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Q4 2005 Earnings Conference Call Remarks
Thank you for joining us today and for your interest in ST.

We continued to improve the financial performance of the Company. Our fourth quarter results were on target with our goals. At the top-line, revenues were solidly in line with our objectives. And from a profitability perspective, gross margin came in above the middle of the range we shared with you at the time of the third quarter release. Looking more broadly at our financial performance, we are seeing progress across our most important financial metrics, as I will share with you shortly.

As we look at the full year in review, 2005 has been a year devoted to strengthening and reshaping ST into a stronger and more competitive industry leader. We have undertaken a number of important initiatives and we have made progress on them. At the same time, we still have several challenges in order to better align our performance with our corporate objectives. Overall, we are moving in the right direction, with the right plans and I believe that our constant quarter over quarter progress through 2005 demonstrates this. Importantly, we are executing according to our time-line and we are utilizing ST's significant assets and resources to drive our progress.

Now, let's turn to a more in-depth review of the fourth quarter and summary highlights for the year.

Net revenues in the fourth quarter increased 6.3% sequentially, compared to our objective of 3 to 9%. Wireless applications were the primary drivers of this growth increasing double-digits sequentially and year over year. We experienced growth reflecting strong volume in the wireless end-markets and an expanding customer base.

By product group, Application Specific Product Groups accounted for 55% of the net revenues in the fourth quarter. On a sequential basis, sales increased 3.4% reflecting wireless growth. Application Specific Product Groups attained a double-digit operating margin over 10%, a 69% sequential increase in operating income.

MLD sales rose approximately 5% compared with the third quarter, reflecting a higher level of turns business in the distribution channel. The group was able to maintain a nearly 14% operating margin, which was similar to the third quarter level.

MPG results improved further from the third quarter. Our progress in MPG comes from our significant internal efforts to minimize the impact of the ongoing difficult pricing environment in FLASH. Looking at our results, total MPG sales increased 14.4% sequentially, with FLASH memory sales up 24%. We were able to post an operating profit in our memory group, in comparison to the third quarter loss of $17 million, due to higher sales and a richer mix for our FLASH products. This higher ASP reflects the migration efforts well underway in FLASH, despite the continued quarter to quarter decrease in prices. We have reached our fourth quarter objective, with 2bit per cell representing about 80% of our wireless production, progressing from 60% in the third quarter and 25% in the second quarter.

Gross margin continues to move in the right direction. Gross margin was 36.5% in the fourth quarter, improving about 240 basis points sequentially. Volume, enhanced product mix and manufacturing performance accounted for about half of the improvement, with more favorable currency representing the other half as we had anticipated. These two positive factors in combination more than offset continued pricing pressure.

On the expense front we also made progress. As stated we have targeted to have operating expenses under 28% of net revenues. We were moving in that direction over the last few quarters and with the fourth quarter we have achieved that goal on a quarterly basis with combined SG&A and R&D expenses totaling 27.7% of net revenues. While sales growth and more favorable exchange rates were also positive factors, our cost initiatives were key contributors to the sequential quarterly improvement as we absorbed about $12 million of higher stock-based compensation costs and pension accruals.

We are also making further progress in increasing our net operating cash flow with an increase to $290 million in the fourth quarter, up from $173 million in the third quarter and $23 million in the second quarter. At year end, our financial position has improved with a move to a net cash balance of over $200 million compared to an $8 million deficit one year ago.

Better utilization of our capital is one of our key priorities. We have been carefully reviewing our capital expenditures. For 2005, our capital expenditures totaled approximately $1.5 billion, down significantly from over $2 billion last year and also well below the $1.85 billion depreciation costs.

We have completed our initial capital expenditure plans for 2006. We have several major objectives for the year. Looking specifically at our major projects, the majority of this amount is for expanding our 300 mm leading edge capacity and our advanced proprietary 8” technologies. We also need to expand our back-end assembly and test operations due to volume growth.

Inventory turns were 4.3 times in the fourth quarter. As we indicated last quarter we would not reach our targeted range this quarter. I want to emphasize, however, that we are committed to improving inventory turns to a targeted range of 4.5 to 5 turns during the second half of 2006.

Moving to our outlook for the first quarter, we expect to see our typical seasonality and therefore, anticipate that first quarter 2006 sales may decrease between 1% and 7% sequentially. Based upon the seasonal mix and volume impacts we expect the gross margin to decrease sequentially to about 35%, plus or minus one percentage point.

From a revenue perspective, our objective is to increase first quarter revenues between 7% and 14% year over year. And from a gross margin perspective, our objective is substantially better than the figure which we reported in the first quarter of 2005.

Since our underperformance at the outset of 2005, we have redoubled our efforts, developed action plans and moved forward with an aggressive roadmap to improve the business and financial performance of the Company.

There are three major phases to this plan from a timeline perspective:

First, 2005 has been a year of restructuring and refocusing.

  • We have sharpened our considerable R&D investments where we have redeployed approximately 10% of our engineers, a substantial effort involving over 1,000 research and development engineers.

  • We have been focusing our efforts to reduce costs and improve our manufacturing. On the cost side, we can confirm that we have been able to reduce our cost structure by $100 million compared to the year-ago period, by our initiatives in purchasing, centralization and increasing efficiencies.

  • Our 6-inch restructuring program is on track from a timetable perspective. We expect to see the bulk of the positive results commencing in the third quarter of this year.

  • Our headcount rationalization program continues to move forward and at the end of 2005 we were approximately 40% completed with our plans from a timetable perspective.

  • Our second phase is underway. After the significant drop in sales in Q1 2005, we have in the past nine months, on a cumulative basis, gained market share, and we intend to accelerate this improvement in 2006. I would point out, however, that this recent recovery of our market positioning is coming from applications such as: wireless up 20% in 2005, data storage up 17% and automotive up 8%. Our goals are to build upon these strengths as well as to recover where we lost ground, notably in consumer products where we are positioned to accelerate our improvement this year.

    The third phase of our roadmap, therefore, is the development of a stronger, more consistent pipeline of new products, which by its nature takes more time. Our significant R&D efforts underway are targeting.

  • In MLD, advanced analog products for industrial applications, which are instrumental for our success in broadening our customer base and enhancing the margin dynamics of that business;

  • In memory, there is a wave of new products for both NOR and NAND on 70 and 65 nanometers, with a strong focus on 2 bit per cell. In this area let me share a few additional points. We have done important work on internal manufacturing and our cost position with our memory operation. ASP increases over the last two quarters are clear indicators of this progress. However, the dimension of scale is a critical element in the memory business, and therefore we continue to be active in strategic discussions and we expect to update you in a reasonable period of time.

  • In automotive, as I have stated before, our technologies perfectly address the needs of this market. We are well-positioned to add new attractive opportunities- and you have seen some highlighted in our press release.

  • In computer peripherals more specifically data storage and printers, new applications are driving growing volumes. In addition, we have an opportunity to expand our positioning due to the disk drive industry consolidation.

  • Importantly, in consumer, our new products are beginning to ramp production for set top boxes, and we will see the positive effect of our digital TV offerings in 2006 as well.

  • Finally, new products in wireless, with 3G, and in particular multimedia and connectivity, where we want to secure and expand our higher dollar content position and benefit from the increased sales in the market.

  • Our R&D focus and emerging design wins are the engines driving the new products that we will launch, particularly in the second half of 2006 moving into 2007.

    In closing, we have a good deal of work ahead of us, but we are confident in our plans underway, our resources and our people. We look forward to reporting on our progress as we move through 2006.

    At this point, my colleagues and I would be happy to answer your questions.

    Carlo Bozotti
    President and Chief Executive Officer