Good morning. I'm Tim Arcuri. I'm the semi and semi-equipment analyst here at UBS. Very pleased to have ON Semiconductor with us.
Mm-hmm.
and we have Hassane El-Khoury, who's the President and CEO, and we have Thad Trent, who's the EVP and CFO. Thank you to you both.
Thank you.
Thank you. It's been a little over a month since your earnings call in late October. We've now heard reports from the entire sector since you reported. How do you feel just about demand, how it's progressing versus what you thought when you hosted your earnings call?
Yeah, I think, like you said, a few months have passed. No real change from what we talked about as far as the demand environment. You know, demand is overall. We see signs of improvement, but stabilization. To me, at this point, stabilization is actually a very positive thing given where we've gone. Ordering patterns have improved from where we were even 90 days ago or where we were at this point in time last year as far as what the outlook looks like. We are looking at stabilization. We are looking at kinda return potentially to normal seasonality.
If you talk about orders having gotten maybe a little better over the past 90 days, is there a customer base that's getting a little better? Is there an end market that's getting a little better? Autos maybe getting a little better?
I think my comment is more across because where we are in the demand environment today is not any more specific to a certain segment or end market. It is more on a macro improvement or macro health. You know, we expect the inventory drain to kinda be behind us by the end of this year. You know, we will not be talking about inventory drain, but inventory remains at a very low level. Although customers drained inventory and that is behind us, we are at a very low level, which means that even before a demand cycle happens, there is a replenishment cycle that has not happened yet. Typically, after an inventory drawdown, you see a replenishment to get back to kinda your normalized demand, and then you have the recovery.
We have a double positive still ahead of us, and we have not seen that replenishment. That is what we are looking at now. From our position, how we have been managing the company operationally, we are in the best position we could be. You know, our inventory in the channel is exactly where we want it. Inventory on the balance sheet is exactly where we want it. The replenishment and the demand, we can take utilization up right away. We do not have to wait to burn, you know, balance sheet inventory and what have you. As soon as we take utilization up to match that, you know, margin will follow up, margin expansion, you know, two-quarter lag, but margin expansion will happen, and we are off to the races again. The last few years, we have managed the company operationally. We have had the Fab Right.
We've had, you know, operational improvements as far as our footprint to position us to capitalize on whatever and whenever demand starts to go up again.
What, why do you think customers have yet to start to build inventory? Why, why hasn't this begun yet? I mean, is it, is it just macro? Is it, tariff uncertainty? And what are you looking for to get more bullish about it?
Yeah, it's, it's all of the above, really. You know, customers, you know, I have a lot of engagements with customers, and the common denominator is what visibility or what demand do we wanna build to? When you talk about, do we believe 2026 is going to be, you know, whatever you believe the market is going to be, customers say, "Yeah, we hope so," but they're not gonna build balance sheet inventory until they see that demand. What needs to happen for them to commit to it? And what I mean by commit is put it on the backlog and commit to the order, not just give me a forecast 'cause I'm not gonna build to forecast and strap cash. I'd rather have free cash flow to buy back shares. What needs to happen? One is certainty, outlook certainty.
That comes from geopolitical certainty. It comes from tariff certainty. It comes from a lot of that macro, uncertainty we're living through. That's what we need to see first and foremost 'cause that builds consumer confidence. Consumer confidence builds demand. Demand builds backlog. That's what we need to see. We look at all of these metrics internally, both Thad and I, every week to make sure that, one, we're not getting a false positive. You know, one uptick or one big order or one short-term order doesn't mean a recovery is happening. We do have signals that we're monitoring that are gonna be a leading indicator for us to start building that inventory.
Are there some, so some of your peers have talked about this sort of odd dynamic where it's the end of the year and, you know, nobody wants to build inventory because it's the end of the year, but there's some sort of risk mitigation. People are putting bookings into the backlog just because they're worried about shortages. And, you know, maybe some optimism growing about the first half of the year.
Let me, I'm smiling because I don't sell insurance. You want an insurance policy for potential shortages and so on, then put the order in and buy it and put the inventory on your book. What I mean by, you know, in all seriousness, I'm not going to start taking utilization up and building inventory just in case because then it's on my balance sheet. It's on my cash flow. And then if the demand doesn't really materialize, I have to take utilization down again. That's more harmful than having the conversation with, "Look, our lead times are low." You know, call it about 14 weeks. Okay, you want orders in Q1, place it in December. You see what I mean?
Mm-hmm.
There is no, no benefit for the customer 'cause if the customer puts an order for, call it June, what do you think? I'm gonna start building it now? I'm not gonna build it. I'm gonna build it sometime in April, whatever the cycle time. I may have it in Die Bank already. You see what I mean?
Mm-hmm.
I don't think that's a sign that I use to change our approach to operational excellence.
Got it. It's the time of the year, or it's the time for end-of-the-year annual price negotiations. I have to ask about the pricing environment, how you see it?
I think it's, it's, has not really changed. You know, we're looking at overall kinda as an industry that, low single-digit, pricing. It's not kind of, all a cliff in, you know, the January or February. It's just staggered throughout the year, but you can talk about overall for the year is low single digits.
That plays out throughout the year, basically.
That plays out throughout the year.
Got it. Let's talk about silicon carbide. The market's been pretty challenging. You don't tell us a whole lot about the business anymore, but you do think that you outgrew the market this year?
Overall, we don't talk about the business as a standalone business 'cause we consider it now part of our baseline or part of our core. I don't break out every business we have. From a market share gain, we've been very successful gaining share, one in North America. We've been very successful gaining share in China. You know, I've been very vocal about our China market share, reaching the 50% from models introduced. We continue to make progress with ramps in Europe. From a market position versus the ramps that customers are having, we feel very comfortable, and we feel pretty good about where we need to be. As that market continues to evolve, we're just gonna keep continuing to grow with it and gain share.
Do you do think that this year you gained share and you expect to gain share next year?
We yes.
Okay. Can we talk about silicon carbide, the, some of the emerging applications inside the rack?
Mm-hmm.
How big is this? You know, customers trying to optimize efficiency and power density. How much of a driver could this be?
It is a driver. You know, we talked about our AI revenue reaching, for 2025, being at the $250 million range. I've always said we're coming at it from the high-power side, getting all the way to the smart power stage. Silicon carbide plays a big role for us. If you recall, we acquired the silicon carbide JFET business a few quarters ago from Qorvo. That business has done very, very well for us because JFET, silicon carbide JFET specifically, is one of the best technologies from an efficiency and power density for the UPS and the power in the rack, especially as customers start moving to the 800 volt.
Maybe we can talk about the competitive landscape for silicon carbide in China. I continue hearing investors, who are concerned about, you know, some of the Chinese customers, moving to more of an ODM model rather than just buying the integrated devices. I'm sure that you get this question all the time. Can you just talk about that? Is that completely overblown?
I think it's overblown for a few reasons. One is the competition in China, and I'll take it in two ways. One is, we've been talking for two years about how silicon carbide competition in China is gonna be so intense. Here we are today, and I'm still gaining share in China because I've been very consistent in my approach of you're not gonna win based on pricing. What you're gonna win, especially in China where EV is really a key advantage, is you're gonna win based on the technology. The technology, meaning efficiency, the number of die. If I'm able to do in three die what my competition needs four or five, I'm already ahead from a cost and system level. That's how we win. That's why we win. That's why we gain share in China.
It's not against the indig, you know, China, silicon carbide supplier. It's also against Western companies in China. That's why we're winning. Now, the transition, you know, you talk about ODM and integrated and so on. I've talked about that transition, even last year where we have seen a transition from, you know, modules also to die. We have a mix of both. That's not positive or negative. That's more of a cost. If they want to bring it in, that's great. They still use our die because we still have the best die. Where you need advanced packaging and differentiated packaging, those customers are still buying our modules and our packaging. It's really dependent on the customer capability and really the use case.
We still tackle both, but with a transition from what used to be 100% module when this market was brand new to now there are capabilities out there just from assembly houses that can do some of these, call it the prior generation modules. There's an ASP change. If you look at it from a volume perspective, our volume has been increasing. That's why I refer to the market share. I think 2025 is gonna be that transition year.
Just to point out, on both those scenarios, whether it's module or die, it's favorable margin for us.
That's right.
It's just a difference in ASP. Does it pressure utilization for your packaging operation?
No, no, because packaging, from a utilization perspective and so on for these is not the overhead. You know, we size our packaging because our investment, and Thad has said this, part of our fab or manufacturing right approach is we only want to manufacture internally what is differentiated, meaning what we cannot get outside. That actually fits very well with our strategy 'cause I do not want to build modules internally if somebody else can do it. Our utilization is dependent on that differentiated packaging that I talk about, and that is still internal. That is not going outside. There is no change to our manufacturing optimization approach because the market dynamic actually fits very well with our manufacturing strategy.
Got it. Thad, maybe we can talk about gross margin, and some of the puts and takes headed into 2026 with a few maybe more normal seasonal quarters, you know, maybe even some above seasonal quarters. You know, utilization maybe begins to have a bit of a modest tailwind if we, you know, begin to go above normal seasonal. How do you think about the puts and takes on gross margin and maybe, how mix could be a little different next year than it was, this year?
Yeah. So, you know, you fit it, right? I mean, the short term, short term meaning 2026, gross margin's gonna be driven by utilization, right? And as Hassane said, we can match our utilization with whatever the market recovery starts to look like given, given our portfolio or, or a profile of inventory in the channel inventory on our balance sheet. So as utilization goes up, every point of utilization is 25 to 30 basis points of gross margin improvement. You know, today we're running at 74%. I said Q4 was gonna be flat to down slightly as we're building some, some mass market inventory in Q3. But if you think about fully utilized for us, is in that low 90%.
If you do the math on that, getting from where we are today to that maximum level, you get 650-700 basis points of gross margin improvement. Now, you need revenue to get there, obviously, but we'll be able to match that utilization with the market. On top of that, you know, we announced the impairments. In Q1, we took 12% of our capacity offline. A couple weeks ago, we announced more capacity coming offline. This is a result of all the activities we've been doing in our manufacturing footprint, our Fab Right initiatives to get more output out of the existing footprint. You think about it from a depreciation standpoint for next year, it's $45 million-$50 million of benefit in depreciation just with these impairments for next year.
Now, there's some lag for that to hit the P&L, but, you know, exiting next year, it's almost another 100 basis points right there if you think about the impairments. Favorable mix longer term is, is Treo Ramps and these other products. You know, we think we'll get another 200 basis points of gross margin benefit there over time. We believe there's more on our Fab Right initiatives, so another 200 basis points there. That kind of includes our divestitures of fabs that we did a couple years ago. If you start adding all that up, you can get greater than 50%, which is what we aspire to be on a gross margin standpoint. When we think about our line of sight, we see improvement. It's a matter of what this market recovery looks like. That's the number one driver.
Just on the divestiture piece, that's an additional 200 basis points. How will the timing of that lay out? Like.
So.
Will that all be recognized next year?
No, we won't see it all next year because we built inventory as a part of that fab transition. Now, the market has come down, right? It is going to take a little bit longer for us to burn that through. The benefit is when we burn that inventory and then we start manufacturing it inside. That is where you get the true leverage. We will see a little bit of it next year, probably a lot more of it in 2027.
Yeah, that's a lot market and demand dependent. The faster we burn that strategic inventory, the faster we can start bringing it inside, which helps both from a cost and mix, but also from utilization. Got it. All things considered, back to your point about next year really will be about utilization. If utilization's flat, gross margin should be about flat. All these other things really help more in 2027 than in 2026.
Yeah, but I believe that, you know, if there is some recovery, we're gonna match that, and I think we will see margin benefit in the latter half of the year next year, assuming that there is some recovery that we start to see early next year. Also keep in mind all this underutilization is non-cash, right? So if you look at our free cash flow margin, you know, talked about the free cash flow margin being around 25% this year. That's, as that utilization goes up, gross margin improves, it improves operating margin, but free cash flow is already there.
Can you talk about maintenance CapEx? The fab network is, you know, far from fully utilized, obviously. Where, what kind of projects are you directing CapEx toward for this year?
Basically maintenance. We're in this mid-single digit CapEx intensity, right? We were there this year. We'll be there for the foreseeable future. It's maintenance. We're not, we're not having big investments. I mean, I just talked about taking capacity offline.
Yeah.
Right? We've got plenty of capacity.
It seems to me like if the market doesn't recover, there's an argument that maybe you should further consolidate the fab network. How do you think about that?
We're always looking at it. We're not done, as I said, with Fab Right. We've done a lot on the front end. We haven't done a lot on the back end, but we're tuning up that footprint. We'll continue to consolidate where it makes sense.
Yeah, but we have to also be very, very clear on there's the operational efficiency, operational excellence, and strategic intent. What we've been doing are things we're doing regardless of market being up or down because those are efficiency improvements that we've had, improve costs, improve margin, improves the structure of the company. Of course, you know, we're not looking at the market as we sit today in the short term, even, you know, in 2026 and saying, "Oh, if the market is gonna be at this level, we have to take capacity out," 'cause now you're starting to stifle your strategic growth. Everything we've done so far is driven by efficiency, driven by getting more throughput out of our existing footprints 'cause all the fab rights we've done. They do not have an impact to our long-term trajectory of growth. We're balancing the two.
We have to have the most optimal footprint based on where our strategic plans go. You know, Treo, for example, you know, we talked about Treo being a very successful launch, and we're starting to generate revenue. We're starting to get customers across all of the end markets. That CapEx is already in. That's already in, in East Fishkill. We look at capacity rationalization and footprint rationalization, not as a market kind of navigating the current market environment, but more on two, three years from now, do we have the most optimal capacity from a cost and throughput? That's the decisions we've been making now.
Got it.
I get this question all the time from investors, "Why not just buy something to fill the fabs?" I know your answer is, "We're not in the fab filler business." You've said that before. I mean, given how much capacity you do have, this might not be a bad time for you to, if something was strategic and, you know, for you to make an acquisition.
Again, your first comment is true. We're not gonna make an acquisition to fill the fab. Acquisition, you know, we're gonna use our firepower to do strategic acquisitions. Now, of course, a strategic acquisition that we can bring internal is very valuable as well. Practically speaking, let's say we announce something, it takes about a year or so to close and a couple of years to bring that technology in unless we already have it, which is if we already have it, why would we buy it? Does that make sense?
Mm-hmm.
That approach doesn't solve a it's not a 2026 solution or even early 2027 solution, even if I wake up today and I say I have a deal done. Does that make sense?
Mm-hmm.
Part of our M&A and our discipline, of course, we look at all of the above. We look at strategic intent, technology gap, differentiation versus our financial model. Part of the synergies we can extract from a potential acquisition is, can we leverage our manufacturing footprint both front end and back end? We consider 100% all of these as part of a deal.
Got it. Can you talk about just an update on these non-core, you know, pieces of business that you're walking away from? It's sort of come a little slower than what, than what, you know, you would've thought. Can you talk about why that is and sort of what the update is as you look into next year?
Yeah, let me calibrate it. In 2025, there's 5% of the revenue that won't repeat in 2026. Let's call it roughly $300 million. We've talked about these non-core exits for several years now. The way that we were exiting that business is we were pricing ourself out of the market. It turned out we didn't lose all that business because it got to favorable margins and it didn't disappear. The fact is, this downturn has been prolonged. We've seen competitors now coming back and start to take some of that business. Today, that business is healthy business around the corporate average. We're not going to chase it down as the margin comes down and the pricing comes down on that stuff.
There's about $100 million out of that 300 that is in that category for next year. There's another 50-100 that is a part of our ISG, our image sensing business that we've repositioned. We've been talking about this for several years, repositioning that business into machine vision away from human vision. We are exiting some of that business just by the nature of us repivoting that business. The third piece is stuff that we've been EOLing over the last several years, and that's another $50 million-$100 million . Roughly, you get to about $300 million for next year. The non-core exit that we've talked about for several years is about 100 going into next year. There's about a 5% revenue that just doesn't peak, repeat in 2026.
Got it. Hassane, do you, do you have when you, when you think about, gaining content in data center, do you have all the IP you need? You know, you have Treo and that's going well, which I wanna ask you about in a second. From an IP perspective, are there building blocks that you need to gain, Sharon?
No, I, as it stands today, we have built the complete portfolio. You look at it, we started with power. We complemented our existing IGBT or silicon power, whether it's high voltage or medium voltage, with an acquisition of silicon carbide JFET that I mentioned. We've also announced the acquisition of Aura Semiconductor, which puts us even closer to the controllers and, you know, closer to the core from the power pedigree. As it stands today, we've announced the vertical GaN as well, which is also servicing a high voltage, think about the 800 volt, but also higher frequency, much higher efficiency. If you look at overall the portfolio that we've built over the last couple of years, both organic and inorganic, we have everything we need to deliver on the complete power tree.
As that power tree collapses, the number of conversions, you're gonna start squeezing out competitors that don't have high voltage. You know, competitors that can go from 800 volts directly to, call it 48 or even 12 volt, but they're very strong at 12 volt, they have to go find a solution for that high voltage. We have the whole thing. We are in a very good spot to, to navigate and really capture, share as the market moves more into a less conversions starting with an 800 volt.
Vertical GaN is more of a 2027 revenue con.
That's right.
Can you talk about how big you think that could be and how important of a piece that is?
I'll talk about the market. The market for vertical GaN is complementary to the other technologies we have. If you think about, you know, when you have the silicon carbide brought a higher efficiency to IGBT, higher efficiency and higher power density, vertical GaN adds to that high voltage, it adds high frequency that silicon carbide can do it. It's not a cannibalizing market. It's really a complementary market, which having all of that technology in the portfolio is actually very favorable from a competitive posture perspective. The overall market for GaN in general, you can think about it as $2 billion-$3 billion. That, of course, will take time to mature, but that's where having that penetration, having that differentiated technology that as it stands today, nobody has been able to deliver to the market yet.
We've, we're already sampling and we have customers engaged. That's the confidence we have in our, in our technology and innovation that we're putting forward.
Let's talk about Treo. Can you give us an update in terms of how much revenue is flowing through Treo and sort of where you are on that journey?
Yeah, so we haven't, we haven't broken up the, the revenue, but I, what I mentioned, I think a few quarters ago, we've already shipped over 5 million. That was a few quarters ago. That business is ramping pretty quickly. We're, we're way beyond the, the 5 million units at, at that time. The importance of that is, you know, I've always said, once you get the first dollar and the first customer, you've just proven the technology. Otherwise, it's kind of a cool toy that you invented. So having these customers and a broad set of customers is really the, credibility of the technology and the platform we've done. Now, where is that headed? We are still, on track, you know, to deliver that billion dollar by 2030 of revenue. The margin, we talk about 60%-70%.
When, as Thad mentioned, as the new products ramp and become a higher % revenue, that's gonna be the tailwind for the corporate margin to get to that 50%+ gross margin. From a market exposure, we talk about, you know, industrial. We talk about automotive. We talk about medical. It's proliferating across many of our existing end markets. It's a very, very versatile technology that has proven adoption through customers designing it in and customers ramping it in production. We're very excited about that. We're excited about how quickly we got that signal from the market. Remember, we announced the Treo Platform in November of last year. In one year, we've done not just an introduction, but a revenue ramp and a volume ramp. That's pretty compelling.
Great. Thad, can we talk about OpEx for a second? I had in my notes at the beginning of the year, you were, I think you were thinking that it'd be sort of $250 million a quarter run rate, and obviously you're higher than that. Can you just talk about that? I know you were a little bit above even guidance last quarter. Can you talk about OpEx and maybe, you know, you're taking costs out, but you're also adding costs from some of these strategic investments and things like that?
Yeah, what we've been doing is reallocating OpEx within, within the company that you haven't seen. We've had huge investments that we've been making in Treo, these other platforms, vertical GaN, a lot of what we've announced, some of these small acquisitions that we've done have come with some OpEx as well. When I think about where we are today with OpEx here in Q4, this is our new baseline. You can think about this as going, what, where we're gonna be going forward. Regardless of what the top line does, OpEx is gonna be in this tight range here. Now, you'll get the reset early next year with FICA and all that type of stuff, but this is our new baseline of OpEx. As the revenue grows next year, I don't expect OpEx to grow.
I expect it to remain in this range. If you think about it from 2025 to 2026, OpEx is actually gonna be down. There is a lot of leverage in that model as revenue grows, hopefully as margin improves, OpEx declines slightly, there is a lot of leverage in EPS.
Yeah, at this point, from a percent, we expect to grow into our OpEx model, long-term model. Got it. Maybe one more quick question. The LTSA balance is down a lot year over year. I think it's at $8 billion or something like that. I mean, customers don't seem to be interested in LTSAs anymore, so all the orders you're getting are all in backlog, not in an LTSA, I would think. What are the value of the LTSAs? Like, why do you still even have them?
It is a customer choice, really. You know, some customers said, you know, we're getting what we need. We commit to the backlog, so we're not gonna renew or add. Some customers still value because look at it, if a customer is sitting here looking at and hearing some of the shortages that are caused by, you know, AI supply and so on, they go, "Get me in line now.
They're still happy to be in LTSA.
Yeah. We have always said the LTSA is not a gun to the head. It is really a constructive construct that we have with our customers. Do we tackle and take business without LTSAs? Of course. The volume or the level of LTSA dropping is purely a factor of we have been shipping against it. As we ship against it, that balance comes down and we are now replenishing at the same rate that we had, but that is not a positive here nor there because it is really a customer, customer choice.
Got it. We've run out of time, but thank you.
Thank you.
Absolutely. Thank you.