Infineon Technologies AG

XETRA:IFX

Earnings Call Transcript 2021-Q3

[Operator]

Everyone, welcome to the conference call for analysts and investors for Infineon's 2021 Fiscal Third Quarter Results. Today's call will be hosted by Alexander Foltin, Executive Vice President, Finance, Treasury and Investor Relations of Infineon Technologies. As a reminder, today's call is being recorded.This conference call may contain forward-looking statements based on the current expectations or beliefs as well as a number of assumptions about future events. We caution you that statements that are not historical facts are subject to factors and uncertainties, many of which are outside Infineon's control that could cause actual results to differ materially from those described or implied in such statements.Listeners are cautioned that Infineon's actual results could differ materially from the results anticipated or projected in any of these statements, and they should not put undue reliance on them. For a detailed discussion of important factors that could cause actual results to differ materially from the statements made on this conference call, please refer to our quarterly and annual reports available on our website.At this time, I'd like to turn the call over to Infineon. Please go ahead.

[Alexander Foltin, Head of Investor Relations]

Good morning, and welcome, ladies and gentlemen, to our 2021 fiscal third quarter earnings call. As usual, the entire management board of Infineon is on the call Reinhard Ploss, CEO; Helmut Gassel, CMO; Jochen Hanebeck, COO; Constanze Hufenbecher, CDTO; as well as Sven Schneider, our CFO.You are familiar with our usual procedure. As last time, Reinhard's summary will come after the Q&A, so please stay tuned until the end of the call. The illustrating slide show, which is synchronized with a telephone audio signal, is available at infineon.com/slides. After the introduction, we will be happy to take your questions kindly asking that you restrict yourself to 1 question and 1 follow-up. 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.Now Reinhard, over to you.

[Reinhard Ploss]

Yes. Thank you, Alexander, and good morning, everyone. The general market picture in our business situation continue to look very positive. Demand is by far outstripping supply. Shortages exist across the majority of end markets and in many product categories. Reopenings of economies in various countries, coupled with enormous stimulus programs, provide a healthy tailwind. Structural semiconductor content growth opportunities come on top. Capacity constraints, however, remain the limiting factor.Besides the general current imbalance between demand and supply, there are company-specific incidents. Infineon is not immune from such disruption. As you know, in February, an unexpected winter storm had hit our front-end fab in Austin, Texas. The resulting production stop had a negative impact on our margin in the March quarter and furthermore, led to lost revenue in the June quarter as predicted.Meanwhile, we have reached pre-shutdown output levels again at our Austin site. However, recently, our back-end site in Malaysia has also been affected by a disruption. After the state of Melaka experienced several phases of COVID-19 infection spikes, the local government authorities ordered shutdowns at short notice at the beginning as well as at the end of June.Infineon has been applying comprehensive protective safety and hygiene measures for employees ever since the beginning of the pandemic. In recent weeks, we have carried out a comprehensive vaccination campaign, which has helped us get fully operational again in the meantime. However, the shutdowns, including preparation and ramp-up, have been reducing our output since early June, and it will take until later this month to be back at 100% output. This means there has been a sizable impact in the third quarter, and we expect a similar one in the fourth quarter of our fiscal year as well. We will quantify the magnitude in a moment and in our outlook respectively. We are clearly striving to limit these impacts on our customers through compensatory measures like using inventories, but this is not completely possible in times of severe allocation. In this context, I would like to express my sincere gratitude to our teams who are grappling for months with every challenging conditions.Let's take a closer look at our fiscal third quarter in which we performed strongly. We recorded revenues of EUR 2.722 billion, slightly up from the previous quarter. The general foundry scarcity and the already mentioned manufacturing disruption were headwinds to our growth. Revenue loss in the June quarter due to the Austin incident was a mid-double-digit million amount, which we had already factored in our guidance.On top came the unforeseen negative impact from the Melaka disruption, which amounted to a high double-digit million euro amount, affecting predominantly automotive and power and sensor systems. The year-over-year comparison is a reminder of how quickly things have turned since last year's peak of the coronavirus pandemic. Our revenue is up 25% over the June quarter of 2020, which was the first one as we consolidated Cypress but only for 10 out of 12 weeks.The segment result for the quarter under report amounted to EUR 496 million, leading to a segment result margin of 18.2%. Also here, it is fair to say that our performance was limited by the burden of the Austin and Melaka shutdowns. Sven will have more details in his part.Before coming to our divisional overview, let's spend a moment on the book-to-bill ratio. On a like-for-like basis, the figure has further increased to 2.4 at the end of the June quarter from a 2.1 at the end of the March quarter. The order intake continues to be very strong. In fact, we have temporarily switched to manual and shorter-term order confirmation to optimize our ability to match the dynamic demand with scarce production capacities. As this will distort our reported book-to-bill figure, we have adjusted it assuming the same confirmation rate of newly received orders as in the previous quarters. Currently very strong business momentum can also be seen from our overall backlog, confirmed and unconfirmed orders as well as customer forecasts. These have grown quarter-over-quarter by about 1/3 and is now standing at a close to 2 years revenue.Now to our divisions. Supply constraints clearly left a dent in the top line of automotive, in particular, the Austin and Melaka incidents. Revenues came in at EUR 1.205 billion in the June quarter, 1% down sequentially despite significant demand across all product areas. At the same time, the profitability level was preserved. The segment result amounted to EUR 199 million, equivalent to a segment result margin of 16.5%, a quite similar level as in the previous quarter.The book-to-bill ratio remained at a high level of 2.3 on a like-for-like basis. The rebound of global car markets continues to be hampered by acute supply limitations across the entire value chain. Semiconductor shortages have not yet been elevated. Inventories are extremely tight and end demand is being postponed. All in all, it will take time to get back to a supply-demand equilibrium. In our view, this will take until well into 2022. Within an overall restrained car market, the adoption of electric vehicle is remaining on a strong trajectory. Sales of battery electric and plug-in hybrid vehicles were up once again in the June quarter to their highest quarterly level yet around 1.5 million vehicles, some 25% more than in the previous 3-month period. Regulation continues to be one driving force through not only the -- only one.Take Europe as an example. The EU commission is proposing a further tightening of CO2 emission rules and the requirement for 100% of new car sales in the EU to be zero emission by 2035. Many OEMs have already publicly communicated to reach this goal sooner. With our fully scalable solutions, be it they silicon or silicon carbide based, we stand ready to enable the accelerating transition to electro-mobility.Regarding silicon carbide, we are very pleased to see our claim of outsetting performance and quality confirmed as customers are adapting their decisions about allocating business in our favor. Furthermore, we have cars become smaller and are happy to report a major platform win at a leading European Tier 1 with AURIX and TRAVEO microcontrollers for a broad variety of applications with a 3-digit million euro lifetime revenue.Now over to Industrial Power Control, which had an excellent quarter with all-time high revenues of EUR 412 million, a sequential increase of 14%. All application areas contributed to this strong growth, in particular, industrial drives and renewable energies. The segment result expanded to EUR 82 million, corresponding to a segment result margin of 19.9% after 16.3% in the quarter before. The comparable book-to-bill figure upticked to 1.8 at the end of the June quarter from 1.6 in the prior quarter indicative of continuous business momentum. This is consistent with macro indicators and application-specific forecasts pointing to continued growth momentum ahead.For industrial drive, recoveries ongoing, driven by robust business optimism. Renewable energy installations need to go up significantly and over extended periods of time in order to meet CO2 reduction targets, which various countries are bringing forward. Furthermore, energy storage system, EV charging infrastructure as well as power efficient home appliances are needed to support the energy transition. In other words, we see key structural drivers completely intact, including strong uptake of our silicon carbide solution. Regarding the overall silicon carbide revenue target of around EUR 170 million for this fiscal year for Infineon, we are well underway.Let's now come to Power & Sensor Systems. The segment's revenue decreased by 4% compared to the previous very strong quarter and came in at EUR 757 million. The decline was caused by 2 factors: a temporary drop of demand for RF and sensor components for smartphones; and secondly, supply limitations resulting from constraints at our Austin and Melaka fab as well as at external contract manufacturers.Meanwhile, demand remains very strong across the entire range of power products from server power stages to MOSFET and ICs for battery-operated tools. The segment result for PSS for the June quarter decreased to EUR 167 million, equivalent to a segment result margin of 22.1% in line with the revenue decrease. More than half of our products are currently on allocation and inventory sit below normal levels. Demand remains very strong, and we are limited in our ability to serve incoming customer orders. Like-for-like, our book-to-bill ratio moved from 1.9 at the end of the March quarter to 2.5 at the end of the June quarter. Currently, everything that is being built is getting shipped and sold to end customers.With respect to the current quarter, we see supply conditions improving and also expect a snapback in the area of mobile handsets. This will bode well for our MEMS microphone business, where market data for 2020 is showing that we have extended our global #1 position. We continue to see good design win traction here in phones, in adjacent headsets and in new fields like conference phones. Another area we are excited about is data centers, especially those related to cloud computing. The need for high density, high efficiency power solution brings considerable structural growth opportunities, for example, for AI training systems. We are having encouraging discussions with high-performance computing leaders who value our ability to offer complete solutions like the entire DC-DC power distribution for a multi-kilowatt system. Key selling points are: the efficiency of our components resulting in unrivaled power density; a super slim form factor achieved by innovative packaging technology; and above all, a deep understanding of customer needs at system level.Now to Connected Secure Systems, which recorded revenues of EUR 346 million. The 5% quarter-over-quarter increase was driven by some limited supply improvements on the one hand, and higher project business in identity solution on the other hand.On the higher revenue, the segment result of CSS increased to EUR 47 million. The segment result margin improved to 13.6% after 9.1% for the quarter before, which had been burdened by some negative factors like charges related to the Austin weather incident. Generally speaking, supply constraint prevail over brisk demand for general purpose microcontrollers, WiFi and Bluetooth components and security solutions. Reflecting this imbalance is the staggering book-to-bill ratio of 3.4 for the June quarter, up from 3.1 in the quarter before.Meanwhile, the proliferation of small and connected device is leading to an ongoing design win momentum. Our connectivity chipsets have been selected for new infotainment platforms by major automotive OEM as well as for key sockets in next-generation smarthome and smartwatch devices. In microcontroller, we have achieved a key design win at a leading OEM for power tools. On the security side, we have announced a reference design for the next-generation biometric smart card architecture together with the Norwegian biometric specialist IDEX. It enables fingerprint authentication with low latency, high accuracy and power efficiency. The integration of the fingerprint sensor, the secure element, power management and communications reduce the complexity of car manufacturing, which shortens time to market and lowest cost.Now over to Sven, who will comment on our key financial figures.

[Sven Schneider, CFO & Member of Management Board]

Thank you, Reinhard, and good morning, everyone. Let me start with our margin development. Gross profit in our fiscal third quarter came in at EUR 1.65 billion, resulting in a gross margin of 39.1%. Excluding non-segment result effects, the adjusted gross margin improved by 250 basis points to 41.8%, up from 39.3% in the previous quarter, which had been negatively impacted by charges related to the Austin power outage. Having said this, Reinhard already mentioned in the beginning that revenue and margin in the June quarter have been affected by the shutdowns in our Austin and Melaka sites. These effects have cost us around 1.5 percentage points of gross margin, evidence of healthy underlying profitability.Research and development expenses went up to EUR 376 million from EUR 341 million in the previous quarter. Selling, general and administrative expenses increased to EUR 342 million from EUR 328 million. R&D expenses included EUR 6 million of nonsegment result charges, SG&A expenses EUR 60 million. The net other operating income was nil containing minus EUR 9 million of nonsegment result charges. In total, the nonsegment result for the quarter amounted to minus EUR 149 million, a typical current run rate.The financial result for the June quarter was minus EUR 56 million after minus EUR 42 million in the previous quarter. Income tax expense amounted to EUR 49 million for the third quarter of the current fiscal year, equivalent to an effective tax rate of 17%. We expect this rate to come in below 20% for this fiscal year.Cash taxes in the June quarter amounted to EUR 44 million, resulting in a cash tax rate adjusted for PPA effect of 11%. For the current fiscal year, we expect this rate to be around 15%, primarily as a result of the existing German tax loss carryforwards. We expect to benefit from tax loss carryforwards for another -- for around another 4 to 5 years during which time the cash tax rate will be lower than the effective tax rate.Our investments into property, plant and equipment, other intangible assets and capitalized development costs in the June quarter amounted to EUR 285 million, down from EUR 332 million in the quarter before. We expect to see a significant increase in the September quarter. Quarterly depreciation and amortization, including also acquisition-related nonsegment result effects were EUR 380 million after EUR 368 million in the preceding quarter.In terms of free cash flow from continuing operations, we once again saw a strong print with EUR 477 million compared to EUR 407 million for the March quarter. Dampening this improvement, our own inventories increased to a large extent, driven by higher raw materials and work in progress stocks, which accumulated due to constrained back-end capacities. Furthermore, certainly, not all of our products are on allocation. Thus, we slightly increased inventories in specific areas like high-voltage switches.In the last quarter, I had mentioned the signing of a USD 1.3 billion U.S. private placement as another chapter of the successful Cypress refinancing. In the meantime, we have drawn the funds as planned and use them to pay back a corresponding amount of the outstanding bank term loans well ahead of maturity. By doing so, we have further extended and smoothened our maturity profile, details of which you can see in our Investor Relations presentation.Our gross cash at the end of June stood at close to EUR 3.9 billion. Our gross debt amounted to EUR 6.8 billion leading to a further reduced net debt figure of EUR 2.9 billion. Our leverage ratios improved noticeably from the last quarter. Net leverage at the end of June stood at 1.1x compared to 1.5x 3 months ago. Gross leverage improved from 3.1 to 2.6x driven by increased EBITDA. Our reported after-tax return on capital employed, or ROCE, stood at 7.3% for the third quarter. Excluding bookings related to the acquisition of Cypress and International Rectifier, in particular, goodwill, fair value step-ups and amortization as well as deferred tax effects, the adjusted ROCE was around 27%, once again clearly exceeding our cost of capital.Now back to Reinhard again, who will comment on our outlook.

[Reinhard Ploss]

Thank you, Sven. At the beginning, we spoke about the imbalance between supply and demand caused by a cyclical tailwinds and structural factors. In our view, this imbalance will persist for quite a while. In the large majority of our end markets, we see that demand is delayed in the light of current capacity tightness. Inventories remained low and restocking to presumably higher than pre-pandemic levels has not yet started.Supply limitations, on the other hand, remain pervasive, in particular, regarding foundry capacity at mature nodes. For product that we manufacture in-house, especially power and sensors, the picture looks somewhat brighter. But given the significant content growth opportunities, we expect demand to continue to outstrip supply. Against this backdrop, we anticipate revenues to come in at around EUR 2.9 billion for the running fourth quarter of our 2021 fiscal year. In this figure, we consider a revenue loss related to production constraints in Melaka of around EUR 100 million. This will mainly impact ATV. Here, we expect a more or less flattish revenue development. Also IPC should see stable revenues. For CSS, we expect a slightly positive revenue progression at -- as some specific supply constraints are gradually easing.Finally, we anticipate PSS to post strong growth, mainly due to the seasonal strength in smartphone components. At the guided revenue level, segment result margin is expected to be around 19%, mainly driven by higher revenues.The outlook for the full 2021 fiscal year as a consequence of our Q4 projection is as follows: revenues should be around EUR 11 billion, with a segment result margin of 18% plus. Our projected investments in property, plant and equipment, other intangible assets and capitalized development costs in the 2021 fiscal year remain unchanged at around EUR 1.6 billion.For depreciation and amortization, we continue to expect a value between EUR 1.5 billion and EUR 1.6 billion, including amortization of around EUR 500 million resulting from the purchase price allocation for Cypress and to a lesser extent still related to International Rectifier.Strong operating performance will be reflected in our further increased free cash flow, for which, we now estimate a value of around EUR 1.5 billion. To save the best for last, we are very happy to report that we have again pulled in the next important milestone at our new 300-millimeter fab in Villach. Right today, it is ready for production. The first wafer starts will now occur and we plan an official opening ceremony in mid-September when such wafers are finished and ready for back-end processing. The capacities created by this milestone project will help us to address faster-growing power semiconductor applications even better.Before opening the call for Q&A, let me quickly remind you of our Capital Markets Day scheduled for early October now precisely the 5th. As you would expect, we are taking into account the latest advice and guidance as well as recent developments regarding the spread of the coronavirus before we make a decision on the format. Preferably, we would very much like to meet you all in London again. However, we have to keep the option for a virtual format open.Let's now come to your questions. At the end of the Q&A, I will summarize the key points. With this, Alex.

[Alexander Foltin, Head of Investor Relations]

Operator, please open for Q&A.

[Operator]

[Operator Instructions] And we will take our first question from Johannes Schaller from Deutsche Bank.

[Johannes Schaller, Research Analyst]

Given that the demand picture at the moment is, I think, relatively well understood, and you have a lot of your capacity planning already in place, I presume also for next year. Could you maybe give us a little bit of a sense, maybe a broad corridor in terms of potential capacity outcomes for Infineon next year? I think that would be quite helpful.And then as a second question, just in terms of lockdowns, we're obviously seeing corona spread again in China. How do you look at the situation there? Are you reasonably confident that you have in your back-end facilities, for example, the preparations in place to keep those fabs running in this the situation may be worsens? If you could give us a quick update here.

[Reinhard Ploss]

Yes. Thank you, Mr. Schaller. So the capacity planning, which we have currently in place, a lot of the investments we have made this year will come online next year. Maybe Jochen can give some flavor on it. And -- but I think here, still the investment, especially for back end will continue to go, and this will also become effective, which we cannot give guidance at the moment, as we match it with the structure and the demand. Jochen, please.

[Jochen Hanebeck, COO & Member of Management Board]

Yes, Mr. Schaller, hello from my side as well. You know we have invested this year in other major facilities. We intend to increase our CapEx budget for next year as well, but this will be part of the overall guidance in November. But you can count on more output in that part. And as Reinhard pointed out, the facility in Villach comes on stream right now. So perfect timing. Market is strong. We can serve better.With respect to your second question, corona in China, you may know that we have also 1 facility in Wuxi. We are currently making high efforts to vaccinate our colleagues, especially in Southeast Asia, also in China. And I can tell you that we have achieved a level of higher than 80% in all facilities on the first vaccination except for the Philippines yet. And we expect all colleagues to get the second vaccination then, of course, on a voluntary base in this month, so from September onwards, we should be fine.

[Reinhard Ploss]

Generally speaking -- sorry, please.

[Johannes Schaller, Research Analyst]

I was just wondering if I could maybe ask a quick follow-up on the foundry side of your capacity equation. I think some of your competitors were very happy with the foundry allocation they got into H2 and next year and others were maybe not as happy. So if you could maybe give us a quick update on that as well.

[Jochen Hanebeck, COO & Member of Management Board]

Yes. It's obviously a hot topic, the foundry supply situation. You know that all foundries are expanding capacities, that takes time depending on whether there is clean room space available or whether new clean room space where it needs to be built, that will take typically 2 years. Now with respect to the foundry allocation, it depends a little bit on which -- on what sort of setup you have in areas where there's a single-source situations and a, let's say, high value-add market, the foundries serve customers and also serve us with a rather higher share of the demand in areas where it's multisource, so meaning 1 or more foundries or partially overlapping with internal capacities this, let's say, share of demand served is lower. In general, I think we have good relations with all foundries and we are in constant discussion here to not only reserve capacities for next year, but in areas where we are in single-source mode to really go for multiyear agreements.

[Operator]

Our next question comes from Sandeep Deshpande from JPMorgan.

[Sandeep Sudhir Deshpande, Research Analyst]

I have a couple of questions. Firstly, my question is on capacity again, you've got your Villach fab ramping up starting later this year. Can we understand what kind of product you will be able to put into that fab given that historically, automotive qualification takes time and you're under allocation in automotive, but will that fab be able to supply the automotive customer base? And how quickly do you expect to ramp up that fab through the next 12 months or such? So could we expect significant capacity from the fab to the rest of this -- through the next fiscal year? And then I have a quick follow-up on the automotive market.

[Reinhard Ploss]

Yes. So the first one, of course, is Jochen's curve and then most likely Helmut with the automotive market.

[Jochen Hanebeck, COO & Member of Management Board]

Sandeep, this is Jochen. So on the Villach facility, this is a much easier ramp than the one in Dresden. You may know that we have developed the 300-millimeter technology in Villach. So there was always a small line available in Villach, and we only scale it up. And therefore, yes, we can create revenue basically from September onwards because we start today, the first wafers in the new facility will create revenue than beginning of this next fiscal year. And now we are in a situation basically where we can accelerate the ramp if -- according to the market, of course, in both facilities, Dresden and Villach, and therefore, we are very well positioned in this portfolio covering power discretes for all related end markets, MOSFETs, IGBTs, high voltage. And there's no special qualification required in that regard for automotive because the products are already qualified in this small facility.

[Sandeep Sudhir Deshpande, Research Analyst]

Understood. Then just quickly following up on the automotive market. I mean, can you give us an update on what sort of revenues you expect on EV hybrid-related autos this year? And given your supply constraints, do you believe you're maintaining your market share? Or is there some impact on market share from the supply constraints that you're facing at this point?

[Helmut Gassel]

Yes, Helmut Gassel. Sandeep, automotive market, we see extremely strong momentum on the battery electric and plug-in hybrids. When you compare first half year '21 with first half year '20, volume increased by 160% globally. So very steep recovery in the second half of '20 momentum carrying on in '21. We expect total volume for the full year of '21 as compared to '20 to be around 60%, north of 60% potentially, and we do expect our revenue also to grow comparatively in the ex EV market. So this, I'd say, shows very strong momentum and us keeping more or less essentially market share. We're not -- I'd say, black and white, not capacity constrained in the xEV market.

[Reinhard Ploss]

And also, we will see some effects that some of our -- in this market, we had a situation where there was a Japanese OEM who has a captive situation. And now, of course, with the growth of others, we see this being positive for us.

[Operator]

The next question comes from Didier Scemama from Bank of America.

[Didier Scemama]

First, I would like to go through the book-to-bill. Maybe if you could elaborate a little bit on the duration of your orders in the backlog. Obviously, the book-to-bill is in uncharted territory, and we hear from virtually all your competitors that they're now seeing and signing long-term non-cancellable orders and contracts with automotive, industrial and even some consumer customers. So I just wondered if you could elaborate a little bit to put in perspective this book-to-bill, whether you are seeing effectively your capacity being booked already through calendar year 2022.And related to that, I just want to go back to the question that was just asked by Sandeep. As we exit fiscal year '22, so 12 months from now, how much of Villach will be sort of utilized or ramped up, I should say, given the current demand environment? And I've got a follow-up.

[Reinhard Ploss]

Yes. Thank you, Didi, for your question. I hand over the first one to Helmut and the capacity the home term of Jochen.

[Helmut Gassel]

Yes. So book-to-bill came in at 2.4 like-for-like basis, wherein CSS is slightly higher and IPC industrial is slightly lower, but all of them are well above 1, automotive and PSS more in line. We have an order book that represents approximately 2 years of revenue. We, of course, expect there to be in some double ordering, which is as always impossible to quantify. But that shows that we have a very, very strong momentum. This order book increased by 30%, 3-0%, in the June quarter. So unbroken, very strong demand coming in from the market. We also see that the distribution inventory is at record lows. All our customers are extremely tight. So yes, I do believe that the market shows continued momentum well for the year.

[Jochen Hanebeck, COO & Member of Management Board]

So on the capacity question, and this is installed capacity, not now revenue yet. But at the end of the fiscal year, it's maybe in the range of 25%. So we are ramping the facility over a 4 to 5 years' time frame. But of course, we can accelerate or decelerate depending on market requirements.

[Didier Scemama]

I just wanted to understand that a little bit, are you constrained by the supply of equipment and lead times of equipment? Or what's the problem, given the book-to-bill and the order intake, I think in the last 9 months, you booked orders more than EUR 10 billion. So I just wondered why would you not ramp the Villach fab faster than the current schedule you just mentioned?

[Reinhard Ploss]

Didier, you have to put this into the various buckets. One, we mentioned is the biggest challenge is the supply from the foundries where we have the most constraints and the biggest challenges. The ramping for Villach and the power factories has already, I would say, we continued even last year during the weaker situation to add capacity. And we also reported that in this area, we are much better off. Maybe Jochen can give additional flavor to this and also comment on the availability of equipment.

[Jochen Hanebeck, COO & Member of Management Board]

Yes. The typical lead times in front end once you have a clean room is like 12 months. And therefore, we have ordered already most of the equipment, which will come on stream for next year. And yes, the equipment market is tight. We see some areas with prolonged lead times. But given the fact that we have the 2 facilities to ramp, I think this market, we can serve pretty well.

[Operator]

Our next question comes from Amit Harchandani from Citi.

[Amit B. Harchandani, Director & Head of EMEA Technology Research]

Amit Harchandani from Citi. Two questions, if I may. My first question goes back to the topic of gross margins and pricing. Looking at the gross margin evolution quarter-on-quarter and even if we quantify and try to take out all the puts and takes, it does suggest a healthier pricing environment. Could you kindly confirm if it is turning out to be better than anticipated? And how are you addressing that in terms of pricing as you negotiate with your customers? And also potentially pricing in terms of what your own suppliers are charging you, so any comments around pricing would be helpful.And secondly, if I may, on the free cash flow side, we have seen some healthy cash flow from operations dynamic in the last quarter and this quarter. Could you give us a sense for what's happening on the working capital side? How sustainable is this level of free cash flow conversion as we think about going into next year and beyond?

[Reinhard Ploss]

Thank you, Amit. So the first question will be jointly answered by Sven, Helmut and Jochen and the cash flow, of course, is Sven's home turf.

[Sven Schneider, CFO & Member of Management Board]

Yes. Amit, maybe I'll start with the free cash flow, then I go to the gross margin and hand it over to Helmut. So on the free cash flow, Amit, yes, it's a very good development over the course of the last quarters, as you just confirmed, which is a combination of a couple of effects as we have communicated earlier in this year. On the one hand, it's the increased fall-through from the revenues and the profitability increase. On the other hand, it's the very low inventory and working capital levels. And also, the fact that we kept the investment levels at around EUR 1.6 billion. I think we also explained that because of the increased lead times, it was not possible to pull in even more invest into the fiscal '21.Now -- and I fully understand that you are all very much focusing on '22, we don't want to give too much guidance here for the new -- next fiscal year. But let me make 1 comment, if you just take into consideration the fact that we confirm that there will be more invest to come in '22 compared to '21 and that we expect over the course of the fiscal '22 that some inventory buildup will happen in the channel and in our own inventory, this, I think, gives you some indication to the direction of the free cash flow going forward. Of course, the positive effect on the free cash flow will be -- if the growth continues and the fall-through comes. That's the free cash flow.On the gross margin, again, it's a combination of various elements. Firstly, it's the revenue fall through. There is also the component of a better, a more profitable product mix and structure mix. You know we are targeting P2S, so product to system solutions, which have a higher value contribution, and there's also some pricing component in it. And with that, I would hand over to Helmut.

[Helmut Gassel]

Yes. On the -- Amit, on the pricing side, we have actually risen our average selling price, and that's for 3 reasons: number one is we have a better product mix; number two, we have a higher share of product to system solutions business; and we have some price increases that already come into effect or have come into effect in the June quarter. On pricing, we generally have said before and we repeat this year, we honor our contracts that we have worked with our customers, and we have a comparatively high share of annual volume purchasing agreements with our customers. So pricing effects will become to be more effective in the 2022 time frame.I hand over to Jochen.

[Jochen Hanebeck, COO & Member of Management Board]

Yes. And from the positive side of Helmut, it's partially compensated, but only partially compensated by supplier price increases. We are focused in procurement completely on security of supply. And here, we see, of course, certain markets being very tight. We mentioned already the foundry part, but also certain base material copper namely, other raw materials, and this will come into the P&L over time, mainly '22.

[Amit B. Harchandani, Director & Head of EMEA Technology Research]

So just to clarify very quickly on the last set of comments. The pricing benefits from your customers as well as the pricing headwinds from your suppliers both are similar in terms of timing and would be felt starting 2022. Is that correct?

[Reinhard Ploss]

Yes, that's broadly correct, Amit.

[Operator]

[Operator Instructions] Our next question comes from Matt Ramsay from Cowen.

[Matthew D. Ramsay, MD & Senior Technology Analyst]

I wanted to dig a little bit deeper into the gross margin, Sven. The first part of the question is, I think I heard in your prepared script that there was an additional 1.5 points of gross margin headwind absent some of the near-term challenges in Malaysia and Austin. I just want to make sure that that's right. And then secondly, given all the dynamics we've talked about in pricing in prior questions, do you guys feel like this gross margin level that you're seeing now is sustainable going forward? And are we sort of at a new floor in gross margin?

[Sven Schneider, CFO & Member of Management Board]

Yes. Matt, it's Sven here. So first of all, you are right. The headwind of 1.5 percentage points would have come on top without the Melaka and Austin impact. One other thing to bear in mind, if you compare the gross margin development from Q2 to Q3 is that, in Q2, we had the burden of the Austin impact on the profitability, but no impact on revenue. That's also something to take into consideration if you compare. And I think the other things we mentioned, it's a combination of the factors we just highlighted. Now going forward, again, without guiding beyond the end of the fiscal year, but looking at Q4, I don't see a reason why the current gross margin should not be at a comparable level in Q4 as well.

[Matthew D. Ramsay, MD & Senior Technology Analyst]

Just a really quick follow-up. You guys were kind enough to quantify the revenue impacts from Austin and also Malaysia in the results and the guidance. I wonder if you look forward into fiscal '22, I know you don't want to guide anything yet, but should both of those situations be essentially resolved as you see it now? And obviously, you're still going to be chasing demand as your supply ramps. But specific to those 2 situations, should there be any impact into the first quarter [ of next fiscal year? ]

[Reinhard Ploss]

No. Specific to those 2 events, we have vaccinated all colleagues by then, as I mentioned before, and Austin, hopefully is a onetime event. But of course, the supply chain is very instable these days. We have the flooding in Germany. So there are always surprises. But for those 2 events, I can confirm.

[Operator]

We will now take our next question from Francois Bouvignies from UBS.

[Francois-Xavier Bouvignies]

My first question quickly is a follow-up on the gross margin. So if we look at beyond fiscal Q4 and the Villach coming online, should we expect any underlying changes from charges coming up as you ramp into this fab, just to get the driver there? And the second question is a bit more around the capacity and a bit more long term. So if you think that Villach you said it's going to take maybe 4 to 5 years to fill it in, and in light of the strong demand environment, I was just wondering with the lead time it takes to have a new one, are you thinking about new one already in light of the very strong demand and supply constrain? Is it in the thought process at the moment?

[Reinhard Ploss]

Thank you, Francois. So Jochen already explained it and will go into more detail, but the situation with the Villach is completely different than the one with Dresden, as we have not a long period of qualification and transfer. Jochen, how does it look like?

[Jochen Hanebeck, COO & Member of Management Board]

Yes. As I mentioned before, we intend, according to our long-term demand planning, to fill the facility in Villach around 4 to 5 years. We have also still space to grow in Dresden. But of course, as we are a long-term planning company, we have some thoughts about potential further expansion, which we will then announce in due time.

[Sven Schneider, CFO & Member of Management Board]

Yes. And then your question, Francois, regarding gross margin again. So if we think about the next year and if we are all right with the market expectation, I don't think that the underutilization charges of the Villach ramp should be an issue. You are aware that we are always having some kind of structural idle, which we always have. This year, we will come out slightly above that level. Given now the Melaka situation where we also have some back-end idle, but for next year, the Villach ramp will not add to any idle from today's perspective. The only thing which will, of course, come on stream from now on, being included in the gross margin is the depreciation, but that is, I think, something you know. And just one additional word on the profitability level, at gross margin level, you are probably also all aware that the Cypress acquisition is also accretive in that respect.

[Operator]

Now take our next question from Janardan Menon from Liberum.

[Janardan Nedyam Menon, Technology Analyst]

So I just want to understand on your capacity planning internally based on your comments just now. So am I correct in understanding that based on your current order book, which is very strong for the next 2 years and your capacity which you're bringing on board at Villach and other sites over the next sort of 15 months that you don't think you will be capacity constrained on your internal products, power discretes and other products that you do internally into FY '22? Or is there -- is it that even with this, you could continue to be capacity constrained? What I'm saying is, is the capacity constraint now going to be predominantly from the foundries rather than internally?

[Reinhard Ploss]

Janardan, thank you for your question. And basically, you're right, the constraints will be dominantly from foundry in-house. Of course, we will see some structural effects because, of course, there may be the one or other bucket that changes shorter term, and we cannot supply fully. But our strategy in order to provide capacity here is, I think, very much forward-looking. Jochen some additions to that? No.I think here, so fully agreed in power should be -- and sensors, we should be fairly balanced with the demand and we even can accelerate further. But as Jochen stated, additional capacity due to the lead time of equipment might take some time, but we are in an excellent position about the clean rooms. So here, I believe, we will, I would say, being able to manage the demand.

[Janardan Nedyam Menon, Technology Analyst]

And as a follow-up, could you just give us an update on your silicon carbide design win trends in the automotive side. Since you haven't announced an additional design win, I presume you haven't got that as yet. But what is the market like? Is there still a lot of tenders out there, which you are bidding for? And can we expect more wins over the next 6 to 12 months?

[Reinhard Ploss]

Yes. Helmut, what about?

[Helmut Gassel]

Yes. First of all, I'd say silicon carbide, we're seeing very strong growth here -- growth, strong growth in this year. We expect to double our revenue. Most of that is not coming from automotive yet. On the automotive side, yes, continued very strong momentum on the design activities. Nothing to report for this quarter, but please stay tuned.

[Operator]

Our next question comes from Aleksander Peterc from Societe Generale.

[Aleksander Peterc, Equity Analyst]

I just like to come back a little bit on -- I know it's a bit late now to talk about the current year CapEx budget. But you did increase it from initially 1.4 to 1.5 to currently 1.6, that's a small increase and it's a standard against your free cash flow guidance, which basically doubled versus what it was at the beginning of the year from EUR 700 million to EUR 1.5 billion. I'm just wondering, is it right to prioritize so strongly free cash flow over CapEx in a period of such severe shortages across the industry? That was just my first question. And I'm sure you correct that next year with a bolder CapEx guidance, but just a little bit of color on that.And then secondly, are there any market areas where your market share might have eased as a result of the supply issues that you have faced and which products are those?

[Reinhard Ploss]

Yes. So Alexander, thank you for the question. Basically, the message is pretty simple. We do not prioritize CapEx over free cash flow. But there are some, I would say, special aspects, Sven will go into.

[Sven Schneider, CFO & Member of Management Board]

Yes. Alexander, thank you for the question. And I think it's a great question, but we should also be fair and look back to 1 year ago where we were all coming out of a COVID year with a bit of an uncertainty in how markets and this situation develops. At that time, we got a lot of questions, do really need all that investment and what about your free cash flow. I think for us, it is important, as mentioned before, we have a mid- to long-term view and we want to find the right balance between the different KPIs. CapEx is very important for our future growth. Free cash flow is also very important given the fact that we just did the biggest acquisition in history and we have made a deleveraging commitment, where, by the way, we are probably ahead of our plan. So it's a balance between the 2. And as I said earlier, let's say, a couple of months ago, we would have loved to pull in more CapEx into that year. But given the increased lead times, it will now come the new CapEx in '22. So it's the right balance you have to find. And I think we have good -- made a good choice, but it's not prioritizing the one over the other.

[Reinhard Ploss]

And very clear to add to this, the strategy for the company is to having the capacity around the 9% plus growth, which in some buckets is significantly higher as we see currently. And we always had some headroom which I think here, as Sven already mentioned that we have some structural idle. So we are believing very strongly that you should have enough capacity to avoid a location because that is distorting everything so much. And we see a huge opportunity with our power and sensor products to grab more market share, and we will do. Unfortunately, we do not have the same control on the foundry side.

[Operator]

Conscious of time, we have time for 1 last question from David O'Connor, Exane BNP Paribas.

[David O'Connor, Analyst of IT Hardware and Semiconductors]

Maybe just squeezing in one last one, Reinhard. On the foundry side, you've articulated that it's the biggest bottleneck. Just wondering what does the path towards normalization look like on the foundry side? Set against your comments of supply and demand remaining in balance through 2022, yet at the same time, you expect powered sensors more of a balance coming there earlier, it sounds like in 2022. But if you could just focus or highlight on the foundry side, when we can expect the kind of a significant step up there and that's coming back into balance?

[Reinhard Ploss]

David, thank you for your question. I think Jochen already commented on here, the, I would say, legacy Infineon situation is that we have a very good for the majority of our product relation to the suppliers and have a reasonable supply situation. We have had a discussion with them and even involved a lot of the automotive OEMs and so on, understanding the demand, and they have understood that they have to invest in the more mature and differentiated nodes. While for the legacy Cypress business, we still have to catch up in the structure and the way how we are dealing with the foundries. Maybe Jochen, you can add a little bit more to that.

[Jochen Hanebeck, COO & Member of Management Board]

Yes, your question path to normalization. So our products are mainly in competition in those nodes, 28 to 90 nanometers, particularly 65 and 40 nanometers. And the competing markets are here, the consumer communication markets, in particularly the smartphone. So any normalization or better -- dramatically better access to capacities in the foundry place, no matter whether you are independent of which foundry you're talking about depends pretty much on the smartphone market. Here, we have -- you have products in the smartphones like LCD drivers, OLED drivers, like CMOS imagers, which are in competition. And therefore, we are watching this market very closely.

[Operator]

With this, I would like to hand the call back over to Infineon for any additional or closing remarks.

[Reinhard Ploss]

Yes. Thank you. So let's summarize. Despite 2 force majeure incidents in Austin and Melaka, Infineon concluded a strong third quarter of its 2021 fiscal year. We recorded above EUR 2.7 billion of revenue, an 18.2% segment result margin and EUR 477 million of free cash flow. A strong cyclical background and an unchanged structural growth driver mean that demand continues to outstrip supply considerably. Many products are on allocation and inventories are low.In this context, we are very pleased that our second 300-millimeter fab in Villach as of today is ready for production. And with the additional capacities, it's comprehensive product portfolio and system expertise, Infineon is ideally positioned to shape and benefit from the 2 secular themes, electrification and digitalization. In addition, design wins achieved with the complementary products and capabilities from former Cypress are nicely supporting midterm business momentum.Based on a strong fiscal fourth quarter, we expect revenues for the full fiscal year 2021 to be around EUR 11 billion, with a segment result margin in excess of 18% and around EUR 1.5 billion of free cash flow.Ladies and gentlemen, this concludes our earnings call. Thank you for dialing in and your questions. Stay safe and healthy and have a good summer.

[Operator]

That concludes today's conference call. Thank you, everyone, for joining us. You may now disconnect.