ON Semiconductor Corporation (NASDAQ:ON) Citi’s 2023 Global Technology Conference Call September 7, 2023 2:30 PM ET
Company Participants
Hassane El-Khoury – Chief Executive Officer
Thad Trent – Chief Financial Officer
Conference Call Participants
Unidentified Analyst
Thanks for coming, everyone. Next up is one of our top picks in the whole semiconductor space, onsemi. We’ve got the dream team here, Hassane El-Khoury, the CEO; and Thad Trent, CFO, extraordinaire. Why is it one of our top picks? An absolutely amazing turnaround story architected by these guys, to my left, gross margins 10 points above the previous peak, operating margins more than 15 points above the previous peak. And then you also have a very nice growth aspect with silicon carbide and just the general automotive market.
So, guys, thanks for coming. And, why don’t we start there, before we dig into the 17 million questions on silicon carbide that, I’m sure myself and the audience will ask. And by the way, this is intended to be interactive. So, if anybody has any questions, feel free to ask them.
Question-and-Answer Session
Q – Unidentified Analyst
Let’s start with automotive. Automotive has been strong for you guys all year. How are things going? And you’ve had a number of your competitors say everything from the previous companies said automotive is great. It’s going to be up. No issues. And you’ve had other companies say automotive is, correcting a little bit. So, we’re ON stand on the automotive spectrum? And then we’ll jump in from there.
Hassane El-Khoury
Yes. From, an automotive perspective, obviously, we still see that as a positive end market for us, for a few things. The biggest growth driver, for us is electrification.
Unidentified Analyst
Yes.
Hassane El-Khoury
And from an EV perspective, you can see a little bit on the global, from an EV, the numbers of units are going up, and that’s going to drive the growth for us. But even if I take outside of the silicon carbide growth, that we’re seeing, automotive has grown. Now, obviously, it’s not at the same rate as we’ve seen in the last few years, but there was still growth. And that’s the content that we keep referring to where apples-to-apples we have more content in newer cars than we had in previous cars.
And it’s not, a lot of people that look at it from the glass half empty. Well, we’ve been building premium vehicles. So, content is higher. Well, name one entry vehicle that doesn’t have more power than it did last year, more screens. Every car today has power windows, power seats, power steering, the key term is power, which is what we do.
So, all of that is net incremental content for us. So, any new car being built, is going to have more content and every new EV being built is going to have almost 14x more content just on the drivetrain.
Unidentified Analyst
Yes.
Hassane El-Khoury
Because if you think about the content for, on a drivetrain in an internal combustion engine, onsemi has about $50 worth of content, that same car turns into an EV, that’s $750. So, you have 700 incremental dollar per vehicle that converts from ICE to EV, that’s where the underlying strengthen our businesses, and we see that continuing.
Unidentified Analyst
And Hassane, maybe you could take us through, what your sort of current average and peak content is in, like an ICE versus a hybrid versus an EV car? And give us a sense of, you talked about your content has gone up, even in an EV car over the last few years, like, how much has your content gone up over the last few years and then maybe give us a sense of your content per, each one of those three models.
Hassane El-Khoury
Yes. Look, I mean, the plug in hybrid, there’s it’s very subjective. So, I’ll focus on, the two streams here, because that’s really where the focus is. And that content has, look, in 2022, what we talked about in our last, not this Analyst Day, but the prior one, when we deployed our strategy, we had a vehicle that went into production with $841 worth of content.
Unidentified Analyst
Not bad.
Hassane El-Khoury
That’s not just, from a power perspective because, tangential to the electrification there’s something we can’t really forget about because onsemi is a very big player in automotive also is the ADAS side of it. Every vehicle now has cameras in it, for some level of, autonomous driving, whether you believe in level four, level five or when we will achieve full autonomy, let’s talk about just level two plus, which is from surround cam — the surround view, which at least requires four cameras, to adaptive cruise control, to lane departure, and, and, and, all that’s driving content in automotive, orthogonal to electrification, because you have that same trend happening in internal combustion.
Unidentified Analyst
Yes.
Hassane El-Khoury
So, when I talk about content for onsemi and automotive, I’m not only referring to just the power semis, which is, of course, a big growth. That’s the $700.
Unidentified Analyst
Yes.
Hassane El-Khoury
We got almost a $1000 on all the other stuff. So, net-net, that’s why we always talk about. We’re not pegged to SAR or units sold. It’s more on the content that is going into these units.
Unidentified Analyst
And then how do you, looking into 2024, how do you guys feel about the automotive market there?
Hassane El-Khoury
We feel pretty good. Obviously, you have the continued, execution, continued growth in silicon carbide. But even outside of silicon carbide, we’re going to see, some of that more content. We, some people may not know we’re number one in LED drivers for automotive. Anecdotally, LED is the new Chrome, right. Every car identities now has more LEDs than, in the 60s and 70s was Chrome.
Unidentified Analyst
Yes.
Hassane El-Khoury
That’s more content, ultrasonic sensors, image sensors, power. All that content is driven by megatrends that OEMs are using to differentiate their product from every other product. And that’s where they put the value, and that’s where we pull into that demand. So, we’re very comfortable and very excited about the, the future of automotive, including in ‘24 and beyond and led by, of course, the continued ramp in silicon carbide.
Unidentified Analyst
With this increasing content and increasing growth in the automotive market, have the — has the margin profile for your automotive business changed over the years? Has it gotten better? Or do you sort of, price to some sort of margin and any implications going forward?
Hassane El-Khoury
No. So, we don’t price, from our cost plus to hit a certain margin. What we’ve — maybe that historically was how the company did, but that, you said we’ve been in a very —
Unidentified Analyst
Different mode.
Hassane El-Khoury
Very different mode, right now is value. So, as long as we create technology and we create products that add value to the customer, we’re going to extract that value. And that’s across all the products. From a margin profile, of course, if you look at the last two years, our margin profile, like you said, went up, almost 20 points.
Unidentified Analyst
Yes. We like that, by the way.
Hassane El-Khoury
That’s right. We do too, because it allows us to invest in more competitive technologies, and we invest in our business. That, at the same time, our auto industrial has become about 80% of our revenue. So, we’ve driven a fundamental mix shift in the business on the end market and the products and the value that we create for our customers in these markets and the value that we extract with our product.
So, that’s been all the, multi-pronged transformation of our strategy that we’re not done with it yet. We put out a target, a financial target over the next five years at 53% gross margin, we feel comfortable with it given everything that we have executed to, but yet we have to still execute to. And that’s a lot of it as new products, and the scale that we will be able to achieve. So, that’s all been positive.
So, we’re not stopping at, where we’ve delivered. We actually upped it and we’ll — we’ve always talked about our financial target as a milestone, not a destination.
Unidentified Analyst
Yes.
Hassane El-Khoury
So, that’s how we run our business.
Unidentified Analyst
Just to give you a funny anecdote, I saw a friend of mine yesterday who retired five years ago from Wall Street, we were talking about onsemi. He goes, yes, so is ON still trading between like eight and 15 bucks? Where is it in that $8 to $15 range? That’s higher, buddy.
Hassane El-Khoury
We’re, yes, very different company.
Unidentified Analyst
Out of zero. Before we move on out of auto, could you just touch on the sensor business a little bit? To me, this is a bit of a, like an unsung hero. You made some key acquisitions there. It’s a pretty nicely growing business. Just give a sense of, like, size, growth rates on the sensor business?
Hassane El-Khoury
Yes. From, the image sensing business, in general, a lot of us focus on the turnaround and the new financial, performance of the company, but within the financial performance of the company, is a very successful turnaround of our image sensing business. Where, margin are around the 50%, they reach 50% from a kind of the same level as where the corporation was, new products. So, we’re leveraging our new products into the new market. So, what does that mean? The last five years, the number of cameras per car has doubled. We expect that number of cameras to double again in the next five years.
Unidentified Analyst
Yes.
Hassane El-Khoury
So, there’s unit growth just from a penetration and more cameras per car going forward, but also more cars getting that level two plus, functionality in it. So, that’s one. The other trend that’s helping this business is the megapixel or the resolution for these cameras.
Unidentified Analyst
Yes.
Hassane El-Khoury
When we talk about now the future is eight megapixels versus, one, two and three megapixels in the last few years. Eight megapixel camera is about two and a half times the ASP.
So, again, there’s an ASP uplift more unit. That’s what’s going to accelerate the growth.
Unidentified Analyst
Yes.
Hassane El-Khoury
So net-net, I go back to the prior comments about automotive. When we talk about content driving growth, just one camera going from one resolution to the next, give you more than 2x the lift.
Unidentified Analyst
Yes.
Hassane El-Khoury
That’s growth even with the same number of vehicles just by changing the resolution. So, these are things that we are indexed to more than the number of vehicles itself.
Unidentified Analyst
Yes. Great. Let’s touch on the industrial business. It’s another fairly large business for you guys. Just talk about the trends there and what you see over the next, I guess, year prospects for 2024?
Hassane El-Khoury
Yes. So, the same as automotive, we see, I would say overall stability. We’ve seen some softness exiting, last year. I think that’s behind us. We see stability in the industrial market. That’s a general industrial market. But within that, what’s important for us is what end markets within the industrial we anchor on. That’s, renewable energy, energy storage, energy conversion and energy distribution.
So, think about it as solar wind for generation, energy storage systems, and chargers for the deployment.
Unidentified Analyst
Yes.
Hassane El-Khoury
All three of these have seen the exact same growth, because they’re driven by what I call the sustainable ecosystem by the E-Mobility.
Unidentified Analyst
Yes.
Hassane El-Khoury
So, when EVs ramp, you need the infrastructure and you need the charging. The charging is going to ramp when they see the EV. So, that combination is uplifting both markets. That business for us in the renewable side has grown in the last two years, about 70% year-on-year. That’s tremendous growth. And it’s not small business. It’s meaningful part of our company and that’s going be also growth.
So, that’s going to overshadow any, flatness or call it short-term market fluctuation in industrial, but over the long-term it’s going to drive industrial above GDP plus that we look at.
Unidentified Analyst
Yes. One question I get is, maybe downturn is hitting everybody else, why isn’t it hitting ON? And if you look at your non-silicon carbide, I guess your core semi business, you have seen some fluctuation and perturbation in there. Maybe touch on that and the preemptive measures you guys have taken as far as keeping inventory low and utilization rates?
Hassane El-Khoury
Yes. And just in terms of the markets and what we saw. I mean, Hassane did a great job of covering the EVs alternative energy which are growing nicely. What we saw really Q2 of last year was those other soft markets.
Unidentified Analyst
Yes.
Thad Trent
We saw consumer and compute. Small piece of our business, but we saw that getting soft. We saw the consumer side of industrial, getting soft as well. I think we saw that decline for a couple of quarters, and it’s basically gone sideways, since then. Now what we’ve done starting back in Q2 of last year is we started taking utilization down pretty hard.
Unidentified Analyst
Yes.
Thad Trent
We’ve taken our utilization down from 83% down to 70% this last quarter. At the same time, our margins are holding, right. So, it shows the structural changes inside the company. We’ve managed our, just the inventory extremely tight. We’ve got it at, seven weeks. We’ve been running in that range for really two years. We’ll continue to run there. Historically, the company ran 13, 15 weeks, right? I mean, so —
Unidentified Analyst
On a good day.
Thad Trent
We proactively manage that, and the distributors would take much more inventory if we’d ship it to them. We’re actually not shipping it to them. So, the LTSA coverage that we have is actually protecting us, and we’re building the LTSAs. And that’s allowed us to take that utilization down and not and kind of starve the other markets.
As I think we go forward, we’re assuming other than the secular drivers, we’re assuming this market kind of goes sideways for a period of time.
Unidentified Analyst
Yes.
Thad Trent
If we’re wrong, there’s a nice tailwind behind us as we take utilization back up and start cranking again.
Unidentified Analyst
Yes. Two questions on that, number one, can you talk about internal inventory add-on, where it is right now and what the ideal range is?
Thad Trent
Yes. So, we’ve been building inventory for two reasons. One, silicon carbide, with the ramp of silicon carbide. And I know you’re going to hit on that. The other piece is, we divested four fabs, and we’ve been going through fab transitions. If you exclude that and you look at the base inventory, excluding that inventory, our inventory was actually down six days last quarter. So, on total, I think we’re about a 163 days.
Unidentified Analyst
Yes.
Thad Trent
Clearly, we’ll be below that at steady state once we get through these transitions and the sick ramp, but that’s another indication of just how we’ve been managing. We’ve been trying to take inventory down and keep it lean as well.
Unidentified Analyst
And when do you think you could be at the ideal inventory level barring anything, flipping out up or down in the market as of two, three quarters out?
Thad Trent
No. I think we’re further than that, just because of the silicon carbide ramp, right. We’ve still got a ramp for next year for ‘25 as well.
Unidentified Analyst
Got it.
Thad Trent
So, it’ll take a while to burn through that. And the fab transitions take three years anyways, right.
Unidentified Analyst
Yes.
Thad Trent
So, those are strategic builds for long-term support for customers.
Hassane El-Khoury
Yes. One thing, just on the LTSAs, Thad mentioned, we’re not building to backlog. We haven’t built the backlog for the last two years or so. We’ve always said we’re under shipping demand.
Unidentified Analyst
Yes.
Hassane El-Khoury
And, fast forward to now, that puts us in a much better position because we haven’t really been shipping to demand whether you believed it or not, we’ve always been under demand. So as demand kind of readjusted, the gap got smaller —
Unidentified Analyst
Yes.
Hassane El-Khoury
Versus it got under our supply, and that’s why we’re in a much more, or better position than some of our peers because we didn’t blindly ship to backlog while trying to figure out what is real, what is not.
Unidentified Analyst
Yes.
Hassane El-Khoury
We pegged it to LTSAs. The decision we made also over the last few quarters when we were talking, Thad and I talking about the structurally, how are we going to get ready for the uncertainty in, call it the next coming quarters, whether it’s two, three, four whatever the number is. We had a choice of, okay, do we bring fleet times in, and get utilization up.
We thought it would be way more cautious and much better set up for whenever the recovery happens to actually take utilization down and keep the lead times where they are, because there’s no business value of bringing lead times in, given that most of our business is under LTSA. We’re getting that visibility.
Unidentified Analyst
Yes.
Hassane El-Khoury
Lead time is an artificial number at this point because customers are booking to what they need. So, we’re more proactive about not focusing on, building inventory and do that for the lead time, rather than structurally getting us set up for whenever the recovery happens. Like that said, all that turns into tail.
Unidentified Analyst
Actually two questions on that. Number one, on the utilization rates. So, whenever the utilization rates go back up, what would be your gross margin, especially, by then, I would assume that silicon carbide is back to like corporate average at least or a little bit better. What would the overall gross margins look like, when you guys are back to say 85%, 90%?
Thad Trent
Yes. So, a couple of things. The silicon carbide will exit this year at corporate averages for silicon carbide. So, that dilutive impact peaks here in Q3. When you think about utilization, we’ve got a couple things going on. So, it’s not just utilization. It’s what we call Fab Right.
So, we went through the last two years doing Fab Liter, divesting those four fabs, shrinking the footprint, bringing on the East Fishkill fab for capacity, and now it’s a matter of getting the mix right across the network, finding the optimal structure, driving capacity by actually doing that at the same time. But rough rule of thumb, and it depends obviously what ramps, right. So, it’s hard to give an exact number. But if it was like-for-like, similar mix, every point of utilization is about 15 basis points of margin improvement.
Unidentified Analyst
15.
Thad Trent
Yes, yes.
Unidentified Analyst
Okay. Great. And then on the lead time comment you made earlier, Hassane, can you give us a sense of, where lead times, where and when your lead times peaked and where they are right now and how you see that going forward over the next year or so or six months or whatever, time horizon you want to provide.
Hassane El-Khoury
Obviously, average lead time being mid-to-high-40s.
Thad Trent
Yes, that’s right.
Hassane El-Khoury
We’re still about there.
Thad Trent
Yes. Yes.
Unidentified Analyst
I’m sorry. What was that again?
Hassane El-Khoury
Mid-to-high-40s.
Unidentified Analyst
High-40s —
Hassane El-Khoury
We’re still –
Unidentified Analyst
That’s average, right?
Hassane El-Khoury
Yes.
Thad Trent
Yes. Yes, average. We’re still about there, maybe a few weeks off. You know, there’s some areas where we did, bring it in, but to our first order, we’re still at that level.
Unidentified Analyst
Yes. And you said you’re going to try and keep them there as long as possible, is that —
Hassane El-Khoury
Until we see consistent sign of recovery.
Thad Trent
Yes.
Unidentified Analyst
Okay. And then what would be your ideal lead time, not the customer, because they want it — but what would be the ON ideal lead time?
Hassane El-Khoury
It depends on the business. It depends on the product type. So, we have targets by every product type and every product technology, not to get into the weeds. Because if a product, if we have one customer, one product, that’s going to be built to order.
Unidentified Analyst
Yes.
Hassane El-Khoury
Longer lead time. If we have a broad range of customers, it’s going to be shorter because we can kind of repurpose it. So, that’s the level we go to when we’re architecting our lead time where we want to land.
Unidentified Analyst
Yes.
Hassane El-Khoury
So strategically, we have those targets. We’re just not — there’s no reason to get there yet.
Unidentified Analyst
Okay. And, is the shortage situation fixed, is everything within, like, some sort of band around that 40 something weeks, or would you say that you still have some, like, shortages out there in terms of —
Hassane El-Khoury
We have, we have some that, technology based there are some that are still constrained, where even now with demand where it is, we’re still not able to support. And, of course, that we have capacity coming online as we convert from the businesses that we exited, that takes time.
Unidentified Analyst
Yes.
Hassane El-Khoury
But there are some technologies. If a customer comes in today and says, I need 10% more. There’s not 10% more.
Unidentified Analyst
Yes.
Hassane El-Khoury
So, we’re able to support the demand we have now. It’s just upside.
Unidentified Analyst
Yes.
Hassane El-Khoury
Like silicon carbide, for example, and we’ve always said, we’re building two LTSAs. We’re not overbuilding capacity and hoping to fill it because that never works. You always fill it. You may just not like how you fill it. So, we’re signing LTSAs and then we go build capacity. And that is the cadence we’re going through.
Unidentified Analyst
Great. One more thing on the lead times. So, we’ve had some of your competitors here and they’ve talked about, oh, yeah, we brought lead times down, orders fell off. We brought lead times down. Is there any fear or concern Hassane that, if you’re going to a customer right now and saying, hey, we can get you that product in whatever 42 weeks, then you have company x that says they can get them that product in 20 weeks. Would that be a competitive disadvantage ever run into that at all?
Hassane El-Khoury
No. So, two things. One is, the products are not fungible. The fungible product where I can get it from you or from a or b, where they don’t care whose logos on it, that’s the stuff we’ve been exiting. So, that’s fine. If they can get it somewhere else or they can get it cheaper, knock yourself up.
Unidentified Analyst
You don’t want that product?
Hassane El-Khoury
I don’t want that product anyway because there’s no differentiation back to my point on we focus on value. So, that’s the, the primary driver. Number two is, it’s not about lead time. Our customers have five year LTSAs. We know what they want. They know what they need from us over the next five years. Whether my lead time is 13 weeks or 40 weeks, I know what they want for five years. So, that’s what we built to. It’s not about when it hits the backlog, we start scrambling to build, it is that long-term visibility. And that’s the value of the LTSAs that we have.
Unidentified Analyst
Yes. And in terms of the LTSAs, how do you feel about your backlog coverage for 2024 in terms of LTSAs. And is there an ideal number? Do you want, 80%, 90%, 110%? What’s the…
Hassane El-Khoury
Yes. Right now, we’re about, on a 12 month period, we’re about 75%.
Thad Trent
Yes. 75%, 80%. So plus NCNR orders on top of that.
Hassane El-Khoury
Plus NCNR. So, we’re pretty well covered. And that’s where we want it because you always want the flexibility. Right? You wouldn’t want to tie everything because, in the case a customer does come in and wants 3%, 4% because they’re seeing strength. You don’t want to be the bottleneck. Sorry. I tied it up elsewhere. So, we have it gives us that flexibility. So we’re comfortable with the coverage, where we are.
Unidentified Analyst
Okay. Yes, if you guys are the bottleneck in autos, you don’t get a call from Mary Bari, you get a call from Joe Biden. That’s not good, right, he could speak. So, on pricing, has the LTSAs provided you a nice sort of pricing blanket for next year. And if you could compare on average what pricing has done for ON this year in terms of how much it’s increased. And would you expect the same sort of increase next year? Will that ease a little bit, or could it be higher?
Hassane El-Khoury
So, there’s no increase. All the benefit that’s — think about it ‘22 even and ‘23 there’s no pricing, clinical pricing benefit because it’s all in the baseline already from prior to that period. So everything here is all new product, operational excellence, self-help, gross margin, thousands of line item, is all our execution internally on getting more out of our footprint, you know, back what Thad mentioned, the fab from a manufacturing site, fab right to fab — or fab liter to fab right. Any additional wafer we get out of each one of these fabs, all cost structure drops were all wafers because you got one more wafer out. That’s the focus that we’ve had. So, pricing is not a factor. Mix will be because as we’ve always talked, all new products are at or above our target margin. So as those products go to revenue and become a more material portion of that revenue, of course, ASPs are going to be better and margin is going to be better, but it’s not apples-to-apples price increase that’s helping us.
So that goes back to why we always focus on why our results are sustainable because it’s been two years of that self-execution and the sustainability of the results even in a softer market.
Unidentified Analyst
One of your, illustrious competitors was here, maybe speaking with a German accent, talked about some expedite fees that had really helped them and have now gone away. Do you guys any expedite fees for.
Hassane El-Khoury
Well, I’m sorry. I’m laughing because somebody…
[Multiple Speakers]
Thad Trent
From the day, I was like, I’m sorry. I never, you know, I never counted on expedite fees to hit the margin target. Because we’ve always said…
Unidentified Analyst
Never mentioned that before.
Hassane El-Khoury
So, it’s a little bit funny, but we’ve said we did have expedite fees by the way. But we’ve always said and we’ve been very transparent about we’re passing the costs on to our customers. So, if we’re not getting expedite fee, there’s nothing to pass on to customer. So, it wasn’t a margin. It was margin neutral for us. We did it just because, look, those are real. We got an expedite. The customer had a choice. Do you really want it tomorrow, or can it wait for five days? And we ship it USPS, whatever.
That’s the conversation we had with the customer. So it was a customer choice. We never forced it because we were trying to hit a target model. So, it’s like nothing changed today.
Unidentified Analyst
Not germane to the ON situation. I’ll take that.
Hassane El-Khoury
It’s got no impact.
Unidentified Analyst
Sure. So, one question on the long-term contracts. How ironclad are those? I mean, I would imagine that in the part of your business like industrial that had somewhat of a correction. There might have been some renegotiations going on there. Are these, tough know these guys? You said you’re going to take the product. This is how much product you’re going to take, is it, okay, we’ll, you don’t have to take as much product, but we’ll charge you some sort of cancellation fee or something like that, or how does it work?
Hassane El-Khoury
Yeah. So look, if you if you rewind even the last year, year and a half, and people always ask the question about, well, really, you’re going to go after your customer if they want to get out of it and so on. And I’ve always said one thing very consistently, if I get one thing from the LTSA, I’m going to get a phone call as soon as the customer sees softness. That’s it. I want a phone call because that’s the conversation I want to have. Historically, backlog disappeared 30 days before I ship it. And you’re left holding the back. So, the LTSAs is somebody’s going to get the bat phone and call and say, we got a problem, six month, nine month from now, let’s have a conversation.
So, we’ll have the conversation, but it has to be a win-win. What does that look like? Look, if demand is down, it doesn’t really help us maybe in the short-term, but it doesn’t help the company in saying, well, you got to take it. I don’t care. Put the inventory on your shelf. It doesn’t help anybody to have inventory at the customer if demand is not there. So we’ll have the conversation about, okay. Well, we know we have 50% share on this product. Can we increase the share, offset the gap and so on and so forth.
So, we have those conversations from a company perspective, we would rather ship product any day than have fees and because those are one time benefits. I really don’t care for them. Right? I like the sustainability of it, which is, okay, let’s talk about revenue. Let’s talk about share gains. Hey, maybe we extend the LTSA and you bolt-on more. Let’s put more products that you maybe are not buying from us, but we can qualify because we have a new product.
So, all of these are win-win. Now if the customer is not interested in a win-win, but a win lose, that’s where it’s ironclad. It’s a legally binding agreement that both parties in a win-win will we negotiate an amendment. But net of that, we’re not going to be left holding the back. And so far, I will tell you conversations with the customer have been very, very productive?
Thad Trent
Yeah. And the one thing I would add is pricing is locked. Right? So, it’s not a pricing discussion. It can be a quantity discussion. Just if demand is changing, but it’s not a pricing discussion. And even over the last couple of years, we couldn’t even keep up with LTSAs. So, we couldn’t commit to the full volume that customer wanted. So, in some cases, we’ve been under shipping demand as well. But, but pricing’s locked and these things on average are four or five years, and we’ve got them going out 10 years. That’s good visibility on pricing.
Hassane El-Khoury
Yeah. And to your point, it’s not all the conversations is not all negative because, there are customers where we didn’t have enough so we were shipping 70% of what they really wanted. So, now they’re coming back and saying, okay, can you at least go to 80%. So, some of them are net positive. They want more because we haven’t signed up for more because we couldn’t, really when we have supply assurance in the LTSA, I’m not going to sign up for something I can’t deliver to. Well, now they’re coming in or other customers that we didn’t have capacity to even give an LTSA to. They’ve been looking at it from the outside. They’re in now and saying, okay, I want an LTSA for the next five years, whether the product is constrained or not, they see it as a competitive advantage and a benefit for them.
Last quarter, we added $4 billion in LTSAs. You would say, okay, that’s all net, like in incremental. So, that tells you that customers now see the value as a tool versus as a protection.
Unidentified Analyst
Great. So, let’s talk about happier times, if they could get any happier for you guys silicon carbide. I have to ask the obligatory, how are things standing on the $1 billion revs for the year and the gross margin goals. I think you answered part of that earlier. It’s funny, Parag and I, commensurate every quarter. You guys have an illustrious competitor in silicon carbide. They blow up every quarter. I don’t want to mention their name. It rhymes with [Bullfweed] (ph), but our phone lines light up. We spend three days saying it’s not going to hit on, and then you guys have a good number, and it gradually goes away, but it’s like clockwork. So, just want to ask you, are you still on track with the revenue market targets?
Hassane El-Khoury
Everything is when it comes down to operational, I can tell you that’s I control operation and execution every day. I can’t do anything about the market. All of that, we will have to navigate it. But when it comes to our team’s execution, our team is executing great. And I appreciate every day they come in and deliver the results that we have, including ON silicon carbide. Last two quarters, we talked about how a silicon carbide is actually ahead of where our own targets were.
Thad Trent
Look, haters can hate. That’s fine. Results don’t lie.
Unidentified Analyst
What sort of growth rate or margin ran could we expect for the next year or two beyond the short-term?
Hassane El-Khoury
So for — so what we talked about last quarter, we said silicon carbide margins doubled and we delivered high teens operating income. Now, of course, the reason we delivered both, because you can say, the haters can say, well, you doubled from 1% to 2%. Well, okay. But when you give the operating income, it’s not 1% to 2%. It’s actually meaningful. We’re still on-track to exit the year, with the dilutive impact at the corporate average for silicon carbide. So, progressing very well. That’s been our target since we started this journey, and we’re on target. The other target we will also, on-track to meet is majority of our substrates will also be internal. That’s also testament to our execution with our GTAT acquisition that there’s a lot of negativity around, but we’ve proven that we’re executing very well to that, and that’s on track to deliver a majority of our substrates. And that because we’re adding more capacity, you’re going to see that margin kind of stay with the corporate average. But then as we get the scale and we get that absorption from the capacity side for silicon carbide specifically, you’re going to see that business at or head our target.
Unidentified Analyst
What sort of revenue growth should we be looking at? Will you guys grow sort of market average better than the market after this year?
Hassane El-Khoury
Yes. So, our focus for silicon carbide, if you expect the market to grow about 30% to 35%, we expect to be about 2x to market. So, that’s the growth we see over the next five years. And, obviously the trajectory is not straight line, because you have ramps. It’s a new product ramp just like anything else. It’s always, as you add more and more, customers and as you ramp LTSAs. We have the LTSA secured for that performance. So, it’s a bottoms up performance. Right now, it’s in execution mode.
Unidentified Analyst
And can you talk about the competitive environment? We had your two biggest competitors here, earlier in the week present and then it seems like every other month, China’s got some silicon carbide startup. It’s like whack a mole or something like that popping up. They’re nowhere near commercial liability, but I’m sure you get this question all the time.
Hassane El-Khoury
Yeah. Look, so I don’t look at as a company, we don’t look at China any different than we look at European competitors or North American competitors. We look at the competitive landscape with the — exactly that, the competitive landscape, no matter what regions they’re from. Every region’s got a different dynamic. We need to be able to win against all of them. And the only common denominator to win against all competitive threats is technology. As long as we have the best technology and we execute, like we have been on that technology, we’re going to win. I guess, the proof is the LTSAs that we’ve had. We have $11 billion of LTSAs on silicon carbide. And that’s what we’re going to be delivering to. So, you don’t hear me talk about funnel and pipeline and all of that. It’s literally contractual agreements that we have with our customers to do just that.
Unidentified Analyst
Great. Two quick questions on gross margin for Thad, because I know we’re running out of time. So, you guys are increasing the CapEx. I would imagine that’s going to, increase depreciation. Thad, when do we think depreciation peaks? And is that going to be much of a headwind to gross margin over the next two, three years?
Thad Trent
No. The way we look at this is we’re building the capacity to support the LTSAs. Right? So it’s not like we’re not going to have revenue associated with that. So, if you look at our depreciation today, it’s 5%, 6% of revenue. As we go forward, we project that to stay basically in that same range, even as we’re adding capacity. So, we’re going to — our capacity or CapEx is going to be high teens this year and next year. And then it starts to taper down at 10%, 11% over the next four years. And that’s at the same time, we’re bringing on additional capacity even at that time, because we go to 8 inch on silicon carbide, which is a capital efficient move for us because most of the equipment is retrofitable. So, short answer, about the same percentage of where we are today.
Unidentified Analyst
And then, last question on, East Fishkill, the latest diamond in the rough, you guys are buying and polishing, give us a sense on how things are progressing there and what the margin ramp should look like.
Thad Trent
Yes. Look we’ve got 250 basis point headwind. That’s in the numbers right now. The cost structure in that fab is much higher than we anticipated. It’s blocking and tackling. We know exactly what we have to do. We have an old fab network. We know how to benchmark material cost, cycle times, everything. So, we’ve just got to go work on that. The challenge is the fab is fully loaded today. So, it’s hard to go take cost out when a fab is fully loaded. You have to be really careful that you don’t break the fab. So, we think by the time we exit ‘24, will have that dilutive impact back under control and back at the corporate average.
Unidentified Analyst
Great. With that, we’re out of time. Thanks, everyone. Thanks, guys. I appreciate it.
Hassane El-Khoury
Thank you.
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