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STMicroelectronics NV (NYSE:STM)

Q4 2012 Earnings Call

January 31, 2013 5:00 pm ET

Executives

Tait Sorensen – Director, Investor Relations

Carlo Bozotti – President and Chief Executive Officer

Mario Arlati – Executive Vice President and Chief Financial Officer

Lorenzo Grandi – Corporate Vice President, Corporate Control

Analysts

Francois Meunier – Morgan Stanley & Co.

Tristan Gerra – Robert W. Baird & Co. Equity Capital Markets

Gareth Jenkins – UBS

Didier Scemama – Bank of America Merrill Lynch

Simon Schäfer – Goldman Sachs

Sandeep Deshpande – JPMorgan Securities Plc

Peter Knox – Société Générale

Johannes Schaller – Deutsche Bank

Lee Simpson – Jefferies International Ltd.

Operator

Ladies and gentlemen, good afternoon. Welcome to the Q4 and Full Year 2012 Earnings Results Conference Call and Live Webcast. I’m Goren, Chorus Call operator. 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, Global Investor Relations. Please go ahead, sir.

Tait Sorensen

Thank you, and thank you to all for joining our fourth quarter and full year 2012 conference call. Hosting the call today is Carlo Bozotti, ST’s President and Chief Executive Officer.

Joining Carlo today on the call is Georges Penalver, Executive Vice President, Chief Strategic Officer; Mario Arlati, Chief Financial Officer; Carmelo Papa, Executive Vice President of the Industrial & Multisegment Sector; Jean-Marc Chery, Executive Vice President, Manufacturing & Technology R&D and General Manager of the Digital Sector; Lorenzo Grandi, Corporate Vice President, External Reporting.

This call is being broadcast live over the web and can be accessed through ST’s website. A replay will be available shortly after the conclusion of this call.

This call will include forward-looking statements that involve risk factors that could cause ST’s results to differ materially from management’s expectations and plans. We encourage you to review the Safe Harbor statement contained in the press release that was issued with the results last night and also in ST’s most recent regulatory filings for a full description of these risk factors. As a reminder, please limit yourself to one question and then a brief follow-up.

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

Carlo Bozotti

Thank you, Tait, and thank you for joining us on this call, and thanks also to those of you who attended the year-end presentation earlier today in Paris. As we enter 2013, we are energized by the new possibilities in front of us, as we sharpen our focus and build a new ST, leveraging our proven leadership in important key product markets. In this regards, in December, we outlined our vision and new strategic plan, our growth drivers and confirmed our new financial model.

During 2012, we prepare for this future while also managing through a difficult year as we dealt with a weaker semiconductor industry and business environment, as well as significant structural changes in market and end customer competitive dynamics, which negatively impacted ST. We exit 2012 with a strong position, with respect to market leadership in key areas of our product portfolio, IP leadership, and solid flexible financial position.

Today, I would like to begin with some key summary points and then move to a review of the fourth quarter and the year, our new strategic plan and then our outlook and initiatives for 2013.

First, both revenue and gross margin were in line with our outlook, in particular our revenue performance came in above the midpoint of our guidance even with the ongoing softness in the semiconductor market. Our wholly-owned businesses increased 0.2% and 1.6% on a sequential and year-ago basis. Based on independent market projections, we believe we gain market share in the fourth quarter in our served markets.

Second, our action during 2012 enabled us to improve our net financial position at year-end compared to 2011, despite the significant cash used by ST-Ericsson. So, this was a big challenge to overcome and we did.

Third, we’ve been able to maintain a dividend of $0.40 per share for shareholders during 2012. In total, we paid $355 million in dividends this past year.

Fourth, our new product momentum represents a combination of strategy and innovation and marketing initiatives. During 2012, we made important progress in our new major accounts program with revenue from these accounts growing a 13% on an annual basis. In addition, this group of companies is well balance across our five target product growth drivers. Looking forward, we also want to be more pervasive in the mass market and our product and marketing plans under our new strategy will drive this objective.

Fifth, we are advancing our plans towards our exit from ST-Ericsson. In the fourth quarter, ST took an impairment charge of $545 million for wireless goodwill and other intangible assets, bringing investment value of ST-Ericsson on our books to a negligible amount.

In addition, both Ericsson and ST have waived their loan to ST-Ericsson in the amount of $1.54 billion. For ST, this loan was reflected in our new financial position already – in our net financial position already. So our net financial position and net attributable financial position are both at $1.19 billion at the end of 2012.

Turning now to the fourth quarter, let me share some key points. As I mentioned earlier, our revenue and gross margin results were well in line with our guidance. Looking at ST’s revenue results, based upon our bookings, we had expected to see relatively flat revenue results on a sequential basis. And that was the case.

At the same time, we anticipated strong results for AMM, and that was the case – thanks to the ramp of our MEMS product. As expected, Automotive, Digital and Power Discrete segments, also sequential decreases reflecting a still-soft semiconductor market.

AMM revenues increased 7.4% sequentially. As we had anticipated, we did see strong sequential revenue growth in our motion MEMS and environmental sensors and continue to progress in microcontrollers. We also saw a quarter-to-quarter improvement in the operating margin to 13.9%.

The market environment continued to be tough in Automotive, our APG group, leading to a 6% revenue decrease and the lower operating margin as a result. However, we are very well positioned in this market and once unit volumes increase we will do well here at both the revenues and operating profitability level.

We also are expanding our product offerings to this key market for us, so even more content per car. Digital saw about a 2% decline in revenue. The operating loss was up materially, mainly reflecting manufacturing inefficiencies related to a sharp decrease in loadings.

As we announced last quarter, we are now restructuring digital to improve these operating results. We plan to capture annualized savings of about $150 million by the end of 2013. Power Discrete sales decreased 11% on weak market demand with the operating margin declining but still slightly positive.

Turning to our gross margin, our results here were also inline with our expectations and slightly better than the midpoint. The fourth quarter results reflect the actions we took to lower our inventory, leading to significant quarter-to-quarter rise in unsaturation charges, $66 million in Q4 compared to $19 million in Q3.

Through our manufacturing actions, we significantly reduced inventory with a cash impact of $143 million in the quarter. Inventory in the fourth quarter improved to 4.3 turns or 84 days. Importantly, we entered 2013 much better positioned with respect to inventory compared to the year ago period, where our turns level was 3.8 or 95 days.

Turning to cash flow, we began the year with a positive quarter and we finished the year in a similar manner. Lower CapEx and inventory were both positive contributors to the fourth quarter improvement in cash flow. As a result, STA reported a slightly positive cash flow for the full year in spite of significant pressures on cash flow from ST-Ericsson.

A kick on point into cash flow management was our control of spending. Capital expenditures for 2012 were $476 million down 60% compared to 2011. So you have seen during the year a recalibration of our capital expenditures adjusted for weaker market conditions.

In the fourth quarter, we drew an €350 million multi-currency eight year credit facility granted by the European Investment Bank in 2010 to support our R&D programs in Europe. The proceeds have further strengthened our financial flexibility.

Turning to our future, in December, we unveiled our vision and new strategy, growth drivers and presented our new financial model. Our vision remains unchanged. We want to make a positive contribution to people’s lives and looking at the evolution of our product portfolio, we are reaching more parts of everyday life, energy management and savings, trust and data security, healthcare and wellness and smart consumer devices among them.

Our strategy has changed, taking into account the evolution of the market we’re in and environment we see in the years ahead. We want to make sure our future success is built on a solid foundation. So our growth drivers we have outlined are those where ST has a strong leadership position today, as well as where we have the right ingredient to be successful in the future.

Our five product families where we would focus MEMS and sensors, smart power, automotive products, micro controllers and the application processors including digital consumer products are those well we have assessed the highest growth rate, improved profitability and market share gain opportunities for us.

Let’s start from MEMS and sensors, they’ve been one of our tremendous success stories and our foresight in anticipation the direction of the market and developing the right products led to 22% year-over-year revenue growth. We successfully began high volume shipment of our MEMS pressure sensors, microphones and six-axis combos. In total ST shift over 1 billion MEMS unit during 2012 and ST market share in the MEMS mobile and handset market is up to 48% according to IHS iSuppli more than twice, as large as that of our closest competitor.

Smart Power is the second key growth driver for us. With our innovative range of products in the smart grid, power management for portable equipment and automation. We delivered high volumes of the new MOSFET family for high-end chargers for a leading smartphone manufacturer. For new generation 4G, LTE devices, we also introduced to several leading smartphone manufacturers, high performing power saving tunable capacitors. And one measure of the market’s recognition of our success in managing power is that more than 70% of the world’s ICs for powering efficient AMOLED displays are supplied by ST.

Our third growth driver is automotive, where we are number one in China and number two in Europe and U.S. We are one of the very few companies that can address all semiconductor opportunities in the curve. During 2012, a major global player selected our 32-bit microcontroller for their vehicle safety platform because it covered the full financial range from entry level anti-lock brakes to the most complex dynamic vehicle control.

We also celebrated the year of infotainment as we reached a milestone of having more than 200 million cars in the world running on ST’s leading infotainment technologies. And also this news is not part of the fourth quarter review, let me proudly announce today a collaboration with the Hyundai to design the best engine management solutions to address both high performance and low cost.

Moving to our Embedded Processing Solutions product segment; microcontrollers, were in fact the microcontrollers is our fourth growth driver. 2012 was an excellent year for us, where our investment in 32-bit ARM Cortex and M-based microcontrollers continues to bear fruit. We introduced seven new product lines, expanded the families and most important increased billings 30% year-over-year.

In imagining, we continued to diversify by delivering breakthrough technology new applications such as proximity sensors, to earn design wins in industrial automotive, the digital still cameras and gaming. And through multiple design wins and business awards for new image sensors, camera modules and image signal processors, we expanded our customer base in mobile imaging.

Finally, in application processors including digital consumer and ASICs, a key objective is to offer application processors to serve many markets through a unified processing platform.

During 2012, we saw fast adoption of our 40-nanometer set-top box families for cable, terrestrial and IPTV. We earn the important design wins for Orly, the world’s most powerful set-top box system-on-chip in both 32 and 28-nanometer, and we introduce our DOCSIS 3.0 products for new high speed cable networks.

And just last quarter, we gained increased traction for high-resolution multimedia monitor controllers in premium monitors and public displays with LG, Samsung and others. Also, we were awarded a major 32-nanometer ASIC with a major networking company, and we have started to work on innovative ASICs for various applications using our FD-SOI Technology.

In addition to our key product areas, let me acknowledge two important technical successes. ST proprietary 28 FD-SOI Technology Platform, manufactured at our Crolles, France, 300-milimeter facility has now proven it can deliver 30% higher speed at the same power and up to 50% greater power efficiency at the same performance as bulk processes.

We have proven we can do it at comparable costs, and we have significant opportunities in portable equipment, gaming and digital still camera, among others. Enabled by our advanced BCD9S technology platform, demonstrating superior device performances in the silicon area reduction, we won a significant award for power ASICs for automotive.

So, with this product portfolio, we expect to significantly enhance our financial performance at the gross margin line, operating margin and net earnings per share, as well as driving significant cash flow and growth of our net financial position.

Let me turn now to our outlook. Looking at ST’s wholly-owned businesses, we are seeing some positive signs including improved bookings in January on several product lines that may be early indicators of a recovery ahead at some point in 2013. We anticipate a better than normal seasonality from our wholly-owned businesses leading to a sequential decrease in revenues of about 3% at the midpoint, while increasing about 2% year-over-year.

The total revenue outlook for ST of down 7% at the midpoint takes into account the fact that ST-Ericsson anticipates a very significant quarter-to-quarter decrease in revenues. Reflecting the lower unsaturation charges and no revenues from licensing compared to the fourth quarter, gross margin in the first quarter is expected to be about 31.4% plus or minus 2 percentage points.

Following our announcement to exit ST-Ericsson after a transition period that is expected to end during the third quarter of 2013. We are finalizing our decision regarding available strategic options. Our current best estimate is that ST for its part could incur cash costs including the ongoing operation of ST-Ericsson during the transition period and restructuring cost in the range of approximately $300 million to $500 million during 2013, taking into account the impact of the strategic options.

To conclude, let me share a few final observations. Globally there are a number of signs that 2013 may show an improving economic environment as the year advances. We are well positioned with our innovative product portfolio and customer relationships to benefit. We are especially encouraged by the traction we are gaining with our new major accounts and the expectation for a major turnaround in our distribution business.

More specifically as this position to outperform the market addressed by our two newly refined product segments. Key products expected to show the strongest growth in 2013 include imaging, microcontrollers and analogue and MEMS. In addition, as the year progresses, we expect to benefit from improved loading.

With respect to ST-Ericsson, we will communicate further details when they become available. We are finalizing our decision regarding available strategic options, and while we do not underestimate the challenges related to the transition, we are committed to ensure a smooth and timely exit.

We are resizing our net expense base, essentially reducing it by about 30% to bring our net expense base from a run rate of almost $900 million per quarter to within a range of $600 million to $650 million, by the beginning of the first quarter in 2014.

So overall, we’re creating a new more focused ST portfolio and this will add positive implication across the Board in terms of improving operating metrics and returns on adjusted. Our net financial position continues to be strong and we remain committed to protect our financial resources.

Now, my colleagues and I are ready to take your questions. Thank you.

Question-and-Answer Session

Operator

The first question is from Francois Meunier from Morgan Stanley. Please go ahead.

Francois Meunier – Morgan Stanley & Co.

Yeah, hello, Carlo. I’m sorry to repeat the same question that everyone is asking, but it just feels a bit strange that the cost of closing down ST-Ericsson and all the cash out flow between now and then is, I’m sorry to say only $500 million. I’m just amazed by this number, so if you could run through those calculation again and the number of employees and the cost of redundancies?

Carlo Bozotti

Well, of course I cannot talk about the options today. But, we have looked at our ongoing cost, the transition cost and the potential restructuring cost and we end up having this range that just to make sure we understand, is cash for ST is our portion is in the range between $300 million and $500 million. This is the best visibility that we have today of course it is based on very solid fact and we are committed of course to make a smooth and rapid transition year. We are now finalizing the decision of the strategic option and we will come back, as soon as we have this finalization. But I confirmed the range, this is the best visibility that we have, of course, is our part, and the range includes the ongoing operation, the transition and restructuring and is between $300 million and $500 million.

Francois Meunier – Morgan Stanley & Co.

Okay. So, it cannot be more than $500 million. Also, I understand from Hans Vestberg, who was on the Ericsson call just before, I mean, from their part, it will not be on their balance sheet anymore from Q1. Will it be the same for you? So, basically, it will not be in the accounts at all?

Tait Sorensen

We are looking at this.

Carlo Bozotti

Well, we are looking at this. I think what we will do, of course, is the moment we sign, we finalize with, we’ll take all the necessary actions in terms of accounting. This will be done immediately. Of course, we are impair. The impairment that we have taken in Q4 is the consequence of the decision that we have communicated on the 10th of December. But as soon as the finalization will happen, we will take all the necessary accounting actions right away.

Francois Meunier – Morgan Stanley & Co.

Okay. Now maybe a more interesting question on the MEMS business, which is doing very well. Of course, smartphones and tablets and [Cupertino] customers doing okay at the moment, but we’ve seen a few suppliers to those guys having a strong, very strong, maybe unusually strong Q4 and then Q1 a bit lower than the normal seasonality. So is it what you’re accounting for your guidance of minus three for the core business?

Carlo Bozotti

Absolutely, yes. It is taking under consideration.

Francois Meunier – Morgan Stanley & Co.

Okay. Okay. Thank you, Carlo.

Carlo Bozotti

Thank you. Thanks.

Tait Sorensen

Thanks a lot. Next question, please.

Operator

The next question is from Tristan Gerra from Robert W. Baird. Please go ahead.

Tristan Gerra – Robert W. Baird & Co. Equity Capital Markets

Hi, good afternoon.

Tait Sorensen

Hi, Tristan.

Tristan Gerra – Robert W. Baird & Co. Equity Capital Markets

Could you give us a sense of gross margin in Q1, excluding ST-Ericsson, and also how we should look at this sequentially, excluding Ericsson? And then additionally, what were the other utilization charges in the quarter and the utilization rate?

Carlo Bozotti

Yeah, the gross margin – I cannot provide, of course, all the numbers by business unit. But clearly in Q1, the gross margin of ST-Ericsson is heavily impacting the gross margin negatively. In particular we will not have any license revenues that was a very material. So, this license, lack of revenues impact more than the reduction of the unsaturation cost moving from Q4 to Q1 is a very material deterioration of the gross margin in ST-Ericsson, and this is bigger than the improvement that we have in terms of lower unsaturation cost.

Tristan Gerra – Robert W. Baird & Co. Equity Capital Markets

Okay. And what about the utilization rates expectation for Q1?

Carlo Bozotti

The utilization rate expectation – there is an improvement. It’s not a major improvement, but there is an improvement. We have done, I believe, at the end of the day, about 67% in Q4. Yeah.

Lorenzo Grandi

We do expect to be, Lorenzo speaking. We do expect to be more in the range of 73% in Q1. So there is an improvement, but still the level of unused capacity charges will be significant during Q1.

Carlo Bozotti

Yes. It is also impossible to – frankly, we are encouraged by the bookings that we see in January. It’s now few weeks. Basically, from the second week of the year, we are seeing a strong booking performance in several families, particularly on products where there is more elasticity. But it’s pretty broad. It’s broad across the regions from microcontrollers to discrete, to analog, power, smart power, et cetera. And in the fabs, there are lead times that we need to face the challenges, but at this moment, we see a loading of 73%, 74% in Q1. And it’s frankly difficult to load more and to produce more in Q1.

Tristan Gerra – Robert W. Baird & Co. Equity Capital Markets

Okay. And then the last question for me, does your Q1 revenue guidance implies further reduction of inventories at distribution, so in the channel? And also, what is your gross margin guidance implying for internal inventory days in Q1?

Carlo Bozotti

The inventory in Q1, there is a degree of stability in terms of absolute value of the...

Mario Arlati

On our inventory.

Carlo Bozotti

You mean on our inventory or our distributors inventory?

Tristan Gerra – Robert W. Baird & Co. Equity Capital Markets

Actually, both would be useful if you could comment.

Carlo Bozotti

Okay. So the – in Q4, we saw stability in the inventory of our distributors. So we did not see any material change. This is across the board in the various regions. And we expect similar pattern in the course of the first quarter. I believe the level of the inventory of our distributors is the right level, because we also need to respond to customer demand. Lead times are short, and my assessment is inventory of our distributors are clean today. As far as ST is concerned, after the major reduction of inventory in Q4, we see a degree of stability in absolute value in dollar value moving from Q4 to Q1 for sure in units and of course some form of deterioration in terms of stock terms.

Tristan Gerra – Robert W. Baird & Co. Equity Capital Markets

Very useful. Thank you.

Carlo Bozotti

Thank you.

Tait Sorensen

Thank you, Tristan. Next question.

Operator

The next question is from Gareth Jenkins from UBS. Please go ahead.

Gareth Jenkins – UBS

Yes, just a couple of quick ones, if I could. Thanks for taking the question. Carlo, I just wondered on the $600 million to $650 million OpEx target what level that’s set against versus 2012. So, you mentioned $900 million. But, that obviously includes ST-Ericsson. I just wondered ex-ST-Ericsson what the kind of level of OpEx run rate is today. Is it lower than the $600 million, $650 million or higher? And does that $600 million, $650 million include any potential additional employee [transfers] in from ST-Ericsson should you only partially sell that ST-Ericsson as part of the, one of the options? Secondly, just from the call earlier, I think you mentioned $1.95 billion to $2 billion of revenues and the $600 million to $650 million to get you to over 10% EBIT margin in 2014. I just wanted to check that is the definitely the case.

Carlo Bozotti

No I did not mention that. In fact, what I mentioned in December and also today is the 10% model requires two things. The first is, of course that we execute on this expense base reduction, and we get into this range of $663 million by Q1 of 2014. And second that we go back to the level of revenues that we had in the first half of 2011. I also said that with revenues in the range of $2 billion, our $1.95 billion to $2 billion, our manufacturing infrastructure would not incur in any significant unsaturation cost. But to go to the 10% level of profitability, we need to go back to the level of revenues that we had in the recent month.

Gareth Jenkins – UBS

Sorry, go ahead.

Carlo Bozotti

Yeah, so in the first half of 2011. As far as, the first question is concerned, this range that we have given is taking into consideration the various options. So of course not all options are the same. They are different, but in any of the options that at the end would be selected we will fall into this range of expenses. Of course, this is coming from the separation and the transition from ST-Ericsson. It’s coming also from the restructuring and the saving plan that we have announced in October on the digital sector calling for an annualized saving of $150 million to be achieved by the end of this year.

So if you put all together that was the range, this is the range. The situation of course is, let’s say we are confident that we’ve taken into consideration of possible options. When you progress and you make a transition it is clear that the certain cost will come back. And again, depending on the option it maybe different or slightly different, but the best visibility is that we will fall into this range.

Gareth Jenkins – UBS

Okay. Thank you. And then, so just to be absolute crystal clear, you need revenues of somewhere around $ 2.1 billion, $2.2 billion to get to the 10%, which is I think where you were annualizing in H1 2011 in the core business?

Carlo Bozotti

In the first half of 2011 we were in the range of $2.2 billion, $2.25 billion.

Gareth Jenkins – UBS

Thank you very much.

Carlo Bozotti

Thank you.

Tait Sorensen

Thanks, Gareth. Next question please.

Operator

The next question is from Didier Scemama from Bank of America Merrill Lynch. Please go ahead.

Didier Scemama – Bank of America Merrill Lynch

Good afternoon, gentlemen. Thanks for letting me on. Just wanted to think about the digital business, we’ve seen losses quite substantially in the quarter. I am just trying to understand a little bit, you know, how we improve margins from here since the digital division is really the big moving part in restoring the 10% margin. I think the overall division sales are down about 40% in the last two years versus where you were in the double-digit sort of regions of margin for the group.

So you said, Carlo, this morning that you expected imaging to go back to about $160 million a quarter by the end of this year, but I was also wondering on the digital convergence sub-group, how much we expected the [OLE] win for the cable gateway market to contribute to revenues and whether we should model digital convergence to sort of recover revenues over the course of 2013. That would be my first question.

Carlo Bozotti

Yes. So, in fact there are three contributors. You are absolutely right. One contributor is our recovery in the Imaging business and I mentioned this morning the opportunity to go back to $160 million, followed by the end of this year and we are executing a number of important programs in imaging, including significant ramp-up of volumes during the course of Q1.

We have, we believe, also good opportunity in the area of our digital consumer business and is also material growth, is similar to the growth that we are expecting in imaging. In digital consumer, outside imaging we will grow in Q1. We see, first move in Q1 on the set-top box, on our monitor’s products, on our ASICs, and then a growth that is similar to the one that I describe on imaging in the course of [today]. And the third contributor, of course is the $40 million saving in the quarter, the one that we have announced in October. So, these are the three contributors here.

Didier Scemama – Bank of America Merrill Lynch

Right. So, that should bring you to profitability basically by the end of this year and try to demonstrate with the cost savings?

Carlo Bozotti

Yeah. Yeah, of course, and there is the transition of ST-Ericsson, there is the new organization, the new Embedded Processing Solution, there is microcontrollers, there are some additional cost from ST-Ericsson. So we will start a new reporting, but of course we will provide the necessary reconciliation figures as we usually do when we change a product segment reporting.

Didier Scemama – Bank of America Merrill Lynch

Right. In terms of the gross margin from here, I mean, your inventories have come down quite substantially. You did a great job in a quarter. You are talking about orders recovering. So should orders continue to strengthen, should we see a material step-up in gross margin in the second quarter?

Carlo Bozotti

Well, I think, the gross margin is, there is one quarter lag because there are two effects. One is the unsaturation cost that is in the quarter, but the other one is the manufacturing cost that is not part of the unsaturation and there are unfortunately major disruptions in the fab when the fabs are unloaded.

For instance, if you look at Q4 the unsaturation cost was very material, $66 million. But the efficiency of the fab and the cost of the products that we are manufacturing in Q4 and will be sold in Q1 is impacting. I mean, because, of course, it’s not just at all that inefficiency costs are in the part of unsaturation. There are other important inefficiencies that are on the cost of the products that we sell typically one quarter after. So if we move to a good level of unsaturation, which we expect to do starting from the second quarter, we should see a material increase of the gross margin starting from the third quarter.

Didier Scemama – Bank of America Merrill Lynch

Fantastic. And then my final question, given the sort of wins you’ve announced so far for power, for microcontrollers, for engine management as well as your increased confidence for the Imaging business, do you think quarter two will be sort of totally saturated if and when ST-Ericsson goes down off the perimeter of ST?

Carlo Bozotti

Yes, we think so. Three are three ingredients. One ingredient is of course the logic. We have also additional opportunity to repatriate on the ST-Ericsson products. Clearly, we expect sales to go down. There is no impact in Q1. Q1 is the natural quarter. For ST-Ericsson, it’s a natural quarter. It is really not impacted by the strategic decision of Q4. In any case, we still have important flexibility on certain technologies that today for ST-Ericsson will manufacture outside Crolles that we outsource and that could be repatriated if needed. So anyhow, the first block in logic, with this opportunity of flexibility.

The second block is clearly imaging. In the first quarter there is a major impact in Crolles 200 on the BSI imaging technology, the backside-illumination technology for imaging. And the third block, maybe with some delay in terms of time, in terms of volume is clearly the 90-nanometer and the 40-nanometer embedded flash. The 90-nanometer is a pretty complex product.

We have products for automotive. We have product for the secure microcontroller, the secure element, for instance, and this would be the third pillar of the production that we will run in Crolles in the new configuration. So it’s not only logic. It’s really three blocks of technologies and we believe we have the traction to fully log, crawl even with a significant decrease of the ST-Ericsson revenues.

Didier Scemama – Bank of America Merrill Lynch

Very good. Thanks so much.

Carlo Bozotti

Thank you.

Tait Sorensen

Thank you, Didier. Next question please.

Operator

The next question is from Mr. Simon Schäfer from Goldman Sachs. Please go ahead, sir.

Simon Schäfer – Goldman Sachs

Yes. Thanks so much. I just wanted to ask a question on, some of you said at the presentation this morning and I think you basically alluded to the (inaudible) that your available market excluding ST-Ericsson would be growing by about 4% this year. Given that I think you are looking to gain market share. Is that a reasonable assessment as to what you would expect sales growth to be this year just for the core residual?

Carlo Bozotti

Well, first of all, the 4.3% is not the number coming from ST. I think it’s the WSTS figure. So it’s not our number. It’s a number that is coming from WSTS and we are reporting the number. This is for the semiconductor market that we serve without the part of market that is covered by ST-Ericsson.

Frankly we believe that we can do better or much better. I think last year we have suffered of course because of the weaker market situation and the crisis, but also it was tough year for us for the major swing at our former major customer. This is very, very material. And we believe we are at the bottom. We believe that for ST this major drop has been absorbed now. This is valid for our former major customer. We believe this is valid for them, et cetera. So in a sense we restart now from acquisition that is cleaner and of course we believe that we can restart to grow.

In Q4 we believe we are clearly gaining market share. We are tracking and this is not WSTS because these are forecast and more qualitative indications. But we are tracking the 10 most important competitors that we have in our business without wireless. They are all reporting their number. They are out listed companies. And if I compare Q4 2011 with Q4 2012, our market share in Q4 among these top 10 competitors in Q4 2011 was 10.9% and looking at the guidance because some of these companies have not yet reported, looking at the guidance of these companies in Q4 2012 our market share would be 11.4%. We have done slightly better than our guidance and we believe that in Q4 we have gained market share.

For us there are of course all the new products that we have presented this morning, but there are other two things that I would like to mention. Number one, that we are at the bottom finally with the decline with our major customers of the past. And we believe we have a great opportunity of a major turnaround in distribution. If you take our distribution business in Q4 2012, last quarter, it is still about $120 million per quarter, below the level that we had in, for instance, Q1 and Q2, 2011. So this, of course, is an important opportunity and we want to drive this major turnaround in distribution.

Simon Schäfer – Goldman Sachs

Understood. I guess, Carlo, when you look at the numbers that some of your peers reported, I think everyone vastly pretty much talked about an acceleration of orders into January. You alluded to the same in the press release. Have you seen a continuation of that?

Carlo Bozotti

Well, when I talk about the results vis-à-vis our top 10 competitors, I did refer to Q4 where many of our competitors declined. We did not and we had a small growth compared to Q4 2011. If we look at 2012, this time I think there will be clearly segments growing. I think I did mention consumer before. I think automotive will grow in Q1 definitely. There will be a drop in MEMS and if we will not drop MEMS in Q1 our guidance will be much better. Of course, we are dropping from a very, very strong position on MEMS in Q4. And the result of all of this is minus 3 that we have given.

I can confirm that during the month of January we have seen strong bookings across the board. Many families from Microcontrollers to Discrete, from the set-top box to, let’s say, all our analog automotive, so the booking is pretty strong. Is this sustainable? This is clearly premature to say. However, it’s an encouraging sign, because now its few weeks in January that we are experiencing a strong booking spend, broad range from the products and the geography point of view.

Simon Schäfer – Goldman Sachs

Got it. And sorry, my second question is just on the net financial position. If I just adjust for the investment in ST-Ericsson, the $1.2 billion, I mean, just in light of seasonality and some working capital swings into the first quarter, would you expect to have, end March with a similar or even higher net cash balance, or is it going to be slightly lower?

Carlo Bozotti

No. I think it will be slightly lower. I think we will generate, you know, when we publish our cash flow result, this includes 100% of the cash that is needed by ST-Ericsson of course. So, I think, if we consider 50% of the cash used for ST-Ericsson in Q1 that for us is about $100 million, we will post a positive cash flow for, if we consider just 50% of ST-Ericsson, right, but not enough to cover completely for the dividend.

Simon Schäfer – Goldman Sachs

Okay. Thank you.

Carlo Bozotti

And, therefore, there will be a slight degradation of the net financial position.

Tait Sorensen

Thank you, Simon. Next question, please.

Operator

The next question is from Sandeep Deshpande from JP Morgan. Please go ahead.

Sandeep Deshpande – JPMorgan Securities Plc

Yeah, hi. Thanks for letting me on. I have a question on microcontrollers. That is one of the focus areas in the new ST. If you talk to other companies in the microcontroller space, everybody is talking about ARM-based microcontrollers and how successful they’re going to be in ARM-based microcontrollers. I mean, historically, the microcontroller business has been a great business to be in. I find it difficult to understand if everybody is going to do ARM-based microcontrollers, why will this not become a commodity business, like, say, application processors, not application processors really, but like, baseline processors became a commodity business and highly competitive? And I have a follow-up question.

Carlo Bozotti

Yeah. Well, of course, I mean, the good news for us is that we were the first in the market with our ARM-based microcontrollers. I mean, we stand clearly. We were the first in the market visibly. Today we have 350 32-bit microcontrollers part numbers. We have a strong ecosystem. We are working to even reinforce our existing microcontrollers. And it covers, of course, general purpose microcontrollers that is the base of our discussion here. But we are using the same core, the same technology and the same libraries to make secure microcontrollers.

And one of the important growth drivers that we have this year in this field is the secure element for the near-field communication applications in the smartphones. This is very high volume, and we are driving this very aggressively. Clearly we need to maintain the lead. We have been the first. We are investing. We have another two that many of our competitor do not have. Some have. Some of them have and this is the application connotation. We are in the condition to offer to our customers complete application solutions, including microcontrollers, for instance, low-power microcontrollers, including sensors, our MEMS and also including the power management, the radio frequency interface, et cetera. So, we are working on many axes. Of course we want to maintain the lead. 30% was a good growth last year on the 32-bit.

I mentioned some specific competitive advantages that we have in ST, for instance, our capability to manage security and therefore to be strong and present in the area of secure microcontrollers. I mentioned the application connotation and the fact that we can embed in one single application and offer solutions to our customers with low-power microcontrollers, with MEMS and RF, power management, et cetera. But of course we need to continue to lead and push. This, I believe, is a good business. I think it’s also very fragmented from a customer point of view. So I believe it’s more stable. I think it is a good business for distribution also. I am convinced that it’s a good growth driver and good business to stay and focus on.

Sandeep Deshpande – JPMorgan Securities Plc

Thanks, Carlo. One more, on your MEMS business. Clearly, I mean, you’re by far market leader in the MEMS market. And I mean, in December, when you were around here, you talked quite extensively about the potential in that market. One question there is that this still for you remains mainly a consumer-driven market. You are in the tablet market. You are in the handset market, whereas, I mean, the more sticky markets, such as automotive, which is where you in other businesses have done very well in automotive, you’ve still not made much headway with MEMS sensors in automotive. Can you talk a little bit about that and about any potential in more sticky markets?

Carlo Bozotti

Yes. Clearly it was a choice. We decided to go more aggressively in gaming and the smartphones. We are convinced that in smartphone the business will evolve into a number of hubs. So, what we see is an evolution where, in the smartphones there will three apps. One app’s for motion MEMS, including the brain, one app for audio MEMS with the new microphones, and one hub for the environmental kind of MEMS. We want to drive this because you’re right. This is less sticky, but there are not many companies that can offer, really, I would say there is only ST that can offer an environmental MEMS hub, a motion MEMS hub and an audio MEMS hub, which is our microphone.

Having said that, we decided to go first on gaming and smartphones because it was faster growth. Now we are absolutely committed to automotive. We have started to win. You know very well that we all know that automotive takes a little bit longer time. We have already important wins in the automotive and we will drive this very, very aggressively.

On top of this, there is all the healthcare and all the fitness, the wellness, the wearable. This is an area where potential, I believe, is huge. The pervasiveness will be very, very important. Again, in healthcare, this takes longer. The FDA have approval cycles et cetera. But this is another area where we are really pushing. Now, of course, we should never underestimate competition. We know that there is and there will be a strong competition here. But we are global. We want to cover everything in sensors and we want to cover from gaming to smartphones, from automotive to healthcare, fitness, and wearable.

Sandeep Deshpande – JPMorgan Securities Plc

Thank you, Carlo.

Carlo Bozotti

Thank you.

Tait Sorensen

Thank you, Sandeep. Next question please.

Operator

The next question is from Mr. Peter Knox from Société Générale. Please go ahead.

Peter Knox – Société Générale

Thanks for taking the question. You mentioned about cash flow and the dividend. You paid it through this year. Can you give us any guidance what you’re likely to put to the AGM in terms of dividend moving forward?

Carlo Bozotti

Of course, this is something that I cannot comment today. First, there will be a proposal from management. Then there will be a Board approval. And then there will be the cycle with the AGM that is at the end of May. Of course, we are very committed to protect on one side the net financial position of the company and on the other side, to give continuity, but today I cannot take a firm position on this.

I believe last year we have done despite a tough market environment and despite a major drop with one customer for us. We managed to distribute dividend and at the same time, to even slight improvement at financial position. My motivation, the managing motivation, of course, is to continue to do so, but we will have to go through the formal process. Of course, we will understand the business also, the evolution of the bookings and all of these things. But, we have done in the past and the motivation of the management is to continue to do this in the future.

Peter Knox – Société Générale

Okay. Thanks. Understood.

Tait Sorensen

Thank you, Peter. Next question, please.

Operator

The next question is from Mr. Johannes Schaller from Deutsche Bank. Please go ahead, sir.

Johannes Schaller – Deutsche Bank

Yes. Thanks very much for taking my question, two questions actually. So, one, just a final clarification on the 10% margin target. So, it basically means you have to get to $2 billion, $2.25 billion of revenues as a run rate. And that is just the core business, or did I get that wrong? So, that’s excluding ST-Ericsson. And then the second question is, around your secure element microcontroller shipments. Could you just remind us here of your market position and who you are shipping with, maybe if you can give us an overview here, given that your competitor NXP is supplying a lot of the Android handsets, that would be quite useful. Thank you.

Carlo Bozotti

Yes. Well, yes, on the first one, I confirm. I think, here, the point, of course, is that we did this in the past. This is not too long ago. And, of course, during this last two years we had to suffer the market and on top we had a major drop of our traditional major customers. Today, as I said before, with these customers we are at the bottom. Hopefully, we can start growing again and we are very motivated to go back to the level of sales that we had not only in 2010, but also in the first half of 2011. This is the good range for us and at this level we expect to achieve our financial model.

As far as the secure microcontroller is concerned, well, I think this is a great opportunity. I think it’s more than opportunity. I think it’s important, important wins that we have for 2013. We are now in full production and this will materially contribute to the growth. We have good products. This 32-bit products is ARM products. We master security since many, many years as you know and I think we have a good technology here, a good silicon technology and I think there would be a number of customers, including major customers using our secure microcontrollers in 2015.

Johannes Schaller – Deutsche Bank

And just to confirm as a follow up, I mean, you have a public partnership here I think with Gemalto. Will all of those secure elements use (inaudible) resolutions?

Carlo Bozotti

I cannot comment on customers, I mean, I think it’s broad and it’s big this year, but I cannot make any comment on customer.

Johannes Schaller – Deutsche Bank

Thank you very much.

Carlo Bozotti

Thank you.

Tait Sorensen

Thank you, Johannes. Next question, please.

Operator

The next question is from Mr. Lee Simpson from Jefferies. Please go ahead.

Lee Simpson – Jefferies

Hi, good afternoon, gentlemen. And thanks for taking my questions. Just maybe start off in generic gross margin question. You’re beyond the reversal in the unsaturation charges that you no doubt will see later this year on the back of some of those revenue drivers you’ve talked of. Can you give us a sense for how much the underlying gross margin could increase, perhaps as a result of the cut in CapEx you’ve seen in the last couple of years feeding through as lower depreciation in COGS? And I’ve got a couple of follow-up questions as well.

Carlo Bozotti

Yeah. I think in terms of products, I mentioned three lines contribute to our growth. One is analog and MEMS, one is microcontrollers and one is the imaging. The first two is significantly accretive in terms of gross margin. The third is not, but it’s good business and as we’ve already shown in the recent past, in fact, that we can be a double-digit profit in this business with a reasonable volume.

In terms of depreciation, we expect some material decrease of depreciation in the course of the year and, of course, these are all contributors. I think depreciations may decrease by about $100 million and $150 million or so.

Mario Arlati

Not only in the cost.

Carlo Bozotti

But, this is not only in the cost of goods sold.

Mario Arlati

Yeah.

Carlo Bozotti

There is also a portion that is inexpensive. But clearly, the contribution will come from loading because this is the major detractor now and it’s not only the unsaturation cost. It’s the unstability is the efficiency in the fabs. The second is, of course, selling more analog and MEMS and microcontrollers. This will help. And the third is a material reduction of the deprecation.

Lee Simpson – Jefferies

Sure. Got you. And maybe just on the analog business lines, I mean, do you have any sense for what sort of CapEx spend you expect on capacity for, in particular, the MEMS business? The way I’m looking at this is this continues to be a very big end market potential for you. You’re moving into other end markets now. And I just wondered if there is, as you see it today, this sufficient capacity and even types of equipment there. Maybe your packaging type’s changing. Your pin counts are changing. I wonder if that necessitates a big CapEx spend at the end of the year.

Mario Arlati

No, there is some CapEx, but it’s tens of million, a few tens of million. I have to say that it’s not too intense. There is some CapEx. I think it’s tens of million of dollars on MEMS.

Carlo Bozotti

No, we have some CapEx on [that became] part on the packaging on these kind of things, but MEMS started out, let’s say, definitely needed that, these kind of CapEx, but this is not really a product line that is very expensive in respect to other semiconductor product lines. So…

Mario Arlati

The MEMS is also a line where we are continuously shrinking the dies, because we need to continuously shrink in the packages. We need to continuously focus on miniaturization and making the packages smaller and smaller as integrating functionality. So we need to shrink these dies, but, anyhow, I think it’s more in the range of tens of million of dollars for MEMS and this is not a line that is really very intense in terms of capital spending.

Lee Simpson – Jefferies

Got you. Maybe one quick question on clarification. I think I heard you mention earlier that I think the free cash flow wouldn’t cover the dividend in Q1. Did I hear that right, or was there a subtlety to what you were saying there?

Carlo Bozotti

Yes, in Q1 we expect to have a modest degradation of the net financial position, yes. So we expect that if we cut by two the cash requirements for ST-Ericsson because 50% is us and 50% is Ericsson. If we do this, the free cash flow will be positive in Q1, but this level is not enough in Q1 to fully compensate for the dividend spending. So we expect a modest degradation, deterioration of the net financial position, but we are starting from a pretty solid level today and this remains a very important priority for us.

Lee Simpson – Jefferies

Perfect. Thanks for the answers.

Carlo Bozotti

Thank you.

Tait Sorensen

Thank you, Lee. I think at this point we’ll go ahead and close the call, Carlos, if you have a final commentary.

Carlo Bozotti

No, I think, of course, we are working very hard on three priorities this year. We want to go back to grow. I believe that Q4 and Q1 is a kind of turning point because if we look at year-over-year we have the first initial growth both in Q4 and in Q1 and this is clearly a top priority. I mentioned the major turnaround in distribution is very, very important for us. There are several growth drivers.

The second priority and obviously is the transition from ST-Ericsson. We want to make sure this transition is smooth and rapid and consuming a level of cash that is in the range of what we said today. And the third priority is to drive our $600 million, $650 million expenses per quarter initiative. This is a very important initiative in ST because we want to land at the beginning of 2014 with this level of expenses and we want to make sure that this will be the level of expenses that the company will have not just in 2014, but also during the next three to four years. And enjoy then, the growth and a much better level of profitability. Thank you very much.

Operator

Ladies and gentlemen, the conference is now over. Thank you for using choosing Chorus Call and thank you for participating in the conference. You may now disconnect your lines. Good bye.

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