News Release

Q4 2006 Earnings Conference Call Remarks

Conference Call Remarks, January 24, 2007
Carlo Bozotti, President and Chief Executive Officer

Bozotti - Biography

Thank you for joining us on our conference call today.

Opening Comments:

I would like to focus my remarks in three areas: First, the current market trends underway in selected key markets we serve and the impact on our fourth quarter and first quarter outlook. Secondly, the substantial progress made over the course of 2006 to strengthen ST. And finally, I would like to share with you our roadmap for 2007. So let's get started with a review of the environment and our fourth quarter results.

Fourth Quarter 2006:
Looking first at the semiconductor environment, we did expect to see a moderation and correction in the market. We indicated last October that our sequential growth would be below historical levels for the company, with Wireless and Automotive sales below normal seasonal trends. We expected Automotive would be affected by market weakness, particularly in the U.S., while wireless would suffer from a product mix towards the low end.

This was, indeed, the case. However, these trends were more pronounced than we had anticipated – in particular, our Wireless business came in well below historical seasonal patterns leading to a sequential revenue decrease of 6.5% in telecom. As a result, our net revenues for the company decreased 1.2%, coming in at the low end of the range we had communicated.

On the plus side, our Consumer results were pretty good, with sequential growth of 5%. Here I would like to point out that Q3 is normally seasonally stronger than Q4. This year, however, our Q4 sales were higher, demonstrating the good acceptance of our new products and improving position with selected customers. Industrial and Computer were up about 2% each.

As anticipated, Automotive was flat, compared to normal seasonality for Q4 which generally shows sequential improvement over Q3. I believe having a global presence with automotive customers helped us, as weakness in the Americas was to some extent mitigated by a better automotive environment in Europe and Asia.

Lower than expected revenues and a less favorable wireless mix put additional pressure on our margins and operating performance during the fourth quarter. However, despite this sales performance and a tougher currency environment, we did see sequential expansion of the gross margin to 36.3%, due to our cost reduction activities we have shared with you in the past. The resolution of a tax claim benefited net income in the quarter.

First Quarter 2007 Outlook:
Turning to the first quarter, let me begin by saying that we see a continuation of the market correction in some of the major applications we address, and the level of this multi-quarter correction is somewhat higher than we expected. As a result our first quarter revenue outlook assumes a sequential decrease of between -3% and -11%.

Looking to the full year 2007, we believe the semiconductor market should continue to show year-over-year growth, estimated in the range of 6 to 8%, but we believe it will be back-end loaded, compared to the quarterly trends of 2006. Essentially, 2007 is to some extent the reverse of 2006, with an expectation of a softer first half and strengthening in the second half of the year.

Now, what is ST doing to address this situation? Our key focus is on managing the absolute level of our inventory and this is a top priority in the first two quarters of the year. We finished 2006 with inventory about $50 million higher than we had at the end of Q3 – half of this was exchange rate related and the other half arose from revenues coming in at the low end of our outlook compared to the mid-point. Doing some simple math: revenues were lower by about $80 million; currency added $25 million, so our efforts with factory loadings and closings certainly helped, but not sufficiently.

As a result of our revenue outlook and inventory goals, our gross margin in Q1 will reflect unfavorable fab loading conditions, leading to a gross margin expectation of about 35%, plus or minus 1 percentage point.

Full Year 2006 Review:
Now, in spite of the weakness in the fourth quarter, ST delivered strong year over year improvements in financial performance, with:
  • Revenues up 11% to $9.85 billion; Driven by targeted key accounts, up 48% year-over-year, and by our mass market effort, or sales outside the top 50 customers, which rose 17% over 2005 levels. Regionally, sales in Japan grew 31%-in a local market that was up 7 to 8%- while greater China was up 16%. In summary: ST gained market share in 2006.
  • Operating income increased $433 million to $677 million. Net of other factors, 37% of the $972 million in incremental sales achieved in 2006 hit the EBIT line.
  • Net income was $782 million vs. $266 million in 2005
  • And ST generated over $650 million in net operating cash flow during 2006.

Looking at key operating metrics:

  • Gross margin expanded 160 basis points
  • Operating margin was up over 400 basis points
  • Operating expenses improved to 27.7% of net revenues, under our 28% target level
  • We improved the operating performance of each of our major product groups
  • RONA improved to 8.8%, nearly doubling over 2005's level

So the signs are clear: our product portfolio and marketing strategies as well as our cost restructuring initiatives, are delivering results for ST and are helping the company better navigate the current market correction. Overall, our market share is growing, our financial performance is improving and our balance sheet is stronger.

Now, before opening for questions, let's talk more broadly about our business objectives for 2007 and the continued progress we plan to make, notwithstanding some negative headwinds.

2007 Key Initiatives:
In early December we announced a corporate reorganization. As a result, on January 1, 2007, we have organized our NOR and NAND Flash business into a stand-alone segment. Further, we are moving ahead on creating a separate legal entity in connection with our strategic repositioning of this business. The Flash Memory Group represented 16% of net revenues in 2006. And with the first quarter, we will provide operating data.

We are also driving a significant reduction in our capital intensity. This is visible not only in our 2006 results, with our capex to sales ratio down to 15.6% from over 20% just a few years ago, but also in our guidance for 2007 spending. Specifically, we have set our initial capital expenditures budget for 2007 at approximately $1.2 billion, compared to $1.5 billion in 2006, representing a 20% reduction.

We have initiated a new capex to sales ratio 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 facilities. We are confident we will reach that goal this year.

Our product portfolio continues to strengthen, and in many ways it is the most critical effort we have underway. I believe we are developing the strongest pipeline of new products in our history, with important implications for both our market share and margins. As you know, we have recently reorganized our largest segments, ASG and IMS, and strengthened the management of both. I would like to spend the last few minutes of my remarks focusing on the changes and emphasis we are making in these two organizations.

As an example, looking at our business unit that participates in the digital consumer segment, we can see the improvement in profitability and financial return progressing in each quarter of 2006. From loss-making in Q1, to attractive financial performance in Q4, the primary driver of this improvement has been the new generation of products for the high definition market.

This same sort of initial loss-making when starting the business to sound financial performance trend is likewise seen in computer systems, where our new product efforts in printers are also paying off. While these types of improved results were largely obscured by the wireless performance in the 2006 fourth quarter, they are real. And in the case of wireless, our new products—for connectivity, for multimedia and for the 3G baseband are ready, qualified, and prepared for the market's resurgence.

For the Industrial and Multisegment Sector we are planning to build on the successes of 2006-sales growth of 19% while maintaining a RONA over 20%. Further evidence was seen in the ranking of our industrial segment that grew to the number 1 position in the industry. Advanced analog and linear sales grew faster than, and has superior financial returns, and there are still many opportunities to realize here.

In summary, looking back, the inflection point for ST began in mid -2005, as our efforts started to result in a reversal of our market share losses and the commencement of our market share gains. 2006 was a period of hard work, diligently focused on strengthening all areas of the company, resulting in strong revenue growth and earnings improvement. Looking ahead, 2007 is poised to be a year where ST's longer term potential becomes more evident and visible.
Now let me stop, so that my colleagues and I can take your questions.

Carlo Bozotti
President and Chief Executive Officer