Q3 2020 ON Semiconductor Corp Earnings Call
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I would now like to hand, the conference over to your speaker today to Mr. Parag Agarwal, Vice President of Investor Relations and corporate development. Thank you. Please go ahead.
[music].
Good morning, and thank you for joining on semiconductor proposition third quarter centered on the quarterly Investor Conference call.
I'm joined today like you stepped up our president and CEO and Bernard Gutmann, our CFO.
This call is being webcast and administered in addition protection.
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Our earnings release, and this presentation certain non-GAAP financial measures.
Reconciliation of these non-GAAP financial measures.
To the most directly comparable measures under GAAP.
Also included in our <unk>.
Which is posted separately on our website.
And Mr. relations friction.
During the course of this conference call, we will make projections or other forward looking statements regarding future events or the future financial performance of the company.
The words believe estimate project anticipate intend may expect <unk> nine.
Sure. So much expressions are intended to identify forward looking statements.
We wish to caution that such statements are subject to certain entities that good.
That's pretty much how does that differ materially.
Actions.
Important factors, which could affect our business.
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 Securities and Exchange Commission.
I think some factors are describing our honestly it's important.
Third quarter after deducting our estimates and other forward looking statements made today. The company has no obligation to update forward looking statements.
Turning to themselves.
Malcolm.
Pardon my long.
During the fourth quarter, we talk to whats your confidence.
Yes, It goes NASDAQ Fortitude, we're certainly must Oh sorry.
There's some upfront and that's why wouldn't PMT summit on different due on December 2nd No. Let me turn it over to Bernard Goodman went wide at Waterview off what wouldn't hurt partner.
We're not.
Thank you Barbara and thank you everyone for joining us today.
During the third quarter, we saw strong recovery in business conditions due to sharp acceleration.
I think its TV.
Especially in the automotive market.
Order activity has picked up meaningfully across end markets and geographies.
Manufacturers are striving to meet the upsurge in demand.
As previously disrupted by the only 19.
How long and strong Michael Linenberg, probably a part of business.
Let them in our key strategic growth areas in industrial automotive things our end markets. These facilities.
Our design wins are accelerating and the design funnel these expanding at a rapid pace.
As we stated earlier gross margin improvement is the primary strategic priority for the company.
We're on track with our manufacturing consolidation plan.
And discussions ongoing with serious flooding regarding <unk> <unk> and <unk>.
The sale of our Fabs in Belgium, and at times you Ben.
In the near term revenue tailwind from the ongoing recovery in business conditions in fab deal will end market mix shift should help drive margin expansion.
Now let me provide you details on our third quarter 2020, we felt.
Total revenue for the third quarter of 2000, 21.7 billion, a decrease of 5% as compared to revenues of 1.2.
In the third quarter of 2009.
The year over year decline in revenue was driven primarily by a slowdown in global macroeconomic as Steve you did at Cobiz, 19th and Debbie.
GAAP net income for the third quarter was 38 cents diluted share as compared to a net loss of 15 cents, but isn't that year in the third quarter of 2019.
Non-GAAP net income for the third quarter of 2012 was 27 cents per diluted share as compared to 30 cents per diluted share.
Third quarter 2009.
GAAP gross margin for the third quarter of 2012, west, 33.5% as compared to 34.4% in the third quarter of 2019.
Non-GAAP gross margin for the 2000.
Was 33.5% as compared to 35.8% in the third quarter of 2019.
The year over year decline in gross margin was driven primarily by lower revenue at these costs.
And we'll get 19 related cost.
Our GAAP operating margin for the third quarter of 2012 was 9% as compared to negative 3.2% in that third quarter of 2019.
It's water gap at night, its third quarter 2019 gap operating margin included the bank. The politics, the 9.5 million related to the thing intellectual property settlement, probably think region.
Our non-GAAP operating margin will be affordable housing when <unk> was 12% as compared to 13% in the it would have to go to <unk>.
The year over year decline in operating margin was driven largely by lower revenue and the impact on gross margin.
The call will be made even debbie.
God Overeat operating expenses were one 322.2 million as compared to 519.1 million he didn't do it.
Do.
Third quarter 2019, GAAP operating expenses included 169, and a half million related to the intellectual property settlement with our integration.
Non-GAAP operating expenses for the second.
There were 283.6 million as compared to 314.3 million in the third quarter of 2019.
The year over year decrease in non-GAAP operating expenses.
What's driven primarily by strong introducing them to cost one and by restructuring and cost saving measures undertaken by the company.
The third quarter free cash flow was 101.8 million in operating cash flow was wondering you point 4 billion.
Capital expenditures during the third quarter were 61.6 million, which equates to a capital intensity of 4.7%.
As we indicated previously we are directing most of our capital expenditures in the evening or you wanted to really be to keep.
Keep abilities in <unk> in these few steel fab.
We expect total capital expenditures for 2020 in the range of 370 to 90 million.
We actually did the third quarter of 2020 with cash and cash equivalents 1.654 billion as compared to 2.06 billion at the end of the second quarter of 2020 the.
The decline in cash balance was primarily due to the pay down of amounts drawn under our revolving debt facility that will be partially measurement in response to the movies like any.
At this time with cash balance of approximately 1.6 billion, we're very comfortable with our liquidity position.
In the fourth quarter, we expect to use approximately 690 million to pay off our 2020 convertible note.
[noise] people at maturity.
At the end of the third quarter days of inventory on hand were the duty <unk>. They don't seven days as compared to 140 days in the second quarter of 2020.
The fourth quarter, we intend to continue do we just got a balance sheet.
Before we plan to one or factories that fluid levels of utilization despite expected higher revenue levels.
Sure.
In the third quarter distribution, even used by approximately two weeks.
Fusion channels, he significantly quarter to quarter instead.
Instead of shipping products into the channel for revenue, we brought down channel inventory, even though it was within our comfort zone.
Now let me provide you an update on the performance of our business units, starting with the power solution or PSG revenue for PSG that third quarter was 647.4 million.
Revenue for the advanced solutions <unk> H G.
In the third quarter was 494.6 and revenue millions in revenue for intelligent sensing, whereas Jean was 75.3 million.
Now I would like to turn the call over to Jackson for additional comments on the business environment Heath. Thanks.
Thanks, Bernard Let me first update you on our manufacturing optimization plans and then I will provide an update on our current business environment.
We are in discussions with various parties regarding the planned sale of our Belgium Fabs.
Fabs, we are working diligently to get quick resolutions on these fabs, but we do not have an announcement to make at this time.
Process for ceasing operations of our fab in Rochester, New York is progressing as per plan and we expect to get begin seeing annual savings of $15 million starting in the first quarter 21.
We achieved major milestone in the third quarter as we recognized our first revenue from EUR 300 millimeter products, we continue to make solid progress in our manufacturing transition to 300 millimeter fab in east fish kill New York.
As I've indicated earlier yields for 300 millimeter manufacturing processes have been spectacular and we expect to see a meaningful positive impact on our gross margin as there are 300 millimeter manufacturing ramps in the coming years Adcs.
Additionally, our 300 millimeter manufacturing capability in the <unk> as bad as afforded us significant flexibility, which has enabled us to optimize our network.
We continue to make substantial progress on our initiatives to expand gross margins, we're driving shift towards higher margin products by aggressively winning designs in automotive industrial and cloud power in markets.
At the same time, we continue to optimize our portfolio to drive more margin expansion.
The fundamentals of our cost structure remain unchanged with ongoing recovery as a revenue in factory utilization increase we expect to see meaningful increase in the gross margin.
Benefits from manufacturing optimization mix shift and portfolio optimization should be additive to fall through we see.
Revenue.
Now, let me comment on the current business environment.
We've seen meaningful acceleration in order momentum in the third quarter, and we expect that business activity will continue to grow at above seasonal levels in the near term.
Along with improving global macroeconomic environment are accelerating design wins in automotive industrial and cloud power end markets are key contributors to our momentum.
From a geographic perspective, we're seeing deceleration in demand from all regions.
Economic data, such as PMA and GDP towards a strong recovery in industrial activity and in the overall business environment across the globe.
Although COVID-19 pandemic temporarily affected our business the underlying fundamentals of our business and secular trends driving our business remain unchanged.
We continue to see strong momentum in key strategic initiatives for electric vehicles, Robotics factory and warehouse automation cloud power and data.
We are well positioned to benefit from ongoing recovery with our highly differentiated power analog and sensor products, which enable key secular trends in automotive industrial and cloud power in markets.
Now I'll provide details of the progress in our various end markets for the third quarter of 2020.
Revenue for the automotive market in the third quarter was $419.2 million and represented a 32% of our revenue in the third quarter.
Third quarter automotive revenue declined by 6% year over year, primarily due to 19 driven decline in automotive production.
We are seeing strong momentum for our silicon carbide offerings with additional design wins at leading Oems and tier one customers in.
In addition to winning new designs, we are expanding our engagement with new customer for Silicon carbide and are currently sampling products to many of these customers.
On the eight S. front, we continue to win designs with major global automotive players. We're also seeing a higher level of attach rates for both <unk> and viewing applications.
We're very well positioned to benefit from technology transition in automotive light are to newer S&P in SPD technology remain PD technology.
We're seeing strong traction for our led our products with leading customers.
Other areas of automotive were strong as well in the third quarter, we saw strong growth in our lighting ultrasonic and actuators solutions.
From a geographical perspective, we saw strength across all regions. Despite.
Despite steep increase in automotive production. It appears the dealer inventories are low we.
We expect current recovery in the global automotive production to continue in the near term.
Based on our outlook and third party reports, we believe there are 2020 annual automotive revenue growth rate should exceed 2020 global light vehicle annual production growth rate by a wide margin.
Revenue in the fourth quarter of 2020 for the automotive end market is expected to be up quarter over quarter as we expect to see continuing recovery in <unk>.
Production.
Industrial end market, which includes military aerospace and medical contributed revenue of $327.6 million in the third quarter.
Industrial end market represented 25% of our revenue in the third quarter.
Year over year or third quarter industrial declined 7%. This decline was driven by reduction in global industrial activity over 19 endemic and geopolitical issues related to a specific customer.
In the industrial end market, we are seeing strong adoption of our CIO carbide modules for solar power related applications, and we are rapidly expanding our customer base in the alternative energy market.
On the industrial power front, we are seeing increasing design activity for motor control and building automation energy.
Energy efficiency regulations that are slated to be enacted in 2021 and beyond are driving our management and motor control related activity.
Our business medical business grew strongly quarter over quarter in the third quarter as the pace of electric procedures picked up.
We continue to work with leading market players to design in our image sensors for automation and machine vision applications.
We have secured initial design wins from large format image sensors special movie camera.
Patients.
Revenue in the fourth quarter of 2020 for the industrial end market is expected to be up quarter over quarter.
The communications end market, which includes both networking and wireless contributed revenue of $275.4 million in third quarter and represented 19% of our revenue during the quarter there.
Third quarter communications revenue declined by 7% year over year.
We saw strong year over year growth in our Fiveg infrastructure business in the third quarter, our smartphone business declined year over year in part due to geopolitical factors related to customer.
Revenue in the fourth quarter of 2020 for the communications end market is expected to be flat to down quarter over quarter due to expected revenue decline firms customer specific geopolitical factors.
The computing end market contributed revenue of $172.2 million in the third quarter.
Computing end market represented 13% of revenue.
Third quarter computing revenue increased by 12% year over year due to strength in both server and <unk>.
Yes.
We are seeing strength in our server power business with increasing content in new server platforms and share gains.
Most leading processor makers are projecting higher current requirements in their next generation products.
We expect this trajectory to continue in the near to mid term due to increasing demand for computational capabilities driven primarily by artificial intelligence.
Revenue in the fourth quarter of 2020 for the computing end market is expected to be up quarter over quarter.
The consumer end market contributed revenue of $142.9 million in the third quarter consumer.
Consumer end market represented 11% of our revenue in third quarter.
Third quarter consumer revenue declined by 9% year over year year over year decline was due to broad based weakness in the consumer electronics market opened 19 pandemic and our selective participation in this market.
Revenue in the fourth quarter of 2020 for the consumer end market is expected to be up quarter before.
In summary, we are accelerating our efforts to drive margin expansion, we are rationalizing our fixed cost footprint at the same time. We are also aggressively when he designed to drive mix shift for the automotive industrial and cloud power in markets, which have higher margins.
But some of our 300 millimeter manufacturing processes and these fishkill fab should further help and gross margin expansion.
In the near term strong revenue growth driven by ongoing recovery in our business should contribute to margin expansion.
Business conditions have improved meaningfully and we expect the improvement to continue in the near term.
We are seeing broad based recovery across most end markets and geographies.
Key secular megatrends and long term drivers of our business remain intact and we are excited about our medium to long term prospects.
We are seeing accelerating momentum in our key strategic initiatives for electric vehicles, Robotics factory and warehouse automation Sunpower and Ada Es.
Now I would like to turn it back over to Bernard for forward looking guidance Bernard.
Thank you he.
Based on product booking trends backlog levels and estimated zones levels, we anticipate that on semiconductor revenue.
1.1 point 4 billion in the fourth quarter of 2020.
Fourth quarter of 2012, you expect gap in non-GAAP gross margin between 32.9 intuitive.
And.
We expect total GAAP operating expenses.
<unk>.
Our GAAP GAAP operating expenses moved yet, we'll disease and tangibles restructuring restructuring asset impairments and other charges, which are expected to be the duty beauty.
We expect total non-GAAP operating expenses.
You want me to 97.
Would.
The expected increase in our fourth quarter operating expenses.
Well it is driven by planned reinstatement of salaries and benefits.
Lighting business.
Something from the movies 19 and Debbie.
In 2020 operating expenses variable component of compensation was not significant however, as we enter into 2020, when we plan to live to variable compensation expectation that 2021 will be a strong year. Consequently, we expect an increase of about 25 to 40 million quarterly no operating.
In the first quarter.
One.
We anticipate fourth quarter of 2020 GAAP net income.
From an expense.
Including interest expense will be an expense of 41 to 44 million, which includes non cash interest expense nine to 10 million.
DCP that pools net operating net other income and expense, including interest expense will be an expense of 32 to 34 million.
Net cat cash before income tax in the fourth quarter of 2012 <unk> is expected to.
22 to 28 million.
2020, we expect cash before taxes in the range of 52 to 58 million.
We expect total capital expenditures on with 220 million.
[music].
We are currently targeting an overwhelming proportion for capex for enabling our three on a newly built capability and an accelerated fees.
We expect share based compensation of 16 to 18 million in the fourth quarter of 2020, which approximately 3 million is expected to be cost of the school and the remaining amount is expected to be operating expenses.
These expenses included non-GAAP financial measures.
Our GAAP diluted share count for the fourth quarter of 2000, when he is expected to be the women 25 to 4 million.
Millions years based on our current stock price.
Non-GAAP diluted share count would.
I would have 2020 is expected to be 413 million shares.
Based on our current stock price we're.
Further details on share count and earnings books. Your calculations are provided regularly quarterly and annual we Werent Inc.
And keep respectively.
With that I would like to start the Q and a session. Thank you and deal I'm pleased to open up the line for questions.
Thank you Sir.
As a reminder to ask a question you would need to press star one on your telephone to withdraw your question. Please press the pound key.
Due to the essence of time, we ask that you. Please limit yourselves to one question and one follow up.
Please stand by while we compile the culinary roster.
Sure. Our first question comes from the line of Ross Seymore from Deutsche Bank. Please go ahead.
Hi, guys. Congrats on results and thanks for letting me ask a question I want to focus both my questions on margins. So the first one is on the gross margin side of things.
I I see that you're guiding to about a 50% incremental gross margin in the fourth quarter, given that you're not changing utilization I understand that but I guess first why aren't you changed your utilization given the strength in the business and then if we go beyond the first quarter can you just talk about how the fab closures the utilization increases and.
In the 300 millimeter wrap all layer into the gross margin because I would assume it would need to be above that 50% incremental that you've guided to historically and even in the fourth quarter.
So Oh, hi, and thank you Ross will your question Fernando. We we are also intending to continue working on our inventory in the short term.
We don't plan on increasing our.
Utilization substantially to to keep working on that.
You are correct as we are.
Started getting the benefits of the factory closures.
We have talked about a $75 million of annual savings coming from the from those.
Close or solar fields.
The the watches so closing it's only it's on its way to be yet to be completed in the results. We expect to get about $15 billion that with annual savings in the study in the first quarter of 2021, you ought to do is a function of when we end up.
And though what we end up negotiating with the intended buyers.
Fabs and that's ongoing any problem right now.
So yes. The answer is yes, we should expect to see better than 50% fall through as we as we go throughout 2012.
Great. Thanks for those details and then as my follow up question again sticking on the margin front the move into the Opex side of things.
I think everybody understands why.
You had variable comp down this year and why it would step up sequentially in the first quarter, but if I look at it year over year, It's basically flat is what you're guiding there.
There might have been some coping related impacts in the first quarter of 2020, but given the structural changes in cost cuts you guys announced earlier this year I'm still struggling to figure out why the guide for Opex in the first quarter of 21 would be flat year over year.
So I think that as we said in the remarks that we have no.
In the in any quarters in 2000.
20, as well as 2019.
The.
We did take significant cost reduction actions some temporary in some permanent and right now the variable comp will be layered obviously that depends on the pieces. These all these.
He said it makes your points are in the directional being a strong year, which is what our assumptions auto then we should have a significant.
In addition on bid on variable comp. If obviously you are not in that direction, then we will not.
Thank you.
Thank you I show. Our next question comes from the line of Chris Danely from Citigroup. Please go ahead.
Hey, guys just a quick clarification on the gross margin. So why was it 50 basis points better than the guided was that all revenue upside or was there some mix or pricing or something else that was driving higher.
Mostly revenue upside.
Got it and then any update on the CEO search.
Hi, its ongoing and there is nothing to announce at this time.
Okay. Thanks.
Thank you.
I sure next question comes from the line of Chris Caso from Raymond James. Please go ahead.
Yes. Thank you good morning, I'm, just a question on on inventory and end up.
What you're planning on on doing with production could you give us a sense of where you would like both the channel inventory and your internal inventory to get to before you.
Where do you think increased utilization and generally what what's the reason for the more cautious approach to inventory right now.
So they they inventory we have on the channel.
We don't.
We are within our comfort range.
So we feel good going into next year that we have been a good.
Good level for that in general even though he's a we peaked in the second quarter to 240 days decreased.
And we think those skills.
Gradually decreasing it.
In Q2, 2000 and into the fourth quarter.
All right.
As a as a follow up on the automotive market I guess, it now you're running sort of down mid to high single digits year on year last quarter, you talked about anticipating that the customers would be running at full production in the second half of the year could you give us an update of that where where are your customers running.
Regarding.
Their own production and and I guess with that what's the gap between you know if the customers are kind of getting back to normal and you're still down year on year, what's what's the delta there and what you kind of get you back to.
Flat year on year and that eventually growth.
Yes, so we believe that the auto customers will be largely a running at pretty cold with levels [noise].
With me here in the fourth quarter.
And really the only a the only difference if there was any wouldn't be a change in inventory in the supply chain. There was definitely some some caution in the supply chain to add that a COVID-19 went in and I would expect that in 21.
It would start replenishing even above auto rates.
Thanks.
Thank you.
I sure next question comes from the line of Rajiv Gill from Needham and company. Please go ahead.
Yes, thank you and congrats as well on solid result.
Regarding the the momentum in the automotive business.
You talked about outgrowing auto production by a wide margin, obviously, we're going to see a rebound in an auto production post coated but on top of that what's what's driving the wide margin commentary, specifically and sensors and TV any color there would be helpful. In terms of how much semiconductor content you're going to lose.
We are on top of that the rebound in production.
Yes, So I think you had on the two topics from an EPS perspective, we're seeing.
If it kind of middle of the production moved the level to which has a quite a bit more dollar content.
Kinda goes from $10 at level, one to 150 at level two.
So we're seeing that transition would drive a very significant.
Above the Sars rate and then on the electric vehicles now there will be more electric vehicles still dominated by internal combustion, but nonetheless more vehicles and again the content. There goes from a 40 50 Bucks up to 100. So those are if you look at both of those things there were a an order of magnitude.
To change a in so as a result of that we would expect a very significant.
And just for my follow up I know you can't provide more guidance, but if we're looking at gross margin trajectory. If you look at the margins in 2019.
They were kind of at 36%.
For the year and obviously it took a big dip in the first half of this year because of coated.
But you're kind of moving back up so.
So how do we think about you know the margins and 2021 getting back to kind of normal maybe more normalized levels. What we saw in 2019, and then kind of moving beyond that.
Is it really going to be a function of the revenue I know you talked about the closure that sat in to fill the fab, but should we be expecting to get back to kind of 2090 levels and beyond as we progress into 2021.
Depends on a lot of factors, but the but the premise is that we have with in the past so.
You expect the 50% fall through on just the revenue change it picks up the 2021 will be a good year in terms of revenue layer on top of that mix 80, with the with the premise that the revenue growth in automotive and industrial end cloud power, which has better than corporate average gross margin.
It will contribute to a to be tailwinds on gross margin and as mentioned earlier.
So I would call a question and we do expect to get the savings from the.
Factory seal or closures that we have announced that we need to be.
And last but not least we do still have some lingering cobiz cost you know numbers, we expect that most of those will peak wild you will have to get those.
Exactly.
No.
Sure so on that eases out we should get a little bit.
In addition to just mentioned.
Thank you.
Thank you.
Your next question comes from the line of Vijay Rakesh from Mizuho. Please go ahead.
Yeah, Hi, good morning, guys. Just a couple of questions here on the Disti side I know you talked about September quarter, just interesting meant to coming down two weeks active fortune mentally score down in the channel just wondering what you're seeing in terms of distributor inventories exiting fourq you watched us, but not in the 11 or so thanks.
I'm not sure I got all of that question. The audio was issues on our side, but a week.
We brought the Disti inventory down in the third quarter to kind of the low end of our normal operating ranges. So we're not looking to take it down substantially from there but to kind of hold it towards that lower end. We think this does give us more flexibility, particularly if the market is more robust.
Than we're seeing right now.
Ah So that's the plan to did that get your question BJ Yeah. It does thanks, a lot and one other question here on the gross margin side obviously.
You know, there's some near term costs logistics fluid logistics costs and operational costs I'm just wondering what the headwinds from dollar saw and you see both subside as you go into first half next year. Thanks.
Yes, definitely much less than what we had in the in the first and second quarter is the lingering cost or more logistics.
It will normalize when we see a airlines.
Flying again, so that's mostly commercial so that's a big question Mark So 12.
We're always going to be more protracted.
But it's much less than what we had seen in the first half.
Just some lingering headwinds not significant.
Thanks, a lot.
Thank you.
I show next question comes from the line of Christopher Rolland from Susquehanna. Please go ahead.
Hey, guys. Thanks for the question I guess first following up on the automotive side of things and Silicon carbide can you talk about the pipeline there. After your win on on Silicon Carbide and then also.
Hi, <unk>, how we should think about IGBT is.
And.
And your position there.
So we are we continue to see a wins for both.
Silicon carbide fun, it's maybe oversimplify, but in the a the lower a lifetime or smaller cars or the IDBD is still the dominant solution.
The more powerful cars designed with bunch longer range silicon carbide.
It's becoming the predominant solution. So we have a wins at many different.
Tier ones and.
Yes at this stage for both.
Alright.
Great.
And I was wondering if you could give us an update on your footprint consolidation or I guess any update on on Belgium, and any other updates in terms of targets or potential opportunities.
In Belgium, we are ending.
Called the final round of negotiations right now and I expect that we.
During the quarter, we'll be able to find solutions there.
And he got a there's still a process ongoing probably eat.
Great. Thanks.
Thank you.
Our next question comes from the line of Craig Ellis from B. Riley Securities. Please go ahead.
Yeah. Thanks, so much for taking the questions and I'll just ask a couple of follow ups first on on gross margin. So it's clear that it's hard to handicap, the exact timing of a fab sale, but all right gentlemen, I'm wondering if you can just help us scopes Ah the the amount 75 million and Cogs sufficient.
She gains that you would expect to get.
In calendar 21, not by quarter, but just overall, how much of that could be realized in 21, and then how much would come.
Come through and in calendar 2002.
It's a tough question Greg.
Definitely we can talk about the Rochester, one we just.
That will start immediately you one or the other is still a function of what we end up negotiating buying parties into himself and may see a that will drive what those savings.
Typically the closure of a fab peak somewhere in the 18 to 24 months that obviously, we have been already working on it.
Got it and then if I could just a bundle two follow ups together Bernard.
The first is to Ross's question beyond the first quarter, which not only would include a discretionary comp, but also things like FICA, what should we expect from Twoq to Twoq through Fourq do you actually get some opex decreases in the back half of the year as Spike It goes away and then.
With the debt pay down in the fourth quarter. The convert what should we expect for interest expense in the first calendar quarter.
Let me start from the last question first the interest expense. We do can you paid down debt that we generally the amount of free cash flow year excuse. It was just a function of how much that is paid down definitely the a and the pay down of the $690 million little little interest away. So we expect the trend of interest in.
To.
To a trickle down.
Sure.
Overtime.
Okay, and the topic the opex trend that.
We expect these step functioning well increasing opex.
And indeed, you are correct. In addition to that there is within that assumption.
The timing or seasonality.
A fight Guy and.
Let's face it will expenses.
So I don't expect that the expenses will go up more of the.
For the rest of the beat May trend, mostly flat.
Got it thanks guys.
Thank you and.
Next question comes from the line of Matt Ramsay from Cowen. Please go ahead.
Hi, This is Josh Macarthur on behalf of Matt Ramsey Congrats on the results and Keith Congratulations on your retirement.
I guess I wanted to start on the on the last call. You mentioned you weren't expecting to see any under utilization charges in the second half can you confirm that you know this is still the case, given you're keeping utilization flat and inventory it sounds like are going to trend downward.
Yes, obviously with the disclaimer that we don't control that governments are you on that.
So at this stage, we don't expect the reasonable mandated sheltering Lisa.
Yeah.
Mandates from governments, so if that continues.
Let's see any additional.
Colby really that.
Beauty of expenses.
Sure understood.
Okay. Thank you and then I guess a bigger picture question when you made the point.
Plans to invest in the 300 millimeter fab. It was obviously a very different environment I'm just wondering if any of your strategic assumptions or plans changed for the new environment. According volumes through this fab since the deal was announced a year and a half ago, thanks, and congrats again.
No no we continue to be so.
About that addition to our network.
And so from that perspective, we continue to get.
Qualifications of products processes and customers through there.
And continue to enjoy.
Enjoy the ramp that we envision.
The the only change I would get is maybe a little more celebration on closure of some of the other factories has been brought about by the the overall lower environment.
[music].
Thank you.
Sure. Our next question comes from the line of Toshiya Hari from Goldman Sachs. Please go ahead.
Hi, Good morning, Thanks for taking the question I had two as well first of all on you guys talked about geopolitical factors, having impact on your business in Q3 and I do believe in your Q4 guidance as well.
If you could confirm how meaningful they had the ones were associated with geopolitical factors in Q3.
And what's embedded in your Q4 guidance that would be helpful. Thank you.
In Q3 are there certainly was an impact but primarily in Q4 until licenses are granted the answer is there's no business at all and they.
They were one of the top customers.
Got it and then as a quick follow up I wanted to double click on gross margins as well in the past you guys have talked to a 40% plus long term target for gross margins I guess, a is that still the case and that's still very much intact.
And b to the extent it is I was hoping you could rank order or the drivers that get you. There I think throughout this call you talked about obviously, Rochester, which is which has done a you've got you got to Belgium.
You're rationalizing or optimizing your portfolio, you've got the 300 millimeter transition.
Obviously, you've got the corporate costs, which hopefully go away over time. So if you can rank order some of the drivers as you think about gross margin expansion over the next couple of years that would be helpful. Thank you.
Pretty much a summarized it very well for us. Thank you.
Definitely a when we did our our model, which actually what he was and then we is predicated on a 7.1 billion dollar whether you believe that that still holds true. So we do have a good amount of catch up from the current levels of 5.15, you'll see that level with the fact that we have the than we.
The good fall through on that that should that that's still holds.
The footprint consolidation as well as the benefits of the field.
In the out years will also be a significant factor and a mix I said doing one is the one that will.
Good.
Thank you.
Thank you our.
Next question comes from the line of harsh Kumar from Piper Sandler. Please go ahead.
Yeah, Hey, guys. Congratulations first of all two questions first of all would you be able to give us some color on particularly the automotive and industrial markets I know you said.
It should be up but maybe help us think about how we should think about modeling them and then another part of that same question you talked about distribution inventory auto how many weeks access do you think if at all there isn't the system, particularly in auto.
Yeah, I'll start with the auto I believe that distribution an entire supply chain. There there there's no excess going into fourth quarter I think that's largely been taken care of a in fact if anything.
Undershot and set us up for next year, having to do replenishment.
So that that market.
On the supply chain there.
At this stage in I don't know any any pockets of business.
As I mentioned earlier, we expect auto production rates in Q4 to be largely back to where they were.
Team.
So again by.
Quarter over quarter that is still an improvement from Q3.
From an industrial perspective, you know, we're seeing recovery there we think a again largely the excess supply is out of the channel, but theres no rebuilding that we can see.
So a moderate recovery on industrial.
Understood and.
And then Yo closure of Fabs you mentioned you cited three I think in total.
Maybe help us understand where is this production going to is it going to fishkill.
And you know on a scale of one to 10. If you say you know prior to you getting controller Fishkill. If time is kinda like where you want to be where do you think you out at this point in time.
So most of the production in those two particular factories are going into our other internal fabs.
And what we're doing is taking a selective high volume runners out of the other internal fabs and moving into as you kill so a little bit of a student two step process to get and pay.
Okay.
And relative to a you know 10 is a full ownership and running a weird this stage down around two were just starting or ramp.
During there in the third quarter a in ramping from there.
Thanks, guys.
Thank you.
I sure next question comes from the line of Mark Polyposis from Jefferies. Please go ahead.
Hi, Thanks for taking my question.
I had a question about the process of shutting down or are selling the factory when you're when you're transferring parts from your old facilities here new facilities can you describe what that the qualification process is like how long does that take.
Or is or is it a matter of practice for you that you know parts that you have at primarily make a one factory also.
Our <unk> always qualifying them at other factories, just for redundancy sake, and that's not a big deal to to requalify parts.
That's the first question I had a follow up.
Okay. So for the first one most of our high volume processes have more than one factory running.
Just from a some.
Supply chain risk perspective for.
For those products.
Essence take these specific products that you're running that may not be in the alternate factory.
You have to run some oh reliability tests and you have to run those by your customers in for those processes, it's anywhere from 182.
Days to a year.
For other processes that don't have as much volume you do have to first bring up the process.
In the new factory that can take anywhere from nine months to a year. Then you have to run the same qualification. So that gets you kind of out in the two year range for.
For that.
We had started moving.
Moving things for the factories, we're talking about here.
Before we announced those.
Transactions and so we're well into that a second.
Second phase now of getting the customers qualified.
Blame is selling of the factories.
Uh-huh in or customer agreements or there will be some amount of time required Oh, we will still take product from those factories, but you're now you're now down into that kind of a 18 month or so.
Got you, that's very helpful and and longer term.
Keith to use as you work your way to your gross margin.
Bogey de jure just do you think that translates to a higher internal mix or or higher outsource foundry mix on on the front end Dan. So the front end yeah. The front end part will become more external but that's less to do with the consumer.
Validation and more to do with some of our fastest growing products use nodes that we use foundries for.
Got you. Thank you very much very helpful.
Thank you.
Next question comes from the line of Harlan sur from JP Morgan. Please go ahead.
Morning, Thanks for taking my question.
Has the skills fish has east Fishkill Sop in auto grade qualified and if not when do you guys expect to achieve qualification.
And then in terms of revenues today from Fishkill, what products and end markets you shipping into.
So today, we're shipping primarily into industrial with some automotive content out of U.S.K. So we are qualified for.
Great and then Keith.
Next with 13 to 15 week lead times on average you know you guys are looking into the March quarter.
You also have a good view on customer forecast as well I believe normal seasonality for the team is flat to down a couple of percentage points in March you talked about above seasonal demand trends near term I'm wondering if you're seeing this in the orders for the March quarter.
Ah Yes orders are good in the comments, we made on above market.
Nobody will extend as this year.
Yep. Thank you.
Thank you our.
Next question comes from the line of John Pitzer from Credit Suisse. Please go ahead.
Yeah. Thanks for let me ask the question Keith Keith maybe just a follow on there to Harlan second question.
When you think about the calendar first quarter is there a notch enough leverage above seasonal revenue growth and gross margin leverage that you can have up margins be flattish. Despite the increase in opex and if that's not the case why isn't variable comp more tied to profitability why not wait until later on in 21 to reestablish some.
On the variable comp.
So we really don't want to give guidance for Q1, we do it one quarter at a time or what I will tell you is a certainly a we would expect revenues to continue to increase nicely throughout next year.
The way accounting works you have to accrue for the entire year at the expected rate for the year or even though you may have a quarter somewhere in there that doesn't fully meet the objectives.
That's helpful and then back to the auto side.
When you look at calendar year 17 to 18, Sars was down a little bit in 18, but you guys significantly outgrow outgrew the market almost by another 10 percentage points I'm, just kind of curious given how weak the auto sector has been for you and the overall semi market since really the end of calendar year 18 19.
It was down 21 is going to end up being down.
How are you viewing your outgrowth to Sars has been going into calendar year 21, and do you have kind of a view you can give us on what you think Sars growth will be next year.
So the answer is yes, we actually white margin as I mentioned in my comments.
Again with the drivers being more level two bars on eight asked and a higher percentage of E beam from a Sars perspective, we tend to try and be conservative on that and look for kind of 2019 levels next year on the Sars base.
Yes.
But.
But oh, but again, we think we have been outperforming the.
The overall Sars in 2020, we think the supply chain did oh.
Lean out which took some of that margin away, but in 2021 as I mentioned earlier right. We think there may have to be some.
Restocking to hit the full levels as appropriate.
So can you give us an 18, you outgrew Sars by 10 percentage points do you think 21 setting up to be an 18 ft here for you.
I think the opportunity for double digit outperformance is there.
Thank you very much.
Thank you.
I show. Our next question comes from the line of Kevin Cassidy from Rosenblatt Securities. Please go ahead.
Hi, Thanks for taking my question I, just going back to a factory utilization.
Is there any more efficiency coming in can you get higher gross margin at the same utilization say compared to a couple of years ago.
There will be some help that comes from that from mix as we have.
Talked about.
But definitely we depend on a lot on revenue.
Increases.
The.
I would just add that as we're looking for the other.
Additional a lever is pricing.
And of course, 19 was not necessarily a good year, but as were seeing or 20 excuse me was not a good year, but 21 is shaping up to be a little better pricing environment.
Okay, Great and just one follow up kind of on the qualification process.
You can have your internal qualifications, but does your customers has there been any change in the qualification process relative to the customer. So it really just agree with your data from your.
Your manufacturing or do they want to test the parts too.
Most of them I agree with our reliability data they don't need to do.
Okay dad, but they do need to verify the products are still focusing exactly the same way in their applications. So that takes them. You know that's part of the six month kind of check that they've got to do on their side.
Okay, great. Thank you.
Thank you.
Actually my next question comes from the line of David O'connor from Exane BNP Paribas. Please go ahead.
Great. Good morning, and thanks for taking my questions maybe to go back on the 10 point outperformance Keith that you mentioned.
You talked about a dozen he had been the main contributors as we exit 2020 can you give us a sense of how big These are no for sure the business I'd like the follow up.
So sensors or did the eight cents it was about 20% of total.
The the.
Electric PC, so is smaller, but we haven't disclosed on which it is but we know it.
But with a very strong and best phasing 21 and beyond.
That's helpful and then maybe as my follow up on the 300 millimeter. Each these physical Fabs you talked spoke to spectacular yields there, which should those high volume products, where you're seeing these views and is there an opportunity to pull in the ramp up there given you seem to be ahead of schedule.
Yes, so our first products to ramp there our medium voltage mosfets.
And then followed by our ease.
And we are ramping that are pretty much at the pace our customers are qualifying.
Thank you.
Thank you I show next question comes from the line of Tristan Gerra from Baird. Please go ahead.
Hi, good afternoon I'm good.
Given the did lead times.
He somewhat elevated in parts of your business or industry wide and given your utilization rates down below normal level I'll do it the treaties. So you gain actually market share because your utilization rates being below will actually be an opportunity to other.
Shape in areas, where some of your competitors may be tight or am I right. Now. So can you just the correct way.
No I think we do have some upside opportunities with extra capacity in the factories I'm, we're actually a the inventory positions were taking or really ensuring that that excess capacity can go directly to the customers that.
May have opportunity to grow a little faster.
And I mentioned earlier, the the Ada Es and E.
He decided that particularly those we think maybe due for some additional inventory in the channel.
Okay, Great and then just a quick follow up I know you haven't quantified the dilution from the quarantine a is it a is it fair to assume that it it's no worse than the initial dilution that the business was encouraging.
Right. After the close and are you, giving any consideration to taking additional action on that business. Besides just waiting for the new product twin.
So there there's not been a pretty fine in that business, if that's where you're headed so oh I'm not sure where.
Where that came from so they were not seeing additional declines and we are seeing a the backlog and pipeline.
Hi, Blaine picking up so.
Great. Thank you.
Thank you.
I sure next question comes from the line of Civic are Ya from Bank of America. Please go ahead.
Hi, Thank you for taking my question Keith I had a conceptual question on gross margins you know when I look at gross margins and a power discrete industry. They tend to be at best around high Thirtys percent, even for the largest companies in the space you know such as Afinion, who have been running 300 millimeter fabs.
Quite some time and when I look at all the history gross margins have never really exceeded 38, 39% and even then quarterly revenues were much higher than kind of level. So how much of the gross margin dynamics are just said is not selling certain kinds of products. It seems that you know that there is a limit to how much you can expand gross.
Margin, regardless of the revenue levels or fab closures on 300 millimeter.
Capability. So I just wanted to run this hypothesis for you.
So a simple answer there is when we gave our expectations for being able to reach 43% fully comprehend the product mix and market mix.
That we see here [laughter] and while there was some.
Number of Bips, which we disclosed on mix perspective per se, but from a product perspective, we still think 40.
40, it does take a leaning out of our manufacturing, which we are in the process of and getting the utilization rates up but we don't think inherently that power business is stuck in the Thirtys. We definitely think we can get that in.
The other piece of that equation is a lot of that stuff is modules in there we think the opportunity for the modules.
But then the discrete devices.
Hi, My headphone and keep as my follow up in terms of the competitive landscape just given us in China trade tensions do you see any headwind still gaining share in China, I eat that share, perhaps going more to your European or Japanese competitors.
Have you other than while we have you seen any effect upgrade attention so far or do you anticipate any effects going into next year. Thank you.
I think I think the there will be more reluctance for customers to accept sole source positions from U.S. based companies as a result of the trade tensions.
I still think there, they're very wise economic buyers and they're going to do the best thing for their company, but there's certainly don't want to be completely rule.
Supplier.
But do you see shares shifting to European competitors.
We certainly saw it at a the account you mentioned elsewhere, we have not seen it.
Thank you.
Thank you.
I show next question comes from the line of Shawn Harrison from Loop capital. Please go ahead.
Hi, Good morning, and thank you for taking my question. Keith for you are you seeing anything either on the raw material supplier kind of I guess, yeah, the foundry supply as well given kind of you see the speak the distributors you're reading the press about some prebuying of either materials. Your capacity next year, just given the trade tensions.
So we've seen some tightness.
Things like substrates in the communications market I think that's a fairly wide spread I think the or the expansion there is slower than the market itself growing and there are certainly some tightness in spot areas.
In the foundry market, but overall the supply chain.
Very helpful and Bernard as a follow up just if you could speak to how you're thinking about the return on the share buyback and 21 whats either maybe a leverage ratio you're looking at or some type of metric before share buyback could return.
Sure Sean So historically, what we have done is we have a.
On paying down debt until we reach about a two times net leverage.
Obviously, you need to get components from our board.
Strategy, but that would be.
No approach was the share buyback.
Thank you.
Thank you.
Our next question comes from the line of Nick.
Nick.
Total roll from Longbow Research. Please go ahead.
Yeah. Thanks, good morning, everyone once.
Once you guys complete the three front end fab optimization. So can you maybe talk about approximately a while revenue level you will be at full utilization of your non 300 millimeter footprint.
I'd say a difficult question I'm not sure I have that because a lot of it will be then.
Mix definitely what's up what's so sweet spot of 85%, which is where we like to operate it.
Got it thanks.
Thank you Anil.
Next question comes from the line of.
Craig Hettenbach from Morgan Stanley. Please go ahead.
Yes, I had a question on silicon carbide and naturally allows that discussion is around <unk>, but Keith from an industrial perspective can you talk about any interesting applications or opportunities you see in the industrial market.
Yeah, the we're seeing big pick up in solar energy the pick ups that you get there from an efficiency perspective are pretty significant.
We have an opportunity for about $650 worth or might there.
And then he be charging so not not the traction.
Inverters, but actual charging stations were also seeing opportunities.
Up to $500 a there.
Got it and then just a follow up on just the geopolitical issues with the customer or is that something that you expect open.
Ultimately revenue will go to another OEM and that could be opportunity at some point next year.
The way the rules are written a it's unclear if anyone can ship without a license.
And so that's a lease our interpretation.
And so I think right now or the license process is most critical to answering might be providing this point.
And we should benefit the ship share has shifted to other.
Customers of ours, there is the opportunity for us to.
To also take advantage of that and white and get the wider approach.
Got it thanks.
Thank you.
Your next question comes from the line of Craig Ellis from B. Riley Securities. Please go ahead.
Yeah. Thanks for taking the follow up questions. Keith I wanted to start just going back to some of your end market commentary, you mentioned that and cloud power there should be some server share gain and content gain so I wanted to see if we could get some specifics around that for calendar 21, and then also in cloud power.
What is your interaction with base station customers signaling for basically.
Base station production next year, and what does that mean for room for growth in that part of the <unk> power.
Okay. So one is kind of share gain in the generation change <unk> club car content and the second one is what kind of ramps were seeing and base stations and like I got that right. Yeah. So you know kind of going from the back.
On the base station basically China is driving most of that growth in we do see some significant growth there in China.
U.S. you know maybe late and 21 moving into 22 would become a much more substantial from a a cloud server perspective, we get about $60 out of the current generation in our content and it goes to 75 with the VR.
Our fourteens, which are coming out next year.
That's great and then the follow up is on I am so it seems like right now medical military and energy efficiency are good areas of strength, but we know that 10 industrial there are areas of weakness to energy extraction et cetera, et cetera, no different than 2009, when industrial broad.
The way it was probably the last end markets come off the bottom. The question is this when do you think that segment broadly will be back to good growth. There is that something that could happen in the first half of 21 or is that really something up what happened.
Later next year. Thank you.
Yeah, Okay. So the broad based piece of it should improve we've always seen that kind of following the GDP a in general, but we do see different industrialist I'm. Craig is that the automation has actually been I believe that celebrated bike holds 19.
Strange this companies had their they're looking for much more automation both in assembly in their warehouses or to.
To kind of make its dependence on people less and so.
That would be you know kind of like in automotive, we see electric vehicles, and Ada Es being a a super charger I think in this case automation is the supercharger for industrial.
That's helpful and congrats on the retirement Keith.
Thank you.
Thank you.
I should have further questions in the queue at this time I'd like to turn the call back over to Mr. Parag Agarwal, Vice President of Investor Relations and corporate development for closing. Please go ahead Sir.
Thank you everyone for joining our call today.
We look forward to seeing you at various investor conferences during the fourth quarter fourth quarter Goodbye.
Ladies and gentlemen, this concludes today's conference call. Thank you for participating you may now disconnect.
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