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Q3 2008 Conference Call Remarks

STMicroelectronics
Third Quarter Conference Call Remarks
Wednesday, October 29, 2008

Carlo Bozotti
President and Chief Executive Officer

Bozotti - Biography

I would like to thank all of you for joining us on today's conference call.

ST continues to focus and make solid progress on operating and strategic initiatives but I must say the market today is quite challenging. Let's review some of the highlights of the third quarter and then I will take your questions.

ST's third quarter revenue and gross margin performance were well within the outlook we gave at the end of the second quarter despite the more difficult economic environment in September. Since then, the outlook for the semiconductor industry for 2008 has declined from mid-single digit growth to low single digit growth due to the turmoil in the world's financial markets. On a positive note, the uncertainty in the markets should benefit ST as the dollar has significantly strengthened vis-à-vis the euro.

Looking at our financial performance in the third quarter, we continued to advance and strengthen our market position, in particular with multimedia convergence applications and power solutions. In comparison to the year-ago quarter, ST, excluding NXP Wireless and the former Flash Memory Group that is now part of Numonyx, grew 10.9% sequentially and 12.4% on a year-to-date basis. We believe our performance is superior to that of the market for the similar periods.

We are also making progress in advancing the value of our portfolio. ST is not just growing faster than the market, we are strengthening our product portfolio as well. A key element of this progress was the completion of the deconsolidation of our former flash memory business earlier this year. Additionally, our desire to develop important products such as MEMS, digital baseband ICs and advanced analog ICs, to name a few, have enabled us to organically grow our revenues and improve our margins. Evidence of our success is our sales to new target key accounts which, in the third quarter increased sequentially by 16% and 47% year-over-year. Further evidence is our clean third quarter revenue growth, in comparison to the year-ago period, was principally driven by a significant improvement in ASP due to a richer product mix which more than offset increasing price pressure. Unit volume growth was important but it was not the principal driver.

Now, we have several important points to highlight in our third quarter results.

First, on August 2, 2008 we completed the creation of ST-NXP Wireless, a joint venture owned 80% by ST. I am happy to report that the integration has progressed very smoothly. In particular, the two management teams have come together to form one cohesive team. In addition, relationships with customers and the alignment of the product roadmaps are on track. Related to the creation of ST-NXP Wireless, we booked $133 million of non-recurring in-process R&D and inventory step-up charges in the third quarter.

Second, ST completed the deconsolidation of FMG and retained a minority equity interest in Numonyx on March 30, 2008. Due to a one quarter lag in reporting we booked a non-cash charge of $44 million of equity loss on Numonyx's Q2 2008 results mostly reflecting stand-up costs and purchase accounting items at Numonyx. A further $300 million impairment charge reflected the significant deterioration in both the equity market multiples for comparable companies and the memory industry. To be very clear, Numonyx has a solid capital structure with available cash of about $490 million and we have no plans to inject additional capital into Numonyx.

Finally, we reported an operating income of $55 million and a net loss of $289 million. Upon further examination of the figures at the business operations level, ST registered an estimated $210 million operating profit or operating margin of 7.8%; net earnings of $178 million and diluted EPS of 19 cents. Additionally, return on invested capital improved to 10.5% during the third quarter.

Turning to our third quarter operations:

Net revenues, before the NXP Wireless contribution, increased 2.7% sequentially to $2.46 billion, compared to our revenue outlook range between -1% and +6%, so we were slightly ahead of the mid-point. NXP Wireless sales for the period starting August 2, 2008 were $241 million.

Our gross margin results also tracked to our objective. Specifically, our gross margin, before the addition of NXP Wireless, increased to 37.2%, compared to our range of 36.8% in Q2, plus or minus 1 percentage point. Currency impact was minimal on a sequential basis as our effective dollar/euro rate was 1.54 in the third quarter, similar to the 1.55 rate in Q2.

Here, I would like to make two key points about our gross margin progression.

First, NXP Wireless was a positive contributor to our gross margin by about 50 basis points in the quarter, and including it in our results for the period, brings our gross margin from 37.2% to 37.7% before non-recurring purchase accounting adjustments. So operating improvements, including a richer product mix and manufacturing efficiencies, combined with the benefits from the ST-NXP JV, led to a sequential improvement in our gross margin of 90 basis points in total from Q2's 36.8% gross margin.

Secondly, on a year-over-year basis, our underlying gross margin improvement is also significant. In the year-ago quarter our gross margin was 35.2%. Since that timeframe, the Euro has strengthened by about 13%, with an estimated impact of 250 basis points on our margin. So clearly we have been creating underlying value as our gross margin progress is coming from a number of enhancements in our product portfolio mix to include our divestment of FMG and addition of NXP Wireless and continuing improvements in manufacturing performance.

Operating expenses have remained under control. Excluding non-recurring in-process R&D of $76 million, operating expenses as a percentage of sales were 30.5%, flat with the prior quarter. As a result, operating income, excluding NXP Wireless purchase accounting adjustments and other one-time charges was 7.8%, up from 6.7% in the prior quarter. From the year-ago quarter, we estimate currency had a negative impact on our operating expenses to sales ratio of about 220 basis points.

Turning to our product segments, we are now reporting under three product segments; Industrial & Mulitsegment (IMS) – the same as before, the newly created Wireless Product Sector (WPS), and Automotive, Consumer, Computer and Telecom Infrastructure (ACCI) which is comprised of our former ASG group excluding ST's wireless business.

ACCI's revenues were in-line with our expectations, and reflected very tough automotive market conditions while Consumer and Computer increased sequentially. Year-over-year growth of 9.6% was led by strong growth of both automotive and digital consumer products.

MS continued its strong performance, led by MEMS, IPAD, Smartcards and Microcontrollers. In addition, we continue to enrich our product mix in IMS, with ICs representing 64% of IMS sales in the third quarter compared to 59% in the year-ago timeframe. Sales of ICs were up 8% sequentially an impressive 21% year-over-year.

Our portfolio improvements are clearly evidenced in the operating returns for this business. Specifically, IMS operating profit was $152 million, improving both sequentially and year-over-year. Our focus on new product innovation is delivering results, in particular in Advanced Analog, MEMS and Micrcontrollers.

Total WPS sales, including NXP Wireless, were $696 million and operating profit was $22 million, net of $12 million of recurring amortization of acquisition related intangibles.

We had indicated in our communications about the joint venture that we anticipated achieving cost savings of approximately $250 million over a three year period. With the integration having gone well, and in light of the wireless industry being under pressure due to the current environment, the JV is working to accelerate the savings initiatives. Consequently, we expect to start to see some of the benefits from these actions starting next quarter.

For the first nine months, net cash from operating activities was $1.33 billion and net operating cash flow was $487 million, excluding the $1.69 billion paid for M&A transactions.

Both our cash generation ability and our conservative approach to managing our capital structure have enabled ST to make sizeable moves to improve and enhance our market opportunities and future cash generating activities. We were able to self fund $1.7 billion for acquisitions while increasing our cash dividends to among the highest in the semiconductor universe and undertaking a share buyback program.

Let me also add a comment on our net financial position which was a net debt of $409 million in the third quarter. Up until this quarter, we had a net positive cash position 11 quarters in a row. We firmly anticipate returning to a net positive cash position following the completion of the ST and Ericsson joint venture.

Going into the third quarter we had spoken of a mixed macroeconomic environment and it was clear that we would see weaker results in our automotive business, which we did. The narrow financial challenge has now turned into more of a broad economic crisis, resulting in most of the semiconductor industry looking at a much different Q3-to-Q4 dynamic. Instead of the typical seasonal growth we normally see in the fourth quarter, we are now expecting a seasonal decrease.

We expect sales to range between flat and -8% sequentially. This would lead to a fiscal year growth of between 6.2% and 8.6% excluding both FMG and NXP Wireless.

Despite the sequential decrease in revenue, we expect that our gross margin will show significant sequential improvement to 38.8%, plus or minus 1 percentage point. Our Outlook is based upon improved operational factors and a more favorable currency rate, partially offset by reduced fab loadings during this timeframe.

Our fourth quarter outlook is based on an assumed effective exchange rate of about $1.40 to 1 euro. In addition, this outlook includes the results of ST-NXP Wireless for the full quarter but excludes an estimated $30 million cost in the fourth quarter due to an inventory step-up purchase accounting adjustment related to the former NXP Wireless business.

Summary

In August, we announced plans to combine our ST-NXP Wireless joint venture with Ericsson Mobile Platforms. In combination, the fabless JV will be a leading player and will offer the industry's strongest product offering in semiconductors and platforms for mobile applications. Once approved and started, we believe this new leader will be well positioned to continue and extend customer relationships with the most innovative players in the wireless industry.

To conclude, we have four key priorities at ST:

  • First, the market environment has changed quickly so we will continue to take the appropriate actions to navigate through this downturn. Importantly, we have the financial strength and resources needed to both manage through and emerge as a stronger industry player;
  • Second, even though we are benefiting from a stronger dollar, we will continue to optimize our cost structure, improve our manufacturing efficiencies and advance our asset lighter strategy. Our plans to rationalize our manufacturing operations are well under way but we have not yet reached an agreement to sell our Phoenix fab. Our priority is to sell the fab as an ongoing concern but under the current difficult market conditions we will move forward with our original plan while attempting to find other potential solutions;
  • Third, with respect to our wireless business - as I indicated earlier, we are moving forward on an accelerated timeline to capture the identified synergies. At the same time our goal is to complete the ST- Ericsson joint venture as soon as feasible and to have a clear roadmap to drive success upon closing of the JV;
  • Fourth, we want to continue to leverage vital assets, in particular, our strong base in power solutions. Our presence in MEMS, IPAD, Advanced Analog and Microcontrollers, to name just a few of our many products, are important contributors to our performance. Our new products have enabled us to increase our position in our new key target customers.

In summary, I would like to conclude on our strong financial position. Thanks to our systematic ability to generate operating cash flow and our solid capital structure we have been able to advance our strategic initiatives independent of the uncertainties in the financial markets. We are very proud of our accomplishments in the first nine months of 2008 and we are well positioned to face the downturn in the markets.

Now let me stop to take your questions.


BOZOTTI SIGNATURE
Carlo Bozotti
President and Chief Executive Officer