Ladies and gentlemen, welcome to the STMicroelectronics fourth quarter and full year 2018 earnings results conference call and live webcast. I am Moira, the conference call operator. I would like to remind you that all participants will be in listen-only mode, and the conference is being recorded. The presentation will be followed by a Q&A session. You can register for questions at any time by pressing star and one on your telephone. For operator assistance, please press star and zero. The conference must not be recorded for publication or broadcast. At this time, it's my pleasure to hand over to Ms. Céline Berthier, Group Vice President, Investor Relations. Please go ahead, madam.
Thank you, Moira, and good morning, everyone. Thank you for joining our fourth quarter 2018 financial results conference call. Hosting the call today is Jean-Marc Chery, ST's President and Chief Executive Officer. Joining Jean-Marc on the call today are Lorenzo Grandi, President of Finance, Infrastructure, and Services, and Chief Financial Officer, Marco Cassis, President of Sales, Marketing, Communications, and Strategy Development. This live webcast and presentation materials can be accessed on ST's Investor Relations 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 this morning, and also in ST's most recent regulatory filings with a full description of these risk factors.
Also, to ensure all participants have an opportunity to ask a question during the Q&A session, please limit yourself to one question and a brief follow-up. I'd now like to turn the call over to Jean-Marc, ST President and CEO.
Thank you, Céline. Good morning, everybody, and thank you for joining ST on our year-end earnings call today. Before going through a detailed review, let me start with some opening remarks. First, on 2018, we had solid financial results in the fourth quarter for both revenues and profitability. For the full year, in line with our objectives, we delivered significant revenue growth across our product groups, a strong expansion of our operating profitability, net income and free cash flow, while investing to drive growth opportunities and operating efficiency over the midterm. Second, on 2019, our first quarter outlook reflects the combined impact of increased unfavorable dynamics on top of first quarter seasonality in some of the end markets we serve, smartphone applications, computer hard disk drives, and distribution in China and also in Europe.
On the other hand, we see automotive and power discrete holding well, with significant growth year-over-year. After Q1, we plan to return to sequential growth in the second quarter with an acceleration in the second half of the year. Our key objectives for this year are to continue outperforming our served market and to balance our end market and application focus, delivering sustainable profitability and returning value to shareholders. To support all of that and to execute on our strategic technology, R&D, and manufacturing programs, we expect to invest in CapEx. Part of this CapEx is devoted to support three strategic initiatives that I will detail later. Let's now start with the detailed review. Our financial results in the fourth quarter for both revenues and profitability were solid.
Net revenues increased 7.4% year-over-year on double-digit growth across our automotive and discrete group, in imaging, and in digital ICs. On a sequential basis, our revenue increased 5%, very close to our midpoint target of 5.7%. Sequential growth was driven by imaging, automotive, and power discrete. Our gross profit totaled $1.06 billion, representing a year-over-year increase of 5.6%. Our gross margin was 40%, 20 basis points higher than the midpoint of our guidance. In comparison to the fourth quarter of 2017, our gross margin was 70 basis points lower. Our net operating expenses were $614 million. Operating income increased 7.9% year-over-year to $443 million. Our operating margin was 16.8%, 10 basis points higher than the year-ago quarter. Fourth quarter net income of $418 million and diluted earnings per share of $0.46. Both increased about 35% year-over-year.
Let's look at our fourth quarter results by product group on a year-over-year basis. ADG revenue increased 7.8% to $960 million on double-digit revenue growth for both automotive and power discrete. ADG, I have to correct here. Sorry. It is 17.8. Okay. As you guessed, it is much better than 7.8. Sorry for my mistake. Let's continue now. ADG operating margin expanded 220 basis points to 14.6% from 12.4%. For both the third and fourth quarters, ADG's operating margin were solidly in line or ahead of our low teens second half 2018 target. Moving now to our Analog, MEMS and Sensors Group, AMS. Revenues totaled $988 million, an increase of 9.5% with double-digit growth in imaging and single-digit growth in analog and MEMS. AMS operating margin was 20.5%, stable with the year-ago level of 20.8%.
For AMS, we had initially anticipated second half 2018 operating margins to move into the mid-teens. We exceeded that level in both the third and fourth quarters. Finishing our product discussion with the Microcontrollers and Digital ICs Group, MDG. The inventory correction in microcontrollers continued as anticipated during the fourth quarter due to the mass market softening in China. In total, MDG revenues decreased 6.9% year-over-year to $689 million, with growth in digital ICs offset by microcontrollers and memories. MDG operating margin was 17.7%, below the 19.7% in the year-ago quarter. For MDG, we had initially anticipated second half 2018 operating margins to be about 20%. We came in below that level in both the third and fourth quarters. This was mainly due to a lower than expected level of revenues and less favorable mix between microcontrollers and other products. Turning to our full year results.
As I said earlier, 2018 was an important year of achievement. 2018 net revenues were up by 15.8% compared to 2017, reaching $9.66 billion. In 2018, we achieved our objective to outpace the growth of our market we serve. Gross margin was 40% compared to 39.2% in the prior year. Operating margin expanded 250 basis points to reach 14.5% in 2018 on sales growth and operating efficiency leverage. Net income and free cash flow were up 60% and 73% respectively compared to 2017, while CapEx was slightly lower at $1.26 billion from $1.3 billion in 2017. Also in 2018, revenues were balanced across product groups, customer types, and region of customer origin. ST has over 100,000 customers. By region of origin, 35% of our 2018 revenues were from the Americas, 34% from Asia Pacific, and 31% from EMEA.
Sales to OEMs represents 65% of total revenues and increased 14% in 2018. Distribution representing 35% and growing 19% for the year. By product group, ST's total revenue growth of 15.8% was supported by all three product groups. ADG's revenue increased 16.2% with double-digit growth for both automotive and power discrete. Looking at our products across ST in total, addressing the automotive market-We finished the year with a growth of about 18%, above the famous 17% year-over-year growth expectation that we have shared with you previously. AMS revenues increased 19.9% on sharply higher imaging sales and double-digit growth within analog. MDG revenues increased 11.1% in 2018, with double-digit growth for both microcontrollers and memories and digital ICs. All three groups delivered operating income and operating margin growth.
ADG operating income increased by 48% to $431 million, and its operating margin increased to 12.1% from 9.5% in 2017. AMS operating income increased 34% to $480 million, and its operating margin increased to 15.5% from 13.9% in 2017. MDG operating income increased by 35% to $547 million, and its operating margin increased to 18.6% from 15.3% in 2017. In 2018, our financial performance drove a 10% increase in net cash from operation for the year, reaching $1.85 billion. Our free cash flow increased 73% to $533 million, well covering our cash dividends of $216 million, as well as $62.5 million share buyback under the program launch during the fourth quarter. As anticipated, we exited 2018 with a higher net cash position compared to 2017, at $686 million compared to $489 million at December 31st, 2017. Let's move to our guidance.
Our first quarter outlook is for net revenues of about $2.1 billion at the midpoint. This would represent a year-over-year decrease of about 5.7% and a sequential decrease of about 20.7%. We anticipate a gross margin of about 39% at the midpoint. After Q1 2019, we plan to return to sequential revenue growth in the second quarter with an acceleration in the second half of the year. This is in line with the objective I stated at the beginning of my speech: continue outperforming our served market and balance our end market and application focus, delivering sustainable profitability and returning value to shareholders. In order to support all of that and to execute our strategic technology R&D and manufacturing programs, we expect to invest between $1.2 billion-$1.3 billion CapEx.
Of course, this amount includes the maintenance of our infrastructure, fab and plant and R&D required by all our manufacturing operations, and also capacity addition in some of our existing technologies. However, part of this CapEx is also devoted to support three strategic initiatives. First, a new 300-millimeter wafer fab in Agrate, our site near Milan. The construction work of the first stage to support R&D and first industrial deployment phase has already started, with the related building and facilities to be completed and ready to host some equipment for R&D in 2020. This new fab is designed to be expandable, of course, according to demand, to start volume production starting from 2021. It will be focused on supporting our growth ambitions and leadership in BCD, IGBT, and power technologies.
Second, the expansion of our installed capacity for silicon carbide and the start of production ramp-up for gallium nitride for RF devices. Here, our early investments in wide bandgap compounds have already resulted in over $100 million of silicon carbide revenues in 2018, and we have over 30 active silicon carbide projects with many players around the globe, both in automotive and industrial applications. Also, earlier this month, we announced a multi-year supply agreement with Cree, our partner. These investments support our goal to sustain an important share, about 30%, of the silicon carbide market, which is estimated to be over $3 billion in 2025. Third, our investments in the next generation of imaging sensor technologies. This will enable us to continue our leadership in our focus technologies for personal electronics and to address selected industrial and automotive application in the future.
These initiatives are part of our strategy to reinforce our leadership in our end market, broad-based in industrial and automotive, and with a selective approach in personal electronics and in communication infrastructure. We will discuss in detail our end market and product strategy at the Mobile World Congress in Barcelona on February 26th, and we will provide a more in-depth overview of our company when we will meet at our annual Capital Market Day in London on May 14th. To conclude, in 2018, we met our objectives with 15.8% year-over-year revenue growth across our product groups, as well as a strong expansion of our profitability and cash flow from operations. In 2019, after Q1, we plan to return to sequential growth in the second quarter with an acceleration in the second half of the year.
Our objective for the year is to continue outperforming our served market, to balance our end market and application focus, delivering sustainable profitability, and returning value to shareholders. We are now ready to answer your questions.
We will now begin the question and answer session. Anyone who wishes to ask a question may press star and one on their touch-tone telephone. You will hear a tone to confirm that you have entered the queue. If you wish to remove yourself from the question queue, you may press star and two. Participants are requested to use only handsets while asking a question. Anyone who has a question may press star and one at this time. The first question is from Janardan Menon from Liberum. Please go ahead.
Hi. Good morning. Thanks for taking my question. I have one question and a short follow-up. The first question, Jean-Marc, is just to find out where you're getting your confidence on the sequential growth into Q2, and the acceleration into the second half. My point is, you have had headwinds in the China distribution channel. There are signs there's been a slowdown in the Chinese car market, et cetera. Do you expect some of those issues to recede into Q2, therefore, giving you the upside? Is it coming from signs from your major smartphone customers? Into the second half, can you be a little bit more specific on what are the drivers of that acceleration? My second question is on your inventory days, which came down quite a bit in the fourth quarter to 88 days from 95 days.
Given your sort of guidance into Q1, where do you see those inventory days? Will they be going down further from this 85 in Q1? Where does that bottom out? Do you think your distribution channel is also having this sort of a profile of inventory days where it came down in Q4, and will come down, or what will be the trend in Q1? Thank you. Thank you very much.
Thank you. I will answer your first question, and Lorenzo will take the second one. Clearly, the sequence for the year 2019, overall, we do believe that we will see a similar pattern of what we see now 2018. I guess, everybody remember the pattern of 2018 for ST. More clearly, with an acceleration in the second part. Why we plan this pattern of sequential growth again in Q2 and acceleration in the second half? There is some which are really specific to ST, and some are, let's say, more related to the market. Of course, we will closely monitor on a permanent time what is happening on the market. Today, first, we have no visibility that our market would decline on the full year, and instead, the indication we have are for some growth overall.
Certainly, the inventory correction we have seen started in Q3, continuing in Q4 and in Q1, will slightly continue in Q2, but should start to stop in Q2. On top, we have a growth driver allowing us to outperform. On automotive first, I recall to you that our silicon carbide is performing very well. We have new MCUs in production at the 40 nanometer, and we are performing very well on ADAS components. In smartphone and personal electronic, we will see start of new programs in the second half of the year and in industrial end market, we will introduce this year more than 10 new products to address this market with our general purpose MCUs.
That's the reason why linked to what is specific our company, we have a good confidence level to have a strong acceleration in H2 this year versus H1 and as we guide, a low Q1 guidance. That's the reason why we are confident to see this pattern very similar of 2018 with an acceleration on the second half. This is our plan. Definitively, it is our duty as management to closely monitor on a permanent basis all the business metrics related to the market, our customers and the end market we address. Now, I let Lorenzo to elaborate about inventories, consistently with the plan I described.
Good morning, everybody. About inventory, as you rightly said, in the Q4, the inventory went down significantly. Our revenue grew, and the number of days of inventory went down. What will happen in Q1? In Q1, seasonally, we have a shorter quarter. The production is, today we have our fab fully loaded. What we see is similarly to what happened last year, to have an increase in terms of inventory. Today, the inventory is below one quarter. At the end of Q1, it will be higher in terms of days than one quarter. This is quite seasonally, and this is also a plan in order to fulfill our growth ambition in the second quarter and for the second half of the year.
Any comment on the distribution channel inventory?
As Jean-Marc already highlighted, the distribution channel, we're expecting the inventory correction to be faster than what has been happening, and this is why we have an impact in Q1. The meaning is we had the POS, that we're expecting to be flattish in Q4. Reality, they decline. The inventory correction will take a little bit longer than expected, but we do not see this as an impact on our growth in Q2 and on the rest of the year.
Got it. Thank you very much.
The next question is from Sandeep Deshpande from JP Morgan. Please go ahead.
Yeah. Hi. Thanks for letting me on. My first question is regarding your imaging business and your CapEx. I mean, are you adding CapEx in this environment in smartphones or in the imaging business? Are there wins that you have going forward, which is why you're adding CapEx there? Secondly, my question is on your gross margin. I mean, despite your guidance of a 21% revenue decline in Q1, your gross margin has remained 39%. I mean, clearly, some of these products are built in-house. How has your gross margin remained so at that level, given the extent that the revenue is impacted in Q1? Thank you.
I will answer, Sandeep, too, about CapEx and imaging, and I will let Lorenzo to answer about the gross margin. Well, as I said in my opening remark and speech, clearly I confirm that the end market strategy and product portfolio is to be a broad range leader on automotive and industrial. Where we consider we have a portfolio, which can put us in a position to be a leader or very close to the leader. We want to be very selective on personal electronics, in sensor, in secure solution, power management, and RF and millimeter wave devices. As you know, in sensors, overall to address the personal electronics and smartphone business and especially answering to your question on imaging, we have important R&D effort to continuously improve the performance of our device, especially addressing the time of flight applications and 3D sensing.
We intend, and we will invest in CapEx in order to support. First, our R&D effort to make our product more competitive, better for our customer with better differentiation. Of course, when you improve the efficiency of your device, time to time, you have to put additional, let's say, equipment in order to bring additional process step or to improve your process in order to maintain your capacity to address the need of your customers. This is the reason why we are investing in imaging to personal electronics. Not to grow at infinite capacity, but more to adapt our process, enabling much better device, competitive device, and better than the competition.
About the gross margin of Q1. As you have seen, our guidance for Q1 is to have a gross margin in the range of 39%, mid-point. There are different dynamics on the gross margin. First of all, you have to remind that in Q4, we work really at full speed with our manufacturing, with all the fab fully saturated. This has brought a very good efficiency in terms of manufacturing during Q4 that is reflecting in the gross margin of Q1. As you know, there is a delay due to the inventory of almost one quarter between the performance of manufacturing and the impact of Q1. We are enjoying a positive impact on manufacturing. There will be, on the other side, in Q1, the impact of the renegotiation of pricing with our customers, and this is embedded in our guidance.
We do expect the Q1 not to have any impact of unloading, thanks to the fact that to some extent, we have leverage on some flexibility with respect to what we have to source outside. Also on the fact that we will keep our fab loaded, with some increasing inventory, to support the revenue growth that we expect in the second quarter and in the second part of the year.
Thank you.
Okay.
Next question, please. The next question is from Alexander Peterc from Société Générale. Please go ahead.
Yes. Good morning, and thank you for taking my question. The first will be on automotive. Can you confirm that growth patterns there are broadly unchanged, and could you share what kind of growth automotive was at for ST as a whole in the fourth quarter, and whether we will stay double-digit territory going into the beginning of 2019? Then secondly, could you give us any targets for silicon carbide for 2019 now that you have reached the EUR 100 million milestone in 2018? Thanks.
So you-
Do you want I take the first part of your question about the growth in automotive? As Jean-Marc said in his initial remark, for the full year, we grew in automotive slightly above 18%. This is the full automotive of the company, means that it is encompassing products in the different groups and not only in ADG. When I look at the growth in automotive in Q4, it is closer to 20%. We grow around 20% sequentially. We grow, let's say, not 20% sequentially. Year-over-year, let's say, in Q4 in automotive, in respect to Q4 of previous year. Just to give you an idea how much was the sequential growth in respect to Q3, this was more in the range of 8%.
About silicon carbide, what I can say, that we prepare ourselves, and we plan to support, and fulfill widely our customers' demand. Whatever in terms of mass production, for the car assembly and production, but also delivering all the engineering samples we need to deliver to all the projects we won in 2018. What I would like to simply confirm you, that our expected growth in 2019 is completely consistent with the expected market growth of the silicon carbide application, which I repeat that for the time being, people, they plan to have $3 billion in 2025. If my memory is still very up, $600 million in 2020. Our revenue growth will follow totally this pattern.
Okay, thanks.
The next question is from Stéphane Houri from Oddo. Please go ahead.
Yes, hello. You recently talked about the ability of the group to protect the margins above the 10% line, talking about the operating margin. You also said that you needed to check some of the parameters that should lead to that. If I understand well, you are saying that you will be growing at the end of the year-on-year. You have shown that you are able to protect your gross margin at the level of, let's say, 39%, and if we have growth, maybe it will get higher. What does it mean in terms of OpEx? Are you just cutting the OpEx to make sure that the margins will hold, or you do nothing at the moment and you keep on moving that base?
Lorenzo will comment on the OpEx model.
Yes, for sure. In terms of OpEx, we discuss about in terms of OpEx and our model. We said that the company substantially is equipped to sustain the growth, and we do not expect to have significant growth moving from 2018 to 2019. Apart, of course, the normal increase due to the salary, to the inflation rate. Actually, we do expect in Q1 to have expenses in the range of between 600 and 610. This does not come from, let's say, any cut or any action. You have to consider that Q1, there is some seasonality, that is a shorter quarter, so it's also in terms of expenses. Also, you have to consider that in this number, we embed also some catch up in terms of grants.
When I look overall the expenses, the average expenses by quarter, during 2019, we do expect to have net expenses, including other income and expense, in the range of $620 million-$630 million per quarter. This comes with, of course, some attention to our expenses, but without any plan to cut activity or to cut workforce.
Did I understand correctly that you said that you were expecting some growth for the year, that for the moment you were not seeing any decline? It means that, in term of acceleration in maybe, probably in Q3, it means a double-digit acceleration sequentially. In which division do you see much of this acceleration, sorry?
This is Jean-Marc speaking. Exactly, I repeat what I say after the first question. There is element intrinsic to our company and element, okay, related to the market. Related to our company, clearly again, automotive will accelerate in the second half, thanks to the acceleration of our growth on silicon carbide. This is what I just said a few minutes ago, automotive and discrete. Acceleration related to introduction of MCUs on 40 nanometer, and acceleration on ADAS components. This is the first dimension. Definitively, we have also programs starting in the second half of the year, related to smartphone and personal electronics. This will support mainly AMS product group. Clearly, again, I come back to Marco Cassis' comment about distribution channel.
As I told you, and anticipated during, let's say, various communication, our initial plan was to see inventory correction on microcontroller, mainly to China and a bit in Europe to end in Q1. Certainly, will continue a bit in Q2 because the point of sales, which was flattening in Q3 and supposed to be still flat in Q4, shown some sign of slightly decrease in Q4. In this condition, we do believe that the inventory correction will be prolonged one quarter more. That's the reason why in the second half of the year and, let's say, starting in Q2, we will see an acceleration overall of microcontroller, here more related to the overall market.
However, on microcontroller, I would like to insist with, that we will introduce 10 new products this year in order to embed in our controller more security, more connectivity, and to address mainly the industrial market with high performance ARM core. This, of course, will contribute to the acceleration of our growth across the year. You know, as usual, when we face such situation of market turning down, the growth is coming from new product.
Okay. Thank you very much, Jean-Marc.
The next question is from David Mulholland from UBS. Please go ahead.
Hi, thanks. Just to follow up on a couple of the comments you made on the gross margin for Q1, and kind of hopefully you can help us think of that through the rest of the year. Can you maybe comment on what you're planning to do utilization rates through Q1 then, and obviously, could that end up having more of an impact on the gross margins as we head into Q2. Obviously, depends on what snapback you see, but are utilization rates starting to come down a bit through Q1? It would be helpful if you could comment on that. Then just secondly, as a follow-up, could you comment a little bit on what you've seen in terms of the book-to-bill in the quarter, particularly how bookings trended through the period?
If you can comment at all on how that has started the year so far in January as well, that'd be really helpful.
Okay. Yeah. Lorenzo speaking. Coming back to your point about the gross margin, about the utilization rate. As I said, in the Q4, the utilization rate was substantially with the full fab or the fab full. This translating in a utilization rate that is 90%. You know that for the fab cannot be higher than this level. This level is already stretched. When we move to Q1, the utilization rate will be slightly lower, but I would say that is in the range of 88, 89. It means that there's still a very high level of utilization rate of our fab. This, of course, is one of the reason why we don't see any significant unloading during the quarter. What is the expectation for the gross margin moving ahead? As you know, usually we do not guide on the next quarters.
What we said last year is that, at this stage, considering that in our COGS, we have some headwinds. That is, in particularly, the cost of silicon that is still quite high. We have headwinds in the cost of material and in the power that has increased significantly. On the other side, we do expect to have some positive from still some improvement in our manufacturing. We do expect to have, in the second quarter, based on the plan that we have today in term of revenues, a gross margin similar to the one of Q1, and then move, thanks to increased revenue, back ranging around 40%. That is, let's say, what we were saying a few quarters ago. This is about the dynamic of the gross margin in our plan. What was the other question? Sorry.
Just wondered if you could comment on what happened to bookings in Q4 and the book-to-bill level, and if you can help at all how that's been progressing so far this year.
Okay. Booking in Q4. Booking in Q4, as you can figure out from our guidance of revenue, was not particularly strong. The booking in Q4 declined in respect to the one of Q3. Our book-to-bill was below parity. Was below parity even if in some areas, if you take for instance, automotive and power and discrete, the book-to-bill was close to parity. We see here still the market, the demand still solid. Overall for the company, the book-to-bill was below parity during the quarter. Our expectation is that, in the course of Q1, we will see to revert with some booking to support our growth plan for the next quarter.
That's great. Thank you.
The next question is from Achal Sultania from Credit Suisse. Please go ahead.
Hi. Good morning. Just one clarification, Jean-Marc. I think you mentioned that when we think about second half of 2019, we should see a similar trend to what happened last year in the second half. Obviously, last year you had a benefit with one of your large customers where you had a key design win ramping up materially. I'm just trying to understand, this year, when you talk about similar trend, are we talking about what gives you the confidence of a similar ramp? Is it content gain, or is it new customer wins? Or is it new design wins with existing customers? Just trying to understand what exactly is underpinning that confidence in second half. Thank you.
Thank you for your question. The answer inside your question. It is everything. It is, of course, some content increase, thanks to new programs start. It is other customer growth. Thanks to our, let's say, focus, again, on personal electronics, addressing the full market with sensor, secure solution, power management, chargers, fast charger, wireless charger, and RF and millimeter wave. All in all, okay, it is due to the three reason you mentioned in your question.
Okay. Thank you.
Next, please. The next question is from Johannes Schaller from Deutsche Bank. Please go ahead.
Yeah, good morning. Thanks for taking my question.