Onsemi Q2 2024 Earnings Call Transcript

Quartr
Provided by Quartr
July 29, 2024

There are 15 speakers on the call.

Operator

day and thank you for standing by. Welcome to the On Semi Second Quarter 20 24 Earnings Conference Call. At this time, all participants are in a listen only mode. After the speakers' presentation, there will be a question and answer session. Please be advised today's conference is being recorded.

Operator

I would now like to hand the conference over to your speaker today, Parag Agarwal. Please go ahead.

Speaker 1

Thank you, Kevin. Good morning, and thank you for joining OnStar Mi's 2nd quarter 2024 quarterly results conference call. I am joined today by Hassan Uskori, our President and CEO and Thad Sutt, our CFO. This call is being webcast on the Investor Relations section of our website at www.armsemi.com. A replay of this webcast, along with our 2024 second quarter earnings release, will be available on our website approximately 1 hour following this conference call, and the recorded webcast will be available for approximately 30 days following this conference call.

Speaker 1

Additional information is posted on the Investor Relations section of our website. Our earnings release and this presentation includes certain non GAAP financial measures. Reconciliation of these non GAAP financial measures to 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 the future financial performance of the company. We wish to caution that such statements are subject to risks and uncertainties that could cause actual events or results to differ materially from projections.

Speaker 1

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 ks, Form 10 Qs and other filings with the Securities and Exchange Commission and in our earnings release for the Q2 of 2024. Our estimates, although forward looking statements might change, and the company assumes no obligation to update forward looking statements to reflect the actual results, changed assumptions or other events that may occur, except as required by law. Now let me turn it over to Hassan. Hassan?

Speaker 2

Thank you, Parag. Good morning and thanks to everyone for joining us on the call. In the Q2, we exceeded the midpoint of our guidance for revenue, non GAAP gross margin and non GAAP earnings per share as our global teams continue to execute on all fronts. As we indicated in our Q1 call, we are seeing some stabilization in demand in our core markets. Inventory digestion persists with some pockets improving as customers maintain a cautious stance in 2024.

Speaker 2

We don't change to the L shaped curve I talked about in Q1, but we expect parts of industrial such as energy infrastructure to recover in the second half. Among the regions, Asia Pacific, namely China is recovering driven by both automotive and industrial. During this time of market uncertainty, we have not taken our foot off the pedal and remain focused on what we can't control, our execution. We have doubled down on our investments to build out our strategic portfolio of analog mixed signal and power solutions. We have been gaining share by securing significant design wins in power and we have continued to improve our cost structure through ongoing structural changes.

Speaker 2

All these efforts position us very well in a recovery with top line growth and gross margin expansion. Our advantage remains in our comprehensive and innovative product portfolio to capture market opportunities. On Semi's intelligent power and sensing solutions have become synonymous with high efficiency and performance, which are critical to solving customer problems and the high growth megatrends in automotive, industrial and AI data centers. In Intelligent Sensing, we continue to invest to sustain our technology and market leadership. We announced the acquisition of SWIR Vision Systems to add disruptive colloidal, quantum based, dot based short wavelength infrared technology to our portfolio to further strengthen our industrial and defense product offering.

Speaker 2

We will leverage our manufacturing and R and D expertise to accelerate the commercialization of this technology with cost effective and differentiated products for industrial and defense applications. On the analog mixed signal product development, in addition to sampling our first products, we are now proliferating a broader range of product families from high performance analog with integrated power in automotive to a low power sensing interface in medical. This broad range of applications and products we can already offer to our lead customers highlight the competitiveness of this new technology platform. We are excited to share more detail about our analog mixed signal product and technology roadmap later this year. We continue building on our design win momentum and last week we announced that Volkswagen Group has selected On Semi to be the primary supplier of a complete power box solution as part of its next generation traction inverter for its scalable system platform, SSP.

Speaker 2

The first of a kind solution features silicon carbide based technologies in an integrated module that can scale across all power levels from high power to low power traction inverters to be compatible for all vehicle categories. VW Group is the 2nd largest automotive OEM in the world and we expect that all VW brands including Volkswagen, Audi, Porsche, Skoda will be powered by ON Semi's silicon carbides in their next generation for a vertically integrated silicon carbide manufacturing facility. For a vertically integrated silicon carbide manufacturing facility. This strategic expansion provided the European Commission approves the incentive measure would enable us to meet the rising demand for our silicon carbide modules and other power semiconductors by bringing end manufacturing and advanced packaging capabilities to Europe. As customers place an increasing importance on geopolitical risks to their supply chain, they value the resilience we have built into our manufacturing footprint through our FabRight strategy.

Speaker 2

Our collaboration with the Czech government on this state of the art facility aims not only to support our European customers, but also positions On Semi as a central piece of the European power ecosystem, further enhancing our supply resilient strategy. Additionally, ON Semi is a silicon carbide market share leader in China and we are designed into nearly 60% of the bev models from OEMs who are primarily introducing their 800 volt platforms at the Beijing International Auto Exhibition last quarter. China is the largest and fastest growing bev market in the world and Chinese OEMs are adopting on semi silicon carbide solutions based on the market leading efficiency of our modules and devices like the M3E we've just announced. In automotive, silicon carbide will continue to outgrow the industry for many years as EVs are adopted, but also as the penetration rate in EVs increases. The latest research reports show that 22% of EVs in production are enabled with SiC.

Speaker 2

Excluding the market leader, only 6% of the EVs worldwide include SiC, but all OEMs are driving adoption to improve range and cost of the vehicles. Our success with SiC in automotive extends to the industrial market with demand expanding beyond energy infrastructure with emerging mass market applications such as commercial heating, ventilation, air conditioning. The use of 1200 volt silicon carbide and HVAC applications leads to more efficient, reliable and compact systems, ultimately reducing energy consumption, improving electromagnetic interference and operational costs. We're already working with customers looking to integrate silicon carbide into their next generation designs with revenue over the next 3 to 5 years. We remain on track to outgrow the silicon carbide market growth by 2x in 2024 through share gain and our geographical and market assessment has our growth in units, outgrowing the bev unit growth by 2x further supporting our outlook.

Speaker 2

We also have a significant opportunity in the data center and AI market where our focus is on leveraging our silicon and silicon carbide portfolio to address the entire Power Tree. In Q2, we released our latest generation of T10 power trench family and Elite6 650 volt MOSFET that are being designed into various subsystems of the AI data center including power supply units, battery backup units and intermediate bus converters. These solutions offer superior efficiency, high thermal performance and reduced power losses making them ideal for data centers and energy storage systems. They can reduce energy consumption by 10 terawatt hour annually as compared to our previous generation equivalent to powering nearly 1,000,000 homes per year. We continue to invest in multi phase controllers to pair with our industry leading smart power stages, which enable highly efficient power delivery to the CPUs and GPUs.

Speaker 2

As power consumed by AI data center racks increases from 40 kilowatts today to 120 kilowatts in 2025, our addressable content is expected to increase from $2,500 to $9,500 Our strategy to focus on the high growth megatrends of automotive and industrial by partnering and innovating with the market leaders and disruptors has proven successful. We have been investing in power and sensing technologies to further our leadership position and we will continue to leverage our portfolio to address adjacent market opportunities such as AI and data centers. Let me now turn it over to Thad to give you more details on our results.

Speaker 3

Thanks, Hassane. In the Q2, our teams once again demonstrated remarkable resilience and adaptability in navigating a challenging market environment. Our Q2 results exceeded the midpoint of our guidance with revenue of $1,740,000,000 non GAAP gross margin of 45.3 percent, non GAAP operating margin of 27.5 percent and 12% free cash flow margin. We continue to deliver consistent gross margin performance against the challenging market and underutilization, once again demonstrating the structural improvements in our business model. Q2 revenue declined 7% sequentially and 17% from Q2 of 2023.

Speaker 3

This decline was driven by an ongoing inventory correction in the automotive and industrial end markets, which together contributed 79% of our revenue. While we are facing short term demand uncertainty, our long term outlook remains unchanged. We're at the forefront of the fastest growing segments of the automotive, industrial and AI data center markets and we expect to resume our growth trajectory as in customer inventory levels normalize. In line with our expectations, automotive revenue declined 11% quarter over quarter to $907,000,000 a decline of 15% over the same quarter last year. From the time we embarked on our transformation in Q4 2020, which included a strategic shift to focus on automotive, our automotive revenue has nearly doubled, largely driven by increasing content for vehicle electrification and ADAS.

Speaker 3

Our industrial revenue was $468,000,000 down 2% sequentially and 23% versus the Q2 of 2023. As we noted in our Q1 call, we are seeing pockets of stabilization in this market. Looking at the split between the business units, revenue for the Power Solutions Group or PSG was $835,000,000 a decrease of 15% year over year. Revenue for the Analog and Mixed Signal Group or AMG was $648,000,000 a decrease of 18% year over year. And revenue for the Intelligent Sensing Group or ISG was $252,000,000 a 22% decrease year over year.

Speaker 3

The revenue drop for all business groups was driven by ongoing inventory burn in the automotive and industrial market. GAAP gross margin was 45.2% and non GAAP gross margin was 45.3% compared to 45.9% in Q1 and 47.4% in the quarter a year ago. We continue to maintain gross margins above 45% through this downturn, even as our utilization has reached historical trough of 65%, which positions us well for a market recovery. For reference and previous downturns, our gross margin was approximately 30% at these utilization levels. We continue to deliver on our FabRight strategy of driving efficiency across our global operations.

Speaker 3

In Q2, we executed additional restructuring actions to improve the cost structure of our manufacturing network to support our gross margin expansion plans. We expect our gross margins to benefit once demand begins to recover and we increase utilization back to normalized levels. This coupled with ramping of new products at accretive margins will allow us to achieve our long term target of 53%. Now let me give you some additional numbers for your models. GAAP operating expenses for the 2nd quarter were $396,000,000 as compared to $319,000,000 in the Q2 of 2023.

Speaker 3

Non GAAP operating expenses were $308,000,000 as compared to $306,000,000 in the quarter a year ago. Non GAAP operating expenses were lower than our guidance due to active cost control and lower variable compensation. GAAP operating margin for the quarter was 22.4% and non GAAP operating margin was 27.5%. Our GAAP tax rate was 15.8% and non GAAP tax rate was 16%. Diluted GAAP earnings per share for the Q2 was $0.78 as compared to $1.29 in the quarter a year ago.

Speaker 3

Non GAAP earnings per share was $0.96 as compared to $1.33 in Q2 of 2023. GAAP diluted share count was 433,000,000 shares and our non GAAP diluted share count was 429,500,000 shares. In Q2, we deployed $150,000,000 or 72% of our free cash flow for share repurchases. Turning to the balance sheet. Cash and short term investments was $2,700,000,000 and we had $1,100,000,000 undrawn on our revolver.

Speaker 3

Cash from operations was $362,000,000 and free cash flow was $208,000,000 representing 12% of revenue. Capital expenditures during Q2 was $154,000,000 which equates to a capital intensity of 9%. We achieved our long term target ahead of schedule due to higher efficiency resulting from the structural changes in our manufacturing footprint. We expect to remain at or below our long term target of 11%, including the investments needed for the silicon carbide expansion in the Czech Republic. Inventory increased by $78,000,000 sequentially and increased by 20 days to 2 14 days.

Speaker 3

This includes 97 days of bridge inventory to support fast transitions in the silicon carbide ramp. Excluding these strategic builds, our base inventory increased $6,000,000 sequentially to 117 days, which is within our target range of to 120 days. Distribution inventory increased as expected to 8.9 weeks versus 8 weeks in Q1 to support the mass market, which we have underserved for the last 2 years. Let me now provide you the key elements of our non GAAP guidance for the Q3. Today's press release contains a table detailing our GAAP and non GAAP guidance.

Speaker 3

Given the current macro environment and our demand visibility, anticipate Q3 revenue will be in the range of $1,700,000,000 to 1 $800,000,000 We expect non GAAP gross margin to between 44.4% 46.4% with utilization in the mid-sixty percent range. This includes estimated share based compensation of $7,000,000 We expect non GAAP operating expenses of $305,000,000 to $320,000,000 including estimated share based compensation of $31,000,000 We anticipate our non GAAP other income to be a net benefit of $12,000,000 with our interest income exceeding interest expense. We expect our non GAAP tax rate to be approximately 16% and our non GAAP diluted share count expected to be approximately 429,000,000 shares. This results in non GAAP earnings per share to be in the range of $0.91 to 1 0.3 dollars We expect capital expenditures in the range of $130,000,000 to $170,000,000 As we've previously highlighted, the acquisition of Swear Vision Systems is not expected to have any meaningful impact on our near or mid term financial outlook. Through this downturn, we have remained committed to our long term financial model.

Speaker 3

We are allocating resources for future growth while continuing to execute on our strategies to enhance operational effectiveness throughout the company. During the Q2, we announced the consolidation of many of our facilities to improve efficiencies and accelerate time to market by centralizing our efforts into fewer centers of excellence. We've continued to invest in R and D to drive long term growth and capitalize on opportunities in intelligent power and sensing despite the market downturn. We also remain committed to our capital allocation strategy. Over the last 12 months, we have deployed 78% of our free cash flow for share repurchases, significantly higher than our stated long term target of returning 50%.

Speaker 3

Since initiating our $3,000,000,000 share repurchase program in February 2023, we have returned $814,000,000 to our shareholders. Finally, at On Semi, we are driven to excellence. Guided by this principle, we hold ourselves accountable not only to our financial commitment, but also to our environmental initiatives. This past quarter, we published our 2023 sustainability report, marking another pivotal step in our ongoing commitment to sustainability and highlighting the progress we have made in the past year. Wrapping up, I'd like to thank our employees for their dedication to excellence.

Speaker 3

Our strategy is working and we remain committed to unlocking shareholder value. We are a more resilient company with steady growth drivers and innovation pipeline and trusted relationships with our customers and suppliers around the world. With that, I'll turn the call back over to Kevin to open it up for Q and A.

Operator

Thank you. Our first question comes from Ross Seymore with Deutsche Bank. Your line is open.

Speaker 4

Hi, guys. Thanks for asking the question. I guess for my first question, kind of 2 sneaky parts to it, but any pluses or minuses by your three segments for the Q3 guide? And then the bigger part is, Hassane, you talked about some stabilization on the industrial side and even energy infrastructure potentially rising in the back half. Any sort of similar color on your automotive business that dropped pretty significantly sequentially?

Speaker 4

You talked about some design wins in EVs, etcetera. How are you looking at that for the back half of the year?

Speaker 3

Yes, Ross, it's Thad. To answer your first part of the question, you broke up a little bit, but I think I got it. The end markets played out pretty consistent with what we expected going into the quarter. We were expecting both automotive and industrial to be down. It played out that way.

Speaker 3

If we saw any signs of improvement, it was really in industrials. We continue to see some stabilization there. So really played out as we expected during our guide for the quarter.

Speaker 4

And I guess for my follow-up question then moving on to the gross margin side of things Thad, you talked about some of the idiosyncratic drivers, the East Fishkill side of things as well as the fab divestitures in the past. Can you just walk us through any evolution of those? We get the utilization rate when that goes up, that's going to be beneficial. You laid that out clearly. But the 100 basis points from East Fishkill, that's headwind this year and then the fab divestitures, which I think is about a 2 point tailwind when those kick in.

Speaker 4

Can you just walk us through how those unfold over the next kind of 6 to 12 months?

Speaker 3

Sure, sure. So, starting with utilization, which is the key driver here in the short term, Just to reiterate what we've said in the past, every point of utilization is 15 to 20 basis points of gross margin improvement. So as you think about us coming off of a low of 65% going back into normalized levels, you can do the math on the gross margin expansion on that. And you're right, East Fishkill with the global foundry business that we're running in there is about 100 basis points dilutive. We'll continue that through the rest of this year.

Speaker 3

And then we'll start to see that start to moderate in 2025. And then the other piece is the fab divestitures. We divested 4 fabs in a couple of years ago and it's $160,000,000 of fixed cost that we'll start to recognize as demand picks up and we start manufacturing those products within our existing network. So we've got to bleed through that inventory that we've been building for those fab transitions. And as we move that into our network, we start to see that benefit.

Speaker 3

And then the last thing is and I noted it in my prepared remarks is the ramping of new products that accretive gross margins. And I think if you start to do that math, you can start to get pretty close into our gross margin target, the long term target being 53%. So we feel good. We just need a market recovery here and we have some nice tailwinds. Thank you.

Operator

One moment for our next question. Our next question comes from Vivek Arya with Bank of America Securities. Your line is open.

Speaker 5

Thanks for taking my question. I wanted to revisit the Q3 outlook question. I think at the midpoint, you're guiding is up a bit sequentially. And I was hoping you could, Hassan, maybe give us a sense of how you see your different end markets, especially automotive. Do you expect that to be up, down, flat sequentially?

Speaker 5

Thank you.

Speaker 2

Yes. I mean, Vivek, if you look at our biggest market, 79% of revenue this quarter to auto and industrial, we expect those in the Q3 to be flat to up

Speaker 6

slightly. Okay.

Speaker 5

And then maybe as a follow-up, over the last few months, we have seen deceleration in battery powered EV demand. And I'm curious, if you look at your silicon carbide outlook for this year in absolute dollars and not versus the market, How do you think it has fared? Do you think what you thought in terms of absolute dollars for this year, is it still on track for that or has that view changed? And then kind of part B of that, I think you mentioned more optimism for the China EV market. Is your share in China EV above or below that 35% to 40% share that you think you will have globally for this year?

Speaker 2

So let me break it down. So for the silicon carbide market, I think like you said, regionally from a bev market, it's very different regionally. The comment and the reports that you're seeing more Western than China, But overall, we do expect the bev market to remain healthy with a little lumpiness in the short term. But long term, we're still the penetration of bev and the penetration of silicon carbide within bev is still, call it, mid single digit without the market leader. So having said that, I will anchor back on 2024 growth of 2x market.

Speaker 2

I'm not going to get into the absolute dollars. We have the absolute dollars that we're driving to internally, but I will anchor on the 2x market given all of the news and all the headlines that you referred to. From the China perspective, I talked about our penetration in China being over 60 about 60%. So in China, we're ahead of where we are with the rest of the world or overall, but that's also a timing, meaning we started in China given it's the biggest market ahead of everybody else. If you recall, at the end of last year, I mentioned that in 2024, we do expect the ramps to start in Europe.

Speaker 2

So as the ramps start in Europe, the blend of geographical distribution of our revenue for silicon carbide will change in the second half. But overall, China is ahead of the rest of the world from our market share as well just because it's the biggest market and we started there earlier.

Speaker 5

Thank you, Hassan.

Operator

One moment for our next question. Our next question comes from Toshiya Hari with GS. Your line is open.

Speaker 7

Hi, good morning. Thank you so much for taking the question. I wanted to follow-up on the SiC business as well. To the extent you're willing to share, Hassan, curious how that business trended in Q2, whether it be on a sequential basis or a year over year basis and what your expectations are for Q3? And then I guess for the full year, I'm guessing that the mix of your business, whether it be by application or customer has evolved over the past 90 days.

Speaker 7

What's your outlook there by geo or an application today versus 90 days ago?

Speaker 2

So I'm not going to break out our silicon carbide on a quarterly basis given what we've been talking about the lumpiness of the revenue. That and really the timing of customer ramps when they start, when they peak and when they stabilize. For that, we're only going to be covering silicon carbide revenue on an annual basis and we'll talk about it in at the end of the year of where it all landed. What I will tell you is we externally, what I stated is the 2x market that's where we look at, that's where we're trending. And I added in my prepared remarks, when I look at units growth, which is a lot of it is socket of designed and share, We're also trending at the 2x further supporting our growth in silicon carbide.

Speaker 2

From a regional, we talked about China being strong for us. Europe in the second half will start seeing some ramps in Europe. That's again in line with what we talked about at the end of last year. So all that is coming in exactly as we expected. And we continue to diversify our design in with the announcement with VW Group.

Speaker 2

That's of course out longer in time, but still adding to the distribution of our revenue over

Speaker 7

time. Got it. Thank you. And then as a quick follow-up, just on distribution inventory, it went up a little bit sequentially at the end of June. Curious what's embedded or what's assumed in your Q3 guidance?

Speaker 7

And as you think about the next couple of quarters, several quarters, what's your plan in terms of managing that inventory? You sound relatively still muted as it pertains to the cycle. Should we expect weeks to stay generally flat or do you feel like that can go up just given how much you had under serviced that business over the past couple of years? Thank you.

Speaker 3

Yes, Toshi, it's Thad. So, we exited the quarter at 8.9 weeks just where we expected. We talked about that mass market you referred to that we need to put inventory into the channel. So we're achieving that well. We're managing it tight still, given the market uncertainty.

Speaker 3

But for Q3, I think it's going to be right in this range, let's call it 9 weeks. And I really think through the remainder of this year and probably into next year, you're kind of looking at that type of range, 9 weeks plus or minus. We'll see how the market recovers and the adoption of the mass market. But that's our plan for the short term here.

Speaker 7

Very helpful. Thanks guys.

Operator

One moment for our next question. Our next question comes from Vijay Rakesh with Mizuho. Your line is open.

Speaker 6

Yes, hi. Just a quick question on the in the prior quarters you've given your order of backlog, like if you could give us some thoughts, color on what the same year silicon carbide backlog looks like? Thanks.

Speaker 3

The silicon carbide backlog, look, we announced a few things here over the last few quarters, right? I mean, that backlog is healthy, right? There's some short term softness, that's well known in the EV market, but I would say the backlog is still very healthy.

Speaker 2

Yes. If you look at design and activity, whatever we feel in the market in the short term and I call it short term given the trend for silicon carbide, not just in bev by the way. We talk about silicon carbide in industrial proliferating further because of the benefit that it brings and even silicon carbide making its way into the power stages of the AI data center. So when we talk about silicon carbide, we're talking about a long term multiyear megatrend. That's why we're participating in it.

Speaker 2

So in the short term, of course, we all see what the market shows, but nevertheless, customers are still investing in silicon carbide for their platforms, whether it be a car, industrial or AI data center as I mentioned. This is what we can control is our design and capability on our new products, which means that as the market starts to go uptick the other way and best starts to proliferate further, we are in a much better position than otherwise we would be if we weren't winning today. The VW Group announcement is an example of such a large deployment of silicon carbide in an electrification platform. So if you talk about backlog as that, that's exactly what we can control and we're working on. That same story happens in industrial, that same story happens in the AI.

Speaker 2

We're designed in, now the ramps will support our growth.

Speaker 6

Got it. And one quick question. On the 200 millimeter side, any thoughts on how you're looking at that ramp on silicon carbide?

Speaker 2

Yes, still on track to what we said. We will qualify 8 inches this year. That's when I talk about qualifying, it's substrates all the way through fabs. So that will be qualified this year starting revenue next year in line with our expectations that I outlined last year. So no change to that.

Speaker 2

Obviously, we look at the 8 inches as a what we've talked about earlier. 8 inches for us is a capacity expansion. So once it's qualified, we sample and we start seeing revenue, we will start increasing the share of 8 inches internal versus 6 inches as we convert our furnaces and so on in order to support the ramp. But from a capability 8 inches I'm very happy with where 8 inches is and therefore we're right on track.

Speaker 6

Got it. Thank you.

Operator

One moment for our next question. The next question comes from Blayne Curtis with Jefferies. Your line is open.

Speaker 2

Hey, good morning guys. Thanks for letting me ask a question. I just want to ask, you talked about only really the energy business inflecting in the second half. So just kind of curious, I mean, obviously, the auto market has come in a little bit weaker. Just kind of curious, you said you're sticking with that L shaped recovery.

Speaker 2

Is it right to think though that as you look through the rest of the calendar year that you're looking kind of flat? Just wanted to understand the comment of just highlighting that one bar. Yes. I mean, L, I would say flat. Sublaine, I have no reason to call a recovery.

Speaker 2

Now look, there are going to be some green shoots here and there, some markets within our automotive and industrial that will fare better than others. Probably I don't have a crystal ball. That's why I can manage to what we can see and I can guide to what we can see. But what I would put it in perspective is we're not planning or seeing a what I would call a recovery, which is a big deviation from kind of flattish. So some recovery in certain areas that will change the course.

Speaker 2

We don't guide in the out quarters, but that's kind of my view of the market today. Thanks. And I just want to ask a lot of comments or questions on Slim Carbide. I want to ask on Intelligent Sensing Group. So that business is down quite a bit.

Speaker 2

I mean, you have a driver with 8 megapixel in terms of ASPs. I'm sure you're working through some inventory there as well. Just kind of outlook in terms of that content driver, where that is today and where you see that could go and then kind of just should that follow the same trajectory of recovery? Yes. Yes.

Speaker 2

I mean, we have the difference with the image sensing, we do have a big market share in that market, in the ADAS Automotive market. So that's more on the recovery of the market itself. But like you mentioned, there's an ASP uplift that will increase our revenue disproportional from just the unit growth and also a penetration rate that as ADAS gets to more level 2 plus you got more units within the base of the SAAR that we're targeting. So you can think about it as SAAR plus the content uplift both ASPs and units. Now importantly also, I do want to talk about the industrial side of that business where we don't have the same market share as we do in automotive.

Speaker 2

So there's more expansion we can do. We've had a slew of new products that we've introduced in the industrial market. The SWIR acquisition we've made adds yet another layer of that differentiation and the technology leadership for our image sensing group that goes specifically in the industrial under defense market. So again, same strategy of regional and application proliferation that we're doing in the power, you're seeing that kind of parallel in the imaging or the sensing business. Thanks,

Operator

Our next question comes from Joshua Buckhalter with TD Cowen. Your line is open.

Speaker 8

Hey, guys. Thank you for taking my question and good morning. I know you mentioned that auto was kind of in line with your expectations, but I think 11% sequentially was a little worse than I was expecting and some of your peers are printed this quarter. Was that a conscious decision on semi's part to ship more conservatively? Or did something did anything in your customers' behavior change over the last couple of months as some of the weaker auto production came out or maybe something idiosyncratic was fixed?

Speaker 8

But most importantly, does the slight growth in the Q3 that you're guiding to assume you're roughly shipping to end demand or is there any more digestion going on there? Thank you.

Speaker 2

Yes. Let me start with the last part. We believe it's below end demand as I talk about the inventory burn. But as far as quarter on quarter guide, it's hard and I'll give you a piece of advice. It's hard to compare to peers because it's all a timing.

Speaker 2

In the short term, when I call it within a 90 day plus 90 days minus 90 day, it's really a timing discussion of how much inventory was there, how far ahead or below end demand. At the end of the day, you have to look at it from an end demand. End demand is exactly what I mentioned. We don't see signs of stabilization. Over a multi quarter period, it's all going to stabilize and everybody who ships into auto is going to converge to a auto number plus their content specifically to the company.

Speaker 2

So I don't look at it as a delta to peers or a delta to customers. It's literally a, where we do we believe the automotive market is. Some of our Tier 1s have more inventory than others, so it will take them longer. But inventory burn is directly related to demand. Demand accelerates, inventory burns accelerate.

Speaker 2

Demand doesn't, inventory burn takes longer to achieve. So I would call it just a timing thing. There's nothing, I guess, intentional in managing to a number here.

Speaker 8

Thank you. I appreciate the color, Hassane. And then yes, thanks for the data point on the ex market leader silicon carbide attach rate being here in the 6% range. I mean, you're speaking with customers and have a great insight into obviously ongoing design wins and their product ramps. Any intermediate milestones you could give us and where you expect the stick attach rate to be maybe in 2025 or the next few years?

Speaker 8

Thank you.

Speaker 2

Yes. Look, I mean, we still see a growth in silicon carbide as a market driven, of course, by the auto, industrial and AI that I talked about. So it's a broad proliferation. I think it's too early to talk about 2025. We'll have to see how 2024 exit rate is and really what the market does in 2025.

Speaker 2

If you look at a lot of the reports that are out there and talk to a lot of the customers that have reported already, it's a very broad range of what 2025 is going to look like. So it's too early to talk about 2025. What I can talk about is the rate of design wins that we have, because that I can measure, that I can control and that I can provide where we are. I'm very happy with that progress. We talked about China.

Speaker 2

We talked about the Beijing Auto Show where literally we went through every car that got announced in the show and I can tell you exactly that we are designed into it. As those cars ramp and as those cars become successful and the market recovers for BEV both in China beyond what it is and outside of China, those are the design wins that are going to ramp for us and dictate what 2025, 2026 and beyond are going to be. So I will tell you from a design win perspective and a market relation perspective, we are firing on all cylinders here. Or I guess I shouldn't say cylinders. We're firing on all motors today.

Speaker 8

Well done. Thanks, Hassan.

Operator

One moment for our next question. Our next question comes from Quinn Bolton with Needham and Company. Your line is open.

Speaker 9

Hey, so I'm just wondering if you might be able to give us any sense of sort of timing of the VW ramp. You mentioned you thought you'd be across pretty much all of the VW models over time. Are they staged? Or do they sort of all ramped in the same general time period?

Speaker 3

And then I've got a follow-up.

Speaker 2

Typically, well, that's a question for them really. I can't disclose their plan for a ramp. But it's not an on off switch, I guess I can say that.

Speaker 9

Got it. And then just looking at the second half, it's pretty clear your message is that end demand hasn't really started to recover yet, maybe it's stabilizing. So as you look at your L shaped recovery comments, I guess I'm just trying to reconcile, You guys are shipping below end consumption right now as inventory is being digested. Is your L shaped commentary really more a reflection of end demand or of your revenue? Because I would think at some point as the inventory digestion process ends, you would snap back to consumption and I would think that would put some growth into your numbers if you're currently shipping below consumption levels.

Speaker 9

So any thoughts on that reconciliation would be helpful. Thank you.

Speaker 3

Yes. This is Thad. You nailed it, right. When we talk about the L shape recovery, it's really our revenue, right. We believe right now we're still under shipping natural demand as there's an inventory digestion going on.

Speaker 3

As that inventory is bled off, we think our revenue over time will increase again. But yes, the L shape is not demand. It's more of our revenue just given the inventory out in the channel.

Speaker 9

So it sounds like we've got a couple more quarters of that inventory digestion from your vantage point?

Speaker 3

Well, I think it depends on demand. It's Hans said, right? I mean, if demand picks up, the inventories bled faster. If demand slows, it takes a little bit longer. But look, for what we can see for the remainder of this year, that's why we're saying L shaped.

Speaker 3

If you look at Q3, we're up almost 1%. We'll see what Q4 does. Thank you.

Operator

One moment for our next question. Our next question comes from Chris Danely with Citi. Your line is open.

Speaker 10

Hey, thanks guys. Just a quick question on the disty inventory going back up. It sounds like there's still plenty of inventory out there amongst certain OEM customers. So given the L shaped recovery, why would the disties want to take up their inventory and not keep it flat? Yes.

Speaker 2

So if you recall in our last this is Saan. If you recall in our last call, we talked about the mass market. So it's not really the top customers or the named customers that we have. It's more of the tail of customers that we really ourselves have starved and I've mentioned it multiple times and during the call it the pandemic where we didn't have a lot of we were supply constrained. We prioritized all of our lead customer at the expense of the broad market or mass market.

Speaker 2

Right now, we talked about how we're starting to replenish and address the mass market. We started last quarter, so we expected that slight uptick. So it is driven strategically by us. Obviously, the metric for just to give you a little insights of how I look at it and why it's important for us. I look at it as new customer counts that we are adding.

Speaker 2

And that's again mass market, thousands of customers. As that remains on an upward trajectory, even today, we will continue to replenish the mass market. So strategically, that's the closed loop approach that we that I look at operationally to manage this.

Speaker 3

Yes. And Chris, if you look at that 8.9 weeks, there's actually a mix shift within that 8.9 weeks, right? So more going to the mass market and less going into specifics for customers as we continue to bleed through that inventory. So we're managing that inventory extremely tight in the channel. And just keep in mind, historical levels of inventory in the channel was 11 to 13 weeks.

Speaker 3

So we're significantly below where the company had been been historically.

Speaker 10

Thanks guys. That's really helpful. And then for my follow-up on silicon carbide, I know you're not giving any numbers or anything. But if we look at your backlog and pricing for the year for next year, Was there any volatility? Has that changed in the last 3 months?

Speaker 10

Any sort of changes in your own like 2024, 2025 backlog or pricing assumptions?

Speaker 2

No, no pricing is stable if you recall. I mean whether the units are coming in exactly what we had in the LTSAs or not pricing is in the LTSAs. So we've been very consistent about we discussed with customers on the LTSAs to reach to a win win. But we invested based on the ROI and ROI is specific not just on volume but also pricing. We can't control volume neither can our customers to a first order as market dependent.

Speaker 2

So we're flexible there. But from an investment and pricing, I would say that's stable and that's really stable across all of our business. I won't just say about silicon carbide and it's seen in the margin holding where it is versus historical. So pricing is stable. And recall, when we started on this transformation journey, I said we're pricing for value.

Speaker 2

Value doesn't change based on market environment. If the product brings value, then the product brings value and we'll price accordingly and then the volume and units will follow-up with the market.

Speaker 3

Great. Thanks, Hassan.

Operator

One moment for our next question. Our next question comes from Christopher Rolland with Susquehanna. Your line is open.

Speaker 11

Hey guys, thanks for the question. Just given some of your announcements mid quarter on data center power using SiC, I was wondering if you guys could size that opportunity. It sounded like AI in 2025 was at least a $500,000,000 opportunity, just running some rough numbers there. But if you could size the opportunity, talk about kind of your expected market share or any other details, that would be terrific.

Speaker 2

Yes. I'm not breaking the AI market at that level. We will as that market really in my view starts proliferating for us. If you recall the same thing we did with energy infrastructure where we started talking about it from a design win until it became a more meaningful part of revenue and more meaningful part of the market. So stay tuned.

Speaker 2

What I would like what I talked about today is the opportunity from a product perspective, design in and really that call it the SAM per rack. And as we make progress through these and with our new product introduction on the mixed signal analog, not just on the power, We'll give out a little bit more detail on that.

Speaker 3

And Chris, if you go back to our Analyst Day, last year, we talked about the data center growing at 22% over a multiyear period. I think with AI and data center ramping, you can think about that over a multiyear period. It's probably being higher than that.

Speaker 11

Excellent. Thank you. And then my second question is around LTSAs. I don't know if you have any numbers or updates there, but just kind of how are they trending? Have you noticed in terms of push outs, renegotiations, have those slowed?

Speaker 11

Have they become more favorable in those negotiations? Any changes over the past couple of quarters here?

Speaker 3

Yes, Chris, I would say it's pretty stable. So the lifetime value of our LTSAs are $14,700,000,000 If you look at what's shippable over the next 12 months, it's about $4,400,000,000 So about 30% of that, pretty consistent with what we've been seeing as you ship LTSAs. I think as we've said, the LTSAs pricing is stable. It gives us that call on demand changes and why we've seen many of the market shifts prior to many of our peers. So I think the LTSAs are strategic in the way that they're actually proving value in how we manage our business.

Speaker 2

Yes. I mean even today with the market environment that we've been talking about, we do have customers asking for LTSA because it's not you don't need the LTSA when the market is what it is today. They stage on needing the LTSA when the actual market recovers and they don't want to be stuck in traffic in the allocation. If the snapback is across all markets and very quick, so it's a future proofing, it's a strategic tool and of course it drives that customer about what is their need based on new products and existing product ramps.

Speaker 11

Thank you, guys. Very helpful.

Operator

One moment for our next question. Our next question comes from Harlan Sur with JPMorgan. Your line is open.

Speaker 12

Yes, good morning. Thanks for taking my question. Your direct customer business was down about 18% sequentially in the June quarter versus your distal business, which was up 5%. It seems that most of the inventory related issues are with your direct customers and given that orders are probably the best indicator of inventory dynamics at your direct customers since you don't monitor the sell through, did the order trends in direct start to stabilize in Q2 and has that stabilization continued so far quarter to date?

Speaker 3

Yes. So first of all, in the mix shift between disti and direct, keep in mind most of that industrial business goes through the distribution. So that's that long tail of customers. So that's why you're seeing a little bit more there. We're the big automotive guys typically are direct.

Speaker 3

So you're right. As we've seen some recovery in industrial, you're seeing a little bit more of a shift to disti and a little bit less on direct. So I think it's just kind of a short term as you go through this digestion period. Looking forward, I would say things are stabilizing here.

Speaker 12

Great. Thanks for that. And then other of your peers in the analog and power markets have seen a pickup in China. I know in the Q1, you had not seen the seasonal pickup post Chinese New Year's. As you move through the Q2, it looks like Asia, which includes China, you did see slight sequential revenue growth.

Speaker 12

So have the order trends also started to stabilize or improve in this region? And is it broad based or biased improve in this region? And is it broad based or biased more towards industrial and or automotive?

Speaker 3

Yes. So we said in our prepared remarks, we're seeing China stabilizing, we're seeing growth there. It's both automotive and industrial. We talked about energy infrastructure as well as the second half recovery. So that would be a lot of that goes through China.

Speaker 3

But, yes, I would say it's the broader market of auto and industrial in China and that's definitely leading the recovery right now.

Speaker 12

Great color. Thank you.

Operator

One moment for our next question. Our next question comes from Tristan Gerre with Baird. Your line is open.

Speaker 13

Hi, good morning. Thanks for letting me in. Just follow-up on China, how sustainable do you believe this is? How would you categorize inventories in China specifically? Are you seeing any type of government incentives?

Speaker 13

Or is it just that there's a rebound after several quarters of weakness?

Speaker 2

I guess that's a tough question to posture. But the market pickup in China, I think the demand is coming back. We've had a pretty big trough what we talked about in the prior question. There was no recovery after the Chinese New Year. We've been talking about potential recovery.

Speaker 2

So I look at it as driven by end market demand, not necessarily specific government incentives or any of that because I haven't really seen any major announcements in China to drive their economies. So therefore, I would call it as a broad base demand stabilization towards a recovery. For us with our penetration in China on silicon carbide and really on the silicon across the board, we will just benefit and we will see it. And given that we are very tight on the inventory in the channel, we will see the sell through much quicker than having to wait to drain through large channel inventory like potentially some of our peers. So from our view, we've established ourselves in a very good position to see the uptick really quick.

Speaker 2

We started to see it in Asia, specifically in China like we talked about. But I wouldn't call it any specific incentives that may or may not be sustainable. So therefore, as long as the market stays the way it is, I would call that sustainable.

Speaker 13

Okay, great. Very useful. And then as my follow-up, maybe I missed it. What was the point of sales for distis in Q2 sequentially? And what was the percentage of disti year for your total revenue in the quarter?

Speaker 3

Yes, all that's on the website that we post. Distribution as a percentage of total increased where direct actually decreased, but that's all posted on the revenue trends that we put on the website there.

Speaker 12

Great. Thank you.

Operator

One moment for our next question. Our next question comes from Harsh Kumar with Piper Sandler. Your line is open.

Speaker 14

Yes. Hey, thanks guys. I guess congratulations on weathering the storm reasonably well in this cycle, gentlemen. Hassan, one for you. Is it fair to say that your win at Volkswagen should put all the wafer quality rumors, causal, conjecture, whatever you want to call it that's been going on in the last year that should be put to rest now that you've got a major win like Volkswagen?

Speaker 14

And then the second part to that question is, is there still is your are your wins in silicon carbide still a function of wafer availability, the fact that you are you can make your own wafer? And did you say that you're the lead at Volkswagen for this particular set of wins?

Speaker 2

Yes. So by the way, by now, I thought the whole rumors about yields and quality and all that nonsense has been put to bed. But just for the record, if not, the answer is, of course, the answer has always been. So for the few non believers out there, I think they're either not listening, not looking at the signs, not listening to the announcement or the head is buried in the sand. We've been very clear about our performance.

Speaker 2

Our wins have been speaking for themselves. So the answer is, of course, somebody like VW Group doesn't award on a whim. They award based on audits, based on reviews and based on in-depth on-site and technical depth and reviews. So I'll just put it at that. As far as the VW win, we are the primary, which is to answer your question, yes, we are the primary for that and the breadth is for the VW brand overall or the VW Group overall.

Speaker 14

Okay. That's it, Hassan. And for my follow-up, in the past cycles, Hassan, we've seen the channel recover fast, particularly when it's been stopped in this manner. I guess I'm going to put you in a theoretical spot here. Why do you think the channel is not spiking up?

Speaker 14

Is it because there is still plenty of inventory out there and they don't feel like they need to load up just yet and it's going to come or is something shifted in the way they are thinking about stocking product?

Speaker 2

Yes. Look, I mean, I can't speak for the channel in general. I can speak for what we've done in the channel. If you recall, the last few years, we've been managing the channel way tighter than a lot of our peers and really way tighter than they would want us to manage. They would take more if we ship more.

Speaker 2

But we didn't want to have a balloon in the channel inventory like some of our peers have because that puts us quarters away from seeing a recovery. Because even if you get the POS recovered and you have a lot of weeks in the channel, that's that latency that we didn't want to have and we want to be closely tied. That's why I mentioned strategically as we ship specifically to the mass market, the metric I use is customer count increasing that we ship to. So we are shipping and replenishing the mass market and I do monitor again it's not a quarterly metric, think about it as inventory velocity. From the time we ship it to the mass market, how long before it ships out?

Speaker 2

That velocity is monitored, the number of customers is monitored. That's why we are very good about increasing our channel inventory for the mass market. But if you talk about channel inventory for the top customers, the industrial customers or what I would call the named customers, that just follows the trend because look, half of our inventory in the channel is fulfillment. So it is demand related directly.

Speaker 14

Got it. Thank you, gentlemen.

Operator

Ladies and gentlemen, this does conclude the Q and A portion of today's conference. I'd like to turn the call back over to Hassane Elkhari, President and CEO for any closing remarks.

Speaker 2

We continue to prioritize operational excellence through the market correction and demonstrate the resilience of our business. We're very proud of our global teams for executing through the current demand environment with prudent financial management. We are a better structured company because of the work we put in during the downturn. Thank you all for joining us today.

Operator

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

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Earnings Conference Call
Onsemi Q2 2024
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