Income tax expense

 

During the second quarter of 2018, we registered an income tax expense of $21 million, reflecting the estimated annual effective tax rate in each of our jurisdictions, applied to the second quarter of 2018 consolidated result before taxes. In addition, our income tax included a tax benefit from provisions on the estimated impact of potential tax positions in light of favorable conclusion of certain positions that have been considered uncertain.

Net income attributable to parent company

 

For the second quarter of 2018, we reported a net income attributable to parent company of $261 million. The second quarter 2018 net income represented diluted earnings per share of $0.29 compared to $0.26 in the prior quarter and $0.17 in the prior-year quarter.

 

We also present Adjusted Diluted Earnings per Share, which is a non U.S. GAAP measure. Adjusted Diluted Earnings per Share is used to help management and investors understand our operations and to highlight the impact of excluded items like impairment, restructuring charges and other related closure costs and other one-time items, net of the estimated relevant tax impact. We believe Adjusted Diluted Earnings per Share provides useful information for management and investors because they measure our capacity to generate profits from our business operations, excluding the expenses related to the rationalizing of our activities and sites that we do not consider to be part of our on-going operating results, thereby offering, when read in conjunction with our U.S. GAAP financials, (i) the ability to make more meaningful period-to-period comparisons of our on-going operating results, (ii) the ability to better identify trends in our business and perform related trend analysis, and (iii) an easier way to compare our results of operations against investor and analyst financial models and valuations, which usually exclude these items. In addition, our definition of Adjusted Diluted Earnings per Share may differ from definitions used by other companies and therefore comparability may be limited. Therefore, when assessing the Company’s operating performance, investors should not consider this data in isolation, or as a substitute for the Company’s net income, operating income, earnings per share or any other operating performance measure that is calculated in accordance with U.S. GAAP.

 

Adjusted Diluted Earnings per Share (non U.S. GAAP measure) are determined as follows:

 

 

The following table sets forth consolidated statements of operations data for the periods indicated:

 

 

Net revenues

 

Our first half 2018 net revenues increased compared to the year‑ago period by 20.0% as a result of an approximate 3% increase in volume and an approximate 17% increase in average selling prices, the latter entirely due to a more favorable product mix.

 

Net revenues by product group

 

By product group, the first half of 2018 ADG revenues were up 15.3% mainly supported by average selling prices increase of about 16%, entirely due to product mix improvements, partially compensated by an approximate 1% decrease in volumes. AMS revenues increased 18.4%, due to an approximate 10% increase in volumes and an approximate 8% increase in average selling prices, the latter entirely driven by improved product mix, partially offset by pure pricing effect. MDG revenues increased 27.2% compared to the prior period on a strong growth in general purpose microcontrollers. MDG experienced an approximate increase of 7% in volumes and about 20% in average selling prices.

 

Net Revenues by Market Channel ⁽¹⁾

 

____________

 

(1)	Original Equipment Manufacturers (“OEM”) are the end-customers to which we provide direct marketing application engineering support, while Distribution customers refers to the distributors and representatives that we engage to distribute our products around the world.

 

By market channel, Distribution reached 38% share of total revenues in the first half of 2018, compared to approximately 34% in the first half of 2017.

 

Net Revenues by Location of Shipment ⁽¹⁾

 

____________

(1)

Net revenues by location of shipment are classified by location of customer invoiced or reclassified by shipment destination in line with customer demand. For example, products ordered by U.S.‑based companies to be invoiced to Asia Pacific affiliates are classified as Asia Pacific revenues. Furthermore, the comparison among the different periods may be affected by shifts in shipment from one location to another, as requested by our customers.

 

By location of shipment, all three regions registered revenue growth.

 

Gross profit

 

Gross margin was 40.0% for the first half of 2018, increasing by approximately 200 basis points compared to the year‑ago period mainly due to improved manufacturing efficiencies, a more favorable product mix, partially offset by normal price pressure and unfavorable currency effects, net of hedging. Unused capacity charges were immaterial in both periods.

 

Operating expenses

 

Our operating expenses increased compared to the year-ago period, negatively impacted by unfavorable currency effects, net of hedging, salary dynamics, R&D programs discretionary expenses, higher costs of the share based compensation plans and one-time costs related to a loss in one jurisdiction and post-employment benefits associated with several of our former executives.

 

Total R&D expenses were net of research tax credits, which amounted to $64 million in the first half of 2018 and $53 million in the first half of 2017.

 

Other income and expenses, net

 

In the first half of 2018, we recognized net other income of $26 million, decreasing compared to $32 million in the first half of 2017. The decrease is mainly due to lower income from R&D funding, following the substantial completion of the Nano 2017 program in the first quarter of 2018.

 

Impairment, restructuring charges and other related closure costs

 

In the first half of 2018, we recorded $20 million of impairment, restructuring charges and other related closure costs, entirely related to the now completed set-top box plan.

 

In the first half of 2017, we recorded $11 million of impairment, restructuring charges and other related closure costs, consisting of: (i) $11 million of net restructuring charges related to the set-top box plan; (ii) $5 million of restructuring charges related to the restructuring plan in Bouskoura, Morocco; and (iii) $5 million reversal on provisions related to previously announced restructuring plans, mainly the EPS restructuring plan, for which accrued provisions were not fully used at completion of the plan.

 

Operating income

 

Operating income in the first half of 2018 improved significantly compared to the prior period by $245 million to $558 million.

 

Operating income by product group⁽¹⁾

 

____________

(1)

Certain amounts in the prior periods have been adjusted to reflect the January 1, 2018 adoption of ASU 2017-07 related to the reclassification of certain pension costs.

(2)

Operating results of “Others” include items such as unused capacity charges, impairment & restructuring charges and other related closure costs, management reorganization expenses, phase out and start-up costs, and other unallocated expenses such as strategic or special research and development programs, certain corporate-level operating expenses, patent claims and litigations, and other costs that are not allocated to product groups, as well as assembly services and other revenue.

 

ADG’s operating income improved by $70 million, resulting in an operating margin of 10.3% for the 2018 first half, with both Automotive and Power Discrete contributing. AMS’s operating margin increased from 8.5% to 10.2% compared to the year-ago period, mainly due to MEMS and Analog, while Imaging registered a weaker operating performance. MDG’s operating income sharply increased to $305 million, mainly driven by Microcontrollers and – to a lesser extent – improved results in Digital.

 

Reconciliation to consolidated operating income (loss)

 

(1)

Includes unallocated income and expenses such as certain corporate-level operating expenses and other costs/income that are not allocated to the product segments.

 

 

Interest expense, net

 

In the first half of 2018, net interest expense on our borrowings and banking fees was $5 million, comprised of $26 million interest expense, mainly non-cash, related to the senior unsecured convertible bonds issued on July 3, 2017, partially balanced by $21 million of interest income. In the first half of 2017, interest expense on our borrowings and banking fees was $20 million, of which $12 million was interest expense, mainly non-cash, related to the senior unsecured convertible bonds issued on July 3, 2014, partially balanced by $11 million of interest income.

 

Income (loss) on equity-method investments

 

 

 

In the second half of 2017, we recorded a $2 million loss on our equity investment in Incard do Brazil (IdB).

 

Income tax expense

 

During the first half of 2018, we registered an income tax expense of $44 million, reflecting an estimated annual tax rate. Our income tax also included the estimated impact of provisions related to potential tax positions which have been considered uncertain.

 

In the first half of 2017, we registered an income tax expense of $34 million.

Our tax rate is variable and depends on changes in the level of operating results within various local jurisdictions and on changes in the applicable taxation rates of these jurisdictions, as well as changes in estimations of our tax provisions. Our income tax amounts and rates also depend on our loss carry-forwards and their relevant valuation allowances, which are based on estimated projected plans and available tax planning strategies. In the case of material changes in these plans, the valuation allowances could be adjusted accordingly with an impact on our tax charges. We currently enjoy certain tax benefits in some countries. Such benefits may not be available in the future due to changes in the local jurisdictions; our estimated tax rate could be different in future quarters and may increase in the coming years. In addition, our yearly income tax charges include the estimated impact of provisions related to potential tax positions which have been considered uncertain.

 

Net income attributable to parent company

 

For the first half of 2018, we reported net income of $500 million, representing diluted earnings per share of $0.55, compared to a net income of $258 million, representing diluted earnings per share of $0.28.

 

We also present Adjusted Diluted Earnings per Share, which is a non U.S. GAAP measure. Adjusted Diluted Earnings per Share is used to help management and investors understand our operations and to highlight the impact of excluded items like impairment, restructuring charges and other related closure costs and other one-time items, net of the estimated relevant tax impact. We believe Adjusted Diluted Earnings per Share provides useful information for management and investors because they measure our capacity to generate profits from our business operations, excluding the expenses related to the rationalizing of our activities and sites that we do not consider to be part of our on-going operating results, thereby offering, when read in conjunction with our U.S. GAAP financials, (i) the ability to make more meaningful period-to-period comparisons of our on-going operating results, (ii) the ability to better identify trends in our business and perform related trend analysis, and (iii) an easier way to compare our results of operations against investor and analyst financial models and valuations, which usually exclude these items. In addition, our definition of Adjusted Diluted Earnings per Share may differ from definitions used by other companies and therefore comparability may be limited. Therefore, when assessing the Company’s operating performance, investors should not consider this data in isolation, or as a substitute for the Company’s net income, operating income, earnings per share or any other operating performance measure that is calculated in accordance with U.S. GAAP.

 

Adjusted Diluted Earnings per Share (non U.S. GAAP measure) are determined as follows:

 

 

Legal Proceedings

 

For a discussion of legal proceedings, see Note 25 Contingencies, Claims and Legal Proceedings to our Interim Consolidated Financial Statements.

 

Impact of Changes in Exchange Rates

 

Our results of operations and financial condition can be significantly affected by material changes in the exchange rates between the U.S. dollar and other currencies, particularly the Euro.

 

As a market practice, the reference currency for the semiconductor industry is the U.S. dollar and the market prices of semiconductor products are mainly denominated in U.S. dollars. However, revenues for some of our products (primarily certain of our products sold in Europe) are quoted in currencies other than the U.S. dollar and as such are directly affected by fluctuations in the value of the U.S. dollar. As a result of currency variations, the appreciation of the Euro compared to the U.S. dollar could increase our level of revenues when reported in U.S. dollars or the depreciation of the Euro compared to the U.S. dollar could decrease our level of revenues when reported in U.S. dollars. Over time and depending on market conditions, the prices in the industry could align to the equivalent amount in U.S. dollars, except that there is a lag between the changes in the currency rate and the adjustment in the price paid in local currency, which is proportional to the amplitude of the currency swing, and such adjustment could be only partial and/or delayed, depending on market demand. Furthermore, certain significant costs incurred by us, such as manufacturing costs, SG&A expenses, and R&D expenses, are largely incurred in the currency of the jurisdictions in which our operations are located. Given that most of our operations are located in the Euro zone and other non-U.S. dollar currency areas, including Singapore, our costs tend to increase when translated into U.S. dollars when the dollar weakens or to decrease when the U.S. dollar strengthens.

 

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 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. Moreover, in order to further reduce the exposure to U.S. dollar exchange fluctuations, we have hedged certain line items on our Interim Consolidated Statements of Income, in particular with respect to a portion of the costs of sales, most of the R&D expenses and certain SG&A expenses, located in the Euro zone, which we account for as cash flow hedging contracts. We use two different types of hedging contracts: forward and options (including collars).

 

Our Interim Consolidated Statements of Income for the six months ended June 30, 2018 included income and expense items translated at the average U.S. dollar exchange rate for the period, plus the impact of the hedging contracts expiring during the period. Our effective exchange rate was $1.19 for €1.00 in the second quarter of 2018 compared to $1.18 for €1.00 in the first quarter of 2018 and $1.09 for €1.00 in the second quarter of 2017. These effective exchange rates reflect the actual exchange rates combined with the impact of cash flow hedging contracts that matured in the period.

 

The time horizon of our cash flow hedging for manufacturing costs and operating expenses may run up to 24 months, for a limited percentage of our exposure to the Euro, depending on currency market circumstances. As of June 30, 2018, the outstanding hedged amounts were €803 million to cover manufacturing costs and €512 million to cover operating expenses, both at an average exchange rate of about $1.24 for €1.00 (considering the collars at upper strike), maturing over the period from July 3, 2018 to November 26, 2019. As of June 30, 2018, measured with respect to the exchange rate at period closing of about $1.17 to €1.00, these outstanding hedging contracts and certain expiring contracts covering manufacturing expenses capitalized in inventory resulted in a deferred loss before tax of approximately $47 million, recorded in “Accumulated other comprehensive income (loss)” in the Consolidated Statements of Equity, compared to a deferred profit before tax of approximately $43 million at December 31, 2017.

 

We also hedge certain manufacturing costs denominated in Singapore dollars (SGD); as of June 30, 2018, the outstanding hedged amounts were SGD 139 million at an average exchange rate of about SGD 1.33 to $1.00 maturing over the period from August 5, 2018 to May 30, 2019. As of June 30, 2018, these outstanding hedging contracts and certain expiring contracts covering manufacturing expenses capitalized in inventory resulted in a deferred loss before tax of approximately $2 million, recorded in “Accumulated other comprehensive income (loss)” in the Consolidated Statements of Equity, compared to a deferred profit before tax of approximately $2 million before tax at December 31, 2017.

 

Our cash flow hedging policy is not intended to cover our full exposure and is based on hedging a declining portion of our exposure in the next four quarters. In the second quarter of 2018, as a result of our cash flow hedging, we recorded a net gain of $11 million consisting of a gain of about $10 million to costs of goods sold and $1 million to research and development expenses, while in the comparable quarter in 2017, we recorded a net loss of $3 million.

 

In addition to our cash flow hedging, in order to mitigate potential exchange rate risks on our commercial transactions, we purchase and enter into forward foreign currency exchange contracts and currency options to cover foreign currency exposure in payables or receivables at our affiliates, which we account for as fair value instruments. We may in the future purchase or sell similar types of instruments. See “Item 11. Quantitative and Qualitative Disclosures About Market Risk” in our Form 20-F. Furthermore, we may not predict in a timely fashion the amount of future transactions in the volatile industry environment. No assurance may be given that our hedging activities will sufficiently protect us against declines in the value of the U.S. dollar. Consequently, our results of operations have been and may continue to be impacted by fluctuations in exchange rates. The net effect of our consolidated foreign exchange exposure resulted in a net gain of $1 million recorded in “Other income and expenses, net” in our Interim Consolidated Statements of Income for the second quarter of 2018.

 

The assets and liabilities of subsidiaries are, for consolidation purposes, translated into U.S. dollars at the period-end exchange rate. Income and expenses, as well as cash flows, are translated at the average exchange rate for the period. The balance sheet impact, as well as the income statement and cash flow impact, of such translations have been, and may be expected to be, significant from period to period since a large part of our assets and liabilities and activities are accounted for in Euros as they are located in jurisdictions where the Euro is the functional currency. Adjustments resulting from the translation are recorded directly in equity, and are shown as “Accumulated other comprehensive income (loss)” in the Consolidated Statements of Equity. At June 30, 2018, our outstanding indebtedness was denominated mainly in U.S. dollars and in Euros.

 

For a more detailed discussion, see Item 3. “Key Information — Risk Factors — Risks Related to Our Operations” in our Form 20‑F, which may be updated from time to time in our public filings.

 

Impact of Changes in Interest Rates

 

Interest rates may fluctuate upon changes in financial market conditions and material changes can affect our results of operations and financial condition, since these changes can impact the total interest income received on our cash and cash equivalents and marketable securities, as well as the total interest expense paid on our financial debt.

 

Our interest income (expense), net, as reported in our Interim Consolidated Statements of Income, is the balance between interest income received from our cash and cash equivalents and marketable securities investments and interest expense paid on our financial liabilities, non-cash interest expense on the senior unsecured convertible bonds and bank fees (including fees on committed credit lines). Our interest income is dependent upon fluctuations in interest rates, mainly in U.S. dollars and Euros, since we invest primarily on a short-term basis; any increase or decrease in the market interest rates would mean a proportional increase or decrease in our interest income. Our interest expenses are also dependent upon fluctuations in interest rates, since our financial liabilities include European Investment Bank Floating Rate Loans at Libor and Euribor plus variable spreads.

 

At June 30, 2018, our total financial resources, including cash and cash equivalents and marketable securities generated an average interest income annual rate of 2.20%. At the same date, the average interest annual rate on our outstanding debt was 2.93% including the non-cash effective interest of the convertible bonds, while the average cash interest annual rate was only 0.61%.

Impact of Changes in Equity Prices

 

As of June 30, 2018, we did not hold any significant equity participations, which could be subject to a material impact in changes in equity prices. However, we hold equity participations whose carrying value could be reduced due to further losses or impairment charges of our equity-method investments. See Note 19 to our Consolidated Financial Statements.

 

Liquidity and Capital Resources

 

Treasury activities are regulated by our policies, which define procedures, objectives and controls. Our policies focus on the management of our financial risk in terms of exposure to currency rates and interest rates. 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 Euros and are placed with financial institutions rated at least a single A long-term rating, meaning at least A3 from Moody’s Investors Service (“Moody’s”) and A- from Standard & Poor’s (“S&P”) or Fitch Ratings (“Fitch”). Marginal amounts are held in other currencies. See “Item 11. Quantitative and Qualitative Disclosures About Market Risk” in our Form 20-F, which may be updated from time to time in our public filings.

 

Cash flow

 

We maintain a significant cash position and a low debt-to-equity ratio, which provide us with adequate financial flexibility. As in the past, our cash management policy is to finance our investment needs mainly with net cash generated from operating activities.

 

During the first half of 2018, our net cash decreased by $76 million, due to the net cash used in financing and investing activities exceeding the net cash from operating activities.

 

The components of our cash flow for the comparable periods are set forth below:

 

Net cash from operating activities. Net cash from operating activities is the sum of (i) net income (loss) adjusted for non-cash items and (ii) changes in net working capital. The net cash from operating activities for the first half of 2018 was $816 million, increasing compared to $657 million in the prior-year period mainly due to higher net income.

 

Net cash used in investing activities. Investing activities used $776 million of cash in the first half of 2018, increasing compared to $544 million in the prior-year period. Payments for purchase of tangible assets, net of proceeds, totaled $741 million, compared to $526 million registered in the prior-year period.

 

Net cash used in financing activities. Net cash used in financing activities was $114 million for the first half of 2018, compared to $106 million used for the first half of 2017 and consisted mainly of dividends paid to stockholders.

 

Free Cash Flow (non U.S. GAAP measure)

 

We also present Free Cash Flow, which is a non U.S. GAAP measure, defined as (i) net cash from operating activities plus (ii) net cash used in investing activities, excluding payment for purchases (and proceeds from the sale) of marketable securities, investment in short-term deposits and restricted cash. The result of this definition is ultimately net cash from operating activities plus payment for purchase and proceeds from sale of tangible, intangible and financial assets, proceeds received in the sale of businesses and cash paid for business acquisitions. We believe Free Cash Flow, a non U.S. GAAP measure, provides useful information for investors and management because it measures our capacity to generate cash from our operating and investing activities to sustain our operations. Free 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. Free Cash Flow reconciles with the total cash flow and the net cash increase (decrease) by including the payment for purchases (and proceeds from the sale) of marketable securities, the net cash from (used in) financing activities and the effect of changes in exchange rates. In addition, our definition of Free Cash Flow may differ from definitions used by other companies. Free Cash Flow is determined as follows from our Consolidated Statements of Cash Flows:

 

 

(1)

Reflects the total of the following line items reconciled with our Consolidated Statements of Cash Flows relating to the investing activities: Payment for purchase of tangible assets, Proceeds from sale of tangible assets, Payment for purchase of intangible assets, Payment for purchase of financial assets, Proceeds from sale of financial assets, Proceeds received in sale of businesses, payment for business acquisition, net of cash and cash equivalents acquired.

 

Free Cash Flow decreased in the first half of 2018 compared to the year-ago period, notwithstanding higher cash from operating activities, due to higher cash used in investing activities.

 

Net Financial Position (non U.S. GAAP measure)

 

Our Net Financial Position represents the difference between our total financial resources and our total financial debt. Our total financial resources include cash and cash equivalents, marketable securities and short-term deposits, and our total financial debt includes short-term debt, including bank overdrafts, and long-term debt, as represented in our Consolidated Balance Sheets. Net Financial Position is not a U.S. GAAP measure but we believe it provides useful information for investors and management 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 and cash equivalents and marketable securities and the total level of our financial indebtedness. In addition, our definition of Net Financial Position may differ from definitions used by other companies and therefore comparability may be limited. Our Net Financial Position for each period has been determined as follows from our Consolidated Balance Sheets:

 

Our Net Financial Position as of June 30, 2018 was a net cash position of $411 million, decreasing compared to $489 million at December 31, 2017.

 

Cash and cash equivalents amounted to $1,683 million as at June 30, 2018.

 

Marketable securities amounted to $429 million as at June 30, 2018, and consisted of U.S. Treasury Bills and U.S. Treasury Bonds available for sale.

 

Financial debt was $1,716 million as at June 30, 2018, composed of: (i) $118 million of current portion of long-term debt and (ii) $1,598 million long‑term debt. The breakdown of our total financial debt included: (i) $399 million in European Investment Bank (“EIB”) loans, (ii) $1,297 million in the senior unsecured convertible bonds, and (iii) $20 million in other long-term loans and loans from other funding programs.

 

The EIB Loans are comprised of two long-term amortizing credit facilities as part of our R&D funding programs. The first, signed in 2010, is a €350 million multi-currency loan to support our industrial and R&D programs. It was drawn mainly in U.S. dollars for an amount of $321 million and only partially in Euros for an amount of €100 million, of which $164 million remained outstanding as of June 30, 2018. The second, signed in 2013, is a €350 million multi-currency loan which also supports our R&D programs. It was drawn in U.S. dollars for an amount of $471 million, of which $235 million is outstanding as of June 30, 2018.

 

In August 2017, we signed a new medium term credit facility with the EIB for a total aggregate amount of €500 million in relation to R&D and capital expenditure investments in the European Union for the years 2017 and 2018. The medium term line is available for drawings in Euro and in U.S. dollars until the first quarter of 2019 and has terms and conditions determined at drawdown. As of June 30, 2018, no amount was drawn as part of this new credit facility.

 

On July 3, 2017, we issued a $1.5 billion offering of senior unsecured bonds convertible into new or existing ordinary shares of ST, for net proceeds of $1,502 million. The bonds were issued in two $750 million principal amount tranches, one with a maturity of 5 years (37.5% conversion premium, negative 0.25% yield to maturity, 0% coupon) and the other 7 years (37.5% conversion premium, 0.25% yield to maturity, 0.25% coupon). The conversion price at issuance was $20.54 on each tranche. The senior unsecured convertible bonds are convertible by the bondholders or callable by us, following a given time schedule, if certain conditions are satisfied. Under the terms of the bonds, we can satisfy the conversion rights either in cash or shares, or a combination of the two, at our selection. Assuming the exercise of the Issuer Soft Call at 130% of the Conversion Price after the initial lock-up period, the underlying shares under net shares settlement will be 16.9 million. Net proceeds from the issuance of the bonds of $1,502 million were used for general corporate purposes, including the early redemption of the outstanding $1 billion convertible bonds due 2019 and 2021, completed in the second half of 2017. Upon initial recognition, the proceeds were allocated between debt and equity by determining the fair value of the liability component using an income approach.

 

Our long-term debt contains standard conditions, but does not impose minimum financial ratios.

 

Our current ratings with the three major rating agencies that report on us on a solicited basis, are as follows: S&P: “BBB-” with positive outlook; Fitch: “BBB-” with positive outlook and Moody’s: “Baa3” with stable outlook.

 

As of June 30, 2018, debt payments at redemption value by period were as follows:

 

 

Financial Outlook: Capital Investment

 

Our policy is to modulate our capital spending according to the evolution of the semiconductor market. Based on demand evolution and the healthy backlog for the second part of the year supporting our expectations of net revenues growth of about 14% - 17% in 2018 compared to 2017, we anticipate a capital spending range of approximately $1.2 - $1.3 billion for 2018. Specifically, the Company is investing in 300mm front-end manufacturing and in back-end assembly and test to support technology and product mix flexibility and new products ramp up. The most important of our 2018 capital expenditure projects are expected to be for our front-end facilities: (i) in our 300 mm fab in Crolles (France), to support mix flexibility on our main high runner technologies; (ii) mix evolution, and a few selected programs of capacity growth and infrastructure preparation, mainly in the area of mixed signal and discrete processes; (iii) qualification and ramp-up of technologies in 200 mm in Singapore, Agrate (Italy), as well as the expansion of facilities and the increase of capacity in our 200 mm fabs in Catania (Italy) and Singapore; and (iv) in Agrate (Italy) ground breaking of a 300 mm pilot line supporting the next generation of mixed signal products. The most important 2018 capital investments for our back-end facilities are expected to be: (i) capacity growth on certain package families, including the silicon carbide (SiC) technology, to sustain market demand; (ii) modernization and rationalization of package lines targeting cost savings benefits; and (iii) specific investments in the areas of factory automation, quality, environment and energy savings. In addition, we will invest in overall capacity adjustment in final testing and wafers probing (EWS) to meet increased demand and a changed product mix as well as invest in quality, safety, maintenance, productivity and cost savings in both 150 mm and 200 mm front-end fabs, and back-end plants. To accelerate increased capacity in 200 mm in Singapore, we are pursuing the progressive integration of the former Numonyx fab for which we signed a deferred acquisition from Micron in 2017.

We will continue to invest to support revenues growth and new products introduction, taking into consideration factors such as trends in the semiconductor industry and capacity utilization. We expect to need significant financial resources in the coming years for capital expenditures and for our investments in manufacturing and R&D. We plan to fund our capital requirements from cash provided by operating activities, available funds and support from third parties, and may have recourse to borrowings under available credit lines and, to the extent necessary or attractive based on market conditions prevailing at the time, the issuance of debt, convertible bonds or additional equity securities. A substantial deterioration of our economic results, and consequently of our profitability, could generate a deterioration of the cash generated by our operating activities. Therefore, there can be no assurance that, in future periods, we will generate the same level of cash as in prior years to fund our capital expenditure plans for expanding/upgrading our production facilities, our working capital requirements, our R&D and manufacturing costs.

 

In support of our R&D activities, we signed the Nano2017 program with the French government, which was approved by the European Union in the second quarter of 2014 and, in our role as Coordinator and Project Leader of Nano2017, we were allocated an overall funding budget of about €400 million for the period 2013-2017, subject to the conclusion of agreements every year with the public authorities and linked to the achievement of technical parameters and objectives. The Nano2017 contract contains certain covenants which, in the event they are not fulfilled, may affect our ability to access such funding. Additionally, a portion of Nano2017 program is subject to a payback clause (“financial return”), depending on the future cumulative sales for certain products within the scope of the funded program on the period from 2018 to 2023. The financial return corresponds to the payment in 2024 of the original funded amount (€37 million) multiplied by a rate from 0% to 250%, depending on the cumulative amount of future sales. Based on current visibility, we estimate the return rate to reach 108% resulting in a contingent liability of $43 million as of June 30, 2018.

 

As a result of our exit from the ST-Ericsson joint venture, our exposure is limited to covering 50% of ST-Ericsson’s needs to complete the wind-down, which are estimated to be negligible, based on our current visibility of the ST-Ericsson liquidation balance.

 

We believe that we have the financial resources needed to meet our currently projected business requirements for the next twelve months, including capital expenditures for our manufacturing activities, working capital requirements, approved dividend payments and the repayment of our debts in line with their maturity dates.

 

Contractual Obligations, Commercial Commitments and Contingencies

 

Our contractual obligations, commercial commitments and contingencies are mainly comprised of: operating leases for land, buildings, plants and equipment, long term purchase commitments for material, equipment and software license, agreement to purchase the Singapore fab from Micron technologies, take or pay type of agreements to outsource wafers from foundries, commercial agreements with customers, long term debt obligations, pension obligations and other long term liabilities.

 

Off‑Balance Sheet Arrangements

 

We had no material off‑balance sheet arrangements at June 30, 2018.

 

Impact of Recently Issued U.S. Accounting Standards

 

See Note 5 Recent Accounting Announcements to our Consolidated Financial Statements.

 

Backlog and Customers

 

During the second quarter of 2018, our booking plus net frames orders increased compared to the first quarter of 2018. We entered the third quarter 2018 with a backlog higher than the level we had when entering in the second quarter 2018. Backlog (including frame orders) is subject to possible cancellation, push back and lower ratio of frame orders being translated into firm orders and, thus, it is not necessarily indicative of the amount of billings or growth to be registered in subsequent periods.

 

There is no guarantee that any customer will continue to generate revenues for us at the same levels as in prior periods. If we were to lose one or more of our key customers, or if they were to significantly reduce their bookings, not confirm planned delivery dates on frame orders in a significant manner or fail to meet their payment obligations, our operating results and financial condition could be adversely affected.

 

Disclosure Controls and Procedures

 

Evaluation

 

Our management, including the CEO and CFO, performed an evaluation of the effectiveness of the design and operation of our disclosure controls and procedures as defined in Rules 13a-15(e) and 15d-15(e) under the Securities and Exchange Act of 1934 (“Disclosure Controls”) as of the end of the period covered by this report. Disclosure Controls are controls and procedures designed to reasonably assure that information required to be disclosed in our reports filed under the Securities and Exchange Act of 1934, such as this periodic report, is recorded, processed, summarized and reported within the time periods specified in the SEC’s rules and forms. Disclosure Controls are also designed to reasonably assure that such information is accumulated and communicated to our management, including the CEO and CFO, as appropriate to allow timely decisions regarding required disclosure. Our quarterly evaluation of Disclosure Controls includes an evaluation of some components of our internal control over financial reporting, and internal control over financial reporting is also separately evaluated on an annual basis.

 

The evaluation of our Disclosure Controls included a review of the controls’ objectives and design, our implementation of the controls and their effect on the information generated for use in this periodic report. In the course of the controls evaluation, we reviewed identified data errors, errors in process flow or delay in communication, control problems or acts of fraud and sought to confirm that appropriate corrective actions, including process improvements, were being undertaken. This type of evaluation is performed at least on a quarterly basis so that the conclusions of management, including the CEO and CFO, concerning the effectiveness of the Disclosure Controls can be reported in our periodic reports on Form 6‑K and Form 20‑F. The components of our Disclosure Controls are also evaluated on an ongoing basis by our Internal Audit Department, which reports directly to our Audit Committee. The overall goals of these various evaluation activities are to monitor our Disclosure Controls, and to modify them as necessary. Our intent is to maintain the Disclosure Controls as dynamic systems that change as conditions warrant.

 

Based upon the controls evaluation, our CEO and CFO have concluded that, as of the end of the period covered by this periodic report, our Disclosure Controls were effective.

 

Changes in Internal Control over Financial Reporting

 

There were no changes to our internal control over financial reporting that occurred during the period covered by this report that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.

 

Limitations on Effectiveness of Controls

 

No system of internal control over financial reporting, including one determined to be effective, may prevent or detect all misstatements. It can provide only reasonable assurance regarding financial statement preparation and presentation. Also, projections of the results of any evaluation of the effectiveness of internal control over financial reporting into future periods are subject to inherent risk that the relevant controls may become inadequate due to changes in circumstances or that the degree of compliance with the underlying policies or procedures may deteriorate.

 

Other Reviews

 

We have sent this report to our Audit Committee, which had an opportunity to raise questions with our management and independent auditors before we submitted it to the Securities and Exchange Commission.

 

Cautionary Note Regarding Forward‑Looking Statements

 

Some of the statements contained in this Form 6-K that are not historical facts, particularly in “Business Overview” and in “Liquidity and Capital Resources—Financial Outlook: Capital Investment”, 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 management’s current views and assumptions, and are conditioned upon and also involve known and unknown risks and uncertainties that could cause actual results, performance or events to differ materially from those anticipated by such statements due to, among other factors:

 

·

Uncertain macro-economic and industry trends, which may impact end-market demand for our products;

 

·

Customer demand that differs from projections;

 

·

The ability to design, manufacture and sell innovative products in a rapidly changing technological environment;

 

·

Changes in economic, social, labor, political, or infrastructure conditions in the locations where we, our customers, or our suppliers operate, including as a result of macro-economic or regional events, military conflicts, social unrest, labor actions, or terrorist activities;

 

·

Changes in global trade policies, including the adoption and expansion of tariffs and trade barriers, that could affect the macro-economic environment and adversely impact the demand for our products;

 

·

The Brexit vote and the perceptions as to the impact of the withdrawal of the U.K. may adversely affect business activity, political stability and economic conditions in the U.K., the Eurozone, the EU and elsewhere. While we do not have material operations in the U.K. and have not experienced any material impact from Brexit on our underlying business to date, we cannot predict its future implications;

 

·

Financial difficulties with any of our major distributors or significant curtailment of purchases by key customers;

 

·

The loading, product mix, and manufacturing performance of our production facilities;

 

·

The functionalities and performance of our IT systems, which support our critical operational activities including manufacturing, finance and sales, and any breaches of our IT systems or those of our customers or suppliers;

 

·

Variations in the foreign exchange markets and, more particularly, the U.S. dollar exchange rate as compared to the Euro and the other major currencies we use for our operations;

 

·

The impact of intellectual property (“IP”) claims by our competitors or other third parties, and our ability to obtain required licenses on reasonable terms and conditions;

 

·

Changes in our overall tax position as a result of changes in tax rules, new or revised legislation, the outcome of tax audits or changes in international tax treaties which may impact our results of operations as well as our ability to accurately estimate tax credits, benefits, deductions and provisions and to realize deferred tax assets;

 

·

The outcome of ongoing litigation as well as the impact of any new litigation to which we may become a defendant;

 

·

Product liability or warranty claims, claims based on epidemic or delivery failure, or other claims relating to our products, or recalls by our customers for products containing our parts;

 

·

Natural events such as severe weather, earthquakes, tsunamis, volcano eruptions or other acts of nature, health risks and epidemics in locations where we, our customers or our suppliers operate;

 

·

Availability and costs of raw materials, utilities, third-party manufacturing services and technology, or other supplies required by our operations;

 

·

Industry changes resulting from vertical and horizontal consolidation among our suppliers, competitors, and customers;

 

·

The ability to successfully ramp up new programs that could be impacted by factors beyond our control, including the availability of critical third party components and performance of subcontractors in line with our expectations; and

 

·

Theft, loss, or misuse of personal data about our employees, customers, or other third parties, and breaches of global privacy legislation, including the EU’s General Data Protection Regulation (“GDPR”).

 

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 forward-looking statements can be identified by the use of forward-looking terminology, such as “believes”, “expects”, “may”, “are expected to”, “should”, “would be”, “seeks” 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 Information — Risk Factors” in our Form 20-F. 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 our 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 6-K to reflect subsequent events or circumstances.

 

Unfavorable changes in the above or other factors listed under “Item 3. Key Information — Risk Factors” from time to time in our SEC filings, could have a material adverse effect on our business and/or financial condition.

 

STMICROELECTRONICS N.V.

 

UNAUDITED INTERIM CONSOLIDATED FINANCIAL STATEMENTS

 

 

 

 

STMicroelectronics N.V.
CONSOLIDATED STATEMENTS OF INCOME
		Six months ended
		(Unaudited)
		June 30,				July 01,
In million of U.S. dollars except per share amounts		2018				2017
Net sales			4,463				3,728
Other revenues			31				16
Net revenues			4,494				3,744
Cost of sales			(2,695	)			(2,320	)
Gross profit			1,799				1,424
Selling, general and administrative			(542	)			(473	)
Research and development			(705	)			(659	)
Other income and expenses, net			26				32
Impairment, restructuring charges and other related closure costs			(20	)			(11	)
Operating income			558				313
Interest expense, net			(5	)			(9	)
Other components of pension benefit costs			(5	)			(6	)
Income (loss) on equity-method investments			-				(2	)
Income before income taxes and noncontrolling interest			548				296
Income tax expense			(44	)			(34	)
Net income			504				262
Net income attributable to noncontrolling interest			(4	)			(4	)
Net income attributable to parent company			500				258
Earnings per share (Basic) attributable to parent company stockholders			0.56				0.29
Earnings per share (Diluted) attributable to parent company stockholders			0.55				0.28
The accompanying notes are an integral part of these unaudited interim consolidated financial statements

 

 

 

 

STMicroelectronics N.V.
CONSOLIDATED STATEMENTS OF INCOME
		Three months ended
		(Unaudited)
		June 30,				July 01,
In million of U.S. dollars except per share amounts		2018				2017
Net sales			2,250				1,911
Other revenues			19				12
Net revenues			2,269				1,923
Cost of sales			(1,358	)			(1,186	)
Gross profit			911				737
Selling, general and administrative			(277	)			(239	)
Research and development			(356	)			(326	)
Other income and expenses, net			11				15
Impairment, restructuring charges and other related closure costs			-				(6	)
Operating income			289				181
Interest expense, net			(2	)			(4	)
Other components of pension benefit costs			(3	)			(3	)
Income (loss) on equity-method investments			-				(2	)
Income before income taxes and noncontrolling interest			284				172
Income tax expense			(21	)			(19	)
Net income			263				153
Net income attributable to noncontrolling interest			(2	)			(2	)
Net income attributable to parent company			261				151
Earnings per share (Basic) attributable to parent company stockholders			0.29				0.17
Earnings per share (Diluted) attributable to parent company stockholders			0.29				0.17
The accompanying notes are an integral part of these unaudited interim consolidated financial statements

 

 

 

STMicroelectronics N.V.
CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME
		Six months ended
		(Unaudited)
		June 30,				July 01,
In million of U.S. dollars		2018				2017
Net income			504				262
Other comprehensive income (loss), net of tax :
Currency translation adjustments arising during the period			(56	)			136
Foreign currency translation adjustments			(56	)			136
Net unrealized gains (losses) arising during the period			(4	)			-
Net unrealized gains (losses) on securities			(4	)			-
Net unrealized gains (losses) arising during the period			(49	)			77
Less : reclassification adjustment for (income) losses included in net income			(45	)			20
Net unrealized gains (losses) on derivatives			(94	)			97
Net gains (losses) arising during the period			4				4
Defined benefit pension plans			4				4
Other comprehensive income (loss), net of tax			(150	)			237
Comprehensive income (loss)			354				499
Less : comprehensive income (loss) attributable to noncontrolling interest			4				4
Comprehensive income (loss) attributable to the company's stockholders			350				495
The accompanying notes are an integral part of these unaudited interim consolidated financial statements

 

 

 

STMicroelectronics N.V.
CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME
		Three months ended
		(Unaudited)
		June 30,				July 01,
In million of U.S. dollars		2018				2017
Net income			263				153
Other comprehensive income (loss), net of tax :
Currency translation adjustments arising during the period			(104	)			111
Foreign currency translation adjustments			(104	)			111
Net unrealized gains (losses) arising during the period			(1	)			-
Net unrealized gains (losses) on securities			(1	)			-
Net unrealized gains (losses) arising during the period			(72	)			63
Less : reclassification adjustment for (income) losses included in net income			(11	)			3
Net unrealized gains (losses) on derivatives			(83	)			66
Net gains (losses) arising during the period			2				2
Defined benefit pension plans			2				2
Other comprehensive income (loss), net of tax			(186	)			179
Comprehensive income (loss)			77				332
Less : comprehensive income (loss) attributable to noncontrolling interest			2				2
Comprehensive income (loss) attributable to the company's stockholders			75				330
The accompanying notes are an integral part of these unaudited interim consolidated financial statements