Q3 2021 ON Semiconductor Corp Earnings Call
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Ladies and gentlemen, this is the operator today's conference call is scheduled to begin momentarily until that time your lines will again be placed on music hold thank you for your patience.
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Ladies and gentlemen, thank you for standing by my name is Brent and I will be your conference operator today.
At this time I would like to welcome everyone to the on semiconductor third quarter 2021 earnings Conference call.
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After the Speakers' remarks, there will be a question and answer session.
I would like to ask a question. During this time simply press star followed by the number one on your telephone keypad.
I'd like to withdraw your question again press Star one. Thank you I would now like to turn today's call over to Mr. Parag Agarwal, Sir. Please go ahead.
Thank you Brent.
Thank you for joining us.
191.
This conference call.
I'm joined today by our President and CEO and Brian.
Our CFO.
Call is being webcast on the Investor section.
Www dot on semi dot com.
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Approximately one hour following this conference call and webcast will be evergreen for approximately 30 days. Following this conference call.
Additional information related to our end markets business segments geographies channels Jackup in 2021 'twenty two.
Also posted on the Investor Relations section of our website.
Our earnings release and this presentation includes certain non-GAAP financial measures.
A reconciliation of these non-GAAP financial measures. The most directly comparable measures under GAAP are included in our earnings release, which is posted on.
On our website.
Investor Relations section.
During the course of this conference call, we will make projections or other forward looking statements regarding future events or future financial performance.
The words believe estimate project anticipate intend may expect.
So.
Or similar expressions.
Turning to identify forward looking statements.
We wish to caution that such statements are subject to risks and uncertainties that could cause actual events or results to differ materially.
<unk> and <unk>.
Part of the factor.
That can affect our business.
Including factors that could cause actual results to differ from our forward looking statements.
Described in our most system.
Thank you and other filings with the Securities and Exchange Commission.
Additional factors are described in our earnings for the third quarter of 2021, I Wonder if that's.
Forward looking statements regimes.
We have no obligation to update forward looking statements to reflect actual.
<unk> assumptions are that he thought that'd be upfront, except as required by law now let me turn it over to Hassan Hasan.
Thank you Brock and thank you everyone for joining us today we.
We delivered yet another quarter of record results driven by exceptional execution by our worldwide teams and strong demand for our intelligent power incentive products.
We posted record quarterly revenue and non-GAAP operating margin and EPS.
With our results and outlook, we have made a solid start towards achieving our financial target model.
Even though our Q3 results and Q4 outlook significantly exceed expectations. We believe that we are just in the early innings of transforming the business.
As we make further progress in our transformation initiatives and as our intelligent power and sensing design win.
With automotive and industrial customers, we expect to see sustained revenue growth and margin expansion.
Today, we announced the close of our acquisition of GT advanced technologies, our <unk>.
As we outlined at our analyst day, our goal is to provide our customers in the industrial and automotive end markets with highly differentiated intelligent power and sensor solution and we are investing to achieve that goal.
With <unk> market, leading silicon carbide substrate technology on semi is now the only silicon carbide player in the industry with end to end capability encompassing modules devices and substrates.
Our acquisition of <unk> that has been a catalyst for a key automotive customers to engage in long term strategic partnerships with us and we can expect <unk> to be a critical enabler of our impending ramp in our silicon carbide business.
In fact in Q4 2021, we will be shipping silicon carbide product based revenue utilizing the gaas substrate.
I am also excited to announce that <unk> has delivered 200 millimeter pools, which we have processed at our on semi manufacturing facility and we will be sampling our first devices in January 2022.
We welcome the <unk> team to the on semi family and look forward to expanding its capacity to support our silicon carbide growth plan.
On a year to date basis, our power design win funnel grew by 75% year over year.
At the end of the third quarter, we have signed <unk> or committed revenue of $2 5 billion.
Over three years for our power solutions.
Over $2 billion of this committed revenue is for our silicon carbide solutions for automotive and industrial applications and two thirds of this committed revenue for traction inverters or electric vehicles.
We expect to exit 2023, with Silicon carbide revenue run rate of about $1 billion.
The demand of our intelligent power and sensing solutions in our strategic end markets continues to outpace our current supply capability the.
The strength in demand is driven by secular mega trends, such as vehicle electrification Adas industrial automation and transition to alternative energy from fossil fuel based power generation.
For the third quarter automotive and industrial end markets together grew 42% year over year.
On a year to date basis, our design win funnel for these end markets.
55% year over year.
Giving us excellent visibility into future revenue.
In addition to secular factors demand for our products and being driven by industry, leading performance of our products in both intelligent power and sensing.
Consistent with our strategy outlined at our analyst day, we are driving a mix shift towards automotive and industrial end markets to drive margin expansion.
For the third quarter automotive and industrial together contributed 60% of our revenue as compared to 56% in the quarter a year ago, and we will continue phasing out low margin noncore revenues into next year.
Looking forward, we expect demand to remain robust and outpaced supply through most of 2022.
We are selectively investing in our operations to relieve capacity bottlenecks for our strategic product lines, while working with our foundry partners to obtain a higher allocation of capacity.
At the same time, we are shifting our production to strategic high value mix of products.
Longer term, we are qualifying products and the 300 millimeter east Fishkill facility to increase the efficiency of our fab network, while executing our fab lighter strategy.
Along with expanding supply we are working collaboratively collaboratively with our customers to ensure uninterrupted supply of our products and we have entered into long term supply agreements with many of them.
These lts's commit a multiyear revenue stream with stable and sustainable margin.
Coupled with our expanding design win pipeline in the automotive and industrial end markets, we have outstanding visibility into our revenue and margin in support of our target model.
Along with entering into Lts as many of our largest automotive and industrial customers are co investing with us. These investments solidified the strategic nature of our LTC and enable us to support our customers by ensuring supply and providing development support.
Let me now discuss a few highlights of our key strategic end markets starting with automotive.
We set a record for our automotive revenue in Q3 of $575 $6 million.
<unk> represented 33% of our revenue in Q3, and grew 37% year over year and 4% quarter over quarter.
The strength in automotive was driven by both our power and sensing product categories.
We are seeing strong momentum in our electric vehicle business for both Silicon carbide and IGT based solutions, we have signed <unk> for committed revenue for EV, a little less than $2 billion over the next few years starting to ramp in Q4, 2021, and approximately doubling year over year for the next few years.
Yes.
Over 80% of this committed revenues for Silicon carbide solutions for EV traction and burgers.
As we have indicated earlier in addition to the industry leading performance of our first 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 weight and cost of a power module the.
The efficiency of our modules allows our customers to make no tradeoffs between the cost of battery and the range of the vehicle they get both.
Our automotive imaging revenue grew more than 10% quarter over quarter and 45% year over year, we continued to see momentum in automotive safety with new design wins, and increasing content for our Cmos image sensors and power management.
Year to date, our automotive imaging design win funnel grew by 75% year over year.
And Adas systems shift to higher pixel density and the need for automotive safety requirements are on power management increases our content will increase as these solutions have higher ASP.
This increase is further compounded by a higher number of sensors and power Ics per car and increasing number of cars with active safety features.
The industrial end market, which includes military aerospace and medical contributed revenue of $478 5 million in Q3, representing approximately 27% of our revenue.
Our third quarter industrial revenue increased by 48% year over year, and 11% quarter over quarter, driven by strong demand for our intelligent power in sensing solutions.
We are seeing a more than two X growth and our design win funnel from alternative energy customers for our power solutions and expect the alternative energy market to be a long term driver for our business as utility scale power plant installations are expected to grow worldwide to reduce the.
The climate impact of fossil fuel based power plants.
Industrial power tools are another area of growth as power tools are transitioning from brushed motors to brushless motors and from AC to battery powered both trends driving significantly higher content for us.
The demand for our imaging products and industrial automation applications remained strong with 20% quarter over quarter growth.
Industrial customers are investing in automation at an increased pace to improve efficiency and to reduce volatility in operations due to social distancing mandates and labor shortages.
We have leveraged our experience in automotive to offer our industrial customers Rugen high resolution and high image quality sensors for the most demanding industrial applications.
Now I will turn the call over to Pat to provide additional details on our financials and guidance.
Thanks Hassan.
I'm pleased to announce yet another quarter of record results as if all had mentioned.
We posted record quarterly revenue record non-GAAP operating margin and earnings per share, while generating free cash flow margin of 20% for the quarter.
All three of our business units reported record quarterly revenue at our targeted automotive and industrial end markets grew sequentially achieving record revenue levels.
With a rapidly expanding design win funnel of intelligent power and sensing solutions and ongoing structural changes to our business, we are well positioned to make sustained progress towards our targeted financial model.
While the other semi team has accomplished a lot in a short period of time, we have significant opportunities ahead of us to drive sustained revenue growth and predictable financial performance.
From a revenue perspective, we are in the early innings of the ramp in our vehicle electrification business and expect EV.
Difficult driver of our long term growth complemented by increasing demand for Adas.
That's real automation and alternative energy.
We are pleased with our performance, thus far and remain focused on margin expansion as we execute our transformation initiatives within the portfolio optimization and our wider strategy.
Turning to the results for the third quarter.
Total revenue for the third quarter was $1 74 billion, an increase of 32% over the third quarter of 2024% quarter over quarter.
The sequential revenue growth was driven by our ability to increase our supply both internally and externally shipping 3% oriented than in Q2 and favorable mix and pricing across all end markets.
Revenue for our intelligent power and intelligence products were also at record revenue levels, increasing sequentially, 3% and 8%, respectively, while accounting for 62% of total revenue in Q3.
Our auto our automotive revenue grew 37% year over year and 4% sequentially.
Industrial revenue grew 48% year over year and 11% sequentially.
Automotive and industrial contingent contributed a total of 60% of revenue in Q3 as compared to 56% in the year ago quarter.
Turning to the business unit revenue for the power solutions group or PSG was $892 2 million PSG revenue increased by 38% year over year due to strength in automotive and industrial end markets.
Revenue for the advanced solutions group or ISG was $613 5 million, an increase of 24% year over year.
In addition to strength in automotive ASP benefited from strength in computing, especially of high end graphics cards.
Revenue for the intelligent sensing group or ISG for the third quarter was $236 5 million, an increase of 35% year over year.
Both in ISG was driven by both automotive and industrial end markets.
GAAP gross margins for the third quarter was 41, 4% and non-GAAP gross margin was 41, 5% and 800 basis point improvement year over year, and a 310 basis point improvement quarter over quarter.
Our gross margin expansion is ahead of our original plans with improved efficiencies at our manufacturing sites favorable mix and improved pricing as we continue to examine our portfolio for price to value discrepancies.
Over the last two quarters, we have exited approximately $100 million of.
Non core revenue at an average gross margin of 15% and allocated this capacity to strategic products with accretive gross margins.
Over 60% of this exit occurred in Q3, and we expect to continue phasing out our low margin noncore revenue over the next two years as we outlined at our August analyst day.
To date, we have been successful in navigating rising input and manufacturing cost by adjusting pricing to our customers.
We will likely see more cost increases in early 2000 to do we don't expect these increases to have a negative impact on our gross margins.
Our factory utilization was 80% down slightly from Q2 level of 83% due primarily to COVID-19 related slowdowns affecting our backend facilities in southeast Asia as our operations stabilize we expect utilization to remain in the low 80% range consistent with previous quarters.
GAAP earnings per share for the third quarter was <unk> 70 per share non-GAAP earnings per share for the third quarter was 87 cents per diluted share as compared to 27 per share in the third quarter of 2020 and 63 in Q2.
As noted earlier this is the highest ever quarterly non-GAAP EPS reported by the company.
Now let me give me some additional numbers for your models.
GAAP operating expenses for the third quarter of 2021 were $321 6 million as compared to $322 2 million in the third quarter of 2020.
Non-GAAP operating expenses were $296 2 million, a decline of $18 million quarter over quarter as we continue to restructure our operations to align with our new strategy and reduce investments in our non strategic areas.
While we saw benefits of lower Opex in Q3, we expect to redeploy capital into our strategic areas in Q4, and therefore, there will be an increase in spending back to normal run rate levels, while achieving our 17% operating expense target.
Our GAAP operating margin for the third quarter was 22, 9% as compared to 9% in the third quarter of 2020.
Our non-GAAP operating margin was at a record level of 24, 5% as compared to 12% in the third quarter of 2020 and 19, 6% in Q2.
Our GAAP diluted share count was $440 7 million shares and our non-GAAP diluted share count was $435 7 million.
Please note we have an updated reference table on the Investor Relations section of our website to assist you in calculating our diluted share count at various share prices.
Turning to the Q3 balance sheet cash and cash equivalents was 139 billion and we had $1 97 billion undrawn on our revolver.
Cash from operations was $448 9 million and free cash flow was $355 7 million or 20% of revenue.
Capital expenditures during the third quarter were $93 2 million, which equates to a capital intensity of five 4%.
As we indicated previously we are directing a significant portion of our capital expenditures towards enabling our 300 millimeter capabilities.
Our capabilities at the East Fishkill Fab and expansion is silicon carbide capacity.
Accounts receivable was $720 million, resulting in days sales outstanding of 37 days.
Inventory increased $18 million sequentially to $1 $3 billion and days of inventory increased three days to 119 days.
The increase in inventory was driven primarily by an initial build a bridge inventory about transition and work in progress inventory of finished wafers could not be processed through the backend capacity constraints.
Distribution inventory decreased $39 million to $6 eight weeks from seven three weeks in Q2.
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 in the supply chain.
Total debt was $3 1 billion and our net leverage ratio is now approximately at one times.
Turning to guidance for the quarter and table dealing are detailing our GAAP and non-GAAP guidance is provided in the press release related to our third quarter results. Our guidance includes our expected results for roughly nine weeks of the <unk> acquisition after closing last Thursday, let.
Let me now provide you key elements of our non-GAAP guidance for the fourth quarter.
Based on bookings trends, we believe demand will remain strong through much of next year.
We continue to increase supply through operational efficiencies and working with our external partners to obtain additional capacity.
We are also accelerating product qualification at our 300 millimeter fab in east Fishkill. Despite these efforts will be limited by supply constraints and we are working with our strategic customers to ensure long term uninterrupted supply.
Based on current bookings trends in backlog levels, we anticipate that revenue for the fourth quarter will be in the range of $1 74 billion to $1 8 billion. This includes expected G tap revenue of approximately $3 million to $4 million for the quarter.
We expect non <unk> non-GAAP gross margins between 40% to 44%.
This includes share based compensation of $3 $6 million.
We expect total non-GAAP operating expenses of 298 million to $313 million and includes roughly $4 million and opex, <unk> and share based compensation and $18 $6 million.
We anticipate our non-GAAP or E, including interest expense will be $24 million to $27 million.
So this results in non-GAAP earnings per share to be in the range of 89.
To a dollar one this includes the impact of <unk> business, which is roughly <unk> <unk> dilutive for the quarter.
We expect total capital expenditures of $130 million to $140 million in the quarter.
Our non-GAAP diluted share count for the fourth quarter of 2021 is expected to be approximately 437 million shares.
So in summary, I'm extremely pleased with our progress in the execution of our transformation initiatives by adding my thanks to our worldwide teams for their hard work and unwavering commitment to our customers with.
With that I'd like to start Q&A, but I'll turn it back over to Brent to open the line for questions.
At this time I would like to remind everyone in order to ask a question press star followed by the number one on your telephone keypad. Your first question comes from Ross Seymore with Deutsche Bank. Your line is open.
Hi, guys congratulations on the strong results.
My first question is for you and that's on the transformation on the revenue line at your Analyst meeting you talked about exiting 10% to 15% of your revenues over the next couple of years I wanted to see if we can get an update on that and how much of that is a headwind today or is that still yet to come.
Hey, Ross, it's Matt I'll take that in my prepared remarks, I talked about we've exited approximately a $100 million over the last two quarters, 60% of it being in the third quarter and the average margin for that business was roughly 15% we plan on continuing to exit that business over there.
Two years as we've talked about it will be kind of a.
They think about being fairly linear for the next two years as we continue to execute and we shut that capacity into higher value.
<unk> and <unk> and higher value capacity and then just to add to that you know you talked about the headwinds we are able of course with the demand environment.
We're able to shift that capacity to demand in our strategic market with our strategic customers and that's the mix shift that we are going through that and we'll keep you going through that for the next couple of years.
Great. Thanks for those details and then I guess the follow on to that would be on the gross margin side, great job upside and even your expectations. There can you talk about how much of that do you view to be structural versus cyclical and I know youre going to say, it's structural because of everything you just answered my first question, but how much of a cyclical tailwind are you getting with price.
Pieces et cetera that you.
You think they're truly sustainable going forward.
Yeah, I'll, let Kate this is Pat again.
We think the majority of it is structural right, we've been making changes to our manufacturing operations.
Driving efficiencies there.
The mix shift as well, there's definitely a pricing component of it as a favorable pricing market.
As I stated we've been passing on the cost increases when coming our way.
We believe that we'll continue to get the gross margin expansion.
It remains at 45%.
Over over time here and like I said most of it is structural in nature, Yeah, Dan at the end of the day customers pay for a pay for value we have been reducing the price to value discrepancy like we've talked about.
And you know the <unk> provide a longer term visibility on both revenue and margin and when we talk about long term, we're talking about an average of three years. So that gives you kind of the structural nature of it and the sustainability of it moving forward.
Thanks, guys.
Ladies and gentlemen in the interest of time, please limit yourself to one question and one follow up question. Thank you. Your next question comes from the line of Vivek Arya with Bank of America Securities. Your line is open.
Thanks for taking my question and congratulations on very strong results in under very impressive execution.
How do you see the interplay between automotive production, which is being kind of flattish alright, very weak this year Bush's content and pricing I mean, there's a lot of concern that auto chip suppliers are may be shipping a lot through inventory rather than benefiting from content.
Are you seeing or a mix.
Just love your views on that from an industry, but then obviously from an on spa.
Specific perspective that what's giving you the confidence that.
Your let's say it that are exceeding units. So much is really being driven by content or a mix of pricing as opposed to sitting in inventory from there.
Yeah look I can speak for a broad semi first we track content based on design wins that we have had over the last few years that are starting to ramp and have ramped beyond what we expected in <unk>.
<unk> 'twenty, one timeframe and that's why we kind of cant support.
The demand so from that point of view I know exactly how much content has been going up or are customers using our products. So that ties and that gives me the confidence that it is a content growth story now.
Now as far as you know people talk about inventory being built out look I gauge that we have a lot of data to gauge it but to me. The main gauge is the escalations that we're getting we're still getting an intense level of escalations from our customers.
In order to ensure that parts go into cars and cars go out of the lot, but that is a pretty good gauge for where the economy is and where our content is going I can tell you, it's not being built up its going to cars.
Because if we don't ship the cars don't ship.
Thats, a one to one correlation that I can personally validate given all my conversations with my peers at our customers.
So both of these telling me that we are still in a supply constrained.
Not inventory are there pockets, maybe one or two weeks of inventory here in there yes.
Because we sometimes will pre ship.
And the customers we know.
It is not able to kitted, but that last for about one or two weeks until they get our next shipment. So all of these things are are manageable.
Have full visibility on it and we track it internally and with our customers. So it gives me confidence.
Got it very helpful and for my follow up.
Great job on the gross margin side, but when I look at the incremental margins in Q3, and then the midpoint of skill forward, it's over 100% I imagine part of it is the exit from the non behaviors, but could you help us bridge what.
Your original assumption once what kind of gross margin you know why that's coming at these levels. But then also importantly, you know you and it'd be kind of low forty's gross margins already the cooler competing a lot of the actions that we're supposed to take you to the 45% journey. So it's 45%.
At the end.
Kind of destination of this journey or do you think that there's a very strong start gives you confidence that there may be leveraged through gross margins beyond what you had contemplated thank you.
Yeah, Hi, Vivek.
We've always said, 45% with a milestone and that we would talk once we got there.
Not changing that target.
The improvement that we've seen that's been through operational efficiencies favorable mix and then clearly pricing. If you go back to the chart that I showed in the analyst day, we provided the bridge the.
The next big piece of the improvement is really the manufacturing the fab light or footprint right and that's the part we have always said that we would take the longest.
It would be the hardest to get and it's about exiting the fabs are being consolidated into more efficient fabs ramping the 300 millimeter fab and that's the that's the next leg that we've got to execute on so I think what we've been able to pull forward on as favorable mix operational efficiencies and then clearly a good pricing environment has helped.
But.
What I think is going to get us to that next level of 45 is the manufacturing piece and then once we get there we'll talk about what the end goal should be but we'd never stated 45 would be the end goal as much as it was a milestone.
That we'd be we'd be looking to achieve.
Thank you.
Yeah.
Your next question comes from the line of.
Hari with Goldman Sachs. Your line is open.
Good morning, Thanks, so much for taking the question and congrats on the strong results.
It sounded in your prepared remarks, you talked a little bit about.
Southeast Asia on your operations, there being a little bit disrupted in the quarter can you speak to any impact on revenue and gross margins in the quarter and where your operations are today.
Got a quick follow up.
Yeah, Hi, this is that so.
Talked about our utilization came down slightly to 80%, we think that to return back into normal levels of low 80 per se.
We think it has minimal impact on this quarter.
Primarily because we were able to allocate those resources and that capacity into other sites and recover from it.
The sites are stabilizing now theyre not back up to full speed, yet, but we think there'll be there very quickly and that's why we think the utilization comes back up into a normal run rate levels here pretty quickly.
Got it that's helpful. And then as my follow up wanted to ask about Q1 of next year.
Historically pre COVID-19.
Seasonality.
Would would drive business down a little bit I think.
Pricing some of the adjustments that you would make historically would hit Q1 disproportionately.
I'm curious, how we should be thinking about Q1 into next year, just given how strong the environment as.
You talked about all the design wins and the visibility you have.
For the quarter. So so should Q1 of 'twenty to be above seasonality and again, how should we think about pricing and gross margins into into the March quarter as well. Thank you.
But you know we're not going to give you a guidance for Q1 right. We only guide one quarter, but normal seasonality for Q1 is down 2% to 3%.
Based on what we see today, we are going to perform better than that.
What we can see in terms of backlog again supply coming online, we're probably looking at flat to what our Q4 numbers going to be but we're not going to provide more guidance on that.
Thank you very much.
Your next question comes from the line of harsh Kumar with Piper Sandler Your line is open.
Yeah, Hey, guys first of all in a strong congratulations.
<unk> a tremendous execution effort here.
Wanted to ask a broader question just above the diminishing the data maybe you can help us I know that E V zone near and Dear to your heart and you're making a pretty big bet on on that front two things how much do you how much revenue do you think you'll get from Evs today.
And then once you start to get to your I think you said $1 billion in 2023, let's say exiting 2023, how much of your business will be <unk> at that point in time thrown in you know at Ash and all that other stuff you guys do.
Look we are we're not breaking up breaking out the <unk> revenue today I gave the the outlook just to highlight the growth that we're seeing but more importantly to highlight the penetration of silicon carbide getting to the run rate of a $1 billion. You know we've always said over the next few years, we're going to.
He co existent of IGT and Silicon carbide.
But silicon carbide is starting to accelerate as customers see the efficiency of it coupled with our AR technology on a.
Packaging, so that is going to accelerate our ramp in silicon carbide to get to that run rate above $1 billion by 2023.
Which is very meaningful from where we are today and that revenue trajectory getting to 1 billion is basically doubling for us every year I'll be providing more of that color as we start ramping.
At this point, that's kind of the level I'm going to be talking about.
But I'm very comfortable with the EV ramp.
A lot of people have been talking about E D Ram and content for a few years now.
Now we have it it's starting customers have the lts as to guarantee for their supply.
And we're going to be supporting their their growth along with ours.
Very well thanks Hassan and then for my second question, you've got a I think Vivek mentioned, you've got a long term target of 45% Youre guiding to 42% I guess I wanted to just.
Make sure that there's no near term sort of things that are helping you here that it's all structural could you maybe just give us some color on how much. The strong ESP has helped you versus legacy business reduction, which I think we can calculate it also also you're supposed to show Fabs and we haven't seen much of a program.
So on that front.
But I'm looking at it and saying you're already at low Eighty's utilization why would you even need yourself apps going forward as you grow.
Yeah look a lot of it most of it is self help we talked that talked about the increase in units sold those unit increases are based on favorable margin mix, so you're already starting to see that mix shift.
You already talked about walking away from the $100 million at 15% you know Ive always said even in this pricing environment, a low margin is low margin and we will actively walk away from that business and move it to the auto and industrial that for US are driving higher margin. All of these things are self help and.
Oh of course sustainable are they.
The other thing you know over the last year. The other thing that worked in our favor is the utilization and that's sustainable as you mentioned as we wind down some of our Fabs and we restructure and do the fab manufacturing optimization.
That utilization is going to be and remain at that higher level, even with that 10% to 15% reduction in the non core business. So all of these I would say our self help as far as the current pricing environment. You know there are two things that I would talk about in pricing one is passing on the price increases to our customers that's <unk>.
Margin neutral to us because we are passing on a cost increases that we have incurred to our customers. So that you can think of it as as the margin neutral for us.
The other one is the price to value discrepancy, where we have products of high value that historically for whatever reason, we're shipping below market and those adjustments are sustainable because that's the value of the product that many other customers buy.
So all of these are structural and we just have to stay ahead of the manufacturing utilization as we wind down that 10% to 15% remaining of the low margin business and we're going to get there as we talked about in our analyst day. So all of these are going to yield to a structurally sustainable financial model and when we get there we will.
Talk about how to go to the next level.
Hey, harsh I would I would add.
On the manufacturing sites, we're still planning on exiting the manufacturing sites.
Got the 300 millimeter fab coming online.
Later next year.
But in 'twenty three that we take ownership. So we've got to fill that fab that gives us a better cost advantage as well and you saw that we were building inventory on the balance sheet to support those fab transition. So we've always said, it's not about handing the keys to somebody it's about the exit from the qualification process and the exit over time, so even though we haven't announced a divestiture.
Or are those fabs.
We're making progress in qualifying those products in other locations that are more efficient and were building the inventory for that transition. So the progress is underway.
Understood. Thanks, guys great stuff.
Your next question comes from the line of Rajiv Gill with Needham <unk> Company. Your line is open.
Yes, Thank you and I want to Echo my congrats on the excellent results from Hassan I wanted to delve a little bit deeper in the long term agreements that you see in your business you talked about you know two $5 billion of committed business, particularly $2 billion in S. C.
And for <unk>.
And two thirds was related to the traction inverters.
Could you maybe describe what you're seeing in that market. It seems like you have the products the right products.
To align for the for the future growth.
Can you talk a little bit about.
You know the qualification process the engagements with your customers on that massive kind of committed capital.
Coming into the business and then just more broadly.
Are you seeing in the industry a shift their transition to more longer term commitments.
Better visibility from your customers.
In response to the component shortages that we've seen this year are you seeing a change in behavior from your customers to enter into longer term supply agreements to get access to that to that supply.
Yeah.
So absolutely right I mean, let me talk about the first one so the first one is a I.
I would say a very different engagement model for the design and capability you know when you are talking about.
A product that is.
Fit for purpose for a customer and Burger traction Invertor every car is different whether it's performance or range or heavy duty and so on all of these variables are what our team and the customers' team taken to account in order to get designed in.
I highlight that to give you the visibility.
Visibility that it's not a dual source concept it is a.
Design and concept that leads to the design win and that's why customers once they have that.
Problem solved on their side the long term supply agreement is the next natural step because.
If and when we give them a traction inverted and provide much better efficiency than any of our competitors.
They will either co invest or give us the LTM or and give us the L. TSA over a longer period of time at least through the run rate of that product and then some.
So that's the stickiness of the revenue that I'll talk about that I referred to stickiness from a design win perspective, it's not something that is swappable, but also stickiness from the commitment of the customers are providing to us.
This leads to the second level and the answer is yes. The engagement model is different it's not equal to everything there are products where they're.
They're not strategic Oh potentially for our customers. However, they are important we're not going to lock up capacity with a long term agreement, but why don't you talk about strategic.
Components like.
Silicon carbide like <unk> like the 48 volt grill like the strategic P mix that I've talked about that go along with our Adas for cameras or the image sensors. All of these are key products that enable differentiated technologies, our customer whether its traction for vision with Adas.
Customers do want that stability and they do want the supply of resiliency that we are able to provide to them through the long term agreements and that's the model that as we're moving to with a lot of customers again, it's not 100%, but it is strategic and surgical like I've always talked about when it comes to IPSA.
And for my follow up.
Okay.
Good.
No go ahead.
I would just say from my follow up and thanks for the insight as shown on that it it does relate to the pricing question, but.
More of it again is it a structural on a positive side.
You, obviously, you're seeing some price increases.
But would you say that the days of kind of heavily deflationary pricing for Smbs are starting to come to an end we're at the very least.
The price declines will start to abate going forward because of the strategic importance of these components.
<unk> for industrial automation.
Do you think this is more structural in nature, where the pricing environment.
Maybe not be as high as it is now but could continue to be favorable over the coming years or do you still do you view this as more temporary.
Yeah I think.
It is also sustainable I don't think I don't think the.
Pricing benefit that we historically give our customers a year over year is going to disappear, but it definitely will be very muted for these new ramps given the capital intensity that is required to ramp those products and get them up they're not gonna be under your traditional hey every year. It gives me X percent or at all.
Those days are over for the strategic ones. So that that's what gives me comfort in investing in the Capex in order to increase that.
To match that demand.
You know we work with our customers on.
Efficiencies that we are able to get or efficiencies, they're able to get is look if our products allow our customers to shave off one or $2 and battle because of heating given the efficiency of our products.
It's still money I don't have to give that savings would enable it that's still savings on an end unit price, which is the car. That's what makes our solution attractive is because the efficiency drives a lot more cost reduction outside of the semiconductor and semiconductor and that's very attractive to our customers.
Okay.
Thank you.
Yeah.
Your next question comes from the line of Chris Caso from Raymond James Your line is open.
Yes. Thank you good morning.
A follow up question on the <unk>.
And if you could clarify.
What are the obligations from from both you and the customers are over those agreements what are they promising U.
What are your promising one and within those agreements.
One of the.
Investor concerns right now is one day demand will probably slow from these levels. So what are the provisions in there that protect you and protect them in the event that the demand winds up being different than what's in the midst joke in those agreements.
Look when we talk about <unk>, we are focusing on the strategic intent, let me talk about silicon carbide or Evs IGT in Silicon carbide is a good example.
So to me.
That demand and that ramp is happening evs are happening evs are driven by companies and driven by by our customers.
Themself.
So you know if if the ramp is shifting one quarter or two quarters or whatever you know what.
We will work with our customers what they get and what customers are getting is the supply assurance that when they do ramp.
We will be able to support their ramp now.
What gives me the confidence in the ramp that we are signing up for with our customers is when a customer co invest with you.
In order to support the ramp.
That's a pretty high confidence in high credibility of the ramp because everybody is easy to say, they're going to be the kings of the world. When it comes to EV, but when a company says and put some money down on it as a co investment in order to get their ramp and their supply assurance that tells me that they're going to be.
Winners in that market.
Because they are putting their money where their mouth is.
And we will be doing the same to our capex intensity that Sam talked about we're increasing and in order to support those ramps.
So we get the long term visibility, we get the sustainability of the revenue and the margin associated with it.
We have confidence in investing our.
Capex to expand that capacity and the customers get the confidence that they're going to get it when the when are they already for ramp.
The customer will ramp.
On time, when the time comes given the timeline of the Lts's. So all of these gives me that confidence again I'm not going after <unk> for all of our products I am very very selective and being very strategic about what to get the <unk> in order not to have that issue that you talked about.
Great. That's very helpful. Thank you.
As a follow up I guess, maybe you can give us some sense of you know.
How much of the business now is kind of within that strategic framework that you speak of and I suppose some of it's within L. T. S. As you know.
Some of it's not but.
I guess the question is over time, we've seen.
Pricing for semi you know typical years kind of down 5% a year.
And that's made up with with cost reductions.
It sounds like for a large part of your business you are working with a different a different framework what about for the rest of the business are there structural things happening both within the on in the industry.
<unk> will prevent that that price decline and make things more sticky even in the event of an industry downturn.
Look.
We're not on semiconductor that you're used to.
The nuance semi and our focus is on strategic products and sustainable financial model.
Part of that business that we are walking away from the $100 million, 50% margin that was talking about.
That's the behavior that you are describing.
We're in as good and down you have to give a lot of pricing to maintain share.
I don't care about that business I only care about the proprietary business that adds value to the customer when you have proprietary business.
Even silicon carbide as an example, those are.
Sustainable from both pricing and the margin perspective, we are no longer chasing fab fillers in a downturn, which is what historically the company has done.
We are moving the mix that goes into our fabs to proprietary and high value products and those are not going to be fluctuating based on what the end market does that's a new company. We are that's a new company. We are delivering results against that you see today and that gives me the confidence of the sustainability of our <unk>.
Model moving forward, regardless of what the market does.
Got it well done thank you.
Yeah.
Your next question comes from the line of John Pitzer with Credit Suisse. Your line is.
It's open.
Good morning, guys. Thanks for letting me ask the question.
So I'm just quickly going back to the auto sector. You know if you read some third party reports the industry might miss out on as much as $220 billion of revenue. This year, because they don't have chip inventory I'm just kind of curious as you talk to the auto supply chain, whether or not you think theyre going to structurally change the way they think about their inventory.
And their partners going forward and the L. P. S. A's are great up I'm kind of curious if you've explored the idea.
I've actually taken some customer capital, especially as you work to build out your silicon carbide capacity.
Yeah. So let me let me just touch on the last one we have taken a customer capital through the form of investment or co investments in our capacity expansion.
That model is new and we open it up to customers and some customers are have taken us up on it.
The model is changing.
You know, let me put it this way you talked about the 200 billion in revenue.
Nobody wants to be in that spot anymore. So there are customers.
Unfortunately are still in denial.
And that's okay.
Okay for them that's okay for me.
We're doubling down with customers, who get it who do understand the importance of semiconductor the importance of the power and <unk> sensing in the future of mobility and those are the customers that have jumped on the opportunity to secure a supply now.
Mentioned, one thing there is a shift for customers to go with credible suppliers.
Suppliers credible suppliers of scale that is very important because supply resilience is a hot button for all customers all the way to the OEM.
My personal engagements with Oems are about supply resilience, not just supply assurance and our ability to be able to have a product running into geographically independent locations and a lot of cases give that supply resilience to our customers, where you know it may not be COVID-19, but we always.
Have disruption.
We've had disruptions for the last four to five years, so having that supply resilience and proving it to the customer supports their business continuity because they don't have to build inventory and inventory. They can depend on us that matters in the selection process. Today is not only about the products of course, you have to have products that are.
Proprietary and high efficiency to win but to get selected longer term as a strategic supplier with the co investment we're talking about much more than that.
And then as my follow up I kind of want to go back to the idea of what of this is cyclical versus structural and I guess in your auto in your industrial business, you've done a great job sort of laying out the structural pieces, which is fairly easy to underwrite I kind of want to think about the other bucket a little bit if I add back the <unk>.
$60 billion.
Divestitures I'm, assuming most of that's coming in other that other buckets up over 30% year over year, and it's up almost I believe about eight high single digits sequentially. So even outgrowing your auto business.
When you think about that other bucket was there sort of a value discrepancy that the old on wasn't pricing rate or is that somewhere where we might have to be a little bit worried about the cyclical pricing leverage today that might go away tomorrow.
Yeah. No look you don't have to worry about that what we talked about other that doesn't equate it to non core or declining or commodity either while we put in other for example, we have a lot of our industrial that is not necessarily power that.
That goes into there that's actually very accretive margin already.
So what youre seeing a lot of it is the benefit of that high margin in the core to the other bucket.
That is not getting diluted by that $100 million or 60% of it this quarter at the 15% margin. So there are highly proprietary products even in the other they just don't fall under the power and sensing and that's part of our are describing.
Describing our company so I don't want to equate others to not important to the company.
That's why you see the growth being across the board, but the drag from the $100 million is most of it isn't that other bucket.
Bucket.
Okay.
Thank you.
Yeah.
Your next question comes from the line of Harlan sur with Jpmorgan. Your line is open.
Good morning, congratulations on the solid results and execution on the intelligent sensing business, even if I look at it first nine months of this year.
Underground, both their auto and industrial, but however on a year over year and quarter over quarter. The trends actually haven't been improving every single quarter. This year I know that it's been heavily supply constrained because most of this business is outsourced or it looks like your foundry partners are increasing their supply, but do you guys expect.
Meant to also be constrained through most of 2022 and then Tom can you just give us an update on your efforts to bring in some of the image sensor manufacturing in house.
Yeah. So Harlan you you said it right that business is primarily export all of it is external manufacturing and that hasnt been constrained throughout 2021, we're starting to see.
A little bit more.
City being direct it to us.
Because of the growth that we're seeing and really because of the impact that it has on automotive. So we're getting a secure a secured more secure supply and you're going to see that increasing through next.
Next year.
So having said that we do have an effort for new products of course to bring in house, when you're not going to see us do a very big shift existing.
Existing products just.
Moving them in.
But we do have a healthy funnel of new product development and we already have our products taped out in east Fishkill imaging products, our new imaging products are taped on an east fishkill. So we're gonna have a fab they call. It the flex fab strategy for imaging, where we'll maintain our externally.
But we're also going to double down on the internal in order to expand our supply over the next few years.
And then I appreciate the insights there and then maybe as a follow up to that so on east Fishkill and the transition to 200 millimeter to hand off doesn't occur until end of next year, but you are in the midst of qualifying and numerous products you guys will be benefiting from the better economics of 300 millimeter manufacturing for driving strong.
There will be critical to achieving those lower costs. It includes capacity I know, it's early but how are yields trending on the processes that are being qualified.
At East Fishkill.
Look your yields are.
Of course, I I compare yields do production yields in every fab that we have where the specific technology and the yields are exactly where they need to be to run full production in the 300 millimeter environment.
You know a lot of our power devices are.
Already or have been shipping for a few quarters now out of east Fishkill at production yields.
So I'm not I'm not concerned about the yield of course, when you move to new technology that is very complex like image sensing yeah, you have to work on yield, but I will tell you today, we do have a yielding product that is imaging on our boards. So again, we're out of the research side of it we're actually in a developer.
On a production side of it across a lot of our products and we'll keep doing that through 2022.
Yeah, good to see the execution. Thank you.
Thanks, Tom.
Your next question comes from the line of Theresa Hanford with Stifel. Your line is open.
Yes.
Listen on the record results.
On the first question is on this transition from ice to EV I mean, it seems like the pandemic has really accelerated that transition I don't know if there's anything that you could share with us from from your end.
Any numbers or any data points, because clearly that that transition is accelerating materially.
Can you can you just tell me what transition I missed the first part do you say RGB toll from Covid.
Uh huh from ice from ice to EV.
I C E D look I don't I don't think it's the pandemic that accelerated I think there are a few things one is the heightened focus on environmental responsibility.
That corporations have.
Driven by <unk>.
Corporations and boards drip.
Driven by investors.
And driven by employees.
All of these factors really governmental mandates in lot of cases, whether in the U S. At state mandates or in Europe is or in Asia, It's a government mandates.
All of these factors are driving an accelerated adoption and accelerated investment in launch of car models from ice to Evs that is happening you hear a lot in the targets by 2025 X percent of cars will be evs by 2030 X percent of cars.
Those are hard hard milestones defined either by the company themselves for their own targets or by government, where you can't buy a new car unless you buy those science, that's what's accelerating it.
Out of the pandemic and meeting and the demand in automotive there's a lot more push on E V. Because if somebody's buying a car now they would want a car to be an EV otherwise they don't want to change it in the next five to 10 years.
That's a very positive impact on our push to evs and what's sustaining our growth.
A lot of the numbers I gave as far as the LTE assays for Silicon carbide power.
Power Inverters just to highlight to everybody all of those are incremental to our baseline business. Today. That's that's pure growth net of course that 10% to 15%, we're gonna be walking away from.
But that's sustainable growth over a.
Five to 10 year period of time, and that's what makes it exciting for US we're in the right spot.
That's very helpful and as my follow up for that.
Capex 130, 140 million next quarter is that kind of the run rate we should use for next year or will there be some another step up potentially the following quarter.
No. We've said starting next year the capital intensity will go up to roughly 12% for the next couple of years and then after that it'll moderate down to about 9%, but we will be investing we got more investments to make in east Fishkill and then obviously to support the silicon carbide we've got.
We've got investments there to make and then with the <unk> acquisition as well so 12% for the next couple of years.
That's very helpful. Thank you and congrats again thanks.
Thank you.
Your next question comes from the line of Pradeep Ramani with UBS. Your line is open.
Hi, Thanks for taking my question.
I guess.
Mike I had a couple of thoughts.
You know that there are there's a lot of.
Pricing and you are part of a product portfolio, but I mean can you give us some color around one <unk>.
How much of your pricing actually is a you know on a like for like basis, how much of it is actually a like for like worsens how much of it is benefiting from a mix shift in your product, which I would assume there's a little bit more structural and longer lived.
And then I have a follow up.
Look I mentioned earlier on the call most of our actions are our structural because they are driven by a mix shift.
We talked about walking away from the $100 million.
At 15 averaged 15% our gross margin as those products or not capacity just shifted to a much higher gross margin mix of products. So we replace that 100 million with a much more structurally.
A favorable mix as far as the margin.
For cost I mentioned earlier.
The price increases because the costs are neutral to the margin because we're passing it on to customers, we're passing of directly to customers and therefore, not sustainable as well.
You're not going to see the benefit for it everything else that we talked about earlier from.
Our market condition, we're walking away from that business that 100 million is a dent in the 10% to 15% that's about 1% to 2%.
We talked about 10% to 15% so there still.
The upside on the margin expansion just from the mix moving forward, so I'm not worried about that.
The sustainability of it the benefit is sustainable and the benefit is driven by value of the products that we are shipping today and were shipping 3% more units in Q3 than we did before those 3% more units are on favorable margin that's true demand.
And that is sustainable.
Got it thanks.
G pad.
When I look at G tab.
In context of your overall revenue. These are sort of a contribution you can speak to in terms of.
G that potentially supplying other customers, whereas as you know how much of your EV revenue is actually coming from your products versus <unk>.
Today, a small portion of it is coming from <unk>.
We just closed.
The acquisition I mentioned that we are already and will be shipping more revenue based on <unk> substrates in Q4, moving forward Youre going to start we're going to start seeing more of a mix going from outside substrates that we have historically done more into G tab based substrate.
Which will be internal obviously, it will be on semi substrate moving forward.
As that mix shifts to our internal.
Created or internal grown substrate, our margin will also benefit from that because of course, the cost structure of having a in sourced a vertically integrated substrate is better than externally source. So we haven't seen the benefit of all that margin that will come as we are transitioning.
<unk> more into a G substrates and that's over that ramp that I talked about in my prepared remarks, Yeah. I would just add in the Q4 guidance there is $3 million to $4 million <unk> revenue and that's with third parties with other customers that are outside on semi.
You can think about that as being the run rate going forward. So it's not a material amount to the company.
Got it thank you.
Your next question comes from William Stein with Truth Securities. Your line is open.
Great. Thanks for taking my question.
First I just was hoping you might linger on the co investing theme for a moment is this customers investing in their own capacity that aligns with that of semi or is it more like nonrecurring engineering or are they actually investing to sort of one or perhaps guaranteed capacity in.
In your Fab and then I do have a follow up.
Yeah. So the investment obviously is yes of course, they are investing on their side, but the investments I'm, referring to is theyre investing on our site and.
Primarily obviously for supply assurance and for late stage development for products that will go for their applications.
And that I talked about that's what gives me the confidence in the sustainability of this.
Stickiness of that revenue.
Is the late stage R&D that customers are investing in in order to.
Get that product and the supply assurance that they will depend on us when they need to ramp. So both of these are what the investment is from their side.
Of course in parallel to that we'll they're building up their capacity to run their own vehicles.
But that's not what I'm referring to.
Great. That's helpful. And then the follow up is about the tune of.
[noise] buyers.
Or buyer behavior. If you will if we think about their behavior a quarter a quarter ago relative to where it is today when we think about their propensity to chase shortages and try to you know.
Really as much upside as they can and that sort of thing versus maybe cooling off or narrowing the scope or expanding the scope of expedites can you comment on that trend. Please.
Look I think everybody is in blocking and tackling mode as far as making sure. They get just enough supply to keep the line running you.
You know I can't tell you how many lines are our oh.
Running on what their capacity, but a lot of the.
Lines are now running at 100%, but keeping the line running is more important than keeping it at a 100% versus shutting down the line. That's what the focus has been from our side and our customer site.
Not enough to go around to keep everybody, 100%, but we work constructively with our customers to make sure that they get the minimum quantities across all of our products to maintain the running line and achieve their financial targets of unit sales.
Engagement have directly with the Oems.
No longer between us tier one and then they deal with the OEM, it's either a two party Austin to OEM, where we understand what they need directly or.
Or it's a three week a meeting.
Meeting with the tier one and OEM in order to make sure everybody Triangulates and nobody's hiding anything in their pockets.
It's full transparency blocking and tackling we all have one purpose in mind, which is keep the lines running because that's when demand as wheel versus.
Sitting somewhere in the supply chain and.
That's the level of engagement, we have and that gives me the comfort and the transparency of our engagement and that's what we're basing a lot of our.
We're looking our common stock.
Thank you and congrats.
Thank you.
I would now like to turn the call back over to Mr. Hassan <unk>, President and CEO.
Thank you all for joining us today I once again, thank our worldwide team for their hard work in driving our transformation solid and sustainable results. We have established a strong foundation of revenue L. TSA and funnel growth over the last few quarters to deliver a leadership position in the vehicle electrification ramps driven.
By our silicon carbide products.
Along with a broad offering our semiconductor solutions to enable the rest of the vehicle.
Along with our leadership in automotive safety with our sensing products, we have become the supplier of choice for all marquee names worldwide. We are very excited about the opportunity in front of us and we remain focused on execution to make sustained progress towards our target financial model. Thank you.
Yeah.
Ladies and gentlemen. This concludes today's conference call you may now disconnect.
Okay.
Yeah.