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STMicroelectronics (STM)

Q4 2005 Earnings Conference Call

January 25th 2006, 5:00 PM.

Executives:

Stan March, VP IR

Carlo Bozotti, President and Chief Executive Officer

Alain Dutheil, Chief Operating Officer

Carlo Ferro, Chief Financial Officer, EVP

Philippe Geyres, EVP and General Manager Home, Personal, Communication Sector

Analysts:

Brian Lee, Citigroup

Didier Scemama, ABN AMRO

Tristan Gerra, Robert W. Baird

Nicolas Gaudois, Deutsche Bank

Jeremy Kwan, Piper Jaffray

Janardan Menon, Dresdner Kleinwort Wasserstein

William Conroy, Sanders Morris Harris

Simon Schafer, Goldman Sachs

Francois Meunier, Cazenove

Thomas Becker, HSBC

Matt Gable, George Weiss Associates

Jeff Kitchen, Oppenheimer

Presentation

Operator

Hello, and welcome to the STMicroelectronics Fourth Quarter Conference Call. All participants will be in listen-only mode. There will be an opportunity for you to ask questions at the end of today's presentation. An operator will give instructions on how to ask your questions at that time. Operator Instructions For your information, this conference is being recorded. I would like to turn the call over to Stan March. Mr. March?

Stan March, VP IR

Hello, Andrew. Thank you and welcome to STMicroelectronics fourth-quarter and full-year 2005 results conference call. And thanks to all of you for joining us. Hosting today's call is Carlo Bozotti, our President and Chief Executive Officer; and joining Carlo on the call is Alain Dutheil, our Chief Operating Officer; Carlo Ferro, our Chief Financial Officer; Philippe Geyres, our Executive Vice President responsible for the HPC sector; and Andrea Cuomo, our Executive Vice President responsible for strategy.

Just a bit of housekeeping before we get started. Some of the comments we're going to make today are forward-looking and therefore covered by the risk factors, which were enclosed in the press release and our most recent regulatory filings. If you have any questions about those, please refer to our website for clarification of these important risk factors.

I would now like to turn the call over to Carlo Bozotti for some introductory comments, before we open it up to your questions. Carlo?

Carlo Bozotti, President and Chief Executive Officer

Thank you, Stan. Thank you for joining us today and for your interest in ST. We continue to improve the financial performance of the Company. Our fourth-quarter results were on target with our goals, and the top-line revenues were solidly in line with our objectives. From a profitability perspective, gross margin came in about the middle of the range we shared with you at the time of the third-quarter release.

Looking more broadly at the financial performance, we're seeing progress across our most important financial metrics and 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 timeline, 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 market 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 double-digit operating margins over 10%, a 69% sequential increase in operating income.

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

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 book, 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 2-bit 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, announced 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.

Wide sales growth and more favorable exchange rate were also positive factors, our cost initiatives were key contributors to the sequential quarterly improvement, as we have absolved 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 of $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 are being careful in 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-inch technology. 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 will not reach our targeted range this quarter. I want to emphasize, however, that we are committed to improving the 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 the first-quarter 2006 sales may decrease between 1 and 7% sequentially. Based upon the seasonal mix and volume impact, we expect the gross margin to decrease sequentially to about 35%, plus or minus 1 percentage point.

From a revenue perspective, our objective is to increase first-quarter revenues between 7 and 14% year-over-year. 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 for this plan, from a timeline perspective.

First, 2005 has been a year of restructuring and refocusing. We have sharpened our considerable R&D investment, 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 efficiency.

Our 6-inch restructuring program is on track from a timetable perspective. We expect to see the valt 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 plan from a timetable perspective.

Our second phase is underway. After the significant lock-in phase 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; datastorage, up 17%; and automotive, up 80%.

Our goals are to build upon these strengths, as well as 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 this measure 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. Therefore, we continue to be active in strategic discussions, and we expect to obtain queue 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 we have seen some highlighted in our press release.

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

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

Finally, new products in wireless, in 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 markets.

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. Thank you.

Questions & Answers

Operator

Operator Instructions

Stan March, VP, IR

Andrew, before you take the first question, just I would like to make two points. First, to all you callers with questions, we look forward to answering them. However, please limit yourself to one question and one follow-up in the interest of moving through the queue as appropriately fast as we can.

Then I just want to make one, indicate one point. Carlo was mentioning the sequential, the year-over-year growth rates in wireless, data storage, and automotive. And understand some people thought that number might have -- the correct number is 8% for automotive, 17% for data storage, and wireless 20%. So with that brief clarification, Andrew, let's please answer some questions.

Operator

Yes sir, we have a question from Timothy Arcuri from Citigroup, please go ahead.

Q - Brian Lee

Hi this is actually Brian Lee calling in for Tim. I just had a couple of quick questions regarding your CapEx plans for 2006. First off, what sort of linearity can we expect in your CapEx plans as we progress through 2006? Are you expecting first-half load, or more towards the back-half of the year? Any color there would be great. And I have a quick follow-up.

A - Alain Dutheil

This is Alain Dutheil speaking. Yes, of course, as Carlo was mentioning, we are expecting the second half of the year, in terms of market, to be in higher growth than in the first half. Therefore if we want to be ready, what we need to do is to front-load our CapEx in the first half. So this is what our plans are today. We are going to spend a little bit more during the first half than during the second half.

Q - Brian Lee

Okay, is it going to be heavily skewed towards the first half? Or are we talking like a 60/40 or something like that?

A - Alain Dutheil

Yes, something like that.

Q - Brian Lee

Okay. And second question I had was, how would you characterize the breakout between equipment and facilities in your 2005 CapEx spend? And what sort of CapEx split can we expect in 2006, equipment versus facilities?

A - Alain Dutheil

So 2005, most of the CapEx was on equipment. In fact, the facilities were built already, on a strong front-end point of view. Rousset, Singapore, Crolles, the building and the facilities are there. So most of it was on equipment, and this year is going to be about the same. Now I think it will depend also on when we start our companion facilities. But this anyway is not going to be a big number. So most of this, I would say 90% of our capital investment, will be on equipment.

Q - Brian Lee

Okay, so no big change year-over-year?

A - Alain Dutheil

No, no big change.

A - Brian Lee

Thanks a lot. That's all I have.

A - Stan March

Thank you Brian, next question please.

Operator

The next question is from Didier Scemama with ABN AMRO, please go ahead.

Q - Didier Scemama

Good afternoon gentlemen. Maybe a question for Carlo Ferro, I guess. I think this morning on the analysts meeting you made some

A - Stan March

Could you speak up a little bit?

Q - Didier Scemama

Yes one second.

A - Stan March

Yes, thank you.

Q - Didier Scemama

Hello.

A - Stan March

Yes.

Q - Didier Scemama

Sorry about this; calling probably from a hidden place. Just a question on your OpEx for 1Q '06 and for 2006 if possible. If we strip out the restructuring cost for 4Q and the one-off pension cost that you recorded in Q4, should we assume that the OpEx are flat? Is that what you basically said this morning?

A - Carlo Ferro

Okay, well, Didier, first of all on a personal note, congratulations on the new born and best wishes.

Q - Didier Scemama

Thank you very much.

A - Carlo Ferro

Back on the OpEx, which is favorite subject today, I would say that you are gunshot. It looks a little bit aggressive to me on that number. Usually from Q4 to Q1, we experience some increase in costs, the absolute dollar and the OpEx to sales ratio. So on this basis, for Q1 '06, we may expect a number which in terms of OpEx to sales ratio I would say should be much more mitigated than the 32% experienced in Q1 2005; but would not reach our 28% threshold target. With some dollar dynamic problems in Q4, that which is driven basically by less effect of the vacations on our costs in Europe.

Q - Didier Scemama

Brilliant, okay. And just a quick follow-up on maybe the model for '06 and on the balance sheet. I mean given that the restructuring program will essentially really kick in massively in the second half of '06, it would be fair to assume that the gross margin, I imagine, will increase substantially throughout 2006. Is that a fair assumption? And second, can you maybe talk about how you are going to refinance the convertible, I think, which is maturing in August? Is that only through internal cash resources?

A - Carlo Ferro

Okay, on gross margin, I would say it is good enough, but we expect gross margin to improve on the second half of the year. And actually we see for, individually each of the 2006 quarters opportunity to force a gross margin better than the one of the similar quarter in 2005.

Q - Didier Scemama

Okay.

A - Carlo Ferro

The second of your questions is on the refinancing. I guess you are making reference to the probability that our 2013 bond will be redeemed in August, due to the put option to not hold this. First of all, we don't know yet if this bond will be put back. You see the level of available cash in excess of 2 billion. We continue to have a plan for generating net positive net operating cash flow. So the obligation to redeem it, if it will occur, first of all, is well backed by available cash and the cash flow plan. However, we continue to monitor the market, and should market conditions be favorable, as usual we may consider, not consider, any possibility to have affected the market to refinancing one way or another way, or in any event whatever may be appropriate in order to optimize our cost of financing, and in order to continue to run the Company with the appropriate level of liquidity.

Q - Didier Scemama

Okay, thanks very much, guys.

Operator

The next question is from Tristan Gerra from Baird, please go ahead.

Q - Tristan Gerra

Hi. You've talked about your plans in terms of R&D and new product development for '06. Can you give us an update in terms of Next Generation wireless technologies, including 802.11 and ultra wideband products, or anything else you may want to talk about in terms of connectivity technology?

A - Philippe Geyres

Yes, it's Philippe Geyres. For connectivity, it is one of the areas where we have been focusing R&D activities. Bluetooth and 802.11 are things that are now ramping up in volume, so they were not during 2005; they will be significant in the first-half 2006. This is encouraging us to move forward. In wireless LAN, as you know, we are focusing on the wireless phone. So we are currently developing an 802.11 APG and later N solution, but specifically addressed at the wireless phone, so for low power consumption. We have also an internal program on ultra wideband that, for which we have not yet announced precise product plans; but we have an active R&D program. In addition to that, we are putting a big R&D effort towards moving the RF to digital, to be able to offer all those functionalities in the standard CMOS process, either with multiple RF solutions on one chip or with integration of the RF (indiscernible). So we have a very important program on RF CMOS and 65-nanometer for which we are going to do the first product about, at the end of this year.

Q - Tristan Gerra

Okay, thanks. And also you mentioned in the press release somewhat tougher market conditions than expected in the MLD Group. Is that low-end competition from China? And if you can talk about some of the competitive trends you see in this segment for '06 and your response to those trends.

A - Philippe Geyres

Yeah, this is what we have experienced somewhat in Q4. But I think the pattern is now different, and we see good opportunity for growth in MLD. I think one of the problems that we had in Q4 was stronger demand, particularly from our distributor network in Asia, at lower margin. But today, the demand is strong, and MLD is one of the sectors of products where in Q1 we can partially compensate for the seasonal decline of the wireless portion.

Q - Tristan Gerra

Great, thank you.

A - Philippe Geyres

Thank you.

A - Stan March

Okay, Andrew?

Operator

Operator Instructions The next question is from Nicolas Gaudois with Deutsche Bank, please go ahead.

Q - Nicolas Gaudois

Yes, hi again gentlemen. Two questions, one is a clarification on one of Alain's comments this morning. I think, Alain, you said that utilization rates will go up to 90% on average from 85 in Q1; this is Q4. You are guiding revenues down midpoint 4% in Q1. Could you help us reconcile both, and whether effectively you plan to build inventories in the current quarter, potentially ahead of expected strong demand in the second quarter? And the follow-up will basically be again on MLD. You reiterated that MLD will deliver sequential growth in Q1, which is normally a seasonally down quarter. Is this probably a function of distributors increasing their own inventories? Are you seeing as a consequence leadtimes expanding for these products?

A - Alain Dutheil

Okay, as far as the utilization rate of our wafer fabs increasing, this is quite easy to understand. Because of course we are preparing Q2, and of course the reason is just the cycle trend. So we need to increase our production from then to be ready for Q2. Frankly, today it's too early to talk about Q2, but we are not expecting a sequential increase in Q2. So therefore we need to be ready.

On the MLD, I think the question was on –

A - Stan March

Are leadtimes expanding?

A - Alain Dutheil

Yes, leadtimes are expanding. Leadtimes are expanding. I think as we said, the demand is stronger. It is very much driven from Asia. But I think despite the seasonal pattern, we expect to grow MLD in Q1 this year.

Q - Nicolas Gaudois

Okay. Carlo, this is primarily driven by distributors in terms of demand, or OEM as well?

A - Carlo Bozotti

No; I think there is a good demand overall. I think that, but of course the ways of distributors in the MLD business is very significant. I know that the demand from our Asian distributors is pretty strong. But more recently we had signs of upside also from the Western distributors.

Q - Nicolas Gaudois

Okay, great. And leadtimes you would characterize as being particularly stretched or still normal to, or bit more than normal, basically? If you could give any color on that?

A - Carlo Bozotti

No, I would not describe it as particularly stretched, but I am saying it is stretchening.

Q - Nicolas Gaudois

Okay, that great. Thank you very much.

A - Carlo Bozotti

Thank you.

A - Stan March

Okay, Andrew? Hello Andrew?

Operator

Yes, our next question is from Jeremy Kwan from Piper Jaffray.

A - Carlo Bozotti

Okay.

Q - Jeremy Kwan

Yes, thank you. My first question, I guess, if you could focus a little bit on, one, MLD. Can you help us understand what areas you expect to track growth more throughout 2006? What specifically we can look forward to?

A - Carlo Bozotti

The growth in '06?

A - Stan March

In the products. I think, Jeremy, the question is what products are going to drive growth in 2006 in MLD?

Q - Jeremy Kwan

Right.

A - Stan March

Okay.

A - Carlo Bozotti

Yeah, I think that’s, we expect a significant growth in MLD in 2006. And I think there are two blocks of things. One is, as you know, last year was in terms of overall market growth very modest and much lower than what we had in 2004. And I think that with our more standard products, we are definitely below what was our peak in terms of revenues that in fact was in Q2 2004. So we expect that with the color here, with the growth on those standard products, discrete standard linear, etc. But I think there is another block that is even more important for us. It is all the new initiatives, the new products, the new advanced analog, the new microcontrollers. I think that it is a significant effort, particularly in analog. We have in MLD three different analog and media divisions focusing on various aspects of these products and applications, and is a stronger focus on new microcontrollers. So I expect that this second block of things will also contribute significantly in 2006.

Q - Jeremy Kwan

And can you talk about a little bit more about your RF CMOS plans? I think you mentioned that a little bit earlier. Is this targeted toward specifically for a specific market of handset?

A - Stan March

You're coming back to the RF CMOS? So we are leaving MLD and we are talking about RF CMOS?

Q - Jeremy Kwan

Yes.

A - Philippe Geyres

Yeah, so this is Philippe Geyres speaking. The RF CMOS effort we have, of course can be used in any application; and the technology will be applied to many applications. But the number one objective driving us is the wireless phone. Both RF for the base end of the cellular and RF for all the connectivity.

Q - Jeremy Kwan

Okay. And if I could, just last question. Can you tell us how comfortably you are with inventories in the channel? Are your distributors telling you that it is too low at the moment and they need to stock up a little bit more? Can you just give me a sense of that?

A - Stan March

You are back to distributors now.

A - Carlo Bozotti

Yes, I think that, as I said, we believe that this is an opportunity for short-term growth. Because the visibility is that the distributor inventories are very much under control. They are okay. I think bookings is increasing.

Q - Jeremy Kwan

Great, thank you very much.

A - Carlo Bozotti

Thank you.

Operator

The next question comes from Janardan Menon from DrKW.

Q - Janardan Menon

Hi thanks. Question on gross margins, Carlo. You had mentioned that you believe that margins will increase sequentially in every quarter, Q2, Q3, Q4. I am just wondering, is there a currency store of proviso in that statement? Because you mentioned yesterday morning the currency was at 1.23. Are you confident that if it is at about 1.23 to 1.24 into the second quarter and you will have to hedge at that level, you will still be able to maintain that level, that progression of gross margin?

A - Carlo Ferro

Good point and good question, which frankly helps me to tune the message. I think it is obvious that when talking we always assume some constant trend on the currency dynamic. Also having made significant progresses in mitigating the currency they produce, our gross margin remains significantly still closer to the currency dynamic. Our financial hedging strategy covers basically a portion of the currencies on the next quarter; and very limited one on quarter plus two; and none on quarter plus three. So of course, any kind of future dynamic of the currency may affect our gross margin even from a how significant it is. So please take my prior statement based on, I will say, a Euro to Dollar rate similar to the one of our guidance for Q1 '06.

Q - Janardan Menon

Okay. Just two clarifications on comments made before. One is to Philippe Geyres. When you say you're going to integrate RF with baseband on the RF CMOS program, I suppose you are talking about the 3G ASIC baseband that you have coming out soon.

A - Philippe Geyres

No, I would think that the goal, the reason for this shift towards digital RF and CMOS RF is of course to have cheaper RF functionality; and also to integrate it with the baseband. This is true in general, and you can apply that to Bluetooth, to wireless LAN, and to the cellular connectivity. The RF architecture and technology we are developing will allow to integrate RF with the baseband also for the 3G baseband.

Q - Janardan Menon

Okay. And last question is you mentioned Catania. Can you clarify whether Catania, a ramp is definitely part of this year's CapEx? Or it is still under consideration?

A - Carlo Bozotti

No, Catania, here we are talking about, of course in Catania we have already three fabs running there.

Q - Janardan Menon

Sorry, I am talking about the Catania 300.

A - Carlo Bozotti

That is what I understand. I understand very well, and I was sure what you had written for Catania what we call M6, which is going to be our future 12-inch fab. Catania, you know, we are just completing a building and facilities to be ready to start whenever we need. Frankly, we don't think that we will need Catania up and running in 2006. So this is going to be more 2007. We have not decided yet exactly when it is going to be. So what we are doing, we are spending some money quarter after quarter, but it is a small amount for the time being, just to finish up building and facilities. And of course, it is part of our CapEx, yes.

Q - Janardan Menon

Okay. And Carlo, when you said that OpEx will rise into Q1, is that both R&D and SG&A or is that just SG&A?

A - Carlo Ferro

This is an overall view on both of the two ingredients, eventually. We are continuing to keep cost control quite severe in SG&A. In R&D there is a little bit more room also, according to some objective of expanding our base and supporting the acceleration of developed innovation.

A - Janardan Menon

Okay Thank you very much.

Operator

Operator Instructions Our next question comes from William Conroy of Sanders Morris, please go ahead.

Q - William Conroy

Good afternoon. When you guys look at the revenue contribution, the percent of revenue that is coming from new products, however you care to define new products, can you tell us how that has trended recently and how you see it trending in the near term? My impression is that we may see a bump up. But given what is going on with some of the restructuring, etc., that may be a while out before we see that. Can you address that?

A - Carlo Bozotti

Yeah, I think of course we are monitoring this. It is a very crucial element of our strategy, and we have seen some nice improvement during the last few months in this respect. Our expectation is that this will continue to improve. In fact, I would like to mention some major new waves of products. NAND is a major new wave of products. Digital consumer at 90 nanometer is a major new wave of products. All advanced ASICs in telecom what for telecom infrastructure and also for wireless cellular phone applications is another wave of products. The new system-on-chip at 90 nanometers for computer peripherals, particularly for disc drives, is a new important wave of products. So all of this will, and of course we have more. I did mention all the integral of course, the connectivity is another group of things. And I am not mentioning MLD; MLD is introducing four new products for working days. So is a very significant number of new products. Now these are major waves; and in fact, digital consumer 90 nanometer has started, is in full production. The NAND has started and now significant. The connectivity is starting now and will become very significant, and then we expect that in the second part of the year, all our major new programs in Telecom, Nomadik, ASIC, etc., will contribute significantly. And then, of course, later in the year, beginning of next year, also a new wave of products in computer peripheral. So it is a major, major effort and is a very important element on our driving the Company towards excellence. It is a very strong focus in the Company to improve the effectiveness of what we do to accelerate the R&D products.

Q - William Conroy

That helps. A follow-on question for Carlo Ferro. Carlo, how should we see the decline that I think we're anticipating in depreciation flow in? Is that reflected in the gross margin guidance, given the assets that are coming off of the depreciation base at the end of '05?

A - Carlo Ferro

Yeah, easy as the decline is confirmed, as this morning, they have confirmed a plan of 1.7 billion of depreciation that is basically currency exchange rate for the fiscal year '06. In terms of their impact on the gross margin dynamic, please consider that Q1 '06 depreciation are going to be very similar to those of the fourth quarter 2005, while they will accelerate the reduction, etc., in the second half of the year. Our current visibility at similar exchange rate of today is that depreciation will be in the range of $400 million for the Q4 '06.

Q - William Conroy

Thank you.

Operator

The next question comes from Simon Schafer from Goldman Sachs, please go ahead.

Q - Simon Schafer

Hi there. Just, sorry to ask this again, but on the 240 basis points increase in gross margin, did you say the adverse effect of price was 180?

A - Carlo Bozotti

No, I said approximately 100.

Q - Simon Schafer

100 on price; and then the remainder of the increase was split three ways between the categories that you mentioned?

A - Carlo Bozotti

It's split basically, I have two categories, not that - I have two categories. That unfortunately we do not control, which is the exchange rate impact and internal performances. What we said is added to the 250, approximately 100 of negative effect from pricing; and these approximately 150 basis points you can count by two basically similar pieces. One is the favorable impact of the exchange dynamic. The other one is the favorable impact of the internal initiatives that are reduction of manufacturing costs, thanks to the restructuring, improved efficiencies, and enhanced product mix, coupled with some positive effect of higher volume of production in the quarter.

Q - Simon Schafer

Understood, that's very clear. Then as we look into Q1, obviously, the changes are somewhat different. Would you be able to give us any indication on how you would think the 150 basis point contraction would be composed?

A - Carlo Bozotti

Okay, of course, the level of detail on the actual is much easier than the one on the forecast. Say more qualitatively. There are more qualitatively in the forecast. We still foresee price pressure. Also considering that we enter a new year with some contractual price adjustments on certain customers. So I would say that we expect the negative price impact of the margin is as large even larger than the overall contraction of the margin. On top of that, we have some moderate negative impact from the currency; and we have some recovery from product mix and efficiencies.

Q - Simon Schafer

Understand. Thank you. Then as a follow-up, on the very impressive performance in the Memory Products Group, would you speak to a target of maintaining profitability in the weaker seasonal quarter of Q1?

A - Carlo Bozotti

Of course, you know, target, our target is to remain profitable. I think we need to foresee that on the level on the negative side. And I did mention that there are blocks of products where we have good opportunities to grow in Q1. I did mention MLD. We have consumer; consumer is an area where we have good opportunities to grow in Q1 comparing with Q4. We have automotive, where we believe that we will grow. Wireless as an application will decline, I believe, is the expected seasonal decline in this business. And as you know, the memory also, an important element in terms of products when one is sell to wireless customers. So but despite this decline our target is to remain profitable in Q1. And also, I would like to mention that last year was a year of the 2-bit per cell very much in NOR. But we have other important blocks of potential improvement in NOR, moving to full 90 nanometer at least in wireless; in NAND, the 70 nanometer; in NAND again, the 2-bit per cell. So there are other initiatives to reduce our costs in this area.

Q - Simon Schafer

Thank you very much.

A - Carlo Bozotti

Thank you.

Operator

The next question is from Francois Meunier with Cazenove, please go ahead.

Q - Francois Meunier

Good afternoon gentlemen, quick question on memory, because basically its performance was pretty good. Could you tell us how, maybe with not too many details, but how the margins evolved for NOR on other products? Because maybe you got some good results in EPROM as well, which could have helped?

A - Carlo Bozotti

As I already said this morning not only the Memory Products Group overall, of course, the $27 million profit. But each of the number of dial (ph) families within the Memory Products Group where above the key vending this quarter, so of course, there are different dynamics, but I can confirm that addressing your question I guess the Flash memory, Flash NOR and NAND were above the key vending report.

Q - Francois Meunier

And EPROMs were quite strong as well?

A - Alain Dutheil

Yeah, but there is, there are blocks of NOR also that are very, very strong. I mean, I think that all, as Carlo said, all the (indiscernible) were profitable in Q4.

Q - Francois Meunier

Okay, thanks. Now, in terms of consumer, we had quite a strong consumer holiday season. You did not maybe benefit as much as some others did. What happened?

A - Alain Dutheil

In consumer we see a seasonal effect that is less than in wireless, for instance, in Q4. In consumer it's maybe more Q3 than Q4. Then now what we're seeing in 2006 is a relatively good situation today in Q1, because of the soccer world something in July or June. So this is helping. Also, there are the younger, the retail consumer, you have the dynamics of the operators. What we are seeing, in Q4 we started to see deployment of the new generation of set-top boxes, high-definition, H264, PDR. But not as strong in Q4 as we had expected, as some operators, especially in the U.S., were late in introducing new boxes. So this is why in Q1 we are seeing in consumer a sequential growth compared to Q4, because now all those new products are ramping up in big volume.

Q - Francois Meunier

Okay, thank you.

Operator

The next question is from Thomas Becker of HSBC, please go ahead.

Q - Thomas Becker

Thank you very much for taking my questions. Two quick ones, two housekeeping questions. First of all, could you give us the utilization rate by 6 and 8 inch? And then Carlo probably you could remind us what the actual status of the restructuring, is that means in terms of costs, what can we expect in restructuring spend in 2006?

A - Alain Dutheil

Yeah, about the capacity utilization rate, I was mentioning this morning that the overall utilization rate is about 85%. It's a little bit more 6-inch; in fact it was 86. And it was 84 in 8-inch. So you see it is very close to being a rate of 85. What I said, also, is that we are going to increase at this year utilization rate to about 90%; 89% to be precise, and both 6-inch and 8-inch will be about the same. And just a comment on the 12-inch, where here we have as you know very limited capacity in Crolles too. Here of course the plant is fully saturated.

Q - Thomas Becker

Okay, thank you.

A - Carlo Ferro

Thomas, on the restructuring charges for the 6-inch initiative, you will remind that the anticipated amount was $350 million. So far, 294 million already occurred on our P&L in various quarters. So approximately 55 now remains to completion of the plan. On the new plan, we have still visibility on this range between $100 million to $130 million, out of which 41 have been posted so far. So the balance between 60 to 90, 6-0 to 9-0 remains.

Q - Thomas Becker

Okay, and this will be spent in the first half of the year? Also let's say the first restructuring plan, that means the 55 remaining, will be in the first two quarters, and then the 60 to 90 we will see will be spread over 2006?

A - Carlo Ferro

Well, I will say that this is very, very significant from below that based on the execution of the plan. Frankly, on the timing allocation of some of these items is not even that easy to the visibility of your assumption may have spent as any other possible.

Q - Thomas Becker

Okay, great. Thank you very much.

A - Alain Dutheil

I would like to add one word on utilization rates which I did not mention, but I feel it is important. Probably you remember that when we are talking about utilization rates, we're always comparing ourselves to what we call standard line capacity, which is a kind of five-year situation; and not all semiconductor companies are doing the same. So just to mention that.

Q - Thomas Becker

Okay, thank you very much.

A - Alain Dutheil

Okay, thank you very much. Andrew, do we another question?

Operator

Operator Instructions We have a question from Matt Gable with George Weiss Associates, please go ahead.

Q - Matt Gable

Hi guys, I was wondering if you could comment at all on sequential performance in the Flash segment for Q4. What kind of ASP unit sequential performance you saw, or if you could give some type of color on that?

A - Alain Dutheil

In Q4, we saw an improvement of the product mix that allowed us to have an increase in the ASP. So we had growth both in ASP and in volume. From the technology point of view, we saw in Q4 the NOR Flash continuing the evolution to 2-bit per cell. We reached 80% of the wireless NOR built with 2-bit per cell technology, so this helped to increase the margin on those products.

Q - Matt Gable

Do you, how do you, how are you seeing Q1 ASP environment in Flash, just very generally speaking.

A - Alain Dutheil

There is still price pressure, so the prices continue to be pressured and continue to decline regularly. Today I would say we see a price pressure in line with the cost improvements on the industry. So I would say the normal trend in the price evolution. Unfortunately, the normal trend is channel itself(ph).

Q - Matt Gable

I may have missed this earlier in the call. Where do you think you stand in terms of disposal of the Flash business or JV you are partnering with it? Can you give any color there?

A - Carlo Bozotti

Disposal, I think we will not dispose. In terms of partnering or venturing, I think we have concrete opportunities that we will, that we are proofing. And I think, of course, we're not yet in the position to disclose this, otherwise we would have done. We have opportunities internally, as I said before, to continue to improve in terms of chip size reduction, technology migration, and a reduction of manufacturing costs. On the other hand, because the size, the dimension of scale, is a very crucial element in memory, I think we are discussing on potential venturing. Of course, with the objective to increase the dimension of scale. Now I can say that these discussions are very concrete, and they are moving on. But we're not yet in the position to make a disclose and to give straight information. Otherwise we would have done it.

A - Stan March

Okay, thanks Matt. Andrew, I think we’ve got time for a couple more questions. Can we queue one up?

Operator

Yes, we have a question from Jeff Kitchen from Oppenheimer, please go ahead.

Q - Jeff Kitchen

Yeah, hi a little out of left field, but can you give any color as to the ramp-up in the trusted computing market? I guess last summer you launched volume production of your first TPMs. I am just curious if you can give any follow-up there.

A - Stan March

I think, Jeff, the way to characterize that is yes, that is of course an important product for us. The trusted computing platform market. But we're not going to update every quarter the number of units that we have shipped for this space. But we of course did indicate the threshold. But we continue to ship, and it's just not one of the products we break out on a quarterly basis in terms of our shipment dynamics.

Q - Jeff Kitchen

Fair enough; thanks, guys.

Operator

Operator Instructions

A - Stan March

Andrew, do we have one more out there or we. Because it sounds like you have polled pretty well and I think we have pretty much run the table.

Operator

Currently we have no other questions, sir.

Stan March, VP IR

Well, I think before I offer Carlo Bozotti the chance to wrap up, we should let the historians note once again we were able to answer all the questions of this conference call in the allotted time. So we appreciate everyone working with us to keep it to one question and one follow-up. Carlo, would you like to provide some?

Carlo Bozotti, President and Chief Executive Officer

Again, thank you for your presence, thank you for your interest in ST. I think we were pleased about the Q4 results. We were pleased about the $0.20 of earnings per share that were above the consensus of the market. But of course, we look forward to reporting on our progresses while moving on, moving forward in 2006. I think as we have described to you, we have let's say significant opportunities in terms of new product introduction and better efficiency in manufacturing.

Something that we have not mentioned during this meeting that I think is also important to underline is that with the Board we have decided to propose to an Assembly General the distribution of dividends in the year 2006; and the proposal is to be at the same level we did last year, which is $0.12 per share. So this will be proposed to our Assembly General soon. Thank you again, thank you very much, thank you for your interest in ST.

Operator

Thank you for attending. You may now disconnect.

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Source: STMicroelectronics Q4 2005 Earnings Conference Call Transcript (STM)
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