STMicroelectronics N.V. Q2 FY2024 Earnings Call

Ladies and gentlemen, welcome to the STMicroelectronics Second Quarter 2024 Earnings Release Conference Call and live webcast. I am Moira, the Chorus Call operator. The conference must not be recorded for publication or broadcast. At this time, it's my pleasure to hand over to Celine Berthier, Group Vice President, Head of Investor Relations. Please go ahead, madam.

Thank you, Moira, and good morning. Thank you all for joining our second quarter 2024 financial results conference call. Hosting the call today is Jean-Marc Chery, ST's President and Chief Executive Officer. Joining Jean-Marc are Lorenzo Grandi, President of Finance, Purchasing, ERM and Resilience and Chief Financial Officer; and Marco Cassis, President Analog Power and Discrete, Maintain Sensors Group and Head of Estimate Electronics Strategy System Research Applications and Innovation Office. You can access this live webcast and the presentation materials on the ST Investor Relations website. A replay will be available soon after the call concludes. This call will include forward-looking statements that involve risk factors that could result in actual outcomes 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 and in ST's most recent regulatory filings for a comprehensive description of these risk factors. I would now like to turn the call over to Jean-Marc, ST President and CEO.

Thank you, Celine. Good morning, everyone, and thank you for joining the ST for our Q2 2024 earnings conference call. Let me begin with some opening comments. Starting with Q2. Second quarter net revenues of $3.23 billion were above the midpoint of our business outlook range, driven by higher revenues in Personal Electronics, partially offset by lower-than-expected revenues in Automotive. Gross margin of 40.1% was in line with expectations. On a year-over-year basis, Q2 net revenues decreased 25.3% mainly driven by a decline in industrial and, to a lesser extent, in Automotive. Gross margin decreased to 40.1% from 49%. Operating margin decreased to 11.6% from 26.5%. And net income decreased 64.8% to $353 million. On a sequential basis, net revenues decreased 6.7%. For the first half of 2024, net revenues decreased 21.9% year-over-year to $6.7 billion, mainly driven by a decrease in the Microcontrollers and Power and Discrete segments. We reported gross margin of 40.9%, operating margin of 13.8% and net income of $865 million. During the quarter, contrary to our prior expectations, customer orders for industrial did not improve and automotive demand declined. For Q3 2024, our third quarter business outlook is for net revenues of about $3.25 million at the midpoint, decreasing 26.7% year-over-year and increasing 0.6% sequentially. Gross margin is expected to be about 38% impacted by about 350 basis points of unused capacity charges. For the full year 2024, overall in Q2, customer order bookings did not materialize as expected. Therefore, we now anticipate a delayed recovery in Industrial and a lower-than-expected increase in Automotive revenues in the second half of the year versus the first half. We will now drive the company based on the plan for full year 2024 revenues in the range of $13.2 billion to $13.7 billion. Within this plan, we expect a gross margin of about 40%. By segment, on a year-over-year basis, Analog product, MEMS and Sensor was down 10%, mainly due to imaging. Power and Discrete products decreased 24.4% with a decline in both Power and Discrete products. Microcontrollers revenues declined 46%, mainly due to general-purpose microcontrollers. And digital ICs and RF products declined 7.6%, with a decrease in ADAS more than offsetting an increase in RF Communications. By end market, Industrial declined by more than 50%, Automotive by about 15%, and Personal Electronics by about 6%. While communication equipment and computer peripheral increased by about 2%. Excluding the impact of the change in product mix in an engaged customer program, Personal Electronics was up about 14%. Year-over-year, sales decreased 14.9% to OEMs and 43.7% to distribution. Overall, Q2 net revenues decreased 6.7% sequentially, with a decline of 4.3% in Analog products, MEMS and Sensors; 8.8% in Power and Discrete products; and 15.7% in Microcontrollers; while digital ICs and RF products increased 8.6%. By end market, Industrial was down about 17% sequentially, Automotive down about 8%, and Personal Electronics down about 5%. While communication equipment and computer peripheral were up about 15%. Gross profit was $1.3 billion, decreasing 38.9% year-over-year. Gross margin decreased to 40.1% compared to 49% in the same quarter last year. The decrease was mainly due to a combination of product mix and sales price, and higher unused capacity charges. Operating margin was 11.6% compared to 26.5% in the year-ago period. All reportable segments were down on a year-over-year basis, with the main decline in Microcontrollers and Power and Discrete. On a year-over-year basis, Q2 net income decreased 64.8% to $353 million compared to $1 billion in the year-ago quarter. Earnings per diluted share decreased 64.2% to $0.138 compared to $1.06. Net cash from operating activities decreased to $702 million versus $1.31 billion in the year-ago quarter. Net CapEx in the second quarter was $528 million compared to $1.07 billion in the year-ago quarter. Free cash flow was $159 million compared to $209 million in the year-ago quarter. Inventory at the end of the second quarter was $2.81 billion compared to $3.05 billion in the year-ago quarter. Days sales of inventory at quarter-end were 130 days compared to 122 days in the previous quarter and 126 days in the year-ago quarter. During the second quarter, ST paid $73 million of cash dividends to stockholders, and we executed an $88 million share buyback completing our $1.04 billion share repurchase program launched in 2021. On June 21, 2024, ST announced the launch of a new share buyback plan totaling up to $1.1 billion to be executed within a 3-year period. ST's net financial position of $3.2 billion as of June 29, 2024, reflected total liquidity of $6.29 billion and total financial debt of $3.09 billion. I will now go through a short update on some of our strategic focus areas. As mentioned, contrary to our prior expectation, we saw a decline in automotive demand during the quarter. This was characterized by some reduction in backlog already in Q2 and reduced forecast from some of our customers, including adjustments related to electric vehicle production decreases and inventory adjustments along the supply chain. We continue to execute our strategy supporting car electrification during the quarter. We had multiple wins in Power Discrete with both silicon carbide and IGBT technologies for traction inverters at leading car manufacturers. We also won business with our automotive smart power technology for power domain control in new electrical and electronic architectures. We announced a long-term silicon carbide supply agreement with Geely Auto for silicon carbide power devices in their battery for electric vehicles. We have also established a joint lab to share knowledge and explore innovative solutions related to evolving automotive architectures. In car digitalization, we saw further momentum with our portfolio of Automotive Microcontrollers. This includes wins with our later-generation Stellar MCUs in body domain application with a leading European carmaker, as well as other MCU wins for battery management and HVAC systems. In automotive sensors, we introduced a 6-axis module that enables a cost-effective solution for functional safety applications, such as precise positioning and navigation systems and digitally stabilizing cameras, LiDARs, and radars. Our design win activity in smart mobility highlights the robustness of our technology and product portfolio positioning ST to leverage the structural growth of this key market. In Industrial, during the quarter, the anticipated stabilization of demand did not materialize as expected, and customer orders did not improve. In particular, for general-purpose microcontrollers. We continue to see weakness in the market for short-cycle businesses such as power tools, residential solar, lighting, and appliances, and more resilience in longer-cycle businesses, such as energy storage, grid, electric vehicle charging, and process automation. This has resulted in entering the second half with a weaker backlog than expected. In the short term, we are facing a longer and more pronounced correction in Industrial than what we anticipated due to a progressive weakening of end demand amplified by a severe inventory correction along the industrial market value chain. With this environment, we continue to work with our customers to design in our products of today and to invest in R&D to build the next generation of products. A good example is what we are doing to build on our leading position in Industrial orbital processing solutions. ST was present at the Handrail or the Network show in Germany, where over 5,000 people visited our booth. There, we received very positive customer feedback on the new products and solutions we announced shortly before, including low-cost wireless and high-performance microcontrollers, as well as new 64-bit microprocessors for industrial applications. We also announced an innovative smart sensor with edge AI processing for motion tracking in industrial and robotics applications. We also introduced the first embedded SIM in the industry to meet the incoming GSMA standard for ECM IoT deployment. This simplifies the management of large numbers of connected devices in support of the proliferation of secure cloud-connected autonomous things. Finally, we also continue to build momentum on edge AI enablement for our customers. In early June, the STAI suite came online, bringing together tools, software, and knowledge to simplify and accelerate edge AI application development. The platform supports both optimization and deployment of machine learning algorithms, starting from data connection to final deployment on hardware, streamlining the workflow for different end users. We are confident that our ongoing design in and development efforts with customers and distributors in the industrial sector will position ST to capitalize on the net market upcycle more effectively. In Personal Electronics, communication equipment, and computer peripherals, our engaged customer programs are running as expected. Moving now to manufacturing. In May, we announced a strategic update with the construction of a new high-volume 200-million carbide manufacturing facility in Catania, Italy. This facility will make power devices and modules and will include both device manufacturing and testing and packaging in conjunction with a silicon carbide substrate manufacturing facility being prepared on the same site. These facilities will collectively form ST's silicon carbide campus. This development will fulfill our vision of a fully vertically integrated manufacturing hub for the mass production of silicon carbide devices, all within a single location. The program is projected to be a EUR 5 billion multiyear investment, including EUR 2 billion support provided by the State of Italy in the framework of the European Union Chips Act. During the quarter, we also announced the expansion of the existing multiyear 150-millimeter silicon carbide substrate, wafer supply agreement with Cecrisa. Now let's move to our third quarter 2024 financial outlook and our plans for the full year 2024. For Q3, we expect net revenues of about $3.25 billion at the midpoint, representing a year-over-year decline of 26.7% and a sequential growth of 0.6%. Q3 gross margin is expected to be about 38% at the midpoint, impacted by about 350 basis points of unused capacity charges. For 2024, entering the second half with our current Q3 and year-end backlog and with ongoing market dynamics, we have further revised our plan for 2024 revenues, which we now see in the range of $13.2 billion to $13.7 billion representing a decline of about 22% at the midpoint compared to 2023. Within this plan, we expect a gross margin of about 40%, impacted about 270 basis points of unused capacity charges at the midpoint of our 2024 full-year indication. To conclude, following an unprecedented chips shortage situation, the current semiconductor cycle is impacted by a number of factors: desynchronization between the various end markets in terms of demand normalization or weakening and inventory adjustments or corrections; the available capacity, moving from tension to excess; and the nonlinear acceleration of structural trends towards sustainability in areas like renewable energies, electrification of mobility, right to repair and second-hand devices. This backdrop clearly affects the Automotive and Industrial end markets. As we have pointed out in our strategy, both of these markets are undergoing a deep transformation, also driven by a number of megatrends. This, coupled with the current cycle dynamics I have just mentioned, is bringing both opportunities and challenges in the short, medium, and longer term for ST and for our customers equally. In the short to medium term, we are working to best adapt our operating plans to this complex situation. We have already implemented measures and are exiting them in response to the evolving situation. Medium to long term, we continue to be convinced that this transformation will provide the basis for our growth ambition. We will be hosting a Capital Markets Day on November 20 in Paris, to provide an update. It will be an in-person event, and we will also webcast it live. Thank you, and we are now ready to answer your questions.

The first question is from Jerome Ramel from BNP Paribas.

One question, Jean-Marc, you mentioned on the gross margin, the impact of the underloading cost but also a little bit of price. Could you update us on the pricing environment globally speaking and specifically for Industrial and Automotive?

Jerome, I will let Lorenzo comment at this point.

Good morning. Good morning, everybody, Jerome. In terms of I would say that is consistent with what we have said last quarter. We don't see, at this stage, let's say, significant differences in the price environment. Of course, it's different than last year. Now what we see is that there is some pressure on the pricing. But overall, for the company, it remains at the low single digit. There is some difference between the market; it is higher, let's say, in Industrial, definitely, is higher, especially when we look at our product line of Microcontrollers. Here, we are more in the mid-single-digit. While when we look at Automotive, it remains, let's say, at the low single digit. There is no particular, as I said before, difference in respect to what we were expecting last quarter.

And maybe a quick follow-up. Jean-Marc, you said on the short term, there's some overcapacity for the industry and for you? How are you addressing it in terms of CapEx and maybe a ramp-up of the different manufacturing like you had in mind?

We are adjusting the working hours of our manufacturing already in Q3 definitively and it will follow in Q4. That's the reason why we have actually revised down our sales and operating plan. We have immediately adjusted this activity. And of course, we are cutting all discretionary costs. And as I mentioned already, we have put the company on a higher increase; this is a conjunctural measure. Now, what is important for us is to focus on coming back to the run rate of revenue we had last year.

If I may add, Jean-Marc, regarding the CapEx, we confirm that we will spend between $2 billion and $5 billion this year. This investment mainly supports our transition to the 12-inch wafers and silicon carbide; we have a plan to accelerate our conversion of silicon carbide from 150-millimeter to 200-millimeter. These are the primary projects included in this CapEx of 2.5 billion, and they are confirmed.

Thank you very much, Jerome. Next question please, Moira.

The next question is from Francois Bouvignies from UBS.

My first question is about the general purpose of industrial and microcontroller sectors. Clearly, there has been a significant decline, and I believe we're witnessing some destocking. However, there are discussions in the market suggesting your inventories might be higher compared to two of your peers. When I hear from companies like Microchip and TI, they indicate they have already handled the worst and are actively managing their channel inventories. So, I’m curious to know why your industrial downturn seems to have occurred later and appears to be sharper compared to others. Do you agree with the suggestion that your inventory levels are higher relative to your peers, and could this account for the more significant decline? Furthermore, how do you see the situation developing for the rest of the year? How long do you expect this understocking to continue? That would be my first question.

Thank you. I won't comment on comparisons with our competitors. First, TI has a different marketing strategy and holds more inventory. Regarding microchip, I encourage you to look closely at the numbers. As for the other competitor, I won't provide any comments. We have the most extensive product range for microcontrollers and serve all global regions. As I mentioned, we cater to both short-cycle and long-cycle businesses. The demand in the short-cycle market fluctuated significantly in the recent quarter due to various factors, and the inventory situation does not only involve our distribution channels and EMS, but also extends to the value chain at system makers and end customers. This is why it has taken longer for us compared to others to address the excess inventory at the end customers and system makers. Currently, there is still some surplus inventory among distributors and EMS. This segment faced the toughest challenges during the semiconductor shortage, impacted by demands from car manufacturers, Tier 1 suppliers, and major industrial players in energy and power conversion. Consequently, when we began allocating our capacity, we negotiated guaranteed volumes and non-cancelable orders. Thus, until March 2023, we fulfilled shipments based on their backlogs, which were limited since their end markets were already declining. This led to continued inventory accumulation. After we lifted the non-cancelable order policy, we implemented a new approach and began to reduce our production output, but this process will take time. It's not just an inventory correction; it's a real economic challenge for this short-cycle business. Conversely, we anticipate a more favorable outlook for our long-cycle business, especially in renewable energy, mobility electrification, and charging stations, which also had some inventory, but we expect growth to resume starting in Q4. The reason ST has a longer recovery profile is due to our significant exposure to general-purpose microcontrollers and our extensive portfolio. The non-cancelable policy from '22 to '23 contributed to increased inventory that we now need to manage. Unfortunately, in '24, this business faces demand challenges, which is why the recovery is taking longer. Overall, our behavior mirrors that of our competitors, who also have similar recovery profiles for this year.

Right. And maybe my follow-up, if I may, is on the Automotive. You mentioned that it weakened. I mean maybe you could explain a bit in detail what exactly is happening in terms of Automotive? And if you could remind us what you expect for Automotive and Industrial for the full year? What your full year vision would be great. And I will leave it there.

On Automotive, there are, let's say, three points. The first point, let's classify on legacy. On legacy starting in May, we have seen our main Tier 1s, let's say, pulling out the consignment stock, fewer pieces because you know the Tier 1 now, they came back with carmakers with 2-week call-off. So they have a very short-term visibility. Starting at the end of May, it began for us to pull out from our consignment stock fewer pieces. So as a consequence, they can sell some frame orders. So already in Q2, we have been impacted about less revenue than the forecast that was based on backlog, about $100 million is point number one. The second point, still on this legacy business and, let's say, usual application in the automotive. They have declined, okay, their forecast for H2. So that's the reason why we have been obliged to revise down the forecast for automotive legacy already impacted in Q2 about, let's say, $100 million and about $350 million to $400 million for H2. The third point is the growth for what is related to electric vehicles. We will grow in H2 all of our components related to electric vehicles but less than forecasted. You know why? Because the production of electric vehicles in the world has been adjusted now below EUR 13 million of cars. However, I confirm that H2 will be a growth driver for ST for all the components related to electric vehicles, particularly for silicon carbide and particularly everywhere in China and also with our main customer. That's the reason why we confirm our silicon carbide revenue about $1.3 billion this year. Well, then the third element is what we already mentioned, that there is a little bit, let's say, increasing. You know that last year, one of our main customers for ADAS built a certain level of inventory and is adjusting in Q3 a little bit more the inventory with us. So all in all, the Automotive for us will grow in H2. I have to say versus about H1 $100 million with growth on electric vehicles with silicon carbide offset by the adjustment of the legacy from our Tier 1 and some inventory adjustments from our main customer in ADAS. So this is what we face in H2 in Automotive.

Thank you. The next question, Moira.

The next question is from Stephane Houri from ODDO.

I have a question about your primary customer and the Engage customer program. Can you provide some insights on your expectations for the second half? There has been talk about improving volumes for smartphones and some potential content gains. If you could clarify that for us, it would be helpful.

You have already seen the impact in Q2 because we slightly exceeded the midpoint of our revenue guidance. This was due to Personal Electronics and our main customer. However, this was offset by Automotive. In Q3, we have a solid forecast for them, and as usual, Q3 is the biggest quarter. In Q4, we anticipate a decline compared to Q3. Nevertheless, the plans we received from them are now stable. Regarding the semiconductor content for ST, I want to reiterate that the second half of this year and the first half of next year will mark the lowest point for ST content with our main customer. This is mainly due to the loss of the optical module. However, I can confirm that starting in the second half of 2025, the ST content in our devices for our main customer will increase because we are providing subsidies.

Okay. And maybe a clarification on what you said earlier about the costs at the moment where you are now? Are you saying that you're going to limit the expansion of R&D and maybe cut a little bit of the SG&A going forward?

Today, on R&D, we don't cut our R&D programs because all these programs are engaged and completely consistent with our strategy. Still, we have already cleaned and disengaged a product line we want to disengage, let's say, many years ago. So all the programs are strictly under control and executed, okay, under the decision of the Executive Committee. So now we continue to execute them. Of course, also, I repeat that from the organization we have put in place early this year, we have already extracted some synergy and productivity that enable our capability to run this R&D program minimizing or stopping any hiring. We just, let's say, focus on hiring on critical profiles of experts. On SG&A, of course, we have put it on very strict control.

The next question is from Sandeep Deshpande from JPMorgan.

I'd like to know about the reduction in your full-year guidance by about $1.5 billion. How is that allocation divided between Automotive and Industrial? You mentioned experiencing some weakness in the automotive market during the quarter. Can you provide a quantification of that weakness? Also, do you anticipate that trend will continue into the current quarter?

The variance in the guidance, specifically the $1 billion difference, is roughly 40% from Automotive and 60% from Industrial. In Q2, Automotive accounted for about $100 million of that, with the remainder expected in H2, primarily from legacy business and partially from the ADAS ASIC. It's important to note that while the silicon carbide segment will progress, it will do so at a slower pace than anticipated. For Industrial, there was no impact in Q2 as our execution aligned with forecasts, but we did not secure bookings for 2024 at the expected levels. This led us to reduce our forecast by approximately $600 million. Additionally, distributor purchase orders have decreased, and based on their feedback, we do not foresee an increase in our purchase orders in Q3. Instead, we plan to further reduce the purchase orders in Q3 to lower inventory at the distribution level, although we anticipate an increase in Q4. In summary, about 40% of the EUR 1 billion adjustment is attributed to Automotive, with approximately $100 million recorded in Q2 and around $600 million related to Industrial due to the lack of orders in Q2 and continued decreases in distributor purchase orders.

Understood. And follow-up question is on Automotive. We are hearing from many automotive companies that they are seeing weakness in the market. So do you think that the orders more than the revenue now; you gave me this new and the revenue will continue to be weak in autos for the next few quarters?

We receive delivery forecasts from Tier 1 suppliers, which take into account the adjustments we've observed in the first quarter and that have been somewhat intensified in the second quarter. Our backlog reflects this situation. The Tier 1 suppliers are currently operating on a two-week call-off from car manufacturers. This is something we need to closely monitor, as it’s a dynamic process involving the orders placed by our customers. The scenario for electric vehicles is different, and adjustments have been made. We believe we will deliver around $1.3 billion ASIC. However, the automotive market is dynamic, primarily influenced by inventory adjustments. Analysts estimate vehicle production around EUR 90 million. If this production estimate holds true, we believe the inventory adjustment will be largely completed. Therefore, our backlog remains significant, but we need to keep a close eye on the evolving situation.

The next question is from Sébastien Sztabowicz from Kepler Cheuvreux.

On the OpEx for Q3 and 2024, how should we model the OpEx in the next 2 quarters? Are you expecting to have some benefit of some specific cost-saving impact? Is the first question.

I can address the operating expenses. As previously mentioned, in our current market environment, we are maintaining strict control over our expenses. For Q2, we expected our operating expenses to be lower than anticipated, which was influenced by challenges we anticipated in the second half. For Q3, we estimate our expenses will be between $905 million and $915 million, indicating our continued focus on cost control. Additionally, we benefited from seasonal vacation impacts, particularly in Europe. Looking at the entire year, we anticipate an increase in other income and expenses compared to last year, projecting around $150 million in positive outcomes. Overall, our expenses this year have seen a modest increase compared to last year.

And for Q4, where do you see the OpEx?

You can make the math then; we will stay substantially flat. There will be some increase in respect, very mild, very mild on the very few percentage points. And overall, you can model something similar to what was the net OpEx of 2023 with a very mild increase in respect to last year.

And in terms of dynamics for Q3, where do you see your revenue trending in Q3 by division or by verticals to understand a little bit the different dynamic to bottom in your flattish, I would say, sequential degrowth for the group.

I come back on the revenue after Lorenzo. But if you buy a market first, so compared to Q2 on Automotive, we expect to grow 4% sequentially. On Industrial, unfortunately, as I said, because of lack of visibility and weaker backlog, we will continue to decrease by 17%. Personal Electronics, we will grow 17%, but this is a seasonality effect and the engaged customer program we have with our main customer. And on communication equipment and computer peripheral, we will decrease by 8%. It's related to the legacy business. We are disengaging progressively. If we move to reportable segment, so Analog, MEMS and Sensor will be flattish, almost flattish at 0.2%. More Power and Discrete will increase 12.9%, driven by silicon carbide MOSFET. Our MCUs in Q3 will slightly increase by 1.3%, but general-purpose will continue to decrease and offsetted by auto MCU and secure MCU. And on digital and radio frequency, it will decrease by 17.8%, but mainly it is related to head of us; it is the destocking of our customers that was partially anticipated. So these are the dynamics by end market and by reportable segments.

As you can see, we are very precise this time.

Is it okay with you, Sébastien?

Yes, that's perfect.

The next question is from Didier Scemama from Bank of America Merrill Lynch.

A few things. First of all, Jean-Marc, I mean it feels to me like this is a downturn similar to what we saw at the turn of the last century. So it's a 2-year downturn. And I think the lesson we learned from that downturn is that we need to be much more aggressive on cost. So 2 questions; a, I know you've said you've sort of implemented a hiring freeze, etc., but what do you think about your CapEx? I know it's unchanged, but is that prudent at this stage to be spending that much more on CapEx and adding still capacity? And I would like to come back to a comment you made at a conference recently where you said you were thinking about upgrading your 6-inch and 8-inch fabs to 300 mm. Should you accelerate that transition given that those fabs, especially those in Europe, perhaps even in Singapore are indirect competition with the CapEx being spent in China? So that's my first question, sort of the fiscal discipline of being more aggressive into next year. And I've got a follow-up.

It is clear that we are facing, let's say, the strongest inventory correction certainly we ever faced since a long time. However, I would like to say and I'd like to mention 2 or 3 points. Well, first of all, we continue to be convinced that even if the case is not completely linear or less smooth than expected, that the transformation that our 2 main markets, Industrial and Automotive, let's say, will provide, okay, really for ST, the basis for our growth ambition. Also, supported by some specific, let's say, initiative. Every time we believe we can win differentiation in the field of Personal Electronics or including in the field of server for AI with the power stage or later on in the optical transfer. So we have our mega trend there. Then we said that we are convinced that, for us, our capability to continuously improve the fundamental value of the company is to convert our activity to 300-millimeter for silicon-based technology. Of course, each time it is a trend that is monetary and to convert to 200 mm the silicon carbide one. That's the reason why this year, okay, we have confirmed the on-gauge CapEx and the engagement we have with some suppliers to go in this direction. Now the third point for us as a priority is to assess the baseline in order to understand at which speed we will come back to 2023 revenues. More then, under the light of these 3 points, it is clear that the acceleration of the conversion, respectively, to 200 mm to 300 mm, acceleration of the 150 to the 200 mm in silicon carbide. In the best train, to minimize our CapEx at the right level is what we are working on. It is what I said when I say we are adjusting our sales and operating plan consistently with what we see. But I repeat, we are convinced that ST will come back on a growth trajectory. We are convinced that we must convert to 300 mm and 200 mm, respectively. This is mandatory. Of course, okay, acknowledging the baseline is the dynamic of the market, we will decide which level of CapEx we have to cautiously expect but maybe accelerating some conversion with all the implications linked to this conversion.

Very good. My second question is about geopolitics. So I think how you're thinking about the world we might enter into next year with sort of 10% tariffs on all products imported into the U.S. I mean, one of your competitors, obviously, is boasting about its domestic U.S. capacity, call it, geopolitically dependable. You've taken the sort of, I would argue, a smart decision to partner with a local Chinese company to build the silicon carbide capacity over there, which I think is very differentiated versus your peers. But what are you thinking about the need to have maybe local capacity also in the U.S., which you don't have at this stage? Or do you think that your Automotive and Industrial customer base is European enough to not warrant really the need to have capacity in the U.S.?

At this stage, we have adopted a manufacturing strategy that considers your points. Specifically, we are building an ecosystem in China that is as independent as possible along the value chain, including everything from raw materials to device wafer processing, wafer sorting, testing, and application labs, as well as a design center. We believe that our manufacturing facilities in Europe and other reliable locations for America are adequate to manage this decoupling. However, we remain open to partnerships in manufacturing arrangements. For instance, we have a model with GF in Agrate and Mr. Witorgas. Currently, there are no concrete plans, but we are flexible regarding this model. I can confirm that we do not intend to establish a facility from scratch in the U.S., primarily because we do not have the capacity to do so. We have ongoing projects, such as the campus in Catania, and we continue to develop our capabilities in China. Therefore, we do not plan to invest in infrastructure in the U.S.

Okay. Sorry. And just one quick one. That's pretty helpful. I think you had floated the idea that M&A went back on the table. Any more update on that?

We are working actively on the right target.

We have time for a very last question, Moira.

The next question is from Josh Buchalter from TD Cowan.

Last quarter, you provided details about having two months of channel inventory that needed to be reduced, which was above target. Much of this inventory is held by EMS and OEMs. Could you update us on the current levels as we enter this quarter? Additionally, with the 17% decline in Industrial guidance for the third quarter, does the outlook for the rest of the year assume that channel inventory will return to normal during this quarter?

Maybe I can take this question. During the second quarter, when we look at the distribution evolution, we see that the POS were not improving. In general, they were not improving. We have seen some areas a little bit better, but in general, not improved. So at the end, through that, we were shipping less to distribution, and this is visible in the result, especially when we look at the Industrial. But when we look at the level of inventory, when we look at the situation of the inventory, I would say that it is similar to the one exiting Q1. So I would say that still, we don't see significant improvement in this respect, especially because, let's say, the POS is not improving. Probably, let's say, we will see some mild improvement in Q3. Our expectation is to start to see some more material improvement moving inside Q4. But for the time being, the situation of the inventory remains, as we would say, not particularly on the positive side on the improvement in respect to the one that we'll have exiting Q1. But for what concerns, the inventory in our balance sheet, I can tell you that today, you see we are in the range of 130 days; it will be most likely in Q3. Similar at the end of Q3, we do not expect strong improvement during this quarter, notwithstanding the unused and the level of production has been reduced, while we will start to see the benefit in Q4. In Q4, we expect a decrease in the range of least base average days in respect to where we stand today.

For my follow-up, I wanted to ask about gross margins. So down like 200 basis points in the third quarter guidance, but I believe it implies that you basically improve another 200 basis points in the fourth quarter. Anything with mix that we should be aware of? Or is that all just utilization rates coming back up that's in your assumption sort of for gross margin improvement in the fourth quarter?

In the fourth quarter, the main driver of the improvement of our gross margin in our model is mainly coming from the mix. Of course, we do not expect to have a significant positive impact in pricing. As you know, we are not modeling any improvement in the price environment. We expect prices to stabilize in the range of low single-digit decline. There is a mix that is improving. There will be also the level of unloading. This quarter, in Q3, loading is hitting our gross margin by 350 basis points. It will remain a material also in Q4 but declining in respect to the one in Q3. So these 2 components are the main ones that make us model the Q4 as an improvement in respect to the current quarter, Q3. Moving back the year, let's say, close to 40%.

Thank you very much. This was the last question.

That was the last question. I would like now to turn the conference back over to Ms. Berthier for closing remarks.

I think this is ending our call for this quarter. Thank you very much, all of you for being there and we remain here at your disposal should you need any follow-up questions. Sorry for the ones that didn't have time to ask a question. Thank you very much.

Thank you.

Thank you. Bye.

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.