Renesas Electronics Corp

TSE:6723

Earnings Call Analysis

Revenue and Margin Forecast Amid Market Pressures

Renesas Electronics reported second-quarter revenue of JPY 358.8 billion and a gross margin of 56.7%. The company forecasts third-quarter revenue at JPY 348 billion with a gross margin of 55.5% and an operating margin of 27.5%. They anticipate a 3.3 percentage point decline in operating margin due to lower utilization rates and higher expenses. Despite challenges, including weak industrial demand and higher inventory, Renesas continues to invest in R&D. The company is cautious but expects recovery and growth in the fourth quarter, particularly in sectors like generative AI and automotive.

Company Performance Overview

In the second quarter, the company experienced a mixed performance across its various segments. Revenue experienced a slight increase of 2% quarter-on-quarter, amounting to JPY 358.8 billion. However, on a year-on-year comparison, there was a slight decline of 2.7%. The gross margin was recorded at 56.7%, and the operating profit was JPY 110.6 billion, which translated to a 30.8% margin.

Segment Analysis

Breaking down by segments, the automotive sector saw a positive increase in both utilization and volume, resulting in improved gross and operating margins. Year-over-year, automotive revenue grew by 18.2% and saw a 6.9% increase quarter-on-quarter. On the other hand, the Industrial/Infrastructure/IoT segment faced challenges. The product mix in this segment worsened, leading to a decline in both gross and operating margins. Year-over-year revenue for this segment dropped by 18.9%, and there was a 3.1% decline quarter-on-quarter.

Channel and Inventory Management

The company has seen changes in inventory levels, which have increased to 103 days from the previous quarter due to die bank expansion. Channel inventory also saw an uptick to 11 weeks. Specific sectors, like automotive, had minimal increases, but the Industrial/IoT segment unexpectedly saw a rise in inventory due to weaker sell-through and observed pushouts in Infrastructure-related products.

Operational and Financial Adjustments

Operating expenses increased, influenced primarily by currency effects. The company's costs were impacted by the weaker yen, which was underestimated. Additionally, R&D expenses were in line with forecasts, although there was an increment due to the transfer of certain expenditures. Despite these costs, the first quarter benefited from lower expenses due to the ramp-down of the Kofu plant and lower disposal and inventory-related losses.

Third Quarter Outlook and Guidance

For the third quarter, the company predicts a revenue midpoint of JPY 348 billion, a gross margin of 55.5%, and an operating margin of 27.5%. This anticipates a decline in utilization rates and scale-down effects. The company intends to maintain R&D investments without significant cuts. This cautious approach underscores the company’s efforts to adjust short-term operational tactics while still focusing on long-term growth.

Market and Geographic Trends

Globally, the company’s sales were heavily dominated by overseas markets, making up less than 80% of total sales. Particularly strong regions included the United States and China, while Japan and Europe showed weaker performance. The economic landscape and competitive dynamics, especially in China, are seen as areas of both opportunity and risk. Notably, China’s segment saw a slight growth despite challenging market conditions.

Future Investments and Acquisitions

The recent acquisition of Transphorm was finalized in June, with its contributions reflected in the third quarter forecast. The company expects this acquisition to have a positive, albeit limited, financial impact. Additionally, the anticipated closure of Altium's acquisition in the third quarter is expected to be accretive, although the impact will also be minimal. These acquisitions align with the broader strategy to expand the digital platform and maintain competitive advantages.

Challenges and Recovery Strategies

Looking ahead, the company faces headwinds, particularly in non-automotive segments. Adjustments in the industrial and mass market outlooks reflect ongoing market challenges. However, the company is optimistic about a mild recovery starting in the fourth quarter. This cautious optimism is tempered by the need for inventory adjustment and realistic growth expectations. Overall, the strategy focuses on maintaining robust R&D investments while navigating short-term operational adjustments for sustained long-term growth.

Earnings Call Transcript 2024-Q2

[Operator]

Thank you very much for attending the Renesas' Second Quarter Earnings Report for Fiscal Year 2024 despite your busy schedule.

Today, we offer simultaneous interpretation service. On the bottom of the screen, please click on the interpretation channel and select the language of your choice. Speakers, please turn on your video.

In today's presentation, we have the CEO and Representative President, Mr. Hidetoshi Shibata; and the CFO, Mr. Shuhei Shinkai; and other members of the staff are present.

Mr. Shibata will give us a word of opening. And then CFO Shinkai will talk about the earnings. And after that, we'll have a Q&A session.

We are planning 60 minutes for this meeting. The presentation material that is going to be used today is uploaded on the IR site of our company.

Mr. Shibata, please.

[Hidetoshi Shibata, executive]

Thank you very much. Good morning, everybody. I'm Shibata.

In today's earnings, I think basically, we have to reflect on our performance. And the second quarter numbers, I'm putting that aside. At the first quarter financial results, I think maybe our outlook was a bit optimistic. The reason I say this is mainly, one, the automotive business, we had been anticipating sustainable growth. We have been robust, but I think we have been adjusting to a more cautious outlook. That's the current state. That's number one.

Number two is that the industrial, in the more wide sense of industrial demand, there has been adjustment. Compared to our initial expectations, it seems that this adjustment is continuing for longer and in depth than our anticipation. Initially, we thought that the second quarter, third quarter, we will start to see a recovery. But currently, the third quarter continues to be tough. From the fourth quarter onwards, at some timing, the recovery will be seen, but we'll have to be very cautious about the outlook and we are thinking about controlling the inventory more significantly.

In the third quarter, the channel inventory, we continue to control that. And to be able to manage that, the top line is going to go down. I think that is how we're going to manage our business. But that said, sooner rather than later, the market will recover. That's our view. And going forward, our theme is more than ever growth. We are going to control the top line in the third quarter in terms of OpEx and R&D. In terms of the investment, we are not putting on the brakes and go forward. So that means the operating margin will decline a bit in the third quarter. But even so, we will continue investing in R&D so that we will continue to conduct initiatives towards our growth.

So in the second quarter, unintentionally, we have increased the channel inventory. In the third quarter, quickly, we will adjust that. On the other hand, towards growth, we will continue to invest for R&D.. So that will be our outlook for the third quarter.

So Chris, let's go into the details of this second quarter. I'll give the opportunity to Mr. Shinkai about the financial results. Shinkai-san, please.

[Shuhei Shinkai, executive]

I am Shinkai, the CFO. I would like to give a presentation about the second quarter of this fiscal year, utilizing the presentation material. Please turn to the next slide and then to the next slide.

On the very bottom bullet, on the 20th of June, we have completed the acquisition of Transphorm, so the [ balance ] as of the end of June post the consolidation of Transphorm. After we complete the calculation of PPA, we will retrospectively conduct a revision. But this PPA is expected to finish by the fourth quarter of this fiscal year. The third quarter forecast reflects the contribution of Transphorm. Next slide, please.

This is the financial snapshot for the second quarter. In the middle darker blue column, please refer to that. In terms of revenue, it was JPY 358.8 billion; gross margin of 56.7%; operating profit, JPY 110.6 billion, margin will be 30.8%; net profit, JPY 96.7 billion; EBITDA, JPY 132.8 billion; in terms of the ForEx, JPY 153 to the dollar and JPY 165 to the euro. Against the forecast, if you want to make a comparison, it's on the very right-hand side, but I would like to refer to that later.

Going to the next slide. This page is about the second quarter details, first of all, compared to the forecast, the company total, on the very right-hand side, please look at the top box. In terms of the revenue, compared to the median range, we have slightly outperformed. It's a 1.1% outperformance. So basically, this is due to the currency impact. Excluding the currency impact, it is flat against our forecast. The automotive has increased slightly, and the industrial/infrastructure/IoT has decreased. But in total, it was in line with expectations.

In terms of the gross margin is 1.2% (sic) [ 1.2 percentage points ]above our forecast. The impact of the foreign currency is basically flat. In terms of the product mix, the industrial/infrastructure/IoT, within the segment, the mix has worsened. Our manufacturing cost has gone down. So overall, we have been able to see a positive improvement. In terms of manufacturing cost, as I said, it decreased. The cost of the ramp-up of the Kofu plant has gone down, and disposal and the inventory related losses has not shown up. These are the factors for this situation.

Going to the operating margin, it's 0.3 percentage point increase for this quarter.

In terms of the operating expenses, compared to the forecast, it has increased. However, the impact is coming mainly from the currency. In terms of the calculation of the currency sensitivity, there has been an underestimation. So there was a big impact due to this ForEx.

To talk in more detail, on the cost side, so the non-major currencies has been impacted by the weaker yen, but we have underestimated this impact. So that is the reason why we're seeing this level of impact. For R&D, basically, it's in line with our forecast. And as a [indiscernible] has been transferred to that so there has been some increase there.

So going to the quarter-on-quarter comparison, in terms of revenue, it has increased by JPY 7 billion. So this is a 2% improvement. In terms of the gross margin, it has been basically flat. In terms of the operating margin, it is 1.5 percentage points worsening, so this is because of the increase of the R&D. The first quarter, basically, it has been at a low level. In the same quarter, the R&D level has gone up compared to the first quarter.

On the left-hand side, the segment situation, I would like to give some more color there. In terms of the gross margin, the automotive, due to the increased utilization, it has improved. In terms of the industrial/infrastructure/IoT, the product mix has worsened within the segment. And the gross margin quarter-on-quarter has gone down.

In terms of the operating margin, automotive, because of the volume increase, the op margin has improved. Industrial/infrastructure/IoT, due to less volume, the margin has worsened quarter-on-quarter. Please go to the next slide.

So this is about the revenue, the quarterly revenue trend. The second quarter is on the very right-hand side. Overall, year-on-year is 2.6% (sic) [ 2.7% decrease ] and Q-on-Q, it is 2.6% increase (sic) [ 2.0% increase ].

Excluding ForEx, for automotive, year-on-year, 11.5% growth (sic) [ 18.2% growth ] and Q-on-Q, up 6.9%. And as for IoT (sic) [ Industrial/Infrastructure/IoT ], year-on-year, 24.5% decline (sic) [ 18.9% decline ] and Q-on-Q, decline of 5.5% (sic) [ decline of 3.1% ].

And going on to the next page, here, we're looking at the financial indicators. And down below, free cash flow in the second quarter has grown. This recurs. In the first quarter, there has been intercorporate tax paid and also first quarter bonus payment, which have had an impact.

And here, we're looking at the inventory levels. Q-on-Q, we are looking at the factors of inventory level change and outlook to the right. Now DOI on a Q-on-Q basis, it has increased to 103 days. This is attributed to die bank expansion, which has pushed out work in progress. And the same applies for the third quarter attributed to die bank expansion. The 40-nano microcontroller will be the focus of the expansion.

Now for the channel inventory, Q-on-Q, it is increasing to 11 weeks. As for automotive, as expected, we have seen a rise. However, the rise was minimal. Third quarter in actuals as well as weeks of inventory, we expected growth. However, attributed to the prospects, we believe the pace will be slower.

As for IIoT, second quarter, we expected a decline. However, our expectations are betrayed and we have seen a rise, and this is the impact of trade flow. Basically, sell-through was weaker than expected basically around industry mass market, as well individual factors. Infrastructure-related products, there has been a pushout observed, and therefore, overall, we have seen accumulation of inventory. Third quarter and beyond, for the actual and also WOI, we're expecting a decline. We expect growth in sell-through, which will have an impact.

And going on to the next page, here, we're looking at utilization. To the left, we have the front end on a wafer input basis. The second quarter is as expected, we have seen an increase. However, on the other hand, in the third quarter, because of the summer vacation, we have front-loaded production. And therefore, in this quarter, as a reactionary trend, we expect utilization to drop Q-on-Q 10%, a mid-10% point range is expected. And to the right, we have the CapEx second quarter. We have seen the [ IB ] purchase and also the integration of office, and we have decided on an investment.

And next page, this is the forecast for the third quarter. And please look at the dark shaded area in the center. As to the revenue, the midpoint forecast is JPY 348 billion; and gross margin, 55.5%; operating margin, 27.5%; ForEx assumption, dollar, JPY 157; euro, JPY 170.

As for gross margin year-on-year, it's minus 3.8% (sic) [ minus 8.3% ]; Q-on-Q, minus 3.0%. Eliminating currency, year-on-year, minus 12.4%; Q-on-Q, minus 3.9% is expected. In terms of gross margin Q-on-Q, minus 1.2% (sic) [ minus 1.2 percentage points ] is expected. The other numbers were for revenue.

And as for the factors attributed to third quarter, we're expecting a decline in utilization rate. And as for operating margin, 27.5%. Q-on-Q, there will be a 3.3 point decline. This is attributed to utilization drop and also the size down on scale and other rise in expenses and also ForEx working towards a weaker yen. These numbers are expected. As I mentioned, as for OpEx, we will remain R&D expenses. We do not expect to cut down on R&D investment.

And going on to the next page, let's turn to Page 14. And here, we are looking at the balance sheet. End of June, we have conducted a refinancing. Working capital, JPY 260 billion; commitment light, JPY 150 billion. It has been increased to that number.

And then moving to Page 16. This is a non-GAAP reconciliation. Second from the right, the nonrecurring item, in the second quarter, JPY 3 billion. This is basically attributed to noncash mainly for expenses for reorganization of operating business structure.

And then looking at the highlight, at the outset, we have mentioned we completed acquisition of Transphorm and also for Altium, closing July 1.

And with this, we would like to conclude the presentation. Thank you very much. So let's go to the Q&A session. Shibata-san, would you please join on your video?

[Operator]

[Operator Instructions] First, from UBS Securities, Yasui-san.

[Kenji Yasui, analyst]

I am Yasui from UBS. I have two questions. First is about your free cash flow. So going to the numbers in the first half, it's about [ JPY 110 billion positive ]. This is on Page 7 of the presentation. On the other hand, if you look at the [ cash in ], the free cash flow is minus JPY 85.2 billion. So there is about JPY 200 billion -- so I think the Transphorm acquisition was JPY 50 billion. It seems that the additional cost has been passed, have been used for the acquisition through your subsidiary.

The second question is about third quarter guidance. Shibata-san, you said that there has been some forecast. In terms of forecast, you have to adjust. So I think [ going by sector ], I think it's very difficult to have a precise forecast with the data centers, the major smartphone companies that we have missed the mark or the share has declined. Can you give us a direction in terms of what you're going to see going forward?

[Hidetoshi Shibata, executive]

So for your first question, Shinkai-san will answer the question. For the second question, I will give you the answer.

[Shuhei Shinkai, executive]

So in Page 7, so we have a note on the bottom of the page. So the acquisition of our subsidiary, both the shares of subsidiary and deposits provided to Wolfspeed, so we have excluded that. And the impact or the point I'm giving, so this will be [ $1 billion growth ] and Transphorm acquisition fund is what is the difference that you're seeing, between the 2 numbers you just mentioned.

[Hidetoshi Shibata, executive]

So towards your second question, well, so the industrial market, including the mass market, I think we have seen a major gap there. I'll give you an example. It was a specific customer at the smartphone manufacturer. Is there a major change in outlook? No. Basically, that matter is in line with our expectations. In terms of the infrastructure business, we have the AI that's growing strongly and this conventional data center business, so these 2 combined being included in industrial segment. As of now, compared to the first quarter, we have reduced our outlook in this business.

But on the other hand, I think you can more or less have an image. But the number of customer base is small in this industry. And so there is some fluctuations due to market-specific factors. So in terms of our adjustment of our forecast, it's not because the demand itself has weakened. So the other companies devised what we and our partners use and the platform demand is going down right now. So that's the reason why we are seeing adjustment. So in this area, it's not that there has been some substantial adjustment of the -- substantial change in our fundamental outlook. So one thing where we have seen a different gap is the industrial and the multi-market -- mass market outlook.

In terms of industrial, we have downgraded our outlook substantially. Specifically, it's not a specific segment. If I'm pressed to say so, the so-called hardcore factory automation, I think basically, we have to downgrade our outlook substantially in this area. But the overall industrial business, more or less, we have reduced our outlook here.

For the mass market business, it's not a great magnitude that we are adjusting our forecast. But overall, it's a bit weak. So that's the reason why we have made a downward revision in terms of our forecast. In terms of the mass market business, as Shinkai had mentioned, it's not the case that a specific segment performing worse because we are small industries in here. But by dividing the categories, Japan seems to be weak. Well, in terms of geography, that is, Japan seems to be weak. China is rather robust. It's not that different from our initial outlook. So overall, for the mass market outlook, we have downgraded the outlook.

Well, I have talked on about this, but let me summarize what I have just said. In terms of the content, we have made a downward revision for the industrial business and the mass market business. That's really where we have made an adjustment. For the industrial business, factory automation is a major -- I think that's a major factor. But overall, the industrial market is weak. For the mass market, not as much as the industrial, but it's still continuing adjustment. And Japan as a geography seems to be weak. So that's my view.

[Operator]

From Goldman Sachs, Mr. Takayama.

[Daiki Takayama, analyst]

Just following up on the current discussion, automotive and nonautomotive. And also for other factors, the breakdown and also the growth is what I'd like to hear about. And you are conducting an adjustment. In terms of scenario, October and December, are you going to raise the utilization rate? Or will there be somewhat of a recovery? And therefore, for non-auto applications, we would like to hear. And as for auto application, will it remain brisk? Paying attention to the overseas market, it appears to be somewhat weak. I would like to hear about your thoughts.

[Hidetoshi Shibata, executive]

As you have mentioned. It is as you have said. As for automotive, well, the variance is not that large. Even while the market is strong, we are conducting a downward revision. And hence, what I have just mentioned is in reference to the end demand. It's not about our revenue, but it's about demand in the market. And as we go into the third quarter, as to what will happen, 2% to 3% or so might see somewhat of a decline in that margin.

In the fourth quarter, it's very difficult to predict at this stage. However, as of now, we are taking a more cautious look than before. And hence, for third quarter and fourth quarter, we will continue to maintain a cautious approach for the automotive. But for the mid- to long term, on a year-on-year basis, the currency on basis, you recognize that there is somewhat of a growth. And hence, the trend in terms of growth remains unchanged, and therefore, first quarter next year and beyond, we will put into shape the outlook based on which we will decide on the fourth quarter utilization rate. As of this point in time, I am not taking a pessimistic view.

On non-automotive, on that point, as we have reiterated, for industrial use, we have applied a rather substantial revision of the outlook. And as for the third quarter, from the second quarter, there will be a decline. The first quarter earnings, when we conducted a report, what we had envisioned was to -- I do recall that I used the word U-shaped recovery, however, more of a drop and then thereafter, an upward trend. However, we are seeing somewhat of more of a mild U-shaped curve, and that is what we expect to see up until the third quarter. In fourth quarter, we expect a recovery. However, we cannot maintain an overly optimistic view. And therefore, for the fourth quarter prospects, internally, we will take a cautious approach in pursuing operations.

Industrial in the third quarter, not to a large extent but double digit. Compared to double-digit expectations that we have indicated previously, we are seeing somewhat a cautious approach in fourth quarter, 20%. We will be reducing our outlook, but that is how we will see the third quarter, and we expect there to be a gradual recovery into the fourth quarter. And therefore, the fourth quarter, the expectations for that, we'll see quite a substantial growth. However, in the earlier earnings report, we have not changed our outlook to see a mild recovery into the fourth quarter.

As for mass market, there has not been a dramatic change. But for the third quarter into the fourth quarter, we maintain the view that there will be a pickup. However, we are now shifting to a cautious approach. As for infrastructure related, of course, the outlook in terms of success remains unchanged. However, depending on particular customers there, we have, of course, ups and downs, but the outlook remains basically unchanged.

[Daiki Takayama, analyst]

And in terms of numbers, July and September, will you be able to quote?

[Shuhei Shinkai, executive]

I'm sure you'll be reading the numbers later. To reiterate what I mentioned is in demand. In terms of the numbers overall, second quarter into third quarter, a somewhat of a pickup is expected. And in such a market situation, we expect a recovery and we do not expect to see a downfall in the market situation.

However, as we mentioned in this current earnings report, of course, the reflection is that we had expected there'd be a strong recovery in the second quarter, and we have major channel inventory numbers. However, we have seen somewhat of a slowdown. And therefore, the channel inventory situation has changed. And of course, this is where we will apply adjustment. In third quarter, this will mean that there will be somewhat sacrifice in terms of revenue, further growth.

[Daiki Takayama, analyst]

And for the second item, broadly speaking, in the half year, I'm sure that your operational excellence is very strong, and you're conducting an adjustment earlier than the peers to register and outperform. And then in a long-term perspective, with acquisitions in place, you will grow more than the market trend. However, I will be led to believe that you'll be impacted by the cycle in the 6 months to a year, anywhere in between, the external impact could come into play.

Are you going to be more or less trending on par with the market? Or due to individual factors against your peers, how are you going to grow your top line in order to outperform? Will you be able to see that? Of course, I understand it would be very difficult to, of course, overshoot in a very short term. However, 6 months into a year, will you be surpassing the market? Is there something that you'll be able to factor in? How do you see this?

[Hidetoshi Shibata, executive]

As Shuhei pointed out, of course, really turning to the focal question, in the short term, of course, we believe that it will be aligned with the market, shall I say, idiosyncratic in terms of a growth vector that is not, of course, shaken by market trends. And of course, we are looking towards AI. And we have mentioned at Capital Market Day, in terms of the proportion to the overall company revenue, it's still very small. And hence, it will continue to grow on a secular basis.

But in terms of company for cyclical industrial and overall where there's volume, say, automotive, of course, we will be pulled by trends in these areas. Of course, ADAS EV in the automotive, compared to the past, the proportion is growing, now topping 20% of overall. And with the growth vector against the overall revenue, as it continues to grow, the issue of cyclicality can be somewhat subdued. In terms of trend, we will be impacted by the market cycle trend, and this will likely continue. And internally, we will study how we will be able to establish a growth vector to operate so that we are not impacted by the market cycle.

In the Capital Market Day come next year, I do hope that we will be able to speak about the midterm prospects. As for the long term, the major theme is about the broad base market, how we will be able to grow on the digital platform. The market cycle, to begin with, of course, we are looking at the overall market. And hence, we will be looking at the margin that we can enjoy so that we will not be impacted by a certain sector in the market. For the time being, as we have seen the direction of the revenue, we will be impacted by the cycle. However, we hope to be able to reduce or mitigate the impact of the market cycle, and we hope to be able to tie that into growth.

[Operator]

BofA Securities, Mikio Hirakawa.

[Mikio Hirakawa, analyst]

I'm Hirakawa from BofA Securities. So I have two questions, the first question is about the China-related business. For the FY '23, the sales of China, we show 23%. And the previous year, it was about 28%. It has gone down year-over-year. So currently, you talked about the China situation. It's more or less robust. But in terms of the economic situation and the competition, what is the situation of the China business? And in the long term, so looking at the semiconductor policy or the strategy of China, what do you think about your China strategy? So that's my first question.

[Hidetoshi Shibata, executive]

So if you look at the current situation, it's a slight growth in China. Within China, I think things are kind of patchy. So some customers that are growing, they are growing smoothly and aggressively. So we will focus on customers that has a potential to grow. So I think basically, our growth in China compared to the market trend is slightly stronger. And going forward, we are anticipating that's going to be stronger than the market growth. So I think that in China, we're going to grow slightly.

In the mid- to long term, there's nothing new that we are doing. But going forward, the local suppliers' competitiveness is going to become stronger. And our customers in end applications, so in the short term, they tend to have excess capacity and go into very aggressive price competition, and we are continuously seeing that trend. And the pricing pressure coming from that situation is becoming stronger. And I think going forward, it will become stronger than ever. So from our point of view, in the China market, rather than trying to increase our share, we would like to focus on the strength and go into fields that we can leverage the strength and then try to compete in other areas.

And in terms of the top line, we want to grow steadily. In some cases, even if we lose some share to the local competitors, so we have to accept that. So in terms of top line profit, that will be our focus in China. In terms of share in the China market, that will be our second priority. Specifically about this view, there's nothing new that we're doing. So for the time being, I think that will be our stance in the China business. That's all from me.

[Mikio Hirakawa, analyst]

My second question is that under COVID, there has been some difficulty for procuring semiconductors. I think basically, some companies are arguing that they are more competitive because they have enough capability to produce the semiconductors. But your stance, the fab-light strategy, is that becoming less of an advantage? So if that becomes a disadvantage, then how are we going to respond to that?

[Hidetoshi Shibata, executive]

Well, basically, it's not the case that we are disadvantaged in any area. I don't think that we are in a disadvantaged position. Of course, in the country partners, China plus 1, Taiwan plus 1 strategy, they are strongly aware of that type of strategy, and the foundry partners are taking necessary initiatives. It's not the case that if we are in a disadvantage because we don't have an in-house fab. But as you know, during the pandemic, due to this situation, I think basically, we have lost some position. That's the mobile share losses. But I think the situation has changed since then, the entities against foundries has going forward, so we are not worried. So this fab-light strategy that we're taking, internally, do we have any concerns? No, obviously not. I think we can go forward with our strategy going forward as well.

[Operator]

Citigroup Securities, Mr. Fujiwara.

[藤原 毅郎, analyst]

Citigroup Securities, my name is Fujiwara. I also have two questions. First of which is the following. This may be a repeat for industrial, I have a question. Beyond expectations, sell-through has declined, and therefore, logistics supply has increased. And therefore, you have had to conduct a downward revision. With sell-through be weak, what is the backdrop? What is your analysis? I would like to inquire. Customers have their inventory, was it more than expected? Or was it that the end demand was weak?

In terms of supply and demand, the demand, is it just being pushed out or on FA-related demand layers are also increasing? The share of the customer might be declining. Is that because the demand is declining? If this is also a factor, we would like to hear about that.

[Hidetoshi Shibata, executive]

As to the last point that you made mention of, as to the share, this is not a matter of much concern. Of course, as of now, of course, the proportion of Japanese customers is very large, and that's a fact, but not just restricted to the West, but in China, there are many clients that are globally competitive and their business is growing. And just a little while ago, we have received quite a large design-in order. And hence, depending on the variance of the customer share, will this have an impact on the mid- to long term? That will not be the case. But of course, in the short term, say, on a quarter-to-quarter basis, that might be the case. However, for a mid- to long-term basis, this is not a matter of concern.

However, when we look at the short-term demand situation for a certain specified -- rather than for a certain segment, within industrial, overall, demand continues to be weak, and that is how we see the situation. This might have been expected. However, when we look at the channel partners and together with our partners, we may have overemphasized some bright signs or we do not want that to pass by, and hence, we took a rather aggressive stance. However, that bright signal dimmed as the days went by, and that is the situation. And hence, overall, the market situation has continued to soften and that will describe the situation.

And subsequently, clients' consumption of inventory has taken time. Under COVID, inventory has piled up. And of course, we had expected that, that would, of course, be consumed and things will turn for the better. However, right now, we are finding that the demand is weakening, which has also indicated that consuming inventory has taken more time than earlier expected. And you might, of course, wonder if this has actually lagged to the future. Perhaps that could be described as such, shifting to the future. Some may have expired, have been lost. Especially when we look at the market situation in China, it's not really that bright. And hence, we understand that we need to take a cautious approach, and therefore, internally, we have applied a rather large adjustment. I do hope that this will be a response to your question.

[藤原 毅郎, analyst]

And as for the second question, you have also pointed this out at the outset, the third quarter guidance, GM is quite high on a Q-on-Q basis. Of course, the absolute numbers are really increasing. So what is your plan in terms of percentage, also of scale or scope? Will this continue in the days ahead, I would like to inquire?

[Hidetoshi Shibata, executive]

Our CFO Shinkai will fill in on the details, but we do not expect that this will expand in terms of percentage. So this is to increase the top line where the OpEx has continued in this manner. If the top line does not grow, actually, we will have to cut down on the OpEx in terms of the percentage. But right now, this has been done for the sake of increasing the top line. And what is maintained in OpEx will somewhat taper down.

And now to you, as to OpEx.

[Shuhei Shinkai, executive]

Basically, it will be maintained because of maintaining investment in R&D. And on Q-o-Q, currency impact has raised the numbers. And as a result, in terms of ratio, it appears to be very large. However, the impact to, of course, the top line will also drive this number. And therefore, in terms of the number, we expect the numbers to decline.

[Operator]

Morgan Stanley Securities, Yoshikawa.

[Kazuo Yoshikawa, analyst]

I am Yoshikawa from Morgan Stanley Securities. So I think at the beginning, you said the Altium acquisition is going to end in the third quarter. And of course, it is not reflected in your guidance, I understand that. In terms of Altium, do you have any new updates that you can give us?

And my second question is, it is a duplication of what has been asked on the previous person, but the second quarter SG&A is about a JPY 4 billion increase compared to the midpoint of your guidance numbers. So at the beginning of the presentation, besides the currency situation that you explained, you have underestimated the impact of the yen besides the key currencies. Is it because of currency? Or are there other factors? I think basically, there's JPY 7 billion increase of SG&A. But is it due to the currency between the third fourth quarter?

[Hidetoshi Shibata, executive]

Yes. So I would like to give a quick answer for your question, and the second question will be answered by Shinkai-san. Well, as Shinkai has explained, currently, next week, the transaction will be closed for Altium. And if things go smoothly, the August, September, these 2 months will be consolidated into our financial results. But that said, in terms of the numbers, it's not a big number. So it won't move the needle that much. But in terms of gross margin and whether it be operating margin, this will be accretive to our business. So that's true. So financially, there will be a positive impact, no negative impacts coming from this.

So in terms of the substance of the acquisition, we will give you an update in a timely manner. But based on these discussions, the arm's length that we have initially anticipated, I think it has been more trying to do it together. I think that's the direction that we're looking at. So in terms of neutrality, it will be 100% secured. But on top of that, in terms of organizational initiatives, we will be more working together. So I think a more integrated management will be conducted looking at digitalization. I think at the right timing, we'll give you an update.

So Shinkai-san, please talk about the OpEx situation.

[Shuhei Shinkai, executive]

The second quarter forecast is about an increase of JPY 4 billion against the forecast, about JPY 1 billion is coming from R&D, the timing difference of R&D spending. Rather than spending, it's the incoming cash difference. The remaining JPY 3 billion, half of that is coming from the minor currency sensitivity underestimation. And the remaining half is that, because of the weaker yen, R&D spending is going to become bigger. And for the third quarter plus JPY 4 billion, and half is about currency, half is about non-currency factors. That's our estimation.

In terms of the incoming cash, this is not finalized. We are taking a conservative view and Transphorm is going to be contributing in the third quarter. So that's reflected as well.

[Kazuo Yoshikawa, analyst]

Shibata-san, you talked about to be able to grow the top line, you are going to use your OpEx. But for example, as an image for the next generation, are you going to increase the [ CAR ]?

[Hidetoshi Shibata, executive]

I think, as an image, yes, it's correct.

[Operator]

The Nikkei newspaper, Mr. [ Makano ].

[Unknown Attendee]

[ Makano ] for Nikkei newspaper. I also have two questions, the first of which refers to the acquisition of Altium. Semiconductor market is, of course, a weak and it comes at that timing. Once again, your expectations or any comments that you might have. And as acquisitions complete, ultimately, will the situation improve more than what is visible today?

And the second question is about China, is stepping up the investment into mature segments, into mature nodes? And as we look at the future for Renesas, in the mid- to long term, is it going to be a risk? I would like to hear your thoughts.

[Hidetoshi Shibata, executive]

I do not have much to add from what we have discussed today. But as for Altium, as we have mentioned, in terms of a financial impact, it's basically negligible. As whether it's a plus or minus, it will work to the positive. But the scale is limited. It is very negligible to the extent that you have to study very hard to find where that is.

We hope to be able to accelerate our movement towards digital. And of course, the momentum is building on both sides. The transaction has not yet been come to a close, and hence, it is still too early to say, therefore, I would like to refrain from speaking further. But after July, at the best timing, we will be able to update you, and you'll be convinced that more than before, we are working on integration for the introduction of a digital platform. And you will be able to see that we are working in that direction. There will be signs that will be visible, so please stay tuned.

As for China, there is also not anything more to add. As of now, the silicon IGBT will have the largest impact. From last year, the impact has already become visible, and hence, we're looking at the revenue of IGBT in China. And as for the outlook ahead, to reiterate, we believe that it is very difficult. And that is what we have said from the end of last year in conducting operations, nothing really has changed, and we believe that we're still in a very tough situation.

[Unknown Attendee]

Power discrete, what is going to happen to SIC? In mature node, Micron, Analog, what is going to happen? Might be a question on your thoughts.

[Hidetoshi Shibata, executive]

As for Micron and also analog, from the mid- to long term, we are expecting a large impact, but we believe that it is going to take time, and hence, we still have some time ahead. We will pursue digitalization so that we will be able to shift towards upstream in the value chain. And that is, of course, of course, the motivation or the theme of the acquisition.

As for SIC, it's very hard to say as for now because the situation is a mixed bag. Some will say that China SIC device quality is already up to par. Others will say that they're still not there yet. A mixed view will be the right way of us referring to the situation, but the market overall will grow. And we are also ready to participate in that market. And of course, as a solution, it's important, and hence, we will commit.

But as we have mentioned, to continue to invest our resources in order to really scale the size of the business, that is not the way forward. Of course, we hope to build our presence, but it will be a part of the total solution in our portfolio. So nothing has changed.

[Operator]

Next, from Daiwa Securities, Okawa.

[Junji Okawa, analyst]

I'm Okawa. I would like to ask two questions about the automotive sector. So you have said that you have reduced your outlook in terms of demand. Is it about the sales volume or due to the component makers' common manufacturers? Is there change in how they hold the inventory? Can you give us more detail?

The second question is that you have reduced outlook in terms of demand, but in terms of your sales on a quarter-on-quarter basis, can we expect the quarter-on-quarter sales is going to increase? So on a consolidated basis, the top line decline seems to be large in terms of quarter-on-quarter sales. So what is your outlook of your automotive business?

[Hidetoshi Shibata, executive]

So for our automotive business, in terms of the sales, we changed to take a more conservative view. So rather than trying to grow aggressively, we want to observe the market situation closely and control the inventory. Specifically, in the third quarter, we are going to reduce our outlook. In the fourth quarter, it's still early to say. But whether we're going to take a more aggressive outlook, I think we're taking a more cautious stance.

So the reason behind this is that, as you had just pointed out, so there's two factors that are playing. One is that the third-party says that the worldwide unit outlook has been downgraded. We have had that type of information. So if that is the situation, even your Tier 1 customers, I think basically, will have to be more cautious in terms of holding inventory. And I think that's natural.

And I think in terms of the trend, I do not think that we have seen a major change in the trend. But there are some customers that they are controlling the inventory to a level of very minor products or demand from customers. So I feel that maybe if they just reduce the inventory too much, maybe if the demand goes up, and they be lacking this component, so we do want to continue to confirm with the customers whether their inventory level is too low or not. But I think basically, from a customer point of view, I think there has some internal pressure to reduce the inventory, and they want to control the working capital. And I think that's a strong trend out there in the market.

So for the automotive business, so rather than us controlling the inventory, so I think basically the trend is that the inventory is going to increase gradually. But rather than trying to aggressively increase inventory like before, I think our sense is that we'll look at the situation closely and be cautious rather than aggressively swinging from the positive and negative, we are decelerating, and that's the automotive. For industrial, I think basically, we're going from the positive to negative in a major manner. So I think that's the difference of the perspective that we have for these two markets.

[Operator]

The time to close is near. The last question, Semicon Portal, [ Sudai-san ].

[Unknown Analyst]

Semicon Portal, [ Sudai's ] my name. I have two questions. The first is in reference to, in a growth market, one, components AI. And in AI, you have two, edge AI is one. I believe you acquired some company in that particular segment. And what has happened?

And as for data center, generative AI, for example, the NVIDIA chip, if we look at their situation, not just so much the NVIDIA, but HBM or there are also other microprocessors around that, I'm sure could be a potential target. What is the current situation for data centers? You've acquired IDT, the [ clock ] products, I think, will be viable for the data center. So what are the circumstances for you? What steps are you taking?

[Hidetoshi Shibata, executive]

As for generative AI, in terms of value, we are expecting growth. However, in terms of volume, the unit price is very high. In terms of volume, it will not really grow. Possibly, it might actually be lower. And what is the implementation on our side? The volume in terms of system is not going to grow, but the generative AI. Now how can we capture the demand for generative AI from our business? I think that's your question. What is particular to generative AI will be GPM and HBM.

For HBM, the increase will not really have a great advantage to us. It's not really positive, but with GPM growing and also considering the timing, power, we will also be able to enjoy a tailwind in our power devices. Because of confidentiality, we are constrained from speaking further, but the number of customers is limited in that space with a single platform due to various factors. Platform A could go ahead and Platform B could be delayed or the reverse, and that's what we're seeing right now. So as to which platform and with whom we are aligned, that will, in the short term, shift the situation. And as of now, we're looking at a combination. And are we seeing a great tailwind in our favor? That's not the case, but we are seeing solid growth.

In the fourth quarter, we have, of course, reflections. And hence, I would like to refrain from making any optimistic comments. But as we look at the numbers within the company, fourth quarter and beyond, we can expect to see a good recovery, especially around GPU power products.

As for the timing and also for the microprocessors, of course, that's an advantage. But with generative AI, we do not expect to see a spike, and that is how we are seeing the situation. For edge AI, this is something of that is coming in. The edge AI, in its truest form, as to whether it's going to really grow substantial, it's, of course, indispensable. It's sort of like similar to how we've viewed connectivity. It will gradually grow, and we need to take necessary, of course, steps to prepare ahead thoroughly.

As for PC AI, in the short term, there are specific set makers and application processor vendors that are not really visible in the market yet, but when their presence is there from G5, there'll be a push up and there will be a positive impact. And so generative AI, in the short term, there will be ups and downs. But in the fourth quarter, end of the year, we are hoping to see growth, especially around power. So that's one thing. And before and after, with client PC, there is also a tailwind while not directly felt. The impact will be indirectly felt. As for edge AI, we need to take a mid- to long-term stance. It's very difficult to capture specifically, but we believe that it will become indispensable.

[Unknown Analyst]

That is very clear. And as for the second question, if you look at the Q2 performance, the overseas ratio, for instance, in terms of geography, Japan, United States, Europe, Asia, China, if you divide it by geography, roughly speaking, what is your breakdown by geography?

[Hidetoshi Shibata, executive]

So overseas, of course, it is increasing. So roughly speaking, less than 80% is about overseas sales. Japan is about around 20%. U.S. is stable, about 10% plus. Europe, same as Japan, it's a soft market, maybe 50%. Europe going down to about around 15%. And China, which is relatively strong, going up to 30% and others. That will be the breakdown. But China, because they are strong -- excuse me, China and the U.S., they are relatively strong, Japan and Europe is weak, and as a result, the overseas ratio has, all in all, increased a bit.

[Operator]

With this, we would like to end the Q&A session. Lastly, Shibata-san, would you like to say a word?

[Hidetoshi Shibata, executive]

So I think this guidance of the third quarter, about this earnings report, I think everybody is disappointed and this is the reflection I have. But we will try to start up once again. By the fourth quarter onwards, especially in the fiscal year, we would like to maintain a speed of growth.

In terms of R&D, we will put in efforts to invest there. And even if we have to control our top line, we will adjust the inventory in the short term. So the third quarter, fourth quarter, we don't know how this is going to trend. But I hope that we'll be able to satisfy you in terms of our performance and continue to satisfy you. And that is the reason why we have changed our tracks at the current timing.

Thank you very much for attending this very busy schedule. I thank you for your continued support.

[Operator]

With this, we'd like to end the Renesas Electronics Corporation Second Quarter 2024 Earnings Call. Thank you very much for your participation.

[Statements in English on this transcript were spoken by an interpreter present on the live call.]