Q2 2022 ON Semiconductor Corp Earnings Call
Okay.
Good day, and thank you for standing by.
To the answer my second quarter 2022 earnings Conference call.
At this time all participants are in a listen only mode.
After the speaker's presentation, there will be a question and answer session.
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Please be advised that today's conference is being recorded.
I would now like to hand, the conference over to your Speaker today, Parag Agarwal, Vice President of Investor Relations and corporate development. Please go ahead.
Thank you Denise good morning, and thank you for joining our second quarter Huntington.
This conference call.
I'm joined today by our founder at Ekati.
I've got Frank our CFO .
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Www Dot dot.
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A replay of this webcast.
Our country into a second partner.
It'd be really even on our website approximately one hour. Following this conference call and the recorded broadcast will be available.
Following this conference call.
Additional information is posted on the Investor Relations section of our website.
I wonder if at least in this presentation includes certain non-GAAP financial measures.
Reconciliation of these non-GAAP financial measures with their most directly comparable GAAP measures are finished.
Our earnings release, which is posted separately on our website.
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During the course of this conference call, we will make projections or other forward looking statements regarding future events or the future financial performance of the company.
We wish to caution that such statements are subject to risk and uncertainties that could cause actual results or events to differ materially from predictions.
Important factors that can affect our business, including.
Including factors that could cause actual results to differ from forward looking statements are described in our most recent Form 10-K and form 10, Qs and our.
The filings with the Securities and Exchange Commission.
Our earnings release for the second part of our country.
Our estimates or other forward looking statements may change.
No obligation to update forward looking statements took effect actually.
Changed assumptions are there are there any ones that except as required by law.
No, let's mechanical work.
Sean.
Thank you, Brian and thank you everyone for joining the call.
Nearly a year ago to the day, we unveil our strategy to deliver intelligent power and sensing technologies, what a sustainable ecosystem.
By high growth Megatrends in automotive industrial and cloud power.
This meant that we would not only provide differentiated solutions for our customers, but that we would execute on our commitments to our shareholders.
We announced another quarter record revenue gross margin and EPS and I could not be prouder of the progress we have made.
We achieved our first ever 2 billion dollar revenue quarter with record revenue in the automotive and industrial end markets.
As compared to last year's second quarter, our total revenue increased 25%.
Our non-GAAP gross margin expanded by 1100, and 30 basis points and our earnings per share more than doubled to $1 34 per share.
In the face of challenging business conditions, our employees have maintained steadfast in their dedication to our customers and I want to thank them all for their continued hard work and tenacity.
Despite ongoing geopolitical and macroeconomic uncertainty demand for products in our focus areas remain strong.
Our automotive and industrial revenue now accounts for 66% of our overall business and combined grew 9% quarter over quarter and 38% year over year.
This performance was driven by increasing adoption of our market, leading intelligent power incentive solutions and the fastest growing applications.
We have seen a slowing demand in our non core end markets, but demand from automotive and industrial continues to outpace supply.
The volatility in energy markets and supply chain disruptions across the globe are driving an accelerated adoption of electric vehicles alternative energy and industrial automation.
Our market leading portfolio, coupled with the differentiated performance of our products and end to end capabilities.
Linguists on semi as a premier source or intelligent power and sensing solutions and our customers are increasingly relying on us to enable their roadmap and a rapidly evolving market.
While we are optimistic about our outlook, we remain sensitive to dynamic market conditions.
Structural changes, we implemented over the past 18 months to rationalize our product portfolio and optimize our cost structure and reduce the volatility in our financials and we have positioned the company to be more resilient in all business environments.
The nature of our customer engagements has evolved into a strategic partnership to support our customers' long term technology Roadmaps advanced capacity planning and supply assurance.
Customers continued to expand the scope of their Lps aid to include an entire portfolio of intelligent power and sensing solution, which accounted for 66% of our total revenue in the second quarter up from 62% a year ago.
We have signed <unk> covering up to 200 parts across our entire portfolio and for existing <unk> customers are still requesting additional near term volumes and extending the duration of our agreements in some cases through 2029.
For their longer term demand they are co investing with us I mean capacity expansion to secure their supply, which in turn improves our demand planning.
We continue to make progress in our transformation journey to structurally improve the gross margin gross margin of the company.
We have redeployed capital to high margin high growth areas, such as silicon carbide and over the last 12 months, we have exited approximately $210 million in revenue at an average gross margin of 24%.
Of which 36 million occurred in the second quarter at an average gross margin of 34%.
Despite a deliberate loss of noncore revenue, we have been able to grow at an impressive pace and offset these losses with new product revenue, which increased 35% year over year and favorable gross margins.
Our intelligent power revenue grew by 31% year over year.
And 10% quarter over quarter, driven by the market leading efficiency of our solutions.
The superior performance of our Silicon carbide, and <unk> has enabled us to engage directly and syn <unk> with leading automotive Oems and <unk> disruptors across the globe.
They rely on non semi silicon carbide expertise and end to end capability to help them achieve their electrification goal.
Although internal combustion engine vehicle sales were nearly flat in 2021 east grew by 94% and are expected to grow at a CAGR of 22% to 45% of total light vehicle units in the next five years.
Electric vehicles require up to $700 of incremental on semi content for drivetrain on onboard charging as compared to an internal combustion engine car.
As the transition continues to accelerate from ice vehicles to electric we expect to see steep growth in our intelligent power revenue for automotive.
Our progress to our Silicon carbide leadership is one that I'm, especially proud of we are seeing a steep acceleration in our silicon carbide ramp and have doubled our silicon carbide revenue quarter over quarter in the second quarter.
We had forecasted to double last year's Silicon carbide revenue in 'twenty, two and thanks to our global team's impressive acceleration of our capacity expansion plans and our latest customer engagements. We are confidently raising our annual projection to triple last year Silicon carbide revenue in 2022.
And exceed $1 billion in revenue in 2023.
Towards that end, we have also secured more than $4 billion.
As committed silicon carbide revenue through long term supply agreements for the next three years as compared to the $2 6 billion, we had previously disclosed.
To support the steep acceleration in our silicon carbide revenue, we are rapidly expanding capacity across our sites.
By the end of this year, we plan to quadruple our substrate output on a year over year basis, and we are adding capacity for wafer.
And modules at our various sites around the globe.
Furthermore, we are adding 200 millimeter silicon carbide capacity at our existing Fabs and we are on track to double our front end wafer capacity by the end of 2023 as compared to that at the end of 'twenty, two and further double that capacity by the end of 'twenty four.
Our energy infrastructure business is also growing at a rapid pace.
On a year over year revenue increase of 61% in Q2, we are on track to exceed our 2022 target of 50% growth year over year.
As I indicated earlier volatility in the global energy supply is driving rapid adoption of internet of energy and with our broad portfolio of high efficiency Silicon carbide Andi GBT modules, we are in a key enabler in this market.
We expect the alternative energy market to be long term driver for our business as utility scale power plant installations go rapidly worldwide, reducing both fossil fuel dependence and associated climate impacts.
The top 10 solar inverter suppliers have more than 80% of the global market share and on semi has signed long term supply agreements with seven of them totaling more than $1 billion in revenue.
Beyond <unk>, we continue to expand our footprint and then turned out of energy market.
And in the second quarter, we secured a design win for our Silicon carbide module for solar Inverters with a leading global industrial Oems.
While silicon carbide is the fastest growing part of our power business, our silicon power products remain integral to our intelligent power portfolio with year over year growth of approximately 30% in our IGT and MOSFET revenue.
This growth was primarily driven by automotive and industrial where higher efficiency of our products is a key differentiator.
Our intelligent sensing revenue grew by 39% year over year and by 10% quarter over quarter the growth in our intelligence sensing was driven by both automotive and industrial end markets, which grew by approximately 60% and 30% respectively year over year.
The steep growth in our automotive image sensors is driven by an increasing number of cameras per car a mixed shift towards higher towards higher resolution and higher ASP sensors and accelerating penetration of Adas.
One of the primary drivers of increasing number of cameras per car has been the efforts by traditional Oems to match the Adas and related safety features offered by the <unk> and the new EV models.
We are seeing an increasing use of our image sensors to enable safety through the replacement of traditional mirrors by camera enabled digital mirrors.
We secured a design win for a digital mirror the incorporates four cameras for the rear and outside views.
This mirror overcomes obstructions caused by passengers address and other objects and provide integrated rearview inside view for blind spot monitoring.
We signed another LTE assay to supply image sensors for a revision system to replace mirrored with cameras and commercial trucks.
This system provides the driver with a more complete view of operating conditions over traditional mirrors and delivers improved driver vision and flight spot elimination.
We entered.
In June <unk>, TSA with a leading manufacturer of agriculture equipment to supply our new Super exposure flicker free high dynamic range image sensor for targeted spray systems and we'd elimination.
<unk> system, comprising more than 30 on semi image sensors identifies weeds and signals the nozzle control system to precisely spray herbicide and just the right quantity.
This application sustainably eliminates the indiscriminate use of agricultural chemicals enable savings of more than 75% of herbicide and helps protect the environment.
And the industrial end market, our growth is driven by industrial and warehouse automation applications. Our scanning business grew by 70% year over year, driven by strong traction of our image sensors and industrial and warehouse applications.
This growth is driven by expansion and increased automation of warehouse by global E Commerce leaders.
Our proprietary global shutter technology, which enables high speed capture of images and low light performance coupled with strong technical support are the key drivers of our leadership in this market.
Our transformation journey is well underway and we are aggressively hiring worldwide to keep up with our growth.
Semi is driving disruptive innovation in your route energy in the semiconductor space and the work we do matters for our customers our employees and for the environment. We play a critical role in the most exciting megatrends that will define our future such as electric vehicles autonomous driving robotics and automation.
And alternative energy there is no better time to be part of the growth story like ours and I invite anyone interested in joining our talented team to apply online.
Now I will turn the call over to <unk> to provide additional details on our financials and guidance.
Thanks Hassan.
Another quarter of record results clearly demonstrates our accelerating momentum in the fastest growing semiconductor market and the progress we have made in our transformation.
We are a stronger company today after having focused our strategy redirected our investments and double down on intelligent power and sensing solutions for the automotive industrial and cloud power markets.
We rationalized our product portfolio by exiting price sensitive products in favor of highly differentiated intelligent power in sensing solutions.
Our worldwide teams are focused on operational efficiencies to reduce cost while we continue to make progress towards our fab light or manufacturing strategy with the announced divestitures of two subscale fabs.
The structural changes we have implemented over the last 18 months have significantly improved the predictability of our financial results and position the company to consistently execute and dynamic market conditions.
Our disciplined execution resulted in record financial performance for the last five consecutive quarters and we are thrilled that the results of our transformation are being recognized by the financial and business communities.
And a noteworthy milestone on semi has been included in the S&P 500 index and recognized as a fortune 500 company.
We could not have achieved these results without the dedication of our worldwide teams and I continue to be impressed with their operational excellence quarter after quarter.
To our employees around the world.
Thank you for your unwavering commitment to ensuring the success of our customers.
We are seeing unprecedented demand for our products driven by accelerating megatrend of vehicle electrification Adas factory automation and energy infrastructure and Silicon carbide alone, we have <unk> of more than $4 billion for the next three years.
Our customers value the market, leading performance of our solutions the breadth of our intelligent power and something portfolio and our end to end manufacturing capabilities and she is on semi as a strategic partner to enable their long term technology Road maps.
Our focus markets of automotive and industrial grew by 41% and 34% respectively year over year to account for 66% of revenue as compared to 59% a year ago.
We expect continued strength in the automotive and industrial end markets amid slowing demand for our non core businesses parts of which we are exiting to further achieve our transformation goals.
We are also making progress on our sustainability initiatives last quarter, we published our sustainability report in which we reiterated our commitment to achieving net zero by 2040.
We recognize the importance and doing our part for the environment as we deliver cutting edge technologies that enable our customers to create a sustainable future.
In 2021, approximately 75% of our revenue with sustainable product revenue.
We significantly reduced our water consumption compared to the previous year, and we are already making progress on reducing our greenhouse gas emissions.
Our intelligent power solutions for electric vehicles, EV charging and energy infrastructure are helping to slow the pace of climate change and our intelligent sensing solutions enable automation and efficiencies, which in turn reduce energy consumption.
Turning to results for the second quarter as I mentioned Q2 was another quarter of record results.
Total revenue was $2 85 billion, an increase of 25% over the second quarter of 2021, and 7% quarter over quarter.
This increase was driven by strength in our automotive and industrial businesses, which grew 38% year over year and 9% quarter over quarter.
Our Q2 revenue was above the high end of our guidance range as we navigated the China Lockdowns and recovered the impacted revenue late in the second quarter.
Revenue from both intelligent power and intelligence sensing was at record levels intelligent power grid by 31% year over year to 48% of revenue and intelligent sensing grew by 39% year over year to 18% of revenue.
All three business units reported record revenue in the second quarter revenue for the power solutions group or PSG was 1.06 billion, an increase of 25% year over year and achieving its first billion dollar quarter.
Revenue for the advanced solutions group or ESG with $716 7 million, an increase of 18% year over year.
Revenue for the intelligent sensing group or ISG for the quarter was $311 3 million, an increase of 44% year over year.
GAAP and non-GAAP gross margin for the second quarter was 49, 7%.
non-GAAP gross margin improved 30 basis points quarter over quarter, primarily driven by a favorable mix in automotive and industrial market and despite our proactive slowdown and our wafer starts which reduced our utilization from 81% in Q1 to 77% in the second quarter.
Six quarters into our transformation, a better control of our operational levers to optimize efficiencies maximize output and deliver for our customers and our shareholders.
GAAP operating margin for the quarter was 28% and non-GAAP operating margin was a record of 34, 5%.
GAAP earnings per diluted share for the second quarter was $1 two as compared to 42.
In a quarter a year ago.
non-GAAP earnings per diluted share was $1 34, as compared to <unk> 63 in the second quarter of 2021.
We relaunched our share buyback program and for the first time in over two years repurchased one 5 million shares.
Our $89 7 million at an average price of $59 76 per share.
This represents 44% of our free cash flow for the second quarter and there is $1 $2 billion remaining on our authorized repurchase program.
Now let me give you some additional numbers for your models.
GAAP operating expenses for the second quarter with $453 1 million as compared to $357 9 million in the second quarter of 2021.
non-GAAP operating expenses were $317 7 million as compared to $314 2 million in the quarter a year ago.
non-GAAP operating expenses increased by $14 9 million sequentially, driven by hiring to support our growth.
As I indicated in previous calls Opex will continue to trend higher as we bring in additional talent to support our growth.
As we guided in the past our non-GAAP tax rate will increase in 2022, as we have substantially utilized our NOL attributes for.
For the second quarter, our non-GAAP tax rate increased to 16, 3% from four 6% in the fourth quarter of 2021.
This change accounted for 18 cents of EPS dilution in the second quarter and 34.
Year to date.
Our GAAP diluted share count was 447 million shares and our non-GAAP diluted share count was 441 6 million shares.
Please note that we have an updated reference table on the Investor Relations section of our website to assist you with calculating our diluted share count at variance share prices.
Turning to the Q2 balance sheet cash and cash equivalents was $1 $79 billion, and we had $1 5 billion undrawn on our revolver.
Cash from operations was $420 8 million in free cash flow was $202 $7 million and free cash flow on an LTM basis was 17% of revenue.
Capital expenditures during the second quarter with $218 million, which equates to a capital intensity at 10, 5%.
As we indicated previously we are directing a significant portion of our capital expenditures towards the capacity expansion of silicon carbide, and enabling our 300 millimeter capabilities at the east Fishkill fab.
We expect to see a higher level of capital intensity in the second half of the year as we continue to invest in equipment and capacity expansion to support our growth.
Accounts receivable was $1 $1 billion, resulting in DSO of 50 days with.
The sequential increase in <unk> was due to non linear shipments as we recover recovered revenue late in the quarter from China Lockdowns.
Inventory increased $67 million sequentially to $1 $56 billion and days of inventory decreased by three days to 136 days.
We continue to build inventory to support our fab transitions and ramping silicon carbide.
Distribution inventory decreased approximately $12 million quarter over quarter and remains consistent with Q1 at seven weeks.
Weeks.
We continue to maintain distribution inventory at historically low levels to hold more inventory on our balance sheet for our customers' needs rather than building inventory in the supply chain.
Total debt was $3 2 billion and our net leverage remains well under one <unk>.
Turning to guidance for the third quarter demand continues to outpace supply in our targeted automotive and industrial end markets. While there are pockets of softness in our non core markets.
Given the uncertainty in the macro environment, we are taking a conservative stance and judging down demand and our guidance for the third quarter.
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 key elements of our non-GAAP guidance for the third quarter.
We anticipate revenue will be in the range of 2.07 billion to $2 $1 7 billion we.
We expect non-GAAP gross margin to remain between 48% to 50% this.
This includes share based compensation of $3 million.
Although we continue to focus on long term gross margin expansion and sustainability are rapidly accelerating silicon carbide ramp will be dilutive to gross margins by 100 to 200 basis points over the next several quarters due to the incremental startup costs as we scale the operation.
We expect non-GAAP operating expenses of $319 million to $334 million to include share based compensation of $21 million.
We anticipate our non-GAAP , Hawaii will be $24 million to $28 million.
For the remainder of 2022, we expect our non-GAAP tax rate to be in the range of 15, 5% to 16, 5%.
And non-GAAP diluted share count for the third quarter is expected to be approximately 440 million shares.
This results in non-GAAP earnings per share to be in the range of $1 25 to $1 37.
We expect capital expenditures of $265 million to $295 million in the second quarter.
As we ramp up our silicon carbide production and invest in 300 millimeter capabilities.
In summary, the transformation of the company has enabled us to deliver outstanding financial results.
And at the same time reduced the volatility in our financials.
With leadership and intelligent power and sensing solutions for the fastest growing applications in automotive and industrial we are well positioned to deliver sustained long term financial performance for our shareholders.
With that I'd like to turn it back over to Liz to open up for Q&A.
As a reminder to ask a question you will need to press star one on your telephone please.
Please standby, we compile the Q&A roster.
Okay.
Our first question comes from Ross Seymore with Deutsche Bank. Your line is now open.
Hey, guys. Thanks for letting me ask a question I guess my first question is on the general macro trends and how youre reacting to them you talked about a little bit of weakness in your noncore businesses Hassan and then Pat just talked about the utilization actually coming down sequentially. So how do I in general reconciled demand being greater than supply in your core.
Businesses weakness in your noncore and kind of what does it mean to the ability to backfill on that given your utilization is dropping.
Yes look this is Don.
Not all capacity is fungible, obviously, so what we're doing is we're being very cautious in our inventory management you have seen our inventory go down in days, we're focusing our inventory on the strategic inventory in our core business and silicon carbide and fab transition so that will remain debt side of the.
Utilization is full but but as we see the softening in the and the economics that said our cautious outlook on the macro which is built into our guide.
Were taken down we're taking measures as part of our resilience of our model that we've been talking about in good and bad times and these are kind of the things we're focusing on to get through this and come out stronger.
Yeah.
Great. Thanks for that color Hassan I guess that one for you on a little more specifically on the gross margin side of things you talked about a bunch of different moving parts in your third quarter Guide and then even over the next few quarters with silicon carbide being a point or two headwind to gross margin can you just walk us through the puts and takes and I believe at one point you thought you could keep the gross margin.
Relatively flat at these kind of $49 level for the next few quarters, even into the first half of next year.
Is that still true.
Yes.
We are in our targeted range of 48% to 50%.
Our guidance.
I noted that they've got a headwind of 100 to 200 basis points, resulting from Silicon carbide is Hassan mentioned, the silicon carbide is ramping faster than we anticipated even 90 days ago.
And that's causing the dilutive impact silicon carbide products at scale are at or above the corporate average. So we're comfortable that that won't continue to achieve our goals. There is primarily just the lumpiness of bringing capacity online and supporting that growth that gives us a headwind here, but we're still very happy that.
We can maintain margins at this level within our target range as we ramp silicon carbide.
And by bringing bringing utilization down slightly offset some of the inventory that Bob talked about as well so.
I think again that shows the resilience of the model.
Thank you.
Our next question comes from Chris Danley with Citi. Your line is now open.
Hey, Thanks, guys just to follow on Ross's question, so theoretically when would gross margins bottoms.
For both the silicon carbide and for the overall company.
Well look.
We think we're again, we're at a range right. We think we're there.
There'll be some puts and takes over the next.
Few quarters.
We will be able to maintain that range plus or minus but.
I would I would call this kind of the the.
The rate at which you should be modeling.
Okay, and then as a follow up.
You talked about some macro issues in the non auto and industrial business can you just expand on that and are you guys.
Predicting that they will get any worse or have we seen the worst there and does this have any impact on overall pricing for the company.
Yes. This is John look I don't know about getting better or worse, they're noncore. We've always said a lot of that business are the areas. We want to exit. So we're taking utilization data part of our strategy, it's not going to have an impact on margin from a dilutive side.
Because I've always said that I've been very firm even on these calls prior we're not going to chase that pricing that we are planning on exiting that business and therefore, you shouldnt expect any dilution on the margin because of it.
Great. Thanks, guys.
Thank you.
Our next question comes from Vivek Arya with Bank of America. Your line is now open.
Thanks for taking my question I wanted to dig in into a very strong disclosure on the silicon carbide side, if I got it right. I think you mentioned $1 billion for next year and I think in the past you said a billion dollars exiting 'twenty three.
And then probably more than 2 billion and perhaps 'twenty four and then $4 billion.
In terms of run rate or pipeline I forgot. The exact word you used and I think that number used to be $2 6 billion. So I'm curious what has driven the upside to your silicon carbide our numbers to this extent how much of this is auto is how much of this is expanding relationships with existing customers versus new customers and then I had a call.
Aloha.
Sure.
I've always said the strength of our silicon carbide starts with technology and when I talk about technology devices and packages.
We have differentiated solutions that matter at the end system, meaning it translates into longer battery longer range whatever tuning.
The OEM would like for that specific platform.
So that's consistent that's now proven in the results that we've seen already.
Beyond what we projected but also.
Outlook that we've said and Youre right the first.
The disclosure and I put as I've always said, we're going to double our silicon carbide in 'twenty two.
I changed that to triple in 'twenty two based on the strength that we're seeing already even in the second quarter. So we're going to exit.
2022.
At a higher run rate than we expected.
And then we're going to continue that growth in 'twenty, three which leads to the updated numbers that I've given on the $1 billion in 'twenty three now on the $4 billion. That's a mix of existing cost of our debt started ramping came back and deployed additional platforms on <unk>.
<unk> and some of them extended the LTE assay, but also within the quarter, we have extended the <unk> with new customers and new platforms. So it is broad geographically and its customer diverse.
And some of it includes Oems directly and Thats the level of strategic partnerships. We have had about 90% of it is automotive.
And then you saw me talk about the solar side of it or the renewable energy side, where we've also had <unk>, where the top seven thats a slower ramp obviously than automotive, but nevertheless that keeps pushing so 90% of automotive strength and stickiness because of our technology across the board and.
Of course, we can't underestimate the end to end capability, we have for the supply assurance.
Got it and for my follow up.
How should we think about the percentage of insourcing versus outsourcing of substrates that it would take to achieve your 4 billion target overtime, maybe if you could give us a sense for how much of the substrate requirements are being met internally and then how do you see that ratio.
Go through time, and what that implies for your capital intensity over time. Thank you.
Yes, so look our capital intensity already has a lot of the expansion that we talked about it I've always said, we're going to exit this year with a quadrupling of our substrate capacity. After the <unk> acquisition. We're on track of doing that that's going to fuel the growth in the subsequent years and of course, as we put that capacity online.
The percent of internal is going to keep increasing into what we want which is the majority and term internal we're always going to have an external component of it because we don't build capacity for a max speak of a ramp we built capacity for a steady state. So we're going to use external.
Substrate, if we need to do to flex.
During a ramp but other than that I would expect the majority will be from our internal and that's already accounted in our capex numbers.
Thank you.
Yes.
Thank you.
Our next question comes from Toshi Hari with Goldman Sachs. Your line is now open.
Hi, good morning, Thank you so much for taking.
The question I've got two as well first on gross margins.
I guess a multipart question.
Todd you mentioned that the gross margin headwind from the ramp over the next several quarters to be 1% to two percentage points.
I'm curious.
How how the progression of that will look like meaning should we expect 25 to 50 basis points of headwind every quarter or is it more back half loaded any sort of shape of that headwind would be helpful. And then how should we think about GSK.
From an accounting perspective, how much depreciation would hit here.
What hit your P&L and what are the implications for gross margins.
In the first half of 'twenty three.
Yes.
Let me, let me take those in reverse order. So <unk>. It comes online in 2023, so you'll actually see an impact in Q3 and Q4 obviously.
As we bring on the fab.
We will be providing foundry services to global foundries for the next three years, which will wind down.
As we've said there is revenue associated with that foundry.
Agreement, which is low margin you can think about it as being boundary margins in that.
Mid to high single digit.
Range you can think about for 2023 is that being a headwind of somewhere around 40 to 70 basis points on a quarterly basis.
And that's the impact of that the rest of it we feel like we can we can offset I mean, obviously, we get the efficiency of a better cost structure as we move more and more product into that fab overtime as well.
On the Silicon carbide.
As I said 100, 200 basis points of headwind it is a little lumpy depending on the revenue and the <unk>.
Timing of the equipment.
We do believe we can keep the margins in this range of 48% to 50% for the next several quarters, even with that headwind you may see it move.
Move around a little bit plus or minus 50 basis points here or there, but we think we can be in that tight range, even offsetting those that those margins, but it doesn't necessarily linear from this point.
Two 200 basis points, it's a little more fluctuation of like I said youll.
Youll see a little bit of fluctuation on the gross margin line, but we don't think it's material and we think we can offset it with other efficiencies.
A quick follow up.
The 40 to 70 basis point headwind from the SK.
Should we expect you to hold the current range on gross margins, even with that headwind or could that drive another leg down in <unk> and 'twenty.
Yes.
We believe we can offset it with.
Other gross margin expansion initiatives and our fab lighter strategy.
So even though it's a headwind we feel like we can still maintain our margins in this range.
Okay, Great and then as my follow up just on capital allocation. It was interesting to see you buy back stock in the quarter, just given sort of the capex around you spoke to in your in your <unk> business going forward.
Can you remind us how we should be thinking about the balance between investing in your business versus returning returning cash to shareholders.
Remind us how much cash you'd like to have on your balance sheet, Let me state. Thank you.
I don't think anything really changes with our capital allocation will continue to invest back in our businesses R&D.
R&D Capex.
And obviously investing for our long term growth. So that's our number one priority.
We've always said, we want financial flexibility.
Our M&A if there is some opportunity out there for us on that that fits our model.
And then we would return cash to shareholders through the buyback.
We will obviously pace each of those depending on their requirements. When we've got a lot of capex requirements over the next several quarters.
We will we will be very disciplined when it comes to the capital allocation.
Thank you.
Okay.
Thank you.
Our next question comes from William Stein with Truest. Your line is now open.
Great. Thanks for taking my questions.
Scott I think you said that your Capex plans include some.
Funding from customers can you, perhaps detail how much of your Capex plan includes such advances and how that influences your thinking about spending.
Yes, so our Capex doesn't change right, we said we'd run around 12% for the next few years and I think we'll still maintain that.
Funding from the customer to offset that but you don't see that.
Through the Capex our capex.
It doesn't necessarily change because we don't report it that way, we do have customers that are co investing with us for capital in some cases are eased.
Things like that to invest.
In silicon carbide and other capacity that we're bringing online.
That makes those customers much more sticky.
And it's a good.
It just improves that relationship with that customer on a strategic basis.
And Mike if I can.
Relates to the business that you intend to exit can you remind us how much of that is left after.
After the current quarter whats, what's left to exited maybe the pacing and margin of that please.
Okay.
Yes. Good question. So we've got.
Roughly around roughly $600 million left to exit.
We've always said that would be market driven.
We're pricing.
At a position that as capacity comes back on.
The price sensitive.
Part of our portfolio that we would we would likely exited we havent been exiting it as fast as what we anticipated.
Originally we thought we'd exit about another $300 million in the latter half of this year.
And we think we're probably going to exit about half of that so roughly about 150 million between Q3 and Q4, and then that obviously leaves a big slug for US next year as well in 2023.
If the market gets softer faster, we could exit that faster, we've always said fat.
Faster is better for us.
We will rightsize, our manufacturing and reallocate that.
That capacity into automotive industrial but.
You can expect roughly kind of even I think $75 million a quarter between Q3 and Q4.
And the margin on that can you remind us.
Yes that margin is what we exited last quarter I think it was about 34% margin you can think about most of that today is kind of being in the low 40% range.
Thanks, very much but that is the stuff that is the stuff that is highly price sensitive.
Great. Thank you.
Thank you.
Our next question comes from Rodman <unk> Gill with Needham <unk> Company. Your line is now open.
Yes, thanks for taking my questions and congrats on navigating through this uncertain environment with really good results just.
Another follow up on the gross margins.
If I add up the GSK headwinds of negative 40 to negative 70 basis points, a quarter plus the silicon call by startup costs.
Negative 100 to 200, Youre talking about anywhere between negative $1 40 to negative $2 10.
Jason points.
Headwinds to gross margins over the next <unk>.
Several quarters stripping that out.
Our gross margins above 50%.
For the on a more normalized basis. So my question number one is that still a significant headwind.
Did you combine the two and yet youre still talking about a 48% to 50% range. So specifically what are the drivers to offset that headwind.
Especially the fact, if utilization rates are going to be dropping for some of the non core core business. I'm curious how you are able to offset those kind of several headwinds over the next several quarters.
Yes look.
This is a sign in the short term obviously those are the headwinds that we're offsetting through efficiencies that we have internally I talked about new products ramping so new products ramping outside of silicon carbide are accretive to.
Gross margin. So we have a lot of these.
<unk> always said thousands of line items that we keep working on in order to offset that and over a longer time.
That's going to take itself out with silicon carbide ramping the <unk>.
Dilution effect will get less and less as we ramp into that capacity and the same thing with <unk>, where our foundry business to global foundry will be reduced year over year and quarter after quarter, which will reduce that headwind. So in the short term, it's operational efficiencies that we're driving and longer.
Term structural as we grow into it and while we do that we're navigating the market like you've seen us do using utilization very carefully to balance between utilization and inventory build.
Okay.
And thank you for that and then just for my follow up if you look at your auto business.
$784 million in Q2.
Versus $556 million in June of last year.
Taking out 2021, and 2020, which was during the Covid years.
It's still.
Most 80% above where it was at pre COVID-19 levels.
$440 million in June of 2019, now Youre doing $784 million.
If you looked at it from that perspective so.
Obviously the units have not units had been kind of declining since.
Since 2019.
I know the content is very strong, but just wondering how youre able to get this kind of outsized growth even from kind of pre COVID-19 levels.
What's happening with with respect to pricing and how much of that pricing scenario is going to be sustainable as we go into next year. Thank you. Yes. That's a very good question because thats something I look at internally so from the unit's perspective, you can't really.
Linearize the units because a lot of the things we have been exiting also when we talk about not just the non core market, but also the non differentiated products a lot of it is that very very high volume very very low ASP business that we have been exiting which some of it is going into automotive so from a unit <expletive>.
Fine I review that the only thing I look at that as how to balance the manufacturing into our fab lighter strategy. So that's one thing here, but a lot of the new products that we are shipping our higher ASP.
But not as much volume you don't think about GBT module is thinking about silicon carbide module much higher ASP and much lower volume. The second part of the growth is if you compare the evs built back into if I go back to 2018, if you want to do that as the baseline.
EV units are much much higher percent of total units built than they were three years ago, even when they were last year. So a lot of that is the content. Then of course, you have the pricing stuff, which I've always said is.
Some of it is we're pricing ourselves out of the market and that's the stuff, we're not going to chase down and Thats sustainable as far as margin not sustainable from a price perspective, and that's expected, but the price to value discrepancies that we have been doing is sustainable and the way I monitor that is one the LTE assay to that customer.
Our signing which includes volume and price over that.
<unk> of the LTE assay and even on my in my prepared remarks, I talked about customers coming in and wanting to extend those out TSA beyond the original timeline that they had.
<unk> is not about image sensor or silicon carbide or highly constrained. It's some of them have 200 parts from on semi so customers are valuing the whole portfolio. They are evaluating where we are economically even with the price to value discrepancies because we started way below.
Market and that is sustainable one from the LTE assay side and two I know kind of a feel of where we are versus the market and we're not an outlier.
Thank you.
Thank you.
Our next question comes from.
Gary Mobley with Wells Fargo.
I believe that with me, Gary well the Wells Fargo Securities.
I apologize if otherwise.
Multi part question on Silicon carbide, and so Im wondering what your view is on silicon carbide contribution to gross margin over the long term will it be at corporate gross margin when that business is a $1 billion plus next year and with respect to silicon carbide <unk>.
Curious capacity or supply I believe there is a constraint situation.
In that market today, and so I'm wondering if that's contemplated as well into your fiscal year 'twenty outlook.
Yes, the silicon carbide.
As we said is at or above the corporate average gross margin at scale.
We believe for the next several quarters, we're going to have the headwinds of 100 to 200 basis points.
But I think if you think about late next year, we will that headwind should be behind us and.
We will be achieving those those gross margin targets at that time.
Yes.
From a supply demand perspective, it's hard to make silicon carbide and it's sure as heck harder to scale. It at the pace we are scaling it.
Based on the acceleration of the EV.
Penetration into total vehicles made we do see and I think that comment.
Comment.
Supported by some of the industry analysts out there.
Silicon carbide is going to remain constrained in the foreseeable future and that's why our focus is on investing heavily.
Into that capacity ramping their capacity as hard as we can and supporting our <unk> customers and Thats. The reason we have seen an increase in L. A TSA customers that are signing up with committed revenue because they want to get that capacity they want to have us.
Invest in that capacity. So we are there when they need to ramp versus them having to scramble. The last thing. They want is announced EV aspirations and not have the main event that drives the car. So we're working with our customers to support their EV ramps and we do that through <unk> and we do that through heavy.
<unk> in order to increase the pace, that's what we need.
Appreciate that guys. So this is my follow up I wanted to ask.
What's embedded in your third quarter guidance with respect to some of the end markets that may be.
Showing some some softness in particular I'm curious to know what your exposure is currently between consumer Pcs and smartphones can you remind us of that.
Yes look when we think about the guidance going forward, we believe that auto and industrial continue to be supply constrained.
We believe that auto is up.
More than than our guidance.
Think of it industrial is flat to up and we think the other markets.
Or potentially down.
The conservative.
Our guide there.
We don't break out between those various markets. They are not strategic to us and again part of where we're seeing the softness in the non core business that we're hoping to exit so if that does get softer faster that could allow us to exit even quicker.
Thank you.
Thank you.
Our next question comes from Joseph Moore with Morgan Stanley . Your line is now open.
Great. Thank you.
Staying with the silicon carbide topic.
I would say.
Kind of the numbers you are talking about.
Look at the numbers that your top four or five competitors youre talking about we're getting to numbers that are much larger than kind of the third party estimates for silicon carbide. So I assume that the market is growing faster than third parties assessment I would've thought we were constrained by battery capacity and just kind of the general EV battery power capability of your customers.
Do you think the market is expanding that much more rapidly versus on success within the market.
And do you think some some people might be overly optimistic about where how big this could be.
Yes look one thing history have taught me is external reports are accurate backwards looking not so much forward looking.
The numbers I'm, putting together and I'm sure some of my peers do that our bottom.
US I can speak specifically their bottoms up number they are numbers that are.
Under long term supply agreements and remember we always talk about those are committed revenue. It's not I don't talk about funnel I don't talk about.
Projections of what conversion is going to be these are long term supply agreement contractual.
Documents between Hudson, the customer, stating by year and some of them by quarter about what the ramp profile and we have identified vehicle platforms that we're working on with the customer where that silicon carbide is going to go into so from the on semi side I can speak very comfortably above the ramp that we are seeing because thats what were working on.
Now from what Derisked, the ramp and the market in general is the geographical and the customer slash platform.
First city that we have engaged in where if there is one model that doesn't ramp the way. They expect there will be another model that will ramp faster than they expect because for us the lts.
Especially the ones with an OEM or at an OEM level not necessarily at a moderate level. So that's how we balance the risk a lot of the strategics that we are working with.
Ways look at overall capacity from a battery perspective, because that will be kind of the secondary bottleneck.
A lot of these Oems have committed battery capacity and they have made their own disclosure. So I won't comment on that so from a ramp perspective. It is ahead of where we even thought there is an acceleration silicon carbide that we have seen in our current revenue and have seen outlined in our projection with the long.
Supply agreements, but we are ready for it and our customers have everything else they need two ramped up that volume.
Great. Thank you very much and just a quick follow up kind of more of a housekeeping.
Is the treatment of the startup expense in silicon carbide sort of similar GAAP versus non-GAAP are there any big differences, we should be aware.
All of our startup costs are in our non-GAAP results.
So we don't exclude anything.
Okay.
Great. Thank you very much.
Thank you.
Our next question comes from the line of harsh Kumar with Piper Sandler Your line is now open.
Yeah, Hey, guys I had a quick one when I talk to investors that are negative or bearish on the stocks. They often bring up the fact that you guys might have been involved in raising prices a lot more aggressively than some of your other competitors I was curious if you could walk me through how things work in real life and their business is that even possible.
That you are super aggressive in raising prices and maintain maintain business with customers or do you risk losing business. I was just curious if you can give me puts and takes on that angle and then I've got a quick follow up.
Yes look I'll give you I have been very straightforward about this there is two components of this I'll talk with the easiest one first.
We've always been very straightforward and direct about the fact that a non core business that we plan to exit we priced ourselves out of the market. That's one way to exit that business is by pricing yourself out of the market. So that I would say, if thats, where youre hearing it from that would be true and there is it's not a risk.
Losing business, if the intent of losing the business and we've had that intent and we even disclose it in our prepared remarks of how much we lost and how much we intend on losing so that's one side of it the other side, which is more on the value strategic as I talk about the price the value discrepancy I don't think there is a risk of loose.
That business, especially with the fact that a lot of these <unk>.
<unk> the value products that we supply to our customers.
After the price actions that we've taken we still remain committed to them and we have them under <unk> with our customers that tells you that our pricing is not out of line otherwise why would the customer want to sign up for it one and two why would they want to come back and extend debt now.
Now relative and it's all relative.
Maybe the percent that you hear that we've raised higher maybe higher than as a percent than some of our peers have done I don't know what they've done I don't know what <unk> is in the market, but you also have to remember where we started from and a lot of areas and I have that data that we're acting on we have been.
<unk> pricing way below market.
So getting it back to market may be a bigger percent, but it doesn't mean that you are above market and the data and the commitments from our customers prove that from an external view.
Hey, Thank you very much sounder was very helpful.
And then as a follow up real quickly there's a lot of chatter and a lot of talk not from you guys, but from every warehouse about a tesla contact possibly <unk>.
Are you willing to talk about that at all and it's not a part of the $1 billion 2023, Golar Thats. Another question, we get from investors a lot.
Look I will maintain my my policy of not commenting on specific customer engagement or customer ramps.
So I'll leave it at that.
Fair enough. Thank you assign congrats guys. Thanks.
Thank you. Thank you.
Thank you.
Our next question comes from Matt Ramsey with Cowen. Your line is now open.
Thank you very much for squeezing me in guys. Good morning.
Wanted to ask on the Silicon carbide business as you get to sort of this $1 billion in scale and continue to scale beyond that.
Hasan you mentioned that this is going to be sort of a historically quick volume ramp of a.
New technology.
No doubt complicated to get to yield and to scale.
I would like to understand a little bit more about how your agreements with your customers. Obviously that if there is upside to your ability to scale yields and volumes then great youll be able to fulfill all of that but is there any.
I don't know what the right term would be risk sharing.
And some of these agreements in case the yields maybe don't come through as you guys planned. It's great that you are winning all of this business I'm just trying to figure out how you might risk mitigate some of the volume ramps and the yield ramps at this technology scale. Thanks.
Let me put it this way we have enough data and we've been in this business for a long enough to have a very solid baseline and a very solid learning.
Call it slope.
Whether its yield whether it's boule growth, whether its ramp et cetera, I am very very comfortable with our commitments to our customers.
With I would say the way, we look at it as equal upside downside.
I am not concerned about that my main focus is not on the technology and what the technology is out putting right now it is having putting the equipment in place ramping that equipment and we've done a great job at that so far and we're going to continue to do that.
But the biggest thing for us.
Ramping the baseline that we've already established we have a great product and very good yield that is that has been already is in production.
Thanks for that that's great to hear I think that.
From my conversations anyway, I think that's sort of the last hurdle to get.
Investors across as just the confidence in those metrics.
Yeah, I'm not worried about the about the metrics I personally review those metrics.
<unk> person other than our CEO .
And we have a solid outlook with the solid financials.
Sad projected.
Thanks, very much a quick follow up for for that I got a couple of questions. This morning on the receivables and DSO lines jumping up a bit in the quarter. If you had any context there I appreciate it. Thank you.
Yes, absolutely as I mentioned in the prepared remarks.
We recovered from.
From the China Lockdown. So if you look at our revenue for the quarter it wasn't linear.
Because of that so it was very backend loaded which caused.
To go up in DSO to go up but it's temporary.
You know it takes time to collect that cash, but that's natural in terms of if you look at the slope of linearity throughout the quarter being backend loaded.
Don't expect that to continue now that we've fully recovered.
That revenue in from the China, Lockdowns, and we're not seeing any impact going forward knock on wood here.
But.
That's the reason purely temporary.
Thanks, guys congrats on a progress.
Thank you.
That concludes today's question and answer session I would like to turn the call back to Hassan Al Carey, President and CEO for closing remarks.
Thank you all for joining US today, we delivered outstanding results in the second quarter and I again want to thank our worldwide team for their commitment to excellence as we execute our strategy.
While we have exceeded our expectations, we are nowhere near the full potential of our semi with accelerating growth in our silicon carbide and if you roll in the fastest growing mega trends, we are on a path to deliver sustained above market revenue and earnings growth.
We look forward to seeing you at various investor events during the quarter. Thank you.
This.
Today's conference call. Thank you for participating participants now disconnect.
The conference will begin shortly to raise your hand during Q&A you can dial star one one.
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