STMicroelectronics N.V. (STMPA) Earnings Call Transcript

Ladies and gentlemen, welcome to the STMicroelectronics Q2 2023 Earnings Results Conference Call and Live Webcast. I am Moira, the Chorus Call operator. [Operator Instructions] The conference is being recorded. [Operator Instructions] The conference must not be recorded for publication or broadcast. At this time, it's my pleasure to hand over to Celine Berthier, Group Vice President, Head of Investor Relations. Please go ahead, madam.

Thank you, Mara, and good morning. Thank you, everyone, for joining our second quarter 2023 financial results conference call. Hosting the call today is Jean-Marc Chery, ST's President and Chief Executive Officer. Joining Jean-Marc on the call today are Lorenzo Grandi, President of Finance, Purchasing, ERM and Revenue and Chief Financial Officer; Marco Cassis, President of Analog, MEMS and Sensor Group and Head of STMicroelectronics Strategy, System Research and Application Innovation Office. This live webcast and presentation materials can be accessed on ST's Investor Relations website. The 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 this morning and also in ST's most recent regulatory filings for a full description of these risk factors. [Operator Instructions] I'd now like to turn the call over to Jean-Marc, President, and CEO.

Thank you, Celine, and good morning, everyone, and thank you for joining ST for our Q2 2023 earnings conference call. In Q2, our balanced end market approach, our broad product portfolio and strong customer relationships, enabled again a double-digit year-over-year growth. This performance came along with a year-over-year increase of our profitability. And as already anticipated, 2023 will be another year of progress toward our $20 billion plus revenue ambition and related financial model. Now let's start with the financial highlights overview. Second quarter net revenues of $4.33 billion came in above the midpoint of our business outlook range, and Q2 gross margin of 49% was in line with guidance. Q2 net revenues increased 12.7% year-over-year. The revenue performance continued to be driven by growth in Automotive and Industrial, partially offset by lower revenues in Personal Electronics. Looking at our year-over-year performance, gross margin increased to 49% from 47.4%. Operating margin increased to 26.5% from 26.2%. And net income increased 15.5% to $1 billion. On the first half of 2023, net revenues increased 16.1% year-over-year to $8.57 billion, driven by growth in all product groups, except the Analog and MEMS subgroups. We reported gross margin of 49.3%, operating margin of 27.4% and net income of $2.05 billion. On Q3 2023, our third quarter business outlook at the midpoint is for net revenues of about $4.38 billion, increasing 1.2% year-over-year and by 1.1% sequentially. Excluding the impact of the change in product mix in an engaged customer program in Personal Electronics, I mentioned in January, the Q3 revenue growth at the midpoint would be 3.5% year-over-year and 3.2% sequentially. Gross margin is expected to be about 47.5%. For the full year 2023, we will drive the company based on the plan for revenues of $17.4 billion, plus or minus $150 million. This represents a year-over-year growth of about 8%, and we now anticipate the gross margin to exceed 48% for the full year. Now I will move to a detailed review of the second quarter. Net revenues increased 12.7% year-over-year. This performance was driven mainly by ADG, up 34.4%, and MDG, up 13%, and continued strength in Automotive and Industrial. AMS revenues decreased 15.7%, mainly reflecting lower revenues in Personal Electronics as expected. Year-over-year, sales increased 9.8% to OEMs and 18.3% to Distribution. On a sequential basis, net revenues increased 1.9% with ADG up 8.2%, MDG up 4.3% and AMS down 11.9%. Net revenues came in 110 basis points above the midpoint of our outlook, mainly due to Automotive. Gross profit was $2.12 billion, increasing 16.5% year-over-year. Gross margin increased to 49% compared to 47.4% in the same quarter last year. The 160 basis points expansion was driven by product mix, favorable pricing, positive currency effect net of hedging, and partially offset by higher manufacturing costs. Year-over-year, the second quarter operating income increased 14.2% to $1.15 billion. In the quarter, net operating expenses include negative nonrecurring noncash items amounting to $34 million. Operating margin was 26.5%, increasing from 26.2% in Q2 2022. On a year-over-year basis, Q2 net income increased 15.5% to $1 billion compared to $867 million in the year ago quarter. Earnings per diluted share increased 15.2% to $1.06 compared to $0.92. Looking at our year-over-year sales performance by product group: ADG revenues increased 34.4%, on double-digit growth in both Automotive and Power Discrete. AMS revenues decreased 15.7%, with lower revenues in the 3 subgroups. MDG revenues increased 13%, with growth in Microcontrollers and RF Communications. In terms of operating margin, 2 of 3 product groups delivered year-on-year improvement: ADG operating margin increased to 31.9% from 24.7%. MDG operating margin increased to 35.4% from 33.6%, while AMS operating margin decreased to 14.8% from 24.1%. Net cash from operating activities increased 24.1% to $1.31 billion in Q2 versus $1.06 billion in the year ago quarter. CapEx in the second quarter was $1.07 billion compared to $809 million in the year ago quarter. Free cash flow was $209 million compared to the $230 million in the year ago quarter. During the second quarter, ST paid $50 million of cash dividends to stockholders, and we executed an $86 million share buyback under our current share repurchase program. ST's net financial position of $1.91 billion as of July 1, 2023, reflected total liquidity of $4.56 billion and total financial debt of $2.65 billion. Let me go through a recap of the main Q2 corporate and business highlights. We had 2 important announcements in Q2 related to our 300-millimeter and silicon carbide strategic manufacturing programs. First, we announced the conclusion of the 3-party agreements among the state of France, GlobalFoundries and our company, as approved by the European Commission. This relates to the new 300-millimeter semiconductor manufacturing facility in Crolles, France, first announced last July. This agreement will contribute to our $20 billion-plus revenue ambition and related financial model, and will further reinforce the European and French FD-SOI ecosystem. We will build more capacity for our European and global customers in advanced technologies as they transition to digitalization and decarbonization. The total investment for this project is expected to be about EUR 7.5 billion, and will benefit from French state financial support up to about EUR 2.9 billion, in line with the objectives set out in the European Chips Act. In silicon carbide, we announced a joint venture with Sanan Optoelectronics for high-volume 200-millimeter silicon carbide device manufacturing in China. The joint venture will support the rising demand for ST silicon carbide devices in China for car electrification and industrial power and energy applications. Sanan will build separately a 200-millimeter silicon carbide substrate manufacturing facility to fulfill the JV's need. The combination of the 200-millimeter substrate facility to be built by Sanan, with the front-end JV and ST's existing back-end facility in Shenzhen, will enable ST to offer our Chinese customers a fully vertical integrated silicon carbide value chain, a significant competitive advantage in the silicon carbide landscape. The new joint venture of silicon carbide fab is targeting to start production in Q4 2025, and full build-out is anticipated in 2028. It is an important step to further scale our global silicon carbide manufacturing operations, coming in addition to our continuing significant investments in Italy and Singapore. It will be 1 of the key enablers of the opportunity we see to reach above $5 billion silicon carbide yearly revenues by 2030. In this corporate development overview, I would like also to mention a change in our Executive Committee. During the quarter, Orio Bellezza, President, Quality Manufacturing, Technology and Supply Chain, and Member of ST Executive Committee, announced his retirement from the company. Orio will remain Managing Director of the company's Italian subsidiary until the expiration of his mandate. Fabio Gualandris, ST Executive Vice President, Head of Back-end Manufacturing and Technology and Deputy to Orio Bellezza, is appointed President, Quality Manufacturing and Technology. Upon my proposal, ST's Supervisory Board approved the appointment of Fabio to the company Executive Committee. I would like to thank Orio for his engagement in the numerous roles he has played at ST. And I wish Fabio all the best in his new role. I will now go through a short update on some of our strategic focus areas. In silicon carbide, we continue to increase the number of engagements: we are now working with 90 customers and 140 projects. Silicon carbide based power systems for electrical vehicle traction and industrial drives are complemented by our industry-leading STGAP galvanic isolation drivers based on ST's unique IP and advanced BCD technology. We announced an R&D collaboration with Airbus on wide bandgap semiconductors for aircraft electrification and decarbonization. This confirmed ST's leadership and the strength of our silicon carbide technology roadmap. In car digitalization, we saw continued design momentum with our later generation of automotive microcontrollers called Stellar across multiple applications. In parallel, in ADAS, we continue working closely with our long-time customer and partner, Mobileye. Their EyeQ6 product is now in production, and EyeQ Ultra at the R&D phase. Volumes of previous generations are ramping up. In May, we held our annual STM32 summit event for industrial customers in China, with 2,700 customers in person and a record breaking of 80,000 online. During the event, we made announcements related to edge AI, namely AI running on microcontrollers, microprocessors and sensors. We launched a new family of microprocessor for secure industry 4.0 and edge AI to allow our developers to address higher performance applications. We also gave further details on the upcoming STM32N6 microcontroller. This is ST's first MCU with our neural processing unit hardware accelerator and will bring the best-in-class computing power, power consumption and cost of ownership for the applications we target. One of the industrial application demos we built with the customer performs up to 75 times faster for AI workloads versus today's high performance MCUs. We will start to sample the STM32N6 from September onwards. For developers, we are expanding our STM32Cube.ai software offering, including the launch of a collaboration with NVIDIA around the TAO, so Train, Adapt, Optimize toolkit now available. Edge AI is not only STM32. We have the same approach for sensors with the release of a new toolkit and associated software for our intelligent MEMS sensors for activity recognition and anomaly detection directly in the sensor. Now let's move to our third quarter 2023 financial outlook and our plan for the full year 2023. Wait a minute. For the third quarter, at the midpoint, we expect net revenues to be about $4.38 billion, representing year-over-year and sequential growth of 1.2% and 1.1%, respectively. As anticipated in January, we are entering in H2 2023 with a significant change in product mix in an engaged customer program in Personal Electronics. Excluding this change, our Q3 '23 revenues at the midpoint would grow year-over-year by 3.5% and sequentially by 3.2%. And based on our indication of $17.4 billion revenues for full year 2023, H2 2023 revenues would grow by about 6% compared both to H1 2023 and H2 2022. Q3 gross margin is expected to be about 47.5% at the midpoint, including about 150 basis points of unused capacity charges. For 2023, based on our visibility, we will drive the company based on a plan for full year 2023 revenues of $17.4 billion, plus or minus $150 million. This represents growth of about 8% over 2022. The full year 2023 gross margin will exceed 48%. We confirm our 2023 CapEx plan of about $4 billion. Thank you, and we are now ready to answer your questions.

[Operator Instructions] The first question is from Jerome Ramel from Exane.

Yes. First question, if you could help us to understand the dynamic per division for Q3 and [ year-over-year]? That would be the first question.

The dynamic for Q3 sequentially and year-over-year, I have to say that year-over-year, ADG and, let's say, will grow significantly, let's say, well above 20%. MDG will slightly grow year-over-year Q3 over Q4, but it is linked, okay, to the fact that China will not start slower than expected. Now AMS, okay, will decrease year-over-year by 31%, okay? But also this must be also corrected by the fact that we have this change in product mix. Well, sequentially, if we look Q3 2023 versus Q2, ADG will continue to grow, I have to say, a single-digit. AMS will be basically flattish. And MDG, okay, will slightly decrease again for the same reason because, in China, we do not see the expected restart is slower than expected.

Okay. And maybe a question for Lorenzo on the OpEx. Probably came above expectation for Q2. How should we think about the OpEx for Q3 and maybe the second half of this year?

In terms of OpEx, this quarter -- last quarter, in Q2, we were coming with a little bit higher level of OpEx. As we said, that we had [ one time ] that were not forecasted entering the quarter. And actually, the level of grants that we were expecting were not materializing due to the fact that they were a little bit postponed for administrative reasons, we were not in the position to recognize. What will happen in Q3, next OpEx, including other income and expenses will decline significantly in respect to Q2. We do expect a net OpEx in the range of $880 million and $890 million for this quarter, for Q3. This is the combination of seasonality and let's say the fact that the level of other income and expenses will be significantly positive, thanks to the fact that we will be in the position to recognize R&D grants. That was not the case in Q2. But for the year, I think we will position Q4 for sure in terms of OpEx, there will be some increase. Usually is a quarter that is a little bit, in terms of seasonality, more high level in terms of operating expenses. I think at the end of the year, the range quarterly OpEx will be in the range of between $910 million or $930 million, something like that.

The next question is from Francois Bouvignies from UBS.

So I have 2 quick ones. First 1 is on Automotive. I mean, obviously, very strong performance, 34% growth year-over-year. Now if I look at the peers. I mean, NXP is growing 9% -- it's automotive, Renesas is growing 3% year-over-year this quarter. So you seem to outperform by far your peers in terms of growth rates. Now I understand that silicon carbide is a big growth driver. But even if I try to exclude silicon carbide from this growth, I get definitely more than 25% growth year-over-year anyway. So I was just wondering, can you explain the strong outperformance versus some of your peers. [ Tesla ] is also growing like 20%,, excluding silicon carbide as such? And I'm asking because the U.S. peers, essentially they are saying that they don't want to fill the industry with inventories and they are managing basically this. So is there a risk that you fill too much the channel with inventories? Or yes, that's why I'm asking the drivers behind this stronger performance? And I have another 1 after.

No, I think there is -- the first reason fundamentally that we overperformed our peers, basically 2 reasons, we see that, okay. Do not forget that we partner with Mobileye. Mobileye is a leader worldwide of ADAS system. Now ADAS is more and more [ challenging ] the car industry, also driven by regulation. And if you want to be a 5-star NCAP, this kind of stuff, so you must embed some ADAS features. And ST is a partner of ADAS. And this is what I say in my script, the current generation of ADAS, mainly EyeQ4 and EyeQ3 are really ramping materially more. And the second reason, I know we are focusing on silicon carbide, but there is just Renesas and NXP. On top of that, we have, let's say, a richer portfolio, a larger portfolio on analog and microcontroller and MEMS. Don't forget power. So IGBT, low-voltage MOSFET, high-voltage MOSFET, VIPower, more and more we are [ perfecting ] VIPower, which are very adapted device for the new architecture in this car. Our 2 competitors, okay, have not this kind of technology. So this is the 2 main reasons why we overperformed our peers. It is ADAS and the remaining portfolio we have in power, including the VIPower.

Very clear. And my follow-up question would be on AMS. I mean I expected the share loss happening in the second half of the year. And I was a bit surprised on the Q2 year-over-year decline. And more importantly, the margins that decreased significantly. So I understand the top line, you have some kind of drop-through, but can you explain a bit more what's going on in AMS this quarter, and also a margin bridge would be amazing?

AMS from revenue, let's say, point of view, received a serious hit by Personal Electronics overall in Q2. I have to say, you know that smartphone, okay, this year overall will decrease. But more important, the inventory correction in Personal Electronics is going on, will still continue in Q3 as well. On another side, AMS is also exposed to [ order drive ]. And order drive is in the computer verticals and computer peripheral is also, let's say, very weak. So certainly, this is really the 2 main reasons at this stage of the, let's say, decrease, significant decrease of AMS revenue year-over-year. But about margin, maybe, Lorenzo, you can comment?

At the end, let's say, this impact on the margin is mainly due to the volume. It's mainly due to the fact that, of course, our, let's say, level of top line is declining. And for sure, the leverage on our expenses is worsening in this group. I would say this is the main driver. Then, of course, it's also impacted by some, let's say, deterioration in our manufacturing, especially, let's say, related to the activity that is lower for our MEMS, for these kind of products. But the main driver of our operating margin is related to the fact that the volume decreased and the expense to sales ratio for sure, is worsening for this group.

Next question, please.

The next question is from Aleksander Peterc from Societe Generale.

My first question would be on inventory, which rose to 126 days. How would you qualify this level of inventory? Is it elevated and needs to be worked down in the second half? Or is it no more reflecting usual seasonality for your business? And I have a follow-up.

Lorenzo?

I take this question. But we judge this a little bit too high. It's true that in Q2 our inventory for seasonality is increasing. Anyway, let's say, at this stage, 126 days of inventory is on a little bit on the high side. This is also the reason why, in the second part of the year, as we have already anticipated, Q3 and Q4, we will reduce our activity, our production activity, especially on the fabs that are more exposed to Personal Electronics and the consumer. This will bring unloading and this unsaturation charges. And this is visible in our gross margin this quarter, where we are hit by 150 basis points of unloading in our guidance of 47.5%. If you take it out, this impact, we are more or less similar to the 1 of Q2 in terms of gross margin.

And we finish the year, in terms of inventory?

In terms of inventory, yes, thank you. We will -- with this, let's say, we think to bring down our inventory more in a range of 100, 110 days of inventory in respect to the 126. Thank you for the follow-up

My second question would be on smartphones. You talked about this already in your introductory remarks, there's lack of recovery, let's call it this way, so far. How would you qualify the market now? Do you see any evidence of any bottoming out of the smartphone market, particularly in China in the current quarter? Or is it too soon to call it?

No, this is what I say. I think in terms of demand, the data point we have, looks like this year, the market, okay, with the demand of smartphone will slightly decrease, I think 1.5% or 2%, with still a changement of mix between the 4G and the 5G. The point is, this industry is still paying, last year, a strong decrease, minus 9%. And of course, the inventory, which has been built up, okay, last year are not yet digested. And this will continue in Q3. More so we hope, okay, progressively moving forward, Q4 and Q1 next year, to see first inventory digested and to be exposed to the [ head ] demand to the B2C demand of smartphone. So this is the scenario most likely, okay, we expect.

Thank you, Alex. Next question, please.

The next question is from Andrew Gardiner from Citi.

Can I ask 1 on pricing, please. We covered this with first quarter results, but it would be great to have a real-time update here with Q2. Lorenzo, if I look at the gross margin guidance you've given, particularly as you just highlighted, adjusting for the underutilization charges, gross margin's flat into 3Q and still remaining strong into 4Q. It suggests to me that there hasn't been much change in pricing, but if you can just walk us through some of the moving parts there, that would be helpful. And then I do have a quick follow-up.

No. We absolutely know no significant pricing impact sequentially Q3 versus Q2. Well, again, the gross margin dynamic, we have -- we will move clearly from 49% in Q2 to 47.5% in Q3, but it is impacted by the unused capacity. So in fact, okay, in Q3, basically, without this new capacity that we have decided by ourselves, okay, to decrease inventory level described by Lorenzo a few minute ago, our gross margin is still ballpark at 49%. For all the other effect, okay, you know that our input parameter like the product mix, the pricing, the manufacturing efficiency, all these parameters offset each other. So no, Q3, okay, we don't see any significant impact on the pricing.

And actually just related to that quickly, how much is the Agrate 300-millimeter fab ramp a headwind in 3Q?

Agrate in Q3, okay, has been included in the manufacturing efficiency, okay, as the 8-inch, which are, let's say, exposed to consumer, but Lorenzo, you...

In Q3 started to be, let's say, increasing, but is not yet very significant. It will be a little bit more during Q4 because, of course, the activity will start to be more visible. As we said, let's say, this is one of the factor of our second half gross margin, manufacturing overall and, let's say, the impact of the Agrate are, let's say, the main drivers of the declining, of course, together with the unloading charges, now this is obvious, but of our gross margin in the second half of the year. But still is not, let's say, super strong. It's not yet, let's say -- is part of this degradation, but it's not yet in Q3 so visible.

Okay. And then sorry, just a quick clarification. Jean-Marc, you gave us the sort of adjustments related to the product mix and the customer program in 3Q, saying that instead of 1% year-on-year and quarter-on-quarter, it would be sort of low to mid-3% on both those sort of year-on-year and Q-on-Q. Rough math, that's sort of $80 million, $90 million worth of impact. Earlier in the year, you thought it was going to be $500 million in the second half. Is there -- and I admit you broke up a little bit on my line in terms of when you were talking about the full year impact. Are you saying that sort of more of the impact is in 4Q? Or is it actually less than you had previously anticipated?

Well, it's a bit less than anticipated, but it is still very material because, again, I repeat this module we accepted to support our important customer. The revenue was really concentrated on H2 2022 and H1 2023. And basically, this appear in, let's say, Q3 and Q4 2023. The difference between H2 2023 and H2 2022 impacted by this -- by the device is a multi-hundred million dollar, below the number I gave in April, yes, it's below, but multi-hundred million dollar. That's the reason why, okay, if you make the math, we have confirmed this number of a significant change in the revenue dynamic H2 2023 versus H2 2022. And I have to say, in Q4, if you make the math at the midpoint, it's more important. Because if you compute our Q4 at the midpoint of $17.4 billion, it's a growth H2 Q4 '23 versus Q4 '22 of 0.7%. Corrected by this module, the growth is [ 7% ]. So it's really material. But the impact, difference H2 to H2 is multi-hundred million dollar below the number I gave in April.

Thank you, Andrew. Next question, please.

The next question is from Josh Buchalter from TD Cowen.

I wanted to ask about gross margin as well. So the guidance implies sort of a very modest decline from the third quarter to the fourth quarter. I think you previously called out 3 drivers of half-over-half declines of the start-up costs under your utilization charges and mix. It all seems like those should be peaking around the fourth quarter. Is that the right interpretation? And I guess, is there any reason why the fourth quarter wouldn't sort of be the trough of gross margins as you see things right now, assuming again stable market conditions?

At the end, let's say, when we look at the H2, the gross margin that we will have in average in H2 will be slightly above 47%. And this is impacted by more than 100 basis points of temporary unused capacity charges. Then at the end, let's say, the remaining 100 basis point of decline in compared to H1 are due to the full impact of our manufacturing increased input cost, as we said many times, that we will, let's say, be very, very, let's say, visible in the second part of the year, and the main part of the ramp-up of the Agrate 300 millimeter. I would say these are the key ingredients for our dynamic of our gross margin.