Q2 2023 On Semiconductor Corp Earnings Call
Okay.
Good day, and thank you for standing by and welcome to the answer My second quarter 2023 earnings Conference call.
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I would now like to hand, the conference over to your host today, Parag Agarwal, Vice President of Investor Relations and corporate development. Please go ahead.
Thank you Liz.
Good morning, and thank you for joining our second quarter 2023 quarterly results conference call.
I'm joined today by you have Donald Carty, our president and CEO and Curt.
Our CFO .
This call is being webcast on the Investor Relations section of our website at Www Dot dot.
Dot com.
A replay of this webcast along with our 2020 Three's second quarter earnings release will be available on our website approximately one hour. Following this conference call.
The recorded webcast will be available for approximately 30 days following this conference call.
Additional information is posted on the Investor Relations section of our website.
How about on the earnings release and this presentation includes certain non-GAAP financial measures.
Calculation of these non-GAAP financial measures to the most directly comparable GAAP measures under GAAP.
Yes.
<unk> in our earnings release, which is posted separately on our website in the Investor Relations section.
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 statements are subject to risks and uncertainties that could cause actual events or results to differ materially from projections.
Important factors.
That can affect our business, including factors that could cause actual results to differ from our forward looking statements are described in our most system Form 10-K.
Thank you and other filings with the Securities and Exchange Commission.
Our earnings release for the second quarter of 2023.
Our estimates or other forward looking statements may change and the company assumes no obligation to update forward looking statements to reflect actual results.
Sure.
Or are there.
Except as required by law.
Now, let me turn it over to Hassan.
Hassan.
Thank you Brock.
And thanks to everyone on the call for joining us.
<unk> staff and I are thrilled with the results following another successful quarter for on semi with Q2 revenue of $2 9 billion.
non-GAAP gross margins of 47, 4% both above the midpoint of our guidance.
Our worldwide teams are firing on all cylinders, well, maybe I should start saying theyre spinning all motors now.
Our approach a disciplined consistent and reliable execution.
Continues to be the winning formula for on semi quarter after quarter.
We have again exceeded our targets despite the current market environment.
While delivering best in class performance for our customers.
The most recent example is our <unk> as our silicon carbide performance.
We ramped a new and highly complex technology, while continuing to surpassed internal manufacturing and financial metrics and we are all very proud of everyone that contribute this success daily.
Given our progress in Q2 Silicon carbide revenue growing nearly four <unk> over Q2 'twenty two we remain on track to achieve our first billion dollar revenue year and remain on track to have more than 50% of our substrates coming from our internal production by the end of Q4.
EV is the fastest growing part of this business followed by energy infrastructure.
Customers are excited to work with us our successful capacity expansion is creating an opportunity for <unk> to gain share and silicon carbide by supporting new demand amid ongoing supply uncertainty in this space.
Yeah.
In Q2 alone, we signed more than $3 billion of new Silicon carbide <unk>, bringing our total lifetime silicon carbide revenue committed through long term supply agreements to over $11 billion.
One of our largest wins last quarter was with the Tesco a leader in modern drive technologies and electrification solutions, who signed a $1 9 billion dollar agreement to support the growing need for silicon carbide and electric vehicles.
They are co investing $250 million as part of this 10 year Lps state to ensure capacity for the ramp.
We also extended our silicon carbide engagement with Borgwarner to integrate our elite sick 1200, and 750 volt power devices into its power modules to deliver increased power density and higher efficiency, which increase the range and overall performance of Evs.
We have had a longstanding relationship with Borgwarner and this extended L. TSA now amounts to $1 billion of committed silicon carbide revenue.
Finally, with Magna one of the world's largest automotive suppliers, we have signed to silicon carbide <unk> to expand our strategic collaboration which has long included technologies across our intelligent power and sensing portfolio.
Together, we will integrate our 1200 volt intelligent power devices into magnetic traction inverter solutions to improve the performance of electric vehicles over the next 10 years.
By integrating on semi industry, leading elite Tech technology Magna E drive systems will deliver greater cooling performance and faster acceleration and charging rates that will help improve efficiency and increase the range of evs.
In addition, they will co invest $40 million in new Silicon carbide equipment in our Hudson and Czech Republic locations to ensure access to future supply.
<unk> have become an integral part of the way, we do business with our strategic customers.
TSA has continued to provide us with extended visibility stability in pricing and volume commitments, while allowing us to plan for long term capacity.
In terms of market dynamics, both automotive and industrial remained healthy in Q2 with quarter over quarter growth of 8% and 10%, respectively and now account for 80% of our total revenue.
It was the first time that our automotive revenue surpassed the $1 billion Mark in a single quarter, driven by strength and intelligent power for electric vehicles and intelligent sensing for advanced safety applications.
New regional regulations will require that vehicles be equipped with both a wider field of view to detect vulnerable road users such as pedestrians and cyclists as well as high speed electronic braking for highways.
These new standards can only be met with higher resolution image sensors like the eight megapixel device, which we first introduced two years ago and is now widely adopted by top carmakers for production in their 2024 models.
With this accelerated adoption, we expect our 2023 revenue for our eight megapixel image sensors to more than double year over year.
We have further expanded our intelligence sensing portfolio with the newly introduced hyperlocal family of image sensors for automotive and industrial markets designed to eliminate flicker, all while delivering the highest dynamic range available in the market.
For industrial applications, such as surveillance and machine vision or new products also offer very low power with intelligent wake on motion to even further extend energy savings.
Another significant milestone this quarter is a sampling of our automotive grade image sensor out of our east Fishkill fab to leading global Adas customers and partners, making on stymie, the only image sensing supplier with a U S based 300 millimeter fab and both internal and external sources across every step.
<unk> of the imaging supply chain.
Customers valued the investments on semi has made to improve supply of resiliency.
With evolving vehicle requirements and consumer behavior automotive design cycles are getting shorter and continued to get compressed. Therefore, we must remain at the forefront of the latest trends and regulations and ahead of our customers need.
We are innovating with the best in the world and being recognized for the value we provide.
Most recently, we received a prestigious Volkswagen Group award for innovation for our strategic partnership on fewer future electric vehicles with our broad portfolio of intelligent power intelligent sensing technologies, along with our focus on establishing vertically integrated silicon carbide production capabilities.
We are grateful for partners like VW as well as our other strategic customers, who trust on semi packaging expertise scalable manufacturing capabilities and problem solving approach to deliver joint innovation in the rapidly evolving automotive market.
And.
Our revenue grew 5% year over year, and 10% sequentially with continued strength in medical applications as well as energy infrastructure, which increased nearly 70% year over year in Q2.
Our growth in the industrial segment is driven by the accelerated adoption of high growth energy infrastructure application like solar Inverters energy storage, Inverters and EV fast Chargers.
Solar is forecasted to surpassed coal and gas and installed capacity by 2027 and on semi has the number one market share position with a full suite of silicon and silicon carbide and packaging technologies to deliver the most highly efficient and system optimized solutions to customers.
We have now secured $195 billion in long term supply agreements for power modules with leading global manufacturers of solar Inverters.
<unk>, which are eight of the top 10 solar inverter suppliers.
These customers are securing supply assurance to support their growth.
Highlights in medical include market expansion and expansion for continuous glucose monitors or CGM driven by the reimbursement of monitoring therapies.
We are number one in CGM, which we support with our sensor interface portfolio and we expect this market to continue to grow at a 20% CAGR over the next five years.
And hearing AIDS, we are partners with innovative customers, who will push accelerated adoption in the market with over the counter solutions, improving accessibility and lowering cost of ownership.
Lexi hearing is one of the world's game changers in hearing aid and users on Sami's intelligence sensing technology at the heart of their solution.
Earning them recognition as one of time 100, most influential companies in 2023.
Once again I want to thank all our employees, who work on our incredible silicon carbide effort around the world as well as those who remain focused on all of our other strategic growth areas of intelligent power and sensing.
We have a unique opportunity as a company to accelerate our investments in areas, where we believe we can outpace the market with the capital generated by our mature and growing businesses.
The size and scale of our operation have allowed us to leverage our infrastructure and expertise inside the company to tackle complex problems and drive increased output to support the growing needs of our customers and.
And now let me turn the call over to Thad to give you more details on our results.
Thanks Hassan.
We're pleased to report another stellar quarter for on semi.
Our Q2 results and our Q3 outlet outlook clearly demonstrate our consistent execution outpacing the industry, while navigating the soft macro environment.
We are uniquely positioned as our business has been powered by multiple secular growth drivers and the fastest growing end markets of automotive and industrial.
All of our Q2 financial metrics exceeded the midpoint of our guidance.
We grew revenue, 7% sequentially expanded gross margin by 60 basis points to 47, 4% and delivered a 12% quarter over quarter increase in earnings per share to $1 33, which exceeded our guidance range.
Our global teams have transformed the business to deliver predictable and sustainable performance with above industry growth at attractive margins.
Revenue for the second quarter was $2.09 billion, roughly flat compared to the second quarter of 2022 and increased 7% over Q1.
Sequential increase was driven by growth in the automotive and industrial end markets with accelerating demand for electrification and renewable energy.
Even without silicon carbide, our revenue increased at an impressive pace sequentially.
Turning to silicon carbide.
As Todd mentioned, our continued execution and increasing number of LTE assays with automotive and energy infrastructure customers.
We are ramping our silicon carbide production to support the increasing demand and remain ahead of our internal plans over.
Over the past two years, we have made strategic brownfield investments to expand capacity and ramp production much faster by leveraging our existing manufacturing footprint and expertise.
These industry, leading ROIC investments are now contributing to our financial results and.
In the second quarter, our silicon carbide business nearly doubled gross margins sequentially.
And I'm proud to report our silicon carbide business achieved its first profitable quarter delivering high teen operating margin on a fully loaded basis, which includes all startup cost.
I'd like to take this opportunity to thank to think the 33000 on semi employees across the globe for their commitment to success and delivering outstanding results quarter after quarter.
Turning to end markets, our automotive revenue had a new record of over $1 billion in Q2, growing 8% quarter over quarter, and 35% year over year, driven by the accelerating adoption of electrification and the continued need for sensing and vehicles.
In Q2, industrial revenue grew 5% year over year, and 10% sequentially with continued strength in EV charging medical applications as well as energy infrastructure, which increased nearly 70% year over year and is now a meaningful part of our overall revenue.
We continue to exit volatile non core businesses.
Which included another $57 million in Q2 revenue, bringing our total year to date of exited revenue to more than $100 million.
And nearly $400 million since the start of our transformation.
We will continue to be opportunistic and non core markets.
Our margins are favorable and engagements our strategic with our customers. We now expect to exit $350 million to $400 million in 2023.
Looking at the split between operating units revenue for the power solutions group or PSG was one $1 2 billion.
An increase of 6% year over year with more than 60% year over year increase in auto and nearly 70% year over year increase in energy infrastructure.
Revenue for the advanced solutions group or ISG was $650 million.
A 9% decline over Q2, 'twenty, two driven by deliberate exits and continued softness in non core markets offset by strength in automotive and industrial.
Revenue for the intelligent sensing group or ISG was $325 million a four.
<unk> increased year over year, primarily due to the automotive shift to higher value sensors in our portfolio such as eight megapixel image sensors.
Our GAAP and non-GAAP gross margin of 47, 4% improved 60 basis points quarter over quarter, driven by silicon carbide and despite the significant headwinds from <unk>, we disclosed last quarter we.
We continue to improve the cost structure of the fab, but we expect <unk> to be dilutive to gross margins by approximately 250 basis points for the next several quarters.
We remain committed to maintaining our long term gross margin trajectory as we execute our fab right strategy of driving efficiencies and further consolidation and our internal as well as our external manufacturing network.
Now let me give you some additional numbers for your models.
GAAP operating expenses for the second quarter were $318 7 million as compared to $453 1 million in the second quarter of 2022.
non-GAAP operating expenses were $305 5 million as compared to $317 7 million in the quarter a year ago.
GAAP operating margin for the quarter.
32, 2% and non-GAAP operating margin was 32, 8%.
non-GAAP operating margin increased 60 basis points quarter over quarter.
Our GAAP tax rate was 15, 3% and our non-GAAP tax rate was 15, 8%.
GAAP earnings per share for the first quarter with $1 29, as compared to $1 two in the quarter a year ago.
non-GAAP earnings per diluted share was $1 33 flat year over year and above the high end the high end of our guidance.
Our GAAP diluted share count was $448 7 million shares and our non-GAAP diluted share count was 438 7 million shares.
In Q2, we repurchased $60 million of shares at an average price of $86 49 per share and we remain committed to our long term strategy of returning 50% of free cash flow to our shareholders.
Turning to the balance sheet cash and cash equivalents was $2 6 billion and we had $1 1 billion undrawn on our revolver.
In Q2, we proactively downsized our revolver by $500 million.
$1 5 billion and extended the maturity to 2028 to align to our long term needs and projected cash flow.
Cash from operations was $398 million and free cash flow was negative at $39 8 million.
Due to timing of investments in capital expenditures and growth and strategic inventory in the second quarter.
We expect free cash flow to return to positive for the remainder of the year.
Capital expenditures during Q2 were $436 million, which equates to a capital intensity of 26%.
As we indicated previously we are directing a significant portion of our capital expenditures towards silicon carbide, and enabling our 300 millimeter capabilities.
At <unk> and expect our capital intensity to be in the mid to high teen percentage range for the next several quarters.
Accounts receivable of $944 $4 million increased by $63 5 million and DSO was 41 days consistent with the first quarter.
Inventory increased by $149 5 million sequentially and days of inventory inventory increased by four days to 163 days.
This includes approximately 54 days of bridge inventory to support fab transition and the silicon carbide ramp excluding these strategic built our base inventory declined seven days quarter over quarter.
We continue to proactively manage distribution inventory.
Distribution inventory increased $20 million sequentially with weeks of inventory at seven seven weeks in Q2 versus seven weeks in Q1.
Total debt remained flat at $3 5 billion and net leverage is two seven.
Let me now provide you key elements of our non-GAAP guidance for the third quarter.
A table detailing our GAAP and non-GAAP guidance is provided in the press release related to our second quarter results.
Our business continues to strengthen with improved visibility and we expect to recognize approximately $6 4 billion.
Committed revenue from our Lts days over the next 12 months in addition to our noncancelable and non returnable orders.
Given the soft macro environment.
We're taking a cautious stance in our guidance.
We anticipate Q3 revenue will be in the range of 2.0 95 billion to $2 $195 billion we.
We expect automotive and industrial sales increased quarter over quarter with other markets down mid to high single digits.
As we plan further exits in our noncore markets.
We expect non-GAAP gross margin to be between 46% and 48% due to lower factory utilization <unk> headwind and the dilutive impact of Silicon carbide, which remains ahead of plan.
This also includes share based compensation of $4 4 million.
As we have previously previously stated 2023 will be a transition year for our gross margins and we expect to maintain our trajectory as we manage these temporary headwinds.
We expect non-GAAP operating expenses of 300 million to 315 million, including share based compensation of $29 million.
We anticipate our non-GAAP or E will be negligible for the quarter.
We expect our non-GAAP tax rate to be in the range of 15, five to 16, 5% and our non-GAAP diluted share count for the third quarter is expected to be approximately 439 million shares.
This results in non-GAAP earnings per share to be in the range of $1 27 to $1 41.
We expect capital expenditures of $440 million to $480 million.
Primarily in brownfield investments in silicon carbide and <unk>.
To wrap up the structural changes we've been implementing since the start of our transformation have improve the resiliency of our business and enabled us to better navigate the soft market environment.
We have delivered another quarter.
With results above expectations, reinforcing that consistent reliable execution is our path forward to achieving our long term model.
We have reduced the volatility in our financials and helped our commitments, while navigating short term market dynamics and we plan to continue to deliver for our shareholders one quarter at a time.
With that I'd like to turn the call back over to Liz to open for questions.
As a reminder, if you'd like to ask a question at this time that is star one one.
Our first question comes from the line of Chris Danley with Citi.
Chris Your line is now open.
Hey, you guys cut out here for Chris Daly.
Sorry, you went dark for a second.
Guys. My first question is just on the overall cycle Hassan how would you compare.
Taking silicon carbide out just pure semi is now versus three months ago would you say, it's gotten a little better a little worse any comments on visibility and just the overall semi cycle now versus last quarter at this point.
Yes, I mean, I'll tell your auto and industrial remains healthy even if you take out.
Silicon carbide that business is up.
That's really the way we position those both of these businesses in a lot of the Mega trends that are underlying it would the EV and energy infrastructure. So when you put both of those without silicon carbide. That's also supporting growth in general for what I would call the silicon business. So our strength in these markets.
<unk>.
And how about non auto industrial.
No.
Auto and industrial will see it slightly down.
Slightly down and Thats a lot of our peers that are more exposed to those businesses are seeing and we see the same thing for <unk>.
Our non our non auto and industrial was up slightly but as this onset we expect it to be down mid to high single digits in Q3.
Great and for my follow up any changes in.
On specific lead times and shortages quarter over quarter has your lead times gone down gone up or stayed the same charges up down stayed the same versus three months ago.
And the lead times, if you look at our average lead time, it's very consistent quarter on quarter. There has been pockets where lead times have decreased a few pockets where they are they have increased but on average they are they're relatively flat quarter on quarter.
Great. Thanks, guys.
Thanks.
Yeah.
Our next question comes from the line of Quebec, ARIA with Bank of America.
Hi, This is Blake treatment alternative that carrier. Thanks for taking my question. So first just wanted to start off with that answer may have signed a number of silicon carbide <unk>. So I was hoping you could provide the mix of autos versus non autos and then looking further into the industrial market. Your growth is up 5% year on year, which is certainly well above other peers down 10%.
The 20% I don't know.
Silicon carbide is a partial contributor but I was hoping you can describe maybe what youre seeing versus what peers arent.
Yes couple of thanks, Sean.
Silicon carbide is still within the same mix, we've talked about before about 90% is auto by 10%.
Industrial.
The <unk> that we talked about in industrial or to 195 billion.
That's for the whole market so that includes.
Silicon and silicon carbide or GBT, because we talked about the hybrid modules, we were able to provide that's driving that one point 95 on the industrial side, specifically, what really breaks us apart.
Is the fact that we are extremely focused on the growth markets within industrial.
And we talked about energy infrastructure, which includes renewable and goose charging all of that that has driven those are mega trends underlying the industrial and in my prepared remarks, I talked about our focus on the medical side of the business, which is also under the industrial and Thats seen its own transformation from the hearing.
<unk> eight going over the counter to CGM being part of the <unk>.
Reimbursements.
Scenarios all of these are driving underlying growth, but they are very specific to where we have chosen to put our strategy from a company perspective, that's where our investments have been and the growth is coming specifically so that's the reason I can pinpoint exactly what is specific to on semi versus.
The general peers.
Got it and then as a follow up I was just hoping you can provide an update on the progress of in sourcing silicon carbide substrates on your timeline to be fully enforced and I understand the strategy has been focusing on brownfield investments.
Industry is silicon carbide supply expected to travel demand for the foreseeable future with management ever consider building its own Greenfield facility down the road.
So the private I'll I'll answer both of these separately. So the progress is still on track I reiterated the fact that youre going to be exiting this year with the majority coming.
Internally. So we're still on track that business is actually or that operation is actually performing better than we expected so high confidence in.
Our commitment that we've made about six to nine months ago.
So we're going to exit this year.
With majority of internal as far as brownfield Greenfield, we added a lot of runway with the brownfield we have a great.
Fab and backend.
Exposure and what we're doing is we're going to utilize it we don't see that.
Needing to go to Greenfield at anytime in the future of course, that's dependent on business and economic sense right now with all the wins that we have disclosed those are we are able to support those with brownfield.
Specifically as we embark on our fab right strategy that <unk> described in.
Our analyst day, that's going to be supporting all the <unk> that we've disclosed and look.
If business is even better than what we are talking about today and we have to go to green.
Greenfield then that's a really good reason to do it.
But for now brownfield is the path and we are able to support it and Thats really highlights the good ROIC that we've been able to deliver.
Thank you.
Our next question comes from the line of harsh Kumar with Piper Sandler.
Oh, Hey, guys can you hear me okay.
Yes.
Okay.
First of all congratulation this is yet another fantastic quarter and guide from you guys. So congratulations.
I had two questions as Sean I'm seeing a little bit of a change in your business I used to see sort of transactional business and silicon carbide you'd get.
You'll get orders, you'll get customers, but now we're seeing really large orders really large customers multiyear multibillion dollar deals.
Is this happening because of the competitive environment more recently or is this happening because you are much more comfortable taking on these orders and if so why are you more comfortable taking on these kind of orders and then I know you've said that you never want to Shao <unk>, but I just wanted to clarify.
These orders strictly all 100% chips as they're pushing away fresh air involved as well and then I've got a follow up.
Yes, So let me answer the latter part because that's that's straightforward we're still not interested in.
Selling well.
What we call substrates, we're not in the business of subs.
Substrate.
Our focus on the substrate manufacturing is for internal consumption that has not changed.
And look the demand that we've been talking about utilizes all of our substrate operation. So we're.
Creasing that capacity in tandem just ahead of our.
Revenue derived from our customers.
<unk> remains unchanged and that remains our focus and look that operation is performing ahead of plan. So I'm very very satisfied with what the team has done.
There as far as you know.
The strategic engagements with the customer it's not our it's not only our willingness to take that business, we're always been willing and we've talked very confidently.
Confidently about our capabilities and what we have been ramping what is changing is if you think about the landscape.
We have we are the only one that scaled.
Quickly.
<unk> is a silicon carbide supplier at scale.
And that is now very very clear to our customers and their customers, whether it's tier one OEM and that ability to scale and really deliver exactly on our commitments to all the customers who had had <unk> with us have gotten what they want no hiccups in ramp no hiccups.
In technology, no hiccups and expansion, so theyre coming back and expanding those agreements because they are winning more business with our products and they want us secure more of their future. So its a win win really.
It's how you want it to be.
Fantastic.
A follow up I know investor as always look forward and kind of want you to deliver the next things. So the question that eight inch wafers, we hear a lot of investors about the cost disruption that that might bring supposedly lower costs curious if your customers, bringing this up with you at all at this point in time.
And then I know you have planned trade inch wafers, maybe you could update us on those while youre at it and then for Sean I also had a clarification on your previous question.
Are you are you shooting for more than 50% in total by the end of the year for silicon carbide or the vast majority.
We're okay. The latter one we are expecting over 50% by the end of the year, but that's not what the goal is the goal is above that.
And we will reach that in 2024, so we're going to exit about 50% this year.
And we're going to keep going in into 2024, and we'll update you of kind of where we see that depending on the market and the dynamic there.
The first part of the question eight inch.
So.
We're still consistent and on track with what I've described in the past we are running eight inch currently we are running it for what we what I call building the baseline baseline yield baseline all of that.
So we're able we have been producing eight inch wafers in order to kind of flush out all of the manufacturing. So when we go to ramp we are able to ramp as fast and as successfully as we have done in <unk>.
Six inch so our customers don't ask for that what our customers care for is delivering the cost structure to be competitive delivering the capacity to be able to ramp and being there when they need to ramp.
We're able to deliver on all of these commitments both on six inch today, an eight inch moving forward our customers looked unaudited our manufacturing capabilities on site. They feel as comfortable as we are and look and you see it with when somebody signs a 10 year <unk>.
Eight inch in it and that's the confidence that they have in our business that we're able to deliver.
Congrats again guys. Thank you.
Thank you. Thank you.
Sure.
And the next.
Our next question comes from the line of Gary Mobley with Wells Fargo.
Hey, guys can you hear me.
Yep Yep.
Yes, we're cutting out here at the end of the introduction Paul Jason.
I appreciate the fact that.
Youre, probably going to increase your silicon carbide revenue four five fold this year than maybe if you can speak to.
Preliminary view for fiscal year 'twenty four considering <unk>.
Supply constraints it sounds like you are not demand constrained, but yes.
Maybe focusing primarily on the supply side.
Yes, we're not going to.
Guide for 2024, but you can basically when we get to Q4, you can take the exit rate, which is going to be healthy and that project forward, but we're not projecting into 2024, it will be substantially higher.
Okay.
And maybe if you can give us an update on any sort of government subsidies chipset funding equivalents elsewhere.
Specific to the silicon side of the business and then as well as silicon carbide I understand there really werent a chipset support for silicon carbide, but I think you had an opportunity to comment on that and maybe if you can give us an update on where that stands.
Yes look we're engaging.
All parties not just in the U S. But of course in Europe , and we have a big operation in Korea, which has their own or a variant of the chipset. So we're engaged in.
All three.
<unk>.
Announced a $2 billion investment for an end to end silicon carbide manufacturing, which will be.
The only one in the world really from substrates, all the way to wafers on the same site.
And we're considering all three.
These regions because we have brownfield capabilities in all three of these regions.
We talked about a decision made between now and the end of the year of where it's going to be and part of the decision as well. The main decision is purely economic and financial therefore, the funding from the government plays a big role and swing it one way or another for depending on which site.
We're in the process and the discussions of all of these but that one is specifically related to silicon carbide to comment on your question.
As far as in general we have made comments on silicon carbide, specifically and the chips Act.
But thats really up to them to what they do with it and Thats part of our decision, making progress we're going to go where it makes sense to get the best ROIC for our investments and that's how we create shareholder value that remains the top of our priority and we're going to make that decision between now and the year of where it goes.
Thanks for your time.
Our next question comes from the line of Christopher Rolland with Susquehanna.
Hey, guys. Thanks for the question.
Great quarter.
So.
My question is around your strategy your thinking around co investment on sick.
Are your competitors are looking for $1 billion.
Post financing through these commitments I know you did well with like the task and Magna here for smaller amounts, but I'm really wondering about the strategy here.
Are they investing in new capacity.
Or what are they getting out of this are they getting a haircut on wafers or is it just dedicated capacity and.
How are you thinking about this and the amount you want to take in overall from your customers as well.
Finances.
Yes look.
I will start at a very high level.
<unk> will differentiate on semi we can afford our own investments because of the cash flow from operation. So we're not looking at funds.
Funding as a way to help us.
Grow the business and help us build capacity.
You looked at our balance sheet. If you look at our cash position and you look at cash from operations and our Capex investment all of them are able to be supported by our operations. So very different financial posture when it comes to.
Capacity expansion.
Where it comes strategically from a customer is really it's a win win it's the commitment there is no higher commitment.
And <unk>, then one way or the customer.
And co invest with us and that co investments have multiple.
Scenarios with it depending on the customer and what problem or what opportunity. They look forward. So it's not a haircut. It's basically it's an offset of depreciation that doesn't change our cost structure for the value that we provide and just offset depreciation whether it's depreciation on our book order book based on the ownership of the equipment.
<unk> and how we apply that investment.
And again those are strategic in nature, which means everyone is specific to what that specific customer is trying to solve for and we work on stock constructively with.
All of these customers, but it is not a we must get that money for us to ramp. This is a we are able to ramp.
And those are strategic investments so it's a very different.
Field, we're planning.
Great.
The reason that that was the reason for the Delta in dollars that you see is again goes back to Ron field versus Greenfield.
We're investing in brownfield, which fat analysis, they talked about a 40%.
Better Capex then.
Greenfield so that gives you kind of the Delta why we're able to ramp so quickly much higher and output for a much lower cost.
Yes, we definitely understand the efficiencies there.
I also wanted to talk about solar.
I wasn't expecting $2 billion in Lts.
<unk> saves from solar which is I believe part of industrial.
Are you expecting industrial sick now to ramp faster.
And then just as a follow on there just talking about gross margins for sick. Overall, you said they doubled first profitable quarter talk about this progression is this all.
Moving faster than you would expect and.
Is it in part because of these industrial as a percentage of <unk> as well. Thank you.
Yes, so on the revenue ramp for industrial specifically on the energy infrastructure to 195 billion at both Silicon and Silicon carbide remember that market is being serviced by a very unique value proposition. We have Simon talked about in the analyst day, the hybrid module, where we were able to put the best technology.
Wired into a single module to provide those customers. So that 195 is on both the.
Power technologies, <unk> or silicon and silicon carbide as far as the ramp.
There'll be ramping in tandem together.
But the automotive number given the Tam and automotive will just ramp to a higher number but as far as percent ramp.
Theyre, both going to be a ramp if you recall last year, we talked about how.
That business around 70%.
Both for the last two years, so it's pretty healthy growth.
But from a dollar of course, it's going to trail.
The automotive purely because of the Tam of the market that we're addressing by both growth. Both CAGR are very healthy and we will remain healthy over the next five years as we execute those LTE assays.
Yes.
The performance the financial performance of the Silicon Carbide business look we're extremely proud of what the team has accomplished there doubling gross margins quarter over quarter, achieving the first profitable quarter again on a fully loaded basis.
And operating margins in the high teen percentage, it's very impressive.
For the performance there what I would tell you is we have line of sight to that it's ahead of schedule because we are ramping well.
And on all metrics were ahead of plan. So although we have line of sight to profitability. We've achieved it quicker than what we was in our original plan. So I think as we go forward, we'll continue to see that expansion and as revenue grows.
We'll continue to contribute to the bottom line.
Thanks for that congrats again guys.
Yes.
Our next question comes from the line of Joshua <unk> with TD Cowen.
Hey, guys. Thanks for taking my questions and congrats on the results.
I did want to follow up on the last one so you mentioned in the prepared remarks, I think it's high teens operating margin for silicon carbide any way to disaggregate the levels internal substrates versus external and should we expect as you ramp internal substrates over the coming quarters should that continue to move higher because I would imagine at least initially it would be it would be.
It could be a headwind to margins. Thank you.
Yes look we're not breaking up <expletive>.
What it is you can take it as an aggregate totally mix adjusted is what the number is and it's going to keep going up of course as that business absorbs the startup costs, because look theres still startup costs in that business.
So as we scaled our business startup costs will be more absorption and that is how we will be continuously improving the gross margin trajectory, which consequently will.
<unk> improved the operating margin so that financial milestone that we have achieved is not the destination. It is just a milestone which we have always had line of sight to it like that said, we achieved it earlier than we expected, but the ramp or call. It the slope of that improvement will just continue.
<unk> from here and we will continue to improve on all financial metrics as that business scales and as that mix changes.
Got it. Thank you for the color I'm going to try to ask the question that involves the other 80% of your business now.
Okay.
The east Fishkill headwinds for two quarters in a row of come in higher than anticipated can you walk us through just what's going on there.
Why are they are higher for longer.
Should we expect it to sort of trough in the beginning part of 2024 is that the right timeframe. Thank you.
<unk>.
Yes, I think if you go back to what we disclosed and what we announced last quarter. It's very consistent right. We got a surprise in the cost structure. There. We've we've now been spending six months really getting our arms around it and understanding what we need to get that cost structure back in line.
Look we've got a large manufacturing footprint, we know how to run fabs efficiently. We benchmark, we know exactly what we need to do.
I say this is like blocking and tackling of what we need to do to take the cost structure, but it takes time, it's hard to take cost out when youre running a fab at full capacity so.
So the time horizon is a little bit longer than we expected it will be for the next several quarters I think.
You can think about this as being probably a year, maybe slightly more than a year.
Headwind for us as we continue to take take the cost out, but we expect by the time, we exit 'twenty four we've got that fab at parity and and running efficiently.
One thing I would also highlight is yes, the headwinds are higher than we expected but to use your words. If you look at all of the other operator operational metrics that we've delivered reflected in the reported gross margin and the guide we're able to absorb it and then some given the beat.
This quarter in the rates for next quarter, so back to Pat's point, we know how to fix the stuff we've been fixing it for the last two years. That's just another thing we're going to work on we have line of sight to just going to take time, but of course, the rest of our business is operating and stellar including.
Underutilization that we've had to do so our margin is structurally very different from what it used to be and that I can say I'm very very comfortable happy and confident about.
Understood I appreciate the color. Thank you.
Our next question comes from the line of Quinn Bolton with Needham.
Hi, Sean.
Congratulations on the nice results.
Just wanted to see if you could give us a little bit more color on the gross margin revenue trending up sounds like sick margins are moving higher.
So I'm just wondering are there any particular headwinds in the third quarter for the 40 basis point decline.
Gross margin at the midpoint.
Yes look so we've got a number of things right. We just talked about <unk>. So clearly that's a headwind you've got utilization utilization dropped down slightly in Q2 from 71% to 70.
We look forward, we think about utilization being kind of in that flat to down category. So we may have a little more headwind on that but the key contributor to that margin stepping down just slightly is the ramp of silicon carbide. So even though the margins have doubled it's still dilutive to the corporate average so as revenue increases you have more of a dilutive impact on Q3.
So I would think quarter over quarter really the delta is a little bit more underutilization charge, and then and then the impact of the ramp the silicon carbide.
Great and then just a quick follow up do you expect quarter to quarter the margins to improve on understanding theres still below corporate average.
Yes, absolutely.
Okay. Thank you.
Our next question comes from the line of Timothy Arcuri with UBS.
Hi, Hi, thanks.
Do you have any update to the $4 $5 billion LTE.
<unk> TSA from 2023 to 2025 and kind of anything to help us think about what silicon carbide it could be next year and into 2005.
Yes, no we're not giving update our focus right now is obviously.
This year will be given an outlook on 2024 as we are.
Get towards reporting of the fourth quarter, given the run rate and where we are of course, we have the number in <unk>.
But we're not talking about it yet we're not guiding for it it will be substantially higher than where it is in 2023, given the <unk> and the ramp.
But right now we're focusing on the execution in the short term.
Great and then how do you.
How do you think about the captive versus external mix, you did say youre going to be more than 50%. This year, but when you sort of lay this out longer term, how do you weigh where you want to take that number two longer term given some of the investments that some others are making.
Particularly in China is there like an upper range of where you want to push that 75% or.
How do you sort of think about balancing that thanks.
Yes look there are multiple <unk>.
Factors of how we balanced our focus is to be able to support our customers when we have <unk> and we.
Look at supply resilience and supply assurance and we have to be able to manage it too.
We're not going to be we don't want to be 100% internal offset that in the past you can think about it.
80% give or take and thats going to be dependent on of course supply assurance, especially as.
You can't ignore that geopolitical aspect of it when you say sourcing out of China.
That is not a supply assurance path as we stand today with the geopolitical environment. So that of course has to play a role and more importantly is the cost.
We have a factory we have a factory at scale and we have a factory that is performing very very well so for us to want to get <unk>.
Supply from the outside it has to make also economic sense compared to what we're able to do internally.
So all of these we always consider.
We always look at what the scenario is going to be but you can think about it as 80% give or take depending all of these factors that I mentioned.
Thank you.
Our next question comes from the line of tore Svanberg with Stifel.
Yes. Thank you this is jeremy on for Tori.
Just a couple of follow ups on the earlier questions on the co investments.
Can you help us understand what the mechanics of this are the <unk>.
Impact potentially to your gross margins maybe cash flows on this I'm wondering how how the footing.
$40 million of the $250 million co investment, which can be played out in the financials. Thank you.
Yes, so as we this is tod so as we received the cash flow customers, obviously that goes on the balance sheet.
The way that it gets accounted for as it.
It gets amortized over the life of the agreement. So if you think about <unk> that maybe have five to 10 years, you can think about that dollar amount getting amortized over over the life as those products are shipped it actually is recorded through revenue so actually as a bump in.
And margin.
Over that timeframe, but you can think about the cash coming in in advance.
As we make payments going out hopefully it is favorable from a cash flow standpoint, that's the intent that we get cash before before we make the commitment to the to the equipment and again just as a reminder, all of the capacity that we're bringing on it's to support these <unk> from those committed revenues. So we're not building capacity on the hope that we can fill it.
So in these situations as Hassan mentioned earlier, these customers or co investing for assurance of supply it with us.
But the accounting works that it actually hits the revenue line over time.
Great. Thank you.
A quick follow up to that.
So this is like a revenue prepayment it is not.
He kind of ownership of the equipment.
And are there any limitations on.
Maybe if it's.
Specific to the equipment its not any limitation on.
Is that for other customers.
Yes every situation is a little bit different.
What I just described there is a prepayment rate.
Think about it our customer deposit.
We do have situations, where customers will consign product are saying equipment to us in that situation. It is little bit different. It's just the lower depreciation off of our books and that sits on their books.
But every situation is a little bit different depending on the customer situations.
Obviously, we want as much flexibility as we can have as we develop these things. So we try not to tie up capacity for one customer and have the ability to move.
To move our production on any of the any of the lines on any of the locations.
So it's designed to have the ultimate flexibility for us.
Great and one last question if I could.
With the slightly different free cash flow on our results this quarter and the high teens.
The capital intensity that seems to be consistent with your with your targets.
Outlined on the analyst day is there any change to that in the very long term.
2027 targets.
Are you seeing anything in terms of higher costs.
And also maybe in terms of the.
Ability to achieve the head count we need to ramp as capacity seems like thats been the problem with some of the other fab ramp ups that we're seeing around the world. This is something that.
As extension you guys at this point thank you.
Yes, no I don't think were I mean outside the norm I don't think were seeing a labor shortage right and part of this is leveraging our brownfield investments and brownfield footprint, where we have we have head count.
In terms of the capital intensity no no no change to the long term plan. This is more of a short term.
As I said the free cash flow will go back to positive for the remainder of this year. So it's really just the timing of getting that equipment as well as the ramping of our strategic inventory to support our fab transitions and our silicon carbide ramp but longer term our capital intensity targets.
Ill remain the same we think will be in the mid to high teens for the.
For the foreseeable future, but then stepping down over time as we've outlined previously.
Great. Thank you very much.
Our next question comes from the line of William Stein with <unk> Securities.
Great. Thank you for taking my question congrats on the great results and outlook.
Hassan at the Analyst Day, you discussed your emerging products in digital power control.
I think that is likely related to.
Servers that are focused on a high maybe you can confirm that understanding and also remind us of your targets and traction towards that.
Yes, so obviously part of that.
That focus on what we call driver and controllers is the server to cloud infrastructure, which applies definitely to AI does to play we have there but most of it is also a targeted towards our primary markets auto and industrial with every switch or call. It.
Silicon or silicon carbide switch, we have the opportunity with the flywheel effect that.
<unk> talked about to increase that content.
We're on track there from a technology perspective, we.
I've already some of the products for internal.
I guess performance and.
And we will be making progress in sampling come early next year, so very fast progress.
It's like what you saw us do in Silicon carbide, we're going to we decided we're doubling down we're starting to run and we're going to start delivering on that.
That's going to be the winning formula for this new business also so stay tuned for more updates as we get into Q4 or Q1 of 'twenty four.
Great and then a follow up if I can.
<unk>.
Reiterated many of the goals around the ramp of Silicon carbide.
Today.
But theres one I'm not sure I heard you talk about yet and Thats.
The margin.
Exiting the year I think in the past you've said it will be neutral to the.
At the enterprise level.
Is is is that ready for an update is it possibly you could do better than that or.
Any reason you are backing off that goal. Thank you.
Well this is sad no our expectation remains the same as I was saying earlier Q3 is the highest dilution impact of silicon carbide, just because of the ramp and again the margins being below the corporate average we believe by the time, we exit the year, we will have those margins at the corporate average.
As we've stated previously.
Great. Thank you.
Thank you.
That concludes today's question and answer session I would like to turn the call back to Sean <unk> for closing remarks.
Thank you again for joining our call we plan to continue to put our winning formula to good use with deliberate execution and operational excellence as we continue to navigate the soft market environment.
Through it all we remain committed to delivering value for our shareholders and confident in our long term outlook of outgrowing the semiconductor market by three times through 2027. Thank you.
This concludes today's conference call.
Thank you for participating you may now disconnect.
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