Good day, and thank you for standing by. Welcome to the ON Semiconductor Second Quarter 2021 Earnings Conference Call. I would now like to hand the conference over to your speaker today, Mr. Parag Agarwal, Vice President of Investor Relations and Corporate Development. Please go ahead..

Thank you, Lynn. Good morning, and thank you for joining ON Semiconductor Corporation’s second quarter 2021 quarterly results conference call. I’m joined today by Hassane El-Khoury, our President and CEO; and Thad Trent, our CFO. This call is being webcast on the Investor Relations section of our website at www.onsemi.com.

A replay of this webcast, along with our 2021 second quarter earnings release, will be available on our website approximately one hour following this conference call, and a recorded webcast will be available for approximately 30 days following this conference call.

Additional information related to our end markets, business segments, geographies, channels, share count and 2021 and 2022 fiscal calendar is posted on the Investor Relations section of our website. Our earnings release and this presentation include certain non-GAAP financial measures.

Reconciliations of these non-GAAP financial measures to the most directly comparable measures under 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 the future events or future financial performance of the company. The words believe, estimate, project, anticipate, intend, may, expect, will, plan, should 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 create actual results to differ from our forward-looking statements are described in our most recent Form 10-K, Form 10-Q and other filings with the Securities and Exchange Commission. Additional factors are described in our earnings release for the second quarter of 2021.

Our estimates or other forward-looking statements may change, and the company assumes no obligation to update forward-looking statements to reflect actual results, change assumptions or other events that may occur except as required by law. Our Analyst Day is scheduled for Thursday August 5 in New York City.

We look forward to seeing you in person later this week. Now, let me turn it over to Hassane.

Hassane?.

Thank you, Parag, and thank you everyone for joining us today. We delivered record results in Q2 driven by strong execution and broad-based strength and demand. We posted record revenue of $1.67 billion, an increase of 38% year-over-year and 13% quarter-over-quarter..

Thanks, Hassane. I’m pleased to announce a record quarter as we’re seeing it really impact of our transformation initiatives and our financial results. Customer demand remained strong and design win pipeline for our innovative power and sensing technologies continue to expand.

We’ve been successful in securing additional supply from our internal manufacturing sites as we optimize our efficiency, which contributed to revenue at the high-end of our guidance..

Your first question comes from Ross Seymore from Deutsche Bank. Your line is open..

Hi, guys. Thanks. Let me ask a few questions. Congrats on the results. Hassane, I want to talk a little bit about the demand and the shortage commentary you had, I believe last quarter, you thought that the demand would kind of stabilize, the velocity might -- the increase might slow, but shortages would abate in the second half of the year.

It seems like you've pushed that out into the first half of next year.

So I guess what's changed with any color on the demand side? And how can you be confident that there's no double ordering within that?.

Sure. That's a good question. Look, the demand environment as we've always stated, it's very dynamic. We see it basically pushing out into the first half of next year. That's based on -- our backlog based on customer interactions, and really based on the LTSA that we have been engaging with on customers either signed or in active engagement.

Now as far as the double ordering, we're managing our supply chain to make sure that doesn't happen as far as having it in the channel. So we have been reducing and managing inventory very closely.

That keeps the inventory on our balance sheet, but allows us to serve strategic customers as we see the demand from the end customer without really accounting for any, call it buffer stocking that you may or may not see in the distribution channel or anywhere in between and OEM. So that's how we're managing, call it tactical.

But that's what we need to do right now to make sure that we're not going to suffer from the double ordering. So that gives me the confidence given the numbers of inventory that has been reducing and building up on our balance sheet that we are literally tackling end demand one-to-one basis with our direct customers..

Thanks for that color, Hassane. I guess as my follow-up for either you or Thad. On the gross margin side of things, that's probably the most impressive line, given where ON has been historically and the challenges it face.

Can you just talk a little bit about what drove the upside even to your guidance in the second quarter, similarly for the third quarter.

And a higher level question, how much of that do you believe is structural versus just you guys benefiting from some pretty strong cyclical tailwinds that as we've learned in the past can come and go at different times?.

Yes, if you look at the components of the gross margin strength, obviously, we -- we've always said in the first and second quarter now, we have probably thousands of line items that we are structurally working on improving our operation and streamlining our business. That's going to drive gross margin expansion.

Those have been firing on all cylinders and we are seeing the benefit incrementally, and you're going to see that in our guide for Q3. So those I would call structural. If you look at utilization, utilization has been flagged from last quarter. But you see a big gross margin jump that also is what I would call structural.

It's not really tied to utilization per se because utilization is flat. So the jump from Q1 to Q2 is on all the other work that we have been doing.

So we continue to streamline our operation take cost out of our products, and portfolio mix and portfolio rationalization, a couple quarters ago, I was asked that would be delayed because of the demand environment, my commentary has been, it's actually going to be accelerated because it's going to force us to shift faster to our strategic products that will drive higher margin.

So you're seeing some of that portfolio mix happening earlier than we anticipated. So all of these components will tell you that it is structural, it is sustainable. And forward looking. I'm very bullish on the capability of our gross margin expansion..

Thank you..

Yes, I would just -- I think Hassane, I think if you look at the upside compared to our guidance, we were able to get more supply out of our manufacturing sites. And then obviously, we're getting favorable mix out of that as well, which is helping with the gross margin.

But absolutely agree, it's structural changes that we're making inside the company..

Thanks, guys..

Your next question comes from Charles Danely (sic) from Citigroup. Your line is open..

I think they got the wrong name, but I'll speak up for my unborn son name Charles. It's Chris. Hey, guys. Can you just be a little more specific on the gross margin drivers. Was there any pricing involved, any kind of specific product lines? It's just a big jump given that utilization rates didn't do anything. Any specifics there would be great..

Yes, I mean, it's spread across the board. Of course, there is some, what I referred to the price to value discrepancy. So we have been looking at our pricing from a strategic perspective, what products and what pricing they need to be in the market to extract the value that we provide for our customers.

Cost is a big factor, not just product costs, but supply chain costs, upstream and downstream supply chain costs. Some of the increases that we’ve seen we pass those on to customers, as I've described them in prior calls. So it's really -- Chris, it's across the board.

There's not a big step function that I would anchor on, because when we look at incrementally it came from all of these swimlanes that we have been launched and working on since -- really, since the December timeframe, when I came in, I said we're structuring gross margin.

I have a specific owner in the company that drives gross margin improvements for the company. And we have about, call it, a 1,000 swimlanes that we are delivering to, and those are starting to come out now. Because it takes time to get those through the supply chain, and now is the quarter where we see it.

And they're going to continue in the forward looking quarters as well, given the Q3 guidance range..

Great. And then for my follow-up, you mentioned you expect the shortages to extend into next year.

Can you just talk about where your lead times are these days? Or what they did sequentially? Did they extend during the quarter? Were they flat up or down?.

Yes, Chris, the last quarter, our lead times were in the low 30 range. It's now up to about 42, they've gone up by about 10 weeks, sequentially. Obviously, we're working on that, but that's another reason that given and given us more visibility that why we see the supply constraint being limited as we look forward..

Great. Thanks, guys..

Your next question comes from Vivek Arya from Bank of America. Your line is open..

Thanks for taking my question, and congratulations on the gross margin, and especially the free cash flow improvement. My first question, Hassane, is that investors are trying to grapple with the situation where, as you mentioned, demand is strong.

But will the supply environment stay disciplined? So the specific question is, how undersupplied is the industry right now? And you mentioned the situation could persist until the first half? Is that based on demand level staying at current levels or what they could be next year? Just basically what are your views about the supply response from ON and your peer group to give investors the comfort that the supply response from the industry is not going to change this very strong discipline and the pricing dynamic that your industry is benefiting from right now?.

Yes, that's a good question. I can really speak for and what we're doing here. Of course, the fear is the reaction, you go and build capacity or across the board.

But if you look at what we are doing specifically, and why I'm comfortable with the forward looking view of our margin, and our posture really with the gross margin expansion is we are selectively adding capacity, where we see the growth and our strategic products forward looking. So we're not adding capacity for the sake of adding capacity.

We are first shifting from a lot of what we call the legacy portfolio and to the strategic growth and adding capacity there. So as we are increasing our top line, given the supply relief that we're getting through our supply chain, those are coming from strategic growth products.

So when I look at our strategic plans moving forward, and we'll give a little bit more color at Analyst Day, that's where we're expanding the capacity. It is not equal for all. So there are demand signals on our -- in our visibility to our customers that we are not servicing beyond what we can today. So I'm not adding capacity there. We are selective.

We're very, very disciplined on where we add capacity, and we're adding it in our growth products that are strategic and those will be driving the gross margin forward looking. So very selective, not the shotgun approach..

Got it. And for my follow-up actually a clarification question. On the clarification side, any impact from shutdowns or COVID related issues in Southeast Asia from supply side? And then, Hassane you sound really very confident about ON's prospects in the electrification side.

So could you help us understand what is your current exposure to EVs? And what kind of content growth do you see both on the powertrain and the ADAS side as the industry moves more towards EVs? Thank you..

So, let me answer the EV first. Our exposure, obviously, this is starting to grow, I'm very bullish. I'm not going to -- I can't even hide it. So I'm glad you really picked it up. So, I'm very bullish with our posture, both on the automotive safety and electrification. Electrification penetration is starting to pick up.

We're well-positioned with strategic OEMs directly, but also through their Tier 1 supply chain. So that is really forward looking, how I look at the market and really where our R&D investments are happening. If you recall, we did a big restructure at the beginning of the year, that's moving R&D and capacity and capital into those markets.

Because I see the design wins, I have personally engaged with customers, we have LCSH, as it relates to vehicle electrification, all of these make me very bullish, but more importantly, very excited on the potential of ON in these markets.

For your question about the COVID disruption, yes, we've seen -- we have seen disruption related to COVID in some of our supply chain, direct or indirect. But back to the demand environment, I think our operations and our manufacturing teams were wide, we were able to really redirect and service more demand by shifting the mix again.

So there was disruption. We overcome that disruption. And now we're back on track. So let's call it a blip that we were able to sustain given the demand and given the work that we're doing on releasing more capacity..

Thank you..

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

Good morning. Thanks so much for taking the questions and congrats on the strong results. Hassane, I had a two-part question on gross margin. You talked about addressing price to value discrepancies.

Just curious, what percentage of discrepancies have you been able to execute on in the form of price increases? And how much left is there to go? Guessing your tenure at ON, I'm guessing it's still very early innings.

But curious how much is left? And then as my second part, in terms of the 300 millimeter transition, again, I believe it's very early in the process. But how do you see that evolving over the next couple of years and the impact on gross margins? Thank you..

Sure. So the first question as it relates to price value, obviously, this is an ongoing effort. I would put it under the portfolio rationalization overall. So I don't break it out because of price or because of the shift, because all of those are material.

If you start moving the ship to high value products, without touching the price that's going to impact the value you provide to customers. So I would say, like you mentioned, we're not done yet. That's a continuous improvement. Everywhere we look, there's opportunity. And more importantly, it's the momentum that the company is getting.

If you think about it the first couple of quarters, I have been pushing a lot of that from the top. Right now it's part of our culture, it's part of how the teams are thinking about pricing strategies from new products and moving forward.

So it's not a blip in time where oh, because of that environment, we're able to extract the value, it is structurally how we're moving forward. So new products are not going to be having those issues of price to value discrepancies, because we are pricing the new products and delivering the new products exactly at the value they provide customers.

So that’s really how I look at it.

Does that help?.

It does. And then the 300 millimeter transition? And -- sorry, as my follow-up, just on the OpEx side of things, I think you came in below the low end of your range for Q2, roughly 19% of sales. And then for Q3 your guidance implies an OpEx to sales ratio of around 18%. That compares with the prior management teams long-term target of 21%.

So just curious, is 18% sort of the new normal, is it going to be a little bit higher, a little bit lower. Any thoughts on OpEx going forward would be helpful as well. Thanks..

Sure. So on the 300 millimeter, obviously it's a strategic asset. We have been working with Globalfoundries under our transition. We have not taken ownership of that fab yet. However, we're working very closely on starting to move volume into that fab.

So when we take ownership, we hit the ground running and that, of course, is going to be supportive of our gross margin efforts from a product cost perspective. Where we are there, we're on track.

I review this regularly as far as how many products have we qualified in the 300 millimeter fab, but more importantly, the customers that have qualified that fab for us to be able to ramp with them over '22 and into '23. So that's all on track.

I'm happy with the progress, so that asset is going to be favorable for us in the long run, both from a capacity but also from a cost structure. And I will let Thad comment on the OpEx..

Yes, on the OpEx side of things, when we did a restructuring activity, and we said we'd realize the benefit of that cost savings over the course of the year. We accelerated that and we are able to recognize some of that earlier, and that's the impact that you're seeing here in Q2, that’s more favorable to our guidance.

We still believe we're going to exit the year somewhere just north of $300 million on a quarterly run rate, and that becomes the new baseline. Obviously, you've got the reset of FICA and things like that going into next year, but that becomes kind of a run rate that we maintain.

And then obviously, as we grow, we'll had OpEx back at a much slower pace than our revenue growth..

Thank you..

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

Yes. Hey, guys, First of all, strong congratulations. These are stunning results. Hassane, I'm going to push you a little bit. In the last 5 years results, I think the peak happened at $1.5 billion or 38.5% gross margin, I think it was like 2018, or something like that. You're now talking almost $1.7 billion, 40%.

So my question is, you've got a higher run rate, higher margins, how much is it a function of the actions that you've done and the actions that you've implemented in your opinion? I've got a follow-up..

Sure. Of course, there's only one answer to that. It's all based on the stuff that we've been working on. But let me talk about the timing of it. Of course, the demand environment has helped accelerate a lot of these, as I talked about before.

We've always had part of our structural or restructuring plan to start shifting portfolio and shifting that mix to high value, high margin high strategic products in our target markets of auto and industrial. That is part of the actions that we have been taking, and we started taking since I joined.

They got accelerated with the demand environment because of the capacity constraints.

What we've done is we release capacity from what I will call the legacy commodity products that we've always wanted to move away from part of my strategy, faster into putting that capacity on high value, high growth and strategic products that will grow with us over the next 5 to 10 years. So the actions are all there.

The timing was accelerated and held by the current environment..

I got you..

Harsh, did I answer your question ….

Yes, it does. Thank you very much, and very helpful. And then, on following up on Toshiya's question, want to talk fabs and cost cuts.

So can you remind us the timing of when you will actually have products running through Fishkill, because that could be -- it could be a great benefit also, very that things don't go well, and you're running the factory empty.

So when will you be at a point when you sort of utilized well from a timing angle? And then with that big 12-inch fab coming away, how many fabs do you think they will eventually need?.

Yes, so let me talk about the Fishkill first. We are running revenue and running volume today at Fishkill. Remember, it's a shared fact today with us and Globalfoundries, we have capacity or allocation part of that capacity out of the fab and Globalfoundries has their capacity part of our original agreement.

We are already shipping qualified products to end customers that are generating revenue out of that fab. That revenue will keep increasing through '22, as I mentioned, and we're on track based on customer quals and our own product quals. So that progression is there.

And obviously we will be talking about utilization once we take ownership of that fab in '23 and through '24. But right now it's more of an allocation because the fab is still not owned by ON.

But I measure in this case, are we shipping what we need to be shipping to our customers based on the quality because that's really the latency that you usually get, and we're on track with that. As far as how many fabs we need to run our operations, obviously, that's not something I can comment on today.

My focus is really on rationalizing our manufacturing footprint to going to a fab lighter, so we will have less fabs, but I will be ready to comment more on it as we are ready, and we have communicated plans to that specifically..

Hey, guys, very helpful. Congrats again..

Your next question comes from Mark Lipacis from Jefferies. Your line is open..

Hi. Thanks for taking my questions. First question, sorry to come back to the gross margins. But it sounds like there's something really different going on with ON than the last 10 or 15 years. So, Thad, in your script, I think when you talked about the gross margin upside, you said mix efficiency execution and cost containment.

I don't think I heard pricing in there. And then, Hassane, you use the expression price to value discrepancy, which I thought was a code word for prices. But it sounds like if you're shifting the mix on your limited capacity to the higher value products.

So -- and -- so the question is on the last -- so I guess there's a clarification, I just want to make sure I got that right. And for me, the question is, over the last 10, 15 years I covered on, when things are bad, you hear about 6% to 10% price pressure, and then when things are good, you hear about 5% to 10% price improvements.

Is that part of your business gone? Is this -- is ON now a much lower volatility business on the much less subject to pricing pressure. And then I had a follow-up..

So the short answer is yes. Strategically if you -- I think one of them, it was the first conference that I attended back in January, the CES conference where I really put my focus on gross margin improvement through manufacturing footprint rationalization and product portfolio rationalization.

Those are two strategic directions that I've set as far as what we need to do right now. So what does portfolio rationalization mean, in the terms that you describe, which are very accurate.

One is, look at which one -- which products are we going to grow in and which products are, legacy where we're not going to be investing in and start shifting that to the high strategic products where we want to play. Now, that's more forward looking. Meaning it is not a point in time where those products are now better mix.

And when the market goes the other way, we're going to have to see what you said, the 6%. What we are seeing is we are shifting that to the strategic products that are starting even to grow and will maintain growth over the next 5 to 10 years. That's the structural portfolio mix that we have done.

So once the front from the last 15 years, is -- I don't need fab fillers. When you have fab filler products, which are low value, discrete commoditized products, you keep shoving them in the path, and they go up and down with the market. We're moving away from that, we're moving to strategic high value products that are going to grow over time.

And that capacity has been taken away from the discrete commodity product, I call that volatility. So in summary, when you shift your mix to strategic growth products, that volatility disappears because that's a growth trajectory and a growth trajectory only.

Whatever demand does, it's going to be growth, maybe it's not high growth, but it's still growth. That's the structural impact of the portfolio rationalization..

That’s very helpful..

I’m ready for your follow-up..

Yes, great. That's really helpful. Thank you for spilling that out for me. The -- what are you looking at on for leading indicators to tell you that customers are getting over their skis on their orders? And maybe can you talk about any dynamics you're seeing on any cancellations or push outs or anything like that? Thank you..

Yes. Look, there are many times that we look at. I have analytics to be able to see obviously you're not always going to see 100% around the corner. But I'm comfortable with the visibility we get. Both Thad and I review it, more than once a week in order to make sure we don't miss anything.

But not to be joking about it, but the biggest gauge in how many escalation calls I get from customers is the biggest indicator. When I, my phone stopped ringing often stops ringing off the hook 50 times a day, then I know we're not where we are today.

So both of these, you have the analytics, but you also have that, call it subjective field that you get. And both of those lead me to believe that this is going into the first half of '22..

And, Mark, just to add, we're not seeing any meaningful cancellations or push outs at this time. We've also taken the inventory and the channels down so that we can manage that escalation process, whether that customer is in the channel or direct.

And essentially making sure customers are getting the inventory just as they need it rather than stockpiling it. So we're doing our best to manage it. And I think we've got good analytics and visibility of what's happening right now..

That's great, color. Thanks, guys. Really appreciate it..

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

Yes, thank you, and congrats as well on great momentum across the board.

Just picking up on your commentary around the inventory, I think last quarter, you had talked about that you wanted to build inventory on your balance sheet, while reducing inventory in the channel, that you're actively reducing channel inventory, while holding more inventory on your own balance sheet in order to allocate the right products to the right customers, and therefore preventing any excess inventory sitting in the channel.

Wondering how that strategy is playing out this quarter? And how do we think about that over the next couple of quarters in a continuation of the supply constrained environment..

Yes, so we are at a 8.4 weeks in the channel last quarter. We're at 7.3 weeks this quarter. So on a revenue value, that was a decrease of almost $43 million in channel inventory. At the same time, our balance sheet inventory went up slightly in terms of dollars, up $14 million, but down in terms of days, it went down in 8 days.

So we're still executing to that strategy of putting that inventory. Obviously, as inventory becomes available, finished goods become available, we're showing them. So as we look forward, we think we'll continue the strategy through the remainder of this year. I think inventory in the channel is going to stay level kind of plus or minus.

And I think our inventory on our balance sheet will probably remain relatively flat to down slightly, just depending on our capacity to get more supply. So, through the remainder of this year, we don't see a change in our strategy of holding that inventory..

And just a couple more follow-ups again on -- Thad, you mentioned that you had secured additional supply, internally.

Wondering if you can elaborate further on how much supply you're able to get? What were the steps that you did in order to kind of alleviate that supply and increase more supply and how we think about more supply coming online, whether internally or externally. And just, Hassane, I just have a question on the automotive revenue.

You've had record automotive revenue, you obviously want to shift to electric vehicles, energy, renewable energy infrastructure. Maybe give us some updated thoughts on your silicon carbide power products and power modules for charging stations and onboard chargers. Thank you..

Yes, so, Raji, in terms of the supply, and what we saw in our utilization was relatively flat quarter-over-quarter, but we got more supply out. So this is really the optimization efficiency of our manufacturing site. We manufacture about 65% of our own product in-house, 35% outside.

We still remain severely constrained on the outside, but we've got more control on the inside with what we can do. So as our manufacturing team has executed, we've been able to just squeeze more out of the existing footprint.

And then if you look forward to our Q3 day, which is up at the midpoint, you can see we're getting more supply coming in Q3 as well. So again, this is just really the optimization of that..

Yes, and as far as your second question about our power products, obviously, I mentioned renewable energy, I mentioned electric vehicles, which for me is both traction and onboard charging. So as the power demand goes off as far as the need from customers, think about the fast charging, whether it's onboard charging or infrastructure.

The charger on the road, or attraction, where we are winning and why we are winning is our highly competitive efficiency metric that comes from the province and technology that we are flexing, but more importantly, our packaging technology. When you put those two together, you get a LiDAR and more efficient traction module.

LiDAR is obviously good for EVs for distance. But lighter and smaller is also good for packaging. So we're able to get the same quality equivalent power output of our silicon and silicon carbide modules. And I talked about module being the device, and the packaging is better than the equivalent competitor power output. That's where we went.

You'll hear a little bit more about that at the analyst day. But that's what I tie our current winds to.

And when I look at the funnel, I talk to the customer, since I've taken over a lot of customers I call is why do we win? Why do you pick on and those are the ones that I'm pushing into our strategy to do more of, and where they say we lack we're putting R&D in order to leapfrog the competition.

So all of these give me the confidence; one, on our posture to date, our posture with a design win forward looking that's going to fuel our growth. And more importantly, where we are investing R&D to sustain that momentum forward looking..

Great. Excellent. Thank you..

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

Yes. Hi, good morning, guys. Thanks for let me ask the question. Congratulation the solid results. I'd like to go back to kind of the significant growth margin upside you've seen over the last couple of quarters.

I'm just kind of curious, what inning do you think you're in as far as repositioning the portfolio to higher margin? And I guess, was there any meaningful sort of advantage to kind of trying to price yourself out of certain businesses right now? And customers didn't walk away so that we saw some cyclical pricing advantage to either the June gross margins, for the September gross margins?.

Yes. So, look, where as far as any call, we're in early innings.

As far as what we're able to do, you're starting to see the momentum of the work we've done in Q1 and Q2, starting to kind of come about we haven't seen the benefit from some of the manufacturing rationalization, the actual fab divestitures, that at least the ones that we've talked about, you haven't seen that benefit yet.

So that's going to feel more of the gross margin expansion forward looking. Right now it's on, cost, product, product, mix, product costs, product value, et cetera. All of those are what you're seeing today. So there's more to come as you -- as we deploy and execute our strategy, forward looking.

So that gives me the comfort of where we are, as far as in our trajectory, and the gross margin expansion..

That's all for. And then Hassane, the gross margins were impressive. I would argue the free cash flow, which was even more impressive. And if you looked at your stairs, your share schedule, on your website, that there's not a lot of dilution coming down as the stock price goes up.

So I'm kind of curious how you guys are thinking about sort of the use of cash and cash return. Given how strong the free cash flow generation looks like it was in the quarter and should continue that..

Yes, John, its Thad. You’re right. Now that if we took out that convert and swapped it out for a new convert that old one was heavily in the money. So the dilution impact is in significant as what you're seeing in the past and if you look at our guidance, for next quarter, 436 million shares, it's just up to small.

So as we think about the cash generation, right now its balance sheet flexibility, it's continuing to pay down the debt. long-term, we'll look at returning capital to shareholders, but right now its reinvest in the business and have balance sheet flexibility..

Thanks, guys..

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

Good morning. Congratulations on the solid results and execution. The Image sensor business, again, they grew both auto and industrial on a quarter-over-quarter and year-over-year basis. And I know most of this business is outsourced. You talked previously about being supply constrained into the first half of next year.

As that supply normalization actually pushed out given the strong demand you're seeing? And then just given the strategic nature of sensing to your strategy and portfolio, is this a technology and product segment that the team is actually thinking about potentially bringing in-house..

Look, so that you're absolutely right. This is very constrained because majority of or all of it is foundry big. Now as far as over the long-term strategy about what we do outside or inside, we'll be talking more about that in our Analyst Day. But it is fundamental to our strategy.

And therefore, the supply constraint is not something we can solve right now. Right now, it's more on optimize the existing supply chain that we have. Because imagine that technology is not you can pick up a fab, whether internal or external and get some expansion.

There's a lot of R&D work that needs to go into qualifying and running that image sensing technologies and various specific facts that required CapEx and R&D. Obviously, we're looking at all options, but right now through, call it, '22.

It's what more can we get out of the foundries partners?.

Got it.

And then normally, the team's December quarter from a seasonal perspective is flat to down sequentially, but just given the strong demand velocity, given the backlog visibility combined with your supply additions coming on into the second half, would the team anticipate a better than seasonal growth trend for the December quarter?.

Look, I don't think we can talk about seasonality, but I'll let Thad comment. But seasonality at this point is really, we don't -- we have the demand. Right now our top line and our forward looking is based on the supply and the mix, we were able to get out of our footprint..

Yes. So, Hassane is right. We're limited by supply and the demand is there. So within the fourth quarter, we think we're going to be at the top end of our normal seasonality, which normal seasonality is kind of flat to down 2%..

Great. Thank you..

Your next question comes from Vijay Rakesh from Mizuho. Your line is open..

Hi, Hassane and Thad. Congratulations on a great quarter and guide. Just wondering on the EV and ADAS, looks like really strong growth there. Could you give us some color on how that grew sequentially? And as you exit the year, if you can talk to what the mix you see, especially with the traction on the EV side.

How that EV mix gross year-on-year as a percent of revenues? Thanks..

We're not breaking up by technology or by sub segments. We're just looking at the automotive. We expect automotive to maintain the growth. Obviously, its limited by what I mentioned earlier and to the prior question, on the ADAS side from the supply and imaging, which we are highly constrained on.

As far as the rest of our power products or call it the silicon non-imaging product-- power products, that's going to be on based on how much we are able to get more out of our supply chain footprint as Thad mentioned through the efficiencies that our supply chain team has been working on. So I don't see the momentum there. There is growth built in.

Demand is there. And right now it's how much of that demand can we service..

Got it. And as we look out, I know Thad mentioned going into Q4 more like the top end flattish. But wondering if you can give some idea on how the book-to-bill is trending? How it was in Q2, how you see Q3, Q4? some idea there in terms of how orders are coming in? Thanks..

Yes, Vijay, I mean, the book-to-bill is strong, right, it remain strong. We think it's going to continue through the remainder of the year. Again, it's supply that’s the issue. We're not seeing major cancellations or push outs. We're seeing just consistent strength right now. So we're not seeing any major swings in the book-to-bill..

Great. Thanks a lot..

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

Great. I want to add my hearty congratulations to great results and even better outlook, and I appreciate your taking my questions. First, the compute end market was particularly strong in the quarter. I think you attributed that or you least highlighted graphics cards to part of the success there.

I'm wondering if you can talk about trends in that end market as we look out over the next couple quarters. There's been some concern about perhaps in aggregate inventories or mismatched bills of materials that might cause a hiccup in that end market. I wonder what you're seeing in terms of the outlook there? And then I do a follow-up..

Yes, look, we're seeing trends in both cloud and the server market. So that -- it's over market growth. But if you look what customers are doing, there is more and more capacity for expansion in these markets, and that's what we're correlating on our demand.

So I think the market took a pause in 2020, and maybe at the beginning of '21 and now it's starting to pick up. From an investment side, I don't see that kind of slowing down. We're going to keep monitoring and just like we are every other market and our focus in these is limited to what we want to do on the product side.

Those are what I would call adjacent markets, where we have very compelling and competitive products that we are able to service in these markets and we're going to be pushing that -- through to our customers.

But from the science and the data I get from our customers directly, there's capacity expansion on their side and that gives me the visibility on the confidence and the demand that we have on our backlog for these markets..

Great. And then as a follow-up, you talked about capacity expansion in the next few quarters.

I may have missed it, but is there an aggregate -- a sort of unit growth or dollar growth that's getting built in as we think about demand and supply perhaps rationalizing, or coming into somewhat of a thesis in the first half of next year as you've highlighted.

What should we think about your total capacity as we progress into that timeframe?.

Bill, I would say, we've got a couple of things going on. We've got 300 millimeter fabs coming in line and continuing the push -- production in there. We our supply constraint, we will continue to optimize. But I would look at just our supply as being at least through the time horizon.

You're talking about the first half of next year has been pretty steady with some small increase as we continue to optimize and get more output..

Thanks. Congrats, again..

Thanks..

Your next question comes from Christopher Rolland from Susquehanna. Your line is open..

Congrats as well on all the progress you've made in just a few quarters, guys. The first question is for Hassane. Hassane, LTSAs were a big deal for you guys at Cypress. Can you expand there, perhaps what you -- what end markets you're looking to deal long-term supply agreements for, how they're being used strategically.

And ultimately, do you guys have a goal of kind of what percent of revenue you ultimately want under long-term agreements?.

number one, our strategic markets and two, strategic products and strategic customers in those markets. That's kind of the priority that we are doing because -- and that's the start because think about it from a strategic perspective. I wouldn't want to lock in supply before I get all of my automotive customers taken care of, for example.

And once that happens, then you start going automotive industrial and it's based on customers and the breadth of customer within. Are they buying multiple products where cross selling plays a big impact in our decision? Or is it a one product? So that helps us strategically assess where we are.

Obviously, our goal is to remain and support all of the customers that we have, and that's how we're going to maintain that role.

But as far as LTSA, I'm starting with strategic -- market strategic customers and breadth of customers, because that's what's going to fuel, one, our growth, but more importantly, our stickiness the broader we are, the more sticky we are because that's where the value comes in, not from a product, but from a company perspective.

So that's a percent, given that I really don't have a percent target. What I want is to drive the right strategic behavior because if I throw a percent out there, I guarantee we will meet it.

My view is I'm looking at it strategically, whatever the percent ends up, it ends up, but we do have based on the product lines, so not at the group level, but a click below that they have kind of targets where we may not want to go up to 80%, for example, because you want to keep 20% or 30% dynamic for the growth that we get from new customers that are not yet at the level, we want to do an LTSA.

So there's a lot of play in there. And we're taking a very, very surgical on an account market and segment basis..

Excellent. And then a question around the fab footprint. First of all, any updates on your existing fabs for sale? And then secondly, on East Fishkill, the prior management team talked about $2.3 billion in additional revenue.

Do you have an update there? In this environment, do you think that could be substantially higher?.

In terms of the sound footprint, we continue to look at it in deep discussions with a couple -- well, quite a few parties actually on the two fabs that we publicly announced. So those are tracking along. As you know, it takes time to exit a fab, right. Getting the structure in place is more important than the timing of the exit.

So even though we haven't announced something, we're still along our path of timing, but it does take time, but things are progressing nicely there..

Look on the EFK, on the East Fishkill fab, obviously we are in a path to -- we're changing even the mix of what goes in that path based on our new strategy and our new direction. I wouldn't put yet a number to it. Of course, we're getting it because it's going to drive incremental growth that is part of the strategy.

But I'll be more comfortable disclosing that number and that target and how we progress against it, once we have ownership of that fab..

Great. Thanks, guys. Great progress..

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

Thank you all for joining us today. I once again thank our worldwide team for their hard work and driving our transformation and solid results. It's been an exciting few quarters and we are firing on all cylinders. We remain focused on our execution and our drive to streamline our business and unlock our value.

I look forward to seeing you all at our Analyst Day in a few days for a deeper look into our strategy and our transformation..

This concludes today’s conference call. Thank you all for joining. You may now disconnect..