ON Semiconductor Corporation

Good evening. Welcome to the On 73rd Quarter 2023 Earnings Conference Call. At this time, all participants are on a listen-only mode. After the speaker's presentation, there will be a question and answer session. To ask a question during the session, you'll need to press star 1-1 on your telephone. You will then hear an automated message advising your hand is raised. To withdraw your question, please press star 1-1 again. Please be advised today's conference is being recorded. I would now like to hand the conference over to your speaker today, Parag Agarwal, Vice President of Investor Relations and Corporate Development. Please go ahead.

Thank you, Kevin. Good morning, and thank you for joining OnSummy's third quarter 2023 quarterly results conference call. I'm joined today by Hassan El Khoury, our president and CEO, and Thad Tren, our CFO. This call is being webcast on the investor relations section of our website at www.onsummy.com. A replay of this webcast, along with our 2023 third 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 is posted on the Investor Relations section of our website. Our earnings release and this presentation include certain non-GAAP financial measures. Reconciliation of these non-GAAP financial measures to the most directly comparable GAAP financial measures and a discussion of certain limitations when using non-GAAP financial measures 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 will make projections or other forward-looking statements regarding future events or future financial performance of the company. We wish to caution that such statements are subject to risk and uncertainties that could cause actual results or events to differ materially from projections. Important factors that can affect our business, including factors that could cause actual results to differ materially from our forward-looking statements, are described in our most recent Form 10-K, Form 10-Q, our other filings with Securities and Exchange Commission, and in our earnings list for the third 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, change assumptions, or other events that may occur except as required by law. Now, let me turn it over to Hasan. Hasan?

Thank you, Parag. Good morning, and thanks to everyone on the call for joining us. This morning, we are pleased to announce another quarter where we delivered revenue of $2.18 billion, non-GAAP gross margin of 47.3%, and non-GAAP earnings per share of $1.39, all exceeding the midpoint of our guidance. Our automotive and industrial segments achieved record revenue driven by demand in both silicon and silicon carbide. Despite these results, in the third quarter, we are taking a very cautious approach as we are starting to see pockets of softness with Tier 1 customers in Europe working through their inventory and increasing risk to automotive demand due to high interest rates. It has been nearly three years since the start of our transformation, and our worldwide employees have been relentless in their pursuit of operational excellence. The structural changes we have made across the company have allowed us to maintain our performance and deliver predictable financials. We have built the resilience required in our business to navigate a dynamic macro environment, and we remain focused on controlling what we can, our execution and our commitment to our customers. And silicon carbide has been a prime example of our execution. Our factories in Hudson, Rosnab, and Bouchon all had record output for silicon carbide in Q3. Acquiring GTAT two years ago was a strategic investment that allowed us to produce our own substrates internally and accelerate our path to becoming the world leader in silicon carbide power devices. By the end of 2023, we expect to have more than 25% market share of the silicon carbide market. We are now producing more than 50% of our own substrates internally, one quarter ahead of schedule, and we plan to continue to do so through 2024 even as we transition furnaces for 200-millimeter production. In fact, last week we announced that we completed our expansion of the world's largest silicon carbide fab in Bhutan. At full capacity, the state-of-the-art facility will be able to manufacture more than 1,200-millimeter silicon carbide wafers per year. Our manufacturing output continues to exceed expectations, and the acceleration of our ramp resulted in achieving a billion-dollar run rate quarter in Q3, increasing nearly 50% over Q2. However, for the full year, a single automotive OEM's recent reduction in demand will impact our billion-dollar target, and we now expect to ship more than $800 million of silicon carbide in 2023, 4X last year's revenue. In 2024, we expect the growth of our silicon carbide business to double the market growth. Over the past few quarters, we have accelerated the broad deployment of silicon carbide solutions, and the design activity has been robust across all regions. So far in 2023, we have shipped to more than 500 unique customers that will continue to ramp through 2024, further expanding our geographical customer distribution. Additionally, we have designed WINS and or LTSAs with the leading automotive players who have over 50% share of the global EV unit sales, which includes LTSAs with four of the top five China EV customers. NIO is among them, and in Q3, they made Ansami their prevailing silicon carbide supplier by signing an extension to their multi-year long-term supply agreement, doubling down on 1,200-volt Elite 6 technology as they transition into 800-volt battery solutions through 2030. As we navigate the current market conditions, LTSAs continue to provide demand visibility and stability in pricing. EV traction remains the fastest growing part of our SICK business, with 70% growth sequentially. Most recently, an OEM awarded OnSemi a platform for their 750-volt and 1,200-volt EV traction inverters, previously awarded to an incumbent. Opting for superior technology and a vertically integrated supply chain, This leading OEM has now signed an LTSA with Antec Semi through 2031, putting us in a position to support higher volume production. Energy infrastructure remained healthy in Q3, driven by the continued adoption of solar and energy storage solutions. We remain on track to our full-year projections with nearly 70% revenue growth over 2022, and we expect the growth to continue in 2024. as demand for our hybrid modules with silicon and silicon carbide solutions for this high-growth industrial megatrend remains strong. Our medical revenue, which is reported within our industrial end market, also remains healthy, driven by the improved accessibility of continuous glucose monitoring and hearing aids. We have deep, long-standing customer engagement in high-margin, high-growth areas of continuous glucose monitors and hearing health, where we have leading market share with our technologies. Our CGM business increased nearly 38% quarter over quarter, driven by a ramp from the top two leaders in the market. On Semi is number one in automotive image sensors and number one in industrial scanning. In the industrial end market, our design activity has already surpassed all of 2022. This is a good indicator for the business, given that more than 40% of our image sensing revenue comes from new products. Last month, we introduced another 8-megapixel image sensor with the world's smallest, lowest power family of HyperLux products that can extend battery life by up to 40% for industrial and commercial cameras. In fact, our 8-megapixel revenue more than doubled year over year in the third quarter as the business is shifting to higher resolution, higher ASP image sensors. And now, let me turn the call over to Thad to give you more details on our results. Thanks, Hassan.

At the start of our transformation, we committed to delivering intelligent power and sensing technologies for the sustainable ecosystem. This meant tailoring our investments, our portfolio, our manufacturing footprint, and our resources to focus on the high-growth megatrends in automotive and industrial, such as electric vehicles, ADAS, and energy infrastructure. This has become our winning formula, allowing us to deliver the greatest value for all our stakeholders. Combined, intelligent power and intelligent sensing now account for 72% of our business as compared to 68% in the quarter a year ago. In the third quarter, our financial results exceeded the midpoint of our guidance, demonstrating the resilience in our business in a challenging market environment. Revenue of $2.18 billion increased 4% sequentially and non-GAAP operating margin was 32.6%. Revenue from intelligent power and intelligent sensing combined increased 5% year-over-year. As for the end markets they serve, we had another quarter of record automotive revenue with nearly $1.2 billion in Q3, increasing 9% sequentially and 33% year-over-year, driven by silicon as well as silicon carbide as the need for electrification and advanced features in vehicles continues to rise. In industrial, our record revenue of $616 million increased 1% sequentially and was up lightly year over year with continued strength in energy infrastructure and medical. The rest of our businesses decreased 4% sequentially and 42% year over year as we exited $46 million of non-core business, which was below our expectations, and is highlighting the resiliency of this business and the value of our full portfolio delivers for these customers. As always, we'll continue to be opportunistic in these non-core markets where margins are favorable and engagements are strategic with our customers. Looking at the split between operating units, revenue for Power Solutions Group, or PSG, was $1.2 billion, an increase of 10% year-over-year, with more than 60% increase in auto, and 50% increase in energy infrastructure. Revenue for the Advanced Solutions Group, or ASG, was $622 million, a 15% decline over Q3-22, driven by deliberate exits and continued softness in non-core markets. Revenue for the Intelligent Sensing Group, or ISG, was $329 million, a 4% decrease year-over-year due to lower revenue in industrial applications. Our gap and non-gap gross margin of 47.3% was down 10 basis points sequentially and 200 basis points as compared to non-gap gross margin in Q3-22, primarily due to headwinds from our East Fishkill fab and factory utilization offset by strong manufacturing performance in silicon carbide. Total utilization increased slightly to 72%. As silicon carbide utilization improved, while silicon utilization trended lower as planned. For the next few quarters, we expect to proactively lower utilization to the mid to high 60% range while maintaining our gross margin above mid 40%. This is a direct result of our fab lighter strategy of divesting four fabs in 2022, which is reducing our fixed cost footprint while we continue to consolidate operations in larger, more efficient fabs. As we move to our FabRite strategy to optimize and drive efficiencies across our manufacturing network, we expect to generate incremental cost savings over the next few years. We continue to identify opportunities to drive operational efficiencies and remain committed to our long-term gross margin trajectory. Turning to silicon carbide, as Athan mentioned, our silicon carbide manufacturing output is exceeding our internal expectations. And thanks to the tremendous efforts of our team around the world, we have accelerated our gross and operating margin trajectory. Our Q3 gross margin for silicon carbide was greater than 40%, with strong fall through on a fully loaded basis, including all startup costs. And as we previously highlighted, we expect our silicon carbide business to be at the corporate gross margin in Q4. Further, the yield improvement learnings we are getting from our 150-millimeter wafer production ramp is increasing our confidence in our 200-millimeter capability and validating our strategy of driving cost savings through brownfield investments. This incredible execution and improved manufacturing output on 150 millimeters enables us to slow our capacity expansion and lower 2024 capital intensity from the high teens to the low teens percentage points ahead of our original plan and closing in on our long-term model. Now let me give you some additional numbers for your models. Gap operating expenses for the third quarter were $344 million as compared to $634 million in the third quarter of 2022. Non-gap operating expenses were $322 million as compared to $304 in the quarter a year ago. The increase in operating expenses is attributable to a reserve against a receivable balance with a manufacturing partner. Gap operating margin for the quarter was 31.5%, and non-gap operating margin was 32.6%. Our gap tax rate was 16.4%, and our non-gap tax rate was 15.6%. GAAP earnings per diluted share for the third quarter was $1.29 as compared to 70 cents in the quarter a year ago. Non-GAAP earnings per diluted share was near the high end of our guidance at $1.39 as compared to $1.45 in Q3 of 2022. Our GAAP diluted share count was 451 million shares and our non-GAAP diluted share count was 439 million shares. In Q3, we returned 75% of our free cash flow through $100 million of share repurchases, 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 $2.7 billion, and we had 1.1 billion undrawn on our revolver. Cash from operations was $567 million, and free cash flow was $134 million, or 6.1% of revenue. Capital expenditures during Q3 were $433 million, which equates to a capital intensity of 19.9%. As we indicated previously, we are directing a significant portion of our capital expenditures towards silicon carbide and enabling our 300-millimeter capabilities at ESK. Accounts receivable of $958 million increased by $14 million, and DSO was 40 days, down one day from the second quarter. Inventory increased by $120 million sequentially and days of inventory increased by three days to 166 days. This includes approximately 64 days of bridge inventory to support BAB transitions and the silicon carbide ramp. Excluding these strategic builds, our base inventory declined seven days quarter over quarter to 102 days. We continue to proactively manage distribution inventory DISTI inventory declined $25 million sequentially with weeks of inventory at 6.9 weeks versus 7.7 in Q2. Total debt remained flat at $3.5 billion and net leverage is 0.25x. As we look forward, I'd like to highlight that OnSemi today is a completely transformed company as compared to OnSemi Conductor of the past. The structural changes in our business model have eliminated the historical volatility in the margins and earnings of the company. We remain fully committed to delivering strong operational and financial performance for our shareholders in all market conditions. Now let me provide you the key elements of our non-GAAP guidance for the fourth quarter. A table detailing our GAAP and non-GAAP guidance is provided in the press release related to our third quarter results. Given the current macro environment, we are taking a cautious stance in our guidance. We anticipate Q4 revenue in the range of $1.95 billion to $2.05 billion. We expect a mid-single-digit decline in automotive, given the softness in Europe that Hassan described, with greater sequential declines in industrial and other end markets. We expect non-GAAP gross margin to be between 45.5% and 47.5%, primarily due to lower factory utilization and continued EFK headwinds. Our Q4 non-GAAP gross margin includes share-based compensation of $4.3 million. We expect our non-GAAP operating expenses of $300 million to $315 million, including share-based compensation of $28.5 million. We anticipate our non-GAAP other income to be a net benefit of $4 million with our interest income exceeding interest expense. This benefit is a result of the debt restructuring activities we completed over the last two years, reducing a historical drag on the P&L while effectively eliminating exposure to elevated rates going forward. We expect our non-GAAP tax rate to be in the range of 15.5% to 16.5%, and our non-GAAP diluted share count for the fourth quarter is expected to be approximately 438 million shares. This results in non-GAAP earnings per share to be in the range of $1.13 to $1.27. We expect capital expenditures of $425 to $465 million in brownfield investments, primarily in silicon carbide and EFK. On a final note, given the market uncertainty, we are taking a cautious approach as we exit 2023 and plan for 2024. We are taking proactive actions to set ourselves up for success and we remain focused on our execution. The structural changes we have brought to our business have already proven effective in these market conditions. We have been exiting volatile businesses, lowering utilization, managing channel inventory, controlling wafer starts, and we plan to continue to seek opportunities to improve our efficiencies as we navigate through the current market conditions. With that, I'd like to turn the call back over to Kevin to open up for Q&A.

Thank you. Ladies and gentlemen, if you have a question or a comment at this time, please press star 1 1 on your telephone. If your question has been answered or wish to move yourself from the queue, please press star 1 1 again. We'll pause for a moment while we compile our Q&A roster.

Our first question comes from Ross Seymour with Deutsche Bank.

Your line is open.

Hi, guys. Thanks for my ask a question. Hasan, I want to ask about two questions on the automotive side. The first one that you talked about, Europe being weaker, burning inventory. Can you give a little bit more color? Is that just Europe? Are you worried at all about that spreading to other regions and any more color? Is it just inventory? Is it true demand? Any details would be helpful.

Sure. So we see it in Europe. Obviously, there's a big concentration of, you know, I highlighted the tier ones, big concentration of tier ones in Europe. But I think it's driven by end demand coupled with, you know, we've always said there may be pockets of inventory that were being bled through normal demand. But having demand kind of start to soften because of the high interest rates is causing the burn, the inventory burn to last longer. So we've always said, you know, the LTSAs provide us a phone call. It sets us up very nicely to see it coming. So, therefore, we're taking a very proactive measure on, you know, setting ourselves up to be able to allow customers to burn while we maintain our inventory levels at their shelves, the disti, and on our balance sheet as well.

I guess as my follow-up, also within automotive, but on the SICK side specifically, you lowered the bar from a billion roughly to over 800 million. I think you mentioned one customer. I don't expect you to name that one customer. But again, is that inventory? Are you worried at all about any secular changes? Obviously, the EVs cost more on average than ICE vehicles. So some of the dynamics, I would assume, impacting Europe in general would impact the EV side. But Any sort of change in your secular belief on the silicon carbide side?

No, no change on the secular trend for EVs. You know, EVs are going to grow. They're going to grow for us in the fourth quarter as well. They're just not going to grow in the fourth quarter at the rate that we expected. And, of course, you know, we're all looking at the same headlines as far as EVs are concerned. I think EVs are a long-term growth opportunity. even with the backdrop of a lot of the headlines that we're seeing, customer designs have not slowed down. Conversions to EV platforms have not slowed down. You know, I take this as a temporary while, you know, a lot of the macro stuff gets worked out, whether it's the interest rates, which you called it, you know, the expenses associated with purchasing an EV to the costs, to the energy costs, All of that is just having an impact, but we do not change our long-term view of the opportunity we have in EV. And like I said, we're still going to grow in Q4, just not at the rate.

Thank you. One moment for our next question. Our next question comes from Vivek Arya with B of A Securities.

Your line is open.

Thanks for taking my question. Ahsan, can you help us with kind of the building blocks as we think about calendar 24, so silicon carbide, non-silicon carbide, and the exits that you're planning from the non-core areas? I just want to understand what the puts and takes are for those three building blocks so we can plan our models accordingly.

Yeah, silicon carbide, what we are looking at is silicon carbide in 24, basically growing about 2x the market. So it's still on track to the target that we've put out in Alice Day of growing 2x the market. We still have that visibility in 24. On the silicon side, We see it, you know, flat slightly down. Again, depending on what you believe the market, we are not planning nor are we looking at a first half of 24 recovery. You know, as I said on the last quarter, we see 24 as kind of going sideways with growth in silicon carbide for us. As far as the exits, by the end of this year, whatever we didn't exit is going to stay with us as a business. So we are not going to see us talking about the exits on the legacy business any longer in 2024. I put that all into the silicon outlook that I put out there.

I see. So if I put it all together and look at the growth in silicon carbide and sort of the flattish plus minus in other areas, is it unreasonable to expect ON's overall sales to grow next year? And if they do grow next year, how do you kind of align the gross margin? Can gross margins kind of hang on to these Q4 levels or are there other utilization or other things planned that can take gross margins down? So both kind of conceptually Can sales grow even if it's modest, and then can gross margins kind of continue at these Q4-type levels?

Hey, Vivek, it's Thad. As you know, we guide one quarter at a time. I think given the macro uncertainty, we're not going to try and forecast 2024 at this point. We feel really good about our pipeline, our design pipeline, and our LTSAs at this point, but I think it's too early to provide guidance on 2024.

Thank you. One moment for our next question. Our next question comes from Chris Dainley with Citi.

Your line is open.

Hey, thanks, gang. So another question on silicon carbide. Can you tell us how much of the weakness in Q4 is silicon carbide versus, I guess, just regular semis? And then you say that you still expect silicon carbide to grow 2x the market. in 2024, has your silicon carbide, I guess, market expectations, have those moved downward over the last three months for 24?

No. So I would say majority of the weakness in Q4 is the silicon carbide, obviously. But, you know, the rest of the business came, it's kind of exactly where we expected it at the end of the year. As far as the outlook and the silicon carbide market in general or the EV market in general, it really has not changed our outlook. Our investments that we have been putting and even the investments we announced in Bhutan are not investments for 23 or 24. Those are long-term investments, and that adds to the confidence we have in that market being a megatrend market for us, and that's what we're investing in. to gain that leadership in that market as it evolves. So no change in the outlook and the strategy.

Great. And then for my follow-up, I know you're not commenting on next year, but I think you said your gross margin should hold mid-40s. So if we look at your peers that have started to see the downturn, they're generally forecasting like three-quarters in a row of declining sales. If you guys do have Q1, Q2 revenue down sequentially like your peers that are feeling this, can you still hold gross margins in the mid-40s, or would you have to lower utilization rates further? Or I guess would that depend on just how much is silicon carbide versus how much is semis?

Yeah, so right now we're looking at taking our utilization down to that, over the next several quarters, down into that mid to high 60% range. And as I said, we still expect to be able to hold that 40%, that mid-40% gross margin floor there. This is really a result of all the structural changes that we've made inside the company, reducing that manufacturing footprint, and really now focused on fab right, where we're getting optimized costs out of our existing footprint. But look, we're being cautious for the next several quarters. We'll take that utilization down, but we do believe we can hold that floor of mid-40. Got it. Thanks, Seth. Thanks, guys.

One moment for our next question. Our next question comes from harsh Kumar with Piper Sandler.

Your line is open.

Yeah. Hey guys. Um, I guess it's been a while since you guys have seen a revenue decline on a sequential basis. There's a, there's a lot of things going on in the marketplace to strike the China economy. You've talked about a European, I guess it'd be curious if you could give us a sense of magnitude. You don't have to give us numbers obviously, but just some color on, you know, what are some of the bigger factors and what are some of the smaller factors? And I do have one more. Thanks. Sure.

I mean, at a high level, it's end demand, if you think about it. And end demand is driven by, you can call it two things. One is the financial, which is the higher interest rates that have been with us. And now they're taking a toll on end demand. But also, in all honesty, the uncertainty, the macro uncertainty that as consumers, people are starting to feel. Between these two, we look at it, and we look at the inventory levels across the board. We look at inventory levels internally that we have, and you've always seen us operating with a very proactive approach. So our decisions and our outlook is driven by that cautious outlook on what we can't control, which is our execution. You know, Thad talked about taking our utilization down because we don't want to, you know, bridge it by keep building inventory. you've seen us take down a lot more on the channel, which sets us up very nicely should that turn the other way. So all of these are proactive decisions that we have taken in the short term, but set us up much better in the long run.

Got it. Thank you. So it sounds like it's pretty broad. And I'm I did miss, I think Ross asked earlier about silicon carbide, if it's one customer driven. I did miss that in the commentary. Could you just confirm if it's mostly one customer driven? Are you seeing kind of broad-based weakness in answer to my earlier question? Is that broad-based weakness also prevalent in EVs overall with other guys? And is this also tied to European commentary, the EV side and the European? Are they one and the same problem?

Look, I think from an automotive, I would say it's a broader stroke as far as the inventory comment I made specifically with tier ones in Europe. As far as the EV, yes, it is a single customer. I wouldn't say it is broad as far as in this immediate quarter. but we still expect it to grow in Q4. So I don't want to paint it as any decline or any issue in demand for EVs. EV demand is going to grow. It's going to grow in the fourth quarter, and it's going to grow in 2024. It just didn't grow as much as we expected it to, and that's demand-driven. Whether it's short-term demand or anything different, we'll have to wait until we get closer to 2024.

All right, guys. Thank you so much.

Just to be clear, on the silicon carbide, the expectation of being over $800 million, the impact there is one customer. It's the recent demand softness of one customer.

Thank you so much, Todd.

One moment for our next question.

Our next question comes from Gary Mobley with Wells Fargo Securities. Your line is open.

Hey, guys. Thanks for taking my question. Hassan, I want to pin you down on your market forecast for silicon carbide for next year to really get an insight into what your expectations are. I know you cited in your footnotes of your presentation today a lot of YOL forecast and YOL's forecasting roughly 43% growth in silicon carbide for next year. So are you expecting to grow? your silicon carbide revenue 80% next year. Is that the proper read here?

Well, it depends on what the, but yeah, we're expecting a 2x market. Okay.

And with respect to distribution inventory, you've been running your distribution inventory below the long-term targets purposefully, I read here. What are the triggers and dashboard metrics that you're looking at before you start to take up that distribution inventory back up to a normal level? Is it just as simple as seeing better sell-through?

It's more, yeah, it's seeing sell-through in the mix that we're expecting. So we have, you know, there's no one KPI. Thad and I look at about, you know, 30 pages of KPIs that try to triangulate the health of the business. and the sell-through. Because what we don't want is shipping into the distribution because there's demand or there's backlog, but the sell-through happens at a different mix. So you end up with what we call sludge in the channel. We've been managing this very, very tightly. We have a very robust process that gets us and has maintained very tight control over the distribution inventory. And like that said, Last quarter in Q3, we actually reduced the dollars and the weeks, putting ourselves up very nicely for a Q4 mixed shift or even getting ready for 2024. So all of these KPIs are what lead us to making these decisions. So we're going to look at our metrics and make the decision as we see it.

Yeah, I would add that we've been managing that inventory in the seven to eight week range for several quarters now. I think we're going to stay in that range just given the uncertainty until we see the strong sell through. But we're cautiously optimistic on that as we think about it. But I think for the foreseeable future, you're going to see us in that seven to eight week. You're not going to see us bouncing back up to historical levels the company ran at several years ago.

Thanks, guys. One moment for our next question.

Our next question comes from Joshua with TD Cal and your line is open.

Hey guys, thanks for taking my question. I wanted to follow up on one of Gary's. So I totally understand the near term dynamic where your customer concentrated in ramping silicon carbide, but I'm a bit surprised to see that 24 guidance pegged to market growth given I think the overwhelming consensus is that silicon carbide is going to be constrained for at least for the near term. Can you walk through how much, I guess, of your silicon carbide revenue in 24 is really program specific and how fungible supply is if there is changes in mix across your end customers?

Thank you. Sure.

So it is all, I guess, all of our 24. By now, for the 24, we have visibility on exactly what program, what voltage, what volume, and what mix we need. As far as the inventory, you know, if that talks about ramping strategic inventory for silicon carbide, we stage inventory primarily in, I would say, in two spots. One is blank wafers or substrate, wafer substrate, which is fully fungible across any customer, any platform with any volume. And as we get closer, we stage inventory at EPI, which is when we – I guess partitioned with the voltage levels of the product. So this is where we maintain inventory to give us full flexibility should the shift change. Because, you know, we've always said when we would have one or two platforms at a customer, if one vehicle sells better than the other, the customer would want to shift while still using on-semi. So we give that flexibility to be able to shift between platforms that is similar OEM or between OEMs. So the best place to keep that inventory is in blank wafers and or epi.

So is it safe to assume that TIC's going to remain constrained through 24? Yeah, I believe so. It will be from our side. Got it. Thank you.

For my follow-up, you know, you've called out bridge inventory to support the FAB transitions and silicon carbide ramps. With days above 160, can you walk us through how this unwinds? Basically, I just want to make sure that as your peers are cutting inventory levels at their end customers, that that won't become an issue as you complete some of the FAB transitions and SICK ramps more fully. Thank you.

Yeah, so strategic inventory for FAB transition usually are committed backlog. We call it no change, no return. So we build the bridge inventory given that the customer needs that bridge between the old fab and the new fab. So we see this as a very low risk. It will work itself down over a few quarters as we shut down the old fab. And before we start on the new fab, we will bleed inventory to a level, and then we'll ramp it back up in the other fab. So we don't see this as inventory jeopardy, which which allows us to be a little bit more comfortable with the elevated levels of inventory. But one thing also Thad mentioned is the base inventory, actually we drove that down, which is the one that you're more referring to would be at risk of demand. That's the one we've been managing down. That's the one we'll keep managing down with the lower utilization that Thad talked about.

Yeah, and just to be clear, the FAB transitions, the inventory for the FAB transitions is primarily for the divested FABs that we've divested over the last year. So it takes, you know, three plus years to fully transition out of a FAB. And in those situations, you build inventory and you bleed it off over time. But as Ahsan said, we've got good visibility on that in a lot of cases that's in CNR with those customers over a longer period of time. But it takes time. What we focus on is that base inventory, and we feel good that we're driving that down, you know, as that's down to about 102 days right now.

I appreciate the caller. Thank you. One moment for our next question.

Our next question comes from Justice Moore with Morgan Stanley. Your line is open.

Great, thank you. I wonder if you could talk to pricing. Are you seeing anything that's different in terms of pricing given these shortfall dynamics? And is that different in the businesses that you're exiting versus the kind of core automotive businesses?

No, none of the outlook or the cautionary outlook that we've had has anything related to pricing. Our pricing is stable. It's locked into the LTSAs. The conversations we have had with customers regarding outlook, regarding inventory, regarding LTSA has all been around demand. Therefore, it's just quality. So we feel pretty good about our pricing position.

Great. Thank you for that. And then I may have missed it. Did you give a number for how much business you'll be exiting in the current quarter? And can you talk to the dynamics of Could that accelerate in an environment where there's more plentiful supply? Would that help you to get out of those businesses quicker?

Yeah, so we exited $46 million in Q3. It was below our expectations. And coming back to your pricing question, we're just not seeing pricing decline enough that customers are exiting that business. We are looking, as we look into Q4, we think there's about another 125 that we would exit. That'd bring the year up to somewhere around $275 million below what we originally forecasted. Just as a point of reference, the businesses now that we're talking about exiting are at about a 45% gross margin. So it's not a bad business, assuming the pricing does hold up. The fact is, this is all customer-driven. Customers aren't leaving as fast as we expected. I believe that, you know, at the end of this year, whatever is left, we're going to say is good business and we're going to continue to manage if customers don't leave through the softness.

Great. Thank you. One moment for our next question. Our next question comes from Christopher Roland with Susquehanna. Your line is open.

Hey, guys, thanks for the question. I think the discussion for most broad-based guys are returning to the balance between bookings and backlog coverage going into a quarter and the turns business that is needed in a quarter. So I was wondering if you could perhaps talk about this for what's in your guide, backlog coverage versus turns, and how should we be thinking about that for next year, you know, if you can break it down, you know, into sub-segments too, you know, that would be great as well. Thank you.

Sure. The outlook has nothing to do with returning to turns business. We have full visibility about where the Q4 revenue is going to come in, including full backlog coverage. what we are talking about is getting the call ahead, which is the power of the LTSAs we keep talking about, where customers look at what their consumption is going to be, and the consumption is lower than what they had expected. And of course, we're not here to push inventory to make the problem worse at customers, so we negotiate a win-win with every single one of them. So the outlook is purely demand. We know exactly what the mix is going to be. There is no turns business even in the current quarter. And I would say that comment is across all markets.

Okay, great. Thanks. Just maybe a quick follow-up there. Are you seeing push-outs and cancellations or push-outs in those LTSAs? Is that why that number is lower? Just just wondering you know why we had that sequential decrease in December, maybe the street was just miss modeling. And then my other question is around and you had some comments around industrial and solar in particular I think we've seen guys like and phase and solar edge miss pretty huge it sounded like you had some very product specific. drivers there, but was just wondering why you were so optimistic around that business when it's falling generally so fast.

Yeah, I'll take the first part of your question on the cancellations. Look, we saw cancellations peak late last year. I would say at this point, as we look at the quarterly trends, it's pretty flatline at this point. So we're not seeing a lot of current quarter cancellations or even push-outs within the forecast horizon here. On the LTSAs, when a customer comes in and has a challenge, as Hassan said, we're talking about a win-win with them, and in some cases, we are allowing some push-outs as long as there's a win-win for both companies in that situation. We don't want to overship natural demand. But in terms of cancellations, we're not seeing a spike. Like I said, we saw that peak late last year.

As far as the industrial demand, you're right, I called out renewable energy or energy storage. Those are all megatrends. The companies you refer to are more impacted by the residential, which obviously is expected given the interest rates, given the consumer spending sentiment that I referred to earlier. The business we are targeting is the energy storage industry. A lot of it is larger-scale energy storage, which drives a lot more content, and it's not typically impacted by the residential specifically. That business has remained strong, and we expect that business to remain strong on a forward-looking basis. Thank you, guys.

One moment for our next question. Our next question comes from Quinn Bolton with Needham & Company.

Your line is open.

Thanks for taking my question. Just a clarification in response to one of the earlier questions. I think you said you were not looking for growth in the first half of the next year.

Just wasn't sure if that was a sort of sequential comment or year-over-year comment, if you could clarify, and then I've got to follow up on the silicon carbide business. Yeah, like I said, we're cautiously looking at the first half of next year. We think it's going to be soft, but we do think they're is, you know, a sequential down in Q1 based on what we can see today. You know, we'll look at the rest of the year as we go further. But, you know, we're being very cautious in the first half.

Yeah, my comment was more, I don't see a recovery, a market recovery. So it was more of a macro commentary. Got it.

Thank you. And then on the silky

utilization rates being managed down to 68% for the next few quarters to manage inventory. I assume, given the outlook for EVs still growing in the fourth quarter into next year, that silicon carbide is probably immune from some of those lower utilization rates, but wanted to clarify that.

And if utilization remains high in silicon carbide, could you actually see a scenario where silicon carbide moves above corporate average in 2024? Thanks. Yeah, that's a good question. So the utilization for silicon carbide in Q3 was up where silicon was down, and that pulled the total up. As we look forward, we don't see the silicon carbide utilization decreasing. We will be bringing on additional capacity next year to support 25 and beyond, but I don't expect that utilization to decline. I think it's the silicon that will actually decline that gets us down to that 65% you know, mid-60 to high-60% range.

Thank you. One moment for our next question. Our next question comes from Vijay Rakesh with Mizuho.

Your line is open.

Yeah, hi, Hassan. Just a quick question on your commentary on software demand with higher inventory, I guess. Is that more of a... Is that pretty... What do you think across the board in both combustion engine and EV or can you characterize that better?

Well, it's hard to, you know, for a lot of the general content in automotive, it's hard to figure out if it's EV or not. But I can tell you it's not silicon carbide. It's not IGBT. It's not the EV specific constraint. You know, it's more of a general, I would call it general purpose automotive demand that can go in either car. But given the volume for EV, it's more driven by the internal combustion demand because that's where the volume is skewed to.

Got it. And then as you look at your silicon carbide roadmap, you talked about 2024 might be a transition to 200 millimeters. Is that still something that you see? And what's the expectation on what mix would be on 200 millimeters, let's say, exiting 2024?

So we're on track to what we've always said. We're finished qualifying and the conversion started. I talked about it in my prepared remarks. For 200 millimeter, we feel very comfortable and actually more confident today than we were even 90 days ago on the 200 millimeter, given the performance that we've had in the silicon carbide business, ramping all the way from substrates all the way through devices. The fabs are ready, EPI is ready, and furnaces started conversion. So our plan has always been qualify 24 and ramp revenue in 25. So you're not going to really see a mixed shift in 24. That would be more of a 25. 24 is when we transition manufacturing to the 200 millimeter.

Got it. And last question, when you look at silicon carbide, when do you start to see it getting accretive to the corporate margins, I guess?

Well, so we're going to hit the corporate average in Q4, as I said. As you go into next year, I think it's going to be at or above, depending on kind of what the market does. And that's going to be dependent on overall utilization. But we'll definitely be at parity and potentially higher in 2024. All right.

Thank you.

One moment for our next question. Our next question comes from Timothy Akari with UBS.

Your line is open.

Hi, thanks. I just wanted to ask a question also on the 2023 silicon carbide cut from a billion down to 800 million. You know, you guys had always talked about the LTSAs being, you know, legally binding and it didn't seem like they would be subject to any changes in EV ramps. It sounded like a little bit of a higher bar than what we hear from others. So can you talk about that? Was that some structural change in a program from one of your customers where something is just permanently pushed out? Or should we still expect that amount you're not getting this year? Does that push into next year?

So obviously, I'm not going to comment on specific customer details, specifically on programs. But I will comment on the LTSAs. So the LTSAs are legally binding. Therefore, for us to agree or even acknowledge that push out or even the demand in general outside of silicon carbide in Q4, there has to have been, which there is, a win-win for us and the customer. You know, we've always said, if anything, the LTSAs get us a phone call. We get the phone call way ahead of time in certain areas. when the customer knows that it's coming and we're able to manage with the customer for a win-win. Whether that win-win is a quarter later or a year later or a longer term, that depends on case by case. So we manage it with the customer because what we don't want is, of course, enforce the LTSA at the expense of just shipping inventory if demand is lower. So we take it very cautiously. It has to be a win for us, but also a win for the customer. And that's what keeps the strategic customers engaged.

Got it. Got it. Sure. So given that, is the commitment still to $4.5 billion between 2023 and 2025 so that we still have $3.7 billion left between 2024 and 2025?

We're not commenting on that. What I have commented is, obviously, if you take the growth rate that I described in 2024, and you can compare it to where we were before.

So no change in our outlook. Okay, thank you.

One moment for our next question.

Our next question comes from Tristan Garrow with Bayard. Your line is open.

Hi, good morning. Just wanted to expand a little bit on the coverage for next year for LTSA. Obviously, I'm guessing that you don't have full year coverage like you did entering this year, but could you talk about maybe percentage-wise or when is the average LTA expiring next year? Just wanted to kind of look at the transition for LTAs. LTSA into notably the second half of next year.

Yeah, so what you'll see in our filing is that we've got $5.7 billion of LTSA commitment over the next 12 months.

So hopefully that gets you in the ballpark there.

Okay, and what's the average duration and how should we look at how some of those are unwinding later next year or even in 25?

Yeah, so the number I gave you is a 12 months from this point forward, 12 months. Now, your question is a broader question about LTSAs in general. So, you know, the LTSAs go out three to five years on average, sometimes much longer. It just depends on the customer situation. You know, I think last quarter we talked about customers coming back, extending LTSAs or expanding LTSAs. You know, so it just, as these things come up for renewal, customers are coming and engaging. I would say that customers are looking over the long term versus the short term when it comes to the negotiation and the extension of LTSAs.

Great.

Thank you very much. One moment for our next question. Our next question comes from Chris Picasso with Wolf Research. Your line is open.

Yes, thank you. Good morning. I think I'll just go back to the commentary on silicon carbide into next year. Just some of the questions coming in during the call, there was some uncertainty that I hope we could resolve. So what my interpretation of what you're saying is silicon carbide, it sounds like it's down significantly in Q4 given the fact that it's the majority of the decline here. but you're also suggesting that it grows next year and you stay supply constrained. So that would suggest that what you're implying is some improvement at some point next year in silicon carbide. How do we just reconcile those comments unless we got some of them wrong?

Yeah, so I guess I would say the one comment that I believe you got wrong is Q4 in silicon carbide is not down. Q4 silicon carbide is growth. from Q3, it is just not at the level that we expected. That's what drove the myth. So it is not silicon carbide going backwards. With that correction and the ramps that we have in Q3 and it will continue to ramp in Q4, plus the breadth of customers that I described, those are going to drive sequential growth through 2024. So silicon carbide is not down quarter – will not be down quarter on quarter Q3, Q4. It will be up, and it will continue to be up in subsequent quarters through Q4.

Yeah, that's very helpful.

Yep. Yes, yes.

And just moving on to CapEx for silicon carbide as we go to next year. And your earlier comments suggest this is, you know, long-term investment. But, you know, given the current environment, are there any changes to the investments that you were planning for calendar 24, although certainly it sounds like you'd continue to invest? What do we expect for the CapEx profile next year in light of the change in environment?

Yeah, Chris, in my prepared remarks, I noted that because of our strong performance in silicon carbide and being ahead of our internal plans and our confidence in moving into 200 millimeter, that we're actually taking our capital intensity in 2024 down. We had expected the high teens for 2024. I'm now saying it's low teens, and it's quickly closing in on that long-term target. So we will continue to make investments, but not at the rate that we needed to, just because the performance across the entire manufacturing chain is ahead of schedule and exceeding our expectations.

Very helpful. Thank you. One moment for our next question. Our next question comes from William Stein with Truist Securities.

Your line is open.

Great. Thank you. I'm hoping you can discuss the dynamics in the industrial end market. This is where we've seen more weakness from other semi-companies and similar component manufacturers over the last quarter. The call has been very focused on the change in outlook in silicon carbide, but I'd love for you to discuss trends more broadly in the industrial end market and your expectations as we progress into next year. Thank you.

Yeah, so for industrial, obviously we see the same as a lot of our broad-based peers, so weakness in industrial markets. However, within industrial, I call out the two areas that we have seen and will continue to see strength. That's the renewable energy that we talked about earlier with energy storage and so on, and the medical, both driven by very specific trends on the energy storage. Obviously, it is the renewable deployment, not just the residential scale, but more commercial scale. That's driving a lot of the strength. And on the medical, it is a very specific trend of accessibility of the continuous glucose and the hearing aid, which is now almost over the counter. That's driving a lot of that demand for us. And given that we have a leadership position here, we're seeing that strength. So outside of these two, we do see the softness across in industrial. 2024. You know, I commented we don't expect 2024 to see a very big change in recovery. So you can call it, you know, we'll call it when we get closer to it. But I don't have signs that will change my view of the trend and outlook.

Thank you. Ladies and gentlemen, that's conclude the Q&A portion of today's conference. I'd like to turn the call back over to Hassan Elkari for any closing remarks.

Thank you again for joining our call. As always, we aim to deliver consistency and transparency in our results, and we thank you for your support along the way. The executive staff and I are incredibly proud of our team's continued performance, dedication to our customers, and commitment to delivering shareholder value. Our employees all over the world are solving complex technology and business problems for our customers. Congratulations to the team, and thank you all.

Ladies and gentlemen, this concludes today's presentation. You may now disconnect and have a wonderful day.