Infineon Technologies AG

XETRA:IFX

Earnings Call Analysis

Infineon Navigates Economic Challenges with Strategic Adjustments

Infineon is adjusting its 2024 fiscal year projections due to continued market weakness, now expecting revenue at €15.1 billion and an adjusted gross margin in the low 40s. The automotive segment remains strong, forecasted to grow by low to mid-single digits, while industrial and consumer segments face declines. The company is managing inventory and utilization rates carefully, incurring over €800 million in idle costs. Despite challenges, Infineon remains prepared to capitalize on future growth opportunities in key applications like AI and IoT, supported by its Step Up program aimed at achieving high triple-digit million euro impacts by 2027.

Company Performance Overview

Infineon's fiscal 2024 second-quarter earnings call highlighted the company's efforts to navigate through a transitional phase. Revenues for the quarter stood at EUR 3.632 billion, aligning with expectations, while profits were slightly better than anticipated with a segment result margin of 19.5%. The company remarked on the cyclical downturn affecting various sectors, particularly consumer, computing, and communication, which are showing signs of bottoming, though recovery remains modest at best .

Automotive Sector Performance

The automotive division remains a bright spot for Infineon, thanks to ongoing secular growth in vehicle content and gains in market share. In this quarter, automotive revenues were stable at EUR 2.78 billion, with a segment result margin of 24.6%. The company achieved significant growth in the automotive semiconductor market in 2023, growing 26.2% last year compared to the market's 16.5% growth .

Sectoral Challenges and Adaptations

Despite robust automotive performance, Infineon is facing a downturn in other segments such as industrial, power & sensor systems, and connected secure systems (CSS), each showing meaningful declines. For instance, Green Industrial Power (GIP) saw a 4% revenue decline mainly due to weakened renewable energy generation, with a segment result margin dropping to 19% from 26.7% the previous quarter . The Power & Sensor Systems (PSS) segment recorded a 7% sequential revenue decline, continuing a downward trend affected by consumer computing communications .

Inventory and Cost Management

Infineon has taken actions to manage inventory levels and cut utilization rates to lower idle costs, amidst the weak market environment. Idle costs for fiscal 2024 are now expected to exceed EUR 800 million, up from a previous estimate of around EUR 700 million. This will impact margins, especially in the second half of the fiscal year . Despite these constraints, the company has planned to manage its cycle robustly and strategically, aiming to capture market share during recovery phases.

Future Projections and Guidance

Looking ahead, Infineon has revised its revenue expectations for the fiscal year downward to EUR 15.1 billion, plus or minus EUR 400 million, from an earlier estimate of EUR 16 billion. The company's guidance indicates only modest seasonality expected in the second half. Segment result margins are anticipated at around 20% for the fiscal year, showing resilience despite significant revenue declines across various segments .

Strategic Initiatives and Structural Growth

To navigate through the current cyclical downturn, Infineon has launched an internal initiative called 'Step Up,' aimed at achieving high triple-digit million euro annual impact on its underlying segment results by fiscal year 2027. The program focuses on operational improvements and capitalizing on structural growth areas such as electro-mobility, renewable energy, AI datacenter, and IoT .

Financial Health and Capital Allocation

During the reported quarter, Infineon's free cash flow from continuing operations was EUR 82 million. The company also paid out an annual dividend of EUR 456 million and repurchased shares worth EUR 233 million. Despite a challenging business environment, Infineon successfully placed a EUR 500 million bond and ended the quarter with a gross cash balance of EUR 2.6 billion, maintaining a strong liquidity position .

Earnings Call Transcript 2024-Q2

[Operator]

Ladies and gentlemen, good morning, everyone. Welcome to the conference call for analysts and investors for Infineon's 2024 fiscal second quarter results. Today's call will be hosted by Alexander Foltin, Executive Vice President, Finance, Treasury and Investor Relations at Infineon Technologies. As a reminder, the call is being recorded.

The conference call contains forward-looking statements and/or assessments about the business, financial conditions, performance and strategy of the Infineon Group. These statements and/or assessments are based on assumptions and management expectations resting upon currently available information and present estimates. They are subject to a multitude of uncertainties and risks, many of which are partially or entirely beyond Infineon's control. Infineon's actual business development, financial condition, performance and strategy may therefore differ materially from what is discussed in this conference call. Beyond disclosure requirements stipulated by law, Infineon does not undertake any obligation to update forward-looking statements.

At this time, it's my pleasure to turn the call over to Infineon. Please go ahead.

[Alexander Foltin, executive]

Ladies and gentlemen, good morning. It's spring time, and we thank you for joining our second quarterly earnings call in 2024.

On this call, you have our CEO, Jochen Hanebeck; our CFO, Sven Schneider; and our CMO, Andreas Urschitz. Jochen and Sven will provide an overview on the market situation and divisional performance, key financials and our outlook. After that, we will start our Q&A session. As usual, the illustrating slide show, which is synchronized with a telephone audio signal, is available at infineon.com/slides.

One new thing. Starting this quarter, we will also provide a PDF with Jochen's and Sven's introductory remarks in the course of the conference call on our website, namely infineon.com/investor. A recording of this conference call, including the aforementioned slides and a copy of our earnings press release as well as our investor presentation are also available on our website at infineon.com/investor.

And now, Jochen, over to you.

[Jochen Hanebeck, executive]

Thank you, Alexander, and good morning, everyone. The first half of our 2024 fiscal year is now behind us. It still very much looks like a transition year. Transition refers to a cyclical downswing in between the multiyear upturn following COVID and afterwards, a return to structural growth. Cycles are typical of our industry, but each one has different characteristics.

In the current one, demand and inventory dynamics are taking much longer to play out than in the past. Furthermore, in some applications areas, the downturn is much softer than in others. The prime example is automotive, where secular content growth is continuing. Overall, the picture remains mixed, and Infineon is, of course, not immune to market forces.

It turns out that the cut we made to our guidance at the beginning of the year was not deep enough. Therefore, we lower expectations for the remaining two quarters of our 2024 fiscal year, de-risking our guidance. I will comment more on this revision in my outlook section towards the end of the call.

Broadly speaking, the so-called 3Cs market, standing for consumer, computing, communication and IoT, are bottoming, but not yet recovering. AI is the notable standout in computing. Industrial is showing typical late cycle behavior, with inventory digestion grinding on.

Automotive is remaining the bright spot in relative terms, given secular trends and in the case of Infineon, share gains, in particular in microcontrollers. That being said, slowing EV growth in Western markets and OEMs and Tier 1s, reassessing inventory levels have become more pronounced temporary headwinds, which we are recognizing for this fiscal year. We are managing the cycle in a robust way as can be seen from our performance in the March quarter.

Group revenues amounted to EUR 3.632 billion, in line with our expectations. The segment result came in slightly better than anticipated. EUR 707 million corresponded to a segment result margin of 19.5%. The decrease compared to the previous quarter, reflects the fall-through from lower revenues, pricing adjustments, typically occurring at the beginning of a new calendar year, as well as lower government funding receipts. Currency effects played only a minor role, as this quarter's U.S. dollar-euro exchange rate of 1.09 came very close to the prior quarter's rate of 1.08.

On a positive note, our order backlog has been stabilizing over the past couple of months. With around EUR 24 billion, it stands at the same level as at the end of December. We view the backlog trending sideways as a clear indicator for troughing demand levels in our target markets.

Now let's take a closer look at our divisions. Automotive. In the second quarter of the 2024 fiscal year, Automotive achieved revenues of EUR 2.78 billion, stable compared to the quarter before. Overall, small volume gains compensated annual price resets, and structural drivers offset the ongoing modest inventory correction affecting parts of classical applications. The segment result came in at EUR 512 million, yielding a segment result margin of 24.6% compared to 27.1% in the previous quarter. This is mirroring well-expected low single-digit pricing adjustment as well as some mix effects.

Infineon has a unique position in the global automotive semiconductor market. Latest research data for 2023 by TechInsights is confirming this. While the market grew by 16.5%, we were able to grow by 26.2%. All regions contributed to this impressive outgrowth, enabling us to expand our global leadership. We are the #1 in Korea and China, #2 in Europe and in Japan and #3 in North America. In automotive power, we retained the clear #1 spot in automotive microcontrollers. We achieved the pole position for the first time, gaining almost 5 percentage points of market share.

Now a short spotlight on China. Last year, the market there grew by 15.4%. Infineon achieved growth of 25%. Our business success is built on a very broad portfolio of over 300 automotive product families. In the last 2 years, the pace with which we were winning new designs in China has been clearly exceeding the market growth rate. With several billion euros in the back, we are confident to keep growing our China auto business in the coming years. The Xiaomi design win is a case in point, I will comment more on it in a minute.

From an extremely strong base, we will be able to grow our automotive business also in the adverse conditions of 2024. However, at a noticeably slower pace than anticipated so far, namely at a low to mid-single digit as opposed to double-digit growth rate. What factors are at play here? The estimates for the global car production are being nudged up to around 90-plus million units, stable in comparison to 2023. Inventories of automotive semiconductors are currently being adjusted downwards, reflecting a debate between OEMs and Tier 1s as to who should bear the burden of safety stocks. Pricing, as mentioned, is resilient with low to very low year-over-year declines.

In terms of secular content drivers, the xEV adoption is currently slowing in key western markets, and negative headlines are dominating the narrative. Western OEMs are pushing out the electrification timelines, and we have seen several of our customers reacting to this near-term demand pattern pushing their orders out of this fiscal year.

In China, in contrast, the proliferation of so-called new energy vehicles is continuing. In March, NEV sales penetration was 39% compared to 32%, 1 year earlier, and the figure is rising further as numbers from early April are showing.

A major highlight of the quarter was the recent launch of the Xiaomi SU7 family, where we will be providing our HybridPACK Drive CoolSiC modules for usage in models with an 800-volt drivetrain. This marks another significant design win for our technologically leading silicon carbide franchise. In addition, we are providing system solutions with over 60 different components to Xiaomi, including more than a dozen MCUs from our AURIX, TRAVEO and PSoC families. Overall, we are addressing more than 10 applications in the SU7.

In total, global EV growth will slow down this year. We do, however, remain confident on the midterm outlook for vehicle electrification: 2025 EU emission targets, reaccelerating momentum for plug-in hybrids and launches of new more affordable models are likely to drive xEV momentum in 2025 and beyond.

Our microcontrollers are directly addressing the decade-plus trend of ADAS and software-defined vehicles. Here, we continue to see healthy design wins, especially for the upcoming third-generation AURIX in the quarter under report at leading German OEMs and Tier 1s, supporting our global #1 position in automotive microcontrollers.

Key criteria for the wins are the functional safe hardware concept, certified up to standard of ASIL D, in conjunction with outstanding performance and quality. Together with the complete software stacks of our customers along the value chain, this represents a strong competitive moat.

Moving to Green Industrial Power, which saw a further sequential revenue decline in the March quarter. Sales went down by 4% to EUR 469 million, primarily driven by renewable energy generation. The continued revenue slowdown is leaving its mark on the segment's profitability. With a segment result of EUR 89 million, the segment result margin declined to 19% after 26.7% in the quarter before. The main drivers of this margin deterioration are lower volumes, adverse mix effect, increasing idle costs and unfavorable price changes.

The business environment for our industrial activities remains challenging. The markets for drives and home appliances continue to be affected by weak corporate investing and lower consumer spending confidence. In addition, excess inventories are persisting. Expectation for a gradual recovery are moving to late in the 2024 calendar year, if not beyond.

For renewable energy generation, high channel and customer inventories are temporarily dampening the semiconductor demand. The underlying growth drivers remain strong. Market researchers predict growing annual installation levels of around 500 gigawatts for photovoltaic and of just over 100 gigawatts for wind power in 2024. This would constitute annual growth rates of 24% and 18%, respectively.

Let's take a look at our silicon carbide trajectory. We are very proud to report on the recent introduction of the second generation of our trench-based silicon carbide MOSFETs. Our Gen2 650-volt and 1.2 kilowatt components improved key performance figures such as switching losses by up to 20% compared to the previous generation. Customer interest is very strong. With highest levels of energy efficiency, our silicon carbide-based solutions remain a key enabler of decarbonization in automotive and industrial applications.

Preparation for ramping silicon carbide capacity at our Kulim sites are progressing as planned, including the expected 200-millimeter transition. This will put us in a great position for mid- and long-term profitable growth as the space constraints related to our Austrian fab does no longer exist. That being said, the demand environment is currently more cautious, making our ramp curve less steep in the near term.

For this fiscal year 2024, we are adjusting our expectation for silicon carbide revenue growth to about 20%. A cross-reference to significantly changing market growth rates, we find premature at this point. However, we are confident to clearly defend our market share, if not more.

Now over to the Power & Sensor Systems segment, which saw revenues coming down sequentially by 7% to EUR 730 million. Similar to the previous quarters, components MOSFETs and ICs for consumer-facing applications were under pressure, whereas products for smartphones and servers saw an uptick. As a result of the revenue decline, the segment result decreased to EUR 64 million, equivalent to a segment result margin of 9% after 12.9% in the December quarter.

PSS continues to be severely affected by the projected downswing in consumer computing communications. The segment has now seen six consecutive quarters of a downward trend in revenue, and it is almost 40% down from the peak achieved in the second quarter of 2022. This is the trough. The business is picking up in the currently running quarter. However, against a persistently weak macro backdrop and a prolonged inventory digestion period, the near-term recovery is likely going to be less deep than we had expected previously.

From a midterm perspective, growth dynamics remain favorable, underpinned by structural trends, in particular, the rapid proliferation of artificial intelligence is an extremely attractive opportunity for us. The power requirements of AI processes are orders of magnitude above those of classical enterprise CPUs.

As a consequence, power systems with best-in-class energy efficiency bring tangible benefit in terms of cost of ownership, motherboard space and CO2 footprint. At the same time, there is a notable uplift in the power semi content per server rack. Infineon offers industry-leading solutions for the entire power flow from AC-DC grid power supply via DC-DC conversion, all the way to the final power stage supplying the processor.

Capabilities like digital power control, chip embedding, mastery of silicon, silicon-carbide and gallium-nitride power technologies and in particular, the novel vertical power supply architecture give us a clear differentiation from others in the market.

This has already translated into design wins across AI processor makers, notably with the three most important ones, as well as hyperscale data center players. With mid-double-digit growth rates, we expect this business to reach EUR 1 billion over the next couple of years, driven in particular by the transition to vertical backside-mounted power supply, with an inherently much higher bill of material for us.

Lastly, a look at Connected Secure Systems, where a bottoming is visible. After a steep decline in the previous quarters, revenue in the March quarter increased slightly to EUR 371 million. Demand for consumer IoT and smart card products appears to stabilize at low levels. The pace of channel inventory correction is slowing down. In the area of Wi-Fi, we see some small restocking by distributors.

The segment result of CSS came in at EUR 42 million, corresponding to a segment result margin of 11.3%. In the near term, the inventory digestion in IoT and security markets will progress. Looking at improving order entry, we expect a moderate demand recovery in the second half of this calendar year.

In the meantime, we are getting positioned for the immense structural growth opportunity of edge AI. Our next-generation PSoC Edge family of microcontrollers is optimized for machine learning applications. They are all supported with comprehensive system design tools and software.

Additionally, we are leveraging two of Infineon's core competencies, power management and embedded security. IoT edge devices require low-power capabilities without compromising performance. Security is a vital aspect in IoT deployment, and our PSoC Edge family has been designed to meet the higher certification level provided by the PSA Certified program, a framework for embedded security.

Now over to Sven, who will illustrate our key financial figures.

[Sven Schneider, executive]

Thank you, Jochen, and good morning, everyone. In the second quarter of our 2024 fiscal year, we saw the expected impact of the ongoing market downswing as well as yearly price changes on our profitability. The adjusted gross margin, which excludes non-segment result effects, came in at 41.1% in the March quarter, after 44.9% one quarter earlier. Our reported gross margin declined to 38.6% from 43.2% in the quarter before.

Pricing overall is fairly resilient compared to previous downturns, in line with our previous indication of low to mid-single-digit percent year-over-year declines. Underutilization charges amounted to roughly the same level as in the quarter before. Our OpEx development is well under control. Research and development expenses declined to EUR 487 million from EUR 512 million in the prior quarter. Also, quarterly selling, general and administrative expenses went down from EUR 395 million to EUR 375 million.

We recorded a net other operating loss of EUR 45 million, containing write-offs related to the announced sale of our two back-end sites in Korea and the Philippines, which occurred in line with the optimization of our manufacturing footprint. These losses are also part of the non-segment result, which overall amounted to minus EUR 211 million for the quarter.

The financial result for the March quarter was minus EUR 12 million after plus EUR 25 million in the quarter before, which had benefited from the interest element of a release of a tax provision in connection with the Cypress acquisition.

Income tax expense amounted to EUR 93 million for the second quarter of the current fiscal year, equivalent to an effective tax rate of 19%. Cash taxes for the quarter were EUR 134 million, resulting in a cash tax rate of 28%. We continue to expect both tax rates to be between 20% and 25% going forward outside of any future tax law changes.

Our investments into property, plant and equipment, other intangible assets and capitalized development costs reached EUR 643 million in the March quarter, basically flat compared to the quarter before. Depreciation and amortization, including acquisition-related non-segment result effects, stood at EUR 467 million in the second fiscal quarter after EUR 456 million in the preceding quarter.

Our quarterly reported free cash flow from continuing operations showed a small positive amount of EUR 82 million. The previous quarter's amount of minus EUR 1.6 billion had contained the acquisition of GaN Systems as well as annual success bonus payouts.

Our inventory reach has started to go down. After several consecutive quarters of increases, the DIO went from 185 to 178 days in the March quarter. Overall, we see our inventories plateauing currently and expect noticeable reductions both in relative as well as absolute terms towards the end of our fiscal year.

Keep in mind that the relevant part of our inventories relates to strategic purposes, such as the optimization of our manufacturing footprint or the mitigation of potential geopolitical risks.

In terms of corporate finance activities, it was a rather busy quarter, with a corresponding impact on our liquidity and leverage figures. For our annual dividend, we paid out EUR 456 million. Furthermore, we bought back 7 million shares for EUR 233 million. These shares are to be allocated to equity-related compensation for this and the next year.

Contrary to these outflows, we had very successfully placed a EUR 500 million bond in February on the back of our rating upgrade to BBB+. Gross cash stood at EUR 2.6 billion at the end of March commensurate with our liquidity target and including the continued usage of short-term loan facilities. Our gross debt increased to EUR 5.9 billion, with a gross leverage of 1.2x. Net debt amounted to EUR 3.3 billion, equivalent to a net leverage of 0.7x. Finally, our after-tax reported return on capital employed declined to 7.5% in the March quarter, again reflecting the unfavorable business environment.

Now back to Jochen, who will comment on our outlook.

[Jochen Hanebeck, executive]

Thank you, Sven. Indeed, the business environment remains unfavorable with macroeconomic and geopolitical headwinds lingering. The cyclical correction is continuing, affecting also automotive and industrial applications. The consumer-related parts of our business are bottoming, but the near-term recovery looks still shallow, with short lead times, the visibility into the timing and magnitude of a rebound is limited. On the flip side, green shoots do appear and structural drivers stay in place or are getting stronger, such as powering AI service.

Considering these factors and after scrutinizing all available indicators for the next 2 quarters, we are de-risking our projections for the 2024 fiscal year. We lowered our revenue expectation down to EUR 15.1 billion, plus or minus EUR 400 million from hitherto EUR 16 billion at the midpoint. The reduced and de-risked guidance implies that we expect only a very modest seasonality in the second half of our fiscal year.

Compared to the previous forecast, we are taking out EUR 900 million, around half of that relates to lower growth in automotive and the other half to lackluster industrial markets and to a more tempered recovery in consumer computing and communications. On an annual basis, this still means that the development patterns will differ significantly amongst the segments. Compared to the previous fiscal year, we now expect ATV to grow by low to mid-single-digit percentage, driven by unabated MCU strength, growth of xEV focused on China, but also a longer inventory digest. In contrast to ATV, we expect meaningful annual declines for the other segments: low teens for GIP, high teens for PSS and low 20s for CSS.

Against this background, we are taking further action to cut utilization rates and under-ship end demand in order to lower inventory levels. This will lead to expected annual idle cost of more than EUR 800 million, up from previously assumed around EUR 700 million. These charges will burden our margin development, especially in the second half of our current fiscal year. Nevertheless, for the whole of 2024 fiscal year, we expect a resilient adjusted gross margin in the low 40s, after low-to-mid 40s before.

For the segment result margin, we anticipate around 20% for our 2024 fiscal year, robust given the magnitude of revenue decline becoming apparent only throughout the year. Assuming a structural level of idle costs of around EUR 150 million annually, the cyclical part is now equivalent to more than 430 basis points of margin, confirming an underlying value in line with our through-the-cycle target of around 25%.

For ATV, we had previously indicated a corridor of between 25% and 28%. Despite the lower revenue expectation, we are confident to keep the lower end of that corridor. The profitability of GIP should come in around group level, whereas the segment result margins for PSS and CSS will be noticeably weaker.

As part of our cycle management, we are adjusting investments, once again, slightly and now expect a level of around EUR 2.8 billion after EUR 2.9 billion before. Our depreciation and amortization an unchanged value of around EUR 1.9 billion is anticipated. This includes amortization of around EUR 400 million, resulting from purchase price allocations, mainly in connection with the acquisition of Cypress, which will end up in our non-segment results.

Our adjusted free cash flow, net of the GaN Systems acquisition as well as of investments into major front-end buildings in Dresden and Kulim, is now expected to come in at around EUR 1.6 billion, down from EUR 1.8 billion before. This would represent around 11% of sales.

For the reported free cash flow, we now expect level zero compared to EUR 200 million before. For the currently running third quarter of our fiscal year, we expect revenues to grow sequentially by around 5% quarter-over-quarter to around EUR 3.8 billion. By division, we expect the sequential growth rate of ATV and CSS to be in line with one of the group, GIP to grow at lower and PSS at a higher rate. From a year-over-year perspective, our fiscal third quarter will still be down, but less so than the previous quarter, indicating that the trough is behind us. For clarity sake, all projections are based on assumed U.S. dollar exchange rate of 1.10.

For the segment result margin, we expect a high teens level for the June quarter, reflecting headwinds from higher idle costs. Without the cyclical part in them, the trough would be behind us also in terms of profitability.

Before coming to the summary and to the Q&A, let me provide a view on Infineon's midterm trajectory of profitable growth. Looking beyond the current cyclical downturn and transition phase, we see unabated structural growth opportunities for our company. This continue to be centered around our five broad key applications: electro-mobility, ADAS, renewable, AI datacenter and IoT.

In addition, we see potential to sustainably strengthen our competitiveness. That's why we launched an internal program called Step Up. In contrast to short-term oriented cycle management, it will be about structural improvements to strengthen our target operating model.

With Step Up, we target the high triple-digit million euro annual impact on our underlying segment result against the 2023 fiscal year as the basis. We expect the financial benefits to start kicking in over the course of our 2025 fiscal year, with a full effect becoming visible in the first half of our 2027 fiscal year.

Step Up will combine various measures, including the pulling of those levers communicated in November 2022, at the introduction of our current target operating model, manufacturing productivity, portfolio management, pricing quality and OpEx scaling, but not compromising our innovation power.

We plan to update you on the progress of Step Up as we are further defining and implementing the program. We are convinced it will significantly enhance Infineon's competitiveness and value creation.

Now ladies and gentlemen, it is time to summarize. We have concluded a robust first half of our 2024 fiscal year. The March quarter contributed with revenues as guided and slightly better-than-expected margin. The market environment generally remains weak. The cycle is bottoming in consumer, computing and communication. Things will improve from here, but a quick material snapback is not in sight.

Weaker dynamics affecting industrial and auto, the latter driven by slower EV adoption outside China and inventory digestion. We de-risked our outlook for the remaining fiscal year as Infineon is not immune to market forces. However, even under adverse conditions, we will be able to grow our automotive business in 2024 and show resilient profitability levels fully in line with our target operating model.

We continue to manage the cycle, adjusting loading levels further down to reduce inventory levels, while being prepared to capture market share in an upswing. Our structural growth drivers are intact. Our key applications provide ample opportunities. To enhance our competitiveness and value creation, we are launching Step Up. The program is about structural improvements that will strengthen our profitability.

[Alexander Foltin, executive]

Thank you very much, Jochen and Sven. Ladies and gentlemen, this concludes our introductory remarks, and we are now opening the call for your questions. [Operator Instructions]

Operator, please start the Q&A session now.

[Operator]

[Operator Instructions] And the first question comes from Francois Bouvignies from UBS.

[Francois-Xavier Bouvignies, analyst]

So my first question will be on the cost savings. Jochen and Sven, I mean, you talked about this cost saving program, a structural one. Now we know that we are in a cyclical downturn. But can you maybe help us understand what triggered the initiative to have a structural cost savings? Anything happening that you could -- that make you think to initiate that?

And more broadly related to that question would be, in a scenario where the Chinese are getting more aggressive on the pricing side in some products, maybe, let's say, the low end to medium end, what would be your strategy as Infineon -- do you -- would you like be willing to exit some markets where you don't see like profitability or just -- yes, a bit more details around this cost saving programs that would be very helpful in the chain, right? And I have a quick follow-up after that.

[Jochen Hanebeck, executive]

Yes. Thank you, Francois. We initiated now the Step Up program because, honestly, in a downswing, structural weaknesses are more apparent and the buy-in is easier to get. And I think it's the right thing -- or we are convinced it's the right thing to address in order to develop the full potential of the company.

Chinese competition, we are a company that differentiates by the innovation. And within those five areas of structural growth, we see ample opportunities to differentiate ourselves. And the latest great example is powering AI. But also in automotive, as you can see also from our market share gains in China, which will continue given the design win track record we have on the books, it's a solid assumption.

However, there will be, of course, some areas where Chinese competition will gain some market shares, namely, let's say, in the low-end power discrete arena. But we are confident to offset these potential losses on one end with gains at the other end, driven by our innovation and also, of course, new emerging strong structural growth drivers like powering AI.

[Francois-Xavier Bouvignies, analyst]

And maybe -- the follow-up is on data centers and AI. You mentioned some few design wins in your remarks. Could you elaborate these design wins? And how meaningful it is? And what's the cause, of course, for Infineon to get these design wins? That would be great.

[Jochen Hanebeck, executive]

Yes. Please understand here that I will not be able to name customers, but I think my wording was that we got design wins from the three most important processor companies in the meantime and also are working with all relevant hyperscale companies. And we expect this business to develop nicely.

It will really become a big boost once those players switch to this backside-mounted vertical power supply because then our bill of material is jumping by a factor 3 to 5 from the current lateral 1. So once this transition happens and the compelling cases on the TCO side, total cost of ownership of the operators, so once this becomes mainstream, and I don't see a reason why that should not happen, we have a strong boost. And honestly, we are very well positioned compared to competitors given all the factors I summarized, like the digital power control, like all the different semiconductor material, like the chip embedding, like the modules and so on and so forth. So I'm looking very much forward to that business growing in the future.

[Operator]

And the next question comes from Alexander Duval from Goldman Sachs.

[Alexander Duval, analyst]

You've lowered your expectations in Automotive segment to factor in weakness in the market there. I just wondered to what extent that's driven by generalized automotive demand dynamics as opposed to shifts between full battery electric vehicles and hybrids? You talked about acceleration in hybrids. So I was just wondering what impact that has given the different content per car?

And then also on microcontrollers, you talked about share gains there on the automotive side. Given the robust share gains you've been achieving, just curious how sustainable that is? And to what extent consolidation in MCUs in certain automakers is a countervailing trend we should bear in mind in the long term?

[Jochen Hanebeck, executive]

Thank you for the questions, Alexander. So the weakness in Automotive is a combination of e-mobility in the West, but strong growth in China, in particular also the reemergence of plug-in hybrids, which are very popular in China. And honestly, in my opinion, a trend the Western OEMs have missed to a certain extend.

But also on the other side, what we see that downstream inventories are rebalanced, are discussed between OEMs and Tier 1s, who pays for it, what's the right level of safety stock. So I would say these are the two dominant factors. Our MC growth story is intact. And your question is basically how defendable that position is. I think it's very defendable because I call it sometimes a matrix effect. And you hinted it indirectly. The OEMs are selecting very often these sort of microcontrollers. And the Tier 1s are building platforms.

And this is a sort of metrics. And if you think that through, you need to win at both ends, and that is always putting those in favor that are the incumbents, whereas new players will have a hard time to enter these metrics. So I think that's going to be a story for longer.

[Sven Schneider, executive]

And Alexander, Sven speaking. If I may just add on your first question. Broadly speaking, the content between BEV and hybrid is very similar, except there's no silicon carbide.

[Operator]

And the next question comes from Didier Scemama from Bank of America.

[Didier Scemama, analyst]

Many questions from me, but I will limit myself to two. So first, on the Step Up program, can you help us understand what high triple digit actually means? Would it be fair to say mid-single digit starts with the 5?

And the second question is on the underutilization charges, then. I think you said for Q2, it was unchanged versus Q1. So just give us a sense of what the actual number was just to refresh our memory. And how you see the sequence for Q3 and Q4? And I have a quick follow-up, if I'm allowed.

[Sven Schneider, executive]

Yes, Didier, it's Sven speaking. Yes. So high triple digit is a number, which I would say is below EUR 1 billion and north of EUR 500 million. Otherwise, it would be mid-triple digit. So as we are just announcing it today and as Jochen already explained, that we are now in the process of really defining measures in the next months. We don't want and we cannot be more precised on a number, but it is significant. It's substantial, and it's a high triple-digit amount.

Second question on the idle costs. Yes, indeed. Also, as Jochen explained in the intro, there is a change in the last call, I gave you a number of around EUR 700 million for the full year and said that probably first half is a bit higher than second half, given that we had to underload the fabs more than planned in the second half, given the reduction by EUR 900 million revenues.

Now the picture has changed in two dimensions. Number one, the expected idle costs for the full year are EUR 800 million plus. And it's more a 60-40 shift. Now 40%, so it flips 40% first half, 60% second half, and the peak is expected in this fiscal quarter Q3.

[Didier Scemama, analyst]

Amazing. And sorry, apologies for being sycophantic on the call, but your market share gains in microcontrollers overall and in automotive market controllers are nothing short of spectacular. I've covered this industry for 25 years. And in an industry where normally market share gains are very slow, you've gained tremendous amount of share last year.

So I guess the question that a lot of investors are asking me is how sustainable are those gains? And where are they coming from? I think you've answered previously saying those market share gains are easily defensible, and I think you've given a lot of color. But what's the risk of seeing double ordering of excess inventory that your customers and that this market share gains sort of revert as we go back into a normal market environment?

And specifically, I looked at your #2 and #3 competitors and last year, they were significantly underperforming. So just help us understand how much of that is real demand versus perhaps excess inventories?

[Jochen Hanebeck, executive]

Yes, thank you for the note on microcontrollers. It's indeed, it has been, yes, more than 10 years journey to get where we are today, and that's the first indicator maybe why it is so defendable. Microcontrollers are the stickiest parts of our business, I call it, including the software of our customer in moat, which is very difficult to defend.

Right now, we are in the transition from main volume in 65 to 40 nanometers. And here, we see customer ordering very strong for the next quarters. Of course, microcontrollers were a part in the allocation, which was most searched for. And therefore, I would expect that there is more of safety buffer in those parts. But I think that as this is the most difficult part to replace. I think, the value chain players will keep that in mind and notice it. So in my mind, it's a very well planned trajectory of success for the next years to come based on AURIX and the TRAVEO family.

[Operator]

And the next question comes from Janardan Menon from Jefferies.

[Janardan Menon, analyst]

I just want to take a look at your guidance. You've said you have de-risked it. I'm just wondering what you would -- what you're implying by saying you've de-risked it? Would you think -- say that this guidance is conservative and therefore, there is less likelihood of any further cut? And is there any possibility of upside from here if there is a recovery coming through in the PSS and CSS divisions as you alluded to in the way you're seeing some signs of a bottoming out as you alluded to in your initial comments?

And then my follow-up is on silicon carbide. You've got your growth quite a bit on silicon carbide. How much of that growth of that cut is coming from the industrial side? And how much of it is coming from the automotive side? And are you adjusting your silicon carbide capacity expansion plans at all on the back of this cut?

[Jochen Hanebeck, executive]

Yes, Janardan, thank you for your question. De-risk simply means this was the last cut for this year. Silicon carbide, we reduced. We see weaknesses in solar, in the industrial side and of course, also on the automotive side due to Western programs. This exact split, Sven, is?

[Sven Schneider, executive]

Yes. So Janardan, the number or the growth we have given you is 20%. So if you now look at the expected revenue, it is 50% industrial. That's 45% automotive and 5% PSS. That's the split roughly. And to your question, where is the reduction? A bit more pronounced, I would say, industrial has reduced a bit more than automotive to come to the 20% growth rate number for this fiscal year.

[Jochen Hanebeck, executive]

And with respect to the capacity buildup, you may remember that we were in a bottleneck waiting for cooling capacity to come. So we were a bit behind in terms of capacity buildup, which now, of course, plays into our favor. Nevertheless, we are, of course, adjusting the equipment slotting to the demand we foresee over the next quarters to come.

[Janardan Menon, analyst]

And just going back to the answer to the first question. Are you confident -- are you asserting that you're confident that this will be your last cut for the year? Is that how I should think of your answer?

[Jochen Hanebeck, executive]

Yes.

[Operator]

And the next question comes from Joshua Buchalter from TD Cowen.

[Joshua Buchalter, analyst]

Congrats on the result. To start, I mean, it's kind of overly simplistic, but if I look at your guidance, it looks like you're getting back to roughly seasonal, maybe a little bit below seasonal growth of about, -- down a couple of quarters. Should we take that as sort of your confidence that -- and inventory levels at OEMs and that your customers are in good shape and you're able to shift to end demand? I would just be curious to hear your -- you discussed what levels of visibility you have into end demand and customer inventory levels as many of your peers are still in the midst of trying to bleed levels down at their end customers.

[Jochen Hanebeck, executive]

Yes, Josh, thanks for the question. So shipping to end demand, that's really depend on the application. So in photovoltaic, for example, there's clearly too much inventory in the supply chain at our customers and further down the supply chain.

Also, pockets in the classical automotive, as I hinted at that various inventories, also downstream, which are digested. Whereas, as I said, on the microcontroller side for automotive, we have a good feeling that we are shipping to end demand. So it really, really depends on each and every end market. And the summary of it is what we have put into the guidance.

[Joshua Buchalter, analyst]

Okay. And I guess how much better would you say things need to get for you to bring utilization rates back up? And sort of what's the base assumptions? Or how you would expect underutilization charges to work down through the next couple of quarters?

[Jochen Hanebeck, executive]

Yes. I think maybe Sven can give you an outlook for this fiscal year underutilization charges. Sven, please.

[Sven Schneider, executive]

Josh, so as I said before, 60% of the, more than EUR 800 million in second half and the peak in Q3. So that's probably all I can give you for that fiscal year. I don't want to guide now into '25. Of course, that will depend very much on the growth rate. And if the growth is higher than this year, then, of course, underutilization charges will come back.

I mean, theoretically, as we said in the intro, if we would have no cyclical underutilization charges, then this would be a 430-basis-point uplift to gross and segment result margin, but that would be then no cyclical item.

[Operator]

And the next question comes from Sandeep Deshpande from JPMorgan.

[Sandeep Deshpande, analyst]

My question is regarding your order trajectory. You said that you've seen some sideways movement in orders. Maybe you can give some clarity on that. And with regard to these orders, and that's your view that you have cut your guidance over the last time this year, do you have any view into 2025 -- FY '25 at this point? Do you think that the markets will be growing by then? Or is there any risks into '25 from what we've seen in the past year? Because Infineon saw a result of the weakness much later than many other companies in the market.

[Jochen Hanebeck, executive]

Yes. So I think on your question towards the order backlog, it's stable. 2/3 of it is below 12 months' reach. And the vast majority is Automotive. For fiscal year '25, we do not give a guidance as of now. But after a downturn normally comes an upswing in this industry.

[Sandeep Deshpande, analyst]

My question is on these cost cuts that you're implementing, which are over EUR 500 million that Sven just talked about. How should we be seeing them impacting your segment result? Do they directly impact your segment result? Or are these an impact on the gross margin, which we don't see fully in segment results? So I'm just trying to understand how we should be modeling them going forward?

[Sven Schneider, executive]

Yes, Sandeep, thank you for the question. So first of all, if we go through the timeline, we said that the first positive contributors of Step Up should be visible in 2025, but the full effect should really be in the P&L first half of our fiscal year '27. So that's the starting point.

Usually, with such programs, and again, please give us the benefit of the doubt that we haven't discussed that internally. We haven't detailed the measures. So I cannot give you now a split how much is gross margin versus segment result margin. But of course, the impact will be visible at bottom line over time.

There may also be some one-timers, which are required in order to generate the savings. That's one thing we need to also watch. And let me also add one more color because we heard that question through other channels. Is Step Up included in the target operating model? Or is it coming on top of the target operating model at CP here, very clear. So target operating model, which we announced in November 2022 in the first year, which, by the way, was not only a blue sky year given that the weakness in the 3C markets already started to become very visible, we delivered according to 25 on average, high 20s in a good year with our most profitable year. This year, we are now testing more the lower end of it. We said high teens. Now we are guiding for around 20%. So I think that's the first good evidence.

On the other hand, as I just said, the Step Up measures will take time. They will come into the P&L only over time. We are very confident about Step Up, but please do not just add them now on top, given the factors I have just explained.

[Operator]

And the next question comes from Lee Simpson from Morgan Stanley.

[Lee Simpson, analyst]

Great. Two quick ones, if I could. Just looking at the automotive OEMs, all of these are talking about quite a lot of improvement in the second half of this year, led in the main by new product launches and somewhat better volumes. So that volume and mix haven't generally been weak, and the first quarter seems to be a strong tailwind as we go through the rest of the calendar year.

Just wondered how much of that could have been factored into your guide? And then equally, there has been this pivot with inventories at OEMs, this sort of push and pull between them and Tier 1s you've mentioned as you move to more hybrids in the mix. I wondered if those two forces are the opposing forces? Are you balancing for a temporary gap in that second one for 1 or 2 quarters? Just really trying to get a sense for how the product launches as well as the inventory changes are affecting that guide?

[Jochen Hanebeck, executive]

Yes, Lee, thanks for your question. So first of all, you know that we are very broad-based in Automotive. So new product launches on one end might also cause elsewhere less sales. I think, the right guidance is here, the EUR 90 million. Meaning, on the total car sales, this is stable compared to last year. So at the end of the day, we are again talking about the structural growth drivers. And those ones go in our favor, even though BEV, which means silicon-carbide is weaker, then we are selling more IGBTs on the plug-in hybrids. Of course, there's a difference in the bill of material. But nevertheless, it's buffering the less of the silicon-carbide sales.

Now the inventory effect, that's exactly what we considered when we came up with our guidance that there is certain areas where OEMs and Tier 1s are discussing on what are the right levels of the safety stocks for this period in 2024.

[Lee Simpson, analyst]

Okay. Great. So I guess maybe just a follow-up. I wanted to ask more about -- sorry, a bit of an echo there. Just trying to understand a little bit more about the timing of the wins in the AI server space. Because if you look around, there is a pausity of capability and vertical power delivery. It does seem to me your previous commentary around design wins with three hyperscalers and three leading discrete providers of accelerated compute gives you quite a strong position.

And I just wanted to investigate maybe the extent of that strength. Does your solution does it favor more GPU-heavy configurations at Rack scale? Or does this move right across the board? In other words, is this a story that will pick up later in calendar year '25? Or is it further out for Infineon?

[Andreas Urschitz, executive]

Yes, Andreas speaking. I'll take this question. So it is a trend that has already started to pick up where Infineon is, if you were driving the trend. So with the proliferation of more AI service, if you will, as a function of them more modern GPU technologies to be deployed, the power demand goes up rapidly. And that, as Jochen said, leads to a whole chain of semiconductors, excellent semiconductors from Infineon that start at the grid power supply from the AC towards the DC-DC point-of-load solutions. So with the full range of products, we are very well positioned to follow this trend, as said before.

So with the full proliferation of next-generation AI GPU, we expect the need for vertical power flow to come. The BOM content goes up by a factor 3 to 5, relative to what it is today, while today it is already increasing. I'll just give you one number. If you look today and compare the BOM, the DC-DC BOM for H600 GPU relative to a CPU, if you will, in the normal hyperscaler, we're already talking about the BOM being a higher factor 3 to 4 relative to the CPU BOM as far as Infineon is concerned. So all in all, a very attractive market segment for us, where we are in an absolute pole position to win.

Since we have the full portfolio from the beginning of where the power comes in from the grid till the point of load and optimize the total cost of ownership as a function of increased energy needs, and that's a function of Infineon determining getting the overall power flow efficiency from today, 87% up to 90% to 93%. That's what we're working on. And that's a big deal for AI data center operators.

[Lee Simpson, analyst]

Absolutely. And maybe just to be clear, are you seeing any competitors in vertical power delivery for such high-power GPU usage in the cloud?

[Andreas Urschitz, executive]

So I can only tell what we are seeing. So why we are speaking, vertical power delivery seems to be an absolute sweet spot for Infineon based upon our capabilities in the area of a, wide band gap; b, digital power that you are needing for this; c, module technology and our capability to integrate all of these semiconductors, plus even passives in modules that then can be mounted on the bottom underneath a processor.

I have -- I personally have not yet seen any competitor who has available all these ingredients. So anybody else who I'm aware of needs to kind of put a lot of partners and partnership construction together in order to do what a customer can get out of Infineon as a one-stop shop.

[Operator]

And the next question comes from Johannes Schaller from Deutsche Bank.

[Johannes Schaller, analyst]

Just two questions on inventories. I mean, Jochen, you talked about the situation in Automotive, the downstream inventories and now there's a bit of the discussion who is kind of taking the burden of that. A lot of your internal inventories are strategic or a good part is strategic, and it's coming from the auto industry. I was just wondering if any -- if you've seen any changes in how your customers think about these strategic inventories at all? Or is that is still relatively safe from your perspective?

And then just secondly, maybe more for Sven. With the idle cost that we're now facing in the second half and also your confidence that this is the last guidance cut, should we expect that we're starting 2025 with a relatively normal internal inventory situation?

[Jochen Hanebeck, executive]

Yes. Thank you, Johannes, for your questions. So the strategic inventories, as we called them out the last 2 quarters consisted of inventories in order to optimize our manufacturing footprint. Then the second category was geopolitical risk. Those are the by far dominant ones, and then there are selective OEMs, which keep inventory at our place and pay for it. And they are nicely in place and all good, but the vast majority of the strategic inventories are the other two categories.

[Sven Schneider, executive]

Johannes, to your second question, the answer is no. Even if we go down with the DIOs already this quarter, and we expect the DIO to go down further towards the end of the year, I mean, we are still at a relatively elevated level compared to the past. And therefore, even if revenues are going up, I would not yet guide to a full normalization in the beginning of '25.

You know that a target number is more in the 120 area. So there is still some room to go. We need to work down and it's always a fine balance as we have explained in other calls, between loading profitability, cash flow and also inventory levels. Also to be prepared for the upturn, by the way, where if this comes at a quicker pace, we will be very well positioned.

[Operator]

And the next question comes from Tammy Qiu from Berenberg.

[Tammy Qiu, analyst]

So first question. On those green shoots you discussed, is that the first time you have seen this green shoots in this year? And secondly, we have been hearing that some auto OEM seems to be wanting to working down their inventory over the next 2 years. Do you see any inventory restocking behavior difference between OEMs and the channels, please?

[Jochen Hanebeck, executive]

Okay. On the green shoots, smartphone AI, Andreas will answer. On the inventory side, auto, it's -- I understand why you're asking. But of course, it's not for us completely transparent what goes on between the Tier 1s and the auto OEMs. We only see the results. We get a feeling where we ship to end demand and where there's still more inventory, but as those inventories were not visible for us in the allocation period, they are neither visible for us at this moment in time. We just hope and tell everybody, please learn the lesson from the last cycle. Otherwise, we will be in the same pattern again of potential shortages.

[Andreas Urschitz, executive]

And talking about the green shoots, so the answer is we have been seeing the first selected rush orders coming in, in the area of smartphone. Smartphone demands already a quarter ago. Those have, so to say, increased in the meantime and have been accompanied with additional rush orders now coming up quickly in the area of server -- AI servers. So if you will, probably too early to speak of a trend, but definitely acceleration of green shoots where we speak.

[Tammy Qiu, analyst]

You talked about IGBT. It's probably more open to thread of the -- from the localized Chinese players. Can you talk about your situation in silicon-carbide? Is that as safe as microcontrollers are much safer versus IGBT, please?

[Jochen Hanebeck, executive]

Microcontrollers are at the stickiest end of the product portfolio, given the long design cycles, the software, especially that is built upon it, not only by us, but also our customers. So if you plot it, I would say it's the most stickiest business of all within our portfolio.

When it comes to silicon-carbide and in the power discrete, it depends. To build a simple power discrete switch, we will see more competition. If it comes to an automotive grade, small form factor, high reliability, high temperature, sort of application, then this is a different animal. And we feel that we can differentiate ourselves well from competition.

[Operator]

And today's last question comes from Adithya Metuku from HSBC.

[Adithya Metuku, analyst]

I have two questions. Firstly, just on the MCU business. I think your business there grew over 60% last year. I just wondered if you might be able to give some clarity on what Automotive business will decline by this year if you exclude the growth contribution from MCUs? And on that front, again, would you be willing to use Chinese manufacturing to reduce your MCU cost going forward? Any color on that would be helpful. And then just as a follow-up, on the AI vertical power delivery design wins, are these largely based on silicon? Or are there wins tied to SiC or GaN in there? Any color there would be helpful.

[Jochen Hanebeck, executive]

Okay. The last one is easy to answer. At this point in time, they are based on very advanced silicon MOSFETs. Nothing you can buy anywhere on the street, but latest, greatest silicon MOSFET technology from Infineon. Going forward, we also see a space for wide GaN materials in AI.

The MCU part, last year, not 100%, not sure, on the number was a specific growth rate, because there was also a pricing effect in there, which we were able to implement during the allocation period, which took us then to a fair market price value.

With respect to your question on MCU, in China, we do see some requests from local customers to localize the supply chain more from a resilience perspective. And we will make use here of local or global foundries, but local sites in China in order to serve here also the customer in that regard.

Sorry, I forgot one aspect of your question. If you would take automotive ex MCU, it will probably be flattish this year. So the particular growth is coming from the MCU side of it.

[Alexander Foltin, executive]

All right. Now it's time to wrap up. Thank you, all, for your questions. We are now concluding our fiscal second quarter conference call. For further questions, please do feel free to contact us, the IR team here in Munich. Take care, and have a good day as well as the rest of the week. Bye-bye.