STMicroelectronics N.V. (STM) Q3 2014 Earnings Report, Transcript and Summary

Ladies and gentlemen, good morning. Welcome to the STMicroelectronics Third Quarter 2014 Earnings Result Conference Call and Live Webcast. I am Moira, the Chorus Call operator. [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 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 & 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. And I'd now like to turn the call over to Carlo Bozotti, ST's President and CEO. Carlo?

Good day. 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 $100 million cost savings plan and the discussion on our digital business organization. This will be followed by a review of our 2 product segments, including new designs and product highlights on our roadmap to 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 in the mass market, we came in below the 3% midpoint 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 $603 million, principally due to seasonality. Including R&D grants, net operating expenses in Q3 were $576 million. This level gives us confidence in our plan to now reduce our target net operating expenses range to $550 million to $600 million. Operating margin, excluding impairment and restructuring charges, has demonstrated solid progression, reaching 4% of sales in the third quarter of 2014. When excluding nonrecurring items, such as the Nano2017 grants catch-up and the gain from the sales of assets, the operating results improved by over $60 million sequentially and by $90 million year-over-year. We also showed progress in terms of net income and cash flow. Specifically, we posted net income of $72 million. And our free cash flow, as anticipated, turned to be positive at $140 million. We ended the quarter with strengthened financial resources of $2.46 billion, following the $1 billion of convertible debt raised in July. Shareholders received a quarterly dividend of $0.10 per share in each of the past 2 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 semiannual 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 a continuation of the current dividend level. Well, 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 paths 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 $100 million in annualized 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 3 principal areas: first, application-specific standard products addressing home gateway and set-top box as well as our digital ASICs for consumer applications; second, mixed process and digital ASICs, including silicon photonics, addressing the 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, also 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 microcontroller sales in Q3. During the quarter, we enjoyed 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 STM32L0 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/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' booths. 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 results perspective, EPS segment operating loss was $27 million. And excluding the $97 million of nonrecurrent Nano2017 catch-up recorded in the second quarter of 2014, EPS operating losses improved by $56 million sequentially. Moving to Sense & Power in 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 Sensors group ramped new MEMS products, including our high-performance microphones and high-accuracy pressure sensors and touchscreen controllers for volume market. For example, our pressure sensor and FingerTip touchscreen controller are now used in Samsung's 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 6-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 6-axis gyro, analog microphone, pressure sensor and touchscreen controller, have 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 U.S. 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 through distributions, thanks to our dedicated microcontrollers for automotives, 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 300-millimeter 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 1 suppliers for innovative engine management applications. We also expanded our success in audio power amplifiers in Japan with several design wins. Turning to Industrial & 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 trench PowerMOS technology and captured sockets in server power supply applications from a leading manufacturer in the U.S. 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 600V and 1200V silicon carbide diodes and we released to the market the first silicon carbide 1200V MOSFET transistor. Finally, we did grow in a number of new areas through our distribution partners with our STSPIN 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 of 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 midpoint, plus or minus 350 basis points. With respect to our gross margin, we anticipate about 33.8% at the midpoint, plus or minus 200 basis points. This reflects a negative impact of about 150 to 200 basis points due to unseparation[ph] 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 $2 billion, a gross margin in the range of 36% to 38% and a net operating expenses range of $550 million to $600 million. 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 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 ramp. And with respect to our gross margin, substantial improvement in manufacturing costs will help 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] The first question is from Mr. Gareth Jenkins from UBS.

Yes. Just a couple, if 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 $550 million to $600 million, is that before any potential OpEx benefits -- 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?

Gareth, Carlo Ferro speaking. Maybe I start from your second question about the operating expenses. At the end, you noted that we are running at $603 million gross expenses net of the range. This is already below the $600 million. The third quarter is normally taking benefit from seasonality due to vacation. 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 rate 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 Carlos mentioned the press release has mentioned has been launched in the perimeter of the Embedded Processing Solutions segment, which is targeting to benefit $25 million per quarter. Granted the end should remain stable in the bulk of about $30 million per quarter, so on this mark, you see how can we move from the current level to a very sustainable range, between $550 million to $600 million, 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 are 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, in respect to the average of the second quarter, considering that for the seasonalities on bookings 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 softening in demand, which we are currently witnessing.

Yes. I will say that the unit where we have a positive book-to-bill today is basically our Analog, MEMS and Sensors. And this is, I will say, more customer-specific while the softening of the bookings is more visible in the mass market in the fragmented days of industrial customers and a little bit more in Europe and in Asia and less in U.S.

Maybe just as a follow-up. Would it be, without putting words in your mouth, fair to assume that you have book-to-bill below 1 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.

The next question is from Mr. Andrew Gardiner from Barclays.

I was just interested in diving a bit deeper into sort of the updated operating model you have lined for the second half of next year, specifically around the revenue levels. If we consider what you just told us about fourth quarter and assuming normal seasonal decline into 1Q, then with -- my math is looking at something around the order of the mid-teens rise in revenue from that sort of base in the first quarter to get you towards the $2 billion per quarter mark by third or fourth quarters of next year. I'm just wondering sort of what you're basing that ramp on. How much is -- are you expecting it is going to be sort of seasonal or potentially a cyclical uplift off a weaker 4Q? And how much are you still banking on things like DCG coming back strongly and other sort of structural growth drivers? Any sort of detail around the revenue drivers would be helpful.

Yes, so I take this. And I think, of course, the focus is on the top line. I mean, we have been explicit here. We have, let's say, the ambition to go out to about $2 billion in Q3 and, of course, in Q4 next year. And I would say that here, really is you can see this in 2 blocks. There are customer-specific, let's say, opportunities but also important awards. You mentioned DCG that, of course, will have to contribute on the new products, particularly on the new products. We are experiencing some softening in the market in the set-top box and decline on the old products but very strong momentum on the new products. As we 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/Monaco families. But not all DCG, we also have customer-specific programs and awards today in our sensors. And this, we believe could materially contribute to the growth. And then we plan, of course, also some growth in the core business that is IPD, our microcontrollers, in the Automotive business. So this is starting from the level that we are projecting in Q4, where we see clearly some inventory adjustment. I mean, we have noticed this particularly in distribution, where the expectations of many of our distributions is to have a temporary decline of the U.S. in Q4 this year after, I will say, a good U.S. performance, even in Q3. In Q3, we had a good U.S. performance in distribution on a very broad base, but many of our distribution are projecting some softening of the POS in Q4 and taking measure to adjust on inventory. We have, I would say, slightly increasing inventory and distribution. It's probably in the range between 5% and 10%, with a very modest increase also of the stock turn but is absolutely under control. But again, I think the visibility of some adjustments here is coming from our important -- most important distributors in the world. Now we expect also in this path 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 performance 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.

The next question is from Achal Sultania from Crédit Suisse. Achal Sultania - Crédit Suisse AG, Research Division: First, Carlo, first question on this DCG business. So in the $2 billion quarterly revenue target that you've given long term, do you still believe that a contribution from DCG is going to go up from like $200 million a quarter to $300 million? That's the first question. And the second one is when you've given this guidance for next quarter, the revenue guidance, like what -- I'm just trying to understand, like you talked about October booking similar to September. Are you expecting some sort of a 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? Achal Sultania - Crédit Suisse AG, Research Division: So when you talked about the guidance for Q4, and then you mentioned September -- October bookings similar to September, is that your guidance for Q4 revenues? Does it imply a pickup in October, November? Or I'm just trying to understand what kind of ramp that you expect.

Yes. The assumption -- no, we do not expect a material movement. Some progress, of course, for us, moving out from the -- September was weaker than expected. But of course, it was better than August that was impacting -- impacted also by seasonal, let's say. So the guidance that we have given is -- I could say is on the backlog that we have today. Of course, the forecast and the frame orders from our many important customers and a level of turn business that is certainly not more than what we traditionally get, which is, of course, proportional to the level of bookings. So it's not that we count on more turn business to achieve this guidance. It's 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 plugged in our consideration to build up the guidance. So there was another question on... Achal Sultania - Crédit Suisse AG, Research Division: Yes, and the first one was on DCG.

Yes, DCG. So the contribution of the -- it's a new group, so we call DPG, encompassing basically the 3 divisions. So the one focusing on the consumer product division, addressing set-top box and gateway and consumer ASIC using of this slide. The one core network product division, addressing network communication infrastructure and using-- including photonics technology. And the third one, well, we'll phase out the commodities camera module and focusing on differentiated imaging. So the contribution of this group was $2 billion[ph] will be in the range you mentioned between $200 million to $300 million.

The next question is from Mr. Francois Meunier from Morgan Stanley.

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, it's been quite a big profit running by microchip and everybody's 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 inventory correction? Or is it also because the end markets are quite weak?

No, no. I think that we are progressing very well with our microcontrollers. So for instance, we are very pleased about the wave of design wins and those of -- now with the launch of the new F7 series, so the market at this level of performance. I think it's the softening of the market. In the case of our microcontrollers, there is also some specific situation with customers in the smartphone areas where we have not lost nothing. It is just the volume that is somehow below the expectation. We are absolutely present in 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 is certainly market related. And we have important opportunities in microcontrollers, not only the mass market, but of course, is our major area from drive from microcontrollers. But also, with the major customers and new major customers, which is giving us the -- what can we say, the visibility, now the assessment is positive. So the visibility is for continuous growth also during the course of next year on our microcontrollers.

And then, ultimately, for Q4, how does it look? Is it like also like a temporary pause in terms of growth? Or basically, what's going on?

Well, automotive, what we see in the automotive, let's say, the backlog that we have for it is solid. This is the first thing. We have a good backlog for our Automotive sector. We have noticed some, let's say, 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 being 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, it's -- for instance, the information that we've just got, I think, 1 week ago, so the 6.1% growth of the car production in Europe in September is not a bad signal, but we are attempting also to understand at the end of this year. So what will happen in terms of pulls from the customers during the Christmas period.

The next question is from Kai Korschelt from Merrill Lynch.

I had 2. I just wanted to -- Carlo, if you don't mind, just push a little again on the 10% margin targets, which, I guess, is kind of still standing there by the middle of next year. And so I'm just wondering what is the confidence level that with the additional cost cutting but also, obviously, weaker top line but reasonable gross margin performance to get there. So how should we think about the kind of the conviction in your ambition now versus maybe 6 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 kind of going sub 40-nanometer in your fabs?

Yes. So I take the first, and then Jean-Marc will cover on the research alliance. So well, first of all, we are keeping our midterm 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 the market softening, but also the decision that was already somehow in progress to really now discontinue our, let's say, commodity camera module business. Also, to merge into books and exacting synergies. So this is another step in terms of more focusing and also the opportunity to extract another $25 million of operating income. So this is another sign of our determination to move there. We have also tried to give in my -- it's like reading this introduction before, that the model is a model that is compatible with $2 billion sales, with the opportunity to grow in Q3 next year, as we said before, Carlo said before, to around $550 million. 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 unseparation costs, which is very material. And clearly, at $2 billion 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, let's say, improvement. So overall, I think it is 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 end today, with revenues that are more, let's say, under which based on the visibility that we have.

Points on process technology, I'll cover?

Yes.

So about process technology. So in fact, so we have to acknowledge from this announcement early last week that -- okay, I can mention because it is public that IBM will not remain vertically integrated at 10-nanometer, adopting the 3D transistor technology inverted from[indiscernible]. So this is an important element. Most second important element overall that we are seeing is the industry is really struggling in the learning curve of this 3D advanced technologies. And with is the maturity of [indiscernible] photolithography, making the economics of all this very advanced node more and more difficult. So that confirms many points. So first, okay, to address our consumer product portfolio, 28 of FD-SOI and the next-generation worldwide choice for all this kind of business. And we have to look at all implication for the advanced part of our technology roadmap related to the 2 points I mentioned to you. And we have start to review an assessments to position our sales material element.

And I think I can conclude that the -- so this is new for us. It's something that recently been announced. And at this point, I think all options are open.

So could I -- just to clarify. So you're saying that FD-SOI at 20-nanometer -- 28 nanometers could be a 1 or 2 nodes sort of product event? But for further nodes, you may sort of keep all options open, including not developing that technology further? Is that right?

Yes, on the FD, it's right, it's clear. We have 2 nodes. This is very, very important for ST, for our customers is fully committed that we have a lot of awards. And so this is the 28 and, let's say, the 14 or whatever generation so that this node -- this is absolutely important for ST. What we said that we are reviewing the activity for the part of nodes, and this is following a very recent announcement. And today, all options are open.

The next question is from Mr. Sandeep Deshpande from JPMorgan. Sandeep S. Deshpande - JP Morgan Chase & Co, Research Division: I have a couple of questions. First one I have is on your operating expenses in sales, which, of course, R&D is the biggest percentage. When you look at it, Carlo, you're 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 you're talking about 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 your -- the different business units you are exposed to. You're now announcing exits from the camera module business. This was a business you just considered being exited almost 5 -- 4, 5 years ago. And essentially, at this point, is this not being reactive rather than proactive in terms of deciding to be in businesses?

Yes. Well, I think if you take the first point, maybe Carlo can comment on the model, but we believe that our model is well balanced because we want to have a structure where gross margin is about 38% and with, let's say, 28% of 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, this -- the model is based on a balanced, let's say, weight of SG&A on one side and R&D targeting the model. And R&D, let's say, an R&D level that is the 16%, 17% that seems to be aligned also with that. Now of course, we need to go to the $2 billion. And I believe we have, let's say, 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 5 years ago, but it is now maybe 3 years that we have started our diversification effort. I think it's paying off. Now to discontinue a line, there are other considerations. I mean, you may deemphasize gradually, but there are other considerations, specific customers, let's say, consideration. And also loading consideration. So we have decided now to formalize this debt. And -- but in the meantime, we have been working, let's say, with a lot of determination in new products that are, from my point of view, very, very good products like -- this time will apply technology that is, say, coming from this R&D activity and to cover a number of applications and not only the smartphone, but also in the industrial and in the distribution market.

The next question is from Amit Harchandani from Citigroup.

Amit Harchandani from Citigroup. 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 year, you have given 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 dynamic, 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, would -- 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 generations, what kind of -- what are your assumptions in terms of capital intensity, DNA 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.

Okay. Maybe I take your question, Amit. This is Carlo Ferro speaking. The first one is about the gross margin progression going forward. And of course, the answer to your question whether that 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% rate, right? So yes, there is a big point which is about the loading of the fab. At the end of the quarter, has been still affected by the unused capacity charges, has been 70 basis points at least that was the margin, and our normalized model is based on a full utilization of capacity, recognizing that the $2 billion quarterly revenues as distributed by technology based on the current visibility to be distributed by product group and technology will result in full utilization of all the segments. So this is a first currency basis points of progression. Then the initiative on addressing low-margin product, which is a combination of the tail of former ST-Ericsson products is still in our billing. Plus some of the product pruning, here we target to attract at least 1 point of improvement. The initiative for manufacturing, restructuring, a bigger part of the advantage for the consolidation in the planned closure of Longgang is already in the gross margin, is not in the operating margin. As in the third quarter, we entered to account as a result of the extra cost in the Longgang. So this is no longer a contributor. We were -- the initiative from 6 to 18 share, in particular in Singapore and next year in Catania, still able to continue to contribute together with the targets of improved efficiency in the fab, and this is another point of target improvement. The euro dollar is -- from one of you have rightly mentioned it in prior questions, is also a contributor with the dollar at EUR 1.27. The dollar is EUR 1.27. At the end we have 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 user, plus over 1 point from low-margin product, plus about 1 point from the efficiencies, plus about 1 point to realign on the currency 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 the third quarter could have been the quarter of turning the free cash flow to positive. We have reported $140 million of positive free cash flow for the third quarter. We do anticipate a positive free cash flow also for the coming quarter. So the company's moving towards cash flow generation. Again, and this is very important. And of course, all of these also reflect a model that has been revised several years ago on the capital intensity of the company, which remains the same of expecting recycle CapEx to sales ratio was below the 10%.

The next question is from Mr. Guenther Hollfelder from Baader Bank.

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

Unused capacity? For the unused capacity, wasn't it?

Yes.

Okay. That's it? You have only one question, Guenther?

No, I have some additional ones here.

It's all right. Otherwise, we have been too much diligent on taking action. Okay, I take -- well, I can take this. I think what we see is, let's say, conclusion from 3 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 a good growth on the automotive digital products that is a combination of car infotainment devices and also microcontrollers for automotive and also safety processors. I mean, processors for safety applications in the automotive. So this is the second part. The third part is our general-purpose microcontroller, the secure microcontroller as opposed to running in Crolles. The view that we have is that we will incur a material unloading cost in Q4. As I said, the impact is 150 to 200 basis points. Then we will have a reduction of the unloading cost in Q1. And then we plan to get significantly better with the moves -- manufacturing moves during the course of Q2. And we plan not to have any unsaturation[ph] cost from the digital effects of the company in Q3 next year. And this is based on the visibility that we have in terms of growth, and as I said, in the area of digital products for automotive, secure and general-purpose microcontrollers and, of course, our, let's say, DCG products.

And coming to automotive, could you remind me what's the share of distributors of your total automotive sales today? And maybe also a comment on what the business with the Western tier 1s is doing right now in automotive.

Yes. Well, we are looking at the exact number because now this is for a product group. I think it's around 20%, the total sales that we have in distribution for our APG group. So we said -- which is a 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 way with a strong growth year-over-year of the distribution. Well, in Q3, it was 21%, so it was not too bad.

Your next question is from Mr. Daniele Lepido from Bloomberg News.

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 -- I mean, there was already this question a few minutes ago. So I can repeat exactly what I said. So number one, we want to make sure that there is no doubt in the fact that this is our target margin, so it's the 10%. In order to make sure that we move on the right direction here, we have taken these new initiatives in terms of cost control. First of all is the merge of the 2 groups, the IBP and the DCG. And second also, the discontinuity of the commodity camera business. And we have identified about $100 million 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 $2 billion per quarter. And this is the visibility that we have today taking into consideration certain new products, in particular in the area of DCG but also in the area of sensors and MEMS. And the operating expenses that in Q3 next year will be very, very close to the $550 million, which will be, in fact, below the level that we have this year. With the target gross margin of between 36% and 38%, that we have just described the drivers of the gross margin Q3 over Q3. So about 70 basis points is related to unloading cost. And 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 rate. And then 1 point related to the manufacturing initiatives, restructuring initiatives that we have in progress today. And this will be then partially offset by some, let's say, gap between the natural evolution of the prices and the continuous improvement that we have in our manufacturing machines. So...

You are to determined to reach that 10% margin -- operating margin.

We are very determined, of course. I think, 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 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. This is already a very substantial progression over Q3 last year. In fact, the progression in 1 year in terms of operating income was in the range of $90 million. This is Q3 2014 over Q3 2013.

Last question. Reading the press release -- after reading the press release, I got that it's 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, these are unfortunately the reduction of the workforce.

The next question is from Adithya Metuku from Bank of America.

Most of my questions have been answered. Can you provide some color on whether the demand weakness has exacerbated recently more so in the last couple of weeks? And can you provide some color on what proportion of your discrete revenues are on consignment? And finally, with regards to your process technology review, this is claimed to be $100 million savings, OpEx savings you announced. Does that imply that you're going to cut some R&D expenses from this process technology review?

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 the shippable frame orders coming from the customers that transform into firm orders and real bookings. At the moment, they pool their products, so then 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 pure models 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. 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 in our partners in the research alliance. And as I said, this is open to many possible options. So I think it's absolutely premature here.

Okay. 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 mechanism of -- that are also accounting mechanism of shipment debit, price reduction and the stock rotation that are part of the way to manage the distribution, absolutely.

Okay, perfect. Then just my first question, it was 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 demands in 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 our 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 that POS in Q3 was not bad at all. We had a very, let's say, 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 the 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 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 -- but again, the focus is on the point of sales.

Your next question is from Mr. Dan Gardner [ph] from Harte Research.

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'd be a helpful number.

Yes. I think we can provide. We are not -- I mean, we believe that with our product portfolio, 3 months of inventory is the right number. And of course, we have discussions with our distributors, but we believe this is the right numbers for the product portfolio that we have, for our microcontrollers, power, analog and also sensors that we sell to distributions. Now there was, as I said, a little deterioration in the -- at the end of the quarter, last quarter, but we are still around the 3 months of inventory overall in our distribution channel that is not bad.

Dan, 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.

Very helpful. And on the digital side...

We should have [indiscernible].

On the set-top box business, I wondered if you could give us any more detail on what changed during the market -- sorry, during third quarter and fourth quarter. Broadcom's specifically talking about taking share in emerging markets, which is where you're strong. I mean, how confident can we be that you're not going to lose share in emerging markets, even as you ramp in the U.S. next year? And if what you're seeing is currently a kind of short-term correction issue, why are you taking permanent cost restructuring measures at this point?

Yes. Well, 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 and, at this point also, with the formalization with our customers that the module -- the commodity module business for imaging. And at the same time, because this was -- this is, say, not immaterial in terms of revenues. At the same time, we have decided to merge IBP with DCG. But there is nothing that is -- we are doing in terms of cost-saving initiatives that is, let's say, dodging the design activity, for instance, on the set-top box at all. So that's to make sure that we are aligned on this. I think what we see on the set-top boxes 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 in -- 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 this product is not adjusted 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 very modest. And I think we have good opportunities, including the one on the modem. Our DOCSIS families, the 3.0 and now also the 3.1.

And if I could squeeze in one more. I wanted to clarify the comments on manufacturing you made. Is it your understanding that FinFET development over the last 6 months is not progressing as expected at the major foundries, despite 2 of them expecting to take [indiscernible] within 12 months? And our understanding is that within the IBM alliance, IBM has 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 2 years? And therefore, what the risk is on the new ownership? And if they focus entirely on FinFET, what the risk could be to your FD-SOI process technology?

So -- well, FD-SOI, there is absolutely no risk. because the 28 is completed. It is underway 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 2 nodes will be very, very long-lasting node for our product portfolio, whatever is the consumer or communication network infrastructure. Again, this is what I have said 2 minutes ago. We have to acknowledge the fact that IBM will not remain vertically integrated at 10-nanometer. The second fact is that [indiscernible] photolithography is very far from [indiscernible] productivity on also with the variability expected, making this 10-nanometer node, which will be, let's say, only for very few high-volume application. And many parts of the semiconductor market will remain for a long time on 28 and 14-nanometer on FD-SOI or on some FinFET when the FinFET will be ready. So this is exactly what we think today.

Thank you, Dan. [Operator Instructions]

The next question is from Mr. Gianmarco Bonacina from Equita SIM.

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 this performance in the division to diverge going forward.

You expect the performance on the division to...

Diverge.

Oh, diverge. No, we do not think so. I think we have -- first of all, I think the impact in Q3 was more than the mass market. So this -- of course, we have more of a -- more of the general-purpose microcontrollers in the mass market. But in terms of evolution, I think the 2 lines are very, very important for us. We have, let's say, important programs brought on 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 also short-term opportunities for us. And if I look at just the Q3 results, 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 in the market. So the 2 lines remain important. I also want to mention the fact that there is a lot of synergies in terms of technology that are costs and the use of IPs between the 2 lines. And we expect to continue to grow next year microcontrollers in both areas, secure and general-purpose.

Your next question is from Mark Morris [ph] from Citi.

You mentioned that in spite of the softening you're seeing in the industrial web mobile, your new products are actually providing very strong momentum in revenue growth. At the same time, you produced 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 view is on 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 industry line cost and achieve 10% operating margin.

Jean-Marc 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 in evolution is about the exit from the wireless IT platform. And yes, the ST-Ericsson joint venture. Indeed, in the end, the reduction in R&D expenses reflect the discontinued effort for IT platform in the 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 a product innovation in the core business of the company.

The next question is a follow-up question from Mr. Guenther Hollfelder from Baader Bank.

I just had a question on the automotive tier 1s, the Western ones like the Boschs and Contis and TRWs, what you're seeing there at the moment.

This is too specific. I think, as I said also before, I think when we move to the West, we saw some slowdown in the automotive in Asia. There's the car infotainment in China and generally, the automotive in Japan and Korea. This we noticed. Now when we move to the West, I think the situation is some 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 -- I mean, the growth of the level of production in September, which, of course, was relatively reduced. But we get then into customer specific that we cannot comment.

Today's last question is from Mr. Johannes Schaller from Deutsche Bank.

Just one follow-up on secure microcontrollers, if I could. I mean, one of your major customers there will probably see a 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 kind of market increase but then maybe slightly lower share for you? How are you thinking about that?

No. I -- what we see here, we see some opportunity that we have in secure microcontrollers in Asia. And to gain share, also in United States and in Asia. So I believe that we have lines of new products that are competitive products for a number of applications in the area of Secure Elements. And we believe there is a good traction, and I think we have opportunities to gain share in this business domain.

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.

Thank you.

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.