意法半導體 (STM) 2013 Q2 法說會逐字稿

Ladies and gentlemen, good morning or good afternoon.

Welcome to the STMicroelectronics second quarter 2013 earnings results conference call and live webcast.

I am [Goren], the Chorus Call operator.

I would like to remind you that all participants will be in listen-only mode, and the conference is being recorded.

After the presentation, there will be a Q&A session.

(Operator instructions.) The conference must not be recorded for publication or broadcast.

At this time, it's my pleasure to hand over to Mr. Tait Sorensen, Group Vice President, Investor Relations.

Please go ahead, sir.

Thank you, Goren, and thank you to all for joining our second quarter 2013 conference call.

Hosting the call today is Carlo Bozotti, ST's President and Chief Executive Officer.

Joining Carlo on the call today are Georges Penalver, Executive Vice President and Chief Strategy Officer; Jean-Marc Chery, Executive Vice President and General Manager of the Embedded Processing Solutions segment; Mario Arlati, Executive Vice President and Chief Financial Officer; Carmelo Papa, Executive Vice President, Industrial and Power Group; Lorenzo Grandi, Corporate Vice President, External Reporting.

This call is being broadcast live over the Web and can be accessed through ST's website.

A replay will be available shortly after the conclusion of this call.

This call will include forward-looking statements that involve risk factors that could cause ST's results to differ materially from management's expectations and plans.

We encourage you to review the Safe Harbor Statement contained in the press release that was issued with the results last night and also in ST's most recent regulatory filings for a full description of these risk factors.

As a reminder, please limit yourself to one question and a brief follow up.

And now I'd like to turn the call over to Carlo Bozotti, ST's President and CEO.

Carlo?

Thank you, Tait, and thank you very much for joining us today.

Let me share some brief summary comments and then we'll go into detailed review of the quarter.

First, I am encouraged by the progress we are making with regard to each of the three objectives -- sales growth, gross margin improvement, and expense reduction.

With respect to sales growth, we had a strong quarter excluding our Wireless product line.

From a gross margin perspective, we came in above the midpoint thanks to manufacturing efficiencies and higher volumes.

And with regard to expense reduction, you can see the substantial progress quarter-on-quarter and compared to the year ago timeframe.

Second, we will discuss the product portfolio shortly, but here let me highlight the sales initiatives to strengthen our geographical coverage, greatly expanding our small to midsize customer base as well expanding our sales through distribution.

In the second quarter, distribution represented 26% of sales, up about 4 points from last year and some further improvement from the prior two quarters.

Our midterm goal is to move closer to 30%.

Third, while market uncertainty continues, we saw a progressive improvement in bookings in the second quarter, although we experienced a softening in the smartphone market also impacting ST products towards the end of the second quarter.

And fourth, we anticipate the ST-Ericsson transaction to close early August.

So, let's begin the detailed review with our second quarter sales results.

We delivered revenues in line with our outlook, with total revenues growing 1.8% sequentially to $2.05 million even with the 31% decrease in existing product sales at ST-Ericsson.

Net loss attributable to ST was $152 million, reflecting a one-time non-cash charge of $69 million on ST's equity value in 3Sun due to the impairment charges reported by the 3Sun joint venture.

We saw solid sequential sales growth of 6.8% in our product portfolio excluding the Wireless product line.

The increase came from several key areas.

Microcontrollers, Industrial and Power, Automotive and Imaging saw progress in both of our product segments, Sense & Power and Automotive, as well as Embedded Processing solutions.

Turning first to Sense & Power and Automotive products, revenues increased 7.3% sequentially.

Automotive had a good sequential sales evolution, and it was broad in terms of sales growth across all of the regions.

Second -- and the second half should see further progress for Automotive with a strong backlog thanks to our broader customer base and ST's increasing content within cars.

We also saw a good sequential progression for Industrial and Power products.

MEMS continued to grow sequentially, but was somewhat impacted by softness in the smartphone market.

Sense & Power and Automotive products' operating margin decreased to 3.5%, reflecting in part the wind down process for the ST-Ericsson joint venture as we assumed certain costs providing the activities for the people who will be moving to ST as we strengthen our efforts on new product development.

The decrease also reflects price pressure, mainly impacting MEMS, and a less favorable product mix.

Looking at our Embedded Processing Solutions group, there were some encouraging signs demonstrating that our goal to improve performance in this group is gaining some traction.

Second quarter revenues, excluding the Wireless product line, increased 6.6% sequentially.

In Imaging, we saw an increase of about 29% on a sequential basis, and we are on track to see a further ramp in the second half of this year.

So, the recovery is clearly moving forward for Imaging.

Microcontroller also delivered strong sequential growth of 17% thanks to both general purpose and secure microcontrollers.

Embedded Processing Solutions' operating margin was a negative 12.8%, with the improvement reflecting significantly lower expenses, principally in connection with the ST-Ericsson wind down.

Looking forward, we again expect a further significant reduction in expenses and a favorable product mix evolution.

Moving to gross margin, it increased 150 basis points sequentially to 32.8% in the second quarter, slightly above the midpoint of our guidance.

We benefitted from an improved level of utilization at about 81% compared to the 72% in the prior quarter, resulting in negligible unused capacity charges.

Increased volumes and the resulting manufacturing efficiency also contributed to gross margin sequential progress.

Gross margin improvement was partially offset by the usual price pressure.

Just a brief comment on inventory.

Our goal was to keep inventory steady and in line with expected growth in the quarter, and we did.

Inventory turns were at 4.1 turns, or 88 days, so basically flat with the first quarter.

Now let me turn to our product highlights.

From our Analog, MEMS, and Sensors group, our very low power RF transceivers are gaining traction.

For example, Paris, the City of Light, has begun deploying our SPIRIT1 device to remotely control streetlights along the river Seine.

We also earned some healthcare successes by bringing to market products that help improve the quality of medical equipment, products like our Pulser IC, which is useful in medical ultrasound applications for wave shaping and transmitting pulses of sound.

Our MEMS microphones are also gaining traction, and our high-end digital top-port microphone will become -- will be coming to market soon in an exciting new tablet.

We are also continuing to build on our solid leadership position in motion MEMS, ramping production of a 6-axis accelerometer and gyroscope for new smartphones.

And we are entering into production with a 9-axis inertial module for several innovative navigation related applications from top tier American manufacturers.

We are building momentum in power and smart power with solutions that allow our customers to create smaller, more energy efficient end devices, first of all with our innovative STLUX platform, the world's first programmable digital controller specifically optimized for lighting and power supply applications.

Here we captured multiple wins for several projects with major European lighting customers.

Our VIPerPlus high voltage converters earned design wins in several server switch mode power supply platforms from a major Taiwanese manufacturer.

And again in Taiwan, our RF antenna tuner solution was chosen by a leading OEM for its smartphones.

We were also pleased to see our discrete IGBTs and IGBT intelligent modules achieve big wins for welding and motor control applications.

As vehicles become safer and more comfortable, our Automotive Product group continued to demonstrate its mastery of all the technologies in the car and the strength of our relationships with top tier customers.

The ongoing increase in the provision of semiconductor content in vehicle plays to ST's advantage.

And this quarter our successes in design wins has covered the full range of automotive applications from 32-bit automotive microcontrollers for an airbag application to an microcontroller companion chip that integrates all the key functions for stability control systems.

We captured wins in infotainment with a multi standard digital terrestrial tuner from a leading European tier one, and we had success with several awards for vertical intelligent power technology in body control modules for leading tier ones.

We continued to see success in Microcontrollers and Memories.

Our STM32 family earned multiple design wins for smart watch applications at major global OEMs as a sensor hub in various mobile applications at a major manufacturer and in a next generation low power fitness monitoring system at a key American OEM.

We also began to ramp production of STM32 controllers for Wi-Fi modules for the Internet of Things applications at various customers.

In digital convergence, we are winning business in all the key areas of our focused strategy.

More and more ASIC customers are becoming convinced by the benefits of our faster, cooler, and simpler 28-nanometer FD-SOI technology, and we have been able to add two new design wins for networking and consumer applications.

We continued our success with worldwide customers through the new set-top box Class 2 products, and obtained the full certification from Nagra and Viaccess.

We also have begun an important design at a key customer for the US cable modem based on our early platform.

And finally, in Imaging, Bi-CMOS, ASICs, and Silicon Photonics we made progress in silicon photonics, capturing design wins for ASICs with two of the world's top optical communications manufacturers and winning almost 30 new ASIC projects from customers that use either Bi-CMOS or silicon photonics.

We were also chosen to supply an image signal processor to a leading phone manufacturer.

So, in summary, I think we are making solid progress in improving our product portfolio and, in parallel, we are making solid progress in improving our go to market strategy for sales thanks to the work we did last year, which is beginning to pay off.

Now I would like to discuss with you the second area of improvement, which is expense reduction.

Net operating expenses totaled $736 million in the second quarter, down $72 million compared to Q1, and substantially lower than one year ago when we were at $887 million.

Most of the reduction is related to R&D as we wind down ST-Ericsson, resulting in the chargeback expenses to Ericsson as well as cost reduction initiatives.

Looking forward, we anticipate closing the joint venture transaction in early August.

And as a result, the remaining ST-Ericsson activities will be deconsolidated.

We again expect a significant decrease in expenses in the third quarter.

And we are well aligned with our objective to be at a $600 million to $650 million quarterly run rate for net operating expenses by Q1 2014.

Turning to our cash flow, we had indicated that the ST-Ericsson wind down would result in a few quarters of negative free cash flow.

In the second quarter, it was negative $134 million.

While the third quarter will experience a similar negative impact, we expect to be significantly free cash flow positive in the fourth quarter based on current market visibility.

With our net financial position of $944 million, we will be able to manage -- to well manage through this period and retain our financial strength.

As I outlined last quarter, we had anticipated two quarters of negative impact on our net financial position in Q2 and in Q3.

We will look to rapidly strengthen our net financial position, focusing on free cash flow generation as one of our top financial priorities as we move into the fourth quarter and 2014.

Now turning to the joint venture, we are quickly approaching the final days to closure.

Carlo Ferro and his team have done an outstanding job of managing through this period.

Thanks to them and the team, here at ST we are on track to the plan and in fact we have improved the anticipated exit costs.

Our total cash costs to exit the joint venture are now estimated at between $300 million and $350 million, net of the expected proceeds from ST-Ericsson's sale of its connectivity business, and well below the original estimated range of between $350 million and $450 million.

Turning to our outlook, the market environment remains similar to what we have shared with you over the last three months.

We saw positive signals in the second quarter for bookings with an overall book-to-bill, excluding the Wireless product line, of 1.1.

And yet, at the same time, there is still some uncertainty in the marketplace, in particular in the smartphone market.

Looking ahead, we continue to expect the ramp of key products in MEMS, Automotive, Microcontrollers, and Imaging in the second half of this year, leading to higher sequential revenue results for both the third and fourth quarters of this year.

With respect to our sales outlook, we are anticipating sequential sales growth of 3.5% excluding the Wireless product line, and flat including the Wireless product line.

We expect to see sequential gross margin progression in the third quarter on improved manufacturing efficiency, higher volumes, and better product mix, leading to a gross margin outlook at about 33.5% plus or minus 2 percentage points.

We also expect a further significant decrease in expenses thanks to the deconsolidation of ST-Ericsson and to seasonality.

Going forward, we anticipate progressive improvement in our gross margin.

First, with fab utilization at a more stable and optimal level, we plan to continue to grow our business in our targeted growth drivers.

Second, we are focused on better utilizing and optimizing our technology portfolio.

Third, we are now in a position to more aggressively manage our product mix in order to prune lower margin products from our portfolio.

To successfully achieve this, we will make gradual structural changes to our manufacturing footprint to ensure that it matches our needs, complemented by our foundry sourcing.

As a result, we plan to gradually expand 8-inch capacity in Singapore and Catania, Italy while winding down certain 6-inch manufacturing lines and consolidate our back-end activities in China to Shenzhen.

Finally, let me mention yesterday's important news.

We had the honor to host the French Prime Minister and three other ministers at our site in Crolles, where we announced a key frame agreement with the French government for the Nano2017 program, which supports our proprietary R&D activities for CMOS derivative technology.

This program will strengthen our leadership in key technologies, the FD-SOI for logic, the next generation imaging and next generation embedded non-volatile memories for microcontrollers.

I want to be clear that this agreement was contemplated and is already fully reflected in our plans and financial model.

So, to close, I believe we have shown that we are moving in the right direction and making progress steadily quarter by quarter.

We remain focused on delivering on our three main objectives, sales growth, gross margin improvement, and expense reduction.

My colleagues and I are now ready to take your questions.

Thank you.

We will now begin the question and answer session.

(Operator instructions.) Mr. Sandeep Deshpande from J.P. Morgan.

Hi.

Thanks for letting me on to ask a question.

Carlo, I have a question on your gross margin.

You clearly seem to be showing great progress on your OpEx.

It is declining in line with what your guidance is for Q1 '14, but your gross margin progress is slower than what we were expecting in the market.

Can you try to explain what the mechanism on the gross margin is and how this gross margin of ST can move towards historically more normalized levels that you have?

And secondly, what's the utilization you had in Q2 and Q3?

And is the utilization, say, of Crolles 2 impacting this gross margin because of the wind down of ST-Ericsson?

Yes.

So, we are working on four main drivers for gross margin improvement.

The first you mentioned, of course, is loading in Q2.

We have achieved 81% of loading.

Our target was in fact somehow somewhat -- a little bit higher, and we had anticipated 85%.

We now plan to be at 85% fab utilization during the course of the third quarter of this year.

So, this is an important driver.

Another important driver of course is the stability of this loading.

This of course is to give our manufacturing operation the proper time to improve efficiency.

Another important driver is the decline of the ST-Ericsson products.

In fact, this is playing positively.

This quarter, unfortunately -- in Q3 I mean, unfortunately it will not play positively.

The decline of the ST-Ericsson gross margin moving from Q2 to Q3 is material, and this is impacting about 40 basis points the overall gross margin.

And then, we have the fourth initiative.

That is in the new configuration, as we have already discussed, in fact, during the Investors' Day in London, we will become more aggressive in terms of pruning low margin products.

And with the plan that we have started to implement in manufacturing -- that is not new, by the way, but is along the roadmap that we had already defined.

This new manufacturing program will allow us to be more aggressive in terms of pruning very low margin products.

So, these are the four main drivers, and we expect to grow quarter after quarter.

As you know, in our model, we have flagged to a gross margin to achieve the 10% profitability, a gross margin in the range between 37% and 37.5%.

This is the level of gross margin we are targeting, to land there.

And the other consideration, of course, is the continuous focus on innovation and the contribution of the new products.

So, while I understand that the progress is only gradual, but we are on track to achieve what is our roadmap here.

And there will be improvement in Q3.

There will be another improvement in Q4.

And of course, our objective is to land into 37%, 37.5% as quickly as possible.

Thank you, Carlo.

Just one follow up.

So, you are saying that the gross margin will improve in Q3.

And you are indicating, based on what you know today, that it will improve in Q4 as well.

Absolutely.

Absolutely.

I think in Q3 the gross margin improvement is what we have put in the guidance.

Of course, we do not give a guidance today for Q4, but we expect a further improvement in Q4.

And importantly, we will continue to reduce very significantly our expenses including in Q3.

And the combination of the two things will give us a further significant boost in the earnings per share.

Our earnings per share, the clean earnings per share in Q1, was a negative $0.13.

In Q2, it is a negative $0.06.

We expect another significant jump in Q3 and, of course, another significant jump in Q4.

Also, we do not expect in the second part of the year to have too many of the one-off related items that we have now mostly due to the ST-Ericsson winding down.

Thank you very much.

Thank you.

Thank you, Sandeep.

Next question, please?

Francois Meunier from Morgan Stanley.

Yes.

Thanks for taking my question.

Hello, Carlo.

Hello.

My first question will be about the Nano2017 program and how we should put that into the model.

I think -- previously, I think it was up to 2000 maybe '11 or '12, we were putting something like EUR100 million of other income into the P&L.

Is this something we should model like that?

And will it change the OpEx guidance?

So, basically will you spend more because you get some money from the French government?

Yes.

Well, it is very simple.

I think during the presentation, and in also the material that we have left to our investors during the Investor Day in London, we have quantified what was the contribution from fundings.

There is a chart where there is -- where we have plugged all the various elements for us to decrease the expenses from the $808 million in Q1 of this year to a range between $600 million and $650 million.

So, this is more or less what we had in the past for you to plug.

But, if you refer to the documentation that we left during the Analysts' Day, this is, let's say, plugged in our model and it is to be considered for future modeling.

Okay.

Thank you.

Now, the next question would be about the MEMS market.

I think in your introduction you were talking about pricing pressure in MEMS.

Is that the reason why the margins went down in SPA business despite revenues going up?

And can you explain why is this sudden pricing pressure coming?

Is it because the high-end smartphone market is not so glamorous, as you would say, or is it because there is a risk of being dual sourced at Apple with InvenSense?

No, I think it's -- first of all, one comment on the, let's say, profitability of the Sense & Power Automotive.

A major contribution to the decline is for the first time we have accounted the redeployment of resources from ST-Ericsson into ST, particularly in the area of power management but not exclusively.

There are resources that we have redeployed also into Automotive, particularly in infotainment and microcontrollers, but clearly also on MEMS and analog.

So, this is an important contribution.

The price pressure, as I just said right before, it is also a contribution.

And I think it's a little bit of what you are saying, is a combination of competition being more aggressive overall.

We are working very hard to be less dependent on major customers.

I mean, we are really making great progress at many other smartphone customers, particularly in China where we have a very strong position.

And also, we are focusing very much on new areas for us like automotive and everything that is related to healthcare, wellness, fitness, and wearable applications.

So, the price pressure is more specific to major customers.

And the way to respond, of course, is first of all through innovation, and second is the expansion of the customer base in smartphone and also addressing new markets.

Now, despite this, with the visibility that we have today and with the good level of bookings that we had overall in the second quarter, I mentioned the 1.1 book-to-bill ratio in the second quarter excluding ST-Ericsson, we expect a significant improvement in the profitability of Sense & Power and Automotive in Q3 first and then in Q4 this year.

Okay.

That's very clear.

Thank you, Carlo.

Thank you.

Thank you, Francois.

Next question, please?

Tristan Gerra from Robert W. Baird.

Are you there, Tristan?

Goren, let's go to the next call and we'll loop back in Tristan later.

Stephane Houri from Natixis.

Mr. Houri, you line is open.

Please go ahead.

Maybe try the next one, Goren.

Simon Schafer from Goldman Sachs.

We may be having some technical difficulties here.

Can we take the next question from Mr. Andrew Gardiner from Barclays?

Please go ahead, sir.

Hello.

Can you hear me?

We can.

Yes.

Okay, good.

I just wanted to follow up on MEMS as well.

Can you give us rough idea of where the run rate is of that business?

You guys had previously said at the Analysts' Day it's around $1 billion a year.

Is that still the case?

Do you have sort of updated expectations for growth, given how you see the competitive dynamics at the moment?

Yes, we are running at this rate.

In fact, in Q2 we grew.

I mean, there was a growth in this area in Q2 despite we are running somehow below the expectation.

For sure this will be a very important driver.

The ballpark today is in the range of $1 million including all our MEMS and micro machinery applications.

And I am encouraged clearly also by all the new opportunities in terms of different products like pressure sensors, the microphone, everything that is related to hubs, and the integration of the MEMS functionality in one chip.

So, clearly what we do not see is an explosive growth.

But, just to let you know what we have -- actually, in Q2, we had a sequential growth that is about 9.5% on our MEMS products.

That's helpful.

Thanks very much.

Thank you.

Thank you, Andrew.

Next question, please?

Amit Harchandani from Citigroup.

Good morning.

Good afternoon.

Amit Harchandani from Citigroup.

Thanks for taking my question.

A question and a follow up, if I may.

My first question is really around the weakness that you have talked about in smartphones.

Could you maybe shed a bit more light on it?

Is it high-end, low-end, inventory related, more short term, any particular geographies?

And then, I have a follow up.

Thank you.

Yes, is concentrated, from what we see, on the high-end and is -- I believe is more on the high-end products, and at this point I would say is really impacting two regions.

So, I believe that in general what we see in China is positive.

We see a good trend.

Today the market share of the Chinese smartphone makers reached -- I mean in the second quarter, from what we have seen and from certain market research institutions' figures, we have seen the Chinese market share, I'm talking about the smartphone makers in China, is 25%.

So, this is growing.

The softening that we see, the flattening that we see, is more on the higher end, on the very high-end smartphones.

I think today it's very much in two regions, and this is pretty recent.

I think we have been also reading on the press, and of course we have direct visibility with our major customers.

Okay.

So, do you think that this is more temporary and probably corrects itself over time, or it's just wait and watch right now?

Well, I think this, of course, is a very, let's say, interesting question.

It is not so easy for us to comment on this, but my personal opinion here of course is that this market clearly will be driven by new functionalities and new applications and more interesting applications for the consumers.

So, what we are trying to do is to contribute to the development of these new applications with our newer technologies in the area of MEMS but also in the area of, for instance, everything that is related to the touchscreen displays, clearly the autonomy of the battery and the autonomy of the phone with more innovative power management solutions for the application processor, for the peripheral products in the smartphone, but also digital controls for battery chargers, wireless chargers.

So, of course it's new applications, it's new functionalities, and our contributions is under technologies.

I mentioned MEMS and I mentioned the power management.

I mentioned the touchscreen displays.

But, for instance, in the press release, we mentioned this.

We cannot name the customer, but we are starting an important business with our tunable antenna solution that is making the phone at a much higher performance in terms of radio frequency and the stability of the radio frequency functions of the phone thanks to this tunable antenna architecture.

So, it's all of this.

And of course, our motivation and our drive is to contribute with new technologies and new products through the new functionalities and the new performance of the smartphones together with our customers.

Very helpful, Carlo.

And as a quick follow up maybe, and this is maybe slightly unrelated and apologies if you clarified this earlier.

I was going through the press release issued by Micron as a part of their fiscal results for the May ending quarter, and I noticed that they talked about an agreement with STMicroelectronics wherein around 500 employees from Micron's Agrate facility were transferred to STM, which I found a bit puzzling given the emphasis on reducing OpEx.

Could you maybe clarify what that was all about?

Yes, this is clearly not impacting the expenses of the Company.

There is no relation.

This is part of the wafer cost.

And we share a facility.

It's just the legal configuration of the way we run the operation as a consortium.

But, we are sharing the wafers and of course the management of the fab.

And the drive here is to reduce wafer cost.

The cost of the people is clearly embedded in the wafer cost, and this is not impacting at all the expenses of the Company.

Okay.

So, the 500 employees were transferred to STM, but the costs are being handled by the consortium.

So, no change to your OpEx plan, so to say?

No.

First of all, it's not expenses.

This is part of the wafer cost.

And there is a sharing of the production activity between the two companies.

And we have about 60% ownership of the fab while Micron has about 40% ownership of the fab in terms of wafer consumption.

Then, of course the wafer cost is charged to the two companies based on the products that we are running in the facility.

Okay.

That's very clear.

Thank you so much, Carlo.

Thank you.

Thank you, Amit.

Next question, please?

Tristan Gerra from Robert W. Baird.

Tristan, are you there?

Can you hear us?

Can you hear me now?

Yes.

Yes.

Welcome back.

Okay, good.

Was wireless the only reason for your utilization rate in Q2 to be slightly below the original 85% target?

And if you could go over the catalysts for Q3 in terms of gross margin, is it going to be pretty much driven just by higher utilization rate or is there any other factor?

Yes, I think in Q3, if we say wireless, it's absolutely true because -- excuse me.

If you talk about Q2 wireless, it's absolutely true.

In fact, it is somehow a little bit lower in terms of loading on certain ST-Ericsson products, but also on our MEMS products.

So, the difference between the 85% that we had given one quarter ago and the actual number that we have communicated today that is 81% is very much related to this.

There are other lines, and here I would like to mention Automotive, where the booking is very, very strong and remains -- we have a very, very strong backlog in Q3.

And here the challenge is more to respond rapidly to all the demands of our customers.

If we move to -- if you move to Q3, I think the major contribution to the improvement in the gross margin of the third quarter is the efficiency.

Not per se the loading in Q3, but the efficiency that we have achieved in Q2 in our fab because of course our inventory is rallying and is about three months.

So, what we do in Q3 is to sell the production of Q2.

So, this is a contribution to the gross margin improvement in Q3.

I mentioned a negative contribution because there is a material decrease of the gross margin in the ST-Ericsson products despite the fact that the sales will be strongly reduced.

And this is impacting about 40 basis points the overall gross margin of the Company.

But, the major driver indeed is the better efficiency in our fabs in the second quarter that is impacting positively the gross margin in Q3.

Okay, that's useful.

And then, in order for you to meet your $1 billion revenue target in MEMS for this year and given what you did in the first half, does this imply an acceleration in your revenue growth sequentially in MEMS in Q3 versus what you did in Q2?

Well, we still plan to grow.

As I said, this is not the level of cost that we had, for instance, last year.

But, we are plugging some more moderated growth both in Q3 and in Q4 this year on a wider range of products.

Thank you very much.

Thank you, Tristan.

Next question, please?

Simon Schafer from Goldman Sachs.

Great.

Thanks so much.

Can you hear me now?

Yes, we can.

Hi there.

Just wanted to ask a follow up question on Auto.

I think you just said that loading is still very strong and the backlog indications for Q3 are also good, which I think is a bit unusual just given the summer seasonality.

But, just in context, what was the sequential trend in Q2 and what sort of sequentials are you talking about into the September quarter for Auto?

One moment.

8%.

So, sequentially moving from Q1 to Q2, we have grown 8%.

And we do not give all the details of the guidance, but we expect to make another important growth moving from Q2 to Q3.

Got it.

Thank you.

And just coming back to the MEMS a bit, and apologies for asking it a different way.

But, if there is a more gradual need to diversify, I guess I'd also sort of -- you're accepting the risk of more diversification amongst one of your customers to competition.

Is it still feasible for you guys to get to the type of margin goals that you set for SPA in light of the type of diversification that it now requires, it seems?

That'd be helpful.

Yes.

The answer is absolutely yes.

And today, even with a moderate -- even with a more moderate growth in MEMS, we expect a very significant improvement in the P&L of Sense & Power Automotive moving to Q3 and then Q4.

And I absolutely confirm the guidance that we have given in London that is for double-digit profitability with the ambition to get above 10% and then 15%.

But, we expect a material turnaround in the short term.

Great.

Thanks so much, Carlo.

Thank you.

Thank you, Simon.

Next question, please?

Didier Scemama from Bank of America Merrill Lynch.

Yes.

Good morning, gentlemen.

Can you hear me properly?

Yes, we can hear you very well.

Great.

Thank you.

Now, just wanted to go back to the OpEx developments as well as the gross margin.

So, first on the OpEx side, excluding the sort of cash contribution from Ericsson to cover the LTE R&D, looks like your OpEx actually went up sequentially.

So, just wanted to understand why the STMicro sort of cost specific -- cost saving programs have not kicked in and when they're going to kick in, and whether it's in Q3 or in Q4 both.

And then, the second question on gross margins, as I understand it, your gross margins would have been 40 basis points higher in Q2 without ST-Ericsson.

No, no, no.

And then, you mentioned that ST-Ericsson will be --.

No, sorry, in Q3.

In Q3.

What I said, just to be clear --.

Okay.

Sorry, it should be -- I meant Q3.

Yes.

Yes, what I am saying is --.

Yes, I meant Q3.

The evolution of the ST-Ericsson business moving from Q2 to Q3 is such that we will have a negative impact on the gross margin of about 40 basis points.

This is what I said.

Got it.

But, then going into Q4 where you're going to have a cleaner P&L without the headwind of ST-Ericsson, since it's going to be deconsolidated, should we see a step up of gross margins at that point because, one, ST is not in the mix and, two, because your revenue growth is potentially stronger than it is in Q3?

Yes.

I think first of all, let's start from the OpEx.

You are right.

I mean, there is a contribution, and the fact that the modem effect is important.

In fact, you rightly remember in March it was $29 million.

We wrote it down, so you made the math.

But, you should not forget that we have also assumed costs from the ST-Ericsson operation.

And also, we have, let's say, redeployed all of these resources.

So, I think we need to look at this at the global level, because there is a major redeployment of resources and it is very, very difficult to track all the elements because everything now is accounted in the new unit of the Company.

If we look at the consolidated level -- Lorenzo speaking, our expenses, they went down moving from Q2 -- through Q1 to Q2 to $70 million.

The impact of the modem was in that range, but we do not have to forget that there was also the dynamic of the salary that was totally offset by the reduction in expenses, let's say, related to the restructuring plan that we have ongoing.

So, it's not fully correct to say that there is no visibility of that.

This is completely, let's say, offsetting this dynamic of salary that was --.

Yes, we do the salary increase in the Company the first of -- the first day of the second quarter, the beginning of April.

So, this is -- this has been completely absorbed.

And as we said before, we expect another big jump moving from Q2 to Q3 in terms of expense evolution.

And you should also consider that in this phase we are not accounting any grants for the Nano2017 program yet.

This will be, of course, done as soon as we will receive the clearance from the European Union now -- from the European Union on the Nano2017 program that we just signed.

So, then in terms of the redeployment, these resources are already accounted in the various business units where we have moved resources.

Now, in terms of deconsolidation of ST-Ericsson, when we close at the beginning of August, a few days from now, we will deconsolidate the so-called third bucket that is the remaining part of ST-Ericsson, because there is a significant, let's say, transfer of resources to the Ericsson Group and a part that we have moving to ST.

So, the remaining -- the so-called third bucket will be deconsolidated and we will not see in our operating expenses this any longer.

Any longer these expenses.

It is why -- let me remind you that we are not going to deconsolidate the revenue in the business.

This will remain, because this will be, let's say, the portion that will be transferred to ST.

So, ST will continue to consolidate the top line, and so that's why the comment of Carlo about the gross margin, the impact on overall the Q3.

Got it.

And then, as a quick follow up just to clarify, on the OpEx guidance for 2014, the run rate of $600 million to $650 million bakes in whatever, the $100 million to $150 million you're going to get next year for the full year for Nano2017, as well as the EUR360 million program, Places2Be, for FD-SOI.

Is that correct?

Of course.

I mean, first of all, it's obvious that we will not consider all the -- we will have to decide.

I mean, we will see what is the best way once we have the approval, the clearance from the European Union.

But, our $600 million and $650 million is the model.

And this model is not based on a one-off catching up of the grants, this is obvious, but is a sustainable business model for 2014, '15, etc.

And as we clearly said, all the R&D effort that is part of this agreement that, I repeat, is bought product, R&D in Grenoble, and the technology R&D in Crolles, all of this is already embedded in the financial model that we have given.

So, you should consider the $600 million and $650 million model as, first of all, sustainable and not a function of any one-off adjustment.

So, this is a sustainable model for us.

And number two, clearly the agreement is covering a wide range of activities on FD-SOI, the microcontrollers, and the imaging.

And all of this is already embedded, was already embedded in our model.

It's clear?

Yes, Carlo.

And then, on the gross margin front, when you shut down the 16 fab in Agrate and in Singapore, when is that going to impact the P&L, and maybe can you quantify the impact?

Yes.

First of all, it's not in Agrate.

We do not have any 6-inch activity in Agrate.

Sorry, I meant Catania.

Yes, we have one on Catania.

And this program, I think it's good that I could describe because it is an important program for the Company, is really concerning four fabs.

It's concerning the 6-inch activity in Catania.

It does concern the 8-inch activity in Catania.

We have two modules in the same site.

They are very close, but they are two modules.

And the same in Singapore.

In Singapore, we have two modules.

One module is the most mature module.

That is 6-inch today.

And then, we have a second module in Singapore.

That is a more modern volume that is 6-inch, but where we already started an 8-inch mini line, okay?

So, what we have announced is that we will wind down the two 6-inch activities, one in Catania and the most mature 6-inch line in Singapore.

At the same time, we will expand our business, growing on this smart power -- mostly smart power technologies, power MOS, advanced power MOS technologies, and vertical intelligent power, and of course the IGBT but also the BCD kind of technologies.

For instance, the BCD8 we will expand on the two 8-inch fab in Catania and in Singapore.

It's clear that I cannot -- we have modeled everything over the next year.

So, I think we will start very aggressively this program.

It is a very important program for the Company for two reasons.

The first reason is because we will enrich our mix tremendously, replacing all the 6-inch activities with more modern 8-inch activity on the technology that I mentioned.

And the second reason, because thanks to this, we will enjoy a very significant decrease of the manufacturing variation in the two sites, and overall of the manufacturing costs.

So, this is a very important program for the Company.

Of course, it is very material in terms of gross margin impact, very, very material for this class of products.

I can also state that it's very material in terms of cash generation.

And it is a program that we are starting now and will play gradually on the gross margin improvement, but it's not a small deal.

It's a very important initiative that we have.

Brilliant.

Thank you.

Thank you, Didier.

Next question, please?

Stephane Houri from Natixis.

Hello.

Good afternoon.

Two questions, if I may.

The first one is to come back on MEMS.

And I would like to know if you can help us and clarify what's your view in your market share with the iHand smartphone manufacturer today and what -- and how it should evolve, and also if you could add some comments about how you're exposed to the Chinese smartphone market.

And the second question is about the current bookings.

You have said that book--to-bill was 1.1 and that you had some weakness in smartphone at the end of the quarter.

What's the situation in July?

Thank you.

Yes.

Well, I think if you look at the situation of market share, of course it's not very easy to respond.

I mean, I know that there are market research institutions that they publish results on a yearly basis.

For instance, last year I remember that we had been mentioned as the major supplier here with 48% market share in the smartphone.

Now, clearly this is not trackable quarter after quarter simply because we do not have the figures.

The figures are not available, so we will have to wait.

Overall, I can mention what we have read on the publication of WSTS in terms of evolution of market share and what we have also seen starting from Q4 last year.

I think the WSTS numbers are available through the end of May today.

I think in a few days the number of June will be published, so we will have the final numbers also for June.

But, for what has been reported so far by WSTS, we had increased market share in Q4 last year.

And the increase has continued in Q1, which is for us typically a relatively weak quarter if you look at our history, but also in Q2 through the month of May.

So, there is a progress of the overall market share.

I think if we look at the markets that we serve with the products that we have, of course excluding ST-Ericsson, our last three months' market share is -- as reported by WSTS is 5.4%, which is sequentially higher, a little bit higher compared to Q1, and also higher year-over-year.

Now, if we look at the Chinese market, I think it's important to be in this market with MEMS and with many other products, because the weight of the Chinese smartphone makers is increasing.

And as I said before, I have seen the numbers for the second quarter, and the weight of the Chinese smartphone makers in Q2 is 25% of the overall smartphone volume in the world.

And this number is increasing at certain major accounts that are very well known, of course, but also at many midsize customers.

And we are covering all of these accounts with our geographical organization in China.

And we want to be present in this business of course on the peripheral of the smartphones, because we are not in the digital core any longer.

And we are encouraged by the progress that we see with our MEMS and other products on all of these peripheral products.

Okay.

And on the situation on the month of July, on the bookings?

Well, the situation of the month of July, I think there is a continuity of a good booking trend in general for the Company with softening of the smartphone.

So, I can reconfirm what we have seen.

I think of course it's -- I can reconfirm what we said for the second quarter.

I think it is important also, maybe one word on the point of sales of our distributors.

The point of sales in the month of June was pretty good from our distributors in all the regions where we operate.

This is a good indicator, of course, because it's not inventory adjustment.

And we track regularly the inventory of our distributors.

It's very, very healthy in America and in Europe.

And it's around three months of inventory.

It's around four turns in Asia, but is significantly higher turns both in Europe and in United States.

This is a good indicator.

Now, we see -- we are at the beginning of the quarter and we will see the evolution.

But, I can reconfirm the same trend.

Okay.

Thank you very much.

Thank you, Stephane.

Next question, please?

Kai Korschelt from Deutsche Bank.

Yes.

Hi.

Can you hear me?

Yes, please.

Yes, perfect.

Thank you.

I have a couple.

The first one was really more of a sort of higher level question around your margin targets and percent.

If I strip out the wireless business or revenues, then it looks like your ex-wireless operating margin was probably slightly below break-even the second quarter.

And I think you had already mentioned that you need to get to revenues of about $2.25 million to get to 10%.

Now, you obviously have good seasonality in the second half.

But, sort of beyond that, how are you thinking about sort of the growth drivers maybe beyond MEMS and microcontrollers, because these are a relatively small part of the business?

And maybe also, any sense of timeframe of when you think you may be able to achieve the 10%?

That was my first question.

The second one was really just specifically on MEMS.

And I apologize to beat a dead horse, but you are not excluding the risk of share loss at your largest customer in MEMS.

Is that right?

Thank you.

Yes.

Well, let's start from the first question.

First of all, I mean, it is becoming more and more difficult to see what are the losses in ST-Ericsson and the situation in ST, because we have moved and already -- we are already funding resources that were in ST-Ericsson, so it's now the phase where everything is becoming ST.

And what I want to say here is that we have done $0.13 negative EPS in Q1 with ST-Ericsson EPS.

We have done $0.06 negative in Q2 with ST-Ericsson.

And we expect to move on with important improvements during the course of Q3 and of course during the course of Q4 this year with the progressive improvement of gross margin, but also with a very, very significant reduction of our overall net expenses.

In terms of models, I think the plan that we have is exactly the same that we have described last time.

We want to go back to a run rate that is in the range of $9 billion per year, which is the $2.25 million per quarter that you mentioned, with expenses in the range of $600 million and $650 million and with a profitability of 10%.

What is very important here is that we do not want to achieve this range of expenses just next year, but we want to stay in this range of expenses.

And again, I'm talking about net expenses, which is the US GAAP expenses plus the funding contribution, for a few years.

And of course there is an inflation related to the salary increase that is in our model.

But, we should not neglect the fact that we have redeployed significant good product R&D resources to our six product groups.

I mean, in London we had even quantified the redeployment by product group.

And this is now a boost in terms of product R&D, and therefore we do not plan to increase farther.

And we want to stay in this range of expenses for some time, for a few years.

At the same time, we want to grow.

So, clearly the first step is the $9 billion mark, but then we are serving a market in each of the two blocks of the Company that is today in the range of $70 billion each.

And our aspiration is to grow and to move forward and keeping the same level of expenses, and of course to progressively improve our gross margin.

The initiative that we have described today, that of course was in our roadmap, is an important initiative and it will be accretive in terms of gross margin.

So, ultimately, if you want to see a company like ST five years from now, I think if we are a $10 billion Company, our aspiration is to be a $10 billion Company and a 40% gross margin Company.

And then, of course this would imply a profitability more in the range of 13% to 14%.

Okay.

Could I just maybe ask a quick follow up?

I understand you have very good visibility on your future OpEx run rate.

But, to get to $9 billion, I think that's roughly a 20% increase from the current run rate, if we exclude wireless.

So, I guess my question centers more around the revenue growth where, again, I appreciate second half this year looks pretty good, seasonality and product runs, etc.

But, sort of beyond that, to get to 20% growth from the current run rate, we probably need a little bit more.

So, I'm just wondering kind of what your timeframe of that -- of achieving that revenue run rate would be?

Would it be next year or beyond?

Yes, the target that we have is, as we said already, is to achieve our 10% model.

Of course, this is an ambitious target.

But, it's to achieve our 10% model, it's not the first time that we state this, in the second part of next year.

Okay.

Thank you.

And then, just the follow up, the question on MEMS?

The question on MEMS was, oh, on the market share and major accounts.

Listen, it's very, very difficult for us to say whether we are single source or not single source.

We have major accounts where we are single source.

There are other major accounts where we are not single source.

Clearly, also the -- how can we say, the dynamics in the wireless market is continuously changing with a customer gaining market share and customer losing market share.

Typically, in our business, we are not single source so we do not have the hope that we can be single source.

It may happen that for some time we are single source at a certain major customer, but I do not believe this is something that we should plan on, to be single source forever.

I think here what we should do is to make sure that there is a wider portfolio of customers in the smartphone, knowing that the smartphone makers in China are gaining weight continuously on one hand.

And on the other hand, there is to make sure that -- and we have started, for instance in Automotive, to grow in the Automotive where there is a major MEMS business, and in all emerging applications like healthcare, wearable, wellness, etc.

So, I think this, together with the continuous drive in the innovation and the speed of innovation, should allow us to continue to grow very profitably in this business.

So, rather than looking at a specific position at certain major customers, I think it's -- more important for us is function of the customer base, is function of the product portfolio, not only one or two functionalities but many more functionalities, and addressing different applications, some already well established like Automotive and some that are emerging in terms of volume that for sure will become important in the future.

Great.

Thank you very much.

Thank you.

Thank you, Kai.

I think we have time for one more question.

The last question for today is from Janardan Menon from Liberum Capital.

Yes, hi.

Thanks for taking the question.

You'd mentioned that in the Embedded Processing Solutions division you'd seen a decline in your digital convergence revenues as well.

I was just wondering which product area that refers to.

Was that in set-top box or was that in some other area and what the outlook there is for the second half of the year?

And as a follow up, you said the 10% margin is dependent on a gross margin or based on a gross margin of about 37% to 37.5%.

What is the utilization level that you are -- that you need to be at to get to the 37% to 37.5% gross margin?

And within that, is there a specific utilization level that you need to achieve Crolles 2 to support that, that gross margin level?

Yes.

Well, let's start from this one.

I think what we are planning -- and it's not the first time we comment on this.

But, what we are planning in our model is a fab utilization in the range between 85% and 90%.

Of course, 95% is an optimal position -- excuse me, 90% is an optimal position.

Above 90% we'd be then stretched to respond to customer short term demand.

So, this is the range that we are targeting, between 85% and 90%.

We should not neglect, of course, the advantage from structural measures.

I mean, at the beginning of the conversation, I did mention what are the major drivers.

I think it was the first question today.

So, there are, for us, four major drivers.

One, of course, is this kind of loading.

The second is the stability of loading.

The third, very importantly, is the focus on growing products that contribute fully to the gross margin.

And we will attack this aggressively because now we also have the means through this -- the manufacturing strategy that we have just presented.

And the last one is the mix of products.

For instance, in the short term, the fact that we have $150 million, $100 million declining per quarter with Ericsson today in Q3 did not play positively, as I said.

But, of course with these revenues phasing out, this will be a positive contribution to the gross margin.

Now, I think that in Q3 this year we shall start from a base of $1.935 billion.

I think this was the first part of your question, right?

And we expect to grow from there and to reach then the $2.2 billion, $2.25 billion per quarter in the second half of next year.

I think you had another question that I am now missing, if you can repeat the first one.

Yes, it was on digital convergence.

You'd said that you saw a revenue decline outside of wireless.

So, I was just wondering which area that was and how that's looking into the second half of the year.

Yes.

Overall, EPS outside wireless did increase.

I think the increase was sequentially 6.6%.

Today in Q2 and in Q3 we have a decline of our digital convergence business not in Asia in relation to the low end of the products, and it's the phase out of certain families.

And we expect, through the new design wins and the many new products, to start growing again in Q4 this year.

For us, a very important target is clearly the cable market in United States.

We are very pleased to announce that we have now the first major win in the cable -- in the set-top box cable market in the United States.

So, this definitely is one of our priorities.

In this unit, however, we have also an ASICs business unit.

And during the course of the second quarter, we have gained two major wins.

And one is very material in terms of revenues.

It's portable consumer applications, and this will significantly contribute to revenues starting from mid 2015.

This is a very important addition.

Of course, it's a very important win for us.

We need to develop the products, but it is a very, very important award based on the capability of our FD-SOI technology.

So, the short term is mostly impacted by the low end market in China.

And we are phasing out old products.

We are growing up the new families like the Class 2, the Orly.

Cable in US is crucial, is key for us, and we are very pleased that we have now the first major program for us in the United States on this kind of applications.

Got it.

Thank you very much.

Thank you.

I think at this time, Carlo, did you want to take another question?

Yes, I think we have another -- for me, another five to 10 minutes and then we can go, I mean, if there are questions.

Okay.

We'll take another question, please?

Jerome Ramel from Exane BNP Paribas.

Yes, good afternoon.

Carlo, just would like to understand the comment you made on the impact of the shift from 6-inch to 8-inch on the gross margin for Q3.

I'm not sure I understood the impact it will have on the gross margin.

And secondly, I'd like to understand for what kind of product do you need more 8-inch capacity going forward.

Is it for microcontrollers?

And maybe just a follow up on top of all of this, what is the outsourcing level of STMicro, and is there any impact on your gross margin in Q3 coming from more outsourcing?

Okay.

So, let's see.

I mean, no, it's not microcontrollers.

The manufacturing strategy on microcontrollers is based on the low end products.

We stay 8-inch, and the fabbing is in Rousset.

And the higher end products are migrating into 12-inch.

Today we have the first eight new products running the qualification in 12-inch in our Crolles 300 facility.

This is both for general purpose and the secure microcontrollers.

The four fabs that we are mentioning here, the two lines in Catania, 6 and 8-inch, and the two lines in Singapore, the other 6-inch and the most modern fab where we already have an 8-inch mini line, this is intended for products like power management, smart grid, intelligent industrial control, and everything that is related to home automation and factory automation.

So, what are the technologies in the product?

It is smart power products in vertical intelligent power.

It is BCD8 products.

But, it is also advanced discrete products, for instance power MOS at high voltage, or our family -- the MDMA family.

It is also IGBT.

So, it's all of this.

This is taken care in the same class of facilities and coming from all those 6-inch into more modern 8-inch.

There are two major contributions.

One, as I said before, is the improvement of the mix of the products.

So, the venue of the products is increasing.

So, the average selling price of these products will increase.

And the second is the very significant decline of the manufacturing cost, thanks of course to the evolution from 6-inch to 8-inch.

Today we are confident that in the area of power MOS, in the area of smart power, in the area of industrial applications in general, we have a mass of new products and new technologies that is giving us the confidence that we can now make the step and fill more on the 8-inch and much less on the more mature 6-inch.

This will have a very significant impact on the gross margin, of course, for these products.

And the gross margin is improving for the two reasons.

One is a better mix and the second reason is clearly a very significant reduction in the manufacturing cost.

In terms of outsourcing, I think with the decrease of the volume of ST-Ericsson, there is a decrease.

I think in Q2 we had about 8%.

Yes, in Q2 we were up 8.4% on the overall volume.

That was down in respect to Q1.

It was 10% for the reason that you --.

And in terms of venue, this represents about 15% of -- in terms of venue of the production, let's say.

Production venue is about 15% of the total.

Okay.

Thank you very much.

Thank you.

Okay.

I think at this point we'll probably need to cut it off.

That is fine.

I think we have -- you need to catch a flight to London.

So, we want to thank you again.

And we'll talk again soon, and clearly for the third quarter results.

So, thank you again for your participation and interest into ST.

Thank you.

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