Ladies and gentlemen, thank you for standing by, and welcome to the ON Semiconductor 4th Quarter 2019 Earnings Conference Call. At this time, all participants are in a listen only mode. After the speaker presentation, there will be a question and answer Please be advised that today's conference may be recorded. I would now like to hand the conference over to your speaker today, Parag Agarwal, Vice President of Corporate Development and Investor Relations. Please go ahead, sir.
Thank you, Sydney. Good morning, and thank you for joining ON Semiconductor Corporation's Q4 2019 quarterly results conference call. I'm joined today by Keith Jackson, our President and CEO and Bernard Gutmann, our CFO. This call is being webcast on the Investor Relations section of our website at www.awnsemi.com. A replay of this broadcast along with our 2019 Q4 earnings release will be available on our website approximately 1 hour following this conference call, and the recorded broadcast will be available for approximately 30 days following this conference call.
The script for today's call and additional information related to our end markets, business segments, geographies, channels and share count and 2020 fiscal calendar are also posted on our website. Our earnings release and this presentation include certain non GAAP financial measures. Reconciliation of these non GAAP financial measures to the most directly comparable measures and a GAAP are in our earnings release, which is posted separately on our website in the Investor Relations section. During the course of this conference call, we will make projections or other forward looking statements regarding future events or 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 10ks, Form 10 Qs and other filings with Securities and Exchange Commission. Additional factors are described in our earnings release for Q4 of 2019. Our estimates or other forward looking statements may change and the company assumes no obligation to update forward looking statements to reflect actual results, change assumptions or other factors except as required by law. On August 18, 2020, we will host an event for investment community in New York City to provide a strategic update on our business.
At this event, we will update the investment community on our business strategy and markets. In addition, we will provide information on our manufacturing consolidation plans and economics of our 300 millimeters manufacturing strategy. We will send invitations for the event shortly. Now, let me turn it over to Bernard Gutmann, who will provide an overview of our Q4 2019 results.
Bernard? Thank you, Parag, and thank you, everyone, for joining us today. Following stabilization in the Q3, we have seen improving business trend in the 4th quarter. Order trends continued to improve throughout the quarter. We believe that in addition to the normalization of the supply chain, improving demand across most end markets is driving improved order rates.
Based on our order rates and conversations with customers, we believe that the pace of recovery is moderate rather than a sharp upturn in demand. Macroeconomic data from most major economies is increasingly favorable and industrial activity is showing signs of modest improvement. At the same time, we are cognizant of the potential risks arising from the emerging coronavirus crisis and we are diligently monitoring this rapidly evolving situation. Our traction in our key strategic markets continues to accelerate and our design win pipeline continues to grow at a rapid pace. Our content is fastest growing segments of automotive, industrial and cloud power markets continues to increase.
Our customers are adopting our solutions for industrial, automotive and cloud power market at an accelerated rate. We believe that a highly diversified customer base, growing content in fastest growing applications in the semiconductor market and long life cycle of many of our products should enable us to continue to outperform most of our peers. To accelerate our progress towards our gross margin target, we have begun to make structural changes to our manufacturing footprint. This morning, we announced that we are exploring the sale of our 6 inches fab in Belgium. We will provide updates on financial impact of these actions as we firm up our production transition plans.
Keith will further expand on our plans for the Belgium fab later during this call. Along with making structural changes to improve our gross margin, we are streamlining our investments in various markets. Towards this end, we took limited restructuring actions in the Q1 to reduce our operating expenses by approximately $25,000,000 per year. We should begin to see nominal impact of this action in the Q2 of 2020, and full impact should be apparent by the Q4 of 2020. Now, let me provide you additional details on our Q4 2019 results.
Total revenue for the Q4 of 2019 was 1,402,000 dollars a decrease of 7% as compared to $1,503,000,000 in the Q4 of 2018. The year over year decline in revenue was primarily driven by well publicized microeconomic and geopolitical factors, which have affected the overall semiconductor industry. GAAP net income for the Q4 was $0.14 per diluted share as compared to a net income of $0.39 in the Q4 of 2018. Non GAAP net income for the Q4 of 2019 was $0.30 per diluted share as compared to $0.53 in the Q4 of 2018. GAAP and non GAAP gross margin for the Q4 of 2019 was 34.6% as compared to 37.9% in the Q4 of 2018.
4th quarter gross margin was lower than our expectation due to the combination of certain transitory mix and operational issues. We had unexpectedly high demand for our low margin product line in our consumer segment during the Q4. We expect this strong demand to continue in the Q1 as well. We intend to either discontinue this product line or significantly raise prices after the Q1. On the operations front, we had certain facilities related to scrap issues.
We expect these issues will be resolved by the end of the Q1 of 2020. In the near term, we expect to see headwinds from fixed costs to our gross margins. As you are aware, we expanded our manufacturing capacity in 2018 2019. However, revenue has lagged our expectation due to well under we are now facing underutilization charges and higher depreciation expenses. We expect revenue growth in 2020.
With expected revenue growth in 2020, we should be able to offset the impact from underutilization and depreciation. We expect higher than 50% incremental gross margin for 2020 starting in the Q2 of the year. Our GAAP operating margin for the Q4 of 2019 was 9.9% as compared to 14.8% in the Q4 of 2018. Our non GAAP operating margin for the Q4 of 2019 was 12.3% as compared to 16.8% in the Q4 of 2018. The year over year decline in operating margin was largely driven by lower gross margin.
GAAP operating expenses in the 4th quarter were $347,000,000 flat as compared to those for the Q4 of 2018. Non GAAP operating expenses for the Q4 were $314,000,000 as compared to $317,000,000 for the Q4 of 2018. Recall that our 2019 operating expenses included more than 2 quarters of expenses from our acquisition of Quantenna Communications. The year over year decline in 4th quarter operating expenses was driven by aggressive expense control and 0 bonus accrual. The 4th quarter free cash flow was negative $21,000,000 and operating free cash flow was 92,000,000 dollars The 4th quarter free cash flow and operating cash flow were negatively impacted by the one time payment of approximately 175,000,000 dollars to Power Integrations for previously disclosed settlement of intellectual property litigation.
Capital expenditures during the Q4 were $112,000,000 which equate to a capital intensity of 8%. Going forward, we anticipate that a sizable part of our CapEx will be spent on enabling our 300 millimeter East Qishkil fab. We exited the Q4 of 2019 with cash and cash equivalents of $894,000,000 as compared to $929,000,000 at the end of the Q3 2019. At the end of the 4th quarter, days of inventory on hand were 123 days, down by 5 days as compared to 128 days in the Q3 of 2019. Distribution inventory increased slightly, but is within our comfort zone.
The increase was driven by specific customer programs. Now let me provide you an update on the performance of our business units, starting with the Power Solutions Group or PSG. Revenue for PSG for the 4th quarter was $696,000,000 Revenue for the Advanced Solutions Group, previously known as Analog Solutions Group, for the 4th quarter was $507,000,000 and revenue for the Intelligent Sensing Group was 199,000,000 Now I would like to turn the call over to Keith Jackson for additional comments on the business environment. Keith?
Thanks, Bernard. I will start by reviewing our progress in 2019 and then touch on our objectives for 2020. Despite the macroeconomic and geopolitical challenges faced by the semiconductor industry in 2019, our execution was solid and we expect to outperform most of our peers in the analog and power semiconductor group. Our performance in 2019 clearly demonstrates the transforming nature of our business and the strength of our business model and execution discipline. Our exposure to secular megatrends in automotive, industrial and cloud power end markets has enabled us to outgrow most of our peers.
Despite macroeconomic and geopolitical headwinds, key secular megatrends driving our business remain intact. Our content in the fastest growing applications in automotive, industrial and cloud power applications continue to grow and we continue to strengthen our leadership in key markets such as ADAS, power management for servers and 5 gs infrastructure and high power solutions for electric vehicles. We announced our plan to acquire our first 300 millimeter fab and we expect to start production of our power products at this facility soon. Also in 2019, we closed our acquisition of Quantenna Communications and we are making solid progress toward launching connectivity solutions for the industrial IoT applications. While we are pleased with our performance for 2019, we understand the need to take aggressive, substantial and immediate measures to accelerate our progress towards our margin targets.
As Bernard indicated earlier, we announced this morning that we are exploring the sale of our 6 inches fab in Belgium. We are looking for partners that are willing to enter into an arrangement on mutually beneficial terms that enable smooth and orderly transition for both parties. Our fab in Belgium is an attractive manufacturing asset with robust toolset and highly skilled workforce. It is automotive qualified and its proximity to the world's leading automotive innovation and manufacturing hub is very compelling attribute. We believe that our 300 millimeter East Fishkill fab affords us significant flexibility in optimizing our front end footprint and we will continue to work to improve the efficiency of our manufacturing network.
Recall that in our Q3 20 nineteen earnings conference call, we announced that we had initiated a process of closing down our 6 inches fab in Rochester, New York. We're making strong progress towards ramping production at our 300 millimeter fab in East Fishkill. At this point, we are tracking significantly ahead of schedule and now we expect to begin initial production in the middle of 2020 as compared to our previous expectation to begin in the latter half of twenty twenty. The results and yields of initial wafer runs have been spectacular. Based on our experience thus far with the East Fishkill fab, we're even more confident that the transition of production to this fab will be a major inflection point for our manufacturing cost structure as we consolidate our front end network.
We will provide further details on the financial impact of our 300 millimeter fab transition at our strategic business update on August 18 in New York. In addition to making structural changes to our operational cost structure, we have taken measures to optimize our operating expenses. As previously discussed, we took limited restructuring actions to streamline our investments in certain markets, and these actions are expected to result in annual savings of approximately $25,000,000 A reduction of approximately $25,000,000 per year should accelerate towards our target operating expense intensity of 21%. Let me now comment on the current business environment. We saw moderate improvement in our order rates in the 4th quarter and improvement has continued thus far in the current quarter.
We believe that this improvement is driven by improving macroeconomic and geopolitical conditions and normalization of the supply chain inventories. Macroeconomic data from most geographies suggest improving GDP outlook and modest improvement in manufacturing activity. Data from China pointing towards relatively resilient manufacturing activity has been especially encouraging. Based on publicly available data and inputs from our partners, we believe that the current inventory levels are in line with our near term demand outlook. While we are encouraged by near term trends, we are fully aware of risk emerging from the ongoing coronavirus crisis and we are diligently monitoring this rapidly evolving situation.
Despite the gyrations in macroeconomic and geopolitical environment, we remain focused on our key strategic markets. At the same time, we are making substantial measures to make structural changes to our manufacturing footprint with the goal of expanding our margins and further improving our leading cost structure. We believe that automotive, industrial and cloud power will be the fastest growing semiconductor end markets for the next 5 years. With highly differentiated portfolio of power, analog, sensor and connectivity products, we are well positioned to outgrow the semiconductor industry as we grow our content in the fastest growing applications in our strategic markets. Furthermore, with improving operational efficiency, we expect to meaningfully expand our margins and grow our free cash flow.
Now I'll provide details of the progress in our various end markets for the 4th quarter of 2019. Revenue for the automotive market in the 4th quarter was $462,000,000 and represented 33% of our revenue in the 4th quarter. 4th quarter automotive revenue declined 3% year over year. Although our automotive revenue declined year over year, we continue to see improving trends in the market with ongoing recovery in China. Our momentum in ADAS and vehicle electrification continues to accelerate.
During the Q4 of 2019, we secured design wins for key platforms for ADAS and in cabin viewing applications. Our design funnel for ADAS continues to expand at a robust pace. As we noted in our previous earnings call, we have won 16 of the 17 2 megapixel and 8 megapixel platforms awarded in 2019 for level 2 Level 2 and Level 3 vehicles. Our LiDAR and radar products are gaining strong traction. Our design funnel for these products continues to expand at a rapid pace.
We believe that we are enabling democratization of LiDAR with a solid state solution, which is a fraction of the cost of other existing solutions. Our low cost advantage is enabled by a CMOS based architecture as opposed to that based on exotic materials. Based on our design win pipeline, we expect to have leading share with the top 5 global lidar module makers. In addition, customer feedback on our radar solutions has been very positive and we have emerged as a key contender for upcoming round of design wins. Based on our engagement with leading radar Tier 1 integrators, we expect to gain a very meaningful share in this market as the next round of designs are announced.
On vehicle electrification front, our engagement for silicon carbide modules with major global automakers continues to grow. We are seeing a strong ramp of our IGBT modules for drivetrain of electric vehicles in Asia and in Europe. And based on our design wins and backlogs, we expect continuing acceleration in this ramp during 2020 beyond. We are beginning to see a ramp in analog power management for ADAS Processors. We are engaged with all the leading processor providers for the automotive ecosystem and expect strong revenue contribution from this product line.
We expect to see strong growth in our analog power management solutions for instrument clusters in vehicle networking and advanced lighting. Revenue in the Q1 of 2020 for the automotive end market is industrial end market, which includes military, aerospace and medical contributed revenue of $344,000,000 in the 4th quarter. Industrial end market represented 25% of our revenue in the 4th quarter. Year over year, our 4th quarter industrial revenue declined 12%. While macroeconomic data points to moderately improving manufacturing activity, we haven't seen significant improvement in order activity from our industrial customers.
It appears that industrial customers are still in the process of realigning their inventories. Despite soft end market condition, key secular trends driving our business remain intact. We're seeing strong traction for our silicon carbide modules, and we have commenced shipments of these modules to leading global industrial OEMs. An emerging area of growth for industrial business is e commerce. We have built a strong design win pipeline for our CMOS image sensors for warehouse automation and delivery robots.
We are engaged with leading e commerce retailers on many programs and we expect strong contribution from this segment of the industrial market. Revenue in the Q1 of 2020 for industrial end market is expected to be flat to down slightly quarter over quarter. The communications end market, which includes both networking and wireless contributed revenue of $289,000,000 in the 4th quarter. The communications end market represented 21% of our revenue in the 4th quarter. 4th quarter communications revenue declined 3% year over year.
The decline was primarily due to weakness in our smartphone related business. On a quarter over quarter basis, we saw strong growth in our smartphone business in the 4th quarter, but 5 gs related business was weak as customers continued to realign their inventories. Revenue in the Q1 of 2020 for the communications end market is expected to be down quarter over quarter. The computing end market contributed revenue of 100 and $53,000,000 in the 4th quarter. Computing end market represented 11% of our revenue in the 4th quarter.
4th quarter computing revenue declined 8% year over year. We continue to see strong momentum in our server related computing business. On a sequential basis, we saw growth in our client computing business driven by improved supply of Intel processors. Revenue in the Q1 of 2020 for the computing end market is expected to be down slightly quarter over quarter. We expect that strength in our server business should help mitigate the impact of normal seasonality.
The consumer end market contributed revenue of $153,000,000 in the 4th quarter. The consumer end market represented 11% of our revenue in the 4th quarter. 4th quarter consumer revenue declined by 10% year over year. The year over year decline was due to continuing broad based weakness in consumer electronics. On a quarter over quarter basis, revenue for consumer end market was flat as compared to our expectation of a decline due to previously discussed unexpected demand for a low margin product line.
Revenue in the Q1 of 2020 for the consumer end market is expected to be down quarter over quarter. In summary, we are taking substantial actions to make structural changes to our cost model with the goal of accelerating our progress towards our target financial model. At the same time, we have accelerated the timeline for production ramp at our 300 millimeter fab as we now anticipate that initial production will start in the middle of 2020 as opposed to our prior expectation of the second half of the year. Secular megatrends driving our business remain intact and we are upbeat about our medium to long term prospects. We are focused on the fastest growing end markets of the semiconductor industry and with our automotive, industrial and cloud power applications will continue to grow.
Our performance in 2019 clearly demonstrates the transforming nature of our business, strength of our business model and execution discipline. Now I'd like to turn it back over to Bernard for forward looking guidance. Bernard?
Thank you, Keith. Our guidance for the Q1 of 2020 does not include the impact from potential supply chain disruption resulting from prevailing coronavirus crisis. As we indicated earlier, we are diligently monitoring the situation, but at this time, we don't have enough information on potential impact on our business from this rapidly evolving crisis. Based on product booking trends, backlog levels and estimated turns levels, we anticipate that whole on semiconductor revenue is expected to be in the range of $1,350,000,000 to 1.45 $1,000,000,000 in the Q1 of 2020. For the Q1 of 2020, we expect GAAP and non GAAP gross margin between 33.7% 34.7%.
The quarter over quarter decline in Q1 gross margin is driven primarily by the annual contract pricing reset. We expect total GAAP operating expenses of $357,000,000 to $377,000,000 Our GAAP operating expenses include the amortization of intangibles, restructuring, asset impairments and other charges, which are expected to be in the $30,000,000 to $34,000,000 We expect total non GAAP operating expenses of $327,000,000 to $343,000,000 in the Q1. The anticipated quarter over quarter increase in GAAP and non GAAP operating expenses is primarily driven by the acceleration of process transfer activity at our 300 millimeter fab, the resumption of variable compensation accrual for 2020 and the end of tactical expense control measures in the Q4 of 2019. We anticipate the Q1 2020 GAAP net other income and expenses, including interest expense, will be $38,000,000 to 41,000,000 dollars which includes non cash interest expense of $9,000,000 to $10,000,000 We anticipate our non GAAP net other income and expenses including interest expense will be in the $29,000,000 to $31,000,000 Net cash paid for income taxes in the Q1 of 2020 is expected to be $14,000,000 to $18,000,000 We expect total capital expenditures of $125,000,000 to $145,000,000 in the Q1 of 2020. We currently are targeting an overwhelming proportion of our CapEx for enabling our 300 millimeter fab at an accelerated pace.
We expect our CapEx intensity to subside in the latter half of the current year. We also expect share based compensation of $19,000,000 to $21,000,000 in the Q1 of 2020, of which approximately $2,000,000 is expected to be in cost of goods sold, and the remaining amount is expected to be in operating expenses. This expense is included in our non GAAP financial measures. Our GAAP diluted share count for the Q1 of 2020 is 18,000,000 shares and our non GAAP diluted share count is expected to be 413,000,000 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 Forms 10Q and Form 10 ks, respectively.
With that, I would like to start the Q and A session. Thank you. And Sydney, please open the line for questions.
And our first question comes from Ross Seymore with Deutsche Bank. Please proceed with your question.
Hi, guys. Thanks for letting me ask a question. It's good to see the revenue side turn in the corner, and I think that's an important step. But the gross margin side is a big concern for a lot of investors. So Bernard or Keith, talk a little bit about the greater than 50% incremental fall through going forward.
Any sort of scale on that? Revenues look like they should be up Q2 year over year. Will gross margins take a big step up? And when will some of these fixes really start to be shown on the gross margin side as you work your way towards that 4 handle target that you have?
So a couple of comments. Thank you, Ross. We do expect greater than 50% fall through as revenue resume normal seasonality patterns in the Q2, as we mentioned in the call. We also have certain one off transitionary items that affected us mix wise and factory wise that we expect to subside by the end of the Q1 and that will also allow us to grow at better than 50% fall through in the Q2. Also, let me remind you that we have about probably 30 to 40 basis points improvement starting in the Q2 due to the elimination of the low margin OSA contract.
So and as we mentioned, we are exploring the sale of our 6 inches facility in Belgium, which eventually will also result in some very nice tailwinds for our gross margin. We are quite confident about our secular drivers for growth on the top line in automotive, industrial and 5 gs. So we expect to see some pretty good resumption of our growth. And furthermore, we do feel very good about how the qualification is going at the 300 millimeter fab, which will also be a tailwind as we move further into 2020 2021.
Thanks for all those details. And I guess as my follow-up, moving on to the OpEx side and sticking with the margin target side, I get that you were squeezing things tight at the end of 2019 and some of the variable costs come back into the equation, but it still seems like a pretty big step up. How should we think about the $25,000,000 of cuts coming out? Even with that, it still seems like you're going to be a bit above where most of us had expected to be. So any trajectory and kind of color on when you can get to that 21% OpEx intensity target will be helpful.
Well, we have that laid out for 2022. We are still absorbing the Quantenna OpEx, which is higher than what we had been running. So that has been a reason for being higher. Definitely taking out $25,000,000 should help us get closer by the end of 2020. But we should be looking at 2021 before we can get to that 21% level.
Thank you.
Thank you. And our next question comes from Chris Danely with Citi. Please proceed with your question.
Thanks guys. Just a couple more questions on gross margins. So how big was the impact of the low margin product that
kind
of ballooned up? And then how big was the facilities and scrap issues impact? And then what exactly were the facilities and scrap issues that you had?
So we're not getting into a lot of those details, but I can say that the mix between like the underutilizationdepreciation versus the one off items is about half and half.
Okay, great. And then on the sale of the Belgian fab, generally there's a lot of like stuff like that associated with doing anything over in Belgium. Is there like a way to work around that? Or what's sort of the plan on getting through the costs associated with doing something with FAB?
Yes. So, Chris, we're looking at a similar arrangement that we've made both in Gresham and East Fishkill where we find an interested party who will be ramping the facility as we exit it. And so and that's a sales situation, you don't encounter any kinds of exit costs that you're referring to.
Got it. Okay. Thanks, guys.
Thank you. And our next question comes from Vivek Arya with Bank of America. Please proceed with your question.
Thanks for taking my question. I had a few on margins as well. First, at what revenue level do you expect to get back to your historical 36%, 37% gross margins? And do you think getting to those kind of gross margins is possible in Q2 or Q3 of this year?
Again, if you take the 50% fall through or better than 50% fall through, we should be able to get back to those levels in the rest of the year for 2020.
Got it. And for my follow-up, I think you mentioned some contract price reset in Q1. I'm curious how were those negotiations this year relative to prior years, because there does appear to be somewhat of a gross margin hit. And I think one of the challenges we are facing is to try and discern how much of the gross margin Q1 gross margin is because of that contract pricing versus underutilization trends. So if you could quantify how much of this Q1 gross margin, right, roughly 200 basis points or so below trend, how much of that is because of pricing versus how much due to the underutilization trends?
Thank you.
So as you know, we have a good amount of our annual contracts for OEM that are reset once per year. So we see as a result of that a once per year bigger impact. Our characterization is that the contract pricing has been pretty normal as compared to historical trends.
And any impact from underutilization? Is there a way to quantify that? And when will that disappear?
We definitely need revenue increases to help us absorb that underutilization. So if we have normal seasonal patterns, we should see some good recovery in the Q2 and beyond.
Thank you.
Thank you. And our next question comes from Chris Caso with Raymond James. Please proceed with your question.
Hi, thank you. Good morning. Just to clarify one of the other comments that you made regarding the unutilization charges. Is what you're saying is that, that was one of the contributors to the gross margins being below what you had expected? I think you said it was about half and half.
I guess I don't fully understand why on utilization charges be more than expected if revenue came in with slight upside? Were there changes in production during the quarter? Just some clarification please.
Yes. So a couple of comments there. One of them is we did also reduce inventories in the quarter. And the second thing, our mix of external versus internal was not was more a little bit more towards external, which hasn't helped us has caused the underutilization to be bigger and that was based on the mix of products we had the demand for.
Okay. I guess what a lot of us are struggling with the go forward is kind of understanding gross margin issue that you saw and that was kind of short term and transient gets better as the
year goes, it's much persistent.
As you said, the 50% plus incremental gross margins, I think typically you said in the past, 50% is what you get just on increasing revenue and better fixed cost absorption. So is at some point during the year, some of these transient issues go away and we sort of see step up in gross margins and then you get back to that 50% rate? Just some clarification around that.
Yes. We said that these transitionary items should last Q4 and Q1. And after Q1, the for the most part disappear.
So we should see some degree of step up as you go into Q2, therefore?
That's correct.
Okay. Thank you.
Thank you. And our next question comes from Rajeev Gill with Needham and Company. Please
If we kind of look past the temporary impacts to gross margins and kind of look some of the margin tailwinds that could occur in your business. Can you discuss in terms of the impact of qualifying to the 300 millimeter fab, how much kind of cost benefit increase in utilization rate you think you'll get as you start to transition more process flows to that 300 millimeter fab? And any color in terms of the sale of the 6 inches facility in Belgium, what that will do in terms of COGS? What percentage of that manufacturing is of your internal manufacturing? Just any color there in terms of trying to weigh the importance of that?
Yes. I'll give you kind of directionally the impacts that you're referring to. We'll give the specific models in August when we're ready to do that. The 300 millimeter factory, as we mentioned, is going to allow us to get some very cost effective products to the market. We expect to see some nice and quick ramp there.
So back to Bernard's comment on more than 50% fall through, we think that's a strong contributor to that in the second half of the year. It also enables us to do more in sourcing in the factory rationalizations, selling of the Belgium factory also will contribute to that. We are not going to give specific numbers at this time, but all of those are factors that give us confidence in a much better than 50% fall through as you go through the year.
And just to follow-up on the margins again, and you might have touched on this, but how low is the gross margin percentage for those consumer products? And any color on what those products were and why?
We're not going to get into details by product line, but definitely we're substantially below the corporate average.
Okay. Thank you.
Thank you. And our next question comes from Vijay Rakesh with Mizuho. Please proceed with your question.
Hi, guys. Just following up on gross margin again. I know you talked about lowering inventories through the quarter, but also it looks like year on year also it was a headwind in terms of utilization. But just wondering in the past year given utilization numbers, if you had some thoughts on where utilizations were in Q4 that you expect in Q1 and how you expect that to progress?
So in general terms, we expect flattish utilization in Q1.
Got it.
And on the industrial side, you mentioned there's still some realignment of inventory going on. How do you do you expect that alignment to be mostly done as you go through Q1? Do you expect industrial to kind of return to some sort of growth in the back half?
We think so. We don't know for sure, but our expectation is by the Q2 and definitely by the back half of the year, it should be done. Thanks.
Thank you. And our next question comes from Christopher Rolland with Susquehanna. Please proceed with your question.
Hey, guys. Thanks for the question. About the consumer product again, what were the dynamics for the product? Was this a last time buy? Or are you kind of expecting more after Q1?
And the reason I ask is, it ties into the bigger picture story for ON. For the last decade, you guys have been talking about moving up the value stack with your products and the gross margins would follow. This seems like it's a product that was probably not price optimized considering at volume it does not have the margin profile that you want. So I guess are there opportunities to review your entire product line to optimize pricing and eventually help the margin structure or even shutter some of these really low margin businesses? Thanks.
Yes. Thank you. So really the story there, you've seen the weakness in industrial, which is our highest margin businesses in the company. At the same time, we had unexpected strength in the consumer segment. It is a segment that we were controlling pretty tightly, but we had some very strong demand for both Q4 and Q1 of 2020 deliveries.
We have now taken the steps we need to dramatically change the profile there and expect it to not continue past Q1 from a margin inhibitor. So we do expect if you get Q2 onward, you'll see continued reduction in the consumer profile and increase in the industrial.
Okay, great. And on the distributor side of things, I think you said distributor inventories increased. I think the last update we had was maybe 11 to 13 weeks there. Maybe if you could give us an update there? And then also you talked about increases from specific customer programs.
Maybe you could describe those programs and whether they're related to some of the changes at TI, for example?
So in general terms, what we said is the inventories increased, but we're still within our comfort zone where we like to operate at. I can't comment definitely on the customer programs, but they were differently linked. Some of the increases were linked to those programs.
Thanks, Chris.
Thank you. And our next question comes from Craig Ellis with F. B. Riley. Please proceed with your question.
Yes, thanks for taking the question. It's B. Riley, FBR. Bernard, I wanted to go back and take a longer term look at gross margin. So from the level that we're guided to in the March quarter, we've got a 900 basis point gap to around 30% target level.
What I'm hoping you can do is just help characterize the trajectory of getting there. How linear is it towards target? How much of that gap is closed as we go through 2020 2021? And what are the big levers that you have to move the needle?
They are the same that we have enumerated in our Analyst Day. The fall through on incremental revenue definitely plays a significant role and that was definitely a headwind in 2019 and expect that that will resolve itself with better macros in the rest of the planning period. So we expect to get back into a nice growth rate, which will help us get some pretty good growth rates. The structural changes we're making in manufacturing as well as the ramping of the 300 millimeter fab should help us achieve the 130 or more basis points that will come from manufacturing cost savings. The secular growth drivers where we are expecting to grow faster in high margin end markets is also a contributing that should be fairly gradual over time.
Again, as we mentioned in the short term, we took some step back with this one off consumer thing. But in the long term, we expect the mix to continue being a significant contributing factor. And we will continue doing the portfolio managing, which has allowed us to divest consulting businesses that will continue helping us on that front. So it's the same ones that we have talked about. It will definitely take us a good amount of revenue growth.
It will take us to execute on our manufacturing cost savings, including the 300 millimeter fab and the mix.
But just to clarify that, the drivers are the same, but the gap is much more significant than it was when the target was first established. So which of those variables do you think you can get incremental leverage on so that we can close that gap and make it to 43%?
I think there is a good chance that we can do more on the manufacturing front. We have a good amount of tools that we can do and flexibility with the new capacity we have for the 300 millimeter. But definitely, we need the revenue and the target model was predicated on the of pressure on in terms of getting it done in the timing that we need.
That's helpful. And then the follow ups for Keith. Keith, we're seeing good automotive growth since the Q2 of last year. Is your sense that we're on a sustainable growth trajectory? And then switching gears on industrial, it seems like that business has continued to ease down.
No surprise maybe given global ISMs, but is your sense that industrial set a bottom here in the March quarter? Or do you think there's some further risks just given the different dynamics that you see? And to the extent that it is the bottom, what kind of recovery trajectory you see from the industrial?
Yes, I'll cover both automotive and industrial. The automotive piece, I think there is a feeling that we may see a return to more positive there. I think a lot of the dynamics is going to be accelerating more of the vehicle electrification at faster rates than we've seen in the past, which has a very large increase in our content, which gets us pretty excited about seeing a lot of good growth in automotive as we go through 2020. The industrial side has been weak and it is generally the portion of the business that reflects kind of the GDP side of the equation. We do see that bottoming out.
We're starting to see order patterns pick up. And like all of the sectors, the inventory piece appears to be getting back in control. So I would expect to see the industrial side start picking up again in the Q2.
Great. Thanks, Keith.
Thank you. And our next question comes from Mark Lipacis with Jefferies. Please proceed with your question.
Hi, thanks for taking my questions. The just going back to the strong demand for the lower gross margin products. So the options sound like it either discontinue or increase the ASPs. I just wanted to explore that. So in the process if the decision is made to discontinue, is that because the lower gross margin products also are lower operating margin products also?
Is it total lower profitability and you just want to get out of that business? Would that be the rationale? And if you decided to discontinue, would that hit your utilization rates and then cause a continued challenge for fixed cost absorption or are these outsourced products? That's the first question. So thanks.
So I would say the answer is yes. This is both gross margin and operating margin in terms of crown. Definitely raising prices helps significantly and it is outsourced.
Okay. Got you. That makes sense. Okay. And then on the Keith, you mentioned resilient manufacturing activity in China.
Is this were there particular end markets there? And do you have a sense of the extent this is due to a restocking further downstream or if you had any read that this is real end market consumption that's happening? Thanks. That's all I had. Yes.
No, this is broad based in China and I think it's reflecting the inventories being back in line and still seeing economic growth in China. So I think it's just basically removing some of the headwinds there and it's pretty broad based.
Got it. Very helpful. Thank you.
Thank you. And our next question comes from Harlan Sur with JPMorgan. Please proceed with your question.
Good morning. Thanks for taking my question. On the improving business trends, could you just describe demand by geography? Last quarter, I think you guys saw some improvements in auto in China, continued weakness in EMEA, stabilization in U. S.
Did you guys see the demand profile by GEO start to broaden out in Q4 and here in Q1?
So not a lot of change, some incremental weakness in Europe, incremental strength in China and the U. S. And the rest of the world pretty much on par with what we saw in Q3 early Q3 and Q4.
Great. Thanks for that. And Bernard, on the higher OpEx base starting the year, combined with the restructuring actions announced today, how should we think about the progression of OpEx as the year unfolds?
Yes. So I would expect OpEx to be definitely not higher than Q1 and flat trending towards slightly down.
Thank you.
Thank you. And our next question comes from Ambrish Srivastava with BMO. Please proceed with your question. And our next question comes from David O'Connor with Exane BNP Paribas. Please proceed with your question.
Great. Good morning. Thanks for taking my question. Maybe if you could go back to the 300 millimeter, the East Fischal, the initial production there seems now mid-twenty 20. We pulled that in a bit.
How aggressively, Keith, will you ramp East Fischl? And what type of products are driving the initial ramp there? And maybe then related to that, Bernard, can you remind us how much of the business is outsourced today and how much of that could be insourced as you ramp East fishfield?
Yes, the our 300 millimeter ramp will be driven largely by medium voltage MOSFETs, where we see a great deal of demand pickup in our automotive designs for vehicles of all sorts actually and in the industrial sector across all the segments. So it is one of the high growth areas and we're seeing good demand pickup in the order patterns and so that will be the first part to ramp in 300 millimeter.
So in the external utilization, our model, we like to do 80 inside, 20 outside. Right now, particularly for the front end, we're more in the middle 60s outsourced insourced and middle 30s outsourced.
Very helpful. Thank you.
Thank you. And our next question comes from Mark Delaney with Goldman Sachs. Please proceed with your question.
Yes. Good morning. Thanks for taking the question. I was hoping to understand of the $26,000,000 of synergies that were supposed to be taken out of Quantenna and OpEx. How much of that has been realized so far?
You touch on the OpEx synergies in particular from Quantenna, have those been realized? And then related to that, I mean, I'll just ask my second question now, the new $25,000,000 OpEx reduction plan that was announced, is that entirely separate from the Quantenna synergies or some of that capturing the Quantenna synergies that were previously anticipated?
So they are completely separate programs. One has nothing to do with the other. I would say on the Quantenna, a good portion a good sizable portion of the OpEx has already been realized, and we should see a little bit of dribs or drafts still coming into the 2020. But for the most part, it's all done. And the other one will be all incremental.
Thank you.
Thank you. And our next question comes from Tristan Gerra with Baird. Please proceed with your question.
Hi, good morning. I know your guidance does not include any impact from the Corvid virus, But could you provide some color on what you're seeing so far in terms of factory shutdowns at some of the ODMs and whether there's a risk that there could be some inventory holding? And is some of this potentially benefiting your Q1 revenue outlook? If you could provide any color on what you're seeing, understanding it's still very early in the process?
Yes. It's developed rapidly and the changes have been quite quick. We don't think there was opportunities for any inventory hoarding prior to any actions going on in China. What we have seen is request in China for factories to remain shut down after Chinese New Year longer than they normally would be. It looks like it's approximately a week.
And of course, there is some capacity slack in the system as we've been talking about, utilizations are not full. So we anticipate most people will be looking to recover that extra shutdown during the Q1. So at this stage, really don't have much more visibility than that, but it doesn't look like it will be significant impact at least based on today's data.
Okay, great. And then sorry if I missed it, did you mention what percentage of capacity will be removed from the fab in Belgium?
We didn't no, we didn't have a number yet.
Okay. Thank you.
Thank you. And our next question comes from Gary Mobley with Wells Fargo Securities. Please proceed with your question.
Hey, guys. Thanks for taking my question in. Let's go back to the automotive side of the business. And if I'm not mistaken, in years past, you've talked about having roughly 7% automotive sales growth against a flat SAAR environment. That appears to be the consensus view as it relates to auto sales in 2020.
So against that backdrop, are you confident you can see that mid to high single digit percent growth in your specific auto sales?
We are and we think if we look at the numbers in 2019, it supported that type of rate. The comments I made earlier today though, I think there's more acceleration toward the hybrid and electric vehicles. So that might actually get better for us as we go through 2020. So we are expecting that high single digit or better this year.
Okay. And I just had
a follow-up question. I just want to verify for distribution, was the sell in greater than the sell out during the quarter?
Very slightly.
All
right. Thank you, guys.
Thank you. And our next question comes from Ambrish Bhusraw with BMO. Please proceed with your question.
Hi. Can you hear me, guys?
Yes.
Yes. Yes, sorry about that. I just wanted to get back to gross margin and I'm not sure I caught the response to an earlier question on the quantification of the 3 different factors. How much of underutilization also contributed? And then I'm not sure I understood this, but are the underutil charges going to go away as we go into Q3 or there's going to be lagging underutilization charges in Q3 as well?
So what we characterize this is we said about half of the issues were underutilizationdepreciation and half were transitionary one off items. There is a small lag in terms of the impact of underutilization impacts the quarter. But for the and obviously, it will depend on how strong seasonally the Q2 is in terms of the rebound of revenue, which will dictate how much the utilizations will be.
Okay. Thank you for that clarification.
Thank you. Our next question
comes from John Pitzer with Credit Suisse. Please proceed with your question.
Yes, good morning guys. Thanks for letting me ask
the question. Just wanted to follow-up to the extent that you end up getting out of some businesses
in the consumer sector going into the Q2, for modeling purposes, is there any way to try to quantify what the impact might be to revenue going into the June quarter maybe relative to seasonal?
We're still expecting seasonal or better behavior as we go through this year. As I mentioned, we're through we think we're through the inventory correction phase. And so you should be seeing in a relatively stable economic environment, you should be seeing a better performance this year without those headwinds. And so we're really not attributing a significant lessening of that with the consumer
business. That's helpful. And then guys, probably shouldn't be that important because it doesn't impact free cash flow. But Bernard, I'm just kind of curious, as you march towards that 40 plus percent target for gross margins, how do we think about depreciation from the December quarter levels? What does CapEx look like, especially as you start to really facilitate and build out East Fishkill?
So basically, what we said from the CapEx point of view, we guided for $125,000,000 to $145,000,000 for the very short term for the Q1 and said that a good portion of that CapEx is devoted towards the 300 millimeter fab. And then we expect that to taper off throughout the year and go to a lower level in 2021. At this stage, I would expect CapEx and depreciation to converge and be pretty much aligned. So I don't expect any significant amount of increased depreciation on our P and L as we normalize the CapEx.
And our next question comes from Shawn Harrison with Longbow Research.
Keith, the commentary on a return to normal seasonality, does that also apply to kind of the 5 gs infrastructure related portion of the portfolio?
Yes. So I think, again, the comments are similar. I think the inventory absorption piece is on track to be behind us here in Q1. So I would expect that to also look much more seasonal. However, secularly, it's going to grow.
And so you should see basically no headwinds to that growth as you get through this year go through this year.
And then as a follow-up, Bernard, I know on a dollar basis, the cash tax has not much changed from the Q4, but it's up on a percentage basis. I just maybe any dynamics here in the March quarter associated with that or how it tracks maybe on a percentage basis or dollar basis post the March quarter?
Yes. So CapEx cash CapEx, it's virtually its nature is lumpy. So I would say that Q1 is a little bit on the a tax sorry, tax is lumpy. And it is in the $14,000,000 to $18,000,000 range for Q1. We expect for the year to be 10% or less as a percent of profit.
But again, it is a little bit lumpy.
Thank you.
Thank you. And our next question comes from Chris Danely with Citi. Please proceed with your question.
Hey, thanks guys. Just a quick follow-up on the consumer gross margin issue. Did Chinese competition have anything to do with the gross margins either from Nexperia or somebody else out there?
No, not at all. This was just a business that we thought was going to decline and then there was a surprise upside. So it had nothing to do with any new competitive dynamics.
Okay. Thanks, Keith, for taking the follow-up.
Thank you. And our next question comes from Craig Hettenbach with Morgan Stanley. Please proceed with your question.
Yes, thanks. Keith, just thoughts on
the end markets for 2020. It sounds like you said kind of autos, high single digit growth could kind of lead, industrial near term is lagging a bit, but just as you see over the course of the year kind of the puts and takes but by end market?
So on the industrial side, yeah, we think it's still lagging right now, primarily the portions of that that go into new factory buildings and new residential buildings that has been kind of the drag piece. The medical piece that's in there has been strong and growing quite nicely. We expect that trend will continue in our Milero piece has been holding up quite well. So the change that we're looking in the industrial side are twofold. 1, we think the energy infrastructure will be a secular positive.
We're seeing more solar installations, wind installations. We see growth in that as we go through this year. And then on the building side, hopefully, we will have cleared through all the inventory here in Q1, and you will see a return to normality from a seasonality perspective after that.
Got it. Thanks.
Thank you. I'm not showing any further questions at this time. I will now turn the call back to Parag Agarwal for any further remarks.
Thank you everyone for joining the call today. We hope to see you at various conferences during the quarter. Goodbye.
Ladies and gentlemen, this concludes today's conference. Thank you for participating. You may now disconnect.