ON Semiconductor Corporation

Good morning. My name is Rob and I will be your conference operator today. At this time, I would like to welcome everyone to the OnSemi fourth quarter 2021 earnings conference call. All lines have been placed on mute to prevent any background noise. After the speaker's remarks, there will be a question and answer session. If you would like to ask a question during this time, simply press star followed by the number one on your telephone keypad. If you would like to withdraw your question, again, press star one. Thank you. Parag Agarwal, Vice President of Investor Relations and Corporate Development, you may begin your conference.

Thank you, Rob. Good morning, and thank you for joining OnSami's fourth quarter 21 quarterly results conference call. I'm joined today by Hassan El Khoury, our President and CEO, and Thad Trent, our CFO. This call is being webcast on the investor relations section of our website at www.onsami.com. A replay of this webcast, along with our 2021 fourth quarter earnings release, will be available on our website approximately one hour following this conference call, and the recorded webcast will be available for approximately 30 days following this conference call. Additional information related to our end markets business segments, geographies, channels, share counts, and 2022 fiscal calendar is posted on the investor relations section of our website. Our earnings release and this presentation includes certain non-GAAP financial measures. Reconsideration of these non-GAAP financial measures to the most directly comparable measures in the GAAP are included in our earnings release, which is posted separately on our website in the investor relations section. During the course of this conference call, we'll make projections or other forward-looking statements regarding future events or the future financial performance of the company. The words believe, estimate, project, anticipate, intent, may, expect, with, large, should, or similar expressions are intended to identify forward-looking statements. We wish to caution that such statements are subject to risk 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 recent Form 10-K, Form 10-Qs, and other filings with the Securities and Exchange Commission. Additional factors are described in our earnings reviews for the fourth quarter of 2021. Our estimates for other forward-looking statements may change, and the company assumes no obligation to update overlooking statements to reflect actual results, change assumptions, or other events that may occur except as required by law. Now, let me turn over to Hassan. Hassan?

Thank you, Parag, and thank you, everyone, for joining us today. As we wrap up 2021, I'm extremely pleased with the progress of our transformation journey. We have positioned OnSemi as a leader in intelligent power and sensing by focusing on enabling sustainable ecosystems. We have implemented structural changes to focus our investments and resources on the megatrends of vehicle electrification, ADAS, energy infrastructure, and factory automation, and this is evident by our record financial performance. As we have shifted to focus on the high-value markets of automotive and industrial, closed the price-to-value discrepancies, and improved manufacturing efficiencies, we have expanded our margins to achieve the target model ahead of our stated timeline. Our customers view OnSemi as a strategic partner, as evident by the execution of multiple long-term supply agreements, which provide better demand visibility for capacity planning and investments to support it. To that end, the acquisition of GTAS expands our leadership in silicon carbides, and provides our customers the assurance of supply required to support this rapidly grown market. Additionally, we are exiting volatile and highly competitive non-core businesses and focusing on profitable growth and sustainable financial performance. In 2021, our revenue increased 28% while our operating income and free cash flow increased approximately six times faster demonstrating the operating leverage in our model as we continue on our transformation journey. We had a successful year amid the ongoing pandemic and supply chain challenges that continue to affect the market. Our performance has only been possible thanks to the dedication of our worldwide teams, and I'd like to take the opportunity to thank them for their hard work. Moving on to the fourth quarter, Our fourth quarter was yet another example of exceptional execution by our worldwide teams in a strong demand environment for our market-leading intelligent power and sensing products. Although we met our margin targets ahead of schedule, we expect that with ongoing mix optimization, the manufacturing consolidation we have begun, and the continued ramp of new products, we have headroom to further expand our margins over the coming years. We continue to see strong demand for our products, and in 2021, our design wind funnel grew over 60% year over year, and our new product revenue grew 28% from 2020. This design wind performance, along with long-term supply agreements, have positioned the company for sustained long-term growth. The fourth quarter revenue growth was driven by additional capacity coming online from our investments earlier in the year and an accelerated focus to free up existing capacity to service our strategic markets consistent with our stated goal of exiting low-margin non-core products. We are making selective investments in our internal operations to expand capacity for strategic products, and at the same time, we are relieving bottlenecks in our internal manufacturing operations. We have also been successful in securing additional capacity from our external manufacturing partners. Long term, we are qualifying products in the 300 millimeter East Fishkill facility to increase the efficiency of our FAB network while executing our FAB lighter strategy. This will allow us to further expand both the capacity for products in our strategic markets and our gross margin over time given the cost benefits. The current supply-demand imbalance in the semiconductor industry will likely persist through 2022 and continue into 2023. Based on interactions with our customers and channel partners, we believe that the semiconductor inventory throughout the supply chain remains low and lead times are stretched for the industry. This supply constraint is further compounded by accelerating demand for electric vehicles, ADAS, energy infrastructure, and factory automation and the increase of content in these applications. During the fourth quarter, we saw an increase of approximately $600 million in committed revenue for our silicon carbide products, bringing our current committed revenue to over $2.6 billion through 2024. Over 70 percent of this committed revenue is for electric vehicle traction applications with the integrated end-to-end supply chain and market-leading efficiency of our silicon carbide products as our competitive advantage. To support the steep growth in our silicon carbide revenue over the next few years, we plan to more than quadruple the capacity of our substrate operations exiting 2022 and intend on making substantial investments in expanding our device and module capacity. In 2022, we expect our silicon carbide revenue to more than double year over year as we continue to ramp with our existing customers and begin shipments to new customers under our LTSAs. We remain on track to exit 2023 with a silicon carbide run rate of $1 billion per year. In addition, we continue to make progress on the 200 millimeter silicon carbide development program that we acquired from GTAT. thick wafers with device yields meeting our production targets. These wafers were manufactured using our full capabilities from bulls to substrate all the way through our own fabs. Our silicon carbide modules are powering the recently announced Mercedes EQXX research prototype electric vehicle platform, which has a range of 620 miles on a single charge. We secured this design based on all-around superior performance of our modules across efficiency, thermal conduction, and switching. This win clearly demonstrates our technical leadership and end-to-end supply chain capabilities for silicon carbide. Our focus on power modules for alternative energy applications delivered a 42% year-over-year growth in our design funnel in 2021. We have signed LTSAs with key players in the solar inverter market, including the top two market share leaders. We expect our renewable energy related revenue to grow by over 50% year over year in 2022 and expect the alternative energy market to be a long-term driver for our business as utility-scale power plant installations are expected to grow worldwide to reduce the climate impact of fossil fuel-based power plants. On the intelligent sensing front, our automotive imaging revenue grew by more than 20% quarter over quarter and approximately 40% year over year as we continue to see momentum in advanced safety with new design wins. With consumers' desire for additional safety features and an improved driving experience, we are seeing increased penetration of sensing in cars, including image sensors and ultrasonic sensing at the same time Content per car is growing with each camera attached to one of our PMICs. We're also seeing accelerating demand for our imaging products for industrial and factory automation, in which revenue grew by approximately 10% quarter over quarter and 43% year over year. Industrial customers are investing in automation at an increased pace to improve efficiency and to reduce volatility in operations due to wage inflation and labor shortages, onshoring, and social distancing mandates. We have leveraged our experience in the automotive market to offer our industrial customers rugged, high resolution, and high image quality sensors for the most demanding industrial applications. All of these execution vectors delivered a robust margin performance, exceeding our target gross margin of 45% significantly ahead of schedule. This accelerated gross margin expansion was driven by a strong and accelerated execution in closing price-to-value discrepancy, cost reduction initiatives, a focused drive on ramping new products, a deliberate intent to shift more capacity to products for our strategic markets, and operational efficiencies across our manufacturing footprint, all consistent with the strategy outlined at our analyst day. Along with making operational changes to drive the margin expansion, we are refining our execution in the channel to ensure that our partners are focused on driving growth in automotive and industrial end markets consistent with our strategy. Throughout the year, our team worked extremely hard to pull in the schedule for engineering and operations efforts dedicated to margin improvements to offset some increased material costs we have incurred. We have worked to improve yields and ship more units into the automotive and industrial end markets, which deliver an improved margin profile for our business and help support more of our customers' demand. In the fourth quarter, automotive and industrial 10% quarter over quarter is 63% of our revenue as compared to 61% in the third quarter, both delivering record quarters of $641 million $522 million, respectively. In a supply-constrained environment, this growth came from the increased units we could ship and, more importantly, from the strategic mix shift away from non-core, low-margin business that we intended to exit. In 2021, we walked away from $170 million of non-core business with an average gross margin of 20%. Now I will turn the call over to Seth to provide additional details on our financials and guidance. Seth? Thanks, Hassan.

I'll start out with providing an overview of the results for the full year 2021, then step through the Q4 results and guidance for the first quarter of 22, and wrap up with an update to our long-term model. 2021 was an exceptional year as we transformed the company to drive sustainable performance and shareholder value. We have pivoted to align our investments to the high-growth megatrends in automotive and industrial while implementing structural changes, capturing value for our differentiated portfolio, and optimizing our manufacturing footprint to increase efficiency and improve our cost structure. These initiatives are translating into financial results as we achieved our record annual and quarterly revenue, gross margin, operating margin, and cash flow. Our 2021 revenue was $6.74 billion, increasing 28.3% over 2020. Our automotive business increased 36% year-over-year, and our industrial revenue increased 33% as we continue to see content gains in each segment driven by automation, electrification, and advanced safety. Our non-GAAP gross margins for the year improved 770 basis points to 40.4%, and we exited the year exceeding our 45% long-term target in Q4. Since embarking on our transformation journey a year ago, we've improved our non-GAAP gross margin by 1,080 basis points. 2021 operating income and free cash flow increased approximately six times faster than revenue, with non-GAAP operating margin improving to 21.9%, while free cash flow increased to $1.3 billion, or 20% of revenue. While we have had significant achievements over the last year, we are excited about the opportunities in front of us. Our design wind funnel for intelligent power and sensing is expanding at a rapid rate, and we are securing additional capacity to support our growth from external partners and with selective internal investments for strategic products. From a margin perspective, we expect mixed optimization and our fab lighter strategy to drive further expansion. Our long-term supply agreements are providing increased visibility for revenue growth, and we are confident that the structural changes and decisions we made last year have solidified our baseline to allow for sustainable margin expansion over the long term. Consistent with our fab-lighter strategy, we have taken the first steps towards rationalizing our manufacturing footprint by entering into a definitive agreement for the sale of our 6-inch fab in Belgium. This transaction provides our employees with continued employment and growth opportunities while allowing OnSemi to transition product to other manufacturing sites in an orderly manner. By transitioning production to more efficient fabs within our network, we will eliminate fixed cost and lower unit cost while ensuring a consistent supply of products to our customers. We expect to close this divestiture in the first quarter of 2022. and the savings will be realized over one to three years as we exit the Belgium site. Turning to results for the fourth quarter, as I noted, Q4 was another quarter of record results. Total revenue for the fourth quarter was $1.85 billion, an increase of 28% over the fourth quarter of 2020, and 6% quarter over quarter. The sequential increase in revenue was driven by unit shift increasing 5.7% sequentially and favorable mix in pricing across all end markets. Revenue from both intelligent power and intelligent sensing was at record levels, while revenue from our strategic end markets of automotive and industrial increased sequentially 11% and 9% respectively. Auto and industrial with 63% of total revenue as compared to 59% in the fourth quarter of 2020. Turning to the business units, revenue for the power solutions group or PSG was $953.4 million, an increase of 33% year over year. Revenue for the advanced solutions group or ASG was $647.3 million, an increase of 24% year over year. Revenue for intelligence Sensing Group, or ISG, for the fourth quarter was $245.4 million, an increase of 18% year-over-year. Gap gross margins for the fourth quarter was 45.1%, and non-gap gross margins was 45.2%, a 370 basis point improvement quarter-over-quarter. The key contributors to our margin expansion have been favorable mix shift to higher margin and strategic products, elimination of price-to-value discrepancies in our portfolio, and improved efficiencies in our manufacturing operations. Over the last year, we have exited approximately $170 million of non-core revenue at an average gross margin of 20% and allocated this capacity to strategic products with accretive gross margins. Our factory utilization was 81%, up slightly from the level of 80%, and we expect utilization to remain approximately at this level in Q1. We also achieved record quarterly GAAP and non-GAAP operating margins of 26% and 28.6% respectively in the fourth quarter, again, achieving our long-term model. GAAP earnings per share for the fourth quarter was $0.96, and non-GAAP EPS was $1.09 per diluted share. as compared to $0.35 in the fourth quarter of 2020 and $0.87 in Q3. We are very proud of our teams for having achieved the highest ever quarterly EPS reported by the company. So now let me give you some additional numbers for your models. GAAP operating expenses for the fourth quarter were $352 million as compared to $330 million in the fourth quarter of 2020. Non-GAAP operating expenses were $306 million as compared to $292 million in the quarter a year ago. Variable compensation driven by our strong performance partially offset by cost optimization measures contributed to year-over-year increase in operating expenses. We expect to maintain our non-GAAP operating expenses at approximately 17% of revenue consistent with our target model. We intend to offset the impact of wage inflation on operating expenses through higher efficiency and reallocation of resources to drive growth and margin expansion. Our GAAP diluted share count was 445.3 million shares, and our non-GAAP diluted share count was 438.4 million. 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 various share prices. Turning to the Q4 balance sheet, cash and cash equivalents was $1.3 billion after payment of $416 million for the GTAT acquisition in Q4. We had $1.97 billion on a revolver. Cash from operations was $627 million, and free cash flow was $457 million, or approximately 25% of revenue. Capital expenditures during the fourth quarter were $169.6 million, which equates to a capital intensity of 9%. For the full year 2021, capital intensity was 6.6%. As we indicated previously, we are directing a significant portion of our capital expenditures towards enabling our 300-millimeter capabilities at the East Fish Scale Fab and the expansion of silicon carbide capacity. This increase is in line with the higher capital intensity in the near term, as mentioned in our analyst day. Accounts receivable was $809 million, resulting in DSO of 40 days. Inventory increased $52 million sequentially to $1.4 billion, and days of inventory increased five days to 124 days. The increase in inventory was driven primarily by additional build of bridge inventory to support the FAB transitions. Distribution inventory increased $50 million to 7.3 weeks from 6.8 weeks in Q3. This slight increase was driven by timing of shipments late in the quarter. Weeks of inventory returned to Q3 levels within the first two weeks of Q1. Total debt was $3.1 billion, and our net leverage is now under one time. Turning to guidance for the fourth quarter. The table detailing our GAAP and non-GAAP guidance provided in the press release related to our fourth quarter results. Let me now provide you key elements of our non-GAAP guidance for the fourth quarter. Based on current market trends and booking levels, we believe demand will outpace supply for much of 2022, and we continue to work with our strategic customers to ensure long-term uninterrupted supply. We continue to increase supply through operational efficiencies, selective investments in capacity for strategic products, and by working with our external partners to attain additional capacity. Based on current bookings trends, backlog levels, we anticipate that revenue for the first quarter will be in the range of $1.85 billion to $1.95 billion. We expect non-GAAP gross margins between 45.5% and 47.5%. This includes share-based compensation of $3.4 million. We expect total non-GAAP operating expenses of $298 million to $313 million, including share-based compensation of $17.4 million. We anticipate our non-GAAP OIE will be $21 to $25 million, and this results in non-GAAP earnings per share in the range of $0.98 to $1.10. As we have guided in the past, Our non-GAAP tax will increase starting in Q1 from our historical rate of 6% to approximately 17.5% as we have substantially utilized our NOL attributes. This change accounts for approximately 14 cents of BPS at the midpoint of our guidance for the first quarter. We expect total capital expenditures of $150 to $170 million in the first quarter. As we indicated our analyst day, our capital intensity in the near term will be higher as we ramp up silicon carbide production and dust in 300 millimeter capabilities. Our non-gap diluted share count for the first quarter is expected to be approximately 441 million shares.

As I wrap up, I'd like to shift gears to address our long-term model.

Our Q4 non-GAAP gross margin of 45.2% exceeded our gross margin target ahead of our anticipated timeline through an acceleration of our expansion initiatives and structural changes. As such, we are raising our 2025 targeted gross margin to 48 to 50%, which will be primarily driven by favorable mix as we phase out of low margin non-core products and ramp new products in our strategic end markets. We'll also continue executing on our fab lighter strategy to reduce our fixed cost structure and overall product costs across the portfolio as we exit subscale fabs over a multi-year period. To provide a framework for this expansion, we expect 2022 gross margins in the range of 46.5% to 47.5% based on our visibility today. So our new long-term non-GAAP model is as follows. Gross margin of 48 to 50%, OPEX of 17%, and operating income of 31 to 33%, an increase of 300 to 500 basis points over our previous model of 28%. We believe our early success and our transformation initiative has positioned OnSemi to drive sustained and long-term revenue growth and margin expansion. These results and outlook are only possible with the dedication of our worldwide team focused on execution and delivery of exceptional value for our customers. With that, I'd like to start the Q&A. I'll turn the call back over to Rob to open the line for questions.

At this time, I would like to remind everyone, in order to ask a question, press star, then the number 1 on your telephone keypad. We'll pause for just a moment to compile the Q&A roster. And your first question comes from a line of Ross Seymour from Deutsche Bank. Your line is open.

Morning, guys. Thanks for letting me ask a question. Congratulations on the results. I guess it's on the first question, Orthad, is on the revenue side. You talked a lot about the demand exceeding supply, a lot of good design wins and LTSAs, et cetera. I wanted to dive into the things you're walking away from. I think you said last year you got out of about $170 million of business. It seems like there's about $600 million more coming. So, Thad, you gave a good outlook on the gross margin for the year. I know you're not going to guide revenue every quarter for this year, but I wondered how that incremental exiting process is going to hit and kind of at what pace we should be thinking that.

Yeah, let me start with the second part of your question there on the exit. We've exited $170 million in 2021. So as we look into 2022, We think we will exit more of that in the second half of the year just based on the environment that we see today. So we think there's another piece. But as we've said, this exit will take, you know, three plus years to get out completely of that entire 10% to 15% that we said we'd exit. But we really think it's back and loaded.

Got it. Thanks for the color on that. And then, you know, the gross margin news, I think, is the news of the day, whether it was the court or the guide or the long-term model updates. So I just wanted to understand a little bit more deeply, what was the surprise? Were you guys just conservative back in August? It wasn't that long ago and you've already hit the target. So what's going better than expected? And I think some people might believe that there's some cyclical tailwinds that might not persist. I know you seem to disagree with that, but a breakdown of what surprised you and how much is structural will be helpful.

Yeah, this is Hassan. Look, We had a plan. The plan happened faster than we thought. Obviously, our plan was tied to a lot of the operational efficiencies and the self-help that we've done. We were able to pull in a lot of it, given the demand environment. We were able to much faster shift to our strategic products. As you saw, auto and industrial, which for us drive a higher margin as part of the mix shift, have grown sequentially and for the year and outpaced the growth of the other markets that we are walking away from to have that capacity to be able to allocate to our strategic markets. And of course, we've been on a trajectory of bridging the price-to-value discrepancies. We've been able to close a lot of that, mostly to offset our rise in costs. So all of these have been part of the plan, but the macro allowed us to accelerate them because of the demand environment, we're able to walk away from business and move the capacity to a better mix shift aligned with our stated strategy. So that's what accelerated. It's not about conservative. It's about the unknown and the disruptions that we've been seeing in 2021, but the team pulled together, whether it's from improved yield that drove more units. All of these are sustainable because the mix shift is not related to a market you know all markets are up but we are choosing what to support aligned with our long-term supply agreements and those extend beyond you know the next few years and that gives us the visibility and the sustainability of those results thank you your next question comes from a line of chris daly from city your line is open hey thanks guys congrats on another good result guidance um

I guess on the gross margin guidance going forward, it looks kind of flattish for the time being. Can you just talk about the puts and the takes? What's going to be pushing those up, and then also what's going to be keeping a lid on them? Is it the material cost or something else?

Yeah, Chris, it's that. There's a number of elements in there, and you kind of hit on it. So we are expecting additional input costs going up. We have been successful in passing those on to the customers, but we do expect that happening. As Hassan said in the previous response, we pulled down a lot of the acceleration of the gross margin initiatives. We think there's more here. I think our biggest challenge is we've gotten a lot of operational efficiencies here, and can we just get more throughput out of our manufacturing footprint? But, you know, we do see improvement. You know, if you look at the guidance that I put out for the year, you know, you see improvement through the year. And obviously with our long-term model of the 48 to 50, we don't think we're done.

And for my follow-up, can you just be a little more specific on the impact and timing of the fish kill fab from, I guess, a margin impact and a capacity impact as well?

Yeah, so we take ownership in early 23s. At that time, we have been running production in there. We'll continue to increase production in there. And then there is a period of time where we continue to ramp up and Global Foundries ramps down. So during that time, there's a little bit of a headwind as we're providing some foundry services to Global Foundries until we ramp up. So you can think about a little bit of a headwind for a couple years there. But there is an orderly transition between the two of them. So that is all baked into our...

to our long-term plan as well, the long-term model. Got it. Thanks, guys.

Your next question comes from a line of Vivek Arya from Bank of America Securities. Your line is open.

Thanks for taking my question. Hassan, I'm curious, what's your visibility of inventory of semiconductor components at auto OEMs and tier ones? Just from an industry perspective, there still seems to be a delta between auto production and semiconductor industry shipments. Is that all a mix or pricing? Just conceptually, what are you seeing out there and what is the right way to think about the sustainable content delta when we look at the automotive production improving this year?

Yeah, look, the delta is pretty straightforward. The delta between units shipped in automotive and semiconductor is purely based on the mix that our customers are building. You know, when we've been throughout 2021 in a supply constraint, we remain in that same supply constraint through 2022 into 2023. So therefore, our customers are doing kind of what we're doing. They're moving production to their strategic supply and high value product line, which for semiconductor translate into more content. You know, when you have premium vehicles being built, they historically, and even today, have much higher content to the level of two to three times more content of semiconductors per vehicle. That's what you see the discrepancy between the two. That's a healthy discrepancy because, you know, I've always talked about content being the biggest driver for us, regardless of what the SAR does. 2021 is exactly that. Now, you can talk about what the long-term implications of this. I don't see that being any different. We've always guided automotive being much higher than SAR, and that's related because electrification is happening. You've seen those announcements from a lot of the OEMs where they are doubling down on EVs. That drives much higher content for us in the future than even it is today. Safety, I talked about more and more sensing going into vehicles, and that drives a lot of our cross-selling as well between our sensing and our PMICs. So all of these are driving a higher growth of semiconductor than your unit growth with SAR. So it's very reasonable of what the results are this year and what we're looking at for 2022. So I don't see that as just a short-term thing. because the macro trends extend beyond the next three years.

Got it. And Hassan, for my follow-up, also interested in your views on the silicon carbide opportunity. So you gave us a few numbers about the exit run rate and the long-term agreements you were signing. And where I think investors are trying to get their arms around is we hear of a lot of big numbers and pipeline from some of your U.S. competitors. you know, some of the European competitors. Is this a case of just a rising tide? So there can be four, five, six, you know, successful suppliers? You know, is there going to be, you know, some kind of, you know, differentiation between suppliers? Because everyone is reporting very, you know, large pipelines. So I'm curious, what is ON's differentiation? And does it change your long-term You know capex forecast because I saw that you updated the margin forecast, but you kept free cash flow Forecast the same.

Thank you So let me just I want to highlight some difference between what I talk about and what some of my peers talk about I didn't I don't talk about Funnel or pipeline I'm talking about committed revenue, which is the output of the funnel fully yielded committed revenue is what I labeled it that is more certain and more visibility than then you know the game of big numbers of funnel uh disclosures i don't i don't disclose funnel or pipeline or whatever we want to label it so the comments and the numbers the big numbers i gave are committed revenue under ltsas that we are building our supply chain in order to service uh starting at you know we exited uh 2021 and said we're going to be more than doubling in uh That's where the committed revenue comes in. Now, as far as what that's going to look like in the industry, look, there's a lot of demand out there, a lot of investments from our customers going into the silicon carbide for electric vehicles. Is it going to be six players or so? I don't know. I know we're going to be in the top based on our investment and based on the results of our technology performance. on efficiency, but also, more importantly, the supply assurance that we're able to give our customers. When you want to double the revenue and your flagship customers are depending on you, having supply assurance and controlling bulls all the way to wafers is a competitive advantage, and not a lot can claim that. And I'm happy that we have closed the GTAT and we're performing very well. We're going to be expanding the GTAT capability throughout 2022 in order to support those committed revenues that I mentioned. Thank you.

Your next question comes from a line of Toshiya Hari from Goldman Sachs. Your line is open.

Hi, good morning. Thank you for taking the question and congrats on the strong results. I had two as well. Curious how you're thinking about full year 22 revenue growth at this point. I think three months ago, You had guided us to think about 22 as a year where you guys undergrow the market, just given, you know, some of the dynamics that are ongoing from a portfolio optimization standpoint. Is that still the case? And I ask the question because you guys talked about, you know, obviously the strong design wind funnel, the improving supply backdrop. And if we take the midpoint of your Q1 guidance, you know, Q1 revenue is going to be up 28%. So curious how you're thinking about the full year.

Yeah, Toshi, you know, we don't guide for the full year. I'll give you a little bit of a framework to work on, though. You know, one of the previous calls or answers, questions was around the exit into business that I said would be back half loaded. I think when we look at the full year, you know, taking that into consideration, we're probably growing around market, maybe slightly above.

Got it. That's helpful. And then as my follow-up on that last point said, the 500 million or so in revenue that you'll be exiting, I guess, over the next couple of years, how should we think about the gross margin profile on that part of the business? I think the 170 that you've already exited, you talked about a 20% gross margin profile. Should we be thinking about a higher gross margin profile given the strong market backdrop? Thanks.

Yeah, it is today. You know, last quarter we talked about the $100 million that we exited. It was at 15%. Now that's up to $170 at a combined gross margin of 20%. So if you think about that incremental 70%, you know, it's about a 25% gross margin today. So the next piece that we're going to walk away from is, you know, in that range, the slightly higher, but the challenge is when the market comes back, that's the margin that's going to drop fast if we continue to maintain that. So as we exit that, we'll swap that out for more creative margins. But today, yeah, it's slightly ahead of or slightly above that 25% that I just talked about.

Got it. Thank you.

Your next question comes from a line of Matt Ramsey from Cowan. Your line is open.

Hey, guys. This is Josh Buckhalter on behalf of Matt. Thanks for taking my question, and congrats on the results. In the prepared remarks, you gave some helpful color on the unit growth. I was wondering, as we think about the margins, is there anything you can give us that helps us understand how much is being lifted by pricing versus the mix shifts that you previously outlined? And when I asked for pricing, I mean for the overall market. Thank you.

Yeah, so in our prepared remarks, we really kind of broke it down into favorable mix, pricing and manufacturing optimization in terms of just getting more out and increasing our capacity to reduce our manufacturing costs. That's really the Pareto, if you think about the sequence of what is driving the gross margin improvement, and that's what we continue to see as we go forward. We think the favorable mix is we swap out of this low margin, non-core business. We focus more on auto and industrial, which drives a higher gross margin. That's the primary driver of gross margin expansion, and obviously the manufacturing footprint going forward will be the next piece.

That's helpful. Thank you. And then within your silicon carbide business, the size of your design winds continue to come in very strong. I was wondering, within your broader high-voltage portfolio, are you also seeing share gains in your IGBTs, which have typically been dominated by some of your peers over in Europe and Asia? Thank you.

Yeah, this is Hassan. The answer is yes. We are seeing an uptick. Obviously, the LTSA is a long-term supply agreement that I mentioned focusing on silicon carbide. We do have long-term supply agreements for IGBT. Those are net increases from our baseline. Therefore, I would consider those share gains away from some of our peers that have dominated that market. So we do see the uptick in both in our LTSAs. So you can think about it as ramping as well over the next few years into those LTSAs.

Thanks, guys.

Congrats again.

Your next question comes from a line of Hirsh Kumar from Piper Sandler. Your line is open.

Hey, guys. First of all, congratulations on a very stunning turnaround. Hassan, you've gotten pretty deep into the silicon carbide market, making the acquisition of GTAC. I was curious, with now the emphasis on silicon carbide on for, call it, 69 months to a year, Have there been any surprises, whether good ones or bad ones? I'd be curious about your color on it.

Look, there have been surprises. I would say the surprises are on the positive side. You know, if you recall back in my first earnings, I was very bullish on the company's capabilities on silicon carbide, which I called a favorable surprise walking in the door. That remains. And I would say the positive surprises, number one, are capabilities into quickly getting to the 200 millimeter with the GTAT acquisition, closing the GTAT acquisition and solidifying our baseline as a, you know, full-on silicon carbide provider to our customers. And more importantly, a very competitive roadmap, not just of what we're providing today, but the customer's reaction to our roadmap conversations that we've had for the next five years or so. All of these have been very favorable. That gets me very bullish about our silicon carbide, and that's the reason, in all honesty, our strategy is to double down on it, both from a technology development side, and you heard me talk about the aggressive ramp that we've – we're doing in 2022 in order to support that doubling every year of our silicon carbide revenue, starting with the quadrupling of the GTAT capabilities exiting 2022. All of these are, I would say, positive developments. This is where our investment is coming in, and I remain very bullish on our capabilities and the outlook of our silicon carbide business.

Um, great. Thanks Hassan. And then as you look at some of the changes you guys have made structurally to the, to, to the on business, you know, getting into Silicon car, by getting into focusing on some new areas that are high growth, how should we think not the near term of the midterm, but the longer term growth rate of the company? How should we think about that as maybe, you know, uh, industry growth rate plus X percentage, what would that number be?

We're talking about, you know, you can think about it over the long term, about 2x of the industry given the content gains that we're getting, but also being, you know, over the next few years, moving more and more towards the megatrends that are driving the content, you know, like EVs and ADAS. All of these are going to drive our 2x market growth over, you know, the longer term as we exit some of those businesses that Thad just talked about. But more importantly, it's not just the EV. There's a lot more also investment and content growth in the alternative energy business where I talked about, you know, we are seeing 50% growth in 22. That's going to remain over a multi-year period. All of those are net revenue increases for us because they're new markets. So that's going to keep fueling that growth. So you can see it both on the automotive and industrial and, of course, the cloud business where that investment is going to keep going So all of these are going to fuel our growth because of our exposure to those megatrends.

Thanks, guys. Congratulations again.

Your next question comes from a line of Vijay Rakesh from Mizuho. Your line is open.

Yeah, hi, Hassan. Great quote on solid margins. Just a quick question on the silicon carbide side. I know you mentioned... 2.6 billion in basically committed revenue. Just wondering what should be the contribution for 2022 from that? I know you said a billion a year, but is that what would be incremental to 2022? And if you can give some margin profile on that business as well. Thanks.

Yeah, so I'm not guiding the silicon carbide in 22 other than saying it's going to more than double from the 2021 as we ramp the existing customers we have in 2021 plus layering on top of that the LTSAs that start in 2022 and go through 2024. So we have a multi-year visibility on our silicon carbide LTSAs that will get us to exiting 23 with the billion dollar run rate. That foundation is ramping. We have started ramping. We'll be ramping heavily in the second half of 22, and that's for the full year. It will be more than 2x what it was in 2021. For margin profile, obviously that margin profile, as we ramp into our CapEx expansion, is going to be accretive. Today, obviously, there's the ramp-up cost. And I just want to make sure that you guys understand our margin profile and our margin guide is fully loaded, meaning it includes all of our startup costs for silicon carbide. So that gives you kind of the accretive nature of our silicon carbide over a long time.

Yeah, just to be clear, so in the short term, the silicon carbide ramp is diluted to margins because we have the startup costs. But over the long term, it is accretive to our corporate average.

Got it. And just on the GTAT side, obviously, very good to see you guys are pivoting to that. Obviously, EV and silicon carbide are huge markets. And you're quadrupling the capacity there. But can you give us some color on how that translates, the quadrupling of silicon carbide capacity, how that translates to your silicon carbide wafer capacity, or how much of your revenue will be addressed internally with that quadrupling? Thanks.

That's it. Yeah, our intent to have a majority of our demand supported by our internal capability. Obviously, we have outside sources that we are able to flex capacity during bumps in ramp. But if you think about the quadrupling of our output from GTAD by the end of 22, you can think about it as putting that infrastructure for the supply over the next few years. You know, I talked about more than doubling in 22. We're going to double again from that by in 23. As I mentioned in my prepared remarks this quarter and last quarter, that's what's going to be supported by the GTAT. But today, we do have still a mix, but as we ramp up the GTAT capability and really the capacity expansion I talked about is moving more and more of our substrate internal.

Got it. Thank you. Your next question comes from a line of Chris Caso from Raymond James. Your line is open.

Yes, thank you. Good morning. Just a question on pricing and what's been happening there. And I guess there's two elements of pricing. You know, ASP increases because of the makeshift and then, you know, pricing on individual products. Can you speak about how much of a tailwind that's been and where you see that's going as you go into 2022?

Yeah, so if you look at 2022, it's going to be a majority of a mixed shift. Most of the price or cost increases that we're incurring, we're absorbing through yield improvement or operational efficiency. So that's going to be minimal. But the primary driver is going to be a mixed shift. based on really the new baseline that we've achieved exiting Q4. That new mix shift is going to keep and maintain the margin profile that we have on our product. And of course, it's going to keep sustaining based on that mix shift we're going to be shipping, given the profile we know already in 2022 being fully booked. So that on the gross margin, you know, the value price to value discrepancies we've seen A couple of points I'll make. In the strategic markets, that is sustainable. That's the value of our products that we have in the baseline today. The only, I guess, pricing actions that will not be sustainable is in that non-core business that Sat talked about that will be exiting as the supply comes online from some of our peers. We're not going to chase that price down. Today, it's more favorable than it has been historically. Still dilutive, but more favorable today. But we don't plan on maintaining that business. We'll be exiting that. So that price, that portion of that business where price, I don't see that as being sustainable, is not going to be a drag on margin because we plan on exiting. And that's all part of the guide that Tad talked about. Everything that remains with our profile and our mix shift is what I would call sustainable profile. And that's where we can expect our forward-looking mix to be.

Got it. Helpful.

Thank you. So for a follow-up question, if you could give us some numbers around the Belgium FAB sale, what's the cost and margin impact on that over time? And when do some of those benefits start layering in?

Yeah, so we won't, this is FAB, we won't see the benefit until we fully exit the FAB. So as I said, it'll take one to three years. When we're totally out of that FAB, you can think about about $25 million annualized fixed cost coming off the company. In the short term, when the buyer takes over that FAB, we'll basically be paying the equivalent cost of what we have today, but as we exit, you'll see a benefit over that time period.

Got it. Thank you.

Your next question comes from the line of John Pitzer from Credit Suisse. Your line is open.

Yeah, good morning, guys. Thanks for letting me ask questions. Congratulations on the solid results. Just going back to Channel inventory, you said it's back to six to eight weeks after kind of a pop on linearity at the end of the fourth quarter. Can you help us understand what's a normalized level that you guys are thinking about and how long it might take to get back to that normalized level?

Yeah, so today we think about normalized level as kind of being in that six to seven week range given the supply constraints. As you know, we're holding inventory on our balance sheet rather than shipping channel. We're making sure that this inventory is going to our strategic customers. We're allocating it appropriately, whether it's through the channel or whether it's direct. By holding that inventory, we can control where it goes. So in the short term, I think we popped up to 7.3 from 6.8. I think that's kind of the normal range of what we're going to be looking at probably for the remainder of this year. I think when you look further out there, we're probably looking something around 10 you know, kind of shakes out and when we would do that. But I think for the foreseeable future, it's six to seven weeks.

Got it. And then I also thought I heard you say that unit volumes drove most of the sequential growth in the December quarter. One, is that true? And if it is, I'm just kind of curious if you can help us walk through kind of the incremental margin leverage and what drove that successfully. Because by my math, The exiting of the businesses only gave you about 70 bps. It sounds like most of it was unit driven. I know that utilization was up. Can you just help me kind of square that circle a little bit?

Yeah, so revenue was up 6%. Units were up 5.7%. So you're right. So the top end revenue came from additional units being shipped primarily. And then obviously a mix shift in the higher margin. So when you think about the gross margin improvement sequentially, it is more favorable shift into the strategic markets. We did get operational efficiencies, which is reducing our manufacturing costs as well. And then, as I said, there's a slight pricing increase as well that we're seeing kind of in the market as we're passing on additional costs to our customers that we've been seeing.

John, if you can think about it, the auto and industrial, where that was a recipient of the mix shift that we have from the non-core, the business that we exited, that also drives just a higher ASP also, just because of the market mix. And that's why we favor those markets from a strategy perspective. So it's a unit at a higher ASP.

That's helpful. And then if I could just sneak one in on the silicon carbide market, when you talk about longer term, this being a creative to your model, I'm just kind of curious, how are you thinking about kind of the global capacity for silicon carbide wafers versus kind of the incremental value add that your IP can bring to bear? You know, to what extent are you going to be sort of a prisoner to global supply demand where we have to figure out kind of a CapEx model and to what extent are you not going to be prisoner to that because you bring something unique to the table?

Yeah, look, I've always said that nobody wins because you have material. Nobody wins because you have supply assurance, which makes everybody comfortable and competitive advantages. But what you win is the efficiency of your products. That's how customers look at it. Nobody's going to take an inferior product for a flagship EV that they're ramping just because you have supply. But they will select the supplier, which they have selected us because of our product performance, our roadmap, and they will get more comfortable and more bullish just like I am when we have the supply assurance to support their ramp. That's what's going to be kind of the landscape moving forward. So having our supply and the assurance of supply and really controlling our fate with the substrate through the GTAT acquisition that we closed gives us that baseline that we are able to ramp from But we remain winning based on efficiency of our products and the aggressiveness of our roadmap.

Thanks, guys.

Your next question comes from the line of Christopher Roland from Susquehanna. Your line is open.

Thanks, guys. Congrats and congrats on that gross margin guide in particular. I guess my first question for either of you guys, the LTSAs, I think I missed maybe some of the details there, but if you could describe kind of what percentage of revenue falls under LTSAs today and then looking out to 2025. I mean, we know what you guys did with LTSAs at Cypress, but what are your plans for what percentage of revenue by call at 2025 might be under LTSA?

Yeah, look, I'm not giving percent covered in LTSA. I can tell you in 2022 we're sold out. We're fully booked. Anything incremental we get is going to come from efficiency that we get through the year in units that we're able to ship. So 2022, that's how you can think about it. 2023, our LTSAs that I keep referring to extend through 2024. Our focus on LTSA is on strategic, and obviously there's always the net loss that we're talking about, the 10% to 15% that we're – obviously that's not under LTSA. We're going to be replacing that with an aggressive new product ramp. So I'm not talking about percent under LTSA, but I can tell you the visibility is higher than it's ever been in the company, and it extends much beyond 2022.

Thanks, Hassan. And then for my second question, the exited business that you guys did, you said $170 million at 20% gross margin. I was wondering how much of that might be left. And then secondly, if a downturn were to occur and you guys needed to still fill your fabs, could you re-engage successfully with those accounts or do you think that ship has sailed?

No, look, I'll answer the second part because that's an important pillar of the strategy. The answer is we're not going to chase after it because think about it this way. If there is a market downturn, that business is highly dilutive. I mean, you can think about the 15% to 25% margin today. That's in a favorable pricing environment. So you can imagine in a down market, that revenue or that margin is way worse than it is now at that 20%. So the answer is we're not going to chase after it. Strategically, we are walking away from it regardless of what the market does. What we are doing in the meantime to make sure that is our manufacturing optimization is as we're exiting those, we are resizing our manufacturing footprint in order to prevent underloading that historically has plagued the company. So that's going to give us that sustainable margin that we are delivering. So even in a downturn, we're not going to get the drag from gross margin because of mix. We're going to be in a favorable mix regardless of what the market does from a margin perspective. And we are working on our manufacturing optimization, like I talked about with the Belgian fab, and then ramping of the East Fishkill, where we have scale fab through our fab lighter strategy in order to sustain that and prevent underloads. So we're not going to run after bad business no matter what the market does. That's strategically our direction.

Thanks, Hasan.

Your next question comes from a line of William Steen from Truist Securities. Your line is open.

Great. Thanks for taking my question. I'll add my congratulations on the great results and outlook. I'm wondering if you can dig a little bit more into the LTSAs, just to ask about But specifically, do these look like sort of committed volume where specific orders are allocated as the demand becomes more clear? In other words, sort of just volume commitments? Or are these more like hard purchase orders placed in sort of a blanket fashion?

So I'll answer that. If I understood the question correctly, the LTSAs are committed both volume and pricing. That gives us the visibility, and they're committed on mix. So it's not a blanket LTSA of some revenue number. It is associated to a mix because that's what we're using in order to decide on where to expand our capacity, which is purely on our strategic products. What we don't want is just a blanket, you know, capacity expansion. in good or bad days. So we're focusing our capacity expansion on where the LTSAs are. And again, the LTSAs go down in volume, price, and mix. It's the best visibility we have. And like I said, it extends over a multi-year period because capacity we're putting in today is really impacting 23 and 24. 22 is kind of, it is what it is. And that's why I say it's fully committed year as far as mix and volume. plus some of the efficiencies that I talk about we'll get throughout the year.

That helps. And then just a clarification on that last point as well. It sounds like lead times are beyond 52 weeks at this point. Is that correct? Have they extended further during the quarter? And maybe a similar question around backlog. Has that grown in the last 90 days?

Yeah, well, it's that the lead times are very consistent. They're right around 45 weeks plus or minus consistent with what we've seen in the past couple quarters. So no major change on that. You know, backlog continues to be very strong. It's outpacing supply. You know, this is purely a supply game right now in terms of just catching up with demand.

And just to clarify my comment that anything now is for 2023 is more on the capex, not on really supply and demand. Meaning, installing CAPEX 222 will really impact your capacity expansion in 23.

Thank you.

Your next question comes from the line of Harlan Suhr from JP Morgan. Your line is open.

Morning. Congratulations on the solid results and execution. Good to see the sale of the Belgium tab. I know it's going to take a few years to see the benefits of this. I believe that you guys had targeted total fixed cost reductions from smaller FAB exits to drive about 125, 150 million of fixed costs over the next few years. Is most of this fixed cost reduction still ahead of the team? And have you been able to actually find more opportunities for fixed cost reduction?

Yeah, Harlan, it's that. That number is still the targeted number that we're going after. As I said earlier, you know, Belgium is roughly about $25 million of that fixed cost. So you can see we've got a lot ahead of us. We're not done with the FAB divestitures. You know, we laid out that plan, that FAB lighter plan, and we're still executing to that plan.

Great. Thanks for that. And then... Intelligent sensing on a 4Q and full year basis, I mean, very strong year-over-year growth, but still quite a bit lower than your auto industrial segments combined. In fact, I think ISG growth was almost 2X lower versus PSG in your auto and industrial segments combined in Q4. Yet, we know the demand in content expansion is just as strong as your power business. So, you outsource a big part of ISG. What's the visibility on when capacity situation starts to improve meaningfully from your foundry partners? And is this motivating the team to actually accelerate its insourcing efforts here?

Look, we are, so you're absolutely right. It's not, this is purely a supply constrained environment for dissenting given the higher percent of external manufacturing. So we remain focused on working with our outside foundry partners We were able to get more supply in the fourth quarter. That's what drove kind of the results. And we're working continuously in order to secure more and more supply for 2022. So that's kind of where that business comes in. You're right. It's not a demand. It's more of a supply.

And our focus about the mix internal and external remains on track.

Thank you.

Your next question comes from the line of Tor Zvanberg from Stiefel. Your line is open.

Yes, thank you, and congratulations on the record results. Could you elaborate a little bit on the inventory in the channel? I think you said it went up to 7.3, but I think you also said in this quarter it came back down. So is that mainly because sell-through actually got better again this quarter, or did you take an opportunity to perhaps hold a little bit more inventory? Just wanted some clarification there, please.

The inventory in the channel went up to 7.3 weeks from 6.8 weeks in Q3. It was purely a result of timing of shipments late in the quarter in Q4. Sell-through in the channel remains very robust. It's not necessarily that it's cranked up here in Q1. It was just purely a timing of delivery and when we got supply and be able to get it into the channel. It's already returned back into that 6.8 weeks level and as I was saying earlier, we going forward will maintain kind of the six to seven weeks range for the foreseeable future.

Understood. Thank you for that. And the $650 million run rate for CapEx, how much of that is kind of going to fund regular CapEx versus the additional investments you're having now in $300 million and the silicon carbon capacity?

The vast majority of it going to silicon carbide and to capex for each fish skill the 300 millimeter that build out there is the rest of it I would consider more maintenance capex my helpful come back again your next question comes from the line of Raji Gill from Needham and company your line is open yes thank you and congrats as well

you might have touched upon this before but if i look at the you know percentage of revenue uh coming from auto industrial it's now you know 63 so so x those markets the other markets are represent 37 of sales um last year um the other markets were representing about 42 percent um so you see your your non kind of core markets are going down from 42% to 37%, 38% as you ramp auto industrial. When we're thinking about this 48% to 50% gross margin long term, can you give us a sense, number one, in terms of what percentage of sales do we think auto industrial represent over time, and any sense in terms of the spread of the gross margins you know, between auto and industrial against, you know, the other segments?

Yes. You know, we stated in our analyst data that we expect over the next five years auto and industrial to become about 75% of our total revenue. So we're at 63%, so that gives you kind of our trajectory because it's also tied to our margin expansion as we move forward towards that 75%. You know, obviously the The mix or margin profile is more favorable from these markets because that's part of the trajectory that we have getting to that 48% to 50% is by being more and more exposed to the markets. But more importantly, it's the new products that we are ramping that are better margin profile. So it's a mixed shift for products, new products versus the run rate products. and a mixed shift to end markets, auto and industrial, becoming 75%. At the expense of other markets that have historically have had lower margin profile, so net-net, you get the margin expansion and the growth that we talked about. Now, I just want to highlight one thing. In the other bucket, other than auto and industrial, we do have a growth segment with favorable margin. And that's our cloud and 5G power play for that market. That market, we talked about it growing at 11% in our analyst day. So we see that also as a favorable mix from both product and market that drive an expansion of margin beyond where we are today. So these are kind of the three big components you can think about driving the growth for the company moving forward and the remaining margin expansion that I talked about. Yeah, Raji, just let me expand on that a little bit as well.

The 37% has got some very favorable gross margin in there. It's not like it's all those low gross margins. So as we fast forward and we get 75% of our business in auto and industrial, the other 25% and other, it's still favorable margins, right? It's not low margin business. That's the part that we're exiting. But Hassan is right. As we flex more into auto industrial, that will be more accretive. You know, and obviously the 5G will be creative as well. But there is good high gross margin in our other bucket as well.

That's helpful. And to my follow-up, you know, your shift to a fab lighter manufacturing strategy is underway. You had mentioned in the past that you want to maintain your internal manufacturing footprint around 65%. and you'll achieve that through a lighter footprint by exiting smaller subscale facilities and moving to or expanding larger ones. With your new 48% to 50% gross margin target, how do we think about that component of the internal versus external manufacturing capacity?

Yeah, so today internally we manufacture roughly 65% of our own product. As we fast forward, we bring on East Fish Scale, the 300-millimeter FAP, We've said that we have the capabilities of expanding capacity by 1.3x what it is today. Now, we have the option there as we add capacity and add CapEx to be able to support that. But as we look further out, that model doesn't change. We still believe we'll manufacture 65% of our own product in-house because we'll get a cost benefit of it. It's really just exiting those subscale fabs, moving it into more efficient fabs, and obviously the 300-millimeter FAB is a component of that.

All right, great. Congrats again.

Thanks, Roger. This brings us to the end of our question-and-answer session. I turn the call back over to Hassan El-Khoury, President and CEO, for some closing remarks.

Thank you all for joining us today. I once again thank our worldwide teams for their hard work in accelerating our transformation and driving outstanding results over the last year. With the transformation of our business, we have built a strong engine to power our growth for many years to come. We have established leadership in the fastest growing semiconductor markets, such as vehicle electrification and ADAS, and we are enabling disruption in energy infrastructure and factory automation. We are driving growth while accelerating profitability and rapidly expanding margins. We expect to sustain this momentum with the ongoing transformational changes to our cost structure and the impending ramp of our EV business.

This concludes today's conference call. Thank you for your participation. You may now disconnect.