ON Semiconductor Corporation (ON) Q2 2021 Earnings Call Transcript

ON Semiconductor Corporation (NASDAQ: ON) Q2 2021 earnings call dated Aug. 02, 2021

Corporate Participants:

Parag Agarwal — Vice President, Investor Relations and Corporate Development

Hassane El-Khoury — President, Chief Executive Officer, and Director

Thad Trent — Executive Vice President and Chief Financial Officer

Analysts:

Ross Seymore — Deutsche Bank Research — Analyst

Christopher Danely — Citi — Analyst

Vivek Arya — BofA Global Research — Analyst

Toshiya Hari — Goldman Sachs — Analyst

Harsh V. Kumar — Piper Sandler Companies — Analyst

Mark Lipacis — Jefferies — Analyst

Rajvindra S. Gill — Needham — Analyst

John Pitzer — Credit Suisse — Analyst

Harlan Sur — J.P. Morgan — Analyst

Vijay Rakesh — Mizuho Securities USA — Analyst

William Stein — Truist Securities — Analyst

Christopher Rolland — Susquehanna Financial Group — Analyst

Presentation:

Operator

Good day, and thank you for standing by. Welcome to the ON Semiconductor Second Quarter 2021 Earnings Conference Call. [Operator Instructions]

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.

Parag Agarwal — Vice President, Investor Relations and Corporate Development

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 which can affect our business, including factors that could cause 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, changed 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?

Hassane El-Khoury — President, Chief Executive Officer, and Director

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 in demand. We posted record revenue of $1.67 billion, an increase of 38% year-over-year and 13% quarter-over-quarter. The non-GAAP diluted earnings per share of $0.63 grew significantly year-over-year and quarter-over-quarter as a result of the work we have been doing to restructure the company and streamline our business.

Our sharp focus on gross margin is beginning to show strong results with our Q2 non-GAAP gross margin increasing by 320 basis points quarter-over-quarter and by 760 basis points year-over-year. These sustainable improvements in our gross margin will continue as we rationalize our current portfolio and reallocate R&D investments to high growth and margin accretive new product development. To capture the full value of our products, we continue to evaluate our portfolio to eliminate any price to value discrepancies and focus our manufacturing on our strategic products. In addition, we continue to drive efficiency throughout our upstream and downstream supply chain and optimize our operations to reduce costs.

The demand environment continues to be robust across all end markets. For the second quarter, we posted record revenue for the automotive and industrial end markets. In addition to the company’s broad-based strength in these markets, we are benefiting from the strong traction of our power and sensing products. The strong demand that we have seen over the last few quarters continue to outpace our ability to supply certain products, especially those manufactured by our foundry partners. Based on current booking trends and macroeconomic outlook, we expect that the demand will continue to outpace supply through the first half of next year.

We are working collaboratively with our customers to ensure the uninterrupted supply of our products in the future, having entered into long-term supply agreements with many of them already and actively engaging in discussions with several others. Long-term supply agreements or LTSAs are a win-win for both customers and us by guaranteeing supply to the customer, and at the same time, providing better visibility and allowing us to better plan our capital allocation towards capacity expansion with a committed long-term demand outlook.

Let me now discuss a few highlights of our strategic end markets, starting with automotive. We set a new record for our automotive revenue in Q2 with revenue of $556 million. The success in automotive was driven by strength in our power and sensing product categories. We have emerged as a strategic supplier of highly differentiated technologies for electric vehicles with customers placing high value on the efficiency and footprint advantages provided by our power solutions.

Our engagement with leading global OEMs and Tier 1s continues to expand, and I’m very bullish on our potential in the growing vehicle electrification market over the next few years. In addition to the industry-leading performance of our fabs, the key source of our differentiation is our expertise in packaging, which is critical for improving heat dissipation, increasing power output in a smaller footprint than our closest competitor and reducing the weight and cost of power module. The efficiency of our module allows our customers to make no trade-offs between the cost of battery and the range of the vehicle, they get both.

We continue to strengthen our leadership in automotive safety with new design wins and see the increased penetration of active safety, features driving strong demand for our image sensors and ultrasonic sensors. In Q2, we secured significant wins for our image sensors on key platforms in Asia, and in a few cases, we displaced the incumbents. With increasing sensor content, especially in new electric vehicle platforms, we remained bullish on our ADAS business. We recently announced that AutoX has selected our intelligent sensing technologies to enable 360 vision in its Generation 5 Fully Driverless Robo Taxi. On this platform, our 28 image sensors and for four 3D LiDAR sensors, eliminate blind spots and powerful autonomy.

The Industrial end market, which includes military, aerospace and medical, contributed revenue of $434 million in Q2, representing approximately 26% of our revenue. Excluding the impact from geopolitical factors related to a specific customer, our second quarter industrial revenue increased by 29% year-over-year driven by broad-based demand and strong performance by our power and sensing technology portfolio. We are seeing continuing momentum for a higher power modules and alternative energy applications given the investments in utility scale solar installations that are expected to grow worldwide to reduce the climate impact of fossil fuel-based power plants. With a broad range of power solution and early engagement with key market disruptors, we are well positioned to grow in the market. On the industrial automation front, we saw steep year-over-year growth in our imaging revenue driven by machine vision and scanning applications.

Now I will turn the call over to Thad to provide additional details on our financial performance and guidance. Thad?

Thad Trent — Executive Vice President and Chief Financial Officer

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.

Based on our current outlook, we expect strength in demand to continue through the first half of 2022. The company has been executing on long-term and sustainable actions that have resulted in record revenue, earnings and free cash flow for the second quarter. In a few days at our Analyst Day, we will share our long-term strategy and operational plans to realize the full potential of the company.

So turning to results for the quarter. We saw broad-based strength and the sequential revenue growth across all end markets, regions and business units. Secular megatrends in automotive and industrial contributed to record revenue in both of these end markets and together comprised 59% of revenue. Total revenue for the second quarter was $1.7 billion, an increase of 38% over the second quarter of 2020 and 13% quarter-over-quarter versus normal seasonality and a sequential increase of 3% to 5%. Our automotive revenue grew 69% year-over-year and 8% sequentially. Industrial revenue grew 24% year-over-year and 18% sequentially.

Turning to the business units, revenue for the Power Solutions Group or PSG was $846.6 million. PSG revenue increased by 37% year-over-year due to strength in automotive and industrial end markets. Revenue for the Advanced Solutions Group or ASG was $607.6 million, an increase of 42% year-over-year. In addition to the strength in automotive, ASG benefited from strengthened computing, especially in high-end graphics card. Revenue for the Intelligent Sensing Group or ISG in second quarter was $215.7 million, an increase of 28% year-over-year. Strength in ISG was driven primarily by automotive.

GAAP gross margin for the second quarter was 38.3% and non-GAAP gross margin was 38.4%, a 760 basis point improvement year-over-year and 320 basis point improvement sequentially. Our strong gross margin performance over the last few quarters has been driven by strong execution, a favorable mix to higher margin products, improved efficiencies in our manufacturing sites and cost containment initiatives across the company.

Our factory utilization was 83%, which was relatively consistent with Q1 at 84%. As we move forward, our fab lighter strategy will allow us to continue to reduce on the manufacturing footprint and overall cost structure, while increasing capacities for the demand of our customers. GAAP earnings per share for the second quarter was $0.42 per diluted share. Non-GAAP earnings per share was $0.63 per diluted share as compared to $0.12 per share in the second quarter of 2020 and $0.35 in Q1. As noted earlier, this is the highest ever quarterly non-GAAP EPS reported by the company.

Now let me give you some additional numbers for your models. GAAP operating expenses for the second quarter of 2021 were $357.9 million. Non-GAAP operating expenses were $314.2 million, a decline of $10.5 million quarter-over-quarter as we continue to see the favorable impact of our cost reduction initiatives launched in Q1. Our GAAP operating margin for the second quarter was 16.9% as compared to 3.6% in the second quarter of 2020. Our non-GAAP operating margin was at the highest level since 2010 coming in at 19.6% as compared to 7.4% in the second quarter of 2020 and 13.3% in Q1. Our GAAP diluted share count was 443.6 million shares and our non-GAAP diluted share count was 435 million shares. Please note, we have included an updated reference table on the Investor Relations section of our website to assist you with calculating our diluted share count at various share prices.

So turning to the balance sheet. Cash and cash equivalents was $1.09 million and we had one point — sorry, $1.09 billion and we had $1.97 billion undrawn on our revolver. Cash from operations is $488 million and free cash flow was $383 million or 23% of revenue. Capital expenditures during the quarter of 2021 was $104.8 million, which equates to a capital intensity of 6.3%. As we indicated previously, we are directing a significant portion of our capital expenditures towards enabling our 300 millimeter capabilities at our East Fishkill fab.

Accounts receivable was $669 million resulting in DSO of 37 days. Inventory increased $13.8 million sequentially to $1.31 billion and days of inventory decreased 8 days to 116 days. Distribution weeks of inventory decreased again by $42.6 million to 7.3 weeks from 8.4 weeks in Q1, which is below our target range of 11 to 13 weeks. Once again, we are proactively reducing the distribution inventory to hold more inventory on our balance sheet to support our customer needs rather than building inventory in the supply chain. Total debt was $3.3 billion and we paid down $140 million in the quarter.

So turning to guidance for the third quarter. A table detailing our GAAP and non-GAAP guidance is provided in the press release related to our second quarter results. Let me now provide you with the key elements of our non-GAAP guidance for the third quarter. As mentioned, we believe demand will remain strong for the remainder of the year. Although we continue to increase our supply through operational efficiencies, we’ll be limited by supply constraints and are working with our strategic customers to provide long-term support.

Based on current booking trends, backlog levels, we anticipate the revenue for the third quarter will be in the range of $1.66 billion to $1.76 billion. We expect gross margin between 39% to 41%, and this includes share-based compensation of $3.7 million. We expect non-GAAP operating expenses of $305 million to $320 million, and this includes share-based compensation of $19.2 million. We anticipate our non-GAAP OIE including interest expense will be $26 million to $29 million. So this results in non-GAAP earnings per share in the range of $0.68 to $0.80. We expect capital expenditures of $100 million to $110 million in third quarter of 2021. And our non-GAAP diluted share count is expected to be in the range of 436 million shares.

So in summary, I’m extremely pleased with our early progress and the execution of our transformation initiatives. I add my thanks to our worldwide teams for their hard work and unwavering commitment to our customers. And I look forward to seeing you all at our Analyst Day in New York in a few days.

With that, I’ll turn the call back over to the operator to open the line for Q&A.

Questions and Answers:

Operator

Thank you. [Operator Instructions] Your first question comes from Ross Symore from Deutsche Bank. Your line is open.

Ross Seymore — Deutsche Bank Research — Analyst

Hi, guys. Thanks for letting me ask the question. 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 is no double ordering within that?

Hassane El-Khoury — President, Chief Executive Officer, and Director

Sure. That’s a good question. Look, the demand environment as we’ve always stated is very dynamic. We see it basically pushing out into the first half of next year. That’s based on our backlog, based on customer interaction and really based on the LTSAs that we have been engaging with our 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 as 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 us and the 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 the inventory that had been reducing and building out on our balance sheet that we are literally tackling end demand on a one-to-one basis with our direct customers.

Ross Seymore — Deutsche Bank Research — Analyst

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 faced. 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?

Hassane El-Khoury — President, Chief Executive Officer, and Director

Yeah. I mean, if you look at the components of the gross margin strength, obviously, we’ve always said in the first and second quarter now, we have, call it, 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 flat 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 of quarters ago, I was asked if 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. Thad?

Thad Trent — Executive Vice President and Chief Financial Officer

Yeah. I would just — I think nailed it there, Hassane. I think if you look at the upside compared to our guidance, we are 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.

Ross Seymore — Deutsche Bank Research — Analyst

Thanks, guys.

Operator

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

Christopher Danely — Citi — Analyst

I think you 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? Are you cutting specific product lines? It’s just a big jump given that utilization rates didn’t do anything. Any specifics there would be great.

Thad Trent — Executive Vice President and Chief Financial Officer

Yeah. I mean, it’s spread across the board. Of course, there is some, what I referred to the price to value discrepancies. 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 cost, but supply chain costs, upstream and downstream supply chain costs. Some of the increases that we’ve seen, we’ve passed those on to customers, as I’ve described in prior calls. So it’s really — it’s across the board.

There is not a big step function that I would anchor on, because when we look at incrementally, it came from all of these swim lanes that we have been launch and working on since really since the December timeframe. When I came, I said, we’re structuring gross margins. I have a specific owner in the company that drives gross margin improvements for the company. And we have about, call it, 1,000 swim lanes 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.

Christopher Danely — Citi — Analyst

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?

Hassane El-Khoury — President, Chief Executive Officer, and Director

Yeah, Chris. The last quarter our lead times were in the low-30 range. We’ve now up to about 42. So they’ve gone up by about 10 weeks sequentially. Obviously, we’re working on that, but that’s another reason that’s giving us arm [Phonetic] and giving us more visibility about why we see these supply constraints being limited as we look forward.

Christopher Danely — Citi — Analyst

Great. Thanks, guys.

Operator

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

Vivek Arya — BofA Global Research — Analyst

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 this 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 levels 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?

Hassane El-Khoury — President, Chief Executive Officer, and Director

Yeah, that’s a good question. I can really speak for ON and what we are doing here. Of course, the fear is the reaction. You go and build capacity 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 in 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 into the strategic growth and adding capacity there.

So as we are increasing our top-line given the supply release 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 — and our visibility on our customers that we are not servicing beyond what we can today. So I’m not adding capacity there. We’re selective. We’re 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 a shotgun approach.

Vivek Arya — BofA Global Research — Analyst

Got it. And for my follow-up, actually a clarification and a question. On the clarification side, any impact from shutdowns or COVID-related issues in Southeast Asia from a 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.

Hassane El-Khoury — President, Chief Executive Officer, and Director

So yeah, 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 automotive safety and electrification. Electrification, penetration is starting to pick up. We are well positioned with strategic OEMs directly, but also through their Q1 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 LTSAs 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, yeah, we have seen disruption related to COVID in some of our supply chain, direct or indirect. But back to the demand environment, I thank our operations and our manufacturing teams worldwide, 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.

Vivek Arya — BofA Global Research — Analyst

Thank you.

Operator

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

Toshiya Hari — Goldman Sachs — Analyst

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.

Hassane El-Khoury — President, Chief Executive Officer, and Director

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 either because of price or because of shift because all of those are material. If you start moving the shift 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 is opportunity. And more importantly, it’s the momentum that the company is getting.

If you think about it, the first couple of quarters, I’ve 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 all — 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 the 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?

Toshiya Hari — Goldman Sachs — Analyst

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 team’s 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.

Hassane El-Khoury — President, Chief Executive Officer, and Director

Sure. So on the 300 millimeter, obviously, it’s a strategic asset. We have been working with global foundry on 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 are 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 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’ll let Thad comment on the opex.

Thad Trent — Executive Vice President and Chief Financial Officer

Yes. On the opex side of things, just to remind you, in Q1 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’re 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 more of those $300 million on a quarterly run rate, and that becomes a 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 think we maintain. And then obviously as we grow, we’ll add opex back at a much slower pace than our revenue growth.

Toshiya Hari — Goldman Sachs — Analyst

Thank you.

Operator

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

Harsh V. Kumar — Piper Sandler Companies — Analyst

Yeah. Hey, guys. First of all, strong congratulations on these astonishing results. Hassane, I’m going to push you a little bit. In the last five years’ results, I think the peak happened at $1.5 billion, at 38.5% gross margin, I think it’s like 2018 or something like that. You are 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? And I’ve got a follow-up.

Hassane El-Khoury — President, Chief Executive Officer, and Director

Sure. Of course. There is 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’ve released capacity from what I would 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 five to 10 years. So the actions are all there. The timing was accelerated and helped by the current environment.

Harsh V. Kumar — Piper Sandler Companies — Analyst

I got you…

Hassane El-Khoury — President, Chief Executive Officer, and Director

Does that answered your question, Harsh?

Harsh V. Kumar — Piper Sandler Companies — Analyst

Yeah, it does. Thank you very much and very helpful. And then on — following up on Toshiya’s question, wanted 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 great cost if things don’t go well, and you’re running the fabs that are empty? So when will you be at a point when it’s sort of utilized well from a timing angle? And then with that big 12-inch fab coming your way, how many fabs do you think you will eventually need?

Hassane El-Khoury — President, Chief Executive Officer, and Director

Yeah. So let me talk about East Fishkill first. We are running revenue and running volume today at East Fishkill. Remember it’s a shared fab 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 calls and our own product calls. 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 call, 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 go into a fab lighter source. We will have less fabs, but I will be ready to comment more on it as we ready, and we have communicated plans to that specifically.

Harsh V. Kumar — Piper Sandler Companies — Analyst

Hey, guys, very helpful. Congrats again.

Operator

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

Mark Lipacis — Jefferies — Analyst

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 in 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 the sound, and you used the expression price-to-value discrepancy, which I thought was a code word for we took prices, but it sounds like you’re shifting the mix on your limited capacity to the higher value products. 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 improvement, is that part of your business gone? Is ON now a much lower volatility business on the much less subject to pricing pressure? And then I had a follow-up.

Thad Trent — Executive Vice President and Chief Financial Officer

So the short answer is, yes. Strategically, if you — I think one of — it was the first conference that I attended back in January, the CS 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 described, which are very accurate. One is, look at 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 five to 10 years. That’s the structural portfolio mix that we have done.

So what’s different 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 showing them in the fab and they go up and down with the market. We’re moving away from that. We are 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 that caused 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. I’m ready for your follow-up.

Mark Lipacis — Jefferies — Analyst

Yeah, great. That’s really helpful. Thank you for spilling that out for me. 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.

Hassane El-Khoury — President, Chief Executive Officer, and Director

Yeah. 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 is how many escalation calls I get from customers is the biggest indicator. When I — when my phone start ringing and 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 feel that you get. And both of those lead me to believe that this is going into the first half of ’22.

Thad Trent — Executive Vice President and Chief Financial Officer

And Mark, just to add, we’re not seeing any meaningful cancellations or push outs at this time. We’ve also taken the inventory in 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.

Mark Lipacis — Jefferies — Analyst

That’s great color. Thanks guys. Really appreciate it.

Operator

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

Rajvindra S. Gill — Needham — Analyst

Yes. Thank you, and congrats as well on great momentum across the board. Thad, 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 constraint environment?

Thad Trent — Executive Vice President and Chief Financial Officer

Yeah. So we were at 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, about $14 million, but down in terms of days, it went down in eight days. So we’re still executing to that strategy and holding that inventory. Obviously, as inventory becomes available, finished goods become available, we’ll ship 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 in this 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.

Rajvindra S. Gill — Needham — Analyst

Just a couple of more follow-ups if I can. Thad, you had mentioned that you had secured additional supply internally. Wondering if you could 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 — increase more supply and how we think about more supply coming online whether internally externally? And I guess, 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 you can give us some updated thoughts on your silicon carbide power products and power modules for charging stations and onboard chargers? Thank you.

Thad Trent — Executive Vice President and Chief Financial Officer

Yeah. So Raji, in terms of the supply, our utilization was relatively flat quarter-to-quarter, but we got more supply out. So this is really the optimization and 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 is executed, we’ve been able to just squeeze more out of the existing footprint. And then if you look forward to our Q3 guide, 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 existing footprint.

Hassane El-Khoury — President, Chief Executive Officer, and Director

Yeah. And as far as your second question about our power, our products, obviously, I mentioned renewable energy, I mentioned electric vehicles, which for me is both traction and onboard charging. So the power demand goes up, as far as the need from customers, think about the fast-charging whether it’s onboard charging or the infrastructure, the charger on the road or the traction, where we are winning and why we are winning is our highly competitive efficiency metric that comes from all the prowess and technology that we are flexing, but more importantly, our packaging technology. When you put those two together, you get a lighter and more efficient traction module. Lighter is obviously good for EVs for distance, but lighter and smaller is also good for packaging. So we are able to get the same, call it, equivalent power output of our silicon and silicon carbide modules, and I talked about module being the device and the packaging 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 wins 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 today, our posture with the 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.

Rajvindra S. Gill — Needham — Analyst

Great. Excellent. Thank you.

Operator

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

John Pitzer — Credit Suisse — Analyst

Yeah. Good morning, guys. Thanks for letting me ask the questions, and congratulations on the solid result. Hassane, I’d like to go back to kind of the significant gross 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 your June gross margins or the September gross margins?

Hassane El-Khoury — President, Chief Executive Officer, and Director

Yeah. So look, we’re — as far as inning, call it, we’re in early innings as far as what we’re ere 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, at least the ones that we’ve talked about. You haven’t seen that benefit yet. So that’s going to fuel our more of the gross margin expansion forward-looking. Right now it’s on cost, product, product mix, product cost, product value, etc., all of those are what you’re seeing today. So there is 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 in the gross margin expansion.

John Pitzer — Credit Suisse — Analyst

That’s helpful. And then, Hassane, the gross margins were impressive, but I would argue the free cash flow was even more impressive. And if you look at your share schedule on your website, 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 to be?

Thad Trent — Executive Vice President and Chief Financial Officer

Yeah, John, it’s Thad. You’re right. Now that 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 isn’t as significant as what you’re seeing in the past. And if you look at our guidance for next quarter of 436 million shares, it’s just up by small tick. So as we think about the cash generation, right now it’s balance sheet flexibility, it’s continuing to pay down the debt. Long-term, we’ll look at returning capital to shareholders, but right now, it’s just reinvest in the business and have balance sheet flexibility.

Operator

Thanks, guys. Your next question comes from Harlan Sur from J.P. Morgan. Your line is open.

Harlan Sur — J.P. Morgan — Analyst

Good morning. Congratulations on the solid results and execution. The image sensor business again on the group 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 constraint into the first half of next year. Has 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?

Hassane El-Khoury — President, Chief Executive Officer, and Director

Look, so that, you’re absolutely right. This is a very constrained because majority of or all of it is foundry-based. 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 constrained is not something we can solve right now. Right now it’s more on optimizing our existing supply chain that we have, because imagine that technology is not you can pick out 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 technology in very specific fabs that require capex and R&D. Obviously, we’re looking at all options, but right now through, call it, the ’22, it’s what more can we get out of the foundry partners.

Harlan Sur — J.P. Morgan — Analyst

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

Hassane El-Khoury — President, Chief Executive Officer, and Director

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’re able to get out of our footprint.

Thad Trent — Executive Vice President and Chief Financial Officer

Yeah. So Hassane is right, we’re limited by supply and so the demand is there. So as we look into 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%.

Harlan Sur — J.P. Morgan — Analyst

Great. Thank you.

Operator

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

Vijay Rakesh — Mizuho Securities USA — Analyst

Hi, Hassane and Thad. Congratulations on a great quarter and guide. Just wondering on the EV and ADAS, looks like very strong growth there. If you could give us some color on how that grew sequentially? And as we exit the year, if you can talk to what the mix you see especially with your traction on the EV side? How that EV and ADAS mix grows year-on-year as a percent of revenues? Thanks.

Hassane El-Khoury — President, Chief Executive Officer, and Director

We are not breaking up by technology or by sub-segment, we’re just looking at the automotive. We expect automotive to maintain the growth. Obviously, it is limited by what I mentioned earlier in 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 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. The demand is there. And right now it’s how much of that demand can be service.

Vijay Rakesh — Mizuho Securities USA — Analyst

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

Hassane El-Khoury — President, Chief Executive Officer, and Director

Yeah. Vijay, I mean the book-to-bill is strong. It remained 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 major swings in the book-to-bill.

Vijay Rakesh — Mizuho Securities USA — Analyst

Great. Thanks a lot.

Operator

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

William Stein — Truist Securities — Analyst

Great. I want to add my hearty congratulations to great results and even better outlook, and I appreciate you’re taking my questions. First, the compute end market was particularly strong in the quarter, I think you attributed that or you at 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 of quarters? There has 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 I do have follow-up.

Hassane El-Khoury — President, Chief Executive Officer, and Director

Yeah. Look, we’re seeing strength in both the cloud and the server market. So that — it’s all the market growth. 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.

William Stein — Truist Securities — Analyst

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 stasis 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?

Hassane El-Khoury — President, Chief Executive Officer, and Director

I would say, we’ve got a couple of things going on. We’ve got 300 millimeter fabs coming in line in ’23, we’re 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.

William Stein — Truist Securities — Analyst

Thanks. Congrats, again.

Hassane El-Khoury — President, Chief Executive Officer, and Director

Thanks.

Operator

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

Christopher Rolland — Susquehanna Financial Group — Analyst

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?

Hassane El-Khoury — President, Chief Executive Officer, and Director

Yeah, Chris. So obviously, our focus is to start with; number one, our strategic markets, and two, strategic products and strategic customers in those markets. So 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 full on. 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 the growth. 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 [Indecipherable] 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.

Christopher Rolland — Susquehanna Financial Group — Analyst

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?

Thad Trent — Executive Vice President and Chief Financial Officer

In terms of the sound footprint, we continue to look at it. We’re 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.

Hassane El-Khoury — President, Chief Executive Officer, and Director

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.

Christopher Rolland — Susquehanna Financial Group — Analyst

Great. Thanks, guys. Great progress.

Operator

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

Hassane El-Khoury — President, Chief Executive Officer, and Director

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.

Operator

[Operator Closing Remarks]