2007 Second Quarter Report
Message from the President

STMicroelectronics NV
Carlo Bozotti, President and Chief Executive Officer
Second Quarter Conference Call-Final Wednesday, July 25, 2007

Hello and thank you for joining us on this call today. I appreciate your interest in ST.

This has been a very important quarter for ST from a strategic perspective. Just one quarter ago, we were making progress, but did not have a final resolution to our objective of financial deconsolidation, and possible industry consolidation of our Flash business. Now we do.

Just one quarter ago, we did not have a final resolution to our development of core 300 mm CMOS processes choice. Now we do.

And, from an operational perspective, in addition to the resolution of these key strategic initiatives, we have also clearly identified the next important actions to further improve the efficiency of our manufacturing assets.

So let me begin my remarks with a discussion of our strategic announcements and then move to a review of our second quarter and outlook for the third quarter and rest of the year.

First on Flash, as you know, we entered into a definitive agreement with Intel and Francisco Partners to create an independent semiconductor company, Numonyx. We will be selling our Flash memory assets to this entity and Intel will be selling its NOR Flash memory assets to the new company. Subject to customary conditions and regulatory approvals, we anticipate completing the transaction in the second half of 2007.

While some of you would have liked to see a resolution sooner than we achieved, I believe the extra time has enabled us to put together a very strong company with a significant market position.

As we outlined at the time of the announcement in May, we expected to incur an impairment loss of between $850 and $900 million associated with this transaction, and that we would recognize the significant majority of that in the second quarter. As you can see we took a charge of $857 million, primarily consisting of non-cash impairment charges. And at closing there will be a final true-up.

From a reporting perspective after closing, this will be an equity investment and appear below the operating income line. And based upon assumptions which we believe are reasonable, we anticipate the equity impact of Numonyx to be positive on ST earnings from the first year after closing.

Second, on technology R&D, as anticipated a few months ago, we have just announced reaching an agreement related to the development of core 300mm CMOS processes at 32 nanometers and below. ST will join the IBM consortium for this cooperative effort at the end of 2007. It is anticipated that both companies will have teams at both IBM’s East Fishkill site in the US and our Crolles facility in France working together for core and value-added derivative technologies, respectively.

We believe this alliance will bring a number of benefits to ST: This is a new model for us in advanced logic, which should bring greater efficiency. It should also enhance our ability to master technologies, accelerate time to market and enable us to increase our use of foundries. Finally, it will reduce our overall spending on CMOS technology. In combination with reduced spending on Flash technology as a result of the divestiture, we anticipate from 1 to 2 percent of sales will be redirected from technology R&D spending towards product innovation, when freed up in 2008.

Moving now to the second quarter, net revenues for the period increased 6.2% sequentially and excluding FMG, net revenues increased 6.8%. We came in slightly below the mid-point of our range of between 4% and 10%.

Turning first to ASG, the quarter progressed very much in line with our expectations which we shared with you at the time of the first quarter release. Sales increased 6.8% sequentially, driven by double-digit sales growth in wireless and digital consumer.

• Wireless sales increased over 11% sequentially reflecting volume growth and good performance across several product fronts including connectivity and 3G digital base bands.
• Consumer also had a very good quarter. Areas of strength included set top box and digital television products, driven by our single chip offerings for H.264 and high definition applications, as well as strong box demand in emerging markets. These two divisions combined, were up over 20% sequentially.
• This was a record quarter for sales levels in the Automotive group. Sequentially, Automotive increased about 4% on our strong product offerings.
• Finally, Computer peripherals decreased sequentially on quarter-end shipment shifts, though we see growth resuming from here.

Turning to operating profitability, we saw a significant rebound in operating profits for ASG in the second quarter over the first quarter, benefiting from volume and mix improvements, which more than offset sequential pricing pressure. Virtually all product areas within ASG had positive mix improvement, with the most important coming from wireless and digital consumer. While not yet at the year-ago level, the sequential volume and mix improvements indicate that the plan we articulated is delivering the anticipated results.

Based upon our third quarter outlook and fourth quarter visibility we expect to see substantial improvement in the operating margin for ASG as we move through the third and fourth quarters of this year.

Moving to IMS, it was a record sales quarter. On a sequential basis, net revenues in IMS increased 6.2%, driven by our high single-digit sales improvement in the industrial market segment. The operating margin was 13.4% compared to 14.8% in the first quarter. This margin reduction is largely explained by two factors; substandard manufacturing performance-which has been resolved, and our decision to accelerate investment in the business with a focus on increasing our resources in advanced analog products. In the second quarter we increased headcount by over 100 people to ensure the necessary resources are on hand to continue our product development and growth plans

Looking at some other key metrics for ST:
First, we saw good improvement in sales to our targeted key accounts, which increased 27% year-over-year excluding Flash; Secondly, we had strong sales results in Japan, up 38% year over year; and good progress in the mass market with sales up 12%, also in comparison to the year-ago quarter.

Gross margin was 34.7% in the quarter, and excluding FMG, was 37.8%, improving from 37.0% the first quarter.

Carlo Ferro asked me to provide a brief explanation to our figures regarding depreciation and amortization. You may have noticed that our second quarter figure is lower by $24 million – it was $396 million in the first quarter and $372 million in the second quarter. This almost exclusively benefits FMG inventory, at the moment.

Indeed, in connection with the signing of the Flash agreement, we moved the flash assets to a new category--Assets Held for Sale. As a consequence, we suspended depreciation related to those assets beginning in June. You may be wondering where this amount went. I want to be clear that this reduction did not benefit our gross margin results during the second quarter. Under accounting, the offset benefits will first go to inventory and then to cost of sales depending on the timing of the product sale, a quite limited amount in Q3 and the bulk in Q4.

Moving to currency, we continue to manage the business through adverse currency conditions. One year ago, the US dollar was at a 1.23 dollar exchange rate per Euro and over the last twelve months has weakened further by over 8%. We estimate that this had about a 90 million negative impact on our operating profit with a little less than half of this reducing our gross margin and the rest impacting operating expenses. Specifically, the year-over-year gross profit impact was approximately 170 basis points. Looking ahead to the third quarter, we expect to face further pressure on margins from currency as the dollar continues to weaken.

As discussed at our field trip in May, we started a new round of initiatives to further reduce costs, manage the exchange rate challenge, improve our financial returns, and further optimize our asset utilization. Specifically, we announced in early July plans to rationalize three of our manufacturing operations. We intend to wind down operations at our 6-inch fab in Carrolton, our 8-inch fab in Phoenix and our back-end packaging and test facility in Ain Sebaa, Morocco. We estimate that it will be approximately 2 to 3 years before all products at these sites are re-qualified at other facilities.

We have estimated pre-tax impairment and restructuring charges in the range of $270 to $300 million. At the end of this period, we expect the potential benefit to costs of goods sold will be approximately $150 million per year.

And finally, let me turn to cash flow for a minute. We continued to improve our cash returns, with a strong increase in cash flow from operations for both the second quarter and first half of 2007. Our net cash from operations in the first half represented an 8.4% cash yield on sales, which we think is pretty good for ST and a good figure in comparison to our industry.

This strong cash flow has enabled us to increase our cash dividend by nearly 150%. In the second quarter we paid cash dividends totaling $269 million and ended the quarter with a net cash balance of $870 million, similar to the one we had entering the period.

RONA was over 9% in the quarter excluding Flash. Looking to the second half of the year we expect to see further significant improvement.

Turning to our third quarter outlook, let me first step back to the start of the year. For ST we did, indeed, reach a trough in the current industry correction during the first quarter and we saw a resumption of growth in the second quarter. Looking forward, based upon our current order visibility we see sequential sales growth in both the third and fourth quarters. With respect to the third quarter, we are anticipating sequential sales growth in the range between 2% and 7%.

Also, based upon our order visibility, we expect ASG to continue to show sequential growth a little faster than the corporate average.

Based upon our third quarter sales outlook, spending plans and currency assumptions, we anticipate the gross margin for ST, including FMG, to expand to about 35.5% plus or minus one percentage point. The mid-point of this gross margin outlook would represent an 80 basis points improvement, with the drivers being sales expansion, product mix and operating performance. Regardless of the accounting impacts for the Flash assets our gross margin for the rest of the Company will improve in a similar or better fashion.

With respect to capital expenditures, we are well on track to spend less than 12% of sales this year as we continue to progress with our asset light strategy.

We also expect that ST will be able to meet the low end of our inventory turns target range of 4.5 to 5 times by the end of this year. This is, of course, based upon our current visibility into the fourth quarter as well as currency assumptions.

In summary, ST reached resolutions on key strategic initiatives and we look forward to closing the Flash transaction and working with our new R&D partners in the days ahead. Importantly, I believe we have reached the best resolutions for ST and our shareholders.

At the same time, our top priority is to continue to drive improvements across the company by focusing our efforts and resources on leadership in multimedia convergence applications and power solutions, advancing our lighter asset business model, driving towards a higher RONA and continuing to enhance our cash generation from operations.

I would like to stop at this point and with my colleagues take your questions.


Carlo Bozotti
President and Chief Executive Officer