意法半導體 (STM) 2014 Q3 法說會逐字稿

Ladies and gentlemen, good morning.

Welcome to the STMicroelectronics third quarter 2014 earnings results conference call and live webcast.

I'm Moira, 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.

(Operator Instructions).

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 for joining our third quarter 2014 financial results conference call.

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

Joining Carlo on the call are Jean-Marc Chery, Chief Operating Officer, Carlo Ferro, Chief Financial Officer, Georges Penalver, Chief Strategy Officer, Carmelo Papa, Executive Vice President and General Manager of the Industrial and Power Discrete Group, and Claudia Levo, Corporate Vice President External Communications.

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 this morning in Europe and also in ST's most recent regulatory filings for a full description of these risk factors.

Also to ensure all participants have an opportunity to ask questions during the Q&A session, please limit yourself to one question and a brief follow-up.

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

Carlo?

Thank you Tait.

Thank you for joining us on our third quarter earnings conference call.

We have a lot we want to cover with you today.

The agenda includes a summary financial review.

We will then turn to our $100m cost savings plan and the discussion on our digital business organization.

This will be followed by a review of our two product segments, including new designs and product highlights, on our roadmap to our increasing our revenues.

And I will finish up with our outlook for the fourth quarter and open the call to your questions.

Let me start from our top line.

Net revenues increased 1.2% sequentially with both SP&A and EPS segments contributing to this growth.

Due to the softening of the market towards the latter part of the quarter, specifically microcontrollers and in the mass market, we came in below the 3% mid point of our guidance.

Distribution represented 32% of revenues, up from 31% and 25% in the prior and year ago quarter respectively.

Moving now to the solid performance of the other key metrics.

Gross margin was on target at 34.3%, up 30 basis points sequentially and 190 basis points year over year.

As anticipated, we did have higher unused capacity charges in the third quarter which impacted our gross margin by about 70 basis points.

We benefited from improved manufacturing efficiencies and since the softness in the market came late in the quarter it did not impact gross margin in the third quarter.

At the operating expense level our combined R&D and SG&A decreased 3.7% sequentially to $603m, principally due to seasonality.

Including R&D grants, net operating expenses in Q3 were $576m.

This level gives us confidence in our plan to now reduce our target net operating expenses range to $550m to $600m.

Operating margin, excluding impairment and restructuring charges, has demonstrated solid progression, reaching 4% of sales in the third quarter of 2014.

When excluding non-recurrent items, such as the Nano2017 grant catch-up and a gain from the sales of assets, the operating result improved by over $60m sequentially and by $90m year over year.

We also showed progress in terms of net income and cash flow.

Specifically we posted net income of $72m and our free cash flow, as anticipated, turned to be positive at $140m.

We ended the quarter with strengthened financial resources of $2.46b following the $1b of convertible debt raised in July.

Shareholders received a quarterly dividend of $0.10 per share in each of the past two quarters.

The decision regarding the distribution of a dividend for the fourth quarter of 2014 and the first quarter of 2015 will be decided by our Supervisory Board at their regularly scheduled meeting on December 4.

As you know, the semi-annual dividend resolution is decided by the Supervisory Board of ST upon the recommendation of the Company's management.

Based upon the Company financial resources and cash requirements as well as our visibility of the overall economic environment, management currently intends to recommend the continuation of the current dividend level.

However, as noted above, the ultimate decision remains within the discretion of our Supervisory Board.

Now let me talk about our actions to further lower our cost base.

As we discussed at our Investor Day in May, we have flexibility to achieve our financial model so there are several parts to reach our mid-term operating margin goal of about 10%.

In the digital business, given the softness in the market, the decision to discontinue the commodity camera module products and the timing to ramp up specific ASIC products, we have decided to take additional measures.

Our objective is to reach $100m in annualizing savings at the operating expense level within the third quarter of 2015.

In particular, we have now combined our DCG and IBP groups to sharpen our focus in three principal areas.

First, application-specific standard products addressing home gateways and set top boxes, as well as our digital ASICs for consumer applications.

Second, mixed process and digital ASICs including silicon photonics, addressing communication infrastructure.

And third, differentiated imaging products.

Finally, based upon the recent announcement by our research alliance partners, we have initiated a review of the implications to our process technology.

Now let's move to our product segment results, starting with embedded processing solutions.

EPS third quarter net revenues increased 1% on a sequential basis, driven by set-top box products within DCG and IBP.

MMS sequential sales slowed after our record quarterly revenue in Q2, although still growing almost 5% on a year-over-year basis, driven by general purpose microcontrollers.

In this area we continue to keep a balanced mix between sales to key OEMs and the mass market, which again represented about 70% of total general purpose microcontrollers sales in Q3.

During the quarter we enjoyed a high rate of STM32 microcontroller design wins, fueled especially by the ultra low power and entry range series.

These designs are across the board in everything, from mobile and wearable devices to home appliances and specialized industrial applications.

To offer our customers even more choice with our STM32 family we announced and demonstrated our new STM32 F7 series, the world's first ARM Cortex M7 processor core microcontroller.

This product redefines the performance capabilities in this segment.

We also started ramping production of our STM32 L0 ultra low power MCU.

In digital consumer and ASIC we continued to expand our ecosystem in the HEVC set-top box and home gateways through our Cannes and Monaco family.

Here you can clearly see the progress between IBC in September last year where we first announced these products and IBC this year where devices based on the family were showcased in more than 20 partners' and customers' [boot].

At the show we also demoed the latest members of this family which will pave the way for large scale deployment of the new 4K set-top boxes.

In imaging our latest product announcement is in line with our sharpened focus.

We launched a module based on our Time-of-Flight technology, which combines a proximity sensor, ambient light sensor and basic gesture recognition.

This module is perfectly suited for mobile devices, consumer white goods and industrial applications and it is now in volume production.

As you know, LG is already utilizing our Time-of-Flight technology to assist the laser autofocus performance of its G3 smartphone.

From an operating result perspective, EPS segment operating loss was $27m and excluding the $97m of non-recurrent Nano2017 catch-up recorded in the second quarter of 2014, EPS operating losses improved by $56m sequentially.

Moving to sense and power and automotive, third quarter net revenues increased 1.3% sequentially, driven by IPD and AMS, with APG flat and better than seasonality.

As anticipated, our analog MEMS and sensor group ramped new MEMS products including our high performance microphones and high-accuracy pressure sensors and touchscreen controllers for the volume market.

For example, our pressure sensor and fingertip touchscreen controllers are now used in Samsung cutting edge Galaxy Note 4 and Galaxy Note Edge smartphones.

Microphones are also a growth area for us with a large and attractive market.

During the third quarter we sold our 300 millionth MEMS microphone and we continue to gain share in this market.

Importantly, we started production of analog microphones for a recently launched smartphone for a leading consumer brand.

We also continue to lead on innovation in our established motion MEMS portfolio where we introduced the smallest six-axis motion sensor with industry-leading performance and power consumption.

Our presence in China is growing.

In the third quarter alone 17 new mobile devices were launched in China with our MEMS inside, adding to the 27 models already launched in the first half of the year.

Last quarter we said that we expected our analog and MEMS group to soon become a contributor to the ST performance again and that our latest sensors, such as our six-axis driver, analog microphone, pressure sensor and touchscreen controller, had been selected in various combinations for flagship smartphone models.

AMS grew sequentially and these products are now on the market or coming to the market.

In APG our position continues to strengthen.

Revenues were flat on a sequential basis despite seasonality and they were up sharply year over year by 11% due to broad-based growth.

We took advantage of the healthy market in US and in China, and of the good momentum of premium vehicles worldwide.

Our sales in automotive are outperforming the market growth also thanks to our product offer in active safety, mainly addressing premium vehicles.

ST is definitely ready, together with our partner, to serve the needs of the autonomous driving vehicles market.

We made inroads across our focus areas, in terms of diversifications, since we had a record quarter in terms of billings to distributions, thanks to our dedicated microcontrollers for automotive, but also strengthening our leadership in infotainment with our latest generation car radio processor, earning wins at large Japanese and Chinese OEM manufacturers.

Our digital products for automotive encompassing embedded flash for microcontrollers, active safety and car radio will contribute to loading and scale of our 300mm manufacturing in Crolles.

To conclude, on automotive we also won important designs for our smart power products in major American, European and Korean body applications and at one of our biggest European tier one suppliers for innovative engine management applications.

We also expanded our success in audio power amplifiers in Japan with several design wins.

Turning to industrial and power discrete, IPD, our sales increased 2.3% sequentially and are higher year over year by 6.1%.

In IPD we made progress in each of the growing application areas we are focused on, portable automation motion control and several power conversion areas.

We won business with a leading automotive supplier with our advanced branch power MOS technology and capture sockets in server power supply applications from a leading manufacturer in the US for both high and low voltage MOSFETs.

We also won designs for an advanced family of IGBTs and half-bridge gate drivers for a household appliance with a leading global brand, achieved a number of important design wins with our 600 and 1200 volt silicon carbide diodes, and we released to the market the first silicon carbide 1200 volt MOSFET transistor.

Finally, we did grow in a number of new areas through our distribution partners with our ST Spin family of motor drivers.

Turning now to SP&A operating margin performance, the operating margin was 9.4% in the quarter compared to the 10.5% in the second quarter.

Normalizing for the Q2 benefit for the Nano2017 catch-up funding, the operating margin for SP&A increased 50 basis points sequentially.

Let's now move to our outlook.

Entering the third quarter we went from a favorable macroeconomic backdrop to a mixed backdrop entering the fourth quarter, which we see affecting most of our product groups.

As a result, for the fourth quarter we expect a sequential decrease in revenues of about 3.5% at the mid-point, plus or minus 350 basis points.

With respect to our gross margin, we anticipate about 33.8% at the mid-point, plus or minus 200 basis points.

This reflects a negative impact of about 150 to 200 basis points due to unsaturation charges principally related to digital technology.

Now, as we look further out to the second half of 2015 and considering the current soft market conditions, we are now working to drive to quarterly revenues of $2b, a gross margin in the range of 36% to 38%, and a net operating expenses range of $550m to $600m.

Our roadmap for our product groups is clear.

Within analog MEMS and sensors we have the appropriate product pipeline to drive it forward, both with our major accounts and across a more diversified customer base.

For MMS and IPD we see the consolidation of our leadership and continuous expansion in the mass market and the Internet of Things applications.

For automotive we see continued penetration in growing areas such as active safety and increased customer pervasiveness thanks to our microcontrollers.

And finally, for digital we see a strong and competitive product roadmap contributing to growth in spite of a slower than anticipated trend.

And with respect to our gross margin, substantial improvement in manufacturing cost will help to drive us to this target range even with some softer revenue level.

On the expense front, this is well within our control.

To conclude, ST today has a very solid product portfolio to drive growth, a sharpened focus on its digital business, and overall the ability to adjust to macroeconomic and market dynamics.

This in order to make all of our businesses self-sustainable and successful and ultimately to achieve our operating margin goal.

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

Thank you.

(Operator Instructions).

Gareth Jenkins, UBS.

Yes, just a couple if I could please, Carlo.

Firstly, I wondered if you could talk about the current book to bills across your various units.

And secondly, I just wondered on the OpEx guide that you've given, the $550m to $600m, is that before any potential OpEx benefit -- sorry, any FX benefits, so any foreign exchange benefits?

Or is that just on the underlying cost-cutting that you're taking out incrementally from here?

Thank you.

Hi Gareth.

Carlo Ferro speaking.

Maybe I start from your second question about the operating expenses.

At the end there you noted we are running at $603m gross expenses net of the grants.

This is already below the $600m.

The third quarter is normally taking benefit from seasonality due to vacations so we have also to refer to a more normalized calendar.

So in this respect there is some advantage from the exchange rate of the euro versus the dollar, which considering also our current and outstanding hedging will progressively materialize in the course of the next quarter, and I see frankly a rate net of the hedging similar to the current rage of about 1.27, 1.28 for the third quarter of 2015.

So at that point we would have the full effect of the exchange rate and would of course have also the benefit of the cost realignment plan that Carlo's mentioned, the press release has mentioned has been launched in the perimeter of the embedded processing solutions segment, which is targeting to benefit $25m per quarter.

Grants at the end should remain stable in a bulk of about $30m per quarter.

So on this math you see how can we move from the current level to a very sustainable range between $550m to $600m and possibly towards the low end of this range.

On the first question, the one related to what we see currently in booking, of course we have now a few weeks of the month of October.

Booking in the month of October at the end is materializing in average similar to the month of September.

This has on the ?- it is [fair] to the average of the second quarter considering that for the seasonality on booking in August have been as we have already anticipated somehow weak.

But so far at the end we see the month of October very similar to what we experienced in September and in line with the overall consideration of some softening in demand, which we are currently witnessing.

Yes, I would say that the unit where we have a positive book to bill today is basically our analog MEMS and sensors and this is, I would say, more customer specific, while the softening of the bookings we've done is more visible in the mass market, in the fragmented base of industrial customers and maybe a little bit more in Europe and in Asia, and less in US.

Maybe just if I could follow up then.

Would it be, without putting words in your mouth, fair to assume that you have book to bill below one in all divisional units except AMS, where it's above 1, or is that too much to read in?

It's a fair assessment.

It's a fair assessment.

Thank you.

Thank you Gareth.

Next question, Moira?

Andrew Gardiner, Barclays.

Good morning.

Thanks for taking my question.

I was just interested in diving a bit deeper into the updated operating model you outlined for the second half of next year, specifically around the revenue levels.

If we consider what you've just told us about fourth quarter and assume a normal seasonal decline into 1Q, then we're by my math looking at something around the order of the mid-teens rise in revenue from that base in the first quarter to get you towards the $2b per quarter mark by third or fourth quarters of next year.

I was just wondering what you're basing that ramp on?

How much are you expecting is going to be seasonal and potentially a cyclical uplift off a weaker 4Q, and how much are you still banking on things like DCG coming back strongly and other structural growth drivers?

Any detail around the revenue drivers would be helpful.

Thank you.

Yes, so I take this.

I think of course the focus is on the top line.

We have been explicit here.

We have, let's say, the ambition to go to about $2b in Q3 and of course in Q4 next year.

And I would say that here really is -- you can split this in two blocks.

There are customer-specific opportunities and also important awards.

You mentioned DCG that of course will have to contribute on the new products, but equally on the new products we are experiencing some softening in the market in the set-top boxes and decline on the old products, but very strong momentum on the new products.

As I said before, if I compare IBC this year with IBC last year, there is an important number of customers now that are starting to use our Cannes and Monaco families.

But not only DCG.

We also have customer-specific programs and awards today in our sensors and this we believe that could materially contribute to the growth.

Then we plan of course also some growth.

So in the core business that is IPD, our microcontrollers, it's the automotive, in the automotive business.

So this is starting from the level that we are projecting in Q4 where we see clearly some inventory adjustment.

We have noticed this particularly in distribution where the expectations of many of our distributions is to have a temporary decline of the POS in Q4 this year, after I would say a good POS performance even in Q3.

In Q3 we had a good POS performance in distribution on a very broad base.

But many of our distributions are expecting some softening of the POS in Q4 and taking measures to adjust on inventory.

We have I would say slightly increased inventory in distribution.

It's probably in the range between 5% and 10%, with a very modest increase of the stock turn but it's absolutely under control.

But again I think the visibility of some adjustment here is coming from our important -- most important distributors in the world.

Now we expect also in this part to restart growing and then moving from Q1 to Q2 and Q3 next year.

So you see the contribution of this effort in the mass market where I believe that this year the performances are pretty good, our growth of the POS is very material this year.

And to see this coming back starting from Q2 next year but also specific customer opportunities on specific products in the area of our sensors and DCG.

Thanks very much Carlo.

Thank you.

Thank you Andrew.

Next question please?

Achal Sultania, Credit Suisse.

Thanks for taking my question.

So first, Carlo, first question on this DCG business.

So in the $2b quarterly revenue target that you've given long term, do you still believe that the contribution from DCG is going to go up from $200m a quarter to $300m?

That's the first question.

And the second one is when you've given this guidance for next quarter, the revenue guidance, I'm just trying to understand, you've talked about October bookings similar to September.

Are you expecting some sort of recovery in November, December to get to that level or you're already expecting things to remain broadly stable?

Can you say again on the second one?

So when you talk about the guidance for Q4 and then you mentioned the September -- October bookings similar to September.

Does your guidance for Q4 revenues, does it imply a pick-up in October, November?

I'm just trying to understand what kind of ramping do you expect?

No, we do not expect material improvements, some progress.

Of course for us moving out from the -- September was weaker than expected but of course was better than August that was impacted also by seasonal.

So the guidance that we have given is based on the backlog that we have today.

So of course the forecast and the frame orders from many important customers and a level of turn business that is certainly not more than what we traditionally get, which is of course cautional to the level of booking.

So it's not that we count on more turn business to achieve this guidance.

It is a rate of turn business that is similar to what we have achieved during the last quarters.

And of course we take into consideration also some potential customer slowdown at the end of the year in the Christmas period, which I think we have planned in our consideration to build up the guidance.

So there was another question on --

Yes, and the first one was on DCG.

So the contribution of the new group, so we call DPG, encompassing basically the three divisions, so the one focusing on consumer product division addressing set-top boxes and gateway and consumer ASIC using FD-SOI, the one called network product division addressing network communication infrastructure and using including photonics technology, and the third one where we will phase out the commodities camera module and focusing on differentiated imaging, the contribution of this group to the $2b will be in the range mentioned between $200m and $300m.

Thank you.

Thank you Achal.

Next question please.

Francois Meunier, Morgan Stanley.

Hello.

Yes, the question I have is about the microcontrollers.

Last time I saw you, Carlo, in London you were quite bullish on the microcontrollers and taking market share.

Since then there's been quite a big profit warning by Microchip everybody has seen and now you're having like 5% year on year growth in microcontrollers.

So is it okay that everybody was trying to get market share and it didn't happen so there is an inventory correction or is it also because the end markets are quite weak?

No, I think that we are progressing very well with our microcontrollers.

For instance, we are very pleased about the wave of design wins and also now the launch of the new F7 series, (technical difficulty) in the market, this level of performance.

I think it's a softening of the market.

In the case of our microcontrollers there is also some specific situations with customers in the smartphone areas where we have not lost nothing; it's just the volume that is somehow below the expectation.

We are absolutely present at these customers but they are selling a little bit less than what they thought.

But we are pleased about the progress in microcontrollers.

I think this is I believe a small correction after many, many quarters of growth.

It's certainly market related, certainly market related.

And we have important opportunities in microcontrollers, not only the mass market that of course is our major area of drive for microcontrollers, but also with the major customers, new major customers, which is giving us the, how can we say, the visibility.

The assessment is positive so the visibility is for continuous growth also during the course of next year on our microcontrollers.

And in automotive for Q4 how does it look?

Is it also temporary pause in terms of growth or basically what's going on?

Well, automotive, what we see in the automotive, the backlog that we have for (inaudible) is solid.

This is the first thing.

We have a good backlog for (inaudible).

We have noticed some reduction of bookings, particularly driven by, in the course of the quarter, at the end of the quarter, particularly driven by Asia.

This is Japan, Korea.

China, we're dealing more on the car infotainment part.

While I would say that America is strong and anyhow, let's say, the western world is more customer specific; it's more customer specific.

But we have noticed some booking reductions coming particularly from Asia.

But from a base of a backlog that is pretty solid and robust also for Q4.

Of course for automotive this is, for instance, the information that we just got maybe one week ago, so the 6.1% growth of the car production in Europe in September, is not a bad signal.

But we are attentive also to understand at the end of this year what will happen in terms of pulls from the customers during the Christmas period.

Okay.

Thank you Carlo.

Thank you.

Thank you Francois.

Next question please.

Kai Korschelt, Merrill Lynch.

Yes, hi.

Thanks for taking my question.

I had two.

I just wanted to, Carlo if you don't mind, just push you a little again on the 10% margin target which I guess is kind of still standing there by the middle of next year.

So I'm just wondering what is your confidence level there?

We see additional cost-cutting but also obviously weaker top line, but a reasonable gross margin performance to get there.

So how should we think about the conviction in your ambition now versus maybe six months ago?

And the second question was really on the comment you made around reconsidering your process technology.

Just wondering is this related to your FD-SOI initiative as well or is that just a broader comment on going sub-40 nanometer in your own fabs?

Thank you.

So I'll take the first and then Jean-Marc will cover on the research alliance.

Well, first of all, we are keeping our mid-term quarterly operating margin goal of 10%.

This must be clear.

I think one demonstration that we take this very, very seriously is that we have taken this opportunity of a market softening but also the decision that was already somehow in progress to really now discontinue our commodity camera module business, also to merge the two groups, and extracting synergies.

So this is another step in terms of more focusing and also the opportunity to extract another $25m of operating income.

So this is another sign of our determination to move there.

We have also tried to give in my reading introduction before, the model is a model that is compatible with $2b sales, with the opportunity to grow in Q3 next year, as we said before, Carlo said before, to grow around the $550m.

Of course this will give us additional leverage.

And the gross margin, we have said that in Q4 this year the gross margin is impacted at the level of 150 to 200 basis points by unsaturation cost, which is very material.

And clearly at $2b level we are completely out from this kind of aggravation, which is particularly important in our digital fabs, and this will be clearly a very significant and material contribution to the gross margin improvement.

So overall I think it's clear that there is a softening today but we are determined to get into our model as soon as possible.

Now if you talk about, for instance, Q3 next year I can say that there will be very, very substantial progression from the 4% operating margin that we have in our hands today, with revenues that are more under reach based on the visibility that we have.

Shall I take the point about technology, Carlo?

Yes.

So about process technology, so in fact we have to acknowledge from this announcement early last week, but, okay, can mention because it is public that IBM will not remain vertically integrated at 10 nanometers, adopting the 3D transistor technology from Global Foundries.

So this is an important element.

While the second important element that overall we are seeing the industry is really struggling in the learning curve of this 3D advanced technologies and whilst in the majority of extreme UV photolithography, making the economics of all these very advanced nodes more and more difficult.

So that confirms many points.

So, first, to address our consumer product portfolio, 28 FD-SOI and the next-generation we are the right choice for all this kind of business.

And we have to look at all the implications for the advanced part of our technology roadmap related to the two points I mentioned to you.

And we have start a review and an assessment to position ourselves in front of this material element.

And I think I can conclude that -- so this is new for us now.

It's just something that recently been announced and at this point I think all options are open.

Sorry, could I just -- just to clarify, so you're saying that that FD-SOI at 20 nanometers -- 28 nanometers could be a one- or two-node product event, but for further nodes you may keep all options open, including not developing that technology further.

Is that right?

Yes.

On the FD-SOI it's clear.

We have two nodes.

So this is very, very important for ST, for our customers.

It's fully committed.

We have a lot of awards.

So this is the 28 and, let's say, the 14 or whatever generation.

So these two nodes, this is absolutely important for ST.

What we said, we are reviewing the activity for the further nodes.

This is forming a very recent announcement and today all options are open.

Thank you.

Thank you Kai.

Next question?

Sandeep Deshpande, JPMorgan.

Yes, hi.

Thanks for letting me on.

I have a couple of questions.

The first one I have is on your operating expenses to sales, which of course R&D is the biggest percentage, when you look at it, Carlo, your OpEx to sales is highest among the peer group.

And despite being the highest among the peer group you don't have growth rates much higher than the peer group.

You're now talking about bringing it down slightly and talking about a slightly different model into the second half of next year.

But it still remains higher than, even under the new model it remains higher than the peer group.

Why does ST want to operate on a model which is so different from the peer group and thus have a low level of profitability?

That's my first question.

And secondly, in terms of your internal processes, my question would be, on the different business units you are exposed to you're now announcing exit from the camera module business.

This was a business which was considered being exited almost five, four/five years ago and essentially at this point is this not being reactive rather than proactive in terms of deciding to be in businesses?

Thanks.

Yes.

Well, I think if we take the first point, maybe Carlo can comment on the model, but we believe that our model is well balanced because if we want to have a structure where gross margin is about 38% and with, let's say, 28% of the net expenses, and of course this 28% of net expenses is a combination of 11%, 12% SG&A and 16%, 17% of R&D.

So I believe that overall the model is based on a balanced weight of SG&A on one side and R&D, targeting the model.

And R&D level that is the 16%, 17% seems to be aligned also with that.

Now of course we need to go to the $2b and I believe we have the traction with the products and the applications to get there.

Now considering the camera module business, it's true that we have started our diversification effort.

Maybe not five years ago, but it's now maybe three years that we have started our diversification effort.

I think it's paying off.

Now to discontinue a line, there are other considerations.

You may deemphasize gradually, but there are other considerations, other specific customers' considerations and also loading consideration.

So we have decided now to formalize this debt.

But in the meantime we have been working with a lot of determination on products that are from my point of view, very, very good products, like the Time-of-Flight technology that is coming from this R&D activity and is to cover a number of applications, and not only the smartphone but also in the industrial and in the distribution market.

Thank you.

Thank you Sandeep.

Next question please.

Amit Harchandani, Citigroup.

Good morning gentlemen.

Amit Harchandani from Citigroup.

Thanks for taking my questions.

Maybe my first question would be more in terms of you talked about the fact that you expect the model to be around 38% gross margin, 36% to 38%.

In the past you have given us a bridge of how you go from where you are, the current levels of gross margin, to the target.

Is there any change in the bridge dynamics given the reduced level of revenue or the different moving parts remain the same in terms of gross margin progression?

That would be my first question.

And my second question is in terms of your free cash flow generation and capital allocation.

You have hinted towards the fact that the dividend level, at least from the management side, you would be recommending sustaining it.

As you look forward to your financial model or your revised financial model, in terms of free cash flow generation what kind of -- what are your assumptions in terms of capital intensity, D&A dynamics, and how do you think the free cash flow generation shapes up given your revised financial model?

Any color on that would be helpful.

Thank you.

Okay.

Maybe I take your question, Amit.

It's Carlo Ferro speaking.

The first one is about the gross margin progression going forward.

And of course answer to your question whether the ingredients to move on have changed is absolutely, yes, because of a reason that at the end we have improved 190 basis points year over year.

So part of those initiatives and actions that have been taken are already reflected in the 34.3% gross margin we reported for the third quarter.

So I believe maybe what could be beneficial now is to look at how to move on from the 34.3% into the 36% to 38% range.

So there is a big point which is about the loading of the fab.

At the end, the quarter has been still affected by the annual capacity charges, has been a 70-basis-point hit to the margin and our normalized model is based on a full utilization of capacity, recognizing that the $2b quarterly revenues, as distributed by technology, based on the current visibility to distribute the $2b by product group and technology will result in full utilization of all the fab.

So this is a first 70-basis-point progression.

Then the initiative on addressing low-margin products, which is a combination of the sale of former ST-Ericsson products still in our billing, plus some of the product pruning, here we target to extract at least 1 point of improvement.

The initiative for manufacturing restructuring, a bigger part of the advantage for the consolidation in the closure of Longgang is already in the gross margin, is not in the operating margin as in the third quarter we enter to account as a result the extra cost in the Longgang.

So this is no longer a contributor.

However, the initiative from 6-inch to 8-inch, in particular in Singapore next year, in Catania, still able to continue to contribute together with targets of improving efficiency in the fabs.

And this is another point of target improvement.

The euro/dollar, yes, some one of you has rightly mentioned it in your questions, is also a contributor.

With the dollar at EUR1.27, at the end we've another point in respect to the third quarter.

And then of course you may consider that on this number there is some erosion in respect to price dynamics that are not always fully compensated by the natural improvement in the product mix.

So to wrap up on the math, 34.3%, plus 70 basis points from unused, plus over 1 point from low-margin products, plus about 1 point from the efficiencies, plus about 1 point to realign on the current exchange rate and some minus due to the price higher than mix.

Cash flow.

On cash flow, you know that at the end we have -- we said entering the quarter that third quarter could be the quarter of turning the free cash flow to positive.

We have reported $140m of positive free cash flow for the third quarter.

We do anticipate a positive free cash flow also for the current quarter, so the Company's moving towards cash flow generation.

Again, and this is very important, and of course all of this also reflects a model that has been revised several years ago on the capital intensity of the Company, which remains the same of expecting over a cycle a CapEx-to-sales ratio well below the 10%.

Thank you Carlo.

You're welcome.

Thank you Amit.

Next question please.

Guenther Hollfelder, Baader Bank.

Hi.

Thank you.

First one, when would you expect the trough to be reached for the idle costs in your digital fabs?

Unused capacity?

For the unused capacity, was it?

Yes.

Yes.

That's it?

You have only one question, Guenther?

No.

I have -- would have some additional ones.

Go ahead.

Otherwise we'll be too much diligent.

Unsafe instruction.

Okay.

I take, well, I can take this.

I think what we see is, let's say, contribution from three product groups to the loading of our digital sales.

So there is an increasing contribution in the area of course of digital, with the new products of digital.

But very importantly for us there is also good growth on the automotive digital products.

That is a combination of car infotainment devices and also microcontrollers for automotive, and also safety processors, processors for safety applications in the automotive.

So this is the second part.

The third part is our general purpose microcontroller and secure microcontroller that is also running in Crolles.

So the view that we have is that we will incur material unloading cost in Q4.

As I said, the impact is at least [200] basis points.

Then we will have reduction of the unloading cost in Q1.

And then we plan to get significantly better with the moves, the manufacturing moves during the course of Q2, and we plan not to have unsaturation cost from the digital fabs of the Company in Q3 next year.

And this is based on the visibility that we have in terms of growth in, necessarily in the area of digital products, but automotive, secure and general purpose microcontrollers and of course our, let's say, DCG new products.

Thank you.

Coming to automotive, could you remind me what's the share of distributors at your total automotive sales today?

And maybe also a comment on what the business with the western tier ones is doing right now in automotive.

Yes.

Well, we are looking at the exact number because now this is for the product group.

I think it's around 20%, the total sales that we have in distribution for our APG group, which is very, very -- which is very important for us because also in the automotive we are working very hard to differentiate the customer base and to expand the customer base.

So this is more or less the weight, with a strong growth year over year of the distribution.

Well, in Q3 it was 21%, so I was not too far.

Great.

Thank you, Guenther.

Next question, please.

Daniele Lepido, Bloomberg News.

Good morning.

Thanks for taking my question.

I have a couple of questions for Mr. Bozotti.

The first one is I would like to understand if you can confirm the 10% operating margin for I think mid-2015.

Yes.

Well, we have -- there was already this question a very few minutes ago so I can repeat exactly what I said.

So, number one, we want to make sure that there is no doubt on the fact that this is our target margin, so is the 10%.

And in order to make sure that we move on the right direction here, we have taken this new initiative in terms of cost control.

First of all, is the merge of the two groups, the IBP and DCG.

And second, also the discontinuity of the commodity camera business.

And we have identified about $100m per year of additional cost saving, expense savings.

The third point is that we have underlined that we are now targeting for the second part of next year a level of sales in the range of $2b per quarter.

And this is the visibility that we have today, taking into consideration certain new products, particular in the area of DCG but also in the area of sensors and MEMS.

And operating expenses that in Q3 next year will be very, very close to the $550m, which will be in fact below the level that we have this year, with a target gross margin of between 36% and 38%.

We have just described the drivers of the gross margin Q3 over Q3, so about 70 basis points is related to unloading cost.

Then we have 1 point related to mix, mix improvement, 1 point more related to the evolution of the exchange rate between the euro/dollar per dollar base, and 1 point related to the manufacturing initiatives, restructuring initiatives that we have in progress today.

And this will be then partially offset by some gap between the natural evolution of the prices and the continuous improvement that we have in our manufacturing machines.

You are determinated to reach the 10% margin, operating margin?

We are very determinated, very determined of course.

Clearly the softening of the market is not helping and is making this a little bit more challenging, but there is a very strong determination and the best sign is this new initiative on expense control.

And what I can say that we will have a very, very substantial progression from the 4% of Q3 this year, which is already a very substantial progression over Q3 last year.

In fact the progression in one year in terms of operating income was in the range of $90m; this is Q3 2014 over Q3 2013.

Thanks a lot.

Last question.

Reading the press release, after reading the press release, I got that probably you are planning to cut 550 jobs.

Is that correct or not?

It's 450.

Yes, 450.

450.

So are these job cuts?

What do you mean?

Yes, this is unfortunately a reduction of the workforce of 450.

Okay.

Thank you.

Thank you very much, Mr. Bozotti.

Thank you.

Thank you.

Next question please.

Adithya Metuku, Bank of America.

Yes.

Thank you for taking my questions.

Most of my questions have been answered.

Just a few.

Can you provide some color on where the demand weakness has exacerbated recently, more so in the last couple of weeks?

Hello?

Yes?

Yes.

Sorry.

And can you provide some color on what proportion of your distributor revenues are on consignment?

And finally, with regards to your process technology review, does this play into the $100m savings, OpEx savings you announced?

Does that imply that you're going to cut some R&D expenses from this process technology review?

Thank you.

Well, we do not have a consignment business model with distribution.

We have a consignment business model with major accounts, some of our major accounts.

And the model is such that we work with shippable frame orders coming from the customers that are transformed into firm orders and real bookings at the moment they pull the products.

So the real booking and the billing is at the same time.

But this is not the case in distribution.

In distribution we have a business model that is based more on firm orders, firm orders entry and then delivery.

Of course then in distribution the most important element for us is the evolution of the point of sales.

It's not what we sell to distributors but it's what they sell in terms of our products.

And this is what we track and this is the fundamental indicator of the quality of the business in distribution.

Now to respond to the second question, I think it's absolutely premature to address this question because, as I said, we are now reviewing this -- the implication after this recent announcement on our partners in the research alliance and, as I said, this is open to any possible options, so I think it's absolutely premature here.

Okay.

Thanks.

So just to confirm, you recognize distribution revenues once they've been sold by the distributors.

Is that the right way to look at it?

Yes.

We recognize distribution revenues when we sell to distribution.

But of course there are mechanisms that are also accounting mechanisms of ship and debit price protection and stock rotation that are part of the way to manage the distribution, absolutely.

Okay.

Perfect.

Then just my first question of course on whether the demand weakness has exacerbated recently.

Yes, what we see is a softening of the demand in the second part of the quarter, particularly the month of September and, as we said, more on the mass market and on the fragmented customer base, on the wide base of industrial customers, and this has impacted more our microcontrollers and of course also our power and analog products.

I think this is more visible in Asia and in Europe.

I can report that many of our distributors are expecting a temporary reduction of the POS in the course of the last quarter of this year.

And as a consequence of this expectation because, I repeat, I already mentioned before, the POS in Q3 was not bad at all.

We had a very, very solid performance in terms of point of sales during the third quarter.

But the expectations of our distributors, of our major distributors is for a decline of, a temporary decline of the POS in Q4 and as a consequence of an effort to mitigate any wrong evolution in terms of inventory and stock turns.

As I said before, there was a moderate increase of inventory in Q3.

I mentioned that this is in the range between 5% and 10%.

This is the overall inventory and distribution, with a very modest deterioration of the stock turn in distribution.

But one of the actions that of course we have taken together with our distributors is to make sure that there is no accumulation and then -- but again, the focus is on the point of sales.

Yes.

Okay.

Perfect.

Thank you.

Thank you Adi.

Next question please.

Dan Gardiner, Arete Research.

Good morning gentlemen and thanks for the chance to ask a question.

Just following on that previous question, could you indicate the weeks of inventory in the channel and how it compares to your average?

Apologies if I missed it, but that would be a helpful number.

Yes, I think we can provide.

We are not -- we believe that with our product portfolio, three months of inventory is the right number.

Of course we have discussions with our distributors, but we believe this is the right number for the portfolio that we have, the power microcontrollers, power analog and also sensors, the sensors that we send through distributors.

Now there was, as I said, a little deterioration and the end of the quarter last quarter, but we are still around the three months of inventory overall in our distribution channel.

That is not bad.

Thank you.

Maybe please Carlo?

To add a point of reference at the end, any company may have different metrics depending on the product portfolio in this respect.

I believe the short answer to your question is that the inventory turns at the end of the third quarter are higher than what they were at the end of the first quarter of this year.

Okay.

Thank you.

Very helpful.

And on the digital side, on the set-top box business, I was wondering if you could give us any more detail on what changed during the market -- sorry, during third quarter and fourth quarter.

And Broadcom specifically talking about taking share in emerging markets, which is where you're strong.

And how confident can we be that you're not going to lose share in emerging markets even as you ramp in the US next year?

And if what you're seeing is currently a short-term correction issue, why are you taking permanent cost restructuring measures at this point?

Yes.

The restructuring is not related to the set-top box, and I want to make this very, very clear.

The restructuring is related to the fact that we have decided to discontinue at this point also with the formalization with our customers the module, the commodity module business for imaging.

And at the same time, because this is not immaterial in terms of revenues, at the same time we have decided to merge IBP with DCG.

But there is nothing that we are doing in terms of cost saving initiatives that is, let's say, touching the design activity, for instance, on the set-top box at all.

So just to make sure that we are aligned on this.

I think what we see on the set-top box is the following.

We see some softness of the market.

I think our legacy products, as you know, they have and they are declining a little bit more than what we expected.

But certainly we have a very strong traction on new products.

And not only for America, for the American market.

We have very important design wins also for European customers.

And not only for cable, also for satellite.

So it's broader.

So it's not just for the American cable market.

But the American cable market remains a very, very important target for us because this is a very significant market and our presence is today modest.

And I think we have good opportunities, including the one on the modem, our DOCSIS family, the 3.0 and now also the 3.1.

Thank you.

And if I could squeeze in one more, I wanted to also clarify the comments on manufacturing you made.

Is it your understanding that FinFET development over the last six months is not progressing as expected at the major foundries, despite two of them expecting to tape out within 12 months?

And our understanding is that within the IBM alliance, IBM's not really been at the front seat for IP development for some time.

So could you indicate what ways and areas IBM has contributed to your process technology development over the last two years and therefore what the risk is that under new ownership, and they focus entirely on FinFET, what the risk would be to your FD-SOI process technology?

So FD-SOI, there is absolutely no risk because the 28 is completed.

It is on the way to be qualified for mass production with our partner in Samsung.

ST has already started to develop the next generation and we will follow a similar path than the 28.

And we consider that these two nodes will be very, very long-lasting nodes for our product portfolio, whatever is the consumer or communication network infrastructure.

Again, this is what I have said two minutes ago.

We have to acknowledge the fact that IBM will not remain vertically integrated at 10 nanometers.

The second fact is that extreme UV photolithography is very far from either the productivity or the availability expected, making this 10-nanometer node a node which will be only for very few high-volume applications.

And main part of the semiconductor market will remain for a long time on 28 and 14 nanometers on FD-SOI or on some FinFET when the FinFET will be ready.

So this is exactly what we think today.

Thank you.

Very helpful.

Thank you Dan.

In order to get to all the questions that we still have left in the queue, if you could just limit yourself to one question, that would be appreciated.

So next question, Moira.

Gianmarco Bonacina, Equita SIM.

Yes, good morning.

Just a small one.

Can you tell us in the 3Q how was the performance of the general microcontroller versus the secure microcontroller and if you expect these performance in the division to diverge going forward?

Thank you.

We expect the performance on the division to --

Diverge.

Diverge.

No, we do not think so.

I think we have -- first of all, I think the impact in Q3 was more on the mass market.

So this of course we have more of the general-purpose microcontrollers on the mass market.

But in terms of evolution I think that the two lines are very, very important for us.

We have important programs not only in Europe in terms of secure elements for a variety of applications, including banking applications.

So this is very high-volume opportunities.

And some of them are also short-term opportunities for us.

And if I look at just the Q3 result I think we had a slight increase in the course of the Q3 of our secure microcontrollers.

And, as I said, the decrease was really driven by the general purpose and the market.

So the two lines remain important.

I also want to mention the fact there is a lot of synergies in terms of technology on cores and reuse of IPs between the two lines.

And we expect to continue to grow next year microcontrollers in both areas, secure and general purpose.

Thank you.

Thank you Gianmarco.

Next question please.

Mac Morris, Citi.

Yes, good morning gentlemen.

You mentioned that in spite of the softening you're seeing in the industrial level, your new products are actually providing very strong momentum in revenue growth.

At the same time you've reduced R&D and SG&A each by more than 10% over the last year.

I know you've touched on this briefly, but I was wondering if you could provide any further color in terms of your foreseeing further cuts in those areas or what your views is in the kind of balance that has to be achieved in order to produce those new products that are driving growth currently, while also meeting your aims to streamline cost and achieve 10% operating margin.

Carlo Ferro is taking your question.

As you rightly pointed on the year-over-year dynamic of R&D in respect to the opportunities with new products and of course a very important factor to read this number and the evolution is about the exit from the wireless IT platform and the ST-Ericsson joint venture.

Indeed at the end the reduction in R&D expenses reflect the discontinued effort for IT platform in wireless segment from the joint venture.

And indeed, as a part of the exit from the joint venture, a significant number of resources, about 1,000 R&D people have moved to support and to serve other product groups of the Company, both in the digital or in the analog and the power technologies.

So in this respect I believe really you can read the number together with an increased effort to accelerate product innovation in the core business of the Company.

Thank you for the question.

We'll move to the next.

Guenther Hollfelder, Baader Bank.

Yes, hi.

I just had a question on the automotive tier ones, the western ones, like the Boschs and Contis and TRWs, what you're seeing there at the moment.

This is too specific.

As I said also before, I think when we move to the west -- we saw some slowdown in the automotive in Asia.

It's car infotainment in China and in general automotive in Japan and Korea.

This we noticed.

Now when we move to the west I think the situations are more customer-specific.

And frankly it's impossible for me to comment on this because I think we have been pleased to see the production of -- the growth of the level of production in September, which of course was relatively good news.

But we get then into customer specifics that we cannot comment.

Okay.

Thanks.

Thank you Guenther.

And I think we just have one more question so we'll go to that one please, Moira.

Johannes Schaller, Deutsche Bank.

Yes, hi there.

Thanks for taking my question.

Just one follow-up on secure microcontrollers, if I could.

At one of your major customers we probably see much, much higher attach rate of secure microcontrollers going forward again, but then it looks like some of your peers also quite aggressive.

So when you talked about the growth you expect here, is that the right way to think about it, that we should see a healthy market increase but there may be slightly lower share for you?

How are you thinking about that?

Thank you.

No.

What we see here, we see some opportunity that we have in secure microcontroller to gain share and to gain share also in the United States and in Asia.

So I believe that we have a range of new products that are competitive products for a number of applications in the area of secure elements.

And we believe that there is a good traction and I think we have the opportunity to gain share in this business domain.

Okay.

That's interesting.

Thank you.

Thank you.

Thank you, Johannes.

I think at this point we'll go ahead and close the call.

Thank you to everybody for your participation.

Thank you.

Bye.

Ladies and gentlemen, the conference is now over.

Thank you for choosing Chorus Call and thank you for participating in the conference.

You may now disconnect your lines.

Goodbye.