Conference Call Remarks
President and Chief Executive Officer
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 advantages that ST enjoys, thanks to our emphasis on differentiated products and the strength of our strategic customer alliances. In fact, at a little over S1.7 billion, Q2 revenues came in just at the mid-range of our guidance.
Although of course, we would have welcomed some upside surprises, the SARS epidemic did have a dampening effect on many businesses, including ours, so on an overall basis, we are pleased with the sequential and year-over-year revenue increases of 5.2% and 11.2%, respectively that were achieved in Q2.
As anticipated, the sequential pick-up demand came from wireless, printers, set-top box and certain automotive applications.
As you know convergence has arrived, and it is increasingly more difficult to assign a customer application to a precise market segment. With the caveat that the variance in the absolute dollar amount could be from 5% to 10%, we can tell you that on a sequential basis, Telecom was up nearly 9%, Consumer over 6%, Industrial and Other, which includes Smart Cards, increased about 8%, Automotive was up over 3% and Computer was down about 2% sequentially.
Flash memory revenues rebounded by almost 10% sequentially despite continued price declines, and Discretes revenues increased 11.5% from the first quarter.
Gross profit of $607 million represented a sequential increase of 7.2%, equating to a gross margin of 35.7%, which was at the low end of our guidance range.
Several factors constrained our ability to further expand gross margin in Q2. The most significant of these was the short-term effect of continued erosion of the US dollar.
From Q1 '03 to Q2 '03, the dollar lost another 5% on average vs. the Euro and certain 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.
The stronger Euro vs. the US dollar had a substantial negative effect on our reported operating expenses, the majority of which are Euro-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 aimed at expanding our customer base. Thus, operating income, net income and EPS were flat on a sequential basis.
For the first half of 2003, our 15% year-over-year revenue increase compares favorably with estimates for the industry of about 12% growth and puts us in line with projections for our served market. As you know, several industry rankings based on 2002 revenues place ST in leadership positions in our targeted markets segments and we believe we retained those positions in the 2003 first half.
I believe it is noteworthy that, underlying our commitment to R&D, we added approximately 1,000 design engineers over the last 12 months.
Our balance sheet remained strong with cash and marketable securities of $2 billion. Long term debt was reduced by two bond buy-backs 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 to equity ratio of 0.06.
The sequential increase in inventories in Q2 resulted primarily from a deliberate build-up of certain 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 US dollar.
Net cash from operating activities was $776 million for the first half, and free cash flow was $54 million after payments for acquisitions of about $140 million.
Capital expenditures were $298 million in the second quarter, bringing first half capex spending to $554 million. This is basically in line with our 2003 CAPEX projection of approximately $1 billion, about 60% of which is allocated to leading-edge technologies and strategic R&D programs.
With respect to our outlook for Q3, we provided a guidance range for revenues of between $1.7 billion and $1.78 billion. This reflects the fact that, while demand from several end-markets is progressing, pricing pressures remain strong due to continued industry wide overcapacity. And, there are still no firm signs of a global economic recovery. Within this environment, we believe it is prudent to anticipate Q3 revenue performance that will be flat to about 5% above Q2 levels and from 3% to 8% ahead of last year's third quarter. We expect to see relative strength in Q3 from applications including telecom, set-top boxes, smart cards, automotive and audio applications.
As stated in our earnings release, inventory reduction will be a priority in Q3. Additionally, the impact of current pricing leads us to anticipate a gross margin of approximately 35%.
For the full year we believe that the industry will grow about 10% from 2002 levels. The pricing situation we see today, however, combined with the effect of a strong Euro on our cost of goods sold, have caused us to lower our target range for Q4 gross margin to between 36% and 37%.
Within the difficult industry environment that has persisted over the last 2+ years, ST has distinguished itself by consistently remaining in the black. Efforts to increase our profitability levels in 2003 commensurate with revenue growth, however, have been hampered by the factors discussed earlier.
To firmly address this situation, we will finalize a plan during the 3rd quarter to increase our cost competitiveness by migrating at least one half of ST's 6'' wafer production in the US and Europe either to finer geometry 8'' wafer fabs or to our 6'' wafer fab in Singapore. This plan, which will include a timetable, related impairment and restructuring charges as well as manufacturing costs savings, will be announced once it is finalized, which is expected to be no later than when we announce our Q3 2003 results in October.
With respect to top-line performance, ST continues to emphasize building revenues from strategic customers, which accounted for 44.5% of our net revenues in the first half of 2003. At the same time, as we move from System-on-Chip solutions to providing full application platforms, we see important opportunities to expand our market to an even broader customer base.
At this point, we would be pleased to respond to your questions.
President and Chief Executive Officer