意法半導體 (STM) 2004 Q2 法說會逐字稿

Good morning, my name is Christie and I will be your conference facilitator. At this time I would like to welcome everyone to the STMicroelectronics Second Quarter 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 a question during that time simply press star then the number one on you telephone keypad. If you would like to withdraw your question press star then the number two on your telephone keypad. At this time I would like to turn the conference over to Mr. Stan March with STMicroelectronics. Sir you may begin.

Thank you Christie. Hello Ladies and gentlemen, thank you for joining us today for the STMicroelectronnics Second Quarter 2004 Conference Call to discuss the company's operating and financial performance.

Hosting the call from Milan today will be Pasquale Pistorio, the President and Chief Executive Officer of STMicroelectronics. Joining Pasquale on the call today are Alain Dutheil, Corporate Vice President responsible for strategy, Aldo Romano, Corporate Vice President responsible for Telecommunications, Peripheral and Automotive Groups Philippe Geyres, Corporate Vice President responsible for the Consumer and Micro Controller groups, Carlo Bozotti, the Corporate Vice President responsible for the Memory products groups, Carlo Ferro, our Chief Financial Officer.

As an important liner before we start the call today, some of the statements that we will make are forward-looking and as such are subject to the risk factors, which are identified and listed in today's press release and also available in our most recently filed 20-F and if I may ask one logistical detail, please limit your questions to one primary and one follow-up out of the courtesy to all the participants on today's call to allow for the maximum participation. I would like to now turn the call over to Mr. Pistorio. Pasquale.

Thank you, Stan. Good morning and good afternoon ladies and gentlemen and thank you for participating in today's conference call. I would review our second quarter results, discuss the Q3 guidance and then my colleagues will rejoin me in responding to your questions. Q2 was a period of solid performance for ST. We significantly increased the profitability, while continuing to invest in technology and product development.

Revenues over 2,172 billion, was a second quarter record before the quarter represented a sequential increase over 7% and 27.6% increase over last years second quarter. Given the pace of all the flows we should have been able to produce higher revenues but our ability to ship to certain products was constrained by short-term testing bottlenecks, which have now been resolved. We also experienced some late quarter order push-outs for hard disk and drive applications. Despite of this follow-up ST revenues for certain customers in Q2, increased into 3.5% sequentially represented the 37.5% of the net revenues.

Applications business and product sales were 1.1 billion dollar for the period or 51.8% of the net revenues. Differentiated the products, accounted for the sales over close to 1.4 billion or 64.4% of Q2 net revenues. As you can see from our earnings' the release, both sequential and year-over-year revenue growth, as well as operating profits were posted by each of our major product groups.

The top performer in terms of the sequential revenue gains was our discrete standard linear group, which also achieved the best operating margin reaching 22% in Q2. This is interesting because as you can imagine the ST's gross margin is below that over the companies overall.

The group's ability to generate significant profits is primarily attributable to two major factors it cost competitiveness on the manufacturing side, and the deliberate migration to the more value added mix products such as (inaudible) power high performance analog and similar products. I believe this is a good illustration over the fundamental strength that ST enjoys as a broad range supplier serving at the prime number of the targeted of the market segments.

Additionally, ST's top line potential has been announced, by our ability to carry home (ph) the portfolios overall, of our major product groups in order to provide a broader range of products and solution for each of our key applications. In wireless, where Wilfred (ph) application specific (inaudible) sort of the products.

Q2 revenues increased 3% sequentially and 28% on a year-over-year basis. This included the effect over sequential increase in sales where application specific ICs. These are the consumer, benefiting from strong demand, as well as seasonal factors was up 16% sequentially and 48% over last year levels. Automotive continued the strong upper trend posting a 9% sequential revenue increase on top of about 10% sequential growth in the first quarter.

And in Q2 automotive sales increased into 25% over 2003 second quarter levels. The major driver of a season strong bottom line improvement in Q2 was our ability to significantly increase the gross margin. With one through the basis point of sequential improvement in gross margin, from 55.4% in Q1 to 57.4% in Q2 was primarily achieved through manufacturing efficiencies resulting from greater volumes and higher utilization rates. Approximately 50 basis points of the sequential gross margin improvement came from a more favorable U.S. dollar Euro exchange rate.

I believe it is important to point out that Q2's gross margin expansion was achieved without the help of inventory build up. In fact at the end of Q2, these inventories increased by only 26 million from the prior quarter's levels. And our inventories advanced from 4.9 times in Q1 to 5 times in Q2, which is (inaudible) stated the target range over 4.5 to 5 times.

The significant operating revenues, that we achieved in Q2 was announced by reduction in combined R&D and SG&A expenses to 28.7% of the net revenues from 29.2% in the prior quarter. Importantly this was compression, while maintaining and accelerated pace of the product development.

In Q2 we were able to bring all of the gross profit increase and more down to the bottom line. Operating income more the double the total Q1 levels and increased 58% on a year-over-year basis. The income increased by 92% sequentially and was 68% above last year's second quarter. And earnings per diluted share doubled to $0.16 from $0.08 in Q1, and were up 78% over last year's $0.09.

We are pleased with the sequential earnings improvement with the profit in Q2. But, as you know, our objective is to significantly increase the profitability by first expanding gross margin and by progressively reducing R&D and SG&A expenses as a percentage of net revenue. And of course, we are fully focused on maintaining market share in our target of markets, which we consider the one of the greatest for longer-term growth potential.

The trends we see are positive. We continue to allocate the significant resources to our strategic customer alliance, in order to anticipate and to respond to their requirements. And at the same time, we are systematically expanding our customer base. In the 2004-second quarter, revenues from customers beyond our traditional top 50, grew 17% sequentially versus the company's comparable growth rate of 7%. On a year-over-year basis, this customer universe increases to 45%. We believe this market offers tremendous growth opportunities for ST, to profitably leverage our silicon and system in all.

Our near term target is to achieve gross margin of at least 40% in Q4 over this year. While Q2 performance in this area exceeded expectations, we recognize that the range of our Q3 gross margin guidance is limited due to certain embedded cost. First, there is to be assumption of a Euro to US dollar rate of 1.23 to 1. And then we have the negative effect of a certain technical problem that occurred at the end of Q2, but which would impact the Q3.

The cost of these two factors combined is about 100 basis points, which will officiate the benefit of one more projection in the sequential revenue increase of 43 over 2% to 8%. As a result the Q3 gross margin is anticipated will be approximately 57.5% give or take 50 basis points. We would have presented a more linear (inaudible). But assuming the Euro to U.S. dollar exchange rate similar to the present one. We remain confident with the respect to the fundamental components of our Q4 gross margin roadmap.

In essence, all of the elements are in place to significantly improve our gross margin performance in Q4. Manufacturing efficiencies, laid by the migration for finer geometries and greater situations of leading age fabs will enhance the profitability of incremental revenue growth. And you said we should have the other benefit of a better mix condition. At the same time, we are committed to achieving total operating leverage by progressive reducing R&D and the SG&A costs in the aggregate is the percentage of net revenues.

We saw some sequential improvement in Q2. We now feel comfortable in saying that we believe that R&D and the SG&A expenses combined thick as a percentage of net revenues in Q1 of this year. Consequently, the existing the current rate we should be showing a continued progress in this area during the remainder of the year. Looking at the longer term the picture, ST stands to benefit in 2005 from a confluence of factors, which are turning in our direction.

The accelerated R&D investments we are making to announce our product portfolio are beginning to translate into important product (inaudible). Our Q2 earnings release contains the section summarizing recent technical news. And my colleagues are present here can greater expand on the wave of a new solutions across from the segments and product families.

I will just point out a few in the telecom market. ST won an important GSM, GPRS platform design in China, and we will start to deliver that in the fourth quarter. We introduced our next generation multi-mode wireless LAN chipset and, we began sampling a single-chip product for hand held terminals that has been certified for Bluetooth qualification. And finally, in addition, the acceptance of other nomadic platform is gaining momentum with several major customers.

This gives you some idea of the direction we are taking and the new opportunities we are actively involved within. Similarly, we have made important strides in our programs to expand our customer base. The numbers today do speak for themselves. We see a continued upward trend in the coming periods.

And the benefits of this positive product and customer development, would be magnified by our progressive move to a more compatible cost of structure. Thus, my colleagues entirely are optimistic about ST's future prospects, and at this point ladies and gentleman we would be pleased to respond to your questions.

Christie? Hello Christie?

If you would like to ask a question please press star and the number one on your telephone key pad. If you would like to withdraw your question press the pound key. We will pause for just a moment to compile the Q&A roster. Our first question is from Nicolai Godwin (ph) at Deutsche Bank.

Yes, hello gentleman first question would be on R&D and SG&A. Would you be kind enough to provide us some element of targets on why you couldn't bring the combined ratio back to sales by the end of this year? And I have got a follow up. Thank you.

OK, I will let Carlo Ferro, our CFO to address on the seasonally short term. But, I would like to say that we are running right now in the range of 29% of the sales to combine the little bit relating to Q2. But I would like to recall that in the peak period of the 2000 that we were in the range of 25%.

Our long-term target is to go back at 25%. I think this will be done by a combined situation of faster sales growth where we continue to spend more in R&D and also in the marketing programs. So the leverage of the sales growth will bring a progressive improvement. For the short term, Carlo would you want to comment

For the short term Pasquale say that we indeed in the second quarter what was expected to start to go in the right direction reducing the effects to save the ratio. For both SG&A and R&D and that we would expect above the Q3 and Q4 to show progress in this direction.

OK, could you if you can just elaborate on that long-term target of 25% would it be achievable by the end of 05' possibly?

Well, depends on the market, because we will not cut R&D expenditure for sure. We intended to continue with a push in our accelerator there on the first seven in order to continue to speed up the introduction in new platforms and finally geometries in advance of the technology etc. We believe the sales of revenue will grow faster but as fast as they will depends on the market. So if we have another explosive year may be but it is difficult predict that right now.

Yes thank you. And just as a follow up if you just be coming off to do again the similar mask you have been dong the you have been doing behind these days in May in terms of gross margin, so let's take your guidance midpoint 47.5% in Q3 assume effects on change and put back the 70 basis points exceptional coming from basically the manufacturing one of issues you had from the corrected level what would be necessary to take us to 40% plus in Q4 in terms of both manufacturing efficiencies, high utilization rate and also make some pricing? Thank you.

OK. Of course Nikolai as you all appreciated that we associated some (inaudible) a comment on the matter without entering in the sale measured of basis points. But substantially what we expected is that first of all Q4 would not repeat and the inconvenience that we have occurred in the third quarter. So, that adjusting by decent conditions we start from a normalized basis, which is somehow we move to 38% if you move from the midpoint of the guidance.

We frankly do not expect major advantage from price. Price may firm out but for sure we do not expect pricing going up except while it is staying in fact from improvement in the mix to benefit our gross margin in the fourth quarter.

On top of that I have anticipated, the most of the improvement came from manufacturing, the shifting of our choosing from low cost area to Asia, the loading of our fab, the migration to 130 nanometers technology. All of them are better place and that may generate what they were 200 basis points or whatever could be in excess of -- to go in excess of 40% on our module.

You also may realize from our press release that our 6-inch initiative did not provide in the second quarter major benefit to the margin, while there are some impact, which is to quantified by the way in the press release that would fall in Q4.

OK, thank you very much Carlo.

You are welcome.

Your next question is from Cody Acree of Legg Mason.

You talked a little about your internal inventories not doing much but can you talk about channel inventories throughout your various markets? What is your view of the current balances? Whether it is your OEM partners or within the distribution channel.

Yes, hello, I think that we recently had the opportunity to meet top managers from our key distributors and the visibility that we have is that the inventories as the distribution channel is under control. I think that if we move now to the major accounts, I would say that we do not perceive any accumulation, the demand is strong, of course mix is playing a role. There are customers that are really demanding more of certain models with their products because the demand is very strong , while in other models the demand is weaker. On a global base we do not see any accumulation of the (inaudible) customers today.

Do you expect then your back half of demand trends to track relatively inline within demand or there are inventories to be built yet within that channel?

I think that of course in some portion, some part of our business we expected much stronger Q4 and it is clear that we have to somehow anticipate some of the manufacturing activities to properly serve our customers and to follow the demand in Q4. This is normal and this is a part we have always seen in the past years. So on the other hand, I think we are pleased about our stock performance.

We have today the stock general price. We always said that in order to optimize customer service and financial performance we believe that anything between 4.5 to 5 is the optimal range for our products and our goal of course is to stay as close as possible to 5.

And lastly, can you talk a little bit about pricing across the various units what you saw during the quarter, maybe specifically at least in wireless PCs and in the Flash market?

Let's talk from memories, I think this is not new. We have some stabilization of the price plus I think that our prices were stable if you see in Q2 and we except the same degree of stabilization in Q4.

(inaudible) on the segment -- first of all wireless, I would like to say that there is nothing to mention here. This does not mean that there is not price decline. What I mean here is that the normal pattern that we and our panel decided many quarters ago, two quarters ago, at the end of last year and now we are following it without news and in this --

Your next question is from Utah Orgy (ph) of at JP Morgan.

Christie, hold on we are still answering the earlier question

-- it is the question concerning computer peripherals, in computer peripherals there are in pricing is certain there and this is certainly one of the most --

Aldo you are getting cut off.

Hello, Christie, are you with us?

I am with you sir, the line is cutting in and out we are having extremely difficult time hearing. Ladies and gentlemen if you will please hold online, management will dial back in momentarily.

Can you hear now?

Ladies and gentlemen please resume.

Let's reset it, let us just recalibrate everyone. Are we, is our communications lines open and relatively clear.

The line is still isn't but the line is still cutting in and out.

Even while I am speaking with you right now?

Yes.

OK, standby just give us a short time out and we will return. --Hello, Christie?

Yes sir.

Have you got the participants on hold right now what is the status.

Actually you are still on the main conference, hold one moment.

Why don't we continue this or will come back. Well, I just want to make sure that in this line that they can hear us. Christie?

Yes sir.

Are you still hearing breaks in the line?

Yes sir.

So, about midway through that last Q&A we started to drop off correct?

It went completely silent, that is why I announced the next question.

And I am breaking up on my conversation with you right now?

Yes. Please continue to hold, we are experiencing technical difficulties, please be patient, we are experiencing technical difficulties. Sir, you may begin.

Hello ladies and gentleman this is Stan March, we sincerely apologize for technical difficulty which we encountered in the call. As you may remember, before our brief time out, Aldo Romano was commenting on the situation in terms of pricing dynamics within his group in response to Cody Acree's question ,and I'll now turn the call back over to Mr. Romano. Again, thank you for your patience.

I was commenting on something on wireless and I was saying that basically there is no new event, no recent event. This would mean that our pricing has stabled or growing or whatever, that is the normal part of the price declined during the year, as agreed with our customers during the end of last year. So, there is no new event here to mention.

In computer peripheral, the pressure was high and is still high and frankly, I don't see an improvement in the situation due to the clearly competitive market on which our customer are moving themselves. The automotive division is certainly slightly better, price has been decided when the product has been developed, and when they are going in production, they are not yet generally big news. So, the situation is overall--this is still competitive, still competitive pressure is there, even if there is nothing dramatic to mention.

Philippe can you comment about consumer pricing?

Yes in consumer, as well as Micro controllers, as well as cameras for the phones, we see a good demand, good level of demand. So, we are able to resist to price decline a little better than usual. So, price is I would say declined normally or even a little less than normal. So, normal, a little better than normal situation.

May be comment on discrete, which is about the same as the one Philippe was making, we don't see any big price decline there in this abbreviation and some increase.

OK, Christie let us see if we can get back to answering those other questions in the queue.

Thank you. [OPERATOR INSTRUCTION].

And your next question comes from Utah Orgy (ph) of JP Morgan.

Good afternoon gentleman. I have a couple of questions. At the first is for Pasquale the guidance of 2% to 8% range. What would determine, which far end of the spectrum that is going to swing, I mean what is the unsetting factor that will determine whether it is going to be 2% or 8%? And if you can also tell me how much of that will be covered by the backlog of demand and I have a follow up.

OK, the sales growth range between 2% and 8% is based on factor that we have good visibility and frankly, we have been used in the past that the visibility is valuable with the customer mood. So, to avoid that there are some prices in push-outs and push-in, we are putting some reasonable range, the bid range is five.

I think we will do whatever it takes, to be as much as possible, in the high part of the range, but this is the estimate we are having now, because we have had the experience of a push-out at the end of the quarter. The backlog situation of the alter intake would make us comfortable in the higher parts of the range, but then every time, there is some news event, so, the bid range at the moment, that seems the most likely.

Right, very much. And the next question is for I think both Aldo and Carlo Bozotti on Flash. I am not quite (inaudible) during the conference earlier you were talking about Telecom excluding Flash was opposites 12%. And also the press release you said Telecom was flat excluding Flash. I would assume here that you are losing market share in Flash or Telecom and if so where - what would explain that?

Well, I think it is important to in my view to look at the global numbers. We have enabled to grow 81% on NOR Flash to do this year comparing with last year and I think this is about two times the growth market.

So, definitely we are getting market share and then frankly application-by-application, segment-by-segment is also the way we managed the business, the way we try to optimize the mix and serve our customers. So, it's a combination of many things.

I think, most likely in Q3 there will may be a stronger growth in wireless but again, this is very much driven by customer service requirements, it is driven also by our pay decision to improve certain portion of the business and improve our mix. So, I would not say that we have lost market share in Flash wireless I think it's a portion of the business of course is important to grow everywhere. But, I think it is more important to show a global growth of 80% comparing with one year ago, that is for sure a solid gain in market share.

OK.

Concerning dedicated product, there is no doubt that this was not a good quarter. And certainly the market grew more than a few percent we grew in Q2. This is due to our exposure to customers that didn't increase their own market share in this quarter.

This is very clear to you. But there is also another effect of the many of our new products that are coming out now, are available now with new products and, the effect of this new product will be clear in two or three quarters from now. And so in Q1 and next year or at the end of this year for example for our standard chip set that will start selling in Q4 of this year.

Now this wave of our new product that Pasquale briefly mentioned, which includes, if we talk in general in Telecom, includes the standard chip set for GPRS, which is the standard chip sets for CDMA. The Bluetooth for various application.

The Wi-Fi which is a very interesting product which is able to satisfy different standards A, B, and G in the same chip set. ADSL, with ADSL 2 plus capability. And all these new products are available now. So, the effect of this is not clear is not present in the sales will be present in sales in the next quarters.

OK and then last question is on capacity utilization. Can you just confront for us what it was in the current quarter and what is going to be rendered in the next quarter? And in adding capacity, so is a much?

What you call our current half-quarter is Q2 right?

Q2, that's right.

Yes, Q2 - our utilization rate of 6-inch worth of fab was 87% and on the 8-inch was 85%. The average between being 86%, and so can you imagine. Now we are going to increase our validity ratio rates during Q3 by something like one point in the 6-inch, but you need to keep in mind that we are increasing our capacity also in 6-inch and we are going to increase our utilization rates of the 8-inch by 6 to 7 point. And there, of course we will be above 90%, which means that we need to ramp up very quickly our fab in the 8-inch fab in Singapore as well as our 8-inch fab in USA, which is what we are doing.

Can you just give us an idea of the capacity level will be added in the third quarter? It is 5%, 10% decrease in capacity there?

You know it is going to be significant, you know of course, because we ought to go back to our utilization rate of about 85%.

Right, OK. Thank you very much.

Thank you.

Your next question is from William Conroy of Sanders Morris.

Good afternoon. Can you give us a little bit of detail on what the drivers for the automotive strength are and then I have got one follow on to that as well?

Again, thanks a lot very much for this question. Automotive, which is normally a bit, neglected but the analyst in spite of the importance that this strong market has. So, there is one certainly good event, which is our presence in Japan. Our presence in Japan is growing and we had one important customer in the past and now, we have two important customers growing and, this added to the traditional presence we have in Europe and in United States.

So the major area of growth is micro controller with embedded Flash but, there is also a widespread growth in all our as much power devices where we have a very strong and increasing presence. I like to underline that the growth has been in the 10% range in Q1, sequential 10% growth in Q2 and for what the next quarter have foreseen, we are foreseen again a significant growth in this order of magnitude. So it is not something that they will stop and we are on the other side struggling to deliver everything we have been requested.

Thanks, as a follow on Pasquale you have mentioning, I guess for some quarters the initiative to attack or approach the smaller customers both from the product side and from the marketing side. With the performance that you have put up today. Can you give us a sense of how the margins, whether it is, it will be like something in the operating margins, of approaching those customers compares to the corporate average or these tending to improve the margins or are they improving sales but declining?

This is for investor margin. First of all let me repeat that this direction is very, very good. And, I would like say that this was launched in 2002 and, in 2002 we realized that our success story with the top customers of the key strategic partners in the top 50 would continue but, did not continue to prove the growth at the same level once you reach a circum saturation in those customers.

So we decided to launch this new marketing direction, which is an expansion of what is our basic strategy addressing the universal customers beyond the historical top 50, which means also some of these has to, that we are not in the historical top 50 and our write-off has more medium customers of course. This strategy is proving very, very effective. I would like to mention some numbers.

In the second quarter of this year the growth was 17%, even if I repeat, I am sorry but that's important, 17% of sequential growth in the customer base beyond the historical top 50 versus the first quarter and, 45% on the second quarter of last year. So really is contributing significantly to the average growth of our company.

Now, since we have modest incremental expenses very modest incremental expenses because the fundamental product range is the same. And relatively more or less the marketing incremental expense, what you do, you add the design centers for more direct product for those normally high performance analog, micro controllers, some specific product with this high margin application centers and sales coverage.

So, we leverage our classic silicon and system and allow to a larger customer base. So the margin tends to be better, for the natural portfolio and, for the limited incremental expenses. So improves both the margin and sales coverage and we had at the beginning of this results, I think that with the quarters and years unfolding would be a major contributor to accelerate the growth of the company.

Thanks very much.

Your next question is from Didier's Skimon of ABN Amro.

Hi thanks for taking my question. Good afternoon gentlemen. I would like to start with just a question on the ramp of the (inaudible) IT slab and the Singapore IT slab. Can you give us an update on where you are there and I will follow up for Philippe on - digital consumer, essentially it seems like you had problems of testing bottlenecks. How did that happen how couldn't you foresee these things? And second, did you, as a result of that lose any customers? Is that going to impact the growth in the second half?

OK, I (inaudible) if you guess on the (inaudible) slab, of course the ramp up is ongoing. The plans of the square meter we are available or not yet saturated for they will be saturated second half of next year. So we still have some square meters there and we are accelerating our ramp up in Singapore and in Singapore probably we will saturate the square meters there around the second quarter of next year.

So we still have some room to increase but we are increasing as fast as we can, as fast as the equipment deliveries are allowing us. Now, on top of that, we are also increasing our capacity in 6 inch in Singapore and this is part of our restructuring program as 6-inch restructuring program as you know and a bit of an 8 inch leading edge capacity is going to come from Singapore 8-inch others from outside.

On your second question on digital consumer yes, we had a big increase of the demand around March and April so we stopped it off with those and, in the second quarter we had the June run rate and that's higher. We could not test and produce everything we wanted to as fast as we would have liked but nothing, nothing measured just a few spot issues. So we have not put our customers in trouble, we are not preventing our customers to build and the impact on the first quarter is any is not negative, it is positive because what was not built in second quarter will be built in third quarter. So we still see a good demand in digital consumer level.

Philippe on digital consumer do you have any number you could give us for the full year you know that's CMG but sort of digital consumer portion of the CMG in terms of revenues, what you could get because when we went to the annual Investor Day in Paris (inaudible) was very bullish on rolling shipments for set tops and you had a number of new products rolling out. So I am just wondering if we are still on track there?

Yes we are on track compared to the visibility we had during the annual Investor Day in Paris, as the numbers for the year are all about same so we don't give guidance for the year so I will leave it to myself to the first fourth quarter where we foresee a double digit growth I believe.

OK. Can I just ask a question regarding the SG, I mean you had, to be honest, a phenomenal performance over the last few quarters and in Q2 you are clearly gaining significant amount of market share and that's translating into a very higher operating margins.

My question, I am wondering is, I mean when we look at your comparable what they are saying is that in June basically the order has been weaker and well that's due to seasonality and also you know people are wondering about inventories. So I am just wondering is that the peak year for the SG? Are we going to enter a more muted growth, you know, period and the second part of the question would be, is there a hope that the high performance analog part of the SG is going to be the next you know driver for this division or it is too small at the moment?

I will comment that there is a lot, our group manger here. Yes we are very pleased with the performance and I noticed during my introductory remarks that it is not only volume and manufacturing efficiency is further portfolio improvement. There has been in the last several years a continued is a way of the life you know in our companies. There has been a computer movement towards higher value added products.

This includes the IPAD this includes the high power this includes, high performance analog. So there is no question that we have continued in this direction and in particular in high performance analog there is a significant effort that we are putting trying to expand the portfolios as fast as we can. As far as the Q2 performance.

We are right now the old backlog is very strong I think that our DSG limitation right now has more capacity than all those intake and one contribution to the good margin was also (inaudible) because there is plenty of orders. So we don't see at this point in a turning down point. We see a continued situation of the strength in this division in this group.

OK just a final question for Carlo on Flash. I think from the Web cast on the analyst meeting this morning it seems like NAND Flash was very minor of the contribution there. Do you stick to the guidance you have given of NAND flash contribution for the full year and does that imply that you are going to have very significant growth in the in the second half in NAND flash?

Well, for sure we will have very significant growth in the second half on NAND Flash. I think we will if you refer to the let's say the indication that we gave that this will represent about 10% of our flash revenues. I think it would be probably lower than that but we have of course, strong motivation to go as close as we can.

All right. Well thanks very much gentleman.

Thank you. Christie, next question please.

Your next question is from Adam Parker of Sanford Bernstein.

Yes Hi, Can you explain a little bit more on what you said in the press release about a favorable mix in terms of which higher than average margin products are going to growing faster than average through the remainder of the year?

OK, I will look after my little comment that Aldo prefer to comment. But TPA is expected to grow faster in the second half than they have grown in the first half. And the product group of Also Romano, total group's so Aldo Romano are those differentiated products so that have influenced higher gross margin. Therefore, the overall mix of the company in the second half of the year is going to be more favorable particularly in the fourth quarter. Aldo.

OK, first of all considering wireless, as you will know in wireless there is as stronger seasonal effect. And in addition our customer that we are not able to grow or basically head the to surface some decline in market share has not accepting it so are reacting and the visibility we have raised for a good turn particularly fourth quarter. OK, so wireless will grow.

Wireless is higher margin than the overall company right now?

Wireless is the average of 58 segment. It's about something negative as the pressure on price is at you have in mind that could bring. So, is acceptable. So, the subject is automotive but here I already mentioned. So I think I can go on. And then in a computer peripheral, the result of TPA this quarter has been impacted significantly by the performance in computer peripheral and to be more precise in data storage because in printers our performance has been good it has been a good growth.

But in the other story, we had to suffer because of our customer deciding to deplete their inventory. And this has been done with a little advance. And we have been bit surprised. So, the result in other story this quarter already also is very easy to grow I would say. And in addition also in this segment, there has been some loss of market share of our major customers here, which again is not accepted and is not and therefore is plan at a good reaction here.

I am unable to understand I am sorry. Are you saying that the data storage segments going to grow faster than the ST's average of the back half of the year and it has higher gross margins in the overall company?

Well, what I mean is that if you compare to what we are in this second quarter in data storage. We will grow faster than in many other segments in the company certainly in percentage for sure. And in terms of margin gain they sell products, which in spite of the price pressure that we see overall are contributing well to the margin of the company.

One thing if you could more precise is just to how to explain that what Aldo is saying is that there was an inventory adjustment that generated the reduce of this energy in Q2. So these inventories just in and what shall be able to recover and there fore the rebound will be significant.

Yes, and on the margin, we do not disclose the margin by each of the division of TPA but increasingly all families of TPA have higher margin. So, I think Aldo described all the opportunities that we have passed during TPA in the second half of the year and this will positive impact on the margin of the company.

This second quarter for TPA has not been good and particularly the overall performance in terms of profitability has been at very low level compared to the TPA standard. Frankly, clearly I don't like it. It's has been an effect of what happen in the data storage mainly and also somewhat in wireless but these are event that we will be corrected during the next quarter particularly in Q4. I am very optimistic to come back to the normal profitability of TPA.

Good we love all that.

All right, so if I am just summarizing that my question you are saying normal seasonal demand in wireless and the fact that inventory has been drawn down in data storage is going to result in a more favorable mix in the back half of the year?

Yes, yes it's correct.

OK all right. My second question is about your inventory. It was I think 2% sequentially during the quarter. And I assume you don't want to comment on what these technical problems were. But if you do not have the technical problems what would your inventory have grown and what I think you may have answered before but this is the question that got cut off. What do you think is going to happen to your inventory in the third and fourth quarters and I think you said it was going to boost in Q3 to meet Q4 demand in which case I am wondering how much do you think your gross margins be inflated in Q3 by that inventory build that you expect? Thank you.

Well let make a comment. First of all inventory for same absolute value of less significant to even that inventory to us. We have always been declaring that our target at the range for inventory total is 4.5 to 5. Now we are at the upper limit of those (inaudible) five, which is very good for the financial performance but tends to be a risky for the customer service. Because we have a huge variety of products very large customer base a lot of reserved inventory for critical customers particularly in automotive. So at this level we are already critical.

We intend to maintain the range of 4.5 to 5 even during Q3, but for the seasonal reasons, we will have somewhat inventory increasing Q3 but still not only in the range but in the upper limit of the range. So there should be no significant impact over the inventory in the gross margin. We will deal there whatever is necessary to make the Q4 forecast but again we will maintain the inventory in the range and in the upper limit of the range.

Just on the technical problem side, if you didn't have the problems what would your inventory have gone and can you comment on what those problems were?

We would have resolved more and so (inaudible) before I answered. If those figures would have been occurring we would have sold more or we would have added more products of liable for Q3. I just want to say that those are small glitches that are no more in any operation, but they occur more frequently when we have a quick ramp up and then we add to the situation that occurred in June.

So a new ramp up as we are trying to do and you are hundreds of new people with a very low training. There is the risk of having an operator that introduces a wrong recipe, which is the case. So we have had in three particular parts at different parts of the world. During the June, three incidents that destroyed the few way first and increases the cost of the products sold that were put into though impacting Q3 gross margin. Again it is nothing dramatic, it is something very unpleasant but I mean we didn't have any fundamental problem.

OK, just a last question. It sounds like you are saying that's you know impact your margins by about 50 to 70 basis points so. I am just trying to think through then and if that was because your revenue was pushed out a bit or you would have sold more had-had you met the demand. Doesn't that mean that the sort of revenue guidance for the Q3 is somewhat below normal seasonality and if that's the case why would that be?

This is Carlo Ferro, when measuring the impact of these events we are frankly not taking account of the impact of revenues, which by the way is very well in (inaudible) I think the revenues guidance that we have to provide.

What we refer to is the effect of these occurrences on the level of the season, the manufacturing cost of the month of June that at the end result in a higher cost of sales in the third quarter and as you rightly pointed out earlier, of course this has some effect of inflating the inventory in value at the end of the second quarter due to these events, due to the fact that the actual manufacturing cost in June has been higher than what we had been without these events. And of course to quantify we have been asked to take the mid point of the ranged times to 70 basis point.

Right, OK thanks for your time guys.

Thank you.

[OPERATOR INSTRUCTIONS]. Our next question is from Matthew Gayle of Goldman Sachs.

I will just start off with a basic question. Could you just remind us, is there any difference in the number of days in Q3 versus Q2?

It is the same. What happens is these four, five weeks and the year-end closing on December 31st resulting in the Q4 longer, in the Q1 shorter, but Q2 and Q3 have the same number of days or 91 days.

OK, and then just wanted to follow up on some of the questions on the discrete and standard products group. You know looking back historically we only had three years of margin data in the group and it was in 11% to 12% range and you have talked about shipment and product mix. But will it be possible to look back a little bit further you might have known, how the margins in that product groups stacked up going back over a 10 year basis and how do you are look going forward. What is the potential for outside on a sustainable basis? I would imagine this 22% margin is not something you are expecting, division to do through the cycle. But how is that margin shift change going forward?

You know, of course, we are not going to go back to the last 10 years on the margin but what happened is that you are usually on this type of product there is more pressure during downturn and there is kind of on the pricing and there is more leverage during the upturn. What is new in this case, foresee that we are introducing a lot of new product this year and of course what the new marketing initiative at the first quarter while we are talking about before is of course having a direct impact on this kind of product.

So we are - we think more design resources, developing new product, introducing new technology. So, therefore we cannot look at the history to forecast the future, we cannot look at the reason to forecast in the future plus it is more easier to forecast. So again the difference is that there are lots of new product. As Carlo was mentioning the IPAD, which is now it is an integration of passive components.

This is a new product, I mean it was introduced just few quarters ago and now it's having volume. VIP Vertical Integrated Power is another one new - a lot of the new analog product from this initiative I was talking about are coming now on screen. So I think you know the margin of the GSG product are going to be nice in the future.

Let me make another comment to give you an idea. I think that the gross margin that differentiate the products are normally higher, less volatile. The gross margin of the standard products both namely, discrete and standard ICs are more volatile with amplitude of oscillation during the recycle and tended to be on the average lower.

However, we have run a five year running average profitability of gross over standard products, where we put both the memory product and the DSG product and differentiated product where we put together PPA and CMG and this is very, very close to the industry - to the company average. So we don't support families on the cycle of five years on the longer run are not giving the good profitability to the company.

So I mean you are saying looking back five years that essentially did the same margin as the overall company, which are making a major change over in trying to introduce new products. Is that?

No margin, operating profit.

OK, so look at operating profit, can you expect that this being a standard group going forward with new product line up is going to have a more stable margin structure and possibly able to achieve margins ahead of the total average over the next five years.

Well but the other groups are working larger tools, that an item would be always the same thing. I think that the wave over new product are coming out of a TPA, MPG, CMG, I think is good race what I think is that the overall gross margin of the company is going to increase and the overall profitability of the company is going to increase. And I would like to point out another item that I think is very, very important that lasts in the company and, I am sure that the financial award (inaudible) we are very, very strong in measuring each operating group and each operating division for return on net asset.

The groups and division are not allocated the taxes or other non-operating items so we wish them on a before tax return on net asset. And that is a magic number, which is 14% return on net asset because this is what corresponds to about 11% of return on net asset after tax, which is about our weight of average and cost of the capital. All the foreign groups and all the divisions in the foreign groups are working very hard to exceed this level.

In the last couple of years we have been as the company below but this is going to change pretty soon and we are going to move upper and upper because our medium to long-term goal is to be more closer to 20% rollout then to 14% rollout or 11% rollout after tax. So rollout, return on net asset is very, very strong parameter in which every group is working and every division in which the group is working. And the way you achieve is by cost of structure and little more important in product's introduction.

OK. And you have I guess closed with the balance sheet question? Carlo could you just comment on, I believe you, some of your convertible bonds the 2009 bonds are portable back deal to in September, which can be paid either in shares or in cash by you. Would you just comment on your thinking of which way you are leaning with those bonds?

Yes you may have noticed that we have classified as current portion of long-term, it is roughly $800 million due to the fact that on of September 22nd. These bonds could be put at the option of not a folder and you - as you as very well recall the company and the option to either redeem the shares or in cash or a combination of the total.

We are considering and we will make the decision in the best interest of our shareholders in order to maximize the impact of the choice in term of EPS impacted. This is the only message that we will adopt to make this decision. Of course it would largely depend on the share price at that time. So we will address the point in September based on the share price at that time and I feel very confident about that either one way or the other the company has the ability to meet the obligation keeping this very solid bond structure.

Thank you.

Your next question is from Don Dondue (ph) of Credit Suisse First Boston.

Hi, good afternoon gentlemen. I would have a question on flash pricing and especially the high-density part of if and I am mainly going into wireless. Do you see at moment a stable situation going to the second half or do you see a potential for price pressure on the way down increasing as a result of one of your competitors having a lot of Fidel capacity?

We had a stable price environment during the second quarter and we are estimating we thought that a similar pattern during the third quarter as you know in the past six-to-nine months we had some well say during the first six months we had some positive price result particularly on the low density products. I think this is a result that we have achieved and we see capitalization now and I would say capitalization both on the high end products and low end products.

OK, could you comment quickly on the status of the ramp 2.13 or are you happy with the current situation (inaudible) at the end of Q2 and Q3?

Yes we are in line with what we have forecasted earlier, so we are moving now quickly in fact in full perhaps. I think that in Q2 around 15% and again the ball is to be at 60% in Q4 this year and we are progressing now very rapidly in Singapore. (inaudible) are already practically all 015 ramping up very fast in Singapore but the serving customers on 015 micron also from Sicily and price during the third quarter and also then from Roose (ph) in Q4. So the program is on time and of course this will support our program to improve our profitability on the memory group.

Thank you.

Your next question is from Mark Adelson (ph) with Morgan Stanley.

Good afternoon guys. Pasquale First I have a question on order patterns you saw during the quarter. One of you could just walk us through what the trends were like for orders for the company as a whole as you went through the three months of the quarter, mainly like a weekly run rate type of basis the trends that you are seeing. And perhaps if you could comment what the impact is like with and without the weakness you saw in June in the hard disk drive market?

Well all the quarter was very strong in terms of order intake. So yes there were some slow downs from the products in June but the impact may be simple because we were so saturated, we couldn't get any new orders. So pretty stronger quarter anyway with the summer slow down in some products in June, but again we don't know it is because we were refusing orders because there was some slow down in the demand.

What is part of the push-outs, and the most impacted was Aldo because this was specifically in the area of disk drive and the amount was significant. Several I think was in the range of $40 million and plus others but those who won were significant without this they have sold $40 million with a important impact on the sales and also in the performance of this that particular division. But anyway this is our one time shot that doesn't have a long-term impact.

And as just a follow up Pasquale can you talk about the recent demand trends you have seen within the wire line communications market?

I think Aldo is more qualified there than me. Aldo?

Concerning the chain networking we are experiencing a very good growth. Personally for us not a big segment compared to wireless, otherwise our overall performance would have much better this quarter. So the rate of growth compared to last year is exceeding the 30%-35% and the wire is coming this is mainly in the transmission or same and software communication and the transmission side of the story, OK. We are also to measure that ADSL field on this second quarter has been performing well.

Here we have some concern about the second part of the year, we have to clarify our mind but there we see some decrease in the demand for China, for example, but still we have to understand so (inaudible) soon to rebate this point if the market is bit separated or not may be yourself. This would be clear, more clear in the second part of the year. But overall in this segment the performance has been, I would say excellent.

Thank you very much guys.

Your next question is from Marisa Barber (ph) of SG Security.

Yes, good afternoon, very quick question. First thing, could you give me the amount of revenues on the strategic partners?

I think it was 37.5, right in Q2.

Sorry I couldn't touch the -- 37?

0.5.

OK.

37.5.

OK, thanks.

I think it is still very high but, I am trying to recall that in Q2, 2002 was 45%. So and we are growing very much with those customers. The point is we are growing faster with this expanded customer base strategy.

And to follow up on this type of question, your tax rate was quite low during Q2 and, we would like to have guidance in that and as well on other income and expenses, which was a positive impact in Q2?

Yes, our tax rate in '92 and the year-to-date is being comprised of the effect of the restructuring is basically inline with the 15% to 17% range before the impact of the structure. Indeed if you care about the restructuring and you computed their benefit of restructuring at the rate in the range of 30%. All the other earnings on a tax rate, which is roughly 16% that could not even on the lower end of our range at 15% going forward. So that the outside that for the next couple of quarter is the reference point that remains valid.

And, as far as other income and expenses are concerned?

Other income and expenses this quarter, we had a very good surprise on the fact that a sustained contract of our R&D grants have been signed up and finalized, during the quarter, and that gave the opportunity to have a legal income and couple of million income on the line. On the cut off of (inaudible) two has been discontinued early in the quarter, so the cost of (inaudible) are completely embedded in our manufacturing the cost in for all second quarter. And we just now stop in the other fab mainly in (inaudible) may increase in the next quarter and also into Q4.

I would say that altogether you may expect, we do expect a balance, of other income and expense is negative in third quarter. I would say a high single digit negative in the third quarter, while in the fourth quarter especially who were able a usual seasonality to sign up somewhere in the contract in the quarter. It could change the sign and turn it to a positive balance to a net income.

OK, Thank you, and I needed to ask one and then I will let you go. On TPN, we had the disappointment in margins you mentioned that. What sort of normal margin are looking for is it something around 17% of your targeting for Q4?

You are very precise and I--.

No, because there is something, this is a number that's been mentioned several times.

Yes, yes and your precise are not (inaudible) this is what I had in mind.

OK, thanks.

I think we are time for two more questions operator.

Your next question is from O' Don Delaborde (ph) of Chevrolet

Actually this is Remy Thomas (ph), all this time you guys have maintained your expectations for the market in '05 to grow by 14%. Yet for those of us who have been able to speak (inaudible)it seems that he is getting a bit nervous about this forecast. I don't think he's on the call but, could you perhaps tell us if there anything out there in terms of end demand or capacity arriving onboard or pricing evolution, that would make to guys nervous for '05 and fixes that we may not see a double-digit increase in the market next year.

Well, I think that there has been lately, a variety of forecast that we are receiving for next year. And frankly, they will remember my longest history in this industry, my longest association to this industry, forecast ago as low as 4% growth or as high as 28% growth. During the months of the June I saw, next year the growth is as low as 4 and low as high as 28. We are putting a forecast of 14% growth, I think that is much closer to what, we think would be the outcome, but we are monitoring very careful the evolution and in September will come with the update forecast.

As it likely to be reduced, increased, I mean again, what you get dealing for end demand there?

Today is14%.

Right thanks.

Thank you. One more question.

Christie, we will take the last question now.

Your next question is from Francevou Immanuel (ph).

Hello it's Francevou from (inaudible). I got a question on this discrete and stand off. How much of your phase are going to the distribution? And then I'll follow up.

It was close to 45%, 40-50% depend on the (inaudible), by nature this suggest such a broad customer basis so, anything between 40 and 50% of the depending on the summaries.

And so does it mean this way you had some price increase because of distribution and also some price increase?

No we had also (inaudible).

OK, now my follow up is about the Bluetooth markets. We are seeing at the moment a quite strong growth in these markets. What are your expectations or ambitions going forward?

OK, first of all I have to remind you that we have started shipping already now, in previous generation development for cellular phones. So we are starting the shipping in this quarter Q3 and Q4.

In addition, we have introduced into the market, a new device, which is single chip in 0.15 micron with RF embedded, which in my view is as just in two words, the best of the market. It's the best because in terms of chip size is small, because in terms of power consumption is lower than -- 30% lower than the battery competitor. And also, in terms of RF performance is a very, very good and, is also already in inline with the latest specification 1.2. Therefore, what are we doing, we are in this assembling in this period, our customers and, we are getting with the substances.

So I really count on this product for next year giving a significant return. For what I know in the total market in this moment on Bluetooth for cellular phone is, in the region of 1.5 million per week, so using the -- is a very significant in the month, so it is 70, 80 million parts per year today and is increasing. So for the next year the total market they will be in the 100 million or so. And we plan to capture some significant amount of this 100 million parts.

OK. Thank you very much.

All right, before I pass the microphone back to Pasquale for his concluding remarks we want to thank everyone for participating again, apologize for the brief time out due to technical issues. And thank you for staying with us during that period of silence from Milan. With that I like to turn it to Pasquale for his concluding comments.

Well again thank you very ladies gentleman for being with us now, I would like to give you few final comments on our conversation today. First of all, we are pleased with the results of the Q2 in terms of both advancement in our sales and our gross margin. Second we have a real feel with our 40% at least gross margin in Q4. We have explained the reason for the linearity in the road market towards that level that we (inaudible).

But more than anything, more than the operating results, I would like to leave with a comments about the three major directions in top of our fundamental strategy that is not changed. The teams from use of the (inaudible) in 2002. At the time we launched three directions essentially one in cost structure, one in R&D and another one in marketing. The one in cost restructure was to have a rebalance; of our geographical needs our silicon sourcing. At that time in Q2 2002, some 25% over silicon only 25% over silicon was coming from Asia.

The 16-rationalization problem plus the rapid growth in Singapore 8-inch fabs and the association with the partner is going to make a bigger change. Already in Q4 of this year 40% of our silicon will come from Asia and, with the program we have in place, in Q4 of the next year more than 60% of our silicon will come from Asia.

This will not mean that we will decline our silicon output in Europe and U.S., which will continue to grow. But the growth in Europe will also will be much more moderate than the one in Asia, and therefore this switch in the balance of our silicon sourcing is going to be very, very effective on our manufacturing cost restructure. The second thing is, the accelerated pace in our R&D development. Well you seen impact, in the first six months of this year, we added more than 700 engineers of while (inaudible).

The program accelerated and these working out, the waves on new product are coming out are frankly impressive, they are impacting already somewhat our results. But this impact will accelerate in the second half of the year and, much about definitely next year. And third, the strategy of expanding the marketing base so that again we launched in 2002, is being very evident.

The impact is very, very strong and the cost effective is very strong, because we are leveraging with relatively modest in incremental cost, our silicon knowledge, and our architecture knowledge, therefore bringing in additional sales in a broader customer universe without faring (inaudible) too much incremental expenses.

So, in top of the permanents of all the strategy that for the company has had for 17 years, those new three directions are (inaudible), reinforcing the company. So we think we are extremely well positioned to continue to grow, and, to continue to perform on the bottom line better than we have done in the last several quarters and, to continue to gain market share in the coming quarters and years. So thank you again, for being with us. Ladies and gentleman good evening, and good morning.

[OPERATOR INSTRUCTIONS]