STMicroelectronics N.V. Q2 FY2023 Earnings Call

Ladies and gentlemen, welcome to the STMicroelectronics Q2 2023 Earnings Results Conference Call and Live Webcast. I'm Moira, the Chorus Call operator. I want to remind everyone that all participants will be in a listen-only mode and the conference is being recorded. The presentation will be followed by a Q&A session. It is now my pleasure to hand over to Celine Berthier, Group Vice President, Head of Investor Relations. Please proceed, madam.

Thank you, everyone, for joining our second quarter 2023 financial results conference call. Hosting the call today is Jean-Marc Chery, ST's President and Chief Executive Officer. He is joined by Lorenzo Grandi, Chief Financial Officer, and Marco Cassis, President of Analog, MEMS and Sensors Group and Head of STMicroelectronics’ Strategy, System Research and Applications, Innovation Office. The live webcast and presentation materials can be accessed on ST's Investor Relations website, and the replay will be available shortly after this call concludes. This call will include forward-looking statements that involve risk factors which could lead to results differing significantly from management's expectations and plans. We encourage you to review the safe harbor statement in the press release issued with the results this morning, as well as in ST's most recent regulatory filings for a complete description of these risk factors. We also want to ensure that all participants can ask questions during the Q&A session. Now I’d like to turn the call over to Jean-Marc, ST’s President and CEO.

Thank you, Celine, and good morning, everyone, and thank you for joining ST for our Q2 2023 earnings conference call. In Q2, our balanced end-market approach, our broad product portfolio, and strong customer relationships enable again a double-digit year-over-year growth. This performance came along with a year-over-year increase of our profitability. And as already anticipated, 2023 will be another year of progress towards our $20 billion plus revenue ambition and related financial model. Now, let's start with the financial highlights overview. Second quarter's net revenues of $4.33 billion came in above the midpoint of our business outlook range and Q2 gross margin of 49% was in line with guidance. Q2 net revenues increased 12.7% year-over-year. The revenue performance continued to be driven by growth in Automotive and Industrial, partially offset by lower revenues in Personal Electronics. Looking at our year-over-year performance, gross margin increased to 49% from 47.4%. Operating margin increased to 26.5% from 26.2% and net income increased 15.5% to $1 billion. On the first half of 2023, net revenues increased 16.1% year-over-year to $8.57 billion, driven by growth in all product sub-groups except the Analog and MEMS sub-groups. We reported gross margin of 49.3%, operating margin of 27.4%, and net income of $2.05 billion. On Q3 2023, our third quarter business outlook at the midpoint is for net revenues of about $4.38 billion increasing 1.2% year-over-year and by 1.1% sequentially. Excluding the impact of the change in product mix in an engaged customer program in Personal Electronics, I mentioned in January, the Q3 revenue growth at the midpoint would be 3.5% year-over-year and 3.2% sequentially. Gross margin is expected to be about 47.5%. For the full year 2023, we will drive the Company based on a plan for revenues of $17.4 billion plus or minus $150 million. This represents a year-over-year growth of about 8%, and we now anticipate the gross margin to exceed 48% for the full year. Now, I will move to a detailed review of the second quarter. Net revenues increased 12.7% year-over-year. This performance was driven mainly by ADG, up 34.4%, and MDG up 13% on continued strength in Automotive and Industrial. AMS revenues decreased 15.7%, mainly reflecting lower revenues in Personal Electronics as expected. Year over year, sales increased 9.8% to OEMs and 18.3% to Distribution. On a sequential basis, net revenues increased 1.9% with ADG up 8.2%, MDG up 4.3%, and IMS down 11.9%. Net revenues came in 110 basis points above the midpoint of our outlook, mainly due to Automotive. Gross profit was $2.12 billion, increasing 16.5% year-over-year. Gross margin increased to 49%, compared to 47.4% in the same quarter last year. The 160 basis points expansion was driven by product mix, favorable pricing, positive currency effect net of hedging, and partially offset by higher manufacturing costs. Year-over-year in the second quarter operating income increased 14.2% to $1.15 billion. In the quarter, net operating expenses include negative non-recurring non-cash items amounting to $34 million. Operating margin was 26.5%, increasing from 26.2% in Q2 2022. On a year-over-year basis, Q2 net income increased 15.5% to $1 billion compared to $867 million in the year ago quarter. Earnings per diluted share increased 15.2% to $1.06 compared to $0.92. Looking at our year-over-year sales performance by product group, ADG revenues increased 34.4% and double-digit growth in both Automotive and Power Discrete. AMS revenues decreased 15.7% with lower revenues in the three sub-groups. MDG revenue increased 13% with growth in Microcontrollers and RF communications. In terms of operating margin, two of three product groups delivered year-over-year improvement, ADG operating margin increased to 31.9% from 24.7%. MDG operating margin increased to 35.4% from 33.6% while AMS operating margin decreased to 14.8% from 24.1%. Net cash from operating activities increased 24.1% to $1.31 billion in Q2 versus $1.06 billion in the year-ago quarter. CapEx in the second quarter was $1.07 billion, compared to $809 million in the year-ago quarter. Free cash flow was $209 million compared to $230 million in the year-ago quarter. During the second quarter, ST paid $50 million of cash dividends to stockholders, and we executed an $86 million share buyback under our current share repurchase program. ST’s net financial position of $1.91 billion as of July 1, 2023, reflected total liquidity of $4.56 billion and total financial debt of $2.65 billion. Let me go through a recap of the main Q2 corporate and business highlights. We had two important announcements in Q2 related to our 300mm and Silicon Carbide strategic manufacturing programs. First, we announced the conclusion of the three-party agreement among the State of France, GlobalFoundries, and our Company, as approved by the European Commission. This relates to the new 300mm semiconductor manufacturing facility in Crolles, France, first announced last July. This agreement will contribute to our $20 billion plus revenue ambition and related financial model, and will further reinforce the European and French FD-SOI ecosystem. We will build more capacity for our European and global customers in advanced technologies as they transition to digitalization and decarbonization. The total investment for this project is expected to be about 7.5 billion euros and will benefit from French State financial support up to about 2.9 billion euros, in line with the objectives set out in the European Chips Act. In silicon carbide, we announced a joint venture with Sanan Optoelectronics for high-volume 200mm silicon carbide device manufacturing in China. The joint venture will support the rising demand for ST’s silicon carbide devices in China for car electrification and industrial power and energy applications. Sanan will build separately a 200mm silicon carbide substrate manufacturing facility to fulfill the JV’s need. The combination of the 200mm substrate facility to be built by Sanan with the front-end JV and ST’s existing back-end facility in Shenzhen will enable ST to offer our Chinese customers a fully vertically integrated silicon carbide value chain, a significant competitive advantage in the silicon carbide landscape. The new joint venture Silicon Carbide fab is targeting to start production in Q4 2025 and full build-out is anticipated in 2028. It is an important step to further scale our global silicon carbide manufacturing operations, coming in addition to our continuing significant investment in Italy and Singapore. It will be one of the key enablers of the opportunity we see to reach above $5 billion silicon carbide yearly revenues by 2030. In this corporate development overview, I would also like to mention a change in our Executive Committee. During the quarter, Orio Bellezza, President, Quality, Manufacturing, Technology and Supply Chain, and member of ST’s Executive Committee, announced his retirement from the Company. Orio will remain Managing Director of the Company’s Italian subsidiary until the expiration of his mandate. Fabio Gualandris, ST’s Executive Vice President, Head of Back-End Manufacturing & Technology, and Deputy to Orio Bellezza, is appointed President, Quality, Manufacturing and Technology. Upon my proposal, ST’s Supervisory Board approved the appointment of Fabio to the Company’s Executive Committee. I would like to thank Orio for his engagement in the numerous roles he has played at ST, and I wish Fabio all the best in his new role. I will now go through a short update on some of our strategic focus areas. In Silicon Carbide, we continued to increase the number of engagements, we are now working with 90 customers and 140 projects. Silicon Carbide-based power systems for EV traction and industrial drives are complemented by our industry-leading STGAP Galvanic Isolation Drivers, based on ST’s unique IP and advanced BCD technology. We announced an R&D collaboration with Airbus on wide bandgap semiconductors for aircraft electrification and decarbonization. This confirms ST’s leadership and the strength of our Silicon Carbide technology roadmap. In car digitalization, we saw continued design win momentum with our latest generation of automotive microcontrollers, called Stellar, across multiple applications. In parallel, in ADAS, we continue working closely with our long-time customer and partner Mobileye. Their EyeQ6 product is now in production, and EyeQ Ultra at the R&D phase. Volumes of previous generations are ramping up. In May, we held our annual STM32 Summit event for industrial customers in China, with 2,700 customers in person and a record-breaking 80,000 online. During the event, we made announcements related to edge AI, namely AI running on microcontrollers, microprocessors, and sensors. We launched a new family of microprocessors for secure Industry 4.0 and edge AI to allow our developers to address higher performance applications. We also gave further details on the upcoming STM32N6 microcontroller. This is ST’s first MCU with our Neural Processing Unit hardware accelerator and will bring the best-in-class computing power, power consumption, and cost of ownership for the applications we target. One of the industrial application demos we built with a customer performs up to 75 times faster for AI workloads versus today’s high performance MCUs. We will start to sample the STM32N6 from September onwards. For developers, we are expanding our STM32Cube.ai software offering, including the launch of a collaboration with Nvidia around the TAO (Train, Adapt, Optimize) toolkit, now available. Edge AI is not only STM32. We have the same approach for sensors, with the release of a new toolkit and associated software for our intelligent MEMS sensors for activity recognition and anomaly detection directly in the sensor. Now, let’s move to our third quarter 2023 financial outlook and our plans for the full year 2023. For the third quarter, at the midpoint, we expect net revenues to be about $4.38 billion, representing year-over-year and sequential growth of 1.2% and 1.1%, respectively. As anticipated in January, we are entering in H2 2023 with a significant change in product mix in an engaged customer program in Personal Electronics. Excluding this change, our Q3 ’23 revenues at the midpoint would grow year-on-year by 3.5% and sequentially by 3.2%. And based on our indication of $17.4 billion revenues for full year 2023, H2 2023 revenues would grow by about 6% compared both to H1 2023 and H2 2022. Q3 gross margin is expected to be about 47.5% at the midpoint, including about 150 basis points of unused capacity charges. For 2023, based on our visibility, we will drive the Company based on a plan for full year 2023 revenues of $17.4 billion, plus or minus $150 million. This represents growth of about 8% over 2022. The full year 2023 gross margin will exceed 48%. We confirm our 2023 CapEx plan of about $4 billion. Thank you, and we are now ready to answer your questions.

We will now start the question-and-answer session. The first question is from Jérôme Ramel from Exane. Please proceed.

Yes, good morning, and thank you for taking my question. First question maybe, Jean-Marc, if you could help us to understand the dynamic per division for Q3 and the second half of this year? That would be the first question. Thank you.

The dynamic for Q3 is sequentially and year-over-year. I have to say that year-over-year, ADG and let's say will grow significantly. Let's say, well above 20%. MDG will slightly grow year-over-year, Q3 over Q4, but it is linked okay, to the fact that China will not start slower than expected. Now in IMS will decrease year-over-year by 31%, but also this must be also corrected by the fact that we have this change in the product mix. While sequentially, if we look Q3 2023 versus Q2, ADG will continue to grow, I have to say a single digit. IMS will be basically flattish. MDG will just slightly decrease again for the same reason because in China, we do not see the expected restart is slower than expected.

Okay. Thank you. And maybe a question for Lorenzo, on the OpEx, they probably came above expectations for Q2. How should we think about the OpEx for Q3 and maybe just on half of this year? Thank you.

In terms of operating expenses, this quarter compared to last quarter in Q2, we had a slightly higher level of operating expenses. We previously mentioned that there were some one-time items that we did not anticipate entering the quarter, and the grants we expected did not come through as they were postponed for administrative reasons. We were unable to recognize those grants. For Q3, we anticipate a significant decline in net operating expenses compared to Q2, expecting them to be between $880 million and $890 million. This outlook considers seasonality and the fact that other income and expenses are expected to be notably positive due to our ability to recognize R&D grants, which wasn't the case in Q2. For the year, we expect Q4's operating expenses to increase as it typically has higher operating costs due to seasonal factors. Overall, we expect quarterly operating expenses for the year to be between $910 million and $930 million.

Thank you.

The next question is from Francois Bouvignies from UBS. Please go ahead.

Thank you very much. So, I have two quick ones. First one is on Automotive. I mean obviously very strong performance, 34% growth year-over-year. Now, if I look at the peers, I mean NXP is growing 9%, it's Automotive. Renesas is growing 3% year-over-year this quarter. So, you seem to outperform by far your peers in terms of growth rates. Now I understand that silicon carbide is a big growth driver, but even if I try to exclude silicon carbide from this growth, I get definitely more than 25% growth year-over-year anyway. So, I was just wondering, can you explain the strong outperformance versus some of your peers Texas is also growing like 20%, excluding silicon carbide as such, and I'm asking because the U.S. peers essentially they're saying that they don't want to feel the industry with inventories and they are managing basically this. So, is there a risk that you feel too much the channel with inventories? Or yes, that's why I'm asking the drivers behind the stronger performance? Thank you. And, I have another one after.

No, I think there is a first reason fundamentally that we overperforming our peers is basically tourism is ahead of us. Do not forget that we partner with Mobileye. Mobileye is the leader worldwide of ADAS systems. Now, ADAS is more and more pursuing the car industry also driven by regulation. And if you want to be a faster in cap, this kind of stuff, so you must embed some other features. And ST, as a partner of ADAS, and this is what I say in my script. The current generation of ADAS mainly are really ramping materially. More, and just second reason, I know we are focusing on silicon carbide, but versus Renesas and NXP. On top of that, we have let's say, richer portfolio, a larger portfolio on Analog and Microcontroller and MEMS. Don't forget POWER. So, IGBT, low-voltage MOSFET, high-voltage MOSFET, VIPower, more and more, we are pursuing VIPower, which are very adapted devices for the new architecture in this car. Our two competitors do not have this kind of technology. So this is the two main reasons why we have overperformed our peer: it is ADAS and the remaining portfolio we have in POWER, including the VIPower.

Thank you so much, very clear. And my follow-up question would be on IMS. I mean, I expected the share loss happening in the second half of the year. And I was a bit surprised on the Q2 year-over-year decline. And more importantly, the margins that decrease significantly. So I understand the top line, you have some kind of drop through, but can you explain a bit more what's going on IMS this quarter? And also margin bridge would be amazing. Thank you.

IMS experienced a significant revenue decline in Q2, mainly due to a substantial hit from Personal Electronics. This year, we expect smartphone sales to decrease overall. Additionally, the inventory correction in Personal Electronics will persist into Q3. Another factor is that IMS is also affected by our design efforts, particularly in the computer and computer peripheral sectors, which remain weak. These are the primary reasons for the considerable year-over-year drop in IMS revenue. Regarding margins, Lorenzo may have more to add.

At the end, let's say, this impact on the margin is mainly due to the volume, is mainly due to the fact that, of course, our let's say level of top line is declining and for sure the leverage on our expenses is worsening in this group. I would say this is the main driver. Then of course, it also impacted there by some, let's say, deterioration in our manufacturing, especially, let's say, related to the activity that is lower for our MEMS for this kind of products. But the main driver of our operating margin is related to the fact that the volume decrease and the expense to sales ratio for sure is worsening for this group.

Great. Thank you very much.

Thank you. Next question please.

The next question is from Aleksander Peterc from Société Générale. Please go ahead.

Yes, good morning. And thank you for taking my question. My first question will be on inventory which rose to 126 days. How would you qualify this level of inventory? Is it elevated or needs to be worked down in the second half or is it a normal and reflecting usual seasonality for your business? And I have a follow-up. Thank you.

Lorenzo, I’ll take this question. We judge this a little bit too high. It's true that in Q2, our inventory for seasonality is increasing. Anyway, let's say, at this stage, 126 days of inventories is a little bit on the high side. This is also the reason why in the second part of the year, as we have already anticipated Q3 and Q4, we will reduce our activity, our production activity, especially on those fabs that are more exposed to personal electronics and consumer. This will bring unloading and these unsaturation charges and this is visible in our gross margin this quarter where we are hit by 150 basis points of unloading in our guidance of 47.5. If you take out this impact we are more or less similar to the Q1 or Q2 in terms of gross margin.

And we finished the year in term of inventory?

In terms of inventory, yes, thank you. We aim to reduce our inventory to a range of 100 to 110 days, compared to the current 126 days.

Thank you for the follow-up.

Thank you for the follow-up questions. Yes, absolutely wonderful. My second question would be on smartphones. You mentioned this already in your introductory remarks. There hasn't been much of a recovery so far. How would you assess the market now? Do you see any signs of the smartphone market stabilizing, especially in China this quarter, or is it too early to make that determination? Thanks.

No, this is what I said. In terms of demand, the data we have indicates that this year the smartphone market will see a slight decrease of about 1.5% to 2%. We are still observing changes in the mix between 4G and 5G. It's important to note that this industry is still coping with last year's significant decline of 9%. Additionally, the inventory that built up last year has not yet been fully processed and this will continue into Q3. We expect to gradually see the first signs of inventory digestion in Q4 and Q1 of next year, which will expose us to the actual consumer demand for smartphones. This is the scenario we are most likely anticipating.

Very clear. Thank you very much.

Thank you, Alek. Moira, next question please.

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

Good morning, guys. Thank you for taking the question. Can I ask one on pricing, please? We've covered this with first quarter results, but it would be great to have a real time update here with 2Q. Lorenzo, if I look at the gross margin guidance you've given particularly as you just highlighted adjusting for the underutilization charges, gross margins flat into 3Q and still remaining strong into 4Q. It suggests to me that there hasn't been much change in pricing, but if you can just walk us through some of the moving parts there? That would be helpful. And then I do have a quick follow-up. Thank you.

No, we absolutely see no significant pricing impact sequentially, Q3 versus Q2. Again, the gross margin dynamic we have, we will move clearly from 49% in Q2 to foresee 47.5% in Q3. But it is impacted by the reduced capacity. So, in fact, in Q3, basically, without this unused capacity that we have decided by ourselves okay, to decrease inventory level described by Lorenzo we need to go, our gross margin is still ballpark at 49%. All the other effect, okay, you know that our input parameter like the product mix, the pricing, the manufacturing efficiency, all these parameters offset each other. So now, Q3, okay, we don't see any significant impact on the pricing.

And just related to that quickly, how much is the 300 millimeter fab ramp a headwind in the third quarter?

I can't tell you in Q3, okay, has been included in the manufacturing efficiency, okay, as the 8 inch which are, let's say, exposed to consumer. But Lorenzo, you want to comment?

In Q3 started to be, let's say, increasing, but is not yet very significantly. It will be a little bit more during Q4 because of course the activity will start to be more visible. As we said, let's say this is one of the detractors of our second half gross margin. Manufacturing overall and let's say the impact of the grant are let's say the main drivers of the declining of course together with the unloading charges. Now this is obvious, but of our gross margin in the second half of the year. But still is not, let's say, super strong. It's not yet, let's say, is part of this degradation, but it's not yet in Q3 so visible.

Okay, I just need a quick clarification. Jean-Marc, you mentioned the adjustment related to the product mix and the customer program in the third quarter, stating that instead of a 1% change year-on-year and quarter-on-quarter, it will be around low to mid 3% for both comparisons. Roughly, that translates to an impact of about $18 million to $19 million. Earlier this year, you projected it would be $500 million for the second half. Can you clarify whether more of the impact is expected in the fourth quarter or if it’s actually less than you initially anticipated?

It's a bit less than anticipated, but it is still very material. And because again, I repeat, this module we accepted to support our important customer. The revenue was really concentrated on H2 2022 and H1 2023 and basically disappear in, let's say, Q3 and Q4 2023. The difference between H2 2023 and H2 2022 impacted by this device is multi-$100 million. Below the number I gave in April, yes, it's below, but it's multi-$100 million. That's the reason why, okay, if you make the math, we have confirmed this number of significant change in the revenue dynamic H2 2023 versus H2 2022. And I have to say in Q4, if you make the math at the midpoint is more important because if you compute our Q4, at the midpoint of $17.4 billion. It's a grow H2 Q4 2023 versus Q4 2022 at 0.7%, corrected by this module, the growth is 7%. So, it's really material. But the impact difference H2 to H2 is multi-$100 million below the number I gave in April.

Thank you very much.

Thank you, Andrew. Moira, next question please. The next one is from Joshua Buchalter from TD Cowen. Please go ahead.

Good morning. Thanks for taking my questions. I wanted to ask about gross margin as well. So, the guidance implies sort of a very modest decline from third quarter to fourth quarter. I think you previously called out three drivers, half of half over half declines, the startup costs under your utilization charges and mix, it all seems like those should be peaking around the fourth quarter. Is that the right interpretation? And I guess is there any reason why the fourth quarter wouldn't sort of be the trough of gross margins as you see things right now assuming again stable market conditions? Thank you.

At the end, let's say when we look at the H2, the gross margin that we will have in average in H2 will be slightly above 47%. And this is impacted by more than 100 basis points of temporary unused capacity charges. Then at the end, let's say the remaining 100 basis points of decline in compared to H1 are due to the full impact of our manufacturing increase input cost as we said many times that we will let's say be very, very let's say visible in the second part the year and the name part of the ramp up of the Agrate 300 millimeter. I would say these are the key ingredients for our dynamic of our gross margin.

Got it. Thank you. Just want to follow up, I was hoping to ask about silicon carbide. Any color you could provide on the JV announcement in China in particular, how much capacity are you expecting to get out of that? And what's your confidence in being able to get enough volumes of 200 millimeter wafers from your partner there? Thank you.

So the capacity at the full buildout will be 10,000 wafer per week 200 millimeter in 2028. The confidence level on 200 millimeter is very high, because, okay, they have a process we know very well. Because this process is similar to our process of Norstel, never forget that we bought Norstel from Sanan. And we know exactly our process, and we know that our equipment, which has been designed for 200 millimeter in Norstel do not represent any specialty difficulties to move 200 millimeter contrary equipment, which has been designed purposely only for 150 millimeter. So now our confidence level is very high. So that's the reason why we have done this deal.

Thank you. I appreciate all that color.

Thank you very much, Josh. So next question please.

Next question is from Lee Simpson from Morgan Stanley. Please go ahead.

Good morning everyone. Thank you for having me. I have a couple of clarification questions. You mentioned that operating expenses are around 8.80 to 8.90. As we look towards the second half, could you clarify any changes in other income? Specifically, I'm interested in how the startup costs associated with Agrate will transition from other income to cost of goods sold, and I assume that adjustment is factored into the overall figure. That's my first question, and I have a quick follow-up.

As I mentioned earlier, for the third quarter, we expect expenses to be between $880 million and $890 million. Expenses in the next quarter, Q4, will be slightly higher due to seasonality. Regarding other income and expenses in Q3, we anticipate a benefit from R&D grants that weren't recognized in the first two quarters of the year, as we needed specific documentation to finalize them. This will be addressed in this quarter. Overall, we expect other income and expenses for the year to be a positive $70 million to $80 million, which is slightly better than my initial guidance at the start of the year. Additionally, the startup costs associated with Agrate 300 will affect other income and expenses, but these costs will gradually transition to manufacturing expenses. As we begin wafer production, these activities will also contribute to our revenue. Initially, the efficiency of the 300mm line may not be optimal, but we expect manufacturing efficiency to improve over the course of next year.

Great. Thank you very much. It’s quite clear. Jean-Marc, I think you were also very clear on some of the rationale around the Sanan JV, particularly as it sort of carries on from the design understanding or the work at least that Norstel would have done prior inside Sanan. But it does seem to just get a little awkwardly with your stated aim to verticalize supply, move more things internally for silicon carbide. And also, it stands out a little bit to me that you've involved yourself in a bit of a tech transfer. Admittedly, it brings in your back-end business quite nicely. But I wonder if you could just maybe talk through a little more broadly the rationale for this JV, particularly from that tech transfer risk and really as it works with your existing strategy for internalization? Thanks.

The technology transfer, okay. I would like to be very clear. This JV is a foundry, and this foundry will work exclusively for ST. So, it's exactly the same model that is still used, okay, of an EVM transferring technology to a foundry for its exclusivity usage. So this is this model, okay? Clearly, so there is absolutely no transfer of IP. There is no license, there is nothing. It's a transfer of manufacturing process in a foundry that will work exclusively for us to address vertically the Chinese market, which is booming. I know there is a common consensus that the electrical cars in China, but as important, the related infrastructure, so loading charges, fast-charging loading charges in residential, then hold the power and energy related to the renewable energy, because of the strong decarbonization in China, all these markets will move in the near future. And it's important for ST to address this market with local production end to end. So, from the wafer epitaxy, wafer processing, wafer sort, assembly, and test. For assembly and test, of course, we will leverage our longstanding JV we have in Shenzhen, called STS, that will assemble and test our product. So, the rationale is point number one, this market will be the fastest growth market in the field of electrification and decarbonization. We want to address locally this market, okay, end-to-end. So, that's the reason why with this well-known partner Sanan, we have set up a JV working as a foundry exclusively for us. And we will transfer our production process, not IP that will be processed for us and assembled in our factories.

Yes, that was a great response. Thanks for much.

Thank you. So next question, please, Moira.

The last question is from Didier Scemama from Bank of America. Please go ahead.

Thank you very much. I wanted to revisit a question that was asked earlier. Lorenzo, you mentioned during the last earnings call that we would see a 300 basis points gross margin contraction year-over-year in the second half, which includes 100 basis points from pricing pressure, 100 basis points from input costs, and 100 basis points from underloading of the fab. Could you clarify what the new components are for the gross margin in the second half? Additionally, related to that question, was there a scenario where the gross margin for the first half of 2024 could actually be lower than the second half of this year? I have a follow-up as well. Thank you.

But in terms of dynamic of the gross margin, I would say that you see that our indication for the year is now let's say exceeding the 48% gross margin. That means that today, let's say, in terms of impact of pricing, we don't see any significant, let's say, impact. As we were saying before, let's say, also from market this was the dynamic we have seen in Q3 and Q2 moving forward. So at the end, I would say that as I was saying before, the second half of the year will be mainly impacted by two components, let's say, the first one is they are loading charges that this is clearly something that is driven by the fact that we wanted to control our inventory and here today the visibility is that this impact will be slightly above the 100 basis point. The remaining is mainly impacted by the impact of manufacturing efficiency and this impact of the $300 millimeter mix price or the other substantially offset each other. So, at the end, these are the main drivers that today visibility is giving to us.

Well, this is clearly the baseline, the solid baseline we have in our arena, so 48% it is what I communicated in April as well. And this is totally consistent with our trajectory to reach 50% gross margin associated with our $20 billion plus revenue ambition in 2025, 2027.

So, 48% is the baseline going forward. Interesting. I wondered if you could give us an update also on Agrate 300 millimeter ramp and on Catania, silicon carbide and what I mean by that is can you give us a sense of the timeline through which those fabs individually will contribute to gross margin positively. If that's the second half of next year or if it’s further out? Thank you.

So on silicon carbide, first of all, in Catania in Singapore, we are increasing continuously our capacity. And I repeat this year, okay, we will deliver about $1.2 billion revenue and we have the ambition to be at $2 billion in 2025. So, this is already contributing, let's say, to our operating margin, okay, because it's MOSFET. Never forget that the MOSFET and not the gross margin of ICU or digital IC. Okay, the internal supply, we target to have 40% internal supply more as a run rate, it will happen end of 2024 and will let's say significantly impact our cost starting 2025. For Agrate, we are sticking to our plan. We have an installed capacity of about 1000 wafers per week, which is connected to our unique tool. We have qualified our pathfinder technology, which is very similar to coal, and we are beginning the ramp-up. Our goal with this 1000 wafers per week is to achieve our target by the end of 2025.

We think that at the end already in the second part of next year, Agrate will start to contribute.

To the gross margin.

Just a quick follow-up if I may. Regarding the Sanan joint venture, there seems to be a concern about the track record of Western companies in joint ventures in China. There are issues such as cash being trapped in the country and difficulties in recovering costs related to intellectual property if problems arise. What kind of assurances can you provide that this venture will not lead to negative outcomes for ST and its shareholders?

First of all, I'll be straightforward. We have a joint venture in China that has been operational for over 30 years. Our assembly and test facility is one of the best in the world. It consistently meets our expectations, and we have never encountered any significant problems. They demonstrated remarkable resilience during the COVID period. So, we draw from this experience. As for the financial aspect, Lorenzo, you...

We are not overly concerned because, as Jean-Marc mentioned, we have the experience to manage these situations effectively. We know how to avoid issues related to repatriating cash. We have been operating in China with our joint venture for over 30 years, and currently, we are not encountering any problems with it. I believe we will be able to manage similar circumstances in the future due to our experience and the way we have structured our operations, which minimizes major risks in this area.

We have the experience to handle these situations and avoid problems with repatriating cash. We have been working in China with the joint venture for 30 years, and to be honest, we are not currently facing any issues with it. I believe we will be able to manage similarly with other projects since we have the experience. We have structured things in a way that minimizes major risks in this regard.

Very clear. Thank you so much.

Thank you very much. And now we have time for one last question, Moira.

The last question is from Johannes Schalle from Deutsche Bank. Please go ahead.

Yes, good morning. Thanks for taking my question. The first one is on Agrate again I mean, you have a pretty wide range of products and end markets applications you can address with that fab. Can you maybe give us a bit of an update what you are targeting initially for the ramp in the second half of this year, and then obviously more into next year when volumes are starting which kind of products, which kind of end markets? And then as a second question, not just one of your competitors has talked a bit more about gallium nitride in the first half of this year. There were a few others making comments as well. Can you just give us a bit of an update on your strategy and on your roadmap on the GaN side here and which end applications you think are the most interesting for ST? Thank you.

So, Agrate submission is a mix around Analog. Analog with either Analog with digital content to address, let’s say, personal electronics and computer and communication. This main advantage is to let's say structurally long-term volume, important volume. Of course, the short-term is a bit challenging, but structurally, this is what we want. And then as a complementary mission of Agrate is Analog for Automotive and Industrial. So at the end, we want our strategy is to build an Agrate capable to address basically the four verticals we had asked, in order to warranty a long-term sustainable and stable loading. So, first of course, we start with consumer and Personal Electronics because we go very fast in the qualification. You know that for Automotive, it's taken more time and it is followed by industry. So this is a mix of what the fab will manage. Analog, with digital content and or with more power content to address Automotive and Industrial.

Thank you. And then for GaN?

We believe that the successful leaders in the power energy sector are those companies that can manage a diverse range of technologies. This includes everything from low-voltage and high-voltage MOSFETs, integrated power, IGBTs, GaN MOSFETs, to silicon carbide and modules. This is the foundation of our strategy. We have quickly initiated our GaN efforts to target the consumer market, particularly with fast chargers for personal electronics and computers. To accelerate this process, we are leveraging TSMC's technology. We have already established business relationships driven by this technology, enabling fast charging solutions in personal electronics. Concurrently, we are developing GaN MOSFETs for the power and energy market, specifically for inverters. This technology is currently in development as we set up an eight-inch production line, with plans to expand this capability in the future to serve this market extensively. Additionally, we are focusing on two other areas: developing radio frequency products using GaN power this year, based on our own GaN on SiC technology being processed in Catania. The final aspect involves our smart integrated GaN solution, which combines a BCD driver with an advanced controller and GaN MOSFETs. In summary, we have swiftly launched our collaboration with TSMC to penetrate the consumer market with fast chargers while simultaneously developing our own technology to cater to the industrial market with GaN MOSFETs for inverters. We are also integrating this technology with BCD to create a unique smart integrated GaN solution aimed at a variety of industrial applications.

That’s very clear. Thank you, Jean-Marc.

And I think this concludes our call with the last question. Moira, are you aware?

Yes. That was the last question. Would you like to conclude the call then?

Yes, please.

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