意法半導體 (STM) 2003 Q2 法說會逐字稿

Good morning.

My name is Melissa and I will be your conference facilitator.

At this time, I would like to welcome everyone to the S. T. Microelectronics second quarter 2003 conference call.

All lines have been placed on mute to prevent any background noise.

After the speaker's remarks, there will be a question and answer period.

If you would like to ask your question during this time, simply press star than the number one on your telephone keypad.

If you would like to withdraw your question, press star then the number two.

I would now like to turn the call over to Mr. Stan March with S. T. Microelectronics.

Sir, you may begin.

Thank you Melissa.

Hello ladies and gentlemen.

Thank you for joining us today for the S. T. Microelectronics second quarter 2003 conference call to discuss the Company's operating and financial performance.

Hosting the call today will be Pasquale Pistorio, President and Chief Executive Officer of S. T. Microelectronics.

Joining Pasquali (ph) here in Milan today are Orlan Dutay (ph), Corporate Vice President responsible for strategy, Aldo Romano (ph), Corporate Vice President responsible for the telecommunications (INAUDIBLE) and automotive groups, Belive Jear (ph), Corporate Vice President and General Manager of the Consumer Microcontroller Groups, General Manager the memory products groups and Carlo Bozotti (ph), our Chief Financial Officer.

As an important remainder before we start the call, some of the statements today that we'll be making our forward-looking and as so, are subject to the risk factors which were identified and listed in today's press release, and also available in more detail in the most recently filed 20 F. I'd now like to turn the call over to Mr. Pistorio (ph).

Pasquale?

Thank you Stan(ph), and good morning and good afternoon ladies and gentlemen.

And thank you for participating in today's call.

I will review the key elements that contributed to our second quarter results, go over where we stand for the first half of 2003 and discuss our outlook and plans for the upcoming quarter.

Then my colleagues and I will take your questions.

We are pleased that our Q2 revenue performance was in line with the guidance we provided three months ago at the time of our Q1 release, which we believe speaks to the competitive advantage that S. T. enjoys thanks to our emphasis on the (INAUDIBLE) products and the strength of our strategic customer alliances.

In fact, at a little over $1.7 billion, Q2 revenues came just at the midrange of our guidance.

Although of course we could have welcomed some upside surprises, the (INAUDIBLE) dampening effect on many business, including ours.

So on an overall basis, we are pleased with the sequential and year over year revenue increases of 5.2 percent and 11.2 percent respectively that were achieved in Q2.

As anticipated, the sequential pickup in demand came from wireless, printers, (INAUDIBLE) box and certain automotive applications.

As you know, convergences (ph) arrived and it is increasingly more difficult to assign a customer application for a precise market segment.

With the (INAUDIBLE) the volumes in the absolute dollar amount could be from 5 percent to 10 percent, we can tell you that on a sequential basis, Telecom was up nine percent, consumer over 6 percent, industrial and other, which includes (INAUDIBLE) increased about 8 percent.

Automotive was up over 3 percent and computer was down about 2 percent sequentially.

Last year, memory revenues rebounded by almost 10 percent sequentially despite continued price declines and discrete revenues increased 11.5 percent from the first quarter.

Gross profit then of 6 or $7 million represented the sequential increase of the 7.2 percent, equating to a gross margin of 35.7 percent, which was at the low end of our guidance range.

Several factors restrained our ability to quickly (ph) expand the gross margin in Q2.

The most significant of this was the short-term effect of the continued erosion of the U.S. dollar.

From Q1 03 to Q2 03 the dollar lost another 5 percent on average versus the euro and also 10 other currencies, which on a net basis, cost us about 50 basis points of gross margin.

Additionally, difficult industry conditions persisted with excess capacity resulting in continued pricing pressure.

(INAUDIBLE) Euro versus the U.S. dollar had a substantial negative effect on our reported operating expenses, the majority which are Europe denominated.

At the same time, we moved ahead with continued investments in R&D, the integration of our recent acquisitions and the implementation of marketing initiatives and expanding our customer base.

Thus operating income, net income and EPS were flat on a sequential basis.

For the first half of 2003, our 16 percent year over year revenue increase compares favorably with estimates for the industry of about 12 percent of growth and puts us in line with projections for our serve (ph) of the market.

As you know, several industry rankings based on 2002 revenues placed S. T. in leadership positions in our targets of the market segment, and we believe we have retained those positions in the 2003 first half.

I believe (INAUDIBLE) that underlying our commitment to innovation we added approximately 1000 R&D and design engineers over the last 12 months.

Our balance sheet remains strong, with cash and marketable securities of $2 billion.

Long-term debt was reduced by two bond buybacks and stood at 2.3 billion at the end of the first half.

The Company's net financial position was -$479 million.

Shareholders equity was nearly $7.5 billion, giving us a very modest debt (INAUDIBLE) ratio of 0.06.

The sequential increase in inventories in Q2 resulted primarily from the liberated buildup of assorted products to avoid any disruption in shipments that could have resulted from the SARS epidemic.

The other contributing factor was the further strengthening of the euro versus the U.S. dollar.

Net cash from operating activities was $776 million for the first half, and free cash flow was $54 million after payments for positions of about $140 million.

Capital expenditures were $498 million in the second quarter, bringing the first half cap ex spending to $554 million, and this is basically in line with our 2003 cap ex projection of approximately $1 billion, about 60 percent of which is allocated to leading-edge technologies and strategic guarantee programs.

With respect to our outlook of Q3, we provided a guidance range for revenues of between $1 billion 700 million and $1 billion 780 million.

This reflects the fact that while demand from (INAUDIBLE) markets is progressing, pricing pressures remains strong due to continued industry (INAUDIBLE) capacity.

And there are still a few signs of a global economic recovery.

Within this environment, we anticipate that Q3 revenue performance will be flat to about 5 percent above Q2 levels and from 3 percent to 8 percent ahead of last year's third quarter.

We expect to see relative strength in Q3 from applications including the Telecom, set up (ph) boxes, smart cards, automotive and mobile (ph) applications.

As stated in our earnings release, inventory (INAUDIBLE) will be a (INAUDIBLE).

Additionally, the impact of current pricing leads us to anticipate gross margin of approximately 35 percent.

For the full year, we believe that the industry will grow about 10 percent from 2002 levels.

The pricing situation we see today however, combined with the effect of a strong euro, on our costs of goods sold caused us to lower our target range for Q4 gross margin to be between 36 and 37 percent.

Within the difficult industry environment that has persisted, (INAUDIBLE) 2 1/2 half years, S. T. has distinguished itself by consistently outpacing the average profitability of the industry.

Efforts to increase our profitability levels in 2003 commensurate with our revenue growth however has been hampered by the factors discussed earlier.

To address the situation, we will finalize a plan during the third quarter to increase our manufacturing cost competitiveness by migrating at least one-half of S. T. (INAUDIBLE) production in U.S. and Europe either to finer geometries (INAUDIBLE) or to our 6-inch wafer fiber (ph) in Singapore.

This line, which will include a timetable related independent of restructuring charges as well as manufacturing costs and savings will be announced once it is finalized, which is expected to be no later than when we release our Q3 2003 results in October.

With respect to top line performance, S. T. continues to emphasize building revenues from strategic customers, which accounted for 44.5 percent of our net revenues in the first half of 2003.

At the same time, we see important opportunities to leverage our product portfolio and to expand our market to an even broader customer base.

At this point, we would be pleased to respond to your questions.

At this time, I would like to remind everyone in order to ask a question, please press star then the number one on your telephone keypad.

We'll pause for just a moment to compile the Q&A roster.

Your first question comes from Adam Parker with Sanford Bernstein.

Yes, hi.

A couple of questions here.

Why do you think looking back into Q1, where you pre-released your numbers, that conditions looked worthy of pre-releasing Q1 but not think that, you know, a 9 cent number versus the 12 cent consensus merited prerelease this quarter, given that you probably knew about your operating expenses sometime during the quarter?

By the way, we supplied guidance on our sales and our gross margin.

We have never supplied guidance about our expenses or our EPS earnings.

OK, I'm aware of that, but I think when you think about, you know, what investors might be focusing on, I think the bottom line is certainly something that people look at, and it appears that your operating expenses grew quite substantially.

I guess maybe a different way to ask the question here is, look, this is going to be the third straight year where your operating growth is going to have exceeded your revenue growth.

And I'm just wondering, you know, what -- you talked a little bit about perhaps some restructuring or, you know, what are the goals and targets for expenses here, given that they appear to be, you know, increasing at a rate that's exceeding revenue?

Well, of course if you consider the year 2003, in the year 2003, we have experienced a very strong change in the currency parity.

The euro and related currency to have made very strong upward change versus the dollar and you do not correct those things in a short time.

So it will take time.

Sure, but I mean if you look at 2001 and 2002 and 2003, so sort of a longer-term trend here, your operating expense growth has exceeded your revenue growth in all three of those years.

I think that this is not correct.

Your growth rate, on a growth rate -- year over year growth rate.

Well, first of all, I think that a big change has been in 2003 (INAUDIBLE) 2002, and this is mostly Europe (ph).

There is also another reason.

We have always said, and we continue to say, that we will not cap R&D to accommodate short-term results.

So when the 2003 period, there are two elements that are impacting our operating expenses.

The first one is the euro.

The second one is our determination to continue to accelerate R&D investment.

As I noted, we have added 1000 engineers in the last 12 months for R&D and design, and also to expand our marketing program.

Our portfolio (ph) is very broad.

It's suitable to (INAUDIBLE) customers.

In the past, our main emphasis has been on the top 30 customers and less proactive in the broader customer base.

Now we want to expand this customer base, so we are having a very precise marketing programs, opening the new application centers and Telecom marketing and sales coverage to do that.

So if you look at percentage of sales, in the last quarter R&D stands at 17.5 percent, which is pretty high for our history but is not at all out of line in the present environment.

And our SG&A expenses stands still at 11.2 percent, which is among the best in the industry ...

So you're happy with your operating expenses at these levels?

I am happy with the absolute volume (ph).

I'm not happy on the percentage.

But I don't want to restrain my future by optimizing the percentage in the short-term.

I think in the long-term with the result of the R&D investment, the R&D percentage of sales will go down once the sales rebound at the 15th percent or below, which is what we want, and the expense (INAUDIBLE) SG&A will go down into 10, 10 1/2 percent, which is what we want.

So today (INAUDIBLE) sales but I think will be a mistake to dump them too much for the short-term optimization in a moment that we are pushing the accelerator on innovation and expanding the customer base.

OK, one last question.

Can you help at all with what, you know, depreciation was up -- D&A (ph) was up say 31 million here sequentially.

What's going to happen to depreciation, you know, going forward here in the back half of the year, you know, given what looks to the weak gross margin guidance?

Is there any factor from D&A (ph)?

The depreciation level in Q2 was $400 million, including depreciation amortization.

We expect at the present exchange rate, depreciation to remain the same in Q3 and Q4.

OK, flat with Q2?

Yes.

OK, thanks.

Thank you.

Your next question comes from Matthew Gale with Goldman Sachs.

Good afternoon.

Just a couple of questions here.

First books (ph) on the wireless.

In your wireless business, with Nokia, I guess in the neighborhood of about and 80 percent customer within the wireless area, and please correct me if that number has changed quite a bit.

Company posting nine percent sequential unit growth and noting no real significant inventory in the channel, are we right to assume that for most of the buildup you saw in wireless in the quarter is related to your other 20 percent of your customer base?

And can you go into a bit of detail as far as any particular product types where you're seeing that in?

And then also on the back of recent comments by the likes of TI and Sky Works, that they're also seeing some inventory build in the channel, could you maybe just comment a bit on the overall wireless industry?

Is there a certain areas where you're seeing product buildup, is more focused, and is the customer base more tilted towards the ODM's, where you're seeing the build?

I will make a comment to start and then I will ask Michael Lease (ph) to comment.

First of all, Nokia, as you know, as publicly reported, is our number one customer.

And we are very proud to be associated with Nokia, who keeps continuing gaining market share.

And does indeed (INAUDIBLE) from size and technology, and therefore we are very proud to be associated with them.

Of course, this doesn't mean that we will not push the (INAUDIBLE) with customer base and this is what we are doing.

So also if you can comment, Aldo Romano (ph), the TPA group, is the leading supplier, but everybody else supplies to Nokia because we supplies flash, we supply camera, we supply discrete, we supply (INAUDIBLE) products.

So Alto (ph), if you can comment on the wireless in general.

You also (INAUDIBLE) some question on inventory, which I'm not sure I understood perfectly.

However, the answer is there is no special inventory that has been created outside Nokia customer as you asked before.

But let me make a comment more in general.

It was a good quarter for S. T. in the wireless world.

And if you keep in account the EPA contribution plus the memory contribution, plus the camera and also to some contribution of TSG, we had an excellent growth in a sequential basis, and also on year over year.

Consequently, we grew above the 5 percent and this period is not bad.

And on year over year, the growth has been at 19 percent.

That's just cellular phone application.

So I take the occasion of your question just to remind this data that were not specifically mentioned in our press release.

And the grow, as Pasquale (ph) is saying, is certainly coming from our major customers, but also we are trying to differentiate our revenues with the other.

This effect will be more evident in the rest of the year and next year.

Also, if you correlate our sales to Nokia with the number of phones of Nokia, you need to factor in that in the first part of 2003, we introduced a new product line, the camera that has helped the growth, regardless of the growth in number of phones.

So semiconductor content (ph) is increasing.

OK, but only inventory question, you said there was no special inventory build up outside of Nokia, so you're saying the primary build was Nokia related in order to satisfy ...

With Nokia, but in Nokia, don't -- we don't publishing certainly inventory by -- not by customer, not by segment.

Are you asking inventory (INAUDIBLE) in the industry, that's what you're asking right?

I was asking first primarily if the inventory buildup for S. T. themselves was driven by any dissatisfied Nokia.

And then a follow-up question was how are you seeing the inventory and the industry..

No, no, no, no, no. (INAUDIBLE)

There is no special effect to the mentioned here.

Nothing to mention.

OK, and maybe just one brief question on the consumer business.

I was wondering if Philippe (ph) could perhaps just speak a bit about the competitive situation as he sees it in the major product areas and consumer and how he sees pricing developing over the next two quarters in each of those different product areas.

We continue to see price pressure and there is still (INAUDIBLE) situated in the industry so the more the product is (INAUDIBLE) the more we see price pressure.

So we see it, of course, more on the DVD players and on the setup (ph) box.

We see it more on traditional TVs than on the new digital TV or flat-panel TV, but overall we think consumer, the market, which is for us quite good, we are enjoying good growth in the setup (ph) box.

Both satellite cable and free to air, and it more traditional products like TV.

And the level of business is holding.

Thank you.

Your next question comes from Sumit Dhanda (ph) at Banc of America Securities.

Hi.

On the pricing pressure issue, could you be more specific in terms of either end markets or product segments where you've seen the most pressure?

Well, I would say that it is quite widespread because there is overcapacity.

There is therefore intensive competition to get a socket (ph).

Of course, standard products, multiple (INAUDIBLE) products and to have more competitive environment.

For example, this is the case of a flash.

But we see the pricing pressure spread all over the segment and the products.

OK, thank you.

Your next question comes from John Van Steenburg (ph) with Deutsche Bank.

Yes, good morning gentlemen.

One first question would be on flash.

You saw revenues in flash increasing by about 10 percent despite pricing pressure being slightly above your guidance.

Could you possibly tell us whether this was driven by product mix or by good volumes in the quarter?

I was a combination of significant mix improvement and some volume improvement.

The slight declined was similar to what we had in Q1 and ran between 6 to 7 percent.

This time, there was significant improvement in the mix, in terms of high-end product shipments, and this has definitely contributed to the 10 percent growth I see now.

OK, so the second question I had was in terms of -- I'll have to go back to this pricing pressure.

What I would like to find out is whether your recent pricing negotiations have specifically, for the TPA division, have indicated to you there will be an increasing amount of pricing pressure over the coming six months, which is implied your -- or has pushed your guidance towards gross margins coming down in Q3 and in Q4.

Well, price pressure in our business is always present.

But what TPA is concerned I have to say that I don't have the record number and Carlo, my friend Carlo (INAUDIBLE) can expose to you.

Price pressure is much lower than that.

In effect, in TPA, we have been able up to now to compensate this price pressure with cost reduction programs, and mixed changes.

And in effect, in our profitability, profit and loss -- the manufacturing margin is roughly stable, despite of the overall situation of the market.

Profitability at the end it is above 17 percent, which is not bad, but however compared to one year ago, is a couple of points less.

This difference of two points is only due to additional effort in R&D.

We have to compete with stronger guys here that are locating bigger (ph) for R&D and therefore we have decided to increase our effort to let's say generate the future growth.

So that's the only difference.

The only point that I have to mentioned on TPA and on the price to profitability ratio let's say.

OK.

Thank you very much.

Your next question comes from Turi Swienburg (ph) of U.S.

Bancorp Piper Jaffray.

Good afternoon.

This is actually Jeremy Kwan calling from Turi Swienburg (ph).

Could you talk a little bit about your terms requirement and what it was last quarter?

And what you expect it to be this quarter (INAUDIBLE) guidance range.

Inventory totals you mean?

No, I'm sorry, the turns business.

In the quarter how much turns business is required.

You know, when we started the quarter, you know, in Q2, I think we mentioned that if you take both the firm backlog and the frame backlog, which is what we call (INAUDIBLE) visibility we were covered at about between May 85 and 90 percent.

This quarter is about the same by the way.

So the turns business we had was representing between 10 and 15 percent, but in fact it's more complex than that.

Because you know, we have a lot of frame orders, which can move, so therefore group by group it can be very different.

Most of the turn business is coming on DSG (ph) and a little bit on MPG.

OK.

And turning to Smartcard market, you mentioned that as an area of relative strength for Q3.

Can you just expand a little bit more on your competitive positioning there and what the drivers are for growth.

Yes.

I would say there are two areas which would show good growth in Q3.

The first area is on very high-end products for the SIM card applications for the cellular phone.

In June last quarter, we started to ship the first 128 kB Smartcard in the world.

And this will contribute to sales growth in Q3.

The second area is very significant demand in everything that is related to pay TV, both for European and American markets.

And also, demand in the more traditional banking products is relatively strong.

So we believe that in Q3, there will be good growth in Smartcards.

Thank you very much.

Thank you.

Your next question comes from Didier Scemama (ph) of ABN.

Good afternoon gentlemen.

It's Didier Scemama (ph) from ABN Amro.

I just would like to come back to your guidance for Q4.

I can understand the guidance for gross margin declining because of the inventory buildup that you have to reduce.

Now, you downgraded your gross margin guidance from a range of 38 to 42 to 36/37.

Can you maybe rank in order of importance what was the reason for the change.

Is it a volume shortfall?

Is it pricing pressure?

Is it may be the currency impacting appreciation or is it any mix issue?

Can you maybe talk on that?

And I have a follow-up please.

The first one is the change in currency.

From the moment we gave the guidance of 38 to 40 to now, there is a very strong impact over the euro.

Please consider what I said before, that this change in Q2 versus Q1 has an impact to 50 basis points.

The second one is the delay in the economic recovery, which results in a more pronounced price pressure, and there is no impact on the volume because our (INAUDIBLE) continues to be pretty well situated.

So it's really (INAUDIBLE) by currency exchange and more intense pricing pressure than expected earlier.

OK.

Now, the question -- and maybe it's too early for you to talk about that, but you talk about restructuring your 6 inch capacity in U.S. and in Europe and maybe moving that partly to a Singapore 6 inch and migrating some of the wafers to 8 inch.

I was wondering can you maybe quantify the cost of good level and ideal package level, what could be may be on a yearly basis the impact, the cost savings that you could get (INAUDIBLE)

We will do, once we have a plan.

At this moment, it's a project.

We have launched a project to make a very deep determination and we have to go project by project, fab by fab (ph), discuss with our customers, which have a very strong say in what we can do, and then decide which we will migrate to 8 inch, which we will touch, which when we will not touch.

At that time, we will have an indication.

And as soon as we have the plan finalized, then we will timely inform the market, including the costs associated and the savings resulting.

But at the moment, there is no plan.

OK.

And then if I look at your cap ex, I think you mentioned this morning that your cap ex (INAUDIBLE) could you just reconcile the cap ex going out in '04 compared to your earlier comments that there was a spillover capacity and there was clearly a lack of pricing power.

Yes.

We have to notice however that the over capacity is quite differentiated.

If you look to mature technologies, down to maximum 0.18 Micron, there is plenty of capacity and this is not going to work away anytime soon.

But if you look in final geometries, even 0.18 for spatial like embedded DRAM or embedded flash at 0.18, or going down to 0.13 micron, 0.15, 0.13, then there are -- there's no excess capacity.

Because in the booming (INAUDIBLE) years, the technology that were in volume were maximum 0.18 micron.

So in those areas, there is not enough capacity.

In fact, there is some shortage going to evolve pretty soon.

We are already investing, and we are going to invest in those areas because the next year will be the strong transition in volume to 0.13.

And starting the end of next year, the (INAUDIBLE) weakness will be volume and we have to be ready for that in 2005.

So investment this year and more next year will be aimed at expanding our capacity and 0.15 micron and below.

Right.

And can you may be comment on which products would actually drive (INAUDIBLE) is it in the wireless application processor?

Is it also your CMG business?

Perhaps flash?

Can you maybe give us some color on these points?

You mentioned all the three.

It is the flash, it is the wireless, it is the disk drive, it is on the consumer digital, it is the printer, all the systems chip now, are going to be in 0.15.

We are in a transition phase.

The present generation 0.18, the next generation will be 0.13.

And we are already sampling customers in 0.13.

Right.

So Michael Leeds (ph) may comment about their own products.

And perhaps my very last question, I think you said this morning (INAUDIBLE) that you expect gross margin to go back to about 40 percent in '04.

Should we expect then a very strong improvement in gross margin throughout 2004?

Because I guess this is going to be more, you know, above 40 percent in Q4 '04.

No, no.

We don't know yet because the rebound on the margin is conditioned by two elements.

In one side, the market for capacity being mitigated by very rusty (ph) growth in demand, so related to the economy in general and the increase of demand.

The other one is the migration in finer geometry from the industry in general and ourselves, and then our cost reduction program in manufacturing.

All this is not yet clear when it will happen.

Surely next year sometime, but it's early to call when.

OK.

Thanks very much.

Your next question comes from Manish Goyall (ph) of Neuburger Burman.

Yes, I have several short questions.

Do you expect your internal inventories to decline sequentially in third quarter?

And if you can give us by what magnitude do you expect them to decline.

Yes, this is Carlo Bozotti. (INAUDIBLE) yes we do expect it to regrow, inventory to be reduced in Q3 and in Q4, both quarters sequentially.

We target by the end of the year our turns target in our range of 4.5 to 5 turns.

This is what we may achieve in December, at the end of the Q3 we can achieve a turn in the range of the current 4 to 4.5.

Great.

Could you talk about operating expenses for the second half of the year?

Do you expect the expenses to remain flat at current levels or do you think expenses could rise as your revenues grow sequentially during third and fourth quarter?

The problem in R&D are going to continue.

We are not planning and the reduction in forces.

On the contrary, we are planning to continue (INAUDIBLE) people so for sure, the R&D will increase in absolute dollar in the second month of the year.

And in percent of the sales, it depends on the sales evolution.

In terms of SG&A, we will try to control as much as possible, particularly the G&A (INAUDIBLE) also have determined to expand because we want to expand our customer bases.

So we expect more significant growth in R&D than in SG&A, but we are not going to refrain a few million dollars to damage the future.

So R&D certainly will grow.

Was there any impact of currency on your revenues or most of your product pricing is in dollars?

All our product is denominated in dollars.

Even when we sell in Europe, it takes a few nanoseconds for the customer to realize that we have to adjust the euro price towards the below level, so we are in a situation that the market is driven by the dollar in terms of the pricing.

While our cost structure -- for the customer, it's easy for us to cut the prices.

It's very difficult to cut salaries to our people.

In fact, we don't.

So it takes longer to readjust the cost structure, where the price (INAUDIBLE)

Just my final question is on voice over IP, are you working on voice over IP or -- and today, have you seen any of your sector (INAUDIBLE) customers talking to you to incorporate voice over IP features in the next generation setup boxes (ph)?

Yes, this is Philippe (INAUDIBLE) we've been working on this since maybe more than two years now.

And there was a high expectation to combine voice over IP services with cable setup boxes.

So far, it's in still quite marginal, so we're working on it.

We have solutions we can offer to our cable setup box customers, voice over IP solutions, but we don't see a strong market shift towards this at the stage.

But we are ready.

Thank you very much.

Your next question comes from Antoine Bedel (ph) with CSFB.

Yes, hi.

Could you please give us a bit more detail on this marketing plan to expand the customer base?

And specifically, if you're going towards smaller customers, is there a risk they could be more expensive to serve, and that would put some pressure on your peak margins?

And my second question is you used the forecast 20 percent industry growth for '04, is that still your assumption today?

Well, when we speak to expand the customer base, let's start from the assumption that it's true, then the product portfolio is the same for the big customers, and there is a lot of variety of customers that can export.

So we leverage the big investment we've done in our product portfolio into a larger customer base.

So what we are doing, we are making addition in our sales coverage and in our marketing application sectors.

Indeed, the relative incremental marketing expense (INAUDIBLE) is higher because the revenue per customer you can expect is much less than the bigger customers.

On the other hand, it's incremental revenue on which you don't have to do again the R&D expenditures.

Therefore, the impact on the bottom line is going to be certainly positive.

So any customer there's no particular segment.

It's simply to leverage this.

We have the product portfolio for the digital consumer.

Well, there is many small medium customers that we have not served proactively, but rather reactively.

Now we intend to go look for them actively.

Same for the wireless sector, same for the industrial market.

It's simply trying to growth our customer base, leveraging the investment we've done in our product portfolio.

As far as the market growth next year, this time the industry experts still give a range between 18 and 20 percent growth, and we have no reason to have a different view in that case.

But I think what we need to add on that is that we are not planning our expenses or our cap ex based on 20 percent market growth.

We are just quarter after quarter looking at the visibility our customers are giving us and planning accordingly.

We are not planning expenses.

We were in line with 20 percent of market growth for next year.

Thank you.

Your next question comes from William Conroy with Sanders Morris.

Good afternoon.

Thanks very much.

Just a couple of quick ones.

Pasquale, can you tell us what utilization wound up being in your finance facility?

OK.

Planned utilization ...

Yes, you know -- this is (INAUDIBLE) speaking.

Yes, our plant utilization in Q2 was similar to Q1, a little bit higher in six inch.

So 8 inch was 88 percent, and the six inch was 83 percent.

So overall, it's 84 percent.

I would like to remind you, as always when we talk about utilization, that this is compared to what we call standard line capacity, which is a kind of an ideal case.

So for us, 85 to 90 percent is a good utilization rate.

What we are planning in Q3 is to have some decrease because we want to decrease our inventory.

That is going to be a couple of point decrease, not more.

And what was the use of foundries in the quarter?

What can you say?

Maybe what percentage revenue.

Yes, well, about 6 percent.

And how is pricing from your foundry partners?

Pricing are tabled (ph) to there -- a little bit decreasing.

Of course, you know, everybody loves business.

So (INAUDIBLE) be attractive to get more business.

And lasting, Pasquale, you detailed what the impact of currency was on gross margin.

Can you detail, and maybe I've just missed it, the impact of currency on the operating expenses?

Pueblo (ph)?

Yes, sequentially the dollar exchange rate has impacted expenses by increasing expense at least four percent, and this result on a negative impact on operating income, coupled with the gross margin impact that Pasquali mentioned.

Operating income is negatively affected by at least 150 basis points, 1.5 percent.

Thanks very much.

Your next question comes from Uche Oriji (ph) with J.P. Morgan.

All right, good morning gentlemen.

Can I just ask a question?

If sales guidance was to come in at the low end and inventory turns were to come in at the low end, what is your target absolute reduction in inventory?

You now have the floor (ph).

I think Pueblo (ph)mentioned before that rather than speaking of absolute volume, in order to be disassociated with the sales trend, we prefer to speak of inventory turns.

Our target range of inventory turns at cost, of course, is 4 1/2 to 5 turns.

We are currently around 4.

In Q3, we want to move up in the range of 4 to 4.5 turns.

And in the fourth quarter, we want to go further in the range 4.5 to 5 turns, trying to approach as much as possible the level of 5 turns towards the end of the fourth quarter.

And the other question ...

Our internal target.

Another question (INAUDIBLE) if you were to achieve 4.5 turns and sales were flat, you think you will reduce inventory by as much as $100 million?

OK. (INAUDIBLE)

My apologies.

Looks like -- yes, seems about ...

It makes sense, but please also take into account that the value amount is a factor gained by the exchange rate impact.

Right, I agree. (INAUDIBLE) which is constant exchange rate.

That's constant exchange rate, yes.

Lowering that in this quarter the exchange rate impact affected the volume of our inventory at the end of June compared to the end of March by as much as $50 million.

OK.

All right.

Clear, thanks.

Also say, it will not be necessarily flat. (INAUDIBLE)

5 0.

5 0, OK.

Thank you very much then.

Just a few other questions.

If you were to compare your cost or price per wafer and compare that with the foundries, do you think -- where do you think you are now related to the foundry?

Because in the past, (INAUDIBLE) where you are compared to the foundry.

Right now, are you above or below the foundries on a price per wafer basis?

Well, we don't know the cost of the foundry, first of all.

Well, we know about costs.

Our cost is definitely lower than the price we pay to the foundry.

OK.

We have reason to believe that we are so good at manufacturing that (INAUDIBLE) condition on the size and environment we can be good as any country (ph).

Right.

But again, this is theoretical.

Our internal cost is of course substantially lower over the foundries on the average.

OK.

It seemed like you posted an increase in terms of your foundry risk usage.

I remember it was about 4 to 5 percent last quarter.

Now it's up in 5 to 6 percent.

Where do you think you'll be next quarter?

Is it going to be higher or are you going to reduce the foundry usage because you're working down inventory?

I think some of those observations depend on a given product.

If you (INAUDIBLE) in the foundry, and you're realizing on net you have a particular demand, well, you ask more wafers.

In being so little of the percentage, a little variation can make a significant change.

So (INAUDIBLE) we will be at the same level in Q3.

OK.

And final question is on Nan flush (ph), when you think you'll be able to get into volume production with that?

And you have any way of giving us a sense how to model this, in terms of wafer, wafer out for say per month of a quarter for next year or in terms of number of dyes (ph) produced, if you can just give it a sense what your plans are for nan (ph).

Well, maybe I think it's convenient to start from where we stand today.

The plan is to start sampling our customers in September and of course then we need to designing the products and so I think that we'll start production in Q4 this year for targeting deliveries starting from the beginning of next year.

I think it's premature today to give any guidance on what we expect to manufacture and sell next year in end products.

We are at the moment focusing on (INAUDIBLE) products that is out, and as I said, sampling we'll look for at the end of the third quarter.

OK.

And just on norflush (ph) this time, the 10 percent growth, where would you characterize that you've seen most growth in?

Is it in handsets or is it in sets or boxes?

Well, I would say that we had relatively good performance in Wireless.

Very much driven by mix improvement.

What we defined before as mass market, so our wider range of customers did contribute during the second quarter to the sales performance also.

So I would say mostly Wireless and mass market.

Right, thank you very much.

Thank you.

Your next question comes from Ellen Haven with MSS Investments.

My question's been answered, thank you.

Your next question is from Kirsten Parker with Morgan Stanley.

Hi, I just have a view questions on the flash memory business, if I may, color.

You talk about better density mix.

Are you able to give flash production by geometry and by density first all please?

Then secondly, could you also outlined your expectations for flash memory growth in the third quarter and what the drivers of that will be?

And thirdly, in looking at the profitability of the memory products group, in the first quarter results, you outlined four key factors that would drive that.

Are you still on track to achieve that overall profitability target?

Thanks very much.

Well, I think of course we cannot provide all the details of what we sell in flash.

This is of course confidential, that I think that there is a significant mix improvement planned in what we sell in fresh memory.

And today, more than 50 percent of our product is a 32 Mb and above.

So I think you can (INAUDIBLE) 60 Mb and below and 32 Mb and above, so I think this is where we stand.

I think that this mix improvement trend will continue.

So in Q4 we expect to sell more high-end products, including 128 and we will start selling also 256 Mb, particularly in stacked forms, where we stacked together flash memory products and (INAUDIBLE) or (INAUDIBLE) in the same package.

In terms of profitability, I think that we didn't some improvement in Q2 comparing with Q1, but as you see, it's not yet where we want to be and our target is to be close to breakeven during the third quarter and then a return to profitability in the fourth quarter of this year.

For the group.

I'm talking about the group, of course.

We do not -- as you know, we do not comment on individual product time (ph) release, but the comment is that the group level.

Great.

And I think you've previously stated that you expect the overall memory products group to be profitable for 2003 for the full year.

Does that still hold?

This is increasingly difficult.

It is, I would say, challenging.

Of course, we are striving to do that.

I would say that it's increasingly difficult, but I would say that the improvement (INAUDIBLE) this quarter and our motivation is to continue to improve.

OK, thank you.

And then just the other question was on your expectations for fresh memory growth in the third quarter, what would drive that?

We'll grow, but I think that I saw many of our competitors will not release expected growth for Q3, but we'll grow, we'll grow and there will be another positive step.

OK.

And may I ask one final question and then I'll go way.

In terms of the competitive environment, have you seen it become more aggressive over the past few months in the flash memory business?

Thanks.

The competitive environment.

Oh yes.

This is what we were commenting at the beginning.

I would say with this, we always believe at the group level we had price decline that was in the range of 45 percent.

And for flash, it was around 7 percent, and this is similar to what we had in the first quarter of this year.

I believe that the price special -- the competitive environment will remain there also for the third quarter.

But we need to compensate of course with further mix improvement and volume growth.

OK, thanks very much.

Thank you.

You have a follow-up question from Manish Goyall of Neuburger Burman.

My questions have been answered, thank you.

Thank you.

Your next question comes from Thomas Becker with HSBC.

Yes, thank you for taking my question.

There are only a few left.

When you look at printer, that's a peripheral division, printers and hard disk drives probably you can give a comment there about pricing pressure and then volumes in the last quarter and what you expect for the future.

And then another point is for the new venture group, the loss, where did it come from?

OK, I will answer to data storage and interest (ph).

The performance of these two divisions combined are roughly stable for what the CPA is concerned in Q2 compared to Q1.

However, we have grown, significantly grown on printers, and some decline in data storage, which in my view is mainly due to a seasonal factor.

People working in this environment know that the second quarter is typically the lowest of the year.

So that quarter, I think.

There is also some -- more than price pressure.

You were talking about price pressure.

For me, it's slightly different.

It's technology evolution.

What in the past we've done with -- for example, with two chips remote control (ph) and (INAUDIBLE), today it's done with one single chip.

And typically, the cost of this single chip is not equivalent to the cost and to the price of the previous two devices.

So that's life.

So this technology evolution which brings cost reduction, not a margin decline.

By the way, the data storage is performing extremely well in terms of profitability.

So the cost reduction means price reduction means advantage to all customer means increase of volume.

So at the end of the total market available remains stable, but there are big changes in sight, so big evolution.

Big evolution.

So the price pressure is as always in this segment.

And typically, it's compensated by this cost reduction, thanks to the new technology involved.

So you discovered no price pressure above normal levels?

Yes sir.

It's as high as normal.

OK, and the new venture, new venture group?

Yes, this is Carlos (INAUDIBLE).

I guess your question I'd rather refer to the operating loss we reported other on our press release.

It seems the result of new venture group is at the end a marginal number on the overall.

We posted the 31.8 loss on this other, which is a line that contains miscellaneous items.

Most relevant of that (INAUDIBLE) cost and further strategic research and development programs that are under the corporate guidance.

And this is -- usually you are curious about the stacked up number, so please consider that out of the 31.8 million, 12 million is of course stacked up.

And this stack up costs are mainly related to facilities which is ramping up on track.

OK, and do you expect an equal number for the running quarter?

For the running quarter, we would expect next quarter's this number to slight increase due to higher stack up costs.

OK, thank you very much.

You're very welcome.

Your next question comes from Ingo Queiser (ph) with Bank Julius Caesar.

Yes, good afternoon.

It's from Bank Julius Beier (ph).

Another question on the inventory buildup.

Could you talk about the timing?

When did that exactly happen?

During the last quarter?

Was that particularly towards the end of the quarter?

Or when was it?

No, this started during the quarter.

And by the way, if I well remember, during our field trip meeting, in New York end of May, we have anticipated that company was building up inventory because of the impact of -- anticipating possible impact resulting from SARS.

So the operating impact buildup over the quarter.

The exchange rate, the push of this impact, of course, depends on (INAUDIBLE) the quarter.

So, are inventory levels already on the way down?

Or is it still at let's say peak levels?

You know, we close the month tomorrow and (INAUDIBLE) we may have (INAUDIBLE) on the month, but by the way, we weekly also monitor and look at -- this is something that we prefer to disclose at the end of each quarter.

Right, fair enough.

Then another question on the pricing issue.

We have heard from Nokia that looking forward, their margins are coming under pressure in their mobile phone business.

So have you already felt any increased squeeze from your customer on that side?

The question is if we have seen some additional price pressure.

Not yet, but don't tell it to our customers.

All right then.

This may be happen, but for the time being, not yet.

There's nothing to mention.

All right.

OK, thanks a lot.

Thanks.

Your next question comes from Stephen Frankel of ODO Securities.

Yes, hello.

Thank you.

I just have one question left.

In terms of cost savings you are targeting for you are 6 inch plants (ph), I know it's very early to talk about it, but just to get a sense of it, could you tell us how much of your manufacturing costs are carried by the 6 inch subs (ph) that you are currently studying or how much of your depreciation today represented in order to have another magnitude of what is the cost basis you are targeting.

Well, first of all, please keep in mind that the 6-inch plants (ph) are (INAUDIBLE) so that the next six months (INAUDIBLE) must be at least much bigger than (INAUDIBLE) associated with 6 inch.

Second, it doesn't make any sense at the moment, (INAUDIBLE) to single out anything because we have to select what kind we are going to have, what plants (INAUDIBLE) so I think at this moment it's premature.

We have to look into the situation and then we can have some idea.

We haven't launch the project.

We don't (INAUDIBLE)

OK, thank you.

Just another question about flash memory, do you see some increasing usage of nanotechnology in mobile phones for storing code into a mobile phone instead of data.

Do you see that as a trend that is evolving in the mobile phone industry?

Well, I think we need to keep separated the potential usage of memory cards, as a plug-in memory in the cellular phone that is definitely based on nanotechnology for mass storage.

From the cold storage products that are today all based on normal (ph) technologies, if we look forward, I think that with time they will be a portion of the cellular phone, particularly those phones which would include the multimedia processes for multimedia applications, where there will be the usage also of DRAM, and in association with this, the nan (ph) technology and the nan (ph) products may be utilized also for cold storage applications.

But this is not the case today.

OK, that's it from me, thank you very much.

Thank you.

Your next question comes from John Wallenburgen (ph) with Kempet & Co.

Yes, hello, that afternoon.

I had a question which I might better asked to your economist, Mr. Doven (ph).

He always gives a very interesting split between units and price effects.

For 2003, last May, he said there will be a 15 percent unit growth in 2003 and a 4 percent price erosion effect.

And for next year, it will be around 60 percent, 16 percent in units and 4 percent positive price effects year on year.

Given the level of price pressure right now, how do you think these estimates will change?

Will the level of price pressure in 2003 be more than 4 percent and for next year will there still be a positive pricing effect?

Or will it also be negative?

Thank you.

I can't answer for him.

This is (INAUDIBLE) speaking.

In fact, he has not revised his forecast but today what we think that although this year (INAUDIBLE) 10 to 11 percent growth but probably more volume than more price pressure.

So it's difficult to quantify, but 11 percent will be reached, probably a couple of points more in volume and a couple of points more in the price decrease.

And then for the next year I think the projection he made it is still valuable.

OK.

And a couple of points, you mean a couple of percentage points?

Yes.

A couple of percentage points, yes.

Thank you very much.

Your next question comes from Peter Teste (ph), with One Investment.

Hi, I've a couple of questions, please.

Firstly, just to follow-up on an earlier question on your projection of a greater than 40 percent gross margin next year.

Is it possible to say the degree to which you would say that relies on internal factors such as the reorganization of production you mentioned, as opposed to external factors like a market recovery?

There is -- there must be a contribution of both.

Of course, we would not seek to wait until the market changes.

But of course, the impact will be much stronger if there is also the market healthy.

So we expect, as everybody, that the market next year will be much better.

Alain has just repeated what is the expectation from the growth from the industry.

In this kind of environment, of course, you have a much better pricing impairment.

And the combination with debt and the internal measure should allow us a certain volume next year to go above the threshold of 40 percent.

Do you think the internal activity is strong enough that without much of a market recovery you could get there?

And I'd be interested also as to where you think you're taking action on the margin, the gross margin side, which is say beyond the natural cost adjustment that you guys have to do every year.

The internal measure will be addressing the cost or will be addressing also the (INAUDIBLE) volume mix.

The pressure we are making in R&D expenditure is to accelerate the innovation process.

And this should contribute to a better mix and therefore to a better pricing and therefore to a better gross margin.

So we will act without waiting.

We are acting, we've been acting, without waiting for the market recovery.

But the two things cannot be independent.

I think next year will have both.

But we will do our actions no matter what the market.

OK.

And then just on flash memory, it seems as though an ever-increasing number of the larger players want to get into different aspects of flash memory.

Is your mix evolving fast enough for you to get out of the way successfully and to get your average -- keep your average pricing from deteriorating more than the 7 percent also you mentioned?

Well, today, the price pressure that we experience is not related to a specific portion of the density of the product.

I would say that the price pressure is significant also very high-end products.

And of course, we need to respond, accelerating our efforts in technology R&D and products R&D.

And this is what of course we are trying to do.

During the last few weeks, we have been now working on first engineering samples of (INAUDIBLE) device at 1.8 (INAUDIBLE) with two bits per cell, but of course it's compatible with wireless applications and we expect in Q4 to see our first 1.8 (INAUDIBLE) two bits per cell also in 0.15 micron technology.

So I think that to the price pressure, it's significant on the low-end products.

But it's also important on high-end products.

Some of our competitors are particularly competitive on the high-end products in these weeks.

And I think that we need to respond with the lower manufacturing costs and an acceleration of the R&D effort.

And we have (INAUDIBLE) we expect to have significant reduction in the wafer cost next year in our 8 inch fabs, and stronger -- more rapid migration to the 0.15 and also into the two bits per cell.

OK.

In addition, you also need your customers to be ready to launch higher end to respond to your R&D with product and also absorbs the sufficient volume.

Do you see product launches in volume areas or adaptation of your R&D in flash memory higher value added parts of flash memory in sufficient volume to help you pull the mix as well?

We see most of the new products, most on the new socket, on high-end density and high-end products.

We see most of the new design on stacked configurations, with one or two flash memories in one package and either a static gram (ph) or (INAUDIBLE) in the same package.

So definitely there is a trend towards complexity, both in terms of flash and in terms of combining nonvolatile and volatile memories in the same chip, and in terms of density.

This is a clear trend.

OK.

Thanks.

We have time for one more question from another individual.

So operator, if you could please send us a last question.

Your final question comes from Remi Thomas with Chevreaut (ph).

Thank you very much.

I actually had a couple of questions.

I know it's a bit too early to quantify the cost of the impairment charge and restructuring that you see in your six inch fabs in Europe and the U.S. could We however go back to what you did in Ottawa and Rancho Bernardo (ph) and use that as a matrix or would there the some factors which shows the fact that it's more expensive to lay off people in France and that would make the cost of it higher.

And could you give a rough estimate of what would be a cash charge and what would be just purely accounting?

And secondly, when I look at the profitability of CMG, in spite of a very decent sequentially increase, I see it dropping sequentially by 1.6 percentage points when that of PPA (ph) held up quite well.

Was there a part from the factor that you mentioned in the dollar weakness et cetera reasons that would explain this willingness to gain market share at the expense of margins et cetera?

Well the first part of the question is the cost of impairment or the costs associated with this restructuring or the (INAUDIBLE) associated with that.

The answer is that unfortunately until we have no idea what we will do, we have the idea we must do something, but what, where, how has to be defined by a plan that has to be worked during Q3.

So only when we will have the plan we can address the question, but at the moment, I'm sorry, we have no comments on that.

As far as CMG, I think Philippe can comment.

Yes, CMG has a lot of R&D focused on new applications and maybe CMG will hit more than the others on the impact of the dollar rate on the R&D expenses, while on the price pressure, gross margin and so on, Q2 was in line with I think the big change in -- the big difficulty of Q2 was the dollar rate.

Right, thank you very much.

(INAUDIBLE) cannot make one observation here?

Because we have received a lot of questions on flash, which is usual.

And on other subject, price pressure, as usual.

No question on the best performer, in my view, -- segment, which is automotive.

So what?

It is an important segment.

In absolute terms.

Why don't you ask a question and ...

I feel like (INAUDIBLE)

Moving on to a question (INAUDIBLE)

(INAUDIBLE) automotive market is in the $10 billion range, so it's as big as the cellular phone (INAUDIBLE) market.

And we have -- because you're asking, we have an excellent performance, not so much in sequential but particularly with reference to last year.

If we include also (INAUDIBLE) not only EPA but also the (INAUDIBLE) we had growth which is in the range of 30 percent year on year.

So thanks for the question.

Well, on closing this conference call, I would like to renew my thanks to you, ladies and gentlemen, to have been with us.

I think we are leaving a very challenging time.

There is very competitive environment due to the over-capacity remaining.

However, the recover that started, in our view, in Q1 last year, which was the bottom of the cycle is continuing.

It's continuing and we see service increasing (INAUDIBLE) industry and this will continue to grow.

At a certain point in time with the recovery coming in acceleration, also the pricing impairment will improve.

And S.T is extremely well positioned to capitalize on the accelerated expenditures we are doing right now, in terms of R&D, in terms of marketing efforts.

And our ability to move from system (INAUDIBLE) to system (INAUDIBLE) with a convergence and an entire application platform.

And at the same time, we are looking at ways to improve our cost competitiveness, and we have announced this purpose project that we are going to study.

So the company is committed to remain profitable, to remain in a positive cash generation, and to continue to grow faster than the market as we have been doing in the past, and again, we have done the first half of this year.

Thank you for being with us this afternoon.

This concludes our call.

Thank you.

This concludes today's S. T. Microelectronics second quarter conference call.

You may now disconnect.

END