Ladies and gentlemen, good morning or good afternoon. Welcome to the STMicroelectronics first quarter 2018 earnings release conference call and live webcast. I am Aura, 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. After the presentation, there will be a Q&A session. You can register for questions at any time by pressing star and one on your telephone. Should you need assistance, please press star and zero to call an operator. The conference must not be recorded for publication or broadcast. At this time, it is my pleasure to hand over to Mr. Tait Sorensen, Group Vice President, Investor Relations. Please go ahead, sir.
Good morning. Thank you, everyone, for joining our first quarter 2018 financial results conference call. Hosting the call today is Carlo Bozotti, ST's President and Chief Executive Officer. Joining Carlo on the call today are Jean-Marc Chery, Deputy CEO and Designated President and CEO, Carlo Ferro, Chief Financial Officer, Georges Penalver, Chief Strategy Officer, and Lorenzo Grandi, Corporate Vice President, Corporate Control. This live webcast 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 this morning, and also in ST's most recent regulatory filings for a full description of these risk factors.
To ensure all participants have an opportunity to ask questions during the Q&A session, please limit yourself to one question and a brief follow-up. Now I would like to turn the call over to Mr. Carlo Bozotti, ST's President and CEO. Carlo?
Thank you, Tait, and thank you for joining us on our first quarter 2018 earnings conference call. Our agenda today includes a summary of the quarter, a detailed product group review, and our second quarter outlook. Let us begin. Our objective for 2018 is to leverage the results we achieved in 2017, continuing on the path of broad-based, sustainable, and profitable growth. Based on our first quarter results, we have started the year well on track. Revenues grew 22.2% year-over-year to reach $2.23 billion, and this is our sixth quarter in a row of double-digit year-over-year sales growth. This quarter, we posted double-digit sales growth across all product groups and regions, thanks to our focus on smart driving and IoT applications. On a sequential basis, revenues decreased 9.8%, 20 basis points better than the midpoint of our guidance.
We delivered a better-than-seasonal performance in two end markets, automotive and industrial, well-balanced between large customers and distribution, which represented 37% of our revenues in the first quarter. Gross margin increased 220 basis points year-over-year to 39.9%. Manufacturing efficiency was the largest contributor, followed by product mix. These two improvements were slightly offset by normal pricing adjustments at the start of the year, as well as negative currency effects of about 80 basis points, as well as some one-time negative impact specific to the quarter. On a sequential basis, our gross margin was 40 basis points above the midpoint of our guidance on better product mix. Operating income more than doubled to EUR 269 million in comparison to the 2017 first quarter, thanks to strong improvements across all product groups with higher revenues, increased manufacturing efficiencies, and improved product mix.
As a result, our operating margin reached 12.1%, increasing 480 basis points year-over-year from 7.3%. Net income increased more than EUR 131 million year-over-year to EUR 239 million, driving diluted earnings per share to EUR 0.26, more than double compared to the year ago period. Free cash flow increased by 53% year-over-year to EUR 95 million. In the last 12 months, free cash flow was EUR 372 million, well exceeding the level of our distributed cash dividend. We also strengthened our balance sheet, with our net financial position increasing to EUR 522 million. Now, let's move to a detailed review of our product groups. Beginning with our automotive and discrete group, ADG, revenues were higher year-over-year by 15.4% on double-digit growth for both automotive and power discrete products.
On a sequential basis, ADG revenues were substantially stable, reflecting better than seasonal performance in both areas with a small decrease in power discrete products, mostly offset by slight growth in automotive. Considering all of our product groups and not only ADG, revenues to the automotive market grew 17.4% year-over-year in Q1. ADG's operating margin doubled to 11% from 5.5% on a year-over-year basis, with significant progression for both automotive and power discrete, reflecting higher revenues and improved gross margin. Moving to the product review of ADG, our proprietary technologies dedicated to automotive applications allow us to develop leading-edge products for each of the needs of the car. For example, our vertical intelligent power technology allowed us to win awards for motor control in a door zone application with a worldwide leader and a high-end body control module for a European premium car maker. We also captured an award for our U-chip power supply and drivers for engine management and battery management systems from a major Chinese Tier 1, and we received multiple design wins from German Tier 1s for electric power trunk applications.
Our automotive microcontroller business saw multiple wins, including a design for a chassis stability control unit in Japan. In infotainment, we received awards for telematics solutions from European and American car makers, and we earned multiple design wins for our Accordo processor family for mid-level car radio systems from several Asian OEMs. We were also chosen to supply Class D audio amplifiers for an emergency call module by a major electric vehicle maker. Let's now discuss power discrete that are pervasive across all the end markets that we address.
In automotive, we continue to grow our silicon carbide business with our silicon carbide MOSFET in the traction inverter applications of two car makers in China. We also maintain strong momentum in silicon carbide diodes with multiple design wins for electric vehicle onboard chargers. In industrial, our silicon carbide diodes and power MOSFETs were selected for higher efficiency power conversion systems in servers, solar energy, and hi-fi audio systems with both U.S. and European customers. In IGBT, we won sockets for intelligent power modules for washing machines and dishwashers from a market leader and landed a win for MDmesh power MOSFETs in an implanted cardiovascular defibrillator from a top American medical player. We also won a battery charger socket with our MOSFET from a leading smartphone manufacturer and earned a major design win for integrated passive device filters in 5G base stations.
Moving now to our analog, MEMS and sensor groups, AMS. Revenues increased 26.5% year-over-year on sharply higher imaging sales as well as double-digit growth in analog and MEMS combined. On a sequential basis, AMS revenues decreased by 27.4%, principally reflecting the negative impact of smartphone applications to our imaging business, while analog and MEMS posted better than seasonal performance with lower quarter-to-quarter sales declines. AMS operating margin expanded to 9.8% from 7.6% in the year-ago period on higher revenues and improved gross margin. Year-over-year margin evolution reflected on the one end, strong expansion of our MEMS business operating performance, as well as improvement in analog, and on the other end, the unfavorable effect of smartphone sales on our imaging business. Moving to the AMS products, our analog portfolio was very successful with industrial customers.
Here, we recorded many design wins for our high-end solutions for smart metering, motor control, solar power appliances, and power supplies. This is thanks to our portfolio of dedicated solutions that have been defined together with industry leaders, built on ST proprietary technologies and refined over the past years. Good examples include our STSPIN motor control solutions and our metering ICs. With smartphone makers, our analog portfolio won an award for a linear regulator from a top OEM, several design wins for analog and smart power products with leading OEMs, and designs for touch screen solutions with Chinese players. In MEMS sensors and actuators for industrial, we are seeing an increasing demand in applications such as equipment condition monitoring and asset tracking. These applications often require multiple sensors and sensor fusion know-how, and ST is very well positioned to target this broad industrial customer base.
Our FlightSense proximity and ranging sensors achieved a number of designs in industrial applications such as robots. In MEMS and sensors for consumer, we ramped the production for the Samsung Galaxy S9 and S9+ of a full collection of sensors, including a 6-axis MEMS inertial measurement unit, a barometric sensor, and an optical image stabilization gyroscope. Our success in optical image stabilization gyros is visible at six of the top 10 smartphone models as ranked by DxOMark, a leading source for independent image quality measurement. Six out of the top 10 use ST optical image stabilization products. We capture a number of sockets for accelerometers and pressure sensors in a top-tier wearable supplier and in a Chinese smartwatch manufacturer, and we earn design wins for our time-of-flight proximity and ranging sensors with several leading Asian smartphone manufacturers.
Turning now to our microcontrollers and digital IC group, MDG, revenues were up 26.6% year-over-year, largely driven by a strong expansion of microcontroller sales. On a sequential basis, microcontrollers and digital ICs group revenues increased 1.3%. MDG operating margin increased to 19.4% from 10.3% in the year-ago quarter, reflecting higher revenue growth as well as improved gross margin with respect to our microcontrollers business. We have also achieved a sustainable level of operating profitability for our digital business. Moving to MDG products, our general purpose STM32 microcontrollers, which are used across a very wide range of products and applications, achieved another quarter of record billings. A few of the many STM32 design wins include devices from major OEMs in applications such as digital controlled smart home air vent, a new generation of electricity smart plugs, insulin pumps in medical, and fast-charging solutions for smartphones.
Our success with the STM32 builds on our broad and deep device portfolio and our continuously expanding ecosystem. In the first quarter, we began sampling our STM32WB wireless system on chip, which adds Bluetooth Low Energy and low-rate wireless connectivity to our STM32 family. We have further expanded our ecosystem with a cooperation with Sigfox to support the growing demand of connected devices to low-power wide-area network and added new discovery packs for the fast connection of IoT devices to cloud services over cellular networks. Moving to security. We earn wins for our latest near-field communication controllers in various smartphones from key OEMs. Here, we are benefiting from the cooperation we announced last year with MediaTek to integrate our near-field communication technology into their mobile platform designs. We also won sockets for our trusted platform module solution from two leading PC manufacturers.
In our tags and readers business, we capture design wins for an ST25 near-field communication reader and associated near-field communication tags for authentication of consumable goods from a major medical equipment company. We also ramped the production for an eSPI ROM and a SIM card used in the Samsung Galaxy S9 and S9+. In our custom silicon business, we earn a design win for a digital ASIC in a seven-nanometer FinFET technology from a new customer active in communications infrastructure, and we won two ASIC designs in BiCMOS technology at an optical market leader. Moving now to our second quarter. Based upon the expected mix of our product groups, we anticipate second quarter revenues to increase by about 1.5% on a sequential basis, plus or minus 3.5 percentage points.
As we already anticipated, and now this is well-known by the industry, the second quarter is another quarter of weak sales in smartphones, particularly for our imaging business, while we certainly see another quarter of sequential growth and solid year-over-year growth in automotive and industrial for our broad range of products: automotive ICs, power discrete, analog, microcontrollers, and digital. Indeed, despite this weak demand for smartphones, in the first half of 2018, we anticipate second quarter and first half revenues to grow year-over-year about 17.5% and 19.8% respectively, at the midpoint of our guidance range. This will be driven by the continued better than seasonal sales trend in the automotive and industrial end markets and in Internet of Things applications.
We see healthy demand for the second half of the year, with the backlog supporting our expectations for strong revenue growth across all our product groups and end markets, and this time including also smartphones and regions. In terms of profitability, we expect the second quarter gross margin to be about 40%, ±2 percentage points. This expected gross margin, which we have delivered in the past two quarters, results in a solid level of profitability and return on invested capital. As part of our annual general meeting resolutions issued earlier this month, our supervisory board is proposing to shareholders to declare a cash dividend of EUR 0.24 per common share, payable to shareholders in equal quarterly installments. The annual general meeting of shareholders is scheduled for May 31st, 2018.
To conclude, we look forward to meeting with you at our 2018 Capital Markets Day on May 15 in London. As you know, this will be, for me, a special Capital Markets Day, the last one before my retirement. I will be pleased to meet with you all and thank you in person for your support and continuous interest in ST throughout the years. My colleagues and I will now be happy to take your questions. Thank you.
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've entered a 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 Alexander Duval from Goldman Sachs. Please go ahead.
Yes. Hi, many thanks for the question. Congrats on the solid quarter. Just a couple of quick ones from me. First of all, I wondered if you could give a bit more detail on auto and industrial inventories. What's the latest update on the levels you're seeing across the market, both more broadly and at your own distributors? Are there any signs of double ordering or anything like that? Second of all, on silicon carbide, you talked about multiple design wins in that area for EV and onboard the car. What do you see as the key differentiating features you have there that have allowed you to have this first-mover advantage? Many thanks.
I think let's start from the inventory. We see a strong demand on automotive everywhere. It is across the board from technology point of view, the products, the application, the geography is very strong, we don't see any sign of accumulation of inventory. Just the opposite. Very strong demand. Distribution point of sales in Q1 was our record ever. The point of sales of our distributors in Q1 increased 17% year-over-year. They increased 3.4% sequentially despite the Chinese New Year, which is quite unusual, in fact. I think the situation on inventory is healthy. Of course, the question on double order here is not that black and white. We have, in certain areas, a backlog coverage that is even above the budget of the year.
We could not exclude that there is some doubling ordering, the backlog is very strong, covering several quarters. If we move to silicon carbide, of course, I think the major differentiation is the fact that we are really striving and working very hard to make sure that this is transforming from today initial interesting low volume business into a much bigger business. It is the industrialization effort, the effort that we are putting to make sure that this is good quality, good yield, very high volume, very quickly in 2018 is an important differentiation because we want to be the first. Of course, this is built on many years of innovation in the development of the technology. I think we have accumulated a lot of know-how. I think it's absolutely critical, the performance in terms of power dissipation.
We believe that we have some competitive advantages, we see now more and more with more car makers, also in industrial applications. There are challenges. It is not an easy journey, I think it is a unique opportunity for the company, we are trying really to lead here. We are working very hard to lead and to keep going in this phase of transforming this initial volume in massive volume and spreading in terms of customers and applications.
Great. That's very helpful.
Thank you.
Thank you, Alex. Next question, Mara.
The next question is from Sandeep Deshpande from JPMorgan. Please go ahead.
Thank you for letting me on. I have a question for you, longer term, Carlo. Clearly, your microcontroller business has been a huge winner in your tenure at ST. What are the next big businesses at ST as you see them, in terms of being able to create stable, consistently growing businesses going forward at ST? Clearly, that has been one of them. Secondly, on the gross margin, Carlo Ferro, I have a question on how we should be looking at incremental gross margin from here, given your level of utilization remains very high. Should we be now looking at that you will be building new fabs and that will have an impact on your gross margin on a one or two-year view from here? Is it that most of the incremental growth for ST from here is going to be outsourced? Thank you.
I think, let's start from microcontrollers. We started with the STM32 in 2007, the perimeter of what we had in MDG, that is of course our microcontrollers and digital group. In that perimeter, that is general purpose microcontroller and the secure microcontroller. In 2007, the company was number 12, okay? We had a small presence in 8-bit, nothing on the 32-bit, I would say already a good position in secure microcontrollers. Last year, we were number two. In 10 years, we moved from position number 12 to position number two. What we see in microcontrollers is an important acceleration of the market, we see this acceleration very strong in industrial, we want to keep going. Of course, we want to become number one. This is obvious.
Again, this is the perimeter that is under MDG, that is general purpose and secure microcontrollers. There are some important trends that we see here. The first is connectivity. The second trend is certainly security. Even on general purpose microcontrollers, we want to put on board more security and crypto keys and solutions for more secure applications. Of course, also distributed form of artificial intelligence. These are three important drivers. We want to leverage on a very successful ecosystem now, with more than 50,000 customers. Here again, we want to move from more than 50,000 to 60,000 very quickly. I think, also, on a base of silicon technology that I believe is quite unique, both at the range of 14 nanometer, but also at the range of 28 nanometer.
Sandeep, I'm saying all of this because we want to become stronger in the things that we do. We do not want to do many more things. I think there is enough to do on the portfolio that we have, I believe we have the opportunity to become stronger in any of these product block. Many of these product blocks are really instrumental to be successful in automotive and industrial. These are, from an end market point of view, very important applications for us. Our presence in smartphone, as you know, is more limited to more special products. We are not in the digital core, for instance. It's more on the periphery, important peripheral products, but more specialized.
While industrial and automotive are very broad market for us, there is a lot that we can do in terms of covering, for instance, all the new wave of applications in the IoT world. Particularly the IoT for factory automation, for these new form of applications. Really trying to focus on what we have and become stronger on what we have and growing faster.
Great.
On the gross margin, Carlo will take it.
Good morning, everyone. Good morning, Sandeep. Thanks for the question. On gross margin, you noted the result of the first quarter, and then really this 39.9% comes in with, first, the absorption of a larger chunk of the currency impact, as we have already 80 basis points negative impact from one year ago quarter. Also including a number of one-time event somehow associated with some reshaping of products and the programs plan for the year that have hit about one point the gross margin, a portion already included in our guidance, a portion even on top of that. We have now another quarter solidly at the 40%, and for second quarter midpoint, we anticipate 40%. This you note now is coming with a currency rate at 1.21. Almost absorbing where the euro dollar exchange rate stands now.
This is reflecting a clear improvement in the product mix, this is something that certainly has the opportunity of continuing across the portfolio of the company and is reflecting manufacturing efficiency. Overall, at the end, what we need in manufacturing, in terms of flexibility, now is there. The flexibility in the technology mix in the fab, particularly in those in 300 millimeter that are more asset intense. The flexibility with third-party partner is increasing. We have reached, in terms of value, now 18% of the value of our silicon from Silicon Foundry, about one third of our assembling and testing activity also at a partner. This is a process which is continuing, the flexibility is there.
Looking forward, starting from this situation, clearly there is a great overall opportunity for the company on the margin expansion, on operating leverage, and on the overall evolution over time of operating profitability and return on invested capital. To go on the gross margin dynamic beyond the second quarter, I would not expect me to make a change today in respect to the usual habit to guide on gross margin quarter by quarter, right?
Thank you, Carlo.
Thank you, Sandeep. Next question.
You're welcome.
The next question is from Anthony Stoss from Craig-Hallum. Please go ahead.
Good afternoon, guys, my congrats on the quarter and the guide. Carlo, perhaps you can help us out a little bit more on each of the product segments in terms of your Q2 guide. For instance, on the AMS side, how much do you think that group will be down sequentially? Likewise, ADG and MDG, how much do you think that'll be up? Also just following up on the gross margin side of things. Over the next, call it several years, where do you think gross margins can go? I apologize if I'm stealing any thunder from your upcoming analyst day. Thanks.
Maybe I take the question on the second quarter revenues guidance at the end. That is 1.5%, as mentioned, reflect a quarter even weaker than prior quarter in the imaging division. Would we, at the end, exclude this impact in the imaging division? The Q1 to Q2 sequential dynamic this year is expected to be above the normal seasonality. For us, normal seasonality in this period is a growth between 4%-5%. This is solidly with the Automotive and Discrete Group. This is also in the Microcontroller and Digital Group. This overall, at the end, almost is reflected also in the overall Analog and MEMS business with, as Carlo said, solid demand supporting each of these specific subgroups for the company.
On the gross margin side?
The gross margin side, what is the question? Second quarter dynamic?
No. Further out, where you think it could go.
Okay. Was not the same question I already answered to Sandeep, with, again, if you want, I could repeat. Lot of encouragement and positive and optimistic view on the overall dynamic. In general, the usual caution and prudence to do not give guidance beyond the quarter-by-quarter approach.
Yeah.
Certainly there is the opportunity to, I would say, to continue to grow. I think we see important opportunity to grow. In fact, it was in my script, and we fully confirm what we said three months ago. H1, it is anyhow close to 20% growth year-over-year. Now with the guidance is 19.8%. H2, we said two months ago, we are reconfirming today, is going to be material growth, H2 over H1. Also H2 over H2.
Is H2 this year over H2 last year. We will really remain disciplined to make sure that a part of this growth is transformed into economic leverage. We have done a big way last year, of course, it is kind of unprecedented because we were starting from a level that was pretty low. This year, we are starting from a level that is significantly higher. With the evolution that we see in terms of revenues moving from H1 to H2, certainly we see another wave of economic leverage coming. Of course, we want to remain disciplined to get it done.
Thank you, Carlo. Congrats again.
Thank you.
Thanks. Thank you, Tony. Next question.
The next question is from Stéphane Houri from Natixis. Please go ahead.
Yes. Hello, good morning. I'm afraid this question is, again, around the gross margin, but I'd like to understand what you did during the quarter in terms of manufacturing. Meaning, did you repatriate some product that were manufactured outside to compensate for the weakness of the smartphone market that seems to be even stronger in Q2, and did you have time to react, and does it explain the reason why the gross margin is expected at around 40%? The follow-up is on the level of R&D. There is a step-up in Q1. I think you have alluded to some exceptional items. Is that in the R&D line, and is that the level we should keep in mind going forward? Thank you.
Jean-Marc, I will take the first question. This is clear that we have built in flexibility in our internal fab, and you know, mainly in Crolles 300, which is exposed to the smartphone end market. Clearly, we have built in a capacity able to address embedded non-volatile memory, enabling microcontroller either for automotive, general purpose usage, or secure micro. We also built a capacity able to address digital ICs to address automotive. During the past two years, taking benefits of the six quarters in a row of growth, we have built activity outside with a main partner. Now with this situation, taking into account the smartphone activities, we have the full capability to maintain Crolles 300 fully utilized with adequate mix.
Yeah.
Okay.
Well, on the expenses, well, let's face it, we do not talk much about the euro dollar rate, but it's certainly not helping. Carlo will comment on the expense. In one year, the impact of the euro dollar moving from Q1 last year to the situation today, certainly we are not enjoying a favorable evolution. At the end, Stephane, I see frankly, no surprise on the first quarter result on this metric. We entered with, if I will remember, sharing an expectation of net of tax somehow above EUR 600 million. We have delivered EUR 598 million. I have fairly to say that this EUR 598 million includes a EUR 5.5 million one-time gain from a sale of a small participation on strategic. At the end, if you make the math, EUR 604.5 million is somehow above EUR 600 million, so it's well in the expectation.
On the year-over-year dynamic, it's clearly, at the end, a combination of good progress on the completion of the set-top box restructuring, which is now completed. As a consequence of this completion, the good news is that Q1 2018 is the last quarter that we report restructuring charges associated with these restructuring programs. There are no other on the prospect. We have overall, at the end, also to face the currency, as Carlo said, the overall impact of currency on the operating income year-over-year is negative of EUR 40 million. Also some of the not only inflation dynamic, some of the variable cost component, clearly with better results, are also somehow inflating.
On top of supporting the fast growth of the company, which means sometimes in the R&D of the product groups, and particularly in sales and marketing and our regional footprint of interfacing with the customer, some effort. I think overall, we remain very disciplined in expense control. There are, as Carlo explained, some aggravation. However, for the first time in Q2, restructuring is zero.
In Q1 was EUR 21 million.
It's nice to see that the restructuring cost in the second quarter is zero.
Okay. Thank you very much.
Thank you, Stephane. Next question.
The next question is from Andrew Gardiner from Barclays. Please go ahead.
Good morning, gentlemen. Thanks for taking the question. I had another one on the auto space. Your auto revenue growth continues to accelerate. It's moved from mid-single digit year-on-year growth this time last year to mid to sort of high teens, it looks like in the second quarter. That's coming at a time when auto units are roughly flattish globally. It does seem to suggest a step up in share or in content relative to what we've been seeing previously. Do you have a view as to sort of the balance between those two factors? How much do you think is content gain sort of generally across auto? How much is sort of market share gain for you? I have a quick follow-up afterwards, if that's all right.
If we look back at one year ago, if you look back at 2017, the car registration, the number of car registration in the world increased by about 2.5%. Slightly less than 2.5%. This is last year. In this frame, I believe that the overall, here I'm talking about all the products for automotive applications. The growth, for me last year was in the range of 10%, which is automotive year-over-year. We grew last year about 10%, taking into consideration all of our automotive products. However, starting from the second part of the year, and particularly Q1 last year, we accelerated the growth. In Q4, the growth was, for us, about 17%. In the press release, we report APG, the Automotive Product Group. That does not represent all the products that the company has for automotive customers.
My script, I read that in Q1, we grew more than 17% year-over-year in automotive, with automotive customers. I believe that with this level of growth, let's say that, of course, we want to keep growing. Maintaining a growth in the range of 15%-17%, I am confident that we are now materially gaining market share. I have to say that it's a combination of many things. In the car, we do not have the modem, the 4G modem. We do not have the high-end application processors. For the rest, our presence is very global. Many microcontrollers, car infotainment, safety solutions, very complex ASICs. All the smart power, and more recently, also the power discrete and the sensors for automotive applications.
You see, it's very broad. Moving on with the growth that is in the range between 15% and 17% year-over-year, we believe that we will certainly gain market share in 2018.
You can see that kind of revenue growth rate continuing into the second half. That's sort of the qualitative statement you made around sort of the strength. I mean, within auto, it can remain at those levels.
Absolutely. This is what we see.
Okay. Then just a quick one on inventory. It stepped up in the quarter. Just wondering if you can make a comment sort of across, if there's any particular build across certain areas or whether it's sort of just broad-based planning for growth.
Almost all the evolution of inventory in Q1 is on the semi-finished product, the WIP in the front-end diffusion process and the die bank. Really is for preparing revenues growth in the second quarter and beyond.
Thank you, guys.
You're welcome.
Thank you, Andrew. Next question.
The next question is from Aleksander Peterc from Societe Generale. Please go ahead.
Yes, good morning, and thanks for taking my question. Congratulations on nailing the guidance really nicely. I was just wondering about the second half seasonality because your smartphone exposure increased quite substantially in the fourth quarter last year. Will we see a similar pattern this year, or should we expect more of a smartphone recovery broad-based across the third and fourth quarter? Then just secondly, in terms of CapEx timing, it was quite strong in the first quarter. Could you be more specific on where that went and what we should think about the phasing of CapEx for the year? Thank you.
Well, I take the first part. We see pretty strong Q3, not only Q4. I mean, normally Q4 is higher than Q3, but we see a step up, a step forward. A step up in Q3. From what we see, of course, this is the visibility that we supported by new programs or products or whatever customers' information, we see a step up already in Q3 that is much, for one, material, and we see a further acceleration during the course of the last quarter of this year. If we go to CapEx, Carlo, is broad, to support mostly automotive and power.
The CapEx in the year were already anticipated to be significantly front-loaded to prepare for revenues growth across the board and also to accompany this process of technology evolution in the fab that Jean-Marc has described earlier. As you note, the overall contest for the year in the demand, in the industry, in our revenues expectation, is very much similar on the path to what did happen last year. Like last year, I believe now the question comes at a time where the company is reviewing its capital spending plan, and at the end, based on overall demand, visibility of revenues for the second half of the year, need of increasing the flexibility on the technology mix on the fab. I would not exclude that the company may have to review upside the CapEx forecast for the year.
I believe the May 15, the Capital Markets Day, is a good appointment to make the point on these metrics.
Excellent. Thank you very much.
You're welcome. Thank you.
Thank you, Alexander. Next question, please.
The next question is from Janardan Menon from Liberum. Please go ahead.
Hi, good morning. Thanks for taking my question. I've got two. One is, you talked about automotive growth and how you expect that to be in the region of 15%-17%. I was just wondering whether you can give a similar kind of analysis for your IoT market or the broader IoT/industrial market. Your microcontroller and parts of the analog business has been growing in the mid-20% kind of range. Is that indicative of what kind of growth you're seeing in those segments, and how do you see that continuing in future? My second question is on the sort of 3D sensing space. Some of the other players in 3D sensing have been reporting multiple design wins in the Android space. I was just wondering what is your interaction there, especially from an image sensor or a module packaging kind of a standpoint.
Are you seeing any design wins which will translate into revenues in future years?
I take the first part, Jean-Marc takes the second part. As you know, it's not that simple to track the large fragmentation of IoT applications, we are working hard on that, we have now a new very comprehensive application tree in the company, with hundreds and hundreds of application branches. For any of this branch, we will put a tag, this is IoT, this is not IoT. We are making very systematic work in this respect. However, there is another indicator that maybe is simpler for me to give to you, is our presence in mass market. We see that in Q1, our distributor POS year-over-year increased 17%. I do not believe that this level of increase is sustainable at this high teens level.
However, what we see moving from 2017 to 2018 is certainly a double-digit growth in all the mass market activity of the company. For us, the mass market activity does not include, just to be very clear, our top 10 customers, plus another about 50 customers that are those customers that we manage globally in the world. The rest, if you wish, is what we define in the category of mass market. This is a big part of the company, is becoming, of course, an interesting part of the company. This is double-digit growth, not at the level of the 17% growth that we had at Q1 over Q1. Pretty solid, pretty robust, very much broad-based with today an increasing effort in industrials. We have been investing a lot in industrial. Just few example, the longevity program for our MEMS.
These are 10 years longevity on MEMS. This is for industrial applications. Another example is all the new higher-end microcontrollers and the new development for industrial processors for industrial applications. A wave of smart power products in our analog domain. You see many, the SiC, of course, the silicon carbide, not only for automotive also for industrial. There are many elements, this is a market that is very fragmented. It's a very important market for us. This market is very much through distribution, this is a big block, close to EUR 4 billion. This year we will certainly be above EUR 4 billion, we see this as a double-digit step.
Your IoT broader industrial market, you would say, is about EUR 4 billion will grow at double digit?
Last year it was below EUR 4 billion. This year will be above EUR 4 billion. This is mass market, the definition of IoT technically is not one-to-one, as I explained.
Sure.
However, if we take the mass market, that is all the business of ST basically without the top 10 and another 50 customers that are the customers that we manage globally, so about 60 accounts in the world. It was below EUR 4 billion last year. It is certainly above EUR 4 billion this year, this is another 10% or more step. It is certainly double digit, as I said, not at the level of the automotive.
Janardan, we'll have more details on this at our capital markets day for sure.
Got it. Thanks. On the 3D sensing?
Okay. Jean-Marc is speaking. Now it is really well-known that in the depth sensing technologies to address mobile device, basically there are three big families. The stereo vision, the structured light, and the time-of-flight. Some are more adapted to address depth sensing for the front of the camera, and some are more adapted to address the depth sensing for the back of the camera. It's important to say that STMicroelectronics has currently a portfolio of IPs building block, silicon technology, and complex module assembly and testing to address everything. We have a roadmap related to that as well. Of course, ST will address with the most adapted solution one of these kinds of application and of course, including the Android world.
Okay. So far, have you got any wins as yet?
We have got design win in Android world.
Okay. Thank you very much.
Thank you, Janardan. Next question.
The next question is from David Mulholland from UBS. Please go ahead.
Hi. Thanks. Just one, coming back to the comments you made on silicon carbide, I wonder if you can just give us some color on the timing of when you actually expect these design wins to ramp, and how you feel about the ramp schedule in the context of the wafer supply in the industry on that. Then one quick follow-up on the other income line. Still a, I think, EUR 16 million profit in the quarter. Obviously, in the past, that's been R&D grants that I thought were going away this year. Can you maybe just update us on what's happening there as well?
On the silicon carbide, I think we did confirm what we said, it was in Barcelona. This is the first year of production on the silicon carbide. I think our target, as we said also recent is going to be in the range of EUR 100 million. Then, of course, depends very much on. We see a lot of design awards, design wins, et cetera. I think it will be a gradual increase and will take some years, but this can become very important. Because the addition business opportunity for us in this field of the car electrification, it will be enough to have a few percentage of the total volume of cars in the world with the silicon carbide content in the inverter to drive the motor to make a big step.
Of course, there are many drivers in any of this inverter. It will be gradual. We confirm the plan for this year, I think it will take some time particularly with our automotive customers to grow. We see a lot of design awards, a lot of testing with ST products. On top is not only, as I said before, it's not only automotive, it is also industrial applications. I think it's broad. I think it's a good opportunity. We need to also to make our homework. There is a lot to do, but certainly a great opportunity for the company.
On the other income and expenses line, as I've mentioned earlier, the EUR 16 million other income reported in the quarter include a one-time gain on a sale of a minority participation. If we excluded this amount, it's about EUR 10 million. These reflect the R&D fundings that, as you note, has reduced. This is something we have anticipated, and also this line includes some of the patent expense. Overall, at the end, I would say that starting from this clean EUR 10 million in Q1, for the next quarter, you may expect something between the same number of a couple of million less. If you take an average of EUR 8 million per quarter for the next three quarters is a good approach, I'll say.
Thanks very much.
Thank you, David. Next question, please.
The next question is from Adithya Metuku from Bank of America. Please go ahead.
Yeah. Good morning, guys. I have two questions. Firstly, can you give us some color on the linearity of orders in the quarter? Did that strengthen as you go through the quarter? Secondly, can you give us some color on what gives you confidence on growth in the smartphone market in the second half of the year? Thank you.
Yeah. Well, I think as I said, we have a very strong backlog coverage. Of course, the order entry, during Q1, these reflect also the strength of the backlog and the coverage of the backlog, right? We have regions where the backlog that we have in the year is above the yearly budget. It's covering. Of course, bookings reflect this coverage of the backlog. I think there are a few areas where today we expect, for instance, in Q2, we expect some form of turns business is very limited. The area where we have expectation for additional turns business, very limited. I think, of course, we see, moving on. Now, if we look at the smartphone, of course, as I said, this is an area where our presence is more with special products, with a limited number of customers on more proprietary technologies.
The information that we give is based, of course, on the information that we have, that we cannot disclose, because it is impossible. This is coming from the information that we have from our customers around the world, and is simply based on that. We report what we know. Personally, I believe that what we are reporting is nothing strange in terms of evolution in the smartphone market. It's not unusual things, and it's more our content. It's our content that is making the difference here. We are certainly not counting on volume increase at certain smartphone manufacturers. We are simply taking into consideration the opportunity that we have with the silicon content contribution from our company.
You're saying you expect content growth in the second half of this year versus second half of last year?
We expect content growth. We expect a larger deployment. We expect many things. What we do not expect is that there will be an increase in the volume of smartphone. This is not in our calculation. Our calculation is we are in more models. We are with more content, but it's not more volume, per se.
No, I meant content per se, not more models.
We are in more models. We just talk about Samsung.
Understood.
A couple of new models in Samsung.
It wasn't there.
S9 and S9 Plus.
More content, more models.
We can talk about Huawei if you wish, you know?
Indeed. Thank you.
Thank you, Adi. Next question, please.
The next question is from Veysel Taze from Oddo. Please go ahead.
Yes. Hi. Thank you for taking my questions. The first one would be color around the quarterly OpEx run rate for the rest of the year would be very helpful there. I have one follow-up.
Carlo, I can take the question. Lorenzo speaking. On expenses, you see that on the first quarter, we were in the range of EUR 600 million. If you take it also into consideration, the other income. We do expect for the second quarter in terms of seasonality is not favorable. There is also the impact of the exchange rate. What we do expect, also considering the other income, will be in the range of EUR 7 million, EUR 8 million to be on net expenses for the next quarter in the range of EUR 610 million, EUR 615 million.
There will be the usual seasonality in Q3, a little bit mitigated, there will be some increase in Q4 as usual due to the length of the quarter, the calendar.
No more restructuring cost, which is good news. In Q1 was EUR 21 million.
Okay. On your silicon carbide business, it was in Q4, first revenues, high single digit. There was something, EUR 50 million-EUR 100 million for this year. You are now in the second quarter, are you happy with the progression of your silicon carbide revenues in the outlook? There have been a lot of speculation with one of your lead customers, not able to ramp volumes. How was the first half there?
Well, I think, as I said, we are working very hard. We cannot say we are happy, we're not happy. We need to always really strive to do more, to go faster, improving the quality, the yield. These are new programs. It's certainly a big effort in the company. It's also a big opportunity. We want to keep going with the same level of determination in Q2 to continue the ramp-up and move to higher volume for sure in Q2, higher volume again in Q3. In Q4 is a continuous progress. Overall, I think there is an opportunity to make a difference here, and we certainly want to make a difference. We need to just push more and go faster and make the difference for us and for our customers.
Okay. Quickly on the fab question, it was addressed before, but I'm not sure if you answered that. On the fab question, if you look at one of main competitors, it's speculated that they will ramp a new fab, and there were all this rumor, speculation in the market that you might be ramping a new fab 2020, 2021. If we say the level of growth, let's say, stays at the high single digit, is that something you need to definitely think about to ramp a completely new fab?
No, we did not. Today, we want to have the smart power technology on 12-inch, and we are working on that. What people see here is a pilot line to make sure that on the very advanced smart power technology, I'm talking about smart power ICs technology, we could move the development to 12-inch. We did not have any initiative for new fab. There are opportunities, of course, to exploit better the dimension of scale in certain fabs, and this is an opportunity to grow the volume and, at the same time, to reduce the cost. For instance, in Crolles 300, we have opportunities in the same infrastructure to grow further if needed. But as we said, the priority is also to invest, to build up flexibility, because we want also to build up flexibility. Now we do not have any plan for.
Big fab.
Big fab.
Okay. Thank you very much.
Thank you, Jérôme.
Thank you very much.
Next question, please.
The next question is from Robert Sanders from Deutsche Bank. Please go ahead.
Good morning. Congrats on the quarter. Are you seeing foundry wafer pricing becoming more benign at all, given there's quite a lot of excess capacity now out there? I was just wondering if that could contribute to your gross margin. Secondly, what is your level of concern around the sustainability of your position in imaging at your largest customer, smartphone customer? What's the length of that contract you have in place? Clearly, Apple have bought a startup. There are obviously other companies wanting to compete for that socket. I was just interested in what your confidence level was around that socket. Thanks.
Maybe I take the first question on pricing with foundry. Frankly, again, we see normal business trend. Clearly, pricing reflects the maturity of the different technology nodes. I'll say nothing special in this respect.
Jean-Marc Chery is speaking again. On imaging, I repeat, today, clearly ST, we have the IPs building block, the silicon technology with innovation, strong innovation, the complex specialized module assembly capability. With this set of capabilities and the roadmap associated, we can address structured light, time-of-flight, or part of the stereo vision. Thanks to this position, our imaging position is very strong. We can address custom design with a big customer, whatever is the operating system, I repeat, Android as well.
We cannot comment on specific customer, you know that. Of course, these are very complex initiatives. Certainly, we are not in the condition to comment on-
No
on a specific customer.
Okay. Thanks a lot.
Thank you, Rob. Next question.
The next question is from Günther Hollfelder from Baader Bank. Please go ahead.
Yeah. Thank you. Two questions left, maybe one follow-up on the new capacities. There is this 300 millimeter pilot line project in Agrate, I think, going on. I was wondering, is it one scenario? Could it be, like a conversion to 300 millimeter here? If you could provide an update. The second question would be, in general about gallium nitride. Could you update us on your activities there and when you expect first major sales contribution from gallium nitride transistors going forward? Thanks.
Yeah. Well, maybe I start from the gallium nitride, then Jean-Marc is taking on the R&D activity in 12-inch for smart power. Priority today is to really ramp up nicely the SiC this year. We have cooperation in the area of gallium nitride. We even announced an important design award. This is an activity that is run in cooperation with MACOM. I think we can say because it was a press release, this is more for power RF applications in the area of 4G and 5G base stations. The technology is running in ST. Of course, I cannot describe the detail of the contract, but there are areas where the contribution from our side, it is not only technology and manufacturing, but is also marketing and applications, while there are areas where the contribution is exclusively in terms of technology and manufacturing.
This is one area, this is more on the area of power RF, gallium nitride application and technologies. There is another area that is more for power applications. This is an activity that we run in another side of the company, this is an area where we do not have yet short-term manufacturing initiatives, but is more in R&D. You see is really two blocks in the area of GaN. Having said all of that, the major priority for us in 2018 is, of course, the ramp-up of the silicon carbide fab.
The second one is about the pilot line. The pilot line will be set up based on new equipment in our current infrastructure facilities and capabilities. Today, our equipment capacity in eight-inch and current 12-inch equipment capacity are close to the full saturation, about 90% of saturation. There is no space, okay, for equipment conversion from eight-inch to 12-inch. However, as Carlo said a few minutes ago, we have still opportunities to expand some R&D pilot line or manufacturing capacity in our current infrastructure. This is what we will leverage according to the demand or according to the request in term of technology development.
Thank you, Gunther.
Thank you.
Next question, please.
The next question is from Achal Sultania from Credit Suisse. Please go ahead.
Hi. Good morning. Two questions, if I may. It is on your MDG segment. If I look at MDG, I think there are basically general-purpose microcontroller, secure microcontroller, and your digital IC. Given the growth that you have seen, can you just help us understand or give us a range of how are all of those three segments growing year-on-year in MDG, and any color around the level of growth you are seeing in those segments? On the margin side, you are already touching close to 20% EBIT margins in that business. I remember in the past, you have said microcontrollers is the highest across the whole group. Just trying to understand if there are still any areas where you can improve margins, whether it is digital ICs or secure microcontrollers, or if there is any other headwinds or diluted businesses in that MDG segment. Thank you.
Maybe I take the first part of your question. At the end, indeed, in the microcontroller and digital ICs group, as you said, we have three blocks. One is the digital, one is the EEPROM and the memories, and the other one is the eight-bit and 32-bit microcontroller for general purpose or secure applications. I can confirm that all these three blocks are expected to grow year-over-year in the second quarter based on the midpoint of the guidance.
The other question is?
The margins on-
The margin structure. I think here there is a big difference, of course, between what we call, define as MMS. That is a microcontroller, secure microcontrollers, and EEPROM, basically, and digital. We are coming from digital for a massive loss. Now there is an initial profit. This was achieved certainly not thanks to sales growth. It was on the opposite, a decline in certain areas, phasing out certain products and, of course, the major restructuring. I think in the group here, we have been working on the product mix, big way. Now in digital, I think we are at the level of the first, as I said, as I defined before, at the first sustainable level of profitability. Gross margin ambition is pretty good here.
We need to keep going with our effort, particularly in ASICs, particularly in BiCMOS, for instance, in RF solutions, ASIC solutions, ASIC also for space and defense. Certainly from a technology point of view, everything that is beyond 28-nanometer is not in the company. We have announced a seven-nanometer ASIC win. This is made with the FinFET technology. Of course, it's not technology that we run in ST. Here there was a global change. Sales did not contribute to turnaround. It was really mixed management and also a reduction of the R&D resources in this area.
Looking at the future, as I mentioned, in the BiCMOS, in the RF, the FD-SOI radio frequency, the space and defense, and certain very advanced ASIC solution using FinFET technology, here it may open up to a new wave of growth in the future, but keeping a level of gross margin that is higher than the average of the company. The completely different story is MMS, because in MMS, we have been traditionally very good in EEPROM, always number 1 since many, many years, with a pretty good gross margin and pretty good profitability and return on investment. Then there was this big evolution in microcontrollers. In 10 years, we went from number 12 to number 2. We want to become number 1 in this perimeter. We need to keep innovating.
Structurally, microcontrollers together with EEPROM, together with analog ICs, general purpose microcontroller, EEPROM, analog ICs, these are those families where I believe we can enjoy the higher level of margins and profitability.
Okay. Thank you. Thank you, Carlo.
Thank you.
Thank you, Achal. We have time for one more question, please.
The last question is from Jérôme Ramel, from Exane BNP Paribas. Please go ahead.
Yeah, good morning.
Good morning.
Quick question. We heard from your competitor and some of your customers that lead times for some specific products, I'm thinking about power, which are expanding. I'd like to know what the situation today for STMicro in term of allocations, in term of lead times, and if any, have you increased on prices for discrete and power components? Just a follow-up, just to be curious, what is the current capacity in Crolles 2? Thank you.
We confirm. Lead times take very long on power discrete. The demand is very strong. We talk a lot about silicon carbide, I have to say that is a pattern of longer lead time on both low-voltage power MOSFET and high-voltage power MOSFET. Since we merged our power discrete division with our automotive division, our presence on power MOSFET at automotive customers is, let's say, becoming more important continuously. This is another area of opportunity, I believe is an area that we want to push. It's an area where we want to be stronger, I think we have, let's say, the tools to play a bigger role in these products here. We do not have any sign of getting better in terms of lead time on power MOSFET. The second question was on-
Capacity
Crolles 300 capacity.
No
No, Crolles 300 or Crolles 200?
Crolles 2 is Crolles 300.
Crolles 2 is Crolles 300.
Jerome, Crolles 300 millimeter capacity today is a flexible 4.8K wafer per week with a well-balanced mix between embedded flash, specialized imaging, analog, mixing RF on CMOS, and standard CMOS equal or below 28 nanometer. This is our current capacity.
Okay. Thank you very much.
Thank you.
Thank you very much, everybody. At this point, we'll go ahead and close our call. We appreciate your participation. Again, we'll have our Capital Markets Day on May 15th in London. If you need an invitation, please contact investor relations. Thank you.
Thank you.
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