STMicroelectronics N.V.
Q3 2018 Earnings Call Transcript

Published: 24 Oct 2018

[Operator:]

Ladies and gentlemen, welcome to the Third Quarter 2018 Earnings Release Conference Call and Live Webcast. I am Moira, the Chorus 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. The conference must not be recorded for publication or broadcast. At this time, it's my pleasure to hand over to Mr. Tait Sorensen, Group Vice President-Investor Relations. Please go ahead, sir.

[Tait Sorensen:]

Good morning. Thank you, everyone, for joining our third 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 for a full description of these risk factors. Also, to ensure all participants have an opportunity to ask questions during the Q&A session, please limit yourself to one question and a brief follow-up. I'd now like to turn the call over to Jean-Marc, ST's President and CEO.

[Jean-Marc Chery:]

So, thank you, Tait. Good morning, everybody, and thank you for joining ST on our earning call today. So, let me begin with some high-level comments. ST is on track to deliver a year of strong growth in revenues, operating profitability and earnings per share. We are focused on driving sustainable profitable growth and our third quarter is another step forward in our progress. Importantly, revenue growth and operating leverage are translating into expansion of profitability. Based upon our results and outlook, we anticipate net revenues in 2018 to grow about 16% at the midpoint. This means we are outpacing the 2018 growth of the market we serve, in line with our expectations that we shared with you at our Capital Market Day back in May. Now, let's move to our financial highlights. We had a very good third quarter. Our results were very much as expected and we see a solid fourth quarter ahead of us. Third quarter net revenues increased 18% year-over-year, on strong growth for Imaging, Power Discrete and Automotive products. On a sequential basis, ST's revenues increased 11.2%, 120 basis points above the midpoint of our guidance, on higher than expected sales of Imaging product. Our gross profit increased by about 19% year-over-year to over $1 billion. On a sequential basis, gross profit increased by about 10%. Gross margin was 39.8%, 20 basis points above the year-ago period. Net operating expenses came in at $605 million. Operating income, operating margin, and net income all grew substantially both year-over-year and sequentially. The increase in profitability translated into strong growth in our net cash from operating activities, which was up over 18% on a trailing 12 months basis to almost $1.8 million. Our free cash flow in the quarter was $114 million, back to a positive level compared to the second quarter, as we had expected. For the first nine months, free cash flow was $170 million, comparing favorably with our cash dividends year-to-date of $162 million. I confirm that we will have a positive free cash flow for the fourth quarter much higher than our dividend and that we will exit 2018 with a higher net cash position compared to 2017. Now, let's look at our results by product group, beginning with our Analog, MEMS and Sensors Group. During Q3, AMS revenues reached $899 million, an increase year-over-year of 36.7% on triple-digit growth in Imaging and growth in Analog and MEMS. AMS operating profit grew about 82% to $157 million and it operating margin expanded over 400 basis points to 17.5%. For AMS, we had anticipated second half 2018 operating margins to move into the mid-teens, as we benefit from (6

[Operator:]

The first question is from Stéphane Houri from ODDO. Please go ahead.

[Stéphane Houri:]

Yes. Good morning, everyone. I guess my first question would be about – your feeling about the end demand in the market because everybody is worried that there is a deflation in the market. Yesterday, last night, Texas Instruments did confirm that there was some slowdown in in the market. So, could you drive us through your different businesses and tell us what you see? If I remember well, last time, you talked – publicly, you talked about some weakness at distributors in China. Could you be a bit more specific on the different markets you serve? Thank you.

[Jean-Marc Chery:]

So, Jean-Marc is speaking. So, let's look at the demand and the booking. Well, about the demand, more clearly, our industrial OEM, the demand is solid. In Automotive, very strong, the backlog is really very strong. And you know that, okay, in some areas, we are still okay seeing some shortage, so we have a very strong backlog in Automotive. The new phone platform, customer demand is well on track with our current visibility. And I confirm that the China mass market is suffering, so we are seeing, okay, a POS flattening. And, of course, okay, when we were specifically in China, this kind of softening, acknowledging that the lead time of our Microcontrollers are shortening, more clearly, we see and it is normal reaction and some slight inventory correction. So, this is, overall, what we see in terms of demand. In terms of booking, which is, let's say, providing a kind of dynamic, well, in Q3, the level of booking was good, but it was less strong than the first half of this year, again except Automotive and Power Discrete, well, again the supply chain is still stretched with really some shortage. But the reason of this overall, let's say, booking less strong than H1 is again – now we see and this is what I said late August, early September, it is clean from inventory replenishment and acknowledge some shorter lead time on some device, okay, especially Microcontroller. And again, we are seeing on the China mass market, a market softening and especially for Microcontroller. So, this is the color I can give to you for market ST address.

[Stéphane Houri:]

Okay. And I know it's very early, but can you tell us or share with us what you start to see for as dynamic for 2019?

[Jean-Marc Chery:]

Now, the dynamic we are seeing this is the one I just share with you a few seconds ago.

[Stéphane Houri:]

Okay. Thank you very much.

[Tait Sorensen:]

Thank you, Stéphane. Next question please.

[Operator:]

The next question is from Aleksander Peterc from Société Générale. Please go ahead. Aleksander Peterc - Société Générale SA (UK) Yes. Good morning and thank you for taking my questions. I'd just like to come back a little bit on this Microcontroller slowdown, particularly in China. Could you perhaps share with us which industries in particular or which end markets are seeing a slowing. And also, is this just the kind of a couple of quarters at worst slowdown here or is there anything more serious brewing? Thank you.

[Jean-Marc Chery:]

Yeah. The end market and then certainly I will ask Marco to complement. End market address, distribution channel is basically mainly Industrial but you know is quite wide, okay, from a white goods, consumer, industrial, drones, and this kind of stuff. We also see some automotive commodities or aftermarket. So, this is basically, in term of end market, after the distribution channels, the one which are showing some sign of softening. So, Marco, do you want to...

[Marco Luciano Cassis:]

Yes. I will add just a little bit of color. What we have seen is different from the quarter before. We have seen the POS flattening. Let me underline that year-over-year still we had the double-digit growth, but the POS has been – is growing mainly due to the fact that the end markets are a little bit cautious. And due to that, we have a kind of inventory correction. But, overall, in the channel, we have a level of inventory which is still healthy under three months, except of course the combination of effect of short lead time and inventory replenishment, plus POS now in China not growing but staying flat. So, overall, I think the situation is under control, and we have again some softening but nothing extremely particular. Aleksander Peterc - Société Générale SA (UK) Okay. And can I just have a quick follow-up on the smartphone demand there? Obviously, had a strong third quarter, and so going into the fourth quarter build on the smartphone side, you see demand being as strong as expected or even a bit better perhaps? Thanks.

[Jean-Marc Chery:]

No. This is what I say, with the current visibility we have, the customer demand for the new phone platform are really well-aligned with our expectation. And as you know, our supply chain is very robust and is able to fulfill this customer demand. Aleksander Peterc - Société Générale SA (UK) Thank you very much.

[Tait Sorensen:]

Thank you, Alex. Next question, please.

[Operator:]

The next question is from Jérôme Ramel from Exane BNP Paribas. Please go ahead.

[Jérôme Ramel:]

Yeah. Good morning. Just a question on the inventory correction you are seeing. To the best you can see, how long do you see it will take to see lead time to get back to normal and to get a kind of inventory level where they should be in the supply chain? And I got a follow-up. Thank you.

[Jean-Marc Chery:]

Jérôme, okay, this is what I say in our outlook, okay, so we will grow 5.7% sequentially, 8% year-over-year, so overall 16%. And we see that, in Q4, we did see some inventory adjustment for Microcontroller. But after it's mechanical, it will depend of the dynamic in 2019 and the POS, and it's very mechanical, okay? So, I think it's early to say.

[Tait Sorensen:]

Your follow-up, Jérôme?

[Jérôme Ramel:]

Okay. Yeah. How should we model the OpEx for Q4? Thank you.

[Lorenzo Grandi:]

Good morning to everybody, Lorenzo speaking. How to model the OpEx for Q4? First, in Q3, our OpEx came a little bit lower than expected. If you remember entering in Q3, I was modeling OpEx in the range of $615 million, $620 million. Actually, the actual Q3 came at $605 million. This is lower than expected. This is mainly due to our seasonal effect that was better than planned than anticipated. In Q4, we expect some increase compared to Q3. This increase is mainly due to longer quarter and some unfavorable effect of the seasonality. Anyway, I confirm substantially what I said entering Q3 that in the second half in average between Q3 and Q4, expenses will stay in the range of $615 million and $620 million as average. So, it means that with some lower expenses in Q3, a little bit higher expenses in Q4, but, yes, average per quarter in the second half will be in that range.

[Jérôme Ramel:]

Thank you.

[Tait Sorensen:]

Thank you, Jérôme. Next question, please.

[Operator:]

The next question is from Sandeep Deshpande from JPMorgan. Please go ahead.

[Sandeep Deshpande:]

Yeah. Hi. Two question if I may. Firstly, Jean-Marc, I mean in terms of the end market, I mean there are various worries about the end market in the auto space as such for instance. I mean, you are saying that you're going to grow more than your overall growth in 2018 in the auto market. Do you have visibility into 2019 in terms of the auto growth? Is there where you're going to see weakness or is it that you do not see that coming through in the supply chain at all at this point? The second question I have is regarding your gross margin guidance into the fourth quarter. I mean, you've got revenue growing significantly from the third quarter to the fourth quarter. Probably, this – a lot of that incremental revenue is to do with Imaging and a bunch of that Imaging is built in your own factories. Given that this is built in your own factories, why are you not seeing an improvement in the gross margin from Q3 to Q4 or are there some other impacts there? Thank you.

[Jean-Marc Chery:]

So, I will take the first question and Lorenzo the second one. Well, Sandeep, I confirm that, okay, on Automotive, we still see a very strong and healthy demand. And we have basically no significant impact from carmakers and Tier 1 recent announcement; absolutely no material impact. Our backlog is very strong. We have a very, let's say, good visibility across the next quarter. So, that's the reason why we are very confident in Automotive. Well, as I said, this year, we will grow better than the company average. Well, I also disclosed that, okay, on the retail market, okay, for infotainment, in China, we see some little softer, but it's really to be transparent among ourselves. The supply chain is really still stretched for many components and many technologies. So, as a takeaway, as far as the dynamic for Automotive, for ST is really strong, and we are confident with our capability to continue to grow on a sustainable way.

[Lorenzo Grandi:]

About gross margin, you saw that in the Q3, our gross margin came at 39.8%, 20 basis points lower than our midpoint. This was mainly impacted by different weight in the product group mix in term of revenues. What we see moving from Q3 to Q4, the drivers in the revenue will be definitely our image sensor together with the Automotive and Power Discrete. In this respect, we do not see significant improvement moving from Q3 to Q4 in the gross margin where the manufacturing efficiency substantially will offset the decline, the normal price pressure that we see. So, at the end, we model our gross margin that will remain flat moving from Q3 to Q4.

[Sandeep Deshpande:]

Thank you.

[Tait Sorensen:]

Thank you, Sandeep. Next question, please.

[Operator:]

The next question is from David Mulholland from UBS. Please go ahead.

[David Mulholland:]

Hi. Just coming back on the commentary you gave on bookings, I wondered if you could just quantify what the actual book to bill in the quarter was. I think, in Q2, you'd said it was 1.1. And then, just secondly, as you progressed through October, you've already said a few times you haven't seen any kind of impact in autos, but do you have any thoughts at this stage? Obviously, it also depends on what happens in Imaging, but how we should think about kind of seasonality in the business as we head into Q1? It would be really helpful just to have some understanding of that at this point.

[Marco Luciano Cassis:]

On booking, I would answer. As Jean-Marc already said, we still saw a very good level – a good level of bookings in Q3 even if it was less stronger than before because, as already said, it's clean of the inventory replenishment effect and our customers acknowledged that we have a shorter lead time than previous quarter. So, we stay positive on the revenues evolution for three years and this is the booking evolution that we see during Q3.

[David Mulholland:]

So, I wanted to get (31

[Lorenzo Grandi:]

Book to bill, I can answer. Book to bill in the third quarter was below parity, was above parity in – and this is mainly driven by low level of book-to-bill in the area of the Microcontroller and as well we're explaining before especially in China. So, yeah, slightly below the parity.

[Tait Sorensen:]

So, David on your second question was – did I read it right, is it Imaging seasonality? Was that correct?

[David Mulholland:]

Well, I guess, mainly overall seasonality, but I assume a lot of that's going to be driven by Imaging. So, just some idea on how you're thinking about seasonality into Q1, but I suspect one of the big drivers will obviously be Imaging.

[Jean-Marc Chery:]

As usual, okay, we do not want to share, okay, what we see in Q1 because, okay, remember what happened this year, okay, it's really useless, okay, to give a number, okay. We will see, okay, late December or early January what will be, okay, Q1 visibility, okay. We take lesson from this year.

[Tait Sorensen:]

We'll tell you in three months, David.

[David Mulholland:]

Okay. It was worth trying. Thanks, guys.

[Tait Sorensen:]

Thank you. Next question, Moira?

[Operator:]

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

[Johannes Schaller:]

Yeah. Good morning. Thanks for taking my questions. As a first one, just some of your competitors in Power have talked about better pricing developments quite a little bit over the last few months because of the ongoing supply shortages there. I was just wondering if you could give us a bit of an update on what you're seeing on the pricing side in Power and I also do have a follow-up. Thank you.

[Marco Luciano Cassis:]

Yes. I can confirm – this is Marco speaking, I can confirm that due to the fractured situation on the supply on Power, we can confirm that we see upside on the right levels.

[Johannes Schaller:]

And is that something that will gradually come through over the next quarters or is that already mostly in the run rate?

[Marco Luciano Cassis:]

It will come in the next quarters.

[Johannes Schaller:]

Okay. And as a follow-up, I mean, you talked about the Microcontroller weakness in China. Could you give us a bit of a sense what you see for some of the other end markets for STM32 and the MDG business more broadly, so outside of China? Thank you.

[Jean-Marc Chery:]

U.S. and Europe.

[Marco Luciano Cassis:]

Yeah. I think, in Europe, there was the seasonality due to the – during Q3, during the summer vacation, let's say. But we do not see – so there was some slowing there. But the major program that we see on MCUs also due to the size of the business that we have in China is mainly related to China.

[Johannes Schaller:]

Okay. Thank you.

[Tait Sorensen:]

Thank you, Johannes. Next question, please.

[Operator:]

The next question is from Anthony Stoss from Craig-Hallum. Please go ahead.

[Anthony Joseph Stoss:]

Thanks for taking my questions. Maybe you can help us with your Q4 revenue guide by division. Clearly, AMS is going to be up quite a bit. What do you expect both ADG and MDG to be up or down sequentially? And then also what levers can you pull either via slowing wafer starts and CapEx for 2019? Any thoughts on, if things continue to be softer, what levers can you pull to help try to keep gross margins intact? Thanks.

[Lorenzo Grandi:]

About the revenue dynamic in Q4, what we do expect is to, as well you were saying before, definitely AMS will be the driver of the growth and that will be followed by ADG where we see strong demand both in Automotive and in Power and Discrete, what we see for – sorry, for ADG, Automotive and Power and Discrete. What we see for MDG, the Microcontroller and Digital, we see some slight decline, but much lower pacing in respect what it has been sequentially moving from Q2 to Q3. We continue to see weakness in there – as we said, in the distribution market in China. But at this stage, we do not think that there will be a stronger decline. There will be still a decline in any case. Definitely, Imaging is driving our revenue. Next quarter, Automotive and Power and Discrete are contributing to the growth. Second question was about the level of CapEx for this year, right?

[Anthony Joseph Stoss:]

And gross margin levers to keep gross margin.

[Lorenzo Grandi:]

Let's say in term of gross margin what we said that we are guiding in terms of – to stay at 39.8% in Q4. And as we said, this level of gross margin will be around 40% in the few quarters, I think, with the up and down depending also on the seasonality. In respect to the CapEx, we do expect that for 2018 to be in the range $1.25 billion.

[Anthony Joseph Stoss:]

Thank you.

[Tait Sorensen:]

Thank you, Tony. Next question, please.

[Operator:]

The next question is from Achal Sultania from Credit Suisse. Please go ahead.

[Achal Sultania:]

Hi. Good morning. Just a question on – so I guess like when I look at last year, we had this same situation in Microcontroller where the lead times were exceptionally long and you had very strong growth in Microcontrollers. And, now, we are exactly seeing the same situation in Power Discrete where you're still saying that the market being soft, lead times are still stretching or are very high. So, can you help us understand what gives the confidence that we go into 2019 and, Power Discrete, we don't see a similar situation involving what we saw with Microcontrollers this year, like any drivers just to help us understand what's different, maybe just longer lead times, longer duration projects, anything around those would be helpful. Thanks.

[Marco Luciano Cassis:]

Again, sorry, we are not commenting on 2019. We are focusing on Q4, and I think you have all the information about what are going to be our growth driver for Q4, which are again Automotive, Power and Discrete, and Imaging.

[Achal Sultania:]

Yeah. But my point was like what – like how should we think about Power and Discrete and how is it different versus MCU going forward? Like obviously I'm not telling you to guide for 2019, but how should we think about that business, and what's different versus MCU?

[Marco Luciano Cassis:]

In this moment, we still see a very strong demand, plus we have a strong positioning in new technologies like Silicon Carbide. So, I think, the overall position of our offer to the market is extremely appealing, and this is supported by a very strong backlog. While, in MCU, as you said, we enjoyed a very strong first half. Unfortunately, the overall situation of China has driven to a POS that has not been developing as expected, which has created the necessity of an inventory correction that we do believe is temporary, and we will go back in the near future to grow.

[Jean-Marc Chery:]

And also, we can add that the Power Discrete are well spread across all the end markets we address. So, as Marco said, for sure, the electrification of the vehicle is growing now very fast and is a secular demand in power. So, Industrial, clearly, everywhere you have electrical motor, okay, you have power around. But also in Personal Electronics, on charger, in computer with power supply, in computer peripheral, okay, also as we have said in autonomous driving. So, really, there is a difference, okay, between power that, okay, the spread of this device, but of course all the end market is very wide and with very strong growth driver like the electrification of the vehicle. So, this is, okay, what I can share with you now.

[Achal Sultania:]

Okay. Thanks. Thanks a lot.

[Tait Sorensen:]

Thank you, Achal. Next question please.

[Operator:]

The next question is from Adithya Metuku from Bank of America. Please go ahead.

[Adithya Metuku:]

Yeah. Good morning, guys. Two questions. Firstly, I just wanted to hear your views on POS demand in China. When you look at this demand, can you give us some color on how it compares to what you saw in late 2015 or maybe in early 2013? I'm trying to get a sense for how this could play out as you look out into 2019. And then, second question is for Lorenzo, just on OpEx trends into 2019 given where FX is and the hedging you have in place, any color you can provide on that would be very helpful? Thank you.

[Marco Luciano Cassis:]

I will take this. I do not have the numbers here. But just to give you an overall picture, we are coming from many quarters of POS sequential growth. What is changing in China now is that we see a flattening of this POS. So, the POS are in this moment not growing anymore. And this is, again, linked to the – due to this, again, the inventory grew according to a forecasted POS which is not materializing with calling for an inventory correction which is ongoing – which was ongoing strongly in Q3 and still ongoing in Q4.

[Lorenzo Grandi:]

About expenses, in terms of expenses, as you know, we have already commented some time that we believe that the structure of the company is today substantially suitable for the ambition in terms of growth that we want to have. So, I do not expect to have a significant increase apart the impact of the normal inflation, salary increase. With respect to your question on the exchange rate, definitely, if the spot rate will remain in the range of $1.16, $1.15 today, our effective is more in the range of $1.18, this will give us some benefit. So, all these put together I would say that expenses should stay substantially flat to slightly increasing in the next year.

[Adithya Metuku:]

Understood. Very clear. If I could just a quick follow-up on POS demand. When you look at it, do you ever compare internally on what this looks like versus 2015 or 2013? And if you do, any color you can provide around that? Apologies for belaboring this point. Thank you.

[Jean-Marc Chery:]

So, the difference between what we have seen in 2015, well, here, I think okay, the main important point, it is clearly – we can call it softening or deceleration because we are – the POS overall year-over-year is still growing 10%, which is important, so 10% growth year-over-year. Now, we are seeing in Q3 POS flattening. And again, for ST, the mechanical impact some slight inventory correction. So, our revenue are slightly below. That's the reason why Microcontroller MDG, we decrease minus 8%. So, what we can describe is the current situation. Current situation is a soft deceleration, still good growth year-over-year. But a sequential flattening of the POS with some mechanical adjustment in term of inventory replenishment or adjustment, which is for us back to normal situation, and no more than that. So, this is the main difference compared to 2015.

[Adithya Metuku:]

Understood. Thank you.

[Tait Sorensen:]

Thank you, Adi. Next question, please.

[Operator:]

The next question is from Andrew Gardiner from Barclays. Please go ahead.

[Andrew M. Gardiner:]

Good morning, gentlemen. Thanks for taking the question. I had another one on the Automotive space, please. This is sort of normally the time of year when you'd be having discussions with the OEMs and the Tier 1s about their plans for next year. Given what – at least what the investment community clearly is concerned about in terms of the Automotive space, can you give any sort of further detail sort of qualitatively on expectations from those partners in terms of volume and content and price into next year? You've already commented that pricing, particularly on the power area, is a little bit better. But some of those other levers on the Automotive revenue line into next year would be helpful. Thank you.

[Jean-Marc Chery:]

I understand your question. But I guess you understand that this is really difficult for me. I cannot disclose, okay, the meeting we had at first level or at my level with the Tier 1 in Europe and in U.S. Again, what I really want to confirm to you that our current visibility is really good. (45

[Andrew M. Gardiner:]

Understood. I had to try. Just perhaps another one on silicon carbide, you mentioned a few wins in the recent quarter. Can you give us a better sense as to when those might start to ship? I presume it's not next year, but in terms of 2020, 2021 sort of how you're thinking about the ramp over time? Thank you.

[Jean-Marc Chery:]

Well, this is – clearly with the usual product development lead time and incubation, okay, it will be more impact on 2020 and beyond for ST. But for the time being, I confirm that this year, we will execute and we will achieve $100 million revenue from silicon carbide. Our manufacturing machine is performing well according expectation, and these 30 projects are simply consistent with our mission to be a leader of the silicon carbide market. And we know that with this market, we grow very fast, okay. For the time being, we have visibility to see $3 billion in 2025, and we want to perform this market consistently with our current market share generally speaking Automotive well above 30%.

[Andrew M. Gardiner:]

Thank you, Jean-Marc.

[Tait Sorensen:]

Thank you, Andrew. Next question, please.

[Operator:]

The next question is from Janardan Menon from Liberum. Please go ahead.

[Janardan Menon:]

Hi. Good morning. Thanks for taking my question. I'm sorry. I just want to go back to this POS and your distribution channel for Microcontrollers. So, if I understand you right, you're saying that your POS has flattened since around August-September and continues to be flat, whereas you had expected growth, but you're guiding for an 8% fall quarter-on-quarter in Q3. You're guiding to a lower level of a decline in Q4, and that's because the channel cleared more inventory in Q3, and now you think that there is less inventory to be cleared in Q4, and therefore, the decline into Q4 will be less than Q3. Is that understanding correct?

[Marco Luciano Cassis:]

Yeah. You are correct, plus you have to consider that lead times are also shortening, so we'll have some turns coming during the quarter.

[Janardan Menon:]

Okay. And what gives you that confidence that the further correction of inventory in the channel in Q4 is going to be less than Q3? What visibility do you have as to how low the channel would want to take down inventories in the current phase of demand?

[Marco Luciano Cassis:]

It's the visibility that we do have because we are on the field. And second is, again, it's mechanically, the level of inventory has moved down to a more reasonable level consistent with the POS.

[Janardan Menon:]

Okay.

[Jean-Marc Chery:]

So, we have a turn of inventory slightly above 4. It means, okay, below three months of stock overall, so – which we consider, let's say, something close to normal. So, that's the reason why, okay, we consider the inventory adjustment in Q4 will be well below the one we faced in Q3.

[Janardan Menon:]

Understood. And just going to the sensing business, can you just give us an update on what you are seeing in 3D sensing design wins and how you would expect that market to evolve for you outside of the big ramp that you have in the second half of this year?

[Jean-Marc Chery:]

Well, clearly – well, I'll repeat. For ST, there is today, short, medium-term really – two kind of market we are really leading is proximity sensing and ranging sensor based on our, let's say, Time-of-Flight technology. So, we have accumulated hundreds of million PCs shipped, and here, we continue to really perform well and we will continue to perform. Then, I guess it is very clear for everybody now, okay, ST is really focusing on the structured light, and the key component – part of the bill of material of the structured light, okay, working very closely with our customer. And we want to improve continuously the performance of this system through our component – through the performance of our component. And we are really focusing on it, and we have really a stronger mission to continue to perform as we have done in the recent past quarter. Saying that we can also offer more components part of the structured light, as I mentioned a few minutes ago, as you have seen, we have a wonderful kit (51

[Janardan Menon:]

Just one small follow-up. Your ambient light sensor design win, is it already shipping in the second half of this year or is that to ship next year?

[Jean-Marc Chery:]

No, no, it's not already shipped. It is a design win with an important smartphone maker.

[Janardan Menon:]

Understood. Thank you very much.

[Tait Sorensen:]

Thank you, Janardan. Next question?

[Operator:]

The next question is from Gianluca Bertuzzo from Intermonte. Please go ahead.

[Gianluca Bertuzzo:]

Hi. Good morning and thank you for taking my question. I have just one on the tax rate, as the question on the end market has already been answered. We have seen a very low level of tax rate in the third quarter. Could you help us modeling the level for the fourth quarter and maybe also for – what you see for the next year?

[Lorenzo Grandi:]

Yes. I'll take your question about tax rate. You're right, in the Q3, our tax rate is particularly low, and this is due to two discrete items. Anyway, modeling next quarter, it will be similar in term of tax rate, it will be slightly above. When we move to next year, I would like to remind you that we are enjoying now the positive impact of NOLs that will not be any longer there moving in the next year. So, next year, if you have to model the tax rate, this will be more in the range of 15%, 17%. So, there will be an increase in tax rate moving next year.

[Gianluca Bertuzzo:]

Thank you very much.

[Tait Sorensen:]

Thank you. Next question, please.

[Operator:]

The next question is from Günther Hollfelder. Please go ahead.

[Günther Hollfelder:]

Yeah. Thanks. First question, a follow-up again on the Power Discrete. If we just focus on distributors in China, you mentioned here weakness in some of the areas like white goods and others for Microcontrollers. So, also just focusing on distribution channels in China, you're not seeing any slower demand for Power Discrete units there?

[Jean-Marc Chery:]

On Power Discrete, we still see a strong demand.

[Günther Hollfelder:]

Okay, thanks. And your internal inventories, do you expect then a further increase then at the end of the fourth quarter due to this inventory corrections in Microcontrollers and other issues?

[Lorenzo Grandi:]

You talk about – sorry. You talk about our inventory in ST or inventory in the...

[Günther Hollfelder:]

Yeah.

[Lorenzo Grandi:]

Our inventory in ST, no. For what concern inventory in ST, we do expect in Q4 to have some reductions in term of inventory, and we do expect to have a significant improvement in what concern the turns. So, we do not expect that – well, you see that moving from Q2 to Q3, there has been a slight increase and an improvement in turns that was already anticipated entering in Q3. Now, we do expect that to stay – to reduce – slightly reduce our inventory and significantly improve the turns of our inventory.

[Günther Hollfelder:]

Maybe as a final question from my side, you mentioned some weakness in Automotive in the aftermarket in China. So, I assume this is mainly related to the infotainment segment?

[Jean-Marc Chery:]

Yes. Yes, you're correct.

[Günther Hollfelder:]

Okay. Many thanks.

[Tait Sorensen:]

Thank you, Günther. Next question, please.

[Operator:]

The next question is from Amit Harchandani from Citigroup. Please go ahead.

[Amit B. Harchandani:]

Good morning, all. Amit Harchandani from Citi, and thanks for taking my questions. Firstly, if I may, just to go back and just clarify on the AMS segment and the outperformance of the margins. Could you just reconfirm if you think the outperformance versus your expectations was driven by volume, pricing or was it mix? I ask this because there have been some concerns around pricing pressure exerted by big smartphone makers on the component suppliers. And then, I have a follow-up.

[Lorenzo Grandi:]

No, I'll take the question. Lorenzo. About the performing better in AMS is mainly thanks to better performance that we then expected in manufacturing. And you see that overall in respect our guidance for the second half of this year, we substantially – we are in line with the Automotive and Discrete Group. We are – due to this lower level of revenues than expected, a little bit under our guidance in MDG, in the Microcontrollers and Digital Group. Why we are better in AMS mainly driven by better than expected performance in manufacturing. There are no different impact related to different pricing or things like this. Overall, our expectation is to meet in the second half what we were expecting at our Capital Markets Day, so an operating margin in the second half increasing in respect to the first half of about 360 basis points with a little bit different mix among the three groups.

[Amit B. Harchandani:]

That's helpful, Lorenzo. Secondly, if I may, there's obviously this ongoing backdrop of the trade wars between U.S. and China. From your perspective, how are you thinking in terms of your supply chains and your own operations in China? At this stage, are you evaluating any potential realignment or change in supply chains? Just trying to understand where you stand in terms of how you are thinking and assessing the impact of the ongoing trade wars.

[Jean-Marc Chery:]

First of all, I have to confirm what I have already said some time talking about this topic. For us, of course, it's not welcome, these kinds of things. But it's not a strong – a big material impact for us. We have some impact definitely, but it's not very big. Anyway, through that, we are somehow slightly readjusting our supply chain in order to secure that – for some customer, we may ship from maybe in different location where they need – let's say, where they ask to have the parts. Overall, I repeat that there are no major impact, no major change in our supply chain, and for the company, this impact is really not so material.

[Amit B. Harchandani:]

Thank you. And just finally, if I may, going back to Automotive, a lot of talk about trends in China, but could you broadly confirm that there's been no material shift in the demand trends for you worldwide when it comes to the Automotive business inside and outside China?

[Marco Luciano Cassis:]

Again, what we are saying is that our backlog is extremely strong. Of course, there have been here and there some reduction in terms of volume in terms of cars, but the pervasion of the semiconductor is such that with the backlog we have, we confirm what we already say that we will grow in Automotive this year in the range of 17%.

[Amit B. Harchandani:]

Thank you.

[Tait Sorensen:]

Thank you, Amit. At this point, we'll turn to Jean-Marc for some closing comments.

[Jean-Marc Chery:]

So, before we close this session and – I thank you, okay, everybody for all the question and debate. Before we close, I would like to update you on some changes to our Investor Relations department. So, after 18 years in Investor Relations at ST, so Tait Sorensen has informed our company about his desire and willingness to step down from his position in order to prepare for other professional opportunities within ST. Well, Tait remain committed to the Investor Relations department during this period of transition. He will support the Investor Relations team for some time to ensure a flawless transition. And in the meantime, I am very happy to announce that Celine Berthier has been promoted to the Head of Investor Relations effective immediately. I trust you all know and respect Celine, as she has been with ST Investor Relations for over 11 years. And I am sure that you will join me in wishing them both all the best for the future. However, I would like to take opportunity to thank personally Tait, because we spent many time together visiting you, visiting investors across the world during periods which were not so easy for us. And I have always appreciated the cooperation spirit of Tait, and I have to say it is more than a colleague. It is a friend. So, thank you for your attention. So, we will now close our Q3 call, and looking forward to see you soon. Bye-bye.

[Tait Sorensen:]

Thank you, everyone.

[Operator:]

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