Good day, ladies and gentlemen, and welcome to the ON Semiconductor business update conference call. At this time, all participants are in a listen-only mode. Following management's prepared remarks, we will host a question answer session, and our instructions will be given at that time. If during the conference you require operator assistance, press star then zero, and an operator will be happy to assist you. As a reminder, this conference call may be recorded. I would like to turn the conference now over to Parag Agarwal, Vice President of Corporate Development and Investor Relations. Sir, you may begin.
Thank you, Brian. Good afternoon, and thank you for joining today's conference call. I'm joined today by Keith Jackson, President and CEO of ON Semiconductor, Sam Heidari, President and CEO of Quantenna Communications, and Bernard Gutmann, EVP and CFO of ON Semiconductor. This call is being webcast on the investor relations section of our website at www.onsemi.com. A replay of this broadcast will be available on our website approximately one hour following this conference call, and recorded broadcast will be available for approximately 30 days following this conference call. The presentation accompanying this conference call is posted on our website. During the course of this conference call, we will make projections or other forward-looking statements regarding future events or future financial performance of the company. The words believe, estimate, project, anticipate, intend, may, expect, will, plan, should, or similar expressions are intended to identify forward-looking statements.
We wish to caution that such statements are subject to risks and uncertainties that could cause actual events or results to differ materially from projections. Important factors which can affect our business, including factors that could cause actual results to differ from our forward-looking statements, are described in our Form 10-Ks, Form 10-Qs, and other filings with the Securities and Exchange Commission. Our estimates may change, and the company assumes no obligation to update forward-looking statements to reflect actual events, changed assumptions, or other factors, except as required by law. The discussion in this conference call will be limited only to proposed acquisition of Quantenna Communications by ON Semiconductor. As we are in quiet period, we will not make any comments on current business environment or on near-term outlook for our business.
Now, let me turn it over to Keith Jackson, who will provide a strategic overview of proposed acquisition of Quantenna Communications. Keith?
Thank you, Parag, and thank you everyone for joining us today. At the outset, I extend a warm welcome to the employees of Quantenna Communications. I'm excited about having you as part of ON Semiconductor team, and I look forward to building great products together to better serve our combined customer base. As we indicated during our recent Analyst Day, we intend to build capabilities to accelerate our growth in industrial, automotive, and cloud power end markets. The proposed acquisition of Quantenna is a step towards building our capabilities in ubiquitous wireless connectivity technologies to effectively address industrial, automotive, and related IoT markets. The combination of Quantenna's leadership in high-performance Wi-Fi technologies and software and ON's expertise in power management, low-energy Bluetooth, and multi-protocol radios builds a formidable technology platform to create wireless connectivity solutions for the industrial, automotive, and related IoT end markets.
Both ON Semiconductor and Quantenna Communications are leaders in their respective markets, combination of these two leaders will enable strong wireless connectivity platforms for addressing a wide range of applications in industrial and automotive markets. We intend to use our sales and distribution reach in industrial and automotive markets to aggressively penetrate these markets. We estimate that with the combination of Quantenna's and ON's technologies and capabilities, the combined company will be able to address a new market opportunity of approximately $1.2 billion in 2022. This incremental opportunity is primarily related to the IoT connectivity market and does not include opportunities in the automotive market. The incremental market opportunity of $1.2 billion is in addition to Quantenna's expected market opportunity of $1.9 billion in 2022 from its existing business.
While industrial and automotive markets offer tremendous growth opportunities for future connectivity solutions based on combinations of Quantenna's and ON technology portfolio, Quantenna's current market provides strong growth opportunity for the near to mid-term. Bandwidth of the last mile connection has increased up to 10 gigabits per second, wireless providers will need to aggressively upgrade customers to high bandwidth Wi-Fi solutions to maximize user experience and upsell their broadband services. Drivers are in place for high bandwidth Wi-Fi access points. Proliferation of over-the-top video content by providers such as Netflix, Amazon, ESPN, YouTube, and many others has driven the need for higher bandwidth for Wi-Fi connections. Furthermore, as video content transitions from full high definition or 1080p to 4K ultra-high definition, the need for bandwidth is expected to grow exponentially.
Quantenna, with its leadership in 4x4 and 8x8 MIMO Wi-Fi chipsets with beamforming technology, is well positioned to benefit from increased demand for Wi-Fi bandwidth. Though 4x4 and 8x8 MIMO devices comprise a small part of the overall Wi-Fi chipset market today, according to data from ABI Research and our estimates, the revenue from these devices is expected to increase from $715 million in 2018 to $1.9 billion in 2022. We intend to continue to invest and strengthen Quantenna's R&D capabilities to enable our expansion into the industrial and automotive markets. Teams from the combined company will work together to create power-efficient connectivity solutions for automotive and industrial markets. Along with investment in R&D, we plan to invest to strengthen Quantenna's sales and marketing capabilities to drive our expansion into new markets. With that, I would like to invite Sam to make comments on the transaction. Sam?
Thanks, Keith. We are very excited to announce today that we are joining forces with ON Semiconductor. Since its founding in 2006, Quantenna has been a leading innovator in Wi-Fi technology, introducing market-disrupting solutions that raised the bar on high-performance connectivity. Today's announcement highlights our technology leadership in Wi-Fi and outstanding achievement of Quantenna's team of skilled employees, representing almost 2,000 man-years of R&D and IP development. Quantenna is ready for the next phase of its evolution.
Together with ON, we look forward to broadening our market reach, expanding our technology development, and delivering industry-leading products for the benefit of our customers. The combine of ON 's scale, market leadership, and world-class quality and customer support organization, together with Quantenna's deep Wi-Fi expertise and capabilities, will allow the combined company to take the innovation to the next level and address new and existing customer opportunities. Let me turn the call to Bernard. Bernard?
Thank you, Sam, good afternoon, everyone. Let me start by going over the details of this transaction. As you are aware, ON Semiconductor has agreed to acquire Quantenna Communications for $24.50 per share in an all-cash transaction valued at approximately $1.07 billion. Including net cash of approximately $136 million on Quantenna's balance sheet at the end of the fourth quarter of 2018, the net consideration for the transaction on an enterprise value basis is expected to be approximately $936 million. ON Semiconductor will use cash on hand and its revolving line of credit to fund the transaction. The transaction is expected to be immediately accretive to non-GAAP earnings per share. We expect the transaction to close within the next six months.
The primary purpose of this acquisition is to gain access to Quantenna's industry-leading Wi-Fi technologies and software capabilities, we are not expecting significant synergies as a result of this acquisition. At this time, we forecast annual synergies of approximately $26 million. The synergies are expected to come from cost of goods sold and general and administrative functions. We believe that given our scale, we can achieve cost savings related to external manufacturing services and logistics. On the general and administrative front, the elimination of redundant corporate functions will be the key driver of cost savings. We expect to achieve our annual synergy targets on a run-rate basis within a year of closing. As Keith mentioned in his prepared remarks, we intend to continue to invest in R&D and sales and marketing functions to address new markets and strengthen our presence in existing markets.
Increased investments in R&D and sales and marketing for Quantenna should not have any impact on our recently announced 2022 target model as we plan to redirect investments from other areas to drive growth in industrial and automotive connectivity markets. As there is minimal overlap between the markets and customers of the two companies, we do not expect any significant risk related to the closure from a regulatory perspective. As I indicated earlier, we expect the transaction to close in the next six months. As of now, we have determined that we need regulatory approval in the United States and in China. With that, let me turn the call over to Keith. Keith? Thanks, Bernard. We are very excited about the anticipated benefits that the acquisition of Quantenna Communications will bring to customers, shareholders, and employees of both the companies.
I'd like to take this opportunity to thank the people at Quantenna Communications for their efforts and cooperation in this process, and I look forward to working with them in the future. This concludes our prepared remarks, and we will now take your questions.
Brian, please open up the line for questions.
My pleasure, sir. Thank you. Ladies and gentlemen, at this time, if you would like to ask a question over the phone, please press star and then one on your telephone keypad. We ask that everyone who is participating in today's Q&A session kindly limit yourself to one question and one follow-up. If your question's happened to answer or you wish to remove yourself from the queue, simply press the pound key. Our first question will come from Shawn Harrison with Longbow Research. Your line is now open.
Hey, good afternoon. This is Gausia Chowdhury calling on behalf of Shawn. First off, I just wanted to ask about the transaction funding with cash and interest. Can you give us any details on the split? To just confirm the interest that you're using on the revolver, that's about 3.8%. Is that correct?
Yeah. It is LIBOR plus 125, is the interest that we currently have on the revolver. We'll fund it from the revolver plus cash on hand.
Okay, perfect. In terms of manufacturing, are you able to bring Quantenna's in internally? I wanted to kind of know about the $26 million in savings. If you can give us any kind of idea about the split between COGS and G&A, that would be helpful too, please.
No, there's no intent to bring manufacturing internally on the wafers. We will continue to use foundries going forward. It really is about scale and the supply chain from a materials perspective, logistics costs that are different than ours, and other related things. That is the bulk of it. The G&A would be the second largest portion.
Great. Thank you.
Thank you. Our next question will come from the line of Ross Seymore with Deutsche Bank. Your line is now open.
Hi, guys. Congrats on the deal. A couple quick questions. The first one is on a kind of a blending of the end market targets as well as the technology. Quantenna, for a long time, has had great product in the service provider market, but simplistically, it's more high performance than it is low power. The markets you're attacking with this over time, industrial and IoT, seem to require the opposite technology. Can you just talk a little bit about how you're going to evolve that technology and the time to revenue for attacking the markets that you're highlighting as the primary goal of this deal?
Yeah. Clearly, it's an expansion of markets with a different product set. There's no misunderstanding there. The teams, however, on the ON side, have been working in that direction for some time, and we think by getting together with Quantenna's teams, we can accelerate that process pretty significantly and would be looking for revenues in that 18 to 24-month range.
Got it. Bernard, your comments about, I think, reinvesting to broaden the business and somewhat similarly to what Keith just said, broaden the business and accelerate some things. Is the $26 million savings, is that a gross number or a net number that we should think of relative to the current spending rates that Quantenna has on OpEx and COGS?
It is basically the gross number. It's how much we're going to take out. As I mentioned in the prepared remarks, if we invest more, it will be redirecting investments that we're planning on doing on other parts of the business. The net for the company means we're not deviating from what we said in terms of our operating expense target for our 2022 model.
Got it. Thanks, guys.
Thank you.
Thank you. Our next question will come from Chris Danley with Citigroup. Your line is now open.
Hey, thanks, guys. Just to follow up on Ross's question about getting into these, I guess, lower-end markets. From the Quantenna perspective, would you guys plan on introducing some scaled-down chips for industrial and auto? Then can you guys maybe go through what the product synergies are? Is there any sort of measure of typical ON content for every Quantenna chip that ships?
Well, in their current markets, we wouldn't have those measures. On the other side, we do think there are opportunities for more SoC type things. Then content-wise, you would see significant pickup on the ON content as you go into those other areas. I don't know if you would call it a dumbed-down or subset, but certainly retargeted from a performance perspective, because you still want to be the high-performance guy just with lower power. Again, that's where the teams are going to work together.
Thanks.
Thank you. Our next question will come from the line of Mark Delaney with Goldman Sachs. Your line is now open.
Yes. Good afternoon. Thanks for taking the question. Bernard, wondering if you have any more details on the degree of accretion that you're expecting. I know you said immediately accretive, but any more color on the magnitude that you're expecting? If you can give us any more sense on some of the puts and takes around that, for example, what would happen to the combined company tax rate? I know ON had announced $1.5 billion buyback authorization. Does the cadence of that buyback come down at all? Again, how does it all factor into the potential accretion? Thanks.
In terms of accretion levels, as I said, it's going to be immediately accretive. We think that in a year or so, it can be about $0.05. We are potentially looking at whether we need to adjust our share buyback. We're still committing to do our full plan over the full-year horizon, but there might be some timing differences at the beginning.
Just on combined company tax rate.
We don't have yet a full-blown analysis. We don't think that in the long run, it will affect what we talked about in the Analyst Day, which is a 17.5% longer-term target goal.
Got it. Thank you.
Thank you. Our next question will come from the line of Kevin Cassidy with Stifel. Your line is now open.
Thank you, congratulations on the acquisition. Keith, you had mentioned the $1.2 billion of new market addressability. Is that the low end that you're describing, or is there something more than that on the $1.2 billion?
The 1.2 is really the IoT market as we see it on the industrial side. We did not include the automotive applications in that number.
Okay, just one other. Is there any change in management expected? Is Sam going to continue to run this as a division within ON?
We are not through with those discussions, we are expecting the Quantenna management team to join the company to the extent possible. Okay. Thank you. Congratulations again.
Thank you. Our next question will come from Craig Ellis with B. Riley FBR. Your line is now open.
Yeah. Thanks for taking the question, congratulations on the deal, guys. Keith, I was hoping you could start just providing some broader context. Had you been looking to add Wi-Fi connectivity capability to automotive and industrial, as part of that, had come across Quantenna, was the intersection with Quantenna something that was more recent and opportunistic? Just context on how we got to where we are today would be helpful.
Yeah. Context-wise, we've known for some time, we've been operating at the edge connectivity node with our low energy Bluetooth, looking at the industrial applications and tying back all kinds of management functions through that. We knew we needed a way to get into the internet, which the Wi-Fi connection helped. We were looking for high-performance solutions, and came across Quantenna from that perspective.
That's helpful. I think in the prepared comments, there was mention of minimal portfolio overlap. Can you just specify where exactly that overlap is? To the extent that that would lead to any kind of carve-out, can you quantify how substantial that would be?
Insubstantial.
Immaterial.
Yeah. Immaterial.
Okay. Last question from me, and then I'll hop back in the queue. As you look at the opportunity to incorporate Wi-Fi into the different automotive and industrial solutions, Keith, what are some of the few applications, either on the auto side or the industrial side, where you'd expect to see earlier success, and which applications would be more of a longer-term investment here?
I think the industrial applications will be the first ones to deploy, automotive taking a little bit longer to get into play there. On the industrial side, all of the, I'll call it, factory automation and building automation areas would be top of the list for first revenue.
Great. Thanks, guys.
Thank you. Just as a reminder, ladies and gentlemen, if you would like to ask a question over the phone, press star and then one on your telephone keypad. Our next question will come from Tristan Gerra with Baird. Your line is now open.
Hi, good afternoon. Strategically, should we look at this acquisition a little bit similar to what you did with Aptina a few years ago? Also, does that mean that we could see you as a potential acquirer of other IoT connectivity technologies going forward?
Good question. It is a little different than Aptina in that Aptina, from a technology and market perspective, did touch some of our other markets, but the technology was unique. In this case, the base technologies we're talking about here cross most of our markets and many of our groups. It's going to be, I believe, a lot more synergistic, and not just more of a bundlings approach to the market.
Okay, it sounds like you would be able to leverage those products via your existing distributor base.
Yes
With cross-selling. Okay. Any commentary on expected impact on relative to your free cash flow target?
No, not anything meaningful. In the long run, it should help us as we generate more cash.
Our approach there, Tristan, is this certainly will be moving us toward the model we gave you for 2022, not changing that model.
Great. Thank you.
Thank you. Our next question will come from Vivek Arya with Bank of America. Your line is now open.
Hi, yeah. This is Adam Gonzalez on behalf of Vivek. Sorry, joined the call a little bit late, so apologies if any of these questions have already been asked. I'm just wondering if you can maintain gross margin at current levels as you go into these new IoT markets that you outlined in the prepared remarks.
We actually think we will increase gross margins from their current levels, basically with the scale and opportunity from our network.
Got it. Do you have an estimate for Quantenna's exposure to China from a revenue perspective? Maybe you can outline what some of the regulatory hurdles you might have to overcome to get this deal done.
I would have to refer to Sam for their percentages in China, if he knows that. On the regulatory side, again, just our perspective, and Sam can give his as well, is that there's lower risk here on most things because there is no market overlap, which would typically flag concerns.
Yeah. All the sales in China itself is nominal, but we do sell to companies who manufacture in China, and they sell into U.S. Due to that embargo, there is a transition period that we talked about in the last call with the investors, and we do expect that to go away very soon. The transition period is the moving of the factories out of China into neutral. The exposure is very nominal and is very temporary.
Got it. Thanks.
Thank you. Our next question will come from Craig Hettenbach with Morgan Stanley. Your line is now open.
Yes, thanks. Question for Bernard, just in the context of the 2022 model and investment being redirected. Does this really just serve to kind of accelerate some of the other markets you're going to de-emphasize from an end market perspective?
I don't think it's going to decrease any of the ones that we have our targets of growing industrial at 6%, automotive at 9%, and cloud power at 13% should not be affected by this. We do think, as Keith mentioned earlier, that this will dovetail nicely into allowing us to achieve the target model. It does have some help in terms of enhancing our gross margin as this is better than our corporate average.
Okay, just as a follow-up on the automotive and industrial angle, anything on Quantenna's kind of roadmap or things that you can kind of see it penetrating these markets? Or will, as you buy them, is that really the catalyst to kind of redirect some investments to start to penetrate markets they haven't played in?
Due to NDAs in place, I would have to revert to Sam if he wanted to share their internal data.
Regarding the automotive or industrial IoT, we have always talked about the potential of being on the access point side or in the automotive being the connectivity to the outside. We do think we have a good technology for that kind of application. Historically, we have been held back because of our sales channel and the investment we have done in that area. I think the technology could be easily applicable. Regarding the edge type of devices, I believe that being able to reduce the capability of the, not the capability, but the order of the MIMO, but it still has a very good performance type of a MIMO for the given application, combined with ON's low power expertise we are positioned to develop products which are going to be well-differentiated and capable to get into those markets in the timeline that Keith mentioned.
Okay, thanks for sharing that.
Thank you. Our next question will come from the line of Harsh Kumar with Piper Jaffray. Your line is now open.
Yeah. Hey, guys. Congratulations on the deal first. Two questions from me. With a significant focus now on IoT and an entry into the IoT area through Quantenna, can we expect the growth rate for combined ON to change to be upward? Secondly, is there a possibility of cross sales here?
This business certainly will be growing at the high end of the ranges we gave you, and so it should contribute to faster growth overall. As we're successful in pairing up these products, as we mentioned earlier, into solutions in those other markets, we should be able to get an acceleration factor there. Growth rates should increase from the result of this.
Thank you. I'm showing no further questions in the queue at this time. Now I will hand the conference back over to Parag Agarwal, Vice President, Corporate Development, Investor Relations, for any closing comments or remarks.
Thank you everyone for joining the call today. We look forward to talking to you at the release of our first quarter 2019 results. Goodbye.
Ladies and gentlemen, thank you for your participation on today's conference. This does conclude our program, and we may all disconnect. Everybody have a wonderful day.