STMicroelectronics N.V.
Q1 2007 Earnings Call Transcript

Published: 25 Apr 2007

[Operator:]

Hello and welcome to the STMicroelectronics first quarter 2007 conference call. All participants will be in listen-only mode. There will be an opportunity for you to ask questions at the end of today's presentation (Operator Instructions). For your information this conference is being recorded. I would like to turn the conference over to Mr. Stan March, Vice President, Investor Relations, for STMicroelectronics. Mr. March.

[Stan March:]

Thank you, Vicky. Hello and thanks to all of you on the call for joining us for STMicroelectronics first quarter 2007 earnings discussion. Hosting today's call is Carlo Bozotti, our President and Chief Executive Officer. And joining Carlo on the call today are Alain Dutheil, our Chief Operating Officer, Carlo Ferro, our Chief Financial Officer, Tommi Uhari, our Executive Vice President representing the Application Specific Product Groups, and Carmelo Papa, our Executive Vice President responsible for the Industrial and Multisegment sector. As you know, many of the comments made on today's call will be forward-looking and as such they are covered by the Safe Harbor provisions and risk factors on the most recently issued press release last evening as well as discussed in our 20-F. Should you have any questions concerning these risk factors please make sure you look at these appropriate documents. In terms of housekeeping, we'd like you to keep your questions to one initial question with a follow-up. And then should there be subsequent requests for information on your side, if we just ask you to go to the rear of the queue to make sure we can move through as many callers as practicable in the allotted time today. So with that brief bit of introduction and small amount of housekeeping I'd like to turn the microphone over to Carlo Bozotti to discuss the quarter's performance. Carlo?

[Carlo Bozotti:]

Thank you, Stan, and thank you for joining us in our conference call today. As you have observed, the trough of the multi quarter industry correction has been somewhat different than estimated by us and other industry participants. As a result, our first quarter stage and operating results were negatively impacted by declines in the telecom and consumer segments, a tougher overall pricing environment and unprofitable product mix within the wireless segment. While, I do not want to underestimate the impact of results these last two quarters, I believe ST has done a fair job of navigating operations through this period, while staying focused on advancing our key strategic initiatives in sales and marketing, in carving out and pushing financial deconsolidation of our Flash business, in moving towards a lighter asset model and in generating increased cash flows. Looking at -- we see a resumption of sales growth in the second quarter and believe this semiconductor, this current semiconductor industry correction is coming to an end. Turning to the first quarter, I would like to begin with the Application Specific Group, which was not affected by the industry correction. ASG sales declined 9.1% sequentially with operating income essentially at break even compared to $111 million or an 8% operating margin in the fourth quarter. We saw double-digit sequential revenue decreases in both telecom and consumer products. Importantly, telecom results reflected weak wireless demand, limited mixed shift to higher end products as well as similar to other industry players, weakness in the networking market. The sequential decrease in the Application Specific Group operating income was due to telecom and to a lesser extent consumer, while automotive and computer peripherals maintained similar profitability. Lower volume, down approximately 5% sequentially, was the largest ingredient. A tougher pricing environment, down about 3% sequentially included the impact of January 1st, new pricing contracts. In addition ASG's inventory decreased in the quarter. As we look to the second quarter for ASG, we expect to see sequential revenue growth and this will positively impact volume resulting in improved operating income. We also expect that the mix will improve in the second quarter and this will continue through the year with important new products increasing in volume for all our converging applications. Our Industrial and Multisegment sector, IMS, had a solid performance in the quarter. Sequentially sales were down 5.1% in line with normal seasonality, and the year-over-year sales were higher by 16%. IMS had an operating margin of 14.8% demonstrating some benefit of shifting of our portfolio to higher value added products such as our power conversion and advanced analog. We expect IMS to continue with this strong performance as we move through 2007. Since our January 1st reorganization our NOR and NAND Flash businesses have been combined into a standalone segment. During the first quarter, FMG sales decreased 13.4% sequentially and we posted an operating loss of $17 million due to a gross margin of about 19%. Internal carve-out activities are essentially completed and we are progressing towards the consolidation. Moving to inventory, we actively managed the uploading (ph) to control inventory levels during the first quarter, taking into account the swing in currencies as well as the more severe market conditions. Since the end of December inventory is up $37 million on the balance sheet. However, approximately $17 million is currency related. Therefore the net of currency inventory is up about $20 million exclusively due to Flash memories. We would expect to see improvement in our inventory returns Q1 and Q2 and this improvement will continue to advance as we progress through the year. Turning now to our outlook, firstly, we believe we have reached the trough in the current industry correction and that's the overall so we are now showing the situation should begin improving some time during the second quarter. As we look to our second quarter, we see a resumption of growth for ST. More specifically, our revenue target is for a sequential growth between 4 and 10% giving a mid point of about 7%. Based upon information released by other companies and industry analysts, we expect to show somewhat better sequential improvement in sales compared to the industry overall. We expect to see a strong recovery in consumer and in telecom, with high single digit to double-digit sequential growth. IMS will also certainly be a key factor and automotive, which has a good first quarter both sequentially and year-over-year, is also anticipated to have sequential growth in the second quarter as well. Our gross margin is expected to be approximately 35% plus or minus one percentage point at an average effective exchange rate of $1.34 to 1 euro. The continuing weakening of the U.S. dollar plus our expected effective average exchange rate is 9% lower than the year ago period, will limit the second quarter margin expansion opportunity. In addition, this continued logic product unloading in Singapore coming from the Flash carve-out will negatively impact the gross margin by about 40 basis points. This situation is caused by our removal of logic products from Singapore manufacturing portfolio as we focus this fab entirely on Flash memory products. We are also continuing to manage our inventory levels, so while we will expect to see somewhat better fab loading for ST excluding Singapore in the second quarter, market condition has now resulted in three quarters in a row where the gross margin will not reflect optimal loading of the fabs. While the second quarter group shows the resumption of the growth, we will not be back to the fourth quarter 2006 productivity levels given the depth of the correction as well as currency exchange factors and their impact on ST. Nonetheless, the second quarter performance will be a good step forward as we expect to make progress through the second half of 2007 and to improve our financial average quarter after quarter. Before taking your questions, I would like to share a few financing points with you. First, we continue to focus on cash flow and a lighter asset model for ST. In spite of a significant sequential decrease in the net income due to the severity of the correction, our net operating cash flow increased $20 million to $172 million due to 2007 first quarter, one of the best ever quarterly results of net operation cash flow percentage. Our first quarter capital expenditures of $285 million represented a decrease of 26% from the prior quarter and for the full year. And for the full year we’re driving towards our CapEx to sales ratio target of 12%. Based upon our first quarter investment we are showing (inaudible). In addition to any cash flow this strict capital control will reduce the (inaudible) of our internal manufacturing assets to market fluctuation. Due to our focus on better managing our capital expenditures and moving to a more flexible manufacturing structure, we are generating more cash and we are positioned to return some of that cash to shareholders. At our annual meeting scheduled for tomorrow, shareholders are expected to approve a 150% increase in the annual cash dividend to 30 cents. Second, we continue to advance our sales and marketing initiatives. We have spent our time fruitfully building new relationships and extending existing ones so that our relative market position will be stronger as market conditions improve. For example excluding telecom accounts strategic customer sales were up 1% sequentially. We continue to extend our sales presence in emerging countries and emerging markets. For example, our sales to Japan are up 35% year-over-year. Third, our product portfolio is strengthening. This is evident in the market share gains we achieved during 2006. As you see from our result we have a strong foundation in the Industrial and Multisegment and in the Automotive. During 2007 the work we have been doing in ASG should become more evident. In particular, new ASG products introduced in the first quarter most importantly the 3G digital base band, saw limited sales impact so far, but are expected to ramp nicely through the year. Coupled with planned introductions during the remainder of 2007, including new connectivity products, data-storage System-on-Chips, digital-TV offerings and progressive growth in multimedia processors, we believe our product roadmap and strategy are gaining traction. With that, my colleagues and I will be happy to take your questions. Thank you.

[Operator:]

(Operator Instructions) The first question is from Mr. Cody Acree, Stifel Nicolaus. Please go ahead, sir.

[Cody Acree:]

Thank you, and congratulations on a good outlook, guys. Carlo, could you talk a little bit more about the timing of your flash deconsolidation? Obviously, you're making very specific structural loading plans to get this taken care of. It sounds like some time in the near term, but we've been talking about this for some time now. So can maybe you talk about the timing? And then maybe what the gross margin impact would look like if you are able to get this done tomorrow, what would that impact be to gross margins in Q2?

[Carlo Bozotti:]

Well let's talk about the gross margins. Q2 would be (inaudible). This is our vision, so I think we'll rather than 35 plus minus one would be 38 plus minus one. I indicated in January that we would move forward on the carve-out internally. And now this is essentially completed. And as far as the update on the financial reconsolidation, at this point in the process, I would simply say that we are making good progresses to our objectives. But of course we don't have any, let's say, specific announcement to do today. We are moving in the right direction and we’ll come back to you as soon as practical.

[Cody Acree:]

All right. Very good and a follow-up if I may?

[Carlo Bozotti:]

Please.

[Cody Acree:]

Okay. Could you talk about your end applications and it sounds like we're kind of ending the inventory correction, but obviously not all segments will happen at the same time. Can you talk about where you still believe you're shipping below consumption trend lines and maybe those markets where you believe you're back to consumption trend lines?

[Carlo Bozotti:]

Yes. Well I think that first of all, as I said, as I read in fact, the increasing inventory in Q1 was due to flash -- of flash memories. And I am starting to commence on our products and then I am going to the market. So during the month of March there was a strong negative adjustment on the flash demand. There was a significant reduction of the flash demand. And this has impacted the overall inventory level. Of course the flash but also for the company. And we are going to cure this in the second quarter as we said in our (inaudible) facility. If we go to now the various market segments, I think that in the area of Industrial Multisegment, I would say that overall the inventory position that we see, for instance (inaudible) is under control. We see increasing demand in this area. Bookings are getting stronger and what we see in the first week of April is confirming this strength. So the demand that we see from our mid-sized and small-sized customers including distributors is a good trend overall and we expect IMS will contribute significantly to the growth in the second quarter. Same trend we see in consumer. Consumer was a challenge, particularly after Christmas was very difficult, during the period of the Chinese New Year, very difficult. But today the trend in consumer is very strong. And we expect to see a significant jump in the second quarter on our consumer products. And talking to customers in this area, we do not evidence at this point of real issues in terms of inventory position. Wireless is going to be more mitigated improvement. I think it will take some more time to go back, in fact we believe for us will be in Q3. The inventory position was difficult during the first quarter. I think it is improving, but at slower pace and will increase in Q2, but we expect a stronger growth in wireless in the second half of this year. Automotive grew in Q1 a little bit, we expect to grow, we do not have any evidence of inventory build out in the automotive industry. So, I would say that overall, well computer will not contribute to the growth in the second quarter. I think in the second quarter we expect beginning of stability in our Computer business. And I believe that overall it was some more time to go through the inventory correction wireless. We also have a wireless some evidence, but the mix is now improving. And for us of course this is very important due to the effort and the new products that we have on 3G. But as I said the improvement in the second quarter be somehow limited and we expect strong increase in the second half.

[Cody Acree:]

Excellent. Thank you, very helpful.

[Carlo Bozotti:]

Thank you. Vicky, please, next question?

[Operator:]

The next question is from Mr. Amit Kapoor, Piper Jaffray. Please go ahead, sir.

[Amit Kapoor:]

Great, thank you very much. Obviously, the handset market is being impacted by some inventory overhang from one of the major OEMs out there, as well as some shifting market share, that is vendor focus is more in profitability. With a lot of these changes happening very quickly, could you discuss how you're adapting STMicro to these changes, and maybe some of the opportunities and risks that it brings up in the second half of this year?

[Carlo Bozotti:]

I think Tommi, would you like to try the answer to that question?

[Tommi Uhari:]

Sure, certainly.

[Carlo Bozotti:]

Tommi, can you talk louder, please?

[Tommi Uhari:]

Sure. I think overall for the wireless we see the situation very much like you outlined in your question, that is particularly high end product, end product inventory in parts of the market and then the way that we see that's mostly affecting the low end part of the market. Our product portfolio is very much geared towards the medium to high, high end of the market, so we think that this situation does not impact us in any particular way and we continue to be very confident in the successful ramp up of our 3G products during the second half, and also the strong demand that we are seeing for the existing product portfolio at the moment.

[Amit Kapoor:]

Great, thank you. And then maybe as my follow-up question, could you walk us through some of the major factors that should impact the gross margins later this calendar year?

[Carlo Bozotti:]

Well, obviously the, Carlo you can take of course in the second quarter and then I leave the word to Carlo, in the second quarter the major limitation for us is the strength of the U.S. dollar. So, the impact here is almost one point. But I would like to ask Carlo to comment and response to the question.

[Carlo Ferro:]

It's Carlo. We have characterized already in our press release these two specific factors, the challenging factor whose effect is negative in a range of one point and this peculiar situation of unloading of fab in preparation of fully dedicated this fab to the Flash business after we removed the other product, which of course is an unusual change of un-saturation. And for these reasons we felt appropriate to specifically highlight this negative 40 basis points of impact. So you may appreciate that in the situation dynamic after this event we have some significant factors moving and including the margins. First of all that is there were effect in all the other fabs. This already includes in the first quarter the effect to quarter-to- quarter and of course the impact on margin would be more visible as state of purpose manufacturing as first quarter occurs next quarter. Another is the fab loading, which a pass as case of secure in second quarter substantially normalize, I would say. And the third one is the positive contribution of the mix of the profit. One of the key ingredient, so positively contributed in the second quarter will start a more visible volume of shifting of the digit. On the positive direction while also we look at that by price and we see the price environment is still under pressure, so in the second quarter mainly for Flash and for the wireless applications.

[Amit Kapoor:]

Great, Thank you.

[Carlo Bozotti:]

Vicky, please the next question.

[Operator:]

The next question is from Mr. Nicolas Gaudois, Deutsche Bank. Please go ahead, sir.

[Nicolas Gaudois:]

Yeah, hi there, gentlemen. Just as a first question, and actually my two questions relate to margins. What is somewhat surprising really is Application Specific Group having an EBIT loss of $1 million. As far as I go back in my coverage of ST, I just cannot recall TPN CMG put together, never ever getting close to these levels effectively in clear doing the take downturn. If I was to look at the sequential operating margins or the incremental operating margins q-over-q, you had a decline of revenues into a division of $122 million. And effectively $112 million flew through the P&L. Could you help me rationalize that? And how should we look at the profitability of your ASSP and ASIC business going forward?

[Carlo Ferro:]

Yes, this is a Carlo Ferro, frankly ourselves as well we’re not so much experienced at this level of operating result and Application Specific. We consider that this first quarter 2007 really a specific event where values negative is to altogether concurred to the best match. Carlo in his introduction has mentioned already that in general application specific improved has been a factor that by 3% by pressure. This is a combination of wireless environment and right effect also on other application when entering in the first quarter with new yearly contracted, they new yearly price like for instance in Automotive. The second one is the volume, and volume has been significantly depressed, there being 5% sequential down. The third ingredient is that despite having not met the objective to reduce overall inventory this quarter due to the dynamic in the Flash demand and in the Flash inventory in this specific group, in Application Specific Group, inventory went substantially down from end of December to end of March. This also has affected overall the margins. And I would say that at the end those were three ingredients and their impact on the margin not only for the Applications Specific Group but you over see are they really -- the mostly the ingredient of this dynamic. In addition to the different characterization of the margin change sequential among the core groups that encompass this segment with the Automotive and the Computer groups that substantially capital margin similar to the prior quarter and is being mostly due to the telecom. And all of us know that condition of the telecom market this specific quarter and to a lesser extent the consumer, where the consumer looks substantially driven by the level of sales. This is an application very intensive in term of R&D and very sensitive to the level of sales, the reduction in sales in this quarter is I'd would there are no products, a dynamic of the margin in consumer at which this quarter not deteriorate.

[Nicolas Gaudois:]

Okay, thanks for the details, very useful. Now, just rebounding on what you said, Carlo, on inventory and moving to the positive surprise I would say in your dividend margin, which was for the Flash plus, when we had 5% against your margins, we saw expansion at 12 negative, we think Intel was minus 45 or work expansion mentioned was number on that? And your gross margins were 19, expansion was 14. But you also say about your build up inventory. So should we expect a flow through of inventory really impacting margins for Flash going forward, at least for the quarter? And also could you help us contrast your sales versus expansion in Intel as much as we can in terms of whether there is anything else in terms of mix for instance, which could have helped ST perform better?

[Carlo Bozotti:]

You know, Nicolas, I don't know how much I can, the way I can is to base on the public release information under which it is evident I believe to everybody, that a performance of our Flash business is -- we cannot say we are happy for that, but it's for sure the stronger performing Flash business in the industry. And you have already highlighted, I believe these couple of points of difference in gross margin from our flash business with the other competitor Flash business. This was a difficult quarter also is characterized by heavy pressure on the NAND market and I would add that -- I would say the loss in Flash is driven by NAND this quarter while our NOR business able to continue. The case of inventory will that -- has been substantially related really to the adjustment in demand occurred at the very end of the quarter and these absolutely are related to how to managing the loading of the fab base through the quarter. I would manage the fab base on the expected demand. It proves that this gives effect somehow next quarter, yes, we have anticipated that we had also this effect of unloading in a Nokia, which is a combination of the current inventory situation in flash. But moreover and most importantly, it's due to the fact that approximately 15% of capacity of this that was dedicated to logic, and we have removed the logic from multi rate. Does that answer your question?

[Nicolas Gaudois:]

Yes, it does somewhat. Thanks very much, Carlo, for these depth.

[Carlo Bozotti:]

Thank you for your question, Nicolas. Okay, Vicky, next question, please. Operator

[Mark Lipacis:]

I thank so much for taking my question. A question on depreciation. Depreciation amortization was $398 million this quarter. I was hoping that you would be able to break that into the two components, depreciation and amortization separately. And if you look at your CapEx it seems that you continue to under-fund depreciation expense, which suggests that your depreciation expense should continue to trend down. And I was hoping that you'd be able to give us some guidance or more concrete guidance regarding depreciation expense this year and maybe even a trend line into 2008.

[Carlo Bozotti:]

Okay, yes, we are able to place the 398, 378 depreciation and 22 are amortization. For the year we expect that depreciation at a level of around $1.5 billion, which is $150 million lower than prior year. And unfortunately our current management of capital is not fully reflected on the depreciation projection due to the negative impact of the exchange rate. You are familiar about this effect and you are very aware that at the end it is something that affects negatively our gross margin a way where is a non-cash effect. So depreciation this year is 1.5. Going through next year we can expect that they may continue to go down. We are at the first quarter, in first quarter we have standing capital at $285 million, let's see as the capital spending of the year will work.

[Mark Lipacis:]

I am just unclear, the 1.5 billion that would be for the depreciation line only, not depreciation and amortization, is that...?

[Carlo Bozotti:]

Yes, on the amortization please refer to a flatter trend this quarter, so 22 times 4 in the range of 88 and $90 million m in the year.

[Mark Lipacis:]

Okay.

[Carlo Bozotti:]

Roughly.

[Mark Lipacis:]

Okay. And then, a follow-up question if I may? The inventory, inventories had about 100 days according, as far as I can tell, that's the highest since 1998. Is there any target level that you're modeling to? And if you assume, you know you hit the mid point of your guidance in Q2 and you look at seasonable growth going forwards. How long do you think it will take to get the inventory levels down? And I'm assuming that that's -- that that will impact the fab loadings? Thank you very much.

[Carlo Ferro:]

I guess, this is again a question for me, not -- and I will go to your question not to put justification before, please also consider the fourth quarter performance overall is not midst the harder than the specific Flash event. Our objective is to reduce inventory in absolute dollar in the quarter, also based on the demand and they now go for the following quarter, as we have told about three months ago. At the end, our inventory in absolute dollar increased by $37 million. There is $17 million, which is currency translation adjustment, $20 million, which is the real effect of the operation. And believe me, the Flash inventory increase is higher than these $20 million. Going forward we accept that leveraging on revenues growth and continuing to manage inventory accreted carefully, inventory returns would increase quarter after quarter. So after the second quarter, we target return similar to the one of fourth quarter 2006. And going forward, we expect to continue to improve quarter after quarter, keeping in mind in turn the company target around the company at inventory returns between 4.5 and 5 terms.

[Mark Lipacis:]

Right, thank you very much.

[Carlo Bozotti:]

Okay, Vikki, next question, please.

[Operator:]

The next question from Mr. Otto de la Parque (ph), Cheuvreux. Please go ahead, sir.

[Otto de la Parque:]

Yes, good afternoon, everyone. I've got a first question with respect to equity affiliates. In your P&L we can see that you booked $7 million. Does it mean that your JV with Hynix is profitable? Am I correct in saying that?

[Carlo Bozotti:]

Yes, yes, yes, you are right. This gain on equity refers to our 30% -- 33% interest into the books with the Hynix. Having said that I would not anticipate that you have every quarter these results, to say that this specific quarter also based on the final closing of the joint venture financial report of fiscal year 2006 has sustained ingredient, has a sustained ingredient of, I‘ll say extraordinarily. Apart from that, the joint venture is profitable and this joint venture will continue to be profitable through the year. However that is not more than this very significant level of dollar amount.

[Otto de la Parque:]

Okay. Thank you. And I have…

[Carlo Ferro:]

On the other end, maybe one word from my side, we need to look at the overall net business overall, not just the equity -- the billion dollar in equity. And as Carlo said before, unfortunately in the course of the first quarter our losses on NAND exceeded the $17 million that we have lost overall on the Flash Memory.

[Otto de la Parque:]

Okay, thank you very much. And I have a follow-up, please. A very specific question with respect to Combo Solutions integrating Bluetooth, Wi-Fi -- Bluetooth’s WiFi on FM Tuner…

[Carlo Bozotti:]

Tommi Uhari, can answer that question, please go ahead.

[Otto de la Parque:]

Okay. And some of your competitors, Broadcom and TI, said they have already something -- some solutions. You said, you’ll sample one in H2. Do you think they have a significant advantage on you?

[Tommi Uhari:]

I have understood similar from their announcement and -- but they said, on the schedule that you mentioned. So, basically we are planning for our Combo availability in terms of first samples around the middle of the year -- sorry, sorry about the end of the year for the Wi-Fi, Bluetooth system and then the first step of let say, in the middle of the year with the Bluetooth system. So in this technology; however, what seems to take a long time, it’s the software integration to the platform. And here we have a lot of experience, and a lot of key design wins both on the Wi-Fi and on the Bluetooth. So, I think that’s on -- when does this materialize into business? One aspect is silicon availability, and the second one is really the time that it takes to integrate the software. And we believe that on the software side we are in a very strong position. So, I’ll say that, the juries clearly still out -- on the schedules of us rather just a competition here.

[Otto de la Parque:]

Okay, thank you very much that's very helpful.

[Stan March:]

Okay, Vikki next question please.

[Operator:]

Next question from Mr. Tristan Gerra, Robert Baird. Please go ahead sir.

[Tristan Gerra:]

Hi, thanks for taking my question. Just going back to the basic possibility you mentioned, the unfavorable mix within Wireless. I understand the lower volumes and how this had an impact on profitability in the quarter? But what about the wireless mix at a time when the 3G baseband is supposed to ramp an E&P? Any color on the mix issue within wireless will be useful? And also I was wondering if there was any pricing pressure outside of your wireless business?

[Carlo Bozotti:]

Yes, I think Tommi will take this question. Tommi please?

[Tommi Uhari:]

So, surely I think, the wireless is a very competitive market, and in terms of price pressure that continues. And we are working actively to create more competitive, more competitive product solutions by improving the product competitiveness all the time. Also, and also on existing product, introducing more, lets say, the slot manufacturing technology on those. And then with manufacturing it’s improving, it's improving constantly for all the products. On the mix side clearly with E&P around that will still be a positive thing or kind of will raise the 3G portfolio of ours more versus the 2G.

[Tristan Gerra:]

Okay. Also, could you quantify the impact that you expect from currency on your gross margin Q2 guidance, based on the assumption that you've made in the press release?

[Carlo Bozotti:]

Yes, well I can mention, I think, yes the simple product to quantify. I think compared to Q1 of this year it is about 1 point. And compared to Q2 last year it is about 2 points.

[Tristan Gerra:]

Great.

[Carlo Bozotti:]

So I think it's very clear. And of course, this is something that we are addressing. Not easy, but we address. And I think the memory separation will come some repositioning of our manufacturing infrastructure, of course, both in the kind and in content. And we are addressing this repositioning requirement that is part of the carve-out. Also taking into consideration, into account the needs to reduce disposal to the euro. We have for instance; in terms of manufacturing today we have about 30% of our manufacturing costs in euro. But still, as you see, the impact of this is significant, also because the swing has been significant. I was mentioning that compared to Q2 last year, the swing is almost 10%, in fact 9%. And its almost 2 full points of gross margin Q2 over Q2. But we are working on it, we have worked on it, and we will work more. So this is part of our life, and we believe that the memory carve-out will, as I said, prompt some retuning of the manufacturing infrastructure. And we will take into consideration the need that we have to become less exposed to the euro.

[Tristan Gerra:]

Great, thank you.

[Carlo Bozotti:]

And maybe one day it will be the other way around.

[Tristan Gerra:]

Thank you.

[Carlo Bozotti:]

Thank you, Tristan.

[Stan March:]

Thank you Tristan, Vikki please the next question.

[Operator:]

The next question is from Mr. Didier Scemama ABN Amro. Please go ahead sir.

[Didier Scemama:]

Thank you for taking my question. I have an easy one to start with and then a follow up. Can you confirm that you still have ongoing discussions regarding your NOR Flash business for a carve-out -- sorry, for a joint venture? Thanks.

[Carlo Bozotti:]

Well, I confirm that we have decided to deconsolidate from a financial point of view this business. And I can confirm that yes.

[Didier Scemama:]

But you can't confirm that you are still having discussions?

[Carlo Bozotti:]

Yes I cannot comment on any discussion of course, I -- of course, it's not possible for me to comment. But if the result is the part of our strategy, it is an important pillar of our strategy, because as you know we have decided to operate ST with a CapEx to sales ratio that this year will be 12% or better. It was more than 20% a couple of years ago. And this will go on, and I believe this will bring very significant great step forward in the net asset turnover of the overall company. And as part of this strategy we have decided to deconsolidate the Flash business. And I can confirm that we are active in this process.

[Didier Scemama:]

Okay. I have a follow up on the wireless business. It’s a bit; let me ask it maybe in two parts? With regards to the first quarter, I mean you mention that you were impacted by weakness in the low end. But if I remember correctly I thought your exposure was much more in the mid and high end. At least you've always indicated that you were much more geared towards 3G. And obviously Nokia had a very strong quarter in Q1. So, maybe can you reconcile the two effects, especially given tax instruments reported 10% increased sequentially in 3G revenues? The second part, in the wireless part, is that it seems like two of your competitors are ramping their AGRs (ph) at your largest customer in the second half. Is that having an impact already on your Q2 revenues? And maybe explaining why you see a mitigated development in the second quarter?

[Carlo Bozotti:]

I will comment on the trend, and then Tommi will, let's say, be more specific on answering your question. I think we have (inaudible) in Q1. I think there it was very much related to the market. It was particularly difficult for us on cameras, is a family where we will come back very strongly in the second half of this year. But we had a decent Q1, and this is impacting our wireless figures. I think that overall there will be some increase in Q2. And we expect a very strong increase in the second half although very much driven by the wave of new products that we have introduced, and in fact they are in production. But the impact in Q1 was not material in fact. So, Tommi if you want to comment further.

[Tommi Uhari:]

Yes, I just repeat that with 3G, demand was very...

[Carlo Bozotti:]

Speak a bit louder.

[Tommi Uhari:]

Yes 3G demand was very solid. What I mentioned on the 2G was that what we saw was that in the end equipment we think that it's difficult to do the band Intel product inventory. It is difficult to determine that what is the exact 2G market outlook for the first quarter, due to the inventories carrying over from the fourth quarter. But like Carlo mentioned the cover up issue was one of the items impacting our Q1. Then on the AGRs that has no impact on our forecast.

[Didier Scemama:]

Okay. Thank you very much.

[Stan March:]

Thank you Didier. Vikki, please the next question?

[Operator:]

Next question from Mr. Jonathan Groberg of Merrill Lynch. Please go ahead sir.

[Jonathan Groberg:]

Yes, good afternoon. My first question is on the gross margin impact of unloading logic products in Singapore. Is that not offset elsewhere by increased loading of those logic products, or what's happening to those products?

[Carlo Bozotti:]

Well Carlo, you…

[Carlo Ferro:]

Yes, Jonathan thanks for the question, it has to address a point and I am sorry if answering in too much technical accounting detail. What's happening is that when you move product out of a mature to other logic fab, of course, these higher loading is somehow benefiting the wafer cost, or wafer to a certain extent. While in the meantime this is bringing the fab in Singapore to a level of loading, which trigger accounting for expensing the separation cost. So what's happening is that with the Singapore fab below the threshold to capitalize inventory where a one hit of the saturation cost in the second quarter, due to the unloading of amount of you weight. In the meantime other fabs say, well of course, these productions have been moved enjoy better, slightly better manufacturing costs, wafer costs. This is by the way mostly capitalized. And over time will be reflected in the next two quarters into the P&L. Hopefully I have been clear and it is an easy technical accounting aspect.

[Jonathan Groberg:]

Yes, that's very helpful. Thank you Carlo. My follow up was on the Flash carve-out, now its largely completed can you give us an idea of the value of the asset base associated with the Flash memory group? And so what proportion of net assets we should assume is linked to that?

[Carlo Bozotti:]

Well I am afraid Carlo is taking this again. I am not sure we can provide his egos, but --.

[Carlo Ferro:]

Jonathan thank you I am happy to take another accounting technical question instead, thank you.

[Jonathan Groberg:]

Okay, well I don't have one of those just at the moment, but thank you very much.

[Carlo Bozotti:]

Sorry, for not having met your question.

[Stan March:]

Thank you very much Jonathan. Vikki do you have another question please?

[Operator:]

The next question is from Mr. Janardan Menon, Dresdner. Please go ahead sir.

[Janardan Menon:]

Good afternoon. Just going back to the ASG Group, some of the points you said which affected your margins, like the 5% volume drop and the renegotiation of pricing contracts. Technically these are issues, which can come up every Q1 effectively. So, I was just wondering if you want to move the ASG Group say to the high single digit EBIT margin range across the cycle or across the year, is there anything more structural that you need to do to get to that level? Or do you think that given the current steps that you have in motion will get you there in due course of time?

[Carlo Bozotti:]

Well, of course it’s also there are structural things that we are doing here. The most important structural thing that we are doing is to make sure that we do not suffer like we have suffered in Q4 and Q1 on unloading all the sub-optimal loading in our fabs. And what we are doing, of course, is to increase the portion of business that we are allocating to Silicon foundries to have more significant, how can you call, flexibility platform to use in case of swings in the demand. The way accounting is done, and I do not want to be -- I cannot be too specific here. But of course, the result of ASG overall was severely impacted by the poor loading that we had for instance in the month of December, in the month of January. In fact the inventory in this family has been reduced. And this poor loading situation has hit the bottom line, the gross margin. So this -- I think this is structural. So what we want to do is to ensure that we have a stronger portion of our manufacturing volume outside, and to prevent this to happen and that this is a good opportunity for us. But another, of course, I think element that I want to underline here is that the real problem was wireless. I think Carlo mentioned that in other families there was a continuation of the profitability levels that we had in previous quarters. And the wireless has been severe and, of course, as here the structure of the measure is to make sure that our presence on this family becomes wider positing and also that is a very important socket in the wireless domain. And in Q1 the sales in this field were, of course, very, very intensive R&D work. There was not material work yet. But they will become material in the course of the year with a very significant growth in the second half of this year. So this is another important structural measure that we are taking. So I think that I do not think there is nothing special with the 3% price decline in Q1. I think this is not a business in our industry. But the volume reach in wireless was very significant. The unloading condition in our fab was very significant. And I mentioned that we had technician camera that was also significant, of course, its part of wireless. And was the concurrence of these elements that have hit the margin serious in Q1. We expect to be debt to a more reasonable level in the second quarter, and then to move up in the course of the year.

[Janardan Menon:]

And just to follow up on your guidance, it's a very strong guidance, its unseasonably strong I would say on the revenue side. But on the -- at the same time you are saying that the inventory correction in areas like wireless and consumer will continue into Q2. So, what exactly is triggering that upside? And also is there a currency impact on your sales, and if so how much would that be in to Q2 on the positive side?

[Carlo Bozotti:]

In consumer it's just that we do not have evidence at all of any inventory at this point. I think that the demand of the consumer was very weak in Q1. But now it's very strong. So what I am saying is that wireless may be a little bit longer, but not in consumer just to be more accurate. So, on the topline impact I mentioned at the very beginning primary drivers in the second quarter, there is a kind of recovery in wireless. There is a very strong growth in consumer. I think that the ways of supporting that we have today in the area of Industrial and Multisegment is very good. And in the automotive it's more stable, but there is a continual growth. So the area that is not -- we expect not to see a real growth in the second quarter is consumer and telecom that is relatively stable. In terms of currency impact I will leave to Carlo. But unfortunately overall the impact at the level of gross margin, including the small advantage that we have on revenues, is negative. And we have tried to quantify this impact on the gross margin, and it is about 1% this quarter. But Carlo if you can and want to comment more specifically on the top-line.

[Carlo Ferro:]

Yes, as you know our non-U.S. dollars denominated revenue are less than 20% of total sales, the euro portion is somehow over 15%. So you can measure your own math. At the end, dollar impact on the top-line is not a key driver of the guidance, I would say really well, incorporated in all the various ingredients of a forecast plan, and a guidance as large as 6 points as we do normally provide. What is behind is the level of booking. And you may have also noticed that this quarter we came back to the usual approach to provide guidance on sales on a 6 points range. And for a while, a couple of quarters we have extended it to 8 points and this is driven by higher visibility and a higher level of confidence on the sales when entering the quarter, indeed the second quarter.

[Carlo Bozotti:]

Maybe I can add a word on the dollar impact, because while of course, it may have a small impact on let say next three months, which was described by Carlo Ferro. Two months after as our price as in dollars, our market is a dollar market. Of course, with the complicate did appear, it's a smaller advantage you may have.

[Janardan Menon:]

Sure, thank you very much.

[Stan March:]

Okay, Vikki do we -- I think we have time for one, maybe two questions depending upon -- in terms of the timing here. So, please put up the next one.

[Operator:]

Next question is from Mr. Simon Schafer, Goldman Sachs. Please go ahead sir.

[Simon Schafer:]

Stan, thanks very much.

[Stan March:]

Please.

[Simon Schafer:]

I am sorry, I may have misunderstood the answer a little bit, but with respect to sustainability of target margins and ASG, if I look at 2005 lets say you started off the year with relatively low margins. And also you have driven by inventory corrections, but you still managed to get back to the double-digits. Is that still a target that is sustainable in -- or achievable in ASG?

[Carlo Bozotti:]

Yes. Absolutely, yes, we must do that. And I think we want to have in this family overall a return on capital employed above 12%. And I believe that we have important families in these major groups who are there. There are families who are not there. And I have mentioned some of the structure and measures that we are taking. There are others that we cannot mention. But I believe absolutely yes. I think that on this family we need to go back to return on capital employed that is above 12%.

[Simon Schafer:]

Great, thanks Carlo. And maybe a question on Flash again, some of your competitors, and actually I think yourself as well in the past, have commented that consolidation disappears as if it's a matter of time. But from your point of view do you think your own Flash business would be sustainable on a standalone basis without a partnership?

[Carlo Bozotti:]

Well, I think we are better positioned than others. But this is along the lines. I think that -- I believe that consolidation is the way to go in this family. I believe that with moving to 12 inch manufacturing I think this -- and also with the intensity of technology R&D I think that the consolidation is the right way to go. And this is what we are trying to do. And, of course, the process is complex. The carve-out has been a very complex exercise; it's involving so many functions in the company, from product related to technology R&D, fabs, backend plans and sales and marketing. It is a very complex exercise. But this is the way we want to do, this is the way we want to go, so absolutely yes.

[Simon Schafer:]

Thanks. Maybe as a follow up and adjacent to that…?

[Stan March:]

Sorry. Simon, I don't mean to be rude, but we are trying to get through as many folks in the queue as we can. So if you don't mind can we follow up with you separately?

[Simon Schafer:]

Sure, thanks.

[Stan March:]

Thanks a lot. Vikki next question please?.

[Operator:]

Next question from Mr. Stuart Adrian, Morgan Stanley. Please go ahead, sir.

[Stuart Adrian:]

Yes, hi there, can you hear me?

[Carlo Bozotti:]

Yes, really.

[Stuart Adrian:]

I am afraid I am going to go back to a couple of answers that you gave earlier. Specifically just looking at ASG pricing, I think a year or two ago we talked about the price negotiations in the first quarter and being particularly aggressive as a function of your product portfolio maybe not being as fresh as it could have been. And we've subsequently seen you invest in R&D over the last couple of years as a way in which to refresh your product portfolio. But we are still seeing these big steps down in pricing. Is this something that basically we will just need to see every first quarter that there is a 300 basis point give or take pricing decline? Or is it the fact that maybe some of your new products have not been part of these pricing negotiations that take effect the beginning of this year?

[Carlo Ferro:]

Stuart, this is Carlo Ferro. I would say that normally the pricing pattern from Q4 to Q1 is somehow related to the quality of the product portfolio. And believe me our product portfolio is fresh enough to continue to keep the ground on the relationship with customers. However, there are potentially two different possible approaches in the prices dynamic we sustain clients in families that belong to the application specific group. We have clearly tried that encompasses some expected improvement on the cost structure to the learning curve. And then is released across the year. And for this specific reason normally Q1 is less level and Q4 is more for the level, since we take up front enable adjustment and probably seasonally through the year the cost of structure this, and overrun the objective of the learning the curve. In other cases we have more continued price discussion quarter-after- quarter. And, of course, in these cases the pricing pattern more follow the specific industry related as a consequence. Also, we are not as exposed as Tommi said so much to the lower end of the wireless applications also. Of course, the overall situation and pressure existing for this reason with handset OEM somehow translated in the overall pricing condition for, I believe, all semiconductor supplier to the wireless industry.

[Stuart Adrian:]

Okay. And then maybe just a follow-up, just going back again to inventories, I think on the last call you said that it would be the top priority to kind of manage inventories. And I understand the FX impact and the Flash impact. But even if you back those two out, which were relatively small compared to the overall absolute level of inventories, inventories are clearly still high. I am maybe surprised that you're not doing a little bit more on the inventory side, other than kind of pointing to the forward quarter to kind of move inventories down. Would I be right in saying that is the case, I mean, essentially we are just going to wait till end demand pulls this inventory off your balance sheet?

[Carlo Bozotti:]

Again, Stuart, of course, for us what is absolutely important is also the quality of our inventory and this is absolutely clean. Then there are also different speed of turn in the various product family. For instance I could expect, anticipate that XFlash our inventory turns that could be somehow higher than the one that you see. And my suggestion is when benchmarking with competitors, making sure that we are talking exactly about the same product portfolio. Having said that, there are all sorts of same characterization of the current manufacturing situation that negatively affects inventory level or terms in respect of the competitors. I know where a percentage of purchasing from families is at the end the last years as a part of our inventory is on the work in progress, even the length of the semiconductor manufacturing cycle. And, of course, purchasing a higher volume from foundry will reduce work in progress inventory. And another one is the number of fab and the certain fragmentation into the manufacturing chain. And those are also effect that as part of our overall strategy to make ST lighter asset comp.

[Stuart Adrian:]

Okay. Thanks very much.

[Stan March:]

Okay, Vicky, we have time for this last question please. Operator

[Martino De Ambroggi:]

Good afternoon everybody. My question is still on inventory. Could you give us a rough indication on what could be Flash memory group inventory level? And what could be the inventory terms target once you have deconsolidated FM Group?

[Carlo Bozotti:]

Martino, just because of the question, I try to say again what I have just said in other words. And you may appreciate that at this stage as you have not taken Jonathan question on the asset; we prefer not to answer too much in the strategic level of the table. There will be the right time as we share this information. Inventory terms at Flash are lower than the company average. And as I said XFlash our inventory terms will be somehow higher.

[Martino De Ambroggi:]

Okay. And the follow up on second quarter guidance. Could you give us an indication of the sales for Flash division?

[Carlo Bozotti:]

Normally we offer a 6 point range guidance on the overall ASIC to go to a detailed sales amount for a specific family is something that we prefer not to introduce this quarter.

[Martino De Ambroggi:]

Okay. Thank you.

[Carlo Bozotti:]

Thank you Martino. Sorry, I have not been able to answer your questions as you may have wished.

[Stan March:]

Well, ladies and gentlemen this concludes the Q&A portion of our first quarter 2007 call. I'd like to make one additional observation however. That is for all of you who still have questions remaining, or have further information about the Company that you'd like to explore, please attend our up coming analyst and investor day, which we call our field trip, scheduled for May 10, it's in New York City. If you have any questions about the date or the venue, or the schedule of the day, please contact myself or any member of the Investor Relations team. We've got 90 some odd of you that have signed up. And we hope to see you plenty more. And we will continue an informal and formal session there with Q&A and get through all the questions that might arise for the presentations roll out there. Thank you very much for your participation today. And hope to see you in New York, bye.

[Operator:]

Ladies and gentlemen the conference call is now over, and you may disconnect your telephones. Thank you very much for joining, goodbye.