Good morning and good afternoon ladies and gentlemen and thank you for joining us today.
Conference Call Remarks
President and Chief Executive Officer
I will review Q3 financial and operating results, discuss our outlook for Q4 and share our thinking on ST's positioning for 2004. Then, my colleagues and I will be glad to take your questions.
As you have seen, Q3 revenues came in about $20 million above the high end of the guidance range we provided three months ago, posting a 6% sequential increase over Q2, and a 9.6% increase over last year's third quarter.
Several applications within our targeted market segments were strong performers in the quarter. In Digital Consumer, Set-Top Box and DTV showed strong sequential revenue growth. Wireless, comprised of differentiated, memory and other products, reached about $430 million, a double-digit increase over the prior quarter and accounted for about 24% of our Q3 net revenues.
Data Storage led the Computer Peripherals segment, and Smart Card Applications, benefiting from recent acquisitions, were an important factor in the Industrial segment. While traditional Automotive performed well, overall Automotive and Audio slipped slightly from Q2 levels.
The balance which characterized our end-market performance also served us well in our product families.
In addition to a solid 5% sequential growth rate in Differentiated Products, Micro and Memories was up 21.4% and Discretes increased 4%. Despite continued price pressure, Flash memory product sales increased over 15% sequentially to $191 million and represented 54% of MPG's revenues. This relates only to our NOR Flash business. In early October, we started sampling customers with 512 Megabit and 1 Gigabit NAND products, which could be in volume production by Q2 next year.
As anticipated, overall pricing pressure penalized our Q3 gross margin performance which, at 35.1%, was 60 basis points below Q2's 35.7%. Product mix was also a contributor, given the sequential increase in sales of Flash Memories. Utilization rates declined in the first half of the quarter, bringing down the average for the period to about 78% from approximately 83% in Q2. This was a function of reduced loading of certain 6" wafer fabs and an increase in our overall capacity.
Inventory levels remained constant with those of the prior quarter, as the reduction of SARS-related inventory was offset by a build-up to support increased end-market demand for shipments in Q4. Inventory turns, however, increased to 4.25, just at the mid-point of our target range for Q3.
We maintained our emphasis on discretionary expense control in Q3, helped by seasonal factors. R&D and SG&A expenses together represented 27.4% of Q3 revenues, an improvement of 130 basis points over Q2 levels.
With respect to the breakdown of operating income by product group, you have seen that TPA's operating margin declined sequentially. This is the result of the inventory reduction that I just mentioned. Conversely CMG's operating margin in Q3 benefitted from a better mix, and increased inventory to accommodate strong bookings for Q4.
Our news release details the restructuring plan which we announced at the time of our Q2 earnings and defined during Q3. We are projecting that the full plan will result in a pre-tax charge of about $350 million, (or $ 240 million after-tax), of which about 50% involves non-cash items. Approximately 55% of the charge was incurred in Q3, and the remainder will be taken over the duration of the plan, which should be substantially completed over the next 18 months.
The plan's objectives are to increase ST's cost competitiveness and enhance capacity, which is part of our overall strategy to raise profitability levels by expanding gross margin.
Although impairment and restructuring charges resulted in operating and net losses for Q3, we believe that the restructuring plan is an important step toward enhancing ST's performance potential in the periods ahead.
Our balance sheet at the end of Q3 remained very strong. Cash and marketable securities exceeded $2.7 billion versus total debt of a little over $3.1 billion, giving us a total debt to equity ratio of 0.05. Thus, we have the flexibility to maintain this position, or to leverage it, depending on market conditions and business opportunities. And, our Q3 debt restructuring initiatives have reduced our average interest rate on total debt to 1.2%.
Importantly, we continue to generate net cash from operating activities. At the end of the first nine months of 2003, free cash flow, before acquisitions of $ 135 million, was $ 290 million, after sustaining adequate investment levels to support the transition to 0.13 micron and 90 nanometers. I would like to point out that this is our 8th consecutive quarter of positive free cash flow, before acquisitions.
Leveraging our silicon and system know-how, we are taking full advantage of internal growth opportunities. In Q3, revenues from our 12 strategic customer alliances of $ 760 million were about 3% above Q2's levels and represented 42.1% of total revenues. Thus, much of our sequential revenue increase in Q3 was fueled by product sales to a broader number of key customers.
Our accelerated marketing programs involve the broadening of our product offerings to an expanded customer base through three key initiatives:
- By creating regional competence centers to focus on specific applications
- By increasing design activities in advanced products with multiple applications
- And, by launching a new generation of e-tools for customer support.
Looking by application, we remain focused on our targeted market segments. I mentioned our wireless numbers earlier ---- currently tracking at an annualized rate of over $ 1.7 billion.
And, a word about Flash ---- it is getting better, not yet as profitable as it needs to be, but after a long period of price erosion, we are seeing some stabilization and our orders are picking up significantly.
Now, to our short and longer term perspectives ---------- As we noted in our news release, we expect Q4 to be another quarter of solid growth for ST. Our guidance of 6% to 12% sequential revenue growth is based upon our Q4 backlog and indications we are getting from key customers.
Our revenue growth drivers are likely to be wireless, printers and most digital consumer applications. And, Flash Memory should achieve a significant double-digit sequential revenue increase.
Gross margin, on a constant currency basis, should be between the 36% and 37% range, which we anticipated in July. This range takes into account the effect of Italy's black-out which will cost us about 50 basis points in gross margin. The positive contributors, in addition to increased revenues, should be a higher utilization rate and related manufacturing efficiencies, while pricing will continue to be challenging.
As you read in our news release, our 2003 capital expenditures should be closer to $ 1.2 billion than the $ 1 billion we had previously anticipated. This reflects our increasing confidence in the industry's near term growth prospects. And, our preliminary capital budget for 2004 of $ 1.6 billion is up about 33% on a year-over-year basis, with the majority of these funds earmarked for leading-edge 0.13 and 90 nanometers technologies at our fabs. Moreover, ST's long term strategy of building manufacturing infrastructure in advance will modularly expand this leading-ledge capacity as demand unfolds. Thus, we believe that ST will be very well positioned to profitably take advantage of the favorable industry growth trends that are projected for 2004 and 2005.
And, hand in hand with our focus on top line growth and market share gains, is our emphasis on increased profitability levels. Therefore, we are taking measures that we expect will enable us to accelerate the expansion of our gross margin. These measures include manufacturing restructuring and efficiencies and expansion of the feature-rich and customized products we are selling to a larger customer base, which should benefit our overall pricing and product mix.
President and Chief Executive Officer