ON Semiconductor Corp (ON) — Q1 2024 Earnings Call Transcript

Thank you, Kevin. Good morning and thank you for joining onsemi's First Quarter 2024 Quarterly Results Conference Call. I'm joined today by Hassane El-Khoury, our President and CEO, and Thad Trent, our CFO. This call is being webcast on the Investor Relations section of our website at www.onsemi.com. A replay of this webcast, along with our 2024 first 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. 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 the most directly comparable GAAP 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 the 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. 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-Qs and other filings with the Securities and Exchange Commission and in our earnings release for the first quarter of 2024. 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 hand it over to Hassane.

Thank you, Parag. Good morning and thank you all for joining us on the call. In the first quarter, our worldwide team delivered revenue of $1.86 billion, non-GAAP gross margin of 45.9% and non-GAAP earnings per share of $1.08, all above the midpoint of our guidance. We have remained laser focused on our execution, driving new design win growth of 30% quarter-over-quarter, and gaining share in silicon and silicon carbide based on the strength of our technology. Customers value the breadth of our portfolio and the superior performance of our intelligent power and sensing technologies, which continue to fuel platform wins. Leading indicators of future revenue to support our plan to outgrow the market in automotive and industrial with new product revenue in Q1 increasing 9% year-over-year, and we expect it to continue to outpace total company growth with favorable gross margins at scale. Specifically, we believe our silicon carbide business to have the best financial performance in the industry on a fully loaded basis with more than 50% of substrates coming from internal production in the first quarter. The performance of our silicon carbide solutions, combined with our vertically integrated supply chain, are enabling us to rapidly diversify our customer base. Having just returned from the China Auto Show in Beijing, I remain confident that we are continuing to gain share and expanding into the top 10 leading Chinese OEMs where we are already designed into the newly announced 800-volt EV platforms and set to start ramping in the second half of 2024. As for the global silicon carbide market, we still expect an increase in the TAM, although at a lower rate than previously anticipated. The increase is primarily driven by incremental volumes of EVs produced globally over 2023, even as total SAAR is projected to be flat to slightly down. We continue to gain share in silicon carbide and diversify across all markets and still expect our revenue to increase 2x the market growth in 2024. Outside of silicon carbide, there was incremental softness in the market in the first quarter. Inventory digestion persisted across the automotive and industrial markets with stabilization in the traditional part of our industrial business. We remain cautious about the second half outlook, but we expect customer inventory levels to normalize and the market to stabilize. We will maintain our disciplined approach to navigating the current environment and expect to deliver predictable results as we have demonstrated. Through this environment, we're also investing to further our leadership in the high-growth megatrends of automotive, industrial and cloud, including data centers. During our Analyst Day last May, we highlighted a $19 billion high-margin TAM opportunity that we could service by expanding our portfolio of power management and sensor interface technologies. To best align with the strategic intent, we have formed the analog and mixed signal group, which will deliver industry-leading full system solutions for these markets. Electrification remains the largest growth opportunity for onsemi across xEVs from BEV to ATV. We provide a unique value proposition for our customers with our wide range of silicon carbide and IGBT solutions along with our high-powered packaging technologies. Our revenue from xEV grew by approximately 60% year-over-year, significantly outpacing unit production, and we continue to gain share with our silicon carbide and silicon products primarily in BEV. In automotive sensing, the shift towards higher-resolution image sensor for ADAS systems continues with customers moving to better performance options. Our revenue for 8-megapixel image sensors increased more than 30% quarter-over-quarter and more than 60% year-over-year, demonstrating the market trend towards higher resolution for ADAS systems. In medical, we are leveraging AI technology in our processors for hearing aids to adapt to the user's unique hearing environment for an improved listening experience, and we are designed in more than 50% of over-the-counter hearing aids currently available in the market. With a relentless focus on innovation, we are actively investing in new products and technologies to extend our competitive advantage and drive above-market revenue growth at favorable margins, consistent with our Analyst Day commitment. We remain on track and continue to make progress towards 200-millimeter in silicon carbide. We are already sampling new mixed-signal products, and we are gaining share across the portfolio based on the differentiation of our technology. Our investment in cloud and data centers over the last 3 years has enabled us to benefit from the incremental opportunity we are seeing from the rapid rise of AI. Next-generation AI server racks will require 200 to 300 kilowatts of power, as much as the power needed in a BEV. Our full suite of high-efficiency power tree solutions from the power supply unit or PSU to the CPU or GPU consuming the power continues to present the content expansion opportunity as customers look to us to solve their power density problems in data centers. As we look forward with disciplined, consistent execution while maintaining the customer-centric mindset, we will navigate the current environment and continue to deliver value for our stakeholders. Let me now turn it over to Thad to give you more details on our results.

Thanks, Hassane. Our teams have been dedicated to achieving operational excellence. Their focus on execution to drive more consistent and sustainable results has once again led to first-quarter results that surpassed expectations. Our capability to adapt to the current market landscape and deliver improved results during a downturn reflects the resilience we've developed over the last three years. Despite ongoing inventory adjustments in the automotive and industrial sectors, we reported first-quarter revenue of $1.86 billion, down 8% from the previous quarter and down 5% from the same quarter last year. Our automotive revenue, totaling $1 billion, grew 3% compared to a year ago but declined 9% quarter-over-quarter, in line with our forecasts. Vehicle electrification and advanced safety applications remain key long-term growth drivers for this segment. Revenue from industrial was $476 million, a 14% decline compared to the first quarter of 2023 and a 4% decline sequentially. We are observing early indications of stabilization in our primary industrial business, which constitutes slightly less than half of our total industrial revenue. In the long term, we anticipate growth opportunities in industrial segments associated with energy infrastructure, factory automation, and medical applications. Due to our strategy of aligning with high-growth megatrends focused on a sustainable ecosystem, revenue from our Automotive and Industrial sectors represented 80% of our total business in the first quarter. In terms of operational unit performance, revenue from the Power Solutions Group reached $874 million, marking a 2% year-over-year rise driven by increased silicon carbide revenue in automotive and industrial sectors, despite a decline in silicon power products. Revenue for the analog and mixed-signal group was $697 million, reflecting a 6% year-over-year decline due to decreased sales in industrial and automotive sectors. As previously announced, we have established AMG to provide leading full-system analog mixed-signal solutions. Revenue for the Intelligent Sensing Group was $292 million, down 18% year-over-year due to declines in both industrial and automotive sectors. The GAAP gross margin for the first quarter was 45.8%, while the non-GAAP gross margin was 45.9%, down from 46.7% in the previous quarter and 46.8% compared to the same quarter last year. These figures exceeded expectations, despite utilization being at 65%, a slight dip from 66% in the fourth quarter. Historically, during similar downturns with comparable utilization levels, our gross margin averaged around 30%. Our margin improvements continue, supported by our Fab Right strategy to optimize our existing facilities. The operational efficiency at East Fishkill has significantly improved, aligning our fixed and variable costs to be on par with our other fabs. The dilutive effect in the first quarter was 140 basis points compared to 200 basis points in the fourth quarter. For the rest of the year, we expect this to be about 100 basis points dilutive for the ongoing foundry business with GLOBALFOUNDRIES. Consequently, our cost-reduction efforts at EFK and Fab Right initiatives lead us to project that a 1 point improvement in utilization across our manufacturing network will yield an approximate 15 to 20 basis points enhancement in gross margin. Now, for some additional numbers for your models. GAAP operating expenses for the first quarter were $328 million compared to $353 million in the same period last year. Non-GAAP operating expenses totaled $314 million, up from $286 million in the prior year. As Hassane mentioned, we continue to invest to strengthen our leadership in key markets. The GAAP operating margin for the quarter stood at 28.2%, while the non-GAAP operating margin was 29%. Our GAAP tax rate was 15.7%, and the non-GAAP tax rate was 16%. GAAP earnings per share for the first quarter were $1.04, compared to $1.03 a year ago. Non-GAAP earnings per share were near the higher end of our guidance at $1.08, down from $1.19 in Q1 of 2023. The GAAP diluted share count was 437 million shares, while the non-GAAP diluted share count was 432 million shares. In the first quarter, we allocated $100 million, or 36% of our free cash flow, towards share repurchases. Over the past 12 months, we have repurchased $560 million in shares, returning nearly 100% of our free cash flow to shareholders. Regarding our balance sheet, cash and cash equivalents totaled $2.6 billion, and we have $1.1 billion in undrawn credit. Cash from operations was $499 million, and free cash flow surged threefold year-over-year to $276 million, representing 15% of revenue. Capital expenditures during the first quarter amounted to $222 million, resulting in a capital intensity of 12%. As previously noted, we anticipate 2024 capital intensity to remain in the low teens for the full year. Inventory saw an increase of $35 million sequentially, with days rising by 15 to reach 194. This includes 86 days of bridge inventory to support fab transition in the silicon carbide brand. Excluding these strategic builds, our base inventory decreased by $31 million sequentially, bringing it down to approximately 109 days. We continue to actively manage distribution inventory, which declined by $19 million sequentially, with weeks of inventory at 8, as expected, compared to 7.2 weeks in Q4. As noted earlier, we expect to replenish the channel in 2024 for mass-market customers and anticipate inventory levels to normalize to around 9 weeks over the upcoming quarters. Now, for the key elements of our non-GAAP guidance for the second quarter. A detailed table of our GAAP and non-GAAP guidance can be found in the press release related to our first-quarter results. Given the current macroeconomic situation and our demand outlook, we forecast Q2 revenue to range between $1.68 billion and $1.78 billion, with overall softness across all markets. We project non-GAAP gross margin to fall between 44.2% and 46.2%. As demonstrated, our structural changes are proving sustainable, and we expect to maintain a gross margin floor in the mid-40% range with utilization in the mid-60% range. Our Q2 non-GAAP gross margin includes share-based compensation of $6.5 million. We expect non-GAAP operating expenses to be between $313 million and $328 million, which includes share-based compensation of $28.6 million. We anticipate non-GAAP other income to generate a net benefit of $12 million, with our interest income surpassing our interest expenses. We project our non-GAAP tax rate to hover around 16%, and our non-GAAP diluted share count for the second quarter is expected to be approximately 432 million shares. This leads us to forecast non-GAAP earnings per share in the range of $0.86 to $0.98. Capital expenditures are expected between $180 million and $220 million. Our financial strategy and long-term goals remain unchanged as we continue to invest for the future while implementing our proven strategies to drive operational efficiencies. We remain committed to our capital allocation plan of returning 50% of our free cash flow to shareholders over the long term. We are a different company today, and I want to take this moment to thank our employees worldwide for the value they have created during our transformation journey. Their contributions were recently recognized by the Wall Street Journal's management top 250 ranking, highlighting the most effectively managed companies. We are proud to be recognized as having made the most significant gain of any company, and we will continue to strive for operational excellence as we move forward. Now, I'll turn the call back to Kevin to open it up for Q&A.

First question, Hassane, I just want to get into the linearity of demand you saw in the first quarter and thus far in the second quarter and maybe specifically what you're seeing in the silicon carbide side. I know you said that the market TAM is going to be slower, but you'll still grow 2x that. What's your estimation for what the market TAM is going to do?

Yes. Specifically, on the first quarter, we did see a slowdown through the quarter. Specifically, if I were to break it, you can think about it after Chinese New Year, typically, we would expect a slight recovery or back to linearity, and we didn't that's where we started to see some of the incremental softness that we talked about, specifically in auto. As far as the silicon carbide, I think it's too early in the year to call a market. What I'm basing my comments on, and specifically the 2x growth, is really a bottoms-up share gain that we have based on a vehicle-by-vehicle and socket-by-socket that we're designed in. And we know what the sockets and the designs of the platforms are out there. What is pending to see today, and like I said, it's early in the year still, is the sell-through of these vehicles. As we get through the second half of the year, that picture will get clearer. I'll get a little bit more accurate as far as what the market would do. But for right now, we're looking at it as are we designed in more than 2x the sockets that are deployed this year, and the answer is yes.

For my follow-up, Thad, I have a question for you regarding gross margin. Congratulations on maintaining the 45% floor. Can you explain some of the unique factors that will influence gross margin moving forward? You mentioned the impact of utilization as revenues increase. Considering East Fishkill and exiting fabs, what are the advantages and disadvantages we should keep in mind regarding gross margin throughout the year?

Sure, sure. So just starting with the utilization. So as I mentioned in the prepared remarks, 1 point of utilization is 15 to 20 basis points of gross margin improvement. So think about us being at the mid-60s. If we get back up into the low 80s, you can do the math on the tailwind there. For East Fishkill, we expect this year, it's about 100 basis points dilutive as we go through the rest of the year. That's the foundry business. As I mentioned, we now have the cost parity with our other fabs. So we're happy with the progress we've made there. That gap is underutilized. So you get that benefit, as I mentioned, on the utilization. The other component is the fab divestitures from 2022, the 4 fabs. We start to see that's starting to be monetized in 2025. That's $160 million of annualized costs. We won't see it all in '25, but we'll start to recognize it in '25 and the outer-years as we move that production into our fab network. So that's another nice tailwind. And then we've got the ramping of new products that are accretive to gross margins. That includes silicon carbide. As we continue to scale silicon carbide in '25 and further, that becomes accretive. And all new products, as Hassane mentioned, the new product revenue is growing, that at scale is all accretive as well. So I think if you do the math there, you start to get pretty close to our target.

Hassane, I'm trying to understand the message and outlook for the second half given the weaker conditions and headwinds we experienced in Q2. How should we approach the pace of recovery from this point? I thought I heard Thad mention plans to increase distribution inventory, which sounds like a positive sign. However, if we noticed signs of weakness towards the end of Q1, that seems less encouraging. I'm looking to clarify what signal you're sending for the second half. Is Q2 expected to be the lowest point? How should we think about Q3 based on what we know now? It's clear that the situation is fluid.

Yes, let me clarify. First off, I'm not going to predict when we'll hit the bottom. I was clear last time that I'll make that call when I'm on the other side. We have observed a slowdown related to both inventory digestion and demand. I believe these two factors are connected, and we expect them to persist in our outlook for Q2. However, for the second half of the year, we are beginning to see some stabilization in demand. I wouldn’t go so far as to call it a recovery just yet, but if I had to use a letter that many refer to, I would say it resembles an "L" at this point. This indicates that while we are seeing stabilization and some signs of recovery, demand is not deteriorating further. Whether demand will increase is still uncertain, but we do see stabilization in our outlook.

Okay. And then on the silicon carbide, just 1 or 2 near term and then kind of the longer term. On the near term, what did your silicon carbide sales do in Q1, either sequentially or year-on-year? And what's your China exposure? And then there's a lot of industry discussion about low-priced EVs. And I think you guys have both silicon and silicon carbide. And I'm wondering if there is an industry move towards the so-called lower-priced EVs, especially in the U.S. market? Would that be positive or neutral to ON's power opportunity?

We are not breaking out our silicon carbide sales on a quarterly basis. Last year, we provided annual figures for competitive reasons. However, we anticipate an increase in 2024 compared to 2023, and we will update our annual results for 2024 as we approach the end of the year. Regarding low-cost electric vehicles, the market presents an interesting dynamic. Our position allows us to benefit from whichever technology customers choose, whether silicon carbide or IGBT. We have observed benefits from both technologies in various accounts and platforms. I want to emphasize our efforts to enhance the efficiency of silicon carbide, both in device and packaging, through our new generation that we've introduced and that will ramp up in the second half of this year, particularly with many of the Chinese OEMs focused on low-cost EVs. These OEMs are utilizing silicon carbide because the efficiency gains they achieve with our silicon carbide and packaging solutions lead to significant cost savings on the battery compared to switching from silicon carbide to IGBT. From a system-level perspective, since the battery represents the largest expense, any technology that helps optimize battery costs will be advantageous, and we've seen customers successfully achieve that. Regardless of the technology or system cost they prioritize, we will benefit whether they choose silicon carbide or IGBT.

I have another question about silicon carbide. If you're not going to provide the quarterly revenue, could you update us on what the gross margins are doing? Are they stabilizing or declining? Also, what are your pricing expectations for the remainder of the year? Have those expectations changed? Lastly, what revenue level do you need to reach your 50% gross margin target?

Yes, I believe the gross margin for silicon carbide is stable. As we discussed last year, it will continue to be stable as we increase revenue, and we have also added capacity. The utilization and growth will balance each other out to maintain stability in the gross margin. In the longer term, as we utilize our installed capacity, we expect to see positive growth in the gross margin. As we ramp up internal substrates, it will contribute to the incremental gross margin needed to exceed the 50% target we mentioned, moving us closer to our long-term corporate model of 53%. I also want to emphasize that we are making incremental improvements in efficiency, allowing us to meet customer power requirements with smaller die sizes. This leads to lower system-level costs and reflects our ongoing technology improvements aimed at enhancing our cost structure. The combination of cost management, new product launches, and expanding our capacity will drive our incremental margin. We are confident about our trajectory for silicon carbide margins and will continue to execute our plans effectively.

Great. And then for my follow-up, between your 2 big markets, auto and industrial, would it be fair to say that the industrial market appears to be stabilizing, but the automotive market is getting a little bit weaker? And is all of that weakness in silicon carbide? Or is there weakness in auto outside of silicon carbide?

Yes. Generally speaking, your observation about the market is accurate. In terms of the automotive sector and the second part of your question, the issue isn't limited to just silicon carbide. While the total addressable market for silicon carbide is well recognized, our growth in this area is primarily driven by gaining market share rather than reflecting the entire market. We have consistently communicated this. We remain on track for 2024. However, we did notice some additional softness in the automotive sector regarding silicon, which relates to the broader automotive market conditions.

I had a question on the silicon carbide business as well. For this year, Hassane, what's the rough split between automotive and industrial? And more importantly, I was hoping you could speak to your diversification efforts. I think customer concentration has been a bit of an issue from an investor perspective. Your largest customer was significant last year. I think they'll continue to be significant this year, but how should we think about your customer base and your customer mix broadening, and SiC specifically, going forward?

Yes. So the first part of the question. It's been pretty consistent. You can think about it as 80-20, 80% auto, 20% industrial, give or take. Depending on the quarter and when the ramp happens, they're a little bit asynchronous ramps based on the end market. As far as diversification, we've been very consistent on 2024 will be more diversified than what 2023 was. That remains the case. Last quarter, we called out ramps in automotive OEMs in Europe starting to ramp EV with onsemi silicon carbide. The comment I made today is further proliferation in the Chinese EV, which today is the biggest penetration of electrification in light vehicle production. Between those 2 efforts as these ramp in the second half getting us to that 2x market that I talked about, that's going to come with further diversification across all geographies. Very consistent with where our LTSAs originally were, and where the ramps have started to occur. So predictable, consistent and we're executing to that.

Great. And as a follow-up, I feel like you talked about data center a little bit more than on prior calls. To level set us, can you speak to the exposure you have to AI or data center more broadly today? And how are you thinking about the growth profile there over the coming years given the focus on AI infrastructure spend across your end customers?

Yes. If you go back to our last Analyst Day where Sudhir, in his prepared comments, talked about the power tree being very similar in automotive, industrial and cloud and data center. We've talked a lot about our penetration and our success in auto and industrial, and we've shifted our focus over the last 3 years to the cloud and data center. At Analyst Day, we talked about that outlook being about 22% CAGR over the next 5 years. That's what our investment thesis has been. We've been introducing products both on the power discrete side, and furthermore on, call it, controllers and point of load and so on, which is more on the intelligent power coming from our Analog and Mixed-Signal Group that we've organized around that effort. So all of these put together are where our investment has been. I talked more about it this quarter than I did last quarter even just because of our progress on it. Last quarter, I talked about our success in sampling, a lot of these products coming from that group. We're further sampling and engaging with customers. I'm very bullish about it. You'll hear more about it as we get through the year. But the target markets are auto, industrial, but on top of that is the cloud and data centers.

Are you able to size it for us today? Is it low singles, mid-singles? Any hints there?

Not yet.

Hassane, you probably realized this already, but most investors are worried about the ability for non-China silicon carbide suppliers to compete in the China market against local competition. And your messaging on that front was clear that you're gaining share at the top 10 China automotive OEMs. But longer term, what's your hook to remain successful in that marketplace? Is it a focus on higher-voltage battery systems? Is it hybrid silicon, silicon carbide solution? Is it local investment into the China market? Any color there would be helpful.

Yes. I've always been clear that we compete based on the value of our products. Ultimately, if our products lack value, someone else will be willing to accept lower margins for a product that is merely adequate. That’s not our approach. Hence, we continue to invest and aggressively pursue a roadmap that delivers value to our customers. From their perspective, it’s about cost savings; if they choose onsemi, they can save hundreds of dollars on batteries compared to opting for a cheaper local option, which might incur additional battery costs. This is why we succeed in every market—we prioritize maintaining our technological leadership, rendering competitors' actions irrelevant. We've demonstrated this consistently year after year, regardless of competition from European or local Chinese vendors. Our vertically integrated strategy allows us to operate the most financially sound business in silicon carbide, enabling us to gain market share and exceed market growth. These factors are strong indicators of how we will continue to address this business in both the short and long term.

As a follow-up, I wanted to ask about your design win metrics. You mentioned a 30% quarter-over-quarter increase in design wins, which I assume refers to lifetime value. Looking at this on a long-term basis, are the trends you are seeing in lifetime value over the trailing 12 months supportive of the 10% to 12% long-term revenue growth targets you have outlined?

That's right. We do see that. That's kind of based on the model. You're right, it is a lifetime revenue. But the way I look at it, to support the 10% to 12%, it is the, I guess, the overlaid annual revenue on top of the base, on top of the new products that continue to grow. If I put all of these together, our next outlook is supporting the 10% to 12%. So you take the base, you add the new products, and you add new design wins on top of it, and that layering effect gives us that 10% to 12% growth.

Hassane, I had a quick question for you on distribution and OEM partner inventory. I guess the question is, which one for you is bigger? And then are you comfortable at this point with the inventory you're holding? Clearly, you mentioned that you're raising inventory at the disti, but would you give us some color on the inventory of the OEM partners? And also, this environment is a very good test of pricing. Are you seeing pricing generally hold up pretty well for your products?

Yes. Let me begin with pricing. We have observed that pricing remains stable, thanks to the benefits of the LTSA. Many of our discussions with customers have centered around managing volumes rather than pricing, which reflects our commitment to mutual benefit. We have invested in capacity to support customers even in a softer market, but our conversations have not focused on pricing, and we do not anticipate that changing. Regarding inventory, it fluctuates based on market conditions. We started to reduce our utilization and shipments in the industrial sector at the end of 2022, allowing us to assist customers in managing their inventory more effectively throughout 2023. This has contributed to the stabilization that Thad mentioned and provides a positive outlook for the standard segment of our industrial business. In the automotive sector, while we experienced weakness in Q1 and anticipate similar challenges in Q2, we foresee further stabilization in the latter half of the year. This indicates where we stand concerning customer inventory levels. It's important to note that customer inventory levels are also influenced by demand; if demand increases, the inventory depletion accelerates, whereas stable demand means a slower drain. We believe that customers maintain a healthy inventory level and we are optimistic about stabilization in the second half. Concerning distribution, we've always managed our distribution inventory with discipline. We anticipate an increase in the second half in preparation for new product launches, which we have previously discussed. In the last quarter, we reduced our inventory in the channel by $19 million, while the dollar value of inventory decreased despite an increase in weeks of inventory, slightly exceeding our guidance. This reflects our disciplined approach, which we will maintain moving forward. We do expect distribution inventory to increase as we prepare for the rollout of silicon carbide and other new products in the second half. Our internal inventory management has also been strict, leading to a significant reduction based on utilization. The only increase we have seen is in strategic inventory for good reasons, all of which pertains to capital transfers.

Got it. I had a sort of a multipart question on silicon carbide. You talked about 2x growth relative to the market based on design wins, bottoms-up approach. I guess, when you talk to your customers, what kind of growth are they implying? And then secondly, you talked about wins in China. Are these based on your own internal wafers? Are they based on your outsourced wafers or external wafers? And then is there any situation you see where silicon carbide is flat in 2024 and just kind of wild possibility?

I prefer not to speculate on improbable scenarios. I can only discuss what we observe in the market and from our customers. Silicon carbide is set to expand in 2024, and we anticipate our growth to be twofold. Specifically, we know the platforms that will be scaling this year, the ones we are part of, and the products we are supplying for those platforms. By this stage, everything has been qualified and is in the process of shipping and ramping. That foundation is what supports our expected twofold growth. Regarding the total addressable market, it’s important to note that until those vehicles are in circulation, the total addressable market cannot be accurately defined. As for our substrate mix, over 50% of our substrates are sourced internally. However, we don’t alter our shipping mix based on destination—whether it’s to China, the U.S., or Europe. We ship according to what we need for production. Currently, the mix remains over 50% internal. Customers don’t specify which substrates must be used, as it’s the device that gets qualified at the customer level, not the substrates.

With the view that dynamics in the second half are going to start to normalize or stabilize, are LTSA, customer calls to revised volumes, push out cancellations on the non-LTSA business, are these activity levels here starting to stabilize or decline ahead of the second half shipment stabilization? Or do these activity levels continue to remain at pretty high levels?

Yes, you are correct. They have indeed slowed down requests for pushouts and changes in volumes, which provides us with reassurance regarding the stabilization we discussed for the second half. The LTSAs have been useful during this market softness, and we are observing that same utility as we navigate the slowdown and make amendments with our customers.

And Harlan, I would add, if you look at the non-LTSA orders, the order pattern is getting stronger. So that's the stabilization we're seeing. We're seeing less cancellations, less pushouts than what we saw over the last couple of quarters.

I guess my first one is on the image sensor business, primarily. If you could talk about kind of demand and sell-through there but also inventories and your plans on internalizing some of those wafers from foundry into GLOBALFO as well.

Yes, I think demand for image sensors is strong, and we hold a significant market share in that area. Overall demand for image sensors is closely linked to the automotive sector. We believe the inventory situation is improving, which aligns with my earlier comments about the automotive market. The growth we've observed, particularly in 8 megapixel sensors, is due to the shift towards higher-resolution cameras, a trend we've highlighted over the past two to three quarters. This trend continues, and we see the growth of this business even as light vehicle production numbers are increasing. From this perspective, the situation is clear. We are also introducing new products from our facilities, and while this is not entirely internal, we have valuable foundry partners and will maintain collaboration both internally and externally. You can view this more as a supply assurance rather than a complete shift in strategy to going solely internal.

Yes. Chris, it's Thad. Let me get through that. So just starting in reverse order, the lifetime LTSA value is $15.7 billion over the next 12 months, the value of that is $4.7 billion. I think that's consistent with what you heard last quarter if you think about what rolled off in Q1. Lead times are down just slightly, roughly around 40 to 41 weeks. So not a big change on that side of things. And I did mention in the prepared remarks, utilization decreased slightly from 66% to 65%. We expect to be running in this range, plus or minus, for the remainder of the year until we start to see more of a market recovery. As we see the stabilization, we believe we can keep this utilization for the remainder of the year.

I wonder if you could talk to the opportunity in hybrid cars. As you sort of see some of the demand shifting from battery power to hybrid, what's the opportunity for ON? Is it silicon carbide? Is it IGBT opportunity? Can you just talk to that?

Yes. The opportunity in plug-in hybrids, parallel hybrids, or the non-battery electric vehicle segment of the electrification in mobility involves both IGBT and, in some cases, silicon carbide depending on the drivetrain. Previously, I mentioned that the potential for us in non-battery electric vehicles is about $350 in powertrain content. In contrast, a full battery electric vehicle has approximately $750 in powertrain content, while internal combustion engines have around $50. These figures represent the general range we have discussed.

Great. Regarding the pricing discussion, you mentioned that LTSA pricing is stable. When you enter into new agreements or work with new customers and designs, is the pricing different from what you've experienced previously, and how does it align with your current pricing model?

No, we don't see significant changes on a product-by-product basis. The value we assign to a product is based on our pricing, and that value remains consistent across different designs. Pricing adjustments typically occur with the introduction of new technologies that benefit both our customers and us, such as transitioning to a smaller die due to the efficiency of our new model. These changes are part of our normal business operations and can result in incremental margins for us, although you might notice a difference in average selling prices. However, these are distinct products, and that’s how the industry operates.

And Joe, it's Thad. Just remember, we walked away from that $475 million of highly volatile price-sensitive market. So I think in this situation, you probably see some pricing pressure on that. Obviously, we're not seeing that. We don't have that business today.

I apologize for beating the silicon carbide horse. But I understand there's a lot of volatility in that market, and you're reluctant to give a granular market forecast right now. But maybe we compare it to a few quarters ago, has the increased volatility been, would you say, because of a meaningful change in the adoption curve across the EV industry at a broad base of customers? Or is it because of pushouts or unit dynamics because of the early adopters that's driving the lower and more volatile forecast?

I cannot name a specific customer, but it's clear that everyone can see the discussions and outlooks of particular customers. What I want to emphasize is that there have been no delays in production plans. All the designs we anticipated moving to production in 2023 are still on track. Manufacturers are not abandoning their long-term goals for battery electric vehicles due to short-term fluctuations. We are witnessing a ramp-up in qualified designs, which is scheduled to begin in the latter half of this year. I've already mentioned Europe and talked about China as well. So there are no production delays. Regarding the total addressable market, the planned volumes from last year have adjusted due to current market conditions, but the same models are still set to launch. This is a crucial distinction, as one aspect focuses on the long-term strategy of the manufacturers, while the other addresses the immediate response to our current economic situation.

That's helpful, Hassane. And maybe for Thad. You called out that over the last 12 months, you've returned over 100% of free cash flow to investors, which is more than your formal policy of 50%. And was this because of some dislocation in the market you saw, and we should expect it to trend back towards 50%? Or should we expect it to sort of remain elevated here in particular as you go through the period of peak capital spending?

Yes. If you look back over the last 12 months, in Q4, we bought back $300 million. That was above our target there. And that was the dislocation, right? We've said our policy longer term is 50% over the long term, but we will take advantage and be opportunistic where it makes sense.

I know you're not calling for a recovery yet in the second half of the market. But Hassane, your comments on the battery electric vehicle ramps in the second half of the year certainly imply that perhaps silicon carbide sees a better second half. So I'm wondering what's the offset that would keep revenue sort of more stable in the second half if I'm reading your comments about the battery electric vehicle ramps in the second half correctly.

Yes. We don't provide guidance beyond one quarter at a time. However, silicon carbide is expected to perform better in the second half compared to the first half due to the ramps I've mentioned. When I refer to stabilization, I mean returning to a state of normal supply and demand. The demand levels will determine the stability for the second half. It's too early to say whether demand will recover, but we can definitely identify an increase in demand specifically for silicon carbide. Still on track. What we talked about is qualifying '24 ramp in '25, and we're still on track to exactly that timeline. So no changes there, which is obviously a positive development of our silicon carbide efforts.

Thanks to the tremendous effort of our global teams. We've transformed the company, improved our resiliency, and adapted to changing market conditions to deliver sustainable financial results. We remain dedicated to our customers, our financial commitments, and our strategy of enabling the sustainable ecosystem. Thanks to everyone on the call for joining and supporting onsemi.