ON Semiconductor Corp

NASDAQ:ON

Earnings Call Transcript 2021-Q3

[Operator]

Ladies and gentlemen, thank you for standing by. My name is Brent and I will be your conference operator today. At this time. I would like to welcome everyone to the ON Semiconductor Third quarter 2021 earnings conference call. All lines have been placed on mute to prevent any background noise. After the speakers remarks, there will be a question-and-answer session. If you would like to ask a question during this time, [Operator Instructions] Thank you. I would now like to turn today's call over to Mr. Parag Agarwal. Sir, please go ahead.

[Parag Agarwal, Investor Relations]

Thank you Brent. Good morning and thank you for joining On Semi 's Third Quarter 2021 quarterly conference call. I am 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. Immediately after this webcast, along with our 2021 third quarter [Indiscernible] readily available on our website, approximately one hour following this conference call. And the recorded webcast will be available for approximately [Indiscernible] following this conference call. Additional information related to our end markets in this segments, geography's, channels, share count, and 2021 and 2022 fiscal calendar is also posted on the Investor Relations section of our website. Our earnings release and this presentation include certain non-GAAP financial measures.

The reconciliation of these non-GAAP financial measures to the most directly comparable measures and the GAAP are included in our earnings release, which is posted separately on our website in the Investor Relations section. During the course of this conference call, we will make projections or other forward-looking statements regarding future events or future financial performance of the Company. The words believe, estimate, project, anticipate, intend, may, expect, will launch soon, or similar expressions are intended to identify forward-looking statements. 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 from our Forward-looking statements are described in our most system Form 10-K, Form 10-Qs and other filings with the Securities and Exchange Commission. Additional factors are described in our earnings reviews for the Third Quarter of 2021. Our estimates or other Forward-looking statements may change and the Company has no obligation to update Forward-looking statements to reflect actual results. [Indiscernible] are the other elements that may occur except as required by law. Now, let me turn it over to Hassane.

[Hassane El Khoury, President and CEO]

Thank you Parag and thank you everyone for joining us today. We delivered yet another quarter of record results driven by exceptional execution by our worldwide teams and strong demand for our Intelligent Power Incenting products. We posted record quarterly revenue and non-GAAP operating margin and EPS. With our results and outlook, we have made a solid start towards achieving our financial target model. Even though our Q3 results and Q4 outlook significantly exceed expectations, we believe that we are just in the early innings of transforming the business. As we make further progress in our transformation initiatives and as our Intelligent power and Sensing design win with automotive and industrial customers, we expect to see sustained revenue growth and margin expansion. Today we announced the close of our acquisition of GT Advanced Technologies or GTAT.

As we outlined at our Analyst Day, our goal is to provide our customers in the industrial and automotive end markets with highly differentiated intelligent power and sensing solutions, and we are investing to achieve that goal. With GTAT market-leading silicon carbide substrate technology On Semi is now the only silicon carbide player in the industry with end-to-end capabilities encompassing modules, devices, and substrates. Our acquisition of GTAT has been a catalyst for key automotive customers to engage in long-term strategic partnerships with us, and we can expect GTAT to be a critical enabler of our impending ramp in our silicon carbide business. In fact, in Q4, 2021, we will be shipping silicon carbide product based revenue utilizing the GTAT substrate. I am also excited to announce that GTAT has delivered 200 millimeter bowls, which we have processed at our ON Semi manufacturing facility and we'll be sampling our first devices in January 2022. We welcome the GTAT team to the ON Semi family and look forward to expanding its capacity to support our silicon carbide growth plans. On a year-to-date basis, our power design win funnel grew by 75% year-over-year.

At the end of the Third Quarter, we have signed a LTSA or committed revenue of $2.5 billion over 3 years for our Power Solutions. Over $2 billion of this committed revenue is for our Silicon Carbide solutions for automotive and industrial applications and 2/3 of this committed revenue is for traction inverters for electric vehicles. We expect to exit 2023 with Silicon Carbide revenue run rate, of about $1 billion. The demand of our Intelligent Power and Sensing Solutions in our strategic end markets, continues to outpace our current supply capability. The strength and demand is driven by secular mega trends such as vehicle electrification, ADAS, Industrial Automation, and transition to alternative energy from fossil fuel-based power generation. For the third quarter, automotive and industrial end markets together grew 42% year-over-year.

On a year-to-date basis, our design went funnel for these end markets growth 55% year-over-year, giving us excellent visibility into future revenue. In addition to secular factors, demand for our products and being driven by industry-leading performance of our products in both Intelligent Power and Sensing. Consistent with our strategy outlined at our Analyst Day, we are driving a make-shift towards automotive and industrial end markets to drive margin expansion. For the third quarter, automotive and industrial together contributed 60% of our revenue as compared to 56% in the quarter a year ago. And we will continue facing out low-margin non-core revenue into next year. Looking forward, we expect demand to remain robust and outpace supply through most of 2022. We are selectively investing in our operations to relieve capacity bottlenecks for our strategic product lines. While working with our foundry partners to obtain a higher allocation of capacity.

At the same time, we are shifting our production to strategic high-value mixed of products. Longer-term, we are qualifying products and the 300 millimeter Fishkill facility to increase the efficiency of our fab network while executing our fab lighters strategy. Along with expanding supply, we are working collaboratively with our customers to ensure uninterrupted supply of our products, and we have entered into long term supply agreements with many of them. This LTSAs commit a multiyear revenue stream with stable and sustainable margin. Coupled with our expanding design win pipeline and the automotive and industrial end-markets, we have outstanding visibility into our revenue and in margin in support of our target model. Along with entering into LTSAs, many of our largest automotive and industrial customers are co-investing with us.

These investments solidify the strategic nature of our LTSA and enable us to support our customers by ensuring supply and providing development support. Let me now discuss a few highlights of our key strategic and Markets, starting with automotive. We set a record for our Automotive Revenue in Q3 of $575.6 million. Automotive represented 33% of our revenue in Q3 and grew 37% year-over-year and 4% quarter-over-quarter. The strength in automotive was driven by both our Power and Sensing product categories. We are seeing strong momentum in our electric vehicle business for both Silicon Carbide and IGBT based solutions. We have signed LTSA s for committed revenue for ED, a little less than $2 billion over the next few years, starting to ramp in Q4 2021 and approximately doubling year-over-year for the next few years. Over 80% of this committed revenue is for silicon carbide solution for EV traction inverters.

As we have indicated earlier, in addition to the industry-leading performance of our facts a key source of our differentiation is our expertise in packaging, which is critical for improving heat dissipation, increasing power output at a smaller footprint than our closest competitor, and reducing weight and cost of a power module. The efficiency of our modules allows our customers to make lower trade-offs between the cost of battery and the range of the vehicle, they get both. Our Automotive Imaging revenue grew more than 10% quarter-over-quarter, and 45% year-over-year. We continued to see momentum in Automotive Safety with new design wins and increasing content for our CMOS image sensors, and power management. Year-to-date, our automotive imaging design-win funnel grew by 75% year-over-year. As systems shift to higher pixel density, and the need for automotive safety requirements around power management increases our content will increase as these solutions have higher ASP.

The increase is further compounded by a higher number of sensors and power ICs per car and increasing number of cars with active safety features. The industrial-end market which includes military, aerospace, and medical, contributed revenue of $478.5 million in Q3, representing approximately 27% of our revenue. Our third quarter Industrial Revenue increased by 48% year-over-year and 11% quarter-over-quarter, driven by strong demand for our Intelligent Power and Sensing Solutions. We are seeing a more than 2x growth in our design-win funnel from alternative energy customers for our Power Solution and expect the alternative energy market to be a long-term driver for our business as utility scale power plant installation are expected to grow worldwide to reduce the climate impact of fossil fuel-based power plant.

Industrial power tools are another area of growth, as power tools are transitioning from brushed motors to brushless motors and from AC to battery powered, both trends driving significantly higher content for us. The demand for our imaging products and industrial automation applications remained strong with 20% quarter-over-quarter growth. Industrial customers are investing in automation at an increased base to improve efficiency and to reduce volatility and operations due to social distancing mandates and labor shortages. We have leveraged our experience in automotive to offer our industrial customers rugged, high-resolution, and high image quality sensors for the most demanding industrial applications. Now I will turn the call over to Thad to provide additional details on our financials and guidance.

[Thad Trent, CFO]

Thanks Hassane. I'm pleased to announce yet another quarter of record results. As Hassane mentioned, we posted record quarterly revenue and record non-GAAP operating margin and earnings per share while generating free cash flow margin of 20% for the quarter. All 3 of our business units reported record quarterly revenue, and our targeted automotive and industrial end markets, grew sequentially, achieving record revenue levels. With a rapidly expanding design win funnel of Intelligent Power and Sensing Solutions, and ongoing structural changes for our business. we are well positioned to make sustained progress towards our targeted financial model.

While the on Semi team has accomplished a lot in a short period of time, we have significant opportunities ahead of us to drive sustained revenue growth and predictable financial performance. From a revenue perspective, we are in the early innings of the ramp in our vehicle. I would like to recap some business and expect to be a significant driver of our long-term growth complemented by increasing demand for ADAS, Industrial Automation and alternative energy. We're pleased with our performance thus far and remain focused on margin expansion as we execute our transformation initiatives, including the portfolio optimization and our Baton lighter strategy. The turning to the results for the third quarter. Total revenue for the third quarter was $1.74 billion, an increase of 32% over the third quarter of 2020, 4% quarter-over-quarter.

The sequential revenue growth was driven by our ability to increase our supply both internally and externally, shipping 3% more units than in Q2, and favorable mix in pricing across all end markets. Revenue for our Intelligent Power and Intelligent Sensing products were also at record revenue levels, increasing sequentially, 3% and 8% respectively while accounting for 62% of total revenue in Q3. Our Automotive Revenue grew 37% year-over-year and 4% sequentially. Industrial Revenue grew 48% year-over-year and 11% sequentially. Automotive and industrial contributed a total of 60% of revenue in Q3 as compared to 56% in the year-ago quarter. Turning to the business units, revenue for the Power Solutions Group or PSG, was $892.2 million. PSG revenue increased by 38% year-over-year due to strength in automotive and industrial-end markets.

Revenue for the Advanced Solutions Group, or ASG was $613.5 million, an increase of 24% year-over-year. In addition to strength in automotive, ASP benefited from strength in computing, especially in high-end graphics cards. Revenue for the Intelligent Sensing Group or ISG for the third quarter was $236.5 million, an increase of 35% year-over-year. Growth in ISG was driven by both automotive and industrial-end markets. GAAP gross margins for the Third Quarter was 41.4% and non-GAAP gross margin was 41.5% and 800 basis point improvement year-over-year. And a 310 basis point improvement quarter-over-quarter. Our gross margin expansion is ahead of our original plans with improved efficiencies of our manufacturing sites, favorable mix, and improved pricing as we continue to examine our portfolio for price-to-value discrepancies.

Over the last 2 quarters, we have exited approximately $100 million of non-core revenue at an average gross margin of 15% and allocated this capacity to strategic products with accretive gross margins. Over 60% of this exit accrued in Q3 and we expect to continue phasing out our low margin non-core revenue over the next two years, as we outlined at our August Analyst Day. Today, we have been successful in navigating rising input and manufacturing costs by adjusting pricing to our customers. While we will likely see more cost increases in early 2022, we don't expect these increases to have a negative impact on our gross margins. Our factory utilization with 80% down slightly from Q2 level of 83% due primarily to COVID related slowdowns affecting our back end facilities in the Southeast Asia.

As our operations stabilized, we expect utilization to remain in the low 80% range consistent with previous quarters. GAAP earnings per share for the third quarter was $0.70 per share. Non-GAAP earnings per share for the third quarter was $0.87 per diluted share as compared to $0.27 per share in the third quarter of 2020, and $0.63 in Q2. As noted earlier, this is the highest ever quarterly non-GAAP EPS reported by the Company. Now I'll give some additional numbers financial. GAAP operating expenses for the third quarter of 2021 were $321.6 million as compared to $322.2 million in the third quarter of 2020. Non-GAAP operating expenses were $296.2 million, a decline of $18 million quarter-over-quarter, as we continue to restructure our operations to align with our new strategy and reduce investments in our non-strategic areas.

While we saw benefits of lower APEX in Q3, we expect to redeploy capital into our strategic areas in Q4. And therefore, there will be an increase in spending back to normal run rate levels while achieving our 17% operating expense target. Our GAAP operating margin for the third quarter was 22.9% as compared to 9% in the third quarter of 2020. Our non-GAAP operating margin was at a record level of 24.5% as compared to 12% in the third quarter of 2020 and 19.6% in Q2. Our GAAP Diluted shares count was $440.7 million shares, and our non-GAAP Diluted shares count with $435.7 million. Please note we have an updated reference table on the Investor Relations section of our website to assist you with calculating our diluted share count in periods share prices. Turning to the Q3 Balance Sheet, cash and cash equivalents with $1.39 billion, and we had $1.97 billion undrawn are recover.

Cash from operations was $448.9 million and free cash flow was $355.7 million or 20% of revenue. Capital expenditures during the third quarter were $93.2 million, which equate to a capital intensity of 5.4%. As we indicated previously, we're directing a significant portion of our capital expenditures towards enabling our 300 millimeter capabilities at the East Fishkill Fab an expansion of silicon carbide capacity. Accounts receivable was $720 million, resulting in AFL is outstanding 37 days. Inventory increased $18 million sequentially to $1.3 billion and days of inventory increased three days to 119 days. The increase in inventory was driven primarily by an initial build bridge inventory for vowed transition and work in progress inventory of finished wavers and not be processed through the back-end capacity constraints.

Distribution inventory decreased $39 million to 6.8 weeks from 7.3 weeks in Q2. Once again, we are proactively reducing that distribution inventory to hold more inventory in our balance sheet to support our customer needs rather than building inventory in the supply chain. Total debt was $3.1 billion and our net leverage ratio is now approximately at one times. Turning to guidance for the quarter and table dealing our -- detailing our GAAP and non-GAAP guidance is provided in the press release related to our Third Quarter results. Our guidance includes our expected results for roughly 9 weeks of the GTAT acquisition after closing the last Thursday. Let me now provide you key elements of our non-GAAP guidance for the Fourth Quarter.

Based on booking trends, we believe demand will remain strong through much of next year. We continue to increase supply through operational efficiencies and working with our external partners to obtain additional capacity. We're also accelerating product qualification at our 300 millimeter fab at nice Fiscal. Despite these efforts, we will be limited by supply constraints and we're working with our strategic customers to ensure long-term, uninterrupted supply. Based on current bookings, trends and backlog levels, we anticipate that revenue for the fourth quarter will be in the range of $1.74 billion to $1.84 billion. This includes expected GTAT revenue of approximately $3 million to $4 million for the quarter.

We expect non-GAAP gross margins between 42% and 44%, and this includes share-based compensation of $3.6 million. We expect total non-GAAP operating expenses of $298 million to $313 million and includes roughly $4 million and OpEx for GTAT and share-based compensation, $18.6 million. We anticipate our non-GAAP OIE, including interest expense, will be $24 million to $27 million. So this result in non-GAAP earnings per share to be in the range of $0.89 to a $1.1. This includes the impact of GTAT business, which is roughly $0.01 dilutive for the quarter. We expect total capital expenditures of $130 to $140 million in the quarter. Our non-GAAP diluted share count for the fourth quarter of 2021 is expected to be approximately 437 million shares. So in summary, I am extremely pleased with our progress on the execution of our transformation initiatives. I add my thanks to our worldwide teams for their hard work and unwavering commitment to our customers. With that, I'd like to start Q and A, but I'll turn it back over to Brent to open the line for questions.

[Operator]

At this time I would like to remind everyone in order to ask a question [Operator Instructions] Your first question comes from Ross Seymore with Deutsche Bank. Your line is open.

[Ross Seymore, Deutsche Bank]

Hi guys. Congratulations on the strong results. Hassane, my first question is for you. And that's on the transformation on the revenue line. At your Analyst Meeting you talked about exiting 10% to 15% of your revenues over the next couple of years. I want to see if we get an update on that, and how much of that is a headwind today, or is that still yet to come?

[Thad Trent, CFO]

Hey, Ross. It's Thad. I'll take that. In my prepared remarks I talked about, we've exited approximately $100 million over the last 2 quarters, 60% of it being in the third quarter. The average margin without business was roughly 15%. We plan on continue to exit our business over the next 2 years. As we've talked about, it will be -- I think about being fairly linear for the next 2 years as we continue to execute, and we shift that capacity in the higher-value products and higher-value capacity.

[Hassane El Khoury, President and CEO]

And then just to add to that, you talked about the headwind. We're able, of course with the demand environment, we're able to shift that capacity to demand in our strategic market with our strategic customers. And that's the mix shift that we are going through and we'll keep going through that for the next couple of years.

[Ross Seymore, Deutsche Bank]

Great, thanks for those details. And I guess the follow-on to that would be on the gross margins side. Great job up-siding even your expectations there. Can you talk about how much of that do you view to be structural versus cyclical? And I know you're going to say it's structural because of the way you just answered my first question, but how much of a cyclical tailwind are you getting with price increases, etc, that you think are truly sustainable going forward?

[Thad Trent, CFO]

Look, this is Thad again. We think the majority of it is structural. We've been making changes to our manufacturing operations, driving efficiencies there, it's the mix shift as well. There's definitely a pricing component of it, it's a favorable pricing market. As I stated, we've been passing on the cost increases that we've seen coming our way. We believe that we'll continue to get the gross margin expansion. Our target remains at 45% over time here and like I said, most of is structural in nature.

[Hassane El Khoury, President and CEO]

Yes, at the end of the day, customers pay for value. We have been reducing the price devalue discrepancy like we talked about. And the LTSAs provide longer-term visibility on both revenue and margin. And when we talk about long term, we're talking about an average of 3 years. That gives you the structural nature of it and the sustainability of it to move forward.

[Ross Seymore, Deutsche Bank]

Thanks, guys.

[Operator]

Ladies and gentlemen in the interest of time, please limit yourself to one question and one follow-up question. Thank you. Your next question comes from the line of Vivek Arya with Bank of America Securities. Your line is open.

[Vivek Arya, Bank of America Securities]

Thanks for taking my question, and congratulations on the strong results and the very impressive execution. Hassane, how do you see the interplay between automotive production which has been flattish, right? Very weak this year versus content and pricing. I mean, there's a lot of concern that auto chips suppliers are maybe shifting a lot to inventory rather than benefiting from content or pricing or mix. Would just love your views on that from an industry, but then obviously from an ON very specific perspective that, what's giving you the confidence that -- you're saying that are exceeding units so much are really being driven by content or mix or pricing as opposed to sitting in inventory somewhere.

[Thad Trent, CFO]

Yeah, look, I can speak for Hassane. First, we track content based on design wins that we have had over the last few years that are starting to ramp, and have ramped beyond what we expected in the '21 time-frame, that's why we can't support the demand. From that point of view, I know exactly how much content has been going up for our customers using our products, so that ties and that gives me the confidence that it is a content growth story. Now as far as people talk about inventory being built out, look, I gauge that. We have a lot of data to gauge it, but to me, the main gauge is the escalations that we're getting. We're still getting an intense level of escalations from our customers in order to ensure that part's go into cars and cars go out of the lot.

That is a pretty good gauge for where the economy is and where our content is going. I can tell you it's not being built up, it's going to cars because if we don't ship the cars don't ship. That's a one-to-one correlation that I can personally validate given all my conversations with my peers at our customers. So both of these tell me that we are still in supply constrained. There is not inventory. Are there pockets, maybe 1 or 2 weeks of inventory here and there? Yes. Because we sometimes will pre -ship, and the customers we know are not able to kit it. But that last for about one or two weeks until they get our next shipment. So all of these things are manageable. We have fully visibility on it and we track it internally and with our customers by giving confidence.

[Vivek Arya, Bank of America Securities]

Alright. Very helpful. And for my follow-up, great job on the gross margin side but when I look at the incremental margins in Q3 and then the midpoint of Q4, it's over a 100%. I imagine part of it as the exit from the non-core areas. But could you help us bridge what your original assumption was for kind of gross margin? Why is this coming at these levels? But then also importantly, you're at these kind of low 40s gross margins already before completing a lot of the actions that were supposed to take you to the 45% journey. So it's 45% still the end of destination of this journey, or do you think that's a very strong start given your confidence that, there are maybe leverage or gross margins beyond what you have contemplated. Thank you.

[Thad Trent, CFO]

Yeah. Hi, Vivek. What we've always said, 45% is a milestone, and that we would talk once we got there. We're not changing that target. The improvement that we've seen has been through operational efficiencies, favorable mix, and then clearly pricing. If you go back to the chart that I showed an Analyst Day, we provided the bridge. The next big piece of the improvement is really the manufacturing, the fab-lite or footprint, right? And that's the part we've always said that we take the longest and would be the hardest to get. And it's about exiting the fabs and consolidating into more efficient fabs ramping the no meter fab (ph). And that's the next leg that we've got to execute on. So I think what we've been able to pull forward on is favorable mix, operational efficiencies. And then clearly a good pricing environment has helped. But what I think is going to get us to that next level of 45, is the manufacturing piece. And then once we get there, we'll talk about what the end goal should be. But we've never stated 45 would be the end goal as much as it was a milestone that we'd be looking to achieve.

[Vivek Arya, Bank of America Securities]

Thank you.

[Operator]

Your next question comes from the line of Toshiya Hari with Goldman Sachs. Your line is open.

[Toshiya Hari, Goldman Sachs]

Good morning. Thanks so much for taking the question and congrats on the strong results. Hassane in your prepared remarks, you talked a little bit about Southeast Asia on your operations there being a little bit disrupted in the quarter. Can you speak to any impact on revenue and gross margins in the quarter and where your operations are today. Then I've got a quick follow-up.

[Thad Trent, CFO]

Yeah, hi, this is Thad, so we talked about, our utilization came down slightly to 80%. We think that will return back into normal levels of low 80%. We think it had minimal impact on this quarter, primarily because we were able to allocate those resources and that capacity into other sites and recover from it. The sites are stabilizing now, they're not back up to full speed yet, but we think they will be there very quickly and that's why we think the utilization comes back up into normal run rate levels pretty quickly.

[Toshiya Hari, Goldman Sachs]

Got it. That's helpful. And then as my follow-up, I wanted to ask about Q1 of next year. I think historically pre-Covid seasonality, what would drive business down a little bit? I think pricing some of the adjustments that you would make historically would hit Q1 disproportionately. Curious how we should be thinking about Q1 into next year, just given how strong the environment is. You talked about all the design wins on the visibility you have into the quarter. So should Q1 of 2022 be above seasonality? And again, how should we think about pricing and gross margins into the March quarter as well? Thank you.

[Thad Trent, CFO]

Well, we're not going to give you guidance for Q1. We only guide 1 quarter at a time. But normal seasonality for Q1 is down 2% to 3%. Based on what we see today, we are going to perform better than that and we can see in terms of backlog and supply coming online, and we're probably looking at flat to what our Q4 number is going to be. But we're not going to provide more guidance than that.

[Toshiya Hari, Goldman Sachs]

Thank you very much.

[Operator]

Your next question comes from the line of Harsh Kumar with Piper Sandler. Your line is open.

[Harsh Kumar, Piper Sandler]

Yeah. Hey, guys. First of all, strong congratulations, tremendous execution effort here. I wanted to ask a broader question just above the diminution, the data. Maybe you can help us for -- I know that EVs are near and dear to your heart, and you're making a pretty big bet on that front. 2 things. How much revenue do you think you'll get from EVs today? And then once you start to get to your -- I think you said $1 billion in 2023. Let's say I'd attaining 2023, how much of your business will be EVs at that point in time throwing in [Indiscernible] and all that other stuff you guys do?

[Hassane El Khoury, President and CEO]

We're not breaking up -- breaking down the EV revenue today. I gave the outlook just to highlight the growth that we're seeing. But more importantly, to highlight the penetration of Silicon Carbide, getting to the run rate of $1 billion. We've always said over the next few years, we're going to see a co-existent IGBT and Silicon Carbide. But Silicon Carbide is starting to accelerate as customers see the efficiency of it, coupled with our technology on packaging. So that is going to accelerate our ramp in Silicon Carbide to get to that run rate above $1 billion by 2023, which is very meaningful from where we are today, and that revenue trajectory getting the building is basically doubling for us every year. I'll be providing more of that color as we start ramping. But at this point, that's the level going to be talking about. But I'm very comfortable with the EV ramp. It's a lot of people have been talking about EV ramps and content for a few years now. Now we have it. It's starting. Customers have they LTSA to guarantee for their supply. And we're going to be supporting their growth along with ours.

[Harsh Kumar, Piper Sandler]

Very well. Thanks, Hassane. And then for my second question, you've got -- I think Vivek mentioned, you've got a long-term target of 45%. You're guiding to 43%, I guess I wanted to just make sure that there's no near-term sort of things that are helping you here that it's all structural. Could you maybe just give us some color on how much the strongly ASPs helped you versus legacy business reduction, which I think we can calculate also. Also, you're supposed to sell fabs and we haven't seen much of a progress on that front but I'm looking and then saying you're already at low 80s utilization. Why would you even need to sell FABS going forward as you grow?

[Hassane El Khoury, President and CEO]

Yes, look, a lot of it -- most of it is self-help. We talked -- Thad talked about the increase in units sold, those unit increases are based on favorable margin mix so you're already starting to see that Mix shift. We've already talked about walking away from 100 million at 15%. I've always said even at this pricing environment, low margin is low margin, and we will actively walk away from that business and move it to the auto and industrial that for us are driving higher margin. All of these things are self-help and of course, sustainable. The other thing over the last year, the other thing that worked in our favor is the utilization. And that's sustainable as you mentioned as we wind down some of our fabs and we restructure and do the fab manufacturing optimization, that utilization is going to be and remain at that higher level even with that 10% to 15% reduction in the non-core business.

All of these I would say are self-help. As far as the current pricing environment, there are two things that I will talk about in pricing. One is passing on the price increases to our customers, that's gross margin neutral to us, because we are passing on cost increases that we have incurred to our customers so that you can think of it as the margin neutral for us. The other one is the price devalue discrepancy, where we have products of high value that, historically, for whatever reason we're shipping below market. And those adjustments are sustainable because that's the value of the product that, many other customers buy. So all of these are structural and we just have to stay ahead of the manufacturing utilization as we wind down that 10%-15% remaining of the low margin business. And we're going to get there as we talked about in our Analyst Day. All of these are going to yield to a structurally sustainable financial model. And when we get there, we'll talk about how to go to the next level.

[Thad Trent, CFO]

Yeah. I would add on the manufacturing side, we're still [Indiscernible] the manufacturing sites. We got the 300-millimeter Fab (ph) coming online later. next year in 23 that we take ownership. But we've got to fill that out that gives us a better cost advantage as well. And you saw that we were building inventory on the Balance Sheet to support those Fab transition. So we've always said it's not about ending the Qs. Somebody is about the exit and the qualification process and the exit of time. So even though we haven't announced a divestiture of those tabs we're making progress in qualifying those products and other locations that are more efficient. And we're building the inventory for that transition. So the progress is underway.

[Harsh Kumar, Piper Sandler]

Understood. Thanks, guys. Great stuff.

[Operator]

Your next question comes from the line of Raji Gill with Needham & Company. Your line is open.

[Raji Gill, Needham & Company]

Yes, thank you and I want to echo my congrats on the excellent results. Hassane, I want to delve a little bit deeper in the long-term agreements that you're seeing in your business. You talked about $2.5 billion of committed business, particularly $2 billion in SIC and for EV s, and 2/3 was related to the traction inverters. Could you maybe describe what you're seeing in that market? It seems like you have the products, the right products to align for the future growth. Can you talk a little bit about the qualification process, the engagements with your customers on that massive committed capital -- committed business, and just more broadly, are you seeing in the industry a shift, a transition to more longer-term commitments, better visibility from your customers in response to the component shortages that we've seen this year, are you seeing a change in behavior from your customers to enter into longer-term supply agreements to get access to that supply? Thank you.

[Hassane El Khoury, President and CEO]

Yes. And absolutely right. Let me talk about the first one. The first one is a -- I would say, a very different engagement model for the design and capability. When you're talking about a product that is fit for purpose for a customer inverter, traction inverter. Every car is different, whether its performance or range, or heavy-duty, and so on. All of these variables are what our team and the customers team take into account in order to get a design in. And I highlight that to give you the visibility that it's not a dual source concept. It is a design and concept that leads to the design win, and that's why customers, once they have that problem solved on their side, the long-term supply agreement is the next natural step. Because if and when we give them a traction inverted that provide much better efficiency than any of our competitors, they will either co-invest or give us the LTSA or and give us the LTSA over the longest period of time, at least through the run rate of that product, and then [Indiscernible].

So that's the stickiness of the revenue that I talked about that I referred to. Stickiness from a design-win perspective. It's not something that is swappable. But also stickiness from the commitment of the customers are providing to us, which leads to the second level and the answer is yes, thing major model is different. It's not equal to everything. There are products where they're not strategic potentially for our customers. However, they are important. We're not going to lock up capacity with a long-term agreement. But when we talk about strategic components like silicon carbide, like IGBT, like the 48-volt rail, like the strategic theme that I've talked about that go along with our ADAS for cameras, or the image sensors. All of these are key products that enable differentiated technologies on our customer, where there's traction or vision with ADAS, those customers do want the stability and they do want to supply resiliency that we are able to provide to them through the long-term agreements. And that's the model that is -- we're moving to with a lot of customers. Again, it's not 100%, but it is strategic and surgical like I've always talked about when it comes to LTSA.

[Raji Gill, Needham & Company]

And for my follow-up [Indiscernible] Go ahead.

[Hassane El Khoury, President and CEO]

No, go ahead.

[Raji Gill, Needham & Company]

No. I would think my follow-up And thanks for the insight Hassane on that. It does relate to the pricing question, but it's more of, again, the structural on a positive side. You're obviously you're seeing some price increases, but would you say that the days of heavily deflationary pricing for semi's are starting to come to an end, or at the very least, the price declines will start to abate ongoing forward because of the strategic importance of these components in for ADAS, EDS, for Industrial Automation. Do you think this is more structural in nature where the pricing environment and -- maybe not be as high as it is now, but could continue to be favorable over the coming years or do you still -- do you view this as more temporary?

[Hassane El Khoury, President and CEO]

I think it is also sustainable. I don't think the pricing benefit that, we historically give our customers year-over-year is going to disappear. But definitely will be very muted for these new ramps. Given the capital intensity, that is required to ramp those products and get them up, they're not going to be under your traditional, hey, every year give me X percent or else. Those days are over for the strategic ones. So that's what gives me comfort in investing in the Capex in order to increase that -- to match that demand. We work with our customers on efficiencies that we are able to get or efficiencies they're able to get. Because look, if our products allow our customers to shave off $1 or $2 and metal because of heating. Given the efficiency of our products, it's still money. I don't have to give that savings, but if I enable it, that's still savings on an end unit price, which is the car. That's what makes our solution attractive is because the efficiency drives a lot more cost reduction outside of the semiconductor than in the semiconductor. And that's very attractive to our customers.

[Raji Gill, Needham & Company]

Okay. Thank you.

[Operator]

Your next question comes from the line of Chris Caso from Raymond James. Your line is open.

[Chris Caso, Raymond James]

Yes. Thank you. Good morning. Just a follow-up question on the LTSAs. and if you could clarify, what are the obligations from both you and the customers over those agreements? What are they promising you? What are you promising them? And within those agreements -- one of the investor concerns right now is, 1 day demand will probably flow from these level. What are the provisions in there that protect you and protect them in the event that the demand winds up being different than what's envisaged over those agreements.

[Hassane El Khoury, President and CEO]

When we talk about LTSAs, we are focusing on the strategic intent. Let me talk about Silicon Carbide or EVs, IGBT and Silicon Carbide as an example. So to me, that demand and that ramp is happening. EVs are happening, EVs are driven by Companies and driven by customers themselves. So if the ramp is shifting one quarter or two quarters or whatever, you know what will work with customers, what they get, and what customers are getting is the supply assurance that when they do ramp, we will be able to support their ramp. Now, what gives me the confidence in the ramps that we are signing up for with our customers is, when a customer co-invests with you in order to support the ramp. That's a pretty high confidence and high credibility of the ramp because everybody is easy to say they're going to be the kings of the world when it comes to EV. But when a Company says and puts money down on it as a co-investment in order to get their ramp and their supply assurance.

That tells me that they're going to be winners in that market because they are putting their money where their mouth is. And we will be doing the same through our capex intensity that Thad talked about. We're increasing in an order to support doors, ramps. So we get the long-term visibility, we get the sustainability of the revenue and the margin associated with it. We have confidence in investing our Capex to expand for that capacity and the customers get the confidence that they're going to get it when they are ready for ramp. And then the customer will ramp on time when the time comes given the timeline of the LTSA. So all of these give me that confidence. Again, I'm not going after LTSAs for all of our products. I'm very, very selective and being very strategic about what to get the LTSA in order not to have that issue that you talked about.

[Chris Caso, Raymond James]

Great. That's very helpful. Thank you. As a follow-up, I guess, maybe you can give us some sense of how much of the business now is within that strategic framework that you speak of? And I suppose some of it's within the LTSAs, some of it's not. But I guess the question is, over time we've seen pricing for On Semi typical years down 5% a year and that's made up with cost reductions. It sounds like for a large part of your business, you're working with a different framework. What about for the rest of the business, are there structural things happening in both within ON and the industry, which will prevent that price decline and make things more sticky even in the event of an industry downturn?

[Hassane El Khoury, President and CEO]

Look, we're not the ON Semiconductor that you're used to, we're the new ON Semi and our focus is on strategic products and sustainable financial model. Part of that business that we are walking away from, the 100 million at 50% margin that Thad was talking about, that's the behavior that you are describing. Where an up is good, and down you have to give a lot of pricing to maintain share. I don't care about that business, I only care about the proprietary business that adds value to the customer. When you have proprietary business, even silicon carbide as an example, those are sustainable from both pricing and the margin perspective. We are no longer chasing fab fillers in a downturn, which is what historically the Company has done. We are moving the mix that goes into our fabs to proprietary and high-value products. And those are not going to be fluctuating based on what the end market does. That's the new Company we are. That's the new Company we are delivering results against the [Indiscernible] today. And that gives me the confidence of the sustainability of our model moving forward regardless of what the market does.

[Chris Caso, Raymond James]

Well done. Thank you.

[Operator]

Your next question comes from the line of John Pitzer with Credit Suisse. Your line is open.

[John Pitzer, Credit Suisse]

Hey, good morning, guys. Thanks for letting me ask the question. Hassane, just quickly going back to the auto sector, if you read some third-party reports, the industry might miss out on as much as $220 billion of revenue this year because they don't have Chip inventory. I'm just curious, as you talk to the auto supply chain, whether you're not, you think they're going to structurally change the way they think about their inventory and their partners going forward. And the LTSAs are great up. I'm kind of curious if you've explored the idea of actually taking some customer capital, especially as you work to build out your Silicon Carbide capacity?

[Hassane El Khoury, President and CEO]

Yes. Let me just touch on the last one. We have taken customer capital through the form of investment or co-investments in our capacity expansion. So that model is new and we've opened it up to customers, and some customers are -- have taken us up on it. The model is changing. Let me put it this way. You talked about the $200 billion in revenue. Nobody wants to be in that because spot anymore. So there are customers that unfortunately are still in denial and that's okay -- not okay for them, that's okay for me. We're doubling down with customers who get it to do understand the importance of semiconductor, the importance of the power and sensing in the future of mobility. Those are the customers that have jumped on the opportunity to secure supply. Now, I'll mention one thing, there is a shift for customers to go with credible suppliers. Suppliers credible of suppliers of scale.

That is very important. Because supply resilience is a hot button for all customers all the way in the OEM. My personal engagements with OEM are about supply resilience, not just supply assurance. And our ability to be able to have a product running in two geographically independent locations in a lot of cases, give that supply resilience to our customers, where it may not be COVID, but we always have disruption. We've had disruptions for the last 4 to 5 years. Having done supply resilience and proving it to the customer, supports their business continuity. Because they don't have to build inventory and hoard the inventory, they can depend on us. That matters in the selection process today. It's not only about the products, of course, you have to have products that are proprietary and high efficiency to win, but to get selected longer-term as a strategic supplier with the co-investment, we're talking about much more than that.

[John Pitzer, Credit Suisse]

And then, Hassane, as my follow-up, I want to get back to the idea of what of this is cyclical versus structural? And I guess in your auto and your industrial business, you've done a great job laying out the structural thesis, which is fairly easy to underwrite. I kind of want to think about the other bucket a little bit. If I add back the $60 billion of divestitures, I'm assuming most of that's coming in other -- that other buckets up over 30% year-over-year and it's up almost, I believe about high single-digits sequentially, so even outgrowing your auto business. When you think about that other bucket, was there value discrepancy that the old one wasn't pricing right, or is that somewhere where we might have to be a little bit worried about the cyclical pricing leverage today that might go away tomorrow?

[Hassane El Khoury, President and CEO]

Yeah, now, look, you don't have to worry about that. Well, we talked about other, that doesn't equate it to non-core or declining or commodity either. When we put in other, for example, we have a lot of our industrial that is not necessarily power that goes into there, that's actually very accretive margin already. What you're seeing a lot of it is the benefit of that high margin in the other bucket, that is not getting diluted by that $100 million or 60% of it this quarter at the 15% margin. So there are highly proprietary products, even in the other. They just don't fall under Power and Sensing. And that's part of our -- describing our Company. I don't want to equate others to not important to the Company. That's why you see the growth being across the board, but the drag from the $100 million is -- most of it is in that other bucket.

[John Pitzer, Credit Suisse]

Thank you.

[Operator]

Your next question comes from the line of Harlan Sur with JPMorgan. Your line is open.

[Harlan Sur, JPMorgan]

Good morning. Congratulations on the solid results and execution. On the Intelligent Sensing business, if I look at it, first 9 months of this year has undergrown both your auto and industrial, right? But however, on a year-over-year and quarter-over-quarter, the trends actually have been improving every single quarter this year. I know there has been heavily supply constrained because most of this businesses are outsourced. So it looks like your foundry partners are increasing their supply, but do you guys expect the segment to also be constrained to most of 2022? And then Hassane, can you just give us an update on your efforts to bring in some of the image sensor manufacturing in-house?

[Hassane El Khoury, President and CEO]

Yes. So Harlan, you said it, right. That business is primarily explore, all of it is external manufacturing and that has been constrained throughout 2021, we're starting to see a little bit more capacity being directed to us because of the growth that we're seeing. And really because of the impact that it has on automotive. So we're getting secured -- more secured supply. And you're going to see that increasing through next year. Having said that, we do have an effort for new products, of course, to bring in-house. You're not going to see us do a very big shift of existing products, just moving them in. But we do have a healthy funnel of new product development. And we already have products taped out in East Fishkill imaging products. Our new imaging products are taped on and East Fishkill. So we're going to have fab -- I call it the Flex Fab Strategy for Imaging, where we'll maintain externally, but we're also going to double down on the internal in order to expand our supply over the next few years.

[Harlan Sur, JPMorgan]

And I appreciate the insights there. And then maybe as a follow-up to that. So on East Fishkill in the transition to 300 millimeter the hand of doesn't occur until I guess end of next year, but you are in the midst of qualifying numerous products. You guys will be benefiting from the better economics of 300 millimeter manufacturing. For driving strong yields it will be critical to achieving those lower costs and increase capacity. I know it's early, but how are yields trending on the processes that are being qualified at East Fishkill?

[Hassane El Khoury, President and CEO]

Look, yields are -- of course, I compare yields to production yields in every fab that we have for the specific technology and the yields are exactly where they need to be to run full production in the 300 millimeter environment. A lot of our power devices are already, or have been shipping for a few quarters now out of East Fishkill at production yields. I'm not concerned about the yield. Of course, when you move your technology that is very complex like, image sensing, you have to work on yield. But I will tell you today, we do have a yielding product that is, Imaging on our boards. So again, we're out of the research side of it. We're actually in the development and production side of it across a lot of our products and we'll keep doing that through 2022.

[Harlan Sur, JPMorgan]

Good continued execution. Thank you.

[Hassane El Khoury, President and CEO]

Thanks, Harlan.

[Operator]

Your next question comes from the line of [Indiscernible] with Stifel. Your line is open.

[Tory Stanford, Stifel]

Yes and congratulations on the record results. Hassane, the first question is on this transition from ICE to EV. It seems like the pandemic has really accelerated that transition. I don't know if there's anything that you could share with us from your end? Any numbers, any data points, because clearly that transition is accelerating materially.

[Hassane El Khoury, President and CEO]

Can you just tell me what transition? I missed the first part, do you say IGBT [Indiscernible]?

[Tory Stanford, Stifel]

No. From [Indiscernible] to EV.

[Hassane El Khoury, President and CEO]

[Indiscernible] Look, I don't think it's the pandemic that accelerated it. I think there are a few things. One is the heightened focus on environmental responsibility that corporations have driven by corporations and boards, driven by investors, and driven by employees. All of these -- and really governmental mandates in a lot of cases, whether in the U.S. is statement dates or in Europe is, or in Asia, it's government mandates. All of these factors are driving an accelerated adoption and accelerated investment in launch of car models from ICs to EVs. That is happening. You hear a lot in the targets of by 2025, X percent of cars will be EV, by 2030 X percent of cars will be EV. Those are hard milestones defined either by the Company themselves for their own targets or by government, where you can't buy a new car unless it's EV by those times. That's what's accelerating it.

Coming out of the pandemic and meeting the demand in automotive, there's lot more push on EV because of somebody is buying a car now, they would want a car to be in the EV otherwise, they don't want to change it in the next 5 to 10 years. That's a very positive impact on our push to EVs and what's sustaining our growth. A lot of the numbers I gave as far as the LTSA for Silicon Carbide or IGBT, or power inverters, just to highlight the everybody, all those are incremental to our baseline business today. That's pure growth net of course, that 10 to 15% we're going to be walking away from. But that's sustainable growth over a 5 to 10-year period of time. And that's what makes it exciting for us, we're in the right spot.

[Tory Stanford, Stifel]

That's very helpful. And that's my follow-up for the Capex 130, 140 million next quarter. Is that kind of the run rate we should use for next year or will there will be some another step-up potentially the following quarter.

[Hassane El Khoury, President and CEO]

No, we've said starting next year the capital intensity will go up to roughly 12% for the next couple of years. And then after that, it will moderate down to about 9%. But we will be investing, we've got more investments to make in each fiscal and then obviously, to support the Silicon Carbide, we've got investments there to make and then with the GTAT acquisition as well. So 12% for the next couple of years.

[Tory Stanford, Stifel]

That's very helpful. Thank you and congrats again.

[Hassane El Khoury, President and CEO]

Thank you.

[Operator]

Your next question comes from the line of Pradeep Rahmani with UBS. Your line is open.

[Pradeep Rahmani, UBS]

Hi, thanks for taking my question. I guess -- I had a couple of so. There's a lot of consumers on pricing in your product portfolio. But I mean, can you give us some color around one, how much of your pricing actually is on a like-for-like basis? How much of it is actually like-for-like versus how much of it is benefiting from a mixed shift to your products which I would assume is a little bit more structural and longer lived. And then I'll have a follow-up.

[Hassane El Khoury, President and CEO]

Look, I mentioned earlier on the call. Most of our actions are structural because they're driven by a mix shift. We talked about walking away from the 100 million at 15 -- average of 15% gross margin. Those products order capacity just shifted to a much higher gross margin mix of products. So we replaced that a $100 million with a much more structurally favorable mix as far as the margin. For cost, I mentioned earlier, the price increases because the costs are neutral to the margin because we're passing it on to customers. We're passing it directly to customers and therefore that's sustainable as well. We're not going to see the benefit or it. Everything else that we talked about earlier from a market condition, we're walking away from that business. That 100 million is a dent in the 10% to 15%. It's about 1% to 2%. We talked about 10% to 15%. They are still the upside on the margin expansion just from the mix moving forward. I'm not worried about the sustainability of it. The benefit is sustainable and the benefit is driven by value of the products that we are shipping today. And we're shipping 3% more units in Q3 than we did before. Those 3% more units are unfavorable margin that's true demand and that is sustainable.

[Pradeep Rahmani, UBS]

Got it. Thanks. And on the GTAT, I guess, when I look at GTAT in context of your overall EV revenue, is there a contribution you can speak to in terms of GTAT potentially supplying other customers versus how much of your EV revenue is actually coming from your products versus GTAT basis?

[Hassane El Khoury, President and CEO]

Today, small portion is coming from GTAT. We just closed the acquisition. I mentioned that we are already and we'll be shipping more revenue based on GTAT substrates in Q4. Moving forward, we're going to start seeing more of a mix going from outside substrates that we have historically done more into GTAT based substrate which will be internal. Obviously, it will be ON Semi substrate moving forward. As that mix shifts to our internal created or internal grown substrate, our margin will also benefit from that because of course, the cost structure of having an in-sourced, a vertically integrated substrate is better than externally source. We haven't seen the benefit of that margin. That will come as we transition more into GTAT substrates. And that's over that ramp that I talked about in my prepared remarks.

[Thad Trent, CFO]

Yes. And I would just add in the Q4 guidance, there is $3 million to $4 million of GTAT revenue and that's with third-parties, with other customers that are outside of ON Semi. So you can think about that as being the run rate going forward. So it's not a material amount to the Company.

[Pradeep Rahmani, UBS]

Got it. Thank you.

[Operator]

Your next question comes from William Stein with Truist Securities. Your line is open.

[William Stein, Truist Securities]

Great. Thanks for taking my questions. First, I just was hoping you might linger on the co-investing theme for a moment. Is this customers investing in their own capacity that aligns with that of ON Semi or is it more like non-recurring engineering, or are they actually investing to sort of own, or perhaps guaranteed capacity in your fab? And then I do have a follow-up.

[Hassane El Khoury, President and CEO]

Yes. So the investment obviously is -- of course, they are investing on their side. But the investments I'm referring to is, they're investing on our side. Primarily, obviously for supply assurance and for late-stage development for products that will go for their applications. And that I talked about, that's what gives me the confidence in the sustainability and the stickiness of that revenue is the late-stage R&D that, customers are investing, and in order to get that product and the supply assurance that they will depend on us when they need to ramp. Both of these are what the investment is from their side. Of course, in parallel to that, well, they are building up their capacity to run their own vehicles. But that's not what I'm referring to.

[William Stein, Truist Securities]

Great. That's helpful. And then the follow-up is about the tone of buyers or buyer behavior, if you will. We think about their behavior a quarter ago relative to where it is today. When we think about their propensity to Chase shortages and try to real end as much upside as they can and that sort of thing versus maybe cooling off or narrowing the scope or expanding the scope of expedites. Can you comment on that trend, please?

[Hassane El Khoury, President and CEO]

Look, I think everybody is in blocking and tackling mode. As far as making sure they get just enough supply to keep the line running. I can't tell you how many lines are running at what their capacity, but a lot of the lines are now running at a 100%. But keeping the line running is more important than keeping it at a 100% versus shutting down the line. That's what the focus has been from our side and our customer's side. There's not enough to go around to give everybody a 100% but we work constructively with our customers to make sure that they get the minimum quantities across all of our products to maintain the running line and achieve their financial targets of unit sales. That's engagement we have directly with the OEMs. It's no longer between us and Tier-1, and then they deal with the OEM. It's either a two-party us and the OEM, where we understand what they need directly. Or it's a three-way meeting with the Tier-1 and OEM in order to make sure everybody triangulates and nobody is hiding anything in their pockets. It's full transparency, blocking and tackling. We all have one purpose in mind, which is keep the lines running, because that's when demand is real versus sitting somewhere in the supply chain. That's the level of engagement we have. And that gives me the comfort in the transparency of our engagement. And that's what we're basing a lot of our forward-looking comments on.

[William Stein, Truist Securities]

Thank you and congrats.

[Hassane El Khoury, President and CEO]

Thank you.

[Operator]

I would now like to turn the call back over to Mr. Hassane El - Khoury, President and CEO.

[Hassane El Khoury, President and CEO]

Thank you all for joining us today. I once again thank our worldwide team for their hard work in driving our transformation solid and sustainable results. We have established a strong foundation of revenue, LTSA, and funnel growth over the last few quarters to deliver a leadership position in the vehicle electrification ramps driven by our silicon carbide products, along with our broad offering of our semiconductor solutions to enable the rest of the vehicle. Along with our leadership in Automotive Safety, with our Sensing Products, we have become the supplier of choice for all marquee names worldwide. We're very excited about the opportunity in front of us, and we remain focus on execution to make sustained progress towards our target financial model. Thank you.

[Operator]

Ladies and gentlemen, this concludes today's conference call. You may now disconnect.