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Tech firms face new fear: currency fluctuations

Posted: 06 May 2008 ?? ?Print Version ?Bookmark and Share

Keywords:currency fluctuation? dollar slump? financial results?

In Q1, currency fluctuations lifted margins at Apple Inc., thumped profitability at STMicroelectronics NV, derailed carefully calibrated operating earnings projections at Infineon Technologies AG and gave executives at Taiwan Semiconductor Manufacturing Co. a fright that they promised firmer pricing schemes.

At the beginning of this decade, the U.S. dollar and the Euro were at parity, and fluctuations in the values of the two currencies were limited and unremarkable. Top executives paid scant attention to the foreign-exchange markets and consigned the strategic steps needed to contain the negative effects of currency fluctuations to financial advisers.

No tech executive whose company operates internationally can afford such complacency any longer.

The fluctuating currency market is affecting more than fiscal results; it is also skewing competitiveness and preoccupying corporate boards as top management confronts one more issue over which it has limited control.

Dollar slide
In Q1, the pains and gains from the weakening U.S. dollar were unevenly distributed; but across the high-tech sector, executives are wandering into a topsy-turvy currency world that few are equipped to manage. That's concerning, because what happens in the forex markets can be critical to companies' results and to how investors rate them in equity markets.

Currency fluctuation has become a hot-button topic among manufacturers, including chip companies and OEMs that traditionally tally their revenue and operational costs in the now-unstable dollar. Although analysts believe European companies were hardest hit by the dollar's decline in Q1, rivals in Asia also felt the squeeze, and reportedly some corrective measures came up short.

"For European companies competing in the United States, the falling dollar and slowing U.S. economy will continue to be a drag on performance," Andreas Zsiga, a Stockholm, Sweden-based analyst with Standard & Poor's, stated in a report. "The region's highly export-oriented aerospace and defense, automotive, forest products and high-tech industries are most exposed, to the detriment of their profitability."

How severe is the dollar's slide? At the beginning of the decade, the dollar was worth 1.0155 euros, according to the U.S. Federal Reserve Bank. On April 30, the dollar had weakened to $1.5568 against the euro. Most of the declines have occurred in only the past six months, with the dollar dropping in value against the euro approximately 10 percent.

Even companies that have benefited from the weaker dollar!primarily U.S.-based tech players!find themselves less able to pinpoint projected earnings or losses, gross margins, revenue and cash flow because currency exchange projections have themselves become less reliable.

Medical equipment manufacturer Boston Scientific Corp. and vendor Apple are in this category. Both had based their Q1 revenue estimates on dollar exchange rates that dramatically changed during the three-month period, boosting revenue and margins on gains from foreign sales.

At Boston Scientific, "the contribution of foreign exchange in sales growth for the first quarter was approximately $100 million, or positive 5 percent," said chief financial officer Samuel Leno.

Apple, for its part, had expected its gross margin for the quarter would decline 2.7 percent but instead posted a smaller, 1.8 percent drop, "primarily due to the favorable commodity environment, higher revenue and a weaker dollar," said chief financial officer Peter Oppenheimer.

Company woes
Meanwhile, TSMC saw the opposite effect on its results!one that company executives fear will extend into the current quarter.

Primarily because the company's sales are denominated in U.S. dollars, gross margin at TSMC fell 4.1 percent during the first quarter, while its operating margin sank almost 6 percent, according to vice president and chief financial officer Lora Ho.

The foundry provider has stated that it expects its Q2 gross margin to range from 43 to 45 percent, "including approximately a 1.7-percentage-point negative impact from the forecasted appreciation of the New Taiwan dollar."

TSMC based its Q2 forecast on an exchange rate of 30.24 New Taiwan dollars for each U.S. dollar. As of May 1, however, the U.S. currency had strengthened against the New Taiwan dollar to approximately NT$30.49 per U.S. dollar, which would benefit TSMC's results.

By contrast, "For each 1 percent of New Taiwan dollar appreciation against the U.S. dollar, our gross margin will be reduced by 40 basis points," said Rick Tsai, TSMC's president and CEO. "However, we will make it up by more cost reductions and firmer pricing."

The dollar also improved against the euro last week, following the U.S. Federal Reserve Bank's decision to reduce its benchmark borrowing rate to 2 percent. That's a possible boon to European semiconductor companies ST and Infineon, both of which were savaged by currency exchange swings during the Q1.

Germany's Infineon is particularly vulnerable, judging by executives' comments during the company's last quarterly conference call. The Munich-based semiconductor supplier is shooting for a "low-single-digit positive earnings before interests and taxes [EBIT] margin, excluding net gains or charges," for the current fiscal quarter.

That goal may be difficult to reach because of the currency exchange environment. Infineon based its forecast on a $1.45/euro rate; but as president and CEO Wolfgang Ziebart pointed out, the dollar weakened further, to $1.60/euro, before Infineon announced its revenue outlook.

"Should an exchange rate of $1.60 be sustained through the entire 2009 fiscal year, this 15 percent deterioration would lead to a reduction in Infineon's EBIT of about 120 million euros compared with the 2008 fiscal year, based on our current revenue projections," Ziebart said. "Achieving a 10 percent EBIT margin after an additional hit implied by this exchange rate would not be possible."

Infineon is not alone. Fellow European semiconductor vendor ST has seen some of the positive impact of its cost-cutting actions reversed by the weakening dollar. The Geneva-based company used an exchange rate of $1.47/euro for its Q1 08 results, vs. $1.29/euro during the Q1 07.

On a constant-exchange-rate basis, ST's Q1 08 revenue would have been much higher than the $2.48 billion reported, and its gross profit margin would have been about 3 percentage points healthier. Additionally, its combined R&D and selling and general and administrative costs would have been lower by about $750 million.

If only missed revenue and profit forecasts!of interest largely to investors!were the only challenges posed by the unstable foreign exchange environment. But such is not the case.

Companies could face problems as senior executives venture into the arcane world of currency hedging and derivatives!black arts that baffle even financial experts. Executives must also cope with the fallout on operations. For example, the dollar's decline has helped jack up crude-oil costs, exerting severe pressure on transportation costs.

Cost reduction
Unable to control the exchange rate environment beyond hedging activities, most companies are actively focusing on cost-reduction activities. In some cases, they are renegotiating supplier contracts and transferring overhead costs and other manufacturing activities to regions that are more immune to the weak dollar.

Infineon's actions include "switching contracts for euro-based suppliers to U.S. dollars," CEO Ziebart said.

"We have also started to shift value creation to some extent from euro-based operations into dollar-based operations or to Asia. For example, we have outsourced quite some activities in IT in the past, and we have changed this to insourcing. But we have also founded a new IT site, in Melacca [Malaysia], a low-cost area where we already have built up 150 IT people."

While Ziebart has battled a currency exchange headwind, James Flaws, vice chairman and chief financial officer of Corning Inc., saw his company ride a tailwind in Q1: a favorable yen/dollar rate that clipped income expenses.

"Our second-quarter guidance is based on a yen-to-dollar rate of 103," Flaws said. "Investors should remember that the yen averaged 105 in the first quarter, so if it does average 103 in the second quarter, our display sales benefit by about $25 million."

As this story was being prepared, the yen was at 104.08 to the dollar, and the dollar was at 1.544 to the euro.

Neither Ziebart nor Flaws knows where the numbers will stand on June 30.

- Bolaji Ojo
EE Times

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