All right. Good morning, and thank you for attending JP Morgan's 21st Annual CES Conference. My name is Harlan Sur, Semiconductor and Semiconductor Capital Equipment analyst for the firm. Very pleased to have the team from onsemi here with us today, President and Chief Executive Officer, Hassan El Khoury, Thad Trent, Chief Financial Officer, and we've got Parag Agarwal, Investor Relations here in the audience. Gentlemen, thank you for joining us this morning.
Thank you. Happy New Year.
Happy New Year. I'm gonna kick it off with the first few questions, and I'll turn it over to the audience to see if they have any questions. You know, the team's strong revenue margin, free cash flow performance, you know, has been driven by a strong foundation of technology, product differentiation, focus on core auto and industrial markets, right? Your design win pipeline has been a great indicator of future growth. In 2021, your design win funnel grew 60%, new product revenues grew 28%. How much did the design win funnel grow last year, and what are the areas or product categories within your core auto and industrial that saw the largest gains?
Look, obviously, we're in the quiet period, so I won't comment on last year's result. You know, we'll talk about those when we do our earnings. Overall, you know, we've been investing and focusing on automotive and industrial, so a lot of our design win funnel growth has been in those areas, obviously, to follow our investment thesis that we've been putting together. We don't see that changing moving forward. You know, if you look at our Analyst Day and even our projections that we've had since Analyst Day, where we expect the auto and industrial to outgrow the market, given our focus on it, but also the content gains that we're doing.
Within these, obviously, there are trends within each of these markets that are holding up and driving the design win funnel and subsequently the growth in these markets. In the automotive, you have electrification and ADAS. In industrial, you know, what we call the core industrial, factory automation energy infrastructure, medical. Those are what's driving a lot of that design funnel, and also obviously subsequently the revenue projections that we've had.
You know, demand trends, you know, began to decelerate for the team Q2 of last year, driven by consumer-focused markets like PCs, smartphones, consumer electronics. With automotive and industrial, roughly 2/3 of your revenue exposure remaining quite strong, right? The team took proactive measures in Q2, lowering utilizations, maintaining lean inventories with distribution partners. Q3, you saw weakness compute consumer, and consumer-focused areas of your industrial business, right? That was sort of the incremental part. I know you're not gonna. You're in quiet period. You're not gonna talk about the near term. Looking at full year calendar 2023, you know, qualitatively, what areas do you anticipate continuing to grow and segments that will be weak?
Look, our view, our long-term view has not changed. We expect growth in automotive. We expect growth in core industrial. You know, a lot of the things that are more tied to, you know, PMI or GDP, are just like consumer and compute. We expect those to be dependent on the market. For us, we've set ourselves up starting in the second quarter of last year to be able to weather through these. Now, I'll remind everybody, we have about $400 million to $450 million in those markets that we have been working on pricing ourselves out of the market.
That would accelerate with outlook in the market, which is actually good for us because that business is actually still dilutive to your margin even in the pricing environment that we've been in for the last couple of years. As we wind that down and exit that business, it will actually help us overall. Net, net, it's actually a positive thing of how we're looking at 2023 as a transformative year to set ourselves up for 2024 and beyond.
You know, last earnings call, you talked about the continued tight supply dynamics in auto and industrial, and with a large percentage of the core industrial and auto business covered by long-term supply agreements. In fact, the team noted between long-term supply agreements and NCNR orders, the team's capacity is sold out in auto and industrial for 2023. Again, I'm not asking about the near term, but more on the 2023 profile. Is that still the case that demand still outstrips the team's ability to supply in core auto and industrial for 2023? Maybe sort of more, longer term, you know, the LTAs are great in times of strong demand, tight capacity.
As we potentially move into a period of weaker demand, you know, give us the advantages of these LTAs, and maybe more longer term, have the LTAs resulted in, you know, stronger long-term strategic partnerships with customers where they're actually sharing their roadmaps for the next few years, which is quite different relative to, let's say, you know, three, four, five years ago?
L ook, for the first part of the question, you know, when we talk about the outlook 2023, you know, we've always said we're pretty much sold out between the LTSAs and the NCNR. We're sold out. Given our market exposure, you can say it's auto and industrial are in that same category. As far as the LTSAs, look, I'll start by saying LTSAs for us or long-term supply agreements are legally binding agreement between us and the customer. What is included in those agreements is both pricing and volume, you know, people ask about, you know, ask a lot of questions about what are we doing on backlog?
At this point, we're not building to backlog. We're building to LTSAs because that's where the customer signed. When I say by the customer signed, it's not, you know, Not minimizing the title, but it's not, you know, a director of procurement that's gonna sign the, You know, in Europe, it's a member of the Board. In North America, it has to be an officer of the company. For ourselves, it's me, Thad, or our head of sales that signs. They are a legally binding agreement 'cause they're a liability for the customer because they're take or pay. That's like you said, that's all great when everybody needs the parts, w hat happens in moving forward?
Okay, look, we're not here to quote-unquote, "shove inventory." If the customer has a concern on demand or they say, "Okay, six months from now, it's not gonna be where I thought it was gonna be," that allows us a few things. One is we can manage our manufacturing, so you don't have WIP that's gonna end up in inventory. If we do, the customer will have to take it 'cause we're not gonna be left holding the bag. It has to be a win-win.
If I can move that capacity elsewhere because we're oversubscribed, that's even better for us and the customer. It's a win-win again. What we're not going to have a conversation about is pricing b ecause that's usually where everything falls apart in a softer environment. People say, "Oh, well, I can find it 10% cheaper somewhere else." That's non-negotiable. That's where we will execute the extent of the agreement. That's the call it the framework of the LTSA and our view and how we're approaching it. We haven't had to do that because we're not there yet, and we don't expect to have those, a lot of these conversations with our auto and industrial because of the other part of your question, which is the supply and demand.
We're not able to support the demand that our customers want in 2023. We're still supplying below demand e ven if demand fluctuates based on, you know, concerns in macro and all of that, and demand fluctuates a little bit, even with downward pressure, it'll just get closer to a supply that's still below it.
We're not concerned about what the macro, the demand environment is going to do to our business with the LTSAs, but the LTSAs do provide a very solid visibility on both of those. On the strategic aspect, though, I'll give you know, call it backward-looking data that gives you a projection of the front. A few quarters ago, we talked about increasing our LTSAs. You know, last quarter, Thad talked about we incrementally added $5 billion to now total $14 billion of LTSA. This is overall in the company. That dynamic is new customer, but also existing customers that had an LTSA on maybe three or four parts that were highly constrained in 2021. We signed an LTSA. In 2022, customers came back and said, "That's great. It actually fit what we want.
We were sleeping good at night for Onsemi parts that are on the LTSA. I have 200 parts that I worry about. I wanna put all of them in." Some of those LTSAs are 8 years in length. The next question is, well, how does a customer know what part? Well, they know what technology, and we will create the part together.
That's the strategic importance of these, where the customer knows, especially when they co-invest with us on a specific technology, and we say, "Okay, this analog node, the customer is gonna co-invest for capacity," it's to their benefit to create a roadmap on that technology with us. It makes us, one, sticky and way more visibility long term of what our demand and where the market is going. Net-net, it went from supply assurance to a very strategic document that both us and the customer are engaging with. Why? Because we delivered in the last two years to the essence of the LTSAs, where we didn't take the customer lines down when they have a LTSA. They saw the value.
They saw the value for us as a supplier, but they also saw the value of the breadth of technology that we are providing for their core in the automotive, for example, for their core vehicles, and that matters to the customer.
J ust let me add. Hassan talked about the duration of these. I think there's perception sometimes these are short term in duration.
They're not. These are not just for '23. Normally, they're three to 4 years +. W e're not doing something short-term to solve a short-term, and that's what makes it very strategic. If we look at the softness that we saw in consumer and compute, the LTSAs held up in that process as well.
That's our proof point that says we can enforce these with win-win situations with our customers.
Does the LTSAs in periods of weakness actually motivate your customers to give you more heads-up? N ot three, four years ago, you guys would get 30 days notice, right? That, " I'm not gonna need these products. I'm canceling my orders," and so does the LTSA program actually motivate your customers to say, "Look, we're looking at the macro environment. Six months out, like, things are looking squishy. Let's let the On team know about this." Right?
That's right.
I joke with my team. I'm like, "I f the LTSA do one thing, it's somebody's gonna pick up the bat phone and call me." I remember in end of 2018 when the backlog got a 30% haircut i f you recall. I didn't even get a phone call. I just woke up in the morning. I thought it was a computer glitch, where backlog kinda, somebody didn't add it up. Well, I don't want that.
We're not gonna be left holding the bag because, look, we've made a lot of investments in order to support that outlook from our customers, and therefore, it's a, it's a win-win. The way they see it, they have to take the parts. It's a take-or-pay.
If they let us know six , nine months in advance that, "Hey, this new model is not working out," look, that's fine. The conversation is great. We'll take share on another model that works as long as we utilize the capacity.
The fact that some customers have co-invested with us, they're more likely to give us share because of their investment from others in a, call it in an environment where they don't have the full volume, materialized a ll of those are win-win for us.
What we won't contemplate is a pricing discussion. Right? That's locked. The pricing's in there. We won't have that discussion of I can get it cheaper down the road, right?
It's the pricing's locked. What we can do is create that win-win. If we can move that capacity to another customer, sure, we'll help that customer out, but it's not a pricing discussion. That's why on our last call, I was very comfortable saying the 2023 pricing environment looks extremely stable to us. It's because we have that locked up on LTSA.
Before I move on to some of the product and technology, does anybody have any questions? Let's move to your automotive segment. you know, back at Analyst Day, the team highlighted 17% four-year revenue CAGR, right? That's your target CAGR 2021 through 2025. Given the strong 2022 performance, you guys are gonna be up, like, 40% year-over-year in auto. still implies, you know, low double digits CAGR to meet that 17% target. Electrification is a big driver. XEV production is set to grow 30% CAGR over the next three years. Then on top of that, your dollar content in XEV can be as high, incremental as much as $700 per car. Then on top of that, ADAS is driving strong content growth for your image sensor and LIDAR products.
Seems to us that the 17% growth target is gonna prove to be somewhat conservative. Has the design win funnel in auto outperformed your expectations versus two years ago when you set the targets?
Look, I think overall, the market has accelerated since we set the targets. Look, our investments match the outlook, the new outlook that we have in the market. What I will tell you is we still expect to outgrow the general automotive market because we are exposed to the mega trends that are driving a lot of that growth net of the things in auto that, you know, in the ICE engine and so on that we don't play a lot in. We're very comfortable in our outlook. We're very comfortable at maintaining our momentum fueled by a lot of the design wins, number one, and really the LTSAs that we've been talking about.
Your silicon carbide power technology and portfolio has been a big driver of the design win pipeline and future revenue growth in your core markets. As with any new emerging technology, you know, there can be a lot of noise out there, right? Noise around the yields, reliability, scrappage, parametrics, and I can go on and on, right? To me, the best way to ask the question that encompasses manufacturability, design costs, share traction is, you know, is the team tracking doing what they said they were gonna do, right? Did the team grow its silicon carbide revenues by 3x in 2022? Is the team still on track to drive $1 billion of silicon carbide revenues this year and exiting this year with silicon carbide gross margins at sort of that corporate average gross margin level?
I'll focus on the outlook more importantly. Is the team, I know the FUD out there. The yield, and I don't react to it, nor do I spend time on it 'cause what I measure our team on, including from GTAT to wafer processing.
Epi all the way 'cause we are vertically integrated, and we have metrics and deliverables in our annual plan last year and moving forward through every step of the way. Is the team delivering? The answer is yes, because you never hear me in any forum talk about we planned for perfection, and therefore we're not on track.
This stuff is hard. We have ramped many factories before. Forget about silicon carbide. When you ramp at scale, especially at the scale we are ramping and how fast we're ramping, there are ramp challenges.
We plan on those, and we have a team of experts that are currently running, you know, 20 factories for Onsemi worldwide. They know how to ramp. They know how to tackle problems. They know how to tackle all these. That makes me very comfortable because. I'll give you one thing. We've had issues during the ramp. You know, let's be realistic. We've tackled every single one of them before it becomes systemic. That is the difference between scale manufacturing and a startup.
We're not in that mode yet. You know, a lot of the conversations and so on, I know where it stems from. I'm not worried about it because we are a professional scale manufacturing company also, along with a technology innovator. Both of those puts us in a good position. Moving forward, you know, we're still on track to deliver to our plans that we've talked about, you know, the 2023 plans.
We talked about, you know, the startup costs for silicon carbide being 100-200 basis point towards, you know, exiting 2023, if I remove that stuff, I will tell you the silicon carbide margin is at or above our corporate margin as we grow.
That capacity that we had to build ahead of time, you can expect that to be an actual tailwind. All of these together are going to be helping our margin. I would say we are on track to the plans we've set for ourselves, whether it's the plan from the acquisition of GTAT or the plans for the expansion of our Bucheon fab. All these plans are being executed to our own planning.
O ne of the things I feel like the market underappreciates is that the team has been in the power semiconductor market for over 30 years, right? The market does tend to focus on silicon carbide. O nsemi is a leader in IGBT. Onsemi is a leader in MOSFETs, right? These two power technologies have been growing, I think, even recently, right? 30% year-over-year. These are driving very, very strong growth dynamics. How much, you know, of the competitive advantage that you have on silicon carbide, you know, process, manufacturing, module development, understanding your customer's requirements, how much of this is attributed to your strong position in IGBT and MOSFET?
I would say 100%. You know, if you think about a lot of the conversations we've had, and I've had externally where I talk about, you know, one of our differentiation is module development.
We have multiple decades of power semiconductor module development, design, and manufacturing. That becomes even more important in silicon carbide. Wide bandgap. We've got a lot more power, smaller area than silicon. If you're not able to get that heat out in a very innovative package, you're not gonna get the benefit that silicon carbide bring. You're just gonna be paying a premium for the same performance if you think about it. Being able to do that, now people can say, "Well, we can get the heat out." If you put a big hunk of metal, which adds weight and cost at the system level. Y ou solved it at a component level. You just buried the cost at a system level.
Our approach and our innovative approach for module development, we're able to do the best silicon carbide device in the best package designed for that device. Lower material costs, lower manufacturing costs, better bonding, all of these things that actually added up together is a much better efficiency at the system level that translates into either longer range or lower battery volume. Those are dollar numbers, you know, when it comes to the customer.
That carried over, that experience that carried over from silicon into silicon carbide is 100% applicable. When people talk about where did onsemi come from where we were 3, 4 years ago to now, you know, $4 billion of LTSA is proving with our customers that we have the technology and the know-how to deliver what they need for them to be successful. That's the win. From a manufacturing perspective, you know, back to why I'm not worried about the ramp, as much as a lot of the headlines and the FUD out there is we're moving our IGBT. We have a fab in Korea, in South Korea. It's a large-scale power fab, 6 and 8 inch, that is doing IGBTs for a very long time.
It just pumps IGBT, great yield, clean fab, you know, excellent operational performance. What we've done is we moved the IGBTs to East Fishkill, so we moved it to 12 inch. We're moving silicon carbide in an existing high-scale power fab. I don't have the fab ramp challenges.
We're increasing capacity, of course, but the fab runs power already. Whether it's silicon or silicon carbide, it's a power fab. All of these put together put us in a very competitive position. One, to tackle the market with our technology, and two, to scale to support those customers.
O ne of the other benefits of the IGBT and MOSFET leadership, right? If I look at that $4 billion pipeline in silicon carbide power products, these engagements are creating significant, I feel, additional dollar content, attach opportunities for your MOSFET and IGBT portfolio, right? Gate driver modules, DC-to-DC converters, IGBT inverter attached for front wheel drive. Just a few examples, right? You probably track this, but what's onsemi's additional power management content attached to that $4 billion of silicon carbide revenue pipeline?
Well, if you think about it, obviously, it's not a one-to-one.
Right.
You can think about it. You got the $4 billion that we've talked about, and that's the, you know, the a three-year LTSA window for silicon carbide, but a $15 billion or $14 billion overall. You can think about a lot of these are with the same customers where, you know, the example I gave before, where you may have two or three parts, and now the customer says, "We've had a year now of seeing what is our supply chain for onsemi. We wanna add all of them." That cross-selling is what we're looking at. As we look at roadmaps with customers, we look at it from the system level design of what is the customer trying to accomplish. You know, back to having that breadth of technology especially silicon carbide and IGBT.
Look, if a customer says, "Here's the problem we're trying to solve," if we're able to solve it with silicon power, we're gonna offer silicon power. I don't have to kinda corner into, "Well, I only have silicon carbide. You have to have it.
We're gonna give the best solution for that customer, and that matters from a competitive standpoint of being able to provide that the flexibility for both. That goes back to the comment you made, where sometimes it's a split axle, f ront axle is IGBT. Rear axle is SiC.
Well, if we're able to provide two, they don't have to go to another supplier. That is important for the customer. All of these and the breadth of portfolio is a competitive advantage that we see because the customer can develop a system-level approach with one supplier where trade-offs are being made on the board with one if you think about it. That gives us the ability, forward-looking, to see, okay, if we had to make these trade-offs, how can we design the next generation to not have these trade-offs?
You already designed yourself into the next one because now you're co-developing with the customer.
Got it. On silicon carbide substrate side, you know, what's the mix of insource versus outsource supply of substrates today? Where will you be exiting this year and trajectory over the next three years as you sort of grow into the $4 billion revenue pipeline?
Look, obviously today, well, it's known majority is external. As we ran our GTAT, we've said we will be majority internal, exiting 2023, and that will continue to increase as we move forward. Our intent is to be supporting our customer ramps with internal substrate 'cause that's the one we can depend on. When we talk about supply assurance, that's the one we can really commit to our customers. Obviously we're gonna have a little bit on externally. It's not gonna be 100%, because you need to have a the possibility to be able to spring up for certain, you know, like a quarter of a big ramp.
Right.
We wanna be able to spring up. We can either do it by building ahead or by sourcing from the outside. We'll do that, and that's why we have a good pulse on what we call the merchant market, you know, what's out there. Our goal and our strategy, which has proven the right one, already, is to have it internal.
Let's move over to, industrial. It's a large part of your business, obviously, very diversified. Some of the sub-segments are, you know, there's multi-year demand drivers, right? Like energy infrastructure, automation, you know. Energy infrastructure, for example, I think, last you guys reported was, like, driving 60% year-over-year growth. You know, provide us, you know, some color on the exposure to the different sub-segments, within industrial and which of those sub-segments are more resilient, let's say, in a weaker macro environment. At a high level, you know, the team's confidence on growing the business, this year, you know, should things get weaker from a macro perspective.
Look, in general, you highlighted the trends that are driving the industrial, what we call the core industrial. Energy infrastructure, that's a multi-year, multi almost a decade long because it's gonna be lockstep with the electrification.
You know, as you get more electric vehicles, you're gonna have a bigger infrastructure.
You're gonna have more energy. What does that mean? The renewable energy from solar, wind, but more importantly is the energy storage. W ith the unfortunate events in with the conflict in Europe, that accelerated a lot of the energy storage adoption in Europe, but also in North America, you know, given a lot of the climate disruptions that we've had with the grid. All of these have driven a lot stronger demand on the energy, renewable energy market for us. That is both silicon carbide, but also a very big market for IGBTs today. Those are areas that we don't see that slowing down because it's part of a larger mega trend. You know, let's say you have concerns about macro in 2023, nobody's gonna be like, "Let's not put chargers and let's not do this until 2024." Those are not dependent on that because they're long-term investments.
The longer you wait, the worse it gets. Those, we don't see anything, and we've talked about how the top 10 energy, renewable energy, including storage, have 80% market share.
We have LTSAs with eight of the top 10. That gives you where our growth and how broad our growth is when it comes to that tackling the market. Factory automation growth is driven by coming out of a 2-year of shortage in labor, social distancing, you know, a pandemic where you had to either shut down factories or run with a skeleton crew for social distancing.
Well, the way you solve that is automation. That's driving cameras and analog power. For factory automation, that bet will remain, because we don't see maybe the social distancing is getting less t he labor shortage is not. You see what I mean? Those investments remain. The last one I would highlight that we're focusing on is, of course, the medical. Where macro or not, you can't push out medical procedures or medical needs. Those will get always prioritized independent of the macro. I would say those are the ones that where our growth is coming into, and that's where our investment are going. The outlook is positive because of these mega trends underlying industrial.
My last question, 'cause we're running out of time here, is on the gross margin front. You did mention that there are some potential tailwinds to the gross margins. Obviously, there's offsets in a weaker macro environment, underutilizations. You've talked about some of the impacts from East Fishkill and the startup of the GTAT and the manufacturing in silicon carbide. As you mentioned, the team has exited $277 million of non-core revenues and an average gross margin of 25%. You're planning to exit another $65 million to $70 million in the December quarter. Then, as you mentioned, Hassan, $400 million to $450 million remaining in calendar 2023, which I believe has a gross margin profile in the low 40% range.
Given the market softness into the first half of this year, should we think that the impact of that roll-off of that $450 being more biased in the first half just given that non-core products are more commodity-like and probably more sensitive to the macro trends and so? Would you expect that roll-off to be sort of more linear as we move through the year?
What we're seeing right now, we've always said this is market dependent, right?
Right. Right.
We actually thought we'd lose this business faster than we have, right? We think we're gonna be out of that business by the end of 2023 given the market dynamics. We're seeing right now it's fairly linear but probably more back-end loaded to the second half if you think about it, kind of what the visibility we have on it today. If the macro gets softer and we lose it faster, that's good for us because we can reallocate that capacity to something of higher value.
It's really market driven. It's, there's not a whole lot we can do. We've already priced ourselves at a position where we think we'll exit it, and that was all by design.
Perfect. Well, we're looking forward .
One thing, just one thing on the margin. When you talk about the tailwind when you look at longer term, you know, just to remind everybody, we exited four fabs in 2022 we talked about $160 million of COGS favorability as we, you know, as we fully exit the fabs. You know, we handed the keys to another partner. As we move these products out of those fabs into our remaining fab network, we're gonna be getting that $160 million. That's all tailwind above and beyond of where we are today. Of course, that takes time to exit, fully exit fabs, think about 2-3 years, but that's still tailwind that's yet ahead incremental to the margin that we're able to achieve in the shorter term from that window.
Oh, absolutely. Looking forward to monitoring the progress and execution of the team this year. Hassan, thank you very much for joining us today.
Thanks, Harlan.
I really appreciate it.
Absolutely. Thank you.