2006 Third Quarter Conference Call
Final

STMicroelectronics NV
Carlo Bozotti, President and Chief Executive Officer
STMicroelectronics 2006 Third Quarter Conference Call Final

I would like to welcome all of you to this conference call.

Overview
As our financial results for the third quarter and nine months demonstrate, ST continues to make steady progress in improving the performance of the Company.

First, we have regained market share. This began about one year ago and we have continued since then. Revenue for the third quarter increased 11.8% year-over-year and is up by 13.5% for the year to date. In comparison, the industry has grown approximately 8.5% so far this year. Based upon our outlook for the fourth quarter, we expect to grow the top-line approximately 11 to 13% in 2006. And we believe our strengthening product portfolio and customer initiatives position ST to continue this market share growth next year.

Secondly, we have made great strides in improving our profitability. Specifically, ST has delivered significant year-over-year growth with third quarter operating income up 90%, operating margin expanding 320 basis points and earnings per share more than doubling. In fact, I would also like to emphasize that this is the fourth quarter in a row of earnings per share growth on a year-over-year basis.

Thirdly, we have clearly repositioned the cost structure of the Company over the last year and a half. Improvement in profitability is not a result of higher revenues alone. Both our gross margin for the third quarter and our fourth quarter gross margin outlook demonstrate that our cost restructuring initiatives are delivering. Even with limited sales leverage from Q3 to Q4, we expect to show sequential gross margin improvement. In addition, to some extent currency volatility has clouded the level of underlying improvements in our cost structure.

And finally, the careful management of capital investments has been a key priority. This is evidenced by both improvements in return on net assets, or RONA, as well as capital intensity trends over the last two years.

• We have seen growth in RONA in each quarter of 2006. For the third quarter, our RONA was about 10% and is now at a similar level to our weighted average cost of capital. We have more improvements to come, but we are clearly showing progress on this front.
• Our capital spending trends have important implications for depreciation levels going forward. Based upon our fourth quarter plans, we anticipate that our 2006 capital spending will be approximately $1.6 billion, or $200 million lower than we had previously communicated. I am pleased to say that we have been able to meet our investment requirements by more efficiently utilizing our worldwide resources.
• And - for the second year in a row - our annual capital spending level will be below depreciation. A lower depreciation level in 2007, set to decline by approximately $150 million from 2006, will be an important lever, together with greater manufacturing efficiency and our richer product portfolio, for gross margin improvement in 2007.

Now, let’s turn to our financial review for the third quarter and nine months.

Third quarter and nine months review
Our largest sector, representing over half of our revenues, is the Application Specific Product Groups. Their products are the core focal point of our R&D reorganization which occurred last year. We have started to see the benefit of an improved product portfolio in our figures and anticipate even more benefits as we move into 2007.

While ASG’s revenues were essentially level with the second quarter, operating income rose 16% to $125 million from $108 million. We benefited from an increase in wireless volumes as well as some mix improvement. For the first nine months of this year, ASG’s revenues are up 10%, with operating income sharply higher, posting a 50% increase. Our operating margin for this group was 9.1% for the quarter and 8.1% year-to-date, demonstrating substantial progress in comparison to the year-ago periods.

Advances in ST’s product portfolio are already visible in the results for MPA. As we stated last quarter, we are absolutely delivering on plan for growth and for margin expansion in this group. MPA sales increased 6.3% sequentially. Looking at year-to-date performance, MPA’s sales are up almost 19%, higher than any other group. And operating income is up even more at 27%. From a profitability standpoint, MPA is also the leader, with an operating margin of 15.7% year-to-date. Overall, this impressive performance by MPA confirms the soundness of our strategic decision to focus on advanced analog ICs and complete solutions for the industrial market.

In MPG, our primary day-to-day focus is on maintaining a positive operating income through technology migration and manufacturing excellence as we continued to do this quarter. The environment remains tough, especially in NAND, with price pressure ongoing. On a sequential basis, Flash memory sales, which are about 15% of total ST sales, decreased 7% to $375 million.

Just briefly touching on operating expenses, you can see from our numbers that we continue to manage carefully where and how we invest, and this focus will continue. We did increase R&D spending in the quarter by 3%, driven by important efforts in process technologies and dedicated products.

On inventory, we saw turns decline slightly to 4.1, as shipments in the third quarter were below initial expectations. Given this deterioration in turns we will be carefully managing factory loading and plan the holiday closing of certain fabs to improve inventory levels. However, within the current environment we do not expect to meet our 4.5 inventory turns target in the near term.

I would like to highlight one additional area of significantly improved performance for ST, and that is cash flow. We have continued to systematically generate positive cash flow for the past 5 years, and as you have seen, ST generated over half a billion dollars in net cash from operating activities in the first nine months of 2006. We expect this trend of positive cash generation will continue.

Now, let’s move to our outlook for the fourth quarter.

Fourth Quarter Outlook
For the first nine months of this year, the semiconductor industry has grown about 8.5%. We expect growth to moderate for the remainder of the year as we see some correction in the current semiconductor cycle that may last a few quarters.

As a result, we would expect that ST’s sequential growth will be below our historical levels, with wireless and automotive sales anticipated to be below normal seasonal trends. Automotive will be affected by market weakness, particularly in the U.S., while wireless will suffer from a product mix towards the low end. This leads to an expected fourth quarter revenue growth range between -1% and + 5% on a sequential basis.

Importantly, even though our fourth quarter revenue outlook, reflecting industry conditions, is somewhat lower than we would have anticipated earlier in the year we expect to continue to see gross margin progression. Our fourth quarter gross margin is expected to be about 37%, plus or minus 1 percentage point. This guidance demonstrates the leverage of translating over 90% of incremental sales to gross profit.

Our revenue and gross margin outlook assumes an average effective rate of 1 euro to 1.265 US dollar for the fourth quarter.

So, ST is making important progress across our three major initiatives – we are strengthening our product portfolio, increasing our market share and improving our returns on investment capital.

Looking Ahead
However, these results are not the end of our efforts. As I just touched upon there is a correction underway in the current semiconductor cycle which has caused us to lower our 2007 market growth expectations to about 6-7 %. Despite this tougher environment, ST is poised to again significantly outperform the market. To drive towards this level of performance we will continue to execute our customer, regional and new product initiatives.

Now, let me share with you our most important strategic initiatives underway:

First, in technology R&D, we are addressing the likely changes in the Crolles 2 alliance. We are not waiting. We have potential solutions in our hands already, and through these new partnership options we will continue to lead the way in CMOS technology development below 45 nanometers.

Second, in Flash memory we are pursuing industry consolidation and financial deconsolidation. Let me just say that we are dedicated to a solution here and believe the current environment better positions ST to achieve this objective. Once completed, this will increase asset turns, as well as increase operating margin.

And third, ST will evolve into a less capital intensive company. As you know in the past, ST’s capex to sales ratio has been in line with the industry average, over 20%. We have been successful in improving our capital spending levels over the past two years, bringing this ratio down from 22% to 16% or so by the end of this year. Looking forward, we are working to shift this ratio towards a new target of 12%, through a combination of a less capital intensive product portfolio, increased usage of foundries for non-proprietary technologies, and optimization of our manufacturing resources.

In summary, we are pleased to see the progress in RONA over the past seven quarters from 1.5 to 10%. These additional actions are being implemented to further expand our RONA, as we strive to move into and remain within our targeted range of 12 to 20%.

My colleagues and I would now be happy to take your questions.


Carlo Bozotti
President and Chief Executive Officer