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STMicroelectronics NV (NYSE:STM)

Morgan Stanley Technology, Media & Telecoms Conference

November 17, 2011 04:20 AM EST

Executives

Carlo Bozotti – President & CEO

Analysts

Unknown analysts

Moderator

Thank you. Carlo, CEO of STMicroelectronics, thanks for…

Carlo Bozotti

Good morning to everybody.

Moderator

Coming today. Maybe – we should start maybe with a quick summary of what happened in Q3 for ST Micro and then we start discussing.

Carlo Bozotti

Yes, well, Q3 and Q4 I think we are – clearly the correction started in the second part of the second quarter, accelerated during the course of the third quarter, and is indeed important inventory corrections, but also with some weakness in the underlying demand. And I think moving into Q4, it is now a few weeks that we have seen bookings increasing a little bit. It seems it is bottoming. Our bookings in October was better than in Q3 and the bookings in November is better than in October. But I would say is still too low and is just the start of a new slope and we need to see whether this is sustainable. During Q3 it is clear that the correction was very much across he board, both geographically and also from the market segment’s point of view. So geographically we have experienced weaknesses here in Asia, certain countries in Asia, not only in Europe or in the US, but – and from a segment point of view, well fewer things were not touched, maybe tablets, communication infrastructure, servers.

But most of the things, including industrial, including consumer distribution market, they were all in question. Even automotive it was very strong in the first half of the year. We have countries where performance is pretty poor today, like in a part of Europe, not in Germany, but in a part of Europe and the growth in China in the automotive this year is 2%, 3% and of course this to be compared with last year was 30% growth. So well, let’s see. As I said, we see some better performance in booking and this is recent and we need to understand whether this is sustainable and we need more. We need a stronger positive upside at this stage.

Question-and-Answer Session

Moderator

So basically what you’re saying is that the orders have kind of stabilized and may increase a bit. But visibility remains relatively low and maybe the base line is lower than where it should be for your gross margins to be at a better level?

Carlo Bozotti

Yes, of course I think visibility is very short term. The absolute value of bookings somehow did improve compared to Q3. But of course it’s still at very low level and in terms of priorities for us today, the priority particularly in Q4, but I think if you understand in Q1 is inventory correction. So we have taken important measures to reduce loading in most of our fabs. So there will be a significant reduction of inventory during this quarter and as a consequence a significant improvement of the cash flow performance.

Moderator

Especially because you improve – you lower your CapEx as well in Q4?

Carlo Bozotti

Yes. In Q4 there is also very significant reduction of capital investments and intensity. But we’ll continue also. So I think overall in the year we will be in the range of 1.25 billion. But very much in the first half driven by MEMS. It’s an important investment and it’s also certain, (inaudible) power technologies and some investment also in the area of advanced logic. So there is a significant reduction in the second half and it will be significantly lower next year.

Moderator

So equity opportunity, but MEMs which has been really the big goal driver for ST in the past two years. How is the competitive landscape shaping up ahead of next year? We’ve heard about a new company in the field in the US, also in Asia. I think the key part for ST, especially you own and you manufacture you own MEMS at the moment, and that is probably the strategy long term as well. How do you see the MEMS market in your position doing?

Carlo Bozotti

Yes. I think for us is of course one of the top priority in the company. We have in the first nine months of this year increased by 130%. So overall in the year we’ve basically doubled compared to one year ago. So it’s becoming an important part – important piece of business and we want to make sure that we move on with very innovative technologies, first of all with the capacity that we need to serve our customers and with new products and new applications. And I think in terms of manufacturing capability it is pretty advanced because it is all in 8 inch. These are very, very small packages.

So I believe it’s a very competitive manufacturing machine. And in terms of products there are a lot of new things coming. So we want to continue with this new flow of innovation. We are working on integrated solutions. We have the solution that integrates up to 10 axis in one package. So we can really run now kind of fusion MEMS and we are addressing new applications. It’s not only of course the Smartphone and Tablet, but is many new things, including products for automotive, including products for healthcare application. So I think this is a very important priority for the company.

Moderator

Okay, good. And I think it’s also pretty good in terms of margin for the company.

Carlo Bozotti

Yes, it is with good management product, yes.

Moderator

And then obviously you’ve got exposure – quite significant exposure to a large US customer in terms of MEMS. How do you feel about this customer for performance product?

Carlo Bozotti

I cannot comment on any specific customer. Our presence in MEMS I have to say is pretty large. And as I said first of all in terms of applications, we started from gaming. So this is interesting to underline. Now of course the Smartphone and Tablets are more important. But as I said we can do more in new fields. We can do more for instance in the AutoCAD, in the automotive. And from a geographical point of view we started in Japan and of course Japan remains a very important area for us. But it’s becoming a global business. So I think it’s – we want to be global here. We want to drive the technology innovation to integrate more functionalities and I believe we have the mass to serve all the requirements from our customers and we have the spirit to innovate and to contribute with a lot of very sophisticated sensing hubs to our customers.

Moderator

Now, if we move to the automotive subsector, as you say in the introduction each one was pretty strong and you have seen a slowdown, probably more acute with the French and Italian manufacturers. I mean we will have Peter Bauer here later today on the stage, he’s actually more bullish on automotives than you are. So is it really a question of geographical exposure or a question of product?

Carlo Bozotti

I don’t know. Automotive of course we grew last year 40% and this year 20%. So yes, of course we can always do better. But it is a good level of growth despite some flattening. So in the second half it is flattening. We had a particularly strong second quarter in the automotive, but I would say that overall it’s a very good year. Following the 40% growth in 2010, we are now adding another 20% of growth and this is before we really enjoy the effort that we are doing in the automotive in the new microcontrollers, because our microcontrollers offered in the automotives today introduction is still – for most of the customers is still Legacy products and of course we have a new family that is hitting the market now and this is all new opportunities.

So all this growth in 2010 and in 2011 has been driven by Smartphone products, has been driven by our BCD technologies and we are very pleased to see a continuous interest from our customers. We are moving on with new generations, adding functionality. So this is a very strong point that we’re having in the automotive and we are also working on new technologies for power like the silicon (inaudible) for the future. But what is important to underline that all of this important growth – in all of this important growth, microcontrollers did not really contribute and in the future we will have a very strong presence in microcontrollers in the automotive thanks to the effort that we have been doing in the last five years.

Moderator

So very key goals for market share gain next year?

Carlo Bozotti

Well, we see growth next year in the automotive for sure, absolutely. We see some growth. But what I’m saying is that the market now in certain areas is much less than last year. Like in China, but even in China this year is 2%, 3% growth. But I think it’s going to go back to a more normal growth in China, the 7% to 9% growth next year. This is the visibility that we have. We are number one in China in the automotive and there is a part of Europe that is weak and US is solid. Germany has been good so we’ll see.

Moderator

Okay. Now if we move to the consumer end market for STMicroelectronics, set-top box has been a bit difficult this year. You’ve launched a new product for digital TVs. Maybe if you could give us a bit of an update in terms of the consumer traction.

Carlo Bozotti

Yes. No, the market is very difficult in consumer. I think it was a real difficulty as we have really – we did not have the support on any real drivers in 2011 in the consumer. So I think it was a particularly tough year and I think our set top box business is solid. We are not at the level we had last year when the market was booming. But it’s a solid business and TV’s new products. So we have launched our new product this year. It’s now in production and we expect to grow. In August we introduced our all new family, is a 32-nanometer set top box system. It’s important to underline that the same technology is now used also for TV.

So we have all the IPs that we need to improve the quality of the high end TV. But the processing part is now converging between the set top box and the TV. (Inaudible) is the first machine at 32-nanometer is running four high definition streams at the same time on a TV screen. So it’s a pretty innovative machine and we hope that of course next year with more drivers, including Olympics for instance and of course new product contributions, we can make a step forward in terms of top line, because here the challenge is more the top line and not the margin structure. And of course we aren’t there, but I think hopefully with more drivers next year and new product contributions, we can see a positive step forward.

Moderator

Okay. Now if we move to gross margins, obviously there are relatively low levels in Q3, Q4 and particularly in Q1 as well as you’ve reduced your inventory. Is there anything you could do apart from obviously the lower loading of the fab which is taking place now to improve gross margins structurally? You were very, very close to 40% this cycle. Fingers crossed next cycle you will be above 40%. Does it imply some changes like moving the Singapore fab from 6 to 8 inch, moving the manufacturing to 12 inch as well to compete with TI? I mean is there anything you can do during…

Carlo Bozotti

Well, of course there are many things we can do. I think the first thing is new products. This is obvious, particularly in wireless because we consolidate the gross margin also on wireless and the legacy products in wireless do not show a good gross margin at this point. So the new product in wireless, but in general the new product offer. So this is one element. The second element is going through this inventory production. So at this point the major effort is done in Q4. But we plan to go back to a good loading condition in Q2 next year.

So there will be a transition from where we are. And then in terms of growth, manufacturing growth, we will grow in Asia. This is clear. So we will grow in our facility in Singapore or we will grow more in Asia. So we will grow in our facility in Singapore, including the 8 inch in Singapore. We will grow at our silicon family activities and in terms of European fabs. We have facility, growth to a facility where we run advanced technologies. But on the path that is more mature of the fab. We also run analog in 12 inch. We have products that are running in 12 inch for power management and the radio frequency applications.

So it’s a combination of three things. First of all is the product portfolio which is of course the most important. Second is to grow faster in Asia compared to Europe and third is exploiting the 12 inch for instance when traditionally we run the 8 inch or to exploit the 8 inch when we traditionally run in 6 inch. And so these are the three elements of the driver for the gross margin. Today the strong impact is on the loading situation and the priority is the cash. So there will be a very significant turnaround of the cash flow this quarter for the two reasons that we said before, of course inventory correction and significant reduction of the CapEx.

Moderator

Okay. So moving to the difficult subject of ST-Ericsson, I was with Gilles Delfassy, the CEO of STE last week. It’s tough for him because it looks like it’s a very good product, but going the extra mile to get to the deal and to get the market share. I have been talking about HTC, RIM, Nokia, Sony Ericsson all of this year. But the extra mile is just not getting there. How can you help Gilles to basically turn around the situation in ST-Ericsson or is it just a question of getting more lucky?

Carlo Bozotti

No. I think it’s never – first of all it’s never at the personal level. I mean ST and Ericsson are two shareholders. They are two committed shareholders and I think it is clear that the major problem that we have has been and is moving into 2012, the change of strategy of Nokia because our presence in Symbian was a massive presence that for a number of reasons, particularly the fact that our product was not compatible from a graphic point of view with the Microsoft system, we could not turn it around quickly. So I think the major problem is the lack of the Symbian volume and of course we are working on two fronts. One is the expansion of the customer base. In a sense ST at the consolidated level, even if in the word this is a joint venture 50-50 with the Ericsson Group, we are absorbing two challenges at the same time.

One of course is the one that everybody has which is the market situation. The second is Nokia because our presence in Nokia was very important and Nokia was an important part of ST. It was 14% last year. It was 11% in Q1 this year and now is below 10%. So we have these two at the same time. Anyhow the priority for ST-Ericsson is to expand the customer base. I think that they have done a good job in the Android world. I believe that it’s good to see now that they are into the also Microsoft Nokia ecosystem and three weeks ago we have announced the first design win with Nokia for the Windows 8 phone. So this is good. So the first priority is expanding the customer base and the second priority of course is to work on the cost structure of the company to decrease the time to breakeven.

So these are the two priorities. It’s clear that there is a very strong commitment from ST and there is a very strong commitment from the Ericsson group. Ericsson considers the wireless broadband technology as part of their core business of course and this is important for them to control the evolution of the system here. On the other vein it’s also clear that we need to accelerate the turnaround of the company. So there are many actions that are running at this very moment, including the restructuring plan that we have announced in July to turn it around quicker. So the support is there. So I think it’s not a matter of support, it’s a matter to expand the customer base on one side and to take all the cost reduction actions on the other side.

Moderator

But clearly one of the questions, is it easy to manage this type of turnaround within J because actually I was at the analyst day for Ericsson last week and they just sold their stake in Sony Ericsson and to say actually it is decision to run the company in the J.

Carlo Bozotti

I don’t think so. The problem with Symbian is not the JV. I think the complexity is really not – there is absolutely no problem particularly with Ericsson. We are very much aligned and there is absolutely no divergence of view here. We want to succeed, but we want to succeed fast and we need to work both on the top line and the customer expansion program on one side and we need to work on the construction on the other side. So I think it would have been impossible for ST to run this alone. I think it’s good that we are in a venture with a solid partner. I do not see any penalization at all to drive this initiative in a form of a JV. The two shareholders are very aligned. It’s back to fundamental. So again Symbian is a problem. It’s a big one. We need to address this with more customers with good products and reducing costs. I think this can be done and will be done and the intrinsic value of the company is the base of IPs. It is a huge base. The quality of the product portfolio and the great interest from most of the customers to come with us with ST-Ericsson and of course these are elements that are giving us the confidence that this will succeed.

Moderator

So I am seeing the good news is that the U8500, which is the new chief application processor plus modem is actually shipping at the moment with several customers.

Carlo Bozotti

Yes, we sold one million pieces in Q3. So this is an example of the technology and there will be more of course. But we do not have any doubt on the quality of the product portfolio and we do not have any doubt on the quality of the IPs of this company. It’s just the time to move on with the transition to convince more customers to come. It’s the time of the customer to adopt the products in a situation where let’s face it, there is one major supplier. But this is a big market. This is a market that is moving from 25 billion to 30 billion and there is a lot of space and we are confident that part of this space will be taken by the good products of ST-Ericsson.

Moderator

Basically Qualcomm cannot have 100% market share.

Carlo Bozotti

I’m not mentioning anything. But I think you know to succeed here we do need to go to 50% market share. This is a $30 billion market. At 15% market share ST-Ericsson will be a very successful company.

Moderator

And with a good EBIT margin.

Carlo Bozotti

Absolutely.

Moderator

Maybe we move to questions on the floor. At the back there?

Unknown Analyst

Hi. Can you remind us on your cash flow guidance this quarter? I think you said on the call that you would be around about break even. Is that still the case? And I guess same question for next year, what sort of gross margin level do you think you could be at should not burn cash in 2012?

Carlo Bozotti

Well, I think we cannot – yes, absolutely the case for the short term. I really confirm what we have said it is now one month or so. It is a significant turnaround in the cash flow and moving on as we said before in Q1, we will continue our effort to reduce inventory and now we have significantly reduced CapEx. So the cash flow will improve. In terms of gross margin, of course this will depend on our ability to as we think to go back to a good front loading from the second quarter of next year. But of course we cannot give guidance for next year gross margin at this point. I think from the visibility that we have that as we said before is pretty short term, we foresee let’s say another quarter of correction. But as the tail of the correction in Q1 and then going back to a normal business situation in Q2 next year.

Unknown Analyst

Carlo, just a question on wireless and your recent win with Nokia on Windows phone. Could you maybe just expand a little bit about the opportunities with Windows phone versus what you’ve lost with Symbian? And do you also think the other manufacturers on Windows phones may follow Nokia in terms of using you as a second supplier to Qualcomm?

Carlo Bozotti

I’m sorry. I was not sure (inaudible). But I think I tell you before but (inaudible). So I know that the – of course the problem is the timing because it is clear that the positive impact for us on Symbian would have started now moving on very significantly next year. It has not happened. It is far below the level that we thought. And the Windows phone 8 will hit significant in 2013. So this I think is going to be of course a great potential. I think it’s a very good product for both for very high volume applications. But it’s not going to be a short term business. And so this is part of the challenge. This is the main challenge let’s face it and it’s the timing between the two.

Moderator

So actually on this topic which is the cash position of ST-Ericsson is a bit weak on the weak side. Does it imply that given that it’s going to take a while before we see a bit of a turnaround on revenues you might have to with Ericsson make some kind of cash injection in the company? Or is it too early to say?

Carlo Bozotti

I think it’s too early to say. We see, I mean of course today in ST we have net financial position of more than $800 million. We have – I believe it’s important to underline, as part of this there is 100% of the debt. So this includes of the debts of ST again, all right? So this is the kind of pro forma number is more than $1.1 billion because we consolidate. But of course from a competence point of view this is the part of Ericsson. So I think it’s a solid position. We are now moving back to generate cash and today I think Ericsson has a credit line of about $800 million and we owe $600 million. So we will see with our partner.

Moderator

You have a question at the back. Oh, finish first and then at the back.

Unknown Analyst

On your dividend, talk a little bit about the sustainability of that in a microeconomic downturn that is prolonged next year.

Carlo Bozotti

Today we do not have any evidence of the fact that this is not sustainable. This is what I was just saying. Before the crisis in 2008, 2009, our net financial position was minus $500 million. So it was a negative of $500 million. I believe this was the number. At the moment the other crisis started at the end of 2008. Today the pro forma is a positive of $1.1 billion. This year we decided to accelerate on the front of the investment of MEMS and certain smart power technologies. This level of capital investment is not at the level of what we need to run the company. It’s higher. So there will be a decrease in the capital investment effort. So as I said, despite major effort in the R&D in wireless, we are now going back to in the ultra-low positive cash flow. So we do not have any indication that this is not sustainable at this point. But of course this is not up to management by the way. This is – it is management, it’s the board and indeed it’s the shareholders meeting.

Moderator

Yeah, question at the back.

Unknown Analyst

And then also on ST Ericsson, if the expansion of the customer base doesn’t occur as you anticipate, is there a plan B subdivision?

Carlo Bozotti

Yes. I think first of all the customer base expansion is happening. This is important to underline. What is missing here is a big chunk of a big customer. This is the very first problem. And of course this has a number of consequences because we lack a lot of revenues. This is – we lack a lot of revenue. This is – but in terms of expansion of the customer base, we are pretty instance. And for instance you know that HTC now has phones in the shop using our 8500. But we have a good base of customers and even more importantly we have a great deal of interest from many, many customers. Having said all of that, this must become a profitable business. There is no doubt and therefore it is always good to have plan A, plan B, plan C and plan D and there are many things of course.

I think I did mention this during the last conference call one month ago. There is nothing on the table and of course – but conceptually there are many things we can do. Today ST-Ericsson is run as an independent company which is fine. But the modern can be even more defined. If you take the Ericsson Group, in Q3 they run at 4.5% G&A. ST in Q3 run at 4.5% G&A and ST-Ericsson in Q3 did run at a G&A level that is much higher than 4.5%. So this is already a very significant opportunity in case we decide to restructure the way the company is run, less as an independent company and more as a subsidiary. The second thing of course is the scope of the product. Today the scope of the product is very broad. It’s covering basically everything in the wireless domain and so this is another opportunity. And again I’m talking about conceptual opportunities because they’re not on the table.

Another opportunity is to for instance to share a certain portion of the R&D activity on certain products. For instance with another partner, with a third partner, with a second partner, with another partner. Another opportunity of course is the way to structure the shareholdership between two, between three. So there are many things we can do. But this is not on the table today. I think would be unwise not to have studied all of these things. But the priority as I said at this moment is organically to expand the customer base and to take a number of cost reductions that are on the way by the way through the restructuring plan that we have announced in July this year.

Moderator

Question at the back again.

Unknown Analyst

Can you explain to me – I don’t quite understand from Ericsson’s point of view why they need to own half of this business particularly now that they’ve exited the handset business. I don’t quite see the logic and if I were running Ericsson I’m not sure I would want to put new money into this venture. What is your rebuttal to that?

Carlo Bozotti

I think first of all you should ask them. But I can tell you what is my view of course. My view is that the handset business, and we knew from the very beginning this is not strategic in the sense that the technology per se, the intrinsic technology per se is not developed any longer by Smartphone makers, the intrinsic technology per se. So the technology of the broadband wireless communication is developed either by companies like Ericsson or by company like ST-Ericsson and is very much embedded in the hub of the digital core of a phone or in the heart of the digital core of communication infrastructure system. And I think this is why Ericsson is, from a strategic point of view, very interested to push through this initiative because it’s giving them the control of the intrinsic IPs, the intrinsic knowledge, the intrinsic technology on all the broadband wireless communication. This was not the case of Sony Ericsson because this technology is not developed any longer by phone makers. So I believe this is the rationale and the strategic interest of the Ericsson Group in an initiative like this. But again this is what I know talking to Ericsson. I think of course direct dialogue is maybe better. But this is what I think.

Moderator

I think we are actually running out of time.

Carlo Bozotti

What? Already?

Moderator

Yes. I know. So exciting, but we have to stop. Carlo, thank you very much.

Carlo Bozotti

Thank you.

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