Q2 2021 ON Semiconductor Corp Earnings Call
Good day and thank you for standing by welcome to day on semiconductor second quarter 2021 earnings conference call.
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I would now like to hand, the conference over to your speaker today, He's paper Agarwal, Vice President of Investor Relations and corporate development. Please go ahead.
Thank you Ryan.
Good morning, and thank you for joining on semiconductor Corporation second quarter on 271 partner.
Conference call.
I'm doing pretty by another party.
President and CEO and Kurt Barton our CFO.
This call is being webcast on the Investor Relations section of our website at Www dot on Saturdays on call.
Tom.
And if they are passed along with our country can do on a second partner on industries must be on my neighborhood on our website.
Approximately 1 hour.
That's right.
And reported net pass would be able to name a dropped approximately 30 days following this conference call.
Additionally, information on that need to come on and markers and those segments, you got freeze channel Shin Kong and.
And until 'twenty, 1 'twenty 2.
Kind of index full strength.
The Investor Relations section of website.
I went on in cities and this presentation includes certain non-GAAP financial measures.
Constellation on these non-GAAP financial measures to the most on it.
Got it.
On it.
Our earnings release, which is posted on our website.
On the nation's section.
During the course on this conference call and make prediction on other forward looking statements regarding the future team on our future financial performance of our company. The worst believe estimate project anticipate intend may expect.
Sure.
Question on and turned on to identify forward looking statements.
We wish to caution that such statements are subject to risks and uncertainties that could cause actual events to outer dose could differ materially from protection.
Important factors that can affect our business.
Factors that could create actual results to differ from our forward looking statement on.
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Our nation on factors are described in our earnings release on the second part of a project on day 1.
Our estimates or other forward looking statements may change and the company assumes no obligation to update forward looking statements to reflect actual results changed assumptions, although not directly on corp, except as required by law.
Our analyst day is scheduled for August 5 in New York City.
We look forward to seeing you in for some data to speak now like Mcdonald's or put myself.
Thank you, Brian and thank you everyone for joining us today.
We delivered record results in Q2, driven by strong execution and broad based strength in demand.
We posted record revenues of $1.67 billion, an increase of 38% year over year and 13% quarter over quarter.
The non-GAAP diluted earnings per share of <unk> 63 grew.
Grew significantly year over year and quarter over quarter as a result of the work we've been doing to restructure the company and streamline our business.
Our sharp focus on gross margins is beginning to show strong results with our Q2, non-GAAP gross margin, increasing by 320 basis points quarter over quarter and by 760 basis points year over year.
The sustainable improvements in our gross margin will continue as we rationalize our portfolio.
And reallocated R&D investments to high growth and margin accretive new product development.
To capture the full value of on products, we continue to evaluate our portfolio to eliminate any price to value discrepancies and focus on manufacturing on our strategic products.
In addition, we continue to drive efficiency throughout our upstream and downstream supply chain and optimize our operations to reduce costs.
The demand environment continues to be robust across all end markets for the second quarter, we posted record revenue for the automotive and industrial end markets.
In addition to the company's broad based strength in these markets. We are benefiting from the strong traction of our power and sensing products.
<unk> demand than we have seen over the last few quarters continued to outpace our ability to supply certain products, especially those manufactured by our foundry partners.
Based on current booking trends and macroeconomic outlook, we expect that the demand will continue to outpace supply through the first half of next year.
We are working collaboratively with our customers to ensure the on them to rough did supply of our products in the future having entered into a long term supply agreements with many of them already and actively engaging in discussions with several others.
Long term supply agreements, where L. T. S. A's are a win win for both customers and by guaranteeing supply to the customer and at the same time, providing better visibility and allowing us to better plan, our capital allocation towards capacity expansion with a committed long term demand outlook.
Let me now discuss a few highlights of our strategic end markets starting with automotive.
We set a new record for automotive revenue in Q2 with revenue of 556 million the.
The success on automotive was driven by strength in our power and sensing product categories.
We have emerged as a strategic supplier of highly differentiated technologies for electric vehicles with customers, placing high value on the efficiency and footprint advantages provided by our power solutions.
Our engagement with leading global Oems and tier ones continues to expand and I'm very bullish on our potential in the growing vehicle electrification market over the next few years.
In addition to the industry, leading performance of our fetch a key source of our differentiation is our expertise in packaging, which is critical for improving heat dissipation, increasing power output in a smaller footprint than our closest competitor and reducing the weight and cost of a power module.
Efficiency over module allows our customers to make no tradeoffs between the cost of battery and the range of the vehicle they've got both.
We continue to strengthen our leadership in automotive safety with new design wins and see the increased penetration of active safety features driving strong demand for our image sensors and ultrasonic sensors.
In Q2, we secured significant wins for our image sensors on key platforms in Asia and in a few cases, we displaced incumbents.
With increasing sensor content, especially in new electric vehicle platforms, we remain bullish on our Adas business.
We recently announced that auto ex has selected our intelligent sensing technologies to enable 360 vision and its generation 5 fully driverless robo taxi.
On this platform are 28 image sensors and force really lidar sensors eliminate blind spots and powerful autonomy.
The industrial end market, which includes military aerospace and medical contributed revenue of 434 million in Q2, representing approximately 26% of our revenue.
Excluding the impact from geopolitical factors related to a specific customer or second quarter industrial revenues increased by 29% year over year, driven by broad based demand and strong performance by our power and sensing technology portfolio.
We are seeing continuing momentum for our higher power modules and alternative energy applications given the investments in utility scale solar installations are expected to grow worldwide to reduce their climate impact on fossil fuel based power plants.
With a broad range of power solutions and early engagement with key market Disruptors, we are well positioned to grow on the market.
On the industrial automation front, we saw steep year over year growth in our imaging revenue driven by machine vision and scanning applications.
Now I will turn the call over to Sam to provide additional detail on our financial performance and guidance.
Thanks Hassan.
I am pleased to announce a record quarter as we're seeing the early impact of our transformation initiatives and financial results.
Customer demand remained strong and the design win pipeline for innovative power and sensing technologies continue to expand.
We have been successful in securing additional supply from our internal manufacturing sites as we optimize our efficiency, which contributed to revenue at the high end of our guidance.
Based on our current outlet, we expect strength in demand to continue through the first half of 2022.
The company has been executing a long term sustainable actions that have resulted in record revenue earnings and free cash flow for the second quarter.
In a few days at our analyst day, we will share our long term strategy and operational plans to realize the full potential of the company.
Turning to the results for the quarter.
We saw broad based strength contributing to sequential revenue growth across all end markets regions and business units.
Megatrends in the automotive and industrial contributed to record revenue in both of these end markets and together comprised 59% of revenue.
Total revenue for the second quarter was $1.67 billion, an increase of 38% over the second quarter of 2020, and 13% quarter over quarter versus normal seasonality on a sequential increase of 3.5%.
Our automotive revenue grew 69% year over year and 8% sequentially industrial.
Industrial revenue grew 24% year over year and 18% sequentially.
Turning to the business units revenue for the power solutions group or PSG was $846.6 million PSG revenue increased by 37% year over year due to strength in automotive and industrial end markets.
Revenue for the advanced solutions group or ESG was $607.6 million, an increase of 42% year over year.
In addition to the strength in automotive ESG benefited from strength in computing, especially in high end graphics cards.
Revenue for the intelligent sensing group or ISG second quarter was $215.7 million increase or 28% year over year.
Strength in ISG was driven primarily by automotive.
GAAP gross margin for the second quarter was 38, 3% and non-GAAP gross margin was 38, 4%, a 760 basis point improvement year over year, and 320 basis point improvement sequentially.
Our strong gross margin performance over the last few quarters has been driven by strong execution and a favorable mix to higher margin products improved efficiencies of our manufacturing sites and cost containment initiatives across the company.
Our factory utilization was 83%, which was relatively consistent with Q1 at 84%.
As we move forward, our fab wider strategy will allow us to continue to reduce our manufacturing footprint and overall cost structure, while increasing capacity to support the demand of our customers.
GAAP earnings per share for the second quarter was 42 cents per diluted share non-GAAP earnings per share was <unk> 63 per diluted share as compared to 12 cents per share in the second quarter of 2020, and 35 cents on Q1 as.
As noted earlier this is the highest ever quarterly non-GAAP EPS reported by the company.
Now let me give you some additional numbers for your models.
GAAP operating expenses for the second quarter of 2021, $357.9 million.
Non-GAAP operating expenses were $314.2 million a decline of $10.5 million quarter over quarter as we continue to see the favorable impact of our cost reduction initiatives launched in Q1.
Our GAAP GAAP operating margin for the second quarter was 16, 9%.
As compared to 3.6% in the second quarter of 2020.
Our non-GAAP operating margin was at the highest level since 2010 coming on at 19, 6% as compared to 7.4% in the second quarter of 2020 and 13, 3% in Q1.
Our GAAP diluted share count was $443.6 million shares and our non-GAAP diluted share count was 435 million shares.
Please note. We have included an updated reference table on the Investor Relations section of our website to assist you with calculating our diluted share count at various shows prices.
Turning to the balance sheet.
Cash and cash equivalents was 1.19 million and we had 1 point, sorry, 1.19 billion and we had $1.97 billion undrawn on our revolver.
Cash from operations was 488 million and free cash flow was $383 million or 23% of revenue.
Capital expenditures during the quarter of 2021.
Was $104.8 million, which equates to a capital intensity of 6.3% as.
As we indicated previously we are directing that significant portion of our capital expenditures towards enabling our 300 millimeter capabilities at our east Fishkill fab.
Accounts receivable was $669 million, resulting in DSO of 37 days.
Inventory increased $13.8 million sequentially to $131 billion and days of inventory decreased 8 days to 116 days.
Distribution weeks of inventory decreased again by $42.6 million to $7.3 weeks from $8.4 weeks in Q1, which is below our target range of 11 to 13 weeks.
Once again, we are proactively reducing the distribution inventory to hold more inventory on our balance sheet to support our customer needs rather than building inventory on the supply chain.
Total debt was $3.3 billion and we paid down $120 million in the quarter.
So turning to guidance for the third quarter Keith.
On a table detailing our GAAP and non-GAAP guidance is provided in the press release related to our second quarter results. Let me now provide you with the key elements of our non-GAAP guidance for the quarter.
As mentioned, we believe demand will remain strong for the remainder of the year. Although we continue to increase our supply through operational efficiencies will be limited by supply constraints and are working with our strategic customers to provide long term support.
Based on current bookings trends backlog levels.
We anticipate the revenue for the third quarter will be in the range of 1.66 billion to $1.76 billion.
We expect gross margin between 39% to 41% and this includes share based compensation of $3.7 million.
We expect non-GAAP operating expenses of 305 to 303 hundred $20 million.
And this includes share based compensation of $19.2 million.
We anticipate our non-GAAP, Hawaii on interest expense will be $26 million to $29 million.
This results in non-GAAP earnings per share in the range of 68 cents.
We expect capital expenditures of 100 to 110 million in the third quarter of 2021.
Our non-GAAP diluted share count is expected to be in the range of 436 million shares.
So in summary, I'm extremely pleased with our early progress on the execution of our transformation initiatives.
I add my thanks to our worldwide teams for their hard work and unwavering commitment to our customers.
Look forward to seeing you all at our analyst day in New York in a few days.
With that I'll turn the call back over to the operator to open the line for Q&A.
Thank you.
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Your first question comes from Ross Seymore from Deutsche Bank. Your line is open.
Hi, guys. Thank but let me ask a question congrats on the results. That's on I wanted to talk a little bit about the demand and the shortage commentary you had I believe last quarter, you thought that the demand would kind of stabilize the velocity might of the increase might slow, but shortages would abate in the second half of the year. It seems like you've pushed that out into the first half of next year.
I guess, what's changed with any color on the demand side and how can you be confident that theres no double ordering within that.
Sure. That's a that's a good question look the diner.
Demand environment as we've always stated is very dynamic.
We see it.
Basically pushing out into the first half of next year, that's based on our backlog based on customer interactions on really based on the L. T S aged debt, we have been engaging with on customers either signed or in active engagement now as far as the double ordering we're managing our supply chain to make sure.
That doesn't happen as far as having it in the channel. So we have been reducing and managing inventory very closely.
That keeps the inventory on our balance sheet, but allows us to serve as strategic customers as we see the demand from the end customer without really accounting for any call. It buffer stocking that you may or may not see in our in the distribution channel or anywhere in between us and the and OEM.
That's how we're managing call it tactical but that's what we need to do right now to make sure that we're not going to suffer from the double ordering so that gives me the confidence given the numbers on the inventory that had been reducing and building up on our balance sheet that we are literally tackling and demand on a 1 to 1 basis with our direct costs.
Yeah.
Thanks for that color Hassan I guess as my follow up for either you or that on the gross margin side of things that's probably the most impressive line given where on has been historically and the challenges. It's facing can you just talk a little bit about what drove the upside even to your guidance in the second quarter. Similarly for the third quarter and a higher level question how much of that.
Do you believe is structural versus just you guys benefiting from some pretty strong cyclical tailwind that you know as we've learned in the past can come and go at different times.
Yeah, I mean, if you look at the components of the gross margin strength, obviously, we've always sat in the first and second quarter. Now we have you know call. It thousands of line items that we are structurally working on improving our operation on streamlining our business.
That's going to drive gross margin expansion those haven't been firing on all cylinders and we are seeing the benefit incrementally and you're going to see that in our in our guidance for Q3. So those I would call structural you know.
If you look at.
Utilization utilization has been flat from last quarter, but you see a big gross margin jump that also is what I would call structural it's not really tied to utilization per se because utilization is flat. So the jump from Q1 to Q2 days on all of the other work that we have been doing so we continue to streamline our.
<unk> take cost out of our products.
And portfolio mix and portfolio rationalization.
You know a couple of quarters ago I was asked if that would be delayed because of the demand environment. My commentary has been it's actually going to be accelerated because it's going to force us to shift faster to our strategic products that will drive higher margin. So you're seeing some of that portfolio mix happening earlier than we anticipated.
So all of these components will tell you that it is structural it is sustainable and forward looking I'm very bullish on the capability of on gross margin expansion.
Thank you.
Yeah, Yeah, I would just on I think you know what there.
That's all I think if you look at the upside compared to our guidance, we were able to get more supply out of our manufacturing sites and then obviously, we're getting favorable mix out of that as well, which is helping with the gross margin, but absolutely agree it.
Structural changes that were making inside the company.
Thanks, guys.
Yeah.
Your next question comes from Charles <unk> from Citigroup Your line children.
Uh huh.
I think.
You've got the wrong name, but I'll I'll speak up for my unborn son named Charles It's Chris Hey, guys can you just be a little more specific on the gross margin drivers.
Was there any price involved cutting specific product lines.
Big jump given that utilization rates didn't do anything any any specifics there would be great.
Yeah, I mean, it's it's it's spread across our across the board of course, there is some you know what I referred to the price to value discrepancy. So we have been looking at our pricing from a strategic perspective, what products and what pricing they need to be in the market to extract the value that we provide for our customers.
Cost is a big factor not just product costs, but supply chain costs, you know upstream and downstream supply chain cost you know.
Some of the increases that we've seen we've passed those on to customers as I've described in prior calls.
So it's really Christmas it's across the board, there's not a big step function that I would I would anchor on because when we look at incrementally. It came from all of these swim lanes that we have been launch and working on since really since the December timeframe. When I came in I said, we're structuring gross margin.
I have a specific owner in the company that drives gross margin improvements for the company and we have about call. It a thousand swim lanes that we are.
Delivering to and those are starting to come out now.
Because it takes time to get those through the supply chain and now is the quarter, where we see it and theyre going to continue in the forward looking quarters as well given the Q3.
<unk> range.
Great and then for my follow up on you mentioned you expect the shortage is to extend into next year can you just talk about.
What are your lead times are these days or what they did sequentially did they extended during the quarter, where they were they flat up or down.
Yeah, Chris the last quarter, our lead times were in the low 30 week range. We've now up to about 42 weeks, so they've they've gone up by about 10 weeks sequentially.
We're working on that but that's another reason that.
It's giving us on 1 hand, giving us more visibility, but why we see the supply constraints you know being limited.
As we look forward.
Great. Thanks, guys.
Your next question comes from Leerink Arya from Bank of America. Your line is open.
Thanks for taking my question on that congratulations on the gross margin and then, especially the free cash flow improvement. My first question I saw on is that you know investors are trying to grapple that on the situation, where as you mentioned demand is strong, but where the supply environment stayed disciplined so this.
Specific question is how under supplied is the industry right now and you mentioned the situation could persist until the first half is that based on demand levels staying at current levels on what they could be on next year, just basically what what are your views about the supply response from on and your peer group on 2.
Give investors the comfort that the supply to sponsor on the industry is not going to change this very strong discipline in the pricing dynamic that you're on industry is benefiting from right now.
Yeah.
That's a good question I can I can't really speak for for hot on what we're doing here of course.
The fear is the reaction you go on build capacity for across the board.
But if you look at what we are doing specifically and why I'm comfortable with the forward looking view of our margin on our our posture really with the gross margin expansion as we are selectively adding capacity, where we see the growth in our strategic products forward looking so we're not adding capacity for the sake of adding capacity we are.
First shifting from you know a lot of what we call the legacy portfolio into the strategic growth.
And adding capacity there so as we are increasing our top line given the supply relief that we're getting through our supply chain those are coming from strategic growth products. So when I look at you know our strategic plans moving forward and we'll give a little bit more color at analyst day.
That's why we're expanding the capacity it is not equal for all so there are you know demand signals on our AR and our visibility on our customers that we are not servicing beyond what we can't today, so I'm not adding capacity there. We're selective we're very disciplined on where we add capacity and we're adding it.
And our growth product that are strategic and those will be driving the gross margin forward looking so very selective not not a shot shotgun approach.
Got it and for my follow up actually a clarification on a question on the clarification side any impact from shutdowns on our you know COVID-19 related issues and and southeast Asia from a supply side.
And then Assam, you sound really I'm very confident about ons.
Prospects in the electrification I'm sorry, so could you help us understand what is your current exposure to E vs in and what kind of content growth do you see both on the powertrain and on the Adas side as the industry moves more towards E. D. Thank you.
Yeah.
So.
Yeah, Let me, let me answer the EV first you know our exposure. Obviously this is starting to to grow I'm very bullish you know I'm not going to I can't even hide it. So I'm glad you you really picked it up.
So I'm I'm I'm very bullish with our posture both on the automotive safety and electrification electrification penetration is starting to pick up we are well positioned with strategic Oems directly but also through there or do you want supply chain. So that is <unk>.
Really forward looking how I look at the market and really where our R&D investments are happening you know if you recall, we did a big restructure at the beginning of the year, that's moving R&D and capacity and capital into those markets because I see the design wins I have personally engage with <unk>.
Summers, we have L. T S H as it relates to vehicle electrification all of these make me very bullish but more importantly, very excited on the potential of on in these markets.
Your question about the Covid disruption yeah, we've seen a we have seen disruption related to COVID-19 and in some of our supply chain direct or indirect but you know back to the demand environment.
I think our operations and our manufacturing teams worldwide, we were able to really redirect and service.
More demand by shifting the mix again, so there was disruption we overcome that disruption and now we're back on track so let's call. It a blip that we were able to sustain given the demand and given the work that we're doing on releasing more capacity.
Thank you.
Yeah.
Your next question comes from Doshi of Harry <unk> from Goldman Sachs Goldman Sachs. Your line is open.
Good morning, Thanks, so much for taking the questions and congrats on the strong results.
I was on I had a 2 part question on on gross margin.
You talked about addressing price to value discrepancies just curious what percentage of discrepancies have you been able to execute on and the <unk>.
Form of price increases and how much left is there to go.
I guess on your tenure at par on I'm I'm guessing, it's still very early innings, but curious how much is left and then ask my second part.
In terms of the 300 millimeter transition again I believe it's very early in the process, but how do you see that evolving over the next couple of years and the impact on gross margins.
Thank you.
Sure. So the first question as it relates to price value. Obviously this is an ongoing effort.
Put it under the portfolio rationalization overall, so I I don't break it out.
Cause of price or because of the shift because all of those are material.
Start moving the shift to high value products without touching the price that's going to impact the value provided to customers. So I would say.
You mentioned.
We're not done yet that's a continuous improvement everywhere.
We look Ah theres opportunity and more importantly, the momentum that the company is getting you know if you think about it in the first couple of quarters I've been pushing a lot of that.
From the top right now it's part of our culture and it's part of how the teams are thinking about pricing strategies from new products and moving forward. So it's not a.
You know a blip in time were all because of that environment, we're able to extract the value. It is structurally how we're moving forward. So new products are not going to be having those issues on the price to value discrepancies because we arent pricing the new products and delivering the new products exactly at the value day.
Provide customers. So that's really how I look at it.
But that does that help.
It does and then the 300 millimeter transition.
Sorry that was my follow up just on the on.
Opex side of things.
I think you came in.
Below the low end of your range for Q2.
Roughly 19% of sales and then for Q3 your guidance implies an opex to sales ratio of around 18%.
That compares with the.
The prior management management team's long term target of 21%. So just curious is 18% sort of the new normal is it going to be a little bit higher a little bit lower and your thoughts on opex going forward would be helpful as well. Thanks.
Sure. So on the 300 millimeter, obviously as a strategic asset we have been working with global foundry on our transition we have not taken ownership of that fab. Yet. However, we're working very closely on starting to move volume into that fab. So when we take ownership we hit the ground running and that of course is going to be.
Our support of our gross margin efforts from a product cost perspective.
Where we are there you know we're on track you know I I review this regularly as far as how many products have we qualified in the 300 millimeter fab, but more importantly, the customers to have qualified that fab for us to be able to ramp with them.
Over 22 and into 'twenty 3 so that's all on on track I'm happy with the progress so that that asset is going to be favorable for us on the in the long run both from a capacity, but also from a cost structure.
And I'll, let Scott comment on the on the Opex, yes. So on the Opex side of things just to remind you in Q1, we did a restructuring activity and we said we'd realize the benefit of that cost savings over the course of the year, we we accelerated that and we're able to recognize some of that earlier and that's the impact that you're seeing here in Q2, that's more favorable too.
Our guidance.
We still believe we're going to exit the year somewhere just north of $300 million on a quarterly run rate and that becomes the new baseline obviously you've got.
The reset of FICA and things like that going into next year, but that becomes a kind of a run rate that we think we maintain and then obviously as we grow we'll we'll add opex back at a much slower pace than our revenue growth.
Thank you.
Your next question comes from harsh Kumar from Piper Sandler Your line is open.
Yeah, Hey, guys first of all it's strong congratulations these are stunning results.
And I'm going to push you a little bit in the last 5 years of results I think the peak happened at $1.5 billion. A 38, 5% gross margin I think it was like 2018 or something like that you're now talking almost 1 point something billion, 40%. So my question is you've got a higher run rate higher margins how much is it a function of the.
The actions that you've done and the actions that you've implemented in your opinion on I've got a follow up.
Sure of course, you know, there's only 1 answer to that its all based on the stuff that we've been working on.
But let me let me talk about the timing of it of course the demand environment.
He has helped accelerate a lot of these as I talked about before you know we've always had part of our structural or restructuring plan to start shifting portfolio and shifting that mix to high value high margin high strategic products in our target markets of auto and industrial.
That is part of the actions that we have been taking and we started taking since I joined.
They got accelerated with the demand environment because of the capacity constraints. What we've done is we've released capacity from what I would call. The legacy commodity products that we've always wanted to move away from part of my strategy faster into putting that capacity on high value high growth and strategic products that will grow with us over there.
Next 5 to 10 years.
So the actions are all there the timing was accelerated and helped by the current environment.
I got it.
Yes. It does thank you very much and very helpful. And then on following up on <unk> question wanted to talk Fabs on Costco. So can you remind us the timing of when you will actually have products running through fishkill, because that could be it could be a great benefit to all show good cost if things don't go well and you're running the fab.
M D. So when will you be at a point when it sort of utilized well.
From a timing angle and then what about big 12 inch fab coming your way how many fabs do you think it eventually needs.
Yeah.
Yeah. So let me let me talk about East Fishkill first we are running revenue on running volume today I East Fishkill remember, it's a shared fab today with us and global foundry, we have capacity or allocation part of that capacity out of the fab and global foundry has their capacity part of our original agreement we.
Our already shipping qualified products to end customers that are generating revenue out of that fab.
That revenue will keep increasing through 'twenty 2 as I mentioned and we are on track based on customer quality and our own product quality.
That progression is there and obviously, we will be talking about utilization once we take ownership of that fab in 'twenty 3 'twenty 4.
Right now it's more of an allocation because the fab is still not owned by bye.
By on but I measure in this case are we shipping what we need to be shipping to our customers based on the quality because that's really the the.
The latency that you usually get on we are on track with that as far as you know how many.
Fabs, we need to run our operations, obviously, that's not something I can comment on today.
Today, My focus is really on rationalizing our manufacturing footprint.
Going to a fab later, so we will have less fabs, but I will be ready to comment more on it as we were ready and we have communicated plans to that specifically.
Hey, guys very helpful. Congrats again.
Your next question comes from Mark with patches from Jefferies. Your line is open.
Hi, Thanks for taking my questions.
Our first question sorry to come back to the gross margins, but it sounds like there's something really different going on with on than the last 10 or 15 years. So that in your script I think when you talked about the gross margin upside you said mix efficiency execution and cost containment I don't think I heard pricing in there.
And then Hassan you used the expression price to value discrepancy, which I thought was a code word for we took prices up but it sounds like.
Youre shifting the mix on your limited capacity for the higher value products. So like.
So the question is on the loss. So I guess there was a clarification I just want to make sure I got that right and the for me. The question is you know over the last 10.
On 15 years I covered on you know when things are bad you hear about you know, 6% to 10% price pressure and then when things are good you hear about 5% to 10% price improvements is Donald is that part of your business gone is this is this is on now as a much lower volatility.
<unk> business on the.
And much less subject to pricing pressure.
And then I had a follow up.
So the short answer is yes, you know strategically if you you know I think 1 of them. It was the first.
Conference that I that I attended back in January to see S Conference, where I really put my focus on gross margin improvement through manufacturing footprint rationalization and product portfolio rationalization. Those are 2 strategic directions that I've set as far as what we need to do right now so what does.
Portfolio rationalization Mead and it turns out you described we'll try very accurate 1.
1 is look at which 1 which products are we going to grow in and which products are you know legacy where we're not going to be investing in and start shifting that to the high strategic products, where we want to play.
That's more forward looking meaning it is not a point in time, where those products are now better mix and when the market goes the other way we're going to have to see what you said, 6%. What we are seeing is we are shifting that to the strategic products that are starting even to growth and we will maintain.
<unk> growth over the next 5 to 10 years, that's the structural portfolio mix that we have done so what's different from the last 15 years.
I don't need fab fillers.
When you when you have fab filler products, which are you know low value discrete commoditized products.
You should keep shoving him in the fab and they go up and down with the market. We're moving away from that we are moving to strategic high value products that are going to grow over time and that capacity has been taken away from the discrete commodity product that caused that volatility so.
So in summary, when you shift your mix to strategic growth products that volatility disappears, because that's a growth trajectory on a growth trajectory only whatever demand does it's going to be growth, maybe it's not high growth, but it's still growth.
That's the structural impact.
The impact of the portfolio rationalization.
That's already on your follow up yeah, great. That's really helpful. Thank you for spelling that out for me what are you looking at on 4 leading indicators to tell you that customers are getting over their skis on on their orders.
And maybe can you talk about any dynamics you're seeing on on.
Any cancellations or push outs or anything like that thank you yeah.
Look there are there are many signs that we look at I have analytics you know.
To be able to see obviously, you're not always going to see 100% around the corner, but I'm comfortable with the visibility we get most of that and I review. It you know more than once a week in order to make sure we don't Miss anything.
But you know not to be joking about it but the biggest gauge and how many escalation calls I get from customers is the biggest indicator when I buy my phones start ringing stops ringing off the hook 50 times a day then I know, we're not where we are today.
So both of these do you have the analytics, but you also have that debt you know call. It subjective feel that you get and both of those lead me to believe that this is going into the first half of 'twenty 2.
And Mark just that we're not seeing any meaningful cancellations or push outs at this time.
We've also taken the inventory in the channels down so that we can manage that debt escalation process, whether that customers on the channel or direct and you know on essentially making sure customers are getting the inventory just as they need it rather than stockpiling. It. So we're doing our best to manage it and I think we've got good analytics and visibility on what's happening.
Right now.
That's great color. Thanks, guys really appreciate it.
Your next question comes from Rajiv Gill from Needham and company. Your line is open.
Yes, thank you and congrats as well on great momentum across the board.
Just picking up on your commentary around.
The inventory.
I think last quarter, you had talked about that you wanted to build inventory on your balance sheet, well, reducing inventory in the channel that you are actively reducing channel inventory well holding more inventory on your own balance sheet in order to allocate the right products to the right customers and therefore, preventing any excess inventory sitting in the <unk>.
Wondering how that that strategy.
It is playing out this quarter and how do we think about that.
Over the next couple of quarters.
In a in a continuation of the supply constraint environment.
Yes, so we.
We were at $8.4 weeks on the channel last quarter.
7.3 weeks this quarter. So on a revenue value that that was a decrease of almost $43 million and and channel inventory at the same time, our balance sheet inventory went up slightly in terms of dollars about $14 million, but down in terms of days it went down and he'd days. So so we're still ex.
Getting to that strategy importantly, net inventory.
Obviously as inventory becomes available finished goods become available we're shipping them. So.
So as we look forward, we think will continue this strategy through the remainder of this year I think inventory on the channel is going to stay in this level kind of plus or weighted and I think our inventory on our balance sheet will probably remain relatively flat to down slightly just depending on.
Our capacity to get more supply.
So through the remainder of this year, we don't see a change in our strategy of holding that inventory.
Just a couple more follow up if I can on that.
You had mentioned that you had secured additional supply.
Totally.
Wondering if you could elaborate further on on how much supply you are able to to to get what.
What would the steps that you did in order to kind of alleviate that supply increase more supply and how do we think about more supply coming online whether internally or externally.
And then just on I just have a question on the automotive revenue you've had record automotive revenue you, obviously want to shift too.
Electric vehicles energy renewable energy infrastructure.
Maybe you can give us some updated thoughts on your silicon carbide power products and power modules for charging stations and onboard Chargers. Thank you.
Yeah, So Roger in terms of the supply.
What we saw.
<unk> utilization was relatively flat quarter on quarter, but we got more supply out. So this is really the optimization the efficiency of our manufacturing sites that we manufacture about 65% of our own product in house, 35%.
We still remain severely constrained on the outside but we've got more control on the inside with what we can do so as our manufacturing team has executed we've been able to squeeze more out of the existing footprint.
And then if you look forward to our Q3 guide, which is up at the midpoint you can see we're getting more supply coming in in Q3 as well. So again. This is just really the optimization of that.
Footprint.
Yeah, and as far as your second question about our power products. Obviously, you know I mentioned renewable energy I mentioned on electric vehicles, which for me is both traction and onboard charging so as the power demand goes up as far as the need from customers. You know think about the fast charging whether its on board.
<unk> or the infrastructure the charger on the road or detraction.
We are winning and why we are winning is our highly competitive efficiency metric that comes from the price on technology that we are flexing, but more importantly, our packaging technology. When you put those 2 together you get a lighter and more efficient traction on module lighter obviously good for Ete's for Ford.
Distance, but lighter and smaller is also good for packaging. So we were able to get the same call it equivalent power output of our silk.
Silicon and Silicon carbide modules and I talk about module b in the device and the packaging.
Better than the equivalent competitor power output, that's where we win you'll hear a little bit more about that at the analyst day, but that's what I tie our current wins do and when I look at the funnel I talked to the customer.
Since I've taken over a lot of customers I call is why do we win why do you pick on and those are the ones that I'm pushing into our strategy to do more of.
And where are they saying, we lack weren't putting R&D in order to leapfrog. The competition show all of these give me the confidence 1 on our posture today, our posture with the design win forward looking that's going to fuel our growth and more importantly, where we are investing R&D to sustain that momentum forward looking.
Great excellent. Thank you.
Your next question comes from John Pitzer from Credit Suisse. Your line is open.
Yes. Good morning, guys. Thanks for let me ask the questions. Congratulations on the solid result, Osama I'd like to go back to kind of the significant gross margin upside you've seen over the last couple of quarters.
I'm just kind of curious what inning do you think you are in as far as repositioning the portfolio to higher margin and I guess was there any meaningful sort of advantage to kind of trying to price yourself out of certain businesses right now and customers didn't walk away. So that we saw some cyclical pricing.
Vantage TV that the June gross margins for the September gross margins.
Yeah. So look we're.
As far as inning.
Call, where we're in early innings as far as what we were able to do you're starting to see the momentum of the work we've done in Q1 and Q2, starting to kind of come about.
We haven't seen the benefit from some of the manufacturing rationalization you know the actual fab divestitures that at least the ones that we've talked about you haven't seen that benefit yet so that's going to fuel or more of the gross margin expansion forward looking right now it's on cost product a product mix.
Cost product value et cetera, all of those are what you're seeing today, so theres more to come as you as we deploy and execute our strategy forward looking so that gives me.
The comfort of where we are as far as in our trajectory on the gross margin expansion.
That's helpful and then Hassan.
The gross margins were impressive I would argue the free cash flow was even more impressive and if you look at your share schedule on your website, there's not a lot of dilution coming down as the stock price goes up so I'm kind of curious how you guys are thinking about sort of the use of cash and cash return given how strong the free cash flow generation.
It looks like it was in the quarter and should continue to abate.
Yes, John its debt.
You're right now that we took out debt.
Convert and swapped it out for a new convert debt of old 1 was heavily in the money. So the dilution impact isn't as significant as what youre seeing in the.
Past and on and if you look at our guidance.
For next quarter 436 million shares it's just up a small take rate. So as we think about the cash generation right now its balance sheet flexibility as continue to pay down the debt long term, we'll look at returning capital to shareholders, but right now <unk>.
That's in the business.
Our balance sheet flexibility.
Thanks, guys.
Yeah.
Your next question comes from Harlan sur from Jpmorgan. Your line is open.
Good morning, congratulations on the solid results and execution.
Image sensor business again on the group, both auto and industrial on a quarter on quarter and year over year basis.
And on most of this business is outsourced you talked previously about being supply constrained into the first half of next year.
Supply normalization accident pushed out given the strong demand you're seeing and then just given the strategic nature of sense into your strategy and portfolio is this a technology and product segment that he was actually thinking about potentially bringing in house.
Look so that youre absolutely right.
This is a very constrained because the majority of all of it is foundry base now as far as over the long term strategy about what we do outside or inside.
We'll be we'll be talking more about that in our analyst day, but.
But it is fundamental to our strategy and therefore, the supply constraint is not something we can solve right now right now it's more on optimizing our existing supply chain that we have because I imagine that technology is not you can't pick up a fab, whether internal external and get some expansion.
There's a lot of R&D work that needs to go into qualifying and running that image sensing technologies and very specific fabs that require capex and R&D. Obviously, we're looking at all options on.
Right now through call. It 22, it's what more can we get out of the.
The foundry partners.
Got it and then normally the December quarter from a seasonal perspective.
Flat to down slightly sequentially, but just given the strong demand velocity given the backlog visibility.
Combined with your supply additions coming on into the second half with the teen anticipate a better than seasonal growth trend for the December quarter.
Look I don't I don't think we can talk about seasonality, but I'll let.
Fat comment, but I you know seasonality at this point is really we don't have we have the demand.
Right now our top line on our forward looking is based on the supply on the mixed we're able to get out of our footprint.
Yeah. So you know as long as rates were limited by supply and so the demand is there. So as we look into the fourth quarter. We think we're going to be at the top end of our normal seasonality, which normal seasonality is kind of flat to down 2%.
Great. Thank you.
Yes.
Your next question come try on Vijay our cash from Mizuho. Your line is open.
Hi, Congratulations on a great Corp, and paid.
Just wondering on the EV and Adas.
Very strong growth there to give us some color on how that grew sequentially and as you exit the year.
If you can talk to what the mix you see especially with the inflection on the EV side, how did you get it asked mix gross year on year.
Yes. Thanks.
We're not breaking up.
Bye bye technology or by sub segment, where just looking on the automotive we expect automotive to maintain the growth obviously.
Limited by what I mentioned earlier and the prior question on the Adas side from the supply and the imaging, which we are highly constrained on as far as the rest of our power products arent call. It that the silicon non imaging product our products.
That's going to be on based on how much we are able to get more out of our supply chain footprint as Todd mentioned through the efficiencies that our supply chain team has been working on.
Got it and if you look on that.
I'd mentioned going into Q4 of them on like the top end, so flattish, but wondering if you can give us some idea on.
The book to Bill is trending you know how it was in Q2.
Q3 Q4.
You'll get some idea of that in terms of how orders are coming in thanks.
Yeah.
Yeah, Vijay I mean, the book to Bill strong right. It's remained strong and we think it's going to continue through the remainder of the year.
Again its supply that's the issue.
We're not seeing major cancellations or push outs, we're seeing consistent strength right now.
So we're not seeing any major swings in the book to Bill.
Great. Thanks, a lot.
Okay.
Your next question comes from William Stein from Koulis. Your line is open.
Great I want to add my hearty congratulations to great results.
Better outlook.
And I appreciate you taking my questions first the compute end market was particularly strong in the quarter I think you attributed that or at least highlighted graphics.
Graphics cards to part of the success there I'm wondering if you could talk about trends in that end market as we look out over the next couple of quarters, there's been some concern about perhaps in.
In aggregate inventories or mismatched bills of materials that might cause a hiccup in that end market I wonder what you're seeing in terms of the outlook. There and then I do have a follow up.
Look we're seeing strength in both cloud and server market. So that you know.
It's over market growth. If you look at what customers are doing there is more and more capacity for expansion in these markets and that's what we're correlating on our demand. So I think I think the the market took a pause in 2020 and maybe at the beginning of 'twenty, 1 and now it's starting to pick up from an investment side, you know I don't see.
That kind of slowing down we're going to keep monitoring it just like we are every every other market and our focus indeed is limited to what we want to do on the product side.
Or what I would call adjacent markets, where we have very compelling and competitive products that we were able to service in these markets and we're going to be pushing that.
Through to our customers, but from the science and the data I get from our customers directly there is capacity expansion on their side and that gives me the visibility on the confidence in the demand that we have on our backlog for these markets.
Great and then as a follow up you talked about capacity expansion on the next few quarters I may have missed it but is there an aggregate.
Sure.
It's sort of unit growth or dollar growth.
That's getting built in as we think about.
Demand and supply, perhaps rationalizing where we're coming into somewhat of a thesis in the first half of next year as you've highlighted what should we think about your total capacity as we progress into that timeframe.
Yeah.
Well I would say we've got a couple of things going on we've got the 300 millimeter fab coming on line in 'twenty 3 we're continuing to push.
Production in there.
We are supply constraint, we will continue to optimize but I would look at just our our supply has been at least through the time horizon. You are talking about the first half of next year as being pretty steady.
Some small increase as we continue to optimize and get more output.
Thanks, Congrats again.
Thanks.
Okay.
Your next question comes from Christopher Rolland from Susquehanna. Your line is open.
Congrats as well on all the progress you've made in just a few quarters guys.
The first questions for us on Hassan a L. P. S. As were a big deal for you guys at Cypress.
Can you expand there, perhaps what you eat what you know end markets Youre looking to do long term supply agreements for how they're being used strategically and ultimately do you guys have a goal of kind of what percentage of revenue you ultimately want under long term agreements.
Yeah, Chris So obviously, our focus is to start with number 1 our strategic markets and to strategic products and strategic customers in those markets. So that's kind of the priority that we are doing because and thats. The start because think about it from a strategic perspective, I wouldn't want to lock in supply.
Before I get all of my automotive customers, taking care of them for example, and once that happens on you know you start going automotive industrial and it's based on customers and the breadth of customer within a 4 on you know are they are buying multiple products. We're cross selling plays a big impact in our decision.
Or is it a 1 product so that helps us strategically assess where we are obviously our goal is to.
We remain in support all of the customers that.
That we have and that's how we're going to maintain the growth, but as far as al TSA, starting with strategic markets strategic customers on breadth of customers.
That's what's going to fuel our growth, but more importantly, our stickiness the broader we are the more.
Sticky we are because that's where the value comes and not from our product, but from a company perspective.
So to answer your question about a percent given that I really don't have a percent.
Target what I want is to drive the right strategic behavior, because if I throw a percent out there I guarantee you we will need it.
My view is I'm looking at it strategically or whatever the percent ends up at ends up but we do have based on the product lines. So not at the group level, but at a click below that they have kind of targets, where we may not want on go up to 80%. For example, because you want to keep you know 20 or 30% dynamic.
4.4.
For the growth that we get from new customers that are not yet at the level. We wanted to do an LTE SA. So theres a lot of play in there and we're taking it very very surgical on an account market and really segment basis.
Excellent and then a question around the fab footprint.
First of all any updates on your existing Fabs for sale and then secondly on east.
East Fishkill, the prior management team talked about $2.3 billion in additional revenue do you have an update there in this environment do you think that could be substantially higher.
Yeah in terms of the fab.
Footprint, we continue to look at it we're in deep discussions with a.
A couple well quite a few parties actually on the 2 fabs that we publicly announced them. So those are tracking along.
You know it takes time to exit a fab right.
Getting the structure in place.
Of the exit.
Even though we haven't announced something we're still along our path of timing, but it does it does take time, but things are progressing nicely there.
Look on the on the <unk> on the East Fishkill Fab, obviously, we are in a path to changing even the mix of what goes on that fab based on our new strategy on our new direction I wouldn't put yet a number to it of course, we're getting it because it's going to drive incremental growth that is part of the strategy, but I'll be more comfortable disclosing.
<unk> that number in that target and how we progress against it.
Once we have ownership of that fab.
Great. Thanks, guys great progress.
Thank you I would now like to turn the call live or back to you Mr. Hassan <unk> President and CEO.
Thank you all for joining us today I once again.
Our worldwide team for their hard work in driving our transformation and solid results.
It's been an exciting few quarters and we are firing on all cylinders.
We remain focused on our execution and our drive to streamline our business and unlock our value I look forward to seeing you all at our analyst day in a few days for a deeper look into our strategy and our transformation.
This concludes today's conference call. Thank you all for joining you may now disconnect.
Okay.
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Yes.
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