance based on product bookings events, backlog levels, and estimated turn levels, we anticipate the total ON Semiconductor revenue will be in the range of $1.41 billion to $1.51 billion in the first quarter of 2021. For the first quarter of 2021, we expect GAAP and non-GAAP gross margin between 34.1% and 36.1%. We expect total GAAP operating expenses for the first quarter of 2021 of $345 million to $363 million. Our GAAP operating expenses include the amortization will be manageable restructuring as an impairments and other charges, which are expected to be in the $32 million to $36 million range.
We expect total loan GAAP operating expenses from $313 million to $327 million in the first quarter. The expected increase in our first quarter operating expenses as compared to those in the fourth quarter is driven by the expected the group or variable compensation in anticipation of a strong financial performance in 2021, and is in line with the $25 million to $30 million increase foreshadow in the last quarter earnings calls prepared remarks.
In our 2020 operating expenses, the variable component of compensation was not significant. For the first quarter of 2021, we anticipate GAAP net other income and expense including interest expense will be an expense of $34 to $37 million which includes the non-cash interest expense of $45 million. We anticipate our non-GAAP net other income and expenses including interest expense will be an expense of $30 to $32 million. Net cash paid for income taxes in the first quarter of 2021 is expected to be in the $18 to $24 million. For 2021, we expect cash paid for income taxes to be in the rage of $80 to $90 million. We expect total capital expenditures of $90 to $100 million in the first quarter of 2021.
We expect share-based compensation of $15 to $17 million in the first quarter of 2021. Of which, approximately $3 million is expected to be in cost of goods sold. And the remaining amount is expected to be in operating expense. This expense is included in our non-GAAP financial measures. Our GAAP diluted share count for the first quarter of 2021 is expected to be 438 to 439 million shares based on our current stock price.
Our non-GAAP diluted share count for the first quarter of 2021 is expected to be 431 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.
I would like to end my comments on a personal note. As you are all aware, I have decided to retire after 39 years with ON Semiconductor and its predecessor company. It has truly been an honor to sever the company and its shareholders, employers, and customers for all these years. I have enjoyed interacting with all of you over the years. You have kept me on my toes and always helped me strive to do better at my job. ON Semiconductor has a very bright future. And the company is well-positioned to deliver significant value to its shareholders, customers, and employees.
With that, I would like to start the Q&A session. Thank you. And Michelle, please open the line for questions.
Thank you. [Operator Instructions] Our first question comes from the line of Ross Seymore with Deutsche Bank. Your line is open. Please go ahead.
Hey, guys, thanks for letting me ask the questions. First, Bernard, great working with you all the years, congrats on the retirement. My first question is for Hassane. You mentioned a laundry list of actions you are going to take structurally for the company, I know you are not going into exceedingly detailed levels before the analyst meeting in August, but I wondered how you are balancing the gross margin side versus the OpEx and operating margin side. You mentioned about doubling down on R&D. How do you balance the gross margin versus the operating margin priority for the company?
Sure, Ross. Let me give you kind of how the approach has been because we started doing that work. At a high-level, you can think about it as self-funding, meaning, I don't like to dabble, whether we say we are working on it or not, if we are creating products and low margin businesses or markets that are not our strategic markets, those investments are going to stop. That's going to release capital for us to re-invest, and that's where the doubling down. And don't think about it as we are going to double down and OpEx is going to flip up beyond the levels. We are going to actually reallocate OpEx. And with the simplicity and removing complexity and the way we run our operations here, that's going to release a lot of more capital for us to reinvest. So, I am not worried about having enough investments that we can reallocate, while maintaining at or below our OpEx, which obviously will drive our operating margin favorably.
Thanks for the details, Hassane. And I guess one for either you or Bernard, the guidance is better than seasonally, you said that's going to continue for a bit. Was the better-than-seasonal comment just about the first quarter, or was it longer than that? Any color between the different segments to get to your guidance for the first quarter?
Yes. This is Hassane again. Our focus right now is in the first quarter. Obviously, we are coming out of a very lean inventory, both our customers and the supply chain. So, that's a rebound we are seeing in Q1 better than seasonal. I remain cautiously optimistic for the rest of the year, but it's too soon to call the rest of the year at this point.
In the prepared marks we talked about it may take a few quarters to kind of stabilize the supply and demand situation, and that's when we'll get a little bit more clarity. Obviously, if you've seen the news, a lot of that strength is coming from automotive, and we it the same way, which is a big market and a focus market for us. So we're watching it closely, but I remain cautiously optimistic until we get out of the trend of supply-demand imbalance.
Thank you.
Thank you. And our next question comes from the line of Chris Danely with Citi. Your line is open. Please go ahead.
Thanks, guys. Hey, first of all, Bernard congratulations [indiscernible], I'm jealous. But first question is just on OpEx. I guess what's the thought process of an upfront payment to everybody in front of the upturn versus afterwards? And is this -- should we consider this as the new baseline for OpEx or could it trend down after this?
So it is not an upfront payment, it is an accrual, an accounting accrual as we have an annual plan which actually book cash-wise basis next year, in February, if we achieve the numbers. So this is just an accounting accrual recognizing the liability we are creating with delivering results that lead to the new plan.
Yes, let me just put that stake in the ground. We are 100% focused on pay for performance. We have to accrue throughout the year. But pay will occur in 2022 in the first quarter, just like it did this time for the prior year, so it's after the fact. We don't do any advanced planning as far as payment in any form to employees until after the performance period is done and validated.
Great. And then…
To your question about trend on OpEx, we believe we have the step function increase. And pretty much after that it should be fairly steady -- [multiple speakers]…
Okay, great. Thanks, Bernard. And for my follow-up, hey, Hassane, you mentioned you're going to take a look at the product lines. I guess what sort of rough percentage of revenue are we talking about that's being targeted as far as these low-margin product lines? And can you shed any light on what are these low-margin product lines, is it some MOSFETs or IGBTs or is there some other sort of like passive types of products you guys have?
Sure. It's too soon to tell as far as to give you a percent, because literally I am looking at everything. But the way I look at it is strategic alignment to our end market, strategic alignment to our margin target, and really strategic alignment to the growth that we want to set for the company, both in gross margin expansion and revenue. So, to put a percent on how much is that, it's hard to tell. But it's not going to be like you were expecting or IGBT or effect of whatever kind, because we're not looking at it as just a product family. I'll give you an example. We have IGBTs that goes into EVs; I love that. That's a growth market, it's good margin, and we have a very good position in that market. That's going to be obviously a growth product and market for us. But IGBT and a low margin consumer, that is not going to be an investment for us. So that's the surgical approach we are actually proceeding in order to get the right balance we talked about already.
Got it, that makes sense. Thanks, guys.
Thank you.
Thank you. And our next question comes from the line of Toshiya Hari with Goldman Sachs. Your line is open. Please go ahead.
Good morning. Thanks very much for taking the question. And Bernard, thank you for all the help. Hassane, you talked about you guys addressing demand, so far being pretty successful in addressing demand so far. But can you speak to where lead times are for your business today versus three months ago, six months ago? And sort of related to that, how is the pricing outlook for your business over the next six to four months in relation to what you guys have seen over the past few years?
And so let me address the lead times, they have been inching up. They are still in mid-teens, but moving upwards in direction.
Yes, for the pricing, we see a healthy pricing environment. Obviously, there are price increases that we have incurred from our supply chain, and we are working with customers to pass those on down the supply chain from where we are. There, of course, was supply and demand. We are always reviewing our pricing posture, and we're doing that as we speak. And it's not just only -- let me [reiterate] [Ph] a little bit on it's not just the supply and demand. We do have high-value products, and those high-value products demand a higher margin. So I'm reviewing all our pricing disciple outside of just the supply and demand, and that's something you should see from us moving forward as a structural change we're implementing in the company. Where that's going to get us and where it's going to land as far as tangible result that I can credibly talk to you, that's going to be in the August meeting, because that will give me enough runway to establish that process and see the impact.
Great, thank you. And there is a quick follow-up, just on sort of the long-term model. Again, I appreciate you're not going to preview your August Analyst Day, but when you look at some of the numbers that Keith and Bernard put up during their last investor day, a mid single-digit revenue growth, 43% gross margin, 21% OpEx intensity. Given what you've seen so far, Hassane, where do your views differ the most, is it more on the growth side, is it more on the margin side, is it both? Any would be super helpful. Thank you.
Look, it's not about the top line or gross margin, my focus is on the timing of it. That's kind of where I'm putting my energy right now. And then we will talk about what does that yield on top line and how quickly do we get to the -- and we're going to call it the 43, because that's the only number that is available externally. A lot of people ask me what should we be looking for as far as a financial model, and my answer, and I'll reiterate it here, just hold us accountable to whatever we -- the company has done already even though it was not me personally, until I stand in front of all of you, in August, and change it. But for now, just hold us accountable to the target and the financial model that we have made available already as a company.
Thanks so much.
Thank you. And our next question comes from the line of Raji Gill with Needham. Your line is open. Please go ahead.
Yes, thank you, and best of luck, Bernard, and congrats, Hassane, on the new role. Hassane, a question on the 300 millimeter, the transition that's been undergoing for a couple years, any thoughts on how that progress is happening? And what are your thoughts on that transition to 300 millimeter? Are there steps that you want to try to accelerate that transition and what would they be?
Sure. Obviously a 300 millimeter transition is a transition that we need as a company. We have it internally, and the company has already set itself on a path to have an insource fab for that. There's obviously -- we're looking at the baseline to see if we need more how do we get it. It doesn't necessarily mean we're going to have a multitude of fabs at the 12 inch. It's going to be driven -- to answer your question more directly, it's going to be driven by the product portfolio that we're going to have and we want to be investing in over the next five years, and that's part of the portfolio rationalization. I can't really address a need for a manufacturing footprint until I know exactly what we want to do, where the margin is going to come from, and what the manufacturing footprint needed in order to support it, inside or outside.
So that's the work we're doing on right on. However, we do have the East Fishkill. We have been making progress on it, where products are taken out, some products are only sampling. So technology development in product move into that fab is ongoing, and I'm happy with where we are. To accelerate, is going to be dependent on, as I mentioned, product and margin focus. And that's going to be with the capital associated with it. That's the work in progress we have do, and not completed yet. But I expect it to be completed by the time I give an updated financial model in the August meeting, which will include capital and manufacturing footprint targets.
And for my follow-up, Hassane, you talked about product rationalization, and I think you had mentioned achieving that either through potentially M&A or divestment, and maybe if I -- maybe correct me if that's not the case. But wondering how you would think about product rationalization and with respect to those two possible strategies?
Sure, but it's not -- those are obviously part of the strategy, but that's not the one that's going to get you the most impact. The one that's going to get you the most impact is literally de-focusing on products that we don't see bring us any -- you know, whether it's top line growth or margin expansion. And by de-focusing, there are multiple way you put it in harvest, [indiscernible], short lived, you know, talk about UL anywhere from six months to 18 months depending on engagement with the customer, as far as when we're going to exit that business. We'll notify customers. We'll support them in a transition, transition to our products, which are better margin structured, so we'll force a conversion, or we'll just exit the business and exit that customer and the top line. And we're looking at everything equally.
Where is that going to be as far as divesting? If there is a business that we believe has value for somebody outside of ON Semiconductor, we'll monetize it, instead of doing UL like I mentioned, we'll monetize it through a divestiture. Leading up to the third tenet, which is the M&A, M&A just going to be a complementary view of what we're able to do with our portfolio rationalization, once we have a portfolio footprint that we like in the end-markets that we want, then M&A would be a inorganic growth within these markets. We're not going to use M&A to solve our internal issues, because then you're just creating chaos after chaos. We're going to rationalize our internal markets, our internal portfolio, then M&A will just strengthen that posture.
That makes ton of sense. Congrats, thank you.
Thank you. And our next question comes from the line of Matt Ramsay with Cowen. Your line is open. Please go ahead.
Thank you very much. Good morning. Thanks and congrats, Bernard. It's kind of an interesting call, right because you guys are clearly going to put out longer-term targets in August. But folks are poking and prodding you trying to get a little bit of a hint about where that's going. But I might just ask a couple of questions along those lines. One is you talked a little bit in your script about potentially taking the company a little bit more towards being fab light. And obviously, the product portfolio will, I would imagine mostly inform that decision. But no secret the U.S. government is thinking about incentivizing semiconductor manufacturing and R&D in the state. So I wonder, I guess first question is how much is that going to inform your decision? And then the second piece is, around the channel, Texans taking an interesting strategy of going more direct. You guys have a pretty broad distributor footprint. How are you thinking about that in terms of making your decisions going forward? Thank you.
Sure, let me tackle the fab light comment I made. So, fab light obviously is an analog range that goes between fabless and only internal manufacturing. So where we're a lighter fab, which means we're going to be shrinking our manufacturing footprint from where we're today. So that's a fab light comment. And that's going to be a result of what we need to manufacture internally versus what there are foundries that do a better job at the manufacturing that we do. And that's the balance we're going to be doing. And we started that effort. Obviously, there was a management change that did occur, to start looking at that in parallel with me looking at the portfolio rationalization. So that's ongoing, and the results and the reporting, I do real time.
From the government side of it, listen, we're going to make the best decision for our company that drives shareholder value. That's the first and foremost decision making. If at the end of that first tranche of decisions, there's alignment with where the administration is going or what state we're in. That's great. But we're not going to make a short-term decision based on the current politics that will hinder us from potentially achieving our maximum value creation that we could otherwise. So, our focus is on value creation, as we see it for the company, our shareholder, our customers and our employees. And then we'll figure out how we land in the politics at that time.
From the distribution and other work we've been doing is the channel rationalization just like the portfolio. Once you know, where you want to grow and how aggressively you want to grow in which markets, you're going to partner with the distributors that are strong indeed in that same arena you want to play in. And that's going to be an outcome of the portfolio. And that's why, I keep going back to the portfolio work, we're doing is going to drive a lot of those dependencies because it's all interlocked, but it definitely starts with a portfolio rationalization to market and a strategy. Everything else is really how do you execute the strategy to the best you can.
Thanks very much, all the best as you put things together and excited to see what comes. Thanks, guys.
Thank you. And our next question comes from the line of Vijay Rakesh with Mizuho. Your line is open. Please go ahead.
Yes, hi Hassane and Bernard, good quarter and guide here. Bernard congratulations on a great career. Just a couple of questions, just wondering, on the automotive side, you mentioned sensor module and some pickup on the electric vehicle side. Is your guide, still for a longer-term 9% to 11% above what the automotive market growth is? Or do you see upside based on some of the wins that you have here and then I've follow-up?
Yes, we basically think it's a high single-digit above the current level. And we actually confirmed that with our 2020 performance.
Got it? And Hassane, you made a comment on lean inventory? Can you give us some level is that like two to three weeks of inventory versus normal like four to six weeks for the inventory levels here? Thanks.
Yes, so Vijay, I can't give you a target right now, I'm looking at it because not all businesses obviously we have here are created equal, some of them need more inventory than others. And there's going to be a lot of ins and outs to be fair. As we figure out, as I mentioned before, our EOL, some bridge build or some fab moves that we need to make, that's going to kind of put bumps in the road for our inventory, and we're going to manage it as such, but there's going to be a few ins and outs before we get to a model. So I'll be ready to give you a model where we want to end-up in the August meeting. But between now and then, I'm really going to be opportunistic about what we need to do in order to quickly shift to where I want us to be as a company, whether it's portfolio or manufacturing footprint.
Got it, thanks.
Thank you. And our next question comes from the line of Harsh Kumar with Piper Sandler. Your line is open. Please go ahead.
Yes, hey Bernard, first of all, thank you for all the help over the years, we've worked together, and we really appreciate it and enjoy your retirement. And then for my question, so everybody's talking about tightness in the auto industry. Hassane, you guys have plenty of capacity here, at least available to you. Is there any opportunity for you to be able to take some incremental share? Or is that just not how things work in automotive, given the long design cycles?
Sure, Harsh, so obviously for areas where we're double sourced, we're one of two suppliers. We have some of these in our product lines. If we're able to support it, we will. Of course, we're going to ship, we've already engaged with customers where we know, we don't have 100% share in order for us to help if they need it. So that's ongoing. And that's the way we're running the business day-to-day.
The challenge that we're looking at is okay, even if we do ship that product, is that customer getting the rest of the product from supplier number two, three and four. That's what I don't know. So, to be able to evaluate how much share is actually going to go into revenue. That's going to be call it towards the end of the quarter when the dust settles, we're ready to help. But the problem is our product line is not the bottleneck as far as creating the end product that makes sense. We're watching it, we're going to go after it, because like you said, if we have the capacity, we're going to sell it and we're going to give it to the end customer not sit on distributor shelf or even on our shelves, it's going to go as quickly as we can see the demand for it.
Got it. And so my follow-up, Hassane, can you talk about the activity that that ON Semi is seeing in the EV space in China specifically to charging and chargers. This has been an area, I think that ON has been very active in that particular geography. Could we just talk about, what you think is your position there?
Yes, we're still very active in that area obviously, when you have the products that customers value as far as the technical prowess and the portfolio that we're able to manage, we're definitely always considered, and more often than not, we're the ones being selected, that does not change. And our posture in China EV specifically is strong. And we've had design wins actually in the second-half of 2020 that support that view in the market.
Thank you.
Thank you. And our next question comes from the line of Chris Caso with Raymond James. Your line is open. Please go ahead.
Yes, thank you. Good morning and my congratulations to you, Bernard as well. It's been a pleasure working with you. Hassane, I just wanted to ask a follow-up question regarding some of the comments about refocusing the product line and potentially consolidating the manufacturing footprint. And I recognize that we asked you some unfair questions, because the plan isn't always together, isn't all together yet, but when I look at the gross margins for ON now versus the prior-peak at similar revenue levels, delta is about 300 basis points and most of that depreciation. So I guess the question is, as you've done the initial review of manufacturing, is there enough flex in the system potentially, selling fabs or such that you would be able to make a meaningful dent in that depreciation, if your business review would warrant that's more of a footprint. Is there ability to consolidate if that decision that you want to make?
The answer is, yes, there's always opportunity. And we're looking at everything. And it's not just depreciation. I mean, when you start consolidating, there's obviously the utilization for the fab, the receiving fabs. And really, there's overhead simplification, when I say about rationalizing your portfolio and manufacturing the footprint, all of this is going to drive costs out of the company, it's not going to be sucked in anywhere else, it's not going to be reallocated, it's going to be managed out of the company.
Of course, some timing is different depending on what category of spend, COGS versus OpEx and where OpEx and COGS, but we're tracking every dollar, that is the outcome of every decision we make in order to decide where it's going to end-up. But to answer your question, more generally, I'm optimistic about the levers that we have to drive gross margin expansion since I've been here in the conference. So that has not been a worry of mine of great now, what I do, there's enough to do, and my focus is putting it in a executable strategy that I'll ask, starting with our board of directors, but more importantly, our shareholders and you all outside to hold us accountable to. And that's the work we're doing right now is how do we translate that into a executable plan.
That's great. Thank you. As a follow-up, if I could ask a near-term question regarding production, and if you could talk about where the utilization is now, as compared to where it was last year, and how does that track as you go into next year, as you try to address some of the bottlenecks and then finally, maybe you could talk about where the bottlenecks are, are they more in the front end or the back end or perhaps at some of the outside suppliers?
So, definitely utilization in the last year in the fourth quarter was quite low and we're also affected that time by especially towards the end of it by the pandemic and the shelter in place closings that we have in several of our factories in China into Philippines and Malaysia, we did see a little bit of an increase in utilization towards the low 70, 70, 75 and we expect that as we ramp in 2021, in the first quarter anticipation of seasonal low in the second quarter, finally, on the fab side, we should see helping a little bit of improved utilization in all times.
Yes, most of our constraints are primarily on the outside, not internally and front-end and the back end for us is call it, I'd call it balanced loading gives and takes depending on the product line, but managing the supply constraint externally is really with the foundry at this time.
Great, thank you.
Thank you. And our next question comes from the line of Vivek Arya with Bank of America. Your line is open. Please go ahead.
Thanks for taking my question and congratulations and best wishes to both the Hassane and Bernard. Hassane, for my first question, I'm curious as to your insights on the current demand environment, I think you mentioned all the units were down kind of in the mid-teens, but you say that only down 7.5% last year. And in fact, audited record in Q4 and this Delta between auto units and auto semiconductor sales is perhaps one of the widest that we've seen. So my question is, how much are you shipping to real end demand versus customers stocking up when they just read about the shortages and the auto production shutdowns? How do we get the confidence that these above seasonal quarters that you're seeing in Q4 and Q1 will not be followed by some process of normalization later in the year, what is your level of insight into actual consumption of what you're shipping into the automotive supply chain?
Sure. So I'm going to answer direct as it relates to getting to our customer, which are the tier-1, and I will skip any conversation about does it go through this deal or not this deep, because for this deep, we ship it to this deep, if it shifts out right away to an end-customer. So that's kind of how we're dealing with the distis. So, we don't have a stranded inventory that could go to demand.
So, then to answer your question directly, how do we deal with the tier-1, it's literally direct engagement. We know what the production rates are, and we know what we're shipping in. And we know which OEMs, we all know this side, as far as what OEM are not manufacturing which products. So we know where our product ends with which OEM for which model year to a call it 90th percentile. And that's how we manage it. If we know, for example, there is a shortage in an area or a shutdown of the OEM plant, and we do have products that are targeted for that. We are going to redirect our products to somebody else. Sometimes that engagement is with the OEM. They say, we're shutting down this factory, but we want our capacity to go to this other factory. We know it's going to a call it a vehicle versus just a tier-1 making a box that may not end up in a vehicle.
Obviously, you're not going to get it 100%, right. But if we get 80% to 90% of it, I'll be very happy. And we monitor our inventory. There is a lot of demand, and like you said, we're rationalizing all of that demand to supply to match the demand. And I use the term cautiously optimistic because it will take a couple of quarters, which is call it a full manufacturing cycle time from start to finish goods to kind of get that through the system and see what the real demand is in that timeframe, but -- it's guerrilla warfare that we're doing every day, but I'm happy with what the team's insights are for us to make decisions.
Got it. And Hassane ,as my follow-up on the gross margins for Q1 guided up about 70 basis points at the point, even though say that kind of a flattish. And I heard some mention of the benefits of some prior to the fab closure decisions. So I was hoping if you could -- Bernard could walk us through the gross margin improvement kind of level set us on Q1, are we now looking at all the benefits of pricing and fab closures and everything until you make new decisions like is this Q1 gross margin the new baseline, or are you still seeing the headwinds from a utilization and other perspective, or maybe a different way to ask a same question, what is the incremental gross margin we should be modeling from a Q2 onwards? Thank you.
So, definitely the Q1 number includes the benefit of [indiscernible] numbers, and that is having an effect on, and we said before, it's $60 million a year. So that's having an effect on what our gross margin.
As far as moving forward and what you should expect, I will start with our Q1 guide and that's part of the regular updates I'll be giving you until I give you a trajectory for our gross margin and ended back what trajectory and how committed I am once I deploy a step function by quarters based on my prior life, that's the one we're building right now. Now how much of this is in Q1 for the Rochester closure or the pricing judgment that I've talked about or other levers we're doing? It's actually there is a lot of line items that we have been flowing on. I'm not waiting obviously till August or till Q2 to start to work. We've made tremendous progress. You're going to see a few weeks in Q1 on some items or a full month or two months in Q1 on others depending on when we pulled the trigger.
My focus though is what I call structural gross margin improvement. And what I mean by structural is gross margin improvement that we drive, and it doesn't happen to us. I'll take the stuff the favorable things that happened to us, but there has to be a structural baseline that is up into the right gross margin baseline that you can hold us accountable to and that's the plan we're going to be deploying.
Thank you, and then good luck.
Thank you. And our next question comes from the line of Christopher Rolland from Susquehanna International Group. Your line is now open. Please go ahead.
Thanks for the question, and Bernard I echo my congrats. Thank you for all the time we've spent together. It was great. There is no business like no business. Enjoy your retirement. All the good questions have been asked for the most part. Two quick ones, I guess first of all, disti revenue has traditionally been maybe in the 50s and we've had two strong quarters now in 63, 64. Maybe talk about what you're seeing on the disti side, or there shortages direct and people are going disti at some of your competitors. For example, what is driving that disti number so much higher than typical?
We feel that have been pretty strong in the channel. We are managing our inventories to be within our normal [indiscernible] that way. So it's more just the overall strength.
Yes, I don't know the discrepancy that you're mentioning as far as I'm guessing the 60 and the 50 numbers are percent mixed from distribution. It's been very consistent at about the 60% range. So there hasn't been really a change in behavior, because direct customers are not going to switch to disti because they can't get products from us. And that's what the comment I gave to earlier. We are driving the disti inventory to be able to be a straight shot through disti to our end customer. There is no point on building inventory on the shelf at disti. So if the customer cannot get it direct from us, I can guarantee they're not going to be able to get it from the disti by bypassing that's not a driver, but been consistent. I don't see any change in distribution percentage for the company.
Okay, understood. My second question on the com side, that was better than we had expected. Could you talk about the importance of maybe North America into this as you put handsets into comps, versus rest of the world China and others, just talk about maybe where we're seeing outside strength and how important that North American customer is in particular.
I mean, obviously North American customer is important, because the deployment and the capital expenditure is happening, and given our position with the 5G power side of the market. We are very well-positioned across the regions. There is a certain level of total market. And as things lose share regionally, we will gain it somewhere else. And that's the work we're really monitoring on a global basis regardless of where the design in happens.
Understood. Thank you, guys. Congrats, Bernard.
Thank you. And our next question comes from the line of Craig Ellis with B. Riley Securities. Your line is open. Please go ahead.
Yes. Thanks for taking the question and Bernard congrats. It's been great working with you over the years. Hassane, I wanted to start just by following up on compute sequential strength and dig into it the following by. One, can you help us understand just the distinction between what a server power might've done versus notebook given the strength to notebook units, and then as you looked at the things that distinguish where you'll want to allocate resources, any initial views on the ability to drive high gross margins and value out of those two different sides of the business going forward would be helpful?
Yes. So our focus in the computing space is more on the server and cloud. That's where we have opportunities for enhanced shareholder value in the future. In the meantime, we're taking opportunities of the fact that the client computing has been quite strong. And in that sense, though we believe some of it is work from home. Obviously we are taking advantage of that, but the focus in the long run where we see better margins also enhance globally.
Yes, and that fits kind of when you overlay our strategic markets, I talk about automotive and industrial. There are others, I would call it, submarkets that you're familiar with the server within the compute that is a focus market, because I look as an adjacent technology market. If we are able to create high value products in auto and industrial, those are very valuable for these submarkets that I'm talking about. They will drive growth and margin accretion for the company. And those would be things you're not going to see us invest as a point product in them. But we're definitely going to be addressing them as part of the efficiency we drive. And that's effectively the OpEx efficiency metric.
Got it. And then for the follow-up Hassane, you mentioned early in your script that since you've been aborted on, you've had some notable positive surprises. I was just hoping you could list two or three of those and talk about them and their implications as you think about driving the business forward and creating additional shareholder value? Thanks guys.
Sure. I'll give you, I don't want to steal my own thunder for the August meeting, but I'll give you one that we have -- if you look at the product portfolio mapping versus gross margin profile, I really liked the distribution. I thought the distribution is going to be more less leverage and much higher gross margin businesses then what I found, so we do have some very healthy gross margins. And the focus for me is how do we double down on those and grow them in order to start effectively shifting the mix while we disposition the diluted tail. There is more levers in that view of the business than I had thought walking in. And that gets me excited because I don't have to wait five years to change a mix. We can actually try to manage a mixed shift effectively and we control it.
That's great. Thank you.
Thank you. And our next question comes from the line of Kevin Cassidy with Rosenblatt Securities. Your line is open. Please go ahead.
Yes, thanks for taking my question and congratulations, Bernard. Just on the foundry side, how many different foundries do you use and are they all raising prices? Is this what you're talking about when you say the supply chain is -- your supply chain is increasing prices?
So we use the same usual suspects that pretty much everybody else uses the big ones. It's more once we have a pretty long list of foundries and we are subject to the same pressures that all of our competitors are subject.
Yes, but the comment I made about the supply chain is not really foundry versus internal. You need to look at it as material. There is also -- it's not really the supply shortages that everybody is seeing. But more importantly that I look at is the materials that is required. So there are pockets that our suppliers have asked for and if we're able to absorb them, we are -- if not we usually have a dual source strategy, so we'll move somewhere else. But with the supply constraint that everybody is seeing some of it we just have to basically eat in order for us to support our customers. And in those cases, we are going to pass it down, but it's not a foundry versus internal cost conversation. It's more we call it raw material for our supply chain.
Okay, understood. Thanks. And maybe just a quick follow-up and maybe in part of your strategy in development, is there a consideration for consolidating foundries or trying to get prices down by putting more into one foundry?
Well, obviously if you are able to consolidate even your business on the foundry, you'll get the volume pricing benefit versus being able to -- be spread across multiple. We don't always have the choice because of the technology footprint that you need. Foundry just doesn't do a wide range of the technology we need. But, that's part of how we are looking at it. So when I say manufacturing consolidation, it's both internal and external in order to get the best pricing and the best posture we can to service our end markets.
Okay, great. Thank you.
Thank you. And our next question comes from the line of David O'Connor with Exane BNP Paribas. Your line is open. Please go ahead.
Great. Good morning, and thanks for taking my questions. Maybe one or two just follow-ups from my side, Hassane, you mentioned about being positively surprised when you came in and start to look at the business. Was there any negative surprises, Hassane, kind of stood for you? That's my first question. And then maybe as a follow-up, the industry has been positively surprised by this foundry [tightness] [Ph]? And how do you think that changes the relationship if at all with foundries in the kind of longer term? Is there anything in terms of securing that capacity that needs to change or just even in the relationship? Thank you.
Sure. It's hard for me to answer the negative surprises because I don't have any. My mind works differently. If I see something that is not what I expected, I look at it as a positive opportunity. So, it's always positive whether it's say surprise or an opportunity. Of course, there are a couple that I just didn't know. I didn't have an opinion one way or another because they are internal. I didn't have the privilege of getting in and looking at non-public information before I joined that I discovered. But, I looked at it as, well, that's part of the reason I took the job is in order to be able to identify all of these opportunities and turn them into positive surprises for us and our shareholders, but I will tell you in general the umbrella that I would answer is there has been a day in the last eight weeks when I woke up thinking what the heck did I just do. It's always been let's go at it. Let's write more things down and let's start executing. That's been kind of the mindset I have had. And really, the response from the team has been tremendous and that's why you see an energized workforce. But important, the results are going to start to show. So, that's on this side.
Now, how do we deal with the long term kind of the industry caught by surprise and so on? It's really once you have a strategy and a five-year outlook with a three-year credible window, then you start having those strategic conversations with your suppliers. And turning the conversation from a tactical to a strategic where if you are able to commit, this is your growth. And you are able to keep their factories not lumpy; up and down. Then you have a much better relationship. I have a lot of these relationships personally. Wei-Chung, who we brought in the head of global manufacturing and operation, has a lot of these relationships. And we are going to strengthen those, but it's all going to start with we as a company what do we want to do strategically and how can they help.
Very helpful, thank you.
Thank you. And our next question comes from the line of Harlan Sur with J.P. Morgan. Your line is open. Please go ahead.
Good morning. Hassane, welcome to the team, and thank you to Bernard for your contribution and support over the past number of years. As part of your strategy, Hassane, focus on high margin, high growth products and markets, I think a key part of that is you lead with certain initial products and then drive further dollar content attached given the breath of the portfolio. What's your assessment of the current sales and marketing, organization and focus, and the ability to cross sell and drive higher attach rates to targeted opportunities?
Yes, I think from our direct sales force and marketing the mindset is there. And my drive for these groups is really adding the focus. If you have a sales force and order marketing, I would call it sales and marketing with a very heavy bag to sell and portion of that bag is not going to drive the value, I would rather lighten that bag and have them really hardcore sell the things that we want them to sell still at a breath [indiscernible] material coverage. That's how I am thinking about it. And that by the way is going to match our distribution. I answered the prior question where our portfolio rationalization is going to drive our distribution footprint. I am going to be looking at distribution the same way I look at our direct sales and marketing. It's going to be how do we maximize the content that I want to maximize.
Yes. Thanks, Hassane. And then maybe if you can just give us your thoughts on the silicon carbide power portfolio. I know the team has been talking about growing portfolio and design win pipeline and [indiscernible] silicon carbide-based power solutions and both automotive and industrial, but wanted to get your views.
Sure. I would put that under one of the positive surprises that I have seen since joining. I think our products are very competitive. I like we are on the technology development for that. And really more importantly is the design wins that we have had in these markets. Obviously as far as revenue drive, as we all know the mix of IGBT versus silicon carbide, we are going to see that crossover probably over the next I don't know four to five years, but we're here, we're playing, and we're going to start taking share based on where our products are going to be. So, I see that as a positive surprise for me. And it's going to be definitely part of the strategic intent that we are talking about.
Great, thank you.
Thank you. And our next question comes from the line of John Pitzer with Credit Suisse. Your line is open. Please go ahead.
Yes, good morning guys. Hassane, congratulations and thanks for letting me ask the question. Hassane, you mentioned earlier that we are all trying to steal your thunder for the August analyst day. And I apologize if this is an attempt. But, you talked about the margin targets that are out there today that they wouldn't change until August. But, in that preamble you also talked about timing to get there was being a big focus. I am kind of curious relative to the existing targets that are out there, how quickly do you think you can get there? And if you could help me understand where the long hanging fruit is versus the stuff that's a little bit harder to deal?
Sure. So, you see already Q1 is a move in the right direction as far as margin. So, I will just tell you that. You are not going to wait until -- we have one more quarter before the August discussion we will have. So, you'll see more progress then. As far as the timing, of course, fab changes will take the longest because it takes time to change your manufacturing footprint between transferring technology and getting customer [indiscernible], but you are also not going to hear me say, "Wait for me for three years before we unwind all of this." We have and there are enough levers for us to make a positive impact on margin. What I am hesitating because I really haven't done the full scope it is the scale of that positive impact we can do in the short-term. And again, all I am asking for is till August. But we are not going to see, oh, yes, we are stuck with manufacturing, so it's going to take a long time. That's not what you can expect. You'll expect something much more favorable.
No, that's helpful. And this is my follow-up. Just going back to your M&A comments, I know you are not going to be too specific. But, I was hoping you could give us some broad strokes of you are thinking about M&A. You clearly created a lot of value at Cypress with the Broadcom IoT acquisition. If you look at the history with ON, there has sort of being this tension between M&A and profitability targets. And often times, the M&A set the profitability targets back. What kind of principal views do you have an M&A around accretion, around the model, around what it means to add to the business?
Sure. There is not really one recipe for M&A. Parallel to when I talk about the strategy for the company, I do have a M&A strategy very specifically that matches up to that, and what do I mean? Some deals are strategic deals where maybe it would not be accretive right in the first year or when we do it or at the synergy. But they are strategic to give us a position in the market that we would like - a leadership position. We're going to be looking at those, for example. There are some that are financial deals where you do a deal because it strengthens your current markets. Or, capability that you are growing organically where you can give adrenaline shot in the arm and accelerate the attainment versus doing it organically.
So, I look at M&A and you've seen it the way we have done it at Cypress, in order to fit a certain purpose and that's the thesis that I formed prior to going into the M&A because if I can explain it to all of our employees, I am sure I cannot explain to all of you out there So focusing on why we are doing it is key. But, we are not going do a bad deal just to do a bad deal. We do have the scale. We have the growth. We have a lot of opportunities for us to create value. So, you're not going to see us rushing doing something just for the sake of doing something, we're going to be very disciplined, but when we do something you can expect that it's going to be to achieve a very specific thesis that is very well aligned with our strategy.
Helpful, thank you.
Thank you. And our next question comes from the line of William Stein with Truist Securities. Your line is open. Please go ahead.
Great, thanks for letting me ask the question. My congrats again to Bernard; and Hassane probably for you, I'm hoping you can dig into the end markets a little bit more in particular, I think we didn't hear about consumer and compute in the quarter, maybe that's a talus to the strategic focus of those end-markets, but maybe you can talk also about the Q1 outlook by end-market a little bit? Thank you.
Sure. Your comment is very accurate. I'm starting to set the stage of where we're going to be, and obviously the Q&A session is very, very long, but it's very also important to kind of set the stage of where we are. But you're going to start expecting these commentary in order for us as a company to start driving the narrative of where we're and what our strategy is, and that's why you didn't see a lot of commentary on as far as some of the end-markets that will gladly take if they support growth at the right margin profile that we have, but what I call, they're opportunistic markets. I'm not going to be delving into a lot of those details moving forward. But if there's anything notable, we'll just tell you regarding that. And that includes kind of given the breakdown, forward-looking guidance by all of these end-markets, I don't think that that dilutes a little bit of what we're doing. So, I want to keep the message on point.
Okay. Maybe then I can ask a little bit about the backlog. We've heard a lot about shortages that stimulate double ordering, because customers get nervous, it sounds like that's not so much happening with your business. But maybe you can give us some idea as to the size of the backlog now and the duration of the backlog relative to what it looks like typically?
So, listen, there's always a risk of double ordering, and we have a lot of metrics, our sales force and our operations team have way more data than I can tell you about how do we trend and make sure that there are inconsistencies between what we expect, what the market tells us, and what the orders on our books are. So, I'll leave it at that, and whatever we see risk of double ordering we pick up the phone and have to engage directly. We don't depend just on the backlog to drive our inventory and our wafer starts. So, we do that, again as a day-to-day. Typically in normal times we don't have to do this, but again, it goes back to the comment I made earlier, when we get an order, I want to make sure to whatever confidence I can, 80%,90%, 100% confidence that it's going to be on a board at a customer that's going to ship to an end-consumer. That's the focus, so we're trying to plow through it, but there are indications of some double bookings that we just ignore, I guess.
Thanks, Hassane, and congrats on the great results and guidance.
Thank you.
Thank you. And this does conclude today's question-and-answer session, and I'd like to turn the conference back over to Parag Agarwal for any further remarks.
Thank you everyone for joining the call today. We look forward to seeing you at various conferences and various [non-deal roadshows] [Ph] for the quarter. Thank you, and goodbye.
Ladies and gentlemen, this concludes today's program. You may all disconnect. Everyone have a great day.