ams OSRAM AG

SIX:AMS

Earnings Call Transcript 2023-Q2

[Juergen Rebel, Head IR]

Good morning. I see quite a few familiar names on the call. Very nice to meet you again. I would like to welcome all of you to our Q2 2023 Earnings Call. And with me are Aldo Kamper, our CEO; Rainer Irle, our new CFO, who started July 1. Aldo will take you through the new strategic direction of the group, and Rainer will comment on the business development during Q2, and after which, we're happy to take your questions.

Aldo and Rainer will refer to the Q2 earnings call presentation that you find on our website besides the extended Q2 presentation. With this, I hand over to Aldo.

[Aldo Kamper, CEO]

Thank you, Juergen, and also good morning to everyone from my side. In our earnings call three months ago, I promised that I will take a look for the management team where the company stands. There's no discussion around the fact that our recent performance has been lackluster and has not met our ambition. Over the last three months, we took a careful look at the prospects of each of our 20-plus business lines and the overall strategy. In particular, the outlook for some low-performing consumer applications, amongst others, requires a significant reset in view of the macroeconomic environment. Our core businesses continue to have a healthy and positive outlook.

The reduced long-term forecast for some segments resulted in a goodwill impairment of €1.3 billion. It's obviously purely a noncash item. We know this is a significant correction, and we are convinced this is a necessary step to earn your trust by taking a realistic view on our business outlook in a changing environment and the basis for the path we are taking to improve our performance.

Now let us look at further details on Slide 2 of our earnings call presentation. Whilst we are convinced more than ever that the combination of capabilities emitters, sensors, and ICs under one roof provides a unique opportunity and potential. The balance in end market exposure and between established and new technologies as well as existing and new markets was not ideal. First, a strong focus on disruptive custom technologies for high-volume opportunities in the consumer space has proven to be challenging and it has come to initialization, execution, and market adoption.

Second, we have not always lifted their own standards when it comes to flawless execution of our roadmaps. Third, the uptake of new markets or adoption of new partly disrupted technologies has often happened not as quickly as we'd hoped and planned for. Fourth, we didn't fully explore the growth opportunities in sticky structurally growing core markets, Automotive, Industrial, and Medical. And last but not least, obviously, the price in the macroeconomic environment also caused additional headwinds. Due to this, we have decided to rebalance and refocus the company towards profitably profitability, structural growth and monetizing innovation. And what do we mean by this?

With a stronger commitment towards automotive, industrial, and medical markets, we will focus our semiconductor portfolio toward a very profitable core and differentiated intelligent sensors and emitter components. It also means that we will exit noncore lower-performing semiconductor businesses with a revenue run rate of around €300 million to €400 million. At this time, we cannot share all details as the best approach for exiting certain business areas is still being fine-tuned. The exit of passive Optical Components, however, is one applicate already today. We stress that we will continue differentiated opportunities in high-volume portable consumer devices markets, such as microLED. However, we will focus our engagements on product development where we can achieve sustainable differentiation through cutting-edge innovation.

The automotive and specialty lens business will continue to contribute significantly to the group's earnings. We are actually expanding our leading position in this business. Portfolio choices we made, combined with the performance push and an adjustment of the company's over an infrastructure to with new base is summarized in our Re-establishing the Base program. We also addressed some of the past execution topics by strengthening the ownership and accountability in the semiconductor segment through implementing full end-to-end responsibility in the business units. The strengthening of the divisional entrepreneurial responsibility allows us to move away from the previous organizational model of a functional Management Board. As a consequence, the Management Board can be reduced to two members, the CEO and a CFO, that is Rainer and myself effective January 1, 2024.We're also consolidating the business units in the semiconductor segment from three to two.

One will be dedicated to emitters, the auto sensors, and analog mix signal ICs. The structure is already a theme throughout this Q2 presentation. We expect savings from all of these measures of €75 million by the end of '24 and €150 million by the end of '25 on a run rate basis, improving earnings and cash flow. I will comment on the updated target operating model a bit later.

Taking now a closer look at Slide #3. With our semiconductor core portfolio. We addressed the fast-growing segment in automotive, industrial, medical, and selected high-volume consumer applications of the total opto-electronics and sensor semiconductor market. These segments are expected to grow high single digits, low double-digit percentage every year for the coming years. In total, we can address the market of roughly €17 billion with our core semiconductor portfolio.

Let us take a look at this focused portfolio illustrated the center the slide. The bulk of our portfolio is comprised of differentiated sensors and emitter components as well as mixed signal ICs. Examples are cutting-edge Hyper Red LED special package for verticals or applications, or position sensors for automotive applications. And by sea side, you can imagine differentiated specialized stand-alone driver ICs for LEDs for example.

Now the power and the potential of the unique combination of sensors emitted and ICs under one roof comes into play, combining our own ICs within the middle or sensor in a differentiated package and writing our own firmware to deliver unique intelligent mid- or intelligent sensors that provide a much higher customer value. An example is our recently announced cutting-edge 25,000 pixel automotive forward lighting, EVIYOS solution where we use our own highly sophisticated driver IC and ASIC in our own packet technology. This is currently receiving tremendous traction such that we already have more than €150 million design wins in our books. We are very pleased having been able to announce the first customer ramp with our partner, Magneti Marelli. Our core portfolio continues to enable sensing illumination and visualization like in the past. Innovation and technology leadership will also continue to be the key driver for our success.

For a more pronounced focus to automotive, industrial and, medical markets, we will therefore strengthen investments in the relevant product areas, such high-performance LEDs, lasers, mixed signal analog ICs, and specialty sensors. In many of these markets, we hold leading positions, as you can also see on the next slide, Slide #4.

Let me now take you through Slide #5, the probably the most important slide to understand our revenue model with the short-term changes and a design impact structural growth in coming years. The group will continue to be based on two segments, Semiconductors and Lamp & Systems. The latter segment primarily consists of traditional automotive lamps such as halogen-based lamps and LED upgrade modules as well as relatively smaller business with specialty lens for entertainment and industrial applications.

Looking at 2023, you see that we plan to exit noncore lower performing semi businesses of the order of €300 million to €400 million. Due to this, the revenue base in '24 will be lower but more profitable.

With the structural road drivers in automotive, industrial, medical and consumer, we plan to grow from this lower base in the range of 6% to 10% per year on average. This implies that the Semi segment will grow 9% to 13% on average. As the Lamp & Systems segment will show a development as traditional automotive lamp market is slowly declining, but we continue to expand our share in our portfolio. The growth of the Semi segment is well aligned with the expected growth in selected focus segments, and we want to grow faster than the market in these segments. Of course, the macroeconomic development influenced all these segments, such that all our growth and also profitability expectations are to be understood this through the cycle targets as customary in the semiconductor industry.

Now let us turn to the structural growth drivers in our semiconductor core portfolio. If we look at automotive, we've come on to the #1 position since many years in automotive LEDs and the #2 position in automotive light sensors.

With new products, new applications driven by safety regulations as well as appetite for more convenience, our efforts for comfort vehicle will structurally grow. On top, in many of these areas, we have already secured a significant amount of design wins and OEM launches, which will unfold in the coming years. I mentioned already the design win volume of more than €150 million for the highly pixelated headlamps. Another example of this is income and sensing, where we have a solid designing base of more than €250 million already in our books. When it comes to industrial and medical advice markets, our approach has always been to leverage our cutting-edge sensors, amide and IC platforms to market niches and applications where we are the key for system performance. This has allowed us to become the leading supplier in those very specific product categories such as photon counting for computed tomography.

We will continue this very successful in niche strategy and expand it. Industrial and medical markets are structurally growing as devices become smarter and need more sensors and more emitter technologies. For example, the computed tomography scan market. We are a key supplier for 8 out of the 10 leading CT scanner OEMs and our content per scanner can be up to €60,000 in some high-end scanners. In the white space of consumer devices, our main focus has been portable personal electronic devices to smartphones, smart watches, tablets, and AR/VR devices. This application focus will remain.

However, we will carefully balance the investments into products that evolutionary can improve cost performance ratio and deliver a more steady stream of business. There's more disruptive offer custom technology platforms that are challenging in terms of industrialization, pre-investments, and market introduction. We are determined to improve the risk/reward balance and improve ROIs, which is, in many cases, not come in the way as we aspired. We hold leading positions in areas like display management or camera enhancement for smartphones, where eight out of 10 best cameras are enabled by our technology, and we are renewing many of those sockets. In the past, this strong position in our core markets have pet not been so much in the limelight as they deserve as all of the attention has been towards a new exciting micro LED platform. However, in these core markets because there's a high degree of attractiveness for us as they offer good growth chances and profitability combined with a strong starting position.

Of course, ramping the industry's first 8-inch LED factory with a new generation of LED technology, microLED, remains a significant element in our growth plans. We are well on track in terms of setting the factory operationally, and our microLED effort is in the center piece when it comes to monetizing cutting-edge innovation. The biggest investment in the history of the company, and we're determined to make the success and make it successful and financially rewarding. Now for elements of the structural growth, automotive, industrial, medical, consumer, and monetizing innovation, you will find dedicated sections with more details in the full quarterly presentation, which I highly recommend to flip through as we have reworked and updated substantially and find it on the web.

Then I'm now on Slide 6. We are a high-tech company with great ideas, but we need to put monetizing these innovations more at the center of our thinking. In view of the somewhat lower revenue base within new core portfolio and the next steps in terms of leveraging the capabilities of sensors, IC, and emitters under one roof.

We are launching a multidimensional enhancement program we called Re-established the Base. In addition to the portfolio adjustments, there are further important elements. One element is rightsizing the company over as an infrastructure. This also includes consolidating the organizational structure from three business units in the semiconductor segment to two. At the same time, we get these business units through end-to-end ownership and responsibility supporting our drive to better monetize our innovations. As already stated, we expect an improvement of the bottom line from this program of around €75 million by the end of '24 and around €150 million on a run rate basis until end of '25.

The onetime costs are estimated at around €50 million. We're confident that the planned portfolio streamlining will show the indicated positive financial impact as we have demonstrated a similar procedure in the Lamps & Systems segments, which you can see on Slide 7. We brought the adjusted EBIT from close to breakeven to sustainably mid-teens to portfolio focus and realignment.

Now I want to comment on our revised midterm target operating model on Slide 8. As I laid out at the beginning, the risks in launching disruptive customer technologies for high-volume consumer device applications, the late uptick of new markets is AR/VR, some execution problems and multiple macroeconomic challenges have left our marks on our previous business model. As a consequence, we need to update our midterm target operating model. As I explained, our revenue growth is targeted to be 6% to 10% CAGR from the reduced base. Starting base will be fiscal year 2023 revenues less the €400 million revenues related to the exit of the noncore semiconductor portfolio.

With this growth, we target an adjusted EBIT margin of 15% and above. The CapEx to sales ratio was required to reach the 10% of the cycle, again, meaning it will come down significantly from the high expenditures of the last years. Our long-term goal for the leverage continues to be below 2, measured by net debt to adjusted EBITDA.As usual, the model is to be understood is over the cycle and assumes the structural growth driver for then the ramping of the new Kulim LED Facility in a timely manner. With this overview, I now hand over to Rainer to comment on the Q2 business performance and the financials.

[Rainer Irle, CFO]

Thank you, Aldo, and good morning, everybody. Many of you already know me from my previous role at Siltronic, a leading supplier of semiconductor wafers. I hold degrees in business and engineering with 6-years education and then joined Wacker Chemie and subsidiaries Siltronic. I spent 20 years at the company and various engagements took me to the U.S. and to China.

In 2015, we took Siltronic, and I'm leaving behind a great company with wonderful people. I have been looking for a new challenge in a real semiconductor company, and I'm really happy that I was given the opportunity to work for ams OSRAM. The company has a great product pipeline and a successful core business. We are working hard to put the financing on a new long-term basis as the basis for future growth. A few comments upfront to keep in mind during the financial section. When we refer to adjusted financial metrics, we refer to adjustments for M&A related transformation and share-based compensation costs as well as results from investments in associates and sales of businesses. The reconciliation to the IFRS basis is available in the presentation on our IR website.

All assumptions are based on the year-over-year EUR-USD exchange rate at 1.10.Now let us start with revenues on Page 10. Revenues came in at the midpoint of the guidance was €851 million, slightly up compared to the first quarter of €848 million. If you adjust the consolidation effect of €79 million due to the disposals at the Lamps and Systems segment. I will comment on the sequential and year-over-year development is on the following page.

On Page 11, we see revenue development for the group by end markets. Excluding the consolidation effects, i.e., comparing efforts to Apple. Quarter-on-quarter, the left side, we saw some stabilization and some improvement in all end markets. The decrease in automotive is due to the seasonality in the Lamps & Systems segment, while automotive semiconductors increased quarter-on-quarter. Looking at the year-on-year comparison, we see almost flat automotive revenues, indicating some normalization of the supply chain in the auto semiconductor segment. Industrial & Medical continues to be impacted by the weak macro economy. Consumer remains almost -- remains our most challenging end market. Here, the year-on-year comparison rebuilds a slowdown in consumer spending for personal electronic devices but also the gradual end-of-life, certain bigger sockets.

We rewon and won some new sockets, but there will be a gap opportunity before such wind will contribute. For better understanding that the dynamics behind that is look -- we take a look at the revenue development by end market for the reported segments. And let's start on Page 12. The Semiconductor segment showed mixed traction across the various end markets. Automotive showed improving book-to-bill after almost two years of rapid behavior and inventory corrections and the value of the various macroeconomic shocks to the automotive supply chain. Industrial & Medical business performed better than in Q1 but showed the typical mix behavior during the macroeconomic week period with certain applications running well, such as laser welding, where we sell our new blue edge emitting lasers.

Other applications such as Hyper Red LEDs for horti are disappointed and are muted given the elevated energy and project financing costs. This market is really down and will be so for some time, we believe. The Consumer business showed signs of improvement with a 19% quarter-on-quarter increase due to higher sales from existing targets. However, the consumer business remained challenging for the group compared to previous levels a year ago as some big sockets are approaching end of life and will be declining consistently. CGN market weakness, price pressure remains high and the new designs we have won will only kick in, in '24 and '25. This is particularly true for design wins in smartphones. The Lamps & Systems segment shown on by page 13, recorded robust revenues in spite of the typical seasonal decline on the back of strong off-season automotive aftermarket lamps.

The specialty lamps for entertainment and industrial application came in as expected. However, the specialty lamps for semiconductor manufacturing equipment saw a softer traction due to the global slowdown in the sector. And if you look at group earnings on Page 14, in spite of an essentially flattish revenue development quarter-on-quarter, the adjusted gross margin receded by 1 percentage point to 28%. This resulted in adjusted gross profit of €237 million, in line with expectations. Main reason for this underwhelming performance is the low utilization in high fixed cost manufacturing facilities. 20%, obviously, is just the average temperature, while we have quite a few business lines that deliver good 40% even at that low utilization rate, where other lines are hovering around 0% or even negative. This is where portfolio actions are urgently required, as Aldo pointed out earlier.

Adjusted EBIT margin of 6% came in at the top end of our guidance range. The better-than-expected profitability relative to revenues coming in at the midpoint resulted from strict cost control and reducing fixed operating expense.

Now turning attention to Page 15. You see the sequential development in adjusted R&D and SG&A. While R&D expenses saw savings of €10 million, we could meaningfully trim our SG&A expenses by more than €20 million. These savings brought down the adjusted SG&A to revenues ratio by 1 percentage point, though 11% continues to be too high in maybe.

Let us now look at the segment performance of semiconductors on Page 16, we saw a 10% sequential increase on the back of stabilization in certain consumer and industrial areas as well as the normalization of the automotive supply chain.

Medical business came in strong. With higher revenues, we also saw a return to profitability in the semiconductor segment. 2% continue to be far away from our expectations. Some product lines are simply not delivering sufficient margins and need to be cleaned up. Underutilization and high fixed costs are the second problem.

We need a more flexible cost structure. And finally, R&D costs are high as a percentage of revenue but are the key for future breakthrough innovations like microLED.

Switching to Page 17, Lamps and Systems show the softer than usual seasonality, which is good, with a sequential decline in revenues per €50 million on a like-for-like basis, EBIT margin came in at a strong 15%, and the strong profitability is now structural after the disposals of nonperforming business and a result of a successful streamlining of the portfolio.

Now let us turn to Page 18, I will comment on adjusted net result and earnings per year. The adjusted net result improved significantly to €31 million. A less negative financial result compared to Q1 contributed and is the result of positive FX effects and adjustments due to reduced amount of outstanding OSRAM Licht AG minority shares. The income tax result was also positive €7 million for the quarter, which is related to several changes, mainly around deferred taxes.

This adjusted earnings per share improved significantly to €0.12 or CHF 0.12, reflecting the improved profitability of the quarter.

And let me now comment on cash flow, net debt and the noncash impairment in view of the revised group strategy. On Slide 19, you see that our operating cash flow significantly improved to €232 million, after an already strong €162 million in Q1. CapEx came down to €263 million compared to the first quarter. The bulk of it went into our industry first 8-inch LED front-end factory in Kulim. Some focused investments in European sites for enabling some structural growth opportunities that Aldo mentioned also contributed to the CapEx figure.

Overall, this still resulted in an only negative but only slightly negative free cash flow of minus €31 million for the quarter.

Let me now comment on the noncash impairment on goodwill on Page 20. Obviously, in line with IFRS requirements and regulations, we perform impairment testing. For this, the long-term business outlook is fact. We, as the new management had to take a meaningfully more realistic view in light of the current macroeconomic environment. This revised interim outlook in conjunction with external parameters decreased the fair value of certain goodwill assets, triggering their impairment charge.

This noncash one-time impairment charge related to goodwill came in at €1.3 billion. It is entirely related to the semiconductor segment and has no impact on liquidity. Yes, we had to do that. Now let's look at Page 21. Our net debt position increased to €2 billion. This development is primarily a result of the significant CapEx spending, tendered minority shares, and interest payments.

This brings our group leverage to 2.9x net debt to adjusted EBITDA. Our cash position is north of €800 million, and we continue to have more than €900 million of undrawn multiyear credit lines at our disposal. This includes a fully committed multiyear €800 million revolver, which remains undrawn at this point of time. And again, our refinancing considerations are making good progress, so I cannot disclose any additional details today. And with that, let me hand back to Aldo for the other.

[Aldo Kamper, CEO]

Thank you, Rainer, and let me now walk you through our guidance on Slide 22, assuming an exchange rate U.S. Dollar of 1.10. We expect revenues to come in between €840 million and €930 million during the third quarter. The adjusted EBIT margin should come in between 5% and 8% in Q3. We are clearly here to your call on providing better visibility even if the nature of our business does not allow for precise annual outlook.

We'll try to give you better color, so we want to share a few on the sentiment towards Q4 2023.Looking at the semiconductor segment, we still see a lot of uncertainty. While Automotive outlook seems to be to stabilize in few normalizing supply chain. The second half of 2023 uptake might be less pronounced than we had hoped for. Industrial is certainly further weakening. We have mentioned the weakness in horticulture, but also general lighting and industrial lighting remains very difficult in consumer, that challenges persist.

Looking at the automotive special end segments, we expect the segment to remain on a robust level in the second half of the year. The typical aftermarket lighting season in autumn kicking in towards the end of Q3 will support its robust outlook. If you have a quite substantial change to our strategy and a new midterm target operating model, let me also share some early thinking on 2024. With exiting noncore semiconductor business with a revenue run rate of €300 million to €400 million, our absolute revenue as a group will be lower in '24 by the end of the month. The development of the various end markets is too difficult to predict, but we have good design wins and should outgrow our target markets, all bit of course, to make end markets stabilizing. In view of much reduced CapEx spending compared to 2023 and our efforts to improve profitability, especially our reestablished base program and the portfolio effects.

We targeted a slightly positive free cash flow in '24, again, assuming that the end market stabilize.

With this, let me summarize the key takeaways of today. We have completed a deep analysis of the company and all its business lines. We have taken key decisions and set the direction for focus on profitability, structural growth, and monetizing innovation. Our portfolio in semiconductors will be sharpened towards intelligent sensors and the middle components and more profitable. We will strengthen the focus on structural growth and automotive, industrial and medical markets as we continue to pursue selective high-volume consumer device opportunities where we can sustain a competitive advantage through cutting at innovation.

Overall, we will be a better performing company based on this great technology in the core and based on its innovation power.

This concludes our opening remarks, and we are now happy to answer your questions.

[Operator]

Ladies and gentlemen, at this time, we will begin the question-and-answer session. [Operator Instructions] First question is from the line of Janardan Menon with Jefferies. Please go ahead.

[Janardan Menon, Jefferies]

Yes. Thanks for taking the question and welcome aboard to both of you. Just going to some of the details on the portfolio pruning programs and your comments about 2024. So the €75 million and the €150 million run rate savings that you're targeting, can you split that out as to what is the saving from just the €300 million to €400 million exit? What I'm trying to get at is what is the profitability of that business today?

Is it heavily loss-making? And so what would be the impact from that exit versus any kind of cost reduction program that also you have ongoing as part of that saving? And then when I look at your comment about slight positive cash flow, free cash flow next year. You've done about €170 million of negative cash flow, but with an improvement in Q3 -- I mean in Q2, and you're forecasting improving margins into the second half of the year, your CapEx should be roughly similar in the second half or thereabouts. So I'm just wondering, given your comment of a sharp cut in capital expenditure next year and improving profitability, why that should end up at a small free cash flow? What is it that I'm missing in those numbers? Thanks very much.

[Aldo Kamper, CEO]

Let me take the first question, and then Rainer will take the second. The €75 million and the €150 million run rate improvement for '24 and '25 are roughly 50-50 -- half of it is roughly coming out of the portfolio decisions, half of it coming out of further structural improvements.

[Rainer Irle, CFO]

Yes. So on the free cash flow, we are trying to set a bottom here for next year. Again, we don't know exactly how the market will develop next year. There's still some segments that appear to be very muted with automotive improving so that we have to take that in consideration. We also have to see that the portfolio actions will take some time, right?

We're talking about divesting that. There is nothing that will be available on January 1 next year. And the other actions that we're taking, we also lead to certain one-off costs. We will have next year, we will not be returning, yes, to the 10% CapEx goal because we have to continue the big investment in Malaysia, which is very important and is a one-of-a-kind thing in the industry. So all of that put together, the cash flow will be positive next year by how much we will guide then early next year.

[Janardan Menon, Jefferies]

Understood. And just a small follow-up. On your design wins, you said that you will get new design wins into your revenue in 2024 and in 2025. Can you just clarify when you talk about that -- because the previous management had talked about a new sensor win in smartphones in consumer in 2024. Can I assume that is the same design win that you're referring to?

And is there any other win in 2025 outside of perhaps microLED? And what is your current perception of microLED timing? Thanks.

[Aldo Kamper, CEO]

Well, that's a bunch of questions. combining one. First of all, in the Consumer segment, you're right, there is a meaningful design win that will far to bring volume in the later part of next year. Of course, there are other design wins as well that kind of flow into the portfolio at the same time. The overall demand is quite muted.

And also, of course, we have a certain number of end-of-life events in products as well. So we will see these new products coming in, in '24. And that being, of course, also quite a dynamic market. That is kind of a business where you have to keep winning quarter after quarter, year after year. And of course, we cannot share each and every win with you.

But the bigger one that was talked about is obviously still there, and we're preparing for that. The other numbers that we gave, the €150 million and €250 million, for example, in design wins, these are not tied to specific years. It is the design win that you get and especially automotive. These are then for products that last a number of years, not only 12 months, but 3, 4, 5 years for headlamp generation, for example, or for the in-cabin sensing. Also here, these are normally products that once you design in, you keep these sockets for quite some time. So you have to also think about that not as one event of suddenly adding these numbers in 1 year but as a number of programs that you win with individual SOPs kind of staggered through time, but we want to give you a flavor of how we are converting technology into design wins and we'll give you a feel for the size of the opportunities that we have in, for example, the automotive segment here as we mentioned. Then I think your question was on microLED.

We continue to work towards revenues in '25, like I also mentioned in earlier calls, and that's what we're working hard for and what we're still targeting.

[Operator]

Next question is from the line of Francois Bouvignies with UBS. Please, go ahead.

[Francois Bouvignies, UBS]

Thank you. I just wanted to follow up quickly on microLED. And as you expect the 2025 revenues and when we look at 2026 targets of the growth rate of 6% to 8%. Is it microLED? Is it really meaningful contribution to the target for auto '26 in your growth rate?

So that's my first question. And if you can quantify, obviously, would be amazing. And the second question is on the margin. So if we look at next year, you have this new portfolio that -- the portfolio that you exceed, which we assume lower margins, you have the saving program kicking in. On top of that, your core business is going to outgrow the markets from what you're seeing. So excluding the portfolio exceeding you have growth coming in with this new mobile.

So what I'm trying to get here is, why shouldn't we expect a significant margin recovery into next year, putting all of that together, what would be the drive to the margins and I exclude the one-off cost of restructuring, of course, on an organic basis, that would be great. Thank you.

[Aldo Kamper, CEO]

Let me comment on the microLED. As we said, we will start to see first revenues in '25 or a meaningful size. And of course, that will then become a full year revenue in '26. However, given the overall size of the company and the overall growth of the portfolio they're shooting for, it is a contributing factor, but it is by far not the only contribution to growth in '26.

[Rainer Irle, CFO]

Yes. And yes, I think we started discussing the margin of next year. I mean there's obviously a positive contribution and the negative contributions are negative. It's definitely the market remains to be muted. And for some of the end markets, we are still waiting to see the turning signal.

So -- and then kind of we taking cost takes time. The portfolio measures will take time. It's obviously the measures we are taking are those portfolios, those products that contribute almost nothing or very little to the contribution margin, though, obviously, still also cover a portion of our fixed costs when we trim that or we sell that, we have to take care of the fixed cost. So it is nothing that you can expect to be already in place on January 1. But then within next year, you will start to see that improvement, and we're obviously much more positive ever next year than for next year.

[Francois Bouvignies, UBS]

And do you plan to sell this product, this €300 million to €400 million. I mean, or just exceeds, I mean, can you monetize it at all?

[Rainer Irle, CFO]

I mean, we will try to. I mean, we did not take exact decisions what to do, but we will obviously do whatever is best to generate the highest ROI possible on those businesses.

[Operator]

Next question is from the line of Sandeep Deshpande with JPMorgan. Please go ahead.

[Sandeep Deshpande, JPMorgan]

Thanks for letting me on. I have a couple of questions. Firstly, in terms of the products that you are planning to exit, many of these products in previous management has been talked about as we able to supply complete solutions on optics to customers like these passive optical products, et cetera. So will that impede the sale of your semi higher-value, semiconductor products getting out of the -- some of these supporting products? That's one of my questions. And the second question I have is -- regarding the improvement in profitability from here, when we look at -- I mean, clearly, the market is incredibly weak today, and so your guidance in the long -- mid- to long- term looks very reasonable.

But in a better market with better product mix as well as a better volume, will you not be able to exceed that 15% margin target that you're setting yourself?

[Aldo Kamper, CEO]

Okay. No, it's about very relevant questions. I think, yes, your observation is right that with this step, we're kind of departing from this model of trying to build the business around complete optical solutions. We've seen that the components that make up the overall solution play an instrumental role. And we have to focus our efforts on really making the components as competitive and as intelligent as possible, and that will allow us to focus our R&D efforts towards this goal and be there the most successful that we can. And looking at what we have in the solutions space on the table, I think we will not see any impeding effects of us not having that optical technology or not to that extent anymore, we see that we can work very well within the ecosystems that are surrounding us and make a good use of also other people's technology for the overall solution.

And that at the end of the day, it requires anyway close interaction with our customers, and we have those relations. I have to say, across all the segments, and we'll utilize that to build the overall solution for our customers. On the second question, yes, we have, like Rainer said, take a very, in our mind, realistic look at the business, at the growth prospects in the current environment. And of course, it's a high fixed cost business. And if the factories are really super full, you will see also the fall-through of that. So is the 15% maximum?

No. Is that a realistic first midterm step. Yes. Will it vary, like with the volumes going up and down with its very significantly from year-to-year? Yes, that's kind of the beast that it is.

But we will continue to fight, of course, for better profitability. And in good strong years, that profitability will be also beyond the 15%.

[Sandeep Deshpande, JPMorgan]

Just one quick follow-up on the -- right.

[Rainer Irle, CFO]

In addition to the 15% -- please keep in mind that the factory we are building in Kulim requires a lot of upfront costs, right, both on the cost side, but also on the R&D side, and that will carry well very well into '25, right? The factory will change ams OSRAM into the future, but there's a lot of upfront costs to be borne by the company. And that unfortunately will drag down the margins in the first years. And with the ramp of that factory, yes, definitely, we can go very well north of 15%, but it will take time.

[Sandeep Deshpande, JPMorgan]

Thank you. I will come back in the queue for questions. Thanks.

[Operator]

Next question is from the line of Adam Angelov with Bank of America.

[Adam Angelov, Bank of America]

Hi, thanks for taking the question. So firstly, just in the 6% to 10% CAGR you have for 2026. It sounds like it's a little bit back-end loaded. So just wondering about 2024, I understand visibility is a bit low today. But if the markets were, let's say, flat to slightly up, and it sounds like you still have the smartphone sensing win. Do you think that your core revenue in 2024 can grow? That's the first one. And then I'll follow up with a second.

[Aldo Kamper, CEO]

Yes. As Rainer said, I mean, it's kind of hard we will not really -- it's still quite a bit out and uncertainties are high. So I think overall, we will have to see how the overall demand develops even in automotive, where we see some positive traction right now. Still, the certainties are high. Interest rates are high, how is it going to affect the buying behavior, for example, in the U.S., how are the overall uncertainties affecting our overall business.

We see industrial also coming now more under pressure as the recessionary pressures around the globe kind of spread throughout the different segments. So there's just a lot of uncertainty. And therefore, I think Rainer has been careful in giving a bullish outlook on '24. Of course, we're happy to take volumes if they come back and support those. Obviously, we have the capacity to do so.

[Adam Angelov, Bank of America]

Yes. Fair enough. And then just on the -- I mean, previous management team talked about a prepayment -- sounds like still on track with the microLED timing, but just related to the prepayment, if you could share any details there? Is it contingent on certain yields for the technology on certain steps of the fab buildouts. And yes, I mean, any details that you can share on timing, size and anything else would be very helpful to the extent that you can...

[Aldo Kamper, CEO]

I understand that it is helpful, but unfortunately, you know the sensitivity of our customer in this context. So we cannot unfortunately share much detail on that.

[Adam Angelov, Bank of America]

Okay, fair enough. Thank you.

[Operator]

[Operator Instructions] Next question is from the line of Sébastien Sztabowicz with Kepler Cheuvreux. Please go ahead.

[Sébastien Sztabowicz, Kepler Cheuvreux]

Hello, everyone and thanks for taking my questions. One on inventory. Could you please elaborate a little bit on the level of inventory in your key markets today where they are standing in consumer, automotive, and industrial markets? That would be the first question. The second one will be on 3D sensing. Just to understand when you analyze the company right now, do you see any specific growth opportunity coming from 3D sensing?

We see that behind OLEDs gradually coming to the market with some of your peers, maybe could act as a catalyst to accelerate deployments within the Android ecosystem at some point? And basically, do you see other markets where 3D sensing could gradually, I would say, take off? And where are you standing in your technology road map there in 3D sensing behind OLED and so on. Thank you.

[Aldo Kamper, CEO]

On the inventory side, the positive is that we seem to have worked through the inventory correction on the automotive side. We see now more normalized inventory levels in that segment. At the same time, in the industrial markets and some of the medical markets, we see quite high inventory levels. Usually, in any way, our customers hold higher inventory levels in those segments. And if then their end customer demand kind of drops, it has kind of a bullwhip effect on the -- on the inventory levels at our customers and then the demand that they project towards us. So those are a bit more challenging, but yes, again, it's a mix.

Some segments like automotive, looking better at the moment than the others. It's kind of one market after other that has an issue. And now fortunately, automotive, which is an important invest kind of seems to have worked its way through it, and now we probably have to deal with some of the corrections in the Industrial and Medical segment in the second half of the year, I would assume. On the 3D sensing topic, it is still overall a bit the question what the killer app for it is. I think that's still what people are struggling with to find out. And in that sense, yes, we do see interest, but we don't see a breakthrough at the moment in terms of new applications. Okay, thank you.

[Operator]

Next question is from the line of Jürgen Wagner Wagner with Stifel. Please go ahead.

[Jürgen Wagner, Stifel]

Good morning. Thank you. Looking at your gross margin, what would it be if your factory would be better utilized, so meaning on a normalized utilization level? And then what is the underlying assumption on the gross margin for the 15% margin target in '26. And an update on your minorities, now that we had a ruling from the judge in Munich last month. And has that been appealed by the minority shareholders by now? Thank you.

[Rainer Irle, CFO]

Yes. Jürgen. Good talking to you again. So yes, it has been appealed, simple answer. On the margins, I mean, I mean if we were full, we could easily have just from the better absorption of the fixed cost, we would have a 5% to 10% higher margin.

I mean it could be 10%, but I mean, I've never seen a company there, but is pulled everywhere at the same time. So let's see, 5% to 10%, yes.

[Jürgen Wagner, Stifel]

And the underlying assumption for '26, would that be also the plus 5% to 10% less a bit from portfolio? Measures...

[Rainer Irle, CFO]

As I said, I mean, it's never full everywhere. So it... All the way...

[Aldo Kamper, CEO]

And demand that as Rainer outlined is next year, not that much better than this year. So in that sense. The overall utilization doesn't go through the either. [indiscernible] Sorry, sorry. My mistake. I misheard you. I misheard you.

[Jürgen Wagner, Stifel]

Okay. All right, thank you.

[Operator]

Next question is from the line of Sandeep Deshpande with JPMorgan. Please go ahead.

[Sandeep Deshpande, JPMorgan]

I have a follow-up question on your automotive market. My question is, ams OSRAM has found it in the last three years where the automotive market in semiconductors was incredibly tight and most semiconductor vendors could not supply this did not apply to ams OSRAM, mainly because your content growth in the car was not as much as these other companies are facing in terms of content growth. Do you think that over the next few years as your new products, whether in emitters or in detectors or whatever RAB that you should be able to increase your content per car and thus change your economics per car in comparison to what you've seen in the last two, three years?

[Aldo Kamper, CEO]

Yes, definitely. I think, first of all, the fact that we were not in allocation, so badly with the other guys, yes, what you're saying is partly true that for some very specific semiconductors, the demand kind of exploded and had a hard time getting behind it. But also for us, the content per vehicle has grown also in the last years, but we have been able to accommodate that given the capacity that we have installed. Looking forward, we see really also a content growth per vehicle across the portfolio. You see it in a variety of different ways. We spoke a bit about the high-pixel headlamp.

You can imagine that a complex high-end product like that is a significant add in terms of value per car versus a standard simple LED headlamp. You can also think about the incumbent sensing that is now becoming a mandatory standard. So that wasn't there before or it was only partly there in higher-end cars and becomes now a feature that has to go across. And you can see it in the fact that the amount of intelligent lighting within the car is rising. People want to help the driver kind of be focused on the specific area that you need to pay attention to.

If we had now increasingly his hands off the wheel for a little bit of time. So you can get light bands in different colors within the interior that also kind of have a functional -- functions not only ambient lighting that we're seeing there. And on the out of the car as well, I was in China last week and they actually used the car increasingly on the outset as kind of a display almost. They have not only tail lamps, but on the tail of the car binders of LED points as a metric to also animate a certain welcome light functionality or greetings to other drivers. So actually, vehicles on the road in China, also part of our R&Ds with not a few tens of LEDs on the outside, but the tons of LEDs on the outside. So there is a whole bunch of trends ongoing, partly safety-oriented, partly comfort-oriented, partly styling oriented and light being a new chrome, if you will, that will drive the ASP per car forward.

And at the moment, roughly we are talking about €35, €40 per car. We see that grow in the next years to above €50 per car. And already today in the high-end segments of the market, we are already above €50 per car and continue to see that increase based on these higher-end features that also outlined. So definitely, it is for the automotive market, not only vehicle count that should that should add to the revenue growth, but also the content per vehicle that we see good traction on for the whole portfolio, not only for meters.

[Sandeep Deshpande, JPMorgan]

Thank you very much.

[Operator]

Final question is from the line of Adam Angelov with Bank of America.

[Adam Angelov, Bank of America]

Hi, thanks for letting me back on for just two quick follow-ups. So firstly, just on the comments you mentioned on inventory earlier. I didn't quite catch the inventory situation in the consumer market. If you could update on that one, please? And then just so we're on the same page, the free cash flow of slightly positive for 2024.

Could you share your definition of that, i.e., does it include interest expense payments for OSRAM minorities. Basically just yes, if you could share the definition of that, that would be great. Thank you.

[Aldo Kamper, CEO]

In the consumer segment, I would say that the inventory situation is quite similar to previous quarters, no big change there. No tightness, but also no huge overstocking. So we will not see any significant with whiplash effects out of the consumer area. I think it will more or less fluctuate with overall demand, which, unfortunately, still remains muted. Just looking at China, the people still are kind of hesitant to buy the next phone or the next gadget at the moment, kind of unknowing where the overall economy takes them.

So let's wait and see how the overall consumer segments develop, but the inventory position will, I think, not heavily influence that.

[Rainer Irle, CFO]

Adam, the definition of free cash flow pretty simple is the operating cash flow minus CapEx. It does not include interest payments or any payments under the opportunities from minority shareholders.

[Adam Angelov, Bank of America]

Got it. Thank you very much.

[Juergen Rebel, Head IR]

All right. Thanks very much for your lightly interested questions. With this, we would like to close today's call. If there are any follow-up questions, please reach out to Investor Relations, and we will try to provide more details and the answers. And please do not forget to also flip through our extended Q2 presentation.

There should hopefully be also quite a few more details, particularly also on some of the questions you had. Thank you very much, and have a good day and a good weekend.

[Aldo Kamper, CEO]

Thanks so much. Bye, bye.