As filed with the Securities and Exchange Commission on March 23, 2005
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 20-F
REGISTRATION STATEMENT PURSUANT TO SECTION 12(b) OR (g) OF THE SECURITIES EXCHANGE ACT OF 1934 |
OR
ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 |
For the fiscal year ended December 31, 2004
OR
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 |
For the transition period from____________to
Commission file number: 1-13546
STMicroelectronics N.V.
(Exact name of registrant as specified in its charter)
Not Applicable (Translation of registrants name into English) |
The Netherlands (Jurisdiction of incorporation or organization) |
39, Chemin du Champ des Filles
1228 Plan-Les-Ouates
Geneva
Switzerland
(Address of principal executive offices)
Securities registered or to be registered pursuant to Section 12(b) of the Act:
Title of each class: Common shares, nominal value €1.04 per share |
Name of each exchange on which registered: New York Stock Exchange |
Securities registered or to be registered pursuant to Section 12(g) of the Act:
None
Securities for which there is a reporting obligation pursuant to Section 15(d) of the Act:
None
Indicate the number of outstanding shares of each of the issuers classes of capital or common stock as of the close of the period covered by the annual report:
891,908,997 common shares at December 31, 2004
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days:
Yes No
Indicate by check mark which financial statement item the registrant has elected to follow:
Item 17 Item 18
1
PRESENTATION OF FINANCIAL AND OTHER INFORMATION
In this annual report on Form 20-F (the Form 20-F), references to we and us are to STMicroelectronics N.V. together with its consolidated subsidiaries, references to EU are to the European Union, references to € and the euro are to the euro currency of the EU, references to the United States and U.S. are to the United States of America and references to $ or to U.S. dollars are to United States dollars. References to mm are to millimeters and references to nm are to nanometers.
We have compiled the market share, market size and competitive ranking data in this annual report using statistics and other information obtained from several third-party sources. References in this annual report to published industry data are references to data published by Gartner, Inc., IC Insights Inc., iSuppli, and Databeans, and references to trade association data are references to World Semiconductor Trade Statistics (WSTS). Except as otherwise disclosed herein, all references to our market positions in this Form 20-F are based on 2004 revenues according to published industry data. References to our website, at http://www.st.com, do not incorporate by reference into this Form 20-F any information included thereon. Certain industry and technical terms used in this Form 20-F are defined in Certain Terms.
Various amounts and percentages used in this annual report have been rounded and, accordingly, they may not total 100%. All share data have been adjusted for the 3-for-1 stock split effected in May 2000.
We and our affiliates own or otherwise have rights to the trademarks and trade names, including those mentioned in this annual report, used in conjunction with the marketing and sale of our products.
CAUTIONARY NOTE REGARDING FORWARD-LOOKING STATEMENTS
Some of the statements contained in this Form 20-F that are not historical facts, particularly in Item 3. Key InformationRisk Factors, Item 4. Information on the Company and Item 5. Operating and Financial Review and Prospects and Business Outlook, are statements of future expectations and other forward-looking statements (within the meaning of Section 27A of the Securities Act of 1933 or Section 21E of the Securities Exchange Act of 1934, each as amended) that are based on managements current views and assumptions and involve known and unknown risks and uncertainties that could cause actual results, performance or events to differ materially from those in such statements due to, among other factors:
| future developments in the world semiconductor market, in particular the actual demand for semiconductor products in the key application markets and from key customers served by our products; |
| pricing pressures, losses or curtailments of purchases from key customers as well as inventory adjustments from distributors; |
| further changes in the exchange rates between the U.S. dollar and the euro, and between the U.S. dollar and the currencies of the other major countries in which we have our operating infrastructure; |
| our ability to develop new products in time to meet market demand, for volume supplies; |
| the financial impact of any measures we may decide, if we are unable to load our front-end and/or back-end fabrication facilities (fabs) at satisfactory levels; |
| the ramp-up of volume production in new manufacturing technologies at our fabs; |
| the ability of our suppliers to meet our demands for products and competitive pricing; |
| smooth transition pursuant to recent organizational changes in our top management and our product groups, as well as their and our ability to adapt our strategy to evolving market conditions; |
| the anticipated benefits of research and development alliances and cooperative activities; |
| changes in the economic, social, or political environment, as well as natural events such as severe weather, health risks or earthquakes in the countries in which we and our key customers operate; |
| acquisitions which fail to meet business expectations; and |
| our ability to obtain required licenses on third party intellectual property. |
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Such forward-looking statements are subject to various risks and uncertainties, which may cause actual results and performance of our business to differ materially and adversely from the forward-looking statements. Certain such forward-looking statements can be identified by the use of forward-looking terminology such as believe, may, will, should, would be or anticipates or similar expressions or the negative thereof or other variations thereof or comparable terminology, or by discussions of strategy, plans or intentions. Some of these risk factors are set forth and are discussed in more detail in Item 3. Key InformationRisk Factors. Should one or more of these risks or uncertainties materialize, or should underlying assumptions prove incorrect, actual results may vary materially from those described in this Form 20-F as anticipated, believed or expected. We do not intend, and do not assume any obligation, to update any industry information or forward-looking statements set forth in this Form 20-F to reflect subsequent events or circumstances.
Unfavorable changes in the above or other factors listed under Item 3. Key InformationRisk Factors from time to time in our Securities and Exchange Commission (SEC) filings, could have a material adverse effect on our business and/or financial condition.
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PART I
Item 1. Identity of Directors, Senior Management and Advisers |
Not applicable.
Not applicable.
Selected Financial Data |
The table below sets forth our selected consolidated financial data for each of the years in the five-year period ended December 31, 2004. Data for each of the last five years have been derived from our consolidated financial statements. Consolidated audited financial statements for each of the years in the three-year period ended December 31, 2004, including the Notes thereto (collectively, the Consolidated Financial Statements), are included in Item 18. Financial Statements of this Form 20-F. Data for the three-year period ended December 31, 2004 are derived from the Consolidated Financial Statements included in Item 18 of this Form 20-F, while data for prior periods have been derived from our consolidated financial statements used in such periods.
The following information should be read in conjunction with Item 5. Operating and Financial Review and Prospects and the Consolidated Financial Statements (including the related Notes thereto) included elsewhere in this Form 20-F.
Year ended December 31, |
||||||||||||||||
2004(1) | 2003(1) | 2002(1) | 2001(1) | 2000(1) | ||||||||||||
(in millions except shares, per share and ratio data) | ||||||||||||||||
Consolidated Statement of Income Data: | ||||||||||||||||
Net sales |
$8,756 | $7,234 | $6,270 | $6,304 | $7,764 | |||||||||||
Other revenues |
4 | 4 | 48 | 53 | 49 | |||||||||||
Net revenues |
8,760 | 7,238 | 6,318 | 6,357 | 7,813 | |||||||||||
Cost of sales |
(5,532 | ) | (4,672 | ) | (4,020 | ) | (4,047 | ) | (4,217 | ) | ||||||
Gross profit |
3,228 | 2,566 | 2,298 | 2,310 | 3,596 | |||||||||||
Operating expenses: |
||||||||||||||||
Selling, general and administrative |
(947 | ) | (785 | ) | (648 | ) | (641 | ) | (704 | ) | ||||||
Research and development(2) |
(1,532 | ) | (1,238 | ) | (1,022 | ) | (978 | ) | (1,026 | ) | ||||||
Other income and expenses, net(2) |
10 | (4 | ) | 7 | (6 | ) | (83 | ) | ||||||||
Impairment, restructuring charges and other related closure costs |
(76 | ) | (205 | ) | (34 | ) | (346 | ) | | |||||||
Total operating expenses |
(2,545 | ) | (2,232 | ) | (1,697 | ) | (1,971 | ) | (1,813 | ) | ||||||
Operating income |
683 | 334 | 601 | 339 | 1,783 | |||||||||||
Interest income (expense), net |
(3 | ) | (52 | ) | (68 | ) | (13 | ) | 46 | |||||||
Equity in loss of joint venture |
(4 | ) | (1 | ) | (11 | ) | (5 | ) | | |||||||
Loss on extinguishment of convertible debt |
(4 | ) | (39 | ) | | | | |||||||||
Income before income taxes and minority interests |
672 | 242 | 522 | 321 | 1,829 | |||||||||||
Income tax benefit (expense) |
(68 | ) | 14 | (89 | ) | (61 | ) | (375 | ) | |||||||
Income before minority interests |
604 | 256 | 433 | 260 | 1,454 | |||||||||||
Minority interests |
(3 | ) | (3 | ) | (4 | ) | (3 | ) | (2 | ) | ||||||
Net income |
$601 | $253 | $429 | $257 | $1,452 | |||||||||||
Earnings per share (basic)(3) |
$0.67 | $0.29 | $0.48 | $0.29 | $1.64 | |||||||||||
Earnings per share (diluted)(3) |
$0.65 | $0.27 | $0.48 | $0.29 | $1.58 | |||||||||||
Number of shares used in calculating earnings per share (basic)(3) |
891,192,542 | 888,152,244 | 887,577,627 | 893,267,868 | 885,728,493 | |||||||||||
Number of shares used in calculating earnings per share (diluted)(3) |
935,111,071 | 937,091,531 | 893,036,782 | 901,982,965 | 936,059,212 |
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Year ended December 31, |
||||||||||||||||
2004(1) | 2003(1) | 2002(1) | 2001(1) | 2000(1) | ||||||||||||
(in millions except shares, per share and ratio data) | ||||||||||||||||
Consolidated Balance Sheet Data (end of period): |
||||||||||||||||
Cash, cash equivalents and marketable securities(1) |
$1,950 | $2,998 | $2,564 | $2,444 | $2,331 | |||||||||||
Total assets |
13,800 | 13,477 | 12,004 | 10,798 | 11,880 | |||||||||||
Short-term debt (including current portion of long-term debt) |
191 | 151 | 165 | 130 | 142 | |||||||||||
Long-term debt (excluding current portion)(1) |
1,767 | 2,944 | 2,797 | 2,772 | 2,700 | |||||||||||
Shareholders equity(1) |
9,110 | 8,100 | 6,994 | 6,075 | 6,125 | |||||||||||
Capital stock(4) |
3,074 | 3,051 | 3,008 | 2,978 | 2,824 | |||||||||||
Other Data: |
||||||||||||||||
Ratio of earnings to fixed charges(5) |
16.38 | 3.7 | 5.5 | 3.8 | 29.3 | |||||||||||
Dividends per share(3) |
$0.12 | $0.08 | $0.04 | $0.04 | $0.03 | |||||||||||
Capital expenditures(6) |
$2,050 | $1,221 | $995 | $1,700 | $3,328 | |||||||||||
Net cash provided by operating activities |
2,342 | 1,920 | 1,713 | 2,057 | 2,423 | |||||||||||
Depreciation and amortization(6) |
1,837 | 1,608 | 1,382 | 1,320 | 1,108 | |||||||||||
Net debt to total shareholders equity ratio(7) |
0.001 | 0.012 | 0.057 | 0.075 | 0.083 | |||||||||||
(1) | On November 16, 2000, we
issued $2,146 million initial aggregate principal amount of zero-coupon
senior convertible bonds due 2010 (the 2010 Bonds), for
net proceeds of $1,458 million; in 2003 we repurchased on the market
approximately $1,674 million aggregate principal amount at maturity
of 2010 Bonds. During 2004, we completed the repurchase of our 2010
Bonds and repurchased on the market approximately $472 million aggregate
principal amount at maturity for a total amount paid of $375 million.
In 2001, we redeemed the remaining $52 million of our outstanding Liquid
Yield Option Notes due 2008 (our 2008 LYONs) and converted
them into common shares in May and June 2001. In 2001, we repurchased
9,400,000 common shares for $233 million, and in 2002 we repurchased
an additional 4,000,000 shares for $115 million. We reflected these
purchases at cost as a reduction of shareholders equity. The
repurchased shares were designated to fund employee stock option plans.
In August 2003, we issued $1,332 million principal amount at maturity
of zero-coupon senior convertible bonds due 2013 (our 2013 Bonds)
with a negative yield of 0.5% that resulted in a higher principal amount
at issuance of $1,400 million and net proceeds of $1,386 million. During
2004, we repurchased all of our outstanding Liquid Yield Option Notes
due 2009 (our 2009 LYONs) for a total amount of cash paid
of $813 million.
|
(2) | Other income and
expenses, net includes, among other things, funds received through
government agencies for research and development expenses, the cost
of new start-ups, foreign currency gains and losses, gains on sales
of marketable securities, the costs of certain activities relating
to intellectual property and, for periods prior to 2002, goodwill amortization.
Our reported research and development expenses are mainly in the areas
of product design, technology and development, and do not include marketing
design center costs, which are accounted for as selling expenses, or
process engineering, pre-production and process-transfer costs, which
are accounted for as cost of sales.
|
(3) | All share information has
been adjusted to reflect the 3-for-1 stock split effected in May 2000.
|
(4) | Capital stock consists
of common stock and capital surplus.
|
(5) | For purposes of calculating
the ratio of earnings to fixed charges, earnings consist of income
before income taxes and minority interests, plus fixed charges. Fixed
charges consist of interest expenses.
|
(6) | Capital expenditures are
net of certain funds received through government agencies, the effect
of which is to decrease depreciation.
|
(7) | Net debt is composed of short and long-term interest-bearing liabilities and related derivatives less cash and cash equivalents. |
5
Risk Factors |
The semiconductor industry is highly cyclical, and periodic downturns in the semiconductor industry affect our business and results of operations. |
The semiconductor industry is highly cyclical and has been subject to significant economic downturns at various times. Downturns are typically characterized by production overcapacity, accelerated erosion of average selling prices, high inventory levels, diminished demand and reduced revenues. Downturns may be the result of industry-specific factors such as excess capacity, product obsolescence, price erosion, evolving standards, changes in end-customer demand, and/or macroeconomic trends impacting the economies of one or more of the worlds major regions: Asia, United States, Europe and Japan.
According to published industry data, worldwide sales of semiconductor products, while generally increasing over the long term, have fluctuated significantly on a yearly basis over the past several years. According to trade association data, sales increased in 1995, 1997, 1999, 2000, 2003 and 2004, but decreased in 1996, 1998 and 2001. For 2000, 2003 and 2004, the increase was approximately 37%, 18% and 28%, respectively, while it decreased by approximately 32% in 2001.
In certain years, the increase in the sale of semiconductor products is driven primarily by an increase in the number of units sold, while industry overcapacity and excess supply over demand worldwide have continued to exercise a downward pressure on average selling prices. In 2004, the market increase was driven by the strong demand particularly in the first half of the year and also by an average selling price increase.
We have experienced revenue volatility and market downturns in the past and may experience them in the future. For example, we expect year-over-year semiconductor revenue growth will substantially decrease in 2005.
Downturns in the semiconductor industry, reduction in demand for end products which incorporate the semiconductor products we supply, or increased competition driven by overcapacity exercising a downward pressure on prices, have in the past, and could in the future, have a significant adverse impact on our results of operations.
Increases in production capacity for semiconductor products may lead to overcapacity, which in turn may lead to plant closures, asset impairments, restructuring charges and inventory write-offs. |
Capital investments for semiconductor manufacturing equipment are made both by integrated semiconductor companies like us and by specialist semiconductor foundry companies, which are subcontractors that manufacture semiconductors designed by others.
According to data published by IC Insights Inc. and other industry sources, investments in worldwide semiconductor fabrication capacity totaled approximately $61 billion in 2000, $38 billion in 2001, $27 billion in 2002, $30 billion in 2003, and an estimated $45 billion in 2004, or approximately 30%, 27%, 19%, 18% and an estimated 21%, respectively, of the total available market for such years. The net increase of manufacturing capacity, defined as the difference between capacity additions and capacity reductions pursuant to closures, may exceed demand requirements, leading to over-supply situations, price erosion, and industry downturns. Overcapacity has led us, in recent years, to close manufacturing facilities that used more mature process technologies. In 2001, we closed our 150mm wafer manufacturing facility in Ottawa. In 2002, we closed our 150mm wafer manufacturing facility in Rancho Bernardo, California, and in 2004, we closed our 150mm wafer manufacturing facility in Rennes, France and our back-end facility in Tuas, Singapore. Pursuant to these closures and as a result of some of our more mature fabrication facility capacity being only partially used, we recorded in 2001 a total tangible asset impairment of $200 million, additional charges of approximately $97 million relating to the impairment of purchased technologies, $22 million related to certain investments and approximately $27 million related to restructuring charges. In 2002, we recorded impairment, restructuring charges and related closure costs of $34 million. In 2003, we recorded impairment, restructuring charges and other related closure costs of $205 million in connection with the plan announced in October 2003 to increase our cost competitiveness by restructuring our 150mm fab operations and part of our back-end operations. In 2004, the amount of restructuring charges and other related closure pre-tax costs amounted to $76 million. See Item 5. Operating and Financial Review and ProspectsImpairment Restructuring Changes and Other Related Closure Costs.
Through the period ended December 31, 2004, we have incurred $281 million of the announced approximate $350 million in pre-tax charges associated with the restructuring plan that was defined on October 22, 2003, and which is now expected to be completed by mid-2006.
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In 2005, we decided and announced plans to reduce our Access technology programs for customer premises equipment (CPE) modem products. This decision made in 2005 could result in potential impairment charges of approximately $60 million in the first quarter of 2005 for intangible assets and goodwill related to the CPE product lines and certain additional restructuring charges to be further estimated.
No assurances can be given that future changes in the market demand for our products, overcapacity, obsolescence in our manufacturing facilities, and market downturns may not require us to test for and record additional impairment and restructuring charges, which may have a material adverse effect on our business, financial condition and results of operations.
Competition in the semiconductor industry is intense, and we may not be able to compete successfully if our product design technologies, process technologies and products do not meet market requirements. |
We compete on the basis of a variety of factors, and our success depends on our ability to compete successfully in all of the relevant areas. We compete in different product lines to various degrees on the following basis:
| price |
| technical performance |
| product features |
| product system compatibility |
| product design and technology |
| product availability |
| manufacturing yields |
| sales and technical support |
Competition in the semiconductor industry as a whole is intense, and if our products are not selected based on any of these factors, our business, financial condition and results of operations would be materially adversely affected.
We also face significant competition in each of our product lines. Like us, many of our competitors offer a large variety of products. Some of our competitors may have greater financial and/or more focused research and development resources than we do. If these competitors substantially increase the resources they devote to developing and marketing products which compete with ours, we may not be able to compete effectively. Any consolidation among our competitors could enhance their product offerings, manufacturing efficiency and financial resources, further strengthening their competitive position.
To improve our financial performance we have recently announced plans to eliminate certain low-volume, non-strategic product families whose return on assets in the current environment does not meet internal targets.
In many of the market segments in which we compete for business, we depend on winning highly competitive selection processes to design products and technologies for use in our customers equipment and products, and failure to be selected or to execute could materially adversely
affect our business in that market segment. Even after we win and begin a product design, a customer may decide to cancel or change its product plans, which could cause us to generate no sales from a product and adversely affect our results of operations. |
One of our focuses is on winning competitive bid selection processes, known as product design wins, to develop products for use in our customers equipment and products. These selection processes can be lengthy and require us to incur significant design and development expenditures, with no guarantee of winning or generating revenue. Delays in developing new products with anticipated technological advances and failure to win new design projects for customers or in commencing volume shipments of new products may have an adverse effect on our business. In addition, there can be no assurance that new products, if introduced, will gain market acceptance or will not be adversely affected by new technological changes or new product announcements by other competitors that may have greater resources or are more focused than we are. Because we typically focus on only a few customers in a product area, the loss of a design win can sometimes result in our failure to offer a
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generation of a product. This can result in lost sales and could hurt our position in future competitive selection processes because we may be perceived as not being a technology leader.
After winning a product design from one of our customers, we may still experience delays in generating revenue from our products as a result of the lengthy development and design cycle. In addition, a delay or cancellation of a customers plans could significantly adversely affect our financial results, as we may have incurred significant expense and generated no revenue. Finally, if our customers fail to successfully market and sell their equipment it could materially adversely affect our business, financial condition and results of operations as the demand for our products falls.
Semiconductor and other products we design and manufacture are characterized by rapidly changing technology, and our success depends on our ability to develop and manufacture complex products cost-effectively and to scale. |
The market for our products is characterized by rapidly changing technology. Some of our products have average life cycles of less than one year. Therefore, our success is highly dependent upon our ability to develop and manufacture increasingly complex new products quickly and on a cost-effective basis and to scale. Semiconductor design and process technologies are also subject to constant technological improvements and require large expenditures for capital investment, advanced research and technology development. If we experience substantial delays or are unable to develop new design or process technologies, our results of operations could be adversely affected. In certain cases, it may be necessary to incur costs to acquire technology from third parties, which may affect our results of operations and margins without any guarantee of success. We charged $76 million as annual amortization expense on our statement of income in 2004, related to technologies and licenses acquired from third parties through the end of 2004; as of December 31, 2004, the residual value, net of amortization, registered in our balance sheets for these technologies and licenses was $176 million.
In difficult market conditions, our high fixed costs adversely impact our results. |
In less favorable industry environments, we are driven to reduce prices in response to competitive pressures and we are also faced with a decline in the utilization rates of our manufacturing facilities due to decreases in product demand. Since the semiconductor industry is characterized by high fixed costs, we are not always able to reduce our total costs in line with revenue declines. Reduced average selling prices for our products therefore adversely affect our results of operations. Furthermore, in periods of reduced customer demand for our products, our fabs do not operate at full capacity and the costs associated with the excess capacity are charged directly to cost of sales. Over the last five years, our gross profit margin has varied from a high of 47.4% in the fourth quarter of 2000 to a low of 31.7% in the fourth quarter of 2001. We cannot guarantee that difficult market conditions will not adversely affect the capacity utilization of our fabs and consequently our future gross margins. We cannot guarantee that increased competition in our core product markets will not lead to further price erosion, lower revenue growth rates and lower margins in the future.
In particular, while the U.S. dollar is our reporting currency, a significant portion of our fixed costs, such as manufacturing labor costs and depreciation charges, selling general and administrative expenses, and research and development expenses, are currently incurred in euros and currencies other than the U.S. dollar, and have significantly increased in 2004 due to the decline of the U.S. dollar, thus reducing our profitability. See Our financial results can be adversely affected by fluctuations in exchange rates, principally in the value of the U.S. dollar and Item 5. Operating and Financial Review and ProspectsImpact of Changes in Exchange Rates.
In order to address our fixed costs, we have recently announced our decision to accelerate cost-reduction initiatives, including a more selective process in dedicating capacity to new orders, with priority to high margin products; optimization of the product and production mix in memory; consolidation of certain central function activities to control overhead; and launching an aggressive cost savings program focused on purchasing. There is no assurance that the aforementioned initiatives will be successful, and that our fixed costs will not remain high, particularly in the event of a further decline in the value of the U.S. dollar versus the euro.
Our financial results can be adversely affected by fluctuations in exchange rates, principally in the value of the U.S. dollar. |
A significant variation of the value of the U.S. dollar against the principal currencies which have a material impact on us (primarily the euro, but also certain Asian and other currencies of countries where we have operations) could result in a favorable impact on our net income in the case of an appreciation of the U.S. dollar, or a negative impact on our net income if the U.S. dollar depreciates relative to these currencies. Certain
8
significant costs incurred by us, such as manufacturing labor costs and depreciation charges, selling, general and administrative expenses, and research and development expenses, are incurred in the currencies of the jurisdictions in which our operations are located. Currency exchange rate fluctuations affect our results of operations because our reporting currency is the U.S. dollar, in which we receive the major part of our revenues, while, more importantly, we incur the majority of our costs in currencies other than the U.S. dollar. In 2004, the U.S. dollar depreciated in value significantly, in particular against the euro, causing us to report higher expenses, and negatively impacting both our gross margin and operating income. Our Consolidated Financial Statements for 2004 include income and expense items translated at the average rate for the period. The average rate of the euro to the U.S. dollar was €1.00 for $1.236 in 2004 and $1.125 in 2003; see Item 5. Operating and Financial Review and ProspectsImpact of Changes in Exchange Rates and Item 11. Quantitative and Qualitative Disclosures About Market Risk. The continued decline of the U.S. dollar compared to the other major currencies that affect our operations would negatively impact our expenses, margins and profitability, especially if we are unable to balance or shift our euro-denominated costs to other currency areas or to U.S. dollars. Any such actions may not be immediately effective, could prove costly and their implementation could prove demanding on our management resources. In order to reduce the exposure of our financial results to the fluctuations in exchange rates, our principal strategy has been to balance as much as possible the proportion of sales to our customers denominated in U.S. dollars with the amount of purchases from our suppliers denominated in U.S. dollars, and to reduce the weight of the other costs, including labor costs and depreciation, denominated in euros and in other currencies. In order to further reduce the exposure to U.S. dollar exchange rate fluctuations, we have hedged certain line items on our income statement, in particular with respect to a portion of the cost of goods sold, most of the research and development expenses and certain selling and general and administrative expenses located in the euro zone. No assurance can be given that our hedging policy will be successful in its objective, or that the value of the U.S. dollar will not actually appreciate with the hedging transaction potentially preventing us from benefiting from lower euro- denominated manufacturing costs when translated into our U.S. dollar-based accounts. See Item 11 Quantitative and Qualitative Disclosures About Market Risk for the relevant amounts and contracts.
Because we have our own manufacturing facilities, our capital needs are high compared to competitors who do not produce their own products. |
As a result of our strategic choice to maintain control of our advanced proprietary manufacturing technologies to serve our customer base and develop our strategic alliances, we require significant amounts of capital to build, expand, modernize and maintain our facilities. Some of our competitors, however, do not manufacture their own products and therefore do not require significant capital expenditures for their facilities. Our capital expenditures have been significant in recent years. See Selected Financial Data for the amount of our capital expenditures in the past five fiscal years. We currently expect our 2005 capital expenditures to be approximately $1.5 billion. Our costs are also increasing as the complexity of the individual manufacturing equipment increases. We have the flexibility to modulate our investments up or down in response to changes in market conditions, and we are prepared to accelerate investments in leading-edge technologies if market conditions require. We will continue to monitor our level of capital spending taking into consideration factors such as trends in the semiconductor market and capacity utilization.
To stay competitive in the semiconductor industry, we must transition certain products to 300 millimeter manufacturing technology, which is much more expensive than 150 mm or 200 mm technologies. Currently, all of our fabs process wafers with diameters of 150 mm or 200 mm. We are developing 300 mm process technology on a pilot line at Crolles2, with our partners Philips Semiconductor and Freescale Semiconductor, Inc.
If we are unable to access 300 mm technology for volume production, our ability to develop and market new products could suffer, which could, in turn, have a material adverse effect on our business, financial condition and results of operations.
We may also need additional funding in the coming years to finance our investments or purchase other companies or technology developed by third parties. |
We have constructed a building in Catania, which we have not yet started to equip, for the volume production of 300 mm wafers. In addition, in an increasingly complex and competitive environment, we may need to invest in the acquisition of other companies or third party technology to maintain our competitive position in the market. Furthermore, we may consider acquisitions to complement or expand our existing business.
9
Any of the foregoing may require us to issue additional debt or equity, or both, and if we are unable to access such capital on acceptable terms, this may adversely affect our business and results of operations. The timing and size of any new share, convertible bond or straight bond offering would depend upon market conditions as well as a variety of factors and any such transaction or an announcement concerning such a transaction could materially impact market price of our common shares. We currently have no financial covenants under our existing debt instruments. If we were to issue additional debt, however, it could require that we undertake and comply with certain financial covenants.
Our research and development efforts in the field of CMOS process development are dependent on alliances, and our business, results of operations and prospects could be materially adversely affected by the failure of such alliances in developing new process technologies in line with
market requirements. |
We are cooperating with Freescale Semiconductor, Inc. (formerly a division of Motorola Inc.) and Philips Semiconductors International B.V. for the joint research and development of complementary metal-on silicon oxide semiconductor (CMOS) process technology to provide 90-nm to 32-nm chip technologies on 300mm wafers, as well as the operation of a 300mm wafer pilot line fab in Crolles, France (Crolles2). There can be no assurance that our alliances with Philips and Freescale will be successful or will enable us to develop new technologies in due time, in a cost-effective manner and/or to meet customer demands. Furthermore, if the alliances fail to accomplish their intended goals, we may lose our investment, or incur additional unforeseen costs, and our business, results of operations and prospects could be materially adversely affected. If the Crolles2 alliance or other alliances we enter do not succeed in developing technologies that are commercially accepted, or if we are unable to develop such new technologies independently, we may fail to keep pace with the rapid technology advances in the semiconductor industry, and customers may not buy our products.
Our operating results may vary significantly from quarter to quarter and annually and may differ significantly from our expectations or guidance. |
Our operating results are affected by a wide variety of factors that could materially and adversely affect revenues and profitability or lead to significant variability of operating results. These factors include, among others, the cyclicality of the semiconductor and electronic systems industries, capital requirements, inventory management, availability of funding, competition, new product developments, technological changes, and manufacturing problems. Furthermore, our effective tax rate takes into consideration certain tax regimes which, in the future, may not be available to us. See Note 24 to the Consolidated Financial Statements. In addition, a number of other factors could lead to fluctuations in quarterly and annual operating results, including:
| performance of our key customers in the markets they serve; |
| order cancellations or reschedulings by customers; |
| excess inventory held by customers leading to reduced bookings or product returns by key customers; |
| manufacturing capacity and utilization rates; |
| restructuring and impairment charges; |
| fluctuations in currency exchange rates, particularly between the U.S. dollar and other currencies in jurisdictions where we have activities; |
| intellectual property developments; |
| changes in distribution and sales arrangements; |
| failure to win new design projects; |
| manufacturing performance and yields; |
| product liability or warranty claims; |
| litigation; |
| possible acquisitions; |
| problems in obtaining adequate raw materials or production equipment on a timely basis; and |
| property damage or business interruption losses resulting from a catastrophic event not covered by insurance. |
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Unfavorable changes in the above factors, some of which are further described in this section, have in the past and may in the future adversely affect our operating results. Furthermore, in periods of industry overcapacity or when our key customers encounter difficulties in their end markets, orders are more exposed to cancellations, reductions, price renegotiation or postponements, which in turn reduce our managements ability to forecast the next quarter or full year production levels, revenues and margins. For these reasons and others that we may not yet have identified, our revenues and operating results may differ materially from our expectations or guidance as visibility is reduced. See Item 4. Information on the CompanyBacklog.
The demand for our
products depends in large part on continued growth in the industries
and segments into which they are sold. A market decline in any
of these
industries
could have a material adverse effect on our results
of operations. |
We derive and expect to continue to derive significant sales from the telecommunications equipment and automotive industries, as well as the home, personal and consumer segments generally.
Growth of demand in the telecommunications equipment and automotive industries as well as the home, personal and consumer segments, has in the past and may in the future, fluctuate significantly based on numerous factors, including:
| spending levels of telecommunications equipment and/or automotive providers; |
| development of new consumer products or applications requiring high semiconductor content; |
| evolving industry standards; |
| the rate of adoption of
new or alternative technologies, and |
| demand for automobiles,
consumer confidence and general economic conditions. |
We cannot assure you of the rate, or the extent to which, the telecommunications equipment or automotive industries or the home, personal or consumer segments, will grow, if at all. Any continued decline in these industries or segments could result in slower growth or a decline in demand for our products, which could have a material adverse effect on our business, financial condition and results of operations. In recent years, our sales have increased at a slower pace than the semiconductor industry as a whole and our market share has declined.
In addition, projected industry growth rates may not materialize as forecasted, resulting in spending on process and product development well ahead of market requirements, which could have a material adverse effect on our business, financial condition and results of operations.
We operate in many jurisdictions with highly complex and varied tax regimes. Changes in tax rules or the outcome of tax assessments and audits could cause a material adverse effect on our results. |
We operate in many jurisdictions with highly complex and varied tax regimes. Changes in tax rules or the outcome of tax assessments and audits could have a material adverse effect on our results in any particular quarter. For example, in 2004, we had an income tax expense of $68 million, as compared to an income tax benefit of $14 million in 2003, due to the impact in 2003 of impairment, restructuring charges and other related closure costs that we incurred in jurisdictions with tax rates higher than our average tax rate. In 2004, we also benefited from a favorable reassessment of our deferred tax assets and liabilities due to changes in enacted tax rates, and a favorable settlement of certain minor items relating to prior years tax audits. Our tax rate is variable and depends on changes in the level of operating profits within various local jurisdictions and on changes in the applicable taxation rates of these jurisdictions, as well as changes in estimated tax provisions due to new events. We currently enjoy certain tax benefits in some countries, and these benefits may not be available in the future due to changes within the local jurisdictions, our effective tax rate could increase in the coming years.
Our operating results
can also vary significantly due to impairment of goodwill and other
intangible assets incurred in the course of acquisitions, as well
as to impairment of tangible assets due to changes in the business
environment.
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Our operating results can also vary significantly due to impairment of goodwill booked pursuant to acquisitions and to the purchase of technologies and licenses from third parties. As of December 31, 2004, the value registered on our audited consolidated balance sheet for goodwill was $264 million and the value for
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technologies and licenses acquired from third parties was $176 million, net of amortization. Because the market for our products is characterized by rapidly changing technologies, and because of significant changes in the semiconductor industry, our future cash flows may not support the value of goodwill and other intangibles registered in our balance sheet. Furthermore, the ability to generate revenues for our fixed assets located in Europe may be impaired by the increase in the value of the euro with respect to the U.S. dollar, as the revenues from the use of such assets are generated in U.S. dollars. We are required to annually test goodwill and to assess the carrying values of intangible and tangible assets when impairment indicators exist. As a result of such tests, we could be required to book an impairment in our statement of income if the carrying value in our balance sheet is in excess of the fair value. The amount of any potential impairment is not predictable as it depends on our estimates of projected market trends, results of operations and cash flows. Any potential impairment, if required, could have a material adverse impact on our results of operations.
Disruptions in our relationships with any one of our key customers could adversely affect our results of operations. |
A substantial portion of our sales are derived from several large customers, some of whom have entered into strategic alliances with us. As of December 31, 2004, our largest customer was Nokia, which accounted for 17.1% of our 2004 net revenues, compared to 17.9% in 2003 and 17.6% in 2002. In 2004, our top 10 original equipment manufacturer customers accounted for approximately 44% of our net revenues, compared to approximately 46% of our 2003 net revenues and 49% of our 2002 net revenues. We cannot guarantee that our largest customers will continue to book the same level of sales with us that they have in the past and will not solicit alternative suppliers. Many of our key customers operate in cyclical businesses that are also highly competitive, and their own demands and market positions may vary considerably. Such customers have in the past, and may in the future, vary order levels significantly from period to period, request postponements to scheduled delivery dates or modify their bookings. Approximately 16% of our net revenues were made through distributors in 2002, increasing in 2003 to approximately 18% and to 21% in 2004. We cannot guarantee that we will be able to maintain or enhance our market share with our key customers or distributors. If we were to lose one or more design wins for our products with our key customers or distributors, or if any key customer were to reduce or change its bookings, seek alternate suppliers, increase its product returns or fail to meet its payment obligations, our business financial condition and results of operation could be materially adversely affected. If orders are cancelled, we may not be able to resell products previously made or require the customers who have ordered these products to pay for them. Furthermore, developing industry trends, including customers use of outsourcing and new and revised supply chain models, may reduce our ability to forecast the purchase date for our products and evolving customer demand, thereby affecting our revenues and working capital requirements. For example, pursuant to recent industry developments, we are required to deliver our products on consignment to customer sites with recognition of revenue delayed until the moment, which must occur within a defined period of time, when the customer chooses to take delivery of our products from our consignment stock.
Because we depend on a limited number of suppliers for raw materials and certain equipment, we may experience supply disruptions if suppliers interrupt supply or increase prices. |
Our ability to meet our customers demand to manufacture our products depends upon obtaining adequate supplies of quality raw materials on a timely basis. A number of materials are available only from a limited number of suppliers, or only from a limited number of suppliers in a particular region. In addition, we purchase raw materials such as silicon wafers, lead frames, mold compounds, ceramic packages and chemicals and gases from a number of suppliers on a just-in-time basis. Although supplies for the raw materials we currently use are adequate, shortages could occur in various essential materials due to interruption of supply or increased demand in the industry. We also purchase semiconductor manufacturing equipment from a limited number of suppliers and because such equipment is complex it is difficult to replace one supplier with another or to substitute one piece of equipment for another. In addition, suppliers may extend lead times, limit our supply or increase prices due to capacity constraints or other factors. Shortages of supplies have in the past impacted the semiconductor industry. Although we work closely with our suppliers to avoid these types of shortages, there can be no assurances that we will not encounter these problems in the future. Our quarterly or annual results of operations would be adversely affected if we were unable to obtain adequate supplies of raw materials or equipment in a timely manner or if there were significant increases in the costs of raw materials or problems with the quality of these raw materials.
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Our manufacturing processes are highly complex, costly and potentially vulnerable to impurities, disruptions or inefficient implementation of production changes that can significantly increase our costs and delay product shipments to our customers. |
Our manufacturing processes are highly complex, require advanced and increasingly costly equipment and are continuously being modified or maintained in an effort to improve yields and product performance. Impurities or other difficulties in the manufacturing process can lower yields, interrupt production or result in losses of products in process. As system complexity has increased and sub-micron technology has become more advanced, manufacturing tolerances have been reduced and requirements for precision have become even more demanding. Although in the past few years we have significantly enhanced our manufacturing capability in terms of efficiency, precision and capacity, we have from time to time experienced bottlenecks and production difficulties that have caused delivery delays and quality control problems, as is common in the semiconductor industry. We cannot guarantee that we will not experience bottlenecks, production or transition difficulties in the future. In addition, during past periods of high demand for our products, our manufacturing facilities have operated at high capacity, which has led to production constraints. Furthermore, if production at a manufacturing facility is interrupted, we may not be able to shift production to other facilities on a timely basis, or customers may purchase products from other suppliers. In either case, the loss of revenue and damage to the relationship with our customer could be significant. Furthermore, we periodically transfer production equipment between production facilities and must ramp up and test such equipment once installed in the new facility before it can reach its optimal production level.
As is common in the semiconductor industry, we have, from time to time, experienced and may in the future experience difficulties in transferring equipment between our sites, ramping up production at new facilities or effecting transitions to new manufacturing processes. Our operating results may be adversely affected by an increase in fixed costs and operating expenses linked to production if revenues do not increase commensurately with such fixed costs and operating expenses.
If our outside foundry suppliers fail to perform, this could adversely affect our ability to exploit growth opportunities. |
In order to meet anticipated requirements for high-speed complementary metal-on silicon oxide semiconductor (HCMOS) wafers and nonvolatile memory technology, in the past, we have used outside suppliers, or foundries. If our outside suppliers are unable to satisfy our demand, or experience manufacturing difficulties, delays or reduced yields, our results of operations and ability to satisfy customer demand could suffer. In addition, purchasing rather than manufacturing these products may adversely affect our gross profit margin if the purchase costs of these products are higher than our own manufacturing costs. Our internal manufacturing costs include depreciation and other fixed costs, while costs for products outsourced are based on market conditions. Prices for foundry products also vary depending on capacity utilization rates at our suppliers, quantities demanded, product technology and geometry. Furthermore, these outsourcing costs can vary materially from quarter-to-quarter and, in cases of industry shortages, they can increase significantly further, negatively impacting our gross margin.
We depend on patents to protect our rights to our technology. |
We depend on our ability to obtain patents and other intellectual property rights covering our products and their design and manufacturing processes. We intend to continue to seek patents on our inventions relating to product designs and manufacturing processes. However, the process of seeking patent protection can be long and expensive, and we cannot guarantee that we will receive patents from currently pending or future applications. Even if patents are issued, they may not be of sufficient scope or strength to provide meaningful protection or any commercial advantage. In addition, effective patent, copyright and trade secret protection may be unavailable or limited in some countries. Competitors may also develop technologies that are protected by patents and other intellectual property and therefore either be unavailable to us or be made available to us subject to adverse terms and conditions. We have negotiated in the past broad patent cross-licenses with many of our competitors enabling us to design, manufacture and sell semiconductor products, without fear of infringing patents held by such competitors. We may not, however, in the future be able to obtain licenses or other rights to protect necessary intellectual property on acceptable terms for the conduct of our business, and such failure may adversely impact our results of operations.
We have from time to time received, and may in the future receive, communications alleging possible infringement of patents and other intellectual property rights of others. Furthermore, we may become involved in
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costly litigation brought against us regarding patents, mask works, copyrights, trademarks or trade secrets. See Item 8. Financial InformationLegal Proceedings. In the event that the outcome of any litigation would be unfavorable to us, we may be required to obtain a license to the underlying intellectual property right upon economically unfavorable terms and conditions, possibly pay damages for prior use and/or face an injunction, all of which, singly or in the aggregate, could have a material adverse effect on our results of operations and ability to compete.
Finally, litigation could cost us financial and management resources necessary to enforce our patents and other intellectual property rights or to defend against third party intellectual property claims, when we believe that the amounts requested for a license are unreasonable.
We are required to prepare consolidated financial statements using both International Financial Reporting Standards (IFRS) as from 2005 in addition to our consolidated financial statements prepared pursuant to Generally Accepted Accounting Principles in the United States (U.S.
GAAP) and dual reporting may impair the clarity of our financial reporting. |
We are incorporated in the Netherlands and our shares are listed on Euronext Paris and on the Borsa Italiana, and, consequently, we are subject to a European Union (EU) regulation issued on September 29, 2003 requiring us to report our results of operations and consolidated financial statements using IFRS (previously known as International Accounting Standards or IAS). Since our creation in 1987, we have always prepared our Consolidated Financial Statements under U.S. GAAP and intend to continue to do so, while at the same time complying with our reporting obligations under IFRS by presenting a complementary set of accounts in our 2005 Dutch statutory annual report or as may be otherwise requested by local stock exchange authorities. Our decision to continue to apply U.S. GAAP in our financial reporting is designed to ensure the comparability of our results to those of our competitors and the continuity of our reporting, thereby providing our investors a clear understanding of our financial performance.
The obligation to report our Consolidated Financial Statements under IFRS will require us to prepare our results of operations using two different sets of reporting standards, U.S. GAAP and IFRS, which are currently not consistent. Such dual reporting could materially impair the clarity of our investor communications. The main potential area of discrepancy concerns capitalization and later amortization of development expenses potentially required under IFRS. Furthermore, while we believe all of our accounting systems are in place to prepare a separate set of accounts pursuant to IFRS starting in January 2005, we may not be able to account for capitalization of development expenses pursuant to IFRS in previous periods for comparative purposes. Our financial condition and results of operations reported in accordance with IFRS may differ from our financial condition and results of operations reported in accordance with U.S. GAAP, which could adversely affect the market price of our common shares.
Certain accounting principles of U.S. GAAP are in flux and may lead to significant changes in the way we account for our convertible debt instruments. These changes may lead to significant changes in our financial statements. |
Certain U.S. GAAP accounting principles are in flux and pending proposed amendments are likely to be made. Certain of these proposed changes may bring U.S. GAAP more closely into line with IFRS, while others are independent of the move to converge generally accepted accounting principles. This state of flux makes it difficult for us to predict how accounting rules may evolve over the near- and medium-term.
In particular, the Financial Accounting Standards Board (FASB) has identified accounting for zero coupon convertible debt instruments as an emerging accounting issue. FASBs current proposal would involve uncoupling the debt and equity components of convertible debt instruments, in line with the fair market value of the debt. Recognition of interest expense in line with market rates under the FASB proposal may be considerably higher than the interest currently being charged. In particular, we may be required to show a high interest charge in respect of our 2013 Bonds, even if it is bearing a negative yield. Balance sheets of companies with outstanding convertible debt instruments would also be impacted because shareholders equity would be adjusted to show increased additional paid-in capital for the value of the embedded conversion option. The current proposal could apply both to our existing convertible debt instruments and any such instruments issued in the future. FASBs proposal date of effect is not yet defined. If a new rule is adopted in line with the current proposals, and if there is no provision that limits its applicability to only those instruments issued in the future, we may be required to change the accounting for our convertible 2013 Bonds on our statement of income and on our balance sheet. There can be no assurance that these proposed rules and regulations or any other laws, rules or regulations, will
14
not be adopted in the future, any of which could adversely affect our financial statements, make compliance more difficult or expensive, or otherwise adversely affect our business, financial condition or prospects.
New U.S. GAAP accounting
rules require that share-based compensation to employees be charged
against net income, and this could have a material adverse effect
on our reported income.
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On December 16, 2004, FASB issued Statement of Financial Accounting Standards No. 123 (revised 2004) Share-Based Payment (FAS 123R), which requires that share-based compensation to employees in the form of stock options or similar instruments be considered as a compensation expense and requires recognition of a charge to the income statement, measured on the basis of the fair value of the option at the grant date (with limited exceptions). The cost will be recognized over the period during which an employee is required to provide service in exchange for the share-based compensation. Employee share purchase plans will not result in recognition of compensation cost if certain conditions are met (similar to those in Statement No. 123). We have reviewed our past employee share purchase plans and concluded that they do not meet these conditions and consequently qualify as compensatory. The impact of the new rule such a change is described in Note 2.23 to the Consolidated Financial Statements, currently computed on the basis of FAS 123.
Some of our production
processes and materials are environmentally sensitive, which could
lead to increased costs due to environmental regulations or to
damage to the environment.
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We are subject to a variety of laws and regulations relating, among other things, to the use, storage, discharge and disposal of chemicals, gases and other hazardous substances used in our manufacturing processes, air emissions, waste water discharges, waste disposal, as well as the investigation and remediation of soil and ground water contamination. A recent directive in the European Union imposes a take back obligation on manufacturers for the financing of the collection, recovery and disposal of electrical and electronic equipment. Additional European legislation will ban the use of lead and some flame retardants in electronic components beginning in 2006. Our activities in the European Union are also subject to the European Directive 2003/87 establishing a scheme for green-house gas allowance trading, and to the applicable national implementing legislation. In addition, a legislative proposal by the European Commission will require the registration, evaluation and authorizations of a large number of chemicals (REACH). The implementation of any such legislation could adversely affect our manufacturing costs or product sales by requiring us to acquire costly equipment, materials or green-house gas allowances, or to incur other significant expenses in adapting our manufacturing processes or waste and emission disposal processes. We are not in a position to quantify specific costs, in part because these costs are part of our business process. Furthermore, environmental claims or our failure to comply with present or future regulations could result in the assessment of damages or imposition of fines against us, suspension of production or a cessation of operations and, as with other companies engaged in similar activities, any failure by us to control the use of, or adequately restrict the discharge of chemicals or hazardous substances could subject us to future liabilities. Any specific liabilities we identify as probable would be reflected in our balance sheet. To date, we have not identified any such specific liabilities. We therefore have not booked specific reserves for any specific environmental risks. See Item 4. Information on the CompanyEnvironmental Matters.
Loss of key employees
could hurt our competitive position.
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As is common in the semiconductor industry, success depends to a significant extent upon our key senior executives and research and development, engineering, marketing, sales, manufacturing, support and other personnel. Our success also depends upon our ability to continue to attract, retain and motivate qualified personnel. The competition for such employees is intense, and the loss of the services of any of these key personnel without adequate replacement or the inability to attract new qualified personnel could have a material adverse effect on us.
Changes to our senior management organization, as well as our new top management teams ability to adapt our strategy to evolving market conditions, could adversely affect our operations, if continuity of our relationships with our key customers, partners and suppliers is impaired.
Our common share
price, operating results, net income, net income per share and
net financial position may be negatively affected by potential
acquisitions.
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While our growth to date has primarily been organic, we have in the past and may in the future make selected acquisitions that we believe would complement or expand our existing business. We may pay for future acquisitions with cash, our common shares or some combination of both. Acquisitions, if they occur, may have a
15
dilutive effect for existing shareholders and, whether they are paid for in cash or common shares, may negatively affect our common share price. Announcements concerning potential acquisitions could be made at any time.
Acquisitions involve a number of risks that could adversely affect our operating results, including:
| the diversion of managements
attention;
|
| the integration of acquired
company operations and personnel;
|
| the assumption of potential
liabilities, disclosed or undisclosed, associated with the business
acquired, which liabilities may exceed the amount of indemnification
available from the seller;
|
| the risk that the financial
and accounting systems utilized by the business acquired will not meet
our standards;
|
| the risk that the businesses
acquired will not maintain the quality of products and services that
we have historically provided;
|
| whether we are able to
attract and retain qualified management for the acquired business;
|
| whether we are able to
retain customers of the acquired entity; and
|
| the risk of goodwill and
other intangible asset impairment, due to the inability of the business
to meet managements expectations at the time of the acquisition.
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There can be no assurance that (a) we will be able to consummate future acquisitions on satisfactory terms, if at all, (b) adequate financing will be available for future acquisitions on terms acceptable to us, if at all, or (c) any operations acquired will be successfully integrated or that such operations will ultimately have a positive impact on our business.
We may be faced with
product liability or warranty claims.
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Despite our corporate quality programs and commitment, our products may not in each case comply with specifications or customer requirements. Warranty or product liability claims could result in significant expenses relating to costs of defending against such claims, damages awarded or related compensation payments in line with industry or business practices or to maintain good customer relationships. When faced in the past with potential warranty claims in respect of products supplied by us, we have in certain instances paid compensation to customers and may do so again in the future.
We may invest our
cash in short-term financial instruments as part of our treasury
management strategy, which has certain inherent risks.
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From time to time, we may use cash on hand to purchase short-term financial instruments as part of our treasury management strategy. These instruments may have returns that depend on certain credit events of reference debt obligations issued by reference issuers consisting of different banks with a minimum credit rating. Interest is payable to us on such instruments through the final maturity, typically before the end of the financial year, unless suspended upon an earlier credit event under the relevant reference debt or of the relevant reference issuer. For certain short-term financial instruments, principal would be repaid to us at final maturity, unless such a credit event occurs, in which event early repayment of principal would be reduced based on the decline in value of the relevant reference debt. While we place our cash and cash equivalents with high credit quality financial institutions and manage the credit risks associated with financial instruments through credit approvals, investment limits, we do not normally require collateral or other security from the parties to the financial instruments. Thus, no assurance can be given that a rapid, unanticipated crisis in the global financial system would not have an adverse impact on our results of operations and cash flow. See Item 11. Quantitative and Qualitative Disclosures about Market Risk.
Furthermore, notwithstanding the fact that we are careful in the selection of financial institutions with which we enter into such agreements, a default event pursuant to the relevant contract may materially impact our financial position.
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Reduction in the
amount of state funding available to us or demands for repayment
may increase our costs and impact our results of operations.
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Like many other manufacturers operating in Europe, we benefit from governmental funding for research and development expenses and industrialization costs (which include some of the costs incurred to bring prototype products to the production stage), as well as from incentive programs for the economic development of underdeveloped regions. Public funding may also be characterized by grants and/or low-interest financing for capital investment. See Item 4. Information on the CompanyPublic Funding. We have entered into public funding agreements in France and Italy, which set forth the parameters for state support to us under selected programs. These funding agreements may require compliance with EU regulations and approval by EU authorities.
We rely on receiving funds on a timely basis pursuant to the terms of the funding agreements. However, funding of programs in France and Italy is subject to annual appropriation of available resources, which is outside our control, as well as to our continuing compliance with all eligibility requirements. If we are unable to receive anticipated funding on a timely basis, or if existing government-funded programs were curtailed or discontinued, or if we were unable to fulfill our eligibility requirements, this could have a material adverse effect on our business, operating results and financial condition. There is no assurance that any alternative funding would be available, or that, if available, it could be provided in sufficient amounts or on similar terms.
The application for and implementation of such grants often involves compliance with extensive regulatory requirements including, in the case of subsidies to be granted within the European Union, notification to the European Commission by the member state making the contemplated grant prior to disbursement. In particular, compliance with project-related ceilings on aggregate subsidies defined under EU law often involves highly complex economic evaluations. Furthermore, public funding arrangements are generally subject to annual and project-by- project reviews and approvals. If we fail to meet applicable formal or other requirements, we may not be able to receive the relevant subsidies or may be obliged to repay them which could have a material adverse effect on our results of operations.
The interests of
our controlling shareholders, which are in turn controlled respectively
by the French and Italian governments, may conflict with investors interests.
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We have been informed that as of December 31, 2004, STMicroelectronics Holding II B.V. (ST Holding II), a wholly owned subsidiary of STMicroelectronics Holding N.V. (ST Holding), owned 278,483,280 shares, or approximately 30.8%, of our issued common shares. ST Holding is therefore effectively in a position to control actions that require shareholder approval, including corporate actions, the election of our Supervisory Board and our Managing Board and the issuance of new shares or other securities.
We have also been informed that the shareholders agreement among ST Holdings shareholders (the STH Shareholders Agreement), to which we are not a party, governs relations between our indirect shareholders Areva Group, Cassa Depositi e Prestiti S.p.A., Finmeccanica S.p.A. and France Telecom, each of which is ultimately controlled by the French or Italian government, see Item 7. Major Shareholders and Related-Party TransactionsMajor Shareholders. The STH Shareholders Agreement includes provisions requiring the unanimous approval by shareholders of ST Holding before ST Holding can make any decision with respect to certain actions to be taken by us. Furthermore, as permitted by our articles of association, the Supervisory Board has specified selected actions by the Managing Board that require the approval of the Supervisory Board. See Item 6. Directors, Senior Management and EmployeesDirectors and Senior ManagementManaging Board. These requirements for the prior approval of various actions to be taken by us and our subsidiaries may give rise to a conflict of interest between our interests and investors interests, on the one hand, and the interests of the individual shareholders approving such actions, on the other, and may affect the ability of our Managing Board to respond as may be necessary in the rapidly changing environment of the semiconductor industry. Furthermore, our ability to issue new shares or other securities may be limited by the existing shareholders desire to maintain their proportionate shareholding at a certain minimum level. Such approval process is, however, subject to the provisions of Dutch law requiring members of our Supervisory Board to act independently in supervising our management.
Our shareholder structure
and our preference shares may deter a change of control.
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On May 31, 1999, our shareholders at the annual general meeting approved the creation of up to 180,000,000 preference shares. Pursuant to the 3-for-1 stock split effected in May 2000, the number of such preference shares has increased to 540,000,000. These preference shares entitle a holder to full voting rights at
17
any meeting of shareholders and to a preferential right to dividends and distributions upon liquidation. Pursuant to approval from our shareholders, and in order to protect ourselves from a hostile takeover or other similar action, we entered into an option agreement with ST Holding II, which provides that up to 540,000,000 preference shares shall be issued to ST Holding II upon its request and subject to the adoption of a resolution of our Supervisory Board giving our consent to the exercise of the option and upon payment of the par value of the preference shares to be issued. The option may only be exercised if ST Holding II owns at least 19% of our issued share capital at the time of exercise. No preference shares have been issued to date. The effect of the preference shares may be to deter potential acquirers from effecting an unsolicited acquisition resulting in a change of control. In addition, any issuance of additional capital within the limits of our authorized share capital, as approved by our shareholders, is subject to the approval of our Supervisory Board.
Our direct or indirect
shareholders may sell our existing common shares or issue financial
instruments exchangeable into our common shares at any time while
at the same time seeking to retain their rights regarding our preference
shares. In addition, substantial sales by us of new common shares
or convertible bonds could cause our common share price to drop
significantly.
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The STH Shareholders Agreement, to which we are not a party, permits our respective French and Italian indirect shareholders to cause ST Holding to dispose of its stake in us at its sole discretion at any time from their current level, and to reduce the current level of their respective indirect interests in our common shares to 9.5%. The details of the STH Shareholders Agreement as declared by ST Holding II in its Schedule 13G/A filing dated February 14, 2005, are further explained in Item 7. Major Shareholders and Related-Party TransactionsMajor Shareholders. Disposals of our shares by the parties to the STH Shareholders Agreement can be made by way of the issuance of financial instruments exchangeable for our shares, equity swaps, structured finance transactions or sales of our shares. An announcement with respect to one or more of such dispositions could be made at any time without our advance knowledge.
In addition, €442.2 million aggregate principal amount of France Telecom 6.75% notes are due on August 6, 2005, (the 2002 Notes). The 2002 Notes are mandatorily exchangeable into a maximum of 26.42 million of our existing common shares and a minimum of 20.13 million of our existing common shares, depending on our share price at maturity of the 2002 Notes. Finmeccanica Finance S.p.A., a subsidiary of Finmeccanica has issued €501 million aggregate principal amount of exchangeable notes, exchangeable into up to 20 million of our existing common shares due 2010 (the Finmeccanica Notes). The Finmeccanica Notes have been exchangeable at the option of the holder into our existing common shares since January 2, 2004. Furthermore, Finmeccanica has entered into securities lending and other arrangements that could potentially lead to sales of up to an additional 30 million of our existing common shares potentially at any time. Maturity and/or exchange of the aforementioned 2002 Notes and/or Finmeccanica Notes, into a large number of our existing common shares or sales by Finmeccanica could impact the market price of our common shares.
In addition, substantial sales of our common shares or bonds exchangeable into our common shares or any announcements concerning a potential sale by our shareholders, could materially impact the market price of our common shares. The timing and size of any future share or exchangeable bond offering by our direct or indirect shareholders would depend upon market conditions as well as a variety of factors.
Because we are a
Dutch company subject to the corporate law of the Netherlands,
U.S. investors might have more difficulty protecting their interests
in a court of law or otherwise than if we were a U.S. company.
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Our corporate affairs are governed by our articles of association and by the laws governing corporations incorporated in the Netherlands. The corporate affairs of each of our consolidated subsidiaries are governed by the articles of association and by the laws governing such corporations in the jurisdiction in which such consolidated subsidiary is incorporated. The rights of the investors and the responsibilities of members of our Supervisory Board and Managing Board under Dutch law are not as clearly established as under the rules of some U.S. jurisdictions. Therefore, U.S. investors may have more difficulty in protecting their interests in the face of actions by our management, members of our Supervisory Board or our controlling shareholders than U.S. investors would have if we were incorporated in the United States.
Our executive offices and a substantial portion of our assets are located outside the United States. In addition, ST Holding II and most members of our Managing and Supervisory Boards are residents of jurisdictions other than the United States and Canada. As a result, it may be difficult or impossible for shareholders to effect service within the United States or Canada upon us, ST Holding II, or members of our Managing or Supervisory Boards. It may also be difficult or impossible for shareholders to enforce outside the United States or Canada
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judgments obtained against such persons in U.S. or Canadian courts, or to enforce in U.S. or Canadian courts judgments obtained against such persons in courts in jurisdictions outside the United States or Canada. This could be true in any legal action, including actions predicated upon the civil liability provisions of U.S. securities laws. In addition, it may be difficult or impossible for shareholders to enforce, in original actions brought in courts in jurisdictions located outside the United States, rights predicated upon U.S. securities laws.
We have been advised by our Dutch counsel, De Brauw Blackstone Westbroek N.V., that the United States and the Netherlands do not currently have a treaty providing for reciprocal recognition and enforcement of judgments (other than arbitration awards) in civil and commercial matters. As a consequence, a final judgment for the payment of money rendered by any federal or state court in the United States based on civil liability, whether or not predicated solely upon the federal securities laws of the United States, will not be enforceable in the Netherlands. However, if the party in whose favor such final judgment is rendered brings a new suit in a competent court in the Netherlands, such party may submit to the Netherlands court the final judgment that has been rendered in the United States. If the Netherlands court finds that the jurisdiction of the federal or state court in the United States has been based on grounds that are internationally acceptable and that proper legal procedures have been observed, the court in the Netherlands would, under current practice, give binding effect to the final judgment that has been rendered in the United States unless such judgment contravenes the Netherlands public policy.
Removal of our common
shares from the CAC 40 on Euronext Paris, the S&P/MIB on the
Borsa Italiana or the Philadelphia Stock Exchange Semiconductor
Sector Index could cause the market price of our common shares
to drop significantly.
|
Our common shares have been included in the CAC 40 index on Euronext Paris since November 12, 1997; the S&P/MIB on the Borsa Italiana, or Italian Stock Exchange since March 18, 2002; and the Philadelphia Stock Exchange Semiconductor Index (or SOX) since June 23, 2003. However, our common shares could be removed from the CAC 40, the S&P/MIB or the SOX at any time, and any such removal or announcement thereof could cause the market price of our common shares to drop significantly.
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Item 4. Information on the Company |
History and Development of the Company |
STMicroelectronics N.V. was formed and incorporated in 1987 under the name of SGS-Thomson Microelectronics N.V. and resulted from the combination of the semiconductor business of SGS Microelettronica (then owned by Società Finanziaria Telefonica (S.T.E.T.), an Italian corporation) and the non-military business of Thomson Semiconducteurs (then owned by the former Thomson-CSF, now Thales, a French corporation). Our length of life is indefinite. We are organized under the laws of the Netherlands, we have our corporate legal seat in Amsterdam and our head offices at WTC Schiphol Airport, Schiphol Boulevard 265, 1118 BH Schiphol Airport, Amsterdam, the Netherlands. Our telephone number there is (+31-20) 406-9604. Our headquarters and operational offices are located at 39 Chemin du Champ des Filles, 1228 Plan-Les-Ouates, Geneva, Switzerland. Our main telephone number there is (+41-22) 929-2929. Our agent for service of process in the United States related to our registration under the U.S. Securities and Exchange Act of 1934, as amended, is STMicroelectronics, Inc., 1310 Electronics Drive, Carrollton, Texas, 75006-5039 and the main telephone number there is (+1-972) 466-6000. Our operations are also conducted through our various subsidiaries, which are organized and operated according to the laws of their country of incorporation, and consolidated by STMicroelectronics NV. See Note 3 to the Consolidated Financial Statements.
We completed our initial public offering in December 1994 with simultaneous listings on Euronext Paris and the New York Stock Exchange. In 1998, we listed our shares on the Borsa Italiana.
Business Overview |
We are a global independent semiconductor company that designs, develops, manufactures and markets a broad range of semiconductor products used in a wide variety of microelectronic applications, including automotive products, computer peripherals, telecommunications systems, consumer products, industrial automation and control systems. According to industry analysts Gartner, Inc. and iSuppli, we were ranked the worlds sixth largest semiconductor company based on 2004 sales. Additionally, in 2004, we held leading positions in sales of Analog Products, Application Specific Integrated Circuits (or ASICs) and Application Specific Standard Products (or ASSPs). Based upon 2004 revenues and according to iSuppli, we were also among the top three semiconductor suppliers for key applications such as mobile phones, and we were number two in discretes and number three in automotive electronics, industrial products and NOR Flash. Based on 2004 results, we also believe we are a leading supplier of semiconductors for hard disk drives, printers, set-top boxes, Smart cards and power management. Major customers include Axalto, Alcatel, Bosch, Delphi, Delta, Echostar, Ericsson, Hewlett-Packard, Hughes, LG Electronics, Marelli, Maxtor, Motorola, Nokia, Nortel Networks, Philips, Pioneer, Samsung, Scientific Atlanta, Seagate, Siemens, Sony, Thomson, Vestel and Western Digital. We also sell our products through global distributors and retailers, including Arrow Electronics, Avnet Inc., BSI Group, Eurodis, Wintech and Yosun.
The semiconductor industry has historically been a cyclical one and we have responded through emphasizing balance in our product portfolio, in the applications we serve, and in the regional markets we address. Consequently, from 1994 through 2004, our revenues grew at a compounded annual growth rate of 12.7% compared to 7.7% for the industry as a whole.
We offer a diversified product portfolio and develop products for a wide range of market applications to reduce our dependence on any single product, application or end market. Within our diversified portfolio, we have focused on developing products that leverage our technological strengths in creating customized, system-level solutions with high-growth digital and mixed-signal content. Products include differentiated ICs (which we define as being our dedicated products, semicustom devices and microcontrollers) and analog ICs (including mixed- signal ICs), the majority of which are also differentiated ICs, as well as certain Flash memory products which are sold for specific applications and to particular customers. As a leading provider of differentiated ICs, we have developed close relationships with customers, resulting in early knowledge of their evolving requirements and enabling us to increase the penetration of our standard products. Differentiated ICs, which are generally less vulnerable to market cycles than standard commodity products, accounted for approximately 66% of our net revenues in 2004, compared to approximately 69% in 2003 and 2002. We also target applications that require substantial analog and mixed-signal content and can exploit our system-level expertise. Analog ICs accounted for approximately 44% of our net revenues in 2004, compared to approximately 49% in 2003 and 53% in 2002, while discrete devices accounted for approximately 14% of our net revenues in 2004, compared to approximately 13% in 2003 and 12% in 2002.
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Our products are manufactured and designed using a broad range of manufacturing processes and proprietary design methods. We use all of the prevalent function-oriented process technologies, including CMOS, bipolar and nonvolatile memory technologies. In addition, by combining basic processes, we have developed advanced systems-oriented technologies that enable us to produce differentiated and application-specific products, including bipolar CMOS technologies (BiCMOS) for mixed-signal applications and diffused metal-on silicon oxide semiconductor (DMOS) technology (BCD technologies) for intelligent power applications and embedded memory technologies. This broad technology portfolio, a cornerstone of our strategy for many years, enables us to meet the increasing demand for System-on-a-Chip (SoC) solutions. Complementing this depth and diversity of process and design technology is our broad intellectual property portfolio that we also use to enter into important patent cross-licensing agreements with other major semiconductor companies.
Through December 31, 2004, we ran our business along product lines organized in the following principal groups:
| Telecommunications, Peripherals and Automotive Groups (TPA); |
| Consumer and Microcontroller Groups (CMG); |
| Memory Products Group (MPG); and |
| Discrete and Standard ICs
Group (DSG). |
Effective January 1, 2005, we realigned our product groups to increase market focus and realize the full potential of our products, technologies, and sales and marketing channels. Beginning in 2005, we will report our sales and operating income in three segments:
| the new Application Specific Groups (ASG) segment, comprised of three product groups our new Home, Personal and Communication Sector (HPC), our new Computer Peripherals Group (CPG) and our new Automotive Product Group (APG). Our
new HPC Sector is comprised of the telecommunications and the audio divisions from the former TPA combined with the consumer group from the former CMG Group. Our new CPG Group covers computer peripherals products, specifically disk drives and
printers, and our new APG Group now comprises all of our major complex products related to automotive applications formerly within the automotive group of TPA and in other product groups (notably from the former DSG and the Microcontroller Group); |
| the Memory Products Group (MPG) segment, comprised of our memories and Smart card businesses; and |
| the new Micro, Linear and Discrete Group (MLD) segment, comprised of most of the former DSG plus standard microcontroller and industrial devices (including the programmable systems memories (PSM) division from the former MPG). |
The following discussion in this Item 4 and in Item 5. Operating and Financial Review and Prospects reflects the organization effective in the three years ended December 31, 2004.
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Results of Operations |
The tables below set forth information on our net revenues by product group and by geographic region:
Year ended December 31, |
||||||||||
2004 | 2003 | 2002 | ||||||||
(in millions, except percentages) | ||||||||||
Net Revenues by Product Group |
||||||||||
Telecommunications, Peripherals and Automotive |
$3,485 | $3,268 | $3,074 | |||||||
Discrete and Standard ICs |
1,614 | 1,224 | 1,055 | |||||||
Memory Products |
1,974 | 1,358 | 1,055 | |||||||
Consumer and Microcontroller |
1,619 | 1,321 | 1,026 | |||||||
Others(1) |
68 | 67 | 108 | |||||||
Total |
$8,760 | $7,238 | $6,318 | |||||||
Net Revenues by Location of Order Shipment(2) |
||||||||||
Europe |
$2,363 | $2,012 | $1,832 | |||||||
North America |
1,211 | 985 | 919 | |||||||
Asia/Pacific |
3,710 | 3,190 | 2,748 | |||||||
Japan |
403 | 337 | 275 | |||||||
Emerging Markets(3) |
1,073 | 714 | 544 | |||||||
Total |
$8,760 | $7,238 | $6,318 | |||||||
Net Revenues by Product Group: |
||||||||||
Telecommunications, Peripherals and Automotive |
39.8 | % | 45.2 | % | 48.7 | % | ||||
Discrete and Standard ICs |
18.4 | 16.9 | 16.7 | |||||||
Memory Products |
22.5 | 18.8 | 16.7 | |||||||
Consumer and Microcontroller |
18.5 | 18.2 | 16.2 | |||||||
Others(1) |
0.8 | 0.9 | 1.7 | |||||||
Total |
100.0 | % | 100.0 | % | 100.0 | % | ||||
Net Revenues by Location of Order Shipment:(2) |
||||||||||
Europe |
27.0 | % | 27.8 | % | 29.0 | % | ||||
North America |
13.8 | 13.6 | 14.5 | |||||||
Asia/Pacific |
42.4 | 44.1 | 43.5 | |||||||
Japan |
4.6 | 4.6 | 4.4 | |||||||
Emerging Markets(3) |
12.2 | 9.9 | 8.6 | |||||||
Total |
100.0 | % | 100.0 | % | 100.0 | % | ||||
(1) | Includes revenues from sales of subsystems and other revenues not allocated to product groups. |
(2) | Net revenues by location of order shipment are classified by location of customer invoiced. For example, products ordered by companies to be invoiced to Asia/Pacific affiliates are classified as Asia/Pacific revenues. |
(3) | Emerging Markets in 2004 included markets such as Latin America, Africa, Eastern Europe, the Middle East and India. |
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Strategy |
Our strategy incorporates the following complementary elements: |
Broad product portfolio. We offer a diversified product portfolio and develop products for a wide range of market applications, thereby reducing our dependence on any single product, application or end market. Within our diversified portfolio, we have focused on developing products that leverage our technological strengths in creating customized, system-level solutions for high-growth digital and mixed-signal applications. Such products include ASICs, ASSPs, microcontrollers, non-standard Flash memories and microcontrollers and analog ICs (including mixed-signal ICs). These differentiated ICs help drive our strategic alliances with customers and, as a result of their application-specific features, generally command higher prices and provide lower gross margin volatility across the semiconductor cycles than standard products. Differentiated ICs accounted for approximately 66% of our net revenues in 2004, compared to approximately 69% in 2003 and 2002.
Standard products, which include nonvolatile memories, standard Flash memories, discrete devices, and all standard logic and linear ICs, represented approximately 34% of our net revenues in 2004, compared to approximately 31% in 2003 and 2002. Our standard product families (with the exception of Flash memories) require less capital investment, thereby offering an opportunity to improve our cash flow. They also generally extend the life cycle of our equipment and facilities, bring volume production to our manufacturing infrastructure, thereby helping to reduce the overall cost of production for our differentiated products, and give us the opportunity to benefit from any short-term increases in certain standard product pricing. We believe that the balance between differentiated and standard products contributes to cost-effective manufacturing and represents a strategic advantage for us.
Broad range of design and process technologies. We continue to utilize our expertise and experience with a wide range of process and design technologies to further develop our capabilities. We are committed to maintaining and, in certain areas, to increasing expenditures on core research and development projects as well as to developing alliances with other semiconductor companies and suppliers of software development tools, as appropriate. Technological advances in the areas of transistor performance and interconnection technologies are being developed for our CMOS logic products and semicustom devices. We work on an ongoing basis with key suppliers to develop advanced and standardized design methodologies for our CMOS, mixed signal and nonvolatile memory processes, as well as libraries of macrofunctions and megafunctions for many of our products, and are focusing on improving our concurrent engineering practices to better coordinate design activities and reduce overall product development time.
Leading global customer base with focus on strategic alliances. We work with our key customers to identify evolving needs and new applications and to develop innovative products and product features. We also leverage our position as a supplier of application-specific products in seeking to sell a broad range of products, and emphasize strategic customer alliances to expand our customer base. We have formal alliances with certain strategic customers that allow us and our customers (with whom we jointly share certain product development risks) to exchange information and give our customers access to our process technologies and manufacturing infrastructure. We have formed alliances in our key targeted application market segmentstelecommunications, automotive, consumer and computer peripheralswith customers such as Alcatel, Bosch, Hewlett-Packard, Marelli, Nokia, Nortel Networks, Pioneer, Seagate, Siemens VDO, Thomson and Western Digital, among others. Our 12 strategic alliances with key customers have been a major growth driver for us. In 2002, 2003 and 2004, revenues from strategic customer alliances accounted for approximately 47%, 43% and 39% respectively of our net revenues. Our company-wide initiative to offer our products to an expanded customer base fueled incremental, progressive revenue growth throughout 2004, with sales outside our traditional top 50 customers increasing 31% over 2003 levels. We invested to ensure the long-term success of the accelerated marketing program we began in the second half of 2002, by creating new regional competence centers that focus on specific applications, increasing design activities in advanced products with multiple applications, and launching a new generation of e-tools for customer support.
Market share gains. Building market share in our targeted market segments, wireless, digital consumer, automotive, industrial and computer peripherals, is an ongoing priority for us. To date, our success has been largely a function of organic growth achieved by deepening our partnerships with our existing strategic customers, and expanding our customer base. However, we are careful to strike a balance between growth and profitability and we may discontinue or prune those low volume, non-strategic product families.
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Industry partnerships. Partnerships with other semiconductor companies and suppliers enable us to share the increasing costs and technological risks involved in the research and development of state-of-the-art processes, product architectures and digital cores and to shorten the product development time of certain products. For example, we are currently working under a joint research and development technology cooperation programs in Crolles2 (France) with Freescale Semiconductor, Inc. and Philips Semiconductors International B.V. We are also jointly developing with the Mobile Industry Processor Interface Alliance (MIPI), an industrial coalition, an open standard for wireless application interface, as well as working with Nokia to establish specifications for camera modules, aimed at standardizing this increasingly important component in mobile devices. We work closely with our software and equipment key suppliers on joint development programs to develop easy-to-use design tools for specific applications. Furthermore, we are co-developing NAND Flash memory products with Hynix, and have announced a plan to build a jointly owned dedicated memory manufacturing facility in China.
Global integrated manufacturing infrastructure. We have a diversified, leading-edge manufacturing infrastructure capable of producing silicon wafers using our broad process technology portfolio, including our CMOS, BiCMOS and BCD technologies. Assembling, testing and packaging of our semiconductor products takes place in our large and modern back-end facilities which are located in low-cost areas. We have also developed relationships with outside contractors for foundry and back-end services. We view these relationships as giving us the flexibility when required by market demand to outsource up to a maximum of 20% of each of our front-end and back-end production requirements, enabling us to manage the supply chain to our customers without a commensurate increase in capital spending.
Integrated presence in key regional markets. We have sought to develop a competitive advantage by building an integrated presence in each of the worlds major economic zones: Europe, Asia, North America and Emerging Markets. An integrated presence means having manufacturing and design, as well as sales and marketing capabilities in each region, in order to ensure that we are well positioned to anticipate and respond to our customers business requirements. We have leading-edge, front-end manufacturing facilities in Europe, in the United States and increasingly in Asia, where we sourced over 40% of our wafers at the end of 2004; our more labor-intensive back-end facilities are located in Malaysia, Malta, Morocco, Singapore and China, enabling us to take advantage of more favorable production cost structures (particularly lower labor costs). Major design centers and local sales and marketing groups are within close proximity of key customers in each region, which we believe enhances our ability to maintain strong relationships with our customers. As appropriate, we intend to continue to build our integrated local presence in those regions where we compete, such as China, where we have both a back-end facility and a design center, and plans for a jointly owned front-end memory manufacturing plant, and India, where we have been expanding our design and software development centers. We have also continued to develop our sales and support organization for emerging markets in Central and Eastern Europe, North Africa, and Latin America.
Balanced sales by application in high-growth market segments. We have a diverse customer base across a broad range of market applications. We have developed a strong product portfolio serving major growth applications within our target market segments, including: automotive, computer peripherals, wireless communications, Internet access, networking, digital consumer appliances and power management. Ongoing investments in research and development and design resources are underway to bring to market the next generation of high-growth applications.
Leadership in System-on-Chip and Application Convergence. Since our inception, we have combined our silicon know-how with the system know-how of a broad range of industries and markets to integrate different system functions on a single chip, pioneering the trend towards system evolution on silicon and super-integration. We currently supply highly integrated products in all our main applications, and particularly in high volume domains, such as wireless communications, hard-disk drives, set-top boxes and digital car radios.
We believe that application convergence built around mobility, connectivity, multimedia, storage and security will be a further significant growth driver for new System-on-Chip products that address different applications on a single chip. We plan to use our broad range of capabilities, including technology, system know-how, strategic and industry alliances and our intellectual property portfolio to continue to anticipate and respond to new end market demand and to move in line with customer demand from a provider of components and Systems-on-Chip to a provider of platform solutions.
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Pervasive TQEM Culture and Social Responsibility. We are fostering a corporate-wide Total Quality and Environmental Management (TQEM) program, which has received several prestigious global awards. TQEM has become an integral part of our culture and is designed to develop a self-directed workforce with a common set of values, objectives and problem-solving processes.
Our TQEM program and culture support our belief that there is no contradiction between building shareholders and stakeholders value and that those corporations, such as us, which recognize the importance of their social role and their behavior as good citizens in the communities in which they operate, are not merely fulfilling their ethical obligations, but are also building the basis for improving returns to shareholders. We were one of the first signatories of the Global Compact, the United Nations initiative to promote responsible corporate citizenship and we continually work to strengthen our efforts in the area of Corporate Social Responsibility. In the field of environmental protection, we are actively involved in reducing landfilled waste, lowering total energy consumption per unit of production and developing renewable energy sources. With respect to occupational health and safety, we have received the OHSAS (Occupational Health and Safety Assessment Series) 18001 qualification for all of our plants. Additionally, we have set up and funded an independent foundation, STMicroelectronics Foundation, organized pursuant to Swiss laws relative to charitable organizations whose main mission is, in the field of corporate social responsibility, to help bridge the digital divide by offering computer literacy courses in communities in which we operate. This program aims to reach at least one million people within a decade. Also, we have maintained our commitment to internal training efforts through our STUniversity organization. For example, in 2004, our e-learning program, which optimizes our reach, enabled our internal training hours to reach approximately 8 hours per e-learner.
Products and Technology |
We design, develop, manufacture and market a broad range of products used in a wide variety of microelectronic applications, including telecommunications systems, computer systems, consumer goods, automotive products and industrial automation and control systems. Our products include discrete, memories and standard commodity components, ASICs (full custom devices and semicustom devices) and ASSPs for analog, digital, and mixed-signal applications. In addition, following the acquisition of Incard, we started the manufacturing of Smart cards, which includes both the production of chips, as in the past, and of cards. Historically, we have not produced dynamic random access memory (DRAMs) or x86 microprocessors, despite seeking to develop or acquire the necessary intellectual property (IP) to use them as components in System-on-Chip (SoC).
In the Subsystems segment, we design, develop, manufacture and market subsystems and modules for the telecom, automotive and industrial markets including mobile phone accessories, battery chargers, ISDN power supplies and in-vehicle equipment for electronic toll payment. Based on its immateriality, we do not report information separately for the Subsystems segment.
Through December 31, 2004, we ran our business along product lines and managed our revenues and internal operating income performance based on the following segments, organized into the following principal groups:
| Telecommunications, Peripherals and Automotive (TPA); |
| Consumer and Microcontroller (CMG); |
| Memory Products (MPG); and |
| Discrete and Standard ICs (DSG). |
Effective January 1, 2005, we realigned our businesses to increase market focus and realize the full potential of our products, technologies, and sales and marketing channels. See Business Overview. The following discussion in this Item 4 and in Item 5. Operating and Financial Review and Prospects reflects the organization effective in the three years ended December 31, 2004.
Telecommunications, Peripherals and Automotive Groups |
Through December 31, 2004, the Telecommunications, Peripherals and Automotive Groups (TPA) were responsible for the design, development and manufacture of application-specific products using advanced bipolar, CMOS, BiCMOS mixed-signal and power technologies, as well as mixed analog/digital semicustom-
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devices and Micro-Electro-Mechanical System (MEMS) products. The businesses formerly in our TPA Groups offer complete system solutions to customers in several application markets. All products are ASSPs, full-custom or semicustom devices that may also include digital signal processor (DSP) and microcontroller cores. The businesses formerly in our TPA Groups particularly emphasized dedicated integrated circuits (ICs) for automotive, computer peripherals and industrial application segments, as well as for mobile and fixed communication, computing and networking application segments.
Our businesses formerly in the TPA Groups work closely with customers to develop application-specific products using our technologies, intellectual property, and manufacturing capabilities. The breadth of our customer and application base provides us with a better source of stability in the cyclical semiconductor market.
The former Telecommunications Group had four divisions: Cellular Terminal, Cellular Infrastructure, Network and Access. The former Peripherals Group was comprised of: Data Storage, Printer, Power Conversion and Industrial, and the Microfluidics Division. The Audio and Automotive Group had four business divisions: Car Communication, Automotive, Audio, and the Car Multimedia Division. The three groups were supported by three technical centers: digital signal processing and microcontroller cores division, analog and power technology research and development center and the multimedia platform unit.
Telecommunications Group |
(i) Cellular Terminal Division. We focus our product offerings on cellular phones serving the major original equipment manufacturers, or OEMs, with differentiated ICs. In this market, we have key positioning in energy management, audio coding and decoding function (CODEC) and radio frequency ICs. We are shipping mobile phone energy-management devices in volume to three of the worlds top five original equipment manufacturers. In February 2004, we opened a joint design center with Nokia targeting radio frequency IC development for mobile phones.
We unveiled details of our multimedia application processor chips, known as the Nomadik family of products, for 2.5/3G mobile phones, portable wireless products and other applications, and the chips are being sampled by potential customers. The Nomadik was recognized as the Best Application Processor by Microprocessor Reports in February 2004. In December 2002, we founded open mobile application processor interfaces (OMAPI), a joint initiative with Texas Instruments, to define and promote an open standard for wireless application interfaces, which should promote faster and broader deployment of multimedia-enhanced mobile devices and applications. This initiative was significantly expanded in 2003 when we co-founded the Mobile Industry Interface Alliance (MIPI). Emphasizing our role in the mobile market and reinforcing our commitment to the Open Mobile Alliance (OMA), we are a sponsor member of and on the board of directors of OMA.
In February 2005, we decided to stop work on a reference design chipset for the GSM/GPRS market. Research and development engineers dedicated to this program were redeployed to other wireless projects.
(ii) Cellular Infrastructure Division. We formed the Wireless Communications Infrastructure Products business unit to develop dedicated infrastructure chip solutions that will be focused on primarily the new third-generation telecom standards, but supporting existing standards as well. We have already developed all of the technologies required for the wireless infrastructure application specific IC (ASIC) market due to our many years of experience in this field. For the digital baseband chips that handle complex digital processing tasks, we have developed a family of digital signal processor cores. The digital based band processor for 3G infrastructure was sampled in 2004. We have already developed other key radio frequency and mixed signal products for the demanding performance required by the cellular infrastructure market.
(iii) Network Division. In 2002, as part of our agreement to acquire Alcatel Microelectronics, important know-how and experienced engineers were added to our resources, significantly enhancing our overall capabilities to compete in the arena for Bluetooth ICs. In December 2003, we acquired Synad Technologies for $55 million to expand our wireless local area network (LAN) offerings. Our wireline telecommunications products are used in telephone sets, modems, subscriber line interface cards (SLICs) for digital central office switching equipment and high-speed electronic and optical communications network.
(iv) Access Division. In 2003, we finalized the acquisition of certain assets of Tioga Technologies, including its intellectual property rights for Digital Subscriber Line (XDSL) chipsets. These XDSL products include an integrated Asymmetric DSL (ADSL) multi-channel processor for central office applications. When
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used together with our existing line of advanced analog front-end and power-efficient line drivers, this chipset provides a compact and power-efficient solution. In January 2005, we announced that we would scale back our presence in the CPE modem market. This initiative will result in an impairment charge of approximately $60 million to be recorded in the first quarter of 2005 and certain additional restructuring charges to be further estimated. See Note 31 to our Consolidated Financial Statements.
Peripherals Group |
(i) Data Storage Division. We produce ICs for several data storage applications, specializing in disk drives with advanced solutions for read and write digital channels, controllers, host interfaces, digital power processing and micromachinery. We are actively working on super-integrating these macro-functions into SoC solutions. We believe that we are one of the largest semiconductor companies supplying the hard-disk-drive market based on sales.
A market leader in the data storage market selected our SoC for its next generation desktop drives. This SoC includes a rich variety of our own IP including our read/write channel, Serial ATA controller and microcomputer core. Complementing our leading position in components for desktop and server applications, we began supplying a kit including a SoC disk controller and a motion control power combo to a leading maker of drives for mobile applications. In 2004, we joined the Consumer Electronics - Advanced Technology Attachment (CE-ATA) initiative, a consortium of leading companies working to define a standard interface for small form-factor disk drives that meets the needs of handheld and consumer electronic products.
(ii) Printer Division. We are focusing on inkjet and multifunction printer components and are an important supplier of pen chips, motor drivers, head drivers, digital engines, high-performance photo-quality applications and digital color copiers. We are also expanding our offerings to the laser printer market. We are an important partner of Hewlett-Packard for technology development and manufacturing and are currently developing printer SoC platforms. Other notable successes in the printer field included multiple design wins for stand-alone, photo and multifunction printers as well as becoming the reference SoC vendor for an important printer supplier from 2005 onward.
(iii) Microfluidics Division. This newly created division builds on the years of our success in the field of microfluidic product design, developed primarily for the inkjet print head product line and expands our offering into related fields, such as medicine and health diagnostics. As a result, we announced an agreement with MobiDiag to create a complete system for genomic-based detection of infectious diseases based on our silicon MEMS Lab-on-Chip technology.
(iv) Power Conversion and Industrial Division. We design and manufacture products for industrial automation systems, lighting applications (lamp ballast), battery chargers and switch mode power supplies (SMPS). Our key products are power ICs for motor controllers and read/write amplifiers, intelligent power ICs for spindle motor control and head positioning in computer disk drives and battery chargers for portable electronic systems, including mobile telephone sets. We had multiple design wins for power management chipsets with PC motherboard manufacturers based in the Asia/Pacific region.
Audio and Automotive Groups |
Our audio products include audio power amplifiers, audio processors and graphic-equalizer ICs. Our automotive products include alternator regulators, airbag controls, anti-skid braking systems, ignition circuits, injection circuits, multiplex wiring kits and products for body and chassis electronics, engine management, instrumentation systems and car multimedia.
(i) Automotive Division. We hold a leading position in the IC market for automotive products. From engine and transmission control to mechanical-electronic solutions, microelectronics are steadily pervading all sectors of the automotive industry. Our robust family of automotive products, including MEMS accelerometers, complete standard solutions for DC-motor control and automotive grade 16-bit microcontrollers with embedded Flash memory, provide a broad range of features that enhance performance, safety and comfort while reducing the environmental impact of the automobile.
(ii) Audio Division. We design and manufacture a wide variety of components for use in audio applications including satellite radio chipsets. We received multiple design wins for digital car radio receiver chips with European, U.S. and Japanese car radio makers. We also introduced a family of direct digital amplifications (DDX) digital audio amplifier chips that improve sound quality while reducing power
27
consumption, size and cost. Aimed primarily at applications in digital versatile disk (DVD) home theater systems and mini component stereos, these chips allow powerful surround sound systems to be housed in a compact enclosure. DDX was developed by Apogee Technology Inc. and licensed exclusively to us.
(iii) Car Communication Division. We provide auto manufacturers with full solutions for analog and digital car radio solutions for wireless communication, tolling, navigation and other telematic functionalities. Our solutions are found in many current global car models.
(iv) Car Multimedia Division. The increasingly complex requirements of the car/driver interface have opened a new market for us in the area of car multimedia. We have the know-how and experience to offer to the market complete telematics solutions which include circuits for GPS navigation, voice recognition, audio amplification and audio signal processing. Recent offerings include a high-performance Bluetooth®-based hands-free car-kit reference design and the first prototype of a real single chip GPS embedding radio (RF) and base-band function (DSP) on the same silicon with volume production scheduled in 2005.
Consumer and Microcontroller Groups |
Through December 31, 2004, the Consumer and Microcontroller Groups (CMG) were responsible for the design, development and manufacture of microcontrollers, and application-specific standard products (ASSP) for consumer applications targeting the high-growth digital consumer segment, including digital set-top boxes, DVD players and recorders, digital cameras and displays and digital TV.
Through December 31, 2004, the Consumer and Microcontroller Groups were divided into the Consumer Group and the Microcontroller Group.
Consumer Group |
The Consumer Group was divided into four divisions through 2004: Set-Top Box, DVD, Digital TV and Display and Imaging.
(i) Set-Top Box Division. We continued to expand our product and customer bases introducing solutions for set-top boxes with web-browsing, digital video recording and time-shifting capabilities. We reinforced the market leadership of our STi5500 (OMEGA) family of set-top box back-end decoders in September 2004 with the introduction of the STi7710, the latest member of our OMEGA family of STB decoder solutions. The new single chip SoC device addressing the HDTV market performs at an advanced speed, and has enhanced graphics and security features as well as integrated DVR capability, while retaining compatibility with our earlier products. We continue to strengthen our product offerings by addressing software solutions for DVB-MHP (Java) and Microsoft Windows Media based systems.
(ii) DVD Division. Our product strategy focuses on serving a portion of the DVD player market with significant development targeted at the recorder market in 2005 and beyond. In January 2005, we announced the industrys most advanced single chip silicon solution for DVD playback, the STm8010. This 90-nm product will be available in mid-2005.
(iii) Digital TV and Display Division. We address both the analog and digital television markets with a wide range of highly integrated ASSPs and application-specific microcontrollers. Additionally, we develop and deliver display solutions for Liquid Crystal Displays (LCD), Plasma Displays (PDP), and conventional Cathode Ray Tube (CRT) displays and monitors. In 2004, we introduced the STD2000, our single chip solution for integrated Digital TV, which supports all display types and both standard and high definition formats. Production begins in mid-2005.
(iv) Imaging Division. Our Imaging Division focuses on digital still cameras, video cameras and imaging for a wide variety of industrial, consumer, computer and telecommunications markets. We introduced the latest CMOS imaging solution for mobile phone cameras: a one megapixel chipset combining the CMOS image sensor module and the mobile imaging DSP. Our product roadmap includes multiple megapixel modules with autofocus capability before the end of 2005. We shipped over 30 million CMOS camera phone solutions in 2004.
Microcontroller Group |
Through December 31, 2004, we managed our competitive, high-volume 8-, 16- and 32- bit microcontrollers for all major application segments in our former Microcontroller Group. This family of products has been developed with a wide portfolio of processes capable of embedding nonvolatile memories such
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as erasable programmable read-only memory (EPROM), electrically erasable programmable read-only memory (EEPROM) and Flash memories. In 2003 we introduced new products for the ST7Lite series of integrated 8-bit Flash microcontrollers. The ST7FLite1 and ST7Flite2 are suited for a wide range of high volume applications including appliances, alarms, sensors, battery-powered products, industrial controls and many other portable and low cost systems.
Memory Products Group |
The Memory Products Group (MPG) designs, develops and manufactures a broad range of semiconductor memory and Smart card products.
Through December 31, 2004, our MPG was organized into nonvolatile memory and Smart card divisions: (i) wireless Flash memories; (ii) high density and consumer NOR Flash memories; (iii) standard nonvolatile memories; (iv) serial nonvolatile memories; (v) random access memory (RAM) and automotive NOR Flash; (vi) nonvolatile RAM (NVRAM) and PSM; (vii) NAND Flash and storage media; (viii) Smart card ICs; and (ix) Incard.
Flash memory technology, which is one of the enablers of digital convergence, is the core of our nonvolatile memory activity. The products developed by the various nonvolatile memory divisions are complementary and are addressing different functions and/or market segments.
In 2003, we made two acquisitions which complemented our product portfolio in the Smart card field: Proton World International (a company with expertise in the field of operating software (OS) and applications development) and Incard (a company with expertise in card manufacturing and electrical and graphical personalization and global delivery and support for the Smart card market, particularly in the high-end mobile phone market).
(i) Wireless Flash Memories Division. Wireless applications have very specific requirements in terms of power consumption, packaging and memory addressing. As a result, wireless Flash memories are more comparable to dedicated products than pure standard products. We offer a very wide portfolio of wireless Flash memories. The latest 256 Megabit (M-bit), 2 bit/cell, 1.8V serves the needs of the next generation of multimedia phones. The production of wireless Flash was approximately 90% 130-nm in the fourth quarter of 2004, while 90-nm will be introduced at the beginning of 2005.
(ii) High Density & Consumer NOR Flash Division. We support the consumer market with 64 and 128 M-bit, 3V Flash memories which contains specific security features for applications such as set-top boxes. Our product development of 3V technology will follow the same roadmap as wireless Flash and extend to 256 M-bit and above.
(iii) Standard Nonvolatile Memories Division. We produce a broad range of industry standard, general purpose Flash memories from 1 to 32 M-bit as well as the more mature EPROM, from 16 Kilobit (K-bit) to 32 M-bit. Efficient manufacturing together with our sales and distribution channels have contributed to the exploitation of our technological advantage in EPROM. The same approach is being applied to industry standard Flash.
(iv) Serial Nonvolatile Memories Division. We offer serial Electronically Erasable Programmable Read-Only Memory up to 512 K-bit, and serial Flash memories (SNVM). Serial EEPROMs are the most popular type of EEPROMs and are used in computer, automotive and consumer applications. Combining the typical interface of serial EEPROM and Flash technology, we pioneered the concept of serial Flash. Serial Flash allows integration of up to 32 M-bit in an 8-pin package for a large variety of applications.
(v) RAM & Automotive NOR Flash Division. We have introduced a range of low power static random access memory (SRAM) products from 256 K-bit to 16 M-bit in various voltages. These are aimed primarily at satisfying the memory requirements of wireless applications, as a complement of our Flash offerings, specifically to stack them together with Flash in the same multi-chip package.
We are offering a range of automotive Flash from 4 to 32 M-bit with automotive specific features. We have elaborated a specific manufacturing flow designed to meet the highest automotive reliability requirements.
(vi) Nonvolatile Random Access Memory (NVRAM) & Programmable Systems Memories (PSM) Division. We are producing a wide range of nonvolatile RAMs (battery backed-up SRAM) used in computers,
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industrial and telecommunications equipment. Building on the specific IP developed for the NVRAMs; we are also extending our range with new real-time clock (RTC), reset and microprocessor supervisor families.
Our strategy of developing innovative, differentiated and value-added products allows us to offer configurable memory systems, integrating multiple memory types and control logic. These products serve a variety of applications such as point of sales terminals, power meters, and white goods.
(vii) NAND Flash and Storage Media Division. In 2004, we began offering NAND Flash memory products pursuant to a co-development and manufacturing agreement with Hynix. The first products were available in mid-2004. Our most advanced offering, a single die 1 G-bit at 90nm chip, is now available in production, while at the end of 2005, we plan to introduce 70-nm products. NAND Flash are primarily used to store information such as music, still pictures, video, data files in a variety of consumer applications, including mobile phones, MP3 readers, universal serial bust (USB) keys and digital still cameras.
(viii) Smart Card IC Division. Smart cards are card devices containing integrated circuits that store data and provide an array of security capabilities. They are used in a wide and growing variety of applications, including public pay telephone systems, cellular telephone systems and banks, as well as pay television systems and ID/passport cards. Other applications include medical record applications, card-access security systems, toll-payment and secure transactions over the Internet applications. We have a long track record of leadership in Smart card ICs. Our expertise in security is a key in leading the finance and pay-TV segments and developing the IT applications. Our mastering of the nonvolatile memory technologies is instrumental to offer the highest memory sizes (up to 128 KBytes and even 1 MByte), particularly important to address the emerging high end mobile phone market. Our offer in embedded software provides added value to our silicon and contributes to facilitate the Smart card market development. Proton World International is now part of the Smart card IC division.
(ix) Incard Division. The division develops, manufactures and sells plastic cards (both memory- and microprocessors-based) for banking, identification and telecom applications. Incard operates as a stand alone organization and also directly controls the sales force for this product offering.
Discrete and Standard
ICs Group
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Through December 31, 2004, the Discrete and Standard ICs Group (DSG) was responsible for the design, development and manufacture of discrete power devices, (power transistors and other discrete power devices), standard linear and logic ICs, and radio frequency products.
Our discrete and standard products are manufactured using mature and state-of-the-art technology processes. Although such products are less capital-intensive than other ST products, we are continuously improving product performance and developing new product features. We have a wide customer base, and a large percentage of our discrete and standard products are sold through distributors.
(i) Power Transistors Division. We design, manufacture and sell power transistors, which operate at high current and high voltage levels in a variety of switching and pulse-mode applications. We have three power transistor divisions: Bipolar Transistors, Power MOSFETs (Metal-Oxide-Silicon Field Effect Transistors) plus IGBTs (Insulated Gate Bipolar Transistors) and VIPpower (Vertical Intelligent Power) devices.
Our bipolar power transistors are used in a variety of high-speed, high-voltage applications, including SMPS applications, television/monitor deflection circuits and lighting systems. Particularly, our new family of ESBT (Emitter Switch Bipolar Transistor) is suitable for high current high voltage applications, including auxiliary power suppliers, welding machines and PFC (Power Factor Corrector).
Our family of VIPpower products, as well as Omnifets exhibit the operating characteristics of power transistors while incorporating full thermal, short-circuit and over-current protection and allowing logic-level input. VIPpower products are used in consumer goods (lamp ballasts, battery chargers) and automotive products (ignition circuits, central locking systems, transmission circuits, etc.). Omnifets are power MOSFETs with fully integrated protection devices for a variety of sophisticated automotive and industrial applications.
(ii) Others Discrete Power Devices Division. We manufacture and sell a variety of discrete power devices, including rectifiers, protection devices and thyristors (silicon controlled rectifiers or SCRs and three-terminal semiconductors for controlling current in either direction or Triacs). Our devices are used in various applications, including telecommunications systems (telephone sets, modems and line cards), household
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appliances and industrial systems (motor control and power control devices). More specifically, rectifiers are used in voltage converters and voltage regulators, protection devices to protect electronic equipment from power supply spikes or surges, and thyristors vary current flows through a variety of electrical devices, including lamps and household appliances.
We offer a highly successful range of standard products built with our proprietary Application Specific Discrete (ASD) technology, which allows a variety of discrete structures (diodes, rectifiers, thyristors) to be merged into a single device optimized for specific applications such as interference filtering (EMI) for cellular phones. We have recently developed some electronic devices integrating both passive and active components on the same chip, IPAD or Integrated Passive and Active Devices, which are widely used in the wireless handset market.
(iii) Standard Logic and Linear ICs Division. We produce a variety of HCMOS logic device families, which include clocks, registers, gates and latches. Such devices are used in a wide variety of applications, including portable computers, computer networks and telecommunications systems. We also offer standard linear ICs covering a variety of applications, including amplifiers, comparators, decoders, detectors, filters, modulators, multipliers and voltage regulators.
(iv) Radio Frequency Products Division. We supply components for RF transmission systems used in television broadcasting equipment, radar systems, telecommunications systems and avionic equipment. We are targeting new applications for our RF power products, including two-way wireless communications systems (in particular, cellular telephone systems) and commercial radio communication networks for business and government applications.
Strategic Alliances
with Customers and Industry Partnerships
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We believe that strategic alliances with customers and industry partnerships are critical to success in the semiconductor industry. We have entered into several strategic customer alliances, including alliances with Alcatel, Bosch, Hewlett-Packard, Marelli, Nokia, Nortel Networks, Pioneer, Seagate, Siemens VDO, Thomson and Western Digital, among others. Customer alliances provide us with valuable systems and application know-how and access to markets for key products, while allowing our customers to share some of the risks of product development with us and to gain access to our process technologies and manufacturing infrastructure.
Partnerships with other semiconductor industry manufacturers permit costly research and development and manufacturing resources to be shared to mutual advantage for joint technology development. We have been collaborating with Philips Semiconductors International B.V. for the joint development of CMOS process technologies in Crolles, France, since 1992. In 2003, we began cooperating with Freescale Semiconductor, Inc. (formerly Motorolas semiconductor division) and Philips Semiconductors International B.V. for the joint research and development of CMOS process technology to provide 90-nm to 32-nm chip technologies on 300 mm wafers, as well as for the operations of a 300 mm wafer pilot line fab which has been built in Crolles, France (called Crolles2) with the stated goal of accelerating the development of future technologies and their proliferation throughout the semiconductor industry. TSMC has also been involved in the Crolles2 cooperation for specific programs.
We began working with Texas Instruments in 2002 to jointly define and promote an open standard for wireless application processor interfaces. This initiative has now broadened and is known as the MIPI Alliance. It now includes over 70 members that collaborate as mobile industry leaders with the objective of defining and promoting open standards for interfaces to mobile application processors. Through these open standards, the MIPI Alliance intends to speed deployment of new services to mobile users by establishing specifications for standard hardware and software interfaces to mobile application processors and encouraging the adoption of those standards throughout the industry. We are board members of MIPI.
We have also established joint development programs with leading suppliers such as Air Liquide, Applied Materials, ASM Lithography, Axalto, Canon, Hewlett-Packard, KLA-Tencor, LAM Research, MEMC, Teradyne and Wacker and with computer-aided design (CAD) tool producers, including Cadence, Co Ware and Synopsys. We also participate in joint European research programs, such as the MEDEA+ and ITEA programs, and cooperate with major research institutions and universities.
On November 16, 2004, we signed and announced the joint-venture agreement with Hynix Semiconductor to build a front-end memory-manufacturing facility in Wuxi City, China. The joint venture is an extension of the
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NAND Flash Process/product development and manufacturing relationship. Construction of the facility is expected to begin in 2005. When complete, the fab will employ approximately 1,500 people and will feature an 8-inch wafer production line beginning production in 2006 and a 12-inch wafer production line beginning production in 2007. The total investment planned for the project is $2 billion. We will be contributing 33% of the equity financing, while Hynix will contribute 67%. We will also contribute $250 million as long-term debt to the new joint venture, guaranteed by subordinated collateral on the joint ventures assets. The financing will also include credit from local Chinese institutions, involving debt and a long leasehold. In 2005, when the conditions for the inception of the new joint venture are met, the equity investment from both parties is expected to reach around $375 million, of which amount we will subscribe capital for $125 million and the partner for $250 million. In addition, we will subscribe for $125 million in share capital in 2006.
Customers and Applications
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We design, develop, manufacture and market thousands of products that we sell to approximately 1,300 direct customers. Major customers include Axalto, Alcatel, Bosch, Delphi, Delta, Echostar, Ericsson, Hewlett-Packard, Hughes, LG Electronics, Marelli, Maxtor, Motorola, Nokia, Nortel Networks, Philips, Pioneer, Samsung, Scientific Atlanta, Seagate, Siemens, Sony, Thomson, Vestel and Western Digital. To many of our key customers we provide a wide range of products, including dedicated products, discrete devices, memory products and programmable products. Our position as a strategic supplier of application-specific products to certain customers fosters close relationships that provide us with opportunities to supply such customers requirements for other products, including discrete devices, programmable products and memory products. We also sell our products through distributors, including Arrow Electronics, Avnet Inc., BSI Group, Eurodis, Wintech and Yosun.
The following table sets forth certain of our significant customers and certain applications for our products:
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Telecommunications | |||||||||
Customers:
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Alcatel Cellon Cisco Finisar |
Huawei Humax Kyocera Motorola |
Nokia Nortel Networks Philips Sanyo |
Sagem Siemens Sony Ericsson Thomson |
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Applications:
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Camera
modules / mobile imaging Central office switching systems Data transport (routing, switching for electronic and optical networks) Digital cellular telephones Internet access (XDSL) |
Portable
multimedia Telephone terminals (wireline and wireless) Wireless connectivity (Bluetooth, WLAN, FM radio) Wireless infrastructure |
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Computer Peripherals | |||||||||
Customers:
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Acer | Delta | Intel | Samsung | |||||
Agilent | Epson | Lexmark | Seagate | ||||||
Creative Technology | Hewlett-Packard | Logitech | Western Digital | ||||||
Dell | IBM | Maxtor | Xerox | ||||||
Applications:
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Data
storage Imaging Monitors and displays |
Power
management Printers Webcams |
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Automotive
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Customers:
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Alpine | Denso | Marelli | TRW | |||||
Bosch | Harman | Motorola | Valeo | ||||||
Conti | Hella | Pioneer | Visteon | ||||||
Delphi | Lear | Siemens | XM Satellite | ||||||
Applications: | Airbags Anti-lock braking systems Body and chassis electronics Engine management systems (ignition and injection) |
Global positioning systems Multimedia Radio / satellite radio Telematics Vehicle stability control |
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Consumer
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Customers:
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Bose Corporation | LG Electronics | Pioneer | Tomen | |||||
Echostar | Matsushita | Samsung | Vestel | ||||||
Hughes | Microsoft | Scientific Atlanta | |||||||
Humax | Olympus | Sony | |||||||
Kenwood | Philips | Thomson | |||||||
Applications:
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Audio
processing (CD, DVD, Hi-Fi) Analog / digital TVs Digital cameras Digital music players |
DVDs Imaging Set-top boxes VCRs |
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Industrial / Other Applications | |||||||||
Customers:
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Astec | Echelon | Nagra | Siemens | |||||
Autostrade | Enel | Oberthur | Toppan | ||||||
Axalto | Gemplus | Orange | Taiwan Liton | ||||||
Delta | Hewlett-Packard | Philips | Tyco | ||||||
Applications:
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Battery
chargers Smart card ICs Industrial automation / control systems Intelligent power switches |
Lighting
systems (lamp ballasts) Motor controllers Power supplies Switch mode power supplies |
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In 2004, our largest customer, Nokia, represented 17.1% of our net revenues, compared to 17.9% in 2003 and 17.6% in 2002. No other single customer accounted for more than 10% of our net revenues. Sales to our OEM customers accounted for approximately 79% of our net revenues in 2004, from approximately 82% of our net revenues in 2003 and 84% in 2002. Sales to our top ten OEM customers were approximately 44% of total revenues in 2004, 46% in 2003 and 49% in 2002. We have several large customers, certain of whom have entered into strategic alliances with us. Many of our key customers operate in cyclical businesses and have in the past, and may in the future, vary order levels significantly from period to period. In addition, approximately 21% of our net revenues in 2004 were made through distributors, compared to 18% in 2003 and 16% in 2002. There can be no assurance that such customers or distributors, or any other customers, will continue to place orders with us in the future at the same levels as in prior periods. See Item 3. Key InformationRisk FactorsDisruptions in our relationships with any one of our key customers could adversely affect our results of operations.
Sales, Marketing and
Distribution
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We operate regional sales organizations in Europe, North America, Asia/Pacific, Japan and Emerging Markets which include Latin America, Africa, Eastern Europe, the Middle East and India. For a breakdown of net revenues by product group and geographic region for each of the five years ended December 31, 2004, see Item 5. Operating and Financial Review and ProspectsResults of OperationsSegment Information.
The European region is divided into seven business units: automotive, consumer and computers, industrial, Smart card, telecom, EMS and distribution. Additionally, for standard products, we actively promote and support the sales of these products throughout the region. This effort includes sales force, field application engineers, supply-chain management and customer-service, and a technical competence center for system-solutions, with support functions provided locally.
In the North America region, the sales and marketing team is organized into eight business units. They are located near major centers of activity for either a particular application or geographic region: automotive (Detroit, Michigan), industrial (Boston, Massachusetts), consumer (Chicago, Illinois), computer and peripheral equipment (San Jose, California and Longmont, Colorado), data storage (San Jose, California and Longmont, Colorado), communications (Dallas, Texas) and distribution (Boston, Massachusetts). Each regional business unit has a sales force that specializes in the relevant business sector, providing local customer service, market development and specialized application support for differentiated system-oriented products. This structure allows us to monitor emerging applications, to provide local design support, and to identify new products for development in conjunction with the various product divisions as well as to develop new markets and applications with our current product portfolio. A central product marketing operation in Boston provides product support and training for standard products for the North American region, while a logistics center in Phoenix, Arizona supports just-in-time delivery throughout North America. In addition, a comprehensive distribution business unit provides product and sales support for the regional distribution network.
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In the Asia/Pacific region, sales and marketing is organized by country and is managed from our regional sales headquarters in Singapore. We have sales offices in Taiwan, Korea, China, Hong Kong, Malaysia, Thailand and Australia. The Singapore sales organization provides central marketing, customer service, technical support, logistics, application laboratory and design services for the entire region. In addition, there are design centers in Korea and China.
In Japan, the large majority of our sales are made through distributors, as is typical for foreign suppliers to the Japanese market. However, our sales and marketing engineers in Japan work directly with customers as well as with the distributors to meet customers needs. We provide marketing and technical support services to customers through sales offices in Tokyo and Osaka. In addition, we have established a design center and application laboratory in Tokyo. The design center designs custom ICs for Japanese clients, while the application laboratory allows Japanese customers to test our products in specific applications.
The Emerging Markets region in 2004 included Latin America, Africa, Eastern Europe, the Middle East and India, as well as our design and software development center in India, which employed approximately 1,500 people, in a wide range of activities. We intend to increase our focus on this region to enhance our presence in these new markets. Since January 1, 2005, Eastern European countries now forming part of the EU are no longer included in the Emerging Markets region but in the European region. In 2005, Emerging Markets includes Latin America, Russia, Mediterranean and Eastern European countries which are not part of the European Union, the Middle East and Africa, as well as our design and software development centers in India.
The sales and marketing activities carried out by our regional sales organizations are supported by the product marketing that is carried out by each product division, which also include product development functions. This matrix system reinforces our sales and marketing activities and our broader strategic objectives. We have recently initiated a program to expand our customer base. This programs key elements include adding sales representatives, adding regional competence centers and new generations of electronic tools for customer support.
Except for Emerging Markets, each of our regional sales organizations operates dedicated distribution organizations. To support the distribution network, we operate logistic centers in Saint Genis, France, Phoenix, Arizona and Singapore, and have made considerable investments in warehouse computerization and logistics support with the focus on demand generation for new and existing applications and to promote complete systems solutions.
We also use distributors and representatives to distribute our products around the world. Typically, distributors handle a wide variety of products, including products that compete with our products, and fill orders for many customers. Most of our sales to distributors are made under agreements allowing for price protection and/or the right of return on unsold merchandise. We recognize revenues upon transfer of ownership of the goods at shipment. Sales representatives generally do not offer products that compete directly with our products, but may carry complementary items manufactured by others. Representatives do not maintain a product inventory; instead, their customers place large quantity orders directly with us and are referred to distributors for smaller orders.
At the request of certain of our customers, we are also selling and delivering our products to Electronic Manufacturing Suppliers (EMS), which, on a contractual basis with our customers, incorporate our products into the dedicated products which they manufacture for our customers. Certain customers require us to hold inventory on consignment in their hubs and only purchase inventory when they require it for their own production. This may lead to delays in recognizing revenues as such customers may choose within a specific period of time the moment when they take delivery of our products.
Research and Development
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We believe that research and development is critical to our success, and we are committed to increasing research and development expenditures in the future. From January 1, 2005, we created a new Front-End Technology and Manufacturing organization (FTM) encompassing the present front-end manufacturing and central research and development functions.
In periods of industry downturn, such as in 2001, 1998 and 1997, we continue to invest strongly in research and development, while reducing our other general expenses. In 2004, we spent $1,532 million on research and development, which represented an approximately 24% increase from $1,238 million in 2003, while
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2003 spending represented a 21% increase from $1,022 million in 2002. The table below sets forth information with respect to our research and development spending since 2002. Our reported research and development expenses are mainly in the areas of product design, technology and development and do not include marketing design center costs which are accounted for as selling expenses, or process engineering, pre-production and process-transfer costs, which are accounted for as cost of sales:
Year ended December 31, |
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2004 | 2003 | 2002 | ||||||||
(in millions, except percentages) | ||||||||||
Expenditures |
$1,532 | $1,238 | $1,022 | |||||||
As a percentage of net revenues |
17.5% | 17.1% | 16.2% |
Approximately 87% of our research and development expenses in 2004 were incurred in Europe, primarily in France and Italy. See Public Funding. As of December 31, 2004, approximately 9,800 employees were employed in research and development activities worldwide.
Our policy in the field of research and development is market driven, focused on leading-edge products and technologies, in close collaboration with strategic alliance partners, leading universities and research institutes, key customers and global equipment manufacturers working at the cutting edge of their own markets. We invest in a variety of research and development projects ranging from long-term advanced research for the acceleration, in line with industry requirements and roadmaps such as the International Technology Roadmap for Semiconductors (IRTS), of our broad range of process technologies including BiCMOS; bipolar, CMOS, and DMOS (BCD); High Performance Logic; and stand-alone and embedded Flash and other nonvolatile memories; to the continued expansion of our system level design expertise and IP creation for advanced architecture for System-on-Chip integration, as well as new products for many key applications in the field of digital consumer wireless communications and networking, computer peripherals, Smart cards and car multimedia among others.
Our research and development activities focus on the very large scale integration (VLSI) technology platform, new systems architectures, new product developments and emerging technologies in microsystems, nanotechnologies and photonics. The development of the technology platform (VLSI technologies and design tools) is conducted by Central Research and Development (CRD) while new systems architectures are studied in the Advanced System Technology (AST) units. New product research and development is conducted within each product group in conjunction with customers. The highest concentration of our CRD activities is located in the two main VLSI facilities of Crolles, France and Agrate, Italy. Other important CRD activities are located in Italy (Castelletto and Catania); France (Grenoble, Rousset, Tours); United States (Berkeley, Carrollton, Phoenix, San Diego); United Kingdom (Bristol, Edinburgh); Switzerland (Geneva); Tunisia (Tunis); Morocco (Rabat); China (Beijing, Hong Kong, Shenzen, Shanghai); Singapore and India (Noida and Bangalore).
The central research and development units participate in several strategic partnerships. Our manufacturing facility at Crolles, France houses a research and development center that is operated in the legal form of a French Groupement dintérêt économique (GIE) named Centre Commun de Microelectronique de Crolles. Laboratoire dElectronique de Technologie dInstrumentation (LETI), a research laboratory of Commissariat de lEnergie Atomique (CEA) an affiliate of Areva Group (one of our indirect shareholders), is our partner. Until December 31, 2002, France Telecom R&D (France Telecom is also one of our indirect shareholders) was a member of this GIE.
We also cooperate with Philips Semiconductors International B.V., and Freescale Semiconductor, Inc. as part of the Crolles2 Alliance to jointly develop sub-micron CMOS logic processes to provide 90-nm to 32-nm chip technologies on 300-mm wafers and to build and operate an advanced 300-mm wafer pilot line in Crolles, France. The pilot line was officially inaugurated on February 27, 2003, and the first silicon rolled off the line during the first quarter of 2003 with the stated goal of accelerating the development of future technologies and their proliferation throughout the semiconductor industry. On January 31, 2005, the Crolles2 Alliance extended the scope of the joint semiconductor research and development activities to include research and development related to wafer testing and packaging. The agreement reflects the special needs of wafer testing and packaging for devices produced on 300-mm wafers in 90-nm and beyond.
However, there can be no assurance that we will be able to develop future technologies and proliferate them on satisfactory terms, that the alliance will be successful or will enable us to effectively meet customer
35
demands or that its operations will not be adversely affected by unforeseen events and the sizeable risks related to such development of new technologies, which could materially adversely affect our business, results of operations and prospects. See Item 3. Key InformationRisk FactorsOur research and development efforts in the field of CMOS process development are dependent on alliances, and our business, results of operations and prospects could be materially adversely affected by the failure of such alliances in developing new process technologies in line with market requirements.
In April 2004, we announced an agreement with CEA for a four-year research and development project called Nanotec 300 with the three partners of the Crolles2 Alliance, to expire in 2007. The agreement foresees the joint development of nanoelectronic technologies for 45, 32-nm-and-below CMOS nodes on 300mm wafers. The research will be conducted by LETI in Grenoble, France covering four areas: advanced patterning; front-end materials and process steps; advanced devices; and back-end materials and process steps. Nanotec 300 is supported by a total investment of €300 million funded by the members of the Crolles2 Alliance and various French government authorities.
We also play leadership roles in numerous projects running under the European Unions IST programs. We have actively participated in these programs and are continuing its collaborative research and development efforts within the MEDEA+ research program. On December 15, 2004, we announced that a MEDEA+ project that we led, and which was largely implemented at our research and development center in Crolles, France, won the first of a new series of annual awards for European collaborative innovation in microelectronics, called the Jean-Pierre Noblanc Award for Excellence.
The CRD activities performed at our 200mm facility in Agrate, Italy, are focused on the development of new generation 90-nm Flash memories from which other nonvolatile memory products are derived, such as embedded memories, EEPROM and one-time programmable (OTP) memories. Current Flash developments, which are one of our technology drivers, are targeting very high density multilevel memories and the introduction of innovative materials for nonvolatile applications.
A technical center in Noida, India, has been developing design software and CAD libraries and tools for 10 years. In 2004, we announced plans to open another technical center housing 100 engineers in Bangalore, India. We have developed a wide network of cooperation with many universities worldwide, including in the United Kingdom (Bristol), Italy (Bologna, Catania, Genoa, Lecce, Milan, Naples, Palermo, Pavia, Pisa, Rome and Turin), France (Grenoble, Marseille, Montpellier, Toulouse and Tours), the United States (Carnegie Mellon, Stanford, Princeton, Berkeley, UCSD and UCLA) and Singapore for basic research projects on design and process development.
In addition to central research and development, each operating division conducts independent research and development activities on specific processes and products focusing on developing an advanced range of the key technological building blocks required by targeted applications. These building blocks include (i) motion picture experts group (MPEG2) decoder ICs; (ii) a family of 16-bit (ST10, super 10), 32-bit (ST20) and 64-bit microcontrollers; (iii) a family of general purpose DSP cores for embedded applications as well as several dedicated DSP cores for specific applications; (iv) embedded volatile (DRAM and SRAM) and nonvolatile (EPROM, EEPROM and Flash) memories; (v) the Nomadik family of microprocessors; and (vi) CMOS imaging systems. Applying our broad range of technologies and our expertise in diverse application domains, we are currently embedding dedicated, semicustom circuits and these advanced building blocks on the same chip, in addition to the many dedicated and semicustom ICs developed using power analog, digital and mixed signal technologies.
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Property, Plants and Equipment |
We currently operate 16 (as per table below) main manufacturing sites around the world. The table below sets forth certain information with respect to our current manufacturing facilities, products and technologies. Front-end manufacturing facilities are wafer fabrication plants (known as fabs) and back-end facilities are assembly, packaging and final testing plants.
Location |
Products | Technologies | |||
Front-end facilities |
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Crolles1, France |
Semicustom devices, microcontrollers and dedicated products | Fab: 200-mm CMOS and BiCMOS, research and development on VLSI sub-micron technologies | |||
Crolles2, France(1) |
Dedicated products and leading edge logic products | Fab: 300-mm research and development on deep sub-micron (90-nm and below) CMOS and SOI technology development | |||
Phoenix, Arizona |
Dedicated products and microcontrollers | Fab: 200-mm CMOS, BiCMOS, BCD | |||
Agrate, Italy |
Nonvolatile memories, microcontrollers and dedicated products | Fab 1: 150-mm BCD, nonvolatile memories, MEMS. (converting to 200-mm) | |||
Fab 2: 200-mm Flash, embedded Flash, research and development on nonvolatile memories and BCD technologies | |||||
Rousset, France |
Microcontrollers, nonvolatile memories and Smart card ICs and dedicated products | Fab 1: 150-mm CMOS, Smart
card (phase-out
planned in Q2 2006) Fab 2: 200-mm CMOS, Smart card, embedded Flash |
|||
Catania, Italy |
Power transistors, Smart Power ICs and nonvolatile memories | Fabs 1/2: 150-mm Power metal-on silicon oxide semiconductor process technology (MOS), VIPpower (Vertical Intelligent Power), MO-3 and Pilot Line RF | |||
Fab 3: 200-mm Flash, Smart card, EEPROM | |||||
300-mm building constructed but not fully facilitized and equipped. | |||||
Castelletto, Italy |
Smart power BCD | Fab: 150-mm BCD and MEMS pilot line (closure announced for end Q2 2006) | |||
Tours, France |
Protection thyristors, diodes and application-specific discrete-power transistors | Fab: 125-mm and 150-mm discrete |
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Location |
Products | Technologies | |||
Ang Mo Kio, Singapore |
Dedicated products, microcontrollers, power transistors, commodity products, nonvolatile memories, and dedicated products | Fab 1: 125-mm, power MOS, bipolar
transistor,
bipolar ICs, standard linear Fab 2: 150-mm bipolar, power MOS and BCD, EEPROM, Smart card, Micros Fab 3: 200-mm BiCMOS, Flash |
|||
Carrollton, Texas |
Memories, microcontrollers, dedicated products and semicustom devices | Fab: 150-mm BiCMOS, BCD and CMOS | |||
Back-end facilities |
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Muar, Malaysia |
Dedicated and standard products, microcontrollers | ||||
Kirkop, Malta |
Dedicated products, microcontrollers, semicustom devices | ||||
Toa Payoh, Singapore |
Nonvolatile memories and power ICs | ||||
Ain Sebaa, Morocco |
Discrete and standard products | ||||
Bouskoura, Morocco |
Nonvolatile memories, discrete and standard products, micromodules, RF and subsystems | ||||
Shenzhen, China(2) |
Nonvolatile memories, discrete and standard products | ||||
(1) | Operated jointly with Philips and Freescale Semiconductor, Inc. |
(2) | Jointly operated with SHIC, a subsidiary of Shenzhen Electronics Group. |
As of December 31, 2004, we had a total of approximately 600,000 square meters of front-end facilities, comprised of approximately 360,000 square meters in Europe, approximately 90,000 square meters in the United States and approximately 150,000 square meters in Asia. We also had a total of approximately 240,000 square meters of back-end facilities.
At the end of 2004, our front-end facilities had total capacity of approximately 230,000 150-mm equivalent wafer starts per week. The number of wafer starts per week varies from facility to facility and from period to period as a result of changes in product mix. We have six 200-mm wafer production facilities currently in operation. Of these, four (at Crolles, France; Agrate, Italy; Catania, Italy, and Phoenix, Arizona) have full capacity installed as of December 31, 2004; as of the same date, one (in Rousset, France) has approximately two- thirds of the ultimate capacity installed and one (in Singapore) has approximately one-half of installed capacity.
The first wafers were processed during the early portion of 2003 in our advanced 300-mm wafer pilot-line fabrication facility in Crolles, France. We, along with our partners Philips Semiconductors International B.V. and Freescale Semiconductor, Inc., began volume production here in the first half of 2004. The pilot line, initially designed to produce up to 1,000 wafers per week, should ramp up to approximately 1,500 wafers per week by the end of 2005.
The building shell for our future 300-mm wafer volume manufacturing fabrication facility in Catania, Italy is completed and the first phase of facilitization is planned for completion by the end of 2005.
We have historically subcontracted approximately up to 15% of total volumes for back-end operations to external suppliers. In periods of high demand, we intend to outsource up to 20% of our front-end production requirements to external foundries, reducing outsourcing as needed to meet market conditions, when, due to reduced customer demand, the average level of front-end subcontracting was significantly lower.
We own all of our manufacturing facilities, except Crolles2, France, which is the subject of a capital lease.
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During the most recent downturn in the industry, we limited our capital investment, allocating it to strategic projects such as the evolution of the production capability to lower geometries in the 200-mm facilities; the development of advanced manufacturing processes (90 and 65-nm); the relentless improvement in the quality of our operations; the ramp-up of the new 200-mm production facility in Singapore; the continuation of the two 300-mm projects (Crolles, France, for pilot-line; Catania, Italy, for volume manufacturing); the ramp-up to volume manufacturing of the new Bouskoura, Morocco back-end facility; and the completion of the extension of the back-end Shenzhen, China facility. We have also increased overall installed front-end capacity.
As of December 31, 2004, we had $568 million in outstanding commitments for purchases of equipment for delivery in 2005. The most significant of our 2005 capital expenditure projects are expected to be (i) the capacity expansion of our 200-mm and 150-mm front-end facilities in Singapore; (ii) the completion of building and facilities for our 300-mm front-end plant in Catania, Italy; (iii) the conversion to 200-mm of our front-end facility in Agrate, Italy; (iv) the expansion of our 200-mm front-end facility in Phoenix, Arizona; (v) the expansion of the 300-mm front-end joint project with Philips Semiconductors International B.V. and Freescale Semiconductor, Inc. in Crolles, France; and (vi) the capacity expansion of our back-end plants in Muar, Malaysia, Toa Payoh, Singapore, and Malta. We will continue to monitor our level of capital spending, however, taking into consideration factors such as trends in the semiconductor industry, capacity utilization and announced additions. We plan 2005 capital expenditures to be approximately $1.5 billion, although we have the flexibility to modulate our investments to changes in market conditions. The major part of this amount will be allocated to leading-edge technologies and research and development programs.
Although each fabrication plant is dedicated to specific processes, our strategy is to develop local presences, better serve customers and mitigate manufacturing risks by having key processes operated in different manufacturing plants. In certain countries, we have been granted tax incentives by local authorities in line with local regulations, being recognized as an important contributor to the economies where our plants are located. In periods of industry capacity limitations we have sought, by purchasing from subcontractors both wafer foundry and back-end services, to minimize our capital expenditure needs. In difficult market conditions, we may face overcapacity issues, particularly in our older fabrication facilities that use mature process technologies. Like other semiconductor manufacturers, we could have mature fabrication facility capacity being only partially used, which may affect our cost of operations. Such overcapacity has led us, in recent years, to close manufacturing facilities using more mature process technologies. In 2002, we completed the closure of our 150-mm wafer manufacturing facility in Rancho Bernardo, California. Pursuant to such closure in 2002 we recorded impairment, restructuring charges and related closure costs of $34 million. In 2003, we recorded impairment, restructuring charges and other related closure costs of $205 million pursuant to a plan announced in October 2003 to increase our cost competitiveness by restructuring our 150-mm fab operations and part of our back-end operations. In 2004, two sites, Rennes (France) and Tuas (Singapore) were closed pursuant to this restructuring initiative and the total amount of restructuring charges and other related closure pre-tax costs amounted to $76 million. The total cost of this restructuring plan is expected to be approximately $350 million. Of this amount, approximately $69 million remains to be recorded. See Item 5. Operating and Financial Review and Prospects and Note 21 to the Consolidated Financial Statements.
Our manufacturing processes are highly complex, require advanced and costly equipment and are continuously being modified in an effort to improve yields and product performance. Impurities or other difficulties in the manufacturing process can lower yields, interrupt production or result in losses of products in process. As system complexity has increased and sub-micron technology has become more advanced, manufacturing tolerances have been reduced and requirements for precision and excellence have become even more demanding. Although our increased manufacturing efficiency has been an important factor in our improved results of operations, we have from time to time experienced production difficulties that have caused delivery delays and quality control problems, as is common in the semiconductor industry.
No assurance can be given that we will be able to increase manufacturing efficiency in the future to the same extent as in the past or that we will not experience production difficulties in the future.
As is common in the semiconductor industry, we have from time to time experienced difficulty in ramping up production at new facilities or effecting transitions to new manufacturing processes and, consequently, have suffered delays in product deliveries or reduced yields. There can be no assurance that we will not experience manufacturing problems in achieving acceptable yields, product delivery delays or interruptions in production in the future as a result of, among other things, capacity constraints, production bottlenecks, construction delays, equipment failure or maintenance, ramping up production at new facilities, upgrading or expanding existing
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facilities, changing our process technologies, or contamination or fires, storms, earthquakes or other acts of nature, any of which could result in a loss of future revenues. In addition, the development of larger fabrication facilities that require state-of- the-art sub-micron technology and larger-sized wafers has increased the potential for losses associated with production difficulties, imperfections or other causes of defects. In the event of an incident leading to an interruption of production at a fab, we may not be able to shift production to other facilities on a timely basis, or the customer may decide to purchase products from other suppliers, and, in either case, the loss of revenues and the impact on our relationship with our customers could be significant. Our operating results could also be adversely affected by the increase in our fixed costs and operating expenses related to increases in production capacity if revenues do not increase commensurately. Finally, in periods of high demand, we increase our reliance on external contractors for foundry and back-end service. Any failure to perform by such subcontractors could impact our relationship with our customers and could materially affect our results of operations.
Intellectual Property |
Intellectual property rights that apply to our various products include patents, copyrights, trade secrets, trademarks and maskwork rights. We own more than 19,000 patents or pending patent applications which have been registered in several countries around the world and correspond to more than 8,000 patent families (each patent family containing all patents originating from the same invention). We filed 714 new patent applications around the world in 2004.
Our success depends in part on our ability to obtain patents, licenses and other intellectual property rights covering our products and their design and manufacturing processes. To that end, we intend to continue to seek patents on our circuit designs, manufacturing processes, packaging technology and other inventions. The process of seeking patent protection can be long and expensive, and there can be no assurance that patents will issue from currently pending or future applications or that, if patents are issued, they will be of sufficient scope or strength to provide meaningful protection or any commercial advantage to us. In addition, effective copyright and trade secret protection may be unavailable or limited in certain countries. Competitors may also develop technologies that are protected by patents and other intellectual property rights and therefore such technologies may be unavailable to us or available to us subject to adverse terms and conditions. Management believes that our intellectual property represents valuable property and intends to protect our investment in technology by enforcing all of our intellectual property rights. We have entered into several broad patent cross-licenses with several major semiconductor companies enabling us to design, manufacture and sell semiconductor products without fear of infringing patents held by such companies, and intend to continue to use our patent portfolio to enter into such patent cross-licensing agreements with industry participants on favorable terms and conditions. As our sales increase compared to those of our competitors, the strength of our patent portfolio may not be sufficient to guarantee the conclusion or renewal of broad patent cross-licenses on terms which do not affect our results of operations. Furthermore, as a result of litigation, or to address our business needs, we may be required to take a license to third-party intellectual property rights upon economically unfavorable terms and conditions, and possibly pay damages for prior use, and/or face an injunction, all of which could have a material adverse effect on our results of operations and ability to compete.
From time to time, we are involved in intellectual property litigation and infringement claims. See Item 8. Financial InformationLegal Proceedings. In the event a third-party intellectual property claim were to prevail, our operations may be interrupted and we may incur costs and damages, which could have a material adverse effect on our results of operations, cash flow and financial condition.
Finally, we have received from time to time, and may in the future receive communications alleging infringement of certain patents and other intellectual property rights of others, which has been and may in the future be followed by litigation. Regardless of the validity or the successful assertion of such claims, we may incur significant costs with respect to the defense thereof, which could have a material adverse effect on our results of operations, cash flow or financial condition. See Item 3. Key InformationRisk FactorsWe depend on patents to protect our rights to our technology.
Backlog
|
Our sales are made primarily pursuant to standard purchase orders that are generally booked from one to twelve months in advance of delivery. Quantities actually purchased by customers, as well as prices, are subject to variations between booking and delivery and, in some cases, to cancellation to reflect changes in customer needs or industry conditions. During periods of economic slowdown and/or industry overcapacity and/or
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declining selling prices, customer orders are not generally made far in advance of the scheduled shipment date. Such reduced lead time can reduce managements ability to forecast production levels and revenues. When the economy rebounds, our customers may strongly increase their demands, which can result in capacity constraints due to our inability to match manufacturing capacity with such demand.
In addition, our sales are affected by seasonality, with the first quarter generally showing lowest revenue levels in the year, and the fourth quarter generating the highest amount of revenues due to electronic products purchased from many of our targeted market segments during the holiday period.
We also sell certain products to key customers pursuant to frame contracts. Frame contracts are annual contracts with customers setting forth quantities and prices on specific products that may be ordered in the future. These contracts allow us to schedule production capacity in advance and allow customers to manage their inventory levels consistent with just-in-time principles while shortening the cycle times required to produce ordered products. Orders under frame contracts are also subject to a high degree of volatility, because they reflect expected market conditions which may or may not materialize. Thus, they are subject to risks of price reduction, order cancellation and modifications as to quantities actually ordered.
Furthermore, developing industry trends, including customers use of outsourcing and their deployment of new and revised supply chain models, may reduce our ability to forecast changes in customer demand and may increase our financial requirements in terms of capital expenditures and inventory levels.
Our backlog (including frame orders) decreased significantly in 2001 from the levels of 2000, reflecting the most severe downturn in the semiconductor industry. Starting in 2002 we steadily registered an increase in the backlog (including frame orders) compared to 2001, which continued in 2003 compared to 2002. We entered 2004 with a backlog (including frame orders) approximately 30% higher than we had entering 2003. Following the industry-wide over-inventory situation and the declining level of order booking in the second half of 2004, we entered 2005 with an order backlog that was approximately 9% lower than we had entering 2004.
Competition |
Markets for our products are intensely competitive. While only a few companies compete with us in all of our product lines, we face significant competition in each of our product lines. We compete with major international semiconductor companies, some of which may have substantially greater financial and other more focused resources than we do with which to pursue engineering, manufacturing, marketing and distribution of their products. Smaller niche companies are also increasing their participation in the semiconductor market, and semiconductor foundry companies have expanded significantly, particularly in Asia. Competitors include manufacturers of standard semiconductors, application-specific ICs and fully customized ICs, including both chip and board-level products, as well as customers who develop their own integrated circuit products and foundry operations. Some of our competitors are also our customers.
The primary international semiconductor companies that compete with us include Advanced Micro Devices, Agere Systems, Analog Devices, Broadcom, IBM, Infineon Technologies, Intel, International Rectifier, Freescale Semiconductor, Marvell Technology Group, National Semiconductor, Nippon Electric Company, ON Semiconductor, Philips Semiconductors, Qualcomm, Renesas, Samsung, Texas Instruments and Toshiba.
We compete in different product lines to various degrees on the basis of price, technical performance, product features, product system compatibility, customized design, availability, quality and sales and technical support. In particular, standard products may involve greater risk of competitive pricing, inventory imbalances and severe market fluctuations than differentiated products. Our ability to compete successfully depends on elements both within and outside of our control, including successful and timely development of new products and manufacturing processes, product performance and quality, manufacturing yields and product availability, customer service, pricing, industry trends and general economic trends.
Organizational Structure
|
We are a multinational group of companies that designs, develops, manufactures and markets a broad range of products used in a wide variety of microelectronic applications, including telecommunications systems, computer systems, consumer goods, automotive products and industrial automation and control systems. We are organized in a matrix structure with geographical regions interacting with product divisions, both being supported by central functions, bringing all levels of management closer to the customer and facilitating communication among research and development, production, marketing and sales organizations.
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Except for our subsidiaries in Shenzen, China, in which we own indirectly 60% of the shares and voting rights, and Accent S.r.L. (Italy), in which we own 51% of the shares and voting rights, STMicroelectronics N.V. owns directly or indirectly 100% of all of our significant operating subsidiaries shares and voting rights, which have their own organization and management bodies, and are operated independently in compliance with the laws of their country of incorporation. We provide certain administrative, human resources, legal, treasury, strategy, manufacturing, marketing and other overhead services to our subsidiaries pursuant to service agreements for which we receive compensation. For a list of our consolidated subsidiaries, see Note 3 to our Consolidated Financial Statements (the economic and voting stakes listed in Note 3 are identical). See also Property, Plants and Equipment in this Item 4.
The simplified organigram below shows the principal industrial subsidiaries of ST:
Public Funding |
We participate in certain programs established by the European Union (EU) and individual countries in Europe (principally France and Italy). Such funding is generally provided to encourage research and development activities, industrialization and the economic development of underdeveloped regions. These programs are characterized by capital investment and low-interest financing.
Public funding in France, Italy and Europe generally is open to all companies, regardless of their ownership or country of incorporation, for research and development and for capital investment and low-interest-financing related to incentive programs for the economic development of under-developed regions. The EU has developed model contracts for research and development funding that require beneficiaries to disclose the results to third parties on reasonable terms. As disclosed, the conditions for receipt of government funding may include eligibility restrictions, approval by EU authorities, annual budget appropriations, compliance with European Commission regulations, as well as specifications regarding objectives and results.
In the research and development context, some of our government funding contracts involving advance payments requires us to justify our expenses after receipt of funds. Certain specific contracts (Crolles2 and Rousset, France) contain obligations to maintain a minimum level of employment and investment during a certain amount of time. There could be penalties (partial refund) if these objectives are not fulfilled. Other contracts contain penalties for late deliveries or for breach of contract, which may result in repayment obligations. However, the obligation to repay such funding is never automatic.
The main programs for research and development in which we are involved include: (i) the Micro-Electronics Development for European Application (MEDEA+) cooperative research and development program; (ii) European Union research and development projects with FP6 (Sixth Frame Program) for Information Technology; and (iii) national or regional programs for research and development and for industrialization in the electronics industries involving many companies and laboratories. The pan-European
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programs cover a period of several years, while national programs in France and Italy are subject to annual budget appropriation.
The MEDEA+ cooperative research and development program was launched in June 2000 by the Eureka Conference and is designed to bring together many of Europes top researchers in a 12,000 man-year program that covers the period 2000-2008. The MEDEA+ program replaced the joint European research program called MEDEA, which was a European cooperative project in microelectronics among several countries that covered the period 1996 through 2000 and involved more than 80 companies. In Italy, there are some national funding programs established to support the FIRB (Fondo per gli Investimenti della Ricerca di Base, aimed to fund fundamental research), the FAR (Fondo per le Agevolazioni alla Ricerca, to fund industrial research), and the FIT (Fondo per lInnovazione Tecnologica, to fund precompetitive development). These programs are not limited to microelectronics. Italian programs often cover several years, but financial supply of each fund (FIRB, FAR or FIT) is typically subject to annual budget appropriations. During 2004, the accession to the FAR and FIT have been suspended for new projects. This is also true for the MEDEA+ projects, whose Italian activities are subject to the FAR rules and availability. However, there are some regional funding tools that can be addressed by local initiatives, primarily the regions Puglia and Val DAosta, provided that a reasonable regional socio-economic impact could be recognized in terms of industrial exploitation, new professional hiring and/or cooperation with local academia and public laboratories.
In France, support for microelectronics is provided to over 30 companies manufacturing or using semiconductors. The amount of support under French programs is decided annually and subject to budget appropriation.
In accordance with SEC Statement Accounting Bulletin No. 104 Revenue Recognition (SAB 104) and our revenue recognition policy, funding related to these contracts is booked when the conditions required by the contracts are met. Our funding programs are classified in three general categories for accounting purposes: funding for research and development activities, funding for research and development capital investments, and loans.
Funding for research and development activities is the most common form of funding that we receive. Public funding for research and development is recorded as Other Income and Expenses, net in our consolidated statements of income. Public funding for research and development is booked pro rata in relation to the relevant cost once the agreement with the applicable government agency has been signed and as any applicable conditions are met. See Note 20 to the Consolidated Financial Statements. Such funding has totaled $84 million, $76 million and $76 million in the years 2004, 2003 and 2002, respectively.
Government support for capital expenditures funding has totaled $18 million, $62 million and $55 million in the years 2004, 2003 and 2002, respectively. Such funding has been used to support our capital investment. Although receipt of these funds is not directly reflected in our results of operations, the resulting lower amounts recorded in property, plant and equipment costs reduce the level of depreciation recognized by us. Public funding reduced depreciation charges by $74 million, $80 million and $74 million in 2004, 2003 and 2002, respectively.
As a third category of government funding, the Company receives some loans, mainly related to large capital investment projects, at preferential interest rates. The Company recognizes these loans as debt on its balance sheet in accordance with paragraph 35 of Statements of Financial Accounting Concepts No. 6, Elements of Financial Statements (CON 6). Low interest financing has been made available (principally in Italy) under programs such as the Italian Republics Fund for Applied Research, established in 1988 for the purpose of supporting Italian research projects meeting specified program criteria. At year-end 2004, 2003 and 2002, we had $156 million, $84 million and $62 million, respectively, of indebtedness outstanding under state-assisted financing programs at an average interest cost of 1.0%, 1.1% and 1.2%, respectively.
Funding of programs in France and Italy is subject to annual appropriation, and if such governments or local authorities were unable to provide anticipated funding on a timely basis or if existing government- or local authority-funded programs were curtailed or discontinued, or if we were unable to fulfill our eligibility requirements, such an occurrence could have a material adverse effect on our business, operating results and financial condition. From time to time, we have experienced delays in the receipt of funding under these programs. As the availability and timing of such funding are substantially outside our control, there can be no assurance that we will continue to benefit from such government support, that funding will not be delayed from
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time to time, that sufficient alternative funding would be available if necessary or that any such alternative funding would be provided on terms as favorable to us as those previously committed.
Due to changes in legislation and/or review by the competent administrative or judicial bodies, there can be no assurance that government funding granted to us may not be revoked or challenged or discontinued in whole or in part, by any competent state or European authority, until the legal time period for challenging or revoking such funding has fully lapsed. See Item 3. Key InformationRisk FactorsReduction in the amount of state funding available to us, or demands for repayment may increase our costs and impact our results of operations.
Suppliers |
We use three main critical types of suppliers in our business: equipment suppliers, raw material suppliers and external subcontractors.
In the front-end process we use steppers, scanners, track equipment, strippers, chemo-mechanical polishing equipment, cleaners, inspection equipment, etchers, physical and chemical vapor-deposition equipment, implanters, furnaces, testers, probers and other specialized equipment. The manufacturing tools that we use in the back-end process include bonders, burn-in ovens, testers and other specialized equipment. The quality and technology of equipment used in the integrated circuit (IC) manufacturing process defines the limits of our technology. Demand for increasingly smaller chip structures means that semiconductor producers must quickly incorporate the latest advances in process technology to remain competitive. Advances in process technology cannot be brought about without commensurate advances in equipment technology, and equipment costs tend to increase as the equipment becomes more sophisticated.
Our manufacturing processes use many raw materials, including silicon wafers, lead frame, mold compound, ceramic packages and chemicals and gases. The prices of many of these raw materials are volatile. We obtain our raw materials and supplies from diverse sources on a just-in-time basis. Although supplies for the raw materials used by us are currently adequate, shortages could occur in various essential materials due to interruption of supply or increased demand in the industry. See Item 3. Key InformationRisk FactorsBecause we depend on a limited number of suppliers for raw materials and certain equipment, we may experience supply disruptions if suppliers interrupt supply or increase prices.
Finally, we also use external subcontractors to outsource wafer manufacturing and assembly and testing of finished products. See Property, Plants and Equipment. We also have an agreement with Hynix for the co-development and manufacturing of NAND products pursuant to which Hynix is supplying the co-developed NAND products to us, in part using equipment that we have provided on consignment for capacity dedicated to us.
Environmental Matters |
Our manufacturing operations use many chemicals, gases and other hazardous substances, and we are subject to a variety of evolving environmental and health and safety regulations related, among other things, to the use, storage, discharge and disposal of such chemicals and gases and other hazardous substances, emissions and wastes, as well as the investigation and remediation of soil and ground water contamination. In most jurisdictions in which we operate, our manufacturing activities are subject to obtaining permits, licences or other authorizations, or to prior notification. Because a large portion of our manufacturing activities are located in the European Union, we are subject to European Commission regulation on environmental protection, as well as regulations of the other jurisdictions where we have operations.
Consistent with our TQEM principles, we have established proactive environmental policies with respect to the handling of chemicals, gases, emissions and waste disposals from our manufacturing operations, and we have not suffered material environmental claims in the past. We believe that our activities comply with presently applicable environmental regulations in all material respects. We have engaged outside consultants to audit all of our environmental activities and created environmental management teams, information systems and training. We have also instituted environmental control procedures for new processes used by us as well as our suppliers. All of our 16 manufacturing facilities have been certified to conform to International Organization for Standardization (ISO) international quality standards and Eco Management and Audit Scheme (EMAS).
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We have participated in various working groups set up by the European Commission for the adoption of two directives on January 27, 2003: Directive 2002/95/CE on the restriction of the use of certain hazardous substances in electrical and electronic equipment (ROHS Directive) and Directive 2002/96/CE on waste electrical and electronic equipment (WEEE Directive). Directive 2002/95 aims at banning the use of lead and other flame-retardant substances in manufacturing electronic components by July 1, 2006 at the latest. Directive 2002/96 promotes the recovery and recycling of electrical and electronic waste. Both directives had to be transposed by the EU Member States into national legislation by July 1, 2004. In France, a draft decree implementing the Directives 2002/95 and 2002/96 is currently under review and should be adopted in April 2005.
Our activities in the European Union are also subject to the European Directive 2003/87 establishing a scheme for green-house gas allowance trading, and the applicable national implementing legislation. In particular, in France, one of our manufacturing sites has been allocated a quota of green-house gas for the period 2005-2007. Failure to comply with this quota would force us to acquire potentially expensive additional emission allowance from third parties or to pay a fee for each extra ton of gas emitted. We intend to proactively comply with these regulations. In the United States, we are part of the Chicago Climate Exchange program, a voluntary green-house gas trading program whose members commit to reduce emissions for the period 2003-2006. We have also implemented voluntary reforestation projects in several countries in order to sequester additional carbon dioxide (CO2) emissions.
Furthermore new legislative proposals by the European Commission deal with the registration, evaluation and authorization of Chemicals (REACH). We intend to proactively implement such new legislation when enacted, in line with our commitment toward environmental protection.
The implementation of any such legislation could adversely affect our manufacturing costs or product sales by requiring us to acquire costly equipment or materials, or to incur other significant expenses in adapting our manufacturing processes or waste and emission disposal processes. However, we are currently unable to evaluate such specific expenses and therefore have no specific reserves for environmental risks. Furthermore, environmental claims or our failure to comply with present or future regulations could result in the assessment of damages or imposition of fines against us, suspension of production or a cessation of operations and, as with other companies engaged in similar activities, any failure by us to control the use of, or adequately restrict the discharge of hazardous substances could subject us to future liabilities. See Item 3. Key InformationRisk FactorsSome of our production processes and materials are environmentally sensitive, which could lead to increased costs due to environmental regulations or to damage to the environment. Any specific liabilities that we identify will be reflected on our balance sheet. To date we have not identified any such specific liabilities.
Because we have manufacturing facilities located in southern Italy (Catania, Sicily), we face the risk that an earthquake could damage these facilities, which would cause a reduction in our revenue and profitability. Any disruption in our product development capability or our manufacturing capability arising from earthquakes could cause significant delays in the production or shipment of our products until we are able to shift development or production to different facilities or arrange for third parties to manufacture our products. We may not be able to obtain alternate capacity on favorable terms or at all. The risk of earthquakes to our manufacturing facilities in southern Italy (Catania, Sicily) is significant due to the proximity of major earthquake fault lines to these manufacturing facilities. In addition, some of our suppliers are located in regions where there is a risk of earthquakes. Such risks, like other risks, may not be fully or adequately covered under our corporate insurance policies. See Item 8. Financial InformationRisk Management and Insurance.
Industry Background |
The Semiconductor Market |
Semiconductors are the basic building blocks used to create an increasing variety of electronic products and systems. Since the invention of the transistor in 1948, continuous improvements in semiconductor process and design technologies have led to smaller, more complex and more reliable devices at a lower cost per function. As performance has increased and size and cost have decreased, semiconductors have expanded beyond their original primary applications (military applications and computer systems) to applications such as telecommunications systems, consumer goods, automotive products and industrial automation and control systems. In addition, system users and designers have demanded systems with more functionality, higher levels of performance, greater reliability and shorter design cycle times, all in smaller packages at lower costs. These demands have resulted in increased semiconductor content as a percentage of system cost. Calculated on the basis of the total available market (the TAM), which includes all semiconductor products, as a percentage of
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worldwide revenues from production of electronic equipment according to published industry data, semiconductor content has increased from approximately 12% in 1992 to approximately 21% in 2004.
Semiconductor sales have increased significantly over the long term but have experienced significant cyclical variations in growth rates. According to trade association data, the TAM increased from $32.5 billion in 1987 to $213 billion in 2004 (growing at a compound annual growth rate of approximately 11.5%). In 2003, the TAM increased by approximately 18% and in 2004 by approximately 28%. On a sequential, quarter-by-quarter basis in 2004 (including actuators), the TAM increased approximately 1.6% in the first quarter over the fourth quarter 2003, while in the second quarter it increased by 9.5% over the first quarter, 3.8% in the third quarter over the second quarter, and decreased by 0.8% in the fourth quarter over the third quarter. To better reflect our corporate strategy and our current product offering, we measure our performance against our serviceable available market (SAM), redefined as the TAM without DRAMs, microprocessors and optoelectronic products. The SAM increased from approximately $27.8 billion in 1987 to $142 billion in 2004, growing at a compound annual rate of approximately 10.1%. The SAM increased by approximately 26% in 2004 compared to 2003. In 2004, approximately 18.3% of all semiconductors were shipped to the Americas, 18.5% to Europe, 21.5% to Japan, and 41.7% to the Asia/Pacific region.
The following table sets forth information with respect to worldwide semiconductor sales by type of semiconductor and geographic region:
Worldwide Semiconductor Sales(1) |
Compound
Annual Growth Rates(2) |
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2004 | 2003 | 2002 | 2001 | 1997 | 1987 | 03-04 | 02-03 | 01-02 | 87-04 | 87-97 | 97-02 | |||||||||||||
(in billions) | (expressed as percentages) | |||||||||||||||||||||||
Integrated Circuits |
$181.7 | $142.0 | $120.5 | $118.5 | $119.5 | $25.4 | 28.0 | % | 18.3 | % | 1.7 | % | 12.3 | % | 16.7 | % | 0.17 | % | ||||||
Analog (linear and mixed-signal) |
34.3 | 28.8 | 23.9 | 23.2 | 19.8 | 6.0 | 18.9 | 20.6 | 3.0 | 10.8 | 12.7 | 3.8 | ||||||||||||
Digital Logic |
100.3 | 80.7 | 69.6 | 70.4 | 70.4 | 14.0 | 24.3 | 15.9 | (1.1 | ) | 12.3 | 17.5 | 0.2 | |||||||||||
Memory: |
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DRAM |
26.8 | 16.7 | 15.3 | 11.2 | 19.8 | 2.4 | 60.9 | 9.4 | 35.7 | 15.3 | 23.5 | (5.1 | ) | |||||||||||
Others |
20.3 | 15.8 | 11.8 | 13.7 | 9.5 | 3.0 | 28.3 | 34.2 | (13.9 | ) | 11.9 | 12.2 | 4.4 | |||||||||||
Total Memory |
47.1 | 32.5 | 27.0 | 24.9 | 29.3 | 5.4 | 45.0 | 20.4 | 8.4 | 13.6 | 18.4 | (1.6 | ) | |||||||||||
Total digital |
147.4 | 113.2 | 96.6 | 95.3 | 99.7 | 19.4 | 30.3 | 17.1 | 1.4 | 12.7 | 17.8 | (0.6 | ) | |||||||||||
Discrete |
17.6 | 14.9 | 13.4 | 13.1 | 13.2 | 5.8 | 18.3 | 10.9 | 2.3 | 6.7 | 8.6 | 0.3 | ||||||||||||
Optoelectronics |
13.7 | 9.5 | 6.8 | 7.4 | 4.5 | 1.3 | 43.8 | 40.6 | (8.1 | ) | 14.9 | 13.2 | 8.6 | |||||||||||
TAM |
$213.0 | $166.4 | $140.7 | $139.0 | $137.2 | $32.5 | 28.0 | % | 18.3 | %(3) | 1.2 | % | 11.7 | % | 15.5 | % | 0.5 | % | ||||||
Europe |
39.4 | 32.3 | 27.8 | 30.2 | 29.1 | 6.2 | 22.0 | 16.3 | (7.9 | ) | 11.5 | 16.7 | (0.9 | ) | ||||||||||
Americas |
39.1 | 32.3 | 31.3 | 35.8 | 45.8 | 10.3 | 20.8 | 3.4 | (12.8 | ) | 8.2 | 16.1 | (7.4 | ) | ||||||||||
Asia/Pacific |
88.8 | 62.8 | 51.2 | 39.8 | 30.2 | 3.3 | 41.3 | 22.8 | 28.6 | 21.4 | 24.8 | 11.1 | ||||||||||||
Japan |
45.8 | 38.9 | 30.5 | 33.2 | 32.1 | 12.7 | 17.5 | 27.7 | (8.1 | ) | 7.8 | 9.7 | (1.0 | ) | ||||||||||
TAM |
$213.0 | $166.4 | $140.7 | $139.0 | $137.2 | $32.5 | 28.0 | % | 18.3 | %(3) | 1.2 | % | 11.7 | % | 15.5 | % | 0.5 | % | ||||||
(1) | Source: WSTS. |
(2) | Calculated using end points of the periods specified. |
(3) | Calculated on a comparable basis, that is, without information with respect to actuators, which was not included in the indicator before 2003, the TAM increased 16.8%. |
Although cyclical changes in production capacity in the semiconductor industry and demand for electronic systems have resulted in pronounced cyclical changes in the level of semiconductor sales and fluctuations in prices and margins for semiconductor products from time to time, the semiconductor industry has experienced substantial growth over the long term. Factors that are contributing to long-term growth include the development of new semiconductor applications, increased semiconductor content as a percentage of total system cost, emerging strategic partnerships and growth in the electronic systems industry in the Asia/Pacific region.
Semiconductor Classifications |
The process technologies, levels of integration, design specificity, functional technologies and applications for different semiconductor products vary significantly. As differences in these characteristics have increased, the semiconductor market has become highly diversified as well as subject to constant and rapid change. Semiconductor product markets may be classified according to each of these characteristics.
Semiconductors can be manufactured using different process technologies, each of which is particularly suited to different applications. Since the mid-1970s, the two dominant processes have been bipolar (the original technology used to produce integrated circuits) and CMOS. Bipolar devices typically operate at higher speeds
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than CMOS devices, but CMOS devices consume less power and permit more transistors to be integrated on a single IC. CMOS has become the prevalent technology, particularly for devices used in personal computers and consumer applications. Advanced technologies have been developed during the last decade that are particularly suited to more systems-oriented semiconductor applications. BiCMOS technologies have been developed to combine the high-speed and high-voltage characteristics of bipolar technologies with the low power consumption and high integration of CMOS technologies. BCD technologies have been developed that combine bipolar, CMOS and DMOS technologies. Such systems-oriented technologies require more process steps and mask levels, and are more complex than the basic function-oriented technologies.
Semiconductors are often classified as either discrete devices (such as individual diodes, thyristors and transistors, as well as optoelectronic products) or integrated circuits (in which thousands of functions are combined on a single chip of silicon to form a more complex circuit). Compared to the market for ICs, there is typically less differentiation among discrete products supplied by different semiconductor manufacturers. Also, discrete markets have generally grown at slower, but more stable, rates than IC markets.
Semiconductors may also be classified as either standard components, application-specific standard products (ASSPs) or applications specific integrated-circuits (ASICs). Standard components are used for a broad range of applications, while ASSPs and ASICs are designed to perform specific functions in specific applications.
The two basic functional technologies for semiconductor products are analog and digital. Mixed-signal products combine both analog and digital functionality. Analog devices monitor, condition, amplify or transform analog signals, which are signals that vary continuously over a wide range of values.
Analog/digital (or mixed-signal) ICs combine analog and digital devices on a single chip to process both analog signals and digital data. System designers are increasingly demanding system-level integration in which complete electronic systems containing both analog and digital functions are integrated on a single IC.
Digital devices are divided into two major types: memory products and logic devices. Memory products, which are used in electronic systems to store data and program instructions, are classified as either volatile memories (which lose their data content when power supplies are switched off) or nonvolatile memories (which retain their data content without the need for constant power supply).
The primary volatile memory devices are DRAMs, which accounted for approximately 57% of semiconductor memory sales in 2004, and static RAMs (SRAMs). SRAMs are roughly four times as complex as DRAMs. DRAMs are used in a computers main memory. SRAMs are principally used as caches and buffers between a computers microprocessor and its DRAM-based main memory and in other applications such as mobile handsets.
Nonvolatile memories are used to store program instructions. Among such nonvolatile memories, read-only memories (ROMs) are permanently programmed when they are manufactured while programmable ROMs (PROMs) can be programmed by system designers or end-users after they are manufactured. Erasable PROMs (EPROMs) may be erased after exposure to ultraviolet light and reprogrammed several times using an external power supply. Electrically erasable PROMs (EEPROMs) can be erased byte by byte and reprogrammed in- system without the need for removal.
Flash memories are products that represent an intermediate solution between EPROMs and EEPROMs based on their cost and functionality. Because Flash memories can be erased and reprogrammed electrically and in-system, they are more flexible than EPROMs and, therefore, are progressively replacing EPROMs in many of their current applications. Flash memories are typically used in high volume in digital mobile phones and digital consumer applications (set-top boxes, DVDs, digital cameras, MP3 digital music players) and are also suitable for solid-state mass storage of data and emerging high-volume applications.
Logic devices process digital data to control the operation of electronic systems. The largest segment of the logic market includes microprocessors, microcontrollers and digital signal processors. Microprocessors are the central processing units of computer systems. Microcontrollers are complete computer systems contained on single integrated circuits that are programmed to specific customer requirements. Microcontrollers control the operation of electronic and electromechanical systems by processing input data from electronic sensors and generating electronic control signals and are used in a wide variety of consumer, communications, automotive, industrial and computer products. DSPs are parallel processors used for high complexity, high-speed real-time computations in a wide variety of applications.
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Item 5. Operating and Financial Review and Prospects |
Overview |
The following discussion should be read in conjunction with our Consolidated Financial Statements and Notes thereto included elsewhere in this Form 20-F. The following discussion contains statements of future expectations and other forward-looking statements within the meaning of Section 27A of the Securities Act of 1933, or Section 21E of the Securities Exchange Act of 1934, each as amended, particularly in the sections Critical Accounting Policies Using Significant Estimates, Business Outlook and Liquidity and Capital ResourcesFinancial Outlook. Our actual results may differ significantly from those projected in the forward-looking statements. For a discussion of factors that might cause future actual results to differ materially from our recent results or those projected in the forward-looking statements in addition to the factors set forth below, see Cautionary Note Regarding Forward-Looking Statements and Item 3. Key InformationRisk Factors. We assume no obligation to update the forward-looking statements or such risk factors.
Critical Accounting Policies Using Significant Estimates |
The preparation of our Consolidated Financial Statements in accordance with accounting principles generally accepted in the United States of America (U.S. GAAP), requires us to make estimates and assumptions that have a significant impact on the results we report in our Consolidated Financial Statements, which we discuss under the section Results of Operations. Some of our accounting policies require us to make difficult and subjective judgments that can affect the reported amounts of assets and liabilities at the date of the financial statements and the reported amounts of net revenue and expenses during the reporting period. The primary areas that require significant estimates and judgments by management include, but are not limited to, sales returns and allowances; reserves for price protection to certain distributor customers; allowances for doubtful accounts; inventory reserves and normal manufacturing capacity thresholds to determine costs to be capitalized in inventory; accruals for warranty costs; litigation and claims; valuation of acquired intangibles; goodwill; investments and tangible assets as well as the impairment of their related carrying values; restructuring charges; other non-recurring special charges; assumptions used in calculating pension obligations and proforma share-based compensation; assessment of hedge effectiveness of derivative instruments; deferred income tax assets, including required valuation allowances and liabilities; as well as provisions for specifically identified income tax exposures. We base our estimates and assumptions on historical experience and on various other factors such as market trends and business plans that we believe to be reasonable under the circumstances, the results of which form the basis for making judgments about the carrying values of assets and liabilities. While we regularly evaluate our estimates and assumptions, our actual results may differ materially and adversely from our estimates. To the extent there are material differences between the actual results and these estimates, our future results of operations could be significantly affected.
We believe the following critical accounting policies require us to make significant judgments and estimates in the preparation of our Consolidated Financial Statements.
| Revenue recognition. Our policy is to recognize revenues from sales of products to our customers when all of the following conditions have been met: (a) persuasive evidence of an arrangement exists; (b) delivery has occurred; (c) the selling price is fixed or
determinable; and (d) collectibility is reasonably assured. This usually occurs at the time of shipment. We determine the amount of reported revenues based on certain judgments or estimates, and this amount of reported revenue may vary if we elect to make
different judgments or estimates. |
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Consistent with standard business practice in the semiconductor industry, price protection is granted to distribution customers on their existing inventory of our products to compensate them for declines in market prices. The ultimate decision to authorize a
distributor refund remains fully within our control. We accrue a provision for price protection based on a rolling historical price trend computed on a monthly basis as a percentage of gross distributor sales. This historical price trend represents differences in recent
months between the invoiced price and the final price to the distributor, adjusted if required, to accommodate a significant move in the current market price. The short outstanding inventory time period, visibility into the standard inventory product pricing (as
opposed to certain customized products) and long distributor pricing history have enabled us to reliably estimate price protection provisions at period-end. We record the accrued amounts as a deduction of revenue at the time of the sale. If market conditions differ
from our assumptions, this could have an impact on future periods; in particular, if market conditions were to deteriorate, net |
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revenues could be reduced due to higher product returns and price reductions at the time these adjustments occur. |
Our customers occasionally return our products from time to time for technical reasons. Our standard terms and conditions of sale provide that if we determine that products are non-conforming, we will repair or replace the non-conforming products, or issue a
credit or rebate of the purchase price. Quality returns are not related to any technological obsolescence issues and are identified shortly after sale in customer quality control testing. Quality returns are always associated with end-user customers, not with distribution
channels. We provide for such returns when they are considered as probable and can be reasonably estimated. We record the accrued amounts as a reduction of revenue. |
We do not have insurance against product claims and we record a provision for warranty costs as a charge against cost of sales based on historical trends of warranty costs incurred as a percentage of sales which we have determined to be a reasonable estimate of the
probable losses to be incurred for warranty claims in a period. Any potential warranty claims are subject to our determination that we are at fault and liable for damages, and such claims usually must be submitted within a short period following the date of sale. This
warranty is given in lieu of all other warranties, conditions or terms express or implied by statute or common law. We limit our liability to the price allocable to the products which gives rise to the claims. |
We maintain an allowance for doubtful accounts for potential estimated losses resulting from our customers inability to make required payments. We base our estimates on historical collection trends. We recorded a provision of 1.0% of total receivables in 2004
and 2003. In addition, we are required to evaluate our customers credit ratings from time to time and take an additional provision for any specific account that we estimate as doubtful. Although we have determined that our most significant customers are
creditworthy, if the financial condition of our customers were to deteriorate, resulting in an impairment of their ability to make payments, additional allowances could be required. |
| Goodwill and purchased intangible assets. The purchase method of accounting for acquisitions requires extensive use of estimates and judgments to allocate the purchase price to the fair value of the net tangible and intangible assets acquired, including in-process
research and development, which is expensed immediately. Goodwill and intangible assets deemed to have indefinite lives are not amortized but are instead subject to annual impairment tests. The amounts and useful lives assigned to other intangible assets impact
future amortization. If the assumptions and estimates used to allocate the purchase price are not correct or if business conditions change, purchase price adjustments or future asset impairment charges could be required. At December 31, 2004, the value of goodwill
amounted to $264 million. |
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| Impairment of goodwill. Goodwill acquired in business combinations is not amortized and is instead subject to an impairment test to be performed on an annual basis, or more frequently if indicators of impairment exist, in order to assess the recoverability of its
carrying value. Goodwill subject to potential impairment is tested at a level of reporting referred to as a reporting unit. We define our reporting units one level below the four semiconductor product groups described in Note 30 of the Consolidated Financial
Statements and in Results of OperationsSegment Information in this Form 20-F. This impairment test determines whether the fair value of each reporting unit for which goodwill is allocated is lower than the total carrying amount of relevant net assets
allocated to such reporting unit, including its allocated goodwill. If lower, the implied fair value of the reporting unit goodwill is then compared to the carrying value of the goodwill and an impairment charge is recognized for any excess. In determining the fair
value of a reporting unit, we usually estimate the expected discounted future cash flows associated with the reporting unit. Significant management judgments and estimates are used in forecasting the future discounted cash flows including: the applicable industrys
sales volume forecast and selling price evolution, the reporting units market penetration, the market acceptance of certain new technologies and relevant costs structure. Our evaluations are based on financial plans updated with the latest available projections of the
semiconductor market evolution, our sales expectations and our costs evaluation and are consistent with the plans and estimates that we use to manage our business. It is possible, however, that the plans and estimates used may be incorrect, and future |
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adverse changes in market conditions or operating results of acquired businesses not in line with our estimates may require impairment of certain goodwill. |
| Intangible assets subject to amortization. Intangible assets subject to amortization include the cost of technologies and licenses purchased from third parties, internally developed software which is capitalized and purchased software. Intangible assets subject to
amortization are reflected net of any impairment losses. These are amortized over a period ranging from three to seven years. The carrying value of intangible assets subject to amortization is evaluated whenever changes in circumstances indicate that the carrying
amount may not be recoverable. In determining recoverability, we initially assess whether the undiscounted cash flows associated with the intangible assets exceed its carrying value. If exceeded, we then evaluate whether an impairment charge is required by
determining if the assets carrying value also exceeds its fair value. An impairment loss is recognized for the excess of the carrying amount over the fair value. We normally estimate the fair value based on the projected discounted future cash flows associated with
the intangible assets. Significant management judgments and estimates are required and used in the forecasts of future operating results that are used in the discounted cash flow method of valuation, including: the applicable industrys sales volume forecast and
selling price evolution, our market penetration, the market acceptance of certain new technologies and costs evaluation. Our evaluations are based on financial plans updated with the latest available projections of the semiconductor market evolution and our sales
expectations and are consistent with the plans and estimates that we use to manage our business. It is possible, however, that the plans and estimates used may be incorrect and that future adverse changes in market conditions or operating results of businesses
acquired may not be in line with our estimates and may therefore require impairment of certain intangible assets. At December 31, 2004, the value of intangible assets subject to amortization amounted to $291 million. |
| Property, plant and equipment. Our business requires substantial investments in technologically advanced manufacturing facilities, which may become significantly underutilized or obsolete as a result of rapid changes in demand and ongoing technological
evolution. We estimate the useful life of our manufacturing equipment, which is the largest component of our long-lived assets, to be six years. This estimate is based on our experience with using equipment over time. Depreciation expense is a major element of
our manufacturing cost structure. We begin to depreciate new equipment when it is put into use. |
We evaluate each period whether there is reason to suspect that tangible assets or groups of assets might not be recoverable. Several impairment indicators exist for making this assessment, such as: significant changes in the technological, market, economic or legal
environment in which we operate or in the market to which the asset is dedicated; available evidence of obsolescence of the asset; strategic management decisions impacting production or indication that its economic performance is, or will be, worse than expected.
In determining the recoverability of assets to be held and used, we initially assess whether the undiscounted cash flows associated with the tangible assets or group of assets exceed its carrying value. If exceeded, we then evaluate whether an impairment charge is
required by determining if the assets carrying value also exceeds its fair value. We normally estimate this fair value based on independent market appraisals or the sum of discounted future cash flows, using market assumptions such as the utilization of our
fabrication facilities and the ability to upgrade such facilities, change in the selling price and the adoption of new technologies. We also evaluate the continued validity of an assets useful life when impairment indicators are identified. Assets classified as held for
disposal are reflected at the lower of their carrying amount or fair value less selling costs and are not depreciated during the selling period. Selling costs include incremental direct costs to transact the sale that we would not have incurred except for the decision to
sell. |
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Our evaluations are based on financial plans updated with the latest projections of the semiconductor market and of our sales expectations, from which we derive the future production needs and loading of our manufacturing facilities, and which are consistent with
the plans and estimates that we use to manage our business. These plans are highly variable due to the high volatility of the semiconductor business and therefore are subject to continuous modifications. If the future evolution differs from the basis of our plans, both
in terms of market evolution and production allocation to our manufacturing plants, this could require a further review of the |
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carrying amount of our tangible assets resulting in a potential impairment loss. Factors we consider important which could trigger an impairment review include: significant negative
industry trends, significant underutilization of the assets, and significant changes in how we use the assets in our plants. Since a significant portion of our tangible assets are carried by our
European affiliates and their cost of operations are mainly denominated in euros, while revenues primarily are denominated in U.S. dollars, the exchange rate dynamic may trigger
impairment changes. |
| Inventory. Inventory is stated at the lower of cost or net realizable value. Cost is computed by adjusting standard cost to approximate actual manufacturing costs on a quarterly basis; the cost is therefore dependent on our manufacturing performance. In the case of
underutilization of our manufacturing facilities, we estimate the costs associated with the excess capacity; these costs are not included in the valuation of inventories but charged directly to cost of sales. |
The valuation of inventory requires us to estimate obsolete or excess inventory as well as inventory that is not of saleable quality. Provisions for obsolescence are estimated for excess uncommitted inventories based on the previous quarter sales, order backlog and
production plans. To the extent that future negative market conditions generate order backlog cancellations and declining sales, or if future conditions are less favorable than the projected revenue assumptions, we could be required to record additional inventory
provisions, which would have a negative impact on our gross margin. |
| Restructuring charges. We have undertaken, and we may continue to undertake, significant restructuring initiatives, which have required us, or may require us in the future, to develop formalized plans for the exiting or disposing of certain activities. We recognize
the fair value of a liability for costs associated with an exit or disposal activity when a probable liability exists and it can be reasonably estimated. We record estimated charges for non-voluntary termination benefit arrangements such as severance and outplacement
costs meeting the criteria for a liability as described above. Given the significance of and the timing of the execution of such activities, the process is complex and involves periodic reviews of estimates made at the time the original decisions were taken. As we
operate in a highly cyclical industry, we continue to evaluate business conditions. If broader or new initiatives, which could include production curtailment or closure of other manufacturing facilities were to be taken, we may be required to incur additional charges
as well as to change estimates of amounts previously recorded. The potential impact of these changes could be material and have a material adverse effect on our results of operations or financial condition. In 2004, the amount of restructuring charges and other
related closure costs amounted to $76 million pre-tax. Through the period ended December 31, 2004, we have incurred $281 million of the total expected approximate $350 million in pre-tax charges associated with the restructuring plan that was defined on
October 22, 2003, and we expect to incur the balance in the coming quarters. We expect our manufacturing restructuring plan to be completed by mid-2006, somewhat later than previously anticipated. See Note 21 to the Consolidated Financial Statements. |
| Income taxes. We are required to make estimates and judgments in determining income tax expense for financial statement purposes. These estimates and judgments also occur in the calculation of certain tax assets and liabilities and provisions. |
We are required to assess the likelihood to recover our deferred tax assets. If recovery is not likely, we are required to increase our provision for taxes by recording a valuation allowance against the deferred tax assets that we estimate will not ultimately be
recoverable. As of December 31, 2004, we believed that all of the deferred tax assets, net of valuation allowances, as recorded on our balance sheet, would ultimately be recovered. However, should there be a change in our ability to recover our deferred tax assets
or in our estimates of the valuation allowance, or in the tax rates applicable in the various jurisdictions, this could have an impact on our future tax provision in the periods in which these changes could occur. |
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In addition, the calculation of our tax liabilities involves dealing with uncertainties in the application of complex tax regulations. We recognize liabilities for anticipated tax audit issues based on our estimate that probable additional taxes will be due. We reverse the
liability and recognize a tax benefit during the period if we ultimately determine that the liability is no longer necessary. We record an additional charge in our provision for taxes in the period in which we |
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determine that the recorded tax liability is less than we expect the ultimate assessment to be. See Note 24 to the Consolidated Financial Statements. |
| Patent and other intellectual property litigation or claims. We have from time to time received, and may in the future receive, communications alleging possible infringements of patents and similar intellectual property rights of others. We constantly monitor, with
the support of our outside attorneys when deemed necessary or advisable, the chances of such intellectual property claims being successfully asserted. We record a provision when we estimate that the claim could successfully be asserted in a court of law, when the
loss is considered probable and in the absence of a valid offset or counterclaim. In the event of litigation which is adversely determined with respect to our interests, or in the event we need to change our evaluation of a potential third-party intellectual property
claim based on new evidence or communications, this could have a material adverse effect on our results of operations or financial condition at the time it were to materialize. In December 2004, we settled certain disputes with respect to claims and litigation
relating to possible infringements of patents and similar intellectual property rights of others. An accrual of $10 million had been established at December 31, 2003 for such claims and it will be paid in the first quarter of 2005 in accordance with a final settlement
agreement. No additional accrual has been recorded in 2004 since no other risks were estimated to result in a probable loss. |
| Other claims. We are subject to the possibility of loss contingencies arising in the ordinary course of business. These include, but are not limited to: warranty costs on our products not covered by insurance, breach of contract claims, tax claims and provisions for
specifically identified income tax exposures as well as claims for environmental damages. In determining loss contingencies, we consider the likelihood of a loss of an asset or the incurrence of a liability, as well as our ability to reasonably estimate the amount of
such loss or liability. An estimated loss is recorded when it is probable that a liability has been incurred and the amount of the loss can be reasonably estimated. We regularly reevaluate any losses and claims and determine whether they need to be readjusted based
on the current information available to us. In the event of litigation that is adversely determined with respect to our interests, or in the event we need to change our evaluation of a potential third-party claim based on new evidence or communications, this could have
a material adverse effect on our results of operations or financial condition at the time it were to materialize. |
Fiscal year 2004 |
Under Article 35 of our Articles of Association, our financial year extends from January 1 to December 31 each year. Our fiscal year starts at January 1; the first quarter of 2004 lasted until March 27, 2004. The second quarter of 2004 ended on June 26, 2004, and the third quarter of 2004 ended on September 25, 2004. The fourth quarter ended on December 31, 2004. Based on our fiscal calendar, the distribution of our revenues and expenses by quarter may be unbalanced due to a different number of days in the first and fourth quarters of the fiscal year.
2004 Business Overview |
In 2004, the semiconductor market experienced a period of growth led by a more favorable global economic environment. Semiconductor industry data for 2004 indicates that revenues improved from levels recorded for 2003, driven by stronger demand and by better pricing trends in certain product families. The semiconductor market increase was particularly strong in the first half of 2004, outpacing real demand and generating excess inventories; as a result, the market began a correction phase in the second half of 2004.
The total available market is defined as the TAM, while the serviceable available market, the SAM, is defined as the market for products produced by us (which consists of the TAM and excludes PC motherboard major devices such as microprocessors (MPUs), dynamic random access memories (DRAMs), and optoelectronics devices.
Based upon recently published industry data, semiconductor industry revenues increased year-over-year by approximately 28% for the TAM in 2004, to reach an estimated $213 billion, and by approximately 26% for the SAM, to reach an estimated $142 billion. In the fourth quarter of 2004, the TAM increased approximately 15% year-over-year and decreased by approximately 1% sequentially. The industry data for the SAM indicate an increase of approximately 11% in the fourth quarter of 2004 compared to the fourth quarter of 2003 and a sequential decrease of approximately 4%.
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We achieved a 21% revenue increase during 2004 as a result of increased demand for our products; we recorded net revenues of $8,760 million compared to $7,238 million in 2003. Based upon published industry data, our year-over-year 2004 net revenue performance was lower than the SAM (our revenues increased by 21.0% in 2004 compared to 2003 while the SAM increased by 26%). Our year-over-year sales growth was driven primarily by wireless, digital consumer and automotive applications, which all grew faster than the company average. Our 2004 fourth quarter revenues of $2,328 million increased 10.2% versus the fourth quarter of 2003 and 4.3% sequentially. Our fourth quarter 2004 revenue performance was less than the SAM on a year-over-year basis but stronger than the SAM on a sequential basis; this performance was largely driven by seasonal as well as stronger end-market demand, notably within wireless, data storage and automotive applications, all areas where we have traditionally been a market leader. In line with the total market trend, during the second half of 2004, we also experienced a decline in our order booking flows compared to the first half of 2004. Our gross profit and operating income improved at a strong pace in 2004, despite the negative impact of the following main factors which limited our profitability levels: the industry-wide overcapacity with the resulting competitive pricing pressures that persisted throughout most of 2004, and the continuing decline of the U.S. dollar, which negatively affected our reported cost of sales and operating expenses more than the favorable impact on revenues. In 2004, we continued our restructuring plan launched in the second half of 2003, which was initiated to improve the cost competitiveness of our 150mm wafer fab manufacturing by migrating a large part of our 150mm production from Europe and the United States to Singapore and by upgrading production to finer geometry 200mm wafer fabs, while enhancing our overall manufacturing capacity. Our total impairment and restructuring charges for 2004 were significantly lower than those incurred in 2003. We continued to invest significant resources in research and development and in marketing activities. In 2004, we also reduced our interest expense significantly by repurchasing our remaining 2010 Bonds and by the redemption of all of our 2009 LYONs.
In summary, our improved profitability in 2004 was driven by the following factors:
| higher sales volume and more favorable product mix in our revenues which contributed to a 21.0% increase in our net revenues over 2003; |
| continuous improvement of our manufacturing performances, including a higher capacity utilization and the first positive impact of the restructuring plan launched in the second half of 2003; |
| lower impairment, restructuring charges and other related closure costs equivalent to $76 million pre-tax in 2004, compared to $205 million pre-tax in 2003; and |
| interest expense savings of approximately $50 million pre-tax following the issuance of our 2013 Bonds and redemptions and repurchases of all our outstanding higher coupon 2009 LYONs and 2010 Bonds. |
Our profitability in 2004 was negatively affected by the following factors:
| Negative pricing trends due to the industrys manufacturing overcapacity, with our average selling prices declining by approximately 5%, as pure pricing effect, in 2004 as compared to 2003; |
| The impact of the U.S. dollar exchange rate against the euro and other currencies, which translated into an increase in our cost of sales and our operating expenses significantly higher than the favorable impact on our revenues; and |
| Our determination to continue to invest in research and development and other strategic programs: Our research and development expenses increased by approximately 24% in 2004, as we added approximately 1,000 people compared to 2003. |
Operating income in 2004 was $683 million compared to $334 million in 2003, and 2004 net income was $601 million compared to $253 million in 2003.
In 2004 we continued to invest in upgrading and expanding our manufacturing capacity. Total capital expenditures in 2004 were approximately $2,050 million, which were financed entirely by net cash generated from operating activities. At December 31, 2004, we had cash and cash equivalents of $1,950 million. Total debt and bank overdrafts were $1,958 million, of which $1,767 million were long-term debt.
53
During 2004, we continued to focus on key initiatives to improve our competitive position in the semiconductor industry. Our marketing objectives to broaden our customer base delivered positive results, with approximately 31% growth among customers outside our traditional top 50 customers. Our manufacturing restructuring plan to enhance our cost structure and competitiveness is moving ahead, and we expect it to be completed by mid-2006, somewhat later than previously anticipated to accommodate qualification requirements of our customers. In addition, we reorganized our product groups and entered 2005 better positioned to serve application requirements, particularly the converging marketplace for communications and multimedia. We also added significant resources to our research and development staff in order to strengthen and enhance our product portfolio.
Other Developments in 2004 |
On March 5, 2004, we formed UPEK, Inc., a new joint-venture company, with Sofinnova Capital IV FCPR, incorporated in the United States, as a venture capital-funded spin-off of our TouchChip business. UPEK, Inc. was initially capitalized with the transfer of our business, personnel and technology assets related to our fingerprint biometrics business, formerly known as our TouchChip Business Unit (accounted for as Others in Segment Information), for a 48% interest estimated to be equivalent to $10 million. Sofinnova Capital IV FCPR contributed $11 million in cash for a 52% interest. In the first quarter of 2005, our interest in UPEK was reduced to 33% based on a share capital increase by Sofinnova.
On March 15, 2004, we announced that our Supervisory Board had approved the recommendation of our President and Chief Executive Officer for his succession and would propose that Mr. Carlo Bozotti be appointed as the sole member of the Managing Board and President and Chief Executive Officer. Our shareholders approved of this appointment at our 2005 annual general meeting on March 18, 2005. As part of the succession plan, the Supervisory Board, upon proposal of Mr. Bozotti, endorsed the appointment of Mr. Alain Dutheil as Chief Operating Officer reporting to the President and Chief Executive Officer. Both Mr. Bozotti and Mr. Dutheil served as senior executive officers of our company in 2004.
In the second quarter of 2004, we paid $107 million in dividends pursuant to the decision taken by our shareholders at our annual general meeting held on April 23, 2004 ($0.12 per share).
On September 27, 2004, we announced product group, front-end manufacturing and technology related research and development organizational changes that reflect our continued emphasis on developing application-specific products and platforms for an increasingly convergent marketplace.
Effective January 1, 2005, we realigned our product groups to increase market focus and realize the full potential of our products, technologies, and sales and marketing channels. Beginning in 2005, we will report our sales and operating income in three segments:
| the new Application Specific Groups (ASG) segment, comprised of three product groups our new Home, Personal and Communication Sector (HPC), our new Computer Peripherals Group (CPG) and our new Automotive Product Group (APG). Our
new HPC Sector is comprised of the telecommunications and the audio divisions from the former TPA combined with the consumer group from the former CMG Group. Our new CPG Group covers computer peripherals products, specifically disk drives and
printers, and our new APG Group now comprises all of our major complex products related to automotive applications formerly within the automotive group of TPA and in other product groups (notably from the former DSG and the Microcontroller Group); |
| the Memory Products Group (MPG) segment, comprised of our memories and Smart card businesses; and |
| the new Micro, Linear and Discrete Group (MLD) segment, comprised of most of the former DSG plus standard microcontroller and industrial devices (including the programmable systems memories (PSM) division from the former MPG). |
The following discussion in this Item 5 reflects the organization effective in the three years ended December 31, 2004.
In 2004, we repurchased all of our remaining outstanding 2010 Bonds for a total cash amount paid of $375 million, and we redeemed our 2009 LYONs for approximately $813 million in cash.
54
On November 16, 2004, we signed a joint-venture agreement with Hynix Semiconductor Inc. to build a front-end memory-manufacturing facility in Wuxi City, Jiangsu Province, China. The conditions for the creation of the new company were not met at December 31, 2004; however, we expect to make capital investments totaling $125 million in 2005 and $125 million in 2006. In addition, we have undertaken to extend $250 million in long-term financing to the new joint venture guaranteed by subordinated collateral on the joint-venture assets.
Recent Developments |
In January 2005, we decided to reduce our Access technology products for Customer Premises Equipment (CPE) modem products. This decision is intended to eliminate certain low-volume, non-strategic product families whose returns in the current environment do not meet internal targets. This decision could result in potential impairment charges of up to $60 million in the first quarter of 2005 for intangible assets and goodwill related to the CPE product lines and in certain additional restructuring charges to be further estimated.
On February 28, 2005, we signed an advanced pricing agreement for the period 2001 through 2007 with the United States Internal Revenue Service. We are currently assessing our overall tax reserve, that may lead to the reversal of past provisions, resulting in a net tax benefit in the first quarter of 2005. The foregoing are forward-looking statements within the meaning of section 21E of the Securities Exchange Act of 1934, as amended, that are currently based on management’s current views and assumptions and involve known and unknown risks and uncertainties that could cause actual results, performance or events to differ materially from those in such statements. See “Cautionary Note Regarding Forward-Looking Statements” and “Item 3. Key Information — Risk Factors”.
At our annual general meeting of shareholders held on March 18, 2005, our shareholders approved the distribution of a cash dividend of $0.12 per common share in respect to the 2004 financial year, equivalent to the prior years cash dividend payment, to be paid in the latter half of May 2005. In addition, the shareholders approved the appointment of our Supervisory Board and Managing Board members, amendments to our articles of association and to our 2001 Employee Stock Option Plan, as well as a new 2005 Supervisory Board member and professional stock-based compensation plan, among other resolutions.
Business Outlook |
After the strong increase in 2004, the semiconductor industry is expected to experience a correction phase during the first half of 2005 mainly due to inventory level adjustments. We currently believe that this correction will not likely transform itself into a severe downturn, due to a resilient economy and a favorable technological environment. As a result, we currently estimate that the semiconductor market may increase by approximately 4% in 2005, with a more favorable trend in the second half of the year. Following the industry-wide over-inventory situations and the declining level of order booking in the second half of 2004, we entered 2005 with an order backlog that was approximately 9% lower than we had entering 2004.
In addition to earlier-stated strategic initiatives, we are undertaking several near-term actions to improve our financial performance. We plan to eliminate certain low volume, non-strategic product families whose return on net assets in the current environment does not meet internal targets. In particular, we will reduce our Access technology products for CPE modem products. This decision taken in January 2005 is intended to eliminate certain low-volume, non-strategic product families whose returns in the current environment do not meet internal targets. This decision could result in potential impairment charges of up to $60 million in the first quarter of 2005 for intangible assets and goodwill related to the CPE product lines and in certain additional restructuring charges to be further estimated. In addition, we will accelerate cost reduction initiatives, including: a more selective process in dedicating capacity to new orders, with priority to higher margin products; optimization of the product and production mix in memory; consolidation of certain central function activities to control overhead; and launching an aggressive cost savings program focused on purchasing.
In line with the current industry dynamics, we forecast 2005 capital expenditures of approximately $1.5 billion. The largest part of this amount will be allocated to leading-edge technologies and research and development programs.
These are forward-looking statements that are subject to known and unknown risks and uncertainties that could cause actual results to differ materially; in particular, refer to those known risks and uncertainties described in Cautionary Note on Forward-Looking Statements and Item 3. Key InformationRisk Factors in this Form 20-F.
55
Results of Operations |
Segment Information |
We operate in two business areas: Semiconductors and Subsystems.
In the Semiconductors business area, we design, develop, manufacture and market a broad range of products, including discrete, memories and standard commodity components, application-specific integrated circuits (ASICs), full custom devices and semicustom devices and application-specific standard products (ASSPs) for analog, digital, and mixed-signal applications. In addition, following the acquisition of Incard, we further strengthened our participation in the manufacturing value chain of Smart card products, which includes the production and sale of both silicon chips, as in the past, and of cards. Our principal investment and resource allocation decisions in the Semiconductor business area are for expenditures on research and development and capital investments in front-end and back-end manufacturing facilities. Through December 31, 2004, we managed our semiconductor products in four segments, following our four main product groups: Telecommunications, Peripherals and Automotive; Discrete and Standard ICs; Memory Products and Consumer and Microcontroller (collectively referred to as the Groups, with our Smart card business within MPG). We announced a reorganization of our business segments effective as of January 1, 2005. See Item 4. Information on the CompanyBusiness Overview. As this new structure is not effective until fiscal year 2005, the discussion of our results of operations is set forth according to the structure effective during 2004.
In the Subsystems business area, we design, develop, manufacture and market subsystems and modules for the telecommunications, automotive and industrial markets including mobile phone accessories, battery chargers, ISDN power supplies and in-vehicle equipment for electronic toll payment. Based on its immateriality to our business as a whole, the Subsystems segment does not meet the requirements for a reportable segment as defined in Statement of Financial Accounting Standards No. 131, Disclosures about Segments of an Enterprise and Related Information (FAS 131).
The following tables present our consolidated net revenues and consolidated operating income by semiconductor product segment. For the computation of the Groups internal financial measurements, we use certain internal rules of allocation for the costs not directly chargeable to the Groups, including cost of sales, selling, general and administrative expenses and a significant part of research and development expenses. Additionally, in compliance with our internal policies, certain cost items are not charged to the Groups, including impairment, restructuring charges and other related closure costs, start-up costs of new manufacturing facilities, some strategic and special research and development programs or other corporate sponsored initiatives, including starting-up marketing and design operations in targeted developing areas, certain corporate level operating expenses, and certain other miscellaneous charges.
Year Ended December 31, |
||||||||||
2004 | 2003 | 2002 | ||||||||
(in millions) | ||||||||||
Net revenues by product group: |
||||||||||
Telecommunications, Peripherals and Automotive |
$3,485 | $3,268 | $3,074 | |||||||
Discrete and Standard ICs |
1,614 | 1,224 | 1,055 | |||||||
Memory Products |
1,974 | 1,358 | 1,055 | |||||||
Consumer and Microcontroller |
1,619 | 1,321 | 1,026 | |||||||
Others(1) |
68 | 67 | 108 | |||||||
Total consolidated net revenues |
$8,760 | $7,238 | $6,318 | |||||||
(1) | Mainly includes revenues from sales of subsystems and other products not allocated to product groups. |
56
Year Ended December 31, |
||||||||||
2004 | 2003 | 2002 | ||||||||
(in millions) | ||||||||||
Operating income (loss) by product group: |
||||||||||
Telecommunications, Peripherals and Automotive |
$471 | $550 | $613 | |||||||
Discrete and Standard ICs |
338 | 142 | 135 | |||||||
Memory Products |
87 | (45 | ) | 7 | ||||||
Consumer and Microcontroller |
130 | 78 | 57 | |||||||
Total operating income of product groups |
1,026 | 725 | 812 | |||||||
Others(1) |
(343 | ) | (391 | ) | (211 | ) | ||||
Total consolidated operating income |
$683 | $334 | $601 | |||||||
(1) | Operating income of Others includes items such as impairment, restructuring charges and other related closure costs, start-up costs, and other unallocated expenses such as: strategic or special research and development programs, certain corporate level operating expenses, certain patent claim and litigation costs, and other costs that are not allocated to the product groups, as well as
operating earnings or losses of the Subsystems and Other Products Group. |
Year Ended December 31, |
||||||||||
2004 | 2003 | 2002 | ||||||||
(as a percentage of total net revenues) | ||||||||||
Operating income (loss) by product group: |
||||||||||
Telecommunications, Peripherals and Automotive(1) |
13.5 | % | 16.8 | % | 19.9 | % | ||||
Discrete and Standard ICs(1) |
20.9 | 11.6 | 12.8 | |||||||
Memory Products(1) |
4.4 | (3.3 | ) | 0.7 | ||||||
Consumer and Microcontroller(1) |
8.0 | 5.9 | 5.6 | |||||||
Others(2) |
(3.9 | ) | (5.4 | ) | (3.3 | ) | ||||
Total consolidated operating income(3) |
7.8 | % | 4.6 | % | 9.5 | % |
(1) | As a percentage of net revenues per product group. |
(2) | As a percentage of total net revenues. Includes operating income from sales of subsystems and other income (costs) not allocated to product groups. |
(3) | As a percentage of total net revenues. |
Year Ended December 31, |
||||||||||
2004 | 2003 | 2002 | ||||||||
(in millions) | ||||||||||
Reconciliation to consolidated operating income: |
||||||||||
Total operating income of product groups |
$1,026 | $725 | $812 | |||||||
Strategic and other research and development programs |
(121 | ) | (61 | ) | (83 | ) | ||||
Start-up costs |
(63 | ) | (54 | ) | (57 | ) | ||||
Impairment, restructuring charges and other related closure costs |
(76 | ) | (205 | ) | (34 | ) | ||||
Subsystems |
(1 | ) | 2 | 6 | ||||||
Patent claim costs |
(37 | ) | (10 | ) | | |||||
Other non-allocated provisions |
(45 | ) | (63 | ) | (43 | ) | ||||
Total operating loss of Others |
(343 | ) | (391 | ) | (211 | ) | ||||
Total consolidated operating income |
$683 | $334 | $601 | |||||||
57
Net Revenues by Location of Order Shipment and by Product Family |
The table below sets forth information on our consolidated net revenues by location of order shipment and by product family:
Year Ended December 31, |
||||||||||
2004 | 2003 | 2002 | ||||||||
(in millions) | ||||||||||
Net revenues by location of order shipment:(1) |
||||||||||
Europe |
$2,363 | $2,012 | $1,832 | |||||||
North America |
1,211 | 985 | 919 | |||||||
Asia/Pacific |
3,710 | 3,190 | 2,748 | |||||||
Japan |
403 | 337 | 275 | |||||||
Emerging Markets |
1,073 | 714 | 544 | |||||||
Total consolidated net revenues |
$8,760 | $7,238 | $6,318 | |||||||
Net revenues by product family: |
||||||||||
Differentiated Products |
$5,800 | $5,013 | $4,375 | |||||||
Standard & Commodities |
436 | 367 | 366 | |||||||
Micro & Memories |
1,295 | 942 | 823 | |||||||
Discretes |
1,229 | 916 | 754 | |||||||
Total consolidated net revenues |
$8,760 | $7,238 | $6,318 | |||||||
(1) | Net revenues by location of order shipment region are classified by location of customer invoiced. For example, products ordered by companies to be invoiced to Asia/Pacific affiliates are classified as Asia/Pacific revenues. |
The table below sets forth information on our net revenues by location of order shipment and by product family in percentages of total net revenues:
Year Ended December 31, |
||||||||||
2004 | 2003 | 2002 | ||||||||
(as a percentage of net revenues) | ||||||||||
Net revenues by location of order shipment:(1) |
||||||||||
Europe |
27.0 | % | 27.8 | % | 29.0 | % | ||||
North America |
13.8 | 13.6 | 14.5 | |||||||
Asia/Pacific |
42.4 | 44.1 | 43.5 | |||||||
Japan |
4.6 | 4.6 | 4.4 | |||||||
Emerging Markets |
12.2 | 9.9 | 8.6 | |||||||
Total consolidated net revenues |
100.0 | % | 100.0 | % | 100.0 | % | ||||
Net revenues by product family: |
||||||||||
Differentiated Products |
66.2 | % | 69.3 | % | 69.3 | % | ||||
Standard & Commodities |
5.0 | 5.1 | 5.8 | |||||||
Micro & Memories |
14.8 | 13.0 | 13.0 | |||||||
Discretes |
14.0 | 12.6 | 11.9 | |||||||
Total consolidated net revenues |
100.0 | % | 100.0 | % | 100.0 | % | ||||
(1) | Net revenues by location of order shipment region are classified by location of customer invoiced. For example, products ordered by companies to be invoiced to Asia/Pacific affiliates are classified as Asia/Pacific revenues. |
58
The following table sets forth certain financial data from our consolidated statements of income since 2002, expressed in each case as a percentage of net revenues:
Year Ended December 31, |
||||||||||
2004 | 2003 | 2002 | ||||||||
(as a percentage of net revenues) | ||||||||||
Net sales |
100.0 | % | 99.9 | % | 99.2 | % | ||||
Other revenues |
| 0.1 | 0.8 | |||||||
Net revenues |
100.0 | 100.0 | 100.0 | |||||||
Cost of sales |
(63.2 | ) | (64.5 | ) | (63.6 | ) | ||||
Gross profit |
36.8 | 35.5 | 36.4 | |||||||
Selling, general and administrative |
(10.8 | ) | (10.9 | ) | (10.3 | ) | ||||
Research and development |
(17.5 | ) | (17.1 | ) | (16.2 | ) | ||||
Other income and expenses, net |
0.2 | (0.1 | ) | 0.1 | ||||||
Impairment, restructuring charges and other related closure costs |
(0.9 | ) | (2.8 | ) | (0.5 | ) | ||||
Total operating expenses |
(29.0 | ) | (30.9 | ) | (26.9 | ) | ||||
Operating income |
7.8 | 4.6 | 9.5 | |||||||
Interest expense, net |
| (0.7 | ) | (1.0 | ) | |||||
Equity in loss of joint venture |
| | (0.2 | ) | ||||||
Loss on extinguishment of convertible debt |
(0.1 | ) | (0.6 | ) | | |||||
Income before income taxes and minority interests |
7.7 | 3.3 | 8.3 | |||||||
Income tax benefit (expense) |
(0.8 | ) | 0.2 | (1.4 | ) | |||||
Income before minority interests |
6.9 | 3.5 | 6.9 | |||||||
Minority interests |
| | (0.1 | ) | ||||||
Net income |
6.9 | % | 3.5 | % | 6.8 | % | ||||
59
2004 vs. 2003 |
In 2004, according to the most recently published industry data, the semiconductor industry experienced a year-over-year revenue increase of approximately 28% for the total available market (TAM) and of approximately 26% for our serviceable available market (SAM).
Net revenues |
|
2004 | 2003 | % Variation | ||||||||
(in millions) | ||||||||||
Net sales |
$8,756 | $7,234 | 21.0 | % | ||||||
Other revenues |
$4 | $4 | | |||||||
Net revenues |
$8,760 | $7,238 | 21.0 | % | ||||||
On a year-over-year basis, the increase in our 2004 net sales was primarily due to our higher sales volumes and improved product mix, as our average selling prices declined by approximately 5% due to the continuing wide pricing pressure in the markets we serve. The increase in our 2004 net revenues was mainly driven by higher demand registered in all product groups and in particular in the Memory Product Group and the Discrete and Standard ICs Group.
The Telecommunications, Peripherals and Automotive Groups net revenues increased by 6.6% compared to 2003, primarily as a result of improved product mix and higher volume of sales, while average selling prices declined. Revenues increased mainly in Automotive and Computer Peripherals, while Telecom sales were flat compared to 2003. The Discrete and Standard ICs Groups net revenues increased by 31.8% on a year-over-year basis due mainly to an increase in volumes and an improved product mix of Transistors, Discrete and Digital ICs. The Memory Products Groups net revenues increased by 45.4% compared to 2003 as a result of an increase in volume and a more favorable product mix in all memory products, particularly in Flash. The Consumer and Microcontroller Groups net revenues increased by 22.6% compared to 2003, mainly due to a strong increase in sales volumes in cameras for cellular phones, Set-Top Box products, displays and TV products. See Results of OperationsSegment Information. All product groups experienced declining average sale prices during 2004, especially the CMG and TPA Groups.
During 2004, we maintained our focus on Differentiated ICs, which accounted for approximately 66% of our net revenues, decreasing however from 69% in 2003. Such products foster close relationships with customers, resulting in knowledge of their evolving requirements and opportunities to access their markets for other products. Analog ICs (including mixed-signal ICs), the majority of which are also Differentiated ICs, represented approximately 44% of our net revenues in 2004 compared to 49% of net revenues in 2003.
Historically, these families of products, particularly analog ICs, have experienced less volatility in sales growth rates and average selling prices than the semiconductor industry overall. The difficult competitive environment in the semiconductor market in more recent years, however, has led to price pressures in these product families as well. All product families had solid revenue increases over 2003; in particular, Micro and Memories were up 37.4%, Discretes were up 34.2%, while Standard and Commodities were up 18.9% and Differentiated Products were up 15.7%.
In 2004, by location of order shipment, approximately 42% of our revenues came from orders shipped to Asia/Pacific; 27% to Europe; 14% to North America; 12% to Emerging Markets; and 5% to Japan. The major increase was registered in the Emerging Markets driven by the strong economic development in this area.
During 2004, we had several large customers, with the largest one, the Nokia Group of companies, accounting for approximately 17.1% of our net revenues. Our top ten OEM customers accounted for approximately 44% of our net revenues for the year.
Gross profit |
|
2004 | 2003 | % Variation | ||||||||
|
|
|
|
|
|
|||||
(in millions) | ||||||||||
Cost of sales |
$(5,532 | ) | $(4,672 | ) | (18.4 | %) | ||||
Gross profit |
$3,228 | $2,566 | 25.8 | % | ||||||
Gross margin |
36.8 | % | 35.5 | % | |
60
Our gross margin increased from 35.5% in 2003 to 36.8% in 2004, lower than our initial expectation on the year-end gross margin. This gross margin improvement is attributable to a variety of factors, including sales volume and higher capacity utilization in most of our factories, an overall improvement in our manufacturing efficiency, and a more favorable product mix. These improving factors were partially offset by the negative impact of price decline and the sharp year-over-year decline in the value of the U.S. dollar versus the major currencies in which our manufacturing operations are located. The impact of changes in foreign exchange rates on gross profit in 2004 compared to 2003 was estimated to be negative since the negative currency impact on cost of sales generated by the weaker U.S. dollar versus the euro and other currencies was greater than the favorable impact on net revenues. See Impact of Changes in Exchange Rates.
Selling, general and administrative expenses |
|
2004 | 2003 | % Variation | ||||||||
(in millions) | ||||||||||
Selling, general and administrative expenses |
$(947 | ) | $(785 | ) | (20.6 | %) | ||||
As a percentage of net revenues |
(10.8 | )% | (10.9 | )% | |
Selling expenses have increased in relation to our increased volume of sales and our enhanced spending in marketing activities to broaden our customer base. Also, general and administrative expenses increased mainly due to higher expenditures in information technology and to the expansion of our activities. Selling, general and administrative expenses were also negatively impacted by the decline of the U.S. dollar since large parts of these expenses are located in the euro zone. Selling, general and administrative expenses have increased at the same pace as our net revenues; as a percentage of net revenues, selling, general and administrative expenses were 10.8%, slightly improving compared to 2003.
Research and development expenses |
|
2004 | 2003 | % Variation | ||||||||
(in millions) | ||||||||||
Research
and development expenses |
$(1,532 | ) | $(1,238 | ) | (23.8 | %) | ||||
As a percentage of net revenues |
(17.5 | )% | (17.1 | )% | |
The 2004 increase in research and development expenses resulted primarily from greater spending on product design and technology for our core activities and from the impact of the decline in value of the U.S. dollar since a large part of our research and development expenses is incurred in the euro zone. We continued to invest heavily in research and development during 2004, and we increased our research and development staff by approximately 1,000 people between December 2003 and December 2004. We continued to allocate significant resources to strengthen our market position in key applications, reflecting our commitment to customer service and continuing innovation. Our reported research and development expenses are mainly in the areas of product design, technology and development and do not include marketing design center costs, which are accounted for as selling expenses, or process engineering, pre-production or process-transfer costs, which are accounted for as cost of sales.
Other income and expenses, net |
|
2004 | 2003 | ||||||
(in millions) | |||||||
Research and development funding |
$84 | $76 | |||||
Start-up costs |
(63 | ) | (55 | ) | |||
Exchange gain, net |
33 | 5 | |||||
Patent claim costs |
(37 | ) | (29 | ) | |||
Gain on sale of non-current assets |
6 | 17 | |||||
Other, net |
(13 | ) | (18 | ) | |||
Other income and expenses, net |
$10 | $(4 | ) | ||||
As a percentage of net revenues |
0.2 | % | (0.1 | %) |
Total Other income and expenses, net resulted in income of $10 million in 2004, compared to an expense of $4 million in 2003. The detail of the various items is set forth above. Research and development
61
funding included income of some of our research and development projects, which qualify as funding on the basis of contracts with local government agencies in locations where we pursue our activities. The major amounts of funding were received in Italy and France. In 2004, these fundings increased compared to 2003 in line with the increased number of funded projects and expenditures. Start-up costs represent costs incurred in the start-up and testing of our new manufacturing facilities. In 2004, start-up costs included the upgrading of our 200-mm fab in Agrate (Italy), the start of our 300-mm pilot line in Crolles (France), the launch of our 150-mm fab in Singapore, and the build-up of our 300-mm fab in Catania (Italy). Exchange gain, net, included the gain on foreign exchange transactions. Patent claim costs are composed of patent pre-litigation costs and patent litigation costs. Patent litigation costs include legal and attorney fees and payment of claims, and patent pre-litigation costs are composed of consultancy fees and legal fees. Patent litigation costs are costs incurred in respect of pending litigation. Patent pre-litigation costs are costs incurred to prepare for licensing discussions with third parties with a view to concluding an agreement. Patent claim costs have increased in 2004 in relation to the costs associated with increased activity in connection with patent litigation. In 2004, we settled our outstanding patent litigation with both Motorola, Inc. and Freescale Semiconductor, Inc. See Item 8. Financial InformationLegal Proceedings and Note 20 to our Consolidated Financial Statements.
Impairment, restructuring charges and other related closure costs |
|
2004 | 2003 | ||||||
|
|
|
|
||||
(in millions) | |||||||
Impairment,
restructuring charges and other related closure costs
|
$(76 | ) | $(205 | ) | |||
As
a percentage of net revenues
|
(0.9 | )% | (2.8 | )% |
In 2004, we recorded a $76 million charge for impairment, restructuring charges and other related closure costs, of which $8 million related to impairment of intangible assets and investments, $33 million of restructuring charges related mainly to workforce termination benefits and $35 million related to other closure costs. In 2004, the $76 million charge for impairment, restructuring charges and other related closure costs included $60 million related to our 150-mm restructuring plan, $4 million for our back-end restructuring, $8 million of impairment of intangible assets and investments, and $4 million for other miscellaneous costs. In 2003, we recorded a charge of $205 million, mainly associated with the initial impairment charges recorded for our 150-mm restructuring plan. Through the period ended December 31, 2004, we have incurred $281 million of the expected $350 million in pre-tax charges associated with the restructuring plan that was defined on October 22, 2003, and we expect to incur the remaining $69 million in the coming quarters. We expect our manufacturing restructuring plan to be completed by mid-2006, somewhat later than previously anticipated. See Impairment, Restructuring Charges and Other Related Closure Costs.
Operating income |
|
2004 | 2003 | % Variation | ||||||||
(in millions) | ||||||||||
Operating income |
$683 | $334 | 104.3 | % | ||||||
As a percentage of net revenues |
7.8 | % | 4.6 | % | |
The increase in operating income was mainly driven by the higher level of sales, improved manufacturing performances and the decrease in impairment, restructuring charges and other related closure costs incurred in 2004. The impact of changes in foreign exchange rates on operating income in 2004 compared to 2003 was estimated to be substantially unfavorable because the decline of the U.S. dollar versus the euro and other currencies negatively impacted cost of sales and operating expenses, and these currency impacts on costs were significantly higher than the favorable impact on net sales. See Impact of Changes in Exchange Rates.
All major groups were profitable in 2004 and, with the exception of TPA, also significantly improved as compared to 2003, despite the negative effect of the decline of the U.S. dollar, which impacted the profitability of all groups. The increase in operating income was particularly significant in DSG and MPG, which in addition to the strong increase in volume benefited from a more favorable pricing environment. The operating income for our TPA Groups decreased to $471 million from $550 million in 2003. This deterioration of operating income was due to a variety of factors, including a significant price decline due to the effect of strong competition in the markets we serve, the negative impact of the decline of the U.S. dollar and a significant increase in research and development expenditures. Operating income for DSG increased to $338 million in 2004 from $142 million in
62
2003. Our operating income for CMG increased to $130 million in 2004 from $78 million in 2003, mainly driven by a significant increase in sales volume which was partially offset by strong price declines. As a result of a 45% revenue increase generated by a higher volume of sales and a more favorable product mix, as well as improved productivity in manufacturing, MPG registered an operating income of $87 million compared to an operating loss of $45 million in 2003. See Results of OperationsSegment Information.
Interest expense, net |
|
2004 | 2003 | ||||||
(in millions) | |||||||
Interest expense, net |
$(3 | ) | $(52 | ) |
The decrease in interest expense in 2004 was mainly due to the repurchases of the 2010 Bonds and the early redemption of the 2009 LYONs, which allowed us to save approximately $50 million in interest charges. See Note 22 to our Consolidated Financial Statements.
Loss on equity investments |
|
2004 | 2003 | ||||||
(in millions) | |||||||
Loss on equity investments |
$(4 | ) | $(1 | ) |
In 2004, the shareholders agreed to restructure SuperH, Inc., the joint venture we formed with Hitachi, Ltd. (now Renesas), by transferring SuperHs intellectual property to each shareholder and continuing any further development individually. Based upon estimates of forecasted cash requirements of the joint venture, we paid and expensed an additional $2 million in 2004. The increase in losses in 2004 also relates to new company, UPEK Inc., created with Sofinnova Capital IV FCPR as a venture capital-funded spin-off of our TouchChip business for which we recorded losses of approximately $2 million.
Loss on extinguishment of convertible debt |
|
2004 | 2003 | ||||||
(in millions) | |||||||
Loss on extinguishment of convertible debt |
$(4 | ) | $(39 | ) |
In 2004, we recorded a non-operating pre-tax charge of $4 million related to the repurchase of approximately $472 million of the aggregate principal amount at maturity of our 2010 Bonds. This charge included the price paid in excess of the bonds accreted value for an amount of approximately $3 million and the write-off of approximately $1 million for the related bond issuance costs. The decrease compared to 2003 was because we paid a premium in repurchases of and wrote-off underwriter discounts related to our 2010 Bonds, most of which were done in 2003.
Income tax benefit (expense) |
|
2004 | 2003 | ||||||
(in millions) | |||||||
Income tax benefit (expense) |
$(68 | ) | $14 |
In 2004, we had an income tax charge of $68 million, compared to an income tax benefit of $14 million in 2003 which benefited from the favorable impact of significant impairment, restructuring charges and other related closure costs incurred during 2003 in higher tax rate jurisdictions. Excluding impairment, restructuring charges and other related closure costs, our effective tax rate in 2004 was 12.4% compared to 11.5% in 2003. Both 2004 and 2003 registered an income tax benefit related to effects of change in enacted tax rate on deferred taxes and impact of final tax assessments relating to prior years. Excluding impairment and restructuring charges and other related closure costs and the one-time benefits of 2004, our effective tax rate would have been approximately 15%. Our tax rate is variable and depends on changes in the level of operating profits within various local jurisdictions and on changes in the applicable taxation rates of these jurisdictions, as well as changes in estimated tax provisions due to new events. We currently enjoy certain tax benefits in some countries. These benefits may
63
not be available in the future due to changes within the local jurisdictions, and our effective tax rate could increase in the coming years.
Net income |
|
2004 | 2003 | % Variation | ||||||||
(in millions) | ||||||||||
Net income |
$601 | $253 | 137.3 | % | ||||||
As a percentage of net revenues |
6.9 | % | 3.5 | % | |
For 2004, we reported net income of $601 million compared to net income of $253 million for 2003. Basic and diluted earnings per share for 2004 were $0.67 and $0.65, respectively, compared to basic and diluted earnings per share of $0.29 and $0.27 for 2003. Net income in 2004 included $51 million in charges net of income taxes, or $0.05 per diluted share, related to impairment, restructuring charges and other related closure costs, while net income in 2003 included $140 million in charges net of income taxes related to impairment, restructuring charges and other related closure costs, or $0.15 per diluted share.
2003 vs. 2002 |
In 2003, according to industry data, the semiconductor industry experienced a year-over-year revenue increase of approximately 18.3% for the TAM and of approximately 19% for our SAM. Calculated on a comparable basis, that is without information with respect to actuators, which was not included in the indicators before 2003, the TAM and the SAM both increased approximately 17%.
Net revenues |
|
2003 | 2002 | % Variation | ||||||||
(in millions) | ||||||||||
Net sales |
$7,234 | $6,270 | 15.4 | % | ||||||
Other revenues |
$4 | $48 | (92.7 | %) | ||||||
Net revenues |
$7,238 | $6,318 | 14.6 | % | ||||||
Net sales increased by 15.4% to $7,234 million in 2003 from $6,270 million in 2002. On a year-over-year basis, the increase in our net sales in 2003 was primarily due to our higher sales volumes and improved product mix, as our average selling prices declined by approximately 6% due to the continuing wide pricing pressure in the markets we serve. Other revenues in 2003 decreased to $4 million from $48 million in 2002. Other revenues in 2002 were mainly related to a contract for co-development fees which expired in 2002. Net revenues increased 14.6%, from $6,318 million in 2002 to $7,238 million in 2003.
The Telecommunications, Peripherals and Automotive Groups net revenues increased by 6.3% compared to 2002, primarily as a result of improved product mix and higher volume of sales, while average selling prices declined. Revenues increased in Automotive and in Telecom, while sales in Computer Peripherals were down. The Discrete and Standard ICs Groups net revenues increased by 16.0% on a year-over-year basis mainly due to an increase in volumes and improved product mix in Discretes and to increased volume in Transistors. The Memory Products Groups (MPG) net revenues increased by 28.7% compared to 2002 as a result of an increase in volume and a more favorable product mix, particularly in Flash and Smart cards, while prices substantially declined. MPGs 2003 second half revenues benefited from the acquisitions of Incard and Proton World International, which contributed $58 million in sales. The Consumer and Microcontroller Groups (CMG) net revenues increased 28.8% compared to 2002, mainly due to a strong increase in sales volumes in digital consumer products in our Set-Top Box Division and in cameras for cellular phones in our Imaging Division. All product groups experienced declines in selling prices.
During 2003, we maintained our focus on differentiated ICs, which account for revenues of $5,013 million, or approximately 69% of our net revenues, compared to 69% in 2002. Such products foster close relationships with customers, resulting in knowledge of their evolving requirements and opportunities to access their markets for other products. Analog ICs (including mixed-signal ICs), the majority of which are also differentiated ICs, represented approximately 49% of our net revenues in 2003 compared to 53% of net revenues in 2002, while discrete devices accounted for 13% of our net revenues in 2003, compared to 12% of net revenues in 2002.
64
Historically, these families of products, particularly analog ICs, have experienced less volatility in sales growth rates and average selling prices than the overall semiconductor industry. The difficult competitive environment in the semiconductor market in more recent years, however, has led to price pressures in these product families as well. With the exception of Standard and Commodities, which accounted for only 5% of revenues, all product families had solid revenue increases over 2002. Micro and Memories were up 14.5%, Differentiated were up 14.6% and Discretes were up 21.4%.
In 2003, by location of order shipment, approximately 44% of our 2003 revenues came from orders shipped to Asia/Pacific; 28% to Europe; 14% to North America; 10% to Emerging Markets; and 4% to Japan.
During 2003, we had several large customers, with the largest one, the Nokia Group of companies, accounting for 17.9% of our revenues. Our top ten OEM customers accounted for approximately 46% of our net revenues for the period.
Gross profit |
|
2003 | 2002 | % Variation | ||||||||
(in millions) | ||||||||||
Cost of sales |
$(4,672 | ) | (4,020 | ) | (16.2 | %) | ||||
Gross profit |
$2,566 | $2,298 | 11.7 | % | ||||||
Gross margin |
35.5 | % | 36.4 | % | |
Our gross profit increased by 11.7%, from $2,298 million in 2002 to $2,566 million in 2003. As a percentage of net revenues, gross profit decreased from 36.4% in 2002 to 35.5% in 2003. This decrease was mainly due to strong pricing pressure on our net sales and to the sharp year-over-year decline of the value of the U.S. dollar versus the major currencies in which we have our manufacturing operations. These factors were partially compensated by volume increases, overall improved manufacturing performances and product mix. The impact of changes in foreign exchange rates on gross profit in 2003 compared to 2002 was estimated to be negative since the negative currency impact on cost of sales generated by the weaker U.S. dollar versus the euro and other currencies was greater than the favorable impact on net revenues. See Impact of Changes in Exchange Rates.
Selling, general and administrative expenses |
|
2003 | 2002 | % Variation | ||||||||
(in millions) | ||||||||||
Selling, general and administrative expenses |
$(785 | ) | $(648 | ) | (21.2 | %) | ||||
As a percentage of net revenues |
(10.9 | %) | (10.3 | %) | |
Selling, general and administrative expenses increased 21.2% from $648 million in 2002 to $785 million in 2003. This increase was largely due to the depreciation of the U.S. dollar and to the enhanced spending in marketing activities as we completed the first phase of our marketing program to increase revenue.
Research and development expenses |
|
2003 | 2002 | % Variation | ||||||||
(in millions) | ||||||||||
Research and development expenses |
$(1,238 | ) | $(1,022 | ) | (21.1 | %) | ||||
As a percentage of net revenues |
(17.1 | %) | (16.2 | %) | |
Research and development expenses increased 21.1%, from $1,022 million in 2002 to $1,238 million in 2003. This increase resulted primarily from the impact of the U.S. dollar decline and to greater spending in product design and technology for our core activities, including new projects such as the expansion of our activities in new emerging markets and as a result of acquisitions. We continued to invest heavily in research and development during 2003, and we increased our research and development staff by approximately 1,100 people in 2003. We continued to allocate significant resources to strengthen our market position in key applications, reflecting our commitment to customer service and continuing innovation. Our reported research and development expenses are mainly in the areas of product design, technology and development and do not
65
include marketing design center costs, which are accounted for as selling expenses, or process engineering, pre-production or process-transfer costs, which are accounted for as cost of sales.
Other income and expenses, net |
|
2003 | 2002 | ||||||
(in millions) | |||||||
Research and development funding |
$76 | $76 | |||||
Start-up costs |
(55 | ) | (57 | ) | |||
Exchange gain, net |
5 | 17 | |||||
Patent claim costs |
(29 | ) | (8 | ) | |||
Gain on sale of non-current assets |
17 | 3 | |||||
Other, net |
(18 | ) | (24 | ) | |||
Other income and expenses, net |
(4 | ) | 7 | ||||
As a percentage of net revenues |
(0.1 | %) | 0.1 | % |
Other income and expenses, net include, among other items, funds received through government agencies for research and development expenses, the cost of new plant start-ups, foreign currency gains and losses, and the costs of certain activities relating to intellectual property. In 2003, the net effect of these items resulted in expense of $4 million compared to income of $7 million in 2002. This increase in expense was primarily due to higher patent claim costs associated with certain claims and legal proceedings, partially compensated by gains on the sale of non-current assets. The main items recorded in 2003 as income were $76 million for research and development funding and $17 million as gain on sales of non-current assets. Major expenses in 2003 were $55 million for start-up costs, mainly for our new 300-mm fabs (Crolles2 and Catania), $29 million for patent claim costs and $18 million for other miscellaneous expenses. In 2002, fundings for research and development were $76 million; start-up costs were $57 million and were mainly related to the manufacturing activities in our new 200-mm fabs in Italy and in France.
Impairment, restructuring charges and other related closure costs |
|
2003 | 2002 | ||||||
(in millions) | |||||||
Impairment, restructuring charges and other related closure costs | $(205 | ) | $(34 | ) |
|||
As a percentage of net revenues |
(2.8 | %) | (0.5 | %) |
In 2003, we recorded a $205 million charge for impairment, restructuring charges and other related closure costs, out of which $155 million related to impairment of tangible assets, mainly associated with our 150-mm restructuring plan (see 2003 Highlights Business Outlook included in our annual report on Form 20-F for the year ended December 31, 2003), $6 million for impairment of intangible assets and investments, $43 million of restructuring charges related to workforce termination benefits and $1 million for other restructuring charges. In 2002, we recorded a charge of $34 million, mainly related to costs incurred as a consequence of the closure of our fabs in Ottawa, Canada and Rancho Bernardo, California.
Operating income |
|
2003 | 2002 | % Variation | ||||||||
(in millions) | ||||||||||
Operating income |
$334 | $601 | (44.4 | %) | ||||||
As a percentage of net revenues |
4.6 | % | 9.5 | % |
Operating income decreased from income of $601 million in 2002 to operating income of $334 million in 2003. The decrease in operating income was mainly caused by the $205 million of impairment, restructuring charges and other related closure costs incurred in 2003, the impact of declining selling prices and the significant decline of the U.S. dollar exchange rate against the euro and other currencies. In 2003, the impact on operating income from impairment, restructuring charges and other related closure costs was $205 million, compared to $34 million in 2002; while the impact from in-process research and development expense was $5 million in 2003, compared to $8 million in 2002. The impact of changes in foreign exchange rates on operating income in 2003
66
compared to 2002 was estimated to be substantially unfavorable because the decline of the U.S. dollar versus the euro and other currencies negatively impacted cost of sales and operating expenses, and these currency impacts on costs were significantly higher than the favorable impact on net sales. See Impact of Changes in Exchange Rates.
In 2003, operating income for our Telecommunications, Peripherals and Automotive Groups decreased to $550 million from $613 million in 2002. Operating income for our Discrete and Standard ICs increased to $142 million in 2003 from $135 million in 2002, and operating income for our Consumer and Microcontroller Groups increased to $78 million in 2003 from $57 million in 2002, while the Memory Products Group registered an operating loss of $45 million in 2003 from a $7 million income in 2002. The improvements in the operating results of CMG and DSG were mainly driven by higher volume and improved mix of sales. Deterioration of operating results in TPA and MPG was mainly due to the decline in selling prices caused by difficult market conditions, particularly for memory products, and to higher cost of sales and operating expenses due to the declining value of the U.S. dollar and acceleration of expenses mainly for product development and acquisitions. Impairment and restructuring charges were not allocated to the Product Groups.
Interest expense, net |
|
2003 | 2002 | ||||||
(in millions) | |||||||
Interest expense, net |
$(52 | ) | $(68 | ) |
Interest expense, net decreased to $52 million in 2003 compared to $68 million in 2002 as a result of the transactions related to the offering of the new negative-yield 2013 Bonds and to the repurchase of a large portion of our existing 3.75% 2010 Bonds, which significantly reduced our interest expense in the second half of the year. In addition the favorable cash flow we generated in 2003 resulted in some additional savings in interest charges. Our interest income on our available cash decreased from $49 million in 2002 to $37 million in 2003 as a result of the sharp decline in U.S. dollar-denominated interest rates. Interest expense, which is mainly related to our long-term debt comprised primarily of outstanding convertible bonds issued at fixed rates, decreased to $89 million in 2003 from $117 million in 2002 due to the repurchase of approximately 78% of the total amount originally issued of our 2010 Bonds, which took place during 2003.
Loss on equity investments |
|
2003 | 2002 | ||||||
(in millions) | |||||||
Loss on equity investments |
$(1 | ) | $(11 | ) |
During 2003, we registered a loss of $1 million with respect to SuperH, Inc., the joint venture we formed with Hitachi, Ltd., because the cumulated losses exceeded our total investment, while in 2002 we incurred a net loss of $11 million on that investment.
Loss on extinguishment of convertible debt |
|
2003 | 2002 | ||||||
(in millions) | |||||||
Loss on extinguishment of convertible debt |
$(39 | ) | $0 |
In 2003, we recorded a non-operating pre-tax charge of $39 million related to the repurchase of approximately $1,674 million of the aggregate principal amount at maturity of our 2010 Bonds. This charge included the price paid in excess of the bonds accreted value for an amount of approximately $30 million and the non-cash write-off of approximately $9 million for the related capitalized offering expenses.
Income tax benefit (expense) |
|
2003 | 2002 | ||||||
(in millions) | |||||||
Income tax benefit (expense) |
$14 | $(89 | ) |
67
In 2003, we had an income tax benefit of $14 million due to the impact of impairment, restructuring charges and other related closure costs that we incurred in higher tax rate jurisdictions. In 2003, our effective tax rate benefited from settlement of open audits from prior years. In 2002, we had income tax expense of $89 million. Excluding impairment, restructuring charges and other related closure costs, the effective tax rate was 11.5% in 2003 compared to 16.8% in 2002. Our tax rate is variable and depends on changes in the level of operating profits within various local jurisdictions and on changes in the applicable taxation rates of these jurisdictions, as well as changes in estimated tax provisions due to new events. We currently enjoy certain tax benefits in some countries; as such benefits may not be available in the future due to changes within the local jurisdictions, our effective tax rate could increase in the coming years.
Net income |
|
2003 | 2002 | % Variation | ||||||||
(in millions) | ||||||||||
Net income |
$253 | $429 | (41.0 | %) | ||||||
As a percentage of net revenues |
3.5 | % | 6.8 | % |
For 2003, we reported a profit of $253 million compared to a profit of $429 million for 2002. Basic and diluted earnings per share for 2003 were $0.29 and $0.27, respectively, compared to basic and diluted earnings of $0.48 per share for 2002. Net income in 2003 included $182 million in charges net of income taxes, or $0.19 per diluted share, related to impairment, restructuring charges and other related closure costs, and research and development in process and the loss on extinguishment of convertible debt.
Quarterly Results of Operations |
The following table sets forth certain financial information for the years 2003 and 2004. Such information is derived from unaudited interim consolidated financial statements, prepared on a basis consistent with the audited consolidated financial statements, that include, in the opinion of management, all normal adjustments necessary for a fair presentation of the interim information set forth therein. Operating results for any quarter are not necessarily indicative of results for any future period. In addition, in view of the significant growth we have experienced in recent years, the increasingly competitive nature of the markets in which we operate, the changes in product mix and the currency effects of changes in the composition of sales and production among different geographic regions, we believe that period-to-period comparisons of our operating results should not be relied upon as an indication of future performance.
Our quarterly and annual operating results are also affected by a wide variety of other factors that could materially and adversely affect revenues and profitability or lead to significant variability of operating results, including, among others, capital requirements and the availability of funding, competition, new product development and technological change and manufacturing. In addition, a number of other factors could lead to fluctuations in operating results, including order cancellations or reduced bookings by key customers or distributors, intellectual property developments, international events, currency fluctuations, problems in obtaining adequate raw materials on a timely basis, impairments, restructuring charges and other related closure costs, as well as the loss of key personnel. As only a portion of our expenses varies with our revenues, there can be no assurance that we will be able to reduce costs promptly or adequately in relation to revenue declines to compensate for the effect of any such factors. As a result, unfavorable changes in the above or other factors have in the past and may in the future adversely affect our operating results. Quarterly results have also been and may be expected to continue to be substantially affected by the cyclical nature of the semiconductor and electronic systems industries, the speed of some process and manufacturing technology developments, market demand for existing products, the timing and success of new product introductions and the levels of provisions and other unusual charges incurred. Certain additions of quarterly results will not total to annual results due to rounding.
68
Quarter ended (unaudited) |
||||||||||||||||||||||||
Dec. 31, 2004 |
Sept. 25, 2004 |
June 26, 2004 |
March 27, 2004 |
Dec. 31, 2003 |
Sept. 27, 2003 |
June 28, 2003 |
March 29, 2003 |
|||||||||||||||||
(in millions) | ||||||||||||||||||||||||
Consolidated Statement of Income Data |
||||||||||||||||||||||||
Net revenues |
$2,328 | $2,231 | $2,172 | $2,029 | $2,113 | $1,803 | $1,702 | $1,619 | ||||||||||||||||
Cost of sales |
(1,476 | ) | (1,386 | ) | (1,360 | ) | (1,311 | ) | (1,353 | ) | (1,171 | ) | (1,095 | ) | (1,052 | ) | ||||||||
Gross profit |
852 | 845 | 812 | 718 | 760 | 632 | 607 | 566 | ||||||||||||||||
Operating expenses: |
||||||||||||||||||||||||
Selling, general and administrative |
(245 | ) | (233 | ) | (239 | ) | (230 | ) | (228 | ) | (191 | ) | (191 | ) | (174 | ) | ||||||||
Research and development |
(402 | ) | (384 | ) | (384 | ) | (363 | ) | (354 | ) | (302 | ) | (298 | ) | (283 | ) | ||||||||
Other income and expenses, net |
23 | (3 | ) | 2 | (12 | ) | (13 | ) | (10 | ) | 3 | 15 | ||||||||||||
Impairment, restructuring charges and other related closure costs |
(18 | ) | (12 | ) | (12 | ) | (33 | ) | (12 | ) | (193 | ) | | | ||||||||||
Total operating expenses |
(642 | ) | (632 | ) | (633 | ) | (638 | ) | (607 | ) | (696 | ) | (486 | ) | (442 | ) | ||||||||
Operating income (loss) |
210 | 213 | 179 | 80 | 153 | (64 | ) | 121 | 124 | |||||||||||||||
Interest income (expense), net |
5 | 0 | (3 | ) | (4 | ) | (7 | ) | (12 | ) | (16 | ) | (18 | ) | ||||||||||
Equity in loss of joint ventures |
(2 | ) | (2 | ) | 0 | 0 | 0 | | (1 | ) | | |||||||||||||
Loss on extinguishment of convertible debt |
0 | 0 | (4 | ) | 0 | (2 | ) | (22 | ) | (6 | ) | (8 | ) | |||||||||||
Income (loss) before income taxes and minority interests |
213 | 211 | 172 | 76 | 144 | (98 | ) | 98 | 98 | |||||||||||||||
Income tax benefit (expense) |
(26 | ) | (20 | ) | (23 | ) | 1 | 0 | 49 | (18 | ) | (18 | ) | |||||||||||
Income (loss) before minority interests |
187 | 191 | 149 | 77 | 144 | (49 | ) | 80 | 80 | |||||||||||||||
Minority interests |
0 | (2 | ) | (1 | ) | 0 | (1 | ) | | (1 | ) | |||||||||||||
Net income (loss) |
$187 | $189 | $148 | $77 | $144 | $(50 | ) | $80 | $79 | |||||||||||||||
Diluted earnings (loss) per share |
$0.20 | $0.20 | $0.16 | $0.08 | $0.16 | $(0.06 | ) | $0.09 | $0.09 | |||||||||||||||
Number of shares used in calculating earnings per share (basic) |
891.7 | 891.4 | 891.4 | 890.2 | 888.9 | 888.3 | 887.7 | 887.6 | ||||||||||||||||
Number of shares used in calculating earnings per share (diluted) |
935.1 | 934.9 | 937.0 | 938.7 | 939.1 | 888.3 | 892.6 | 891.1 |
Quarter ended (unaudited) |
||||||||||||||||||||||||
Dec. 31, 2004 |
Sept. 25, 2004 |
June 26, 2004 |
March 27, 2004 |
Dec. 31, 2003 |
Sept. 27, 2003 |
June 28, 2003 |
March 29, 2003 |
|||||||||||||||||
(as a percentage of net revenues) | ||||||||||||||||||||||||
Net revenues |
100.0 | % | 100.0 | % | 100.0 | % | 100.0 | % | 100.0 | % | 100.0 | % | 100.0 | % | 100.0 | % | ||||||||
Cost of sales |
(63.4 | ) | (62.1 | ) | (62.6 | ) | (64.6 | ) | (64.0 | ) | (64.9 | ) | (64.3 | ) | (65.0 | ) | ||||||||
Gross profit |
36.6 | 37.9 | 37.4 | 35.4 | 36.0 | 35.1 | 35.7 | 35.0 | ||||||||||||||||
Operating expenses: |
||||||||||||||||||||||||
Selling, general and administrative |
(10.5 | ) | (10.4 | ) | (11.0 | ) | (11.3 | ) | (10.8 | ) | (10.6 | ) | (11.2 | ) | (10.8 | ) | ||||||||
Research and development |
(17.3 | ) | (17.2 | ) | (17.7 | ) | (17.9 | ) | (16.8 | ) | (16.7 | ) | (17.5 | ) | (17.5 | ) | ||||||||
Other income and expenses, net |
1.0 | (0.1 | ) | 0.1 | (0.6 | ) | (0.6 | ) | (0.6 | ) | 0.1 | 1.0 | ||||||||||||
Impairment, restructuring charges and other related closure costs |
(0.8 | ) | (0.6 | ) | (0.5 | ) | (1.6 | ) | (0.6 | ) | (10.7 | ) | | | ||||||||||
Total operating expenses |
(27.6 | ) | (28.3 | ) | (29.1 | ) | (31.4 | ) | (28.8 | ) | (38.6 | ) | (28.6 | ) | (27.3 | ) | ||||||||
Operating income (loss) |
9.0 | 9.6 | 8.3 | 4.0 | 7.2 | (3.5 | ) | 7.1 | 7.7 | |||||||||||||||
Interest income (expense), net |
0.2 | 0 | (0.2 | ) | (0.2 | ) | (0.3 | ) | (0.7 | ) | (0.9 | ) | (1.2 | ) | ||||||||||
Equity in loss of joint venture |
0 | (0.1 | ) | 0 | 0 | | | (0.1 | ) | | ||||||||||||||
Loss on extinguishment of convertible debt |
0 | 0 | (0.2 | ) | 0 | (0.1 | ) | (1.2 | ) | (0.4 | ) | (0.5 | ) | |||||||||||
Income (loss) before income taxes and minority interests |
9.2 | 9.5 | 7.9 | 3.8 | 6.8 | (5.4 | ) | 5.7 | 6.0 | |||||||||||||||
Income tax benefit (expense) |
(1.2 | ) | (0.9 | ) | (1.1 | ) | 0 | | 2.7 | (1.0 | ) | (1.0 | ) | |||||||||||
Income (loss) before minority interests |
8.0 | 8.6 | 6.8 | 3.8 | 6.8 | (2.7 | ) | 4.7 | 5.0 | |||||||||||||||
Minority interests |
| (0.1 | ) | | | | (0.1 | ) | | (0.1 | ) | |||||||||||||
Net income (loss) |
8.0 | % | 8.5 | % | 6.8 | % | 3.8 | % | 6.8 | % | (2.8) | % | 4.7 | % | 4.9 | % | ||||||||
On a sequential basis compared to the third quarter of 2004, revenues in the fourth quarter of 2004 decreased approximately 1% for the TAM and approximately 4% for the SAM.
69
Net revenues
|
|
Quarter ended | ||||||||||
|
||||||||||
Dec 31, 2004 | Sep 25, 2004 | Dec 31, 2003 | ||||||||
|
|
|
|
|
|
|||||
(in millions) | ||||||||||
Net
sales
|
$2,326 | $2,231 | $2,112 | |||||||
Other
revenues
|
2 | 0 | 1 | |||||||
|
|
|
|
|
|
|||||
Net
revenues
|
$2,328 | $2,231 | $2,113 | |||||||
Our fourth quarter 2004 revenues recorded a strong increase both on a sequential basis compared to the third quarter of 2004 and on a year-over-year basis compared to the fourth quarter of 2003. On a sequential basis, we recorded a 4.3% increase in our revenues in the fourth quarter 2004, mainly resulting from an improved product mix, while volume declined slightly. The major increases in revenues were achieved by TPA and CMG product groups. During the fourth quarter of 2004, due to ongoing price pressure in the semiconductor market, our net revenues and margins were still negatively impacted by declining selling prices. Our average selling prices in the fourth quarter of 2004 decreased by 3.3% sequentially and by 4.4% compared to the fourth quarter of 2003. On a year-over-year basis, our revenues registered a 10.2% increase with strong increases in all of the product groups, mainly originated by higher volumes.
With respect to our product segments, in the fourth quarter of 2004, net revenues from the TPA Groups were $938 million, increasing 4.1% over the fourth quarter of 2003 and 8.5% sequentially over the third quarter of 2004, reflecting stronger sales of Telecom products and computer Peripherals products. MPG net revenues in the fourth quarter of 2004 were $508 million, increasing 11.0% in comparison to the fourth quarter of 2003, and only 0.6% in comparison to the third quarter of 2004, reflecting a more competitive environment and pricing pressures. Net revenues for CMG were $446 million, increasing 15.0% compared to the fourth quarter of 2003 and sequentially 5.5% versus the third quarter of 2004, due to a strong increase in sales in our Imaging Division for cellular phone cameras, while Digital Consumer sales decreased due to seasonal effects. DSG net revenues amounted to $417 million, increasing by 19.0% in the fourth quarter of 2004 over the fourth quarter of 2003 and decreasing 1.2% sequentially below the third quarter of 2004 as a result of revenue increase in Transistors and decrease in Discrete and Standard ICs.
During the fourth quarter of 2004, net revenues from differentiated products totaled approximately 68% of total net revenues for the fourth quarter 2004 compared to approximately 69% in the fourth quarter 2003. By location of shipment, in the fourth quarter of 2004, we realized approximately 43% of our net revenues in Asia/Pacific, 27% in Europe, 12% in North America, 13% in Emerging Markets and 5% in Japan. Major increases in revenues in the fourth quarter of 2004 versus the fourth quarter of 2003 were registered in the Emerging Markets, which revenues increased approximately 35% in the fourth quarter of 2004 versus the fourth quarter of 2003, in line with the more favorable economic environment and due to the move of some customers production facilities to new developing areas.
Gross profit
|
|
Quarter ended | ||||||||||
|
||||||||||
Dec 31, 2004 | Sep 25, 2004 | Dec 31, 2003 | ||||||||
|
|
|
|
|
|
|||||
(in millions) | ||||||||||
Cost
of sales
|
$(1,476 | ) | $(1,386 | ) | $(1,353 | ) | ||||
Gross
profit
|
$852 | $845 | $760 | |||||||
Gross
margin
|
36.6 | % | 37.9 | % | 36.0 | % |
Gross margin in the fourth quarter of 2004 improved to 36.6% compared to 36.0% in the fourth quarter of 2003. However, our fourth quarter gross margin decreased significantly by 130 basis points sequentially compared to the third quarter of 2004. The sequential gross margin deterioration was disappointing, as the sequential revenue increase did not translate into sequential gross margin improvement. The gross margin was negatively impacted by continuing pricing pressure and from an operational standpoint, by our manufacturing results that were affected by reduced capacity utilization and the performance of certain fabs. In addition, the further weakening of the U.S. dollar compared to the other major currencies negatively impacted our gross margin in the fourth quarter by approximately 120 basis points compared to the third quarter of 2004. These negative factors were only partially offset by a more favorable product mix.
70
Selling, general and
administrative expenses
|
|
Quarter ended | ||||||||||
|
||||||||||
Dec 31, 2004 | Sep 25, 2004 | Dec 31, 2003 | ||||||||
|
|
|
|
|
|
|||||
(in millions) | ||||||||||
Selling,
general and administrative expenses
|
$(245 | ) | $(233 | ) | $(228 | ) | ||||
As
percentage of net revenues
|
(10.5% | ) | (10.4% | ) | (10.8% | ) |
The sequential increase in selling, general and administrative expenses was mainly associated with accelerated marketing programs as well as with certain quarter-specific costs and the negative impact of the U.S. dollar decline. As a percentage of net revenues, selling general and administrative expenses remained substantially flat, to 10.5% from 10.4% in the third quarter of 2004, improving, however, from 10.8% in the fourth quarter of 2003 in spite of the strong impact of the U.S. dollar decline.
Research and development
expenses
|
|
Quarter ended | ||||||||||
|
||||||||||
Dec 31, 2004 | Sep 25, 2004 | Dec 31, 2003 | ||||||||
|
|
|
|
|
|
|||||
(in millions) | ||||||||||
Research
and development expenses
|
$(402 | ) | $(384 | ) | $(354 | ) | ||||
As
percentage of net revenues
|
(17.3% | ) | (17.2% | ) | (16.8% | ) |
The primary drivers of the sequential increase in research and development expenses were the acceleration of our strategic programs and the negative impact of the declining U.S. dollar. This level of spendings is the result of our continued commitment to reinforce our investment in our strategic and core programs.
Other income and expenses,
net
|
|
Quarter ended | ||||||||||
|
||||||||||
Dec 31, 2004 | Sep 25, 2004 | Dec 31, 2003 | ||||||||
|
|
|
|
|
|
|||||
(in millions) | ||||||||||
Research
and development funding
|
$47 | $9 | $26 | |||||||
Start-up
costs
|
(18 | ) | (13 | ) | (18 | ) | ||||
Exchange
gain (loss) net
|
14 | 10 | (4 | ) | ||||||
Patent
claim costs
|
(16 | ) | (7 | ) | (20 | ) | ||||
Gain
on sale of non-current assets
|
| | 17 | |||||||
Other,
net
|
(4 | ) | (2 | ) | (14 | ) | ||||
Other
income and expenses, net
|
23 | (3 | ) | (13 | ) | |||||
As
a percentage of net revenues
|
1.0 | % | (0.1% | ) | (0.6% | ) |
Other income and expenses, net resulted in a significant income in the fourth quarter 2004, mainly due to the high level of research and development funding recorded in the period. Research and development fundings were $47 million, significantly higher compared to the third quarter of 2004 and the fourth quarter of 2003 in relation to the signature of new contracts related to programs already started in prior quarters. Startup costs in the fourth quarter of 2004 were related to our 150-mm fab expansion in Singapore, the conversion to 200-mm fab in Agrate (Italy), and the charges associated with the build-up of our 300-mm fab in Catania (Italy). Exchange gain or loss, net, included the gain on foreign exchange transactions. Patent claim costs included costs associated with several ongoing litigations and claims.
Impairment, restructuring
charges and other related closure costs
|
|
Quarter ended | ||||||||||
|
||||||||||
Dec 31, 2004 | Sep 25, 2004 | Dec 31, 2003 | ||||||||
|
|
|
|
|
|
|||||
(in millions) | ||||||||||
Impairment,
restructuring charges and other related closure costs
|
$(18 | ) | $(12 | ) |
$(12) | |||||
As
a percentage of net revenues
|
(0.8% | ) | (0.6% | ) | (0.6% | ) |
71
In the fourth quarter of 2004, we recorded expenses of $18 million, which mainly included the continuation of the major restructuring plans started in third quarter 2003 and the impairment of some intangible assets related to obsolete acquired technologies. The main items are $11 million related to the 150-mm front-end restructuring plan, $5 million related to the impairment of intangible assets, $1 million related to back-end restructuring and $1 million for miscellaneous closing costs. In the corresponding period of the preceding year, we recorded expenses of $7 million related to the impairment of a Singapore back-end facility as part of the back-end restructuring plan, $4 million in charges related to workforce reduction mainly in France and $1 million for closure costs mainly in our Carrollton, Texas wafer fab.
Operating income
|
|
Quarter
ended
|
||||||||||
Dec 31, 2004 | Sep 25, 2004 | Dec 31, 2003 | ||||||||
|
|
|
|
|
|
|||||
(in millions) | ||||||||||
Operating
income
|
$210 | $213 | $153 | |||||||
In
percentage of net revenues
|
9.0 | % | 9.6 | % | 7.2 | % |
The sequential increase in our net revenues during the fourth quarter of 2004 did not translate into an improvement in operating income because of the negative impact of the U.S. dollar decline, because of the impact on our gross profit caused by ongoing pricing pressure and because of the increase in the operating expenses originated by the acceleration of our strategic programs in research and development and marketing. However, our operating income margin for the fourth quarter of 2004 was 9.0%, significantly improving compared to 7.2% for the fourth quarter of 2003. By product group, in the fourth quarter of 2004, only TPA registered an improvement, CMG was flat in dollar values, while both DSG and MPG profitability declined. Operating income of TPA was $135 million in the fourth quarter of 2004, equivalent to 14.4% of its revenues, improving from the 13.1% from the third quarter 2004, although below the 17.2% of the fourth quarter of 2003. The sequential improvement was driven by a strong sales increase and a more favorable product mix. Operating income for DSG was $86 million in the fourth quarter of 2004, or 20.7% of revenues, declining compared to $109 million and 25.7% in the third quarter of 2004. This decline was due to a reduced level of revenues and to increased manufacturing costs associated with lower capacity utilization. DSG operating results improved significantly, both in dollar values and as a percentage of net revenues, compared to the $52 million in operating income and the 14.9% recorded in the fourth quarter of 2003. This improvement was mainly driven by a strong increase in sales. Operating income for CMG was $44 million, basically equivalent to $46 million in the third quarter of 2004, declining, however, to 9.9% of net revenues due to strong pricing pressure. CMG also registered a strong improvement in its operating results as compared to the fourth quarter of 2003, when operating income amounted to $29 million or 7.5% of net revenues. This improvement was due to the strong increase in sales. MPG operating income was $16 million or 3.1% of its net revenues in the fourth quarter of 2004, declining from $27 million, or 5.3% of its net revenues in the third quarter of 2004, primarily due to the strong pricing pressure. In the fourth quarter of 2003, MPG operating income was basically at break even with $1 million profit, or 0.3% of its net revenues. In the fourth quarter 2004, the operating income of all groups registered a negative impact caused by the weakening of the U.S. dollar.
Income tax benefit (expense)
|
|
Quarter
ended |
||||||||||
Dec 31, 2004 | Sep 25, 2004 | Dec 31, 2003 | ||||||||
|
|
|
|
|
|
|||||
(in millions) | ||||||||||
Income
tax expense
|
$(26 | ) | $(20 | ) | $0 |
During the fourth quarter of 2004, we incurred an income tax expense of $26 million, or an effective tax rate of 12.3%. Without impairment and restructuring charges, the effective tax rate would have been 15.8%. The effective tax rate for the fourth quarter 2004 was computed on the basis of actual tax charges in each jurisdiction. Some minor adjustments compared to the previous 2004 estimates were done due to earnings lower than expected in certain entities. Our tax rate is variable and depends on changes in the level of operating profits within various local jurisdictions and on changes in the applicable taxation rates of these jurisdictions, as well as changes in estimated tax provisions due to new events. We currently enjoy certain tax benefits in some countries; as such benefits may not be available in the future due to changes in the local jurisdictions, our effective tax rate could be different in future quarters and may increase in the coming years.
72
Net income
|
|
Quarter
ended |
||||||||||
Dec 31, 2004 | Sep 25, 2004 | Dec 31, 2003 | ||||||||
|
|
|
|
|
|
|||||
(in millions) | ||||||||||
Net
income
|
$187 | $189 | $144 | |||||||
As
percentage of net revenues
|
8.0 | % | 8.5 | % | 6.8 | % |
For the fourth quarter of 2004, we reported net income of $187 million, significantly improving compared to $144 million in the fourth quarter of 2003, and basically flat compared to net income of $189 million in the third quarter of 2004, however declining to 8.0% of the net revenues. Basic and diluted earnings per share for the fourth quarter of 2004 were $0.21 and $0.20, respectively, identical to the third quarter of 2004, and improving compared to basic and diluted earnings of $0.16 per share for the fourth quarter of 2003.
Impact of Changes in
Exchange Rates
|
Our results of operations and financial condition can be significantly affected by material changes in exchange rates between the U.S. dollar and other currencies where we maintain our operations, particularly the euro, the Japanese yen and other Asian currencies.
As a market rule, the reference currency for the semiconductor industry is the U.S. dollar, and product prices are mainly denominated in U.S. dollars. However, revenues for certain of our products (primarily dedicated products sold in Europe and Japan) that are quoted in currencies other than the U.S. dollar, are directly affected by fluctuations in the value of the U.S. dollar. Revenues for all other products, which are either quoted in U.S. dollars and billed in U.S. dollars or translated into local currencies for payment, tend not to be affected significantly by fluctuations in exchange rates, except to the extent that there is a lag between changes in currency rates and adjustments in the local currency equivalent price paid for such products. As a result of the currency variations, the appreciation of the euro compared to the U.S. dollar increases in the short term our level of revenues when reported in U.S. dollars.
Certain significant costs incurred by us, such as manufacturing, labor costs and depreciation charges, selling, general and administrative expenses, and research and development expenses, are incurred in the currency of the jurisdictions in which our operations are located, and most of our operations are located in the euro zone or other currency areas. Currency exchange rate fluctuations affect our results of operations because our reporting currency is the U.S. dollar, while we receive a limited part of our revenues, and more importantly, incur the majority of our costs, in currencies other than the U.S. dollar. In 2004, the U.S. dollar declined significantly in value, particularly against the euro, causing us to report higher expenses and negatively impacting both our gross margin and operating income. Our Consolidated Statement of Income for the year ended December 31, 2004 includes income and expense items translated at the average exchange rate for the period. The average rate of the euro to the U.S. dollar was €1.00 for $1.236 in 2004 and it was €1.00 for $1.125 in 2003. A continuation in the decline of the U.S. dollar compared to the other major currencies, which affect our operations, would negatively impact our expenses, margins and profitability.
Our principal strategy to reduce the risks associated with exchange rate fluctuations has been to balance as much as possible the proportion of sales to our customers denominated in U.S. dollars with the amount of raw materials, purchases and services from our suppliers denominated in U.S. dollars, thereby reducing the potential exchange rate impact of certain variable costs relative to revenues. In order to further reduce the exposure to U.S. dollar exchange rate fluctuations, we have hedged certain line items on our income statement, in particular with respect to a portion of cost of goods sold, most of the research and development expenses and certain selling and general and administrative expenses, located in the euro zone. However, there is no guarantee that we will be capable of reaching a complete balance, and, consequently, our result of operations could be impacted by significant fluctuations in exchange rates. In addition, in order to avoid potential exchange rate risks on our commercial transactions, from time to time we may purchase or sell forward foreign currency exchange contracts and currency options to cover currency risks in payables or receivables. Our management strategies to reduce exchange rate risks have served to mitigate, but not eliminate, the positive or negative impact of exchange rate fluctuations.
Assets and liabilities of subsidiaries balance sheets are, for consolidation purposes, translated into U.S. dollars at the period-end exchange rate. Income and expenses are translated at the average exchange rate for the period. The balance sheet impact of such translation adjustments has been, and may be expected to be, significant
73
from period to period since a large part of our assets and liabilities are accounted for in euro as their functional currency. Adjustments resulting from the translation are recorded directly in shareholders equity, and are shown as accumulated other comprehensive income (loss) in the consolidated statements of changes in shareholders equity. At December 31, 2004, our outstanding indebtedness was denominated principally in U.S. dollars and, to a limited extent, in euros and in Singapore dollars.
For a more detailed discussion, see Item 3. Key InformationRisk FactorsOur financial results can be adversely affected by fluctuations in exchange rates, principally in the value of the U.S. dollar.
Liquidity and Capital
Resources
|
Treasury activities are regulated by our policies, which define procedures, objectives and controls. The policies focus on the management of our financial risk in terms of exposure to currency rates and interest rates. Treasury controls include systematic reporting to our Chief Executive Officer and are subject to internal audits. Most treasury activities are centralized, with any local treasury activities subject to oversight from our head treasury office. The majority of our cash and cash equivalents are held in U.S. dollars and are placed with financial institutions rated A or higher. Marginal amounts are held in other currencies. See Item 11. Quantitative and Qualitative Disclosures about Market Risk.
At December 31, 2004, cash and cash equivalents totaled $1,950 million, compared to $2,998 million at December 31, 2003. Our available cash decreased in 2004 because we redeemed all of our outstanding 2009 LYONs and repurchased all of our outstanding 2010 Bonds; and our long-term debt decreased by an equivalent amount. We did not have marketable securities at December 31, 2004, as well as at December 31, 2003. From time to time, as we did during 2004, we invest our available cash in credit-linked deposits or similar instruments issued by several primary banks to maximize the return on available cash.
Liquidity
|
Maintaining liquidity remains a priority in difficult market conditions, and we believe our strong cash position and low debt-to-equity ratio provide us with financial flexibility. Our investment needs have been financed in 2004, as in the past years, by net cash generated from operating activities. Net cash from operating activities was $2,342 million, while net cash used in investing activities was $2,134 million, in 2004.
During 2004, we completed the restructuring of our long-term financial debt with the buy-back of our remaining 2010 Bonds bearing 3.75% interest and the redemption of our 2009 LYONs.
Net cash from operating activities. The major source of cash during 2004 and in prior periods was cash provided by operating activities. Our net cash from operating activities totaled $2,342 million in 2004, increasing compared to $1,920 million in 2003 and $1,713 million in 2002.
Changes in our operating assets and liabilities resulted in net cash used of $142 million in 2004, compared to net cash used of $61 million in 2003. In 2004, the increase in our trade accounts receivable used net cash of $119 million, while it used net cash of $109 million in 2003. Our higher levels of inventory used net cash of $144 million in 2004, while in 2003 inventory used net cash of $75 million. The inventory increase in 2004 was higher than in 2003, mainly related to the order booking slow-down during the second half of 2004. Finally, our trade payables and other assets and liabilities generated $121 million in cash in 2004, compared to $123 million used in 2003. In 2002, changes in our assets and liabilities resulted in cash used of $251 million, mainly due to trade accounts receivable, which used net cash for $129 million, and to inventory for $71 million.
Net cash used in investing activities. Net cash used in investing activities was $2,134 million in 2004, compared to $1,439 million in 2003 and $1,370 million in 2002. Payments for purchases of tangible assets were the main utilization of cash. Payment for the purchase of tangible assets was $2,050 million for 2004, a significant increase over the $1,221 million in 2003. In 2004, cash used for investments in intangible and financial assets was $81 million, while it was $34 million in 2003. Payments for acquisitions amounted to $3 million related to the portion of Synad cash consideration paid in 2004, while in 2003, payments for acquisitions were $188 million, net of cash received, representing the acquisition of Proton World International, Tioga Technologies, Incard and Synad.
Capital expenditures for
2004 were principally allocated to:
|
| the expansion of our 200-mm and 150-mm front-end facilities in Singapore
|
74
| the expansion of our 200-mm front-end facility in Rousset, France | |
| the facilitization of our 300-mm facility in Catania, Italy |
| the upgrading of our front-end and research and development pilot line in Agrate, Italy |
| the upgrading of our 200-mm front-end facility in Catania, Italy |
| the expansion and upgrading of our front-end facilities 200-mm in Phoenix and 150-mm in Carrollton, United States, and |
| the capacity expansion in our back-end plants of Muar (Malaysia), Toa Payoh (Singapore), Shenzen (China) and Malta. |
Capital expenditures for 2003 were principally allocated to:
| the expansion of our 200-mm and 150 millimeter front-end facilities in Singapore |
| the upgrading of our 200-mm
front-end plant in Agrate, Italy |
| the expansion of our 200-mm
front-end facility in Rousset, France |
| the expansion of our 300-mm
facility in Crolles2, France |
| the facilitization of our
300-mm facility in Catania, Italy, and |
| the expansion of our back-end facilities in Muar, Malaysia. |
Net cash used in investing activities was $1,370 million in 2002, of which $995 million related to payment for the purchase of tangible assets and $307 million related to the payment for the acquisition of Alcatel Microelectronics.
Capital expenditures for 2002 were principally allocated to:
| the upgrading of our 200-mm
wafer fabrication facility and the completion of the shell building
and facilities for our advanced 300-mm front-end plant which
we will operate in partnership with Philips Semiconductors International
B.V. and Freescale
Semiconductor, Inc. in Crolles, France |
| the upgrading of our 200-mm
front-end plant in Agrate, Italy |
| the capacity expansion
of our 200-mm front-end facility in Catania, Italy |
| the construction of the
building for our 300-mm front-end facility in Catania, Italy |
| the expansion of our 200-mm
and 150-mm front-end facilities in Singapore |
| the expansion of our 200-mm
front-end facility in Rousset, France, and |
| some limited expansions of our back-end facilities in Muar, Malaysia and Malta. |
75
Net operating cash flow. We define net operating cash flow as net cash from operating activities minus net cash used in investing activities, excluding payment for purchases of and proceeds from the sale of marketable securities. We believe net operating cash flow provides useful information for investors because it measures our capacity to generate cash from our operating activities to sustain our investments for our operating activities. Net operating cash flow is not a U.S. GAAP measure and does not represent total cash flow since it does not include the cash flows generated by or used in financing activities. In addition, our definition of net operating cash flow may differ from definitions used by other companies. Net operating cash flow is determined as follows from our Consolidated Statements of Cash Flow:
Year ended December 31, |
||||||||||
2004 | 2003 | 2002 | ||||||||
(in millions) | ||||||||||
Net cash from operating activities |
$2,342 | $1,920 | $1,713 | |||||||
Net cash used in investing activities |
(2,134 | ) | (1,439 | ) | (1,370 | ) | ||||
Payment for purchase and proceeds from sale of marketable securities, net |
0 | (4 | ) | (1 | ) | |||||
Net operating cash flow |
$208 | $477 | $342 | |||||||
We generated net operating cash flow of $208 million in 2004, compared to net operating cash flow of $477 million in 2003. This resulted mainly from the increase in net cash used in investing activities. In 2002, we generated a net operating cash flow of $342 million.
Net cash used in financing activities. Net cash used in financing activities was $1,271 million in 2004 compared to $59 million in 2003. The major item of the cash used in 2004 was the repayment of long-term debt for a total amount of $1,288 million, mainly consisting of the redemption of all outstanding 2009 LYONs for an amount paid of $813 million and of the repurchase of all outstanding 2010 Bonds for an amount paid of $375 million. These bonds have been cancelled. During 2003, we received proceeds from issuance of long-term debt of $1,398 million, mainly related to the offering of our 2013 Bonds, and we repaid $1,432 million mainly related to repurchases of our 2010 Bonds. During 2002, net cash used in financing activities was $232 million due to cash used for the repayment of long term debt. In addition, during 2002, we repurchased 4,000,000 shares of our common stock totaling $115 million.
Capital Resources |
Net financial position |
We define our net financial position as the difference between our total cash position (cash, cash equivalents and marketable securities) net of total financial debt (bank overdrafts, current portion of long-term debt and long-term debt). Net financial position is not a U.S. GAAP measure. We believe our net financial position provides useful information for investors because it gives evidence of our global position either in terms of net indebtedness or net cash by measuring our capital resources based on cash, cash equivalents and marketable securities and the total level of our financial indebtedness. The net financial position is determined as follows from our Consolidated Balance Sheets as at December 31, 2004, December 31, 2003 and December 31, 2002:
Year ended December 31, |
||||||||||
2004 | 2003 | 2002 | ||||||||
(in millions) | ||||||||||
Cash, cash equivalents and marketable securities |
$1,950 | $2,998 | $2,564 | |||||||
Total cash position |
1,950 | 2,998 | 2,564 | |||||||
Bank overdrafts |
(58 | ) | (45 | ) | (19 | ) | ||||
Current portion of long-term debt |
(133 | ) | (106 | ) | (146 | ) | ||||
Long-term debt |
(1,767 | ) | (2,944 | ) | (2,797 | ) | ||||
Total financial debt |
(1,958 | ) | (3,095 | ) | (2,962 | ) | ||||
Net financial position |
$(8 | ) | $(97 | ) | $(398 | ) | ||||
76
The net financial position (cash, cash equivalents and marketable securities net of total financial debt) as of December 31, 2004 was negative in the amount of $8 million, representing an improvement from the net negative financial position of $97 million as of December 31, 2003. This net financial position improvement mainly results from favorable net operating cash flow generated during 2004.
At December 31, 2004, the aggregate amount of our long-term debt was approximately $1,767 million, including $1,379 million of 2013 Bonds. Additionally, the aggregate amount of our short-term credit facilities was approximately $1,541 million, under which approximately $1,483 million of indebtedness was outstanding. Our long-term financing instruments contain standard covenants, but do not impose minimum financial ratios or similar obligations on us.
As of December 31, 2004, debt payments due by period and based on the assumption that convertible debt redemptions are at maturity, were as follows:
Payments due by period |
||||||||||||||||||||||
Total | 2005 | 2006 | 2007 | 2008 | 2009 | Thereafter | ||||||||||||||||
(in millions) | ||||||||||||||||||||||
Long-term debt |
$1,900 | $133 | $145 | $115 | $29 | $27 | $1,451 |
During 2002, certain holders of our 2009 LYONs requested conversion into our common shares. The converted amount was negligible. During 2004, we redeemed all the outstanding 2009 LYONs for a total amount of $813 million in cash.
In 2003, we repurchased approximately $1,674 million aggregate principal amount at maturity of our 2010 Bonds, for a total cash amount of approximately $1,304 million, representing approximately 78% of the total amount initially issued. In 2004, we repurchased all of our remaining outstanding 2010 Bonds for a total cash amount paid of $375 million. The repurchased 2010 Bonds were cancelled.
As of the end of 2004, we have the following credit ratings on our remaining convertible debt:
Moodys Investors Service | Standard & Poors | ||||||
Zero Coupon Senior Convertible Bonds due 2013 |
A3 | A |
In the event of a downgrade of these ratings, we believe we would continue to have access to sufficient capital resources.
77
Contractual Obligations, Commercial Commitments and Contingencies |
Our contractual obligations, commercial commitments and contingencies as of December 31, 2004, and for each of the five years to come and thereafter, were as follows:
Total | 2005 | 2006 | 2007 | 2008 | 2009 | Thereafter | ||||||||||||||||
(in millions) | ||||||||||||||||||||||
Capital l |