First Quarter Conference Call Remarks
Tuesday, April 29, 2008
President and Chief Executive Officer
We had a very active start to 2008. We completed the spin-off of our FMG business into a new company, Numonyx. We better secured our wireless position for the future through the announced majority-owned venture with NXP. Combining complementary product lines and customer bases places us in a position of being a very competitive market leader. And we strengthened our position in digital TV with the acquisition of Genesis Microchip.
In addition, we enter 2008 with a much stronger product portfolio through our internal investments in R&D over the last several years. We are also becoming a leaner company in reducing our capital intensity as evidenced by our capital expenditures in the first quarter. And finally, we continue to drive significant cash flow.
So, let me first begin with a review of our financial results. Net revenues tracked to plan, coming in within our guidance. On a sequential basis we saw what I would describe as normal seasonality.
On a year-over-year basis net revenues increased 8.9% and, excluding FMG, were up 11.6%. When we compare to others in our industry I think this shows a very solid performance. Our year-over-year growth was led by automotive, industrial and wireless segments and also benefited from $32 million of sales following the completion of the Genesis acquisition.
Looking at revenue growth by market segment and excluding FMG, our year-over-year growth was led by both telecom and industrial up 15%, followed by consumer which was up 10%, computer up 8% and automotive by 7%.
Looking at revenue growth by product segments, overall ASG's revenues were up 14% year over year driven by application specific wireless, and growth in consumer excluding Genesis and, up strongly, including it. Automotive products were also notable contributors to the growth of ASG. We anticipate that application specific wireless, led by 3G baseband products, and automotive, notably Nomadik based Cartesio devices, will be important contributors in 2008.
IMS' revenues increased 7% year over year principally reflecting strength in MEMS, microcontrollers and advanced analog products. MEMS reached about $100 million in sales in 2007 and we expect the ramp to continue on a steep curve in 2008.
FMG sales decreased sequentially and year over year.
Our gross margin results also came in within our guidance range, in this case right at the midpoint. In total our gross margin was 36.3%. Excluding FMG, our gross margin increased 60 basis points to 37.6% in the 2008 first quarter compared to the year-ago quarter. We estimate, however, that the benefits of our progress in strengthening our product portfolio and manufacturing costs were to a large extent offset by the significant swing in the US dollar. In other words, 300 basis points of improvement in our gross margin excluding Flash were absorbed by currency.
We have continued to invest in R&D where, clean of the one-time In-Process R&D write off, costs are up 12% year over year. However, currency accounts for 10 points of this growth. So, excluding currency, R&D costs were up 2% year over year. This includes internal growth as well as the addition of the Nokia and the Genesis teams.
Similarly, looking at SG&A it was higher year-over-year by 16%, with currency accounting for 11 points and increased stock-based compensation charges contributing another 2 points. Excluding those effects, SG&A grew 3%.
It is true that the first quarter reflected expense levels that were higher than we have targeted. Despite the currency situation, over the next few quarters we will continue to realize the identified synergies of our strategic investments, and we will reach our targeted expense to sales ratio of 28% in the fourth quarter, and this will be done even at current Euro/$ rates.
This brings us to our operating income before impairment, restructuring and one-time costs. For the 2008 first quarter it was $116 million, compared to $74 million in the 2007 first quarter. However, the true measure of the progress we have made can be seen by examining the change in operating income on a constant perimeter basis. During this timeframe the US dollar weakened 14% against the Euro, costing us an estimated $143 million in lost operating income improvement.
I want to emphasize that we did see improvement, notwithstanding currency, but we hope this very transparent analysis helps you understand how much progress we have made across the Company in strengthening our product portfolio, improving our market positioning, improving our manufacturing and improving our return on R&D investments. As a very important example, let me point to ASG. We have made significant underlying improvements in the profitability of this segment during the past year. However, currency masks much of this improvement. In addition, we have the initially higher expenses coming from Genesis until the synergies take effect. At the exchange rate of last year's first quarter and excluding these Genesis effects, the ASG would have shown nearly $100 million in operating profit.
We are also improving our cash flow. In fact, looking at the 2008 first quarter our net operating cash flow was about $220 million, before payment for the Genesis Microchip acquisition, so we continue to generate cash at a run-rate of over $200 million a quarter.
Inventory, reflecting seasonality factors, posted inventory turns, excluding FMG, of 3.5 times from 4.4 times in the fourth quarter. Inventory was $1.54 billion at quarter end – this is after the FMG spin-off, it includes Genesis Microchip inventory, an estimated $40 million due to currency and, in anticipation of sales growth the second quarter. This will be the low point in our turns level evolution for 2008, as we will make progress each quarter through the year.
We indicated last quarter that our capital budget target for 2008 is to be at or below a capex to sales ratio of 10%, improving from our 11.4% level of last year. During the 2008 first quarter we spent $258 million representing 10.4% of net sales. I also confirm that based upon the timing of the remaining tool purchases related to Crolles2, we continue to anticipate a higher capex run rate in the first half of the year compared to the second half. So clearly we are right on target with our goal to advance our asset lighter strategy.
Turning to the 2008 second quarter, we continue to make good progress with our new product introductions. Despite the current economic uncertainties, we expect sales to increase between 5 and 11% sequentially compared to our first quarter sales of $2.18 billion excluding FMG. This would represent year over year sales growth of between 10 and 16%. For the gross margin we are targeting 37%, plus or minus 1 percentage point.
Our outlook is based on an assumed average effective exchange rate of $1.55 to 1 Euro compared to the $1.47 to 1 Euro actual rate for the 2008 first quarter and up from $1.33 to 1 Euro in the year-ago second quarter.
I would like to add a few words here on Numonyx. As you noticed, we closed this transaction at the end of our first quarter. All of the partners are looking forward to the future success of this company. As we have mentioned in the past, we will report ST's pro rata equity ownership of Numonyx performance on the income statement line named ‘Gain or Loss on Equity Investments'. Finally, ST will report Numonyx' results with a one quarter lag, accordingly Numonyx' second quarter results will be reflected in ST's Q3 numbers and there will be no earnings effect in the second quarter from our equity interest in Numonyx.
We remain confident on the earnings contribution of Numonyx after the first quarter of their results which could be affected by purchase accounting items, and reaffirm the expected accretive impact of this transaction to ST's EPS.
Last quarter we indicated that we would look for selective acquisitions in our core businesses to improve returns. During the first quarter we completed the acquisition of Genesis Microchip to add to our home entertainment group within ASG. We started work immediately, and will continue over the next two quarters to diligently pursue in the identified areas the synergies we will achieve. We expect Genesis to be accretive in 2009.
Just a few weeks ago we announced joining with NXP to create a new wireless semiconductor leader with 2007 sales of about $3 billion based on the businesses each of us is contributing. Our goal is to improve the returns in our wireless business while being in a much better position to serve the needs of our customers.
We will consolidate the joint venture into our results given our 80% ownership position. We anticipate closing the transaction during the third quarter and consolidating it into our results as of the closing date.
We plan to move quickly to make this opportunity accretive to ST. With respect to 2008, we continue to expect that it will have minimal impact on our non-GAAP cash earnings per share. And it is expected to be accretive to 2009 and more significantly beyond. And finally, as we mentioned on our recent call, we expect the new company's currency exposure will have a positive impact on ST's cost structure—reducing overall Euro exposure by about 3 percentage points.
We are also returning cash to shareholders through a proposed dividend increase and through the recently announced share buyback plan. This dividend increase results in a dividend yield that is equal 3.1% based on yesterday's stock price, about one point higher than current yield of a risk-free short-term bond investment.
In summary, we demonstrated solid progress at the top-line with revenue following its seasonal pattern. Our year-over-year growth is clear evidence that our new products pipeline is providing positive momentum, and we believe helping ST outperform the market during 2008.
We are clearly in the middle of a significant reshaping of our product portfolio – replacing revenue that was giving us negative returns with revenue that is generating positive results and will further improve our overall returns as we extract identified synergies.
Currency effects have caused ST to be far from our targeted returns range in the first quarter of 2008. However, we still expect to reach our targeted RONA range during the course of this year. Just to remind you, we set this range of RONA objective of between 12% and 20% when the exchange rate was 1.25 $ to the Euro; we reaffirmed it –in fact we realized it in Q3 and Q4 of 2007 excluding FMG-- at 1.35; and at 1.55 we will still reach it!
In conclusion, I believe the fundamentals for ST are positive and our improvements will continue to materialize…… Now let me stop to take your questions.
President and Chief Executive Officer